An agenda to save the euro

By Joseph E. Stiglitz

The euro was supposed to bring growth, prosperity; instead, it has brought stagnation, instability, and divisiveness

It has been three years since the outbreak of the euro crisis, and only an inveterate optimist would say that the worst is definitely over. Some, noting that the eurozone’s double-dip recession has ended, conclude that the austerity medicine has worked. But try telling that to those in countries that are still in depression, with per capita GDP still below pre-2008 levels, unemployment rates above 20%, and youth unemployment at more than 50%.

At the current pace of “recovery,” no return to normality can be expected until well into the next decade.  A recent study by Federal Reserve economists concluded that America’s protracted high unemployment will have serious adverse effects on GDP growth for years to come. If that is true in the United States, where unemployment is 40% lower than in Europe, the prospects for European growth appear bleak indeed.

What is needed, above all, is fundamental reform in the structure of the eurozone. By now, there is a fairly clear understanding of what is required:

A real banking union, with common supervision, common deposit insurance, and common resolution; without this, money will continue to flow from the weakest countries to the strongest;

Some form of debt mutualisation, such as Eurobonds: with Europe’s debt/GDP ratio lower than that of the US, the eurozone could borrow at negative real interest rates, as the US does. The lower interest rates would free money to stimulate the economy, breaking the crisis-hit countries’ vicious circle whereby austerity increases the debt burden, making debt less sustainable, by shrinking GDP;

Industrial policies to enable the laggard countries to catch up; this implies revising current strictures, which bar such policies as unacceptable interventions in free markets;

A central bank that focuses not only on inflation, but also on growth, employment, and financial stability;

Replacing anti-growth austerity policies with pro-growth policies focusing on investments in people, technology, and infrastructure.

Much of the euro’s design reflects the neoliberal economic doctrines that prevailed when the single currency was conceived. It was thought that keeping inflation low was necessary and almost sufficient for growth and stability; that making central banks independent was the only way to ensure confidence in the monetary system; that low debt and deficits would ensure economic convergence among member countries; and that a single market, with money and people flowing freely, would ensure efficiency and stability.

Each of these doctrines has proved to be wrong. The independent U.S. and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility.

Likewise, Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. The crisis caused the deficits and high debt, not the other way around, and the fiscal constraints that Europe has agreed will neither facilitate rapid recovery from this crisis nor prevent the next one.

Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialised), has been hollowing out the weaker economies. It can also result in a misallocation of labour.

Internal devaluation – lowering domestic wages and prices – is no substitute for exchange-rate flexibility. Indeed, there is increasing worry about deflation, which increases leverage and the burden of debt levels that are already too high. If internal devaluation were a good substitute, the gold standard would not have been a problem in the Great Depression, and Argentina could have managed to keep the peso’s peg to the dollar when its debt crisis erupted a decade ago.

No country has ever restored prosperity through austerity. Historically, a few small countries were lucky to have exports fill the gap in aggregate demand as public expenditure contracted, enabling them to avoid austerity’s depressing effects. But European exports have barely increased since 2008 (despite the decline in wages in some countries, most notably Greece and Italy). With global growth so tepid, exports will not restore Europe and America to prosperity any time soon.

Germany and some of the other northern European countries, demonstrating an unseemly lack of European solidarity, have declared that they should not be asked to pick up the bill for their profligate southern neighbors.

This is wrong on several counts. For starters, lower interest rates that follow from Eurobonds or some similar mechanism would make the debt burden manageable. The US, it should be recalled, emerged from World War II with a very high debt burden, but the ensuing years marked the country’s most rapid growth ever.

If the eurozone adopts the program outlined above, there should be no need for Germany to pick up any tab. But under the perverse policies that Europe has adopted, one debt restructuring has been followed by another. If Germany and the other northern European countries continue to insist on pursuing current policies, they, together with their southern neighbors, will wind up paying a high price.

The euro was supposed to bring growth, prosperity, and a sense of unity to Europe. Instead, it has brought stagnation, instability, and divisiveness.

It does not have to be this way. The euro can be saved, but it will take more than fine speeches asserting a commitment to Europe. If Germany and others are not willing to do what it takes – if there is not enough solidarity to make the politics work – then the euro may have to be abandoned for the sake of salvaging the European project.

Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University.