Roads to Prosperity
Greek Lessons for the World Economy
Dani Rodrik
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CAMBRIDGE – The $140 billion support package that the Greek government has finally received from its European Union partners and the International Monetary Fund gives it the breathing space needed to undertake the difficult job of putting its finances in order. The package may or may not prevent Spain and Portugal from becoming undone in a similar fashion, or indeed even head off an eventual Greek default. Whatever the outcome, it is clear that the Greek debacle has given the EU a black eye.
Deep down, the crisis is yet another manifestation of what I call “the political trilemma of the world economy”: economic globalization, political democracy, and the nation-state are mutually irreconcilable. We can have at most two at one time. Democracy is compatible with national sovereignty only if we restrict globalization. If we push for globalization while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalization, we must shove the nation-state aside and strive for greater international governance.
The history of the world economy shows the trilemma at work. The first era of globalization, which lasted until 1914, was a success as long as economic and monetary policies remained insulated from domestic political pressures. These policies could then be entirely subjugated to the demands of the gold standard and free capital mobility. But once the political franchise was enlarged, the working class got organized, and mass politics became the norm, domestic economic objectives began to compete with (and overwhelm) external rules and constraints.
The classic case is Britain’s short-lived return to gold in the interwar period. The attempt to reconstitute the pre-World War I model of globalization collapsed in 1931, when domestic politics forced the British government to choose domestic reflation over the gold standard.
The architects of the Bretton Woods regime kept this lesson in mind when they redesigned the world’s monetary system in 1944. They understood that democratic countries would need the space to conduct independent monetary and fiscal policies. So they contemplated only a “thin” globalization, with capital flows restricted largely to long-term lending and borrowing. John Maynard Keynes, who wrote the rules along with Harry Dexter White, viewed capital controls not as a temporary expedient but as a permanent feature of the global economy.
The Bretton Woods regime collapsed in the 1970’s as a result of the inability or unwillingness – it is not entirely clear which – of leading governments to manage the growing tide of capital flows.
The third path identified by the trilemma is to do away with national sovereignty altogether. In this case, economic integration can be married with democracy through political union among states. The loss in national sovereignty is then compensated by the “internationalization” of democratic politics. Think of this as a global version of federalism.
The United States, for example, created a unified national market once its federal government wrested sufficient political control from individual states. This was far from a smooth process, as the American Civil War amply demonstrates.
The EU’s difficulties stem from the fact that the global financial crisis caught Europe midway through a similar process. European leaders always understood that economic union needs to have a political leg to stand on. Even though some, such as the British, wished to give the Union as little power as possible, the force of the argument was with those who pressed for political integration alongside economic integration. Still, the European political project fell far short of the economic one.
Greece benefited from a common currency, unified capital markets, and free trade with other EU member states. But it does not have automatic access to a European lender of last resort. Its citizens do not receive unemployment checks from Brussels the way that, say, Californians do from Washington, DC, when California experiences a recession. Nor, given linguistic and cultural barriers, can unemployed Greeks move just as easily across the border to a more prosperous European state. And Greek banks and firms lose their creditworthiness alongside their government if markets perceive the latter to be insolvent.
The German and French governments, for their part, have had little say over Greece’s budget policies. They could not stop the Greek government from borrowing (indirectly) from the European Central Bank (ECB) as long as credit rating agencies deemed Greek debt creditworthy. If Greece chooses default, they cannot enforce their banks’ claims on Greek borrowers or seize Greek assets. Nor can they prevent Greece from leaving the eurozone.
What all this means is that the financial crisis has turned out to be a lot deeper and its resolution considerably messier than necessary. The French and German governments have grudgingly come up with a major loan package, but only after considerable delay and with the IMF standing at their side. The ECB has lowered the threshold of creditworthiness that Greek government securities must meet in order to allow continued Greek borrowing.
The success of the rescue is far from assured, in view of the magnitude of belt-tightening that it calls for and the hostility that it has aroused on the part of Greek workers. When push comes to shove, domestic politics trumps foreign creditors.
The crisis has revealed how demanding globalization’s political prerequisites are. It shows how much European institutions must still evolve to underpin a healthy single market. The choice that the EU faces is the same in other parts of the world: either integrate politically, or ease up on economic unification.
Before the crisis, Europe looked like the most likely candidate to make a successful transition to the first equilibrium – greater political unification. Now its economic project lies in tatters while the leadership needed to rekindle political integration is nowhere to be seen.
The best that can be said is that Europe will no longer be able to delay making the choice that the Greek affair has laid bare. If you are an optimist, you might even conclude that Europe will therefore ultimately emerge stronger.
Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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jorgechavez 03:04 13 May 10
Even if the EU is going through a though moment, the experience that they are having is way far more responsible in policy and political action than any other political or economical agreement.
The EU political body was part of the Greek problem by ignoring the huge size of public deficit that many developping countries in the Euro zone were gathering; even in France they run relaxed spending with no substancial change in taxes. Maybe they neglected all this fiscal deficits because they sought an opportunity to get all those countries in to level with the europeans leaders.
With the central banks and the ECB taking part in the solution and supporting Greek gouvernment, they have showed the most solide response in any modern political construction. The construction made by and with developped and developping countries. In North America, the NAFTA doesn't propose this kind of solution or political cooperation.
The great difference between this two sides of the Athlantic is the political construction and mechanisms of political dialogue.
econotarian 11:41 14 May 10
There have been sovereign debt crises as long as there have been sovereigns.
The only difference between sovereign debt crises and private debt crises is that private companies can't directly use the power of violence to take people's money through taxes or indirectly through debasement/inflation.
(Well, OK, it does appear that recently private companies have gained enough political power to get the sovereign to bail them out with taxes/inflation, but I still blame the sovereign).
cheeheongquah 10:44 19 May 10
In today's terms, there's no excuse that language and cultural barriers can impede growth and betterment of mankind.
The Greek crisis would help economies in EU to integrate further given their resistance to labor market assimilation and teach the people and the governemnts a lesson that there is no free lunch and whatever excessive non-market-oriented gains enjoyed would be repaid later.
The crisis would help people to be less nationalistic and hence to assimilate with people from other European states. If this could happen to the immigrant state of US, this can also happen to EU.
And live within your means, so to the governments!
cheeheongquah 10:45 19 May 10
In today's terms, there's no excuse that language and cultural barriers can impede growth and betterment of mankind.
The Greek crisis would help economies in EU to integrate further given their resistance to labor market assimilation and teach the people and the governemnts a lesson that there is no free lunch and whatever excessive non-market-oriented gains enjoyed would be repaid later.
The crisis would help people to be less nationalistic and hence to assimilate with people from other European states. If this could happen to the immigrant state of US, this can also happen to EU.
And live within your means, so to the governments!
Quah, Chee Heong
spz 05:41 04 Nov 10
@cheeheongquah
Quite the opposite, i think the Greek crisis would impede further EU integration. Whenever there is economic turmoil, people turn inwards behind the protection of the nation-state. The European project would be stalled unless it could solve the underlying contradiction: Economic and monetary union without a political union. Unless they move to become a federal Europe which at present is highly unpopular (constitutional treaty rejected by French and Dutch voters), the economic and monetary union would be in a quagmire.
djkruger 10:52 22 May 11
The situation in Greece has already had strong political implications within Europe and it must have financial implications as well, impacting the amount of European aid available for other countries. With the massive bailout ear-marked for Greece, budgets across Europe is already tightening. The financial crisis has highlighted the constraints of euro membership especially for Greece, Spain, Italy and Portugual. With E.U members unable to devalue their currencies to regain competitiveness, and forced fiscal agreements to control spending, Greece, Spain, Italy and Portugal are facing austerity measures just when their economies need extra spending. By increasing taxes and cutting social programs troubled E.U. countries risk further recession, which is likely to lead to further reduction in development aid.
pashley1411 07:18 01 Sep 11
Whether you think economies will further integrate I think depends on whether you think cultural trumps economics, or economics trumps culture. Leftists hold economics as a primary determinent of interests and, thus, should be a primary determinent of action. Rightists reverse this; culture first.
In which case, the Greeks would rather take an (economic) stick in the eye than change their business culture. Leaving the EU will allow for just that.
aussiereader4 11:08 12 May 10
The biggest issue is that Greece was not ready to act in a responsible fiscal manner by being truthful to its European colleagues. Ethics are an essential part of any political and economic union. That is the test.