Unconventional Economic Wisdom
What Can Save the Euro?
Joseph E. Stiglitz
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NEW YORK – Just when it seemed that things couldn’t get worse, it appears that they have. Even some of the ostensibly “responsible” members of the eurozone are facing higher interest rates. Economists on both sides of the Atlantic are now discussing not just whether the euro will survive, but how to ensure that its demise causes the least turmoil possible.
It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal discipline – no country’s fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozone’s member countries that must be kept in check.
In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between “good” current-account deficits – a government creates a favorable business climate, generating inflows of foreign direct investment – and “bad” current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.
In Spain, for example, money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows – say into real-estate investment, for example – are bad, and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EU’s free-market advocates.
The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate. The 1980’s Latin American crisis was caused by excessive borrowing; but that could not explain Mexico’s 1994 crisis, so it was attributed to under-saving.
Then came East Asia, which had high savings rates, so the new explanation was “governance.” But this, too, made little sense, given that the Scandinavian countries – which have the most transparent governance in the world – had suffered a crisis a few years earlier.
There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.
These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment – the interest rate and the exchange rate – and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition – a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.
Moreover, free labor mobility means that individuals can choose whether to pay their parents’ debts: young Irish can simply escape repaying the foolish bank-bailout obligations assumed by their government by leaving the country. Of course, migration is supposed to be good, as it reallocates labor to where its return is highest. But this kind of migration actually undermines productivity.
Migration is, of course, part of the adjustment mechanism that makes America work as a single market with a single currency. Even more important is the federal government’s role in helping states that face, say, high unemployment, by allocating additional tax revenue to them – the so-called “transfer union” so loathed by many Germans.
But the US is also willing to accept the depopulation of entire states that cannot compete. (Some point out that this means that America’s corporations can buy senators from such states at a lower price.) But are European countries with lagging productivity willing to accept depopulation? Alternatively, are they willing to face the pain of “internal” devaluation, a process that failed under the gold standard and is failing under the euro?
Even if those from Europe’s northern countries are right in claiming that the euro would work if effective discipline could be imposed on others (I think they are wrong), they are deluding themselves with a morality play. It is fine to blame their southern compatriots for fiscal profligacy, or, in the case of Spain and Ireland, for letting free markets have free reign, without seeing where that would lead. But that doesn’t address today’s problem: huge debts, whether a result of private or public miscalculations, must be managed within the euro framework.
Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this. They know that growth is needed. But, rather than deal with today’s problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won’t solve Europe’s problems – and it won’t save the euro.
Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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rebentisch 01:21 07 Dec 11
You may disagree with austerity measures but they seem the only way to get the economies back in line. No one actually speaks about what they should have done. One thing for sure, tighter rules. At present we find the drama of some nations as these measures are put in place. Things may get worse before they get better.
tcolgan001 07:01 07 Dec 11
Could it be that the common denominator is globalization? Globalization is what has allowed capital to slosh about the globe so freely. Any controls engineer knows that high gain systems tend to be unstable. The solution is damping. Implementing mechanisms to balance trade would provide the damping. But discussing such things is anathema among main-stream economists. Why?
vbierschwale 08:38 07 Dec 11
All that is necessary to turn this around is to understand what I'm showing you in this chart.
Don't trust my work?
Not a problem.
Produce a spreadsheet showing the GDP for this decade for all countries.
Before you graph it, total up all countries per year and then divide each countries GDP into the total to get each countries percentage of the pie.
Then chart this figure and you will see as I do that as America put more and more of its people out of work by sending their jobs offshore, America's portion of the GDP is getting smaller and smaller as is every country except for China.
Bring american jobs home and we will do our part and buy from all the other countries.
Virgil
Keep The World At Work
Keep America At Work
Bierschwale for Senate 2012
PlanQ2012 09:01 07 Dec 11
A SMART way forward would be to introduce a wholesale fund of VIRGIN CAPITAL for Governments and Banks to raise funds from in lieu of conventional means. It would allow Global cash flow to be regulated dynamically. A dedicated GLOBAL RESERVE CURRENCY, issued at a fixed exchange rate, insulated from markets and currency speculators alike. It's sole purpose, replace our current, unstable economic model with a MODERN sustainable addressable OPEN LOOP system. One could achieve sustainable economic activity and prosperity with ZERO inflation or reliance on growth. Most economist will not understand me, however 100 or even 500 years from now it might make perfect sense. Just THINK about it next time you open your electricity bill or fill up at a Gas station...
joe22 10:29 09 Dec 11
Great article. Only 1 thing i disagree on:
"Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this."
David Cameron doesnt appear to get this. He is going going full-steam ahead with mad savage austerity cuts and it is hurting the UK economy badly.
Jeannin 09:58 10 Dec 11
It may be that the inflation would "save" the euro, but in the long term we are all dead, isn't it, Mr. Stiglitz?
Apart from this, it doesn't exist a "good" current-account deficit. The global investors prefer US mainly because they we're assured that this deficit will be solved through cut spending (and not tax raises) and becuase they are familiar with the business climate.
With your advices, Mr. Stiglitz, inflation & "good" current-account deficits will soon become panacea for all our problems. Until the next crisis.
criticaleye 08:28 18 Dec 11
> Migration is, of course, part of the adjustment mechanism that makes America work as a single market with a single currency. Even more important is the federal government’s role in helping states that face, say, high unemployment, by allocating additional tax revenue to them
Note the contradiction: It works because of migration vs we help states with high employment (so folks don't need to migrate).
Our failure is due to this: we solve every problem by throwing money at it.
For decades a US policy objective was lower cost housing. We tried to achieve that by loans, tax credits, and so on. Elementary economics tells us that can only drive up prices -- i.e. make homes less affordable, and it did just that. Is it possible the real goal was not affordable housing, but more debt for the bankers? Well ... consider this: Since 2007-2008 housing has indeed become more affordable. Do we rejoice? Do we shut down Fannie and Freddie since we don't need them anymore? No way! We try to fix the "problem" by pushing more loans.
louis621 08:13 02 Jan 12
@vbierschwale
You are a prejudiced person in that you believe that certain humans by nationality are endowed with the right to own more wealth than others, and mind you this is not the traditional market argument for the acceptance of super-wealthy within a society. A truly just society would see the average percentage of world gpd per capita be equal for all countries. In other words, it makes sense that with increasing globalization a country with an enourmous population would see its percentage of world GDP rise, and saying otherwise on purely nationalistic grounds is immoral and contrary to natural market fluctuations.
arouet2011 03:29 02 Jan 12
Long term I think the only structural solution is to let the EURO go. It will re-balance balance of payment (and longer term fiscal budget) in European countries meaning it will revigorate local output and more importantly force savings of Spain, France etc..to invest in their country instead of buying German bonds.Difference of competitvity within EU have been significantly exacerbated by the EUR and products of south of EU have been replaced by produced made in north of EU. As a result, the economy of south of EU have been somewhat destructed by the north (Germany++) with the creation of the EUR. The only way for south of EU to recover structuraly is to devaluate. Sure short term it will be difficult (higher energy costs etc..) but probably not much than increasing austerity and at least it will be very beneficial long term. Which is not the plan with the current austerity measures (which are, I think, a terrible error, as in a deleveraging led recession, the gov should leverage itself to balance the lack of private sector leveraging..but this is for another discussion)All other solutions will be short term by nature, unless Germany decides to transfer wealth to other EU countries in a federalist framework, which seems so far out of reach.
Archie_ 10:45 03 Jan 12
Perhaps letting the Euro go is so difficult for European leaders because they have made a conscious connection in their minds that a Europe with a single currency is not an integrated Europe, an European Union. This is of course a lie, mistake.
RedBaker 10:23 05 Jan 12
The problem is massive debt - government, personal, and business. Government debt was caused by financing welfare states by borrowing 2-3% of GDP every year until debt was 100% of GDP. Personal debt was caused by credit cards and home equity financing. Business debt has a variety of causes, but in all cases it should end in bankruptcy and business death; but all too often business is rescued by government, financed by more debt.
If there is no penalty for failure, and failure is subsidized by government, it will (and has) proliferate.
Bring back failure, bankruptcy and its curative, cleansing power. The current model of punishing success and rewarding failure is killing our economies.
Richard44 04:40 20 Jan 12
Unfortunately, the answer to the question is quite painful, and it might involve some austerity: Someone, or some entity, has to fail and go bankrupt. As much as possible this has to involve suffering by investors and private institutions. The govrnments have to stop rescuing large entities, and ignore the risk of some systemic failure, and people (the ones who invested) have to pay for the bad risks they took.
We do this all the time when "average" people have to pay a mortgage larger than the house value or lose the house. Of course they do not pay. They end up leaving and living somewhere else. It is not equivalent to dying. No one is going to rescue them.
To the extent governments have guaranteed such debts there is a problem, but I would propose that a good deal of those guarantees could be unwound by the fraud of the parties taking advantage of the guarantee.
Growth is the problem, of course, but growth comes from confidence that the system "works," and to me that includes that people pay for their mistakes.
Unless such an approach is taken what happens is that the governments reach into the pockets of the taxpayers to protect the wealthy investors and bankers.
RalphMus 06:40 06 Dec 11
Property bubbles derive from fractional reserve banking: the freedom that private banks have to create money out of thin air and lend it. Full reserve banking would ameliorate this problem.