A Euro Tragedy

“Italy, I believe, is the eurozone’s fault line.” Not from an article on the recent crisis, but from a book by Ashoka Mody, called “Euro Tragedy: A Drama in Nine Acts”, just published in the US and due out in the UK in July.

As the title indicates, this is not a pros versus cons assessment. Instead the author treats the Euro as a clear mistake, a triumph of a political ideal of European unity over basic economics. The author provides a clear (and accessible for non-economists) account of how the idea of the Euro began to dominate the political discourse of particularly the French elite and how Germany leaders agreed on the condition that they determined the design, how warning signs during the pre-crisis period were ignored, how the risks from a Greek default were overblown so the wrong policies were adopted in 2009 and 2010, and how subsequent actions exposed the democratic deficit implicit in that German design, encouraging populist movements across Europe. (For UK readers I have to emphasise that this is about the Eurozone and not the EU.)

Many of these points will be familiar to regular readers of my blog, but here the story is told with the knowledge and authority of someone who, as deputy director of the IMF’s European department, was close to the action. The sections on the Greek crisis especially should be read by all those who stick to the ‘official’ line that Greece turned a crisis (excessive deficits) into a disaster because it refused to take the medicine it needed. The reality, as the author describes, is that Syriza’s call for debt relief should have been granted. He writes

“This demand had overwhelming support in both the scholarly economics literature and the practice of economic policy. Scholars for decades had emphasised that excessive debt - ‘debt overhang’ - reduces the ability and incentive to invest, slows economic growth, causes low inflation or even deflation to set in, and makes debts harder to pay.”

And as he notes earlier, these debts should have led to default in 2009/10 rather than being mainly transferred into obligations of the Greek government to other Eurozone governments. Varoufakis may have been unconventional, but many of his proposals, including linking repayments to GDP growth, were “economically sound”.

Indeed he goes further than I have done. He writes about the final days of the standoff between the Syriza government and the Eurogroup after the referendum. The IMF made increasingly strident public noises about the urgency of debt relief, but the Germans - fearing political comeback from their taxpayers - refused to budge. He writes

“The IMF could have forgiven the debt owed to it by the Greeks. This drastic gesture would have created international pressure on the Germans and other European creditors to do the right thing. The IMF had a moral obligation to take such a drastic step, if for no other reason than to make amends for its complicity in the tragedy. At the time of the original bailout in May 2010, IMF management had prevented the Greek government from defaulting on its private creditors, an action that several members of the IMF’s Executive Board and the vast majority of external analysis then and later believed was essential to reduce Greece’s debt burden”

This book is a comprehensive and impressive history of the creation and subsequent performance of the Eurozone, and one of the few books on the subject where I find myself nodding in agreement most of the time.  (Martin Sandbu’s Europe’s Orphan is another.) There is much more interesting detail and analysis that I cannot do justice to in one blog post. I can think of two areas where I might have told a slightly different story. The author in parts writes as if it was commonly understood by economists that the Euro would not work. I think there were, in Europe at least, two other significant groups among academic economists. The first thought that perhaps the Euro could work, but only if it allowed fiscal policy to replace monetary policy as the national stabilisation mechanism. I still remember how astonished I was reading the Stability and Growth pact when it was announced, which effectively ignored this critical role for fiscal policy. Another group gave more unconditional support to the Euro, although whether they did so because they really believed in its merits or because they saw it as politically inevitable is difficult to tell.

The second story which I do not think is given enough emphasis is the role of German wage undercutting in the early 2000s. As Peter Bofinger has argued, this was a deliberate attempt to devalue the German real exchange rate within the Eurozone. It was significant for two reasons. First, it helped Germany to emerge from the financial crisis in an economically stronger position than France and others, which in turn had a strong economic and political influence on subsequent events. Second, it indicated an unwillingness on the part of the strongest country in the union to play by the rules of the game.

But these are just differences in emphasis. I would absolutely agree with the author that to avoid a continuing tragedy the direction of travel has to change. He writes

“The evidence in this book points insistently to specific measures to improve the functioning of the eurozone. These include scrapping the fiscal rules, creating mechanisms for predictable and orderly default on public debt to instill greater discipline in debtor governments and their creditors, and changing the ECB’s mandate to require that reducing unemployment be an objective of monetary policy on a par with maintaining price stability.”

Unfortunately that is not the path the eurozone is currently on. It retains a belief in ‘falling forward’ from each crisis to further integration. If the governing elite is the head and the people are the legs, the great danger is that the legs will not move and the eurozone will fall flat on its face.