Like many people of 20, the European currency has experienced a traumatic adolescence. At some moments, many thought it would not reach this age of maturity at all. But it has. That is a success. Yet the experience has been so difficult that it necessarily raises big questions. In this birthday assessment, I will consider four.
Like many people of 20, the European currency has experienced a traumatic adolescence. At some moments, many thought it would not reach this age of maturity at all. But it has. That is a success. Yet the experience has been so difficult that it necessarily raises big questions. In this birthday assessment, I will consider four.
First, was the euro a sensible idea? In a lucid speech last month, Mario Draghi, president of the European Central Bank — in my view, one of the two people (the other being German chancellor Angela Merkel) most responsible for the euro’s survival — explained the rationale for its creation. It would have been impossible, he argued, to maintain the deep integration of the single market without the single currency. Thus, “support for the single market would be undermined in the long run if firms that did invest in raising productivity could be deprived of some of the benefits by ‘beggar-thy-neighbour’ behaviour through competitive devaluations in other countries. Open markets would not have lasted.”
Yet it was also clear that the euro was very risky. A common monetary policy might drive cumulative divergence, with lower real interest rates in the high inflation countries (and so booms) and vice versa. By yoking together countries with such different economic institutions and behaviours, especially in the absence of a shared political process, the euro might pull the peoples of Europe apart, not together. Thus, in 1991, I argued that: “The effort to bind states together may lead, instead, to a huge increase in frictions among them. If so, the event would meet the classical definition of tragedy: hubris (arrogance), ate (folly); nemesis (destruction).”
Second, how has the euro performed? Most obviously, it has survived, despite big shocks and painful divisions. It has done so because the costs of break-up, or even departure by individual members, look terrifying. It has also done so because, in the depths of the crises, policymakers did enough to keep it alive. Think of the creation of the eurozone’s emergency financing facilities, of the “whatever it takes” statement by Mr Draghi in July 2012 and the willingness of the ECB to use the tools of a modern central bank. As Daniel Gros of the Centre for European Policy Studies remarks: “Ultimately, the euro survived because, when push came to shove, leaders of the eurozone’s member states expended political capital to implement needed reforms.”
Yet surviving is not the same as surviving well. The eurozone took an unconscionably long time to address the crisis. As the economist Ashoka Mody argues, that trauma inflicted deep and enduring economic, social and political wounds on vulnerable countries. Instead of generating convergence in living standards, the euro has allowed divergence. Intra-eurozone bank lending has collapsed. Inflation has been persistently too low, making adjustment of relative costs very difficult. The contractionary policies imposed on crisis-hit countries, together with the persistent current account surpluses of Germany and the Netherlands, have pushed the eurozone into large surpluses, so externalising a sizeable part of its post-crisis adjustment. (See charts.)
Third, will the eurozone survive? The answer is likely to be: yes. Three-quarters of the people in the eurozone are in favour of the euro, the highest since 2004. Some 40 per cent of the area’s adults have not known another currency. The number of eurozone members has also continued to expand, surely a vote of confidence.
Yet the biggest reason for optimism about survival must be the consequences of the alternative. Breaking up would be hugely traumatic, financially and economically. It would also threaten the survival of the EU itself, which has always been built on a foundation of economic integration. The single market would quite possibly collapse. So, then, might the possibility of co-operative relations. Some seem to think that Europe needs another bout of aggressive nationalism. Those with some historical knowledge know how lethal that bacillus is likely to be.
Yet, last, will the euro survive well? Mr Gros emphasises that the record is not too bad. In particular, he notes, “continental European labour markets have undergone an under-reported structural improvement, with the labour-force participation rate increasing every year, even during the crisis”. Today, a higher proportion of the adult population is economically active than in the US. Unemployment rates are also declining, even in the most crisis-hit countries. The euro has forced important reforms. All this is significant.
Nevertheless, the eurozone is not and is most unlikely ever to be an “optimal currency union”. Furthermore, any sort of federal union seems to be off the table. This guarantees that the fundamental political problem — the disjunction between eurozone responsibility for policy and national political accountability — will endure. What is needed, instead, are changes aimed at creating a “good enough” union. Risk-bearing must work through cross-border private finance. That is why the banking and capital market unions are important. It needs to be easier (and more acceptable) to restructure debt. Not least, macroeconomic adjustment needs to be far more symmetrical.
Ultimately, the eurozone is doomed to succeed. A break-up would do huge damage to the fragile order built on the postwar wreckage. Whether or not it was a good idea, the costs of undoing it make that idea unthinkable. But it will not succeed — and might not even survive — if complacency sets in. The eurozone barely survived its near-death experience. To enjoy a long and healthy life, it needs to change substantially.
