2017-2020 / Euro crisis: A compromise solution for a non-democratic Euroland

eurocrisis

In the GEAB no 109 of November 2016 we wondered if “the euro would survive beyond the year 2017”. Five months later, we wish to deepen and complete our analysis. One reason for the weakness of the euro comes from the political anaemia of the euro zone, which is ultimately far too un-integrated to afford a single currency, or (the other side of the coin, if we may say it this way) afford misconceptions around this single currency for a heterogeneous zone.

The well known thesis driving us on this topic is the anchoring of the governance of the single currency in a common democracy which would immediately set in motion all the principles of solidarity, of economic convergence and upgrading, which would be required in order to make the eurozone a powerful and coherent economic player on a global scale.

But we see this road moving farther and farther away. The projects of a Parliament of the eurozone drafted by some (Schäuble, Macron and Hamon) are dramatically lacking imagination, merely wanting to bring together national and European parliamentarians (all elected on a national basis) from the eurozone into a new “democratic” entity; the latter actually has no chance of bringing Eurolanders together around the governance of their common currency.

The tendencies lean heavily to the massive return of European governance in the hands of the national level (project of the right-wing radicals in particular, but also of the centre wing with its multi-speed Europe project draft, exclusively based on the political strength of the re-legitimised member states, thus always eliminating the euro-citizens from the game … on the pretext that they are too anti-European. When we look at the solutions of all these policies, we can wonder who is truly the most anti-European).

Thus, in spite of our own convictions, here follows the anticipation of a compromise solution, which could bring together the characteristics of a reform of the euro “acceptable” by all (maintaining the euro while strengthening the autonomy of the member states), and acceptable from the point of view of our national leaders, the only masters on board this ungovernable Europe.

Euro currency: design problems

In our November article, we mentioned the case of the German reunification: despite a great disparity between East and West, the dream of a Deutsche Mark was made possible by a sufficiently powerful political will joined by a strong redistribution. However, these two conditions are currently totally absent in the eurozone (ironically, one of the most reluctant countries to increase solidarity seems to be Germany, who has experimented with the need for massive redistribution and who, back then, has seen that it was not even enough to completely bridge the gap between East and West).

fig1

Figure 1 – GDP per inhabitant in different German Länders, 2011. Source: Die Zeit.

The designers of the euro currency imagined that the latter would force political union, that it would be a crucial step towards strengthening a solidarity-based Europe. Almost twenty years after the introduction of the euro and in the light of the Greek crisis and all the other European psychodramas, there are unfortunately no signs of such a thing. Moreover, it is still not the case and it will not be in the near future either, given the exclusively national priorities promoted by most of our leaders … This poses a real problem, since the euro is designed to function only in a highly-integrated zone.

For example, the eurozone summit, which normally takes place twice a year, has not had a meeting since July 12, 2015, and has fully delegated the governance of the eurozone to the ECB which advances alone, without any political mandate, on the sole legitimacy granted to it by the treaties in terms of inflation rate (to be maintained at around 2%).

The criticism is known: the competitiveness of the eurozone countries have diverged too much since the introduction of the euro, but they cannot adjust their exchange rate to rebalance. This would require a significant redistribution of the most competitive countries to compensate for their deficit balance; but that redistribution is non-existent since no fiscal union or common budget exists. On the other hand, if we wanted to replace this redistribution by some good monetary policy, we would run up against the famous “impossible trinity” which shows that it is impossible to reconcile everything: with the “fixed exchange rate regime” imposed by the euro, and with the free mobility of capital within the zone, countries cannot possibly adopt a monetary policy adapted to their situation[1].

fig2Figure 2 – The impossible Trinity of Mundell: the three vertices are impossible simultaneously. Source: Wikipedia.

This disparity between the countries of the eurozone, or rather their divergent trajectories due to a lack of political union, is indeed a real problem in designing the euro, unless a redistribution occurs within the monetary union. The so-called North-South divide in Europe is mirrored in the monetary policy habits of the European countries: before adopting the Maastricht convergence criteria, devaluations are frequent in the South in order to restore competitiveness to the economy obtained by the North more readily through “labour market reforms” (aka wage moderation).

fig3Figure 3 – Annual evolution of wages and productivity in Germany, France and Italy, 1996-2004. Source: Odile Chagny, IRES.

fig4Figure 4 – Deutsche Mark evolution compared to the French Frank (left, 1960-2000) and compared to the Italian Lira (right, 1973-2009). Sources: Contrepoints and LordshipTrading.

We can by the way note that the difference between the two methods is not so great as it seems at first sight: widespread wage moderation reduces the purchasing power of foreign products in the same manner as the devaluation of currency. But devaluation is certainly more easily accepted in countries with a strong tradition of social mobilisation…

In light of the above, the criticism which is often heard against Germany; that it would have “taken advantage” of the euro at the expense of its neighbours, finally appears justified: without the single currency, the Deutsche Mark exchange rate would have increased sharply in order to compensate for the competitiveness gains achieved by wage moderation, which would have largely cancelled the “beneficial” effects of the reform of the German labour market. That is why it is absurd to wish that all eurozone countries make the same “efforts”[2]: the resulting rise of the euro makes those efforts vain form the very beginning. But indeed there is great heterogeneity on this subject in the eurozone: average wages go from one to seven times within the same monetary zone!

fig5Figure 5 – Average wages in 2010 in different states (attention: not all the states represented in this figure belong to the eurozone). There is a variation from one to seven times within the euro zone, between Lithuania and Ireland. Source: les-crises.fr.

Accused of all these flaws and of many more, the euro has thus become a convenient scapegoat, whilst its problems (which are real, by the way) are very practical to divert the attention of some sensitive subjects. Thus, rather than seeking to repair these design problems, many people announce that they simply want to leave the eurozone in order to regain a free monetary policy, a wonder panacea.

Why the euro will survive

And yet, despite the storm brewing for a few years now, despite the impossible political union of the eurozone, we reiterate our expectation that the euro will survive… but probably not in the form that we currently know. If it has survived so far, it is because – and the Cassandra always forget it – it is above all a political construction. Thus, it is mainly political risks that threaten it. But are these risks really that dangerous in the short term? The ideas and debates about a possible exit from the eurozone are becoming more and more important in most European countries, but with a Geert Wilders still at the gates of power in the Netherlands[3], with an AfD with no chance to govern Germany after the September elections[4], there is only a Beppe Grillo in Italy[5] and the FN of Mrs Le Pen in France among the important Eurosceptic parties which have some chance to come closer to power… if ever… Subscribe and read more in the GEAB 114/ 2017

_________________________________________________

[1]     In the case of the eurozone, the monetary policy is common to all countries as it is that of the ECB. But we see the reluctance of Germany as to the decisions taken by Mario Draghi, more adapted to the Southern countries than to those experiencing trade surplus and worrying about inflation returning. Source: Financial Times, 05/02/2017.
[2]     One could expect Kant’s country to be tempted to respect the categorical imperative: “Act only according to that maxim whereby you can, at the same time, will that it should become a universal law”.
[3]     Source: Time, 15/03/2017.
[4]     Source: Deutsche Welle, 28/02/2017.
[5]     Source: Politico, 21/03/2017.