Too Late for the Euro?
A decade into its ambitious currency experiment, the Eurozone is in trouble. Business school professor David Beim, a financial-markets expert and former investment banker, says the euro's hour of reckoning is at hand.Published Winter 2011-12
Columbia Magazine: For more than a year we’ve been reading that the European debt crisis, which began in Greece, has put the survival of the euro in doubt. How likely is the euro to survive 2012?
David Beim: Not very. It might hit insuperable stress this year. What would crack the euro would be the defection of one or more countries. Greece has elections in April, and the opposition could well turn anti-euro after yet more austerity. Or the opposition in a small northern country — the Netherlands, Austria, Finland — might try to block further “rescue” payments.
Columbia: In December, the European Union held an emergency summit in Brussels. What did it accomplish?
Beim: It produced a declaration of intent. German chancellor Angela Merkel and French president Nicolas Sarkozy agreed to recommend a treaty change that would establish more central control over member states’ budgets. Debts would have to be reduced to below 60 percent of GDP and deficits to below 3 percent of the GDP. These were the original requirements of the Maastricht Treaty, which set up the euro in 1992, but they were never enforced. In fact, Italy never did meet them, nor did Greece, which concealed its figures to pretend it did.
Columbia: Even Germany doesn’t meet those criteria today.
Beim: Only Finland does. A treaty change would require the signatures of all twenty-seven EU members, which is horrifically difficult to achieve. Of the ten EU members that did not adopt the euro from the outset, only two (Sweden and Denmark) meet the Maastricht criteria today.
As you’ve seen in the papers, Britain has already balked. Prime minister David Cameron said he would not sign, because the EU was going to give powers to the European Court of Justice and the European Union bureaucracy in Brussels to enforce budget discipline and put sanctions on countries that fell outside of their agreements. Cameron said, in effect, we’re not going to let a bunch of bureaucrats in Brussels tell us how to do our budget. Even Sarkozy said publicly that the sovereignty of France comes first and anything that impinges on it is out.
My guess is that there will not be a treaty change for the immediate future. Lacking that, states that consent to more central economic control will have to work out an executive agreement with less than all. That would create three unions: twenty-seven in the EU, seventeen in the euro, and some lesser number in the control agreement. It’s messy.
Columbia: Have you always been a euro skeptic?
Beim: No, I’ve been a euro enthusiast for fifty years. I’ve lived long enough to remember the beginning, when Europe was first getting organized and Europeans said, we’ve been ravaged by two horrible world wars, and we’re going to be sure that never happens again. I thought, fabulous: this is really important. I applauded Europe for getting its act together. The designers of the European Union began brilliantly by lowering trade barriers in the 1960s and 1970s, aligning product rules in the 1980s, and promoting financial-market integration in the 1990s.
Columbia: Wasn’t the union more than economic?
Beim: Absolutely. Its designers wanted to harmonize not just economic relations but also broader social and military policies, so Europe would feel more like a force in the world, a unified set of powers rather than a bunch of people bickering with one another. But there remained confusion about the endgame. Was the ultimate goal a single country, a United States of Europe? Or was it something less, and, if so, what?
The euro was not an end in itself. I get distressed when I hear politicians saying that the euro must be saved at all costs. Really? I would have thought cooperation must be preserved at all costs. If the euro promotes closer cooperation, then it is a good thing. But if the euro becomes divisive, pitting the interests of Northern Europe against those of Southern Europe, then it needs to be rethought.
Columbia: You’ve written that a critical flaw of the Eurozone is that it lacks effective governance.
Beim: There is no governance structure for the euro. There should be. Any great enterprise deserves a CEO and a leadership structure with full authority to make decisions that bind all those connected to it. Instead, the Eurozone needs to get seventeen separate legislatures to agree to every significant initiative. This precludes the EU from taking decisive actions and causes the crisis to drift unresolved. The Eurozone is a monetary union without a political union.
Columbia: Isn’t the European Central Bank (ECB) part of a governance structure?
Beim: The ECB is the manager of the currency. It controls the interest rates on short-term euro deposits, and can increase or decrease the supply of euros — it owns the printing press.
When states give up their separate currencies, they give up having their own monetary policy — they can no longer print money and can no longer devalue their currency. These are important tools for managing an economy, and it is quite serious to lose them. Greece, for example, is now quite dependent on Germany and the other northern countries, and this is uncomfortable on both sides.
This gets to the heart of the euro crisis. Loss of a separate currency is a partial loss of sovereignty. Are the nations of Europe ready for this, or does national identity still trump European identity? The December summit formally raised the idea of a fuller fiscal union. But most European states are less than enthusiastic about such a fiscal union, now that they look at it more closely. The Finns like being Finnish, the Greeks like being Greek.
Columbia: Is the size of the Eurozone part of the problem?
Beim: The Eurozone is too big, and the member countries are too different from one another. A currency union can succeed only if its members are sufficiently alike. In particular, they need to have a common rate of inflation. The currency of a more inflationary country will gradually devalue relative to the currency of a less inflationary country. For example, Greek prices increase about 2 percent a year faster than German prices, and this was true both before and after the euro was introduced. Germany is just more efficient, and its productivity rises faster than Greek productivity. When currencies were separate, the deutsche mark steadily appreciated and the Greek drachma steadily depreciated. In the fifteen years before the euro’s launch in financial markets in 1999, the drachma lost three-quarters of its value relative to the mark.
These value changes played an important economic role: they enabled trade between Germany and Greece to expand without causing balance of payments problems. But look what happens when you lock the two currencies together: now the higher rate of Greek inflation makes Greek goods become more and more expensive to Germans, and makes German goods look ever cheaper to Greeks. As a result, Germany over-exports and Greece over-imports. Cheap northern imports begin to crush Greek businesses, while Germany piles up ever-more cash and IOUs from the south. Germany has now become the China of Europe, and for a similar reason. Currency prices matter a lot.
Columbia: Yet a border-free Europe seemed to hold a lot of promise.
Beim: There is an economic theory called convergence that says that if you globalize — if you open your borders totally so that goods, services, people, capital, ideas, and money move freely across borders — then we will become more like one another.
The hope was that the euro would make Europe converge. But it didn’t. Germany exercised wage restraint, liberalized regulations, and opened further to global competition, all of which boosted German productivity. Greece, Portugal, and other southern economies continued to limit competition, supported local monopolies, and left restrictive labor practices in place. Instead, the euro has revealed the lack of real convergence, the huge differences among these countries in corruption, rule of law, regulatory quality, and government effectiveness. Currency union should not have been implemented until such differences among countries had been more substantially erased.