Austerity can’t save the euro. Growth can’t either. Nothing can.

Simon Johnson at the New York Times Economix blog reminds us that the end of the euro is not about austerity.  The project was flawed from the start and, even if the current banking/sovereign debt crisis were somehow successfully resolved, the flaws would remain.

As one wag once said, it’s like Rosie the Riveter yoked to Lindsay Lohan.

There are those structural problems in productivity and labor mobility, and then that stubborn democracy deficit that delegitimizes the proposals issued from on high.

Here’s Johnson:

The underlying problem in the euro area is the exchange rate system itself – the fact that these European countries locked themselves into an initial exchange rate, i.e., the relative price of their currencies, and promised never to change that exchange rate. This amounted to a very big bet that their economies would converge in productivity – that the Greeks (and others in what we now call the “periphery”) would, in effect, become more like the Germans.

Alternatively, if the economies did not converge, the implicit presumption was that people would move; Greek workers would go to Germany and converge to German productivity levels by working in factories and offices there.

It’s hard to say which version of convergence was less realistic.

As German economic productivity continued to outpace that of the peripheral countries, the latter used their northern neighbor’s good name to borrow more – and spent it unwisely:

In theory, these capital inflows could have helped peripheral Europe invest, become more productive and “catch up” with Germany. In practice, the capital inflows, in the form of borrowing, created the pathologies that now roil European markets.

In Greece, successive governments overspent – financed by borrowing — as they sought to stay popular and win elections…

In Spain and Ireland, capital inflows – through borrowing by prominent banks – pumped up the housing market. The bursting of that bubble has shrunk their real economies and brought down all the banks that gambled on loans to real estate developers and construction companies. Their problems have little to do with fiscal policy.

As conventionally measured, both Ireland and Spain had responsible fiscal policies during the boom, but they were building up big contingent liabilities, in the form of irresponsible banking practices…

In Portugal and Italy, the problem is a longstanding lack of growth….

So… either the PIIGS have to catch up, or northern Europe have to commit to long term transfers of wealth to the south, or… the euro project ends.  I think their only chance is to kick a country (or two) out of the euro for, as John O’Sullivan has speculated, “pour encourager les autres.”  Johnson again:

Peripheral Europe could, in principle, experience an “internal devaluation,” in which nominal wages and prices fall and those countries become hyper-competitive relative to Germany and other trading partners. As a matter of practical economic outcomes, it is hard to imagine anything less likely.

Some politicians still hint they could produce the rabbit of “full European integration” from the proverbial magic hat. What does this imply about quasi-permanent transfers from Germany to Greece (and others)? Who pays to clean up the banks? What happens to all the government debt already outstanding? And does this mean that all Europe would now adopt German-style fiscal policy?

These schemes are moving even beyond the far-fetched notions that brought us the euro.

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2 Responses to Austerity can’t save the euro. Growth can’t either. Nothing can.

  1. Paul Marks says:

    Actually this is (formally speaking) wrong. There is no reason in REAL (as opposed to establishment) economics why people in rich and poor countries can not use the same currency – there is no need (no need at all) for “economic convergence”. After all there were no “fiscal transfers” between rich and poor States in the United States till the 1930s (indeed, contrary to what is often thought, the poorest region in the United States, the deep South, got LESS money in the New Deal period than other areas). Real “fiscal transfers” (i.e. a central Welfare State) did not really begin in the United States till the 1960s (there were no Federal foodstamps and so on in the 1950s).

    HOWEVER – POLITICALLY speaking, this article is correct. Governments in (say) Greece will demand to borrow money (in order to provide Welfare State services they can not afford. Individuals will also demand to be able to borrow money (on the same condiditions and at the same rate of interest as people say in Bavaria).

    And if banks say “NO” – governments and individuals will scream “discrimination” denounce this “Redineing” and so on.

    Thus, yes, the project leads to demands for (endless) “fiscal transfers”, “bank system unification” and other absurdities.

    • John says:

      (Just returning from 2 week vacation…)

      Thanks again Paul.

      Not sure the US had a currency, in terms of how we’re discussing it, until 1911. Maybe earlier, just after the Civil War. There were regional- and bank- notes, and of course specie, and barter. But we did have free trade. And labor mobility in the limited sense of theoretically one could move from Florida to Maine, if not quite so easily in practice. A state back then might have more reasonably resembled what we call a nation today. Hypothetically: if Memphis cotton had a bad harvest maybe you’d move to Nashville and pick something else. They’d probably honor credit or bank notes from Memphis in Nashville and you’d fit in well enough with the locals to get by.

      In the modern era, currency = sovereignty and if you don’t want to share/pool the latter then you better skip the former. If people can’t move and find work in another region when their home economy stumbles, they need a currency to depreciate and restore their relative competitiveness. If the rich country is richer than the poor because it is more productive, it cannot share a currency with the poorer country. Not unless they’re prepared for immigration and transfer payments. (As is the case with our 50 states and their relative, and changing, productivy.)

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