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.
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.