Ifo Viewpoint No. 151: A Rescuing Europe from the Ground Up
Munich, 21 January 2014
The European Union has earned its place as an instrument for peace in Europe. Free trade has brought prosperity to its peoples, and the freedom to choose a place of residence guards against the resurgence of totalitarian regimes. The Acquis Communautaire protects all member states’ citizens under the rule of law. Anyone who doubts the existence of these benefits need only look to Kyiv’s “Euromaidan”, where hundreds of thousands of people have been gathered for weeks to demonstrate their support for closer ties with Europe, rather than an alliance with Vladimir Putin’s Russia.
The paradox is that the same enthusiasm and benefits do not apply when it comes to Europe’s common currency. On the contrary, the euro has plunged southern Europe and France into a deep economic crisis that is fraying the nerves of all involved. I have never seen so many swastikas and hateful slogans directed at Germany. The ex-head of the Eurogroup, Luxembourg’s long-time Prime Minister Jean-Claude Juncker, has said that 2013 makes him think of 1913, when no one could imagine what would happen a year later. That may be stretching things a bit, but a statement like this by such a distinguished politician is chilling.
Unfortunately, the crisis is far from over. While the insurance that the European Central Bank (ECB) has offered, free of charge, to buyers of EU members’ government bonds has temporarily calmed financial markets, ordinary workers fretting about their jobs look to the future with trepidation. In Greece and Spain, half of all young people not studying are unemployed, as is a quarter of the adult workforce. Particularly worrying is the continuing rise in unemployment in France and Italy, where industrial production has been shrinking and price competitiveness continues to deteriorate.
The euro itself is responsible for this debacle. During the first several years after the EU’s Madrid Summit in 1995 officially launched the move toward a common currency, too much capital was steered into southern Europe, creating an inflationary credit bubble there. An inordinately lax regulatory environment proved lethal, encouraging northern European banks to pad their balance sheets with southern European government and bank bonds. When the bubble burst, it left in its wake woefully expensive economies that had lost their competitiveness.
Europe should now use the calm between the storm fronts to rethink the European currency union from the ground up. The effort to create a European equivalent of the dollar and impose a fiscal union on top of it, despite the absence of a common European state, is bound to fail. It will turn member countries into debtors and creditors to each other, stoking even more animosity.
The fundamental requirement for functioning monetary and fiscal unions in Europe is the establishment of a United States of Europe, with a real parliament that gives all citizens equal representation, together with a common legal system. Above all, the success of the European peace project requires a common army and a common foreign policy – that is, a genuine, long-lasting mutual-insurance union based on reciprocity in ensuring security and stability. Those who try to anticipate such a common state with a fiscal union will never achieve their goal.
Because France is not yet willing to accept a common European state, we need an intermediate stage to preserve and stabilize the eurozone. This requires sorting out the current mess and introducing a flexible membership system based on hard budget constraints. Four measures are needed to achieve this.
First, a debt conference is needed, with creditors of the southern European governments and banks forgiving part of the debt. The creditors relinquishing part of their claims must include public entities, first and foremost the ECB, that have now largely replaced private lenders.
Second, eurozone members whose path to regaining competitiveness through price and wage reductions is too long and gruelling, and whose societies risk being rent asunder by the necessary imposition of austerity, must temporarily exit the monetary union. The pain of exiting should be cushioned with communal financial help, which would not be necessary for long, because a devaluation of the new currency would quickly restore competitiveness. In fact, a “breathing eurozone” that permits – and regulates – exit and re-accession should be clearly stipulated. Europe needs a system that is halfway between the dollar and a fixed-exchange-rate system like Bretton Woods.
Third, this breathing currency union must include hard budget constraints on its members’ national central banks. Specifically, a ceiling must be set on local money creation by establishing the obligation to settle balance-of-payments imbalances with gold or other comparably safe means of payment.
Finally, bankruptcy regulation for countries is essential in order to make it clear to investors from the outset that they are taking on risk. This is the only way to avoid the destabilizing credit flows that drove southern Europe to ruin.
If we are serious about deepening European integration, we must recognize that there is no credible alternative to reforming the euro from the ground up. Otherwise, Europe’s admirers and aspirants, like those in Ukraine, will eventually look elsewhere.
Professor of Economics and Public Finance, University of Munich
President of the Ifo Institute
Published under the title “Neustart für den Euro”, Handelsblatt, No. 11, 16 January 2014, p. 48, and under the title “Rescuing Europe from the Ground Up”, Project Syndicate.