Europe’s Ugly Future Muddling Through Austerity Andrew Moravesik And the Wea Safer What They Must? BY YANIS VAROUFAKIS. Nation Books, 2016, 368 pp. Welcome tothe Poisoned Chalice: The Destruction of Grece andthe Future of Europe BY JAMES K. GALBRAITH. Yale University Press, 2016, 232 pp. ‘The Euro: How a Common Currency ‘Threatens tie Future of Europe BY JOSEPH STIGLITZ. Norton, 2016, 448 pp. S ome foreign policy decisions hang ike albatrosses around the necks ‘of the states that made them. For the United States, the war in Iraq offers the prime example ofa costly and seem- ingly ireversible blunder. For Kurope, it is the adopxion of the euro, Fifteen years ago, when the fu established its single currency, European leaders promised higher grovth due to greater efficiency and sounder macroeconomic policies, _greater equality between rich and poor ‘countries within a freer capital market, ANDREW MORAVCSIK is Professor of Polis land Publ Afairs and Dieetor ofthe European ‘Union Program at Princeton Univers ‘Woodrow Witon Schoo! of Pll and interne ‘onal Aa enhanced domestic political legitimacy due to etter policies, and a triumphant ‘capstone for Eu federalism. Yet for nearly. decade, Europe has experienced just the opposite. Even in good times, economic growth under the euro was unexceptional, but withthe global financial ersis, the situa- tion grew dite. Since 2008, inflation- adjusted opp in the eurozone has stag nated, compared with an expansion of ‘more than eight percent in European countries that remain outside. Greece’: economy is more than 25 percent smaller than it was in 2008. Italy’ is almost ten percent smaller, and its financial system may be the next to melt down. The loss of European output totals about six trillion euros—a massive figure, reflected in the shattered lives of unemployed youth, bankrupt business owners, and vulnerable citizens unable to maintain their standards of living. Although losses from short recessions are often offset by higher-thar-average growth thereafter, that process does not typi- cally occur after prolonged depressions such as the current one. In this situa tion, alost decade may well become a lost generation, ‘Nor has the euro reduced inequality among European countries. Since 2007, the German economy has grown, by almost seven percent, whereas the economies of Belgium, France, and the Netherlands have remained stagnant, and those of Finlane, Greece, Ireland, ‘aly, and Portugal have all contracted more than they did during the Great Depression. Inequality has also in- creased within countries—to a stun- ning degree in the worst-performing cones, such as Greece, but even in Germany, too. November/December 2016 139Andrees Moravctit ‘The prolonged depression has helped fuel the rse of right-wing nationalists and Buroskeptics, In Austria, Finland, France, Germany, Greece, the Nether- lands, and elsewhere, radical right-wing parties now enjoy more success atthe polls than at any time since the 1930s, In Italy and Spain, left-wing antiestab- lishment parties, such as the Five Sear ‘Movement and Podemos, have prospered. ‘Trust in £0 institutions, traditionally higher than the popularity of national political institations (even in the con genitally Euroskeptical United King. dom), has fallen through the floor. ‘Anti-Buropean radicalism is spreading ‘A catastrophic collapse of the whole ‘monetary system may yet lie ahead. ‘Most observers now attribute these troubles tothe euro, Yet more than ‘ight years after the financial eisis began, the xv has done littl to funda mentally reform its single-eurrency arrangement, Three new books, all by Keynesian economists, are among the first to argue that more radical change is necessary and that the euro system must be replaced, Yanis Varoufakis, who served as Greece's fnance minister luring the fist half of 2015, and his erstwhile economic adviser, James Galbraith, base their critiques of the system on their firsthand experience guiding the country most ravaged by it. Joseph Stiglitz, a Nobel Prize-winning economist and former chair of the U.S. Council of Economie Advisers, lays out the euro’ failures and flaws and advances original proposals to repair it Ail three would prefer that the system be reformed. Yet all three reluccantly conclude that since that option is off the table, the best remaining choice may be to scrap the system altogether. 140 FoREION Arvarns DECLINE AND FALL How did Europe fll into this trap of low growth, high inequality, and political discontent? Galbraith offers the most suecinct explanation of why the system hhas benefited Germany atthe expense ‘of weaker economies: Without scutreney that could appreci- ate aginst those of her trading part ners, German productivity increased and its technical excellence produced a decining real cost of exports, while in its Buropean trading partners, deprived ‘of currencies that could depreciate, stable purchasing power and easy credit produced a corresponding increase in demand for German ‘goods. Meanvhile, Germany held ‘down its internal wage level while ‘other countries allowed wages and ‘unit labor eosts to rise. The low of ‘goods from Germany... was matched by a flow of credit, either ditety t0 state purchasers of ams and infra structure, a in Greece, or indirectly via private financing of residential and commercial construction booms, asin Spain and Ireland, In all cases the unbalanced flow of goods matched the accumulation of debts; the Greek instance was merely the mot extreme. ‘The Greek story is properly a Euro- ‘ean story in whieh, a nll European stories, Germany takes the leading role In short, Germany depresses the value of its currency to promote exports, just as China i often accused of doing —yet in this case, the euro makes Belin’ policy seem more legitimate and deflects the blame. Varoufakis, Galbraith, and Stghite differ on the details, but they all blame the euro system and, especialy, Germany. Such a failure of international monetary design is hardly unique to to int rey a sic G hy ee th Pr » wl fr RwRSeRR EREtoday’s Europe, Stiglite shows that international systems of pegged eurren- cies, of which Europe's single currency represents only an extreme example, “have long been associated with reces- sions and depression.” In the 1920s, ‘many countries returned to the gold standard, which culminated in the Great Depression. In the easly 1970s, the Bretton Woods system of pegged currencies once again slowed economic growth in a deficit country—in this case, the United States. To restart growth, President Richard Nixon decided to destroy the system unilaterally. And in 1991, Argentina hoped to curb inflation by pegging its peso to the U.S. dollar, whi red a severe economic crisis from which the country has still not entirely recovered, The reason curtency pegs often depress economic growth lies in the essential nature of monetary arrange- ‘ments. Currency pegs force a common policy on countries, and almost all economists agree that this works properly only when the macroeconomic perfor- ‘mance of the participating countries converges. If countries have similar levels of wage and price inflation, public and private deficits, exposure to external shocks, and competitiveness, it is rela- tively easy to find a common policy response to a shared threat that suits all and shares the pain and relief more or less equally. In the real world, however, countries have diverse market positions and domestic institutions, which means ‘that macroeconomic convergence is hard to come by. ‘Thar’ a problem, because a currency peg prevents the governments of coun- ‘ries that run trade deficits and incur debt from pursuing healthy economic Europe's Uply Future policies to correct the problem. When a country faces a recession, a negative externa shock, or eroding competitive ness, its government would normally loosen comestic monetary policy (thereby lowering interest rates and stimulating investment), et its currency depreciate (thereby boosting exports, reducing imports, and transferring income to the sector ofthe economy that produces ‘competitive goods), and increase gov- ‘ernment spending (thereby stimulating consumption and investment). But if a country belongs toa single-currency one, the first two options are by definition unavailable. And in the eurozone, the third option i difficult thanks to the v's stringent fiscal requirements. Defiertountries are thus left with only on: way to restore their competi- tiveness: “internal devaluation, the politically correct term for austerity ‘The country must reduce wages, gov ‘ermen: spending, consumer demand, corporate investment, imports, and, ultimately, growth itself. Stiglite con- cedes that austerity may eventually ‘work, but he argues that even ift does, the cast is too high. Better to allow countries to declare bankruptcy and start over, just as individuals and firms can doin « domestic economy. Varoufakis and Gabraith dismiss austerity as flatly self-defeating, because low growth simply ends up increasing the debt-to-cpe ratio. In such :ases, including Greece in reeent ‘years, permanent austerity becomes the only way to maintain international equilibrium. Tn the acknowledgments to his book, ‘Varoufais promises a forthcoming teal about his negotiations with the Ev and the International Monetary Fund, but he and Galbraith say enough to make it November/December 2016 141Andrew Moravesit ‘clear that the self-interested way in which France and Germany handled Greek debt only served to exacerbate the crisis, At the time, the IMF was led by Dominique Strauss-Kahn, and the European Contral Bank by Jean Claude Trichet—both nationals of France, the country whose banks were ‘most exposed in Greece. German banks also faced large potential losses. As Galbraith els t the French and German governments, loath to accept responsi bility for the migudgments of their own private investors or the design flaws of the sietary union, and seeking to avoid the unpleasant tak of asking their pal ‘ments to bail out domestic banks directly, formed a ‘creditors’ cartel” that foisted. the costs on taxpayers across the EU, as well as on the 14 ‘As Varoulakis and Galbraith detail from the inside, the punitive combina tion of debt, depression, and inequality has rendered Greece and other debtor countries all but ungovernable. Centrist governments have lost political legiti ‘macy, as has the eu. Citizens grasp at increasingly radkal new partes and lack the faith in Europe required to enact needed reforms ‘Germany has emerged almost ‘unseathed xt least so far. Berlin has preserved the existing euro system, which advantages it as an international creditor, an exporter of high-quality goods, and a country that suppresses wage increases. ehas enjoyed lower interest ates and higher growth txan the rest of Europe, ‘which has depressed the real cost of its exports, resultirg in a trade surplus larger in absolute terms than China’. ‘Yer the costs ofa flawed monetary system may eventually boomerang and ‘depress growth even in Germany. 142 rorrtex arrars Austerity is slowly reducing Germany's bility osll is good to other which buy more S than hls exports. German Ly bailing out 3 foci gover: indirectly their own naar ase sarting tole faith in the "Ta pony tat the entre system Could ellpee spreads ear and worry. Ye sock concerts take along time to develop—a longer time Fame than most German poltians seem to be thinking in, Inthe interim, decisions continu tobe ven by eaptal markets, European ules tnd dcetes fom Pars and Bern, REFORMING THE SYSTEM So what should Europe do? Stigliz ‘offers the most thorough evaluation of the possible options, There are three ‘The fist entails reforming the funda rental structure of the euro system so that it generates growth and distrb- utes the benefits faitly. Stiglitz details how the Eu and the European Ceniral Bank might rewrite tax laws, loosen monetary policy, and ehange corporate governance rules in order to boost ‘wage growth, consumer spending, and investment. Such policies could push the euro exchange rate downward, ‘enhancing the entire region's compat tiveness in relation to non-EuropeanYer since the basic problem is the divergence of national economi sound common policies are insufficient. National policies must be made to converge. The crisis has already placed pressure cn deficit countries to adjust through internal devaluation, but to climinate macroeconomic imbalances within the #u, any such program would also have to force the German economy, into fine, To do so, the EU could dis- courage tride surpluses by imposing a taxon them, The German government, meanwhile, could unilaterally engineer tte in domeste wages (by, sty, strength ening unions’ bargaining rights) and increase deficit spending. Over tine, such moves might help cfc counties stimulate growth and cetore ths compet tiveness of ther exports, both is Germany (by increasing German demand and raising the elative price of German goo) and vis--visthe rest ofthe wold (oy farther lowering the real exchange rate of the euro). Another st of structural polices would encoarage large Fal transfers dnd migration in order to ose the inegutes tha the euro ha induced a essence, this would repiatethe move sens of capital and people that make November/December 2016 143Andrews Moravcrit single currencies viable within individual ‘countries. Inthe United States, for example, federal spending on unemploy- ment insurance, welfare, infrastructure and industry bailouts, along with progres sive tines, adds up to sizable fiscal trans- fers from richer and more economically vibrant regions to poorer ones. The ru might establish similar system of fiscal transfers from creditor countries such as Germany to deficit countries such as Greece and Ialy. Viroufakis, for example, favors massive European investment and antipoverty programs. ‘An even more important factor that makes the dolla work in the United States is internal migration, When sectors in some regions decline—such as farming in the Midwest or manufacturing in the rust belt—people move to places with ‘more jobs. In Europe, Stiglitz proposes, Germany and other surplus countries could do more to accept and encourage continuous migration flows from deficit ‘countries. Germany might even benefit {rom such policies, since its growth has also slowed recently in large pare due to its dependence on exports to other Euro pean countries suffering under austerity Intheory, deep structural reforms represent the optimal choice—so much so that the phrase "monetary union requires fiscal union” has become a cliché among ‘European federalists, Yet such reforms hhave litle chance of being adopted. Germans are unlikely to renounce the export-led growth that has stemmed from their 60-year tradition of high savings, low inflation, and modest labor contracts, fiscal transfers to other countries, The net contribution of Germany to the BU totals just over 06 percent of cor. Ty match the transfer levels from rich to poor states 144 roRRION avrains within the Uniced States—hardly a erous welfare state by European Stands tat net contribution woud have tobe at lear 40 times big Moree, German tehnocat rote, wet ome justieaton, tha sl tan Tere cmply enennrge espns behavior by debrore=so-clled moral taza Beni the German gvenment wer ined to support such polices es own letras and busines eles would surely loc the, Tata nel sa majo: uptick in angio fom Burope' sath tots forth, Tbe sure, a few perento the Gree labor force hassle fed, tos to counties outset euro tone. Yt for migration to ve 2 major macroeconomic effect, mary more milion of Gre, Rains, Portugues, and Spanish would have ro move to Germany. Cites the sizeof Phoenix would have © popup in northern Europe an unthinkable prospect n thecrrenepotcalclimae Despite thew principle of fee mevement, many informal aries to obi sil protec special interests, Potialopos fon co imigtation i already rong in Acai, Denmark, Germary andthe Netherland and tes courts would not tolerate many milion of doa foreigners. ven ifthe north were more welcoming not southern Europeans have ile desire co leave me MUDDLING THROUGH [If major structural reform is unrelists, then the only way left to save the euro is totum toa second policy option: mud dling through. In tis scenatio, member states would strengthen the rv’ ability to manage the crisis. Governments have already taken initial steps in this direction.Jn 2012, the Ev created the European Stability Mechanism, an institution responsible for bailing out member states. "The Buropean Central Bank has engaged in monetary easing. And by putting in place greater central oversight and regulation, the 2v has fnally taken the early steps toward areal banking union, Yet a8 Stilt ight insists, such changes ar insufficient to make the 0's single-currency system work properly. ‘The burden ofthe current system on deficit countries must alo be eliminated — change that requires far more serious reform. Eventually, Europe would have to restructure it debt, perhaps by swapping existing debt with Goe-indexed bonds, ‘which reward investors if given country’s economy grows, oF by issuing so-called eurobonds, which would make all Euro- pean governments responsible for the debts national governments incur. At the same time, the EU eould more stingently regulate and guarantee the solvency of national banks, thereby decoupling them from national governments, Yet Germany and other creditor governments are naturally hesitant to accept financial responsibilty for debtor countries. With some justification, they view guarantees for banks and the mutu- alization of debt as ways of sneaking major structural reform and European fisal union in through the hack door, resulting in greater costs for Germany. ‘Such reforms would lo requir the BU to massively expand its oversight over national financial stems, soa to avoid the possibile that responsible behavior and moral hazard would create costs for others. No county likes ths idea, because in every member state—Germany no less than Greece or Italy~the government is loath to accept any external controls that Europe's Uply Future right call into question quiet political deals it has made with specific banks. ‘THE END OF THE EURO If neither of the two options to save the single currency and restart groweh is viable, this leaves only a third option abolishing the euro. Almost all Euro- pean politicans, and majorities in every ‘member state, reject this course, Most contend thzt it not only would prove uunimaginably expensive in the short term but also would spark another ‘economic crisis and deal a fatal blow to European integration. Yet various governments have already come closer to abandoning the euro than ‘many people realize. Galbraith recalls the Greek government preparing to withdraw from the eurozone (“Grexit”) both in 2011 and in 2015, Italian Prime Minister Siivio Berlusconi seriously contemplated withdrawal in 2011, as did the Spanish government at various times. Although Stiglitz would prefer that the eure be reformed, he admits that “there is moze than a small probability that i will not be done” and therefore argues for breaking up the system. ‘A.unique virtue of Stiglta’s book is that he takes this option seriously, advanc- ing original proposals fora “friendly separation.” Such options range from Groxit to his preferred alternative of breaking the eurozone into several subgroups, each with its own currency. Stiglitz makes the controversial argument that eliminating the euro as currently constituted, if implemented properly, would be feasible without speculators gaming the eystem or triggering. catastrophic bank runs—and that the move may be the only viable way to save ‘Europe. Varoafakis and Galbraith would November/December 2016 145Andrets Moravctit Tikely sympathize with his proposal and were more representative, they argue, clearly regret that Greece lacked the paliti- then they would enjoy sufficient legti- ‘al courage to forsake the system earlier, macy to solve these problems. The Fu when it could have done so more easily. needs more transparency in Brussel ‘Yet even the radical step of breaking up more robust direct elections to the the eurozone, Stiglitz makes clea, would European Parliament, a grand continent: probably help deficit countries only if wide debate, and political union, the ‘Germany agreed to increase domestic argument runs, so that the resulting spending, rein in speculation, and reduce Buropean superstate would be empowered deficits. Recall that European govern- to impose massive fiscal transfers and ‘ments originally embraced a single __ macroeconomic constraints on surplus ceurrency in part to limit the sel interested countries. Alternatively, if mote radical tuse of German monetary power, Abolish- alternatives could be fully debated in ing the euro might slightly improve the national elections, then member states options for deficit countries, but absent might muster the power to pull out ofthe deeper structural reforms, it would not eurozone or renegotiate their terms int. climinate the underlying problem. "These three books show how far from "The truth is, politicians want to be reality such schemes for democratiing reelected, and no European leader will Europe really ae. Despite their ereatvity risk his of her future by pursuing a policy in suggesting alternatives, these authors that is costly inthe short term but possibly concede that in the end, everything comes beneficial in the long term. The result down co choices made by self-interested of muddling through by politicians with sovereign states. Governments have tle ‘shore time horizons can thus only be more incentive to make charitable and risky of the same: austerity and slow growth, concessions, even in a united Europe with punctuated by intermittent economic economic prosperity onthe line, Poli: ‘and political criss. cans siuply lack the strength and courage to make a genuine break with the stcus FROM HERE TO AUSTERITY quo either toward federalism or toward "These three books advance compelling monetary sovereignty. As Varoufak’s critiques of the current euro system and writes, “All talk of gradual moves tovard creative suggestions for alternative poli- political union and toward ‘more Europe’ cies, And yet ironically, they make for are not ist steps toward a European depressing reading, because in the end, democratic federation but ather, and they suggest that there is no easy way ominously, leap into an iron cage that tout of Europe’s predicament, given the prolongs the crisis and wrecks any prospect ‘current politieal constraints. In the long of a genuine federal European democracy trun, muddling through may be the worst Thus, one is forced to conclude that ‘outcome, and yet itis the most likely. _ short of a catastrophic economic criss, Tn response to such a bleak prognosis, Europe can do little more than continue many European federalists, particularly to muddle through in aself-nduoec state ton the left, contend that Europe's real of austerity, thereby undermining iss problem is its “democratic deficit.” IFonly future prospects and global standing ® ‘0 institutions or national governments 146 FOREION arparas