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Reply #22: What Can Save the Euro? Joseph E. Stiglitz [View All]

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Demeter Donating Member (1000+ posts) Send PM | Profile | Ignore Thu Dec-08-11 08:11 AM
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22. What Can Save the Euro? Joseph E. Stiglitz

Just when it seemed that things couldnt get worse, it appears that they have. Even some of the ostensibly responsible members of the eurozone are facing higher interest rates. Economists on both sides of the Atlantic are now discussing not just whether the euro will survive, but how to ensure that its demise causes the least turmoil possible. It is increasingly evident that Europes political leaders, for all their commitment to the euros survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal discipline no countrys fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozones member countries that must be kept in check. In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between good current-account deficits a government creates a favorable business climate, generating inflows of foreign direct investment and bad current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euros founding would imply.

In Spain, for example, money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows say into real-estate investment, for example are bad, and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EUs free-market advocates. The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate. The 1980s Latin American crisis was caused by excessive borrowing; but that could not explain Mexicos 1994 crisis, so it was attributed to under-saving. Then came East Asia, which had high savings rates, so the new explanation was governance. But this, too, made little sense, given that the Scandinavian countries which have the most transparent governance in the world had suffered a crisis a few years earlier.

There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do. These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment the interest rate and the exchange rate and put nothing in their place, or that the European Central Banks mandate is to focus on inflation, whereas todays challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition a race to the bottom to attract investment and boost output that could be freely sold throughout the EU. Moreover, free labor mobility means that individuals can choose whether to pay their parents debts: young Irish can simply escape repaying the foolish bank-bailout obligations assumed by their government by leaving the country. Of course, migration is supposed to be good, as it reallocates labor to where its return is highest. But this kind of migration actually undermines productivity.

Migration is, of course, part of the adjustment mechanism that makes America work as a single market with a single currency. Even more important is the federal governments role in helping states that face, say, high unemployment, by allocating additional tax revenue to them the so-called transfer union so loathed by many Germans...But the US is also willing to accept the depopulation of entire states that cannot compete. (Some point out that this means that Americas corporations can buy senators from such states at a lower price.) But are European countries with lagging productivity willing to accept depopulation? Alternatively, are they willing to face the pain of internal devaluation, a process that failed under the gold standard and is failing under the euro?


Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.
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