The economics literature looking with a critical eye at the functioning of the Eurozone is expanding. A living legend, Nobel Prize laureate Prof. Joseph Stiglitz of Columbia University, the author of many influential scientific and popular books and articles, has zoomed in on this monetary bloc. Named “Euro and its threat to the future of Europe,” this majestic treatise ranges from a very brief history of the euro through the single currency’s current effect on the member countries’ economies to policy suggestions on how to fix the flaws of this monetary construct.
Key to Prof. Stiglitz’s argument of why the Eurozone concept is proving to malfunction is the fact that this monetary area in its implications undermines the economic growth of its member countries. In so doing, on a practical plane, it destroys dreams and aspirations of many millions of Europeans who have been without proper employment. Unemployment is stuck at high levels in many a Eurozone country and, tragically, the youth unemployment rate in the magnitude of 40% of those able to work is not rare in Southern Europe. So much for Prof. Stiglitz now.
Clearly, the euro has disappointed on the growth front yet. Which factors have been shaping this outcome?
This blog highlights that – aimed initially at monetary unification of the most advanced countries – the Eurozone spread further and also included peripheral countries in the South and East. As such, this area has hardly ever represented optimal currency area as defined by the seminal work of Prof. Robert Mundell, another Columbia University’s Nobel Prize winner. Furthermore, these peripheral countries, far from being mature and advanced ones, were caught in the middle of their own convergence processes.
Even if simplifying a bit, one can sketch a technical argument showing that countries within the currency bloc growing faster typically tend to develop higher inflation (Balassa- Samuelson effect should give rise to this phenomenon). How this all gets addressed by one monetary policy stance of the ECB – when the EA19 inflation landscape is quite heterogeneous – is hard to envisage.
Furthermore, with irrevocably fixed cross nominal exchange rates among Eurozone member countries, adjustment to shocks in the case of individual countries is much harder now. Without having one’s own currency an automatic equilibrating mechanism is missing. Typically, countries that found themselves far from their respective equilibria losing competitiveness had to undertake a very painful adjustment called “internal devaluation”.
For instance, tragically, Greece lost at least two decades in its development after the debt crisis erupted and when it had to undertake this socially very costly adjustment program. In all likelihood, the alternative would have been less painful; delinking from the euro resulting in a weaker Greek currency would have led to higher exports and more demand for domestic goods and services. It would have helped stop the real economy carnage.
Given all these arguments, what is the right palliative for the Eurozone so that one can look with more optimism to this currency bloc’s future?
Coming back to Prof. Stiglitz’s book, he advocates measures that imply either a higher degree of centralization in the Eurozone compared to the present (more Europe) or an amicable exit of some Eurozone countries (less Europe) as a solution to the Eurozone woes. The alternative position presented here by the author chooses to remain in the middle on “the less – more Europe dimension”. It rather focuses on early reforms and supply-side adjustment on an individual country level.
Given that economic systems continuously evolve, what could be helpful is more research and learning how Eurozone economies actually work. Focusing on early detecting the signs of whether countries are heading for major imbalances would be useful. For instance – in addition to current country-level surveillance practices – tracking the individual real effective exchange rates of the Eurozone countries and comparing them to a well-defined equilibrium yardstick would help with ringing the alarm bell in the case of countries that are vastly drifting away from their equilibrium positions. This way, pre-emptive policy measures could be put in place early.
Macroprudential policies and fiscal retrenchment could help the overheated economies in most instances. On the other side, structural policy measures aimed at restoring competitiveness can help countries heading for slow-downs or those stuck in low-growth traps. Innovative ways of boosting the supply side of the economy with early policy reaction would be particularly helpful. Such early policy responses could obliterate the need for deep internal devaluation and prevent the possible hysteresis effects from taking place, lowering the costs of adjustment.
As Prof. Daniel Trefler of the University of Toronto, the world’s renowned expert on competitiveness issues, suggests, the crux of competitiveness of national economies comes under the following triad: operational sophistication and strategy at the company level, micro-business environment, and macro, legal and political background.
This blog adds that fixing formal and lifelong learning education sectors to reduce skills mismatches on the labor markets, policies spurring entrepreneurship, and building functioning innovation ecosystems are some of the examples of measures under the rubric of improving a country’s competitiveness. A myriad of measures to improve the quality of the business environment, easing of the unnecessary regulatory and red tape burden on the real economy, and institutional reforms leading to lower country risk are additional examples.
However, it seems fair to say that these policies do not address the root cause of the weak Eurozone growth performance. Arguably, this stems from the very design of this monetary construct: it is the lack of natural adjustment due to the absence of own nominal exchange rates and own monetary policy response by the Eurozone member countries. Nevertheless, these supply-side policies, important in their right, may not only palliate the consequent mal-effects of the common currency but also significantly improve the productive capacity of the national economies.
There is a huge diversity among the Eurozone countries and the individual countries’ supply-side policy responses to structural weaknesses are still mostly national prerogative. Hence, room for policy innovations there is enormous and basically not circumscribed by anything except by local politics.
It is near deja vu. Even though we are talking the 2020’s, it seems, it is the right mix of supply-side policies that is the answer to the growth agony of many a Eurozone’s national economy.
Vladimir Zlacky