In this extract from his new book, the Nobel prize-winning economist argues that if the euro is not radically rethought, Europe could be condemned to decades of broken dreams.
Europe, the source of the Enlightenment, the birthplace of modern science, is in crisis. This part of the world, which hosted the Industrial Revolution that led to unprecedented changes in standards of living in the past two centuries, has been experiencing a long period of near-stagnation. GDP per capita (adjusted for inflation) for the eurozone – the countries of Europe that share the euro as their currency – was estimated to be barely higher in 2015 than it was in 2007. Some countries have been in depression for years.
When the US unemployment rate hit 10% in October 2009, most Americans thought that was intolerable. It has since declined to less than 5%. Yet the unemployment rate in the eurozone reached 10% in 2009 as well, and has been stuck in double digits ever since. On average, more than one out of five young people in the labour force are unemployed, but in the worst-hit crisis countries, almost one out of two looking for work can’t find jobs. Dry statistics about youth unemployment carry in them the dashed dreams and aspirations of millions of young Europeans, many of whom have worked and studied hard. They tell us about families split apart, as those who can leave emigrate from their country in search of work. They presage a European future with lower growth and living standards, perhaps for decades to come.
These economic facts have, in turn, deep political ramifications. The foundations of post-cold war Europe are being shaken. Parties of the extreme right and left and others advocating the breakup of their nation-states, especially in Spain but even in Italy, are ascendant, and in June Britain voted to leave Europe altogether. What had seemed inevitable in the arc of history – the formation of nation-states in the 19th century – is now being questioned. Questions are arising, too, about the great achievement of post-second world war Europe – the creation of the European Union.
While there are many factors contributing to Europe’s travails, there is one underlying mistake: the creation of the single currency, the euro. Or, more precisely, the creation of a single currency without establishing a set of institutions that enabled a region of Europe’s diversity to function effectively.
The common currency was an outgrowth of efforts that began in the mid-20th century, as Europe reeled from the carnage and disruption of two world wars. Europe’s leaders recognised that a more peaceful future would necessitate a complete reorganisation of the politics, economics and even the national identities of the continent. In 1957, this vision came closer to being a reality with the signing of the Rome treaty, which established the European Economic Community (EEC), comprising Belgium, France, Italy, Luxembourg, the Netherlands and West Germany. In the following decades, dominated by the cold war, various other western European countries joined the EEC. Step by step, restrictions were eased on work, travel and trade between the expanding list of EEC countries.
But it was not until the end of the cold war that European integration really gained steam. The fall of the Berlin Wall in 1989 showed that the time for much closer, stronger European bonds had grown near. Hopes for a peaceful and prosperous future were higher than ever, among both leaders and citizens. This led to the signing of the Maastricht treaty, which formally established the European Union in 1993 and created much of its economic structure and institutions – including setting in motion the process of adopting a common currency, the euro.
Advocates of the euro rightly argue that it was not just an economic project that sought to improve standards of living by increasing the efficiency of resource allocations, pursuing the principles of comparative advantage, enhancing competition, taking advantage of economies of scale and strengthening economic stability. More importantly, it was a political project; it was supposed to enhance the political integration of Europe, bringing the people and countries closer together and ensuring peaceful coexistence.
The euro has failed to achieve either of its two principal goals of prosperity and political integration: these goals are now more distant than they were before the creation of the eurozone. Instead of peace and harmony, European countries now view each other with distrust and anger. Old stereotypes are being revived as northern Europe decries the south as lazy and unreliable, and memories of Germany’s behaviour in the world wars are invoked.
The eurozone was flawed at birth. The structure of the eurozone – the rules, regulations and institutions that govern it – is to blame for the poor performance of the region, including its multiple crises. The diversity of Europe had been its strength. But for a single currency to work over a region with enormous economic and political diversity is not easy. A single currency entails a fixed exchange rate among the countries, and a single interest rate. Even if these are set to reflect the circumstances in the majority of member countries, given the economic diversity, there needs to be an array of institutions that can help those nations for which the policies are not well suited. Europe failed to create these institutions.
Worse still, the structure of the eurozone built in certain ideas about what was required for economic success – for instance, that the central bank should focus on inflation, as opposed to the mandate of the Federal Reserve in the US, which incorporates unemployment, growth and stability. It was not simply that the eurozone was not structured to accommodate Europe’s economic diversity; it was that the structure of the eurozone, its rules and regulations, were not designed to promote growth, employment and stability.
Why would well-intentioned statesmen and women, attempting to forge a stronger, more united Europe, create something that has had the opposite effect? The founders of the euro were guided by a set of ideas and notions about how economies function that were fashionable at the time, but that were simply wrong. They had faith in markets, but lacked an understanding of the limitations of markets and what was required to make them work. The unwavering faith in markets is sometimes referred to as market fundamentalism, sometimes as neoliberalism. Market fundamentalists believed, for instance, that if only the government would ensure that inflation was low and stable, markets would ensure growth and prosperity for all. While in most of the world market fundamentalism has been discredited, especially in the aftermath of the 2008 global financial crisis, those beliefs survive and flourish within the eurozone’s dominant power, Germany. These beliefs are held with such conviction and certainty, immune to new contrary evidence, that they are rightly described as an ideology. Similar ideas, pushed by the IMF and the World Bank around the globe, led to a lost quarter-century in Africa, a lost decade in Latin America, and a transition from communism to the market economy in the former Soviet Union and eastern Europe that was, to say the least, a disappointment.
Germany, however, holds itself out as a success, providing an example of what other countries should do. Its economy has grown by 6.8% since 2007, but at an average growth rate of just 0.8% a year – a number that, under normal circumstances, would be considered close to failing. (By comparison, the US growth rate in the same period averaged 1.2%.) It’s also worth noting that developments in Germany before the crisis, in the early 2000s – when the country adopted reforms that aggressively cut into the social safety net – came at the expense of ordinary workers, especially those at the bottom. While real wages stagnated (by some accounts decreased), the gap between those at the bottom and the middle increased – by 9% in less than a decade. And through the early years of the century, poverty and inequality increased as well. Germany is talked about as a “success” only by comparison with the other countries of the eurozone.
It is perhaps natural that the eurozone’s leaders want to blame the victim – to blame the countries in recession or depression or reeling from a referendum result – for bringing about this state of affairs. They do not want to blame themselves and the great institutions that they have helped create, and which they now head. But blaming the victim will not solve the euro problem – and it is in large measure unfair.
It should have surprised no one that Europe’s response to the UK’s referendum was dominated by the same harsh response that greeted Greece’s June 2015 ballot-box rejection of its bailout package. Herman Van Rompuy, a former European council president, expressed a widespread feeling when he said that David Cameron’s decision to hold a referendum “was the worst policy decision in decades”. In so saying, he revealed a deep antipathy towards democratic accountability. Understandably so: in most of the cases in which voters have been directly turned to, they have rejected the euro, the European Union and the European constitution. Moreover, polls at the time of Brexit showed that a majority of those in many European countries besides the UK had an unfavourable view of the EU (including Greece, France, and Spain).
The economic and political consequences of Brexit will, of course, depend a great deal on Europe’s response. Most assume that Europe will not cut off its nose to spite its face. It seems in the interests of everyone to work out the best economic relationship consistent with the democratic wishes and concerns of those on both sides of the Channel. The benefits of trade and economic integration are mutual, and if the EU takes seriously its belief that the closer the economic integration the better, that implies an attempt to make the closest ties possible under the circumstances. Anything the EU does to the UK to try to punish it would have an equal and opposite effect, hurting itself at least as much in the process. The fact that European stock markets were down markedly and European banks were particularly hard hit at least suggests that Brexit was bad for Europe as well.
But Jean-Claude Juncker, the proud architect of Luxembourg’s massive corporate tax-avoidance schemes and now the head of the EU commission, has taken a hard line – perhaps understandably, given that he may go down in history as the person on whose watch the dissolution of the EU began. His line is that Europe must be unrelenting in its punishment, and should offer little more than what the UK is guaranteed under normal global agreements, such as the World Trade Organisation, lest others join the rush to the exit. What a response! According to Juncker, Europe is not to be held together because of the benefits that accrue – benefits that far exceed the costs, the economic prosperity, the sense of solidarity, the pride in being a European. No, Europe is to be held together by threats and fear – of what would happen if a country leaves.
The euro is often described as a bad marriage. A bad marriage involves two people who never should have been joined together making vows that are supposedly indissoluble. The euro is more complicated: it is a union of 19 markedly different countries tying themselves together. When a couple in trouble goes for marriage counselling, old-style counsellors would try to figure out how to make the marriage work, but a modern one begins by asking: Should this marriage be saved? The costs of dissolution – both financial and emotional – may be very high. But the costs of staying together may be even higher.
One of the first lessons of economics is that bygones are bygones. One should always ask: given where we are, what should we do? On both sides of the Channel, politics should be directed at understanding the underlying sources of anger; how, in a democracy, the political establishment could have done so little to address the concerns of so many citizens, and figuring out how to do that now: to create within each country, and through cross-border arrangements, a new, more democratic Europe, which sees its goal as improving the wellbeing of ordinary citizens. This can’t be done with the neoliberal ideology that has prevailed for a third of a century and played such an important role in the construction of the euro. And it won’t be done if we confuse ends with means – the euro is not an end in itself, but a means, which, if well managed, might bring greater shared prosperity, but, if not well managed, will lead to lower standards of living for many or possibly the majority of citizens.
While there are many reasons for pessimism, more important are those for hope: that so many throughout Europe have held on to their faith in the European project, that even in countries where there is every reason for despair, there is still hope – hope that the EU can and will be reformed. There are political leaders throughout Europe who have become politicians because they still believe that democratic politics can bring about changes that will deliver shared prosperity to ordinary citizens. And throughout Europe, there are people, many of them young, who have marched, in the tens of thousands, for a different Europe; one, for instance, in which new trade agreements serve not just corporate interests but broader societal interests.
There are alternatives to the current arrangements that can create a true shared prosperity: the challenge is to learn from the past to create this new economics and politics of the future. The Brexit referendum was a shock. My hope is that the shock will set off waves on both sides of the Channel that will lead to this new, reformed European Union.
By Joseph Stiglitz