Tuesday, January 10, 2012

European revival: what Sarkozy, Merkel, Greece and others must come to terms over

Rules for European revival

When it comes to Europe’s problems there are several clear steps it can take to relieve its stress. It does not take these steps because Europe’s problems stem less from an economic misunderstanding of what it needs than from political divisions on what member states want or can agree to.

The simplest way to reform EMU would come from the usual approach to problem-solving: do not be too committed to what you have. But France is too-committed. France views the euro as Europe and as Europe’s future, thinking that if the euro fails Europe fails. It’s a view that is a bit dramatic and certainly not true. But if that view takes hold it will limit growth and restrict options for fixing Europe.

We maintain that until the name ‘euro’ stands for EUROPE instead of for the name of a currency (the ‘euro’), Europe cannot win. No country should make subservient its goals to the preservation of a currency. That is backwards. The currency or currency zone needs to serve the needs of those who use it, not the other way around.

For Europe it is a simple problem to fix the currency Zone that was an experiment that wound up with a lot of failures if Europe learned from them. In that case it can move to fix those problems and go on. But some of these failings are not completely understood or accepted by those who are members.

We think that the easiest way to fix this thing is to START OVER. Sometimes a policy is so poorly designed that it is better to start over. This is sometimes true in business too. For example, a piece of software may have thousands of lines of code and a business may want to keep all that work that has been put into it. But if the application does not work or is buggy it may be best just to start from scratch rather than to debug and rearrange things. I compare Europe to a flawed piece of software that needs to start from square one. But Europe is not there yet…

What are some of the antecedents of e-Zone failure? Solutions? Prospects?

1. Europe’s fiscal rules were lax; Europe’s fiscal rules were not enforced

2. When members were clearly drifting from their original currency parities (in real terms as some members ran persistently higher inflation) no country or institution in the Zone did anything about it.

3. Euro economies were too insulated from one-another.

4. Labor markets were too inflexible (Spain’s unemployment rate is over 20% while Germany is experiencing a post reunification low rate of unemployment!)

5. Given the huge social policy and productivity differences there almost has to be some supranational fiscal policy to bridge differences.

6. Euro.1.0 suffered from ‘the Japanese lunch box effect’. The Zone was not run as a whole but as an amalgam of independent regions with a common currency and central bank. Yet the needs and operations of all economies mix together in a currency zone and no country can ignore problems in a fellow member.

7. IF…IF… Europe want to go ahead and ignore problem #6 (Germany’s stance more or less) then it will need VERY strict fiscal rules to make each nation accountable and to make deviations in inflation, productivity, growth and fiscal policy actionable to bring trends back into common alignment.

8. On the other hand, with a supranational fiscal authority a stick AND carrot approach could be used when members’ paths began to diverge.

9. Europe needs to decide if it wants to be ‘European first’ or not.

10. IF it wants to be European first it then has to decide if it can get to that result in the context of one Zone or if it need to split up to let some of its more challenged members join together in a separate pool and try to make the changes that will eventually make them acceptable in a single zone.

11. IF countries cannot drop their national demands the Zone will break apart and these decisions will be taken from the members and made by the markets. While some Euro countries are critical that outsiders do not understand the insiders’ commitments to the Zone, what the insiders do not understand is that by being insiders they are too close to the issues and that they have too much of a personal view that they think they can convince others to accept. The Zone needs rules all members can abide: not France’s rules or Germany’s rules. There is some flexibility, here but there are some clear needs for a Zone to succeed. There is too little attention in the e-Zone on those matters that a Zone must have to survive and too much emphasis on what the large countries insist upon.

12. Europe may not be one nation, one vote. But without a clear vision a common vision shared by all members, every single one, it will not survive.

The list above is about suggesting the sorts of things that the e-Zone got wrong, that it needs to do and places where it needs to weigh and balance in order to survive.

In the end the e-Zone is a system. And like any system there is action and reaction. The Zone must resilient for a wide variety of repercussions. The Zone may need to break apart in order to stay together. If a few countries leave the euro is there still a Euro? If counties are allowed to leave with the option to mend some their flaws then be readmitted is that a bad development? Does letting one country leave damage the Zone forever because it sets the precedent that country can leave? That is a possibility. But if the Euro adopts a strong internal fiscal rule with vigilance and actionable oversight the trick will be to keep members in the middle of the fairway so that speculation about getting off track will not build. That is the way to deal with moral hazard if the Zone is allowed to break up.

For those who are worried about the Zone breaking up because of the current rules and their implications, take warning! Let’s remember that there are all sorts of rules that explain why a country will not leave EMU because it then can’t be in EU and to be in EU it must be committed to EMU (with two exceptions, Denmark and the UK). But take one step back! If EMU decided to divide, it would likely change these rules! Never bet against the person that can re-write the rules of the game while it is still in progress!



Their is no way out of the euro crisis.


Excellent post on revival.