After a 17-hour summit, Europe’s leaders have reached a deal. If the Greek parliament passes a package of reforms by Wednesday night, the country’s creditors will move forward with a third bailout on terms that are much stricter than previous proposals.
If the deal proceeds, it will avert the immediate chaos that Greece’s uncontrolled exit from the euro area would entail, and enable European leaders to talk about something else for a while. Unfortunately, it does nothing to address the fundamental issues that have repeatedly landed Europe in crisis since 2009. Former German Economic Minister Karl-Theodor zu Guttenberg quipped that Europe hasn’t been kicking the can down the road, it’s been kicking it up a hill and wondering why it keeps rolling back on its foot.
The core issue: Although the European Union can handle economies of widely varying types and levels of development, the euro area cannot. Greece’s gross domestic product per person was about half of Germany’s when it joined the euro in 2001. Since then, Greece’s competitiveness relative to Germany’s has slid by about 40 percent.
For a currency union to handle widely divergent economies, they must be deeply integrated across multiple dimensions. In the U.S., the average citizen of Mississippi makes just $20,618 a year, compared with $37,892 in Connecticut — almost as big a gap as between Greece and Germany. Yet the U.S. doesn’t worry about a “Missexit,” because the country has various mechanisms for smoothing over differences among its states. The recent problems of Puerto Rico show the danger of being locked to a currency without such buffers.
The mechanisms include large fiscal transfers– by necessity currency unions are transfer unions. Last year, 28 U.S. states sent the equivalent of 2.3 percent of their gross domestic product through the federal budget to the other 22 states. The biggest donor, Delaware, gave 21 percent. The biggest recipient, North Dakota, got 90 percent. By contrast, in 2011 Germany made a net contribution of 0.2 percent of its GDP to the EU budget, while Greece received 0.2 percent. Would German voters really support a tenfold jump in their contributions from 210 euros to 2,100 euros per person?
Large-scale fiscal transfers are not the only mechanism needed. Mississippi has probably run the equivalent of a current account deficit with New York ever since the Civil War. Every April, the banks in the Federal Reserve system reallocate assets and smooth over such regional imbalances. By contrast, when Greece runs a deficit with Germany — for example, due to trade with Germany or capital flight from Greece — its central bank accumulates debts to the Bundesbank indefinitely. The Bundesbank currently holds more than 500 billion euros in credits against other euro zone central banks. Again, would German taxpayers be willing to see the Bundesbank regularly write off some portion of those liabilities?
Another reason U.S. states don’t pop out of the dollar area is that they (with the exception of Vermont) have to balance their operating budgets. Only the federal government can run a long-term deficit. Again, Germany and other EU states have explicitly rejected any kind of euro-area sovereign-bond arrangement that would pool deficits. Finally, the U.S. has a deep single market for products, services and labor and a true national banking union, all of which in Europe are only partially completed projects. The lack of truly integrated markets allowed real interest rates and inflation to diverge across the euro zone, leading to a loss of competitiveness and a credit boom and bust in the south.
Thus, the euro area is stuck in a dysfunctional netherworld between a fully integrated union and a more flexible exchange rate mechanism. So Greece has to become a lot more like Germany (unlikely), the euro area needs to become a lot more like the U.S. (also unlikely), or we’ll have another crisis (very likely).
I have argued that given political reality the only long-term solution is a managed exit for Greece, in which the country would stay in the EU and receive lots of help from fellow member states. Although the transition would be difficult, it would ultimately allow the Greeks to regain sovereignty over their economy and rekindle growth, while helping Europe heal its divisions and move on.
The counterargument is that minimizing the pain of a Greek exit would encourage others to run for the door, unraveling the whole euro project. At the moment, though, no other country is as unstable as Greece. Given the costs and uncertainties of even a managed exit, it’s unlikely that others would want to follow Greece’s path. If over the coming decades a few do, a small number of managed exits might be better than constant crisis or a true unraveling.
The euro was never conceived as an end in itself. It was created as a means toward greater growth and unity. It has failed badly on both counts. If U.S.-style integration is politically unrealistic, then the only hope for long-term stability is a slimmed-down euro area of more homogeneous countries.
Europe must get out of its halfway house of horrors. Repeated bailouts and austerity won’t achieve that. Europe’s leaders may buy themselves a period of respite this week, but eventually they must choose: Either integrate far more deeply, or help the euro area’s most troubled members escape.