A Greek exit from the Eurozone is a very bad outcome for that country and for the European Union, but it probably is the least-bad one for either, and it may be inevitable over the long run.
The joke going around my field is that Canadian-born economist Robert Mundell, often called “the father of the euro,” should get a second Nobel Prize this year. He got his first in 1999 for his work, begun in 1961, on “optimum currency areas” — widely credited as the theoretical basis for the multi-national European currency.
The euro debuted for general use Jan. 1, 1999, and Mundell got the Nobel that fall amid general ebullience over the new currency.
However, it’s been obvious to many economists, even going back 20 years, that the now-19-nation eurozone really does not meet Mundell’s criteria for an optimal area. So the joke is that he should get a second award because his same work can now be used to predict that forces like Greece’s prolonged crisis could eventually bring down the system, or at least severely diminish it.
The primary issues are labor and capital mobility. Workers across the whole currency area must be free to move without legal, cultural or even language barriers. They must be able to take their pensions with them. If people in a depressed area cannot simply load their belongings into a rental jalopy and head to another region that has more jobs, you don’t have labor mobility.
Similarly, capital has to be able to flow freely across borders, with no major disincentives in tax treatment or securities laws, for example.
These first two conditions then lead to a third, that there be some sort of “fiscal transfer mechanism” to move money to those depressed regions that suffer through loss of local labor and capital. Funds would have to come from the areas that benefited.
Finally, business cycles of participating countries would have to be roughly in synch. If some frequently are in recession while others face inflation, it is hard to find an appropriate unifying monetary policy.
The eurozone clearly doesn’t meet these conditions.
If Mundell’s criteria are met, a common currency across a wide area can boost economic efficiency by broadening markets. It can increase trade and foster economies of scale. But if the criteria don’t apply, efficiency would be lost as disadvantaged areas suffered persistent stagnation. Unless the new pact would be able to backtrack, society as a whole would be worse off, with the misery concentrated in specific regions.
That unwinding process seems to be underway.
Yes, perhaps a last-minute deal will be patched to kick the Greek economy down the road a few more months or perhaps years. But if Mundell’s work is correct, and I think it is, then the 19-nation eurozone he “fathered” is an economic mistake that will make its residents poorer rather than richer. They would have been better off had it never been attempted. This is clearly true for Greece. Which other nations does this also apply to?
And how, then, do they unscramble this omelet? It will be difficult, but not impossible, to unravel all the euro-related financial ties woven over the past two decades. In the immediate case, it simply cannot be done without Greece suffering a long and wrenching recession.
Naive Greek voters, who think it never will happen, and naive economists, like Nobelist Paul Krugman, who think a Greek exit — or “Grexit” — can be short and only slightly sour, are going to be shocked at how bad things will get before there is improvement.
Neither side in the negotiations occupies any moral high ground. Germany benefited from numerous debt writedowns over the past century. That nation and France both flouted the “convergence criteria” rules agreed on for euro participation. The Greeks have done little in some areas, like putting real teeth into tax collections, that are vital to sustaining finances for the long run. But as former U.S. Secretary of State Dean Rusk once observed, “moral leadership … is highly overrated.”
As debt crisis expert Carmen Reinhart and others have pointed out, there is no example in history where a debt crisis of this magnitude was resolved without a significant write-off of principal to be absorbed by the lenders. Repeated reschedulings, as in the Third World debt crises of the 1980s, provide no long-term solutions. Other EU members, particularly Germany, are not willing to write off substantial principal. Greece is unwilling, or currently unable, given its political and economic culture, to make substantial and lasting changes to its taxing and spending.
However, even if the EU were willing to write down principal and Greece did make structural reforms, the fact remains that the eurozone, at least with its current membership, may be a negative factor for the continent’s economy. It will be a drag on economic growth and a source of political tensions unless it is dissolved or greatly restructured. And there is no practical way that can happen without a wrenching recession in many areas and political tremors in some.
The current euro may have to be sacrificed to save the underlying European Union itself. (A smaller currency zone, say between Germany, France and the Benelux countries, might be viable, but that is another question.) No key leader is yet saying this. But infection is accumulating under economic and political bandages and will seep out eventually.