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Resolving the euro drama

by Brigitte Granville

Resolving the euro drama

Since 2012, the crisis of the euro area, and hence of Europe, has ceased to be a financial market malaise and has instead become a slow-burning political crisis.

For around 24 hours last year – on 15 July – it seemed the crisis could end. Wolfgang Schäuble, Germany’s finance minister, proposed Greece should ‘temporarily’ leave the euro area and gain financial support from euro area members as it returned to its national currency.

François Hollande, the French president, crushed that idea. Of all his mistakes, this is one of the most underestimated. Yet Europe’s basic problems lie still deeper than Greece, with countries at the euro area core. Realigning nominal exchange rates between these core countries is a necessary condition for any serious growth upturn.

Schäuble has suggested a controlled euro area dismantling. The alternative will be that electorates take matters into their own hands and opt out. I mean electorates within the core: Italy and France. It is here that this great drama will be resolved.

Damp squib recovery
The European Central Bank forecasts the euro area will grow 1.4% this year against 1.5% in 2015. Growth is slowing despite the oil price windfall and the euro’s depreciation following ECB quantitative easing.

This comes against the background of a double-dip recession in the early years of this decade. A strong bounce-back would normally follow such a recession. Instead we have a damp squib, with persistently high unemployment.

‘Euro-optimists’ point to the well-known global problems of weak demand, with China now a particularly fashionable theme. ‘Euro-pessimists’ insist the root causes are within Europe. In my opinion, the single currency provides the essential perspective. The euro has a direct negative effect on growth. This exerts an indirect effect on everything else.

The Italian economy’s dreadful performance since the euro’s launch results from a collapse in labour productivity growth. Alberto Bagnai, the Italian economist, in a paper for the International Review of Applied Economics, demonstrates that only one explanation fits the facts – Italy’s membership of monetary union, which has brought real (inflation-adjusted) appreciation of the Italian currency relative to Germany and other similar countries.

Both devaluation and any change in German policies of domestic demand compression are impossible, so Italy’s only choice is internal devaluation. Bearing down on wages cannot generate a positive demand shock: this policy is simply degrading Italy’s industrial and social fabric.

So-called anti-austerity policies would not work either. Such an approach would result in Italy violating its balance of payments constraints and soon lead to another financial crisis.

We see degrading of the industrial and social fabric in all other euro members that have become uncompetitive relative to Germany, and above all in France.

The economic effects are explained by the ‘cumulative growth model’ refined by Tony Thirlwall, the British economist. He warned in the 1990s that, far from making the balance of payments irrelevant, monetary union would make participating countries more vulnerable by accentuating competitiveness divergences. ‘Once a country obtains a growth advantage, it will tend to sustain it… but if a country undergoes a negative growth shock, it will be trapped in a low-productivity growth path’.

France is trapped in exactly this way. Or, more accurately, France has trapped itself, as it was the French governing class that forced Germany to accept monetary union in 1990.

The euro-induced absence of growth significantly complicates responses to all Europe’s other problems. If European unemployment were on a par with the US, at 5% rather than 10%, the difficulties of handling the migrant crisis would still be great, but they would be more manageable.

Europe is like a man cast overboard into the sea with his legs tied together. Using his arms, he can just about keep his head above water, but he cannot solve his predicament. Over time, sheer grind and exhaustion will overcome him.

Electorates will increasingly want to opt out. The latest example is the Netherlands’ rejection of the EU’s association agreement with Ukraine in the April referendum. We can expect more such episodes in future. 

■ Brigitte Granville is Professor of International Economics and Economic Policy and Director of the Centre for Globalisation Reform at Queen Mary, University of London. This is an abridged version of a speech at the State Street Global Advisors-OMFIF seminar in London on 13 April.