The Real Issues Of The Eurozone And How To Solve Them

Joe Stiglitz, thank you very much for joining us today. Let’s dive in right at the deep end. People might be forgiven for not following the Eurozone crisis and the euro crisis too closely, and it’s been rumbling on for years. Just to get us started, what in your view are the key problems of the euro and the Eurozone crisis?

One could think about it in the following way: the euro was created in the belief that it would further prosperity in Europe, and that in turn would lead to more political solidarity, more support for the European project. In fact, it’s led to an economic disaster. Growth in Europe, in the Eurozone in particular, has been abysmal; even the best performing countries, if you were grading them, would get a ‘D’. Even though the crisis itself began in the United States, the United States is reasonably well on the way to recovery. Not so for Europe; it careens from one crisis to another.

In the real crisis countries – Greece, Spain, Portugal, Ireland – the depth of the downturn was greater than in the ‘Great Depression’. That shows you how serious it is. Even today in Spain they call it a victory that the unemployment rate is down, finally, to 20%, youth unemployment is close to 50% in Greece. They thought they had solved the problem a year ago and GDP has continued to decline, so their GDP is now 25% below what it was before the crisis.

What is very clear is that things have not worked out the way they thought. What my book tries to do is to explain why that is, and there are two schools of thought. One of them is bad policymakers; they made some bad political decisions, too much attention to austerity.

What I argue is that the euro was flawed at birth. It was the design of the euro, the Eurozone itself. The best of policymakers could not have made this system work. To be sure, there were very bad policy mistakes that made things even worse, but it was a political project, as I said, but the politics were not strong enough to create the institutions that would have enabled the euro to have worked.

You just mentioned that you’ve got a new book on the whole subject out, called ‘The Euro: How Common Currency Threatens the Future of Europe’, and you also mention policymakers. What happened here in Europe is that the apparent solution – and that is ‘solution’ in inverted commas, I would like to add – was the creation of the so-called ‘Troika’, including the IMF, the ECB, and the European Commission, administering different programmes but all based on austerity and structural reform. Obviously, from what you said in your answer to my initial question it’s not worked out as expected, so, especially with austerity and structural reform, what went wrong?

First let me say my theory is that what you need is structural reform, but not in individual countries but of the structure of the Eurozone itself. It was precisely because they didn’t understand this they couldn’t design policies that would work. You have to go back to what does it mean to have a single currency? Having a single currency takes away two of the key adjustment mechanisms: exchange rate and interest rate.

If you do that, you have to put something in its place. They didn’t do that. In fact, they made things even worse: they tied the hands of each of the countries so that they would not have too big of a deficit; deficits had to be limited at 3% of GDP. Then, to make matters even worse, they told their central bank, the European Central Bank, “Focus only on inflation; don’t worry about unemployment,” unlike the United States, where we have a mandate – our central bank has a mandate – for inflation, but also unemployment growth and financial stability.

What happened is they had this peculiar idea that deficits caused the crisis in the first place, so they responded by saying, “Let’s get rid of the deficits.” Let me just point out: that diagnosis was wrong. Spain and Ireland had a crisis and they had a surplus before the crisis, so their diagnosis was wrong. Therefore, their prescription was wrong.

What happened then is, as they started insisting on more and more austerity, the economies got weaker, tax revenues went down, and years later the fiscal position of these countries, the debt sustainability, is even worse than when they began.

‘Structural reform’ is one of the most abused terms around. You mention actually structural reform should be about Eurozone structural reform rather than what they administered in different deficit countries – i.e. liberalising labour markets, cutting back the roles of collective bargaining and trade unionism, and so on and so forth. Has it been a smokescreen for basically a political agenda in many cases?

Yes, very much so, a political agenda and also a special interest agenda. Every country needs structural reform, the United States needs structural reform. We have real problems in many of our sectors; economists are increasingly worried about the concentration of market power in many of our sectors, undermining efficiency, but those structural deficiencies result in lower standards of living.

Structural deficiencies in Greece before 2008 resulted in their having a lower per capita income than, say, in Germany, but they don’t result in massive unemployment, GDP going down, all the symptoms of the depression or the deep recessions that country after country was confronting.

Another way of thinking about this is, if only one country had a problem, you would say, “Maybe there’s something wrong with that country, with its structure,” but when you see so many countries having a problem, you can’t help but suspect it’s something common. That common thing is the euro.

The reason the countries have not gotten well very quickly is that the prescriptions – both the austerity and structural reforms – have been the wrong medicine. The structural reforms that they’ve imposed have been used as a way, as you say, a political agenda to try to weaken labour, to increase inequality, to lead to more inequality.

Let me give you an example of the kind of peculiar structural policies, demands that were imposed in the case of Greece. The fire is burning, Greece is in a deep depression, and the Troika is discussing how old milk can be and still be labelled ‘fresh’. You ask, “Why? How can you be talking about that? What was the issue?” The issue was – appears to be – that big producers, corporate producers of milk in northern Europe and the Netherlands wanted to be able to sell their unfresh milk to Greek consumers, with the label ‘fresh’.

Interestingly, doing that would actually exacerbate the balance of payments, the trade deficit of Greece, make Greece’s situation worse, would lower Greece’s GDP, so it was actually a bad medicine. But they weren’t focusing on that; what must’ve been on their mind is how do they use this structural reform agenda to help some special interests that were weighing in on Troika politics.

Joe, in your book you make the argument that I, personally, agree with and a lot of commentators agree with that in the end it’s either make or break so that the current structure, it’s a halfway house, it’s unsustainable, but obviously this meets a European Union whose core competency is ‘muddling through’ and not resolving problems in a timely fashion.  

At the same time – and I know this is a subject you’ve also written a lot about – we are in the middle of, or maybe even at the beginning only, of a backlash against globalisation, against elites. There’s a lot of discontent amongst publics in the Western world. How would you see this interacting with the need – the dire need – for reform in the Eurozone? Does this put the pressure on?

Very much so. As you said, I think that this halfway house is not going to work and is going to have dire consequences, both economically and politically. Let me give you two scenarios, both of which should be of great concern. One of them is that, because the euro is not working – and it’s obviously not working in the crisis countries, but it’s also not working in Spain, in Italy, in France, what you might call the ‘near crisis’ countries; we’re talking about a very large fraction of the Eurozone – the fact that these economies are doing so poorly and so many people are unemployed, there’s so little hope, has fed the anti-EU parties.

It’s fed the extremist parties on both the left and the right, particularly on the right, because what they’re telling the voters is, “Look, you have voted many times in austerity, but every time we have an election the new government comes in and says, ‘I tried to bargain with Germany, but it says, ‘No.’” It’s so humiliating – it must be – for a government to have to campaign on the agenda: “I am the best person for bargaining with Germany.” You’ve lost an enormous amount of sovereignty and so the extreme parties on the right are saying, “I’ll get that sovereignty back for you.” That’s not a healthy situation.

The interesting thing is that this politics also weighs into a real risk of economic instability because, should it appear to be the case that that there might be a victory for an anti-euro party, people will start taking their money out of the country; there will be capital flight. That capital flight will exacerbate the problems that they are already confronting. So, what worries me is not only are there dangers to the, you might say, democratic politics of Europe, there’s also real danger to the economic stability of the Eurozone.

You’ve just mentioned that one of the key criteria for elections in other European countries should be who can bargain best with Germany. We both know how difficult it is to enact policy change, but in your view what would be the way, what needs to happen for political change in terms of economic policy in Germany?

Here the difficulty is that there are widespread differences in Germany with most of the rest of the world with respect to economic policy. That’s why I’ve argued that not only do you need economic convergence to make a single currency work, you also need political convergence.

Let me explain what I mean. In most of the world we’ve learned that austerity doesn’t work. I sometimes refer to this as ‘Hooverite policy’, because Herbert Hoover was the one who introduced these policies in response to the stock market crash and converted the stock market crash in 1929 into the ‘Great Depression’.

Since then those policies of austerity have been tried over and over again; they were tried by the IMF in East Asia, in Latin America. Today economic science is pretty clear that austerity never worked. Even the IMF has come out and explained that austerity doesn’t work. Contractionary policies are – guess what? – contractionary. The IMF is not a left-wing institution here; the mainstream has said, “austerity doesn’t work.”

In spite of that, the German government and it’s a very strong view held by the German people, they still believe that austerity works. When you have a system that gives that much power to Germany, what you’re doing is you’re telling the people in Italy, Spain, the other countries of southern Europe, “You have to delegate economic policy to people who have a totally different economic theory” – an economic theory that has been discredited. “The fact that it’s not going to work, don’t let that bother you; you’ve signed up to this and accept it.” I don’t think that that’s viable over the long run.

Any ideas? Where would you start if you wanted to change the situation? What would be the first step?

I think the first step is either you get them to agree to more Europe or less Europe. I think it’s going to be very difficult to get them to agree to more Europe – that is to say to have common deposit insurance, to have Eurobonds, to have the kinds of policies that would really lead to convergence of the countries.

If that is not going to work, the other way forward is to say, “The EU has a lot of strengths; you could have free mobility of goods, but this idea of a single currency, we’re not ready for it now.” Whether we’re going to be ready for it in the future is another question, but we put the cart before the horse, so we have to think about what is the best way of leaving the euro?

In the book I talk about several alternative ways of leaving the euro behind: an amicable divorce, a system of what I call the ‘flexible euro’. You could have a two-euro region: a northern euro and a southern euro. There are several alternatives.

Some people will say, “Isn’t leaving the euro going to be very costly?” My response is very simple: the current system is enormously costly. If you thought about how the breakup could be managed in the best way possible in this amicable divorce, the cost of leaving would be small relative to the current system of muddling through.

You mention the economic points, but talking briefly about the politics, this reminds me very much about the Brexit situation. Is there really a scenario for an amicable divorce, or isn’t there bound to be a political fallout that will also stifle cooperation going forward?

Maybe in the first blush there might be some hostility, but look at what’s been happening after the Brexit. Right after the Brexit, Juncker comes out and says, “We’re going to treat the UK really shabbily. Why? Because we have to show other countries they can’t leave.”

If you think about that for a moment, it’s a really striking because he wasn’t saying, “The EU provides such benefits to the citizens of each of the member countries that they will want to stay in, and the benefits were not adequately explained, we didn’t do a good job of explaining it.” What he says is, “We have to keep the EU together by fear.” To me, that kind of attitude is precisely the kind of attitude that will lead to the breakup of the EU – the people of Europe have to be brought together on a basis of solidarity and an understanding that is to their common benefit, not out of fear.

A little bit later, you start hearing from Germany and from other countries of Europe, “No, Juncker was not reflecting our considered opinion that we are going to have to make the best deal possible consistent with the outcome of the referendum. There are large benefits to economic integration, and we’re going to figure out the best way forward.”

I think, in the long run, that kind of reasonableness will prevail. It’s obviously going to prevail; there are so many interests in Germany and other countries to ensure that it’s going to prevail. So, in my mind, that is the more likely outcome.

Okay. With Brexit we are only at the beginning, but if you finish on a more positive note and assume that we in Europe can muster the political and economic courage to address the Eurozone problems head-on, what in your mind are the most pressing policy steps that should be implemented in the short term, then the ones in the medium term, and maybe some long-term reforms, to make the whole system more stable?

If you’re going to continue with the euro, the kinds of things that you need to do are the kinds of things that address the most obvious deficiencies. You begin with the fact that when you adopted the euro you took away the adjustment mechanism of exchange rate and interest rates, and you don’t leave anything in its place. So, then you say, “How do we adjust the real exchange rate when there is a need to adjust the real exchange rate?”

One of the things is – there are two ways of doing it – to increase the price in the countries with the surplus, like Germany, or lower the price in the deficit countries, so countries like southern Europe. We know from economic theory that downward price movements are much more difficult than upward price movements. To put it another way, when you lower wages and prices, which is called ‘internal devaluation’, you increase leverage and that has a very adverse effect. That’s why deflation is viewed as being so negative in its consequences.

What you need to do is, for instance, impose a tax on surplus countries. The revenue of that tax could be used to help the deficit countries to finance a solidarity fund for stabilisation, to help the countries that are having difficulties. You have to have a system, as I mentioned before, of common deposit insurance, because otherwise money will move to the strong countries.

One of the real problems that we’ve seen in Europe is that, rather than convergence, we’ve got divergence. The weaker countries have gotten poorer and the stronger countries gotten stronger. That has to be reversed. One way of preventing that is strong industrial policies that help the poorer countries catch up on the stronger, but you also need to have common deposit insurance; you have to have Eurobonds.

Those are some of the things that you would need to do in both the short term and the medium term in order to make the euro work.

Joe Stiglitz, the game is on and hopefully European policymakers can make this work. Thank you very much for talking to us today.

Thank you.