The Euro Isn’t Dead (Yet)

To many southern Europeans, euro membership is the lesser of two evils when greater monetary control by their national governments is the alternative.
June 4, 2018 • Commentary
This article appeared on The Weekly Standard on June 4, 2018.

People have been forecasting the end of the euro since the currency came into being in the late 1990s. Yet the euro has survived five sovereign bailouts—including three successive ones of Greece (the continent’s most troubled economy)—and two bank rescues aimed at Spanish and Cypriot banks. The Eurozone debt crisis reached a climax in the summer of 2012, when European Central Bank Chairman Mario Draghi defused it with his vow to do “whatever it takes” to preserve the single currency.

Regardless of one’s views on the prudence of the ECB’s subsequent monetary easing, Draghi’s promise succeeded in calming financial markets.

Yet six years on, political uncertainty in Italy and Spain has people pondering the imminent demise of the euro again:

Earlier this week, the Italian president’s refusal to appoint a finance minister who had previously advocated contingency planning for a potential Italian exit from the euro unsettled bond markets, causing interest rates on the country’s debt to skyrocket. While subsequent negotiations have ended the stalemate and delivered a coalition government, their members’ strong anti‐​EU disposition will prolong policy uncertainty.

In Spain, a vote of no confidence in the centre‐​right government has led to its replacement by a left‐​wing administration propped up by communists and separatists, igniting fears that the market reforms undertaken since 2012 may be unraveled.

And raising taxes, increasing regulation and centralizing power would indeed spell doom for the Spanish economy, whose GDP has been growing at annual rates in excess of 3 percent for three years. Unemployment, which topped 26 percent at the height of the crisis, has since fallen rapidly thanks to a much‐​needed loosening of hiring and firing rules.

Italy’s recovery has been less resplendent, with tepid growth, stagnant labor productivity and wages, and a national debt of around 130 percent of GDP. Nevertheless, its fiscal position had stabilized in recent quarters and business investment had picked up after a number of modest regulatory reforms.

* * *

Skeptics of the euro blame the single currency for the poor economic outcomes of southern European countries (the uncharitably nicknamed “PIGS”).

However, if you look closely at the data, it’s clear that bad performance long precedes the advent of the euro: Unemployment rates of 25 percent have characterized every major Spanish recession since the 1970s. Greece has defaulted on its external debt on half a dozen occasions since it became an independent country. Italian productivity growth began to falter in the early 1990s, hampered by onerous labor market rules, inefficient taxation, poor property rights protections, and a weak bankruptcy code.

In other words, the barriers to the economic healing of these countries lie mostly with domestic politics and policy, not the strictures of their membership in the Europe‐​wide currency.

There are problems with the euro, to be sure. A single currency for a large and diverse geographic area makes optimal monetary policy difficult to implement. Furthermore, the absence of control over the currency makes governments unable to use devaluation as tool of crisis management. (Although depreciating currencies can temporarily improve a country’s competitive position, in the long‐​run it lowers living standards and has historically been resorted to more by incompetent governments in failing economies than by responsible democracies.)

Another problem of the euro as it exists today is that its rules are routinely violated. Member countries were never supposed to borrow as much as many have. Nor was there supposed to be any tolerance for bailing out individual countries. Some have even questioned the constitutional propriety of the ECB’s monetary loosening.

But, to many southern Europeans, euro membership is the lesser of two evils when greater monetary control by their national governments is the alternative. There are few things that Spaniards and Italians enjoy less than the patronizing politicians from Germany and the Netherlands. But one of them is surely their own political classes.

Which explains the persistence of public support for euro membership, even as politicians routinely disparage the constraints it places on domestic policy‐​making. When the Greek government held a referendum on the conditions imposed by its creditors in 2015, a majority supported its defiant stance. Yet Greeks refused to countenance the country’s departure from the euro and the E.U., and the associated loss of freedoms and purchasing power.

This time is unlikely to be any different. Even if political squabbles prolong uncertainty into the summer, the cataclysm will probably fail to materialize. There is simply too much at stake in Italian and Spanish membership of the euro, and even disgruntled citizens know this in their heart of hearts.

About the Author
Diego Zuluaga
Former Associate Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives