Tuesday, February 7, 2012

More Euro Agonistes

We've always believed that resolution of the euro crisis had to include a Greek exit from the currency union. Now, many the consensus-driven financial community are busy hedging towards a similar position.  For example, from the Wall Street Journal, we read:

"Citigroup on Monday raised its estimate of the likelihood of a Greek exit from the euro area over the next 18 months to 50% from a prior range of 25% to 30%, according to the bank’s latest “Global Economics View” analysis by economists Willem Buiter and Ebrahim Rahbari." (Wall Street Journal)

The Jerome A. Chazen Institute of International Business at the Columbia Business School recently sponsored a panel discussion on the euro crisis.  A video of the forum, along with pdfs of the presenters slides is available.

The foundational issues are good, old fashioned issues of international economics.  The European currency union was put together with members whose economies were too diverse in size and character.  The entire theoretical framework of the currency union  put together by Robert Mundell, Roland McKinnon and Peter Kenen required a basic assumption that inflation rates among the members were similar.  The entire model, like most international trade models, requires factor mobility (labor and capital), and no economic rigidities in labor markets, for example.  The creation of the customs union was a backdrop for the currency union.

However, the elephant in the room was always "harmonisation" of fiscal policies in the language I read in the economic literature when studying in Europe. That harmonisation was supposed to magically lead to integration of fiscal and political policies.  There never was a harmonisation of fiscal policies,  and there surely will never be an integration.  The geographical and politicial balkanization of Europe has settled that issue. 

The current situation has also introduced significant economic distortions in Europe, as Professor Beim's slides show. Germany was the first to rationally remove labor market rigidities, regulatory burdens, and to provide financial incentives for its export-oriented sectors.  Subsequently, German industrial output showed rapid growth, while those of large economies like Italy fell, from the date that the euro exchange rate was fixed.  Greece fared far worse. 

European politicians are skilled diplomats, unlike our own rough-and-tumble media brawlers, and so they will put a better face on the crisis.  More importantly, they will stretch out the meetings, summits, communiques and public lectures so that any exit will be relatively orderly.  Meanwhile, the economic and social  costs of the adjustment to the weaker EU members will be genuinely painful. 

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