What if the euro’s not worth saving?

June 26, 2012

The world is hardly lacking in clever ideas for how to salvage the euro zone. On Tuesday, several influential officials (including European Council President Herman von Rompuy and European Central Bank President Mario Draghi) put out yet another report calling for sweeping changes to the currency union. The usual proposals — banking union! common debt! — made an appearance. All that's needed, we keep hearing, is the political will.

A woman begs as shoppers walk by in central Athens. (Yannis Behrakis/Reuters)

But what if all these endless proposals for holding together the fractious euro zone are a mistake? What if the euro zone shouldn't be salvaged? In a long post on Tuesday, economist Scott Sumner explores the notion that no one wants to discuss. "Yes," he says, "a collapse would be very messy, and perhaps it should be avoided, but let’s not ever forget that the system we are trying to save is a bad one, and if we 'succeed' then the eurozone will be condemned to further crises in the future."

A few highlights from his essay: Many economists have argued that the euro zone should develop a "transfer union" like the United States has, in which richer states subsidize poorer ones. But Sumner argues that this analogy isn't perfect:

There are studies showing places like Mississippi receive massive subsidies from other states. ... But Mississippi does not elect Senators who call for higher taxes on the rich with the money going to support poor people in Mississippi.  The GOP would insist that’s because Mississippians have much more solidarity with the US than Greek voters would have with the eurozone. Dems would insist it’s all about white Mississippians having solidarity with other white people.  But even using that worse case assumption, America’s fiscal union is still based on a more stable foundation, after all, there are affluent taxpayers spread all across America.  There aren’t many affluent Greek taxpayers residing in Hamburg.

And here's an argument that a euro zone in which wealthy countries like Germany subsidize the rest will be unsustainable over the long term because it will suffer from an adverse selection problem. Richer countries like Sweden, Norway and Great Britain are never going to want to join. But poorer countries will want in:

Because of Abraham Lincoln, affluent states like Massachusetts can’t suddenly decide they want no part of our fiscal union, and would rather just reap the benefits of our large single market.  But Switzerland, Norway can and did make that choice.  Britain almost certainly would, and both Sweden and Denmark might as well.  In contrast, Bulgaria, Romania and Croatia would like nothing more than to join such a union.  And all the likely future expansion of the EU is into areas further east, and much poorer than even Greece and Portugal.  Places like Armenia, Georgia, Ukraine (a country nearly the size of France) Belarus, Serbia, Macedonia, Bosnia, Moldova (the saddest place on Earth—even the name is depressing.)  And did I mention Turkey?  Indeed why not Russia at some distant point in the future?

I’m sure the actual fiscal and political union ideas being kicked around are much more modest than the scary picture outlined here.  But once you start down that road, there isn’t any natural stopping point short of the United States of Europe.

Poor Moldova. There's a lot more in Sumner's post, so go read it. And, in fairness, he does offer his own way to save the euro zone: having the European Central Bank use determined NGDP targeting -- setting euro zone targets for nominal gross domestic product -- which he argues would boost inflation and growth and put the debt burdens of countries like Italy on a more sustainable footing.

Meanwhile, any argument that the 17-nation euro zone is futile needs to address the countervailing concern — that a break-up of the union could be quite painful. Der Spiegel is reporting that a secret analysis from the German finance ministry has found that a euro crackup would cause Germany's GDP to shrink by 10 percent in the first year alone and would double the number of unemployed to 5 million people. (Mind you, the German government is denying this report even exists.)

That said, scary projections like those seem to be losing their power to faze the German public. According to Bloomberg, a new poll has found that 39 percent of Germans "favor leaving the euro." And majorities in both Germany and France say they'd prefer to kick Greece out of the currency union if it can't repay its loans, which seems increasingly likely.

And that matters. As FT Alphaville's Masa Serdarevic writes, German Chancellor Angela Merkel is facing her own elections soon and has to pay attention to the voters. So, "it’s as important to understand what the German public is thinking and reading." And, increasingly, German voters seem to think that saving the euro just isn't worth the hassle.

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