Euro – Quo Vadis? How much more punishment will Europeans take to defend the misconceived Euro currency – asks Wolfgang Kasper

This image is derived from  Printer Mario Draghi © 2012 by Ondrej Kloucek, used under a  Creative Commons Attribution-ShareAlike license. This derivative, by Wolfgang Kasper, is licensed under the same  Creative Commons Attribution-ShareAlike license .

This image is derived from Printer Mario Draghi © 2012 by Ondrej Kloucek, used under a Creative Commons Attribution-ShareAlike license. This derivative, by Wolfgang Kasper, is licensed under the same Creative Commons Attribution-ShareAlike license .

The Eurozone is in crisis, and only bold reforms can tackle the root causes.  In the following article, Wolfgang Kasper explains why we should be tuning the clock back to before the Maasstricht Treaty, and proposes that an understanding of institutional economics is crucial in order to comprehend the current politico-economic predicament.

Signs of gross monetary dysfunction

The economic and political landscape of the Eurozone is not pretty. In Spain and Ireland, people and banks own useless apartments and houses, which they built because they were misled by monetary signals telling them credit was easy. Many others have lost their homes to foreclosures, and numerous banks are ailing under the weight of bad loans despite injections of government funds and official guarantees. Small and medium-size enterprises, once the backbone of economies from Portugal to Italy and Greece, face a punishing credit drought. Industrial plants get closed without notice. Local governments do not pay overdue invoices, ruining local suppliers. Eurozone unemployment mounts, often despite wage cuts. Unemployment has surpassed 19 million (more than 12% of the euro-area workforce) and is rising, as a new recession looms.

Embittered about the unexpected cutbacks in pensions, public welfare and other services, and frightened by increasingly harsh austerity and spreading poverty, street demonstrators from Lisbon to Athens are marching under red banners.

Private lenders – attracted by high interest rates on Greek government debt and trusting that the collective of Eurozone governments would guarantee the loans – found that an official decree had nullified part of their investments (by what was cynically called a ‘haircut’). And savers, who deposited their funds in Eurozone banks, learnt during the recent Cyprus bank crisis that they, too, now have to fear EU-decreed ‘haircuts’, the part-confiscation of their bank accounts. Little wonder that Cypriots (and others) blame foreign politicians and suspect that sudden ukases from Brussels now make Euro bank deposits risky. Nationalist resentments and populist blame games are on the increase; the noble post-war  aspiration to European integration is forgotten.

There is a fair chance that a new political party – the Alternative for Germany, which advocates Germany’s exit from the dysfunctional Euro – will sit in the next Berlin parliament, possibly making stable government there as elusive as it is in Rome. After all, Germany, too, is drifting increasingly into indebteness in order to bail out less creditworthy governments, and Germans, too, fear for their children’s future.

The old political establishments are increasingly polarised over the austerity measures and forced bailouts, and are confronted by internet-based civil-society movements that are driven by the hatred of bureaucrats and politicians. They may one day even overturn Europe’s familiar democratic political order.

A spectre is haunting Europe, the spectre of fear about the future.

Institutional economics can explain matters

To comprehend this politico-economic mess, one needs to understand a few fundamental concepts of institutional economics, a new discipline which has lately gained much influence in thinking about innovation and development, but which has old roots, going back to classical liberalism and Austrian economics. This branch of economics introduces realistic assumptions about human psychology, sociology and law. It dismisses the model building of neoclassical economics and instead assumes that the finding and testing of useful knowledge (as well as prosperity and social harmony), depend critically on the quality and enforcement of rules that coordinate human actions (called ‘institutions’).

What matters are the ‘traffic rules’, not only those made and enforced by political authorities, but often more importantly those cultural norms that are deeply enshrined in customs, work attitudes, preferences for material security, free choice and preparedness to compromise. What degree of spontaneous honesty is expected? How much corruption is tolerated? The so-called external (i.e. government-made) institutions are normally only effective if they are in reasonable harmony with underlying cultural norms, which are anchored in the shared values of the people.

Money is an artificial construct, which is intimately related to the external legislation and fiscal traditions of nations and, more importantly, the internal customs and habits of the population, as – for example – the great economist Joseph A. Schumpeter showed in a posthumously published work.

Internal institutions are decreed by no one and no political power can reshape them. They are part of a community’s cultural identity. They rarely evolve rapidly, except possibly in painful traumas.

When, from the late 1960s onwards, powerbrokers in the European Commission began to argue for a unitary currency to promote integration and match the US dollar’s strength, they were told that a common money would be far too weak a tool to force the disparate, diverging political and individual behaviours and cultural norms of disparate European nations into a unitarymould. This would be much harder than the painful birth of the US dollar, which Washington D.C. (led by Alexander Hamilton) had nevertheless been able to engineer, because there was an American nation with a shared language and woven together by a great mobility of the population. Alas, a European common money could not be based on a ‘European nation’, for there is no such thing. Indeed, the debate at the time about ‘optimal currency areas’ and fixed versus flexible exchange rates indicated that the genuine, wealth-creating integration of markets would be obstructed by the coercive imposition of a common money.

Wrong way—go back!

Alas, the expert predictions have been proven correct a mere dozen years after the attempt by Europe’s political elites to foist the Euro on disparate European nations and economies –– arguably the biggest experiment in monetary social engineering since Lenin tried to abolish money after the birth of the Soviet Union.

That institutions mattered was recognised by the fathers of the Euro when they wrote a number of (external, political) rules on debt and inflation into the Maastricht Treaty. But those rules were promptly and arrogantly flouted by many European governments, including France and Germany, despite faint-hearted, toothless warnings from Brussels.

Why? The main reason was that the disparate internal rules of European societies let such political opportunism happen. There was hope in deficit countries with loose monetary and fiscal discipline that others would bail them out, if necessary. They were right. After the initial elation about the removal of currency conversion costs within the monetary union, it morphed predictably, almost automatically into a bailout union. The consequences are poorer monetary discipline, opportunistic political posturing and moral hazard.

As Eurozone crisis meetings multiplied, the European Central Bank promised to inflate the money supply as palliative care for sufferers from fiscal pain and fundamental imbalances. Easy money can have a temporary effect, even if central banks cannot print jobs. However, if monetary history offers any lessons, this is a dangerous path towards the inflation of prices and the consequent expropriation of savers holdings of monetary assets for their old age. The dangers are not immediate, but surprise run-away inflations can occur even during recessionary times.

Muddling-on by clueless political and bureaucratic establishments and more ever-unrepayable bridging loans to austerity-tortured deficit countries is in prospect for the short term. But the Euro crisis requires bold reforms to tackle its root causes. Since the internal institutions of the various European nations are rooted in geographic differences and century-old cultural histories, flexible buffers between the various economic cultures of Europe will be needed; in other words, there is a need to return to some system of gradual adjustments of exchange rates between different currency blocks.

Could we imagine that Germans, the Dutch and the Finns emulate Italy’s strike-prone union behaviour and Greece’s lax fiscal morale to ease pressures on the Mediterranean regions? Deeply entrenched norms would not allow this. Just as unlikely is that the Portuguese develop a Protestant work ethic and the French transit to small government. So the tensions in the Euro area will persist and the divergence will grow.

Were Germany to reintroduce the D-mark, it would regain a much-needed measure of economic sovereignty, and ailing deficit countries would be released from some intolerable pressures. Some nations would stay with a new, appreciating D-mark. Others would be freed from the illusions that the present Eurozone-wide rigidity fosters. The integration of markets across the EU would no longer suffer from distorted real prices and interest rates. Exporters in Germany & Co would miss out on the stimulus of artificial downward exchange-rate pressure that they now owe to the Greeks, Italians and Irish. But the southerners would be able to live their lives as they see fit with their own currencies and still be able to export and attract investments.

Returning to before the Maastricht Treaty is the only hope for a prosperous, harmonious and peacefully integrated European community. It is not a panacea. But it will enable the various national communities to regain control over their economic fates, and all Europeans could learn from each other how to cultivate their institutions and tackle the challenges of their future in the global economy.

Wolfgang KasperWolfgang Kasper is emeritus Professor of Economics, University of New South Wales, Sydney, Australia. In the late 1960s and early 1970s, he worked for the German Council of Economic Advisors and published analytical work on early proposals by the European Commission to impose a unitary currency on nations of the (then) European Economic Community. He was the lead author of W. Kasper, M.E. Streit, P.J. Boettke, Institutional Economics – Property, Competition, Policies (E. Elgar, 2012).

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