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Exploring the Role of Institutions and Ideologies in Euro Crisis

Mridul Mehndiratta ( is a doctoral student (UGC-senior research fellow) in Department of Economics, Panjab University, Chandigarh.

The Euro and Its Threat to the Future of Europe by Joseph E Stiglitz; Penguin Random House UK, pp xxix + 454, 999.

The euro crisis that followed the 2008 global financial crisis has significantly transformed Europe and has manifested itself in the form of “a lost decade,” ruined countries, and dented aspirations.

The Euro and Its Threat to the Future of Europe by Joseph E Stiglitz is an attempt to explore the ideas, ideology and beliefs that underlie the “euro project” that was envisaged not just as an economic project that would enhance the stability and prosperity of the region but also as a political one to promote regional solidarity. It also explores in depth the role of institutions and consequences of “intertwining of politics and economics” in the build-up to the euro crisis. The book sets itself apart as a convincing critique of neo-liberal capitalism or market  fundamentalism and is an insightful assessment of the structuring and functioning of euro currency union.

The author is a Nobel laureate (2001) and has held various positions of repute across international institutions. Widely recognised for his works, the author’s other books include Globalization and Its Discontents, The Price of Inequality, and The Great Divide his most recent work is a strong critique of the euro project, which he believes to be “incomplete and based on flawed assumptions.” The book goes beyond just giving an account of the unfolding of the euro crisis and its effects so as to examine the underlying reasons for why the adoption of a common currency threatens the economic future of the entire European region. The author strongly argues that the attempts at monetary and economic integration by adopting the euro as a common currency itself has been the cause of the euro crisis. The theory of optimum currency area gives a convincing framework to evaluate the macroeconomic performance resulting from economic integration. The theory states that the extent of benefits from joining a currency area depends on whether the country’s economy is integrated with currency union, which can be assessed by looking at integration of product market and factor market. While the intra-European Union (EU) trade has increased from 14% in early 1990s to nearly 18% of the gross domestic product at the turn of the century, but the extent is not large enough for the EU to be considered as an optimum currency area. While there are no barriers to factor mobility, labour movements are constrained by differences in languages and cultures across countries.

Hence, though the EU does not qualify as an optimum currency area, the founding of the euro which is based on the sacrosanct belief of “market fundamentalism” was envisaged as not just an economic project that would achieve higher living standards, prosperity and strengthen economic stability for European nations, but also as a political project that would help in the creation of a stronger, coherent and politically integrated Europe. The book argues that both these goals have not been achieved by the euro and now are even more distant now than they were ever (p 12). It questions the globally held view that economic integration yields better economic outcomes. Instead, the costs of economic integration without adequate political integration can outweigh its benefits.

The book is divided into four parts. Part I describes how the crisis in Europe has unfolded post the 2008 global financial crisis; Part II argues that the conception of the euro project was flawed, divergent and based on weak foundations; Part III analyses the policies and reforms that have been largely “misconceived” and flawed and has aggravated the convergence. Part IV traverses “The Way Forward” for the Eurozone. The author makes a compelling case for reforms, in contrast to the “there is no alternative” (TINA) approach of advocates of current policies.

Why Euro Created the Euro Crisis

Recognised as a significant historical and economic development, the euro project ever since its enunciation in 1992 and the formal adoption of currency in 1999 garnered high regional and international support. The project was embraced as a bold attempt to reap the efficiency gains from using a single currency for a diverse group of sovereign states. However, whether or not the common currency was able to strengthen the resilience of Europe was tested post the global financial meltdown of 2008 as the world witnessed the spillover effects and Europe also faced region- specific macroeconomic challenges. Delving deeper into the causes of the crisis, Stiglitz says that envisaging and creation of the euro is based on the ideological rigidities and faith in “power and abilities of the market” and totally lacked the understanding of “market limitations” in achieving prosperity and stability. The classical ideas and beliefs of free market, propagation of conservatism of the central bank gained ground and flourished in Europe at a time when across the world, faith in market credibility was wavering. Stiglitz also argues that the euro was not only not able to withstand the shocks, but was actually responsible for the crisis given its flawed structuring and the rigidities within the currency union. This not only made the currency union unresponsive to acute challenges but also facilitated differential impact on countries.

Stiglitz says that the success of the euro currency requires more supportive, robust institutions and shared values and understanding of the decision-makers and stakeholders. The institutions involved in the project have faced a “democratic deficit” given their inability to inculcate diversity of opinion, and formulating and imposing singular rules and regulations in entirety on an increasingly diverse region. The author also asserts that “collective problems” call for a collective solution. While the advocates of the euro put forth that a Europe united by the euro would be more influential globally and would enable coexistence by reducing the possibility of conflicts, Stiglitz argues that the expected benefits from the euro project have been quite limited and ambiguous and the creation of the currency union has run counter to the cause of greater economic integration (p 38) and, in fact, has undermined the macroeconomic performance of the region (p 79). This, the author argues, is difficult for the countries with wide disparity to adopt a common currency without necessary institutions in place to accommodate the diversity.

Flawed at Birth?

This section primarily highlights how and why the adoption of a single currency created divergences among countries along with other factors contributing to it like divergence in technology, wealth, public investment, which widened during the crisis. The euro project, however ambitious it may be, was flawed at conception. For a common currency to succeed for a group of countries, it is imperative that the currency sharing countries be sufficiently similar. But the countries that comprised the eurozone “were too diverse to share a common currency” (p 87). Also, the innate rigidities and sacrosanct criterions made the currency union unresponsive to diverse and changing macroeconomic realities, circumstances, beliefs, and values across the system.

The author also deliberates upon the role of the troika (the European Central Bank (ECB), International Monetary Fund, and European Commission) aggravating the crisis. The author says given the ECB’s mandate to tame inflation while ignoring the most critical problem of unemployment, flawed governance, its functioning guided by certain ideological beliefs and absence of democratic accountability has had not only distributive consequences but also adverse implications for macroeconomic performance. The ECB proved to be an outlier of a kind in a global environment where the central banks have had flexible mandates and have responded. The book outlines a case for the ECB and other institutions to limit their procyclicality.

Misplaced Policies and Reforms

In this part of the book, the author discusses different financial and welfare aspects of the macroeconomic policies that were adopted as a part of reforms packages, specifically imposition of severe austerity measures: a contraction in government spending and an increase in spending, on the crisis-affected countries as a condition for providing assistance. It is argued that austerity measures had “potentially disastrous” consequences: social, economic and political. It proved to be the major source for erosion of living standards for lower and middle income people. Instead the reforms that would have “mattered” and that would also have led to stronger and more resilient economies in longer term include structural transformation of economies by adopting appropriate industrial policies, correcting the socially unacceptable levels of inequality, structural reform of the financial sector that had significantly weakened in crisis countries, and articulating a response to climate change. A compelling argument is that the reform package of the troika had adverse effects for inequality and did not yield anticipated results. The troika demands have been essentially draconian, lacked empathy and have been highly technocratic focused on certain macroeconomic variables of debt and deficits and did not capture the humanitarian suffering.

Traversing the ‘Way Forward’

The author discusses three alternatives to the current strategy. The first is undertaking major structural reforms. Stiglitz argues that an “unfinished euro project,” that is, adoption of a common currency is not enough and it has to be backed up by appropriate institutions, rules and regulations. He mentions six structural changes with shared frameworks that are essential to prevent divergence, promote convergence and to create a eurozone that advances the cause of economic and political integration and prosperity, which include: creating a common banking system, mutualisation of debt, building a stability framework, including stabilising fiscal policies and regulating economic excesses, and ensuring full employment and growth for Europe in entirety, and strengthening commitment to shared prosperity. Achieving fiscal stability needs to go beyond austerity pacts and putting stringent ceiling to deficit. The version of fiscal stability needs to be shared and solidarity needs to be strengthened on making more resources available to the affected countries. And the mandate of the institution, specifically the ECB, needs to be relooked to include “economic stability” as an important goal. The case for deeper structural reforms is strengthened by the compelling need to bridge the gap between the pace and extent of economic integration and political integration in the region. Stiglitz also deliberates on the possibility of euro exit in order to save the larger euro project, what he calls as amicable divorce. The separation that has essentially been referred to is not the breakdown into 19 different currencies as was prevalent in pre-euro era, but limited breakdown of larger euro group into smaller groupings with greater intra-group homogeneity.

The feasibility of such a breakdown may be high, but the probability of it happening is incredibly small. The third alternative is to adopt a “flexible euro,” which implies that each country in the eurozone will have its own euro and allows the value of different euros to fluctuate within bounds. These fluctuations can be reduced gradually, eventually achieving the goal of a single currency. This, Stiglitz argues, would be a better system than the current one in place, which has imposed huge, disproportionate and unequal costs across the different countries of the regions. All these measures, however, call for European cooperation of varying yet substantial degrees.

The book sets itself apart as a convincing critique of neo-liberal capitalism or market fundamentalism and is an insightful assessment of the structuring and functioning of euro currency union highlighting the flawed beliefs and ideas that underlie its construction and clearly underlines how the practices and ideologies of EU took a detour from global trends both in terms of defining the mandate of central banks and limiting it to merely inflation control as well as upholding the sanctity of beliefs in markets. The book reinstates Keynesian state intervention is essential for influencing production and distribution patterns. Stiglitz finally concludes that the euro project, an experiment that lasted over a decade and a half, should be saved, but not at all costs, if those costs are in the form of recessions and depressions that further result in massive social, welfare and economic costs. The euro project is not an end in itself but rather a means to end, which is, more jobs, shared prosperity and economic stability. However, the book, while it might be a critique of euro project, also adopts a hopeful approach towards the euro project. Stiglitz aptly remarks that “Europe need not be crucified on the cross of the euro-the euro can work” (p xii), provided key reforms are made in the structure of the 28-member currency union. At the same time, alternative arrangements must be explored objectively to achieve shared prosperity and to build a resilient Europe. This calls for a transformation of institutional structures and deep-rooted ideological beliefs. However, whether the call for tough yet necessary structural reforms is able to garner necessary political will of the countries and institutions is a question that needs to be explored. The political realism of the reforms and alternatives need further exploration.



Updated On : 4th Jun, 2018


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