How Europe Ended Up Someplace Else Ashoka Mody EuroTragedy: A Drama in Nine Acts New York: Oxford University Press, June 2018
Thesis: monetary union would lead Europe into political union. Early warnings it would not. Nicholas Kaldor, March 1971: o Single currency would amplify economic divergence, and o A house divided against itself cannot stand. Robert Marjolin, crucial catalyst of Treaty of Rome, in the 1970s: o Political efforts to counteract economic divergence would be impeded by the sovereignty barrier: o European leaders obviously not ready to give up core sovereign functions; o Change required was too profound.
A flawed euro, which the French desperately wanted, on German terms. Chancellor Helmut Kohl despite severe initial misgivings pushed the euro, overriding German public s deep opposition to giving up the deutsche mark Seeking the Bundestag s authorization on April 24, 1998, he twice said: According to the treaty rules, the community shall not be liable for the commitments of the member states and there are no additional financial transfers. Translation: Germany will not pay the bills of other member countries. Kohl s mantra: euro would ensure Europe s peace.
But there was no conception of what the end goal was and, hence, no idea of how Europe would get there. If you don t know where you are going, You'll end up someplace else. Yogi Berra The tragedy: the euro inevitably pushed Europe into a someplace else that was not good.
Kaldor s ghost stalks: The euro divides Europe
The great divergence in euro-area incomes and employment. Per capita incomes (In thousands of US dollars, corrected for purchasing power parity) 50 48 46 44 42 40 38 36 Germany France Italy 13 12 11 10 9 8 7 6 5 Unemployment rates (Percent) Italy Germany France 34 2003 05 07 09 11 13 15 4 2003 05 07 09 11 13 15 Sources: Conference Board, Total Economy Database (Adjusted Version), http://www.conferenceboard.org/data/economydatabase/; IMF, World Economic Outlook Database, https://www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx.
The euro-area north-south divergence: public debt and youth distress. Public debt Youth unemployment and inactivity Italy 2007 2017 2007 2016 Greece 2007 2017 2007 2016 Spain 2007 2017 2007 2016 France 2007 2017 2007 2016 Portugal 2007 2017 2007 2016 Finland 2007 2017 2007 2016 Austria 2007 2017 Germany 2007 2017 Netherlands 2007 2017 0 50 100 150 200 Public debt as a percentage of GDP 2007 2016 2007 2016 2007 2016 0 5 10 15 20 25 Percentage of population 15 to 29 years old Inactive Unemployed Source: IMF, World Economic Outlook Database; Eurostat (edat_lfse_20). Note: Countries on the left side correspond to the countries on the right side. The unemployed are those who are looking for a job but are unable to find one; the inactive are not looking for a job and neither are they in an educational or training program. The sum of the unemployed and inactive is known as neither in employment, education or training (NEET).
Divergence was predictable, not an accident: southern euro area suffers from weak governance and institutions, which weaken growth potential: The euro is cruel on countries with low growth potential. Italy 1998 2015 Greece 1998 2015 Spain 1998 2015 France 1998 2015 Portugal 1998 2015 Better governance and institutions Finland 1998 2015 Austria 1998 2015 Germany 1998 2015 Netherlands 1998 2015 0.0 0.5 1.0 1.5 2.0 2.5 Source: World Bank, Worldwide Governance Indicator. Note: The overall index presented is an average of measures of government effectiveness, regulatory quality, rule of law, and control of corruption. Each individual measure is normally distributed, with a mean of zero, a standard deviation of 1, and an approximate range of 2.5 to 2.5. Larger values indicate better governance.
Poorer long-term growth prospects a trap: persistently low R&D rates in the euro-area periphery, hence persistently low growth potential. (R&D as a percentage of GDP, 2016 versus 1997) 3.5 Sweden R&D/GDP ratio (percent) in 2016 3 2.5 2 1.5 1 Portugal Italy Spain Greece Ireland Austria Germany Denmark Finland United States Belgium France Netherlands United Kingdom 0.5 0 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 R&D/GDP ratio (percent) in 1997 Source: OECD Statistical Database.
Predictably, German exporters shift their sights away from the euro area. (Percent of total German exports to the various countries) 12 10 France Czech Republic, Hungary, and Poland 8 United States 6 Italy 4 China 2 0 1999 2007 2016 Source: IMF Data, http://data.imf.org/regular.aspx?key=61013712. Undercuts the idea that the euro would promote trade and, hence, growth.
Kaldor s ghost stalks also the eurozone s politics
Italians lost trust in Europe: economic wounds left political scars. (Decrease in percentage of respondents who trust the European Union, 2016 relative to 2001) 0 Italy France Germany -5-10 -15-20 -25-30 -35-40 Source: Standard Eurobarometer survey, available at http://zacat.gesis.org. Note: Respondents answered the following question: I would like to ask you a question about how much trust you have in certain institutions. For each of the following institutions, please tell me if you (Tend to trust it; Tend not to trust it): The European Union. The chart presents the change in share of people who said they trusted the EU. For each year, 2001 and 2016, responses for the two available quarters are averaged.
European chancellor Merkel held eurozone together: Became polarizing force. Between 2010 and 2016, Merkel was de facto European chancellor, a goal that Kohl had dreamt of. Ipso facto, she became a politically polarizing figure, dividing Europe. In Italy, February 2013 election: o Rise of the anti-euro Five Star Movement o Silvio Berlusconi, whose party also performed well, asked at his rallies, Do you want a government that that is subject to the diktats of Europe? o Pro-European Mario Monti electorally humiliated. In Germany, starting in 2012: o Breakaway group from Merkel s Christian Democratic Party (CDU) formed Alternative für Deutschland, initially as an anti-euro party and then as an anti-immigrant party.
Looking ahead: The future ain t what it used to be
For now, Greece has lost its democracy. Failure to provide substantial and upfront debt relief implies o Large primary surpluses o Historically hard to maintain o Will constrain government investment o Keep growth low More seriously o Greek parliament will mainly rubber-stamp decisions made in Berlin, Brussels, and Frankfurt.
The ECB has reached its political limits
ECB tardy in initiating bond purchases: Euro-area inflation rate began dropping in mid-2013, delivering the lowflation wound. (Three-month moving average of core annual inflation rates, percent) 2 1.8 United States 1.6 1.4 1.2 Euro Area 1 0.8 0.6 Jun 2012 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17 Dec 17 Jun 18 Source: Eurostat: HICP All Items Excluding Energy and Food ; St. Louis Fed, FRED: Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index).
The ECB keeps forecasting a rise in inflation: Inflation remains stubbornly low. 1.8 1.6 2013 forecast 2014 forecast 2015 forecast 2016 forecast 2017 forecast 1.4 1.2 2018 forecast 1.0 0.8 0.6 Solid line is the actual euro-area core inflation 2012 13 14 15 16 17 18 19 20 Sources: ECB s Macroeconomic Projections made in March of the year, https://www.ecb.europa.eu/pub/projections/html/index.en.html. Note: 2018 core inflation is the average of months January to September 2018.
The ECB lacked commitment to bond purchases, even more so than the Bank of Japan. Depreciation relative of the dollar 150 140 130 Start of quantitative easing January 4, 2013: Bank of Japan January 22, 2015: ECB February 1, 2016 Taper talk July 1, 2016 JPY/USD 120 110 EUR/USD October 24, 2017: ECB begins tapering QE 100 June 14, 2018: ECB announces 90 QE end date as end-2018 Taper talk January 1, 2017 September 15, 2017 80-100 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 Number of days from the quantitative easing announcement Note: Exchange rate for JPY/USD equals 100 on January 4, 2013 (date of the announcement of quantitative easing by the Bank of Japan) and exchange rate for EUR/USD equals 100 on January 22, 2015 (date of the announcement of quantitative easing by the ECB). Source: For USD and Japanese Yen, https://www.investing.com/currencies, for USD and Euro rates ECB, https://sdw.ecb.europa.eu/quickview.do?series_key=120.exr.d.usd.eur.sp00.a&periodsortorder=asc.
World trade rather than ECB s bond purchases moves eurozone growth. (Annual growth rates, percent; three-quarter moving averages) 7 6 5 4 3 World trade Germany industrial production France industrial production Italy industrial production ECB bond purchases in flow from March 2015, but unable to raise economic 2 1 0-1 Aug 2015 Nov 15 Feb 16 May 16 Aug 16 Nov 16 Feb 17 May 17 Aug 17 Nov 17 Feb 18 May 18 Aug 18 Source: For world trade growth data World Trade Monitor, https://www.cpb.nl/en/data; for the industrial production of Germany, France and Italy Eurostat, code [sts_inpr_m]. Note: The three-month average of growth over the same three months in the previous year.
Italy: theater of EuroTragedy
Italy needed and needs the crutch of a depreciating currency to offset its abysmal productivity growth. 1400 1200 1000 800 600 400 200 The depreciating lira (Number of liras for one D-mark) 0 1970 74 78 82 86 90 94 98 Italian productivity fell relative to German (annual total factor productivity growth) 2.5 2.0 1.5 1.0 0.5 0.0 1970-79 1980-89 1990-98 Italy Germany US Dollar/Euro exchange rate is back where it began, 1999-2018 1.6 1.5 1.4 1.3 1.2 1.1 1 0.9 0.8 1999 02 05 08 11 14 17 The euro's starting exchange value Italian productivity collapsed while even German fell behind the U.S. (annual total factor productivity growth) 0.8 0.6 0.4 0.2 0.0-0.2-0.4-0.6-0.8 2008-08 2009-16 Italy Germany United States Source: Top left panel: Banca d'italia, https://tassidicambio.bancaditalia.it/timeseries; top right panel: ECB data warehouse https://sdw.ecb.europa.eu/quickview.do?series_key=120.exr.d.usd.eur.sp00.a&period SortOrder=ASC; bottom left and right panels: The Conference Board, https://www.conferenceboard.org/data/economydatabase/index.cfm?id=27762.
Young college-educated Italians leave Italy in growing numbers. 30 16 Number of college-educated migrants older than 25 (thousands) 25 20 15 10 5 0 2002 04 06 08 10 12 14 16 14 12 10 8 6 4 2 0 Share of 25 to 34 years-olds among migrants with college degrees Share 25-34 of 25 to 34 year-olds among migrants with college degrees (right) Number of college graduates leaving Italy (left) Number of college graduates returning to Italy (left) Source: Italian National Institute of Statistics. Italy's low growth trap: poor opportunities, the educated leave, R&D remains weak, and opportunities remain poor.
Italy s financial problems: The government-bank doom loop, always latent, has remerged. 4.0 1.2 3.5 3.0 2.5 2.0 1.5 Jan 2018 Government bond yield (left, percent) Feb 18 Mar 18 Apr 18 May 18 Financial sector performance (right, index) Jun 18 Jul 18 Aug 18 Sep 18 Oct 18 1.1 1.0 0.9 0.8 Sources: FTSE Italia All-Share Financial Index: Global Financial Data, ticker IT8300 Index; FTSE Italia All-Share Index: Global Financial Data, ticker FTSEMIB Index; Italy ten-year bond yield: Datastream International, code S310DT. Notes: The graph presents the relative performance of financial stocks and the Italian 10-year bond yield from 2 January 2015 to 18 September 2012. The relative performance of financial stocks for Italy is the ratio between the FTSE Italia All-Share Financial Index and FTSE Italia All-Share Index.
Sovereignty barrier remains as strong as ever
The myth of Franco-German friendship.
At the December 2012 European Council, Herman Von Rompuy proposed a eurozone budget. Merkel asked, Where will the money come from? French president François Hollande helpfully suggested to Merkel that she think of it as a solidarity fund. Again, Merkel coldly asked, And where will the money come from?
The search for a savior.
How the saviors fall: Matteo Renzi and Emmanuel Macron approval ratings. (Approval ratings, percent) 70 60 50 40 Emmanuel Macron Matteo Renzi 30 20 10 May 2014 May 2015 May 2016 May 2017 May 2018 May 2017 May 2018 May 2019 May 2020 May 2021 Source: Ipsos polls for Matteo Renzi, www.ipsos.it; Ifop for Emmanuel Macron, https://www.ifop.com/wpcontent/uploads/2018/08/indices-de-popularit%c3%a9-ao%c3%bbt-2018.pdf. Note: Percent "Don't know" excluded.
There are no saviors.
Europe: a declining continent for over a century: The future does not look much better, as Asia surges ahead. (US patents granted annually to companies in different countries, numbers in thousands) 18 16 Republic of Korea 14 12 10 8 6 4 2 0 Germany China France Italy 1995 97 99 01 03 05 07 09 11 13 15 Source: World Intellectual Property Statistics Database, https://www3.wipo.int/ipstats/index.htm.
The warnings were sounded. It need not have been. It almost was not. The rest followed. It could get worse, a lot worse. The euro has hobbled many of its member countries. It has created bitter political division among Europeans. If Aristotle were alive today, he would see how eminently good and just men and women enacted the EuroTragedy, not by vice or depravity, but by error or frailty.