THE FUTURE OF THE EURO:
A Comparative Analysis of Five Policy Options
A Research Commissioned by
the European Christian Political Foundation
and
the Scientific Institute of the Dutch ChristenUnie
By Prof. Dr. J.J. Graafland
Sounding board:
Prof. Dr. E. de Jong
N. Vogelaar MSc
T. Palm MSc
The first version of this report was published in Dutch under the title “De Euro Gewogen”
(http://www.christenunie.nl/l/library/download/542523)
English translation by I.E. de Wilde MA and prof. dr. J.J. Graafland
2
Preface
Last spring, the European Christian Political Foundation in co-operation with the Dutch
ChristenUnie and its Scientific Institute commissioned a research into the euro crisis. The
research is a reflection from the Dutch perspective with profound conclusions for the whole
eurozone. An independent working group set to work under the supervision of Prof. Dr. Johan
Graafland, which has resulted in the following report: 'The Future of the Euro: A Comparative
Analysis of Five Policy Options'. The last six months, the crisis has deteriorated and the call
for perspective has intensified. The economic crisis within the European Union has also hurt
the Dutch economy. Unemployment increases and benefits are cut back. Economic policy
measures are really affecting us now. And it gets worse. As this study makes clear, whatever
path we will take to combat the euro crisis, it is always be very costly. But there is more to
this crisis than money and property alone. The added value of this report is at least twofold:
the scientific foundation of the claim that there are good alternatives to the current path (of
further integration) and the connection that is made between economic and political-cultural
factors.
Dominant in the current EU debate is the so-called TINA thinking. The leading elite says:
There Is No Alternative. We must further integrate, because otherwise everything will
collapse and there will be nothing left but chaos. In a globalizing world, this is the only
option. This report explicitly chooses an open approach, in which alternative views are
studied as well. The report outlines five policy options that are worth to be examined with an
open mind: 1) further integration of the euro-zone, 2) exit of Greece, 3) exit of some southern
European countries, 4) splitting the euro into a neuro and a zeuro, and 5) leaving the euro
altogether.
Which option will be the best one? If you are looking for a ready-made answer, you will be
disappointed. This report does not provide a simple solution; the crisis is too complex and
there are too many uncertain scenarios to be able to do this. What becomes apparent, is that
there are more and less obvious options. It turns out that a return to the Dutch guilder and a
break-up in a neuro and a zeuro offer little perspective. However, a Grexit or an exit of some
southern European countries will probably, in the long term, give better outcomes with regard
to social support, economic growth and solidarity. The central question to be considered is:
what is, in the long term, the best option for the EU as well as for countries that will possibly
leave the euro-zone? Thus, the research question of this report will be: which policy option
provides the best guarantee of a sustainable economic development of all the countries of the
EU?
For the European Christian Political Foundation, the EU has always been more than a euro
project alone; it also considers the EU as a community of peace and public justice, of values
and standards (in the beginning of 2013, the ECPF will publish a detailed research on this
subject matter, executed by Dr. Sander Luitwieler).
3
The key question is how the cultural diversity within the EU relates to the formation of a
political unity. Currently, Brussels is increasingly dictating this unity, thereby not leaving
room for gradual development. It is very questionable whether peace is served this way. Does
this not feed populism, which is so fiercely denounced by the European elite? The lesson of
the referendum on the 'European Constitution' seems to be forgotten. Feelings of solidarity
and common destiny are not enforceable. Social support needs to grow, which is not easy at a
European scale – and even impossible, in some views. In concrete terms, having influence on
the ESM billions is desperately needed, as well as setting and maintaining strict conditions for
loans to all countries.
Profound cultural differences play a role here. The classic contrast between the North and the
South becomes apparent, for example, from the view of the role of the government, from the
way in which agreements are handled, the degree of corruption, a certain work ethic and the
level of mutual trust. This has implications for the crisis. Structural, economic differences are
difficult to fight precisely because they reflect the different cultures, an idea which is also
supported by this report. In this respect, further imposed integration can be very risky. This
would be a denial of the central causes of the euro crisis, which ultimately lie in the cultural
diversity within Europe. The search for a way out of the crisis will be little effective if these
causes are ignored. In short, continuing on the path of further integration may be beneficial
under certain conditions, but it is so doubtful whether these conditions can and will ever be
met that we must reject this option.
We would like to thank Prof. Dr. Graafland very much for this comprehensive study. The
research has resulted in a balanced report on an equally urgent and complex problem. We
would also like to thank the other members of the working group: Prof. Dr. Eelke de Jong,
Trineke Palm MSc and Drs. Niek Vogelaar. Based on their specific expertise, they each have
made indispensable contributions to this publication. It is our belief that this report, 'The
Future of the Euro: A Comparative Analysis of Five Policy Options', will be of great
significance for the way of thinking within the ECPM on this subject matter. It is our hope
that it will have a positive effect on the political debate in the EU and beyond.
Jan Westert, President of the Board of Trustees of the Scientific Institute of the ChristenUnie
David Fieldsend, Chairman European Christian Political Foundation
4
Summary
1. This report analyzes five policy options: 1) further integration of the current euro zone; 2)
exit of Greece from the euro zone; 3) exit of some European countries from the euro zone; 4)
splitting the euro into a neuro and a zeuro; and 5) leaving the euro altogether and returning to
national currencies. The research question is which option will give the best perspective of a
sustainable economic development of the countries in the EMU.
2. The current euro zone meets the criteria for an optimal currency area only moderately to
badly. This is confirmed by the finding that the structural advantages of the euro have been
rather modest. If one takes into account the high costs of combating the current crisis in the
euro zone, the contribution of the euro to economic growth in the euro zone since the
existence of the EMU has been negligible.
3. An important advantage for a country to leave the euro zone is that it will allow for the
devaluation of its national currency. Past experiences show that devaluation is more
effectively reinforcing the competiveness of a country than so-called internal devaluation (that
means, restoring competitiveness through wage and price reduction).
4. Independent of whether countries leave the euro zone or not, there is a need for substantial
write-offs on loans to southern European countries to provide them opportunities for
economic growth. Whether the costs of the amortization of debts will be higher or lower if
one or more countries leave the euro zone cannot be determined ex ante and will highly
depend on the conditions of the exit.
5. A complete break-up of the euro zone is suboptimal from an economic point of view, in
comparison to the other options where a smaller euro zone continues to exist. As a number of
countries within the current euro zone meet the criteria for an optimal currency area, a
complete return to national currencies will be needlessly costly.
6. Splitting the euro into a neuro and a zeuro is suboptimal from an economic point of view,
in comparison to the policy option that one or some countries leave the euro zone, because the
countries that would qualify for the zeuro zone meet the criteria of an optimal currency area
only moderately to badly.
7. The ranking of the three remaining options is ambiguous and strongly depends on how
various types of risks are assessed. If the current euro zone is able to develop a reliable
institutional framework that makes the euro zone better meet the criteria for an optimal
currency area, the policy option of further integration of the current euro zone is most
preferable. But there are substantial risks that decrease the probability that this policy will
succeed in doing so. The reasons for this are, for example, a high diversity in production
patterns, whereas the share of exports of southern European countries to northern European
countries has declined since the introduction of the euro. Furthermore, the probability of more
budgetary transfers between countries in the euro zone, more homogeneous policy
preferences and more solidarity is low. This makes this option less attractive.
5
8. Under certain conditions, the option of Greece leaving the euro zone is more attractive for
Greece as well as the rest of the euro zone than further integration of the current euro zone,
including Greece. These conditions are: 1) the exit is well managed; 2) Greek debts are
substantially diminished through the amortization of debts; 3) Greece is financially supported
during the transition period; 4) Greece should acknowledge the advantages of an exit and
prefer it itself; and 5) after the exit, Greece should remain a full member of the EU and should
still be entitled to receive support from Europe’s structural funds. Under these conditions, it
can be expected that economic growth will increase both in Greece and the euro zone and that
the amortization of debts will be lower in the long run. The stability of the euro zone will
increase in the long run, because it will better meet the criteria of the theory of optimal
currency area. The Grexit will provide Greece more opportunities for economic recovery.
During the transition towards the Greek drachma, one can possibly make use of a parallel
currency system. The exit of Greece should be accompanied by a design of exit conditions for
euro countries. This will discipline other countries and will increase the chance of a successful
integration of the remaining euro zone.
9. If more southern European countries (Greece, Spain, Portugal and Cyprus) leave the euro
zone and introduce national currencies, similar effects will occur as with Greece leaving
alone, but on a much larger scale. In comparison to a Grexit, the advantage of this policy
option is that the remaining euro zone will better meet the criteria for an optimal currency
area, which will increase the probability of a successful integration. An important
disadvantage of this policy option, however, is that the remaining countries in the euro zone
that are least able to meet the conditions for the optimal currency area (especially France and
Italy), will face severe competition from the exiting countries, which will threaten the stability
of the smaller euro zone.
6
Contents
Preface
Summary
Preface J.J. Graafland
3
5
9
1
Introduction
11
2
Convergence and Divergence between Euro Countries
13
3
Policy Options
21
4
4.1
4.2
4.3
4.4
Economic Analysis
Theory of the Optimal Currency Area (OCA)
Application of Economic Criteria of the OCA Theory
Costs of Break-up of the Euro
Consequences of Devaluations
24
24
26
28
31
5
5.1
5.2
Political Analysis
Application of Political Criteria of OCA Theory
Other Political Considerations
38
38
42
6
6.1
6.2
6.3
6.4
6.5
Implications for Five Policy Options
Further Integration of the Euro zone
Exit of Greece
Exit of Some Southern European Countries
A Neuro and a Zeuro
Leaving the Euro Altogether
48
49
52
56
59
64
7
7.1
7.2
7.3
Conclusions and Policy Implications
Chapter 4
Chapter 5
Chapter 6
65
65
68
70
Literature
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Postscript
Personalia
Core Elements of Further Integration of the Euro Zone
Lessons from Financial Crises in the Past
The Matheo Solution
Bilateral Trade Relations between Euro Countries
7
73
77
78
80
82
83
87
8
Preface
This study on the future of the euro has been commissioned by the Scientific Institute of the
Dutch ChristenUnie. Despite the fact that articles on the euro appear almost daily in the
newspapers, there are relatively few studies available in which various policy options are
compared systematically. Governments and central banks are very reluctant to release
analyses of alternatives for the current euro, because every official statement can produce
dynamics that will increase the pressure on the euro further. Many comments from
policymakers are therefore highly strategic in nature and offer little insight for an independent
assessment.
Although there are several studies available on the possible effects of the break-up of
the euro, the independency of these studies are sometimes questionable. Parties that have
carried out these studies (or have commissioned others to do so) sometimes have a clear
interest in a particular outcome and therefore tend to focus on particular risks, whereas they consciously or unconsciously –insufficient pay attention to other risks.
It is generally known that the ChristenUnie holds a critical view of financial support to
Greece and further European integration. To ensure the independence of this study as much as
possible, a sounding board was formed, not only to give advice, but also to give corrections if
information tended to be rendered or interpreted in a one-sided way. Herewith, I would like to
thank Eelke de Jong, Niek Vogelaar and Trineke Palm for the very enjoyable and constructive
way in which they have executed their task in this sounding board. In particular, I would like
to thank Eelke de Jong for the many useful suggestions that helped me get a quick grasp of
the many aspects that are important while doing research into the euro. His expertise in the
field of international monetary economics was of indispensable value to support the quality of
this study. It is up to the reader now to decide whether this has led to an independent and
adequate study.
My hope is that this study, by combining various insights and assessing them
critically, will contribute to further reflection on the future of the euro, in particular within the
ChristenUnie. Given the limited scope and means of this study, it should be seen as an initial
impetus for further research, which could lead to a deeper analysis and an adjustment of
expected effects. However, even extensive research will hardly give more certainty, because
this is inherent to the subject matter of this study. Despite the fundamental uncertainties which
policymakers have to deal with, it is essential that all alternatives are carefully considered.
J.J. Graafland
9
10
1
Introduction
Since the collapse of Lehman Brothers in 2008, it was all hands on deck for economic
policymakers. What began as a crisis in the housing market in the United States, first
expanded into an international financial crisis, then into an economic crisis with a significant
drop in GDP and a deterioration in government finances and currently into a European debt
crisis. A common element in many countries is that the combination of a deterioration in the
financial sector and a deterioration in government finances created an explosive situation,
which led to various flywheel effects (Blundell-Wignall and Slovik, 2011). Governments in
countries like Ireland, Belgium, France and Spain had to support their banks to prevent an
implosion of the financial sector. By doing so, they were at risk of losing the confidence of
the financial markets, because of the heavy financial burdens and risks associated with this
support. The resulting impairment of government debts brought the banks that had invested in
government bonds in deeper problems. Studies show that since 2007, the financial markets
have increasingly imposed punishment on high government deficits and debts through higher
interest rates (risk premiums) (Attinasi et al., 2009).
One of the many effects of the crisis was a growing divergence in confidence in the
economic situation of various European countries. The effect of the crisis seemed to be
strongly dependent on the specific economic situation of countries. For example, while
German banks also suffered deeply from the crisis, there still seemed to be great confidence in
the German economy, due to the fact that it has a very competitive economy. As a result,
economic growth soon recovered and government finances could be brought under control. In
other, mostly southern European countries, the crisis caused a deep breach of trust, which
made it hard for those countries to independently regain control over the economy and
government finances. This was reflected by rising interest rates for the refinance of
government debts in those countries (and declining interest rates in countries which managed
to retain the confidence of the financial markets). Obviously, this gave ground to the existing
pessimistic expectations. Government debts become unsustainable if the so-called primary
government surplus (i.e. the difference between government revenues and government
expenses minus interest charges) is not sufficient to pay the costs of the debts. In theory, the
differences in interest rates reflect the market’s estimation of the chance that a government
loan will not be paid back for that reason (Blundell-Wignall and Slovik, 2011).1
These differences put European policymakers under great pressure to come up with
additional policy measures to reverse the situation. Especially for countries that seemed to be
most vulnerable, it was essential that the EU took the responsibility to achieve a more equal
distribution of risk premiums in order to reduce the pressure on government finances. But
because European countries held different views of what policy could best be followed, only
few measures were taken. Thus, the necessary recovery of the confidence of the financial
markets in these countries failed to appear.
1
In practice, however, financial markets seldom discipline governments that well. In euphoric times, risks are
often underestimated (Boot, 2011).
11
Because there was a continuous threat in some countries that government finances
would get completely out of hand and/or banks would go bankrupt, European policymakers
decided to put important steps towards European integration over the past year. The chosen
path is controversial, however. There is an important undercurrent of economists who
strongly object to this form of integration forced by the economic situation. The fact is that
the economies that are united in the EMU differ greatly from each other. Real convergence in
economic performances is needed to make a common currency zone successful. But there is
serious doubt whether it will be possible to reverse the divergence and the ever growing debts
and credits through economic reforms. Also for this reason, some political currents strongly
object to the centralization of powers and the forced solidarity between European countries.
Because if the jumping pole of further European integration is not long enough to achieve
lasting economic recovery in countries that are doing badly, the vulnerable support of the
European project may decline even further. The current policy response is then indeed a risk
for the further development of the European project of peace and cooperation.
The question is how realistic these objections are from an economic and political point
of view and whether there are alternatives for handling the euro crisis. Since this study has
been commissioned by the scientific institute of the ChristenUnie, we have narrowed down
this broad question in the sense that the research in particular focuses on the desirability of the
euro. In the past, the ChristenUnie stated that splitting the euro into two different currencies
(neuro and zeuro) might be a possible alternative to maintaining the euro. In this study, we
would like to compare this policy option with four other policy options as a way out of the
euro crisis. The second policy option is a further integration of the European economies
through a coherent set of institutional measures for the euro countries, including a banking
union and a budgetary union. The third and fourth policy options represent a middle ground,
where one or more countries leave the EMU. The fifth policy option is the other extreme,
where all EMU countries return to a national currency. The central research question of
this report is which policy option(s) offer(s) the best chance of a sustainable economic
development within the EMU countries.
Recent policy developments within Europe make it unlikely, however, that there will
be political support for a (substantial) transformation of the euro zone. Current top executives
in Europe (most of whom are from Southern Europe) are strongly committed to keep the
current euro zone from falling apart and take decisions that make an alternative very costly. 2
Many think that the point of no return has already been passed. This does not mean that
reflecting on the euro zone has no sense. Because also in the case of further integration, it will
be necessary to take political decisions that do not disregard the risks. Furthermore, in the
recent past, unthinkable changes that were too often considered impossible, became politically
relevant because of unexpected developments (like banks taken over by the state). For
politicians who support TINA (There Is No Alternative), it is also desirable to reflect on
alternatives in order to be prepared if developments take a different turn.
2
However, we do not really know for sure. Because if there were serious plans to transform the euro zone, it
would be important to show a strong commitment to the current euro zone in order to be able to totally surprise
the market when the euro zone is really transformed.
12
The contents of this study are as follows. Chapter two describes the divergence
between the economies of the euro countries since the introduction of the euro in 1999, which
forms the background of the crisis of confidence in some countries. Chapter three describes
the policy options that are studied in this research: speeding up European integration, exit of
one or more countries from the euro, splitting the euro into a neuro and a zeuro, and complete
return to national currencies. Chapter four and five offer a qualitative economic and political
analysis of various mechanisms that are relevant for studying the effects of these policy
options. Chapter six applies this analysis to the five policy options and evaluates them on the
basis of five criteria. Chapter seven closes with conclusions.
2
Convergence and Divergence between Euro Countries
“The Euro was a noble experiment, but it has failed.”
(Robert Barro, Wall Street Journal, January 10th, 2012, “An Exit Strategy from the Euro”)
The Start of the Euro and Convergence in Inflation
The euro project started with the Treaty of Maastricht in 1992 and the creation of the
European Monetary Institute (EMI) in 1994.3 On May 2nd, 1998, the Council of the European
Union decided that 11 countries met the conditions for the introduction of the euro on January
1st, 1999. The first participants were Belgium, Germany, Spain, France, Ireland, Italy,
Luxembourg, the Netherlands, Austria, Portugal and Finland. The number of countries
increased to twelve on January 1st, 2001, when Greece started the third phase of the EMU.
Slovenia became the thirteenth member of the euro area on January 1st, 2007, followed by
Cyprus and Malta on January 1st, 2008, Slovakia on January 1st, 2009 and Estonia on January
1st, 2011.
At the start of the EMU, Italy and Belgium (and, as appeared later, Greece) did not
completely meet the entry conditions. For example, Italy’s net government debt amounted to
106% of GDP in 1998 (far higher than the 60% maximally allowed) and Italy had a history of
high government budget deficits, inflation and regular devaluation of its currency. The
participation of Italy in the EMU was therefore mainly decided on political grounds.
A monetary union goes beyond a system of fixed exchange rates, because it means
that countries have one common currency and the same monetary policy. Just like a fixed
exchange rate system, it can discipline member countries that otherwise would probably have
a loose monetary policy and, consequently, high inflation. As the euro countries had a fixed
exchange rate system before the introduction of the EMU, convergence had already occurred
in the period prior to the introduction of the EMU (see Figure 1).
3
In the first phase of the EMU, the European capital market was liberalized. Citizens from the European Union
could open a bank account in any Member State, conclude a mortgage and freely trade in stocks and bonds. In
the second phase, the EMI was erected. The goal of the EMI was to prepare the operations of the EMU. In 1999,
the EMI was transformed into the European Central Bank (ECB). In the third phase, the euro was introduced as a
common currency for scriptural payments.
13
Figure 1
Source: Krugman, Obstfeld and Melitz (2012)
Still Structural Divergence in the Current Account
Table 1 shows that since the third phase of the EMU, convergence between the euro Member
States has occurred for several economic parameters, but not for all.4 Particularly, the current
account shows divergence for different countries. Greece, Portugal and Spain exhibit a current
account deficit which is larger than in the period before 1999. To a lesser extent, this also
applies to Ireland, France and Italy. In contrast, Germany, Finland, Luxembourg and the
Netherlands and, to a lesser extent, Austria and Belgium show a current account surplus and
have not deteriorated since 1999 (except Belgium). Berger and Nitsch (2010) therefore
conclude that the magnitude and the persistency of the current account imbalances have
increased since the introduction of the euro. This indicates that large differences in
competitiveness between the various EMU countries continued between 1999 and 2011. This
is partly due to the fact that northern European countries developed more innovative industrial
products and services than southern European countries (which depend more on agriculture
and tourism). A recent research by Wierts et al. (2012) shows that the exports of the northern
European countries (Belgium, Luxembourg, Germany, France, the Netherlands and Austria)
to emerging markets in Eastern Europe, Asia and South America are much higher than the
exports of southern European countries to emerging markets. As emerging countries have a
higher growth in income, the northern European euro countries benefit from this. Wierts et al.
4
For example, the unemployment rate substantially declined in Spain and Ireland. But in recent years,
unemployment dramatically increased in both countries because of the crisis.
14
(2012) explain this difference in export performance by the share of technological advanced
products, which is much lower for southern European than for northern European countries.
Table 1
Economic developments within the euro zonea
Annual
GDP
growth
Belgium
Germany
Finland
France
Greece
Ireland
Italy
Luxembourg
The
Netherlands
Austria
Portugal
Spain
Inflationb
Unemployment
ratec
1.8
1.2
2.4
1.5
2.4
3.7
0.7
3.7
1.9
2.1
1.5
1.8
1.8
3.3
2.5
2.2
2.6
2.2
7.8
8.8
8.5
9.0
10.1
6.1
8.2
3.8
3.8
1.9
1.2
2.6
1.8
2.5
2.8
4.3
7.6
11.9
Government
budget surplus
(% of GDP)d
1999-2011
-0.4
-2.2
4.1
-2.7
-5.4
1.5
-2.9
2.3
-0.6
-1.6
-3.7
0.3
1991-1999
-2.9
-2.2
-2.4
-3.9
Belgium
4.4
8.5
Germany
1.4
1.8
8.1
Finland
3.9
1.9
13.2
France
1.9
1.5
10.3
Greece
Ireland
12.7
0.4
Italy
1.4
3.9
10.3
-5.0
Luxembourg
2.6
2.7
The
3.2
2.4
5.6
-3.3
Netherlands
Austria
2.5
1.8
-3.5
Portugal
5.9
-4.5
Spain
2.8
3.9
18.1
-4.9
a
Source: Eurostat
b
For 1991-1999: based on national currencies, consumption price index
c
d
Gross
government
debt (% GDP,
2010)e
Balance
payments
GDP) e
96
83
48
82
144
95
118
63
2.7
4.7
5.4
0.0
-9.1
-1.9
-1.5
9.4
5.3
72
93
61
1.8
-9.6
-5.7
124
59
54
58
97
67
118
7
71
5.3
-0.7
4.6
1.9
-2.9
2.1
2.5
10.7
5.3
66
56
65
-2.5
-4.9
-0.5
of
(%
For 1991-1999: average in 1991-1998
For 1999-2011: average in 2000-2007; Source: Teulings et al. (2011), p. 15; For 1991-1999: average in 1995-
1998
e
For 1991-1999: average in 1995-1998
Another reason is the higher productivity growth in Northern Europe as a result of the
automation and digitization of industrial production and commercial services. The labour
costs per unit of product are consequently much lower (Rodenburg and Zuidhof, 2012).
Between 1998 and 2011, the labour costs per unit of product increased in France (28%),
15
Ireland (36%), Spain (38%) and Italy (40%) much more than in Germany (6%). Since all
countries had the same exchange rate, northern and southern European countries actually had
an undervalued and overvalued currency respectively, causing increasing divergence in their
trade balances. According to Bofinger (2012), the undervaluation of the euro has been the
main cause of the success of German exports.
However, one cannot only blame southern European countries for these growing trade
imbalances. One can also argue that the northern countries based their economic growth onesidedly on exports and that growth of domestic expenditures lagged too much behind. This
was partly due to a relatively high real interest rate in comparison to southern European
countries, caused by the uniform monetary policy of the ECB. The difference between private
savings and investments in Germany was 8% of GDP. There are several causes for this saving
surplus (partly demographic), but it also resulted for the one-sided economic growth in
Germany, based on exports and low domestic expenditures (Rajan, 2010). Also government
deficits were kept rather low in Germany. The high national savings were invested in southern
European countries, which put downward pressure on the real interest rates in these countries.
This provided an incentive to easy borrowing in southern European countries, not driven by
excess demand, but rather by excess supply of financial means worldwide.
It should be noted that divergence in the current account would not have caused such
big problems between the euro countries if countries with a current account surplus had
invested their surplus savings in a riskier way. German banks provided southern European
countries loans with fixed interest rates, rather than, for example, investing in stocks. If that
had happened, investors would have sooner doubted the profitability of their investments and
would have exercised restraint in providing financial means. As a result, the southern
countries would have been forced to reduce their imports and, consequently, the exports of the
northern countries and trade imbalances would have diminished. Moreover, as the investors
would have carried a part of the risks instead of the borrowers, the problem of too large debts
would have diminished as well (De Jong, 2012c).5 This illustrates how the debt crisis has been
partly caused by the northern European countries.
Convergence in Interest Rates
This leads us to another (for many economists unexpected) result of the introduction of the
euro. We had expected that introduction of the euro would cause the interest rates in the
various countries to converge, because the risk of a devaluation of the exchange rate had
disappeared. However, we did not expect that the interest rates on government loans would
become almost equal. We expected that capital providers would still ask some countries
(Italy, for example) an additional fee, because their state debts were still much higher than in
Germany. In the worldwide wave of undervaluation of risks during the first decade of this
century, they did not. This may be due to the fact that the ECB accepted debt papers of all
5
De Jong therefore proposes to include a provision in loans saying that, in times of crisis, these are partly
automatically converted into shares or that no interest is paid anymore if a country faces severe problems to pay
off its debts.
16
euro countries as a collateral, without applying a fee for the less creditworthy countries. The
CPB believes that this is not a sufficient explanation for the sharp decline in interest rates,
because due to the no-bailout clause6 in the Maastricht Treaty, investors still ran the risk that a
country with too high debts would not be able to repay its debts entirely (Teulings et al.,
2011). It explains the strong convergence in interest rates therefore by the faith of the markets
that the no-bailout clause would not stand if countries that borrowed a lot from others would
fail to pay off their debts. The result was that the interest rate on government bonds of the
countries of the South converged to that of Germany. Because inflation in those countries was
still higher than in Germany, the real interest rates were relatively low in those countries. In
Ireland and Spain, this led to an increase in the prices of real estate.
Research has shown that the interest levels determined by the ECB were not in
accordance with the fundamental economic developments in various countries, such as
Germany (Hayo and Hofmann, 2006), Greece (Arghyrou, 2009) and Spain (Arghyrou and
Gadea, 2012).7 Especially for Spain, this is striking, because Table 1 shows that Spain had a
relatively high economic growth and no big public deficit or public debt. But inflation was
relatively high, causing a real appreciation (i.e. a rise in the value of the currency in relation to
other countries, adjusted for inflation differentials). As a result, the real interest was even
negative. This not only caused a trade deficit, but also led to a large bubble in the real estate
market, making the economic growth of Spain in retrospective very one-sided and therefore
vulnerable. If Spain had not been part of the EMU, the Central Bank of Spain had probably
set a higher interest rate to reduce the inflationary pressures (Arghyrou and Gadea, 2012).
This would have slowed down the bubble in the real estate market. Precisely because of the
unified monetary policy within EMU, Spain has become so vulnerable to the economic crisis
from 2008. Given the institutional setting of the EMU, the ECB could also do little else than
pursuit price stability for the EMU as a whole. There was no room to combat macro
imbalances of specific countries.
Divergence in Labour Costs Per Unit of Product
Under spending in the northern euro countries and excess spending in the southern euro
countries also explain the differences in inflation rates that determine the competitiveness of a
country. These differences in inflation rates date already back from the period before the
EMU. Already in the 1980s, the Netherlands had an inflation rate similar to that in Germany,
but countries like Italy, Spain and Greece had a constantly higher inflation rate. As a result,
they regularly devaluated their currencies relative to the German mark in order to maintain
their competitiveness. In fact, the introduction of the euro has not radically changed this trend,
because since 2002 the southern European countries have constantly had higher inflation rates
than the average of the euro zone (Rodenburg and Zuidhof, 2012). Consequently, between
6
The no-bailout clause implies that, in principle, Member States have to resolve their own financial problems.
Mutual economic assistance between Member States or from the EU to the Member States in the EMU is only
possible within a strict framework.
7
Nechio (2011) shows that before 2008, the target rate of the ECB was too low for the peripheral European
countries (Greece, Ireland, Portugal and Spain), but after the economic crisis in 2008, it was too high.
17
1970 and 2012, the index of labour costs per unit of product drifted substantially apart, from
255 for Germany (1970 = 100) to 4560 for Portugal and 7905 for Greece (DNB, 2012a).
Although the degree of divergence is less than in the period before 1998, the relative unit of
labour costs also increased substantially in southern European countries after 1998 (see Figure
2). The reason for these persistent differences in inflation is often sought in the various
institutions of the labour and goods markets, such as concerning lay-off protection and
entrance barriers on goods markets. According to Rodenburg and Zuidhof (2012), it is
difficult to fight the structural differences between countries like Greece and Germany,
because they reflect the culture of a country. Because Greece has not only an inflexible labour
market, but also other problems, such as corruption, poor tax morality, bureaucracy and
patronage, which restrict the growth capacity of the country. Nevertheless, the members of the
Monetary Union hoped that its creation would boost economic reforms. But looking back, we
must conclude that the convergence in per capita income in the past ten years has been more
the result of rising spendings, made possible by cheap credits, than of reform policies that
improved competition on the labour market or the goods market (ING, 2012a).
Figure 2 Labour costs per unit of product (compared to the average in the euro zone)
Source: DNB (2012a)
18
Public Deficits and Debts
Another structural difference concerns the public deficits and debts, which are particularly
high in Greece and Italy. For some countries, national debts have risen to over 90% of GDP.
A debt of 90% of GDP is often considered as critical, because such a high debt hampers
economic growth and, hence, the capacity to pay off the debt. In part, the increase in debts has
been the result of the economic downturn since 2008. Till 2007, countries like Spain and
Ireland even had a budget surplus. But also before the crisis, the structural budget deficits in
some countries increased. Countries that had large deficits before the crisis, have faced a
larger increase in their structural budget deficits after the crisis (Gilbert and Hessel, 2012). As
mentioned before, one of the reasons that structural debts were allowed to rise so high before
the crisis, is the convergence in interest rates on government debts in all EMU countries since
1995. This took away the incentive to limit borrowing for countries with a large deficit. The
euro and the uniform monetary policy, resulting in confidence of the financial markets within
the whole euro zone, in this way enforced the divergence between countries. The Maastricht
Treaty did not provide for mechanisms insuring budgetary convergence. While some rules
(the 3% norm for the government deficit and the 60% standard for the debt ratio) should have
provided for this, they were soon violated by Germany and France, which made discipline and
credibility disappear. This also gave other countries room for moral hazard.8 In this way,
Germany and France contributed to a situation in which budget deficits and public debts could
rise in the southern European countries. 9 This implies that the euro as a common currency has
played a role in the rise and development of the euro crisis.
Effects of Imbalances and the Role of Financial Markets
Due to the economic crisis, the differences between European countries have become a
crowbar for the financial markets. Early 2010, markets started to doubt the sustainability of
Greek public finances. This increased the risk premium on Greek government bonds. This
soon had a contagion effect on the Portuguese and Spanish economies, while Ireland also got
into big trouble. Financial markets and the financial sector have grown rapidly in recent
decades, due to three causes. First, technical developments (ICT) have allowed fast
transactions around the world. Secondly, there has been a reduction in regulation of financial
markets. Thirdly, the supply of money has increased, because of loose monetary policy.
Traders on the financial markets serve the interests of citizens in their role of savers,
pensioners, investors or taxpayers. If the risk of loss on an investment increases, they demand
a higher return. This can be effectuated real-time, by selling bonds on the secondary market.
As the market value of a bond decreases, the related interest payment increases as a
8
Moral hazard refers to changes in the behaviour of economic agents, caused by a change in the allocation of
risk.
9
Another flaw in the Maastricht Treaty is that it did not provide for European banking supervision.
19
percentage of the nominal value (and vice versa). If interest rates of government bonds
increase, the government is forced to follow a more prudent policy.
The role of the financial sector is not undisputed. Initially, capital markets or investors
in those markets had insufficiently acknowledged the risks of the investments in the southern
European countries. As noted earlier, they may not have been convinced of the no-bailout
clause. The market discipline was therefore too late. Due to their size and technological
capabilities, financial markets react quickly. They are nervous and exhibit herd behaviour.
When investors noticed that the euro zone was not able to stabilize a small economy like
Greece, they lost faith in Portugal and Spain as well.
For a long time, European politics barely managed to calm down the financial
markets. Their measures were often too little and too late. Successive European summits have
shown that the political process in Europe proceeds too slowly against the background of the
high dynamics of financial and economic developments. The need for political support in
national parliaments makes it very difficult to settle a common and convincing EU policy.
Difficult decisions were postponed as long as possible, because a sense of urgency was
needed to convince the national parliaments. It appeared almost impossible to pursue a crisis
policy in a way that procedures that have to guarantee the (already weak) democratic
legitimacy of European policy are respected. That also applies to the democratic process
within countries. In Italy, for example, only an unelected (technocratic) head of government
was able to create order in the economic chaos.
Meanwhile, the financial markets have enforced divergence in Europe. Countries that
face an outflow of capital, can only borrow at a relatively high interest rate. Just because of
that, northern countries, where money flows in, benefit from relatively low interest rates. That
makes it almost impossible for the weaker countries to recover. One of the problems of the
euro is therefore that, in case of divergence, a common currency union puts the burden of
adjustment not on the strong countries, but on the weak countries. They are forced to restore
their economy through internal devaluation (i.e. restore competitiveness through wage and
price moderation) and reduction of their public expenditure (Tepper, 2012).10
The Future is Uncertain
Although many measures have already been taken, it is still uncertain whether the euro will
continue to exist in its current form. This depends on the economic development. All sorts of
scenarios are still possible. To illustrate this, we will describe two possible scenarios. In the
first scenario, the process of integration will become more and more convincing. The southern
European countries will be able to take structural measures that will improve their
competitiveness in the long term. Portugal and Ireland will make progress. The bail-out of the
Spanish banks will stabilize the financial markets. Italy will take substantial policy measures
that will restore confidence in its own economy. This policy will therefore find support among
10
Ireland was even forced by the ECB to a buy-out of investors. See:
http://www.independent.ie/business/irish/michael-noonan-im-willing-to-overrule-finance-officials-and-releaseecb-letter-on-bailout-3213041.html.
20
the population and successive governments will continue the policy of Monti. The ECB will
take additional measures to stabilize the financial sector in these countries, possibly without a
mandate.
In the second scenario, the southern European countries will not be able to take
convincing structural measures. Public expenditure cuts in southern Europe will further
decrease their GDP. The situation will continue to deteriorate and governments will lack the
support of their population to realize imposed cuts. The downward spiral between banks and
governments cannot be stopped. Germany will refuse to financially facilitate further
postponement. The ratings of countries and banks will drop further. Also strong countries like
the Netherlands and Germany will be negatively affected, because of the high costs of rescue
operations. At some point in time, this will lead to a transformation of the euro zone.
The probability of these or other scenarios depends, of course, on external conditions,
like economic developments in the United States and Asia. This study does not aim to
determine which scenario is most likely to happen. The uncertainty is too great and the
interactions are far too complex to be able to do this. But it is important to realize that the
assessment of the different policy options studied in this report depends on the type of
scenario that will manifest itself. It stresses the great importance of a fundamental reflection
on alternatives besides that of further integration of the current euro zone, in order to be
prepared if the economy develops in another direction than hoped for.
3
Policy Options
The Euro zone as designed, has failed. It was based on a set of principles that have proved
unworkable at the first contact with a financial and fiscal crisis. It has only two options: to go
forwards towards a closer Union or backwards towards at least partial dissolution.
(Martin Wolf, Financial Times, May 31st, 2011)11
Even though the economic crisis has made clear that the EMU has failed, this does not
necessarily mean that the best way forwards is to return to the old situation of national
exchange rates. Yet it is striking that most studies, as well as the current strategy of the EU to
combat the crisis, only concentrate on the first option in the above quotation. Even the
interesting and instructive study by the CPB (Netherlands Bureau for Economic Policy
Analysis) called “Europe in Crisis” devotes only two short sentences to the benefits of
returning to the old situation of national currencies, followed by a detailed description of the
costs of an exit from the euro. This is remarkable, since there are indeed economic indications
that a transition of the euro could also bring benefits, which will be shown in Chapter 4 of this
study. Thus, it is understandable that the ChristenUnie has asked for a more detailed report, in
which the advantages and disadvantages of the various options are investigated further.
In this study, we have chosen to explore five policy options.
11
Source: Teulings et al. (2011, p. 11.
21
1.
Further integration of the current euro zone12
The policy option of further integration comes down to a continuation of the current euro zone
in combination with a permanent emergency fund, banking union, budgetary union and a
macroeconomic imbalance procedure.13 The exact interpretation of this policy option
obviously depends on the realization of the above elements. ING (2012a) even distinguishes 6
different scenarios, which focus to a greater or lesser extent on the possibilities of further
integration.
2.
Grexit
Besides the option of further integration of the current euro zone, the first variant that we
distinguish is the exit of Greece from the euro zone. The reason to investigate this policy
option is that it is probably the most likely alternative. In this case, we assume that the exit of
Greece from the euro zone will not be temporary. Although technically possible, a temporary
exit would have great disadvantages. This would not only mean double costs for the transition
(out of the currency union and in again), but also reduced confidence of other countries in the
stability of the currency union. The currency union would erode then to a block of countries
that are connected through fixed exchange rates.
3.
Several countries leave the euro zone
The third option is that several countries leave the euro zone. As with the previous variant, we
assume that this exit will be permanent. In chapter 6, we will examine which countries qualify
for this exit.
4.
Splitting the euro into a neuro and zeuro
In the fourth place, we will examine the policy option in which the euro is split into a
common currency for the northern European countries (neuro) and a common currency for the
southern European countries (zeuro), an option which the ChristenUnie would applaud. In
chapter 6, we will examine which countries qualify for the neuro and zeuro.
5.
Complete Return to National Currencies
The final policy option is the most radical variant, in which all EMU countries return to
national currencies. This policy option has been analyzed in a report that was commissioned
by the Dutch PVV (Party for Freedom).
12
In case of further European integration, there are two variants: with or without a political union. The difference
between integration with/without a political union can be denoted as democratic versus state federalization
(Crum, 2012). With democratic federalization, national sovereignty is sacrificed in favor of monetary integration
and democratic decision-making. This variant would give the European Parliament a more important role. With
state federalization, the focus on monetary integration and national autonomy is at the expense of democratic
decision-making. This variant would give the ECB a more important role, as well as the big member states.
13
For a brief description, see Appendix 1.
22
This study will be limited to a qualitative analysis. If possible, quantitative data from other
studies will be used to assess the potential scope of various partial effects that are expected to
occur. Since it is highly uncertain what the effects of the various policy options will be and
historic data on the break-up of a currency union cannot be used because of the uniqueness of
the current economic situation, we will refrain from giving a quantification of the economic
effects, both for the Netherlands and for any other EMU country.
Another assumption that we will make, is that an exit from the euro zone does not
mean that countries should leave the EU as well. EU treaties do not make statements about the
possibility to exit the euro zone without having to give up one’s EU membership. According
to the CPB, it is conceivable that European rules on this point will be rewritten or simply put
aside (Teulings et al., 2011).
A further assumption that we will make, is that the position of EU countries that do
not belong to the euro zone will not change. It is conceivable that a reconfiguration of the
euro zone will trigger non-euro countries to step in, especially in the northern euro zone. The
current problems with the euro and the great dynamics in various countries make this unlikely
in the short term, however.
Finally, this study will not answer the question how a possible break-up of the euro
should be managed. Although this is an important question, it is not within the scope of this
study to give a proper answer. Moreover, there are interesting studies available that take this
question as a starting point (Capital Economics, 2012).14 It is clear, however, that a
disorganized break-up of the euro will have substantial negative effects on the economies of
the euro countries. In section 4.3, we will elaborate on the transition costs that are involved
with the transition from the euro to national currencies.
14
Capital Economics (2012) recommends the following measures to manage the process of leaving the eurozone. First and foremost, absolute secrecy during the preparation of the exit; only when the planning has been
completed, should the key officials involved in the first phase notify partners in the euro-zone that necessarily
have to cooperate, including the EC and the ECB. Other organizations like the IMF should be warned several
hours before the official announcement of the exit so that they can stand ready to support the global financial
system. After a public announcement about when the transition to the new currency will be effectuated, national
banks and financial markets should be closed. The new currency has to be introduced at parity with the euro.
The authorities have to permit the use of euro banknotes and coins for small transactions until the new notes and
coins are available. Shortly after the introduction of the new currency, domestic banks and financial markets
should be reopened. The external value of the new currency would be free to depreciate. The government should
redenominated its debt in the new national currency and have to make clear that they are open to renegotiate on
the repayment terms. This is likely to involve a substantial default, ideally sufficient to reduce the ration of debt
to GDP of 60%. The government should also make clear its intention to resume servicing its remaining debt as
soon as practically possible. The national banks of the countries that exit have to be prepared to make available a
substantial amount of liquidity to the banks and to recapitalize the banks if necessary. The exiting country should
announce immediately a regime of inflation targeting, adopt a set of tough fiscal rules, outlaw wage indexation
and announce the issue of index-lined government bonds. Furthermore, it should continue with structural
reforms to enhance the flexibility of product and labour markets. The authorities should provide clarity about
legal issues, including the EU membership of the countries that exit and the way in which international contracts
that are denominated in Euros will be treated. In addition, Capital Economics (2012) mentions a number of other
conditions which the countries that stay in the euro-zone have to meet.
23
4
Economic Analysis
After the description of the divergence between the economies of the euro countries and the
resulting crisis of confidence (Chapter 2), the preceding chapter distinguished five policy
options that offer a possible solution. For an evaluation of these options, it is important to
make a good assessment of the risks, benefits and costs that are involved with these options.
If you are making a hiking tour in the mountains, you may encounter a situation in
which reaching the destination becomes very uncertain, because of all kinds of setbacks. In
high mountains this can be very dangerous. The problem that you are faced with then, is that
either continuing to the next shelter or going back to the place of departure is fraught with
danger. The disadvantage of going on to the next shelter is that you do not know what more
difficulties the tour will have in store, because you do not know the route yet. But returning is
also extremely unattractive, not only because you have to acknowledge that you have failed
and must give up your ambitions, but also because you know very well that the many
problems that you already encountered on your way up will have to be overcome again and
that it is highly uncertain that you will reach the previous shelter in time, before darkness sets
in.
A similar dilemma is described in the quote by Wolf at the beginning of Chapter three.
Now the euro is in crisis, there are two options according to Wolf: speeding up the economic
and monetary integration of the EMU countries or going back to the original situation. Which
of these two extreme options is most attractive, depends on how the chances of a successful
further integration are assessed in comparison to the benefits of returning to the situation prior
to the euro. Both options involve high risks and costs. So the question is how the loss, which
you have to bear anyway, can best be borne. Which solution provides the best long-term
guarantee for a sustainable economic development of the countries in the EMU?
To investigate this question, we will first describe the theory of optimal currency area
(Section 4.1) in order to formulate a framework of analysis. Then we will apply this theory to
the euro zone (Section 4.2). We will find that the outcome of this analysis is not
unambiguously positive. A break-up of the euro involves, however, many other disadvantages
and costs, which will be discussed in Section 4.3. On the other hand, national currencies offer
the possibility to restore economic growth by national monetary policies and exchange rate
policies. The effects of devaluations will therefore be discussed in Section 4.4.
4.1
Theory of the Optimal Currency Area (OCA)
The optimal currency area theory has developed a number of economic and political criteria
on the basis of which one can decide whether it makes sense for a group of countries to
abandon their national currencies and form a monetary union together. In this section, we will
highlight the economic criteria.
There are several advantages and disadvantages associated with a monetary union (see
also Section 4.2). The CPB mentions four different positive effects of the euro (Teulings et
al., 2011). First of all, the common currency has reduced transaction costs; because there is no
24
need to exchange money, exchange rate risks are eliminated and there is no need to hedge the
risks from fluctuations in exchange rates. This has led to more trade and a decrease in
production costs. In addition, transparency in prices has improved, which has strengthened
competition. Baldwin et al. (2008) estimate that, as a result of the EMU, trade between
European countries has increased by 5%. Secondly, the euro has promoted foreign
investments within EMU countries, because of reduced exchange rate risks. It is estimated
that this effect amounts to 15% to 30% since the EMU. A third benefit of the euro is that the
interest rate on government debts has dropped. Because there are many more buyers and
sellers, the market is more liquid and investors face less liquidity risk. A final benefit of the
euro is that the credibility of monetary policies has increased, because ECB has only one
important objective, namely a controlled price development. It is estimated that the GDP per
capita in the Netherlands (in 2008) increased by 2%, because of these positive effects of the
euro, mainly due to lower prices resulting from more competition. Comparable effects may
have occurred in Germany, Belgium and France. For countries like Spain, Italy, Ireland and
Greece, the CPB estimates that the benefits were probably much larger.
But a common currency has also several disadvantages that are associated with the
loss of national monetary policy autonomy. A common monetary authority is unable to react
to each and every local particularity. The basic idea of the optimal currency area theory is that
diversity translates into asymmetric economic shocks and that national exchange rates are
very useful for dealing with these shocks. This is not only the case if countries are exposed to
very different shocks, but also if countries are subject to the same shock (like the economic
crisis in 2008), but respond very differently to this shock. There can be many reasons why
countries react differently to a shock: differences in socio-economic institutions, like labour
market regulation and traditions; differences in the relative importance of industrial sectors;
differences in the size of the financial and banking sectors; differences in the country’s
foreign debts; differences in the ability to make agreements with firms, trade unions and the
government, and so on. Because of this kind of diversity, a common monetary policy of the
central bank of a currency union can have very different effects in the various Member States.
Criteria for a common currency uniona
Economic
1 labour mobility
If people move easily between the countries of the union
2 product diversification If countries have a widely diversified production structure that is
comparable to other countries within the union
3 openness
If countries have intensive trade relations
Political
4 budgetary transfers
If countries agree to compensate each other for adverse shocks
5 homogeneous
If countries share a wide consensus on how to deal with shocks
preferences
6 solidarity
If countries accept costs with regard to a common destiny
Table 2
a
Source: Baldwin and Wyplosz (2012)
25
The OCA theory developed a number of criteria to determine which countries should share
the same currency. There are three classic economic criteria and also three political criteria,
which were not part of the classical OCA theory. The first economic criterion is proposed by
the economist Robert Mundell and states that a currency union is optimal in an area in which
the labour market mobility between countries is high. The reason for this is that asymmetric
shocks in that case can be absorbed by labour market flows from areas in which the
production strongly decreases to areas in which the production does not decrease so strongly.
An example is the United States, where people in case of unemployment do not hesitate to
seek employment in another state where things are going better. Flexible adjustment of wages
and prices may have the same effect as labour migration. If in a negatively affected country
wages and prices drop quickly, the country can improve its competitiveness, and then
employment will increase. The second criterion is product diversification: countries with a
wide diversification of both production and exports and with a similar sector structure, are
very well able to form a currency union. The reason is that shocks are more likely to be
symmetric, so that countries will be less out of step and each country will need less frequent
exchange rate adjustments to correct for divergence from other countries. The third economic
criterion is that countries that have an open economy and have intensive trade relations with
each other are more suitable for a currency union. This is because the strong trade relations
and the competition will equalize the prices of most goods in different countries.
The OCA theory also distinguishes three political criteria. These will be described in
Chapter 5.
4.2
Application of Economic Criteria of the OCA Theory
Application of the economic criteria of the OCA theory to the euro zone shows that the euro
zone performs poorly to moderately.15 Firstly, the labour mobility between countries is very
low. In 2008, the labour mobility between the 15 euro countries amounted to only 0.2% of the
population, which is much lower than for example the 2.3% between the states in the United
States. This difference is due to costs of moving, large cultural differences (language, religion
and tradition) between European countries, and the social security system (unemployment
benefits). Moreover, labour markets in the various European countries are rather rigid,
particular in southern countries. As a result, wages and prices only slowly respond to an
external shock.
The score for the second criterion differs per euro country. If we take Germany as a
point of reference, we see pretty similar trade structures in Italy, Austria and Belgium, but we
see greater differences, for example, in France, Spain, Ireland and the Netherlands. It is also
remarkable that there seems to be relatively little difference between euro countries and noneuro countries: if we compare the trade structures of all EU countries with Germany’s trade
structure, euro countries score on average only slightly better than non-euro countries.16
15
For earlier applications of the OCA theory to the euro zone, see Eichengreen (1990), De Grauwe and
Vanhaverbeke (1993), Bayoumi and Eichengreen (1997) and Artis (2002).
16
See also Figure 15.10 in Baldwin en Wyplosz (2012).
26
A similar picture arises for openness, defined as the ratio between the sum of exports
and imports and GDP. In general, European countries have open economies, but the countries
that do not belong to the euro zone have on average a higher score on openness than euro
countries (Baldwin and Wyplosz, 2012), particularly because Italy, Spain, France and Greece
score relatively low on openness. Wierts et al. (2012) show that the export performances of
the southern European countries within the euro zone have not improved since the
introduction of the euro. It was expected that the euro would lead to a growth in the exports of
the southern European countries to the northern European countries as a % of GDP, but this is
not the case. Only the exports to other southern European countries have increased as a % of
GDP. But as a whole, the exports of the southern European countries have stagnated as a
percentage of GDP.
Hence, it can be concluded that the euro zone has performed badly to moderately on
the economic criteria of the OCA theory. While labour mobility between the euro countries is
nil, there are also significant differences in the structure of production and trade. That is why
the economic development in countries like Greece, Ireland and Spain and to some extent
France and Portugal has differed so much from that of Germany after the economic crisis. The
same holds for the third criterion of openness, where especially Italy, Spain, Portugal, France
and Greece have a low score.17 This is further confirmed by the divergence in inflation rates
and balance of payments, as was highlighted in Chapter 2. After all, if production and trade
structures are sufficiently uniform and competition is fierce because of intense mutual trade
relations, one would observe no major differences in inflation rates, economic growth and
balance of payments.
There are only few studies that have analysed the effects of the EMU on asymmetric
shocks. A study of Verhoeckx (2010) shows an ambiguous finding. On the one hand, the
study confirms an increase of mutual trade relations in the euro zone. But this trade effect
concerns trade between industries rather than trade within industries. This means that the
EMU has fostered a clustering of industries in certain countries, which would indicate an
increase in asymmetric shocks. On the other hand, increased financial relations and deeper
markets in European assets have reduced the chance of asymmetric effects from economic
shocks.
The optimality of the euro zone as a currency union cannot only be based on the
performances of the euro area in the past. Although past performances are an indication of
future developments, the euro zone may perform better in the future, partly because of the
euro. As labour mobility is concerned, no substantial improvement is to be expected within a
time frame of one or a few decades. However, labour flexibility is an alternative for labour
market mobility. Due to pressure from the EU, southern European countries are currently
taking various measures to reform the labour market, like less lay-off protection, shorter
periods of entitlement to unemployment insurance benefits upon dismissal, abolition of
overtime payments, reduction in the number of vacation days, more choice for individual
companies to evade collective wage negotiations and greater flexibility in determining labour
17
See also Table 7 in Section 6.4.
27
conditions. Ireland and Greece have also, under heavy pressure, reduced wages in the public
sector. But it remains uncertain how successful these reform measures will be in the longer
term.18 With respect to more uniform production structures, there is little reason to assume
that the situation will improve. If mutual trade relations intensify, one would expect more
specialization between countries, based on their comparative advantages. But it is also
possible that trade relations within industries will increase, which will stimulate diversity. It is
not certain, however, whether the intensity of mutual trade relations will increase, in
accordance with the OCA-condition. Wierts et al. (2012) show that the share of exports of the
southern European countries to the northern European countries has declined rather than
increased since 1999. Moreover, the proportion of exports from northern countries (excluding
Ireland and Finland) to other northern countries has diminished. It is uncertain to what extent
these trends can be reversed.
4.3
Costs of Break-up of the Euro
For this reason, it is understandable that some argue that the euro zone should be modified.
However, the assessment of the economic benefits should not only take into account what
costs and benefits the euro generated in the past. Decisive is how high the future costs and
benefits will be of maintaining or modifying the euro zone. In analyzing these future costs and
benefits, we will distinguish permanent costs and transition costs.
Permanent Costs of Break-up of the Euro
For the analysis of the permanent or structural advantages or disadvantages of the euro, it is
important to distinguish between membership of the euro and membership of the European
Union and the associated internal market. According to the CPB, EU membership increased
the net income in the Netherlands with 4 to 6% in 2005, due to more trade, competition,
specialization, innovation and expansion. These structural advantages resulted from the
reduction of import tariffs and other trade barriers by the internal market (Teulings et al.,
2011). This effect could even become larger in the long term, because the innovation effect
has not yet been fully realized.
The introduction of the euro has generated less benefits according to the CPB, namely
a growth in income of approximately 2%. As a result of the break-up of the euro, the euro
zone will lose the benefits of the introduction of the euro: less competition and trade, less
mutual foreign investments and higher average interest rates on government debts. According
to ING (2011), this will especially affect the Netherlands, because a trading nation with large
pension funds and a large financial sector like the Netherlands is strongly related to the other
euro countries. In case of a full collapse of the euro, ING estimates that the Dutch economy
will shrink with 10% within two years and unemployment will rise to more than 10% of the
working population. Exports will decrease with an estimated 25%, as a result of a lower
18
See, for example, The Economist (2012a), Cunat (2012) and http://reformwatchgreece.wordpress.com/
28
demand in European countries and rising prices of Dutch products. If only Greece leaves the
euro zone, the damage will of course be much smaller, because only 1% of Dutch exports is
going to Greece.
A problem with this study is that ING, in contrast to Teulings et al. (2011), does not
make a distinction between the advantages of the euro and the advantages of membership of
the EU. The analysis presented by ING concerns a full collapse of the EU rather than a
complete break-up of the euro. The assumption is that a complete break-up of the euro will be
accompanied by the reintroduction of trade barriers, in order to protect domestic industries
from cheap products from countries with strongly depreciated new currencies. This is an
extreme assumption, because whether the internal market will suffer from a reconfiguration of
the euro depends on how it is shaped. It is even conceivable that reverse effects will occur, for
instance if, due to further integration of European countries, differences with other EU
members will increase and non-euro members will therefore be less willing to support the
internal market.
Other studies also indicate that the trade effects of the EMU have been rather weak.
Wierts et al. (2012) discuss various economic studies. Some studies showed that the euro
initially increased the trade intensity within the euro zone, but later studies reported much
smaller effects. Berger and Nitsch (2008) even conclude that, after correcting for a trend-like
growth in trade integration, the effect of the euro on trade in the euro zone seemed to be
entirely absent.
Table 3
Economic growth, inflation and current account balance in the EU
European Union (27)
Euro zone (17)
Source: Eurostat
Economic growth
Inflation
1999-2008
2008-2011
2.2
2.0
-0.3
-0.4
19992008
2.3
2.3
20082011
2.1
1.5
Current account balance
(% of GDP)
1999
2007
2011
-0.6
-0.5
-0.5
0.1
-0.5
0.0
A very simple test whether the euro has indeed generated added value on top of the positive
effects of the internal market, is to compare economic growth in euro countries with economic
growth in EU countries that were not part of the euro zone between 1999 and 2008. If the euro
contributed to economic growth in euro countries in this period, one would expect this
growth to be larger than in non-euro countries within the EU. Table 3 shows that this
hypothesis is not confirmed. On the contrary, during the period between 1999 and 2008,
economic growth outside the euro zone in the EU was larger. Also inflation rates do not differ
for this period. Only the balance of payments in the euro zone slightly improved on average.
A possible explanation for this weak performance of the euro zone is that lack of
competitiveness of southern European countries also reduced the pressure on northern
29
European countries to strengthen their competitiveness, thereby weakening their
competitiveness in comparison with countries outside the euro zone.19
Of course, this comparison does not prove the low added value of the euro. The
economies within the euro zone and outside the euro zone differ too much for this. Also, one
needs to realize that a number of advantages of the euro, like convergence and reduction of
(fluctuations in) inflation, already took place in the period prior to the euro. At most, it offers
a further indication of the finding of the CPB study that the contribution of the euro in the past
was rather small. In combination with the fact that the euro (among other factors) led to large
divergence within the euro zone and that the euro made a number of countries very vulnerable
for the 2008 crisis, one can seriously doubt whether the euro on balance has generated added
value. For that reason, the permanent costs of the break-up of the euro will be limited. Nobel
laureate Krugman believes that the euro was a mistake and that the European countries would
have done well without it. 20
Transition Costs
Even if one acknowledges that the structural advantages of the euro are limited, this does not
mean that the way back will be easy. The introduction of the euro has radically changed the
economy of the euro zone and reverting the euro will therefore involve very high transition
costs. With transition costs, we mean the costs that are made during the transition to a new
sustainable euro zone, like the costs of new coins, write-offs on loans or other forms of
support to southern European countries.
First of all, banks must adjust their IT system, payment machines must be converted
and new coins and banknotes must be printed. DNB estimates that these costs will be 1% of
GDP.
Although not insignificant, the above costs are low in comparison to the potential costs
involved with the risk of temporary disruptions in the functioning of banks. It is difficult to
predict how orderly a transition to a national currency will be executed. For exiting countries,
the transition from the euro to the new national currency should be done quickly and
unexpectedly to prevent bankruptcy of banks and a massive run on the financial system. In
addition, the dissolution of the euro will lead to imbalances in the form of speculative capital
flows. This becomes evident from experiences with the break-up of currency unions in the
past.21 Take, for example, the disintegration of the Austria-Hungarian Empire after 1919, the
USSR in 1991, Czechoslovakia in 1993, and to a lesser extent, the Latin Monetary Union and
19
A nice illustration is a statement by Xavier Comtesse that the historical position of Switzerland outside the
European Union has made the Swiss economy the most innovative of Europe: If you are on your own, you are
forced to make smart solutions (Steketee, 2012).
20
Interview in NRC, 3rd of June 2012, p. 13.
21
Rose (2007) shows that in the 69 countries that have left a currency union since the Second World War, no
major macroeconomic consequences occurred before, during or after the break-up. New coins were introduced
without major disruptions. Bootle (2012), however, notes that these examples are not comparable with a breakup of the euro zone, because the analysis of Rose concerns many small, post-colonial economies, which
subsequently linked their currency to stronger currencies and had no large foreign or public debts.
30
the Scandinavian exchange rate union.22 Based on an analysis of these examples, Capital
Economics (2012) concludes that before a currency union breaks-up, there are large capital
flows that destabilize the union and accelerate the collapse of the currency union. For
example, within the euro area, people will want to bring their savings in safety, by moving it
to banks in strong countries, because of the expected changes in exchange rates after the
break-up. This process is already going on for some time and has led to major imbalances in
the Target2 funding of the ECB23; the net positions of countries like Germany and the
Netherlands greatly increased and those of southern European countries greatly diminished
(DNB, 2012b). However, if an exit is expected, these flows will increase. A break-up should
therefore be accompanied by strict control and restriction of capital flows. Another lesson
from these historical examples is that the fate of the successive currencies after the break-up
may vary greatly. For example, after the dissolution of the USSR, the currencies of the Baltic
States developed well, while other currencies within the USSR area underwent high inflation
and devaluations.24
It depends on the time horizon envisioned by policymakers how heavy the transition
costs should weigh in this decision. The shorter the time horizon, the more transition costs
should be taken into count. However, if the aim is to have a sustainable and optimal currency
union in the long term, the costs should have a lower weight. According to Capital
Economics, even in the short term, substantial transition costs should not be too high a barrier.
If the short-term policy, based on preventing transition costs, does not convince the financial
markets, speculation will remain present and will eventually necessitate an adjustment in the
currency union in the future.
4.4
Consequences of Devaluations
If a country leaves the euro zone and introduces its own currency, exchange rate movements
will undoubtedly occur. If a weak European country exits, devaluation will occur (in the order
of approximately 40% for Greece and 30% for Italy and Spain and 25% for Ireland) to
compensate the loss of competitiveness since the launch of the euro zone in 1999 with respect
to Germany (Capital Economics, 2012, p. 130-1). The reason for this substantial devaluation
is that the share of trade with other countries (as a % of GDP) in southern countries is
relatively low. If these economies recover, a partial recovery of the exchange rate will follow
in the longer term.
22
These break-ups cannot easily be compared with the situation of the euro zone either. In none of the listed
examples, the problems of lack of competitiveness of one of the participating countries or of excessive debts
existed. In addition, the relevant currencies were not of global importance, whereas the financial markets
nowadays function much more globally.
23
Target2 is the interbank payment system for real-time processing of cross-border payments within the
European Union.
24
The exit of one or more countries from the euro zone will also have consequences for the write-offs on loans
to these countries. But because these effects are linked to the expected devaluation of the new currencies, we will
discuss these effects in the next section.
31
Trade Balance
In the short term, a country's trade balance will deteriorate, because the extra demand for
export goods will only gradually develop, while the devaluation will immediately lead to
higher import prices. If exports and imports respond sufficiently to changes in the relative
price of domestic over foreign products, in the medium term, exports will increase and
imports will decrease as a result of improved competitiveness. This delay is known as the Jcurve effect: after an initial worsening, the trade balance improves after some time. To what
extent the balance of trade will recover, depends on the price response, because the rise in
import prices will have an upward influence on domestic prices and wages. The price of the
imports of intermediate and final goods will be passed on to consumers and they will in turn
(in their role of employee) demand higher wages. If domestic prices and wages rise at an
equal rate as the exchange rate declines, the real exchange rate will not change and
competitiveness will not improve. Whether this inflationary effect will occur, depends on a
complex mix of factors, like the response of the Central Bank on the devaluation, price inertia
(due to costs associated with price changes) and the business cycle (Garcia-Solanes and
Torrejon-Flores, 2010). If there is a large excess surplus on the domestic goods market and
high unemployment on the labour market, there is sufficient production capacity and labour
available to absorb the additional production that results from the rise of exports and the
decrease of imports, without too much strain on the goods market and labour market. Then
inflationary responses will be weak.
It is striking that various studies (such as Teulings et al. (2011)) consider only negative
effects of devaluations. According to these studies, the possible benefits from increasing
competitiveness, resulting from a devaluation, will only be temporary and will soon
disappear. Higher import prices, directly caused by the devaluation, will soon encourage
higher wages, thereby soon destroying the price advantage and thus the competitive
advantage. Insofar as the exiting country will indeed benefit from more exports or less
imports, this would be at the expense of other European countries.
Northern European countries indeed fear that the revaluation of their currency will
have a negative effect on their economic growth. Also at the time of the ERM crisis in 1992,
countries with revaluating currencies faced severe competition from other countries. French
fishermen, wine producers or car dealers lost market share to their Italian, British and Spanish
competitors, whose products had suddenly become a lot cheaper after the devaluations of the
lira, pound and peseta.25 These experiences also illustrate that exchange rate movements can
increase the call for protective measures to prevent an abrupt loss of competitiveness.
But there are four arguments against this fear. First of all, one cannot defend the
current situation of large export surpluses in northern European countries, because these
mainly result from an (for northern European countries) undervalued euro. This export
25
See: Trouw, February 26th,1993, Boze vissers krijgen hun zin: minimumprijs voor import vis (Angry
Fishermen Are Getting Their Way: Minimum Prices for Imported Fish); NRC, December 24th, 1992, De
financiële kater van de Franse wijnhandelaren (The Financial Hangover of French Wine Traders) ; NRC,
October 8th, 1992, Peugeotverkopen dalen 1,3 procent (Sales of Peugeot Vehicles Decrease by 1.3 Percent).
32
position is inextricably related to the balance of payment deficits in southern European
countries. A more market-based exchange rate ratio is preferable. Flexible exchange rates will
prevent divergence between countries in the future. Secondly, as mentioned earlier, lack of
competition from southern countries will weaken the competitiveness of northern countries
with respect to countries outside the euro zone in the longer term. The Netherlands is a good
example of this, because its exports mostly go to other European countries; exporting goods
outside the EU seems to be much more difficult. A third criticism of the argument that more
competition from southern countries will negatively affect the exports of northern countries is
that this might be true in the short or medium term, but not in the long term. If economic
growth in southern European countries recovers because of improving competitiveness, the
imports from northern European countries will eventually also rise again.26 A final argument
is that the exports of northern European countries do not depend on price competition as much
as the exports of southern European countries, due to the high technological level of their
export products (Wierts et al., 2012). A price reduction in the exports of southern European
countries will therefore not severely erode the competitiveness of northern European
countries.
Financial Markets
Devaluation will also affect the financial markets. A country with large foreign private or
public debts will face an increase in debts as % of GDP, at least if these debts continue to be
denominated in euros. This will diminish the country's access to the capital market. The risk
premium will rise, with negative impacts on investments. For the other European countries,
this will also lead to more risks. Because if the debt ratio of the exiting country increases, an
untenable situation will arise that can only be solved by an additional round of amortization of
debts. Given the fragile financial situation of both governments and financial institutions in
various European countries, this will cause a further economic decline in euro countries and
may regenerate a bank crisis. Both German and French banks, for example, have made
substantial loans to Spain, while French banks have also lent much to Italy, and Germany
(together with England) has lent much to Ireland.
Private loans will also have to be partly written off. The value of all loans that fall
under the law of the exiting country will decline proportionally to the devaluation of the new
currency. Whether a private debt in euros will still be collectible, depends on a multitude of
factors, such as the nature of prevailing legislation applicable to the contract, whether the
redenomination is in accordance with the public policy in the relevant country, the clear intent
of the contract concerning the currency in which the debt should be paid off and, above all,
whether the legislation is enforceable (Clifford Chance, 2012a).
ING (2012b) calculated that the total public and private loans of the Netherlands to
European countries that may exit (Greece, Italy, Ireland, Portugal, Spain) amounts to € 339
26
Furthermore, one can point out that the revaluation of the (revised) euro vis-à-vis the currencies of exiting
countries will cause a drop in import prices and therefore lead to an increase in consumer surplus in the
remaining European countries.
33
billion euros. € 121 billion concerns loans and guarantees of the Dutch government and
claims of DNB and € 218 billion concerns private claims (€ 111 billion of Dutch banks, € 36
billion of pension funds, € 35 billion from companies, € 10 billion of insurers and € 26 billion
other things). If only Greece exits, € 22 billion is at stake.27
On the other hand, the possibility of exchange rate fluctuations also provides a means
to reduce debts in the long term. If a country can improve its competitiveness by a
devaluation, it will also be able to pay off its debts in the long term and hence the debt ratio
may fall below the level that is feasible without a devaluation. Experiences of countries facing
large devaluations show that this will probably occur (see below and in Appendix 2). In many
cases, the devaluation initially led to an increase in the debt ratio, but when economic growth
recovered, the interest rates on the debts and the debt ratios declined again. We must also
realize that internal devaluation (i.e. restoring competitiveness through wage and price
moderation) will also increase external debts as a percentage of GDP. One way or the other, it
will be necessary to amortize debts. Also Buiter (2011) argues that it is inevitable that public
and private parties must write off on their loans to southern European countries, whether they
stay in the euro zone, or not.28 The restructuring of debts is a requirement for southern
European economies to recover.29 Although the amortization of debts may stimulate moral
hazard by rewarding bad behaviour, it is necessary to provide sufficient perspective on
economic growth. A reconfiguration of the euro will accelerate and even enforce the
acknowledgement of the need to amortize debts.
The crucial question is henceforth what policy options will provide the best guarantee
of a structural economic recovery of a country: support from the EU in conjunction with a
policy of public budget cuts and structural reforms of the economy or leaving the euro with a
devaluation of the national currency. Losses from the amortization of debts will appear
anyway. A priori, it is difficult to assess whether the loss on loans will be larger if a country
stays within the EMU (and therefore is not able to regain its competitiveness within a
reasonable time span) than if it leaves the EMU and devaluates its national currency. This
means that one of the main arguments of the proponents for keeping the current euro zone
unchanged must be put into perspective.
The latter reveals that the current support offered to southern European countries can
also be a trap. Because the longer the exit is postponed and the more other European countries
have borrowed in the meantime to keep a country within the euro zone, the greater the
damage that occurs if this country eventually exits and the harder it is to take this step. Some
27
The private exposure to southern European countries will have further declined since then due to capital flight.
From July 2011 to July 2012, savers and financers in the euro zone withdrew € 326 billion from the banks in
Spain, Portugal, Ireland and Greece (NRC, 2012a). As a result, mutual financial dependence of private parties
has rapidly declined within the euro zone. But instead, there is now a bigger financial dependence of countries
through the Target2 program of the ECB.
28
This amortization of debts may be effected by an extension of the expiration time. A haircut of 80% requires
an extension of the maturity by (on average) 33 years.
29
Keynes already noted that the cancellation of debts is ultimately the only remedy to relieve the real economy
from the negative effects of a high debt burden (Mensonides, 2012). The IMF also believes that write-offs on
loans from other euro zone countries to Greece will be necessary. According to the current forecast, in 2020,
Greece's debts will not be reduced to 120% of GDP (as previously was intended), but will be up to 140%. This is
untenable (Lorié et al., 2012). But euro countries refuse to take major steps so far.
34
therefore believe that the bailouts of Draghi through the purchase of government bonds of
weak countries function as a poisonous arrow, which is aimed at making the costs of a
reconfiguration of the euro zone as high as possible (De Jong, 2012b).
Empirical Studies
Empirical research has provided insight into the effects of devaluations. On the one hand,
there are many examples of devaluations that barely had positive effects and sometimes even
led to economic chaos, like in Argentina (1955, 1959, 1962 and 1970). In other cases,
devaluations led to a substantial recovery, like in Britain in 1992 and in several Asian
countries, like Korea, Singapore, Taiwan and Thailand (Kim and Ying, 2007). As discussed
above, the effects depend, among other things, on the inflationary response to the devaluation.
In more recent years, we saw inflation rates indeed increase after a devaluation in various
countries, but not always proportionately.30 31 That explains why in these countries,
devaluation led to an improvement in their trade balance, initially mainly because of lower
imports, but afterwards also in many cases by a rise in exports. The trade balance improved so
quickly that even a J-curve effect did not occur. Because most countries showed an
improvement in their trade balance and economic growth, their foreign debts also gradually
declined as % of GDP.
A recent example is Iceland, which devaluated its crown in 2008 by 50%. The
consumer price index increased in 2009 with 18%, but then fell back. In the end, the real
exchange rate declined with 31%. Significant is a comparative international study of Iceland,
Ireland and Latvia (Darvas, 2011). This study is particularly interesting, because these
countries are quite similar: they are small, had a large banking sector and rapid credit growth
before the crisis, high foreign debts and a booming real estate sector. Therefore, the
experiences of these countries provide a kind of controlled experiment of the effects of
exchange rate policies, strict controls on capital flows and bail-outs of banks. The study
shows that Iceland, by devaluating its crone in combination with strict capital control and the
restructuring of debts (where private parties also had to bear losses), performed better than
Ireland, which could not devaluate its currency and Latvia, which itself opted to maintain the
link between its currency and the euro. As a result, the decline in employment in Iceland was
significantly lower than in the other countries, namely 5% between 2007 and 2010 against
13% in Ireland and 17% in Latvia. In particular, employment in the export sectors increased
in Iceland. The expectation is that the economy in Iceland will grow this year by 2.4%
(against a decrease of 0.3% of the euro zone). Internal devaluation in Ireland and Latvia has
not worked as well as external devaluation did in Iceland. An important difference is that
Iceland did not bail out banks, while the Irish government took the whole burden from its
30
For a description, see Appendix 2.
This corresponds with simulation results of Garcia-Solanes and Torrejon-Flores (2010) with a general
equilibrium model, which show that the impact of devaluations on domestic consumption and production prices
for countries with large debts is limited. They conclude that devaluation for this type of countries is a good
means to adjust the real exchange rate.
31
35
banks and put it on the shoulders of the taxpayers.32 Bankruptcy in Iceland caused a loss for
foreign lenders of 47 billion euros (Darvas, 2011: p. 7). Currently, Icelandic banks have high
capital ratios and are for 90% financed by deposits. Interestingly, despite the restrictions on
capital flows and despite the bankruptcy of its banks and the amortization of foreign debts,
Iceland proved to be able to borrow again on the international capital market in 2011. This
shows that recovery of a country’s competitiveness is fundamental for the confidence that
investors have in the country and is more important than rigidly saving fragile banks and
avoiding the necessary amortization of foreign debts.
Table 4
Recovery after the crisis: Iceland, Ireland and Latvia in 2010
Iceland
Ireland
Net foreign debt (% GDP)
629
91
Real effective exchange rate (2007 Q4=100)
69
87
Nominal exchange rate (2007 Q4=100)
55
98
Consumer price (2007 Q4=100)
136
98
Real wage (2007 Q4=100)
91
102
Employment (% change since 2007)
-5
-13
Real GDP (% change since 2007)
-9
-10
a
Latvia
80
81
99
108
84a
-17
-21
mainly because of wage reduction in the government sector; source: Darvas (2011).
Whether a devaluation will lead to inflation also depends on the openness of a country
to international trade. The higher the share of the imports, the stronger the inflationary
pressure will be. Yet there are reasons to expect that a devaluation will not directly lead to
higher domestic prices. Because of high unemployment and weak domestic demand in
southern European countries, companies will have difficulty to raise their prices. Also the
wage response to the rise in consumer prices will be moderated by the high unemployment
rate. It can be expected that a devaluation will not result in a proportionate increase in the
domestic price level. Hence, I expect that a real depreciation will take place, which will
improve the competitiveness of these countries.
If a devaluation would, however, induce a proportionate increase in domestic prices
and wages, there will be no competitive advantage and no recovery of the balance of
payments. But under certain conditions, such a devaluation will still help a country to control
its government debts. This is particularly the case if the debts are denominated in the national
currency. Through inflation, provoked by the devaluation, the real value of the debts will
drop. But if the devaluation does not induce a proportionate increase in domestic prices, the
competitiveness of a country will improve. In that case, the reduction in the public debts as %
of GDP is less. In short: a devaluation will restore the competitiveness of a country or make
32
Rumour goes that in November 2010, ECB president Trichet forced the Irish government to guarantee the
debts of its banks in order to spare debt bondholders, by threatening he would otherwise hold back the
emergency liquidity assistance (ELA) to Ireland. This can be interpreted as a political intervention beyond the
mandate of the ECB. See: http://www.independent.ie/business/irish/michael-noonan-im-willing-to-overrulefinance-officials-and-release-ecb-letter-on-bailout-3213041.html.
36
the debts more manageable or provide a combination of both benefits for a country that leaves
the EMU.
Devaluations in the past incidentally showed that countries usually wait too long with
adjusting their exchange rate, namely until their reserves to support the exchange rate are
exhausted (Frankel, 2003). De Beaufort Wijnholds et al. (2011) conclude that it is dangerous
to maintain a fixed exchange rate in a world with increasingly mobile capital, especially in
emerging countries whose foreign exchange markets are generally thin. Orderly adjustment of
exchange rates in combination with inflation control is more effective than sticking to a fixed
exchange rate. This also seems relevant for some European countries, because the euro
prevents them to adjust their exchange rates and the barrier to leave the euro zone is very
high.33
The picture that emerges from the various studies is that devaluations certainly can
make an important contribution to the economic recovery of countries that suffer from an
overvalued currency in combination with high foreign debts, provided that several conditions
are met, such as an orderly restructuring of unsustainable debts, in which also private parties
are involved. However, also a policy of internal devaluation may eventually improve the
economic situation. An example seems to be Portugal. According to the evaluation of the
Troika (ECB, EC and IMF), in June 2012, Portuguese reforms were implemented on
schedule. Recent growth in Portugal’s exports is stronger than expected and imports have
decreased by 3.3%. It is expected that in the medium term, the current account will recover
(Wise, 2012). Especially the Portuguese exports to China significantly increased (with 76% in
2011). It is also important to note that the export growth concerned high-quality products,
such as exclusive shoes and vehicles (Volkswagen). This suggests that reforms can improve
technological competitiveness rather than just price competitiveness (induced by a
devaluation). De Jong (2012a) therefore concludes that reforms can achieve the same and
even better results than a devaluation.
In a recent study, Wierts et al. (2012) found, however, that the share of technically
high-quality manufactured goods in the exports of the peripheral countries is relatively small
and that this will not significantly increase in the short term. Therefore, it will not be easy for
these countries to quickly increase their export growth significantly. This is confirmed by
Table 5, which shows that for other southern European countries than Portugal, exports have
barely grown since 2007. Especially the difference with Iceland is significant, which indicates
that an adjustment of the exchange rate can be a powerful means to restore competitiveness.
This is confirmed by the findings of Wierts et al. (2012), which state that the effect of a
reduction in the real exchange rate on export growth declines with the share of technically
high-quality manufactured goods in exports. That means that an improvement in price
33
Other conclusions that De Beaufort Wijnholds et al. (2011) derive from financial crises in the past is that
orderly workouts of unsustainable debts needs to be promoted to avoid chaos (as in Argentina at the time). The
crisis should not be resolved through the provision of official finance alone, as this would generate unwanted
moral hazard. Involvement of private creditors in resolving financial crisis is highly desirable in order to limit
moral hazard and to share the burden of solving the problem with the public sector. A tight monetary policy is
needed to restore confidence. If executed skilfully, high interest rates need to be maintained only for a limited
period of time in order to turn the market sentiment around.
37
competitiveness, resulting from a devaluation, will have a stronger impact on the export
growth of the southern countries than on that of the northern countries of the euro area.
Table 5
Belgium
Cyprus
Germany
Expected export growth in 2012 in relation to 2007a
Euro zone: 13.9
Non-euro zone: 18.5
10.7
Italy
3.6
Denmark
14.5
0.5
Luxembourg
7.8
Latvia
45.0
18.1
The
21.4
Poland
42.7
Netherlands
39.2
Austria
6.9
Czech Republic
14.7
-12.2
Portugal
18.6
UK
16.8
9.7
Slovenia
7.1
Iceland
71.6
1.4
Slovakia
26.3
Sweden
2.8
23.7
Spain
16.7
Estonia
Finland
France
Greece
Ireland
a
100* (prediction export 2012/export 2007-1); in constant prices (purchasing power standard);
Source: Eurostats
5
Political Analysis
In addition to the three economic criteria discussed in section 4.1 and 4.2, the Optimal
Currency Area theory also contains three political criteria. First, the transfer criterion, which
states that countries that are willing to compensate each other for adverse shocks, can form a
currency union together (solidarity in the sense of financial support). The second political
criterion is homogeneity of political preferences, which can make the policy response to
shocks unambiguous. If political preferences strongly diverge, central policies will always be
controversial and lead to resentment, which will put the currency union under tension. The
third political criterion is solidarity in the sense that countries strive for a common future and
destination and are willing to make costs to achieve this and make national interests
subordinate to this. An assessment of the various options can therefore not be made without a
political analysis.
Next, we will explore the possibility of mutual transfers, the degree of homogenous
preferences and solidarity. This will be followed by several other political considerations.
5.1
Application of Political Criteria of the OCA Theory
Mutual Transfers
Until now, mutual transfers have existed mainly between regions within European countries.
For instance, if the production in Groningen declines and employment rises as a result of an
economic shock that especially hits the northern region of the Netherlands, tax revenues in
38
Groningen will decline, whereas income transfers (especially unemployment benefits) to
people in Groningen will rise, which will tone down the economic consequences of the shock.
The total budget of the European Union amounts to around 1% of EU GNP, of which
(in 2011) 42% was spent on direct aid to farmers and market related expenses and 45% on
cohesion, growth and employment.34 Especially the Structural Funds provide a form of
redistribution. After the accession of Spain, Greece and Portugal in the 1980s, these funds
were doubled in order to help these countries function in a competitive market if the internal
market integrated further. With the current crisis, we see a rapid increase in mutual transfers.
The so-called European Financial Stability Facility (EFSF) and its permanent successor, the
European Stability Mechanism (ESM), help to provide loans to countries that are in big
financial problems. This is a first step towards mutual transfers. Nevertheless, the euro zone
does not fully meet the criterion of the OCA theory, since these loans have to be paid back
with interest, contrary to transfers within countries, like unemployment benefits, which have
an important redistributive effect and are automatic and are not implemented through
discretionary policies. Furthermore, the willingness to provide loans decreases if some
countries continuously need financial support. This is especially the case if this support to
countries triggers moral hazard. Overt direct support operations therefore encounter much
resistance. As a result, mutual transfers occur rather invisible through loose monetary policies
of the ECB (ING, 2012), like low interest loans.35 In short, mutual transfers occur on a
limited, but growing scale.
Homogenous Preferences
Besides major macroeconomic differences in performance, there are major differences in
political preferences, which are reflected in the commitment of countries to prevent inflation,
government deficits or debts or to combat unemployment, the institutional design of the
economy, fiscal policy, the role of the state, the role of unions, the vision of the ECB, the style
of leadership and political culture, etc. As a result of the difference in preferences, the policy
response to economic shocks will be quite different.36
In southern European countries and in France, the government traditionally plays an
important role in the economy. Top executives often move from government enterprises to the
public sector, and vice versa. Both society and organizations have a hierarchical structure and
there is often a reluctance to market operation as a solution to social problems. Countries like
France score high on Power Distance and Uncertainty Avoidance indices (Bohn and De Jong,
2011). Politics in France are highly centralized and less inclined to make compromises.
34
See http://europa.eu/pol/financ/index_nl.htm
But like De Jong (2012b) argues, these non-transparent measures are more inefficient than direct support
measures (like an interest subsidy), since the signal for the credibility of the policies of countries is weakened,
which increases the risk of failure. Furthermore, the danger of a policy of low real interest rates is that weak
banks survive.
36
A recent example is France, where the government wants to combat government deficits through higher taxes
instead of budget cuts.
35
39
Although in Germany the government also plays a more important role than for
example in the Anglo-Saxon countries, it is not as central as in the southern countries.
Germany scores lower on the Uncertainty Avoidance index, which means that it is more open
to market operation. Because of its federal structure, German politics are more focused on
consensus building.
These differences are reflected in the vision of the EMU. The French are opposed to
an independent Central Bank that they cannot control politically. For this reason, Chirac did
not want Duisenberg to be the first president of the ECB. He motivated this by the words: “Je
ne me laisse pas faire chanter par un petit fonctionnaire.” For France, it was therefore not easy
to accept the independence of the ECB. In 2001, the former director of DNB, Szász, already
suspected that France would expect to have sufficient possibilities to get political grip on the
policy of the bank later in de drafting of the treaty and its implementation, which is actually
taking place now (De Jong, 2002). The French are also opposed to strict rules and automatic
penalty procedures, whereas the Germans strongly support this policy. Even during the
current crisis, the French president was not willing to accept the authority of the existing
Treaty of Maastricht. Sarkozy did not hesitate to promise Greece financial support without a
mandate, in defiance of the non-bailout rule of the treaty. We see comparable differences
within the ECB. Whereas France strongly supported the purchase of government bonds of
weak southern European countries and Sarkozy urged the ECB to do this (which is in itself a
violation of the independence of the ECB), Germany strongly protested (Bohn and De Jong,
2011).
In short, there are heterogeneous preferences when it comes to the relation between the
government and the economy and the role of central banks. This heterogeneity makes that the
EU often reacts in a cumbersome or inconsistent way to the expectations and demands of the
financial markets. The crisis has strengthened this effect. Endless discussions and
compromises are very harmful to the clarity and credibility of the policy. Fundamental
changes to the Stability Pact, which should enable the EC to intervene in the national fiscal
policies of Member States, are therefore not possible in the short term (Kerber, 2010). The
temporary measures that are taken, like the ones taken by the ECB, often bring only
temporary peace. The markets are aware that the Bundesbank has strong objections to the
extension of the powers of the ECB.
What are now the prospects of the euro? To answer this question, we will use the
theory of Williamson (De Jong, 2002). He distinguishes different levels of social analysis,
ranging from:
1.
2.
3.
4.
informal institutions (customs, norms and traditions)
formal rules (laws, functions of governments, etc.)
governance (the way in which contracts are respected)
and the actual allocation of goods and services
When it comes to the first level, things change very slowly, in a time span of a century. The
second level also changes slowly; Williamson estimates that this will take 10 to 100 years,
40
although unexpected accelerations sometimes occur (like at the end of the Cold War). At the
third level, customs can change rather rapidly (10 years). The fourth level involves the actual
allocation of goods and services; at this level, changes occur at a daily base as a result of
changes in price and quantity. Because the cultural differences between the northern en
southern European countries fall under the first level of social analysis, on the base of
Williamson’s model it is to be expected that differences in political preferences will continue
to occur in the future. This means that in the future, the euro zone will also only partially meet
the requirements of homogenous preferences. However, recent events have shown that under
economic and political pressure, significant policy changes can be made, which makes that
measures that previously encountered fierce resistance are nevertheless accepted (ING,
2012a).
Solidarity
The last criterion is similar to the first one, but addresses a deeper and broader dimension of
solidarity. The central question with this criterion is whether countries are willing to bridge
the differences when asymmetric shocks occur while there are differences in interests and
visions of the policy to be followed, knowing that they are dependent of each other and share
the same future ultimately.
Although it started out as a coal and steel union, the vision of the European
Community has always involved more than an economic project. The central idea behind
European integration was to prevent a new war at the European continent. Founders like
Schuman have always stressed that the European peace project is rooted in shared values and
comprehends more than shared interests. Despite all the diversities, there also exists a
common European culture and history, which is reflected in everything that Europe has
produced (Luitwieler, 2013).
The question is whether this “big” story behind the European project has sufficiently
taken root in the “hearts and minds” of European citizens. In the past decades, the emphasis
on the economic dimension of European integration has increased due to the advantages of
the internal market, the free movement of persons, services, goods and capital. But since
economic profits are decreasing now and there is more pressure on countries, support for the
euro, and thus the European Union, is declining. Although the political elite within Europe is
aware of the need for a common future, its citizens – especially less educated people – are far
less willing to give up national sovereignty. The current Euro Barometer shows that only 16%
of the people answer the question ‘Do you ever think of yourself as not only nationalistic, but
also European’ with “often”, whereas 43% of the people answers with “never” and 38% with
“sometimes”. Especially in times of crisis, national sentiments are getting much stronger.
This shows itself best in how Germans think about the Greek, and vice versa.
It is essential that the euro debate is not only carried out from an economic cost-benefit
analysis (although indispensable for the assessment of various policy alternatives), but that the
European Union is also viewed as a community of values (Luitwieler, 2013). This not only
concerns solidarity as a form of altruism, but also the awareness that the future of the
41
Netherlands is inextricably linked to the future of the euro zone. The euro contributes to the
European project to bring peace and stability in Europe. Like Krugman argues, for example:
‘The European project has created peace, prosperity and democracy for sixty years. If the
biggest adventure - the euro - fails, this will be disastrous for the European project.’37
Another possible basis for solidarity is reciprocity. The idea behind this is that if we
help other euro countries now, they will help as when we need them. It is a matter of give and
take. This is already the case now, since the northern countries do not only give, but also
benefit from the poor economic situation in the southern countries due to the low euro
exchange rate, which raises the export of the northern countries, and due to the low interest
rate in the northern countries. Yet this reciprocity is not experienced by many. Because when
it comes to mutual support, it is predominantly one-way traffic from the north to the south and
it is not to be expected that this will change in the near future.
A major obstacle to solidarity is also caused by the high degree of cultural diversity
within Europe. Luitwieler (2013) argues that redistributive social policy at a European level is
not desirable, since the Member States of the euro zone all have their own cultural identity.
In short, according to the last criterion of the OCA theory, it is difficult to say to what
extent the euro zone meets the requirements of an optimal currency union. According to
Baldwin and Wyplosz (2012), the glass is either half full or half empty. The euro zone does
not score high on this criterion, and the crisis puts mutual solidarity under pressure, but one
cannot say that it fully fails.
5.2
Other Political Considerations
Besides the political considerations that arise from the OCA theory, there are numerous other
relevant political aspects which play a role in the public debate about further European
integration and alternative policy options. In this section, we will briefly discuss the following
aspects: democratic legitimacy, influence of small euro countries, peace and security,
relations between euro and non-euro countries in the EU, solidarity within countries, and
commitment of the European elite.
Democratic Legitimacy
The European Union and its State Members stress in their relations with the rest of the world
the importance of democratic decision-making and legitimacy. The euro crisis shows,
however, that the euro countries themselves are also struggling with democratic legitimacy.
There are more and more “parliament free zones”, which means that if parliaments have to
vote, they can only do this afterwards. In practice, they just have to approve the measures that
are taken, because otherwise they will endanger the euro according to the government. For
example, Italian Prime Minister Monti, who was never elected, proposed in Der Spiegel to
limit the power of national parliaments with respect to European policies, because parliaments
37
Interview in the Dutch NRC newspaper, June 3rd, 2012, p. 13
42
are too much of a nuisance for national governments. The example mentioned earlier that the
ECB forced Ireland to pay the debts of the banking sector to limit the damage to banks in
other countries reflects a serious violation of the ECB mandate, which makes that political
interventions are made without parliamentary supervision.
Democratic legitimacy is essential, especially when central banks and financial
markets are playing a dominant role and need correction. Since debts are made public now,
the democratic legitimacy of policies has to be strengthened. Therefore, it is necessary to
assess for various policy options to what extent democratic legitimacy is either strengthened
or weakened, both at a national and European level.
Credibility of the European Union
The EU is not only faced with lack of democratic legitimacy, but also with a credibility
problem. Many agreements and rules that were decided on in the past, seem to fail under
political or economic pressure. Although it is certainly not exceptional that norms (either
constitutional or not) are violated in the policy of states, the seriousness of the violation of
norms within the euro zone is alarming. In the past, countries like Italy, Portugal and even
Germany and France took the freedom to depart from the rules of the Stability Pact without
being punished for it. Eventually, it appears to be very difficult to punish countries that break
the rules, because the punishment itself causes destabilization. In addition, the group is too
small to feel confident enough to punish others. If countries have borrowed and lent much
capital from and to each other to support government expenses, they are reluctant to take
additional risks by punishing countries that have violated fiscal rules, which will diminish the
chance of repayment further. In this way, the threat to be punished disappears.
We have seen the same with the no-bailout clause of the Maastricht Treaty. Under the
threat of rising interest rates, this no-bailout clause was actually abandoned when the ECB
(indirectly) purchased government debts. Despite its limited monetary mandate, the ECB
more and more took on a financial stability role by generously providing loans to European
banks and by demanding qualitatively low requirements to the collateral for these loans.
Whereas the ECB was explicitly modeled after the German Central Bank, the crisis made that
its political role increased by buying bonds from southern European countries. By setting
requirements in the form of necessary reforms, the ECB went beyond its authorities and took
over the role of national governments without having the democratic legitimacy for this. Thus,
the ECB put its independence at risk, because it became more vulnerable to political pressure.
According to De Jong (2012b), the goal behind the measures taken by the ECB is to make the
euro irreversible. Asmussen (2012) (director of the European Central Bank and successor of
Jürgen Stark, who resigned early) says something similar: ‘Our starting point is that the euro
is irreversible. And that we have to repair the flaws in the currency union. That is indeed
politics, yes… We have to complete the monetary union…work on a banking union and an
economic, financial and political union.’ But it is up to politicians and parliaments to decide
on this. This is not a goal of the ECB and it should not be either.
43
These experiences call into doubt to what extent agreements made within the EMU
can in general be maintained when economic and/or political constellations change. As long
as the pressure from the financial markets is killing, there is enough motivation to meet the
requirements set by such a union. But once confidence slightly recovers and the pressure
disappears, it is questionable whether a strict application of European fiscal rules remains
feasible.
Power Relations: Position of Small Countries
As a small country, the Netherlands has little influence on the EU eventually. The more
integration, the more the Netherlands is subject to institutions that the Dutch population can
exert little influence on.
At the same time: from a global perspective, taking the competition of the BRIC’s 38
into account, the Netherlands and other European countries probably cannot get around
further European integration in order to survive. Scheffer (2012) believes that a unified
Europe is necessary for self-determination in the world economy and says: ‘If this is true,
European integration is not about loss of sovereignty, but about increased influence by acting
with joint forces.’ Being the biggest country of the small countries, it is possible for the
Netherlands to exert influence by working together with other small countries, for example.
Furthermore, it should be clear that the freedom of policy in countries like the Netherlands
will also be limited if no further integration takes place (or if Europe is put at a distance). In
practice, the Netherlands cannot afford this, because it depends too much on other countries.
This is illustrated by the fact that the monetary policy of DNB during the period prior to the
euro in practice was mainly dictated by the policy of the Bundesbank.39
Countries that refuse to be part of the euro zone (and even the EU) are at risk of
having no influence at all on the developments within the EU, whereas they are still highly
dependent of and have to conform to these policies. An example is Switzerland, which in
contrast to Norway, Iceland and Liechtenstein, is not part of the European Economic Area
(EEA), the common European market with free movement of goods, persons, services and
capital. However, through numerous bilateral agreements, Switzerland has obtained access to
the common market, although not to all markets. This exceptional position has a number of
advantages – e.g. Swiss banks are therefore (still) exempt from European supervision – but it
also imposes restrictions. For example, the negotiating position of Switzerland is weak,
because of asymmetric relations: eventually, the EU is more important to Switzerland than
vice versa, because two-thirds of the Swiss exports go to the EU. In practice, Switzerland has
little room to deviate from EU rules, but since Switzerland is not a EU member, it cannot codetermine the EU rules (Steketee, 2012).
38
The fast- growing economies of Brazil, Russia, India and China.
There is a difference, however, because following the policy of the Bundesbank was a free choice, which DNB
could deviate from, if necessary.
39
44
Peace and Security
As already discussed, many think that the euro crisis is inextricably linked to the European
project for peace and security. According to Jean-Claude Piris, former director general of the
Legal Service of the European Council, all hidden conflicts will break out immediately if
Europe collapses, like the one between Greece and Macedonia.40 Schepers, vice-president of
the EBRD, argues that the EU in general and the euro in particular anchor peaceful aspirations
in an ‘extremely tense area’.41 It is not that long ago that countries like Spain, Portugal and
Greece had an authoritarian regime. And the recent riots in Greece show the vulnerability of a
democratic constitutional state. It is therefore important that the various policy options are
weighed with respect to their contribution to peace and security.
However, it is questionable whether a common currency is really so important for the
peace and security of Europe. A comparison can be made between the difference in economic
benefits of the euro zone and the economic benefits of the European Union and the internal
market, the latter being much higher. With respect to peace and security, it will probably be
more important that countries are anchored well in the European Union and the internal
market than that they share the same currency. This is especially true if having the same
currency leads to many tensions, because the economic situation of countries does not meet
the criteria of the optimal currency area. In addition, further integration of the euro zone
makes the relationship with countries that do not belong to the euro zone more difficult (see
below). For the sake of peace and security, it is therefore questionable whether keeping the
euro area together is so important. It could even be argued that maintaining the euro, together
with all the reforms and budget cuts enforced by the EU, might even lead to more internal
tensions and disturbances.42
Since the euro policy is strongly determined by political motives, economic
considerations receive far too little attention (and vice verse). To restrict the potential
economic risks resulting from this, it would be better to consider the euro predominantly as an
economic instrument and to emphasize the European Union as the locus of European
integration, instead of the euro zone. This provides more flexibility to base euro policies on
economic interests and diminishes the chance that a reconfiguration of the euro zone will
damage the European project for peace and security.
Relationship between Non-Euro Countries and Euro Countries
A disadvantage of further integration between the EMU countries is that the distance to the
other EU Member States increases when these are not willing to go that far. Thus, the
preservation of the euro might drive a wedge between EMU countries and other EU Member
States. One example is the plan made by the British Secretary of Foreign Affairs, William
40
Interview with Jean-Claude Piris, Dutch NRC newspaper, June 24th, 2012, p. 13.
Interview in Dutch NRC newspaper, June 21st, 2012, p. 31.
42
Scheffer (2012) also questions the importance of the euro for peace and security in Europe. He qualifies the
‘never war again’-argument as an outdated form of euro-centrism and stresses that defending the euro is not a
matter of the past, but of the future, with all the changing relations in the world.
41
45
Hague, to submit every aspect of the European legislation to “a comprehensive research” to
see if it serves the British interests. The British are still rather annoyed about the fact that the
seventeen euro countries took a number of measures last year to protect the euro, while Great
Britain and other EU countries outside the euro zone were passed over.
Non-euro countries are worried that there will be a two-speed EU and that this will be
at the expense of the level playing field between companies within and outside the euro zone.
One example concerns the banking union. Once banks within the euro zone have the security
that they, if necessary, will get support from the ESM fund, banks outside the euro zone are at
a disadvantage.43 Although non-euro countries have the option to participate in the banking
union, they are not allowed to co-determine the design and implementation of its policy,
because they do not belong to the ECB. In particular, the United Kingdom is concerned that
its influence on the regulation of the banking sector will diminish.44 45
More in general, greater divergence between the EU Member States within and outside
the euro zone will cause a mismatch between European constitutions and the purpose they
serve. Because when the euro zone needs to be stronger integrated, it will be necessary for
other European institutions, like the European Parliament, to be strengthened. The European
Parliament, however, is not the most appropriate authority for regulations that concern the
euro zone, because non-euro countries also participate in it. For stronger integration of the
euro zone, a double number of institutions is actually needed as a firm foundation of the euro
zone and European Union.
National (Inner State) Solidarity
Solidarity between euro countries is limited, because most EU Member States are only willing
to transfer minimal powers to Europe. But also at the state level, a process of diminishing
solidarity can be seen, which is also fostered by the crisis in the euro zone. This is illustrated
by the current tensions between Catalonia and the central government of Spain46 and between
Flanders and Wallonia in Belgium.47 The Catalans criticize the Spanish government for
shifting the required budget cuts on to the regions. Thus, the crisis stirs up their passionate
desire for independence. The Catalan president Artur Mas announced a referendum on selfdetermination if he was re-elected on November 25th. Just like Rajoy protests against the
conditions that are linked to a European rescue of Spain, so do the Spanish regions at a
national level. Taking into account that Catalans do not show solidarity with other regions in
43
This might be intentional if the goal is that other EU countries also join the euro zone eventually.
Another complication concerns countries that belong to the euro zone, but where banks are mainly owned by
non-euro countries, like Estonia.
45
This is also reflected in the position that Germany occupies within the euro zone. This has to do with the fact
that Germany holds a minority position in the euro group and – although often supported by the Netherlands,
Finland and Austria – cannot make a stand against France, which operates together with southern European
countries. More natural allies of Germany – like the Scandinavian countries and central European countries - are
non-euro countries and therefore, further integration of the euro zone will increase the distance even more.
46
See: http://euobserver.com/political/118125
47
Similar tensions occur in Germany, in the federal state of Bavaria, where criticism on the many contributions
to Berlin to finance the new federal states is growing. Another example is the proposed referendum on
independence for Scotland, but the reasons for more autonomy are of a different nature there.
44
46
Spain and Flanders does not do so with Wallonia, one may wonder why citizens in northern
European countries should show solidarity to southern European countries. Thus, there are
limits to the solidarity that can be expected between European countries.
At the same time, being embedded in a large euro zone will give regions more
opportunities for self-sufficiency with regard to the national state. It is difficult to estimate
what the consequences of this development will be. On the one hand, countries splitting up
will enhance the complexity within Europe, which will make it even more difficult to pursue
an effective policy. On the other hand, this will make the individual countries more dependent
of Europe, which will cause the balance of power to shift in favour of Europe, thus enhancing
the possibilities for a central policy.
In addition, the crisis in the euro zone puts solidarity at a national level under pressure,
because under the current policy plans, further integration of the euro zone will lead to a more
flexible labour market. As long as a country has its own currency, it can adapt rather easily to
changing economic circumstances. By devaluating its national currency, it becomes
competitive again. But if this mechanism fails, a country is dependent on a flexible labour
market, where wages adjust rapidly if unemployment rises. Given the rigid labour market in
many southern European countries, this can be seen as an important advantage for the current
policy of further integration in combination with structural reforms. In today’s globalizing
world economy, well-functioning labour markets are essential, not only because of tough
price competition (through moderation of wage costs), but also with regard to competition on
quality. An adequate match of supply and demand of labour makes that employees can move
to jobs in which they are most productive. The crisis works like a crowbar, making it
necessary for outdated labour market institutions to adjust. However, under the great pressure
of the crisis, the scale could possibly tip to the other side, thereby insufficiently discounting
the economic disadvantages of too much flexibility. If the labour market becomes too flexible,
this will hamper innovation, because the commitment of employees will erode (Volberda and
Heij, 2012). Furthermore, flexibility goes together with uncertainty among employees.
Research into human happiness shows that a flexible labour market substantially harms
people’s happiness (Layard, 2002).
Commitment of the European Elite
The people who currently have to decide on the future of Europe are highly committed to
saving the euro. It is therefore unlikely that the current European elite will accept any other
solution than to continue on the chosen path. This complicates an orderly withdrawal. Nor is it
likely that one or more countries will voluntarily leave the euro zone, because the southern
countries are convinced that they have no other option than to trust that they will be saved by
the EU or the ECB or a form of bailout, financed by the other EMU members (Kerber, 2010).
Only when southern European countries feel they are at risk of losing the support of the EU or
ECB and when there is enough backup for leaving the euro zone, they will seriously consider
an exit. In peripheral euro countries, there is therefore no political will (yet) to form a zeuro
zone.
47
It is also unlikely that strong countries will leave the euro zone. There is no legal
mandate for this and this could motivate the European Committee to start a so-called
infringement procedure. Finally, blowing up the euro will cause so much political damage that
countries like Germany will never consider such a step.
6
Implications for Five Policy Options
In this chapter, we will apply the analysis of the previous chapters to the various policy
options and we will evaluate these policy options, based on economic and political goals. To
this end, we will first present a framework of economic and political criteria. Then, in the next
sections, the various policy options will be assessed, based on the different criteria.
In the analytical framework, we will distinguish three economic and two political
goals: economic growth, value of debt positions, economic stability, democracy and peace
and security. With each of these goals, different aspects are involved (see Table 6).48
Table 6
Economic goals
Economic growth
Inflation,
competitiveness,
current account
Evaluation criteria
Value
of Economic stability
debt
positions
Value of debt
positions
within
the
EMU
Convergence
in
economic performances
Foreign investments
Political goals
Democracy
Peace and
security
Democratic legitimacy
and support
European
solidarity
Tension between euro
countries and non-euro
countries within EU
Risk
regional
conflicts
of
Economic
growth,
unemployment,
consumption
level,
national debt
Most criteria are evident, because they play an important role in the debate on the euro zone.
The economic and political criteria of the OCA theory can especially be found in the third
criterion of economic stability. If a policy option is more in line with the conditions set by the
OCA theory for a currency union, the chance of economic divergence between the
participating countries within the currency union will decrease, resulting in a more sustainable
currency union.
48
One could also analyze regional differences (the Netherlands, exiting country, other euro countries, euro zone,
other EU Member States, EU, rest of the world), but these distinctions will not be systematically discussed.
48
6.1
Further Integration of the Euro Zone
First, we will discuss the risks that are involved with the current policy, based on the
assumption that no country will leave the euro zone by imposing further monetary and
economic integration on euro countries.
The expected effects of further integration of the euro zone on economic growth
highly depend on how successful the southern European countries will be at reforming the
economy, which in turn highly depends on political developments that are hard to predict.
Institutional changes typically require a longer period of time (see above), but under the
influence of the current crisis, changes can accelerate. Only if the euro zone turns out to be
able to show a clear institutional framework that creates the right economic preconditions for
southern European countries to strengthen their competitiveness significantly, this policy
option will be the most favorable. Reforms will then lead to convergence in inflation, interest
rates and current accounts and the confidence of foreign investors in the southern European
countries will recover. This will strengthen the economy and increase the growth of prosperity
in the southern countries significantly in the long term, which will make that the euro zone
will more and more meet the criteria for an optimal currency union.
However, there is great uncertainty, both in the short and in the longer term. There is a
real danger that the process of internal devaluation will not lead to recovery of the competitive
position of the southern European countries fast enough. Structural reforms in southern
European countries will only be effective in the long term (Blundell-Wignall and Slovik
(2010) believe this will take decades). Increasing labour productivity through reforms is a
very difficult process: it would be quite an accomplishment if a government, by good policy,
could make the annual labour productivity growth increase by 0.5%, but even then it would
take decades to catch up with its competitors if they lag behind with 30-40% (Bootle, 2012).
In the short term, the effects of supply-oriented reforms could even be negative, because of a
reduction in the demand for goods. Combined with the current need for cuts in order to reduce
budget deficits, there might be too little perspective on recovery, which would diminish
political support for reforms and cause political instability. This generates great risks for
economic recovery and stability in the long term. On the other hand, if the recession or
depression is not as fierce as expected, there is a risk that as soon as the crisis ebbs away,
cultural differences between countries within the euro zone (that are often more persistent)
may cause permanent differences in economic institutions, so that reforms within economic
institutions may get stuck halfway. The euro zone will then not be able to meet the conditions
of an optimal currency zone in the longer term either, thereby creating a substantial risk of
economic instability.
Another important source of uncertainty concerns the quality of European institutions.
Due to cultural-political differences between euro countries, the design and the actual
functioning of European institutions and policies are often characterized by lack of
consistency.49 In addition, it has become evident that many agreements and rules are not able
49
Luitwieler (2013) relates the lack of consistency of European institutions to a lack of input legitimacy. He
blames this on a combination of supranational integration and intergovernmental coordination. European leaders
49
to resist political or economic pressure. There is little reason to assume that this will change in
the future. Even when we look more specifically at the various building blocks for the further
integration of the euro zone, significant risks are likely to appear.
The first risk concerns the emergency fund. Such a fund assumes that the problems
that a country experiences will be temporary and that by providing sufficient liquidity, the
confidence of the financial markets will return. Chapter 2 showed, however, that the problems
of the southern European countries are structural and indicate lack of competitiveness. If
additional loans are offered in that case, problems can increase in the longer term, because if a
country has no political will to reform structurally or otherwise is unable to improve its
competitiveness through structural reforms, the increased debts will bring the country even
further down. The emergency fund will then lead to greater losses in the future for the
stronger euro countries by means of write-offs on loans to problem countries. This is exactly
what the renowned German economist Hans Werner Sinn fears, who argues that the prelimiting conditions for support from the emergency fund are getting less and less strict, which
is clearly demonstrated by the financial support to Spain. Experience shows, however, that
transfers from richer to poorer regions do not result in an improvement of the competitive
power of the latter group. If the emergency fund is extended too much and is also used, for
example, to pay for the national debts of Spain and Italy, the healthy euro countries could get
into trouble as well.50 51
Both with indirect support through the ECB and with direct transfers, there is a risk
that the recipient countries will get permanently dependent of other countries within the euro
zone. The Economist (2012b) refers in this context to the permanent support of West
Germany to former East Germany after their unification. This support has created a form of
permanent dependence. There is a similar risk with a transfer union at a European scale. The
costs involved are potentially very high. The Economist (2012b) even mentions an annual
amount of € 250 billion.
Another important risk of further integration is that the past has shown that various
European institutions never function fully in accordance with their economic function. This is
shown, for example, by the stress tests for European banks, which, under the influence of
political and banking interests, were not strict enough and soon lost their credibility,
especially when banks that well passed the tests, got into major financial problems afterwards.
often make no real choice for one of the two models, but make use of a compromise that is sub-optimal in terms
of efficiency, transparency and democracy.
50
A tricky aspect is the financing of a European emergency fund for the banking sector. In the longer term, this
emergency fund should function as a deposit-guarantee scheme, whereby the fund can build up resources
through premiums on bank deposits. But this takes time and banks do not have these resources at the moment,
due to the current crisis. In the meantime, it is necessary to make use of funding from the ESM.
51
This is also the danger of Eurobonds. Although the advantage is that government debts can be sold on a larger
scale, the problem is that correction of too large budgets from the financial markets diminishes. The more
difference between the budgetary disciplines of countries, the more unjust the common use of Eurobonds,
because the costs of lack of budgetary discipline are then passed on to other countries. To prevent moral hazard,
intermediate forms are proposed, for example by limiting Eurobonds to a certain percentage of government debts
(and grant them high seniority), or by only guaranteeing short term bonds to a limit of 10% of the GDP of the
country that issues them. This reduces the potential losses for taxpayers in Northern Europe, because short-term
debts will be repaid first if there are any payment problems. But a disadvantage is that it encourages countries to
make short-term debts instead of long-term debts, which makes that they are soon in need of new funding.
50
Again and again, it becomes evident how difficult it is to make supervision effective.
Supervisors seem to be highly susceptible to pleas from those whom they have to supervise,
so that it often takes too long before necessary interventions are made. Thirdly, in practice it
seems to be very difficult to escape from the delusion of the day and identify early financial
bubbles and other risky excesses within the financial sector.
Another risk is that the good reputation of the ECB as an independent Central Bank
gets eroded. In fact, this has already happened, now the Bundesbank has turned openly against
the ECB. The conviction that the ECB has become a dangerous player is gaining more and
more ground. This is demonstrated by the storm of protests that arose in Germany after the
announcement of the unlimited purchase of bonds. Jens Weidmann, president of the
Bundesbank, thinks that the ECB violates the rule of the European Treaty that the ECB is not
allowed to finance states. If the Bundesbank turns out to be right about this, the ECB will lose
the support of the German population and will therefore not be able to function properly
anymore. Another problem is that the ECB has lack of expertise with regard to banking
supervision. After the possible establishment of a banking union, supervision will continue to
be very vulnerable if the ECB becomes responsible for all banks in the euro zone. To oppose
this objection, the ECB argues that it will work closely together with national supervisors. But
then the ECB would be dependent of these supervisors again.52 Furthermore, this would
increase the risk that the ECB has to write-off on the ECB bonds of southern European
countries, which will also harm its reputation.
Integration in the form of adjustment of macroeconomic policies looks straightforward
on paper, but just like it is hard to determine at the micro level when banks have taken too
much risk, it is also hard to determine objectively at the macroeconomic level when harmful
imbalances develop within one or more countries. Often economists also have different kinds
of judgments. Combined with political conflicts of interest between euro countries, this makes
taking a decision to intervene in the economic situation of a country and demand adjusting its
economic policy very controversial.
In chapter 5, it was already pointed out that further economic integration of the euro
zone could create several risks for democratic legitimacy. Political decision-making is
currently strongly influenced by the response of the financial markets. Thus, the interests of
the financial markets are getting a disproportionate large influence on the policy, not only
with regard to European integration, but also with regard to the content of the proposed
reforms. Also from a procedural perspective, the democratic deficit has increased rather than
decreased with the crisis, because the far-reaching political and economic decisions that are
needed to tackle the crisis offer no room for a careful democratic process. This increases the
danger of manipulation from the top instead of legitimacy from the bottom. If further
European integration is continued in this manner, it is questionable whether the European
project will actually be internalized by the population. This would possibly make many
people feel detached from Europe and thus vulnerable to nationalist responses and political
instability. As already mentioned before, it is therefore essential that the quality of the
52
Banking supervision is not independent either. If a bank has to be recapitalized with tax money, accountability
to parliament is required.
51
democratic foundation of Europe is decisive for the degree of integration. Combined with the
great political diversity within Europe, further integration should be realized very carefully,
with respect to the principle of subsidiarity.53 This has also implications for the extent to
which the economic policy is integrated. As already mentioned before, another important risk
of further political integration within the euro zone is that the distance between EU countries
within and outside the euro zone will grow. Due to diverging interests between euro countries
and non-euro countries, the complexity of European institutions will increase, thereby
hampering their democratic foundation. In addition, the divergence between euro countries
and non-euro countries within the EU will also cause economic risks (obstruction of the
internal market).
With respect to the effect on peace and security, this policy option seems to be one of
the better options. If further integration is convincingly realized, the economic crisis will
contribute to a stronger European unity and thus serve peace and security in Europe. In order
to maintain peace and security, further integration has to be realized with a degree of
solidarity that will also please the southern European countries. Because as long as European
integration goes along with debt stacking in the southern European countries, large budgetary
cuts and massive unemployment, there will be few prospects for new generations. In the past,
mass unemployment turned out to be a recipe for discontent and insecurity. Scheffer (2012)
also argues that the euro provokes conflicts between and within countries. The euro was
intended to make the power of Germany invisible, but it is more visible than ever now.
6.2
Exit of Greece
There are several advantages to Greece leaving the euro zone. The biggest advantage is that
this will allow Greece to devaluate its national currency and thus strengthen its competitive
position. This will increase its exports and production in the medium term, which will lead to
further recovery through declining government deficits and debts and increasing foreign
investments. If Greece devaluates its currency, the competitiveness of other European
countries will diminish and their exports to Greece will decline. In many studies, this is
regarded as a disadvantage of this option, but in our view, this is indeed an advantage,
because it will strengthen the economic development of Greece. Since in the end, a
fundamental recovery of the competitiveness of Greece will also be of great importance to the
other EMU countries, because in the longer term, this may also increase the imports of
Greece, which will benefit the exports from the other EMU countries. Thus, it is really shortterm thinking to consider the devaluation of the currency of a country purely as negative for
the exports of the other EMU countries. Under certain conditions (see below), it is therefore
to be expected that economic growth will recover earlier, both in Greece and in the rest of the
53
Luitwieler (2013) distinguishes horizontal subsidiarity (which is comparable with sovereignty in an inner
circle) and vertical subsidiarity, which is deeply rooted in the EU and is an efficiency criterion for the
distribution of powers between different levels of government. Both forms of subsidiarity are important, because
of the (value of) cultural diversity within the euro zone.
52
euro zone, than with further integration of the euro zone with Greece, which will limit the
flexibility of Greece.
A second advantage of the exit of countries that diverge the most from the economic
development of other EMU countries is that this will enable EMU institutions to form a more
strict economic community, which is necessary for a sustainable monetary union. This will
offer Germany the possibility to do more concessions with respect to further integration of the
euro countries (like allowing Eurobonds and a banking union), because the risks decrease
with a smaller, but stronger Union. Continuously doing concessions to Greece will weaken
the credibility of the policy planned by the EU, thereby harming the stability of the euro zone.
In addition, with the exit of Greece, the EU will give a clear signal to the other EMU
countries that agreements made within the euro zone should be taken seriously. This will
discipline the other EMU countries and will thus increase the chances of a successful further
integration within the euro zone. The EMU cannot refrain from setting exit conditions and
applying them where necessary, in order to set boundaries to the divergence within the EMU
and to maintain its credibility and avoid moral hazard. Van Baalen (2012), Member of the
European Parliament for the Dutch VVD (People’s Party for Freedom and Democracy) states:
'If countries are unable or unwilling to make structural reforms in order to stay in the euro
zone, then they should exit, either voluntarily or involuntarily.' However, European Treaties
do not contain any criteria and rules on this subject matter yet. A proper procedure will
contribute to an orderly exit. In addition, it can be argued that maintaining a country without
perspective on convergence will also foster uncertainty, thereby enabling the crisis to continue
longer. CPB proposes, for example, that it is possible that the postponement of a Greek
bankruptcy has even increased uncertainty and has undermined confidence in Italy and Spain
(Teulings et al., 2011, p. 178).
As described in Chapter 4, there are not only benefits, but also large costs and risks
involved with the exit of Greece. First of all, there will be costs for the design, printing and
distribution of the new currency, which will hamper payments for a short period of time. The
Economist (2012b) thinks this is not an insurmountable problem, since payments have
become predominantly electronic, and combined with the temporary use of euro banknotes,
economic transactions will continue to a large extent.
Another great risk is that as soon as it is known that a country is going to exit, there
will be a run on the banks in the country concerned and chaos will erupt.54 The study of
Capital Economics (2012) explains why it is so important to manage the exit well, to keep the
decision of the exit totally secret until it is fully realized and to apply strict control on capital
flows, just like Iceland has done successfully.55 Also the introduction of a parallel currency, as
proposed by Ten Dam (2012), can contribute to a smooth transition (see Appendix 3). Due to
54
Buiter (2011) also points out that the balance sheets of Greek banks and other institutions will get unstable if
a part of the financial titles (i.e. the part that falls under Greek law) also devaluates and another part (i.e. the part
that is still noted in euros) does not, which will cause a large mismatch in portfolios.
55
Countries are free to impose restrictions on capital flows, but restrictions on current transactions require the
consent of the IMF. European legislation prohibits exchange control, except in extreme circumstances. The latter
probably concerns also an exit from the euro zone (Clifford Chance, 2012b).
53
these and other measures such as described in Capital Economics (2012), the risks can be kept
within acceptable limits. The key question is whether such an operation can be kept secret
until the last minute. If not, it will lead to disorderly processes.
In addition, considerable write-offs on loans to Greece will be needed, with a risk of
uncertain legal procedures in the settlement of private contracts. If only Greece exits, The
Economist (2012b) calculates a total debt of € 270 billion (€ 130 billion concerns emergency
loans that were already supplied, € 40 billion concerns Greek government bonds in the hands
of the ECB and another € 100 billion concerns money that the ECB supplied as part of the
Target2 debts to local banks). According to ING (2012b), the possible risk for the Netherlands
would account to € 22 billion (thereby not only including government debts, but also private
loans). The Economist (2012b) and also Buiter (2011) assume that the debts of the Greek
government will (virtually) entirely be written-off. Buiter (2011) argues that if Greece is
forced to leave, there will be no reason for the Greek government not to put aside all debt
obligations to private parties and the ECB, as well as loans that were supplied as part of the
Greek Loan Facility and EFSF (despite the fact that this falls under British law). But this
seems an extreme assumption, because even after its exit, Greece will remain dependent on
the EU and the possibilities of the internal market. The CPB estimates a write-off of 30%,
equal to the expected devaluation of the new drachma. The Economist (2012b) estimates a
devaluation of 50%, but the value of the drachma is expected to recover somewhat over time,
at least if Greece is able to strengthen its competitiveness after the devaluation, which will
also increase the country’s ability to meet its debt obligations.
The biggest danger of a forced exit of Greece is the contagion of other countries. If a
country leaves the euro zone, other countries may also consider an exit. This will increase
uncertainty, and financial markets will demand an additional risk premium on bonds of other
weak euro countries. This will require even more support from other euro countries to
stabilize these countries, which will accordingly increase the risks for all euro countries. The
expectation that other southern European countries could also exit, will increase the capital
flow from those countries. The run on banks in southern European countries will also affect
banks in the northern European countries, which are still very vulnerable. According to Buiter
(2011), it is very likely that due to the financial chaos resulting from this, Europe will fall into
an even deeper recession. Given the fact that there are great uncertainties in the whole world
economy, this, in turn, will have an important influence on the economy outside Europe. This
risk can only be dealt with if the EU simultaneously gives a convincing signal that the exit of
the weakest link offers more room for stronger integration of the remaining parts of the euro
zone.
How the advantages and disadvantages of Greece leaving the euro zone will work out,
also strongly depends on the attitude of Greece itself. The devaluation will initially lead to a
severe loss of purchasing power for the Greeks on top of the current loss of purchasing power,
because the import of goods will become much more expensive. Despite the strong negative
feelings towards other euro countries, in particular towards Germany, Greece wants to stay in
the euro zone. This means that it would be a forced exit, which will impede the chance of a
good preparation and controlled transition. The extent to which Greece subsequently will
54
benefit from the devaluation of its own currency will also depend on the prevailing attitude in
the country. Greece is highly dependent on tourism, but if a forced exit has an even more
negative influence on its attitude towards foreigners, few tourists from other euro countries
will plan their holiday in Greece. Under these conditions, the anticipated positive effects will
not occur and the prediction by ING (2011) that Greece as a result of its exit will undergo a
decline in GNP in the medium term (ING estimates 4%) will be more likely, thus diminishing
the chance that other euro countries will benefit from the exit of Greece in the long term. The
willingness of Greece to meet its debt obligations after leaving the euro zone and the possible
recovery of the Greek economy over time will also depend on the attitude of Greek citizens
and politicians. The way in which they respond to the exit will also have important political
consequences.
Based on these considerations, it is sensible and plausible that the euro countries will
create goodwill by giving Greece extra support when leaving the euro zone to make the
transition to the new situation easier. The Economist (2012b) estimates that the additional
costs will amount to € 50 billion. In addition, financial support will possibly be needed for
banks that are getting into trouble as a result of the Greek exit. This meets an objection made
by Buiter (2011) against the exit of Greece. According to Buiter, an important difference
between Greece leaving or not leaving the euro zone is that Greece will still have the
possibility to borrow money in the latter case, whereas in the first case it will not. Buiter
argues that the Greek government would have to cut back public expenditures even more then
and could be tempted to resort to monetary finance, which would create high inflation. Given
the weak institutions in Greece, this would be a real danger. This could be prevented with
support from the EU, however. After all, it is not only in the interest of Greece, but also of the
EU that Greece gets a good start after leaving the euro zone.
Under this condition, we believe that the effects of this policy option will on some
points be more positive and on other points be more negative than the effects of further
integration. Positive points are a higher growth forecast for Greece and, in the longer term, for
the euro zone, because the competitiveness of Greece will get stronger. The economic
stability of the euro zone will also be enhanced in the longer term, because with the exit of
Greece, convergence within the euro zone will increase, which will enable the euro zone to
better meet the criteria of the OCA theory. The exit will also offer better opportunities for
integration within the euro zone and more possibilities to reduce the democratic deficit in the
EU. For Greece, the prospects of stability are more mixed. A positive point is that Greece will
have the flexibility again to adjust the exchange rate and its monetary policy to its own
situation. By leaving the euro zone, Greece will be released from the strong interference of the
EU, which will increase the influence of the Greek people on their own politics and
strengthen the democratic base for decision-making.56 But if Greece stays within the euro
56
There is, however, one important exception, i.e. the decision to leave the euro zone. To avoid a disorderly
transition, this cannot be decided in a democratic way.
55
zone, it will need to be managed intensively by external parties for a long time, because of the
weakness of Greek institutions. This will be a continuous source of tension.57
It is unclear whether the exit of Greece will score better or worse with respect to the
value of the financial assets of the remaining euro countries. This depends on the further
economic development of Greece. If the policy of internal devaluation and intended reforms
works well, the chance of write-offs on loans to Greece will decrease. But if this policy is less
successful, debts could increase (just like has happened in recent years) and the question is
whether the damage will not be much bigger in the long term. If Greece leaves the euro zone,
a partial amortization of debts combined with a solid financial support package can give the
country a better perspective and eventually also increase the chance of paying back or
refinancing loans.
On two points, the Grexit scores probably worse than further integration, with Greece
staying within the euro zone. First of all, the exit of Greece could increase the chance of
conflicts in the region and thus increase the risks of peace and security in Europe. Of course,
this highly depends on how Greece will perceive its exit from the euro zone and furthermore
on the consequences this will have on the Greek economy. It also highly depends on how
strong Greece will remain embedded in the European Union. As the transition to the new
situation is better managed58 and Greece keeps its claim on other rights that are associated
with membership of the EU (like support from Structural Funds), the chance of conflicts
decreases and the Grexit may even strengthen peace and security. The second and most
important disadvantage of the exit of Greece is that the risks will increase in the short term,
because there is a danger of contagion of other southern European countries. Given the fact
that economic uncertainty is very high already (due to the crisis in real estate, but especially
due to the risks of economic developments outside Europe, in particular in the United States
and Japan), European policymakers are very strongly inclined to avoid additional risks.
Although this is certainly understandable, because risk perceptions strongly hamper
investments and consumer confidence at the moment, one should not forget that risk-averse
policy is not always better. A convincingly executed Grexit could even reverse risk
perceptions quickly. After all, further integration also has major risks in the longer term,
because this could lead to permanent dependency relations.
6.3
Exit of Some Southern European Countries
Besides Greece, also Portugal, Spain and Cyprus are having structural problems caused by
lack of competitiveness and are having little prospect of returning to a healthy, autonomous
57
To what extent will Greece allow, for example, its defence budget to be reduced in order to make its
government finances healthy, something which is a very sensitive political issue in Greece? A recent report on
Greece’s 2013 budget states that, with a total of € 7.8 billion of fiscal measures, Greece will only cut € 300
million on defence (on a total budget of 6 billion), against, for example, nearly € 4 billion on pensions (Eurobank
Research, 2012).
58
Among other things, through strict capital control, sufficient write-off on Greek debts and financial support of
the other euro countries and the possible introduction of a parallel currency.
56
economic development.59 It could therefore be argued that a more complete integration within
the euro zone would provide a higher chance of a sustainable currency union in the long term
if these countries also leave the euro zone.60 The Economist (2012b) also adds Ireland to this
list, but we estimate that Ireland has enough perspectives to stay in the euro zone.
The expected consequences of this third option are judged very differently. The
Economist (2012b) prefers this major adjustment of the euro zone over an exit of Greece
alone, because this will enhance the viability of the euro zone and will give Germany the
opportunity to do more concessions with regard to further integration of the remaining part of
the euro zone. Just like Greece, the other exiting countries will benefit from a rapid
improvement in competitiveness through a devaluation of their own currency. If the exits are
accompanied by convincing steps towards further integration of the remaining euro zone
through a banking union and a common guarantee of government debts in order to protect
France and Italy in particular, The Economist estimates that the euro crisis can be brought to
an end at once, and confidence in the smaller, but more solid euro zone will recover.
On the contrary, ING (2012b) estimates the exit of some countries as a much larger
risk. Important is that in its analysis, ING assumes that five peripheral countries will leave the
euro zone: besides Greece, Portugal and Spain, also Italy and Ireland. If we correct this, the
effects are proportionally smaller, because Dutch claims on Italy and Ireland amount to 26%
of the total claims on the five countries mentioned above. The total claims at risk therefore
decrease from € 339 to € 250 billion (Cyprus excluded), but this is still a very substantial
amount of money. For the total euro zone, the risks will also increase, obviously. The
Economist (2012b) estimates that if besides Greece, also Spain, Portugal and Cyprus (and
Ireland) leave the euro zone, the costs involved with write-offs of loans to these countries and
the bailout of banks that will consequently get into trouble can amount to €1650 billion in
total. The government debts of the remaining euro countries will thus increase by around 20%
of GNP. ING therefore argues that the exit of some countries from the euro zone will generate
far more risks for the Netherlands than leaving the euro zone unchanged. ING estimates that
the total financial claims at risk will amount to € 62 billion for the five countries that ING has
examined (and consequently will be proportionally lower if Italy and Ireland are excluded).
The problem with this calculation exercise by ING is that only the immediate risks of
further integration are portrayed.61 The long-term costs of further integration of the euro zone
59
Just like The Economist (2012b), we will exclude Italy, but it would also be possible to include Italy in this
option. According to Cheptea et al. (2010), just like the exports of Greece, Portugal and Spain, the exports of
Italy also suffer from weak sectoral specialization. Table 5 also shows that Italy has a disappointing export
performance. If we therefore include Italy in this option, the analysis would change in quantitative terms, but in
qualitative terms, it would be fairly similar.
60
In this case, it is conceivable that Spain and Portugal will form a currency union together. According to the
analysis of Bayoumi and Eichengreen (1997), such a currency union will meet the economic criteria of the OCA
theory.
61
Another problem with this calculation is that the amounts of € 339 billion and € 62 billion are not comparable,
because the first amount concerns gross claims (which are much higher) and the latter amount concerns net
claims and. Moreover, in the second case, net foreign debts are only calculated if they are higher than 35% of
GDP.
57
because of support of weak euro countries (as described in section 6.1) are not taken into
account.
The best argument for the exit of the GSPC countries in relation to the previously
discussed options is that it will provide a better foundation for a euro zone that meets the
criteria of the theory of optimal currency area. Both the stability of the smaller euro zone and
the exiting countries will probably improve, because there will be even more convergence and
opportunities for further integration within the euro zone, whereas the exiting countries will
get more flexibility to strengthen their competitive position. The exit of Spain, Cyprus,
Portugal and Greece will lead to a substantial decline in the exchange rate of the national
currencies of these countries. Qualitatively, the effects will be the same as the effects of the
devaluation of the drachma, as described before: initially, a strong decline in purchasing
power due to higher import prices; initially high inflation, but because of high unemployment
insufficient to fully redress the effects of the devaluation on the real price ratio; in the medium
term, recovery of GNP due to the improvement of exports as a result of a stronger competitive
position; write-off of foreign debts, but due to the recovery of the economy in the medium
term, a substantial part can still be financed. On the other hand, leaving the euro zone will
reduce the incentive for structural reforms. Exports will predominantly increase due to price
competition, but it is not plausible that these countries will also be able to improve their
competitiveness in high-quality products through innovation if structural reforms are not
made. This will reduce their growth potential in the long term.
Nevertheless, the risks as described with the Grexit will be proportionally bigger if
more countries leave the euro zone. There is an additional risk for countries like Italy and
France if Greece, Spain, Portugal and Cyprus leave the euro zone, because they will
experience even more competition due to the expected real depreciation of the new
currencies. Financial markets will consequently focus on these countries. If, also under the
influence of the current recession, the political landscape in Italy strongly deteriorates and
there are no prospects of reforms anymore, the stability of the smaller euro zone will be in
danger again.
Whether the exit of GSPC will lead to a bigger drop in the value of financial claims of
the remaining euro zone in comparison with further integration, will depend on the effects on
economic growth. Restored competitiveness through devaluation will increase the earning
capacity and thus the ability to pay off debts. Since with internal devaluation, the burden of
foreign debts will also increase for these countries, there is little reason to assume that this
exit will diminish the prospects in comparison to further integration. In addition, keeping
GSPC countries in the euro zone and further integrating the euro zone will make the support
to the GSPC countries endless and will also entail considerable risks in the long term. The
Economist (2012b) estimates the potential costs will amount to € 250 billion annually.
As with the Grexit, the democratic legitimacy of economic policies increases, because
the population will have more influence on its own politics. There will be even more pressure
on European institutions, because the yawning gap between the further integrating euro zone
and the growing number of countries that do belong to the EU, but are not part of the euro
zone, will get bigger. The reconfiguration of the euro zone will therefore require a new
58
structure of European institutions. It will no longer be possible, for example, to make the
European Parliament in its present form responsible for the monetary and economic policies
of euro countries and non-euro countries. For this reason, a reconfiguration of European
institutions is needed, so that representation will be more in tune with common interests and
governance.
Finally, as peace and security is concerned, just like with the Grexit option, the chance
of conflicts in the region will increase. To limit this risk, it is essential that the exiting
countries remain fully embedded in the EU. Support with the transition to the new situation
can also be a stabilizing factor. However, it is inevitable that the exit of southern countries
will increase the gap with northern countries. Economic competition through downward
adjustments of exchange rates always puts a heavy burden on politics, because this is often
regarded as unfair.
6.4
A Neuro and a Zeuro
The fourth policy option which we will examine is a break-up of the euro into a neuro and a
zeuro. This option hardly plays a role in the policy debate and is politically unlikely at first
sight. But this does not make this policy option less interesting. We will now first examine
how an optimal reconfiguration of the exchange rates into a neuro and zeuro area might look
like, based on the theory of optimal currency union.62
According to Capital Economics (2012), the following countries would qualify for a
northern euro zone: Germany, Austria, the Netherlands, Finland and Belgium.63 Luxembourg
can also be added. The economies of these countries are largely converged. Their economic
and budgetary performances are fairly similar. These countries also meet a number of the
conditions that are set by the theory of optimal currency union. First, the flexibility of the
labour market has greatly improved in these countries over the last few decades. The openness
of the economy is also fairly similar in the countries mentioned. The exports of Belgium, the
Netherlands, Austria and Luxembourg form a similar or higher part of GNP than the exports
of Germany; only Finland scores lower on this point (but still higher than Portugal, Italy,
Spain, France and Greece). This is also shown by the mutual trade relations (see Table 7).
Except for Finland, both the exports to neuro countries and the imports from other neuro
countries amount to more than 10% of GNP.
With respect to political-economic preferences, these countries are also more
homogenous than the euro zone as a whole. This can be illustrated by cultural indices that
differ significantly for Northern and Southern Europe. Studies on the relationship between
culture and the willingness to change show that the willingness to change is great if the scores
62
This analysis could even be applied to the currencies within the European Union instead of the euro zone, but
this interesting research question is beyond the scope of this study. If we also involve other EU countries in the
analysis, it would be conceivable, for example, to include countries like Sweden and Denmark in the neuro zone
and possibly also the UK and Switzerland.
63
Bayoumi and Eichengreen (1997) believe that because Austria, Belgium and the Netherlands meet three
criteria of the OCA theory, they could form a currency union together with Germany. According to their
analysis, Ireland and Switzerland also meet these criteria. Furthermore, it is striking that France scores relatively
bad, even worse than Italy, Portugal or Greece, for example. The same holds for Finland.
59
on Power Distance and Uncertainty Avoidance are low and the score on Individualism is high
(Leung et al., 2005). Additionally, people from collectivist cultures are more likely to attribute
the causes of other people's behaviours to external causes such as situational demands (as
opposed to internal causes such as personality traits) (Leung et al., 2005, p. 367). One
illustration is the difference between Ireland and Spain. It is remarkable that Irish people seem
to accept fast rising government debts much easier than Spanish people do with much slower
rising debts. This corresponds with the scores that indicate that Spain is far less willing to
change.64
Intensity of trade relations between euro countries (2010) a
Exports as a percentage of GNP
Imports as a percentage of GNP
b
b
World
EU15
neuro
zeuro
World EU15 neuro zeuro
Belgium
87.16
52.51
44.91
7.59
82.71
40.82
36.58
4.23
Germany
38.45
15.60
11.33
4.26
32.27
13.38
10.58
2.79
Estonia
67.56
18.78
17.67
1.10
69.45
24.51
21.77
2.73
Finland
29.61
9.00
7.50
1.49
29.04
11.27
9.94
1.32
France
19.94
9.64
6.19
3.44
23.35
13.79
9.76
4.02
Greece
7.33
2.60
1.58
1.01
21.52
9.49
6.25
3.23
Ireland
57.28
22.49
18.12
4.36
29.31
8.10
6.97
1.12
Italy
21.72
9.31
7.48
1.82
23.66
10.19
8.92
1.26
Luxembourg 26.33
18.95
17.03
1.91
38.59
38.29
36.43
1.85
The
Netherlands 63.18
33.47
27.64
5.82
56.43
24.12
21.41
2.70
Austria
38.20
19.81
16.13
3.67
39.70
27.73
24.28
3.45
Portugal
21.32
13.53
7.01
6.51
32.89
21.78
10.20
11.83
Slovakia
73.36
34.84
28.40
6.43
73.81
26.90
22.95
3.94
Slovenia
51.29
28.49
21.24
7.24
55.90
34.82
23.32
11.50
Spain
17.82
9.85
6.54
3.29
22.90
11.62
8.79
2.82
Table 7
a
Source: OECD ITCS 2010 database
Countries considered as neuro countries: Austria, Belgium, Estonia, Finland, France, Germany, Ireland,
Luxembourg, the Netherlands, Slovakia and Slovenia. The other countries are considered as zeuro countries.
b
With respect to the three other criteria, the scores of the countries mentioned above are
less convincing. Although Germany shows great similarity with Austria, and to a lesser
extent, with Belgium and Finland, as the composition of the production and the diversification
of the exports is concerned, this does not hold for the Netherlands, for example. The
production structure of the Netherlands deviates strongly from Germany, whereas the
64
Ireland
Spain
Individualism
70
51
Power Distance
28
57
60
Uncertainty Avoidance
35
86
difference between Germany and Italy, in particular, on this point is very small (Baldwin and
Wyplosz, 2012). With respect to budgetary transfers, the countries mentioned above are
currently not having higher scores than the euro zone as a whole, but the potential for
improvement on this point is (with the creation of a neuro) clearly present. When it comes to
solidarity, the countries mentioned above have mediocre scores. A positive point is that, with
the exception of Austria and Slovenia, the people in these countries (i.e. the Netherlands,
Germany, Belgium, Finland and Luxembourg), on average, feel more European than people
in the EU as a whole.
Table 8
Assessment EFISS countries for neuro zone
Estonia
France
Ireland
Criteria OCA theory a
Labour mobility
good
bad
good
Product differentiation
good
mediocre mediocre
Open economy
very
bad
very
good
good
Budgetary transfers
bad
Homogenous preferences
good
bad
good
Solidarity
mediocre good
mediocre
Economic
performance
between 1999 en 2011 b
Economic growth
good
mediocre very
good
Inflation
bad
good
mediocre
Current account
good
mediocre mediocre
a
b
Slovenia
?
very good
good
Slovakia
?
good
very good
?
bad
mediocre
mediocre
very good very good
bad
mediocre
bad
bad
Based on data from Baldwin en Wyplosz (2012)
Based on data from Eurostat
Estonia, France, Ireland, Slovenia and Slovakia are intermediate cases.65 If we assess
these countries according to the conditions of the theory of optimal currency area, Estonia and
Ireland have fairly good scores and France has bad to mediocre scores, whereas Slovenia and
Slovakia have unclear scores. A positive point for Slovenia and Slovakia, however, is that
both exports to and imports from the neuro zone are substantial. In combination with their
geographical location, this would be enough reason to include Slovenia and Slovakia in the
neuro zone. If we also take the economic performances of these countries into consideration,
we see that France has a mediocre score.66 From an economic point of view, it would
therefore, strictly speaking, be better if France is added to the zeuro zone.67 An advantage of
this is that the neuro zone and zeuro zone will be more equal in size and that it will be
65
Malta is not taken into account, because there is insufficient information available about Malta.
The Economist (2012c) even considers the weak economy of France as the biggest potential danger for the
euro at the moment.
67
Bayoumi and Eichengreen (1997) also believe that the OCA indices for the relationship between France and
Italy, Spain and Portugal respectively are better than with Germany. Furthermore, according to their analysis,
Italy and Greece meet the economic criteria of the OCA theory.
66
61
possible to establish, besides a NECB in Frankfurt, a ZECB in Paris. France would then have
an important integrating function in the zeuro zone. Another advantage of the break-up in a
neuro zone and zeuro zone is that it will give more flexibility with respect to the extension of
the currency unions. Thus, Denmark, Sweden, Poland and the Czech Republic can be added
easier to the neuro zone.
However, including France in the zeuro zone encounters important political
objections, because the European project is mainly based on the desire for peace between
Germany and France. But, as argued above, strictly speaking, this would not be a weighty
argument if one recognizes that for peace and security, a well-functioning European Union is
of greater importance than a potentially unstable euro zone. Including France in the zeuro
zone would therefore be conceivable if the common currency, as a symbol of unity, is
replaced by another symbol for the European Union as a whole. The odds are low, however,
because splitting the euro zone, thereby including France in the zeuro zone, will be considered
as a great loss of prestige by France. Therefore, we assume that it is likely that France,
Ireland, Estonia and Slovakia will also be included in the neuro zone, if it comes into
existence.
The following countries would qualify for the zeuro zone: Greece, Cyprus, Italy, Spain
and Portugal. According to Capital Economics (2012), merging these countries into a
common currency union would offer benefits in terms of less transaction costs, more
competition and scale benefits that are accompanied by larger and thus more liquid financial
markets. In addition, the formation of a southern euro, next to a northern euro, would have a
constitutional benefit, because both currencies can be considered as legitimate successors of
the former euro.
From an economic point of view, there are also parallels between the Southern
countries mentioned above. Between 1999 and 2011, all these countries had, on average, a
deficit on their current account and a relatively high inflation rate. But with respect to
economic growth, there is a great difference between these countries. This becomes apparent,
for example, from a correlation analysis by Capital Economics (2012), the results of which
are shown in Table 9. With respect to government debts and budget deficits, the countries also
vary widely.
Table 9
Spain
Portugal
Greece
Cyprus
a
Correlations between annual growth in GNP since 1999 a
Italy
Spain
Portugal
Greece
.84
.78
.74
.46
.75
.32
.85
.79
.47
.56
Source: Capital Economics (2012), p. 105
With respect to the criteria of the OCA theory, there are relatively few similarities
between the countries mentioned above. First of all, they differ in diversification and the
nature of their production structure. Whereas the trade structure of Italy, in particular, shows
62
great similarities with the trade structure of Germany, there are substantial differences with
Portugal and Spain. Furthermore, the labour mobility between these countries and the
flexibility of the labour market within these countries is low, although this could improve
under the influence of labour market reforms. In addition, the trade relations between several
countries are weakly developed. Although mutual trade between the southern European
countries as a part of GNP has increased since 1990 (contrary to the trade to the northern
European countries) (Wierts, 2012), Table 7 shows that for no country from the zeuro zone
(except for Portugal), the exports to and imports from the zeuro zone account for more than
10% of GNP.68 This diminishes the benefits of a currency union. Just like in the current euro
zone, there are few budgetary transfers between zeuro countries. With respect to
homogeneous preferences, the zeuro zone has better scores, but it is unclear whether there is
more solidarity. Finally, an objection to this policy option is that the weak southern European
countries will have great difficulty to integrate Greece, which demands a great effort from the
current euro zone already. Based on these considerations, it is doubtful whether it would be
rational for the southern European countries to form a currency union together.
Nevertheless, if we assume that the euro zone is split into a large neuro zone
containing Germany, Austria, the Netherlands, Finland, Belgium, Luxembourg, Ireland,
Estonia, Slovenia, Slovakia and France and a small zeuro zone containing Greece, Cyprus,
Italy, Spain and Portugal (thus not taking Malta into account), what then will be the expected
effects if we look at the five evaluation criteria that we also applied to the other policy
options?
If we compare the neuro-zeuro option with the exit of GSPC option, there are two
important differences. First of all, in the first option, on top of GSPC, Italy will also leave the
euro zone. Secondly, in this option, the exiting countries will together form a new currency
union, the so-called zeuro zone. Whether the exit of Italy, on balance, will have a negative
effect on economic growth, will depend, among other things, on the consequences for
economic policy in Italy. It is reasonable to expect that the exit will greatly diminish the
stimulus to reform, which will increase the chance that Italy will revert to previous policy
patterns and decrease the chance that the Italian economy will strengthen its competitiveness
in high-quality products. On the other hand, the exit will enable the Italian economy to benefit
from price competition as a result of the expected devaluation of the zeuro in relation to the
neuro. However, this will put even more pressure on France, which is in a vulnerable position
already.
Second, we have found that the benefits of a common currency union as set out in
Chapter 4, will probably not outweigh the loss of flexibility for the various south European
countries, because these countries only partly meet the criteria for an optimal currency union.
For this reason, we consider it plausible that the prospects on economic growth will be
slightly less positive for the neuro-zeuro option than for the exit of GSPC countries. This has
also consequences for the expected financial losses that the northern European countries will
68
This is also the case when France is included in the zeuro zone instead of the neuro zone.
63
suffer on their loans to southern European countries, which will be larger as the growth
perspective of the southern European countries is less positive in the long term.
As stability is concerned, we estimate that the neuro-zeuro option will at least be
equivalent to the exit of GSPC countries. Although there will be loss of flexibility, the fact
that countries are part of a common currency union within the framework of (partially
adjusted) European institutions will offer an important impetus for policy discipline with
regard to fighting inflation, achieving budget balance and current account balance. This will
strengthen the stability of the southern European economies and decrease the divergence with
the northern European economies as the current account is concerned. This will reduce
uncertainty at this point. The break-up in a neuro and a zeuro therefore offers better
opportunities for institutional embedding than the previous variant, in which countries
individually leave the euro zone. This will increase the chance of an orderly transition from
the present to the new situation and will reduce uncertainty and transition costs.
The reconfiguration of the euro zone will require a new structure for European
institutions. For example, it will no longer be possible to make the European Parliament in its
present form responsible for the monetary and economic policies of both euro zones and also
of non-euro countries. Consequently, a reconfiguration of European institutions will be
necessary, so that representation will be more in tune with common interests and governance.
Although this is very drastic, it will offer opportunities to strengthen the democratic
legitimacy of monetary and economic policies. In addition, breaking up the euro zone will
offer more room for national parliaments, because if there is more stability in the euro zone,
there will be less urge to exclude national parliaments. On balance, the quality of the
democratic process will consequently increase.
With respect to peace and security, in comparison with the previous policy option, the
risks will also diminish if the southern countries decide to form a currency union together.
The currency union will offer opportunities for further economic integration and will reduce
the chance of economic isolation. This can also have a positive effect on the political relations
between these countries.
6.5
Complete Return to National Currencies
The Dutch PVV does not stand alone in its desire to leave the euro altogether and completely
return to national currencies. Record (2012) argues that if a country’s exit from the euro zone
is considered, it is best to instantly decide to completely return to national currencies. Because
as soon as a country leaves the euro zone, this will be a signal for markets that the euro is
reversible. This will provide ammunition to put pressure on other structural weaknesses in the
euro, which will be a recipe for continuing crisis.
The analysis in the preceding section also gives insight into how we should assess the
last policy option of a complete return to national currencies. It is shown that the various
northern euro countries should be able to form a sustainable common currency union. The
break-up of the current euro in 17 national currencies will therefore unnecessarily damage the
advantages of a smaller currency union as discussed in Section 4, like less transaction costs
64
with international trade, no exchange rate uncertainties and more transparency in competitive
relationships. These effects come on top of the other effects already discussed while
examining the third policy option of the exit of some southern European countries. This will
have a negative effect on competition, productivity growth and cost level, so that prosperity
will decrease. Countries like Germany, Austria, the Netherlands, Finland and some other euro
countries are mutually well-adjusted and are therefore able to form a sustainable currency
union. In addition, the transition costs of a full break-up of the euro zone will be higher than
with the other options. For these reasons, we consider it likely that the prospects for economic
growth in the long term will further deteriorate with this variant in comparison with the other
policy options discussed.
Furthermore, this policy option entails more risks for economic stability. Because with
the dismantling of the euro, the divergence in the economic development within the EU will
increase again, if we consider the large difference in inflation rates in the period prior to the
EMU (see Figure 1). Although flexible exchange rates will provide more opportunities to
redress these differences, uncertainty will increase.
A complete return to national currencies will offer countries, though, the advantage to
be more in control of their own monetary and economic policies and to respect more the
autonomy of the people in the design of economic institutions and economic policies. This
enhances the democratic legitimacy of the policy. Furthermore, the tension between euro
countries and non-euro countries within the EU will decrease.
On the other hand, a full break-up of the euro zone will increase the risks for peace
and security, because it offers room for more nationalistic policies.69
7
Conclusions and Policy Implications
In this final chapter, we will summarize the main findings of this report.
7.1
Chapter 4 (Economic Analysis)
Economic Criteria of the OCA Theory
So far, the current euro zone has performed moderately to badly with regard to the economic
criteria of the OCA theory. Firstly, labour mobility between countries is very low, because of
large cultural differences (including language barriers), while the flexibility of the labour
markets of many countries is limited. Secondly, the production structure of euro countries
varies substantially. As a result, economic shocks affect the economies of euro countries in
very different ways, as we have seen during the recent economic crisis. Thirdly, the degree of
openness and the intensity of trade relations between euro countries differ. The exports of
69
Baudet (2012) opposes this by arguing that a legal state requires strong national sovereignty. Supranational
organizations erode national sovereignty by assigning powers to themselves, which weakens the legal state.
Supranational organizations do not make political decisions based on law, but based on power relations, with the
elite exerting a disproportionate amount of influence.
65
Finland, France, Greece, Italy and Spain to other euro countries amount to less than 10% of
their GDP. Also, since the introduction of the euro, the share of exports from southern
European countries to northern European countries has unexpectedly not increased. However,
it is possible that in the future, the euro zone will better meet the economic criteria of the
OCA theory if reforms increase the flexibility of the labour markets in southern European
countries and if, consequently, the trade between euro countries grows. But whether and to
what extent this will happen, remains uncertain.
Structural Advantages of the Euro
Given the fact that the euro zone meets the economic criteria of the OCA theory only
moderately to badly, one would expect that the contribution of the euro to the economies of
euro countries has been rather small. This is confirmed by various empirical investigations.
The CPB estimates that for the Netherlands, the euro has generated a structurally higher GDP
of 2%, which is about a quarter of the contribution of the internal market. However, the euro
has contributed to a marked reduction of (fluctuations in) inflation rates in various euro
countries. The small contribution of the euro is also indicated by the fact that, since the
introduction of the euro, euro countries do not show higher economic growth than non-euro
countries. Taking into account the current high costs of stabilizing the euro zone, it is likely
that the net contribution of the euro to the economy of the euro zone has been negligible or
even negative.
This has two implications. First of all, it indicates that a complete break-up of the euro
(in a controlled and orderly way) will only generate a limited loss of structural economic
growth.70 The second policy implication is that, when considering different options for the
euro from an economic point of view, the economic importance of the internal market needs
priority.
Transition Costs
A reconfiguration of the euro zone comes with potentially high transition costs. Apart from
the costs of reintroducing national coins (which amounts to about 1% of the GDP of the
exiting country), there is a risk that this break-up will lead to speculative capital flows, which
will endanger the financial sector. It is all highly uncertain. Some studies present a black
scenario in which just the exit of Greece will be reason enough to put the already vulnerable
banking sector in Europe under even more pressure, resulting in a deeper recession in Europe
with substantial effects on the rest of the world. Other studies estimate that these negative
effects can be largely prevented, provided that the reconfiguration of the euro zone is
managed well.
Apart from these predictions, one could question in how far transition costs should be
taken into account in policy considerations. This depends on the time horizon of
70
That is to say, economic growth resulting from the reduction of transaction costs, promotion of transparency
and competition, etc. (not taking into account the transition costs involved with a complete break-up of the euro).
66
policymakers. Because politics is often driven by a short-term horizon and because economic
growth is already fragile as a result of the overall vulnerable economic situation in the world,
there is a strong inclination to give priority to short-term interests, making transition costs
very dominant in policy considerations. Thus, there is a danger that the long-term costs of
some policy options will not be sufficiently taken into account. However, if one aims at a
sustainable and optimal currency union in the long term, the costs in the long term (> 20 year)
should be the key factor during the policy making process.
Trade Benefits of Devaluation
Provided that the exit is well-managed, the big advantage for a country that leaves the euro
zone is that the prospects of economic recovery will greatly improve due to the reduction of
the exchange rate and strongly improved competitiveness. Recent research shows that the
exports of southern European countries depend more on price competition than the exports of
northern European countries. A decline in the exchange rate is therefore of great potential
importance for the competitiveness of southern countries. Experiences in other countries show
that it is unlikely that a devaluation will be completely neutralized by high inflation. Because
of high excess supply and unemployment in southern European countries, there will be
sufficient production capacity and labour available to meet the extra demand for production,
caused by the increase of exports and the decrease of imports. Therefore, inflationary
pressures will be limited. Devaluation then provides a means to fight the main underlying
cause of the current euro crisis, i.e. the difference in competitiveness between various
countries. A comparison with Iceland, Ireland and Latvia shows that (in addition to the
amortization of debts) external devaluation is more effective than a tedious process of internal
devaluation through wage moderation and that the social costs with respect to unemployment
are lower. One of the reasons is that strengthening competitiveness through structural reforms
only creates a perspective in the very long run, whereas it remains uncertain whether the
measures will be permanent.
Although the devaluation of the currencies of one or some southern euro countries will
initially affect the competitiveness of the northern euro countries, in the long term, the
northern euro countries will benefit from the recovery of economic growth in the southern
euro countries, because the demand from these countries will recover. It will also challenge
the northern countries to strengthen their own competitiveness.
Write-offs on Loans to Exiting Countries
The exit of countries from the euro zone puts the repayment of loans by the exiting countries
at high risk. Depending on which country exits, large to very large sums of money will be
involved. If the exit is badly managed, write-offs on loans can bring the European economy
into a deeper recession, because of the precarious economic situation in other euro countries
and the vulnerability of the financial sector. In that case, high legal costs are to be expected,
caused by complex settlements of debts that are denominated in euros.
67
In how far these risks should affect policy considerations depends on the counterfactual. Because even if no country leaves the euro zone, substantial write-offs on loans to
vulnerable euro countries will be inevitable. This will be necessary and desirable in order to
give weak euro countries sufficient perspective on recovery. Moreover, there is a real risk that
the commitment to keep a country within the euro zone will generate very high costs in the
long term, because the support needed for that purpose leads to a permanent dependency
relationship. In contrast, an exit from the euro zone offers the perspective that in the long
term, a country will be able to partly meet its commitments and repay its debts because of
recovered competitiveness. Therefore, it is difficult to predict whether the loss on loans will
be larger or smaller if a country stays within the euro zone (and therefore is unable to regain
its competitiveness within a reasonable time span), than if it leaves the EMU (and devaluates
its national currency relative to the euro). In the meantime, the current policy to adhere to the
commitment to support weak euro countries through large-scale emergency aid, creates an
increasingly higher barrier to adjust the policy.
Amortization of Debts, Necessary for Economic Recovery of Southern Euro Countries
Claims on southern euro countries with regard to debts and interest payments impede the
economic recovery of these countries. The ECB has played a dubious role in this respect.
Previously, it forced Ireland to take on the debts of Irish banks. And until recently, the ECB
refused the amortization of Greece debts, which the ECB bought itself at a substantial
discount. Therefore, the economic policy seems to be too much aligned to the interests of the
financial sector in other European countries. A comparison between Iceland and Ireland
shows that this impedes the economic recovery of problem countries.
7.2
Chapter 5 (Political Analysis)
Political Criteria of the OCA Theory
The euro zone meets the three political criteria of the OCA theory only moderately to badly.
Financial transfers between euro countries are low, political preferences of financialeconomic policies are heterogeneous and solidarity is limited. A process of further integration
of the euro zone can promote that the euro zone will better meet these criteria, but the chance
of success is low. Laborious negotiations about the EU budget illustrate that it is unlikely that
transfers will substantially increase. Because cultural differences are persistent and cannot be
abolished by a treaty, differences in political preferences will continue to exist.71 Cultural
diversity also limits solidarity. For these reasons, it is important to decentralize
responsibilities in accordance with the principle of subsidiarity. 72 73
71
Heumakers (2012) states that the optimists who tried anyway, caused the crisis.
The European deposit-guarantee scheme should only guarantee modest amounts of deposits, for example
25,000 euros per account holder. Otherwise, the individual market parties face too little responsibility to limit
their risks.
72
68
Democratic Legitimacy
Now debts have become more public, it is of great importance that further integration of the
euro zone is accompanied by an improvement of its democratic legitimacy. Therefore, the role
of the European Parliament and national parliaments should be strengthened.
Due to the independence of the ECB, politics cannot control the ECB. This
independence can therefore only function properly if the ECB abstains from interventions that
require political considerations and democratic legitimacy. The ECB has not always respected
this principle and has stretched its mandate of maintaining price stability too far. As a result,
the ECB has become more susceptible to partial interests. The mandate of the ECB must
therefore be very strictly defined to prevent reputation loss of the ECB in the future.
Credibility of the European Union
The confidence in further centralization at a European level is undermined by the fact that
important agreements made in the past, like the non-bailout clause, proved not to be resistant
against political or economic pressure. With the transfer of political autonomy from a national
to a European level, one should therefore reckon with the possibility that new agreements will
also prove to be unsustainable in the future and are subject to conflicting interests.
Position of Small Countries
For a small country like the Netherlands, the disadvantage of the transfer of political
autonomy to a European level is limited influence on European policies. At the same time,
from the perspective of a globalizing world, European integration is necessary to exert more
influence by acting collectively.
Peace and Security
It is doubtful whether the euro is crucial to the European project of peace and security in
Europe. More important is that countries are well embedded within the European Union. The
euro policy should primarily be based on economic considerations.
73
Caution with regard to high solidarity at a European level is partly motivated by the lack of efficiency of some
EU funds in the past. One example is the agricultural policy of the EU (see e.g.
http://euobserver.com/institutional/118108). These experiences illustrate that large-scale financial support at a
European level may generate perverse economic incentives and become very expensive, and that adapting a
policy later on seems to be very difficult, because of the large asymmetric political interests between countries,
created by these programs.
69
Relationship with Non-euro Countries
Further integration of the euro zone will increase the tensions between euro countries and
non-euro countries within the European Union. The danger is that this may cause a mismatch
between European institutions and the purpose that they are serving.
National Solidarity
Further integration of the euro zone will lead to more tensions between regions within
countries in the euro zone.
Due to the crisis, which has led to further integration of the euro zone, labour market
operations in southern European countries have improved, though. However, one must be
aware not to go too far in labour market liberalization, because too much flexibility will
impede innovation and reduce solidarity on the labour market.
7.3
Chapter 6 (Implications for Policy Options)
Sustainable Currency Union
Further integration of the euro zone will have a higher chance of success if euro countries
better meet the criteria of the OCA theory.
Further Integration of the Current Euro Zone
If the euro zone is able to create a clear institutional framework that makes it better meet the
criteria of the OCA theory, this policy option is preferable. However, it is highly uncertain
whether the euro zone will succeed. There is a high risk that structural reforms will only be
partly implemented. Another substantial risk is that the intended European institutions will not
perform optimally in view of the economic and political functions for which they have been
designed.
Grexit
Similar to the option of further integration of the current euro zone, a Grexit has advantages
and disadvantages, depending on how it is implemented. If the exit is carefully managed and
euro countries offer Greece sufficient financial support and write-offs on loans in order to
give Greece a good starting position, this option has the advantage that Greece can recover its
competitiveness. After the exit, Greece should remain a full member of the European Union
and should still be entitled to make use of structural funds. This will increase the chance that
Greece will choose for a voluntary exit. This will offer prospects of higher economic growth
in Greece as well as in the euro zone. Another important advantage is that the exit of Greece
will increase the chance of successful further integration and convergence within the euro
70
zone. If not carefully managed, the advantages of the exit of Greece as described above will
be dominated by the disadvantages that are related to large transition costs.
It is necessary that (in addition to access conditions) exit conditions are designed for euro
countries. This will discipline euro countries and increase the chance of successful further
integration of the euro zone.
It is uncertain whether the option of the Grexit will demand more write-offs on loans to
Greece than the option of further integration of Greece within the euro zone. This depends on
how well the exit is managed and how the attitude of Greek politicians and citizens will be
towards both options. A great danger of further integration is the creation of a permanent
dependency relationship, which will involve very high costs in the longer term.
In comparison to a policy of further integration of the current euro zone, a Grexit will
strengthen the democratic legitimacy of economic policies in Greece, but may also endanger
peace and security in the region of Greece.
The biggest disadvantage of a Grexit is the danger of contamination of other southern
European countries.
Exit of Greece, Cyprus, Spain and Portugal
Qualitatively, the expected effects of the exit of Greece, Cyprus, Spain and Portugal are
similar to the effects of a Grexit: improved competitiveness through devaluation of the new
currencies and a bigger chance of successful integration of the remaining euro zone. Because
the proportion of technically high-quality products in the exports of peripheral countries is
relatively low, devaluation can make an important contribution to exports by improving price
competitiveness. As the remaining European countries better meet the criteria of the OCA
theory, the stability of the euro zone will increase.
Negative effects are that the chance of structural reforms in the exiting countries will decrease
and that the devaluation of their currencies will endanger the competitiveness of Italy and
France. This may destabilize the smaller euro zone. Because this policy option will lead to a
very significant reconfiguration of the euro zone, the risks are much higher than for a Grexit.
The democratic legitimacy of economic policies will increase, because people can exert more
influence on their own political decisions, but just as with a Grexit, the chance of conflicts
between countries and/or regions will increase. Therefore, it is very important that the exiting
countries remain full members of the EU.
71
Break-up in a Neuro and a Zeuro
Based on the OCA theory, the following countries would qualify for a new neuro zone:
Germany, Austria, the Netherlands, Finland and Belgium. Estonia, Ireland, Slovenia and
Slovakia could also be included. The remaining countries - Greece, Cyprus, Italy, Spain and
Portugal - would qualify for a zeuro zone. Based on the criteria of the OCA theory, France
could best participate in the zeuro zone and play an integrating role. The additional advantage
would be that the neuro zone and the zeuro zone are more equivalent in size. However, for
political reasons, this seems unrealistic and it is more likely that France will be classified as a
member of the neuro zone.
Qualitatively, the expected economic effects are similar to the effects of the exit of Greece,
Spain, Cyprus and Portugal. Nonetheless, we expect that the prospects of economic growth
will be less favourable, because the countries that belong to the zeuro zone meet the criteria of
the OCA theory only moderately to badly. The benefits of a common currency union in the
zeuro zone will therefore not outweigh the disadvantage of loss of flexibility with regard to
monetary policies and exchange rates.
If the euro is split into a neuro and a zeuro, a reconfiguration of European institutions will be
inevitable, for the sake of good democratic legitimacy of monetary and economic policies.
Return to National Currencies
Based on the OCA theory, a complete break-up of the euro into national currencies will be
unnecessarily harmful to the economies of the neuro zone. For the countries in the neuro zone,
a complete break-up will lead to higher transition costs and more permanent economic
disadvantages, like less competition and productivity growth. An advantage of this policy
option is that the democratic legitimacy of monetary and economic policies will increase. In
contrast, the risks for peace and security will also increase, because this option provides more
room for nationalistic policies.
72
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76
Appendix 1 Core Elements of Further Integration of the Euro Zone
Emergency
fund
Banking union
Budgetary
union
Macro
Imbalance
Procedure
The emergency fund should prevent that liquidity risks in euro countries develop into a
solvency problem and offers a partition between vulnerable banks and national government
finances. In order to function well, the emergency fund must be large enough to overcome
the risks that can manifest themselves in extreme scenarios through various channels of
infection (Van den End and Frost, 2012). This reduces the chance that these means will
actually be used. In addition, strict conditions should be imposed on countries that make use
of it to make structural adjustments in their policies and institutions. By now, the
emergency fund has got a permanent character, due to the foundation of the ESM
(European Stability Mechanism), so that countries will be able to appeal to this emergency
fund in the future. Thus, de facto, this is a Eurobond-light. In the longer term, European
bonds should be issued, thereby making euro countries fully responsible for each other's
debts.
International supervision of European banks will be implemented, together with a European
deposit guarantee scheme and a European resolution fund. The ECB can only perform the
role of lender of last resort well, if there is adequate supervision of banks and preventive
budgetary surveillance. Otherwise, the ECB will run the risk that loans to European banks
will not or only partially be paid back, which is eventually at the expense of the taxpayer.
European banking supervision, in turn, can only really function properly, if a European
deposit guarantee scheme and a European resolution fund are available which decide on the
rescue or liquidation of banks (Schoenmaker, 2012). Conversely, a European emergency
fund for deposit guarantee and resolution provides a strong incentive for strict supervision
of European banks.
The introduction of Eurobonds and a banking union is only possible, if the EMU
concentrates more on the mutual adjustment of budgetary policies. If countries erect a
banking fund, a claim is made on the budgets of euro countries. To ensure that government
finances are in order and are thus able to finance a banking fund, a budgetary union is
needed. This requires more stringent agreements to discipline government finances. Each
euro country should get annual European approval for its budget. If a country intends to
spend more than the agreed debt level, it needs permission at a European level. In the long
term, a budgetary union could be formed, in which a far greater part of tax revenues (than
the current 1% of GNP) are levied and spent at a central European level.
In addition to common monetary policies, there should also be more common economic
policies. The existing coordination of economic politics should be more enforceable. Trade
balances, competitive powers, unemployment and private debt formation will be closely
monitored and Member States that do not follow EU directions for economic policies, will
be fined. In the longer term, the EMU will develop into an economic union, in which
reforms can be enforced, because lack of this will harm the whole currency union.
Macroeconomic imbalances can thus be prevented beforehand. There will also be a need for
a new agenda for growth and competitiveness at a European level.
77
Appendix 2 Experiences from Financial Crises in the Past74
Mexico
(1995)
Korea
(1997-98)
Brazil
(1998-99)
Argentina
(20002002)
74
Main cause: overvalued exchange rate, large external debts, weak banking system
Domestic policy response: floating exchange rate, balanced macroeconomic policies, reform of
the banking system
International policy response: large rescue operation: US loan and record IMF credit
Result: stabilization, no default, permanent improvement in economic performance, but
structural reform lagging behind
Note: Initially, inflation rates increased to an average of 35%, but then quickly fell back to 15%
in 1996. There was a very quick improvement in the trade balance, particularly because of a
strong decline in imports. But from 1997, imports increased substantially, allowing the trade
balance to deteriorate sharply again. Public debts in dollars exploded as % of GDP after the
devaluation and could only be maintained after additional support from the US. But when
economic growth increased after 1996, Mexico was able to repay these loans again in 1997 and
since then, external debts as % of GDP gradually but substantially decreased. Foreign
investments initially declined substantially after the devaluation, but once the recovery gained
momentum, confidence was restored again.
Main cause: pegged exchange rate while externally vulnerable, highly leveraged corporate
sector, contagion
Domestic policy response: floating exchange rate, tighter monetary policy, structural reforms
International policy response: unprecedented rescue package: IMF credit plus second line of
defence, foreign bank loans restructured
Results: quick turnaround, highly successful recovery
Note: after the devaluation in 1997, inflation rose until 1998, but remained limited to 8% and
decreased already in 1999 to 0.5%. Trade deficits turned into a surplus, mainly by a decline in
imports. After three years, both exports and imports showed a major growth, while the trade
balance remained positive. Government debts to foreign parties significantly decreased after the
devaluation, partly because of the trade surplus. Foreign investments initially showed a decline,
but recovered quickly, after which a strong growth occurred.
Main cause: overvalued exchange rate, large external debts, wrong macro policy mix, contagion
Domestic policy response: floating exchange rate plus inflation targeting, tight monetary policy,
improved budgetary results, very few structural reforms
International policy response: IMF packages plus voluntary rollover agreement with foreign
banks
Result: gradual improvement, better mix of macro policies, structural reforms lagging behind,
new crisis in 2002 narrowly avoided with huge IMF package, followed by significant
improvement
Note: After the devaluation of the Real in 1999 with 52%, inflation rates increased slightly to
7%. Economic growth quickly recovered and the trade balance became immediately less
negative and showed a substantial further improvement until 2007. Public debts as a % of GDP
significantly increased, from 49% in 1999 to 64% in 2002, and foreign investments decreased
substantially, until 2002.
Main cause: overvalued exchange rate (currency board), unsustainable external debts, inadequate
budgetary policy, weak financial system, weak institutions, dysfunctional domestic politics
Domestic policy response: initially austerity measures, clinging to currency board too long,
giving up dollar peg in chaotic fashion, record debt default
International policy response: succession of failed IMF programs, IMF and World Bank de facto
rollover their claims on Argentina
Sources: De Beaufort Wijnholds (2011: 120-121), Van Heyningen, 2012.
78
Results: capital controls, deposit freeze, decimated banking system, depression, restructuring of
debts with huge haircut, poor relationship with IMF. Subsequently, a strong recovery aided by
undervalued exchange rate and commodity boom, return of inflation
Note: After the sharp devaluation in early 2002, there was initially a high inflation of 26%, but
exports also grew substantially, and after two years, the price level stabilized. The trade balance
improved, partly because imports decreased initially, but also by an increase in exports. But
because of the increase of economic growth, imports recovered over time, while the trade
balance remained stable. Foreign investments unexpectedly remained stable and increased once
the recovery continued. Partly due to economic recovery, government debts to foreign countries
also declined from 2003.
79
Appendix 3 The Matheo Solution
An alternative to the Grexit policy option is the so-called Matheo Solution (TMS), proposed
by the Dutch euro researcher A. ten Dam (2012). This is a variant on a parallel currency
system and is inspired by the situation of the euro zone in the transitional period between
1999 and 2002, when national currencies were linked to the euro. In this policy option, a
distinction is made between the euro as the sole legal tender (in coins, banknotes and
electronic payments) in all European countries versus the euro as a unit of account for the
calculation of prices and wages. The innovation is that, in addition to the euro, a national
exchange rate unit is introduced that can freely fluctuate. All domestic prices and incomes,
balances of domestic banks and loans are displayed in this national unit, but one continues to
pay in euros. For example, if the exchange rate of the Greek drachma equals 1 euro, you
would be able to pay 1 euro for something that originally cost 1 drachma (for example, a glass
of ouzo). If the rate of the drachma decreases with 30%, a Greek only needs to pay 70 euro
cents for that same glass of ouzo (Verbon, 2011). All international debts remain denominated
in euros. Ten Dam calls the resulting system ‘Euro Currency Units-Exchange Rate
Mechanism’ (ERM-ECU). The national exchange rate unit makes it possible to devaluate the
virtual drachma relative to the euro, without risking capital flight or high costs for the creation
of money denominated in the new currency. The ECU-ERM and the money supply are
managed by the ECB.
The Matheo solution is an intermediate option in between full exit of Greece from the euro
zone and a further integration of the current euro zone. But how does the virtual currency
function in practice? To this end, I assume that all prices in Greece will henceforth be
expressed in drachmas. If the ECB decides to reduce the virtual drachma with 50%, an
employee’s monthly salary in drachmas will not change. Only the amount of euros earned by
the employee will be half as low as before. Because prices on the price tags of goods and
services will also be expressed in drachmas, these will not change either. Only if the customer
pays in drachmas and the shopkeeper uses his calculator to convert the amount of drachmas
into euros, it turns out that the customer pays only half of the amount of euros than prior to
the devaluation. Compared to the internal devaluation, the virtual currency thus has a potential
advantage: that it is able to coordinate price reductions in Greece.
If we compare the Matheo Solution with a real exit of Greece from the euro zone, the Matheo
Solution offers the advantage of saving costs for the introduction of a new currency. In
addition, the chance of economic chaos will be smaller, because all debt positions will remain
in euros. However, the virtual currency will increase the probability of inflation (in
drachmas), because the link with the euro remains largely in place. As the merchant is paid in
euros, (s)he directly observes that, although the price in drachmas does not change, the
devaluation actually means a heavy price decline. The tendency for the merchant to increase
the prices of his products in drachmas will therefore be greater in the longer run. This will
also feed uncertainty among people, who doubt whether their wage in drachmas will not be
80
eroded by inflation after devaluation. The result is that the real depreciation probably will be
lower than the depreciation of a new real (non-virtual) drachma that is separated from the
euro. A virtual currency therefore functions better as a short term solution during a transition
period to the introduction of a new currency than as a means to restore competition in the long
term. The virtual currency in Brazil in 1994 (the URV) also served only for a short period of
time in the run-up to the introduction of the new Real in 1994, which was linked to the dollar.
Another problem of the Matheo solution is that it is only a partial solution, because the
monetary policy within the euro zone will remain homogeneous. It therefore is not possible to
adjust the interest rate policy to the local conditions in Greece. If we compare this with the
current situation of Greece within the euro zone, the Matheo Solution can play a role in a
transitional situation if Greece leaves the euro zone. But it does not provide a structural
solution for improving the competitiveness of Greece.
81
Appendix 4 Bilateral Trade Relations between Euro Countries (in 2010)
Export as % of GDP
Importing
Country:
Exporting
Country:
Austria Belgium Estonia
Austria
0.51
0.03
0.05
Finland
France
Germany
Greece
Ireland
Italy Luxembourg Netherlands Portugal
Slovakia Slovenia
Spain
0.17
1.49
11.74
0.18
0.06
2.70
0.04
0.58
0.12
0.76
0.74
0.68
0.57
14.46
16.23
0.48
0.49
4.00
1.52
10.39
0.51
0.22
0.13
2.61
10.35
1.51
3.19
0.05
0.08
0.56
0.00
1.40
0.05
0.10
0.03
0.45
0.97
2.78
0.10
0.09
0.74
0.01
1.94
0.09
0.06
0.04
0.56
3.23
0.14
0.11
1.61
0.10
0.83
0.22
0.09
0.05
1.48
0.24
0.17
2.34
0.22
2.49
0.31
0.35
0.15
1.38
0.01
0.79
0.00
0.17
0.05
0.02
0.04
0.18
1.74
0.05
1.98
0.27
0.04
0.03
2.16
0.03
0.54
0.22
0.13
0.23
1.25
1.28
0.09
0.11
0.08
0.50
0.45
0.19
0.09
2.01
0.04
0.01
5.66
0.54
1.89
Belgium
0.85
Estonia
0.23
0.79
Finland
0.17
0.81
0.63
France
0.17
1.50
0.01
0.10
Germany
2.13
1.83
0.05
0.31
3.62
Greece
0.07
0.11
0.00
0.06
0.28
0.80
Ireland
0.20
8.67
0.01
0.19
2.88
4.08
0.20
Italy
0.51
0.55
0.02
0.09
2.51
2.81
0.35
0.06
Luxembourg
0.33
3.32
0.01
0.10
4.27
7.48
0.05
0.06
1.28
Netherlands
0.74
6.22
0.05
0.61
5.10
14.02
0.40
0.41
2.97
0.21
Portugal
0.12
0.60
0.01
0.13
2.50
2.73
0.06
0.06
0.79
0.03
0.78
Slovakia
4.97
1.18
0.04
0.24
5.02
14.12
0.27
0.07
4.06
0.07
2.14
0.22
Slovenia
4.19
0.59
0.08
0.12
4.17
10.17
0.18
0.06
6.28
0.10
1.03
0.15
0.75
Spain
0.15
0.50
0.01
0.05
3.24
1.87
0.16
0.07
1.57
0.02
0.56
1.57
0.04
0.64
0.04
Import as % of GDP
Exporting
Country
Importing
Country
Austria
Austria
Belgium Estonia
1.06
Belgium
0.41
Finland
France
Germany
Greece
Ireland
Italy Luxembourg Netherlands Portugal Slovakia Slovenia Spain
0.01
0.11
1.18
18.58
0.06
0.11
2.78
0.05
1.53
0.07
1.14
0.52
0.54
0.03
0.41
8.16
12.84
0.07
3.80
2.40
0.37
10.29
0.29
0.22
0.06
1.48
7.82
1.24
8.30
0.04
0.15
2.06
0.04
2.00
0.09
0.18
0.19
0.54
1.04
4.37
0.08
0.16
0.80
0.02
2.00
0.13
0.09
0.02
0.32
4.67
0.03
0.23
2.02
0.09
1.55
0.22
0.17
0.08
1.75
0.07
0.25
1.75
0.12
3.31
0.19
0.37
0.15
0.78
0.14
2.45
0.01
1.05
0.05
0.08
0.03
0.74
0.58
0.02
1.55
0.07
0.03
0.01
0.46
0.03
1.12
0.09
0.17
0.14
1.06
3.17
0.13
0.12
0.09
0.43
0.23
0.24
0.06
1.00
0.08
0.03
9.53
0.40
0.69
Estonia
0.52
1.34
Finland
0.28
1.13
0.83
France
0.22
2.66
0.01
0.09
Germany
1.35
2.32
0.02
0.20
2.51
Greece
0.23
0.77
0.00
0.08
1.19
2.67
Ireland
0.12
1.11
0.01
0.11
1.34
2.68
0.02
Italy
0.50
0.92
0.01
0.09
2.01
3.76
0.11
0.17
Luxembourg
0.31
13.56
0.00
0.03
5.01
13.95
0.03
0.19
1.27
Netherlands
0.28
6.28
0.03
0.59
2.74
10.57
0.07
0.53
1.41
0.09
Portugal
0.19
1.05
0.00
0.09
2.43
4.52
0.06
0.25
1.99
0.02
1.54
Slovakia
3.31
1.16
0.02
0.17
2.69
13.36
0.08
0.09
3.06
0.06
1.69
0.11
Slovenia
5.91
1.27
0.01
0.20
2.84
10.32
0.26
0.13
10.05
0.09
1.55
0.06
1.00
Spain
0.19
0.88
0.01
0.10
2.73
3.28
0.04
0.32
1.85
0.02
1.13
0.93
0.12
82
1.13
0.02
Postscript
On November 29th, 2012, this report was published in the Netherlands. Many commentaries
judged that the report is independent, well-founded and well-balanced. Below, I will
summarize some critical responses to the report and give a short response to each of them.
In response to an interviewer, Van Wijnbergen states that a Grexit and the resulting
devaluation of the Greek drachma will increase the debt burden and cause hyperinflation in
Greece. Van Wijnbergen argues that the economic policy should aim at raising productivity
rather than wage cost reduction. Van Wijnbergen is an excellent economist and his views on
economic policy are often very relevant, but it seems that Van Wijnbergen did not have the
opportunity to read the report himself before responding to the journalist, because his remarks
are discussed at several places in the report. Given the uncertainties, it is indeed possible to
defend Van Wijnbergen’s view. He basically repeats the views of Buiter (2011) described in
the report. But these views neglect the empirical evidence that indicate that inflation will
probably not fully redress the positive effects of the devaluation. Consequently, he also
ignores the possibility that a country with large foreign debts may be more able to repay its
debts in the long run if the economy recovers after the devaluation. Furthermore, I agree that
raising labour productivity would be the first best solution. I have referred to the case of
Portugal to illustrate this point. However, as discussed in the report, it will take many years
(decades) before the gap in labour productivity between Greece and northern European
countries will be bridged. Moreover, it is highly uncertain to what extent policy reforms that
aim at productivity growth will really succeed. This shows one basic feature of the debate on
the euro, namely that the proponents of one or another policy option often stress certain risks
(which are certainly present), but neglect other risks that would cast doubt on their view.
Another response is from Mathijs Bouman. He qualifies the report as a rational and balanced
report. But still Bouman believes that the report misses the crucial issues. First, he criticizes
the method used. I use the prevailing economic theory of optimal currency area and apply it to
different options of the euro zone. On the basis of this theory, I conclude that a preference for
maintaining the current policy of the current euro zone is ambiguous. Bouman argues that we
already knew that the EMU is not an optimal currency area. But that is not, according to him,
the cause of the current problems. Rather, the euro crisis has been caused by the financial
crisis. My response to this criticism is that the theory of optimal currency union is definitely
of great importance to assess the conditions under which the euro zone constitutes a stable
currency area. Indeed, currently the crisis in the banking system is the direct cause for the
divergence within the euro zone. But in the future, another shock could put pressure on the
euro. The report shows that it is not likely that all countries in the current euro zone will meet
the OCA criteria in the short or medium term. That means that economic shocks in the future
will cause quite different economic developments in different countries and will again be very
costly. We live in a world full of economic crises. From 2001 to 2008 is only seven years. It is
too optimistic too believe that the probability that between now and ten years, no other major
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shock will occur in the world economy that will lead to divergence in the euro zone again.
Think of a war in the Middle East with great implications for the oil price; a conflict between
China and Japan or possibly the US; or a dollar crisis if the US cannot control its high debts
anymore. That is why it is so important for the euro zone to meet the conditions of the OCA
theory in the next ten years. As stated in the introduction of my report, the report aims to
analyze the long-term trade-offs: is the long-term goal where the current policy strives at
really sustainable? To answer this question, the theory of the optimal currency area is the
most appropriate instrument of analysis.
The second criticism of Bouman is that the report does not indicate how the transition
to another euro zone should take place. For example, how do you avoid capital flight?
Bouman acknowledges that the report does describe these problems and that it calls for a good
management of the exit as an important precondition for this. But the report does not go into
details with regard to the management process. On the one hand, Bouman is right. But I do
not consider this as a serious problem, as the report refers to (among other things) the
comprehensive and award-winning study of Capital Economics 'Leaving The Euro: A
Practical Guide', which focuses precisely on this question. If Bouman does not agree with the
analysis of Capital Economics, he should criticize this report (which he does not).
A final serious criticism is that the report too easily ignores the biggest risk of an exit
of Greece, namely the risk of contagion. Although the report certainly mentions this danger
and warns that this might happen, a solution to prevent the contagion effect is not given. I
think this is a valid and serious criticism on the report. Actually, in an earlier version, I did
formulate some guidelines on how to deal with this danger. But since this topic is also an
element of good exit management, I did not expand on this analysis. But in the (unpublished)
section on this issue, I stressed that a good timing of the exit is crucial. For example, I think
that, if the economy develops in a way that makes a Grexit more politically preferable, one
should implement a Grexit when confidence in other southern European countries is already
recovering. As soon as financial markets have changed their expectations for the economic
development in Italy or Spain, a Grexit will probably cause much less turmoil in financial
markets than right now. At that time, it will be no longer necessary that the ESM is
enormously extended to fully protect Spain or Italy or that the ECB extends its safety net
beyond reasonable limits to neutralize contagion of these large countries.
FD reporter and ex-Brussels correspondent Martin Visser judges that the report is pleasant to
read, because it is very nuanced. In his view, all arguments are presented in a clear way. But a
big disadvantage of the report is that it gives no quantitative underpinning. All figures are
retrieved from other sources, of which some are lacking scientific status (like The Economist).
I partly agree with this criticism. Although the report presents some original empirical
analyses, most figures are indeed based on different other sources. A more systematic
empirical analysis is definitely possible and warranted. Given the small budget available to
the ChristenUnie, it was however not feasible to dig deeper into the quantitative analysis.
Moreover, as stated in the report, one should be aware that the factors that are crucial for the
policy evaluation are inherently highly uncertain. Even if one would employ a larger research
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team and have more data available, it would still be very hard to narrow down the kind of
uncertainties discussed in the report.
ND editor Peter Bergwerff also doubts the feasibility of a Grexit, because it should be well
managed, very speedy and secretly prepared, allowing no democratic control in order to
prevent financial disorder. In the report, I acknowledge that democratic legitimacy of a Grexit
will be absent. But when deciding on such an exit, one could certainly make a good
assessment of how the Greek people will perceive an exit and take this into account.
Moreover, currently many fundamental financial decisions are taken in the EU that also lack a
good democratic legitimacy for exact the same reason, namely to prevent financial disorder. If
one would take Bergwerff’s argument literally, the euro zone would be a kind of Hotel
California: once in, one can never leave. This may deter other countries that are currently
outside the euro zone, to become part of it.
This brings me to another, more fundamental, point. Namely, that my analysis implies that the
sustainability of the euro zone requires a design of exit conditions. Exit conditions will
discipline the euro countries in the future (Eijffinger and Mujagic, 2012). However, exit
conditions can only function properly if the possibility of an exit is seriously considered.
Obviously, this would be an important change in the current commitment to the euro zone.
Because once one is convinced that a design of exit conditions is required to make the euro
zone sustainable in the long term, one admits that the current euro zone must not be
maintained at all costs.
Next, if policymakers do, for the sake of the stability of the EMU, formulate exit
conditions, my report indicates that it is not plausible that all countries of the current euro
zone will meet the conditions of staying in the EMU in the medium or even long term.
The political implication is that policymakers should keep other options than the integration
of the current euro zone in mind. This means, for example, that it is sensible to amortize
Greek debts, because that is inevitable anyway, even if Greece stays in the euro zone. But it
also keeps open the option of a Grexit, if the economy develops in a way that makes this
option more likely.
According to the economist Beetsma, the report rightly states that continuing the current
policy is untenable, because then Greece’s economy will fail to recover. Nevertheless,
Beetsma thinks that keeping Greece within the euro zone is better than a Grexit. Because a
Grexit will not help the Greek economy, which is barely competitive, ahead. Before Greece
entered the euro zone, it regularly devaluated its drachma to be cheaper and be able to
compete with foreign countries. However, at that time, the Greek economy did not become
stronger. According to Beetsma, that is what Europe is doing right now, by forcing Greece to
sound public finances and privatisations.
This criticism is similar to Van Wijnbergen’s point that a Grexit is not a first best
policy, which I agree on. The reason why a Grexit should, nevertheless, be taken serious is
that one can doubt whether Europe can continue to take over the management of the economic
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policy in Greece forever. Beetsma does not address the issue of cultural differences in Europe.
But in the long term, these cultural differences may have a decisive influence on what is
politically feasible.
Beetsma and Bovenberg also criticize the evaluation of the exit of more southern
European countries from the euro zone, basically for the same reasons as expressed by Peter
Bergwerff that it is not feasible to keep an exit secret. Consequently, financial disorder effects
may set in, as described in the report. According to Bovenberg, an exit of Spain and Portugal
would make investors doubt that Italy and France can be maintained within the euro zone.
And then the whole euro zone will collapse. Moreover, the debts of these large countries are
too big for writing off. I do agree with this criticism. I already noted this danger myself by
describing it as the major threat for this policy option (see conclusion 9 of the summary). But
I refrained from judging that this risk would dominate the advantage that if Greece, Cyprus,
Spain and Portugal leave the euro zone, the remaining euro zone will gain in convergence and
stability. Beetsma and Bovenberg may be right about this. However, again much depends on
the timing of the exit as well as on how Italy and France will develop. If Italy and France are
able to improve their competitiveness and government budgets in the nearby future and the
euro zone stabilizes, an exit of other southern countries than only Greece will not be as
dangerous anymore for the remaining euro zone.
Furthermore, Bovenberg repeats the criticism of Bouman that the report ignores the role of the
financial sector in the euro crisis. According to Bovenberg, Spain got into trouble, because
Spanish banks lent too much to the real estate sector. As I already stated above, I think this is
true, but only partially. Because in the future, other large shocks may occur that will cause
divergence in the euro zone, if countries do not meet the conditions for a common currency
area. Moreover, as described in Chapter 2, Spain would have been better able to prevent the
bubble in its real estate market, if it was not a member of the euro zone. Because then, its
central bank would have probably applied a more strict monetary policy with consequently
higher real interest rates.
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Personalia
Prof. Dr. J.J. Graafland (1960) is Professor Economics, Business and Ethics at Tilburg
University since 2000. Previously he worked as an economist at the CPB (CPB Netherlands
Bureau for Economic Policy Analysis) as head of the applied general equilibrium models
division.
Prof. Dr. E. de Jong (1955) is Professor of International Economics at the Radboud University
Nijmegen since 1994. Previously he worked at the University of Groningen and the
University of Amsterdam.
Drs. N. Vogelaar (1949) is Chairman of the AK Rabobank Foundation. He was until recently
as a financial economist working at Rabobank Netherlands and has now retired.
T. Palm MSc (1987) is political scientist and is working as a PhD student at the Free
University Amsterdam in the Department of Political Science. She investigates military
operations of the European Union.
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