What has happened? With advances in economic science, aren’t we supposed to understand better how to manage economies? Indeed, Nobel Prize–winning economist Robert Lucas declared in his 2003 presidential address to the American Economic Association that the “central problem of depression prevention has been solved.” The mark of a well-functioning economy is rapid growth, the benefits of which are shared widely, with low unemployment. What has occurred in Europe is the opposite.
America’s depression at the end of the 19th century was linked to the gold standard, where every country pegged its currency’s value to gold and, therefore, implicitly to one another’s currencies: with no new large discoveries of gold, its scarcity was leading to a fall in the prices of ordinary goods in terms of gold—what today we would call deflation. In effect, money was becoming more valuable. And this was impoverishing America’s farmers, who found it increasingly difficult to pay back their debts. The election of 1896 was fought on the issue of whether, in the words of Democratic candidate William Jennings Bryan, America would “crucify mankind upon a cross of gold.”
So, too, the gold standard is widely blamed for its role in deepening and prolonging the Great Depression. Those countries that abandoned the gold standard early recovered more quickly.
In spite of this history, Europe decided to tie itself together with a single currency—creating within Europe the same kind of rigidity that the gold standard had inflicted on the world. The gold standard failed, and, other than a few blinkered diehards known as “gold bugs,” no one wants to see it restored.
Moreover, there has to be sufficient flexibility in the rules to allow for adaptation to differences in circumstances, beliefs, and values. Overall, Europe has enshrined this in its principle of “subsidiarity,” which entails devolving responsibility for public policy to the national level, rather than the European level, for as wide a range of decisions as possible. Indeed, with the budget of the European Union only about 1 percent of its G.D.P. (in contrast to the United States, where federal spending is more than 20 percent of G.D.P.), little spending occurs at the E.U. level. But in an arena crucially important to the well-being of individual citizens—monetary policies that are critical in determining unemployment and the bases of livelihoods—power was centralized within the European Central Bank, established in 1998. And, with strong constraints on deficit spending, the individual countries were given insufficient flexibility in the conduct of their fiscal policy—their ability to tax and spend—to enable a country facing adverse circumstances to avoid a deep recession.
Worse still, the structure of the eurozone built in certain ideas about what was required for economic success—for instance, that the central bank should focus on inflation, as opposed to the mandate of the Federal Reserve, in the United States, which incorporates unemployment, growth, and stability as well. It was not simply that the eurozone was not structured to accommodate Europe’s economic diversity; it was that the structure of the eurozone, its rules and regulations, were not designed to promote growth, employment, and stability.
The problems with the structure of the eurozone have been compounded by the policies the region has pursued, especially within the crisis countries—Portugal, Ireland, Greece, Spain, and, later, Cyprus. Even granting the zone’s flawed structure, there were choices to be made. Europe made the wrong ones. It imposed austerity—excessive cutbacks in government expenditures. It demanded certain “structural reforms”—changes in how, for instance, the afflicted countries ran their labor markets and pensions.
But for the most part, it failed to focus on those reforms most likely to end the deep recessions the countries faced. The crisis countries faced two related problems: they were importing more than they were exporting, and the resulting insufficiency of domestic demand was depressing the economy. Structural reforms that would have encouraged exports and discouraged imports would have simultaneously addressed both. Thus, one needed to make import-substituting activities more productive and encourage consumption of local goods, supporting, for example, local fresh foods. In Greece, exactly the opposite was done, as Greece was ordered to change milk labeling, so that 11-day-old milk from northern Europe could still be called “fresh” and undercut Greek producers.
There was, moreover, something decidedly odd about Europe’s leaders focusing on what could be called fresh milk, the size of loaves of bread, and what over-the-counter drugs could be sold outside of pharmacies even as Greece plunged into a depression, with G.D.P. plummeting by a quarter. Even if they had been perfectly implemented, the policies pushed on the crisis countries would not have restored the afflicted countries or the eurozone to health.
The most urgent reforms needed are in the eurozone structure itself—not inside individual countries—and a few, halting steps have been taken in that direction. But those steps have been too few and too slow. Germany and others have sought to blame the victims—countries that suffered as a result of the flawed policies and the flawed structure of the eurozone. Without reform of the eurozone itself, Europe cannot return to growth.
What is to be done? A return to the status quo ante—what has been called a mutual “amicable divorce”—could have profoundly negative consequences on many fronts. And going “all in”—creating a Europe that is even more politically and economically integrated, with the necessary institutions to back it up—is not a regime that all of the member nations would support at this time. Between these poles, however, there is a way forward: adopting a “flexible euro.”
This entails recognizing that there has been some progress in creating eurozone institutions since the euro crisis broke out, but not enough to make a single-currency system work. The flexible euro would build on these successes and create a system in which different countries (or groups of countries) could each have their own euro. The value of the different euros would fluctuate, but within bounds that the policies of the eurozone itself would affect. Over time, perhaps, with the evolution of sufficient solidarity, those bounds could be reduced, and eventually, the goal of a single currency set forth in the Maastricht Treaty of 1992 would be achieved. But this time, with the requisite institutions in place, the single currency might actually achieve its goals of promoting prosperity, European solidarity, and political integration.
I won’t go into technical detail here about how a flexible euro would work in practice. Given the digital capabilities of modern financial management, creating the appropriate architecture is quite feasible. The essential point is that, under a flexible-euro system, the value of one country’s (or group’s) euro could vary relative to that of another’s. This is the flexibility in exchange rates that the current system lacks. At the lower exchange rate, the countries of southern Europe (for instance, Greece and Italy) could export more and would import less. Demand would increase, and with it incomes and employment. At the moment, the only way that they can achieve a balance between imports and exports is to depress the economy so much that consumers don’t buy much of anything—including goods from abroad. With a more flexible exchange rate, they could achieve trade balance and full employment.
This reform would show, moreover, that the German “model” was less impressive than it has claimed (though critics have pointed out that Germany, the best performing of the eurozone countries, only looks good in comparison to its neighbors). The northern euro exchange rate would rise, and Germany’s huge trade surplus—the major source of global imbalances—would decrease. Germany would have to find another engine for its economic growth.
Monetary systems come and go. Monetary arrangements, like the Bretton Woods system that governed the world after 1944, was heralded at its onset as the replacement of the gold standard. It seemed to work in the years after World War II, but in the end it did not last even three decades. The euro’s moment of glory was even shorter; and even in the brief time that it seemed to be working, the imbalances that would eventually bring on the euro crisis were building up, and the euro (together with the associated economic arrangements) was largely to blame.
The euro can be saved and should be saved, but saved in a way that creates the shared prosperity and solidarity that was part of the promise of the euro. The euro was a means to an end, not an end in itself—and a flexible euro would address some significant fundamental problems. For all the emotions that the euro has brought on, for all the commitments that have been made to preserve it, in the end, the euro is just an artifice, a human creation, another fallible institution created by fallible people. It was created with the best of intentions by visionary leaders whose visions were clouded by an imperfect understanding of what a monetary union entailed. This was perhaps understandable: nothing like it had been tried. The real sin would be for Europe not to learn from what has happened in the past two decades.
Adapted from The Euro: How a Common Currency Threatens the Future of Europe, by Joseph E. Stiglitz, to be published this month by W. W. Norton & Company, Inc. © 2016 by the author.