Tuesday, November 1, 2011

Politics: the beginning and the end of the Euro

As much as economists have been wondering for years about the economic benefits and costs of sharing a currency, such as the Euro, the decision to create the Euro area and to be one of its members has always been a political one. As an academic, I have written about the costs and benefits of sharing a currency and my work has led me to the belief that, in the case of the Euro, the benefits outweigh the costs. When I have had an occasion to present my work in this area to those in charge of making the decision (politicians) I always realized that economic arguments matter very little when there are political constraints.

As an anecdote, back in January 2010 I wrote a chapter for a book about the 10 year anniversary of the Euro and the lessons for countries such as Sweden that stayed out of the Euro area. Anders Borg (Swedish Finance Minister) was in charge of commenting on our book and he made it very clear that from the point of view of economics there was no doubt that Sweden belongs in the Euro area but that we need to wait for the "right timing" (a similar position, although less explicit, is held by the UK government with their entry tests). And the right timing is decided on political grounds and not so much on economics. Given the current Euro crisis, it is likely that the timing of entry of any of these countries has just moved into the very distant future...

The countries that are part of the Euro area joined under different political agendas. There is the core (France, Germany) who has been driving European integration through the years (for reasons linked to the end of WWII). There is the periphery (Greece, Spain) who wanted to be like the core. With relatively low income per capita, their societies aspired to converge not only in terms of development but also from an institutional point of view to the levels of the rich Euro partners. And this was the reason why these countries supported every step of European integration, including membership to the Euro area.

And now are looking at the possibility of exit. In the last months, when I have been asked whether Euro exit was a possibility I have always said that it would be economic suicide for any country to leave the Euro area. But economic and political incentives are not always aligned and I have also argued that I could imagine a country leaving the Euro area if the political dynamics of the country produce a potential referendum where the question of Euro membership is simply read as "us versus them". In that environment you could imagine a country leaving the Euro area simply because its citizens have lost faith in the European project and the other countries are seen as enemies not allies. This has happened in recent times in Europe, where a referendum (about the Maastricht Treaty or the European constitution) was turned down in several countries and the only thing the European politicians could do is to repeat the referendum over and over again until it was approved...

Today the Greek government has surprised other Euro members and financial markets announcing a referendum on the last Euro bailout plan. This can be the end of the Euro, at least in some countries. Given the difficult economic situation in Greece and Europe, a "No" vote is not just possible but very likely. And while the vote will be just on the details of the plan, it will be seen as a referendum on the Euro. And this time there will be no second chance to repeat the vote if we do not like the outcome. And my fear is that just the announcement of a vote and the anticipation of that scenario might lead to a crisis months before the referendum takes place.

Antonio Fatás

on November 01, 2011 |   Edit