Is It Only a Matter of Time Before the Euro Collapses? (event archive)

February 23, 2011 by  

Dr Iain Begg (professor, London School of Economics) spoke at a joint event of the Common Sense Society, the LSE Alumni and the Hungarian Europe Society about the effects of the financial crisis on the European Union. His lecture addressed the most important question of the future regarding the financial and economic integration of the EU and the monetary policy problems lying ahead: Will the EU become a United States of Europe or a United Europe of States?

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Summary

The Collapse of the Euro? Please Place Your Bets

Amidst the European economic gloom and doom, British humor and some well-founded LSE optimism was a refreshing reminder of the fact that all is not lost in the European economic sphere.  “No, the Euro won’t collapse” was the basic message of Professor Iain Begg of the London School of Economist, who nevertheless projected that the road ahead is much bumpier than anyone would like to think.

The economic governance of the EU has many shortcomings that explain why European macroeconomic policy went wrong in the past decade. First, the European Central Bank is one institution, but in Europe there is a mixed bag of 17 Euro zone finance ministers’ policy practices. Their goals do not necessarily converge. How is this sole institution then supposed to create a one size fits all policy for the entire Euro area?

Second, the attempt to monitor what exactly is going on in these 17 countries has also gone wrong. Neglecting the imbalances and their causes has had grave consequences, like the banking problems in Ireland and the asset bubble in Spain.

Third, there is the question of the political economy of implementation: all the countries could be asking themselves, perhaps not even in secret: So why should we comply with the Euro zone rules?

Long-term interest rates have widened since the crisis broke, causing discrepancies among national economies. An underlying cause is a fundamental imbalance: the Netherlands and Germany have huge budget surpluses while Portugal, Spain, and Greece are constantly running deficits. There exists vast tension within the Euro area due to diverging economic governance.

The trends in consumer prices also show an important parallel: the inflation rate of Spain grew considerably faster than that of Germany, resulting in huge divergence over time.

A lack of substantive fiscal coordination so far has undermined long term homogeneity of the monetary area: unit labor costs in Germany were held down while in Spain, Italy, and Greece they rose by 25%. These Mediterranean countries thus lost their competitive edge. Professor Begg’s take on the trend:  “Things that can’t go on forever… don’t”. So, after a while, the delicate balance naturally tipped. Greece and Ireland were ticking time bombs, something that could have been foreseen.

The crisis might, however, be an opportunity ‘too good to waste’ as the line goes in Brussels offices. This is evident from the policy steps taken under Herman van Rompuy, president of the European Council. Plenty of ad-hoc answers arose to the challenges posed by the crisis, but not many solutions have been brokered yet, precisely due to the political economy reasons that paralyze the institution-led and inter-governmental process. There is an instant need to make the rules stricter, but there seem to be no clear answers for specific questions and definitely no clear leaders to spearhead the process.

Those who want to push for European integration look at the current crisis quite opportunistically. There is still no consensus over what the Euro should be between the German and French concepts. One suggestion, introducing a ‘Madame Euro’ just like the two new positions created in the Lisbon Treaty, would raise the currency’s profile and ensure a more determined leadership to save it at all costs.

So the economic governance problem boils down to questions the political economy. Is the European Central Bank or its members in charge of policymaking? The big winner is going to be Germany thanks to its strongly export-driven economy and whose bailout money will ultimately flow back to whence it came.

In essence, the Euro is not in serious peril. But it remains a matter of debate whether there is the right amount of political will towards stabilizing it at a certain cost of political will and national sovereignty. The road to the land of stability will be difficult and full of unexpected turns. Hungary should not be in a hurry to join the club, since it will instantly lose the flexibility of foreign exchange rate alternations. This is what actually may help the country preserve its competitiveness. Who would have thought?!

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