How the Euro Divided Europe
Twenty years ago this month, Europe’s common currency became a tangible reality with the introduction of euro notes and coins.
To mark the occasion, eurozone finance ministers issued a joint statement calling the currency “one of the most tangible achievements of European integration”. In fact, the euro has done nothing to promote European integration. Quite the contrary.
The main purpose of the euro was to facilitate integration by eliminating the cost of currency conversions and, more importantly, the risk of destabilizing devaluations. Europeans were promised that this would encourage cross-border trade. Living standards would converge. The business cycle would be dampened.
This would bring greater price stability. And intra-euro area investment would lead to faster overall productivity growth and convergent growth among member countries. In short, the euro would support the benign Germanization of Europe.
Twenty years later, none of these promises have been kept. Since the formation of the euro area, intra-euro area trade has increased by 10%, significantly less than the 30% increase in world trade and, more importantly, the 63% increase in trade between the Germany and a trio of European Union countries that have not adopted the euro: Poland, Hungary and the Czech Republic.
It’s the same story with productive investments. A huge wave of loans from Germany and France swept through eurozone countries like Greece, Ireland, Portugal and Spain, leading to the sequential bankruptcies that were at the heart of the lending crisis. euro ten years ago.
But most foreign direct investment has gone from countries like Germany to the part of the EU that has chosen not to adopt the euro. Thus, while investment and productivity diverged within the euro zone, convergence took place with the countries that remained outside.
In terms of income, in 1995, for every €100 ($114) earned by the average German, the average Czech earned €17, the average Greek €42 and the average Portuguese €37. Of the three, only the Czech was unable to withdraw euros from a domestic ATM after 2001.
And yet, his earnings in 2020 have converged towards the German’s €100 average income of €24, compared to just €3 and €9 for his Greek and Portuguese counterparts, respectively.
The key question is not why the euro failed to bring about convergence, but rather why anyone thought it would.
A look at three pairs of well-integrated economies offers useful insights: Sweden and Norway, Australia and New Zealand, and the United States and Canada. The close integration of these countries has increased – and has never been compromised – because they have avoided monetary union.
To see the role of monetary independence in keeping their economies closely aligned, consider their inflation rates. Since 1979, the rate of inflation has been broadly similar in Sweden and Norway, Australia and New Zealand, and the United States and Canada.
And yet, over the same period, the bilateral exchange rates of their currencies have fluctuated wildly, acting as shock absorbers during asymmetric recessions and banking crises and helping to keep their integrated economies aligned.
Something similar happened in the EU between Germany, the biggest economy in the eurozone, and Poland without the euro: when the euro was created, the Polish złoty depreciated by 27%. Then, after 2004, it appreciated by 50%, before falling by 30% during the financial crisis of 2008.
As a result, Poland avoided both the debt-fueled growth that characterized eurozone members like Greece, Spain, Ireland and Cyprus, and the massive recession once the crisis of the euro was in full swing. Is it any wonder that no EU economy has converged more impressively with Germany’s than Poland’s?
In retrospect, it looks as if the architecture of the euro was designed to cause maximum divergence. Indeed, the Europeans created a common central bank that lacked a common state to cover their backs, while simultaneously allowing our states to continue without a central bank to cover their backs in times of financial crisis, when states have to bail out banks operating in their territory.
During good times, cross-border lending created unsustainable debt. And then, at the first sign of financial distress (whether public or private debt crisis), the writing was on the wall: a eurozone-wide spasm whose inevitable result was a sharp divergence and huge new imbalances.
Simply put, the Europeans looked like a hapless car owner who, in an effort to eliminate body roll when cornering, removed the shock absorbers and drove straight into a deep pothole.
Why countries like Poland, New Zealand and Canada have weathered global crises without being left behind (or, worse, giving up their sovereignty) by Germany, Australia and the United States, c It is precisely that they resisted a monetary union with them. If they had succumbed to the lure of a common currency, the crises of 1991, 2001, 2008 or 2020 would have turned them into debt colonies.
Some argue that Europe has now learned its lesson. After all, in response to the euro crisis and the pandemic, the euro area has grown stronger with new institutions such as the European Stability Mechanism (a common rescue fund), a common surveillance system for European banks and the Next Generation EU recovery fund.
These are undoubtedly big changes. But they are the minimum necessary to keep the euro afloat without changing its character.
By implementing them, the EU has confirmed its desire to change everything so that everything remains the same – or, more precisely, to avoid the only change that matters: the creation of a genuine budgetary and political union, which is the condition prior to managing macroeconomic shocks and eliminating regional imbalances.
Twenty years after its creation, the euro remains a fine-weather construct, fueling divergence rather than convergence. Until recently, this result inspired heated debates – and therefore the hope that Europe was aware of the centrifugal forces threatening its foundations.
This is no longer the case. When the finance ministers of the eurozone released their common hymn to the single currency, something remarkable happened: nothing.
No one joined in the celebrations. No one cared enough to disagree. Such apathy does not bode well for a union torn apart by widening inequality and xenophobic populism.
Yanis Varoufakis, former Greek finance minister, is the leader of the MeRA25 party and professor of economics at the University of Athens.
Disclaimer: This article first appeared on Project Syndicate and is published by special syndication agreement.