Tuesday, July 14, 2015

Who Wants to Deal with a Bully Longterm? What Comes of Germany Imposing its Will on Greece?

German Finance Minister Wolfgang Schaeuble

So it looks like Germany has imposed its will on the Greeks. For now. It's a shame. 

The Greek banking crisis and the euro have become divisive for the European project. The euro has become divisive, says Barry Eichengreen, because the different economies of different countries in Europe needed the euro to do different things. Since the start of the financial crisis in 2007, poorer countries like Greece needed a much cheaper euro; creditor countries like Germany did not. Peripheral countries like Greece, but also Italy, Spain, Portugal, Ireland... needed fiscal stimulus (lots of infrastructure projects, government spending) to get back on their feet, and some inflation to help grow out of debts; Germany did not. 

Germany, the largest economy in the euro zone, imposed austerity on all others (no government stimulus,  decrease in government spending, increase in taxes) and a monetary policy that would not allow for inflation. For the last seven years, Germany has been fine...., Greece's economy has imploded; they have unemployment of 25%.  Germany has thrown its weight around and gotten its way. Germany's needs have been met, those of poorer countries have not.

The EU has no mechanism for transfer payments from rich countries to poor. They have no political mechanism to get this done.  Instead of witnessing leadership that would help build Europe, we've had to listen to moralizing lectures from the German press and the German finance minister. [And this from the country that had 50 percent of its debt forgiven in 1953 after it launched the greatest homicidal disaster in the history of the world] 

In the United States, we have banking union (the Fed manages the money supply and interest rates, and the FDIC rescues banks in individual states when they run into trouble) and we have fiscal union (the Federal government collects taxes from all states, reallocates money between the states). Here is a map of the rough magnitude of transfer payments that occur in the U.S. (numbers are per capita).

Net contributions calculated as taxes paid minus narrow transfers received.
For example, Kentucky receives more than $1,800 in benefits from the federal government (over and above what it pays in taxes to the federal government for) for every person in the state. This is helped along by the fact that poor and less populous states in the U.S. are structurally overrepresented in Congress (the least populous and poor states have two senators, just as many as the most populous and  wealthy states). 

In the Europe of today, the bullies rule. The EU has no political mechanism to transfer payments to Greece. It's like expecting California to make transfer payments to Kentucky without the federal government involved--it wouldn't happen.

Transfer payment of 1,800 per capita from Germany to Greece would be $19 billion/year. 

The EU has open borders and labor mobility, but labor is not nearly as mobile in the Eurozone, with its diverse cultures and languages, as it is in the United States. Moving from Greece to Germany to get a job is not like moving from Kentucky to California.

Wolfgang Muenchau at the Financial Times wonders about the fallout. He sees a Europe where the strong (Germany) push around the weak (Greece) and he ventures that others (Italy, Spain, Ireland, Finland, Portugal?) must be observing the same thing. What's their takeaway?  

He speculates that the takeaway will be: Perhaps this Europe thing is not for us? Maybe not right away, but soon. 

1.  For the past 20 years, the glue holding the EU project together has been the political commitment of its members to build a European entity. This has transcended economic interest: they wanted to be part of an ambitious project of European integration. 

2.  But if the strong bully the weak, what happens to this starry eyed aspiration. Does it give way to disillusionment? How are the Greeks feeling today, whether or not their parliament approves this deal.

3.  If Italy, Finland, Ireland, Spain, Portugal, Greece, etc. begin to feel that this is a club run by and for the powerful and rich, they will look much more closely at the economic cost/benefits. 

4. Looking at it from a purely economic point of view, says Muenchau, the leadership of Germany does not look so good for the weak. 
"The euro has worked well for Germany. It worked moderately well for The Netherlands and Austria, although it produced quite a degree of financial instability in both. .... But for Italy, it has been an unmitigated economic disaster."  
Similarly, the euro has not worked for Finland, especially as its economy has slumped in wake of Nokia's collapse.  What about Spain, Portugal, Ireland?  Greece is not the only country for whom the euro has not been a blessing.

5.  A few years down the road someone will look at Germany and say.... "You're a bully, we don't want to play this game anymore?" 

"Once you strip the eurozone of any ambitions for a political and economic union, it changes into a utilitarian project in which member states will coldly weigh the benefits and costs, just as Britain is currently assessing the relative advantages or disadvantages of EU membership. In such a system, someone, somewhere, will want to leave sometime. And the strong political commitment to save it will no longer be there either."