Books that attack the conventional wisdom are refreshing. They force us to rethink. That is what Martin Sandbu’s Europe’s Orphan does — and what makes it stand out in the increasingly crowded field of eurocrisis analysis.
The main argument made by Sandbu, an economics commentator at the Financial Times, can be summarised as follows. The eurozone sovereign debt crisis that erupted in 2010 has little to do with the alleged design failures of monetary union. This crisis, rather, is the outcome of bad macroeconomic policies that were wholly avoidable. In particular, the abhorrence shown by the major policymakers (the European Central Bank, the European Commission, and German, French and other government leaders) towards debt restructuring, both of banks and sovereigns, is at the core of the crisis.
The failure to write down debts condemned these policymakers to choose the wrong policies — chief among them excessive fiscal austerity and monetary tightening. This approach produced a new recession in 2011-12, created misery for millions of unemployed people and only increased the debt burdens it was supposed to bring down.
Since it is not the euro but bad policy that is responsible for the crisis, it follows that no deep institutional changes are necessary to sustain the euro in the long run. In particular, there is no need for a fiscal and political union. What is needed are better macroeconomic policies, which can best be achieved by returning responsibility for fiscal policies to national governments while unshackling these governments from ill-advised rules such as the 2012 fiscal compact. Of course, some co-ordination of national fiscal policies is desirable. But the way to bring this about is through voluntary agreement between national fiscal policymakers.
There is much to agree with in this analysis. It is clear that the generalised fiscal austerity imposed on eurozone countries has made this crisis more intense and has led to a double-dip recession. In addition, ill-advised macroeconomic policies have created disunity by pitting creditor and debtor nations against one another. There can also be no doubt that, as Sandbu argues, the intrusive interventions by the ECB and the European Commission in fiscal programmes imposed on the debtor nations have been highly undemocratic, undermining the legitimacy of the monetary union.
But there is also a lot to disagree with in Europe’s Orphan. Let me focus on two points. First, there is the claim made by Sandbu that the sovereign debt crisis would have erupted with or without the euro: countries that accumulated too much private or public debt would at some point have experienced a bust and been forced to adjust. But I would also argue that the absence of the exchange rate instrument in the eurozone made this adjustment more difficult. It led to the need to apply deflationary demand policies in many eurozone countries, thereby creating a deflationary bias in the system as a whole — the result of which has been stagnation since 2008. This is not only the result of bad policies; it also follows from a systemic feature that makes the eurozone resemble the gold standard mechanism of adjusting to balance-of-payments crises.
Second, there is the claim that the eurozone does not need a fiscal and political union. I have my doubts. Surely, one of the things we have learnt about the eurozone is that when financial markets lose faith in one or more governments (and there will often be reason enough to do so), “sudden stops” in capital flows occur, leading to massive movements towards safe havens in the same currency area. This forces those distrusted by the markets into instant austerity and deflation. It is not enough to hope that, in the future, enlightened governments will prevent such a situation from arising. The institutional set-up of the eurozone makes it almost inevitable that this will happen again.
Only through a mutualisation of eurozone debt that introduces much greater risk-sharing — together with a willingness on the part of the ECB to step in at times of crisis — can this problem be tackled. Sandbu recognises the potential of debt mutualisation but argues that it is not really needed. I disagree. Insurance mechanisms are necessary and they can only be guaranteed in the framework of a political union.
Like Sandbu, I have no illusions; the willingness to move forward into a political union is extremely weak. And surely, trying to force such a unification from the top down would be undemocratic. The conclusion drawn by Sandbu is that this should not worry us: the eurozone can function without fiscal and political union. My conclusion is that this unwillingness will continue to make the eurozone fragile.
Whatever disagreements one may have, Europe’s Orphan is a stimulating and important book. It is stimulating because it forces us to question what many in Brussels and Frankfurt consider to be self-evident. It is important because such rethinking will surely lead to new insights.
Europe’s Orphan: The Future of the Euro and the Politics of Debt, by Martin Sandbu, Princeton University Press, RRP£19.95/$29.95, 336 pages
Paul De Grauwe is professor of European political economy at the London School of Economics