I attended a lecture by Alan Brown, the Chief Investment Officer at Schroders, Tuesday at the U.K.'s oldest think tank, The Economic Research Council.
The topic was the "Collision of economics and politics in the eurozone." I thought I had heard everything there was to hear about the euro crisis. But Brown's analysis made me think of the eurozone crisis in a fundamentally different way.
According to Brown, the problem with Europe is that the euro makes it seem like it is a single market and economy. But it's not. The apt analogy he used was that the eurozone was like building a house starting with the roof (currency union) and trying to put in the walls (fiscal union) afterward.
But if you look at EU countries as the individual economies they are, the entire eurozone crisis is just a good, old-fashioned balance of payments problem. Germany and the rest of Northern Europe are running a balance of payments surplus with Southern Europe. And Southern Europe has a balance of payments deficit with Northern Europe. In fact, German banks are owed more than 500 billion euros by their Southern European trading partners.
To better understand this as a thought experiment, I translated the current European crisis into U.S. terms.
Think of Washington, DC as Germany and Detroit as Greece. Like Greece, Detroit became hopelessly uncompetitive. It produced automobiles that no one wanted to buy. Union workers were overpaid. And despite its glorious past -- Detroit was the fastest-growing city in the world in 1900 -- the city fell into steep decline.
The problem wasn't with the automobile industry, per se. Plenty of greenfield manufacturers were making cars productively in the southern U.S. in the same U.S.-dollar-denominated economy. But they were competitive because they paid lower wages, weren't burdened by high legacy costs and produced the Toyotas and BMWs people wanted to buy.
So, how did the Washington respond to Detroit's crisis?
Washington essentially bailed two of Detroit's iconic car manufacturers, GM (GM) and Chrysler. In addition, a vast array of government welfare programs transferred funds from "wealthy" Washington to "poor" Detroit. Although some free market types kicked and screamed and opposed the bailouts, two things made this politically possible
First, the bailout and transfer of wealth from Washington to Detroit went to American companies, thereby saving American jobs. The other government transfers also benefited American citizens down on their luck. And because the U.S is genuinely a single economy, the massive wealth transfers keeping Detroit afloat are largely invisible. Germans would view a similar transfer of their hard-earned wealth to the ne'er-do-well Greeks very differently.
Second, Washington never required Detroit to implement austerity measures to help pay back its debt. And the idea that the Washington would cut Detroit government employees wages and benefits, just because they were from Detroit is unthinkable. If it did, downtown Detroit would be having the same kinds of riots in the streets as Greece.
Let's turn back to Europe. Greece suffers from the same lack of competitiveness that Detroit does. Since the introduction of the euro, Greek labor cost have risen 35% while in Germany they rose only 10%. And like Detroit, Greece doesn't have a lot to offer a lot that the rest of the world wants to buy.
So, what is to be done?
First, you can try to build walls to the house. That's the German solution and what Europe is trying to do with last week's fiscal pact. But that only makes Greece stand in the corner with a dunce cap. It does not put any more money into Greece's pocket.
Brown pointed out that the Germans have been spending 4% of their GDP rebuilding East Germany for the past 20 years. Maybe Germans could view fiscal contributions to Greece and Southern Europe the same way, much like Washington transfers wealth to Detroit, albeit essentially invisibly.
But that would be like asking the ant (Germany) to bail out the grasshopper (Greece), as opposed to another ant (East Germany) down on his luck. That didn't happen in the fable. And it's unlikely to happen in real life. If Europe were genuinely one economy like the U.S., the transfer of wealth from one part of the economy to another could take place without inflaming nationalistic passions.
Second, you could get rid of the roof. That is, return Greece to the drachma. Sure it would be difficult at first. But once Greece exits, it could return to growth in its own terms. By way of example, after the U.K. exited the European Exchange Rate Mechanism (ERM) 20 years ago, the pound sterling devalued by 25% and the UK enjoyed 15 years of uninterrupted growth.
The second option is clearly the better -- and ultimately more likely -- solution.
It's just taking the EU a long time to get there.
