The euro is still in big, big trouble: here’s why
As I’ve said before, the best way to understand the euro crisis is through the medium of beer.
Take an extended pub crawl through the Eurozone and you soon discover an uncanny pattern: the more deeply-embroiled a country is in the crisis, the more its local beers cost. This impression is borne out by the statistics. Here’s what’s happened to beer prices in various European countries since 1996.
As you can see, German beer prices have remained low while the prices of countries like Greece, Italy and Spain soared.
So what? Well, the cost of beer is in many ways an analogy of the broader economic problem in the euro area. The single currency was supposed to cause the various member states to converge economically. Over time, prices in those countries should move more uniformly.
Of course, no-one’s expecting everything to cost the same throughout the single currency area, but you wouldn’t expect divergence of this extent. Quite simply, it costs too much to produce beer (or for that matter other economic “outputs”) in Greece, Spain etc, in comparison with their fellow euro members.
Those beer prices aren’t expensive because the citizens are well-off: they’re expensive because the country is inefficient. A broader way of illustrating this inefficiency is through unit labour costs – the measure of how much it costs to generate a given unit of economic output (GDP) in different countries. The shape of the chart is strikingly similar to the beer price chart.
In a functional currency area the unit labour costs should be at least broadly in line across the piece. You should be able to get the same bang for your buck from a euro throughout the currency area – or else a euro issued in one country simply isn’t the same as a euro elsewhere.
In a functional currency area, it should cost more or less the same, too, for both governments and companies/individuals to borrow. But as you can see, clearly this isn’t the case for governments:
All else being equal, these charts are pretty damning proof that the euro project is still in dire trouble. So what can one do in the circumstances?
Pragmatically-speaking, there are two broad options.
First, you can try to bring the lines on those charts (particularly the unit labour cost one) back in line with each other. Make Greece etc more efficient, make Germany slightly less efficient. That (at least the former) is what’s being tried at the moment: Greece is having unprecedented deflation imposed on it; households are facing massive wage cuts.
This is at least economically logical: it costs too much to produce every unit of GDP in Greece, so cutting wages by a quarter should, all else being equal, make each unit of GDP a quarter cheaper.
And you can see that, to some extent at least, it is working. Look at that unit labour costs chart: Greece is getting more efficient. So too is Ireland: dramatically so. The Irish beer price index, as you can see from the beer price chart, has dropped sharply and is now lower than Germany’s.
The problem is that there is still a tremendous way to go; and this comparative improvement in efficiency has come at the cost of a number of governments, of large-scale rioting, of a potential breakdown in social cohesion, and of a rise in extremist parties – in Greece at least. So there is a big question mark over how much more austerity you can impose.
Which brings us to the second option. Rather than trying to bring those lines back together – making Greece as efficient as Germany, which few would argue is really feasible – you create an economic system which adjusts for those internal imbalances. It’s called real fiscal union, and it exists in every other major country or currency area you can think of.
If you were to construct a state-by-state measure of unit labour costs in the US, it would probably look rather similar to the Eurozone one, except with Mississippi and New Mexico in the place of Greece and Spain, and New York or New Jersey in the place of Germany. The same would go for the UK, with the North East and Northern Ireland at one end of the efficiency scale and London on the other.
The difference is that these countries have a permanent system of fiscal redistribution from the efficient areas to the less efficient areas. Here, courtesy of The Economist, is a map showing which areas of the US have received subsidies (the red ones) and which ones have effectively donated to their less efficient state neighbours (the green ones) over the past 20 years.
This redistribution, which is done through the tax system, is an integral part of a currency area (although, it should be said, one that politicians in countries like Britain or the US don’t much like to talk about).
In the end, the only way the euro can survive is if its politicians come up with some way of creating a similar system. Countries like Germany have to agree to give up some of their money – permanently – to their poorer, less efficient neighbours.
It’s not a loan. There is no prospect of being repaid, just as London will probably never be repaid the money it sends out to other regions.
Is Germany ready for this? Certainly not yet. Most of the money that has been given to Greece has been branded a loan – the implication being that it will eventually be paid back.
This is, of course, bogus. Which is why the next few months will be very interesting. European policymakers are now finally grappling with the inevitable: that they may have to write off those loans to Greece. If German taxpayers take this in their stride, it is a sign that maybe – maybe – the euro might have a chance.
If, as one suspects, it causes yet more brow-beating and trans-European tension, I suspect pretty soon we will all be asking ourselves once again just how long the single currency has to survive in its current state.