How Europe Ended Up Someplace Else Ashoka Mody EuroTragedy: A Drama - - PowerPoint PPT Presentation

How Europe Ended Up Someplace Else

Ashoka Mody EuroTragedy: A Drama in Nine Acts New York: Oxford University Press, June 2018

Thesis: monetary union would lead Europe into political union. Early warnings it would not.

• Nicholas Kaldor, March 1971:
• Single currency would amplify economic divergence, and
• A house “divided against itself cannot stand.”
• Robert Marjolin, crucial catalyst of Treaty of Rome, in the 1970s:
• Political efforts to counteract economic divergence would be

impeded by the sovereignty barrier:

• European leaders “obviously not ready” to give up core

sovereign functions;

• Change required was “too profound.”

A flawed euro, which the French desperately wanted, on German terms.

• Chancellor Helmut Kohl—despite

severe initial misgivings—pushed the euro, overriding German public’s deep opposition to giving up the deutsche mark

• Seeking the Bundestag’s

authorization on April 24, 1998, he twice said:

• “According to the treaty rules, the

community shall not be liable for the commitments of the member states and there are no additional financial transfers.” Translation: Germany will not pay the bills of other member countries.

• Kohl’s mantra: euro would ensure

Europe’s peace.

But there was no conception of what the end goal was …and, hence, no idea of how Europe would get there.

“If you don’t know where you are going, You'll end up someplace else.”

Yogi Berra

The tragedy: the euro inevitably pushed Europe into a “someplace” else that was not good.

Kaldor’s ghost stalks:

The euro divides Europe

The great divergence in euro-area incomes and employment.

Per capita incomes (In thousands of US dollars, corrected for purchasing power parity) Unemployment rates (Percent) Sources: Conference Board, “Total Economy Database (Adjusted Version),” http://www.conference- board.org/data/economydatabase/; IMF, World Economic Outlook Database, https://www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx.

34 36 38 40 42 44 46 48 50 2003 05 07 09 11 13 15 Germany France Italy 4 5 6 7 8 9 10 11 12 13 2003 05 07 09 11 13 15 Italy France Germany

The euro-area north-south divergence: public debt and youth distress.

Public debt Youth unemployment and inactivity Source: IMF, World Economic Outlook Database; Eurostat (edat_lfse_20). Note: Countries on the left side correspond to the countries on the right side. The “unemployed” are those who are looking for a job but are unable to find one; the “inactive” are not looking for a job and neither are they in an educational or training program. The sum of the unemployed and inactive is known as “neither in employment, education or training” (NEET).

50 100 150 200 2017 Netherlands 2007 2017 Germany 2007 2017 Austria 2007 2017 Finland 2007 2017 Portugal 2007 2017 France 2007 2017 Spain 2007 2017 Greece 2007 2017 Italy 2007 Public debt as a percentage of GDP 5 10 15 20 25 2016 2007 2016 2007 2016 2007 2016 2007 2016 2007 2016 2007 2016 2007 2016 2007 2016 2007 Percentage of population 15 to 29 years old Inactive Unemployed

Divergence was predictable, not an accident: southern euro area suffers from weak governance and institutions, which weaken growth potential: The euro is cruel on countries with low growth potential.

Source: World Bank, Worldwide Governance Indicator. Note: The overall index presented is an average of measures of government effectiveness, regulatory quality, rule of law, and control of corruption. Each individual measure is normally distributed, with a mean of zero, a standard deviation of 1, and an approximate range of –2.5 to 2.5. Larger values indicate better governance.

0,0 0,5 1,0 1,5 2,0 2,5 2015 Netherlands 1998 2015 Germany 1998 2015 Austria 1998 2015 Finland 1998 2015 Portugal 1998 2015 France 1998 2015 Spain 1998 2015 Greece 1998 2015 Italy 1998 Better governance and institutions

Poorer long-term growth prospects a trap: persistently low R&D rates in the euro-area periphery, hence persistently low growth potential.

(R&D as a percentage of GDP, 2016 versus 1997)

Source: OECD Statistical Database.

Austria Belgium Denmark Finland France Germany Greece Ireland Italy Netherlands Portugal Spain Sweden United Kingdom United States 0,5 1 1,5 2 2,5 3 3,5 0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 R&D/GDP ratio (percent) in 2016 R&D/GDP ratio (percent) in 1997

Predictably, German exporters shift their sights away from the euro area.

(Percent of total German exports to the various countries) Source: IMF Data, http://data.imf.org/regular.aspx?key=61013712.

Undercuts the idea that the euro would promote trade and, hence, growth.

United States Italy Czech Republic, Hungary, and Poland 2 4 6 8 10 12 1999 2007 2016 France China

Kaldor’s ghost stalks also the eurozone’s politics

Italians lost trust in Europe: economic wounds left political scars.

(Decrease in percentage of respondents who trust the European Union, 2016 relative to 2001)

Source: Standard Eurobarometer survey, available at http://zacat.gesis.org. Note: Respondents answered the following question: “I would like to ask you a question about how much trust you have in certain institutions. For each of the following institutions, please tell me if you (Tend to trust it; Tend not to trust it): The European Union.” The chart presents the change in share of people who said they trusted the EU. For each year, 2001 and 2016, responses for the two available quarters are averaged.

• 40
• 35
• 30
• 25
• 20
• 15
• 10
• 5

Italy France Germany

“European chancellor” Merkel held eurozone together: Became polarizing force. Between 2010 and 2016, Merkel was de facto European chancellor, a goal that Kohl had dreamt of. Ipso facto, she became a politically polarizing figure, dividing Europe.

• In Italy, February 2013 election:
• Rise of the anti-euro Five Star

Movement

• Silvio Berlusconi, whose party also

performed well, asked at his rallies, “Do you want a government that that is subject to the diktats of Europe?”

• Pro-European Mario Monti

electorally humiliated.

• In Germany, starting in 2012:
• Breakaway group from Merkel’s

Christian Democratic Party (CDU) formed Alternative für Deutschland, initially as an anti-euro party and then as an anti-immigrant party.

Looking ahead: The future ain’t what it used to be

For now, Greece has lost its democracy.

• Failure to provide substantial

and upfront debt relief implies

• Large primary surpluses
• Historically hard to

maintain

• Will constrain

government investment

• Keep growth low
• More seriously
• Greek parliament will

mainly rubber-stamp decisions made in Berlin, Brussels, and Frankfurt.

The ECB has reached its political limits

ECB tardy in initiating bond purchases: Euro-area inflation rate began dropping in mid-2013, delivering the lowflation wound.

(Three-month moving average of “core” annual inflation rates, percent)

Source: Eurostat: “HICP—All Items Excluding Energy and Food”; St. Louis Fed, FRED: “Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index).”

0,6 0,8 1 1,2 1,4 1,6 1,8 2 Jun 2012 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17 Dec 17 Jun 18 United States Euro Area

The ECB keeps forecasting a rise in inflation: Inflation remains stubbornly low.

Sources: ECB’s Macroeconomic Projections made in March of the year, https://www.ecb.europa.eu/pub/projections/html/index.en.html. Note: 2018 core inflation is the average of months January to September 2018.

0,6 0,8 1,0 1,2 1,4 1,6 1,8 2012 13 14 15 16 17 18 19 20 2013 forecast 2014 forecast 2015 forecast 2016 forecast 2017 forecast Solid line is the actual euro-area core inflation 2018 forecast

The ECB lacked commitment to bond purchases, even more so than the Bank of Japan.

Note: Exchange rate for JPY/USD equals 100 on January 4, 2013 (date of the announcement of quantitative easing by the Bank of Japan) and exchange rate for EUR/USD equals 100 on January 22, 2015 (date of the announcement of quantitative easing by the ECB). Source: For USD and Japanese Yen, https://www.investing.com/currencies, for USD and Euro rates ECB, https://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=120.EXR.D.USD.EUR.SP00.A&periodSortOrder=ASC.

80 90 100 110 120 130 140 150

• 100

100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400

Number of days from the quantitative easing announcement JPY/USD EUR/USD Depreciation relative of the dollar Start of quantitative easing January 4, 2013: Bank of Japan January 22, 2015: ECB February 1, 2016 July 1, 2016 January 1, 2017 September 15, 2017 October 24, 2017: ECB begins tapering QE Taper talk Taper talk June 14, 2018: ECB announces QE end date as end-2018

World trade rather than ECB’s bond purchases moves eurozone growth.

(Annual growth rates, percent; three-quarter moving averages)

Source: For world trade growth data World Trade Monitor, https://www.cpb.nl/en/data; for the industrial production of Germany, France and Italy Eurostat, code [sts_inpr_m]. Note: The three-month average of growth

• ver the same three months in the previous year.
• 1

1 2 3 4 5 6 7 Aug 2015 Nov 15 Feb 16 May 16 Aug 16 Nov 16 Feb 17 May 17 Aug 17 Nov 17 Feb 18 May 18 Aug 18 World trade Germany industrial production France industrial production Italy industrial production

ECB bond purchases in flow from March 2015, but unable to raise economic

Italy: theater of EuroTragedy

Italy needed—and needs—the crutch of a depreciating currency to offset its abysmal productivity growth.

The depreciating lira (Number of liras for one D-mark) Italian productivity fell relative to German (annual total factor productivity growth) US Dollar/Euro exchange rate is back where it began, 1999-2018 Italian productivity collapsed while even German fell behind the U.S. (annual total factor productivity growth) Source: Top left panel: Banca d'Italia, https://tassidicambio.bancaditalia.it/timeSeries; top right panel: ECB data warehouse https://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=120.EXR.D.USD.EUR.SP00.A&period SortOrder=ASC; bottom left and right panels: The Conference Board, https://www.conference- board.org/data/economydatabase/index.cfm?id=27762.

200 400 600 800 1000 1200 1400 70 74 78 82 86 90 94 98 1970 0,0 0,5 1,0 1,5 2,0 2,5 1970-79 1980-89 1990-98 Italy Germany 0,8 0,9 1 1,1 1,2 1,3 1,4 1,5 1,6 99 02 05 08 11 14 17 1999 The euro's starting exchange value

• 0,8
• 0,6
• 0,4
• 0,2

0,0 0,2 0,4 0,6 0,8 2008-08 2009-16 Italy Germany United States

Young college-educated Italians leave Italy in growing numbers.

Source: Italian National Institute of Statistics.

Italy's low growth trap: poor opportunities, the educated leave, R&D remains weak, and opportunities remain poor.

2 4 6 8 10 12 14 16 5 10 15 20 25 30 2002 04 06 08 10 12 14 16 Share of 25 to 34 years-olds among migrants with college degrees Number of college-educated migrants older than 25 (thousands) 25-34 Number of college graduates leaving Italy (left) Number of college graduates returning to Italy (left) Share of 25 to 34 year-olds among migrants with college degrees (right)

Italy’s financial problems: The government-bank “doom loop,” always latent, has remerged.

Sources: FTSE Italia All-Share Financial Index: Global Financial Data, ticker IT8300 Index; FTSE Italia All-Share Index: Global Financial Data, ticker FTSEMIB Index; Italy ten-year bond yield: Datastream International, code

• S310DT. Notes: The graph presents the relative performance of financial stocks and the Italian 10-year bond yield

from 2 January 2015 to 18 September 2012. The relative performance of financial stocks for Italy is the ratio between the FTSE Italia All-Share Financial Index and FTSE Italia All-Share Index.

0,8 0,9 1,0 1,1 1,2 1,5 2,0 2,5 3,0 3,5 4,0 Jan 2018 Feb 18 Mar 18 Apr 18 May 18 Jun 18 Jul 18 Aug 18 Sep 18 Oct 18

Government bond yield (left, percent) Financial sector performance (right, index)

Sovereignty barrier remains as strong as ever

The myth of Franco-German friendship.

At the December 2012 European Council, Herman Von Rompuy proposed a eurozone budget. Merkel asked, “Where will the money come from?” French president François Hollande helpfully suggested to Merkel that she think of it as a “solidarity fund.” Again, Merkel coldly asked, “And where will the money come from?”

The search for a savior.

How the saviors fall: Matteo Renzi and Emmanuel Macron approval ratings.

(Approval ratings, percent)

Source: Ipsos polls for Matteo Renzi, www.ipsos.it; Ifop for Emmanuel Macron, https://www.ifop.com/wp- content/uploads/2018/08/Indices-de-popularit%C3%A9-Ao%C3%BBt-2018.pdf. Note: Percent "Don't know" excluded.

maj 2017 maj 2018 maj 2019 maj 2020 maj 2021 10 20 30 40 50 60 70 maj 2014 maj 2015 maj 2016 maj 2017 maj 2018 Matteo Renzi Emmanuel Macron

There are no saviors.

Europe: a declining continent for over a century: The future does not look much better, as Asia surges ahead.

(US patents granted annually to companies in different countries, numbers in thousands)

Source: World Intellectual Property Statistics Database, https://www3.wipo.int/ipstats/index.htm.

2 4 6 8 10 12 14 16 18 1995 97 99 01 03 05 07 09 11 13 15 Republic of Korea Germany China France Italy

The warnings were sounded. It need not have been. It almost was

• not. The rest followed. It could

get worse, a lot worse.

• The euro has hobbled many of

its member countries.

• It has created bitter political

division among Europeans.

• If Aristotle were alive today, he

would see how “eminently good and just” men and women enacted the EuroTragedy, “not by vice or depravity,” but by “error or frailty.”