Economist Debates adapt the Oxford style of debating to an online forum. The format was made famous by the 186-year-old Oxford Union and has been practised by heads of state, prominent intellectuals and galvanising figures from across the cultural spectrum. It revolves around an assertion that is defended on one side (the "proposer") and assailed on another (the "opposition") in a contest hosted and overseen by a moderator. Each side has three chances to persuade readers: opening, rebuttal and closing.
In Economist Debates, proposer and opposition each consist of a single speaker, experts in the issue at hand. We also invite featured guests to comment on the debate—not to take sides, but to provide context and informed perspective on the subject.
Those attending an Oxford-style debate participate in two ways: by voting to determine the debate's winner and by addressing comments to the moderator. The same holds here. As a reader, you are encouraged to vote. As long as the debate is open, you may change your vote as many times as you change your mind. And you are encouraged to air your own views by sending comments to the moderator. These should be relevant to the motion, the speakers' statements or the observations of featured guests. And they must be addressed directly to the moderator, who will single out the most compelling for discussion by the speakers.
Daniel Gros has been director of the Centre for European Policy Studies (CEPS) since 2000, president of Eurizon Capital since 2005 and member of the Supervisory Board of the Central Bank of Iceland since October 2009. He worked at the European Commission (1988-90) as Economic Adviser for Monetary Affairs at DG ECFIN (working mainly for the President and the Delors Committee which developed plans for EMU) and he has been an Adviser to the European Parliament since 1998. He was founding member (2002) of the Shadow European Central Bank Council and is currently a member of the Euro 50 Group. He is editor of Economie Internationale and International Finance and author of several books and numerous articles for scientific journals and newspapers.
Sign up for e-mail alerts. We will remind you when a new debate is about to start and when each phase of a debate begins.
Martin Feldstein is the George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research (NBER). He served as President and CEO of the NBER in 1977-82 and 1984-2008. He continues as a Research Associate of the NBER. From 1982 to 1984, Mr Feldstein was Chairman of the Council of Economic Advisers and President Reagan's chief economic adviser. He served as President of the American Economic Association in 2004, and was appointed in 2006 to the President's Foreign Intelligence Advisory Board and in 2009 to the President's Economic Recovery Advisory Board. Mr Feldstein is an economic adviser to several businesses and governmental organisations in America and other countries and is a director of Eli Lilly. He is the author of more than 300 research articles in economics and is a regular contributor to the Wall Street Journal and other publications.
While Mr Wyplosz refers to the single currency as "protecting" Greece from a currency crisis, I see it as preventing Greece from achieving a helpful increase in net exports by a natural currency depreciation.
Charles Wyplosz is Professor of International Economics at the Graduate Institute in Geneva where he is Director of the International Centre for Money and Banking Studies. He has served as Associate Dean for Research and Development at INSEAD and Director of the Economics PhD programme at the Ecole des Hautes Etudes en Science Sociales. He also has been Director of the International Macroeconomics Programme at the Centre for Economic Policy Research. A founding Managing Editor of Economic Policy, he serves on the boards of several professional reviews and European research centres. Mr Wyplosz has published a number of books and is a regular columnist for newspapers such as the Financial Times, Le Monde and Handelsblatt; he also speaks weekly on Radio Suisse Romande. He is a member of the Group of Independent Economic Advisors to the President of the European Commission, the Panel of Experts of the European Parliament's Economic and Monetary Affairs Committee, and the Bellagio Group.
In the case of Greece exiting from the euro area, the pain is bound to be acute. Devaluation may help restore current budget and external imbalances, but under extreme duress.
Paul Wallace is Britain economics editor of The Economist, where he has covered the British economy and public finances since 2000. He has written international surveys on pensions and health care for the magazine. He is the author of "Agequake", a book about the economic impact of global population ageing published in six languages, and co-author of "The Square Mile", an account of the financial revolution in the City in the mid-1980s.
The debate is attracting a great deal of interest and a stack of insightful contributions from the floor. Many of them highlight that the future of the euro is as much about politics as economics. For example, fritz04 says: "The current debate about the future of the euro is in truth a debate about the future of Europe." Manneken says that "as long as the important players have the political will to continue, so will the euro", but adds that the "euro is a half-built house" and that "the markets are forcing the euro zone to either go fast forward to political union or to fall apart".
In his rebuttal Martin Feldstein says that the political commitment in the main euro-area countries will allow the euro to survive, but not in its current form and not with all of its current members. He reiterates his argument that Greece would now benefit by leaving, because this would allow the devaluation needed to promote net exports and so soften the economic pain caused by harsh fiscal retrenchment. He argues that some debt restructuring is virtually inevitable in Greece and that this would offset the rise in local-currency terms of external euro-denominated debt as the reborn drachma depreciates.
Charles Wyplosz, for his part, accepts that Greece is exposing the "worst weaknesses" in the monetary union, but says that a "traumatic" exit from the euro area would be the wrong answer. Euro-denominated debts when converted into new drachma would vault upwards, resulting in defaults by both the government and private borrowers. Even within the euro area he accepts that a government-debt rescheduling is probably unavoidable but argues that this would be more palatable for Greece than one outside the single currency.
Adding to the cut and thrust is the first of the guest contributions, by Barry Eichengreen, a professor of economics at the University of California, Berkeley, whose view that euro membership is effectively irreversible was cited by Mr Wyplosz in his opening statement and is rejected by Mr Feldstein in his rebuttal. Mr Eichengreen tells a wry parable about the US dollar to highlight the weaknesses he sees in the motion that the euro area will fragment over the next ten years.
At this stage in the debate, both Mr Feldstein and Mr Wyplosz are focusing their arguments on Greece. They concur that some form of Greek debt default looks unavoidable. A crucial question is whether this would be more damaging for Greece in or outside the euro area. The voting so far is around 40% in favour of the motion and around 60% against it. Let’s see how opinion moves as each side clashes with the other.
Martin Feldstein is the George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research (NBER). He served as President and CEO of the NBER in 1977-82 and 1984-2008. He continues as a Research Associate of the NBER. From 1982 to 1984, Mr Feldstein was Chairman of the Council of Economic Advisers and President Reagan's chief economic adviser. He served as President of the American Economic Association in 2004, and was appointed in 2006 to the President's Foreign Intelligence Advisory Board and in 2009 to the President's Economic Recovery Advisory Board. Mr Feldstein is an economic adviser to several businesses and governmental organisations in America and other countries and is a director of Eli Lilly. He is the author of more than 300 research articles in economics and is a regular contributor to the Wall Street Journal and other publications.
Charles Wyplosz is candid in his admission that the euro is "an ongoing bet" that may or may not survive. I believe that it will survive but not in its current form and not with all of its current members.
More specifically, I think that one or more of the 16 countries that are now members of the euro system may leave during the next ten years. But I am not predicting the end of the monetary union. As I explained in my first statement in this debate, while the single currency and the single monetary policy will be a cause of continuing problems for the euro-zone countries, the political leaders of the major euro-zone countries are likely to accept those economic costs in order to achieve what they see as the political advantages of a more unified and politically centralised Europe.
But Greece would now benefit by leaving the euro zone. In order to get financial help from the other euro-zone countries and from the International Monetary Fund, the Greek government has agreed to very large increases in taxes and cuts in government spending over the next three years. That fiscal contraction will reduce domestic demand in Greece, causing a collapse of economic activity and personal incomes. In contrast, the countries in Asia and Latin America that have accepted such large IMF-imposed fiscal contractions have avoided sustained devastating reductions in economic activity because they have been able to devalue their currencies at the same time, leading to increases in exports and reductions in imports. The single currency prevents that offsetting adjustment. While Mr Wyplosz refers to the single currency as "protecting" Greece from a currency crisis, I see it as preventing Greece from achieving a helpful increase in net exports by a natural currency depreciation.
If Greece reverts to the drachma and floats the currency, it would probably achieve a devaluation of about 30%. That would make its products and services much more competitive, boosting economic activity and employment. Although the value of its external euro-denominated debts would rise by a similar percentage when stated in drachma, that would be largely offset in the debt restructuring that is virtually inevitable in Greece. There would not be the doubling up in local currency terms of its debt that Wyplosz asserted.
I agree with Wyplosz that there would be administrative issues in reverting from the euro to the drachma. But these administrative problems would not be a major burden. Many countries introduced new currencies when they achieved political independence. The drachma would be familiar to the Greek public and therefore would have ready acceptance. Going back from the euro to the drachma would be easier than the initial shift from the drachma to the euro.
Mr Wyplosz cites an article by Barry Eichengreen on the problems that a country would face in leaving the euro. In a later version of that same article (Barry Eichengreen, "The Breakup of the Euro Area", in Alberto Alesina and Francesco Giavazzi, Europe and the Euro, University of Chicago Press, 2010), Mr Eichengreen concluded that it would be possible for a euro-zone member to leave but that, acting rationally, none would chose to do so. That article was written in 2008, before the current fiscal crisis and the imposition of the IMF's fiscal squeeze on Greece. The case for leaving is clearly stronger now than it was then.
In my comment on Mr Eichengreen's article in that same volume I disagreed with his implicit benefit-cost evaluation and also emphasised that the decision to leave would be political rather than just economic. I cited extensive survey evidence collected by the European Commission in which Europeans indicated much greater identification with and loyalty to their own currencies than to the euro and the euro zone. A politician seeking election or re-election could disregard what some see as the economic risks of leaving the euro zone in order to get broader popular support.
Mr Wyplosz emphasised that it is a "political necessity" that fiscal policies "remain in the national sovereignty domain". That is why the Stability and Growth Pact, imposed at the level of the euro zone, failed to limit fiscal deficits. It is also why the recent proposal of the European Commission to require that that each country's annual budget be subject to review by all other euro-zone countries would never be accepted.
But making a commitment to future fiscal discipline would be important, especially for any country that leaves the euro zone. Greece would be well advised to enact a constitutional amendment similar to the one adopted recently by Germany and proposed for France by President Sarkozy that would require a cyclically adjusted balanced budget. The experience of the individual states in the United States with such constitutional amendments shows that they can be very effective in limiting fiscal deficits. As it became clear over time that Greece was respecting its own constitutional amendment, the interest rate on its debt would gradually decrease.
The economic conditions in Greece are now a disaster. Greece would do well to begin planning how it will eventually leave the euro.
Charles Wyplosz is Professor of International Economics at the Graduate Institute in Geneva where he is Director of the International Centre for Money and Banking Studies. He has served as Associate Dean for Research and Development at INSEAD and Director of the Economics PhD programme at the Ecole des Hautes Etudes en Science Sociales. He also has been Director of the International Macroeconomics Programme at the Centre for Economic Policy Research. A founding Managing Editor of Economic Policy, he serves on the boards of several professional reviews and European research centres. Mr Wyplosz has published a number of books and is a regular columnist for newspapers such as the Financial Times, Le Monde and Handelsblatt; he also speaks weekly on Radio Suisse Romande. He is a member of the Group of Independent Economic Advisors to the President of the European Commission, the Panel of Experts of the European Parliament's Economic and Monetary Affairs Committee, and the Bellagio Group.
Greece is undeniably exposing the two worst weaknesses of the European monetary union. These are that first, each country must exercise fiscal discipline because it has lost the ability to inflate its debt away, and yet countries remain sovereign in fiscal matters; second, having lost the exchange rate, any home-made inflation hurts competitiveness, with no easy solution in hand.
These weaknesses were known long before the launch of the euro and it was then hoped that all member countries would recognise the implications. That Greece did not rise to the task does not mean that the monetary union has failed. Nor does it mean that a traumatic exit from the euro area is the best way out. No one denies that Greece is in deep trouble, as are other countries that have made similar mistakes.
Leaving the monetary union is superficially appealing but it would be the wrong answer. True, being able to depreciate away the loss in competitiveness would greatly help. A deep depreciation would boost exports and the real economy, making it much easier to close down both the external and budget deficit. But we all know that policy choices are usually a matter of trade-off. Any suggestion that Greece should leave the euro area is incomplete, and therefore unconvincing, without a thorough analysis of the drawbacks and of the alternatives.
For ease of exposition, let us imagine that Greece reintroduces the drachma at an exchange rate of 1 drachma to 1 euro. Previous examples of countries that unpegged their currencies in the middle of a crisis (Argentina in 2001, Korea in 1997), suggest that the drachma could quickly lose half of its value, to 0.5 euro per drachma. The public debt stands at nearly €300 billion, and it is entirely in euros, so €300 billion it would remain, unless Greece defaults, which it can—and should—do within the euro area. Its GDP is about €240 billion. Some 20% is exported, so this part would approximately retain its value—the combination of lower unit prices and a higher volume. The rest is not traded and will lose approximately half of its euro value. The new GDP, measured in euros, will therefore decline to some €140 billion, 40% lower than initially. This works out to a public debt to GDP ratio of 210%. Furthermore, according to estimates by Centre for Economic Policy Research (CEPR) research fellows, Philip Lane and Gian Maria Milesi-Ferretti, Greece's net external liability position stood at €220 billion at end-2007 and has probably increased to €240 billion by now. Again, most of it is in euros and will remain unchanged, so the net external debt would amount to about 155% of GDP, up from about 100% currently. Worse, millions of households and firms are indebted in euros to each other. Their debts expressed in drachmas will also double. Defaults by both the government and private borrowers would be unavoidable. At this stage, it is very difficult to see an exit from the euro area as a panacea.
This is not a surprise: we know that a devaluation works by acting as a levy on domestic citizens. Exports rise only because they become cheaper in foreign currencies, which means that wages must decline. The first levy is a reduction in domestic incomes; this is precisely what the 40% decline in GDP captures. The second levy is a wealth tax on all assets that are set in the domestic currency and an increase in external indebtedness, which is precisely what the calculations above show. The truth is that there is no painless devaluation. In the case of Greece exiting from the euro area, the pain is bound to be acute. Ask the Argentines and the Koreans what they think of their own devaluations. They will tell you that this has been the most horrific experience in their lifetimes. Devaluation may help restore current budget and external imbalances, but under extreme duress.
The trade-off is likely to be less painful within the euro area. Under the current IMF/EU programme, the Greek government is committed to slashing its budget deficit by 10% over the next four years, much of it being front-loaded. This is probably mission impossible, especially as the impact of the measure is bound to deepen the recession and, quite probably, worsen the budget deficit. The solution is for Greece to gain some breathing space. This means being shielded from daily market pressure on its debt, which needs to be regularly rolled over. The IMF/EU rescue plan provides the required space but under unrealistic conditions. These conditions have been requested by the euro-area countries in exchange for their support, but it would have been much better to go straight to the IMF and organise a standstill, followed by an orderly debt rescheduling. The rescheduling will probably become unavoidable when Greece fails to deliver on its promised deficit reduction plan. This can be followed by a more gradual fiscal retrenchment, which should be less destabilising than the default that would inevitably follow an exit from the euro area.
Greece will also have to claw back the 10% or so loss in external competitiveness that it has suffered since it joined the euro area in 2001. This can be spread over time, say a decade. Nominal wages in the private sector do not need to be reduced across the board. All that is needed is a lower inflation rate than in the rest of the euro area and labour productivity gains. Raising labour productivity should not be an exacting objective for the distorted Greek economy. Such a gradual improvement is considerably more attractive than the immediate collapse of real wages that would accompany an overshooting depreciation, followed by a gradual recovery through high inflation.
Sticking to the euro is a far better deal than dumping it.
Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political Science at the University of California, Berkeley, where he has taught since 1987. He is a Research Associate of the National Bureau of Economic Research and Research Fellow of the Centre for Economic Policy Research. In 1997-98 he was Senior Policy Adviser at the International Monetary Fund. Mr Eichengreen is the convener of the Bellagio Group of academics and economic officials and chair of the Academic Advisory Committee of the Peterson Institute of International Economics. He is a regular monthly columnist for Project Syndicate and has published several books and e-books, including "The European Economy since 1945: Coordinated Capitalism and Beyond" (updated paperback edition, 2008).
On the motion at hand, only one conclusion is possible: the dollar area will fragment over the next ten years.
Recent events have made it clear that the idea of monetary union is deeply flawed. Economic specialists have long pointed to the contradictions, but politicians pushed ahead for essentially non-economic reasons. We are now paying the price.
The coexistence of a single currency and a single central bank with a set of separate state budgets is a fundamental contradiction. The union lacks a mechanism for adequately co-ordinating those budgets. The result is the unseemly spectacle of some states (California, Nevada) chronically overspending while others (West Virginia, Wyoming) live within their means. Often the deficit states are the ones with high unemployment rates and serious competitiveness problems.
This unsustainable state of affairs has multiple causes, but it has been aggravated by the existence of a single currency. Without the risk of exchange-rate changes, the member states share a common level of interest rates, making it easier for the profligate to live beyond their means. So long as investors remain somnolent, the less disciplined member states are encouraged to throw "one big fat Greek party". When they finally awake to the fact that government finances are unsustainable, all hell breaks loose.
Aggravating this problem is that states with debt and deficit problems expect bail-outs in bad times. The American Recovery and Reinvestment Act of 2009 included block grants to member states, funds for local law-enforcement agencies, budgetary infusions for local transit agencies, and transfers for public transport and water infrastructure projects. Filling state budget gaps in this way is a clear source of moral hazard.
Fiscal rules have been adopted to restrain this profligacy, but they are honoured mainly in the breach. Rules with real teeth would be better, but member states have shown no willingness to accept them.
Sooner or later the contradictions surface, and volatility spikes. Given the manifest inability of the authorities to adequately regulate the banking and financial system, this creates the danger that markets will seize up. The central bank then feels compelled to step in, buying the most toxic bonds. Unprecedented interventions to prop up markets in weak securities damage the central bank's credibility. They expose it to balance-sheet losses that it will be tempted to recover by printing more of its own liabilities. Our central bankers reassure us that they will be able to reverse out their unprecedented interventions before they become inflationary. We shall see.
Fundamentally, the problem with the single currency is the absence of adequate political leadership at the level of the union. The different power centres cannot agree on how to reform the institutions. When there is a need for quick action, they only bicker among themselves, which is precisely what forces them to enlist the central bank to do their bidding, undermining the independence and credibility of one of their strongest institutions.
Ideally, recent events would serve as a wake-up call. Governments would put their fiscal houses in order. At the level of the union, institutions and policies would be reformed. Banks and financial markets would be strengthened, so the next time a problem of debt sustainability arose it would be possible to restructure the offending debt without threatening the stability of the system. Problems would be headed off early enough that it would not be necessary to enlist the central bank in solving them. Perhaps. But history provides little assurance that this clarion call will be heard.
Creating a monetary union of the 50 American states was a mistake. The dollar area is sure to fragment in the next ten years.
This house believes the euro area will fragment over the next ten years
Sign up for e-mail alerts. We will remind you when a new debate is about to start and when each phase of a debate begins.
This house believes that the war in Afghanistan is winnable.
This house believes that making trade fairer is more important than making it freer.
Copyright © The Economist Newspaper Limited 2010. All rights reserved.
Read Full Article »