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What ails Europe? Joseph E. Stiglitz dismantles the prevailing consensus around Europe’s current predicament – arguing that economic stagnation and political fragmentation are a direct result of the Euro’s flawed birth, demolishing the champions of austerity and offering solutions that can rescue the continent from further devastation.

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PHILIP ALDRICK, THE TIMES

‘Original, hard-hitting … Much more than a demolition job. These chapters are full of constructive proposals‘ M ARTIN SANDBU, FINANCIAL TIMES

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JOSEPH E. STIGLITZ THE EURO

Cover illustration: Ryan Etter/Getty Images. Author photograph: Dan Dietch

‘Stiglitz could hardly have timed The Euro better … he has a rare ability to help readers understand complex ideas‘

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‘Coolly analytical … he is surely right: without a radical overhaul of its workings, the Euro seems all but certain to fail‘ ECONOMIST I S B N 978-0-141-98324-0

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‘Highly readable ... passionately written … this important book will unnerve millions’ L IAM HALLIGAN , SUNDAY TELEGR APH

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T H E E U RO

‘The man who warned us that the Euro wouldn’t work . . . pulverising’ Dominic Lawson, Sunday Times ‘As a critique of the Euro, his book will appeal as much to the right as to the left’ Jeremy Warner, Daily Telegraph ‘Stiglitz nails the Euro’s flaws’ John Kampfner, Observer ‘Many of Mr Stiglitz’s most damning observations are on target’ Wall Street Journal ‘Stiglitz is often associated with the politics of the radical Left, but the economics that he lucidly expounds in this book is essentially mainstream’ Paul Collier, The Times Literary Supplement ‘A cogent and urgent argument of compelling interest to economists and policymakers’ Kirkus Reviews

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Joseph E. Stiglitz was Chairman of the President’s Council of Economic Advisers 1995–7 and Chief Economist at the World Bank 1997–2000. He is currently University Professor at Columbia University, teaching in the Department of Economics, the School of International and Public Affairs, and the Graduate School of Business. He is also the Chief Economist of the Roosevelt Institute and a Corresponding Fellow of the Royal Society and the British Academy. He won the Nobel Prize in Economics in 2001 and is the bestselling author of Globalization and Its Discontents, The Roaring Nineties, Making Globalization Work, Freefall, The Price of Inequality and The Great Divide, all published by Penguin.

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jos e p h e . s t ig litz The Euro And its Threat to the Future of Europe

P EN GU I N B O O K S

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P E N GUIN B O O KS UK | USA | Canada | Ireland | Australia India | New Zealand | South Africa Penguin Books is part of the Penguin Random House group of companies whose addresses can be found at global.penguinrandomhouse.com.

First published in the United States of America by W. W. Norton & Company, Inc. 2016 First published in Great Britain by Allen Lane 2016 Published in Penguin Books 2017 001 Text copyright © Joseph E. Stiglitz, 2016 The moral right of the author has been asserted Printed in Great Britain by Clays Ltd, St Ives plc A CIP catalogue record for this book is available from the British Library ISBN: 978–0–141–98324–0

www.greenpenguin.co.uk Penguin Random House is committed to a sustainable future for our business, our readers and our planet book is made from Forest Stewardship Council® certified paper.

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To the future of Europe and the European project upon which so much depends, in the hope that this book may contribute to policies ensuring its prosperity and promoting its solidarity.

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CON T EN T S

Introduction to the Paperback Edition Preface

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x xvii

Acknowledgments

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PART I. EUROPE IN CRISIS 1. THE EURO CRISIS

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2. THE EURO: THE HOPE AND THE RE ALIT Y 3 . E U R O P E ’ S D I S M A L P E R FO R M A N C E

34

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PART II. FLAWED FROM THE START 4 . W H E N C A N A S I N G L E C U R R E N C Y E V E R WO R K ?

5. THE EURO: A DIVERGENT SYSTEM

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6 . M O N E TA R Y P O L I C Y A N D T H E E U R O P E A N C E N T R A L B A N K

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PART III. MISCONCEIVED POLICIES 7. C R I S E S P O L I C I E S : H OW T H E T R O I K A E N S U R E D D E P R E S S I O N

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8 . S T R U C T U R A L R E FO R M S T H AT F U R T H E R CO M P O U N D E D FA I L U R E

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PART IV. A WAY FORWARD? 9. C R E AT I N G A E U R OZO N E T H AT WO R K S 1 0 . C A N T H E R E B E A N A M I C A B L E D I VO R C E ?

1 1 . T OWA R D A F L E X I B L E E U R O 1 2 . T H E WAY FO R WA R D

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Index

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A F T E R WO R D : B R E X I T A N D I T S A F T E R M AT H

Notes

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IN T RODUC TION TO THE PA PERBACK EDIT ION

To an American like me, the time in which this book was first published—just one year ago—already seems almost another era. I opened and closed the book arguing that the success of Europe and the European project entailed the closer integration of the countries of Europe, and was important not just for Europe, but for the world. I wrote that Europe was “the source of the Enlightenment, the birthplace of modern science” and “the moment the world is in now calls out” for European values.

At the time, it was unthinkable that someone like Donald Trump could be elected president of the most powerful nation in the world.

But it happened. And the assault on the values I discuss in The Euro— from basic rights of individuals and tolerance of diversity, to the preservation of our planet, and even to the nature of truth—has been worse even than most expected. Europe is needed now more than ever.

Yet the euro remains one of the greatest threats to the success of the European project. Some will look to the fact that the euro has survived another year as evidence that my thesis is wrong. On the contrary, I suggested in this book that the eurozone would most likely muddle along, moving from crisis to crisis—a course of brinkmanship that provides ample opportunity for the hedge funds that

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live off of volatility and instability but that undermines growth and long-run increases in standards of living. The eurozone has had more years of mediocre growth—an estimated 1.7 percent in both 2016 and 2017 (slightly lower than the 2.0 percent in 2015).1 The one positive note has been unemployment, which was at a nine-year low of 9.1 percent in June 2017.2 But even then, a broader measure of underemployment—taking into account those who would like to work longer hours but can’t and those who have given up looking for jobs because they searched and searched and haven’t found them—stands at 18 percent.3 And youth unemployment remains unacceptably high, at 19.1 percent in March 2017,4 and 44 percent of young people (15 to 24) with jobs in the EU were on temporary contracts in 2016.5

STIRRING A DEBATE The Euro hit a raw nerve. It was hard for anyone not to agree that Europe’s economic performance was far from stellar. I was fortunate in the months after the book was released to have a large number of conversations, some in open forums, with Europeans drawn from civil society, academia, and government about the issues the book raised. My discussant in Amsterdam was Jeroen Dijsselbloem, the Netherlands’ finance minister and president of the Eurogroup, the group of the eurozone’s finance ministers responsible in large measure for the design of the harsh programs imposed on the crisis countries that I describe in the book. At Davos in January 2017, I joined a panel discussing the future of Europe, which included Pierre Moscovici, the European commissioner (equivalent, in some sense, to a cabinet secretary in the United States or to a minister in other countries) responsible for Economic and Financial Affairs, Taxation and Customs. In Vienna I had a wide-ranging televised discussion with Christian Kern, the chancellor of Austria.

I was struck by the intelligence and commitment that all brought to the subject. But these discussions, as well as remarks made by various European officials over the past year, also reinforced my view of

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the deep fissures in the eurozone’s foundation, which arise not just from differences in economies but also from disparities in perspective. Dijsselbloem, for instance, was quoted in an interview with the German newspaper Frankfurter Allgemeine Zeitung6 as saying: During the euro crisis, the countries of the north of the eurozone showed solidarity with the countries in crisis. As a social democrat, I think that solidarity is extremely important. But whoever benefits also has duties. I can’t spend all my money on booze and women and then ask for your support.

Not surprisingly, the crisis countries were deeply offended—and asked for his resignation.

At the Davos panel on the euro, audience questions threw a spotlight on the division in perspectives. What hope did European leaders offer to the millions of young people in the eurozone, especially in the crisis countries, without jobs? There was widespread agreement among the panelists about what should be done to make the eurozone work. The European commissioner on the panel forcefully described the actions that had already been taken; but when it came to the critical steps that had to be taken if youth unemployment was to be brought down to tolerable levels, all he could say was that they were politically very difficult. In other words: don’t expect much action any time soon.

These discussions with European leaders threw into relief the differences between the three stances on what is ailing the eurozone.

The first attributes the eurozone’s problems to the failings of individual countries within Europe. The countries that are doing poorly need structural reform, and the leaders of Europe should be thanked for pushing needed reforms on these countries. It is the obstinacy of politicians and vested interests within each country that stand in the way of progress, and pressure from Brussels and Frankfurt is needed to get the reforms made. The second view is that it is the failings of the

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European policymakers. If only they had acted in a more farsighted way, Europe would have done better. The third view is that the fault lies in the very design of the eurozone. Only a structural reform of the eurozone itself will restore Europe to health. This book, The Euro, comes out strongly in favor of the third view.

European officials of course supported the first view: their policies (in their view) may not have been perfect, but in the midst of a crisis, given the speed with which the problems had to be addressed, their performance was in fact commendable. Look at how much has been accomplished! Critics like me were focusing on the glass half-empty, rather than half-full. The real fault lay with the crisis countries that simply didn’t do what they should have done.

I agreed that what had been accomplished was impressive. But what was not accomplished was even more significant, and had severe consequences—for instance, impairing prospects for growth for years to come. The Euro explains why these “blame the victim” theories were unpersuasive. Many of these countries had done well before the crisis. It wasn’t as if they had suddenly lost their way and become unproductive. Before the euro, when they had problems, their economies might suffer—but not to the same extremes of unemployment and stagnation brought about by the euro crisis. The gap between the outcomes predicted by Europe as it administered its painful medicine to the crisis countries and the outcomes actually realized showed that the economic assumptions of Europe’s leaders were just wrong.

Inadequate economic theories and analyses led to bad prescriptions, which led to bad results. It was that simple.

If one or two countries within the eurozone had had problems, then this “blame the victim” theory might have had some plausibility. In every barrel there is a rotten apple. But when so many countries were having problems—even Finland, a Nordic country with good institutions that had done quite well before the euro—it suggested that there was a problem with the barrel itself. Indeed, the eurozone as a whole was performing poorly.

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My meetings with European officials reinforced my conviction, expressed in The Euro, that there is a fundamental misunderstanding of what is required to make a single currency work. Some reviewers took me to task for putting too much emphasis on ideology and the role of neoliberalism. But a central message of The Euro is that ideas matter.

The Euro attempts to explain both what was required to make a single currency work and why prevalent beliefs of officials within the eurozone were misguided, and to establish a clear link between underlying economic beliefs and decisions about eurozone structure and policy.7 Many pundits around Europe favored the second theory: if the policymakers had only been less stringent in their pursuit of austerity and more thoughtful about supporting the banks in the crisis countries, things would have turned out differently. But The Euro also tackles this argument, emphasizing that if the crisis countries had managed to get to full employment, they would have faced large, unsustainable current account deficits. The exchange rate needed to adjust. Without real exchange adjustments, some countries (such as Germany) wind up with huge current account surpluses, while others (the crisis countries, in particular Greece, Spain, and Portugal) face unsustainably large current account deficits, as do the near-crisis countries that are languishing with high unemployment, like Italy.

Any analysis of a currency union that doesn’t begin by asking what happens when exchange rates are fixed misses the central issue: the fundamental problem of the euro was that it took away the exchangerate adjustment mechanism and did not put anything else in its place.

Even the wisest policymakers could not have solved Europe’s problems without addressing this issue.

Of course, there were things that Germany could have done—it could have inflated its economy, raising wages and prices, and that would have engineered the needed real exchange rate adjustment. But this was not part of the toolkit of the Troika—the trinity of the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission—as it confronted the euro crisis. Indeed, as Germany was

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lecturing others about what they should do, it pursued policies that led it to have an even larger surplus.8 The Euro explains why Germany’s trade surpluses make it harder for other eurozone countries to decrease their trade deficits. Rather than helping the crisis countries—and the eurozone as a whole—move toward a sustainable equilibrium, it was making it more difficult to achieve such an equilibrium, and increasing the adjustment costs confronting the rest of the eurozone. Less austerity would undoubtedly have changed the political debate, and lessened the immediate pain, but it would have left the underlying problem unaddressed.

The Euro argues that what was needed, and is still needed, is a more fundamental reform of the eurozone structure: ways to force Germany and the other surplus countries to bear more of the cost of adjustment; to give European officials the tools (through a banking union) to prevent the decimation of the banking systems in some of the worst-hit crisis countries; and to create a framework to prevent the inevitable problems that arise when a country borrows in a currency not under its own control—in short, what is needed is a reform along the lines suggested in chapter 10.

I approached the issue of the euro first and foremost from an economic perspective—though recognizing that it was a political project.

Whatever the motive for creating a single currency area, there was an extremely important analytic question: Under what conditions can a diverse set of countries share a common currency? My Columbia colleague Robert Mundell had won a Nobel Prize in 1999, partly for providing an answer to that question. But he provided that answer before the euro was created. The question now was, how well did Mundell’s theory stand up?

The Euro makes it clear that Mundell has provided only part of the required analysis. As had become conventional in modern macroeconomics—even as practiced by central banks—he left out banks.

This is especially odd, because without banks, there would presumably be no central banks. But it was more than just odd: a key part of the euro crisis (and of the 2008 crisis that helped generate it) was

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a banking crisis. Thus, one of the contributions of The Euro was to introduce banking into the standard model of a currency area. So, too, the standard analysis focuses on equilibrium, with insufficient attention to the dynamics of convergence. The Euro shows that the system that had been created gives rise to divergence.9 These and other analytic advances were not just of academic importance: they helped explain why the forecasts of the Troika did so poorly—and understanding that in turn is key to understanding the reasons for the failure of the Troika policies. I worry that the fact that so many reviewers did not fully grasp these analytic advances means that I have not done as good a job as I should have in my explication of the alternative interpretations of what went wrong.

As I noted above, to a large extent, many readers and reviewers read into the book what they wanted to see. Critics of the euro and the EU more broadly focused on my criticisms; supporters focused on my solutions. Unsurprisingly, the reception in the UK was especially strong, because the book supplied a message that many on both sides of the Brexit debate wanted. For those supporting the UK leaving the EU, reading The Euro reinforced their image of a dysfunctional Europe. (At a reception in New York not long after the Brexit vote, the British foreign minister, one of the leaders of the “Leave” campaign, told me how much he liked the book.) To those who supported Remain and Reform, it explained both the importance of the European project and a road to reform. They were, of course, reading the book in the way I had intended.

France provided one of the most challenging moments. On a TV show, the presenter confronted me with a tape showing the enthusiastic endorsement of the book by Marine Le Pen, the right-wing populist and anti-EU politician who has come to represent the challenge to the “establishment.” What, he asked me, was my reaction, my response?

My answer was simple: I had written the book because I believed in the European project, and as I say both in the beginning and the end of the book, it is too important to be brought down by the euro, by mere bits of paper and metal. The monetary arrangements were a means to

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an end, not an end in themselves; the single currency was supposed to bring the countries of Europe closer together as it brought a new prosperity. But the currency has done just the opposite. Le Pen was, in fact, reinforcing one of the key messages of the book, though not in a way that I would ever have hoped to witness: the failure to make the reforms that the book calls for, reforms that are necessary to make the eurozone function in the way intended, would have severe political consequences.

The fact that there is a surge in populism around the advanced world, including in the United States, makes it clear that the euro alone cannot be blamed for this new extremism that is afflicting so many countries. The fact that there is unrest among middle-class workers, especially men, around the world makes it clear that their plight also cannot be blamed on the euro. But the failures of the euro have fed into and exacerbated these trends. Populists like Le Pen disproportionately blame the euro, immigration, trade, and globalization more generally—they like to blame others—and they offer no solutions that will work. But it is important to understand why their message resonates. Too many citizens have seen their standards of living lowered.

As I note in The Euro, one can understand the backlash against the euro and the backlash against globalization through much of the same lens. Globalization is the closer integration of the countries of the world. The European project is the closer integration of the countries of Europe. The euro is the most ambitious aspect of this project of integration. Migration has been one of the most controversial aspects of globalization; the EU has taken a strong stance: within the EU, there is free movement of people.

While globalization, as I have suggested, is only part of the explanation of these adverse trends, it is the part that is most palpable— workers see factories shuttered and their jobs lost, as the multinational corporation for which they used to work opens a new production facility abroad. Confident in their own abilities, these workers believe they could more than meet the competition if only the rules of the game

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were set fairly. They see the rules of globalization as stacked against them. Not surprisingly, they are angry, and they turn to politicians who argue for rewriting the rules—if necessary, even withdrawing from globalization. Again, not surprisingly, the politicians who helped write the old rules of globalization—who advocated for economic integration—are seen as the cause of the problems they confront; they cannot be trusted to produce a solution.

This confidence in their own abilities explains why many workers remain techno-optimists; they believe that they can upskill in response to new technology, and they have bought into the idea that new technologies create new jobs as they destroy old ones. At the turn of the last century, for example, as jobs making buggy whips faded away, new jobs in car manufacturing and repair were created.

While this confidence is commendable, the reality is that the magnitude of the changes that our economy and society are going to be facing as a result of technological advances and globalization is so large that many—probably most—individuals and communities will not be able to respond adequately on their own. Without strong national actions— including helping individuals and our society make this enormous structural transformation—the living standards of many individuals will decrease significantly and many communities will be left behind.

The result will be anger; and this anger will provide an opportunity that demagogues will seize. Trump illustrates the risk that this can present to our democracy, our society, and our basic values.

The stress being faced by workers largely arises from changes in technology. Even in the absence of globalization, even in the absence of the euro, workers’ well-being would almost surely be at risk. What matters for politics, of course, is these perceptions, not their accuracy.

Demagogues like Trump and Le Pen have been successful in blaming globalization, the euro, and the EU regardless of their real role in today’s economic travails.

The fact, though, as I stress in this book, is that within the eurozone, the euro has made matters worse. European leaders have made it all

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too easy to blame the euro. For instance, Europe’s central institution, the ECB, is not supposed to concern itself at all with employment but only with inflation, to ensure that the value of bonds is not eroded. It is easy to suggest, as a result, that the eurozone was not constructed with the interests of workers at its heart.10 Though Le Pen was resoundingly defeated—by a 2-to-1 margin— the fact that she got even a third of the votes and that voter turnout was so low is a reminder of the extent of discontent and of the dangers that lie ahead. Those concerned with the future of Europe and of the values for which it has stood need to double their efforts to ensure the success of the European project. This has given new urgency to the message of this book: the necessity of reforming the structure of the eurozone, and doing so quickly.

As I have just noted, the creation of the eurozone is, in many ways, akin to globalization, entailing as it did closer economic integration of the countries of the eurozone. In both cases, there are important implications for sovereignty. In the case of the eurozone, the extent to which economic sovereignty was surrendered was not realized until the crisis itself, when countries came to understand that, to a large extent, their economic policy would now be dictated by the European Union and the eurozone—in Brussels, the host of the main institutions of the EU, and Frankfurt, where the ECB is located—rather than made by their elected leaders, meeting in their own capitals.

It would have been one thing if economic sovereignty had been given to those who seemed to be acting in ways that ensured the well-being of the eurozone as a whole, and simultaneously each country within the eurozone. Of course, the establishment—both of the center-left and of the center-right—claimed that membership in the euro would lead to higher standards of living; and so, too, for what was being demanded of each country from Brussels and Frankfurt. When these policymakers asked for “reforms,” even reforms that seemed painful, it was for the long-run good of the people (so went the theory).

Indeed, Frankfurt and Brussels could formulate these “wise” policies

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partly because they were freed from the pressures of domestic politics that had led to the dysfunctional politics and economics that had led in turn to crisis or near-crisis. But as the euro crisis continues, this narrative put forward by the establishment seems increasingly unconvincing.

In reality, ordinary citizens experienced not the increase in incomes and jobs that had been promised but a decline in both, the consequences of which were exacerbated by cutbacks in government services. They faced increased insecurity and declining standards of living, just the opposite of what had been promised. All of this undermined the credibility of the establishment. Were they really simply pursuing their own self-interests? Or were they duped by their own models? For those who have seen their standards of living stagnate, or plummet, the natural response has been to look for alternative models to those provided by the center-left and the center-right. In several countries there has been a growth in protectionism and nativism. The protectionist arguments are simple, but unfortunately, also simplistic. Protectionism promises that jobs that moved abroad will return home. Restrictions on immigration supposedly mean there will be less competition for jobs, and the wages of those competing with immigrants will be higher. So their misguided arguments go.

The establishment counters that openness leads to greater efficiency, to a larger economic pie. But that promise carries weight only if the promise of a bigger pie is delivered; and it doesn’t help much if the overall size of the pie increases, if at the same time the slice of the pie that workers receive becomes smaller and smaller. The reality is that in the United States and many other countries—including the eurozone as a whole—growth has been slower than it was in the decades after World War II; and what growth has occurred has gone overwhelmingly to the top.

So, too, the statement that because of increased efficiency associated with more European integration, everyone could be better off doesn’t mean much if everyone isn’t better off. And when those in the

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center-right (and increasingly in the center-left) worry about the costs of redistribution, and allow the social safety net to fray just when it’s most needed, support for globalization or the European project can be expected to diminish and that of extremism to increase. It similarly undermines support for globalization or Europeanization when its advocates argue that the burden of taxation needs to be shifted away from corporations and the rich—lest they leave and go somewhere else. Doing so means that either government services are cut back, or that taxes on the rest have to increase. In either case, ordinary citizens are the losers. And their anger increases even more as they see rich multinational corporations, like Apple, taking advantage of globalization and the willingness of some countries (Ireland or Luxembourg) to cut special deals, to lower their already low tax burden. In effect, so-called partners in the eurozone seem perfectly willing to steal tax dollars from other countries; indeed, both Apple and Ireland seemed to feel proud of their cleverness in weaving their way through the complex regulations designed to ensure fair competition among the countries of the eurozone.

In many cases, protectionist sentiments feed off ever-present strands of nativism or long-standing national divisions. Thus, in Spain for example, the move away from the center parties has manifested itself in support for increased regional autonomy and Catalan independence. And while the growth in extremism isn’t solely due to Europe’s economic woes, including those arising from the euro, economic problems and the way they were created and then mismanaged have certainly played a role.

Of course, these economic, social, and political problems have been worse in the countries where crises have appeared and reappeared. The newest crisis, which has reared its head during the past year, occurred in Italy. Indeed, at the beginning of the euro crisis in 2010, Italy was identified by many hedge funds as one of the most likely candidates for a full-scale rupture. In 2009, its debt-to-GDP ratio had reached 113 percent, just a little lower than that of Greece at

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the time, at 127 percent.11 Yet Italy has managed to avoid a full-blown crisis by maintaining a primary surplus (the amount by which revenues exceeded spending net of interest) that is among the highest in Europe.12 There has been a cost: GDP growth has been very anemic (at 0.88 percent for 2016, -0.4 percent over the period 2010–16, and a forecasted 0.84 percent in 2017), and the youth unemployment rate is hovering above 35 percent.

Any economy that stagnates for a long period of time almost inevitably finds its banks getting into trouble, as seemingly good loans turn sour along with the economy, feeding into a vicious cycle. Lending becomes constrained, reinforcing the downward movement of the economy.

Indeed, this is what happened in Italy. The Italian banking crisis was widespread, but the troubles of Monte dei Paschi di Siena (MPS), Italy’s third-largest bank and one of the oldest banks in the world, illustrate the quandaries facing the eurozone. The amount it needed, a few billion euros, was small, but the political and economic consequences of a failure would be large. European rules make a public bailout difficult—it would be viewed as unfair state aid to a private company (never mind that the United States, freed of such constraints, did it to the tune of hundreds of billions of dollars). Italy’s prime minister, Matteo Renzi, tried to engineer a private bailout, a rescue by other banks, through a mixture of coercion and persuasion. Though such a bailout seemed admissible under the European rules, from the perspective of standard economics and the rule of law these so-called private bailouts may be far worse than a transparent public rescue.

In the end Renzi failed to engineer the desired private bailout, and his successor went ahead with a public bailout—but only in the face of much criticism, especially in Germany. Further, the controversy over the bank bailout contributed to a political crisis. Renzi had called for a constitutional referendum, but the vote on changing the Constitution became a vote on Renzi, including his handling of the banking crisis and the economy more broadly. Yet anything he could do on those

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areas was circumscribed by the eurozone—given the constraints he faced, there was no way that the economy could have performed well.

The December constitutional referendum was defeated, and Renzi resigned. A deeper political crisis was avoided only by skillful political management. Still, there is an expectation that as elsewhere in the eurozone, centrist parties in Italy will perform weakly in the next election, if they do not face widespread defeat. The resurgent Five Star Movement—united by the view that existing parties are corrupt and incompetent—has been growing in strength and may well become the leading party. Furthermore, they may well unite with right-wing parties to call a referendum on leaving the euro. Even though there remain constitutional questions about the reach of such a referendum, the uncertainty it has triggered has contributed to an increase in interest rates that Italy must pay. And because of Italy’s high indebtedness, any significant increase in interest rates could feed into a downward debtgrowth spiral.

Many economists, looking forward, see Italy and the eurozone in a bind. If the eurozone returns to “normal,” interest rates will rise. (There may be pressure even before that, as US interest rates increase.) But if interest rates increase anywhere near to normal levels, the amount Italy will have to pay to service its debt will soar given its already high debt-to-GDP ratio, which stood around 133 percent in 2017.13 If investors worry that Italy can’t meet its debt payments, of course, interest rates would increase even more. Italy would join the crisis countries. The only thing that could stop this would be the ECB buying up even more Italian government bonds—doing “whatever it takes,” as Mario Draghi, the bank president, put it in 2012—or at least the belief that it could or would do so. Supporting Portugal’s debt (with a debt-to-GDP ratio not much different from that of Italy) is one thing; doing so for Italy is another: Italy’s debt is ten times greater.

Could or would the ECB do “whatever it takes”? Shortsighted markets haven’t yet focused on what happens when interest rates return to normal; but when they do—and it is almost inevitable that they even-

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tually will—the eurozone will face a challenge as great as any it has confronted so far.

Meanwhile, France’s GDP growth has continued at a mediocre rate of 1.2 percent in 2016 and is forecast to grow at 1.4 percent in 2017, with unemployment at 9.6 percent as of May 2017. There, stagnation fed into support for Le Pen’s far-right National Front party: as elsewhere, euro-induced stagnation has helped move the political landscape toward extremism.

Spain’s troubles are more severe, where growth for 2016 was 3.2 percent, about the same as 2015, and is forecast to decrease to 2.6 percent in 2017. Growth is expected to slow significantly in coming years.14 Yet in Spain, many are celebrating that they “did it”—they believe they’ve successfully managed their way through the recession—even though youth unemployment remains at around 40 percent, and a mortgage crisis has resulted in more than 325,000 foreclosures.15 Of course, worst hit by the crisis was Greece. As I predicted, the new austerity program imposed on Greece by the Troika as a condition of assistance led to a further contraction of the economy. Greece’s GDP shrank 0.2 percent in 2015, and “grew” at a rate very slightly above 0 percent 2016. It is forecasted by the IMF to expand 2.2 percent for 2017 and 2.7 percent for 2018—far below the rate that would be required to regain the former size of the economy anytime soon. In 2016, some 75 percent of households reported a decrease in their income, 40 percent had to cut back even on food, and a third had at least one unemployed member.16 The poverty rate is now twice what it was before the crisis.

One country to report good news was Ireland—yet its “good news” highlighted precisely what was going wrong in Europe. Ireland’s official GDP increased a whopping 26 percent in 2015. The explanation: the country had changed its tax rules to induce more firms to report profits in Ireland, at the expense of the rest of Europe. Apple, the world’s richest company, even made a lucrative secret agreement with Ireland that enabled it to avoid taxes not just in Ireland but globally— until the secret was inadvertently exposed in a US Congressional

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hearing. European Commissioner Margrethe Vestager rightly ruled that Apple’s agreement violated European rules; but even if it had not, it was surely unseemly for a company trying to create an image of corporate responsibility “to pay an effective corporate tax rate of 1 percent on its European profits in 2003 down to 0.005 percent in 2014,” as Vestager put it.

I explain in The Euro that in the construction of the eurozone and the EU, there had been an awareness of externalities—that one country could impose costs on others. The rules were supposed to proscribe actions that impose significant costs on others. But I suggested that they focused on the wrong externalities, and that, as a result, they inappropriately constrained the economic sovereignty of individual countries. Here, however, was a case where one country’s actions had enormous effects on the rest of Europe, as it unfairly tried to steal tax revenues and, in some cases, even jobs from others. But, at least in Ireland’s view, there were no rules against doing so—and European solidarity was so weak that Ireland felt no compunction about it.

Remarkably, even when the EU ruled that Apple needed to pay Ireland some $13 billion in back taxes—money that the country desperately needed to maintain public services—rather than admitting that it had acted badly, Ireland joined Apple in appealing.

PERCEPTIONS AND POLITICS Given the poor performance of the eurozone, the euro retains a higher level of support than I would have expected. That’s partly because even in crisis countries, citizens tend to blame their own politicians, not fully appreciating the constraints under which they operate. This is especially true, of course, where there is corruption (as in Spain) or where the leadership appears ineffectual. Ironically, while the public likes the euro, there is growing distrust in European institutions, including the central institution of the euro, the ECB. In Spain, distrust of the ECB stands at some 66 percent; even

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in relatively healthy Germany, distrust is still over 50 percent.17 The ECB tends to get blamed for the high level of unemployment in the eurozone.18 This distrust is important, because there is growing evidence that for societies and polities to work well there has to be at least a modicum of trust. The lack of trust may have long-run implications for European growth.

European officials have done a good job convincing citizens that the crisis is largely over, and that the euro has survived the test. Having invested so much in the future of the euro, they argue, now is not the time to abandon it. Doing so would bring unprecedented uncertainty.

But the failures of the euro have taken a toll; it’s no longer widely touted as an important source of European identity, but instead is being evaluated from a more pragmatic utilitarian perspective.

Increasingly, the question is whether, going forward, the euro is useful for advancing prosperity and stability.19 To me, there is a clear answer to that question: without reforms in the eurozone as described here—reforms that have been at best slow to come—the euro is not likely to support European prosperity. With Germany’s trade surplus reaching an all-time high in 2016, Europe’s macro-imbalances are getting larger. Even the European Commission was forced to criticize Germany’s surplus.20 Without a course correction, the euro will become little more than a tool for German prosperity.

As I note in the afterword on Brexit, while the UK was not a member of the eurozone, what went on within the eurozone surely affected the outcome of that referendum. In part, the strength of the “Leave” vote was a reflection of the same distrust of European institutions noted above—and as those in the UK looked across the channel at how the euro crisis was being handled, they had every reason to be skeptical. At the same time, the fact that the dire forecasts of the consequences of Brexit have not been realized so far may embolden those in other countries thinking about leaving the eurozone. They see that current arrangements are not working. They understand that it will

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be hard for prosperity to be achieved without major reforms—but politically, these reforms seem out of reach. There is risk no matter which way they turn: the risk of continual stagnation or worse, with a small chance that things turn out well in the end; or the risk of severe costs during a large adjustment, with at least the prospect of a return to true shared prosperity.

Until recently, the arc of history pointed to ever closer integration of the countries of the world. Globalization seemed inevitable, and the European Union seemed at the forefront of these global trends.

The European project was one of the great projects of the 20th century. The EU was one of the reasons why the second half of the 20th century was so different from the first half, which was marked by the Great Depression and two world wars.

The events of the last year—Trump’s election and Brexit—have pointed in a quite different direction. The success of Europe and the European project is now more important than ever. But that will be difficult to achieve if Europe is not restored to prosperity. And it will be difficult to ensure a shared European prosperity so long as the euro and the eurozone remain dysfunctional.

As I wrote in the conclusion to The Euro, the euro can be saved, and in fact the actions needed to do so are not economically difficult. Yet they require a political solidarity that so far has proven to be an elusive dream. One hopes that Trump’s rise and Brexit will galvanize efforts at reforming the eurozone. The European project is a testament to the strength of human ideals. It would be a tragedy, both for Europe and for the world, if that project were to founder on the euro—a monetary arrangement that was supposed to strengthen the European project but has done just the opposite. The past year has shown the urgency of taking bold action.

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PREFACE

The world has been bombarded with depressing news from Europe.

Greece is in depression, with half of its youth unemployed. The extreme right has made large gains in France. In Catalonia, the region surrounding Barcelona, a majority of those elected to the regional parliament support independence from Spain. As this book goes to press, large parts of Europe face a lost decade, with GDP per capita lower than it was before the global financial crisis.

Even what Europe celebrates as a success signifies a failure: Spain’s unemployment rate has fallen from 26 percent in 2013 to 20 percent at the beginning of 2016. But some 40 percent of youth remain unemployed,1 and the unemployment rate would be even higher if so many of its most talented young people had not left the country to look for jobs elsewhere.

What has happened? With advances in economic science, aren’t we supposed to understand better how to manage the economy? Indeed, Nobel Prize–winning economist Robert Lucas declared in his 2003 presidential address to the American Economic Association that the “central problem of depression prevention has been solved.”2 And with all the improvements in markets, shouldn’t it be even easier to manage the economy? The mark of a well-functioning economy is

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rapid growth, the benefits of which are shared widely, with low unemployment. What has happened in Europe is the opposite.

There is a simple answer to this apparent puzzle: a fatal decision, in 1992, to adopt a single currency, without providing for the institutions that would make it work. Good currency arrangements cannot ensure prosperity, but flawed currency arrangements can lead to recessions and depressions. And among the kinds of currency arrangements that have long been associated with recessions and depressions are currency pegs, where the value of one country’s currency is fixed relative to another or relative to a commodity.

America’s depression at the end of the 19th century was linked to the gold standard, where every country pegged its currency’s value to gold and, therefore, implicitly to each other’s currencies: with no new large discoveries of gold, its scarcity was leading to the fall of prices of ordinary goods in terms of gold—to what we call today deflation.3 In effect, money was becoming more valuable. And this was impoverishing America’s farmers, who found it increasingly difficult to pay back their debts. The election of 1896 was fought on the issue of whether, in the words of Democratic candidate William Jennings Bryan, America would “crucify mankind upon a cross of gold.”4 So, too, the gold standard is widely blamed for its role in deepening and prolonging the Great Depression. Those countries that abandoned the gold standard early recovered more quickly.5 In spite of this history, Europe decided to tie itself together with a single currency—creating within Europe the same kind of rigidity that the gold standard had inflicted on the world. The gold standard failed, and, other than a few people known as “gold bugs,” no one wants to see it restored.

Europe need not be crucified on the cross of the euro—the euro can work. The key reforms that are needed are in the structure of the currency union itself, not in the economies of the individual countries. Whether there is enough political cohesion, enough solidarity, for these reforms to be adopted remains in question. In the absence

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of reform, an amicable divorce would be far preferable to the current approach of muddling through. I will show how the split-up can be best managed.

In 2015, the 28-member European Union was the second largest economy in the world—with an estimated 507.4 million citizens and a GDP of $16.2 trillion, slightly smaller than the United States.6 (Because exchange rates can vary a great deal, so can relative country sizes. In 2014, the EU was the largest economy.) Within the European Union, 19 countries share a common currency, the euro. The “experiment” of sharing a common currency is relatively recent—euros only began circulating in 2002, though Europe had committed itself to the idea a decade earlier, with the Maastricht Treaty,7 and three years earlier the countries of the eurozone had pegged their values relative to each other. In 2008 the region was pulled, along with the rest of the world, into recession. Today the United States has largely recovered— an anemic and belated recovery, but a recovery nonetheless—while Europe, and especially the eurozone, remains mired in stagnation.

This failure is important for the entire world, not just for those countries in what has come to be called the eurozone. Of course, it is especially dire for those living in the crisis countries, many of which remain in depression. In our globalized world, anything that leads to stagnation in such an important part of the global economy hurts everyone.

Sometimes, as the example of Alexis de Tocqueville’s Democracy in America so clearly illustrated, an outsider can give a more accurate and dispassionate analysis of culture and politics than those who are more directly entangled in ongoing events. The same is true, to some degree, in economics. I have been traveling to Europe since 1959—in recent decades, multiple times a year—and spent six years teaching and studying there. I have worked closely with many of the European governments (mostly in the center-left, though not infrequently with the center-right). As the 2008 global financial crisis and the euro crisis brewed and broke out, I interacted closely with several of the cri-

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sis countries (serving on an advisory council for Spain’s former prime minister José Luis Rodríguez Zapatero and as a long-term friend and adviser to Greece’s former prime minister George Papandreou). I saw firsthand what was happening within the crisis countries and the councils of the eurozone that were forging policies in response.

As an economist, the euro experiment has been fascinating.8 Economists don’t get to do laboratory experiments. We have to test our ideas with experiments that nature—or politics—throws up. The euro, I believe, has taught us a lot. It was conceived with a mixture of flawed economics and ideologies. It was a system that could not work for long—by the time of the Great Recession, its flaws were exposed for all to see. I believe that the underlying deficiencies had been evident from the start for anyone willing to look. These deficiencies had contributed to a buildup of imbalances that played a central role in the unfolding crises and will take years to overcome.

This experiment was especially important for me, since I had been thinking and writing about economic integration for years, and especially since I had served as economic adviser to President Bill Clinton, as chairman of his Council of Economic Advisers, in the 1990s. We worked on opening up borders for trade between the United States, Canada, and Mexico through NAFTA, the North American Free Trade Agreement. We worked, too, on creating the World Trade Organization, launched in 1995, the beginning of an international rule of law governing trade. NAFTA, launched in 1994, was not as ambitious as the European Union, which allows free mobility of workers across borders. It was much less ambitious than the eurozone—none of the three countries shares a currency. But even this limited integration posed many problems. Most importantly, it became clear that the name “free trade agreement” was itself a matter of deceptive advertising: it was really a managed trade agreement, managed especially for special corporate interests, particularly in the United States. It was then that I started to become sensitive to the consequences of the disparity between economic and political integration, and to the consequences of international agreements made by leaders—as well-

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intentioned as they might be—in the context of far-from-perfect democratic processes.

I went from working with President Clinton to serving as chief economist of the World Bank. Here, I was confronted with a new set of issues in economic integration that was out of kilter with political integration. I saw our sister institution, the International Monetary Fund (IMF), try to impose what it (and other donors) viewed as good economic policies on the countries needing its assistance.

Their views were wrong—sometimes very wrong—and the policies the IMF imposed often led to recessions and depressions. I grappled with trying to understand these failures and why the institution did what it did.9 As I note at several points in this book, there are close similarities to the programs that the IMF (sometimes with the World Bank) imposed on developing countries and emerging markets, and those that have been imposed on Greece and the other afflicted countries in the wake of the Great Recession. I also explain why there are marked similarities in the reasons these programs continue to disappoint, and the widespread public opposition to them in the countries they have been imposed on.

Today, the world is beset by new initiatives designed to harness globalization for the benefit of the few. These trade agreements, which reach across the Atlantic and the Pacific, called the Transatlantic Trade and Investment Partnership and the Trans-Pacific Partnership (TTIP and TPP) agreements, respectively, are once again being crafted behind closed doors by political leaders, with corporate interests at the table. The agreements evidence a persistent desire for economic integration that is out of sync with political integration. One of their most contentious features would enable corporations to threaten countries with lawsuits when their expected profits are adversely affected by any new regulation—something that no government would countenance within its own borders. The right to regulate—and to change regulations in response to changes in circumstances—is a basic aspect of the functioning of government.

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The eurozone project was, however, different from these other examples in one fundamental way: behind it was a serious intent to move toward more political integration. Behind the new trade agreements, there is no intent of having harmonized regulatory standards set by a parliamentary body that reflects the citizens of all those in the trade area. The corporate agenda is simply to stop regulation, or, even better, to roll it back.

But the design of the “single-currency project” was so influenced by ideology and interests that it failed not only in its economic ambition, bringing prosperity, but also in its ambition of bringing countries closer together politically.

Thus, while this book is aimed at the critical question of the euro, its reach is broader: to show how even well-intentioned efforts at economic integration can backfire when questionable economic doctrines, shaped more by ideology and interests than by evidence and economic science, drive the agenda.

The story I tell here is a dramatic illustration of several themes that have preoccupied me in recent years—themes that should have global resonance: The first is the influence of ideas, in particular how ideas about the efficiency and stability of free and unfettered markets (a set of ideas sometimes referred to as “neoliberalism”) have shaped not just policies but institutions over the past third of a century. I have elsewhere described the policies that dominated the development discourse, called the Washington Consensus policies, and shaped the conditions imposed on developing countries.10 This book is about how these same ideas shaped what was viewed as the next step in the tremendously important project of European integration, the sharing of a common currency—and derailed it.

Today, the same battle of ideas is being fought in myriad skirmishes.

Indeed, in some cases, even the arguments and evidence presented are fundamentally the same. The austerity battle in Europe is akin to that in the United States, where conservatives have attempted to downsize government spending, including for badly needed infrastructure,

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even while unemployment remains high and resources remain idle.

The fights over the right budgetary framework in Europe are akin to those that I was immersed in with the IMF during my tenure at the World Bank. Indeed, understanding the global reach of these battles is one of the reasons I have written this book.

The ideas wielded in these battles are shaped by more than just economic interests. The perspective I take here is broader than narrow economic determinism: one cannot explain an individual’s beliefs simply by knowing what will make him better off economically. But still, certain ideas do serve certain interests, and we should thus not be surprised that by and large, policies tend to serve the interests of those who make them, even if they use more abstract ideas to argue for them. This analysis leads to an inevitable conclusion: economics and politics cannot be separated—as much as some economists would like them to be. A key reason that globalization has often failed to produce benefits for large numbers in both the developed and less developed world is that economic globalization outpaced political globalization; and so, too, for the euro.

A further theme is related to my more recent research on inequality.11 Economists, and sometimes even politicians, focus on averages, what is happening to GDP or GDP per capita. But GDP can be going up, and most citizens nonetheless could be worse off. That has been happening in the United States for the last third of a century, and increasingly, there are similar trends elsewhere. Economists used to argue that how the fruits of the economy were shared did not matter—that was an outcome that might be of concern to a political scientist or a sociologist but not to an economist. Robert Lucas has gone so far as to say, “Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.”12 We now know that inequality affects economic performance, so that one cannot and should not just shunt these matters aside.13 Inequality also affects how our democracies and our societies function. I believe,

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however, that we should be concerned about inequality not just because of these consequences: there are fundamental moral issues at stake.

The euro has led to an increase in inequality. A main argument of this book is that the euro has deepened the divide—has resulted in the weaker countries becoming weaker and the stronger countries becoming stronger: for instance, German GDP going from 10.4 times that of Greece in 2007 to 15.0 times that of Greece in 2015. But the divide has also led to an increase in inequality within the countries of the eurozone, especially in those in crisis. And this is so even in those European countries that were making progress in reducing inequality before the start of the euro.

This should not come as a surprise: high unemployment hurts those at the bottom, high unemployment puts downward pressure on wages, and the government cutbacks associated with austerity have particularly negative effects on middle- and lower-income individuals that depend on government programs. This, too, is a cross-cutting theme of our times: the neoliberal economic agenda may not have succeeded in increasing average growth rates, but of this we can be sure: it has succeeded in increasing inequality. The euro provides a detailed case study on how this has been accomplished.

Two other themes relate more directly to work on economic systems in which I have long been engaged. It is now (finally) widely recognized that markets on their own are not efficient.14 Adam Smith’s invisible hand—by which individuals’ pursuit of self-interest is supposed to lead, in the aggregate, to the well-being of the entire society— is invisible because it is simply not there. And far too little attention has been paid to the instability of the market economy. Crises have been part of capitalism since the beginning.15 The standard model used by economists simply assumes that it is in equilibrium; in other words, if there is ever a dip in the economy, it quickly reverts to its normal path.16 The notion that the economy quickly converges to equilibrium after an upset is key in understand-

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ing the construction of the eurozone. My own research has explained why economies often do not converge, and what has happened in Europe provides a wonderful if sad illustration of these ideas.

The role of the financial system is also integral to the story told here. Financial systems are obviously a necessary part of a modern economy. But in other work I have described how, if not carefully regulated, financial systems can and do lead to economic instability, with booms and busts.17 What has happened in Europe again provides an illustration of these issues—and of how the design of the eurozone and the policies pursued in response to the crisis exacerbated problems that are ever-present in modern market economies.

A final theme with which I have been long concerned, but which I can only touch upon in this book, relates to values that go beyond economics: (a) economics is supposed to be a means to an end, increasing the well-being of individuals and society; (b) the well-being of individuals depends not just on standard conceptions of GDP, even if that concept were broadened to include economic security, but on a much wider set of values, including social solidarity and cohesion, trust in our social and political institutions, and democratic participation; (c) and the euro was supposed to be a means to an end, not an end in itself—it was supposed to increase economic performance and political and social cohesion throughout Europe. This in turn was supposed to help achieve broader goals, including enhancing the wellbeing and advancing the fundamental values to which I have alluded.

But it should be evident that everything has gone awry. Means have become ends in themselves; the ultimate objectives have been undermined. Europe has lost its compass. This waywardness, however, is not a uniquely European phenomenon. It has happened so often in so many places: it seems almost to be a global disease of the times.

In a sense, then, the story of the eurozone is a morality play: It illustrates how leaders out of touch with their electorates can design systems that do not serve their citizens well. It shows how financial interests have too often prevailed in the advances of economic inte-

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gration and how ideology and interests run amok can result in economic structures that may benefit a few, but put at risk vast parts of the citizenry.

It is a story, too, of platitudes, uttered by politicians unschooled in economics who create their own reality, of positions taken for shortrun political gain that have enormous long-term consequences. The insistence that the eurozone should not be designed in such a way that strong countries would be expected to help those having a temporary problem may have a certain appeal to selfish voters. But without a minimal degree of risk-sharing, no monetary union can possibly function.

For most Europeans, the European project, the further integration of the countries of the continent, is the most important political event of the last 60 years. To see it fail, or to suggest that it might fail, or that one aspect of the project—its currency system—might fail, is viewed almost as heresy. But reality sometimes delivers painful messages: the euro system is broken, and the cost of not fixing it very quickly will be enormous. The current system, even with its recent reforms, is not viable in the long run without imposing huge costs on large numbers of its citizens. And the costs extend well beyond those to the economy: I referred earlier to the disturbing changes in politics and society, the rise of extremism and right-wing populism. While the euro’s failure is not the only reason for these trends, I believe that the huge economic toll that has been imposed on so many of its citizens is one of the more important causes, if not the most important one.

These costs are especially high for Europe’s youth, whose future is being put in jeopardy, whose aspirations are being destroyed. They may not understand fully what has happened, they may not fully understand the underlying economics, but they understand this: they were lied to by those who tried to persuade them to support the creation of the euro and to join the eurozone, who promised that the creation of the euro would bring unprecedented prosperity and that, so long as countries stuck to basic strictures keeping deficits and debts,

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relative to GDP, low, the poorer countries of the eurozone would converge to the richer. They are now being told, often by the same politicians or politicians from the same parties: “Trust us. We have a recipe, a set of policies, which, while it may inflict some pain in the short run, will in the long run make all better off.”

Despite the dismal implications of my analysis for what will happen if the eurozone is not changed—and the even worse implications if the eurozone is changed in ways that many in Germany and elsewhere are now arguing for—this book is, in the end, hopeful. It is a message of hope that is especially important for Europe’s youth and for those who believe in the European project, in the idea that a more politically integrated Europe can be a stronger and more prosperous Europe.

There is another way forward, different from that which is currently being pushed by Europe’s leaders. Indeed, there are several ways forward, each requiring a different degree of European solidarity.

Europe made a simple and understandable mistake: it thought that the best way toward a more integrated continent was through a monetary union, sharing a single currency. The eurozone and the euro— both the structure and its policies—have to be deeply reformed if the European project is to be saved. And it can be.

The euro is a man-made construction. Its contours are not the result of inexorable laws of nature. Europe’s monetary arrangements can be reconfigured; the euro can even be abandoned if necessary. In Europe as well as elsewhere, we can reset our compass, we can rewrite the rules of our economy and our polity to achieve an economy with more and better-shared prosperity, with a strengthened democracy and stronger social cohesion.

This book is written in the hope that it provides some guidance on how Europe can do this—and that it provide some impetus to Europe’s undertaking this ambitious agenda quickly. Europe must restore the vision of the noble ends it sought at the inception of the European Union. The European project is too important to be destroyed by the euro.

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ACK NOWLEDG MEN T S

The euro crisis has been in the making for years, and in those years, I have accumulated a large set of debts from those with whom I have been engaged in innumerable discussions on the future of the euro—academics, political leaders, those in financial markets, and citizens.

Some of the key ideas were presented at a conference, “Debt Crises: How to Manage Them, How to Ensure There Is Life after Debt,” organized by the International Economic Association in Buenos Aires, August 13–14, 2012, and as the Fourteenth Angelo Costa Lecture, on May 6, 2014, at Luiss Guido Carli University, Rome.* I wish to acknowledge my debt to my discussants, Martin Guzman and Daniel Heymann, and to the other participants in these events.

Many of the ideas contained here have been discussed at conferences in recent years sponsored by the Initiative for Policy Dialogue (IPD), by * The presentations were subsequently published as “Can the Euro Be Saved? An Analysis of the Future of the Currency Union,” Rivista di Politica Economica, no. 3 (July–September 2014): 7–42; and “Crises: Principles and Policies: With an Application to the Eurozone Crisis,” in Life After Debt: The Origins and Resolutions of Debt Crisis, ed. Joseph E. Stiglitz and Daniel Heymann (Houndmills, UK, and New York: Palgrave Macmillan, 2014), pp.43–79.

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the Foundation for European Progressive Studies (FEPS), and by the Initiative for New Economic Thinking (INET), and at a multitude of other conferences debating the future of the euro at events in Washington, Berlin, Brussels, Rome, Madrid, New York, and elsewhere. I have particularly benefited from the discussions at the Symi Symposium organized by the Andreas G. Papandreou Foundation in Greece every summer, at which I have been a regular participant. Especially valuable was the 2015 meeting with its discussion of the crisis in Greece, with insights from Richard Parker, Robert Skidelsky, Nathan Gardels, Kemal Dervis, Leif Pagrotsky, Mats Karlsson, and Mary Kaldor, among others.

Over the years both before and after the crises, and especially in the midst of the crises, I have been fortunate enough to engage with a number of Europe’s leaders, its presidents, prime ministers, central bankers, and finance ministers—with some of them quite deeply—not only in the crisis countries (Ireland, Portugal, Spain, and Greece—the one crisis country that I did not have a chance to visit was Cyprus) but also those facing difficulties (Italy, France, Finland) and some of the seemingly strong countries (Germany, Netherlands, Belgium), enabling me to get a better understanding of how they saw the future of Europe and the euro. I served on the Advisory Committee of Progressive Intellectuals for José Luis Rodríguez Zapatero (prime minister of Spain, 2004– 2011). I engaged in debates and discussions with Italian prime ministers Mario Monti (2011–2013) and Matteo Renzi (2014– ); presidents Nicolas Sarkozy (2007–2012) and François Hollande (2012– ) in France; Enda Kenny, taoiseach of Ireland (2011–2016); José Sócrates and António Costa, prime ministers of Portugal (2005–2011 and 2015, respectively); and Alexis Tsipras, prime minister of Greece (2015–), among others. I should single out Yanis Varoufakis (Greece’s finance minister during much of 2015) and James Galbraith for particularly insightful discussions in the summer of 2015 concerning the critical period surrounding the potential Grexit, and George Papandreou (Greece’s prime minister, 2009–2011 and organizer of the Symi Symposium), whose insights into not only Greece but also into the entire eurozone were invaluable. His

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teaching stint at Columbia after he left office gave us an opportunity for even more extensive discussions. His brother Nikos, a former World Bank economist and student of mine at Princeton, provided distinctive perspectives on the interface between economics and politics and the media-banking oligarchy that had long been so influential in Greece.

The IMF, one of the members of the Troika formulating the crisis policies, has been not only more open than in the past but unusually selfcritical of some of the country programs, as I note later in this book. I have benefited enormously from discussions with senior officials at the IMF and want to acknowledge their openness and their willingness to discuss frankly the economics and politics behind the programs—even if I did not always agree with their conclusions.

The global financial crisis of 2008 morphed, almost seamlessly, into the euro crisis, and as the storm clouds gathered, the president of the General Assembly of the UN asked me to chair the Commission of Experts on Reforms of the International Monetary and Financial System, whose recommendations were the basis of a broad and substantive statement on the World Financial and Economic Crisis and Its Impact on Development adopted by a consensus of the 192 member states on June 26, 2009.* I am greatly indebted to the members and staff of the commission for their insights into crises, their causes and consequences. Though we focused much of our attention on the impacts of the crisis on emerging markets and developing countries, much of what we said has proven equally applicable to Europe.

The subject of the euro has, of course, been a fascinating one for economists. Among the numerous individuals from whom I have learned enormously, three require special note: Martin Wolf, both

* The report of the commission was published as The Stiglitz Report: Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis, with members of the Commission of Experts on Reforms of the International Monetary and Financial System appointed by the president of the UN General Assembly (New York: The New Press, 2010).

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from conversations and from his book The Shifts and Shocks (New York: Penguin Press, 2014); George Soros, whose deep concern for the consequences of the euro crisis and his substantial understanding of financial markets inevitably led to his immersion into the euro crisis—and again I have learned from both his writings on the subject and our innumerable discussions; and Rob Johnson, president of INET and my former student at Princeton, to whom I am grateful not only for frequent discussions on the subject but for his convening of economists from Europe and America who have attempted to come to a common understanding of the causes and responses to the crisis.

Among the most thoughtful studies on the euro crisis and reforming the eurozone have been those produced by the Bruegel think tank in Brussels, and I have found their papers, including the work of Jean Pisani-Ferry, Paul De Grauwe, and André Sapir, particularly helpful, enriched by discussions in multiple venues. At the risk of important omissions, I should also acknowledge Jean-Paul Fitoussi, Maria João Rodrigues, Stephany Griffith-Jones, Daniel Gros, Daniel Cohen, Ernst Stetter, José Antonio Ocampo, Adair Turner, Paul Krugman, Nouriel Roubini, Peter Bofinger, Heiner Flassbeck, Richard Koo, Hans-Werner Sinn, Richard Portes, George de Menil, Dennis Snower, George Akerlof, Olivier Blanchard, Jeff Sachs, Nick Stern, Dominique Strauss-Kahn, Dani Rodrik, and Thomas Piketty.

As I explain in the preface, one of the reasons that I have been so fascinated with the “euro experiment” is that it brings together so many strands of thought, so many issues, with which I have been involved: the economic integration that is at its core is central to the globalization theme, to which two of my earlier books (Globalization and Its Discontents and Making Globalization Work) were devoted. Those books set forth the great number of colleagues—both in academia and especially at the World Bank and other international institutions—to whom I am beholden. Those books, as well as Freefall: America, Free Markets, and the Sinking of the World Economy and The Roaring Nineties: A New History of the World’s Most Prosperous Decade, set forth

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the dangers of adherence to simplistic ideas (neoliberalism, or market fundamentalism) about the functioning of markets—dangers which I saw firsthand during both my years in the Clinton administration and at the World Bank. This book builds on those insights, and thus my debts are compounding. My ideas about crises and their management were shaped by the East Asia crisis, in which I was intimately involved as chief economist of the World Bank. (Even before that, as I entered the World Bank, we had to deal with the aftermath of the Mexican crisis, which had begun at the very end of 1995, while I was serving on the Council of Economic Advisers of President Clinton.) I am especially grateful to my colleagues at the World Bank who helped shape our policies in response to that and other crises and those we recommended for preventing another occurrence—in particular, Amar Bhattacharya, Ravi Kanbur, Masood Ahmad, Gerard Caprio, Patrick Honohan, Uri Dadush, Bill Easterly, Roumeen Islam, Anupam Khanna, Guillermo Perry, Boris Pleskovic, Ajay Chhibber, Stijn Claessens, Dennis de Tray, Ishac Diwan, Isabel Guerrero, Michael Walton, Danny Kaufmann, Danny Leipziger, Homi Kharas, Mustapha Kamel Nabli,* Akbar Noman, John Page, Jean-Michel Severino (who served as vice president for East Asia during this critical time), Marilou Uy,†

* He later went on to become chair of Tunisia’s central bank in the aftermath of the Arab Spring. We worked together in the years after 2011 to facilitate a smooth transition to democracy. Earlier, we had worked together as members of the High Level Group of Experts established by the secretary-general of the UN in 1993 to analyze key aspects of development policy in the light of the new thinking on economic and social issues. The results of that working group were published as Edmond Malinvaud et al., eds., Development Strategy and the Management of the Market Economy, vol. 1 (Oxford: Clarendon Press, 1997). † Together with John Page, we had worked on an important project assessing the lessons for development from East Asia’s success, subsequently published as World Bank, The East Asian Miracle: Economic Growth and Public Policy (New York: Oxford University Press, 1993). Marilou Uy and I also wrote more specifically on the role of the financial sector: “Financial Markets, Public Policy, and the East Asian Miracle,” World Bank Research Observer 11, no. 2 (August 1996): 249–76.

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Jason Furman, and Vinod Thomas. I have continued my involvement with the World Bank, serving on an advisory board to the chief economist. Inevitably, our discussions would turn to the global and euro crises, and the insights of the advisory board and staff of the World Bank have been very helpful. In particular, I should acknowledge discussions with the current chief economist, Kaushik Basu.* For almost two decades, Columbia University has been my intellectual home. It has given me the freedom to pursue my research and provided me with bright, enthusiastic students who sought out challenges, and brilliant colleagues from whom I have learned so much, including many who have studied the euro crisis and/or the multiple other crises that have afflicted market economies, including Patrick Bolton, Charles Calomiris, Glenn Hubbard, Frederic Mishkin, and Tano Santos. Tano brought special knowledge of the Spanish crisis.

The broad diversity of students from all over the world—so many of whom were keenly interested in the future of the euro—has provided an abundance of occasions for rich discussions on the topics discussed here. Most importantly, the ideas expressed in this book have been shaped by long discussions with my longtime friend and coauthor Bruce Greenwald. For many years, we have discussed the euro crisis in the course we jointly teach on globalization and markets, and these ideas have repeatedly been tested on the students in that course.

Of course, I need to make the usual disclaimer: none of those who have provided me with insights and ideas should be held responsible in any way for anything contained in this book.

The production of a book such as this entails the concerted effort of a large number of individuals. Over the years, a large number of research assistants have helped me on this project, and I wish to thank them all: Sandesh Dhungana, Jun Huang, Leo Lijun Wang, Laurence * Together, we published a paper on a key issue in the crisis: “Sovereign Debt and Joint Liability: An Economic Theory Model for Amending the Treaty of Lisbon,” Economic Journal 125, no. 586 (August 2015): F115–F130.

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Wilse-Samson, Ruoke Yang, and Feiran Zhang. Also, a special thanks to Hannah Assadi and Sarah Thomas for their support through the writing process. Once again, I had the good fortune to work with W. W. Norton and Penguin, with keen editorial contributions from Drake McFeely and Stuart Proffitt, and especially Brendan Curry.

Debarati Ghosh and Eamon Kircher-Allen in my office not only pushed the project through, including managing the enormous tasks of gathering data and fact-checking, but also made important intellectual and editorial contributions.

Finally, as always, I owe my biggest debt to my wife, Anya Schiffrin, who not only helped edit the book—bringing what would have been a discursive tome into what I hope is a very readable volume—but constantly reminded me of the importance of the European project and that the key question was the impact of the euro on that. This book would not have been possible without her.

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PART I

EUROPE IN CRISIS

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1 THE EURO CRISIS

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urope, the source of the Enlightenment, the birthplace of modern science, is in crisis. The 2008 global financial crisis morphed seamlessly into the 2010 “euro crisis.” This part of the world, which hosted the Industrial Revolution that led to the unprecedented changes in standards of living of the past two centuries, has been experiencing a long period of near-stagnation. GDP per capita (adjusted for inflation) for the eurozone1—the countries of Europe that share the euro as their currency—was estimated to be barely higher in 2015 than it was in 2007.2 Some countries have been in depression for years.3 When the US unemployment rate hit 10 percent in October 2009 most Americans thought that was intolerable. It has since declined to 5 percent. Yet the unemployment rate in the eurozone reached 10 percent in 2009 as well, and has been stuck in the double digits ever since.4 On average, more than one out of five youths in the labor force are unemployed, but in the worst-hit crisis countries, about one out of two looking for work can’t find jobs. 5 Dry statistics about youth unemployment carry in them the dashed dreams and aspirations of millions of young Europeans, many of whom have worked and studied hard. They tell us about families split apart, as

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those that can leave emigrate from their country in search of work.

They presage a European future with lower growth and living standards, perhaps for decades to come.

These economic facts have, in turn, deep political ramifications.

The foundations of post–Cold War Europe are being shaken. Parties of the extreme right and left and others advocating the breakup of their nation-states, especially in Spain but even in Italy, are ascendant. What had seemed inevitable in the arc of history—the formation of nation-states in the 19th century—is now being questioned. Questions are arising, too, about the great achievement of post–World War II Europe—the creation of the European Union.

The events that precipitated the acute euro crisis were symptoms of deeper problems in the structure of the eurozone, not its causes: interest rates on the bonds issued by Greece and several of the eurozone countries soared, peaking in the case of Greece at 22.5 percent in 2012.6 At times, some countries couldn’t get access to finance at any terms—they couldn’t obtain the money they needed to repay the debts they owed. Europe came to the rescue, providing short-term financing, with strong conditions.

After the euro crisis broke out in early 2010, Europe’s leaders took a succession of actions, each of which seemed to calm markets for a while. As this book goes to press, even the Greek crisis has slipped to the background as Europe hopes that its latest agreement, in the summer of 2015, will at last work, and as other crises have come to the fore: the migrant crisis erupted to take front stage, as did that posed by the threat of Britain’s exit from the EU and the terrorists’ threats made so clear by the attacks in Paris and Brussels. The euro was supposed to bring about closer economic and political integration, helping Europe address whatever challenges the region faced.

As we emphasize in the next chapter, the reality has been otherwise: the failure of the euro has made it more difficult for Europe to face these other crises. Thus, though this book is about economics—the economics underlying its failure and what might be done about it—

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