European Dreams & Economic Realities
Modernity is an attempt to escape the tragedy of great power politics. Nowhere is this more evident than in the Eurozone.
One of the core underlying themes defining modernity is the avoidance of suffering. With an intellectual tradition deeply rooted in Liberalism, particularly Liberalism’s more Progressive strains, modernity advances the belief that it is possible to escape tragedy through better education and better social institutions. Yet, great power competition poses a fundamental challenge to modernity’s ideological aims.
Within the nation-state, there is a national government that serves as the ultimate authority. This government possesses the power to keep countervailing interests in check by serving as the final arbitrator. If the government is righteous and responsive to its citizens, a tolerable justice and tolerable peace might be established to where liberty and prosperity takes root.
Within international relations, there is no authority above the sovereign nation-state. This makes global politics inherently anarchic. It is a world where, as Thucydides poignantly notes, “the strong do what they will and the weak suffer what they must.” Consequently, the only entity capable of blocking the will of a great power is the will of another great power. And if war is seen as necessary to further the self-interest of the great powers, violent hostilities are inevitable.
Modernity is an attempt to escape the tragedy of great power politics. By creating international institutions and endowing them with ultimate authority, globalization hopes to create a tolerable justice and tolerable peace and establish a truly global community. The chaos of geopolitics might be transformed into order.
Nowhere is this more evident than in the Eurozone.
The Eurozone originated as a means to escape the horrors of war. This institutional extension of the European Union is meant to be the cement that binds together of the peoples of Europe. By sharing a currency and monetary policy, the nations of Europe would align their economic and political interests. Through economic and political integration, peace and prosperity might be permanently secured.
Despite these lofty intentions, there are basic economic and political realities which undermine the Euro’s long-term goals. These problems originate in the Euro’s failure to form an optimal currency area (OCA). To qualify as an OCA, a currency order must meet the following four conditions: 1) Members must possess similar economic structures. 2) Members must possess similar economic cycles. 3) Members must share a common market. 4) Members must share a similar economic culture.
The Euro only meets the third condition.
Germany’s economy is driven by manufacturing and exports while Greece’s economy is centered around agriculture and tourism. While German economic theory places a premium on fiscal restraint and responsibility, France believes in economic stimulus via deficit spending. The Eurozone just doesn’t share similar economic structures, cycles, markets, or cultures.
In theory, this shouldn’t be an issue. The Eurozone requires members to follow specific standards regarding deficit spending and macroeconomic policy. In practice, there are no enforcement mechanisms for these standards. The consequence is that the Eurozone isn't an OCA which means it’s possible for one region to flourish while another region stagnates.
Despite these issues being known, the Euro is approved and launched in 1999. This leads Markus.K. Brunnermeier et. al to note in The Euro and The Battle of Ideas that “the currency union was a high-minded European political project that went way beyond economic realities.” In other words, the Euro is an act of pure ideological hubris.
At first, it doesn’t seem to matter. Throughout the 2000s, the Eurozone makes considerable improvements in the areas of fostering price stability, facilitating economic integration, and improving financial certainty. And while Germany’s economy is relatively stagnant, the economies of Southern Eurozone nations, such as Spain, grow rapidly. The Euro’s goal of creating peace and prosperity is an overwhelming success.
Until fate intervenes.
On September 15, 2008, the day Lehman Brothers collapses. As the 2008 Financial Crisis spreads, it is revealed that borrowers worldwide are over-levered and are unable to payback their debts. But it’s not just mega-corporations that find themselves in a liquidity trap, it’s sovereign nation-states.
The dark truth behind the rapid growth of Southern European economies in the 2000s is that the growth is fueled by government debt. This can work when the debt is used to finance high-return commercial projects, less so when the debt is used to increase government jobs and pensions. Which is what happened in Southern Europe.
When the Financial Crisis hits, the supply of funds for new debt dries up overnight. Suddenly, Portugal, Italy, Greece, and Spain find themselves facing massive government deficits while being unable to service existing debt payments. This is the beginning of the Eurozone Crisis.
As Southern Europe spirals into economic depression in the early 2010s, Germany remains relatively unscathed and emerges the undisputed economic hegemon of the Eurozone. Compounding matters, while Germany possess a surplus of financial capital, it demands that any needy country undergo painful austerity measures before receiving financial assistance. This causes much political turmoil. Many think the Euro would collapse.
But it didn’t.
Since the Euro Crisis’ final dramatic game of chicken between Greece and Germany during the summer of 2015 that ended with Greece’s full capitulation to German demands, the currency union remains somewhat calm. While there are periodic bouts of instability caused by political developments, particularly in Greece and Italy, the Euro doesn’t face existential crisis. It appears that the combination of bailouts and austerity measures worked. But these measures are just band-aids. The Euro’s original sin, its failure to form an optimal currency area, remains unaddressed.
Thing is, this shouldn’t be the end of the Euro. Currency unions that don’t form an OCA can survive. The U.S. isn’t an OCA. When one state languishes economically and another experiences rapid growth, capital and labor can migrate to take advantage of new economic opportunities. This is seen today as capital and labor flees states like California, Illinois, and New York in favor of states like Florida, Tennessee, and Texas. Issue is that doesn’t happen in the Eurozone.
People share different languages and cultures, so they don’t want to leave home to move to another country. From 2012 to 2020, Germany experiences unemployment of 5.5% or lower - nearly full employment. Meanwhile, Greece and Spain’s unemployment hovers between 15-25%. France and Italy routinely experience unemployment rates of above 10%. Labor isn’t moving.
Compared to the U.S., Europe is awash in regulatory red tape. This over-regulation is a deterrent to outside business investment, and this is reflected in foreign direct investment. According to Eurostat data from 2013-2019, foreign direct investment (FDI) flows originating from other Eurozone nations as a percentage of GDP is relatively small. For Germany and France, FDI flows fluctuate between 0.5-2.5% of GDP. For Italy, Greece, and Spain, FDI flows rarely get above 0.5% of GDP and are sometimes negative. Capital isn’t moving.
So what then? How does the Eurozone overcome these challenges? The only solution is “an ever-closer union among the peoples of Europe.” Despite the fact there is mobility of capital and labor in the U.S., Washington often directs investment to economically depressed states. These actions function as transfer payments which are supposed to prevent a situation where one region is permanently flourishing while another region is permanently depressed.
The Eurozone doesn’t have transfer payments, and there’s not an easy way to create transfer payments.
Establishing transfer payments would likely require the creation of a fiscal union. For the U.S., this means the 50 states surrender some of their sovereignty to the federal government and to their fellow American states. For the Eurozone, this means 19 countries surrendering some of their sovereignty to a supranational entity and to other nation-states. It means that the French would let the Germans legislate French spending policies. It means the Germans would let the Italians determine German tax rates.
If that idea seems laughable, that’s because it is.
Fiscal union is like a marriage. It requires mutual self-sacrifice in working towards the same goal. Yet, the only commonality within the Eurozone is each nation has done its best to murder the other numerous times over the past 1,500 years. Not exactly the best of foundations.
The problem the Eurozone faces is each member is pursuing contradictory political goals. The French want to maximize their political power, the Italians want to stabilize their economy, the Greeks want to escape their poor fiscal decisions, and the Germans want to maintain the status quo. It’s impossible for every country to achieve what it wants at the same time. It’s the tragedy of great power politics.
None of this means the Euro is about to collapse though. Far from it. The consequences of the Eurozone fragmenting would likely plunge most of Europe into a prolonged depression. No one in the currency union wants that outcome. And there are some encouraging signs.
In the aftermath of COVID-19, the European Union as a whole is launching a €750 billion recovery fund for its members. While this is unquestionably a dramatic step for the EU, the COVID-19 relief fund passed by U.S. President Biden is valued at €1.56 trillion. And that doesn’t include the COVID-19 relief bills passed under President Trump. Europe has a long way to go before becoming a true fiscal union.
This leaves the Eurozone - modernity’s grand attempt at escaping the tragedy of great power politics - at a crossroads. The Euro’s structural problems make it fundamentally unstable, but there is no political will for reform. On the other hand, while the status quo is untenable, the costs of letting the Euro collapse are too high. And since Germany is the economic hegemon of the Eurozone, its policy preferences win out. The status quo holds.
That is, until the German twilight turns to nightfall.