Why Can't Europe Save Itself?

The eurozone will be forever crippled unless it becomes a real currency union -- like the United States.

Pity Mario Draghi, the president of the European Central Bank. Even without having to endure constant sniping from finance ministers in the eurozone, maintaining a currency union among such diverse countries would be no easy task. Happily, several factors could help the eurozone to smooth out its differences in business cycles and economic prospects over the long term. Frustratingly, it refuses to use any of them.

In general, currency unions are three-legged stools, supported by fiscal policy, migration, and trade. From the beginning, in a feat of late 20th-century European design aesthetics, the eurozone was intended to have only the last two legs. Neither of them was particularly strong, however, and their weakness has made an initially challenging situation even more precarious.

To understand why, consider the basic setup. The members of a currency union don't just use the same money; they also cede all the power to make monetary policy to a single authority, in this case the European Central Bank. The ECB has a tough job, since it has to decide on one level of short-term interest rates for the 17 members of the eurozone. That can be practically impossible in times like these, when some countries are booming while others are in recession.

With the passage of years, the euro itself was supposed to make this job easier. In theory, trade between the members would help to synchronize their economies. The idea was that their companies and consumers would be so intertwined that they would all rise and fall on the same economic wave, with similar trends in employment and inflation.

This may seem paradoxical, since trade works best as an economic stabilizer when exchange rates can move freely. A country in a downturn typically sees the value of its currency fall as investors demand fewer of its securities, and so its exports become more attractive abroad. In the eurozone, this isn't possible. 

But trade still has a role to play. When some euro members are struggling -- and especially when their governments are having a hard time making ends meet -- the others can try to export some growth by stimulating their own economies. In other words, Germany -- Europe's economic engine -- could funnel extra money to its consumers through tax cuts or spending increases in hopes that they would buy more goods and services from Greece, Portugal, and Spain. This isn't the most direct way to support the laggards, but it could be more politically attractive than just giving them money. After all, domestic consumers get to choose how they'll spend the extra cash.

Yet Germany, supposedly the strongest advocate of the eurozone's integrity, has explicitly refused to do it. Angela Merkel, the German chancellor, has rejected a public plea by Spain's prime minister, Mariano Rajoy, to juice the German economy with new spending. By doing so, she has put her country's fiscal health above the health of the eurozone -- an understandable decision, but one that keeps the currency union in peril.

The situation wouldn't be so dire if the eurozone were taking full advantage of its other channel for smoothing out the differences between its economies: people. Free internal migration, a founding tenet of the European Union, can have a similar effect to trade. If one country is in the dumps, its people can move to another country where prospects for work are better. All other things being equal, the unemployment rate would drop in the first country and rise in the second, bringing their economic cycles closer together.

Alas, internal migration in the eurozone is not exactly free. Not every country recognizes the others' professional qualifications, and the requirements for starting a business can be completely different from member to member. Moreover, each country can have different administrative formalities for migration, and immigrants who lose their jobs can be forced to return to their countries of origin. Aside from these administrative issues, there are social and political barriers; in the midst of economic hardship, anti-immigrant sentiment is rising across the continent.

Of course, most successful currency unions don't just rely on trade and migration to synchronize their members' economies. Alongside a shared monetary policy, they also have a shared fiscal policy. That's right: Canada, India, the United States, and other big countries with regionally diverse economies are among the world's thriving currency unions. When one region is suffering, the central government can send cash to prop it up. It's no secret, for example, that federal tax revenues are redistributed from Washington toward some of the poorer states. 

There's also a degree of redistribution in the eurozone (and the EU as a whole) thanks to the recent bailouts, farm subsidies, and other programs. But the amounts of money pale in comparison to the entirety of the eurozone governments' budgets, which totaled about 4.7 trillion euros in 2012. In addition, there is no central authority for taxation in the eurozone or the EU, so half of fiscal policy is completely off limits.

Teetering on two unsteady legs -- the third is barely a stub -- the eurozone will continue to be a weak currency union at best. I say "at best" because its members' economies are heading in very different directions in the long term, with distinct risks and opportunities in each region. Indeed, as I wrote in a recent book, the EU could conceivably split into several contiguous economic blocs, each of which would have a much easier time maintaining its own currency union. For now, though, the eurozone seems feebler than ever, and no one is doing much to strengthen it for the future.

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Daniel Altman

The Magic Number

South America's experience suggests a tantalizing possibility: that reaching $8,500 in income is the secret to sustainable growth.

What makes volatile countries settle down and grow in a stable way? Is it a change of institutions, opening the door to trade, or the end of a war? Perhaps it's none of these. As crazy as it sounds, simply reaching a set level of income may be enough.

Economic growth can happen under almost any kind of government, though there are few models that seem to guarantee steady, equitable increases in living standards over the long term. Take South America. In the past century, countries there have tried just about every model there is, from disorderly Weimar-style democracy to dictatorship. Most often, they have swayed back and forth between various flavors of left-wing populism and right-wing authoritarianism. In the meantime, they have managed to grow, but only fitfully.

For some countries, however, the political pendulum has stopped swinging. In Brazil, Chile, Peru, and Uruguay, roughly the same sequence of events has resulted in relative stability. First, a center-right government has taken power and instituted the kinds of policies that warm the hearts of international investors: flexible exchange rates, fiscal balance, and tight monetary policy. Then, a center-left government has been elected. These new leaders have maintained the policies of their predecessors but, crucially, have also legitimized those policies by pursuing priorities that spread the gains of investment-led growth: education, health care, social programs, and other forms of redistribution.

It's no coincidence that these four countries are now among the most promising on the continent, from an economic perspective. They and Colombia (more about it later) attracted the biggest inflows of foreign direct investment per capita in 2011, and the five are the only ones rated as "investment grade" by Standard and Poor's. But why did this transformation happen when it did?

Here's a theory. As people's incomes rise, they're less likely to be swayed by political extremists. Neither populist promises of a chicken in every pot nor severe measures to suppress dissent are particularly appealing. The people are too well off to be persuaded by advocates of revolution, which makes approval of undemocratic crackdowns similarly unlikely. They just want to hold onto what they've got and enjoy their civil and economic freedoms.

The question is: How much do people have to earn for their economic situation to anchor them in the political center? Remarkably, this question may have an answer in South America. In the four countries that made the transition to stability, the completion of the sequence outlined above occurred as average purchasing power reached $8,500 per year at 2005 prices, as computed by the World Bank. In those four cases, the first election after crossing the $8,500 threshold ushered in the center-left government that would confirm the country's path of steady, equitable growth.

So, what does $8,500 buy you? The figure is a measure of an entire country's GDP adjusted for differences in prices around the globe and divided by its population. It's not a median income, nor is it for an entire household; a typical household in one of these countries might have something like $15,000 in total purchasing power every year. (As a guide, the United States has per capita GDP of about $48,000 and median household income of about $53,000, but households in the United States average about 2.5 people, versus more than 3.5 in Brazil.) That's by no means a high-income family, but in most countries it represents middle-class, or at least working-class, respectability. Such a household might spend $1,500 a year on taxes, $400 a month on housing, $50 a week on food, and $120 a week on everything else.

The latest South American country to reach the $8,500 threshold was Colombia, in 2011. If it follows the same path as the other four, the election in 2014 will replace the center-right government of Juan Manuel Santos -- and previously Álvaro Uribe -- with a center-left government. A center-left government isn't always easy to spot in South America; plenty of observers thought Brazil's Luiz Inácio Lula da Silva might turn out to be a loose cannon or fellow traveler of Venezuela's Hugo Chávez, but he was nothing of the sort.

In fact, Santos, who was elected in 2010, may himself qualify for the center-left distinction someday. He is already moderating some of Uribe's harsher policies, and his coalition in Colombia's congress commands support from left-wing liberals. In other words, the transition may already be happening.

Of course, not every country with more than $8,500 per capita in purchasing power has attained the magical combination of political and economic stability, even in South America. Though the World Bank's figures don't go back before the 1980s, it looks like Argentina crossed the $8,500 line sometime in the 1960s, coinciding with the progressive government of Arturo Illia. But Illia was elected by a flawed process and soon ousted in a military coup. Venezuela may have reached $8,500 even earlier and has had elected governments since the late 1950s. Yet as in Argentina, its living standards were essentially stagnant until the past decade or so.

The difference here may be as simple as one word: globalization. Brazil, Chile, Peru, and Uruguay have been able to bolster their growth with foreign investment to a degree that Argentina and Venezuela never could, not just in the extent of the investment but also in its diversity. Globalization has also made South American countries less isolated, both politically and culturally. It's easier than ever for their people to compare the performance of their governments with others around the world.

With that in mind, could countries in other regions follow the South American example? Possibly, but the similar and shared histories in South America make the case for the $8,500 rule particularly compelling. And their story of development is by no means the only one; in East Asia, the narrative of state-organized industrial growth in Japan, South Korea, and Taiwan is equally notable. More likely, up-and-coming regions like South Asia and Sub-Saharan Africa will write their own stories of stability and success.

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