Much discussion of the euro crisis today revolves around two claims: that the crisis is essentially a debt problem, and that the worst of the crisis is behind us.
“People are saying that the Euro crisis is essentially a debt problem, so if we solve that, we’re done,” he stated. “Debt is as much a symptom as a cause, and there are deeper causes behind the situation.” Because the solutions are painful and politically difficult, he fears the worst of the crisis is yet to come.
Chiappori told a standing-room crowd of undergraduates that he chose to talk about the euro crisis —an area outside of his work on matching models—out of frustration with public discussions. “As an economist you should be willing to talk about any topic that is important, and few are more important than this one,” he said.
He told students the risks of the monetary union were known at its inception. He recalled attending a luncheon in 1999 when Jacques Delors, a former French minister of finance and an influential player in the move to the euro, came to campus specifically to meet with University of Chicago’s famed economists. Over lunch, Nobel laureate Robert Fogel told Delors that over history, no currency union had ever succeeded; they either revolved into a fiscal or political union or they collapsed.
According to Chiappori, Delors replied, “Professor, you’re right, and we know it, but what you have to understand is this is just the first step.” The intention was to eventually move toward a fiscal and political union.
Without these additional powers to harmonize policy across borders, “monetary unions are dangerous, because you are freezing exchange rates,” Chiappori said. “Essentially, you are fixing prices of currencies. If countries experience divergent macroeconomic paths, tension accumulates and eventually the economic stress becomes unbearable.”
That’s exactly what happened across Europe. Chiappori showed data comparing unit labor costs relative to Germany, normalized to 100 in 1999. Greece, Italy, Portugal, and Spain already had significantly higher labor costs, but after the implementation of the Euro, they shot up, reaching peaks 20 to 30 percent more than the German baseline. The consequences were slow growth and lack of competitiveness, and “they no longer had devaluation to fix this,” he noted.
“That’s the most important problem that the Euro is facing now. It’s not bad luck; it was clear from the beginning.”
“One solution, which seems to be the path we’re on now, is that these countries—Greece, France, Italy, Spain, Portugal—will have to deflate their way back to growth,” Chiappori said. What this takes is a recession and sufficient unemployment to drive down labor costs. The question is, how much of a recession will be needed and how much pain will result.
Structural features of labor markets across Europe resulting in 50 percent unemployment among youth make corrections even more difficult. Likewise, the notion that the European Central Bank could fix the problem by flooding the region with money will not work.
An effective rescue package would renegotiate debt to boost competitiveness and require structural reforms in labor markets. Reforms also must address public finance—tax collection rates are pitifully low in Greece, for example—and public spending.
He concluded by offering three possible directions for the future. The rosy scenario is to move in the direction of fiscal and political unification, and, in the end, a European federal government. That means creating the kinds of structures that allow the United States to function as a successful fiscal and currency union, with internal migration and transfers of resources across economically divergent regions. That scenario is not very likely; it means abandoning sovereignty, and the crisis has heightened resentment across nations.
Another scenario is implosion or collapse, after one or more countries exiting the union. Chiappori thought it was more that Europe splits into two zones: wealthier northern nations in one union, and southern nations in another that devalues its currency by 30 percent.
“The third scenario is that we continue limping on this path where we painfully try to restore productivity,” he said. That depends on political success. Pointing to radical movements like the Golden Dome in Greece, Chiappori wondered whether a democratic government can impose painful but necessary reforms and survive.
“This doesn’t sound very optimistic but I’m trying to be as realistic as possible,” he concluded.