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If this isn't fixed we must abandon the euro

Date:05 April 2017
Author:Jochen Mierau
Jochen Mierau, Associate Professor, University of Groningen Faculty of Economics and Business
Jochen Mierau, Associate Professor, University of Groningen Faculty of Economics and Business

Talk has returned to Greece and its debt crisis. There is no acknowledgement that this situation exists merely due to a flaw in the design of the euro zone. This must be fixed if the currency is to continue -- otherwise the union will merely lurch for crisis to crisis.

For an example of a permanent solution, we could look to the United States.

Greece is sometimes characterised as a reprobate country that has spent beyond its means and must be punished. In fact, this situation only exists because it is in a currency union with stronger exporting countries like Germany. Germany and Greece are two sides of the same coin.

Here's why. Annually, Greece imports €36 billion in goods from the EU, and sells €16 billion euros worth back. That means €20 billion euros leave Greece every year. Unless euros flow back into Greece it will run out of money to spend on goods from Europe.

Germany in contrast exports €150 billion more in goods than it imports. Over time, it is hoarding euros, and a good way to get rid of them is to lend them to the Greeks, so they can keep buying German goods.

This is Greece's "debt" problem. The situations of Germany and Greece only exist because of the other. It is a vicious cycle: the Greeks keep getting funds from German and other investors, which they use to buy more German goods, inflating the debt bubble.

Outside of a currency union, this imbalance would be resolved because the German currency would get more expensive, pricing goods above what Greeks can afford. But Germans can keep selling their fridges and cars at bargain basement prices because they are in the euro, kept low by the anti-inflationary policies of the European Central Bank. Without that, their trade surplus would have evaporated like snow in the sun.

In theory,  this imbalance is supposed to even out by free movement of labour in the EU. Wages are supposed to rise in Germany, attracting more Greeks to move there. But in reality this doesn't work, because people are not motivated merely by salaries, but have other complex reasons for choosing to live where they do.

This situation is unsustainable. For a solution, we could look to the United States.

We could consider a state like Mississippi as the "Greece" of the United States. Over a 20 year period between 1990 to 2009, Mississippi received 200 percent of its annual GDP in fiscal transfers, according to the Economist. In other words, imbalances between states in the US are fixed by taking dollars from strong exporting states like Minnesota and funneling them to places like Mississippi on a massive scale.

Not every state can export more than it imports: Minnesota sellers rely on Mississippi buyers. There is nothing necessarily reprehensible about Mississippi because it exports less than Minnesota. It can be down to neutral facts, such as geography, history or population.

The same goes for Greece. The debt that the country is now burdened with is impossible for it to pay off. It must and will be cancelled at some point. What this means is that Greece, like Mississippi, will ultimately receive a fiscal transfer. But it will be an unplanned one, that causes chaos and instability in the mean time.

There will always be a Greece. If Greece were to leave the euro, its predicament would simply befall the next weakest state, such as Spain, Portugal or Ireland.

The euro zone must to be adjusted to allow for this fact. There need to be enormous fiscal transfers to states that import more than they export. Such transfers already exist within states, for example in the Netherlands, where there are huge fiscal transfers from richer to poorer regions.

The choices available are either to accept this, or to abandon the euro.

Jochen Mierau is an associate professor at the University of Groningen Faculty of Economics and Business.


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