Even under the rosiest scenario that a deal is reached on Greece’s new three-year bail-out program, the economic conditions of Greece, and of the Eurozone as a whole, will remain serious. Europe seems unable to find the political path to move out of such deadly gridlock. Yet, the logic is simple.
Eurozone like Monopoly
Consider the Eurozone like the game of Monopoly. This is a popular board game where players, at some point, begin to go bankrupt, until the last solvent player left in the game, after all others have gone bankrupt, wins. In the game, there is a Bank that constantly distributes a salary to each player and collects taxes and fines. The game is constructed in such a way as to create the conditions for bankruptcy.
This is achieved by setting the Bank’s net spending (i.e., salaries paid to players net of taxes and fines collected) low enough so that at some point there is not enough money to fund all the payments that players must make when they land on improved properties. Sooner or later, the less liquid player (there must be one, by lack of skills, or lack of luck) goes bankrupt. Soon, another player follows, until the last player left in the game wins. Anyone who has played Monopoly removing the rule that each player collects $200 each time a player’s token lands on or passes over GO has found that the game gets shorter, as bankruptcies happen sooner.
Euro’s fiscal rules work precisely like this. Fiscal net spending is not high enough to support all payments, so the weakest player must go bankrupt. When the player leaves the game, it will soon be the turn of the next player to go bankrupt. With one difference: Europe will be in ruins before the last player wins!
The Eurozone could be saved without and before political union
It is often argued that the Eurozone cannot function without political union. A confederation, it is said, could allocate funds from its central budget to assist a local government like Greece that can’t reasonably fund itself. This would not necessarily be uncontroversial, as other local governments might express their concerns with allocations from the central budget to a specific region. It would not, however, raise the specter of a dissolution of the monetary system.
Additionally, a confederation would entail another constructive option. The first option (above) is there to assist local governments in financial trouble. If, however, the confederation in general suffers from depressed aggregate demand and unemployment, as is the case today in the Eurozone (apart from the critical conditions of the weakest player, Greece), the central government could increase its net spending across the board (increased public spending or lower taxes), a move that would improve economic conditions throughout the confederation while at least partially addressing the problem of any one government that is experiencing funding difficulties.
The bad news is that Europe is not a confederation, and any decisions to fund a troubled country must be addressed by means of crisis summits, as we have seen numerous times.
The good news is that a monetary union that is not (yet) a political union can set out a fiscal expansion. There is a variety of ways in which this could be done, including (and not limited to) orchestrating a plan of pro-quota infrastructure expenses over and above the existing fiscal rules or granting an across-the-board, pro-quota tax break, in either case, all funded by “EU Peace and Prosperity Bonds” backed by the ECB. This would help Greece and all the other 18 countries that in different degrees are hurt by economic stagnation. This includes Germany, which claims it has no money for public infrastructure and which is giving up a large amount of its products through exports that will be consumed abroad because average Germans cannot afford to buy them.
Ending the collapse is possible, and yet Europe clearly lacks political will. This week begins with a country in ruins. As it is, the Eurozone will not last long.