Germany’s leaders are loath to do what it takes to save the euro, in large part out of the not unreasonable fear it will cost their country too much.
By our calculations, their concerns are misplaced.
Time and again, efforts to contain Europe’s worsening debt, banking and economic crises have run into the same obstacle. Any credible solution requires a commitment by euro-area governments to back one another’s debts and help one another through hard times. Yet the wealthier countries, and Germany in particular, reject measures that hint at transfers of money -- instead of loans -- to struggling states such as Greece and Spain. They assume they would be dragooned into supporting weaker economies forever.
It’s easy to understand why the Germans are worried. The experience of the U.S., the world’s largest currency union, suggests fiscal transfers can be very expensive for individual members of the union. The relatively affluent state of Connecticut, for example, has in some years sent as much as 8 percent of its gross domestic product to poorer states. The payments, made largely through the federal income tax system, serve both to equalize levels of income across the U.S. and to cushion regional downturns. States in recession, for example, receive transfers large enough to offset as much as 40 percent of their loss in income.
Like it or not, the euro area will need a similar risk-sharing system. Economists have long warned that the member countries’ economic cycles are too far out of sync to coexist without some kind of stabilizing mechanism. Inflation and unemployment rates diverge wildly, and European workers aren’t mobile enough to compensate by moving to where the jobs are.
So what would it cost to turn Europe into a better fiscal union? Let’s try a thought experiment.
The first step is to figure out what kind of fiscal transfer system best suits the euro area. Equalizing income levels need not be the goal -- trade and investment can play that role. What matters for the currency’s viability is diverging growth rates. So, the transfers should be aimed at smoothing them out.
To get a sense of how this could work, imagine a fictional European Stabilization Fund. Countries experiencing relatively fast growth (more than 2 percent, adjusted for inflation) would contribute to the fund. Countries in recession would receive payments equal to 40 percent of their loss in income, a cushion at least as generous as that in the U.S. If the 12 countries that have been in the euro since 2001 all participated in such a fund, how would it have worked out?
Based on the economic performance of the 12 countries, it’s possible to come up with an answer. The results are surprising.
From 2001 through 2012, a period that included one of the worst recessions on record, the contribution required from the fast-growing economies to keep the fund above water would have been only 0.64 percent of their gross domestic product. Germany grew fast enough to qualify as a contributor in only four of the 12 years, so its average payment would have been a meager 0.03 percent of GDP -- a total of about 11 billion euros for the whole period. In the recession year of 2009, Germany would have received a stimulus equal to 2 percent of GDP, more powerful than the program the U.S. put in place that year.
Spain, not Germany, would have been the biggest net contributor in euro terms, putting in more than 14 billion -- a function of its real-estate boom in the first part of the decade. France would have come in second at nearly 13 billion euros. Greece would have been a contributor in most years; ultimately, it would have received a net 5 billion euros, mostly in 2011, a year it desperately needed the help.
In other words, history tells us there’s no reason to believe that a deeper fiscal union would entail constant support from Germany to peripheral countries such as Greece and Spain. Money would flow in all directions, and the transfers could go a long way toward mitigating booms and busts.
Starting such a fund today would not be much more difficult than it would have been in 2001, even though harsh austerity measures have snuffed out growth in most of the euro area. Based on the International Monetary Fund’s growth forecasts, a newly created stabilization fund would have to borrow about 10 billion euros to cover payments for this year and next. It would have enough contributions to pay the borrowed money back by 2015.
The exact cost and impact, of course, would depend on how European leaders chose to design the transfer mechanism. We favor a euro-area unemployment-insurance fund, which would make payments directly to the jobless in hard-hit countries. In return, workers could be required to sign more flexible employment contracts, encouraging the kind of labor-market reforms needed to make the region’s struggling economies more competitive. Such a mechanism, according to one of its designers, Jacques Delpla of France’s Conseil d’Analyse Economique, might cost as much as 1 percent of GDP for contributing countries.
Fiscal transfers aren’t the only form of risk-sharing needed to make the euro area work. To get past the current crisis, euro-area nations must also take on some collective responsibility for government debts, a move that would probably require Germany to pay a higher interest rate on its portion of the debt. Here, too, Germany’s burden might not be very large. A European Commission report, for example, suggests the country’s borrowing costs could be about half a percentage point higher. On a German net debt load of about 2 trillion euros, that amounts to 10 billion euros a year, or 0.4 percent of GDP.
There were signs this week that a shift might be taking place in Germany. On Monday, the opposition Social Democratic Party signaled its support for a tighter fiscal union. The move was an acknowledgment of something that’s been too clear for too long: The euro area’s approach to solving its problems isn’t working. European governments and the ECB have lent more than 2 trillion euros to support struggling member countries, while imposing austerity measures that are serving only to make the situation worse. If the euro falls apart, they stand to lose much of that money. Doing what it takes to make the currency union viable looks like a much better option.
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