Are the eurozone leaders close to resolving their debt crisis? Probably not, said Columbia Business School professors at a panel discussion on February 2, 2012, titled “Understanding the Euro Crisis” that was sponsored by the Jerome A. Chazen Institute of International Business. Powerful economic trends will continue putting stress on the eurozone — so much so that one speaker predicted the exit of one or more countries from the euro in the next 12 months.
Glenn Hubbard, dean of Columbia Business School and Russell L. Carson Professor of Finance and Economics, moderated the discussion. Panelists were Shang-Jin Wei, director of the Chazen Institute; David Beim, professor of professional practice; Michael Johannes, professor of finance and economics; and Emi Nakamura, David W. Zalaznick Associate Professor of Business.
Beim said that euro member countries never should have formed a currency union. “Germany and Greece are so incredibly different that they have no business being in the same currency together,” he said. Before the euro was launched in 1999, Germany had long had strong productivity growth, while Greece, Portugal, and other countries in southern Europe had low productivity, he said. As a result, the German currency was strong, while currencies in the south were devalued. In the 1990s, the weak currencies made products from southern Europe cheaper, enabling Greece and Portugal to export their goods.
But after they adopted the euro, the southern countries no longer received a boost from falling currencies. While German exports boomed, sales of southern goods sagged. The southern countries borrowed heavily to pay for imports. “Suddenly an enormous payment imbalance developed between the north and south,” he said, adding, “When I first looked at this picture, I was amazed. I thought this is doomed. It can’t last.”
Who Did It Right, Who’s Doing It Wrong
Emi Nakamura cautioned that it would be costly for Greece or any other country to abandon the euro. Under the European Union treaties, there is no plan for how customers can pay their bills outside of the eurozone system. “The euro was designed intentionally to make it difficult to leave,” she said. “Banks would have to be closed in Greece. This could cause major disruption, and it would be very hard to have any kind of economic activity in the short run.”
Instead of dissolving the monetary union, member states could strengthen it by following the model of the United States, where individual states belong to both a fiscal and monetary union, Nakamura said. “We share the same currency, and the federal government has powers to tax and spend.”
The fiscal legacy of the United States could prove instructive for EU leaders, she noted. When states ran up debts in the 1800s, the US federal government refused to bail them out. Officials in Washington decided that states should be responsible for their own fiscal discipline. The emphasis on discipline has worked well over the years, said Nakamura, and states have been forced to run balanced budgets.
The same kind of approach could work in Europe, she said. “The United States decided that it is hard to have a monetary union without a fiscal union,” she said. “The question for Europe is whether it wants to become more integrated and move in the direction of the US model.”
Michael Johannes, meanwhile, focused on the strategy of the European Central Bank (ECB), which recently relaxed the collateral requirements of banks and bought bonds of Greece, Portugal, and other troubled governments. He held out little hope that the move would stop the bleeding, noting that similar approaches had been tried in Japan and other countries that faced debt problems. “We have learned over the last few crises that central bank interventions actually make the problems worse,” he said. The interventions “give us a false sense of relief that the problems will be fixed. That delays solving the problems and allows them to compound.”
Johannes said that a default by Greece could lead to a resolution of the crisis. Seeing the economic downturn that Greece would experience after a default, other countries would raise taxes and trim benefits, and the crisis would dissipate, he said.
The Big Winner: China?
While Asian countries are known as prominent exporters to the eurozone, the euro crisis may be less harmful for China than it first appears, said Shang-Jin Wei. “The raw trade numbers can be misleading,” Wei said. “They exaggerate how much China is dependent on foreign markets.”
He said that exports account for 32 percent of China’s GDP. But only half of that figure is from domestic content. The rest is foreign products that are incorporated in Chinese goods and then shipped overseas. As a result, the domestic content of exports to Europe is only 5 percent of China’s GDP. “Declining trade will not translate into a terrible outcome for China,” he said.
One Asian country that might not fare is well is Korea, because it relies heavily on foreign bank loans. If financing is cut off, then the economy could suffer. However, China is not as vulnerable because it obtains heavy financing through foreign direct investment. Those investments could continue, even if European banks struggle. “Perhaps China will emerge from this crisis in a relatively strong position,” Wei said.