On Sept. 14, Swedes will vote on whether to join the euro. Today, a majority of Swedes appear likely to vote no. To advocates of the euro, this is a mystery. Isn't the euro a success, as marked by the currency's increasing strength against the dollar?
No one ever doubted that the euro would gain acceptance as a currency -- in economists' jargon, that the euro would become an important "medium of exchange," or even a good "store of value." But currencies are not ends in themselves; they are means -- to stronger, more stable growth.
Whether the euro -- with its associated institutions, including an independent European Central Bank (ECB) which focuses on inflation -- is "good" or "bad" should be judged by economic performance -- whether it leads to faster, steadier growth. Judged on those terms, the best that can be said for the euro is that the jury remains out. The worse that can be said is that the euro has failed its first test.
Growth in Euroland since the introduction of the euro four-and-a-half years ago has been dismal, and immediate prospects look little better. Yet the euro was supposed to enhance growth by lowering interest rates and stimulating investment. While it may have done so in a few countries, it has not done so in Europe as a whole.
So the UK and Sweden are right in questioning whether it will deliver better growth to them. Indeed, there is every reason to believe the contrary -- that the euro will lead to slower growth and higher unemployment.
Of course, the euro alone is not to be blamed for Europe's slow growth. The weak global economy, including moribund America, is part of the problem. But economies are always buffeted by shocks. A good monetary system should protect an economy against such shocks.
Before the euro was introduced, euro-skeptics worried that in focusing on Europe's core (Germany and France), the periphery would be disadvantaged. For example, if economic growth in the center were strong but smaller countries were showing weaknesses, monetary policy would be determined by the needs of the center. Smaller countries would not get the monetary stimulation they needed.
Few anticipated how events turned out: institutional rigidity prevented the ECB from responding in a timely manner to weaknesses in Europe's most important economy, Germany. Combined with the Stability Pact -- another case of institutional rigidity that prevents effective use of fiscal policy -- Europe has unnecessarily slipped into a major slowdown, if not a recession.
Confidence in the euro, along with mounting evidence of America's economic mismanagement, provided an opportunity for Europe to lower interest rates to stimulate growth. By focusing narrowly on inflation, the ECB made Europe lose twice: both the lost investment that lower interest rates might have prompted, and the loss of exports and increase in imports that are sure to follow from the euro's higher exchange rate.
Supporters of the euro point to the success of the US, with its single currency. But America's institutional structure differs markedly from Europe. Labor mobility is an important part of the adjustment mechanism in the US. In the early and mid-1990s, when vast cutbacks in defense expenditure led to unemployment rates in excess of 10 percent in California, many Californians migrated to other parts of the country where jobs were easier to find. Moreover, the federal government could boost California's economy by redirecting its expenditures to that state.
While cross-country labor mobility in Europe is higher nowadays, language and cultural barriers mean that mobility is far lower than in the US. Apart from the Common Agricultural Policy, expenditures at the European level are meager.
Finally, the US has steadfastly refused to tie its hands in the way that Europe has. A balanced budget amendment to the US Constitution was rejected, as were attempts to change the Federal Reserve's charter.
International exchange-rate markets can be volatile, and this uncertainty translates into higher effective borrowing costs. But such risks are far less important for countries with sound economic management and low levels of indebtedness. Furthermore, modern techniques of dynamic hedging have improved the capacity to manage these risks. It is not destabilizing speculation that poses the biggest threat to Sweden today, but rather poor monetary management -- including an excessive focus on inflation in the manner of the ECB.
For economies with a strong track record, such as Sweden and the UK, joining the euro offers little to gain and much to lose -- at least for now. Today, the Stability Pact appears frayed. Large economies, like Germany and France, extract forbearance when they breach the pact's deficit ceiling. But small countries, like Portugal, do not. The ECB is unlikely to pay serious attention to Sweden's specific needs, so Sweden will probably not be given the wiggle room granted its larger neighbors.
Euro membership may become more attractive in the future. The institutional framework responsible for Euroland's poor economic performance may improve, or capital markets may become more volatile, making the cost of bearing exchange-rate risks intolerable.
But matters within Euroland may also worsen: the Stability Pact, with its de facto separate rules for large and small countries, will almost certainly be replaced. But with what? Uncertainty about the future direction of economic policy may lead to higher than necessary interest rates in Euroland -- and thus slower growth.
When uncertainties about the direction of institutional change within Euroland are settled, decisions about joining the euro can be made. For now, Britain's decision to postpone euro membership makes sense. Swedish voters seem likely to show similar wisdom.
Joseph Stiglitz, a Nobel laureate in economics, is professor of economics at Columbia University and was chairman of the Council of Economic Advisers to president Bill Clinton and chief economist and senior vice president at the World Bank.
Copyright: Project Syndicate
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