Martin Sandbu, Europe's Orphan and his Critics.

One of the few people to think that there is not much structurally/institutionally wrong with the Eurozone, the problems are all bad policies, is Martin Sandbu, who wrote an interesting book last year called Europe's Orphan.  if you have time and are writing on the EZ crisis, I suggest you buy it on Kindle.

I have my misgivings about some of his argument. But it supplies a useful counter-argument to some of the OCT people (see the citations earlier on the blog entry for  Eurozone Crisis.) Indeed. it is well-worth juxtaposing the arguments of Sandbu, on one side, and Krugman and Stiglitz, on the other.


At the time the book came out, I wrote this:

"Been reading Martin Sandbu's book on the Euro Crisis--it's the best thing I've read on the topic, even if it begs more questions than it answers.

The thesis of the book: The Euro Crisis was not a consequence of structural problems with the Euro, but a consequence of (i) failure to allow Ireland and the Southern European countries--including Italy--to default; (ii) the misallocation of capital by debtor national governments (esp. Cyprus, Greece, Ireland, Portugal, and Spain) in the 2000s; and (iii) an unwarranted fixation on austerity.

Unlike most commentators--"austerity-obsessives"--he focuses less on (iii), less on reckless lenders, less on Germany, and more on (ii).

He dismisses (i)--somewhat too easily in my view--by invoking, what he terms, "Lehman Syndrome"--the exaggerated fear that defaults would blowup the European and global finance system.

The trouble with this thesis is that he has nothing to say in explanation of why the Southern European countries wasted all the low-interest money flowing into their economies in the 2000s on public-sector wages and housing booms. (He contrasts the Southern European countries here with Norway, which ran deficits in the 1990s to construct a globally-competitive energy industry.)

PS. I haven't yet finished the book; this is very much a comment (as much to myself) in media res.

{{In some respects, I was unfair in saying he didn't know anything about Southern European countries. he has written a couple of useful pieces on Italy that I link to in the Niall Ferguson blogpost.}}

There are good discussions of Sandbu's argument by the following:

Manos Matsanganis, Can Europe Have Both Monetary Union and Democracy? (Greek Perspective)

Patrick Honohan (Irish Perspective)

Wolfgang Streeck review (LRB)

Sandbu Public Lecture at LSE

Paul de Grauwe review (FT)

Paul de Grauwe Review:

Books that attack the con­ventional wisdom are refreshing. They force us to rethink. That is what Martin Sandbu’s Europe’s Orphan does — and what makes it stand out in the increasingly crowded field of eurocrisis analysis.

The main argument made by Sandbu, an economics commentator at the Financial Times, can be summarised as follows. The eurozone sovereign debt crisis that erupted in 2010 has little to do with the alleged design failures of monetary union. This crisis, rather, is the outcome of bad macroeconomic policies that were wholly avoidable. In particular, the abhorrence shown by the major policymakers (the European Central Bank, the European Commission, and German, French and other government leaders) towards debt restructuring, both of banks and sovereigns, is at the core of the crisis.

The failure to write down debts condemned these policymakers to choose the wrong policies — chief among them excessive fiscal austerity and monetary tightening. This approach produced a new recession in 2011-12, created misery for millions of unemployed people and only increased the debt burdens it was supposed to bring down.

Since it is not the euro but bad policy that is responsible for the crisis, it follows that no deep institutional changes are necessary to sustain the euro in the long run. In particular, there is no need for a fiscal and political union. What is needed are better macroeconomic policies, which can best be achieved by returning responsibility for fiscal policies to national governments while unshackling these governments from ill-advised rules such as the 2012 fiscal compact. Of course, some co-ordination of national fiscal policies is desirable. But the way to bring this about is through voluntary agreement between national fiscal policymakers.
There is much to agree with in this analysis. It is clear that the generalised fiscal austerity imposed on eurozone countries has made this crisis more intense and has led to a double-dip recession. In addition, ill-advised macroeconomic policies have created disunity by pitting creditor and debtor nations against one another. There can also be no doubt that, as Sandbu argues, the intrusive interventions by the ECB and the European Commission in fiscal programmes imposed on the debtor nations have been highly undemocratic, undermining the legitimacy of the monetary union.
But there is also a lot to disagree with in Europe’s Orphan. Let me focus on two points. First, there is the claim made by Sandbu that the sovereign debt crisis would have erupted with or without the euro: countries that accumulated too much private or public debt would at some point have experienced a bust and been forced to adjust. But I would also argue that the absence of the exchange rate instrument in the eurozone made this adjustment more difficult. It led to the need to apply deflationary demand policies in many eurozone countries, thereby creating a deflationary bias in the system as a whole — the result of which has been stagnation since 2008. This is not only the result of bad policies; it also follows from a systemic feature that makes the eurozone resemble the gold standard mechanism of adjusting to balance-of-payments crises.
Second, there is the claim that the eurozone does not need a fiscal and political union. I have my doubts. Surely, one of the things we have learnt about the eurozone is that when financial markets lose faith in one or more governments (and there will often be reason enough to do so), “sudden stops” in capital flows occur, leading to massive movements towards safe havens in the same currency area. This forces those distrusted by the markets into instant austerity and deflation. It is not enough to hope that, in the future, enlightened governments will prevent such a situation from arising. The institutional set-up of the eurozone makes it almost inevitable that this will happen again.
Only through a mutualisation of eurozone debt that introduces much greater risk-sharing — together with a willingness on the part of the ECB to step in at times of crisis — can this problem be tackled. Sandbu recognises the potential of debt mutualisation but argues that it is not really needed. I disagree. Insurance mechanisms are necessary and they can only be guaranteed in the framework of a political union.
Like Sandbu, I have no illusions; the willingness to move forward into a political union is extremely weak. And surely, trying to force such a unification from the top down would be undemocratic. The conclusion drawn by Sandbu is that this should not worry us: the eurozone can function without fiscal and political union. My conclusion is that this unwillingness will continue to make the eurozone fragile.

Whatever disagreements one may have, Europe’s Orphan is a stimulating and important book. It is stimulating because it forces us to question what many in Brussels and Frankfurt consider to be self-evident. It is important because such rethinking will surely lead to new insights.

Mark Harrison review

Sandbu's Review of Varoufaxis book is interesting too: the gist of his argument is here:

Yanis Varoufakis burst on to the British public consciousness in January last year when, as Greek finance minister-in-waiting, he quoted Dylan Thomas in a radio interview with the BBC.

By putting their trust in his radical leftwing party Syriza, Varoufakis said, the Greek people had resolved “not to go gentle into that good night, to rage against the dying of the light”. To many, it meant austerity-weary Europeans could now dare to hope for change. In retrospect, the quote suggests something more tragic. Thomas’s poem is not one of hope; it makes no suggestion that raging will do anything to delay the dying of the light. It is not about how you take back control of your destiny but how you suffer the inevitable without submitting to it.
Much the same can be said of Varoufakis’s five-month tenure as Greece’s finance minister. His intellectual rebellion (in many ways justified) against the eurozone’s consensus view of what needed to be done with his country often seemed an end in itself rather than a policy in the service of changing the world for the better.

It is with this in mind that I read Varoufakis’s new book. Readers may be disappointed to learn that there are few revelations about his time in office. Varoufakis had written most of the book before he became finance minister and has merely added a few anecdotes to illustrate his broader argument. The book is nonetheless highly readable. It is also important, outlining a perspective on global economics that influences policy thinking in broader circles than the radical left.
Varoufakis has spent much of his life as an academic economist, and his book is an opinionated history of the post-second-world-war international monetary system. It starts with the Nixon Shock of 1971, when the US president destroyed a pillar of the postwar Bretton Woods fixed exchange rate system by ending the dollar’s convertibility into gold. This marked the end of sustained global currency co-operation and ushered in Europe’s decades-long quest for a stable monetary system of its own.
In Varoufakis’s telling, the Nixon Shock foretold the problems that would bedevil the euro. Tying different countries’ exchange rates to one another, he writes, is bound to fail in the absence of a “political surplus recycling mechanism” — that is, policies to lend the net export earnings of surplus economies to those who buy their exports.
In good times, private markets take care of this. Banks channel the net exporters’ surplus earnings back to net importers in order to finance those very same trade imbalances. But when growth slows, these “fair-weather recyclers” freeze up, leaving deficit countries a choice between devaluing or suffering a harsh recession in order to close their newly unaffordable deficits.
Varoufakis sees not only Bretton Woods, but the failed European monetary systems of the 1980s and 1990s, and eventually the euro, as the all-too-predictable casualties of these economic laws. Or rather, of leaders either ignorant of the laws or maliciously intent on using them to force recession on weaker countries. It is not always clear which: Varoufakis generously attributes Machiavellian genius to some (Germans and Americans) and bottomless ignorance to others (the French and many others). That juxtaposition, so common in conspiracy theories, is apt to raise eyebrows among impartial readers.
The only fair way to maintain exchange-rate pegs, Varoufakis argues, is for governments to substitute for the fair-weather recyclers, and politically administer resource transfers to deficit countries (“surplus recycling”) to avoid the abrupt squeezing of trade.

This, the technically couched call for stabilisation loans, is where it all comes together: the monetary history; the critique of the euro; the implicit vindication of Varoufakis’s own time in office; and, of course, the rage quivering in the book from the start. (The title paraphrases the dialogue between the Athenians and the vanquished Melians in Thucydides’ History of the Peloponnesian War.)
Varoufakis’s thesis has some deep, but deeply instructive, problems. It does not work too well for Bretton Woods. The US was a political surplus recycler, its postwar trade surpluses financed by its foreign aid. The system didn’t collapse because Washington (or banks) stopped recycling surpluses but because the surpluses vanished. An expansive US monetary policy led dollars to accumulate abroad, and soon enough foreign central banks and private speculators preferred Washington’s gold over its paper promises. Once greenbacks were being exchanged for gold in earnest, the end of convertibility was a certainty. Europeans then had no desire to keep their money supplies chained to a dollar which, freed from the discipline of gold, would be managed to serve Washington’s domestic objectives.
The euro experience is different. The large post-2000 trade surpluses in Germany and other core economies, and the corresponding deficits in the periphery, did indeed cause the crisis. Yet it’s hard to blame the depth of the eurozone crisis on the absence of a political surplus recycling mechanism. Such a mechanism was after all precisely what the eurozone instituted through its various rescue funds. Varoufakis is right to criticise the policies that accompanied them, including excessive fiscal austerity and overly tight monetary policy. But the surplus recycling did happen. It was everything else that was badly done, in particular the policy on how to handle outstanding cross-border debts.
Varoufakis writes: “Debt was never Europe’s problem. It was a symptom of an awful institutional design.” But of course debt was a problem. The alternative to the bailouts Varoufakis rightly slams was to restructure unsustainable debts, which would have softened the slump and hastened the return of the private sector surplus recyclers.
Varoufakis himself says as much. He clearly, and correctly, thinks Greece should have defaulted on its sovereign debt and Ireland should have restructured its banks in 2010. But if alternative policies did in fact exist, which leaders could have pursued but chose not to, then a fatalistic monetary theory that blames everything on the euro’s design serves, paradoxically, to exonerate the mistakes of those leaders. That may not be his intention, but Varoufakis glosses over why national governments repeatedly declined to restructure debt before it was refinanced by the rescue funds. Above all he does not mention why he, as finance minister, did not restructure Greece’s banks early in his tenure, so as to undo their dependence on the European Central Bank, which last summer forced Athens to accept a third bailout by shutting down banking liquidity. This very partial focus is why Varoufakis’s literary references are so telling. The rage expressed by Thomas and Thucydides’ Melians is not a constructive anger but a cover for helplessness. Neither death nor the Athenians are moved by their rage. Nor, I suspect, will eurozone decision makers be moved by Varoufakis’s.
And The Weak Suffer What They Must?: Europe, Austerity and the Great Threat to Global Stability, by Yanis Varoufakis, Bodley Head, RRP£16.99/Nation Books, RRP$27.99, 320 pages