The Euro And The Wealth Of Nations

Francisco Goya - Peasant Carrying a Woman 
As euro leaders struggle to save the zone, and global hedge funds reckon whether the Merkel-Sarkozy fix is a five foot leap over a six foot pit, the unresolved question most economic journalists seem focused on pertains to near-term bond auctions:

Will Mrs. Merkel finally agree, not only to the purchase of even more southern European debt by the Central European Bank, but to the issue of a "Eurobond" guaranteed by the collective of euro zone member states (read, German taxpayers). Will she, that is, finally try to get her voters to shake off the inflation nightmares of Weimar and use the German government's current revenues to, in effect, subsidize the ongoing deficits of, say, Spain, much the way Ontario--albiet, through more transparent "equalization payments"--has historically subsidized Quebec? Will the European federation become fiscally united, controlled, real?

These are good questions, but are they really the right ones? Clearly, if the southern countries do not grow more quickly, subsidies of this kind would be unsustainable into the future, even for Germany. How does imposing more fiscal controls on southern states allow them to create more real wealth? Yes, keeping today's southern European consumers buying is as important to German factories operating as American consumers are for Chinese factories. And if Germans were not on the euro, whose value is being depressed by bail-outs of poorer member countries--if, say, Germany was still on the DM--a VW Golf made in Wolfsburg would sell in Tel Aviv for what an Audi does now.

Nevertheless, the best question in deciding whether saving the euro makes sense at all should be this: Under what scenarios are the southern economies most likely to grow? Who will be starting, owning, and profiting, from what businesses? In that context, would not Spain, Portugal, Greece, etc., be better off with their own currencies? Would they not become more competitive if they could simply devalue them? 

No, they would not. 

 THIS SEEMS THE right time to reiterate the point I've made before, that the euro implies an economic vision of a networked world no sane leader of a developing country dare retreat from. The euro is a way of understanding the future; the case against it is chasing the past.

The argument for allowing the euro to retreat from the southern European countries is still widely made. If poor and still essentially developing counties like Portugal and Greece had their own currencies, they'd be able to weather fiscal crises (i.e., unsustainable national debt, ongoing deficits, sovereign bonds at junk-bond rates of interest, etc.) simply by devaluing. 

In this way, so the argument goes, they would become more competitive. Why? Because their exports would become cheaper. As I've said, development economists as different as Paul Krugman and Martin Feldstein take this axiom for granted. The euro, in this view, has proven a kind of hammerlock that rich European countries like Germany and France now have on them, a kind of monetarist scold sitting on their shoulder, and advantaging—wait for it!—German exports. 

But what exactly would southern European countries be exporting more cheaply with devalued currencies of their own? To think that they would be able to devalue themselves out of crisis assumes a world of 1950, not 2010--a world in which companies-qua-factories made most of what people needed (toothpaste, tires, pencils, typewriters; things anybody could learn to make with imported recipes, formulae, and blueprints)--and local companies could get a leg-up on imported consumer goods if local labor costs could be driven down relative to more developed countries. In this world, the game is “import substitution.” Devaluation cheapens, first and foremost, people. 

Really, however, does any seasoned economist or business executive really think this is the world we still live in? Today, production of consumer goods is in a world ecosystem whose drivers are science and advanced design: a changing complex of know-how, advanced information technologies, networks and supply-chains, global branding, financial instruments—indeed, a globalized system that rewards the tech-savvy initiated while punishing those left behind. 

If Portugal and Greece have a hope of developing, it is by getting the direct foreign investment of Volkswagen, Phillips, Bayer, Thomson, ABB, GE Capital, Samsung. It by getting Apple and Google to expand design hubs in Madrid. It is most of all in getting globals to invest in local enterprises that might be drawn into their supply chains. The key is not cheap labor but rich brainpower, the climate that will cause globals to inject the DNA of various businesses into the commercial life of southern European states.

The path to development is not devalued money in the hinterland, but intellectual capital from the metropole. Why would globals invest directly in economies where currencies were constantly spiraling down? How would they negotiate wage contracts or buy new real estate for its plants when imported goods (that is, its employees’ most favored goods) were constantly rising in price, kicking off new rounds of inflation and real estate bubbles? How would they react when local assets lose, say, 20 percent of their value overnight in a devaluation? 

Rather, southern European countries need to be slowly improved and integrated into northern economies over a generation. All need to become both importers and exporters in a true division of labor, like Adam Smith's hunters of beaver and hunters of deer. Countries outside the euro zone, like Israel or Argentina, have had the same problem, of course, but they attracted direct investment by more or less pegging their currencies to the value of the dollar. Why should not southern European countries achieve the stability globals need by staying on the euro instead?

THE MERKEL-SARKOZY agreement puts the EU in the right direction, then. These leaders mean to put in place judicial actions, decision-making structures and regulations that override national sovereignty so that no member can go on cooking their books. Meanwhile, and under the radar, richer European countries will be transferring wealth and critical know-how to the south for the coming generation, much as West Germany did for East Germany.

The lesson here is not just for Europe. The relationship between Germany and Spain is not that different from the one between Massachusetts and Mississippi. In a networked economy, poorly paid, ill-educated people are no longer any advanced democracy's competitive advantage. The knows have to find a way to teach the know-nots. A common, stable currency is the place to start.