Daily Management Review

What If Germany Goes Out Eurozone?


Debates about Grexit have revived talks on if Germany and other such strong economies left the monetary union, it would be of more benefit the rest of the continent. Although this idea may have received some support, its implementation would be short-sighted, impractical and economically questionable step, Allianz chief economist Michael Heise writes on Project Syndicate.

For a start, it will not be easy to pull the biggest European economy out of the single currency, and any serious discussion on this subject will lead to chaos in the financial markets. Although, the economic disadvantages of this idea, three of which are lying on the surface, are the more important argument.

First, proponents of Germany’s quit have excessive faith in the weak currency, which can supposedly stimulate the economy. They argue that if Germany leaves, the rest of the Eurozone would devalue the currency, which will lead to the restoration of growth. But this is unlikely.

Before the introduction of the euro, countries such as Italy, Greece, Spain and Portugal (and before 1980, France), often devalued their currencies. The result was inflation and low growth. These painful consequences of currency depreciations led these countries to join the monetary union with Germany.

Currency devaluation can boost exports in a short period of time, but it also makes imports more expensive, thus reducing the purchasing power of households. Workers in this case are demanding higher wages to compensate for the lower actual revenue.

If the central bank is not strong enough and not prepared for economic slowdown, higher wages tend to lead to higher inflation. As a result, the spiral of wages and prices rapidly eliminate competitive advantage received from the weaker currency.

Second, proponents of exit of Germany claim that the German economy is too competitive to have a common currency with the weaker members of the Union, such as Italy, France and Spain. All this is flattering to the Germans, but not quite right. Since 2000, cumulative GDP growth in France was the same as in Germany. Moreover, Ireland and Spain had an even better result, even despite the deep recession during the crisis. Competitiveness does not depend only (or even mainly) on the exchange rate.

The fundamental factors as productivity, education, research and the tax system are much more important. In these areas, Germany is not the undisputed leader. On the contrary, the Germans need to carry out internal reforms if they want to maintain a leading position in the euro area and the world. In any case, it is absurd to reorganize the monetary union every time when the level of competitiveness of its individual members is changing.

Finally, proponents of Germany quitting insist that the current configuration of the Eurozone has a lot of flaws (though without mentioning specifically what those are). Of course, the euro area does not meet all the standards of an optimum monetary union (where should be open and diversified economy, free movement of capital and labor, as well as flexible wages and prices).

Yet, despite all the shortcomings of the Eurozone, the crisis has helped strengthen its integration and flexibility. Eurozone is hardly ideal, but it is strong enough to survive for a long time.

One of the most important conditions (often ignored) of the success of monetary union is the willingness of its members to adhere to a particular economic policy. Despite historical and cultural differences between countries such as France, Italy, Spain and Germany, they all agree to follow the fundamental principles of the market economy.

And most importantly - they all agree that the private, not the public sector, is responsible for creating jobs and sustainable economic growth requires an open market for goods and labor markets.

In the case of Greece, all these fundamental ideas, as it turned out, were not fully accepted. For decades, the state serves as the main employer. The commodity market was restrained by numerous bureaucratic restrictions and was under the influence of certain interests. Such a system could exist only through continuous public borrowing. Over the past 20 years (including the period prior to the entry of Greece into the euro area), the average annual budget deficit of the country was above 7% of GDP.

Wages and prices in Greece has seriously declined, helping to restore its competitiveness; today the country needs such a structure, in which the private sector can flourish. When linked with the third aid package conditions lead to the emergence of a sustainable economic model in Greece, the Greeks will be able to stay in the Eurozone.

First of all, the success of the euro zone should be based on that all members have strong and flexible economy, and thus remain competitive. Talks about the need for more (or less) economically competitive countries to leave the Eurozone are, of course, intellectually attractive. But it does not help solving problems.

Original by Michael Heise, Project Syndicate