In memory of Dr. Andreas Höfert

Helmut Kohl is right, but not right enough

| Tags: Andreas Höfert

Economists were not very good at forecasting the financial crisis of 2007-08 and the ensuing Great Recession. They were far better at heralding the euro crisis. Before the euro was introduced in 1999, many warned that the way the European Monetary Union was constructed would eventually lead to the kind of crises we have experienced during the last five years.

As Milton Friedman thoughtfully stated in a debate with fellow Nobel economist Robert Mundell in 2000, “…its [the euro’s] attainment was driven by political, not economic, considerations, by the belief that it would contribute to greater political integration […] If achieved, political integration would render the monetary and political areas coterminous, the historical norm. Will the euro contribute to political unity? Only, I believe, if it is economically successful; otherwise, it is more likely to engender political strife than political unity.”

Many economists agree. The euro was first and foremost a project engineered by a generation of politicians who likely had a broader historical perspective than the tunnel vision of winning the next election. This is why the main economist critique, i.e. the lack of institutions needed to render the European Monetary Union an optimal currency area, was downplayed by its founding fathers.

They argued that once the common currency was there, the institutions would naturally follow. Unfortunately, 15 years after the euro’s creation, this is still not true. Now, one of the “founding fathers of the euro” has published his very personal analysis of the euro crisis. Helmut Kohl, the 84-year-old former German Chancellor, can barely speak and is wheelchair-bound, but still has all his teeth and wits when it comes to criticizing his successors. In his new book “Aus Sorge um Europa - Ein Appell” (Out of Concern for Europe), Kohl attributes the origin of the euro crisis to two major errors committed by his successor Gerhard Schroeder. The first, in 2002, is to have accepted Greece into the euro, despite its already being in an untenable situation, which “was quite obvious for everyone looking closer.” The second and really fatal error was to weaken and finally dilute the stability and growth pact by 2005.

Kohl is right, I think, but he is not right enough. Greece, by the fiscal and monetary metrics of that time - let alone flaws later uncovered - did not qualify for the monetary union. But by strict adherence to the Maastricht public debt criterion, neither Belgium (with a 117% debt to GDP ratio in 1998) nor Italy (114%) should have been admitted. Moreover Portugal, which in 1998 had and now still has a GDP per capita of roughly two-thirds the average Eurozone GDP per capita, and was competing in completely different international markets than more advanced economies, could not have supported so strong a currency as the euro.

Between 2002 and 2005, both Germany and France broke the growth and stability pact that was meant to be the fiscal bedrock of the Eurozone, and created a precedent. By reforming and diluting the pact in 2005, the Eurozone laid the foundation for almost all its members to break the pact during the financial crisis. This was certainly one cause of the euro crisis that followed. The growth and stability pact, however, as many economists and I also believe, is not enough to replace a true fiscal union needed for a functioning currency area. Neither is the so-called “six pack,” which replaced the stability and growth pact by 2011 and was supposed to strengthen the economic union but has de facto been breached repeatedly by many Eurozone members, including France a couple of weeks ago.

In my view, Kohl’s essay falls short in explaining the causes of the euro crisis, and therefore also on possible remedies. For those interested in the topic, I recommend instead the magnum opus of Professor Hans-Werner Sinn: The Euro Trap. On Bursting Bubbles, Budgets, and Beliefs.

This said, one must nevertheless agree with Kohl when he writes “(…) the euro is more than just a means of exchange, first and foremost it is a condition for political unity.” Regrettable is how contemporary European politicians utterly ignore this in today’s petty debates and blame-gaming.