No, Italy Isn’t a Victim of the Euro

(Bloomberg Opinion) -- Italian President Sergio Mattarella scuppered two populist parties’ attempt to form a government because they insisted on a euro hater as economy minister. As Italy gears up for a new election in the fall, it might be worth remembering why the euro is actually good for its member states.

Paolo Savona, the octogenarian economist Mattarella didn’t want in the cabinet because of his belief in making non-public  contingency plans for leaving the common currency, has described the euro as a “German cage.” That attitude is widely shared; the idea is that the common currency has deprived Europe’s economically weaker countries of devaluation as an instrument of economic policy, forcing them instead to use what is essentially Germany’s currency. The euro, according to this logic, has allowed Germany to issue cheap loans to the weaker economies so they could buy more German goods; Germany benefited while its euro area neighbors ran up debts and suffered the consequences of losing monetary sovereignty. 

So why would any country want to adopt the euro – or, if they are already eurozone members, keep using it? The high costs of giving it up are a strong argument but not a particularly satisfying one: If the argument against the single currency is right, it may be wise to take on the costs in the short term to reap the long-term advantages of running one’s own monetary policy.

The euro, however, is not the dumb mistake its detractors make it out to be. In a 2017 paper for the International Monetary Fund, Johannes Wiegand quantified the “euro privilege” – the economic advantage that comes from a lower perceived risk of investing in euro assets. The nature of this phenomenon is the same as that of the “exorbitant privilege” former French President Valery Giscard d’Estaing ascribed to the U.S. – the advantage that flows from ownership of the world’s most widely-used reserve currency. The Wiegand paper shows the privilege existed before the debt crisis that hit the euro zone early in this decade, was erased during the crisis and has re-emerged again since 2015. It means more investment and cheaper debt servicing than countries would have enjoyed without the euro.

While some recent research has suggested that euro membership has delivered negligible trade benefits to most member states, there’s plenty of evidence to the contrary. Italy’s bilateral trade flows with euro area members, for example, have received a powerful boost, increasing by 38 percent compared with the counterfactual as construed by Italian economists Paolo Manasse, Tommaso Nannicini and Alessandro Saia in 2014.

The three compared Italy’s performance after adopting the euro with a “synthetic control” – an aggregate of  the performances of countries outside the euro area, including EU members such as the U.K., Denmark and Poland and non-European members of the Organization for Economic Cooperation and Development, such as Australia, Canada, Japan and Switzerland. This method showed that, despite popular perceptions to the contrary, Italy also experienced lower inflation than it would have done without the euro. At the same time, the introduction of the common currency appeared to have hurt the growth of its per  capita economic output – but less than it did in Germany, supposedly the euro’s biggest beneficiary.

Another important effect of the euro has been significantly to increase tourism inside the euro area, at least by 44 percent.  Travel and tourism contribute some 11 percent of Italy’s gross domestic product –that’s a significant bonus.

Of course, many economists have argued that the single currency is not a finished product: There is no fiscal union to cushion the blow for regions hard-hit by economic crises. Bruising unemployment has instead served as a bitter adjustment mechanism and that has contributed to euro-resentment. But then, even the U.S., a much closer currency union, hasn’t been immune to this ill: Unemployment in bankrupt Puerto Rico is at 9.9 percent, compared with 3.8  percent for the U.S. as a whole.

Despite all the criticism of the euro since the debt crisis, despite top economists’ such as Paul Krugman and Joseph Stiglitz weighing in on the common currency’s design flaws, most Europeans have noticed the benefits. According to the December, 2017 Eurobarometer survey (the latest published by the European Union on the matter), there’s only one country where people believe, on balance, that the common currency has done more harm than good: Lithuania, which only joined the euro in 2015. Even in Greece, where, the euro’s critics claim, the deep economic crisis was caused by the currency, a majority of citizens doesn’t want to give it up.

What the euro has failed to achieve, at least so far, is its major political goal of fostering a shared European social identity. That’s  an important reason why populist parties in a number of countries have gained traction with their case against the euro as a sovereignty destroyer. For nationalist voters, the word “German" in Savona’s formula is more important than the word “cage.”

In Italy, the pro-euro – anti-euro balance of public opinion is one of the most precarious. A strong political campaign could sway voters either way, if the populists dare make it the central issue of the election. Mattarella took a risk by encouraging the League and the Five Star Movement to take the matter to voters. The “German cage” story may well triumph over the far more complex reality in voters’ minds. But the pro-euro camp does have strong arguments. It should just make them more convincingly in the run-up to the election, whether or not the populists decide to make the euro a central campaign issue.

©2018 Bloomberg L.P.

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