There is a very interesting piece by Kash Mansori in the New Republic on the origins of the Euro-area crisis. The main point seems to be this: the crisis cannot be reduced to policy mistakes or misbehavior by the PIGS (Portugal, Italy, Greece, and Spain). Greece, especially, had some real problems with budgeting, spending, and tax avoidance that are integral for explaining why their government has had such a tough time adjusting to the crisis, but Mansori points out that

the very design of Europe’s common currency area not only caused, but was meant to cause the eurozone’s periphery to incur large amounts of international debt.

His conclusion is that it’s the Euro, not just problems internal to Greece’s political economy, that led Greece to where it is today. (One important piece of supporting evidence is that countries like Spain and Ireland, models of fiscal discipline in the 2000s, are in a fix too, just like naughty Greece.) I’ve had this argument before with numerous Germans and admirers of Germany, for whom the structural problems of the Euro itself aren’t obvious (and who, understandably, are loathe to view themselves–as members of the Euro–as somehow responsible for Greece’s problems).

But there is an interesting counterfactual question here that leads me to disagree with Mansori’s conclusions a bit. Let me try to lay it out. To what extent did the Euro versus the contemporary global financial system cause the Greek crisis? This is a paper that I will never write–not even with tenure–because it requires me to enter into a world of Greek politics and political economy that I do not know well. But I’ve spent some time thinking about this (I once had a bit of a public debate on it with Kevin Featherstone) and I think that there is something to what I’m about to write.

My task, in this paper that I will never write, is to imagine a counterfactual scenario in which the Euro does not exist but the global economy is otherwise the same. Then compare what I anticipate would have happened in Greece in that imaginary world, and see if it’s any different from what actually took place. I contend that from the perspective of Greece (if probably not Spain or Ireland), the world would not have looked much different in October 2007 without the Euro than it did with the Euro.

Here are some aspects of the global economy that I take to be features of a world without a Euro.

1. Capital accounts are still very open in Europe. That is, it’s still nearly costless to move money from Germany to Greece, either to lend or to invest. The only difference is that you have to convert marks into drachmas rather than just bringing your Euros
2. Exchange rates are fairly stable (or at least predictable, which can be shown to be the same thing for the purposes of my argument). This is probably debatable. But we do know that in one actual example of a non-Euro peripheral European economy–Iceland–exchange rates prior to the crisis were believed to be predictable. Ask English savers.
3. The “big” northern European economies are doing well, but trend growth is lower in Germany than in the PIGS (the “convergence” of the neoclassical growth model), so there’s an incentive for investors in Germany and France to look abroad for higher rates of return.
4. Smaller economies like Greece cannot borrow abroad in local currencies (“original sin“) but have to borrow abroad in international currencies–in this case, probably the mark and the pound instead of the drachma.

OK, so what happens in this imaginary world? Well, to begin with, you still get capital flowing to Greece from Germany because (following 1) there are still no barriers, (following 2) there’s still not too much exchange rate risk, (following 3) the incentive to lend is still there, and (following 4) the need to borrow is still there. The same pathology of overborrowing, overspending, and ultimate overheating would ensue–implicitly, I have assumed that the imaginary Greece is no better able to manage its public sector, force its wealthy to pay taxes, or avoid “cooking the books” in national accounting than the real Greece actually is.

The outcome from this would probably be another financial crisis that started off a lot like the one that actually occurred.

In fact, the only real thing that the existence of the Euro itself may have done is to shape beliefs about the exchange rate between Greece and the rest of Europe. Adopting a common currency is just an extreme form of fixing your exchange rate. If traders believe that exchange rate is fixed and credible (or predictable–again it makes no difference, due to high-volume currency arbitrage [another feature of the global financial system]) then they will act as if exchange rate risk does not exist. That is what adopting a common currency did: it make European lenders and borrowers believe, it seems, that the peg between the currencies of Greece and the rest of Europe was irreversible. Without the Euro, you’d imagine that lenders and borrowers around the region would be a bit more careful. But I’d argue that’s probably not true: look at Iceland and the UK. Also, look at every other emerging market crisis in the past thirty years where you have international overborrowing (which we could equivalently call “international overlending“) following mistaken beliefs about the future path of the exchange rate. We could talk about Latin America in the 1980s. Or Mexico in the 1990s. Or Southeast Asia in the late 1990s.

If I were to write this paper, I would argue that the actual effects of the Euro were not in causing the crisis but in exacerbating the problems that Greece faces in adjusting to the crisis. Here my argument isn’t new, it’s been told repeatedly by Krugman. Conditional on the existence of a financial crisis (which I argue might well have happened with or with the Euro) the fact that the crisis occurred with the Euro in place has probably made things worse, both for Greece and for the rest of Europe.

One final note: it’s often the case that there is a kind of code language that political economists use. “Political economy” can mean, for example, a kind of Marxian analysis of politics to some, or it can mean the study of political constraints on economic policy from a libertarian perspective to others. Here, the buzz-phrase that some readers may want to use to divine something about my politics is “contemporary global financial system.” It’s possible to read what I’ve written to imply that I’m critiquing the modern global financial system. Not necessarily so. I do not have have an alternative global financial system that I believe is clearly better for all people or all countries at all times. Although I would probably favor a Tobin tax, and I would certainly favor better economic policymaking in countries like Greece and better financial regulation in the U.S., I’m not sure that any of that would eliminate the phenomena that I’m describing here. I simply take it as a feature of the contemporary global financial system that from time to time, there are exchange rate/debt/banking/etc. crises. We had them before the Euro, we’ll have them elsewhere without it, too.