Studies of Life

Learning by doing.

Solving the European Debt Crisis

02 May 2015 by Jim

The European Debt Crisis has had horrible consequences for the citizens of the peripheral countries like Greece, Portugal, Spain and Italy.

Greece is again now in trouble because it has trouble finding enough cash to make the necessary debt payments that will be due in the next weeks.

Several solutions to the debt problem have been suggested here and there, which I will sum up briefly.

Possible solutions

EU-wide inflation: if inflation were allowed to increase a lot, the amount of the sovereign debts compared to GDP would quickly be eroded. In the middle of the 20th century, France used this process, with annual inflation above 50% for four years, to reduce it’s debt to GDP ratio from over 100% to barely 20%. This works, but it’s ultimately a way of eroding the value of all accumulated capital, thereby making wealthy people and institutions (pension funds, banks) pay for what is essentially a hidden write-off.

Giving Greece the money: the EU’s member states could decide to simply give Greece the money needed to pay off most of its debt. Alas, such transfers would be resented by public opinion and very difficult to agree to. A more intelligent way of doing the same thing would be converting most of the debt into so-called “eternal bonds”, i.e. bonds that pay a coupon but never mature. Given the expected long-term average inflation rate of around 2%, even the coupon would, eventually, be worth practically nothing in a few decades and thereby reduce the immediate and future pressure on Greece.

Spectacular Greek Economic Growth: this is not realistic, and if it were to happen, it would not suffice to solve the issue. (Fun fact: the 60% maximum debt / GDP ratio defined in the Maastricht treaty rests on a premise of 3% annual economic growth, which is unobtainable, especially in the long run, by a developed economy in our day and age.)

Cancelling the debt: Cancelling the debt or levying a one-time tax on the wealthy and their bank accounts to pay off the debt would be different ways of making the wealthy pay for the mess. While possible, such a spectacular decision would erode the faith of the saving public in their own governments in Portugal, Spain, etc. and therefore not be very wise. Cyprus did it, but Cyprus is much smaller.

My favourite solution

A European transfer union: This is my personal favourite. The eurozone countries are bound to each other by the euro, yet their economies are diverse and do not have the same structure. Economic convergence as the EU expected / hoped did not manifest, and therefore macroeconomic imbalances are bound to continue to occur: if a country has an eternal trade surplus and another one has an eternal trade deficit, that means money is accumulating in the first and leaving the second. If their currency is the same, however, the exchange rate cannot compensate for this, so one of the two becomes less and less financially stable and the other’s financial health increases. It is not realistic to believe that Greece’s economy will ever be the same as Germany’s. It might be less competitive in 50 years, or more so, but it will not be exactly the same. Other big unions of states, like the USA, also have a mix of very competitive business places (New York, California) and smaller, less competitive places (Detroit right now) even though the labels may be switched at some point. For this reason, the US Federal Administration works as a buffer, collecting more tax in the competitive states and distributing more benefits in the less competitive ones. This ensures that the differences in lifestyle between different Americans is not too high, because the government guarantees a certain lifestyle for everyone. Europe should do the same.

In my mind, the real solution has to be permanently fixing the problem of the eurozone, which is monetary union of very diverse countries. It is normal in any given country that those who are well off be taxed more than those who are worse off, and that the proceeds from this levy be used to improve the situation of the worse off.

If Europe wants to remain a union, it has to move into this direction and become a kind of United States of Europe. All European countries are already social welfare states. So they already accept the logic of social transfers. The same logic needs to be applied to the whole continent.

I live in Luxembourg, where living standards are high, and I do not like paying taxes anymore than anyone else. But I know that 1000 euros taken from me via taxes and given to a Greek to pay his rent or buy groceries will have a bigger impact, and greater social utility, in the hands of that Greek than in my own hands.

We are all citizens of the world, and I am proud of the Europe we’ve built so far. Europe can be a prototype for how sovereign nations can unite to form something bigger. If it continues going into this direction, Europe could be the model for a United States of the World in a few hundreds or thousands of years, where we all realise that we’re not different from each other and all work together for the common good of all. In fact, the United Nations show that we are already moving into this direction. We live in ways ever more close to that of the others. Chinese accountants learn much of the same things that American and French accountants learn, and Thaï hygiene standards are rapidly converging with those of Japan, to name but a few examples. Even Russia and America work together on space exploration, because it’s more efficient than doing so alone. The future of the human race is to work together. The only question is how long it will take.

Maybe the next stage is discovering an alien species, and the new division from then onwards will no longer be by nationality but by species. And then we’ll take another few thousands of years to understand that we’re all part of the same universe, no matter the planet we hail from.

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