07 April 2012

Wolfson’s Prize, and Plan “A” and Plan “B” for Europe

As you probably know, the £250,000 Wolfson Economics Prize has challenged the world’s brightest economists to prepare a contingency plan for a break-up of the eurozone. According to (a prominent eurosceptic) Lord Wolfson who is sponsoring the prize: “There is now a real possibility that political or economic pressure may force one or more states to leave the euro. [...] The stakes are enormous.” The question that the applicants had to answer was formulated as follows: “If member states leave the Economic and Monetary Union, what is the best way for the economic process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership?” (Original press release and information pack for applicants)

The respectful judging panel announced the five finalists and some other entries of interest in 3 April 2012. (The winner(s) of the Wolfson Economics Prize will be announced on the 5th of July, after each of the finalists has had a chance to further “polish” his/her work.) You can take a look to the essays as well as watch video clips on the website of Policy Exchange. Doing so is both, educational and entertaining. Let me point out a few reasons.

* No summary in a newspaper article or a blog post can possibly deliver everything important in these thorough works which convey the personal views, ideas and expertise of their authors.

* One can find a collection of brilliant analogues and parallels (even if not original) such as: differentiating between the white and yolk in the current “omelette”, the (unlikely) “onion peeling” break-up process vs a “big bang” break-up scenario, or “one size fits none” eurozone monetary policy.

* Some essays include even surprising bluntness like this (backed by facts, analysis and/or argumentation, btw.): “The projections for Greece and its austerity programmes are a typical mix of ‘denial’ and bluff.”; “Germany’s beggar-my-neighbour policy”; investing the wage and salary of ordinary Dutch and German people “in junk”; “a large number of the eurozone banks are on their death bed, kept alive by the ECB’s life support machine”.

Diverging views

Notably, even though all of these smart people appear to see the current problems in the eurozone rather similarly, their focuses and views concerning the way forward are rather divergent. This despite that every applicant had the same “givens”: the same question to answer (which assumes that at least some country has to leave the single currency area) and the same issues to explore.

Is the break-up of eurozone a Plan “A” or a Plan “B”?
Catherine Dobbs writes in the introduction to her essay “The NEWNEY approach to unscrambling the Euro” that: “It does not suggest that the break-up of the Economic and Monetary Union is in any way desirable or inevitable.”
At the same time, already the title of the Jonathan Tepper’s essay is suggesting something else: “A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution”. In the text part, he states: “The best way to promote growth in the periphery, then, is to exit the euro, default and devalue.”

A country exiting the euro: is it a catastrophe or nothing special?
As Catherine Dobbs puts it (most probably reflecting the opinion of several other economists):  “One or more member states leaving the European Monetary Union, if this were to happen in a disorderly way could, as will be shown, be a five to ten times larger event for the global economy compared with the Lehman collapse. [...] The process by which one or more country leaves the Economic Monetary Union is, therefore, in itself the biggest threat to the future growth and prosperity of the current membership of the Economic and Monetary Union.”
On the other hand, Jonathan Tepper writes in the conclusion of his above referred essay that: “This paper has shown that many economists expect catastrophic consequences if any country exits the euro. However, during the past century over one hundred countries have exited currency areas with little downward economic volatility.”
Roger Bootle, the lead author of the thorough paper “Leaving the euro: A practical guide” has a counterargument to Mr. Tepper: “Leaving the euro would represent a combination of currency redenomination and devaluation. Each of these has umpteen precedents and the experience of such episodes can teach us much. But the combination is, I think, unprecedented.” (Comment by Robert Bootle in The Telegraph: How to escape the euro with the minimum of pain)

Do we need thorough planning for the eurozone break-up, or is it rather a matter of technicalities?
According to Neil Record “Planning is essential.” (“My core idea is that unless we have a plan, we have a chaos in the break-up.”) He is not the only one suggesting the necessity of careful analysis and planning. As another example, Jens Nordvig, the lead author of “Planning for an orderly break-up of the European Monetary Union” is insisting that: “This [the eurozone break-up] is very complicated task, because the euro is a national currency that is used widely around the world...” and “Policy makers should therefore plan primarily for the very limited break-up as well as the full-blown break-up scenario. The latter could be highly disruptive from a macroeconomic stand-point in the absence of any detailed and thoughtful advance planning.”
Citing the essay of Jonathan Tepper: “The mechanics of a currency breakup are surprisingly straightforward...” He is not saying that the eurozone break-up is simple, but according to him, it’s not as difficult as many seem to think.

Should eurozone break-up be prepared openly or in secrecy?
Most of the finalists are suggesting at least some degree of secrecy. The strongest case is being made by Neil Record, who in his entry proposes absolute secrecy: “The route that I recommend requires the formation of a secret Task Force by either Germany alone or (possibly) by Germany as the lead, and France as a junior partner. I deem absolute secrecy and deniability to be essential, because if the markets get wind of any plans for the dismantling of the Eurozone in its current form, then events will accelerate and spiral out of these Governments’ control, rending the Task Force’s plans irrelevant.”
Differently to this view, Jens Nordvig proposes as Step 1: “Communicate guiding principles for the redenomination of Euro denominated assets and obligations under local and foreign law in various break-up scenarios.” From the summary of his essay we find that: “Communication ahead of the event would allow market participants to prepare efficiently, helping to avoid triggering bankruptcies and other disruptions as a function of losses on new currency exposures.”

The question about the future of Europe and eurozone

It will be interesting to follow who will evolve from the “championship” to Wolfson’s Prize as the winner, and how much the final version of his/her essay will differ from the current one (after the author has had time to think about the ideas and arguments made by the other “challengers”).

In any way, right now it seems that the eurosceptics have a strong case to make, especially when considering all the wrongdoings in the process of setting up the European Economic and Monetary Union. (As a reference, take a look to the revelations in the essay of Charles Dumas that did not make to the shortlist, but was highlighted under the “Additional entries of interest”.) However, at this point it is important to remember what the question for Europe is actually all about. In other words, the Wolfson’s question needs to be considered in a broader context.

For this purpose, I have illustrated the (hi)story, the current decision point and the two possible futures for the European Union in a simple theoretical framework about the economic integration. (See the figure below.) Nine years ago while still at the Uni, I was taught that there are only two stable standings: Stage 1 (Free Trade Area) and Stage 5 (which is basically the United States). All other standings are transitional. Have the European policy makers understood it? Yes, they have. Already the European Coal and Steel Community (ECSC) back in 1950s has been declared as “a first step in the federation of Europe”.

Currently, the eurozone is quite at the point of completing Stage 4 / entering Stage 5. Since Stage 5 means a political union and essentially giving away the sovereignty of individual states, the transition / the final decisive step can in no way be easy. The question really is: whether to go back into Stage 1, or go ahead and move to Stage 5. Plan “A” or the official policy is to go ahead. Plan “B” would be the result of adopting the viewpoints of eurosceptics.

Wolfson’s question is basically urging to think about how to adopt plan “B” with lesser pain. In that sense, the discussions and the conclusions of the essays are bound to be biased towards undoing the eurozone. What would be a better question? Plan “A” seems too centralised and too rigid, and all questions related to it would be deviated in this direction accordingly. Plan “B” in turn would fail to cope with the current level of globalisation   / integration, and the progress of modern technologies, let alone the fact that going back in time means by definition degeneration.

What about this: “How to enable decentralised decision-making in a single currency area so that the individual decisions would not have negative externalities for the others?” But this question is most probably not going to be asked because it would require thinking outside the existing (theoretical, institutional etc.) frameworks.

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