The eurozone peripheral nations paid a high price for single currency folly

Of course, counter-factual experiments are always just that – experiments. And yet it is also lays bare that the huge cost that the ill-fated attempt to dragoon the whole of Europe into a single currency has taken across a whole range of economies. It is increasingly obvious that it is by far the greatest self-inflicted economic policy mistake ever made. 

We have all known for a long time that for the peripheral countries across the eurozone – Greece, Italy, Ireland, Portugal and Spain, known collectively as the GIIPS – have seen their economies contract dramatically since the crash of 2008. Three of them had to be bailed out, and Italy might still have to be if its slow-motion banking crisis ever finally comes to a head.

Greece remains the most dramatic example, with per capita GDP now one quarter below its 2009 level, but a third of the countries in the zone ended 2014 worse off than they were in 2009. Unemployment has risen to catastrophic levels, and government debt ratios are out of control. 

But how much of that was specifically due to the single currency, and the austerity that came with it? And how much was simply caused by the long-running structural rigidities and profligacy of the nations involved? Economists and central bankers have bandied around different numbers, but they are mostly just guesswork. We can see that countries that said no to the euro, like Sweden, or the UK, came through the recession of 2008/9 in far better shape. But there isn’t an alternative universe where Ireland or Portugal never signed up for the euro.

It is possible to model that, however. In a new paper, University of Michigan professors Christopher House and Linda Tesar, along with Christian Proebsting of the Ecole Polytechnique Federale de Lausanne, constructed a model to work out how the European economies would have fared under different scenarios. 

First they looked at how the economies actually performed since the recession of 2008, and found that Greece, Ireland, Italy, Spain and Portugal between them contracted by 18pc in total. Then they ran a simulation in which there was no euro, and those countries had been able to devalue their currencies, or simply seen them weakened by the markets. In that universe, output by the end of 2014 would have been 7pc higher than it actually was. The rest of the eurozone was roughly neutral, because it already benefited from a weaker exchange rate.

In a second simulation, they ran the same figures for a world in which the austerity demanded by the European Central Bank, and by a German-led European Union, had not been imposed, and those countries were free to set their own fiscal and monetary policy. The result? The peripheral countries would have contracted by only 1pc, not the 18pc that they actually did. So, in total, output is now 17pc lower across those countries than it would have been without monetary union and the austerity that it demanded.

That is not all. They would have ended up with lower overall debt ratios as well. The cuts in government spending demanded as the price of the bail-outs should have reduced debt ratios across the region. The plan was for debt to come down by 20 percentage points in the five peripheral countries, from an average of 95pc when the crisis started. What happened? The overall ratio actually went up by 20 points, as economies shrank, and the overall amount owed either remained the same or carried on rising. It would be hard to think of a more self-defeating policy. 

An overall loss of 17pc of GDP in less than a decade is a huge price to pay for an experiment in monetary union. For a comparison, the Great Depression in the United States in the Thirties saw a drop in output of close on 30pc. The figures for the UK are less clear – GDP data was not reliably collected in those days – but most economic historians reckon Britain suffered around an 8pc drop in output in the early Thirties. So the trauma in the peripheral eurozone is already twice as bad as in this country in the Thirties. 

Nor is there any sign of it ending. The Greek economy, which on the original bail-out plan was meant to have recovered by now, is heading back down again – in the latest quarter output shrank by 0.4pc. After another three months of decline it will officially be back in recession. Portugal has seen its bond yields start to climb again as its economy stagnates and its debts become even more unmanageable. Italian growth has stalled since it joined the single currency 17 years ago and its banking debts grow worse and worse.

Of the peripheral countries, only Ireland and Spain appear to have escaped the cycle of debt, austerity and recession. But arguably, their place has just been taken by other countries – Finland is now shrinking again and France looks close to stagnation. The scale of the overall decline has not quite matched the Great Depression in the US. But then again it isn’t over yet. 

True, we will never know for sure what would have happened without the single currency. Still, the paper makes it clear that the single currency has imposed a huge cost on countries that were hardly rich to start with. With figures this stark, it is hard to believe those countries will put up forever with the damage. The only real question is which will be the first to escape and how?