How useful are the estimates of the economic consequences of Brexit?

blogs.lse.ac.uk/brexit/2018/03/13/how-useful-are-the-estimates-of-the-economic-consequences-of-brexit/

March 13, 2018

In this blog, Josh De Lyon (LSE’s Centre for Economic Performance) discusses some of the concerns with the economic forecasts of the effects of Brexit and suggests that the available reports are informative of the likely consequences of Brexit. He also provides an insight into how such research should be interpreted, beyond the headline-grabbing figures reported in the news.

On 29 January, a new government impact assessment on the economic effects of Brexit was leaked to Buzzfeed. The report predicted that a “soft” Brexit would restrict economic growth by 2 per cent, while a “hard” Brexit or “no deal” scenario would reduce growth by 8 per cent over a 15-year period. This is broadly in line with almost all other economic predictions of the economic consequences of Brexit. Following the leak of the report, some politicians and commentators were quick to discredit the integrity of such predictions. For example, Steve Baker, an MP and a minister in the Department for Exiting the EU, claimed that these predictions are “always wrong”.

The evidence on the effect of Brexit on the economy is almost unanimous: it predicts that Brexit will cost the UK economy in the region of 1 to 10 per cent of GDP in the long run, with greater costs for a hard Brexit relative to a soft Brexit. The mechanism driving these results is straightforward. The EU currently receives around 43 per cent of UK exports (House of Commons Briefing Paper, 2017). When the UK leaves the EU, barriers to trade will rise, causing trade and therefore GDP to fall. These findings come from HM Treasury (2016), OECD (2016), PWC (2017), NIESR (2016) and Dhingra et al. (2017) among others, in addition to the recently-leaked internal government report. These estimates often account for the benefits of new trade deals with non-EU countries such as the United States, China, and Australia. On top of this, other studies show that Brexit will cause a fall in inward foreign direct investment (FDI) of around 28%, leading to a 3.4% decline in real income (Dhingra et al., 2016).

The exception to these predictions is the study by the group “Economists for Free Trade”, who predict that Brexit will benefit the UK economy (Minford et al., 2018). However, the methodology used in this study has been heavily criticised by many economists and commentators for making wildly unrealistic assumptions, the details of which are discussed in a previous blog post by Dhingra et al. (2017).

So where do the numbers produced in the government impact assessment and other studies come from? The fundamental concept underlying these predictions is known as the “Gravity” model of trade, which predicts that the amount of trade in goods and services that flows between countries will depend on the economic size of each country and the distance between them. Gravity models have been very successful in predicting actual trade flows and are often regarded as one of the great successes of empirical economics (Anderson, 2011). In relation to the UK and the EU, gravity models accurately predict that there should be a high volume of trade between the two bodies. When barriers to trade are wedged in between the UK and EU, as is inevitable with Brexit, trade between the two will become costlier. The volume of trade between the UK and EU is likely to fall and, in some cases, the UK will switch to second-best trade partners. These costs then filter through the economy. This is the simplified mechanism driving the results of the reports discussed above.

It is good practice to critically analyse economic research. Economists themselves spend much of their time providing feedback on the research of others with the aim of improving the quality of the overall body of research. Every study is revised many times to ensure that the conclusions are solid. There are of course limitations with the literature on the economic effects of Brexit. For example, no sovereign country has ever left the EU, so there is no historical evidence to benchmark against the forecasts. Also, it can be difficult to translate the predicted trade effects into an overall welfare effect without adding more economic structure to the model. However, the strength of the prediction that Brexit will, on average, be harmful to the economy comes from the near-unanimous consensus of negative predictions from different types of models based on varying assumptions. Across all scientific fields, results that are reproduced multiple times are considered most reliable and economics is no different in this respect. That being said, economists are often guilty of producing academic research that is not accessible to the public. In the case of Brexit, the methodology of these studies is perhaps still somewhat of a “black box” to those outside of the field, given the relative complexity of the analyses. But the findings of these reports are clear and should be taken seriously: Brexit will reduce trade and investment, therefore directly harming the economy.

What is perhaps less clear is precisely how these estimates should be interpreted. Each analysis considers a pair of hypothetical situations. The first is where the UK leaves the EU and terms of the agreement are explicitly stated as the assumptions of the model. For example, a hard Brexit scenario might assume that the UK leaves the Single Market and Customs Union and trades according to WTO terms. Importantly, each analysis is very open about the type of agreement that is being estimated. The second situation is the counterfactual, whereby the UK does not leave the EU and the economy evolves as it would have done in the absence of Brexit. By estimating the economic differences between the two situations, the causal effect of Brexit can be isolated. That is, the estimates do not predict the future level of GDP in the economy. Instead, they isolate the causal effect of Brexit on the economy. In other words, it does not say “the UK economy will grow by x per cent after Brexit” but instead “as a direct result of Brexit, the growth of the UK economy will be x per cent different to how it would otherwise have been”.

Public Domain

It is impossible to predict the exact economic effect of a change as complex as Brexit. We will never directly observe the economic effect of Brexit because the economy is shaped by a wide variety of factors, many of which are unrelated to Brexit. In fact, further economic analysis will be necessary in years to come to identify the impact of Brexit after the event.

But this certainly does not mean that the forecasts are useless – they can, and should, be used to guide policy. There are many cases where the work of economists has helped to shape government policy for the better. A good example is the introduction of the national minimum wage in April 1999, which has been shown to have successfully raised wages without significantly harming employment. The Institute for Government reported in 2010 that the minimum wage was most frequently cited among members of the UK Political Studies Association as the most successful policy intervention since 1980. The introduction of the minimum wage followed the recommendation of many economists, including those on the Low Pay Commission, who recommend the level of the minimum wage.

One of the key policy prescriptions from the research on the economic effects of Brexit is that a hard Brexit scenario is considerably costlier to the economy than a soft Brexit scenario. Another example comes from the work of Dhingra, Machin and Overman (2017) who show how the economic effect of Brexit will vary across the UK, with some areas to be hit significantly harder than others.

Governments must consider a whole set of objectives when setting policy, of which the economy is just one. Likewise, voters will have considered many factors that go beyond economic issues when casting their vote in the referendum on June 23rd, 2016. But given the magnitude of the decision of the UK to exit the EU, it is essential to have a solid idea of how this will affect the economy and UK citizens. Hopefully, the research agenda discussed here is being considered as part of the overall policy-setting process for the UK’s separation from the EU.

This post represents the views of the authors and not those of the Brexit blog, nor of the LSE. 

Josh De Lyon is a research assistant in CEP’s trade programme.

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EUROPP – What happened to Europe’s left?

— Read on blogs.lse.ac.uk/europpblog/2018/02/20/what-happened-to-europes-left/

Only a handful of European states are currently governed by left-wing governments, and several of the traditionally largest left-wing parties, such as the Socialist Party in France, have experienced substantial drops in support. Jan Rovny argues that while many commentators have linked the left’s decline to the late-2000s financial crisis, the weakening of Europe’s left reflects deep structural and technological changes that have reshaped European society, leaving left-wing parties out in the cold.

Last year was an ‘annus horribilis’ for the European left. In Austria, France, and the Czech Republic, the left lost its governing position, and the same might occur in Italy in a few weeks. Today, only Portugal, Greece, Sweden, Slovakia, and Malta are governed by the left. The 2017 collapse was precipitous. The Dutch Workers’ party went from roughly 25% to 6%; the French Socialist Party went from roughly 30% to 7%. The Czech Social Democrats went from 20% to 7%. And the Czech Communist party saw its worst result in its almost 100-year history.

It may be tempting to connect the failure of the European left to the recent economic recession. It was during this recession or its aftermath that many left-wing governments (in Britain, Spain, Denmark) lost their mandates. Undeniably, the recession with its massive social cost caused much electoral instability, and opened a political door to various populist challengers. It would be, however, naive to suggest that the economic crisis was anything other than a catalyst. It was an accelerator that speeded up the onset of consequences of a structural development that we have been witnessing for at least three decades.

The weakening of the political left has been long in the making. It has been largely caused by deep structural and technological change that has altered the face of European societies, changed the economic patterns of the continent, and given a renewed vigour to politics of identity. In this process, traditional left-wing parties have lost not only the grasp of their main political narrative, they have lost much of their traditional electorates. These electorates did not so much ‘switch’ away from the left, they have rather disappeared as a comprehensible social group.

What was left behind?

Let us start at the beginning by asking what was the European left in its heyday. The defining characteristic of the post-war European left (which was distinct from the eastern European left of the time) was the democratic fight for the rights of working people. Shortly after the Second World War, most of the mainstream European left rejected Communism, and accepted a democratic path towards the emancipation and support of the working class. During the golden age of post-war development, the left participated in the construction of European welfare regimes, and where it has been most successful – in Scandinavia – it built up universalistic, egalitarian, and predominantly tax-funded and state-run systems of welfare provision.

In this construction, the parties of the left have primarily leaned on a significant and relatively homogenous group of working class electorates. These electorates were since the late 19th century defined by a strong sense of group belonging, or ‘class consciousness’. This consciousness was constructed from the cradle and lasted to the grave. It was passed on from parents to children, and cultivated by a plethora of party-associated organisations, such as daycare centres, sports clubs, choral societies, women’s clubs, and others. Together with workers’ unions organising the work on factory floors, and later in offices, these organisations helped construct a working-class subculture that permeated the social as well as the political, and that ensured the electoral stability of the European left.

Seymour Martin Lipset suggested that the greatest achievement of the left had been the lifting of the working class away from authoritarianism and towards cosmopolitanism espoused by left-wing intellectuals. Indeed, the general success of the left in capturing and ‘educating’ the lower social strata profoundly shaped European party systems. In western Europe, the political left has been uniformly and continuously associated with progressive policies not only in the economic domain, but also in non-economic matters such as the environment, women’s rights, and (slowly and shyly) the rights of minorities – both ethnic and sexual.

Somewhat paradoxically, the left’s success precipitated its own demise in a dialectic fashion. First, the emancipation of the working class – primarily the extension of access to higher education – changed the working class and its dependence on left-wing subcultures and organisations. Second, the left’s enabling of the search for rights allowed younger generations to seek personal liberation from traditional hierarchies, including those of the left.

From proletariat to ‘precariat’

Having lived in Gothenburg, Sweden, the home of the Volvo, I eagerly visited the Volvo factory, looking forward to meeting the contemporary proletariat. What did I see? Halls and halls of conveyor belts shuffling skeletons that would become fancy SUVs in about an hour, while silver robotic arms added various parts to them. And the working class? I saw precious few of them. They were mostly young women, sitting on comfortable chairs surrounded by computer screens and keyboards, listening to their iPods… I later learned that these workers earn as much as Swedish university professors (that means – a lot).

The traditional working class as we imagine it from the times of Henry Ford does not exist anymore. Most of the workers at Volvo with their above-average pay, comfort and job security can hardly be considered as such. Today’s working class is much less visible, and much more atomised. Today’s working class are the masses of unskilled service workers who predominantly cook, clean or drive. Often, their jobs are short-term or part-time, and low-paying. These people do not come into contact with each other nearly as much as the traditional factory-floor workers did. They are more often than not from diverse minority backgrounds, and thus are separated by cultural boundaries. In short, these people have significantly reduced ability to organise, and they do not. As my research with Allison Rovny shows, their political belonging is weak, and – in the absence of a formative subculture – it is malleable.

The extension of access to higher education has increased the individual ability of people to process more complex information and make their own choices. As education also brings better jobs, this process has created more cognitively and financially independent citizens. The 1968 generation opted for more socially liberal and less hierarchical politics, forming new social movements and later political parties that espoused left-wing economics, but that were defined by their social and cultural openness.

In the context of the changing working class and the developing political supply, the traditional left parties became parties of the new middle class – primarily of the increasing numbers of white-collar state employees. In doing so, the traditional left responded to the Green challenge by adopting more environmental and generally socially liberal profiles, but also it slowly but surely abandoned the new ‘precariat’ – the new service working classes and those in poor or irregular employment. Politically pulled by social-liberalism (of the ‘new’ left), and by economic moderation to the centre (preferred by a new group of urban white-collar workers and ‘yuppies’), the traditional left opened a political breach – a gaping political vacuum around those seeking economic protection, and a certain cultural traditionalism. The salience of this left and traditionalist political space, vacated by the mainstream left parties, would be boosted by another important structural development – the growth of transnational exchange.

Transnational transformations

The fall of the Berlin Wall in 1989 was a symbolic milestone, opening not just communist eastern Europe, but the entire developed world up to increased international exchange. My ongoing research with Gary Marks, Liesbet Hooghe and David Attewell shows that the three decades since have witnessed significant liberalisation of international trade, expressed in the formation of the WTO, and in the deepening of European integration, which has always practically centred around the free flow of goods, capital and people. The opening of European borders, as well as various conflicts on Europe’s doorstep and beyond, further increased migration into and within Europe.

The rise of transnationalism – of extensive cross-border flows of goods, services, money and people – is firstly an economic phenomenon. It replaces domestic products and labourers with cheaper foreign alternatives. Transnationalism thus divides society into those who, while happily consuming cheaper products, earn their income in either sheltered (public) or internationally competitive sectors on the one hand, and those, on the other hand, whose livelihood is threatened by foreign competition in the form of imported products, and imported labourers. Transnationalism thus creates economic winners and losers, who are increasingly keenly aware of their status in our globalised societies.

Transnationalism is, however, also a cultural phenomenon. While the privileged enjoy cross-border travel for business and pleasure on an unparalleled scale, they gain experiences, learn languages, build friendships and, on occasion, have found families across borders and cultures; those with limited financial, and educational means live in a world defined by national boundaries, customs, and language. The inflow of culturally distinct migrants into urban centres furthers this alienation. This opens a cultural chasm between the transnational cosmopolitans, concentrating in larger cities that increasingly embrace pluri-culturalism, and national traditionalists mostly present in smaller, peripheral localities, fearful of immigrants, and sceptical of their immigrant-accepting cosmopolitan co-nationals.

Transnationalism redefines the political space by dissociating economic progressivism from socio-cultural openness. Transnationalism associates cosmopolitanism with open economic exchange on the one side, and national traditionalism with economic protectionism on the other. In doing so, transnationalism effectively shatters the old electoral coalition of the left. The naturally protectionist workers are pulled away from the naturally cosmopolitan intellectuals. This brings us back to the great political void, to the question of who will represent the new ‘precariat’, seeking economic protection, and cultural traditionalism. Transnationalism also increases the salience of populist anti-elitism, as rural traditionalists feel unrepresented by, shunned by, and distinct from the largely urban, cosmopolitan elite. The populist call to the ‘common man’, is a call of economic and cultural protection against the transformations of transnationalism.

The left out

In shifting its focus to the new middle classes, the left let the new ‘precariat’ fall towards nationalist protectionism, where it became fertile ground for the populist radical right. The populist radical right has been around for a good while. First, as an anti-tax, anti-welfare critique of the left, but later, with the dawn of transnationalism, it tapped into the sensitive issue of immigration with game-changing vigour. Attracting a wide coalition of economic interests through its blurry economic proposals, as my earlier research shows, the radical right married its traditional petit bourgeois electorate to swaths of the new ‘precariat’, and outperformed the left as the dominant political voice of the contemporary working classes.

The transformation of the left, however, offers opportunities for diverse political entrepreneurs. As my forthcoming work with Jonathan Polk, as well as with Bruno Palier and Allison Rovny demonstrates, in countries that experienced particularly drastic economic downturn during the economic recession, such as Greece and Spain, and where the ‘precariat’ consequently includes many young and educated citizens, the populist challengers are mostly radical left parties that call for a return to true – economically interventionist, and culturally liberal – left-wing politics. In other places, populists eschewing comprehensible political labels gain electoral support largely through the votes of the ‘precarious’ left-behind.

The transformation of the proletariat into the ‘precariat’, together with the dawn of transnationalism, have reframed the political field. Post-war politics saw economic interests – primarily the extent and contours of the welfare state – as the dominant political contest that subsumed or largely ignored other, non-economic divides. The new politics of transnationalism promises to be a politics of identity, with the cleaving lines defined by ethno-national labels, as well as by the distinction between large urban centres and the rural periphery. As my work with Gary Marks, Liesbet Hooghe and David Attewell suggests, these divides may be as deep, sticky and formative, as were the traditional class lines of the 20th century. While these divides are as economically rooted, as they are cultural, the new political entrepreneurs will find it easier to frame their narratives in identity-based terms. We should thus expect to see economic issues couched in non-economic discourses of national and local identity.

This competition frame is foreign to traditional left-wing parties, whose identity was always rooted in economic class. They are facing a struggle to adapt to this changing dimensional structure. Recent presidential elections in France as well as in the Czech Republic demonstrate the shift, as both countries saw a leftish authoritarian opposed by a centrist liberal in the second round, while the traditional left imploded. Interestingly, in the context of this new political competition, the west resembles the east, and the mainstream left everywhere is left out in the cold.

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Note: This article gives the views of the author, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: © European Union 2013 – European Parliament (CC BY-NC-ND 2.0)

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About the author

Jan Rovny – Sciences Po, Paris
Jan Rovny is an Assistant Professor at Sciences Po.

Austerity by Design

Yanis Varoufakis’s lessons for reasserting European social democracy.

J. W. Mason

Image: Ververidis Vasilis/Shutterstock

Adults In The Room: My Battle With Europe’s Deep Establishment

Yanis Varoufakis

Farrar, Straus and Giroux, $28.00 (cloth)

In the spring of 2015, a series of debt negotiations briefly claimed a share of the world’s attention that normally goes only to events where celebrities give each other prizes. Syriza, a scrappy left-wing party, had stormed into office in Greece on a promise to challenge the consortium of international creditors that had effectively ruled the country since its debt crisis broke out in 2010. For years, austerity, deregulation, the rolling back of labor rights and public services, the rule of money over society, had been facts of life. Now suddenly they were live political questions. It was riveting.

Syriza was represented in these negotiations by its finance minister, Yanis Varoufakis. With his shaved head, leather jacket, and motorcycle, he was not just a visual contrast to the gray-suited Eurocrats across the table. His radical but rigorous proposals for a different kind of Europe—one based on meeting human needs rather than rigid financial criteria—offered a daily rebuke to the old refrain “there is no alternative.”

The drama was clear, but the stakes were a little obscure. Why did it matter if Greece stayed in the euro? Orthodox economic theory, after all, gives little role for money or finance. What matters are real wants and real resources, for which money is just a convenient yardstick. University of Chicago economist John Cochrane probably spoke for much of the profession when he asked why it made any more sense to talk about Greece leaving the euro than about Greece leaving the metric system.

Transformed from a critic of the play to one of the main characters in it, Varoufakis is like the protagonist in a postmodern fable.

But money does indeed matter—especially in economic relations between countries, as Varoufakis himself has convincingly shown. In his three books—The Global Minotaur (2011), And the Weak Suffer What They Must (2016), and Adults in the Room (2017)—Varoufakis offers a fascinating lens on the euro system and its masters. While the first two books chart the history of the international monetary system from World War II up to the debt crisis, his last and most recent book is a reflection on his five months as Greek finance minister. Taken together, they read as if Varoufakis is the protagonist in some postmodern fable, in which he is transformed from a critic of the play to one of the main characters in it.

Greece today has 20 percent unemployment—the highest in Europe. It would be higher still if it weren’t for the loss of a tenth of the working-age population to emigration. The most recent IMF projections say that unemployment will remain in the double digits well into the 2040s. Multiple rounds of bailouts and “reform” packages left its GDP a quarter below pre-crisis levels, and the IMF projects it will not regain the lost ground until around 2030.

And yet the Greek government is committed to sending 3.5 percent of national income abroad as tribute to its creditors each year, for the indefinite future. The battle by Varoufakis and his Syriza comrades against this intolerable state of affairs is, even in defeat, a rare spot of genuine heroism in today’s discouraging political landscape. There is plenty to question and criticize. But any political movement that hopes to reassert the values of European social democracy against its current legatees will have much to learn from his example, as well as his books.

National economies are linked by a vast web of money flows—payments for goods and services, of course, but also loans, interest payments, asset purchases, profits on foreign investment, and so on. Since David Hume in the eighteenth century, theorists have looked for automatic mechanisms—changes in prices, or interest rates, or exchange rates—that would bring all these flows of money across borders into balance. If such a mechanism existed, then in discussing the economic relations between countries we could safely ignore money, and imagine a kind of international barter serving the needs of all sides. The central claim of Varoufakis in The Global Minotaur, however, is that there is no such mechanism.

In Varoufakis’s story, money is not just an accounting device; real productive activity is organized—and disorganized—by flows of money. The stable reproduction of an international economy requires flows of money across borders to balance. But when this has happened over any significant period, it has either been through dumb luck or else because some more or less conscious “surplus recycling mechanism” moves money from countries gaining it back to those losing. Otherwise, human labor and other real resources must be sacrificed to bring the money flows into line, or else the imbalance will eventually end with a crisis.

The Eurozone’s crisis can only be understood through the political choices of its central bankers. This is the most important lesson of Adults in the Room.

Since World War II, there have been two main global surplus recycling mechanisms. The first, in the twenty-five or thirty years after World War II, is the Bretton Woods system, or what Varoufakis calls the “global plan.” During this period, the United States ran trade surpluses, but recycled them—plus whatever additional dollars the world needed—through a mix of foreign aid, military spending and foreign investment. During this period, exchange rates were more or less fixed; the first resort for a country losing hard currency was expected to be not devaluation, but capital controls—restrictions on financial flows out of the country. This system worked well, says Varoufakis, as long as the United States accepted responsibility for running it, managing the U.S. economy to maintain a sufficient but not excessive outflow of dollars to the rest of the world.

By the 1970s, this responsibility came to seem like too much of a constraint on achieving domestic policy goals. After a chaotic period of experimentation, the recycling mechanism shifted toward what Varoufakis calls “the global minotaur” and what others, less creatively, sometimes call Bretton Woods II.

Under this system, the pattern of flows was reversed: the United States runs a trade deficit, financed by foreign investment from the rest of the world. Capital controls were now verboten, and exchange rates were supposed to float; countries losing foreign exchange would solve the problem by allowing their currency to depreciate until their exports were competitive enough to earn the hard currency they required.

Perversely, the new recycling mechanism, and the U.S. position within it, benefited from the now-frequent currency crises. Safe assets—meaning dollar assets—were in great demand by anyone who wanted to protect themselves against the vicissitudes of international markets. The United States could comfortably finance its trade deficits with financial inflows from the foreign central banks that desperately needed reserves in the new regime of capital-flow and exchange-rate uncertainty. The United States was, in effect, selling insurance against the instability it had itself created when it abdicated responsibility for the international order.

One way of looking at the financial crisis of 2008 is as a breakdown in the post-Bretton Woods surplus recycling mechanism. Mortgage backed securities had played a key strategic role in the system in which dollars flowed out of the United States to pay for imports, and then back in as investment in the safe financial assets the United States was uniquely able to provide. So when the U.S. mortgage market blew up, so did the international payments system.

Europe at first seemed to better weather the 2008 financial crisis. But it soon suffered a financial breakdown and deep recession even worse than those in the United States. This crisis—and its deep institutional roots in the development of the euro system—is the subject of And the Weak Suffer What They Must?

The euro project, as Varoufakis tells the story, sprouted from the rubble of Bretton Woods. Elsewhere, the flexibility of floating exchange rates was supposed to help countries weather the rougher waters of the new international non-system. But in Europe’s tightly integrated economies, the idea that stable trade flows could coexist with wild swings in exchange rates was a non-starter.

It is rare to get such a frank and seemingly unfiltered account of the private conversations in which power is exercised.

A vast array of cross-border links were “calibrated to function under the assumption that all European currencies moved gradually together.” If Europe was to be tightly integrated in terms of real productive activity—something no one had seriously questioned once plans for a permanently deindustrialized Germany were abandoned shortly after the war—then it needed a tightly integrated monetary system as well. When the global system of fixed exchange rates broke down, a European equivalent had to be built up.

With one difference: the New Dealers who set up “the global plan” at Bretton Woods recognized that someone had to actively manage the international monetary system. Their European successors did not. Obsessed with “the fantasy of apolitical money,” they placed at the center of their new system a central bank with no political oversight, and no responsibility for Europe’s financial system.

The combination of maximally fixed exchange rates with maximally free trade led, inevitably, to the development of large trade imbalances within Europe—imbalances that were amplified by the otherwise desirable convergence of incomes across members of the union. (Despite the focus on competitiveness, faster growth probably played a larger role in southern deficits than did higher costs.)

For the corresponding financial flows from north back to south, the system relied on the private decisions of profit-seeking investors. This meant that when things broke down there was no one at the center focused on getting payments flowing again or maintaining the viability of the weaker partners, only a gaggle of burghers who wanted their money back.

The play-by-play of this breakdown is ably narrated by Varoufakis. The short version is that a number of poorer countries in Europe—Spain, Greece, Ireland, Portugal—enjoyed huge expansions of credit in the first decade of the euro, which financed (among other things) a big run-up in property values. The immediate lenders were the banks in the peripheral countries, but they in turn financed themselves by borrowing from elsewhere in Europe, an arrangement made much easier by the euro system.

Among the lessons in Varoufakis’s story is that real power does not always lie where titles and organizational charts say it should.

The crisis saw an abrupt halt to these cross-border financial flows. The result was a steep decline in lending, in asset values, and soon in real activity. With incomes falling steeply and interest rates rising, the debts incurred by a number of governments—Greece, Portugal, Ireland, but also Spain and even Italy—threatened to become unpayable. The deep cuts in public spending these countries were forced to make in response—along with business-friendly reforms to boost their “competitiveness”—were an economic disaster, plunging millions of people into a new world of deprivation and insecurity.

They were also the euro system working as designed.

Thomas Mayer, the former chief economist of Deutsche Bank, once described the euro as an attempt to create “the modern equivalent of a gold standard.” The goal was to subject the managed economies of postwar social democracy to a hard external constraint, outside the control of national governments. Forced to rely on money that “politicians could not conjure up from thin air,” governments would once again be subject to the judgment of the market. Capital would be fully mobile, national governments would voluntarily surrender the tools once used to manage financial flows, and exchange rate adjustments would no longer be available as even a last ditch resort to cushion trade imbalances.

Governments that wish to maintain a stable position in the international system would instead have to focus on two goals. First, to maintain an acceptable balance on the financial account, they would have to maintain the confidence of the markets; and second, to maintain an acceptable balance on the trade account, they would have to keep wages down and productivity up. The narrowing of policy space for national governments was, arguably, not a bug but a feature—even the central one.

Some version of this analysis is widely shared by both supporters and critics of the euro system. It has an important element of truth. But reality isn’t so simple, for a number of reasons. First, the role of exchange rates in stabilizing trade flows has been greatly exaggerated. It is simply not the case that Greece, for instance, could “pay its own way” before the euro by devaluing its currency, as is sometimes suggested. In fact, despite frequent devaluations Greece ran trade deficits continuously for decades before entering the euro. (As Varoufakis points out, the last time the country had a trade surplus was under German occupation in 1943.)

Second, financial flows often shift for reasons that have nothing to do with the policies of particular governments. The experience of peripheral Europe, like the experience of smaller countries around the world that have accepted free capital mobility, is not the strict but fair discipline of stern foreign investors, but rather of wildly unpredictable floods and droughts of money from alternately credulous and panicky markets, which depend more on financial conditions in the world’s financial centers than anything happening in the receiving countries.

At times Varoufakis’s narrative has the feel of a horror story where the protagonist tries to operate by the rules of normal life, only to gradually discover the conspiracy all around him.

A third difference between the euro system and the gold standard ideal is more subtle. Under the gold standard, as under the dollar standard that most of the world operates on today, central banks are subject to the same constraints as national governments. The Bank of Mexico cannot print dollars, it can only acquire them in the same ways as anyone else in Mexico. The European case is different. Despite the common perception that the European Central Bank is, well, the central bank of Europe, national central banks still exist and perform almost all the routine functions of central banking. (Among other things, they literally print euros.)

The central banks, in turn, make payments to each other through the TARGET2 system. If, say, there are more payments from people and businesses in France to Germany in a given period than from Germany to France, the difference shows up as a credit for the German central bank in the TARGET2 system, and a debit for the French central bank. This system has one critical feature: no one has to approve a central bank borrowing through it, and there are no limits to the balances it can run up. In effect, each central bank in the euro area has an unlimited overdraft facility from all the others.

There were good reasons to design the system this way. Indeed, it is hard to see how one could have a monetary union without some mechanism to ensure that a euro in a bank account in one country can always be used to make a payment of one euro to any other. But from the point of view of creating a disciplining mechanism on states, it is a fatal flaw. With a cooperative central bank, it is impossible for a euro area government to ever run out of euros.

Whatever limits the system puts on public spending, then, do not come automatically, but must be actively imposed by central banks. Under the gold standard, central banks were inside the nation-state, sharing its international constraints. But in the euro system they are outside it, part of the machinery that imposes those constraints. This critical difference means that the euro area’s crisis cannot be understood in terms of bad institutional design; instead, it must be understood in light of the political choices of its central bankers. This is perhaps the most important lesson of Adults in the Room.

In January of 2015, when Varoufakis entered the stage, Greece was already on its third loan negotiations with its official creditors. The first one had swapped the Greek government’s debt to private lenders elsewhere in Europe with debt to other European governments, to the ECB and to the IMF. The money loaned to the Greek government had been used to repay loans that private lenders were unable or unwilling to roll over. It was a bailout—but for banks in Germany, France, and elsewhere, not for Greece. From the point of view of the Greek state, their debts to private lenders had simply been replaced with debts to official lenders.

‘We were dealing with creditors who did not really want their money back.’ The real issue was power.

While the bailouts did not reduce the amount of debt owed by the Greek state, they did change its character. While private lenders are primarily interested in getting their money back, public authorities often have a broader set of interests in the behavior of their debtors. The new loans to Greece were governed by a Memorandum of Understanding (MoU) laying out a set of policy changes the Greek government had to make to receive the money. The loans were to be doled out in installments, with each new payment contingent on the “conditionalities” being satisfied.

This model followed a precedent set by numerous loans to developing countries since the 1970s. In principle, the goal was to not just solve the immediate crisis, but to make the “hard choices” necessary to put the borrower on a sound footing to avoid future payments crises—something that, by hypothesis, local political institutions would not be willing to do on their own. Whatever their intentions, these agreements necessarily involve a substantial transfer of authority from national governments to creditors.

By the time Syriza took office, the Greek state had already agreed to a long list of “reforms”—from banning collective bargaining to loosening restrictions on milk freshness—and had surrendered control over key government functions, including tax collection, to officials appointed from outside. Varoufakis describes the arrangement as “neocolonial,” and with reason. In the nineteenth century, turning over tax collection to European authorities was a penalty imposed on defaulting governments from China to Turkey to Egypt, often as a first step toward outright subjugation. The central issue under dispute in the first month of negotiations was whether the new government would continue to be bound by the agreements signed by the previous one.

The bulk of Adults in the Room is a detailed account of the negotiations between the Greek government and its creditors between February and June of 2015. The creditors were, notionally, three public institutions—the IMF, the European Central Bank, and the governments of the other euro-area states as represented by the European Commission. It was this “troika” that had drafted the MoUs and appointed the officials running the Greek tax authority and other government functions under government control. The legitimacy of this body was immediately challenged by the new Greek government, leading to the famous exchange at the end of the first public meeting between Varoufakis and Dutch Finance Minister Jan Dijsselbloem, who angrily told him “you’ve killed the troika!” before pointedly refusing to shake his hand. (In the end, the accusation proved premature.)

Confusingly, the negotiations themselves took place in the Eurogroup, an informal working group that included all euro-area finance ministers as well as representatives of the three troika bodies. Within these meetings, the dominant figures were Dijsselbloem, as president of the Eurogroup, and perhaps the book’s most fascinating character, German finance minister Wolfgang Schäuble.

Austerity was supposed to be just a means to stabilize payments by Grece to its creditors. But what if the actual goal was austerity, and the crisis and unpayable debt just convenient openings to pursue it?

Varoufakis’s description of his time in the Eurogroup meetings is never less than gripping. He is a master storyteller, and it is very rare to get such a frank and seemingly unfiltered account of the private conversations in which power is exercised. For this narrative alone, the book deserves a place on the short shelf of great political memoirs. The content of the negotiations described by Varoufakis—not to mention his own political role—will look very different in retrospect, depending on whether Europe continues down its current path toward a Hayekian prison of nations, changes course, or blows itself apart. But no matter what happens, this book will be read in fifty years by anyone who wants to understand how elite politics actually works.

Several lessons are clear from Varoufakis’s story. First, real power does not always lie where titles and organizational charts say it should. Neither Schäuble nor Dijsselbloem has, on paper, any more authority over the Greek debt than any of the other fifteen finance ministers. Nonetheless, their control of the proceedings is seldom questioned and never seriously challenged.

In one striking scene, Pierre Moscovici (representing the European Commission) initially agrees to replacing the existing MoU with language he and Varoufakis draft together and promises to get the new text through the Eurogroup. But the moment he presents their new language “in the room,” Dijsselbloem swats it down. And “in a voice that quavered with dejection,” Moscovici meekly assents: “Whatever the Eurogroup president says.”

A second lesson is that the rigidity or flexibility of rules is a decision variable for whoever is in charge of enforcing them—and the more opaque and indirect the decision-making process, the more space for discretion there is. In a dramatic scene near the end, Dijsselbloem announces that the Eurogroup will depart from its til-then ironclad principle of unanimity and issue an official statement over Greece’s veto. When Varoufakis asks how that is allowed, he gets this response from the EU secretariat: “The Eurogroup does not exist in law. . . . and therefore its president is not legally bound.”

Third, arguments are seldom decided, or even debated, on the merits. Varoufakis’s main activity during his months in office seems to be putting together detailed “non-papers” (the EU’s suggestive term for unofficial proposals) on possible resolutions, which the other side simply ignores. As he puts it:

On the assumption that good ideas encourage fruitful dialogue and can break an impasse, my team and I worked very hard to put forward proposals based on . . . sound economic analysis. Once these had been tested on some of the highest authorities in their fields . . . I would take them to Greece’s creditors. Then I would sit back and observe a landscape of blank stares. . . . Their responses, when they came, took no account of anything I had said. I might as well have been singing the Swedish national anthem.

Curiously, no matter how often it is repeated, this experience doesn’t lead him to question his assumption that good ideas are what matter. Even when Schäuble tells him bluntly in a one-on-one meeting that “I am not going to negotiate with you,” Varoufakis goes on gamely trying to make a deal. Right to his last days in office, he is offering new proposals, all vetted by the highest authorities.

At times the narrative has the feel of a horror story where the protagonist tries to operate by the rules of normal life, only to gradually discover the conspiracy all around him. In Berlin, for example, Varoufakis is invited to a dinner by a couple of leading figures in the Social Democratic Party. The Social Democrats are Merkel’s junior coalition partners but, they assure him, they see the insanity of what is being done to Greece and they want to support him in his struggles with their government. The dinner must be a secret of course—no aides, no press—so they can strategize together. Then, at the restaurant, one of the Germans’ phone rings. He hands it to Varoufakis: it is ECB president Mario Draghi, calling to say that assistance for Greece’s banks is being cut off.

The message is threatening enough, but it is doubly chilling that it is delivered through a supposed ally.

What was it all about, then? More precisely: what did the creditors want? What leverage did they use to get it? And, could Greece have done any better?

The negotiations which dominated Varoufakis’s five months in office were ostensibly aimed at a long-term resolution in which the Greek state could continue servicing its debts while getting the resources it needed to foster economic growth and development. But it would be a mistake to see the stakes as being whether the debtor could continue borrowing, or the creditors would get their money back.

For one thing, Greece already had a primary surplus—its revenues were more than enough to fund expenses other than debt service costs. No one on either side contemplated a return to primary deficits. So the funds being doled out or withheld by the creditors were not in any sense financing the activities of the Greek government. Quite literally, the creditors were lending Greece money only so that it could keep paying back those same creditors. In effect, the Greek state was paying a substantial tribute to its creditors each year for the privilege of remaining in debt to them.

Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions go well beyond what we normally think of as the remit of a central bank.

The circularity of this arrangement in financial terms makes it clear that the financial side was never what mattered. As Varoufakis shrewdly notes, “we were dealing with creditors who did not really want their money back.” The real issue was power—the power the debt gave the creditors to dictate the Greek government, and the power they had to punish Greece if it didn’t comply.

Concretely, this meant, on the one hand, acceptance of the existing MoU and everything it implied, including even deeper austerity, fire-sale privatization of everything owned by the public, a permanent end to collective bargaining, and steep cuts in public and private wages; and on the other hand, the ECB’s ability to shut down the Greek banking system.

We will return to the second point—the key strategic role of the ECB. As to the first: why were the European authorities so insistent that Greece surrender control over domestic policy and accept the ultra-liberal program of the MoU? Varoufakis suggests two possible answers.

At some points, he argues that the MoU and the larger austerity agenda were embraced opportunistically by politicians who did not want to admit that the first bailout had handed over public funds to their own banks. Blaming Greek profligacy was the politically easier cover story. “The sole reason that the IMF and EU were asphyxiating us [was] because they did not have what it took to confess the error” of the earlier bailouts, he says. Austerity, in this telling, is not a goal in itself, but merely “a morality play pressed into the service of legitimizing cynical wealth transfers from the have-nots to the haves during times of crisis, in which debtors are sinners who must be made to pay for their misdeeds.”

A second possibility is that austerity and the rolling-back of social democracy were the goals all along, for which the Greek crisis simply provided an opportunity. In this version, Greece was subject to “fiscal waterboarding” not to avoid acknowledging the earlier bailout, but precisely to force compliance with the MoU—and even more, to provide an example for other governments in Europe.

It is clear why Varoufakis prefers the first story: the logic of his position in government required something like it to be true. If austerity were not an accident, a mistake—if the authorities would not in principle be just as happy with an active, egalitarian Greek state—then what was he sitting in all those meetings for? You can’t walk into negotiations unless you believe that a mutually satisfactory agreement is at least possible.

Unfortunately, Varoufakis’s narrative doesn’t cooperate with his analysis here. Just a few pages after the “sole reason” line, he describes a meeting with Pier Carlo Padoan, Italy’s finance minister:

Our discussion was friendly and efficient. I explained my proposals, and he signaled that he understood what I was getting at, expressing not an iota of criticism but no support. To his credit, he explained why: when he had been appointed finance minister a few months earlier, Wolfgang Schäuble had made a point of having a go at him at every available opportunity. . . .

I enquired how he had managed to curb Schäuble’s hostility. Pier Carlo said that he had asked Schäuble to tell him the one thing he could do to win his confidence. That turned out to be ‘labour market reform’—code for weakening workers’ rights, allowing companies to fire them more easily with little or no compensation and to hire people on lower pay with fewer protections. Once Pier Carlo had passed appropriate legislation through Italy’s parliament, at significant political cost to the Renzi government, the German finance minister went easy on him. ‘Why don’t you try something similar?’ he suggested.

“I’ll think about it,” is Varoufakis’ diplomatic reply.

A couple days later, he has his first meeting with the German finance minister himself. Schäuble brushes off Varoufakis’s suggestions for strengthening the Greek tax authorities, insisting instead on “his theory that the ‘overgenerous’ European social model was no longer sustainable and had to be ditched.”

Comparing the costs to Europe of maintaining welfare states with the situation in places like India and China, where no social safety net exists at all, he argued that Europe was losing competitiveness and would stagnate unless social benefits were curtailed en masse. It was as if he was telling me that a start had to be made somewhere and that that somewhere might as well be Greece.

Schäuble’s frank language is revealing, and we owe Varoufakis thanks for bringing it—and many similar statements by other officials—into public view. At the same time, it is a problem for his argument that the only obstacle to a decent deal was the authorities’ need to save face over the earlier bailouts.

The exchange with Schäuble also makes clear how right Varoufakis is to dismiss as a “fundamental misconception” the idea that Europe’s crisis involves “a tussle between Germans and Greeks.” The battle in Europe may be between interests, classes or ideas; but it is not, except superficially, between nations. Whichever way the austerity machinery is pointed at the moment, it can easily be turned somewhere else.

During the debt negotiations, one of the rare moments of disunity on the creditor side is a shouting match between Schäuble and the French finance minister Michel Sapin. Varoufakis, on the other side of the room, asks someone what is going on. “Wolfgang said that he wants the troika in Paris,” is the reply. For German conservatives such as Schäuble, Greece is indeed just somewhere to make a start; the real target is the larger and stronger welfare states of Europe—and ultimately their own working class.

The ostensible purpose of the negotiations was to resolve the crisis and stabilize payments by the Greek government to its creditors; austerity was supposed to be just a means to that end. In that case, if the same financial results could be achieved with a less brutal set of policies, everyone should be ready to sign on. But what if it is the other way round? What if the actual goal was austerity, and the crisis and unpayable debt just convenient openings to pursue it?

One doesn’t have to look far to find this argument being made quite openly. I suspect the real attitude of much of the European elites is well captured in a 2006 Economist editorial, which argued:

The core countries of Europe are not ready to make the economic reforms they so desperately need—and that will change, alas, only after a diabolic economic crisis. . . . The sad truth is that voters are not yet ready to swallow the nasty medicine of change. Reform is always painful. And there are too many cosseted insiders—those with secure jobs, those in the public sector—who see little to gain and much to lose. . . .The real problem, not just for Italy and France but also for Germany, is that, so far, life has continued to be too good for too many people.

If Varoufakis didn’t want to take Schäuble’s word for the real stakes, he might have listened to the various representatives of the troika who repeatedly made clear that “labor reform”—specifically, a permanent ban on collective bargaining—was one of their red lines. Or he might have looked at the ECB’s record as an enforcer of austerity in Ireland, Italy, Portugal and Spain, years before Syriza came into office.

In 2011, when the Italian bond market was in turmoil, the ECB intervened to stabilize it—but only after sending a private letter to then-prime minister Silvio Berlusconi demanding a long list of “structural” reforms, including “full liberalisation of local public services,” particularly “the provision of local services through large scale privatizations,” “reform [of] the collective wage bargaining system . . . to tailor wages and working conditions to firms’ specific needs,” “thorough review of the rules regulating the hiring and dismissal of employees,” and cuts to private as well as public pensions, “making more stringent the eligibility criteria for seniority pensions” and raising the retirement age of women in the private sector. (Strangely, this intervention and the similar demands by the ECB on the governments of Spain, Ireland and Portugal get almost no mention here.)

Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions go well beyond what we normally think of as the remit of a central bank. And since the letter was private (it was published later) it can hardly be seen as a cover story for a bank bailout. The only reason for the ECB to make these demands is if they really wanted them met.

Dozens of poor countries have been forced to sign humiliating agreements with the IMF. What was new here was just that this treatment was being applied to a country in the rich world.

Looking beyond Europe, Varoufakis might have looked at the many structural adjustment programs promulgated by the IMF in countries of the South. Varoufakis is not wrong to liken Greece’s treatment to that of Europe’s colonies and protectorates in the age of gunboat diplomacy. But one needn’t look back to the nineteenth century for precedents. Since the 1980s, dozens of poor countries have been forced to sign humiliating agreements with the IMF, surrendering autonomy over economic policymaking and committing to brutal austerity. What was new here was just that this treatment was being applied to a country in the rich world.

Late in the book, Varoufakis has a meeting with IMF chief Christine Lagarde. Of the leaders on the creditor side, Lagarde comes off as the most sympathetic, and Varoufakis is cautiously optimistic he may be able to win her over. But when he gets his private meeting, what is the first thing she wants to talk about? Pharmacy deregulation! In a country with a quarter of the workforce unemployed, massive poverty, and public services in a state of collapse, that has already seen wall-to-wall deregulation, the most urgent problem she sees is that family-owned drugstores are still too sheltered from competition with international chains.

Stories like these—and the book is full of them—suggest that the creditors were not just looking for a politically palatable way to avoid responsibility for their earlier failures. They were sincere and consistent ideologues, striving to remake Europe in the model of an idealized free-market society. Varoufakis recounts these stories masterfully, yet curiously they never seem to shake his view that a mutually beneficial deal is just around the corner.

If Varoufakis’ account of his opponents’ motives is somewhat unsatisfactory, his account of their means is lucid and compelling. One of the central points is that the European Central Bank is a thoroughly political actor. Its decisions to buy or not buy government debt, to lend or not lend to banks, are always described in terms of statutory rules, but in practice, the rules mean what the ECB wants them to mean.

Perhaps the most dramatic expression of this was Draghi’s 2012 interventions to bring down rates on euro-area governments’ bonds—something the ECB’s charter was understood to explicitly forbid. In Greece, of course, the rules were bent the other way.

‘They want to destroy us.’

Varoufakis gets this exactly right: “In reality, after 2008, any attempt by the ECB to impose its charter rigorously . . . would have ruled out any of the various waivers, reinterpretations and extraordinary shenanigans that have so far prevented the eurozone from collapsing altogether. Far from being apolitical, the ECB’s huge discretionary power over when to enforce its rules and when to circumvent them . . . make it the most political central bank in the world.”

The ECB was also the only one of the three troika institutions with direct coercive power. The other creditors could, of course, refuse to extend new loans. But by 2015, the funds Greece was receiving from its official loans were being used entirely to service their existing debt. So a threat to cut off lending would just mean that if Greece defaulted on its loans, it would have to default on its loans.

The ECB, on the other hand, had the power to withdraw liquidity assistance from Greek banks, forcing them to shut down. Indeed, even the threat that assistance might be withdrawn was enough to provoke a bank run. This was the creditors’ only real stick, but it was a big one.

Dijsselbloem, who uses his first meeting with Varoufakis to deliver an ultimatum (“the current program must be completed or there is nothing else!”), clearly expects that the mere threat of a bank shutdown will end all resistance. As Varoufakis observes, “Experience has taught functionaries operating on behalf of Europe’s deep establishment [that] . . . government ministers, prime ministers, even the president of France, buckle at the first whiff of . . . the ECB’s big guns.”

Was there anything to be done? Could different choices by the Syriza government have allowed them to deliver on their promises? Or were the creditors always going to get their way?

Varoufakis’s answer is unambiguous: Greece should have walked away from the negotiating table at the end of February, when the creditors withdrew an earlier offer to reconsider the policy commitments made by previous Greek governments, and made it clear that the troika would not accept any modifications to the existing MoU.

If Greece had walked away at that point, the ECB and Bank of Greece would certainly have withdrawn liquidity assistance from the Greek banking system, forcing it to shut down—just as they eventually did in June.

But if the confrontation had come in February rather than June, Varoufakis believes, his colleagues would have chosen to fight rather than to surrender. Four months of fruitless negotiation, of “fiscal waterboarding” (letting the state get enough resources for minimal functions but not for any new initiatives), of vilification in the press, and of public and private pressure on individual members, left the Syriza government too demoralized and divided to resist when the ultimatum eventually came.

Varoufakis, to his great credit, takes responsibility for the decision to go on with talks even when it was clear that the other side would accept nothing but continued austerity. In a section entitled “mia maxima culpa,” he doesn’t mince words: “It was a tough call,” he writes, “but I should have made it. . . . I failed to rise to the challenge.”

This book will be read in fifty years by anyone who wants to understand how elite politics actually works.

Suppose the Greek government had refused to continue negotiations after February 24. What would have happened then? The ECB and/or the Bank of Greece would have announced an immediate end to emergency liquidity assistance (ELA) to Greek banks. The pretext would have been that the Greek government debt held by the banks, being rated below investment grade, was not acceptable as collateral, and that a waiver from this requirement could only be granted if an IMF program was in place and Greece was in compliance with it.

Without ELA, the Greek banks would have shut down and available cash would have had to be carefully rationed, just as eventually happened in June. At that point—as did not happen in June—the Syriza government would have activated its “deterrent.” The three key pieces of this were, first, a unilateral write-down or “haircut” of Greek bonds held by the ECB; second, the introduction of a parallel payment system, including both a system of electronic payments and certificates against future tax liabilities that could circulate in the place of cash; and emergency legislation to replace the head of the Bank of Greece, an establishment politician hostile to Syriza who had been appointed in the final days of the previous government.

Varoufakis is convinced that the bond haircut was seen as a serious threat by the ECB—not of course for the financial loss involved, which is trivial and anyway irrelevant for a central bank, but because of the administrative and political headaches it would cause. But given the ECB’s flexible approach to its own rules, it is hard to be convinced on this point.

Much more important is the second piece. If an alternative payments system could allow purchases to be made, workers to get paid, and businesses to buy needed inputs even with the country’s private banks shut down, then the ECB would be largely defanged. With the creditors’ threat to bring economic life to a halt removed from the game, Greece could return to the bargaining table in a much stronger position. And in the worst case, if the creditors still refused to accept anything but the existing package, the parallel payments system would become the basis for a new currency, allowing a gradual transition out of the euro instead of a wrenching leap. Obviously there are many devils in the details, but the logic of what Varoufakis describes seems sound.

The greatest strength of the political establishment in Europe—as of political establishments everywhere—is the perception that their rule is an unchangeable fact, that there is no alternative. The sight of Greece still standing—businesses running, people working and paying bills, public services functioning—after the ECB had done its worst would severely damage this aura of inevitability.

For precisely this reason, a Greek non-capitulation was directly threatening to conservative politicians elsewhere in Europe, especially those facing challenges from the left. As Varoufakis says, “What mattered to them was their authority, and that was being challenged by a leftist government whose success at negotiating a new deal for its country was the creditors’ greatest nightmare, as it might give ideas to other Europeans.”

Spanish finance minister Luis de Guindos directly confirms this at one point, telling Varoufakis that his position in the Eurogroup meetings was dictated by fear that any Syriza success would give ammunition to his government’s opponents in the leftwing party Podemos. Conversely, as Varoufakis observes, a hardline treatment of Greece served “as a deterrent to any other politician in Spain, Italy, Portugal or indeed France, who might be tempted” to challenge the reigning orthodoxy.

It would be easy to cast Varoufakis as naïve, but he isn’t. Rather, he is a believer in the European project.

In short, Greece had to be made an example of so people in the rest of Europe wouldn’t get ideas. Varoufakis is bluntly told at one point that austerity is necessary not to improve Greece’s repayment prospects, but “to demonstrate to Paris what is in store for France if they refuse to enact structural reforms.” Or as the Slovak finance minster—“Schäuble’s keenest cheerleader in the Eurogroup”—put it, “We had to be tough on Greece because of their Greek Spring.” But this dynamic might also have worked in Greece’s favor if they had stuck to their guns. Rather than risk an example of successful noncompliance, the creditors might have compromised instead.

As for the third component of the Greek response—replacing the leadership at the Bank of Greece—Varoufakis doesn’t think much of it. It is certainly true that Stournaras, the holdover governor, did everything he did to undermine the Syriza government, deliberately stoking panic in financial markets in direct violation of a central banker’s core responsibility. And it is true that, officially, the final decision to shut down the Greek banks was made by the Bank of Greece, not the ECB. But Varoufakis is convinced that Stournaras was just following instructions from his masters. Against those in Syriza who see control of the central bank as critical, he insists that it is just “a branch office of the ECB.”

I’m not sure he is right about this. On paper, at least, the euro system gives considerable autonomy to the national central banks, and it is easy to find examples of national central bank leaders defying the central authorities in Frankfurt (most visibly, Jens Weidemann of Germany). Any future European government considering a challenge to the authorities will need to explore whether, and how, the national central bank can become a strategic asset.

We’ll never know whether Varoufakis’s “Plan X” could have worked. When the moment came it was not activated. Faced with the troika’s final ultimatum in June, the Syriza government put it to a referendum—and then ignored the public’s resounding vote of “No.”

Varoufakis makes a convincing case that, contrary to what some have alleged, he did have a coherent plan for dealing with a breakdown in negotiations. But it is also clear that he was not really prepared to use it. In a small but telling detail, the alternative payments system is always described as a “deterrent,” as if it is merely leverage to get a better deal from the authorities, not as a step toward greater independence from them. And while the basics of the plan were in place when he took office, neither he nor his staff seems to have put much effort into developing it further.

Despite all the evidence, he seems to have been convinced to the end that the creditors would eventually come around. It is striking that whenever he talks about the need for more time, the benefits of waiting just a bit longer, it is in the hopes that the creditors will at last see reason. Even after the “No” vote, preparing the alternative payments system is only one of four priorities for his staff; number one is developing yet another offer for the creditors to reject. When he assures Alexis Tsipras, then the Prime Minister of Greece, that Merkel will “100%” accept his new proposal if she is rational, one wants to reach through the page and shake him and say, “Yanis, haven’t you been reading your own book?” The dejected Tsipras has a clearer view of the situation when he replies that new proposals don’t matter: “They want to destroy us.”

Game theorist that he is, Varoufakis must know that the bargaining power of the weak depends on their exit options.

It would be easy to cast Varoufakis as an academic out of depth in the deep waters of power. But I don’t think he is naïve. Rather, he is a believer in the European project.

The tension between believing in Europe and regarding its current stewards as enemies comes out clearly in his discussion of capital controls—the restrictions on financial payments across borders. Many people thought that the new Syriza government should have immediately limited payments from bank accounts in Greece to accounts outside it, slowing the bank run and making the Greek banking system less dependent on emergency liquidity of ECB and BoG. But Varoufakis rejected this, writing, “Capital controls are inconsistent with monetary union.” And later, “capital controls would be detrimental to the EU member states common interests and for that reason alone we had to oppose them.” Here and elsewhere, he comes across as a committed European—an honorable stance but perhaps not the best fit for the position he occupied.

The same logic plays out with the Bank of Greece. Tsipras and the rest of the Syriza leadership urgently wanted to replace the hostile Stournaras as bank governor. But Varoufakis is against it: “For as long as the ECB negotiated with us in good faith, I argued, we needed to show respect for its Greek branch.” It is an old story—the insurgent who unilaterally disarms in an effort to show good faith while the authorities have no intention of reciprocating.

Five months of being stonewalled, lied to, and vilified by the European establishment did nothing to diminish Varoufakis’s faith that the future of democratic, egalitarian politics lies at the European level. The book ends with him, now out of office, barnstorming France and Germany to build up a new Europe-wide political movement. His refusal to give in to cynicism or despair (or return to the safe harbor of academia) is inspiring, and indeed, there is no one better to make the case for a humane, democratic Europe.

But, from the outside, one might still wonder if his way is the only way. It is exhilarating to imagine a genuinely democratic Europe, one that reflects the collective choices of the continent’s people as a whole. But perhaps the best route to this model of integration would be, paradoxically, for some countries first to de-integrate—to reassert their sovereignty and reject the free movement of money and goods that have defined the European project in favor of a model in which economic ties are managed in the service of a national program of development.

The greatest strength of the deep establishment that Varoufakis struggled with so valiantly is the idea that there is no alternative. In Europe today, integration is presented not as something that will bring a better life for ordinary people, but rather something for which they must sacrifice—since the alternative is unthinkably worse. As long as there is no credible path to prosperity and sovereignty outside Europe, why should the authorities feel compelled to offer them inside? Game theorist that he is, Varoufakis must know that the bargaining power of the weak depends on their exit options.

Adults in the Room by Yanis Varoufakis: My Impressions

Zeitung für Katzen

A while back, I had dinner with an old friend who works in the Wellington beltway. He had recently gained a small amount of publicity for a study into the then government’s 90 day “fire at will” employment policy. The Tories sold this to the public under the guise that it would create jobs by encouraging employers to take a chance on people.

My friend’s research showed that the policy failed to increase the hiring of workers. We then joked about how then Prime Minister John Key tried to dismiss his findings by  using anecdotal evidence!

I also remarked that it was fascinating that academic economic research tended to support many left-wing policy viewpoints in contrast to the right-wing framing of concepts presented at the level of ECON101. I saw it as a sign of the validity of the political left, much to the amusement of my…

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Germany and Brexit: Berlin won’t put economic interest above its political support for European integration | British Politics and Policy at LSE

If the UK wants to secure favourable terms during the Brexit negotiations, it will be crucial to win the support of Germany. But what are Germany’s key priorities? Luuk Molthof writes that the 2015 Greek debt negotiations offer some insights into the German approach, and that the UK is likely to be disappointed if it believes Germany will put economic interests above its political support for European integration.

A sigh of relief was heard on both sides of the channel when Jean-Claude Juncker announced on 8 December that ‘sufficient progress’ had been made in the first round of Brexit talks, opening the way for the second, and much more important, phase of the negotiations. Some commentators saw the breakthrough as a sign that the British government had finally acknowledged its place as the junior partner. Indeed, to be able to move on to the trade talks, Theresa May had given in to most of the EU’s demands.

Yet the British government still seems fully confident that it will be able to negotiate a bespoke trade deal for itself. At the heart of this optimism is the assumption that some EU countries, such as Germany, the Netherlands, and Belgium, have a significant interest in good trading relations with the UK and won’t want to harm themselves economically merely to ‘punish’ Britain for leaving the EU. The British government seems to be particularly counting on Germany, the EU’s central power, whose export sector is seen as being much too dependent on the British economy for it to allow Britain to walk away without a deal.

However, many German politics experts have warned the British government not to keep its hopes up. According to Charles Grant, “Germany’s top priority is to ensure that Brexit does not weaken the EU, and that means the UK must not be allowed any kind of special arrangements that could undermine the European institutions”. In a similar vein, Sophia Besch and Christian Odendahl point out that “politically, nothing is more important to Germany than the stability and integrity of the EU”.

To understand why the British government would do well to heed these warnings, it is useful to be reminded of Germany’s role in the 2015 Greek bailout negotiations. The case is illustrative for two reasons. First, Germany’s decision back then to agree to a third bailout package for Greece, despite the apparent failings of the first two packages, is indicative of Berlin’s willingness to prioritise political over economic ends. Second, Germany’s refusal to soften Greece’s bailout conditions, even after repeated attempts by the Greek government to put pressure on Berlin, suggests that Germany is not one to soften its position at the behest of a junior negotiating partner.

Berlin’s willingness to prioritise political over economic ends

What the British government tends to forget is that for Germany, the EU is first and foremost a political project. In its efforts to further and safeguard European integration, Germany has often prioritised political over economic interests. So too in the summer of 2015, when Germany, alongside the other eurozone countries, agreed to extend a third bailout package to Greece. To be sure, over the course of the Greek debt negotiations, Germany never lost sight of its economic interests, refusing to grant Greece its much wanted Schuldenschnitt and remaining firm in its insistence on a strict reform programme. However, it always kept a larger perspective in mind.

Greece had received two bailout packages before, the first in 2010 and the second in 2012. An important motivation for both bailouts was the concern over a potential domino effect in the case of a Greek default and/or exit from the eurozone. Another – at least in 2010 – was the exposure of German and French banks to Greek debt. In bailing out Greece, then, Germany and the other eurozone countries acted perfectly in line with their own economic interests.

The situation in 2015, however, was markedly different. Not only had the chances of a domino effect been significantly reduced, Europe’s banks had written off most of their Greek debt. The economic argument for bailing out Greece yet another time was therefore not particularly strong, especially since Greece was increasingly seen as a Fass ohne Boden, or a bottomless pit. The reason why Germany ultimately agreed to another bailout was because a Greek exit from the eurozone would undermine the euro’s credibility as an instrument of political integration. Most significantly, a Grexit would mean that European integration would no longer be an irreversible and linear process – note that this was before the Brexit referendum. Speaking to the Bundestag on 19 March 2015, Merkel stated:

I have repeatedly said: If the euro fails, Europe fails. Some found and still find this too dramatic. But I remain insistent; for the euro is much more than just a currency. It is, next to the institutions that we have established, the strongest expression of our willingness to really unite the populations of Europe in prosperity and peace.

Economically, it may well have made better sense to let Greece go. Yet in order to protect the euro’s role as a political instrument, Germany was willing to bear the economic costs. Similarly, Germany is likely to be willing to bear the economic costs of a no deal Brexit should that be necessary to protect the integrity of the internal market.

Germany is not one to soften its position at the behest of a junior negotiating partner

Just like the British government is currently expecting the German government to eventually soften its position and give in to certain demands, so too did the Greek government expect the German government to eventually soften its austerity demands and perhaps even write off some debt. Greece found out the hard way, however, that Germany is not one to soften up when negotiating with a junior partner. Over the course of the 2015 debt negotiations, the Greek government made continued attempts to put pressure on Germany to adjust its position, using delaying tactics, insisting Germany still owed Greece compensation for WWII, and even calling a domestic referendum on the bailout conditions. All these attempts proved futile and in fact only strengthened Germany’s resilience.

Only after Germany’s finance minister, Wolfgang Schäuble, started talking about the option of a temporary ‘timeout’ from the eurozone, did it dawn on the Greek government that it had vastly overestimated its negotiating position. In the end, the Greek government inevitably caved, accepting all of the conditions that had been so resoundingly rejected by the Greek population in the bailout referendum. The drawing out of the negotiations had been a costly affair for all involved, but primarily for Greece. The British government faces a similar suboptimal outcome should it fail to come to the realisation soon that it is indeed the junior negotiating partner, that time is really not on its side, and that empty threats to walk away from the negotiations without a deal aren’t likely to change anyone’s mind, least of all Germany’s.

The fact that Germany is likely to prioritise its political interests over its economic interests in the Brexit negotiations, and is unlikely to give in to the demands of a junior negotiating partner, is not to say that Germany does not seek a good trading relationship with Britain. It is merely to say that it won’t agree to a type of deal that undermines the EU institutions simply because it doesn’t want to see a drop in Mercedes’ sales. Indeed, even the German industry itself has let it be known that the integrity of the internal market should not be sacrificed for access to the UK market. The British government would do well to keep this in mind and prepare a realistic vision for its post-Brexit relationship with the EU, instead of waiting for the Germans to lend them a helping hand.

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Note: This post was originally published on our sister site EUROPP.

About the Author

Luuk Molthof is a Research Fellow at d|part, a political think tank based in Berlin. He completed his PhD in Political Science at Royal Holloway, University of London. His thesis examined Germany’s role in European monetary history and provided an explanation for Germany’s reaction to the euro crisis.

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

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