Why should you choose Princeton over Stanford

Hans-Werner Sinn

Interview with Hans-Werner Sinn, observer.ch, April 4th, 2014

The crisis is far from over, says the German economics professor Hans-Werner Sinn. Without drastic reforms, the EU would creep away.

Hans-Werner Sinn, 66, is head of the Ifo Institute for Economic Research at the University of Munich and one of the most renowned economists in Germany. The economist and finance scientist worked as a visiting professor at Princeton, Stanford and at the London School of Economics. He was an appraiser for the Federal Constitutional Court in the process surrounding the purchase of government bonds by the European Central Bank.

Observer: The euro crisis is no longer in the headlines. Is it really over?

Hans-Werner Sinn: No, it's just smoldering under the carpet.

Observer: Does that mean it will break out again?

Sense: There are several options. For example, that the financial markets are getting nervous again for some reason. But we have opened so many rescue packages that it is not likely. Or that the unemployed in Spain or Greece turn to parties that prefer more radical solutions.

Observer: Do you expect that?

Sinn: I rather assume that there will be a creeping sickness. The solution to the real economic problems of the southern countries will take a long time to come.

Observer: What is the problem with the countries in the south?

Sinn: They are too expensive. The euro put them in a credit bubble, and as a result the economy grew a little from 1995 to around 2007. Everything looked splendid there. Then the Eastern European countries joined the EU, which resulted in a completely new competitive situation. Even with the old wages, the countries of southern Europe would have had difficulties. With the new, loan-financed wages, however, it became almost impossible for them. Today in Spain we have wages three times as high as in Poland. Even in Greece they are twice as high. That is the fundamental problem.

Observer: Will the countries converge, so the rich get poorer and the poor get richer?

Sense: The rapprochement has already taken place. Since the announcement of the euro at the Madrid summit in 1995, the standard of living in the southern countries has risen dramatically. Only this increase was financed on credit. Now the standard of living is so high that it has made them lose their competitiveness.

Observer: What is the fundamental flaw?

Meaning: The non-bailout clause of the Maastricht Treaty says: If a country has borrowed money and cannot repay it, it goes bankrupt and the creditor has to forego. This rule was never taken seriously. Had that been done, there would not have been as much credit in the first place and the inflationary bubbles would not have appeared. One of the main reasons was investors' expectation that countries would be able to repay their debts with the printing press in an emergency. You have to change these expectations - with a repayment system. If the eurozone had to pay off debts with gold, as was the custom in America, then there would have been no way out via the printing press, and creditors would have been more cautious.

Observer: You objected to the European Central Bank being allowed to buy government bonds. How so?

Sense: It is simply a shift of risk from the investor to the taxpayer. If the central bank has the paper and has to write it off because a state goes bankrupt, then there is eternal interest loss on money creation. This means that the taxpayers bear the loss.

Observer: You get the impression that those responsible only put out the fire where it starts.

Sinn: Yes, of course. But there may be a goal behind it: to provide the countries of the south with cheaper loans than is possible on the market. In this case, by offering free insurance benefits. The central bank tells the investors: "You can buy the government bonds, don't be afraid of bankruptcy, if something goes wrong, you come to me, I'll buy them from you." The value of this insurance, which the central bank provides here, is in the order of 75 billion euros per year.

Observer: You keep repeating the same mistake. Why aren't politicians getting smarter?

Sense: Because it is a way of life that you can get along with under certain circumstances. At least as a recipient. If you have the political majorities, you can continue this policy.

Observer: What advantage do the politicians in the donor countries have?

Meaning: You avoid the crash taking place in your legislative period.

Observer: Thinking in terms of short electoral terms.

Sinn: Yes, and of course they also give themselves to the - let's assume honest - hope that the problem will solve itself.

Observer: What does your solution look like?

Sense: We should end the game, take a big haircut and force the taxpayers and wealthy owners of the north to see the truth.

Observer: Who would be affected?

Sinn: investors from all over the world. American pension funds as well as German banks. But mostly French banks. They essentially sucked up the money in the world and lent it to southern Europe. The euro area crisis is a crisis affecting France, French banks and French industry, which largely sold its products to these countries. We have to recognize that certain credit claims are not being serviced - we as private creditors and we as citizens who stand behind the states. Then we should head for a regime under which those countries that are no longer competitive will leave the euro zone.

Observer: Which countries are you thinking of?

Sinn: That is up to the countries concerned to decide for themselves. What is certain is that the devaluation rates necessary to achieve competitiveness are particularly high in Greece, Portugal and Spain.

Observer: What would be the consequences?

Sinn: The first consequence would be that these countries would have to give up all possible dreams, just as the creditor countries would have to give up their dreams. Everyone should turn to reality. But the reboot of the eurozone that follows leaves the computer running again. Our research showed that in countries that were depreciating, the economy grew again after a year or two.

Observer: How should Greece grow? The country hardly produces its own goods.

Sinn: A manufacturing industry is not necessarily required for growth. It would be a big mistake if Greece tried to imitate Germany. Trade lives from the diversity of the countries, from their specialization. The difference is wealth, not imitation.

Observer: Where do you see specific growth potential?

Sinn: Tourism and agriculture can certainly flourish in Greece. If Greece devalues, the Greeks do not buy agricultural products in France, but go to their own farmers. Then they have to do and hire people. The tourists will return. The same goes for the rich Greeks who have parked their money in Switzerland or elsewhere - they will go on a bargain hunt. Capital returns home, is invested, and the demand of the local population is directed again towards local products.

Observer: What is needed besides the haircut and the exit of weak countries?

Sense: A new, functional system. The rules need to be changed and the most important rule is the gold standard within. The holes in the balance of payments caused by excessive use of the printing press in southern Europe have to be wiped out with gold. Gold is an international means of payment. If you don't have enough gold, you can sell assets to get some.

Observer: Does Europe also need more integration?

Sinn: That is the only way to drive around a monetary union. We need a political union that captures the centrifugal forces of the monetary union, similar to the Swiss confederation. That would be a possible possibility. What is currently not needed is a fiscal union. It took Switzerland 350 years to develop something halfway fiscal, before it was purely a defense union. We, on the other hand, start with the money, then we want to move on to fiscal and then on to political union.

Observer: But most Europeans don't want any further integration.
Sinn: That's right, but that's the only way to do it. Because they don't want it, the euro doesn't work that way. And certainly not the fiscal union. That makes matters worse. That would be the second big mistake after the euro.

Observer: Switzerland does not want to join the EU either. Can it still prosper?

Sense: It depends on what the others allow. A free trade situation would of course be an attractive option for Switzerland. But if the rest of them say that we don't want free trade, but close the borders, unless you open yours politically, then Switzerland has a problem.

Observer: What do you say about the Swiss “yes” to the immigration initiative?

Sinn: Migration is a basic requirement for free movement in Europe, and it is a shame when a country closes its borders. On the other hand, migration can only increase efficiency if it is carried out for real economic reasons, because one can find better-paying jobs elsewhere. A migration to the welfare state, which only serves to go elsewhere, because the gifts from the state are bigger than at home, is inefficient.

Observer: The battle for the best minds is always won by wealthy countries. From the poor you suck off those who could provide growth there.

Sinn: I don't see it that way, because we also have capital migration. At the same time, capital is migrating to these countries because wages are correspondingly low. Labor and capital are migrating in the opposite direction. The labor goes to the high-wage country, the capital goes to the low-wage country. That makes sense because both measures increase the European national product. Both capital and labor go where they can make a greater contribution to the national product.

Observer: Would you recommend Switzerland to more or less political integration in Europe?

Sinn: You can't say that in general. The Swiss population has now pulled the emergency brake, which I think is understandable. And that is perhaps also a certain incentive for Europe to think about whether everything that is going on here is right. I believe freedom of movement for social migration is wrong. That is one of the fundamental design flaws of the European system. We have the principle of inclusion, that is the sacred cow in the EU treaties. It means that someone who goes from one EU country to another is entitled to social benefits there, even if they are tax financed. The alternative to the inclusion principle would be the home country principle that existed in Switzerland. The home parish remained responsible for one welfare recipient. We don't have that right now in the EU. That is the basic mistake.

Observer: What can the EU and Switzerland learn from each other?

Sinn: I think the Swiss Confederation is a good model for the way the EU can develop. This means that Switzerland has a strong political union with a common army. We are far from that. The countries have their own armies, which are perhaps loosely linked via NATO, but everyone keeps the key to their own weapons locker. In my opinion that is completely unbearable within the EU. The first thing that has to be changed is that if you follow the integration path, as it is in Switzerland. We have to create a relatively decentralized Union, with many rights still at the national level ...

Observer: ... the principle of subsidiarity ...

Sinn: ... yes, exactly. And you need the no bailout clause. If a state goes bankrupt, it goes bankrupt. And nothing in the world helps. In Switzerland, since the bankruptcy of the Valais municipality of Leukerbad, this has been established at least at the municipal level. In the USA it's exactly the same: If a state goes bankrupt, no federal government comes to the rescue - and certainly not the US Federal Reserve - and buys government bonds. These are the things that can be learned from functioning federations.

Observer: Wouldn't less Europe be a solution?

Sinn: Yes, good. That is the other option. What we have now is in between. It just doesn't work at all. I would prefer the first way because the other one takes us back to times of war.

Observer: Isn't it trade that makes peace?

Sinn: No. We have always had trade, and Europe is a history of wars. I consider it a dangerous illusion that wars should suddenly no longer be possible when we always had them.