By Arnold Kling
C. Fred Bergsten and Jacob Funk Kirkegaard (BK) write,
There are only two alternatives. Europe can jettison the monetary union. Or it can adopt a complementary economic union. This brief argues that, for all the turmoil, Europe is well on its way to completing the original concept of a comprehensive economic and monetary union, and that Europe will emerge from the crisis much stronger as a result.
Pointer from Tyler Cowen, who is a euro-pessimist.
What I argue here is that we need to model this as a Prisoners’ Dilemma, in which there are two parties, each of whom can choose either to co-operate or defect. The outcome if both parties compromise is better than the outcome if both parties defect. However, what I suggest is that each party may have a dominant strategy to defect. That is, regardless of what the Greeks decide to do, the Germans prefer not to increase their own spending to save the euro. Meanwhile, regardless of what the Germans decide to do, the Greeks do not wish to reform their labor market, their pensions, or their tax collection system. The fact that there will be a bad outcome if both sides defect is not sufficient to prevent that outcome.
Think about this another way. Substitute “United States” for Europe, “Democrats” for Greece, and “Republicans” for Germany. Are you optimistic that the Democrats and Republicans will cooperate by raising taxes and cutting entitlements?