A Tale of Politically-Failing Single-Currency Area
Assaf Razin and Steven Rosefielde
September 1, 2012
Paper prepared for Contemporary Economics, September 2012
It seems almost yesterday that Europhiles confidently declared that the American
dream of democratic free enterprise within a unitary nation state was dead; that the
European Union's supranational (transnational) vision (Rifkin, 2004) had eclipsed
it. Europhiles claimed that Europe was on the fast track to creating a
superior postmodern culture and had successfully fashioned a series of novel
institutions to realize this dream in the Treaties of Rome (1957-58), Schengen (1985),
Maastricht (1992-93), Amsterdam (1997-99), Nice (2001-03) and Lisbon (2007-09),
applicable to current members and extendable later to others on its immediate
periphery and eventually beyond including Russia and North Africa. Proponents,
moreover encouraged other regions (like ASEAN) to emulate the EU example so that
in the not too distant future traditional nation states like America would find
themselves on the endangered species list, replaced by supranational clusters of the
EU type, culminating logically in an ill-defined progressive transnational world
government.1
1
Federiga Bindi, ed., The Foreign Policy of the European Union: Assessing Europe's Role in the World, Washington, DC,
Brookings Institution Press; 2010. Elizabeth Bomberg, John Peterson and Richard Corbett, eds. The European Union: How Does
it Work? Oxford: Oxford University Press, 2012. Richard Corbett, Francis Jacobs, and Michael Shackleton, The European
Parliament , London: John Harper Publishing, 2011.Paul Craig and Gráinne Búrca, EU Law, Text, Cases and Materials, Oxford:
Oxford University Press, 2007. Wolfram Kaiser, Christian Democracy and the Origins of European Union, Cambridge:
1
The global financial crisis of 2008 and its aftermath have put EU visionaries on the
defensive, but have not undermined the faith. It is universally acknowledged that the
Eurozone's (EZ) architecture is defective, prompting calls for "more" Europe (Merkel
2012) and in some instance “less”.2 Should EU and/or EZ supranationality be
adjusted? The answer depends on the kind of transnationality members consider best.
They can construct a better community-wide macroeconomic system by adopting full
economic union, that is, complementing monetary union with fiscal union,
transforming a supranational regime with strong reserved sovereign powers into one
that resembles an unified federal nation state like America. Or they could opt for “less
Europe,” also constructing a better community-wide macroeconomic system by
downsizing the monetary union to a “coalition of the willing,” with or without fiscal
union. Each approach has pluses and minus that members will have to sort out
normatively according to their scale of values. Muddling through by refining the
existing supranational fiscal regime is another option, but runs the danger of putting
Cambridge University Press, 2007.John McCormick, The European Union: Politics and Policies, Boulder, Colorado: Westview
Press, 2007.John Pinder and Simon Usherwood, The European Union: A Very Short Introduction, London: Abe Books, 2008.
Jeremy Rifkin, The European Dream: How Europe's Vision of the Future Is Quietly Eclipsing the American Dream, New York,
Tarcher, 2004. Charles Smith, International Trade and Globalisation, Stocksfield: Anforme, 2007. Andreas Staab, The
European Union Explained: Institutions, Actors, Global Impact, Bloomington: Indiana University Press, 2008. Josephine Steiner,
Lorna Woods and Christian Twigg-Flesner, EU Law, Oxford: Oxford University Press, 2006. Birol Yesilada and David Wood,
The Emerging European Union, New York: Pearson , 2009. Jean-Claude Piris, Lisbon Treaty. Cambridge: Cambridge University
Press, 2010. Michael Burgess, Federalism and European Union: The Building of Europe, 1950 – 2000. London: Routledge,
2000.
2
“Germany's Merkel: More, Not Less Europe Is Needed BERLIN --German Chancellor Angela Merkel and Polish Prime
Minister Donald Tusk Thursday called for greater solidarity and further integration in Europe, citing them as crucial elements for
resolving the euro-zone debt crisis,” Dow Jones, May 31, 2012. "We need more Europe and not less," Merkel told a gathering at
a ceremony to award Tusk this year's Walther Rathenau prize, an award for achievements in furthering the European ideal
granted by the Walther Rathenau Foundation. Merkel said that structural reforms to labor markets and national economies to
promote competitiveness were needed not just in the euro zone but throughout the European Union.
2
the EU on a dysfunctional “treadmill of reform,”3 suggesting that EU leaders should
return to basics. They should rethink the concept of supranationality to determine the
precise form of transnational governance they prefer, and more broadly whether any
form of supranationality is superior to forging a unified federal European nation state.
An exercise of this sort was implicit in the EMU debates leading up to monetary
union, but the results have not lived up to expectations. It now seems clear with the
benefit of hindsight that adopting a monetary union was premature; that EU prospects
would have been greatly enhanced if monetary union had been preceded by fiscal
union. It also seem to be true that monetary union without fiscal union is hazardous so
that unless members are prepared to cede greater fiscal sovereignty to Brussels the
entire EZ project must be drastically reformed and or downsized.
This essay offers a fresh framework for constructive debate. It investigates the
historical roots of EU political culture, the concept of supranationality, reviews
Europe’s postwar successes and elucidates the intrinsic vulnerabilities of the
transnational project.
EU Supranationality
3
Gertrude Schroeder, “The Soviet Economy on a Treadmill of Reforms.” In Soviet Economy in a Time of Change,
Washington, DC: Joint Economic Committee of Congress, 1979, 312–66.
3
Nationalism was and remains a bugaboo for EU architects who see it as the source
of various evils, including WWI and WWII.4 They fear both the chauvinism of
individual states and the centralized authority of a construct like the United States of
Europe. Postwar leaders accordingly sought to forestall WWIII and reap intra-regional
cooperative benefits without relinquishing their own primary authority by hewing a
middle path. Helmsmen counseled delegating some state powers to transnational
(supranational) entities over intra-regional trade, mobility, standards, justice, culture,
international relations and defense, while retaining other fundamental aspects of
member autonomy. They forged a succession of treaties eliminating intra-regional
tariffs and subsidies that foster capital and travel mobility and reconcile contradictory
standards and laws to create a level, pro-competitive, union-wide playing field as a
platform for European global power.5
EU supranationalism from its leaders’ perspective is more than the creation of a
strong central authority without a formal national sovereign federation. It
is an institutional pathway to a superior system where the conflicting governance
claims of members and central authorities are democratically and socially
harmonized. It is supposed to generate communitarian benefits that go far beyond
4
Yun Chen and Ken Morita, “Toward an East Asian Community,” in Steven Rosefielde, Masaaki Kuboniwa and Satoshi
Mizobata, eds., Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore: World Scientific 2012.
5
EU international policy is floundering too. See Bernd von Muenchow-Pohl, Carnegie Europe,” Courting the
Dragon, Wooing the Elephant,” Commentary, August 23, 2012
4
gains from customs unions and multinational coordination in a transnational federal
setting without entailing significant efficiency and welfare costs. EU Supranationalists
claim to vouchsafe the priorities of mature, culturally diverse members over the
counterclaims of Brussels, not just through constitutional safeguards as in America,
but via key reserved executive, judicial and legislative powers, including taxation.
Transnationality privileges member economic, cultural, security and political
independence over central national rule. Members are willing to talk about anything
and cooperate to the extent that they have, but are unwilling to create a full union
political or economic union (monetary plus fiscal union) that allows Brussels to
disregard member autonomy. EU architects believe that the welfare costs of
delegating member authority to Brussels outweigh the micro and macroeconomic
efficiency gains. Supranationality from this perspective is best because it prevents
central authorities from suppressing member autonomy in the name of the community.
EU leaders are free to build consensus, but coercion is off the table. In short
Europeans are ambivalent about being homogenized EU-ropeans. They are happy to
doff an EU-ropean identify when this suits them, but don't want individuals,
communities, or nations to be dominated by central political authorities. Supranational
advocates appreciate that this precludes solving the EU's woes by forming a United
States of Europe, but believe that there is a satisfactory middle ground. This mostly
means “more Europe,” but if need be “less Europe” as well.6
6
Martin Feldstein, “The Failure of the Euro,” Foreign Affairs, Jan/Feb2012, Vol. 91 Issue 1, p105-116.
5
EU Successes
The EU in many ways is an enormous success story. Postwar leaders cajoled their
nations into putting aside deep-seated enmities in favor of building a progressive
social democratic community nurturing common political, social, cultural and
economic needs. Much of this agenda has been beneficially achieved. The vast
majority concur that today’s Europe is better than its predecessors. On the economic
front, cooperation has allowed EU members to create an efficiency enhancing customs
union that reduced the costs of the region’s production, trade, finance, and monetary
exchange. It also abolished cross-national barriers to non-labor mobility. Partly as a
result, the EU rapidly recovered from the devastation of World War II, grew at a
respectable rate until 1975 and broadly provided its people with a superior way of life.
The magnitude of the accomplishment can be easily gauged in comparison with Asia
which has made significantly less progress in forging an integrated, egalitarian
postwar regional economic community. Nonetheless, there are clear signs of EU
degeneration.
Barry Eichengreen, “When Currencies Collapse,” Foreign Affairs, Jan/Feb2012, Vol. 91 Issue 1, p117-134.
Sebastian Mallaby and Olin Wethington, “The Future of the Yuan,” Foreign Affairs, Jan/Feb2012, Vol. 91 Issue 1, p135-146.
Andrew Moravcsik, “Europe after the Crisis,” Foreign Affairs, May/Jun2012, Vol. 91 Issue 3, p54-68.
Raghuram Rajan, “The True Lessons of the Recession,” Foreign Affairs, May/Jun2012, Vol. 91 Issue 3, p69-79.
Steven Rosefielde and Assaf Razin, “Asian Currency and Financial Crises In the 1990s,” in Steven Rosefielde, Masaaki
Kuboniwa and Satoshi Mizobata, eds., Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore:
World Scientific 2012. Steven Rosefielde and Assaf Razin, “The 2008-09 Global Crisis,” in Steven Rosefielde, Masaaki
Kuboniwa and Satoshi Mizobata, eds., Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore:
World Scientific 2012. Steven Rosefielde and Assaf Razin, “PIIGS,” in Steven Rosefielde, Masaaki Kuboniwa and Satoshi
Mizobata, eds., Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore: World Scientific 2012.
Steven Rosefielde and Quinn Mills, “Global Default,” in Steven Rosefielde, Masaaki Kuboniwa and Satoshi Mizobata, eds.,
Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore: World Scientific 2012.
Steven Rosefielde and Huan Zhou, “Global Imbalances,” in Steven Rosefielde, Masaaki Kuboniwa and Satoshi Mizobata, eds.,
Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore: World Scientific 2012.
6
Eurosclerosis
The European Union appears to be susceptable to two serious economic maladies:
Eurosclerosis and supranational macroeconomic dysfunction. Eurosclerosis is a
devitalizing disease caused by union-wide microeconomic over-regulation and overtaxation. Brussels has sought to obviate the effects of social democratic big
government with pro-competitive market initiatives, but the EU's anemic economic
growth since the mid-1970s testifies to the fact that stepping on the gas doesn't
eliminate the adverse effects of simultaneously slamming on the brakes. This illadvised policy however has nothing to do with supranationality. It is merely
a contemporary manifestation of the age old struggle between free enterprise and state
management that doesn't warrant further elaboration because it applies equally to
national and supranational regimes.
Supranational Macroeconomic Dysfunction
The EU's macroeconomic plight is different because it is attributable in significant
part to supranational rigidities that come into play when aspects of EU architecture
impede macroeconomic equilibration; that is, when member full employment, price
stability and growth require cooperation other members are reluctant to provide. Intraunion labor immobility offers an illuminating example. EU
members resolutely protect their citizens' domestic jobs, despite professions of
7
community solidarity. As a consequence the vast army of unemployed in the PIIGS
(Portugal, Ireland, Italy, Greece and Spain) cannot be alleviated by temporary or
permanent labor migration to Germany. The Schengen agreement permits tourists and
businessmen to freely flow across national borders, but this doesn't extend to work
rights, embedding micro and macroeconomic disequilibria. Likewise, there are no
institutional requirements for financially strong community members to fiscally
support chronically weak regimes or rich members to share the wealth as is the
norm in unitary nations such as America. European leaders speak as if they have these
obligations, and act accordingly when burdens are easily managed, but balk at
accepting onerous dependencies. The same principle holds for cooperative
management of monetary, interest rate and foreign exchange rate policy. When skies
are blue EU supranational institutional weaknesses are invisible, but they surface in
stormy weather.
Maastricht
These generic EU vulnerabilities have been exacerbated for member states
that have joined the common currency Eurozone created by the Maastricht treaty
1992-93.7 Countries that agreed to scrap their national currencies for the Euro in the
7
The Werner Report (1969) set out a blueprint for stage-by-stage European economic and monetary union. It sought
to eliminate intra-European exchange rate movement and central EU monetary policy decisions. The 1986 Single
European Act provided for free movement so people, goods, services and capital. In 1989, the Delores report laid
the foundations for the single currency, the euro. The Maastricht treaty (1991) set out the blueprint for the transition
process from European Monetary System (EMS) fixed exchange rate system with national currencies to European
8
mistaken belief that the EZ was an optimum currency area8 belatedly came to
appreciate the full tri-lemma cost of surrendering control over two fundamental
macroeconomic instruments.9 When it seemed desirable to devalue their own national
currency, and/or increase their money supplies in the aftermath of the 2008 global
financial crisis these remedies were unavailable and could not be realized derivatively
Monetary Union (EMU). The Stability ad Growth Pact 1997 set up national budgetary objectives, with
unenforceable penalties, to strengthen the EMU.
8
The United States provides a good example of an optimal currency area. It has a high volume of intra-national trade
(Mckinnon). American labor is mobile (Mundell), and Washington has the muscle to effectively use fiscal power in alleviating
distress in vulnerable states (Kenen). Also, the Federal Reserve has the authority to act as a "lender of last resort" if Washington's
fiscal policy is insufficient. See: Robert A. Mundell, “A theory of Optimum Currency Areas” The American Economic Review,
September 1961, 51, 657-64 ;Ronald I. McKinnon, "Optimum Currency Areas", The American Economic Review, Vol. 53, No. 4
Sep., 1963, pp. 717-725; Kenen, Peter, “Toward a Supranational Monetary System,” in G. Pontecorvo, R.P. Shay, and A.G.
Hart, eds., Issues in Banking and Monetary Analysis, New York: Holt, Reinhart, and Winston, 1967; and Paul De Grauwe, The
Greek crisis and the future of the Eurozone.The structural problem in the eurozone is created by the fact that the monetary union
is not embedded in a political union. Eurointelligence 11.03.2010. See also Paul De Grauwe, Economics of Monetary Union,
New York: Oxford University Press, 2000. The EU by contrast is a dubious candidate for an optimal currency area because
although it too trades intensively within the region, national work restrictions greatly impair intra-European labor mobility, and
supranational fiscal power is feeble because rich members don't want to assume heavy financing burdens during turbulent times.
The obverse also is true. Countries like Sweden and Norway which shunned the euro are thriving and appear to have benefited by
retaining their monetary option.
Robert Mundell and Marcus Fleming have succinctly formulated the problem bedeviling optimal currency unions, particularly
supranational ones in the form of a two-not-three tri-lemma. Countries seeking to form a monetary union can enjoy two, but only
two desirable policy goals: 1) free international capital flows (connected with optimal fiscal policy), 2) potent monetary policy to
stabilize output, employment, inflation and financial markets, and 3) exchange rate stability. The United States picked free capital
mobility and monetary independence, letting their foreign exchange rate float. China decided to retain its monetary independence
and control its exchange rate, abandoning free capital flows, while the European Union has selected a third way. It mimicked the
United States at the supranational level, accepting floating exchange rates for the euro, but at the national level failed to
complement the choice with a supportive fiscal regime for distressed economies and friction free labor mobility, leaving
vulnerable nations like the PIIGS in a lurch. When times are bad, the euro appreciates as investors shift to what they perceive as a
German safe haven reducing the PIIGS export competitiveness, while idle labor is prevented from migrating.
What works for America, doesn't for the EU because of supranationality, the omitted variable in optimal monetary union
discourse. The trilemma solution for the PIIGS are three bads: no independent monetary policy, no independent exchange rate
policy, and fiscal paralysis(due to excessive debt), while Germany and other current account surplus members retain free capital
flows, a supranational monetary policy tailored to their needs, and an appreciating currency of their desire. Robert Mundell,
"Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates," Canadian Journal of Economic and
Political Science, Vol. 29, No. 4, 1963, pp.475-85. Marcus Fleming, "Domestic Financial Policies under Fixed and Flexible
Exchange Rates," IMF Staff Papers 9, 1962, pp.369-79.
9
There are two basic types of tri-lemma. The most common occurs where people are compelled to choose among three
undesirable options. The economic usage is different. Tri-lemmas here all involve favorable options, but picking any two
precludes acquiring the third. The three positive policy goals sought by all nations are: first, to promote international capital
flows, because by doing so they allow investors to diversify their portfolios overseas and achieve risk sharing; second, to use
monetary policy as a tool to help stabilize inflation, output, and the financial sector in the economy, and third to make exchange
rates stable in order to facilitate international transactions, and promote exports and investment. China has chosen options 2 and
3; America 1 and 2, and the EMU 1 and 3.
9
under the new collective regime.10 Members whose domestic price levels became
uncompetitive found that they could not independently devalue the Euro,11 or inflate
their way out of excessive indebtedness and slack aggregate effective demand. Instead
they had to depend on internal devaluations (wage and price reductions), the
solicitude of creditors at home and abroad, and fiscal assistance from strong EU
members.12
The financial crisis of 2008 brought all these issues to the fore. However, it is
worth noting that the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) over
indebtedness would have posed a serious problem for the EU, even if the Maastricht
10
A single currency means that all of the countries in the monetary union have the same monetary policy and the
same basic interest rate; interest rates differ among borrowers only because of perceived differences in credit risk. A
fixed exchange rate within the monetary union means that the same exchange rate holds relative to all other
currencies, even when individual countries in the monetary union would benefit from changes in relative values.
11
Superior German productivity exacerbated the PIIGS plight. PIIGS unit labor costs rose steadily 2001-2010, while German
unit labor costs fell reciprocally. Ceteris paribus, the incentive for Germany to outsource and invest in PIIGS diminished at the
same time foreigners were coaxed into diverting their purchases of EU exports from the PIIGS to Germany. Given the EU's
supranational straitjacket, there doesn't appear to any compelling reason to anticipate a swift reversal of the PIIGS's ill-fortune. A
utopian welfare-state vision intended to ameliorate transnational income inequality, thus may perversely aggravate the problem.
12
The Euro deal amounted to a trade-off between low interest rate and speculative capital inflows into less
developed member in return for foregone monetary and foreign exchange rate flexibility. The result was a growth
spurt, together with financial bubbles, inflation. When a country has its own monetary policy, it can respond to a
decline in demand by lowering interest rates to stimulate economic activity. But the European Central Bnk must
make monetary policy based on the overall condition of all the countries in the monetary union. This means interest
rates that are too high for those countries with rising unemployment and too low in other countries where wages are
rising too rapidly. The shift to a monetary union and tough anti-inflationary policy of the European Central Bank
caused interest rates to fall in countries like Spain and Italy, where expectations of high inflation had previously kept
interest rates high. Households and governments in those countries responded to the low interest rates by increasing
their borrowing. Households used the increased debt to finance a surge in home building and house prices.
Governments borrowed to finance budget deficits hat accompanied larger social transfer programs. The result was
rapidly rising ratios of public and private debt to GDP in several countries, including Italy, Greece, Spain and
Ireland. Despite the increased risk to lenders that this implied, the global capital markets did not respond by raising
interest rates on countries with rapidly rising debt levels. The financial crisis was a spark that led to the burst of the
credit bubble, and the interest rates jumped. A different market dynamic affected the relation between the
commercial banks and the European governments. Since the banks were heavily invested in government bonds, the
declining value of those bonds hurt the banks. The Euro came into existence in 1999 at the time when the German
economy following the German unifications was weak. The euro made investors believe that Southern Europe is
safe, causing a fall in interest rates there. This in turn led to vast inflows of capital. The flip side was large deficits,
and large counterpart surpluses in Germany.
10
treaty had been rejected because members could not turn a blind eye to sharp
devaluations and rampant inflation on Europe's southern periphery. The merit of the
EU’s brand of supranationality was going to be tested at some point. The global
financial crisis and Maastricht merely accelerated the process.
Road to Crisis
The macroeconomic perils of Eurozone supranationality were evident long before
the Euro was launched in 1999. The EZ wasn't forged overnight. An experiment was
conducted under the auspices of the European Monetary System 1996-98 testing
aspirants’ ability to contain deficit spending, inflation, and foreign exchange
rate volatility. It was an unmitigated failure, but EZ advocates resolved to press
forward anyway with surprisingly positive results,13 not because Southern Europe had
an epiphany, but because the German dominated European Central Bank (ECB)
fostered the illusion in investors' eyes that PIIGS were creditworthy. Interest
rates promptly plummeted and profit expectations soared leading in turn to vast
inflows of capital and a hard asset bubble. Exportable, importable and non-tradable
PIIGS prices skyrocketed without commensurate gains in factor productivity, sharply
13
The Euro system is like a lab experiment that was incorrectly planned: a monetary union with no banking-fiscal-political
union.
11
diminishing competiveness in high budget deficit member states, while productivity
and competitiveness advanced reciprocally in Germany and its Northern neighbors. 14
It should have been obvious 1999-2007 that this was a recipe for disaster because
without vibrant productivity growth PIIGS' debts couldn't be repaid,15 but as is always
the case during bubbles naysayers were easily brushed aside. Indeed, as expectations
soured, exacerbated by the American generated global financial crisis of 2008,
investor sentiment swiftly shifted from euphoria to despair. During the Euro
honeymoon borrowing costs were artificially low, but became onerous for the PIIGS
thereafter. Foreign investors, who threw money at the PIIGS during the first seven
years of the new millennium, abruptly fled causing acute credit contraction, default
and bankruptcy. The contagion then gradually crept from the vulnerable EZ periphery
towards its core, including France.16
The situation was dire, compounded by the Euro straitjacket. Nonetheless, the
initial response of strong EZ members was to treat the disorder as a liquidity problem
occasioned by the shock of the American financial crisis. EU leaders after meeting in
14
See Steven Rosefielde and Assaf Razin, “PIIGS,” in Steven Rosefielde, Masaaki Kuboniwa and Satoshi Mizobata, eds.,
Prevention and Crisis Management: Lessons for Asia from the 2008 Crisis, Singapore: World Scientific 2012.
15
The details of the crises varied country by country. In Greece, the public sector went out of control with chronic
budget deficits. Spain was devastated by a burst real estate bubble. Ireland’s unregulated banks became insolvent,
with debts being shifted from the financial sector to the government. Italy experienced a crisis of growth with the
government unable to repay debts due to high risk premia. Greece, Ireland, Portugal and Spain lost a lot of
competitiveness. Low interest rates led to a surge in domestic demand, and sharp rises in real wages because
productivity growth was not vigorous enough to compensate.
16
The EZ is riven by fundamental imbalance with the “north” in trade surplus, the “south” in trade deficit and the
competitiveness of the peripheral countries relative to Germany deteriorating.
12
15-20 summit conferences and crafting 3-5 rescue plans with scant positive effect still
repeatedly assert that a series of emergency loans, and adjustment of ECB lending
requirements will do the trick, but the claim is becoming increasingly suspect.17 The
PIIGS crisis seems to be intensifying and metastasizing.18
Economic Framework
This isn’t surprising because the EU and the EZ have been in a state of
fundamental disequilibrium for a decade that either required frictionless competitive
adjustment or deft trans-union macroeconomic coordination. Given sticky wages and
other impediments that cause inadequate aggregate effective demand and involuntary
unemployment, member states and supranational authorities are obligated to devise
potent counter-depression monetary, fiscal, financial and regulatory policies to
promote recovery, low inflation, full employment, robust economic growth and even
social justice. Supranationality from this perspective is supposed to be innocuous, but
it isn’t because the institutional framework has fostered a stealthy political economic
culture where members struggle for national advantage behind the rhetoric of
17
Seven heads of government were replaced; only Angela Merkel remains.
Macroeconomic equilibrium can be restored in principle by “internal” depreciation; that is, cutting wages and
increasing productivity relative to other countries, but in practice it is difficult to improve productivity in hard times,
and with low inflation in Germany, the reduction of wages at the periphery must be very large. Also, employment
tends to be wage inelastic.
18
13
transnational duty, frustrating efficient macro policymaking, while encouraging
speculative assaults.19
This is why Angela Merkel presses the "more" Europe theme. She believes
(wishes) that members will accept enough increased centralized authority to create a
macroeconomically efficient EU. There is no reason to doubt that centralization might
have macroeconomic benefits. However, this carrot may not be enough to carry the
day, and of course as America's financial crisis experience demonstrates, cannot be
considered a panacea.
The Case for More Europe
"More Europe" means different things to different people. For many it merely
entails more emergency financial assistance in exchange for a moratorium on fresh
deficit spending. Others urge fiscal union and some may secretly view it as a pathway
to national federation. The case for more Europe on all these scores is the same. The
PIIGS and other members with similar proclivities don’t seem willing to restrain
themselves and require a stronger central hand to impose the requisite fiscal
discipline. The issue in contention among more Europe advocates is how this should
be accomplished. For the moment, the only option officially on the table is reforming
existing financial policies and institutions. Sovereign and national bank indebtedness
The market understands that it can force monetary union countries’ sovereigns into default because the ECB is
reluctant to serve as lender of last recourse. Non-EZ members like the UK are in a stronger position because it has
an independent monetary policy.
19
14
can be capped. Limits can be set on new deficit spending, the composition of national
budgets can be mandated, assistance quotas fixed, and the enforcement powers of
central authorities strengthened.20 However, if these policy reforms prove insufficient
sentiment for fiscal union requiring explicit delegation of financial authority from
members to Brussels is likely to increase.
The outcome is hardly a foregone conclusion. PIIGS and other members while
grudgingly accepting some conditionality as a temporary palliative in times of crisis,
adamantly oppose any permanent ceding of their fiscal sovereignty to Brussels
beyond those powers granted in the Lisbon Treaty amending the Maastricht Treaty
and the Treaty of Rome. Consequently, while nothing precludes "more Europe," any
advance in this direction will be an arduous and protracted undertaking.21
Cages
The EU's implicit rejection of "more Europe" properly understood means that EZ
members have put themselves in a cage, not unlike the gold standard. Member states
have surrendered control over their monetary and foreign exchange rate policies to the
German dominated European Central Bank (ECB), without supplementary central
20
Quentin Peel, “Germany’s Judgment Day,” Financial Times, August 7, 2012. Germany’s day of judgment on the eurozone’s €500bn
rescue fund is fixed for September 12, 2012.
EZ leaders agreed in October 2011 that banks should increase their capital ratios. This plan won’t work because
the banks don’t want to dilute current shareholders’ equity by seeking wither private or public capital. Instead they
are reducing their lending, particularly to borrowers in other countries, causing a further slowdown in European
economic activity. The ECB is lending hundreds of billions of Euros, just like in the “Lehman moment” three years
ago. The new European financial stability facility is 1 trillion Euros. Activation is contingent on adopting an
austerity policy, but the fund is relatively small. Austerity policy increases deficits in the short term, and reduces
future growth.
21
15
fiscal, private banking and political union institutions. They can neither devalue nor
inflate national currencies that they no longer possess, and they cannot count on
timely supranational crisis assistance from strong brethren. Adjustments to
shocks therefore come down to painful internal price and wage deflation haphazardly
ameliorated by the kindness of strangers and bottom-fishing speculators. This should
be enough in general competitive theory, but too often leads to factional and societal
gridlock that compounds the misery, and could cause the EU to permanently and
gravely underperform relative to community's "un-caged" potential.
The PIIGS plight is instructive. Politicians in these countries cannot bring
themselves to cease deficit spending and reduce national debt. Their desires have been
partly accommodated by loans from strong members, but the assistance is
incommensurate with the PIIGS’ appetite to overspend, compelling their leaders to
take various ill-advised measures. They issue sovereign debt until interest rates rise to
ruinous levels, or buyers flee the market. They borrow from private domestic banks
until they succeed in bankrupting this segment of the financial sector. And when all
else fails, they resort to "haircuts," refusing to repay their obligations and sticking
"some other guy" with the debt baby.
The PIIGS predictably deny that their excess deficit spending is premeditated; that
they prefer to live permanently beyond their means at other expense, depicting
16
themselves instead as victims of circumstance. They contend that if investments
hadn't soured, debt service costs hadn't risen, or creditors had been more
compassionate they could have weathered the storm by repaying debts from
anticipated growth dividends. They assert that if they hadn't been placed in a
monetary cage, and strong members provided them with the wherewithal needed the
crisis would have been averted.
Consequently, the PIIGS and other union members do not feel obliged to
surrender their reserved economic freedoms for what they perceive to be the
procrustean bed of stronger political, fiscal and financial union. Their brethren failed
them after the 2008 crisis. Why should they anticipate more compassionate treatment
in a German dominated political, fiscal and financial union? Supranationality from
their perspective isn't faulty; the problem is that some EU members are stingy and
hard hearted.22
22
Juergen Baetz, “Eurozone Crisis Saves Germany Tens of Billions,” Yahoo!Finance, July 22, 2012. “While other countries in
17-country group that use the euro have battled against investor fears that their economies are buckling under the pressure of too
much debt, Germany has managed to save tens of billions of euros thanks to its reputation as a safe place for investments.”
Financially healthy Germany, meanwhile, has secured billions of euros in debt at record low — sometimes negative — interest
rates.
Germany has long been seen as a safe bet. It is Europe's biggest economy and is the biggest single contributor to eurozone rescue
funds, with a gross domestic product of €2.6 trillion ($3.17 trillion). The country's economy has grown steadily in the past two
years and, with quarter-on-quarter GDP growth of 0.5 percent, prevented the eurozone a whole from sliding into recession in this
year's first quarter.
The country recently sold billions of its 10-year-bonds with an interest rate — or yield — of around 1.5 percent. Last Wednesday,
it auctioned €5 billion ($6.1 billion) in two-year treasury notes with an average yield of minus 0.06 percent.
In other words, investors are losing money and paying Germany for the privilege of safely parking their funds in the state coffers.
Growing Germany offers the prospect of risk-free debt repayment, and other safe investments don't offer great interest rates —
the European Central Bank recently cut the rate on its overnight deposit facility to zero.
"The interest rates are unnaturally low at the moment," Finance Minister Wolfgang Schaeuble acknowledged last month, adding
they reflect the amount of "uncertainty in financial markets."
The side-effect, however, is a gain for Schaeuble's coffers.
"Germany saves about €10 billion ($12.5 billion) this year alone thanks to the low interest rates," economist Jens BoysenHogrefe of Germany's Kiel Institute for the World Economy told The Associated Press.
17
Some analysts argue that the eurozone debt crisis has already secured Germany a windfall of about €100 billion ($125 billion) for
Germany, giving the government extra leeway for growth-friendly spending or reducing its debt burden while other countries in
the eurozone struggle to stay afloat.
Germany's savings from its bond sales are little talked-about because money that is not spent is harder to keep track of. But a look
into the government's past financial outlooks gives an idea of the sums Germany is saving: In 2009, the government forecast that
it would have to spend €52 billion to service its debt in 2013. Now, it expects that cost to total only €20 billion next year.
Comparing what Germany paid in yields since 2009 with the period from 1999 to 2008 — when it paid much higher interest
rates, economist Boysen-Hogrefe estimates the German central government will save some €68 billion through 2022 on the debt
it has auctioned off since 2009.
"If there are no major catastrophes stemming from the eurozone crisis, the figure will soon be in the three digit range," he said.
If the debt issued by state governments and municipalities are also added into the equation, Germany's savings through the low
interest rates could be about 50 percent higher still, resulting in a figure already well above the threshold of €100 billion through
2022, he added.
By not having to pay higher interest rates on its debt, Germany has been given an opportunity to slash its budget deficit without
having to drastically reduce its spending — or having to introduce any of the austerity measures it has recommended other
European countries implement. The government expects to have a fully balanced budget by 2016 and aims to start reducing its
debt of €2 trillion ($2.5 trillion), about 80 percent of the nation's GDP.
Germany benefits from the eurozone's debt crisis, but it also has to shoulder major risks. If the crisis drastically escalates, with
one or possibly several member states abandoning the currency, Germany as the bloc's economic heavyweight could have to
inject up to €300 billion in the form of loans and guarantees to weaker European members and the bloc's rescue funds. That
would be about equivalent to the central government's budget for one year.
However, should the crisis in the eurozone worsen, Germany's savings are in danger of being seriously eroded. Roland Doehrn,
the RWI economic think tank's chief expert on growth and economic cycles, argues that gains from the eurozone's problems
should not be viewed in isolation. The first phase of the region's financial crisis — the 2008 financial storm set off by the
bankruptcy of U.S. investment bank Lehman Brothers — cost Germany dearly, forcing it to take on more debt to rescue banks
and stimulate the economy. Because Germany's overall debt significantly rose since 2008, he argues, it is not that easy to say how
much Germany is exactly saving because of the eurozone crisis alone. As a ballpark figure, however, an interest rate lower by 1
percent on a debt pile of €2 trillion would mean annual savings of about €20 billion, he added.
"If interest rates go up again, that would mean significant additional spending for Germany," he said, noting that such a
development could easily unravel the government's hopes to balance its budget by 2016.
Schaeuble, who previously said that Germany's sustainable long-term interest rate on 10-year-bonds should be in the 2 percent
range, said he hoped that the country's interest rates would go up again once the eurozone is out of its current turmoil.
"I believe the interest rate level — which practically is a negative interest in real terms — is more the reflection of the financial
markets' worries than of stability. That's why I prefer stability (for the eurozone), then we will still have a low interest rate level,"
he said. Schaeuble acknowledged that "some of our partners in Europe suffer from the burden of too high interest rates caused by
the irritations in financial markets," But he insisted that those countries must reform their economies and bring their finances in
order to regain market confidence."One does not have to apologize that the trust in the Federal Republic of Germany (...) is high
in financial markets," he said. “German minister: Greek euro exit has lost 'horror',” Yahoo!Finance, July 22, 2012. “Germany's
vice chancellor questioned whether Greece can fulfill the conditions for receiving further international aid and said Sunday that
the idea of the country leaving the euro has "lost its horror."The comments from Philipp Roesler came amid pressure on Greece
as the so-called "troika" of international debt inspectors prepares to determine whether Athens has implemented enough reforms
and budget cuts to merit more help. Roesler, who is also the economy minister, leads the pro-market Free Democratic Party —
the junior partner in Chancellor Angela Merkel's governing coalition. It often talks tough on Europe's debt crisis."Of course we
will all wait for the troika report in the autumn, but I will say here that I am more than skeptical," Roesler told ARD television,
adding that experts believe "Greece probably will not be able to fulfill its conditions."
"If Greece does not fulfill its conditions, then there can be no further payments to Greece," he added.
Greece has received two bailouts totaling €240 billion ($292 billoin) from other eurozone governments and the International
Monetary Fund after bond investors would no longer lend it money at affordable rates. In return for the money, Greece is
supposed to cut its budget deficit and reform its economy. However, the economy has continued to struggle and the new
government of Prime Minister Antonis Samaras has said it wants more time to meet some of the conditions. There's little
enthusiasm among creditors such as Germany for granting that wish.A cutoff of bailout money could lead to Greece defaulting
on its remaining obligations and possibly leaving the euro. Asked about the consequences, Roesler said it would first of all mean
Greece becoming insolvent — "but then perhaps the discussion will start in Greece itself and the Greeks will themselves come to
the conclusion that it is perhaps smarter to leave the eurozone.""I think that for many experts, for the FDP, for me too, a Greek
exit from the eurozone has long since lost its horror," he said. Roesler added that he didn't expect any other countries would leave
the 17-nation currency.
18
Macroeconomic Indeterminism
Fiscally conservative EU members reject these excuses, but there is little that can
be done. They cannot deny that further deficit spending might spur employment and
growth because the strategy has become an article of faith for many macro-theorists
and political leaders across the globe. They cannot gainsay the claim that flexible
exchange rates and independent monetary policies would have offered PIIGS more
opportunities for stimulating positive Keynesian multiplier effects at home and
abroad. All they can do is chastise, exhort, plead and assert their version of
macroeconomic orthodoxy against the PIIGS’ variant. There undoubtedly is some
truth to worst case scenarios of financial collapse, hyper-depression and perpetual
stagnation, but no one is listening.
Economic Union
This partly reflects a failure to recognize that a stable and sustainable supranational
economic regime requires an economic union combining both a monetary and fiscal
union. Monetary union allows members to reap the benefits of a common currency,
interest and exchange rate. Fiscal union permits central authorities to optimally
coordinate deficit spending and finance across the community. There is no need to
choose between them. They are mutually compatible, but as a practical matter it is
19
best to proceed by introducing fiscal union first and monetary union latter in
accordance with the American example, 23 because while an effective fiscal regime
shouldn’t cause macroeconomic disorder, a well-functioning monetary union may
unintentionally trigger severe macroeconomic disequilibrium by abetting PIIGS-like
speculative investment and over-consumption. Had the EU project proceeded in
reverse order starting with fiscal and ending with monetary union, the result in all
likelihood would have been better.
It is too late to alter the EU project’s development path, but the second best option
remains. Leaders can start the process of fiscal union building whenever they choose.
However, there has been little discussion of the matter yet because many members
remain wedded to EU supranationalism in its present form and are reluctant to
surrender more sovereignty to Brussels.
Expediency
The course of least resistance under these circumstances is expediency. Anti-full
economic unionist sentiment remains too strong to easily achieve fiscal union and
macroeconomic theory is too malleable to hold politicians' feet to the fire. The French
under socialist President Francois Hollande have decided that the best way to spur
23
The US has a monetary and fiscal union. Income in some states can be transferred to other states, using the federal
budget. In 1790 George Washington created the first federal government. Many states were bankrupted after the war
with the British Empire. Alexander Hamilton, the Secretary of the Treasury, replaced the states debt by one federal
debt. There were no “haircuts” for bond holders. After the union, Hamilton levied taxes to cover the debt. In the US
the order was first fiscal union, then monetary union. In Europe, if fiscal union is achieved, the process will be the
other way round.
20
growth and cut the fiscal deficit is ending exemptions and raising taxes on the rich.24
Others are cutting social spending, but hardly enough because national debt continues
increasing across the EU. The Germans tirelessly preach monetary discipline and all
express confidence in the future as if temporizing is a shrewd solution. Euroslerosis is
ignored on the premise that chanting the mantra of competitiveness will suffice
without drastically deregulating or reducing tax burdens.
24
“Lower house votes to end exemptions, raise taxes on wealthy,” AFP, July 19, 2012. French lawmakers Thursday backed a
series of measures abolishing tax breaks and taxing the wealthy as the new Socialist government pursued efforts to kickstart the
economy with a tax-and-spend programme.
The measures were part of the first budget bill presented by President Francois Hollande's government since he unseated rightwing Nicolas Sarkozy in May with pledges to focus on growth instead of austerity.
The lower house National Assembly approved the first measure in the early hours of Thursday, ending a Sarkozy policy dubbed
the "work more, earn more" rule of exempting overtime hours from payroll charges and income tax.
Lawmakers later voted to back an emergency rise in the ISF wealth tax applying to taxpayers with a net worth of more than 1.3
million euros ($1.6 million) and which is expected to bring in an extra 2.3 billion euros in revenues this year.
They also approved a tightening of the inheritance tax to reduce the exemption ceiling from 159,000 euros per child to 100,000
euros, the creation of a three percent surtax on cash dividends and the doubling of a tax rate on financial transactions to 0.2
percent.
With a strong majority in the lower house, the Socialists and their parliamentary allies were able to easily push through the
measures despite some fierce opposition from right-wing and centrist deputies.
The policies are part of a revised 2012 budget up for approval. More measures are expected to be voted in later, including a 30
percent decrease in salaries for the president and ministers.
Lawmakers on Tuesday had already voted to scrap a planned increase in the value-added tax pushed through by Sarkozy to
compensate for a reduction in payroll charges aimed at boosting competitiveness.
More fiscal steps promised by Hollande, including a 75 percent tax rate on annual incomes in excess of a million euros, are
expected to be introduced next year.
During the debates Budget Minister Jerome Cahuzac defended the measures as "a tough effort asked of those who can" afford it.
The right accused the Socialists of "lying" during the campaign and of hitting the middle-class with unexpected tax hikes.
"The rich will pay a little bit more but those who will make the biggest efforts will be the small and medium" income taxpayers,
former labour minister Xavier Bertrand told France Inter radio.
The French cabinet earlier this month approved the revised 2012 budget, which includes 7.2 billion euros in tax rises and 1.5
billion euros in spending cuts this year.
Tax increases are expected to raise another 6.1 billion euros next year.
France has made commitments to the European Union to reduce its budget deficit from 5.2 percent of GDP last year to 4.5
percent this year, aiming to get down to the EU limit of three percent in 2013 and to balance the budget in 2017.
The government is hoping that investment in infrastructure and job creation will reboot France's stagnant economy, which is
expected to have suffered a slight contraction in the second quarter.
21
New Normal
The cunning of the invisible hand could make this hodgepodge of contradictions
work in a crude sense. Aggregate effective demand could improve and unemployment
could be pared. The danger of an adverse new normal however is also real. A long
series of false recoveries, combined with negative returns to saving could depress
economic activity for decades. The EU is displaying signs of disorientation which
may be heralding a dyspeptic age.
Shadow Boxing
The EU's performance potential is severely constrained by political and ideological
obfuscation. Leaders have embraced supranationalism as a device for branding their
pan-European social democratic vision without thinking through the practical
ramifications. It makes little difference whether they have done so out of conviction,
or convenience. They have hamstrung their institutional and policy choices either way
and are suffering for it. Moreover, EU helmsmen have shown little willingness to
rethink their supranational faith. Some eclectically counsel more Europe, others less
including expelling Greece from the EZ without a comprehensive assessment of
opportunity costs.25 This is a trap. EU statesmen should take stock of community as it
25
Although there is no provision in the Maastricht treaty of a country to leave, political leaders in Greece and other
countries are considering that possibility for Greece. While Greece is currently receiving transfers from the other EZ
countries, it is paying a very high price in terms of unemployment and social unrest for those transfers. The primary
practical problem of leaving the Euro is that some Greek businesses and individuals have borrowed in Euros from
banks outside Greece. Since those loans are not covered by Greek law, the Greek government cannot change the
22
is, and is likely to be, not as they hope. Greece isn’t the fundamental problem. It is the
EU’s prevailing form of supranationality. If fiscal policy reform doesn’t suffice,
leaders should quickly grasp the nettle by revising EU supranationality with either
more or less Europe as community politics dictate.
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