Wolfgang Munchau started off a recent FT column as follows:
Just imagine it is this Thursday evening in the European Council’s gathering of Europe’s heads of state, and the Italian prime minister stands up and says this: “Mr President, dear colleagues. We are confronted with a simple choice: we can today either save the euro and build the foundation for a future political union, or we could flunk it and achieve neither. We all know what we need to do to save the euro. We require a banking union for Spain, a fiscal union for Italy and a political union for Germany.
“We can, of course, disagree on details. But we have to settle some of these differences this weekend, and take a decision on the steps that are needed right now. Our crisis resolution policies have failed time and again. We now need something that works fast. If we fail, I can assure you that I can no longer be part of this group, and my country can no longer be part of this project.”
I’m having a great deal of trouble following the logic of all this, but perhaps my commenters can set me straight. Obviously lots of smart people agree with Munchau.
It seems obvious that the euro was a colossal blunder, for reasons ably explained by Paul Krugman in this post. It also seems clear to me that the euro can’t be fixed with fiscal and banking unions. If Greece doesn’t devalue, it will remain deeply uncompetitive for many years. And yet most Very Serious People (and even Krugman is in that group) would be sad to see the euro collapse and are reluctant to pull the plug. I think they overrate the effects on the European project, (which I agree has been mostly a force for good.)
In my view the euro is fatally flawed, and Europe would be much better off with the monetary regime of the late 1990s. Yes, a collapse would be very messy, and perhaps it should be avoided, but let’s not ever forget that the system we are trying to save is a bad one, and if we “succeed” then the eurozone will be condemned to further crises in the future. Maybe not debt crises, but at the very least competitiveness/unemployment crises. So we shouldn’t enact other flawed policies to save this flawed one.
Now the talk is adding three more unions; banking, fiscal and political. These are very poor policy options, which wouldn’t even be undergoing consideration if not for the frantic desire of the VSPs to save the euro. Banking union will make the moral hazard problem even worse. As it is, the Spanish government didn’t do enough oversight of the regionally-owned savings banks. And now we are talking about shifting the burden of bank failures from the national governments to the eurozone taxpayers? How is that likely to improve regulation? And why stop there, why not an OECD banking union? (The new issue of The Economist says the burden of financing the deposit insurance fund will fall on banks, not taxpayers. Yeah, and motorists don’t pay petrol taxes, oil companies do. I expect that from the mainstream media—but The Economist? )
I can see how banking union might conceivably be defensible. Perhaps the eurozone regulators will be controlled by countries that want much tougher standards. Perhaps it will work. But fiscal union and political union seem to be an even greater leap into the unknown. I’d consider these as a pair, as I don’t see how you could have one without the other. Whoever is cutting the checks will demand a say in how the money is to be spent.
It seems inconceivable to me that Britain would agree to a political union, so I presume this discussion refers to the eurozone, not the EU. The eurozone excludes Norway, Iceland, Sweden, Denmark, Britain and Switzerland. That’s a fairly affluent group of countries. The eurozone is shaped roughly like a pyramid, with Finland on top, and a wide base stretching from Portugal to Cyprus on the bottom. Most of the weight if a pyramid lies in the bottom half, which in the case of the eurozone is mostly lower income countries like Italy, Spain, Greece, Portugal, Cyprus, and Malta.
The balance of power would probably lie with France. Germany must be terrified that the new French government has just lowered the retirement age to 60 for some workers, and is throwing its lot in with the “pro-growth” PIIGS. It seems to me that a fiscal union would basically be a regime for shifting wealth from the north to the south. Given that Germany is one of the few northern countries that’s actually in the eurozone, they must be feeling very isolated right now. Oh wait, I forget about Estonia . . .
I recall that Krugman mentioned that places like Greece and Portugal are about as far below the eurozone average as Mississippi is below the US average. That’s true, but misleading for all sorts of reasons.
1. There are studies showing places like Mississippi receive massive subsidies from other states. In my view those data are somewhat misleading. If taxpayers in New York pay into Social Security for many years, and then receive benefits when they retire in Florida, it seems a bit misleading to view that as some sort of gift from the state of New York to the state of Florida. Ditto for money spent on things like nuclear weapons silos in North Dakota. Nonetheless, I accept the basic point that poorer states like Mississippi are net receivers of federal money. But Mississippi does not elect Senators who call for higher taxes on the rich with the money going to support poor people in Mississippi. The GOP would insist that’s because Mississippians have much more solidarity with the US than Greek voters would have with the eurozone. Dems would insist it’s all about white Mississippians having solidarity with other white people. But even using that worse case assumption, America’s fiscal union is still based on a more stable foundation, after all, there are affluent white taxpayers spread all across America. There aren’t many affluent Greek taxpayers residing in Hamburg.
2. The pyramid structure I referred to earlier is likely to get much worse as the eurozone grows over time. And it seems to me that here you have a massive adverse selection problem. Because of Abraham Lincoln, affluent states like Massachusetts can’t suddenly decide they want no part of our fiscal union, and would rather just reap the benefits of our large single market. But Switzerland, Norway can and did make that choice. Britain almost certainly would, and both Sweden and Denmark might as well. In contrast, Bulgaria, Romania and Croatia would like nothing more than to join such a union. And all the likely future expansion of the EU is into areas further east, and much poorer than even Greece and Portugal. Places like Armenia, Georgia, Ukraine (a country nearly the size of France) Belarus, Serbia, Macedonia, Bosnia, Moldova (the saddest place on Earth—even the name is depressing.) And did I mention Turkey? Indeed why not Russia at some distant point in the future?
I’m sure the actual fiscal and political union ideas being kicked around are much more modest than the scary picture outlined here. But once you start down that road, there isn’t any natural stopping point short of the United States of Europe. People often compare Europe to the US. That’s wrong; the eurozone is sort of like the US, although a bit poorer. But Europe as a whole is far poorer than the US, far more corrupt, backward, inefficient, whatever other pejoratives you want to apply. Even America at its worst (say the treatment of ethnic minorities) isn’t as bad as the treatment of gypsies in Eastern Europe. I hope the Europeans look before they leap. (In case I sound like an ugly American, I’d add that Europe is also better than America in some respects; lower crime rates, more attractive cities, less carbon emissions, etc. But none of that changes my basic argument here.)
Now it’s time for me to take off my reactionary hat, and put on my progressive hat. The best way for the Germans to avoid this potential fiscal nightmare is to agree to modestly adjust the ECB mandate, perhaps to a 4.5% NGDP growth mandate for the eurozone, level targeting. This would give wavering countries like Italy a sense of hope that there would be growth going forward, and that they would not get crushed under an ever growing burden of public debt to GDP.
I understand that most Germans would prefer the current 2% inflation target. But they need to think long and hard about which would be worse, tweaking the ECB target, or an open-ended commitment to eventually transfer trillions in German tax money to the south and the east of Europe. (I’m a utilitarian who is not opposed to redistribution. But if they really feel that generous I’d suggest Bangladesh or the Congo, not Greece.)
PS. After I wrote this post it occurred to me that more sophisticated euro analysts will view my scenario as simplistic and unrealistic—no one is seriously contemplating that level of integration. My point was not to predict the future, but rather to provide a warning. Once you start down that road, there will be constant pressure to go further. Quite likely at some point the northern European taxpayers will rebel, and we won’t end up with a United States of Europe. The policy will collapse. But why start down a road that will end in failure? The eurozone really only has two options; a more expansionary monetary policy or a breakup. There’s no point in looking for alternative solutions.