Revisit the EU Discussion

[FitzFord]

As an example of a decentralization, the current and recent issues can potentially shake the EU as a fully developed model. Threats of UK leaving if reforms are not undertaken, and at least one member under threat of expulsion, a weakened currency, all indicate that the institutional design of the system may need to have significant changes. To what extent does the ongoing stress and increasing discord suggest that  without careful and extensive review and adjustments the existing framework, there will be substantial and increasing weakness in the structure? Or will it fix itself without much effort? Are there clear or emerging lessons that educate other countries on the design of decentralization?

Fitz.

[John Short]

Fitz,
Perhaps the issue is not about decentralisation but about centralisation?  Were the conditions of the euro zone inappropriate for some of those joining?  Were those that stayed out of the euro wishing for a free trade zone, now fearful of political union even though not in the single currency?  Time will tell, I guess..... but when?

[FitzFord]

John,

You raise an interesting set of issues. What links the two perspectives is how to design systems of relationships between countries. One is an arrangement based essentially on a special relationship with regard to trade, in which case agreements are built around the instruments of trade: currency, preferences, rules that define the quality of products and the pricing thereof, and some sweetening of economic elements, including agreements on labor access across borders that are beneficial to both countries. There is no effort at kinship that would bind the relationship into an extended family. When the family exists, there is a commitment to the long-term wellbeing of all the family members, despite occasional annoyance and disagreements. That commitment also requires agreement to behavior that, at minimum, does not threaten the family. Indeed, the commitment is to strengthen the family as a whole. In that context, idiosyncrasy is accepted, within bounds that are well-known, and when these bounds are breached, sanctions are known ahead of time, and applied. No one is happy to see sanctions, but everyone accepts its fairness. This brief description omits some of the complexity, but tries to capture the principle of the system.

Which one is the EU?

Fitz.

[John Short]

Fitz,

Any easy questions? - might need a few Red Stripes for this!

Without their benefit, I venture a  qualified first one - not all are in the € and some are quibbling at labour access.  The second one  is not there yet - it still looks like you can be kicked out or even walk away so it does not quite measure up to being one of Francis's children.

Now if you come down to join me in your home land for a few Red Stripes we might solve all the world's conundrums!

John

[harnett]

Interestingly the economist, Robert Mundell, who was one of the architects of optimum currency union - ended up going against his own theory and supporting the €.  Optimal Currency Union (of which he was a main proponent) suggests that the following are required:

 1.   Labour mobility across the region. This includes physical ability to travel (visas, workers' rights, etc.), lack of cultural barriers to free movement (such as different languages) and institutional arrangements (such as the ability to have pensions transferred throughout the region).
  2.  Openness with capital mobility and price and wage flexibility across the region. This is so that the market forces of supply and demand automatically distribute money and goods to where they are needed. In practice this does not work perfectly as there is no true wage flexibility.  The Eurozone members trade heavily with each other (intra-European trade is greater than international trade), and most recent empirical analyses of the 'euro effect' suggest that the single currency has increased trade by 5 to 15 percent in the euro-zone when compared to trade between non-euro countries.
  3.  A risk sharing system such as an automatic fiscal transfer mechanism to redistribute money to areas/sectors which have been adversely affected by the first two characteristics. This usually takes the form of taxation redistribution to less developed areas of a country/region. This policy, though theoretically accepted, is politically difficult to implement as the better-off regions rarely give up their revenue easily. Theoretically, Europe has a no-bailout clause in the Stability and Growth Pact, meaning that fiscal transfers are not allowed. During the 2010 Eurozone crisis (relating to government debt), the no-bailout clause was de facto abandoned in April 2010.
  4.  Participant countries have similar business cycles. When one country experiences a boom or recession, other countries in the union are likely to follow. This allows the shared central bank to promote growth in downturns and to contain inflation in booms. Should countries in a currency union have idiosyncratic business cycles, then optimal monetary policy may diverge and union participants may be made worse off under a joint central bank.

Note points 3 & 4.  The Eurozone does not adopt a risk-sharing system a la USA (when Miami ran a deficit the Fed stepped in and rescued it, not so for Greece).  As for the business cycle issue, point 4, we all know that the country out of step is Germany.  It went into the € at a low ex rate and also with an aggressive export orientated growth strategy (not to mention aggressive Banks looking for lending, when the funds rolled in) - a recipe for failure.  If anyone thinks that Greece is the exception take a look at productivity rates across Europe as in this old article:

http://www.theatlantic.com/business/archive/2012/04/the-euro-is-still-doomed-why-most-of-the-news-out-of-europe-doesnt-matter/256230/

Mundell seems to have thought that the economics would "sort" the politics, but as many of us know (in particular the USA) - its the politics that needs sorting first.

So....by contravening an old economic theory, Europe got it wrong with the introduction of the € - and let's not be shy... first Greece and then who?

Having said that... it appears that the current spat has crystallised the argument away from economics and towards politics.  A left wing Greek government cannot be seen to succeed.  Personally I'm interested in who was democratically elected.  EU?  ECB?  IMF?  And whose interests should be paramount?  Bankers or people?

[FitzFord]

Harnett,

Interesting indeed! Today is even more interesting. The IMF has taken the position that the Euro should be like the US$ to the US, i.e. a currency that the currency for all EU members without any caveats. No British Pound, no options; we are all together in the same pool and no other currency plays in this pool as a member.

I happen to agree, incidentally...

Fitz.

I have been trying to post the NYTimes report on it but my computer is not cooperating this morning... It anyone can post the story it would be helpful to the rest of us. F.

[harnett]

Yes - theoretically sound - as long as there is political union!!.... which there isn't, and has been shown to be the case more than ever now!!  Even more people across the EU will now be anti EU - here in UK we will have the unlikely (unholy?) alliance of the left and right against the EU during the forthcoming referendum methinks.

[FitzFord]

I find it interesting that there are so many elements of a political union, as if it was either intended to have one. Perhaps someone may be able to explain why it did not go all the way? And why, it was believed that this incomplete effort would be able to be succeed as a coherent institutional system. Was there no anticipation of the type of issues that are now at play, and was there not a plan or program to address the future as the "Union" become more complex?

Fitz.

[John Short]

Maybe the answer can be found here.

[harnett]

What is interesting is that Mundell supported the € introduction on the assumption that it would enforce political union.  Obviously he didn't factor in the short sightednes of politicians!  Or electorates?

[FitzFord]

Harnett,

I thought for some time with regard to why a country (like Britain) with a currency that is well accepted in the world market would be willing to give up its currency unless the governance of the Union has proven to everyone that it was of superior benefit to do so. My concern was that countries with weaker currencies would be attracted by their ability to get a cushion of a stronger currency if they did not agree to a system that would enforce discipline in the interest of the whole. Some might think that they could enjoy the benefit without the discipline of immediate response to poor fiscal management. But I guess I was wrong...

Fitz.

[harnett]

Fitz

Surely right!  Though the debate should be only partially about poor fiscal management. Optimal Currency Union shows that the currency will fail even if all countries engage in prudent fiscal management.  In the case of the EU, all countries would have had to have adopted the same economic strategies, which they didn't - indeed couldn't.  It just took one country to engage in export led growth and an aggressive loaning of surpluses to other countries and..... the rest is history. Sure, the ones with the weakest fiscal management / economies would emerge as problems first, but the fundamental problem is political union rather than fiscal management.

[FitzFord]

This seems to be the time revisit the questions about the structioning of a number of existing independent countries into a framework that tradition had been associated with large countries that structured tiers of smaller physical areas that are given a degree of control and execution of authority by the national government. (This is not the same as creating a larger country by conquering smaller or weaker countries). The EU has been a collection of independent countries that agreed to participating in a representative body that had been negotiated (not conquered or otherwise overrun). The consequence is that members may leave the association unilaterally. In hindsight, what elements of the EU structure and processes should have been included or excluded in the creation of the EU?