by Amar Bhidé, Elliott Morss and John Lounsbury
This is a three sided debate on the Euro crisis. Prof. Amar Bhidé, Thomas Schmidheiny Professor of International Business, Fletcher School of Business, Tufts University, represents the position that the current course of action simply needs to be followed through to be successful. Elliott Morss, former IMF economist, argues that the logical solution is to break up the eurozone and reestablish sovereign currencies. John Lounsbury, Managing Editor of Global Economic Intersection, says there is a third solution, the United States of Europe.
In Praise of the Beleaguered Euro
by Amar Bhidé, in The Wall Street Journal, 7 May 2012
Sunday’s trouncing of Greece’s ruling coalition in parliamentary elections is fanning fears that it will leave the euro zone and try to devalue its way out of crisis.
Some believe this to be the right course of action. They argue that Greece and other countries on the continent’s southern periphery should never have joined the euro. Tough global competition depresses prices, while rigid labor markets prop up wages. A lower exchange rate would ease the squeeze, but the competitiveness of exporters in Germany and other northern countries keeps the euro high.
The argument for fleeing the euro to devalue is misguided. Greece and the other peripheral economies lost little in giving up their national currencies. Nor did their membership make the euro zone too sprawling to succeed. If anything, its size and heterogeneity are a plus.
Currency devaluations supposedly give countries with chronically uncompetitive businesses and rigid labor markets a way out. Devaluation is tantamount to a price cut that allows local companies to maintain or even expand their share of international markets. Devaluation, the argument goes, also raises the price of imports, giving local businesses an edge in their home market.
The Only Workable Option: Break Up the Eurozone
Written by Elliott Morss
For some time, I have argued the Eurozone is not a viable economic entity. In a recent piece, I predicted that until it is broken up:
- The French and German governments, working on behalf of their banks, will squeeze all they can out of the ‘weak sisters’;
- Unemployment rates will continue to increase with accompanying civil disorder/riots becoming more intense;
- The leaders of the “weak sisters” will commit political suicide by continuing to support the ECB/IMF mandates.
Political developments of the last week make it even more certain that a break up is the only viable outcome. And yet, there are some who disagree. Amar Bhidé, in a recent Wall Street Journal piece, argued that:
“Sovereign over-indebtedness and banking solvency are serious problems for Europe, but the common currency is doing its job just fine.”
Bhidé is not alone in feeling this way. In what follows, I will examine the arguments made by those wanting to keep the Eurozone together.
Giving Up National Currencies
“The argument for fleeing the euro to devalue is misguided. Greece and the other peripheral economies lost little in giving up their national currencies.”
Lost little? What? In giving up their national currencies, countries also lost their ability to use monetary and fiscal policies to achieve full employment. Does this matter? Well, maybe not if all Eurozone countries had the same unemployment rates. But they do not. Take a look at the following table. You have some Eurozone countries near full employment. But the countries starting with Belgium have serious unemployment problems. Monetary policies in these countries should be keeping interest rates low while fiscal policies should be creating jobs. Not so for Austria, The Netherlands and Germany: countries at or near full employment. A common monetary and fiscal policy simply cannot address the vast differences in economic conditions in the Eurozone countries.
Source: IMF WEO Database
There is one other important point to note about Table 1. The two right-hand columns give government deficits as a percent of GDP. Note that under IMF/German austerity pressure, the deficits of all high unemployment countries are supposed to fall in 2013. They will not.
When all countries have to use the same currency, they are held to the competitive standard: they must adjust their internal costs structures to compete on world markets. Take a look at Table 2. Most Eurozone countries with high unemployment have negative current account balances – an indicator of an inability to compete on world markets.
Table 2. Current Account Deficits (as percent of GDP), 2012 Source: IMF WEO Database
If a country has its own currency, its value relative to other currencies will adjust to make the country more competitive on world markets. For example, if a country is running a current account deficit, its currency will weaken, thereby making its exports cheaper for other countries to buy. This valuable adjustment mechanism is not available to countries using their own currencies.
What do the “keep-the Eurozone-together” proponents say about devaluations? I again quote from Bhidé:
“Devaluation is a blunt, top-down intervention whose benefits and costs diffuse in unpredictable and often unwanted ways.”
I disagree. Take the US as an example. Back in the 1980’s, Japan became extremely competitive as an export nation. Japan was then the “Asian tiger”. In 1985, a US dollar would buy 239 yen. Today, a dollar only buys 83 yen. That devaluation helped US costs adjust so it could remain competitive on world markets. It was not “blunt, top-down intervention”. Instead, it happened gradually through time.
So what do the Eurozone proponents want to do to make its “weaker” countries’ cost structures competitive? A good example is what they tried in Greece under an IMF monitored standby agreement. I quote from an earlier piece I did on the IMF program:
“In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country. The general categories include: fiscal reforms, pension reforms, health sector reforms, Social Security reforms, government performance reforms, and economic system reforms. In order to achieve these objectives, the Greek government has agreed to foreign technical assistance in more than 20 different fields. Ok. So maybe if Greece did everything on the IMF list, they could stay in the Eurozone and compete with the Germans. But don’t hold your breath. This will not work.”
There are two primary Eurozone imbalances that need to be addressed:
- Unemployment rates – with some countries at full employment and others with 50% of their younger workers without jobs, how can a “zone” with a single monetary/fiscal policy and little migration get unemployment rates down without causing inflation in countries at full employment?
- The competitiveness gap – without using the devaluation adjustment mechanism, how will Greece ever be made competitive with Germany.
A Third Option for Europe: The U.S.E.
Written by John Lounsbury
Amar Bhidé and Elliott Morss have presented two articulate and well thought out arguments why the Eurozone should continue on its current course (Bhidé) and why it should be broken up, returning to a number of separate sovereign currencies (Morss). However, there is a third option that neither discussed: A United States of Europe. The early days of the U.S. attempted to operate under a decentralized confederation and found less than success. The Eurozone, although much more centralized on a monetary basis than the early American experiment, has a somewhat similar political and fiscal decentralization. There are reasons why this third option may well be more difficult to implement than either of the other two, but it is actually the end result that many leaders (including despots, whose single-country visions were not democratic) have dreamed of since at least the 1400s.
In this essay I will attempt to discuss the significant obstacles that stand in the way of forming a U.S.E., which are primarily rooted in national and cultural diversity. We will also try to look at just how the formation of a single political-monetary-fiscal entity for Europe, analogous to the U.S.A., might actually deal with the economic diversity following a different path than either Bhidé and Morss have suggested.
The Political and Monetary Geography of Europe
The European Union (EU) is a political and economic confederation with distributed fiscal authority among its member nations. The graphic below from Wikipedia shows the growth of the EU from 1957 to date.
What are the specific Differences Between the EU and the U.S.?
Each country in the EU has retained its own power to determine its own level of taxation and appropriation within its domain as an exclusive right. In the United States each state also taxes and appropriates but without exclusivity. The federal government has the power of taxation and appropriation for the entire country. It is this centralized fiscal authority in the U.S. which defines a primary structural organization difference between the EU and the U.S.
This lack of fiscal authority for the EU is not a fatal flaw overall, but only for the Eurozone, the users of the common currency which is created by the ECB, the European Central Bank. Taxation is an essential management factor for the maintenance of a viable fiat currency; this is present in the U.S. system and not in the Eurozone.
The solution supported by Amar Bhidé, the current organizational structure of the Eurozone, does not contain all the tools that would be useful to deal with the current debt crisis. The only re-balancing processes available in the Eurozone involve resolution of national budgetary imbalances through austerity where deficits exceed guidelines. This results in something called wage repression, which occurs through two mechanisms: high unemployment and reduced hourly pay for those still working. This is highly deflationary for countries where it occurs. This result obviously will be widely unpopular.
The concomitant expansion of the ECB balance sheet to push more currency into the system to combat the deflationary forces will create inflation in Germany which has a positive balance of payments and no debt problem, a change that will also be very unpopular there.
In the U.S. the additional tool of federal taxation and distribution of money is available. Such things as emergency national unemployment benefits, distribution of food stamps, uneven distribution of expenditures among the various states are all tools the U.S. has that the EU does not.
How Does the U.S. Deal with Uneven Economic Activity?
Obviously, things like food stamps, extended unemployment benefits, etc. go more to the states that have the greater economic problems. These are tools that mitigate wage repression in areas where it is more severe in a severe downturn like The Great Recession. Such stabilizing options are not easily (or not at all) available in the Eurozone. There the re-balancing, if it is to occur, must be born entirely by austerity and wage repression.
The U.S. System Works Good Times as Well as Bad
Even in good times the U.S. is constantly leveling the economic conditions across the fifty states. An example is the fact that has existed in much the same pattern for years: Some states receive more federal money than they pay in taxes and others less. This is a way that a stable economic system is maintained were wealth is not evenly distributed among the states by market forces. It is a way that Mississippi, with a median family income of $37,000 can survive in a country with Maryland, with a median family income of $64,000.
There is a a great disparity among the states regarding distribution of federal payments. For the most part this is based on taking from the wealthy states and giving to the poorer states (although there are some exceptions). The following table shows the redistribution of tax revenues in 2005, clearly not a year of recession.
Can you imagine such a distribution of taxation and benefit occurring in the Eurozone? It could only happen, in my opinion, under a stronger central government (the U.S.E). And that would be a way for a Mississippi (Greece) to co-exist with a Maryland (Germany).
Impediments to Forming the U.S.E.
There is a deep history of language and cultural differences that stand in the way of a stronger centralization of government in Europe. There are pockets of strong nationalism and centuries of military conflict that have polarized the political DNA of the continent, going all the way back to the Romans. While there are intellectual, as well as emotional pressures to push toward a stronger centralization for the very reason that it would create conditions counter to the old nationalistic pressures that resulted in almost continuous military strife for millennia.
The ancient character of the divisions will make it hard for the new intellect to fully realize the unified Europe dream. It seems that the position I have taken in this debate is probably the least likely of the three to be an immediate solution. I would argue, though, that it may well be the ultimate solution.