Dismantle the Eurozone

by George Hatjoullis

The National Bank of Poland has published a working paper making the case for, and offering a route map to, dismantling the eurozone ( see earlier blog). The IMF has published a paper entitled ‘Toward a Fiscal Union for the Euro Area’, (http://bit.ly/1b5wHkv). Central to both papers is the notion that the eurozone can only survive with greater fiscal integration and a consequent loss of national sovereignty. In the absence of such integration, the eurozone is doomed to a structure of have and have-not states, which will require unrealistic and destructive movements of labour and capital. The movements are unrealistic because of the scale required and the fact that the states are ethnically and culturally distinct with long and proud histories. The social and political stresses and strains that result will threaten internal political stability and even the continued existence of democracy. Nowhere is this more evident than in Greece today. The irony is that the whole situation is being perpetuated by Berlin’s response to the eurozone crisis and the economics resemble Germany’s own experience in the interwar years as a result of severe reparations imposed on Germany by France. It is fiscal union or bust and this is what both the NBP and IMF papers imply.

Full fiscal integration is not a panacea. It does not alter the absolute productivity levels of Greece or its comparative advantage. It does however allow for fiscal transfers to accommodate economic shocks and smooth adjustment to such shocks. There is a difference between the transfer involved at a macro level for fiscal policy and at a micro level for regional policy. The latter exists within EU budgets and is designed to enhance productivity levels. Even if productivity differences were small, different regions might experience different economic cycles or suffer more from eurozone wide shocks. As independent states these shocks can be accommodated via currency fluctuations and monetary policy. This degree of freedom is lost within the eurozone but as things stand it is not replaced by any other tools. Indeed the thrust of the Berlin-inspired reforms is to limit the capacity for member states even to carry out counter-cyclical fiscal policy. Each member state is presently impotent with respect to conventional macro economic policy tools. It has no degrees of freedom. Each state must run its fiscal budget according to externally defined criteria and accept a monetary policy defined by the weighted average needs of the region, irrespective of domestic economic and social conditions. Moreover, there is no collective fiscal arrangement to smooth country-specific problems.

The difference is noticeable when one looks at the USA. The situation differs in two important respects. First, there is a federal budget and a federal borrowing programme which is the collective liability of the federal structure. Second, all inhabitants are US citizens. Labour mobility is excellent because there are no barriers, legal, cultural or language. The USA still experiences variations in economic activity across the states and differential productivity levels but it has enough degrees of freedom to cope without too much civil unrest. Fiscal transfers to individual states are allowed. Most important, the national identity dominates ( by and large) state identity. The contrast with the eurozone is obvious. The IMF is suggesting a move towards an US type of fiscal arrangement. However, it cannot change the sovereign state structure of the eurozone.

Fiscal integration is a necessary but not sufficient condition for the survival of the eurozone. It is ultimately going to be necessary for the eurozone identity (citizen of the eurozone) to dominate national identities. This may never happen and is certainly not going to happen in the time the eurozone has left. It was a mistake to embark on such an ambitious eurozone structure before the EU had absorbed all the countries it was ever going to do so and before the populations had time to adjust their sense of identity. The stresses of the disastrous eurozone experiment threaten the EU itself and this is the concern of the NBP. Dismantle the eurozone before it threatens the EU.

Of course, this is easier said than done. Moreover, the response to the crisis by weak and strong alike has been driven by fear of the consequences of reneging on the irrevocable nature of eurozone membership. One exit, it was feared, opened up the possibility of many and threatened the very existence of the zone. Individual member states fear the dislocation of exit and so have accepted whatever medicine has been thrust down their throat, by and large. It has enabled Berlin to impose its own vision of the eurozone on everyone. But the Berlin vision is unworkable in the long run. It ignores the social and political stresses that arise from severe economic hardship imposed from outside. You would have thought they would understand but it seems Germany has wiped part of its memory.

The eurozone crisis seems to be over but it is not. If one member unilaterally defaults or otherwise exits the eurozone the whole mess begins in earnest once again. None of the measures in place will be able to contain the stresses. It is not hard to see a scenario in which this comes to pass. Dismantle the eurozone now before it is too late.