Tuesday 14 June 2016

Can the Eurozone survive?

The Eurozone faces a crisis of epic proportions. Unemployment in Spain stands at over 20%. Youth unemployment in Greece exceeds 50%. GDP per capita in Italy is back to where it was in 1996. This crisis––the crisis of the single currency––was not without forewarning. A number of prominent commentators predicted it some years in advance. One such commentator was the economist Martin Feldstein, who in a 1997 Journal of Economic Perspectives article noted:
My own judgement is that the net economic effect of a European Monetary Union would be negative. The standard of living of the typical European would be lower in the medium term and long term if EMU goes ahead than if Europe continues with its current economic policies…
Another such commentator was Baroness Thatcher, who in a 1992 interview with Forbes remarked:
Every single fixed exchange rate has cracked in the end. We’re all at different levels of development of our economies. Some countries simply couldn’t live up to a single currency. It would mean massive extra subsidies from the rest of us for them or massive movements of immigration from their countries into ours. Both would cause resentment and not produce harmonious development.
Arguably most prescient of all, however, was the Nobel Prize-winning economist Milton Friedman, who in a 1997 article for Project Syndicate wrote:
Europe’s common market exemplifies a situation that is unfavourable to a common currency. It is composed of separate nations, whose residents speak different languages, have different customs, and have far greater loyalty and attachment to their own country than to the common market or to the idea of “Europe”. Despite being a free trade area, goods move less freely than in the United States, and so does capital. 
The European Commission based in Brussels, indeed, spends a small fraction of the total spent by governments in the member countries. They, not the European Union’s bureaucracies, are the important political entities. Moreover, regulation of industrial and employment practices is more extensive than in the United States, and differs far more from country to country than from American state to American state. As a result, wages and prices in Europe are more rigid, and labour less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism… 
The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues.
As the quotations above imply, in order to make the Eurozone work, much greater fiscal integration of Eurozone economies is required. Employment and industrial law will need to be harmonised still further; various tax and spending powers will need to be transferred to Brussels; and far higher levels of inter-state migration will need to be encouraged. For illustration, compare the EU to the United States––a rather more successful monetary union. Whereas the EU (of which the Eurozone comprises the larger part) accounts for only ~3% of spending in Europe, the US federal government accounts for ~60% of spending in America. Whereas rich EU countries such as the Netherlands make net contributions on the order of 0.4% of GDP, rich US states such as Connecticut run net fiscal balances (federal taxes paid minus federal spending received) on the order of 5% of GDP. And whereas just ~4% of people who were born and still reside in the EU live outside their country of birth, ~31% of people who were born and still reside in the US live outside their state of birth. 

Is wholesale fiscal integration of Eurozone economies achievable? Evidence from surveys and opinion polls suggest that it is very likely not.

First, despite the EU’s extensive efforts to cultivate a Pan-European identity, Europeans continue to identify more with their nation than with Europe as a whole. There is no European demos. In the 2014 wave of the Eurobarometer survey, respondents were asked to say whether they identified: with their country only; with their country first, then Europe; with Europe first, then their country; or with Europe only. The average proportion identifying with their country only or with their country first was >90%; in no country did less than 75% of people identify as such. And if we again turn our attention to the United States, we see a starkly different picture. Only a tiny fraction of Americans––around 7%––identify more with their state than with the United States itself. 

Second, when questioned specifically about taxation, social spending and employment law, most Europeans are decidedly sceptical about further centralisation. In the 2005 wave of the Eurobarometer survey (administered before the financial crisis), respondents were asked to state, for each of a number of policy areas, whether they believed decisions should be taken separately at the national level or jointly at the EU level. Only 39% supported joint decision-making on fighting unemployment; only 29% supported joint decision-making on health and social welfare; and only 25% supported joint decision-making for taxation. 

Third, there appears to be little appetite for softening the terms of the Greek bailout deal among citizens of the rich, creditor nations in Northern Europe. A YouGov poll conducted in July of 2015 found that 53% of Swedes, 61% of Germans, 64% of Danes and 74% of Finns were opposed to any renegotiation of Greece’s debt repayments. Moreover, sizable majorities in each of these countries––65% in Sweden, 59% in Germany, 70% in Denmark and 73% in Finland––blamed the Greek crisis squarely on successive Greek governments, rather than on either the troika (the EU, the IMF and the ECB) or on both Greek governments and the troika. The same poll found that 47% of Germans expressed a preference for Greece to leave the Eurozone. This percentage had risen to 59% in another YouGov poll carried out one month later. 

In conclusion: the Eurozone is currently embroiled in a crisis, a crisis which can only be overcome through much greater fiscal integration of Eurozone economies. Yet wholesale fiscal integration is not achievable in the near term. Europeans identify much more strongly with their nation than with Europe as a whole; they are largely opposed to the centralisation of taxation and social spending; and those living in the rich, creditor nations of Northern Europe show little appetite for fiscal transfers to their crisis-stricken counterparts in Greece. As Larry Elliot comments in The Guardian:
Brexit will remain a live issue unless the eurozone can sort itself out. That means either admitting that the euro has been a terrible mistake, or going the whole hog and integrating further, with a single banking system, a Europe-wide treasury, and a democratically elected finance minister with the power to raise money in Germany and spend it in Greece. This is not going to happen any time soon, and perhaps never.

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