The Eurozone and the failure of today's politics

8:49am 8th June 2010

The recent volatility in the Euro and problems in the Greek economy have highlighted some of the deep divisions and structural problems within the Eurozone. The British government must be looking on with great amusement as the very concerns that saw them abstain from the Euro currency all those years ago have materialised. To me, the most interesting thing about the debates that surround this event are the facets of the socio-political paradigm of today's nations that they reveal.

One of the main characteristics of the Eurozone is that it requires the member economies to maintain a materially identical monetary policy, which is set by the European Central Bank in light of overall economic conditions in the Eurozone generally. Striped of sovereignty over domestic monetary policy, national governments are left with the other major economic tool in their bag, fiscal policy. However, governments must implement their fiscal policies in light of a monetary policy set by the ECB which may at best be appropriate for domestic conditions, or at worst, exacerbate problems and destroy advantages. Due to the enormous differences between member economies, it is inevitable that both situations will arise from time to time in different member states.

In other large national economies such as India or the United States, monetary policy is also set by a central bank for component economic units that may operate under vastly disparate circumstances. The current situation in the Eurozone could be compared to the US, where California, by far the largest state economy in the US, shares the same monetary policy with Vermont and North Dakota, the union's smallest economies.

How is the problem solved there? There are many ways that economic policy is harmonised, but the main way is through a complementary national fiscal policy. A set of taxes, subsidies and regulatory frameworks ensure that economic policy between the states are brought into consistency by transferring funds from rich states with large economic surpluses to those with deficits. This is a simplification of economic policy, but illustrates one of the main ways in which the overall economic strength of the United States is used to benefit all of its members, big and small. While larger, more well-developed states may be economically better off being independent, they reap significant political benefit by being part of the Union, while smaller economies give up some of the sovereignty they would otherwise have in return for the economic support of the US federal government.

Back to the Eurozone, implementing this would require putting fiscal policy control over national economies into the hands of the ECB, allowing fiscal transfers between member economies so that surpluses are put to work strengthening economies with deficits and turning them around with capital investment and infrastructure development rather than being spent on marginal gains in economies that are already well developed. Translating that into practice, the ECB would take money from Germany and France through taxation, and use it to subsidize things like factories in Spain, schools in Cyprus and highways in Portugal.

Unfortunately, under the current European political and economic structure, such systematic transfers would be unthinkable. The only way that such international transfers could be carried out are via bailouts, and they come with stiff penalties in the form of relatively high interest rates, nasty ratings adjustments to national governments' credit ratings and potentially ruinous blowouts to national debt levels. For it to be effective, it has to be conducted in a manner akin to national fiscal policy rather than international loans; the funds need to be given free. In the United States, California does not have a choice if the taxes paid by its residents are used to subsidize farmers in Nebraska.

However, almost all policymakers would baulk at the very suggestion that France should give money to Portugal for free. While it is clear that the members of the Eurozone derive benefit from economic consolidation, it does not appear that there are any benefits to be had by, say, Germany or France paying for highways or bridges in Portugal or Malta. The benefits only become apparent if one considers "benefit" in light of the total welfare of the Eurozone and thus, a welfare increase in Portugal is of benefit to Germany as well. Even at the highest levels, modern thinking is guided by self-interest, with cooperation only occurring where the parties both stand to gain, a benefit to one is not considered sufficient.

This seems almost nonsensical at first, but go back to the United States example; when the US federal government takes an action that benefits a few states but not others, the overall increase in strength of the union benefits all member states indirectly. In Western political thinking, the Us vs Them nation-state geopolitical paradigm means that unless there is total political integration between states, a benefit to one is not seen as a benefit to the other.

To further illustrate this point, assume you and I have $1,000 between us, split evenly. However, if I already have a house, a car and enough food, but you have nothing, the greatest joint benefit will be created by the spending of the whole of the money investing in your life assets (home, food etc). Given the way we think today, you'll spend your half on those things, while I'll spend my half on ice-cream or something else that will only marginally increase my welfare. In Europe, wealthy nations spend economic surpluses on such marginal increases to national welfare, such as sports stadiums or unnecessary infrastructure developments to ensure full employment. Less developed nations, however, struggle with investment in basic services and national infrastructure while burdened with far higher levels of unemployment.

This brings us to the core of the issue. Unless the EU finds a mechanism to integrate cross-border fiscal policy through fiscal transfers, the attempt to integrate Eurozone economies is doomed to failure. Countries that are not be able to balance their fiscal policies with the prevailing Eurozone monetary conditions will suffer greatly, and may even fail. This could be one of the reasons for Greece's current financial woes.

There must be a body that possesses the ability to set overall economic policy for the Eurozone as a whole, for the benefit of the Eurozone as a whole. member states need to recognize and accept that many of them will be benefited at some times, and disadvantaged at others. Right now, the Eurozone is considering bailouts and other options to save Greece from bankruptcy. However, if there were a properly federated economic structure in the Eurozone, these bailouts would take the form of subsidies to key Greek industries, tax breaks to struggling sectors of the Greek population and any other appropriate fiscal instruments to provide some financial breathing room to the Greek economy.

This would not be a "subsidy on stupidity". Economists agree that Greece's woes are not the result of it's own economic mismanagement. Rather, Greece is a victim of it's overall economic conditions, most of which are external. Unable to adjust monetary policy, Greece was almost powerless to avoid this situation. Thus, from a European point of view fiscal transfers to Greece could not fairly be viewed as supporting carelessness. The rest of Europe benefited from a monetary policy that suited them, it stands to reason that they should transfer some of that benefit to states that suffered as a result of it.

The EU stands at a crossroads right now: either integrate further to allow more harmonious management of its member economies and adopt a greater sense of international cooperation, or begin unravelling the integration of the last decade to give member economies better control over their own individual affairs given their own individual situations.

The latter option would result in the last decade of work on the Eurozone being undone, a reversal of historical proportions and a concession that true co-operation is just not possible under the nation-state paradigm due to the political attitudes of national governments and the inherently selfish nature of today's thinking.

The former option, however, as philosophically desirable as it may be, appears impossible in practice. The desire for superiority is too ingrained in current thinking and is fundamentally incompatible with the notion of true international cooperation. If a single nation is at an advantage over another, there is virtually no chance that politicians will give up that advantage in the interests of mutual benefit, especially if the benefit is weighted to the other side. The very notion that this could happen would be labelled "socialist" and disregarded. However, for the Eurozone to succeed, politicians must do just that; give up their tendency to take every advantage and concede some benefits to other nations who could use it to derive greater overall benefit.

In this blogger's opinion, the problem outlined here is intractable under current socio-political conditions. Selfishness is too strong a part of the modern mind. People, especially politicians, simply do not think cooperatively, which is why globalization is not really achievable in its true sense, and why it is just resulting in a descent into rule by the rich and powerful.