The Future of the European Monetary Union: A Guide to Love, Loss & Desperation
Marriage can be quite a commitment: Taking care of each other both in good and bad times, reconciling conflicting interests, sharing everything; it is unsurprising that the Eurozone took it rather slow with such a big step as the transformation into a fully integrated Economic and Monetary Union (EMU). Considering how hard it can already be to balance the interests of two partners, finding a common ground for 19 sounds horrifying. And on top of this, add the epitome of a relationship fight in form of a sovereign debt crisis.
Et voilà, welcome to the Eurozone in 2015, a time at which we clearly stand at a crossroads. The Euro Crisis revealed how flawed a half-hearted approach is when it comes to economic integration. 16 years ago the single currency was introduced, 16 years later we are still sitting in a car without brakes. The Euro was established in the expectation of further economic competences being transferred within the following years. These additional competences on European level are necessary to properly control and stabilise the single currency. Although starting a car without checking the brakes beforehand does not sound like the best idea, it can go well. It didn’t do so for the EMU. The political reality didn’t meet the expectations, inevitably resulting in a crash.
The premise that half-hearted integration produces an unsustainable economic model allows for two conclusions: First, the happy end. We should pursue further economic integration. Second, the break-up. We should abolish the single currency and return to national currencies. Relationship advice should be unbiased and sound. This can’t be said about the public discourse evolving around the future of the EMU. Apart from populism and political turf battles, what actual arguments are there for both sides?
The happy end scenario is based on comparing the Optimum Currency Area (OCA) theory with the current Eurozone and then reducing those disparities. According to its founder Robert Mundell large, economically diverse areas can successfully share a single currency if they ensure high labour mobility, share bank regulations, finance debt collectively and transfer tax money, which was collected at a centralised level, amongst the regions. Practically speaking, workforces must be able to move from places without jobs to places with them. Banks are regulated and bailed out on a centralist level. Taxes are collected wherever there is a surplus and transferred wherever there is need.
So what does this mean for the Eurozone? With labour mobility and bank regulations already being on the Eurozone’s agenda, the fiscal union would require the greatest structural change. Nevertheless, the idea already found some advocates amongst European politicians: Recently the French economy minister Emmanuel Macron suggested the appointment of the Euro Government, a new EU body, which would allocate fiscal transfers and investment funds.
Criticism for the Eurozone’s potential to become an OCA mainly highlights the cultural and political obstacles of the project. Using the US as an example for a good OCA, one realises how far-reaching changes in the Eurozone would need to be. First, labour mobility in the Eurozone can’t be compared to the US level. If one region in the US is hit by an asymmetric shock thereby causing unemployment, workforce can easily move to another region which experiences a boom. This doesn’t happen in Europe. Cultural and linguistic barriers abound. Greeks won’t pack up and move to Finland. And if Americans had stayed in their crisis hit home state, they would have received fiscal transfers from the central government to cushion the blow. There is no central European government that can make fiscal transfers. The European Union’s centralized budget equals only about 1 percent of Europe’s GDP’s, compared with more than 20 percent for the American federal government. Effective redistribution politics would require a severe rise of Member States’ EU payments – an agenda which equals political suicide in the current public climate of rising nationalist and anti-EU parties. After all transforming the EU into a real OCA fails because of cultural homogeneity and democratic legitimacy.
It is said that opposites attract. At the same time one must accept that sometimes the differences between some partners are simply too great to allow for a happy relationship. The break-up case is constructed around this assumption, namely the economic differences between north and south. Even if the debts of crisis countries of the Eurozone would be restructured, it would not correct their large gaps in competitiveness compared with Germany. Critics argue that the Eurozone is a dictatorship of the rich northern countries, bullying the peripheral members into decisions that favour northern interests more than their own. Although the return of all countries to national currencies sounds like a drastic measure, advocates of the break-up scenario consider it the only way out of this dilemma.
They want to see the ECB abolished and its functions returned to the national central banks. All bank accounts, assets, liabilities and obligations in each Member State would be immediately redenominated into national currencies. With floating exchange rates the countries’ currencies would finally reflect the real values of their economies again. I will use a simplified example to explain the principle of floating exchange rates and devaluation, assuming a one to one conversion rate between the Euro and the national currencies. When then markets would re-open after the enforced bank holidays, the new Drachma would fall, say, 60% below its official euro conversion rate and the new Deutschmark would rise, say, 20%. In the next step Greek products and services would become cheaper compared to German ones, raising Greek competitiveness by boosting exports. With national currencies, advocates argue, we can restore both economic flexibility (the currency of a country which is hit by an asymmetric shock would simply devaluate and thereby evening out the effects) and democratic legitimacy
But breaking-up doesn’t automatically mean you have to kill the dog you got together and burn down the house you bought, right? What about consensually dividing the things you were previously sharing? A more moderate for the future of the EMU suggests the break-up into two currencies instead of 19. Although there is an enormous north-south divide in the Eurozone, advocates of this proposal argue that the economic structures within those two regions are homogenous. Some have imagined a hard currency, the duro, including Germany while a weaker currency, the medi, would exist for the periphery countries.
Besides highlighting the complete lack of any legal basis for the break-up scenario, critics mainly focus on the technical problems. Returning to national currencies is an enormous logistical challenge and demands temporary capital controls for the transition period. Using our example from above, Greek citizens would deposit their money in German banks as soon as information about the return to national currencies leaks. This is due to the premium they would earn after the exchange rates are allowed to float. Capital controls would do severe damage to trade and investment and might cause a collapse of the European markets. Moreover, what would happen to the debt of peripheral countries when it is “translated” from Euros into their new, old national currency? Peripheral Member States and their companies owe most of their debts either core countries such as Germany or international institutions such as the IMF. With the peripheral debtors’ currencies devaluing compared to the currency of their creditors, their debts would multiply, going further through the roof. An immediate default would be the likely consequence.
But the strongest argument of the critics probably is to simply point out all the economic harm abolishing the Euro would do. The need to exchange currencies again would not only affect individuals during their summer holidays, but would also result in high transaction costs for firms thereby harming intra-European trade. Moreover, the Euro’s criticised inflexibility also means stability. Especially the periphery countries benefit from the trust foreign investors have in the Euro, thereby boosting investment.
Relationships are not rational. Nor are decisions about the Eurozone’s future. When analysing the economic side of the matter, we shouldn’t forget about the political applications. The Euro might or might not make sense economically. But even if it does not, it never was a purely economic project. A common currency always results in deeper political integration as well. Not breaking-up for the sake of the common child – should the Eurozone be led by this principle? On the other hand the Eurosceptic voices get louder and louder. How could we ensure the democratic legitimacy of deeper integration in such a political climate?
In Shakespeare’s Hamlet the protagonist contemplates life and suicide. The decision about the future of the Euro is of comparable importance. To marry or not to marry, that’s the question.