Sunday, 11 December 2011

Europe

It is quite clear that Europe is in crisis, you didn't need me to tell you that. Perhaps a discussion of how/ what is being done to solve the crisis would be more appropriate the confirming what you should already know.

The solution proposed is a fiscal union whereby countries would have to submit their budgets to a central "budget committee" for approval. Countries would be told to revise "unsuitable" budgets, and essentially give up complete discretion in their fiscal policy. You could argue that countries like Greece forwent their right to have that discretion when they borrowed so excessively that their public sector commitments became unsustainable leaving them in a position where they could not pay their debts back and more importantly, investors saw this. Speculation and confidence are far more important than any real substance in a problem or success, even if the two are often (but not always) linked. Moreover, if countries cannot be trusted to borrow and spend sustainably than someone else should do it for them - parents don't just give their 15 year old money to spend as they wish but rather, either simple buy "stuff" for that 15 year old themselves or, in a more mature relationship, put rules on what that 15 year old can buy. For example, sweets are a big yes, while borrowing a big no no. Apply that to a government and unemployment benefits a big yes, but borrowing extra money to fund a space programme to Jupiter a big no no. On a purely theoretical level, it could work - if Greece physically cannot spend more than it receives in tax, or at least, cannot spend that much more than it receives in tax then it cannot ring up all the debt that caused the problem. Indeed, if all countries were forced into sustainable borrowing, countries would not build up debt and bingo, problem solved.

However, there are major issues with a fiscal union.

Firstly, countries across the Eurozone are not the same. Greece is going to need to set different budgets to Germany and to Spain and to Ireland, budgets that may be deemed unsustainable and not fall under the limits set by the "budget committee" and thus rejected. Economies will experience natural differences in the business cycle that can neither be explained nor accounted for by other countries. Ireland may enter a cyclical, short, recession that a simple injection of spending would solve but is powerless to do so because it doesn't fit the rules. It is impossible to set rules that can be adjusted for different countries - that simply would not be credible or fair and thus you are left with a situation where you are trying to get one size to fit all (again). Simply put, you cannot force a size 3 shoe onto a boy with size 12 feet, nor can someone with size 3 feet walk in a shoe for someone with size 12. I have my worries as to whether this could work. While the problem with simply monetary union was governments could still ring up massive debts due to reckless fiscal policy, that does not imply monetary union = reckless government spending. Rather, those countries, as will be concluded, should not have been let into the monetary union in the first place. Moreover, fiscal and monetary union leaves the next problem:

Europe is big. There are issues linked with the differences detailed above, but also the simple fact that exogenous shocks, for which fiscal policy is a major response, will have different effects everywhere or indeed no effect. Say a massive tiger wave hits Greece. Germany is completely unaffected but Greece suddenly has hundreds of thousands homeless, almost as many unemployed because of damage to business. Greece is now unable to set an emergency budget where it spends massive amounts, amounts that in normal times would appear ludicrous, in these troubled regions to try and get them moving again. Fiscal Union can only make these problems more intense. When a government experiences problems, it has 2 tools it can use - Fiscal Policy and Monetary Policy. Both would be taken away and in times when more extreme fiscal/monetary policy is needed, the government would be powerless to make any changes. Essentially, governments will be faced with different situations that call for different policy responses, some of which may not be possible but this is not just because the economies are all different, but because different things will happen to different economies.

Thirdly, more powers are going away from the people. People could no longer vote for policies as they please, government could no longer set policies as they please. Does that sound democratic? Policies are not set for the people of that country, but for Europe. That simply is undemocratic. Governments will now be asked to answer to Europe and not their people. Take the Irish Example mentioned above. In recession and, by coincidence, a general election is coming up. Now, the people want to see a commitment to say, increased spending to boost employment and also tax relief so they can keep more of there money and spend it at the difficult times rather than give it to the government. However, no matter what the Irish people want and what the Irish government want to promise, they cannot do so because of the fiscal policy rules. Not cool.

Fourthly, and perhaps least importantly, if/when shocks hit the entirety of the Eurozone - say another American Bank collapses and there is another recession, how long will it take for the budget committee to change its rules or for countries to be able to set new budgets in response to the shocks. Moreover, the shocks would affect different countries differently so the new budget rules may not be suitable for all, as mentioned above. Even when all countries have similar problems, the responses may need to be different.

The solution? Because there is a problem. It is not necessarily to disband the Euro, in fact that would be ludicrous I think. You need to look back and see the problems that the Euro faced - countries that should never have been admitted to the monetary union, have been admitted. Greece, Spain, Portugal and perhaps a few others are simply not suitable, not the same and did not meet the guidelines that Europe set out for Euro-joining. Those rules were, for whatever reason, ignored and we have the problem we have now where Greece and others' fiscal recklessness has caused it to have mounting debts which are unsustainable. The solution is not to tie them down and bring them closer to European integration because that would just cause more of the problems, but to let them go as orderly as possible. The solution may very well be fiscal union, but it is probably a fiscal union of "Eurozone - X" where X is a number of current Eurozone countries rather than just fiscal union of everyone.

Although, to be honest, once you rid the Eurozone of the countries that are the reason for its problems, you probably don't need further integration to solve those problems.

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