The eurozone will be forever crippled unless it becomes a real currency union -- like the United States.
- By Daniel AltmanDaniel Altman is the owner of North Yard Analytics LLC, a sports data consulting firm, and an adjunct associate professor of economics at New York University’s Stern School of Business.
Pity Mario Draghi, the president of the European Central Bank. Even without having to endure constant sniping from finance ministers in the eurozone, maintaining a currency union among such diverse countries would be no easy task. Happily, several factors could help the eurozone to smooth out its differences in business cycles and economic prospects over the long term. Frustratingly, it refuses to use any of them.
In general, currency unions are three-legged stools, supported by fiscal policy, migration, and trade. From the beginning, in a feat of late 20th-century European design aesthetics, the eurozone was intended to have only the last two legs. Neither of them was particularly strong, however, and their weakness has made an initially challenging situation even more precarious.
To understand why, consider the basic setup. The members of a currency union don’t just use the same money; they also cede all the power to make monetary policy to a single authority, in this case the European Central Bank. The ECB has a tough job, since it has to decide on one level of short-term interest rates for the 17 members of the eurozone. That can be practically impossible in times like these, when some countries are booming while others are in recession.
With the passage of years, the euro itself was supposed to make this job easier. In theory, trade between the members would help to synchronize their economies. The idea was that their companies and consumers would be so intertwined that they would all rise and fall on the same economic wave, with similar trends in employment and inflation.
This may seem paradoxical, since trade works best as an economic stabilizer when exchange rates can move freely. A country in a downturn typically sees the value of its currency fall as investors demand fewer of its securities, and so its exports become more attractive abroad. In the eurozone, this isn’t possible.
But trade still has a role to play. When some euro members are struggling — and especially when their governments are having a hard time making ends meet — the others can try to export some growth by stimulating their own economies. In other words, Germany — Europe’s economic engine — could funnel extra money to its consumers through tax cuts or spending increases in hopes that they would buy more goods and services from Greece, Portugal, and Spain. This isn’t the most direct way to support the laggards, but it could be more politically attractive than just giving them money. After all, domestic consumers get to choose how they’ll spend the extra cash.
Yet Germany, supposedly the strongest advocate of the eurozone’s integrity, has explicitly refused to do it. Angela Merkel, the German chancellor, has rejected a public plea by Spain’s prime minister, Mariano Rajoy, to juice the German economy with new spending. By doing so, she has put her country’s fiscal health above the health of the eurozone — an understandable decision, but one that keeps the currency union in peril.
The situation wouldn’t be so dire if the eurozone were taking full advantage of its other channel for smoothing out the differences between its economies: people. Free internal migration, a founding tenet of the European Union, can have a similar effect to trade. If one country is in the dumps, its people can move to another country where prospects for work are better. All other things being equal, the unemployment rate would drop in the first country and rise in the second, bringing their economic cycles closer together.
Alas, internal migration in the eurozone is not exactly free. Not every country recognizes the others’ professional qualifications, and the requirements for starting a business can be completely different from member to member. Moreover, each country can have different administrative formalities for migration, and immigrants who lose their jobs can be forced to return to their countries of origin. Aside from these administrative issues, there are social and political barriers; in the midst of economic hardship, anti-immigrant sentiment is rising across the continent.
Of course, most successful currency unions don’t just rely on trade and migration to synchronize their members’ economies. Alongside a shared monetary policy, they also have a shared fiscal policy. That’s right: Canada, India, the United States, and other big countries with regionally diverse economies are among the world’s thriving currency unions. When one region is suffering, the central government can send cash to prop it up. It’s no secret, for example, that federal tax revenues are redistributed from Washington toward some of the poorer states.
There’s also a degree of redistribution in the eurozone (and the EU as a whole) thanks to the recent bailouts, farm subsidies, and other programs. But the amounts of money pale in comparison to the entirety of the eurozone governments’ budgets, which totaled about 4.7 trillion euros in 2012. In addition, there is no central authority for taxation in the eurozone or the EU, so half of fiscal policy is completely off limits.
Teetering on two unsteady legs — the third is barely a stub — the eurozone will continue to be a weak currency union at best. I say "at best" because its members’ economies are heading in very different directions in the long term, with distinct risks and opportunities in each region. Indeed, as I wrote in a recent book, the EU could conceivably split into several contiguous economic blocs, each of which would have a much easier time maintaining its own currency union. For now, though, the eurozone seems feebler than ever, and no one is doing much to strengthen it for the future.