This is both simpler, and harder, than Fixing America’s Budget Mess.
It is simpler because any of several political bodies can just “do what it takes”. To fix the USA mess will take action by an agreed collective of US States sufficient to revert the Constitution to a form that recognizes the ills of Democracy and puts back in place the checks and balances on spending, devolving power back to the States, and diminishing the push to Socialism.
It is harder because most of the possible “fixes” are very messy and unpleasant. Worse, those that ARE proposed are often very poorly matched to the problem and unlikely to fix it in any case.
The problem is a structural one. Germany has a larger stronger productive capacity than the other nations of the EU. It also has a stronger work ethic and more tightly focused and controlled economic structure. Basically they work harder, smarter, and save their money. In the merger of nations that made the EU, Germany essentially got a built in Mercantilist Advantage.
Normally in a trade zone with free trade and different currencies, any trade imbalance would be met with a change of relative exchange rates for the respective currencies. The producer that “wins” too much, has their currency rise in price. Their goods become relatively more expensive (so fewer bought) in the other countries. The less effective economies have their currency erode. Their products become relatively cheaper, so more are sold. This set of lower sales by the “winner” and larger sales by the “loser” eventually leads to a new equilibrium between the two countries on exchange.
In a case like China, where they have pegged to the $US, such exchange rate changes are prevented, or slowed to a crawl. This builds in a structural advantage in marketing goods. Businesses in the “target” of the mercantilism gradually die out under the continued pressure from lower cost goods. Yet no adjustment can happen in the currency. The economy practicing mercantilism gains a growing and robust economy, but at the cost of lower effective labor rates being paid to their citizens and less import of foreign goods. (There will also be inflationary pressures inside their country if the other country floods liquidity. Essentially, the peg causes the action of the target country Central Bank to have effect in the mercantilist country instead. That is why as the US Fed eased money, China had inflation spike up. The easy money flows to the mercantilist and has impact there.)
So in the EU, the “winners” continue to win and will push very hard against any tendency to inflate the currency as much of that effect would show up in their part of the economy.
Often the USA will be held up as an example for the EU to emulate. What this misses is that within the USA there are effectively no barriers to the movement of industries and population from region to region. If one State, such as California today, has a crazy high budget deficit, is raising taxes, and promising benefits that can never be sustained; the people will just pack up and leave. (At present, even the Illegal Aliens from Mexico have been net returning home…) There are no language barriers to leaving. No cultural barriers. Companies can close factories with little notice and low penalties. The major employer in my old home town, a peach cannery, simply closed up and left town. The local peach farmers, with many orchards established, were told to find some other cannery to use their fruit. (The nearest being a fairly long truck haul away). That kind of flexibility is not available in the EU.
So, at present, Texas is growing like crazy with loads of folks flooding in from California. North Dakota has an economy thriving on new oil finds and exploitation. Folks building new facilities in large numbers. Detroit has shrunk dramatically with a loss of about 1/2 of their population and a large cut in local industry.
Would the EU be “happy” with Athens shrinking by 1/2 in the next decade and those folks moving to Munich and Bonn? Would the French be happy with the local canneries and food packers just shuttering operations and moving them to Greece? Would they remove the laws that prevent that kind of rapid change?
That is a “cost” of economic integration that I think the EU has not yet realized.
Without that mobility and flexibility, the US style “let a region just deal with the consequences” will not work in Europe.
The ghost towns of the Old West, the Gold Rush of the ’49rs to California, the post W.W.II diaspora, and so many more all have their ongoing equivalent. Detroit is shrinking by leaps. Stockton, in California, a bedroom community boom town 2 decades ago has now filed for bankruptcy. Would the EU be “OK” with Madrid filing bankruptcy and walking away from public debt and obligations? That apparent chaos is a structural norm in the USA. It is also an essential consequence of having all our regional economies ‘joined at the hip’ via one currency.
California can not depreciate away its public debt, nor can it depreciate the California Ruble to make the pensions it must pay “cheaper” in foreign exchange earned from sales of fruits and vegetables to Texas. It can only either cut services and the budget (“austerity”) or raise taxes that will drive even more population and jobs / industry out of the State. (So far they have been resistant to cutting expenditures and benefits, and the loss of business and population and the tax base that goes with them continues…) They have been just borrowing more money, but are reaching the point where borrowing costs are prohibitive.
A few years back, before things got really really bad:
High yields in California bond sale could tempt investors
March 20, 2009
California may be forced to pay some rich yields next week to sell $4 billion in tax-free general obligation bonds.
That could present an opportunity for income-hungry investors in mid- to upper-income tax brackets.
As of Thursday, the talk in the market was for annualized yields of about 4% on the five-year bond in the deal and about 5% on the 10-year issue, just to give two examples.
So 5% Bonds then. Rather close to 6% bonds now in some EU states with “issues”…
In my opinion, this is clear evidence that tying closely together State (or Nation State) economies under one currency with one Central Bank does nothing to remove the effects of State over spending on benefits, government pensions, and social programs. Nor does it reduce their borrowing costs. Nor does is solve the loss of jobs and industries.
It would be far worse if the people of California could not (or would not) leave for places like Texas and North Dakota. Or if the folks from Detroit could not move to Florida.
I would suggest to folks in the Euro Zone who think that “Tighter Financial Union” would solve the problems to take a long slow look at California, our present Greek Like trajectory to financial ruin, and our debt problems and bond costs. It is not significantly improved compared to Spain, or Italy, or… We are still faced with a choice of “Austerity” or “Higher Taxes – with more job loss” or runaway borrowing costs and economic collapse. We may get to find out if a State can declare bankruptcy in some way. None of that is any different here, with tight fiscal union.
These are the same choices facing Greece today.
As these do not actually exist, it is a bit hard to figure out exactly how they might work.
Uses a model of a Eurobond that is based on the proportion of GDP of each economy in the union. This is, essentially, saying that everyone can borrow on the common credit card, but obligation to pay will be apportioned according to ability to pay. (Classical Socialist Mantra: From each according to his ability, to each according to his need.) Unfortunately, it is entirely unclear how the payment is made, or by whom, in the case of default. The immediate effect would just be to dramatically raise borrowing costs in Germany. ( Who just had a debt quality downgrade based on the belief that they will at most get back about 1/2 of the money they have already loaned to the PIIGS.) When fully joined, this would be like allowing California to borrow by selling US Treasuries. All that would happen is California would go even more into debt faster and the US Treasury rate would start rising. Perhaps fairly fast.
It is worth noting that even in the USA the States can NOT issue a US Treasury. We have a common currency, but each State has its own bonds and debt. Integrating the European banks (rather like US Banks) does nothing to change how sovereign bonds are handled, even inside the USA. (Interstate banking only started here a few decades back. When on my honeymoon in Hawaii, I could not deposit a check in my California account in a Hawaiian bank. That’s changed now. But I think that shows that it is not banking integration that made the USA what it is.)
So exactly what integration of financial activity would do to let Spain borrow more is very unclear to me. The only one that “works” for Spain, is a German Credit Card with a German Payment behind it. But if THAT is what is done, all it will achieve is to drain more money from Germany and ruin their credit rating and bond rate as well.
So Germany can loan money to Spain, Greece, and Italy (and get downgrades and higher interest rates) or it can let Spain, Greece and Italy directly borrow on the German Credit line with he same effects. Nothing gained. (PIIGS interest rates would drop a little, until the combined rate rose again, but thats a small window.)
What I see looks like further financial integration is a political goal, not one that fixes the economic problems.
This WILL fix the budget mess. But at a political cost that most likely can not be survived. The basic problem is over spending and under working. Austerity reduces the spending. (That will also cause less spending and less economic activity by the folks who lose there jobs and pensions, so there’s a bit of a feedback loop until the crash completes).
It is presently being demanded and presently being found politically unacceptable. Even in a very tight financial integration, the net effect of Austerity will remain the same.
IMHO, some cut backs in various expenditures is a requirement for any solution. It is 1/2 of the whole problem (and perhaps more in some places).
Essentially, a country can have a ‘take’ of about 30% of the GDP and survive, but it works best at about 20%. When total taxation / government expenditures exceed 40% to 50%, economies stagnate and then collapse. Folks just stop working and line up for the dole.
So government programs and pensions need to fit inside that 30% or less band to work well (and preferably 20% or less). Given present Greek and Spanish expenditures, that means some Austerity.
Angela Merkel wants a Tobin Tax or Financial Transaction Tax. These have been around in a variety of forms since long ago and Keynes advocated for wider use. (That right there ought to give some pause…)
The year 1694 saw an early implementation of a financial transaction tax in the form of stamp duty at the London Stock Exchange. The tax was payable by the buyer of shares for the official stamp on the legal document needed to ratify the purchase. As of 2011 it is the oldest tax still in existence in Great Britain. In 1936, in the wake of the Great Depression, John Maynard Keynes advocated the wider use of financial transaction taxes.
I would only point out that a similar “Stamp tax” on tea contributed to the American Revolution…
Politicians like to think that taxes have no effect other than generating revenue. That is never true. Take the California 9+% Sales Tax. A person only has a fixed amount of ‘disposable income’. Taking nearly 10% for the State, means that first off, that person has 10% less “stuff” to enjoy. This causes some of them to move to Texas or Oregon (where there is no sales tax). It also means that tire stores sell 10% less tires, and restaurants 10% less dinners and… This is a simple necessity of having that money not available to the people to spend. 10% is just not spent. The state may spend it, but that money is more likely to go to things like debt service out of State and leave the economy of the area. But even to the extent it spends in State, what is sold is different. More paper and pens, less lunch at Taco Bell.
So putting on a Financial Transaction Tax will cause changes. It may be that financial transactions simply leave the EU. If I can route a trade via London or via Tokyo or via New York, I’ll route to the one that has the lowest costs. If a load of hidden costs are in the EU financial system, they WILL end up in final prices. Tourists will stay shorter periods, or just not come. Some of that is already visible in the costs of visiting the EU. At present prices, I’m not going. Make them higher, my spouse will likely stop asking to go ;-)
Would a Financial Services Tax fix the basic problem? Only if the “problem” is too little money for the Government to spend…
It will not reduce excessive pension, benefits, and Social Welfare Program costs. It will not stop the government from continuing to spend. It MIGHT have a small reduction in debt carrying costs; but ONLY if the various nations actually used the money to pay down debt.
So far, I’ve only seen more taxes used for more spending and more Government payrolls. It might help with some symptoms but not with the disease. California has an initiative on our ballot for November, IIRC, to raise taxes. The legislature could not agree to pass the tax hike, so they are asking the people to do it. If it passes, even more folks will leave the state. That will not help. The Laffer Curve says that once at too high a tax rate, higher rates result in lower tax revenues. We are already well past that peak revenue point. So higher taxes will not make for higher revenues as economic activity will reduce in proportion.
So What Will Work?
There are a couple of things that are known to work. Not too surprising, they are the opposite of what is being proposed.
Throughout time, having floating currency exchange rates has been a common solution to such things. The debtor country devalues their currency, the folks holding that debt lick their wounds, and the local economy picks up as their goods are now cheaper in foreign markets.
Part of the basic problem facing Greece, Italy, and Spain is that they are overpriced, being in German dominated Euros. Furthermore, if they can not practice Austerity and cut their expenditures, the only alternative is to repudiate those expenditures and debts. (Higher taxes will not work, thanks to the Laffer Curve). That repudiation can be a formal default, but that is highly disruptive. Still, it has been done. The more polite mode is the slow default of inflation; but that can only be done if the currency inflates.
IF Germany could be persuaded to let the Euro inflate (and take the inflationary problems that will bring to Germany) then the PIIGS could get some relief. At least until the lenders noticed and added an inflation premium to loan rates…
LESS Financial integration would work. Basically, the PIIGS could leave the Euro and get their own currencies. Then the regional pressures are absorbed into exchange rate changes and the debt overhang can be inflated away without an impact on Germany and other EU countries.
The PIIGS could CUT taxes (cutting back to the other side of the peak in the Laffer Curve stimulates MORE tax revenue and an economic expansion). So look at the counties (in the Baltic countries and some others like Russia and Hong Kong) that have cut tax rates. They boom. Tax revenues rise, payments for unemployment drop.
It is the other half of the “more taxes drive more folks away”; less taxes cause more economic activity and growth. The “underworking” part of the problem is solved. So if you lower taxes, and get more economic growth and tax revenues, then you can reduce Social Welfare Programs without quite so much pinch from the Austerity. Essentially, if you cut government and taxes, the private economy more than makes up for it. This is not a hypothetical. It has been done many times in economic history. Most recently in the Baltic states. This does not solve their German Mercantilism problem, though.
So to fix the ‘internal mercantilism’ that happens with a shared currency and to reduce the need for internal mobility and chaotic change; the more helpful thing to do is to break the bonds to the Euro. Go back to a national currency.
To deal with the insufficiency of tax revenues and economic stagnation, CUT tax RATES (and revenues will increase) while cutting the size and scope of government and removing as much regulatory burden as possible.
That only leaves the issue of the existing bonds and debt. Ideally, the country would simply declare the old debt redominated in their new currency. As this had to be done when they went INTO the Euro, they clearly know how to do this. (It is less clear what laws apply and if it is legal for any given issue.)
FWIW, I don’t expect any of those answers to be what the EU does. I expect the EU will instead go for more taxes, more interventionist central government policies, more tight integration and less flexibility. That won’t work, but it is what I expect they will do. Germans are sure that they can fix things if only they had more control, and the PIIGS are sure that holding tight to the EU and Germany will bring more German money. All of them are sure that they can fix things with enough higher taxes. None of them will want to take the “risk” that a cold plunge into lower taxes and freer economies would entail. Fear and greed. Fear of market solutions and greed for others peoples money.