A few days ago,
EU chief José Manuel Barroso hinted that the ultimate solution to Eurozone’s
ongoing crisis called for greater fiscal integration. Though the task
apparently seems very challenging given the strong political biases in the
region, it is important –in itself- that the leadership has started to discuss
such sensitive issues which remain critical to the survival of Eurozone. Though
European Central Bank (ECB) didn’t hesitate to bring in its bazookas (LTROs, SMP
and now OMT) to reduce the fears of downside but deep down everybody knows that
ECB is just kicking the can down the road. Because theoretically while ECB can
buy all the troubled sovereign debt through its liquidity injections programs,
those debts either have to reverse –causing liquidity constraints- or have to
be effectively written off by haircuts –resulting in direct injection of hot
money- both requiring a further action
and ultimately a vicious spiral like a ponzi game.
While Eurozone
has offered great political and economic benefits for its members, the eurozone
has always been a heterogeneous mixture with different political as well as
economic structures and policies. For example,
1-
Eurozone continue to suffer from differences in
economic competitiveness. At one extreme there are countries with very high
economic efficiency like Germany, France and Netherlands etc and on the other
hand there are economically uncompetitive economies like Greece, Portugal,
Spain and so forth. Even if Eurozone
would operate closed, these differences would ultimately result in assets laden
competitive countries and debt laden uncompetitive economies unless the union
operated in perfect harmony (Balanced trade and budget accounts). However, this
would only be possible given all the economies converged to similar competitiveness
that would only be possible
a.
If Competitive economies would shed some of
their competitiveness, which has not happened.
b.
Or if the uncompetitive economies would grow
rapidly in competitiveness to catch up with competitive economies, which hasn’t
happened either since its too unrealistic to suppose that Greece would become
Germany in a decade or so.
So in either case, sooner or later, a collapse would be imminent due to structural
imbalances which need to be addressed when idea of creating such union was
being worked out.
2-
The eurozone economic and political dynamics can
be considered as a game with peripherals holding the moral-hazard card. If
Greece had piled up debt from both within and outside the Eurozone due to its
uncompetitiveness, the easiest way would be to default on the debt since it
naturally didn’t have the capacity to generate enough resources to pay them back. However, if Greece defaulted on
her debt, the choice of second player –say Ireland- would also be to default on
her debts since she faced a similar problem. But this chain reaction would also
mean the destruction of assets held by competitive economies because their
asset holding would effectively be the debt issued by peripherals (A classical
piece on the issue was written by Martin Wolf named “The grasshoppers and the
ants – a modern fable” see notes for reference). This would also mean that if a
competitive country - for example Germany - is perceived as economically
strong, it is because it derived its growth and asset holdings from
economically uncompetitive economies and thus could not escape the damage of
chain reaction, if started. So the best interest of such countries would be to
stop peripherals from defaulting by bailing them out (what has been happening
so far).
3-
Thirdly Eurozone has been in a situation where
one Monetary Policy has to face 16 different Fiscal policies by individual
members. This not only makes Monetary Policymaking challenging for ECB but also
distorts the Monetary-Fiscal coordination. Furthermore, banking regulation of
monetary union has also been a challenge where around 6000 banks operate under
the supervision of different national central banks with varying degrees of
supervision and regulations.
However, would
such proposal be a workable idea? Answer
can be yes. For example, we can look at
the economic model of US where different states operate with greater autonomy
under one federal administration. For example, a state can levy taxes on her
residents, can raise debt from market with municipal debt. Likewise a similar
model can be adopted for Eurozone with greater political acceptability. This
may include
1-
A tax contribution or tax for proposed supranational
fiscal body (just like federal taxes in US)
2-
Autonomy to raise domestic taxes as well as debt
as per needs of member countries.
This would be
more acceptable to general residents since
1-
All residents will pay similar tax
2-
A tax contribution would be more acceptable to
common German -given a Greek is also making a similar contribution- instead of
footing the German funded bailout of Greece.
The economic benefits
of such a superanational body would be manifold for economic stability of the
region since
1-
The Collected taxation at superantional body may
be used in restoring the economic competitiveness across the region. This can
either be done by supernational-regional government partnership projects or
directing the funding to its most efficient use. This would effectively create
a development wedge which would be helpful for peripheral countries in need for
infrastructure investments.
2-
Since the financial position of Superantional
body would be much improved vis-à-vis member countries (due to revenue
generation ability), the supernational body would be able to raise funding much
more economically as compared to member countries. Thus this would also help
member countries bring down the costs of their development expenditures since
the high cost of debt raising would mean more cost on development activities of
government as well.
Though arguing
about the feasibility- both politically and economically- of idea and appropriate
structure would be farfetched at the moment. But there is, nevertheless, a
growing awareness and political will amongst the policymakers that a collective
effort would be required to tackle the issue on permanent basis. The only thing
of concern is that whatever to be done should not be “too late to be done”.
(This work in an intellectual property of Author,
I have no issues with the material being used given accompanied by a proper
acknowledgment of source)
Refernces
1-Barroso
calls for EU ‘federation’
(http://www.ft.com/intl/cms/s/0/83f2e49c-fcbe-11e1-9dd2-00144feabdc0.html)
2-The
grasshoppers and the ants – a modern fable
(http://www.ft.com/intl/cms/s/0/202ed286-6832-11df-a52f-00144feab49a.html#axzz2G69LtTVv)
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