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)
1-Barroso calls for EU ‘federation’
2-The grasshoppers and the ants – a modern fable