IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
In March 2010, when the Greek debt crisis was heating up, then-ECB president Jean Claude Trichet declared to the EU parliament that the “monetary Union in Europe is far more than a monetary arrangement. It is a union of shared destiny”. Less than two months later the ECB reversed its refusal to monetize debt and openly started buying government bonds in violation of its own charta. Germany also gave up its reservations about bailing out other countries. A first aid deal for Greece was signed and, because that didn’t help for long, a Euro rescue package to the tune of € 750 billion was put in place.
In her defence of these measures to the Bundestag, German Chancellor Angela Merkel echoed Trichet. ”Monetary union is a common destiny (Schicksalsgemeinschaft)”, she said, but then took it a step further: “It is about nothing more and nothing less than preserving the idea of Europe”.
Since Merkel’s speech, the Euro as a Schicksalsgemeinschaft (common destiny) has become a recurring theme among the defenders of the Euro and the associated rescue packages in German and Austrian media.
As the literal translation of Schicksalsgemeinschaft is “a community of fate”, the common translation as “a common destiny” hardly reflects the gloominess of the German term. Having been abused as a tool of political propaganda in the past, Schicksalsgemeinschaft would also seem a curious choice of words to any historically literate German.
In the current context, however, the reason why the invocation of destiny, or fate, is popular among Euro supporters is because it makes it appear as though there were something inevitable about the currency union. If it were true, the Euro would be a venture that could not be questioned. Consequently, we are told that the Euro must be defended “whatever it takes” (Barroso) and that plans to do so are “without alternatives” (Merkel).
If nothing else, invoking destiny comes with the benefit of avoiding the question of how we got here in the first place. Yet there was nothing inevitable about the Euro; destiny had nothing to do with it. It was a political project conceived by politicians and brought to life in a particular spirit that is well worth examining.
Towards a Common Currency
After WWII, European unification was meant to be a way to give the war-torn continent a framework in which former enemies could deal with each other in a civilized manner. The idea was that a few basic freedoms, such as those set out in the Treaty of Rome, would guarantee the free exchange of people, goods, and services among sovereign nations.
But over time the idea of a united Europe moved ever further away from its humble beginnings. Member states were expected to increasingly cede sovereignty with the union itself becoming more like a state—with an executive, a parliament, harmonized taxes, and social standards. The combined weight of its members was also meant to make it a global player—one that some thought might even rival the US.
This has been called an ‘ever-closer’ union or, less favorably, the “socialist” or the “empire” vision of Europe. The common currency was hoped to be a big leap forward in bringing about that vision. Plans for the common currency existed as early as the 1970s, and gathered steam in the second half of the 1980s under Jaques Delors, who was then head of the European commission. But the general perception at the time was that implementation would not take place for decades.
Yet, in the end, it was not just about a certain vision of Europe. In the final push towards the Euro something else came into play, and that is a proper dose of good old fashioned Realpolitik.
In 1990, when Germany was suddenly about to reunite, France, with Francois Mitterand at its helm, was reluctant to consent. A reunited Germany, it was feared, might simply become too powerful, unless one could take away its most dreaded weapon; and that was its economic strength embodied in the Mark.
In the European Monetary System (EMS) that preceded the Euro, currencies were allowed to float within certain limits, and, thanks to its relative stability, the Deutschmark played the role of an anchor within that system. For the other currencies, this meant that they could inflate only as much as the Bundesbank allowed; otherwise they would have to devalue or, worse, face the humiliation of having to leave the EMS altogether.
That is why the Bundesbank, with its relatively hard money policies, had become anathema to spendthrift politicians not just within Germany. Mitterand—also the first socialist president of the Fifth Republic—regularly complained about the Bundesbank, even likening the Deutschmark to a German nuclear force.
So during the negotiations for reunification, when Germany feared that it was becoming isolated, Chancellor Helmut Kohl conceded that a reunited Germany would be firmly embedded in a united Europe. In the end it boiled down to a quid pro quo: Germany would get its reunification provided that the Mark was socialized as a common European currency. This new reality was codified into the Maastricht Treaty, which Jacques Attali, a close advisor to Mitterand, later described as a complicated contract whose purpose was simply to get rid of the Mark.
Economists’ warnings went unheeded
As for the economic feasibility of such a project, there were ample warnings. Prominent American economists pointed out the flaws of the proposed common currency. Milton Freedman famously predicted that the Euro would not survive its first major recession. Paul Krugman said it was “simply a bad idea economically”. MIT economist Rudiger Dornbusch summed up his American colleagues’ attitudes towards the Euro as falling into three categories: “It can’t happen”; “It’s a bad idea”; and “It can’t last”.1
In 1992 a group of sixty highly respected German economists (among them a former minister of economic affairs) published a manifesto protesting the Euro that in hindsight reads stunningly prescient.2 They claimed that a common currency could only work if the economies in the participating countries were to consistently converge over a longer period of time. Since this was unlikely, the currency bloc might end up becoming a transfer union: “In the case of a common currency the economically weaker countries will be subject to the increased pressure of competition, whereby they will—due to their lower productivity and competitiveness—end up with growing unemployment. High transfer payments, used as a means of financial compensation, will become necessary.” Consequently they predicted that “a premature inception of a European currency union would expose Western Europe to strong economic tensions, which over time might lead to political conflict and thus endanger the goal of integration”.
In 1998 an even larger group of German economists published a second manifesto, warning that the inception of the Euro was premature because deficits had not reached agreed-upon levels, and the stability pact itself would be toothless in enforcing budgetary discipline due to the lack of automatic sanctions.3
In hindsight, the responses of the Euro supporters to these objections were hopelessly naive. Fears of a transfer union, they said, were overblown because there was simply no mechanism to require Germany to pay other countries’ debts.4 Jean-Claude Trichet, then governor of the Banque de France, even went as far as saying that the currency union becoming a transfer union was as likely as a famine in Bavaria. Further, Euro supporters argued that inflation would not be a problem, since the ECB was independent, and deficit financing by means of printing money was explicitly ruled out in the treaties.
So while there are good reasons to ask “How Did Economists Get It So Wrong?” concerning the 2008 world financial crisis, the same cannot be said about the present Euro crisis. Economists saw this one coming.
Yet, considering the noble goal of European unification and all the grandeur that comes with it, for proponents of the Euro it was only natural to disregard economic factors. After all, bringing the European project forward is about nothing less than a world historical experiment in overcoming the nation state, a step towards lasting peace. Hence European elites recklessly went ahead with an experiment without precedent. Critics were brushed aside as small minded at best, or as nationalists and reactionaries at worst.
The European Project: From Grandeur to Panic
Now that the evidence is in, things do not look pretty. As predicted, the Euro did not lead to more economic convergence; it instead increased imbalances.
Thanks to the Euro, countries on the periphery enjoyed very low interest rates, which led to excessive wage growth and all sorts of bubbles. Now that the tide has reversed, they are stuck with huge debts and high unemployment rates.
At the same time, the grandeur that earlier accompanied the European project has started to take on a decidedly shrill, even apocalyptic tone, as the possibility of a Eurozone breakup is considered. “If the Euro fails, Europe fails,” said Angela Merkel. Nicolas Sarkozy went one step further and even raised the specter of war by declaring that an end to the Euro would not only mean an end to Europe but also an end to peace.
Finally, former German chancellor Helmut Schmidt—definitely not known as a hysteric—has claimed that nothing less is at stake than European civilization itself. Schmidt goes on to remind his countrymen of their particular responsibility: “If, in the 19th and 20th centuries, we Germans contributed substantially to strife in Europe and the world, then in today’s situation we have to make sure, though in a different way, that the horrors of the past cannot repeat themselves. This requires further sacrifices of sovereignty and money”.5
That still hits home. After all, German elites fear Germany going it alone more than they fear a common demise. Therefore, the Germans’ willingness to save the Euro, no matter the cost to themselves, simply cannot be overestimated.
However, none of the proposed measures to save the current construct (Eurobonds, fiscal compact, fiscal union, large scale money printing by the ECB) can do away with the basic fact that there is a material conflict of interest between surplus countries and deficit countries. Therefore the tensions caused by the common currency are here to stay, making themselves felt in the backroom of yet another European summit, on the front pages of increasingly jingoistic tabloids, on the streets littered with broken glass in the capitals of Southern Europe.
No Alternatives to a Failed Model?
Given the mess we are in, one would expect the Euro enthusiasts to be somewhat deterred. That, unfortunately, is not the case. In the spirit of “never letting a crisis go to waste,” they welcome the current troubles as a paradoxical twist of history that will finally pave the way toward a stronger fiscal union, European economic government, harmonized taxes, and whatever other central planning scheme they are dreaming up at the moment.
Due to the crisis, they say, we have no choice; we will be finally forced to embrace complete political union. Ultimately this may prove no more than a “Last Hurrah” for a failed model because, while support among European elites for such designs may still run strong, voters are increasingly losing faith along with their willingness to repair the current EU and Eurozone construct.
Make no mistake, a breakup of the Eurozone in whatever form (weaker countries leaving, stronger countries leaving, a return to national currencies, or national currencies alongside the Euro) would be extremely disruptive.
However, breakup would in no way mean the end of the EU, let alone the end of Europe. Countries leaving the Eurozone would still be members of the EU, and they still could enjoy all the benefits that come with that membership, just as those ten EU countries do (such as the United Kingdom, Sweden, Czech Republic, etc.) that never joined the Eurozone in the first place.
No doubt, some banks may go bankrupt, just as some countries’ debts will have to be restructured. The ensuing recession would be deep. But, while most of these things will happen anyway, it would also clear a path towards an economy that could once again grow in a self-sustaining manner instead of being continuously juiced up by yet another monetary injection, yet another stimulus package.
If there is a lesson to be learned, it is what Austrian economist Eugen von Böhm Bawerk stated some 100 years ago in his classic essay “Control or Economic Law”, which is that in a conflict between politics and economic law, the latter ultimately wins.
Considering all the murky reasons that helped to bring about the Euro—political delusions of grandeur, a misplaced utopianism, and, in the case of Germany, mere historical guilt—it should not be any wonder that the outcome is dismal.
The current narrative of the Euro as a “common destiny” suggests that there is no alternative to the current path of an ‘ever-closer’ union, which will result in more centralization, more interference.
But destiny is the opposite of freedom. If Europeans are to be free, they must be permitted to choose among different social models, different tax regimes, and different political arrangements. For one thing we know: if Europeans adopt the model of the central state, we are certain to end up in a Europe that is decidedly less free and less prosperous.
The people of Europe deserve to share a destiny better than that.
*Johannes Maierhofer is contributor to the Slovak think-tank INESS