What conditions are required for a monetary union to work?
WHAT are the necessary requirements for a common currency to actually work effectively to the benefit of all its members? Why do the dollar-zones in the US, Canada and Australia not experience the same level of crisis, divergence and stagnation as the Eurozone has been plagued with? Simply put, the institutions in place in federal states such as these allow for the smooth, timely and effective recycling of excess profits from surplus states to those experiencing deficits. They also have central banks that have a mandate to ensure full employment, as well as price stability. In comparison, following the Bundesbank model, the ECB’s mandate is solely to maintain price stability and it is not to concern itself with employment.
When a downturn or crisis hits a common currency area, it will cause an asymmetric shock unless there has been sufficient convergence in the economies of the union. Divergent economies would be affected differently by different external and internal developments. This danger was understood by the architects of the euro, but for ideological reasons they focused only on attempting to achieve convergence in government debt and deficit levels at Maastricht and ever since, instead of looking at the more important role of divergence in balance of payments between members.
In 1961, economist Robert Mundell articulated his ‘optimum currency area’ theory on how currency unions could work to overcome asymmetrical shocks. The adjustment mechanisms identified through this theory include price and wage flexibility; mobility of labour and other factors of production; financial market integration; a high degree of economic openness; the diversification of production and consumption; similar inflation rates; fiscal integration; and finally, political integration. Some of these mechanisms can be seen to work effectively in the US. The three most important factors in place in the US economy identified by Stiglitz and others are: (1) the ease of migration across states, (2) federal spending on national programmes, and (3) the fact that the US banking system is a federal and not state-based system.
If one state in the US experiences a shock, workers can easily migrate to another state in a better economic condition in order to look for work. Technically there is freedom of movement of labour in the EU, but in practice migration within the US is far easier due to the fact states share a common language, a common culture and national identity, and the same access to federal welfare programmes. National government programmes such as social security and Medicare are available across all states, which means that if one state is experiencing a downturn, the federal government will automatically recycle surpluses towards the state in trouble in the form of, for example, increased unemployment benefits. Around one-fifth of GDP is spent at the federal level in the US. The federal government can also choose to boost investment or spending in certain federal projects at the state level in order to aid economic recovery. By comparison, in the Eurozone there is very little fiscal capacity to redirect funds towards depressed states because the European budget is around one per cent of member states’ GDP. Almost all spending occurs at the member state level. US banks are also guaranteed at the federal level by the Federal Deposit Insurance Corporation, preventing capital flight from one state to another in times of crisis.
Clearly the EU lacks similar institutions. But with the exception of a common deposit insurance scheme, the creation of such adjustment mechanisms in the Eurozone is either impossible in the short-to-medium term, or completely undesirable from a left standpoint by virtue of the fact that increased economic, fiscal and political integration require unacceptable trade-offs in the ability of people to participate in the decision-making process democratically at the local and national level.
Eurozone’s architects opt for internal devaluation
Of the various adjustment mechanisms identified by optimum currency area theorists, the Eurozone’s founders have clearly focused single-mindedly on attempting to achieve ‘flexibility’ of wages. Countries inside a common currency area cannot engage in competitive devaluations by devaluing their currency to make their exports more competitive. But they can implement policies domestically to bring about an ‘internal devaluation’ – lowering their real exchange rate vis-à-vis their neighbours. The main way this takes place is by compressing or reducing wages, which causes prices to fall. Germany has consciously implemented this policy for several decades, at the expense of German workers, millions of whom are working but living in poverty. This long-term strategy was intensified in 2003 under the then social-democrat/Green coalition government, which carried out a radical and vicious reform of the labour and welfare systems entitled Agenda 2010.
The competitiveness of prices largely determines the performance of a country’s exports, and the key factor determining prices is the nominal unit labour cost (the nominal unit labour cost is the ratio of labour cost per employee to productivity – the value added per worker). Unit labour costs in Germany stopped growing in the mid-1990s. Between 1998 and 2007, the rise in unit labour costs in Germany was zero. But in the rest of the Eurozone over the same period, average wage costs mainly increased with inflation, of around 2 per cent per year. This difference greatly increased the competitiveness of German exports and reduced it for the exports of other Eurozone members. So the success of Germany’s economic model is at the expense of the rights and living standards of its workers. The Agenda 2010 strategy has been deepened under successive governments and by 2015, more than 12.5 million Germans, out of a population of 80 million, were living in poverty in Europe’s “economic powerhouse”.
The EU’s focus on structural reform, particularly labour market reform, with a view to achieving increased “flexibility” has been a constant feature of its agenda since Maastricht. This was a major element of the Jobs Strategy of 1994, and the Lisbon 2010 Agenda adopted in 2000. The Lisbon Agenda originally set out to make the EU “the most competitive and dynamic knowledge-based economy in the world” by 2010. It included an economic pillar, a social pillar and an environmental pillar. In 2005, the Lisbon Agenda was revised by the European Council and Commission. Their verdict was that the agenda was failing to achieve its goal, and so they decided to drop the social and environmental pillars and focus on the economic pillar. In 2010 the Lisbon Agenda was relaunched as a new 10-year plan, the Europe 2020 strategy – “an agenda for new skills and jobs: to modernise labour markets by facilitating labour mobility and the development of skills throughout the lifecycle with a view to increasing labour participation and better matching labour supply and demand”.
The “progress” of member states in implementing structural reforms that will facilitate downward movement on wages is monitored through the European Semester process, a yearly cycle of policy “coordination” between member states and the Commission. In spring each year, Member States submit their plans for managing public finances – including keeping debt and deficits within the Stability and Growth Pact limits – and their National Reform Programmes to achieve “smart, sustainable and inclusive growth”. These plans are then assessed by the Commission, which proposes country-specific recommendations to member states, which are discussed and adopted by the Council. Then each autumn member state governments are graciously permitted to present their draft national budgets to their respective parliaments. The Five Presidents’ Report of EU leaders of 2015 proposed the creation of National Competitiveness Authorities to advance this agenda further.
The Eurozone elites believe (or claim to believe) that if only “wage rigidities” in the member states were overcome, both unemployment and trade imbalances would disappear. If only a country’s population could be forced to work for poverty wages, there would be a job for everyone; and the resulting stagnation in domestic demand would mean prices would fall and this country’s real exchange rate, which had become misaligned and risen too high, could regain its balance. This view underpins the repeated attacks on the rights and wages of French workers, set to intensify fiercely under President Macron, as well as underpinning the EU’s overall agenda and forcing structural reforms in the member states in order to increase productivity and competitiveness – and profit, of course. The austerity imposed by the Troika was not only designed to regain market “confidence” in peripheral governments, but also to facilitate internal devaluations in member states by a form of shock therapy. Of course, this adjustment facilitates not only the reduction of trade imbalances but also a sharp increase in the amount of wealth transferred from labour to capital.
There has certainly been an internal devaluation process in the Eurozone countries, affecting primarily the peripheral economies. But as Stiglitz points out, “this has not worked – or at least not fast enough to restore the economies to full employment. In some countries such as Finland, low inflation not been enough to even restore exports of goods and services to the levels before the crisis”. An increase in exports in these countries should have boosted growth and employment. But with the exception of the hugely distorted “globalised” data from the Irish economy, this has not been the case. The restoration of trade balance that the Eurozone has experienced since the crisis has largely been due to the fact that imports fall when demand stagnates – “one can achieve a current account balance by strangulating the economy”. For the crisis countries, the reduction in their trade deficits post-crisis largely resulted from a reduction in imports and not an increase in exports.
Crucially, internal devaluations also increase the level of debt of households, firms and governments who have borrowed in euros – as the value of their income is depressed, they owe a higher proportion of their income. High levels of debt were a major factor in causing the recession, because those in debt cut back on spending on both imports and domestic goods, causing a decline in GDP. It has also contributed greatly to the lingering problem of non-performing loans burdening Eurozone banks, particularly in the crisis countries.
This is an excerpt from the economic discussion document launched by MEP Matt Carthy on October 27, entitled The Future of the Eurozone. Download the full document for a referenced version of Chapter Five, above.