The start of the euro
Text-books often talk about ‘market failure’, but the euro is a glaring example of government failure. What’s happening at the moment isn’t merely a Greek crisis, or even a eurozone crisis – it’s a European Union crisis. Eurocrats keep boasting they’ve got the political will to fix the eurozone’s troubles. Yet it was their misguided political will that created the mess in the first place.
Twenty years ago, at Maastricht, fifteen EU member-states agreed to set up a ‘single currency’. Three countries chose not to join: Denmark, Sweden and the United Kingdom. Brussels refers to these three as ‘pre-ins’, but perhaps now we should label the seventeen countries currently in the eurozone as ‘pre-outs’? In 1998, the entry of Greece was deferred for two years, while the other eleven countries were allowed to join straight away. But how many of them met all five of the Maastricht requirements? Only one: tiny Luxembourg – with a population about one-tenth of one per cent of the eurozone total. The European Central Bank’s first chief economist was Otmar Issing. He said, ‘if monetary union is taken to be a club for teetotallers or, at least, only moderate drinkers, then the acknowledged drinker ought to prove that the course of rehabilitation has been successful before he joins’. But things soon got worse. After a few years, Germany and France dumped the Stability and Growth Pact as soon as it became inconvenient. Later the ‘no bailout’ clause was cast aside. This history is still relevant. No wonder financial markets today distrust irresponsible eurostrutters who disregard solemn international treaties.
An optimal currency area?
Since the euro started, unit labour costs in Club Med countries have risen much faster than in Germany. There are three main ways for countries to adjust:
Allow some real wage-rates to fall;
Get workers to move; or
Devalue the national currency.
But none of these works in the Eurozone:
Money wage-rates are notoriously sticky downwards. Tha is why Keynes, in the General Theory, proposed what he called ‘flexible money’ – meaning currency debasement.
With so many different languages and cultures, most workers aren’t willing to move between countries in Europe.
And no euro member-state can devalue. Hence William Hague’s graphic description of the eurozone as a burning building with no exits.
As many of us warned in advance, the eurozone is by no means an ‘optimal currency area’. One can see this by comparing it with America:
where real wage-rates are twice as flexible as in Europe.
and America’s work-force, unlike Europe’s, is highly mobile.
Despite confident predictions from Brussels, the euro economies haven’t converged. Many years ago, Sir Donald McDougall said that unless the eurozone could overcome these problems, it would become ‘a low growth, high unemployment area’. And this very month, eurozone unemployment went over 10% and the OECD downgraded its growth forecast for 2012 from 2% to 0.3%. For what it’s worth, McDougall estimated that an EU fiscal union would need central taxes amounting to at least 20% of GDP.
Moreover the euro’s not very popular, to put it mildly. In Italy, Spain and France, in a recent poll asking about the effect of the euro on their country’s economy, roughly 65% thought it was negative versus 15% positive, with 20% don’t knows – a net balance of minus 50%. In Germany there was a net balance of minus 20%.
Political union
What are the options now? Given the current crisis, EU leaders might now attempt to sweep eurozone countries into a political union – the United States of Europe. Which is what many of them have wanted all along.
For example, here are a few quotes from over the years (and I could give dozens more) – Luigi Einaudi, then President of Italy: ‘the next goal is the United States of Europe’; Joseph Luns, then Dutch Foreign Affairs Minister: ‘countries wishing to join the EEC must accept the objective of political union for Europe’; Jacques Santer, then President of the Commission: ‘with the launch of the euro, the EU moves on to the next phase: political union.’ Even the then EEC’s own official general guide set out clearly enough: ‘economic integration isn’t meant to be an end in itself, but merely an intermediate stage on the road to political integration.’
The United States of America is an example of a political union, with people in the fifty states comprising a single nation. Large tax revenues allow the federal US government to make transfers year after year from wealthier regions to poorer ones. I doubt if the peoples of Europe would welcome such central direction. Not that the antidemocratic European Union would let a trifle like that stand in its way.
Political union may indeed be the ‘logic’ of a single currency area – as the Germans, among others, repeatedly said in advance – but why on earth is our government pressing for it? British foreign policy for four hundred years has aimed at preventing a single power dominating the continent of Europe.
Even if all eurozone members were willing to go as far as full political union, what would happen to the ten EU member-states currently outside the eurozone? Only Denmark and the UK have an ‘opt-out’, though Sweden voted against joining. (When that happened, Brussels asked: ‘what’s wrong with Sweden?’ not ‘what’s wrong with the euro?’) At least seven of the ten countries are obliged to enter the euro in due course. So in a few years’ time – if the ‘irreversible’ euro survives – instead of seventeen EU members in the eurozone and ten outside, there could be twenty-four in and only three out.
There are several problems with a fiscal union: voters in wealthier regions won’t want to pick up most of the bill; there’d be a massive moral hazard for governments in poorer regions. If they’re going to get large subsidies every year, why should they ever put their house in order? And, the tensions between European nations would go on getting worse, the EU would become even more unpopular than it is already, and the democratic deficit would continue to rise. This is not a happy prospect.
Carry on regardless?
Another possible outcome is for the eurozone to continue to bumble along with its leaders failing to recognise reality, failing to convince financial markets and failing to satisfy (or even consult) their own people – and still overspending. But continuing as now would do nothing to restore competitiveness within Europe.
In order to cut their debts enough, several governments need to default now. The many delays are making things worse. But who can predict the level of defaults? My last book was called Margins of Error in Accounting, so I should emphasise it’s impossible to be very precise. My own guess would be 80% for Greece; and 50% for Portugal, Italy, Spain, Ireland and Cyprus. That would mean losses for government bondholders – including the European Central Bank – of hundreds of billions of pounds. It’s highly dubious in law to talk of a ‘voluntary haircut’ for selected private Greek government bondholders, which somehow wouldn’t count as a real default. In fact, it’s typical eurobabble; and no more realistic than Ralph Harris’s sarcastic call years ago for a Common European Bedtime.
A different solution to the debt overhang would be to debase the single currency massively. But, given their history, I can’t believe the Germans would ever agree to that.
Is it Eurozone break-up then?
Another possible outcome is for the eurozone to split into two. A northern ‘Neuro’ could include Finland, Austria, Netherlands, as well as Germany. A southern ‘Sudo’ could include Portugal, Italy, Greece and Spain. A delicate question would then arise: in which group does France belong? Since the Sudo would be able to devalue against the Neuro from time to time, this might mean – with a lot of luck – that both these two new currencies could co-exist.
A more complete break-up of the eurozone would restore separate national currencies. Making a drachma out of a crisis! Several governments would still need to default and exchange controls might return for a time. In my opinion, this is the only outcome that might work, since devaluation, combined with overdue reforms, could lead to a big improvement in competitiveness. But we mustn’t expect too much: the Greeks will never behave like the Germans. Incidentally, nor will the French.
It’s hard to envisage eurozone members agreeing on an orderly break-up. So I predict a disorderly break-up. The obvious drawback – for eurocrats – would be the transparent failure of the euro project. But as Confucius said, ‘a man who has made a mistake and doesn’t correct it, is making another mistake’.
The European Union
So far we’ve considered only Eurozone, but let’s turn to the European Union itself. Today’s EU is very different from the Common Market of the early 1970s. Since then, to quote the Japanese emperor’s 1945 surrender broadcast, ‘the situation has developed not necessarily to our advantage’. If we’d known then what we know now, we’d probably never have joined the Common Market the first place.
Trade with the EU accounts for less than half of Britain’s exports, and represents less than one-sixth of our national income. Yet Brussels imposes burdensome red tape on the whole British economy. So the tail is wagging the dog. Its top-down, one-size-fits-all approach is unhelpful, to say the least. And the EU’s very different legal system, based on the Napoleonic Code, causes huge special problems for the UK and Ireland.
Not for the first time in our island’s history, continental Europeans are causing us a great deal of expense, inconvenience and political danger. They’re our partners today, not our enemies, though you wouldn’t always know it. Partnerships depend on “utmost good faith”. Despite its Latin origin – uberrimae fides – this thought seems to lose something in translation as it crosses the English channel.
250 years ago, David Hume noted that developed countries often looked at their neighbours’ commercial progress with a suspicious eye, assuming that one gained at the other’s expense. He thought this was a mistake. ‘I assert’, Hume wrote, ‘that the increase of riches and commerce in any one nation, instead of hurting, commonly promotes the riches and commerce of all its neighbours. As a British subject, I pray for the flourishing commerce of Germany, Spain, Italy and even France itself.’ He expressed this view during the Seven Years War, a splendid example for all who believe in free trade. It’s perhaps worth recalling that the Greek word καταλασσειν [catalassein], meaning ‘to exchange’, also means ‘to turn from enemy into friend’.
Leaving the EU
The eurozone fiasco may give us the best chance we’ll ever have to make our excuses and leave the European Union peacefully. But will our current political leaders have the judgement and courage to do it? Hayek once remarked that, in the course of a long life, his opinion of politicians had steadily gone down. I share his disenchantment with people that Adam Smith described as ‘those insidious and crafty animals’.
Having less than one-tenth of the votes gives Britain only a small say in running the EU. But we don’t really want to participate in governing Europe: we just want to govern ourselves. We’d have far more ‘influence’ on our continental neighbours with an independent free-market low-tax economy outside the EU. It’s quite true we’d then have no part in setting the EU’s internal rules. But does that really matter?
British firms do business with American, Japanese, and other firms all round the globe, though we don’t have any say in their internal rules. And somehow they manage to trade perfectly well with the EU. Under WTO rules it would be illegal for the European Union to discriminate against the UK, even if they wanted to. And anyway tariff levels now are far lower than when we joined the Common Market customs union. If we wanted, we could still co-operate with other countries in all sorts of areas, like NATO, Interpol, and so on. Just as Norway and Switzerland can, two of the most prosperous countries in Europe. And so tellingly, outside the EU.
I regard the European Union as an alien tyranny. ‘Alien’, because it’s mostly run by foreigners; and ‘tyranny’, because we can’t throw the rascals out. As Enoch Powell said, ‘we’re happy to trade with people on the continent, as we’ve done for hundreds of years; but we don’t want to be ruled by them’. To me it seems crazy for Britain to hang on as a reluctant member of an expensive bureaucratic anti-democratic old men’s club – whose main aim (‘ever-closer union’) we don’t share.
Professor D.R. Myddelton is the IEA’s chairman of trustees and emeritus professor of finance and accounting at Cranfield School of Management.