THE POLITICAL ECONOMY OF THE EUROPEAN ECONOMIC AND MONETARY UNION:

POLITICAL SOURCES OF AN ECONOMIC LIABILITY

STRUCTURE OF THE PPT

Introduction I: Bottom-Up vs. Top-Bottom

Introduction II: Net Economic Effects

The Politics of the EMU

The Economics of the EMU

Conclusions

Critique & Discussion

INTRODUCTION I

BOTTOM-UP (HOW IT SHOULD BE)

EMU as a result of human action or human design?

Optimum Currency Area: (Mundell, 1961)

Labor Mobility. Openness with capital mobility and price and wage

flexibility across the region. A risk sharing system (e.g. automatic fiscal transfer

mechanism). Participant countries have similar business cycles.

INTRODUCTION ITOP-BOTTOM (HOW IT ACTUALLY IS)

European Coal and Steel Community (Treaty of Paris in 1951) European Common Market (1957 treaty of Rome) European Communities (1967) European Monetary System (EMS 1979) Single European Market (1992) European Union (Maastricht Treaty in 1993). Each stage increased the range of centralization of power.

UNINTENDED CONSEQUENCES OF A TOP-BOTTOM DESIGN: European Idiosyncratic Risks Europe’s Competitiveness.

e.g. low labor mobility, labor unions pushing up the welfare state, pushing for sticky wages, sticky prices, and for minimum wage laws, and for import quotas, and so on and so fort…

Great Divergence btw Monetary and Fiscal Policies.

Risks associated with lack of Fiscal Union btw member States. No Bail-out clause from Stability and Growth pact of 1998… REALLY???

Forced Solidarity from disciplined countries to the PIGS.

INTRODUCTION II:

NET ECONOMIC EFFECTS (-)

EMU as Political Agenda “Economic Liability”

The Standard of living of the average European will be lower (after EMU), since they already enjoy (in 1997) from:

① Single market for trade in goods and services.

② Free flow of capital and labor.

③ Adjustable ex. rates within broad bands.

④ Domestic monetary policies aimed at low inflation.

EMU has been marketed as a source of improved economic performance, without understanding the economics behind such move.

THE POLITICS OF THE EMU

No single coherent political case for a EMU.

Mixture btw pro-European Internationalism and National Self-Interest.

Although these views may be mutually contradictory, taken together may propel the Monetary Union:

① Protecting Peace and Projecting Force.

② National Interests.

③ Majority Preferences and Political Elites.

1. PROTECTING PEACE AND PROJECTING FORCE

Changing the violent history of Europe (Jean Monnet) Political influence of Helmut Kohl “Germany is our fatherland but Europe is

our future.”

Discourse based on fear against war.

*BUT: Less freedom of individual member States (to create own Ec,

Social and Intl. policies) would increase (rather than diminish) conflict.

A two-class Europe (EMU members and not) recipe for new dialectics.

Initial ideal to harmonize foreign and military policies (before a EMU) was reversed!

2. NATIONAL INTERESTS

Who are we kidding…

How will my country benefit from a more centralized Europe?

Opportunity to become a “Co-Manager” of Europe. Current Domination of Eu MP by the Bundesbank ECB where

Germany and France would sit and vote as equals. Center of EU Brussels (or Strasbourg) instead of Berlin.(Wishful thinking, but still, it persuades French officials from pushing for the EMU)

ECB located in Frankfurt (and its charter design in the Maastricht Treaty to make it

function like the Bundesbank) Dominate MP. Stability Pact May provide the fiscal discipline that Germans

want.

*Clearly, French expectations for equality and Germans aspirations for hegemony are NOT compatible.

2. NATIONAL INTERESTS Who are we kidding…

How will my country benefit from a more centralized Europe?

Urgency to meet Maastricht criteria Driven by national pride.Feldstein wonders why Italy (whose economic growth exceeds that of both Germany and France), wants to conform to new pan-European economic regulations that may hinder its growth trajectory.

Political desire of being part of the original group (Treaty of Rome)

To show that Spain has overcome its past history of political and economic isolation during the Franco regime.

To “have a sit at the table” where the policies are made that will affect them in the future.

*Clearly, this route to influence was an illusion since giving up MP independence was more costly than beneficial to the PIGS.

BONUS TRACK Tax Harmonization versus Tax Competition:

European Commission actively engaging in centrally-planned harmonization regulations (even back in 1997).

This will deny the opportunity to tailor tax policies that could allow increases in their productivity levels and thus, to expand their TFP frontiers (e.g. via an inflow of new technologies through FDI.)

Domestic economies will be harmed.

“The pressure to have a common labor legislation and economic regulations, common tax rules and common social benefits would strengthen the control of government relative to the market and would eliminate the

COMPETITIVE [emphasis given] process by which different types of government rules can be judged in practice.” – (Feldstein, p.31)

3. MAJORITY PREFERENCES AND POLITICAL ELITES

Another Top-Bottom design (implemented by force).

Even when the majority of the EU citizens remained unconvinced, the political class (even the opposition in each country) pushed for the EMU.

In Germany, 2/3rds of the voters opposed it. In France, a plebiscite approved a MU with a majority of

less than 1%.

Impossible to know why they pushed for it (acc. to Feldstein)

THE ECONOMICS OF THE EMU

Evaluate potential gains from increased trade against macroeconomic losses:

① Reducing the Cost of Trade Among EMU Countries

② Effects of Monetary Union on Cyclical Unemployment

③ EMU, ECB and Inflation.

④ Structural Unemployment and Protectionist Policies

1. REDUCING THE COST OF TRADE AMONG EMU COUNTRIES Trade-Creating effects (i.e. increased trade among MS) versus Trade-Diverting

effects (i.e. diversion of existing imports from countries outside the EMU to countries inside it).

Shift to single currency exacerbates unemployment by eliminating the possibility of national dif in i rates and changes in nominal ex rates (i.e. not only the inability to conduct monetary policy but also the absence of autonomous mkt responses of i rates and ex rates to exogenous demand shocks)

Prospects for price stability diminished.

Potential protectionist trade policies against non-EMU countries.

Thus, the gains from reduced transactions costs can be outstripped by the risk of protectionism and of cyclical instability, raising the cyclical unemployment rate.

2. EFFECTS OF MONETARY UNION ON CYCLICAL UNEMPLOYMENT

A country (with its own currency) experiences a decline in Demand for its exports Currency Value Declines.

The mkt Response ? Increases X and Reduces Q

AD decreases:

a. real i rate declines b. real value of currency declines.

Non of these stabilizing responses within EMU.

A country that is part of a MU and lacks its own currency is obviously precluded from using such discretionary policies (e.g. QE) to reduce cyclical fluctuations in unemployment.

CONCLUSIONS-Disagreements about both monetary and fiscal policy EMU at this stage would hinder relations among European countries, creating conflict rather than harmony.

-Economic consequences will be negative.

(Imposing a single i and inflexible ex.rate on countries that are characterized by dif. ec. Shocks, inflexible wages, low labor mobility and separate national fiscal systems w/o significant cross-border cyclical transfers will raise the overall level of cyclical unemployment among EMU members)

-Shift from National monetary policies towards a system (ECB) dominated by politically determined ex.rate policy will raise the average Level of inflation.

-Emphasis on common ec. And social policies will reduce scope for experimentation and competition (which would have otherwise helped to reductions in the high level of structural unemployment.

-EMU as Political Agenda EMU as Economic Liability.

(Political leaders in Europe seem to ignore these adverse consequences bc they see EMU as a crucial step towards a Federalist European political union (i.e. with a common foreign and military policy). Therefore, instead of provide union the EMU might produce the adverse effect.

-EMU will be judged not by its impact on inflation and unemployment but by its effect on peace and conflict within Europe and with the RoW.

CRITIQUE & DISCUSSION:

The probable consequences of a unitary interest rate? More specifically, the PIGS’ potential access to cheap credit expansions???

The real effects of Forcing solidarity from one member State to pay for the irresponsibility of another (more irresponsible) member State.

Understanding the economic liabilities of a “centrally designed” EMU and yet, failed to highlight the HOW/WHY this very move could become the genesis of the EU’s own demise.

Should a Monetary Union be the result of human action or human design?

“A government with the power to print money knows no limits”– Jeffrey Tucker