A single currency implies a federal state, like the US or Brazil. The Greek crisis confronts Europe with its future.
Greece is experiencing an economic hurricane. Since the 2008 financial crisis, the Euro Zone has been struggling to recover and in constant danger of a deflationary spiral. Greece’s problems began before the financial crisis, but only became clear as a consequence of a major shock from overseas (or, for those who were already arguing that the monetary union was problematic, it brought the problems back to the discussion table). Regardless of the current difficulties, this may be an opportunity for the far-from-perfect monetary union to build towards a more sustainable form of integration.
The economics of what went wrong
The issue of giving up the right to print money in exchange for economic development via integration is not new. Some large countries have monetary union, e.g. the U.S. and Brazil; but a continent faced with challenges like Europe has assigned a special role to the single currency. It is a symbol of what Europeans can accomplish together. But it is also a symbol of what can go wrong if coordination fails. Choosing to share a currency with another State is a delicate matter. Robert Mundell’s brilliant paper, A Theory of Optimum Currency Areas, published in 1961, sheds light on the requirements for such decision.
Imagine two countries (A and B) operating at full-employment, and in balance-of-payments equilibrium, each of which produces one different good (1 and 2, respectively). Assume a shock that increases the demand for good 2. Under a fixed exchange rate regime, this shock would cause inflation in country B, an increase in unemployment in country A – and possible domestic economic policy responses for avoiding it – and a trade imbalance whereby country B has a surplus and country A, a deficit. Under a flexible exchange rate, the adjustment would occur at the nominal exchange rate, balancing not only the national economy but also the international relationship.
Now imagine the same two countries, but both of them producing the two goods (1 and 2). The same demand shock would have a different impact, regardless of the type of exchange rate regime. The increase in the demand for good 2 would cause inflation in the region of the country that produces this kind of good and a rise in unemployment in the other. The monetary policymaker would have to choose whether to fight inflation or unemployment, since the interest rate would affect the whole country. Note that even if this occurs in both countries, the exchange rate regime has no influence, given the fact that this becomes a domestic imbalance.
The optimum currency area theory defends regional fixed-exchange rate regimes where the factors of production have high mobility and the business cycles are synchronized. On the other hand, the interregional relationship would be mediated by a flexible exchange rate regime. The theory has evolved by embracing two other factors: fiscal transfers and unified banking oversight. The latter tackles problems arising from specific regions within currency unions. Integrated oversight prevents disagreeable surprises. Europe has taken some steps in this direction following banking problems in some of the countries. However while this method deals with future problems, it fails to confront current needs for for recovery. This brings us back to the issue of fiscal union.
We have at least two examples of sustainable monetary unions: the United States and Brazil. Even though they are culturally and economically very different (and are at different development levels), both consist of individual states with the power to create laws and independent budgets within a federal framework, one element of which is a single currency.
The fact that countries like the U.S. and Brazil manage to maintain a single currency depends heavily on transfer mechanisms. If there is a region with increasing unemployment, people from other regions that are doing better help to cover the increased costs of unemployment. In Europe, for example, this would mean the German people paying for Portuguese unemployment insurance or vice versa, depending on who is faring better. This creates a sensation of belonging, of being a part of a federation. Of course excesses have to be avoided through the introduction of checks and balances that are both politically and economically sound.
Labor mobility is also crucial. If there is an adverse shock in Washington or São Paulo, people should consider moving to Ohio or Bahia. It works as follows. If, for any reason, output in Washington were to fall, this would imply a lower demand for labor. If people opted to stay put and to continue to look for work locally, unemployment would rise. On the other hand, if they were to leave and seek work in Ohio, a state that for the purposes of our example is doing better and thus creating demand for labor, the shock would be attenuated and the economy as a whole would suffer less. In these two countries (Brazil and the USA), there are fewer barriers, given that each has a single main language and shared cultural and social values.
Empirical evidence points towards greater labor mobility in the US than in Europe. It is difficult for an Italian family to move to France or another part of the Euro Zone in search of job opportunities. This is why transfer mechanisms are important. If the unemployed stay at home, Europeans need to realize that, to avoid recession in the absence of local monetary autonomy and limited fiscal room for manoevre, federal intervention is required. Either resources have to move from one place to the other, or labor, or capital.
The politics of what may go right
Despite the economic bottlenecks discussed above and the policy difficulties faced by the European bloc, the progress already achieved during the process of continental integration should not be overlooked. If on one hand the creation of a common currency has reduced the ability of countries to make macroeconomic adjustments, on the other hand the Euro has emerged as the main symbol of renewed bonds between nations that for decades had confronted each other on the battlefield.
As in all types of complex arrangements, it would be naive to assume that any system of integration is infallible. Integration in the real world is never perfect; it demands unremitting effort to manage common problems efficiently. In this sense, the Greek crisis could be interpreted not as a sign of European failure, but as a new challenge to be met within a context of previous achievements.
Even with its imperfections, the integration promoted by the European Union has established a model of interaction between countries that prevails over the logic of realpolitik and that reaffirms the possibility of building international strategies based not just on interests but also on shared values. By adopting “democracy”, “free trade” and “respect for international law” as foundational principles, Europe has proved to the world that it is possible to achieve development without old-style “hard power politics” based mainly on capital accumulation and military capacity.
If so-called “complex interdependence” – so-named by Robert Keohane and Joseph Nye in Power and interdependence (1989)– is an inescapable reality of the globalised system, it means that reciprocity is what countries naturally expect. The innovation, therefore, is not in the announcement of new crises, but in the willingness of nations to cooperate and their ability to develop mutual empathy and tolerance.
By promoting respect for institutions, Europe has invested in the ability of States to communicate through diplomatic channels. Dialogue, even in the face of obstacles to consensus building, allows countries not only to increase their access to information, but also to find opportunities for negotiation, to monitor commitments already assumed, and to adhere to signed agreements. As is widely discussed by liberal International Relations theorists, dialogue clarifies and moderates expectations, facilitates reciprocity, and reduces the costs and the complexity of relationships. Consequently, resolving problems collectively necessarily means employing decision-making mechanisms of a kind that are likely to give better results.
Treating the Greek crisis and the eventual abandonment of the Euro as an irrefutable sign of European failure is not only a dangerous simplification, but a binary diagnosis as well. It means treating integration as an end itself rather than as a process. What the current crisis reveals is the importance of analyzing patterns from the past in order to make judgments and perhaps to develop new political arrangements aimed at making the European integration model more sustainable. In Gramscian terms, the present conjuncture constitutes an interregnum between one moment and another.
One lesson, above all, already seems clear: integration does not mean eliminating inequalities nor the utopia of supranationality nor the creation of a common European identity; it means a gradual coalescence of values, improvement in processes and the will to reconcile differences.
Europe’s enemy is not the Greek crisis but its own earlier paradigm of war and violence.
This article has been republished from opendemocracy.net.
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