Editor's Note: Martin Feldstein, Professor of Economics at Harvard, was Chairman of President Ronald Reagan's Council of Economic Advisers and is former President of the National Bureau for Economic Research. For more from Martin Feldstein, visit Project Syndicate or follow it on Facebook and Twitter.
By Martin Feldstein, Project Syndicate
Europe is now struggling with the inevitable adverse consequences of imposing a single currency on a very heterogeneous collection of countries. But the budget crisis in Greece and the risk of insolvency in Italy and Spain are just part of the problem caused by the single currency. The fragility of the major European banks, high unemployment rates, and the large intra-European trade imbalance (Germany’s $200 billion current-account surplus versus the combined $300 billion current-account deficit in the rest of the eurozone) also reflect the use of the euro.
European politicians who insisted on introducing the euro in 1999 ignored the warnings of economists who predicted that a single currency for all of Europe would create serious problems. The euro’s advocates were focused on the goal of European political integration, and saw the single currency as part of the process of creating a sense of political community in Europe. They rallied popular support with the slogan “One Market, One Money,” arguing that the free-trade area created by the European Union would succeed only with a single currency.
Neither history nor economic logic supported that view. Indeed, EU trade functions well, despite the fact that only 17 of the Union’s 27 members use the euro.
But the key argument made by European officials and other defenders of the euro has been that, because a single currency works well in the United States, it should also work well in Europe. After all, both are large, continental, and diverse economies. But that argument overlooks three important differences between the US and Europe.
First, the US is effectively a single labor market, with workers moving from areas of high and rising unemployment to places where jobs are more plentiful. In Europe, national labor markets are effectively separated by barriers of language, culture, religion, union membership, and social-insurance systems.
To be sure, some workers in Europe do migrate. In the absence of the high degree of mobility seen in the US, however, overall unemployment can be lowered only if high-unemployment countries can ease monetary policy, an option precluded by the single currency.
A second important difference is that the US has a centralized fiscal system. Individuals and businesses pay the majority of their taxes to the federal government in Washington, rather than to their state (or local) authorities.
When a US state’s economic activity slows relative to the rest of the country, the taxes that its individuals and businesses pay to the federal government decline, and the funds that it receives from the federal government (for unemployment benefits and other transfer programs) increase. Roughly speaking, each dollar of GDP decline in a state like Massachusetts or Ohio triggers changes in taxes and transfers that offset about 40 cents of that drop, providing a substantial fiscal stimulus.
There is no comparable offset in Europe, where taxes are almost exclusively paid to, and transfers received from, national governments. The EU’s Maastricht Treaty specifically reserves this tax-and-transfer authority to the member states, a reflection of Europeans’ unwillingness to transfer funds to other countries’ people in the way that Americans are willing to do among people in different states.
The third important difference is that all US states are required by their constitutions to balance their annual operating budgets. While “rainy day” funds that accumulate in boom years are used to deal with temporary revenue shortfalls, the states’ “general obligation” borrowing is limited to capital projects like roads and schools. Even a state like California, seen by many as a poster child for fiscal profligacy, now has an annual budget deficit of just 1% of its GDP and a general obligation debt of just 4% of GDP.
These limits on state-level budget deficits are a logical implication of the fact that US states cannot create money to fill fiscal gaps. These constitutional rules prevent the kind of deficit and debt problems that have beset the eurozone, where capital markets ignored individual countries’ lack of monetary independence.
None of these features of the US economy would develop in Europe even if the eurozone evolved into a more explicitly political union. Although the form of political union advocated by Germany and others remains vague, it would not involve centralized revenue collection, as in the US, because that would place a greater burden on German taxpayers to finance government programs in other countries. Nor would political union enhance labor mobility within the eurozone, overcome the problems caused by imposing a common monetary policy on countries with different cyclical conditions, or improve the trade performance of countries that cannot devalue their exchange rates to regain competitiveness.
The most likely effect of strengthening political union in the eurozone would be to give Germany the power to control the other members’ budgets and prescribe changes in their taxes and spending. This formal transfer of sovereignty would only increase the tensions and conflicts that already exist between Germany and other EU countries.
The labour mobility in the European Union doesn't apply to all countries. A German can live and work anywhere he likes within the E.U. But Romania and Bulgaria, which became members in 2007 have to wait till 31 December 2013 in order to enjoy full labour mobility. Dynamic people in Poland who left for the U.K. some years ago, now return now home, as their country's economy is booming. I wouldn't go to work in Poland, because of the language. Greece and Portugal saw a brain-drain in their countries, as the economy boomed elsewhere in Europe. In many regions on the Mediterranean, one saw more German or British pensioners than young locals.
I hate to sound giddy over an article that I agree with, but obviously the formula for consolidating to a single currency is not understood. Speaking the same language and having the same law unmbrella might help. Lets be honest, many of the European countries blame each other in a constant comedic caper. Its funny for the Irish to blame the Scottish, else every pub in Ireland would close down, because there would be nothing worth talking about. Football (or Soccer) is built on to this notion. You see how they act when a football rivalry ends in defeat, and that is just football.
Embracing, not watering down European diveristy should be the goal, when making the final decision on the Euro. The Euro begins to remove the diversity of, perhaps the most intriguing continent on the planet.
Thank you, Martin Feldstein for echoing what I've been saying on my posts all along. The very idea of a Eurozone is and always has been a bad idea. For instance, Germany needs to quit the Eurozone and go back to using the Deutschmank plus assert it's will in NATO as a counterweight to U.S. domination of that alliance.
Well said, Onesmallvoice. The above is the most sensible comment here yet!
@j. von hettlingen– Feldstein is not talking about a lack of legal rights regarding labor mobility, but the fact that there are differences between EU member states such as language, culture, religion, and union memberships that make labor mobility incredibly difficult for most people.
On a more general note, I think the EU would work, but I don't think they (Europeans) have the stomach to do what would be sufficient to create a truly integrated super-national political authority. I did think it was funny Feldstein basically said at the end let the Germans run everything, lol. Viel Spaß!
@Midwester, danke für Ihren Hinweis. Ich hatte den Artikel ganz genau gelesen!
It's essential that the wealthy pay 70% or more Taex. Last 10 yers the number of Billionairs in the world inceased 10 folds,while the poor got more poor. The GOP,if they don't wake up they will be history for good.
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