Europe Needs an "Economic Government" but Greece Has Made the Goal Even More Elusive

February 22, 2010 12:00 PM

It is hardly a surprise that Greece's struggles and Europe's fitful response have come to illustrate the problems of an incomplete integration of Europe and the eurozone. As predicted by many economists before the introduction of the euro, the fact that the eurozone is not an "optimum currency area"1 has left the region vulnerable to asymmetric shocks, which then played a large role in the current crisis. The European Union and the eurozone do have relatively large degrees of labor and capital mobility, despite language and cultural barriers. Similarly, Europe has had—at least during the current downturn—a relatively synchronized business cycle.

What the eurozone lacks, however, is an "economic government" that could facilitate automatic redistributive fiscal transfers between geographic regions. There are no automatic fiscal stabilizers, in other words, to transfer funds to the worst-hit countries to help them return to growth. The European Union's Lisbon Treaty explicitly rules out the second best option to a continuous "fiscal transfer mechanism," namely the "sporadic ad hoc fiscal transfer" to a country in crisis, by outlawing any form of a financial bailout from the European Central Bank or other EU institutions.

Faced with the threat of contagion from a crisis-stricken Greece, many EU policymakers and commentators are talking openly about the need for a "European economic government."2 Whether this means "greater coordination on economic policy,"3 "deeper surveillance of European economies,"4 or a requirement that each eurozone member submit its annual budget to the 16-country bloc for majority approval,5 the intent is clear. In order for the euro to survive in the long run, the economic and monetary union must now be completed with a political and fiscal one.

Like Rahm Emanuel of the White House, European integrationists may not want to let an economic crisis go to waste. They lean toward creation of a new European institution to solve the crisis, thereby fighting yesterday's war. The real Greek tragedy, however, is that while the case for further European integration is compelling and that more European economic government would prevent future Greek situations—the politics of the Greek crisis itself makes further European integration more unlikely.

To begin with, the need for drawn-out timing and a referendum for such a step would set up huge obstacles. A "European economic government" would be the first attempt at additional European integration after the implementation of the Lisbon Treaty, which took 10 years and multiple referenda attempts before it was enacted in December 2009.

No process toward greater integration could succeed without the direct involvement of European publics and European leaders. Yet as late as after the last Irish referendum in October 2009, these leaders vowed that the EU's institutional setting would be fixed for a decade. It will take a brave European political leader to propose any additional jump toward further European integration right now and a superhumanly charismatic one to carry any referendum on the topic in the current climate.

There is also the issue of what is being proposed. Any "European economic government" relevant in the current economic context would, whether as part of a permanent framework or as a one-off financial bailout, have to include provisions for some kind of "fiscal transfers"—initially to Greece. A far-reaching proposal focused on getting longer-term policy coordination among EU members, while beneficial, would not be of any help to Athens.

Another obstacle is simply the public's resistance to bailouts. Recall that the current EU ban on bailouts and the lack of any institutionalized fiscal union resulting from the fear of a political backlash among the original political framers of the Economic and Monetary Union when writing the original Maastricht Treaty. Neither François Mitterrand of France nor Helmut Kohl of Germany thought their taxpayers could accept such explicit transfers to other member states, beyond the more than 1 percent of GDP the EU budget already commits to in a stealthier manner.6

A similar political logic occurs in welfare states that engage in high levels of income transfers between groups. Only those countries with relatively small and homogenous populations, for instance Scandinavia, accept and carry out such policies. That is because people tend to accept tax-paid transfers to "needy recipients" only if these recipients are "roughly like themselves" in terms of culture, ethnicity, language, or other factors. Otherwise moral hazard carries the day.

Persistent cultural and linguistic differences among EU member states—in particular between the "paying North" and "recipient South"—will thus likely rule out any direct and explicit fiscal transfers among them. Greece's record of repeated statistical fraud and more lavish social spending programs (especially a considerably lower pension age) compared to other EU members obviously poses additional political obstacles to more aid to Greece.

Just as the prolonged debate over health care has eroded public support for reform in the United States, public hostility in Europe toward any bailout or adoption of a "European economic government" initiative, especially if it includes direct fiscal transfers, is also likely to increase the longer the crisis continues. Indeed a recent opinion poll in Germany showing 71 percent against any financial solidarity with Greece and only 25 percent in favor was a sign that resistance to EU member states contributing funds will grow.

The need for a "European economic government" is greater than ever. Unfortunately, Greece will not likely serve as the catalyst to make it happen.

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Notes

1. As originally defined in Mundell, R.A. 1961. A Theory of Optimum Currency Areas. American Economic Review 51:657–665.

2. German Chancellor Angela Merkel and EU Council President Herman Van Rompuy at the European Council on February 11, 2010.

3. Spanish Finance Minister Elena Salgado, February 17, 2010. Available here.

4. European Commissioner Olli Rehn, February 17, 2010, ibid.

5. Former French Prime Minister Eduard Balladur, February 19, 2010. Available here.

6. The EU budget in 2010 is €141bn, representing 1.2 percent of EU-27 GNI, and is distributed across member states. Available here.

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Jacob Funk Kirkegaard Senior Research Staff

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