November 16, 2011

A new baby is being born -- call the doctor

Giving birth is supposed to hurt, and with nations it is no different. The labor pains of a nation's birth do not end, however, with the toppling of the dictator, the expulsion of the invaders/conquerors, or the signature of an armistice treaty. The next step in a nation's life is the most crucial one: The Foundation of the State. Europe is currently in the labor pains stage. Its current travails show a marked parallel with the origins of the United States as a Nation: Jefferson (read Merkel) did not want the U.S. to assume the debts of some profligate former colonies (read Greece/Ireland/Portugal/Spain/Italy) and issue U.S. Federal Bonds (read Pan-European Bonds). Hamilton (read Barroso, and to some degree Sarkozy) pushed for the single issue and fiscal integration. The result: Jefferson ceded and the U.S. assumed the debts of less frugal states in exchange for picking a location for the new nation's capital near his home state of Virginia. Integration triumphed. The baby was born healthy.

Will integration win for Europe? Robert Mundell won the 1999 Economics Nobel Prize for explaining precisely what is needed in order to have an "optimum currency area" -or what is needed to integrate several formerly independent economies with different currencies into one single market economy. However -for a reason I still do not understand that might have to do with his reputation-, no one has ever mentioned his findings in the mainstream media. Mundell states that in order for a Optimum Currency Area to work, it must:

  • Have Labor Mobility within its boundaries. If you quit your job you easily get hired somewhere else.
  • Have Capital Mobility. So investment decisions are not influenced by which region within the country one is doing business other than the risks inherent in the project per se.
  • Share a Central Fiscal Revenue collection agency, so taxes are levied on prosperous regions to subsidy and eventually develop less rich areas.

Labor mobility is something Europe definitely lacks. Spain's 20% unemployment rate (44% among youths) is due in great part because -ironically- people don't get fired. It's very expensive for Spain bosses to fire employees -despite the government's lukewarm efforts to liberalize its labor market. Unions there have succeeded in restricting labor supply, making wages artificially expensive. In Italy the government still controls the supply of labor by issuing permits for certain professions -a practice Milton Friedman derides as a way to restrict economic freedom and limit economic development. Then you have the cultural barrier - imagine that moving from Texas to Oklahoma you had to speak a different language to be able to get a job.

Capital mobility is something that Europe scores better, though. One needs only to see the footprint of European transnationals within the continent to know that they have easily established operations in different regions of the Euro area. Santander, Deutsche Telekom, Vodafone, are good examples of companies that have harnessed well the ease of capital mobility within the Eurozone. The very fact that Germany exports 60% to the other Eurozone countries is also good. Although trade by itself is not strictly capital mobility as Mundell defines it -it is the mobility of capital goods' end products-, trade is a precursor that can lead to capital mobility.

And as far as sharing fiscal revenues, well, that's definitely an area Europe has not succeeded. I don't need to extend much here. They don't have a joint tax collector, and every state has responsibility to combat its own evasion. Frugal, efficient tax-collector states (Germany) wince at the thought of subsidizing so-called squandering nations.

Out of 3 conditions, Europe fails on 2. Notice that these 3 factors in Mundell's Optimum Currency Area are preconditions for it to work. You have to have them, and then issue the single currency. Europe did it backwards. The Maastricht Treaty was supposed to lay the ground for those conditions to be met, not by creating a unified European fiscal revenue agency, but by simply "inviting" its member to abide to the 3% of GDP deficit rule. Not exactly the best way to enforce fiscal frugality.

So, we have arrived here. The European nations (plural) are suffering from labor pains, struggling to give birth to the new European nation (singular). Will the baby survive? If they don't give him the right medicine, (liberalizing labor markets and implementing fiscal integration) chances are he will not. Somebody call the Doctor!

Update 2-11-12:
I now have a theory about why Mundell´s model has not been quoted during this whole European Debt debacle. Maybe -just maybe- it has to do with the Canadian's damaged reputation after his participation in Olympus' board and its epic corporate scandal.


  1. To compare the "birth" of this putative nascent "European nation" that you speak of to the birth of the US is ... well let's just call it silly.
    You did not have a bunch of 17 sovereign nation states pre-existing within the boundaries of what is now the United States now, did you?

    1. Sovereignty is a very loose term. So I caution you to use carefully when you debate. You call the European States Sovereign? Greece has now an Ex-ECB vicepresident (Papademos) who was not democratically elected (he was actually appointed by pressure of the Financial Markets), and Greece has an IMF team in Athens telling them how to collect taxes and spend their money. Is Greece Sovereign? How about Italy? Monti was not democratically elected either (he also appointed by pressure of the markets). And oh, Italy ALSO has a IMF mission in Rome to tell the Italians how to run their deficit. So, to call the European Nations (plural) sovereign is very, very misleading.

  2. The birth of the US had something else that Europe lacks: an external enemy. In the case of the US it was the English Empire, against which only unification and a system of mutual support among the colonies could triumph. Could the current fiscal threat in Europe be enough of an external enemy to force the Eurozone nations to further unite? Doubtful.

    -Mark in Seattle

    1. I agree with you Mark. A common enemy/threat is a unifying factor in any society, but I do believe that Europe has a unifying threat: Its own past. I subscribe to the idea that the motivation behind Europe's politicians to push the continent's integration is to avoid at all cost what they suffered in WWII. I write about that here:

  3. The first comment about sovereignty lacks any sense of cultural history. The first fifty years of the Union people identified more as Virginian, Carolinian, etc. than American. At some point, people had to buy into the national project on a conceptual level. Certainly the economic factors mentioned in the blogpost about jefferson, etc. created the appropriate terrain for that to occur. But there was a very strong Federalist cultural project in geography textbooks, reading primers, etc that attempted to facilitate the cultural buy-in.

    Why do you think we still sing the national anthem at baseball games? etc. Flags have purposes beyond merely helping know who to shoot at during war. Sovereignty in the United States remains a touchy subject---ever hear of states'rights. . . ?

    1. Agree. To speak about Sovereignty is to fall pray to Demagogy. Sovereignty is a great "unifying" concept when politicians want to rally support for a particular narrative. Thanks for reading.