The remedy for the European Union��sfinancial crisis, EU leaders have decided, is ��fiscal union.��But if the agreement they reached last week ultimately leads, inthe fullness of time, to a real fiscal union, the country mostlikely to be unhappy is Germany, its original leading proponent.
Truly, understanding the workings of the EU mind is notalways easy.
Jens Weidmann, president of the Bundesbank and a councilmember of the European Central Bank, made the point about fiscalunion and ��fiscal union�� last week. This is not a union but a��pact,�� he said. Sovereign rights would be preserved, and the EUwould have no power to intervene directly in a country��sfinances. Euro-area countries are promising to obey strongerfiscal rules of the sort they already have in the Stability andGrowth Pact, with new automatic penalties (yet to be spelledout) if they fail.
Weidmann is right. Stronger fiscal rules do not make afiscal union. A real fiscal union looks like the United States -- with federal spending, federal revenue and federal debt.
The salient characteristic of such a system is cross-borderfiscal transfers. When an economic shock strikes one part ofU.S. with particular force, fiscal resources flow in itsdirection automatically. If California slumps, its contributionto federal revenue falls and federally supported spending in thestate goes up. In this way, taxpayers in the rest of the U.S.help cushion the blow.
Transfer Union
A fiscal union in the proper sense of the term is atransfer union. Yet Germany��s government, which has pressed sohard for what it calls fiscal union these past few weeks, isimplacably opposed to a transfer union. Shielding Germantaxpayers from the cost of supporting Greek, Irish or Italiantaxpayers as this crisis has unfolded is the organizingprinciple of Chancellor Angela Merkel��s entire policy.
Is her position hopelessly illogical? I wouldn��t go thatfar. Germany��s leaders calculate, I imagine, that a strongfiscal pact will make a! transfe r union less likely. In thisbelief, they are not being illogical, merely delusional.
The fiscal pact��s main innovation is a so-called goldenrule, which leaders have said they will write into theircountries�� basic laws, restricting structural budget deficits to0.5 percent of gross domestic product. Critics are right, ofcourse, that this rule contributes nothing to solving Europe��simmediate problem. It barely even pretends to. Nonetheless it isa momentous step. Eventually, after the immediate crisis hasbeen resolved, the golden rule will impose tighter fiscalrestraint across the euro area.
Merkel doubtless reckons that tighter fiscal restraint willmean less public debt over the long term, less chance of afuture sovereign-debt crisis, and less danger that citizens inwell-run countries (Germany) might be asked to bail out citizensin badly run countries (all the others). The trouble is thatfiscal irresponsibility is only one way to get a financialcrisis started. If one starts for some other reason -- say, acredit boom -- flexibility in fiscal policy may be vital tocontain the damage.
The current emergency demonstrates, in the clearestpossible way, just how laughable Germany��s position is. Fiscalprofligacy brought Greece to disaster, true enough, but theslump in the euro area��s other distressed economies was causedby reckless expansion of private credit. Taking the euro area asa whole, budget deficits were less than 3 percent of GDP in thefive years leading up to 2008. Ireland, one of the most severelyhit economies during the crisis, had a budget surplus for yearsbefore the crisis struck.
Needed: More Flexibility
For many countries, fiscal expansion was the right responseto the emergency. And in Germany��s case, it still is: Theproblem there has been too little stimulus, not too much. Thegolden rule would restrict this vital flexibility.
Admittedly, one can imagine worse rules. A ceiling of 0.5percent for structural deficits does allow so-called automaticstabilize! rs to wo rk. In a recession, actual deficits would beallowed to rise under the pressure of a shrinking tax base andhigher transfers to the unemployed, for instance. However,except for countries that had previously been running bigsurpluses, the golden rule would forbid a change in policy inresponse to an economic slump: a tax cut, say, or an increase ininfrastructure spending, or extended unemployment benefits.
Germany��s structural budget deficit was 3.3 percent of GDPlast year. Even allowing for what the Organization for EconomicCooperation and Development calls ��one-offs�� -- nonrecurringextraordinary items -- it was 2.3 percent. Under thecircumstances, Germany��s fiscal policy has been extraordinarilytight, yet it stands in violation of the new rule. This isabsurd.
A better fiscal rule would take a different form: ��balancethe budget over the course of the cycle,�� or ��keep public debtbelow 60 percent of GDP except in extraordinary circumstances.��Both of those allow more wiggle room, so Teutonic fiscaldisciplinarians will recoil, but greater flexibility is thepoint. In severe recessions, discretionary stimulus -- a more-than-automatic fiscal response to the downturn -- is needed. Andas the case of Germany itself proves, it may sometimes beunavoidable.
With the golden rule in place, the EU��s next economiccrisis will be an interesting moment. The best and (let��s hope)likeliest course for the EU would be to suspend the rule orabandon it outright. That, presumably, is something Germanywould resist. Why propose this rule in the first place if youare going to have to abandon it as soon as it starts to pinch?The alternative would be to let the pact stifle recovery anddrive up unemployment -- much as the EU��s dithering has done inthe present emergency, only more so.
Let��s suppose that Europe muddles through this time. Nexttime, with zero fiscal flexibility, persistent underperformancein many parts of the EU, and an ever-widening gap betweenincomes in Europe��s core and its periphery! , a star k choice willpresent itself. Let the euro area and the single European marketdissolve, which would be a disaster for Germany as for everyoneelse. Or form a transfer union that puts German taxpayerspermanently on the hook for the EU��s backward regions, which isthe very outcome that Merkel dreads most.
How do you say ��pretzel logic�� in German?
(Clive Crook is a Bloomberg View columnist. The opinionsexpressed are his own.)
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