Collective Conscious

It won’t hap­pen right now:

“There have to be incen­tives for every coun­try to keep the dis­ci­pline in its own pub­lic finances,” Mr. West­er­welle[, leader of the pro-​​business Free Democ­rats in the gov­ern­ing coalition,] said. “That incen­tive is gone the sec­ond that some­body else takes respon­si­bil­ity for your own debt — just as it is for pri­vate individuals.”

Now, this is exactly true, and it is also exactly the rea­son why US states are gen­er­ally required to have bal­anced bud­gets in and of them­selves. Wash­ing­ton does not want to be con­stantly bail­ing out the finances of Cal­i­for­nia, so we have devel­oped a fully fed­er­al­ized fis­cal sys­tem where states stay main­tain bal­anced bud­gets by law. In return, Wash­ing­ton picks up the tab for the most costly and coun­ter­cycli­cal pro­grams, par­tic­u­larly defense spend­ing, Social Secu­rity, Medicare, unem­ploy­ment, and a good chunk of Med­ic­aid. At the same time, the Fed­eral Reserve man­ages the cur­rency with regard for the nation as a whole, not with the inter­ests of indi­vid­ual states in mind.

In order for this sys­tem to work, the mem­bers of the cur­rency union have to sur­ren­der a great deal of power to the cen­tral gov­ern­ment. Health spend­ing, retire­ment sup­port, and employ­ment arrange­ments — the hall­marks of the wel­fare state — are extremely dif­fi­cult to keep in bal­ance on a year-​​to-​​year basis. If Euro­pean states were to cen­tral­ize fis­cal issues, indi­vid­ual coun­tries would need to run large sur­pluses in boom years to ensure that fund­ing would be avail­able for these mas­sive pro­grams dur­ing slumps. This is, for obvi­ous rea­sons, very dif­fi­cult to man­age if you can­not issue debt. Again, the US han­dles this prob­lem by allow­ing states to issue debt for invest­ment pur­chases but not for year-​​to-​​year expenses — but in the US, state year-​​to-​​year expenses are much smaller, accounted for mostly by edu­ca­tion and law enforce­ment spending.

So what can Europe do? They are already locked into the mon­e­tary part of the bar­gain, and the ECB has made clear it will defend the cur­rency at all costs — and it can. But fis­cal per­for­mance is heav­ily tied to mon­e­tary per­for­mance, as evi­denced by the excel­lent recov­ery of Poland. With­out the assis­tance of a fed­er­al­ized expen­di­ture sys­tem and the Eurobonds to back it up, indi­vid­ual Euro­pean nations will likely con­tinue to face crises and require bailouts. So while Ger­many expresses a desire to “to keep its sov­er­eignty over its pub­lic finances,” the bailout cul­ture will only deny that oppor­tu­nity to smaller nations.

So fis­cal fed­er­al­ism is the only clear way for Europe to ensure the finan­cial suc­cess of all its nations. Cred­i­tor coun­tries’ unwill­ing­ness to face the req­ui­site debt assump­tion only forces the ECB to do it behind the scenes, under­min­ing their sov­er­eignty even fur­ther than if they were to enter the arrange­ment fac­ing for­ward. Only time will tell if they can over­come the polit­i­cal hur­dles and ele­vate Europe to mod­ern greatness.

Update: Ryan Avent under­scores how effec­tive the monetary/​fiscal fed­er­al­iza­tion bar­gain works in the US.