The European Problem

One piece of news yesterday which I found quite ironic was that the President of the European Commission Jose Manuel Barroso has warned EU member states not to succumb to populist calls against austerity such as those seen in Italy. He argued,

“I hope we are not going to follow the temptation to give in to populism because of the results in one specific member state.

The question we have to ask ourselves is the following: should we determine our policy, our economic policy, by short-term electoral considerations or by what has to be done to put Europe back on the path to sustainable growth? For me the answer is clear.”

I found this statement intriguing because populist movements in other countries are preventing the EU from enacting the one policy which could help resolve the crisis – a fiscal union. Whilst some countries are calling for a union, others are arguing against such a policy. A majority of EU citizens find the union undesirable, after all why should the Germans, French or any other national in a EU country pay for the problems created in Greece by the Greeks. The German bail out of Greece in 2011, for instance, highlighted this when it caused a large amount of public resentment.

The fact is that any monetary union without fiscal union is deemed to meet problems. This is because countries locked into a monetary union lose their ability to combat external shocks with exchange rate policy. The country’s only instrument is therefore fiscal policy, however in a debt ridden country such as Greece this option also becomes unavailable. In short, a fiscal union can help alleviate such problems by transferring money from regions unaffected by a shock to those which are. This would be particularly useful for nations which have already rejected bail out packages due to stigma such as Spain. Furthermore a fiscal union can help prevent a debt crisis in the first place by promoting a centralized, organised and well disciplined fiscal policy. This would be a sharp contrast to the current clash of ideals and policies now becoming apparent in member states such as Italy (against austerity) and Germany (for austerity).

The economic theory on optimum currency areas further promotes the idea of fiscal transfers as necessary instrument for a monetary union to be successful. However the road to such a union is going to be tricky, the longer EU leaders wait the more difficult it will become. In a recent post by the re-define think tank, I can’t help but agree that public opinion will become more hostile to the idea as EU taxpayers realize the losses they have incurred through successive bail outs. This lack of trust in their leaders and resentment towards recipients of the bail outs could grow  the longer the crisis continues and possibly de-rail the process altogether.

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