An alternative perspective

01 May 2010

Europe and the Euro: Is Fiscal Integration Inevitable?


These are difficult times for the euro and the European project. Many who warned of the problems of creating a single currency are now barely concealing their pleasure as the Greek tragedy unfolds. Yet it is far too soon to write off the euro or indeed the European project. There have been many crises in Europe since the Second World War, and the processes of first reconciliation and then integration have been ones of bouts of progress, interrupted by periods of political and economic difficulties.


For many economic commentators, the euro is a technocratic currency scheme to be analysed in strictly economic terms. Yet there is another perspective: a very political one. The euro was the product of the agreement for the reunification of Germany after the fall of the Berlin Wall. It was a project to bind a greater united Germany irrevocably into Europe, and a deal effectively between Kohl and Mitterand.

Not everyone wanted to join – especially Britain. And not everyone could meet the Maastricht conditions which Germany insisted upon. Yet it is remarkable what the politics of the euro achieved. It provided a monetary anchor for the newer members to aspire to – and it is no accident that the three countries posing the greatest problems now are the three dictatorships which the EU managed to help transform into democracies with EU membership – Greece, Spain and Portugal. It remains a goal for Poland and throughout Eastern Europe. Euros change hands much in the way that dollars function as a stable currency alternative in Central and Latin America. Iceland provides another example – people prefer to be paid in euros.

This role as a ‘hard’ European currency has an important political consequence – it makes it very hard for the newer members to backslide through devaluation. They have to be ‘grown up’ members of the club, and strive to be modern European economies. Their political elites cannot easily resort to the printing press, inflation and weakening currencies. The euro creates a deliberate political constraint on irresponsible and popularist political elites. This was the price of getting Germany to give up the Deutschmark – German discipline. Greece is trying to make one last effort to address its deep seated problems – and but for the euro – it probably wouldn’t even try.


The euro has therefore achieved a lot. But the economists have been right to point out that once devaluation is ruled out, countries are forced to improve their competitiveness and to limit their borrowings. They cannot follow the UK and the US and use devaluation. The only alternative is what happens in the UK – England pays for Scotland’s public expenditure. In Europe, this means getting the richer countries – especially Germany – to pay for the social security systems of Greece, Spain and Portugal.

The union is incomplete – it lacks a fiscal dimension. There is no single European economy to back up the single currency – and no single European budget, borrowing and debt.

This puts the weaker euro countries in a bind, especially when the global economy nose-dives. The (Keynesian) critics in the UK and the US point to the dangers of cutting public expenditure and increasing taxes to demand. They argue that a vicious circle sets in: cuts mean lower demand, which means lower output, which means lower tax revenues and more unemployment costs, which weakens the fiscal position further, requiring yet more cuts and tax rises. Default thereby becomes ever more likely.

In the short run (the only time period Keynes was seriously interested in), this view is correct. But in the medium to longer term, it’s seriously flawed. What Greece needs now is a breathing space to put its house in order. It needs a functioning tax system where the middle classes actually pay their taxes and it needs a sensible pensions system. It needs to rebalance its economy, reducing its public sector and it needs wages to adjust. In other words, it needs a dose of what Ireland has done.

Providing the breathing space is what the IMF is for – and indeed the ECB too. But being the lender of last resort is not a blank cheque approach: it is provided with the purpose of sorting out the Greek economy. If Greece could devalue, it would thereby lower the Greek standard of living. Reducing wages and public subsidies does the same thing. There is no way out: if a country lives beyond its means, it will have to reduce its standard of living to those means. The difference lies between confronting the population with the hard reality, and pretending it can go away. The euro forces the former, whilst the floating pound and dollar allows the latter.

Germany is therefore right to demand that Greece puts its house in order. Who benefits if Germany subsidises Greece, whilst Greece maintains an early retirement age and has a lax tax collection system? Greece benefits only in the short term. It is like Scotland, for which fiscal union has created a dependency culture in which public sector employment becomes ever more important – over 50% for much of the Scottish economy. Where would Greece be in ten years’ time if it now devalued its way out of the current crisis or was paid off by German taxpayers? The answer is probably still with a retirement age much lower than other European countries whose taxes they were spending, and still with an inefficient tax collection system. In other words, it would remain uncompetitive and in relative decline.


If Germany is right economically despite what the Keynesians claim, and if these weaker economies need to make the painful adjustments they have yet to achieve if they are to become fully participating European economies, there is nevertheless a broader political case for fiscal integration. What lies at the heart of the European project is not some technocratic currency union, but rather a project aimed at integration – integrating nationalities into European citizens.

What distinguishes members of a country from those of its neighbours is that its citizens have certain common rights and obligations. People who live in Liverpool, Glasgow and London are all entitled to the same treatment under British law – and the same educational, health care and social security protections. We do not differentiate between them. What the European project has been largely about is gradually giving the same answers for people who live in Berlin, London or Athens. When monetary integration is combined with fiscal integration, it is this profound and deep equality of treatment which supersedes nationalities and nation states.

It is a path Europeans have been following from the outset. European law gradually encroaches on the national approaches. Examples vary from the working time directive through to the determination of renewables investments. The early, smaller EU took everyone along on this project. But once the original six expanded to include countries like Britain, it became apparent that not all would want to (or indeed could) proceed at the same pace. The euro is the greatest example of this multi-speed approach. Some joined at the outset, others were keen candidates, whilst outliers like Britain strongly opposed membership.


There are two routes to fiscal integration: top down through forced bail outs, and bottom up through the gradual development of European citizens’ rights. Whilst there is no sign whatsoever that the latter approach will go into reverse, and hence good reason to think that eventually de facto fiscal integration will become a reality, the time scale is decades. Adding in new members – like Turkey – would slow the pace to that of a tortoise-style incrementalism.

The top down approach is more immediate. The economic crisis has forced Europe’s hand, and the bail out of Greece has inevitably taken on a much wider dimension. Greece is not in any serious shape yet to turn its position around. It is not emulating Ireland. Even with its austerity plans, it will probably have to default. The question is how? By rescheduling its debts? Or by its debts being partially taken on by the other euro members?

In practice, both will probably happen. In many ways the remarkable feature of the current situation is that despite the shadow of the North Rhine Westphalia regional election in the run-up to the bail-out and the domestic economic difficulties within Germany, Germany has in effect stepped in. Admittedly, it has insisted on the IMF coming in too, and forced a very tough set of constraints on Greece. But why wouldn’t it? What possible benefits are there in being soft on Greece? Indeed anything other than a ‘tough’ stance undermines serious support for subsequent countries in difficulty. No one ever suggested the IMF should be soft.


Contrast this with Britain. Its fiscal hole is at least as big as Greece’s – and it does not have the luxury of raising the pension age or getting people to pay taxes as feasible options. The pension age is already high and most people already pay their taxes. Britain’s solution is as it has been since the 1930s – devaluation. After the best part of a century of taking the soft option (and having had the windfall of the North Sea oil and gas), it does not look better placed to compete with Germany and France as a result. Its productivity remains lamentably behind and the ‘services-based economy’, reliant heavily on financial institutions, is very vulnerable. In the short (Keynesian) run, devaluation lowers standards of living. But it does not offer a medium term competitive recovery. Greece has no option. But at least it does not have to defend the drachma.

Whether Europe will weather this storm with the euro intact is not yet completely clear. But it probably will. Whether it is forced towards further fiscal integration quickly depends upon how the economic crisis plays out. But the underlying trend towards gradually expanding the notion of European citizenship has enormous momentum. That, in the end, is what will make fiscal integration much more likely. Only a political pulling away from the European project by Germany, in the name of German nationalisation, is likely to stop this. Despite the angst and the nostalgia for the Deutschmark, Germans remain deeply European.
Dieter Helm, Professor of Energy Policy, University of Oxford & Fellow in Economics, New College, Oxford

Dieter Helm is an economist, specialising in utilities, infrastructure, regulation and the environment, and concentrates on the energy, water and transport sectors in Britain and Europe.

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