OPINION: Euro-Zone Fails The Basic Test Of Economic Union
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THE BridgeNews FORUM: Viewpoints
on the birth of the euro.
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*Europe Lacks The Fundamental Conditions
Behind Success Of U.S. Single-Currency Market
By David Smith, economics editor of The Sunday Times
LONDON--The euro, Europe's single currency, has had a rocky start.
Rows between finance ministers and the European Central Bank, top-level
political resignations and the almost daily drop in new currency's value suggest
monetary union is already in deep trouble.
In fact, while the current problems are both interesting and unexpected, they
say little about the euro's long-term prospects. Those depend on more
fundamental factors.
Almost 40 years ago, economist Robert Mundell set out the three conditions for
an "optimum currency area."
His conditions were: wage flexibility, needed when countries lose the
ability to vary their exchange rates; geographical mobility of labor, so that if
certain regions become economically depressed people would move elsewhere in
search of work; and finally, "resource" transfers, a big enough central budget
to allow government spending to be directed at easing the impact of economic
shocks on certain regions.
Economists have subsequently added to and refined Mundell's three
conditions, but they remain the most important.
The United States, a large single-currency area, largely meets Mundell's
conditions.
Wages are flexible in the United States because they have to be.
On becoming unemployed, Americans initially receive a level of benefit of
around two-thirds of income but those benefit levels tail off sharply after six
to nine months, unlike in Europe.
The United States' success in creating employment -- more than 30 million
net new jobs since the early 1970s, including more than 12 million in the 1990s
-- contrasts sharply with Europe's depressing record of fewer than 4 million net
new jobs since the 1970s and a net reduction in private-sector employment.
The U.S. labor market works on the basis of incentives, low taxation,
together with a limited role for trade unions. Only 18 percent of Americans are
covered by collective bargaining arrangements, against more than 90 percent in
several European countries (98 percent in the case of Austria).
The United States also scores well in terms of geographical mobility.
American manual workers are 18 times more likely than their European
counterparts to move between states or regions for work. Overall mobility levels
in the United States are four or five times those in Europe.
The third condition for an optimum currency area is not one they shout about
much in the United States: that even with labor mobility and flexibility,
government will be needed to help out regions that fall victim to chill economic
winds. But it exists.
In a U.S. state, between 20 percent and 40 percent of the loss of income
resulting from an economic "shock" is offset by higher federal spending or
lower tax payments.
Now consider Europe, a baby in the single-currency stakes.
The "Rhineland model," so adept at delivering high productivity, wage
moderation and low unemployment in the German economic miracle for 30 years
after the war, now looks to be running on empty. German companies are voting
with their feet, to set up elsewhere.
France has introduced the 35-hour workweek, in a vain attempt to spread a
limited amount of work across a wider number of people.
The only significant economy in the euro zone to have achieved low
unemployment similar to America and Britain, the Netherlands, has done so
through a sharp rise in part-time jobs -- a third of total employment -- and by
embracing temporary work.
Europe fails the flexibility test.
Out of 53 countries ranked by business executives for labor market
flexibility, in a Davos World Economic Forum survey, Spain was 47th, Belgium
48th, Germany 51st, France 52nd and Italy 53rd.
Europe also fails, even more spectacularly, the test of geographical mobility.
Labor mobility in Europe has been stagnant or declining since the 1970s,
both within and between member states.
Despite the single market, one of whose four freedoms is the free movement
of labor, European workers, when faced with unemployment, tend to stay put.
Language is, of course, a telling factor.
The American single-market, single-currency economy may not have begun life
as a single-language country, and some would argue that it is not that now. But
it is a lot closer to it than Europe can ever be.
The most worrying thing, after a long period in which European politicians at
least paid lip service to the need for labor market reform, is that there are
governments in power in Europe now which have never really bought the story
about the need for greater labor market flexibility or mobility.
Their belief is that Europe's unemployment problem is mainly a result of
lack of demand, and that governments and central banks can make up for it. Many
European politicians think Europe has too little, not too much, government
spending.
Pressure will build inexorably for "something to be done," for large-scale
resource transfers from the center, for a beefed-up European budget coordinated
by European finance ministers.
Currently, the European Union's budget is just 1.27 percent of gross
domestic product. Estimates prepared for the European Commission in the 1970s
suggested the EU would need a budget equivalent to 20 to 25 percent of GDP to
cope with the regional shocks that would arise in a single-currency area.
Not all of this would be in addition to already high government spending but
some of it would. Resource transfers and higher public expenditure would mean,
as sure as night follows day, higher taxes. And the trouble is that, in the
absence of mobility an
d flexibility, this money would be a mere bandage over a gaping wound.
Benjamin Franklin said that nothing is certain in life except death and taxes.
Nothing is more certain now than that a highly taxed, inflexible Europe
under monetary union is doomed to eventual failure.
DAVID SMITH is economics editor of The Sunday Times, London, and author of
"Will Europe Work?", recently published by Profile Books in association with
the Social Market Foundation. His views are not necessarily those of Bridge
News, whose ventures include the Internet site www.bridge.com.
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