“The Euro: Monetary Unity To Political Disunity?”

The re-eruption of the euro crisis as sparked not only economic and financial concerns, but maybe even more important the crisis is now very clearly leading to serious political disunity exemplified by an article the Spanish newspaper El País in, which Chancellor Merkel (somewhat unjustly) was compared to Hitler. And it is pretty clear that Germans are unlikely to get the same level of service if they go on vacation in Spain, Greece or Cyprus this year.

The political disunity in Europe should hardly be a surprised to anybody who have read anything Milton Friedman ever wrote on monetary union and fixed exchange rate regime. His article “The Euro: Monetary Unity To Political Disunity?” from 1997 has turned out to have been particularly prolific.

Here is Friedman on why the euro just is a bad idea:

By contrast, Europe’s common market exemplifies a situation that is unfavorable to a common currency. It is composed of separate nations, whose residents speak different languages, have different customs, and have far greater loyalty and attachment to their own country than to the common market or to the idea of “Europe.” Despite being a free trade area, goods move less freely than in the United States, and so does capital.

The European Commission based in Brussels, indeed, spends a small fraction of the total spent by governments in the member countries. They, not the European Union’s bureaucracies, are the important political entities. Moreover, regulation of industrial and employment practices is more extensive than in the United States, and differs far more from country to country than from American state to American state. As a result, wages and prices in Europe are more rigid, and labor less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism.

If one country is affected by negative shocks that call for, say, lower wages relative to other countries, that can be achieved by a change in one price, the exchange rate, rather than by requiring changes in thousands on thousands of separate wage rates, or the emigration of labor. The hardships imposed on France by its “franc fort” policy illustrate the cost of a politically inspired determination not to use the exchange rate to adjust to the impact of German unification. Britain’s economic growth after it abandoned the European Exchange Rate Mechanism a few years ago to refloat the pound illustrates the effectiveness of the exchange rate as an adjustment mechanism.

Note how Friedman rightly notes that downward rigidities in price and wages are likely to cause problems in the euro zone in the event of a negative shock to one or more of the euro countries.

These problems cannot be ignored and if they are ignored it will likely lead to political disunity – if not indeed political disintegration. As Friedman express it:

The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.

Friedman unfortunately once again has been proven right by events over the past couple of weeks.

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2 Comments

  1. “The Euro: Monetary Unity To Political Disunity?” | Fifth Estate
  2. Celebrating Friedman and Hetzel | The Market Monetarist

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