Wednesday, July 25, 2012

Penny Wise, Euro Foolish

Gerard N. Magliocca

The European Union has one of the world's most dysfunctional constitutions. This should come as a shock to nobody, but the consequences of this legal failure could be profound.

One part of the original understanding of the EU, to use that term, was to end the national rivalries and autocratic regimes that twice plunged the world into war.  A single currency without central fiscal and regulatory institutions, though, is reviving national tensions in Europe. Moreover, the politics of harsh austerity in countries like Greece are the best friend the enemies of democracy could have. It is ironic that Germany, which fell into the abyss in part because of unrelenting demands by its creditors to pay its World War One indemnity, is now playing a similar role for Southern Europe. They still have time, though, to make a U-Turn before it is too late.      


Europe is an idea being built in a complex negotiation. To say Europe is dysfunctional is to miss the whole idea of the project - getting beyond the profound pre-1945 dysfunctionality with its horrible and profoundly devastating consequences.

Europe has no Constitution. In spite of the existence of binding treaties (the Treaty on European Union and the Treaty on the functioning of EU), the general conception is that rules of international law apply to relations between states of the EU, not rules of municipal law. This means that unless a wide change in our conceptual scheme occur, we won't even have a minimally integrated legal system (such as confederation), let alone a federal union. We have a common market; our economies are so tightly intricated that we can't go to war one against another. But a constitution, we do not have.

PS. I agree that Mrs Merkel makes irrealistic demands. But, I should say that the most problematic country in EU today is not Germany. This country (guess which it is) should never have gotten into the EU in the first place. At least Mrs Merkel is trying to achieve a greater intergation, not running backwards.

PPS I should have specified that I am French (hence a EU citizen)!

JMHO, but I think Germany's plan is to force Greece to leave the Euro. That's the only way the whole dispute makes sense to me.

For what is worth, the contry I was alluding to is not Greece. A hint: it is not a member of the Euro zone.

Ms. Carpentier is correct. The EU has no constitution and its current dysfunctional structure makes the old Confederacy seem like a rational form of governance.

Contrary to the left CW in this country, the PIGS countries are cutting government spending because they spend more than their citizenry is willing to pay in taxes and no sane investor will lend them money any longer without a stiff risk premium.

Germany is not compelling the PIGS countries to pay them an indemnity, but rather is resisting demands by these deadbeat countries that Germany bail them out.

Germany should leave the Euro and readopt the Deutchemark, leaving the free trade provisions of the EU intact.

I beg to differ with Mr De Palma. Things are sliiiiightly more complicated than that. The problem with Greece is indeed quite different than the one with Sapin or Italy. In Greece, sure, people did not pay their taxes very often, but the problem is that Greek government not only spent money it didn't had, but did not make a very honest use of the funds they had. So instead of reinvesting it in the economy, which would have brought growth and greater taxes (provided a stricter taxing policy), they just spent money away. The point is that today austerity measures are the perfectly BAD solution, since they are killing economic activity.

And it is obviously untrue that if the Germans left the euro, it would leave the free trade zone intact : they would most probably reevaluate the Deutschmark in order to avoid inflation. And this would obviously distort the possibility for other EU countries to get on the German market.

But anyway, Merkel has no such plans (one may hope). The one with similar plans (not leaving the Euro, obviously, but leaving EU) is Mr Cameron's Party. Well, good riddance.


The PIGS countries have no alternative than to shrink their welfare states because they have run out of other people's money to spend. So called austerity is a fact of life, not merely an alternative to yet more borrowing and spending.

Indeed, if other EU nations like your France (and my United States for that matter) want to avoid joining the PIGS countries in the near to medium term, they have no alternative to shrinking government.

France is about to discover (as the UK did this year and the United States did during the Hoover administration) that imposing taxes on a wealthy minority causes economic contraction and does not bring in the expected tax revenues to support spending.

BTW, if Germany leaves the EU in favor of the Deutchemark, the value of their neighbors currency will fall compared to the mark and it will actually be easier for them to sell goods in Germany and harder for Germans to sell their now more expensive goods to their neighbors. This fact is probably what is keeping Germany in the Euro for now.



The UK imposed a tax on the wealthy this year, fell into recession and tax collections dropped.

The UK imposed a tax on the wealthy this year, fell into recession and tax collections dropped.

# posted by Bart DePalma : 10:13 AM

That's a pretty amazing coincidence.

I'll take that under advisement but I was guessing at the question MC posed.

1° Germany has always favored a strong currency. That may be economically absurd (as opposed, for instance, to the US inflation-driven monetary policy since 1971), but that's a fact. That's why Germans are sooo opposed to quantitative easing on the ECB's part. What would happen if they left the Euro Zone? Well, it is difficult to say, but it would not be a return to the status quo ante Mr De Palma describes. It would be certainly harder for EU companies to produce in Germany (which is also the point in a free market zone). Sure Germany would not be able to export their fridges as easily as they do today. But Germany's balance of trade is traditionally exceptionally good, so I am not sure it would be such a setback, since importations, on which they are quite dependent too, would be easier.
This is why, actually, I maintain that Mrs Merkel is right in emhasizing the need for greater political and legal integration. But this would be definitely off would Gemrany be returning to the DM. And this certainly means (at some point) mutualizing debts.

2° Sure Greece has not always had a very rational economic and fiscal policy in the past. But what's the point here ? You may say : they were pigs, they have got to suffer now! This kind of retributivism is not very appealling to me. Europe should be about solidarity. This said, I am aware that the Euro was ill-prepared, that a real economic government should have been designed to go with it, and that Europe was notoriously careless when it came to control what its member countries were doing. And also, I am aware that the private investors are not concerned by solidarity, they want their money back. But HEY. They are also responsible for this fiasco. THEY speculated on Greece's debt. It is not like they suddenly realized that Greece is on the verge of default !

3° Do not mistake me. I love UK, I think it is a great country. But as far as EU is concerned, they have always been the black sheep, always resisting integration, always using Europe as a tool for short-sighted interests. If, having refused the Euro, they were in a good economic situation, well, I would applaud. But it is far from being the case.

Live and learn.

Wikipedia tells me:

"PIGS (also PIIGS) is an acronym used to refer to the economies of Portugal, Italy, Greece and Spain. Since 2008, the term has included Ireland, either in place of Italy or with an additional I."

So many acronyms!


Ireland does not share the same problems as the other four southern EU countries and I do not include them in my shortened acronym.

Ireland is the living example that very low taxes do not bring about perennial growth. Sure, during ten years, Ireland was very attractive for start-ups thanks to its VERY generous fiscal policy; but as soon as the crisis occurred, fiscal collections went down, and Ireland had not any money left to support its economy.

As a matter of fact, the situtation of each of the PIGS is quite different. In Greece, for instance, the problem is careless public spending, unefficient tax collecting, corruption, and high-running debt (as I stated earlier, speculators are not innocent in Greece's situation). In Spain, the situation is a typical example of a real estate bubble : the State and private investors massively invested in real estate, and principally in building new buildings. When down payment time came, they realized no one had the money to buy those buildings!So credit crisis, ruined banks, and so on.

I understand that Mr De Palma does not neccessarily find austerity wonderful, but thinks that it is something unavoidable, some kind of a strong medical treatment. But here lies the contradiction : austerity aims at a reduction of deficit. In order to reduce deficit you have basically a twofold solution : you cut spendings AND you improve your fiscal collections. So higher taxes ARE necessary in an austerity-driven perspective. So if you do not impose taxes on the wealthiest, you will impose them on the middle class and/or the poor, who, by definition, are less able to contribute to the budgetary recovery, since they have even less money thanks to austerity. Only in a configuration of growth, not of recession, is it necessary to cut taxes on the rich, because you can hope that they will reinvest this money in the economy.

Of course, it may produce fiscal evasion. That was the argument of Nicolas Sarkozy during the presidential campaign. "Oh you are gonna tax riches, they are gonna go away!" But this is an ABSURD reasoning. It is like saying : "we should not make a law, because people would break it!"

And besides the "patriotic" (Buffett-like) argument, which is put forward by the French government, I think that taxing the rich in this context is in some way analogous to fighting rent effects.

To be clear : the solution is not national austerity, but a EU solution. It involves : a federal economic government (Mrs Merkel would say 'yay' to that) and acceptance that a little bit of inflation is good for growth in a recession context (Mrs Merkel would not be so happy after all!). I mean if the ECB is not authorized to make adjustments of the kind that the FED makes every month, how do you expect Europe to compete with US, let alone China!
It would not necessary imply a purely keynesian tactic, but could be combined, progressively, with incentives to production, through a nicer fiscal regime for societies investing, e.g., in strong R&D, new technologies, and so on. A little bit of inflation would make it a lot easier.

And maybe Greece ought to get out of the Euro after all. It would involve sort of an Argentinian shock on its economy, but a devaluated drachma is maybe the only way out.

I am outlining a book arguing that the progressive/socialist welfare state has become unsustainable because of changes in medicine and birth control.

Advances in medical care all but eliminated child death, made the work force healthier and later extended our lifespans.

The advent of birth control enabled women to plan their reproduction.

The result was a temporary demographic dividend when the number of dependent children fell, but the previous generation of elderly were still dying early, creating a bulge of productive workers as a percentage of the population.

The demographic dividend paid for a dramatic expansion of the welfare state, especially public pension systems.

This is when things started going off the tracks.

The expansion of the welfare state replaced extended families as the primary social safety net and children became expensive luxuries. The fertility rate across the EU and much of the US fell to well below replacement rates. As the demographic dividend workforce retires there are not enough young workers to replace them and this demographic death spiral can only get worse over time.

Progressive attempts to redistribute wealth by mandating ever higher minimum wages and other benefits priced the inexperienced and the young out of entry level work, spiking youth unemployment and further reducing the replacement workforce.

The progressive regulatory state and tax systems reduced business growth and the resulting tax revenues to near stagnation.

When the citizenry refused to pay more taxes either through the democratic process or evasion, the progressive welfare states started to borrow massively to pay for their ever growing elderly welfare states.

This inevitably leads to a choice between voluntarily and dramatically reducing the welfare state to the point where families voluntarily begin to reproduce at a replacement rate or involuntarily reducing the welfare state when people stop lending to the government.

This will lead to economic depression unless these countries also discard their progressive regulatory and taxing systems to allow the private sector to grow again like Thatcher did in 79-80.


Welfare states work fine, as long as the middle class is taxed to pay for them. (While you are wrong that taxing the rich retards economic growth, it also doesn't raise enough money to pay for a generous welfare state.) Northern Europe is in not much trouble at all.

Dilan said...

"Welfare states work fine, as long as the middle class is taxed to pay for them."

It is correct that welfare states were traditionally financed through high across the board taxes. My point is that the interaction of birth control and the welfare state (especially the public pension systems) are in the process of dramatically reducing the number of workers paying taxes - middle class or otherwise.

"Northern Europe is in not much trouble at all."

Sweden, Finland and Germany liberalized their economies to increase productivity to pay for their welfare states. Norway is like Alaska, lots of oil and not much population.

Apart from oil rich Norway, the productivity gains of Northern Europe will not begin to replace their shrinking workforces and expanding elderly dependents.

The EU and large segments of the United States are literally dying off.

This is not some flight of fancy I departed on. The EU has been looking at this demographic death spiral for a decade or so, while the US is just becoming cognizant of it.

You are leaving out the variable of immigration.

If we need more workers, we will bring them in.

Jack Balkin's Atlantic article on the debt ceiling crisis is a good read. Since its publication, apparently a deal has been made to postpone that crisis until after the 2012 elections. Perhaps Jack might consider an "UPDATE" at his Blog post on his article as to the political ramifications vis-a-vis other "cliff" items pending at the end of this year.


By the Bybee [expletives deleted], our yodeler (and resident economist) provides a deluge of economic unconsciousness on Europe's economy, countered only by a few observations by Dilan. Regulars may recall on earlier threads our yodeler's warning to me not to mess with him on the subject of economics which he minored in back in his college days before his achievements as a DUI legal scholar (which may or may not have been aided by his minor economics expertise).

Dilan said...

"You are leaving out the variable of immigration. If we need more workers, we will bring them in."

This brings up another complication which I decided not to address in my book - the battle of civilizations.

America is rather unique in its ability so far to absorb immigrants into our society. The EU is having a far harder time and China/Japan are downright xenophobic.

In the EU, the natives are resisting assimilating the growing population of largely Muslim immigrants. At the same time, the Europeans are not reproducing while the Muslims are. The most common new baby name in the EU is reportedly Muhammad.

What this means in the long term is that an unassimilated Muslim culture is eventually going to outnumber the Europeans and very likely become the dominant culture. Will the United States then become the last bastion of the western civilization?

Demography is destiny.

Our yodeler brings back memories of political scientist Samuel Huntington's "The Clash of Civilizations," written back in the 1990s. Here's David Brooks' take on 3/3/11 in the NYTimes "Huntington's Clash Revisited":

Maybe our yodeler majored in political science to add to his credentials minoring in economics.

Regarding our yodeler's "Demography is destiny," what's he done about this, off hand?


How did you guess?

Poli Sci was my masters work before Army service left it incomplete.


Perhaps our yodeler missed Huntington's "The Clash of Civilizations" due to his military stint and is now catching up. [I note our yodeler ups it from a "Clash" to a "Battle," perhaps based upon his adulation for Bush/Cheney and the search for WMD in Iraq.]


I am well aware of Huntington's rebuttal to Fukuyama's triumphalist claim that history ended in favor of a liberal (libertarian) political economy and agree with many of his points concerning the clash of civilizations. My one critique is that Huntington tends to understate the effect of economic structures.

The Brooks essay to which you linked is wishful thinking. The Arab Spring has hardly showed a universal desire for liberty, rather it showed a desire to elect one's own Islamic autocrats, who generally oppose western culture and fit perfectly into Huntington's world view.

Brooks is not the only one who has challenged Huntington's "Clash .... " since its publication in the 1990s as any educated political scientist knows. In fact, Huntington expressed his own druthers over time. Perhaps our yodeler wants to lead a new Crusade. Of course, that would not address Russia and China. So perhaps we can expect Foreign Affairs to publish our yodeler's views on the complexities of the "Clash ..." for a review by the Poli Sci community.


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