Hamilton, the EU and the Upside to Shared Debt
I suggested in a recent article that better coordination of policies by member nations would attract investments to the euro zone. Specifically, if recently elected President Emmanuel Macron could make reforms to the tax system and the labor market, France would be on the same page as Germany, the region’s largest economy. In turn, such measures would reduce risks for investors and increase economies of scale for producers, who would find equally business-friendly policies in the two neighboring countries.
Germany’s structural reforms date to 2003, when then-Chancellor Gerhard Schroeder initiated changes that have since made the country’s low unemployment rate the envy of the developed world. Its labor relations are considered to be among the best in the world, and France would have to take several steps to move toward the German ideal.
Macron’s election, and his subsequent landslide victory in parliamentary elections, may have set the stage for this to happen. He campaigned for the presidency on an unambiguously pro-Europe platform, and proposed both a more flexible labor market for France, and a common euro-zone budget managed by a finance minister for the entire region. The latter proposal, along with one to issue common debt, got a major boost on June 20 when German Chancellor Angela Merkel gave her conditional approval.
The Merkel nod was significant for two reasons. First, she is known to be a cautious politician, and had previously rejected suggestions to issue euro-zone-wide bonds or to pass a common budget. After all, being the largest creditor in the region, Germany would have to foot the bill if one of the other members -- say, Greece -- is not able to pay its share.
Second, German taxpayers are reluctant to bail out their European neighbors, and issuance of euro-zone debt would increase that risk. That Merkel showed her willingness to consider the Macron proposal even before the German elections in September signaled that she realizes there is no better time than now to cooperate with the reforms that Macron is attempting to make in France.
Macron took steps toward labor-market reforms on June 28 when his government introduced measures to make decisions about wages and layoffs more through negotiations between employers and workers rather than through battles with France’s notoriously contentious unions. Severance payments and other costs of firings are to be limited, and restrictions on foreign companies’ ability to lay off workers in their French subsidiaries would be reduced. The last measure is particularly oriented toward attracting foreign investments to France.
Despite these positive measures, how much of a risk are Merkel and Macron taking in planning a common fiscal policy for the region? History provides a context. In 1789, Alexander Hamilton, the first U.S. secretary of the Treasury, was faced with the substantial debt member states had incurred to fight the Revolutionary War. Little attention had been paid to repaying the obligations and, by the end of the 1780s, much of the debt was virtually worthless.
In a bold move, Hamilton proposed that the federal government take over the state obligations and pay them off at full face value. The idea was controversial. Some states, for example, Virginia -- comparable to today’s Germany -- had been fiscally prudent and paid off its entire debt. New England states, on the other hand, remained heavily in debt, as Italy and Greece are today. Hamilton was also criticized for providing a windfall to holders of New England debt that had been heavily discounted in the secondary market.
Notwithstanding the short-term issues, the move proved prescient. The newly independent United States was able to borrow at much cheaper terms than any of the individual 13 states could have done. This lowered the cost of capital, financing much-needed investment spending for the infant nation. Second, the newly issued U.S. obligations provided liquidity to make economic transactions easier. In a sense, these U.S.-obligation bonds were the precursor to today’s global medium of exchange -- the dollar.
The lesson for Germany and France is clear. Yes, they would run a risk in including more profligate neighbors in issuing common debt. However, the potential downside could be mitigated by the common finance minister’s tax-and-spending policies that Italy or Greece, for example, would be forced to follow. Risk could also be reduced by introducing new members gradually.
The benefits for the euro zone would be increased global use of the euro, broader export markets, and increased access to capital markets. Investors would benefit from a strengthening euro, falling debt yields, upward revaluation of euro-zone equities, and reduced risk in longer-term placements.
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