What the Euro Zone Can Learn From the U.S.
European Commission President Jean-Claude Juncker and Boris Johnson traded barbs this week over how far the EU intends to push its integration agenda. In a speech on Wednesday, the U.K. foreign secretary accused the EU of seeking to create an "overarching European state." Not true, Juncker responded: "I am strictly against a European superstate. We are not the United States of America."
This exchange of views looks baffling to an economist. The question is not what level of integration Europe intends to reach, but how much cohesion is needed to support the existing institutional framework, including monetary union. The risk is that the euro zone remains a halfway house, vulnerable to a repeat of the sovereign debt crisis which took place at the start of this decade.
George Osborne -- a former Conservative chancellor of the exchequer -- called it "the inexorable logic of a currency union." In order to thrive, the euro zone needs a common budget, to support countries that are facing economic shocks. There is also a need to complete the banking union, so that individual governments are not left alone in addressing a financial crisis. In other words, the euro area needs to become more like the U.S. not because it wants to, but because it has to.
These calls, however, forget how much the euro zone has achieved in less than two decades from its inception. As a new report, edited by Jacob F. Kirkegaard and Adam S. Posen for the Peterson Institute of International Economics (PIIE) shows, the speed of integration in the currency area has been remarkable. The authors argue that future progress will inevitably be slow and may, in fact, be accelerated by crises. The key will be resisting pushes for disintegration, which are bound to happen especially during the bad times.
In many ways, the euro zone is in a much better place than the U.S. was at the same stage of institutional development. The Federal Reserve System was established only after two failed attempts in the 19th century. Even the Federal Reserve Act of 1913 did not prescribe how the Federal Reserve System should respond in the case of financial panics, which ended up reinforcing "doom loops" between the banking sector and the economy up until the 1930s.
The European Central Bank, by contrast, has quickly established itself as one of the world's leading monetary policy institutions. True, the ECB has been less flexible than some of its peers, including the U.S. Federal Reserve, in reacting to the crisis. But under the stewardship of Mario Draghi, it has finally embraced a wide range of new monetary policy instruments, including quantitative easing, which have significantly reduced the risk of a break-up of the currency union. And over the last couple of years, the ECB has also taken responsibility for the supervision of the euro zone's largest banks. While many investors believe there is still room for improvement, few doubt that the "Single Supervisory Mechanism" is here to stay.
The banking union is, in fact, another example. Restrictions on interstate bank expansion in the U.S. were only lifted in 1994, more than two centuries after the signing of the Constitution. Not only does the euro area have no such restrictions, but it is also making good progress toward the creation of a single mechanism to deal with banks in crisis. Of course, Europe's banking union lacks a common deposit insurance scheme, such as the one the U.S. introduced in 1933. However, the euro zone has already set up a body in charge of winding down large failing banks, wherever they might be (the co-called Single Resolution Board), and has agreed to a common set of rules to handle such banking troubles.
The biggest difference between the U.S. and the euro area relates, of course, to fiscal matters. Europe's monetary union still hasn't matched the efforts of the first U.S. secretary of the treasury, Alexander Hamilton, who succeeded in consolidating the debts of all American states into the new federal government. The idea of a common fiscal capacity, which for some should include "eurobonds," raises hackles in fiscally prudent countries such as Germany, who fear they would have to pay for their more profligate partners.
However, as Posen and Kirkegaard argue, fiscal integration in the U.S. took some time. "From the beginning the U.S. had the power to issue its own debt, but for the first more than 130 years of American history it did so sparingly and only to finance the nation's wars," they write. Only the New Deal program of expanded spending during the 1930s made the U.S. federal debt significantly larger than today's EU budget. The euro zone may be very far away from having a fiscal union -- but for decades the U.S. had a very incomplete one too.
The study offers some useful suggestions on how the euro zone should progress. The U.S. experience shows that, as the French diplomat Jean Monnet once famously said, "Europe will be forged in crises." Governments will only really have an incentive to act during an emergency, as happened during the reform spurt which accompanied the sovereign debt crisis. Brexit seems also to have concentrated minds, creating the current push for a strengthening of EU institutions. When the times are good, one useful idea which the U.S. can lend is to identify areas which are best handled collectively (the migration crisis, for example) and then ask member states to pool resources, rather than the other way round. Earmarking a particular source of revenue to fund these projects could also be a promising avenue.
Juncker may not be seeking to create a superstate. But there is little doubt that for the euro zone to thrive, it will have to borrow a little more from the U.S. still.
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Therese Raphael at email@example.com