The powers that be are at it again. Since a while back (I really should have written this post earlier, but my time is limited due to exams etc) there have been serious talks about a fiscal union, that would incorporate either just the Eurozone countries or, if Germany gets as they want (and most of the time, they do), the entire EU.

First; why would anyone want to include the whole EU? The simple reason is; to keep countries with healthy economies from leaving the Eurozone. Take a country like Finland: A relatively healthy economy and a national debt nowhere close to dangerous levels. Why should they accept being governed by Germany in economic matters? Germany’s own economy isn’t really impressive in the first place; it’s really the size of it that makes it possible for them to have the influence they have and save other countries.

Finland might simply take their ball and go home if Germany tries to force them to accept fiscal supervision. As members of the EU, Finland can still have free trade with all the other EU countries, and will still have influence in European politics (well, they won’t have less influence than they currently have). They’ll still get to send representatives to the European Parliament, and they’ll be entitled to sending a commissioner to represent them in the EU Commission, the executive body of the European Union.

However, if in order to escape this fiscal totalitarianism, you have to actually exit the whole EU, then the choice becomes much tougher for a lot of countries (although personally, if I were the President of for example Finland, I’d still give Germany the finger). The price is suddenly much higher. Will it be enough, or will countries (if this kind of fiscal union becomes reality) exit the EU? Hard to say, but if I were to bet, I’d bet they will all stay in for now (the UK being a possible exception).

Having cleared that, could a fiscal union really save the Eurozone? That’s what we keep hearing – that having a common monetary policy isn’t enough, and that the problem is the lack of fiscal co-ordination. While I agree that in theory and on the surface that appears to be the case, I still disagree with the notion that a fiscal union would be a good step. Here’s why:

1) Politics. If Germany (in practice, it will be them and France who will be the supervisors) gets a say in every country’s fiscal policy, don’t believe for one second that they won’t use this to their advantage. Let’s say that a country wants to run a deficit to pay for a cut in the capital gains tax (probably the most stupid tax ever invented). Let’s say that Germany doesn’t really like this idea as it would make investing in Germany less attractive relative to this country, what do they do? Well, they simply stop them from going through with the tax cut, citing concerns about the deficit. On the other hand, this gives Germany a powerful position to do some political trading: “If you agree to have the EU subsidies sauerkraut, we’ll allow you to run a deficit”. The EU has always been corrupt, so what makes anyone think that this fiscal union/oversight thing would be any different?

Now of course someone is going to disagree and say that Germany wouldn’t be able to control everyone else like that. To them I say; isn’t that what you said about the Eurozone? That Germany wouldn’t dominate the ECB, that everyone would have a say in setting interest rates? Have the last years taught you absolutely nothing?

But even ignoring the obvious reality that Germany would dominate a “fiscal supervision council” (or whatever it will be called), a council where every country had one vote would soon become corrupt as well. Basically, everyone would allow everyone to spend as much as they want – I vote to allow your country to run a deficit, you vote to allow my country to run a deficit. I scratch your back, you scratch mine. Co-operation at its worst.

2) The economies are still different. The reason why Ireland can experience a boom while Germany experiences a bust, and vice versa, is not simply that Ireland and Germany have different fiscal policies. That’s part of the reason, for sure, but it’s not all of it. The fact is that the Eurozone economies look very differently; you go from high-tax Finland to low-tax Spain, from high-tech Ireland to agricultural Greece etc. If the demand for high-tech products for some reason were to fall, Ireland could enter into a recession. If the weather is really good, Greece’s economy might boom. If these two things happen at the same time, Ireland will have a recession and Greece will have a boom. So where do you set the interest rate? Low, to stimulate Ireland economy, or high to cool down Greece’s? The example may not be perfect (I’m  not sure how big agriculture is in Greece to be honest), but the point remains: Changes in consumer preferences (whether rational or irrational) and other factors than just monetary and fiscal policy can throw one country into a recession and another one into a boom (or, more realistically, cause one country to have really high growth while another has only very moderate growth).

This is very serious as it means that a fiscal union won’t stop the Eurozone from malfunctioning in the same way it does now. And when it does malfunction, you can count on the politicians to use this as an excuse to grab themselves more, not less, power. Because in the eyes of a politician, whenever there is a problem, the solution is to cede more power to him.

To me as a freedom-loving individual, that is really worrying.

3) Asymmetric and incomplete information. In the most simple, theoretical economic models, we assume complete information: That everyone knows everything there is to know about the markets and the economy. In reality, this is not the case. You may for instance buy a car for $20,000, because you didn’t know there was another car dealer who would have sold it to you for $15,000. Also, you may end up buying a product not knowing that the quality isn’t as high as you’d expect – the seller in this case knows more about the product than the buyer. The opposite exists too, in particular in the insurance market, where the buyer of the health insurance knows more about his health than the insurance company does. In most cases, neither the seller nor the buyer could be said to have complete information.

That was just a basic introduction to the concept of incomplete and asymmetric information. So what does this have to do with the Eurozone? The thing is, Germany doesn’t have complete information. If they are to decide how high a deficit a country should be allowed to run, they need to understand the economy in question and the state of the public finances. That sounds simple enough, but it isn’t. As a matter of fact, I have a hard time seeing Germany knowing a country’s economy better than the country itself. Understanding an economy is more than just numbers, you need to really get the country and all the non-quantitative factors that come into play. Sure, countries sometimes make the wrong decisions, but for Germany who can’t understand a country as well as the country itself, it becomes virtually impossible to make the right decision (even if they were to have the best of intentions).

What Germany is trying to do is to set everyone’s budgets in a way that will ensure that no economy is booming more than anyone else (because that would require different interest rates). That is a task that I believe is absolutely impossible in practice. If they lower interest rates to boost their own economy, they would have to raise taxes in other countries so that those economies don’t become overheated. How long do you think people would accept that? Which brings us to my fourth point:

4) Lack of popular support will tear down the union. Here is another issue: A fiscal union will face so much public resistance that it may bring down not just the European Union, but the capitalist system in Europe as well. Imagine the outrage once Germany forces a country to cut spending because they, the Germans, want to lower the ECB interest rate. Imagine German bureaucrats coming into a country, auditing its budget and then shutting down schools and universities in order to balance the country’s budget. Do you think people are going to accept that? Or do you think they will revolt? This is the kind of stuff that has the potential of not just causing riots, but actual civil wars.

In a best case scenario, this will simply lead to a break-up of the Eurozone, but in a worst case scenario, this could actually endanger all forms of European co-operation for generations to come. With all the bitterness that will be left between the countries after this fiscal union breaks up (mainly between France/Germany and the rest), it’s hard to see how these countries will ever be able to co-operate again, on anything. And even I think that we need some European co-operation. If this leads to a breakdown of the whole EU project, then free trade in Europe could be threatened.

Finally…

We don’t know exactly how the fiscal supervision would work. Some say it’s just going to stop countries from running deficits higher than a certain % of their GDP. That may be where it starts, but it’s not where it ends. Remember, the EU started as a coal and steel community…

At some point, Germany and France (yes, it will be them – you’re fooling yourself if you think otherwise) will have to make more intrusions than just making sure no-one runs an unreasonably high deficit. They’ll have to make sure that booming sectors are sufficiently taxed and not subsidized (see; Irish property bubble). They’ll have to make sure there is a stable tax base so that revenues don’t collapse in case there is a recession (see; Ireland, Spain). Simply monitoring the deficit won’t suffice. And monitoring all these things that would have to be monitored can’t be done efficiently, due to incomplete information (see point 3).

There is another point to be made: The Germans are no economic wizards themselves. Remember why the ECB cut rates so low in the early 2000’s? Because the German economy had stagnated. The Irish economy was booming (together with a lot of other countries), but the German economy was doing badly, and so the ECB decided that instead of Germany “taking one for the team” (ie, instead of raising interest rates to cool off the Irish, Spanish etc economies), the team would take one for Germany. If Germany had managed their economy better, maybe their economy would have boomed like all the others in the first half of the naughties. Of course, since Germany’s economy never really became overheated, the crash was much milder for them than for the countries now known as the PIGS. Yet, given Germany’s dismal growth figures over the past decade, I’m not sure if they got something to brag about. And let us not forget, their debt is 80 % of GDP – which is low compared to Ireland, Italy and many others, but again nothing to brag about.

If you’re looking for a country to supervise Europe, maybe you should take a look at a country where the economy is booming, where the national debt is lower today than it was in 2006 and where unemployment is falling fast? No, I’m not seriously suggesting that, but it would make more sense.

But if the Eurozone can’t be saved by a fiscal union, then what could be done to save the Eurozone? I don’t have an answer to that question; many things might have been done if they had been done earlier perhaps. At this point, the least painful thing in my view seems to be a controlled demolition (where you deconstruct the Eurozone in a controlled, “safe” way, perhaps allowing for a transition period where the euro will be in circulation together with the national currencies). I don’t know – but a fiscal union certainly isn’t the answer, for reasons outlined above.

This will do for now. Thank you for reading.

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