Project Euro

The writer is a freelance contributor.

It was supposed to be a grandiose project of economic and political integration on a scale that the world had never witnessed before. But Britain’s exit revealed cracks that had been there for some time within the European Union (EU).

There were some who had doubts about this kind of union from the very start. This group included a few economists who had foreseen these troubles. In discussing the troubles faced by the EU, we can also analyse the proposed idea of a South Asian union that has been doing the rounds for some time now.

Common markets and currency unions have, at least theoretically, some advantages that make them attractive. For example, they help reduce the transaction costs of doing business across boundaries, which is a boon for increasing trade and generating jobs. A similar logic underlies the theory and practice of currency unions and common markets like the euro.

Many academic papers provided the intellectual foundations for such integration. Two of the prominent ones were by Robert Mundell and Peter Kenen. Both these papers seemed to provide solutions to the probable problems encountered by attempted economic integration. Opponents of integration had pointed out several flaws, none bigger than the loss of monetary independence (or monetary policy) of a country.

In short, Mundell’s paper argued that this loss can be compensated by ensuring a high level of factor mobility (goods, labour and services) within a single market. Kenen stressed the need for fiscal integration in order to ward off any adverse economic shocks. The idea was that this kind of arrangement would make the countries in the union share and act together in terms of an adverse shock to the economy. In the process, it would alleviate the need for stretching a particular country’s fiscal and financial resources.

The outcome of these theories and papers, and others like them, was a common currency, easier travel across borders, a European parliament and the European Central Bank (ECB) that conducts the monetary policy of the integrated euro area.

Both these theories, however, were based upon two critical ideas: almost perfect factor mobility (especially labour) and fiscal integration. Both of these, unfortunately, were lacking in Europe when the idea of European integration was being bandied about. So what made euro enthusiasts overlook these and believe that the euro project would work fine?

It is difficult to pinpoint any one source of their enthusiasm, but in general, there was a belief that countries within the euro area would adopt sound economic policies over time, thus reducing the chances of adverse economic shock. Also, there was genuine hope that countries within the EU would undertake such structural reforms that would make markets for factors flexible enough to withstand any shock.

With this belief, the euro project finally took off in 1999 with the launch of the euro currency. Sixteen years later, the EU received perhaps its biggest shock in the form of Britain’s exit (or Brexit), with the possibility that others may follow.

It would be worthwhile to analyse what went wrong. There are several factors that led to the evolution of the present crisis. The primary one relates to lack of fiscal integration, a critical underpinning of any such arrangement. Despite being part of a union, euro area governments pursued their own fiscal policies. While some members (like Germany) concentrated their fiscal policies towards debt reduction and consolidation of expenses, others (like Greece) went on an expenditure spree, helped in large part by the generous loans under the euro arrangement.

A secondary source of this spending binge were investments by core members (like Germany and France) to peripheral countries (like Greece and Portugal) in the initial years of the euro. In pursuing different fiscal priorities, the goal of fiscal integration took a back seat. This fiscal imbalance between the core and the periphery imploded spectacularly a few years ago as Greece’s fiscal troubles not only caused an economic meltdown at home, but also started a chain reaction that saw other countries like Spain, Ireland and Portugal announce their own fiscal straits.

The hope of evolving sound fiscal policies merely remained a hope without any concrete steps towards the goal. Especially noticeable was Greece, the most troubled economy of the euro area. The Greek government, in a manner very similar to ours, continued to take debt without charting any plan regarding how they would pay back all that money. With low economic growth, low tax revenue and meagre future prospects for growth, the Greek government had little alternative but to announce their predicament to the world. It was followed by other euro members also announcing their dire fiscal straits.

This all unleashed a wave of unease and serious debate about the advantages of remaining part of an integrated market. For German and French policymakers, it has become a question of whether they want to keep subsidising the wayward fiscal priorities of other euro members. (Most Greek loans, for example, are German taxpayer money. It’s at serious risk of default).

For others like Greece, there has been some serious introspection regarding the loss of independent decision-making by being members of a political and economic union. In their case, options like an independent central bank that could have helped in the times of economic upheaval are no more available. As Greek banks took to rationing cash in the aftermath of their economic woes, an independent central bank could have acted to stem such a calamity. Instead, they have to face some tough negotiators who are at their throat regarding the reimbursement of their loans.

In hindsight, the adverse economic shock that the dreamers of European integration had hoped to avoid actually did take place after all. In fact, the integration paved the way for the contagious effects of the failure of countries like Greece to spread to other countries within the union. Keeping all this in mind, people should not have been that surprised that Britain opted out of such an arrangement. And my hunch is that if the British economy can ward off the negative implications of this move, then we will see more euro area countries opting out of this arrangement.

This brings me to the proposed South Asian integration along EU lines. Given South Asia’s stark realities and the discussion regarding the plight of the euro area, it should be clear that this idea is not workable. What are the odds of Pakistan and India having fiscal or monetary integration, a common currency and allowing unhindered factor mobility across their borders? Close to zero. A similar case can be put forth in terms of Pakistan and Bangladesh, or Pakistan and Afghanistan. And so it is an impractical idea.

By sharing the relatively recent history of efforts at European economic and political integration (‘recent’ because these efforts go back to at least the 1950s), I intended to demonstrate that such grandiose projects should take account of ground realities before their ambitious launch. Perhaps more than anything, history suggests that an uncertain future can lay to dust even the best of intentions.

Email: shahid.mohmand@gmail.com

Twitter: @ShahidMohmand79