Why the EU doesn’t work, and other Federations do

Amongst all the angst about the so called EU melt-down, it is worth considering why the federation of Euro Countries is in such trouble and other federations (eg Canada, Australia, the US) generally are not.

The problem with the Europe project is that it is “half pregnant” ie there is a common currency, but not common fiscal and monetary policies. This means all member states accept the market price for the European currency, but they can basically do as they like with the other leavers  of economic management. This means that Greece can pay its population way above what the country can afford, and far more than most countries in the EU, and the others cannot do anything about it. Economic imbalances are inevitable in these circumstances.

Before the Euro, when each country had their own currencies, countries would be judged by the international market, and their currencies would be adjusted by that market based on their economic health. In the current circumstances, some economists are estimating the a free floating Drachma would be less than half its equivalent in Euros. This means amongst other things that Greek exports (eg tourism, shipping, olive oil) would be 50% cheaper to the rest of the world and imports would be twice es expensive, thus the Greek economy would be relatively more competitive. In the absence of this adjustment mechanism, internal adjustments have to be made: cutting pension levels, reducing real wages across the boards, recapitalising Greek Banks, substantially reducing government expenditures at all levels, in order to make Greek goods more competitive with the rest of the world. It is a hard, possibly impossible process. In fact, in my view, a Greek exit from the euro zone is even now inevitable, and they will be better off for it. If you want proof, just look what Iceland has done in the last 18 months. It is now almost back to health.

Contrast with other federations. In Australia for instance, the federal government has taxing powers and distributes monies to the states based on certain criteria. The objective of this is to even out the different growth rates in each state. At the moment, in the middle of mineral boom, the mineral states of Western Australia and Queensland are growing at over 6% per annum. The rest of the country is below 1%. The distributions of money are therefore adjusted down for those two states and increased for the others. This has the affect of smoothing out the imbalances across the country.. In this way government expenditures across Australia are controlled in the interests of responsible economic management. By the way, this is the opposite of what has happened for the first hundred years of Federation – the outlying states consistently were subsidized by Sydney and Melbourne taxpayers. Interest rates are also set by the Central bank, as are inflation and money supply targets, both of which are administered by the independent Reserve Bank of Australia.

The EU euro zone has two choices: full economic union, or break up the currency union. Until a decision is made on this, I’m afraid the euro zone will be condemned to year on year recession (like Japan has been since the mid 1990’s)

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