A tale of two currency areas

PALO ALTO – The United States and Europe are two giant free-trade areas, each wealthy but with serious short-run problems and immense long-run challenges. They are also two single-currency areas: the dollar and, for much of Europe, the euro. The challenges facing both are monumental.

PALO ALTO – The United States and Europe are two giant free-trade areas, each wealthy but with serious short-run problems and immense long-run challenges. They are also two single-currency areas: the dollar and, for much of Europe, the euro. The challenges facing both are monumental.

But only Europe’s currency union faces uncertainty about its future; America faces no existential crisis for its currency. The two economic powers’ similarities and differences, particularly with respect to
internal labor mobility, productivity, and fiscal policies, suggest why – and provide clues about whether the eurozone can weather the crises on its periphery and evolve into a stable single-currency area.

Labor mobility from poorer to richer areas provides a shock absorber against differential economic hardship.
The other natural shock absorber is a depreciating currency, which increases competitiveness in the area hit hardest. That cannot happen with a common currency, and economic adjustment is doubly difficult when labor is not mobile enough to help mitigate regional contractions in income and unemployment.

The reasons for lower labor mobility in the eurozone than in America are legion. True, America’s original thirteen colonies were a loose federation, and many Americans considered themselves citizens of their
state first and of the US second as late as a century after the Revolution. But one’s state was not a fully formed nation, with its own shared and deeply ingrained history, culture, ethnic identity, and religion.

Perhaps the most important cultural component of labor mobility is language. From Mississippi to Maine, and from New York to New Orleans, America’s written language is the same and the spoken language is understandable to all. Not so from Berlin to Barcelona or Rome to Rotterdam. (Or, for that matter, from northern to southern China or in multilingual India, where Hindi is spoken by only 42% of the population.) For eurozone citizens who do not speak a major language, especially English, mobility across national borders within the single-currency area is limited at best.

These are differences that cannot be easily erased. While some aspects of culture are becoming globalized, variation across borders in Europe is far greater than it is between US states. For example, until the second half of the twentieth century, today’s eurozone members regularly slaughtered each other on centuries of battlefields.

By contrast, history is more commonly shared among Americans from different states, who, other than in the Civil War, have fought side by side in the nation’s external wars.

All of this means that when California slumps, residents simply leave for the mountain states; when manufacturing jobs disappear in the upper Midwest, people migrate to new jobs in Texas. That pattern is much less prevalent in Europe.

Moreover, it is a pattern that has closed the gap (now roughly 40%) between per capita income in America’s poorest and richest states, as labor and capital continually adjust by moving to areas where productivity is higher. The range of productivity and per capita income within the eurozone is considerably wider, making mobility even more important.

Finally, while fiscal systems differ among American states, the overall fiscal burden is under half that of the federal level. Almost all states’ constitutions require balanced budgets (with exceptions for emergencies). American states and municipalities do face serious medium- and long-term fiscal challenges from underfunded pension and health-care systems, but citizens living in different states have a common national budget, whereas citizens of different eurozone countries face radically different central-government fiscal positions.

Indeed, many observers argue that the eurozone’s lack of a common fiscal system is its main problem. But competition over taxes and services is beneficial, not harmful. Nevertheless, much tighter constraints, with serious and enforceable penalties, must be placed on permissible budget positions and their transparency if the euro is to survive.

And it can survive. Those who would write off the euro as a failure should consider that it is only ten years old. America, too, historically had problems as a single-currency area, from early chaos before the Constitution to the clash between agricultural and banking interests over the gold standard in the late nineteenth century. While the euro faces strong headwinds, the dollar’s early sailing wasn’t always smooth, either.

The eurozone countries must first deal with the sovereign-debt crisis, reduce their fiscal deficits, and strengthen the woefully undercapitalized banking system. But, if the eurozone is to survive and prosper beyond the current crisis, it will also need comprehensive structural reforms to boost internal labor mobility and defuse the pressures caused by economic adjustment among nations and regions.

Whether citizens will support politicians who propose the labor, tax, and other reforms needed to enhance mobility, and whether such reforms will be sufficient to overcome linguistic and cultural barriers, are open questions.
Successive generations of post-war European political leaders initiated the European Union and then currency union in order to knit countries so closely together that another major war between them would become impossible.

Whether monetary union was necessary to accomplish that aim is debatable. Despite the considerable advantages of a common currency (price transparency, lower transaction costs, and inflation credibility, to name a few), the difficulty of macroeconomic management of such diverse economies looms larger than ever. The euro was always a big gamble, a grand experiment. Historical efforts at monetary union have sometimes collapsed, and sometimes they have survived multiple crises. The future of the eurozone may be cloudy, but it will not be dull.

Michael Boskin, currently Professor of Economics at Stanford University and a senior fellow at the Hoover Institution, was Chairman of President George H. W. Bush’s Council of Economic Advisers, 1989-1993.

Copyright: Project Syndicate, 2011.


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