United States of Europe?

A United States of Europe has been advocated for centuries as a means of preventing European War. Even after the US Civil War demonstrated that war between federated states was by no means impossible, prominent European figures continued to argue for such a project.

The devastating wars of the twentieth century gave fresh impetus to the idea, and in the 1940’s the federalists effectively gained the upper hand over those who favoured looser associations such as the Council of Europe and EFTA. Recognising however that their ideas were well ahead of European pubic opinion, they agreed to a step by step approach towards “ever closer union”. The most recent step was the Lisbon Treaty of 2007, which effectively reintroduced the previously down-voted European Constitution under another name. It is under Article 50 of this constitution that the UK is currently negotiating withdrawal from the EU. A number of notable politicians have endorsed a United States of Europe in recent years.

However recent years have also seen a significant push back against the centralising tendencies of the European Commission in particular. Heavily indebted members of the Eurozone have been forced to accept major deflationary measures despite consequent heavy unemployment and popular discontent. Migratory waves have placed the open borders Schengen system under intolerably heavy political strain. Nationalist political forces have grown stronger in various member states.

To all of this the Brussels answer is more Europe, not less. For example the single currency won’t work properly without a common fiscal policy and to save the single currency from the pressures it has come under we must therefore remove the individual fiscal freedom of member states. The absence of a popular will for this is not considered an obstacle.

To some, European federalism is yesterday’s answer to yesterday’s problems. Aloof, remote government is no longer acceptable to populations who, in the information age, are far more in touch with alternative thinking on how their needs may be met.

This is not to say that the ideal of fraternity is not a fine one. However, if fraternity is to be realised, ways need to be found of making it compatible with liberty and democracy.

The Euro makes you sick

If anyone still believed in the community spirit of the European Union they should have found themselves roundly disabused this week.

I have discussed in earlier blog posts the fundamental flaws of the Eurozone system. In brief, by removing the economic safety valves of devaluation and balance of payments effects, a single currency drives countries of unequal efficiency further and further apart by reducing the GDP and employment levels of the weaker.

In single currency areas such as the USA and the UK relatively little fuss is made about arranging compensating financial flows because the members are all parts of a single political state. The Barnett Formula exists to provide this compensation to Scotland (despite imaginative claims for the alleged strength of the Scottish economy.)

In the Eurozone there is no such political unity. This week has seen economic liberalisation measures forced on Greece as the price of its third bailout in six years that are too extreme even for the strong economies such as Germany to stomach themselves.

Yet as the leaked IMF paper reveals, the measures proposed will not allow Greece to pay off its mountainous debts. For all its ineptitude, the Syriza government has been correct about one thing; the so-called remedies are making the situation worse by increasing Greece's debt to GDP ratio.

The common cliche describes the Eurozone as kicking the can further down the road. I prefer to describe them as treating the symptoms (badly) whilst denying even the existence of the disease. Something is rotten at the heart of the single currency and no amount of name calling and blame allocating will put it right.

David in Euroland

A Tale for Children

David had to go to Euroland for a big meeting in Brussels. This is where sprouts come from and sprouts, as every child knows, are horrid tasteless vegetables resembling solid green ping-pong balls that adults won't let you leave on the side of your plate after Sunday dinner. Instead you're told they're good for you and made to sit there at the table until you've eaten every last one.

David was The Prime Minister of Britain and normally he quite liked sprouts but sometimes even Prime Ministers who like sprouts just feel that they've had enough and would rather have something else for a change.

Strangely enough the meeting that David had to go to wasn't about sprouts like most of the other meetings but about another kind of animal altogether called Eurocats - or maybe it was Eurocrats, he couldn't quite make out the foreign accent over the telephone - but in either case it had as usual been decided that all of them should be exactly the same, all green and all perfectly round with great grins on their faces because they'd skimmed off so much of the cream.

Once upon a time if you wanted to go to Euroland, which very few people in Britain usually did, you had to get on a cross Channel ferry. Nobody really knew why the Channel ferry was so cross, but as long as they could remember it always had been. Most people thought it was probably because it had to go to Euroland every day and they all sympathised.

Anyway that was before they dug a big tunnel under the Channel. It was officially considered much better to go by train because Euroland had long ago started running on rails. David was pretty sure of this because the papers continually published stories about how the European train had departed from the station leaving him standing on the platform. Some of the newspapers considered this a great shame, whilst others said that the train was on the wrong track anyway and would most likely end up in the United States.

David wasn't very good at geography, but the United States sounded like completely the wrong direction to him. The editors explained they meant the United States of  Europe. Now David knew perfectly well this didn't exist and he thought it was a pretty silly idea for the Eurocrats to have built a railway line going there, let alone got on a train and started on the journey.

However, he saw things a little differently after he got a telephone call from his girlfriend Angela to ask why he hadn't come over. Angela was a German lady who had grown up wanting to be an engine driver and had been so successful that she was nowadays known in her own country as 'Der Steamroller'.

Angela told David that all the leaders agreed their destination was sure to exist by the time they got there. David didn't really find this very reassuring. All things considered, he thought, he would probably rather stay at home and eat sprouts. But Angela told David that if he didn't come on the train with all the rest then he'd have to follow behind on a bicycle and that sounded like an even worse idea to him. So David reluctantly agreed to go over.

Well of course by the time he got to Brussels everybody else had been on the train for some time and whilst they were waiting they had all been eating and drinking and playing cards. Angela was playing the Queen of Hearts but François was playing the field. Since all of the leaders were such terrible gamblers, the Eurocrats had carefully concealed all the real money in a big black box and handed out some imitation cash called Euros so that their chiefs could do what they liked with it and it wouldn't matter.

Unfortunately first the Greek leader and then the Irishman and then the Portuguese and then the Spaniard and then the Italian lost all the Euros that they had been given to play with. Every time this happened Angela had to give them some of her Euros in order to prevent them getting off the train.

So that when David arrived nearly everyone already owed Angela a lot of make-believe money. As if that wasn't a bad enough start to the meeting, the others all told David that whilst they were waiting they had already chosen a new driver for the train and his name was Jean-Claude. David didn't like the sound of this. He pointed out J-C rhymed with K-C and people called Casey were famous for crashing trains.

Angela said that this didn't matter ein pfennig because they had also decided that on the Eurotrain all the passengers could go at different speeds except those who had paid for their tickets using her money and they would have to go at the same speed as her so that she could keep an eye on them.

"Look at it this way," she said to David. "We had an election and nearly three quarters of the people in Europe said they wanted anybody but Jean-Claude, so obviously Jean-Claude has to get the job."

"I scarcely see why," said David, quite mystified as usual in his typically British way. The British are terribly bad at foreign languages and have never really understood Eurospeak.

"Because of the democratic deficit of course, dummkopf!" said Angela. "In Euroland we have a system that people should never get what they want because it only spoils them, so since hardly anybody wants Jean-Claude it follows he is the perfect choice."

"What experience does he have driving a train?" asked David.

"He's very popular in Luxembourg," said Angela, deftly changing the subject.

"That settles it," said David. "Do you know how much trouble the Labour Party leader in Britain got into trying to eat a bacon sandwich last week? You can't possibly expect me to swallow a Luxemburger."

"Look David, we're all agreed. Except for Viktor that is. He disagrees with everything that isn't in Hungarian."

"Good for him. I'll vote for Jean-Claude on condition he agrees to do everything in Hungarian too."

"Now be reasonable, liebchen. You don't want to be isolated, do you?"

"Actually, yes. That's the only way I'll ever be re-elected after all the austerity. You did hear UKIP topped the Euro-poll in Britain, didn't you? Now would one of you chaps mind pulling the emergency stop? I think I'll get off the train."

But liebchen," Angela wailed, "the Eurotrain is not moving."

"Excellent," said David. "I don't know if you've noticed but the British train on the other hand is moving along quite smartly. I might even manage to pull off another term in office. Toodle-pip, you chaps!"

And so saying David got off the train and took the bus to Calais for the ferry. Both David and the ferry were very happy about this because they were on their way back to England. In fact the ferry was so happy that it completely forgot to be cross and as a result it sailed to Southampton instead of Dover.

This was a bit unfortunate for David, since all the newspaper reporters were waiting for him at the wrong port and when he failed to arrive they naturally jumped to the wrong conclusion.

The next day all the British newspapers ran stories saying David had missed the boat.

Scotland's Currency in a Customs Union

In an earlier article I suggested that a currency union does not make market forces go away, it simply diverts them into other channels. It so happens that a customs union is already diverting these market forces into other channels, so there is a shortage of alternative channels left available.

A customs union means that partner economies have no tariff barriers between themselves but have a common external tariff towards non-members, thus in principle creating a single domestic market. Let us assume that Scotland is admitted to (or remains a member of) the EU and that the rest of the UK remains in the EU after 2017. The EU is a customs union.

Whilst the EU single market is not perfect, the RUK and Scottish markets have long been one. Not only are goods and services traded freely between the countries of the UK but workers and capital also move freely.

A larger domestic market enables firms to produce on a larger scale and so make efficiency savings. The result is faster economic progress than the member economies could have achieved separately. However for poorer areas, membership of a customs union comes with a downside. If they can, most people will want to sell goods and labour in places where they receive more for them. This means that for trade between richer and poorer economies to continue in the long term, one or more of three possible adjustments must be made.

1. The simplest adjustment is for the less developed economy to run a balance of payments deficit with the more developed. The more developed extends credit to the less developed, effectively transferring funds to finance the continued purchase of its own exports. But a customs union has a single market. Scotland currently has no more meaningful a balance of payments with RUK than Yorkshire has with Lancashire.
2. The second possible adjustment is for the poorer country to devalue its currency relative to that of the richer. This makes the poorer country’s exports cheaper and more attractive in the richer country, whilst the latter’s exports become prohibitively expensive in the former. But within a currency union, Scotland’s pound could not be devalued against RUK’s, nor could Scotland's Euro be devalued against Germany's any more than Greece's Euro can be.
3. The third possible adjustment is for employment and national income in the less developed economy to fall to a level consistent with its relative inefficiency. Because this depresses the internal economy rather than adjusting the economy's external relationships, it is far more painful and ideally should be a last resort, allowing the two external adjustments to take as much of the strain caused by the imbalance as possible. Unfortunately inside a combined customs and currency union this third adjustment is not the last resort, it is the only resort.

Taken as a whole, the Scottish economy is somewhat less developed than that of England. This is an observation, not a criticism. It is structurally less diverse and hence more vulnerable to swings in the markets for its major industries, a phenomenon exacerbated by a disproportionately large (and currently weak) financial sector and the temporary as well as highly volatile effects of North Sea oil.

The discrepancy between the Scottish and English economies is of course as nothing compared to that between the Greek and German economies. Yet Scotland still needs to take note of what has happened to Greece inside a customs and currency union.

Currently within the UK, the old industrial areas are poorer than the south-east of England, but economies of scale created by our currency and customs unions raise national income sufficiently for compensatory transfers from richer to poorer areas to be politically acceptable. It would be difficult to make such transfers to Scotland after independence.

In summary, I am not sanguine about any of the currency options facing an independent Scotland. Nevertheless, in the event of independence, one of the options must be selected. My judgement would be that a Scottish currency is the least of the evils, but that it requires preparation to start yesterday and much statesmanship from Scottish ministers.

Budapest

In tourist shops around the Hungarian capital they are fond of selling tee-shirts bearing the motto, "Good girls go to Heaven. Bad girls go to Budapest." I am far too old to understand what they mean, but they seem to be enjoying themselves. I did not go to Budapest to find bad girls. In fact I cannot recall with any certainty what I expected to find. The lack of expectation perhaps enhanced the very agreeable surprise when I got there. The city is imposing, picturesque and charming, as well as remarkably cosmopolitan in its cultural and architectural heritage. It has of course been disputed between rival cultures for much of its history.

Upon arrival, the captain of our riverboat obliged us by sailing downstream to the inner city limits before returning upstream to our berth. The Danube on a fine day affords glorious views of the twin cities, high Buda on one bank, low-lying Pest on the other, that were united in the late nineteenth century. The fine series of bridges connecting the two were all destroyed in the war but are now reconstructed and restored to their former glory. When the principal buildings on each bank are illuminated after dark on a warm, fine night, the entranced viewer might very well have been transported into a fairyland.

The remarkable parliament building, the centrepiece of the old Austro-Hungarian Empire, is far too large for today's small Hungarian state. At the same time it must be one of the most picturesque legislatures in the world, and one of the most photographed. When once you recognise the building, you seem to see it everywhere in travel advertisements.

Almost equally stunning is the huge expanse of Heroes Square, which contains some of the most beautiful equestrian statuary that I have ever seen and which is flanked by two national museums. The ornate baroque Basilica of St Stephen's is another architectural highlight. In Buda, the magnificent views from the heights of the Castle district are not to be missed. Wandering around the hilly medieval streets of old Buda is demanding on the legs, but educational.

If your legs will still stand it, there is a fine covered market in Pest that offers an interesting range of local products and foodstuffs, but it's on more than one floor and takes a long time to get round. Why is it so often the case that markets tell you as much or more about the local culture than the guidebooks? I think perhaps that whilst buildings impress us, people fascinate us. Sharing a market used by local people helps us to feel that we belong.

Sharing a Currency

A modern economy is based on achieving efficiency by specialisation and then exchanging produce with other specialists. A currency facilitates exchanges because it gets round all the problems of having to barter. You might therefore think that in principle it would be good to share a currency with as many as possible of those with whom you hope to trade. The problem is that a currency has to perform other functions too. For example it measures value and value is not the same everywhere and to everyone.

The Euro was the EU's response to the failure of attempts to fix exchange rates between EU members by means of the so-called 'Snake'. The Snake was overwhelmed by market forces. Politicians believed that this could not happen to a currency union. The truth is that a currency union does not make the market forces go away, it simply diverts them into other channels.

The Euro is not a currency in which all members are equal. For most of the Eurozone's members it is effectively a foreign currency except for the absence of exchange costs. Market forces do not give equal weight to small economies and big economies. This means that all along the Euro has been in reality a Deutschmark-lite.

If you use a foreign currency you also accept a foreign country’s monetary policy, whether it is appropriate for your economy or not. You cannot simply demand that the foreign country takes account of your needs if they conflict with its own. 

Inappropriately low Euro interest rates before 2008 therefore fuelled unsustainable credit expansion and property booms in several weaker economies than Germany that needed more monetary discipline. This contributed to a series of crises as soon as the currency union came under serious stress. Meanwhile for Germany the Euro offered an artificially lowered exchange rate that allowed faster export-led economic growth than was justified by German costs of production.

Just like the Euro in Ireland or Greece, the pound will be effectively a foreign currency for an independent Scotland whether or not a Sterling Area is agreed and whether or not parity of status is claimed by politicians.  RUK is about ten times the size of Scotland.   An independent Scotland using the pound will have to accept what will essentially be the RUK's monetary policy.

The claim that an independent Scotland would become entitled to a seat on the Bank of England's Monetary Policy Committee is misleading at best. The independent status of the Bank (since 1997) precludes any government exercising influence over the MPC, which comprises Bank executives and independent economists. The UK Treasury representative who attends its meetings is not allowed to vote. Who could imagine that a Scottish government representative, even if allowed to attend, could have a greater role?

Scotland's Currency

A long time ago, when the earth was young and dinosaurs still stalked the uplands of Sliabh Mannan, I trained as an economist. I say this in order to justify a limited intervention in the independence debate. Mine is an economic commentary, not a political one. Substituting politics for economics was what led Europe into the débacle of its single currency and, since this precedent should not be emulated by the wise, I wish to examine the question of a currency for Scotland.

Any modern economy requires a currency. The fundamental choice is between one of your own and someone else's. Until recently, no-one was seriously suggesting that Scotland should adopt its own. In theory, creating your own currency is the only way to attempt monetary independence, since sharing a currency involves sharing sovereignty over monetary policy. In practice however, no open economy has full monetary sovereignty anyway, since the foreign exchange markets are too large for governments to control. It would not be impossible for Scotland to adopt its own currency. It would be expensive and it might be risky.

For a small and trade-dependent economy such as Scotland's, a new currency might seem an undesirable course, since it automatically introduces barriers to trade in the form of exchange costs. Unnecessary barriers to trade reduce the competitiveness of an economy and with it the standard of living in the country. To introduce barriers to trade with England, Scotland's principal market, would seem a bad way to start on an attempt to increase prosperity.

A new currency would also be vulnerable to exchange rate fluctuations. It would be more vulnerable than sterling to oil price changes, since oil is more significant in the context of the Scottish economy than that of the UK. An erratic currency handicaps trade by forcing buyers and sellers to protect themselves against unpredictable exchange rate changes.

The currency might well be discounted against sterling until traders became confident of its stability (and this discount would be greatly increased should the Scottish Government carry through its 2013 threat to refuse its share of the UK National Debt). It seems not unlikely that Scottish interest rates would have to rise relative to those of the residual UK in order to defend the Scottish currency. Investment would thus be adversely affected.

In all probability an independent Scotland would therefore be obliged to use an existing currency. Given that the majority of Scottish trade would be with England it would make most sense to use the pound. The only viable alternative would be the Euro, which is currently enduring an unresolved long term crisis, rather like a householder who pushes filler into the cracks in his walls and resolutely refuses to inquire why they have cracks in the first place.

In a future article I shall return to the economic implications of a shared currency.