In 1999, when the Irish government adopted the euro, most Irish economists disagreed with the decision. It was made partly to reduce the country’s trade dependence on the U.K. But to use currency policy to achieve this was to place the cart before the horse.
Ireland’s business cycle is out of sync with the euro zone. It has an Atlantic economy: The U.K. remains the major export destination for Irish-owned companies, while the U.S. is the source of most incoming investments. A fiscal policy harmonized within the euro area will not synchronize the Irish business cycle with that of the French-German core.
In the U.S., any such lack of synchronicity among regions is addressed by the enormous federal budget. For every $1 worth of shock to a region’s income relative to the U.S. average, the budget provides 30 to 40 cents through reduced federal taxation and increased regional spending.
Such fiscal federalism is necessary for a monetary union to function effectively. The European Union deal announced last week studiously ignores this need. But at some point it must come onto the agenda, or further crises are guaranteed.
The current plan will embed within the system a contractionary bias. If Europe is hit by a major supply-side shock, such as the oil-price crises of earlier decades, some countries may be able to cope. For those tripped into a recession, however, the plan will impose further austerity. Such automatic destabilizers are surely a recipe for disaster.
John Maynard Keynes argued at the Bretton Woods Conference in 1944 that responsibility for the correction of global disequilibria lay with the surplus, as well as with the debtor, countries. The U.S. makes this argument today with respect to China. But in the euro zone, the point is ignored.
Germany and France have championed the notion that a “Stability and Growth Pact with teeth” is necessary to ward off moral hazard. But this is relevant to resolving the current crisis only if based on the assumption that, once the moral hazard has been dealt with, the European Central Bank will step in as a backstop.
No one seems to remember that these two countries were among the first to breach the original pact with impunity. And it is not at all clear that the current plan will deal with a major design flaw in the original euro-zone blueprint: the lack of a centralized banking-regulation and resolution regime.
A deeper concern that many in the smaller member states may share with Ireland is the way the euro-zone powers, in responding to the current crisis, sidelined the European Commission, the EU’s executive body. The phrase “coup d’etat” was used last week by some European federalists in Brussels. The commission’s traditional role as originator of proposals had been crucial to the defense of smaller member states’ interests.
What Ireland needs now, more than anything else, is a sharing of the burden of its bank-rescue package. Protecting Irish banks saved Europe from contagion. And these private debts are being shouldered entirely by the Irish taxpayer. The euro system had more design flaws than even its most vociferous detractors recognized, and the Brussels proposals do surprisingly little to address them.
(Frank Barry is a professor of international business and development at Trinity College Dublin. The opinions expressed are his own.)
To contact the writer of this article: Frank Barry at BarryFG@tcd.ie
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