Tag Archives: International

Why The Monetary Union Is A Failure

Over the last months it’s become quite clear that Europe‘s monetary union (EMU) is – more or less – a failure. So, what happened? And what do we do now? In this article professor Kevin O’Rourke provide a comprehensive explanation of the why’s and how’s, and put forward some suggestions for possible solutions of the greatest crisis in modern European history.

“Whether EMU can survive in the long run if the status quo persists is an open question.”

Kevin O’Rourke

“In order to understand why EMU happened, we often turn to the familiar Mundell-Fleming monetary policy trilemma. Given intra-European capital mobility, the decision by a subset of EC members to move to EMU was a logical, if radical response to the challenges posed by this trilemma. However, the institutional framework of EMU is seriously flawed,” Kevin O’Rourke writes.

Kevin O’Rourke is Professor of Economics at Trinity College Dublin, a co-organiser of the CEPR’s Economic History Initative, a Research Fellow of the National Bureau of Economic Research, and a Member of the Royal Irish Academy.

He received his PhD from Harvard in 1989, and has taught at Columbia University, UCD, Harvard, and Sciences Po (Paris).

He is currently serving as President of the European Historical Economics Society, and an Editorial Board member of World Politics.

Here is professor O’Rourke’s recent article, syndicated by www.eurointelligence.

A Tale of Two Trilemmas

For decades economists have argued that fiscal union was a desirable, and perhaps indispensable, complement to EMU.

What we now know is that a common euro zone framework for regulating financial institutions, and dealing with the consequences of their failure, is equally important.

We have a monetary union with neither of these complementary institutions, and it is clear that this architecture is not fit for purpose.

How did we end up here, and what happens now?

To answer these questions it is helpful to turn to what Dani Rodrik has labelled the “fundamental political trilemma of the world economy”. Rodrik argues that “we cannot simultaneously pursue democracy, national determination, and economic globalization.

“If we want to push globalization further, we have to give up the nation-state or democratic politics. If we want to maintain and deepen democracy, we have to choose between the nation-state and international economic integration.”

And if we want to keep the nation-state and self-determination, we have to choose between deepening democracy and deepening globalization” (Rodrik 2011, pp. xviii-xix).

The argument is that “deep globalization” involves a commitment to not just open commodity and capital markets, with the constraints that these imply, but also to a competition for mobile factors of production that makes it difficult for national governments to adopt regulatory standards or other interventionist policies, even when their populations want this.

The solutions are either to allow popular opinion to manifest itself through supra-national mechanisms, or to ignore it.

EMU solves the political trilemma by abandoning national monetary policy-making, and delegating it to a technocratic Central Bank.

The fact that this has occurred without fiscal union, or common banking policies, can be well understood within the trilemma framework.

Regarding fiscal policy, the combination of the nation-state and democracy has prevented deeper political union: German voters (among others) do not want a transfer union, while Irish voters (among others) do not want a common tax system.

When it comes to banking regulation, on the other hand, the combination of deep economic integration and national policy-making has made it very difficult to respond to the clear demands from citizens for far stricter banking regulation.

It seems that EMU is stuck between two trilemmas, one economic and the other political. Where do we go from here?

There are several features of EU politics which are relevant in thinking about this issue.

The first is the question of governance: how decisions should be made at a supranational level is a contentious issue, which can again be illustrated by means of the trilemma. For most people, ‘democracy’ involves direct elections to parliaments which legislate.

One could leave European decision-making to the European parliament, but the nation-state remains the basic focus of political identity and authority, and national governments remain centrally involved in the process.

One solution would be to prioritize national parliaments and the nation-state: one could then have intergovernmental cooperation, but this would involve national vetoes, and it is hard to see a particularly proactive EU emerging in such a scenario.

The other solution is what we have: an essentially intergovernmental mode of decision-making that gives rise to accusations of a ‘democratic deficit’. This has created a constituency in Europe that is hostile to further integration.

The second relevant feature of EU politics is the international cleavages that exist regarding EMU. In particular, German citizens were opposed to it at the time, and this has political implications today.

The third feature is the existence of sharp intra-national cleavages in opinion regarding the EU in general, and EMU in particular.

The unskilled and the poor tend to be opposed to both, while the skilled and the rich tend to be in favour. The potency of these divisions was illustrated in the 2005 and 2008 referenda in France and Ireland, where voters divided largely along class lines.

Superimposed upon these long-run political cleavages are the effects of the global crisis of 2008-9, and the present banking crisis.

In principle, the global financial crisis could have led people to view the EU as a port in the storm, and there is an element of this in the Irish referendum approving the Lisbon Treaty in 2009. On balance, however, Eurobarometer surveys indicate that attitudes towards the EU have become more negative during the crisis, while there has been a fairly dramatic deterioration in trust in the institutions of the Union.

The interaction between a sharp economic crisis in several countries, and underlying class-based or national hostility to EMU, could turn out to be a potent one.

Even more serious could be the mishandling of the banking cum debt crisis. The decision of the ECB to veto the new Irish government’s desire to impose burden sharing on private bank bondholders is extraordinary, and provides Irish eurosceptics with an extreme example of the democratic deficit in action.

Meanwhile, taxpayers in Finland and elsewhere are revolting against the notion that they should bail out their profligate partners – recognising that this is a European banking crisis that needs a European solution might help change perceptions.

So would recognise that an end to regulatory competition in the financial sector would be a more logical concession to be sought from the Irish, in return for cutting interest rates, than an increase in their corporate tax rate.

Whether EMU can survive in the long run if the status quo persists is an open question.

Governments have tended to muddle between the stark trade-offs implied by the political trilemmas, but this crisis may force them to confront those trade-offs head-on.

What happens then is anyone’s guess.

By Kevin O’Rourke

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Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

El-Erian On G20: A Non-Cooperative Game

Pimco’s Mohamed El-Erian considers whether the G20 Summit in Toronto created a constructive compromise on financial stability, or generated a losing plan to turn around a slowing global economy. The chief executive of the worlds largest bond fund see the last alternative as most likely.

“The result is what game theorist label a “non-cooperative game,” with a very high likelihood of sub-optimal outcomes.”

Mohamad El-Erian

“We are digesting this morning an unusually long communique from the G20 Summit in Toronto. This self-congratulatory statement is worth reading for what it says and how it says it-both of which make me worry even more about the future of a post-global financial crisis world that is in desperate need for better cross-border policy coordination and harmonization,” Mr. El-Erian writes in today’s edition of Financial Times.

Some will attribute the length of the “G20 Toronto Summit Declaration”-49 main points and another 82 in 3 annexes-to the pronouncement in the very first paragraph that this was the “first Summit of the G20 in its new capacity as the premier forum for our international economic cooperation.” And we should have no doubt that the G20 is a much more representative global policy forum than the outmoded G7/G8.

Yet, there may be much more to the unusual length of the communique.

I suspect that many veterans of multilateral gatherings will see this communique as typical of those drafted by a committee whose members have different views and priorities, and speak to different national audiences.

Indeed, we are already seeing the G20 communique being spun very differently in national capitals.

If anything, the outcome of the G20 is a confirmation of what many expected and feared-namely, and in sharp contrast to the April 2009 G20 London Summit, an inability to reconcile divergent views of the world.

If anything, we are being exposed this morning to the realities of different national historical experiences, different national initial conditions, and different national views on how economies should and do work.

The differences are most visible in the sections on fiscal adjustment and growth. They are also evident in the discussion of financial sector reform. Indeed, there is something for everyone!

Before we rejoice too much about the ability of the G20 to deliver constructive compromises, we should think carefully about the consequences of leaving major issues unresolved and, thus, essentially kicking the can down the road when it comes to serious analysis and courageous decisions.

Consider the following three points as a partial illustration of this risk:

First, the communique illustrates the extent to which we now live in a multi-polar world with no dominant economic party and with excessively weak multilateral coordination mechanisms.

The result is what game theorist label a “non-cooperative game,” with a very high likelihood of sub-optimal outcomes.

Second, taken at face value, the communique speaks to a relative world in which the US will be the only major country to pursue expansionary policies while others focus on addressing budgetary consolidation-either because they have to or because they wish to.

This is yet another factor that points to an increasingly unstable global configuration over time.

Third, we will likely face growing bilateral frictions due to the inability to use this weekend’s G20 gathering to properly address what I argued in a Friday FT column to be an incomplete and narrow characterization of the “growth now” versus “austerity now” debate.

The bottom line is as follows: I worry that, absent some urgent mid-course corrections, this weekend’s G20 gathering has failed to mark a much needed turning point for a slowing global economy with persistently high unemployment in industrial countries.

Instead, it reinforces the concern than we are in for a future of muted growth, deleveraging, periodic debt dislocations in some countries, and higher protectionist pressures.

Populations in Europe and the US may have much more to worry about than seeing so many of their teams knocked out early from the World Cup tournament in South Africa.


Mohamad El-Erian is chief executive and co-chief investment officer of Pimco. El-Erian’s previous commentary on the G20’s earlier Busan summit is available here.

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Filed under International Econnomic Politics, National Economic Politics