Angela Merkel and Nicholas Sarkozy spent part of Tuesday (16 August) mapping the future of the Euro Area (EA) and apparently came away pleased with their work. The good news is that they want to move towards serious EA economic governance and seemed to have agreed on a Tobin tax as part of the deal. The bad news is that they want all members of the EA-17 to write a ‘balanced budget’ rule into their constitution; ie, to replicate the German ‘debt brake’ (Schuldenbremse) law across the EA. It won’t work.
The reason a generalised balanced budget rule won’t work is simple; it follows from the basic national accounting savings balances. Because (over the business cycle as a whole) the private sector normally runs a savings surplus, a government balance of zero logically entails a current account surplus.[1] While this may hold true for Germany, it cannot be true for all EA countries taken together.
For the EA as a whole, one country’s exports are another’s imports—for some countries (like Germany) to run a surplus, others must run a deficit. This is not an empirical matter but follows logically from national accounting definitions; Merkel and Sarkozy are guilty of a basic fallacy of composition.
There is only one way a ‘balanced budget rule’ might work for the EA as a whole—each EA deficit country would have to run a countervailing surplus with the non-EA world. But there are two problems here. The first, shown in a paper by Whyte, is that there is not enough excess demand in the rest of the world to absorb the extra EA exports.[2] Even if there were, the resulting global trade imbalance would result over time in the EA accumulating excess reserves, much as China today.
Crucially, Mrs Merkel and Mr Sarkozy made no mention of strengthening the ‘bailout fund’ or issuing E-bonds. The latter is vital if short-term crisis is to be avoided.
In a sane world, the German Chancellor and the French President would sack their economic advisors who clearly lack an understanding of basic economics or national accounting principles. Sadly, the world is growing less sane by the day. The financial markets will know this and soon enough return to speculating against member states’ sovereign debt.
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[1] The ‘savings balance’ identity is normally written (I-S) + (T-G) = (X-M) where (I-S) is the ‘private sector balance, (T-G) is the public balance and (X-M) is the current account of the Balance of Payments.
[2] See Whyte, P (2010) ‘Why Germany is not a model for the Eurozone’ London: Centre for European Reform.
#1 by RCS on August 18, 2011 - 12:28 am
The approach of the political class to the euro crisis fills one with dismay.
They cannot either embrace pure federalism, becuase the politicians will lose domestically, and they cannot begin to offer a realistic solution to the economic problems that face Europe. We are now seeing the end-game of the European fantasy.
The EU started as a typically grandiose French project, in which the French thought that they would control Europe, that has become completely out of control and unmanageable due to the astonishing hubris of the political class.
The only way forward is diminish the EU to a trading block and to restore sovereignty to the countries within it.
This requires recognition that the EU is a political and economic failure that has failed to deliver any substantial benefits to Europe.
I have no doubt that the Euro-Elite (self styled) will cling on to their fantasy for some time yet and, I am sorry to say, that the result will be poverty and bloodshed.
#2 by Raymond Finch on August 18, 2011 - 9:33 am
The fact is that the EU is a political construct built out of knowledge of the end of the European political hegemony. The reasoning being “we can’t beat the USA alone, we will make the nations of Europe unite to beat the USA together”.
This was built by the power elite of Europe without consultation with the peoples. Indeed, whenever the peoples are asked the answer is “no”.
There is no EU “Demos”. To attempt to build one without the consent of the people is a fruitless and, ultimately, anti-democratic exercise which is doomed to failure.
Sadly, it is costing us all a great deal of money and loss of liberty.
You are all building a bonfire which is, unfortunately, going to spread to engulf the blameless.
#3 by Felix on August 20, 2011 - 6:30 am
Mr. Irvin, almost all US states have balanced budgets provisions and it works. Too bad that the Federal Constitution does not
#4 by Marcel on August 21, 2011 - 3:31 pm
Felix, even those balanced budget provisions are a total fraud. You know how California ‘balanced’ its budget? They added a line stating ‘miscellanous income that we expect when the economy -miraculously- improves, somehow’. And the amount tied to that item was 4 billion dollars, which in theory balanced the budget, The only flaw in the plan was that the economy did not improve, and in fact receipts were down creating a deficit bigger than even the aforementioned 4 billion dollars.
But what is the most troubling, is that everyone seems to think we can conjure money up out of thin air, that the ‘perpetual population growth’ economic model is sustainable and that natural resources will never run out. Yet politicians assume all those when making decisions. Everyone seems to want to keep the unsustainable part-ponzi scheme financial economic model up, desperately clinging to the illusion that it will all be all right somehow, and even if cuts have to be made, not to their pet spending item.
#5 by Joe on August 24, 2011 - 3:47 pm
You’re right. California is a particularly strong example of Nero-like self-regard. US states as well as county and city governments carry a lot of debt, including bond obligations and debts to externalized governmental entities such as pension funds.
Most states have tried to embolden the confidence of current and potential bond buyers by passign laws that state that governments MUST pay out on bond obligations, but that only goes as far as their capacity to actually do so in a crisis. I can picture the activists crawing out of the woodwork demanding that bondholders NOT be paid because babies and old people will be thrown out into the snow, forgetting that those demands for social development funds are precisiely why bonds are issued to build things: to cover the money not available due to social intervention, and for things like government employee pension obligations that have been raided or spread around with a level of “generosity” that they weren’t meant to when established.
#6 by Lawrence on September 2, 2011 - 9:40 pm
RCS Agree with you.
The only way out os out of the euro and out of the and to scrap the whole eu project.
Whatever Merkozy and others try to do they shall not save the euro and the eu.
#7 by Pedro on September 6, 2011 - 8:58 pm
OH MY GOD, OH MY GOD! The Euro is disappearing! The Eurozone is breaking apart! The European Union will be no longer! I haven’t heard that before…*yawn
#8 by Lawrence on September 7, 2011 - 2:01 pm
Pedro it’s not that far away thank God
#9 by Pedro on September 7, 2011 - 6:36 pm
“Pedro it’s not that far away thank God”
Lawrence, wish I had a Euro for each time I heard that. I guess some people enjoy being wrong, and enjoy being thought of as fools…..