Help for Poorer Neighbors: Designing a Transfer Union to Save the Euro

By Michael Sauga

Many economists argue that the euro zone needs to become a transfer union, where payments flow from richer to poorer states, if the single currency is going to survive. But a look at existing systems in different countries shows that the design of such a union is crucial -- otherwise some countries will become permanently dependent on handouts.

The Portuguese Finance Ministry in Lisbon. Experts say that the euro zone will have to become a transfer union if it is to survive. Zoom
REUTERS

The Portuguese Finance Ministry in Lisbon. Experts say that the euro zone will have to become a transfer union if it is to survive.

In the summer of 1990, the deutsche mark was declared the official currency of the German Democratic Republic, as communist East Germany was known. Three months later, the five East German states joined the Federal Republic of Germany.

All at once, the newly enlarged "deutsche mark zone" had what economists and politicians want for the euro zone today: a common economic and financial policy, largely uniform fiscal and social systems and an extensive redistribution of income among the regions. The agreements were an "expression of solidarity among the Germans," then-Chancellor Helmut Kohl said approvingly. He famously promised that there would soon be "blossoming landscapes" in the east.

His promise proved to be wishful thinking. Since then, more than €1.4 trillion ($1.98 trillion) in financial assistance and transfers have flowed from the former states of West Germany to the former East Germany. But Kohl's blossoming landscapes have yet to materialize.

To this day, incomes, exports and productivity rates in the eastern German states are only a fraction of what they are in the west. The eastern states have the highest rates of unemployment and the fastest-growing public debt. Statisticians characterize the situation as a "stagnating catch-up process."

Arguing for Central Control

The experiences in the former East Germany provide a counterpoint to the ongoing debate about the future of the euro zone. To lead the common currency out of the crisis, both politicians and economists want to finally create the political underpinnings the euro has lacked until now. European Central Bank (ECB) President Jean-Claude Trichet advocates creating the position of a European finance minister, Euro Group Chairman Jean-Claude Juncker wants to collectivize credit policy through European bonds, and German Chancellor Angela Merkel and French President Nicolas Sarkozy have announced their support for a European economic government.

The common message of all of these initiatives is that financial policy should no longer be left in national hands. The euro, they argue, needs central standards for taxes and government budgets, liability for national debts and a redistribution of income that offsets the differences between rich and poor regions. "A common currency without a common fiscal policy is not viable," says Thomas Straubhaar, director of the Hamburg Institute of International Economics.

The example of the states of the former East Germany, however, shows that a political union can sometimes even amplify existing economic imbalances. Instead of seeking a way out of their economic crisis, some poverty-stricken regions might prefer to become permanent subsidy recipients.

If we take a close look at the financial systems of industrialized nations, the conclusion is simple: The question of whether to have a transfer union or not is less important than the question of how it is constructed. How large do regional transfers have to be? Must the central government be given control over national fiscal policy? And, most of all, does it make sense for the community to guarantee national debts in the future?

Sacrifices Required

At issue are the handling of economic imbalances, the difficult balance between fairness and efficiency, and the economic mechanics of a monetary union. If each country has its own currency, it has a proven instrument for shrinking balance-of-trade deficits or surpluses. Rising or falling exchange rates ensure that the flow of goods among nations is readjusted appropriately.

In contrast, if countries are members of a monetary union, the adjustment process must be achieved in other ways. Either substantial financial assistance flows from rich to poor, or the deficit country makes economic sacrifices -- in that its workers emigrate to countries with surpluses, or they remain at home and accept drastic pay cuts -- so that their country's own products can become competitive again.

Both approaches are usually found in functioning currency zones. If a region within one of these currency zones runs into trouble, the richer partners provide it with assistance. At the same time, the local population is willing to make sacrifices and accept losses. The problem is finding the right balance, because financial assistance is often easier to implement politically than austerity measures.

This has led to the development of many transfer systems in Europe that do not reduce economic imbalances but entrench them instead. Although plenty of money is being spent, the gap between rich and poor is not shrinking.

Frittered Away

In Italy, for example, the wealthy north has been sending financial assistance to the poor south since the end of World War II, most recently in the form of annual payments of €50 billion. The money is used to build roads, construct steel mills and promote small businesses. But this hasn't narrowed the economic divide. Instead, the money has trickled away into pointless large-scale projects. A not insignificant part of it has ended up in the pockets of the mafia. The assistance has not led to the economic upswing it was intended to produce. Today, the per-capita income in the southern region of Calabria is less than half as high as in the northern region of Lombardy.

In Belgium, annual payments of more than €10 billion flow from the affluent northern half of the country, Flanders, to the former coal and steel regions of the south, and yet the economic divide between the two regions remains unchanged. In Wallonia, the French-speaking south of the bilingual nation, unemployment is almost twice as high as in the north. In Charleroi, a run-down city in Wallonia, agencies now offer tours of "the ugliest city in the world."

Italy and Belgium were already divided economies when they had their own currencies. But the tensions have only increased since the euro was introduced. In Belgium, the struggle over the capital Brussels is the only thing preventing the two mutually antagonistic parts of the country from splitting apart. And in Italy, where the right-wing Northern League defends northern Italian interests, a party representing the south has also now been formed. It sees its main objective in liberating the poorer parts of the country from "northern Italian oppression."

An extensive system of financial redistribution also exists in Germany, where the individual states have hardly any sources of tax revenue of their own. Instead, the federal and state governments derive most of their funding from joint taxes. In addition, poor states, like Saxony-Anhalt, Saarland and the city-state of Berlin, are entitled to subsidies from the wealthy states of southern Germany. In Germany, about €7 billion in funds are redistributed among the states each year to offset economic imbalances within the republic.

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1. No to a one-way transfer union
Eleos 09/06/2011
Money should be transferred only in return for collateral coming in the reverse direction. Greece has more islands than it needs, Italy has more fine art than it needs; and if necessary the reintroduction of indentured labour, serfdom and even slavery should be considered. Of course the European Human Rights Convention will have to be rewritten. Half a page should be sufficient.
2. Misinformation in Financial Markets
rustylink 09/06/2011
Interested parties keep trying to convince politicians that the bankrupt states must be supported to avoid collapse of the Euro. This is obviously nonsense, as this excellent Spiegel article illustrates. The health of the Euro may well depend on allowing bankruptcies to occur. Greedy lenders and profligate politicians might then become more responsible when faced with the consequences of their stupidity. Incompetent bank lenders who failed to evaluate or make provision for the possible failure of national government borrowers deserve to go bankrupt or to be relieved of their highly ruminated positions. In particular European Financial and Political Institutions must not betray the public interest by futile attempts to prop up the incompetent at taxpayer expense. Easy interest rates, soft credit, bail-outs, access to euro loans backed by European taxpayers, and market interventions i.e. ECB purchases of weak government bonds, all are erroneous policies which exacerbate the long-term problems caused by government expenditures exceeding government receipts. Suspiciously, the people who would gain most from from implementing such ill informed and foolish policies are those have committed grievous errors and demonstrated fiscal imprudence, and incompetence; too frequently bankers and politicians running State Ponzi Schemes paid for by taxpayers. Letting the economically insignificant Greek State go bankrupt will not damage the Euro as a currency; although a number of banks might need to change management as a price for survival. Helpfully, some of those who need to learn haw to lend and borrow prudently would be forced to face up to the consequences their personal and institutional failures.
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Graphic: Inequalities within the euro zone Zoom
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Graphic: Inequalities within the euro zone

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Graphic: Comparison of the American and German systems



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