WASHINGTON, Nov. 22 (UPI) -- Two prominent economists have commented this past week on the problems facing the core of the European Union, and their role in retarding recovery from the global economic slowdown.
Milton Friedman emphasized the negative effects of the single currency, while Robert Samuelson criticized European regulation, and decisions made at the time of German reunification. Yet in the long run, all of these issues are symptoms of an underlying problem with the European approach, one which threatens to get worse, not better.
Milton Friedman, speaking with the German economic magazine DM Euro, blamed the European single currency for Germany's current economic crisis.
"If it wasn't for the euro, then Germany would not have its current problems," the Nobel Prize winning economist claimed. "A single European monetary policy is not suitable for the 15 countries in the Eurozone."
Friedman then repeated his prediction that the euro would collapse, saying, "The euro will bring more political instability. I would not be surprised if it came to crisis point in the next 10 or 15 years and the euro came to the point of breaking up."
Meanwhile, Samuelson in his column cited a study by economists Dirk Schumacher and David Walton of Goldman Sachs that argued underperformance of German economy could continue another decade and possibly more.
Commenting, Samuelson said, "As they diagnose it, Germany has two major problems. One is common in Europe: overregulation, especially of labor markets." He then noted "But Germany also suffers from mistakes made during unification a decade ago...East Germany's currency (and wages) were converted into West German marks at an unrealistic exchange rate of one to one; then, East German wages were raised more than 50 percent from 1991 to 1995."
Going beyond Samuelson, I wonder if the real mistake wasn't so much the exchange rate between the West and East marks, but the whole idea of currency union, at least at that time. If they had merely let the East German mark become freely convertible, it probably would have plunged, like the Polish and other Eastern European currencies, but then stabilized around a realistic value.
Of course, many East Germans would have gone west, where many would have ended up on unemployment, but eventually many of them would have gone back home if they could have a job paying a livable local wage, and probably a bigger house or apartment. Meanwhile fewer eastern factories would have gone under because the labor and products would have been priced realistically, and all the infrastructure money the German Federal government spent would have gone a lot further, especially in providing jobs.
British Euroskeptic economists, such as Patrick Minford, keep making the point that currency unions work better after political unions have become established, rather than before. They point out, for instance, that the United States used multiple competing currencies for decades after independence, until the Civil War. The German experience with reunification seems to be a case in point.
The German currency union was the triumph of politics over economics. To be fair to the Germans, the political drivers were very strong. In 1989-91, after all, it wasn't at all obvious that the Soviet Union was really going away for good. To the German politicians then, the primary driver was the need to grasp what might have been a very narrow historic window to achieve reunification.
The secondary driver was the fear of a huge flood of East Germans swamping the West German social welfare system, with all the domestic backlash that would have caused. Immediate currency union and an unrealistic conversion rate probably seemed like a cheap price to pay for the political benefits they brought. But they're paying, paying, paying it still.
Merely to critique their decade-old decision is an exercise done with the luxury of hindsight. However, the German currency union problem should be studied as a cautionary tale when and if Poland, Hungary, and the Czech Republic join the EU.
The implementation of European Union regulations will add new burdens to those countries' private sector. Adopting the Euro will rob them of currency flexibility, which was one reason they adapted better over the last decade than eastern Germany. EU infrastructure spending will probably not be nearly as great, per capita, as German infrastructure spending in the east, which did mitigate somewhat their problems.
Harmonized EU labor regulations means they will not be all that more attractive for manufacturing than Western Europe, so new job creation will be slow, while the Western Europeans will be free to sell their products on the newly-opened Eastern markets. Meanwhile, asymmetrical agricultural payments will burden Eastern European agriculture vis-a-vis Western European farmers.
The European fetish with uniformity, a trait the Germans share with particular enthusiasm, prevented a flexible and pragmatic approach to the problems of German unification. The coming extension of this fetish to the recovering economies of Eastern Europe cannot be justified by the excuse of political urgency as in the German reunification situation.
America's successful drive to include these nations in NATO, celebrated this week in Prague, offers a clue to U.S. policymakers for mitigating the effects of this pending catastrophe. We did not insist that these states first join a pan-European defense organization, and only then interact with the US through that body. We extended direct and full cooperation regardless of their attitude toward other European initiatives. Rather than persist in the outdated approach of seeing the EU as the all-inclusive European pillar of the Atlantic community, the U.S. should begin preparing a broader free-trade framework.
Such a structure would enable free trade between North America and the European Union states. It should be equally open to those European states that vote not to enter the EU, as Norway and Switzerland have, and Poland may; those that may never be allowed in, like Turkey; and those that are now in the EU but may someday choose to leave. We can exhort the EU to become more flexible ad nauseam, or we can create realistic initiatives that will force it to become more flexible because its members will have other practical options.
America, Continental Europe, and Japan each contributed to the global downturn through problems with their political-economic systems. America has recognized these problems, absorbed the economic pain, and is addressing its problems. Japan has finally begun to recognized its problems, and is trying to summon the political will to fix them. The Continental Europeans still seem to believe that the sources of their problems are in fact their advantages.
It's going to be an interesting decade.
