Perfidous Albion: Cameron might not have made an incorrect move

Last week at the much-anticipated EU summit in Brussels, UK Prime Minister David Cameron both rejected the call for EU treaty revision and opted to stay out of the proposed new treaty, or “fiscal compact,” that most other EU members finally agreed to. Sweden, the Czech Republic and Hungary will wait for their parliament’s approval. (Obviously, Sarkozy was not pleased.)

Was this a wise play, or an example of Cameron blowing fog into the channel in an effort to cut more ties with the continent and perhaps even set the stage for an eventual departure from the EU?

It’s hard to project coherent intentions in what are often unintelligible, technical bargaining processes, but I do not think Cameron wants to be responsible for the UK exiting the EU. Yet the fact remains that the only part of EU integration strongly supported by Albion’s politicians has been the single market. There has never been much love for the Schengen Agreement or the monetary union. For a variety of reasons, the UK does not want to bleed power over to Brussels.* Simply put, it opposes a federalized EU.

And though it might be the only one left out of what looks like a 23+3 fiscal pact, that doesn’t necessarily mean Cameron made an unintelligent play.

Personally, I support more EU federalism. I think the project of political and economic union is necessary both if Europe wants to remain an internationally powerful entity (and sit at the big boy table with the US and China) and if it wants to continue using a common currency in an non-optimal currency area that is subject to a relative immobility of productive factors as well as asymmetric shocks.**

(An example of Europe’s immobile productive factors includes the constraints language imposes on free labor migration in the Union. An example of asymmetric shocks includes those times when some part of the EU is booming while another part is busting. In these situations, other currency areas generally transfer funds from richer regions to poorer regions – this has of course been difficult (and maybe even illegal) to effect in the EU.***)

Yet while I support a federal Europe in the abstract, I’m not sure I agree with how the 23+3 have decided to go about establishing it – or something like and also unlike it.

It’s not that I think the UK deserves more financial regulatory freedoms than the rest of the EU (I see arguments for and against on this one), but because I think the fiscal pact the others have proposed represents another example of more technocratic (i.e., less democratic) solutions. Because the process of amending treaties in the EU takes so long and because some “tiny state” can easily upend the whole thing, EU leaders have always preferred the technocratic route. It’s just easier to bargain among your own class than to have to deal with annoying constituents.

So there’s the continued problem of a lack of transparency in EU decision-making. More pressingly, however, I’m not even sure what the 23+3 have agreed to is all that good. In fact, it could very well backfire and prolong the recession it’s been designed to redress.

As I understand them, the main problems in Europe right now have to do with the European Central Bank not taking on lender of last resort duties (it won’t print money) and Brussels not authorizing transfer payments to relieve regions suffering from economic shock. Currency areas need lenders of last resort to provide the kind of faith in market operations, and trust in market contracts, that investors look for. Furthermore, to ignore the issue of transfer payments – because it’s (admittedly) politically unpalatable – is to ignore the need to address the asymmetric shocks the EU (and any large currency area) is susceptible to. Issuing euro-bonds, which would ease the borrowing costs of peripheral states, would be one way to alleviate intra-union imbalances. These instruments are not included in the fiscal pact.

Additionally, there’s at least some chance that what the 23+3 have agreed to will actually worsen the situation. This is the “pro-cyclical” (or perhaps Keynesian) argument. It goes like this: As has been said, a large currency area like the euro zone is bound to have regional economic imbalances. This leads to inflationary pressure in the booming regions and unemployment pressure in the busting regions. Counteracting these pressures (counter-cyclical policy) calls for fiscal transfers and mobile productive factors. But this doesn’t always work in the immediate term. Thus a government needs to have the freedom to increase budgetary spending (draw deficits, quantitatively ease, etc.) in an effort to stimulate the economy back to health. Opponents of the recent Brussels agreement think that retaliatory measures imposed against states that violate arbitrary budgetary rules is a pro-cyclical recipe for disaster. The retaliatory measures will only add more stress to already reeling local economies.

I’m still not sure where I stand on all this, but I do think the underlying issue comes down to how well the eurozone deals with its status as a non-optimal currency area. And it’s too bad that because so many of the policies that could fix the problems are simply politically impossible to pass, EU leaders are left tweaking around the edges and bargaining behind closed doors.

* The UK has special international obligations/relationships/agreements that it doesn’t want the continent meddling in. And while they enjoy the benefits that accrue to them from the euro, they certainly have no plans to cede financial and fiscal regulatory authority of the island over to Brussels. The lesson of the hammering the British pound took in 1992 when it briefly entered the EC’s exchange rate mechanism is also not lost on UK politicians.

** The dilemma of a currency area is this: at what point do the costs of productive factors immobility and asymmetrical economic shocks outweigh the benefits of decreased transaction costs and more robust economies of scale? Robert Mundell fathered this field.

*** Article 125 of the Treaty on the Functioning of the European Union: “The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”

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One Response to Perfidous Albion: Cameron might not have made an incorrect move

  1. Pingback: Yes Minister on British Diplomacy | On Hyperborea: ideas from the north

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