Is US a good model for a Monetary Union?

Just when you thought, US stands as a nice model for how to make a monetary union work, we have some contrarian thoughts.

Erik Jones of John Hopkins Univ in this post says not all is well the US model either.

The concern is not whether Europe meets the criteria of fiscal or labor market integration.  No-one would suggest that it does – or, indeed, that many Europeans want to see more significant fiscal and labor flows across borders.  The real concern is whether any of that actually matters for regional adjustment in a monetary union like the United States.  Krugman insists that it does.  The data is less straightforward.  As a result, some of the developments within the U.S. monetary union are counter-intuitive given the theory that Krugman presents. 

Consider the comparison between the states of New England and the Southwest.  These two regions make for a good comparison because they had sharply contrasting experiences in the late 1970s and early 1980s.  New England busted and then boomed; the Southwest boomed and then busted.  If you look at nominal income per capita, the shock emerges as a permanent change in the growth trajectory.  The two regions grow together and then suddenly part company.  The pattern is even easier to spot if we focus on the ratio of wage and salary disbursements per employee relative to the U.S. average.  Workers in the Southwest become too expensive; workers in New England become relatively cheaper; and then their fortunes reversed.

The point to note in this comparison is that the divergence in regional performance is permanent.  New England wages go up and stay up while wages in the Southwest go down and stay down.  In part this is a result of labour force dynamics.  Despite the adverse contrast in wages and per capita income, more people move to the Southwest than to New England.  The two regions start with roughly similar populations in the late 1960s and yet end up looking very different four decades later.  Meanwhile, the share of population in employment in New England grows more than in the Southwest.

Jones then looks at the difference between Southeast and Mideast region (NY to DC). Obviously mideast does much better in terms of salaries but we have more number of people moving to Southeast. So, the labor market integration does not really work well.

In the end he says:

These pictures reveal a more complicated influence of integrated labor markets and common fiscal institutions than the theory of monetary integration suggests.  Although it is possible that such institutions will aid in adjustment, they may also push in the other direction – with continuous inflows of migrants holding down wages while state and local governments respond by reining in social benefits.  Whatever the reason, in the Southwest and Southeast regions of the United States shocks are permanent and so are relative income differentials.  The currency union has survived nonetheless.  What has not survived is any consensus on the virtues of having a large federal fiscal system or even a large federal government.  Europeans are probably right to avoid the kind of controversies that a federal fiscal system can engender.

Hmmm.

How does one look at this issue. It comes down to how the monetary union is managed in a crisis. In case of EMU, Germans  did not want to bailout Greece etc. But you did not really hear some of the US states not wanting to bailout the others.

Same is the case with India. One keeps hearing the US vs Europe debate on this monetary union. One could even look at the India debate. How did India achieve the monetary integration despite having such diverse states and provinces? It is an interesting historical account. We do read on how the political integration was done but not much is known about monetary integration.

Based on this Gulzar said:

Any country is, among other things, also a currency union. But a currency union can succeed only when complemented with some other factors. Consider this. 

Imagine if the city of Bombay (or the state of Maharashtra), which contributes an over-sized share to India’s gross tax revenues, refuses to share the taxes collected within its territorial jurisdiction. Or the central government at New Delhi refuses help to beleaguered wheat farmers of Punjab devastated by floods. Or Tamil Nadu restrains Telugu speaking people from Andhra Pradesh working in Chennai and elsewhere in the state. 

Any currency union immediately takes currency and monetary policy autonomy out of the equation. You sink or swim along with all others within the union. The problem arises when different areas within the union are at different stages of the business cycle. 

Denied off the freedom to lower interest rates (and thereby stoke inflation and lower the real domestic debt burden) or devalue the currency (and thereby increase competitiveness and lower the real external debt burden), the struggling areas need help from outside. They need fiscal transfers from elsewhere to cushion the impact of reduced output and lower tax revenues and there should also be freedom for labor migration that would take the load off the local job market. 

The first requires fiscal integration and the second political union. This does raise questions about the difficulty of sustaining a currency union without greater political and financial integration. Bombay or Tamil Nadu cannot have the benefits of a national economy without the costs imposed by fiscal transfers and labor mobility. Similarly, Eurozone economies cannot enjoy the benefits of a currency union without greater political and economic integration. 

Political Union emerges as a key. Jones may be right saying that fiscal integration might not be enough. But one cannot have a situation where one state opposes helping the other. In India too we keep having these issues where states question other states but somehow the centre manages the show. There was nothing of this kind in Europe. You had multiple institutions with the name European attached before it. But most leaders on these forums worked as Germans, French etc, with each trying to show his superiority.

Even in India, we will have a case of states showing different economic performances like Jones points for US. It could be that some states were similar at time of independence or say till 1970s and then diverged. What could be worse is that populations increased in worse performing states. Partly reason could be lack of education and healthcare which might have prevented them from migrating to better performing regions. But as Gulzar has said that has not led Centre not to help the crisis states. Or other states opposing this transfer.

I am just kind of thinking about this currency union case since the Europe crisis happened. It has some exciting lessons to learn and understand from economic history of such unions in the past.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.


%d bloggers like this: