Rodrik writes this nice post on the topic.
He says though Europe has some superb instis but all are work in progress. It is unfortunate the crisis occurred in Europe at this time when the instis were evolving and there were gaps between them.
The European Union, and the Eurozone in particular, has impressive institutional achievements to its name. We have a European Parliament, European Commission, European Court of Justice, a set of common regulations that exceeded 100,000 last time I checked (acquis communautaire), and of course the European Central Bank. These institutions are meant to underpin its unified market.
Yet we have now become all too aware of how incomplete these institutional arrangements are. To see the point, it is instructive to compare what is going on with Greece today with how a truly unified nation, such as the United States, deals with crisis in one of its constituent units, say California.
What are the differences between Greece and California in this regard. Say Calif busts. what happens?
California shares a common currency with the rest of the U.S., just as Greece (or Ireland or Spain) does with the Eurozone. But when the state government in California goes bust:
- Californians automatically get welfare checks and other transfer payments from Washington.
- Californian borrowers do not get shut out of credit markets and those with healthy balance sheets can borrow from the rest of the nation. This is because there is no “California risk” the way there is Greek sovereign risk; borrowers in California operate under a federal legal regime and the state of California cannot force them to hold California paper or prevent them from repaying their debts to non-Californians.
- The Federal Reserve stands ready to act as a lender of last resort to any Californian bank. (Why? Well, because it is one country after all…)
- California has representatives and senators in Washington, D.C., who can push for remedies for California’s economic troubles through political channels (e.g., fiscal spending, federal assistance, debt relief)
- Californians can easily move and seek jobs elsewhere in the U.S.
California has given up its sovereign powers to be part of the union of USA. So whenever there is trouble people know federal govt will help California. Same does not apply to Greece which maintains sovereign but have given up currency and mon pol to ECB:
The flip side of these benefits is that there is no expectation that Washington, DC must bail the state government.
A subtle point here is that Washington’s “no bail out” commitment is rendered credible by the direct support residents of California get from Washington, DC. This support limits the economic/political fallout in California. By contrast, the bankruptcy of the Greek government condemns the entire Greek financial system and sends the entire Greek economy down the drain.
In other words, because the state of California has no “sovereign powers,” it is effectively just like any other moderately large borrower. The consequences of its bankruptcy are no more or less serious.
The political quid pro quo in the U.S. is this. California has given up its sovereignty and has accepted the reach of federal laws and regulations. In return, Californians are part of the governance structure in Washington. Neither of these is true to quite the same extent in the Eurozone.
So there are two options for Europe. Either it goes for more political union or less economic union. It is moving towards latter so better to have a core EMU and let others go:
But that is all water under the bridge now. The main lesson from the debacle is that economic union requires political union. The EU needs either more political union if it wants to keep its single market, or less economic union if it is unable to achieve political integration.
At this stage, the former path looks by far the less likely. If it has to come to it, the more orderly and premeditated the coming break-up of the Eurozone, the better it will be.
Nicely put. Krugman adds it is worst of both the worlds: the inflexibility of a currency union, with the you’re on your own structure of national sovereignty.