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The Euro is a trap


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#1    Blackleaf

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Posted 20 May 2005 - 05:47 PM

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Why the non-Euro countries - Britain, Sweden and Denmark - should keep their own currencies.

Free-Riding on the Euro
Anthony de Jasay (A British-Hungarian economist)



In most places around the world, it is still usual that parents look after their small children and grown children look after their elderly parents. The looking after is unpaid work and is not counted in the national product. Sweden has passed that stage. In Sweden, the lookers-after look after other people's small children and elderly parents, while their own small children and their own elderly parents are looked after by yet other people. The state pays everybody for the looking after. The total of this pay is added to the national product. It also gets added to the budget deficit unless taxes have meanwhile been increased.

It is a commonplace that Sweden runs what is probably the world's most extensive welfare state, and suffers from the absurdities that welfare states usually generate. It is tempting to blame the obtuseness of the electorate for voting with absolute consistency, in election after election, for the extension or at worst the maintenance of the welfare system and a sharp egalitarian bias in tax policy at the cost—a cost most do not recognise—of reduced material wealth.

It is arguable that with its high level of education, exemplary civility and admirable technological leadership in many fields, Sweden should be much richer than it is. Nevertheless, it is also true (though less of a commonplace) that if they really must have a welfare state, the Swedes manage it less wastefully and more intelligently than most. Since the reforms put in place over the last few years, the country's overall economic performance has improved markedly. Moreover, while until the late 1990s Sweden's "social" spending as a share of national income was the highest in Europe, this share has since been reined back a little and is now exceeded by that of France whose welfare system is not quite as comprehensive, but is more wasteful.

Sensible Sweden has now taken a sensible decision; in a referendum on 14 September, it has by a majority of 56 per cent rejected the proposal to adopt the Euro as its currency. Two things are remarkable about this outcome. One is that government and opposition, large corporations, the media and all the chattering and scribbling classes have joined forces in a sometimes quite frantic campaign for a "yes" vote. Outlandish claims were made about how the Euro will speed up economic growth and reduce the cost of living,—the exact opposite of what has happened in the Euro-zone since its formation. The electorate has remained deaf to these extravagantly un-Swedish promises. Nor did dire threats of being "shut out of Europe" impress it.

The other remarkable feature of the referendum was that according to the pollsters, the chief reason for rejecting the common currency was the fear that as a member of the Euro-zone, Sweden would be obliged to curtail its welfare system—a misperceived threat if ever there was one. However, the upshot is that Sweden is staying out, Denmark is less and less likely to reverse its earlier rejection of the common currency, while the present British government's ambition to persuade the country to adopt it looks for the time being utterly hopeless.

Maybe the Euro is rejected for all the wrong reasons, but the choice is probably right: the Euro is a trap. It is an unintended one, but no less cunning for that.

Each member state of the Euro-zone is caught between two alternatives: to engage in fiscal free-riding or to be the sucker, the victim of free riding by the others. The reason is easy to grasp. When a country has its own currency, fiscal profligacy carries its own punishment. Interest on the national debt rises more than proportionately to the debt, both because the country's own capital market gets overstretched, and because the risk attaching to its currency increases. Default on the debt and devaluation of the currency (coming after a flight into inflation to water down the debt), though perhaps still remote, start looking less improbable. The repercussions render a loose fiscal posture more and more difficult to hold, and in due course tend to impose some discipline on the government.

As a member of the Euro-zone, the same government running a large deficit is spared most of these disciplinary consequences. No member country, with the possible exception of Germany, is big enough in the zone as a whole, for its deficit financing to represent a significant strain on the zone's capital market. Currency risk subsists only relative to currencies outside the zone, in practice only the dollar and the yen, but it is eliminated within the zone; there is no Greek Euro and no Spanish Euro, so one cannot weaken relative to the other. Fiscal irresponsibility by one country still has adverse consequences for the zone as a whole, but only a small fraction of them is borne by the irresponsible country in question, with the bulk spread over all the other member countries. This is the classic breeding ground for free riding.

Under these circumstances, fiscal vice is not punished but fiscal virtue is. Today, Spain maintains a balanced budget, while both Germany and France are running deficits that hover around the mark of 4 per cent of GDP. According to all serious forecasts, their deficits will exceed 3 per cent of GDP for four years or more in a row, not dipping below that level before 2066 at the earliest. One result is that Spanish borrowers have to pay higher medium and long rates of interest than they would do if Germany and France also had balanced budgets. This is not to say that budget deficits are always evil if some of their negative consequences are shifted to other countries, as they in fact are in the Euro-zone. In the short run, occasional deficits may be justified—or would be if they were not habit-forming. However, it is clear that in a Euro-zone-type arrangement, defence against the free riding of others consists in becoming a free rider oneself.

Where the markets do not automatically provide deterrents to overspending, can "constitutional" rules do so? Germany, with its strong anti-inflationary, sound-money leanings has tried to inject such rules into the Euro-zone when it got its partners to adopt the so called "growth and stability pact", as part of the Maastricht treaty. The rule sets an upper limit of 60 per cent of GDP on the national debt and 3 per cent of GDP on the annual budget deficit of Euro-zone countries.

The debt limit has no "teeth"; in fact, the average share of the national debts of the Euro-zone countries is now 71.5 per cent of their GDP, with Italy and Belgium the chief offenders with over 100 per cent and both France and Germany now over 60 per cent and rising. The deficit limit has "teeth" but very weak ones. The offending country is summoned to take remedial measures, and if it fails to bring its deficit down to the limit, it may be fined. However, few observers seriously believe that the Brussels Commission would dare to fine an influential member country, nor that the fine, if by miracle it were imposed, would change that country's fiscal policy. To make doubly sure, a strong movement is now afoot to take the "rigidity" out of the pact.

If the pact is not kept when it is not convenient to keep it, what remedy can the Euro-zone find against fiscal free riding that looks capable of undermining the Euro? In the United States, the vast bulk of public spending is decided in Washington at the federal level. The states might have an incentive to free-ride, but have little or no scope to do so. In Europe the central budget is only about 2.5 per cent of the member states' combined GDP, and each member state has both incentive and scope to free-ride at the expense of the rest.

The conclusion is obvious: to throttle back fiscal free riding by the member states and protect the Euro, taxing and spending decisions have gradually to move from the states to Brussels. Whatever it may be called, in practice it means a move towards a move towards a more politically centralized Europe—a move the new European constitution, now in the final negotiating phase, would surreptitiously facilitate.

  

www.econlib.org . . .


#2    Celumnaz

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Posted 20 May 2005 - 05:53 PM

agree, but Euro's don't want opinions from the states.  They'll figure it out for themselves.

I'm really suspicious of Belgium, but have been asked why before.  I don't have any research on it, just a gut feeling something's rotten in Den... Brussels.


#3    Erikl

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Posted 21 May 2005 - 12:10 PM

Europe is on the path to it's inevitible unification.... question is, will it be able to stay that way and for how long even after it'll consume gunpowder barrels such as the Balkan states and Turkey.

Edited by Erikl, 21 May 2005 - 12:10 PM.

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#4    Lady

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Posted 21 May 2005 - 12:16 PM

not sure going into Europe is a gd idea myself and i def. don't like the thouht of having the Euro instead of the pound  dontgetit.gif
i reckon Europe would never last, we fight too much as it is!


#5    Mr Slayer

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Posted 21 May 2005 - 12:18 PM

Great topic.
Euro is perhaps seen as the competitor to the US dollar. But to economically try to put all countries to some sort of equal level to fit it to the Euro- system is insane and dangerous.



#6    Lady

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Posted 21 May 2005 - 12:20 PM

same currency's gotta be bad  mellow.gif   wot happens if the economy crashes in a country?  i don't know much about economics, but wouldn't it lead to terrible inflation?


#7    Mr Ed

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Posted 21 May 2005 - 12:22 PM

Dont worry about it, Britain will probably enter the Euro one day, but not for years yet. Blair's majority might not be big enough to push it through and public opinion is heavily against it.
I haven't made up my mind yet...

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#8    Lady

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Posted 21 May 2005 - 12:28 PM

Blair will get it through if he really wants to  mellow.gif  the prob at the mo is we don't have much political say.  after all, can u really differentiate THAT MUCH between our parties?  Lab's jst turning into a milder form of the Cons and the Libs are so busy trying to score points off Blair that they don't really know wot they're doing.  As for the Tories, change ur leader and maybe i'll think about it...


#9    warden

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Posted 21 May 2005 - 05:32 PM

QUOTE(Lady @ May 21 2005, 12:28 PM)
Blair will get it through if he really wants to  mellow.gif  the prob at the mo is we don't have much political say.  after all, can u really differentiate THAT MUCH between our parties?  Lab's jst turning into a milder form of the Cons and the Libs are so busy trying to score points off Blair that they don't really know wot they're doing.  As for the Tories, change ur leader and maybe i'll think about it...

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That is already in the prosses,and remember the Tories had a majority of 600.000 votes in england ,so dont think blair will be able to push it throw as easy as you think


#10    Mr Ed

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Posted 21 May 2005 - 08:23 PM

Blair already said he wasn't going to bring up the Europe issue in general as a main one, it is too risky.
I don't agree with you when you say Labour are turning into a milder from of the Conservatives. The cons party split years ago over Europe and has yet to recover fully. Labour took the middle, realising they were far too socialist to be elected, they dropped Clause 4.
The Cons are pitiful in my opinion.

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#11    warden

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Posted 21 May 2005 - 08:27 PM

QUOTE(Mr Ed @ May 21 2005, 08:23 PM)
Blair already said he wasn't going to bring up the Europe issue in general as a main one, it is too risky.
I don't agree with you when you say Labour are turning into a milder from of the Conservatives. The cons party split years ago over Europe and has yet to recover fully. Labour took the middle, realising they were far too socialist to be elected, they dropped Clause 4.
The Cons are pitiful in my opinion.

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Lets hear why you think they are pitiful,inyour opinion yes.gif


#12    Mr Ed

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Posted 21 May 2005 - 08:35 PM

So many reasons! These are just some of them...
1) Their awful public image
2) The fact that they actually lose votes to UKIP and the BNP, but not Kilroy just yet...
3) Their scare tactics
4)They called the Prime Minister of England, a position that demands and deserves respect no matter what happens, a liar. Children mimic the posters and ask their parents if the PM is a liar...
5)Michael Howard and David Davis- right wing ish and Euro skeptics
6)Michael Howard is a vampire
7) Their policies; Labour and the Lib Dem's saw that their budget would not have worked out unless money for operations etc
8)Their choosing of Ian Duncan Smith, ex leader of their party.

There are many others, but I haven't looked over their policies recently.
I realise some of these points are more valid than others...original.gif

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#13    warden

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Posted 21 May 2005 - 09:00 PM

QUOTE(Mr Ed @ May 21 2005, 08:35 PM)
So many reasons! These are just some of them...
1) Their awful public image
2) The fact that they actually lose votes to UKIP and the BNP, but not Kilroy just yet...
3) Their scare tactics
4)They called the Prime Minister of England, a position that demands and deserves respect no matter what happens, a liar. Children mimic the posters and ask their parents if the PM is a liar...
5)Michael Howard and David Davis- right wing ish and Euro skeptics
6)Michael Howard is a vampire
7) Their policies; Labour and the Lib Dem's saw that their budget would not have worked out unless money for operations etc
8)Their choosing of Ian Duncan Smith, ex leader of their party.

There are many others, but I haven't looked over their policies recently.
I realise some of these points are more valid than others...original.gif

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1)An image should not win you votes ,its your policys,people that vote for a party because of an image are arse holes
2)Labour lost more votes than all the parties(every one else gained,some more than others)
3)And labour never scared any one into believing not joining the Euro and the European constitution was not scare tactics(he also scared the whole of Britain that we had to go to war ,remember WMDs)
4)Whats wrong in being called a liar,when you are one thats what i would call the truth
5)Right wing-ish and Euro sceptics,,,,,thank goodness they are,remember when the votes were counted Howard had 600.000 more votes than blair in England,i think that tells you some thing about being a Euro -sceptic and right wing policys
6)Being a vampire is not a crime,its only when you SUCK the nation dry and call it stealth tax ,know thats what i would call a crime
7)Untill a party gets into power and tries it ,know one can say 100% it wont work,know one has a crystal ball
8)And Labour have never had any one in power they wished later they had not,come on every one in life makes mistakes

If you want to give me more examples you are more than welcome


#14    Mr Ed

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Posted 21 May 2005 - 09:10 PM

1) You are right, but that's how politics works now. I believe Labour policies to be significantly better, they actually realise asylum seekers are human. Unlike one big hitting Con who one recently said they should all be held on an island for processing.
2)Labour didn't lose enough votes to lose. The main reasons Labour lost votes is because our people always got angry and bored with a government that stays in, look at the cons in the 70s-80s. People turned to cons because they wanted to give labour a 'bloody nose', not because they liked them.
3)I am glad we went to war, it was right as Saddam was/is mad and killed thousands of his own people. The cons said they would have gone regardless of anything. We need Europe. Thousands of jobs are dependent on it and so is our economy. Hague did so badly because he was so anti-Europe- no-one really cares that much about it. He thought people did and wasted too much time and effort on it
4)Tony Blair never lied. Goldsmith told him the law was legal, the chief weapons inspector told him there were weapons and so did our secret service. Given all this evidence I cannot blame him for going to war, he should have done anyway. He never lied, he had bad intelligence. So did the chief weapon's inspector...
5) I don't think it does, it just shows how people were angry with Labour, they don't really care about Europe that much- referring back to how Hague lost the election so badly.
6)Oh, sorry I forgot about Howard's great ideas- lets cut everyone's taxes and increase spending on everything-oh hang on, that doesn't work does it...
7)It would not have worked, they would have had to get money from somewhere.
8)Not as bad as Ian Duncan Smith, who was finished within months. He demonstrated how much of a mess the con party was still is.



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#15    Lady

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Posted 21 May 2005 - 09:15 PM

u say people who vote for image are arseholes, true, but i'm afraid that's wot most peeps do original.gif  they're all rather naive i'm afraid and as 4 Lab being a milder form of the Cons... if u look back at the late 1800s/ early 1900s i think u might see some similarities!





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