One of the criticisms levelled at the euro – before and after its creation – is that the countries adopting the single currency were singularly unsuited to do so. In the jargon, they were far from constituting an ‘optimal currency area’.
Countries suitable for a common currency are ones that are strong enough to weather economic and financial storms; they can do so because the necessary adjustment mechanisms exist.
When a recession hits, it always affects some regions and countries more than others. Those areas badly hit, within a currency union, have a number of brutal choices: they can cut wages relative to the rest of union, receive cheques from the rest of the union or move to the rest of the union. So, labour markets have to be super flexible and/or the strong must be willing to financially support the weak.
Example
The great financial crisis revealed that one or two countries do indeed have labour markets capable of lowering wages and ones that have significant numbers of people able, if not exactly willing, to move to where the jobs are.
Ireland is, perhaps, the clearest example of this. Greece, of course, might be thought as a counter example but this would be, at best, only partly correct. Greek wages have adjusted and some Greeks did emigrate but, and this is where it gets really brutal, wages didn’t fall far enough and not enough people upped sticks.
What didn’t happen was a sudden outbreak of fiscal generosity on the part of the richer countries. When the relatively poorer parts of Ireland encounter economic trouble, they receive cheques from, essentially, Dubliners. When Ireland gets into trouble we receive nothing: this is the Achilles heel of the euro, something that still represents a potentially mortal threat to its existence.
When we think about sensible currency unions we often mention the US and, sometimes, the UK. In the US there have been waves of migration between and within States ever since the country was created. As industries boomed, others have been destroyed: technology in California, textiles in New England; the examples are many.
The point about all of this turmoil, which we euphemistically call adjustment’, is that it is only necessary because all of the known alternatives are worse. Just look at Greece.
Reforms
Indeed, just look at Italy, an economy that hasn’t grown this century and whose poorer regions, especially the Southern mezzogiorno, are potentially next month going to deliver a severe blow to the Renzi government hopes of constitutional reforms, ones believed necessary to enable economic reforms that will sort out the growth problem.
Another example, perhaps, of relatively poor people voting to make themselves poorer. That’s at least one parallel with Trump and Brexit. Voting for Marine Le Pen in France is potentially another.
Italy and Greece suffer from multiple problems. They should never have signed up for the single currency: they are not economically similar enough to their stronger European cousins.
Unnecessary austerity has combined with the euro to produce an ongoing economic and social disaster. For the poorest parts of Greece and Italy it may be even worse than that: the countries themselves may no longer be optimal currency areas. Restoring the lira or drachma may give Rome and Athens a boost but could do little for other towns and regions.
Implications
If something is not an optimal currency area the implications are not just economic. Political and social tensions build between the prosperous and poorer regions, sometimes to the point where institutions fail, threatening cohesion and the integrity of whole countries.
Perhaps the insight to be gleaned from Brexit and Trump is that the US and the UK are no longer optimal currency areas.
London is now such a different economy compared to the rest of the UK that it needs its own, strong, currency. Similarly, the ‘rust belt’ Trump voting regions of the US need a new and devalued dollar more than anything else. But, ironically, London has been made even more competitive via sterling’s fall and the old mining towns of West Virginia are facing the consequences of a soaring US dollar.
Economic differences within countries have become so great that traditional adjustment mechanisms are no longer enough. Labour mobility within the US is falling. Much vaunted labour market flexibility has not been enough to attract new businesses to places that once thrived on now defunct coal, steel and auto industries.
We can speculate why this might be true: retraining and/or upskilling may simply be beyond most people – it can take decades of formal and on-the-job training to become employable in many modern industries. People can no longer switch from one unskilled job to another: those jobs are disappearing altogether. Housing markets could be so distorted that it makes no sense to move to where the jobs are: look at property prices in London and San Francisco. Plenty of jobs in those cities – labour shortages actually.
Zombies
Professor Diane Coyle, writing in the Financial Times this week, joined the growing list of economists who linked the closure of factories and the shortage of unskilled jobs, to Trump and Brexit.
She laid the blame with governments who do little to cushion economic shocks. But when we consider the decades of initiatives, regional development strategies, hard cash spent, the efforts of economic agencies of multiple varieties, it is unfair to say governments do nothing.
It might even be possible to make the counter argument that governments have done too much: efforts to regenerate old industrial cities and towns have merely resulted in economic zombie zones. It might have been kinder, in the long run, to have just let these places die.
Too many regions of the UK and US have institutionalised unemployment and all of the social problems that go with it. Which, when you think about it, is slightly odd for countries tearing themselves apart over the fact that they have to import hundreds of thousands workers every year.
Unemployment assistance has in too many cases become a permanent solution. That involves personal tragedy and national waste on a grand scale.
Just as the euro area still risks falling apart because it is not an optimal currency area, so do the US and the UK. Maybe even Ireland isn’t an optimal currency area any longer. What used to work doesn’t any longer.
Trump and Brexit won’t solve this. Sterling and the dollar are moving in ways guaranteed to make all of these problems worse, in anticipation of the likelihood that everything implied by Trump and Brexit will make poor people poorer.
