Monday, 9 July 2012

Euro Zone Nations’ wrestle with Rodrik’s ‘Trilemma’

superb article by Stephen Castle of NYT. I had tried to summarise several trilemmas here. Infact Europe is going through all of these trilemmas:
  • Mundell trilemma: Between independent mon policy, open economy and fixed exchange rate. As Euro is a single currency shared by all, it is like a fixed exchange rate. Hence one needs to be given up.
  • Bruegel trilemma: There are three issues: absence of co-responsibility for public debt, the strict no-monetary financing rule and bank-sovereign interdependence.  As debt levels have risen there is no fiscal union in Europe to transfer. This leads banks to face problems as they are the large holders of sovereign debt. ECB says no to buying sovereign bonds leading to a doom loop between banks and govt. One of them needs to be resolved or…given up..
  • Rodrik trilemma:  Is between nation states, economic integration and domestic policies. If one becomes a democracy and  agrees to follow econ integration, nation states or sovereignty has to be given up. This is exactly what we see in Europe. Democracies in GIPs though agreeing to remain part of the Union, reject policies dictated by the Troika.
Amazing really. What a case Europe is. Utterly complex..

Back to the Castlr article. He gets feedback from Rodrik on state of Eurozone:
“To remain in the euro zone under current conditions, countries like Greece, Italy and Spain are increasingly being forced to give up decision-making authority to rules imposed by Germany,” said Dani Rodrik, the father of the trilemma theory. “This is creating democratic stresses at home,” he said. “Ultimately, externally imposed austerity becomes incompatible with democracy at home.” 

It talks about a report from European ministers which leads to further giving up of nation state rights:
A group of 10 European foreign ministers, with Guido Westerwelle of Germany as chairman, issued an interim report last month that argued for just such an approach.

The measures, the ministers wrote, could include a directly elected president of the European Union’s executive body, theEuropean Commission, a post now filled by a candidate nominated by the European Council and approved by a majority vote of the European Parliament. The report also proposed a pan-European minister of finance and a two-chamber parliament for Europe. Such a parliament might be able to initiate legislation — something the current European Parliament cannot do — and it would have a new, second chamber. How those second-chamber representatives would be selected was not specified. 

So what does Rodrik think?
So how does Mr. Rodrik, the Harvard economist, propose that Europe resolve its trilemma?
A solution, in his view, might involve giving Greek, Spanish and Italian voters a greater say over euro zone decisions through a transnational system of democracy.

“This would be something like the U.S. federal system,” he wrote in an e-mail, “in which the federal government doesn’t bail out state governments but looks after residents of Florida, California, etc. directly because they are represented through their congressmen and senators.”
An alternative, Mr. Rodrik suggested, might be for those countries to leave the euro union, sacrificing greater economic and financial integration to regain sovereignty and democratic space.

“This is in essence the trilemma as it works out for the euro zone,” he wrote. “It says that economic union requires political union. The choice for Europe is either more political union, or less union — unless, that is, weaker countries are willing to give up on democracy.” 

The first choice is just not workable now as it involves a fiscal authority. What we then have is the giving up econ integration or breakup.

History shows Europe earlier also voted for limited econ integration:
Another advocate of the theory, Nicholas Crafts, director of the Center for Competitive Advantage in the Global Economy at the University of Warwick, points to a historical parallel. 
Under the 1944 Bretton Woods agreement, which proposed a system of convertible currencies and set up bodies including the International Monetary Fund, the side of the trilemma triangle that was sacrificed was economic integration, he said. Instead of merging economies, countries were permitted to limit the flow of capital across borders, giving them the freedom to pursue the economic paths they thought best.

The euro zone, Mr. Crafts said, is putting an unbalanced emphasis on fiscal union through tough rules on debts and deficits meant to prevent a repetition of the crisis. “But we also need some compensating rules on the pooling of risks,” he said. “This would be a fiscal union that people want to belong to it; that has something to do with the federal level helping a state and not just disciplining it with a harsh straitjacket.”

But Mr. Crafts said the political realities of the euro zone might make such a federal helping hand difficult to create. “If you can’t deliver the federalism as well as the economic straitjacket,” he said, “you might see the euro zone breaking up.” 

Fascinating discussion all this. More macro perspective and getting to the basic.

What is even more amazing is to note how the three trilemmas are working (or creating pressure to break-up) in Eurozone…


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