The British Monetary Union Isn't Working Either....

In my Money Week column this week, I've been looking at the the UK as a monetary union, like the euro....and concluding that doesn't work either. Here's a taster.


What does the euro need to make it work better? The most common answer is that it needs to be turned into a fiscal union, with large-scale transfers from the richer regions to the poorer. It is the conventional wisdom of every editorial, and City pundit. Until it becomes a ‘transfer union’ it doesn’t stand a chance of succeeding.
A caveat or two is usually thrown in. The political obstacles are formidable. The Germans might never agree to their taxes being sent to bail-out Greece or Portugal. The treaties might need to be re-written, and that would require the agreement of all the European Union’s members. Still, if only those obstacles could be overcome, a fiscal union would smooth out most of the problems.
The trouble is, no one seems to have stepped back and questioned the fundamental assumption. The evidence suggests it may well be wrong. Europe has another monetary union between countries at very different stages of economic development. It is called the UK, and the currency is sterling. Reverse the polarities – the UK has a rich south, and a poor north, rather than a rich north and a struggling south – and the sterling area has many similarities to the euro area. It is made up of group of countries with very different levels of prosperity. And it has huge transfers between the richer regions and the poorer.
And the result? It doesn’t do any good at all. True, it holds the currency area together. But it only does so at the cost of creating regions that are ever more dependent on state aid. The truth is, a transfer union won’t save the euro even if it was politically feasible. Nothing will. The project is doomed.
That doesn’t stop people from trying, The most common critique of the single currency is that is an economic union without a political union. George Soros has argued for a year that without a single government the currency won’t survive. The President of the European Central Bank Jean-Claude Trichet has called for a European finance ministry.
The UK’s experience, however, suggests that even if it happened, it wouldn’t work. Britain used to be a fairly homogenous economy, with wealth relatively evenly spread out across its major industrial centres, much as it is in modern Germany. Not any more. Post-industrial Britain has a very, very prosperous capital, surrounded by equally wealthy suburbs. The Midlands and East are doing fine. The rest of the country has been falling behind at an increasingly rapid rate. The result is that there are huge disparities between output per head in the South and Wales, Scotland and Northern Ireland. It isn’t quite as dramatic as the gulf between Germany and Greece – but it isn’t that far off.
That gets fixed by fiscal transfers. The UK, which has of course a single government, and single finance ministry, shuttles large sums of money from the richer regions to the poorer. Oxford Economics, the consultancy firm, has calculated the amount the British government spends per person employed – per taxpayer, in other words - for the different parts of the country. In the prosperous South-East, the government spent £14,100 per working person. In Northern Ireland, it spent £21,200. Wales, Scotland and the North-East were all way above average. The East, East Midlands, and London were all below average – although London, which has pockets of real poverty amidst its wealth, not by as much as you might think. It also looked at expenditure relative to gross value added, that is the actual output of the region. Taking the average for the UK as 100, Northern Ireland scored 155 and the South-East just 84. In other words, a lot of the wealth from the South-East gets sent to the ‘periphery’.
The UK is, therefore, a monetary union with very significant transfers between its richer and poorer regions. The trouble for the euro’s would-be fiscal unifiers is that there is very little evidence that it fixes the problem. Northern Ireland for example has had a consistently lower growth rate than the UK as a whole – this year, it will grow by 1.1% compared with 1.7% for the UK according to estimates by Northern Bank. Much the same is true of Wales and the North-East. The regions with the biggest fiscal transfers have grown consistently more slowly than the rest of the UK, with the result that the ratio of state spending relative to their local economies has grown steadily over time. Between 1999 and 2010 state spending rose from 50% of the Welsh economy to 69%, according to calculations by the Centre for Economics and Business Research.
Fiscal transfers can hold a monetary union together. There is no sign of the sterling area breaking up, although the Scots might eventually decide to go their own way. But they won’t close the gap between the richer regions and their poorer neighbours. They are a permanent subsidy – and one that will probably grow over time.
If anything, the fiscal transfers probably make the problem worse. They crowd out private investment – after all, why would anyone in Northern Ireland set up a business when they are relatively few industries where it has much strength, and when they could just get on a plane to London, or else get a secure job in the public sector? It creates whole regions where the fiscal transfers are the only thing that keeps the economy afloat.
That just about works in the UK. It has been a unified state for several hundred years, and has close ties of language, culture and family between its regions – although it remains to be seen whether the Tory voters of the south-east will accept the deal forever. But it is very hard to see it working for the euro zone. Voters in Munich and Eindhoven already seem outraged by paying for the Greeks and Portuguese. When they get told that the transfers are permanent, and will rise steadily over time, they will surely refuse to pay. The scary truth is that even the one plausibly fix for the euro crisis doesn’t work.