Political union is transfer union

It is very often suggested that there is no point looking at solutions to the European crisis that don’t involve more “political union”, an EU institutional term meaning a move towards a more centralised and “federal” (in the special EU sense) union. This argument is curious.

For a start, what is it about political union that is meant to solve the problem? Some people will probably say that it would be “a message” or “a signal” or something, a demonstration of commitment to the European Union that would in itself create confidence. But this sounds a lot like hand-waving to me, or the kind of genius that suggested introducing a pan-European tax as a way of making the Union more popular (yes, Mr. Verhofstadt, it is not entirely forgotten).

More seriously, political unions tend to have a substantial budget and the capacity to use it in a discretionary sense. In the political union between the provinces of Germany, there is a systematic redistribution of money between richer and poorer parts of the union. In the political union between the states of America, there is less overt redistribution, but there are very large federal agencies that in practice tend to redistribute money around the union. NASA, for example, had a secondary and very important role subsidising the industrial development of the South-Eastern US, and this goal influenced important design decisions in the Apollo and Shuttle programs.

It is also true that some degree of redistribution is inseparable from anything that could be described as a political union. Try to imagine the opposite. The political union would have to be designed so as to make absolutely no change to the a priori distribution of income, an exercise that boggles the mind in its complexity and futility.

The simplest model would probably be a libertarian utopia/dystopia with a minimal state devoted solely to defence, funded by a flat tax on the citizens. But now imagine what would happen when its army deployed for annual exercises. A large quantity of income collected all over the union would suddenly be spent in the exercise area. If, as is likely, there were a limited number of convenient training areas, or the army tended to train where it expected to fight strategically, we would expect to see a military-industrial complex emerge in those areas.

Just because your biggest customer is the army doesn’t make you useless, of course, it may make you indispensable. And in that case, our political union that is not a transfer union would have to think about how to keep you going between deployments, in which case it would be undertaking both industrial and regional policy. A state (or political union) that has no budget, or a budget that is economically indistinguishable from the absence of one, is no state (or political union). Marx thought that the state would wither away in true communism; you can argue about what he meant, but I think he imagined a society in which the functions of the state were either unnecessary, or else carried out by the citizen as a matter of course, not even perceived as a duty. A state whose budget changed the structure of the economy so little as to be totally non-redistributive would, I think, have a fair claim to have withered away.

I can’t see how an entity that made no transfers of wealth or income can be considered to have the functions of a political union. Further, even if a political union was created that was not also a transfer union, it wouldn’t solve the problem. Various parts of Germany need transfers from others; the same goes for all political unions. Declaring “political union” doesn’t solve the problem in itself. It might be taken to mean “direct ECB management of Greek public finances”, but then this is just hoping that the Greeks can find some more money with more will, and perhaps a pony as long as the pony is Karlsruhe-compliant.

Here is the problem: political union is transfer union, or it is not political union, and anyway, if it is not transfer union it is no solution. Transfer union is unacceptable. Therefore, political union is unacceptable, and anyone who talks political union is saying “Let the file mature while we do what the EU does best, holding an Inter-Governmental Conference”.

19 thoughts on “Political union is transfer union

  1. Good one.
    Many years ago Staten Island, an outlying and very much suburban borough of New York City, commissioned a study on what they thought would be the benefits of seceding from the city. They found out they get more in subsidies than they give back in taxes.
    So much for that.
    Even on a relatively micro level, political unions are transfer unions.

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  3. It seems obvious that a transfer union involves moral hazard. But is this necessarily the case?

    Suppose that we have some formula which said how much aggregate demand each country needed. If the agreement is simply that the surplus countries hand over the money to the deficit countries, that would be moral hazard. Suppose, however, we had an agreement as follows: each surplus country must invest some amount (given by the formula) in the private sector of the deficit countries. The surplus country retains ownership of the equity they have invested in. In this scheme, the moral hazard would be eliminated: because each country would be acting separately, rather than contributing to a central pot, the managers of each investment would be accountable to the electorate which was paying for it.

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  5. Political Unions are transfer unions. You are absolutely right. I’m not convinced your conclusion (unacceptable) is as inevitable as you make it sound. Everything depends on how you sell it. From what I see now it is going in this direction: more political union: yes. Therefore: more transfers.

    BUT: the price to pay for this will be outsized political weight for Germany (France will take advantage of this). Britain (as non-euro member and general pain in the a$$) will lose out and may even leave the EU (Cameron needs something to show as his achievement).

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  7. To be honest, I don’t care about moral hazard; in pretty much every case it gets invoked, the problem you’re dealing with (here: Depression 2.0) makes the alleged consequences of the hazard (slightly higher charge offs on some classes of debt) look risibly puny.

  8. Henry Farrell has pointed to this interview more than once. Schäuble: “Political union naturally means a bit of federalism in the German sense of federal … If you want to create a federal organisation, you must be ready to have a certain amount of redistribution within it. You can dismiss that by rudely calling it a ‘transfer union’. But strong and weaker states both have their responsibility. We are asking a lot of the weaker ones, but the strong also have their responsibility, and we must explain that as well.”

    If loans become transfers with another big restructuring in Greece (OSI rather than PSI this time), we’ll see how big the appetite is for redistribution. I think the German electorate and the German press will be much keener on retribution, and who’d back the politicians to do anything other than follow ? Would there be greater willingness to extend solidarity to the Spanish, rather than the Greeks, if it comes to that? I don’t see why. What would change would be the calculation of German self-interest, rather than an acceptance on principle of fiscal transfers. As for “political union”, everything we’ve seen so far shows a preference for Berlin-based supervision of national budget-making, along the lines you describe in your second-to-last paragraph.

  9. The original US government might be a suitable framework for the EU. There was no ‘transfer union’ between Pennsylvania and Massachusetts. The Federal government existed mainly on revenue from customs, running the post office, the mint etc. The states ran their own affairs ( and occasionally went bankrupt).

    It worked fairly well until the 1850’s when the cotton industry became so lucrative ( and slavery controversial) that the Southern states wanted out of what they perceived was a ‘transfer union’ wherein they subsidized the North through tariffs on their imports financed by their exports of cotton and got nothing but ‘abolitionists’ for their trouble.

    Well enough history. The point is a limited Federal government is possible even in the modern world if you give it control of the currency and a source of revenue sufficient to fund its agreed upon duties. In fact, that is the real beauty of the original Federal concept. States were free, within the limits of the Federal Constitution, to experiment, to provide as much or as little government as their citizens desired. Public schools got started in Massachusetts in the 1820s. Other states saw the benefits and started their own until they all had them but each state funded its own to the level it thought suitable and within its means. That was the key. The Federal government was constitutionally delegated control of what was ‘legal tender’ or money so it was not unlike the current Euro system ( without the Target 2 feature).

    We may even be heading towards our own version of Greece or Spain wherein some of our state governments ( California and Illinois ) made pension promises to public employees they will not be able to meet. There will be no going to the Federal government of the Central Bank for loans or bailouts though because the other states would outvote them in Congress. California would either have to raise taxes on its citizens to pay its obligations or the citizens will have to vote to void those pension promises. The economy of those states will not collapse because they simply could not indebt themselves to European levels owing to their inability to borrow from our Central Bank or the Federal government.

  10. The problem is, though, that “make sure they can’t borrow too much money again” is a secondary issue. If someone is having a heart attack, you don’t tell them to stop smoking and go for a run. Prevention would have been interesting 10 years ago; what we need is cure.

    And of course, the € was designed to provide quite a lot of prevention. Among other things, however, nobody seems to have thought that a national government whose finances were entirely in order could suddenly find itself on the hook for vast amounts of money because the banks blew up.

  11. On Facebook, Edward Hugh has been arguing that a defacto transfer union already exists within the eurozone. Surplus generating countries (Germany) making transfers to Deficit countries (say Spain) via the private sector. Edward’s example is the savings of Germany being invested in Spanish property. The risk is that the transfer becomes permenant due to the crisis.

    The current tack of forcing soverigns to absorb and then borrow for their national bank losses is proving destabiling.

    To go back to one of your initial points, I believe that the focus on greater political union has nothing to do with economics but is simply to publically legitimise the previous and future loans from the core to the rest of the eurozone. If the running of core functions like the ECB is a template, then greater political union really means greater German control of the system.

  12. scott, in large parts of the US the currency used prior to the Civil War was issued by local banks in the form of bank notes, theoretically redeemable at the issuing bank for gold/silver coin of course, theoretically being the operative word.
    It wasn’t until Lincoln, via the institution of an onerous tax on these notes, eliminated them that we actually had a uniform currency for the first time. The US prior to the Civil War was, currency wise, a lot more like Europe before the euro in the sense of having a large number of what were in effect local currencies, valued according to the creditworthiness of the issuing banks, said creditworthiness being tied, of course, at least partially to the soundness of the local economy. The criticism is of course that it was a mess, but that misses one very interesting little thing: in the places where this occurred, the economy grew very very rapidly and, as Galbraith pointed out in Money: Whence it Came, Where it Went, the looseness of both the currency and the banks that issued them allowed a lot of people who would otherwise not have had a chance for a start at their chosen enterprise to get that chance. One wishes the economists who pushed for the euro had known a bit more history and a bit less economics.
    See Steve Mihm’s A Nation of Counterfeiters, which is in fact a very nice little history of this era.

  13. Also, it should be noted that the US’s longstanding structure is that it pays for debts incurred for the common good of all the states ONLY. If a state runs into trouble with its finances, it’s on its own as far as fixing it.
    However, it’s also true that only a small minority of states are net contributors to the Federal gov’t, the rest being net receivers, through the trinity of defense/farm/social transfers (mostly Social Security and Medicare, in the latter case). California, as far as I know, is a net contributor usually, although these things tend to reverse with local economic conditions. Also, California does have a very large defense component to its economy, which even in normal times would tend to dampen its net contributor status.
    The idea of a banking union is, to my mind, no different than the FDIC over here, or any of the depositor insurance schemes the individual countries in the eurozone might have. Part of the scaffolding for the euro should have included something like an FDIC from day one. It’s kind of shocking, actually, that that wasn’t the case.

  14. That libertarianism is a fundamentally flawed political ideology which can not work in reality is an argument against libertarianism, not an argument against federalism. This is ironic as the author apparently himself is a libertarian who finds taxes (which is what he really means by ‘state budgets’ and ‘transfer unions’) unacceptable.
    But for some inexplicable reason a significant minority on the net still cling to the failed ideology of libertarianism, so I will also point out the obvious: federal republics, what the author terms “transfer unions”, work. The US, France, Brazil, India and Russia are all examples of federal republics, and are among the most successful countries on the planet.

  15. @Andy
    “Edward’s example is the savings of Germany being invested in Spanish property. The risk is that the transfer becomes permenant due to the crisis. ”
    I don’t know if this is really Edward’s point but it semms completely wrong to me.
    For example, in Italy the national health service is mostly paid by taxes but, since Lombards are on average wealthier than Sicilians, this means that Lombards are actually subsidizing Sicilian’s health. This is a “permanent transfer” system: Lombards giving every year money to Sicilians.
    If Germans were to donate – and never ask back – some bazillion euroes to Italians, this would be a one-off transfer, not a permanent one.
    If Italians were to default on bonds owned by Germans, this would be a the same: a one-off transfer, not a permanent one.
    If the Germans lend another bazillion euroes to the Italians, this is not even a transfer, since the Italians are debtors and the Germans can count their credit among their assets.
    If the Italians, who have a lot of debt with the Germans, can only rollover it, but cannot pay it back – for whatever economic mechanism – then this is a permanent transfer, meaning that the Italians are transferring wealth to the Germans, not the opposite.

    This really is funny and surprise me: people treat capital loans as if they were gifts. But tell me: is this the same if I give you 1000€ for Christmas or if I lend you 1000€ at 2% interest? It seems to me that this is very different.

  16. “For example, in Italy the national health service is mostly paid by taxes but, since Lombards are on average wealthier than Sicilians, this means that Lombards are actually subsidizing Sicilian’s health. This is a “permanent transfer” system: Lombards giving every year money to Sicilians.”

    But of course. Just as all Americans now pay for uninsured and underinsured persons by mechanisms they do not see. And just as Germany now pays for problems in Greece, whether or not they ‘approve’ payments. One way or another we all pay for those who do not or cannot.

  17. @wallyfurthermore

    “And just as Germany now pays for problems in Greece, whether or not they ‘approve’ payments”

    But in facts Germany is not “paying” for problems in Greece, Germany is “lending”.
    This means that the actual transfer is, currently, going from Greece to Germany, and not in the opposite directtion.

    It is possible (though not necessarious) that Germans will pay, sometime in the future, something for the Greeks, but this has not happened up to now, so the rethoric that Germans are paying, or have paid in the past, for waste in GIIPS countries, is highly misleading; in particular, this is highly misleading for the Germans IMHO.

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  19. This is ironic as the author apparently himself is a libertarian who finds taxes (which is what he really means by ‘state budgets’ and ‘transfer unions’) unacceptable.

    No. I really have no idea why you think this. Further, it’s not me who finds “transfer union” unacceptable in principle. It’s the Germans.

    My point is that:

    1) If it’s not transfer union, it’s not political union.
    2) If it’s not transfer union, it’s no solution.
    3) Anyone who argues for “political union” while considering “transfer union” unacceptable in principle is being incoherent at best and dishonest at worst.

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