Go West and Take the Best
Paul Krugman has an interesting piece on federal and local expenditure in the United States, where he shows that the consolidated fiscal stance has been considerably more restrictive with Obama than during the Reagan era. This is not what retained my attention, nevertheless. Krugman does not mention that most of the US states (the exception being Vermont) have some form of balanced budget amendment. Krugman himself had warned a while ago that this made the task of the federal government in fighting the recession particularly hard. But once again, this is not the point I want to make.
The point I want to make is how disruptive the balanced budget rule has been for American states that were forced to cut spending and lay off public employees at the very moment in which the opposite were needed, thus exacerbating the crisis. It is true that most American states have stricter rules than the fiscal compact just approved in Brussels (notably, the budget must be balanced every year); but it is also true that the federal government in the US retains the possibility to conduct discretionary policy, that it used massively also to (partially, as Krugman shows) contrast the procyclical expenditure cuts at the state level. European countries have no supranational entity of that sort.
The fiscal arrangement of a monetary union crucially depends on the articulation between the different layers of government. I assisted last week to a speech of Thomas Sargent, a redo of his nobel lecture; he shows that the transfer of debt from the state to the federal level in the 1790’s happened concomitantly with the transfer of power to tax (most notably imposing custom duties), i.e. with the creation of a fiscal union. He left the audience free to draw the lesson it wishes from this.
Sargent seems to suggest that t a monetary union can pre-exist or follow a fiscal union, but that one cannot go without the other for a long time. And furthermore that a fiscal union needs to be much more than simple coordination of policies: it needs transfer of power to tax and spend, which in turn requires political integration (remember? “No taxation without representation”…).
I spent my years in school studying comparisons between the US and the EU that would emphasize how flexible the US economy is. Look west, we were said. Liberalize your labor and product markets, and you’ll grow like the US. I became convinced over time that the US economy also has other flexibilities (notably in the conduct of macroeconomic policies; I will come back to this) that we lack. Now I realize that we are tightening our institutional setting as well, while the US institutions are carefully designed as to retain a certain flexibility. Interesting how selective we are when looking at the American model…
The United States example shows that stripping local governments of the right to conduct discretionary fiscal policies should only be done if a federal government on top retains the capacity to react to shocks. Are our leaders ready for the United States of Europe?