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The road to a unified currency: Two views
Reprinted with permission of The Wall Street Journal, ©1992 Dow Jones & Company, Inc. All rights reserved.
Opinion polls in Europe show increasing opposition to ratification of the Maastricht Treaty and, hence, to European unification. This opposition is understandable because the treaty's ideas for further economic integration, including coordination on fiscal policies in order to facilitate the adoption of a single currency, can be viewed as additional steps toward a centralized European government. Not surprisingly, such steps are popular mainly with people who like large centralized government.
France, which faces a referendum on Maastricht in September, is a good example. There, the overwhelming majority of supporters of President Mitterand's Socialists favor ratification of the Maastricht Treaty, whereas more than half of the supporters of Jacques Chirac's neo-Gaullist party now oppose the treaty.
Some economists argue from basically an engineering perspective that the unification of currencies is efficient. A single currency avoids the transaction costs and uncertainties involved with the exchange of one money for another. From this standpoint, the argument for a unified currency is analogous to the case for a common language.
Settlement on a single language (English, it is to be hoped) would eliminate the costs associated with translation. The savings on transaction costs would, in fact, be far more substantial than those generated from a move to a common currency. We observe, however, that small nations are often willing to bear high costs to maintain or promote their distinct languages, such as Catalan in Catalonia (well publicized recently because of the Barcelona Olympics) or French in Quebec. This willingness indicates that groups of people with a common heritage attach significant benefits to having their own language. Much smaller benefits from individual currencies would be enough to outweigh the saving in transaction costs from moving to single currency.
Dukakis inflation
Unfortunately, the main case that economists have made against monetary unification (and similarly against a regime of fixed exchange rates without capital controls) is the Keynesian argument for the benefit of independent monetary policies. An economy that experiences a recession it supposed to value the opportunity to print a lot of money in order to stimulate the economy, and monetary unification eliminates this option. According to this argument, Massachusetts would have benefited greatly in the late 1980s if it could have printed a lot of Massachusetts greenbacks (presumably without former Gov. Dukakis's face on the bills) to counter the downturn in its economy.
A more serious analysis of the Massachusetts situation suggests that real factors are involved—shifts of industry away from defense and computers, high state tax rates, and the decline of the national economy—and that money creation would not be helpful. More generally, economists have been recognizing that the main function of monetary policy is to provide an underlying framework for the economy, not to attempt to fine-tune the business cycle. This outlook suggest that the benefits from independent monetary policies would be minor at best.
A more important criticism of monetary unification is that it contributes to the centralization of government more broadly: It represents a repression of national identity that could also be applied to language, culture, per capita incomes, the extent of public-sector activity, and so on. The appeal of a single currency is like the superficial attraction of central planning. A single monetary authority is thought to eliminate the unnecessary transaction costs from the existence of competing currencies, while the social planner is thought to remove the wasteful duplication from market competition. In both situations, the benefits from central planning are exaggerated and the rewards from competition are underestimated.
Proponents of a strong central government sometimes argue that "chaos" results from the uncoordinated policies of individual governments—for example, from 50 state governments instead of the U.S. federal government. Such arguments have been used to rationalize and advance the centralization of governmental power in the U.S. This concentration of power loses the benefits from competition among governments and also precludes a good match between public policies and the preferences of the residents of the individual states.
Each state government can, for example, choose different levels of spending on education and welfare, different policies on drugs and crime, and—if the Supreme Court would allow it—different regulations on abortion. The apparent chaos from this diversity should instead be viewed as a mechanism to give the people in different states the policies that they desire.
The central issue, which is not well understood, is the optimal size of a country and, as a related matter, the optimal range of application of a language or a currency. Empirical observation suggests the desirability of avoiding the two extreme outcomes: a single world government with one language and one currency and a proliferation of thousands of countries, each with its own media of speech and exchange. Languages and currencies would not be very useful if each person used his or her own specialized medium, but the desirability of full coordination is also doubtful.
Large countries can secure the benefits from reduced costs of public goods, and a common language and currency are two examples of these benefits. The costs of larger countries involve the increased potential for government-sponsored monopoly power and the decreasing likelihood that centralized decisions can be matched with the differing wants of more diversified constituents.
In some cases, outcomes would be better if countries became smaller and if government policies thereby became better suited to the characteristics of their populations. These arguments can rationalize the kinds of sessions that have recently become popular, although the process of separation sometimes entails violence and other costs. These costs can be attributed now to the act of secession, but they can just as well be ascribed to unwise unifications—forms of forced integration—that took place in the past. One drawback from excessive unification, such as the current plans for bringing the European countries closer together, is the high cost of dissolving these linkages later on.
United Nations no model
A similar perspective applies to various international organizations that seek to perform governmental functions that extend beyond the boundaries of single countries. The United Nations, for example, strives to perform some functions of a world government, and some observers think that it would be desirable if this kind of institution made numerous global decisions, including environmental regulation, energy production, redistribution of income between rich and poor countries, choices about war and peace, and so on. If a single European currency is a good idea, then why not go forward to a world currency managed by a central bank stationed at the U.N.?
Before we get carried away along these lines we ought to worry about how well the U.N. has been performing its existing tasks. We might worry, for instance, about New York Times reports of Secretary General Boutros-Boutros Ghali's recent pronouncement that Yugoslavia's problems are not a priority because they amount to "a rich man's war."
The case for the United Nations, like the case for European unification, is similar to the argument for socialism, but now expressed on a global scale. Advocates of limited government should therefore be troubled by policies that increase the power of the U.N. and similar institutions. Remarkably enough, the major recent contribution to this power came from President Bush's effective use of the U.N. during the Gulf War. Presumably, the president did not intend to contribute in this way to world socialism!
In response, Minneapolis Fed Research Director Arthur J. Rolnick disputes Barro's claim and says a unified currency—or a fixed exchange rate system—will promote international trade and bring prosperity to participating countries. Rolnick, along with Minneapolis Fed Senior Research Officer Warren E. Weber, argued for fixed exchange rates in the bank's 1989 Annual Report.
