Euro Zone Nations Wrestle With a 'Trilemma'
The New York Times, July 6, 2012
LONDON — So, let’s say you have mastered the euro zone concept of “financial contagion.” Maybe you even know a thing or two about the euro “doom loop,” in which sickly banks and indebted governments threaten to drag each other down a death spiral.
Time now to learn a new buzzword, one that captures the anxieties of those seeking long-term stability for the euro currency union: “trilemma.”
The term, coined a dozen years ago by a Harvard University economist writing about the global economy, has come to encapsulate the awkward political options confronting the 17 euro zone countries.
To make the currency union work for the long haul, euro countries’ heads of state have generally concluded that they must more fully integrate their economies. But within their own countries, the political leaders have only shallow support for that idea, if not outright resistance, from voters.
According to the trilemma theory, drawn in part from studies of the economic crises of 1930s and 1940s, it is possible to have two of three things: deep economic integration, democratic politics and autonomous nation-states.
But under the theory, it is not possible to have all three.
“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.”
Mr. Rodrik, professor of international political economy at the John F. Kennedy School of Government at Harvard, first wrote about the trilemma idea in 2000, well before the euro zone debt crisis began. But he said the euro problems presented a perfect illustration of his theory.
It is much more than an obscure academic debate. Almost everyone now accepts that much closer economic integration is needed to save the euro.
But that raises the prospect of a reduced role for each nation-state within the currency bloc, and the creation of something closer to a federal structure for Europe, of the type that many of the original architects of the euro always expected to evolve.
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 theEuropean Union’s executive body, the European Commission, a post now filled by a candidate nominated by the European Council and approved by a majority vote of theEuropean 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.
The democracy question also surfaced late last month, when four of the European Union’s most senior officials published their blueprint on deeper monetary union.
“Integration and legitimacy have to advance in parallel,” said the paper by Herman Van Rompuy, president of the European Council; José Manuel Barroso, president of the European Commission; Mario Draghi, president of the European Central Bank; and Jean-Claude Juncker, the head of the euro zone finance ministers.
But they ducked the question of how such a parallel advance might be achieved.
One preliminary suggestion, which was to create a new parliamentary body for the euro zone, made up of members of the European Parliament and of national lawmakers from the 17 nations that use the currency, proved too controversial to be included in final draft of the four presidents’ blueprint.
Even so, in European capitals, the ideas dominating debate tend to center on the creation of a new euro zone parliament or on drawing national parliaments more closely into European decision-making — or some combination of the two.
Yet policy makers know the political context for making such changes is extraordinarily difficult. Nations in the euro zone’s southern tier are already facing years of fiscal austerity to meet their obligations to the currency union, while people in the stronger, northern economies that have provided financial guarantees for the bailouts are reluctant to take on further monetary burdens.
“We must respond to citizens in countries which undergo protracted structural adjustment and where unemployment is high,” Olli Rehn, a European Commission vice president who is responsible for economic and monetary union, said in a speech last month. “But we must also dispel the concerns of those citizens, who would otherwise perceive this process only as financing a supposedly perpetual flow of transfers.”
And it is difficult to argue for “more Europe” when smaller countries are already bristling at the decision-making power of larger countries and as long as bureaucrats in Brussels seem remote from voters.
“When Europe’s citizens and the authorities in Brussels look in the mirror, they don’t see each other,” said one European official, who was not authorized to speak publicly. “Yet every new step toward integration cuts closer to the sinews of the state — and in most countries that hurts.”
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.”
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.”
A version of this article appeared in print on July 7, 2012, in The International Herald Tribune.
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