Here's Why the European Union Is Fraying and Could Fall Apart
Former Federal Reserve Chairman Paul Volcker has stated that the most important price to an economy is the price of its currency relative to other currencies. This seems to be the problem underlying issues in the European Union and the now-fracturing relationship between Great Britain and the European Union.
The European Union was formed around the creation of a monetary union based upon the euro, which became the common currency used by almost all the nations making up the EU. As the monetary union was formed, its founders always understood that this "union" was only a start and had to be supplemented by a political union that would coordinate government budgets and economic structures.
The political union of the EU has been the biggest point of contention over the lifetime of the euro, and most of the skeptics of the survival of the currency based their skepticism upon the notion that the euro can't be successful if political union is not achieved.
Several examples can be cited of the weakness. First, there are the fiscal policies of the individual member nations. Although the EU has rules and regulations about governmental budgets and deficits, these have not been fully enforced, and even when they have been enforced, there is enough slack in the requirements that sovereign governments can conduct economic policies that are at odds with the overall position of the European Union.
Second, the various nations within the union have different policies with respect to labor unions and labor laws. These differences have led to varying degrees of productivity in the various member nations and have led to constraints on business innovation and market structure. As a consequence, some countries, Germany for example, have high levels of productivity and competitiveness in world markets, while other countries are lagging in productivity and competitiveness.
Third, as we have seen, over the past several years, several EU member nations have experienced growing "populist" movements composed of people wanting to hang on to the "old" ways of doing things, to hang on to the "old" economic structures, and hang on to the "old" structures of pensions and social welfare benefits. The British vote to leave the European Union was an example of the strength that these group have achieved within the European geographical limits.
As a consequence, the European Union has tended to bifurcate in terms of those countries that are more productive, that have more responsive labor markets, and that are not weighed down by historical legacies and out-of-date social structures and those that fall into the opposite camp.
The battle continues with Greece, Italy and Portugal constantly being highlighted as potential "exit" countries and with Spain and France not being far behind.
The euro-skeptics contend that this division cannot continue. The British situation just throws more issues into the fire. First of all, the British maintained their own currency, separate from the euro.
Then, you throw into the pot the type of divisions just mentioned that are being dealt with within the European Union and you have an even more complex situation.
Furthermore, there is the immigration issue, something that the various EU member nations have had some problems with, but which have not reached the level of the British discontent over the matter.
Finally, as Martin Wolf contends in the Financial Times, the people who voted to "leave" had no program, or, even and idea, of what leaving the European Union meant. Each component of the "leave" voters brought their own discontents to the ballot box and, as a consequence, left those in charge with no idea of how to proceed.
The European Union was formed to eliminate the many prices that existed between the various currencies of the member nations, thereby eliminating all the battles that go on between governments and their trading partners concerning the value of each currency.
Given only one currency, the EU could then build a geographic region that had the scale and competitiveness to operate within world markets and go up against the producers in the U.S., China and elsewhere.
The only thing lacking was the political union to coordinate economic policies and build economic structures that allowed for the creation of productive and innovative businesses that could compete within the world.
With the British pulling out of the European Union the issue of the separate exchange rate goes away as does the need to coordinate economic policies and structural rules and regulations with other governments. Or does it? This is the basic problem that will be dealt with in the negotiations about Britain's exit from the EU.
And, in the meantime, Great Britain loses the benefit of being a part of the European Union and gaining from the benefits of freer, more open trade.
Ultimately, the British and the European Union must deal with the fact that the world is becoming more and more integrated with more and more international trade. This means that the issues of currency value and trade interaction are not going to go away. And, the issue of innovation and productiveness is not going to go away.
And, as Paul Volcker suggested, the value of a country's currency is going to play a major role in such developments.
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.