Why asymmetrical monetary unions are bound to fail (unless they feature an effective, extra-market surplus recycling mechanism)

Asymmetrical monetary unions, wherever and whenever tried in combination with free trade and deregulated capital movements, ended up in tears and retribution. The Gold Standard, the various pegs between domestic currencies and the US dollar (S.E. Asia, Argentina, Mexico etc.), the ERM (European Exchange Rate Mechanism), the Eurozone that followed the latter’s collapse etc. they all resembled invasions of Russia – that is, a brisk beginning full of enthusiasm and hope, rapid progress that seemed unstoppable, followed by a heart wrenching slowdown as Cruel Winter took its toll, ending up with blood on the snow and infinite retributions thereafter.

This short paper offers a theoretical explanation of asymmetrical monetary unions’ inexorable slide toward crisis and explains:

(a)  Why the Eurozone’s current response to its crisis (e.g. the so-called banking union decided upon, the ECB’s OMT, the insistence on austerity with ‘structural reforms) will ultimately fail, and

(b)  Why our Modest Proposal for Resolving the Euro Crisis offers a minimalist yet sufficient prospect of reconfiguring the Eurozone in a manner that renders it viable.

1. Introduction: the hypothesis

What is an asymmetrical monetary union?

It is a monetary union between:

  • national economies that comprise large oligopolistic manufacturing sectors, replete with economies of scale (as well as of economies of networks and of scope), with production units operating at excess capacity (that reflects their market power and their capacity to deter competitors) and concentrating much of economic activity on the production of capital goods; and
  • national economies where the capital goods sector is atrophic, where production is much less capital intensive, and where economic rents are not due to economies of scale but due to corrupt practices and socio-political impediments to competition (e.g. restrictive practices, crony relations between authorities and particular business interests).

What is an extra-market Effective Surplus Recycling Mechanism?

Surpluses can be (and often are) recycled by privateers who invest their profits or surpluses (that are accumulated in a region or a country which enjoys large net exports) into a region which is in deficit (vis-à-vis the surplus region from where the investment funding originated).

In contrast, an extra-market surplus recycling mechanism is one which relies on political (as opposed to market) institutions. For example, unemployment insurance or the food stamp program in the US offer automated extra-market mechanisms by which surpluses from the surplus regions or states are recycled to the regions or states with higher unemployment and/or poverty– that is, mostly, to the deficit regions or states. Another example is America’s military-industrial complex, which famously directs large-scale investments into the deficit regions or states of the Union. Europe’s Common Agricultural Policy and so-called structural funds are also examples of surplus recycling mechanisms (even though they are not effective ones, at least in the context of the Eurozone).

For such a mechanism to be effective as a stabiliser of the asymmetrical monetary union it must be sufficiently large enough to counteract the inherent imbalances of an asymmetrical monetary union; and flexible enough to increase its ‘volume’ of recycling pro-cyclically.

Must monetary unions fail?

The answer is: Yes if

  • they involve free trade and free capital movements
  • they are asymmetrical, and
  • they feature no efficient extra-market Surplus Recycling Mechanism that helps stabilise it.

Here is why:

2. Real Adjustment in a Symmetrical Monetary Union

Consider a monetary union between two countries, A&B, in which:

(i) there are no trade barriers and capital can move freely from one country to the other

(ii) each market comprises exclusively price taking firms, customers and workers (i.e. no one has the capacity to influence price by reducing the quantity they supply to the market)

In this case, as each supplier is unable to influence the price she is selling at, the supply of goods, services and labour will carry on increasing until their price exactly equals the cost of supplying the last unit (marginal cost). Prices in each country will, therefore, equal marginal cost while wages will equal the product of the price of the final product (produced by the worker) and of the marginal product of the worker (i.e. the quantity of the final product she produced during the last house she worked).[1]

For there to be an equilibrium in this symmetric two-country (free-trade and free-capital movement) union, there must be no incentive for suppliers in one country to divert output from their domestic to the foreign market. Real prices, in other words, must be the same in both countries. To see how equilibration is achieved here, suppose that (for some unspecified reason) productivity rises faster in country A than in B. As this happens, the marginal cost of producing in A falls and so does the price of goods and services in country A (since we have assumed that competition so vigorous that prices will merely reflect marginal costs). But as the marginal cost of production in B has not fallen, prices in B remain at the original, higher, level. This means that, all of a sudden, A’s producers can make a profit by selling their output in B rather than in A.

The trade imbalance will cause both prices and wages in B to start falling relative to A: As supply in country B rises (due to more imports from A), domestic prices fall. As they do, they push down wages – since the labour market is also competitive.[2] [The only way that wages will not fall also is if marginal labour productivity goes up at the same time. But that is another story altogether.]

Meanwhile, in country A, as output produced domestically shifts to country B, due to the price differential, supply in A’s domestic market falls and price pA rises. As that happens, the wage in A also goes up.[3]

The end result? The productivity boost in country A will have left real wages the same in both countries (both prices and wages will have increased in the country with the productivity gain and will have fallen in the other country) but will have increased output in both, thus spreading the benefits of the productivity gain to both countries – even to the country in which there were no productivity gains.

Monetary Union irrelevant: In this ‘world’, whether the two countries are in a monetary union or have their separate currencies is neither here nor there. If they have the same currency, the above holds and prices are expressed in the same, common, currency. If they have separate currencies, nominal levels of prices and wages will not change in either country except that the exchange rate will alter (with A’s exchange rate strengthening vis-à-vis B’s) so that B’s wages and prices are now worth less in terms of A’s wages and prices. Still, trade will be balanced and real wages will remain unchanged in both countries (even though in nominal terms, and measured in A’s currency units, prices and wages will have increased in A and diminished in B).

Concluding remark: In this type of symmetrical Monetary Union trade surpluses and deficits, as well as different productivity growth paths, are auto-corrected though a process of internal devaluation in the country whose productivity growth lags behind and of internal revaluation in the ‘stronger’ country.

3. An asymmetrical Monetary Union

Recall the above definition of an asymmetrical monetary union. In the context of our two-country model in the previous section, this would be equivalent to assuming that country B is as before while A comprises large oligopolistic manufacturing sectors that produce high end consumption as well as capital goods (and featuring significant economies of scale, large excess capacity, entrance deterrence capacities that keep competitors at bay (that reflects their market power and their capacity to deter competitors).

Let us take a closer look at the two quite different countries in terms of their price and wage dynamics

COUNTRY A: Heavily oligopolised, with a strong capital goods sector

Price setting dynamics: Corporations have the (oligopoly or monopoly) power to effect price changes simply by restricting output to levels below the ones that would eliminate profit margins. In analytical terms, as economists like to say, price changes in A are now mediated by the elasticity of domestic demand.[4] The less responsive domestic demand is to supply changes the greater the price-cost margin and the more supply reductions push prices up.

Related remark: This helps explains why the price inflationary dynamic is more of a threat to countries like Germany when output drops than in places like Italy and Greece.

Wage dynamics: Similarly, the lower the elasticity of demand the greater the impact, and the more disproportionate the impact, on the wage independently of the level of marginal productivity. Moreover, the less responsive the labour supply to wage changes, the larger the wage boost (for the same labour productivity) for a given price rise.

Related remark: This also explains the concern of Japanese and German corporations to shift production to regions/countries with a more elastic labour supply – i.e. Portugal and later Eastern Europe for Germany; S.E. Asia in the case of Japan].

In short, a reduction in domestic supply will affect prices and wages disproportionately in countries featuring strong, oligopolistic producers enjoying high degrees of capital intensity and a capacity to deter foreign competitors via the preservation of excess capacity. Real output and employment will fall while real wages will probably rise, unless some corporatist policy is enacted that keeps wages lower while high interest rates preserve price stability.

Related remark: Before the introduction of the euro, for instance, the German Central Bank, the Bundesbank, was notorious for keeping interest rates too high for the likes of France, Italy, Spain etc. (i.e. for its partners in the ERM, the European Exchange Rate Mechanism), thus making it hard for them to join Germany on the ‘glidepath’ that would lead to the common currency they had all agree to work towards. Many Europeans were asking: Why is the Bundesbank doing this? Why is it wrecking the ERM by pursuing high interest rates? The above offers one explanation. (It also points to reasons why corporatism is all the rage in places like Germany – along with a tendency to shift production to a wider ‘vital space’; e.g. Eastern Europe.)

COUNTRY B: Week capital goods, no or low price-cost margins, negligible entry deterrence

My assumption here is that, meanwhile, country B remains one with a minimal capital goods sector, few economies of scale, and no entry deterrence capacities by local industrialists. In short, country B remains as it was under Section 1 above – the symmetrical case. Economically, this is significant because in country B (unlike country A) the movement of prices and wages will reflect a lot more (that in A) the movements of marginal costs and productivity.

Moreover, as marginal productivity tends to be much lower in the more monopolistic economy (A), due to expensive R&D in capital goods, country A’s goods will tend to be more price competitive than B’s in country B even though B’s producers will enjoy no price-cost margin. Which means that A’s output can yield substantial net exports until the point is reached when A’s productive capacity is exhausted (or, more likely, until producers in A suspect that exhausting their excess capacity further will reduce unacceptably their entry deterrence capacities).

Naturally, country A producers would love to practise price discrimination, charging higher prices at home than they do in country B. However, in this union between A&B the scope for price discrimination are severely circumscribed by the free trade agreement. So, since they cannot really price-discriminate, A’s factories will self-restrain and stop producing at a quantity of output well short of the level at which price equals marginal cost (i.e. well before pA=MCA).

In short, A will develop a major surplus vis-à-vis B which no amount of price competition can annul and which is only restrained by the degree of price inelasticity of demand in country A. To be precise, the more elastic A’s domestic demand, the greater the surplus that A has vis-à-vis B.

4. Real adjustment in asymmetrical Monetary Unions

Unlike the symmetrical case (see Section 2 above), where monetary union makes no difference to the dynamics of adjustment following some shock (e.g. differences in productivity growth), in the case of asymmetrical monetary unions monetary union (or fixed exchange rates) make all the difference.

If exchange rates are variable, a large imbalance of trade in favour of A causes a reduction in B’s exchange rate that must, in turn, push down both prices and wages in B as denominated in the currency of country A. Hence the incentive of A’s producers to sell in B should diminish. As their exports to B fall, B’s producers will begin to contribute more output that will replace to the supply of goods in B (even manage to export part of their output to A). In short, B’s deficit will have been checked by an exchange rate adjustment – a devaluation of B’s currency.

But under monetary union, there is no such direct equilibrating mechanism. The only possible adjustment comes from internal devaluation in B courtesy of B’s financial constraint.

B’s financial constraint and its ‘overcoming’ by capital inflows from A

Persistent trade deficits need to be financed somehow. If B is starved of financing, as a result of the permanent transfer of rents to A, at some point aggregate demand in B will wane. As it does, prices will fall and wages will follow – the internal devaluation route toward equilibration being activated by B’s lack of access to sources from which its deficits can be financed.

As A’s trade surplus builds up, rents accumulate in A’s banks and, importantly, savings in A exceeds massively the amount of investment needs of its oligopolistic firms. This glut of savings pushes interest rates downwards and, more generally, rates of return are at very low levels. Under a variable exchange rate regime, financial flows are limited by exchange rate uncertainty. However, under a credible peg or, even better, a common currency, the temptation is too great to resist: capital flows abundantly from A to B, where it finds higher yields, financing B’s aggregate demand for A’s net exports.

Crucially, B’s capital inflows alter the structure of B’s economy. A large intermediation sector (services) develops in B while B’s manufacturing wanes under the inexorable pressure of A’s exports. While manufacturing wages collapse in absolute and per worker terms, the portion of the wage bill that comes from this parasitic, import-and-debt financed sector rises. As it does, aggregate demand in B is bolstered in this manner and, therefore, B becomes immune to the standard internal devaluation dynamics that standard trade theory predicts. Additionally, the capital flows into B prop up asset prices which create an internal financialisation drive which further boosts domestic aggregate demand within B.

Interestingly, B’s bubble economy grows faster than A’s. Why? Because asset prices are kept stable in A courtesy of the capital outflows. Moreover, to preserve its mercantilist stance, in the absence of a monetary union (e.g. under the ERM’s quasi-fixed exchange rates which were combined with different interest rates in each country), country A has a tendency to keep interest rates higher at home in order to prevent a further capital exodus from A. This has the effect of limiting domestic aggregate demand, suppressing both growth rates and well as inflation rates. The end result is a deepening of the productivity and competitiveness differential between the two countries causing a reinforcement of the bubble dynamics in country B.

In short, A exports to B not only goods but also (a) a recession in B’s real economy and (b) an asset inflation in its financial and real estate sectors – until some shock (external or internal) bursts these asset inflation bubbles proving beyond doubt that the earlier ‘growth’ phase was, indeed, unsustainable.

5. Crunch time

What happens when the bubbles burst (e.g. as a result of over-extension of some developers, borrowers, financiers in country B)? Capital flows are instantly reversed and private sector debts turn bad. Banks in B then begin to fail, causing stress in A’s banks (due to their exposure to B’s banks, developers, and intermediaries), the state has to intervene (in both countries to keep banks open) and, therefore, private debts are transferred to the public purse.

Without a monetary union, the major shock absorbers in B are (a) devaluation, (b) default on foreign denominated debt (but not on domestically denominated debt as the Central Bank can cover those), and (c) bank nationalisation (in conjunction with the nation’s Central Bank that pumps liquidity and capital into them).

Under a monetary union, B’s government has no Central Bank to back its debt refinancing. Yields rise massively and the state is forced either to default or to turn to austerity. Default creates more problems for the banking sector (which is going under anyway) and cannot work within a monetary union – unless the default is used as a negotiating tactic by B within a monetary union, demanding a new architecture that makes it viable. Austerity, on the other hand, serves the role of imposing a proportional reduction of wages and prices – one that, as we have seen, works only if (a) we live in a perfectly competitive world of price takers in both A and B, and (b) there is no debt (private and public) overhang (see Section 2 above).

Why austerity is bound to fail in an asymmetrical monetary union

Wage and price reductions must be huge to stimulate domestic production in country B to a degree that makes a difference. The reason, of course, is that marginal costs in A are so much lower; indeed, many of the goods that A produces are no longer being produced in B (e.g. white goods in Greece after the takeover of that industry by German companies during the ‘good’, boom, times).

But even if these reductions are enormous (as a result of the depth of the recession in country B), and thus manage to boost domestic manufacturing output, such reductions will destroy the parasitic non-manufacturing sector which is where, following the boom years, B is deriving most of its income from. Which means that neither private nor public debts can be repaid.

6. Summary

Following a financial crisis, the debt dynamics of the weaker member of an asymmetrical monetary union, in combination with the logic of oligopoly market power in its stronger partner, ensure that the internal devaluation effected by austerity will fail at bringing about the necessary real adjustment in the indebted deficit country – while undermining the net export position of the surplus economy.

What of the so-called ‘structural reforms’ that reduce labour and non-labour costs to business in the less developed deficit economy? The problem here is twofold:

First, it is not at all clear that such reforms will cause the advanced country’s corporations to be interested in investing in the deficit country when they are already choosing to maintain high levels of excess capacity at home (for the purpose of maintaining their market power via entry deterrence).

Secondly, and more importantly, once in the clasps of the kind of crisis described above, the monetary union’s common Central Bank is forced to push interest rates close to zero – the infamous liquidity trap of John Maynard Keynes (also known in the US as zero lower bound – ZLB). Once ‘there’, structural reforms may well fuel expectations of prolonged deflation (a fall in the absolute value of prices and wages) which, as nominal interest rates are stuck, give rise to an increase in real interest rates; precisely what the monetary union’s more depressed country does not need!

Epilogue: What should we do when caught up in such an asymmetrical monetary union at a time of crisis?

A prelude to the Modest Proposal

Monetary Unions that contain no Surplus Recycling Mechanism are bound either to collapse or to place the economies within into a never-ending, vicious, recessionary dynamic.

The question then becomes: What should a country whose social economy is caught up in this vicious cycle do? If the monetary union is loose (i.e. the currencies are pegged) the answer is simple: Away with it! Sever the peg, float the currencies and allow for exchange rate adjustments to do their trick. While asymmetrical oligopoly power will remain, continuing to curtail the less advanced country’s developmental possibilities, at least the debt-deflationary spiral will end.

However, when the monetary union is of the Eurozone kind (i.e. national currencies have been abolished and replaced by a common one), a decision by the weaker country to return to the national currency is tantamount to announcing a massive devaluation eight to twelve months before it is to come to effect (since this is the length of time it takes to create a new currency, to rejig the relationship between the banks and the Central Bank etc.). This will cause a prolonged exodus of capital, liquidation of assets and an almost total cessation of economic activity for anything up to a year. For that period, it is questionable whether the government of the departing country will have access to the foreign reserves it needs for the importation of basic goods (pharmaceuticals, energy etc.). Last, but not least, the breakup of this monetary union will necessarily cause a large recession in the advanced economy, as its own currency appreciates violently and its exports to third countries drop (e.g. German exports to Asia); a development that is bound to reduce demand for the weaker country’s potential exports to its former monetary union partner.

However awful the above scenario may be, a breakup of an asymmetrical monetary union caught up in such a downward spiral is inevitable. And because it is inevitable it is best to break it up sooner rather than later unless it can be recalibrated in a manner that addresses its faulty architecture. As this paper has argued, asymmetrical monetary unions that contain no effective extra-market surplus recycling mechanisms are guaranteed to fail. But what if an effective extra-market surplus recycling mechanisms were to be introduced? Might this not allow us to avoid the horrendous costs of the union’s breakdown?

The major problem with this idea is that, during a crisis, the political will to bring the asymmetrical monetary union’s economies closer together, via institutional changes, is weakened. Citizens turn their back to the monetary union, understandably, and begin to crave more (rather than less) national sovereignty. So, the great, big question becomes: Is it possible to give the peoples of such an asymmetrical monetary union more sovereignty while, at once, introducing an effective extra-market surplus recycling mechanism?

We believe that this is possible. And it is to this purpose that we have developed our, so-called, Modest Proposal for Resolving the Euro Crisis. In effect, its contribution is precisely that: To recommend four simple changes that can be immediately effected within the Eurozone, without any Treaty changes, and in a manner that enhances our Parliaments’ sovereignty, such that our asymmetrical, crisis-ridden Eurozone can be given the automatic stabiliser it misses: an effective extra-market surplus recycling mechanism.


[1] i.e. pA=MCA, pB=MCB, wA = pAXMPAL, wB = pBXMPBL, where pA is the price of output produced in country A, MCA is the marginal cost of output produced in A, and MPAL is the marginal product of workers in country A – and similarly for country B.

[2] Recall that wB = pBXMPBL. Hence, as price pB declines (following a flood of cheaper imports), the wage wB also diminishes.

[3] In A, wA = pAXMPAL. As the exodus of goods and services from A to B restricts supply in A, price pA goes up thus driving wage wA up along with it.

[4] In case of firms with a power to influence price, price exceeds marginal cost by an amount that is inversely related to the firm’s elasticity of demand: pA(1-1/ε)=MCA

24 thoughts on “Why asymmetrical monetary unions are bound to fail (unless they feature an effective, extra-market surplus recycling mechanism)

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  6. Yani,

    These are all theories that someone has to agree with and nobody with any power does.
    At this point Germany is moving full speed in the opposite direction, France does not care as long as the happy markets let it borrow at +-3%. Frankly the markets are so happy that nobody cares what happens in Greece. (Even the Greek politicians don’t care – why bother they are making 100K a year – never seen the crisis in their bank accounts)

    The only people that care are the Greek taxpayers because they are getting taxed and taxed again and again. And they face chronic unemployment while capital flows to safe heavens Germany, Belgium or Luxembourg?

    What Greece’s partners want is to preserve their own safe heaven status and to keep Greece in the high risk status because that reinforces their own safe heaven and reduces further their borrowing rates. They could care less about jobs and people in Greece.

    The heavily taxed Greeks on the other hand are still mesmerized by the euro so this story goes on for a little longer until someone wakes up.

    • Yanni,

      A few countries are clearly driving their own course for their own benefit and they are doing very well. There is no doom for a country like Germany that can borrow at 1.5% for 10 years. The stock markets outside of Greece are in the stratosphere. Housing in the US is higher than even the peaks before the crisis. This course of events dooms the weak and transfers wealth from weak to strong hands. Greece has no tools to cope with this type of competition – the euro took away all the options. Our partners give Greece low interest loans which is great relief but what they don’t give is the safe heaven status that could come from backstops and euro bonds. That they keep for themselves and they are thus producing this steady flow of capital and business northward drying out vital parts of the economies of the southern countries.

      If I were Angela Merkel and I cared about Greece, I would be alarmed that the biggest Greek companies like FAGE, Coka Cola 3E and now Bioxalko have decided to move to the safe heavens (OTE the DT controlled telecom monopoly transfers its cash balances daily to banks in Germany). For her to see that and to not realize that they are driving a huge wedge in the middle of Europe, borders on incompetence.

    • I totally agree with your comment. No european country has the incentive to pursue an extra market policy-even if it would be something good- which requires a very strong political will as well as a very strong european ideology and communal spirit. They couldn’t care less for Greece. Greece’s image is totally destroyed to the minds of the majority of european citizens. What puzzles me is that -unlike the opinions of most greek academics- the point of view a few aqcuaintances I have from the buziness world (the shipping buziness, small exporting industries and tourist enterprises) was from the very beginning that Greece should adopt again its own currency and show the way to other countries as well that are now as Greece trapped in the very specific and strategic interests of big powers. No fear that they would not be able to buy machines etc. I personally would rather live in a poorer country without iphone and expensive cars but with the vital ability to have- at least the prospect of -an internal market and domestic production. Not to mention dignity and freedom. Sometimes something which is rotten needs to collapse. I have read the book of professor Yani “the global Minotaur” and I think it is a great book. But unfortunately neither contemporary economic models/thinking nor european humanism can promise a change. Only history one day will point out which was the best choice. Dostoyevsky has very nicely expressed the trade between material hapinness and freedom in the parable of the Grand Inquisitor …the choice is ours.

  7. Following the logic of your article, this MP of yours is just a first step towards a “countrification” (aka “federation”) and it (the MP) is also irreversible, once adopted (2 out of 4 policies are technically irreversible and the other 2 are pragmatically irreversible).

    Those rejecting the viability of your MP solution see that adopting the logic of this short-term MP of yours will inevitably lead to a “countrification” of the EZ, and either
    (A) do not want it, for the same reasons they rejected it in 2005, or
    (B) like myself, want it but they don’t believe it will happen, thus turn to the alternative “sooner rather than later”.

    Are you still hoping that the EZ will start this “recycling” needed to make it viable, just because it makes short-term “economic sense”? Haven’t the 2005 referendums not happened? Hasn’t the “PIGS view” dominated public debate (even in the deficit countries) since 2009? Are you reading any signs in the stance of the franco-german elites that they are preparing for federation, or that they are preparing for the breakup of the EZ? Can you point out to me something I have missed?

    Last but not least, why don’t you encourage our country’s political parties to present to the Greek people (in layman terms) the real options (ALL the options), but instead you tolerate this campaign of deceit going on by the political establishment on both sides of the political spectrum? — ok, maybe you don’t exactly “tolerate” it, but you have such a skill at “smoothing” your arguments that most people I know come away perplexed.

    [A side-note: It is amazing (bewildering?) me as a non-economist that the dynamic you described is not codified by a technical term in the (so-called) science of economics. After all this same dynamic is apparent in every monetary zone there is — that is, inside every country, either between sectors, or between classes or geographically!]

  8. There were asymmetrical unions inside the actual European countries (North and South of Italy and Spain, for example), which “only” survived thanks to a tax recycling surplus scheme (tax transference’s from North to South), and even today something similar occurs “inside” the same A German country, where the former RDA survives thanks to tax transference from rich lands.

    Without an exchange currency rate to protect the weakness productivity countries, a recycle mechanism of any kind converts the “helped” country or region as a forever second class territory and a reservoir of cheap workers for the first class one.

    Quit the euro could be dramatic, but don’t do that can be a tragedy.

    Push Germany out of the euro could probably be the best solution: the south debt should be reduced in terms of the new Deutschmark and south countries would be protected again thanks to its currency. They should still be less productive countries, and therefore less rich than Germany, but they should avoid the extreme inequality than austerity means and they should be able to forget depression.

    Referred to your analysis, Yanis, I’m quite surprised with the fact that you still need and maybe believe in the neoclassical “marginal” theory. After be economy professor for several years I was working in the real economy for almost 20 years more, and I never saw a company under marginal diminishing productivity. Usually, they apply the optimal input combination, the one with the minimum medium costs and maximal productivity, and replicate this combination as much as they found demand for their products. An Sraffa/von Neumam approach is quite much heuristic than neoclassic, I believe. With this alternative approach I arrive to similar conclusions than you, about asymmetrical monetary unions, but with a stronger accent on the productivity as a territorial characteristic. Maybe some other day I’ll explain you may approach.

    Regards form Catalonia, the next European state.

  9. The symmetric monetary union is of course an academic fiction. I can’t imagine such a thing existing, as there are always differences between economies that competition will amplify. Rather, if the productivity differences are smaller than the extra-market surplus recycling mechanism the union is stable, and if the differences overwhelm the recycling mechanism the union falls apart.

    That much was known when the Eurozone was drawn up, and the architects thought that politically motivated convergence mechanisms would continue and be kept stronger than the productivity differences. I guess Ms Merkel and the German public was never told.

  10. Professor,

    If the EU does not listen to your Modest Proposal – the most likely possibility in the current context – what would be your advice to the periphery countries?

    Stay in the monetary union and undergo austerity, perhaps forever? Try to get out even under the risk of a full stop in the economy for a year or so, as you point out in your piece? Start paying part of the government bills in a parallel unconvertible currency in order to diminish the negative impact of austerity on aggregate demand? None of the above?

    Keynes once said that economists should be like dentists – useful practitioners, able to help people. Greece has already suffered a depression worse than the 1930s version, and there is still no light at the end of the tunnel. Perhaps the time has come for economists to provide advice taking into account the EU as it really is – not as it should be in an ideal, fraternal yet (alas) non existent world.

  11. Yannis, I have to respond in the middle of the reading the post.
    Is there a union but the asymetrical? Is there two fully symetric countries anywhere?
    Obviously there is no fully compatible symetric countries that could enter single monetary union.
    In EZ there is many countries and Germany has the most power of control and such asymetry is producing problems. Kick out Germany and in time you would get the repeat of the problem, there would pop out another country that is the most advanced. It is only a matter of time.

    Butt still you have the right solution even tough analysis is not right.
    Why did you make a mistake? As almost all economists you mix real goods and monetary elements as representative of each other. That is possible in some fixed currency quantity environment which, btw, never existed nor will ever exist.
    Please do analasys in pure monetary or in pure real goods elements.
    How real goods and services move independent of money relation? can that be done witrhout putting price on it? you see where mix up occurs?
    But pure monetary analasys can be done. Knowing that money moves real goods and services there is the reason to rely on pure monetary movements.

    How is productivity defined? How much money is invested to produce return in goods priced in money again? It becomes obvious that productivity is affected by price of money even tough all other elements would be equal.
    Price of labor is just a sliver of productivity, much of it is from organizationational skill (lack of corruption) but overwhelming is the price of money (interest rate).
    Is the price of money above profit rate or under? There is asymetry.

  12. I think you just very clearly demonstrated that monetary unions are bound to fail. Even from your theoretical analysis it can be deduced that a symmetrical MU is a purely fictional concept and of course asymmetrical ones have a 100% chance of failure. If you factor in the political aspect that is always present in the formation and function of the MU as it was presented in the book by Connolly regarding the ERM and our bitter experience of the euro crisis then you come to the inevitable conclusion that for the vast majority of European citizens the formation of the MU is against their interests. Thus the question that comes to mind is quite simple: If the citizens of Europe had the facts on the table (and were allowed to have a say in the matter) they most certainly would not choose to embark on the formation of the MU, so why on Earth then would they choose to go to the trouble and suffering required (in addition to your recycling mechanism suggestion) to give the thing a lifeline and a chance for survival. What is so wrong economically speaking nowadays with a system of national currencies, trade restrictions, capital controls and the necessary national recycling mechanisms within each country? Have we not reached a point in time technologically that it is possible for indipendent nation states to reach a viable level of self-sufficiency and make up for their various shortages by using their competitive advantages?

  13. I always liked the idea of the modest proposal. Especially since it somehow circumvents a lot of constitutional obstacles – made-up or real – that the german decision makers like to point out in order to rationalize their rather subconscious aversion to “transfer unions” of any kind and their likewise irrational insistance on the no-bailout clauses in the EU treaty framework.

    I think the problem here is that it depends on the important players’ ability to see reason when it is offered for free and doesn’t come with a price tag from some consulting firm or lobbying institute.

    So my question would be: In order to implement such an external surplus recycling mechanism, wouldn’t the political elites of the eurozone first have to be made to accept it as a viable alternative to the surplus expansion mechanism presently envisioned by country A’s current and propably also next administration?
    How can the political class of country A be convinced that, contrary to their obvious belief, they are not living in the same hypothetical universe as described under section 2?
    How can they be made to understand that they can never achieve this highly theoretical Idea of a symmetrical monetary union by forcing internal devaluation on countries B, while everything they have said or done so far suggests that they strongly believe to be able to create this kind of economic wonderland by means of austerity and thus, literally, out of thin air?

  14. Pingback: Yanis Varoufakis: Why Asymmetrical Monetary Unions Are Bound to Fail « naked capitalism

  15. Excellent piece. The theoretical framework is masterfully explained. Thank you.

    I am sold on the concept that a recycling mechanism is needed in asymetrical monetary unions. Where I remain somewhat unconvinced is when it comes to non-monetary unions, such as what came into effect post early 70’s (when Nixon went off the gold standard). Since then, freely floating exchange rates amongst the US and countries like Japan, Germany, etc. would have provide the required stabilization mechanism. Would you agree?

    • Two quick points: First, I did suggest that floating exchange rates cannot fully reverse the asymmetries caused by differential concentration rates. Secondly, exchange rates between the yen and the US dollar were not exactly ‘free’ floating. Recall the 1985 Plaza Accords?

  16. “What is an extra-market Effective Surplus Recycling Mechanism?”

    It is an admittedly very scholarly sounding version of ‘permanent transfer union’.

    • Yes, nice wording in order to heep those calm that have to pay for it so that their employers can export tons of stuff below market price and pay them salaries below market price.

    • two of the proposals are reasonable. two of the proposals are accounting gyrations that fail to address the real problem. the debt is just too high.

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