What Europe can learn from the US

By Andrew Walker
Economics correspondent, BBC World Service

Image caption,
How has the US succeeded in avoiding major crises in its currency area?

The crisis in the euro area highlights two problems with a currency shared by states with their own taxing and spending powers.

What happens if some of individual states fail to control their own finances? And what about a situation where their competitiveness diverges?

The same questions arise, or could arise, with another large currency area, the United States.

It has more individual units - 50 compared with the euro area's 16. That might make it even more unmanageable.

But unlike in Europe, there is no talk of the currency union breaking apart. Why not?

Tight rein

For one thing there is more discipline on the finances of the states. Nearly all have a legal or constitutional obligation to at least attempt to balance part of their budgets - though many can borrow for investment.

They do struggle sometimes, as California is now. It is certainly a political issue. But the shortfall is modest compared to the crisis facing some European states.

The gap, which Governor Arnold Schwarzenegger is trying to close, is $18bn (£12.4bn) for two years, about 0.5% of state income, its GDP. Then there is borrowing for investment which is also this year less than 1% of California's GDP. For Greece, the total last year was 13.6%.

So the US has a system of fiscal discipline - at state level that seems to be more effective than Europe's Stability and Growth Pact which tries, and has failed, to limit deficits to 3% of GDP.

Easy does it

The US has another major advantage. The Federal budget has an important role in softening the impact of shocks that hit one state more than another. If one state is especially hit by economic events, its people pay less in federal taxes, and federal spending can be increased.

Some of this happens automatically, especially on the tax side. And it can be augmented by deliberate policy decisions by the Federal government.

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European nations have agreed to work on new rules, but that could take years

In Europe, the EU budget is too small for that effect to help very much. It is less than 1.5% of GDP. Public spending is dominated by the member states. In the US, Federal spending is about 15 times larger.

Some European countries also have a problem with competitiveness. For a country with its own currency there is the option of allowing it to depreciate. But when you lose competitiveness against countries with the same currency it's no solution.

That has happened in the Euro area. One measure of competitiveness is unit labour costs, which reflects changes in both workers pay and how much they produce.

Between 2001 and 2008, according to OECD data, unit labour costs increased by more than 20% in Greece, Spain, Italy and Ireland. In Germany they fell slightly and the average for the Euro as a whole was a more moderate increase of 12%.

In the absence of a depreciation option, the only way of restoring competitiveness is lower pay and other costs. It can happen but it is hard to achieve and can easily lead to the kind of strife now hitting Greece.

Of course the US does have internal differences in competitiveness, but workers are more ready to move - the single language helps of course - and pay cuts aren't quite so hard for employers to impose.

Differences do persist, but there are features of the country's labour market that act as a kind of shock absorber.

What the Euro crisis has underlined is the difficulty of a single currency in the absence of a closer political union and more flexible labour markets.

It may be possible to fix those problems. But it will take years.