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The European Union’s Next Step: A Hamiltonian Commonwealth

The Europeans took a big step towards a stronger Union this Spring, when they approved a wealth transfer of €310 Bn (or €390 Bn – described and calculated variously) from the Rich North to the Distressed South (that’s how I will describe it)… They funded it by issuing debt backed in common by the entire European Union, on a large scale, for the first time. It was a watershed event, unexpected, unwanted by many, shrouded in skepticism – until it happened. (I predicted it, as a certainty, in an earlier column – though some of my European friends scoffed at my “naïveté”).

Yet here we are. Germany’s finance minister branded it a Hamiltonian Moment, invoking America’s founding financial engineer (Alexander Hamilton) who “mutualized” (Europe’s ungainly term) the Revolutionary War debts of the 13 individual colonies. The federal government assumed these debts, and issued new financial instruments back by the Treasury, to create a robust financial structure for the new United States.

Europe’s Hamiltonian Moment did seem bright, historic even – at least for a moment. But now, people are doing the numbers on the deal – not the €310 or €390 Bn per se, but the numbers behind the numbers, the longer term implications of a deeper fiscal union – and new anxieties are stirring. The skeptics are regaining their footing. “Beware of smoke and mirrors” we are warned. Fears are mounting that a new system of transfer payments has been created, which has its winners and losers, so to speak. Who will pay, and who will spend? In particular, it looks like the rich countries – many of those who objected in the first place – will indeed be stuck with the bill.  

 

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The American Example

Once again, it may be useful to draw a lesson from the American experience. 

The map below highlights a little-known but all-important aspect of American economic geography. Pause now – and try to guess what single variable cleanly divides the 7 red states from the 43 green ones. (It should not be hard.)

  Yes, the red states are richer, with household incomes 16% above the national average. Yes, they vote for the Democratic party. (In fact, all 7 states have voted for the Democratic candidate in the last 7 presidential elections.) [Disclaimer: I apologize for using the color red for these states, which are normally Democratic Blue, following the American convention. It is an artifact of the software I had to use.] 

But the map depicts something else: these are the states that in Fiscal Year 2018 ran a “balance of trade” deficit with the rest of the country. In other words, under the American federal system, these states pay out more to the rest of the country in taxes than they get back in federal spending for services ranging from medicare and social security to food stamps and disaster relief. For example, New York (whose Comptroller prepared these numbers) paid out to the U.S. Treasury $26 Bn more than it received back. Alabama, for example, has a $36 Bn surplus. 

In per capita terms, every citizen of New York State provides a $1300 subsidy to the rest of the country, while New Mexico residents receive a net bonus of more than $10,000 each.  

From 2014 to 2018, New York State alone paid out $116 Bn more than it received back from the federal government. (You’re welcome, Alabama.) 

Today these 7 “cash cow states” subsidize the rest of the country, as they have done and likely will do for years to come. The wealth transfer out to the other 43 states (plus the District of Columbia) over the past decade would have been on the order of a trillion dollars. 

At the Intra-State Level

Within individual states, there is a similar pattern. In 2010, New York City and its suburbs paid about $10 Bn more to the State of New York than they got back.  

In Pennsylvania the pattern is a bit different. The largest city, Philadelphia, is a huge beneficiary in the balance of payments within the state, receiving 157% more from the state than it pays out in taxes. The subsidizers are the surrounding suburbs. Most of the state’s rural counties also have a positive “balance of trade.” 

 

The Workings of Federalism

This is the way Federalism works. Federal Democracy, translated to the economic sphere, is a rat’s nest of transfer payments, subsidies, levies, and penalties. Wealth is taxed, redistributed, taken from some and given to others. 

Are these outcomes “fair”?  

But that’s not really the right question, is it? Better to ask whether the transfers flow mostly uphill or downhill – that is to say, whether they accrue more to those in power, or to those in need. If the former, the system can be called exploitative – as most political arrangements historically, and still today, can be described. Whether under feudalism in the the European Middle Ages, or today’s corrupt and kleptocratic regimes in China or Russia, the tendency for wealth transfers to flow up the social hierarchy from the Have-Nots to the Haves is the sad norm of human political behavior. It is really only in the Western democracies (and perhaps lately in some few Asian systems) that the fiscal plumbing has been designed (at least in principle) to run the other way, to redistribute down from the Haves to the Have-nots, and even there it doesn’t always work well.

In the U.S. we have mostly put this matter out of mind. The ironies are sometimes commented – the fact that the payer-states tend to vote for political programs that involve paying more, and the payee-states go the other way. But no one gets worked up about the subsidies that New York and California provide to Alabama and Mississippi. This strange unconcern is the product of two hundred years of American federalism. 

The Challenge to the European Union

Europe has not yet achieved such equanimity on this matter. Despite the fact that many/most European countries have embraced the model of a social welfare state for their own domestic arrangements, the members of the European Union are still uncertain how much redistribution they are willing to tolerate among the members of their club. The EU is famously lacking (apparently) in the constitutional mechanisms for transferring resources from the New York’s to the Mississippi’s of Europe. The system still looks more like a confederation of independent fiscal entities than a true federal union.

The maneuver is now being resisted by some of the countries tagged to become the payers under this arrangement. Germany led this contingent for a time, until in a spasm of communal good judgment Angela Merkel reversed her long-standing opposition to “mutualization” (she had once said it would only happen over her dead body, or words to that effect). The coda to this crisis was drawn out by the “Frugal Four”: the small, very rich countries (Denmark, Austria, Sweden, and The Netherlands) feared the moral and economic precedent of funding the weaker members, whose internal governance systems seemed to them inadequate. Their leader, Mark Rutte, PM of the Netherlands, was often brutal in his comments on the shortcomings of his Mediterranean colleagues. Here’s a sample:  

  • “The Dutch should not pay for the irresponsible decisions, tax evasion, and corrupt governments of Spain and Italy. If Southern Europe wants to spend money, they should spend their own.” 

In the end, he acceded with bad grace, and vowed that “it is definitely a one time thing.” 

Well, one-time-things have a way of taking root. That is now happening, or trying to happen, in the EU. Rutte and his quartet are dragging their anchor, hoping to slow down and complicate the process as much as they can. But as surely as the first step towards a more comprehensive union was taken in the Spring, the next steps will follow now. The European Central Bank is already calling for the pandemic relief fund to be made permanent.

I think this, too, is inevitable, and after much moaning and groaning it will come to pass. And when it does, the roles will be parceled out to the respective parties. Some will pay and some will spend, and that will be that. In another generation or so, no one will think any more about it. The correlation between the ways and means of these payments is striking already. Basically, any country with a GDP/capita above €30K will be asked to subsidize, and those below that threshold will become the beneficiaries. 

Alexander Hamilton 2.0

Which is as it should be, Alexander Hamilton would say. The assumption of the debts of the 13 colonies was not a “just-this-one-time” proposition. It was a foundation upon which to build a commonwealth –– where the more advantaged states would provide support for the less advantaged, on an ongoing and indeed a permanent basis. Over time, the role of the Federal government as the framework for redistribution has become the great non-issue (for a country which certainly has its other issues these days). 

It is hard to see why this concept is so difficult for some European politicians to grasp. As noted, all European countries are already following this course in their domestic fiscal policies. The embrace of social welfare as the guiding meta-principle of government is stronger in Europe than in the U.S. Why choke on it then at the EU level? The Hamiltonian moment was promising, exciting and bold. But it now must lead to the Hamiltonian Commonwealth – or it will have failed.

Source: Forbes – Money

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