On Milton Friedman’s 103rd birthday one of his most dire warnings of economic disaster has come true – the Eurozone crisis.
Although he did not live to see the eruption of the Eurozone crisis, Friedman predicted with admirable clarity why Europe’s monetary union would lead to nothing less than misery for the continent. Friedman recognized that the drive for a common European currency was based on politics, not economics. In 1997, Friedman made his case against the monetary union.
One of his chief criticisms was that the Euro area was not an optimal currency zone, where using the same currency across the regions would create the greatest economic benefit.
“Europe’s common market exemplifies a situation that is unfavorable to a common currency. It is composed of separate nations, whose residents speak different languages, have different customs, and have far greater loyalty and attachment to their own country than to the common market or to the idea of ‘Europe.’ Despite being a free trade area, goods move less freely than in the United States, and so does capital,” Friedman wrote.
Aside from the cultural and political problems the Euro would throw up, Friedman argued European economies gave too much room for state intervention for the project to work. European labor laws make it more difficult to hire and fire workers meaning the market is less able to respond to shocks. Furthermore, a common currency means countries like Greece are unable to devalue and make their exports more competitive.
“Regulation of industrial and employment practices is more extensive than in the United States, and differs far more from country to country than from American state to American state. As a result, wages and prices in Europe are more rigid, and labor less mobile. In those circumstances, flexible exchange rates provide an extremely useful adjustment mechanism,” said Friedman.
Indeed, somethings haven’t changed at all since Friedman’s critique was published. “As of today, a subgroup of the European Union — perhaps Germany, the Benelux countries, and Austria — come closer to satisfying the conditions favorable to a common currency than does the EU as a whole,” Friedman wrote. That statement is as true today as it was then.
Finally, Friedman predicted that the Euro, far from being a mechanism for bringing Europe together could, in fact, achieve the exact opposite.
“It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.”
With the election of the radical socialist party Syriza in Greece and rise of far left and right wing nationalist parties across Europe the Eurozone and wider European Union project is in greater danger than it has ever been.
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