According to Migeru in the diary on the Franco-German Trade Gap, the monetary union in Europe creates 'economic tensions' which can only be solved on the level of the entire economy, thus necessitating a political union (or at least a common economic policy).

There are a lot of European policies that cause spillover pressures in one way or another, and spillover pressures alone rarely spur further integration. Rather, they are solved through ugly ad-hoc adjustment mechanisms or ignored insofar as they can be. The mere existence of pressures to create a political union is no guarantee at all that anything of the sort will come into existence.

What are these economic tensions? And are they too big to be ignored, or solved through things other than a more political union?

There is problem that might be described as jurisdictional competition (Standortwettbewerb) between the different eurozone countries to be the most attractive location for business investment. This causes a number of difficulties, such as that corporate taxes are set at too low a level, or that countries try to keep their labour costs low. Internally, this is socially undesirable and externally it might cause economic problems for other states. Amongst French politicians a traditional concern exists that this will lead to a race to the bottom, but it should be noted that it is possible for a state to pursue alternative strategies (taking the high road).

The low road that the Germans took will cause them some difficulties in the future. As Afew has noted in the diary on the Franco-German Trade Gap, it depends upon offering cheap, disposable labour. The labour force of Germany, however, is set to shrink. At the same time, old age entitlements are set to rise. It should be a matter of state policy, therefore, to maximise the wealth generated by its labour (at least this seems like the logical conclusion to me but my economic knowledge is not unlimited). Instead Germany is or has been seeking high participation through wage moderation, which is not the right policy as it drives the more talented workers away and has a negative effect on domestic consumption.

The interest rate policy of the ECB is another issue. This was also talked about in the Franco-German Trade Gap thread. There, it was asked by naneva if higher interest rates which would be good for Germany would be bad elsewhere. I don't think that they will be bad anywhere right now as there are no parts of the eurozone that are in depression. However, according to Daniela Schwarzer and Sebastian Dullien the rates will be bad for Portugal and Italy plus economies with low domestic demand (read Germany?). The reason given for this is that Portugal and Italy are in more direct competition with Asian countries. I guess that this means it will be due to a stronger Euro with regard to the currencies of these countries, but I don't know if that will happen (the euro will grow against the dollar but not necessarily against the currencies of the Asian countries -- that all depends upon their monetary policy). In any case, the low interest rates of the ECB were not beneficial in the past to the faster growing economies.

A rather elaborate discussion on the ECB's policy is given on AFOE by Edward Hugh in a post where he quotes a piece by Claus Vistesen. In the discussion on the German economy they note the slumping domestic spending, which they both attribute to the demographic pattern in that country (whereas I think it's more logical to assume that it is due to wage moderation). One interesting thing to note is the chart on the 'real exchange rate' in the piece of Vistesen. Although he states that Germany has been having a kind of 'beggar thou neighbour' relationship with its fellow Eurozone countries due to its low real exchange rate, note that the same might actually be said of France.

The problem that there are differing levels of inflation in the eurozone exists in part due to the lower level of economic integration of the EU compared to the US (trade between US states is 2 to 3 times greater than between EU15 states Update [2007-2-5 17:22:18 by nanne]: see this briefing (pdf)). Theoretically, a higher level of trade and labour and capital mobility should have a dampening effect on inflation differences, and also on differing economic cycles.

Problems related to differing economic boom and bust cycles within one monetary area are described by Vistesen as 'asymmetric shocks'. Other than a newly developed globalisation adjustment fund (which is tiny) the EU doesn't have any real mechanisms to deal with this issue. As Migeru describes it in the Franco German Trade Gap diary, a single employment, redistribution and industrial policy is needed.

Right now all we have in that area is the stability and growth pact and the Lisbon agenda, but these have not brought about a strong enough degree of policy coordination to parse for a common economic policy.

There is, however, a redistributive policy in the EU through its structural funds and general budget. It is unclear to me to what extent it can stabilise asymmetric shocks (seems like it can't do it for all countries because it only favours the poor areas which are largely concentrated in the poorer countries). But it fulfils the separate but equally valid aim of reducing long term inequalities. In a study made in 2000, it was found that the EU budget has a 'remarkably redistributive effect' (pdf file here).  I'll give you a quote:

Finally, when we consider the net financial balance, we find that the EU budget has a remarkably redistributive effect on the income of its members. This result is a necessary condition to speed up the convergence process among European countries. Our results show that the EU budget redistributes the 5 percent of any difference between richer and poorer countries. Although this number is well below the estimates for the United States (federal taxes and transfers redistribute approximately a 20 percent), it is important to notice that this redistributive effect is achieved with budget resources that represent less than 1.27 percent of the European GNP. (DOMÉNECH, R., MAUDES, A. AND J. VARELA (2000): Fiscal Flows in Europe: The Redistributive Effects of the EU Budget.)

This is impressive, but again we can note that the actual redistribution (which is all that counts) in the US is 4 times greater, its trade flows are 2-3 times greater and it does have substantial stabilising mechanisms which don't exist in Europe. Also note that this data is historic and that with the expansion, the redistributive effect of the budget has probably decreased.

So... what are the answers?