Monday, June 20, 2011

Of nations and states - issues of democracy and economics

One of the central themes of Greek crisis is the distinction between Greek government's duty as a national government and its duty as a member of a currency club. The difference is important and we must focus on it a little more than traditional media does.

Let us look at a mechanism for national and state governments, say in US. The US follows a federal system which means the states are as good as independent nation except for some national issues for which these states have agreed to collaborate. The collaboration, in principle, is rather limited. The role of the central government is to create a basic infrastructure that will reduce the cost of interactions (of which doing business is but a part) among states. Therefore, the central government creates a currency system, maintains an army for protection of national borders, sets up court system to resolve inter-state or supra-state (pollution, foreign policy, FTAs etc) issues etc. The central government also ensures all states maintain cordial relations and there is no free-riding etc.

Because of the activities of the central government and its role as defined by federal structure, it is incumbent on the central government to undertake some policies. Monetary policy, by virtue of being issuer of currency, defense, by virtue of maintaining the armed forces and fiscal policy for creating inter-state infrastructure and assets. In return for these services the state give the center a part of their tax collections (I refer to the ideal - normally, central government is given the right to tax a few things). 

Let us look at Greece and EU. The union is in a formative stage because the differential responsibilities are not spelled out clearly. Greece has ceded its monetary policy by virtue of being in the currency union but the union has not bothered to enforce compliance of basic principles of natural justice. Concurrently, EU has not truly unionized the regional banks (by which I mean, made the banks truly European). Thus banks continue their country-focus leading to asymmetric losses to one country (government and citizens) if they were to fail. All this puts pressure on the country-level fiscal policy (i.e. taxes, government jobs and spending) which is independent.

Here we must spell out the disconnect clearly. The aim of the government is the welfare of its people. The aim of policy is to be fair resolution mechanism for both parties. If we go for fair resolution we will hurt the greeks more than what should be fair. If we given in to greek population, we will be unfair to the savers of Germany and elsewhere. The solution is to use bit of both. However, in the overall scheme, we must side with welfare of population. Democracy has to supercede economics.

Unless this political-economic mess is sorted through law (treaty or agreement), there is unlikely to be a systematic solution to the PIIGS crisis. Every time a country faces a problem we will have a big discussion, rhetoric and grand standing and negotiations that lead to nowhere. Solve this and you will bring certainty to the markets and economies.

My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.