JR Max Wheel
26 March 2013
Free movement of capital is an essential condition for the proper functioning of the European Union Single Market. It enables a better allocation of resources within the EU, facilitates trade across borders, favours workers mobility, and makes it easier for businesses to raise the money they need to start and grow. Free movement of capital is at the heart of the Single Market and is one of its ‘four freedoms’. It enables integrated, open, competitive and efficient European financial markets and services – which bring many advantages to us all.
It would be somewhat ironic if the smallest domestic economy signalled the end of the great € experiment. It allegedly accounts for only 0.2% of Euro GDP, yet the bungled attempt at restructuring the Cypriot economy by taxing customer deposits in effect condemning it to years of stagnation, could yet prove the tipping point.
Looking at the four freedoms above one seriously wonders whether any of them make sense in the integrated and conflictive world of the early 21stC.-freedom of movement of capital, people and services. Capital is obviously highly mobile anyway, so barring heavily enforced capital controls, note just introduced in Cyprus, a step that finishes the island’s role as a financial centre for good. Given the unlovely sources of much of the money, this may be highly welcome to some, but it is precipitate and highly destabilizing. Capital controls can be dodged around, albeit via a somewhat clumsy movement of high value physical assets, gold, diamonds, artworks and so on. Could this seriously happen elsewhere in Euro-land, certainly, most of Southern Europe has been watching anxiously as the Cyprus affair unrolled. The extraordinary idea articulated by Dutch Finance Minister, Mr Dijssellbloem that this is a blueprint for future sovereign restructurings is like Lord Byron ( another Hellenophile) mad, bad and dangerous. Firstly, this blue print was claimed to be generic, then quickly retracted to be specific to Cyprus as an exception: it cannot be both, this betrays a complete lack of understanding of market sensitivities, creditor seniorities, and of course hits the liability side of the balance sheet, whereas the problems are naturally enough, on the asset side. It is not because bailing-in creditors is a bad or unwelcome idea, but bailing in depositors is most certainly. Naturally, depositors should choose their bank and jurisdiction with care; unfortunately many have done so on the back of tax wheezes rather than any consideration of sovereign risk, banking solidity and probity. Therefore, there is precious little sympathy there, but creating a collapse to prove a point to separate banking from sovereign debt issues is highly dangerous given the collective weakness and chronic lack of competitiveness evident over a decade in much of Southern Europe and it could easily spread.
Cyprus has, in my view, little choice but to leave the single currency and in doing so; it breaks the mythology around “ever closer union” and the immutable nature of the Euro. If it does so successfully and certainly not without a lot of pain, it will start to grow again with a competitive currency and stand out like a beacon against the stagnant Eurozone. There are countless examples of such recoveries, Many European countries in the 1930s, the UK leaving the Gold Standard, Latin America in the 1980s, Asian countries and Russia in the 1990s. This is not arguing for devaluation as an endless policy prescription but a necessary flexibility in a crisis. Regrettably, it has become far too easy to use this tool as means of inflating away debts by unscrupulous or ignorant politicians, but we are not in the land of many choices here. It is the complete inability to adjust currency values, as well as the forced rescue of undercapitalised banks, that has broken many sovereigns. The alternative is a massive downward adjustment in real wages and returns to individuals that forces readjustment. This is both unfair, too slow and in any democratic state a policy that is liable to cause serious civil unrest. Freedom of movement of people is another ambitious construct in a world where, due to conflicts, economic migration, and international terrorism, there is a need to control movement, not fling open the doors. This is not to condemn migration as malign, but it is utterly fanciful to imagine that it cannot, even should not, be controlled in a world of highly integrated economies. Freedom of movement of goods and services is a nod towards the benefits of free trade, it is not without its consequences either, attraction of inward investment, competition in corporate and personal tax rates. Since even shareholders have little or no control over transnational countries, plant and jobs can be moved swiftly, resulting in lopsided and distorted economic development in host countries. Indeed one of the major issues for many deeply indebted countries is how to find a system to tax such highly mobile companies both fairly and to limit tax-engineering between countries. This is a serious issue because as the Cypriots and many other countries have found out rapidly, the tax base of many countries is declining thanks to the ingenuity of international tax mitigation schemes. The Single Market is of course in many areas anything but a level playing field, many industries and services are still closed off to competition, energy, some financial services, communications, and defence to name a few. This is hardly a good score card for the four freedoms and that is because they are lofty ideals and do not correspond to real world problems. Have they contributed to real competition, dynamism, economies of scale and other desirable outcomes? The short answer is no, cultural factors or national interest issues still dominate.
There is life outside the Eurozone and the quicker most countries realize it and act accordingly the better for them and their long-suffering electorates