Difficult Convergence among the Five Main European Union Countries and the Crisis of the Euro Area

By Caputo, Michele; Forte, Francesco | Atlantic Economic Journal, December 2015 | Go to article overview

Difficult Convergence among the Five Main European Union Countries and the Crisis of the Euro Area


Caputo, Michele, Forte, Francesco, Atlantic Economic Journal


The EU and EMU as Clubs and their Convergence Parameters

Union of Governments as Clubs and their Convergence Parameters

According to the now familiar definition of James Buchanan [Buchanan (1965) and Buchanan and Goetz (1972)) (1)], club goods are an intermediate category of public goods: common in use, but to some degree, exclusionary for those who do not participate in the "club." If preferences among members are too heterogeneous, the club must try to adapt its rules to minimize welfare losses (Fedeli and Forte 2012). (2) In a large-club with heterogeneous preferences, minimization may be too difficult and costly. Non-territorial clubs of public goods that one may observe (and private clubs) normally imply a relevant degree of homogeneity. The reason is that those who have inhomogeneous preferences either do not participate in clubs or leave them, once such individuals realize they are unable to adapt to the rules.

Differences arise when governments are territorial clubs, as first theorized for local governments by Buchanan and Goetz (1972), and also in the case of a union of autonomous states, such as the European Union (EU) and the European Monetary Union (EMU), as studied by Buchanan [(Buchanan 1990, 1995, 1996, 1997, 2001a)]. The spatial dimension implies territorial ties and increases the costs of opting out. The problem becomes much more complex for government clubs, whose members are primarily national governments. Indeed, only a unique market may be an "optimal monetary area" (Mundell 1961, 1973).

Monetary union among different countries may be useful because of the enlargement of the market, due to the existence of a common currency. Flowever, market unification is essential to reap the benefits of this enlargement.

The rate of exchange of conventional money in circulation in a union of governments for the member states and their own central banks is an exogenous variable. In fact, countries with wage rigidities cannot regain competition by domestic currency devaluation. Moreover, exiting the monetary club is not a bearable solution for a new monetary union for the non-performing countries. Indeed, the participation of any member state must appear irreversible in order to assure the credibility of new paper money. Therefore, the strict interest of the monetary union is to hinder the exit of a member state, particularly if it is an important one. (3) The situation for non-performing countries seeking membership in the EMU is similar to that of the contract of Faust with the devil. The first step is voluntary, the next step is obligatory.

"Club convergence," first employed by Baumol (1986), has been extensively studied in growth theory. (Dowrick and Nguyen (1989); Barro and Sala-i-Martin (1992), (1994); Galor (1996); Ben-David (1997); Reiss (2000); Dowrick and DeLong (2003); Islam (2003); Busetti et al. (2007); Cunado et al. (2006); Fischer and Stirbock (2006); Mathunjwa and Temple (2007); Cavenaille and Dubois (2010); Caputo (2012a, b)). The convergence of the parameters of countries belonging to a given club government (CG) is important in order to ensure the viability of the club. This is relevant to the rules of the club and growth-enhancing employment. Therefore, we consider the following 15 parameters (Table 1) as relevant for the measurement of convergence in the EU and EMU as clubs.

The first eight parameters are relevant measures of the main variables of the neoclassical growth model, with the exception of the "inflation rate." The latter measures the country-specific degree of rigidity in the supply of production factors, particularly labour. The next two parameters are specifications of the eight growth parameters. The other five are the financial parameters of the Maastricht Treaty and of the fiscal compact that, together with inflation, show a considerable influence on monetary policy, the rate of exchange and the fiscal policy of the EU and EMU and of the member countries. …

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