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Funding Poorer Members Won't Help the Euro Zone

A remedy that's often suggested to address the weaknesses of the euro zone, laid bare by its sovereign-debt crisis, is to permit systematic transfers of resources from the more prosperous states in the currency union to the poorer ones.

It's called a transfer union and it's what happens in federal systems of government such as the U.S.

The idea, which has backers such as the Princeton University economist Paul Krugman, would be to allow greater public financial transfers from richer to poorer economies, perhaps by expanding the European Union budget.

The proposal is aimed at softening the blow of the severe economic adjustment that now faces the peripheral euro-zone countries.

That adjustment, which will almost inevitably involve a reduction in real wages of workers to increase their competitiveness, won't be accomplished suddenly. Economists agree that painful process is likely to last for years.

The EU does oversee some such transfers already through its so-called cohesion funds. The net contribution to the Greek economy from the EU in 2009 amounted to some €3 billion (about $4.1 billion), 1.3% of gross domestic product. Softening the blow from the abrupt termination in private-sector financing will require much more than that.

But would it work? The U.S. example of chronically weak state economies such as West Virginia may give some pause for thought. A report from a group of leading European economists, to be published next week, cites an example of a transfer union from within the euro zone: former East Germany. Their conclusion: It wouldn't work.

The report is from economists from the European Economic Advisory Group, seven scholars from seven countries including Germany's Hans-Werner Sinn of the Ifo Institute for Economic Research in Munich and Italy's Giancarlo Corsetti of Cambridge University. The 2011 edition of their report will come out Tuesday, offering a wide-ranging analysis of the origins of the euro-zone crisis and proposals for how it should be resolved.

In an excerpt from the report, the economists point out that the question of public transfers to Greece and other economies is a "distributional" matter that will have to be decided by politicians.

"Politicians should not overlook," the authors say, "that there is the risk of Greece becoming addicted to the transfers, since it seems to have become addicted to the capital flows of the past." Political constraints limiting these flows will never be as tight as market constraints, they point out.

They then turn to East Germany, which reunified with West Germany in 1990.

Since then, about €1.2 trillion of public money has been pumped into the east, rising to €1.5 trillion if the former East Berlin is also included. Public transfers from west to east continue at about €60 billion a year.

What have the economic results been? Even before the last boom ended in 2008, unemployment in the east hadn't fallen below 12%. There has been mass emigration, with the population shrinking by 2.3 million from the original 16 million. About 60% of that emigration occurred after 1995.

Income per capita is just 69% of the west German level, compared with 60% in 1995, and the main reason for that modest increase is emigration of low-wage earners to the west.

"The purchasing power of the privately produced GDP in eastern Germany has been surpassed already by that of Slovenia, even though Slovenia joined the European Union 14 years later and has no comparable support from the outside," the authors say.

Eastern Germany suffers, they say, from the Dutch disease, where in the 1960s and 1970s a growing natural-gas sector weakened the rest of the Dutch economy by elevating real wages. In eastern Germany, it's not energy income but public transfers that have boosted wages "above the level compatible with a self-sustained growth process."

The report suggests eastern Germany has become the Teutonic equivalent of Italy's Mezzogiorno, the Italian south, where income per head has been stuck around 60% of the levels of the rest of Italy for half a century.

In Italy, the problem is a national wage policy, where wages set in the north are too high for lower-productivity workers in the south.

The result has been persistent mass unemployment and underdevelopment that have encouraged fiscal transfers from the north. These have provided an "alternative income source in the south to which the political system and the economy have grown accustomed, perpetuating the situation, as it seems, even more," the authors conclude.


Why has Spain, widely agreed to have a low-productivity problem of its own, managed to maintain its share of world exports since the euro has been introduced and even increase its share of service exports?

The answer, the economists say, is in "pockets of competitiveness" in banking, construction, energy, transport and telecommunications, some of which developed out of privatized industries.

Beyond that, small and medium-size enterprises in two areas—Catalonia and the Basque region—have stayed competitive, benefiting from more diversified regional economies less dependent on construction.

Write to Stephen Fidler at

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