European. Union.
"European" conjures images of cultural and financial prosperity, and a long history of monarchy and military power. "Union," for those familiar with Mancur Olson's Logic of Collective Action, represents a generally large form of organization which depends upon coercion or selective incentivization of its members to maintain group efforts toward the common goal of collective benefits. When statesmen bring these two words together, however, another set of images have recently made news. In April of this year President Papandreou of Greece, an EU / European Community member since 1981, requested an emergency bailout of his country's nationalized debt - the culmination of decades of large entitlement payments and labor union protections by multiple iterations of elected and appointed men and women who dug the very deep hole of indebtedness in which their neighbors, fellow citizens and their children may live for decades to come.
Cynical and wise American readers may hear a familiar bell tolling for their own country - a cautionary tale of the damage that foreseeably follows when people, in their role as government officials, buy political support with entitlement programs and special-interest protections with both tax revenue on citizens' and their businesses' earnings as well as the potential capital accumulation for their offspring. However, Americans may rejoice that such issues can theoretically be addressed in their elected Congress, with one entity controlling monetary policy and availability (the Federal Reserve Board). As an investigative article in the September 27th edition of The Wall Street Journal describes, the European Central Bank (ECB), the banks of each European Union, and their appointed and elected national leaders must engage in collective action whose chaotic process can be predicted by Olson's theory.
Pity Mr. Jean-Claude Trichet, president of the ECB, self-declared ringmaster of the cobbled pact which temporarily saved the euro zone from unraveling at its multinational seams. Promises, pacts and a single currency are all that keep the the member countries' poorly-aligned economic policies together. These promises between appointed officials are the result of layers of selective incentives, both personal and national, and of coercion to keep members' governments from spending far beyond their means. Greece habitually did this until Standard and Poor's downgraded its bonds to "junk" status in April, which sparked a rush to bid the yield on those bonds to levels so high that Greece alone could not afford to pay off the foreign investors of its socialized governance. Though member rules were established by the Maastricht Treaty to maintain an annual debt-to-GDP ratio of about 3%, Greece for years persistently disobeyed this rule; for 2010 President Papandreou anticipates a ratio near 13%. How did such flaunting of membership rules come to pass?
Unless there is coercion or adequate selective incentives, membership in a large organization is not sustainable, according to Olson. It is highly unlikely that actual physical (read "militarized")force by other members would be implemented to enforce membership rules. And until investors suddenly withdrew their currency from Greek and Portuguese bonds in a panic, no clear or effective plan emerged for the group to police itself. The leaders of Greece and Portugal, both deeply indebted countries, were not acting in the interest of the European Union - they were acting in the rational self-interest of, not even their constituents, but their consituents' votes.
Financially weaker member states supported the EU and the European Central Bank's euro not simply for the collective benefits to all member countries, but for the advantages and protections that access to the collectivized bank funds could bring to its respective citizens. In the waning moments before markets opened on May 10th, Germany flexed its muscle and insisted on an enormous bailout package for Greece, Portugal and other heavily indebted members, which mainatined the sovereignty of each members' funds through their respective national banks. This development was to the chagrin of France, which insisted on collectivized, ECB-issued debt, which would give even more power to unelected officials at the EU and ECB.
For the moment Germany's model for member-controlled solutions appears to be secure. The European Union salvaged its solvency in the eyes of global money markets, but whispers of a more powerful, centralized bank may come to pass, threatening the voluntary cooperation of its most powerful economic member. Without coercion or better incentives, Germany may force the hand of its surrounding members and persuade its northern neighbors to pursue a smaller, more effective organization of economies seeking the collective goal of prosperity.
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