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In the March 1999 lecture of the EMU and… series, Professor Peter Sinclair addressed three of the central challenges which must be resolved not just for Britain, but for the Euro zone itself.
First, the lack of portability in pensions, resulting from the big differences in national pension systems, reduces EU labour mobility within the EU and contributes to labour market frictions there.
Second, and related to this, is the question of labour mobility itself, without which regions afflicted by different shocks suffer overheating or unemployment. Whereas separate currencies can respond to such difficulties, under EMU, aggregate conditions govern monetary policy.
Third, there is the question of pensions insolvency – a problem not merely for the individual countries themselves, but for the future economic stability of the EU. Over the next decades the age dependency ration will increase. A fully funded system is insulated against changes in the birth rate, though it must adjust to morality patterns whereas an unfunded system must adjust to both. As Professor Sinclair suggests: ‘Long term solvency for Pay-as-you-go (PAYG), generous, unfunded, state systems is especially doubtful for countries with fast-lengthening lives and many fewer births.’
While the process of reform has begun in most OECD countries, the question is how far will politicians be tempted by the prospect, no matter how slight, of a future debt aggregation or the pooling of all public sector liabilities. (This happened in 1790 with Alexander Hamilton’s financial reforms in the US). Sinclair explains that the temptation to governments would be to spend more and tax less, leading to a debt race: ‘Debt aggregation benefits those with higher debt. Majority voting, if then in force, might lead to this if the heavy debtors could outvote the light - unlikely but possible.’ Instead of this direction, policy should address first and foremost the pension problem so as to improve the portability of pensions between EU countries and correct pension underfunding in a variety of countries. As neither of these problems has yet been solved, Professor Sinclair concludes ‘EMU is a worse bet for Britain than it would otherwise have been’.
Peter Sinclair is Professor of Economics, University of Birmingham and was previously fellow and tutor in Economics at Brasenose College Oxford and has published widely on economic subjects.