Year XLVI, 2004, Number 3, Page 188
Harmonization of Budgetary Policies in
a Monetary Union
A Critical Analysis of the Werner Reoprt*
a Monetary Union
A Critical Analysis of the Werner Reoprt*
1. In the ambit of the process of economic integration of the European Community’s nine member states, the most ambitious objective, decided by the Conference of Heads of State and or Government in The Hague on 1-2 December 1969 and reiterated at the Paris summit of 19-20 October 1972, was completion of economic and monetary union by 31 December 1980.
Prompted by the difficulties that quickly became apparent following the introduction of the European Monetary System (or “monetary snake”), the political and academic communities analyzed the problems that must be tackled in pursuit of the objective of completely fixed exchange rates between the different European currencies. But there are other aspects of economic and monetary union that, in our view, are worth considering in greater depth.
In particular, we feel that it is extremely important to analyze, in this framework, the effects that can derive from the harmonization of budgetary policies contemplated by the Werner Report, especially in relation to the possibility of pursuing not only balance of payments equilibrium, but also the internal objectives of stability and growth. We maintain, indeed, that it is very difficult to proceed with the building of economic and monetary union if, at the same time, the states are not guaranteed the possibility, through employment of the usual fiscal or monetary instruments, of achieving fundamental economic policy objectives.
In truth, such harmonization of budgetary policies deprives the member states of an instrument of control over the economic system, without at the same time making provision for the creation of similar instruments at supranational level. And this is, in our view, the fundamental flaw that undermines, at root level, the harmonization approach characteristic of the stage-by-stage establishment — in the Werner Plan — of economic and monetary union.
2. In this paper, having analyzed the conditions that guarantee maintenance of the balance of payments equilibrium within an integrated economic system that has absolutely fixed exchange rates (par. 4-10), it will be revealed that these conditions, if realized, severely limit the effectiveness of independent monetary and fiscal policies at national level (par. 12-13).
These limitations are exacerbated considerably the harmonization of budgetary policies, which impedes the effective use of fiscal policy for the achievement of other internal objectives (stability, growth, regional equilibrium) (par. 14-17).
The conclusions (par. 18-19) highlight the inadequacy of the Werner Plan’s harmonization approach, and the need — if one wants to render the pursuit of the objectives of stability and growth compatible with the maintenance of balance of payments equilibrium and, thus, with fixed exchange rates —, when imposing the necessary limitations at national level, also to transfer to a supranational authority effective powers of decision in the sector of fiscal (and monetary) policy.
3. As regards the objective of fixed exchange rates, two opposing methods have, of course, long been advanced: the method of the monetarists and the method of the economists. The fundamental elements of the first are: preliminary consultation of the central banks; reciprocal short-term aid and medium-term and long-term loans for countries with balance of payments difficulties; and the issuing of central banks with common directives on the creation of the monetary base on credit policy and on interest rates. “Obviously, all this implies that monetary policy will play a fundamental role as an instrument of the stabilization policy and that the stabilization policy will be employed intensively to create the domestic conditions (in salaries and demand) most conducive to the objective of irrevocable currency parities”. In less neutral terms, it implies that, in order to make it possible to guarantee fixed exchange rates, the objective of growth will be sacrificed for that of the balance of payments equilibrium. But this point will be discussed in more depth later on.
According to the economic policy method, monetary unification must be based, instead, on close harmonization of taxation; on the monitoring and sanctioning, at Community level, of the fundamental lines of national budgetary policies, particularly in relation to the determination of the size of public deficits (or surpluses) and decisions as to how these should be financed (or utilized), the structuring of the stabilization policy, through monetary and/or fiscal policy instruments and decisions on investments, be they public or supported through fiscal incentives by the public sector; and finally, in the last stage, on the growing importance of revenue and expenditure established autonomously at Community level.
The Werner Plan is, in a sense, a combination of these two approaches. It indeed affirms that “the development of monetary unification must be based on sufficient progress in the field of convergence and then in that of the unification of economic policies. Parallel to the limitation of the autonomy of the member states in the matter of economic policy it will be necessary to develop corresponding powers at the Community level.” In the final stage of the process, it indeed makes provision for the setting up of a centre of decision-making on economic policy and of a Community system of central banks, in other words for the transfer to supranational level of powers currently held by the national governments.
This final stage should be reached at the end of a gradual process; indeed, the Werner Report “in no way wishes to suggest that economic and monetary union are realizable without transition. The union must, on the contrary, be developed progressively by the prolongation of the measures already taken for the reinforcement of the coordination of economic policies and monetary cooperation.”
In the analysis that follows, we will seek to highlight, above all, the contradictions that are destined to emerge in the course of this intermediate stage, in an effort to identify the analytical tools that might help us to explain the current difficulties of the process of monetary integration and, in particular, to establish whether the choice of a stage-by-stage approach in the economic and monetary field, in the absence of a parallel evolution in the political sphere, does not in fact constitute an insurmountable obstacle to the achievement of the very objectives the Werner Report sets out to pursue.
4. The first problem we wish to consider in our analysis concerns the possibility of guaranteeing balance of payments equilibrium among the member states of the monetary union. This is a problem that, unless an effective solution is found, could plunge the whole process into crisis — a fact confirmed by the dramatic difficulties that, from the outset, have dogged the “monetary snake” policy.
In a monetary union, “only the global balance of payments of the Community vis-à-vis the outside world is of any importance. Equilibrium within the Community would be realized at this stage in the same way as within a nation’s frontiers, thanks to the mobility of factors of production and financial transfers by the public and private sectors.”
It is worth analyzing the theoretical implications of this proposition, in order to be able to evaluate not only the objectives, also institutional, that must be pursued in order to allow, in the final stage, efficient functioning of the monetary union, but also in order to have at our disposal the analytical tools needed to understand the difficulties and tensions that may emerge in the period of transition leading up to its creation.
5. A simple, but indicative, statement of fact may provide the starting point for an analysis of this problem, and it is this: balance of payments difficulties arise between different countries, but not between regions that belong to the same political community. The points generally made when seeking explain the difference between adjustment mechanisms at regional and at international level are linked to three facts: “1) the fact of a common or unified currency in use within a country, whereas different currencies are used by different countries; 2) the fact of a homogeneous economic policy (monetary, fiscal, trade and migration policies) governing the regions within a nation, while at the same time different nations pursue independent and divergent policies; and 3) the explanation of the classical economists, the fact that factors of production move within a country, but are relatively immobile as between countries. It will be shown that the most important determinant in the maintenance of regional balance-of-payments equilibria in this country [the United States of America], has been the mobility of productive factors and especially that of capital.”
It is thus worth taking this analysis of the mechanisms of adjustment at regional level as a starting point for our assessment of their effectiveness and workability within the framework of the economic and monetary union that, with characteristics defined in the Werner Report, should emerge in Europe, and thus to highlight their limitations and the scope for overcoming these limitations.
6. Let us suppose that within the framework of a political community divided into different regions there emerges an import-export imbalance, and thus a deficit in one of the community’s regions in relation to the others.
One of the first mechanisms that comes into play is financial, and it has the effect not of immediately restoring balance of trade equilibrium, but of generating a flow of transfers of funds and securities that, by creating a surplus in the balance of capital movements, offsets the current deficit. The region with the deficit, in order to pay for its surplus of imports over exports, must in fact relinquish part of its financial assets, previously accumulated, to the rest of the community, which has recorded a balance of trade surplus. In balance of payments speak, one might say that the regional deficit in the balance of current transactions is “financed” through capital imports and/or selling of foreign currencies, whereas the surplus in the other regions is compensated by a capital outflow and/or a purchase of foreign currencies. It is likely that this adjustment can be made without resulting in major variations in the quantity of money and thus through movements of other financial assets, given that the desired quantity of liquid funds depends more on income flow than on financial asset stocks, and this flow — initially at least — is not markedly altered.
The rapid and efficient working of this system of compensatory financial flows nevertheless requires that certain conditions be fulfilled. First of all, the country needs to have at its disposal a relatively high stock of financial assets. Second, it has to be possible to transfer a sufficiently large share of these assets out of the region that has the deficit, which in turn presupposes the existence of an interregionally organized and integrated financial market. Finally, portfolio structure choices have to be such that the residents in the rest of the community will be willing to purchase the very financial assets that the financial operators of the region with the deficit wish to sell. Indeed, if this is the case, the transfer of securities does not trigger major price variations.
7. In a subsequent stage, the long-term adjustment process presumably involves changes in economic magnitudes that influence the balance of trade. First of all, regions with deficits will become poorer and this negative effect on wealth, influencing propensity to spending, will lead to shrinking imports. But this process is markedly accelerated when the conditions cited above are not fulfilled, or, in situations in which the financial markets are not completely integrated — situations in which financial assets are not perfectly transferable and portfolio structure choices are influenced by the country of origin of the various assets (in short, savers prefer national securities). In such situations, regional operators, in order to finance the balance of payments deficit, have to sell to the rest of the community securities that cannot easily be transferred at their pre-existing value. As a result, the prices of financial assets vary, falling in regions recording a deficit (where there is excessive negative demand) and increasing in the rest of the community, where the balance of payments surplus has generated extra demand. At the same time, if the transfer of liquid assets is used to help finance the deficit, the liquidity of the regional banking system is reduced as the banks, seeing their reserves reduced, are prompted to sell part of their non-cash (and, in this case, not perfectly transferable) assets, thereby generating similar effects on the prices of securities.
In short, the prices of non transferable securities fall in the region recording the deficit (and increase in the rest of the community), until a point is reached at which their purchase becomes economically advantageous for operators in countries recording surpluses — i.e., they become transferable — and their sale inopportune for operators in regions with a deficit.
Changes in the value of securities speed up the balance of trade adjustment process, as capital losses induce operators in the country with the deficit to downsize their spending plans (and vice versa in the country recording a surplus). It is necessary to add that changes in the value of securities also reduce income, production and employment levels, because they are associated with rises in interest rates and restrictions on credit, and have repercussions on investments, on the building and housing industry, and on the hire purchase of consumer goods. Meanwhile the opposite effects manifest themselves in the rest of the community. This process, through its effects on imports, favours the restoration of an equilibrium in the balance of trade. Clearly, the extent of these income movements depends on the changes in the value of securities: it will be more marked in the presence of greater distortions and imperfections of the financial market. Similarly, the greater the share of non transferable securities (as a proportion of total financial assets), the less flexibility there will be for the replacement of transferable with non transferable assets.
8. In a regional system, with a centralized fiscal power, there exists another powerful factor of adjustment. “A region that forms part of a political community, with a common scale of public services and a common basis of taxation, automatically gets ‘aid’ whenever its trading relations with the rest of the country deteriorate. There is an important built-in fiscal stabilizer which arrests the operation of the export-multiplier: since taxes paid to the Central Government vary with the level of local incomes and expenditure, whilst public expenditures do not (indeed they may vary in an offsetting direction through public works, unemployment benefits, etc.), any deterioration in the export-import balance tends to be retarded (and ultimately arrested) by the change in the region’s fiscal balance — in the relation between what it contributes to the central Exchequer and what it receives from it (…). This seems to me to be the main reason why there appears to be no counterpart to the ‘balance-of payments problem’ on the regional level.”
Indeed, if in the region recording a deficit, there is a reduction in production activity in the course of the adjustment process, then there will automatically be a reduction in the tax revenue received by the central government. The opposite pattern occurs in the region recording a surplus. On the other hand, the portion of expenditure (for example, on social security) destined for the country with a deficit in the balance of payments increases. This is a mechanism which does not require specific political decisions and which, like the so-called automatic stabilizers, tends to reduce the income effects provoked by the processes described above, but at the same time produces equilibrium-restoring effects on the balance of payments. The payment of taxes can, indeed, be likened to imports, whereas the social expenditure, from a regional point of view, corresponds to exports. Obviously, this adjustment mechanism can, through the use of fiscal policy instruments, be slowed down or speeded up on the basis of discretionary decisions of the political power.
9. A final factor helping, at regional level, to reduce the balance of payments problem is that of the mobility of factors of production and the integration of their markets. Movements of labour within the territory tend, within an economically unified area, to bring about greater wage uniformity, concerted action on the part of the unions, which is a necessary result of integration of the labour market, tends to have the same effect. The mobility of capital and of entrepreneurial capacity can lead to increased productivity in economically weaker areas; in the same way, sales techniques and processes of technological innovation can spread more rapidly (because of a demonstration effect) in the less dynamic geographical areas. In this way, some of the causes of balance of payments disequilibria are attenuated.
It must, however, also be noted that even in an integrated market, the mobility of factors of production is not perfect and, above all, that there can occur movements of factors of production that even have the effect of destabilizing the balance of payments; in particular, movements of capital and entrepreneurial capacity away from areas in decline to more developed areas. It is clearly the job of economic policy, employing the instruments at its disposal (investments in infrastructures or direct investments in production, tax and credit breaks, etc.), to stimulate greater mobility of these factors of production and to channel them in the desired direction.
10. Having summarized, extremely briefly, the mechanisms of automatic adjustment that operate at regional level, it is worth highlighting that the re-establishment of the conditions associated with maintenance of the interregional balance of payments equilibrium is considerably accelerated by economic policy measures decided by the central government. As regard the United States’ experience, for example, Hartland emphasizes the compensatory role played by transfers of federal funds to the regions recording a deficit, through the Federal Reserve System. This observation is based on the negative correlation (empirically detected through an analysis of the period 1919-1939) between Treasury transfers (net flows of public capital) and transit clearings (net flows of private capital) between the Federal Reserve Districts.
The central government can, in any case, stimulate these compensatory movements of public funds through discretionary monetary or fiscal policy decisions. In particular, a stabilization policy, conducted at national level, can set itself the objective of guaranteeing the income and employment levels of each region. In this case, in the regions that have to sustain a balance of payments deficit, the increase in demand from the public sector halts the process of adjustment, which had been started the reduction of imports caused by the drop in regional income. The stabilization policy thus precludes balance of trade re-adjustment through the income effect, but restores balance of payments equilibrium through the flow of public funds and thus the positive variation of capital movements.
11. Our analysis, so far, has allowed us to highlight the conditions that guarantee the maintenance of the balance of payments equilibrium within an economically integrated regional system that has absolutely fixed exchange rates. It has emerged that the efficient working of balance of payments adjustment mechanisms depends: 1) on complete integration of the financial and monetary markets; 2) on the existence of automatic stabilizers deriving from the operation of a centralized fiscal system; 3) on the mobility of factors of production; and 4) on the existence of flows of public funds, which compensate for the movements of private funds, in the framework of a centralized monetary policy.
It thus seems possible to conclude that, in the final stage of economic and monetary union, providing we see the creation of an economic policy decision-making centre and of a Community system of central banks, both of which must be equipped with adequate powers, that these conditions may be fulfilled and the problem of the balance of payments equilibrium within the Community may be overcome, just as it normally is within any regional system.
But this, in reality, is not a conclusion, only a more analytical framing of the point from which we started out, i.e., that balance of payments problems do not exist within regional systems. What we need to establish, on this basis, is what problems will emerge in the intermediate period, in order to be able to evaluate whether the proposals contained in the Werner Plan are adequate, or whether, on the contrary, they threaten to make pursuit of the final objective impossible. In other words, we need to ask ourselves whether, in the intermediate period, characterized, institutionally, by the total absence of any power of intervention at supranational level, it is possible to pursue simultaneously not only the objective of balance of payments equilibrium, but also internal objectives of growth and stability. If, indeed, it is not — and the recent withdrawal of the British and Italian currencies from the monetary “snake” seems to confirm this — the growth of resistance to the maintenance of irrevocable currency parities will become unstoppable, and the whole process of moving towards monetary union will be jeopardized.
12. We saw earlier the importance of the role played, with respect to the mechanism of adjustment, by the degree of integration of the interregional financial market. We must now consider the effects that derive from this, compared with the conducting of an independent monetary policy at regional level.
In reality, the effectiveness of the monetary policy is lost if a sufficiently broad quota of financial assets are perfectly transferable and, thus, securities prices in the different regions are homogeneous. In this situation, an expansionary policy that aims, by increasing securities prices and reducing interest rates, to stimulate the formation of capital and spending on consumer goods will result only in an outflow of capital and the importation of foreign securities. Let us take, as an example, an open market policy. The purchase of securities by the monetary authority does not modify prices or interest rates. Indeed, securities purchased on the market or from banks are immediately replaced by securities purchased abroad, whose price is, temporarily, lower, and the liquidity introduced into the system is transferred abroad to fund the purchase of financial assets. In the same way, a restrictive monetary policy, which hinges on interest rate increases and credit restrictions, provokes exportation of securities and importation of capital, which restores the liquidity removed from the system.
In short, monetary policy conducted at regional level, in the event of perfect integration of the capitals market, can generate balance of payments deficits or surpluses, but has no effect on employment and income levels.
13. In a perfectly integrated economy, the limits imposed on fiscal policy conducted at regional level are different, but still considerable. The effectiveness of these limits is in fact conditioned by how “exposed” the system is vis-à-vis the other countries. In particular, in an area that is part of a regional system, marginal propensity to import, like average propensity, is likely to be higher and this will reduce the internal effects of an anti-cyclical or pro-development fiscal policy. Thus, the effects of an increase in public expenditure tend to be felt not only internally, but also — to a greater extent when the marginal propensity to import is greater (and the open market multiplier smaller) — in the community’s other regions; this means, moreover, that every region feels, to a greater extent, the effects (deflationist or inflationist) of the fiscal policy conducted in the rest of the community. From the balance of payments point of view, on the other hand, the effectiveness of the fiscal policy is strengthened, given that a small reduction in expenditure brings about a marked reduction in imports. It can thus be affirmed that the cost of an anti-cyclical or pro-development policy is higher, first of all because, with the same increase in national income, a more marked change in demand through public expenditure or tax cuts is necessary; and second because the negative effect on the balance of payments is greater.
The effectiveness, at regional level, of fiscal policy is further reduced by the loss of autonomy in the sphere of taxation caused by the mobility of factors of production at community level. In truth, the importance of this factor must not be exaggerated, since choices regarding the location of capital, labour, and entrepreneurial capacity are obviously influenced by other, non fiscal, factors, and can present differences even within the confines of an economically unified area. Thus, for example, a higher level of taxation of companies might be offset by greater availability of public services or a better structured labour market, and so on. The fact nevertheless remains that autonomy in the conducting of fiscal policy is limited by the increased mobility not only of products, but also of factors of production.
14. On the basis of the above analysis it can thus be affirmed, as a first conclusion, that the conditions guaranteeing the automatic working of balance of payments adjustment mechanisms also limit, considerably, the effectiveness of an independent monetary and fiscal policy geared to promote stability and growth of national income.
But, in fact, the problem is more serious. In relation to fiscal policy in particular, the Werner Plan has set as an objective the progressive harmonization of budgetary choices, remarking that “for influencing the general development of the economy budget policy assumes great importance. The Community budget will undoubtedly be more important at the beginning of the final stage than it is today, but its economic significance will still be weak compared with that of the national budgets, the harmonized management of which will be an essential feature of cohesion within the union. The margins within which the main budget aggregates must be held both for the annual budget and the multi-year projections will be decided at the Community level, taking account of the economic situation and the particular structural features of each country. A fundamental element will be the determination of variations in the volume of budgets, the size of the balance and the methods of financing deficits or utilizing any surpluses.” “According to the economic situation in each country quantitative guidelines will be given on the principal elements of the public budgets, notably on global receipts and expenditure, the distribution of the latter between investment and consumption, and the direction and amount of the balance.”
It is necessary to highlight, from the point of view of the Community’s member states, the repercussions of this close coordination of budgetary policy, which, as we have seen, affects not only quantitative aspects, but also the internal articulation of the budget structure.
The objective in mind, let us recall, is that of shaping a business cycle that is compatible with the establishment of irrevocable parities between the different currencies, or put another way, that allows maintenance of a balance of payments equilibrium. In the absence of an effective decision-making power, and thus of instruments of autonomous intervention at Community level, the coordination of the national budgetary policies runs the risk of showing a strong deflationist bias.
Indeed, the main obstacle to stability in the realization of economic and monetary union is the possible presence of inflationist trends in one (or more) of the member countries, and, more generally, of a different evolution of the general level of prices in the various countries — a situation liable to give rise to persistent disequilibria in the balances of payments within the Community.
The simplest solution to this problem might seem to be that of maintaining a state of suboptimal exploitation of production capacity by cutting demand and, above all (in order to prevent inflationary developments on the costs side), by preventing wage level increases from exceeding increases in productivity, in accordance with the classic (but contested) income policy rule. Clearly, in this case, the cost that must be borne in order to achieve the objective of balance of payments equilibrium is excessively high (in terms of the sacrificing of other objectives), and furthermore this course of action is, to a large extent, contradictory.
Through flexible application of fiscal policy it is indeed to render variations in monetary wages — even though, in the short term, these may exceed variations in productivity — compatible with the predetermined values of the price level variable, without having to sustain, within the system, a high level of unemployment. But the rigid budgetary policy coordination procedures exclude this flexible application of the fiscal policy tool, and as a result generate the need to curb wage increases. What it imposes, albeit in a different form, is the “golden rule”: either monetary wages increase in parallel with the growth of productivity (that is, inflationist risks are eliminated through the reduction of demand)” or, in the final instance, through an increase in the level of unemployment and, thus, a curtailing in real terms of total wages.
This choice is, to a large extent, contradictory, given that the level of demand depends on investments and “if a high rate of investments can, with regularity, be maintained, this makes it easier, in any period, to solve economic policy problems (…), since it increases the compatibility between the various objectives. It has now been demonstrated that a high rate of investments is a necessary condition for a high rate of growth of productivity. From this it follows that the extent of the increase in productivity in each period will correspond to the increase in wages compatible with a given price stability objective, to the increase in exportation, and thus to the increase in imports compatible with the objective set for the balance of payments equilibrium.”
15.The harmonization of budgetary policies is thus less efficient than a solution that, in the framework of complete integration of the different markets (products, factors of production, monetary and financial), attributes effective powers of intervention to an independent centre of economic policy making at Community level. In this situation, as we saw earlier, the automatic balance of payments adjustment mechanisms work efficiently and, characterized by perfect monetary and financial market integration and independence of fiscal and monetary policy at European level, in the long term favour equilibrium without causing large fluctuations in income, and thus unemployment levels.
On the other hand, the existence of an integrated market of factors of production (of which liberalization of labour mobility is only a necessary condition) tends to bring about a levelling of wage increases, in part due to concerted action on the part of the unions. This does not exclude the possibility of cost-push inflation due to the existence of different rates of productivity in different regions and/or manufacturing sectors. But in this case a flexible fiscal policy can intervene effectively both, in the short term, through differentiated modifications of the parameters that influence the cost of labour per unit of product, and, from a broader perspective, through the sustaining of demand as a means of stimulating investments and thus increasing productivity, and finally by favouring processes of reallocation of production activity, directly through public investments or indirectly through a policy of incentives (or disincentives).
Should the situation of inflation be related to an excess of demand, and due, in particular, to differentiated evolution at territorial level of supply and demand that thus brings about the generation of disequilibria in the balance of payments, the state can intervene effectively either through increased spending or taxation.
16. An autonomous fiscal power at Community level may also serve as an instrument for ensuring that cumulative processes of development and underdevelopment in the European area are avoided.
The Werner Plan repeatedly focuses on the need for regional policies, drawing attention to the fact that “the realization of global economic equilibrium may be dangerously threatened by structural differences. Cooperation between the partners in the Community in the matter of structural and regional policies will help to surmount these difficulties, just as it will make it possible to eliminate the distortions of competition. The solution of the big problems in this field will be facilitated financial compensatory measures.”
It thus highlights the need, in order to avoid territorial disequilibria, to direct capital flows in such a way as to compensate for the dynamics generated by the automatic play of market forces. But, in reality, the logic of the common market has so far had the opposite effect, and the considerable capital draining effected by American enterprises through the parallel Eurodollar market assumes emblematic significance. In any case, even in the framework of the envisaged economic and monetary union, the solution to regional disequilibria cannot be sought through simple coordination of budgetary policies. To remain within a national framework of reference, the problem of southern Italy continues to be, in the absence of common management of economic policy, a purely Italian rather than a European problem; and whereas we fail to see “financial compensatory measures” on the part of the richer in favour of the poorer areas, what we in fact see — this phenomenon is abetted by an anarchic liberalization of the movements of factors of production — is an increase in Italian capital exports, as well as (and this is an inevitable result of the serious economic backwardness of many Italian regions) an exacerbation of the social problem of emigration.
17. A brief consideration may be advanced at this point with to the problem of the reforms in Italy. It is clear that the distortions in the process of growth that have emerged in the past can be corrected concentrating utilization of resources in the social sphere; and this means, with a view to creating a modern community, using a considerable share of the public budget to make up for the deficit in essential services. But this increased use of resources for social purposes can generate inflationist phenomena; consequently, the need to respect the limits imposed by the balance of payments makes it possible to justify the decision not to sustain the cost of the reforms.
Although this line of reasoning is clearly too schematic, it nevertheless seems to underpin many affirmations advanced in connection with recent controversy over national budget deficit limits. In any case, in a framework of coordination of budgetary policies, the size of the balance and decisions regarding expenditure would be taken at Community level on the basis of the objective of fixed exchange rates. We thus seem to be confronted with something of a dilemma: either a squeezing of the national budget prevents increased expenditure in the social sphere (a politically unacceptable solution), or the rate of absorption of resources by the state in Italy exceeds the budget growth rate in the Community’s other countries and threatens to throw the fixed parity rate into crisis. In reality, the problem of the public services deficit in Italy has to be resolved through the provision of adequate financial means to cope with any balance of payments difficulties that may arise as a result of the considerable planned increase in public expenditure. And this financial support on the part of the Community can be justified, and thus upheld politically, within the framework of those structural interventions designed to improve the distribution of resources and services at territorial level.
18. At this point we can draw some conclusions from our analysis. We have seen that the efficient working of automatic balance of payment adjustment mechanisms depends on the existence of a perfectly integrated financial market and a centralized decision-making power in the fiscal and monetary sector. The Werner Plan envisages that these conditions will not be fulfilled during the transition stage and that harmonization of fiscal and monetary policies is all that will be needed; in accordance with this, the establishment of an economic policy-making centre and a community system of central banks is postponed to the final stage.
From a theoretical point of view, this approach is contradictory, and recent experience seems to support this affirmation. Indeed, even though the financial market is already partially integrated at European level, the monetary policy is seeing its effectiveness (with regard to the stability and growth objectives) declining at national level. And similarly the cost of an anti-cyclical and pro-development fiscal policy becomes increasingly burdensome in an economic system that has reached a high level of exposure vis-à-vis the Community’s other countries; in addition, having set out on the road towards the harmonization of taxation structures and budgetary policies, the state sees its freedom of choice in the matter of taxation increasingly restricted.
It is thus necessary to find a solution that makes it possible to deal with the problems relating to the balance of payments equilibrium without jeopardizing the objectives of stability and growth. “Balance of payments disequilibria occur within single countries in the same way as they do within the Community. In the former, there exist monetary as well as fiscal mechanisms that make it possible to spread the rebalancing process over a longer period of time. The almost total absence of such mechanisms in intercommunity relations leads to a concentration of the process of adjustment into a shorter space of time, and renders it more acute — so acute that it demands major sacrifices in terms of the importance attached to the different economic policy objectives. If, at the present time, bringing down inflation seems to be the priority objective, the monetary union cannot hinge on a mechanism that tends to put growth and full employment at the bottom of its scale of priorities, in other words, that reverses the choices accepted by most of the peoples and governments of this post-war period.”
19. To guarantee fixed exchange rates, without sacrificing the other economic policy objectives, it is necessary, from the outset, to transfer certain competences to supranational level, through the creation (currently under discussion in the ambit of the EEC) of a European reserve fund and a European regional development fund. This would facilitate not only the process of adjustment of the balance of payments, but also through financial flows towards the economically weakest regions, the achievement of real objectives. However, this solution is still not enough. “The necessary condition for currency unification to be workable is that the participating countries give up their sovereign authority to conduct an independent monetary and fiscal policies directed at internal price and employment goals. Such policies would have to be conducted by a centralized monetary and fiscal authority charged with responsibility for internal stability for the group of countries as a whole.” The building of monetary union thus presupposes the founding of a European government with limited, but real powers, which is responsible for the pursuit of the economic policy objectives that cannot be pursued at national level. Realization of this solution is difficult due to the states’ reluctance to relinquish certain typical attributes of sovereignty. But it is crucial to appreciate that the price to be paid for refusing to follow this road will probably be paralysis of the process of monetary unification.
* This text was published in French in Le Fédéraliste, XVI (1974), under the title «Compatibilité entre l’équilibre de la balance des paiements et d’autres objectifs de politique économique dans une union monétaire (Une analyse critique du rapport Werner)». The Italian version, published in Le imprese multinazionali (edited by Dario Velo), Milan, Giuffré, 1974, has been translated into English and presents some variations in the first part.
 “A monetary union implies inside its boundaries the total and irreversible convertibility of currencies, the elimination of margins of fluctuation in exchange rates, the irrevocable fixing of parity rates and the complete liberation of movements of capital. It may be accompanied by the maintenance of national monetary symbols or the establishment of a sole Community currency. From the technical point of view the choice between these two solutions may seem immaterial, but considerations of a psychological and political nature militate in favour of the adoption of a sole currency which would confirm the irreversibility of the venture.” See EEC, Report to the Council and the Commission on the Realization by Stages of Economic and Monetary Union in the Community (“Werner Report”), Supplement to Bulletin 11 -1970 of the European Communities, p. 10.
 On this point see, for example: R. Ossola, “In attesa di un’organizzazione politica dell’Europa”, in R. Triffin, R. Ossola, M. Albertini, Verso una moneta europea, Bologna, Il Mulino, 1971, pp. 32-33.
 See F. Forte, “Verso una moneta europea?”, in L’Europa, 1970, n. 24-25, p. 90.
 See Werner Report, cit., p. 14.
 See Werner Report, cit., p. 14.
 The analysis that follows of the balance of payments adjustment mechanisms is taken from par.s 2-7, written exclusively by the author, of the paper by E. Gerelli, A. Majocchi, entitled “Politica fiscale e meccanismi di aggiustamento della bilancia dei pagamenti”, in Società per lo studio dei problemi fiscali, Il Piano Werner e l’armonizzazione fiscale nella CEE, Padua, Cedam, 1971.
 See Werner Report, cit., p. 10.
 See P.C. Hartland, “Interregional Payments Compared with International Payments”, in Quarterly Journal of Economics, August 1949, p. 393. On the strategic role of the interregional mobility of capital in the readjustment mechanism, see: T. Scitovsky, Money and the Balance of Payments, Chicago, Rand McNally, 1969, pp. 87 onwards.; Id., “The Theory of Balance of Payments Adjustment”, in Journal of Political Economy, August 1967, pp. 523-530; Id., “The Theory of the Balance of Payments and the Problem of a Common European Currency”, in Kyklos, 1957, pp. 18-38 (reprinted, with a few changes, in Economic Theory and Western European Integration, London, Unwin, 1962, part II); J.C. Ingram, “State and Regional Payments Mechanisms”, in Quarterly Journal of Economics, November 1959, pp. 619-632; M. von Neumann Whitman, International and Interregional Payments Adjustment: A Synthetic View, Princeton Studies in International Finance, n. 19, Princeton, February 1967; J.C. Ingram, The Case for European Monetary Integration, Princeton Studies in International Finance, n. 98, Princeton, April 1973.
 It is known that the distinction between capital movements and reserve movements is purely formal. As regards the question under consideration here, however, the point that it is worth highlighting, leaving aside albeit important (to other ends) questions of definitions, concerns the effects brought about by the operation of the abovementioned financial mechanism. On the concepts of the balance of payments surplus and deficit, and on the distinction between autonomous and compensatory capital movements, see, for example: F. Machlup, “Three Concepts of the Balance of Payments and the So-called Dollar Shortage”, in Economic Journal, March 1950, pp. 46 onwards; F. Masera, Commercio estero e bilancia dei pagamenti, Rome, 1966, pp. 22 onwards.
 The final effects on the balance of payments clearly depend on the value of the “open market multiplier with repercussions”. On this point see also: G. Gandolfo, Aggiustamento della bilancia dei pagamenti ed equilibrio macroeconomico. Un’analisi teorica, Milan, Angeli, 1970, part I, chap. III.
 See, on this point: A. Lamfalussy, “Le système des taux de change et l’avenir de la CEE”, in Revue d’économie politique, July-August 1970, p. 656; T. Scitovsky, Money and the Balance of Payments, cit., pp. 97-98.
 See N. Kaldor, “The Case for Regional Policies”, in Scottish Economy, November 1970, p. 345.
 See P.B. Kenen, “The Theory of Optimum Currency Areas: An Eclectic View”, in R.A. Mundell, A.K. Swoboda, Monetary Problems of the International Economy, Univ. of Chicago Press, 1969, p. 47.
 See N. Kaldor, “The Case for Regional Policies”, cit., p. 345.
 “In the short run the net balance of payments effects of labour movements in either direction, but it appears that generally the movement of labour from areas of payments deficit to those of payments surplus will tend to aid the adjustment process”. See T.D. Willett, E. Tower, “Currency Areas and Exchange-Rate Flexibility”, in Weltwirtschaftliches Archiv, 1970, 105/1, p. 53. Also: T. Scitovsky, Economic Theory and Integration, cit., p. 85.
 See P.C. Hartland, “Interregional Payments Compared with International Payments”, cit.
 On the quantitative importance of the automatic stabilization mechanisms, J.C. Ingram, Regional Payments Mechanisms: The Case of Puerto Rico, Chapel Hill, Univ. of North Carolina Press, 1962, pp. 21-22; M. von Neumann Whitman, lnternational and Interregional Payments Adjustment, cit., pp. 22-23.
 Scitovsky demonstrates that the total of public funds transferred at regional level is greater than the failed shrinkage of imports due to the stabilization policy. Indeed, if the so called stability condition occurs that is normally assumed in the analysis of income effects on the balance of payments, i.e. m+s <1 (where m and s are the marginal propensity to import and to domestic spending, respectively), then
i.e. the imports provoked by the increase in public spending at a regional level (DM) areinferior to the amount of spending itself (DG). See T. Scitovsky, Economic Theory and Western European Integration, cit., p. 93.
 See T. Scitovsky, Money and the Balance of Payments, cit. p. 120.
 See, regarding this conclusion: R.A. Mundell, “Capital Mobility and Stabilisation Policy under Fixed and Flexible Exchange Rates”, in Canadian Journal of Economics and Political Science, November 1963, pp. 475-485 (reprinted as chap. 18 in R.A. Mundell, International Economics, New York, MacMillan, 1968); R.T. McKinnon, W.E. Oates, The implications of International Economic Integration for Monetary, Fiscal and Exchange-Rate Policy, Princeton Studies in International Finance, n. 16, Princeton, Princeton Univ. Press, January 1966, p. 5.
 See G.K. Shaw, “European Economic Integration and Stabilization Policy”, in C.S. Shoup (editor), Fiscal Harmonization in Common Markets, New York, Columbia Univ. Press, 1967, vol. II, chap. II.
 See Werner Report, cit., pp. 10-11 and 19.
 This limit is implicit in the confederal constitution of the Community, and has already
been verified in the past. See, for example, the behaviour of the Brussels Commission,
in relation to the recession of the Italian economy in the period 1963-65. On
this point, see: F. Forte, La congiuntura in Italia. 1961-1965, Turin, Einaudi, 1966, pp. 255 onwards.
been verified in the past. See, for example, the behaviour of the Brussels Commission,
in relation to the recession of the Italian economy in the period 1963-65. On
this point, see: F. Forte, La congiuntura in Italia. 1961-1965, Turin, Einaudi, 1966, pp. 255 onwards.
 On this point, see: L. Izzo, A. Pedone, L. Spaventa, F. Volpi, Il controllo dell’economia nel breve periodo, Milan, Angeli, 1970, p. 33.
 See Ibidem, p. 36.
 On the scope for using fiscal policy in the event of cost inflation, see F. Romani, “Tipi di inflazione e politica fiscale”, in Moneta e Credito, 1965, pp. 229-251.
 See Werner Report, cit., p. 11.
 See G. Carli, “Crisi monetaria internazionale e politica di ripresa economica”, in Bancaria, 1973, p. 546.
 See W.L. Smith, “Are There Enough Policy Tools?”, in American Economic Review Papers and Proceedings, May 1965, p. 217. For a similar conclusion, see: T. Scitovsky, Economic Theory and Western European Integration, cit. p. 98. Both these authors highlight the political difficulty of achieving this objective. On these aspects of the problem of economic and monetary union, see: M. Albertini, “Aspetti politici dell’unificazione monetaria”, in various authors, Verso una moneta europea, cit., pp. 57-64.