Tuesday, August 10, 2004

Currency Unions and Economic Reality

I've been aware for some time of the tendency amongst certain circles of African intellectuals to imagine that all that would be required to initiate a new golden age on the continent would be for its constituent nations to emulate a merger along the lines of the European Union, an idea which has a fair amount of history behind it, "Africa Unite!" being one of those 1970s slogans I can still remember. Anyway, the latest iteration on this theme seems to be that Africans ought to adopt a single currency after the fashion of the Euro (the "Afro", as wags might call it), but as Laurence Caromba explains, this is quite simply a lousy idea.

The broader point is that no amount of "having your act together" is sufficient to make a project like this work. It's hard to imagine a continent that has its act together more than Europe does, and yet even there, the single currency has been a disaster.

The problem is simple. One of the most basic ways in which a government can control the economy is by controlling the money supply, ie. the interest rates. In an economic downturn, you lower interest rates to pump more money into the economy. If the country starts showing inflationary tendencies, you raise them. Basic stuff.

When you're part of a single currency, that power gets taken away from your government, and given to a supra-national body that has to act on behalf of the entire continent.
I must take issue with one point Caromba makes, which is that Germany was the strongest economy in Europe - it wasn't. Germany had (and still has) the largest economy in Europe, but the problem is that thanks to the absorption of the former East Germany at an absurd 1:1 exchange rate* way back in 1990, it is now the weakest major European economy, and as such in dire need of lower interest rates than the ECB, which must set policy continent-wide, is willing to entertain.

But this is really a minor point, and the essential thrust of Caromba's argument stands: one currency rarely fits all, and if Europe isn't an optimal currency area, there's simply no chance that Africa will be. In fact, everything that would make for a successful currency union is even more lacking in Africa than pretty much anywhere else in the world - the continent displays a dizzying amount of linguistic diversity, its constituent states are held together in the face of ethnic strife only at gunpoint, and its leaders are too busy siphoning funds off to Switzerland for them to ever be willing to implement the sorts of transfer payments that would be necessary under a single-currency regime. What Africa needs is division, as in a radical redrawing of state borders, not more pie-in-the-sky "unity."

*The problematic absorption of East Germany also illustrates another serious problem with currency unions - it's very, very difficult to get the exchange-rate at entry right, and this difficulty is compounded by the high likelihood of extraneous political factors coming into play. Unfortunately, getting the entry rate wrong can be disastrous, as wages aren't equally flexible upwards and downwards (in economic jargon, they tend to be "sticky").