December 20, 2001

The Euro: Cash in Hand

Weakened Euro, Conversion Is Concern
For Economist Who Champions Currency

Nobel Prize-winning economist Robert Mundell has as much right as anyone to claim paternity for the euro. But he is a worried father. Europe is weighed down by heavy taxes, rigid labor rules and mindless regulation, he argues, that diminish the economic lift that his baby, the euro, can deliver.

The Columbia University professor's research on exchange rates, monetary policy and currencies forms part of the philosophical foundation for a common European currency, although he didn't play any policy role in devising the euro. His work also earned him a Nobel Prize for economics in 1999, which has given him a wider platform for his views.

Through the 1980s, Mr. Mundell championed low-tax, antiregulation supply-side economics, which became the trademark of the administration of former U.S. President Ronald Reagan. Now Mr. Mundell wants continental Europe to go through similar reforms. Only then, he says, can the euro play its historic role and, perhaps, help Europe challenge the U.S. as the world's most powerful economy.

On a recent visit to Brussels, Mr. Mundell shared his thoughts on the euro and on Europe with Wall Street Journal Europe reporter Philip Shishkin.

* * *

Why do you think the creation of the euro is important to the world economic order?

Robert Mundell: When the euro was created, it was instantly the No. 2 currency in the world. And with its expansion potential to the accession countries of Central and Eastern Europe, eventually the euro area will probably have a population of 450 million people and a GDP [gross domestic product] larger than that of the U.S. So it will definitely affect the whole picture of the international monetary system.

Within 10 years, countries will want to keep equal proportions of dollars and euros. But the dollar still has a lot of advantages over the euro, namely one government that manages the U.S. policy. And you've got 12 governments managing the euro-area policies.

You've always said that Europe needs to undertake serious economic reforms. What are the main areas that European policy makers need to address?

The tax rates on labor are too high. For example, if an Italian worker gets taxed something like 59% of the gross salary, the take-home salary of the worker is something like 41%. That difference is called social contributions, social security. But they could buy much better social security through a private system and they could do it with a third of that. And then of course there are work rules, the difficulty of firing people. If you make labor a fixed cost of production, that could be very harmful.

What do you see as the main challenges for the introduction of the euro notes and coins?

There's a problem with respect to the conversion of the cash. All the cash that's used outside the United States and outside Europe in third countries, in Latin America, Russia and other places. Deutsche marks in particular. When those cease to be legal tender, they will have to be converted into euros.

But the way the process works, to convert large sums of money into euros, you'll have to fill out a lot of forms and people don't want to lose their anonymity. Part of the reason for keeping that money is to be anonymous, maybe for tax avoidance or for some other purpose.

So in the current run-up to the changeover, one would expect an increase of these Deutsche marks and other currencies to be converted not into euros but into dollars. That will keep the dollar over this transition period stronger than it otherwise would be and the euro weaker than it otherwise would be.

And that would be a little bit of a risk for the European Central Bank and a bit of an explanation of why they are afraid of reducing interest rates too quickly.

Do you think that the introduction of the euro notes and coins will lead to more political integration within the EU?

I think so, because the currency helps to perfect the common market and it will increase distortions due to the very diverse systems. I think you have to get more coordination in the banking systems. And you'll have to get some forms of tax harmonization in some areas where there are big distortions.

Is the single currency going to make Europe better equipped to deal with the global economic recession?

Probably some countries may think that they'd be better off if they were independent from the standpoint of being able to mange their own economic cycle. I don't think so. Even in the U.S., you have a difficulty in finding the right fiscal policy to cope with a recession or a slowdown.

You can always argue that when different parts of the U.S. economy operate differently, it might be better if they had separate economies and separate currencies. When the price of oil goes up, for example, it hurts the Northeast and helps the Southwest.

But it's not clear that separate currencies would help solve those problems. I don't think that Europe is going to hampered by this. I think, on balance, coordination of monetary policy is going to be a good thing and Europe is going to be better off having a unified currency than having separate currencies.

Write to Philip Shishkin at philip.shishkin@wsj.com¹

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