The Case for the Amero: The Costs: Loss of Economic, Political, and Cultural Sovereignty

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Many people believe that Canada will sacrifice too much of its economic, political and cultural sovereignty by joining a North American Monetary Union. Let us consider the merit of these concerns.

National economic sovereignty

National economic sovereignty means the ability to pursue monetary, fiscal, exchange-rate, trade, taxation and many other economic policies without restraint by international agreements. For some Canadians, such economic sovereignty is an end in itself. For them, it represents the very essence of being an independent nation. The political left in Canada considers "being different from the Americans" the most important policy agenda.

I respect those who hold such views. As an economist, however, I think the sovereignty is not infinitely valuable. The merit of giving up some aspects of sovereignty should be determined by the gains brought by such a sacrifice. It is important to note that in practice Canada has given up its economic sovereignty in many areas, the most important of which involve the World Trade Organization (formerly the GATT), the North American Free Trade Agreement, International Conventions on Refugees and the use of Landmines, the International Monetary Fund and the World Bank. As a signatory to these international agreements and organizations Canada can no longer impose tariffs and other trade restrictions without suffering serious sanctions. Canada is committed to providing capital to the International Monetary Fund and World Bank without being able to decide what the specific uses are to which this capital is put. The acceptance of refugees and the use of landmines are subject to conditions that restrain Canada's sovereignty.

While some vocal Canadians oppose all of these losses of economic and political sovereignty, the decision to become signatories to these treaties was made by democratically elected legislatures that represent all Canadians. The decision was reached after careful analysis of the economic and social benefits in relation to the cost of reduced economic sovereignty.26 I believe that such a calculation needs also to be undertaken to assess the merit of joining a North American Monetary Union.

The most important part of this calculation in my view involves assessing the cost of losing the ability to pursue monetary, fiscal, and exchange-rate policies to serve the national interest. In theory, sovereignty in these policies is important and should improve the performance of the Canadian economy for the benefit of all. In practice, however, it has not done so very well.

Until the 1970s, Canada and other countries were committed to fixed exchange rates in the belief that the accompanying loss of sovereignty was worth the increased prosperity and stability they brought. However, economic theory and the apparent success of planned economies like the Soviet Union caused a re-examination of this position. It was widely believed that economic prosperity and stability could be raised through a switch to flexible exchange rates.

Unfortunately, after the adoption of flexible exchange rates in the 1970s economic performance did not improve. It deteriorated. Canada's unemployment rose with each business cycle and now is double that of the United States. The exchange-rate has lost nearly one third of its value not just against the US dollar but also against European currencies. Economic growth has not been impressive and during the 1990s has lagged seriously behind that of the United States.

It makes no sense to attribute the poor record of the Canadian economy to the existence of flexible rates alone, though as I argue above, they have contributed to a lack of labour-market discipline and interfered with the rational adjustment to a more appropriate mix of industries. Excessively generous unemployment insurance benefits, high rates of taxation, inflation, permanent subsidies to ailing industries and regions, misplaced agricultural policies, and other government measures are also to blame for the poor performance of the Canadian economy. The main point is that flexible exchange rates and national monetary sovereignty have not been able to compensate for the problems caused by these policies. In fact, because they masked the effects of some problems, they have contributed to their strength and persistence. For this reason, I believe that the loss of national economic sovereignty over exchange rates and monetary policy will raise rather than lower the well-being of Canadians in the future.

Canada's experience with flexible exchange rates is not singular. Some European countries, most notably the Netherlands and Austria, experienced poor economic performance for many years until in the 1980s they linked their exchange rates to those of Germany. In the process, they lost their economic sovereignty and had to accept the interest and exchange rate policies of Germany. In all but name they had formed a currency union. The economic performance of both the Netherlands and Austria improved as a result and they obviously found these benefits greater than the cost of having lost sovereignty in monetary policy formation.

There are some highly respected economists who continue to believe that economic sovereignty brings large benefits.27 These economists tend to be "Keynesians" in the sense that they have great confidence in the ability of monetary and fiscal policy to "fine-tune" economies. Such fine-tuning involves changes in policies to counter cyclical economic developments--booms and recessions--and to restrict fluctuations in growth and unemployment. These economists tend to be Euro-pessimists. They foresee that the loss of economic sovereignty will lead to great suffering in some member countries in the European Union, which in turn will create civil unrest and possibly even civil war.

However, there are also Euro-optimists. They tend to distrust the ability of governments to fine-tune the economy. Often called "monetarists" for the lack of a better term, they believe that economic well-being is best secured by governments that provide a stable monetary and fiscal environment. They consider the economic instabilities, slow growth, and high unemployment since the 1970s to have been the consequence of attempts to fine-tune the economies through the vigorous use of monetary and fiscal policies. I am one of these monetarists and Euro-optimists and my proposal for the establishment of a North American Monetary Union is rooted in these ideas exactly because it brings institutional safeguards against fine-tuning.

Barry Eichengreen assessed the likely consequences of the European Monetary Union using an empirical approach. In one of his papers (1992), he compared the historic experiences of American states and members of the European Monetary Union in dealing with economic shocks.28 He concluded that American states hit by adverse economic shocks did not need sovereignty over monetary and exchange-rate policies since unemployment was readily relieved through emigration and large automatic transfers from the central government. Since migration opportunities are much more limited in Europe and central government transfers are very small, European countries need monetary and exchange-rate sovereignty to deal with adverse economic shocks. Eichengreen's findings are widely used to support the views of Euro-pessimists.

The problem with Eichengreen's results is that they are based on historic experience and neglect the fact that a number of important institutions determining a country's ability to deal with shocks are themselves shaped by the exchange-rate system in place. (This point has been made forcefully by Frankel and Rose 1997.) For example, unions tend to be stronger under a flexible than under a fixed-rate system for reasons outlined above. As a result, wages are more rigid and labour markets are less able to deal with exogenous shocks. As another example, consider that private international capital flows are the free market equivalent of transfers from the central government. Both sources of finances can be used to deal with the adverse consequences of shocks. In a monetary union, individual countries will have access to foreign capital at much lower interest rates and in larger quantities than they do when they have flexible exchange rates. In my view, therefore, Eichengreen's results do not lend strong support to Euro-pessimists.

Most of the economics literature on the subject of asymmetric shocks and the need for flexible exchange rates to deal with their effect on unemployment is theoretical, with casual references to the oil-price shock of the 1970s and the lowering of defence spending in the 1990s. However, Belke and Gros did some empirical work aimed directly at measuring the effect. They state: "We show that the data from the past 30 years in Europe does not show any strong link between external shocks and unemployment. Hence we would argue that EMU is unlikely to lead to the serious additional unemployment problems that have often been predicted" (italics in original; 1999: 38). They found that changes in the exchange rate did not alleviate unemployment. The highest correlation of unemployment is with changes in domestic investment, the classical cause of business cycles.

There is another reason to be sceptical about the ability of flexible exchange rates to cushion the effects of lower commodity prices on unemployment. This reason involves changes in behaviour induced by the existence of the insurance against low prices inherent in the flexible exchange rates. It is well known that such changes in behaviour (called moral hazard in the economics literature) cause an increase in the incidence of the insured risk. For example, houses insured against burglary are broken into more often than those that are not. Restaurants with fire insurance burn more often than those without. Workers with unemployment insurance have more frequent and longer spells of unemployment than those without insurance. (For an early analysis of these ideas, see Grubel and Walker 1978).

Under a fixed exchange-rate regime, firms and workers in commodity-producing industries know that periodically they face lower world prices. Firms prepare for them by putting away earnings during good times and build inventories during the slump, financed with such reserves and stand-by credits from banks. By evening out production over the cycle of low and high demand, they can keep workers employed and reduce the risk that they find jobs in other industries and locations. Workers who know that slumps occur and that exchange-rate depreciation is not available to cushion the effects will restrain wage demands during booms so that their employer can keep them on during slumps.

It is possible that, because of moral hazard, the cushioning effect of exchange rates during low demand for natural resources has been strong enough to wipe out much of the beneficial effect of the exchange-rate depreciation, though I know of no research that has attempted to quantify this effect.

In this context, I want to discuss another important rationale for my proposal. It is well known that the Canadian Charter of Rights and Freedoms was deemed necessary to protect Canadians from the sovereign will of parliament if and when it results in the passage of legislation that interferes with basic human rights. The United States has a similar protection of human rights through constitutional clauses concerning the freedom of speech, the right to habeas corpus, and the right to bear arms.

Unfortunately, neither country has a Charter of Economic Rights and Freedoms. In my view, this is a serious omission since the economic interests of individuals and of future generations, in particular, need protection from simple parliamentary majorities. If such a charter had existed, the inflation of the 1970s and the irresponsible deficits of the 1980s would have been prevented. Tax structures that have seriously damaged incentives to work and investment would probably have been prevented. Economic prosperity would have been higher and unemployment lower.29

Membership in international organizations and treaties are imperfect substitutes for charters and legislation protecting economic rights and freedoms. However, presently, they are the only politically feasible measures. For these reasons, I welcome the proposed North American Monetary Union.

Cultural sovereignty and political independence

Many Canadians will oppose a North American Monetary Union on the grounds that it will interfere with national cultural sovereignty and that it represents a further step in a process that will ultimately lead to the political absorption of Canada by the United States. They will use the same arguments that they advanced in the debate over the Free Trade Agreement and the North American Free Trade Agreement. They will predict the loss of Canada's freedom to have an independent foreign policy and a broader and deeper social security net than the United States.

These concerns of the Canadian nationalists are well known, do not have to be elaborated here and were dealt with during the debate over the two free trade agreements. Suffice it to note that none of the restraints on Canadian sovereignty predicted by nationalists have developed since the free trade agreements were adopted. (For an overview of the predictions made by nationalists and a study of the actual results, see Law and Mihlar 1998.)

Since the adoption of NAFTA, Canada's foreign policy under free trade has been as independent as ever. Lloyd Axworthy, the Minister of Foreign Affairs, had his Moosehead beer and Cuban cigar during a chat with Fidel Castro in Cuba, in spite of strong opposition from the American government. Prime Minister Chretien advocated a revision of NATO's nuclear policies without regard for the American government's views on the subject. Sheila Copps, the Minister for Cultural Affairs, continued to advance policies in support of Canadian cultural industries. Canada's Medicare system has not been hijacked by American business and is in as much trouble as it was before free trade. Canadian provinces prohibit the export of bottled water. Supply management for the dairy and other agricultural industries continues to thrive and make some farmers into millionaires.

The basic fact is that the introduction of the amero does nothing to the existing national border and the ability of Canadian governments to pursue policies that get them re-elected. Nationalists do not have a good case to oppose the amero except on the grounds that it results in the loss of national monetary and fiscal sovereignty. But, as the preceding analysis shows, this loss is incurred in the expectation of large economic gains.

Above I noted that increased border shopping in the wake of a common currency will create a dilemma for Canadian politicians. They will have to collect excise taxes at the border or lower tax rates. If the politicians are convinced that the excise taxes create a better society by reducing "sins," fostering agriculture, and raising revenues for good spending causes, they can maintain their programs. The extra money and political costs of increased tax collection should be worth the achievement of these worthy goals. Protests over costs and border delays would help politicians with the assessment of the popularity of their measures. In my view, the increased transparency of policies implied by such protests is highly desirable and promises to make economic and social policies conform better to public preferences.

Finally, some people believe that symbols of nationalism are important for human well-being since they satisfy the need for affinity to larger human groupings and national identities. The flag, the Royal Canadian Mounted Police, geographic landmarks like Lake Louise and Niagara Falls, the design of passports, and the architecture of the Houses of Parliament are such symbols. Canada's history, the settling of a wild continent, the heroics of her armies, multiculturalism, and generous social security nets are intangible but no less important symbols of a national identity. Ranked high on the list of such symbols is the currency bearing images of the Queen, important Canadians, and outstanding geographic sites.

Nationalists will deplore the loss of Canada's national currency as a major disaster and will oppose monetary union on these grounds. I agree with the proposition that symbols are an important part of a country's national identity, which is important to many people and can provide social cohesion and peace. Therefore, to minimize the loss of national symbols brought on by a common currency, my proposal envisages the design of North American notes and coins with national symbols on one side and abstract symbols on the other. This solution may not satisfy the most ardent nationalists but I am hopeful that their opinions will not carry the day and that others will remember that the currency is only one of a long list of nationalist symbols important to the Canadian identity. The Canadian identity should be strong and vibrant enough to survive the reduced strength of the currency as a nationalist symbol.

I am not optimistic that the preceding analysis and historic evidence will dampen the attack by nationalists on the proposed North American Monetary Union. I can only hope that these attacks will not interfere with a rational discussion of the proposal that, I am convinced, will lead to the creation of a common currency for North America because benefits by far outweigh the costs.

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