To survive, the eurozone must become more like the United States

Another round of negotiations between Greece and the eurozone’s powers-that-be broke down on Thursday. That leaves the two sides with little time to negotiate the terms of further aid to Greece before the current bailout runs out at the end of February. If they can’t come to an accord, Greece may well pack up its bags and ditch the eurozone.

On its face, this is a straightforward story of obtuse, high-handed decision making by the Germans. With the French, the International Monetary Fund, the European Commission, and the European Central Bank (ECB) in tow, the Germans effectively run the eurozone’s financial and monetary affairs. When Greece first plunged into crisis in 2010, they chose to bail the country out only on the condition of punishing austerity.

Rather than stabilizing Greece, the tax hikes and cuts to public spending just drove its economy further into the ditch.

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But there’s also a deeper structural story here, about how the very creation of the eurozone set it up for exactly this kind of crisis. In a way, the European Union was an attempt to remake the Continent in the image of the United States. But the Europeans didn’t take the change all the way — and in that gap lies the cause of Germany and Greece’s ongoing game of chicken.

Think of the countries in the eurozone as the states in America. Each has its own budget funded by its own taxes. But they all share in the same broader economy, with one single currency that’s centrally controlled; by the Federal Reserve in the U.S., and by the ECB in Europe.

But this setup comes with a huge weakness. If Greece controlled its own currency, it could respond to the current crisis by just devaluing, which would stabilize its economy and debt. Except it doesn't, and it can't. It needs the ECB to run a sufficiently loose monetary policy on its behalf.

But the ECB has a bunch of other economies to consider. Germany, in particular, wields disproportionate influence on monetary policy and historically has been hugely inflation-averse. Hence the current impasse.

The United States has managed to avoid a similar situation for two reasons. First, the 50 states are just way more economically integrated. Unlike the eurozone, they share a common language and many common cultural norms. There are fewer if any trade barriers between states. And while each state can have its own regulatory rules, the fact that the federal government also runs its own overarching regulatory policy brings a certain uniformity. So an isolated crisis in one state or a small number of states is just way less likely.

But more important, the U.S. federal government runs its own central fiscal policy. Liberals like to needle the red states for being net beneficiaries of federal taxation and spending, while the blue states are net losers. But the discrepancy also illustrates the great strength of America’s system; between mandatory and discretionary spending, the federal government reshuffles roughly 18 percent of national economic output around the 50 states every year.

That’s a huge distributional effect, and it acts to smooth out aggregate demand across the entire country, ensuring no state’s economy gets too far out of whack from any other state’s.

Meanwhile, the eurozone has no binding fiscal policy — that buck stops with the individual countries — so it has no equivalent smoothing mechanism.

As a result, the American states tend to rise and fall together through the cycles of the national economy. At the end of December, North Dakota had the lowest unemployment rate at 2.8 percent, while Mississippi had the highest at 7.2 percent. A spread of 4.4 percentage points may seem like a huge deal in the American context, in which we cheer a one-point drop in the national unemployment rate. But it’s peanuts compared with the massive gulf between Greece's Great Depression–esque 25.8 percent unemployment rate and Germany's unpleasant but hardly catastrophic 6.5 percent.

The recent decision by the ECB to finally loosen monetary policy and begin quantitative easing will help ease tensions. But at this point, Germany and Greece occupy two entirely different worlds. Greece sees itself as being forced by the eurozone to destroy its economy in the name of saving it, while Germany merely sees itself as enforcing fiscal discipline on a wayward partner.

Imagine if all the U.S. federal government did was run the currency, while merely negotiating fiscal policy between the states. The situation would be nearly impossible. Indeed, this is largely why the U.S. abandoned the Articles of Confederation for the much more centrally powerful federal system we have now. Europe is beyond the Articles of Confederation stage — there wasn't even a single currency there — but not beyond enough to function.

Worse, moving on to the next stage will probably be much more difficult for Europe than it was for America, precisely because Europe’s political and cultural divisions are so much deeper. But if the eurozone wants to avoid another mess like this in the future, that’s the route it will have to take.