What California Can Teach the EU

California has many advantages. The climate is pleasant, the nature is beautiful and there is an excess of labor potential. But the state has one malicious shortage – it is unmanageable. California is hopelessly divided between a nasty right wing (mainly living in the south of the state) and a radical left wing (mainly residing in the north). This leads to lively discussion, but the consequence is that the state has not been functioning politically for a long time now.

The left wants to spend, spend, spend; the right fights for a restriction, if not a lowering, of taxes. The predictable consequences are chronic budget deficits.

Despite this political extremism, the state has always been able to handle itself – until now at least. But the economic crisis has hit California hard. The tax revenues have collapsed, the budget deficit has exploded to more than 21 billion dollars and the state and the cities are unable to finance the deficits with the sale of their bonds.

The choice seems to be restricted between big cutbacks in government expenditures or aid from the federal government. All roads seem to lead to Washington. But will Washington agree with that? With Obama in the White House, the answer might be yes. Just like General Motors and Citibank, California will be seen as too big to go bankrupt. President Obama has, so far, not provided the state with a fiscal stimulus. There is much to say for speeding up the aid to California. Also, federal guarantees for municipal obligations do not have to cost the American taxpayer much. A federal rescue operation for California would not even be a bad idea, if it would lead to reforms. But is that likely to happen?

Until now, the approach of President Obama was to attach conditions to support. In the case of California, he could demand a restriction of government expenditures and set boundaries for the labor unions in the public sector, who demand increasingly more money, but give back little extra service. Also, constitutional changes can be demanded, which would no longer require a two-thirds majority for tax increases, a difficult hurdle for fiscal interventions.

Does the case of California sound familiar to Europeans? It should. Political deadlock, out-of-control government expenditures and budget deficits, an inability to devalue the currency in answer to the crisis, weak politicians who seek salvation in aid – it all belongs to the current European landscape. California even has a ‘European’ as its highest boss.

But there is an important difference. California is able to turn to a strong federal government for support. But such a federal government does not exist to come to the aid of Italy, Greece, Portugal and God knows who else in the eurozone.

That is an important advantage for Europe – if at least the advancement of a sound budgetary policy is taken as a starting point. If the U.S. comes to the aid of California, this clearly has a ‘moral danger.’ Like the current prospect of rescue gives Californian politicians motive to stay put, avoiding difficult decisions and waiting for the help of Washington, the same will happen in the future – conditions or no conditions. And how can Washington impose conditions on a sovereign state? In a rescue of California, a ‘me-too’ effect in other American states will have to be taken into account. Many states in the U.S. are going through rough times. They will ask for support as well. Where do you draw the line?

The analogy with Europe is clear. If the EU would come to the aid of, for example, Greece and the Italians, then the Portuguese will call for help as well, etcetera.

Apart from that, this does not imply ‘cold turkey’ for special cases in which European countries get into big economic difficulties. As such, the European Central Bank has lent three billion euros to the Swedish bank Riksbank following an existing agreement to prevent threatened Swedish banks from pulling out of Latvia, which is in a deep economic crisis.

If the money stream from the Swedish banks to Latvia were to dry up, the consequences would ooze through to the entire Baltic region and would be felt in the eurozone as well. The ECB loan must be seen as a onetime emergency measure – with this, the ECB does not take the responsibility for euro-wide emergency operations. A system without a federal budget like the eurozone demands a certain flexibility for emergencies.

But southern Europe is no emergency. The absence of a federal budget in Europe means that the people who want Germany and Holland to ‘rescue the ECB and the euro’ by helping out the euro countries with a deficit in the south – or even in eastern Europe – will have a tough job.

In the long run, this is a better recipe for a sound budgetary policy than what is waiting for Obama’s America with all its rescue operations.