14. Costs of keeping/creating a federation

The knowledge learned about international trade can be applied also to interstate/federation circumstances. The same way as international trade can yield only no additional profits or trade surpluses/profits at one side contra trade deficits/losses at counterparty the mechanisms are working similarly between smaller trade zones, formed by states in a federation or even counties and cities between themselves.

If there are imbalances between smaller units, like cities or counties they are manifesting in the form of higher salaries, low unemployment and better tax incomes in winning units and exactly opposite situation in less fortunate ones. But as these are still within the same state, and citizens share the same language, legal system and government it is still manageable. It is considered as acceptable to move from city to city for work, study as it is still seen as “our country”. There are also build in certain transfer mechanisms, which through taxes are channeling money from profit generating centers to less productive ones as these are generating some other generally recognized benefits, as: 

  • Steady source of new people, later moving to bigger cities
  • Agricultural areas
  • Strategically important sites
  • Retirement areas
  • Cultural and tourism areas, etc…

The state is acting as an integrated organism, whose parts are working together, complementing each other and together forming synergies which nobody is questioning.

For as long as nobody begins questioning them.

As we well know, even in states there are constant disputes about level of taxes transferred from central government to local units. These quarrels are never ending and their source is stemming from the very same paradigm which was explained in the previous chapters:

Profit generating centers are succeeding because they are sucking in demand from subordinated units. To regenerate that demand and make it sustainable transfers are needed at 100% of monetary gains, which would fully negate the profits gained by the centre. Without further indebtedness or monetary policy only insufficient level of transfers is provided and that is causing dissatisfaction at lower levels, which are diminishing in every aspect of social and economic activity.

The picture describes multiple relationships within economy. Bigger centers with more intensive economy activity are generating bigger demand and paying bigger taxes. Smaller centers are getting proportionally bigger share of taxes to supplement deducted buying power which was spent in bigger centers.

The example is more factories at certain areas, which are generating many goods which are distributed into wide geographies. They are spent there and sales are coming back to respective centre, allowing for bigger salaries and higher demand. But as there is usually unbalanced trade at smaller centers, without additional buying power added by transfers, these internal deficit bearing smaller centers have tendency to shrink.

The same is happening at the state level in federation or trade union where there are trade imbalances between member states. However here the situation needs to be resolved more decisively as otherwise states will gain deep grudge against each other. What was tolerated within state is no longer possible.  The grudge itself, stemming from permanent underperformance and lack of opportunities is not just a feeling of hurt national pride. There is real danger (surety) that by continuous outflow of funds from trade deficit suffering states these will literally bleed out of money.

Add to it national differences, race, religion, language, history of conflict and you have explosive situation where finger pointing is just the beginning. These differences apply more to the Europe with its 27 distinct nations, but the process is equally important within USA.  How would it be seen if some states would be in permanent economic depression with GDP regularly shrinking and their unemployment in double digits? Surely such states would be seriously thinking about reasons of remaining in such federation and secession talks would be a seriously considered daily theme.

Therefore, serious considerations have to be taken to ensure unity of such entity and process of federal taxation and transfers need to be put in place. However, very soon the fathers of the federation will find out that such task is not as easy as it seems at the first glance.

As described by the diagram what constitutes trade deficit at one state is just sales at receiving state. From these sales only certain percentage is profit and that is taxed definitely below 100%. Only certain portion of that tax is going to central government and so final replacement arriving to deficit state to replace diminished monetary supply is substantially lower then what left as trade deficit.

That is the underlying problem of any federation, how to finance deficits stemming from interstate trade imbalances.

 If somebody says why to bother at all, have a look at Europe and its 25-30% unemployment problem and heavily depressed economies in its southern states.

Without effective mechanisms, such situation would very soon follow even in USA.

So further taxation is needed well in excess of surplus taxes gained as result of trade surplus.

Federal taxes 2) represent additional taxation needed to fully offset trade deficit arising in state A. These are substantially higher then original tax directly coming from surplus profit. As a result, all citizens of surplus state are paying higher taxes than they would if there were no federation or no trade surplus.  This leads to their discontent and complaints that they, the “productive ones” are paying to “lazy, unproductive”. If under additional stress like recession, there are often even talks of secession. In Spain, it is Catalonia which feels that they are carrying the rest and paying unproportionate taxes. In Italy, it is more industrialized Padania which is contemplating declaring independence of “lazy” south. There are many examples around the world but what they all have in common is that they are wrong in their thinking. The productiveness of more industrialized area is benefiting its citizens only as long as they have that extra demand which is enabling their industries to make profit. This extra demand, from “external” area is absolutely needed to provide that missing buying power to cover for profit part of sales, as described in beginning chapters.  As soon as these productive areas would secede and stop contributing, their less developed partner would stop buying from them (if they had any brains at all) and start developing their own industries. Very soon the proud productive victors would realize that their superiority was indeed based only on willingness of others to buy from them.

-          These are nowproviding the missing buying power in surplus countries, all coming from external environment


Everybody can produce, the quality may by lower at the beginning, but as time goes by it will eventually improve. Even if it takes longer time, they will get there after few years. And then all will be sorting the age old problem what to do with the overproduction.

As the size of total federal taxes needed to fully offset damage to one economy done by permanent deficit occurrence would represent substantial amount of buying power withdrawal from surplus country these federal taxes collected are never up to the size needed to do the job. Indeed, inability of government to raise them up to the desired size is one more pressure factor to incur government debt and to finance many programs to supplement insufficient taxes exactly from this debt.

Another way to deal with trade imbalances in federation/trade area would be to simply introduce/keep national currencies. That would very soon establish the natural balance through appreciating currency of states exporting too much and so making their exports uncompetitive. Of course that would cancel the whole point of federation/currency areas, which is only one:  enable excessive flow of goods otherwise impossible because of natural barriers and corrective mechanisms of exchange rates.

Here is important to remember the methodology of profit creation (debtors, money printers, predators) especially in formation of federation/monetary union as is the case of EU.

Before the EU states joined the common currency euro, they were all pursuing different ways of achieving profit. Some (like Greece) were happily printing money and others (Italy) running debt.
After their melting in Euro zone remnants of their original strategies remained: high debt (Italy), inflation (Greece). When these married with predatory strategy of Germany, Netherlands, Belgium and others (who clearly gained an upper hand) it is obvious that they cannot survive. Either a full federation with significant transfers is introduced in Europe, which will at least diminish the destroying effects of trade imbalances, or the EU is doomed for dislocation. Requests to repay old debts and pursue internal devaluation in view of predatory strategy already sucking out the buying power of suffering south Europe will lead to total monetary winter in affected countries. Frost will be permanent and there will be no sources of future growth, as both avenues of improvement - debt (fiscal pact preventing its further growth) or monetary easing (resistance of Germany) are no longer possible within euro zone structures.