Much has changed since the Maastricht timetable was first agreed. Slower growth in Europe and a change in political leadership have strengthened the case for a "constructive postponement." David Marsh argues that the hazards of a premature launch far outweigh the risks of delaying Emuby David Marsh / April 20, 1997 / Leave a comment
Published in April 1997 issue of Prospect Magazine
Economic and monetary union is ostensibly an economic project. In reality, it is a political venture with strong overtones of European psychodrama. It combines the elegance and high intentions of Moli?re with the epic nature of Goethe’s Faust and the mystery of Agatha Christie. One of the main elements of suspense stems from the economic and political changes we have seen in Europe since the Maastricht treaty was agreed in 1991. Because of these changes, Emu is unlikely to be accomplished according to the Maastricht timetable. Motivations behind Emu, too, have changed. The EC’s latest effort to forge monetary union was founded in the mid-1980s on the desire to complete the single market. Then came the fall of the Berlin wall and German reunification, and the primary motivation switched to the aim of controlling and constraining renascent Germany in an enlarged and strengthened European framework. Plus d’Allemagne made it necessary to construct plus d’Europe. More recently, the motivation has shifted once again. Emu is being used as a means of putting pressure on European governments to carry out economic and budgetary reforms which, but for their incompetence, impotence or foolhardiness, they should have carried out anyway. The difficulty is that the EU has neither the power nor the legitimacy to shoulder the burden of driving forward such reforms. Europe risks being blamed unjustifiably for unpopular measures for which governments should bear the responsibility. the tandem of Germany and France has been of vital importance in promoting Emu. As a British European, I support the Franco-German relationship that has developed since the war. Yet these ties have a neurotic aspect that cannot be ignored. Emu can be regarded as a late 20th century Arc de Triomphe constructed to celebrate the ending of the cold war. France saw and sees Emu as the means to reproduce on a European scale the power and influence it knew it would lose, as a result of German unity, on a national level. Accordingly, France has been seeking to dismantle, stone by stone, the edifice of the Bundesbank and build a new structure in the shape of the European central bank (ECB). A larger Germany, meanwhile, ostensibly sought not to gain power but to give it up, in the interest of European harmony and co-operation with its neighbours. Monetary union, through the dissolution of the Bundesbank and the replacement of the D-mark by a supranational European currency, was the chosen route. But just as France sees Europe as an extension of itself, so with Germany. The Bundesbank is to be abolished at the national level but only to be recreated at the European level. These political and psychological problems do not mean that a successful Emu would not have important economic benefits. A single currency, working well, would increase the competitiveness and efficiency of the single market, by rendering costs and prices transparent throughout the member countries and by removing the uncertainty of currency volatility for exporters, importers and inward investors. It would also reduce industry’s costs arising from currency conversion and hedging operations. A single currency could bring political advantages, too, by strengthening the commitment to co-operation and cohesiveness on which our countries, interlinked as they already are, depend. But there are potential economic and political disadvantages. For a start, there is no guarantee that the new Euro-bloc would be stable against the dollar and the yen. Simply increasing the size of the new currency area does not increase the likelihood of stability. Indeed, if the arrangements for running the new money are inadequate-for instance, if there were dissent among the constituent countries on monetary and exchange rate policy-then the Euro could become a Spielball for speculators. If the markets saw the danger that the Euro could be weak against the dollar or yen in its first few months or years, the ECB might be forced to run an unnaturally tight interest rate policy while it builds up credibility. This could have dire consequences for the Euro area. By forgoing flexibility in national interest rate and exchange rate policy, Emu members will lose an important economic safety valve that could otherwise be used to ward off the effects of economic shocks or simply to adjust to shifts in relative patterns of costs and prices within the Euro area. Unless Emu members introduce more flexibility in other areas-above all in labour markets-any deterioration in their relative competitive position would show up immediately in lower growth, higher unemployment and higher fiscal deficits. The problem here is that Europe could be bla-med for the consequences of mistakes made by the governments of individual countries. The European Monetary Institute (EMI) in Frankfurt is now considering whether the ECB, when it is formed, should build its own foreign exchange dealing room, or whether such operations should be entirely devolved to national central banks. I would suggest another innovation: those responsible for the physical design of the ECB’s building should make sure that it is surrounded by a high fence. If things work out badly, the ECB could become the focus of much popular discontent. However the balance of advantage is calculated, Emu should be judged solely on economic rather than political criteria. It is worthwhile only if it produces more jobs, investment and growth throughout Europe than would otherwise be the case. Money is a commodity closely tied up with the psychology of individuals and nations. No more so than in Germany, where the D-Mark has become the badge of honour of postwar revival. If currencies are made the instruments of purely political ends, those who seek to manipulate them risk grave disappointment unless other vital factors are also in step. I submit that these factors are not in step at the moment. Nor for a variety of political and economic reasons are they likely to become so during the next 18 months. It is one of the many uncomfortable paradoxes of Emu that the political and economic benefits of monetary union will be least when membership is restricted only to those countries that are already relatively harmonised and “convergent.” There would be relatively little benefit to exporters from a monetary union made up of those countries which already enjoy exchange rate stability. The economic benefits become significant only when countries such as Italy, Spain and Britain, which have not experienced stable patterns of exchange rates during the last decade, are brought in. Precisely because they have not been “convergent,” bringing the so-called “out” countries into Emu is hazardous, but could also generate great rewards. This is the crux of a dilemma about the “ins” and “outs” which can be expressed as Marsh’s first theorem of Emu: where Emu is possible-among the “convergent” core-it is not necessary. And where it is necessary-through the inclusion of the “divergent” periphery-it is not possible. Anyone who weighs up the risks and benefits of a “wide” Euro can see that the consequences of not meeting the 1999 timetable would indeed involve many risks, but that there would be still greater dangers if the project went ahead on time and had to be abandoned later on because it had been inadequately prepared and implemented. If there is divergence among Emu aspirants, especially in the field of political and economic “culture”-as there evidently is-then establishing new institutions will not, by itself, cover this up. People such as myself are often accused in Germany and France of being kleinmutig. Sometimes, however, avoiding ?bermut can be more courageous. And much has changed in Europe during the past five years to justify caution. The decision-making context for Emu has become far less propitious, not least because of the recent weakening in the authority of Europe’s pivotal leader, Helmut Kohl. But the most striking change has been the decline in economic growth. In the second half of the 1980s, the EU recorded an average growth rate of slightly more than 3 per cent. This has fallen during the last six years to no more than 1.5 per cent. Consequently, efforts to adhere to the Maastricht criteria for public sector debt and deficits have been greatly impeded. Many people believe that Maastricht has forced governments to adopt a fiscal straitjacket. In fact, during the past five years public sector debt throughout the EU has risen from 55 per cent of GDP to more than 70 per cent. In total, governments have collectively taken on an extra $2,000 billion in public debt. Yet the truth is that the effects, both good and bad, of the Maastricht treaty on EU economic performance have been modest. External factors have had a far greater impact. Behind the fall in EU inflation lies intense international competition forcing down costs and prices, coupled with an excess supply of labour in Europe. Inflation has receded everywhere during the past six years-look at Latin America. Economic policy mistakes have played a role, too. To name but two: the mishandling of the “policy mix” in Germany after reunification, and Europe’s collective mismanagement of exchange rates in the ERM in 1992-93 (Britain must shoulder part of the blame for the events leading up to sterling’s departure from the ERM in September 1992). This record of mismanagement should teach politicians and civil servants a little humility. Can they really be trusted with a grand scheme such as Emu? The people who brought you the ERM collapse of 1992-93 are now asking us to believe that they can successfully fix exchange rates among a chosen group of European countries, not just for a few years or until the next election but for all time. Supporters of Emu say the sharp fall in Europe’s growth rate makes monetary union more necessary, since it is the only way to unlock sub-optimal investment and economic dynamism. That may or may not be the case. Unquestionably, however, slower growth makes monetary union more difficult. First, slower growth has impeded efforts to meet the Maastricht fiscal criteria. The value of these criteria may be debatable from an economic point of view, but adhering to them is necessary because they represent a political compact in Germany between the government and the majority of the electorate who would prefer to keep the D-Mark. Germany has said it does not want to make use of the undoubted flexibility of interpretation in the Maastricht treaty for one excellent reason-pour d?courager les autres. If Germany does not hit the criteria exactly, then it will be more difficult to keep out weaker currency countries such as Italy which Germany does not want in the Euro-bloc at the start. Second, economic difficulties in EU countries have inevitably heightened electorates’ fears of the large changes that would ensue from abandonment of time-honoured national currencies and their replacement by a new one. This fear is particularly great in Germany, especially in the eastern part of the country that was so eager to gain access to the D-Mark at reunification. Third, the self-confidence and authority of Europe’s political leaders have suffered as a result of the slow growth phase. Most of those individuals who signed up to Maastricht are no longer in power. Above all, Helmut Kohl’s ability to push through Emu in the teeth of a sceptical electorate is now much weaker than it would have been three or four years ago. Kohl has linked his political destiny to the outcome of Emu. Both could founder together. Fourth, the economic strains reduce politicians’ margin of manoeuvre for taking risks over Emu. If monetary union fails, the political and economic “safety net” in nearly all countries would be more threadbare than it would have been after a period of higher growth. There are also various specifically Franco-German difficulties that dog the Emu project. First, for the first time since the war, both France and Germany are weathering simultaneously a period of sub-average growth. The two countries that have been the motors of EU integration have a particularly poor record in job creation: 40 per cent of EU unemployment is concentrated in these two countries. A time of weakness in the European economic “core” is not an auspicious moment to launch Emu. Second, the two countries approach the establishment of the European central bank from different cultural perspectives. Autonomy and independence are much more ingrained in the Bundesbank’s tradition than in that of the bank of France. Historically, French public sector institutions see their job as protecting the state from the depredations of the people; the German institutions, during the past 50 years at least, see their task as protecting the people from the state. Recent weeks have underlined the gulf between Germany and France on this crucial question of central bank independence. Third, France and Germany also have differing perspectives on the use of the exchange rate as a tool to influence economic growth. This is an impor- tant point as the external value of the Euro will clearly be a matter for joint policy between the ECB and European finance ministers, meeting in the “stability and growth council” whose formation was agreed at the Dublin summit. A dialogue will be necessary between the ECB and the council over the interaction between internal and external monetary policy, and this may prove another area where pressure will grow for political interference in the ECB’s deliberations. Finally, there are basic differences between France and Germany over which countries should join Emu at the outset. France has good reasons for starting straight away with a relatively wide Emu, since a monetary union that simply linked France to the existing members of the D-Mark bloc could be regarded in Paris as a Pyrrhic victory. Germany, on the other hand, for reasons I have already mentioned, has a strong interest in an initially narrow Emu. Despite Bonn’s success in bringing the ECB to Frankfurt and modelling it on the Bundesbank, many Germans still fear that it will be a form of Trojan horse bringing hidden French-style soft money policies. The French, conversely, are worried that the institution which they see as a means to win back monetary power from the Bundesbank will eventually reveal itself as a Frankenstein’s monster-a European Bundesbank with an even bigger B. the closer we get to the planned time of decision on the Euro in early 1998, and the more these difficulties remain unresolved, the more seriously we will have to consider postponement. What are the impediments blocking the path to Emu? First, Kohl’s weakness-over the mishandling of the tax and pensions reform, over unemployment, and over his eventual succession-may continue or be exacerbated as he approaches next year’s elections. It has become a clich? to say we should never underestimate the chancellor. However, no one can rule for ever. One day it will be accurate to talk of his impending political demise, and that day may be approaching. Second, Germany’s own difficulty in meeting the Emu criteria leaves Bonn’s political leadership with three options. The government can try to hit the fiscal targets exactly by stepping further on the fiscal brakes, which would cause more unemployment. It can accept a softening of the criteria, which would conceivably let in countries such as Italy. Or it can propose a postponement-an outcome that has always been implicit in the formula “Stabilit??t ist wichtiger als Zeitpl??ne.” Third, Italy and Spain are the two most important aspirants which might be left outside Emu when the decision is made next year. They have powerful means to block a narrow Emu. Decisions will need to be taken at the European council based on qualified majority voting. The ERM “core” group commands 42 votes in the council, 20 short of the necessary majority (62 out of a total of 87 votes). Together with Britain (ten votes), Italy and Spain form a blocking minority. Put crudely, to form a narrow Emu of the sort favoured by Germany, Italy may be required to vote for Belgium even though Belgium will not vote for Italy. Finessing these political hands may prove impossible. Finally, Chancellor Kohl promised the German electorate in 1991 that monetary union would only succeed if it were combined with political union (however defined). Progress towards political union has been halting and there are unlikely to be any breakthroughs before the intergovernmental conference closes in Amsterdam in June. So one fundamental German condition for Emu is not in place. Postponing Emu would involve risks of course. There is unfortunately no provision for delay beyond 1999 in the Maastricht treaty, so many people might claim it was tantamount to abandoning the whole idea. Some politicians, among them Kohl himself, have made this point already. Their words of warning might prove self-fulfilling prophecies. Then there is the real fear that taking away external convergence pressure might lead to “reform fatigue” in countries such as Italy. A further worry is the possibility of foreign exchange unrest and an appreciation of the D-Mark that could set back economic recovery in Germany and the rest of Europe. These fears have to be put into perspective. The fear of a D-Mark appreciation is exaggerated at present since the currency is under pressure because of Germany’s severe economic problems and political uncertainty in Bonn. The risks of delay also have to be weighed against the hazards of launching Emu at the wrong time. These include instability in Italy and Spain as well as financial market unrest within the Euro area that could eventually lead either to the ECB running a deflationary policy or to the unravelling of the entire monetary union. We would also have to bear in mind the possibility of a legal threat to Emu from the German constitutional court, which would cause extra financial market turbulence. All in all, the risks of launching Emu are at present greater than the risks of postponement. And from a narrowly British perspective a constructive postponement of Emu-that is, one in which convergence and reform pressure are maintained-would also allow Britain to help forge monetary stability in Europe. We can assume that the Labour party will form the next government and that it will be somewhat more “Euro-friendly” than the Tories. But there is no way that Tony Blair can bring the pound into Emu by the due date of January 1999, for a mixture of political and economic reasons. These include both the necessity to hold a referendum in Britain on the issue and the difficulty of passing an Act of Parliament to make the Bank of England independent in time. Postponing Emu would increase the likelihood that Britain could join Emu at the same time as most other members, and at a time when the chances for its successful implementation would have improved. Great projects such as Emu require a great deal of preparation and thought, but they also require a political consensus among the people. They cannot be a leap of faith. Additionally, they cannot be launched simply because of the fear of the unpleasant consequences that would allegedly ensue if they were not to happen. Angst ist ein schlechter Ratgeber. Kohl now possibly faces the most difficult and strenuous decision of his political life. It would be a sign of statesmanship and wisdom were he to decide -for the good of Europe-that the Maastricht timetable for Emu can no longer be safely implemented. People sometimes say that Emu is “the only game in town” for Europe. That is simply not true. Europe has other projects on which to focus. Europe needs to safeguard and maintain the development of the single market. It needs to create the conditions for what should be its priority objective: enlargement to the east. It needs to find a solution to the pressing needs of reforming generous pensions and social security systems that grew up in the more bountiful years after the war. There is the small matter of reducing the unemployment total of 18m peo- ple. And there is also the task of rekindling the electorate’s confidence in the political process after the setbacks of the past five years. None of these aims would be greatly supported by proceeding with Emu now. And none of these aims are likely to be compromised by a constructive postponement. Rather than going ahead with Emu with all the attendant risks-sauter pour mieux reculer-Europe will, I believe, take the alternative route-reculer pour mieux sauter. Provided the decision is handled sensibly, postponing the 1999 starting date for Emu in the next few months would increase rather than diminish the chances for genuine convergence in Europe. And postponement would increase the likelihood that Emu could meet the two central requirements: that it should encompass as wide a membership as possible, and that it should stimulate growth and jobs. Emu is beginning to resemble a Greek tragedy with the drama heading inexorably towards disaster. But politicians can still take the initiative-two politicians in particular, Jacques Chirac and Helmut Kohl. The two leaders should release a joint communiqu? which postpones stage three of Emu at least until 2001, but which seeks to retain the convergence momentum in other, more modest ways. The communiqu? should reaffirm the goal of monetary union and as an interim measure should propose reducing the fluctuation bands within the ERM. Further, the two leaders should announce with great symbolic fanfare that the governor of the Bank of France and the president of the Bundesbank should have a right to attend each other’s meetings. And at the same time a Franco-German convergence plan would be proposed with the aim of cutting budget deficits to 2.5 per cent by 1999 combined with some joint measures to tackle unemployment. Who knows, perhaps the Bundesbank could even be persuaded to cut interest rates.