An Economist Looks at Europe
SEPTEMBER 1, 2014
Europe in Disarray
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"There is a lesson to be learnt by all democracies about the clash between politics and the economy... about the continuous and perhaps inevitable interference of politics in the economy. They are two worlds with their own logic, malfunctions and misunderstandings."
The European Union is sailing through choppy waters. Actually, this can be said of Europe as a whole. One tends to forget that there are nations that have expressed a desire to be in the EU but are still in negotiations with the Union or, more alarmingly, have halted negotiations due to Russia proclaiming them a part of its Hinterland, as the Germans would have said in the 20th century. The shallows and miseries faced by the EU make up a long list. The economy is still not doing well two years after the end of the financial crisis. Germany and Italy have shown negative growth in the third quarter of the present year; France has not grown at all during the last six months. Where there is some growth, as in the United Kingdom, the fear is that it may be an effect of excessive money creation rather than increasing productivity. The new currency, the euro, is far from safe, principally from excessive debt, public and private. The late European Parliamentary elections have revealed the strength of euro-scepticism in all the member countries, especially France and the United Kingdom, and not all in reaction to the late financial crisis. Jean-Claude Juncker, the newly elected President of the Commission, has faced much opposition because he wants "More Europe!" rather than less, as the British and many voters in the whole of Europe have said they wish. The European Council has not agreed on who is to be its President, or the high representative of the Union before the rest of the world, of which more anon. A number of member states are facing separatist movements, principally the UK in Scotland and Spain in Catalonia. British Prime Minister David Cameron is demanding deep reforms in the EU as a condition for campaigning in favour of the continued membership of the UK in a referendum three years hence. On its borders, the EU not only faces anarchy in the Middle East but also Vladimir Putin's Anschluss in Crimea and other parts of Ukraine; and Putin is answering the EU sanctions against his henchmen by stopping food imports from Europe. Perhaps I should have said stormy rather than choppy waters.
EU affairs are always complicated and obscure for outsiders, no less than for ordinary Europeans. It would be an act of kindness to spare my readers the Byzantine details of the situation in the continent were it not for one thing: there is a lesson to be learnt by all democracies about the clash between politics and the economy; I should say, about the continuous and perhaps inevitable interference of politics in the economy. They are two worlds with their own logic, malfunctions and misunderstandings.
Before proceeding I must remind my readers across the Atlantic of the institutional arrangements of the EU Though this breaks the rhythm of my exposé it is in fact essential to understand how the EU works and more importantly to follow the twisted course of European affairs, pushed this way and that by federalists wanting "an ever closer Union" and persistent nationalists resisting the increasing powers of the Brussels establishment.
Power in the EU is shared mainly by three institutions: the Commission, the European Council, and the Parliament. The Commission is really the government of the EU; it is the guardian of the treaties and monitors the application of European law in all member countries. There is one Commissioner per state and each governs a department. The bulk of the EU civil service works there. The Commission also holds the exclusive right to initiate legislation. It has a fledgling Foreign Service headed by the High Representative for Foreign Affairs and Security Policy, a position that is also vacant due to disagreements in the Council. The new President of the Commission, Monsieur Juncker, is a federalist who will be trying to nominate people of his own bent as new Commissioners, twenty-eight no less, one per member state. As I said, David Cameron strongly resisted the nomination of Juncker but lost.
The European Council decides the political strategy of the Union. It is the voice of the member states; it comprises the heads of state of the different nations. It meets at least four times a year, the latest was to elect its own President—the place is full of presidents—and vet the proposed Commissioners. It failed to do either.
The Brussels Parliament has recently seen its powers increased. The general complaint is that it cannot represent the will of the European demos because there is no such demos. The participation of voters, reduced this time to 42.54%, has fallen in every one of the seven general elections since 1979. Voters in the different member countries take the European general elections as mid-term rehearsals for national elections. This is but one instance of what goes by the name of "the democratic deficit of the EU", in plainer words, the remoteness of the European institutions from ordinary people. Since most European citizens neither understand nor care what this Parliament does, the European elites are trying the remedy of giving it ever greater powers so that the people take more seriously a Chamber that so impinges on their daily lives. It shares legislative power with the Council and approves the budget in tandem with this body. It elects the President of the Commission, can withhold its approval of the Commissioners proposed by him, and has the power to dismiss the Commission with a no confidence vote; and (tremble ye free traders) must give its consent to trade agreements such as the North Atlantic Partnership now being negotiated with the United States.
The appearance of a more or less orderly division of labour among these three main bodies that share political power in the Union is deceptive. The Commission thinks of little else but the expansion of its own powers of intervention, which can go from the number of hours a lorry driver can stay at the steering wheel over the week to the shape and size of the apples and bananas purchased by households—all in the name of an ever deeper union. The Council is the place where the voice of states resisting integration can be heard, though mutedly: in the end it is Angela Merkel, the German Chancellor, who imposes her will, as when recently during a leisurely walk on the beach with David Cameron she was overheard rejecting his objections to the nomination of Juncker for President of the Commission. Parliament untiringly demands wider powers to show how important it is. The number of languages heard in its hallowed halls is no less than twenty-four. You will have an inkling of this Babel of tongues and the work cut out for the numerous simultaneous translators by going to the website of the European Central Bank: you will there see the name of this Bank written in a diversity of languages and alphabets.
Why do I mention the European Central Bank at this point? Because this is a crucial institution of the EU, though unelected and in principle apolitical. The Bank is the issuer of the euro, the currency that not all member states want to use; it acquired immense importance during the financial crisis of these last years and is looked up to as the possible saviour of the European economy. The euro was devised apparently for an economic reason, to help with the creation of a single market in the EU. In truth, the reason was political: to bind the Union more tightly around an everyday symbol, the currency constantly used by all and sundry. The first trouble was that the British, the Swedes, and the Danes did not want it and did not take it up. The next difficulty was finding a compromise between French fears that the euro might become a Deutschemark in disguise and German nightmares of runaway inflation as in 1921 and 1945.The new Bank, set in train with the century, was to be politically independent and have one single target, that of keeping the internal value of the currency steady. For these reasons the Bank would never receive instructions from the other European institutions and would have as its only target to maintain the rate of inflation at or just below two per cent a year. It was set up as totally independent of the governments of Europe and its constituent nations, and hence was not permitted to lend funds to any European institution or national government.
The fractured character of the European Union has never been more evident than with the near catastrophe of the euro. Canadian economist Robert Mundell had set out the conditions of an Optimal Currency Zone in 1961: flexible prices and wages; free movement of goods and services; and to complement both, free movement of resources across the area, especially of labour. In other words, the single currency would function with ease if the member economies had converged or were on the way to converging. In the 1990s Mundell let it be believed that if Europe was not a monetary union it could quickly become one. And he was awarded the Nobel Prize for Economics. His avowed motive was that he wished to see another world currency come into existence and be a rival to the U.S. dollar.
Different member countries massaged their statistics to look as if they fulfilled the conditions for entry. These were the so-called Maastricht conditions: a stable exchange rate, low interest rates and, more importantly, a budget deficit not higher than the equivalent of three per cent of GDP and an amount of public debt also below the equivalent of three per cent of GDP. When the euro was launched, financial markets put their faith in the new contraption and proceeded to value the debt risk of the different countries as if they had converged, forgetting that the U.S. dollar zone had taken more than a century fully to come into existence. When interest rates were brought to rock-bottom levels by the Federal Reserve, the Eurozone enjoyed a long Christmas office party. The rest of the story is well known.
There was one unnamed 'Maastricht condition' that should have forewarned frivolous entrants, to wit, "no bail-outs". This rule is in force in the U.S. monetary zone: bankrupt cities and states will not be saved by the federal government. When the crunch came, Greece was not expelled or suspended and its debt was restructured and reduced by half. On top of refusing to bail ailing regions, the American monetary zone has another mechanism to make the dollar function with less volatility and pain than under the gold standard: the automatic stabilizing effect of federal income tax. Of course you do not need these stabilizers if the economy is fully flexible and takes corrections on the chin, as happened under gold; but far west pioneers did not expect to be molly-coddled as we demand in the 20th century. In consequence it is proving impossible for the ECB to concentrate exclusively on its one target, keeping the value of the euro stable.
Such was the euro and its central bank at the moment of their foundation: twins of the Deutschemark and the Bundesbank. They were intended as a solid currency and an unforgiving bank. The pain of the financial crisis, however, is making them more and more similar to the dollar and the Fed. During the crisis, the ECB expanded its balance sheet to increase the liquidity of a congealed financial system; it is now reducing it by reselling the company bonds and commercial it acquired in an emergency. However, the cry is going up that it should imitate the quantitative easing of the Federal Reserve and the Bank of England to revive the faltering European economy. And there are unceasing complaints that the euro is too expensive and should try to depreciate like the dollar. However hard the Germans, the Finns, and the Dutch may try to resist, a majority in the Eurozone want to say good bye to the 'Germanic' euro and say hello to Keynesian policies.
Juncker's ten point programme
The Union is slowly turning itself into a quasi-socialist welfare state. Continentals speak proudly of the 'European model' of human capitalism in contrast to the 'Anglo-Saxon model' of wild capitalism. The EU itself does not have much money to spend on favoured interest groups and mendicant nations, as its main sources of income are the tariff on imports and a small share of the VAT charged by member states. But, as George Stigler used to point out, regulation is another way of generating income for the chosen few—and the EU is the high kingdom of regulation. The Commission has even found a way of turning its Common Agricultural Policy into a policy to protect the environment: landowners (and I mean especially big landowners) are paid for leaving their land fallow so that wild plants (and their pocket books) prosper.
Let us look for a ray of hope in the ten points of the program of Jean-Claude Juncker put forward in Parliament when confirmed in his new post at the head of the Commission. It reflects the twin (and conflicting aims) of the EU. On the one hand he promised to work for the single market, that is, to make the EU a really integrated economy, with no obstacles to the internal free movement of goods, services, capital and people, which of course would increase European productivity and welfare. A single market Europe is far from being a reality. Juncker wants to push for integration on two difficult lines: within the first six months of his presidency, he wants to create "a connected single digital market", and over the five years of his Presidency "a resilient energy union". There are huge obstacles to both, namely governments' defence of their IT markets and their national energy companies, especially on the part of the French. Thus, the state company Electricité de France has successfully stopped high tension cables across the Pyrenees because the towers might upset some flocks of wild goats who live in those mountains, thus unfortunately stopping Central European competitors from selling Spanish and Portuguese power. In his program Juncker added to his high hopes for a resilient energy policy the clause "with a forward-looking climate change policy". The catch is, as always, the environment. In any case those plans are well intentioned.
There are more hitches in Juncker's program. He says he wants to deepen the internal market but "with a strengthened industrial basis". Who will strengthen it he does not say. And he has a dig at London when he says that to re-industrialize Europe needs an integrated capital market. It is not every region in the world that has a financial market like the City of London.
The rest is all downhill. He wants to mobilise € 300 billion of public and private investment over the next three years. Tax evasion and tax fraud are disparaged in the same breath, though tax evasion is legal: the object is increasing the tax burden on ordinary citizens. Measures to make countries apply the conditions of the Monetary Union should be examined not only by financial standards but with "a social impact assessment" as well. The European legislation on genetically modified organisms (GMOs) should be changed so that member countries are not forced to accept them when public opinion objects. And the free trade agreement with the U.S. should be reasonable and balanced: "I will also be very clear that I will not sacrifice Europe's safety, health, social and data protection standards or our cultural diversity on the altar of free trade." The North Atlantic Partnership is not in the clear yet.
The British, with the exception perhaps of the Liberal Party, do not want any of that. Not even the Labour Party wants more Union in the form of a single currency or of externally imposed immigration and labour market rules as decreed by Brussels. This is the reason for Prime Minister Cameron promising to call an "in or out" referendum in 2017. He adds that if he does not get a change in the rules imposed on Britain he will campaign for the 'out'. Whatever happens, the British have thrown a gauntlet with consequences for all concerned. The questions are: Would the reforms demanded by Cameron be good for the Union as a whole? Would the EU lose much with the British secession? Could the UK prosper outside the EU?
In effect, a majority of the British resent the way Europe has developed. The common market seemed a good idea except for the agricultural policy included in the treaties to please the French. The free movement of goods and services would make the whole of Europe prosper. As to the free movement of Europeans within the EU, many British people now (wrongly) resent it at because it is means more competition in the labour market and (rightly) because immigrants often abuse the social safety net and the health service. In the UK there is great confidence in the court system and diffidence toward European judicial interference. The British are proud of their democracy and look askance at the goings-on in the European Parliament. The UK has always been a force for the liberalization of Europe: with the Brits out, the Junckers would have a field day. I know that all the member states are now solidly democratic or will soon be so when Soviet habits will have been expunged. But history counts, and nations which once were ruled by Salazar, Franco, Pétain, Mussolini, Hitler, Pildsuzki, and Horty and the colonels should treasure the presence of one of the oldest democracies of the world in their midst. As a Spaniard I would feel very sad to see a nation with such a drive for economic and political freedom leave the Union of which I am a citizen.
The harmful effects of secession for the British would be weighty in the beginning: the EU is the largest market for British imports and exports, not less their exports in services. If the separation were acrimonious the negative developments could last for quite some time. In the long run however, the UK would be able to compete in a world free of the directives of Brussels—an interesting experiment and perhaps an alluring example for the rest of Europe.
Politics and economics
The EU is one of the most telling examples of the mutual interference of economic logic and political aims. The Founding Fathers of the EU, Konrad Adenauer, Alcide de Gasperi, Jean Monnet, Robert Schuman, and Paul-Henri Spaak, wanted to create the conditions for avoiding a repetition of the two terrible World Wars. Their idea was to use economic collaboration to pave the way for political brotherhood. They started with an agreement on coal and steel, which had been the material sinews of those two wars. To this they added the common exploitation of peaceful nuclear power. Then came the 1957 Rome Treaty setting up the common market, whereby it was hoped that growing prosperity would create the underpinnings of political harmony. Trade is not on its own an antidote for war, as the story of how Europe sleepwalked into the 1914 war clearly shows but politics and economics can work hand in hand.
The logic of politics, however, is the achievement and exercise of power and that of economics the fostering of voluntary exchange and unplanned collaboration. When economic activity and prosperity are seen as instruments of power they both suffer: the free market is turned into crony capitalism and political service turns into hostile power grabbing.
If Britain is forced from the European Union because the Union is bent on becoming a world power, the world as a whole would be the loser.
When unemployment is high there may appear an increasing productivity per worker still employed. The productivity to watch is total factor productivity, which follows not from money creation but from real factors, such as population growth, technical advances, and/or more competition.
I should say the Parliament in Brussels (Belgium) and Strasbourg (France), for the Chamber periodically moves lock, stock and barrel from one to the other of these cities its every plenary session; and the Secretariat is in Luxembourg—all to accommodate national sensitivities.
The group which has suffered most is the European Liberals, who in this part of the world are the more pro-market. Euro-sceptics and decidedly anti-EU parties now make up no less than 16% of the Chamber or 29% if one adds the Greens and the non-aligned.
The ECB must keep the Harmonised Consumer Price Index of the Eurozone growing at two per cent a year or just under. It also must, as all central banks, keep the financial system functioning smoothly.
It could therefore not subscribe any government bonds at issue but could buy them on the secondary market for purposes of 'open market operations' whereby central banks control the amount of money in the economy.
Mundell, R. A. (1961): "A Theory of Optimum Currency Areas". American Economic Review 51 (4): 657-665.
Convergence on all these variables would mean that Euro-countries would be on parallel economic cycles.
Pedro Schwartz is "Rafael del Pino" Research Professor of at San Pablo University in Madrid where he directs the Center for Political Economy and Regulation. A member of the Royal Academy of Moral and Political Sciences in Madrid, he is a frequent contributor to the European media on the current financial and social scene.
For more articles by Pedro Schwartz, see the Archive.