Will the EU survive?

[MonteZuma]

Scruff...You look like an angry young man.

 

Give us a smile....go on!

[Live-Wire]

Following is my official answer (written for one of my classes):

 

 

Causality for economic growth is difficult to ascertain, even in hindsight, which makes predicting economic growth in the future even more troublesome. The European Union (EU) and European Monetary Union (EMU) are fairly recent attempts at a unified Europe, but they are not the first attempts. Since the 1940s, the nation-states of Europe have been working on how to carefully balance the need for economic stability and growth, and the want for national sovereignty. Compared to the early 20th century, Europe is now far closer to a unified continent, but is this a step in the right direction? By examining the successes and failures of the Bretton Woods and European Snake Systems, we can attempt to determine what the future holds for the EU. The economic and political ramifications of this system are tied together so strongly that despite potential benefits from a unified Europe, the history of the continent has seen each unification system crumble and eventually fail for various reasons. What has sometimes been called the “Unholy Trinity” is the idea that a country can not simultaneously control their domestic monetary policy, while allowing free capital flows across borders, and a fixed or managed exchange rate. By examining the history of the EU and EMS to date and comparing them to the previous systems, we see that the future of Europe is not in monetary and political unification. All of this, of course, is !@#$%^&*uming that unification is indeed beneficial to Europe, a claim that is questionable.

 

The Bretton Woods System was the brainchild of a combination of British and American thinkers. John Maynard Keynes and Harry Dexter White each wrote a plan for the international monetary order, which were the basis for the “Joint Statement” and Articles of Agreement that established the monetary system for Europe. The Keynes Plan called for a more regulated system, while the White Plan intended to have relatively free controls with an international body to veto changes. Their reasoning for each plan differed. Keynes summarized his view when he said:

 

To suppose that there exists some smoothly functioning automatic mechanism of adjustment which preserves equilibrium if we only trust to methods of laissez-faire is a doctrinaire delusion which disregards the lessons of historical experience without having behind it the support of sound theory.

 

Yet, the comprised agreement’s quotas appeared more similar to the White Plan of free controls. The White Plan called for $5 billion, while the Keynes Plan called for $23 billion, while the final plan financed the process with $8.8 billion. Keynes was perhaps not accounting for the reality of the ability of an international body to acquire funds from the United States, as White tried to convince him in a letter. Hindsight shows that this final figure was far too small. There was a vast shortage of necessities, such as food, in Europe following the war. Under the Marshall Plan, the United States ended up extending large aid packages to Europe anyway, and the International Monetary Fund (IMF) was created in 1948. The combination of the IMF, adjustable exchange rates, and limited capital flows were the intended mechanisms to begin economic reconstruction.

 

The period of growth following the creation of the Bretton Woods System happened despite the system, not because of it. Because of an attempt to control domestic monetary policy, there was a lack of coordinated effort among the European powers. Countries had no option to devalue their currency to promote exports, but even if they did, there was nobody to export to. It resembled a prisoner’s dilemma – no countries wanted to import, only export, and the result was that nobody exported. A unified liberalization of capital flows would have seen a higher standard of living, but instead countries feared imports lowering their own standard of living. The Bretton Woods system sought to restrict foreign capital flows, but the investment caused by the beginning of an alliance against Communism happened despite the intended restrictions, and this was one reason behind growth. Capital from the United States entering Europe came as Keynes originally had wanted under his plan. This is the most apparent of events happening despite Bretton Woods, not because of it. If the Bretton Woods system had enacted a plan more similar to the Keynes Plan than the White Plan, this flow of capital from the United States would have begun earlier and been more effective.

 

Bretton Woods sought to insulate against the pressures of balance of payments by limiting capital flows, but market actors learned the loopholes to cir-*BAD WORD*-vent these restrictions. This put the European states into a difficult situation. Countries had to defend parity when a readjustment might have been the correct move, else there would be an enormous outflow of capital. Even the slightest hint of readjustment might send market actors into a period of uncertainty. These attempts at parity were generally bad for the growth of Europe, and eventually for the United States’ ability to control their own currency. Bretton Woods finally collapsed with the transition to floating exchange rates in the early 1970s after it became apparent that continuation under the system could lead to economic ruin worldwide.

These limits on capital flows in the Bretton Woods system resemble the caps on incentives in the European Union today. The intention of each of these systems was to level the playing field among the European states, but the reality is that the private sector suffers by being unable to move to the best location. It is not accidental that capital flows out of some countries and into others. Restrictions on these capital flows are detrimental to the economic health of the region as the private sectors become less productive. To prevent “unfair” practices, the EU caps the ability of each of their members to entice investment, at the expensive of economic prosperity. While it is true that no EU member will be able to lose investment to a neighbor, neither will they be able to lure the investment from a neighbor, and thus another tool of the EU member states to manage their economies is lost.

 

The lesson to be learned from the Bretton Woods System is that the European powers can not effectively regulate capital flows, because each nation-state has a political responsibility to their cons!@#$%^&*uents. Bretton Woods relied on the United States to run a deficit to avoid a dollar shortage of liquidity in the world, and the crisis of the dollar proved the gold exchange standard is fundamentally flawed, what is now called the Triffin Dilemma. The dilemma suggests that to stop speculation against the dollar, the U.S.’s deficit spending would have to stop, but that would cause a liquidity crisis as the supply of dollars became too small to continue rebuilding Europe. To avoid a liquidity crisis, the U.S. would have to continue deficit spending, which would lead to destabilization of the dollar and a crisis of confidence in the United States. Bretton Woods made the !@#$%^&*umption that the U.S. would always be able to stabilize economic policy, but in the 1960s, spending on social programs and the Vietnam War led to inflation. Other governments, responsible for defending their peg rates, defended them and continued this inflation, showing the flaw in the Bretton Woods System’s ability to manage payment imbalances. The answer had to be to move to floating exchange rates.

 

The Bretton Woods system had several flaws that are not solved in the European Union. There is still a political responsibility of each nation-state to its own cons!@#$%^&*uents, and that will not ever change. The European systems of unification can only become effective when there is a convergence in the interests of cons!@#$%^&*uents continent-wide. Unlike Bretton Woods, the EU does at least take steps to prevent reliance on the United States – in fact there is no reliance on the dollar with the creation of the Euro. These lessons were not learned quickly, however, as is demonstrated by the brief existence of the European Snake.

 

The system of exchange rates in the 1970s was not perfectly floating. Following the Werner Report, exchange rates were allowed to float within a narrow band that was determined by a peg to the dollar. When graphed, this would look like a snake moving through a tunnel, hence the name given to it, the Snake. In 1973, when it was decided to let the dollar float as well, the “tunnel” disappeared, as the dollar was no longer stably pegged. Unlike Bretton Woods, the Snake was extremely short-lived. Britain stopped participating in 1972, Italy in 1973, and France in 1974 (although they rejoined a year later, a switch to expansionist fiscal policies forced them to leave again in 1976). The Snake was extremely ill suited to stabilizing exchange rates. The OPEC price-shock showed that the effects differed sharply from nation to nation, and a unified policy that required narrow floating exchange rates forced nations to withdraw from the system to deal with pressing domestic concerns. For instance, France’s expansionary policies during this period forced them to leave the Snake. Meanwhile, Germany made demands of the other participating nations in the Frankfurt realignment in exchange for their continued participation in the system. Various countries’ politicians and policymakers saw different responses to the shock as the correct measures to take, leading to a disunity of policy that contrasted with the motives behind the Snake. The intention of the Snake was to have Economic and Monetary Union in Europe by 1980, but by the late 1970s it became obvious this was an impossible goal. The lack of policy coordination sealed the grave of the Snake.

 

While it may be easy to simply blame the demise of the Snake on its poor structure, the events during the time of the Snake were not especially conducive to European unity. The OPEC price-shock forced a disunity of policy, yet there is not a system in the EU to provide for similar situations. The cap on deficit spending (3% of GDP) will face a similar problem when the European economy faces a price shock – member-states will be unable to spend their way out of trouble. The EU has been lucky in that it hasn’t faced the same sort of problematic environment the Snake failed in.

 

From the ashes of the Snake came the European Monetary System (EMS). While this system seemed to work in figuring out what to do with exchange-rates by again pegging with a slight float, unemployment was extremely high during this period. Because Germany was the anchor of the system, German desire for low inflation limited the ability of other governments to manipulate their macroeconomic policy to lower unemployment. Instead, governments used microeconomic policies to create social programs that were highly inefficient and inflexible. Despite these problems, the EMS was largely successful through the 1980s in stabilizing exchange rates. However, this changed in 1992 when, following speculative attacks in the currency market, Italy and Britain left the EMS. In 1993, the allowed fluctuation in exchange rate was increased from +/- 2.25% to +/- 15.00%. This change was following German reunification and a weakening of the dollar. This new freedom allowed currencies to revalue, but with a new margin of 30%, one had to start questioning whether the system of floating-pegs was the correct system. Under EMS, countries pursued different macroeconomic policies, and there was no attempt at setting a standard to manage inflation other than to use Germany as an anchor. In his 2001 book, Money and Power in Europe, Matthias Kaelberer suggests that “Germany’s position as standard setter lost legitimacy because other EMS members became unwilling or unable to adjust to Germany’s standard through the traditional means of domestic or external adjustment.” This is a similar reason for collapse as the Bretton Woods and Snake Systems suffered. There appears a fundamental problem in attempting to have a unified monetary system without a unified political policy.

 

With Bretton Woods, Snake, and EMS all collapsing, a common thread became apparent; a difference in policy preference among the European nations and attempts to converge policy lead to the collapse of the system. Yet, the European Union continues the previous attempts to unify Europe. Is it a different kind of system? The EU unifies the separate nations of Europe in more ways than one. For the first time, the EU introduces a common currency, the Euro. The Euro is not a currency meant to replace, per se, the independent currencies of each member nation, but rather to compete with the dollar and the yen. For the first time there is a real European bloc, a sort of “United States of Europe” that can be compared loosely in structure to the United States of America. But the mindset of the U.S. differs from that of Europe, and this is one of the primary flaws in any ability to unify the region. Federalism in the United States was a response to the dangers external threats posed. France and Spain posed significant threats each state was incapable of dealing with alone. Europe, on the other hand, is only threatened by itself – the unification of the European states is to prevent internal conflicts. This is a different mindset, less conducive to cooperation than the U.S.’s.

 

This difference in policies and preferences manifests in several different areas. With the creation of the Euro, there must be an attempt at convergence of monetary policy, determining an ideal unemployment rate, as well as managed inflation. Given the varying preferences (as usual, Germany’s despise of inflation takes the forefront), this alone is a challenging prospect. Yet, there are other policy differences that must be reconciled. With fifteen nations participating in the EU so far, it becomes readily apparent that a convergence of policy is impossible, even ignoring that previous attempts have failed.

 

The EU consists of Belgium, Germany, France, Italy, Luxembourg, the Netherlands, Denmark, Ireland, the United Kingdom, Greece, Spain, Portugal, Austria, Finland, and Sweden. Ten more countries will be added in 2004. There are five ins!@#$%^&*utions in the EU. The European Parliament is directly elected by the citizens of the EU. The Council of the European Union represents each member state. The European Commission, along with the previous two ins!@#$%^&*utions, all combine in the decision-making process of the EU. Along with these, the Court of Justices upholds European law, and the Court of Auditors monitors the EU finances. In addition, two important bodies in the EU are the European Central Bank (ECB) and the European Investment Bank. The Investment Bank is responsible for financing EU investments. The ECB controls the EU monetary policy. Unlike the United States, the EU member-states are all still independent nations, and unlike a treaty-organization, the unifying systems extend to trade, military conflict, and nearly all exercises of sovereign power. The ECB is intended to remain completely independent of the policy preferences of each participating nation, and to instead determine monetary policy that is best for the entire European bloc. This sort of organization is wholly unique as it is, in essence, pooled sovereignty.

 

Pooled sovereignty can be a powerful tool, as the EU has already demonstrated in its tariff negotiations with the United States, but differences in policy make it hard to determine what to use that sovereignty for. Negotiating with the United States and other world powers is simpler for the group to do together, but only if they can determine what they collectively want. Some things, such as lowering the United States’ tariffs, are a simple and direct goal that all EU members can agree on. Others, such as determining internal policies or regulating programs, are not as straightforward. Aside from the practical differences among the European countries in, for instance, their balancing of inflation versus unemployment, each member state has a strong cultural history that they are weary of having !@#$%^&*imilated into a European iden!@#$%^&*y. An example is France, a country that has outlawed “franglais” (a mixture of French and English) on television. Yet, now France is supposed to share a currency with Germany? For this reason, a lot of superficial debate over the Euro took place. For instance, each state prints its own “kind” of Euro with something unique to their nation on the face of the bill. Each member-state is giving up a part of their culture to participate in the EU in an attempt to again push Europe into the forefront of world power past the United States, but at some point each member will draw the line – until this barrier disappears, there can not be a truly unified Europe.

 

It is somewhat ironic that the EU is an attempt to promote peace and prosperity while maintaining the culture of each member state, when that culture is universally one of war and conflict. The reason for European unification was war-weariness following the destructiveness of World War II. For centuries before that war, the states of Europe had fought amongst each other. Following WWII, Europe has successfully rebuilt and not had any outright internal conflicts, that much at least can be said in praise of the new move towards unification. Yet, this peace and prosperity isn’t unique to Europe. In reality, no democratic governments wage war on each other . The peace felt in Europe can as easily be attributed to their forms of government as to their membership in the European Union. It was most likely the triumph of Democracy and Capitalism over Communism through the transfer of capital in the Marshall Plan that had the longest lasting effect on the stability of the region. This stability will likely continue into the future, regardless of the level of unification among current EU members.

 

Like the systems preceding it, the EU attempts to coordinate policy that will inevitably lead to the failure of the system as a whole. The Stability and Growth Pact (SGP) is essential for the coordination of fiscal policy in the European Monetary Union (EMS), and therefore vital to any attempts at unification. The most important point of this pact is to restrict the maximum budget deficit of each member state to 3 percent of GDP in the short-term and in the medium-term, a target, “close to balance or in surplus.”

 

Already, the members of the EU are violating this maximum deficit. This problem is a manifestation of the problems each of the preceding systems had suc-*BAD WORD*-bed to. In 2002, Germany and Portugal passed the deficit cap. The United States, unhindered by the policies the EU members must adhere to, far surp!@#$%^&*es the 3% of GDP budget deficit. If two countries have already violated the SGP, what sort of long term enforceability does the pact have? If the United States is a model of economic prosperity in the modern world, is it important to note that they would never fit the requirements under the SGP? It is important to realize this, and to understand that in all likelihood the future will show more countries breaking this deficit cap when similar events to the OPEC price-shock in the 1970s occur. EU members will be unable to satisfy their cons!@#$%^&*uents while remaining part of the EU. Even if the EU manages to maintain the 3% of GDP deficit cap, it may not be an appropriate cap. The United States ran the most negative balance of payments in 2002, while Japan ran the most positive – the EU must reevaluate whether their policies dictated in the SGP are wise.

 

Up until this point, we’ve been operating under the !@#$%^&*umption that unification is beneficial. This !@#$%^&*umption, however, must be questioned. Unification provides benefits, but has more than one harmful side effect. The loss of some cultural iden!@#$%^&*y among member-states is unavoidable, as is the loss of mobility among politicians. Similar to the choices some developing nations make to tie their hands by implementing an independent central bank to attract investors, politicians in the EU member-states have tied their own hands – but unlike the implementation of independent central banks, there isn’t a benefit immediately gained by joining the EU. The creation of an independent central bank calls for a credible commitment to not seize the bank to control monetary policy for the bank to succeed in attracting investment. There is not this credible commitment for the EU members to stand by the policies dictated in the SGP. Germany and Portugal have already violated these policies, and under previous European unification systems, politicians have chosen new domestic policies and decided to leave the group, such as France in 1976. It is important to remember that in a democracy, each new election represents a new government, one that is not entirely bound to the policies of the preceding government. Changes in policies after elections can result to changes made in the dynamic between EU members that challenges the foundations of a system. While the politicians who originally orchestrated the creation of a unification system were inevitably favorable towards cooperation, there is not a guarantee that future politicians will maintain the same policies. In reality, these politicians may see the pooling of sovereignty as a loss of their own ability to do their job.

 

The European Union exemplifies the destruction of national sovereignty by globalization in recent years. The EU doesn’t appear to have a solution to OPEC oil-shocks which affect members in differing degrees, the problem that ended the Snake. Fiscal federalism, as Eichengreen calls it in his 1996 book Globalizing Capital, is not a solution to these differing policy needs. EU members do not have the tools to adequately deal with a price shock – their inability to spend past the deficit cap hampers their capabilities in maintaining their own nation-state’s economies. The Very-Short-Term-Financing Facility is a good idea, but in reality it is an international body telling a nation-state how they can spend their own money. We can liken the fiscal federalism of the EU/EMU to the fiscal federalism of the United States. Fiscal federalism works in the United States because the overwhelming mindset among Americans is that they are, indeed, Americans, and not New Yorkers or Missourians or Floridians. Europeans, however, are French or Dutch or German, not simply European.

 

This intangible carries weight, it isn’t a superficial element. Nation-states are functionally equal, but not equally capable. All states collect taxes, for instance, but do the citizens willingly give their money to the government, or does the government need to kick down doors and send goons as tax collectors? This difference can largely be determined by the idea of common destiny. If the people in a democracy see a common good, they will be more cooperative. The problem in European unification is that common destiny is nation-specific, not continent-specific. Because of this lack of common destiny among all Europeans, fiscal federalism is a challenging prospect. This poor implementation of fiscal federalism is readily visible by comparing Germany’s inflation-killing tactics to the rest of Europe’s desire for low unemployment. Under the EMS, it was the German Bundesbank that provided the anchor for Europe’s monetary policy, but under the EU/EMU there is not one country determining policy.

 

In the EMU, it is the European Central Bank that determines monetary policy without favoring any country over another. Yet, the Governing Council of the ECB is inevitably always filled with members from each country. The United States provides a reasonable model for understanding this system. In the U.S. Congress, each member is supposed to vote for what is best for the country, yet inevitably votes for what is best for their cons!@#$%^&*uents. This is where James Madison feared democracy might become too risk-averse and unable to reach decisions when he wrote in the Federalist Papers. Likewise, the ECB, as well as all the other EU/EMU ins!@#$%^&*utions, has inevitable and unavoidable inherent problems. The intention is to be neutral, or to not have any connection to politicians, but this connection must be present. One might try to counter this argument by pointing to the congress of the United States and calling it a success, but compare the cons!@#$%^&*uents of each state represented in the U.S. to those in the EU. The U.S. is far more homogeneous, largely because of the history of the nation and the mindset of her people. It is highly unlikely that the French are very favorable to their politicians when a new policy favoring Germans over themselves is announced. Any attempt to remain neutral is impossible; there is always going to be a difference between the policy objectives of each nation-state.

 

This difference, and inability to converge on an agreeable set of policies, has been a component of the downfall of each of the systems of unification that preceded the EU, and will be a component in the failure of the EU as well. While the EU has been fairly successful to date, the system has not yet been challenged by the same threats that the preceding systems dealt with. Price shocks and changes in domestic policies in member states will result in clashing over policy issues. The nations joining the EU in the near future will only serve to further add to the overwhelming group of conflicting policy desires. There is an inherent difference between each member-state of the EU due to a culture of conflict and war with the other member-states, and there is no immediate feeling of common destiny. The loss of cultural uniqueness and sovereignty may be too much for some member-states to bear, which will become apparent when the EU faces significant economic threats through price shocks or compe!@#$%^&*ion with other regions. The EU does have an advantage over the past systems in that they have moved closer to monetary unification with the Euro, but there are still significant problems with a loss of sovereignty in the ability to manipulate their own currency. An inability to tailor policy to domestic situations leaves politicians without an important tool to satisfy cons!@#$%^&*uents. Policy is instead tailored towards what is considered best for the entire European bloc, which ends up stifling the abilities of each member-state to provide important incentives to lure foreign investment, and in reality, compete with the United States and Asian financial centers.

 

At least, unlike the Bretton Woods system, the new EU appears to be taking Keynes’ original ideas to heart. This system is less laissez-faire than any of the preceding; it is a true grouping of powerful ins!@#$%^&*utions that represent the European people and economy. There is no doubt that the EU has met moderate success, but then again many considered Bretton Woods in the same light in its very short-term ability to turn around the economies in Europe. However, like Bretton Woods, the Snake, and EMS, the EU will not last indefinitely into the future – some unpredictable event will show the inherent problems in unifying Europe. If nothing else, the inability to abide by The Stability and Growth Act will lead to sanctions on many European nation-states, further hurting their economies. Like the systems before it, the moderate prosperity in Europe is despite the EU/EMU, not because of it, and at some point in this century this will become apparent and seal the fate of another failed attempt at European unification.

[scruff]

Andf you expect someone as stoned as me to read all that? Go one, give us a summary.

[»nintendo64]

The main idea is "This is another attempt to unify Europe that will fail".

 

Most USA Citizens think that Europe will fail, that's ok, you are all accustomated to the 1 Country makes a SuperPower only that the next years to come will be the judge of what will happen to the EU and while history tell us something different, we can always end up wrong.

 

-nintendo64

[scruff]

Noone has ever attempted to unify Europe before, as far as I know...only conquor it all, such as the Germans in the world wars, and the French under Napoleon, and they failed for obvious reasons, one country cannot take on many, or a whole world.

[Live-Wire]

Noone has ever attempted to unify Europe before, as far as I know...

=P read my post

 

First Bretton Woods, then the Snake, then the European Monetary System. Now, the European Union and European Monetary Union. Ever since the middle of WWII they've been working on various forms of European unification.

[scruff]

meh i couldnt be bothered reading it all, it was far too long for my liking