The Politics of Economic Integration in Europe

Professor Sir Timothy Garden

Indiana University 26 February 2001

Towards Monetary Union

You will know the history of the European Union. It is a pretty short one and has covered the most extraordinary developments. European nations have a long history of trading with each other, but also of going to war with each other. It is a region where the balance of power was a constant source of worry to leaders, and the development and protection of trade was key to economic success, and hence power. The 20th Century saw two world wars (three if you include the Cold War) - and each had its start in troubles of distribution of power in Europe. The settlements after World War 1 laid the foundations for the developments in Germany which led to World War 2. I think we can look back now at how the post World War 2 reconstruction took place and take a pride in how much better it was handled - and the world’s thanks are due in large measure to the generosity of the United States, and the wisdom of how the Marshall Plan for aid was handled. It is sad that it was not possible to include Central and Eastern Europe then, but that is being rectified now.

In many ways all that we see today in the European Union is derived from the mechanism that was used to manage the economic aid to Europe under the Marshall Plan. The Committee for European Economic Cooperation in 1947, and its aid agency the Organisation for European Economic Cooperation, were actively supported by the US as a way to move towards European unification as a way to prevent yet another war between the European states. There was considerable support in those early days in Europe for giving up some national sovereignty for the greater good of the region. Yet when it came to detailed proposals, there was always a number of national objections, usually from the British or French. In 1951 one part of Western Europe - France, Italy, Belgium, Netherlands, Luxembourg and West Germany formed a much closer economic alliance in the European Coal and Steel Community (ECSC). This was a significant split, where the British and Scandinavians did not take part. The effects of that division are still with us to an extent today. In the 50s, a failed attempt to add a European Defence Community to the role of the 6 was something of a setback to the integration process, and the Western European Union formed as a separate organisation to allow the re-arming of West Germany. Nevertheless the Six pushed on with other aspects of integration and the Rome Treaty was signed in 1957 and ratified in 1958 bringing into being a common market and an atomic energy community - the European Economic Community (EEC) and Euratom. The EEC Treaty was a commitment to economic integration over a period of 12 years.

Definitions:

The Rome Treaty for the EEC was a route map to the establishment of a Common Market - and indeed you will still hear people talking loosely about the Common Market today, although we have moved on beyond that. The key objectives laid out in the Treaty were the elimination of internal trade barriers, creation of common external tariff, abolition of free movement of the factors of production. The treaty provided for the need to harmonise national laws where relevant, and the creation of a system to ensure that competition in the market was not distorted. There are other elements in the Treaty which take it beyond just the common market aspects, and set the scene in the long term for the deeper integration. Common policies on agriculture and transport were proposed, as were social policies such as development of the poorer regions. There were difficulties in this period with keeping special preferential trade arrangements with former colonies that affected some of the Six but not others. By the end of the transition period in 1969 a common market had been pretty well achieved. The institutions underpinning the wider remits beyond economics had also been emerging. The European Parliament, the Commission, the Court of Justice and the European Council were all exploring their relative roles. France during this period acted to restrain the emergence of a supranational power. Decisions were intergovernmental and taken by consensus rather than majority.

EFTA

While we now know that the Six and the Rome Treaty were to be the winners in economic integration in Europe, another Six European nations had pursued the route to a free trade area only. These were Britain, Norway, Denmark, Sweden Austria and Switzerland. The UK had a particular problem with the large number of preferential arrangements it had with the Commonwealth. Accepting the rules of the EEC would mean a steep rise in UK food prices and would be damaging to the economies of its colonies and former colonies. EFTA was formed in 1960 and eventually rose to ten members with the addition of Portugal, Finland, Iceland and Liechtenstein. The rules of EFTA suited its members very well since they were free to deal externally how they wished, and the basis of the internal free market was industrial with hardly any agricultural trade included. This meant that they could continue their own agricultural systems unlike the members of the EEC who were under remit to harmonise arrangements under the common agricultural policy.

Yet it was clear that the long term economic interests of the EFTA members would be in their trade with the heavyweights of the EEC. In a slightly extraordinary change of policy, the British Government began exploring the prospects for membership of the EEC in 1960 just as EFTA came into being. It was however 1973 before the UK, Denmark and Ireland were accepted by the founding Six in the EEC. France had been particularly difficult during de Gaulle’s time. By this time the Six were embarked on the next phase of the integration process with a European Union as the goal.

Towards a European Union

The heads of state of the Six held a summit at the Hague in 1969 to review the progress to wards a common market, that should have been complete by then. They decided, despite the need to fill the gaps that emerged, that they need to push on to a new vision for Europe. They proposed that the EEC should work towards becoming an Economic and Monetary Union. This led to a bigger drive toward economic integration although the vision of that time was not to be realised. It was redefined in Paris in 1972 as the establishment of a European Union by 1980. The exact definition of such a Union was left rather ill-defined.

Negotiations were in full flood for the three new members who were to join in the following year. The UK, as ever, was the most difficult to accommodate. A transition period of 5 years was agreed for UK to harmonise its external tariffs, and to remove the barriers to fee trade within the Community. this was a difficult period for its relations with some of its Commonwealth members. Another difficult aspect centred around the Community budget. This budget extended beyond just running the administration of the EEC. The Common Agricultural Policy was expensive to maintain with its buying up of surpluses across the region. Nor was the UK content with the Community’s fisheries policy. Despite all this the UK, Ireland, Denmark and Norway concluded their negotiations successfully in 1973. Unfortunately, Norway was unable to sell the economic benefits to its electorate who declined the opportunity in a referendum. This is an important reminder of the difficult domestic politics which attach to much of the European integration developments. Not only do governments have to be convinced of the long term benefits of giving up sovereignty, they have also to convince their populations. Agreement cannot be taken for granted. The EFTA members who remained outside the Community did negotiate an arrangement for linkage on industrial goods only.

The Single European Act

The European Parliament picked up this concept of a Union. Most important was the decision of the first directly-elected European Parliament of 1979 to take up the European Union issue again to produce a draft European Union treaty. The Parliament's European Union treaty would have brought both economic and foreign policy matters within the range of the Union's decision making machinery. They hoped for greater power so that they could make decisions on behalf of the nations . As before the individual governments were reluctant to see their national power moving away to Brussels.

The Single European Act of 1987 did not go as far as the Parliament had wished . However it contained a number of important commitments to carry integration forward . The European Council was recognised as the supreme body. There were major changes to the Rome Treaty. Majority voting was to be allowed in the Council of Ministers in respect of the completion of the single market. The internal market was to be completed by the end of 1992. This would be a market without internal frontiers.

The European Monetary System, in which the states attempted to keep their exchange rates moving around week's narrow band, had been launched in 1979. The UK had not joined the system at that time. The Single European Act moved the convergence of economic and monetary policy further forward. It looked to members taking account of experience in the E M S with a view to the development of the European currency Unit.

The Maastricht Treaty

As soon as the Single European Act was ratified, work began on a the move for awards Monetary Union. The Delors report of 1980 recommended a three-stage approach to monetary union which would end with a single currency. The first stage required members to participate in the exchange rate mechanism of the European Monetary system. As I said, the UK had not been a participant or when the the EMS had been launched at. The exchange rate mechanism required participants to keep their currency exchange rates closely in step. Unfortunately, the UK eventually chose to join at a time in 1990 when it was suffering higher rates of inflation than other European members. When speculators took advantage of this weakness, it was forced out of the mechanism and British public opinion hardened against greater economic integration with Europe .

Other great changes were happening in Europe at this time. The end of the Cold War meant that German reunification was now on the agenda. In addition the central and Eastern European nations were prospective members of the Union in the longer term. The European Council (the leaders of all 12 EU members) met in Maastricht in December 1991 to hammer out the agreement for a treaty on a European Union. The reunification of Germany made the political pressure for integration greater on the continent. This brought into focus the differing schools of thought on the future of Europe. Some, and at that time it would be the strong French/German axis) had a vision of political union that would be aiming towards some federation. The UK was of a different view. As Margaret Thatcher made it clear that she saw this as an arrangement for co-operation between independent sovereign states.

The negotiations to bring the EU into being were complex and reflect the different priorities of the states. The road to monetary union was seen by the UK and Denmark as leading to the federal vision, and they secured an opt-out. There was a wish among some to give the European Parliament more powers, because Europe was seen as having a democratic deficit. France needed convincing that it would have compensating influence in the European Council. The proposal for a Social Charter was another sticking point for the UK, although it was argued that fair competition within the EU required states to work to the same rules for workers. It was Maastricht which also brought in the formal recognition that Europe should have a Common Foreign and Security Policy.

Maastricht was ratified in 1993 and is the basis of the current European Union. It gave three roles (or pillars as they are usually known) to the EU. The first is the economic, social and cultural competences. The widening of the Rome Treaty provisions transformed the EEC to the EC. The aim was to move onwards from a common market to an economic and monetary union. The second pillar is that of foreign and security policy, and the third is Justice and Home affairs.

The Euro

Progress towards monetary union has been surprisingly rapid. The criteria for ensuring that the different economies were sufficiently in step were pretty demanding. They needed to get inflation under control, reduce debt and get budget deficits under control and keep their currencies in step.

Convergence Criteria

1. Inflation rate <1.5% above average of lowest three.
2. Interest rates <2% above average of lowest three.
3. Budget Deficit < 3% of GDP
4. Public debt ratio < 60 % of GDP
5. Currency in normal band of ERM for 2 years

This convergence was achieved by eleven of the now 15 states in 1998. (Greece had joined in 1981, Spain & Portugal in 1986, and Austria, Finland and Sweden in 1995). The UK, Greece, Sweden and Denmark were not to be in the inner circle that were planning to give up their currencies, although Greece subsequently met the criteria for joining.

From 1 January 1999 the currency exchange rates between the 11 were fixed. They issued any public debt in Euros, and the European Central bank set interest rates on behalf of them all. The changeover from national notes and coins will take place in the first half of 2002, with the Euro being used instead of French Francs, Lira, DMarks, Guilders, Belgian Francs, Irish pounds, Pesetas, Austrian schillings, Escudos, Finnish Markkaa, Luxemburg Francs.

Britain & the Euro

Let me turn now specifically to the politics of monetary union in Britain. The arguments for an against are held very strongly by the various proponents. They are to some economic, to others political but to many they are emotional. While the three main political parties in the UK can be broadly characterised as the Labour party in power wanting to join monetary union eventually, the Conservatives against it for the foreseeable future and the Liberal Democrats ready and enthusiastic to join as soon as practical. But within the three parties there is much dissent over the issue. The economic arguments revolve around whether the UK benefits or not from membership. There are worries that a centrally set interest rate by the European Central Bank cannot reflect the economic needs of all the member states. The counter to this argument is that we already have a centrally set rate which has to cover the widely differing needs of the regions within the UK. In any event, the UK rate is affected by the ECB rate as we must monitor the exchange rate with the Euro. The exchange rate is an other source of debate. It was widely expected that on launch the Euro would be strong with respect to the £. In fact at first the Euro reduced very significantly in relative value, and this has given manufacturing industry in the UK some difficulties with pricing exports competitively.

The UK has done well over the years with inward foreign investment in manufacturing industry. It has been seen as a region with reasonably helpful tax regimes, less intrusive regulation than the Continent, but as a good place to launch into the European market. Foreign investors are now seeing some disadvantages in the uncertainty of the £-¤ exchange rate fluctuation, particularly when the £ is strong. Yet others would argue that the UK does much more proportionately of its trading on a global basis, and particularly with the US. There have been some fairly spectacular moves away from the UK by multinationals just recently, and it looks as though the preservation of jobs will become a bigger factor in advancing the movement towards monetary union among industrialists and politicians.

If the economic argument seems to be moving onwards greater integration, the political arguments are still mixed. Nobody denies that joining a monetary union is as much a political act as an economic one. Throughout Europe there is a divided view as to whether the long term aim is for an integrated federal structure or the continuation of an intergovernmental system. In the UK the federal vision is viewed with horror and no political party advocates it. Yet monetary union will inevitably transfer many powers from individual governments to Brussels, and make a federal structure more likely. For competition to be fair, many would advocate harmonisation of taxes between member countries. The UK views Europe as being too profligate with its social spending, and values the advantages that its low tax regime gives it in inward investment.

Perhaps the greatest problem however is the emotional one. If a referendum took place today, the UK population would almost certainly reject monetary union by a significant majority. Most of the big circulation newspapers (owned by non-British owners) wage a constant propaganda battle against all things to do with the EU. The reason for this anti-EU feeling may still be a hangover from World War 2, it may be an excessive patriotic zeal, it may even be football team rivalry. Whatever the cause, it is an uphill struggle for the government to convince the population to abound the Pound for the Euro.

The strategy that has been adopted is to defer the decision until 5 economic tests have been met. It is generally accepted that this is no more than a political formula for delay as the tests are sufficiently subjective to be met whenever the government decides the time is right. Earlier this month Tony Blair surprised the country by saying that if re-elected, his government would decide whether to go ahead with a referendum within two years. No government will go into such a referendum without a good prospect of getting the answer that it wants.

The future of the EU

Economic integration is a reality in Europe, and many of the members of the monetary union are already feeling great benefits in low inflation, falling unemployment and increasing standards of living. There are still challenges to be faced. The single interest rate can distort economies, and Ireland has been booming with more than average inflation because it cannot raise interest rates to match its particular circumstances. The Common Agricultural Policy is overdue for change. As enlargement of the EU comes closer, something will need to be done to contain the costs of the CAP. There are also problems in some countries with the potential costs of social pensions provision in aging societies.

Perhaps the most difficult next step on the path to economic integration will be with reforming the institutions of the European Union. At the last summit in Nice in December 2000, the members failed to make much progress on a number of measures to make the Commission smaller and more accountable, or to move more towards majority voting. The pressure to retain individual nation’s veto on important issues remains strong. The democratic deficit of the EU is a problem. Much of the practical legislation comes from the work of the Commission which is unelected. The Parliament which is elected has little power beyond the ability o dismiss the Commission. Governments are fearful of giving the European Parliament more power for fear of it beginning to be more important than the Council through which they exercise inter-governmental control. If all this seems complicated, w sometimes have difficulty in Europe with working out where the power lies in the US system.

If I was to make a prediction for the EU in 20 years time, I think all members will be in the Euro, which will be a strong global currency. The EU, which already has a GDP as large as the US, will be significantly larger and richer given its expansion. It may be as many 30 countries by then. It will be an equal partner with the US in NATO, and the partnership across the Atlantic will be a force for stability and prosperity for the rest of the world.

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