Options for Europe – Part 18

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[PRIOR MATERIAL HERE FOR CHAPTER 1]

[NEW MATERIAL TODAY – NOTE THIS IS A SMALL SECTION PRIOR TO THE DISCUSSION OF THE EMS TO PROVIDE A CONTEXT FOR THE SO-CALLED COPENHAGEN INITIATIVE]

The rise of Monetarism and free market ideology – neo-liberalism crawls in to take centre stage

While the traditional rivalries between France and Germany and the desire to maintain fixed exchange rates were at the centre of the Eurocentric negotiations about increased economic and monetary union in the late 1970s, a new, even more insidious factor, entered the picture. This factor would prove to be a major catalyst for the sequence of events that took Europe to Maastricht and resulted in the flawed Economic and Monetary Union that exists today.

In the 1970s, the high inflation that followed the OPEC oil price hikes and the resulting high unemployment that accompanied it as governments tried to suppress economic activity to control inflation – the so-called era of stagflation (simultaneously high unemployment and inflation), provoked a major shift in economic thinking.

The Keynesian macroeoconomic orthodoxy, that had dominated in the Post World War II period up until the mid-1970s, was predicated on the view that the level of unemployment was determined by the level of aggregate demand or spending in the economy. Firms employed people if they had sales orders. After the cessation of the War and with the mass unemployment of the Great Depression of the 1930s still firmly etched in the minds of policy makers and the population, governments generally committed to using fiscal and monetary policy to maintain states of full employment where everybody who wanted a job could find one. This led to an acceleration of prosperity across the advanced world.

Accompanying this approach was a view that inflation would only result if the spending outstripped the capacity of the firms to produce goods and services, leaving them no option but to increase prices. So if unemployment became very low as levels of economic activity became high, we might expect inflation. So the stagflationary combination mystified the popularised version of the dominant macroeconomic paradigm. Of-course, macroeconomists schooled in this tradition understood that inflation could also emerge as a result of sudden cost pressures (for example, imported raw material price rises such as oil) which then squeezed existing profit margins and the real value of the workers wages, and, under certain circumstances, could trigger a struggle between labour and capital over who would bear this loss. That struggle would manifest as rising wage demands and/or rising prices (to protect profit margins) and inflation would be the result. In this context, the correct policy response was to address the incompatible demands for more national income from labour and capital by seeking some sort of consensual approach to sharing the costs of the imported raw material price rise.

However, this understanding was lost on policy makers when responding to the OPEC oil price hikes and they sought to stifle the accelerating inflation by suppressing aggregate spending using policy measures we now refer to as fiscal austerity (public spending cuts and/or tax increases) and tight monetary policy (increasing interest rates). The result was rising unemployment and persistent inflation (once the expectations of higher inflation drove behaviour independently of the state of the labour market). The stagflation created a perception that the Keynesian policy era had failed and bestowed a sense of legitimacy on the free market approach, that had been wholly discredited during the Great Depression by the work of John Maynard Keynes and others, but which was still alive and well in the more conservative academic departments.

The 1970’s thus saw the long-standing dominance of so-called Keynesian macroeconomic theory and policy abandoned by a large number of economists, particularly those in academic institutions in the United States. Blinder (1988: 278) says that by “about 1980, it was hard to find an American macroeconomist under the age of 40 who professed to be a Keynesian. That was an astonishing turnabout in less than a decade, an intellectual revolution for sure.” The resurgence of the free market approach, which we now rather roughly refer to as neo-liberalism manifested initially as Monetarism and Milton Friedman and his University of Chicago colleagues championed the entry of these ideas back into the mainstream. policy debate. Margaret Thatcher’s government was the first to really embrace this conservative academic resurgence.

The rise in acceptance of Monetarism and its related academic theories was not based on an empirical rejection of the Keynesian orthodoxy, but “was instead a triumph of a priori theorising over empiricism, of intellectual aesthetics over observation and, in some measure, of conservative ideology over liberalism. It was not, in a word, a Kuhnian scientific revolution” (Blinder 1988: 278). In other words, a significant part of the rejection of Keynesian macroeconomics reflected the ideological disdain among a growing number of academic economists in state involvement in the economy. Economics has always been fractured by the ideological division between those who consider that state intervention, regulation and spending is crucial for the achievement of a balanced and equitable economy, and, those who eschew state involvement and believe, with religious passion, that a self-regulating free market can provide increasing wealth and opportunity for all.

The central ideas promoted by the Monetarist resurgence were that inflation was caused by excessive growth in the money supply associated with excessive government spending and lax monetary discipline by the central banks (interest rates too low) and that price stability would only come with the imposition of deflationary policies, which involved tighter credit policies and cutbacks in fiscal deficits via spending cuts. The conservative nature of the approach considered fiscal retrenchment should come from spending cuts rather than tax hikes. In general, there was a bias towards lower taxation, particularly on high income earners. In response to the observation that this sort of deflationary policy would cause unemployment to rise even further, the Monetarists introduced the concept of the natural rate of unemployment, which became a central tenet of the anti-Keynesian stance.

Put simply, they argued that a free market would deliver a unique unemployment rate that was associated with price stability and that government attempts to manipulate that rate using fiscal and/or monetary policy would be futile and would only leave a legacy of accelerating inflation. The policy makers thus should just fight inflation and let the unemployment settle at this natural rate. By this time, any Keynesian remedies proposed to reduce unemployment (such as, increasing the fiscal deficit) were met with derision from the bulk of the economics profession who had wholeheartedly embraced Monetarism. An examination of the research studies of the day and that which has since been produced demonstrates, that despite the predominance of Monetarist thought, there was very little evidence presented to substantiate their policy approach.

But with policy makers increasingly loathe to use discretionary fiscal and monetary to stimulate the economy, unemployment rose and persisted at high levels. The battle against unemployment has been largely abandoned in order to keep inflation at low levels. This major shift in macroeconomic policy paradigms was going on as the ‘snake’ was slithering into dysfunctional oblivion and the political elites in Europe were seeking their next strategy in the pursuit of the ‘European Project’.

[NOW THE MATERIAL ON THE EMS – AFTER FRAMING IT IN THE CONTEXT OF BROADER DEVELOPMENTS IN ECONOMIC THINKING]

Next stop – “L’Europe se fera par la monnaie ou ne se fera pas” – the European Monetary System (EMS)

In 1950, Jacques Rueff, who was a trusted economic advisor to Charles De Gaulle and French central banker wrote that “L’Europe se fera par la monnaie ou ne se fera pas” (“Europe will be made by money or it won’t be made”), which provided the mantra for those who believed that the ‘European Project’ ultimately would require a single currency (Rueff, 1950).

As the ‘snake’ was falling apart, the President of the Commission of European Communities, Roy Jenkins delivered the first Jean Monnet lecture in Florence on October 27, 1977. Jenkins (1977: 3) described the demise of the Werner plan as a “retreat rather than an advance”. In making the case for a renewed push to monetary union he said (1977: 5) that there would be advantages in “creating a major new international currency baçked by the economic spread and strength of the Community, which would be comparable to that of the United States, were it not for our monetary divisions and differences”. He claimed that eliminating the currency fluctuations within Europe would improve economic welfare. Rueff’s agenda was very much back on track.

On December 5, 1978, the European Council met in Brussels and agreed to set up the European Monetary System (EMS), which was to absorb what remained of the ‘snake’ and establish a European Currency Unit (ECU) (European Council, 1978). The EMS emerged out of a proposal put to the European Council meeting in Copenhagen in April 1978 by the French President Valery Giscard d’Estang and the German Chancellor Helmut Schmidt.

It won’t surprise the reader to learn that the system eventually found itself in crisis and instead of abandoning the almost impossible idea of tying these disparate European economies together into a functioning fixed-exchange rate currency zone, the European political leaders began the rocky road to Maastricht with a compromised EMS and the creation of the Delors Committee. But first, we have to tell the story.

[NEW MATERIAL TODAY FOLLOWS]

In the traditional struggle between the French policy makers in the Planning Ministry (under Jean Monnet) and the technocrats in the Ministry of Finance (who were more amenable to the German position on integration and economic management), Giscard d’Estaing was in the latter camp. When elected as President in 1974, he had to share power with the Gaullist Prime Minister Jacques Chirac. In 1976, the latter quit that position in an attempt to reassert the Gaullist power in the French government. In proclaiming Raymond Barre, the “meilleur économiste de France” (best economist in France), Giscard d’Estaing, appointed him Prime Minister to succeed Chirac. He also took on the role of Minister of Economy and Finance. The pair promoted a powerful anti-Gaullist position with respect to both domestic economic policy, reflecting thier neo-liberal views, and moved the French perspective on ‘Europe’ closer towards the German ‘economists’ viewpoint.

Canadian philosopher and writer, John Ralston Saul, examined the role played by Giscard d’Estang in France during the 1970s in his 2005 book ‘The Collapse of Globalism and the Reinvention of the World’. In an interview with The Guardian, Saul told Stuart Jeffries (2005) that Giscard d’Estang “first verbalised the idea that economics was the prism through which we should see civilisation” at the initial G7 meeting in 1975. Saul also said that the French politician “believed free markets would establish natural international balances” and that “Boom and bust was over”

[TO BE CONTINUED]

[TOMORROW I WILL FINISH THE DEBATES IN THE LATTER 1970s AND THEN TURN TO THE DELORS REPORT IN THE LATE 1980s. IT WAS SLOW GOING TODAY GIVEN THE DOCUMENT RETRIEVAL AND READING IN FRENCH, MOSTLY]

Additional references

This list will be progressively compiled.

Blinder, A. (1988) Hard Heads, Soft Hearts: Tough Minded Economics for a Just Society, Addison-Wesley, Reading, Mass.

Howarth, D. (1999) ‘French aversion to independent monetary authority and the development of French policy on the EMU project’, Paper presented at the biannual ECSA conference, Pittsburgh, Pennsylvania, June.

Jeffries, S. (2005) ‘The prophet of anti-globalism’, The Guardian, June 9, 2005.

Saul, J.R. (2005) The Collapse of Globalism and the Reinvention of the World, Viking Penguin Canada, Toronto.