Options for Europe – Part 92

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).

Part III – Options for Europe

[FINAL TASKS – INTRODUCTION AND ADDING SOME BITS TO A FEW CHAPTERS – MINOR EDITS]

Chapter 1 – Introduction

[I AM STILL THINKING ABOUT THE BEST WAY TO START THE BOOK – THE FOLLOWING IS ONE APPROACH WHICH GOES FROM SETTING A GENERAL CONTEXT THEN PLACING THE SPECIFIC EUROPEAN PROBLEMS WITHIN IT. THE ALTERNATIVE IS THAT I START TO IMMEDIATELY DOCUMENT THE EUROPEAN PROBLEM AND THEN STEP BACK TO PUT IT IN CONTEXT. I CURRENTLY PREFER THIS APPROACH BUT WILL DECIDE LATER IN THE WEEK WHICH WAY I GO – COMMENTS APPRECIATED THROUGH THE WEEK OF-COURSE]

[PRIOR MATERIAL HERE]

[NEW MATERIAL TODAY]

When European political leaders first thought about integration in the late 1940s, the economics profession was in a very different state. The Keynesian approach was dominant and the mind-numbing Groupthink that dominates the profession today was less stifling because economists were much more concerned with advancing prosperity for all out of the wreckage of the Second World War II. The correspondence between the way macroeconomists approach problem solving and reality was high, whereas today, it is more or less non-existent. The concerns of the great European visionaries were not to put the European economies into a straitjacket of austerity and hardship but to achieve much broader political aims. In the immediate post World War II period, the ‘European Project’ was devised by Europe’s political leaders as an ambitious plan for European integration. The European Project was largely about detente after two very fracturing wars and lots of smaller disputes in the C20th. It was believed that by creating a political union, the historical enmities, principally those between France and Germany, would fade and cordial relations could be fostered. It was an extension of the logic that led to the earlier (1904) Entente Cordiale between the French and the British which ended their long history of military conflicts. France was determined to stop Germany ever invading it again and considered political integration to be a way of ensuring this.

In economic terms, the Great Depression had taught politicians that without major government intervention, capitalism is inherently unstable and prone to delivering lengthy periods of unemployment. The dominant orthodoxy in the 1920s of balanced budgets, tried during the 1930s, failed. Full employment came only with the onset of World War II, as governments used deficit spending to prosecute the war effort. The challenge was how to maintain this full employment during peacetime. Western governments realized that with deficit spending supplementing private demand, they could ensure that all workers who wanted to work could find jobs. All political persuasions accepted this commitment to full employment as the collective responsibility of society. As a result, very low levels of unemployment in most Western nations persisted until the mid-1970s. While private employment growth was relatively strong during this period, governments maintained a buffer of jobs for the least-skilled workers. These jobs were found in the major utilities, the railways, local public services and major infrastructure functions of government. By absorbing workers who lost jobs when private investment declined, governments acted as an economic safety valve. In addition, welfare systems provided income support and other public services (such as health and education) to citizens in need. While there were significant differences across nations in the scope of these systems, they all shared the view that the state had a role to play in providing economic security to citizens.

After World War II, the 44 allied nations also agreed to fix their exchange rates relative to the US dollar, which, in turn was linked to the price of gold, because they believed this would bring economic stability. Under the so-called Bretton Woods system, established in July 1944, the central banks of participating nations would buy and sell their currencies to to maintain the agreed fixed parities and the newly created International Monetary Fund (IMF) offered short-term funding to any nations that could not earn sufficient foreign currency reserves via trade. The US government, in turn, agreed to convert US Dollars into gold at a fixed price. The pursuit of full employment was conducted within the context of this international monetary system.

There were several overlapping agendas in European politics in the immediate Post World War II period that influenced the path that the Member States would take on the way to establishing the flawed EMU in the early 1990s. Driving all these agendas was the rivalry between the two large states, France and West Germany. That rivalry would lead to a series of compromises, none of could be construed as well thought out solutions to the issues involved. The first faux step was the Treaty of Rome which was signed in 1957 and established the European Economic Community (EEC) with the six founding Member States. Given the respective wartime roles (aggressor versus occupied), the Treaty was heavily biased in favour of the occupied France at the expense of the aggressors Germany and Italy, particularly evidenced by the unanimous decision- making rules at the expense of majority voting. France saw an integrated Europe as a way of consolidating their dominant role in European affairs but was determined to cede as little national sovereignty as possible to achieve these aims. The failed 1962 Fouchet Plan defined France’s Europe in terms of intergovernmental committees rather than supranational entities. France also exploited the fact that West Germany, shamed by its criminal behaviour during the War, had little political capital on which to challenge France’s desire for supremacy. France was also resentful of the influence that the US was exerting in Europe, particularly through the Marshall Plan, which intrinsically tied West Germany to the US. Charles De Gaulle resented any suggestion that West Germany was an equal partner and the 1965 ‘Empty Chair’ crisis, where France blocked any move to majority voting, was only resolved by the ‘Luxembourg Compromise’ where the Member States agreed to maintain France’s power of veto. But Germany was building its industrial stronghold, which was increasingly becoming a major threat to the French economy and would eventually require France to compromise on its fierce resistance to ceding any national sovereignty to a European-level entity. The German economic rebirth as an export powerhouse and the stability of its currency would become the vehicles through which Germany could build a national confidence again given the national shame it was carrying. It was also the platform that Germany would use to exert its dominant influence over the destiny of European integration and, ultimately, this dominance would a key reason for the dysfunctional design of the EMU that was accepted at Maastricht in 1991.

After the Second World War, Europe was not only enduring high unemployment and poverty but was also beset with crippling food shortages due to the War damage to the food supply chain. After the Treaty of Rome was signed, the six founding Member States met in July 1958 at the Stresa Conference to discuss further integration, particularly in the context of these shortages. The first major achievement of the newly formed EEC was the Common Agricultural Policy (CAP), which was introduced in 1962 and a major step towards the goal of unified Europe. But initially this was on France’s terms with Italy (the poorest of the 6 ‘partners’) paying the highest net contributions to the fund that was established to maintain the system and Germany also a major net contributor. The policy introduced a common price by removing tariffs on agricultural products, although this took some time to achieve given the parochial resistance of rural communities in the participating nations. At the heart of the policy design were the competing interests of France, who wanted to protect their farmers, and Germany, who wanted to expand its industrial export market. The CAP, more or less, provided for a German subsidy to French farmers which was the compromise required to allow each nation to achieve its domestic political needs. The capacity of the CAP to generate farm subsidies to France was a major motivation for their quest for integration. Again, an example of a poor motivation creating a dynamic that would eventually become a common currency. But the gains the French were receiving from the EEC also put paid to any threats that the Gaullists would from time to time make about abandoning the Community. The Germans soon worked out that they could lever this situation for their own advantage (Ludlow, 2005).

While the CAP carried these political tensions it also relied on the fixed exchange rates provided through the Bretton Woods system for administrative ease given the multitude of agricultural prices that had to be supported across the Community. The CAP could not function effectively with sudden or significant fluctuations in currency values. Thus, once the Member States locked in the CAP they were also locked into trying to manage their exchange rates. The uncertainty of the Bretton Woods system in the 1960s accelerated the idea that a common currency within the Community would be desirable. However, the experience that the European nations had with the Bretton Woods system was illustrative of the problems that would confront them in a currency union. The French and the Italians were under constant pressure of devaluation in the face of a the growing export power of the German economy. The Deutsch Mark emerged in the 1960s as the strongest currency and the Bundesbank was motivated to keep it in a state of perpetual undervaluation to ensure the export effort was supported. This put strain on the other Member State central banks to maintain the agreed parities. Some degree of stability was maintained through capital controls, which reduced the capital flows out of say, France and Italy and into Germany. When the disparities between the various nations in terms of trade strength became too large, the agreed exchange rate parities were realigned (Britain devalued several times as did France while the German Mark was revalued when the tensions became unsustainable). These changes in the exchange rates let some of the steam off and gave the French government, for example, some room to move in terms of domestic policy. The problem that the Bretton Woods system presented was that deficit countries like France had to engineer harsh domestic cuts via high interest rates when their currencies were losing value to attract capital inflow. The resulting stagnation and high unemployment was politically unsustainable. Things would get worse under the Snake arrangement which the Member States put in place when the Bretton Woods system collapsed in 1971 to support the CAP.

But at least these systems allowed for some exchange rate flexibility. The lesson was for all to see – these disparate economies would always struggle to maintain fixed parities with each other. Of-course, under the EMU these tensions play out through so-called ‘internal devaluation’, which involves savage cuts to wages and pensions, given there is no scope for exchange rate realignment. The lessons were not learned.

The Hague Summit in December 1969 marked a further important milestone along the way to integration. The antagonisms were prominent. France wanted to advance financial integration principally to ensure that the very favourable system of cross subsidy under the CAP would continue to benefit its farmers. Germany, on the other hand, was increasingly tense about funding the surplus farm production of other nations. De Gaulle had vetoed any notion of enlargement of the EEC. But after his resignation in April there was a new a new sense of detente towards the question, particularly in relation to Britain’s inclusion. De Gaulle’s successor Georges Pompidou thus was prepared to compromise on enlargement to advance the French aspiration for more monetary cooperation. Germany had been impacably opposed to any notion of monetary integration unless the Bundesbank could control monetary policy. The obsessive fears of inflation in Germany were never far below the surface. But under Willy Brandt, Germany saw the French compromise as a way of advancing Germany’s ‘European’ credentials, a way to restore some lost pride and standing among its neighbours. The Hague Summit was also a turning point in that the operationalisation of enlargement would see the Community at the centre of the negotiations with intergovernmental arrangements largely eschewed. France was losing ground.

The vague discussions at the Hague Summit about advancing a union led to the Prime Minister of Luxembourg, Pierre Werner being appointed to head a working party, which would flesh out the details of how this union would be achieved. The Werner Report published in May 1970 outlined a comprehensive timetable for the creation of a full economic and monetary union by the end of the decade. The conceptualisation of the newly created economic and monetary union as a new ‘nation’ where the member-countries would effectively become states of a federation was clearly thought elemental. Significantly, this was not the conceptualisation that emerged after the Treaty of Maastricht. The Werner Report was clear that monetary and fiscal policy would be centralised with the “centre of decision of economic policy will be politically responsible to a European Parliament” (Werner Report, 1970: 13), which would be elected on the basis of universal suffrage. The recognition that economic policy should be democratically determined and those responsible for the policy should be held accountable to the will of the people, was fundamental to the way the Europeans were conceptualising economic and monetary union in 1970. There was no hint that this level of intervention would be the domain of officials centred in Brussels who would do deals with unaccountable bodies such as the International Monetary Fund (IMF) that would result in millions of Europeans being made unemployed, which is the norm in Europe in 2014.

The Werner proposals were clearly more in line with what the Germans desired and the French knew it. The rivalry within French politics between the republicans who eschewed handing over national sovereignty to European-level decision-making units and other leading officials (Barre, Marjolin, d’Estaing, and later Delors) who were sympathetic to the German position was played out within the French government. Pompidou faced major opposition within his Gaullist party to the Werner Report intent of establishing supranational institutions. The Report came out as the Bretton Woods system was in its death throes. Both the French, who wanted currency stability and the Germans, who sought a way out of the continued upward pressure on the Mark, saw a way to compromise. Gone were any concrete plans to transfer power to any supranational institutions. The French gained some traction by getting Brandt to agree to the creation of the European-level reserve fund to reduce exchange rate fluctuations. But the unwillingness of either nation to commit fully to the Werner proposals meant that the only real development was the agreement to allow the currency fluctuations to snake within a defined band (the ‘tunnel’). With growing fears about the stability of the US Dollar value and the sustainability of its convertibility into gold, the European leaders were keen to take some initiative to provide more certainty to European trade.

The ‘snake’ came under immediate pressure because there were huge capital outflows from the US, which forced European central banks, particularly the Bundesbank to sell large volumes of their currency to defend the fixed parity. Ultimately, the Bundesbank was forced to suspend further foreign exchange market intervention in May 1971 and they closed the foreign exchange market. This action provided on a temporary reprieve but demonstrated very clearly that nations with very different economies and export strength would always find it difficult tying their exchange rates together unless they were prepared to accept politically unpalatable choices regarding fluctuations in domestic economic outcomes, particularly rising unemployment for external deficit nations and threats of inflation for the stronger currencies.

[I WILL FINISH INTRODUCTION OVER THE NEXT FEW DAYS – THEN EDITING AND CLEANING UP TO DO. NORMAL TRANSMISSION WILL RESUME NEXT WEEK]

Additional references

This list will be progressively compiled.

Barbash, J. (1982) ‘The Guilds of Academe’, Challenge, 25(1), March-April, 50-54.

Blanchard, O. (2008) ‘The State of Macro’, NBER Working Paper No. 14259, National Bureau of Economic Research, August.

Democracy Now (2007) ‘The Conscience of a Liberal: New York Times Columnist Paul Krugman on Healthcare, Tax Cuts, Social Security, the Mortgage Crisis and Alan Greenspan’, October 17, 2007. http://www.democracynow.org/2007/10/17/the_conscience_of_a_liberal_new

European Commission (2014) ‘History of the CAP’, http://ec.europa.eu/agriculture/cap-history/early-years/index_en.htm, Accessed May 26, 2014.

Independent Evaluation Office (IEO) (2011) ‘ IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07’, Washington, International Monetary Fund. http://www.ieo-imf.org/ieo/files/completedevaluations/Crisis-%20Main%20Report%20(without%20Moises%20Signature).pdf

Janis, I.L. (1972) Victims of Groupthink, New York, Houghton Mifflin.

Janis, I.L. (1982) Groupthink: Psychological Studies of Policy Decisions and Fiascoes, Second Edition, New York, Houghton Mifflin.

Goodacre, H. (2014) ‘Economics Departments have fallen behind’, Financial Times, May 23, 2014. http://www.ft.com/intl/cms/s/0/c32a888a-dc38-11e3-8511-00144feabdc0.html

Gordon, D.M. (1972) Theories of poverty and underemployment, Lexington, Mass: Heath, Lexington Books.

Grim, R. (2009) ‘Priceless: How the Federal Reserve Bought the Economics Profession’, Huffington Post, May 13, 2009. http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html

Gross, C.C. (2008) ‘Three before their time: neuroscientists whose ideas were ignored by their contemporaries’, Experimental Brain Research, 192(3), January, 321-34. http://www.ncbi.nlm.nih.gov/pubmed/18641979

Kazin, M. (2006) A Godly Hero: The Life of William Jennings Bryan, New York, Alfred A. Knopf.

Krugman, P. (2009) ‘How Did Economists Get It So Wrong?’, New York Times, September 2, 2009. http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html

Kuhn, T.S. (1996) The Structure of Scientific Revolutions, Third Edition, Chicago, The University of Chicago Press.

Lakatos, I. (1970) ‘Falsification and the Methodology of Scientific Research Programmes’, in Lakatos, I. and Musgrave, A. (eds.) (1990) Criticism and the Growth of Knowledge, Cambridge, Cambridge University Press, 91-195.

Ludlow, N.P. (2005) ‘The Making of the CAP: Towards a Historical Analysis of the EU’s First Major Policy’, Contemporary European History, 14(3), August, 347-371.

Schiller, R.J. (2008) ‘Challenging the Crowd in Whispers, Not Shouts ‘, New York Times, November 2, 2008. http://www.nytimes.com/2008/11/02/business/02view.html

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.