The Economist

EURO BRIEF

The power of eleven

We conclude our series of euro briefs by recalling that economic and monetary union (EMU) was conceived by politicians for political ends. Their main purpose was not to raise economic efficiency—but to change the way Europe was governed

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THE main begetters of EMU a decade ago were President François Mitterrand of France; Chancellor Helmut Kohl of Germany; and Jacques Delors, president of the European Commission. They saw it as a means to bind Europeans more closely together. They believed that it would strengthen the supranational institutions of the European Union. Indeed, it was precisely this potential for political transformation that made monetary union attractive. Economic gains were a secondary consideration: they appeared relatively small, if they could be calculated reliably at all. Nobody pretended that a system of national currencies was provoking widespread dissatisfaction.

The 11 countries that have now signed up for the project see it serving their national interests in different ways. France has long wanted to get its hands on some of the economic power wielded by the German Bundesbank. It has suited Germany to indulge France, especially since German unification. By swapping the D-mark for the euro Germany is proving to nervous neighbours its continuing commitment to European integration. France and Germany still see a united Europe—whatever that means—as the best vehicle for advancing their interests in the world at large.

The determination of France and Germany to pursue monetary union has meant that other countries have faced a more limited calculation. They have not been asked to decide whether the single currency is a good idea; only to decide whether to join a project that would go ahead anyway. Not surprisingly, most have chosen to be in not out.

The decision was easy for the Benelux countries. Belgium, the Netherlands and Luxembourg were founder members of the European Economic Community (predecessor of the European Union), with France, West Germany and Italy. They have been consistent supporters of European integration, partly because they depend heavily on intra-EU trade, and partly because the tide of history has left them with few illusions about the worth of national frontiers.

Germany accounts for a quarter of the foreign trade of the Netherlands. The guilder has been tied closely to the D-mark since 1979. The Dutch were critical of the emerging shape of monetary union, but not of its desirability in principle. The Dutch wanted to be sure that the interests of Europe’s smaller countries would not be ignored in a project dominated by France and Germany. It pleased almost everybody that a Dutchman, Wim Duisenberg, was chosen to run the new European Central Bank—despite a last-minute French attempt to insert a Frenchman into the job.

Belgium has been even keener to reinforce its European “identity” since its national identity started falling apart seriously in the 1980s. Deepening divides between a French-speaking south and a Dutch-speaking north have transformed Belgium from a unitary state into a federated one. European integration is one of the few goals on which the whole country can agree. The Belgians also found the euro a useful outside discipline that helped them to force through unpopular measures to control their public finances.

Club Med worries

If Belgium had problems, Italy seemed an even less obvious candidate for the euro. It has a poor record of fiscal and monetary discipline, a notoriously ineffective political system, and wide regional disparities. For a long time it seemed likely to be a candidate for later entry, after the new system had bedded down. But Italians feared that failure to join with France and Germany would reduce their country to small-country status within the European Union. Many Italians also see EMU as a good way to entrench price stability and put control of their economy in safer (non-Italian) hands.

Hence the broad political consensus in Italy in favour of early entry at any cost. Enlightened politicians and central-bank technocrats found a surprising measure of popular support for the fiscal reforms needed to qualify for monetary union. The struggle to get borrowing down, tax revenues up and public debt on a falling trajectory—much of it undertaken in 1996-97 by the centre-left “Olive Tree’’ coalition led by Romano Prodi—has been a painful but inspiring sight.

There was little help for the Italians from elsewhere. Because the idea of sharing a currency with Italy has been anathema to German (and Dutch) public opinion, German politicians have gone out of their way to insist on rigid application of the EMU entry rules. Spain and Portugal, even though their interests are often grouped with Italy’s in a jocularly named “Club Med”, have kept their distance, the better to advertise the healthier state of their own public finances.

Spain and Portugal also share, with Ireland, a popular enthusiasm for monetary union, based on the huge benefits that European Union membership has brought them. Farming and poverty have produced subsidies from the EU budget equivalent to as much as 4-5% of GDP. All three were enjoying economic booms as 1997 approached, and so could qualify without too much budget-squeezing—although, as with Belgium and Italy, the Maastricht debt rules had to be massaged a bit for them.

Three of the countries that signed the Maastricht treaty are not joining the euro (see article). Greece would like to, but its fiscal position is a bar. Britain and, after its June 1992 referendum, Denmark, negotiated opt-outs from the single currency that they have chosen to exercise for political reasons.

Countries joining the EU since the treaty were expected also to seek membership of the euro as a matter of course (a requirement for all future entrants too). Of the trio that entered the EU in 1995, Austria, a natural ally of Germany, plunged straight in. Finland has also chosen to sign up, though after some soul-searching. It is eager to show off its European credentials and delighted to leap ahead of Sweden and Denmark. But its biggest trading partners, including Britain and Sweden, are outside the euro. Sweden, though it had no formal opt-out, has contrived to stay out of the single currency on technical grounds.

Sovereign states

Most European governments have decided that the benefits of monetary union justify surrendering much of their national power over macroeconomic management. From January 1st finance ministries and national central banks will no longer fix interest rates to meet domestic needs. Participating governments will also—at least in theory—stand to be fined heavily if they run budget deficits exceeding 3% of GDP, the ceiling fixed in the “stability and growth pact”.

It seems inevitable that some countries will disagree with the monetary policy imposed by the independent European Central Bank—or with the application of the stability pact. Indeed, some economists have suggested that EMU, designed for political reasons, will raise economic tensions within Europe. Harvard’s Martin Feldstein notoriously suggested that it might make European war more likely.

On the face of it, there is a loss to democracy as well as a loss of sovereignty at stake here. National governments, and their citizens, are surrendering powers of self-determination that governments and citizens of the future are not meant to recover. The presumption in the benign view of EMU must be that the loss to democracy and self-determination will be offset by a gain in those commodities at the European level.

But first, two fundamental questions about the political aspects of the project need to be answered. One is how governments can be sure that the new super-independent European Central Bank does roughly what they expect it to do. The second is how management of the single currency should be integrated with the other business of the European Union, an especially tricky matter when four out of 15 EU members are not in the monetary union.

The Maastricht treaty seems to answer both questions: the Bank will do what it thinks best, deaf to governments of any kind. But that answer is no longer to politicians’ taste. The governments and leaders overseeing the euro’s birth are not the ones that negotiated its conception; they are less happy with the proposed truncation of their powers.

In France, Italy and Germany (and in Britain), the past two years have brought left-wing governments to power, keen to push growth up and unemployment down. The Socialist government of Lionel Jospin, elected in France in mid-1997, has been a main proponent of an “economic government” to counterbalance the presumed bias of the European Central Bank towards austerity—a call now taken up by the new German government under Gerhard Schröder.

One candidate for this counterbalancing role is the so-called “euro-11” group of finance ministers from countries taking part in the single currency. Euro-11 is a new body: the participating countries were chosen only in May. It has no legal basis in the EU treaties. But its informality may, perversely, add to its power. It has no obligation to reconcile its discussions and conclusions with the run of EU business in which all 15 governments take part, seeking consensus.

A second, even more informal, caucus also seems to be setting itself up as a political check on the ECB. These are the finance ministers from the EU’s 11 socialist governments, who speak for seven of the euro countries, plus the four outs. On November 22nd this group met in Brussels to endorse a manifesto calling for the ECB to keep interest rates low in order to promote growth and jobs.

When finance ministers from all 15 governments want to discuss policy formally, and pass EU legislation, they do so in the Ecofin council. In the event of a clash of interests, euro-11 might serve as a caucus or leading group for single-currency countries to steer Ecofin their way (collectively, they constitute a “qualified majority”, big enough to pass most EU single-market directives, for example). So too might the socialist grouping.

Voting in Ecofin could acquire a new significance with monetary union. The “stability and growth pact” says governments that run big budget deficits should be fined heavily. But finance ministers, voting without the offending country, have to approve any penalty first. Finance ministers may refuse to fine each other, especially if several countries are at fault. This fairly drastic course of action could risk being catastrophic if the European Central Bank were to respond by pushing interest rates up to counter the inflationary effects of bigger deficits.

Governments could try to assert themselves over the central bank in other ways. One might be to rewrite its statutes to require the prompt publication of its minutes and voting records. It is conceivable that Britain or Sweden might demand such a change before they sign up to the euro. But the best solution would probably be for the bank to pre-empt tensions by treating national politicians with more respect—and vice versa.

A structural point often overlooked is that national governments are now dealing directly with each other and the ECB. The European Commission has been pushed to the margins, as has the European Parliament—even though it will hold hearings with Mr Duisenberg. Euro-11 meetings will be prepared by the “economic and financial committee” of representatives from national finance ministries and central banks. Monetary union may, as its founding fathers foresaw, mark a frontier beyond which national and European politics start to merge. But it is not the Brussels institutions that are strengthening their grip on national politics. Rather, it is national governments that are reclaiming the European agenda for themselves.