External Perspectives on 1992
Myron J. Frankman
[A] one-currency regime is much too radical to envisage in the near future. But it is not too radical to envisage 25 years from now, and indeed some such scheme or its functional equivalent, will be necessary to avoid retrogression into greater reliance on barriers to international trade and financial transactions. Moreover, it is useful to have a "vision," . . . some idea of where we would like to get to provides a sense of direction for the next steps.
-- Richard Cooper
A day hardly passes without some publication conjuring up the specter of a Fortress Europe as the outcome of 1992. I shall suggest here that unless certain points are adequately addressed, Europe 1992 will not live up to expectations. One of these emphases is the social dimension, the relative neglect of which in the One Europe project has already been the subject of considerable comment. The other is change in the global economy. The general tacit assumption is that external constraints confronted by each of the member states individually will be overcome by acting in concert. But can Europe resolve its own problems independently or are international economic spillovers of such consequence that the European Community (EC) must pursue an active campaign for global economic cooperation, if it is to be successful in achieving the goals set for a united Europe?
In this paper I shall explore, in particular, two dimensions requiring internal and external coordination and/or cooperation: monetary and exchange arrangements, which are already high on the EC agenda, and income redistribution, which the Community has barely touched. I shall argue, as was done in some of the optimum currency area literature, of which little has been heard since the mid-1970s, that redistributive measures must accompany monetary integration. Following the observation of Peter Kenen that the world is now an optimum currency area, I shall try to spell out some of the implications of global interdependence for the EC, which has not yet begun to deal seriously with its own regional disparities.
My objective then is to
a critique of key elements missing from the vision of Europe 1992 or,
put it in a constructive perspective, to suggest items which should be
on the agenda for the next stage in the process of European
The market may be complete in 1992, but, contrary to the
claims, even more difficult tasks lie ahead for the Community.
Among Europe's principal economic problems are unemployment and industrial relocation. These problems and others all have significant international dimensions which cannot be dealt with satisfactorily within the confines of the EC, except by externalizing the consequences of the problems. Policies which tend to beggar one's neighbor are at best likely to be effective domestically in the short run only. In the long run all suffer. Moreover, coping with internal imbalance is not confined to "externalization"; the adversely altered competitive position of states has led, inter alia, to reductions in government deficits, the dismantling of state enterprise, hesitancy on environmental controls and attacks on both the welfare state and support for cultural activities.
The dilemma posed by jurisdictional spillovers is succinctly summed up by Robert Gilpin as a problem of national welfare capitalism in a non-welfare international capitalist world:
While solving the problem of a closed economy, the welfare state has only transferred the fundamental problem of the market economy and its survivability to the international level. The problem of reconciling welfare capitalism at the domestic level with the nature of the international capitalist system has become of increasing importance.
In the case of the EC, the problem outlined by Gilpin exists at two levels: each national economy confronts challenges to the welfare state originating both at the community and global market levels.
The task of "completing
internal market" requires as a complement steps to facilitate the
of the global market -- what has been termed "international
By contributing to global growth, Europe would be expanding its export
markets and would, in consequence, be enhancing its ability to deal
regional disparities, structural unemployment, and industrial
The discontent with the distortions and uncertainties introduced since 1973 by wildly gyrating exchange rates led to a search for a way back to exchange rate stability. There were new advocates of a return to the gold standard, while others called for a multi-commodity standard. Talk of target rates was heard, somewhat reminiscent of the old fixed rates with a band of variation around them. The European countries which formed the European Monetary System (EMS) in 1978 tried to carve out a stable situation at least between their member currencies. However successful the 8 EMS countries may have been in their limited objectives, the world and the Europeans are still left with extreme fluctuations relative to the U.S. dollar and the Japanese yen. As a significant portion of EC transactions are with countries outside of the Community (about 45 percent each of export and imports in 1985), large exchange rate fluctuations are a major concern.
In a world in which financial markets are more integrated every day, in which the empire of money is now the one on which the Sun never sets, have we not reached the point where a major institutional departure is called for? John Stuart Mill spoke over a century ago of the barbarism that keeps us from having a single world currency. Has the time not now arrived when Mill's vision is no longer such a bold departure? Is it not time to speed the process of institution building that will rescue us from the problems associated with currency volatility? The rather abundant literature on the process of economic integration contains the consistent observation that the more integrated economies are the more extensive policy coordination needs to be. The experience of the 1970s and 1980s has clearly indicated that this is true whether one is talking of a de jure regional grouping such as a common market or nations whose goods, services, factor and financial markets are de facto progressively more intertwined.
While Mill may have reflected on a world currency over a century ago, the theoretical literature on the extension of a single currency to a larger area (or, for logical completeness, reduction to a smaller area) dates only to the early 1960s work of Robert Mundell. The world of the 1960s having been one of relative exchange rate fixity and limited capital mobility, writers spoke of optimum currency areas as likely to be limited in extent. Delbert Snider listed the following conditions for an optimum currency area:
Balance of payments adjustment within this regime would be asBut let me give credit where it is due. At least Cooper does not assume that the invisible hand will resolve imbalances. Ronald McKinnon, in contrast, continues to speak of adjustment as being even swifter, smoother and more effortless than David Hume envisioned it in the mid-eighteenth century:
easy, or as difficult, as it is between regions of the United
States or any other large country today. . . . Fiscal policy in
its various forms could be used to cushion such unemployment.
. . . among the financially open economies of the 1980s, tradeIn the absence of nominal exchange rate change -- or in the the absence of that possibility where there is but one currency -- price adjustments will alter the real (notional) exchange rate between regions or countries. With the disappearance of nominal exchange rate changes, one loses as well the generalized shocks that these changes impart to price levels and, by extension, to investment decisions, especially where capital goods imports are large.
deficits and surpluses are better balanced by offsetting automatically
flows of private capital much like the balance achieved between
Texas and California.
Europe provides the ongoing example of the difficulties of moving toward a unified supranational monetary area. One of the lessons that John Pinder has drawn from the EC experience is that coordination of national policies has not been an effective approach; indeed, little has resulted from such efforts. Community-wide instruments and policies, however, have borne fruit. Pinder points to the Common External Tariff as giving the EC substantial bargaining power within the GATT. In his view, the EMS is not a common instrument.
Although the ECU has existed for one decade, and would appear to be the logical candidate to become the Community's single currency, considerations of political expediency have until now excluded steps to achieve this end. That changed in April 1989 with the publication of an EC report calling for a European Central Bank and the eventual adoption of a single currency. The Economist has been an outspoken advocate of currency unification, both in Europe and globally -- arguing that there is no good economic reason for dismissing that option. Perhaps Europe will lead the way to a world currency, which will be a means of payment and not just a unit of account for governments and large scale debtors. Use of the ECU has grown markedly in the private financial sector, whereas use of the SDR has not. But this is just a beginning. What must be perceived by Europe and the world is the advantage that a single currency conveys to all, when supplemented by redistributive measures.
Presently perceptions focus on the disadvantages of a single currency. Warren Smith asked two decades ago whether there were sufficient policy tools to achieve internal and external "balance". With the fixing of exchange rates, policy-makers at the national level lose two of those tools: the exchange rate and monetary policy. Pinder argues that permanently fixed exchange rates or a single unified rate would generate either unacceptable levels of inflation or unemployment in some member countries. Yet would this be the case? Fiscal policy and selective measures remain available. In the judgement of Charles Wyplosz these should be quite sufficient: "there is hardly anything which is achieved through exchange rate changes that cannot be done through fiscal policy measures."
Conventional wisdom suggests that exchange rate flexibility allows countries to chose their own inflation rates; but might a unified market not be expected to produce both less inflation and less unemployment? To realize as fully as possible the benefits of a single market, it seems entirely reasonable to reduce the number of currencies, for foreign exchange costs and risks themselves impart an inflationary bias. Robert Triffin has argued that if the goals of exchange freedom and stability were truly taken at face value, then we would we well on the road to a single currency for the world.
The EC has for many years spoken with one voice in the GATT negotiations, a change incorporated in Article 113 of the Treaty of Rome. The Common External Tariff would appear to have necessitated the transfer of sovereignty over tariff and quota bargaining from the national level to that of the Community. In retrospect, this change seems to have been passed over lightly by chroniclers of the EC, yet commercial policy has been a central area of sovereign control over the management of economies. In this realm the Community has been said to have been far more effective than in areas where policy coordination has been the rule. Why not one voice in international monetary matters? At present the EC participates at Group of Seven (G-7) summits, but more in evidence are the four discordant European national voices which speak there. Why not one voice for the EC within the G-7?
And what of the International Monetary Fund (IMF)? In the IMF the votes of the 12 EC members are cast by 9 different Executive Directors. Spain, for example, is "represented" by an Executive Director from Latin America. Some have spoken of the political influences in the IMF. In fact, the IMF was born politicized. The US is the sole country to have veto power on major questions in the Fund and has had it throughout the Fund's existence. As the relative economic strength of the US declined, the 80% majority-20% veto on special questions would no longer have been adequate to assure a US veto, if it had accepted the quota revision proposed in the late 1970s. And so since that time we have had an 85% majority-15% veto on special questions. In principle, were votes in the Fund to be regrouped, the European Community, for one, would also have a veto, with 28.61% of the total vote (as it stood on April 30, 1987). Multiple vetos are a two-edged sword: they might either immobilize the Fund or, in my view, turn it into a forum for serious horse trading, that might better serve the international community.
The 1987 report to the European Commission of the group headed by Tommaso Padoa-Schioppa, Deputy Director General of the Banca d'Italia envisions a 'Stage Two' EMS that would aim for the following:
(a) stronger co-ordination and joint management of monetary policy; (b) strengthened EMS mechanisms to counter speculative capital movements; (c) a new model of safeguard mechanisms, providing for more effective Community control over exceptional derogations from complete capital mobility; and (d) well-structured Community participation in international monetary co-operation.
If these four points are the true intent, then the way seems clear. A single Community voice in international finance and a single Community currency. While the Report accepts that monetary union "has several first-best properties", it does not see the time as being right. Yet as Peter Ludlow observes "events in the real world are now moving so strongly in the direction of a European Union that it is unrealistic any longer to postpone serious consideration of the major institutional and policy problems involved." A single currency and a single voice in the IMF and what has been the G-5, 7 or 10 would be perfectly consistent with Article 30 of the Single European Act of 1985 which calls for convergence of economic and monetary policies.
If policy coordination
harmonization required that the EC adopt a single voice and a single
in the sensitive area of control over imports, is a unified approach to
monetary policy and the exchange rate not now necessary after three
of progress in economic integration?
Income redistribution, as such, has not been tackled directly by the EC. Attention has effectively been limited to regional development policies, supported through three funds: the European Agricultural Guidance and Guarantee Fund (EAGGF), the European Regional Development Fund (ERDF), and the European Social Fund (ESF). While these funds accounted for 90 percent of EC expenditures in 1985, the EC budget has consistently represented less than one percent of the combined GDP of the 12 members and less than two percent of the combined government expenditures of the members (which tend for each of the EC member states to represent between 40 and 60 percent of its GDP).
Redistribution through the Community budget does occur through the back door and in other guises. It occurs principally through the Agricultural Fund, which has been the preponderant part of the EC budget; expenditures for price guarantees have regularly represented 2/3rds of EC expenditures in recent years. Redistribution responds to the noisy wheel principle and to our romanticism for a world gone by. It is not targeted to assist those with greatest need. It is yet one major example of redistribution to entrenched interests, interests one may add whose relative weight in the total population has fallen precipitously since the signing of the Treaty of Rome. It is not unreasonable to imagine that without the Common Agricultural Policy (CAP), France, Germany and Italy would have far smaller agricultural populations than they continue to have today. In evaluating the significance of unrequited transfers under the CAP one may take as a first approximation of the income transfer that takes place the ratio of the agricultural price guarantees provided by the EC to the value added in agriculture; the figures for 1985 expressed in percent are:
The CAP is an anachronism which may have made political sense when the Treaty of Rome was signed: at that time the share of the economically active population in agriculture was one-third or more in France, Germany, Italy, and the Netherlands. Today, it is only in Ireland and the southern countries of the EC (Portugal, Spain, Italy, and Greece) that agriculture's share of total employment still exceeds 10 percent. In Belgium, Luxembourg, the Netherlands, and the United Kingdom the share is less than 5 percent. In terms of contribution to GDP, it is only in Ireland and Greece that agriculture's share exceeds 10 percent; while in seven of the twelve the contribution to GDP was 5 percent or less in 1986. Yet, as noted above, in recent years the price guarantee program has absorbed two-thirds of the budgetary expenditures of the EC, leaving little for other purposes.
The old habits of thought die hard. Agriculture is still protected, subsidized and supported in a myriad of ways; ways which seem to attend to the demands of some farmers, but which do not assure that the needy are looked after. The unemployed in the EC are many, the farmers are few: in 1985 the unemployed outnumbered the farmers in every EC-12 country except Greece, Luxembourg and Portugal. (The highest ratios of unemployed to agricultural employment were 3.0 in the Netherlands, 5.2 in the United Kingdom and 5.3 in Belgium; for Europe-12, the ratio was 1.5.) Why do we (for the EC is not alone) continue to support agriculture? It is not primarily because of intrinsic economic merit, but rather because it is (was) a way of life. Here, to use the words of C. Wright Mills, we confuse biography and history: we wax sentimental over individual farmers rather than considering the goal of adequate caloric intake for the people of the world. Or we support agriculture because it is unthinkable for a nation to be vulnerable to unreliable external circumstances. It does bear mentioning that large farmers do predominate in most of the non-Mediterranean countries of the EC, which certainly helps us understand a phenomenon like the CAP. We have learned only one of David Ricardo's two arguments for free trade; we have not paid attention to that part of his reasoning which focussed on free trade as a necessary antidote to relentlessly mounting agricultural rents.
What holds for agriculture, now also holds for industry, where, on balance, jobs are disappearing daily. Employment in industry fell by 6.4 million in Europe-12 from 1977 to 1985. To the extent that this occurs through "migration" of industry, losses are localized. But increasingly job losses result from product design changes, improved production processes, and resort to robotics. The national response to job loss in industry is to offer various incentives to firms, notably tax breaks, subsidies and/or protection from foreign competition. Rather than harnessing the productive potential of technology to make the world work for 100 percent of humanity there is an insistence on maintaining national industries operating at output levels that assure high unit costs.
Again the focus is on biography, not history: new jobs are (for now) being created in the everywhere burgeoning service sector, which includes the even faster growing information-based activities. That which is critical is not necessarily jobs, but rather the generation of wealth and adequate levels of taxation of the activities that do so. Yet EC regional development policy continues to be tied to job creation as the vehicle for generating disparity-reducing growth. Even so, regional programs absorbed only 6.2 percent of the rather limited EC budgetary expenditures in 1985, while social programs received 5.3 percent. The changing pressures on national actions and alterations in patterns of work create an urgent need for a reconsideration of the work-income link and of the nature of national sovereignty and for a consideration of formalizing international income transfers.
If a long lead time is necessary for us to accept a major organizational departure, then it is certainly not too early to begin speaking in earnest about international income redistribution. A single fiscal authority would not be necessary, but some central redistributive mechanism would be. Differing fiscal regimes would in all likelihood persist, as they do in federal states at present. This is perfectly consistent with the writings on fiscal federalism, a concept which in the EC jargon has been rendered as the principle of sudsidiarity, i.e., functions should reside at the lowest level at which they can be efficiently performed.
Perhaps the search for exchange rate stability prior to the establishment of interregional and/or international transfer payments involves putting the cart before the horse. Perhaps once compensatory schemes are in place to deal with the already prevalent fallout of changes in world economic structure, the way would be paved for steps toward a world currency.
In the quest for the unification of the internal markets for goods, services, and financial flows, the EC and the EMS have at best paid only lip service to redistribution. Indeed to a certain extent Community policy has operated in a regressive manner. Redistribution as such has been near the bottom of the agenda. Moreover, even if it had been a priority area, the size of the EC budget relative to national ones was sufficiently small to have made such assistance as might have been provided of little moment, except to farmers.
The 1987 Padoa-Schioppa report, was quite emphatic in its call for action by the EC on income redistribution:
Overall, it is the Group's judgement that the Community's presentAn impediment to redistribution within the Community, as elsewhere, is the sense of the resourceful having to prop up the profligate, without requiring the less prosperous to look to their own failings. This has always been at the heart of objections to welfare policies. Economists have lent support to this kind of argument by their single-minded espousal of market solutions, with an ostrich-like disregard for the basic fact that the market functions within a framework of law and is, in effect, a public good.
initiatives in the allocation branch do indeed need to be balanced
by policy developments in the stabilization and distribution branches.
. . . Indeed, if no action is taken in these areas, even the acquis
in other fields would be at stake.
Redistribution should be
as the reverse side of the free market coin. We should not speak of one
without invoking the other.
Conclusion: Closing the Casino
The internationalization of capital markets is not per se undesirable, indeed quite the contrary. What is undesirable is the dominance of financial flows motivated purely by the quest for speculative gains and which reach levels that are antithetical to the growth and welfare objectives of jurisdictions. The exchange rate and the state of the balance of payments are the "privileged problems" in Albert Hirschman's words, other problems tend to be put on the back burners unless they can be seen as offering assistance with the resolution of these privileged ones. Are we not at a point in which the subservience of other priorities to exchange rate levels and the influence of interest rates on exchange rates represents an intolerable situation? Attention is focussed on the exchange rate if it is a flexible one or on the balance of payments and export surpluses if the rate is a fixed one. To shut down the casino requires initially the fixing of exchange rates as a first step on the way to eliminating separate currencies. (The EMS is a partial step in this direction, as rate fixing is only internal to the group.) Fixed rates will, of course, not eliminate all flows of speculative short term funds, but would tend to limit them to occasions when rates appear to be misaligned. With a single currency, speculative flows can be expected to diminish further.
My argument throughout this paper is that an open trading system requires the addition of compensatory measures if it is to be maintained and, moreover, compensatory measures are a prerequisite for successfully moving on to closer economic integration. If "internationally defined conditions" are judged by many to produce intolerable outcomes, then steps should be taken to redefine those conditions. To only slightly overstate the case: if exchange rates no longer serve a useful role in guiding resource allocation, then it is proper to ask, "Who needs them?" Thorstein Veblen, among others, made the distinction between making goods and making money and pointed to the circumstances when incentives could be such as to render making money the only reasonable option. Redefining conditions to unify currencies and to establish formalized international redistributive mechanisms is important for tipping the balance back in favor of making goods and services and attending to human well-being. Such a change would free jurisdictions from the need for obsessive preoccupation with the balance of payments.
The vision that looks to a world of largely self-sufficient regional blocs may have been a reasonable scenario to those considering these matters in the 1940s. This may have seemed the proper path to Karl Polanyi in 1945 or a likely one to Aldous Huxley in his Brave New World. Since the advent of the world-transforming communications revolution (which is still in its infancy) there can only be one unified globe. The spatial consequences of the technical changes in the twentieth century have been revolutionary in the fullest sense of the world. The car and the plane have made every corner of the earth accessible to an important part of the world's population. Today's electronic marvels provide an instantaneous link available in principle to every home and workplace -- in fact, to virtually every location. In this world, sovereignty must be rethought, for it no longer is what most leaders still imagine it to be.
Dermot McAleese and A. Mathews believe that sovereignty in the guise of the pretense (my phrase, not theirs) of having greater discretionary power is more likely to be surrendered if the result is increased ability to influence the policies of others which are having international spillover effects. If Community monetary policy is effectively made in Bonn, then, it follows that Rome may well be disposed to abandon the pretence of sovereignty on money questions for a voice in the determination of the monetary policies that really matter. Well-functioning European and global economies require precisely the perception that the well-being of one depends on the welfare of all and that one's own welfare is best served by an effective voice rather than by the flexing of muscles to dubious effect. If the belief that union contributes to national aspirations becomes widespread, barriers will fall more swiftly.
of nations may be better preserved by recognizing which of the tools of
sovereignty are amenable to local control and which have long since
from effective control. A viable renewed social compact may only be
if governments appreciate what is realistic and what is not. And
the way ahead to European and global integration appears to lie though
the exercise of politics by interests who see their needs served best
different levels: today's issue may require EC level action;
local or regional; and on subsequent occasions, national or even
It is not the logic of the functionalist that wins the day for
organization, but rather the ebb and flow of a multitude of diverse
for needs and wants which range from the narrowly self-serving to the