Saturday, 6 December 2003

Future Development Of Europe


First a note on future telling. The future is formed by future knowledge. Future knowledge cannot be known in advance. Nevertheless some degree of prediction on political developments is possible. Even if the productive forces will be totally different in the future because of new knowledge, the political tensions will be the same. That is so because politics is based on relations, not on absolutes. A large part of politics is determined by three basic relations: The relation between rich and poor; the relation between management and ordinary workers and the relation between strong and weak employees. These relations are almost universal. The basic features of politics do not change with technological change and economical growth. ‘Poverty’ is historically relative; unemployment is always shifted toward higher levels of labour conditions. There will always be a factual divide between rich and poor, no matter how rich the poor are. There will always be an establishment interested in stable power relations. There will always be a clash of interests between employees who can be replaced without losses and employees that are crucial for profitable activities.

That is why we can learn from the past. To be able to predict something about the development of the European monetary union, we must look at what happened with the monetary union of Germany in the 19th century. This history shows much parallels with the European unification.

First there was the German Zollverein founded in 1848 during the economic and political crises all over Europe. This customs union was a spectacular success. The industrial revolution sprang all over Germany. Economically the different German countries converged. Only the customs union did that. There was no monetary union. There was not even a union of measures and weights. Still the Germans thought they needed one state and one currency. After the implementation of these ‘requirements’ Germany was not such a success anymore.

Also the British monetary union is revealing. Scotland did not need monetary union to be in the forefront of the industrial revolution. Up till the late 18th century the British laws had no effect in Scotland and the Scots had their own currencies. Yet, precisely during this period Scotland was the most advanced country in the world. In a previous lecture on Europe I held in October 1996 in Brussels, I predicted that the euro would be a weak currency and that the monetary restraint would be loosened once the monetary union would be a fact. These predictions came true. The euro lost 25% of its value in terms of dollars and pounds and no European leader talks about the stability pact anymore. I must confess that I could not really have known that for sure. I was lucky in my prediction. At that time, Europe was at a crossroad. Then it was still possible that the monetary unification would collapse. Today we are past this point of no return. Now Europe is faced with the same choices but with fewer options. I am asked to talk about the future again. And again I will sketch a scenario with a weak euro and with budgetary discipline of the member states going from bad to worse. This time I can do this with more certainty because the monetary union is a fact and can hardly be abolished. The monetary union drives the EU toward further political integration. It sets in motion forces that are difficult to control. Probably we will end up with the United States of Europe, a real federal state with a central fiscal, social, educational, trade and foreign policy. In this lecture I will explain why this will probably happen, why it is better to stop this development and why it is so difficult to stop this development.

Monetary union of sovereign member states sets in motion inflationary policies

There have been many efforts to converge the economies of the member states.

The reasons are manifold:

1. There is a broad political consensus that the business cycle requires the emission bank to change interest rates.

2. If lending is heavier than saving, than the interest rates have to rise.

3. If a region is economically depressed, there is a broad consensus that it should lower wages. Since many western-European countries have very rigid industrial relations, wages can only be lowered in a linear way through devaluation of the currency.

In any case these have been the traditional measures to cope with macroeconomic fluctuations. Europe does not have immediate alternatives. Yet these means are taken away because of the European Monetary Union.

It is very unlikely that a country will accept higher interest rates because other member states borrow too much. The problem is solved with inflating the currency. In the long run nobody feels responsible anymore for the stability of the currency. To avert runaway inflation, a creeping inflation will be combined with transfers of federal tax money to depressed regions. These transfers suffer from the dilemma of any form of development aid. Either the authority that furnishes the aid takes over economical decision making. This amounts to central planning, a system that was not very successful in the past. Or this authority does not meddle with local affairs and the European taxpayer does not have any control over what happens with the aid. The result is that the local authorities buy a lot of Mercedes cars and build marble office- and university palaces with the funds.

Creeping inflation is more dangerous than runaway inflation. The latter reverses the chain of causes and effects. When prices rise very fast, the emission bank has to hurry to print enough money to keep up with inflation. In stead of monetary expansion causing inflation, it is inflation that creates shortage of money. This process cannot last very long and will end soon with monetary reform and a fresh start. Creeping inflation on the other hand can be maintained indefinitely and it causes families and businesses to make the wrong buying decisions. Creeping inflation is nice for vested interests on the supply side of the economy (industrialists, workers, banks, government) because and as long as people do not anticipate fully the price rises that will come. This causes bad investment and lower quality of life.

What are the alternatives?

1. Very strict federal controls over national budgets. But this would mean a further encroachment on national sovereignty. If some states are unable to balance their budget then the European Commission would have to step in and take over the departments that are shedding too much money. For some states it would mean the end of their sovereignty over their own schooling system. Some states only recently have acquired such autonomy. Now they would have to give it up again. This is clearly not intended in the consecutive treaties that form the European Union and that were ratified in the national parliaments. It would not be democratic to let monetary affairs dictate a further political unification of the European member states.

2. The best possible solution to these tensions would be of course to return to national currencies. But that is probably too late now.

3. Another solution would be to have a very strict monetary policy combined with the principle that the member states simply do not have the right to borrow money at all. Depressed regions could not be bailed out by inflation, nor by budget deficits. I think this would be a good thing. So in principle the monetary union could work. (The dollar union is to some degree such a system. There are very strict rules for the states and local governments to borrow money. This is combined with more centralism.) But why will this last solution not be chosen?

European Conservatism In General

To answer this question we have to learn something of the character of the Europeans or at least of some of the Europeans. Germans, Belgians, French, Dutch, Danes, Northern-Italians and Austrians think of themselves that they are √úbermenschen. They are wealthy because they are hard working, hard saving, tidy and well organised. In itself this belief is not untrue. But the problem is that when there is a financial and economical crisis, √úbermenschen do not blame themselves, but tend to blame international capitalism. How can they be to blame if they work hard, save hard and are well-organized and disciplined? Europeans simply do not accept to undergo economic downturns.

The same story we see unfolding today in Japan. In Japan we see very clearly that the problem is not the quantity of investment, but the quality. Japan suffers from bad management.

There is always the danger that the captains of industry, the bank executives and the bureaucrats form an elite. They come from the same schools and they rather protect each other than control each other. Today they are called the Masters in Business and Administration, in ancient China they were called the mandarins. They prosper under the ideology that administration and management are very important for society to prosper. Today this ideology is reinforced with the high regard we have for science and scientific planning. Although we seem to agree that central planning did not work and that we need a market economy, economists of today think the market should be scientifically planned.

Not only the European Commission, but every modern state nowadays has its bureau of competition planning. ‘Planning competition’ sounds to me like an internal contradiction, but not so for the economists of today. They think they have a meaningful concept of optimal production and they can prove mathematically that some forms of imperfect competition results in suboptimal production. Since monopolists hurt the scientifically proven optimal outcome for society, they must be a kind of criminals. That is why the establishment thinks monopolies should be broken by judges instead of by brilliant innovators. The neoclassical economists of course have forgotten that the model of perfect competition is only an educational device to explain to children how competition can lower prices. In order to explain something to children you have to freeze other important factors such as costs and innovation. The market is not a device only to raise production and lower prices, but also to lower costs, create new needs and solve problems that could not be solved before.

These pseudo scientists effectively took over decision power in Europe. The number of science and management jobs in Europe more than doubled between 1960 and 1994. In that year they already formed 25% of the total workforce.

Managers in office are in general a conservative force. Why should they allow laymen to judge them? The consumer is a layman. What does the consumer know what is good for him? If more consumers postpone the purchase of a new car, the manager of the car factory does not want to know why this is so. She only wants the consumers to come back. She wants cheaper money. Little does she know that more consumers want better health insurance first, or a private nurse for their ailing grandparents, rather than a new car. Little does she care that inflation will create the illusion for the consumer that he can have both. Because of inflation, the consumer who bought the car, will be confronted only later with prohibiting health care prices. But then it will be too late. The same holds for the investor herself. Because of inflation she will overestimate the purchasing power of the potential consumer and she will invest too much. The problem then reoccurs with a vengeance. Suddenly nobody wants to buy a new car anymore because people hardly come by to pay health care. More inflation is needed. This vicious circle progressively lowers the standard of life. But why should a manager care? A manager has no more stomach for reorganising, cuts, sacking workers than the workers themselves. Everybody on the supply side of the market wants no market.

The Drive Toward A Corporatist Europe

In a monetary union with sovereign states the effects of budgetary free rider behaviour of some states are ‘federalized’. A strong currency and stable prices are a ‘public good’ for all the member states. But when some member states borrow too much, the price (higher interest rates or a weak currency) is spread over the whole union. Those who cause the problem do not have to pay the full price.

The European Council agreed in Amsterdam 1997 on a monetary stability pact. The member states must be open about their budget. The European Commission each year defines budgetary targets for each country with the intention that the budget deficits or surpluses of the different member states converge. Otherwise a country that has a balanced budget will still have to pay high interest rates because some other member states borrow too much money. This would create political tensions. Either the good member states have to slow down their economy because of others. This would undermine the legitimacy of the union and the loyalty of the European citizens as such. Or these tensions would be smoothed out by monetary expansion. Then the good countries would not pay higher interest rates, but they would have a weak currency and inflation despite their sound financial policies.

The right of the member-states to have their own deficits creates political tensions within a monetary union. At first sight, the tax-payer does not have to worry about the deficits of another member-state, because it are the tax-payers of that member-state who will have to carry the burden of the interest payments on the public debt. It is true that the German citizen is not affected by Belgian or Walloon state-debt in his capacity of a tax-payer.

But a German citizen is not only a tax-payer, he is also an investor, a wage-earner and a account-holder. As such he is affected by the deficits made by another member-state because those deficits will be made in his own currency. The German investor, borrower and wage-earner will not accept recession because interest-rates rise as a result of the rising demand for credit by the member-states unwilling to cut their deficits. The only possible political compromise is then to let the money-supply increase. But this loose monetary policy is exactly what some of the criteria of Maastricht were meant to prevent.

Monetary expansion is of course a concealed form of taxation which creates much more so than ordinary taxes distortions in the entire economy because it creates within the private households an illusion of wealth. This illusion causes people to buy more than they can afford. More often than not they will spend money which will subsequently lack to finance more urgent needs. In that way society harbours primary frustrations despite its apparent affluence. An already classical example of misoriented individual planning is the person who lived in luxury but when she retires is taken aback by the prohibiting cost of care for the elderly. This illusion of wealth may bail out industries with overcapacity, but only so at the expense of industries with undercapacity.

Since all processes of production overlap (in the process from bare nature to finished product all products compete several times for the same resources) there can only be more fully staffed service-flats for the elderly when less value is consumed in the production of cars. “Overcapacity” really means that the industry or factory in question cannot raise prices enough so as to be able to pay the costs. This industry could sell its stocks and work at capacity levels if it would lower its prices. If it cannot lower wages nor find cheaper sub-contractors, this means that the industry is not adapted to the real priorities on the market. In stead of attracting more labour and capital, it should lay-off resources and thus signal society that resources and people, especially young people, should look for employment elsewhere. If fresh money is poured into the economy (inflationary policy), this adaptation will be postponed because prices never adapt perfectly. Some prices will rise too fast, others too slow. Moreover, as soon as prices adapt to the swollen money-supply, the overcapacity will reoccur. Bad investment will cause wages and supplier’s prices to rise faster (or to drop slower) than the prices the customers are willing to pay. Average price-level trends in themselves never cause business cycles. The real cause is that the industries with overcapacity are bailed out (either directly or through inflationary policies) and do not adapt, but instead keep on attracting resources which could have generated more value somewhere else. When prices adapt themselves, the overcapacity will show and will force the industry to shrink. When not, shortages will occur and society will not be able to reproduce its current level of wealth.

A recession is caused by bad investment or miscalculations. Miscalculations are inevitable. If there is a coincidence of many miscalculations there will be an economic downturn. This means that too many producers are confronted with prices of the suppliers that rise faster (or drop slower) than the prices they can get for their products. Inflation will bail them out temporarily on condition that the prices do not adapt in time to the increased money supply.

But this means that the same problem as before will return with a vengeance. The reorganisations are only postponed. This adds to the problem. If there are miscalculations, adaptations are necessary. If we agree that an economy must adapt to changing circumstances, then there is no defence for inflationary policies. The reason why we need a market economy is not to lower prices and raise production. The reason is that man does not accept natural selection. The reason for a market economy is that the economy must adapt, not man. As long this is not clearly stated, the people on the supply side of the market will invariably call for measures against competition. In that case we will always end up with an old-European political coalition between the management elite, the hard working and hard saving workers and the spoiled youth who thinks wealth is a birth right. I always wonder why it is so difficult to understand fascism. Fascism is nothing else but this coalition of conservatives. The hard working, hard saving workers do not accept an economic downturn and want steady jobs. The elite wants to stay in power. The youth wants everything immediately for free. When these three groups find each other there will be an anti-capitalist coalition from the political right.

A small country cannot afford to be protectionist. The European economic space gives the illusion that it can. And at least for a while it can. A vast European economic expanse can withdraw itself from international trade. At first this will seem as if business cycles were not necessary after all. It will fuel the belief that capitalism is not necessary. Only in the long term the relative decline and the real drop in the standard of living will be noticed.

Until now the architects of the Monetary Union assure us that the member-states will, also after they entered the monetary union, comply with strict limits on their deficits. But in practice, the political strength of the corporatists by far outweighs the political strength of the modernisers. This is even true for every member-state separately, but up till know there was still this competition between the European trade-partners which made it possible to compare the results of different national policies and which meant a check on what the politicians were inclined to do. In a politically integrated Europe, this check will disappear and we will get a convergence to the lowest common denominator. If for instance the Belgian government needs alternative funds to finance its social insurance and wants to introduce a tax on carbondioxide-emissions or some other tax on so-called “pollution”, then the other countries will follow suit. Today this is not possible, because Belgian industry would get an additional competitive disadvantage when such a tax would be introduced in Belgium alone. It is clear that the Belgian government today hopes that the IGC will decide to abandon the unanimity-rule for decisions on tax-harmonisation in Europe.

This is “deepening” the EU in practice. It is needed to be able to increase taxes without one country having to endure competitive blows by its major trading partners. Of course this convergence to the lowest common denominator of more taxes and deficits will diminish the competitive strength of Europe as a whole in the global economy. But this only illustrates that politicians often create the circumstances where it becomes difficult to stop further steps in an undesirable direction, in this case towards protectionism. Political integration of Europe will spontaneously create a European “Grossraumwirtschaft”, the nazi-ideal of a heavily politicised European protectionist block against the rest of the world. The majority in Europe does not really wants this to happen, but it will happen, because the same majority is not prepared to accept massive unemployment when entire European industries are defeated in the global competition. So the drive toward a European protective block will be a spontaneous process. The deliberate construction of a monetary union will drive the European leaders to take steps nobody wanted. The constructivists are surely wrong when they think that the EU will further develop according to some blueprint. But evolutionist could make the opposite mistake in thinking that which evolves spontaneously, will be desirable.

The monetary union could thus cause a drive towards a European state which totally abolishes the sovereignty of its member-states. Although this end-result is not likely in the short run, it may be the outcome of a long and painful process of experiencing the drawbacks of monetary union. It is simply impossible to allow member states to abuse their autonomy at the expense of the European taxpayer and Euro-account-holders indefinitely. If Europe is not ready to choose between permanent recession because of sky-rocketing interest-rates on the one hand and letting its currency become some kind of a totally unreliable and inconvertible rouble on the other hand, then it will have to interfere in the policies of the different European governments.

In that case a monetary union would have more chances of survival. But it would still lack the mobility of labour that we see in the United States. And even the Dollar-union creates tensions. American families are said to move house more readily than Europeans. America is not hindered by language-barriers. But even in the USA there are depressed regions next to booming regions. The first need to produce more and consume less. The booming regions on the contrary need a strong dollar in order to use their surplusses – not to increase exports – but to innovate. Otherwise they will keep on exporting products at the expense of investments in new activities with higher added value. Strong economies should have high purchasing power abroad such that they are complied to use their strength to modernise in stead of maintaining their traditional export of products which could be imported cheaply.

One theoretical possibility would be to deepen the EU radically. The European state would then supplant the other states. Only a European state that completely abolishes sovereignty of its member-states can stop deficit spending by financially unaccountable governments. Even education could not be left to the discretion of the member-states. When the European majority decides to make cuts in education, then the Walloons and the Greeks and the French would not only have to follow suit, they would simply have to implement orders from the European state. In the Belgian federal state for instance the Walloons and Flemish would have to give up again their only recently acquired autonomy in education. Wallony already creates its own state-debt because it has not enough revenues to finance its own educational system.

Another possibility is that corporatist Europe wins the political debate and that everybody is satisfied with stagnation. Because of the political redistribution of wealth, the regions which lag behind get addicted to European tax-funding, and in the strong regions the people begin to loose interest in modernisation because the heavy tax burden excludes that personal gains can be made by outperforming the competition. This stagnation can last for a relatively long period of time. Europe has had no war and destruction for over fifty years, there are many assets left to the new generations who do not have to work hard. However, an economy which does not react to new opportunities, is also an economy that cannot react to new problems. When for instance more health care and day care for the elderly is required because of an ageing population, resources need to be shifted from other industries to the personal care industry. Because the other industries did not save resources because they were protected against competition, their output has to be reduced. In other words, a protectionist economy can meet new problems only by reducing the standard of living. So there are limits to stagnation. Unless the Europeans accept permanent decline, they will lead the kind of revolution which ended the Soviet-Union, followed by a long and painful depression.

In theory it could still go the other way. The other way is widening Europe: additional member states, the more the better, no majority rule. This would mean increasing pressure on the European Commission to withdraw from agriculture. When for instance the Poles become members, their agriculture would get access to an enormous market and it would grow enormously. There are no physical restraints to the expansion and the productivity rise in Polish agriculture. But under the current rules the numerous Polish farmers and the emerging big industrial farms would devour the entire European budget. European agricultural policy would simply collapse. At the same time Polish membership will also exclude any socialist dreams of a European convergence of social norms. There is no way that Poland can have the same social insurance and minimum wages as France or Germany. Germany did not even process the integration of the former Eastern provinces yet.

If Europe proceeds with the planned integration of Poland, Czechia, Hungary and Slovenia, then it will probably change the rules of decision making, possibly in combination with further integration with different gears or speeds: with a core union and a periphery.

More matters of policy will be decided by qualified majority rule. The official reason is that eventually the union will not be able to take any decision at all when the number of members with a veto increases. But it would allow the current member states also to avoid the aggressive competition from the low wage new members. Europeans are very afraid of low wage competition from abroad. I will later in my speech explain why this is so. It is rather surprising that there is not yet more unrest about the prospective expansion of Europe. I cannot explain why the dominant labour unions of the current member states and the socialist parties did not yet protest against the plans to let the new democracies into their federal union. As in 1996 I am under the impression again that there is a hidden agenda. Back then I did not understand why many social-democrat governments agreed to the budgetary discipline of the Maastricht criteria. For many years these governments had to follow a policy of budgetary restraint with a macroeconomic equilibrium on a very low level. I do not know if you remember that, but the first half of the nineties showed low growth, high unemployment and continuous cuts in spending in social insurance and public assistance. So I concluded in 1996 that these governments had a hidden agenda: loosen the budgetary and monetary controls immediately after the monetary union was save. This of course begs the question why the political elite wanted the monetary union anyway.

The official reason is that monetary union promotes competition and facilitates trade within the customs union. This is a beautiful prospect. But we must be realistic. There is no interest group interested in more competition. Not the industrialists, not the workers, not the banks and not the bureaucrats want more competition. Political leaders have to go against vested and organised interests if they want to promote free trade. There is neither much public support for the expansion of the free trade zone. Now the tragedy is that even if Europe has progressive leaders who really want to go through with widening Europe, this process will most likely turn out totally different because of the recurrent features of European vested interests.

Martin De Vlieghere