Prof. Dr. Christian Watrin

Institute for Economic Policy University of Cologne, Germany

Will the European Union Survive the 21st Century?

Paper Presented to The Philadelphia Society, April 24,1999

As a rule political economists are not very good at forecasting the long-run stability of complex institutions. Otherwise, they should have been able to predict the collapse of the Soviet empire - ending Socialism in its heartland and in satellite countries - in time. In explaining this oversight two arguments could be mentioned: First, the Hayekian one that the future is not only unknown, but to a certain degree unknowable, and second, that our knowledge about the functioning of institutions and, especially, the conditions under which a break-down can occur, is still rather limited. Taking both views into account, an attempt to answer the question whether the EU can survive the 21~t century is highly speculative in nature. I belong to the skeptics. The institutional setting of the EU today is loaded with conflict potential. The Union needs far-reaching reforms to solve the problems facing it. The Intergovernmental Conference leading to the Treaty of Amsterdam left the most important problems unsolved. In addition, the possibilities of getting into conflicts have been aggravated recently by the introduction of the Euro in eleven of the fifteen member countries.

The diagnosis, which I shall present, is shared by many observers. It raises the question, whether paths out of this dilemma exist. Many proposals have been put forward put forward in the ongoing discussions. Personally I do not see where the political initiatives should come from to turn the wheel in a direction agreeable to classical liberals. I confess that public choice theory contributes to my sinister thoughts, but admit that more promising scenarios might also be possible.

In my following remarks I will point out four problems possibly causing serious struggles for the EU, (1) the dissent among federalists and non-federalists over the ultimate aims of European integration, (2) the conflicts which might be caused by the introduction of majority voting, (3) the inconsistencies in the economic framework and (4) the tensions which the single European currency could create.

I. The Unknown Goal of European Integration or Where is European Integration Heading?

The unsettled question in the great debates on European Integration is the ultimate goal of the entire integration process. Winston Churchill in his famous speech in Zurich (1946) called for the provision of a structure, in which Europeans could live in peace, in safety and in freedom. He used the often quoted phrase: "We must build a kind of United States of Europe" (Lipgens and Loth, 1988, 662) and pleaded for minimal barriers between European nations, for unrestricted travel and for common armed forces to prevent the preparation of future wars (Robertson, 1966, 4). He also pledged that the defeated Germany on the one hand, and liberated France, on the other, should take the lead (Issing, 1996, 12) in ensuring a brighter future in Europe.

During the first decade after the Second World War (1946-54) numerous political initiatives were launched. Some aimed at building a "larger Europe" (for instance, the OEC, the West European Union and the European Council ), others were in favor of the establishment of a "Little Europe" including only France, Italy, the Benelux countries and West Germany. But neither a political union, nor a common defense union were agreed upon. The Benelux states rejected the former and the French parliament voted down the latter proposal (1954).

Since then an endless discussion has been going on, as to whether the primary, aim of European integration should be the establishment of an economic union with free trade and unrestricted migration of the factors of production plus a single currency or whether the ultimate goal should be the foundation of a common state, a supranational federation. This topics can be discussed under the heading of the "finality of European integration" (or where is European integration heading to~. For the first aim the foundation of an economic union within an international or intergovernmental contract (from which a member state could withdraw) would be sufficient, whereas for the second aim, the establishment of a supranational union with irrevocable agreement would be necessary. According to the preamble of the Maastricht-Treaty the Community is striving toward an "ever closer union of the peoples of Europe". But the treaty itself abstains from any further comments, whether a confederation of states, a federal state or a political entity sui generis - in other words: a political structure somewhere in between - is meant.

In a speech given at the University of Oxford under the ambitious topic, ,,Europe's Future in the Twenty-first Century", the German Minister of Foreign Affairs, Klaus Kinkel, said, ,, We do not want the United States of Europe according to the North-American model. We do not want a European superstate. The European Union will not and must not question the special character of each member state. Europe gains it powers out of the great diversities of its cultures, its languages and its traditions. This rich potential must be preserved and supported."

A loose interpretation of this quote could be that Europe - a continent, not a country - needs (for historic reasons) a new architecture, a "third way" between the nation-state and a centralized superstate. But what is the criterion for assigning powers and authorities to the different levels of that body? The evaluation of practical matters would be different, when analyzed from the perspective of a political union, i.e. a federal state, as opposed to that of a confederation or an international contract with an entry and exit option. But without an explicit or implicit consensus on the ultimate aim of the political endeavors, any European integration policy is like sailing on the high seas without a compass.

II. European Decision Procedures: Unanimity or Majority Rule ?

In every union of states, wherever it is heading, the decision procedures are of crucial importance. In a union of sovereign states (i.e. a confederation) with small and large member countries, cooperation is based on the principle of unanimity. Where consensus between the representatives of the member states can be achieved, there is no reason to believe that one of the participating countries will be made worse off due to the respective policy measure taken[ Any deviation from unanimity causes risks for those outvoted, thereby leading to tensions and conflicts.

Of course, it cannot be denied that in a multi-state union like the EC the decision costs could be quite high and that they are bound to increase with the growing number of member states. This has lead the federalists to ask for a so-called double majority, in which not only the allocation of votes according to the Maastricht Treaty counts, but also the population in the respective member-states. This resembles, if I understand it correctly, the famous "concurrent majority" proposal of John C. Calhoun in the American constitutional debates. The acceptance of such a rule or the rule of a qualified majority of 7l percent - established in the Single European Act (1987) - would lead to a situation in which there are winners and losers.

The many pitfalls arising here, attract attention to the well-known recommendation of constitutional economics to draw a dividing line between fundamental rules on the one hand and statute law on the other (Buchanan, 1985), thereby confining unanimity only to the constitutional level. But such an advice might be difficult to apply in an setting like the EC, where the center of political power still rests within the nation-state and day-to-day politics tends to be highly interventionist.

The problem to be solved in this context is the discovery of rules preventing a country from slipping onto the losing track. Sometimes the rather naive view is put forward that the solidarity among Europeans will forestall such an outcome. But this would imply that conflicts of interest between member states are insignificant - a view simply not corroborated by the facts of political life in Europe2. Therefore, strict rules are necessary barring negative outcomes for participating countries in the long run. And only unanimity or a credible exit option opens the chance of favorable outcomes for all.3

This brings to mind Ludwig von Mises suggestion to abstain from the majority, principle in multi-nation states as long as the parties in the respective parliaments are made up of groups organized by nationalities as opposed to political profiles. In his review of the collapse of the Austrian-Hungarian Empire after the First World War, Mises insists that even under democratic rules national minorities will not profit from majority voting, as long as the political process is dominated by cleavages among the different peoples (Mises, 1919). A future European Union with eventually a total of 28 member states4 in a decade or two would - under the assumption that present European law remains unchanged - increase the number of official languages from 1 l today to 23, the number of seats in the European Parliament (EP) from 626 to 967 and the number of Commissioners from 20 to 355. The largest country among the potential newcomers (Turkey) would receive 87 parliamentary seats, smaller ones (Cyprus, Slovenia) would have to be content with only six mandates, less than one percent of the total. It's a widely held view that such a political structure would develop into an administrative infarct. But what is an acceptable alternative?

Comparing the unanimity and the majority rules, the conclusion can be drawn that the unanimity principle is to be preferable. National preferences - determined by whomever in the political process - differ. Therefore, outvoting can easily create conflicts of interest with sharp political reactions diminishing political loyalty to the Union, which badly needs a needs a boost from its position of low popularity.

The federalists claim that the price of failure to introduce majority voting would be that, in the end, the process of economic and political integration might come to a frustrating halt. But they do not take into account, that a forced integration policy not backed by widespread agreement of the citizens of the European nations could bring about the opposite of what the EU aims at, in other words the strengthening of nationalistic tendencies.

III. The Economic Order of the European Community: Inconsistent Rules

One of the main outcomes of the long debate on economic systems in the twentieth century is that only consistent rules are able to further economic cooperation. All efforts to establish so-called mixed economies combining elements of a market order with central planning have seriously failed. This makes it necessary to review the rule system of the EC, which has changed considerably since its establishment in the form of the Treaty of Rome in 1957. The original charter could be classified as a document based on the principles of a market economy with some important, but not decisive, exceptions in those areas which were named ,,common policies". Agriculture, Transportation and Energy are the most important ones. They are the sectors where dirigistic policies abound causing serious political tensions among member states, and even with third countries.

The Rome Treaty (1957) focused on building a Common Market between the six founding members and tried to define the rules, to be observed to make such a market work. This was a very ambitious aim in the Fifties, considering the fact that all participants had a history of protectionism and bilateralism in the decades before. Not only was the removal of all sorts of tariff barriers necessary, but the free movement of factors of production also had to be reintroduced. Rules of competition, combined with the question of which state subsidies would be compatible with a Common Market and which would not, had to be agreed upon. And the basic principle of European anti-trust law, the rule of undistorted competition, had to be introduced (Art. 2 f and 85). French ideas of coordinating economic decision-making with the help of centralized directives from the state, the so-called economie concertee, or planification, were not included in the Treaty. All in all, it could be said that the principles of the market dominated at the start of the economic union.

The Maastricht Treaty (1992) has changed this in a very important aspect. Not only the number of common policies has been significantly increased, but under the heading of "industrial policy" the principle of market coordination was supplemented by opening a wide field for dirigistic policies. Written in diplomatic language, instead of clear legal diction, the Maastricht Treaty amends the older text by endowing the Community with the responsibility to ensure that industry as a whole, as well as single undertakings, should be able to enter into competition with their rivals on the global market. The reservation is made that any industrial policy has to take into account the system of open and competitive markets in the EC; however, a long list (6) of the duties of the Community follows giving nearly unrestricted access to all kinds of discretionary policies. It is obvious that the Maastricht Treaty opens, herewith, a nearly unrestricted playing field for all sorts of interest group policies and rent-seeking with never-ending quarrels over state, protective measures and other privileges to be handed out by the Community. Even though this is important, it is not the central point here. It is the simple fact that the economic constitution of the EC is based on contradictory principles: the rules of the market, on the one hand, and the dirigism of the superstate on the other (7).

IV. Monetary Union: Will it Work?

There is no other topic which was so fiercely debated in the EC countries as the introduction of the Euro which took place on January lst, 1999. The economic arguments for establishing a single currency are not very convincing. Martin Feldstein, for instance, predicted in a scathing attack on European monetary unification not only economic, but also political calamities. Others forecasted a money as stable a the German mark - a currency which has lost two-thirds of its purchasing power during its fifty years of existence. And C. Fred Bergsten recently praised the economic integration of Europe as the "most sensational instance of nations voluntarily relinquishing their sovereignty in favor of international collaboration" (Bergsten, 1999, 34).

According to the views held by those favoring a supranational state, a "United States of Europe", the Euro serves two purposes: the completion of the common market and an irrevocable step to the establishment of a political union among the member-states. But are these two aims achievable by introducing a common money?

From an economic point of view several minimum conditions must be fulfilled to make a single money a success. Prices and wages must be flexible and factors of production mobile in the whole economic space, i.e. a real internal market must exist among the participating countries. Officially, the single European market was completed in 1993. However, in fact impediments to trade (Art. 36 and 115) and also high barriers to labor migration still exist, since many member countries have introduced - with the approval of the European Court of Justice - minimum wage laws for workers having the effect of shielding the national labor markets against competition from other member states. No wonder, labor migration is extremely low in the EC. As far as real shocks are concerned, there are many signs that the EC is not fully integrated and will not be so in the near future (Tichy). Large depressed areas exist in the south of Italy and other countries of the southern periphery, in Ireland and in the North and even in my home country, Germany, especially the East. From this follows that the traditional mechanism of counterbalancing capital and labor migration plus price and wage flexibility will not work in the single market and there is little hope that this will change in the near future.

Further, there is a strange institutional discrepancy in the political structure of the EC at large. Whereas in modern economies, monetary and economic policy-making are assigned to the central state, in the Maastricht architecture only monetary policy is situated on the supranational level; all other economic policies remain under the control of the participating countries. Each member state can pursue its economic policies according to their national propensities.

Such a constitutional design is destined induce conflicts whenever the business cycles in the member countries differ. At present, the southern periphery (Spain, Portugal) and Ireland are booming, whereas the old industrial countries in the center (France and Germany) are suffering from high unemployment and low growth. The south needs a tight monetary policy to prevent inflationary developments and the center could gain from low interest rates thereby stimulating investment. But this is not the only relevant case. In addition, misled employment policies exist, which increase labor costs by mandatorily cutting the weekly working hours as in France and possibly in Germany in the near future or unsound national fiscal policies. In the later case the treaty on monetary union (the Maastricht Treaty) does not provide a bail-out obligation of the member states, on the contrary, it strictly objects to any bail-out operations. From this follows that a sovereign member country of the European Community could go bankrupt. But does that mean that the respective country would have to leave the union or would be excluded?

This and other considerations lead to the conclusion that by entering into a system of ,,irrevocably fixed exchange rates" a monetary union would sooner or later make it inevitable to take further steps in the direction of a political union by centralizing the fiscal policies of the member states. This, by the way, was the position taken by the so-called "monetarists" in the debates on the Werner Plan in the Seventies. For them a single money was the vehicle to bring about a political union of Europe.

Whether such a strategy of establishing a common state through the "backdoor" will work, should raise serious doubts. It embodies great risks and could lead to a collapse of the integration process in Europe.

To sum up, replacing the fifteen plus x European states in the long run by a federal state called the "United States of Europe" - is, at least from the point of view of a liberal economist, not a very stimulating perspective, especially when sociologists are heard, who state that in the course of European history different national identities have evolved and that no signs are evident at present that a European identity is in the making. Furthermore, historical experience shows that multi-nation states are extremely fragile. During the twentieth century not only the Austrian-Hungarian and the Ottoman empire have collapsed, but also the multinational and multilingual Soviet Union. The civil wars in Lebanon and Yugoslavia's, as well as Czechoslovakia's break-ups are the latest examples of the many problems arising in a multi-national context. This should not be misunderstood as a plea for a social order in Europe in which ever5' ethnic nation should build its own state. The libertarian ideal is the civic nation (Dahrendorf 1990), in which people of different ethnic origin live together peacefully. The United States of America is probably the only historic case, where such a society exists successfully. The European case is more complicated, not least because of the many military conflicts which have taken took place over the centuries. Perhaps it is more important for peace and harmony among European peoples that all of them establish true democracies, the rule of law and open market economies instead forming a superstate.

Starting from this perspective does not mean that the European idea should be dismissed. In the decades before the First World War Europe - at least from Madrid to St. Petersburg - was a region, where free trade and also a high degree of personal mobility existed (see the works of W. R6pke). The reconstruction of this world during the next decades would be a great success. But this makes it necessary to develop another approach to a European union than the one on which the Treaty of Maastricht has been built. Enlarging or widening the Community and not its deepening via a single money should be the first priority of the European Community.

Literature

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Bergsten, Fred, America and Europe: Clash of the Titans? In: Foreign Affairs, March/April 1999. Buchanan, James M., Europe's Constitutional Opportunity. In: Europe's Constitutional Furore.
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Footnotes:

l Of course, this argument rests on the assumption that the political representatives are perfect agents of their citizens as principals.
2 See, for instance Connolly (1995,378) and his thorough analysis of the battles inside the Exchange Rate Mechanism (ERM) on monetary policy in the first half of the nineties.
3 This could also explain why majority voting is seldom used by the Council.
4 The fifteen EU-members plus the Czech Republic, Hungary, Poland, Slovakia, Bulgaria, Romania, Slovenia, Estonia, Latvia, Lithuania, Turkey, Malta, Cyprus. All states on this list have applied for membership or, at least, they will do so in the near future.
5 See Streit and Voigt, 1995. - For comparison, the US-Congress consists solely of 535 representatives and senators.
6 On this list the following responsibilities are included: assistance in the process of structural adjustment, aid for the future development of undertakings, especially small and medium enterprises, promotion of conditions for the cooperation among businesses and the exploitation of the potential for innovation, research and development.
7 The Common Agriculture Policy (CAP) is a deterring example demonstrating where dirigistic policies might lead. The Treaty of Rome ruled in Art. 38 to 47 that European policy should (1) increase agricultural productivity, (2) ensure a fair standard of living for the agricultural community, (3) stabilize markets, (4) provide certainty of supplies and (5) ensure supplies to consumers at reasonable prices. Further, Art. 110 has to be taken into account. Here the Treaty indicates that the member states should aim to contribute to the harmonious development of world trade.
It is easy to recognize that there is, as Dennis Swan writes (1992, 233), plenty of scope for conflict. The improvement of farm incomes requires significant price increases, but this conflicts with the interests of consumers. There is no indication given as to what is a fair income level or what is a reasonable level of prices. Certainty of supplies can be read as justifying a high degree of self-sufficiency reducing the access of third countries, especially those which are not associated with the EC, to the Community's food market which in turn jeopardizes the achievement of a "harmonious development of world trade". No wonder that the CAP is nowadays looked upon as a scandal, which not only consumes one half of the yearly expenditures of the Community plus unknown funds of member states, but also threatened in the eighties the cohesion of the community.