Yves here. The designers of the European Union recognized that the structure that they had created was incomplete and critical issues remained to be resolved, but they were convinced that the high cost of two world wars meant that when crises inevitably occurred, they would be an impetus for greater integration. But as we have seen in the post-financial meltdown period, fissures in the European Union, and particularly in the Eurozone have widened.
As a result, Ashoka Mody questions the conventional wisdom that more integration, such as more fiscal transfers, will resolve these disputes. While he does not tease out his reasoning fully in this short piece, he seems to be acknowledging that greater economic integration will increase stresses on other fronts. Recall Dani Rodrik’s policy trilemma, which he set forth in 2007, and I’ve invoked in the past when discussing the difficulties facing Greece and the EU:
I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.
To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs.
So what do we do?
One option is to go for global federalism, where we align the scope of (democratic) politics with the scope of global markets. Realistically, though, this is something that cannot be done at a global scale. It is pretty difficult to achieve even among a relatively like-minded and similar countries, as the experience of the EU demonstrates.
Another option is maintain the nation state, but to make it responsive only to the needs of the international economy. This would be a state that would pursue global economic integration at the expense of other domestic objectives. The nineteenth century gold standard provides a historical example of this kind of a state. The collapse of the Argentine convertibility experiment of the 1990s provides a contemporary illustration of its inherent incompatibility with democracy.
Finally, we can downgrade our ambitions with respect to how much international economic integration we can (or should) achieve. So we go for a limited version of globalization, which is what the post-war Bretton Woods regime was about (with its capital controls and limited trade liberalization). It has unfortunately become a victim of its own success. We have forgotten the compromise embedded in that system, and which was the source of its success.
So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man’s land.
The issue facing Europe is that many states, most critically Germany, do not want to cede national sovereignity to more powerful federal structures. In many ways, smaller states like Ireland, Greece, and Cyprus, show Germany what its future would be like if it effectively had circumscribed rights as they do. The Eurozone’s current protracted negotiations with Greece in no small measure result from the reluctance of unelected officials, particularly those at the ECB, from appearing to trump democratic processes, even though the consistent message from the creditors has been that Greece must figure out how to honor pretty much all of its existing structural reform commitments, popular will be damned.
Thus while Germany, plus the need to preserve appearances that democratic process still mean something are big constraints on further economic integration, it’s not clear how the Europeans find a more stable compromise.
By Ashoka Mody, Charles and Marie Robertson Visiting Professor in International Economic Policy at the Woodrow Wilson School, Princeton University. Originally published at Bruegel and Handelsblatt.
Sixty-five years ago on May 9, French Foreign Minister Robert Schuman read a Declaration, triggering the birth of the European Union. Still in the shadow of World War II, Europeans began to create, historian Tony Judt writes, “a new and stable system of inter-state relations.” Put simply, Europeans learned
once again to work with and talk to each other. It was a magnificent achievement.
May 10 is the fifth anniversary of the bailout of Greece. Set almost exactly 60 years apart from the Schuman Declaration, the events triggered by the Greek bailout have unleashed a daunting challenge to European cooperation and harmony. Above all, Europeans have lost the ability to talk to each other.
For some, this is not a European problem—it is a Greek problem. Greece, so this view goes, is sui generis, and once it is brought back into the fold, the systems of cooperation will return to normal functioning.
That is a mistaken view. The Greek problem will not go away. But the bigger problem is that the euro placed European integration into an unmanageable overdrive.
The policy package proposed by Greece’s creditors, requires further austerity and reduction of wages and social benefits. Those measures will help down the road, but the deflationary contraction will work faster. Debt will become harder to repay. A debt-deflation spiral could overwhelm Greece quickly.
German Chancellor Angela Merkel has blamed her predecessor Gerhard Schroeder for allowing Greece to enter the Eurozone. Indeed, Greece should never have been in the Eurozone. But the real problem lay in the construction of the Eurozone itself.
Schuman had said: “Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.” That philosophy was admirably embodied in the Treaty of Rome in 1957, when European nations opened their borders to each other. Numerous commercial relationships sprouted among the European businesses and citizens. Empathy for the trading partners generated a sense of European identity. Citizens’ trust in European institutions followed the share of intra-European trade. The Treaty of Rome succeeded because it aligned national interests—nations and their citizens all gained through enhanced commerce.
With the euro, national interests collided. A common monetary policy is more favorable for some than for others. And crucially, the euro created the ever- present risk that one nation would have to pay the bills for another. The Treaty of Rome created a “level playing field,” in which nations participated as
equals. In the euro area, some nations are inevitably “more equal than others.” Greece must play by the rules of its creditors—even when these are evidently dysfunctional. Proponents insist that this will discourage others from deviating, and fidelity to the rules will ensure a stable Eurozone. But that
equilibrium will, at best, be fragile. The problems will worsen in Greece and, will inevitably, arise elsewhere.
The economic and political costs of breaking the Eurozone are so horrendous that the imperfect monetary union will be held together. Instead, the cost of the ill-judged rush to the euro and mismanagement of Greece will eventually be a substantial forgiveness of Greek debt.
But this is a good moment to step back and loosen European ties. As Schuman said, “Europe will not be built according to one plan.” The task is to create a de facto solidarity—not to force a fragile embrace. A new architecture should scale back the corrosive power relationships of centralized economic
surveillance. Let nations manage their affairs according to their priorities. And put on notice private creditors that they will bear losses for reckless lending. The European fabric—held together by commercial ties—is fraying as European businesses seek faster growing markets elsewhere. That fabric
could tear if political discord and economic woes persist. History and Schuman will be watching.