Before and Beyond EMU: Historical Lessons and Future Prospects

Before and Beyond EMU

The launch of the euro has already had profound effects on both European economies and societies—but it is also of huge importance for the international community as a whole. This timely book, from a collection of key names in European Integration Studies, is an authoritative piece of work that is truly multi-disciplinary by nature. The focus of the collection of papers is on the background to EMU and future prospects for the EU. With varied contributions from respected academics, this book touches on many important themes, including: • • • •

Historical background and precedents The international implications of EMU Political identities and the euro The next steps after EMU

Before and Beyond EMU is a well-written, readable contribution to the debate that will continue for some time to come. It will be of great interest not only to advanced students of European Economics and Monetary Integration, but also to policy-makers and those with a general interest in the European Union. Patrick M.Crowley is an Associate Professor of Economics at Texas A&M University in Corpus Christi, Texas, USA. After getting a BSc and an MSc from the University of Bristol (UK) he went on to gain his PhD in economics from McGill University in Montreal, Canada, in 1995. He specialises in the study of economic integration, with special focus on the European Union and North American integration, and also has other research interests in international macroeconomics, Austrian economics and the history of economic thought.

Routledge Studies in the Modern World Economy 1 Interest Rates and Budget Deficits A study of the advanced economies Kanhaya L.Gupta and Bakhtiar Moazzami

11 The Legal and Moral Aspects of International Trade Freedom and Trade: Volume III Edited by Asif Qureshi, Hillel Steiner and Geraint Parry

2 World Trade after the Uruguay Round Prospects and policy options for the 12 Capital Markets and Corporate twenty-first century Governance in Japan, Germany and Edited by Harald Sander and the United States András Inotai Organizational response to market inefficiencies 3 The Flow Analysis of Labour Markets Helmut M.Dietl Edited by Ronald Schettkat 4 Inflation and Unemployment Contributions to a new macroeconomic approach Edited by Alvaro Cencini and Mauro Baranzini 5 Macroeconomic Dimensions of Public Finance Essays in honour of Vito Tanzi Edited by Mario I.Blejer and Teresa M.Ter-Minassian 6 Fiscal Policy and Economic Reforms Essays in honour of Vito Tanzi Edited by Mario I.Blejer and Teresa M.Ter-Minassian 7 Competition Policy in the Global Economy Modalities for co-operation Edited by Leonard Waverman, William S.Comanor and Akira Goto 8 Working in the Macro Economy A study of the US labor market Martin F.J.Prachowny 9 How Does Privatization Work? Edited by Anthony Bennett 10 The Economics and Politics of International Trade Freedom and Trade: Volume II Edited by Gary Cook

13 Competition and Trade Policies Coherence or conflict Edited by Einar Hope 14 Rice The primary commodity A.J.H.Latham 15 Trade, Theory and Econometrics Essays in honour of John S.Chipman Edited by James C.Moore, Raymond Riezman and James R.Melvin 16 Who benefits from Privatisation? Edited by Moazzem Hossain and Justin Malbon 17 Towards a Fair Global Labour Market Avoiding the new slave trade Ozay Mehmet, Errol Mendes and Robert Sinding 18 Models of Futures Markets Edited by Barry Goss 19 Venture Capital Investment An agency analysis of UK practice Gavin C.Reid 20 Macroeconomic Forecasting A sociological appraisal Robert Evans

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29 Technology, Trade and Growth in OECD Countries Does specialisation matter? Valentina Meliciani

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24 International Health Care Reform A legal, economic and political analysis Colleen Flood 25 Competition Policy Analysis Edited by Einar Hope

32 International Trade and National Welfare Murray C.Kemp 33 Global Trading Systems at the Crossroads A post-Seattle perspective Dilip K.Das

26 Culture and Enterprise 34 The Economics and Management of The development, representation and Technological Diversification morality of business Edited by John Cantwell, Alfonso Don Lavoie and Emily Chamlee-Wright Gambardella and Ove Granstrand 27 Global Financial Crises and Reforms 35 Before and Beyond EMU Cases and caveats Historical lessons and future prospects B.N.Ghosh Edited by Patrick M.Crowley 28 Geography of Production and Economic 36 Fiscal Decentralization Integration Ehtisham Ahmad and Vito Tanzi Miroslav N.Jovanovi

Before and Beyond EMU Historical lessons and future prospects

Edited by Patrick M.Crowley

London and New York

First published 2002 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2003. © 2002 selection and editorial matter, Patrick M.Crowley; individual chapters, the contributers All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record has been requested for this title ISBN 0-203-46339-0 Master e-book ISBN

ISBN 0-203-46920-8 (Adobe eReader Format) ISBN 0-415-28271-3 (Print Edition)

Contents

List of illustrations Notes on contributors Acknowledgements

ix xi xiii

Introduction

1

PATRICK M.CROWLEY

PART I Before EMU: some historical perspectives 1 Building ‘Europe brick by brick’: the United States and European integration, 1945–57

9

11

ALISON MEEK

2 Monetary unions: a historical perspective

26

XAVIER DE VANSSAY

3 Monetary unification under the French monarchy

42

T.J.A.LE GOFF

PART II Before EMU: reflecting on the debate 4 Why EMU happened: a survey of theoretical explanations

69 71

AMY VERDUN

5 The economic case against the euro: North American view JAMES W.DEAN

vii

99

viii

Contents

6

International implications of EMU

113

PATRICK M.CROWLEY

PART III Beyond EMU: lessons for EMU 7

The single market and monetary union: recasting the politics of economic liberalization

131

133

MITCHELL P.SMITH

8

Some Canadian lessons for EMU

146

MALTE KRUEGER

9

European integration after EMU: what next?

157

PATRICK M.CROWLEY

PART IV Beyond EMU: evaluating success

181

10 One money, one people? Political identities and the euro

183

ERIC HELLEINER

11 The euro and the transformation of international relations

203

DAVID LONG

Index

223

Illustrations

Tables 2.1 Successful monetary unions 2.2 Common characteristics between German monetary unification and the EMU 3.1 Proportion of foreign coins hoarded within the 1610 frontiers of France during different reigns 3.2 Purchasing power of the livre, 1660–1739 4.1 Clustering political theories of integration 9.1 Extended Balassa stages of economic integration 9.2 Preconditions for economic integration 9.3 Possible ‘spillover’ consequences of integration 9.4 Reclassifying integration by level 9.5 Comparing regional integration projects 9.6 Implied changes and commitments from integration

30 36 50 66 90 160 161 163 164 167 171

Figures 3.1 3.2 8.1 9.1 9.2

Long-term depreciation of the livre tournois (official rates) The livre tournois, 1651–1726 (official rates) Secession from the EMU: the bargaining situation Network mapping of linkages between integration stages Nodal map of integration stages for the EU, West Africa and NAFTA 9.3 Integration for the EU post-EMU

ix

46 47 149 164 170 174

Contributors

Patrick M.Crowley is an Associate Professor of Economics at Texas A&M University in Corpus Christi, Texas, USA. After getting a BSc and an MSc from the University of Bristol (UK) he went on to gain his PhD in economics from McGill University in Montreal, Canada. He specialises in the study of economic integration, with special focus on the European Union and North American integration, and also has other research interests in international macroeconomics, Austrian economics and the history of economic thought. James W.Dean is Professor of Economics at Simon Fraser University, and has also held twenty-two visiting positions in other universities and research institutes on all continents of the globe. He specialises in international finance, in particular pathological circumstances such as debt and currency crises. He has a particular interest in the developing and transition economies of East Asia and Eastern Europe, where he frequently lectures and consults. Eric Helleiner is Canada Research Chair in International Political Economy at Trent University, Peterborough, Canada. He is co-editor of NationStates and Money (Routledge, 1999), and author of States and the Reemergence of Global Finance (Cornell, 1994) and The Making of Modern Money: Territorial Currencies in Historical Perspective (Cornell 2002). Malte Krueger works as a consultant for PaySys Consultancy GmbH (Frankfurt). He holds a PhD in economics from the Universität Köln (Germany). He has worked as a research fellow for the Bank of Spain, the University of Western Ontario, the University of Durham and the European Commission. Dr Krueger has published widely in academic and industry journals on exchange rates, monetary policy and innovations in the payment system. T.J.A.Le Goff is an Associate Professor at York University in Canada. Among other accomplishments, he was Professeur invité, Collège de France, 1991. x

Contributors

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David Long is an Associate Professor of International Affairs at Carleton University, Ottawa, Canada, and President of the European Community Studies Association-Canada. Professor Long has written extensively on EU foreign policy and on liberal international theory. Alison Meek is a former Canada-US Fulbright scholar, and currently is an Assistant Professor of History at King’s College in London, Ontario. Dr Meek specialises in Cold War American history, particularly America’s relations with the European Union in the years between 1955 and 1960. Her upcoming project includes an examination of America’s policy towards the European Common Agricultural Policy. Mitchell P.Smith is Assistant Professor of Political Science and International and Area Studies and Co-Director of the European Union Center at the University of Oklahoma. His work has appeared in numerous journals, including the Journal of European Public Policy, Politics and Society, Journal of Common Market Studies and West European Politics. He is the co-editor of Legitimacy and the European Union (Routledge 1999) and is completing a manuscript, ‘States of liberalization’, which focuses on the impact of the single European market on the scope of the public sector in EU countries. Xavier de Vanssay is an Associate Professor of Economics at Glendon College, York University. His area of research is international economics, public finance and public choice. He has published in Public Finance Quarterly, Public Choice, Journal for Studies in Economics and Econometrics, Journal of Public Finance and Public Choice and Journal of European Integration. Amy Verdun is an Associate Professor of Political Science and Director of the European Studies Programme at the University of Victoria, BC, Canada. She also holds a Jean Monnet Chair in European Integration Studies. She is the author of many articles and book chapters on issues related to European economic and monetary integration. She has published articles in the Journal of Public Policy, Journal of European Public Policy and Journal of European Integration. Three of her recent books are European Responses to Globalization and Financial Market Integration: Perceptions of Economic and Monetary Union in Britain, France and Germany (Macmillan/St Martin’s Press 2000); a co-edited anthology Strange Power: Shaping the Parameters of International Relations and International Political Economy (Ashgate 2000) (with Thomas Lawton and James N. Rosenau), and an edited volume The Euro: European Integration Theory and Economic and Monetary Union (Rowman and Littlefield 2002).

Acknowledgements

I would like to acknowledge those who have helped to put this volume together, either through hard graft or through moral support. First, I would like to thank all the contributors to the volume for largely sticking to the tight deadlines that I imposed on them, and for giving me the latitude to edit their work. Second, I must acknowledge the hard work of my research assistant at Texas A&M, Josh Osborne, who went beyond the call of duty to assist in compiling the volume. I would also like to thank the ECSA-C executive, both past and present for their support for the project, and in particular Steve Wolinetz, Amy Verdun and David Long, who have given considerable advice in helping the project come to fruition. Robert Langham and Terry Clague at Routledge are also thanked for their work on the volume and shepherding it to final publication. Others who should be mentioned are three anonymous referees for their comments on the volume, Robin Rowley (McGill University), Jim Lee (Texas A&M University), Mitchell Smith (University of Oklahoma) and Barry Eichengreen (University of California at Berkeley) for their ongoing support for my work. In terms of final production, I would like to thank Alfred Symons in the production editing department at Routledge, and also Felicity Watts for close proofreading. Last but not least, I thank my mother, Cherry Crowley, a long-time euro-sceptic, for supporting and encouraging my endeavours.

xii

Introduction Patrick M.Crowley

On a bitterly cold day in Toronto in March of 1999 a group of academics met at York University to discuss the launch of the euro. This disparate group was a small band of scholars who collectively are known as the European Community Studies Association—Canada (ECSA-C). Amy Verdun, of the University of Victoria, and I had planned this colloquium on the euro as both of us realised that there was little being done in Canadian academia to increase awareness of the important events that were taking place in the European Union (EU). Several of the papers in this volume had their first airing at this seminar, and the discussion and debate was lively and entertaining. Contributors Malte Krueger, Alison Meek, Mitchell Smith (who was at Middlebury, as was I at this time), Amy Verdun, David Long, Eric Helleiner, Tim Le Goff and Xavier de Vanssay all attended the colloquium, along with John Murray from the Bank of Canada, Edelgard Mahant and Chris Paraskevopoulos from York University and our erstwhile President, Steve Wolinetz (Memorial University, Newfoundland), plus a dedicated band of graduate students from University of Toronto, McGill University and York University. I realised at that seminar that what was taking place was quite unique in the academic world—a group of academics from disparate disciplines and backgrounds were coming together to present and discuss their viewpoints on an issue that was taking place on another continent. While it is not unusual for North American economists to discuss international issues, or for political scientists to debate the nature of European integration, it is unusual for a multi-disciplinary panel of North American academics to come together to debate a single European project happening thousands of miles away. Fast forwarding to the summer of 1999, and once again in freezing conditions at Memorial University in St John’s Newfoundland (who would expect snow and ice in June?), Economic and Monetary Union (EMU) was the topic of extensive debate at the ECSA-C meetings. A joint session was also organised with the Canadian Economics Association who brought together two Canadian economists, James Dean and myself, for a vigorous and heated debate. At the time James was saying that EMU would not be successful—I, naturally, was on the opposite side, and used the famous Keynes 1

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Patrick M.Crowley

quote1 on the outset of discussions at Bretton Woods to frame our debate in an optimistic tone. Certainly an interesting feature of the debate on EMU has been the polarised views on the process and its prospects—not only in the extremely divided views that emanate from the UK, but also within the wider economics and political science professions. Some of this debate has spilled over to resurface abroad, and particularly in the context of a single currency for North America, a debate that has been controversial, particularly in Canada. Canadians are very conscious of the fact that they live in a country that is not culturally homogeneous, as it contains not only an English-speaking population but also sizeable minorities who are Francophones (both inside and outside Quebec), and also a substantial population of indigenous peoples. Keeping Canada together has, at times, been an arduous task, and Canadians are mindful of the fragile nature of their confederation and the economic and political ties that bind the country together. So it is quite natural for Canadians to take an interest in events in the EU, even though Canada’s main economic and political influence, and its largest trading partner, is the United States. Americans do not have this natural affinity with the EU, as for them there is no historically differentiated cultural identity to balance between the individual states. By incorporating this cultural backdrop, it is perhaps not so surprising that the majority of American economists were sceptical about EMU. The practical reasons for this high level of cynicism among American economists stemmed from the adopted framework used for EMU, which appeared to some like a myth akin to Jason and the Argonauts, given its reliance on convergence criteria, adoption of central bank independence and agreement to continuing constraints under the Stability and Growth Pact of 1996. The other prominent reasons for cynicism are related to the debacle over the narrow-band exchange rate mechanism of the European Monetary System in 1992/3, the lack of economic convergence only two years before EMU was due to come into being, and the protracted and sometimes bitter arguments over the practical details of EMU (such as the presidency of the European Central Bank (ECB) and whether gold sales could be incorporated into member state budgets for the purpose of meeting convergence criteria). Another pertinent reason for the cynicism surrounding EMU during the 1990s, and continuing to the present, was face value. EMU was billed as an economic enterprise, but numerous studies found that EMU was not what economists call an optimal currency area (a geographical area where the constituent parts of the area experience similar shocks or business cycles—see Mundell 1961) so introduction of the euro did not seem to be a sensible enterprise. Political scientists, on the other hand, regarded EMU as largely an economic exercise, as it did not involve any further concentration of political powers at the supranational level, given that the

Introduction

3

ECB was to be wholly independent of government. So, to a large extent, political scientists regarded EMU as an economic exercise while economists regarded EMU as political exercise. This point came through clearly in our various meetings in Canada in 1999, and to a lesser extent pervades the literature in the two disciplines even today. The principal point to be made here is that inter-disciplinary interaction can help to inform us how the various tools of analysis and perspectives of each discipline can shed a multifaceted light on a process such as European integration, and this is reflected in the composition of this edited volume. Eichengreen and Frieden (1994) attempted this with their volume on the political economy of EMU, and indeed were successful in achieving an interesting blend of political science approaches incorporating the economic analysis of the day. This volume in one sense is more ambitious, as it extends the multi-disciplinary approach far beyond the confines of economics and political science. In this volume historical, sociological and comparative perspectives are presented, which makes for a rich and diverse mix of viewpoints and theoretical approaches. The volume is therefore a unique attempt to provide a transatlantic multi-disciplinary contribution to the existing literature on EMU, and it is my hope that the reader finds it successful in accomplishing this ambitious task. Economic and Monetary Union (EMU) is now in progress, and is nearly complete. The aim was indeed visionary back in 1989 when the Delors Committee first seriously proposed it, and it has led to a considerable volume of research and debate. Staying the course to implement EMU has not been an easy task for most member states of the EMU. The fact that the project has, to date, been successful belies several hurdles that have had to be overcome—events such as the reluctance of various member states to initially embrace the project, the speculative attacks of 1992 and 1993 on the exchange rate mechanism (ERM) of the European Monetary System (EMS), meeting the economic criteria specified in the Maastricht Treaty, arguments over who was to be the first president of the European Central Bank (ECB) and problems in implementing a pan-EMU monetary policy. These events, in retrospect, could have easily derailed the project. As Eichengreen (1993) has noted, there is no precedent for EMU anywhere else in the world, and yet there are examples of monetary unions that have been successfully concluded in other countries or between countries, using a single existing currency. When comparing these monetary unions, the novel component of EMU arises because the euro is a completely new currency, and so the problem is not one of assimilation or policy alignment, but one of process and credibility. EMU is also novel for two other reasons: first, monetary and exchange rate policy has been elevated to a supranational level of governance, and yet fiscal policy remains in the economic arsenal of member states; and second, the euro does not have the usual nation-state association that currencies do. In addition there is also the issue of whether the euro will eventually achieve a much wider circulation outside the EU.

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The issues outlined above arise in many of the papers in this volume, and they prompt some very interesting questions, such as: 1 Will the same level of credibility be bestowed upon the ECB as was bestowed upon the Bundesbank? 2 Will EMU prompt further integration, in either the fiscal or political arenas? 3 Will the euro lead to a greater sense of belonging to the EU for participants, and thereby dilute nationalism in member states? 4 Will the euro become an international currency, as well as a regional currency? Much ink has been spilt analysing the process itself, as to whether it will be successful or not—the aim here is not to summarise this discourse but rather to map various aspects of the project as a whole, both looking backwards and forwards—hence the volume title. The first two sections take a historical look back, either at the EU or at other monetary unions, and also consider the theoretical debate as to why it did happen or why it should not have happened. The last two sections of the volume then look forward beyond EMU to what might come next, and what the implications of completion of such an ambitious project might be. The volume begins with a historical look at the EU, in which Alison Meek maps out the early evolution of the EU from after the Second World War through to the establishment of the European institutions that the Treaty of Rome gave birth to. She emphasises the involvement of the US government in the early stages of the EU, and how at this stage the US government even envisaged a United States of Europe, a position that has clearly been reversed given the current and recent administrations, together with attitudes towards the establishment of a single market and an EU defence force. The second chapter is a contribution from Xavier de Vanssay, who explores two historical cases of monetary unions—the Scandinavian monetary union and the German monetary union. Both are of interest, not only because there are interesting parallels to EMU to be drawn but also because, in one instance (German monetary union), the outcome was permanent and bound together with nationalism, whereas in the other instance (Scandinavian monetary union) the arrangement was between several countries, and although there were close economic links between the countries concerned, the arrangement did not last. The chapter suggests that if EMU prompts member states to identify with an encompassing European identity, there is a much greater chance that EMU will be successful. The last contribution in the first section of the book is made by Tim Le Goff. Le Goff’s chapter deals with monetary union in France, and essentially describes the way in which the country formed its own currency from a mixture of foreign and locally issued currencies. Part of the rationale for a national currency in this instance was as a mechanism for the royal fiscal abuses that a unified monetary union permitted. The

Introduction

5

implication for EMU is obvious: if monetary and fiscal policy are in the same hands, there is a great incentive to debase the currency for political ends. What Le Goff’s article does not say is whether fiscal policy in the EU should be centralised or decentralised. In this context, clearly the Growth and Stability Pact is a compromise, as fiscal policy is constrained but choice of tax base and expenditure is left to the discretion of member states. The second section of the book also addresses the situation before EMU, and contains papers that reflect on why EMU happened, the claims for EMU, and what the implications are of the design of EMU. Amy Verdun provides a survey which uses the cleavage in political science integration theory to evaluate the wide spectrum of nuanced theoretical explanations for why EMU occurred. The divisive debate that raged in the political science literature in the 1990s between the intergovernmentalists (who believe that the main actors in the EU are the nation-states) and the neofunctionalists (who believe that EU institutions had a key role to play in events that took place) is important because it either establishes and recognises EU institutions as a catalyst for further integration, or explains EU integration as being driven mainly by a coincidence of member-state interests. No doubt there is an element of both explanations in every EU decision, with weights on each of the theoretical explanations changing depending on a multitude of factors and circumstances. Verdun takes the theoretical explanations, applies them specifically to EMU and finally categorises the explanations for us. James Dean’s contribution is quite different. Essentially this is the paper which Dean presented at St John’s in 1999, and it provides an entertaining— if somewhat irreverent—economic case against the euro. The one point that the paper makes very forcibly, though, is that EMU should not be billed as giving immediate and substantial economic benefits, because the EU or the eurozone member states do not constitute an optimal currency area and there are no mechanisms in place to properly offset this. In other words, the justification for EMU should be political rather than economic, as the economic rationale is not strong. This contradicts the main rationale given for EMU by the EU in the early 1990s in the hefty volume entitled One Market, One Money (Commission of the European Communities 1990). In the words of Dyson (1994:255) One Market, One Money was a classic illustration of the role of economic ideas as legitimator of policy. Like the earlier Cecchini Report on the single European market, it was an example of economic research after the decision of political principle had already been taken. The first of my contributions deals with EMU from an international perspective. Not much attention was given to the external effects of EMU, and further, to counter Dean’s paper, I wanted to draw attention to an issue that was largely ignored by North American economists who were in

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opposition to EMU. As a result, roughly half of the paper deals with the external effects of EMU—the effects on non-EU countries and the consequent feedback effects of the EU—and the second half of the paper deals with the institutional design of EMU and the less apparent economic benefits from EMU that might turn out to be significant. One particular issue raised here is that of EMU forming an endogenous optimal currency area (see Frankel and Rose 1997). The main idea here is that by having a single monetary policy for the eurozone countries, even though the zone is currently not an optimal currency area ex ante, it may become one ex post through time. This muddies the waters, of course, and does not lead to clear-cut economic decision-making, but it does tend to lead to justification of the project solely on political grounds, with potential economic benefits to be reaped in the future. The third section of the book looks beyond EMU, but uses existing examples to try and identify the likely changes that EMU will foster. Mitchell Smith’s chapter studies the changes in competition policy that occurred after the single market was implemented. The original justification for EMU was that it would complement and build on the single market (hence the ‘one market, one money’ theme used by the European Commission), so EMU could be seen as representing a significant enhancement to the single market by ironing out any price discrepancies based on different currencies (through conversion costs or lack of transparency). The ramifications for financial market competition of EMU are clearly significant, and Smith explores these by studying the German state banks. Malte Krueger’s contribution takes a Canadian perspective on EMU, and makes essentially two proposals based on Canada’s experience with monetary union in the context of a successful multicultural federation. The first is that the Stability and Growth Pact is unnecessary and should be scrapped, with a bankruptcy code substituted; the second is that an exit clause should be negotiated as part of EMU, just in case a member state should decide to leave. The last chapter in this section is another contribution from the editor and it focuses on what stage of economic integration would logically follow from EMU—fiscal union or political union. To do this I take the accepted template for economic integration and analyse it both from a comparative perspective and as a process in and of itself. The final section of the volume continues to look beyond EMU, but incorporates views on the possible ramifications beyond the internal EU economic and political considerations. Both the chapters in this section consider whether EMU will be successful in giving the EU a greater impact on the peoples of Europe and on the international community. Eric Helleiner’s paper is sociological in nature. He evaluates whether the usage of money in the EU might engender a greater sense of European identity, using historical precedent and analysis of the designs and images portrayed on the new euro notes and coins compared with the images that usually adorn national currencies. The final contribution by David Long evaluates whether the introduction of the euro will transform EU international relations, using both international relations theory and observations on EU representation in

Introduction

7

international bodies. The ramifications here could be either profound or largely cosmetic, depending on whether the international bodies to which the EU belongs are prepared to reconfigure their current structures. Although the journey to EMU has been a painfully long and winding road, the prospects for the future of the euro now look good. The Eastern European candidate countries will probably succumb to euroisation over the next few years, the ECB seems to have effectively dealt with an initial credibility problem, and the euro has apparently halted and reversed its slide against the US dollar. One of the key tests of whether the euro will actually live up to its name as the currency of the EU will be whether the UK decides to join the project. Although prospects for UK EMU membership seemed distant even two years ago, there now appears to be more willingness to discuss the issue and to at least address the possibility of UK EMU membership. The ultimate goal for the euro must be to have a single currency throughout the EU, and until this is the case complete success will not be wholly achieved. Corpus Christi, Texas December 2001

Note 1

‘I am greatly encouraged, I confess, by the critical, sceptical and even carping spirit in which our proceedings have been watched and welcomed in the outside world. How much better that our projects should begin in disillusion than that they should end in it’ (J.M.Keynes, Closing Address, Bretton Woods Conference, 1944).

Bibliography Commission of the European Communities (1990) One Market, One Money, European Economy 44, Directorate-General for Economic and Financial Affairs, Brussels, Belgium. Dyson, K. (1994) Elusive Union: The Process of Economic and Monetary Union in Europe, Longmans, Harlow, Essex, UK. Eichengreen, B. (1993) ‘European monetary unification’, Journal of Economic Literature 31, pp. 1321–57. Eichengreen, B. and J.Frieden (eds) (1994) The Political Economy of European Monetary Unification, Westview Press, Boulder, Colorado, USA. Frankel, J. and Rose, A. (1997) ‘Is EMU more justifiable ex post than ex ante?’ European Economic Review 41, pp. 753–60. Mundell, R. (1961) ‘A theory of optimum currency areas’, American Economic Review 51, pp. 657–75.

Part I

Before EMU Some historical perspectives

1

Building ‘Europe brick by brick’ The United States and European integration, 1945–57 Alison Meek

Introduction Although the roots of European integration can be traced back to the theories of Jean Jacques Rousseau, Immanuel Kant and Victor Hugo, and to the military dreams of Charlemagne, Napoleon, and Hitler, it was the devastation experienced in Europe between 1919 and 1945 that gave the push for unity a new urgency and a new legitimacy. At war’s end, Europe was exhausted, for all intents and purposes Germany was divided, while France and Italy, unable to maintain a semblance of political stability, witnessed the growth of powerful political parties. It was in this context that ideas for a politically and economically united Europe took on a new life, providing a much-needed ray of hope to deal with the vexing problems of the post-war period. A united Europe was not simply a goal of the ‘Europeanists’ in Europe; it was also a fundamental objective of the United States who saw an integrated Europe as the best solution to help Europe correct the errors of their ways. Ending the Franco-German rivalry, tying Germany firmly to the West, and establishing an efficient and prosperous European economy were the guiding political and economic imperatives of the United States from Franklin D.Roosevelt to Harry S.Truman to Dwight D.Eisenhower. To implement these policy imperatives, Roosevelt, Truman and Eisenhower relied on their respective Secretaries of State—George Marshall, Dean Acheson and John Foster Dulles— and the committed ‘Europeanists’ in the State Department. In turn, those in the United States charged with devising and carrying out a policy for uniting Europe frequently drew on the ‘informal networks’ of close personal relations that connected the American State Department with the Foreign Ministries in France, England, Germany, Belgium, and Italy (Duchêne 1994).

World War II to 1947 Even before peace had arrived in Europe, many of those who had witnessed war first hand were beginning to voice their concerns that unless far-reaching changes to the European political and economic structure were forthcoming, 11

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the deadly systems of nationalistic rivalries of the interwar period would be revisited. Political boundaries became economic barriers leaving the economy of Europe entangled in a mesh of rules and regulations (Kohnstamm 1963; Lipgens 1982). Establishing a multilateral European trading system based upon large-scale production, greater competition, freer non-discriminatory trade and convertibility of currency would guide both European and American policy-makers in the immediate post-war years (Hogan 1987; Jensen and Walter 1965). If Europeans feared a return to the past, then the Americans shared their fears. Ending patterns of hostility and suspicion, particularly between France and Germany, assumed a high priority for Washington. The bitter FrancoGerman rivalry had thrice led to war, and the cost of these conflicts could be measured in millions of dollars. Equally important for the United States in the post-war years was ensuring that Germany aligned itself with the West. The lessons of the inter-war period regarding Germany were taken to heart: this time around Germany was not to be isolated and condemned, but instead fully integrated and tied to the Atlantic Community. To do otherwise left the door open for the ‘rebirth of aggressive German nationalism’ (Hogan 1987; Harper 1994). An early foray towards political and economic integration came from an unlikely source. A concrete indication of changes afoot came in early September 1944 when the governments in exile of Belgium, Luxembourg, and The Netherlands agreed to form a customs union to end import duties and to create a common external tariff (National Archives and Records Administrations (NARA) No. 1). Although it would take years to get the Benelux economic community off the ground, this announcement nevertheless signalled a change in attitude towards the economic nationalism of the recent past.

The Marshall Plan and the OEEC Europeans were not alone in thinking about the direction in which Europe should move during the post-war years. Despite a debate in the historical literature regarding the motives behind, and the success of, the Marshall Plan (Milward 1984; Hogan 1987; Milward et al. 1993), the basic thinking in Washington in 1946–7 was that to ensure the continued growth of the American economy, Europe needed to be reconstructed and reintegrated into a multilateral system of trade. Equally, the United States was moving away from a piecemeal approach of aid to Europe, and was devising something more co-ordinated. As Hogan writes, the ‘tangled web of two hundred bilateral trade and payment agreements seemed to be perpetuating the very order that had hampered economic growth’ (Hogan 1987:19). Instead, Europe needed to be treated as a whole. The first public move toward a more co-ordinated European aid package came with Secretary of State George Marshall’s commencement speech at

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Harvard University on 12 June 1947. Marshall spoke not only of giving American aid to help European reconstruction, but also of wanting to see the European countries who accepted Washington’s offer join together and coordinate how this money was to be divided. Although the Marshall Plan is a crucial component of the emerging Cold War story, it is of equal importance in the nascent European unity movement. For what was emphasised by Marshall was the need for Europe to engage in co-ordinating national economic and trade policies. Both political stability and economic prosperity dictated an American insistence upon European co-operation and integration into a multilateral system of trade (Hogan 1987; Gillingham 1996; Kaufman 1982). The seventeen European nations who accepted the American economic recovery programme met for the first time in Paris on 12 July 1947, just one month after Marshall’s Harvard speech, and the Organisation for European Economic Cooperation (OEEC) was established in April 1948. As a group, the members pledged to engage in ‘closer and everlasting co-operation’ in liberalising intra-European trade through the abolishment of quotas and the harmonisation of monetary policies to allow full currency convertibility (Rappaport 1981; NARA No. 2). In many ways, this move was historic— not only did national governments agree to allow experts from other countries to examine national accounts for the first time, but problems that developed in one nation were ‘analyzed in a spirit of mutual confidence and cooperation’ by other OEEC members (Jensen and Walter 1965:9). One participant of the integration movement in the 1950s, acknowledged that the OEEC ‘achieved remarkable results’. New methods of co-ordination were devised, measures for trade liberalisation were enacted, and co-operation in economic policies between national governments in a multinational forum was promoted (van der Beugel 1965). Still, although the aim of the OEEC was neither economic nor political integration, this did not preclude those on both sides of the Atlantic from voicing their disappointment at the merely co-operative nature of the organisation (Polach 1964). For those who hoped to see the OEEC as a stepping stone to a more integrative structure, the realisation came quickly that this intra-governmental system was too big, too unwieldy and too diverse to be anything but a co-operative economic clearing house. Europeans who wanted more than the OEEC could offer began to move in their own direction. In May 1948, the Council of Europe met for the first time at The Hague, with Winston Churchill as its honorary president. Following Churchill’s call for the nations of Western Europe to unite, many of the 800 invited guests felt as if ‘they were present at the birth of a great movement’ (Harrod 1957:225). But despite such hopeful beginnings and the consensus of historians since on the improvement of the Council over previous intergovernmental gatherings, the Council of Europe almost immediately became bogged down in divisive debate (Coudenhove-Kalergi 1953; Zurcher 1958; Pollard 1981; Harrod 1957). Walter Hallstein, himself a participant at the Council of Europe and the first president of the European Communities in 1958, writes that despite the Council’s best intentions and the dedication

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of many influential Europeans, the meetings only served to produce ‘a deep sense of frustration’ (Hallstein 1962:9). American officials and private citizens were also grappling with a sense that something more was needed. In April 1948, a ‘nonprofit, nonpolitical, nonpartisan organization’ designed to promote the idea of a united Europe was established by Count Coudenhove-Kalergi and Senator William Fulbright. The Action Committee for a Free and United Europe attracted such influential people as William C.Bullitt, Hale Boggs, Allen Dulles, Christian Herter, Herbert Hoover Jr, Robert La Follette Jr and Henry Luce (Rappaport 1981; Lipgens 1982). The United States Congress eagerly added its support to the emerging unity movement through a concurrent resolution proclaiming that ‘the Congress favors the creation of a United States of Europe within the framework of the United Nations’ (Rappaport 1981:123–4). The resolution passed overwhelmingly in both houses. At the American Club of Paris, in November 1948, John Foster Dulles spoke of the ties that bound the United States with Europe and of the ‘great investment’ that the United States had put into Europe, including sending American men to fight and die in two world wars. Europe needed to be united, Dulles said, calling disunity ‘a weakness that ambitious despots will constantly seek to exploit’. While the United States wanted to deepen its ties with ‘a strong, vigorous and contributing partner in freedom’, the future Secretary of State was unwilling to tie the fate of the United States ‘to the fate of a Western Europe that insists on retaining a disunity that invites recurrent war’. What emerged in Europe must be a pattern of Europe’s choosing, so long as there was ‘concrete and sustained progress’ towards a united Europe that was ‘strong, free and independent’ (NARA No. 3). The belief among both European and American officials in the need for Europe to do away with restrictive barriers to trade raises the question of regional versus multilateral trading systems and their place in American trade policy. Historically, the United States has favoured a multilateral approach to trade, as is evidenced in the most-favoured-nation policy of nondiscrimination that followed from the 1922 Fordney-McCumber Tariff Act and the repeated extensions of the Trade Agreement Act of 1934. In the post-war years, this approach was reinforced by the Truman administration’s desire to see the establishment of the International Monetary Fund (IMF), the International Trade Organisation, and the General Agreement on Tariffs and Trade (GATT) (NARA No. 2). Taking into account the very real contradictions in trade practices engaged in by the United States, multilateralism remained the preferred method of trade, and as such, it is interesting to see how little angst American support for a European regional economic bloc caused in America. In part, this can be traced to the fact that the GATT treaty provided for the development of customs unions or free trade areas. More importantly, however, economic policy objectives were never divorced from the political considerations involved in support for a united Europe. As such, short-term economic dislocations, caused by the

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development of regional blocs, were tolerated by the United States so long as the outcome was a strengthening of a multilateral system of trade and, ultimately, a politically unified Europe (Cleveland and Cleveland 1966; Diebold 1960; Frank 1970; van der Beugel 1965). In other words, economic integration was meant to be one step on the road to political integration.

The European Coal and Steel Community The first example of unity in action came with the announcement by French Foreign Minister Robert Schuman of a plan to create a common market for coal and steel. The roots of the European Coal and Steel Community (CSC) can be traced at least as far back as 1943, when Frenchmen Etienne Hirsch and Jean Monnet discussed the centrality of coal and steel in the war-making arsenals of France and Germany. Ending the hostilities between these two enemies meant, in part, finding a way to deal with coal and steel (Duchêne 1994). Therefore, coal and steel were not chosen by accident, but by a predilection on the part of Schuman, Hirsch and Monnet to make war between France and Germany ‘not only unthinkable but materially impossible’ (Hallstein 1962:10; Hitchcock 1997). At the heart of the CSC was the recognition of the need for a sectoral approach to integration. This was not to be an immediate change, but one accomplished gradually over several years and with the focus on one specific sector of the economy (Jensen and Walter 1965; Zurcher 1958). The CSC treaty, concluded in Paris in April 1951 and inaugurated on 10 September 1952, has been called a ‘precedent-shattering treaty’ as the participating nations were required to surrender a measure of their own sovereignty to the CSC’s governing body, the High Authority (Camps 1964; Hallstein 1962). The CSC included not only a supranational High Authority empowered to formulate a common market for coal and steel and to set rules for prices, wages, investment and competition, but also an advisory Council of Ministers and an Assembly which included delegates from national parliaments. A Court of Justice was established to adjudicate disputes between members (Dinan 1993; Haines 1957). The geographical scope of the CSC was significantly reduced to just the six members that would become the core group of European integration throughout the 1950s—France, West Germany, Italy, Belgium, The Netherlands and Luxembourg. Both the supranational character of the treaty and the smaller number of participants were lessons learned from the OEEC experience. A minority of Americans were appalled by Schuman’s announcement. Clarence Randall, President of the Inland Steel Corporation and a former consultant to the ECA, for example, attacked the plan ‘as a sacrifice of industrial interests to political goals, as an embodiment of the features of a cartel, [and] as a limitation of free competition by means which would be impermissible in the United States as an avenue to socialism’ (Beloff 1963:60).

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But Randall’s opinions were drowned out by a chorus of those in Washington who looked at the political advantages of events transpiring in Europe and saw the treaty not as an end to itself, but as a first step towards a larger goal (Frank 1961; Kohnstamm 1963). The United States was not directly involved in the negotiating process, although its presence was certainly felt behind the scenes (Duchêne 1994). Once the treaty was signed, the United States immediately appointed a permanent and official representative to the CSC, William M.Tomlinson, and in April 1954 provided the new organisation with a $100 million loan (Duchêne 1994; Winand 1993).

The European Defence Community and the Western European Union With the successful completion of the CSC, supporters of European integration began to plan the next step in their quest for European unity. This time they turned to the ‘jealously guarded domain’ of the military (Hallstein 1962). In October 1950, French Premier René Pleven announced plans for the creation of a European Defence Community (EDC). The impetus for the EDC is found not only in the perceived success of the CSC, but equally in the realisation that an unarmed Germany could prove dangerous if the existing Cold War ever went hot. Initial American reactions to Pleven and Monnet’s EDC were quite negative—the plan was viewed as ‘unrealistic and undesirable,’ posing as it did a threat to the delay of West German rearmament and its incorporation into NATO. But following a meeting between Dwight D.Eisenhower and Jean Monnet in June 1951, in which Monnet emphasised the ‘political soundness’ of the common structure, Eisenhower reportedly ‘saw the light’ (Winand 1993). Eisenhower, in fact, went on to speak at the English Speaking Union in London to tout the plan’s benefits to NATO, particularly the desirability of having politically stable and psychologically self-confident allies who were partners of the United States (Winand 1993; Harper 1994). The United States Congress was not the least bit hesitant to give its approval to the EDC idea. In passing the Mutual Security Act of 1952, Congress resolved that part of the American military aid package to Europe would go to the EDC to demonstrate support for ‘concrete measures for political federation, military integration, and economic unification in Europe’ (Winand 1993:31). Under the Richards Amendment to the Mutual Security Act appropriations of 1953–4, one half of the funds provided for European military aid were to be made available only to the EDC or its member countries. If the EDC was not ratified, funds were to be withheld until Congress reconsidered these provisions. The actual EDC treaty envisioned a unified European army having national units of brigade strength and a European senior line of command (Jensen 1967). With memories very much conditioned by the destructiveness of a militarised Germany, there was little chance that the French National Assembly

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would willingly permit a purely West German standing army; but perhaps one attached to—or, even better, fully integrated into—a European structure would be acceptable (Gillingham 1996). The signing of the EDC took place in the Clock Room of the Quai d’Orsay on 27 May 1952. The negotiations, however, turned out to be the easy part. It was the ratification process which turned into a long and arduous affair. The Germans were grappling with whether rearming was legal under their constitution, while the French faced more entrenched nationalistic problems. With the death of Joseph Stalin in March 1953, the ending of the Korean War in July 1953, the possibilities of East-West détente in the air, the increasing problems in Indochina, and a growing opposition to the basic concept of West German rearmament, many observers worried about the ability of French leaders to get the EDC through the notoriously nationalistic French National Assembly (Young 1993; Jensen 1967; Harper 1994). With increasing delays looming, part of the American dilemma revolved around breaking the log jam of getting the treaty ratified or cutting their losses and looking elsewhere for alternatives. ‘French rejection’ was at least an improvement on ‘French inaction’ (Guhin 1972). To break the log jam, John Foster Dulles embarked on a public campaign to nudge the French towards ratification. On the new medium of television, Dulles, in 1953, warned that if there was little indication of the Six moving towards effective unity and if, in fact, they each went their separate way, ‘then certainly it would be necessary to rethink America’s own foreign policy in relation to Western Europe’ (Winand 1993:38; Kaplan 1988). Dulles took the same tone at a NATO meeting in December 1953. Dulles’ speeches were not the fulmination of a lone ranger, and indeed had the support of high-ranking officials in the State Department who argued the need to take a hard line with the French. But if the point of the exercise was to nudge the French toward ratification, then it, and Dulles, failed. American actions only managed to irritate the French and make the EDC out to be an American ‘dictat’ (Winand 1993). These actions, in concert with the more basic French fears of German rearmament and a cooling of East-West tensions, led to a rejection of the EDC treaty by the French National Assembly in August 1954 (Haines 1957). Dulles was particularly angered by this outcome, but despite residual feelings of betrayal, anger or exhaustion, the fact remained that the problem of German rearmament was no closer to conclusion in August 1954 than it had been in 1950. Simple pragmatism and the professionalism of the diplomats involved meant that attentions were turned to finding alternative means to rearming West Germany and tying it to the West. At British Prime Minister Anthony Eden’s urging, the United States, the United Kingdom, Canada, and the CSC Six met in London in September of 1954 to discuss what to do about West Germany and NATO. With compromises made on all sides, the Western European Union was formally established with the signing of the Paris Agreements in October 1954. Dulles, recovering from the EDC debacle,

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believed that the WEU provided a ‘durable’ basis for promoting the Atlantic relationship, guaranteeing West German sovereignty, allowing West Germany to contribute to international peace and security, and, by controlling arms levels, guarding against renewed militarism (Eisenhower 1955). Despite the practical exercise of creating the WEU, the fact remained that the unprecedented drive towards a united Europe, begun in the bleakest days of World War II, had stumbled. The opportunity was taken in the autumn of 1954 to reassess achievements and failures to date. The CSC was in place and working; France and West Germany had, for the first time in almost a century, become tolerant neighbours, if not partial allies; a new WEU was inaugurated, and the OEEC continued to function. On the other hand, the military-oriented EDC failed to materialise. These lessons proved invaluable during the negotiations for what, in only three short years, would become the European Economic Community.

Messina to Brussels to Rome In June 1955, Messina, Italy, played host to a three-day conference symbolising the Relance Européene, the renewed drive toward the political and economic integration of Europe. In bringing together the foreign ministers of the six CSC countries, the purpose of the meeting was twofold: to find a new president for the CSC’s High Authority and to discuss a proposal circulated by the Benelux countries to expand the scope of the CSC. The first item of business was dealt with when René Mayer was selected to succeed outgoing CSC President Jean Monnet. A committed ‘Europeanist,’ Mayer was a welcomed choice (NARA No. 4). As for the expansion of the powers of the CSC beyond coal and steel, the discussion here revolved around the Benelux Memorandum on European Integration. The initiative for the Benelux Memo was rooted in a proposal circulated by the Benelux countries in May 1955 to continue the drive for European integration, this time through a reversion to economic avenues. As early as April, American officials in Europe and Washington were receiving reports that Belgium and The Netherlands were looking for means to ‘move forward to a customs union on a six-country basis within the framework of a supranational organization’ (Foreign Relations of the United States (FRUS) No. 1 (25 April 1955); FRUS No. 2 (12 April 1955); Kitzinger 1960). The Belgians and the Dutch were beginning to worry that perhaps the desired rapprochement of France and West Germany begun with the CSC was working too well and could possibly mean the exclusion of the other four powers from future endeavours (Business Week, 29 April 1955). In addition, concern was expressed that following the successful conclusion of the WEU in 1954 and the ‘recovery of its sovereignty’, West Germany would ‘be more concerned with other foreign policy problems’ such as trade with

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the Soviet Union and Eastern Europe and the always-present issue of German reunification (NARA No. 5). Copies of the memo were sent to the capitals of the Six on 16 May 1955, with an extra copy being smuggled to the Americans on a confidential basis by the Foreign Office of The Netherlands. The memo articulated the Benelux view that the time had arrived for ‘a new stage along the road to European integration’ which needed ‘to be accomplished first in the economic field’. The activities of the CSC were to be expanded, but the ultimate goal remained Western European political integration. Four areas were targeted— transportation, conventional energy, atomic energy, and a general common market. To achieve these goals, the structure of the CSC, with a common authority, was to be mimicked. The memo concluded with a call for a ministerial conference to discuss and prepare draft treaties (NARA No. 6). Using the Benelux Memo as a basis for discussion, the foreign ministers at Messina agreed with its premise, but decided that more time was needed to deal with specific issues. In early June, it was decided that a commission of experts be set up to study more closely the Benelux proposals and then report back to the Foreign Ministers (Spaak 1971; Bromberger and Bromberger 1968). One of the few press reports on the Messina conference lamented that ‘the difficult questions have all been sidestepped’ (The Economist 1955). PaulHenri Spaak, one of the key figures at the Messina meeting, not only agreed with this criticism in his memoirs (Spaak (1971) but was in many ways responsible for this, knowing as he did that little headway could be made unless the French were firmly on board. In particular, this translated into the need to ensure that there was not even a whisper of supranationalism in the integration discussions (NARA No. 7). The memories of the EDC debacle, combined with the chronic instability of the French political system, meant that no move was made unless it could be assured that there would be support in the French Parliament (The Economist 1956). Sidestepping controversial issues in 1955 was also dictated by the simple fact that there was a great deal of disagreement among the CSC Six over the structure, components, pace and meaning of what was being discussed. Still, the American State Department was able to conclude that, despite this dissension, Messina ‘paved the way for preparations toward future increased integration’ and that the time had come ‘to make further progress in the building of Europe’ (NARA No. 8). In early July 1955, this progress continued when the Intergovernmental Committee on European Integration met outside Brussels. Paul-Henri Spaak was named to chair the meetings, and the first order of business was the establishment of four subcommittees. These would study, individually, conventional energy, nuclear energy, transportation and public works, and a general common market. Very quickly it was evident that transportation and conventional energy could be better served by intergovernmental co-operation rather than integration attempts. It was, therefore, in the areas of nuclear

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energy and a common market that the CSC Six, and the United States, saw the greatest potential for integration. Interestingly, however, it was atomic energy that took centre stage in the integration process, with the common market assuming a secondary position. Atomic energy was an area that was relatively new, and thus held few ‘vested interests’ (NARA No. 9). Equally, nuclear energy was touted as the means to shore up supposedly dwindling oil reserves (FitzSimmons 1959; Hewlett and Holl 1989; Moore 1958), launch a ‘new industrial revolution’ (NARA No. 10) and bind old enemies together in a new Europe (FRUS No. 3, 15 July 1955). The United States itself saw multiple advantages in an atomic energy pool in Europe, including the chance to create new markets outside the United States to help alleviate its stagnating domestic nuclear industry (Hewlett and Holl 1989). More importantly, however, in the eyes of the Eisenhower administration, here was an opportunity to achieve a fundamental goal of post-war American foreign policy—the political and economic integration of Europe (NARA No. 11; Duchêne 1994). Unfortunately for supporters of European integration, achieving a united European atomic energy community was anything but straightforward. No sooner did meetings begin in Brussels than internal and external complications threatened to derail the drive towards what has been dubbed EURATOM. As a result of these complications, the negotiations for an atomic energy community were mired in debate. It would take the ironic timing of the Suez crisis and the personal intervention of French Premier Guy Mollet and German Chancellor Konrad Adenauer in late 1956 to make the EURATOM community possible. Given the consequences of the EDC debacle, a deep division within the Six, lingering anti-Americanism on the continent, and internal divisions within the United States, the Eisenhower administration refused to publicly play a role in the EURATOM negotiations (NARA No. 12). This stance was repeated in the parallel talks underway for a European Common Market. Dismantling politically sensitive economic barriers to create a customs union would be a difficult task, and it is little wonder that the Common Market was labelled a ‘pretty nebulous project’ right from the beginning (NARA No. 13). Still, there were high hopes in Washington that an economically united Western Europe could, over the long term, provide both economic and political advantages for the United States and its allies. Of fundamental importance was the chance to create a market of 160 million people and to make European trade more efficient. To do this meant doing away with ‘obsolete plants, with cartels, [and] with small markets’ (NARA No. 14). Naturally, the United States was opposed to any arrangement that created a preferential trading bloc detrimental to American exports, but the Eisenhower administration was willing to tolerate short-term economic dislocations so long as the final arrangements for a customs union would lead to a higher level of international trade, be compatible with GATT and,

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most importantly, help promote an integrated community of the Six (FRUS No. 4, 13 July 1956). Following in EURATOM’s footsteps, the Common Market negotiations proved equally difficult, with each of the Six attempting to protect its national concerns. There was a particularly acrimonious debate over linking the Common Market and EURATOM treaties that pitted the French, who were content to pursue only an atomic common market, against the Germans and the Benelux, for whom EURATOM was the price they were willing to pay to have the Common Market established (Camps 1956; NARA No. 15). Washington, which continued to rely on the political significance of EURATOM to propel the integration movement forward, was on record as being willing to shelve the Common Market in order to guarantee EURATOM’s successful completion (NARA No. 16). With the European Six reaching an agreement to proceed with both treaties simultaneously, the French still managed to throw a wrench into the negotiations at the last minute by tabling a list of demands, including the inclusion of their overseas territories, as a condition of their agreeing to a European Common Market. Once again, approaching the proverbial eleventh hour, it was Konrad Adenauer who made significant compromises, allowing the Common Market treaty to be concluded. On 25 March 1957, the Foreign Ministers of France, West Germany, Italy, Belgium, The Netherlands and Luxembourg met in Rome to sign the historic Treaties of Rome. The EURATOM treaty laid out the structures for an atomic community, which would promote research and development, the training of scientists, and the enforcement of safety standards and uniform terminology. The EURATOM Commission would, moreover, own all fissionable materials, control relations with third countries, and devise security and control measures (FitzSimmons 1959; Moore 1958; Duchêne 1994). The Common Market was in many ways equally impressive in its designs to gradually lower and then, over a twelve to fifteen year transition period, eliminate ‘all customs duties, equalisation taxes, and quantitative restrictions’. There were rules laid out for the free movement of labour, capital and goods, for a common social policy, for a Common Agricultural Policy, for a European Bank of Investment, and for a European Social Fund (Haines 1957; Frank 1961; Kitzinger 1960).

Conclusion There was a ‘new Europe’ perhaps, but one that certainly came into this world with a significant amount of uncertainty for its future. France, under the EURATOM treaty, was able to continue pursuing its military weapons program. As for the Common Market, agriculture and the level of the Common External Tariff were considered too politically sensitive and

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complex and thus left for another day. France’s success in being wooed into signing left a bitter taste among some of the Six, especially among the Benelux (The Economist 1956). And certainly, following the deliberate designs to avoid references to ‘supranationalism,’ the treaties raised concerns whether they were indeed ‘European’ or simply mere intergovernmental cooperative agreements on a smaller scale. And yet, despite these weaknesses, what had been accomplished in the three years since the failure of the EDC, or even in the twelve years since the guns fell silent in Europe, was truly spectacular. France and West Germany had ironed out most of their major differences and were beginning to embark on a new, non-life-threatening relationship. West Germany appeared to have solid ties with the West. The United States managed to work diligently behind the scenes to help a united Europe become a reality. But with the implementation of the treaties beginning to take effect, and in a time of changing political and economic imperatives on both sides of the Atlantic, a whole new set of challenges was awaiting the true believers in European integration.

Bibliography Beloff, M. (1963) The United States and the Unity of Europe, Washington DC: The Brookings Institute. Bromberger, M. and Bromberger, S. (1968) Jean Monnet and the United States of Europe, New York: Coward-McCann. Business Week (1955) ‘New ripple in coal-steel pool’, 29 April (March-April), vol. 1338, pp. 124–6. ——(1955) ‘International outlook’, 7 May (May-June), vol. 1340, p. 148. ——(1955) ‘Integration at a standstill’, 28 May (May-June), vol. 1343, pp. 148–50. Camps, M. (1956) The European Common Market and American Policy, Memorandum No. 11, Princeton, New Jersey: Center for International Studies, Princeton University, 28 November 1956. ——(1960) ’The European Common Market and American policy’, Foreign Affairs, vol. 39 (October), no. 1, pp. 112–22. ——(1964) Britain and the European Community, 1955–1963, Princeton, New Jersey: Princeton University Press. Cleveland, H. and Cleveland, J. (1966) The Atlantic Alliance: Problems and Prospects, Headline Series No. 177, no place given: The Foreign Policy Association. Coudenhove-Kalergi, Count (1953) An Idea Conquers the World, London: Hutchinson. Diebold, W. Jr (1960) ‘The changed economic position of Western Europe: some implications for United States policy and international organization’, International Organization, vol. XIV, pp. 1–19. Dinan, D. (1993) Historical Dictionary of the European Community, Metuchen, New Jersey: The Scarecrow Press. Duchêne, F. (1994) Jean Monnet: The First Statesman of Interdependence, New York: W.W.Norton. Economist (1955) ‘Relaunching Europe’, 11 June, vol. 175, no. 5833, pp. 923–4. ——(1956) ‘Free trade seen from Paris’, 15 November, vol. 189, no. 6021, p. 615.

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Eisenhower, D.W. (1955) Dwight D.Eisenhower Library, Abilene, Kansas.Ann Whitman File. Dulles-Herter Series. Dulles. Box 4. February 1955 (2). Memorandum for the President, ‘Issuance of Western European Union Assurances’. Signed Herbert Hoover, Jr, 4 February 1955. FitzSimmons, L. (1959) ‘The United States and Euratom’, unpublished thesis, Georgetown University. Frank, I. (1961) The European Common Market: An Analysis of Commercial Policy, London: Stevens. ——(1970) ‘The economic constraints’, in I.Frank, America and the World: From the Truman Doctrine to Vietnam, Baltimore: Johns Hopkins University Press, pp. 237–88. FRUS No. 1 (29 April 1955) Foreign Relations of the United States, Volume 4: 1955– 1957, No. 9. Memorandum of conversation. ——No. 2 (12 April 1955) Foreign Relations of the United States, Volume 4: 1955– 1957, No. 82. Memorandum from the Assistant Secretary of State for European Affairs (Merchant) to the Secretary of State. ——No. 3 (15 July 1955) Foreign Relations of the United States, Volume 4: 1955– 1957, No. 111. Memorandum of conversation: ‘Proposals for six nation European Atomic Energy Authority patterned on the Schuman Plan’. ——No. 4 (13 July 1956) Foreign Relations of the United States Volume 1955– 1957, No. 180. Circular airgram from the Secretary of State to certain diplomatic missions: CA-454, ‘Common Market negotiations’. Gillingham, J. (1996) ‘Introduction’, in Francis H.Heller and John R.Gillingham (eds) The United States and the Integration of Europe: Legacies of the Postwar Era, New York: St Martin’s Press. Guhin, M. (1972) John Foster Dulles: A Statesman and His Times, New York: Columbia University Press. Haines, C.G. (1957) ‘What future for Europe?’ Headline Series, Foreign Policy Association, July-August, vol. 124, pp. 1–55. Hallstein, W. (1962) United Europe: Challenge and Opportunity, Cambridge, Mass.: Harvard University Press. Harper, J. (1994) American Visions of Europe: Franklin D.Roosevelt, George F. Kennan, and Dean G.Acheson, Cambridge: Cambridge University Press. Harrod, R. (1957) ‘Britain and the Common Market’, Foreign Affairs, vol. 35 (January), no. 2, pp. 225–37. Hewlett, R.and Holl, J. (1989) Atoms for Peace and War: Eisenhower and the Atomic Energy Commission, Berkeley: University of California Press. Hitchcock, W. (1997) ‘Origins of the Schuman Plan, 1948–1950,’ Diplomatic History, vol. 21 (Fall), no. 4, pp. 603–30. Hogan, M. (1987) The Marshall Plan: America, Britain and the Reconstruction of Western Europe, 1947–1952, Cambridge: Cambridge University Press. Jensen, F. and Walter, I. (1965) The Common Market: Economic Integration in Europe, Philadelphia: J.B.Lipincott. Jensen, W.G. (1967) The Common Market, London: G.T.Foulis. Kaplan, L. (1988) NATO and the United States: The Enduring Alliance, Boston: Twayne. Kaufman, B. (1982) Trade and Aid: Eisenhower’s Foreign Economic Policy, 1953– 1961 , Baltimore: Johns Hopkins University Press.

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Kitzinger, U.W. (1960) ‘Europe: the Six and the Seven’, International Organization, vol. XIV, pp. 20–36. Kohnstamm, M. (1963) The European Community and Its Role in the World, Columbia: University of Missouri Press. Lipgens, W. (1982) A History of European Integration: The Formation of the European Unity Movement, 1945–1947, vol. I. (translated by P.S.Falla and A.J.Ryder) Oxford: Clarendon Press. Milward, A. (1984) The Reconstruction of Western Europe, 1945–51, Berkeley: University of California Press. Milward, A., Lynch, F.M.B., Raniere, R., Romero, F. and Sorenson, V. (1993) The Frontier of National Sovereignty: History and Theory, 1945–1992, London: Routledge. Moore, B. (1958) EURATOM, the American Interest in the European Atomic Energy Community, New York: The Twentieth Century Fund. National Archives and Records Administration (NARA) No. 1. College Park, MD. Record Group (RG) 59 Central File (CF) 840.00/5–1856. AmEmbassy Brussels to the Department of State Foreign Service Despatch 1271: ‘Review of the Benelux progress in economic integration’, 18 May 1956. ——No. 2. RG 43. Department of State International Trade Files. Lot 57 D 284. Economic integration. ‘Relevant US policies and the need for their review’. Not dated. ——No. 3. RG 43. Department of State International Trade Files. Lot 57 D 284. Economic integration. ‘Relevant US policies and the need for their review.’ Not dated. ——No. 4. RG 59. Records of the Policy Planning Staff. Office files, 1955. Lot 66 D 70. Office memo. Fuller to Bowie, ‘Current status of European Movement; problems of US policy’, 18 August 1955. ——No. 5. RG 59. CF 840.00/5–1655. AmEmbassy The Hague to the Department of State. Foreign Service Despatch 1041. ‘Benelux memorandum on European integration’, 16 May 1955; CF 840.00/4–1955. The Hague to the Secretary of State. Incoming telegram 1627, 18 April 1955; and Bureau of European Affairs. Office of Atlantic Political and Economic Affairs. Records relating to atomic energy matters, 1956–63. Box 4.1.1. Background data. Office of the US Representative to the ECSC, Luxembourg, 15 September 1955. ——No. 6. RG 59. CF 840.00/5–1655. AmEmbassy The Hague to the Department of State. Foreign Service Despatch 1041. ‘Benelux memorandum on European integration’, 16 May 1955. ——No. 7. RG 59. CF 840.00/5–1755. AmEmbassy Brussels to the Department of State. Foreign Service Despatch 1268. ‘Speech by Minister for Economic Affairs Rey on May 13 on Benelux, CSC, and European integration’, 17 May 1955. ——No. 8. RG 59. Current Economic Developments: A Department of State Policy Report, 1955 Lot 70 D 467. No. 471. ‘Committee established to study European integration proposals’, 5 July 1955. ——No. 9. For example, RG 59. Special Assistant to the Secretary for Energy and Outer Space. Records relating to atomic energy matters, 1944–63. Lot 57 D 688. 19.8 US-EURATOM Program General, January-August 1955. Department of State to AmEmbassy Paris, 15 July 1955. ——No. 10. RG 59. Bureau of European Affairs. Office of Atlantic Political and Economic Affairs. Records relating to atomic energy matters, 1956–63. Box 4. Background data. Office of the US Representative to the ECSC, Luxembourg, 15 September 1955. ——No. 11. RG 59. Special Assistant to the Secretary for Energy and Outer Space. Records relating to atomic energy matters, 1944–63. Lot 57 D 688. 19.8. USEURATOM Program General, January-August 1955. Memorandum of

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conversation. ‘CSC foreign ministers’ conference at Messina’, 6 June 1955. Special Assistant to the Secretary for Energy and Outer Space. Records relating to atomic energy matters, 1944–63. Lot 57 D 688. 19.8. US-EURATOM Program General, January-August 1955. Robert Eisenberg to Joseph Palmer, 30 June 1955. ——No. 12. Bureau of European Affairs. Office of Atlantic Political and Economic Affairs. Alpha-numerical Files, 1948–63. C.4. Monnet’s Action Committee, 1956– 68. Philip Sprouse to Robert Barnett, 31 January 1956. ——No. 13. Special Assistant to the Secretary for Energy and Outer Space. Records relating to atomic energy matters, 1944–63. Lot 57 D 688. 19.8. US-EURATOM Program General, January-August 1955. Robert Eisenberg to Joseph Palmer, 30 June 1955. ——No. 14. RG 59. Records of the Policy Planning Staff. Office files, 1956. Lot 66 D 487. Memorandum of conversation, 12 June 1956. ——No. 15. RG 59. Special Assistant to the Secretary for Energy and Outer Space. Records relating to atomic energy matters, 1944–63. Lot 57 D 688. 19.8. USEURATOM Program General, May-September 1956. Intelligence report no. 7305. ‘Venice foreign ministers’ meeting on EURATOM and the Common Market’, 26 July 1956. Records of the Office of Western European Affairs. Subject file relating to France, 1944–60. Lot 61 D 30. Box 1, 1957. Briefing papers, France, 12 December 1956. ——No. 16. RG 59. CF 840.1901/2–756. Paris to the Secretary of State. Incoming telegram 3535, 7 February 1956; Current Foreign Relations: A Department of State Policy Report, 1956 Lot 70 D 467. No. 7. ‘Ministers’ meeting on European integration’, 15 February 1956; and CF 840.1901/5–2456. Department of State to certain diplomatic missions, 24 May 1956. Polach, J. (1964) EURATOM: Its Background, Issues and Economic Implications, Dobbs Ferry, New York: Oceana. Pollard, S. (1981) The Integration of the European Economy since 1815, London: George Allen and Unwin. Rappaport, A. (1981) The United States and European integration: the first phase’, Diplomatic History, vol. 5 (Spring), no. 2, pp. 121–49. Spaak, P.-H. (1971) The Continuing Battle: Memoirs of a European, 1936–1966 (translated by Henry Fox), London: Weidenfeld and Nicolson. van der Beugel, E.H. (1965) ‘The United States and European unity’, Internationale Spectator, Jaargang XlX-nr 7 (8 April), pp. 444–56. Winand, P. (1993) Eisenhower, Kennedy and the United States of Europe, New York: St Martin’s Press. Young, J. (1993) Britain and European Unity, 1945–1992, London: Macmillan. Zurcher, A. (1958) The Struggle to Unite Europe, 1940–1958, New York: New York University Press.

2

Monetary unions A historical perspective Xavier de Vanssay1

Introduction The first of January 1999 saw a historic event in the construction of Europe. On that date, eleven of the fifteen member countries of the European Union (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain)2 took three steps that many observers thought they would never take. First, they tied their exchange rates to the value of the euro. Second, they adopted a common currency (the ‘euro’), and finally they gave up national control over monetary and foreign exchange policies. This was the third and final stage of the European economic and monetary union (EMU). The first two stages were the abolition of capital controls (in July 1990) and the creation of the European Monetary Institute, precursor of the European Central Bank (January 1994). Euro notes and coins were (physically) introduced in January 2002, and if everything goes according to plan all national notes and coins will be withdrawn by July 2002. This paper has two objectives. First, it aims to show that monetary unions can take (and actually have taken) many forms and that the model of EMU is just one of many. Elsewhere in the world, many new monetary arrangements are being created or discussed. As recently as January 1999, Argentina was considering surrendering its currency (the peso), giving up its currency board3 and completely ‘dollarizing’ the economy. Similarly, some prominent Canadian economists have advocated a common currency for North America. The second objective of this paper is to look at two examples of past monetary unions: one successful (the German monetary union), and one that did not persist but was successful while it lasted (the Scandinavian monetary union). In the past, some monetary unions have been successful (lasting or incorporated into an even larger monetary union), while others have collapsed. As it turns out, one can draw many historic parallels between past monetary unions and EMU. The birth of the EMU is all about timing and institutional change. The abolition of capital controls across Europe in July 1990 played a major role 26

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in this policy. Once this step was taken, a closer monetary union (in whatever form) was unavoidable. Specifically, without open capital markets the need for a monetary union would have been less urgent. This is because, with open capital markets, a country cannot simultaneously maintain fixed exchange rates and pursue an independent monetary policy. This economic fact is known as the ‘inconsistent trinity’. Two European countries that tried to defy this ‘open-economy trilemma’4 learned their lesson the hard way in September 1992. Currency speculators forced UK sterling and the Italian lira out of the EMS. This debacle was followed by the devaluations of the Irish punt, the Spanish peseta and the Portuguese escudo. Finally, in July 1993, following a speculative attack against the French franc, the EMS nearly imploded. As a result, rules governing exchange rates for members of the EMS were changed. Exchange rates could now fluctuate by up to 15 per cent (instead of 2.25 per cent) either side of their central rates. This move effectively killed the pretence of fixed exchange rates within the EU. It reinforced the view that the only way to get fixed rates across Europe was to adopt a common monetary policy. This paved the way for EMU. On the institutional side, the European System of Central Banks (ESCB), comprising the European Central Bank (ECB) and the national central banks, has been established and is constitutionally independent from political pressures. Price stability (which has been defined by the ECB as inflation of less than 2 per cent per year in the euro area as a whole) is the central priority of the ESCB (Article 105[1] of the Maastricht Treaty). The Bundesbank’s independence has been seen as an effective device to ensure price stability in post-war Germany (and some economists have even speculated on a positive link between economic growth and central bank independence).5 The mandate of the Maastricht Treaty for an independent central bank was a logical step (and it reassured the Bundesbank as to the future of its anti-inflation mandate). Incidentally, according to the Maastricht Treaty, the ECB will not act as a lender of last resort and will play only a limited role supervising the stability of the financial system. National banking authorities keep their supervisory role and the responsibility of providing liquidity in a crisis. The stage was therefore set for a historic event: the (physical) disappearance of twelve currencies in 2002 and the introduction of a new common currency. The novelty is not the creation of a monetary union (indeed, as we shall see, these unions have been around for a long time) but rather the sheer size and complexity of its inception.

Monetary union: the basic concepts What is a monetary union? Basically, it is an agreement in which two or more countries agree to a jointly managed monetary policy. As noted by Allen (1976), a monetary union has three minimum requirements.

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First, in any monetary union either there must be a single currency or, if there are several currencies, these currencies must be fully convertible, one into the other, at immutably fixed exchange rates, effectively creating a single currency. Second, as the immutability of fixed exchange rates depends upon mutually consistent monetary policies within the union, there must be an arrangement whereby monetary policy for the union, including control of high-powered money and regulations affecting the commercial banks’ ability to create money, is determined at the union level, leaving no national autonomy in monetary policy. Finally, since there can be only one rate of exchange between an external currency and the union currency, there must be a single external exchangerate policy. Toward this end, the national authorities must relinquish individual control over their international reserves and invest such control in a union authority.6 Some economists prefer to distinguish between a full monetary union and a simple exchange-rate union. The former refers to a situation where ‘all monetary authority is formally centralized in a single supranational agency and separate national moneys are all replaced by a single common currency’. The latter refers to ‘ostensibly freezing mutual currency values but otherwise leaving monetary management largely to the discretion of individual governments’.7 In this paper, I shall use the more general (and encompassing) definition of monetary unions (single effective currency, single monetary policy and single effective exchange rate). The study of monetary unions of the nineteen and twentieth centuries leads to two observations about the institutional arrangements. First, beyond the above three requirements, which represent the bare minimum for a monetary union, various possible institutional models are possible and have been tried. In particular, monetary union arrangements may differ with respect to currency, the central bank and the level of economic and political integration between the union members. For the currency, we have three possible cases. First, we can have a supranational union-wide currency (for example, with the EMU, the euro is the union-wide currency). Another possibility is a national union-wide currency (for example, Switzerland and Liechtenstein both use the Swiss franc and the Swiss National Bank co-ordinates monetary policy). A final solution is to have separate currencies (for example, Belgium and Luxembourg had distinct currencies, with a fixed exchange rate and with both currencies legal tender in both countries). This supposedly immutably fixed exchange rate (in the case of Belgium and Luxembourg, one to one) with full convertibility is equivalent to having one single effective currency. Actually, in the case of Belgium and Luxembourg, the parity did change! From 1929 to 1935, 1 Belgian franc was equal to 1 Luxembourg franc. In 1935, 1 Luxembourg franc was worth 1.25 Belgian francs. After the Second World War, the oneto-one parity was re-established.

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Similarly, for the central banks four cases compatible with a monetary union are also possible. First, we can have a supranational union-wide central bank. For example, with EMU, the ECB is the union-wide central bank making monetary policy and instructing the national central banks to implement it. A second possible arrangement for central banks in a monetary union is to have just one national central bank. Today, for instance, the Swiss National Bank sets monetary policy for Switzerland and Liechtenstein, the latter having also formally adapted its banking practice and legislation to Swiss norms. A third possibility is to have more than one multinational central bank. For instance, the Zone Franc, which covers thirteen former French colonies and one former Spanish colony, has two multinational central banks (now located in Africa). The first one is the Banque Centrale des Etats de 1’Afrique de 1’Ouest (BCEAO) which includes Bénin, Burkina Faso, Côte d’Ivoire, Mali, Niger, Sénégal and Togo, and the second is the Banque des Etats de 1’Afrique Centrale (BEAC) which comprises Cameroun, Congo, Gabon, Guinée Equatoriale, the République Centre-Africaine and Tchad.8These two central banks have (slightly different) agreements with the French government to ensure convertibility with the French franc. The BCEAO issues a single currency for all seven states, while the BEAC issues currencies with distinctive national features that are legal tender throughout the region. The last possible arrangement consists of having as many national central banks as there are members of the monetary union. Each central bank would then follow an appropriate monetary policy consistent with the monetary agreement. This arrangement supposes an intense (and continuous) level of monetary and economic co-operation between the members of the monetary union. More precisely, it works as long as national central banks perceive that their national interest is best served by adopting co-operative behaviour. In the nineteenth century, the Latin monetary union9 and the Scandinavian monetary union were perfect examples of monetary unions with multiple national central banks. As we shall see, both unions collapsed when these independent central banks tried to follow their own monetary policies. The second observation is that, despite good intentions, no monetary union arrangement is cast in stone. Indeed, these arrangements evolve over time. Some countries may leave the monetary union and then come back later (not necessarily under the same conditions). For instance, Mali left the Zone Franc in 1962, then came back in 1967.

Some recent unions The oldest continuing monetary union is the one linking the US and Panama. Since 1904, Panama has pegged its currency (the balboa) to the US dollar. The US dollar is legal tender in Panama and represents the bulk of the money

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Table 2.1 Successful monetary unions

Source: Adapted from Graboyes (1990)

supply. The Banco Nacional de Panama, which is not a central bank, issues balboa (mainly coins). The situation of Belgium and Luxembourg is a second interesting example. As noted above, Belgium and Luxembourg form a monetary union. In fact, they first implemented an economic union (the Union Economique BelgoLuxembourgeoise) beginning in 1921, then proceeded to monetary union. The Belgian franc, which replaced the German mark after World War I, did not have legal tender status in Luxembourg until 1935 (although it did circulate widely in that country from 1919). The Belgian central bank is responsible for monetary policy and this agreement has worked quite well, except in 1982 when Belgium devalued its currency against the wishes of Luxembourg. There were talks of an independent Luxembourg franc, but nothing materialized. Not coincidentally, shortly after that, in 1983, Luxembourg created its own central bank: 1’Institut Monétaire Luxembourgeois (which was later renamed Banque Centrale du Luxembourg).10 Nevertheless, monetary policy has remained firmly in Belgian hands. Although very closely linked to Austria, Liechtenstein officially adopted the Swiss franc in 1924; it had already circulated widely since 1918. It also withdrew legal tender status for all locally issued coins in 1931.11 But things may change with the arrival of the euro.12 A fourth lasting monetary union is the CFA franc zone. CFA means ‘Communauté Financière Africaine’ in the Union Monétaire ouest-africaine,

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and ‘Coopération Financière en Afrique’ in the six countries which are members of the Banque des Etats de 1’Afrique Centrale.13 There is a fixed link between the CFA franc and the French franc: 1 CFA=0.01 French franc. The CFA was devalued (for the first time since 1948) by 50 per cent on 12 January 1994. The causes of this devaluation (advocated by the IMF) were the persistent trade deficits and the secular downward trend in the price of raw materials. Interestingly, after this devaluation, a movement towards a common African market has started to emerge. The Dakar Treaty (January 1994) creates a ‘Union économique et monétaire ouest-africaine’ (UEMOA), while a treaty signed in N’Djamena in March 1994 creates the ‘Communauté économique et monétaire de 1’Afrique centrale’ (CEMAC). So, unlike the European example, the CFA countries had a monetary union prior to proceeding towards an economic union. (See Table 2.1.)

Monetary union: historical examples As noted in the introduction, monetary unions have been around for a long time. Some existed as far back as Ancient Greece14 and during the time of Charlemagne.15 But if there was a golden age of monetary unification, it was the nineteenth century, after the industrial revolution. This was, not coincidentally, the period during which the modern nation-states formed. Among the most famous we find the German monetary union that accompanied the Zollverein (within the German Federation), the Scandinavian monetary union and the Latin monetary union. Of these three, only the German monetary union passed the test of time, as it led to the creation of the Reichmark and the Reichsbank, the precursors of Deutsche mark and the Bundesbank.

A lasting union: German monetary unification In 1990, we witnessed a new episode in the German monetary unification process. The economic collapse of East Germany (1988–9), with its important labour exodus to the West, led to the German Treaty on Monetary, Economic and Social Union (18 May 1990). It was basically an economic absorption of East Germany by West Germany with the monetary unit of the new Germany as the Deutsche mark. The OstMark was converted at the rate of one to one for a Deutsche mark (below a certain threshold, and at the rate of two for one above that threshold). That extremely high conversion rate (indeed, previously, on the black market one Deutsche mark was worth up to ten OstMark) was controversial. On the one hand, it represented a massive transfer of wealth from the West to the East, as well as a competitiveness nightmare for (former) East German firms. On the other hand, this conversion rate was seen by some as an incentive to stem the labour exodus from the

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East to the West. Interestingly, the issues of labour mobility, interregional wealth transfer, conversion rates and competitiveness were already present during the nineteenth century and predate the creation of the modern German state. However, at the time, the monetary situation was much more complex.16 The Vienna Congress (1815) first established the existence of the German Federation (the Deutscher Bund) which was composed of thirty-five independent states and four Free cities. The Bund removed all restrictions on the internal migration of labour and capital in 1815. Within the Bund, Prussia, which had gained some territories (some of them without any common border with the former Prussia), now represented 54 per cent of the population of the Federation.17 It had first to integrate its territories by eliminating internal trade barriers. This is what it did from 1816 to 1821. After that, Prussia set out to establish more customs unions with neighbouring states (1831: Zollverbund). Finally, on 1 January 1834, Prussia formed a customs union (Zollverein)18 with twenty-five other states (excluding Austria), with a common external tariff. With the free movement of factors of production and (internal) free trade, the main obstacle to deeper economic and political integration was the absence of a common currency. The participant states agreed, and one article (Article 14) of the Zollverein Treaty stipulated that ‘governments of the Zollverein states should take action in order to bring their coinage systems on to a common standard’.19 At the time, paper money did not have legal-tender status, although local governments sometimes issued it for fiscal purposes. Paper money was a credit instrument rather than a means of exchange. Coins (especially silver coins)20 represented the majority of the money supply. Each state minted its own coins, with its own denominations, purity and weights. There were even different monetary standards (for instance, in the Northern states (with Prussia) there was the Thaler standard, and in the Southern states (with Austria) there was the Gulden standard). This monopoly on coinage allowed states to charge a fee (‘coinage fee’ or seigniorage) which represented an important share of their fiscal revenues. For instance, for a Thaler, the coinage fee would be ‘the difference between the quantity of silver demanded by the mints in exchange for a Thaler coin and the silver content of the Thaler coin’.21 To compound the monetary complexity of that period, different states charged different coinage fees (between 3 and 6 per cent). A first monetary agreement for the Southern states, the Munich Coinage Treaty, was signed in 1837. This agreement defined common coinage standards, limited the traditional rights to monetary sovereignty by member states, and established legal tender for the Gulden coins. Note that this agreement did not eliminate coinage fees: it just standardized them. In 1838, most members22 of the Zollverein signed the Dresden Coinage Convention. It stipulated that each state had to adopt either the Thaler or the Gulden standard. The link to silver was established through the Cologne Mark (worth 233.855 grams) or 14 Thaler or 24.5 Gulden. Each signatory state had to mint Thaler or Gulden according to a precise silver-specification. Again, coinage fees were not abolished, but instead harmonized.

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In 1842, there was even an attempt to further the ideal of a common currency with the issue of the Vereinsmünze (union coin). It was worth 2 Thaler or 3.5 Gulden. This coin was too heavy to be used by merchants (who preferred banknotes) and too high a denomination for ordinary people. It was more of a curiosity. Austria wanted to join the Zollverein but Prussia derailed its application. Austria and the members of the Zollverein, however, did reach an agreement on currency exchange. This was settled with the 1857 Vienna Coinage Treaty. Austria had wanted to establish the gold standard all over Germany, but this was not accepted, as the silver standard was now dominant. The new basic weight was half a kilo (one Zollpfund). There were now three currencies with a fixed parity to silver. One Zollpfund was equal to 30 Thaler or 52.5 Gulden or 45 Austrian Gulden. The 1857 Vienna Coinage Treaty also tightened the rules on the circulation of small-change coins. A ceiling was placed on the amount each region could issue. Small-change coins did not have legal tender outside the currency area (Thaler, Gulden or Austrian Gulden) to which the issuing state belonged.23 After Prussia’s defeat of Austria (1866), the political unification of Germany started in earnest. Under the leadership of Prussia, the North German Federation24 replaced the German Federation. The Federation outlawed the creation of new fiduciary money by the states. The issuing of banknotes was now essentially the responsibility of the Prussian Bank (created in 1847). After 1871, a unified coinage system was instituted. One Mark was worth a third of a Thaler. It was backed by gold—a move facilitated in part by the receipt of gold reparations payments from France following her defeat in the Franco-Prussian War of 1870.25 All banknotes not denominated in Marks were to be withdrawn by 1 January 1876. The silver Thaler kept its legal tender status until 1907. The final stage of German monetary unification came with the creation of the Reichsbank (January 1876). It was a transformed Prussian Bank, but with more legislative power. The decision to create a ‘General German Reichsbank’ was quite controversial at the time and engendered much (academic and political) debate. The Prussian government opposed the creation because it feared a loss of power, influence and seigniorage. The South German states were in favour because they hoped to use the Reichsbank to take away some monetary power from Prussia.26 In time, the Reichsbank progressively and through successive legislative acts would acquire the monopoly issue of banknotes. Initially, however, there were thirty-three regional note-issuing banks. A final point of interest is that in theory the Reichsbank was subordinated to the government. Indeed, the ‘Banking Act made the Reich’s Chancellor the head of the Reichsbank’. In practice, however, ‘the Reichsbank enjoyed a considerable degree of autonomy and—with minor exceptions— remained free from government interference’.27 This was due to the fact that government could not use the Reichsbank for its fiscal needs.28 Commercial paper, gold, silver and only a small quota of treasury notes essentially made

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up the Reichsbank’s assets. In 1922, the Reichsbank’s autonomy would be established by law.

A less successful union? The Scandinavian monetary union (1873–1920) Denmark, Sweden and Norway share a geographic proximity and some linguistic similarity but they have also had numerous military conflicts. As a result, the establishment of monetary union between these three countries proceeded slowly, with few modifications along the way (after Norway joined on 1 January 1877). Importantly, in contrast to German monetary union, this union was neither part of a grand political scheme to unite these three countries, nor was it a part of a grand plan for an economic union. Around that time, only Norway and Sweden had a customs union (from 1874 to l895).29 At the beginning of the 1860s, the Scandinavian countries were experiencing economic development (for example, the modernization of agriculture and the growth of the electricity, chemical and steel sectors). More trade ensued between the three countries, and accompanying this increase in trade, more transactions in foreign currency. There was a lot of currency inter-circulation and banks accumulated lots of foreign coins. For instance, in the south of Sweden, Danish coins were quite frequently used. However, the complexity and the incompatibility of the denominations and weights between the three currencies pushed the governments to initiate some discussion for currency unification. These discussions started in 1862 and would last ten years. In the meantime, the idea of a universal currency was floated at the Conference Monétaire de Paris (1865), but it remained just an idea. Prior to unification, Denmark, Norway and Sweden had a monetary system based on silver and their basic unit was the Thaler. But one Norwegian Thaler was equal to two Danish or four Swedish Thalers. To further complicate the matter, the Norwegian Thaler was divided into 120 Schillings, while the Danish Thaler was divided into 6 Marks (with each Mark worth 16 Schillings), while only the Swedish Thaler had a decimal division into 100 Oere.30 Politically, it was impossible for Denmark to adopt the German system (especially after the military defeat of 1864, when Denmark lost two-fifths of its territory to Prussia), and the Germans were not interested in any association with the Danish.31 Denmark and Sweden considered joining the Latin monetary union. However, the bimetallic standard of the Latin union was not practical for the Scandinavians. Economically, it was tempting to adopt a gold standard, as England and Germany had done (1871). The Scandinavian monetary union opted for a decimal gold standard in 1872.32 The Convention called for the creation of a new common currency unit, the Krone (Krona). Each country was allowed to mint gold coins of 10 and 20 Kr as well as subsidiary coins of 2 and 1 Kr, 50, 25 and 10 Oere.

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Denmark and Sweden signed the Convention in 1873. However, the Norwegian parliament rejected the deal in a close vote. Norway would nevertheless join the Convention by signing a treaty in 1875, after having adopted a gold standard and a new currency, the Norwegian Krona. There were no limits placed on minting of subsidiary coins, which were legal tender in all three countries (Article 9). Subsidiary coins had a metal value lower than the nominal value. According to the Convention, each country was obliged, upon request of another country, to exchange its subsidiary coins for gold, thereby eliminating the temptation to over-issue subsidiary coins. Paper money represented an important share of the money supply (52 per cent in Denmark, 70 per cent in Sweden and 74 per cent in Norway in 1885)33 and was convertible. Each country’s central bank accepted banknotes from the other two countries at parity immediately after the beginning of the Convention. The Bank of Sweden and the Bank of Norway would later formalize this unwritten agreement in 1894, and in 1901 the Bank of Denmark and the Bank of Norway would do the same. The three central banks established a compensation mechanism in 1888. Each debtor country had to repay the other two in gold, or by draft. By the end of the nineteenth century, the Scandinavian monetary union was very successful: gold coins, banknotes and subsidiary coins circulated in the three countries and were accepted at par. Unfortunately, the union did not survive the divergences in monetary policy caused by the First World War. Even though all three countries were neutral, they were differently affected by hostilities. Norway was closely linked to Great Britain, while Denmark did quite a lot of trade with Germany, and Sweden was the most neutral, trading with both belligerents. At the start of the war, the Scandinavian countries suspended the convertibility of their notes, as did many other European countries. This in effect allowed countries to inflate their currencies to support wartime expenditures. Norway and Denmark expanded the currency in circulation at a more rapid rate than did Sweden.34 But the story is more complicated than a simple inflation tax. Because currency circulated in the three countries, this was akin to an attempt to free-ride, as the cost of inflation would ultimately be shared by the three countries, while the benefits accrued mainly to the country over-issuing currency. As we shall see, this put an unacceptable strain on the Scandinavian monetary union. First, to keep inflation in check, in October 1915 the Bank of Sweden (the Riksbank) stopped accepting Danish banknotes at par. In December 1915, it also refused to accept Norwegian notes at par. Initially the depreciation rate was around 2 or 3 per cent. By 1920, however, the rate of depreciation against the Swedish Krona was 22.95 per cent for the Danish Krona, and 19.25 per cent on the Norwegian Krona.35 Note that gold coins and subsidiary coins still circulated at par; therefore, it was possible to exchange them for Swedish banknotes, then arbitrage back into Norwegian (or Danish) banknotes and realize a small profit.

Table 2.2 Common characteristics between German : monetary unification and the EMU

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Second, in February 1916 Sweden exempted the Riksbank and the Swedish Royal Mint from the duty of buying gold or coining it. Due to exports to the belligerents, the amount of gold in Sweden had dramatically increased.36 At the same time, the Swedish Riksbank was obliged to buy gold from Scandinavians at a price higher than it could get on the world market. To be exact, the Swedish embargo placed upon gold was ‘only an exemption of the Riksbank and the Royal Mint from the duty of introducing imported gold into the Swedish monetary system’.37 Initially, this ban did not affect interScandinavian gold exports, as gold coins from each country had legal tender in the other two. The same was true for Denmark and Norway. This led to arbitrage (with the use of depreciated Norwegian or Danish banknotes) and after a few failed attempts at co-operation between the three central banks, in the summer of 1917, the Swedish gold embargo became national. This effectively ended the monetary union. The last chapter of the monetary union involved the role of the subsidiary coins. They were still legal tender at par. Because the Norwegian and Danish Krona traded at a discount, some arbitrage was possible. By 1924, one Swedish Krona was worth 1.87 Norwegian Krona or 1.59 Danish Krona. Denmark and Norway were exporting massive amounts of these small coins, but again this could not last, and indeed, in 1924 legal tender status was limited to the currency of the issuing country. Although the 1872 Convention has never been formally denounced, 1924 effectively marks the end of the Scandinavian monetary union.

Conclusion German monetary unification and the Scandinavian monetary union evolved very differently. As it should be clear, one was part of a grand political project (the overall political and economic unification of Germany), while the other was not. Therefore, no attempt is made here to compare them. However, both can provide useful lessons for EMU. From the German experiment, monetary unification proceeded slowly, accompanying the expanding customs union led by Prussia. Initially started as a standardization of a complex coin system, it progressively evolved into the creation of a common currency. An interesting observation here is that the process started well before the creation of modern Germany. Actually, German monetary unification was all but complete before the final political unification (the 1871 Reich led by Prussia). However, it should be noted that, especially after 1857, Prussia was already playing a leading role in German monetary unification. Both nineteenth-century German monetary unification and European economic and monetary union started after a customs union was in place.38 Table 2.2 shows the similarities between German monetary unification and EMU. The main lesson of the Scandinavian monetary union is that co-operation between central banks and the economic similarity between countries may

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well be necessary conditions for a successful (and lasting) monetary union. They did not seem to be sufficient conditions for Scandinavia. Indeed, when a crisis (in this instance, World War I) came, the lack of a supranational institution for monetary policy led each country to try its own non-cooperative path. This is a classic case of a prisoner’s dilemma, as co-operation is the optimal solution only if every player perceives that there will be a repeated game, otherwise non-co-operative behaviour is the dominant strategy. Does the creation of the independent supranational European Central Bank solve this co-operation problem? It is too early to tell. First, in the twentyfirst century, central banking has changed radically. We are now in a world of fiat money, in contrast to a gold or silver standard. Price stability is now the main concern. Second, the ECB will still have to be accountable for its actions even though it is ‘independent’. How will it handle the various regional economic conditions of Europe? Specifically, how will a tight monetary policy affect an economically depressed region? Will the ECB be able to resist calls for ‘distinctive’ national macroeconomic-monetary policies? The capacity of the ECB to address these issues will be the true test for its survival and that of EMU. Could built-in fiscal stabilizers be the answer to accommodate the various regional economic conditions of Europe? This is unlikely for two reasons. First, the Maastricht Treaty (Article 104[c]) commits each country to limit its public sector deficit to a maximum of 3 per cent of the gross domestic product. Only under very special circumstances (such as a natural catastrophe or a severe recession) could a country exceed that limit. Second, at the European level, there is currently very little appetite for a common fiscal policy. Therefore, financial transfers to economically depressed regions are likely to remain quantitatively very limited. On this issue, the past experience of German unification is quite telling. The central government started to play an important fiscal role only after the First World War. It was only after forty years of successful co-operation that the Scandinavian monetary union started to disintegrate, so it is difficult to predict the evolution of the political landscape in Europe for even the next ten years. Consequently, there are definite limits to what we can predict for EMU based on any preexisting monetary union in Europe.

Notes 1 This is an updated version of a paper first published in the Journal for Institutional Innovation, Development and Transition (vol. 4, 2000, pp. 35–4). An earlier draft of this paper was presented at the Third International Conference ‘Institutions in Transition’ organized by the Institute of Macroeconomic Analysis and Development, Maribor, Slovenia, 8–9 October 1999. 2 Denmark, Greece, Sweden and the United Kingdom have not taken part in this first round. Greece, which did not initially meet the Maastricht Treaty criteria (on public finance, inflation and interest rate convergence), adopted the euro on

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3

4 5

6 7 8 9

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

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1 January 2001. Denmark, Sweden and the United Kingdom, which met the Maastricht Treaty’s criteria, have voluntarily elected to remain outside the eurogroup for the present time. A currency board stabilizes the exchange rate of a currency by guaranteeing that the domestic currency issued is fully backed by foreign exchange reserves. It cannot be considered as a monetary union because it does not satisfy our criteria. In particular, a currency board does not imply a common monetary policy. Obstfeld 1998, p. 14. The economic importance of central bank independence has received a lot of attention from economists over the last decade. Alesina and Summers (1993) and Cukierman et al. (1992), among others, have identified a negative correlation between various indicators of central bank independence and long-run industrial countries’ inflation rates. The link between economic growth and central bank independence is less clear, see nevertheless Cukierman and Webb (1995). For an overview of the political economy of central bank independence, see Eijffinger and De Haan (1996). Allen 1976, pp. 4–5. Cohen 1998, p. 68. To further complicate matters, the République des Comores (in the Indian Ocean) is part of the Zone Franc, but has its own central bank and its own currency. The Latin monetary union comprised France, Belgium, Switzerland, Italy and (later) Greece. It was an ambitious project to regulate exchange rates, based on a bimetallic standard during the period 1865–1920. However, the enforcement mechanism was very weak and this encouraged some central banks to over-issue silver currency (after the drop in the relative price of silver). These problems were compounded by the financial demands of the war. It effectively collapsed shortly thereafter. See Flandreau (1993) and Vanthoor (1996, pp. 31–7). On a related issue, Belgium and Luxembourg show that it is possible for two countries with diametrically opposed fiscal policies to have an economic union and a monetary union. Olszak 1996, pp. 58–9. ‘Even in Liechtenstein, where Swiss francs line citizens’ pockets, the new currency may prove hard to resist for those who trade with neighbouring Austria and other parts of euroland’ (The Economist, 9 January 1999, p. 48). CFA used to mean ‘Colonies françaises d’Afrique’. Graboyesl990,p. 8. Olszak 1996, pp. 4–5. The details on what follows are drawn from Holtfrerich (1989, 1993), James (1997), Mahant and de Vanssay (1996) and Olszak (1996). Mahant and de Vanssay 1996, p. 172. Actually, it qualifies as a ‘common market’ because of the freedom of movement of factors of production. On the respective roles of factor mobility and trade, see Mundell (1957). Holtfrerich 1989, p. 220. Only Bremen adopted the gold standard in Germany. Holtfrerich 1989, p. 218. In 1842, Luxembourg joined the Zollverein but refused to adopt the Dresden Coinage Convention. Holtfrerich 1989, p. 224, and James 1997, p. 5. In 1871, the South German States joined in to form the German Reich. James 1997, p. 9, and Vanthoor 1996, pp. 22–3. As noted by James 1997, p. 14:

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There is a precise analogy in this respect to the contemporary argument made in France and Mediterranean Europe that the monetary policy of Europe is already effectively made by the German Bundesbank and that the creation of a European central bank is the only practical way for Germany’s partners to achieve influence over monetary policy. 27 Holtfrerich 1989, p. 233, and Vanthoor 1996, pp. 25–6. 28 Today, the Maastricht Treaty (Article 104[1]) also prevents the ESCB from monetizing public debt. 29 The details on what follows are drawn from Bergman et al. (1993), Heckscher et al. (1930), Lester (1939) and Olszak (1996). 30 Olszak 1996, p. 70. 31 Bergman et al 1993, p. 508, footnote 2. 32 The Scandinavian return to the gold standard would be later copied by the Netherlands’ (1873), Austria’s (1879) and India’s (1893). See Lester 1939, pp. 175–6. 33 Olszak 1996, p. 76. 34 Lester 1939, p. 179, and Bergman et al 1993, p. 515. 35 Bergman et al 1993, p. 514. 36 Heckscher et al 1930, pp. 185–6. 37 Heckscher et al 1930, p. 190. 38 Nevertheless, as we have seen, this is not a necessary condition. In Africa, the CFA zone predates the as yet non-existent customs union.

Bibliography Alesina, A. and Summers, L.H. (1993) ‘Central bank independence and macroeconomic performance: some empirical evidence’, Journal of Money, Credit and Banking 25:151–62. Allen, P.R. (1976) Organization and Administration of a Monetary Union, Princeton: Princeton University Press. Bergman, M., Gerlach, S. and Jonung, L. (1993) ‘The rise and fall of the Scandinavian Currency Union (1873–1920)’, European Economic Review 37:507–17. Cohen, B. (1998) The Geography of Money, Ithaca: Cornell University Press. Cukierman, A. and Webb, S.B. (1995) ‘Political influence on the central bank: international evidence’, World Bank Economic Review 9:397–423. Cukierman, A., Webb, S.B. and Neyapti, B. (1992) ‘Measuring the independence of central banks and its effects on policy outcomes’, World Bank Economic Review 6: 353–98. Eijffinger, S.C.W. and De Haan, J. (1996) The Political Economy of Central Bank Independence, Special Papers in International Economics no. 19, Princeton: Princeton University Press. Flandreau, M. (1993) ‘On the inflationary bias of common currencies: the Latin Union puzzle’, European Economic Review 37:501–6. Graboyes, R.F. (1990). ‘The EMU: forerunners and durability’, Economic Review (Fed. Reserve Bank of Richmond) July/August: 8–17. Heckscher, E.F., Bergendal, K., Keilhau, W. and Thorsteinsson, T. (1930) Sweden, Norway, Denmark and Iceland in the World War, New Haven: Yale University Press. Holtfrerich, C.-L. (1989) The monetary unification process in 19th-century Germany: relevance and lessons for Europe today’, in M.De Cecco and A.Giovannini (eds) A

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European Central Bank? Perspectives on monetary unification after ten years of the EMS, Cambridge: Cambridge University Press (pp. 216–41). ——(1993) ‘Did monetary unification precede or follow political unification of Germany in the 19th century?’ European Economic Review 37:518–24. James, H. (1997) Monetary and Fiscal Unification in Nineteenth-Century Germany: What Can Kohl Learn from Bismarck? Essays in International Finance no. 202, Princeton: Princeton University Press. Lester, R.A. (1939) Monetary Experiments: Early American and Recent Scandinavian, Princeton: Princeton University Press. Mahant, E.E. and de Vanssay, X. (1996) ‘Preferential trading arrangements’, in C.Paraskevopoulos, R.Grinspum and G.Eaton (eds) Economic Integration in the Americas, Cheltenham: Edward Elgar (pp. 169–81). Mundell, R.A. (1957) ‘International trade and factor mobility’, American Economic Review 47(3) (June): 321–35. Obstfeld, M. (1998) ‘The global capital market: benefactor or menace’, Journal of Economic Perspectives 12(4): 9–30. Olszak, N. (1996) Histoire des Unions Monétaires, Paris: Presses Universitaires de France. Vanthoor, W.F.V. (1996) European Monetary Union since 1848: a political and historical analysis, Brookfield, VT: Edward Elgar.

3

Monetary unification under the French monarchy T.J.A.Le Goff

This chapter examines the emergence of a national currency in France before 1789 and the reasons for this transformation. The first part briefly describes the rise of a primitive royal currency based on coins and money of account, down to the early seventeenth century. The second part analyses the changes in this system during the period from about 1630 to 1726, when the French livre gradually took on the stability characteristic of money in a currency union, and the third part discusses the reasons for this change.

The emergence of a royal currency (to c. 1630) The currency used under the French monarchy developed over several centuries, as did the lands and powers of the monarchy itself. The territorial unit we think of as ‘France’ only assumed a durable shape in something like its present form towards the end of the fifteenth century; and the powers of Louis XIV at the end of the seventeenth century were vastly different to those of a feudal monarch like Saint Louis at the end of the thirteenth. There is, however, a thread which runs through the history of the old monetary system which has some analogy with the creation of the euro: the strong dose of political motivation which accompanied the evolution of the French currency, even though fiscal and economic reasons also shaped its outcome. As with the creation of the euro, a monetary policy was in part a means to a political end. The monetary unification of the monarchy took place in stages. In examining these stages, we might keep in mind the criteria of a valid monetary union as Xavier de Vanssay’s paper in this collection expresses them: a ‘single effective currency, single monetary policy and single effective exchange rate’.1 In the initial stages of unification, the French king imposed the primacy—not the monopoly—of the French king’s currency over that of states absorbed into his lands, over the local currencies of feudal barons and powerful churchmen inside the realm, and over foreign currencies. Something like this was achieved momentarily by Charlemagne (ruled 768–814) and his immediate successors, but in the context of an extremely primitive economy, and eventually it collapsed along with the vast Carolingian empire. A second 42

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high point came in the thirteenth century, when Louis IX (Saint Louis; reigned 1226–70) proclaimed his own currency, the heavy silver gros and the golden guinea (écu), as the default currency. Three powerful feudal kings, Philip III the Bold (1270–85), Philip IV the Fair (1285–1314) and Louis X the Quarrelsome (1289–1316) nearly managed to turn these monies into a proper legal currency, but the Hundred Years War (1348–1453) intervened to postpone that event another century until the reign of Charles VII (1422– 61), who was also the first monarch to establish a regular annual tax, in 1445.2 It would be wrong, however, to think that France now had a national currency. Instead, we might better view this period as the EMS epoch of the French currency, vaguely analogous to the attempts from 1979 onwards to impose on Europe a common unit of currency, the ECU, based on a basket of currencies. The money supply in Charles VII’s day was still very basic: only coins and some primitive forms of credit. After the king took over Touraine in 1205, the crown recognised two systems of currency, the livre (pound) of Tours (livre tournois) and the livre of Paris (livre parisis), the latter worth 25 per cent more than the former. The livre of Tours became the king’s official currency, but, for obscure fiscal reasons,3 the livre parisis retained legal status for over four centuries longer. Foreign currencies were common on French soil; as late as 1636, a check of the royal treasury discovered that nearly onethird of the cash held was in foreign coin; another audit in the same year found practically nothing but foreign coin.4 There were multiple exchange rates: official rates maintained at the treasury for the exchange of gold and silver, and unofficial rates used among merchants.5 Finally, during most of the monarchy’s history, the official unit of currency was what is now known as a ‘money of account’.

The transformation to a unified currency after 1636 The French king, of course, minted coins of varying weights and metallic content. In the eighteenth century, the best-known gold coins were the louis, worth 24 livres, the double louis and the demi-louis (a name also applied irreverently to one of Louis XV’s bastards).6 The standard silver coin was the silver guinea (écu or louis d’argent), worth 3 livres, also with analogous multiples and subdivisions.7 Although this looks like a modern currency system, appearances are deceptive. In reality, the gold and silver coins depended for their assigned value on the will of the king. This becomes apparent when we examine one of these handsome pieces. Take, for example the silver demi-écu of 1729. Typically, the face bears an image of the monarch’s bust, in profile, and an identifying inscription: Lud[ovicus] XV D[ei] G[ratia] Fr[anciæ] et Nav[arræ] Rex—‘Louis XV, by Grace of God, King of France and Navarre’. On the reverse appears, beneath a crown, a shield bearing three fleurs-de-lys, surrounded by a laurel wreath, with the

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inscription Sit nomen domini benedictum—‘Blessed be the name of the Lord’.8 The piece has a slightly larger dose of theology than most modern coins, but the big difference is that it bears no denomination. Neither did any of the king’s other coins that were minted of precious metal. With good reason: in France, as in many other European countries before the nineteenth century, the basic units of French currency were not these pieces, but a theoretical unit, known technically as a money of account. In France, this unit was the ‘livre’, from the same root as the Latin equivalent of the English ‘pound’ (libra); it was also referred to as the ‘franc’.9 The livre itself was divided into twenty sous, each sou itself worth twelve deniers, just as in the old British duodecimal system, with its pounds, shillings and pence. The sous and deniers were represented by real physical coins: in the eighteenth century the usual small change consisted of two silver alloy coins, the 2-sou and 1s 6d piece, plus several brass pieces: a 1-sou piece, a sixpence and a threepenny bit.10 The main point is that there was no livre coin that you could put in your pocket: instead you had to content yourself with a clutch of small change, or, if you had several livres to carry around, with a gold louis, a silver écu, and so on. You did this at some risk, however, because the king could change, with a stroke of the pen, the relation of these gold or silver coins to the livre. Here then was a reason why these coins had no denomination: this omission allowed the king to change their value without embarrassment. He could do so because the livre and its subdivisions, rather than any of the coins circulating in France, were, by law, the way in which debts, contracts, taxes or interest on state debt were stipulated.11 To pursue the analogy with the EMS, we might say that it was as if, some time in the early 1990s, Jacques Delors, sitting in Brussels, could have pegged the ECU at whatever rate he wanted to all the different European currencies and made his decision stick, because he had cunningly arranged for all European contracts, debts and legal instruments to be specified in ECUs rather than francs, marks, pesetas and the like. The king could change the livre value of the coins in three ways. The most obvious was to recall them to his mints, have them melted down or simply over-struck, and reissue them, declaring that each new coin was now worth more or less than its earlier version. The king usually carried out reminting when he wanted to make the coins worth more livres than before, in which case he was effectively devaluing the livre in relation to gold and silver. In the process, the king could levy a commission on the operation, called seigniorage (seigneuriage), as well as keep back some of the precious metal for himself. The second method was simply to declare by Order in Council (arrêt du Conseil) that the livre equivalent of coins was to be changed. This method was usually employed to revalue the livre, in which case the king would declare each coin to be worth fewer livres than before. In either event, the king might carry out a third operation, in which he changed the relation to each other of the two precious metals used in minting, declaring that a given weight of gold was to be worth more or less in terms of silver. The

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king’s right to define the relative value of the three currencies—gold and silver coins whose minting was his monopoly, and the livre money of account—made him, in theory, the master of domestic monetary policy and the arbiter of foreign exchange. This was only in theory, however: when we examine the fluctuation of the livre in late medieval and early modern times (see Figures 3.1 and 3.2) we may well ask how much real control the monarch exercised over his currency. It seems clear that the most pressing reason for the livre’s fluctuations through the medieval period was the king’s need for revenue. Until the middle of the fifteenth century, when the French monarchs gained the right to extract taxes on a regular basis from their subjects, their income came from their own estate revenues, occasional taxation, booty and—most important for our concerns here—manipulation of the coinage so as to leave the king with a portion of the precious metal used in the coins. This can be considered a universal tax on savings. For this reason alone, the livre became worth less and less in terms of precious metal over the centuries. Political choice caused this: the choice by the Capetians, Valois and Bourbons to make war and expand their domains—though one may wonder how much ‘choice’ there was to do otherwise, given the ruthless struggles of the time. Pressures other than sheer need might also induce the king to alter the silver and gold content of the livre. Shortages of precious metal in the economy, particularly in the medieval period, could force a king to debase coin just so that his subjects might have enough currency for ordinary transactions. Sometimes these shortages resulted from shifts in the relative availability in Europe of gold and silver or even of the copper used to mint sous and deniers. The ratio struck between silver and gold was called the ‘bimetallic ratio’; through the eighteenth and nineteenth centuries, for example, it stood at roughly 15.5 to 1, but in preceding centuries, when silver had been less abundant in Europe, it had been much lower (see Figure 3.1).12 In reality, there was not one ‘bimetallic ratio’ but two: one set officially by the king, and one set by the market outside and inside the country. It was up to the king to keep his own rates in rough agreement with the market rate; if he did not, the silver stock or the gold stock of the country might be shipped abroad, or disappear into holes dug under apple trees. Some writers have claimed that once the monarchy established regular taxation at the end of the fifteenth century, the political imperative for currency adjustments was eclipsed by these technical considerations. According to one authority ‘the reasons for a weaker currency were [now] no longer political, but generally economic: they were a result of the very nature of metallic currency, and the imperfections of the bimetallic system’.13 This was never completely true, but it did come close to being reality during the sixteenth century and during the first three-quarters of the seventeenth century. From the beginning of the sixteenth century, gold and—after midcentury—silver flooded into Europe, upsetting the usual balance between the stocks of silver and gold coins. During the sixteenth century, as well,

Figure 3.1 Long-term depreciation of the livre tournois (official rates)

Figure 3.2 The livre tournois, 1651–1726 (official rates)

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dynamic population growth pushed up the prices of foodstuffs and commodities in general. All of this made the value of the currency very unstable. Those who managed the king’s monetary policy wanted to keep enough coins in the economy to allow normal exchanges. Broadly speaking, they saw two obstacles to maintaining this stock. The first was the flight abroad of good coin—usually gold—in search of other coin—usually silver, whose increasing abundance in Europe created gaps between the official rate at which gold and silver coins were supposed to be exchanged in France and the effective price of silver and silver coins in terms of gold on the unofficial market in France or abroad. The second was the reflux into France of foreign coins which could be purchased more cheaply abroad or in the numerous enclaves which still dotted French territory (Avignon, Orange, Monaco and so forth). The English writer Sir Thomas Gresham (1519–79) described the phenomenon so neatly that it became Gresham’s Law: ‘bad money drives out good money’. The presence of foreign coinage on native soil was perceived as an insult to the king’s sovereignty as well as lost revenue for royal mints. Moreover, foreign coinage provided ready material for private entrepreneurs to forge, debase and mutilate. But even when the foreign coin was perfectly sound, the multiplicity of its forms caused disputes and confusion among those who had to use it. The logical remedy for these ills, we might think, would be for French officials to devalue their superabundant silver in terms of gold and possibly to devalue the fictitious livre tournois against one or both of the two precious metals. Ideally, that would bring the value of French silver coin into line with that of other nations, and cheapen French silver to the point where it was no longer advantageous to import it. But the officials in charge of the monetary system had an inadequate theoretical understanding of the way currency systems worked (many thought that natural law decreed a fixed bimetallic ratio), to devalue was to dishonour the king, and in any event the results were unpredictable.14 So they were cautious. As one expert has written, ‘the major preoccupation of those in power…seems indeed to have been…to avoid as much as possible devaluing the livre tournois’.15 As a result, French officials found themselves every few years with an over-valued currency. Faced with an increasingly dramatic gulf between official and real rates for French currency and silver, they would eventually be forced, unwillingly, to devalue. Of course, these royal servants were aware that devaluation had other effects, many of them beneficial.16 But although the monarchy had both political and economic purposes behind its monetary policy, it had not worked out how to attain them. A comparison of the pattern of devaluation in the sixteenth and most of the seventeenth century with what came subsequently (Figures 3.1 and 3.2) leaves the distinct impression of a state reacting to monetary events rather than acting on them. The frequency and intensity of these currency crises abated somewhat after 1636, though there were devaluations again in 1640–1, 1652–6, and

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again in 1666. This period mostly corresponds to the rule of the mature Louis XIII and the ministry of Cardinal Richelieu (1626–42), the rule of the young Louis XIV and his first minister Cardinal Mazarin (1643–61). This was a time of great social turbulence in which the Bourbon monarchs gradually imposed absolute rule on the country. Perhaps the constant threat of social upheaval deterred those responsible for the king’s finances from undue tinkering with the currency. Nevertheless, they struggled in a hit-or-miss way to regain control. One aspect of this struggle was the elimination of foreign coinage on French territory. Part of this change was due to technical progress and intelligent imitation. In 1640 and 1641, the monarchy ordered the conversion of all foreign gold and silver coins, and created the gold louis and the silver écu. As most foreign coins in France were of Spanish origin, the new coins were French imitations of the golden Spanish doubloon (or pistole), and the silver eight-real coin. These coins were made by the balancier, a machine which speeded up coinage and made coins more handsome and uniform than Spanish and previous French issues. In 1645, it was decreed that all future coinages would be done by machine, and the use of the balancier spread to the various royal mints.17 These measures did not eliminate all foreign coin usage, but they were a step in that direction. What did the officials have in mind? Jean-Baptiste Colbert, the official mainly responsible for financial policy from 1661 until his death in 1683, seems to have shared the same ideas as his predecessors in this as in other economic matters.18 Like them, he believed that an abundance of gold and silver coinage in the kingdom (another way of wanting a favourable balance of trade) was good for the economy and therefore for state revenue. One of his main justifications for his ‘mercantilist’ industrial policy which aimed to encourage exports and restrict imports by higher tariffs was the need to increase the money supply in France.19 And as with Colbert’s predecessors, political considerations were mixed in with economic motives: he considered the mere presence of foreign coins inside France an affront to the king’s majesty. Nothing [he wrote] marks more the dignity and greatness of a State than uniformity in coinage, and…the first sign of decline in that greatness and dignity is in a fall in the value of money and different rates for it in each province.20 Like all his contemporaries in power elsewhere in Europe, Colbert tried to maintain an abundant supply of coinage and precious metal in the kingdom. Once he obtained power under Louis XIV’s personal rule from 1661 onwards, however, Colbert showed more persistence than his predecessors in the pursuit of this aim. He struggled to get control of the money supply into the hands of the state, and succeeded in doing so because of the greater authority of the state to which he himself contributed so much. This meant, first of all, simplifying the range of currency options available to the French. The livre

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tournois’ old rival money of account, the livre parisis, was abolished in 1677.21 Colbert made a determined effort to force the conversion or elimination of the various parallel forms of small change and foreign coins circulating in France22 and tried to eliminate parallel markets in foreign currency and gold and silver.23 The counterpart to this was, eventually, to outlaw the export of French silver and gold coins; Colbert even demanded at one point that French troops serving abroad should bring the coins in which they were paid back home with them.24 There were potential contradictions between Colbert’s economic and political aims. Particularly at the start, it must have been difficult to pursue monetary expansion within France while carrying out a forced liquidation and conversion of the massive state debt left over from Richelieu and Mazarin’s long struggle with Spain and Austria, because such brutal moves tended to drive up the interest rate.25 More pertinently, to outlaw parallel and foreign currency was, in practical and short-range terms, to reduce, not increase, the money supply. To compensate for this, the second thrust of his policy was to attract uncoined silver into France, and to induce French holders of foreign coin or precious metals to convert them to French coin at the royal mints. This meant making it possible for silver to buy more livres in one way or another. In 1663, Colbert eliminated tariffs on the import of silver bars and ingots26 and freed the trade in gold and silver inside France;27 he also made a new mint in Marseilles available to potential sellers of precious metal.28 All this made it easier and more attractive to import precious metals and sell them to the king. For the same reason, in 1679 Colbert eliminated the king’s profits from seigniorage on foreign gold and silver coin brought to the mint. Table 3.1 Proportion of foreign coins hoarded within the 1610 frontiers of France during different reigns

Source: Adapted from Droulers, Les Trésors de monnaies, passim. Note The period at which the hoards were hidden away can be estimated approximately from the effigy on the most recent coins in each hoard.

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By sacrificing the state’s profit on the operation, he was subsidising the price paid for precious metal used in coinage.29 The most important single step Colbert undertook, however, was his revaluation of 1666.30 In two measures that year, he managed by trial and error to revalue the livre against gold and gold against silver. In this Colbert drew the lesson from French experience with the bimetallic ratio over the previous half-century, when administrators had learned the folly of holding on to an unrealistically low bimetallic ratio.31 The result had been a steady speculative influx of Spanish silver coins to France, but only to purchase French gold, which would then be exported from France to Spain in order to buy yet more cheap silver for re-import to France. Now Colbert lowered the bimetallic ratio to a level comparable to the Spanish rate of 15:1 for the first time—a level at which it was to remain by and large until the Revolution (see Figures 3.1 and 3.2). This re-jigging of the bimetallic ratio compensated for the otherwise deflationary effect inside France of revaluing the livre against precious metals, but the more expensive livre meant that the state could demand more silver and gold in payment for the same amount of taxes. Because Colbert hit on the right combination of the two rates in the circumstances of the time, the livre enjoyed twenty years of stability. In all this, he had political as well as economic goals, and it is said, not incorrectly, that it was the growth of administrative centralisation and state power that made them attainable.32 Of course, these actions were not perfect solutions. The French economy was a relatively open economy, and even Colbert’s strong-arm techniques never completely cut off inflows and outflows of silver and gold. But his measures seem to have created enough friction in the system to give the French king control over a mostly ‘national’ mass of standardised currency. We know, for example, that audits of the French treasury in 1701 and 1713 found no foreign currency on hand, unlike similar inspections in the first third of the seventeenth century33 Further evidence of Colbert’s success comes from a compilation of data on hoards of French coins discovered from 1806 to 1978.34 Using this information, I have worked out the proportion of hoards discovered within the 1610 frontiers of France which contained foreign coins. The reign of Louis XIV stands in clear contrast to the earlier periods. Before 1643, over half the hoards contained foreign coins; under the ‘Sun King’ only a fifth of hoards had them (see Table 3.1). Louis XIV’s reign thus marks an important stage in the transition to a national currency. This transition was more than just a prestige operation. A state which could control the inflow and outflow of its own currency could dictate to some degree the terms on which it could be bought and sold and hence the rate of interest, at least within the relatively narrow circle of those who lent money to the state, and perhaps beyond this group’s limits. Colbert was probably aware of this benefit; certainly he made it possible for his successors to press the currency into service after 1689 to help finance Louis XIV’s last two long and extraordinarily expensive wars. When we observe the pattern of the livre’s fluctuations during and after these wars in Figures 3.1 and 3.2,

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two things are immediately apparent. 35 One is the frequency of the devaluations/revaluations. There were no fewer than five devaluations followed by revaluations in the quarter-century before 1713 (1689, 1693, 1700–1, 1704, 1709). The second is the way in which the currency shifts were deliberately managed. In the period 1689–1726, the currency crises were successfully orchestrated and managed by the monarchy, for the purpose of creating windfall income and manipulating the money supply and interest rates. The creation of currency windfalls under Louis XIV took the form of a cycle (Figure 3.2). It began with the issuance of a solemn edict calling in coins and reissuing them with less silver or gold content, but with the same livre equivalence as before. 36 This amounted to devaluing the livre. The government could gain on the operation: it could keep back some of the new coin to pay its creditors, and collect seigniorage on the new minting. The sums realised on Louis XIV’s devaluations were considerable, of the same order as the revenue from an entire year’s direct taxes.37 And if the king chose to pay back some of his debts in hard cash, those liabilities were stipulated in livres, the money of account, and cost fewer coins than before. Subsequently, either in the same year or at a later date, the king would revalue the livre by a simple Order in Council, making it worth more silver and gold coins again. A revaluation on the heels of a devaluation also ensured that the king would get more or less the same amount of hard currency as before the initial devaluation when his subjects paid their taxes. Fiscal calculations of this kind underlay all the devaluation-revaluation cycles of Louis XIV’s later reign. Devaluation-revaluation cycles such as these also affected the money supply, and thereby the exchange value of the livre against foreign currencies. In the short run, holders of cash, having learned that revaluations often signalled an impending devaluation, might hoard the old coins and continue to hang on to them, or send them abroad after the devaluation, despite the threat of penalties. One purpose of revaluing on the heels of a devaluation seems to have been to discourage such speculation. Thus, after a recoinage and devaluation of -4.3 per cent in April 1701, the merchants in Marseilles, Lyons and Paris complained in June that hard currency was fleeing abroad.38 A rapid revaluation of 9.3 per cent appears to have been in part an attempt at a remedy. These concertina-like movements of the money supply were also deliberately designed to facilitate state debt management, particularly at the end of wars. For example, the devaluations of 1700 and 1701 came on the tail of a big refinancing of state annuities associated with the Peace of Ryswick (1697). At that point, the government wanted to buy back securities it had sold during the war at official rates of up to 7.4 per cent. In order to finance their redemption, it offered the holders new securities at a peacetime rate of 5 per cent, but to make the new rentes attractive it had to drive down the interest rate in the larger economy. Timely devaluations of

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the livre in 1700–1 ought, at least in principle, to have increased the money supply by multiplying the money stock. In 1708, Louis XIV’s controllergeneral Nicolas Desmaretz conducted monthly devaluations of the livre, in order to force holders of ‘assignations’ on current revenue (a form of shortterm state debt) to exchange their paper for similar certificates issued on the next year’s revalued revenues, rather than demand their cash back from the state right away. Then with current tax receipts freed from the claims of these creditors, he was able to raise further loans to finance military operations.39 It seems likely that the long stepwise revaluation which Desmaretz began in 1712 and which only ended with a massive devaluation after Louis XIV’s death, at the end of 1715, had an analogous purpose: to encourage holders of state short-term debt to hold on to their securities in anticipation of repayment in more valuable currency later on, countering fears of the customary post-war financial crisis and collapse of government funds. Finally, as the long-term movement of the livre was generally downward, devaluation was a way for the state to reduce its long-term indebtedness across several generations. In short, state manipulation of the currency was an instrument of monetary and financial as well as of fiscal policy. That the king could do this with relative impunity was a measure of how much more powerful the monarchy had become by the end of the seventeenth century. It has been suggested that this flurry of currency devaluation around the beginning of the eighteenth century was an attempt to make up for a chronic Europe-wide currency shortage caused by a slowdown in the rate of shipments of precious metals, a shortage exacerbated in France by the absence of a banking system.40 A further extension of this idea appears in Daniel Dessert’s work, the most far-ranging study of Louis XIV’s financial system to be published so far. In Dessert’s view, the shortage of specie gave the sort of people whom the English called ‘the monie’d interest’ a stranglehold on French wealth and state policy. 41 The evidence for a structurally anaemic European specie stock during Louis XIV’s later reign, however, is slim. Much of it comes from a hasty reading of the published correspondence of the provincial intendants with the controller-general. In this correspondence, there is no lack of allusion to monetary problems. However, many of these citations turn out to be statements whose premises, on close analysis, reflect peculiar local situations or the pleas of interest groups. The devaluation of December 1689/January 1690, for example, provoked a flurry of complaints about specie shortages in the following year, but most of these originated with officials seeking excuses not to buy more royal offices, as the king had wanted them to do.42 At other times, it is plain that officials used the words ‘currency shortage’ as synonymous with ‘economic depression’, a confusion of effect and cause which was common in the economic thinking of the day.43 It is no accident that at the time all this was going on, one of the first great economists, Pierre Le Pesant de Boisguilbert, 44 convincingly stood this conventional but mistaken

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relationship between money supply and economic activity on its head in numerous pamphlets and in correspondence with the government. Instead of being the consequence of currency shortages, Boisguilbert asserted, economic downturns were themselves the cause of specie hoarding. He placed the blame for slumps on economic and fiscal policy—taxation and interventionism—and not on monetary manipulation. He appears to have been more correct, at least compared to the orthodoxy of his day. Certainly money supply at this time was not restricted to gold and silver coinage, and provincial banking did indeed exist in France at this date as a vast informal system run by the same people who handled the king’s tax income and expenditures.45 Finally, as to the supposed Europe-wide shortage of specie at the turn of the century, recent research has demonstrated that there was no significant slowdown of silver and gold shipments or meaningful change in the rate at which they were retained in Europe during the decades around the turn of the century. An extensive study of private loan contracts in Paris has shown a broad decline in interest rates paid from the 1660s to 1720, again suggesting that the money supply was mostly adequate for the economic needs of the time.46 Extraordinary pressures in the War of the League of Augsburg (1689–97) and, especially, the War of the Spanish Succession (1701–13) did force the French state into experiments with paper currency and ultimately, under the aegis of John Law, into a brief demonetisation of precious metal, but these pressures came from the state’s need for short-term credit, not from a general shortage of specie. Notes of various sorts had circulated for centuries within the milieu of the financiers who managed the king’s revenues, but mainly as credit instruments and objects of speculation. A different sort of note, however, appeared briefly in 1694, and then more permanently in 1701, in conjunction with recoinage operations. These were mint notes (billets de monnaie), issued to people who had obediently brought metal or specie to the royal mint for coinage, and who could not be immediately given coins in return. Because specie was in short supply and because they were honoured punctually when presented for coin, they were a success, and became a substitute for currency in the larger sort of settlement, though only in Paris. In May 1704, another big coinage operation inspired a new issue of mint notes, but this time the government issued more notes than it could cover, particularly to pay interest from the caisse des emprunts, a short-term state credit fund. Although the mint notes bore interest, the volume issued was such that by early 1705 they began seriously to depreciate. The government made various attempts to mop up the excess by making the mint notes convertible into more attractive state securities and bonds. Perhaps believing this had succeeded, it then took the step in April 1707 of permitting them to be used for up to one-third of the amount due in settlements, and for up to half of the purchase price of certain state securities; it also allowed them to circulate in the provinces. This was tantamount to monetising the notes, but it did not work. Provincial merchants made a great outcry, the notes sank

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and the king watered down the application of these decisions. He also launched further mopping-up measures in which the mint notes were absorbed in the flood of dubious wartime state paper floating about in the money-market.47 In the famine winter of 1709, the rector of the large Parisian parish of Saint-Eustache complained that he could not provide relief to the numerous poor of the neighbourhood because his congregation had given in two-thirds of his collection in the form of billets de monnaie and other discredited state notes.48 After the end of the War of the Spanish Succession and the death of the Sun King in September 1715, these notes and their successor forms were absorbed into a general reduction and consolidation of short-term debts. In April 1716, all such creditors were issued 200 million livres’ worth of state notes (billets de l’État), bearing interest at 4 per cent. It could be argued that the billets de l’État, had some of the properties of paper currency; the trouble was that most people could not wait to get rid of them. It was the need to mop up this unmanageable mass of debt certificates that provided the initial impulse to the creation of the Scottish projector John Law’s Banque Générate in May 1716 and thereby to the first generalised use of paper money. The larger story of Law’s experiment falls outside the bounds of this article,49 but a brief summary of its monetary aspects has its place here. As originally set up, Law’s bank was to make its profits by discounting commercial paper and by transfer and exchange operations. It also had the right to issue notes. It was a private bank with official backing, which became a royal bank in December 1718. It was set up with a capital of 3.3M livres, of which 1.4M was to be in specie and the rest in billets de l’État.50 Here, in fact, was one of the underlying purposes of Law’s bank: it was one of a number of devices invented after Louis XIV’s death to absorb this paper. During the second half of 1717 alone, the state created 1.2 billion livres’ worth of life annuities at 6.25 per cent, which could be bought with various forms of state paper on the market; it launched a vast lottery for the same purpose, and set up a chartered West Indies Company (the Compagnie d’Occident), also controlled by John Law, in which investors could buy stock with billets de l’État against the promise of a 4 per cent dividend.51 Finally, in February and May 1718, as part of a general devaluation of the livre, holders of coin were allowed to top up the value of coins brought in for reminting with a certain proportion of billets de l’État. Gradually, the notes issued by Law’s bank took on the characteristics of a paper currency which briefly replaced coinage. The first step in this direction came in April 1717, when the regent Philippe d’Orléans authorised taxpayers to acquit themselves with banknotes at Law’s bank. That September, Law, who wanted to channel public revenues through his institution in order to increase his cash flow and operations, got his friend the Regent to issue an Order in Council requiring tax officials in Paris to deal in his notes. In December 1718, the bank was declared to be a royal bank and branches were opened in Lyons, La Rochelle, Tours, Orléans and

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Amiens, where it was announced that it would henceforth take no cash for payments greater than 600 livres. The following April, an Order in Council decreed that the bank’s notes in livres would not be subject to any reduction in the value of specie, that creditors could require their debtors to pay in banknotes and refuse specie, and that the king’s tax collectors could keep nothing but these banknotes in their coffers. In July, the branch network was extended to all the major towns of France. Meanwhile, Law built up a speculative boom in Indies Company shares by declaring attractive dividends and multiplying the supply of his banknotes, thereby drawing in still more of the old state debt certificates. In December 1719, the regent issued a series of measures designed to drive silver and gold out of circulation: a drastic devaluation, the limitation of their use to petty settlements of 10 livres in silver and 300 livres in gold, etc. Finally, on 28 January 1720, another Order in Council directed that the notes of his bank were to become legal tender everywhere. Law had two main aims, besides the unavowable one of making a great deal of money for himself, his friend the Regent and the crowd of courtiers whom he was obliged to buy off. The first was to absorb all the outstanding short-term credit obligations left over from the previous wars, and to manage the long-term financing of the state debt. The second purpose was the demonetisation of gold and silver and the creation of a state bank to manage short-term credit, one of the great lacunae in French royal finances. Presumably if he had succeeded in the second aim, currency manipulations of the kind so common hitherto would no longer have been needed. But Law’s means to these ends were inadequate; his bank was insufficiently capitalised. To gather more funds and absorb even more old state paper, Law merged other concerns with the Weat Indies Compnay, linked the banknotes to the shares to create a gigantic Indies Company, which absorbed the bank and acquired a virtual monopoly of French overseas trade. The attraction of the Company’s prospects, the expectation of large dividends, the low interest rates fostered by copious and opportune issues of banknotes, and the requirement that the Company’s first two shares offerings be purchased with billets de l’État drove numbers of people to exchange the hitherto worthless notes for shares. In the process of bidding up the Company’s shares, Law eventually linked the banknotes to the Company’s shares by making them exchangeable for each other. When the bubble burst, the banknotes collapsed along with the shares, and Law was obliged to flee the country.

The stabilisation of the livre Hard currency returned in May 1720, and the last of Law’s banknotes disappeared in a great write-down managed in 1721 by the four Pâris brothers, financiers who took over the management of the mess. The Pâris were faced

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with the task of absorbing a mass of near-worthless government paper and notes, and restoring confidence in royal credit. One of their techniques was to conduct a chain of revaluations, pushing the livre by early 1726 to levels not seen since the death of Louis XIV, thereby raising the interest rate and inducing a massive recession. Then in January 1726, the Pâris began a devaluation. The unpopularity of their monetary operations, among other deeds, forced the prime minister of the day, the Due de Bourbon, out of office on 11 June and the Pâris brothers went with him. On 15 June 1726, just before leaving his job, the Duke’s controller-general, Gaspard Dodun, issued an Order in Council devaluing the livre still further, and in the process pegging the livre at a fixed rate (the equivalent of 4.5 grams of silver and 0.3 grams of gold). Subsequent Orders in Council prorogued this measure at six-month intervals until 1738, after which the rate was declared permanent, and so it remained, except for a minor adjustment in the bimetallic ratio in 1785.52 Although the livre remained a money of account, and therefore theoretically capable of being moved up and down against silver and gold, the relationship remained by and large stable for the last sixty years of the old regime. After 1790, as is well known, the Revolution conducted, in its own style, a repeat performance of Law’s exploits, creating a paper assignat based initially on the supposed value of confiscated church lands, a currency which it subsequently multiplied to near-infinity. But from 1797 onwards, the French gradually came back to virtually the same quasi-permanent 1726 rate, made permanent when Napoleon pegged the franc to silver (and, accessorily, to gold) on 17 Germinal Year XII (7 April 1804). That rate remained until 5 August 1914, when the franc of Germinal became one of the first casualties of World War I. If, then, there was any single moment in French monetary history comparable to the events of 1999–2002 in Europe, the Order in Council of 15 June 1726 was it. It completed the task of giving the French a single currency, a single monetary policy and a single exchange rate. Indeed, if it had not been for the last two wars of Louis XIV, we would probably now date the turning-point back to some time in the 1670s. The experiences of Louis XIV’s last two wars, and particularly the Law episode, delayed this transformation, but they at least proved the degree to which the state had learned how to master monetary policy. Surprisingly, though, after 1726 Cardinal Fleury only used that power in a very cautious fashion and avoided further manipulation of the money supply, even though there were certainly times in the eighteenth century when a more flexible policy might have helped attain the government’s other goals, such as a lower interest rate. Why did the government renounce further manipulations after 1726? One reason was that during the first third of the eighteenth century, a revolution took place in the way that decision-makers in government looked upon the use of state credit. Writing at the end of this sea-change, just as the economic crisis of 1738–41 was beginning to recede, the Marquis d’Argenson, one of the most alert political commentators of the time, put the

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blame for France’s difficulties on ‘the unfortunate nervousness and… pseudo-science which, after the death of the Regent [1723] provoked the diminution of coin [i.e. the revaluation of the livre]; since then, debtors have become insolvent and taxpayers overburdened’.53 Although this statement betrayed the still common confusion between economic and monetary crises, d’Argenson cannot be faulted on his historical context. The incredible financial roller-coaster lasting from 1715 to 1726 produced a reaction among both investors and policy makers. As a result of the currency manipulations at the end of Louis XIV’s reign and the start of Louis XV’s, investors with money tied up in loans, public or private, between 1690 and 1730 would have seen their principal reduced by more than 40 per cent, most of the loss being concentrated in the years 1720–29.54 True, the purchasing power of that amount would have actually increased, but angry investors are apt to forget such details.55 It is therefore not surprising that the burden of opinion shifted against using this brutally effective tax on savings. Part of the fiscal package which the Pâris brothers imposed when winding up the Law affair in 1721–6 had been the maintenance of a strong and stable livre, in order to restore confidence in French state securities. Cardinal Fleury was able to exploit the turmoil caused, in large part, by the Pâris’ attempt to implement their policies, when he took over as prime minister from the Due de Bourbon in 1726. But although Fleury at first carried out some drastic debt-reduction, he soon turned into a fiscal conservative, particularly when he had to work with Jean Orry as controller-general (in office 1730–45). Orry tried to reduce outstanding state debt, maintained tax revenues and actually produced budget surpluses in several years. This conservatism increased as the Pâris brothers returned to power in the 1730s and tightened their grip on the financial system after Fleury’s death, in 1743. It was reinforced under the regime of controller-general Machault d’Arnouville (in office 1749–54). Machault’s approach to financing wars and, consequently, to currency stability, followed the desires of the Pâris brothers, with whom he had to work. During the three wars of mid-century—the War of the Polish Succession (1733–8), the War of the Austrian Succession (1740–8) and the Seven Years War (1756–63)—despite the enormous strains which war put on its finances, the monarchy turned its back on the freewheeling methods of war finance employed under Louis XIV. The ideal method of long-term war finance became the state annuity paid back in a blend of interest and principal over a relatively short term of years: the economist Véron de Forbonnais, one of the leading spokesmen for this approach, proposed a very short term of six years as the ideal.56 Solid loans such as this required a solid livre. True, there were still prestigious writers in the 1730s and 1740s who advocated currency manipulations. J.F.Melon, as Law’s sometime secretary, perhaps felt a duty to justify jiggling the currency, as he did in his Essai politique sur le commerce (1734), arguing that, given a choice, it was better to favour debtors over creditors.57 The Marquis d’Argenson,58 Voltaire59 and

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even the conservative Montesquieu60 agreed with him. However, the trend was increasingly in favour of hard currency. In a famous polemic against Melon, Dutot reasserted the need for stability: ‘Currency… was sacred among the Romans…Our present government appears to be in the same mind; it has made no change in our currency for the last ten years, thereby rendering a great service to the State.’61 Forbonnais, probably the most influential writer on state finance in the 1750s and a back-room adviser to the government, agreed: ‘Among the many bounties France has enjoyed, she should count above all the present stability of her currency.’62 The Physiocrat theorists of mid-century viewed Law and his experiments with even more distaste: the Marquis de Mirabeau dismissed Law’s System as ‘so fatal, so incredible, so necessary to forget’.63 The immediate impact of stable currency in the context of French war financing during the wars of the 1730s and 1740s would, of course, be to reassure state creditors that the large annual refunds of capital for which they had contracted would not be amputated. The counterpart of this stability was the apparent loss of state control over monetary policy. However, the loss was not total. The state continued to set a statutory usury rate, which it moved up and down from time to time, and such shifts could have an impact in dissuading investors from selling state securities with a higher yield.64 Towards the end of the old regime the state twice set up a Discount Bank (1767 and 1776) aiming at least in part to control the money supply.65 One of the uses for the new Paris stock market founded in 1724, which dealt primarily in state securities, was as a device to shift short-term interest rates at crucial moments to suit the state’s purposes. Sometimes this was done by covertly subsidising operators to buy up key issues such as Indies Company stock. This seems to have been more frequent than the known cases (which resulted in scandals and ministerial dismissals in 1730 and 1788) would suggest.66 Sometimes it was done by carefully targeting the date and class of security when reimbursing war debt certificates, as happened in the 1760s and 1780s after the Seven Years War and the War of American Independence.67 Finally, from 1759 to 1784 the state consciously chose to reduce its seigniorage in order to absorb an increase of 4 to 16 per cent in the cost of the silver and gold it used to make coins, rather than disruptively alter the silver content of the livre.68 Monetary policy thus became more discreet but did not die as a result of the stabilisation of 1726. A second reason for leaving the silver and gold equivalent of the livre fixed after 1726 was the increasing complexity of the money supply itself. What was the money supply in the old regime? The answer to that question is never easy in any economy. The stock of silver and gold coins, naturally, made up the old regime’s Ml. One estimate puts the total hard money supply in France at the start of Louis XIV’s reign at 1.2 billion livres, at the same level in 1754 and at 2.2 billion in 1788,69 which would have given each adult an average of about 120 to 160 livres a head. In fact the money supply was much larger than this, for reasons which have to do with both the archaic

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character of many regions, and the increasing modernisation of the financial and state sectors. On the archaic side, a great deal of the rural and the shopkeeper economies functioned on transactions in kind and informal credit, with verbally acknowledged debts or tally-sticks (favoured by bakers).70 At a higher level, wholesale merchants and bankers used book credit among themselves. By the middle of the seventeenth century, and probably long before, there was also a lot of near-money in the form of bills of exchange. These were sums drawn by one businessman on another, with whom he had some credit, and passed to a third party for payment; terms normally ran from sight to three months, but longer terms were not uncommon. There was a credit element in bills of exchange, because the third party would have to accept a discount if he wanted to sell the bills before they were due, but these bills circulated with such facility at third, fourth and fifth hand that they functioned as a substitute for cash. The development of the commercial economy in the later reign of Louis XIV and through the eighteenth century made these instruments increasingly common. Their use was spread by the king’s local tax officials, who acted as country bankers, using the cash in their tills to accept, at a discount, bills of exchange which they would either resell or use to transmit their receipts elsewhere in the royal financial system.71 The size of the monetary stock beyond the level of Ml was thus both considerable and impossible to calculate. But its increasing complexity, and the proportion of it which was not in specie, doubtless made the prospect of state-imposed devaluations frightening. A further development was the reform of the way the king’s finances were managed. Not a great deal is known about this process, but those managing the short-term credit of the state at the centre took increasing care to make the king’s funds more readily available to pay the king’s expenses. It seems that Colbert, Louis XIV’s principal financial official from 1661 to 1683, managed to put some order into the management of royal funds. Henceforth, instead of simply drawing money on the Receivers General, who handled the money collected in direct taxes, the state asked each for a set of rescriptions (promissory notes) spread over regular intervals for a term of fifteen months. These functioned as a primitive form of treasury bond, which the state put directly on the money market in Paris. The system fell apart during the instability surrounding state finance during Louis XIV’s last two wars and during the Regency, but was readopted in the 1720s. From the 1720s onwards the government also required the corps of Farmers General, who leased the collection of indirect taxes from the Crown, to put up guarantee bonds. All these instruments and many more circulated during the eighteenth century. Instead of draining the country of its hard currency or jigging the value of the livre up and down by devaluations and revaluations, the state now found it easier to spread its expenses through the year by employing these instruments, which found willing takers on the money market. It was a very imperfect system; indeed, its flaws finally brought

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down the old regime monarchy in 1788. But it was better than what had gone on before Colbert’s day, and its expansion brought with it the need for a stable currency.72 Two final reasons for this transformation may be adduced. One is a change in social attitudes towards money, and towards ‘the monie’d interest’: the public image of credit and those who managed it became increasingly respectable. In the seventeenth century, it was common practice for the king to hold a show-trial of financiers at the end of each major war, exploiting popular resentment to force them to give back some of their presumed vast gains. The last time the state did this—with considerable misgivings—was in 1716.73 Similarly, a study of the Farmers General, the consortium of financiers who leased the right to collect the king’s indirect taxes, has shown how the public image of these operators softened, at least among the elites, in the course of the eighteenth century.74 If the ‘monie’d interest’ were now respectable, was it surprising that the object of their speculations became untouchable? The second is related to this change in attitudes. Current research appears to show a quantum increase in the volume of private credit in the eighteenth-century economy. State credit too, although to a lesser extent, enjoyed a widening social base, the most extreme example of this extension being the life annuity loans which were so popular in the late 1770s and early 1780s, but which had antecedents in the 1690s.75 Broadening the creditor class meant that more and more people had a stake in currency stability.

Conclusion It is tempting to read the long history of French national monetary unification as a scenario for the creation of a supranational European currency. This can easily be carried too far. Unlike the ECU and the euro, the standardised livre/ franc emerged over many generations in the context of an economy and society which, even at the end of the process in the eighteenth century, were radically different from the European economy of the last four decades. The livre became a national currency over centuries of royal territorial expansion, contraction and re-expansion, whereas the ECU and euro emerged in a brief twenty-five years within the territory of the existing EC/EU. The livre’s transformation was carried out while the very existence of the French royal state was constantly called into question by the ruthless ambitions of magnates and by the disruptions of bloody civil and foreign wars; the euro was established by agreement among sovereign nations during the longest period of peace Europe has ever known in recent times. Yet there remain some similarities in the stages of unification. The gestation of the ECU was drastically shorter than that of the livre, but like the ECU from 1979 to 1998, the livre first had to share its territory with other currencies or near-currencies. As a money of account, the livre was, like the ECU, tied to other circulating media of exchange (silver and gold ingots and domestic and foreign

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coins) in a complex and unstable relationship arbitrated by public authority. It has been argued here that it was only in the 1660s that Colbert took the livre into a new stage by ending that instability, if only temporarily. It has also been argued that from 1726 onward, the livre did indeed function as a de facto ‘single effective currency’ characterised by a ‘single monetary policy’ and a ‘single effective exchange rate’, thereby anticipating Napoleon’s establishment of the 1803 franc— the French equivalent of the events of 1998–2002. The purposes of that stabilisation had some similarities to the creation of the euro. When Colbert and his predecessors sought to banish foreign coins from French soil, one of their reasons was to get control of monetary policy; the giddy currency manipulations engineered by Colbert’s successors in Louis XIY’s later reign were a perverse testimony to Colbert’s success. But in addition to the hold over the interest rate that this gave these officials, it also allowed them repeatedly to manipulate fiscal policy using devaluation-revaluation cycles and to levy a crude inflation tax on savings. Not even the most unabashed eurosceptic has ever accused the euro enthusiasts of plotting similar measures! It was only from 1726 onwards that the French government abandoned this dubious advantage, despite its occasional hankerings for times past (to which it only yielded once, in the brief but chaotic experiment of the revolutionary assignats between 1790 and 1798). Finally, the economic and political circumstances that encouraged the stabilisation of the livre and franc in 1726 and 1803 also have some analogy to the creation of the ECU and euro. On the negative side, the financial chaos left by Louis XIV’s wars, the unsuccessful attempts at creating a paper currency under John Law in 1719–21, and the second unhappy experience of the paper assignat in the Revolution produced a conservative reaction in favour of sound and stable currency, just as the alarming collapse of the Bretton Woods arrangements in the 1970s provided all sorts of economic reasons for Europeans to move to a trans-national currency. On the positive side, the creation of a single royal currency was presented by Colbert and others as an enhancement of his king’s sovereignty, just as the EMS and the euro have been seen as a means of forcing the pace of European unification, giving ordinary Europeans a sense of common identity, and enhancing the prestige of the EU.

Notes 1 X.de Vanssay, ‘Monetary unions: a historical perspective’ in this collection. The author wishes to thank Dr de Vanssay for his criticisms and suggestions. 2 Handy summaries in A.Neurrisse, Histoire du franc (Paris, Presses Universitaires de France, 1963) and R.Sédillot, Le Franc: histoire d’une monnaie des origines à nos jours (Paris, Receuil Sirey, 1953). 3 It was possible to increase duties surreptitiously by specifying the rate of collection as an equivalent of ‘Paris’ currency. 4 D.Dessert, Argent, pouvoir et société au Grand Siècle (Paris, Fayard, 1984), p. 189, citing F.Bayard, ‘Les espèces monétaires à 1’Epargne en 1636’, Lyon et

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l’Europe: hommes et sociétés, Mélanges d’histoire offerts à R.Gascon (Lyon, Presses Universitaires de Lyon, 1980), pp. 7–32. See also A.M.de Boislisle (ed.) Correspondance des Contrôleurs généraux des finances avec les intendants des provinces (Paris, Imprimerie Nationale, 1874) I, no. 1788 (18 November 1689), where foreign specie, tolerated in Provence by the provincial Estates, is given official recognition by the government. R.Pillorget, ‘Les problèmes monétaires français de 1602 à 1689’, XVIIe siècle, nos. 70–1 (1966), p. 123. Charles Emmanuel Marie Madelon, daughter of Mme de Vintimille, born in 1741; see M.Antoine, ‘Les bâtards de Louis XV’, in Le dur métier de roi (Paris, Presses Universitaires de France, 1986), p. 295. M.Marion, Dictionnaire des institutions de la France aux XVIIe et XVIIIe siècles (Paris, Picard, 1923, reprinted 1969), p. 383. Shown in J.J.McCusker, Money and Exchange in Europe and America, 1600– 1775. A Handbook (London and Basingstoke, Macmillan, 1978), p. 84. The standard treatment of coinage is A.Blanchet and A.-E.Dieudonné, Manuel de numismatique française (Paris, Picard, 1912–). From the nickname of the ‘Frank on horseback’ (franc à cheval) mistakenly given to the image of a mounted warrior (and confused with the inscription Francorum Rex) on the gold franc of 1360; see Sédillot, Le Franc, p. 70. J.-P.Rousselot de Surgy, Encyclopédic méthodique. Finances (Paris, Panckouke, 1787), III, p. 143. J.-N.Guyot, Répertoire universel et raisonné de jurisprudence (Paris, Visse, 1785), XI, pp. 600–4. The equivalents used in Figures 3.1 and 3.2 were worked out by Natalis de Wailly, ‘Mémoire sur les variations de la livre tournois depuis le règne de Saint Louis jusqu’à 1’établissement de la monnaie décimale’, Mémoires de l’institut imperial de France, Académie des Inscriptions et Belles-Lettres, no. XXI (1857), pp. 233–363. Sédillot, Le Franc, p. 74. B.Barbiche, ‘Une tentative de réforme monétaire à la fin du règne d’Henri IV : 1’édit d’août 1609, XVIIe siècle, no. 61 (1963), pp. 3–17; H.Germain Martin, ‘La monnaie et le credit privé en France aux XVIe et XVIIe siècles; les faits et les theories (1550–1664)’, Revue d’histoire des doctrines économiques et sociales, 2e année (1909), pp. 1–40. Pillorget, ‘Les problèmes monétaires’, p. 129. R.J.Bonney, The King’s Debts: Finance and Politics in France 1589–1661 (Oxford, Clarendon Press, 1981), p. 171. Pillorget, ‘Les problèmes monétaires’, pp. 121–2; B.Collin, ‘La politique monétaire de Louis XIV, Comité pour 1’histoire économique et financière de la France. Ministère de 1’économie des finances et du budget, Etudes & documents, vol. I (Paris, Comité pour 1’Histoire Economique et Financière de la France, 1989), p. 53. Extensive treatment of Colbert’s theories in, among others, C.W.Cole, Colbert and a Century of French Mercantilism, 2 vols (New York, Columbia, 1939, reprinted Hamden, Connecticut, Archon Books, 1964). Lettres, instructions et mémoires de Colbert, ed. P.Clément (Paris, Imprimerie impériale, 1861–82), vol. VII, no. 15 (1670). Lettres, instructions et mémoires de Colbert, vol. II (1), no. 311, p. 719. J.-F.Melon, Essai politique sur le commerce (1734), in E.Daire (ed.), Economistes financiers du XVIIIe siècle (Paris, Guillaumin, 1843), p. 775; P.Clément, Histoire de Colbert et de son administration (2 t., Paris, Didier Slatkine, 1874, reprinted Genève, 1980), vol. I, pp. 391–3. Arrêts du Conseil 10 August 1661, 6 November 1663, 5 August 1665, 19 January 1668, etc.

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23 E.g. Arrêts du Conseil 10 September 1663, 10 February 1680, 19 September 1692. 24 Colbert, Lettres, vol. II, i, p. 74, cited in Cole, Colbert, vol. II, p. 544. 25 Edict of December 1665, in F.Véron de Forbonnais, Recherches et considerations sur les finances de France depuis 1595 jusqu’en 1721 (Liège, 1758), vol. II, p. 339. 26 Arret du Conseil, 8 October 1663. 27 Arret du Conseil, 10 September 1663. 28 Arret du Conseil, 10 January 1664. 29 Declaration, 23 March 1679; Véron de Forbonnais, Recherches et considerations, vol. III, pp. 134–5. 30 Colbert raised the livre from the equivalent of 1.80 francs in nineteenth-century currency to 1.94 at the start of 1666, and then, in the face of complaints from the merchant community, lowered it to the equivalent of 1.88 francs, but this was still a net revaluation. But at the same time he moved the silver: gold ratio from 13.7:1 to 15.2:1, and then 15.0:1. F.C.Spooner, The International Economy and Monetary Movements in France, 1493–1725 (Cambridge, Mass., Harvard University Press 1972), pp. 189–95 apparently misses this point. See N.W. Posthumus, Inquiry into the History of Prices in Holland (Leiden, E.J.Brill, 1964), vol. II, pp. 592–4. 31 In Spain, the ratio had been 13.33:1 from 1609 to 1642, and then 15.45:1 from 1643 to 1686; in France, it had been as low as 11:1 as recently as 1602, and only reached 14:1 in 1640. According to Véron de Forbonnais, Recherches et considerations, I, p. 102, the rate at the beginning of the seventeenth century in Spain was 1:13.5 at a time when the French was only 1:11. This is borne out by E.J. Hamilton, American Treasure and the Price Revolution in Spain, 1501– 1650 (Cambridge, Mass., Harvard University Press, 1934, reprinted New York: Octagon, 1965), p. 71 (figures for Castile; cf. lower ratios for Valencia, p. 123); and War and Prices in Spain 1651–1800 (Cambridge, Mass., Harvard University Press, 1947), pp. 24–5, 57. 32 Pillorget, ‘Les problèmes monétaires’, p. 127. 33 Dessert, Argent, pouvoir et société, p. 189. 34 F.Droulers, Les trésors de monnaies royales de Louis XIII à Louis XVI découverts en France et dans le monde depuis le XIXe siècle (Monte Carlo, Feydeau numismatique, 1978). 35 General introduction to these problems in R.Mousnier, ‘L’évolution des finances publiques en France et en Angleterre pendant les Guerres de la Ligue d’Augsbourg et de la Succession d’Espagne’, Revue Historique, vol. CCV (1951), pp. 1–23. See also A.-P.Herlaut, ‘Projets de création d’une banque royale en France à la fin du règne de Louis XIV (1702–1712)’, Revue d’Histoire Moderne et Contemporaine, vol. VIII (1933); G.B.McCollim, The formation of fiscal policy in the reign of Louis XIV (1708–1715)’ (unpublished PhD thesis, Ohio State University, 1979); M.Bonney and R.J.Bonney, Jean-Roland Malet, premier historien des finances de la monarchic française (Paris, Comité pour 1’Histoire Economique et Financière de la France, 1993); H.Lüthy, La Banque protestante en France de la Révocation de l’Edit de Nantes à la Révolution (Paris, S.E.V.P.E.N., 1959), vol. I, pp. 93–125. There is a convenient summary of the wars themselves in John A.Lynn, The Wars of Louis XIV 1667–1714 (London and New York, Longman, 1999). 36 This was usually done by simply imposing a mark on the coins and reissuing them at a higher equivalent in livres, except for 1709, when a total reminting took place. 37 Estimates of the gains made by the king vary. The latest give 29.8 million livres in 1689–93, 48.7 million in 1693–1701, 36.7 million in 1701–4 and 31.1 million in 1704–5. See F.Droulers, ‘Réformations et profits monétaires de Louis XIV’, in

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45 46

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G.Depyrot, T.Hackens and G.Moucharte (eds) Rythmes de la production monétaire, de l’antiquite à nos jours (Louvain-la-Neuve, Séminaire de numismatique Marcel Hoc, 1987), pp. 639–71, esp. pp. 644–5. Income from direct taxes ran at around 39 million livres in the 1690s; see R.J.R.Malet, Comptes rendus de l’administration des finances du royaume de France (London, Buisson, 1789), pp. 368–9. Boislisle, Correspondance, vol. II, no. 287 (20 June 1701). On the 1708 manipulations, McCollim, The formation of fiscal policy’, p. 264. Lüthy, La Banque protestante, pp. 96–8. Dessert, Argent, pouvoir et société, esp. pp. 27–41. Boislisle, Correspondance, vol. I, nos. 939, 943, 956, 1013 (9 May to 24 November 1691). E.g. Boislisle,Correspondance, vol. II, nos. 445 (16 July 1703); 522 (9 October 1703); 852 (24 July 1705), etc.; T.Luckett, ‘“There is no more money here”: money famine and tax revolt in early modern France’, in J.L.DiGaetani (ed.) Money: Lure, Lore and Literature (Westport, Conn., Greenwood Press, 1994), pp. 77–85. Boislisle, Correspondance, vol. II, pp. 536–7, Boisguilbert to Desmaretz, Controller-General, 1 July 1704; and his Dissertation sur la nature des richesses, de l’argent et de tributs, ou l’on découvre la fausse idée qui règne dans le monde à l’égard de ces trois articles, in Daire, Economistes financiers du XVIIIe siècle, pp. 394–424. Dessert, Argent, pouvoir et société, pp. 185–8. M.Morineau, Incroyables gazettes et fabuleux métaux (Cambridge, Cambridge University Press, and Paris, Maison des sciences de l’hommes, 1985); cf. Dessert, Argent, pouvoir et société, pp. 174–5; P.T.Hoffman, G.Postel-Vinay and J.-L. Rosenthal, ‘Redistribution and long-term private debt in Paris, 1660–1726’, Journal of Economic History, vol. LV (1995), p. 261; and P.T.Hoffman, G.PostelVinay and J.-L.Rosenthal, Priceless Markets: The Political Economy of Credit in Paris, 1660–1870 (Chicago and London, University of Chicago Press, 2000), 52–3. There were, of course, short-term local shortages of cash, caused, for example, by the shipment of hard currency to pay the French army when it was campaigning outside the frontiers. Herlaut, ‘Projets’; Lüthy, La Banque protestante, pp. 103–4; Véron de Forbonnais, Recherches et considerations, vol. IV, pp. 270–6; vol. V, pp. 303–11; Boislisle, Correspondance, vol. II, nos. 541 (30 October 1703), 1857 (18 July 1715) and passim. Boislisle, Correspondance, vol. III, no. 668 (24 December 1709). The best recent general studies are A.E.Murphy, John Law: Economic Theorist and Policy-Maker (Oxford, Clarendon Press, 1997) and Richard Cantillon: Entrepreneur and Economist (Oxford, Clarendon Press, 1986), and E.Faure, La Banqueroute de Law (Paris, Gallimard, 1977); a recent study of the political impact is T.E.Kaiser, ‘Money, despotism, and public opinion in early eighteenthcentury France: John Law and the debate on royal credit’, Journal of Modern History, vol. LXIII (1991), pp. 1–28. Nominally 6M livres, but the billets de l’État were at a 60 per cent discount at this point; see Murphy, Richard Cantillon, pp. 70–1.

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51 The Company was to pass the billets to the royal treasury, which would give the Company 4 per cent annuities in return, but only after the first year’s annuities had gone to the Company itself; see Faure, Banqueroute, p. 128. 52 M.Marion, Histoire financière de la France depuis 1715, t. I (Paris, Rousseau, 1927), p. 140; although the livre remained stable in terms of silver and gold coinage, in fact the state increased the price it paid for gold by foregoing seigniorage partially and then entirely. Moreover, it sometimes gave special rates to favoured suppliers; see Rousselot de Surgy, Encyclopédie méthodique. Finances, vol. III, pp. 143–4; M.Morineau, ‘Les frappes monétaires françaises de 1726 à 1793 Premières considérations’, in J.Day (ed.) Etudes sur l’histoire monétaire XIIe-XIXe siècles (Lille, Presses Universitaires de Lille, 1984), pp. 69–141. 53 Journal et mémoires du Marquis d’Argenson, ed. E.J.B.Rathery (Paris, J.Renouard, 1867), vol. III, p. 434 (26 December 1741). 54 Hoffman, Postel-Vinay and Rosenthal, ‘Redistribution and long-term private debt’, pp. 275, 278; investors in royal funds or financial operations were subject in addition to arbitrary reductions, forced conversions and inquisitorial prosecution. 55 Calculations from M.Baulant, ‘Le prix des grains à Paris de 1431 à 1788’, Annales: Economies, sociétés, civilisations, vol. XXIII (1968), pp. 520–40, and G. and G.Frêche, Les prix des grains, des vins et des légumes à Toulouse (1486–1868) (Paris, Presses Universitaires de France, 1967) produce the indices in Table 3.2. Table 3.2 Purchasing power of the livre, 1660–1739

56 T.J.A.Le Goff, ‘How to finance an eighteenth-century war’, in W.M.Ormrod, R.J.Bonney, M.Bonney and R.Bonney (eds) Crises, Revolutions and Self-Sustained Growth: Essays in European Fiscal History (Stamford [England], Shaun Tyas, 1999), pp. 377–413; and ‘Les caisses d’amortissement en France (1749–1783)’, Ministère de 1’Economie et des Finances, Comité pour 1’Histoire économique et financière de la France, L’Administration des finances sous l’Ancien Régime (Paris, Comité pour 1’Histoire Economique et financière de la France, 1997), pp. 177–96. 57 J.-F.Melon, Essai politique sur le commerce (1734) reprinted in Daire, Economistes financiers du XVIIIe siècle, pp. 699–835. 58 Journal et mémoires, vol. III, p. 434 (26 December 1741). 59 Marion, Histoire financière, vol. I, pp. 140–1, note 2. 60 Mes pensées, in Œuvres completes, ed. R.Caillois (Paris, Gallimard, 1949), vol. I, no. 2029, pp. 1514–15.

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61 Dutot, Réflexions politiques sur les finances et le commerce, ed. P.Harsin (Liège, Faculté de philosophie et lettres, 1935), vol. I, p. 195. Dutot’s essay was written in 1735–6 and went through a second and third edition in 1743 and 1754. 62 F.Véron de Forbonnais, Elémens du commerce (1754), vol. II, p. 172, cited in P. Harsin, Les doctrines monétaires et financières en France du XVIe au XVIIIe siècle (Paris, F.Alcan, 1928), p. 253; see also his Recherches et considerations, vol. IV, pp. 52–5, 99, 162, 207, 391–2; vol. V, pp. 18–20, 261–8, 375; vol. VI, pp. 133–43. 63 G.Weulersse, ‘Notes inédites sur Boisguilbert par le Marquis de Mirabeau’, Revue d’histoire des doctrines économiques (1910), p. 116, cited in Harsin, Les doctrines, p. 211. 64 B(ibliothèque)N(ationale) Mss Fr. 8019 Papiers Marquet de Bourgade, f. l-8v. 65 BN Mss Fr. 8020 Papiers Marquet de Bourgade, f. 112v. 66 BN Mss Fr. 8020 Papiers Marquet de Bourgade, f. 61v–63; on the 1730 scandal, see G.Antonetti, ‘Les manoeuvres boursières du contrôleur général Le Pelletier des Forts et la réglementation du marché des valeurs mobilières (1730)’, in Revue historique de droit français et étranger (1984), pp. 577–97; on that of 1788, G.V. Taylor, ‘The Paris Bourse on the eve of the Revolution, 1781–1789’, American Historical Review, vol. LXVII (1961–2), pp. 951–77 resumés the older literature. 67 Le Goff, ‘Les caisses d’amortissement’ and ‘How to finance an eighteenth-century war’; T.Luckett, ‘Credit and commercial society in France, 1740–1789’ (unpublished PhD thesis, Princeton University, 1992), pp. 204–9. 68 Natalis de Wailly, ‘Mémoire sur les variations’, pp. 266, 362; Morineau, ‘Les frappes monétaires françaises de 1726 à 1793’. 69 Morineau, ‘Monnaie et fiscalité modernes’, pp. 125–8, drawing partly on Véron de Forbonnais, Recherches et considerations, vol. II, pp. 171–5 but converting Forbonnais’ values to the 1726 livre; for other estimates of currency stock, see D.Glassman and A.Redish, ‘New estimates of the money stock in France, 1493– 1680’, Journal of Economic History, vol. XLV (1985), pp. 31–46 and ‘Currency depreciation in early modern England and France’, Explorations in Economic History, vol. XXV (1988), pp. 75–97. 70 J.Meuvret, ‘Circuits d’échanges et travail rural dans la France du XVIIe siècle’, Études d’histoire économique (Paris, A.Colin, 1971), pp. 139–50; ‘Circulation monétaire et utilisation économique de la monnaie dans la France du XVIe et du XVIIe siècle’, Études d’histoire économique (Paris, A.Colin, 1971), pp. 127–37; A. Poitrineau, La vie rurale en Basse Auvergne au XVIIIe siècle (1726–1789) (2 t., Paris, Presses Universitaires de France, 1965, reprinted Marseilles, Lafitte, 1979), p. 490; S.L.Kaplan, The Bakers of Paris and the Bread Question 1700– 1775 (Durham, N.C., Duke University Press, 1996), pp. 137–52. 71 The general treatment is R. de Roover, L’évolution de la lettre de change XIVXVIIIe siècles (Paris, A.Colin, 1953), now rather dated. More recent information in, among others, D.Dessert, Argent, pouvoir et société au Grand Siècle (Paris, Fayard, 1984), p. 126; J.B.Collins, Fiscal Limits of Absolutism: Direct Taxation in Early Seventeenth-Century France (Berkeley, University of California Press, 1988), p. 131; T.J.A.Le Goff, An eighteenth-century grain merchant: Ignace Advisse Desruisseaux’, in J.F.Bosher (ed.) French Government and Society 1500– 1850. Essays in Memory of Alfred Cobban (London, Athlone Press, 1973), pp. 92–122; C.Carrière, M.Courdurié, M.Gutsatz and R.Squarzoni, Banque et capitalisme commercial: la lettre de change au XVIIIe siècle (Marseilles, Institut historique de Provence, 1976); F.-X.Emmanuelli, La Crise marseillaise de 1774 et la chute des courtiers: contribution à l’histoire du commerce du Levant et de la banque (Paris, Editions du Centre Nationale de la Recherche Scientifique, Centre Regional de publications, 1979); see also Boislisle, Correspondance des

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contrdleurs generaux, vol. II, nos. 859 (1 August 1695), 1023 (30 April 1706); vol. III, no. 953 (27 January 1711) and passim. Recent treatments of the pre-1661 system in F.Bayard, Le Monde des financiers au XVIIe siècle (Paris, Flammarion, 1988); Collins, Fiscal Limits of Absolutism; Bonney, The King’s Debts. J.F.Bosher, ‘Chambres de justice in the French monarchy’, in Bosher (ed.) French Government and Society 1500–1850. Essays in memory of Alfred Cobban (London, Athlone Press, 1973), pp. 19–40. Y.Durand, Les fermiers généraux au XVIIIe siècle (Paris, Presses Universitaires de France, 1971), pp. 387–442. P.T.Hoffman, G.Postel-Vinay and J.-L.Rosenthal, ‘Priceless markets; private credit markets in Paris, 1690–1840’, Journal of Economic History, vol. LII (1992), pp. 293–306; ‘Economic et politique: Les marchés du credit à Paris, 1750–1840’, Annales: Economies, Sociétés, Civilisations (1994), pp. 65–98; ‘Redistribution and long-term private debt in Paris, 1660–1726’, pp. 256–84; A.Vührer, Histoire de la dette publique en France (Paris, Berger, 1886), vol. II, pp. 120–30, 189–90.

Part II

Before EMU Reflecting on the debate

4

Why EMU happened A survey of theoretical explanations Amy Verdun

Introduction Ever since Economic and Monetary Union (EMU) first emerged on the agenda of the European Community (EC) there have been analyses trying to explain why it happened. More often than not, however, the kinds of arguments provided by scholars offer only a partial explanation of the EMU process. This is totally understandable. Many analyses do not even set out to explain anything more than a particular part of the process, e.g. the role of the national governments, the Commission, the national and supranational experts, ‘globalisation’, policy learning, etc. In fact, the process itself is so complex that one cannot imagine a parsimonious explanation. Yet the explanations provided by scholars sometimes contradict each other. Some authors, for example, argue that the national executives are the core actors in the process of creating EMU. Others state that one cannot understand the outcome of the EMU process without looking at the process of policy learning that took place in the context of the European Monetary System (EMS). In other words, we find that scholars value the various factors that influenced the EMU process differently. As for the lessons to be learned from the case of EMU for our wider understanding of the European integration process, we also find diversity in approaches. Some scholars who only look at a very specific part of the process do not generalise in so far as the full EMU process is concerned, nor can their observations be of use to analyse European integration more generally. Others, by contrast, claim that they can ‘prove’ a particular theory because it holds true for their study of EMU. What we observe here in a sense forms part of a more general debate in political science, and European studies in particular (see, for example, ECSA Review, Spring 1999; Jachtenfuchs 2001; Pollack 2001). That is, how can one judge the usefulness of various propositions? What is the usefulness of adopting different theoretical approaches? How does one’s approach and theoretical framework influence one’s findings? What are the natural limits of any one particular case study? To what extent can a case study be generalised? 71

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This chapter will address some of these issues. It will first provide a brief historical background outlining why and how EMU happened. The second section will provide a literature survey on the various explanations of EMU. It will focus on the factors or actors that scholars have considered to be the most important, and what in their view determined the path of the EMU process. Next, these explanations are placed in a broader framework of European integration theories by summarising what most theories assume and predict about the integration process. The final section of the chapter draws some conclusions.

A historical background to why and how EMU happened Even though EMU first started on 1 January 1999, and coins and banknotes only entered into circulation in January 2002, Economic and Monetary Union (EMU) has been on the agenda of the EC since 1969.1 Originally, it was mainly a response to the gradual process of European integration. At that time EC member state governments had been working on the completion of a customs union in 1968, concerned about difficulties with exchange rates, and with the problems surrounding the Common Agricultural Policy (CAP). However, EMU eventually did not take off in the 1970s. The downfall of the EMU plan occurred for a number of reasons: unfavourable international circumstances (i.e. the end of the Bretton Woods system and the oil crisis), a variety of domestic responses to these international shocks, a lack of consensus on the exact strategy to take regarding the ‘economic’ and ‘monetary’ integration (here we are referring to the famous debate between the ‘economists’ and the ‘monetarists’), and the failure of the system of relatively fixed exchange rates (the so-called snake), to cite just a few. EMU re-emerged in the 1980s. The changed circumstances were, among other things, the surprising success of the European Monetary System (EMS), the awareness of lack of competitiveness of European business vis-a-vis the Pacific Basin and the US, the prospect of the completion of the so-called ‘Internal Market’ or ‘1992 Programme’, the move towards more capital liberalisation, and the need for a new project to be found to keep the European integration process moving. To relaunch the EMU project in 1988 the European Council called upon a committee comprised of mostly central bankers to create a blueprint for EMU. The so-called Delors Committee came out with its report in April 1989.2 Eventually this EMU blueprint was incorporated in the 1992 Maastricht Treaty with only minor changes.3 In order to appreciate the rapid move from the idea to relaunch the EMU project through to its actual acceptance, one needs to keep in mind that in the period 1989–92 the international situation had changed substantially. Many have wondered why the German government and the Bundesbank eventually agreed to create EMU, when it was unclear how they would benefit from EMU per se. The reason Germany benefits from EMU was that

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the 1980s had shown that the German government and Bundesbank were de facto setting monetary policy for most of Europe. In this sense they were ‘hegemonic’ (Gilpin 1987). At the same time, Germany reunified. The first indications that the Communist regimes were crumbling in Central and Eastern Europe occurred in the autumn of 1989, culminating in the Berlin Wall coming down in November 1989. In July 1990, a monetary union was created between East and West Germany, and then, on 3 October 1990, Germany was reunified. Obviously these two factors—the end of the Cold War and German reunification—were important changes in the international and European context. European member state governments of the then EC of twelve reacted to the challenge posed by the changing geopolitical circumstances by discussing the next steps in European integration in two separate Intergovernmental Conferences (IGCs). One IGC focused on Economic and Monetary Union, whereas the other focused on Political Union. However, the accounts differ as to exactly how important the two geopolitical factors were in creating the new momentum for EMU. It is often noted that the Delors Committee had started discussing the EMU blueprint half a year before there was any sign at all that the communist regimes were coming to their end. In addition to the puzzles about why EMU happened in the 1980s, many have been surprised that EMU did not fail during the 1990s. Observers were aware of possible problems with the planning of EMU, especially as it became clear that German reunification turned out to be more costly than originally anticipated. Moreover, the costs of reunification for Germany were spilling over into other countries. The Ostmark-D-Mark conversion rate and low economic development in former East Germany led to a massive flow of money and government funds into former East Germany, leading to inflationary pressures. The Bundesbank reacted to this upward pressure on prices by increasing interest rates. As the monetary authorities of countries participating in the EMS had all based their policies on those conducted by the Bundesbank, the interest rate in all EMS countries went up. A recession struck Europe in the early 1990s and unemployment rose. Apart from the macro-economic conditions, a number of important factors led many observers to doubt the political will and capacity of national leaders to create EMU. The project first came under fire when the Danish population rejected the Maastricht Treaty in a referendum in the spring of 1992. This outcome prompted French President François Mitterrand to decide also to hold a referendum about the acceptability of the Maastricht Treaty. When the opinion polls started showing a possible negative result in the French referendum, the financial markets reacted. The British pound, the Italian lira and the French franc came under attack. This downward pressure eventually led to the exit of the pound and the lira from the exchange rate mechanism (ERM) of the EMS. It also started a year of turbulence in the currency exchange markets, which led to various devaluations of the currencies still in the EMS. Eventually in August 1993 the bands of the ERM were widened to ±15 per

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cent (with the exception of the D-Mark-Dutch guilder parity, which stayed in the original band of ±2.25 per cent). The turbulent 1990s also saw a major move by national governments to restructure public expenditure in order to fulfil the so-called ‘convergence criteria’. The criteria—which referred to the interest rate, inflation rate, exchange rate stability, public debt and budgetary deficit—had been drawn up to ensure that enough convergence existed prior to the move to EMU. However, as the recession spread across Europe, many governments were confronted with adverse fiscal conditions. In order for governments to comply with the criteria, fiscal retrenchment was needed. Another factor that needs to be kept in mind in order to appreciate how extraordinary it is that eventually an EMU was created, is that EMU was not an inevitable step forward in the process of economic and monetary integration. Differences of opinion existed about its need, possible definition and precise contents. Moreover, by the late 1990s the political landscape in Europe had shifted to the political left. In principle these left-of-the-centre governments could be considered to be more concerned about unemployment than about inflation. More generally, there were concerns about the legitimacy of the EMU design, in particular the ‘asymmetrical nature’ of EMU that has a well-developed monetary component including an independent central bank, and an economic component that is based merely on the internal market, convergence of fiscal and budgetary policies, with no supranational authority (Verdun 1996, 2000a). This institutional design left unanswered the question of who will be ultimately held accountable for the EMU process (Verdun 1998a, 1999a; Verdun and Christiansen 2000). Thus the outlook in the late 1990s was considerably different from that in the late 1980s. As is now well documented, in May 1998 the European Council decided that eleven member states were ‘ready’ to participate in the euro when it was launched in 1999 (Greece joined the eurozone only on 1 January 2001). Let us now turn to the theoretical explanations of why EMU happened. Note, however, that most of these explanations focus on the first part of the EMU process, i.e. what factors led to the adoption of EMU in the Maastricht Treaty by the member states. They do not necessarily explain why EMU remained the favoured solution throughout the 1990s.

Theoretical explanations In the literature on EMU, various authors identify one or more of the following factors as having been very important in explaining the EMU agreement: the dominance of politics over economics (inter alia Minkkinen and Patomäki 1997; Eichengreen and Frieden 1994; Dyson 1994; Kenen 1995); domestic politics (Milner 1995; Jones et al. 1998; Sandholtz 1993); domestic politics and certain ideas (Marcussen 1997; McNamara 1998; Ungerer 1997); the

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role of experts (Dyson 1994; Verdun 1998b, 1999b); issue linkage (Martin 1993); the role of national identity (Risse et al. 1999; cf. Helleiner 1998); international bargaining (Moravcsik 1998a); institutional aspects (Campanella 1995; Kaufmann 1995); German reunification (Garrett 1993); the success of the EMS (Cameron 1997); the optimism surrounding the Internal Market Programme (Sandholtz 1993; Sandholtz and Zysman 1989); financial market integration (Andrews 1993; Pauly 1992); globalisation or a combination of these factors (inter alia Dyson 1994; Dyson and Featherstone 1999; Sandholtz 1993, 1996; Verdun 2000a). As one can see from this list, the number of explanations of EMU is quite extensive, and this list is by no means complete. Let us now turn to the review of the literature.4 Kruse (1980) and Tsoukalis (1977) discussed the first EMU project in great detail. In their analyses they reflected on the neofunctionalist versus intergovernmentalist approaches and found evidence for both. However, most of the analyses in both works focused on the domestic situation and on the intergovernmental bargaining at the EC level. These studies brought interesting insights also into the changes in the larger international context, and the way in which the EC responded to these changes. Both Kruse and Tsoukalis emphasised the fact that the EMU process failed in the 1970s due to the divergent views on further economic and monetary integration and their inability to find a common collective co-ordinated response to the international circumstances, such as the two oil shocks, end of Bretton Woods, stagflation, etc. Rosenthal (1975) has offered an analysis of the early EMU process that largely focuses on the role of experts and expertise. In her view, the role of the monetary elite has been crucial in understanding the process towards the creation of the EMU plan in 1970. In her 1975 study she also emphasises the problems in lack of convergence in the views of the experts, especially between the so-called ‘economists’ and the ‘monetarists’, for finding a common strategy to deal with the problems of the 1970s. During most of the 1970s and 1980s, however, very few things happened with regard to the EMU process. Of course, the European Monetary System (EMS) had been set up, and eventually it worked well. Scholars who kept on studying the EMU process were few (an exception being Tsoukalis, for example, and some scholars, mainly economists, who studied the EMS). The absence of academic research on EMU in the early and mid-1980s was not surprising. First of all, the EMU idea had been shelved, and few thought that it would surface again soon. What is remarkable, however, is that there were very few studies by political scientists conducted in the mid to late 1980s on economic and monetary unification and the European integration process more generally. This author was confronted by this academic vacuum when she was conducting her initial research on EMU in the late 1980s and early 1990s (Verdun 2000a). It was as if the whole discipline was waiting for something to happen first before commenting on it. The theo-rising on European integration in general had not gone through its revival,

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which only occurred in the course of the 1990s (see inter alia Moravcsik 1991; Sbragia 1992). As for the literature on EMU, arguably the first seminal article on why EMU became incorporated in the Maastricht Treaty is Sandholtz (1993). In it he argues that a combination of five factors made the EMU agreement possible in the late 1980s (similar points have been made by Pauly 1992 and Campanella 1995): 1 domestic support for monetary and price stability existed; 2 the Internal Market programme and increasing internationalisation of financial markets generated the need for a regime of monetary stability and gave rise to a widespread sense of Euro-optimism surrounding the 1992 project (see also Cameron 1995); 3 some governments (for example, the French, the Italians and the Benelux countries) who had been participating in the EMS and had shadowed German monetary policies desired a greater voice in EC monetary policy; 4 German reunification implied that Germany needed to show the rest of Europe that it would remain committed to the European integration objective;5 5 EMU was considered desirable by the EC member states to institutionalise their commitment to low inflation. Sandholtz’ account was very persuasive. Published in the immediate aftermath of the Maastricht Treaty, it points to a number of factors contributing to EMU, such as domestic politics, changes to the European economies (in particular Europeanisation and the de facto institutionalisation of monetary policy). It identifies how EMU would offer a European (institutional) solution to some of these domestic problems. It offered a very good first analysis of EMU. Another type of analysis of EMU was provided in these early years by Andrews (1993). His analysis of the origins of the EMU agreement emphasises in particular the role of global factors. It stresses that the EMU process cannot be understood merely by looking at spill-over mechanisms or domestic politics. His argument was that external developments provided the major impetus for the Maastricht Treaty (Andrews 1993:118), especially structural changes in economics and politics, which led to a redefining of national governments’ interests. The global integration of financial markets and the interdependence of the European economies made national monetary authorities less capable of pursuing independent monetary policies (Andrews 1993; cf. 1994). In the July 1993 issue of Economics and Politics, various authors examine the reasons behind the success of the EMU project.6 Eichengreen and Frieden state the obvious by stressing that the process was determined by political rather than economic factors because, according to them: ‘neither economic theory nor economic evidence provides a clear

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case for or against monetary unification’ (Eichengreen and Frieden 1993:98). The absence of a clear economic justification for EMU leads us to conclude that events in Europe are being driven mainly by political factors’ (ibid). In order to explain political consensus in favour of EMU, they discuss three sets of political considerations: interstate bargaining, issue linkage, and domestic distribution factors. They conclude that no single factor can explain the EMU process, and that the outcomes are a result of all the political considerations taken together (Eichengreen and Frieden 1993:98). Garrett (1993) focuses on specific aspects of the EMU negotiations. Garrett examines why Germany accepted the type of EMU agreed to at Maastricht. He rejects the usual interpretation of the Maastricht Treaty, which views the EMU arrangement as recreating the German model at the European level. Writing in 1993, he claims that EMU could lead to higher inflation because ‘Membership was not limited to countries that mimic the German commitment to price stability’ (Garrett 1993:105). He concludes that the reason for Germany’s acceptance of this ‘suboptimal outcome’ is to be found in the international circumstances at the time of the Maastricht negotiations: that is, German reunification and the demise of the Soviet empire, which gave Germany broader political interests to deepen European integration. With the benefit of hindsight it can be noted that German policies have tended to demand a ‘strict’ interpretation of the Maastricht convergence criteria for entering EMU, a policy choice which Garrett does not seem to have anticipated. A later analysis by Henning (1994) clarifies the process by which the German government moved towards accepting EMU. The Bundesbank was more sceptical than the German government and was concerned about ‘weaker member states’ participating prematurely in EMU. The Kohl government was willing to accept EMU if it was firmly based on German principles of price stability and central bank independence (Henning 1994:228–37). Heisenberg (1999) devotes an entire volume to the question of the role of Germany in European monetary co-operation. She disagrees with the type of argument provided by Garrett. In her view there are three claims about why Germany agreed to EMU. First, EMU was more advantageous to Germany than to other member states. Second, EMU was a ‘deal’ to make German reunification acceptable by others. Third, Chancellor Kohl was committed to Europeanisation. Her book convincingly dismisses the first two explanations, and finds a variety of the third most convincing. She clarifies that one needs to see Kohl’s personal commitment to Europe in the broader context of Bundesbank policies to European monetary integration. Kohl was, of course, influenced by the influential German central bank. She furthermore explains that Kohl was able to take such a leadership role and go unchallenged on this matter because of the specific German historical background which makes European integration for Germany less controversial (Heisenberg 1999:181–91).7

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Martin’s article in Economics and Politics examines the ways in which formal institutions and decision-making procedures have constrained the EMU process (Martin 1993). Her thesis is that the final EMU arrangement was a result of issue linkages (that is, not only achieving EMU but also incorporating in the Treaty a cohesion fund, the social chapter, and extending the powers of the European Parliament). She stresses that these linkages were possible as EMU was negotiated in a particular institutional set-up, namely the IGC on EMU that aimed at amending the Treaty of Rome. As a consequence, all member states ultimately could veto the final outcome, so as a result the final package had to please every member state. Furthermore, because the Treaty had to be ratified by twelve national parliaments this implied it had to be acceptable to the negotiators as well as their national parliamentarians. Thus, she discards a purely intergovernmental analysis of the EMU negotiations. Martin’s analysis offers a key to understanding why some countries, for example ‘poorer’ member states who at first could have thought they would not be able to join EMU right away, still accepted EMU. In an article comparing the NAFTA agreement with the Maastricht Treaty, Milner, much like Martin, concludes that domestic politics and the institutional set-up are the most important variables in explaining the EMU agreement. In Milner’s view, the role of the Commission and of its president should not be diminished, but ‘National political leaders’ interest in monetary union was what brought the issue back to life’ (Milner 1995:351). Her analysis takes the increasing international economic interdependence and dominance of German policies as a given. Hence, political leaders responded to domestic pressure in addition to the changed international environment. McNamara, another author who examines the role of domestic politics, also comes to the conclusion that ‘domestic politics do matter’, but only if one moves beyond the level of sectoral interest group pressures on government action. Instead, McNamara points to the fact that policymakers need to respond to ‘continued uncertainty over what constitutes the correct prescriptions for monetary policy’ (McNamara 1994:21). She points to the role of ideas in bringing about—or ‘helping to construct’—perceptions of national interests. In her view the relatively under-examined role of changing ideas is in need of study in order to understand diverging and converging interests in the move towards EMU. She argues that the constraints of international capital mobility and the neo-liberal consensus on monetary policy led to ‘the consensus of competitive liberalism’ (McNamara 1998:166). Her book on the ‘idea formation’ underlying the EMS clarifies the importance of converging policy objectives prior to the EMU initiative having been relaunched (McNamara 1998); a comparable ideational study of economic and monetary policy change is provided by Marcussen (1998a, 1998b); on the role of ideas and knowledge see also Radaelli (1995, 1997). Another domestic politics approach is provided by Walsh (2000). His study analyses how Britain, France and Italy determined their exchange

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rate policies from the mid 1970s through 1998. He seeks to explain why their preferences for exchange rate co-operation differed and what role domestic politics played. He examines this question by looking at domestic preferences as such, and domestic preferences embedded in institutional settings. The conclusion of his study is indeed that ‘domestic politics matter’. His study shows that a complex set of domestic actors and interactions can explain the variance in outcome regarding exchange rate policy in the three countries he studies. He does, however, find that an approach which embeds domestic politics in the broader (domestic) institutional setting is more capable of explaining the outcome than a domestic politics approach that ignores institutions. In contrast to McNamara he finds little evidence that learning and communication were important for international co-operation. At the same time, he does find that institutionalised interaction and learning was important at the domestic level (Walsh 2000:2, 154–6). So far, Dyson (1994) and Dyson and Featherstone (1999–see below) have written the most comprehensive study of economic and monetary integration in the Community. Dyson’s (1994) central argument was that the EMS and EMU policy process is best understood as composed of a distinct set of interdependent bargaining relations and rules of the game, embedded in a framework of structures that they have a limited, and fluctuating, capacity to influence. (Dyson 1994: x) His first book on EMU (Dyson 1994) looks at the policy actors, the bargaining relations and what he calls ‘structural power in the international political economy’. Regarding the actors, his thesis is that the ‘will and capacity of the central actors involved’ shaped the EMU process (Dyson 1994:x). Four factors influence this will and capacity: 1 The actors have to operate in a ‘scene’, a ‘two-level game’ (Putnam 1988). 2 These central actors also hold certain economic beliefs. 3 These actors are confronted with changing structural conditions in the international political economy. 4 Their will and capacity to create EMU is heavily influenced by their experience with European economic and monetary integration process, notably the EMS and EMU (Dyson 1994:10–17). Finally, with respect to ‘structural power’, Dyson refers to control over a wide range of factors in the external environment (see also Strange 1994). These include, among others, control over the anchor currency, control over supply and demand of capital, control over ‘economic fundamentals’ and, notably, the ‘control over the key ideas and beliefs informing the policy process, in particular the “capture” of the EMS policy process by economic ideas of

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“sound money” and the prevalence of political beliefs about European Union’ (Dyson 1994:16). This latter emphasis on the importance of monetary experts is also found in a subsequent piece by Cameron (1995), in which he examines the process leading to EMU. Cameron’s analysis questions whether the process should be seen as primarily supranational or intergovernmental. His conclusion is that both types of politics were important, but that The EMU initiative also witnessed a third type of politics that involved neither the national governments of the member states nor actors embedded in the supranational institutions of the Community but, rather, transnational actors. (Cameron, 1995:73–4, italics in original) The transnational actors he refers to are monetary officials who were members of the Monetary Committee or the Committee of Central Bank Governors. Cameron points to the fact that these actors not only represented their national governments but also met with one another regularly, as their meetings were highly institutionalised. Cameron’s line of thinking reminds us of the work done by Rosenthal (1975) on the Werner Report (1970), in which she draws similar conclusions. In my own work on the role of experts (Verdun 1999b), I have emphasised how the final outcome of the EMU process has been predominantly constructed by monetary experts, in particular the central banking community. In it I examine how the Delors Committee operated as an epistemic community, thereby creating the kind of EMU that was logical from the perspective of the central banking community. However, to fully appreciate the process one needs to examine why national governments decided to ask a group of mainly central bankers to draft a blueprint. I argue in that piece that it was the only way forward at that point in time. The status quo was no longer desirable, and a step ‘forward’ required that the institutional design remained close to the status quo. Thus it implied institutionalising a German-type monetary regime which places a lot of emphasis on a politically independent central bank, whose main mandate is to safeguard price stability. Elsewhere, I have examined the role of EU expert committees and policy learning (Verdun 2000b). My findings were that not only did the central bankers in the Delors Committee form an important epistemic community, but also the other EU committees (e.g. the Monetary Committee and the Committee of Central Bank Governors)8 played an important role in creating common ideas, a common language and long-term commitment to policy objectives. These points are consistent with the conclusions drawn by Rosenthal (1975) and McNamara (1998) discussed above. Finally, in recent work I set out to understand why a cross-section of domestic actors was interested in creating an EMU in the EC (Verdun 2000a).

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The study contains mainly an explorative research project, rather than offering a theory-testing exercise. It finds that actors had incorporated changes in the European and in the global political economy, and were thus willing to embark on a new project. EMU was accepted as a way to pursue neo-liberal policies. At the same time, EMU offered a policy instrument that could be used to influence monetary policy that many had accepted as no longer under the control of any given government or actor (Verdun 1996; 2000a). Each of the actors also had specific reasons to pursue EMU Jones et al. (1998) offer an analysis of EMU by examining various smaller member states. The interesting phenomenon observed here is that they find that there is no ‘small country’ explanation of why EMU happened. EMU seemed to occur because it served all participants at the same time in different ways. However, the analyses of several smaller member states point to international factors, globalisation and financial market integration as having been important for the realisation by national monetary authorities of the limited room for manoeuvre in macro-economic and monetary policy-making. Yet, at the same time, it is clear that congruence of national interests was crucial in pushing the EMU process forward. Still, they do not at all claim that monetary integration was in any way inevitable. In addition to all the above, there are several others that take on different perspectives. Campanella (1995) takes on a neo-institutionalist approach to explain the EMU process. McNamara and Jones (1996) examine the specific role of the Bundesbank in Germany and try to understand the specific German background to the EMU process, examining how the EMU process might well need to re-address the imbalance by creating a system too much focused on the German case. Wolf and Zangl (1996) offer a sophisticated two-level game analysis. Finally, economists provide many other analyses. Some emphasise the importance of understanding the political nature of the EMU project (see inter alia Apel 1998; Gros and Thygesen 1998). The above is by no means a complete review of the literature. But it is fair to say that it is a good sample of the many studies that look at parts of the economic and monetary integration process. More recently the debate in European integration theory has re-emerged and the old debate between the neofunctionalists and intergovernmentalists has resurfaced once again. Moravcsik (1993, 1994, 1998b) emphasises the fact that the EMS and the EMU negotiations were part of a strategy of national executives to gain more domestic control, given that international interdependence was reducing the room for manoeuvre of national politicians (Moravcsik 1994:38–51; Milward 1992). Moravcsik’s earlier analyses do not discuss the recent EMU process. On the basis of other parts of the integration process, he argues that national executives have increased their importance vis-a-vis domestic actors by using progress in the European integration as legitimisation for difficult domestic policy decisions. Moravcsik’s analysis rejects the idea that the integration process may have an internal dynamic, which may push forward the process.

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The analysis also plays down the role that the EC/EU institutions or transnational actors have in the integration process. In his provocative book, Moravcsik (1998a) does discuss at great length the negotiations that led to the EMU arrangement in the Maastricht Treaty. His main proposition is that national governments acted rationally and aimed at safeguarding their own national interests. He treats the national governments as ‘unitary actors’, not because they are but because they act as if they are unitary. He strongly disputes the conclusion that the EMU package in the Treaty can in any way be seen as a result of unintended consequences, or path dependence. Rather, according to Moravcsik, EMU is the result of careful negotiation and bargaining of national governments, reflecting in particular the interests of the most powerful member states. In his view, the process can be best analysed by assuming that national governments formulate preferences, then engage in interstate bargaining and finally decide whether or not to delegate or pool sovereignty (Moravcsik 1998a: 473). Aware of the challenges that the EMU arrangement poses for neorealism, Grieco (1995) offers a revised neorealist analysis of the process. In his analysis, the ‘voice opportunities thesis’ may help explain why countries such as France, Italy and many smaller member states favoured EMU; by creating the European System of Central Banks (ESCB), monetary authorities of these countries could regain power which was in practice lost to the Bundesbank. Moreover, assuming that there are external challenges to be met, it could be considered consistent with neorealist assumptions that countries co-operate multilaterally in order to be strong enough to face a hegemonic power (Grieco 1995:40). Grieco criticises the neofunctionalist concept of ‘spill-over’ as not functioning properly in the case of EMU. He argues that ‘simultaneity of financial liberalisation and the decision to seek EMU would not appear to be in accord with the spill-over hypothesis’ (Grieco 1995:33). However, Grieco does not address the fact that the decision to liberalise capital by 1 July 1990 had been decided before the Delors Committee came out with its report. In fact, the Delors Committee decided to let the first stage of EMU coincide with the first date of full capital liberalisation in the EC. So one could well argue that spill-over was at work at this particular point in time. More recently, a project informally christened the ‘Laguna Beach project’ has focused on the importance of supranational, transnational and domestic actors and their drive for integration (Sandholtz and Stone Sweet 1998). Cameron’s contribution in this edited volume focuses on EMU (Cameron 1998). Unfortunately, however, Cameron’s analysis does not clearly specify the role of those actors in the process of creating EMU, even though Cameron’s chapter forms part of an otherwise path-breaking book that re-establishes a ‘transactional’ or ‘supranational’ approach. Nevertheless, his account of the road to EMU, including his view of the changes in the European economy, the asymmetrical nature of the EMS, etc., is very insightful.

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Finally, the most ambitious and detailed study of the economic and monetary integration process is Dyson and Featherstone (1999). That study provides the reader with a wealth of details about the actors and structures at play. They offer a domestic account of what happened by examining what caused EMU to be accepted in Britain, France, Germany and Italy as well as within the European Commission. Their study focuses in particular on the individuals behind the negotiations. They portray the state leaders, the ministers of finance, the most important governors of the central banks and various other persons who were influential in the process. The book concludes that EMU was a core-executive activity and the monetary and financial elites were keen to limit the discussions about EMU to the narrow focus of monetary and financial affairs (Dyson and Featherstone 1999:746–7). Ideas were important; EMU was part of the ‘sound money’ paradigm. Another characteristic of the EMU process which they identify is that the process was dominated by experts and by political leadership (in particular the Franco-German relationship). Finally, they argue that agenda-setting power and the role of policy entrepreneurs was absolutely crucial. They considered the role of individuals who have been extremely important and that without their entrepreneurship EMU would not have happened. In addition to the importance placed on the role of individuals in explaining EMU, Dyson and Featherstone’s analysis moves on to identify three further ‘bases’ that enabled EMU to happen: economic, political and diplomatic. There are various economic bases that are considered to have been important: the shared economic-policy beliefs (the primacy of ‘sound money’); the relative positive economic environment in the late 1980s and early 1990s; and, finally, the economic ‘spill-over’ effects from the Single European Market. In the ‘political’ realm there are also three important factors: first, the core-executive nature of the negotiations; second, the negotiations took place in a highly institutionalised setting; and, finally, the subject of negotiations remained restricted to monetary matters. The third basis, the diplomatic one, refers to the fact that EMU was embedded in negotiations that ultimately aimed at avoiding another war in Europe and to strengthen (peaceful) ties between France and Germany (Dyson and Featherstone 1999:756–7). Though Dyson and Featherstone’s analysis provides incredibly detailed insights into the process, it falls short in explaining in clear abstract terms why EMU happened. The reader is left with the impression that everything is important. For the purpose of academic generalisability and in particular the desire to draw theoretical conclusions, however, their study does not present the reader with the primacy of any specific factors or a general approach. As will become clear from this literature review, there are numerous analyses and theories as to why EMU happened and what factors should be considered to be the most important. Let us now turn to a closer analysis of these explanations and place them in the wider context of more general

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political science theories, which aim at explaining complex political phenomena.

Creating a taxonomy As stated above, the traditional intergovernmentalist versus neofunctionalist/ supranationalist debate has been slow to develop in the recent literature on EMU, even though it was there in the early accounts of EMU in the 1970s. Emphasis has been placed on structural factors which were translated either as background variables for institutional change (Sandholtz 1993), or for elusive actors to play a more dominant role (Dyson 1994). Later, they were used to paint the background of an intergovernmentalist power play (Moravcsik 1998a). In the sections above, a large number of actors and structures have been identified as having played an important role in the European economic and monetary integration process. We can also group them together into three main categories, i.e. (1) role of actors and institutions, (2) mechanisms, and (3) international structural factors. Once we have adopted those three categories the actors and structures can be regrouped as follows: 1 Role of actors and institutions: • • • • •

supranational actors and institutions; national actors and institutions; sectoral, regional actors; national interests; domestic situation; institution, culture and history.

2 Mechanisms: • • • • • • • •

spill-over; path-dependence; unintended consequences; bargaining; two-level games; socialisation; policy-learning, lesson-drawing; sharing norms and values.

3 International structural factors: • • • •

globalisation and financial market integration; Europeanisation; structural power factors; hegemonic power.

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As was stated in the introduction, the case of EMU illustrates the kinds of debates currently taking place in the broader Political Science/European Studies academic literature. Our specific actors and structures are in fact explanatory variables for the case of EMU. We can also place them within the larger framework of European integration theories and classify them in a spectrum, based on their assumptions and the variables that are the most important in determining the outcome. We would obtain the following classification of theoretical approaches, some seminal work connected to the approaches, their assumptions and predictions: Neofunctionalism Haas (1958, 1964); Lindberg and Scheingold (1970, 1971). Assumptions The domestic elite pursues policies in the arenas they find most successful; due to ‘spill-over’ the policy-making process will become obsolete at the national level; supranational actors play an important role in the process. Predictions The process of policy-making will gradually be transferred to the European level; political integration will occur because people transfer loyalty to the European level.

Historical institutionalism Hall and Taylor (1994); Pierson (1996). Assumptions Actors are constrained by decisions taken earlier. Institutions and governments work in this framework. ‘Path dependence’ leads to favouring several outcomes above others. Predictions The institutional context and the rules and norms determine the outcome beyond the mere calculation of the ‘interests’ of national governments. Policy-learning/lesson-drawing Bennett and Howlett (1992); Rose (1991). Assumptions Policy-makers have a memory of ‘successful’ policies in the past. They value their policies not only on the basis of ‘interests’. Predictions The outcome of the process depends on the evaluation of earlier decisions. The institutionalisation of policy choices: those that build on policies

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that were successful in the past are very likely to be adopted, whereas those that have a history of failure are unlikely to be adopted again.

Epistemic communities approach Haas (1992, 1997). Assumptions Experts have a crucial input in the process. National governments cannot easily come up with solutions to complicated problems, be they for reasons of bargaining or for reasons of the technocratic details of the arrangement. Predictions Members of an ‘epistemic community’ can create a policy project drawing on shared causal beliefs and the use of shared discursive practices.

Advocacy coalition approach Sabatier (1998); Sabatier and Jenkins-Smith (1993). Assumptions Groups of experts and policy entrepreneurs can create a policy advocacy coalition. What binds an advocacy coalition is their core of shared beliefs, which need to be stable over time (at least a decade). They share a common belief system. Predictions An advocacy coalition can influence the policy-making process above and beyond simple intergovernmental bargaining based on national ‘interests’.

Policy networks Börzel (1997). Assumptions Policy networks exist. They play a crucial role in the policymaking process. Predictions Policy networks constitute arenas for non-strategic communicative action that can provide solutions going beyond the mere national bargaining of national governments. Multilevel governance Hooghe and Marks (2001); Kohler-Koch (1996); Marks et al (1996). Assumptions Policy-making occurs at a variety of ‘levels’ (e.g. sectoral, regional, national, European).

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Predictions The outcome of the process cannot be understood only by examining the outcomes and the processes at the various levels.

Europeanisation thesis Green Cowles et al (2001); Kohler-Koch and Eising (1999). Assumptions The process of Europeanisation has a direct effect on national and European decision-making. Thus, the freedom of actors to decide has been constrained. Predictions The outcome of the policy-making process depends on actors’ perceptions about feasible policy-making, given the changed European circumstances and the effects of European policy-making on national policymaking.

Structural factors—globalisationlfinancial market integration thesis Helleiner (1994); Strange (1996); Verdun (2000a). Assumptions The environment in which policy-making occurs has changed. As a result, actors are less free to choose their options. Predictions The outcome of the policy-making process depends on actors’ perceptions about feasible policy-making given the international circumstances.

Constructivism Risse et al (1999); Christiansen et al. (1999). Assumptions Interests and bargaining are embedded in a larger sociological, cultural and historical framework. ‘Interests’ and ‘motivations’ can only be understood if one examines the underlying framework. Predictions Socialisation, cultural and historical experiences and the use of language influence the outcome of the policy-making process. Intergovernmentalism Hoffmann (1966). Assumptions National member state governments are the most important actors for explaining European integration. National interests are based on national preferences.

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Predictions The outcome of international bargaining is the result of the bargaining of national governments, which aim to protect their interests. Larger member states have disproportionate influence over the outcome of the bargaining process compared with smaller member states. Liberal intergovernmentalism Moravcsik (1993, 1998a). Assumptions National member state governments are the most important actors for explaining European integration. National interests are based on national preferences. National preferences can be deduced from economic interests at the domestic level. Predictions The outcome of international bargaining is the result of the bargaining of national governments, which aim to protect their interests. Larger member states have disproportionate influence over the outcome of the bargaining process compared with smaller member states. Two-level games Putnam (1988). Assumptions In making multilateral/international agreements, national executives operate on two levels: the domestic and the international levels. Predictions National executives can argue in both arenas that their hands are tied because of a situation on the other level. They can use their exclusive situation on both levels to enhance their bargaining position. Thus, the outcome of the bargaining depends strongly on the role of national executives. Rational choice institutionalism Tsebelis (1990). Assumptions Actors are constrained by decision rules and norms of institutional frameworks. Institutions and governments work in this framework. Predictions The institutional context and the rules and norms determine the outcome. Actors (i.e. national governments and supranational institutions) pursue strategies to safeguard their ‘interests’. Domestic politics approach Bulmer (1983, 1994, 1998); Huelshoff (1994).

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Assumptions Domestic situations differ from one another. The particular domestic situation, (historical, institutional, legal, cultural, etc.) as well as domestic interests determine the acceptability of policy-making. Predictions The outcome of the policy-making process depends on the domestic situation. As a result, the national executives are strengthened in their bargaining position. The outcome depends strongly on the bargaining of national executives against the background of their domestic situations.

Agenda-setting theory Tsebelis (1994). Assumptions Those who manage to set the agenda are able to influence the outcome of the policy-making process. Predictions The outcome of bargaining is in part determined by the agendasetting process, and the underlying rules and institutional framework. The outcome of the process can subsequently be understood by adopting a bargaining analysis.

Hegemony thesis Gilpin (1987). Assumptions One or more countries have considerably more influence over the policy-making process than others do. This country or these countries perform the role of a hegemon. The hegemon has a greater influence over the policy-making process. At the same time other countries try to constrain a large accumulation of influence of the hegemon. Prediction The hegemonic power has a larger role than others do in the bargaining process. At the same time, others try to constrain the hegemon. The outcome of the process reflects these two processes. When these various approaches are examined, clusters of theories can be identified that are more similar and others that are more dissimilar, depending on the criteria one uses to cluster them. If we wanted to identify explanatory approaches that put emphasis on the gradual, incremental nature of the process so the process starts taking on a ‘life of its own’, we might call this group the ‘gradualists’. This group would contain: neofunctionalism, historical institutionalism, policy-learning/lesson-drawing, the epistemic community approach, the advocacy coalition approach, policy networks approach, multilevel governance approach, the Europeanisation thesis approach, the structural factors approach and constructivism. Another group of approaches would be characterised as having identified actors who act on the basis of

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their rational expectations, with limited or no ‘path dependence’ or ‘automatism’ being assumed. This group of approaches sees the actors as being in charge and able to determine the outcome of the process. In this view the outcome is to a large extent the consequence of actors’ behaviour and actions. We could call this group the ‘rationalists’. This group would contain the following approaches: intergovernmentalism, liberal intergovernmentalism, two-level games approach, rational choice institutionalism, the domestic politics approach, agenda-setting theory, the hegemony thesis approach. See Table 4.1. Though the approaches now have been placed into two groups, one should of course remember that they still consist of a large variety of approaches. Yet placing these theories into two groups serves the purpose of emphasising where ultimately the most important differences lie. A large number of approaches assume that there is much more going on than meets the eye. A mere focus on a few actors and trying to understand their impact on the overall process remains difficult in the eyes of the ‘gradualists’. The ‘rationalists’, by contrast, have as their very aim the desire to identify the exact contribution of each of these actors on the overall process. They narrow the focus of study down to a much more limited set of actors and factors. It seems that what we are dealing with here are two groups of theories with fundamentally different ontologies. Judging the usefulness of theories when their ontologies are so far apart, and when within the group there is a mosaic of different nuances on what to look out for, proves to be a difficult task, which we will not further attempt in this short chapter. It should be clear from the above that EMU offers a case study that can be studied with as many approaches as there are for the entire European integration process. Table 4.1 Clustering political theories of integration

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The outcome of the analysis is determined by the choice of the approach and the actors and factors studied most closely. Conclusion The explanations of EMU have a lot in common with the larger European integration theoretical frameworks, as well as with the broader theories of political science. What we find is that they aim at explaining different parts of the process, have different assumptions, and thus come to expect different outcomes from the integration process. When turning to the original aim of this chapter—namely, to evaluate the usefulness of these different approaches—we come to the conclusion that it becomes extremely difficult to judge the ‘usefulness’ or ‘value’ of one theoretical approach over another without moving to the meta-theoretical level. However, by moving to the meta-theoretical level we adopt one set of assumptions over another. We have to identify one factor as being of more importance than another. In doing so, we can more easily see the differences between the various approaches, though we lose some of the richness of their diversity. This chapter has shown three things. First, it has shown that explanations of EMU are not substantially different from many other cases in EU studies. The explanations offered resemble many of the various theories or partial theories of European integration. Second, it has been argued that the usefulness of the approach adopted depends on the specific part of the process we want to understand. Finally, in the view of this author there is no overarching explanation of EMU. There is merely a collection of many explanations of the many parts of the process. When looking at the richness of the various approaches, we could attempt to make a meta-theoretical analysis about what these theories try to explain, and what core mechanism lies behind the analyses of the various approaches. We could identify a group of ‘gradualists’ and a group of ‘rationalists’. Each seems to have different aims in what they try to explain. It also appears that they work with different ontological assumptions. The chapter has made a first attempt at mapping the theoretical explanations of why EMU happened, and in doing so has also made a start with putting some order into the chaos of European integration theory. Notes 1

Because this chapter aims at mapping the various integration theories and examining the different theoretical explanations of EMU, starting with a historical background is tricky. Of course, there is no such thing as providing a historical background without some sense of judgement as to what factors are important. Many analyses would disagree among themselves as to the importance of various factors in the EMU process. Nevertheless, this section provides a brief historical background so that the reader can place into context the various explanations of EMU

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2

The Delors Report framed the issues so that they built on the earlier Werner Report and the lessons learned in the 1970s and 1980s—namely, the EMS, capital liberalisation and internal market; an independent central bank based on price stability, but no role for a supranational authority over economic policy. The open ends were:

3

• • • •

4 5

the decision to adopt a single currency (preferred option of the Delors Report); transition period; exact definition of the criteria for entry (convergence criteria); the implicit assumption in the Treaty about whether or not it would be an inclusive or exclusive EMU (i.e. more or fewer countries). The eventual decision was for more countries with an option for less (see formulation of the convergence criteria debt-deficit criteria).

The following section draws on Verdun 2000a, chapter 2; Verdun 1998d; and Verdun 2000c. Moreover, in later work Smith and Sandholtz stress that ‘Germany was a vital source of leadership and of initiative on behalf of monetary and political integration’ (Smith and Sandholtz 1995:248). They also stress the importance of the ‘EC’s institutional structure’:

He [Chancellor Kohl] was able to push for a Treaty on EMU despite the reluctance and scepticism of the Bundesbank…The EC’s institutional structure for amending the Treaty of Rome empowered Kohl—and the heads of state in general—during the intergovernmental, treatymaking phase. (ibid.) 6 7

8

These and several additional papers were reprinted in Eichengreen and Frieden (1994). Loedel (1999: ix) asks a similar question in his study: ‘Why was Germany prepared to sacrifice the DM for European Monetary Union?’ He answers the question by examining the role of, on the one hand, the relationship between the German government and the Bundesbank and, on the other, German bargaining strategies towards European and global monetary governance structures. His interesting study shows the intricate balance of power between the German government and the Bundesbank. The Monetary Committee has ceased to exist. With the start of EMU on 1 January 1999 it was transformed into the Economic and Financial Committee. However, at the time of the change-over insiders suggested that only the name would change. Its mode of operation and its culture were not considered likely to be subject to change. The Committee of Central Bank Governors first became incorporated in the European Monetary Institute. The latter was transformed into the European Central Bank.

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——(1994) ‘Capital mobility and state autonomy: toward a structural theory of international monetary relations’, International Studies Quarterly, 38:193–218. Apel, E. (1998) European Monetary Integration 1958–2002, London/New York: Routledge. Bennett, C. and Howlett, M. (1992) ‘The lessons of learning: reconciling theories of policy learning and policy change’, Policy Sciences, 25:275–94. Börzel, T. (1997) ‘What’s so special about policy networks? An exploration of the concept and of its usefulness in studying European Governance’ , European Integration Online Papers, EloP, 1, 16, http://eiop.or.at/eiop/texte/1997–016ahtm. Bulmer, S. (1983) ‘Domestic politics and European Community policy-making’, Journal of Common Market Studies, 14:349–63. ——(1994) ‘The governance of the European Union: a new institutionalist approach’ Journal of Public Policy, 13(4): 351–80. ——(1998) ‘New institutionalism and the governance of the Single European Market’, Journal of European Public Policy, 5(3): 365–86. Cameron, D.R. (1995) ‘Transnational relations and the development of European economic and monetary union’, in T.Risse-Kappen (ed.) Bringing Transnational Relations Back In. Non-State Actors, Domestic Structures and International Institutions, Cambridge: Cambridge University Press. ——(1997) ‘Economic and Monetary Union: underlying imperatives and third-stage dilemmas’, Journal of European Public Policy, 4(3): 455–85. ——(1998) ‘Creating supranational authority in monetary and exchange-rate policy: the sources and effects of EMU’, in Wayne Sandholtz and Alec Stone Sweet (eds), European Integration and Supranational Governance, Oxford: Oxford University Press, pp. 188–216. Campanella, M. (1995) ‘Getting the core: a neo-institutionalist approach to EMU’, Government and Opposition, 30(3): 347–69. Christiansen, T, Jørgensen, K.-E. and Wiener, A. (1999) The Social Construction of Europe, special issue of Journal of European Public Policy, 6(4). Delors Report (1989) Report on Economic and Monetary Union in the European Community, Committee for the Study of Economic and Monetary Union, Luxembourg: Office for Official Publications of the EC. Dyson, K. (1994) Elusive Union. The Process of Economic and Monetary Union in Europe, London and New York: Longman. Dyson, K. and Featherstone, K. (1996) ‘EMU and economic governance in Germany’, German Politics, 5(3): 325–55. ——(1999) The Road to Maastricht. Negotiating Economic and Monetary Union, Oxford: Oxford University Press. Dyson, K. and Michalopoulos, G. (1995) ‘Strapped to the mast; EC central bankers between global financial markets and regional integration’, Journal of European Public Policy, 2(3): 465–87. Eichengreen, B. and Frieden, J.A. (1993) ‘The political economy of European monetary unification: an analytical introduction’, Economics and Politics, 5(2): 85–105. ——(eds) (1994) The Political Economy of European Monetary Unification, Boulder, San Francisco and Oxford: Westview Press. Garrett, G. (1993) ‘The politics of Maastricht’, Economics and Politics, 5(2): 105– 25. Gilpin, R. (1987) The Political Economy of International Relations, Princeton: Princeton University Press. Green Cowles, M., Caporaso, J. and Risse, T. (eds) (2001) Transforming Europe: Europeanization and Domestic Change, Ithaca, NY: Cornell University Press.

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Grieco, J. (1995) The Maastricht Treaty, economic and monetary union and the neorealist research programme’, Review of International Studies, 21(1): 21–40. Gros, D. and Thygesen, N. (1998) European Monetary Integration. From the European Monetary System to Economic and Monetary Union, 2nd edn, Harlow, Essex/ New York: Longman. Haas, E. (1958) The Uniting of Europe, 1st edn, London: Stevens. ——(1964) Beyond the Nation State. Political, Social, and Economic Forces 1950– 1957, Stanford: Stanford University Press. ——(1968) The Uniting of Europe, 2nd edn, Stanford: Stanford University Press. Haas, P. (1992) ‘Introduction: epistemic communities and international policy coordination’, International Organization, 46(1): 1–35. ——(ed.) (1997) Knowledge, Power and International Policy Coordination, Columbia: University of South Carolina Press. Hall, P. and Taylor, R. (1994) ‘Political science and the new institutionalism’, Political Studies, 44:936–57. Heisenberg, D. (1999) The Mark of the Bundesbank: Germany’s Role in European Monetary Cooperation, Boulder, Col.: Lynne Rienner. Helleiner, E. (1994) States and the Reemergence of Global Finance, Ithaca: Cornell University Press. ——(1998) ‘National currencies and national identities’, American Behavioral Scientist, 41(1): 1409–36. Henning, C. (1994) Currencies and Politics in the United States, Germany, and Japan, Washington, DC: Institute for International Economics. Hoffmann, S. (1966) ‘Obstinate or obsolete? The fate of the nation-state and the case of Western Europe’, Daedalus, 95(3): 862–916. Hooghe, L. and Marks, G. (2001) Multi-level Governance and European integration, Lanham, MD: Rowman & Littlefleld Publishers. Huelshoff, M. (1994) ‘Domestic politics and dynamic issue linkage’, International Studies Quarterly, 38(2): 255–79. Jachtenfuchs, M. (2001) ‘The governance approach to European integration’, Journal of Common Market Studies, 39(2): 221–44. Jones E., Frieden, J. and Torres, F. (eds) (19 98) Joining Europe’s Monetary Club. The Challenges for Smaller Member States, New York: St Martin’s Press. Kaufmann, H. (1995) ‘The importance of being independent: central bank independence and the European system of central banks’, in C.Rhodes and S.Mazey (eds) The State of the European Union. Building a European Polity? Boulder, Col.: Lynne Rienner, pp. 267–92. Kenen, P. (1995) Economic and Monetary Union in Europe. Moving Beyond Maastricht, Cambridge: Cambridge University Press. Kohler-Koch, B. (1996) ‘Catching up with change: the transformation of governance in the European Union’, Journal of European Public Policy, 3(3): 359–80. Kohler-Koch, B. and Eising, R. (eds) (1999) The Transformation of Governance in the European Union, London: Routledge. Kruse, D.C. (1980) Monetary Integration in Western Europe: EMU, EMS and Beyond, London: Butterworth. Lindberg, L. and Scheingold, S.A. (1970) Europe’s Would-be Polity. Patterns of Change in the European Community, Englewood Cliffs, New Jersey: Prentice Hall.

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——(eds) (1971) Regional Integration: Theory and Research, Cambridge, Mass.: Harvard University Press. Loedel, P. (1999) Deutsche Mark Politics: Germany in the European Monetary System, Boulder, Col.: Lynne Rienner. McNamara, K. (1994) ‘Economic and monetary union in Europe: do domestic politics matter? Does hegemony?’ paper delivered at the 1994 APS A meeting, New York, 1–4 September. ——(1998) The Currency of Ideas: Monetary Politics in the European Union, Ithaca: Cornell University Press. McNamara, K. and Jones, E. (1996), The clash of institutions: Germany in European monetary affairs, German Politics and Society, 14(3), Fall: 5–30. Marcussen, M. (1997) ‘The role of “ideas” in Dutch, Danish and Swedish economic policy in the 1980s and the beginning of the 1990s’, in P.Minkkinen and H.Patomäki (eds) The Politics of Economic and Monetary Union, Helsinki: Ulkopoliittinen Instituutti (The Finnish Institute of International Affairs), pp. 75– 103. ——(1998a) ‘Ideas and elites. Danish macro-economic policy-discourse in the EMU process,’ PhD dissertation, Aalborg University, Institute for Development and Planning, ISP-Series No. 226, April. ——(1998b) Central Bankers, the Ideational Life-Cycle and the Social Construction of EMU, EUI Working Papers, RSC No. 98/33, Florence: European University Institute. Marks, G.,, Hooghe, L. and Blank, K. (1996) ‘European integration from the 1980s’, Journal of Common Market Studies, 34(3): 341–78. Martin, L.L. (1993) ‘International and domestic institutions in the EMU process’, Economics and Politics, 5(2): 125–45. Milner, H. (1995) ‘Regional economic co-operation, global markets and domestic politics: a comparison of NAFTA and the Maastricht Treaty’, Journal of European Public Policy, 2(3): 337–60. Milward, A. (1992) The European Rescue of the Nation State, London: Routledge. Minkkinen, P. and Patomäki, H. (1997) ‘Introduction: the politics of economic and monetary union’, in P.Minkkinen and H.Patomäki (eds) The Politics of Economic and Monetary Union, Helsinki: Ulkopoliittinen Instituutti (The Finnish Institute of International Affairs), pp. 7–18. Moravcsik, A. (1991) ‘Negotiating the Single European Act: national interests and conventional statecraft in the European Community’, International Organization, 45(1): 19–56. ——(1993) ‘Preferences and power in the European Community: a liberal intergovernmentalist approach’, Journal of Common Market Studies, 31(4): 473– 524. ——(1994) Why the European Community Strengthens the State: Domestic Politics and International Cooperation, Harvard University Center for European Studies, Working Paper Series No. 52, Cambridge, Mass.: Harvard University Press. Presented at the Annual Meeting of the American Political Science Association, New York, September. ——(1998a) The Choice for Europe. Social Purpose and State Power from Messina to Maastricht, Ithaca, New York: Cornell University Press. ——(1998b) ‘Does international cooperation strengthen national executives? The case of monetary policy in the European Union’, paper presented at the Third

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Workshop on Europeanization and Domestic Political Change, Florence, European University Institute, 19–20 June. Patomäki, H. (1997) ‘Legitimation problems of the European Union’, in P.Minkkinen and H.Patomäki (eds) The Politics of Economic and Monetary Union, Boston/ Dordrecht/London: Kluwer, pp. 162–204. Pauly, L. (1992) ‘The politics of European monetary union: national strategies, international implications’, International Journal, 47 (Winter 1991–2): 93–111. Pierson, P. (1996) ‘The path to European integration: a historical institutionalist analysis’ , Comparative Political Studies, 29(2): 123–63. Pollack, M. (2001) ‘International relations theory and European integration’, Journal of Common Market Studies, 39(2): 245–64. Putnam, R. (1988) ‘Diplomacy and domestic politics: the logic of two-level games’, International Organization, 42(3): 427–60. Radaelli, C.M. (1995) ‘The role of knowledge in the policy process’, Journal of European Public Policy, 2(2): 159–83. ——(1996) ‘Fiscal federalism as a catalyst for policy development? In search of a framework for European direct tax harmonisation’, Journal of European Public Policy, 3(3): 402–20. ——(1997) The Politics of Corporate Taxation in the European Union. Knowledge and International Policy Agendas, London: Routledge. Risse, T. (with Engelmann-Martin, D., Knopf, H.-J., and Roscher, K.) (1999) To Euro or not to Euro? The EMU and identity politics in the European Union’, European Journal of International Relations, 5(2) (June): 147–87. Rose, R. (1991) ‘What is lesson-drawing?’ Journal of Public Policy, 11(1): 3–30. Rosenthal, G.G. (1975) The Men Behind the Decisions: Cases in European PolicyMaking, Lexington, Mass., Toronto and London: Lexington/D.C.Heath. Ross, G. (1995) Jacques Delors and European Integration, New York: Oxford University Press. Sabatier, P. (1988) ‘An advocacy coalition framework of policy change and the role of policy-oriented learning therein’, Policy Sciences, 21:129–69. ——(1998) ‘The advocacy coalition framework: revisions and relevance for Europe’, Journal of European Public Policy, 5(1): 98–130. Sabatier, P. and Jenkins-Smith, H.C. (eds) (1993) Policy Change and Learning. An Advocacy Coalition Approach, Boulder: Westview Press. Sandholtz, W. (1993) ‘Choosing union: monetary politics and Maastricht’, International Organization, 47(1): 1–39. ——(1996) ‘Money troubles. Europe’s rough road to monetary union’, Journal of European Public Policy, 3(1): 84–101. Sandholtz, W and Stone Sweet, A. (1998) Supranational Governance: The Institutionalisation of the European Union, Oxford: Oxford University Press. Sandholtz, W. and Zysman, J. (1989) ‘1992: recasting the European bargain’, World Politics, 42:95–128. Sbragia, A. (ed.) (1992) Euro-Politics: Institutions and Policymaking in the ‘New’ European Community, Washington, DC: Brookings Institution. Smith, M. and Sandholtz, W. (1995) ‘Institutions and leadership: Germany, Maastricht, and the ERM crisis,” in C.Rhodes and S.Mazey (eds) The State of the European Union. Building a European Polity? Boulder, Col.: Lynne Rienner, pp. 245–65.

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Stone Sweet, Alec and Sandholtz, W. (1997) ‘European integration and supranational governance’, Journal of European Public Policy, 4(3): 297–317. Strange, S. (1994) States and Markets, 2nd edn, Manchester: Manchester University Press. ——(1996) Retreat of the State: The Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Taylor, C. (1995) EMU 2000? Prospects for European Monetary Union, London: Royal Institute of International Affairs. Tsebelis, G. (1990) Nested Games, Berkeley: University of California Press. ——(1994) ‘The power of the European Parliament as a conditional agenda setter’, American Political Science Review, 88(1), March: pp. 128–42. Tsoukalis, L. (1977) The Politics and Economics of European Monetary Integration, London: George Allen and Unwin. Ungerer, H. (1997) A Concise History of European Monetary Integration: From EPU to EMU, Westport/London: Quorum. Verdun, A. (1996) ‘An “asymmetrical” economic and monetary union in the EU: perceptions of monetary authorities and social partners’, Journal of European Integration/Revue d’Integration européenne, 20(1), Autumn: 59–81. ——(1998a) ‘Creating EMU: issues of legitimacy, accountability and democracy?’ CEPS Review, 7, Autumn: 21–30. ——(1998b) ‘The increased influence of the EU monetary institutional framework in determining monetary policies: a transnational monetary elite at work’, in B. Reinalda and B.Verbeek (eds) Autonomous Policymaking by International Organizations, London: Routledge, pp. 178–94. ——(1998c) ‘Understanding economic and monetary union in the EU’, Journal of European Public Policy, 5(3): 527–33. ——(1999a) ‘The institutional design of EMU: a democratic deficit?’, Journal of Public Policy, 18(2): 107–32. ——(1999b) ‘The role of the Delors Committee in the creation of EMU: an epistemic community?’ Journal of European Public Policy, 6(2), June: 308–28. ——(2000a) European Responses to Globalization and Financial Market Integration: Perceptions of Economic and Monetary Union in Britain, France and Germany, International Political Economy Series, Basingstoke: Macmillan/New York: St Martin’s Press. ——(2000b) ‘Governing by committee: the case of the Monetary Committee’, in T.Christiansen and E.Kirchner (eds) Committee Governance in the European Union, Manchester: Manchester University Press, pp. 132–44. ——(2000c) ‘How did EMU really happen? Who did it? What can we learn from EMU?’ Journal of European Public Policy, 7(5), December: 823–9. Verdun, A. and Christiansen, T. (2000) ‘Policy-making, institution-building and European Monetary Union: dilemmas of legitimacy’, in Colin Crouch (ed.) After the Euro: Shaping Institutions for Governance in the Wake of European Monetary Union, Oxford: Oxford University Press, pp. 162–78. Walsh, J. (2000) European Monetary Integration and Domestic Politics: Britain, France, and Italy, Boulder, Col.: Lynne Rienner. Werner Report (1970) ‘Report to the Council and the Commission on the realization by stages of Economic and Monetary Union in the Community’, Council and Commission of the EC, Bulletin of the EC, Supplement 11, Doc. 16.956/11/70, 8 October.

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5

The economic case against the euro A North American view1 James W.Dean

Preface In early 1996, when I wrote this diatribe against the euro, it was very much in the spirit of North American thinking at the time—at least among many prominent economists. Martin Feldstein had made a similar argument in The Economist magazine, and Milton Friedman famously remarked that he knew of no respectable economist ‘in the world’ who was prepared to defend the euro project on economic grounds. Feldstein even argued in the pages of Foreign Affairs, that bastion of American establishment thinking, that the euro might so exacerbate wrangling within Europe as to trigger World War III, exactly the opposite of what its political promoters intended. Indeed, there is little question that the euro was, from the outset, a political and not an economic project. But the euro is now a fait accompli. Moreover, it has already engendered certain economic efficiencies. And finally, it is likely to spread to Central and Eastern Europe (CEEC). I will comment first on extant and putative efficiencies, and then on the spread to CEEC. The arguments in my essay are based on so-called Optimal Currency Area (OCA) criteria, derived from Robert Mundell’s seminal 1961 paper. As such, they remain valid. But much has changed since 1961.2 Notably, capital is much more mobile internationally. Hence countries can live with current account imbalances—a likely side-effect of fixed-rate and common currency regimes when prices are rigid—for as long as they are willing and able to borrow and lend across borders. Moreover, good arguments can be made that such regimes actually encourage welfare-enhancing capital flows. Indeed the early evidence, from 1997–2001 data, is that intra-Euroland bond flows have burgeoned (Dean and Kasa 2001). Further evidence of such effects is that intra-European interest rates have dropped dramatically, reflecting the absence of currency risk. This is the extant efficiency; now to the putative. Advocates of the euro argue that many of the OCA objections are based on a short-sighted vision of economics that sees such phenomena as wage rigidity and labour immobility as exogenous rather than endogenous to the regime. Modern macroeconomic theory endogenises wages via rational expectations, and by a rather generous leap of logic, euro-advocates extend such reasoning to regulations, industrial 99

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organisation and even institutions. Euroland’s inefficiencies will thereby dissipate under the discipline of a common currency, or so goes the mantra. Admittedly the argument has some force, but the jury is still out. Although the French, for example, have recently made it easier to hire and fire, the Germans have just rejected an EU initiative on mergers. Endogenous reform, if it happens, will be slow. Finally, the euro may spread rapidly eastward to the CEEC countries. The DM long served as an informal, parallel currency in the region; in January 2002 it was replaced by the euro. Several CEEC countries—Bulgaria, Bosnia, Estonia and Lithuania—operate hard fixes to the euro via a currency board. Kosovo and Montenegro made the DM virtually their official currency, and that role will now be played by the euro. And those CEEC countries poised to join the EU—Poland, the Czech Republic, Hungary and Slovenia—aspire to adopt the euro as quickly as Brussels and Frankfurt will allow. In the face of all this informal and potentially formal euroisation, the benefit/cost ratio facing holdout countries rises, probably exponentially. In short, while I (and many other economists) harbour lingering doubts about the euro, it is here to stay, it will spread, and it may even spawn some serious efficiencies in the long run. I have nevertheless chosen to leave the strident anti-euro tone of my original essay unblemished by doubt, as a reminder that the case for the euro is by no means closed.

Introduction The tired old joke has an economist stranded on a desert island with an engineer and a chemist and nothing but a can of beans between them. The engineer suggests opening the can using ingenious mechanical devices. The chemist sets to work formulating ways of concocting acids from the plantlife available on the island. The economist is somewhat more conjectural. ‘Let us begin,’ he asserts, ‘by assuming a can-opener.’ By this standard, the economic bureaucrats in Brussels—let’s call them econocrats—are true to their training. They are bound and determined to introduce a single currency across fifteen countries that speak eleven major languages, with sharply different political and legal institutions, with highly disparate stocks of public debt and with dramatically different levels and rates of growth of productivity. As well-trained economists, they seem to be saying, ‘Let us begin by assuming that in 1999, none of this will be true.’ Of course it will be true in 1999. The smart money at the moment is betting that at least eleven of the fifteen hopeful EU debutantes will actually make it to the Euro Ball. And what will happen to the four wallflowers that have to stay at home? Rumour has it that they might not be as popular as before in Brussels and Bonn, and that they might even be accused of ‘competitive devaluation’ or ‘unfair competition’ if their currencies happen to fall against the new ‘euro’.

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Well, we in North America are just waiting to scoop up the broken hearts and make good the broken dreams. We believe that those who don’t join the Economic and Monetary Union (EMU) may become second-class citizens of Europe, but we believe that they will remain first-class citizens of the world. We in North America would rather buy Italian shoes through a depreciated lire than French shoes through the franc fort; and if the pound sterling remains realistically priced, we would rather buy a Jaguar than a Mercedes. We might also be more inclined to invest in Denmark or Britain than in Austria or Belgium. In an effort to lure debutantes to the magnificent Euro Ball of 1999, the Eurocrats in Brussels have promulgated a long list of luring attractions. Unfortunately, not one of these attractions is nearly as attractive as the Eurocrats would have us believe. I wouldn’t want to call them lies, but I will go so far as to call them myths. The first of these myths is that ‘Everybody’s doing it, so why not you?’

Euromyth No. 1 The world is moving from flexible to fixed exchange rates Ten years ago only eight of the world’s major countries had fully flexible exchange rate regimes. Fourteen countries employed managed regimes and sixty-four maintained fixed exchange rates. Today some thirty-three countries operate under flexible regimes, eighteen under managed and only forty under fixed. And the list of flexible regimes is growing longer since the Asian currency crisis of 1997, a crisis that would not have happened had half a dozen Asian countries not tried to maintain fundamentally unrealistic fixed rates. There are several ways of interpreting these facts. Advocates of fixed rates might argue that the apparent unsustainability of fixed regimes reflects lack of monetary discipline, and that rigidly fixed rates, bound by a currency board, or better still a common currency, would automatically enforce monetary discipline. However, the past fifteen years have seen convergence of national inflation rates rather than the reverse. In the developed world, inflation rates have fallen from double- to single-digit levels and in the less developed world from triple- to double-digit levels or below. In 1997, inflation rates in the European Union were mostly under 2 per cent. This is hardly a set of countries in need of stern monetary discipline, at least for the moment. Rates of productivity growth, though, have not. Nor is the world any freer from oil shocks, earthquakes or beef scares than it was fifteen years ago. To retain its export competitiveness in the face of relatively low productivity growth or unpleasant shocks, a country must, perforce, devalue or depreciate its real exchange rate. If the unfortunate country is locked into a fixed nominal exchange rate it must deflate internally, by lowering its wages,

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prices and incomes relative to its competitors. In practice this means an unpalatable period of recession and unemployment. Exchange rate depreciation permits adjustment to the new reality with much less pain. Hence, countries from Britain to Mexico to Malaysia have fallen off the fixed exchange rate wagon, not necessarily because their inflation rates were irresponsible, but because for any of a variety of reasons their real exchange rates no longer reflected economic reality. Had they been on flexible rates all along, the sudden sharp devaluations, with their attendant losses to taxpayers and windfall gains to speculators, would not have been necessary. ‘Ah,’ but the Eurocrat says, ‘if you allow yourself to fall for a flexible rate, you will be preyed upon by rapacious speculators who will drug and deceive you with horribly nasty devices picked up off the streets of New York. They’re called “derivatives” darlings, and don’t you ever, ever use one. In fact, if you stay at home here with us in Brussels, you’ll never, ever have need of one.’

Euromyth No. 2 Speculators and derivatives have made flexible exchange rates more volatile It is true that exchange rates are now more volatile than they were in the 1960s, when capital markets were tightly controlled and all major exchange rates were fixed. After the collapse of the Bretton Woods arrangements in 1973, speculators entered the scene in force. They make money by buying low and selling high, and as long as they do that they should smooth out market fluctuations, not exaggerate them. Since the 1970s, the honest work of speculators has become ever more efficient, as derivatives like exchangetraded futures and options have become available. Simply put, derivatives allow speculators to bet on larger amounts of foreign exchange for a given outlay of cash, and therefore should enable them to smooth the market more effectively. Understandably, Eurocrats and many other observers of recent derivative disasters are suspicious of this kind of armchair reasoning, yet the numbers bear out the armchair reasoning. A simple measure of short-term volatility is the standard deviation of monthly percent changes. By this measure, exchange rate volatility rose from 0.4 in the 1960s to 1.3 in the 1970s, 1.7 in the 1980s, and then down a sliver to 1.6 in the 1990s. This is hardly evidence of an explosion of chaos over the last twenty years, when derivatives have come into their own. ‘Well, I’m not going to waste my breath any more about speculators,’ says the Eurocrat. ‘But the fact remains that flexible rates are much too complicated for simple little countries to deal with on their own. You will never ever be able to sell your wares abroad because you’ll never know what price to charge.’

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Euromyth No. 3 Flexible exchange rates inhibit international trade Dozens of econometric studies have tried to establish a link between the volatility of exchange rates in Western Europe and the volume of international trade. None has established any link. Foreign exchange hedging, using forwards, futures and the like, can remove short- and medium-term exchange rate risk at very little cost. Among the world’s ‘simple little countries’, we in Canada have perhaps the longest experience, with floating exchange rates since World War II. Yet our external trade, over 80 per cent of which is with the US, has been unimpeded. And during the 1980s, when the US dollar was extremely unstable against the yen and the Deutschmark, both American and Japanese trade volumes grew at unprecedented rates. It is, of course, true, as every tourist knows, that there are transaction costs of converting between currencies. These conversion costs presently absorb about 0.4 per cent of Western Europe’s GDP each year. This is not a trivial cost, but it must nevertheless be weighed against the likely costs of a common currency, which I believe would be much higher. It is important to understand that these transaction costs are essentially the same whether exchange rates are fixed or flexible. The additional hedging cost associated with flexible rates is proportional to the extra cost of converting a currency forward rather than spot, and for the major currencies that extra cost is very small. The only way of avoiding conversion costs, which are substantially higher than hedging costs, is to move from fixed exchange rates to a common currency. I believe that the only unambiguous benefit associated with a common currency would be the saving of the transactions costs attached to converting between currencies, a saving that has been estimated at 0.4 per cent of GDP annually for the moment, but will undoubtedly continue to fall as electronic technology becomes more and more sophisticated. I believe that the costs of the common currency are likely to be much higher than 0.4 per cent of GDP. Admittedly, much of my argument against the common currency will rest on an assessment of the relative advantages of flexible rates. However, I will also argue that even fixed rates, especially if they are fixed within a band as they are in what remains of the European Monetary System, are likely to be superior to a common currency. At least the countries in the EMS are there by choice, keep some control over their own economies, and can leave if circumstances change. Joining a common currency is more like an arranged marriage—in fact, an arranged group marriage—from which divorce is impossible even under circumstances of extreme abuse. The Eurocrats in Brussels, Madame Dufort under Herr Dr Machschwer, are arranging the debutante ball because they hope it will lead to marriage. In many cultures, arranged marriages work well because the Mommies and

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Daddies who arrange them are very careful indeed to confine their matchmaking to girls and boys from the same class and caste, and usually from the same corner of the country. But the girls and boys that Madame Dufort and Herr Dr Machschwer have chosen not only come from different countries; they don’t even speak the same language. The Eurocrats are really just econocrats who are assuming there’s a can-opener when there’s nothing of the sort in sight. The myth that they are propagating is:

Euromyth No. 4 Europe is a natural common currency area Certainly, few people in North America need to be persuaded of the sharp economic and cultural differences within Europe. According to the latest World Competitiveness Report released by the Institute of Management Development in Lausanne, only three countries in the EU are amongst the world’s top ten economic ‘competitors’, with Italy and Portugal placing at 30 and 31 respectively. Measures like these underscore vast differences in productivity even between countries within Western Europe. A corollary is that the future will probably bring major differences in productivity growth: for example, productivity in Italy and Portugal will probably continue to grow faster than in Germany and France. Thirty years ago a distinguished Canadian economist, Robert Mundell, laid out two conditions for an optimal common currency area. The first is that the regions within the area should be subject to common real economic changes with common effects; and the second, which to some extent can make up for the absence of common economic change, is that labour should be mobile between regions so that workers can migrate when one region flounders while another prospers. But within Europe, sharp differences in productivity suggest that economic change is likely to be divergent. It is true that integrated economies are more likely to experience symmetric economic change: both Belgium and Luxembourg score high on integration, with intra-EU trade accounting for over 40 per cent of their GDP. But the biggest five EU economies—Britain, France, Germany, Italy and Spain—are not well integrated: they trade only 10–12 per cent of their GDP within the EU. Contrast this with Canada, which trades 22 per cent of its GDP with the US, yet has limited interest in monetary union. Moreover, sharp cultural differences within Europe suggest that labour mobility is likely to remain limited. For example, labour is almost three times more mobile between American states than it is within individual EU countries. It is hard to pretend that Europe is an optimal currency area. If Polish agricultural productivity grows faster than French agricultural productivity over the next ten years, which is likely, and if Poland joins the

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EU and is allowed free access to French markets, Poland will run a large agricultural trade surplus against France. Of course, under present arrangements the Polish zloty is likely to appreciate in value, moderating the trade surplus. Under separate currencies and flexible exchange rates this would occur quite naturally, but under a common currency it would have to occur as a result of higher wage and price inflation in Poland, or lower wage and price inflation in France. This could be extremely painful for both countries, since in the real world prices and especially wages are rarely flexible enough to react to economic change without bringing about unemployment. In short, if Poland were to join the common currency in 1999 (an extremely unlikely prospect), the result would probably be more unemployment and unrest among French farmers than there already is. And, of course, it would be extremely unlikely that French farmers would choose to move to Poland. ‘Ah yes,’ say the Eurocrats. ‘We grant you that wages will have to rise faster in some countries than in others, but the overriding goal is to keep overall wage growth in line with overall productivity growth. The only way to guarantee this is to have one currency and one central bank for all. Short of that Europe will not be able to control inflation.’

Euromyth No. 5 The euro will mean lower inflation Conventional wisdom has it that fixed exchange rates lead to lower inflation. More precisely, conventional wisdom has it that fixed exchange rates are sufficient for lower inflation. They are certainly not necessary to achieve lower inflation, as we in Canada can witness: with the help of a single-minded (some would say bloody-minded) central banker (who was imported, by the way, from Britain by way of the IMF), we brought our inflation rate down to the lowest level in the world, currently 0 per cent, without pegging our exchange rate to the American dollar, the Argentinean peso, or anything else. Strictly speaking, fixed rates are not sufficient for monetary discipline either: witness how Mexico persisted with easy money despite its peg to the US dollar, and ultimately paid the price. But conventional wisdom is more or less correct if it applies to countries with politically susceptible central banks that are firmly committed to maintaining their exchange rates fixed to a country with a politically independent central bank. Thus, the European Monetary System has probably disciplined member countries and lowered inflation rates, but only because the Deutsche Bundesbank was already disciplined. Of course, several countries within the EMS got off with running inflation rates higher than Germany’s since they were able to exercise the ultimate option of pulling out. Conventional wisdom has it that moving beyond fixed rates to a common currency will remove the option of pulling out and therefore enforce sustained

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discipline on weak-willed countries like Italy, Spain and the UK. But this argument conveniently ignores the reality that the new European central bank will reflect the political and economic preferences of all member countries, not just Germany. In fact, underlying France’s enthusiasm for the euro is a thinly disguised desire to dilute Germany’s hegemonic control over European monetary policy. The political reality is that once Latin (and Anglo-Saxon!) votes are brought in, European monetary policy under the euro will probably prove more inflationary than it has been under the EMS. This is especially likely given Europe’s chronically high unemployment. This brings us to the next Euromyth. Euromyth No. 6 The euro will mean lower unemployment Ideally, monetary policy is able to counteract the so-called ‘real’ shocks to aggregate demand. When these shocks are contractionary, or ‘negative’, as the jargon goes, skilfully administered expansionary monetary policy can obviate the shocks and thus obviate unemployment. In this way, unemployment, which results from deficient demand, can ideally be avoided, or in practice substantially reduced. Since a common currency will make independent monetary policies impossible, countries which adopt the euro will find themselves unable to conduct such traditional Keynesian countercyclical monetary policy except when negative demand shocks hit them all at the same time and with roughly the same magnitude. Critics of this argument suggest that Keynesian counter-cyclical policies are unworkable in practice because of lags and perhaps even in principle because the trade-off between unemployment and inflation—the ‘Phillips Curve’—is transitory. I do not subscribe to this view. However, a second and more persuasive line of criticism is that European unemployment in the 1990s is mostly of a structural, supply-side nature, and is thus resistant to demand-management. From a North American perspective, Europe has contracted what we rather smugly like to call ‘Eurosclerosis’. Indeed, the key word to describe European unemployment is ‘chronic’. Structural unemployment—the mismatch of job qualifications with job opportunities that is a necessary by-product of technical progress everywhere in today’s world—lasts longer in Europe because wages are more rigid and labour mobility is lower. Labour mobility in Europe has always been lower than in North America for reasons of language and culture, but thirty or forty years ago, before Europe caught Eurosclerosis, their unemployment rates were lower than ours. Now, after a couple of decades of deregulation in North America that has not been matched in Europe, the reverse is true. The important thing to understand about structural unemployment is that it cannot be reduced with expansionary monetary or fiscal policies. That is why economists, somewhat misleadingly, now call it ‘natural’ unemployment.

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Nevertheless, countries with high ‘natural’ unemployment rates are likely to push the central bank in Frankfurt for easier (common) monetary policy than is consistent with low inflation. Except for brief periods of time, the easier monetary policy will not buy lower unemployment: it will merely mean periods of inflation followed by painful periods of recession once the inflation becomes unacceptable. Because of the recession that inevitably follows such misguided attempts at expansion, I would argue that across all countries that adopt the euro, both inflation and unemployment are likely to be higher. Add to this common level of unnecessary unemployment higher levels in those individual countries that experience negative demand shocks and are unable to respond to them, and the result will be, I believe, substantially higher unemployment than would be the case were flexible rates adopted, or even the current regime of fixed but potentially adjustable rates simply maintained. This suggests that both ups and downs—business cycles—are likely to be exacerbated relative to the present system where monetary policy, at least for the members of the rump EMS that remains, emanates from Bonn, bringing us to our next Euromyth.

Euromyth No. 7 The euro mil moderate business cycles It might be surmised from my remarks thus far that the EMS, with exchange rates fixed to a non-inflationary German mark, does as good a job of minimising business cycles as can be expected in this imperfect world. That is not quite what I mean to suggest. What I mean to suggest is that, given a choice between the present system where Germany dictates monetary policy for all of Europe, and the plans for 1999 where monetary policy is to be run by implicit consensus, the present system is likely to be both less inflationary and more stable. But given a choice between either the present or planned systems and a system with flexible rates, the prognosis is not so clear. Recall that optimal currency areas are regions or countries subject to similar shocks and with high labour mobility between them. Europe satisfies neither of these conditions. When a particular country within Europe is subject to a shock whose impact is not common to all of Europe, the ideal response is compensating monetary policy for that particular country, but not for all of Europe. Thus, lower oil prices might call for expansionary monetary policy in Norway but certainly not throughout Europe. Under either fixed rates or a common currency, Norway would be denied the luxury of monetary policy independent of Europe’s and would thus be forced to bear the brunt of the oil shock. Without high labour mobility, unemployed Norwegians would be trapped in Norway. The general point is that flexible exchange rates preserve the option of independent monetary policy and therefore the option to counter undesirable demand shocks to a country’s economy. Of course, the potential benefits from

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preserving this option must be set against the risks that politically pressured central banks might misuse it, or that they might simply misjudge the need to use it. The issue is whether modern central banks are endowed with sufficient integrity and skill to be trusted with the conduct of monetary policy. That issue is, of course, debatable. Personally, I am enough of a residual Keynesian to believe in the desirability of active, counter-cyclical monetary policy. After flirting with rule-dominated monetarism in the late 1970s, virtually all the world’s central banks gave it up. Certainly Alan Greenspan, Governor of the United States’ Federal Reserve System, has managed to conduct non-inflationary monetary policy while remaining highly pro-active in an effort—a successful one, I believe—to moderate the US business cycle. Among academic economists, prevailing sentiment has moved in the 1990s towards ‘New Keynesianism’, by which is meant a renewed recognition that, in the real world, wage adjustment and labour mobility are still too slow to leave the business of moderating business cycles entirely to the free market. More precisely, since some markets—notably, money and foreign exchange markets—adjust much faster than others—notably, labour markets - it would seem foolish to relinquish national control over the former. Just as the common currency is unlikely to moderate instability over time, it is also unlikely to moderate instability over space. Yet that is exactly the myth the Eurocrats seem to be trying to sell us when they suggest that in our new Group Marriage we will share not only the same bed, but the same quality of pyjamas. This brings us to yet another Euromyth.

Euromyth No. 8 The euro will moderate regional disparities I have already argued that the euro is unlikely to moderate national business cycles. I will now argue that it is also unlikely to moderate regional disparities, and is even less likely to even out national disparities. Let us begin with regional disparities. When coal mines close in Wales, there is considerable opportunity for coal miners or their sons to move to Manchester, but much less opportunity for them to move to Metz or Madrid. As long as Britain retains the option to lower interest rates or allow the pound sterling to depreciate, she retains the option to stimulate demand and encourage migration from regions of high unemployment to regions of low unemployment. Of course, this option should not be exercised if it is likely to prove inflationary, and in any case it will not be sufficient to eliminate unemployment in Wales overnight. Much of the adjustment will depend on keeping wage rates low in Wales relative to Surrey. Nevertheless, it is fairly certain that Britain will be able to manage regional unemployment better if it retains control over its monetary and exchange rate policies than if it delegates them to Brussels.

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What is absolutely certain is that Britain will be able to manage its national unemployment better if it is able to manage its money, and by extension its exchange rate, independently of Brussels. In other words, if by regional disparities we mean national disparities, the Euro-speak that suggests these will lessen under a common currency is very clearly a myth. On the contrary, the euro will lock Europe into common aggregate demand policy that cannot help but be a compromise for most member countries most of the time. A related myth is that Brussels will compensate for the loss of independent monetary policies by means of compensatory fiscal policy.

Euromyth No. 9 Within the EMU, fiscal policies will compensate for monetary policies One of the reasons that regional disparities in Canada and the United States, large as they are, are no worse than they are despite two ‘common currencies’ across the length and breadth of two vast countries, is that we have automatic compensatory fiscal policy. Thus, when incomes are relatively low in Arkansas or New Brunswick, tax payments to Washington and Ottawa are disproportionately lower, and transfer payments disproportionately higher. In Canada we have carried regional redistribution one step further, with massive net transfers from rich provinces to poor provinces, administered by Ottawa using Federal tax revenues. European countries pay taxes to their national capitals, not to Brussels. If one member of the EU or the EMU falls into dire straits, there is no automatic mechanism whereby transfer payments relative to tax collections can increase except by running a fiscal deficit. The Maastricht conditions for joining the EMU place strict limits on that option. In practice, EMU members will have to rely on Brussels for explicit redistribution, Canadian style. Believe me as a Canadian, that kind of redistribution policy is unpopular and divisive. Moreover, it involves surrendering more power to Ottawa than most, if not all, of our ten provinces are happy with. I find it hard to believe that Britain or even Italy is going to be any happier surrendering fiscal control to Brussels. Perhaps the best way to summarise most of the case against the common currency is to articulate a tenth and final myth. Although I have never actually heard a respectable Eurocrat utter this particular myth (Eurocrats are far too highly educated for this one), it is nevertheless a myth that persists just beneath the surface in the popular press and in the popular mind.

Euromyth No. 10 The euro will eliminate balance of payments problems This is really a mega-myth. When imports and exports between two

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countries with separate currencies are of unequal value, one country has what we call a balance of trade surplus and the other has a balance of trade deficit. The surplus country then exports capital to the deficit country, and it may accumulate foreign exchange reserves as well. The mega-myth is that these trade and capital deficits and surpluses cannot occur under a common currency. In fact, the only difference between the separate and common currency cases is semantic. Within common currency areas we do not as often use the words ‘balance of payments problems’. But almost inevitably any common currency area experiences just such problems. Consider my country, Canada. In many ways, Canada is not an optimal common currency area: it is a country the great bulk of whose population and economy is stretched, despite geographic imperatives, along a 7,000kilometre border with the much more attractive United States. As a result, we have terribly troublesome regional equities, which reflect, in turn, regional balance of payments problems. Some regions are net exporters of goods and services, some are net importers. The fact that we have a common currency simply masks this fact, since regional trade balances are not well publicised the way international trade balances are. The consequence of Canada’s regional trade imbalances is relentless downward pressure on wages in the net importing regions—the Maritime provinces in particular—in order to make their exports—like McCain’s frozen foods—more competitively priced. But the downward pressure on wages is never sufficient to generate full employment in the Maritimes. The combination of low wages and unemployment does encourage migration to more prosperous parts of Canada, like Ontario and British Columbia, but for one hundred years there has never been enough migration out of the Maritimes to solve their problem. The point is that Canada’s regional disparities would be lessened if the Maritimes could float an independent currency—the Currency of Deprivation or COD. The COD would rapidly fall to a sufficient discount against the Canadian dollar to balance the Maritimes’ trade deficit with the rest of Canada, and unemployment in the Maritimes would decline. Currency prices fall much more rapidly than do wages, and with much less painful side-effects. Why, then, don’t we split Canada into currency regions? It is certainly arguable that we should, on economic grounds, but on political grounds the last thing Ottawa wishes to do is encourage regional separatism at this delicate juncture in our fragile national history. On purely economic grounds, the argument against separate currencies rests on precedent and reputation: the Canadian dollar has a reputation for integrity because of a history of responsible monetary management. The COD would not: currency markets would likely be suspicious that the COD would be subject to intense political pressure. The markets would fear that the Central Bank in Halifax might end up subscribing to something closer to a Fish Standard

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than a Gold Standard, in a misguided attempt to generate prosperity through inflation and devaluation. Most Western European currencies also have a reputation for integrity and a tradition of acceptability, partly but not entirely because responsible monetary management has been enhanced by the past fifteen years of German hegemony. To replace tried and true existing currencies by an untried and untested ‘euro’ requires a leap of faith towards monetary management from Brussels that the currency markets may not be willing to make. I find it difficult to believe that the euro is likely to be a more desirable store of wealth than the core currencies it is likely to replace: the German mark, Benelux currencies, Austrian schilling, Finnish markka, French franc and even Irish punt. Consider the following item from the Wall Street Journal, 30 January 1996: traders bought…German currency out of fear that the timetable for the single European currency is unrealistic. Investors turned to the mark on the assumption that it would be a more attractive investment by itself than melded into a basket of European currencies that don’t have its postwar record of stability. But, of course, if the euro does come along, and it will, there’ll be no more Deutschmark to invest in. So here’s another recent opinion, from an economist based at J.P.Morgan in London: German money is flowing into Switzerland for safety…people in Europe think European economic and monetary union is for real; they fear the Bundesbank won’t be around in five years…Switzerland is going to be the new Japan of Europe, as investors increasingly look upon the Swiss National Bank as a substitute for the Bundesbank. (Avinash Persaud, quoted in the WSJ, 22 September 1995) Or consider this somewhat more romantic item, published in the WSJ on St Valentine’s Day, 1996: Sterling gained steadily against the dollar and the mark…encouraging sterling buyers is the perception that it’s unlikely European economic and monetary union…will occur by Jan. 1, 1999. Sterling, which isn’t expected to participate, is acquiring a ‘safe-haven’ image because of doubts about EMU. Admittedly, comments like these are mostly ex post rationalisation of whatever direction the mark or Swiss franc or the pound sterling happens to be taking. Nevertheless, it is by no means certain that the currency markets will embrace the euro with open arms if and when it appears. In fact, in the opinion of a senior vice president at Natwest Markets in New York, ‘Instead of buying

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marks as a safe currency in times of EMU uncertainty… investors may flee Europe altogether’ (Graham Broyd, quoted in the WSJ, 1 January 1996). This is a far cry from the Brussels party line, which has the euro emerging to rank with the dollar as one of the world’s mightiest moneys.

Conclusion Even if EMU does occur (which it has) and even if the euro does preserve responsible monetary management (which it may), the hard fact remains that it will impose common monetary (and exchange rate) policies on a collection of countries that do not comprise an optimal common currency area. It is hard to believe that this collection of countries, let alone those that will be encouraged to join, will never in future be hit by differential shocks. And certainly they will experience differential productivity growth. In the absence of compensatory monetary and exchange rate policies, these differential real economic changes will place an extraordinary burden on internal wage and price adjustment, and also on the migration of labour. My guess, therefore, is that the euro will increase rather than decrease balance of payments problems. These will be symptomatic of much more than accounting problems in the lives of ordinary Europeans.

Notes 1

2

An earlier version of this paper was given as the Ernest Sykes Memorial Lecture, Gibson Hall, Natwest Centre, Bishopsgate, London, 24 April 1996. See also James W.Dean, ‘Is the European common currency worth it?’ Challenge, 40(3), May/June 1997:57–74. For an essay on how Mundell’s thinking evolved beyond OCA criteria to advocacy (as early as 1970!) of a European common currency, see Dean (2001).

Bibliography Dean, James W. (2001) ‘Robert Mundell: consensual frameworks for enduring controversies’, Central Banking, Summer. Longer version in Abu Wahid (ed.) The Frontiers of Economics: Nobel Laureates in Economics, Westport, CT: Greenwood, 2002. Dean, James W. and Kasa, K. (2001) ‘Capital flows in Euroland’, Working Paper, Simon Fraser University. Presented at the 7th Annual Dubrovnik Economic Conference, July.

6

International implications of EMU Patrick M.Crowley

Introduction This chapter takes an international perspective on European economic and monetary union (EMU). The chapter differs substantially in substance, but not in style, with Buiter (1998). Buiter neatly summarises the economic rationale for EMU, using a sequence of propositions which encompasses microeconomic and macroeconomic considerations as well as incorporating some challenges to the received wisdom on EMU using recent Keynesian models of the open economy. The aim of this chapter, however, is much more modest: a review of EMU, an evaluation of potential external effects on the international economy, and an incorporation of some of the political economy issues that may arise out of EMU. The final stage of EMU is nearly complete. Eleven member states were deemed to meet the convergence criteria by the European Council in May 1998, and now, with the addition of Greece, have proceeded to adopt the euro (in electronic form) at the chosen reference conversion rates for the transition phase from 1 January 1999 to 1 July 2002. Outside the EU, and particularly in the US and Canada, governments and businesses are continuing to explore the profound implications of EMU for their multinationals, trade flows and exchange rate and monetary policies. All now acknowledge that if EMU is successful—in that all EU member states without an abrogation proceed to successfully adopt the euro in a relatively short period of time, say five to ten years—then there could be major implications for the international monetary system and world economy. In short, international monetary co-operation could move to a bipolar framework, and the dollar could eventually be challenged as the world’s ‘vehicle’ or ‘numeraire’ currency (see Bergsten 1997; Alogoskoufis et al. 1997). Within the EU, the post-EMU constraint on fiscal policy, known as the Growth and Stability Pact (signed in Amsterdam), specifies the nature of fiscal policy co-ordination after 1999 for participating member states. Ongoing political developments combined with the prospect of having to improve on the Maastricht criteria (as per the implied fiscal restrictions over 113

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the business cycle embodied in the Growth and Stability Pact) have already caused certain member states (notably Ireland and Italy) some difficulty during the transition period. Further, there is the danger that the operations of the European Central Bank (ECB) during the first few years of operations may continue not to instil the level of credibility that had been hoped for in financial markets. This chapter makes ‘assertions’ where relevant on international aspects of EMU but, unlike Buiter’s propositions, the chapter attempts to widen the analysis to cover some political economy aspects of EMU. The chapter is arranged as follows: in the following section a consideration of international microeconomic considerations for EMU is presented, then the distribution of seigniorage is analysed. In the following section a brief review of volatility effects and an analysis of the optimal currency area literature is provided. Then the elimination of the exchange rate as a policy instrument is discussed, and the last section of the paper looks at the introduction of the euro at the start of 1999 in relation to the high degree of capital mobility that exists in the EU.

International microeconomic considerations Microeconomic efficiency arguments for a single currency revolve around the ‘efficiency gains’ that would accompany a single currency. Dowd and Greenaway (1993) cover most of the arguments concerning the ‘network externalities’ of the single currency, and Allen (1993) uses an economic model to show how network externalities may operate during the transition to monetary union. The real costs of moving to the euro have to be offset against the eventual elimination of costs inherent in using exchange rates (in terms of the bid-offer spread) plus the in-house real costs of dealing in different currencies. Essentially, the one-off real costs incurred by companies during the transition have to be set against the elimination of exchange rate conversion costs during the transition, plus the continuing gains from operating with a single currency from 1 July 2002 onwards. As with any cost-benefit exercise, the costs should include the associated losses in employment that will inevitably occur when the single currency is introduced, and many economists argue that the employment losses associated with the Maastricht criteria should also be included in this exercise (see Bovenburg and de long 1997). This is essentially the microeconomic argument for a single currency, but there are several other microeconomic effects of the single currency. First, there are potential pass-through effects of lower costs for companies operating in the single market EMU zone to consumers.1 If companies benefit from cost savings, some of these savings may be passed on to consumers, or will show up in increased profits for shareholders. Either way, there is likely to be some ‘pass-through’ which will benefit consumers and/or shareholders.

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Second, there will be a change in trade patterns with countries outside the EU and EMU zone, which in essence is similar to the theoretical effect of the formation of a customs union. Consider a country that has been exporting to an EMU zone member state. If EMU leads to lower costs for companies selling to companies in other EMU zone member states, then the company exporting from outside the EMU will now be at a cost disadvantage (as they will still have the foreign exchange costs of converting into euros or national currency), given that the unlikely scenario that the importer willingly bears the currency risk is ruled out. This will lead to a higher effective rate of protection, and will cause a diversion of exports bound for the EU. Whether companies outside the EU will be made worse off depends on several factors. First, if foreign companies squeeze profits in order to maintain market share, then there will be no trade pattern effects. Second, if the foreign company cannot compete with the EU EMU bloc competitors, if it can sell the product that would have been sold to the EU member state company elsewhere, at the same price, then the firm’s revenue will not have changed (ignoring questions of variety of goods and noting that trade patterns will change). But if a higher volume of goods is offered in other countries, then price will fall in this market (unless demand is perfectly inelastic), so even if the company manages to sell its product there will be a fall in revenues for companies outside the EU. Hence, as EMU will yield lower firm costs and therefore some degree of price reduction (or increased dividend payments) for the EU, then welfare for the EU should rise due to the net discounted costs savings to companies and consumers. But, as noted above, this has to be weighed against the loss of welfare to companies outside the EMU bloc. Hence, it is not at all certain whether EMU will lead to a higher level of global welfare and, depending on such factors as the configuration of member states that initially join the first wave of EMU, whether agglomeration effects occur for non-EMU bloc EU member states (see Martin and Ottaviano 1995) and whether changes in trade invoicing practices occur, welfare for the EU as a whole could either fall or rise. Clearly, though, as long as EMU is successful (in the sense that all EU member states eventually join EMU), then the net welfare effect for the EU will be positive in the longer term.

Assertion 1 If EMU is successful (in that all EU member states join EMU), then there will be net benefits from EMU for the EU (assuming a reasonable discount rate), but it is uncertain whether the rest of the world will enjoy net benefits from EMU, or net costs (assuming away any exchange rate effects on trade), because of uncertain effects on trade flows and markets outside of the EU.

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Seigniorage Given the low rates of inflation that currently exist in the EU, at first sight seigniorage income does not appear to be an important issue as the convergence criteria have encouraged extremely low levels of inflation. Further, most member states will not have been highly dependent on seigniorage income during the transition to EMU. But there are likely to be changes in seigniorage income for any member state that joins EMU. If the currency union were to be enacted and shares issued on the basis of share of money supply to total money supply, then if a member state proceeds to EMU, the smaller the country, the less the impact that its price level has on the new monetary union price level so the greater the potential loss of income, as any policy action will have a smaller effect on the monetary union policy stance. As Casella (1992) showed, though, smaller countries would recognise this, so if costless exit from the monetary union were possible, a smaller country would exact a greater than proportional weight over the common monetary policy to compensate for the loss in potential seigniorage income. So, given the assumptions about the distribution of seigniorage income, the smaller the member state concerned, then the more susceptible is that member state government to a loss in autonomy over seigniorage income when moving to a monetary union. The internal aspect of seigniorage therefore leads to the following assertion:

Assertion 2 If seigniorage income were divided by the ECB on the basis of share of money supply to total money supply, then the governments of smaller, more traditionally inflation-prone member states would experience a greater potential reduction in seigniorage income. Conversely, larger, more traditionally low-inflation member state governments will experience a smaller diminution in policy autonomy, and so the smaller the potential reduction in seigniorage income in EMU

The assertion is made on the assumption that share of money supply to total money supply determines share of seigniorage income—the Maastricht Treaty specifies the method for distribution of seigniorage income in a Protocol on the ECB.2 If the proportion of the population living in a member state and contribution to EU GDP were roughly equal, with no outside usage of a member state’s currency, then Assertion 2 would apply. But there are many small member states in the EU, whose size is relatively small compared to the whole. A small and relatively poor member state (such as Portugal or Greece, for example), will clearly suffer a greater loss in policy autonomy than the richer larger member states, as even if there is monetary expansion in the smaller member state then not

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only is the effect on the EU price level small, but also the share in seigniorage will be small. Given the Maastricht Treaty’s formula for distribution of seigniorage income (as Sinn and Feist 1997 show), the effects are also dependent on the effects of the harmonisation of reserve requirements.3 Given that the reserve requirements for the ESCB have now been in effect for some time, it is clear that high reserve-ratio member states (such as Italy) have lost seigniorage income. All these factors in combination imply that the distributional issue of seigniorage wealth may yet transpire to be a significant issue in EMU. There is also an international element to the calculation of seigniorage income, which we now explore. The international aspect to the seigniorage associated with member state currency issuance versus a single EU currency relates to the fact that private agents, firms and governments abroad also hold currency. The larger the foreign ‘network externality’ associated with the single currency (and particularly here for the Deutschmark), the larger the international element of seigniorage income. Thus member state currencies that were largely held by domestic agents could have significant seigniorage income gains, while Germany will almost certainly lose seigniorage income, depending on the enthusiasm of foreigners for the new single currency and the up-take of the single currency for trade invoicing purposes. This suggests the following assertion:

Assertion 3 The smaller the international ‘network externality’ enjoyed by a member state’s currency, the larger the potential international seigniorage income to be gained from EMU. For a member state whose currency already enjoys significant international ‘network externalities’, the direction of change would be dependent on the degree of ‘network externality’ that the new currency enjoys.

Assertions 2 and 3 clearly imply a trade-off that the smaller countries may have made in joining EMU. The loss of policy autonomy may be set against the potential gains in income because of the enhanced international network externality enjoyed by the member state, yielding higher seigniorage income.

Volatility and OCAs Most European economists do not subscribe to the thesis that money is neutral in both the short and the long run: this is one notable difference between North American and European economic orthodoxy. The longrun non-neutrality of money requires at least one of two phenomena to be present: either the long-run Phillips curve is non-vertical or there is hysteresis in the natural rate of unemployment. The former is rarely used in economic modelling, and the latter is empirically unsubstantiated, so it is

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sensible to assume that monetary non-neutralities are strictly confined to the short run. In that case, exchange rate flexibility only has short-run beneficial effects. Ignoring the theoretical distinction between the short run and the long run, there is evidence, however, that limiting exchange rate flexibility by using an adjustable-peg exchange rate system can reduce interest rate volatility (see Artis and Taylor 1994; Crowley 1995), which also implies the converse, that interest rate volatility—and therefore non-fundamental financial market volatility—may enter the system through fully flexible exchange rates (particularly in the context of a relatively open economy). It seems likely that, if exchange rates were more volatile, then this would tend to increase the probability of exchange rate misalignment at any given point in time. This proposition, combined with the view espoused by many economists that financial markets are inefficient, leads to the conclusion that exchange rate volatility would (apart from its other potential effects) likely give rise to greater and more persistent exchange rate misalignment, which can clearly have serious consequences. This misalignment argument for completing the EMU as a complementary cementing of the single market is outlined in Eichengreen and Ghironi (1995). Economists have still not tackled the issue of whether exchange rate volatility has any relationship with misalignment—clearly the relationship between the two is not linear, as fixed rates can still be misaligned, but there may be some underlying nonlinear relationship. Considering the combination of the two effects leads to the following assertion:

Assertion 4 Exchange rate volatility can lead to increased interest rate volatility, which suggests that additional financial market volatility effects exist with exchange rate flexibility, creating extrinsic noise and non-fundamental volatility transmission into the real side of the economy. Exchange rate flexibility may breed excess volatility and possibly persistent currency misalignment.

The optimal currency area literature originates from work done by Mundell (1961), and has been the recent subject of much of the economics literature dealing with the economic arguments that might suggest the number of member states entering the third stage of EMU; the argument is that if a certain number of member states collectively experience aggregate demand and/or supply shocks that are correlated, then these countries would best be suited to forming a monetary union. Much of this literature has used dubious empirical methodology to separate out demand and supply shocks,4 but most yield the result that the so-called Deutschmark bloc of member states can be characterised as an optimum currency area (examples are Eichengreen 1990; Bayoumi and Eichengreen 1993; von Hagen and Hammond 1995). The economic

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logic behind the optimality of currency areas is that if shocks that hit countries, either from internal or external sources, affect all regions of a country relatively simultaneously and equally in magnitude, then economic policy will be relatively effective at mitigating these shocks. Hence, if shocks are ‘symmetric’ across a set of regions, then this implies that this set of regions can be classified as an optimum currency area, whereas if shocks are ‘asymmetric’ then this will not be the case. Clearly the optimal currency area approach suffers from several drawbacks— mainly that it does not consider any other factors except supranational economic policy considerations; so trade, income and unemployment differences, and lastly political acceptability, are all ignored in this framework (although Bayoumi and Eichengreen (1997) have attempted to include trade considerations in more recent work).5 Discounting the above comments for the moment, it is not enough to look at correlations between shocks, and then discount a monetary union because a set of countries experiences asymmetric shocks—by assuming nominal rigidities and a managed float for exchange rate policy it is easy to show that asymmetric shocks need not be a problem if they originate in the financial economy (LM shocks in a Poole-type analysis) rather than in the real economy (IS shocks), so long as there is a high degree of capital mobility. So only real demand shocks need be of concern. Real demand shocks, though, because of a single market, are much more likely to be transmitted through to neighbouring single currency area participants. The reason is that with countries that are highly integrated through trade, an asymmetric shock in one country will likely affect trade flows to and from other countries (an empirical evaluation of this viewpoint by Frankel and Rose (1997) appears to suggest that this logic is correct). This is the basic reasoning behind the endogeneity of optimal currency areas. International examples are German reunification and the pattern of Canadian business cycles in relation to US cycles. Thus, in these examples, an asymmetric shock could have symmetric effects, through the traded goods sector. Hence, if most of the regional economies are extremely open (as are the European Union member states and Canadian provinces within NAFTA), then asymmetric shocks are not likely to be of major concern on the demand side of the economy. It is also interesting to note that in the North American context, in general Canadian provinces trade much more heavily with the United States than with neighbouring provinces (see McCallum 1993),6 which would imply that Canada is probably a much less viable single currency area (given the view that trade is an important justification for a single currency) than either the United States or the European Union. This may explain the development of the strong federalist tendencies in Canada relative to the United States, as a means of mitigating any adverse economic shocks and to bind the country politically, in order to offset any asymmetric regional economic developments. Thus a single currency may also endogenously become optimal through developments in the political arena to offset any adverse

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regional effects, even though it may not be optimal ex ante. In terms of the discussion of optimum currency areas presented above, then, the only types of shocks that appear to be of concern are asymmetric supply shocks. But there are further concerns with shocks. In a monetary union with constraints on both supranational and member state fiscal policy (as defined in the Growth and Stability Pact), asymmetric shocks can be accommodated by self-liquidating member state transfers, but assuming that the ECB does not pursue an exchange rate policy of depreciation, then supply-side symmetric shocks (such as an innovation productivity shock or an oil price shock) are also of concern. Besides, leaving aside some of the more technical aspects of optimum currency areas, if this economic methodology were to be applied globally, it would imply that countries such as the United States and Canada should not be single currency areas and, by extension, viable economic units. This is because research on the correlation of demand and supply disturbances in North America (see Bayoumi and Eichengreen 1994) has shown that there are regional blocs within the continent that experience similar shocks but, as a whole, neither the United States nor Canada can be characterised as optimum currency areas.7 Clearly, while such research is interesting from the point of view of identifying which countries might have most to lose by joining a monetary union (if, for instance, a country experiences different types of shocks from the rest of the countries in the bloc), its use is limited. The decision to form a monetary union is therefore much more based in the political sphere, as Dyson (1994), McKinnon (1997) and Feldstein (1997) note, and economics can only really highlight problems and act as a potential legitimator, or otherwise,8 of political policy initiatives. This leads to the following proposition:

Assertion 5 The decision to form a monetary union is essentially political in nature. In economic terms, the greater the degree of trade between members of the currency union and the higher the correlation of real supply shocks between the members, the more successful the union is likely to be and the looser the political union required in order to be able to take mitigating actions to offset adverse regional supply shocks.

The loss of the exchange rate instrument and the Growth and Stability Pact What is required to make up for the loss of exchange rate flexibility in a single currency area? Many economists have argued that fiscal transfers are necessary to offset regional asymmetric shocks (see Sala-i-Martin and Sachs 1992; Courchene 1993; Bayoumi and Masson 1994; Crowley 1996), so

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propose in the EU context that the EU budget be allowed to grow in order that supranational institutions can supervise some redistribution of income between member states. Other economists argue that labour mobility is also a major factor, not only in the ability of the labour force to relocate, but also in terms of overcoming the psychological, cultural and linguistic barriers between regions or member states (see Blanchard and Katz 1992; Bayoumi and Prasad 1997). One should distinguish between fiscal redistribution to offset transitory disturbances and permanent redistribution through the federal budget: the former is effectively compensation for the loss of the exchange rate instrument (and therefore is related to the optimum currency area issue), whereas the latter is clearly desirable on economic convergence grounds. Although greater international and interregional redistribution may be necessary to render the political system viable, there are clearly connections between adoption of a single currency and the scenario-dependent political ramifications which stem from the possible economic effects. First, a single currency area is likely to increase trade between the constituent parts of the area, effectively requiring that the members act together on external trade issues (such as in relation to the WTO): this requires a much greater degree of co-ordination and likely requires a supranational body to collect data, monitor developments and deal with other such concerns.9 Second, the single currency requires a monetary authority to control issuance and to implement monetary policy: hence the formation of a supranational institution to undertake these tasks, the ECB in Frankfurt. The ECB delegates responsibility to the constituent ESCB (former member state national central) banks for implementing monetary policy, but if monetary policy is implemented following the principle of subsidiarity, this means that the operations of the ESCB cannot be arranged in the same way as the US Federal Reserve—no one ESCB bank can take one particular monetary policy function without all others having the right to the same function as well.10 Further, the ECB will not be able to replicate the political environment in which the Bundesbank in Germany is situated, in the sense that it will not have the equivalent of the German Ministry of Finance as a political counterbalance within the state structure (see Scharpf 1997). Third, the once-and-for-all loss11 of the exchange rate instrument implies the transfer of exchange rate policy from wherever it resided at the national level, to the supranational level: while there is little in the Maastricht Treaty which specifies the onus of responsibility for exchange rate policy between the ESCB and the Council,12 it is clear that the ECB is in charge of foreign exchange market intervention. The transferral of three significant areas of policy will lead to further consolidation of powers at the supranational level for three reasons: 1 EMU represents one important step in the process of European integration: if successfully completed, it provides an incentive for further initiatives (what political scientists call ‘spill-over effects’).

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2 The necessity for an institution to monitor and operate pan-EU fiscal policy has not been evident in the past, but EMU could lead to agglomeration effects (Martin and Ottaviano 1995) which may halt progress towards economic convergence for those member states remaining outside the single currency bloc, or if member states end up leaving the single currency. 3 A single currency within a single market will likely lead to greater pressure to harmonise other economic policy levers (and in particular, as was seen during 2000, fiscal policy levers), such as income and corporate tax rates as well as VAT rates, otherwise some peripheral member states will tend to lose economic activity from participating in EMU (good examples here are Sweden and Finland). The latter point is particularly important, as in most single currency areas a certain amount of harmonisation has occurred, otherwise there would be substantial out- or in-migration.13 In the EU, if competition does not emerge between different public jurisdictions to harmonise fiscal policy measures,14 perhaps because of the existence of limitations for fiscal policy manoeuvrability inherent in the Growth and Stability Pact, then this (through the link imposed by the pact between monetary and fiscal policy via the inflation tax—see Artis and Winkler 1997) will trigger penalties on member states that are found to be in violation of the post Stage 3 fiscal guidelines. Clearly the ‘penalty’ approach to harmonising fiscal policy might not prove to be successful, depending on other factors such as the growth effects of EMU, agglomeration effects and the intensity of any asymmetric shocks that occur within the single currency zone after 2001. Effectively, the only alternatives to penalising member states are to harmonise at the supranational level or to scrap the Growth and Stability Pact. The latter action is not likely to be seen as politically acceptable until the transition is complete for all EU member states, so an endogenous harmonising process appears to be the most likely initial outcome. The Growth and Stability Pact is a rule-based substitute for pan-EU fiscal policy, as it requires virtual budgetary balance over the business cycle. The stated purpose of the pact is to ensure that fiscal policy influences on interest rates in the EU as a whole are minimised—although some commentators have speculated that it might have been skilfully engineered by Germany (its main protagonist) so as to discourage the southern EU member states out of EMU by enshrining the fiscal constraints in the Maastricht criteria as a permanent feature of monetary arrangements in the EU, or eventually to force these countries out of EMU once they enter a business cycle downswing, possibly during the transition period or at a later date. Whatever the original motivation for the pact, its conception as a co-commitment to EMU is unnecessary for EMU (as no federal states have anything similar). Also, although it is a pact between the member states, it was not negotiated as a constitutional legal instrument, as were the Maastricht and Amsterdam treaties, so there is a question mark over the commitment to abide either by the

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constraints inherent in the pact, or to pay the fines consequent on breaches of the constraints. Indeed, recent pronouncements by the ECB have suggested that the central bank favours a flexible interpretation of the pact, given the slowdown in growth experienced in late 2001. There may eventually be some willingness to scrap the pact, depending on the original intentions. If the original intention was to discourage recent non-fiscally-compliant southern EU member states from joining EMU, then if EMU is completed successfully with southern and potential eastern EU member states abiding by the constraints, scrapping the pact would allow endogenous harmonisation. Also, if the pact proves troublesome to implement and countries threaten to leave EMU, then there also might be some willingness to soften or scrap the pact. Germany’s intentions here are key, however. Germany has stated on several occasions that it wishes to see a greater degree of political union in the EU, so granting more power to the EU parliament by permitting fiscal sovereignty at the supra-national level may alleviate the need for any pact. On the other hand, if problems arise in the fiscal policy of a particular member state then Germany may wish to see strict implementation of the punitive measures in the pact so as to discourage fiscally wayward member states from remaining in EMU. Certainly, though, it is a block to developing a supra-national institution to co-ordinate fiscal policy. What about the nationalist attitudes towards the EU’s accumulation of more powers that appears to be of concern to several member states? Though there is significant resistance to the EU’s acquisition of further competencies at present, if EMU is successful resistance to such developments could be lowered. Indeed, EMU might be viewed as the ‘path of least resistance’ in terms of beginning the transfer of economic policy competency to the supranational level. Although the preceding paragraphs addressed circumstances in which arguments might arise for more centralised institution-building in the EU, none of these arguments relates directly to the loss of the exchange rate instrument as a cause for increased concentration of competencies at the supranational level—if the exchange rate is involved at all, it is in the form of a catalyst, through circumstance or political momentum, which leads to further pan-EU policy initiatives. This prompts an assertion:

Assertion 6 EMU, if successful, will prompt further initiatives to centralise economic policy at the supranational level in the EU (perhaps accompanied by a move to a more federalist structure), as the difficulties of operating and co-ordinating a centralised (ECB Council determined) monetary policy and a decentralised (member state determined) fiscal policy become apparent.

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The introduction of the Euro and capital mobility In May 1995, the Commission introduced a Green Paper (European Commission 1995) which specified the method of introduction of the euro into the financial and real markets. With some minor modifications, the European Council decided to adopt the three-phase reference scenario at its December 1996 summit in Dublin, Ireland. The phase from January 1999 to January 2002 was particularly crucial. During this period, participating intra-EU member state exchange rates effectively disappeared, being replaced by conversion rates. One particular concern of the EU related to the acceptance of the plan by the financial markets and their reaction from the 1999 deadline when this phase began (see Arrowsmith and Taylor 1996; Crowley and Rowley 1996), particularly after the debacle that surrounded the ERM crises of 1992 and 1993. The Green Paper acknowledged15 that exchange rate pressures might arise during this part of the process if: 1 markets test the credibility of the decision to move to Stage 3 of EMU; and/or if 2 disturbances occur in exchange rates of non-participating currencies originating from expectations of a lower level of commitment to the Treaty convergence criteria; and/or if 3 there were uncertainties concerning the irrevocably fixed conversion rates in Phase A, which could push exchange rates away from levels justified on the basis of fundamentals; and/or if 4 there were unexpected demand or supply shocks in participating member states. The first reason (markets testing the credibility of the decision) no doubt underlined the adoption of the Growth and Stability Pact. The second reason (i.e. disturbances in non-participating country currencies) for exchange rate instability underscores the fact that the speculative attacks of 1992/3 caused both the UK pound and the Italian lira to leave the ERM, prompting additional strains on the membership of the remaining members of the ERM and accusations of ‘competitive devaluations’. The agreement on a revised ERM2, once Stage 3/Phase B began (see European Commission 1996) minimised the inherent risks of these types of disturbance, although there was agreement that participation in the ERM2 would be voluntary, on the insistence of the UK. The third reason (that of speculation regarding the conversion rates) is now irrelevant, given that the conversion rates are now in effect (see Obstfeld 1997 for an evaluation of alternative ways of deciding on conversion rates). The fourth reason (unexpected shocks in participating member states) is a real danger, given that there are frequent general elections in Europe, in addition to the unexpected events that even the best-laid plan can never control for.

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Despite the fact that legal tender legislation16 would be in place to ensure that euros and national currencies of participating countries are perfect substitutes in the legal sense, i.e. national currencies would be different denominations of the euro with changes between denominations being made according to irrevocably fixed conversion rates and not exchange rates,17 euro-currency markets operate outside of these legal jurisdictions. As eurocurrency markets are largely outside of the EU’s control—again London, UK, and New York, USA, are major centres for euro-currency transactions— then there was also the possibility that until national currencies were replaced by the euro (i.e. in the last six-month phase from January to July 2002), trading in participating member state deposits would have continued, which could have, inter alia, affected exchange rates. In other words, the ‘irrevocably’ fixed nature of exchange rates during Phase B was the linchpin to the whole process. If speculators had perceived at any point that a member state’s currency was misaligned from the official conversion rate, then this could have created enormous pressures on the ECB if there was a rush to convert that currency into other EU member state currencies. Although the ECB had stated that it would convert unlimited amounts of any currency into euros and vice versa, if serious misalignment had occurred this would have created liquidity problems in certain member states, and as monetary policy is decided by the ECB there would have been little scope for alleviating this problem. So, assume that the correct (fundamental-determined) rates of conversion were chosen, but that there was a non-zero probability of EMU failure, because of a large asymmetric shock that adversely affects one or several member states. If this were the case, then for firms (the general public will not be using the euro until 2002) there was an incentive to delay any changeover to the euro to the end of Phase B of the final stage of EMU—in other words to 2002—and to use either the ‘hardest’ domestic currency in EMU or an external currency in the meantime. Why? First, if there is any possibility of a member state pulling out of EMU (and therefore the perception that the whole process might be in jeopardy), then as exchange rates are ‘irrevocably’ fixed there was an incentive to use (or convert contracts into) the strongest currency in the EU, or to use an extra-EU currency, rather than leave amounts in current currency terms. If so, then potential currency losses would have been eliminated and the probability of currency gains would be maximised. In other words, with a perceived non-zero probability of EMU failure, there was an incentive to move funds to the ‘hardest’ EMU currency, and this in itself may then have created a so-called ‘self-fulfilling’ speculative attack (see Obstfeld 1986). If the ECB could successfully create an infinite amount of any member state currency, as well as euros, then any internal speculative attack could be repelled. But if the attack emanated from outside the EU, then there would be the possibility that any repulsion of an attack would not

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have been successful, as the ECB cannot create infinite amounts of non-EU currencies. In summary, the process for Stage 3 of the Maastricht Treaty contained some risks, in that it assumed that foreign exchange markets would not act if exchange rates became misaligned at the ‘chosen’ conversion rates, and that the foreign exchange markets would act in the belief that the process was and is irreversible. The Commission’s solution to this problem was based on legally enforcing the conversion rates outside the EU and on maintaining strict adherence to the Growth and Stability Pact for the duration of Stage 3. While this was probably an inadequate insurance policy against foreign exchange market turbulence, it was clearly better than nothing. This suggests a final assertion:

Assertion 7 The chosen plan for adopting the euro during Phase B of Stage 3 of Maastricht could have been the object of an external speculative attack on the conversion rates if there was a risk of collapse of EMU. Real economic convergence between member states, however, helped to discourage speculative attacks on the fixed conversion rates during the transition period.

Assertion 7 might appear to be mutually inconsistent with the view that the Growth and Stability Pact is an unnecessary constraint on member state fiscal policy. This is not so: the level of real convergence should not determine whether EMU goes ahead or not, but given the fact that the Commission appeared to be unprepared for any disruptive activity during the 1999–2002 phase, then real convergence (both inside and between inside and outside the EMU ‘core’) helped to minimise the risk of any derailment. Assertion 7 also appears to speak to the past, in that the first wave of EMU member states will soon be at the end of the entire process. But this is not entirely so, as there are three remaining member states to join EMU and there are also the future Eastern European member states waiting in the wings. These issues are likely to affect the processes that both these groups of nonEMU members will have to complete to move to full EMU membership.

Conclusions This chapter attempted to provide an international perspective on the economic issues that EU member states faced in their endeavours to move to a single currency. It is clear from this chapter that there could be significant international effects from EMU, not just because of the ‘network externality’ aspect. Economists can offer little to explain why EMU should happen, so clearly the political forces which bind the project together must be the dominant justification for EMU. The optimal currency literature certainly

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has something to offer as an interesting academic exercise, but suffers from omissions and problems in operationalisation. Further, there is still little justification for the Growth and Stability Pact measures on a continuing basis, and in particular the penalties incorporated in the pact could eventually prove to be a burden, inducing economic (and perhaps political) divergence among the member states. Hopefully the Growth and Stability Pact will be discarded once EMU is complete. Clearly, the lessons of the ERM crises of 1992 and 1993 have not been entirely absorbed (particularly by the Commission). In particular, the second phase of Stage 3 of Maastricht, from 1999–2002, carried certain risks, as it did not foresee the possibility of adverse events or disruptive foreign exchange market activity, which could have derailed EMU—and still could, when the remaining member states or new Eastern European member states join. In this sense, the fiscal convergence criteria and the Growth and Stability Pact (for Phase B only) may be useful in providing some assurances to the markets that member states are serious in their intention to proceed and remain part of EMU. With regard to further research in this area, there are many further political economy aspects that need to be addressed with regard to a successful implementation of EMU, not only in terms of the accumulation of economic policy competencies, but also with regard to the establishment of new supranational institutions, the process of pan-EU decision-making, and the relationship between EMU and the evolution of the international monetary system into the next century.

Notes 1 There are also potential gains to be made if member states that are not in the first wave to adopt the euro decide to denominate their accounts and trade in euros. This is likely to be the case for those member states that expect to be in the second wave, or those countries outside the EU (in Central and Eastern Europe, for example) that decide to adopt the euro as a trade invoicing currency. 2 Article 33 of the Statute of the European System of Central Banks and the ECB Protocol states that ‘net profit shall be distributed to the shareholders of the ECB in proportion to their paid-up shares’. Article 29 determines the weighting scheme to be used for capital subscriptions of national central banks to ECB capital—the weighting is to be determined 50 per cent by the share of the member state in the population of the EU and 50 per cent in the GDP of the EU as recorded in the previous five years preceding EMU. These weights are to be recalculated every five years thereafter. 3 If the member state’s reserve-deposit ratio was high, creation of bank money would have been more limited than in countries where the reserve-deposit ratio was low—therefore, as regulations are harmonised, then high reserve-deposit ratio member states lose income, and vice versa. 4 Most VAR studies have assumed that demand shocks have only short-run real effects and that supply shocks have long-run real effects. 5 Attempts have also been made to derive conditions for an optimal currency area from microeconomic foundations—see Bayoumi (1994).

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6 In fact, Canadian provinces tend to trade more with the rest of Canada than with their contiguous state, but the cross-border trade tends to be more substantial than trade with any other single province. 7 Another strand of the empirical OCA literature looks at the synchronicity of business cycles and finds similar results for NAFTA (see Crowley 2001). 8 Feldstein (1997) goes as far as viewing the political consequences of a successful EMU as ‘an economic liability’. 9 The ECB collects and monitors balance of payments data for the euro area as a whole: see EMI (1997) for more details. 10 Here I am referring specifically to the special status of the Federal Reserve Bank of New York. 11 I have not seen any discussion in the literature about leaving EMU, for example if a member state decides that arrangements are not desirable or suitable, or if it transpires that EMU is not economically advantageous for a member state. 12 The onus of responsibility is likely to be the same as that of the Bundesbank in relation to the German Finance Ministry: the EU Council will therefore decide overall policy but the ESCB will implement it. The general principles guiding the selection of the operational framework of the ECB are described in EMI (1997): the principle to be adopted with regard to foreign exchange intervention is that it can occur in the ESCB at a centralised level or a decentralised level. In fact, in the transition phase, both centralised and decentralised decision-making seem to have occurred. 13 Consider what would happen in the US if a state decided to impose a significantly higher sales tax without any corresponding increase in publicly provided goods and/or services, or consider the recently harmonised sales tax (HST) in Canada, which outlaws cross-province trade flows for tax avoidance purposes. 14 Competition between different public jurisdictions should occur to attract mobile labour, according to the Tiebout model (Tiebout 1956) in public finance. 15 Paragraph 72. 16 Para 128 of the Green Paper. 17 Para 127.

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EMI (1997) The Single Monetary Policy in Stage Three: Specification of the Operational Framework, Frankfurt, Germany: EMI. European Commission (1995) ‘One currency for Europe’, Green Paper on the Practical Arrangements for the Introduction of the Single Currency, Office for Official Publications of the European Communities, Luxembourg. ——(1996) ‘Conclusion of the Presidency—Dublin European Council, 13 and 14 December, 1996’, SI (96) 1000, Brussels, 14 December 1996. Feldstein, M. (1997) ‘The political economy of the European Economic and Monetary Union: political sources of an economic liability’, Journal of Economic Perspectives, 11(4): 23–42. Frankel, J. and Rose, A. (1997) ‘Is EMU more justifiable ex post than ex ante?’ European Economic Review, 41:753–60. Ilzkovitz, F. (1994) ‘Recent developments in the international use of currencies: towards a tripolar regime?’ European Commission Document II/425/94-EN, European Commission, Brussels, Belgium. McCallum, J. (1993) National Borders Matter: Regional Trade Patterns in North America, McGill University Working Papers in Economics 12/93, Montreal, Canada: McGill University. McKinnon, R. (1997) ‘EMU as a device for collective fiscal retrenchment’, American Economic Review , 87(2): 227–9. Martin, P. and Ottaviano, G. (1995) The Geography of Multi-Speed Europe, CEPR Discussion Paper 1292, London, UK: CEPR. Mundell, R. (1961) ‘A theory of optimum currency areas’, American Economic Review, 51:657–75. Obstfeld, M. (1986) ‘Rational and self-fulfilling balance of payments crises’, American Economic Review, 76(1): 72–81. ——(1997) A Strategy for Launching the Euro, CEPR Discussion Paper 1732, London, UK: CEPR. Sala-i-Martin, X. and Sachs, J. (1992) ‘Fiscal federalism and optimum currency areas: evidence for Europe from the United States’, in M.Canzoneri, V.Grilli and P.Mason (eds) Establishing a Central Bank: Issues in Europe and Lessons from the United States, Cambridge, UK: Cambridge University Press. Scharpf, F. (1997) ‘Economic integration, democracy and the Welfare State’, Journal of European Public Policy, 4(1): 18–36. Sinn, H.-W. and Feist, H. (1997) Eurowinners and Eurolosers: The Distribution of Seigniorage Wealth in EMU, Center for Economic Studies Working Paper 134, Munich: University of Munich. Soros, G. (1995) Sows on Sows: Staying Ahead of the Curve, New York: John Wiley. Tiebout, C. (1956) ‘A pure theory of local expenditures’, Journal of Political Economy, 64:416–24. von Hagen, J. and Hammond, G. (1995) Regional Insurance against Asymmetric Shocks: An Empirical Study for the European Community, CEPR Discussion Paper 1170, London, UK: CEPR.

Part III

Beyond EMU Lessons for EMU

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The single market and monetary union Recasting the politics of economic liberalization Mitchell P.Smith

Introduction This chapter explores some of the consequences of a simple point: the reconfiguration of economic space wrought by European economic and monetary union (EMU) also reshapes political activity. The creation of markets represents an act of political will; in the wake of market creation, the political opportunities, incentives and interests of actors change. The result is an array of contests over the rules that govern the European market and the distribution of the resources it generates. Europe’s single market process has had particularly profound consequences for political struggles over the scope and extent of economic liberalization. Developments in the regulation of government aid to public and private enterprises, procurement of goods and services by public authorities, and liberalization of markets served by the public sector, including telecommunications, electricity, gas, banking and postal services, have redrawn the boundaries of both economic and political competition. Monetary union has extended the range of interests affected by these processes and amplified their effects. This chapter briefly traces the lines of political contest emerging from this restructured regulatory environment, focusing on the politics of liberalization of public sector activities. Underlying the chapter is a concern central to studies of “European ization”—the degree to which domestic political economies of EU countries converge in response to economic integration—and, more broadly, globalization: what is the impact of emergent political contests on the boundaries between state and market in EU countries? Analyses of European economic and monetary union (EMU) have tended to focus on the process and prospects for convergence of macroeconomic policies and outcomes. This focus coincides with the broader concerns of the literature on globalization, which emphasizes the consequences of capital mobility for domestic policy choice. Scholars examining globalization have more recently turned their attentions to the impact of the international economy on national institutions, and the extent to which massive capital flows and intensified trade and foreign direct investment produce convergence of institutions governing economic 133

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policy-making and the scope and role of the public sector. It is instructive to ask a similar question about EMU: to what extent does European economic and monetary integration uniformly promote a broadening of economic competition at the expense of protected public sector activities? Ultimately, pressures for institutional convergence in EU countries go well beyond the Maastricht criteria, the stability pact and the impact of a single monetary policy. Indeed, the development of Europe’s single market promotes regulatory competition and encourages imitation of best practice in multiple policy areas. But the force for convergence accorded greatest attention in this chapter is the political response of economic actors to opportunities for market entrance or competitive advantage opened by European Community competition rules. Central to the single market process are rules to insure that state assistance to industry, both public and private, does not distort competition. As private sector actors increasingly have entered into competition with public sector activities, they have seized on opportunities to use the competition rules to foster liberalization and augment their opportunities to enter markets previously reserved for public sector monopolies. In short, European economic integration and the authority to oversee competition vested in the European Commission have altered the political opportunity structures facing private sector actors. Whereas prior to the single market private firms in EU countries frequently confronted government ministers determined to assist public companies or sustain traditional forms of public enterprise, these companies now have recourse to EC competition rules enforced with increasing urgency by the European Commission and European Court of Justice. To what extent does the ability of private sector firms and business associations to invoke EC competition rules portend a convergence not only of macroeconomic fundamentals, but also of the scope of public sector activity throughout the EU? This chapter maps out some of the ways in which the construction of the single European market and the development of monetary union have reconfigured political interactions. The chapter draws on evidence from a case that highlights the impact of EMU on public sector activity: the political contest over protection of Germany’s public sector banks. The case illustrates how the single market has put new political and legal weapons into the hands of interests favoring economic liberalization, and how the introduction of the euro has expanded the range of interests affected by this process. While Germany’s public sector banks have for several years defended their subsidized status against German commercial banks, monetary union has altered the balance between these forces by deepening the interest of European banks in penetrating the diffuse and heretofore largely impermeable German banking market. The case of German banking also reveals an irony of economic and monetary union: a Germany that supported EMU partly because it hoped to export the virtues of its fiscal and monetary prudence throughout Europe

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finds critical elements of its institutional infrastructure under severe pressures for change as a consequence of economic integration. Yet the case also demonstrates that external forces for restructuring facing the German political economy are mediated by domestic politics. Put differently, the process of EMU does not automatically translate into increased competition across sectors. The German banking case provides a basis for evaluating how much the restructuring of political contestation induced by European economic integration fundamentally redefines the role of the public sector in EU countries. The case suggests, the strength of the forces of economic liberalization unleashed by the single market process and reinforced by monetary union notwithstanding, that any reconfiguration of public sector activities is shaped by interaction with domestic political structures.

EMU: restructuring politics The EMU process fundamentally restructures politics. Politics accumulate where authority resides; the shift in regulatory functions from national to European level transfers some political struggles to that level. Specifically, private sector firms which compete in national markets with public sector activities benefit from the development of a European-level competition policy. Rather than having to battle national governments for greater latitude to compete with public sector enterprises, firms and industry associations can use European Community law to broaden competition. Furthermore, transEuropean firms can use European competition regulations to increase their penetration of selected national markets. The balance of domestic political support is most likely to shift away from protection and toward sectoral liberalization when the efforts of domestic and trans-European firms or industry associations coincide. Introduction of the single currency broadens the range of economic activities and actors with an interest in more rigorous application of European Community competition regulations. Implementation of the single market demanded more stringent application of EC competition rules, since governments of wealthier states could otherwise provide assistance to domestic companies that would give them a competitive edge inside a market with neither tariff nor non-tariff barriers. Endorsement of the single market project by the governments of EC member states also gave the European Commission added political authority and autonomy to establish a rigorous regime of control of state aid to industry.1 This regime includes particularly close attention to the widespread practice of government aid to public enterprises, which has the potential to undermine competition both within and across member states. Regulation of government aid at the Community level and the Commission’s intensified activism in the regulation of state aid during the 1990s opened up new political opportunities for private sector firms and business associations perceiving competitive disadvantages for the public

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sector. These private interests increasingly responded to the Commission’s highly visible competition policy by bringing before the Commission more complaints against competitors, especially those in the public sector. These complaints about allegedly illegal state aid to public enterprises have included the postal services, telecommunications, airlines and banking sectors.

The politics of public sector banking in Germany The German banking sector provides an evocative illustration of the new political opportunities opened for private sector firms by the single market’s regulatory regime. Germany’s public sector state banks (Landesbanken) as well as local savings banks (Sparkassen) have been critical contributors to the public service throughout the post-war era. The Landesbanken, which include some of the largest banking institutions in Germany,2 were established to serve as clearing banks for the networks of Sparkassen and to provide financial services to their state governments. The local savings banks provide banking services to lower- and middle-income families and service the financial needs of public authorities and local firms (Edwards and Fischer 1994:97– 105; Deeg 1999; DSGV 2000). Collectively, the public sector banks conduct about two-fifths of all banking business in Germany (Sinn 1999:4, Figure 2.1). Over time, the Landesbanken and the largest Sparkassen have come to operate similarly to commercial banks, engaging in corporate lending and international investment banking.3 This increasingly has brought these public sector institutions into direct competition with the private banks. The Landesbanken benefit from competitive advantages bestowed on them by state governments. State governments have boosted the capital of several Landesbanken by transferring the assets of state housing construction agencies. Moreover, the public authorities that created the savings banks are fully liable for their debts. By severing the link between credit ratings and the potentially more fragile underlying financial strength of the institution, these government guarantees lower Landesbank borrowing costs.4 Consequently, Germany’s large commercial banks have argued that state governments have subsidized the investment banking and corporate lending activities of the Landesbanken. The Bundesverband Deutscher Banken (BDB), industry association for Germany’s commercial banks, sought for several years to challenge the advantages accruing to the Landesbanken. After fruitless discussions between the federal government, the BDB, and the Bundesverband Oeffentlicher Banken (VOeB), the association of public sector banks, the BDB announced in March 1997 that it was no longer prepared to participate in talks at the national level, and that it would pursue the issue exclusively in Brussels.5 Failing to make progress in the realm of domestic politics, the BDB sought to exploit the political opportunity opened by the European Commission’s aggressive implementation of state aid policy in the years following the development of the single European market. The BDB moved in this direction

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by lodging an official complaint with the Commission against Westdeutsche Landesbank (West LB), the largest of Germany’s public sector banks, which had in 1992 received a capital infusion of $2.5 billion from housing construction funds on which it provided little return to the state of NordrheinWestfalen. In response to the BDB’s actions, the VOeB, arguing that the commercial banks simply were reacting to the growing market share of the public sector banks and trying to bolster their market position, joined the smaller DSGV, the Federation of German Savings and Giro Banks, in a threat to withdraw support for European monetary union (FAZ, 25 April 1997:19). Germany’s commercial banks, on the other hand, hoped for the Westdeutsche Landesbank case to draw the European Commission’s attention beyond the matter of the state housing development funds to the much more significant issue of state loan guarantees extended to the Landesbanken. The BDB was aware that the case of WestLB would lead the Commission into a searching investigation of the compatibility of Germany’s public banking system with single market competition rules.6 In advance of its decision in the WestLB case, the European Commission staked out a clear position that state guarantees provided to the Landesbanken violated EC competition rules. At the November 1998 meeting of EU Economics and Finance Ministers (ECOFIN), the Commission expressed concern about the ability of the large Landesbanken to use state guarantees of their liabilities to obtain more favorable credit ratings (Schragl 1997). The Commission’s position was broadly supported by EU member state governments, leaving the German government isolated.7 Nonetheless, the Commission’s investigation into the transfer of assets to WestLB provoked strong opposition from pivotal actors supportive of Germany’s federal structures. This support cut across party lines at the state and local levels. The Director of Schleswig-Holstein’s Landesbank called the Commission’s involvement a “frontal attack” against the existence of Germany’s public credit institutions (der Spiegel 10/1997:106). The Minister-Presidents of the Länder also took to the defensive. Following a January 1997 meeting in Brussels with European Commission President Jacques Santer, NordrheinWestfalen Minister-President Johannes Rau (SPD), claiming to speak for the executives of all the Länder, asserted that the German banking system would be “unimaginable without the Sparkassen and Landesbanken.”8 Heide Simonis, Minister-President of Schleswig-Holstein, accused the private banks of “treachery,” and warned EU Competition Commissioner Karel van Miert against conducting a one-sided investigation in the interest of the private banks (Süddeutsche Zeitung 2 April 1998). Despite high-level political opposition, the European Commission in July 1999 ruled that WestLB would have to repay $868 million of aid to the Land of Nordrhein-Westfalen. The Commission reasoned that a market investor would have demanded a higher rate of return than that received by Land Nordrhein-Westfalen for the housing construction funds

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transferred to West LB; the repayment demanded by the Commission reflects the difference between a market rate of return and that paid by WestLB, plus interest (Monti 1999). But the significance of the European Commission’s decision extended far beyond the immediate case of the transfer of capital to WestLB in 1992. In late 1999 the Commission began investigating cases involving similar infusions of capital into six additional Landesbanken (Süddeutsche Zeitung 25 November 1999:25). In response, Germany’s Federation of Public Banks (VOeB) called upon the European Parliament and the German Bundestag to impose tighter controls on the activities of the European Commission. The VOeB’s president argued that the Commission’s decision represented a fundamental attack on Germany’s public law institutions (Vereinigte Wirtschaftsdienste 29 October 1999). Moreover, the VOeB insisted that the banking structure is a core part of the social market economy, essential to funding local and regional development, and as such outside the jurisdiction of the European Commission. Although the Commission ruled in July 1999, implementation of the decision remained a matter to be negotiated between the Commission, representatives of WestLB, and officials from the federal government and Land government of Nordrhein-Westfalen. WestLB and the Land government initially proposed that the matter be resolved by an increase in Nordrhein-Westfalen’s equity in the bank by an amount equivalent to the illegal state aid. The Commission rejected this decision, determined to negotiate a more comprehensive resolution of the larger problem of state loan guarantees. However, a standoff ensued because of the staunch backing provided to the Landesbanken by state-level politicians. Several of these political leaders, including Detlev Samland (SPD), NordrheinWestfalen’s Minister for European Affairs; Henning Scherf, premier of Bremen; and Edmund Stoiber (CSU), premier of Bavaria, threatened to use their power in the German Bundesrat to block any proposed institutional reforms designed to prepare the EU for enlargement (Hargreaves 2000; Süddeutsche Zeitung 2000; Hanke and Simonian 2000). Moreover, these politicians and others exacerbated tensions between a federal government willing to compromise with Brussels and recalcitrant Länder by rejecting the proposal of Chancellor Gerhard Schröder that the public credit institutions resolve the incompatibility with Community law by establishing a barrier between subsidized public functions and commercial activities. Ultimately, monetary union contributed significantly to a break in the impasse. Introduction of the single currency has intensified competition within the banking sector, induced reductions in excess capacity, fostered trans-European mergers, and heightened interpenetration of banking markets within the euro zone (European Central Bank 1999). But these processes have been slow to permeate the German banking sector, which remains Europe’s most diffuse.9 This helps explain why in December 1999 the European Banking Federation (EBF) entered into the battle over

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Germany’s Landesbanken, further “Europeanizing” the dispute. The complaint lodged by the EBF alleges that “state guarantees gave public banks an unfair advantage in the highly competitive euro-zone” (Hargreaves 2000:8). Moreover, the support for Germany’s private banks provided by the European federation further undermined the position of the Landesbanken and contributed to an erosion of their support from the political parties at the federal level. In essence, the issue began to divide along federal/state lines rather than along party lines. Growing awareness of the untenable political and legal position of the German public sector banks enhanced the prospect for a resolution acceptable to Brussels, Bonn, WestLB, and the Land governments.

Convergence and diversity in European political economies The globalization literature has highlighted three mechanisms promoting economic convergence among industrial democracies. First, international markets may penalize systems that give significant weight to considerations of equity and social justice. In other words, market forces may produce a “competitive downgrading of welfare and citizenship rights” (Berger 1996:12). Second, competition among national regulatory models may promote borrowing of best practice. And third, international trade liberalization may amplify political pressures on national governments to alter certain practices, as national structures of finance, production, distribution and innovation come to be perceived as barriers to competition from other countries (Wade 1996). Still, many scholars of comparative political economy reject the notion of convergence. These scholars put forward two arguments that explain why institutional diversity prevails. First, there is the conception of the national political economy depicted by the regulation school—national political economies are complex interconnected networks, and therefore individual elements of national systems are not readily adaptable to others. National constellations of economic policy-making institutions represent complementary arrangements; isolated institutional adaptations are therefore likely to reduce efficiency. Borrowing of “best practice” therefore becomes infeasible in reality (Hollingsworth 1997). The second argument has to do with the continuing dominance of domestic political economies despite some indicators of growing economic interpenetration. From this perspective, domestic markets continue to generate the most important signals for the decisions of firms, and national governments are still powerful gatekeepers with substantial capacities to shape domestic economic outcomes (Wade 1996). In addition, even though national political economies may be facing common external economic pressures, those forces are mediated through domestic political economies. As Berger writes, the internal structure of politics and economics “not only accommodates the

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externally pushed change but, far more actively, also pulls it in and shapes it” (Berger 1996:17). The regulation school and the domestic dominance perspective share an emphasis on institutional embeddedness in a complex network of relationships, with the implication that domestic structures change slowly and in ways that are both unpredictable and divergent across countries (Hollingsworth and Boyer 1997). European economic integration represents a robust test of these arguments about institutional embeddedness, for it constitutes an intense form of economic interpenetration in which national governments have voluntarily acquiesced to a set of rules for macroeconomic convergence and supranational economic regulation. Powerful coalitions within each EU country have been instrumental in shaping the preferences that brought about these arrangements. Yet studies of the impact of European economic integration on national institutions by no means reveal an unequivocal pattern of convergent outcomes. In his study of systems of corporate governance, Woolcock finds that, despite harmonization, there remain very substantial differences within the EC across a wide range of corporate governance dimensions, including forms of corporate financing and the nature of banking relationships; the relationship between stakeholders and management; employee representation and the mechanisms of corporate restructuring (Woolcock 1996). Woolcock’s explanation for persistent divergence echoes the view of the regulation school that the interconnectedness of national institutions makes convergence unlikely: “The effects of competition among the different national systems of corporate governance are dampened, because each is made up of a set of linked policies, regulations, practices, and philosophies affecting capital markets, company structures, and industrial relations” (Woolcock 1996:182). On the other hand, in their study of European competition policies since WWII, Dumez and Jeunemaître find that implementation of the single market program represents a departure from earlier efforts to impose competition policies across western Europe (Dumez and Jeunemaître 1996). External pressures for convergence of competition policies in Europe date back in the cases of Germany, the UK, and France to American leverage immediately after WWII. However, as Dumez and Jeunemaître illustrate, convergence around the anti-trust legislation envisaged by the American liberal model took place only in skeletal form. Anti-trust legislation and the creation of enforcement agencies did not prevent political control of competition policies. Although important constituencies favored greater market competition, within each country the application of competition policy was flexible because it was clear that deviations from liberal competition policies could serve vital national ends. The creation of the EEC gave a boost to the aspirations of those who were interested in a formalized competition policy regime. However, the development of a rigorous regime did not take place until the European Commission began to assert its powers under the EEC Treaty following

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implementation of the single market program. Since that time, the Commission has been more aggressive in its application of EC competition rules. As a consequence, assert Dumez and Jeunemaître, through the application of EC competition law to public services and state subsidies to industry, the European Commission and Court of Justice are promoting convergence toward an Anglo-American model based on privatization of public monopolies, independent regulatory agencies, and augmented competition (Dumez and Jeunemaître 1996:237). But does EMU really accelerate convergence of institutions of economic policy-making? Outcomes in German banking and other sectors—electricity, postal services, for example—indicate that whatever the strength of external pressures, domestic political variables represent critical mediating factors in the translation of European-level economic forces into domestic political change.

Germany’s public sector banks: domestic institutional constraints From the outset of the dispute with the European Commission and Germany’s commercial banks, constituents of Germany’s public sector banks were aware that the significance of the Westdeutsche Landesbank case reached well beyond the compatibility of capital transfers from state housing construction funds with Europe’s single market. The VOeB, the Minister-Presidents of the Länder, and numerous other political elites at state and federal level argued that the stakes encompassed not simply the existence of Germany’s public sector financial institutions, but the very fabric of the social market economy.10 However, by mid-2000, and just six months after the complaint lodged by the European Banking Federation, German political leaders from the CDU, FDP and SPD, including some state-level leaders, had begun to emphasize the distinction between the Sparkassen, and their critical role in local economic development, and the Landesbanken, which have become progressively more divorced from their initial public service mission.11 A strict application of European Community competition rules would require a change not only in the status of the Landesbanken, but also in that of the larger Sparkassen, which create barriers to entry in the German market. However, the European Commission recognized the vital role of the Sparkassen as an instrument of local economic development and social cohesion, and sought to soften the application of competition rules to the small and medium Sparkassen. Reflecting a sensitivity to Germany’s domestic institutional needs, EU Competition Commissioner Mario Monti, in a March 2000 speech before the economics ministers of the German Länder, indicated that European Union law provides a basis for distinguishing between the Landesbanken, which raise most of their funds on the capital markets (an activity that invokes the benefits of the higher credit ratings generated by state guarantees), and the

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Sparkassen, which rely instead on savings deposits (Monti 2000). By late 2000, the coalescence of European- and domestic-level political forces around this distinction between the Landesbanken and Sparkassen marked the outlines of a settlement that would alleviate the tension between the public law segment of Germany’s banking industry and EC competition rules without jeopardizing the vital contribution of public sector financial institutions to the social market economy. As the federal/Land cleavage became more pronounced, pressure on defenders of the public law institutions intensified. The Commission’s decision in the WestLB case and its formal announcement that state guarantees constituted illegal state aid created market uncertainty for WestLB, which began to experience a small but observable impact on its cost of raising capital. Along with the threat of Commission legal action on the complaint lodged by the European Banking Federation, this provided WestLB with a powerful incentive to seek a final resolution of the conflict with the Commission.12 The Commission’s investigation of capital transfers to other Landesbanken had a similar impact, concentrating the attention of the Landesbanken on a decisive settlement. The solution that emerged involved the elimination of the state guarantee of Landesbank liabilities. A second “institutional guarantee” (Anstaltslast) provided by German law, with regards to the public sector, would operate with the provision that if the guarantee is used, it would be reported to the Commission as state aid and subject to the Commission’s approval according to the terms of EC competition rules.13

EMU and institutional convergence European Community rules limiting the use of state aid to industry have created a powerful symbiosis between the private sector and the European Commission. Studies of the development of the single market frequently emphasize the way in which business sector mobilization preceded and catalyzed the single market process. Less studied is the way in which private sector engagement with the European Commission follows market liberalization. As the Commission has fostered sectoral liberalization, private sector competitors have sought to use rules constraining state aid to public enterprises to improve their competitive position. The Europeanization of the banking sector fostered by EMU follows this pattern. By taking advantage of the opportunity to shift the conflict from the national to the European level, Germany’s private banks have gained the Commission as a powerful ally. By strengthening Germany’s private banks relative to the public credit institutions, the Commission advances its own broader interest in more sharply defining the role of public services and limiting the impact of government aid on competition within the single market. Furthermore, monetary union has amplified this effect by multiplying the number of actors with an interest in the institutional structures inside other EU countries.

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Moreover, what is distinct about the impact of European economic and monetary union is that forces of change have been endogenized. Acceptance of EC competition rules and such arrangements as the stability pact by the member states of the EU reflect preferences emerging from coalitions of finance ministers, central bankers, center-right political elites, social democratic party reformers, and outward-oriented segments of the business sector. Consequently, the ability of national institutional structures to resist changes driven by these rules is severely compromised. Recognizing the limits of national political resistance to endogenous forces of convergence, Hans-Olaf Henkel, President of Germany’s industry federation, the BDI, has concluded that Europe’s single monetary policy, the stability pact, and the EC’s competition policy, “are stronger than any national populist” (Financial Times, 8 December 1999:2). Philippe Schmitter similarly asserts that “Only those countries that elected not to join the EC/EU could confidently expect to preserve their quaint practices of informal collusion, associational concertation, and private interest governance” (Schmitter 1997:423–4). Indeed, as evidence from the EC competition-law-driven reform of Germany’s public sector banks demonstrates, the political mobilization fostered by the process of economic and monetary union generates powerful constraints on the role of the public sector in European Union countries. But the case also reveals that precisely how and when those constraints refashion the role of the public sector depends heavily on nationally unique, enduring, and politically entrenched structures of economic policy-making.

Notes 1 For an account of how the single market project enhanced the European Commission’s authority and how the Commission used its increased autonomy to broaden the state aid regime, see Smith (1998). 2 As of the mid-1990s, Landesbanken comprised half of the twenty largest banking institutions in Germany. See Deeg (1999:82, Table 4), and Sinn (1999:12, Table 2.1). 3 On the investment activities and rapid asset growth of Germany’s public sector banks, see Financial Times, 18 December 1996, p. 24. Also see Sinn (1999:105– 6, Appendix 2), who documents some of the acquisition activities and overseas market penetration of the public law banks in the 1990s. 4 The high ratings given to the Landesbanken by rating agencies such as Fitch and Moody’s contrast with their much lower financial strength ratings, suggesting that their credit ratings are a direct product of state guarantees. Moreover, the substantial exposure of some Landesbanken to the financial crises in Asia and Russia provide a “test” of this proposition—their credit ratings did not suffer. See Financial Times, 10 July 1999; and Tony Barber, “Privileged status under threat,” Financial Times Survey of German Banking and Finance, 25 October 1999, p. 6. 5 “Bankenverband dringt auf pünktlichen,” Süddeutsche Zeitung, 18 March 1997. According to one German commentator, the private banks would have to pursue their rights outside the national level, since in German domestic politics, the

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complaints of the private banks “have no chance.” See Winfried Minister, “Das Thema des Tages: Nur Brüssel sichert den Wettbewerb,” Süddeutsche Zeitung, 25 September 1997. Author’s interview with European Commission official, 21 January 1999. Confirmed in author’s interviews with EU officials, Brussels, 20 and 21 January 1999. Press release, Düsseldorf, 24 January 1997 (www.NRW.de). Calling for the European Commission to preserve the status quo, Rau emphasized the high level of public trust garnered by Germany’s “three pillar” system of public, cooperative and commercial banks. He credited the public sector banks with facilitating structural adjustment and numerous local and regional cultural and social projects. As of 1999, there were more than 3,200 banks in Germany, compared with 1,200 in France and 500 in the UK (Financial Times, 22 October 1999). See, for example, the comments of Wolfgang Clement, Minister-President of Nordrhein-Westfalen, who suggested that, along with codetermination in the workplace, Germany’s form of public enterprise is a competitive advantage of the European social model (Frankfurter Allgemeine Zeitung, 13 October 1999, p. 20). For example, the CDU/CSU parliamentary group’s competition policy spokesman, Hartmut Schauerte, argued that “The time for privileges that narrow competition has passed,” and that “The complaint of the private banks is fundamentally justifiable” (CDU/CSU Bundestagfraktion, “Landesbanken und Sparkassen müssen öffentliche Garantien marktgerecht verzinsen,” News Aktuell, OTS Originaltextservice, 3 August 2000; http://web.lexis-nexis.com/ universe). Peter Hintze, European Affairs spokesperson for the CDU/CSU parliamentary group, asserted that the Landesbanken had far overstepped their initial mission, and had become “overly large, internationally active investment banks” (CDU/CSU Bundestagfraktion, “Hintze: Landesbanken fit machen für Europa— Privatisierung sauberste Lösung,” News Aktuell, OTS Originaltextservice, 20 July 2000; http://web.lexis-nexis.com/universe). Interviews with officials of the European Commission, Brussels, 15 May 2001; officials from the German Permanent Representation to the EU, Brussels, 16 May 2001; and representatives of Westdeutsche Landesbank, Düsseldorf, 17 May 2001. See European Commission Online (http://www.europa.eu.int/rapid/start/cgi), “Commission requests Germany to bring state guarantees for public banks into line with EC law,” IP/01/665, 8 May 2001.

Bibliography Newspapers Frankfurter Allgemeine Zeitung (FAZ) Der Spiegel Süddeutsche Zeitung

Books, book chapters, and journal articles Berger, S. (1996) “Introduction,” in S.Berger and R.Dore (eds) National Diversity and Global Capitalism, Ithaca: Cornell University Press, pp. 1–25.

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Deeg, R. (1999) Finance Capitalism Unveiled: Banks and the German Political Economy, Ann Arbor: University of Michigan Press. Deutsche Sparkassen- und Giroverband (DSGV) (2000) Public-Law Credit Institutions in Germany, Berlin: DSGV. Dumez, H. and Jeunemaître, A. (1996) “The convergence of competition policies in Europe: internal dynamics and external imposition,” in S.Berger and R.Dore (eds) National Diversity and Global Capitalism, Ithaca: Cornell University Press, pp. 216–38. Edwards, J. and Fischer, K. (1994) Banks, Finance and Investment in Germany, Cambridge: Cambridge University Press. European Central Bank (1999) Possible Effects of EMU on the EU Banking Systems in the Medium to Long Term, Frankfurt am Main: ECB, 1 and 2 February. Hanke, T. and Simonian, H. (2000) “States resist Schröder’s solution to banks dispute,” Financial Times, 19 July: 12. Hargreaves, D. (2000) “Brussels to act on German bank guarantees,” Financial Times, 28 July: 8. Hollingsworth, J.R. (1997) “Continuities and changes in social systems of production: the cases of Japan, Germany, and the United States,” in J.R.Hollingsworth and R.Boyer (eds) Contemporary Capitalism: The Embeddedness of Institutions, Cambridge: Cambridge University Press, pp. 265–310. Hollingsworth, J.R. and Boyer, R. (1997) Contemporary Capitalism: The Embeddedness of Institutions, Cambridge: Cambridge University Press. Monti, M. (1999) “Competition policy and financial services,” speech before the European Banking Congress, Frankfurt, 19 November. ——(2000) “The Community’s state aid policy,” speech before the Conference of the Sixteen Ministers of Economic Affairs of the German Länder, 30 March 2000. Speech 00/113; http://europa.eu.int/rapid/start. Schmitter, P.C. (1997) “The emerging Europolity and its impact upon national systems of production,” in J.R.Hollingsworth and R.Boyer (eds) Contemporary Capitalism: The Embeddedness of Institutions, Cambridge: Cambridge University Press, pp. 395–430. Schragl, B. (1997) “EU: Kompromiss Bei Banken-Privilegien,” Wirtschaftsblatt, 19 June: 3. Sinn, H.-W. (1999) The German State Banks, Cheltenham, UK: Edward Elgar. Smith, M.P (1998) “Autonomy by the rules: the European Commission and the development of state aid policy,” Journal of Common Market Studies, 36, 1: 55– 78. Siiddeutsche Zeitung (2000) “NRW warnt Brüssel wegen Sparkassenstreit,” 24 July: 21. Wade, R. (1996) “Globalization and its limits: reports of the death of the national economy are greatly exaggerated,” in S.Berger and R.Dore (eds) National Diversity and Global Capitalism, Ithaca: Cornell University Press, pp. 60–88. Woolcock, S. (1996) “Competition among forms of governance in the European Community: the case of Britain,” in S.Berger and R.Dore (eds) National Diversity and Global Capitalism, Ithaca: Cornell University Press, pp. 179–96.

8

Some Canadian lessons for EMU Malte Krueger

Introduction Proponents of an ‘ever closer union’ of European states like to look towards the United States of America—perhaps dreaming of something like a ‘United States of Europe’. Canada, on the other hand, receives relatively little attention. This is unfortunate because the Canadian Confederation has much more in common with the EU than the US. While it is not always clear how well the idea of a ‘melting pot’ describes reality in the US, there are clearly no strong cultural and linguistic differences within the US that run along state borders and, in particular, English is the only official language of the nation. Canada, however, has a dominantly French-speaking province that is in many ways distinct from the rest of Canada. These differences go back to the time when Europeans settled Canada. So, Canada, just like Europe, has to cope with the integration of existing cultures. In the US, cultural diversity is based much more on immigration.1 This poses much less of a problem because immigrants are usually more prepared to accept the existing language and culture. Thus, when exploring blueprints for economic, monetary and possibly political union, I believe Europeans should look towards Canada rather than the US. Judging from the Canadian experience, it is highly likely that differences in culture, language and politics are going to persist in Europe—even if the ‘ever closer union’ proceeds. Such differences can have many advantages—in fact, without them, the world would indeed be a dull place. However, differences can also give rise to conflict—in particular when binding decisions are taken at the central level. In order to avoid such conflicts, it is argued below that a high level of de-centralisation (‘subsidiarity’) should be retained. Furthermore, if differences lead to irresolvable conflicts a union should provide an option for orderly and peaceful secession. The Canadian example shows that secession is not just of theoretical relevance. It has been a possibility for the last twenty years. In spite of its rejection in the 1995 referendum, the Partis Quebecois is still pursuing secession and enjoys considerable support in the Quebec population. 146

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Secession: dangerous games The Canadian example shows that integration does not have to be a one-way street. Even if economic and monetary union is achieved, there is always the possibility that members will wish to leave. Although there has not (yet) been secession in Canada—in fact, there have not even been negotiations about secession—the mere possibility of secession has made clear that the Canadian constitution is incomplete; it lacks rules governing the proper handling of secession.2 There is no generally accepted framework that regulates secession. The lack of such a framework may lead to difficult negotiations full of conflict. A case in point is the question as to whether a simple majority in a referendum gives the government of Quebec the right to secede. The Quebec government thinks it does, the Federal government thinks it does not. Another significant point of disagreement is the role of the Supreme Court of Canada. According to the Federal government the Supreme Court should be the final arbiter in case of conflicts. The government of Quebec, however, is not willing to accept this opinion. In the 1995 referendum, the population of Quebec rejected secession by a small margin. Strictly speaking, a majority in favour of secession would only have given the Quebec government a mandate to negotiate secession with the rest of Canada. However, the former prime minister of Quebec, Jacques Parizeau, stated that he would have declared independence right away. After the referendum of 1995, Parizeau also mentioned that the former French prime minister, Giscard d’Estaing, had advised him to do just that. Parizeau’s statement shows how close Canada had been to a break-up -possibly accompanied by turbulent and costly negotiations. In spite of the defeat in the referendum, the Partis Quebecois is still the strongest political party in Quebec and the issue of separation still has a lot of support. Up until recently, the European Union had not reached a level of integration in which it would have been difficult to exit. After all, the EU was and still is an intergovernmental organisation rather than a federal state like Canada. However, the completion of monetary union is a great leap forward in the integration process so, with the advent of EMU on 1 January 1999, exit has become much more complicated. Therefore, the EU should urgently consider supplementing the EU Treaty with a secession clause. As the Canadian example shows, once a member wants to exit it is much more difficult to agree on the proper rules. Everyday life, as well, shows that unions require exit clauses: for instance, a large fraction of the law of marriage consists of laws governing divorce. In this respect, political marriages should not, I believe, be treated differently. Secessions do not have to be disasters. After all, conflicts and prolonged negotiations would be costly for both sides. However, there are only a few examples of peaceful secessions in history, and even in these cases there was a lot of tension and unrest during negotiations (Young 1994b: 782). Such tensions and rising nationalism may complicate negotiations and

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easily lead to conflict, even war. One does not have to take recourse to seemingly ‘irrational’ behaviour, however, in order to discount the argument that peaceful negotiations will prevail, because it is in both parties’ interest. Secession games are complicated and potentially dangerous games. One reason is that the two parties involved can only separate politically, but not geographically and only to a limited extent economically (Young 1994a: 239–40). Thus, unlike in the case of divorce in marriage, they have to deal with each other after secession. Thus, in the case of EMU, if a member wanted to secede then the questions of the future exchange rate regime and continuing membership in the single market would arise as issues. Another issue would be the treatment of foreign lenders holding euro-denominated debt of the seceding member country. While short and co-operative negotiations seem to be in both parties’ interest, there may be strategic reasons for nonco-operation. A majority of EMU members may feel reluctant to be too ‘soft’ on the seceding country in order to prevent further secessions. After all, secession may have destabilising effects for the euro area as a whole and may weaken the euro. Therefore, these countries may choose to ‘defect’ rather than ‘co-operate’. At the same time, the seceding country may come under intense market pressure. Under these circumstances there may be little time for negotiations and the seceding country could choose to act unilaterally instead of co-operating in lengthy negotiations. So, in short, it is not clear that negotiations would be cooperative. The bargaining situation of the two parties can be analysed in a game theoretic framework (Young 1994a). The pay-off matrix in Figure 8.1 depicts a situation with two players, the ‘secessionist’ and the ‘Rest of the EMU’. Both players have two strategies. They can try to compromise (‘cooperate’) or they can try to ‘play tough’ (‘defect’). Thus, there are four different bargaining outcomes. The likelihood of each of these outcomes depends on the preferences of the two players: that is, on the ranking of the four outcomes. It is worthwhile to try to imagine what these four outcomes could look like. The four scenarios are described below: Co-operation (Co-op): Rest of the EMU is willing to grant exit immediately, and the seceding country will remain a member of the EU with all rights. If demanded by the seceding country it will be allowed to peg its currency at a mildly lower exchange rate; the seceding country promises to find a suitable solution for its euro-denominated debt. Tough exit (TE): the seceding country will not only leave EMU but also loses some of its rights as an EU member; it has to agree to peg its exchange rate for a certain period at the old central rate; existing foreign debt remains euro-denominated (alternatively, the country wishing to secede gives up its plans and remains within EMU).

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Figure 8.1 Secession from the EMU: the bargaining situation Note Capital letters denote the pay-offs for Rest of the EMU and lower-case letters the pay-offs for the seceding country

Soft exit (SE): the seceding country is allowed to exit immediately and depreciate its currency considerably; it remains an EU member with all rights; all of its debt will be re-denominated in its new currency. Impasse (I): both parties cannot agree on the conditions for secession; this might prompt a unilateral decision to secede and possible retaliation by the rest of the EMU.

One likely ranking is: TE > Co-op > SE> I for the Rest of EMU SE > Co-op >TE> I for the seceding country Given these rankings, the two parties would play a game of chicken (Young 1994a).3 In this situation, both sides have an incentive to threaten defection. If, for instance, the seceding party believes that the rest of EMU will play tough in any case, then co-operation is the best strategy because TE is ranked higher than I (and SE and Co-op are not attainable). This raises the question whether the threat to defect is credible. After all, the ranking of the other party cannot be known with certainty. In general, it can be said that cooperation is the more likely the more both parties are convinced that the other party is, indeed, willing to defect. This implies that a nonco-operative outcome (I) may result from underestimation of the other side’s willingness

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to fight. Thus, although both parties rank SE and TE higher than 7, they may end up with I. However, if both sides take the threat of the other side seriously a co-operative outcome is likely. While it seems plausible to assume that Impasse is the least preferred alternative, this does not need to be the case. If the majority of member states think that it is in their best interest to prevent further secessions the ordering could be: TE > Co-op > I > SE for the Rest of the EMU Similarly, if one country desperately wants to exit EMU the ranking would be: SE > Co-op > I > TE for the seceding country In this case, the resulting game would be a prisoner’s dilemma. In a pure prisoner’s dilemma, both parties cannot communicate and I would be a stable equilibrium (Sugden 1986:104–21). However, if negotiations are possible, both players may choose a strategy conditional on the strategy of the other player. Each may offer to co-operate if the other is co-operating and threaten to defect if the other is defecting (Young 1994a: 238). Again, the success of this strategy depends on its credibility. While it seems plausible to assume that both sides have an incentive to cooperate in secession negotiations, a game theoretic analysis shows that things can go wrong. This is particularly the case when one side or both sides underestimate the willingness of the other side to defect. Therefore, it would be helpful to have a legal framework for secession.

Fiscal policy: the case for subsidiarity A striking feature of Canadian politics is the move towards decentralisation. Ever since World War II, when the share of central government spending reached its peak, the provinces have been clawing back their own revenues (Courchene 1995:5–7). Thus, in spite of growing transfers from the federal government in the 1960s, the provinces managed to gain more fiscal independence. However, more independence also involves more responsibility. When provincial deficits rose in the early 1990s, markets became concerned about the solvency of the provinces (in particular Saskatchewan) and interest rate payments became a heavy burden for provincial governments.4 In confronting this problem, the reaction was not to curb provincial independence in financial matters. Rather, each province reacted independently. Most provinces have enacted laws limiting deficit spending and have managed to reduce debt-to-GDP ratios significantly (see Millar 1997).

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The EU has tackled the deficit problem in a different fashion. Instead of relying on member states to reduce their debts on their own, they agreed on an EU-wide rule. At the European summit in Dublin in 1996, the European heads of government decided on a ‘stability and growth pact’. Thus they opted for a centralised rather than a decentralised option, as in the Canadian case. The stability pact is supposed to contain deficit spending within the future European Monetary Union. However, the practical relevance of this agreement is still far from clear. Some countries, notably Germany, whose finance minister Theo Waigel proposed the pact, want (or wanted) strict rules and automatic sanctions. Others, led by France, are strictly opposed to a rule that leaves no room for political decision-making. The compromise agreed upon in Dublin is neither an automatic mechanism to be applied without much fuss nor an agreement that will disappear in a dusty shelf in Brussels and be forgotten. Rather, the stability pact sets the stage for an endless drama, with some (more stable) countries sitting in court over other (less stable) members. Clearly, the stability pact is automatic enough to set into motion a process of evaluation whenever a country reaches the 3 per cent deficit limit. And, just as clearly, there are a large variety of cases where sanctions can be applied but do not have to be applied. A wide margin of interpretation remains. Now, by itself the need for interpretation is hardly a problem, as there are many rules or laws that cannot be mechanically applied but have to be interpreted. In such cases it is common practice to delegate interpretation to a third party that is not directly involved. This can be a judge, a referee or a panel of experts. However, instead of delegating the interpretation of the stability rules to a third party, say the European Court of Justice or the European Central Bank (ECB), the EU governments agreed in Dublin to interpret the rules themselves. Supposedly, this will ensure ‘democratic’ as opposed to ‘bureaucratic’ decisionmaking.5 Still, the whole construction rather looks like a set of rules which prescribes that it is best when the collective decides ‘democratically’ whether a situation is to be sanctioned or not, thus avoiding the ‘undemocratic’ interference of a referee. The outcome of such a procedure seems clear: endless negotiations and severe and bitter conflicts between member states. On these occasions, one or more member countries will exhibit deficits that are somewhat ‘excessive’. But since the sanctions do not have to be applied in each and every case, there is room for negotiation. These negotiations would take place between politicians representing different countries. So what in fact takes place is that one country is the defendant—‘accused’ by other countries (and maybe defended by some). Given that there often will be hard-liners on both sides who try to win votes by ‘playing tough’, these negotiations can easily produce strong national sentiments directed towards other countries. This is the problem of the ‘quasi automatism’ of the rules. If there is no strict rule saying that sanctions always have to be applied in case of excessive deficits, then it is hard for the citizens of a country to see why sanctions have to be applied in its particular case. Also, if there is a precedent where sanctions were not

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applied, the imposition of sanctions must appear arbitrary and will be interpreted as the bad-will of the other member states. If the analysis above is correct, then the compromise reached in Dublin was not a ‘Victory for Europe’, as it has been claimed after the summit. The lack of automatic application of the rules will inevitably produce harsh conflicts. However, criticising the lack of ‘automatism’ does not imply that a binding and automatic stability pact would be ideal. While such a pact would clearly reduce the potential for conflict, it has to be remembered that there is no satisfactory definition of what constitutes an ‘excessive deficit’. Thus, a strict rule could, though it need not, produce a lot of damage. The example of the UK shows what is at stake. During the severe recession in the early 1990s, the budget surplus of 1989 (1.55 per cent) turned into a large deficit (6.56 per cent) in 1993.6 Thus within four years there was a swing of about 8 per cent in the balance of the UK budget. In such a situation, binding restraints on fiscal policy could have been very harmful. What follows from this? First, it would be better to change the pact in order to have a third party interpret the rules. However, this seems currently impossible because some members consider such a procedure to be undemocratic. Second, if the pact cannot be changed it may be better to abandon the stability pact. This leads to the question whether there should be some other mechanism to replace it. In order to answer this question one has to analyse why a stability pact was deemed necessary in the first place. Why should a monetary union require safeguards against excessive deficit spending?

A bankruptcy code for Europe One option for Europe would be to follow the Canadian example and let all member states enact budget rules on their own. However, debt-to-GDP ratios vary widely within Europe and those members who have relatively low debtto-GDP ratios may find such a solution hard to accept. In principle, the no bailout clause of the Maastricht Treaty and the restriction on central bank financing of government deficits should prevent ‘spill-over’ of budget deficits on other member countries. However, these provisions are yet untested and it seems uncertain that they will be adhered to (DeGrauwe 1992:172) and Watrin (1993:182). Thus, it will be difficult to convince low debt/deficit countries to abandon the stability pact, and the EU may be stuck with an inflexible rule that is likely to lead to severe conflicts. One possible way out of this dilemma is to replace the stability pact by a bankruptcy code for sovereign borrowers. Such a bankruptcy code would strengthen the credibility of the no bailout clause.7 This would enhance the effectiveness of capital markets as guardians of stability and lower the probability that countries with sound budgetary policies would have to bail out the others. Current policies are geared towards preventing the worst case of an outright bankruptcy, so such measures nourish the expectation

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that politicians will do everything to prevent such a case—even if this means committing taxpayers’ money to bail out others. This undermines the credibility of the no bailout clause. On the other hand, if the possibility of sovereign default were openly acknowledged and if it were shown how state bankruptcy would be handled practically, investors would be warned that state bankruptcy may indeed be an option for governments. The possibility of sovereign default could no longer be ignored.8 The very existence of a bankruptcy code would change the rules of the game. Of course, governments could still try to persuade others to bail them out, but an outright default may be preferable in some cases. After all, a bailout would usually be in the form of soft loans from other governments, so there would be no reduction in the existing stock of debt. A default, on the other hand, could bring lasting relief. Once sovereign default of member states has become a practical possibility, market participants will monitor the soundness of public borrowers much more closely. Increasingly, interest rates will reflect credit risk of individual member states. Countries with sound macroeconomic policies will be rewarded with low interest rates and will not be affected adversely by over-spending of others. Furthermore, if excessive spending is ‘punished’ with high interest rates then there is an incentive to curb spending in order to reap the benefits of a better credit standing. Why should governments be prepared to enact such a bankruptcy code? The answer is simple. When compared to the stability pact, a market solution backed by a bankruptcy code allows for much more flexibility. Any country can use deficit spending to stimulate the economy if need be. It just has to be prepared to pay higher interest rates. As long as deficit spending is used wisely such a rise in interest rates may not even be very large. Capital markets will probably not be disposed to punish a country that uses fiscal policy to get out of a deep recession. So there is no need to specify in advance how high a deficit may be in all kinds of conceivable situations.9 Each government can decide on its own without endless negotiations with the other governments. Given the wide differences of opinion between different EU countries, this is a major advantage of the market solution. By allowing different national approaches to fiscal policy, it could reduce a severe source of conflict.10 A bankruptcy code could be agreed upon and enacted on the EU level, possibly giving a role to EU institutions in the negotiations between creditors and debtors. But it seems to be preferable that each country should decide on its own about a bankruptcy code and that there should be no involvement of EU institutions in the negotiations. If the EU is participating in the negotiations, there is a possibility that this will ultimately lead to the EU committing funds to help out. This scenario is well known after fifteen years of IMF experience in crisis management. ‘Crisis management’ only too often meant letting taxpayers pay for debts of other countries. 11 Thus a bankruptcy code which is overseen by the EU could be interpreted as more like a bailout rule in disguise. Under such a rule, markets would hardly

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believe in the credibility of the no bailout rule and interest rates would not reflect risks properly. In order to enhance the credibility of a no bailout commitment, it would therefore be preferable to have national bankruptcy codes and no EU involvement. There is another reason why the EU should be kept out of the settlements of bankruptcies. If EU institutions are involved and if, contrary to expectations, they do not spend any money during bankruptcy negotiations, the position of the EU could be quite awkward. A bankruptcy of a country can be a traumatic experience for the population or part of the population. In such a situation the EU can easily become the scapegoat for financial problems which have been caused by national politicians. The result of this could be strong anti-Europe feelings and resurging nationalism. For the sake of European integration, delicate matters like the handling of a state bankruptcy should be left to national politicians. To sum up, a market solution is going to work if responsibility for the soundness of public finances rests ultimately with national governments. A bankruptcy code would signal to investors that there would be no supranational assistance when things go awry and a country defaults on its debt. Therefore, a code would allow for efficient pricing of government debt. Furthermore, a market solution has the great advantage of avoiding conflicts between member states, and it provides more flexibility than a strict rule, allowing national governments to follow different approaches to macroeconomic policy.

Conclusion For an ardent believer in European integration it must be hard to accept inclusion of a secession clause in a document that establishes the ‘Union’ of Europe. It might also appear equally sinister to use a bankruptcy code for sovereign borrowers to safeguard monetary union. However, rules are most important when things go wrong—not when everything goes well. Rules help to prevent conflicts and provide codes of conduct when conflicts arise. A secession clause and a bankruptcy code would achieve just that. Charles P.Kindleberger once asked his students for the difference between domestic and international trade. One student answered that domestic trade is among ‘us’ whereas international trade is between ‘us’ and ‘them’ (Kindleberger 1986:1). Whether we like it or not, this distinction also applies to the relationship between EU member states. It is still ‘us’ and ‘them’. To be sure, the relationships are mostly friendly and there is little residual hostility. But it cannot be denied that ‘us’ hardly ever means ‘we the Europeans’. As the German Constitutional Court put it, there is no common European public opinion. As long as the national aversion to European centralisation persists, supranational centralisation should not be pushed too far. The EU has taken

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over the important and beneficial task of ensuring fair market competition within the community (and other less beneficial tasks). With the implementation of the EMU, monetary policy has now been centralised as well, so given the different philosophies in economic policy it would be folly to add fiscal (or even social) policy to this list. If economic conditions worsened in one country, there would be little agreement on what to do, so the EU would become the scapegoat. It would be the others who made mistakes— ‘them’, not ‘us’—and friendly relationships between ‘them’ and ‘us’ could quickly deteriorate. This shows that centralisation does not necessarily foster further integration. The opposite can also be true. Centralisation and standardisation can easily produce disintegration and even hostility (Feldstein 1997). Canada with its strong separatist forces is a prime example.12 This does not mean that integration, in general, has to stop or to be reversed, but it does show how important it is not to centralise those tasks each country can perform independently, and perhaps more efficiently.

Notes 1 Being an immigration country, Canada also has to integrate immigrants. But this aspect of Canadian policy will not be considered here. 2 The recent attempts by the Federal government to establish a ‘Clarity Act’ which governs the rules by which a province can secede have been met with derision in Quebec. 3 This game is also known as ‘hawk-dove game’. See Sugden (1986:58–62). 4 Rising debt-to-GDP ratios and falling credit ratings are reported in Kneebone (1994). 5 See Financial Times, 14 December 1996. 6 International Monetary Fund (1996) and own calculations. 7 This was first pointed out by Fuest (1993). See also Kratzmann (1982). 8 The enactment of a bankruptcy code for sovereign borrowing might also encourage developing countries to follow this example. This would make it easier to overcome financial crisis in emerging markets. 9 Under special circumstances, deficits may exceed the limits laid down in the stability pact. However, in most cases this is subject to the consent of the other member states. 10 It may be argued that the introduction of a bankruptcy code would reduce the credit standing of the countries involved, because markets would interpret this as an acknowledgement that bankruptcy is not only possible but also probable. However, such a view of market behaviour is ill conceived. The enactment of a bankruptcy code would show that governments live up to reality. After all, sovereign default has a long history. Indeed, at times it looked as if the history of public finance was a history of public bankruptcy (Manes 1922; Eichengreen 1991; Tammen 1990). However, most governments simply ignore this phenomenon—at least while they can. Any government that acknowledges the possibility of sovereign default and introduces sensible ways to deal with it can expect to be treated better than governments which simply pretend that the problem does not exist. 11 Eaton (1990) provides a critical account of the management of the debt crisis. 12 See Courchene (1991) and Young (1994a).

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Bibliography Courchene, T.J. (1991) In Praise of a Renewed Federalism, Toronto and Calgary: C.D. Howe Institute. ——(1995) Celebrating Flexibility: An Interpretative Essay on the Evolution of Canadian Federalism, Montreal: C.D.Howe Institute. De Grauwe, P. (1992) The Economics of Monetary Integration, Oxford: Oxford University Press. Eaton, J. (1990) ‘Debt relief and the international enforcement of loan contract’, Journal of Economic Perspectives, 4:43–56. Eichengreen, B. (1991) ‘Historical research on international lending and debt’, Journal of Economic Perspectives, 5:149–69. Feldstein, M. (1997) ‘EMU and international conflict’, Foreign Affairs, 76:60–73. Financial Times (1996) ‘Politics of EMU’, 14 December. Fuest, C. (1993) ‘Stabile fiskalpolitische Institutionen für die Europäische Währungsunion’, Wirtschaftsdienst, 1993/10. International Monetary Fund (1996) International Financial Statistics. Yearbook, Washington, DC: IMF. Kindleberger, C.P. (1986) ‘International public goods without international government’, American Economic Review, 76:1–13. Kneebone, R.D. (1994) ‘Deficits and debt in Canada: some lessons from recent history’, Canadian Public Policy—Analyse de Politiques, 20:152–64. Kratzmann, H. (1982) ‘Der Staatsbankrott-Begriff, Erscheinungsformen, Regelung’, Juristenzeitung (JZ). Manes, A. (1922) Staatsbankrotte. Wirtschaftliche und rechtliche Betrachtungen, 2nd edn, Berlin: Siegismund. Millar, J. (1997) ‘The effects of budget rules on fiscal performance and macroeconomic stabilization’, Bank of Canada Working Paper, 97–15. Sugden, R. (1986) The Economics of Rights, Co-operation and Welfare, Oxford: Basil Blackwell. Tammen, M.S. (1990) ‘The precarious nature of sovereign lending: implications for the Brady Plan’, Cato Journal, 10:239–63. Watrin, C. (1993) ‘Europas ungeklärte Ordnungsfragen’, in Norbert Glatzel and Eugen Kleindienst (eds) Die personate Struktur des gesellschaftlichen Lebens, Berlin: Springer, pp. 169–90. Young, R.A. (1994a) ‘The political economy of secession: the case of Quebec’, Constitutional Political Economy, 5:221–45. ——(1994b) ‘How do peaceful secessions happen?’ Canadian Journal of Political Science, 27:773–92.

9

European integration after EMU What next?1 Patrick M.Crowley

Introduction As the first wave of eurozone member states complete the EMU process, many academics and policymakers are now asking what will come after EMU in Europe. In economic terms, the template most social scientists think of when referring to economic integration is in fact a template usually referred to as the Balassa stages of integration, after Balassa (1961). The problem with this template is that it is outdated and also focuses on the earlier stages of integration rather than the later stages of the process. One of the aims of this chapter is to try and shed some light on the later stages of the integration process, and in particular to look forward to the options for further integration, post-EMU, in the EU. Effectively then, the question that this paper asks is ‘What next?’ The assertion made here is that to effectively answer this question, we need to take a look at the whole integration template and the possible dynamics that can arise from the template. In this chapter a multi-disciplinary multi-regional approach is taken, in that elements of international economics, political science and comparative regional analysis are incorporated. The Balassa stages of economic integration are reviewed and analysed and then used as a theoretical starting point for a comparative review of economic integration. Following a review and analysis in the next section, some caveats and observations are made about the actual integration dynamics observed in various parts of the world in the third section. The fourth section applies the framework to the EU at its current stage of economic integration and looks at the various options the EU has for further integration, and the final section concludes.

The theory and nature of economic integration In this section the early literature on economic integration is reviewed. This is important (see Blaug 2001 for a justification for this approach), as it informs the researcher as to the context of the theory of economic integration and allows some insight into the conceptual gaps that exist in the literature. 157

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A historical perspective The theory of economic integration was developed by Balassa (1961), Tinbergen (1954), Meade (1953 and 1955), among others. This theory was obviously going to be more focused on the earlier stages of the integration process, given that for the most part European countries had quite recently adopted a customs union. In Tinbergen’s analysis of economic integration, the classic distinction was made between positive and negative integration, where positive integration refers to the creation of policies and institutions which enable international economic activity, while negative integration refers to the dismantling of barriers which inhibit such activities. Notwithstanding the pejorative nature of the labelling used by Tinbergen, such a distinction is now somewhat dated, as Laffan et al. (2000) recognise, as both types of integration are likely implied, to some degree, by any economic integration initiative. In fact, it is now far more common for both economists and political scientists to be more concerned with whether economic integration implies (more) centralisation to regional or supranational institutions, or whether reciprocity, co-ordination or harmonisation will suffice. Also, to take up the pejorative nature of the ‘negative’ and ‘positive’ labels which Tinbergen attached to his taxonomy of economic integration, many supporters of integration in the Americas, for example, would only favour negative integration and would discourage positive integration, giving the labels a rather odd resonance when applied to the world in which we now live. Tinbergen, though, was writing in the 1950s, when the power of nationstates was unquestioned and when it was an accepted axiom that national economies needed a certain degree of protection from outside forces. In terms of the practice of economic integration, over the last fifty years there have been two waves of economic integration, as Robson (1998) points out. The first wave of economic integration started with the open questioning of the effects of Article 24 of the GATT, which was originally put in place to protect British trade with its colonies and Commonwealth, and the optimism instilled before and after the founding of the European Economic Community. The classic analysis of Viner (1950) was really the starting point for analysis of a free trade area or customs union, and his usage of terms such as ‘trade creation’ and ‘diversion’ does reflect the real concern that economists of the day had with maintaining trade-preference arrangements across huge distances. Also, the theoretical debate in journals such as the Journal of International Economics (see Viner 1965) encouraged a lively programme of research in the area. The lack of progress on initial steps to further integrate Europe and the decline of Britain as an economic power really curtailed any extension of the research programme. The second wave of economic integration, as most economists and political scientists are aware, occurred after 1980, and particularly over the last decade. Although the first wave of economic integration did have some regional focus, it was not exclusively regional as references to British Commonwealth trade-preferences above imply,

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whereas the second wave has had an exclusively regional focus. Paul Krugman’s seminal piece on monopolistic competition and international trade found in Krugman (1979) and then linked with economies of scale and placed in a regional context in Krugman (1991) probably is the genesis for the explosion of interest in this area in the international trade literature during the second phase. The move towards a single market in Europe and the Maastricht Treaty then also gave an impetus to both political scientists and economists to begin research agendas that addressed problems and likely outcomes in more advanced economic integration agreements.2 There are also some semantics to be dealt with here. The term ‘economic integration’ does not usually implicitly refer to regional integration any more, as since Tinbergen’s analysis significant steps have been taken in a multilateral setting to promote international integration, first through the General Agreement on Trade and Tariffs (GATT) and now through the World Trade Organisation (WTO). Indeed, the tension between the two approaches has recently sparked significant debate in economics, not least through the attacks mounted on regional economic integration by economic heavyweights like Jagdish Bhagwati (see Bhagwati et al. 1998 for an excellent exposition of the theoretical underpinnings of this viewpoint). For the sake of clarity, in the rest of this paper the term ‘economic integration’ refers specifically to regional economic integration.

The stages of economic integration Balassa’s five stages of economic integration (Balassa 1961) were a free trade area, customs union, common market, economic union, and total economic integration. As Laffan et al. (2000) note, Balassa’s view of a common market underestimated the amount of positive integration necessary in practice, and similarly overestimated the amount of centralisation necessary for an economic union or monetary union. In fact, Balassa’s vision of total economic integration coincided with a federation or confederation, so could not have envisaged the European Union as we now know it. Balassa’s stages have since been expanded and now usually include the following steps: free trade area, customs union, common market, economic union, monetary union, and political union (see Molle 1997, for example). Even this is not a complete sequencing of the true stages of economic union, as fiscal union or some kind of fiscal arrangement (such as the Stability and Growth Pact) does not fit into this taxonomy.3 Table 9.1 presents an extended version of the Balassa process, with examples at each stage of economic integration—these examples reflect countries that have been in such a situation, or are currently in such a situation. Several things are noteworthy about the table. First there is an implicit assumption in the literature and in the way that most people read the table that the levels of economic integration imply a sequential process. But in practice this is not the case. The first two levels of integration, A and B, relate

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Table 9.1 Extended Balassa stages of economic integration

Note E and F are actually interchangeable, as for example various authors place these two levels of integration in different orders (see Molle 1997, and contrast with the order of chapters in Robson 1998)

only to trade in goods and services, and either can be used as a basis for further integration to a common market. So, for example, NAFTA is not a customs union, but there is no theoretical reason why the regional trade agreement cannot skip the customs union stage and become a common market or a monetary union, or economic union for that matter. But note that a common market (C) does imply either A or B, but a monetary union does not necessarily imply any other stages of integration. Indeed, dollarisation

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represents a form of monetary union, but that does not imply or give a country the right to eliminate tariffs and quotas with the United States. Furthermore, even in the context of a regional trade agreement such as NAFTA, monetary union does not imply a common market, economic union or a customs union. Indeed, it is also apparent that new ‘models’ of integration are emerging. Two examples spring to mind here: (1) the Central and South American countries, where Ecuador has gone for full dollarisation, Panama has been dollarised for decades and Argentina had a currency board against the US dollar. In the context of the Free Trade Agreement of the Americas (FTAA), this likely implies very different levels of integration with the old NAFTA bloc and implies different integration dynamics for these three countries; and (2) when the CEE countries join the EU, they are expected to be able to assimilate into EMU almost immediately, but they will not be allowed full membership of the common market (labour movements are likely to be restricted)—this will clearly lead to a different integration dynamic than we have seen previously. So are there any preconditions for any given form of economic integration? The sequence of economic integration, taking a backwards-looking view of integration is described in Table 9.2. Table 9.2 highlights several issues. First, it suggests that there are few preconditions, in theory, for adoption of any of the given stages of integration. Second, the table illustrates that certain levels of integration, notably a common market (C) and the political union (G), do imply prior ‘stages’ of Table 9.2 Preconditions for economic integration

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integration have been accomplished. Clearly a common market, defined as an area where all factors of production, goods and services can move freely implies that goods and services can move across borders without any constraints.4 Likewise, a political union implies that the parliament or government has some fiscal sovereignty, so some form of fiscal union is desirable. Interestingly, though, a political union does not imply that a monetary union has occurred—there are no examples of this (that the author is aware of), but national central bank independence couched within a supranational political union would contain no contradictory features from an economic policy perspective. In fact, it is the mirror image of the current situation in EMU, as in EMU monetary policy is operated from a supranational level, but fiscal policy is determined in the national arena -here fiscal policy is operated from a supranational level but monetary policy is determined domestically.5 The third feature of the table shows that there is one subcategory of fiscal union (fiscal sovereignty at a subcategory level) that would require at least some elemental form of political union—in other words, one form of F would in fact require G as a prerequisite! The above only goes to illustrate that the Balassa stages of economic integration are only one sequencing of the various facets of what are the components of regional economic integration. But although a backwardslooking analysis of necessary preconditions for every component of Balassa’s stages shows how ‘earlier’ stages are usually not a prerequisite in theory, it does not illustrate how ‘spillover effects’, which refer to different phenomena in political science and economics, might push any regional integration agreement towards ‘deeper’ levels of economic integration. To a political scientist, spillover effects refer to the phenomena whereby a policy prompts policy initiatives in other areas. To an economist, spillover effects refer to the phenomena whereby ‘public policies in one jurisdiction necessarily have effects that significantly affect others’ (quoted from Robson 1998:125)—these are often referred to as ‘cross-border externalities’. An example of a ‘political science’ spillover effect would be the need for greater co-ordination of fiscal policies after the establishment of EMU as embodied in the Stability and Growth Pact. An example of an ‘economic’ spillover effect might be increased shopping in France by UK citizens because of lower excise taxes on certain goods, given the existence of the single market. Of course, some spillover effects are both political and economic in nature, and an example of such a case might be the establishment of an EU competition policy given the existence of the single market. Despite the confusion that originates from separate development of conceptual terms in the two disciplines, it is clear that one level of integration might lead to another. This is explored in Table 9.3. Table 9.3 stresses the linkages between the stages of economic integration using both economic and political spillover criteria. Combining this with the earlier analysis in Table 9.2, it suggests that there are both backwards and forwards linkages between the different types of economic integration.

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Table 9.3 Possible ‘spillover’ consequences of integration

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Figure 9.1 Network mapping of linkages between integration stages

Table 9.4 Reclassifying integration by level

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Figure 9.1 and Table 9.4 summarise these linkages using what mathematicians call a network map. Each ‘node’ represents a stage of economic integration, and the arrows between the nodes represent either preconditions or spillover dynamics. If the arrows in the figure point to an earlier stage of integration, this implies conditionality on that previous level of integration, and if the arrows point to a later stage of integration, then spillover effects tend to move the regional integration project towards this later stage. Clearly, if there are arrows pointing both ways between any two boxes then the former is a prerequisite for the latter and through spillovers the former tends to promote the latter. In the context of network maps, one might label this relationship as ‘mutual interdependency’. One of the striking things about the network mapping is that only in the early stage and later stages of integration is there any mutual interdependency (two-way mapping). These stages are the trade integration and common market stages and the fiscal and political union stages. The analysis implies that other stages of integration, if achieved, are due to spillover-type effects or political decisions to move to a specific stage of integration. One other interesting feature of the network mapping is that monetary and economic union do not seem to be strongly related, and yet, of course, the EU decided to package these two together in EMU. From a theoretical perspective, then, there is apparently little to connect the two—and indeed this perspective was very prominent in the economics literature surrounding the Stability and Growth Pact, as well as criticisms made by Crowley (1996), Buiter (1998), Eichengreen and von Hagen (1995) and others. Only in the minds of the designers of EMU was there a link between the two.6 An important caveat is in order here. Politically motivated considerations, rather than economic considerations, may also drive the integration dynamic. In particular, the popular appeal to the ‘two-level’ games framework is thought to also drive integration, as politicians seek to tie domestic policy to internationally determined criteria. One example of this would be the way in which economic convergence was achieved according to the Maastricht criteria, which allowed certain member states to enter EMU.

Homogeneity, process path-dependence and exogenous factors If economic integration is to be thought of as a process, then like all scientific processes it has to have both initial conditions and various factors that promote a certain type of dynamic. Particularly in the case of economic integration, process path-dependency is likely to be an important consideration. In the analysis below, initial conditions for integration are likely to be important in determining the integration dynamic, and these ‘homogeneity’ factors are explored using existing regional integration agreements. I then go on to consider the actual integration dynamic—which includes such factors as

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changing membership, etc. Finally within this section, I consider how exogenous factors may engender more impetus to the integration dynamic.

Homogeneity (initial conditions) Given our analysis above, it is tempting to assert that apart from the ‘endpoints’ of economic integration, the remainder is a ‘smorgasbord’ from which countries or member states can choose according to political expediency. But this belies the fact that in reality much economic integration can be viewed as a non-linear process: a process that is responsive to political perceptions of factors such as the ease of implementation and the consequences of not proceeding with further stages in terms of loss of impetus, or the alienation factor if the initiative is blocked (for example, in the case of the UK and EMU). Apart from politics, another factor which might impinge upon the degree of acceptance for integration and the path taken to given ends might be historical and cultural commonality—this may foster greater trust and understanding that the means seek to attain common ends. Clarkson (2000) based on Helleiner (1994) suggests this in comparing the three major continental regional integration projects, and his schema is extended and reproduced for our purposes below, but in this case including two further trading blocs, Mercosur and WAMU. Table 9.5 reveals several interesting features. First, that the approaches in NAFTA and the European Union are radically different—as Clarkson puts it, comparing the two is like comparing ‘apples and oranges’ in the sense that on a certain level comparisons can be made (both apples and oranges are fruit) but on another level the comparison doesn’t work too well (apples and oranges are different types of fruit). Clarkson mentions that both continents experienced a long history riven with conflict, and both continents have a shared history of conflict with the largest country in the bloc (Germany for the EU and the US for NAFTA), but culturally and politically the two could not be more different.7 Europeans sought to establish a forum where Germany could participate as an equal partner in economic and political development, whereas after the war the victorious USA really did not actively pursue any ‘special’ relationship with either Mexico or Canada, so the Canadian-US Free Trade Area (CUFTA) and its successors NAFTA and soon-to-be FTAA were born much later. This also probably explains the reticence on the part of the USA to pursue deeper integration—it has little concern as to what either of its NAFTA partners thinks about its political or economic intentions or ambitions—therefore a deeper form of integration which might tie or bind US policy to a particular treaty or supranational institutional interpretation is likely to be an anathema to its politicians. Following this line of argument, the FTAA, signed in Quebec City in May of 2001, likely extends NAFTA to other Central and South American countries, signifying that there is really no

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‘special’ relationship with Mexico because of its geographical position (ironically some politicians might claim that NAFTA caused Mexico to become a policy problem!).8 In counterfactual terms it is interesting to mull over what would have happened to CUFTA if Mexico had not been brought in to create NAFTA in 1994—perhaps the shared cultural and historical background (European settlers, settling the west, and for the most part a common language) would have engendered a greater desire for a deepening of arrangements in CUFTA rather than the widening that will likely occur going from NAFTA to the FTAA. Turning to the EU, it is clear to both insiders and outsiders that history and culture also affects the present situation in Europe, through 1 the fact that the UK, with its separate experience in the early part of the twentieth century plus its physical separation from the rest of Europe (see Bryson 1995 for an amusing perspective on this) and a different experience with the EU and current ‘outsider’ status in EMU, reflects a radically different cultural and historical background; 2 the treatment of the Central and Eastern European (CEE) countries by the EU—neither Greece nor Portugal were put through the same lengthy and rigorous process for membership of the EU as the CEE countries have been subjected to, and yet neither of these two countries had an economic or political record that was beyond reproach; clearly, the shared history of Western Europe binds the current EU together, and even though the CEE countries are deemed to be European, they represent a differentiated Europe; Table 9.5 Comparing regional integration projects

Note Economic integration refers to industry integration and the formation of a single market

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3 the refusal of most Europeans to perceive the EU as anything other than European—Turkey, Russia and Northern African states, albeit for apparently different reasons, are unlikely to be allowed into the EU in the future. Two other factors evident from Table 9.4 are also noteworthy. First, ASEAN is another different model of integration, with a much looser form of integration and a large membership. Although ASEAN and China plan to implement an FTA some time in the future (the date keeps changing!), most commentators doubt that this will occur soon—nevertheless, co-operation in the area will likely increase in the light of the common experience offered by the Southeast Asian crisis and the economic malaise in Japan. Second, Mercosur, the Southern American integration project which to a large extent mimicked the EU, has to date not been wholly successful. Recent reports suggest that in fact economic integration has gone into reverse as both Argentina and Brazil appear to have problems in implementing further trade liberalisation due to the domestic political ramifications—and particularly as Brazil maintains a crawling peg exchange rate while Argentina, now floating its official currency while the population still hangs on to its dollars, is trying desperately to avoid both political and economic collapse.9 Although Mercosur institutions have been established, their influence is very limited and policymaking initiative remains in the hands of the constituent countries. But, from a qualitative perspective, note that apart from Brazil the Mercosur members have very similar historical experiences and cultural roots. The experience of the Mercosur bloc suggests that a specific model does not necessarily translate well elsewhere in the world, and in turn suggests that beyond a certain point the specificity of arrangements for any regional integration project must be determined by the combination of particular state interests that bring the countries to the table, along with their preferences for supranational delegation versus co-ordination and harmonisation. Further, it suggests that differing exchange rate arrangements can affect progress with integration on another policy front (a matter that is pursued below). The case of North Africa is also interesting. These countries all have a similar culture and shared history as they are nearly all ex-French colonies. Hence their arrangements, as both Robson (1997) and El Nabi (1995) describe, are somewhat unique. They have embarked on a monetary union and an overlapping but slightly different membership is now pursuing a common market. A previous customs union was established (OACU), with fiscal compensation payments (a form of fiscal union), but economic difficulties in the early 1990s unfortunately caused the arrangements to lapse. Clearly their common heritage and shared culture made it much easier to enact a monetary union, tied to the franc (and now the euro). The qualitative analysis above suggests that the initial conditions for any regional integration project differ substantially from continent to continent, and that any attempt to impose a template from one region on to another

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region is likely to fail. This is because it does not account for the specificity of the regional integration arrangements under consideration in terms of history, culture and the willingness to delegate policy responsibilities to a supranational level.

Process path-dependency Clearly, not only do initial conditions differ between the regional integration projects for historical and cultural reasons, but also path-dependency matters in the sense that, as Figure 9.1 illustrates, it is not necessary to use the same integration path. Further, there are two other points to be made about Figure 9.1. First, and perhaps most important in both European and North American contexts, members have been added along the way. This must lead to a change in preference among the participants in the project. Many examples of this exist in the European context, from the UK’s obstinacy over the budget to the emergence of a lobby group of ‘olive’ member states from the Mediterranean regions, and the addition of CEE countries is clearly going to significantly change the balance of power again in EU institutions and decisionmaking. The decision to add new members can change the integration dynamic and cause the direction of the process to shift from its original course.10 It has now been clear for some time in the EU that there is a ‘hard core’ of member states (notably Germany, Austria, the Benelux member states and France) who are keen to see a deeper level of integration achieved more rapidly. As more member states are added to the EU, member states that will need to acclimatise to EMU, a common market and the political bargaining that takes place in the EU will not be anxious to move forward too swiftly. In fact, letting the six CEEs join together might create a significant voting bloc to stall any future initiatives, regardless of how the integration dynamic plays out after EMU.11 The second point that stems from Figure 9.1 relates to the move from autarky to either an FTA or a CU. In the Figure, the presumption was made that an autarkic state with bilateral trade agreements may make a first move towards a trade agreement rather than to any other type of integration treaty. But this may not be so, and one example of this type of behaviour exists and is well documented.12 The West African states have operated a monetary union for some time now (WAMU), using the French franc as a nominal exchange rate anchor for their collective currency, the CFA. Although WAMU was supposed to complement a customs union (OACU) and fiscal union, the CU collapsed in the 1980s during the debt crisis, and they became largely autarkic. The WAMU shows that from autarky, countries can move to a much deeper stage of integration, bypassing the intermediate stages in Balassa’s process. Figure 9.2 illustrates three different routes through the integration stages, using the same coding as Figure 9.1. All three routes have one thing in common—they all contain the objective at some point of the creation of a

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common market (C). All three examples of attaining a common market use a different route, and interestingly in all three cases commentators have noted that the achievement of a common market has not yet been met. All the regional integration projects clearly have different initial conditions, in the form of cultural and political homogeneity—but we have also suggested that path-dependence also exists. What are the factors that affect which path is taken? This is a difficult question to answer satisfactorily, if at all, so here we address this by asking a somewhat different question but one which does indirectly address the path-dependency issue. The way economists deal with this question is to appraise the costs and benefits of proceeding with a new stage of economic integration, but as Mayes (1997) shows, assessing these costs or benefits is not easy, and both methodology and size of effect is likely to be questioned. So applied economics alone does not give an adequate response—this decision must be taken considering both possible net economic benefits and political costs. In other words, as politicians are the real decisionmakers, the real question countries and states need to address when moving to a specific level or type of integration is ‘What is being given up, or how are domestic policymakers’ hands tied by adopting this form of integration?’ Table 9.6 attempts to provide some answers to this question. Several points arise from Table 9.6. First, the ‘deeper’ forms of integration (forms D, E, F and G) imply substantial loss of national autonomy, although D appears to be least objectionable from the point of view of protection of domestic interests. This might explain why, with the notable exception of the

Figure 9.2 Nodal map of the integration stages for the EU, West Africa and NAFTA Note *=members added to integration project between stages ()=partial

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Table 9.6 Implied changes and commitments from integration

EU, Mercosur and WAMU, nearly all other regional trade agreements focus solely on the earlier stages of integration. Second, as Krugman (1991) makes clear, a common market would imply that specialised labour would move to the highest paying countries instead of corporations moving to the lowest cost countries: so, clearly, in terms of potential economic dislocation an FTA or CU implies less structural dislocation for an economy than implementing

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a full common market.13 Third, out of E, F and G, E (monetary union) is likely the easiest to accomplish because it gives up a policy prerogative that is usually delegated to a government agency rather than decided by political representatives. Certainly, mainstream economic literature stresses the potential inflation advantages of central bank independence and perhaps even growth advantages (although there is almost no evidence to support this latter claim). Lastly, although D could conceivably operate most efficiently with supranational institutions, these are not necessary for its effective operation, whereas for E, F and G, clearly supranational institutions would likely be necessary. As national governments have a certain reticence about establishing supranational institutions, because of ‘political’ spillover, these stages will probably be deemed less palatable to most national governments. A good example of this logic might be the Stability and Growth Pact (see Artis and Winkler 1997; Crowley 2001). Here a potential spillover from E to F was recognised but a way was found to avoid supranational institution building by agreeing on a pact to co-ordinate fiscal policy. Although recognition of spillovers clearly gives rise to certain policy problems in this context (how to enforce the Stability and Growth Pact), non-recognition can also be equally problematic. An example of this might be the problem of the asymmetry surrounding the arrangements for the ECB, given that it effectively has no single democratic institution to be accountable to (see Crowley and Rowley 1998 for a description of possible solutions to this problem). To summarise, in comparative terms within the context of the stages of regional integration, the above reasons go a long way towards explaining (1) why most of the regional integration agreements in the world are FTAs or CUs; (2) why fiscal, monetary and political union are not seen as desirable to many countries; and (3) why, if one of (2) has to be chosen, then monetary union would most likely be least problematic and easiest to achieve.

Exogenous factors In this section we briefly return to a theme that was presented at the beginning of the chapter, namely that of the multilateral trading system and the loophole in Article 24 of GATT that allows regional integration agreements to exist. Clearly, frustration with the GATT process, particularly during the Uruguay round, led to many countries deciding that regional trade liberalisation was a better option than the multilateral process. Thus, today, the numerosity and depth of regional integration agreements to some extent owes its existence to the slow progress made on a multilateral context, and in this sense the process has been exogenously determined by external factors. From a political perspective one might add that the conservatism of

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the 1980s fostered a greater desire to implement more open trade regimes to reap the benefits of a more competitive environment, and if the multilateral process could not provide this environment quickly enough, then regional agreements could be implemented very quickly given a mutual willingness to do so.

Implications for the EU Having nearly completed EMU, the EU is looking beyond 2002 and is dealing with the expansion of the EU to the CEE countries. This is a challenging task, but it will modify preferences towards integration in the EU, leading to a different path in the future. The question then becomes: what effect will EMU have on the EU integration dynamic, and what is the need for further integration? Further, is there any logical sequence for further integration? Taking the extended Balassa template, given that EMU is successfully achieved, Figure 9.1 points to fiscal or political union as the next obvious stage of integration. But what about the sequence? Balassa’s schema implies that fiscal union should occur first, but Figure 9.1 suggests there are actually three possible routes: 1 EMU endpoint: EU integration ends at EMU, and although there are some efforts to co-ordinate and harmonise some aspects of fiscal policy, fiscal policy independence is retained by member states, perhaps with the eventual scrapping of the Growth and Stability Pact. 2 Fiscal union: move to fiscal union (F), and then there are two possibilities: (a) the Growth and Stability Pact is maintained, and fiscal co-ordination and harmonisation becomes the ‘finality’ of the EU integration process; and (b) due to spillovers, fiscal union leads to political union (G). 3 Political union: move directly to political union (G), by giving the European parliament more powers and perhaps (following suggestions by Joschka Fischer and Tony Blair that were incorporated in the Treaty of Nice) the incorporation of national parliament representatives in a second EU chamber, which would grant more legitimacy to supranational democracy. Figure 9.3 illustrates these three possible outcomes for integration within the EU given that EMU is successful. The diagram illustrates that if fiscal union is blocked by member states but there is a possibility for some degree of political union, then this (option 3 above) may be the best way to achieve fiscal union in the long run, as a legitimate political union should then be able to acquire fiscal responsibilities at a supranational level much more easily than using the usual Balassa stages of integration, which would imply

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Figure 9.3 Integration for the EU post-EMU Note ()=no necessity that this will occur

option 2 above (see Wessels 1997 for more on the political implications of EMU). The only paper (that I am aware of) that addresses the issue of the need for further economic integration after EMU is Costa and De Grauwe (1999). Costa and De Grauwe take a much narrower view of the integration process beyond EMU and focus on the political ‘spillovers’ as well as single-market issues that will arise after EMU implementation. Costa and De Grauwe analyse labour mobility, tax harmonisation, industrial location, transportation and legislation regarding takeovers as possible areas where EMU will put further pressure for integration or at least harmonisation or co-operation. Here, industrial location and associated agglomeration effects, as well as legislation regarding takeovers, will be put aside, because they largely fall under the rubric of single-market issues, and they are ongoing issues which may have been exacerbated or highlighted by EMU. Transportation is certainly important, and with the single market it is clearly becoming more important to have a minimum harmonisation of national standards under some umbrella EU transport policy—but again, this comes under the rubric of economic union, an integration initiative that is ongoing. So this leaves labour mobility and tax harmonisation. Labour mobility once again comes under the rubric for the single market, the EU version of a common market, but nevertheless does have an important interrelationship with EMU, so like tax harmonisation is considered below. According to the theory of optimum currency areas (developed by Mundell 1961; Kenen 1969; McKinnon 1969), labour mobility is important if a single currency area is not optimal (see De Grauwe 1992; Artis and Zhang 1998; Bayoumi 1994; Bayoumi and Eichengreen 1993, 1994; LaFrance and StAmant 1999 for a detailed review of the OCA literature; and Björksten and Syrjänen 2000). But, on the other hand, EMU might turn out to be optimal

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ex post, as Frankel and Rose (1999) have pointed out.14 So all we can say at this juncture is that labour mobility might turn out to be important. So what is the evidence about labour mobility in the EU? The evidence is that labour mobility in the periphery is greater than in the ‘core’, so in a sense this does bode well given that agglomeration effects should eventually lead to more activity in the core. Also, further evidence suggests that low-skilled labour mobility in the core is much lower than high-skilled labour mobility—the economic rationale being social security.15 As taxes fall on income of lowskilled labour in the core, this should increase net wages and prompt an increase in labour mobility, but there is significant resistance to this process so it may take some time to occur. Suppose that EMU does not become an endogenous optimal currency area, and so labour mobility becomes an issue—which form of integration is this likely to engender? If labour becomes more mobile in the EU then clearly fiscal issues will be of prime concern—ensuring social security contributions and pension contributions are portable—plus harmonisation of tax systems. If these issues become crucial for the success of EMU, then Figure 9.3 above suggests that integration dynamic 2 is most likely. If EMU is not an optimal currency area and the strains are significant, then it might be that other initiatives are taken which tend, through spillovers, to promote political union. When it comes to fiscal harmonisation, Costa and De Grauwe (1999) make the point that taxation on very mobile taxable items will be much more likely to be harmonised or co-ordinated than taxation on a less mobile tax base.16 This harmonisation will also likely lead to tax competition on mobile factors, but less competition and therefore an array of different rates (and public service offerings) on less mobile factors.17 This analysis points to little co-operation or harmonisation on income taxes and withholding taxes, but more pressure to harmonise and maybe set a common rate for VAT and corporation taxes. In terms of our analysis above in Figure 9.3, this fits in with integration dynamic 2 again. The crux of the issue surrounding the integration dynamic outlined above is that in fact EMU points to only weak integration beyond EMU in the fiscal area—in other words, the political ‘spillovers’ are not likely to cause a fiscal union where policy responsibilities are transferred to a supranational level.18 Further, in terms of the integration dynamic, they will likely lead to the ‘finality’ of integration in the EU without any further tendency towards political union. An integration dynamic that is institutional in its scope and embraces the notion of political union before fiscal union will be much more likely to lead to a fiscal union that encompasses fiscal sovereignty at the supranational level leading to a deeper level of integration in Europe. Part of this depends on whether EMU is an endogenous optimal currency area: if it is, then unless a separate initiative for political union is launched, the integration dynamic alone is unlikely to produce political union; if it is not, then the integration dynamic suggests that a political union might be achieved.

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General conclusions In this chapter, the Balassa stages of economic integration were reviewed and analysed from both a historical, economic and political context. The implied sequence of integration was also placed in the context of the liberalisation of the world trading system, and examples were given of regional integration projects and different integration dynamics. The Balassa framework was found to be useful but limited to the early stages of integration from a dynamic perspective, so a new taxonomy was developed which encompasses a variety of integration dynamics. The sequence of economic integration was analysed using two different approaches: a backward-looking economic conditionality approach, where each stage of the integration was conditioned on other stages, and a forwardlooking politico-economic spillover approach which looked at how further stage(s) of integration are suggested at any specific stage of integration. Comparisons were then made between the economic integration projects that exist today. Discussion of the starting points and the dynamics of each integration project included cultural and historical commonalities, political preferences and regional context. Further, using the notion of process pathdependency, each stage of economic integration was analysed, and it was determined that monetary union was the easiest to implement and likely implied less political spillover effects at the supranational level. The framework used to link the different stages of economic integration was then applied to the EU, given a successful implementation of EMU. The analysis uncovered three possible options, all with different implications for the endpoint of the integration dynamic in the EU. The main finding was that there is no logical reason why fiscal union needs to occur directly after EMU— the alternative being a dynamic that pushes for political union first, and then this might legitimate fiscal sovereignty at a supranational level. Whether a political union or fiscal union is achieved first was shown to depend on whether Europe turns out to be an endogenous optimal currency area. If it does, then the pressure to move on to another level of integration may be absent, which may lead to either an endpoint for integration at EMU, or only a loose coordination of fiscal policies with no supranational sovereignty, which would not imply that further political union would be needed. If not, then further integration would be likely to occur, but it is not clear whether political union or fiscal union would occur first. The answer, then, to the question ‘What next after EMU?’ is a range of possibilities, with determinants of each possibility based largely on the will of politicians and whether EMU induces greater synchronisation of economic cycles in the eurozone member states. Notes 1 I would like to thank my research assistant Josh Osborne at Texas A&M for excellent assistance over the past year, and Dean Abdelsamad for funding my research this year. An earlier version of this paper was presented at the European

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Union Studies Association meetings in Madison, Wisconsin, USA, 30 May to 2 June 2001. Two early and influential papers on these subjects are Flam (1992) and Eichengreen (1993). Below, we rectify this by adding fiscal union to the Balassa stages. If a common market is defined as an area where factors of production can freely move, then clearly the implications are different. In the EU context a common market is used interchangeably with the single market concept. The G7 policy initiatives of the 1980s are probably the closest we have come to an arrangement whereby fiscal policy is co-ordinated/integrated coupled with monetary policy independence. In the document used by the Commission to sell EMU to finance ministers (European Commission 1990), the Commission acknowledges this (p. 11), but goes on to justify economic union on the basis of deepening the single market (‘impulsion’), the threat of errant governments in terms of fiscal profligacy (‘cooperation’) and political expediency (‘cohesion’). See El-Agraa (1997 and 1999) and Martin (1992) for analysis of regional integration arrangements worldwide. Interestingly, Mexicans used to designate North America as anything north of the Rio Grande—since NAFTA this is increasingly used in a self-inclusive manner. In 2001 the Argentinian finance minister announced that the currency board would consider introducing the euro as one of the components of a basket of currencies that might supplant the dollar as the anchor for the peso exchange rate. For example, as de Witte (2001) notes, the German call in mid-2000 for an EU ‘constitutional treaty’ was met with a positive reaction by only the original founding six member states of the EU! See Wallace (1999). Unilateral adoption of another currency is another example of monetary union—but as it usually does not form part of a regional integration agreement, we focus on the one example of a regional integration agreement where this has happened. Interestingly, Canada is a good counter-example to this logic: Canada still does not constitute a single market, even though it is a single currency area and has a fiscal and political union, because of provincial trade barriers that were erected to protect goods markets such as brewing. Attempts to remove provincial trade barriers were made by Prime Minister Mulroney as part of the Charlottetown accord in 1991, but these were rejected by the referendum over issues relating to Quebec and the Constitution. Economists usually refer to an optimal currency area (OCA) that occurs ex post as an endogenous OCA. Social security in the core countries is very well developed and eliminates any financial incentives for low-skilled labour to move. Or, to quote Costa and De Grauwe (1999:35), ‘the pressure to harmonise tax rates increases with the mobility of the good and the factor that is taxed’. Costa and De Grauwe claim this could lead to lower taxes on capital and higher taxes on labour, but do not offer any evidence for this. Clearly Tiebout factors will also come into play. During the UK election (7 June 2001), Frits Bolkestein, the EU internal market commissioner, declared that ‘harmonisation of income taxes is out’. A few days later, similar gestures were made by Tony Blair, UK prime minister, with regard to corporation taxes in response to suggestions by French prime minister Jospin that taxes in the EU should be harmonised.

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Bibliography Artis, M. and Winkler, B. (1997) The Stability Pact: Safeguarding the Credibility of the European Central Bank, CEPR Discussion Paper 1688, London, UK: CEPR. Artis, M. and Zhang, W. (1998) Core and Periphery in EMU: A Cluster Analysis, EUI Working Paper RSC No. 98/37, Florence: EUI. Balassa, R. (1961) The Theory of Economic Integration, Homewood, USA: Irwin. Bayoumi, T. (1994) ‘A formal model of optimum currency areas’, IMF Staff Papers, 41(4): 537–54. Bayoumi, T. and Eichengreen, B. (1993) ‘Shocking aspects of European monetary unification’, in F.Giavazzi and F.Torres (eds) Adjustment and Growth in the European Monetary Union, Cambridge: Cambridge University Press. ——(1994) One Money or Many? Analyzing the Prospects for Monetary Unification in Various Parts of the World, Princeton Studies in International Finance 76, Princeton: Princeton University Press. Bhagwati, J., Greenaway, D. and Panagariya, A. (1998) ‘Trading preferentially: theory and policy’, Economic Journal, 108:1128–48. Björksten, N. and Syrjänen, M. (2000) How Problematic are Internal Euro Area Differences?, EUI Working Paper RSC 2000/14, Florence: EUI. Blaug, M. (2001) ‘No history of ideas here, please, we’re economists’, Journal of Economic Perspectives, 15(1), Winter: 145–64. Bryson, B. (1995) Notes from a Small Island, Toronto, Canada: McClelland and Stewart. Buiter, W. (1998) ‘The economic case for monetary union in the European Union’, in C.Deissenberg, R.Owen and D.Ulph (eds) European Economic Integration, supplement to Review of International Economics, 5(4): 10–35. Clarkson, S. (2000) Apples and Oranges. Prospects for the Comparative Analysis of the EU and NAFTA as Continental Systems, EUI Working Paper RSC 2000/23, Florence: EUI. Costa, C. and De Grauwe, P. (1999) ‘EMU and the need for further economic integration’, in W.Meeusen (ed.) Economic Policy in the European Union, Cheltenham, UK: Edward Elgar, pp. 27–48. Crowley, P.M. (1996) ‘EMU, Maastricht and the 1996 IGC’, Contemporary Economic Policy, XIV(2): 41–55. ——(2001) ‘The institutional implications of EMU’, Journal of Common Market Studies, 39(3): 385–404. Crowley, P.M. and Rowley, R. (1998) ‘European integration and monetary unification: configurations, fiscal and monetary policy design and institutional development’, Journal of European Integration, XXI(3): 203–229. De Grauwe, P. (1992) The Economics of Monetary Integration, Oxford, UK: Oxford University Press. De Witte, B. (2001) ‘Après Nice: Time for European Constitution?’ ECSA Review, Spring: 10–11. Eichengreen, B. (1993) ‘European monetary unification’, Journal of Economic Literature, 31:1321–57. Eichengreen, B. and von Hagen, J. (1995) Fiscal Policy and Monetary Union: Federalism, Fiscal Restrictions and the No-Bailout Rule, CEPR Discussion Paper 1247, London, UK: CEPR. El-Agraa, A. (1997) ‘Regional integration arrangements worldwide’, in A.El-Agraa (ed.) Economic Integration Worldwide, New York: St Martin’s Press, pp. 12–33.

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——(1999) Regional Integration, London, UK: Macmillan. El Nabi, I. (1995) Economic Integration in Africa—A Critical Assessment, Khartoum, Sudan: Khartoum University Press. European Commission (1990) ‘Economic and monetary union: the economic rationale and design of the system’, Working Document of the Commission, presented to Finance Ministers, 31 March-April, 1990, Brussels, Belgium. Flam, H. (1992) ‘Product markets and 1992: full integration, large gains?’ Journal of Economic Perspectives, 6(4): 7–30. Frankel, J. and Rose, A. (1997) ‘Is EMU more justifiable ex post than ex ante?’ European Economic Review 41:753–60. Helleiner, E. (1994) Regionalization in the International Political Economy: A Comparative Perspective, Toronto, Canada: University of Toronto/York University Joint Centre for Asian Pacific Studies. Kenen, P. (1969) ‘The theory of optimal currency areas: an eclectic view’, in R.Mundell and A.Swoboda (eds) Monetary Problems of the International Economy , Chicago: University of Chicago Press. Krugman, P. (1979) ‘Increasing returns, monopolistic competition, and international trade’, Journal of International Economics, 9:469–79. ——(1991) Geography and Trade, Cambridge, USA: MIT Press. Laffan, B., O’Donnell, R. and Smith, M. (2000) Europe’s Experimental Union, London, UK: Routledge. LaFrance, R. and St-Amant, P. (1999) ‘Optimum currency areas: a review of the recent literature’, paper presented at the Canadian Economics Association meetings, Toronto, Ontario, 28–30 May. McKinnon, R. (1969) ‘Optimum currency areas’, American Economic Review, 53: 717–55. Martin, F. (1992) ‘Local and regional impacts of a FTA: Canada, US, Mexico’, in G.Bertin and A.Raynauld (eds) Economic Integration in Europe and North America, Paris, France: Clement Juglar, pp. 23–52. Mayes, D. (1997) ‘The problems of the quantitative estimation of integration effects’, in A.El-Agraa (ed.) Economic Integration Worldwide, New York: St Martin’s Press, pp. 74–96. Meade, J. (1953) Problems of Economic Union, London, UK: Allen and Unwin.—— (1955) The Theory of Customs Unions, Amsterdam, Netherlands: North-Holland. Molle, W. (1997) ‘Basic concepts and structures’, in W.Molle, The Economics of European Integration, Brookfield, VT: Ashgate, Ch. 2. Mundell, R. (1961) ‘A theory of optimum currency areas’, American Economic Review, 51:657–75. Robson, P. (1997) ‘Integration in Sub-Saharan Africa’, in A.El-Agraa (ed.) Economic Integration Worldwide, New York, USA: St Martin’s Press, pp. 348–67.——(1998) The Economics of International Integration, 4th edition, London, UK: Routledge. Tinbergen, J. (1954) International Economic Integration, London, UK: Macmillan. Viner, J. (1950) The Customs Union Issue, New York, USA: Carnegie Endowment for International Peace. ——(1965) ‘Letter to W.M.Corden dated 13 March 1965’, Journal of International Economics, 6:107–8.

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Wallace, H. (1999) ‘Whose Europe is it anyway? European Journal of Political Research, 35:287–306. Wessels W. (1997) ‘An ever closer union? A dynamic macro-political view on integration processes’, Journal of Common Market Studies, 35(2): 267–99.

Part IV

Beyond EMU Evaluating success

10 One money, one people? Political identities and the Euro1 Eric Helleiner

Introduction Academic analyses of the significance of the euro have focused largely on economic and political issues relating to the wealth, power and interests of different states and social groups. What has been quite absent are analyses of a more cultural kind that examine the euro’s potential role in eroding national identities and fostering a more pan-European identity. The neglect of this issue is surprising given its prominence in public discussion in Europe. Opponents of the euro, for example, have argued that the abandonment of national currencies will ‘dilute’ their national identity.2 Its supporters, though less frequently, have also recognised that the exchange of national currencies for the euro may ‘feel almost like a change of identity’ (European Commission 1995:49). Similarly, researchers have found that attitudes of some Europeans towards the euro are influenced by their concerns about its implications for national identities (Meier and Kirchler 1998). In this chapter, I suggest a number of ways in which we might think analytically about the relationship between the euro and political identities. To do this, I return to insights made by analysts from the nineteenth century. These analysts lived in an era when national currencies were first being created in the leading economic powers of the world. I show how many advocates of the construction of national currencies in that era developed some specific arguments about how these new monetary structures could help foster national identities. Building on these analyses, I suggest five different ways in which the relationship between money and political identities might be conceived and I analyse the potential significance of each in the contemporary European context. My objective is not to try to prove any causal relationship between money and political identities in the past or today; rather, I am simply trying to put forward a way in which future researchers might begin to think about the nature of this relationship.

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to ask why contemporary academics have been so slow to analyse the ways in which the introduction of the euro may influence political identities. One reason may be the absence in contemporary scholarship of analyses of the relationship between national currencies and national identities. In the large and rapidly growing literature on nationalism, for example, currency structures are rarely mentioned as significant. If we turn to academic literature on money and currencies, the significance of national currencies to national identities is sometimes acknowledged, but usually just in passing before attention is focused on economic issues.3 This neglect of the relationship between currency structures and national identities is difficult to explain, but it might reflect the influence of two famous sociologists of money, George Simmel and Karl Marx. Although coming from quite different ideological perspectives, both thinkers developed a similar and influential view of the impact of modern money on social identities. They each argued that the pervasive use of money in modern societies had the effect of transforming traditional social and personal ties into ones characterised by impersonal and instrumental economic calculations. Money’s ability to assign value in a standardised way to diverse items was seen to dissolve the concrete relationships of traditional societies and replace them with abstract and impersonal social relations. For this reason, Marx (1974:132) referred to money as a kind of ‘radical leveller’ that ‘does away with all distinctions’ associated with traditional social relations. Likewise, Simmel ([1900]1978:377, 373, 128, 440) talked of the ‘colourlessness’ of money, its ‘uncompromising objectivity’ and its indifference to ‘particular interests, origins, or relations’, features that derived from its ability to ‘become a denominator for all values’. As Viviana Zelizer (1994) has noted, this perspective on the relationship between money and social identities became and has remained a dominant one in the social sciences. For our purposes, what is interesting about this perspective is that it steers analytical attention away from the potential links between national currencies and national identities. If modern money undermines social context and tradition, how could it be linked to the sense of collectivity and common history which underlines national identities? Similarly, if modern money promoted rationality, how could it cultivate the kind of emotional attachments to the nation on which national identities rest? It is not surprising, then, to find that Marx and Simmel devote little attention to the ways that the construction of national currencies in the nineteenth century may have strengthened national identities.4 In the last few years, Marx and Simmel’s approach to the study of the link between modern money and social identities has begun to be strongly critiqued. Zelizer, in particular, has argued that these authors neglected the ways in which money has always been profoundly embedded in various localised cultural and social structures and thus invested with very diverse kinds of social meaning. She has demonstrated this point by highlighting the pervasive practice of earmarking modern currencies and the creation of special forms

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of localised currency in the US during the very nineteenth-century historical period that Marx and Simmel were analysing. Zelizer’s important point is relevant not just at the micro level of earmarked and localised forms of money but also at the macro level of national currencies. During the nineteenthcentury period, the project to create national currencies was closely connected to the project of nation-building. These new currencies were seen by many nationalists as something that could help to strengthen a new kind of national identity. Far from displaying ‘uncompromising objectivity’ or doing ‘away with all distinctions’, modern forms of money in the nineteenth century thus became invested with social meaning that was intricately connected to the intensely political project of constructing unique and distinct national identities. Whether this project was a successful one—that is, whether national currencies did in fact play an important role in fostering national identities— is not the subject of this chapter. My objective is rather to draw on the ideas of supporters of national currencies in the nineteenth century as a way of developing some analytical tools about how currencies might potentially influence political identities. Specifically, I want to highlight five different ways in which nineteenth-century analysts thought national currencies could foster national identities, and then explore how these may be relevant to understanding the possible significance of the introduction of the euro.

Imagery on money and the construction of political identities The first way that national currencies were seen by nineteenth-century thinkers to promote national identities is through the imagery emblazoned on them. Anyone who has travelled widely, or simply collected the money of different countries, cannot help but notice the nationalist imagery that covers each country’s coins and notes in the modern age. Strangely, however, these images and their influence have not attracted the attention of scholars of nationalism. Nationalist imagery on items such as flags, stamps and statues has been analysed, but that on money has been neglected.5 Even Eric Hobsbawm’s (1983) important essay on the mass production of nationalist tradition in the late nineteenth century ignores this topic, despite his brief acknowledgement that money is the ‘most universal form of public imagery’ (p. 281). The potential importance of imagery on money was not neglected by policymakers engaged in nation-building during the nineteenth century. In the second half of the century, in particular, most independent governments across the world began a systematic and organised campaign to place nationalist imagery on their money. Aided by advances in the technology of printing, they began to cover banknotes with detailed images of national landscapes and landmarks, personalities, key national historical events, and scenes of the everyday life of national citizens. Why was imagery on money seen to be so significant to the project of official nation-building? Some

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government policymakers involved in constructing this imagery were insightful in identifying its significance. Here, for example, is the explanation given by the chief clerk in the US Treasury who first advocated the use of the new kind of imagery on that country’s new national banknotes in 1863: [they] would tend to teach the masses the prominent periods in our country’s history. The laboring man who should receive every Saturday night, a copy of the ‘Surrender of Burgoyne’ for his weekly wages [a painting of this historical event was placed on one of the new notes], would soon inquire who General Burgoyne was, and to whom he surrendered. This curiosity would be aroused and he would learn the facts from a fellow laborer or from his employer. The same would be true of other National pictures, and in time many would be taught leading incidents in our country’s history, so that they would soon be familiar to those who would never read them in books, teaching them history and imbuing them with a National feeling.6 In this passage, the chief clerk identified two central points about the potential power of nationalist imagery on money in constructing a collective national identity. First, images on money were guaranteed a much larger audience than images carried by other media because of the pervasiveness of the use of money in the kind of market economy that was spreading across all leading states in the nineteenth century. Images on money were particularly effective in conveying messages to the poor and illiterate, with whom the state had difficulty communicating through other means such as newspapers or schooling. In contexts where the infrastructural reach of the state was weak, transport and communications were difficult and illiteracy was high, imagery on money often provided a state with one of the few means to convey symbolic messages to vast numbers of such citizens.7 Second, images on money may also have been particularly effective tools of propaganda because they were encountered so regularly in the context of daily routines. As Fernand Braudel (1985) puts it, money is one of the basic ‘structures of everyday life’. The US clerk noted that this gave particular force to the imagery, providing a frequent reminder to people that they were members of what nationalists considered to be a common, homogenous community. For this reason, national currencies may have acted as much more effective purveyors of nationalist messages than flags or anthems. Indeed, as Virginia Hewitt (1994:11) observes, coins and banknotes are ‘among the most mass-produced objects in the world, painstakingly designed for millions of people to use’. As she notes, they thus offer ‘an unparalleled opportunity for officially-sanctioned propaganda, to colour the recipient’s view’. The symbolic role that national currencies might play in cultivating a sense of national identity was thus clearly identified in the nineteenth century. How relevant might this analysis be in evaluating the significance of the euro? It would be difficult to argue that the imagery on the euro has been designed in

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a way that is meant to foster a strong sense of common European identity. Although the face of the coins has a common image of a map of the EU and the stars of the EU flag, each member state has been allowed to continue to decorate the obverse side with its own motifs, and the various states have chosen traditional nationalist images for these motifs. The banknotes are also quite timid in their invocation of a new European identity. On their front side we find images of windows and gateways, while the reverse of each denomination has a map of Europe and an image of a different bridge. The official EU website suggests that the former is meant to be ‘a metaphor for communication among the people of Europe and between Europe and the world’ and the latter are ‘symbols of the spirit of openness and cooperation in the EU’.8 But nowhere do we find images of a common history or culture of the kind that is found on most national banknotes.9 In the words of one journalist, ‘[t]he currency looks as if it has been designed for a Star Trek episode about some culturally denuded land on Mars—not for the home of Socrates, Charlemagne, Martin Luther, Notre Dame, the Uffizi, Bach, Beethoven and Mozart’ (Zakaria 1999). The quite limited use of imagery on the new euros to cultivate a common European identity undoubtedly reflects the limited extent to which political support exists for such a conception of identity within the EU. One European monetary official put it this way: ‘What is really European, without raising nationalistic objections?’ (quoted in Cohen 1998:37). There is much stronger support among Europeans for the EU as a political and economic body that offers certain political rights and economic benefits than there is for the EU as a community conceived as a unified organic people with a common cultural identity that replaces the nation (e.g. Waever 1995). Still, many enthusiasts have long hoped that the incremental steps in building the former kind of community may spill over into a growing sense of community in the latter sense. And in this respect, the potential symbolic role of the euro should not be entirely discounted. While the imagery on the new banknotes may not go very far in building up a common cultural identity, it does eliminate the presence of nationalist imagery. And although the euro coins retain nationalist motifs, the EU has made an effort to cultivate a more cosmopolitan outlook by allowing every coin to circulate across all member states. As the EU website puts it, this will create the possibility that ‘a French citizen will be able to buy a hot dog in Berlin using a euro coin carrying the imprint of the King of Spain’. It is difficult to say whether these shifts in the imagery on coins and notes will have quite the same impact as the US Treasury clerk suggested they would during the nineteenth century. Not only has the state’s capacity to communicate images and messages to citizens via alternative means been vastly enhanced in the twentieth century as literacy has spread and the state’s direct relationship with citizens has grown. But money itself is also less of a novelty in people’s everyday lives than it was in the nineteenth century and the imagery on it may thus be less likely to attract attention. Furthermore, an

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increasing number of the everyday transactions in the national currency do not involve a form of money with nationalist imagery on it. Electronic forms of money as well as debit and credit cards are increasingly supplanting government-issued cash as a means of payment in a wide range of daily transactions. Still, judging by the comments of opponents of the common currency project in Europe, these national symbols on money remain significant sources of identification for many people in the contemporary era. As one English observer put it: Messing about with the currency…is deeply unpopular because, at a gut level, people feel [it is] organic to our national identity—veins and arteries to our consciousness. The Queen’s head on our coins…says something reassuring to the average person.10 If these comments are reflective of a broader sentiment across Europe, then the euro may have some impact on political identities at this iconographic level.

Currencies as a medium of social communication The second way nineteenth-century thinkers hoped national currencies might foster national identities was by creating a common ‘economic language’ with which citizens of the nation could communicate. Many analysts of money in the nineteenth century likened it to language, in that both act as a basic medium of social communication (e.g. Shell 1982). Little wonder, then, that the creation of a national currency was seen alongside the creation of a standardised national language as a crucial task by nation-builders in that era. To understand the potential significance of national currencies as a unifying medium of communication, one must recall the complexities of the organisation of money before national currencies were created (Helleiner 2002). Before the nineteenth century, economic communication within each state was often impeded by the uneven nature of domestic coinage and the large diversity of paper notes in circulation, as well as by the wide use of foreign coins and counterfeits. The poor within most countries of the world also predominantly used low denomination tokens or copper and bronze coins, often privately issued, that were not easily convertible into the kinds of money used by the more wealthy. The creation of a homogenous national currency out of this chaotic monetary situation was a central part of nationbuilding in the nineteenth and early twentieth centuries and it resulted only from what Viviana Zelizer (1994:205) calls the ‘painstaking and deliberate activities of public authorities’. The various monetary reforms took place at quite different speeds in different countries, but the result was the same almost

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everywhere: the creation of a new territorially exclusive and homogenous medium for communication in the monetary realm within each nation. In what ways might this new communications medium have contributed to the construction of national identities? Karl Deutsch (1966) argued that national identities emerged only once a people could begin to communicate more effectively and over a wide range of subjects. In his list of channels of social communication that could bolster the ‘communicative efficiency’ (p. 98) within the nation, he briefly mentions the example of the role of a common currency (p. 50). Although he does not analyse this example, it may have been an important one. The emergence of national currencies certainly helped to encourage economic transactions within the nation by eliminating the enormous uncertainties and transaction costs associated with the old chaotic monetary order. The facilitation of national economic communication was often the explicit aim of the various monetary reforms mentioned above. An Italian Parliamentary Commission examining the need to unify the currency standard of the new country in 1862 noted how use of diverse local coins and units of account was preventing unity in ‘economic language’ (Royal Commission 1868:307). Monetary reforms aimed at bringing the poor more fully into the official monetary system were also often driven by nationalist thinking which sought to bring the poor into the national community as more equal citizens. Before the French revolution, the monetary authorities such as the Royal Mint in Britain had not in fact considered the production of low denomination coins for the poor to be an altogether proper activity for itself, and had even refused to put the monarch’s face on such money (Craig 1953:250; Whiting 1971:13–25). These various monetary reforms, in turn, may have encouraged a closer sense of identification with the nation among those who experienced their economic benefits. An American supporter of the creation of a single national banknote in 1861, for example, argued this point: Every citizen…who is supplied with such a currency—a currency which will be equal to gold through every foot of our territory, and everywhere of the same value, with which he can travel from Oregon to Florida and from Maine to New Mexico, would feel and realize, every time he handled or looked at such a bill bearing the national mark, that the union of these states is verily a personal benefit and blessing to all. (Potter 1879:5) Monetary reforms benefiting the poor may also have contributed to what Gabriel Ardant (1975:229) calls the financial ‘infrastructure of national feeling’, as they experienced the concrete benefits that the new monetary arrangements brought and the associated sense of membership in the national society. In France, for example, Eugen Weber (1976: xii, 32–4, 40) cites the growing use of a national currency among the rural poor of France as one

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part of a broader transformation which transformed ‘peasants into Frenchmen’ in the late nineteenth century. In his words, the new standardised national currency became ‘a universal language that all understood and all now wanted to speak’ (p. 40). As a medium of communication, national currencies might be linked to national identity, not just in the kind of functional ways described above— that is, through the economic associations and benefits they produced—but also at a deeper psychological level. Here again, the parallel to language is useful. To the French revolutionaries, a common national language was seen as important in a functional way of encouraging participation in the national political community; without the ability to speak and read in the same language, citizens would be unable to communicate with each other in national political discourse or learn their new political rights. To Herder, however, its importance was quite different: since language was central to the operation of the human mind, people who spoke the same language could be expected to think in a similar way (Szporluk 1988). The power of money as a medium of communication to transform identities at this deeper level also caught the attention of thinkers such as Karl Marx and George Simmel, as we have already seen, although they did not link their analysis to national identities. As noted in the first section of this chapter, both of these thinkers commented on how modern forms of money, as a new mechanism of communication, could assign value in a standardised way to diverse items, leading to a dissolution of the concrete relationships of traditional societies and their replacement by abstract and impersonal social relations. Neither author commented much on the significance of the national nature of modern currencies, but their analysis of money as a ‘radical leveller’ (Marx) because of its ability to ‘become a denominator for all values’ (Simmel) was highly suggestive. The analysis implied that, through its ability to reduce everything in the nation to a common ‘language’, a national currency enabled citizens not just to communicate economically but also to think in a similar way and to situate themselves in a common fashion within the national community. Moreover, by doing away ‘with all distinctions’, money ensured that this community was one that, to use Benedict Anderson’s (1983) phrase, was ‘imagined’ as level or based on a kind of horizontal comradeship. At the same time, we can recognise how this radical levelling function of national currencies stopped at the border, beyond which a different monetary ‘language’ would have to be learned and understood. In this way, the ‘levelling’ and ‘communistic’ characteristic of national currencies may have contributed not only to a sense of national affiliation but also to a feeling of distinction from others. These links between national currencies as a communication medium and national identities may be quite relevant in thinking about the significance of the euro. Some opponents of the euro, for example, have

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drawn the parallel between a common language and common money, critiquing the euro as ‘esperanto money’ (quoted in Engelmann et al. 1997:122). The European Commission (1995:48) also discusses how the euro is creating a new price language that alters the mental universe of monetary calculations that an individual makes every day: ‘People do not become instantly accustomed to a new money. In at least one respect, adjusting to it is somewhat like learning a language—it takes time and practice before it is possible to “think” in the new currency.’ Charles Goodhart (1995) has also noted that people will ‘think’ in this new supranational currency not just in the market-place but also with respect to official fiscal transfers and payments across Europe. Judging by the experience of existing national currency zones, he argues that this too will contribute to an erosion of the identification with the nation: Although it is possible to estimate the net benefits to Queensland, Indiana, or Manitoba from a change of the federal budgets of their respective countries, the existence of a single currency tends to shift the focus of debate toward the effect on the representative agent defined by type, for example, age, income, and job, and not by geographical locality. He predicts a similar result in Europe: Because the continuation of separate currencies encourages the calculation of benefits and costs in national terms, it exerts a centrifugal force, causing national politicians to fight for ‘our money’, the juste retour, and so forth. By contrast, calculations that concentrate on a similar treatment of similar types of agents, irrespective of location, exert a centripetal force. Adopting a single currency would be an important step in moving in this direction. (pp. 473–4)

Collective monetary experiences and communities of shared fate Nineteenth-century analysts suggested national currencies could contribute to national identities by creating a new sense of collectivity not just at the level of communication but also at the level of experience. By experiencing monetary phenomena together, it was expected that citizens using the same money might feel like members of a ‘shared community of fate’ which characterises national identity. During the revolutionary regime in France, for example, defenders of the assignats often referred to this new national paper note as the ‘cement’ of the new nation, binding individual interests to the new general interest (Crouzet 1993:134, 136; White 1933). Similarly, US Treasury Secretary Chase, who created the national unified banknote in 1863,

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hoped it would encourage ‘the stimulation of the patriotism of the people which would arise from their closer touch with national affairs’ as a result of their new direct interest in the management of the national currency (quoted in Davis 1910:106). We can think of how a national currency might contribute to a sense of common experience in several ways. An increase in the domestic supply of the national currency will be experienced by everyone in the nation in ways that have a direct impact on their lives. The nation as a whole will also adjust collectively to changes in the country’s external payments position when the same currency is used by every citizen in that nation. If, for example, the exports of one region within the country decline, the currency might depreciate and all citizens—albeit in different ways and to different degrees—will experience the adjustments unleashed by this monetary change. If the government seeks to maintain a fixed exchange rate in this situation, the entire population will also feel the effects of the adjustments (e.g. a bank rate rise or a reduction in the money supply) that are required to try to restore the external balance. This is not to suggest that these various collective experiences lead to similar outcomes for individuals or groups or regions. Of course, changes in the money supply, devaluations, and interest rate alterations will have very different effects on creditors and debtors, on exporters and importers, and so forth. My point is simply that, regardless of these differences, everyone within the nation experiences the changed monetary circumstances in a synchronous, collective manner. Obviously, collective monetary experiences need not necessarily encourage a sense of positive allegiance to the nation. In fact, they may often promote the exact opposite sentiment. How many citizens of Germany felt proud to be German during the collective hyperinflation they experienced in the early 1920s? The point here is simply that these collective monetary experiences may have forced citizens to recognise themselves as members of a common national community. In many instances, they no doubt deeply disapproved of the way their community chose to manage its money. But even in instances such as these, the existence of a national currency may have provided them with a strong incentive to participate in the national political arena to influence that choice. The German monetary experience of the early 1920s appears to have resulted in a remarkably strong and deeply felt political commitment among Germans as a whole to preserve a conservatively managed national currency, a commitment that played a very significant role in influencing West German monetary policy in the post-war period. How relevant is this analysis for understanding the identity-related implications of the introduction of the euro? It encourages us to think about how the loss of the potential for national monetary policy or national exchange rate adjustments may be important not just for economic reasons but also for political identities. When one region within a European country experienced a sudden decline in its exports to other EU countries before the euro’s introduction, the entire nation experienced this change and adjusted

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accordingly, with perhaps devaluation or a tightening of national monetary policy. After the introduction of the euro, however, this region is forced to find alternative adjustment mechanisms, perhaps a decrease in wages or migration. These new adjustment mechanisms are region-specific and do not directly involve other citizens of that country, just as similar adjustments within existing national currency zones are regionally specific. With this change may be lost the sense of being in the same national ‘monetary boat’ together, and of experiencing a shared monetary destiny at the national level. Might there also be a greater sense of identification with a broader European community as citizens across the eleven countries now experience monetary phenomena collectively? This point is hinted at in the new references in the journalistic press to these eleven countries as some kind of ‘euroland’ which are experiencing common interest rates and inflation rates. Supporters of the euro often seem uneasy with these references, again preferring not to call attention to the ways in which the Economic and Monetary Union (EMU) project might cultivate a sense of collective political identity. But these references do highlight a key point made by one economic journalist: ‘that even large countries, such as Germany and France, have ceased to exist as relevant macroeconomic units. To all intents and purposes, they have become regions’ (Munchau 1999).

Money and popular sovereignty In this examination of nineteenth-century analyses of the relationship between national identities and national currencies, one source we have not yet examined in detail is the writings of key nationalist theorists themselves. The first prominent nationalist theorist of the nineteenth century to write about currency structures was Johann Fichte. In his 1800 work The Closed Commercial State (which he considered one of his best works), Fichte advocated the creation of a state-issued inconvertible national currency that could be managed to serve the economic needs of the people. A similar idea was advanced in more detail by other economic nationalist theorists later in the nineteenth century. In North America, for example, Henry Carey and Isaac Buchanan also advocated an inconvertible national currency on the grounds that it would remove any external constraint on the creation of domestic money to promote the economic growth of the nation (Nugent 1968). In Buchanan’s (1880) words, a currency based on a universal form of money such as gold was ‘disloyal’, since it would serve only an ‘alien’ class ‘whose boast is that money capital owns no allegiance to country’. These ideas highlight a further way in which a national currency may contribute to a sense of national identity. A central aspect of the new kind of national identity that emerged out of the era of the American and French revolutions was a commitment to the idea of popular sovereignty. Many of those who believed in this new sense of political community and identity

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quickly came to see a national currency as an important tool which could help contribute to its realisation. In modern cases where a national currency has been managed closely in line with popular preferences, it has indeed often been associated closely with a national identity. Perhaps the best example, once again, involved the Federal Republic of Germany during the post-war period, where the association between the national currency and national identity was particularly pronounced. This association—sometimes called ‘deutschmark nationalism’ (Engelmann et al 1997)—can be explained in part by the fact that the deutschmark in this period was managed in a way that has closely reflected the ‘will of the people’. Emerging out of the experience of hyperinflation in the early 1920s, a strong national consensus concerning the need for conservative forms of monetary management has existed in West Germany throughout the postwar period. One source of the deutschmark’s close association with West German identity is thus that it is viewed as a tool that serves the nation and helps it to meet its aspirations.11 The West German example is also useful in clarifying that national currencies need not be managed in the inconvertible and activist manner that Fichte, Carey and Buchanan advocated to be associated with a sense of popular sovereignty. The significance of their work, then, was not the specific policy suggestions about how a national currency should be managed, but rather their recognition that a national currency could serve the goal of popular sovereignty that emerged from the French and American revolutions. If national currencies contribute to national identities by bolstering a sense of popular sovereignty, one might expect the introduction of the euro to challenge these identities in Europe. Interestingly, the euro does not seem to be perceived in this way in many European countries. As activist monetary management has become less popular in recent years, the link between national currencies and popular sovereignty has eroded. No longer is this abandonment of a national currency inevitably seen to undermine popular sovereignty, since ‘the people’ appear to have little desire to actively manage money anyway. In many EU countries, for example, much support for the euro has come from liberal circles who would like to see the management of money removed from national governments’ hands. Others have become persuaded that, even if they wished to do so, the active management of a national currency is no longer an option in an atmosphere of high international capital mobility (McNamara 1997). This point should not be overstated, however. In Britain, many nationalists—including strong supporters of economic liberalism—portray the euro as a challenge to British identity on the grounds that a national currency is central to a nation’s sense of sovereignty. In Germany, too, many politicians have insisted that support for the euro is conditional on the German people knowing that it will be managed in line with their national preference for ‘sound’ money. If this goal is not realised, they warn that Germans will

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see the euro as more of a challenge to their national identity and oppose it (Engelmann et al 1997). In addition to challenging national identities based on a sense of popular sovereignty in some instances, could the euro also strengthen a sense of European identity as citizens of all eleven countries feel a sense of collective control over the management of this new currency? This might seem a difficult case to make given that the management of the euro has been delegated to a body—the European Central Bank—which has been designed to be highly insulated from democratic politics. But if the kind of management it pursues is seen to reflect the ‘popular will’ of these citizens (as the Bundesbank did for West Germans in the post-war period), this may be a possibility. And if the euro is also seen to give Europeans a greater voice in global monetary affairs, it may also contribute to a heightened sense of collective identity.

Modern money as a national fiduciary standard If Fichte’s ideas were closely related to ‘Jacobin nationalism’ (Hayes 1931:265), a final argument linking national currencies to national identities can be found in the writings of a nationalist theorist from the romanticist movement in the early nineteenth century: Adam Muller. Muller was a conservative Prussian who acquired considerable influence as a critic of liberal economics in Metternich’s Austria as well as in Europe as a whole in the early nineteenth century. He believed that ‘[t]he state’s duty is to awaken national pride, the feeling of “oneness” with the national state in the economic sphere’ (Roll 1939:223). A national currency was seen as a key tool in this project because it could act ‘as an expression of the oneness of the people’ (Bell 1953:307). But this bond was not in terms of the issues of imagery, communication, the ‘community of fate’ or sovereignty that we have already examined. Rather, it was at a more emotional level. A clue to what he was driving at comes from the fact that, like Fichte, he was particularly keen that the national currency be inconvertible. His reasoning was not that this would bolster popular sovereignty, as Fichte had hoped. Rather, Muller predicted that this kind of national currency would strengthen the allegiance of citizens to the nation in a more profound psychological sense. Erich Roll (1939:224) explains that Muller thought that metallic forms of money were too ‘cosmopolitan’, a feature that ensured that they ‘destroyed the links which should tie each individual indissolubly to his own state’. An inconvertible form of paper currency, by contrast, was ‘patriotic’ (Roll 1939:224) because it ‘tied men closely into the state’ (Bell 1953:307). In Muller’s own words, a national currency that was inconvertible would act as an expression of the ‘inner spiritual unity’ of the nation (quoted in Pribam 1983:212). Although well outside of the mainstream economics of his day, Muller’s

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ideas raised an important point about the potential sociological implications of national currencies.12 His was, as Roll (1939:223) notes, a ‘mystical theory of money’ which emphasised the ways that non-metallic ‘token’ forms of money might bolster a kind of collective faith in the nation and the state that issued it. This was an interesting observation in an era when money increasingly took this token form. Before the nineteenth century, most official currency in circulation consisted of gold and silver coins whose metallic value was, at least in theory, close to their nominal value. During the nineteenth century, these ‘full weight’ coins were increasingly replaced by ‘fiduciary’ forms of currency—both token coins and banknotes—whose face value derived not from their metallic content but from a value assigned by the state. In light of Muller’s preference for inconvertible money, it is important to recall that this transformation took place not just in those countries whose national currencies were of this kind, but also those whose currencies were convertible into a metal such as gold. Monetary systems that were placed on the gold standard in the nineteenth century had very few full-weight gold coins in circulation. Rather, the bulk of the currency in use consisted of paper notes and token coins whose value derived from an assigned value they were given by the state in relation to gold. Whereas ‘commodity money’ was accepted on the basis of its intrinsic value, the new fiduciary forms of money had no intrinsic value, and both Giddens (1985) and Simmel have noted how ‘trust’ played an important part in their acceptance among the population. Giddens focuses on the importance of trust in the state that issued and managed the money, a trust that was essential since token forms of money had to be closely managed by these authorities to ensure that they maintained their reliable value. Equally necessary was trust in one’s fellow citizens. For something with no intrinsic worth to be accepted as having value, people must trust each other to accept that it has value. Particularly significant was inter-temporal trust, since token money received for work today could only be translated into real goods tomorrow if others continued to accept that form of money as valid. As Frankel (1977:32) notes, it was for this reason that Simmel compared token forms of money to ‘a bill of exchange drawn on society on which the name of the drawee has not been filled in’. And, although Simmel does not call much attention to this point, it is important for us to note that the ‘society’ on whom the ‘bill’ was drawn was the nation. Because of the dependence of the new ‘token’ national currencies on these forms of trust, it is easy to see how their use could encourage identification with the nation-state in the way that Muller suggested. Like it or not, people were forced to recognise that the value and use of their money was now dependent on the trustworthiness of the national state and of their fellow national citizens over time. This dependence, in turn, may have helped to contribute to a greater sense of belonging to, as well as faith in, the national community, in contrast to the ‘cosmopolitanism’ fostered by metallic forms of money. For this reason, it seems plausible to conclude that the ‘imagined’

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value of token money may have played a role in encouraging a recognition of one’s membership in this new ‘imagined’ community of the nation. This identification with the nation was likely particularly strong when the national currency was very reliable as a medium of exchange and stable in value over time. In these instances, the trust that one was forced to place in one’s state and fellow citizens would seem well deserved. Indeed, the users of the currency might come to see this money as an important symbol of the national community and their faith in it. Simmel, for example, suggested that stable money can become a powerful symbol of trust and social stability because of its certainty as a measure of value. Moreover, this symbolic value of national currencies might be further bolstered by the fact that trust in token money and trust in the nation in fact both seem to share a similar quasi-religious form of belief. Benedict Anderson (1983) has suggested that the sentiments surrounding nationalism are also really more akin to those of religious faith than those associated with a secular ideology. And the way in which token money is so widely used and accepted, despite its lack of intrinsic value, is a phenomenon often seen as based on a similarly deep level of mysterious faith. In the contemporary age, a good example of the way in which a stable national currency can become a symbol of faith in the nation comes from a case we have already examined: the nationalist attachment to the deutschmark in West Germany during the post-war period. This attachment appeared to stem not just from the sense of past collective experiences or popular sovereignty mentioned earlier. Also significant was the fact that this currency became a symbol of trust and social stability in a nation that experienced so much of the opposite in the interwar years. In the post-war years, when German nationalism had been so discredited, faith in the currency and the stability it represented came to be one of the few acceptable ways of expressing identification with the nation. How useful are these insights in analysing the significance of the euro? Since the euro has been designed to be managed in a very stable way, it seems possible that it will become an important source of identification for people, an identification that could spill over to a broader identification with the European community that manages and uses it. This may be particularly true for those Europeans whose national currencies had been managed in a more unstable fashion. Many citizens in the poorer EU countries, for example, seem quite happy to abandon their national currencies in favour of the euro because of this perceived benefit. Their unstable national currencies had ceased to be a source of national pride. In a country such as Germany, where the stability of the national currency had been a source of national identification, the situation may be more complex. Rather than welcoming the euro, there is considerable distrust among Germans about the stability and ‘credibility’ of the new currency. If this distrust proves to be deserved, it may spill over in a broader distrust of the European community. In this way, as Bernard Connelly (1995) has suggested, the euro

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could become a potent symbol of anti-European sentiment rather than proEuropean sentiment. Thus, although Muller was correct to argue that the token nature of modern currencies can cultivate a sense of identification with the political community that manages and uses them, it is important to remember that the opposite can also happen if the currencies prove to be untrustworthy.

Conclusion In this chapter, I have argued that the insights of various nineteenth-century analysts provide a useful starting point for analyses of the ways in which the euro may influence political identities in Europe. As noted in the introduction, the goal of this article has not been to prove that the five causal relationships highlighted between national currencies and national identities have in fact existed historically or that they exist today. Instead, the objective has been a more limited one of developing some analytical ways to begin to think about how the euro might influence political identities in Europe. At one level, this analysis suggests a number of ways in which the elimination of national currencies in Europe may weaken national identities. The new euro notes and coins will no longer be carriers to the same degree of the kind of nationalist imagery that national notes and coins have often been in the past. The national currency’s role as a distinct medium of social communication among members of the nation will be eliminated. The sense of collectivity that may derive from shared monetary experiences within a national currency zone will become a thing of the past, as will the availability of the national currency as a tool for realising popular sovereignty. Lost, too, will be the national currency’s potential role as a symbol of national faith. While each of these developments may be important, one of them could be more significant or relevant than others in any particular country, depending on the distinct history of each nation and the way in which money may have been linked to its national identity in the past. Just as nineteenth-century nation-builders hoped to cultivate nationalist sentiments by building a national currency, contemporary enthusiasts of European integration could also try to use the euro to strengthen a panEuropean political identity. Although the EMU project is driven partly by political forces committed to a more ‘Europeanised’ form of identity (Engelmann et al. 1997), it is striking that, in contrast to the nineteenthcentury era, EMU supporters seem very tentative in linking their monetary project to this goal. The imagery on the notes, as we have seen, does little to cultivate a sense of common European culture or history. EMU supporters also appear much more comfortable discussing the economic benefits of the euro than the ways in which it might promote a common European identity. Indeed, after acknowledging that the introduction of the euro may ‘feel almost like a change of identity’, the European Commission (1995:49)

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feels compelled to add that ‘[n]ational identity is not in peril, however’. A recognition of the limited support for such a concept of identity seems to be behind this caution. Despite this tentative approach, the euro may still help to foster a panEuropean identity in the long term in some of the ways I have mentioned: creating a new Europe-wide medium for social communication, producing new collective monetary experiences, acting as a tool for the expression of the popular sovereignty of Europeans, and acting as a symbol of faith in the European political community. In these ways, the euro may in fact be quite typical of many of the reforms pushed to promote European integration in the post-war period. Although the changes are portrayed primarily as an institutional reform designed to facilitate economic exchange or political cooperation in incremental ways, enthusiasts of European integration often hope that they will encourage spillover effects that foster a long-term goal of constructing a common European political community. Whether ‘one money’ will in fact contribute to the construction not just of ‘one market’ but also of ‘one people’ is, however, too difficult to predict.

Notes 1 Portions of this chapter appeared previously in an article I published as ‘National currencies and national identities’, American Behavioral Sciences 41(1998): 1409– 36. For their comments and research help, I am grateful to: David Andrews, Samuel Barkin, Laura Chrabolowsky, Osvaldo Croci, Patrick Crowley, Ron Diebert, Emily Gilbert, Derek Hall, Andrea Harrington, Peter Johnson, Samuel Knafo, David Leyton-Brown, Andrew Linklater, Margaret Moore, Julie Nelson, Randy Persaud, Mitchell Smith, Vince Sica, Christopher Tomlins and Amy Verdun. I also thank the Social Sciences and Humanities Research Council of Canada for helping to finance some of the research for this article. 2 Quotation from the British politician, David Heathcoat-Amory, in the Financial Times, 28 May 1994. 3 Two recent exceptions are Cohen (1998) and Gilbert and Helleiner (1999). 4 I suggest in later sections of this chapter, however, that their ideas may be useful in thinking through some elements of this relationship. 5 For brief exceptions in numismatic literature, see Doty (1989), Hewitt (1994), Swanson (1995). See also Gilbert and Helleiner (1999), McGinley (1993). 6 Letter from S.M.Clark to Secretary Chase, 28 March 1863, Record Group 318, Records of the Bureau of Engraving and Printing, Press Copies of Official and Miscellaneous Letters Sent, 1862–1912, Vol. 1 of 346. National Archives, Washington, DC. 7 For this reason, money was an especially important tool for conveying nationalist messages in places such as Latin America where all these phenomena were particularly present, as Doty (1989) points out. See also Swanson (1995) for the case of the US. Anderson (1991) also highlights the importance of printed images in an age of widespread illiteracy (although not on money). 8 http://europa.eu.int/euro/html/rubrique-defaut5.html?lang=5&rubrique=100 9 The EU website attempts to suggest that ‘[t]he designs are symbolic for Europe’s architectural heritage’ but it quickly goes on to say that ‘[t]hey do not represent any existing monuments’. It also notes that the graphic symbol for the Euro ‘was

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inspired by the Greek letter epsilon, in reference to the cradle of European civilisation and to the first letter of the word “Europe”’. 10 Hugh Dickinson in his column in the Financial Times, 9 July 1994. It is worth noting that the monarch’s image did not appear on any English banknotes until after 1945. Thus, this symbolic attachment is a relatively recent phenomenon. See Weatherford (1997). 11 This argument that the deutschmark is linked to a sense of popular sovereignty might strike some as odd since its day-to-day management is tightly insulated from any democratic influence in the independent Bundesbank. But as analysts of the Bundesbank make clear, its independent status has survived so long only because of its popular legitimacy. See, for example, Kennedy (1991). 12 In a general sense, my argument here is similar to that of Schumpeter (1954:99) who thought Muller and other romanticists made little contribution to economics but did contribute to development of ‘economic sociology’.

Bibliography Anderson, Benedict (1983) Imagined Communities, London: Verso. Anderson, Patricia (1991) The Printed Image and the Transformation of Popular Culture 1790–1860, Oxford: Clarendon Press. Ardant, Gabriel (1975) ‘Financial policy and economic infrastructure of modern states and nations’, in Charles Tilly (ed.) The Formation of National States in Western Europe, Princeton: Princeton University Press. Bell, John (1953) A History of Economic Thought, New York: Ronald Press. Braudel, Fernand (1985) The Structures of Everyday Life, translated by Sian Reynolds, London: Fontana. Buchanan, Isaac (1880) ‘Nothing could be more practically disloyal, unpatriotic, and unchristian than the hard money legislation of England’, mimeo, January. Manuscript Group 24, D14 v.108 070994, Canadian National Archives. Cohen, Benjamin (1998) The Geography of Money, Ithaca: Cornell University Press. Connelly, Bernard (1995) The Rotten Heart of Europe, London: Faber and Faber. Craig, John (1953) The Mint: A History of the London Mint from AD 287 to 1948, Cambridge: Cambridge University Press. Crouzet, François (1993) La Grande Inflation: la Monnaie en France de Louis XVI à Napoleon, Paris: Fayard. Davis, Andrew (1910) The Origin of the National Banking System, United States National Monetary Commission, 61st Congress, 2nd Session, Senate Document No. 582. Washington: US Government Printing Office. Deutsch, Karl (1966) Nationalism and Social Communication, 2nd edition, Boston: MIT Press. Doty, Richard (1989) ‘Nationhood through numismatics: Latin American proclamation pieces’, in Coinage of the Americas Conference Proceedings, New York: American Numismatic Society. Engelmann, Daniela, Knopf, Hans-Joachim, Roscher, Klaus and Risse, Thomas (1997) ‘Identity politics in the EU: the case of economic and monetary union’, in Petri Minkkinen and Heikki Patomäki (eds) The Politics of Economic and Monetary Union, Boston: Kluwer. European Commission (1995) Green Paper: On the Practical Arrangements for the Introduction of the Single Currency, Brussels: European Commission. Frankel, S.Herbert (1977) Money: Two Philosophies, Oxford: Basil Blackwell. Giddens, Anthony (1985) The Nation-State and Violence, Cambridge: Polity

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Gilbert, Emily and Helleiner, Eric (1999) Nation-States and Money: The Past, Present and Future of National Currencies, London: Routledge. Goodhart, Charles (1995) The political economy of monetary union’, in Peter Kenen (ed.) Understanding Interdependence, Princeton: Princeton University Press. Hayes, Carleton (1931) The Historical Evolution of Modern Nationalism, New York: Richard Smith. Helleiner, Eric (2002) The Life and Times of Territorial Currencies, Ithaca: Cornell University Press. Hewitt, V.H. (1994) Beauty and the Banknote, London: British Museum Press. Hobsbawn, Eric (1983) ‘Mass-producing traditions: Europe, 1870–1914’, in Eric Hobsbawn and Terence Ranger (eds) The Invention of Tradition, Cambridge: Cambridge University Press. Kennedy, Ellen (1991) The Bundesbank, London: Pinter. McGinley, Christina (1993) ‘Coining nationality: woman as spectacle on nineteenthcentury American currency’, American Transcendental Quarterly, 7(3): 247–69. McNamara, Kathleen (1997) The Currency of Ideas: Monetary Politics in the European Union, Ithaca: Cornell University Press. Marx, Karl (1974) Capital, Vol. 1, London: Lawrence and Wishart. Meier, Katja and Kirchler, Erich (1998) ‘Social representations of the euro in Austria’, Journal of Economic Psychology, 19:755–74. Munchau, Wolfgang (1999) ‘Welcome to the Euro-zone’ Financial Times, 4 January: 19. Nugent, Walter (1968) Money and American Society 1865–1880, New York: The Free Press. Potter, O.B. (1879) The National Currency and Its Origins, New York: J.J.Little. Pribam, Karl (1983) A History of Economic Reasoning, Baltimore: Johns Hopkins University Press. Roll, Erich (1939) A History of Economic Thought, London: Faber and Faber. Royal Commission on International Coinage (1868) Report, London: Eyre and Spottiswoode. Schumpeter, Joseph (1954) Economic Doctrine and Method, London: George Allen and Unwin. Shell, Marc (1982) Money, Language and Thought, Berkeley: University of California Press. Simmel, George ([1900] 1978) The Philosophy of Money, translated by Tom Bottomore and David Frisby, London: Routledge and Kegan Paul. Swanson, Guy (1995) ‘Agents of culture and nationalism: the Confederate Treasury and Confederate currency’, in Virginia Hewitt (ed.) The Bankers’ Art, London: British Museum Press. Szporluk, Roman (1988) Communism and Nationalism: Karl Marx versus Frederick List, New York: Oxford University Press. Waever, Ole (1995) ‘Identity, integration and security: solving the sovereignty puzzle in EU states’, Journal of International Affairs, 48:389–431. Weatherford, Jack (1997) The History of Money, Crown: New York. Weber, Eugen (1976) Peasants into Frenchman: The Modernization of Rural France 1870–1914, Stanford: Stanford University Press. White, Andrew (1933) Fiat Money Inflation in France, New York: Appleton-Century.

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Whiting, J. (1971) Trade Tokens: A Social and Economic History, Newton Abbott: David and Charles. Zakaria, Fareed (1999) ‘Money for Mars’, Newsweek, 11 January. Zelizer, Viviana (1994) The Social Meaning of Money, New York: Basic Books.

11 The euro and the transformation of international relations David Long

Introduction The transformation of the international system is a hot topic these days. From the popular press to academic theses, the chimes of globalisation, global change and international transformation can be heard. This chapter considers whether and in what ways European Economic and Monetary Union and the establishment of the euro have contributed to a transformation of international relations. Some academic proponents of transformation, such as David Held and Andrew Linklater, suggest that developments in the European Union constitute a laboratory for what we can expect in the face of significant global change. In this paper, I examine the relationship of the European Monetary Union to international transformation. In doing so, I use international relations theory to elucidate the meaning of transformation. Specifically, I use neorealist theory and the work of John Gerard Ruggie to operationalise what is otherwise a rather slippery concept. The chapter considers the way that the introduction of the euro has transformed or can be seen to be transforming the international system. My focus is not so much on changes within the EU as on the wider global context. That is, it is not about how EMU has transformed relations among EU member states but rather the ramifications of the euro for international relations more generally, beyond the borders of the EU. This study is significant for its focus on the impact that the EU has on the international scene. Many EU studies either ignore the outside world altogether or take the international environment as a given, as a terrain for the EU to act on, so to speak. Where external factors such as geopolitical change or globalisation are taken into consideration, they are considered wholly exogenous to the EU.1 By contrast, this chapter examines the influence that the EU has on its international environment rather than the other way around, an international environment that the EU impacts on, rather than simply acts in. The paper is organised as follows. I first trawl the international relations literature for a concept of international transformation, distinguishing it from and relating it to concepts such as change and integration. I then elaborate 203

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my own conceptualisation of transformation, incorporating insights from neorealism and Ruggie’s multilateralism. In the second half of the paper, I consider the international impact of the euro and the extent of international transformation, in theory and practice. The achievements and impacts to date have in many respects been modest, so far as the demanding standards of international transformation are concerned. But, ironically, it is in halfway measures and compromises associated with the reality of the euro, rather than the utopianism of bold EU-wide projects, that genuine international transformation seems to lie.

What is international transformation? To begin with we need to understand what international transformation is. Transformation can mean a number of different things in international relations but they all relate in some way to change. To be meaningful, transformation must at the very least entail significant or fundamental change. Zinnes (1980) argues that studies of international transformation are only significant insofar as they indicate whether and when we can expect the international system to remain as is and whether and when we should expect a change of actors or of actor behaviour. Unfortunately, change is a concept that the international relations discipline has had trouble grappling with, despite its ubiquity (Jones 1981). Mainstream international relations theories such as neorealism and neoliberalism axiomatically posit the sovereign state as the unit in an anarchical international system. This characterisation of the international system means that structure and units of analysis are fixed in advance, and as a result a good deal of international change is defined out of consideration for these theories (Walker 1993:120). As Ruggie (1998:137) has pointed out, the two ‘neos’ have a logic of reproduction but no logic of transformation. On the other hand, the counter-claim to the effect that change is everywhere and ever-present does not advance us very far either (Vincent 1983). As Wallerstein (1974:3) has observed, ‘Change is eternal. Nothing ever changes. Both clichés are “true”.’ For sure, it is important to recognise that change is a constant feature of international relations, but what is needed is an understanding of the variation in change over time and space, as well as what causes change and what types of change (Jones 1999). In contrast to change, transformation brings to mind dramatic, radical and/or structural change. Change may or may not be all around us; transformation by definition cannot be ever-present. The concept of transformation entails qualitative rather than simply quantitative change, and revolutionary rapid change rather than simply incremental adjustment. Furthermore, major transformative shifts from one arrangement or system to another are usually accompanied by crisis. Such crises occur not only in the perceptions of some of the actors in the system but in the system itself as

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the old is supplanted by the new (Genco 1980). In sum, international transformation will be some sort of major change in the character of the international system. This change must be observable, significant and permanent/durable. Regrettably, there has been to date little in the way of a satisfactory theory of international transformation (Ruggie 1998:174–5). Yet, while there are reasons to be critical of scholarship in international relations for this failure, there may also be sound reasons for it. The task of theory-building in the case of international transformation is made intrinsically difficult by the subject matter. By definition, transformation creates a historically new system. This new system can only be known and vocabulary for it articulated once it has been solidly founded. That is, transformation can only be comprehended and explained in hindsight. To be clear, the conceptual problem is not transformation or change so much as it is fundamental discontinuity.2 Frameworks and terminology to describe a contemporary transformation must perforce be inadequate. Indeed, the failure of our terminology satisfactorily to describe events, let alone theories to explain them, might be regarded as an indicator of social, political or international transformation. Theories and categories shift from the certainties of concepts and descriptions couched in ‘either/or’ terms, to the resignation or exasperation of ‘neither/ nor’ terms. For example, there was a time when it would have been reasonable to describe the European Community as either primarily a collection of nationstates or a regional organisation that superseded these—the debate between intergovernmentalism and supranationalism. Presently, most would agree that neither is the EU simply a collection of nation-states, nor have these states been superseded by a regional entity. Our terminology has become increasingly inadequate and needs to be reworked (Journal of Common Market Studies 1996). Taking the above caveat into account, one can at least begin, as a pretheoretical task, to sketch out the ways in which an international system might be transformed. The starting point of an analysis of what has radically changed is to know what has been. In the case of international relations literature, this commonly involves an assumption about the nature of the international system and that the territorial states are its primary actors. While there are reasons to be sceptical about the claims to absolute state supremacy and the nature of international order, the principles of the late Westphalian international system (state sovereignty, national self-determination, international anarchy, and so on) are a good place to start.3 There are a number of explorations of the concepts of change and transformation in the discipline of international relations. Indeed, among international relations scholars interested in the European Union, the notion of regional integration has explicitly and implicitly been concerned with change. On closer inspection, though, the literature on integration is of limited utility here. First of all, international integration is only one among many

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routes to (and forms of) transformation. By contrast, international transformation might occur in a number of other ways, as for instance happened in Europe, where great power war and international crisis changed the pattern of relationships, giving us the Cold War standoff from the late 1940s to the late 1980s. Furthermore, transformation encompasses a number of different processes of change and can result in a range of different end states. Transformation can mean disintegration, as was the case in the former Soviet Union. Finally, integration is usually considered in terms of incremental change that is determined by endogenous causes, whereas transformation is properly understood as a step-level process and/or stochastic process, most often generated by shocks or reaching a threshold of change resulting from long-term fundamental disequilibria (Zinnes 1980; Genco 1980). If integration studies cannot explain international transformation, other theoretical approaches in international relations are more useful. If we mean to begin with the Westphalian system, then Robert Gilpin’s War and Change in World Politics (1981: ch. 1) is a useful starting point for analysis. Gilpin develops a neorealist view of the international system, constituted by the rules of interaction, the structure of the system and the units in the system. He distinguishes between three types of international change: interaction change, systemic change and systems change, the last two of which might be considered types of transformation. Interaction change is a change in the ways or rules of interaction between states. If, for example, states consistently negotiated their differences peacefully, as is suggested by democratic peace theorists with regard to established democratic states (Russett 1993; Doyle 1986), instead of pursuing their national interests through the threat or use of force, this would be an interaction change. Such a change would not be transformative, nor in principle irreversible, according to Gilpin, nor would it reshape the structure of the international system nor change the character of the units that make up the system. By contrast, systemic change in international relations occurs when the ordering or organisation of an international system changes—that is, the structure of the system is altered. For example, with the end of the Second World War, the multipolar system dominated largely by the European great powers was transformed into a bipolar system dominated by the two superpowers, the United States and the Soviet Union. The collapse of the Eastern Bloc and then the Soviet Union itself in 1989–91 precipitated another systemic change in the Cold War bipolar system. Some have characterised the new system as unipolar, with the United States as the sole dominant actor. Others characterise it as an interregnum. Others have seen the consolidation of a polycentric or polyarchic system in which the main actors are the triad of the US, Japan and the member states of the EU. This last view, the enhanced importance of international economic issues in state power compared to traditional military dimensions of raison d’État, redefines the important actors in the system. However, as a rule, following Gilpin, systemic change means that the basic elements of the system, the units that make it up and the nature

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of their relations, remain the same. All that has been altered is the distribution of power in the international system. According to Gilpin, systems change means a change in the character of the units that make up the system and, by implication, the character of the whole system itself. A shift to polycentricity in the international system, as international economic relations and economic power grow in importance, may in fact indicate systems change rather than simply systemic change. James Rosenau (1990) has argued that recent changes are not simply modifications to the centuries-old Westphalian states system but rather mark a shift to a system where individuals and social groups have more influence globally. Proponents of globalisation claim that it entails inter alia the acceleration of communications and the collapse of geography as a significant factor in finance and certain sectors of production, implicating the effective power of the sovereign state. For globalisation to be a significant term above and beyond the transnationalism and interdependence that has marked much of the period since the beginning of the Industrial Revolution at least, a transformative potential has to be immanent (Jones 1999; Scholte 1997). There is much debate as to the significance of changes occurring under the rubric of globalisation. (For a sceptical view, see Hirst and Thompson 1999.) The more expansive claims suggest that globalisation amounts to systems change, whereas the more conservative views of internationalisation suggest that changes amount to what Gilpin would describe as systemic change at most, and more likely interactions change—that is, simply an increase in international transactions. Gilpin’s neorealist perspective leads him to dismiss any suggestion that international transformation is being wrought by technology or other social changes at the turn of the twentieth century. According to Gilpin, there has been only one systems change in the last millennium. The beginnings of the modern states system are usually for convenience identified with the Treaty of Westphalia in 1648. This is said to mark the transformation from a system based on religious authority to one based on the primacy of territorial political organisation. In this transformation, the Church and the Holy Roman Empire4 ceased to be key actors in the political organisation of Europe, to be replaced by a number of states competing for territory and power. While much of the globalisation literature is indeed ‘globaloney’, Gilpin’s neorealist conceptualisation of transformation is overly restrictive. Gilpin does admit that the various types of change he describes intermingle and, at least in the case of systems change, will of necessity be accompanied by changes that can be characterised as systemic and interactions change as well. However, to be an adequate description of what constitutes transformation Gilpin’s neorealist framework requires further elucidation, in particular because it has a structural bias. Interactions change is fundamentally ephemeral, according to neorealism. The wider, overarching international structure constrains and determines the range of state behaviour. For neorealists, structure determines actor behaviour; actor behaviour has only limited, if

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any, influence on structure.5 But this reification must, by definition, make systems change difficult to accomplish and impossible to explain. Gilpin explains such major change in terms of supposedly exogenous factors, such as technological change, while failing to account for endogenous factors such as social structure and social values that condition and affect technological development and change. In developing a more adequate concept of transformation in international relations, the work of John Gerard Ruggie is especially useful. Drawing on Durkheim, Ruggie (1998: ch. 5) introduces two systemic notions—the principle of differentiation and dynamic density—in order to remedy the deficiencies of neorealism. While Ruggie’s critique is applied specifically to Kenneth Waltz (Waltz 1979), the insights can readily be applied to Gilpin’s typology of change. According to Ruggie, the principle of differentiation is the rationale and manner in which units or actors are distinguished from one another. In Gilpin’s neorealist account, states are simply posited as the actors in the international system. Yet this is an unrealistic assumption: the emergence of states and their continued primacy in the international system is integrally tied up with ideas of what constitutes them and distinguishes them from one another. In the early Westphalian period, dynastic legitimacy was the rule of sovereign statehood. More recently, popular sovereignty and national selfdetermination have been a major influence. Such changes in political organisation are not unimportant. As is evident in the shift from dynastic to popular sovereignty, or from so-called ‘night-watchman’ states to twentiethcentury welfare states, when the systemic principle of differentiation changes, so does the international system.6 Dynamic density refers to the level of interaction between units/actors in a system. To begin with, we need to acknowledge that interaction is not, as assumed in neorealism, a unit level phenomenon but a systemic characteristic. Two systems with the same skeletal structure will differ if there are different levels of interaction: an international system where the units hardly interact at all is different from one where there is a consistently stable high level of interaction. We can expect states in the former international system to be mutually suspicious or wary, simply on the basis that they barely interact. By contrast, though a high level of interaction does not guarantee friendly relations, there is likely to be a degree of certainty in such a relationship, produced by continuous and ongoing interaction. In addition, friendly relations among states tend to correlate with high levels of interaction in international relations. As a result, there are a number of studies that suggest that relations among the advanced industrial states differ from their relations with other states, qualitatively as well as quantitatively. These two ideas suggest supplements to our discussion of international transformation. Dynamic density means that interactions matter in characterising an international system. Indeed, using Gilpin’s terminology, major interactions changes may reflect and/or generate systems change. Significant increases or decreases in interaction can change the nature of the actor (the

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character of the state), from a unity assumed in neorealism to a multifaceted organization. As a result, the boundaries between states become blurred, as some see occurring especially in the European Union (Linklater 1998; see also Marks et al. 1996). Changes in state organisation—that is, in the principle of differentiation—are also an important facet of change in international relations. The world of states legitimised by the ‘divine right of kings’ only bears a limited resemblance to the contemporary international system. To argue that there are significant commonalities is not incorrect, but to assert that all the important elements of the international system are captured by these commonalities is to omit significant features of international relations. In what follows, I adopt an expansive conception of international transformation. Combining Gilpin’s and Ruggie’s requirements for major change prompts us first of all to look for the three types of change: interactions change, systemic change and systems change. At the same time, we must recognise that major systems change results not simply from a dramatic change in the actors in the international system, as Gilpin asserts, but as a result of changes in what Ruggie has described as the principle of differentiation and dynamic density.7 In the absence of some such combination, we cannot say that the international system has been or is being transformed. Such thresholds of course have their limitations, but an expansive definition has the merit of limiting cavalier hyperbole while overcoming the excessively restrictive definition given to us by Gilpin. It certainly suggests that international transformation is rare, and this might seem to stack the odds against the euro as a part of international transformation. However, the introduction of Ruggie’s elements of international systems in fact widens the criteria for major change. Gilpin’s criteria for transformative systems change allow only a change of the units, while Ruggie’s conceptual discussion widens this to a discussion of change within and thus among the units. While Gilpin’s criteria are hard to meet until states cease to be prominent entities in the international system, Ruggie’s allow us to identify transformation with states as well as without them: to give an example, changes in the character of states from absolutist monarchies to some variant on the nightwatchman state to the welfare state to the latest turns towards neoliberalism. Such changes can be seen as part of processes of international transformation.8

The euro and international transformation Christiansen et al (1999:529) argue that [a] significant amount of evidence suggests that, as a process, European integration has a transformative impact on the European state system and its constituent units. European integration has changed over the years, and it is reasonable to assume that in the process agents’ identity and subsequently their interests and behaviour have equally changed.9

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The introduction of the euro marks a fundamental change in the international monetary system of Europe. The replacement of twelve currencies with one, and the mandate to include all EU member states ultimately, transforms the monetary map of Europe. While the European exchange rate mechanism was certainly accompanied by a period of stability in monetary relations in Europe in the 1980s, proponents of EMU argue that monetary union renders the 1992–3 ERM crisis a technical impossibility. Though many European currencies were de facto pegged to the Deutschmark in the EMS, in 1992–3 withdrawal from the ERM/EMS was permitted, a choice that was exercised by a number of EU states. With monetary union, and thus no separate national currencies, there is less for global finance to speculate against, it is argued. As a result, some have claimed that ‘monetary union has fundamentally changed the structure of international monetary relations’ (Henning and Padoan 2000:1). Even if we accept this argument, any changes in Europe can only be a part of the story of the euro’s impact on the international system. A series of questions arises about the relationship of EMU to international transformation. In particular, to what extent does the introduction of the euro indicate a fundamental change in the international system as a whole? And to the extent that there is global change, how is this patterned across the international system? That is, is the pattern of change influenced by geographic proximity to Europe or by, say, ideological orientation to the European mixed economies, or is there a more general trend that we can identify? I will not address the empirical aspects of answering these questions in this paper. Instead, I draw on the international relations literature discussed in the previous section to help us understand what the introduction of the euro might mean for the international system as a whole. When we assess whether the euro will generate a transformation of the international system, it is worthwhile remembering that international transformation cannot simply be comprehended in economic terms but is also a political, social and cultural phenomenon. In addition, we need to be mindful that any changes will have different impacts at different levels of the international system, from the local level of the state, to the European, to the international system as a whole. Consider, for example, German reunification in 1990.10 If we follow Gilpin’s approach, reunification was a systems change for Germany because where there had previously been two states, the FDR and the DDR, now there was one. In Europe, reunification was a systemic change, because reunified Germany for the first time in decades had a considerably larger population, GNP and so on, compared to the other large states in Europe, notably the UK and France. Finally, German reunification was an interactions change in the international system as a whole. Germany remains a major player internationally, but has begun to be more assertive in its foreign policy stance, as for example in the recognition of Croatian and Slovenian independence from Yugoslavia in 1991.

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The neorealist perspective, then, suggests that even a bona fide transformation of international relations within Europe may be little more than a shift in the tenor of relationships in the wider international system. On the other hand, adding Ruggie’s elements, if dynamic density and differentiation change, not only within Europe but beyond, then what looks like simple interactions change at the state or regional level to a neorealist may be mani-festations of a wider transformation. I next consider the implications of the different approaches to international transformation for our understanding of the impact of the euro internationally. Here, I compare a neorealist approach with the more expansive definition of transformation that I outlined in the previous section.

Neorealist minimalism Neorealism suggests that the international system will be relatively unaffected by EMU and the creation of the euro. After all, so this argument goes, international relations generally have not changed and the prerogatives and interests of the multitude of states remain the same. Neorealists are generally sceptical that states can co-operate on key issues of national interest (Mearsheimer 1994–5). Indeed, they have difficulty explaining why EU states would even consider an enterprise such as EMU at all, given its closeness to national sovereignty (Grieco 1995). According to neorealist theory, insofar as the EU does develop into a coherent actor in international affairs as it develops common policies among the member states, it would become a major player in the international system. Comparisons would then need to be made to the US or Japan or some other regional agglomeration in terms of population, GNP, share of world trade, and so on. The development and consolidation of EMU can be interpreted through a neorealist view of international transformation. Following Gilpin, a neorealist view suggests that the introduction of the euro will not transform the international monetary system but it might make for a new arrangement of the significant players and, arguably, new battle lines. Before the euro was introduced in 1999, some expected that the strength of the new currency would challenge the US dollar as an anchor currency, a reserve currency, and become the unit of account for a larger and larger proportion of international trade (Walter 1999). The emergence of the euro would also, it was argued, change the status of the Japanese yen, relegating it to second-class status behind the US dollar and the euro. This bipolar system (or tripolar if the yen is included) might be expected to be more volatile since the euro-zone is relatively more self-sufficient than the twelve separate currencies, and so the US dollar-euro rate will fluctuate more widely because of reduced interdependence (Henning and Padoan 2000: ch. 2). In short, according to the neorealist view a successfully completed EMU means at most a systemic change in international monetary relations. Insofar

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as the Euro-12 becomes a coherent monetary entity, it will behave much like any other monetary entity, just a very large one. In this view, the actors in the monetary system stay the same. Only the distribution and balance of power has shifted with the concentration of monetary power in one larger entity located in Frankfurt. Indeed, the euro probably means less than systemic change when we consider the international system as a whole rather than only international monetary relations. The European Union still does not have credible military capabilities to make itself a major force, and, in general, it remains less than a coherent political, diplomatic or military actor in the international system, despite increasing coherence in economic terms (Bull 1983). Claims that the euro is another step towards a Federal Union in Europe with more state-like powers are likely to be met with scepticism by neorealists. In conclusion, the creation of the euro is at most a systemic change in international relations, and probably a lot less. As such, according to neorealists, there is little case for arguing that this is a transformation at the global level. Intriguingly, even if the euro is a harbinger of substantial change within Europe not only in economic but political and other terms, these ambitious claims for the euro transforming international relations within the EU will hardly change the wider international system at all. Even if it indicates the beginning of a regional super-state, this is at most systemic change, as Gilpin would describe it: that is, from one arrangement of the states system to another. The emergence of the EU as a regional actor, a federation that can at least be compared to the US and, on the other hand, to China and Japan, does not undermine the state-centric principles of international relations, or the basic motivation for state behaviour. Indeed, arguably it reinforces them by creating large entities that are more self-sufficient, and thus less vulnerable to changes in the international system or accountable to others for internal changes. There are good reasons to take the neorealist-inspired reflections very seriously. The establishment of the euro arguably does nothing with regard to, for instance, the gross structural inequality in the international system: that is, between the developed and developing worlds. And there are good reasons to be cautious about grand claims to international transformation for what remains, after all, territorial money. However, the problem with this neorealist analysis is that the perceived failure of the euro to transform international relations is built into its assumptions about the international system. Even powerful states cannot transform the international system because the balance of power will inevitably reassert itself. The structural bias of neorealism means that neither the character of states nor their size relative to the rest of the system ultimately matters for neorealist theory. Both these factors are important in the transformative impact of the euro, as we see below when we consider the factors introduced by Ruggie. Empirically, neorealism seems to have done well, explaining the weakness of the euro relative to the US dollar since its establishment. However, the explanation is rather thin. The euro did not fall in value simply because of

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concerns about the future of EMU or disagreements between members of the Euro-11. Rather, the weak performance results from concerns about the policy being advanced by the European Central Bank and other complex factors relating to the performance of the US economy and the US dollar. It is important to understand that critiques of ECB policy assume that there could be a better policy (in contrast to neorealism, which suggests conflict and dissonance are inevitable). In short, these arguments involve assumptions about the character of EMU as a monetary entity. In sum, as a constant prophecy of doom, neorealist analysis tends to overexplain the weakness of the euro. On the other hand, neorealist analysis does serve as an antidote to the triumphalist discourse from certain quarters in Europe and at the same time is the theoretical foundation for the doomsday forecasts that have continued to flow from the US (Feldstein 1997; Bergsten 1999). Analytically weak, neorealism continues to be an important rhetoric in international relations.

The euro, the principle of differentiation and the EU as an international actor Neorealist analysis of the transformative potential of the euro has some interesting insights, but also clear limitations. What does adding the notions of differentiation and dynamic density to our concept of international transformation tell us? The principle of differentiation prompts us to consider the character of the actors in the international system. In this regard, contra neorealism, the creation of a large monetary entity covering a significant proportion of the world economy should be expected to alter the character of the international system. This is essentially because the larger the states, the bigger the international ramifications of changes therein. This is not simply in geopolitical terms, per neorealism, however. It is rather to note that the domestic context of powerful international actors is important for the rest of the world. For example, US regulations lead international standards in a number of areas, and in others the internationalisation of standards is a fight between the US, various configurations of European countries and Japan. All other actors in the international system need to pay attention to the domestic politics of the more powerful international actors in their decision-making. To take as an example an issue far removed from monetary relations, the different sides in the Arab-Israeli dispute know that it is important to exert influence such as they can within the American political system. The significance of the domestic politics and economics of the larger states such as the US or more powerful international actors such as the EU create a layering of governance in the international system. International relations across the globe are managed at various levels of government or in different agencies within the more powerful international

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actors. As a result the character of the larger polities, whether states like the US or more sui generis international actors like the EU, is important in the international system. This gives added significance to the internal workings of EMU. The design of monetary union, particularly the constitution and role of the European Central Bank, as well as the constrained involvement of governmental authorities has created a unique structure in international monetary relations. The external representation of the EMU is still in its nascent stages, but already there have been debates about the nature of representation. For instance, some have suggested on the financial side that the G7 should become the G3. The EU’s status in, for instance, the IMF and the Bank for International Settlements, has changed with the creation of the euro. In another context, a new troika has been proposed including the President of the ECB, the President of the Council of Finance Ministers (when it is one of the Euro-12) and a representative of the European Commission (Henning and Padoan 2000:33–51). As the member states’ finance ministers continue to have their own role, this has created a very complex set of relationships that is still in flux. The creation of an ‘in’ group, the Euro-12, and an ‘out’ group that has not joined EMU as yet, has in some senses contributed to a blurring of the inside and outside of the European monetary entity. In addition, monetary union and the international implications of the euro are nested in a wider EU context that is, by any account, unusual, and arguably unique. The face that the EU shows the world is a product of its bureaucratic culture and elitist origins, as well the original focus of the EEC on economic issues. The Commission has long had a role in the external representation of the EU in areas where it has competence within the Union. This has existed alongside national foreign policy and foreign economic policy-making. In addition, the Pillar system innovated in the Maastricht Treaty ratifies not only a division of economic from political and security issues, but also the different methods for decision-making in a way unprecedented in other polities. The institutionalised disarticulation of EU foreign policy decision-making results in segmented, one might almost say functional (or dysfunctional) decision-making (White 1999). There has been considerable controversy over how to characterise the EU as an international actor. Because of its size and influence internationally, these different characterisations have different implications for our understanding of international transformation. In between the extremes of views of the EU as a nascent regional super-state or of its continued incoherence as an international actor (both of which fit comfortably within the neorealist view of international relations) lie a number of other interesting pictures of the EU. These include civilian power conceptions, the EU as a regulatory state, the EU as a multilevelled polity, as well as ideas that see the EU as an institutionalised intergovernmental arena (Journal of Common Market Studies 1996). In the context of these views, monetary union heralds a new type of

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international monetary actor, one that is not readily comprehended in the state/not-state dichotomy. While the EU (or, in the case of monetary union, the Euro-12) has appeared on the international scene as a special player internationally, the member states continue to exist as international actors. Yet the emergence of the euro hardly leaves the Euro-12 untouched. Giving up control of national money has more than mere policy implications. National money has traditionally been tied up with national sovereignty. Yet the European states that have created the euro categorically continue to be sovereign. These states no longer conduct their own independent monetary policy, and monetary authority has been disarticulated from sovereignty. In sum, the national basis of differentiation in the international monetary system is challenged by the euro, which is clearly neither national money nor a straightforward supranational regional EU monetary entity either.

The euro, dynamic density and extended multilateralism The transformative implications of the introduction of the euro are seen in a different light when monetary union is considered as part of the extended multilateralism within and around the European Union. Dynamic density has arguably already transformed the politics of the European Union. The dense patterns of interdependence and institutional links among the member states of the Union have fundamentally changed their international relations. But the intense multilateralism among states on a vast range of topics does not stop at the borders of the EU. It is extended in a variety of formal and informal relationships that the EU conducts with future members, its neighbours, its key interlocutors, and other states and regional organisations around the world. Understanding the euro and international transformation is impossible without a wider understanding of extended multilateralism, the dense network of interactions of which the European Union is a major part, if not a hub. In this chapter, I can only hint at a few instances of these relationships.11 Most important of all is the enlargement process that is contributing to a reorientation of the international relations of the thirteen candidate countries. In Central and Eastern Europe, states are not only shifting specifically from their amity-emnity relationship with Russia, but are also shifting more generally from balance of power conceptions towards notions of security community in their foreign policy conceptions (Adler 1998). The central point here is not so much the particular institutional setting of the relationship of the EU and its European partners, but rather the special relationship that is being built between the EU and prospective members. The dynamic density that so marks the EU does not engulf the new members overnight, but is developed as part of an accession process (Long 1997; Friis and Murphy 1999).

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The euro-zone has its own enlargement dynamics, an especially unusual aspect of EMU as a monetary authority. The initial Euro-11 accepted Greece as the twelfth at the Fiera European Council summit. It is understood that the door is always open to the other EU members, the UK, Sweden and Denmark, to join the EMU whenever they are ready. The EU enlargement process means that twelve states are in line to join, as well as possibly Turkey, with the expectation that ultimately each of the new entrants should themselves join monetary union. As a result, there is a built-in enlargement dimension to EMU. It is entirely novel for a monetary system to grow in this way. As the enlargement process unfolds, it is challenging the borders inside and outside the Union because, while there is a clear border demarcating members of EMU today, this border need not be the same in a few years’ time. In the meantime preparations are under way to get potential new EMU members ready for the rigours of membership. Institutionally, the creation of the euro adds another layer to the multifarious official relations between the EU and its member states on the one hand, and a range of overlapping and complementary organisations in the North Atlantic area. With different memberships and mandates, the OSCE and NATO, OECD, the Council of Europe, as well as the bilateral transatlantic dialogues of the EU with the US and Canada, all shape the international system of the developed world. There are more meetings and groups dealing with a multitude of sectoral issues among the states of the North Atlantic area than can easily be counted. For neorealists like Gilpin, these sustained multilateral and nested bilateral relationships and the euro’s contribution to them indicate merely an interaction change in the international system. Arguably, the growth of formal EU contacts with the rest of the world and the appearance of the EU in other multilateral fora has introduced no more than an increase in a bureaucratic and officious tendency in international relations. But this too easily dismisses the impact of this density of interaction, the degree of institutionalisation, and the extended multilateralism that includes non-EU and non-Euro-12 members. Overlapping relationships and multiple connections are creating and solidifying a social network, the character of which is in the process of transcending the traditional interaction of sovereign states in international relations. Certainly it is too much to suggest that the euro has determined the shape of this nascent social network within or beyond Europe. Nevertheless, the euro is part and parcel of an internationalising and globalising of a range of previously domestic issues and sectors. This may not be overnight transformation and the transcendence of sovereign states, but it may be slow-motion transformation that radically alters not only our understanding of monetary authorities but also the character of political communities.

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Concluding remarks The discussion of the euro in terms of the literature on transformation in international relations may strike some readers as merely hypothetical. After all, in the ‘real world’ the full impact of the euro has yet to be felt, and with its less than stellar performance in the foreign exchange markets the implications for international economic relations are not yet clear. Furthermore, the public impact of the euro will only be evident with the distribution of euro notes and coins. Cash may be a small proportion of the money in a developed economy, but it is nevertheless the medium that most people are most aware of, and thus the political story of the euro has, at the time of writing, hardly begun. But if we need to pause for the passage of time in order to assess the impact of the euro correctly, we also need to be clear about what constitutes significant change in international relations. We have seen that different definitions of transformation critically influence the assessment of whether the euro can be said to be transforming or (more likely) to be part of a transformation of international relations. For neorealists, even the grandest change resulting from the euro is likely to be dismissed as at most a systemic change. Even granting that the EU is an unusual international actor, and that EMU is a fundamental shift in the monetary relations of Europe, it is difficult to argue that it has had a transformative impact on international relations as a whole. This seems to confirm the neorealist conclusions of Gilpin’s analysis of change, that the global implications of the euro are modest. We have seen, however, that neorealism’s conclusions regarding transformation are built into its assumptions, in particular that international structure is the sole determinant of state action. Furthermore, the positivistic bias in neorealism assesses the impact of the euro as a single cause, isolated from other factors. When we widen the scope of the definition of transformation to include significant changes in what Ruggie calls the principle of differentiation and of dynamic density, as well as appreciating that the euro may reflect transformation as well as cause it, we are given reason to doubt neorealism’s conclusions. There are a number of factors that suggest that the limited changes noted by neorealism are far from the totality of change in progress. First of all, the principles on which the ECB is founded reflect perhaps the pinnacle of neoliberal attitudes to the management of monetary issues. This is exemplified in an arrangement that arguably puts monetary policy further away from democratic control than any other developed economy. Not only is the ECB formally independent but, in practice, it is accountable finally to the unelected Council of Finance Ministers. (For the European Parliament’s marginalised role, see European Parliament 1998.) Second, EMU may represent international transformation as it demonstrates how the conception of monetary authority is changing. As a general rule, for the last century or so the rule was that nation-states were

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expected to have their own currencies, even if they were pegged to gold, the US dollar or some other anchor currency. In this context the creation of the euro, a transnational money, is exceptional, although a longer-term view might suggest that national currencies are the anomaly (Cohen 1998). Whether the euro is a harbinger of greater change is unclear. After all, the money may be transnational inasmuch as it will be used across the Euro-12 area. However, it remains a territorial money: it is a money for a territorial aggregate of European countries. As Held et al. (1999:443) note, ‘EMU can be seen…as reflecting a view that national autonomy in monetary policy has been so compromised that the only means of recovering it is at a European—regional— level’. Thus, the euro may be as much a reaction or resistance to—rather than an indicator of—the deterritorialisation of finance that is a feature of contemporary globalisation. EMU has without a doubt provoked debate in a number of countries in the Americas about a North American monetary union or the benefits and costs of dollarisation, although it must be said that this discussion is not going very far in Washington. This suggests the possibility that the euro is the beginning not of a wholesale deterritorialisation of money but of a regionalisation. At the very least, we are in an era when the national control of money is being questioned. Third, the awkward compromises that made EMU possible ironically have the potential to constitute dramatic change in international relations. The politically intractable problem with transferring authority on such a ‘hot button’ issue as money from the national to supranational level has generated a series of halfway house compromises on governance that create in EMU a unique domestic/international mix. The complex internal governance structures and external relationships are de facto producing a world of multilevel governance. Even the idea that a non-state should have its own monetary policy, or foreign policy, even if only imagined, challenges the fundamental bases of the late Westphalian international system, dominated as it is by nation-states. This infranational transformation—that is, within and across nation-states— though incomplete and only occasionally visible, should not be ignored. But at present, the existence of the ECB and of the euro contributes to a blurring of foreign and domestic in monetary policy and increases the difficulties of categorising monetary authorities, as the old categories seem to lose their salience and new formations break the rules of the old. (For a discussion of changing categorisation in a very different context, see Wallerstein 1974:235–49.) For some, like Andrew Linklater, David Held and John Ruggie, the changes in Europe indicate that our old conceptions of political community need to be questioned. But the hints from these authors that the European Union is somehow in the vanguard of the current international transformation need to be subjected to careful scrutiny, lest we overstate the case, certainly when the case is the euro.12 Linklater (1996:77–8) is far too optimistic when he argues that ‘[t]he conjunction of forces which are transforming contemporary Europe reveals that the time is

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ripe to engineer a new revolution in political thought or, more accurately, to complete the Copernican Revolution in political thinking initiated by Kant’. The current mix of international procedures and structures in Europe might be transformed still further or, by contrast, might be rolled back after all. In an investigation of international transformation it is important to start from the beginning, and that means knowing that states have been central to the international monetary system. At the same time, it is important to recognise that an exclusive concentration on nation-states is problematic because it reduces the meaning of transformation to the abolition of state sovereignty. We must, with this neorealist focus, end up looking for the roles that national governments play (or are no longer playing), with a consequent neglect of processes that do not fit nation-state categories or the new roles that states play. Between the high-minded aspirations of the proponents of political change on the one hand and the neorealist counsel of despair on the other, there is an alternative to understanding the change that the euro is bringing internationally. We have seen, following Ruggie, that the character of states and other international actors, as well as the extent and nature of their interactions, are important systemic variables. What are needed are methods to apprehend and reliably document these changes. In the EU context, alternative approaches far from neorealism are required, such as a focus on the everyday politics of the European Union or a consideration of the bureaucratic politics of the EU institutions—for instance, the many Council Working Groups (Wincott 1995; Beyers and Dierickx 1998). An alternative would be social historical or social psychological analysis of the EU citizens’ experience and understanding of ‘the international’ as indicators of how national attitudes are changing with regard to the euro. In conclusion, the dramatic transformation of the end of nation-states as the main actors in the international system has not been brought about by a sovereignty-challenging euro. Thus far, the neorealists are correct to be sceptical about the transformative potential of the euro. But a wider transformation of the international system as a result of changing technology of money and the transnational organisation of money and monetary authorities appears to be under way. And the very ambiguity of the development of the euro as a transnational and territorial currency suggests that major change is afoot in the late Westphalian system. It may be difficult to describe and categorise, but this may be one more indicator of the extent of the changes as our conceptual categories are bent by novel international practices.

Notes 1 Rosamund (1999) is a notable exception. 2 This contrasts with positive theories that explain change in terms of a transition from one state to another that is already predetermined. For a discussion of positive theories as transition theories, see Wendt (1998:105).

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3 For a very useful discussion of change in the international system, see Mark Zacher (1992). Note that Zacher sets up a stylistic realist account of international relations as the history of the international system. 4 Though the Holy Roman Empire only ceased to exist with Napoleon’s conquests in the nineteenth century, and the Catholic Church continues to have a territorial political role encapsulated in the Vatican’s status in the United Nations. 5 For a critique of this view, see Alexander Wendt (1999). 6 As Christian Reus-Schmidt (1999:164) argues, If constitutional structures define and shape the nature of the international systems of rule…then changes in the metavalues that comprise those structures must be the primary determinants of systems change…Purposive change involves a redefinition of the moral purpose of the state, leading to shifts in the meaning of sovereignty and procedural justice. The transition from the absolutist to the modern systems was just such a systems change. 7 While I note simultaneous occurrence above, it is important to realise that the timescale for transformation can be decades rather than days, weeks or months. 8 For a discussion, see Robert W.Cox, ‘Social forces, states and world orders’, Millennium, 10(2): 1981. 9 I cannot broach this topic here as it is beyond the scope of the chapter. However, it is clear that any account of the transformation being wrought by and on the European Union would include a discussion of the supranational institutions such as the Commission, of the dense intergovernmentalism that is sometimes called Brusselsisation, and of the limited but nevertheless real development of multilevel governance in the EU 10 Gilpin uses German unification in 1870 as his example. 11 For further discussion of the international relations of the European Union, see Piening (1997) and Redmond and Rosenthal (1998). 12 See for example, Held et al (1999:446).

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Christiansen, T, Jorgensen, K.E. and Wiener, A. (1999) ‘The social construction of Europe’, Journal of European Public Policy, 6(4). Cohen, B.J. (1998) The Geography of Money, Ithaca: Cornell University Press. Deutsch, K., Hoffmann, R., Kern, S. and Speyer, B. (1998) Europe’s New Currency: Special Report, Deutsche Bank. Doyle M. (1986) ‘Liberalism and world polities’, American Political Science Review, 80(4). Durfee, M. and Rosenau, J.N. (1995) Thinking Theory Thoroughly: Coherent Approaches to an Incoherent World , Boulder: Westview. European Parliament (1998) The Single Currency and the European Parliament, Strasbourg: European Parliament. Feldstein, M. (1997) ‘EMU and international conflict’, Foreign Affairs, 76(6). Friis, L. and Murphy, A. (1999) ‘The European Union and Central and Eastern Europe: governance and boundaries’, Journal of Common Market Studies, 37(2). Genco, S. (1980) ‘Integration theory and system change in Western Europe: the neglected role of systems transformation episodes’, in Ole R.Holsti, Randolph M.Siverson and Alexander L.George (eds) Change in the International System, Boulder: Westview. Gill, S. (1992) ‘The emerging world order and European change: the political economy of European Union’, in Ralph Miliband and Leo Panitch (eds) New World Order? Socialist Register 1992, Rendlesham: Merlin Press. Gilpin, R. (1981) War and Change in World Politics, Cambridge: Cambridge University Press. Grieco, J. (1995) ‘The Maastricht Treaty, economic and monetary union and the neorealist research paradigm’, Review of International Studies, 21(1). Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations: Politics, Economics and Culture, Stanford: Stanford University Press. Henning, C. and Padoan, P.C. (2000) Transatlantic Perspectives on the Euro, Washington, DC: Brookings Institution Press. Hirst, P. and Thompson, G. (1999) Globalization in Question: The International Economy and the Possibilities of Governance, 2nd edition, Cambridge: Polity Press. Jones, R.J.B. (1981) Change and the Study of International Relations, London: Pinter. ——(1999) ‘Globalization and change in the global political economy’, International Affairs, 75(2). Journal of Common Market Studies (1996) Special Issue on the European Union and a Changing European Order, edited by Michael Smith. Linklater, A. (1996) ‘Citizenship and sovereignty in the post-Westphalian state’, European Journal of International Relations, 2(1). ——(1998) The Transformation of Political Community, Cambridge: Polity Press. Long, D. (1997) The Why and How of EU Enlargement, UBC Institute of International Relations Working Paper 16, Vancouver: UBC. Marks, G, Hooghe, L. and Blank, K. (1996) ‘European integration from the 1980s: state centric v. multilevel governance’, Journal of Common Market Studies, 34(3). Mearsheimer, J. (1994–5) ‘The false promise of international institutions’, International Security, 19(3). Piening, C. (1997) Global Europe: The European Union in World Affairs, Boulder: Lynne Rienner. Polanyi, K. (1944) The Great Transformation, Toronto: Rinehart. Redmond J. and Rosenthal, G.G (eds) (1998) The Expanding European Union: Past, Present, Future, Boulder: Lynne Rienner.

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Reus-Schmidt, C. (1999) The Moral Purpose of the State: Culture, Social Identity, and Institutional Rationality in International Relations, Princeton: Princeton University Press. Rosamund, B. (1999) ‘Discourses of globalization and the social construction of Europe’, Journal of European Public Policy, 6(4). Rosenau, J. (1990) Turbulence in World Politics; A Theory of Change and Continuity, Princeton: Princeton University Press. Ruggie, J. (1998) Constructing the World Polity: Essays on International Institutionalization, London: Routledge. Russett, B. (1993) Grasping the Democratic Peace, Princeton: Princeton University Press. Scholte, J. (1997) ‘Global capitalism and the state’, International Affairs, 73(3). Vincent, R.J. (1983) ‘Change and international relations’, Review of International Studies, 9(1). Walker, R.B.J. (1993) Inside/Outside: International Relations as Political Theory, Cambridge: Cambridge University Press. Wallerstein, I. (1974) The Modern World System, Volume 1, London: Academic Press. Walter, N. (1999) ‘Will the Euro challenge the dollar? The view from Frankfurt’, Central Banking, 10(4). Waltz, K. (1979) Theory of International Politics, Reading, MA: Addison-Wesley. Wendt, A. (1998) ‘On constitution and causation in international relations’, Review of International Studies, 24, Special Issue. ——(1999) The Social Theory of International Politics, Cambridge: Cambridge University Press. White, B. (1999) ‘The European challenge to foreign policy analysis’, European Journal of International Relations, 5(1). Wincott, D. (1995) ‘Institutional interaction and European integration: towards an everyday critique of liberal intergovernmentalism’, Journal of Common Market Studies, 33(4). Zacher, M. (1992) ‘The decaying pillars of the Westphalian temple: implications for order and governance’, in James N.Rosenau and Ernst-Otto Czempiel (eds) Governance Without Government, Cambridge: Cambridge University Press. Zinnes, D. (1980) ‘Prerequisites for the study of system transformation’, in Ole R.Holsti, Randolph M.Siverson and Alexander L.George (eds) Change in the International System, Boulder: Westview.

Index

Acheson, Dean 11 advocacy coalition 86, 89–90 Anderson, Benedict 190, 197 Argentina 161, 168 Association of Southeast Asian Nations (ASEAN) 163, 168 asymmetric shocks 119–20, 122 Austria 25, 29, 50, 101, 169; and German Monetary Union 36; liberal economics 195 War of the Austrian Succession 58; and Zollverein 32–3 bailout 152–4 balance of payments 109–10, 112 Balassa, R. 157; stages of integration 157–60, 162, 169, 173–4, 176 bankruptcy: code for the EU 6, 152–4; negotiations 154 Belgium 11, 15, 26, 101; and customs union 12, 18; and Luxembourg 28, 30, 104; and Treaty of Rome 21 Benelux 12, 18–19, 21, 36 76; currencies of 111, 169; Memo 18– 19 Brazil 168 Bretton Woods 2, 62, 72, 75, 102 Britain: see United Kingdom Buchanan, Isaac 193–4 Bundesverband Deutscher Banken (BDB) 136–7 Bundesverband Oeffentlicher Banken (VoeB) 136–8, 141 business cycle 2, 107–8, 114, 119, 122 Canada 2, 3, 17, 110, 146, Bank of 1; fiscal union 163; monetary union 6, 103–5, 109; optimal currency area 110, 119; political union 161, 166; secession 147, 155; and the US 113, 119, 120, 216

Canada-US Free Trade Area (CUFTA) 166–7 capital mobility 78, 114, 119, 121, 133, 171, 194 Carey, Henry 193–4 Central and Eastern European Countries (CEEC) 161, 167, 169, 173 Charlemagne 11, 31, 42, 187 Charles VII 43 Cold War 13, 16, 73, 206 Colbert, Jean-Baptiste 49–51, 60–2 Commission see European Commission Common Agricultural Policy (CAP) 21, 72 Committee of Central Bank Governors 80 common market 15, 19–21, 159–62, 164–65, 168–172, 174 Communauté Finanacière Africaine (CFA) 30–1, 36, 169 Conférence Monétaire de Paris 34 constructivism 87, 89–90 convergence: criteria of 2, 74, 77, 113, 116, 124, 127; economic 121–2, 126, 165; endogenous forces 143; fiscal and budgetary policies 74; inflation rates 101; institutional 133–4, 140–2; lack of 75; of macroeconomic policies and outcomes 133, 140 Council of Europe 13–14, 216 Council of Finance Ministers 214, 217 currency union 42, 116, 120 customs union 12, 18, 20, 32, 34, 36– 7, 72, 115, 158–61, 164, 168–9 d’Arnouville, Machault 58 Delors Committee 3, 72–3, 80, 82 Delors, Jacques 44 Denmark 34–37, 101, 216

223

224

Index

Desmaretz, Nicolas 53 disparities 108–10 Dodun, Gaspard 57 d’Orléans, Philippe 55 differentiation 208–9, 211, 213, 215, 217 Dresden Coinage Convention 32, 36 Dulles, John Foster 11, 14, 17–18 dynamic density 208–9, 211, 213, 215, 217 economic and monetary union (EMU) 1–7, 26–30, 101, 147, 155, 176, 203; agglomeration effects 122 and automatic mechanisms 109; convergence 126, 134, 141–3; economic benefits of 198; and ERM 210; and EU 111–12, 121, 157, 160–2, 122, 169, 213, 216–18; and homogeneity 166–7; international implications of 113–27; and international transformation 210, 217; neorealist minimalism 211; and politics 133–5, 193, 198; relation of 165; in relation to other monetary unions 36–8; secession from 148– 50; seigniorage 116–17; and Stability and Growth Pact 127, 162; stages of integration 173–5, 123–5; theoretical explanations of 71–85, 91 economic integration: 12, and Germany 135; history and theory of 15–9; homogeneity 166–7; lack of success in 168; stages of 6, 157, 159–62, 165, 170, 174, 176; and pathdependency 165–6 and political integration 15, 18, 20, and convergence 133–4, 140; Economics and Finance Ministers (ECOFIN) 137, 163 economic union 30–1, 34, 36, 159–61, 164–5, 174 Eichengreen, Barry 3, 74, 76, 118, 119, 165 Eisenhower, Dwight D. 11, 16, 20 EURATOM 20–1 euro 1–7; argument against 99–112, 190–1, 194–5; argument in favour of 99–100, 193; arrival of 26, 30, 74, 113–14, 124–6, 134; and balance of payments 109–12; and banking sector 138–9; and business cycles 107–8; dynamic density 216– 7, exchange rates 26, 114; ECB 27–

8, and EMU 28, 36, 112; and European identity 198–9; and inflation 105–7; compared to livre/ franc 42, 61–2; multilateralism 215– 6; and national identity 183, 185, 187, 190, 192, 194–5, 197–8; and neorealist minimalism 211–13, 217; and political identity 183–4, 188, 193, 198; and regional disparities 108–9; and secession 148; and the transformation of international relations 203–19; and unemployment 106–7 eurocrat 101–5, 108, 109 euromyth 101–9 European Banking Federation (EBF) 139 European Central Bank (ECB) 2–4, 29, 121, 214; credibility of 7, 38, 114; and economic integration 160; and ESCB 27, 121; monetary policy 123, 213, 217–18; and seignoriage 116; and speculative attacks 125–6; and Stability and Growth Pact 27, 120, 123, 151, 172 European Coal and Steel Community (CSC) 15–20 European Commission 71, 124, 127, 214; conversion rates 126; and EEC 140; and EMU 83; and German banking system 137–8, 141; and national identity 190–1, 198; and private sector 134, 142; public policy 135–36, 141; role of 78 European Community 205; competition rules 134, 135, 141–2; and EMU 71–2, 76, 80; and integration 73, 82; and intergovernmentalism 75 European Community Studies Association—Canada (ECSA-C) 1 European Council 72, 74, 113, 124, 216 European Court of Justice 134, 151 European Currency Unit (ECU) 43, 44, 61–2 European Defence Community (EDC) 16–20, 22 European Economic Community 18, 158 European identity 4, 6, 183, 187, 195, 198–9 European integration 1, 3, 11, 71–3; and atomic energy 20; and CSC 15– 6, 18–9; and Intergovernmental Conference 73; and intergovernmentalism 87–8; and

Index

international transformation 209; and nationalism 154; and political identity 198–9; spill-over effects of 121, 199; theories of 72, 75–77, 81, 85, 91; and US 11–22 Europeanisation 76–7, 84, 87, 89–90 Europeanists 11 European Monetary Institute 32, 36 European Monetary System (EMS): asymmetrical nature of 82; and EMU 71, 76, 78–80; ERM of 3, 74, 210; and inflation 105–107; and interest rates 73; and France 43–4, 62; as opposed to common currency 103; speculative attack 27; success of 72, 75 European Parliament 78, 138, 173 European System of Central Banks (ESCB) 27, 117, 121, 82 European Union (EU) 1–7, 61–2, 100, 140, 143; and automatic mechanisms 109; and bankruptcy code 152–4; and banks 137–8, 141; and capital mobility 114; competition of 104; convergence 134; and euro 125–6, 196–7; and EDC 27; and EMU 91, 113; exchange rates 124; role of expert committees and policy learning 80; fiscal policy 122; and Germany 100, 166; and integration process 82, 133, 135, 146–7, 157, 160–2, 165– 71, 173–6; and international implications 115–17, 126–7, 142, 154–5; and monetary policy 194; and national identity 187, 194; and Poland 105; secession 147–9; Stability and Growth Pact 113, 120, 122–3, 126, 151–2; and transformation of international relations 203–206, 210–216, 219 exchange rate 3; and capital 119; as a catalyst 123; and convergence 124; conversion rates 115, 125, 126; fixed 101–2, 126, 192; and France 43, 57, 62; and inflation 105–6; and integration 168–9, 171; international implications of 113; and international trade 103; and monetary union 28, 42; management of 167; nominal and real 101; as a policy instrument 114; policies of Italy and France 78–9; and secession 148; Stability and Growth Pact 74, 120–1; and

225

unemployment 107–9; volatility 102, 118 Exchange rate mechanism 2, 3, 73, 210 Federal Reserve System seeUnited States Federal Reserve System Fichte, Johann 193–5 Feldstein, Martin 99 Fiera European Council Summit 216 fiduciary money 33 fiscal union 6; and customs union 168– 9; and political union 162, 164, 173, 175–6; stage of economic integration 159–61, 171, 173, 175– 6 Fleury, Cardinal Fordney-McCumber Tariff Act 14 France 11–12, 26, 33; and convergence of competition 140; and CSC 15, 18; and EDC 22; and EMU 82–3, 169, 193; euro 106; exchange rate policies 78; and German reunification 210; monetary union in 4, 30, 42–62; national currency 189–191; productivity 104–5; and Stability and Growth Pact 151, 162; and Treaty of Rome 21 Franco-Prussian War 33 free trade area 14, 158–9, 164 Free Trade of the Americas (FTAA) 161, 163, 166–7 Friedman, Milton 99 General Agreement on Tariffs and Trade (GATT) 14, 20, 158–9, 172 Germany 11–12, 26, 34–5, 143, 166; and CSC 15–16, 18; and ECB 121; and European Defence Community 16–18, 22; and EMU 72, 77, 81, 83, 169, 193; fiscal union 163; inflation 36, 105, 192; monetary policy 106– 7; monetary union 30–1, 37; national currency 194, 197; price stability of 27; productivity 104; public sector banks 134, 136–42; reunification of 73, 76, 210; seigniorage 117; and Stability and Growth Pact 122–3, 151; Treaty of Rome 21; Zollerein 33 German Treaty on Monetary, Economic and Social Union 31 Gilpin, Robert 206–12, 216–7 globalization 71, 75, 81, 84, 133, 139, 203, 207, 218 Greece 31, 36, 74, 113, 116, 167, 216

226

Index

Greenspan, Alan 108 Gresham, Thomas 48 Gresham’s Law 48 Growth and Stability Pact see Stability and Growth Pact harmonisation: and economic integration 158, 160, 161, 163, 173; of monetary policies 13, 171; and regional integration 167, 168; of reserve requirements 117; and single currency areas 122, and the Stability and Growth Pact 123; of taxes 160, 174–5; hegemon 73, 82, 84 High Authority see also European Coal and Steel Community 15, 18 homogeneity 106, 111, 165–6, 170 Hundred Years War 43 Hungary 100 imagery 185–8, 195, 198 Indies Company 55–6, 59 Inflation 36, 75–7, 101, 102, 111, 193; convergence criteria 74; 101, 102, ECB 27, 172; and the euro 105– 108; and free rider problem 35; German 73; hyperinflation 192, 194; seigniorage 116; tax 35, 122 institutionalist 76, 79, 81, 85, 88–90 intergovernmentalist 5, 81 Internal Market programme 75–6 International Monetary Fund (IMF) 14, 31, 105, 153, 214 international relations 7, 203–6, 208– 18 International Trade Organisation 14 international transformation 203–15, 217–19 Ireland 27, 114, 124 Italian Parliamentary Commission 189 Italy 11, 27; and central bank 82; competitiveness of 104; complications with Maastricht; and CSC 15, 18; 27; exchange rate 78, 104; monetary union 30; negotiations of EMU 83; and redistribution policies 109; 114; seigniorage 117; and Treaty of Rome 21 Japan 103, 111, 160, 168, 206, 211–13 Keynesian 106, 108, 113

Kindleberger, Charles P. 154 Law, John 54–8, 62 liberalisation: capital 72, 82; economic 133–5; financial 82; of markets 133, 142; of public sector 133; of the world trading system 176; sectoral 135, 142; trade 13, 139, 168, 172 Louis IX 83 Louis X 43 Louis XIII 49, 80 Louis XIV 42, 49–53, 55, 57–60, 62 Louis XV 43, 58, 80 Louis XVI 80 Luxembourg 12, 15, 21, 27, 28, 30, 36, 104 Maastricht criteria 77, 134, 165; difficulties with 113; fiscal constraints 122; limits on fiscal deficit 109; and unemployment 114 Maastricht Treaty 36, 38, 122, 159, 214;; reasons for acceptance 74, 76– 8; and central bank 27; Danish rejection of 73; and Delors Committee Report 72; and EMS 3; exchange rate policy 121; no-bailout clause 152; and path dependence 82; seigniorage 116, 117; stage three of 126, 127 Marshall Plan 12–13 Marshall, George 11–13 Marx, Karl 184–5, 190 Mazarin, Cardinal 50, 89 member states 3–5, 32 Mercosur 160, 163, 166, 168, 171 Mexico 102, 105, 166–7 Mitterrand, François 73 Monetarist 72, 75 Monetary Committee 80 monetary integration 72, 74–5, 77, 81 monetary policy: and business cycles 107–8, central bank and 29–30, 108, 121, 123, 125, 217; convergence 134, 143; and EMU 3, 78, 81, 106, 155, 162, 215, 217–18; French 42, 47–8, 57, 59, 62; and fixed exchange rates 27; and Germany 73, 76, 106, 107, 192; institutionalisation of 76; and optimal currency areas 6; and monetary union 27–8, 35, 38, 163, 171; national 192–3; seigniorage from 116; and unemployment 106–7 monetary union 26–38, 42, Canada

Index

and US 104, France 4, 30–1, 42–62, Germany 4, 26, 31, 34, 36, 73, Latin 29, 31, 34, North American 218, Scandinavia 4, 26, 29, 31, 34– 8, table of 30, US and Panama 29 see also economic and monetary union Monnet, Jean 15–16, 18 Monopoly 32–3, 42, 47, 56 Montesquieu 58 Muller, Adam 195–6, 198, 200 Multilateralism 14, 42, 204, 215–16 Mundell, Robert 2, 99, 104, 118, 174 Munich Coinage Treaty 32 Napoleon 11, 57, 62 national identity 75, 183, 185–6, 188, 190–1, 193–5, 198 neofunctionalist 5, 75, 81–2, 84–5, 89– 90 neoliberalism 167, 204, 209, 217 neorealism 82, 203, 204, 206–8, 211– 14, 217, 219 neorealist minimalism 211 Netherlands 12, 15, 18–19, 21, 26 North American Free Trade Agreement (NAFTA) 78, 119, 160–1, 163, 166– 7, 170 North Atlantic Treaty Organisation (NATO) 16–17, 216 Norway 34–5, 37, 107 optimal currency area 5, 99, 104, 114, 118, 121; and asymmetric supply shocks 120; definition of 2, 107; drawbacks of 119; and EMU 175, endogenous 6, 175–6; theory of 174 Order in Council 44, 52, 55–7 Organisation for European Economic Cooperation (OEEC) 12–13, 15, 18 Orry, Jean 58 Panama 29–30, 161 Partis Quebecois 146–7 Parizeau, Jacques 147 Philip III 43 Philip IV 43 Phillips Curve 106, 178 Pierre Le Pesant de Boisguilbert 53–4 Poland 100, 104–5 political union 6, 73, 146, 162, 176; characteristics and examples of 160– 1; degree of 120, 123; desirability of 172; and political integration 164;

227

spill-overs and 175–6; stages of 159, 165, 173, 175 Portugal 104, 116 Prussia 30, 32–4, 36–7 Quebec 2, 46–7 regional autarky 160, 164 regional integration 159–60; arrangements of 162, 169, 172; and change 205; projects 166–70, 176; and spill-over effects 165; stages of 172 Richelieu, Cardinal 49–50 Roosevelt, Franklin D. 11 Ruggie, John Gerald 203–5, 208–9, 211–12, 217–19 Russia 168, 215 Santer, Jacques 137 Schröder, Gerhard 138 Schuman, Robert 15 Secession 146–50, 154 Seigniorage 32–3, 44, 51–2 59, 114, 116–17 Seven Years War 58–9 Simmel, George 184–5, 190, 196–7 Socialisation 84, 87 sovereignty 15, 18 Spain 26, 50–1, 103–4, 187 spill-over 73, 76, 82–4, 122, 162–3, 165, 173, 175–6, 197, 199; and domestic elite 85; of budget deficits 152; political 162, 172, 174–5 Stability and Growth Pact 2, 6, 113–14, 120, 122, 124, 126–7, 151, 159, 162, 165, 172–3 supply shock 118, 120, 124 supranationalism 2–3, 19, 22, 205 Sweden 34–7, 122, 216; Bank of 35–6 Treaty of Rome 4, 21, 36, 78 Truman, Harry S. 11, 14 Unemployment 73–4, 102, 105, 119; natural rate of 106–7, 117; structural 106; and the euro 105–10 unilateralism 148–9 United Kingdom (UK) 17, 78, 83, 101, 105, 109, 125, 140, 152, 158, 162, 167, 169, 189, 210; and EMS 27, 124; and EMU 2, 7, 36, 104, 166,

228

Index

194, 216; and Norway 35; pound 124; unemployment 158 United States (US) 72, 185, 206, 211; and Canada 2, 4, 103–4, 108–10, 113, 119–21, 216; dollar 6, 103, 105, 211–13, 217; and Europe 11– 12, 14–16, 20, 22, 146, 211–14; and European Coal and Steel Community Foreign Relations of the 18, 20, 22; Federal Reserve 108, 121 monetary union 161; and Panama 29–30; US Treasury 186–7, 191 Vienna Congress 32–3 Voltaire 58

Waigel,Theo 151 War of the League of Augsburg 54 War of the Polish Succession 58 War of the Spanish Succession 54–5 West African Monetary Union (WAMU) 161, 166 169, 171 West Indies Company 55 World War II 11, 18, 103, 150 World Trade Organisation (WTO) 121, 159; see also General Agreement on Trade and Tariffs Zelizer, Viviana 184–5 Zollverein 30–3, 36