Why Maastricht will fail - Maastricht Treaty

ONLY A YEAR AGO there was widespread agreement that the European nations were marching inexorably toward monetary union and, through monetary union, to a political union that would gradually replace the twelve nation states of the European Community with a centralized form of continental government. Jean Monnet's dream of a United States of Europe looked as if it would become reality before the end of the century. The Maastricht treaty embodied and extended the strategy of gradualism that Monnet had advocated nearly a half century ago for shifting power from national governments to European institutions.

In this process of European unification, monetary union was far more important as a political symbol than as a substantive economic reform. Replacing national currencies with a single currency for all of Europe would promote a popular perception that Europe had become a "single nation." Replacing national central banks with a European Central Bank would shift the real locus of economic power away from national governments and would eventually lead to a centralization of budget and tax decisions along the lines already proposed by EC President Jacques Delors. The Maastricht treaty made the political goals explicit by combining monetary union with a commitment to a political union that would have responsibility for the domestic and international policies that are now decided by the individual national governments.

In the last year, the perceived prospects of European monetary and political unity have fluctuated widely. In 1992, the initial optimism faded rapidly under the impact of two major events: the crisis in the European system of exchange rates and the 1992 Danish referendum rejecting the treaty. The collapse of the European Monetary System (EMS) left the British and Italian currencies floating outside it, and thereby destroyed what many regarded as a major step along the way to monetary union. The initial Danish rejection of the Maastricht treaty was particularly striking because it occurred despite support for it by the leaders of both the government and the opposition parties. And while some advocates of monetary union dismissed the first Danish vote as a reflection of the opinions of only a handful of voters in a continent of more than 200 million people, subsequent testing of opinion in France, Switzerland, and Britain showed that the Danes were not alone in having serious reservations about the desirability of monetary union in general and the Maastricht agreement in particular.

In the French referendum, only a 1 percent majority favored the Maastricht treaty despite massive pro-treaty government advertising. The Swiss referendum, which overwhelmingly rejected membership in the European Economic Area, showed how far the Swiss are from joining the European Economic Community. And the problems that John Major had with his own party indicated the lack of support for European Monetary Union (EMU) in Britain.

More recently, there has been something of an apparent recovery in the Maastricht treaty's prospects. In May of this year, the Danes ratified it in a second referendum. Immediately afterwards, the Major government succeeded in having the treaty approved by the House of Commons (by 292 votes to 112, with no fewer than 246 members abstaining and with 41 conservatives voting against their leadership).

There is less to these recent developments than meets the eye, however, and their impact is destined to be rather superficial. Among informed private individuals, and even among government officials when they speak privately, there is widespread agreement that the prospect of monetary and political union remains remote, and will continue to be so even if all twelve countries of the EC should eventually ratify the treaty. As a practical matter, countries that do ratify the Maastricht treaty will have ample opportunity to reconsider the substance of their decisions. The treaty explicitly grants Britain the right to decide later whether to accept the single currency. Even more significant exemptions were explicitly given to Denmark in order to induce the Danes to ratify the treaty. The German parliament has made it clear that it also reserves the right to decide later whether it will abandon the deutschemark, even though it has not been explicitly given that right in the treaty. It is unthinkable that France would not demand for itself a right given to others, and indeed President Mitterrand's televised statement to the French nation that European monetary policy would not be left to European central bankers but would be under the control of national politicians implies a fundamental French reinterpretation of monetary union.

Apart from these reservations, only three of the twelve current members of the European community now satisfy the "convergence conditions" on inflation, interest rates, and budget deficits set forth in the Maastricht plan as preconditions for joining the monetary union. There is substantial reason to doubt that all twelve will satisfy a literal interpretation of those conditions anytime in the next decade. And before the end of the century the European Community is likely to add several new members who will have their own problems in achieving these preconditions for monetary union.

Beyond the Treaty Process

SO RATIFICATION of the treaty by all twelve of the current EC countries would still leave Europe far from monetary and political union. To assess the likelihood of monetary union, it is important to look beyond the treaty process to the forces that will determine whether or not EMU is actually implemented.

The most important recent change that has diminished the likelihood of monetary union has been the collapse of the Soviet Union. The threat of Soviet aggression no longer provides a driving force for European political union that is powerful enough to overcome the natural reluctance to sacrifice national sovereignty and independence. The early history of the United States is instructive. Despite the similarity in the backgrounds of the individual colonies, there was substantial reluctance after independence to go beyond the very weak form of association embodied in the Articles of Confederation. The subsequent decision to substitute the stronger central government of the Constitution for the weaker association under the Articles of Confederation was motivated primarily by the desire to provide for a common defense against foreign alliances and foreign intervention in the former colonies.

Perhaps even more fundamentally, the generation of Europeans who dreamed of a United States of Europe as a way of preventing a repetition of the horrors of World War II by containing Germany in a larger political entity is shrinking rapidly in both size and political influence. For most young people, the prospect of German militarism is not a palpable concern that justifies sacrificing national identities. Although the argument that Germany must be "contained" in a broader European government to prevent a repeat of German military aggression is made by Germans as well as non-Germans, it is demeaning to the German people and contrary to the past half-century of German history. It is unlikely to provide a powerful motive for political union in either Germany or elsewhere in Europe.

Those who still share Jean Monnet's dream of creating a United States of Europe as a way of preventing a return of German militarism will also have to deal with those critics who remind them that, as the American Civil War and other intramural conflicts have demonstrated, a devastating war can occur even within a single political entity. This is particularly relevant to those who are concerned by the recent tendency of German officials to refer to World War I and World War II as "European civil wars." Indeed it would not be difficult to argue that the American Civil War would not have occurred if the North and South had been separate countries from the time of American independence.

To the best of my knowledge, history offers no precedent of one country merging with another as a way of protecting itself from the other country's future aggression. Similarly, there is no precedent for a country voluntarily giving up its sovereignty to prevent itself from acting aggressively in the future. In contrast, history offers many examples of countries that pursue and promote political union in order to increase their power over their neighbors. One need look no further than Prussia's nineteenth-century merger with the previously independent areas of Germany as a way of achieving Prussian hegemony over their territories. It seems unlikely that Britain, France, and the other countries of Europe will want to form a continental government in which Germany has the largest population and the strongest economy as a way of limiting Germany's future power or the military exercise of that power.

If I am correct that containing possible future German militarism will not be a decisive force for European monetary and political union, the future political evolution of Europe will depend on the more mundane issues of the economic benefits and costs of monetary union and the desirability of maintaining national control over domestic and international policies. The most basic reason for doubting the viability of the Maastricht plan is that the potential economic benefits of monetary union are small at best while the political consequences involve a fundamental loss of national self-determination.

These adverse consequences are clearly not strong enough to persuade the current European leaders to abandon the quest for monetary and political union with which they have long been associated. There will, however, eventually be an end to the era of Francois Mitterrand and Helmut Kohl, as well as to the already shaky-looking term of Prime Minister John Major. The next generation of European political leaders will not have the same personal commitment to the Maastricht treaty and to the goal of European monetary and political union as did Mitterrand, Kohl, and Major. The political reputations and personal egos of the new leaders will not be tied to the success of monetary and political union, and they will not equate the future of EMU and European Political Union (EPU) with their own personal places in history. The new political leaders will see that public support of EMU and EPU is weak at best and that there is greater political advantage in pursuing other goals.

Questionable Economics

THE MOST immediate reason for the weakening of public support for monetary union is that the process of economic change required to satisfy the "convergence" criteria that are specified in the Maastricht treaty is very painful. The Maastricht agreement specifies target levels for inflation, interest rates, and budget deficits that a country must satisfy before it can join the monetary union. Reducing inflation rates, budget deficits and public debt ratios requires contractionary monetary and fiscal policies that have contributed to the depressed levels of economic activity throughout Europe and the resulting double-digit unemployment rates.

Attempting to achieve the explicit convergence targets specified in the Masstricht agreement would probably mean that economic weakness would continue for the remainder of the decade. The recent statements in national capitals and in Brussels about the need for a "growth strategy" based on fiscal expansion and easier German monetary policy indicate an unwillingness to pursue such deflationary monetary and fiscal policies.

The collapse of the exchange rate mechanism in September 1992 was the most visible evidence of the high cost of the Masstricht program. The attempt to sustain the exchange rates that had prevailed since 1987 collapsed because inflation differences and other domestic conditions had made those rates unsustainable. Italy and Britain had current account deficits that were large in relation to their foreign exchange reserves. Higher inflation in those countries than elsewhere in the EC implied that their trade imbalances were likely to deteriorate further. While the real exchange rate adjustments that were needed to eliminate the trade imbalance could in principle have been achieved without nominal exchange rate changes--by dramatic cuts in domestic prices and wages, or by sustained reductions of domestic inflation to a level lower than that in France and Germany--the suppression of domestic demand that would have been required to achieve such deflation was politically unacceptable.

Even after the dealuations that have occurred, it will be very costly for several of the EC countries to maintain fixed exchange rates relative to the deutschemark. Now that financial capital is very mobile within Europe in the very short run, even countries that do not have trade deficits or high inflation are forced by the European monetary system to maintain interest rates that are higher than the rates paid in Germany, in order to compensate financial investors for the risk of a future devaluation. The high real interest rates set by the Bundesbank, in order to offset the inflationary pressures caused by German unification, therefore force high real rates on the other countries of Europe, even when such rates are not justified by their own domestic conditions. The resulting high unemployment rates and sluggish growth may eventually cause other countries to follow Britain and Italy in allowing their exchange rates to float.

The high cost of transition might be politically acceptable if the public saw sufficient long-term economic gains from achieving monetary union. But even the long-term benefits of that union are at best questionable. Put briefly, European monetary union is not needed to promote trade within Europe and is more likely to raise European inflation than to lower it. Moreover, the loss of separate national monetary policies that would result from the creation of a European Central Bank would be likely to increase cyclical problems and thus raise the average unemployment rate. Finally, the process of monetary centralization would ultimately require a parallel centralization of tax and spending decisions that is neither necessary nor desirable.(1)

Consider first the link between trade and monetary union. The European Commission argues that a single currency is needed to facilitate the increased trade that could result from the new "single market" rules, summarizing this view in the title of its report: One Market, One Money. More modestly, some European businessmen favor a single European currency because it would lower transaction costs and reduce the variability of profits caused by short-term currency fluctuations, without the need for explicit hedging actions.

The Commission's idea that free trade requires fixed exchange rates is certainly contrary to all standard economic analysis. Economists understand that the benefits of free trade can be obtained in a world of floating exchange rates. Indeed, unless the domestic prices of goods and services and domestic wage rates respond rapidly to changes in market conditions, the benefits of free trade are enhanced by exchange rates that adjust freely.

Although volatile exchange rates might in principle inhibit the volume of trade, the economists who have tried to find statistical relations between the volatility of currency fluctuations and the volume of trade have identified no convincing statistical evidence that the first reduces the second. On the contrary, the ability of trade to flourish when exchange rates are volatile is demonstrated by several readily available examples. Canada's imports and exports each exceed 20 percent of Canada's national income despite its floating exchange rate. Again, sharp currency fluctuations have certainly not limited Japan's ability to expand its trade with the rest of the world.

Although proponents of monetary union argue that it would result in a lower inflation rate in Europe, there are at least four reasons for doubting this. First, the experience in France, the Netherlands, and elsewhere has shown that inflation can be virtually eliminated without abandoning national currencies by adopting a policy of linking the currency to the deutschemark.

Second, low inflation can be achieved even without such an exchange rate policy by a country that really wants low inflation; witness the experience in such otherwise different countries as the United States and New Zealand.

Third, the major countries of Europe other than Germany have made it clear that they would like to see a less restrictive German monetary policy at the present time. A European central bank that reflected the views of most European countries would undoubtedly favor a less anti-inflationary policy now than the one being imposed on the members of the European monetary system by the Bundesbank.

Fourth, despite all the talk about the independence of the European Central Bank, there is a substantial risk that the de facto authority for monetary policy would shift to the politically controlled Council of Ministers. The locus of effective control is obscured in the technical issue of who determines the international value of the ECU (European currency unit). The Masstricht treaty can be interpreted to mean that the Council of Ministers, rather than the European Central Bank, would determine the basic policy changes that affect the external value of the ECU. A decision of the Ministers to reduce the value of the ECU relative to the dollar or yen (similar in spirit to the decisions made at the Plaza in 1985 or the Louvre in 1987) would force the European Central Bank to pursue an easier and more inflationary monetary policy. Perhaps this is what President Mitterrand had in mind when he reassured the French public that politicians rather than central bankers would be responsible for European monetary policy.

In addition to this inflationary bias, the shift to a single European currency would also increase cyclical instability and raise average unemployment rates. This increase in cyclical instability and unemployment occurs not only because the shift to a single currency denies national governments the ability to tailor monetary policy and exchange rates to national economic conditions, but also because it prevents natural market forces from changing long-term interest rates and market exchange rates when conditions warrant such a change.

With a single currency for all of Europe, there obviously cannot be different interest rates and different monetary policies in different countries. National governments unambiguously lose the ability to adjust national monetary policies and interest rates to offset shocks to economic demand that are greater in their own country than in the EC as a whole. Those who favor EMU usually reply to this last point by arguing that demand shocks are not likely to differ substantially among the European countries, and therefore that the lack of separate monetary policies is not a serious problem. Although few demand shocks are localized to a single nation, there are enough differences between countries like Spain and Denmark or Britain and Italy that it would be wrong to minimize the usefulness of national monetary policies and adjustable nominal exchange rates.

Abandoning individual currencies in favor of a single European currency would make it literally impossible to shift the relative prices of products in different European countries by changing exchange rates. Even defenders of monetary union recognize that this loss of flexible nominal exchange rates would make it more difficult for countries to respond to shocks in demand that create local unemployment. In addition, real exchange rates must adjust to balance trade when there are national differences in technology, tastes, and in rates of income growth. The inability of nominal exchange rates to adjust would mean that real exchange rates would have to be adjusted by altering domestic wages and prices, a process that could involve substantial and prolonged unemployment.

There is one further aspect of the economic gains and losses from the Maastricht arrangement: the transfers from the highincome countries to the lower-income countries. The original Delors proposal for such transfers was a bribe, designed to strengthen support for the treaty in low income countries. The Irish government, as part of its campaign for referendum votes in favor of treaty ratification, emphasized the transfer that Ireland would receive. The prospect of such transfers still remains a major source of the appeal of economic union in Portugal and Spain. It is unlikely however that in the end any country would actually sacrifice its political and economic independence in order to obtain a temporary transfer equal to 2 or 3 percent of its national income. Moreover, the higher income countries, including Britain and Germany, have already made it clear that they are unwilling to support more than minimal transfers.

In summary, my analysis of the economic consequences suggests that the process of transition to monetary union would be long and painful, and that, once there, the trade gains from a stable currency would be relatively small and more than offset by the adverse effects on inflation and unemployment.

Political Consequences

THE POLITICAL consequences of the Maastricht treaty would be even more important than its economic effects. A political union would shift responsibility for international and domestic policies from national capitals to European institutions. For most purposes, the proposed location of the decision-making within the European political system (the Commission, the Council, or the Parliament) is less important than the fact that the decision authority would be shifted away from national capitals.

In trying to assess the likely political consequences of moving ahead with the Maastricht program, Europeans will have to consider not only the changes that are explicitly called for by the Maastricht treaty but also the additional changes that may flow from it in the future.

The recent experience with Denmark shows that the treaty cannot be regarded as a legally binding document when a strong majority of countries wishes to expand the role of the European institutions at the expense of national governments. The Maastricht treaty is formally a revision of the original Treaty of Rome which states explicitly that any treaty revision must be unanimous. After the initial Danish "No" vote, many European political leaders asserted that Denmark did not have the right to block the treaty revision proposed at Maastricht. Those political leaders indicated that they expected to go ahead with the Maastricht treaty even if Denmark rejected it. Denmark might have been forced to leave the Community, losing the trade benefits of being part of the single market. Although the Danes have now ratified the treaty, other governments will undoubtedly worry that if they were to reject some future proposal to revise the treaty they too might be forced to leave the European Community at that time.

It is thus clear from the Danish experience that anything agreed to as part of the Maastricht treaty, whether it is about technical matters like the role of the European Central Bank or more fundamental issues like the division of responsibility between the Council and the Parliament, is de facto subject to change in the member countries, even though unanimity is supposed to be required to change the treaty.

There has been substantial discussion in recent months about the principle of "subsidiarity," i.e., about the division of authority between the European central government and the national and local governments. Although there is great ambiguity about what this would mean in practice for domestic issues, there can be no ambiguity about the implication of political union for foreign policy and military policy. If it is accepted that the European Community will eventually have a single foreign policy and a single military policy, there is no room for national governments to have independent positions.

The political union envisioned in the Masstricht treaty would eventually mean that decisions about military actions in Eastern Europe, in the Middle East, or in North Africa would be made collectively for Europe. Individual countries could not veto such collective decisions, and individual countries could not abstain from participating in military actions even if they were unpopular domestically. That these military decisions were made democratically by an elected European Parliament or a Council of Ministers would not alter the fact that nations might find themselves drawn into wars that they believed to be contrary to their national interests or moral principles.

Although this issue has until now received less attention in the public debate than the question of domestic subsidiarity, at some point it may become a major focus of concern. If it does, the people of Ireland or Portugal (to name just two cuntries) might well object to a political union that involves an irrevocable commitment to fight wars in Eastern Europe or the Middle East. And since this is a treaty without limit of time, the possiblities for future military conflicts cannot be judged by current military and diplomatic configurations.

Domestic issues of "subsidiarity" are of course more immediately visible to the public. The Brussels bureaucracy made itself unpopular last summer by what many regarded as excessive meddling in matters that should have been left to national or local governments. The Commission initially attempted to defuse this criticism by asserting that the Commission and its bureaucrats would be made more accountable to the European Parliament. This appeal to increased democratization failed to reassure people who rightly recognized that the loss of sovereignty and national self-determination could not be corrected by increasing democracy in a system that did not permit national vetoes on European decisions.

The problem is not bureaucratic power but a loss of national sovereignty. The principle of "subsidiarity"--assigning decisions to the lowest appropriate level of government--has therefore been emphasized by those who favor monetary and political union, in an attempt to reassure people that they and their national governments will not lose control over important issues. There is however so little practical content to the idea of "subsidiarity" that it cannot provide comfort to anyone who worries about a pan-European assumption of authority for rules affecting local lifestyles and national fiscal decisions.

Americans are accustomed to the gradual drift of authority from state governments to Washington that has taken place over the years, despite our Constitution's seemingly unambiguous Tenth Amendment that reserves to the individual states all powers not specifically vested by the Constitution itself in the central government. It is hard for someone who is not a lawyer to reconcile this straight-forward constitutional language with the fact that Washington effectively sets the maximum speed limit on local roads and the minimum age at which young people can purchase beer. The federal government sets the rules that govern safety in the workplace and discrimination in hiring. It is not clear why the American subsidiarity principle does not leave these decisions to the states or localities.

If this shift of power to the central government has happened in the United

States, despite the apparently explicit prohibition of the Tenth Amendment, what comfort can Europeans take in the vague promise that decisions will be made "at the lowest appropriate level of government"?

As a traveler to Europe, I am occasionally struck by the things that take place in individual European countries that do not happen elsewhere in Europe and that would not be allowed in the United States. The bull fights that are a central part of the national culture in Spain are certainly not permitted in the United States. How long would the public slaughter of bulls for sport be permitted in Spain if the decision were taken in Strasbourg or Brussels? The European Commission's recent decision to ban the use of rabbits to test cosmetics does not bode well for bullfight aficionados.

The American protectors of animal rights have also been successful in preventing Americans from consuming the foie gras that the people of France enjoy despite the discomfort that it apparently imposes on French geese. How long would a pan-European parliament tolerate the force feeding of geese? The decisions of the Brussels bureaucracy to limit the flavors of potato chips made in Britain suggests a willingness to meddle in every aspect of personal consumption.

Subsidiarity affects major issues of fiscal policy as well as more personal lifestyle issues. The original Delors plan would have limited the ability of member governments to have fiscal deficits. Many European economists who favor monetary union think that a balanced budget requirement must eventually accompany monetary union. National tax authorities are already being forced to restructure their value added taxes to conform to European guidelines. Although the European Community as such still has little revenue of its own, there is nothing in the Maastricht arrangement to stop the evolving transfer of fiscal power and resources to the center if a majority of nations wants to do so. Nor is there any limit to the extent to which such a European tax could be used to redistribute income among countries and individuals.

The ultimate protection of national sovereignty is of course the right to withdraw from the Community. It is significant therefore that neither the original Rome Treaty nor the Maastricht plan contains any provision for unilateral withdrawal by a member country. What would happen if a country felt that its national interest and way of life were so threatened by the rules of the centralized European government that it wanted to leave the Community, even if that involved foregoing the trade benefits? Could the Community government prevent secession by military force as the United States did when South Carolina wanted to leave the Union some seventy-five years after ratifying the American Constitution?

As Europeans start to focus on the political consequences of the European union envisioned in the Maastricht treaty they are likely to conclude that the risks and uncertainties are too great, and the potential political changes too unsatisfactory, to go forward with monetary and political union. Even if monetary union were possible without political union--something that apparently neither Germany nor France wants--the adverse effects of monetary union for price stability and employment would outweigh the small advantages of trading with a single currency. It would be surprising in light of all of this if Europe began the twenty-first century with a monetary union and a single currency.

(1)My views on the economic consequences of European monetary union are discussed more extensively in "The Case Against EMU," The Economist, June 13, 1992.

COPYRIGHT 1993 The National Interest, Inc.
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