Economic and Monetary Union in Europe

Geoffrey Denton, Geoffrey Denton

• Publisher: Routledge
• Year: 2022
• ISBN:
  9781000549720
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

In its pursuit of economic integration, economic and monetary union (EMU) had become a primary commitment for the European Community. Originally published in 1974, this study sets out to examine the meaning of economic union and its relationship with monetary union.

The contributors look at the problems and costs for attaining economic union for the member states of the EEC at the time. Steven Robson writes on economic management. Paul Woolley examines the integration of capital markets. Santosh Mukherjee looks at the implications of labour market policy. Geoffrey Denton and Adam Ridley consider the impact of economic and monetary union on regional problems. Alan Prest is concerned with tax harmonisation specifically Value Added Tax and Corporation Tax and Douglas Dosser discusses the development of a European Community budget.

Though the long-term benefits of EMU were clear, in the short term it would impose strains and pressures on national economies and particular sectors within them. This study goes a long way to clarifying where these difficulties would arise and suggests some ways of coping with them.

1 The Meaning of Economic Union

Geoffrey Denton

Recent studies of the prospects for European economic integration in the 1970s and 1980s have emphasised monetary union. The purpose of the present Federal Trust study is to examine the meaning of economic union. Subsequent chapters examine this phenomenon from the various standpoints of stabilisation policy, capital markets, regional problems and policy, fiscal policy, and the Community budget. The purpose of the present chapter is to introduce the papers on these different aspects by some general remarks about the meaning of economic union, the relationship between it and monetary union, the distinction between the final condition of full economic and monetary union (hereafter called EMU) and the transitional phase leading up to it, and the relationship between the policy-created EMU and the process of autonomous integration.

The Aims of Economic Union

The group spent some time in its early meetings in attempts to define what it considered to be the aims of economic union. It recognised the diversity of views which must exist on the meaning of so general a concept. Nevertheless it was able to arrive at a working description to guide its further work.

The first matter to clarify is the distinction between economic and political objectives. The primary aim of economic union for some people may be to contribute to the creation of a political union, which in turn is desired for internal and external political and strategic reasons: the avoidance of conflict among west European nations, or the strengthening of western Europe vis à vis other powers. This group was not directly concerned with such broad political motivations, but rather with elucidating the economic benefits and costs of economic union.

Economic union may be regarded as desirable in its own right if it can be shown to contribute to the economic welfare of the people of western Europe. This overall welfare criterion can be disaggregated to describe the normal set of national economic objectives: growth of overall output per head, efficient allocation and use of resources, stabilisation of the levels of activity, employment and income, an acceptable distribution of income, regional balance, and preservation of the physical and social environments. Some of these objectives may be controversial; for example, not everyone would agree that regional balance is a proper objective even for national governments, and many might hesitate to propose it as an objective of the Community to be given similar status to that which it is accorded in the existing nations. Simply to list the objectives is in any event rather meaningless; more important is the ordering of priorities among them and defining the trade-offs that are to be accepted when they are in conflict. These are matters of much political debate in the individual countries; it follows that they must also be controversial for the Community as a whole. An ordered set of economic objectives for any society also requires that it has adequate political institutions to determine them. Since such institutions have yet to be created at European level, it follows that there is considerable difficulty in arriving at a set of aims of a European economic union.

The definition of economic union in the context of the European Community is thus extremely difficult. We have, therefore, in this book, preferred to let the definition emerge from the detailed accounts of problems and policies in specific areas. This does not detract from the validity of the study of European economic union, any more than the similar problems involved in defining economic union at the level of the nation state imply that one should be inhibited from studying its economic problems.

A fruitful approach to the definition of economic union at the European level is to attempt to clarify the special characteristics of an economic union in western Europe that would enable it to make specific contributions to the general set of Community/national objectives. In this way one can set out a number of intermediate objectives of forming an economic union that would contribute to the ultimate aims. These would include: the creation of a larger market free of distortions, and enabling economic gains through specialisation in production and wider choice in consumption; stabilisation of the internal conditions of this larger market through joint economic management and policy co-ordination; stabilisation of the external conditions through a common commercial policy, external monetary policy, etc. The difficulty of this approach is that these intermediate objectives have all been considered in various ways also to bring disadvantages to the member states, and it is therefore necessary to find the balance of benefits and costs of the policy communalisation and co-ordination involved in economic union before one can reasonably judge whether it is beneficial for any one member. The subsequent chapters of this book make no attempt to hide the costs, which arise for some members on some policies, and indeed much of the discussion is concerned with setting out the safeguards, the positive policies and in general the conditions in which the members of an economic union could be reasonably reassured that costs and benefits would be fairly distributed and that net gains would result for each and every one.

The Relation between Economic Union and Monetary Union

Economic union is often regarded in current discussions as necessary to the achievement of monetary union. Thus many of the elements of economic union: common regional policy, fiscal harmonisation, a common budget, can be treated simply as conditions for the successful adoption and operation of a monetary union. But to be content with this would be to let the monetary tail wag the economic dog with a vengeance. Economic union as a requirement for monetary union can only be accepted if the case for monetary union can itself be firmly based on theory and empirical evidence. This has been the subject of many official and private reports and studies, including an earlier Federal Trust Report.¹ It is not necessary here to do more than outline the kind of case that can be made, and no attempt is made to argue its validity.

The main elements of the case are as follows:

1. that Europe is, or will soon become, an optimal currency area: with much greater internal than external trade and other economic interdependence, as measured for example by proportions of GNP traded internally and externally, internal factor movements, equalisation of prices;
2. that the individual capital markets in western Europe are too small to support stable individual currencies, and that price, wage and other interdependences are so great that parity changes do not function to restore payments equilibrium;
3. that European industry requires to be organised on a continental scale in order to retain the power to compete with the US, Japan, USSR. (This argument requires that the option of organisation in interdependence with US industry is ruled out for political or economic motives.)

The evidence on these issues is strong but not overwhelming. Benelux countries have a very high degree of dependence on trade within the EEC, but Germany, France and Italy only moderate, and the UK still very small though likely to grow rapidly. Eire has a high degree of interdependence, but this is primarily dependence on the UK. Cross-frontier capital investments have come predominantly from the US, and labour movements predominantly from non-EEC southern Europe.

The evidence of the inadequate size of European capital markets and national currency reserves is strong, but the evidence on prices does not support the interdependence hypothesis. Price trends have in practice diverged, and the parity adjustments, at least up to the period of monetary turbulence since 1971, have been fairly well correlated with the relative price trends over long periods, whereas the argument requires parity changes to be rapidly offset by relative price adjustments. Micro-economic studies also show little tendency towards price equalisation among the Six. Moreover, the inadequacy of reserves to take the strain of speculative movements can support an argument for flexible parities as well as one for monetary union if prices are not interdependent. Willingness to adjust the peg in response to long-term disequilibria, and to allow fluctuations within a broad band to meet short-term changes, could then alleviate the capital market problem.

The argument from interdependence is certainly strengthened if one examines trends rather than actualities, as has already been noted in the case of UK dependence on intra-trade. Moreover, interdependence to some extent constitutes a self-fulfilling prophecy. The problem is to judge the moment, if any, at which the economies are about to become sufficiently interdependent to justify a monetary union.

The Transition to Economic Union

Even if it is judged that interdependence is already so advanced that an early creation of a monetary union is necessary in the 1970s, there remains the problem of the transitional period. Agreement on the creation of a monetary union does not necessarily justify policies during the transitional period that will be appropriate only in the conditions of fuller interdependence brought about, in part, by the final union. There is a political case in favour of ‘crisis therapy’; the early creation of an ‘unbalanced’ union in which monetary integration has far outrun the harmonisation of economic policies, on the ground that it is necessary to create problems by committing ourselves to immediate monetary integration, since only in attempting to solve these problems will national governments create the necessary common institutions and the common policies. But this argument is unconvincing politically as well as economically harmful; it is just as probable that the shock of a ruthless adoption of this ‘monetarist’ strategy would disrupt the whole process of monetary and economic integration by causing one or more countries to leave the Community.

Being primarily concerned with the requirements of economic union, the group adopted the working assumption of eventual monetary integration. However, they took the view that permanent locking of the internal parities of the member countries was not to be expected in the near future. The freedom to adjust exchange parities was required in order to deal with the problems of price-cost adjustment, until such time as autonomous integration had removed the existing divergencies in trends of relative factor prices and productivity levels in different member countries. The group acknowledged that speculative currency flows into and out of various national currencies might result in parity adjustments which had no real economic rationale. However, while this strengthened the case for an early fixing of rates, it certainly did not make an early fixing of rates feasible in advance of adequate mutual support operations to prevent parities being upset by such movements.

Although the group had been mainly concerned to discuss policy at national and European levels, the members were always aware that the really important question is to what extent integration is in practice taking place among firms, banks, trade unions, etc. within the European Community, and the effects on the main economic variables, prices, wages, etc. Unfortunately, there is little firm evidence of the extent of this increasing integration to which policy must be adapted, and more analysis of the extent and of the probable future development of this ‘autonomous’ integration is urgent. Much of the case for monetary union, and therefore for the concomitant economic policies discussed in this report, hinges on the actuality and the prospects of the real process of integration.

A Summary of the Findings

The conclusions arrived at by the group have already been published in a summary Report, prepared by the Chairman and Rapporteur. It may, nevertheless, be helpful to set out very briefly at this point the main conclusions of the group. Some of these relate to matters such as industrial policy and social policy which are not treated in separate chapters below; most are derived from these chapters.

The group considered the impact of monetary integration on the business cycles within the Community. They concluded that present analysis of evidence does not promote a clear judgement as to how far the business cycles will be unified, nor whether such unification of fluctuations would have the consequences of amplifying or dampening the overall movements. Further analysis of this problem is urgently required. Concerning the problem of assigning instruments to Community and national institutions, there was a general presumption in favour of assigning monetary instruments to the Community and fiscal instruments to the national administrations, if only on the ground of administrative simplicity. However, it was recognised that, given the development of fiscal powers at Community level, there would be a substantial case for some mix of monetary and fiscal policies at this level for the purpose of controlling the Community cycle. Further, since the Community cycle would be influenced by the autonomous actions of member states, there would also be a need for some Community supervision and control of national policies in respect of budget deficits, prices and incomes policies, etc. It was also noted that the consequences of Community action to stabilise the European economy would be unevenly spread over the various national and sub-national regions and that this would require some degree of differentiation in the application of stabilisation policies. Since fiscal policies are more readily differentiable than monetary policies in a monetary union, this was an additional argument for the existence of fiscal stabilisation instruments at Community level.

The group considered the implications for factor markets of monetary integration. They concluded that there was no need for an early and complete liberalisation of capital movements. It might continue to be desirable, especially in the light of particular problems in member countries and in some of the regions, that there should be controls on the free movement of capital toward one part of the Community and from another. There could be no general presumption that the gains from freer movement of capital would outweigh the costs. Given some increased liberalisation of capital movements internally, it would be essential to set up a common ring-fence of external capital controls. Massive movement of labour from one country to another was not expected, but there would be a problem of redundancy as industry was restructured in the face of competition unrestrained by any parity adjustments. This redundancy would create regional problems where industries affected were concentrated in particular regions.

The group noted that the removal of the instrument of parity adjustment could result in a worsening of the competitive situation of some regions. This effect would be in addition to the effect of the customs union in making some regions more peripheral, and therefore more disadvantaged, than they had been within their national markets. It followed that there would be a need for two kinds of regional policy to exist in the monetary union. First, national governments would have to be permitted to continue, and possibly even to develop further, their existing regional policies. It was recognised that these could create problems for competition policy, and that criteria, preferably of a very simple kind, would have to be agreed for defining the existence of a regional problem which would justify such national policies. Secondly, there would be a need for a substantial Community regional fund to enable some substantial redistribution of the gains from integration towards those regions which suffered as a consequence. In order that the transfers should be significant, there were two requirements in the operation of this fund. First, it should be large enough to generate substantial transfers; and secondly, the regions eligible for assistance would have to be selectively chosen; that is, it would not be meaningful if each country’s own definition of its problem areas were to be accepted without any reference to Community-wide criteria. The group further considered, however, that aid to particular regions from the Community fund would probably be most efficient if granted in support of national programmes for the development of particular regions rather than existing alongside national programmes.

The discussion of industrial policy in the Community has been prolonged but not very productive of results, even in terms of policy. The group felt that the development of industrial policy in the Community would be facilitated by an economic and monetary union. They wished to draw attention to the need to make industrial policy, both at national and at Community level, more coherent than it has been. In particular, it was necessary to resolve some of the contradictions, for example, as between merger policy and competition policy It was also necessary in view of the wide range of proposals already under discussion, to concentrate on a few priority areas in which progress towards a common policy could most easily be achieved.

The possible increase in redundancy would require the establishment of a common fund in order to share the burden equitably within the Community. Regarding social security in general, the group thought that alignment both of contributions and of benefits was likely to be a slow process, dependent on progress in other aspects of redistribution within the Community There was a case for alignment of contributions on the ground of creating fair conditions for competition, but this could not be pressed while the burdens of standardisation would be excessive for low-income member countries. Equalisation of benefits would have to await development of the Community spirit. The group also concluded that a European economic union could make a contribution to social innovation, and that this indeed would be an important means of making the economic union acceptable to public opinion. In particular, common policies towards problems such as the environment, participation in industry, the quality of life, etc. could be facilitated since the Community could modify, so far as internal trade was concerned at least, the competitive pressures which tend to bring about the neglect of these social problems.

It was accepted that, following the present development of common fiscal policy, the Value Added Tax (VAT) must be assumed to be the major basis for the future Community budget. However, in the light of the discussion of national and regional problems arising in a monetary union, there was a need to reconsider the approach to the harmonisation of taxation...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Title Page
• Original Copyright Page
• Table of Contents
• Preface
• 1. The Meaning of Economic Union Geoffrey Denton
• 2. Economic Management in a Monetary Union Steven Robson
• 3. Integration of Capital Markets Paul Woolley
• 4. Labour Market Policy Santosh Mukherjee
• 5. Regional Problems and Policy Geoffrey Denton and Adam Ridley
• 6. Fiscal Issues Alan Prest
• 7. Development of a European Community Budget Douglas Dosser
• Notes on Contributors
• Index