CIAO DATE: 11/04

The View From the European Commission
Part of EMU Day

Jonathan Davidson
Head of Academic Affairs And Political Advisor
European Commission, Washington, D.C.

Occasional Paper Series No. 28

Before the European Union Studies Center
City University of New York

October 28th, 1998

European Union Studies Center

Thank you, Professor Kaufmann, for that generous introduction, and for your kind invitation to join this illustrious group of speakers.

Let me congratulate CUNY, along with other members of the New York Consortium (Columbia University, New York University, and the New School for Social Research), on the award of a European Commission grant for an EU Center in a very hard fought national competition. We attach a great deal of importance to the new network of EU centers, which are funded under a provision of the New Transatlantic Agenda calling for new people–to–people links between the EU and the U.S.

Let me also commend Professor Hugo Kaufmann for his role in the creation of the New York Regional EU Center, and for his consistent interest in the EU generally and EMU in particular, as evidenced by this very interesting symposium today.

Changing Political and Economic Scenery…

In Europe, as in the U.S., we approach the end of 1998 a bit less confidently and perhaps a bit more nervously than we did at the beginning of the year. Specifically, we have lower economic growth forecasts. Last week the European Commission reduced its forecast for next year by 0.6% to 2.6%. Relatively robust as our economy has proved to be in the current global financial situation, the so-called Asian contagion has not entirely spared Europe.

Meanwhile, along with the changing background music of the global economy, Europe’s political scenery has been changing too. Chancellor Schrder’s swearing in yesterday highlights the fact that most of the fifteen countries of the European Union are now led by center left governments, in contrast to the situation at the turn of the decade, when center right governments prevailed. Now the only large EU member country led by a center right government is Spain.

It’s for others to speculate whether this reflects a changing political mood or portends a shift in policy direction in Europe. There are statements and actions on the record to suggest, on the contrary, that the center left governments will hold fast to the course of economic orthodoxy and pro–European integration at home, and follow the same internationalist foreign policies abroad, as their predecessors.

It’s not for me to speak for the member governments, and I’m not going to draw any conclusions. But we clearly should not ignore the political scenery of Europe as part of the overall picture as we approach what we call Stage III of Economic and Monetary Union. This involves the launch on January 1 of the euro, the irrevocable locking of participating currencies, and the implementation of a single monetary policy, run by the European Central Bank and the European System of Central Banks.

It’s an era of relative prosperity, but remember that our chronic scourge of high unemployment continues with only slight abatement. Unemployment rates in the EU 15 still hover above 10%. There’s more optimism about European construction than during the eras of Euroscepticism in the early 90s and Eurosclerosis in the seventies and early eighties. But the current mood is still tinged with concerns about the uncertain global outlook. And there are as many questions as answers about the future of Europe. Indeed our government leaders met in a special informal European Council summit last weekend to discuss that very question–the Future of Europe, particularly how to relate the building of Europe more to the concerns of Joe Citizen. There are still more questions than answers, since they spent much time discussing the global economy and other hot topics. Joe Citizen is no different from here—his first concern is his pocketbook.

… But Widening and Deepening on Track

There is no reason to suggest that either the global crisis or the changing political complexion of Europe will throw the EU off course in its march towards widening and deepening. There are reasons to conclude, on the contrary, that developments in both the domestic political situation and the global environment will tend to reinforce Europe’s chosen policies rather than erode them.

The global crisis has made even clearer the fact that Europe is the partner of the U.S. in most of the world challenges that we face together. It is now up to Europe to become a more unified partner for the U.S. if we are to make real progress in the world together. Statements by Prime Minister Tony Blair last week seem to indicate willingness on the part of the U.K. to drop their reservations about closer European military integration, which might be an important step in the direction of a European Security and Defense Identity (ESDI). Economic integration in Europe is already well advanced, but we still have some way to go to achieve political cohesion internally and in our external representation. The need has never been greater, now that Europe and the U.S. are the two poles of greatest stability in the uncertain global economy.

But the main questions I would like to explore today relate to the political and economic issues that we in Europe face as we move into this new era of deepening and widening. I won’t talk about widening in any detail since it’s not on the agenda of this symposium. But I should just mention that EU enlargement is an equally historic challenge facing Europe as we take another bold step towards integration at the turn of the century. It is axiomatic, in my opinion, that we are firmly set on the course of deepening and widening. The questions are how we will handle these challenges, not whether we will.

Euro–Benefits and Challenges

The euro will be unveiled with much fanfare in two months time. (As you know the actual bills and coins won’t hit the streets for another three years, and 11 countries will take part from the beginning). The advantages have been much trumpeted so I don’t need to rehearse them again—

• the elimination of exchange rate risk and the removal of foreign exchange costs within Euroland;

• the prospect of a stable euro, which will improve the investment climate and thus help to boost growth;

• greater transparency in cross–border pricing, to consolidate the benefits of the single market and improve healthy competition;

• greater efficiency in our financial services and capital markets;

• and the eventual emergence, one day well in the future, of the euro as partner alongside the dollar as a reserve currency.

But you’ve heard all that, so I don’t need to go into it other than to say that the fiscal discipline demanded by EMU has turned out to be a timely fitness course for Europe in the current global crisis, and serves as a role model for others. The euro should also make its contribution to ameliorating the global crisis if it serves as an engine of growth in Europe, as we hope it will.

You’ve also heard about the risks and challenges—

• How will we handle asymmetric shocks?

• How will a single monetary policy work in the absence of fiscal federalism?

• How will it succeed without greater labor mobility, and more flexible labor laws?

• What will governments do when their countries, or industrial sectors or regions within them, are hit with economic downturns, when they no longer have the option of using exchange rate policy as an instrument of adjustment?

• Can they even use fiscal policy as an instrument of reflation in times of need, given the stringency of the Treaty and the Stability and Growth Pact?

We don’t know the specific answers to these questions because the problems involved will arise only in the future and are therefore potential and somewhat hypothetical. How far ahead in the future, no one knows for sure. The tests for the euro could come soon or they could come late. It’s a fair bet that the euro, like any currency, will face tests, and being the new kid on the block its tests could be tougher than most.

The European public and its leadership are well aware of the issues. They’ve been thoroughly debated in Europe, even more than here. But political leaders are unlikely to come up with answers to questions that haven’t yet been put specifically. You would hardly expect political leaders here to talk about what they will do when the next recession hits. How can they publicly address the hypotheticals of an economic scenario that hasn’t yet arrived?

So in Europe we will cross these bridges when we get to them. As in every previous stage of European construction, the process will seem messy and painful, there will be frustrations and compromises, perhaps some steps forward and some back. As Jean Monnet said with characteristic vision and foresight:

"L’Europe ne se fera pas sans crises. Mais elle sera le resultat de la solution ces crises."

Mostly this will reflect on the conflicting interests of our member states and the interplay of conflicting political, social and economic forces within them. No one ever claimed that democracy was an efficient form of government.

Meticulous Preparations

This does not mean that there is a lack of advance planning for the euro. On the contrary, it is one of the best and most intricately planned policy moves ever. The financial markets have sent a strong signal of confidence in the euro, indicating they believe it has been extremely well planned and the governments and community institutions involved have been relatively surefooted. They should be–economic and monetary union has been on the drawing boards for nearly thirty years, so we have every reason by now to get it right.

I do not underestimate the potential problems of Euroland. I believe our political leaders are right to accentuate the positives, however, in the interests of launching the euro with confidence and optimism. They need to be prepared to handle crises as and when they occur, but not necessarily to dwell on hypothetical problems in advance. In any case there’s no shortage of economists to do the handwringing for them!

Most of the political and technical issues have been hammered out, some of them after arduous debate. The principles include:

• Maximum independence of monetary policy under the new European System of Central Banks (ECSB), and its executive agency, the European Central Bank (ECB), and

• Continuing fiscal stringency on the part of member governments, as defined in the Maastrict Treaty on European Union (1993) and the Stability and Growth Pact (1997).

Some important issues remain to be resolved before the euro has landed. How to represent the EMU abroad, for example, is a complex and politically sensitive issue that remains to be thrashed out, hopefully at the next European Council summit in Vienna in December if the Austrian Presidency have their way.

Who Will Run the Economic Policy?

Unlike monetary policy, which will be unified under EMU, fiscal and macroeconomic policy will remain in the hands of national governments. The logic of EMU, however, implies a high degree of convergence of economic policy in Euroland. It also implies considerable solidarity among the member states. Since there is a relatively small "federal" budget in the EU to act as an automatic stabilizer, and a ceiling on fiscal expansionism in individual states in the Stability and Growth Pact, the member governments will need to work closely together to meet the economic challenges that will arise in individual regions and member states.

Contrary to the view of some observers, however, the small size of the Union budget itself is not necessarily an impediment. Much more pertinent is the fact that the public sector resources available to EU governments are very substantial, perhaps larger overall than in this country. So there is scope to use fiscal policy in pursuit of macroeconomic goals in Euroland without swelling the Union budget or busting member state budget limits set by the Treaty and the Stability and Growth Pact. Remember that keeping budget deficits well below the 3% ceiling in good times will allow fiscal breathing space in cyclical downturns. As in the United States, our goal is to reach balanced budgets in each member state, and we are well on the way to achieving such fiscal discipline in Euroland.

The Treaty Speaks on Economic Policy

Also remember that the Treaty, often overlooked by observes and commentators, specifically charges the ECB with supporting the general economic objectives of the EU. It is the first sentence of Article 105 (of the Treaty of Rome as amended) which lays down the ESCB’s primary responsibility:

"The primary objective of the ESCB shall be to maintain price stability."

But many people don’t read on to the second sentence of Article 105:

"Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the objectives of the Community as laid down in Article 2."

And what does Article 2 say? It’s worth reading at some length:

"The Community shall have as its task, by establishing a common market and an economic and monetary union…to promote throughout the Community a harmonious and balanced development of economic activities, sustainable and non-inflationary growth respecting the environment, a high degree of convergence of economic performance, a high level of employment and of social protection, the raising of the standard of living and quality of life, and economic and social cohesion and solidarity among Member States."

It will require much political will to realize this commitment to a high degree of solidarity among the member states. On the evidence of past performance, the political will should be there–it has been displayed very impressively in arriving at the convergence targets, much better than most skeptics believed possible. The stakes in making the euro a success are even higher than they were in getting to the starting gate. So there is reason to believe that governments will find the political will they need when they face the economic crises that will inevitably confront them in the years ahead. But this can only be speculation based on reasonable extrapolation, not hard fact at this stage.

A great deal of work has already gone into ensuring that Europe remains competitive in the global economy, which will be part and parcel of ensuring the health of the euro. This involves long term investment in training and education in advanced technology, revisiting our social policies to ensure that they continue to provide social protection without leading to unacceptable labor market rigidities, and so on. We must solve Europe’s chronic unemployment problems. In addition to the stable growth that we hope the euro will help ensure, and sound education and social policies, best practices of the various member states can have a useful role in ameliorating employment problems, and the member states have introduced systematic procedures for the EU as a whole to benefit from this approach. These are among many measures afoot to ensure the success of Euroland’s economy and to promote the increasing global competitiveness of the EU.

Turbulence, or a Smooth Ride Ahead?

The fact that the official Commission economic growth forecasts came out significantly lower this month suggests to me, entirely unofficially of course, that the Euro area will face its first political tests earlier rather than later. Some member governments may find themselves bumping up against the budget deficit ceilings prescribed by the Treaty and the Stability and Growth Pact earlier than they would have under conditions of more robust growth. This could be accentuated by the widely predicted need for the European Central Bank to establish its credibility and the credibility of the euro early by adopting tough monetary policies from the outset. But this too is speculation at this stage. Only time will tell how the various scenarios will play out. My hunch is that the longer term ramifications of EMU are that the EU will be propelled in the direction of greater political cohesion as well as greater economic integration. For my money, that’s no bad thing if it helps Europe project its true weight in the world.

Meanwhile, attention in Brussels, Frankfurt, and the EU member states is focussed on ensuring as smooth a transition as possible to the new currency on January 1, and on keeping the value of the euro stabile. If we succeed in these aims, the euro will promote both stable economic growth in Europe and international financial stability. This will be no small contribution towards ameliorating current global economic concerns.

So let’s look forward to January, 1999, to see if Europe succeeds in these initial objectives for the euro.