March 14, 2007
Why liberalism is the right future for a declining Europe
The European Union has been an astonishing success. It has helped create prosperity and peace across a continent devastated by the two most destructive wars in human history and then divided by an iron curtain. Its challenge now is to adapt to the world of the 21st century.
On March 25 1957, the six original members (Belgium, France, Germany, Italy, Luxembourg, Netherlands) signed the treaties known as the treaties of Rome. Today, after successive enlargements, the EU has 27 members, with an aggregate population of 493m that generates 30 per cent of world gross product, at market prices. If imitation is the sincerest form of flattery, then enlargement is flattery’s apotheosis. Each wave of members has chosen to absorb not just the EU’s values, but its body of laws, the celebrated acquis communautaire, recently estimated at 170,000 pages of legislation.
The great achievement of the EU is to establish the co-operative “service state” as the norm across the continent. Such a state sees its purpose as serving its citizens, not dominating them, and as co-operating with other states, not dictating to them. The genius of the founders was to realise that a law-governed market economy was the means to this end. It would do so by binding the discretionary interventions of each, thereby creating predictability and stability for all.
The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Charles Wyplosz: Martin is right in many ways. Europe is a living example of how countries can shift from wars to rules-based deep cooperation. Europe is wrong to fear globalization and must accept its diminished role, as should the US. Many European countries have failed to adapt and this failure lies at the roots of fears about the new world. But Martin also rekindles the old debate of the ultimate aim, endorsing the view sometimes caricatured as limiting Europe to a free-trade area. This is not feasible and the debate is not helpful.
A real free-trade area, one where nation-states abdicate their rights to conduct their own foreign trade policies, cannot just exist as such. It must go much, much deeper, whether we want it or not. The reason is simple: real free trade does not just bring into competition production structures but also nearly all aspects of social systems. For instance, a country with an efficient labor market will always do better, competition-wise than one where all sorts of interventions weigh on competitiveness. The naïve answer is: this is fine, let the better win and the loser adapt. Sure, it would work, but consider what it means. The loser must dig very deep in its welfare system. It must build up political coalitions that will be able to conduct reforms that cover nearly every aspect of the existing compact. It may all be for the collective best in that country, but we are a long way from just shipping goods under commonly agreed competition principles.
This example explains why Europe has evolved into a far more complex arrangement than just free trade, and why it will keep moving in such a way even if it is not always desirable from an economic effectiveness viewpoint. By the way, it is not just Europe that moves that way, every modern state follows a similar route. This is not to deny that many European countries, and Europe as a collective undertaking as well, have moved too far and ought to reverse gears; the point is simply that a real free-trade area has to deal with such messy things as labour standards, environment protection, tax base harmonization and many more aspects that go far beyond the “liberal” aims identified by Martin.
Should we then debate about these unavoidable implications of free-trade? Should we discuss, yet again, whether a United States of Europe, an aim that Martin summarily dismisses, is the utlimate goal to which all actions should lead? I believe that we should not, for one simple reason: there can be no agreement, only divisive and ultimately fruitless debates. Truth is that no one knows where Europe is going. This does not prevent us from making it work as well as it can. Messy muddling-through is what has been happening over the last fifty years and, I believe, what will go on over the next fifty years.
Posted by: Charles Wyplosz | March 15th, 2007 at 11:32 am | Report this commentRoland Vaubel: Martin Wolf’s eulogy on the European Union is hard to swallow. He rightly praises market integration but he is absolutely silent about “political integration” which is simply another word for political centralisation. By removing the national barriers to international transactions in the common market, the EU has raised efficiency and enhanced economic freedom. But by centralising economic policy making in Brussels, the EU is increasingly suppressing international differences in preferences and needs and is giving the state more power over the citizens and the market because exit becomes more costly and comparisons of government performance are made more difficult.
This is most painfully felt in the field of regulation. The budget of the European institutions is not large because financing has to be agreed unanimously whereas spending is decided by majority. But regulation is almost costless to the European policy makers. Its cost is borne by the private sector.
By now the EU has introduced more than forty labour market regulations – most of them after the Single European Act and the Social Chapter of Maastricht which introduced majority voting on many aspects of social and labour market policy. Empirical research shows that most of these EU regulations are even more restrictive than the most restrictive national regulation had been. The reason is that the governments assembled in the Council act as a regulatory cartel or that the majority of highly regulated countries is given the right to impose EU-wide regulations on the rest. This is the so-called “strategy of raising rivals’ costs”. Remember the working time directive, the works councils directive, the droit de suite directive or the failed temporary workers directive. Other victims of excessive EU regulation are the financial markets, the chemical industry etc.
The analysis of voting in the Council reveals a North/South divide. To quote from one study: “A clear majority of the issues where there are significant divisions between Northern and Southern delegations concern choices between free-market and regulatory alternatives … In general, the Northern delegations tend to support more market-based solutions than the Southern delegations” (Thomson, Bourefijn and Stokman, European Journal of Political Research, 2004).
The model inspiring the European Union is not “the cooperative service state” as Martin Wolf suggests but, quite the contrary, the regulatory state. What he calls “streamlining decision making” is the lowering of the upper majority requirement (from 73.9 to 65 per cent). With a threshold of 65 per cent, however, the temporary workers directive would have been adopted. What is at stake is the freedom of contract in Europe. Any lowering of the majority requirement in the Council is an invitation to raise rivals’ costs by EU regulation. This is not the right future for a declining Europe nor for the liberal British labour market and the City of London.
Posted by: Roland Vaubel | March 15th, 2007 at 3:31 pm | Report this commentMartin Wolf: I want to thank Charles and Roland - a French economist and a German one - for their valuable contributions to this discussion, particularly because they define the extremes of this debate quite beautifully.
Charles takes what one might define as the “French” position: free movement of goods, services, labour and capital creates tax and regulatory competition among countries. High-tax and high-regulation states will then find that they lose economic activity to lower-tax and lower-regulation states.
As I argued in my book, Why Globalization Works, individual states become more like local governments. They can impose higher taxes or higher regulations only to the extent that they are taxing fixed factors of production or use the proceeds to finance location-specific amenities. People may still pay higher taxes to support better schools, for example, if they value the schools sufficiently and can only enjoy them if they pay the taxes. But, given the greater freedom of choice, high taxes and regulations will become less workable.
More highly taxed and regulated countries will then want to spread their regulations and high taxes to all their partners as the price of agreeing to any liberalisation. This is, indeed, what has been happening, as Roland Vaubel points out.
If the majority of states is in favour of relatively high taxes and regulations, the net outcome might indeed be freer internal trade, but at the cost of more onerous regulations in the previously less highly regulated countries. It is perfectly possible that the net outcome for the latter would be worse than the starting point.
This would be particularly likely if the opening is to the world. The liberalisation of financial markets is a case in point. The regulations imposed by intra-European negotiations could lead to the export of the activity from previously less regulated European countries to somewhere outside the European Union.
Roland talks rightly of the emergence of a “regulatory cartel”: high costs are imposed by ministers acting in concert to satisfy the constituencies they care about, at the expense of everybody else, including the wider interests of their own countries. We have seen this consistently in agriculture.
I am very sympathetic to Roland’s arguments. But I am also aware, as Charles notes, that without some capacity to agree common standards liberalisation may be impossible. A balance needs to be struck.
What does this mean for institutional reform in the EU? On this I am also closer to Roland than to Charles and should indeed have made this clearer in the column.
Making it easier for ministers to agree is itself a silly aim if those agreements are likely to interfere with competition. I strongly support unanimity on taxation, for example, where majority rule would prove very dangerous. I would personally want labour markets to be taken outside European purview altogether, but accept that this is impossible now. I agree with Roland that lowering the thresholds for qualified majorities is dangerous. That would make it easier to reach decisions, but the decisions are likely to be the wrong ones.
I agree, too, that EU states are regulatory states. But I would suggest they are also service states. Are these diametrically opposed positions? Only up to a point, since some regulation is surely inevitable.
Nevertheless, on the big divide between Charles and Roland – whether states are by and large doing the right things – I am closer to Roland. As I wrote: “Regulations have proved an inevitable concomitant of the extension of the market economy. But if the price of further liberalisation, at the EU level, is ever more regulation, the game may cease being worth the candle.” So it might indeed be better to call a halt to further liberalisation and forget constitutional reforms than make it easier to reach (bad) agreements.
Posted by: FT Forum - Martin Wolf | March 19th, 2007 at 1:28 pm | Report this commentPatrick Messerlin: I fully share many of Martin’s concerns. The amazing stubborness of European politicians insisting on an European Constitution (despite low popular support for Europe at home, in particular in the three last member states in charge of the EU Presidency) and the attraction to glamourous initiatives (reflecting our still deeply aristocratically minded European societies) are generating a deep sense of a “virtual” Europe – something that fits the elites, not the peoples. Add a big touch of opacity, as recently stressed by former German President Herzog, and it is not difficult to understand why Europe has a “mid-life” crisis.
That said, I would like to underline three points. Firstly, I would not say, as Martin did, that the new members have “chosen” the EU’s acquis communautaire. They were forced to do so, at an uncredibly rapid pace – I believe that the Polish Parliament adopted more than 160 Directives in one day. More importantly, we knew that many aspects of the “acquis communautaire” were unadequate – think about the Common Agricultural Policy. Nevertheless, we insisted not to change our acquis by one inch, and we imposed it on the new members (even though some of them already did the painful reforms that we still have hard time to do, hence they had to undo them when acceding). Which is the appropriate term for describing this approach – integration, benevolent annexion, velvet neo-imperialism? One may wonder why to raise such a point – after all it is the past. It is because the full price for this too rigid approach remains to be seen. A recent comparison between Central Europe and Central Asia raises the possible negative role of the acquis communautaire in terms of growth and macroeconomic balances [Aslund 2006]. In a longer run, it may take some time for the Central Europeans to recover such a blow to their re-nascent governance. And what will be the feelings of the next generation of Central Europeans, when they will be rich enough to look back and realize what happened?
Secondly, my list of things to do will include all Martin’s items. But I will rank “liberate enterprise” first, not third, and I will use the expression “liberate markets of goods and services”. The long-lasting European obsession about rigid labor markets hides the even more urgent (to my view) necessity to make European markets of goods and services more competitive. A more mobile European labor force with too many cozy markets of goods and services runs the risk of letting “freer” workers to go to the goods and services with the highest rents. I feel that too little attention is paid to the proper sequencing of these reforms, and to the high (largely unexpected and indeed hard to grasp) difficulties to create a Single Market (absent the help of new technologies). The recent coming back of a higher dose of harmonization as an approach for hastening the emergence of a Single Market (such as in the case of contract enforcement regulations) or for addressing common challenges (such as in the energy efficiency plan) is another serious risk – ending to more rigidities if enforced, to more virtualities if circumvented (the most plausible situation).
Lastly, Martin refers to the “European decline” as unavoidable. It is certainly the case if one looks in relative terms, and, as Martin points out, it is very desirable in this sense – it means the end of “under-development”. But, should we be happy with his ambiguous “magnificent decline” for Europe? I don’t think so. Europe faces the fantastic challenge to create a governing machinery capable to hold together half a billion of affluent people (the whole world population of the 17th century!) who deeply differ in many respects and choose not to cut with their past. This is a completly uncharted field that Europe will share with India. Why not then to think about Europe as a possibly magnificent rising star – if it invests in this endeavor the intelligence, the energy and the modesty of its founding fathers?
Posted by: FT Economists' Forum | March 22nd, 2007 at 11:56 am | Report this commentMartin Wolf: Patrick has made some excellent points.
First, I agree that accepting the acquis communautaire was hardly voluntary. It was part of the deal. The big question is how much of this acquis was harmful to the newcomers. I would guess that the answer is not so much. The big mistakes made by the central and eastern Europeans were domestic ones: excessive public spending; excessive labour market regulation; and so forth.
Second, I certainly agree on the case for liberating enterprise. Maybe, I should have put this first.
Finally, I agree that if Europe pulled its integration off, it would be a magnificent success. But that is what I meant by declining magnificently.
Posted by: FT Forum - Martin Wolf | March 26th, 2007 at 5:44 pm | Report this comment