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Europe in 1992: threat or promise?

Taking a thirty-year view of Europe 1992, defined as a single market and a monetary union, a protective trade bloc is not expected. However, an open and outward-looking system will be a major competitive threat to the U.S. A single market will require free movement of goods and services and the free movement of capital and labor as well. Three power blocs will emerge: Europe, Asia and the Americas. Goods will move freely among them, but capital movements will be protected. Europe is forecast to be dominant is the 21st Century, with the Americans third.

IN DISCUSSING "Europe in 1992: Threat or Promise?", I believe we should be looking thirty or more years ahead, not thirty or fewer months. My main remarks thus concern developments into the next century rather than into the next decade.

Let me make clear at the outset that I take the broadest definition of the concept of 1992 to include not merely the completion of the single internal market, but also the parallel move to establish a European monetary union. I shall later argue that the blueprint for the single market, which all member governments have agreed, necessarily entails monetary union. Only by retreating from the former can Europe avoid advancing to the latter.

A PROTECTIVE TRADE BLOCK?

Conventional wisdom suggests that the completion of the single European Internal Market by end-1992, or thereabouts, will be a threat to the United States, if that market becomes an inward-looking protective trade block, and a promise if it becomes an outward-looking freely trading area.

The likelihood that it will become inward looking will be increased if Britain, at one extreme, opts out of the Community, as it has from the European exchange rate mechanism, or remains in but obstructs its progress. At the other extreme, if Britain joins fully and enthusiastically into the task of creating the kind of market the original 1985 White Paper envisaged, it will be an open one.

The formation of a protectionist trading block in Europe, from which American and Japanese products and companies are excluded, would be an unmitigated disaster for Europe, which would be less efficient and less prosperous as a result. But it need not be such as disaster for America, since Europe would then be less capable of competing on world markets. America would be wise to stay back and watch Europe's relative decline, rather than retaliate by raising its own barriers to trade. The greater threat to America is a vibrant and dynamic Europe, whose rapid growth accelerates the relative decline in the U.S. economy.

I think fortress Europe is unlikely. I suspect that Britain's attitude to Europe will undergo a sea-change well before 1992. Opponents to European monetary union, which the single market entails, are in a minority, both in the government and in the country. As of now this minority monopolize the top jobs. But given the mess they have made of running, as distinct from reforming, the British economy of late, I doubt whether they will continue to do so for much longer. (I was an Adviser to Prime Minister Edward Heath, so I would say that, wouldn't I?)

1992, and all it entails, is to my mind a more powerful threat to the U.S. than the inefficient Communist system ever was. I believe that it will produce in Europe before the middle of the next century, the largest and strongest of the world's rival economic blocs. Moreover it will do so precisely because it will, so far as trade in goods and services is concerned, remain open and outward-looking.

PRODUCER VS. CONSUMER INTERESTS

The completion of the single internal market according to the 1985 blueprint represents a change of kind rather than of degree. In the first thirty years of the European Community's existence, producer interests dominated its development. The grotesque Common Agricultural Policy is the best, but not the only, example of this. Others include the cartelization of European air and road transport, continued national restrictions on competition in financial services and national public sector procurement programs.

The creation of the single market will tilt the system in favor of the consumer. Although the CAP is not included, most other restraints on intraarea competition are to go, At best, therefore, producer interests are now fighting a rear-guard action to limit their losses by creating Fortress Europe. With reasonable luck they will lose. The European Commission's proposal to open all Europe's markets to Japanese car imports will be an early test case of member countries' free trade credentials.

The consumer is winning on the wider European stage precisely because he has largely lost on the national stage. Continental Europe is typified by weak national governments. Italy, Germany, France, Belgium and Holland all have coalition or minority Governments. (The longevity of the Italian Governments is directly proportional to its inactivity.) None has found it easy to face up to producer or sectional interest groups at home. All their economies, and particularly the German economy, remain rigidly overregulated and inflexible. The result, following the structural changes to the world economy in the 1970s, was miserably slow growth and high unemployment through the first half of the 1980s, dubbed Eurosclerosis. This Eurosclerosis provided the political momentum for a supply-side revolution in the community as a whole. The appeal to the European ideal, now sharply focused on 1992, is the deus ex machina with the aid of which national politicians hope to defeat national sectional interests.

Britain, by contrast with the rest of Europe and with the 1970s, has had strong government in the 1980s. Mrs. Thatcher has pioneered supply-side reform. It is ironic that it should now be obstructing European progress. 1992 is Thatcherism or Reaganomics writ large. But the Thatcher Government fought for a decade first to obtain, then to preserve, its monopoly of power at home. The role of jealous guardianship of national fiscal and monetary sovereignty comes naturally to it, even when that sovereignty is now largely an illusion.

MINIMUM UNIVERSAL STANDARDS

The dominance of consumer over producer interests in the completed single market is enshrined in one simple piece of European law, the requirement that what is permissible in one country must be permitted in all. Thus, for example, if a bank is licensed in Britain to establish a branch network taking retail deposits and also to conduct securities business, it must be allowed to do so in every other member country whatever their own national rules may be.

I call this the American drivers' license system. To drive here one must possess a license, but each state accepts licenses all others issue, regardless of ease with which they may be obtained.

Without this rule, the completion of the single internal market would be an insuperable task. It removes the need to replace all national regulations by European regulations. Instead the Commission in Brussels need only establish minimum European standards on which a weighted majority of member countries can agree. Even so, the completion of the market requires agreement to some 300 directives.

The single market is, however, a misnomer. In a single market there is no need to make the rules the same in each country. There is no need to harmonize such things as value added tax. All that is required is that every European producer should be able to sell on the same terms as any other in each of the twelve member countries' markets. These terms must be the same for every producer but need not be the same in every market.

The single market being created requires the free movement of goods and services, which satisfies this condition. But it also requires the free movement of capital and labor. These are the mobile factors of production. In permitting their free movement, Europe will be creating a single production line. Therefore, producers, wherever they are located, can be expected to compete on equal terms with one another.

Crucial consequences follow from the free movement of factors of production and the American driver's license rule. There will be competition between Europe's rival regulatory, monetary and fiscal regimes over the location of production. Companies located in countries where regulations are the most liberal, taxation the lowest and money the cheapest (which in effect means currency the most undervalued) will have a competitive advantage that they will be able fully to exploit in their sales into all other countries' markets. Regulatory, fiscal and monetary systems inevitably will converge on the most successful. Only the reerection of the barriers destined to be torn down by end-1992 can prevent this from happening. Failing that, progress towards monetary union will occur, whether or no the politicians explicitly will it.

We are at a turning point in history. Reaganomics, Thatcherism and for that matter Rogernomics in New Zealand, have educated and harnessed the power of public opinion on the side of the general interest and against the special interest. It is a force that is now unstoppable, and it extends far beyond the narrow frontiers of the U.S., Britain or New Zealand.

AGE OF THE FREE MARKET

Let us then presume that the true age of the free market has arrived on our two continents. I very much doubt that Japan, with its present political system, can readily follow suit. Then it is doubtful whether the spread of this classical liberalism can be confined in producer-dominated economic systems, in which the consumer has neither the market nor the political means of influencing the use of resources. Its failure has become glaringly obvious to all. It is therefore in East Europe and Russia where the potential gains form the supply-side revolution are greatest. It would be remarkable if, by the first half of the next century, these were not being substantially exploited.

The first decade of the European Common Market's existence was spent creating a free trade area, with all its limitations, within the boundaries of the original six members. Owing to its success, the next two decades were largely spent in the enlargement of the six to twelve member countries. The successful completion of the single internal market will similarly be followed by the extension of the area over which it operates. Western European countries, which have remained outside the Community, such as Scandinavia, Austria and Switzerland, will clamor to join. Austria has already applied to do so. But the process will not stop there. As Eastern Europe and Russia embrace capitalism, so they will inevitably be drawn into the European Community's sphere of influence.

German reunification will not occur in the guise of a return to the nation state model of the 19th and 20th Centuries. That possibility has been ruled out already. Nor will the prospect of German reunification hinder progress towards European economic union. Rather it will take place within, and contribute powerfully towards, the creation of the Greater Europe Economic Community. We are not about to return to rival nationalism but poised to advance to rival continentalism.

I believe that the revolution in travel and in communications, which has already gone far to internationalize the demand and supply of capital in a single global financial market, is the fundamental cause of the consumer-dominated supply-side revolution. One episode of "Dallas" seen by Russian TV viewers is worth to my mind more than one billion dollars spent on political propaganda. Because of it, the days of the small, sovereign national economy are numbered.

THREE POWER BLOCS

It seems likely that in the 21st Century there will emerge three giant economic power blocs, in the Americas, in Europe and in the Pacific. But I think the danger that each of these will be a fortress within which goods and services move freely, but between which trade is greatly restricted, is much exaggerated. Attention instead will be focused on the far greater issue of the free movement of capital.

We are already seeing the consequences of the free movement of capital on the relationship between America and Japan. Exchange rates are now dominated by capital movements. The purchasing power parity theory is defunct. Its role has been usurped by lending power parity, or if you like, asset price parity. Capital movements determine exchange rates. Exchange rates drive trade balances. Countries that have the cheapest assets of the highest returns on capital consequently have the most overvalued currencies and the worst trade deficits.

The theory of comparative advantage can, however, be readily extended to apply to this changed state of affairs. The U.S. is one of the richest countries in the world in terms of natural resources, and in particular in land, the one factor of production whose free international movement is impossible. America's small population, with its high living standards, thus has a comparative advantages in the price of assets relative to the price of products. Japan, at the other extreme, has a comparative vantage in the production of cheap products. So long as there is both free trade in goods and the free movement of capital, the U.S. will sell its cheap assets to foreigners in exchange for their cheap products.

The U.S. balance of payments problem lies in the fact that it is a capital asset exporting country. It therefore runs a persistent and structural surplus on its long-term capital account. So wherever the current account deficit falls too low, because demand in the U.S. is depressed, the dollar comes under intense upward pressure. This can only be relieved by lower interest rates, faster monetary growth and a faster rise in asset prices than in product prices.

Asset price inflation necessarily redistributes wealth towards those who own assets. Because wealth is less evenly distributed than income, it therefore increases the degree of inequality in a community. Product price inflation, by contrast, redistributes income in favor of those who produce. Asset price inflation is thus potentially the more lethal in its divisive political consequences. We can already see this is in Japan.

The three great economic power blocs that I believe will emerge in the 21st Century will differ widely in the comparative cost of assets and of products in each, if only because of their differing natural endowments and populations. The free movement of capital between them will thus ensure large structural trade surpluses and deficits, coupled with major ramifications for the distribution of wealth and of income in each.

I believe that the free movement of trade and of capital are incompatible. But I believe that it will be the ownership of assets that will be protected between each, rather than the movement of goods and services. I see this already happening in the U.S., with the Treasury's proposal that foreign companies seek U.S. government approval for American mergers, takeovers and other investment deals. It is not easy to control the movement of goods when the rewards are high, as the drugs problem amply shows. It is even more difficult these days to control the movement of money. But controls over the ownership of immovable assets in the country in which they are located, is essentially simply and it is popular. This therefore is where the barriers will be erected.

Finally, if we examine the potential of each of the great power blocs to expand over the next fifty years, I have to say that I believe the Greater European economic community will have the edge. The Pacific will win the silver medal and the America's the bronze. This is because I believe that it will be easier to integrate Eastern Europe and Russia into the West European system, of which it was always an integral part until 1971, than it will be to integrate Latin and South America into the U.S. system. So whereas it has been said that the 19th Century belonged to Europe, the 20th Century belongs to the U.S. and the 21th Century will belong to the Pacific, I think that Europe will resume its dominance in the 21th Century, while America will be relegated to third place. This, as I see it, is the threat that 1992 and all it implies must entail.

Brian Reading is London Partner and International Economist, HME Interational Advisory Associates, Inc.
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Author:Reading, Brian
Publication:Business Economics
Date:Jan 1, 1990
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