Printer Friendly

Routes to economic integration: 1992 in the European Community.

ROUTES TO ECONOMIC INTEGRATION: 1992 IN THE EUROPEAN COMMUNITY

1992 is a staging post on the route to European economic integration. For Britain, the real issues are not national sovereignty versus supranationalism, but the choice between a liberal, market oriented path to integration and a planned, centralised one. The paper assesses these options as they arise in regulatory policies, in industrial strategy, and in the monetary and fiscal policies facing the Community. It recognises that there are major policy areas where the creation of a central authority is essential but concludes that the market route is often the right--and the only feasible--approach. This is the third article from members of the CLARE Group to appear in the Review. Future articles will normally appear about twice a year. The Review is pleased to give hospitality to the deliberations of the CLARE Group but is not necessarily in agreement with the views expressed. Members of the CLARE Group are M.J. Artis, A.J.C. Britton, W.A. Brown, C.H. Feinstein, C.A.E. Goodhart, D.A. Hay, J.A. Kay, R.C.O. Matthews, M.H. Miller, P.M. Oppenheimer, M.V. Posner, W.B. Reddaway, J.R. Sargent, M.F-G. Scott, Z.A. Silberston, J.H.B. Tew, J.S. Vickers, S. Wadhwani.

1. Introduction

Britain still calls it the Common Market; most of the rest of Europe uses the term `European Community'. The 1992 programme (for its chief agreed features, see Box A), is however mainly about commercial and financial matters, about barriers to trade and their removal. It is therefore correct for economists in their professional role to ignore the ideals and the ideology, and concentrate on what `will' necessarily happen in commercial reality and what `ought' to happen in the realm of economic policy. Even economists, even British economists, however, cannot ignore the excitement that the prospect of a Europe without frontiers engenders for many people, especially young continental Europeans. This excitement reflects a genuine idealism. It transcends purely commercial effects: but it may also generate commercial effects.

The driving force of national unification was, for at least Germany and Italy, the all powerful patriotic cry of the last century, and the extension of such ideals of unification to much of the rest of Europe is not an unduly athletic leap; and, as for France, while her existence as a modern nation state has deeper roots, she has more recent memories which make the removal of barriers on her German frontier a political issue of far more importance than the pure economics would suggest. It would be insensitive for UK readers to ignore these ideas, and unwise not to anticipate their consequences for the bargaining process.

Yet there are many routes towards political or economic integration, and the present continental urge may be described as Bismarckian--the imposition, fairly early in the process, of a strong central authority on the component parts. By contrast, in the United States (and some would say that the same was true, several centuries earlier, in the United Kingdom) the process was slower, allowed a greater degree of pluralism and diversity, and permitted a process of social Darwinism to spread `best practice' throughout the Union; this we call the Jeffersonian model. It is a continuing theme of this article that often, although not always, the Jeffersonian process may be preferable to the Bismarckian, for both economic and political reasons.

The process of integration can be measured either by the amount of trade between countries or the degree to which barriers have been dismantled. The latter is an elusive concept, but Box B measures the first: economic integration within the Community is progressing, but there is a long way to go before a single market is an economic, as well as a legal, reality. The path towards it can be analysed along three scales. Must common institutions be developed early, or can they be delayed? Must the solutions be centralised, or is a large degree of local diversity possible? Must the solutions arrived at (the regulations, or the commonality of institutions) be tight and rigid, or can they fruitfully be somewhat looser?

Is the best route to integration one which tears down barriers to trade, and leaves the evolution of political and economic structures to follow: or is the development of these political and economic structures a prerequisite to the advance of integration? A `true' Bismarckian approach is tight, centralised and occurs early in the process; the true `Jeffersonian' approach is loose, local and the ultimate Union-wide solution comes, if at all, late in the day. We survey in this article the various issues and cases, and ask which combination of characteristics is appropriate to each particular case.

The history of the USA offers many examples of disputes about jurisdiction between the Union and the individual States: for Europe today, the analogue might seem to be disputes about `sovereignty'. We do not think it is helpful to use that term, or pursue that argument. Any small open economy lives in mutual interdependence with the rest of the trading world; British `sovereignty' in economic policy has been undermined as fundamentally by the growth of trade and international investment as by the supposed machinations of Brussels bureaucrats. It is sometimes better to recognise these facts explicitly, through the institutions of the EEC, or by international organizations with a wider coverage, than to pretend to a continuation of glorious isolation. In any case, the notion of `sovereignty' in economic matters has a flavour of government interference which is perhaps a little dated. On some issues Whitehall and Westminster remain `in charge'; doubtless some will go to Brussels, others to Paris, yet others to Washington; it would be nice to feel that some could revert to UK local government in a way that seems successful in Switzerland or the United States or West Germany. We shall often ask in this article which level of government is appropriate for the exercise of specific economic powers: that is the relevant issue, not standing up for Britain. There is perhaps an issue of democratic control (Westminster tries to control Whitehall, does the European Parliament control Brussels?), but that is a different matter to be decided in a different way: one first start might be a combined effort by the Westminster political parties to interest the UK electorate in the next Euro elections.

What are the likely gains from further integration (or the losses that might be incurred if the changes displayed summarily in Box A were not made?) The Cecchini Report (1988) sets out to analyse this question, and concludes that there might be once-for-all gains of about 6 per cent of GDP in Europe as a whole. The Cecchini estimates (more fully and very clearly described in Emerson et al (1988) and in voluminous appendices), derives the major part of the calculated gain from two sources. One is the increased capacity of a rationalised European industry to secure economies of scale. The second is the equalisation of price levels for certain commodities such as cars and pharmaceuticals where segmentation of European markets at present allows manufacturers to engage in substantial price discrimination. It is assumed that post-1992 prices will emerge at a figure towards the lower end of the range of what currently prevails anywhere in Europe. (Such a change would imply a short-term squeeze on profit margins, possibly to be offset eventually by changes in the pattern of production.)

Whether or not these estimates exaggerate, in our view they do provide a somewhat misleading account of what the true benefits of economic integration are likely to be; we suggest that the benefits will arise more from the increase in competition and diversity and less from the realisation of economies of scale than Cecchini suggests. The degree to which manufacturers will be able to continue to practice price discrimination across European markets after 1992, and the probability that any price equalisation that occurs will be towards the lowest rather than the average of current prices, is an issue which can be resolved only by reference to specific cases. We argue in section 3 that the principal stimulus to improvement will in practice come from the enhanced opportunity for effective market entry into markets which have previously been subject to comfortable domestic cartels.

We turn first in section 2 to the regulatory issues--standardisation of products, restrictions on behaviour, which have so far been a main focus of argument in Brussels. Section 3 discusses industrial policy--what might happen as the market becomes more integrated, and how it should be controlled. Sections 4 and 5 deal with the fiscal structure, discretionary fiscal action, and the monetary framework. Section 6 touches upon some other aspects of Europe which we do not tackle in depth. Section 7 offers some conclusions.

2. Regulation and non-tariff barriers to trade

The contrast between Jeffersonian and Bismarckian routes to integration is nowhere more marked than in the context of regulation. Different European states entered the Community with very different structures of rules governing subjects as various as the minimum standards to be met before a product could legally be described as jam or chocolate, the safety requirements that motor cars must fulfill to be permitted on the road, and the solvency margins imposed on insurance companies.

The Bismarckian approach seeks to lay down a common set of rules for the Community as a whole, thus enabling Eurojam--though far from being a homogenous commodity--to be traded freely in all member states. Jam is a commodity for which this approach proved successful, but there were not many. The attempt to find a common standard for chocolate failed because national chocolate producers, with the support of their governments, sought to promote definitions of chocolate which would benefit their own product and restrict the opportunities available to their competitors. This is a common issue, and a common problem. Different countries historically adopted different standards and different regulations for reasons which reflected national preferences, or simply historical accident. Patterns of local production grew up which reflected these local standards, and so regulations which begin with no protectionist intent come to have that effect. Britain traditionally eats chocolate rather different from that consumed in other member states, and that is what British chocolate manufacturers make. France has a tax regime which favours low quality dark tobacco and that is the type of cigarette which is produced in France.

Free trade allows consumers access to these different products: indeed that is one of the main advantages which it brings. But it raises the issue of different national standards. In the face of these divergencies in preferences and production, harmonisation on any basis is bound to advantage some producers and disadvantage others, and the attempt to secure agreement runs into major political difficulties. And the outcome of this process--if there is one--reflects the balance of political forces not the evolution of the set of rules most appropriate for an integrated customs union. Work to establish a common type approval system for motor cars across the Community continues. Hopes of European standards for insurers remain a far off dream.

The Jeffersonian approach sees harmonisation as a consequence of free trade, not a preliminary to it. In this model, jam which is legally on sale anywhere in the Community may be sold anywhere else within the Community. If jam from--say--Luxembourg is not to consumers' taste, then Luxembourg jam producers will have to modify their product and Luxembourg may be forced to align its jam regulations with those of countries whose jam is more successful. This `competition between rules' is of course very similar to competition between producers (and in this example raises the question of why competition between producers is not enough to ensure that European jam adequately fulfills consumer requirements) and the result should be that superior systems of rules drive out inferior just as better value products drive out worse.

Frequently we regulate producers as well as products. Most Community states have extensive regulation of their insurance industries, ostensibly for purposes of consumer protection. It is at least arguable that the relatively liberal regime in the UK has given British consumers lower prices and a much wider and more innovative range of products. Competition between rules would enable German customers to decide whether they preferred the lower prices and possibly diminished security offered in Britain and would, equally, enable British customers to pay for the enhanced stability of a German company if they thought it worth the price. If, as we imagine, few thought it was worth the price, German insurers would lose business and encourage their government to introduce a regulatory structure more in line with customer needs.

Thus there are two routes to trade liberalisation where national standards differ--the Bismarckian structure of harmonisation of regulatory systems, or the Jeffersonian model of competition between rules. Our choice between the two systems should depend very much on the functions which the regulation is intended to serve. These types of product regulation can be justified on two main grounds--information asymmetry (consumers are ignorant of the quality and characteristics of the product which they buy) and externalities (the product affects users other than the purchaser) (Kay and Vickers, 1988). Public monitoring of the solvency of insurance companies is the result of information asymmetry (the insurer is better placed to judge whether he is insolvent than the purchaser) and, insofar as jam or chocolate requires regulation at all, the reasons are presumably similar. The jam manufacturer knows what he has put in the jam: the customer does not. Here competition between rules seems appropriate. It enables the consumer to choose the regulatory regime he requires and should prevent the continuation of those kinds of regulation common in industries such as aviation and road transport and financial services which purport to protect the customer but have in fact been captured by producer interests.

We do not necessarily want competition between rules, however, where externalities are the issue. First, there are those externalities which are genuinely international in their scope--acid rain, or Rhine pollution, or destruction of the ozone layer. The need for international cooperation and agreement here is clear. Acid rain from British power stations falls in Scandinavia, the Rhine flows through many jurisdictions, and the same ozone layer protects us all. If unsafe aircraft fall from the sky, or kill passengers whom they have picked up in other countries, the results affect not only the country in which the airline is based or where its flight began. So we need common minimum airline safety standards if we are to have a free market in aviation. Individual airlines may, of course, choose to seek a reputation for higher standards.

Next, there is a need for common standards for traded commodities even where the externality is local. Although the domain of a noisy lawn mower does not extend beyond the next street, if different countries have different standards of permissible noise levels, the result may be that trade will be restricted. Producers will typically look first to their national markets: countries that allow noisy mowers will tend to make noisy mowers and those that insist on quiet will manufacture quiet ones. Trade will be inhibited and all countries will see the extension of their standards to the whole Community as a means of gaining competitive advantage. Consumer protection leads to producer protection. Denmark's insistence that beverages be bottled in returnable containers has admirable motives, but is at the same time a remarkably effective measure of domestic protection.

These externalities affect consumption of traded goods. Where there is no potential barrier to trade, there is no need to promote common standards and much to be said for divergent ones. The Community is right to promote common standards for car emissions, but it is difficult to see why it should seek common levels of water quality. If consumers in East Anglia are unwilling to pay for the cost of removing nitrates from their drinking water, they should not be deprived of that choice because Germans are willing to pay the higher costs of reducing their nitrate levels. It is very likely that Greece and Portugal will be ready to accept lower environmental standards than Denmark: that is an inescapable result of their lower income levels and, to a degree, a means of combating it. The Community has enjoyed a political success by recognising public concern for environmental issues ahead of many member governments: we should, nonetheless, distinguish between those environmental issues which are appropriately tackled at Community level and those which are not.

Trade is also inhibited by historical differences in standards in different countries (Kay 1989). The French drive cars with yellow headlights, and have a different system of television transmission. The British drive on the left-hand side of the road and use three pin electrical plugs and sockets. Some of these differences are imposed, or reinforced, by laws or regulations. Many are private rather than legal requirements. The most fundamental and far reaching of differences in national standards--the nine different languages of the Community--is of this kind.

For these, an ad hoc approach which combines elements of competition and centralisation is appropriate and inevitable. There is merit in common standards, but often the most successful means for standards to evolve is through market competition. There is a world standard in personal computers, and in video cassette recorders, which is the outcome of consumer decisions, not official fiat. We will never agree on a community or a world language: but the spread of English is ineluctable. After extensive negotiation we have still not succeeded in implementing a common structure for electronic funds transfer at point of sale, although the system has been technically feasible for years, while the success of a liberal regime for mobile telecommunications in the UK is forcing Europe to follow the British standards. Much of the difficulty is again that firms see negotiation over standards as a source of competitive advantage. The attempt by European and American firms to stop the Japanese from exploiting their technical advantage in high definition television is all too likely to lead to a fragmented world market and to inferior provision for consumers everywhere. In other cases where standards differ, the costs of convergence may exceed the benefits. It would be better if we drove on the same side of the road as our European neighbours and most of the rest of the world, and if we could start again no doubt we would, but we cannot start again.

The Community's approach to regulation has increasingly reflected the implications of this analysis. For long, the primary concern was the--rarely successful--promotion of harmonisation. A major ruling by the European Court in the now famous Cassis de Dijon case paved the way for the `new approach' adopted in 1985. The Court ruled that goods which were legally on sale in any community country could validly be excluded from another only on grounds of safety or consumer protection. A framework directive, designed to cover these issues, may then be implemented by member governments or by national or European standards organisations. These may extend the scope of the agreed standards but such extensions cannot legally be used as a basis for excluding products from other member states.

Thus the history of Community regulatory policy reflects the triumph of Jefferson over Bismarck: of political realism over European utopianism. In other areas of policy, however, the battle lines are still joined.

3. Industrial policy

For any differentiated product, there is a tradeoff between product variety and price. If we were all willing to read only one book, its price would be very low. But there are still many fewer books on the market than there are potential titles: the limited size of the potential market, given the many other books which already exist, makes the production of many additional titles uneconomic. The larger the market, the better are the terms of the tradeoff between scale and variety. Readers of English are offered a wider range of books and lower prices than readers of Dutch.

Market expansion therefore potentially permits both greater variety and lower prices (see Geroski, 1989). If consumer preferences demand variety, most of the benefits of economic integration will take the form of wider product ranges within national markets reinforced by the gains from more extensive competition. If there are major scale economies, then concentration of production into a smaller number of lower cost units is the likely outcome. Thus just as there are pluralist and centralist alternatives for the political development of the Community, so there are pluralist and centralist alternatives in the organisation of European production. Moreover, these choices translate into public policy options. To what extent should European industrial policy emphasise the need to sustain competitive forces, and to what extent seek to stimulate the development of European champions?

These choices depend on the rate at which cost and variety may be substituted for each other, both by producers and in the minds of consumers. Much popular discussion of the probable effects of 1992, and the Commission's own survey of the evidence, lays considerable stress on the potential for scale economies; more, in general, than the evidence produced there would seem to warrant. As far as production is concerned, the list of goods for which the `minimum efficient scale' of operation exceeds 20 per cent of the established national markets of the major European economies is quite a short one. Aircraft, chemicals, electric motors and paper are those listed, and since all of these are very heterogeneous products, even that list lacks conviction.

Nor does the existence of unexplored economies of scale demonstrate that there are always benefits from rationalisation or that such rationalisation is a probable result of further integration. Because of the magnitude of design and development costs in the car industry, for example, costs fall more or less indefinitely as the volume of production rises. It does not follow from this, however, that further integration of the European economy is likely, by itself, to promote further rationalisation in this industry. There would be apparent `savings' from such rationalisation, but similar savings would potentially be available from equivalent rationalisation in the integrated markets of Japan or the United States. Although the European market remains heavily segmented by the persistence of substantial price differentials between the UK and continental states, the European car industry is already almost completely integrated. Further rationalisation does not take place because revealed consumer preferences are for a wider model range at higher prices. Indeed, it is fortunate for the European car industry that this is so, or else it would already have disappeared in the face of competition from lower cost Japanese producers.

There are, however, some major industries where reorganisation of production on a European scale promises substantial benefits. Particularly prominent among these are those industries where nationalist public procurement polices have supported an excessive proliferation of European producers--in industries such as power generation equipment and public switching systems for telecommunications. The rationalisation of these industries into a smaller number of effective competitors may offer both lower prices to European consumers and better prospects of meeting effectively challenges from Japan and North America. We would not, however, wish this to be confused with the reproduction on a European scale of the protectionism which has so rarely proved a successful policy when implemented by national governments. The objective is to promote European production where production at the European level is efficient, not to promote it as an objective in itself.

In some industries, the main benefits from 1992 will result from the promotion of a more competitive domestic environment. In retail financial services, for example, the likelihood of extensive market interpenetration is not great because of the local knowledge required for effective provision. But the potential threat of new entry, and the relaxation of local regulations which is necessary to permit that, is likely to undermine the cartel structure which characterises many sectors of this industry in several Community states (Davis and Smales, 1989). Many of these benefits would have been gained by unilateral action, but it is the existence of a Community dimension which has brought them about in practice.

It should be apparent that there are some industries where integration should, and will, lead to greater centralisation of European production: others where it will not. Our overall judgement, however, is that much of the public discussion of the impact of the 1992 programme overestimates the contribution of scale economies and production rationalisation to the growth of the European economy and underestimates the extent to which the benefits of integration are the result of the extension of variety. We feel that policy, too, should stress the latter rather than the former.

This gives added importance to the Community's competition policy. This is based on Articles 85 and 86 of the Treaty of Rome: Article 85 prohibits restrictive agreements while Article 86 outlaws the abuse of a dominant position. In contrast to Britain's domestic competition rules, which require enforcement by an administrative agency, Articles 85 and 86 can be enforced not only by the European Commission but can form the basis of private actions, which can now be brought in the British Courts as well as in the European Court of Justice. The promotion of corporate restructuring as an aspect of the 1992 programme gives a special importance to merger policy.

Already, most member states operate such policies domestically. Britain and Germany have a well-developed structure of institutions, while in several other countries government influence is exerted more informally, but not necessarily less powerfully. As the European economy becomes more integrated, the number of mergers with a European dimension is likely to increase.

There are several possible aspects to this European dimension. The case for a European merger policy is clearest where the merger involves, or would create, a European company (as distinct from a British, or German, or American company, which operates in a number of European countries). While there is much general discussion of the possibility of this style of operation, there are very few current examples, or specific proposals. Indeed the best examples of truly European companies are still the products of two great Anglo-Dutch mergers which created Unilever and Royal Dutch Shell. The complex legal structures which these companies require is one obstacle to true transnational operation, and one which a European company statute may (to a degree) remove. When Britain entered the EEC, it was assumed that such combinations would become more frequent, and the Dunlop-Pirelli Union was seen as the precursor to many similar proposals. It was not, and the Union itself collapsed. The most important European merger of this type in recent years--that between ASEA and Brown Boveri --brought together Swedish and Swiss corporations, outside the EEC. The problems of achieving synergy between two established firms with different cultures even within a single country are well known, and by no means always successfully tackled, and the obstacles to integration when different national backgrounds and languages intervene are considerable (the business of senior management in Asea Brown Boveri is conducted in English). Business is likely to conduct itself in the Jeffersonian model, even if some elements of the Commission and some large companies would like to see it otherwise.

A Jeffersonian would go on to observe that, for the foreseeable future, trans-European mergers will involve the acquisition of a smaller company in country A by a larger company from country B, and ask why control by the authorities of country A is inadequate to meet the situation. Such an issue may arise when there is an effect on European competition which is distinct from that on domestic competition. The acquisition of Rover by British Aerospace fell into this category, and here the differing requirements of British and European competition authorities were appropriately mediated. Intervention may seem necessary if control by country A is simply inadequate in its own terms. Thus the Commission felt (rightly in our view) that the safeguards and mechanisms for their enforcement which the MMC imposed on BA's acquisition of British Caledonian were insufficient to protect (principally British) consumers. While the effects of the Commission's intervention were beneficial in this case, the existence of multiple jurisdiction over the same issue is costly, both administratively and to the firms concerned.

Merger is much easier, and occurs much more frequently in the UK than in other member states. This is a reflection of broader differences in financial structures. The stock market is a more important institution in the UK than elsewhere: the changes in corporate management and corporate structure brought about by takeovers in Britain are effected by other means in other countries in the Community. Arguments for reciprocity--UK firms should be open for acquisition only by firms which are themselves vulnerable to takeover--are without economic merit except occasionally as a useful bargaining ploy.

Under the proactive Commissionership of Peter Sutherland the incidence of Community involvement in merger proposals increased substantially, and Sir Leon Brittan has inherited with that portfolio proposals for a Community mergers directive, which would transfer scrutiny of most large mergers and those involving companies trading in several Community countries from national governments to Brussels. Since powers already exist (principally under Articles 85 and 86 of the Treaty) to introduce the European dimension in cases where that dimension is relevant--and the examples above illustrate how this has been done--the mergers directive reflects straightforwardly the conflict between centralism and pluralism in Community policy.

4. Fiscal Policy

(a) Fiscal structures The completion of the internal market requires adaptation of tax systems in member states to allow the removal of fiscal frontiers. It is necessary to limit cross-border shopping by consumers to take advantage of lower rates of VAT and excise duties, to find mechanisms for enforcing VAT on transactions between traders, and to regulate trade in products--particularly tobacco and alcohol--which are subject to high rates of excise duty.

The Bismarckian approach here involves the creation of a common fiscal system, at least for indirect taxes, for the Community as a whole. The Commission's approach comes close to this, though falling somewhat short of it: it is described as convergence by reference to points of departure rather than points of arrival. Thus `it must be clearly understood that the present package is not an attempt to design an ideal fiscal system for the Community, but a blueprint for abolition of fiscal frontiers'. These phrases are designed to convey that the basis of the proposals in the 1985 White Paper was not an attempt to find the best structure for an integrated Community, but rather to seek consensus on an average of existing Community systems.

For trade within the Community, the system of refunding VAT on exports and levying it on imports would end. Instead a British manufacturer using goods imported--from say--Milan would reclaim Italian VAT in the course of completing his British VAT return just as he now reclaims the VAT he pays on goods shipped to him from Manchester. The British government would then recover the VAT from the Italian government through a settlement procedure. Frontiers with Europe would thus be irrelevant to the administration of VAT.

This system does not require that Britain and Italy charge VAT at the same rates (Cnossen and Shoup, 1986), although it is marginally more robust to fraud if they do. Large differences in rates would, however, encourage cross border shopping by private individuals. In order to deal with this, the Commission has proposed a common VAT base throughout the Community with two rate bands--a higher rate between 14 per cent and 20 per cent and a lower one of 4 per cent to 9 per cent on goods such as food and fuel.

Differences in rates of excise duty on alcohol and tobacco across the Community are currently huge. In the absence of other measures, the disappearance of fiscal frontiers would lead to substantial commercial and personal `import' of taxed commodities from low rate countries, with major revenue losses for the countries affected. The Commission's proposals to deal with this required community-wide harmonisation of excise duties. (COM (87)320).

The implications of these proposals for both the structure of taxation, and the revenue position of member states, were very considerable. For Denmark and Ireland, in particular, there would be major losses of indirect tax revenue. In the UK, the overall revenue impact would be small, with the reductions in rates of tax in tobacco and alcohol compensated by increased VAT revenues, primarily from food. In the Mediterranean countries, there would be substantial rises in excises, particularly on tobacco and, in some cases, spirits. (Lee, Pearson and Smith, 1988).

The British government has put forward an alternative Jeffersonian model, relying on market forces to secure convergence. If fiscal frontiers were simply removed, without further adjustment, then high tax countries would have to choose between reducing their tax rates or accepting loss of trade to other EC states. For tobacco and alcohol, such a solution is obviously impossible: the result would simply be that all trade was routed through the member state with the lowest tax rates, with the result that all countries would be obliged to charge the lowest rate imposed by any. The proposal is less impracticable for VAT, where the problem here is largely confined to cross-border shopping by individuals. This has been significant in certain areas of the Community (particularly around Luxembourg and in Ireland) but is unimportant elsewhere, particularly for those countries (such as Great Britain and Greece) which have no common land frontiers with other EC countries.

It is apparent, then, that neither a pure Bismarckian nor a pure Jeffersonian approach is likely to work. The centralist mechanism breaks down on the unwillingness of member states to accept either the revenue implications of the changes or the losses of sovereignty involved: the competitive approach imposes equally unacceptable changes through forces which are largely arbitrary in incidence. Until the end of 1988 it appeared that the intransigent commitment of Lord Cockfield to a package which lacked political realism was a major obstacle to the realisation of the 1992 programme as a whole. (Kay and Smith, 1989).

In 1989, however, a new French Commissioner was appointed, and Mme Scrivener's recent communication to the European Parliament holds out the prospect that a compromise which contains elements of both competitive and centralist approaches may be reached. Such a package would involve aligning those features of tax structures in geographically contiguous states which would otherwise give rise to cross-border shopping issues, while otherwise allowing existing administrative structures and politically important measures which have no potentially significant effects on European trade (such as Britain's zero-rating of food) to continue unchanged. Trade in alcohol and tobacco, already the subject of extensive regulation to protect tax revenues internally as well as internationally, would be the subject of special rules.

The disappointing progress towards integration in the area of fiscal policy is a good illustration of the problems of pursuing a centralised approach in an area in which the central authority is very weak. In corporation tax, for example, extensive discussion of harmonisation has produced one draft directive in the 1980s--a proposal to make uniform the period for which losses can be carried forward. Such a proposal is not only insignificant when countries differ radically in systems and rates of corporation tax, but can have no impact whatever on trade. The evolution of fiscal policy has been characterised by the problem that since there little no prospect of action on harmonising things which are important, energy is then devoted to harmonising things which are not, with results that do little for the reputation of the Community or the cause of European integration.

(b) Discretionary changes The more open an economy, the greater its macro-economic interdependence with others; and the more its trading relations (and any international mobility of labour) are clustered within one particular group of countries, the greater the interdependence of that group. Such a group or `area' will tend to draw benefit from the operation of a common currency (or tightly pegged exchange rates) and will also find it useful to operate a greater degree of `coordination' of fiscal stabilisation policy than is habitual for the trading world as a whole.

That general proposition requires qualification. There are costs as well as benefits from operating a common `fiscal area' or a common currency, and the point may therefore be better expressed by the suggestion that there is some (fairly high) degree of interdependence at which the benefits do begin to outweigh the costs: `Europe' it is suggested is beginning to register that degree of interdependence, although it may not have reached it yet.

As regards discretionary fiscal policy (stabilisation or counter-cyclical policy) most governments are now substantially more sceptical about the desirability of frequent, discretionary, adjustments of tax rates than were the `Keynesian' textbooks of the 1960s, implying that the pay-off from coordinating such adjustments are also less. Nevertheless, the pay-off from successful countercyclical actions can be large relative to the hoped for gains from economic integration and any arrangement for coordinating or centralising such policies should not gratuitously make them less available or less effective. In general, the necessary degree of mutual compatibility of both fiscal and monetary policy can often be achieved by `follow my leader' (the leader being the most successful of the large partners) rather than by formal `coordination'; although the necessity for explanation and justification at regular private meetings of Ministers or high officials should not be underestimated as a way of putting some intellectual pressure on the leading institutions. Once, however, the general context has been set by the leader, or by the big boys working together, that context provides the state of the world into which the individual policies of other countries can be fitted by the normal operation of the invisible hand--everyone pursuing their own best interests may ensure a moderately good outcome for all.

Whether or not decisions about stabilisation policy are centralised, it is difficult to see any argument for identical, simultaneous changes of tax rates in all countries; the economic cycle will surely for some many years yet be differently timed in, say, Denmark and Greece, and the effects of structural changes (for example in rules for financial institutions) may pull one country out of synchronisation with its partners. Significant losses in economic performance might therefore be registered if Europe moved at all quickly (any time in this century?) to a system of legally enforced centralised uniformity of fiscal measures. And since the size of such discretionary changes in tax rates is bound to be small, their effect on trading patterns (through any short-term disturbance of fiscal structure) or balance in the European labour market would surely be small as well: 2p on the standard rate of income tax or 2 percentage points on the VAT rate, imposed for stabilisation purposes, will not upset trade flows or stimulate a sizeable emigration.

All this suggests a slow, informal, even decentralised approach to the coordination of fiscal policies. While there might be overriding considerations against that sort of conclusion in the case of monetary coordination, to the consideration of which we now turn, there seems no reason to press for Bismarckian moves on fiscal affairs. Such steps would wait for what the Delors report calls `Stage Three' of monetary and fiscal integration and in narrow economic terms is unlikely to be necessary or even desirable until well into the next century.

5. Monetary integration

Today, in both the UK and the US, there is a single unified monetary mechanism, capital market, central bank and currency. In the 19th Century both Germany and Italy moved to establish such mechanisms, in response to political changes and in parallel with moves towards internal fairly free trade (de Cecco and Giovannini, 1989). On these analogies, common sense suggests, and economic analysis does not wholly deny, that a `common money' should accompany a `common market' the whole to be managed by a `Community Finance Minister' and a `Community Bank Governor' responsible to a Community Parliament; the Federal Europe which is the dream of some, the nightmare of others.

The Bismarckian case for reaching that system promptly, say in the next decade, is put sometimes in a wholly political way (for instance, the US has the dollar, Japan has the yen, Europe needs its own currency); the economic case is that if Munich is to be regarded as part of the home market by a firm in Leeds, currency uncertainty and obscurity needs to be removed. There are other arguments, for and against, as we set out below: but that simple point is of the essence. Europe would move faster towards the advantages of a `single market if it had an early prospect of a single currency.

Analytically, there are at least two alternatives to a common currency. First, we could envisage a set of stable-in-isolation monetary systems, tightly united by a gold standard with fixed but occasionally adjustable parities (or possibly by a Keynesian-type Federal super-Central Bank which would determine the rate of creation of the high-powered money that should be the sole acceptable reserve asset of the constituent banking systems). Essentially, such a system would be an extension of the existing exchange rate mechanism (ERM) of the European Monetary System (EMS), uniting all members of the Community. Secondly, and even more bravely, it is possible, as a sort of schoolroom exercise, to describe an integrated trading system of countries with quite separate banking systems and variable exchange rates; countries which were forced into frequent depreciations might eventually be led by internal democratic pressures to change their governments--there might be a sort of competition between different monetary policies--but there would be no need to insist on such a convergence at the beginning of the process, and no need even to see it as a necessary destination. The Delors report effectively ignores these alternatives, presumably on an implicit political judgement that they are impossible. No doubt the British Government will dispute that judgement strongly over the next year.

We do not pursue this argument at length here. As regards the second option, it is hard to convince anyone--even economists--that the extreme fluctuations of recent years in the DM/[pound] rate have been desirable; and the enthusiasm of governments and electorates for unified trading markets would diminish sharply if they thought that trade unification would be accompanied by currency fluctuations of that dimension. Most of those concerned with the management of macroeconomic policy would feel similar doubts. But of course to say that an international system should permit fluctuations in exchange rates is not to say that it should require frequent and large fluctuations. The question thus becomes quite complex: which system would generate more fluctuations--that which `forbids any' changes of parities without agreement between members or that which `allows all' movements? And, if the chosen alternative is to forbid exchange-rate changes, would it not then be better to go the whole way with the Delors report, and opt for an eventual common currency?

Irrespective of the answer to that set of questions, there is the simpler issue of timing. Whatever degree of monetary integration is to take place, should it come early or late? Historical experience gives no decisive guide. In the UK, it came early in the evolution of the modern economy, but slowly; in Germany, very late in calendar time, but early and abruptly in relation to the Zollverein and political events of the mid-19th century; in the US, early, and with a degree of flexibility, Analysis suggests two major considerations, which are central to the concerns of this paper.

Any increase in trade must be expected to generate increased trade imbalances--perhaps most strongly between the European centre and its peripheries. Such imbalances must, by definition, be financed; and one simple `story' would allow the counterpart finance to take the form of an inflow of investment funds that, in the long run, would enhance the deficit area's ability to export, and hence redress the original imbalance. Currency risks tend to inhibit investment flows and hedging in futures or options is not an effective response. Would locked exchange rates, or a common currency, make such investment flows more attractive? Yes, to some extent, but if currency risks are chiefly the counterpart to inflationary risks, this point is of dimished importance.

In any case, a second consideration points away from monetary integration, whether a common currency or a tightly locked EMS. The Delors system for the European economy would impose a new set of constraints whose combined effect might make it difficult to generate any desirable outcome. The different countries of Europe differ substantially in their ability to compete. Whatever initial set of exchange rates are chosen for the common currency or ERM, economic development is likely to generate circumstances in which some countries will find themselves with excessive absolute advantage in costs, prices and all other relevant features of their product range--design, modernity, etc. Other countries will be at the other end of the scale. Investment flows will deal with part of the problem; convergence of efficiencies will deal with other parts; but the three key variables that need to carry most of the burden of adjustment are labour practices, the price of labour in local currency, and the exchange rate.

A common currency would seek to remove the third element of flexibility; aspects of the `social charter' may make the first option increasingly unusable; the flexibility of money wages would, in the Delors system, be the sole acceptable pillar on which economic Europe is supported. Writing from the geographical standpoint of the UK, and with the historical experience of the last few decades in mind, that pillar looks too weak to bear the load.

Admittedly, neither reflection on the last 22 years of international economic policy making (dating from sterling devaluation in 1967), nor the results from much econometrics and model simulations, leave much room for optimism about the use of exchange rate depreciation to force down excessively high real wage costs. If Monsieur Delors did have his way, and Europe abandoned such an option irrevocably, policy makers would not thereby throw away a proven and reliable instrument. (The use of currency appreciation to guard against imported price inflation has perhaps more to be said for it). Nevertheless, unless the gains from early currency unification are very substantial, it would be unwise to throw away any potential instrument of policy: the armoury of weapons to deal with trade disequilibrium is not very rich.

Perhaps the Community can generate other policy instruments: it is hard to see that they could be generally attractive or useful. For instance, regional policy as a way of redistributing wealth may have political attractions to many; but as a way of `picking up the pieces' when labour market rigidities have failed to allow sufficient variation in real efficiency wages between regions, it is analogous to the provision of ambulances when what we need is better engineered roads or slower cars.

So far the run of the argument seems against haste in monetary matters. What, then, explains the more favourable position adopted by many, both in banks and in governments? One consideration is that, in practice, the ten ERM countries are already locked into a DM bloc; recent moves may, for some, represent an attempt to find a convenient `Community' garment to cover the relative unattractiveness of that arrangement to both Germany and her partners. Another explanation is analogous to that found within individual government departments in many countries; the key levers of power, it is always feared, by Ministries of Education, Industry, Trade and so on, are held by the bankers and the Ministers of Finance; Brussels will have no influence on the course of events until there is a Directorate General dealing with those topics, and a committee of the European Parliament which can summon bankers to appear before it as do Congressional Committees in the United States. On this view, the alternative to a European voice in financial and monetary matters is not 12 national voices, but no voice at all. And perhaps a final push to integration is the hunch--the informed judgement--that further removal of trade and migration barriers will not take place until the process is given a `kick' from the monetary and financial sector. Such an argument cannot be stigmatised as `nothing to do with economics'--it is advanced by those who believe they understand how economic events are caused; but it is in its essence a political argument.

These considerations cannot, in our view, overturn reluctance to go far or fast towards monetary integration now. There is, however, a different type of question which is of relevance. Its point of reference is not the future of monetary integration in the full sense, but the immediate policy options facing the UK Government. Whatever the long-run balance of argument, it asks, is there not now an immediate practical case for joining the ERM?

For reasons which at the time seemed good, many British economists, from the early 1970s onwards, accepted that a `nominal anchor' for economic policy was highly desirable. If one aim of policy was to control inflation, it was thought insufficient to say `we shall attempt to stop the retail price index from accelerating'--some intermediate target, to which policy instruments can be more tightly assigned, was appropriate. Monetary aggregates were fashionable for a time; for a variety of reasons, the exchange rate is, in the minds of many, a better variable to target. The economic reasoning is sometimes complex; but the political economy often resembles closely the policy stance of the 1950s and early 1960s, when the defence of the parity enforced fiscal or monetary `stops' with the aim of constraining demand, output, prices and wages. It is held by many that France, for instance, has found it possible to constrain wage settlements, and hence moderate price increases, over the last few years in part because of the general acceptance of the existing exchange rate with the DM within the EMS.

The more sceptical one is about the necessity of achieving the `correct' exchange rate for trade balance reasons, and about the ability of policy makers to influence real wage costs by exchange-rate manipulation, the more attractive such a mechanism seems. But the circumstances in which the `anchor' is cast overboard, the general state of confidence of the markets, the domestic pressures still working their way through the financial system--all these are important practical issues. And some might doubt whether the adoption of a new intermediate target--or of any intermediate target at all in current circumstances--is opportune. No doubt an underlying rate of inflation of 5 per cent or more needs to be corrected, and a squeeze needs to be applied in a steady and persistent manner. But to join ERM today with a `Spanish' margin of variation of 6 per cent is unlikely to help that process much in the short term: to join immediately with a narrow margin would seem rather rash.

These are essentially `political matters--matters of timing and policy and the composition of convincing packages. It seems unlikely to us that British problems will be magically solved, nor dangerously magnified, whatever immediate choice is taken on the ERM. The underlying questions of current counter-inflation policy have to be addressed on their own merits, and discussed fully.

Our exploration of both fiscal and monetary considerations lead us to recommend a `slow lane' for Europe; willing to move, seeing the case for an eventual substantial degree of locking of exchange rates and even perhaps eventually a form of monetary union; but insistent that the system contains sufficient degrees of freedom to allow relative monetary adjustments between countries for many years--possibly several decades--yet. There are quite possibly gains to be won on the trade side by speeding up, but we doubt whether they outweigh the consequential losses in flexibility. And on fiscal policy, in particular, we are very Jeffersonian.

6. Social and regional dimensions

The sooner the removal of the remaining barriers to trade is complete, and the larger the proportion of economic activity which is tradeable, the greater will be the competitive pressure on the less efficient enterprises. Agricultural policy, which aims to protect particular, regionally located `farms', and public sector employment; and employment in enterprises supplying services which must be consumed locally; all these will serve to mitigate the consequences of such pressure and to some extent will also inhibit competitive forces themselves. An inefficient manufacturing enterprise in a peripheral part of the unified market may succeed in maintaining its sales by passing on the competitive pressures to its own local suppliers of services or its local landowners. But there will be an important residual pressure that must be passed on either to tied local consumers or to the industrial labour market.

In a Jeffersonian system, that could result in longer hours, more burdensome patterns of work, worse working conditions, even greater `effort' in the less efficient enterprises (often but not always, located in less advanced regions). But the more successful are, for instance, German trade unions in securing Community wide regulations that forbid continuous shift weekend working, the less possible will it be for Spanish entrepreneurs to compete by forcing continuous shift working on their own labour force. It is a familiar irony that Spanish trade unions vigorously support the social policies of their German confreres.

It follows that competitive pressure will need to make a residual impact on interregional differences in real pay costs per employee and to a large extent on pay rates when expressed in a common currency. Of course, we all hope that `convergence' of productivity levels across the Community will eventually mitigate the problem: but it would be foolish to expect such convergence within one or two decades. If levels of real pay must continue to differ across countries in response to competitive pressures, then either there must be good, flexible labour markets with regionally differentiated pay; or there must be room for substantial currency flexibility between regions. We have discussed some implications of the latter issue in section 5. Fortunately, so far pay bargaining has been a purely `national' matter: long may it remain so.

This labour market dimension has stimulated much controversy. In part, it is indeed pure politics. In much of Europe (certainly France, Germany, Italy,) the spokesmen for organised labour are still treated with the respect and attention which is now regarded as `corporatist' by much of the political establishment in the UK. No major constitutional or economic change (and `building Europe' is certainly such a major issue on the continent) could possibly be considered without the acquiescence of the social partners: sometimes allusion is made to Polish experience to provide illustration of the truth that no economic policy, however objectively necessary or desirable, can succeed without consensus.

It is therefore a political necessity (not just a bureaucratic consequence of the Committee structure in Brussels, or the political accident that a French social democrat is currently the Commission's President) that requires, for many European countries, a social dimension to 1992. Some of the matters under consideration have nothing whatsoever to do with trade or payments: for instance, `worker representation' on Boards of Directors happens to be a feature of German management structure, and in light of the long history of political squabbles on this question in the UK, it is only natural that the TUC should attempt to resurrect the ghost of the Bullock Commission to tease Mrs Thatcher. An attempt will certainly be made to force the UK into corporatist gestures which are anathema to our present government. Careful diplomacy and tough sounding ministerial speeches will allow us to escape most of the traps. In economics, and even in management practice it is unlikely to matter very much either way.

But other aspects of `social Europe' are important. The easement of marginal incompatibilities of social security systems and entitlements is essential to labour mobility. Franco-Swiss political friendship across their common frontier is as strong as friendship between France and Germany across the Rhine; but for Swiss people to work in France is far harder than for Germans, because labour regulations and social insurance are already largely harmonised within the Europe of the 12. More remains to be done, and difficult political questions abound; for instance, almost all European countries have their own favoured source of `Gastarbeiter' and ultimate replenishment of the stock of citizens from third countries (Commonwealth citizens in the UK, Algerians in France, Turks or Yugoslavs in Germany)--should barriers remain for the intra European mobility of these people, and if so, how? At present `guest-worker' status in one country gives no rights elsewhere: but this rule has implications for immigrant procedures which tend to perpetuate barriers between Community countries.

The removal of commercial barriers can bring economic benefits without factor mobility across frontiers: but Europe of the 12 is absolutely committed to a fuller integration on a pattern which has always held in the USA (even in Jefferson's time, and more so after the Civil War) and it is now in Europe just not possible to envisage the one without a good measure of the other. Economists have no reason to object to that. Standardisation of labour practices to the best (? West German) standards is however, another matter. We have already noted that diversity of working practices is one way of compensating for differences in efficiency; the more Brussels enforces homogeneity, the greater the burden to be borne by differences in money wages. This consideration must push an economist in the Jeffersonian direction on this set of issues.

Continuing effort is made by the Brussels Commission to further Regional Policy. This is not bureaucratic meddling for its own sake: there are certainly some Member Countries who are poor, whose infrastructure is weak, and whose educational system is not up to the European best. When `Europe' was six countries, the problem was small: in Europe of the Twelve, it is the Council of Ministers and the Parliament which pushes Regional Policy. But within richer countries there are poorer regions: by natural extension, lobbies develop to speak for Calabria and Belfast as well as for Greece or Portugal. 1992 will bring increased pressure for `Community spending that will allow the peripherals to compete on level terms'. The economists' concern must be to insist that regional subsidies are spent wisely, not wasted. Those with Third World experience will fear the worst.

7. Conclusions

The process of economic integration in Europe is both inevitable and desirable and is one which is bound to undermine the capacity of any country to pursue independent economic policies. But integration cannot be imposed: the actions of the Commission and the Council of Ministers can help it--a bit--or hinder it--a bit--but that is all. And 1992 should be seen in this context. It is a staging post on the road to integration and in many respects a rather minor one: certainly the likely benefits to trade from the programme are small relative to those which were involved in creating, or entering, the Community in the first place.

If M Delors' proposals are too Bismarckian, those of Mrs Thatcher are insufficiently Jeffersonian. Argument in defence of national sovereignty or in assertion of supranational authority, distracts from the substantive question of what kind of European Community we want. We regret the way in which, earlier this year, the strident tone of some British governmental speeches has diminished British influence over the directions in which the Community evolves. We deeply hope that a new leaf has been turned by the UK since the Madrid summit.

Whether the topic is regulation, or industrial policy, taxation, or fiscal and monetary policies, the real issue is not states rights versus Brussels, national sovereignty versus multilateralism, or even decentralisation versus centralisation. On some regulatory issues, the promotion of a common European standard is one of the great potential achievements of the European community (many environmental issues). In others (many areas of financial services or electronics) it is little more than a device for protecting weak sectors of European industry against competitive forces: the right procedure is to pull down trade barriers and let common standards evolve. In tax policy the task is to identify those areas (currently quite limited aspects of indirect taxation) where free trade really does demand convergence, and let the areas of harmonisation develop as integration proceeds.

And in monetary and fiscal policy, the central need is to keep the development of central institutions and effective integration in line with each other. If we promote the evolution of common currencies ahead of the growth of trade between states, we risk exacerbating income inequalities within the community and imposing strains on central institutions which they lack the capacity to bear. The removal of trade barriers in 1992 does not make a common currency either necessary or desirable although its consequences ultimately might. As integration advances, the capacity of individual governments to pursue independent policies diminishes whether they like it or not, and to fail to recognise this institutionally is to give up such limited influence over economic events as is now available. In this context, an argument about national sovereignty is simply an irrelevance: the UK's posture has been not that of Jefferson, but of Robert E. Lee, and we risk enjoying a similar position in the eyes of history. The better course is to fight for a liberal Europe.

BOX A CHIEF AGREED FEATURES OF 1992 PROGRAMME 1. Abolition of Physical Controls

Abolition of controls related to means of transport (goods and people) COM(88)800 2. Technical Harmonisation and Standards

New approach in technical harmonisation and standards policy. White Paper from the Commission,

June 1985. 3. Opening of Public Procurement Markets

Public works contract COM(86)679

Compliance Procedures COM(87)134

Amendment to Supplies Directive COM(87)468 4. Common Market for Services
 (i) Financial Services
 Second directive on co-ordination of credit institutions COM(87)715


(ii) Transport
 Freedom to provide services by non-resident carriers within a member st
ate COM(85)611
 Fares for scheduled air service DIR 87/601


(iii) Professional services

Right of establishment COM(85)355 & COM(86)257

5. Liberalisation of Capital Movements

Liberalisation of capital movements COM(87)550 6. Introduction of EC Company Law

European company statute COM(75)150

Regulation for EEIG REG 85/2137 7. Removal of Fiscal Frontiers

Approximation of rates COM(87)321

Harmonisation of the structure of excise duties COM(87)325/328 [Box B Omitted]

REFERENCES Cecchini, P. (1988), The European Challenge, Wildwood House, Aldershot. de Cecco, M. and A. Giovannini, (1989) `A European Central Bank: Perspectives and Monetary Unification after ten years of EMS', Centre for Economic Policy Research, London. Cnossen S. and C.S. Shoup (1987), `Coordination of Value Added Taxes' in Tax Coordination in the European Community (ed. S. Cnossen), Kluwer Law and Taxation Publishers. Davis E.H. et al (1989), 1992: Myths and Realities, Centre for Business Strategy, London Business School. Davis E.H. and C.A. Smales (1989), `The Integration of European Financial Services' (in Davis et al, 1989). Emerson M. et al (1988), The Economics of 1992, Oxford University Press, Oxford. Geroski, P.A. (1989), `The Choice Between Diversity and Scale', (in Davis et al, 1989). Kay J.A. (1989), `Myths and Realities' (in Davis et al, 1989). Kay J.A. and S.R. Smith (1989) `The Business Implications of Fiscal Harmonisation', (in Davis et al, 1989). Kay J.A. and J.S. Vickers (1988), `Regulatory Reform in Britain', Economic Policy, 8, 285-351. Lee C., M. Pearson and S. Smith (1988), `Fiscal Harmonisation: an Analysis of the European Commission's Proposals', IFS Report 28, London.
COPYRIGHT 1989 National Institute of Economic and Social Research
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Author:Kay, J.A.; Posner, M.V.
Publication:National Institute Economic Review
Date:Aug 1, 1989
Words:10627
Previous Article:How Europe would see the new British initiative for standardising vocational qualifications.
Next Article:Comparative properties of models of the UK economy.
Topics:

Terms of use | Copyright © 2016 Farlex, Inc. | Feedback | For webmasters