McNair Paper Number 49 Chapter 4, March 1996

A truly apocalyptic scenario for Europe could unfold as a result of failure to arrest the processes described so far in this study. The implications of each of these crises would be sufficiently adverse to warrant action, but taken together, they could produce a negative synergy with overwhelming consequences. At some point, cumulative quantitative change could become qualitative and visible. The pressure to cut welfare state programs at a time of increasing unemployment would certainly undermine social stability, intensifying the impact of joblessness. A conflict of "haves" and "have-nots" could result, either along new, perhaps unpredictable, dividing lines or taking the old forms of class conflict. Massive labor unrest not witnessed for decades could reappear; the resulting economic and social friction might spread to several of Europe's regions, especially those burdened by persistent, long-term unemployment and continuous flows of political and economic refugees. The failure of mainstream political parties to manage problems of such magnitude could eventually lead to elections of extremist leaders as heads of government with unpredictable consequences for Europe, both internally and externally.

The void created by a deep crisis of the nation-state and its political system would not contribute to the development of the European Union and might actually threaten its survival. At a time when power is divided

between the nation-state and Brussels, the vitality of nation-states is indispensable to the further development of European institutions. Only strong and healthy democracies can negotiate the complex process of transferring power from the nation-state to the EU; a large-scale crisis affecting Western Europe could lead to the collapse of the EU.

While such a scenario may not be likely, it is certainly not improbable. If the existing economic, financial, and political trends were to continue unchecked, they could undermine European cohesion and thus erode popular support for further integration in the areas of social, economic, and foreign policy. Most importantly, the implications for European monetary union could be catastrophic. The single market would remain incomplete because the benefits likely to accrue from monetary union would not be realized. Monetary policy making would continue to be exercised de facto by Germany's Bundesbank, further delaying collective decision making on financial matters and the formation of the system of European central banks envisioned in the Union Treaty. Such a development would exacerbate the perception (and contribute to the development) of yet another form of democratic deficit, this time associated not with the European Parliament (a relatively weak institution) but rather with the vital task of management of European financial resources. As a consequence, political friction might ensue: Franco-German cooperation, a necessary condition for European integration, could be endangered; if so, Germany's mooring to Europe could become less secure while France's willingness to strain its resources for the sake of monetary union might weaken. In the final analysis, failure to arrest the convergence of economic and political crises could conceivably rock the very foundations of the EU and of the Franco-German partnership on which postwar European arrangements have been based.

It would be tragic indeed if these were the prospects for Europe's future following the end of the Cold War. Fortunately, under a set of less extreme but more realistic assumptions, the future course of European integration into the next century may be much more positive and could become promising.

The depth, extent, and intensity of Western Europe's integration and interdependence achieved over the second half of the 20th century suggest that the EU has reached a stage of considerable institutional and social maturity. The end of the division of Europe has brought with it tremendous change in the composition of demand for and supply of scarce resources. As an overwhelming exogenous shock, the end of the Cold War has upset traditional economic patterns, caused a reordering of trade and commercial alliances, and been accompanied by new population movements. If the impetus behind the current crises is economics, then it may be cyclical and temporary. In that case, a general unravelling of European society can be avoided and there may be time for Europe to adjust to new realities.

The return of higher rates of economic growth for the remainder of the decade of the l990s could be the single necessary and sufficient condition permitting a soft landing for the social and political status quo in all of Europe: economic growth would create jobs, boost income levels and generate tax revenues. What are the prospects for reinvigorating economic growth by means of trade, technology, EU enlargement and monetary union?

GROWTH THROUGH TRADE

Growth through trade is very much a European tradition; it has been tried and it has worked. Indeed, for the members of the European Union, growth through trade has been a key objective of the European Economic Community and, later, of the single European market. The original creation of a customs union followed by the elimination of trade (and many nontrade) barriers has given rise to the present situation where intra-European trade among European Union member states is larger than trade between all of them and the rest of the world.

External trade (between the EU and the rest of the world) has also grown significantly. The European Union is the world's biggest exporter, accounting for over one-fifth of total world trade. By comparison, trade represents a much lower level of economic activity in other regions. Exports from the United States and the whole Western Hemisphere combined account for less than half as large a share of world trade; intraregional trade across all of North and South America amounts to less than a third of the region's external trade. Even countries of the Pacific rim, with their exports combined, cannot challenge the EU's primacy as an exporter with global reach.(Note 1)

Trade is what the Europeans do very well and they would like to do more of it--but so does everybody else. The creation of the North American Free Trade Area (NAFTA) was undertaken in the belief that it would expand trade. The APEC agreement aims in the same direction. At the same time, European countries that are not yet beneficiaries of EU membership also look to trade as the best means of promoting economic growth. And "trade, not aid" is a political phrase with significant economic content for all less developed countries. But at all times, one country's exports automatically constitute other countries' imports. Even under the most favorable conditions of worldwide and widespread economic growth, not all countries can enjoy export-led expansion at the same time. In the real world, increases in export shares by one region or bloc will be at the expense of the export share of another, at least initially; in the short run, the EU can increase its share of world trade so long as no one else can do likewise.

If trade is conducted under zero-sum conditions, real or perceived, then friction is likely to ensue. Some evidence of friction between the EU and non-EU European member states has already surfaced, largely with respect to agricultural products, as might be expected. Trade friction between the EU and the United States has a longer history and is not unexpected, especially for annual trade flows in excess of $1 billion. But there is a widespread feeling in Europe that the Clinton administration is making economic policy the essential element of its foreign policy and has recently been engaged in something tantamount to economic war with Europe.

Until recently, one source of the trade friction between the EU and its trading partners had been the complex system of European agricultural support policies (known as CAP, for common agricultural policy). Funded mainly through the EU's central budget, the CAP had been the largest expenditure component; in the late l980s, agricultural support claimed almost 70 percent of the EU budget.(Note 2) Since then, partly in response to trade-related pressures and the outcomes of the Uruguay round, and partly as a result of other internally competing claims, the EU is reducing its emphasis on agricultural subsidies. It has adopted a more restrictive pricing policy and is scaling down financial support for farm products; by l992, the CAP absorbed less than 60 percent of the EU's budget and this proportion will further decrease.

In terms of EU-U.S. trade, major areas of disagreement have involved procurement in telecommunications goods, services and construction; extension of the l992 U.S.-Airbus decision to other aircraft parts; development of technical standards (for software, gas connectors, blood products, outdoor power equipment) and testing and certification procedures; broadcasting; public procurement (including buy-American legislation); air transport services; eco-labeling; fisheries; and meat hormone ban, third-country meat certification and labels on the use of BST (a drug to promote cow milk production). In most of these disputes, negotiations between the EU and the United States have resulted in interim arrangements satisfactory to both parties, subject to further negotiation and compromise. However, there persists a difference between the two partners in their overall approach to trade disputes.

There has been a persistent tendency on the part of the United States to prefer and attempt to resolve trade problems through bilateral agreements rather than through U.S.-EU dialogue exclusively. In addition, the Congress has intervened quite actively in trade matters in recent years, with initiatives ranging from adoption of a new and tougher "Super 301" procedure to proposals seeking to expand the scope of U.S. antitrust law. Such measures are unilateral in nature and not in harmony with multilateral rules adopted by GATT and OECD; in fact, Congress is generally reluctant to accept GATT panel rulings and to modify existing U.S. law accordingly. By contrast, the European Union places emphasis on the management of external trade problems at the level of the Commission; even though individual member countries may have particular preferences or prior experience in specific trade issues, they have subordinated national trade policy to the Commission, which speaks for all of the EU members.

This difference in approach explains only part of the trade friction. A more significant factor has to do with perceptions of protectionism prevailing on each side of the Atlantic. In the American view, Europeans are more interventionist and thus willing to subsidize industrial or commercial enterprises, products or services to overcome trade barriers and gain market share. Europeans, on the other hand, point out that the U.S. Government intervenes for the same purposes as a matter of course, except that it does so most often in the name of national security, broadly (and loosely) defined. These analogies have been relevant, for example, in comparisons of European "subsidies" to Airbus with U.S. "subsidies" to military (and then civilian) aircraft production; in discussions about national laws controlling foreign ownership of broadcasting and telecommunications organizations; and in debates on the nature of "buy American" versus "buy European" practices in public procurement. Because both sides have a point, the key issue concerns the ability to prevail in negotiation of particular disputes in the future.

To the extent that America's trade position in general has deteriorated and its trade orientation is still much lower than that of the EU, it appears that the tendency toward unilaterialism is likely to grow stronger in the United States. This has been the case already in the context of U.S.-Japan trade and could trigger anti-European trade sentiment even though U.S. trade with the EU is still well balanced. If that happens, trade conditions would continue to favor the EU, not because of her "Fortress Europe" behavior but because of her "Exporter Europe" tradition. However, trade flows could be adversely affected for both the United States and the EU. Should the United States decide to take a more aggressive, protectionist stance vis-…-vis its trade with Europe in response to such a development, it might do so at the expense of its political cooperation and dialogue with the EU. In the worst case, it is possible that the perception of the tradeoff between trade and the whole trans-Atlantic relationship as a zero-sum solution might be reinforced. In conclusion, Europe can expect to make some--perhaps limited--economic gains through trade expansion, but at the risk of increased economic conflict with the United States with possible political and security spillovers.

GROWTH THROUGH TECHNOLOGY

Can Western Europe overcome its current economic problems by placing greater emphasis on technological innovation and greater diffusion of technology in all sectors of its economy? This question raises several controversial issues that tend to obscure a central fact: namely, that technological advancement is not sought as an end in itself but rather as a means to improved well-being and greater material prosperity. The real problem, from a policy perspective, is whether technological progress can be fostered in a climate of low economic growth.

In an economic sense, meaningful (that is, efficient) technological progress leads either to falling per unit prices, over time and in real terms, of established product lines or services, or to development of new forms of output. These phenomena have been observed in a great number of industries, primarily goods-producing (agriculture, construction, manufacturing) but also in several sectors of the service-producing industries (especially communications and transportation). In both its manifestations, technological progress results in significant, often revolutionary, productivity improvements leading to permanent reductions in cost of production over time. Technological progress has, as a rule, transformed highly labor-intensive operations to fully automated processes. In releasing labor from onerous or dead-end jobs and boring tasks, technological progress (as opposed to mere application of technology)(Note 3) can lead to economic expansion that raises living standards. Europe's record in this respect is impressive. Under what conditions can it be improved?

Pessimistic assessments of Europe's potential to channel technological innovation into the production process are based on several trends: erosion of Western Europe's comparative advantage in some high-technology sectors (notably consumer electronics and related apparatus, computing equipment and office supplies), its low ranking in patent awards (behind Japan and the United States), lagging spending on research and development and not sufficiently large numbers or proportion of researchers. (In R&D spending as well as in numbers of researchers, Western Europe is behind Japan and, by some measures, behind the United States as well, in both absolute and relative terms.) In addition, some evidence can be read to suggest that de-industrialization has affected not just the United States but also Western Europe (as indicated by the ascent of its service-producing industries at the expense of manufacturing).

But another set of factors deserves equal attention, for it is tempting to overlook important structural differences when making broad international comparisons. First, with respect to secular changes in comparative advantage, trade balances matter a lot. If a technology gap exists, it has not affected the robustness of European trade, as discussed earlier. In fact, trade data lend support to a more optimistic assessment of Europe's international competitiveness position vis-…-vis the United States and Japan. Thus, even though by some technological indicators (i.e., number of new patents and researchers) the United States has been a longtime 0leader, this position has not prevented it from becoming also the world's largest debtor nation. In its trade balance and among broad end-use categories of merchandise traded, the United States usually has a surplus in only two (and these are overshadowed by larger deficits in most other categories). Of these, the more significant surplus is in foods, feeds, and beverages, not normally classified as high technology sectors; a much smaller surplus is shown under industrial supplies and materials. By contrast, the EU (ranked third in terms of technology orientation) has a balanced trade with the United States and a much smaller trade deficit with Japan than does the United States. Thus, the connection between technological supremacy measured in factor inputs and production efficiency or productivity gains may be much more roundabout (and certainly less obvious) than normally assumed.

In gauging the potential for greater technological advancement in Europe, the following advantages stand out:

Europe's human capital stock is impressive in scientific and technological know-how as measured by the share of engineering and natural science graduates in terms of total population of university students (EU: 28 percent; U.S.: 17 percent; Japan: 25 percent).(Note 4)

Europe is ahead of the United States in terms of investment orientation, a condition commensurate with high savings rates; European gross savings rates, at 20 percent of GDP, are now lower than Japan's (at 30 percent) but have historically been higher those of the United States (at 14 percent).

Western Europe's traditional exposure to the competitive pressures of international trade has been and remains singular; by comparison, the U.S. economy still retains a strong domestic focus while Japan's size has yet to confer on it a role larger than Europe's or America's in world trade.

All in all, Europe has the potential to push forward in terms of technological advancement. This will be good for its international competitiveness position, although its overall gains through trade may become more limited for reasons discussed earlier. It is even more likely that technological advancement will eventually create conditions favorable to higher economic growth in general, as it always has in the past. However, technology per se will probably not be an important factor for short-term turnaround in European unemployment. Thus, while technology remains essential for the preservation of high living standards in the future, it cannot serve as a substitute for countercyclical macroeconomic policies aimed at joblessness. For this reason, it is possible that fewer resources will be diverted toward technology-related investments and more toward job creation schemes. If so, the role of technology could become even more limited.

GROWTH THROUGH ENLARGEMENT

Europe can also grow by expanding its membership wisely. The club of 12 added three new members in l995: Austria, Sweden, and Finland. These affluent, industrialized democracies bring with them higher than average per capita incomes, well-developed market economies and strong export orientation; such attributes change immediately the economic statistics of the EU as a whole and in the right direction. The financial benefits are especially visible because these new members will be net contributors to the EU's budget and thus enhance EU-financed projects. At the same time, potential costs to political cohesion in the European Union are minimized because the new members are, in reality, old and established partners of the EU through EFTA. Their political, social, cultural, and economic institutions are mature and in harmony with those of EU member states. Thus, Europe's most recent enlargement may actually represent a win-win outcome and one that stimulates economic expansion for the union as a whole. Nonetheless, this enlargement does present some problems. It reinforces the need to overhaul the cumbersome institutional structure of the EU at the l996 Intergovernmental Conference (IGC). The three new members' security identity is marked by a long tradition of neutrality: they may be less willing to support the idea of robust European security cooperation. Finally, these nations seem less committed to the Monnet ideal of Europe; Swedish public opinion is already showing reservations about the likely benefits of EU membership.

But what are the limits to the EU's enlargement? In theory, Europe could have and should have become whole again after the end of the Cold War. Instead, there is now a new divide, the result of the de facto separation between two groups of countries: those that are members of the EU (industrial democracies with developed political institutions and mature market economies) and those that are not (former Communist countries facing serious problems of political and economic adjustment). The success and speed with which Western Europe can integrate the states of Central and Eastern Europe, as well as Russia, into its political and economic structures will be critical determinants of this process. If true integration can be achieved, the single market will expand immensely. The benefits associated with economies of scale will be considerable and, if past trends are a guide, trade flows will grow significantly as well.

It would be a mistake to invoke economics as the singular driving force pushing toward EU expansion. A strong argument can be made that economic integration is a means toward a larger goal, that of political (and, by extension, social and cultural) unification. In contrast to other economic zones or free trade areas (including the largest and most recent one, NAFTA), the EU is composed of countries with a common collective conscience, heritage, and culture. Geographically, their boundaries and history tie them together on the European continent. Their political and economic institutions are similarly based on common conceptions of governance, from the birth of participatory democracy in the Greek city-states to monarchy to parliamentary democracy and from feudalism to contemporary political economy. Culturally, EU member states have created and share in the values of Western civilization, from Greek philosophy to the spread of Christianity to the Renaissance and the Age of Enlightenment. Indeed, the notion of a European identity (symbolized in the EU passport since l985) has a far stronger cultural, sociogeographic content than the American one (in the sense of the North American or South American continent, and even less so in the case of both of them combined). These factors indicate that the current divide in Europe may be temporary, ephemeral, and artificial. The limits of the EU will most likely be expanded to include all the states professing a broadly based and genuine popular allegiance to a common European ethos, culture, history and civic values. By these criteria, the European Union might eventually include all the countries on the continent of Europe all the way to the Urals; indeed, Russia is as much a European power on its western side as it is Asiatic on its eastern side.

There are grounds for optimism that such an accomplishment is possible: since l989, the reunification of Germany has involved not just the absorption of the former GDR by the FDR but also the immediate inclusion, through Germany's membership, of the former Communist GDR into the EU. This has not been an easy process; in addition to major political, social, industrial, and other dislocations caused by the decision to reunify the two countries, the financial costs have been enormous and borne mostly by German taxpayers. But beyond the direct financial costs, the full economic costs of this inevitable task are incurred (directly or indirectly) by all citizens of the EU. It is inconceivable now that Europe would have room for two German states, one inside the EU, the other outside, because despite their differences in political and economic systems over decades, the two German states share common linguistic, cultural and historic traditions. The extent to which such traditions form a common civic denominator among the peoples of Europe will most likely define the limits of the post Cold War EU, its economic geography, ethnographic composition and new political identity. European history, after all, reflects a legacy of both centripetal and centrifugal forces. Diversity and unity are not contradictory. In the High Middle Ages, for example, there was a remarkable unity in cultural and intellectual life at a time of political fragmentation. Today it is possible to imagine political and economic integration together with enormous degrees of cultural diversity.

In the near term, enlargement of the European Union is constrained by serious political uncertainties. These, in turn, lead to calculations unfavorable to the commitment of scarce resources outside of the EU. The issues, prospects and problems associated with future enlargement must be dealt with in terms of the economic calculus prevailing in Europe today. Further enlargement can take place in two directions: south and northeast.

Expansion to the south would mean simply opening up the EU to Malta and Cyprus. The economic benefits or costs would be minimal, given the small size of the economies involved. The political gains would be negligible, the potential dangers great. Malta has a long history as a maverick within international organizations. Giving Malta the existing right of veto could paralyze the operations of EU institutions, especially if the Maltese Labour Party returns to power. Entry of Cyprus is predicated on a solution of the Cypriot question, which depends in turn on a breakthrough in Greek-Turkish relations. Far more than expansion, there will certainly be greater involvement of Europe in the Mediterranean. The conflict in Algeria has focused the attention of Mediterranean states like France, Italy, and Spain on the importance of stabilizing the countries of the Maghreb to avoid generalization of instability and immigration because of Islamic fundamentalism, a high birthrate and economic backwardness. It is to conjure potential dangers emanating from the Maghreb rather than in pursuit of economic gains that the EU is likely to incur significant financial burdens.

Thus when EU enlargement is invoked what is usually meant is expansion to the northeast. The first tranche of candidates are the Czech Republic, Poland, and Hungary (Slovakia is often included in this group, but will be discussed separately). The political experience of these three countries since the end of Communist rule has been generally positive. Democratic elections, alternation of power, freedom of speech, and rule of law have prevailed. The process of democratization was based either on historical experience (the Czech Republic from 1918 to 1938), the record of resistance to Communist rule (Solidarity in Poland), or the origins of a genuine multiparty system under Communist rule (Hungary). Neither Poland nor the Czech Republic is involved in any significant boundary disputes or national minority questions, although antisemitism persists in Poland. Hungary's differences with Slovakia seemed to have been resolved by a new treaty negotiated under the stability pact rubric but reemerged when Slovakia voted to make Slovak the official language of the country. A treaty with Romania remains to be negotiated. The left wing Hungarian government of Gyula Horn has been far more conciliatory on issues related to the large Hungarian national minorities in neighboring countries than was its conservative predecessor. Assuming that this issue is satisfactorily resolved, there is reason to think that the membership of these countries in the EU is at least as sound a proposition on political grounds as was Greek membership in l981 and Spanish and Portuguese membership a decade ago. Including them in the EU would expand the zone of stability and security in Europe.

Slovakia has not gone as far in creating a free market and has weaker democratic credentials. Had it not been part of Czechoslovakia it is unlikely that it would be considered at this point for EU membership. Beyond this tranche of countries it is hard to see many likely candidates for EU membership in the next decade. Until peace reigns in the Balkans, incorporating any Balkan state could be risky, as it could be involved in a widened war. This certainly is the case of most of the republics of the former Yugoslavia. Nor is there much progress toward liberal democracy in other Balkan countries, although Bulgaria has shown good sense in dealing with its minority problems. Slovenia is economically developed, but it is not clear whether it should be rewarded for having pulled the plug out of Yugoslavia and unleashing civil war. Rumania seems not to have undergone much genuine reform at all. The Baltics remain a problem because of the continuing problem of Russian minorities.

It is fair to say that EU membership can consolidate democracy. But affording EU membership to states not yet far advanced toward democracy or harboring territorial disputes with neighbors or unresolved national minority questions runs the risk of importing these problems into the EU. Even the admission of the strongest candidates poses serious risks if the decision making mechanism of the EU is not reformed and until there is a consensus on the direction the EU is supposed to take. The more states are admitted, the more difficult it will be to change the institutional structure and the more dysfunctional the present structure will be. One danger is that once admitted, new states will immediately be relegated to the bottom tier of a multispeed Europe, which will have to be multispeed in part because of their admission. The upcoming IGC will have to resolve issues of institutional structure that logically should have been dealt with before any enlargement.

Beyond the political dimension, expansion to the east involves equally serious problems of economic integration. Both in terms of industrial development and income levels, a large gap exists between Western Europe and countries that stayed behind the Iron Curtain for decades. The least troubling and most optimistic case is the Czech Republic, the best economic performer in Eastern Europe: its per capita income is just over $7,000, putting the country in first place among all non-EU states in Europe. Yet, compared to EU income levels, the Czech standard of living is very low: it barely reaches one-half of average EU income, significantly lower than that of Greece and Portugal, the EU's least well-off member states (both have average incomes around $9,000).

The Czech Republic situation is similar to that of Slovenia (a new state but located in a region with a strong industrial tradition). Slovakia, Hungary, Belarus, and Estonia may be grouped together in a tier below, with income levels around $5,500. The former Yugoslavia might also have been placed in the same group; Croatia and, to a lesser extent, Serbia and Montenegro were relatively well off before the dissolution of the Yugoslav state. But all other former members of the now-defunct Warsaw Pact are countries of even lesser means, with average incomes inordinately low in comparison to EU levels. The economies of Poland, Ukraine, Bulgaria, and Romania show signs of improvement but will remain fragile in the transition to decentralization and open market rules. By any measure, these countries do not have the economic credentials to be considered candidates for admission to the EU any time soon. Nor are their evolving political institutions stable enough to contribute to inter-European cooperation in the realm of foreign policy and security. Admission to the EU would amount to virtual guarantee of significant income transfers (at high cost) from Western Europe in exchange for future (unspecified if not insignificant) political benefits.

However, the need to develop stronger ties between Western Europe and its eastern neighbors cannot be overlooked. Short of enlargement by formal expansion through admission of new states, it is possible to meet that need through interim measures such as association agreements. This course of action has already received policy priority, is feasible, and can benefit all sides. Greater economic integration can lead to political integration between east and west in Europe, in much the same way that it has facilitated political integration throughout the EU in the post- World War II period. Despite its cumbersomeness and slow speed, EU enlargement through economic integration has been successful for Europe. The recent admission of former EFTA countries adds to the body of strong evidence that long-term association agreements promote de facto economic and political integration, leading naturally to EU membership. Of even greater significance is the success with which association agreements paved the way for admission into the EU of Greece, Spain, and Portugal in the l980s. Not only were these countries relatively poor, but their political record had been marked by military dictatorships in the post-World War II period. By comparison, the countries to the east of the EU are less well off in material terms and significantly more burdened by the experience of Communist rule. Enlargement of the EU to the east may be out the question for now but could become possible in the future, even though it might require long-term association agreements.(Note 5)

Political considerations will probably lead to the admission of the Czech Republic, Hungary, and Poland by early in the next decade. In the long term, inclusion of these states and of other states in the East later on will pave the way for enormous expansion of European trade and economic growth. Initially and for some time, however, the economic and financial costs to the EU will be far greater than the benefits. Enlargement to the East may help solve Europe's economic problems in the future but will certainly exacerbate them in the next decade.

MONETARY UNION

Europe's internal market has benefited greatly from economic liberalization and integration processes at work since the implementation of the Single European Act. Economic union is to be complete when full monetary union is implemented, leading to higher economic growth across Europe.

The direct benefits of monetary union can be substantial. They include savings on currency conversion costs as a result of irrevocable locked exchange rates; sustainable price stability as a result of monetary policy coordination by a European System of Central Banks; savings on government finances through lower interest rates; and reduced costs on currency conversion and forward exchange covers incurred by banks and other enterprises doing international business in ECUs (central banks will also economize on the costs of holding foreign currencies). Removal of restrictions on capital flows has already been achieved. Indirect benefits are difficult to quantify but could be even more profound, not just in terms of their economic effects but also because of their political ramifications.(Note 6)

European monetary integration has a long history and is marked by several phases. An important phase began in l978 when the European Monetary System (EMS) was conceived and, by one account, "sold to the rest of the Community by (then) West German Chancellor Helmut Schmidt and French President Valéry Giscard d'Estaing."(Note 7) In the late l980s, not just academics but business leaders also would engage in speculative talk of the advent of a common European currency. The Economist featured a cover story on the Phoenix (a fictitious name for the European coin and paper that might be issued one day). In the meantime, the European Currency Unit (ECU) has achieved the status of a premier international monetary unit; even though it is not issued in paper or metal form, it has been traded in world currency markets as a key foreign currency and is used to settle official accounts and private invoices. In the last 10 years or so, many European government bonds have been denominated in ECUs. But the most ambitious phase of monetary integration began with the incorporation of European monetary union (EMU) in the articles of the Union Treaty in 1992. In December l995, the EU baptized its future single currency "Euro."

The literature on the problems, crises, prospects and promises of European monetary integration is quite prolific. Beyond the theoretical issues related to the demand and supply of Euromoney, interest rates and effects on macroeconomic aggregates, there has been a lot of debate on the implications of monetary union for the distribution of political power within and among EU member states. American observers, but also several European economists, have attached special importance to the meaning of EMU for national sovereignty and particularly for its effects on the distribution of political power among participating states: as control of the money supply is effectively handed over to a European central bank, the ability of the government of each sovereign state to control national economic activity is diminished or eliminated. For political conservatives who advocate devolution of power away from the center, EMU represents a most undesirable condition, threatening the very existence of democratic governance.(Note 8) On the other hand, interventionist economists and politicians have argued that monetary union will contribute to more effective management of the economy at a pan-European level, increasing the synergism between fiscal and financial policies in a truly single European market.

From a conceptual and even from a technocratic viewpoint, the evolution of EMU should be assessed with reference to parallels in the development of central banking in the United States since the 19th century. In contrast to all other major powers in the Western world, the United States did not have a central bank until just before World War I. The U.S. banking system was controlled and regulated by the states, not by the Federal Government. The creation of a uniform, single currency standard as well as the establishment of a U.S. central bank did not materialize until l913 (with legislation creating the Federal Reserve System), after a long series of crises and years of financial chaos, especially after the turn of the century.(Note 9) The U.S. banking system is still unique as a two-tier system, with state banks chartered by state authorities and national banks licensed to operate as members of the Federal Reserve System. Using this analogy and applying it very loosely to the EU setting, it is evident that the EMU provisions of the Maastricht Treaty will create a similar two-tier banking system in Europe: in each EU member state, control of the banks will be exercised by the national authorities, while a European system of central banks will set monetary targets and policies to achieve them.

Theoretical considerations notwithstanding, the practical implications of a single EU currency to be used in daily cash transactions are overwhelming. The European Union of the 15 may now boast more currencies (exactly 15)(Note 10) than official languages (a total of 11). The proliferation of official languages has led some public officials to suggest that the total number of languages be reduced (in official EU communications including publications) by half, to, say, five or six.(Note 11) The accounting logic may be flawless but proposals of this sort enraged the public in countries that might be affected (generally the smaller ones). Such proposals were quickly withdrawn for further study; language, after all, is the most powerful symbol of national culture and sovereignty in the multinational EU. By comparison, the lowering of the status of a country's currency (as would be the case when ECUs are minted) is viewed with much less sentimentality by Europeans. The complexities and costs of dealing with 15 currencies can be tremendous: from the policy demands of exchange rate adjustment to inconvenience and expense due to transaction costs, the multiplicity of currencies has been an obstacle to European monetary integration. This may explain why the movement toward a single currency has met generally with public approval.

European attitudes toward a single currency have been positive. According to a poll conducted in spring l993, a majority of EU citizens would like to see national currencies replaced by a single currency by l999. Opposition to a single currency is highest in the United Kingdom, Denmark, and Germany, lowest in Italy, Greece, and Belgium.(Note 12) Similar attitudes prevail toward a European Central Bank.(Note 13)

In the years following the signing of the Union Treaty, it seemed as though the evolution toward a single currency in Europe was inevitable, but monetary union could take longer, might be more complicated and troublesome, and could create greater protracted adjustment problems than originally estimated. Time is an important element but hardly the most critical. As with economic union, which took over 40 years to reach its present stage in Europe, the optimal date for issuing a European currency is still open to debate. In the end, a single European currency can materialize at such time as the EU's economic power and political and social integration make it imperative.(Note 14) But what if monetary union proved to be more complicated and protracted than initially envisioned?

There have been obstacles along the way and more could emerge, however. In the post-Cold War era, there have been tendencies in Western Europe to resort to stratification in order to deal with current problems, as analyzed in earlier sections of this book. For all the reasons already listed, the EU is considering interim solutions that may be more divisive than cohesive. One example is a multitier approach to monetary unification, suggested as a means of keeping with the letter (but not the spirit) of the Union Treaty; a two-tier EU, with some countries in the top tier (or in a "hard core") and most in the bottom tier (or "soft core") may be technically possible but could prove politically dangerous. Would the increased commitment to monetary union of "hard core" countries be exactly offset by the (justifiably) diluted commitment of "soft core" countries? What would be the impact on the future of financial discipline within the EU as a whole? What signals would be thereby transmitted to prospective EU candidate-members concerning their monetary integration? And if there is something truly negative to be said about the convergence criteria for monetary union, it is that they were deemed irrelevant and unnecessary (at least by implication) for the monetary union between the Federal Republic of Germany (FRG) and the former German Democratic Republic (GDR). By any measure, the GDR's economy was in much worse condition at the time of German reunification than the least well-off EU member state, now or at the end of the decade. If monetary union without any preconditions was feasible between the former FRG and GDR, why would it not be achievable by EU member states characterized by fewer economic disparities among them and with a 40-year history of economic and financial integration?

The events in France in December of l995, in the form of public workers union strikes that paralyzed urban life, underscore the importance of answering the question posed above. Among the first to assess as paradoxical (and, perhaps, unacceptable) the nature of the tradeoff offered by the government, the French perceived that the benefits of EMU came at an exorbitant cost: higher unemployment and lower living standards. The government's insistence that its austerity measures are necessary for France to satisfy EMU criteria may be technically valid but politically explosive. This fact alone suggests that the application of the criteria as well as their interpretation warrant reevaluation as to their economic validity and political relevance. In many ways, the future of EMU may be hostage to a set of quantitative tests that have the virtue of being highly specific yet extremely arbitrary.(Note 15)

In the final analysis, it is imperative that conditions for participation in the final stage of monetary union be observed and financial discipline enforced. Under any circumstances, the stability of a single currency will depend on sound public finances. This fundamental monetary principle is at the heart of the provisions of the Union Treaty. Its application will be a function of the technical tools with which the EU Council is already armed as well as of the manner in which they are used. But above all, monetary union will be determined ultimately by the Europeans' political will to bring it about. The fact that the Maastricht Treaty was ratified at all despite the obstacles encountered demonstrates Europe's underlying commitment to eventual monetary union by the end of the century. Monetary union once achieved should provide an important impetus for faster economic growth.

In summary, of the four factors examined for their likely impact on Europe's growth and prosperity toward the next century, two seem to hold the most promise: monetary union and limited enlargement. It should not appear paradoxical that while these are the most difficult, riskiest, and perhaps most ambitious undertakings, they are also the ones that are likely to generate the greatest pay-off to Europe's prosperity. By contrast, Europe's near-term gains from continuing its tradition as a premier world trader or from maintaining its technological prowess are bound to be more limited. This does not mean that a choice to emphasize the bigger projects needed to truly unite Europe can or should be at the expense or exclusion of the more traditional options (trade and technological advancement). But it does mean that resumption of a course of strong economic expansion will depend mainly on Europe's successful pursuit of monetary unification and prudent management of EU enlargement.

BUT IS THE POLITICAL WILL THERE?

But a far more obvious threat to Europe's economic future is whether Europe will have the political will to move resolutely toward EU institutional reform at the upcoming IGC meeting, on which economic growth depends. The European Union looks like the Ptolemaic system of the universe before the advent of Copernicus, with its ponderous system of circles within circles. Enlargement of the EU only makes it more cumbersome. Widening has preceded adequate deepening. The structure of the EU reflects the underlying ambivalence of European states about yielding sovereignty in areas particularly sensitive to them.

What is alarming is that expectations for the IGC are being cut back. It is not surprising that the British Government is wary about majority voting and "federalism" in general. France under Chirac is uncomfortable about the increasingly clear signals from Bonn that Germany will insist on additional movement toward federalism in exchange for EMU. The French seem to have forgotten that the primary purpose of their historical European policy was to irreversibly moor Germany to European institutions. Paradoxically, they are now resisting Germany's demand to be further tied down.

It is almost certain that the EU will come up with some kind of package addressing institutional reform by 1997; after all, the IGC cannot be allowed to fail. The question is whether the politically acceptable package will also prove workable. The need to compromise between different visions of Europe may produce a Europe without vision. The states of Europe lack the reality of power they once possessed to act effectively on the national level, or the will to make Europe really succeed; the whole seems to be less than the sum of its parts. Europe awaits its Copernican revolution. Whether the leadership necessary to make that revolution presents itself--under the admittedly difficult economic and political circumstances just described--may be the critical factor in determining whether the EU will survive as a viable institution and whether Europe will play the kind of role to which its wealth, population, and history would seem to destine it.

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