Dae Woong Kang and Ashoka Mody have a piece on how macro ideas to create European Monetary union were birthed:
In a March 1969 paper, Harry Johnson – of the London School of Economics and the University of Chicago – restated Friedman’s argument. Greater exchange rate flexibility would allow national authorities greater freedom in domestic macroeconomic management. In contrast, he said, “little reasoned defence of [the fixed exchange rate system] has been produced beyond the fact that it exists and functions after a fashion, and the contention that any change would be for the worse” (Johnson 1969, pp. 12-13).
On 29 September 1969, Germany let its exchange rate float. Once again, the Germans were ahead of the Anglo-Saxons.
And then Europe chose to go against the tide of history. The French steered Europe to its preference for fixed rates and the Germans, reluctantly at first, followed. In August 1969, the newly elected French President Georges Pompidou quickly devalued the French franc and made monetary union of Europe one of his priorities. Willy Brandt, who became West German Chancellor in October, was willing to test the idea so that he could gain space for reconciliation with the East, Ostpolitik. Thus Brandt agreed to Pompidou’s call for a summit of European leaders at The Hague in December 1969 to discuss, among other things, a European monetary union. The leaders created a committee headed by Pierre Werner, the Luxembourg Prime Minister, and in October 1970, the Werner Committee delivered its blueprint.
The Germans were not yet ready to concede. At the Franco-German consultations in July 1971, they reported on “the advantages [floating the D-Mark] had already brought” (Rutherford 1973). In October 1971, at the Annual Meetings of the World Bank and the IMF, German Economics Minister Karl Schiller stated, “the mechanism of exchange rate adjustment has been far too rigid… it is important that unrealistic parities [exchange rates] should be adjusted promptly and sufficiently. We ought to look at parity changes not as matters of political prestige and of victory and defeat but from a sober economic point of view” (Schiller 1971, p.195).
The Franco-German differences on exchange rates reflected a deeper difference in their view of the role of markets in determining economic outcomes. Their positions were starkly different even when negotiating the Treaty of Rome in the 1950s to open borders to European trade. The then German Economics Minister Ludwig Erhard opposed the Treaty because he wanted borders to be open for all countries, not just to other European countries. The French did not want to open borders, even to other European countries (Marjolin 1989, p.281).
The story then moves onto a familiar one. How Germans finally tilted towards French and created the Union against all expectations.
This one on group think is interesting as at the end, this is what matters shaping such ideas:
Roland Benabou says that groupthink has four characteristics: a leader to champion a view; the disregard of external critics; the silencing of internal critics; and, as a consequence, the slide into missions of great – and unreasonable – risk.2
The conscious disregard of external critics is well known. A whole swathe of ‘Anglo-Saxon’ contemporary economists and policymakers warned against the dangers, starting with the University of Cambridge economist Nicholas Kaldor, who wrote a scathing critique a few months after the Werner Report was published.3
Among internal critics, some left and others aligned themselves to Kohl. Among the most prominent critics who chose to leave was Bundesbank President Karl Otto Pohl. Like all German civil servants, he deferred to the goal of European integration. But on the single currency, he was clear that Europe was not ready. And while it was possible to construct a technical vision of how such a currency may eventually operate, much groundwork, he believed, was needed before the conditions for success would be attained. In 1989, in the months before German reunification, Pohl made repeated public efforts to slow the process down. Indeed, on one occasion, he said that British Prime Minister Margaret Thatcher – the fiercest political critic of the single currency –understood the risks better than his own chancellor.4 Repeatedly undermined, Pohl left in May 1991 before his term ended.
Finance Minister Theo Waigel, personally at odds with Pohl, agreed with him on the economics. The two had opposed the conversion of one East German Ostmark for one West German D-Mark. Waigel also insisted on a slower pace of European monetary integration at least till the Maastricht Treaty in December 1991. But then he fell in with Kohl’s agenda. The compromise that Waigel shepherded was European fiscal austerity to protect Germans from picking up the tab for others. Once again, contemporary critics warned that this – along with a single monetary policy for disparate countries – would make macroeconomic management harder, especially in economic downturns. But disregarding those warnings, an incomplete monetary union, without the safeguards of labour mobility and a fiscal union, was forged.
Again reinforces the idea of being weary of economic elites. How they shape and destroy societies after societies is amazing.
In the end, the whole French agenda splashes egg on its face:
Thus, at that bend in history – when politics defied economics – the European macroeconomics of austerity was born, protected by groupthink and necessarily cast in institutional straightjackets. Even as the Europeans narrowed their macroeconomic options, the rest of the world moved steadily to macroeconomic flexibility – in exchange rate, monetary, and fiscal arrangements.
In the run up to the euro in 1997, Milton Friedman warned that when politics clashes with economics, the outcome is not a pretty one. Today, the clash is manifest in Greece. Ironically, although the French intent was to reduce German influence, a more dominant Germany now determines how Europe sees its financial crisis. The economic logic and evidence for dealing with Greece are clear. Politics, however, continues to defy economics and groupthink prevents the painful but sober course.
Here the authors make a mistake of keeping economics seperate from politics. It is always political economy which shapes policies and institutions. It is not either politics or economics as we are made to study. Haven’t there been economists who marveled on how the European integration will bring unprecedented efforts. It is after all politicians who have the democratic credibility and they take the help of economists to make policies. It takes two to tango..
Anyways, a nice short piece to get a macro picture of Europe woes..