20 years of Euro: Why single market is not just an extension of the globalisation process

Interesting speech by Mario Draghi of ECB.

He discusses the Euro project and tries to dispel several myths around the project. European countries were struggling after WW-II and wanted to avoid future wars. This led to the political leaders to try and build economic integration within members. They first started allowing easier trade policies between the  countries. After initial gains from intra-EU trade, the growth from trade began to plateau. This was largely because trade was mainly done in intermediate goods.

The Single Market was conceived during a period of weakness in the European economy. Annual growth had averaged just 2.2% from 1973 until 1985 in the 12 countries that would go on to form the euro area[1], down from 5.3% between 1960 and 1973. Growth potential had also fallen from about 5% per year at the beginning of the 1970s to around 2% per year by the beginning of the following decade.

The typical response of governments to low growth was to increase fiscal deficits. From 1973 to 1985, public deficits in the euro area 12 averaged 3.5% of GDP, while in Italy the average was 9% of GDP. Unemployment rose from 2.6% in 1973 to 9.2% in 1985 for the euro area 12. In Italy, it climbed from 5.9% to 8.2% over the same period.

But the EU had a powerful tool at its disposal to raise growth: the common market. 

One reason that growth potential had decelerated was that intra-EU trade growth had stalled in the early 1970s, because the common market covered mainly intermediate goods where growth was already saturated. Trade in sectors with high R&D and skill content was restricted by non-tariff barriers, preventing productivity spillovers.[2]

The Single Market offered a way to remove these barriers, reverse the decline in economic potential, and bring more people back into work.

The Single Market was different than Globalisation:

The Single Market is often seen simply as an expression of the globalisation process, which over time has even eliminated exchange rate flexibility. But the Single Market and globalisation are not the same thing.

Globalisation has led to higher overall welfare for all economies, and for emerging markets in particular. But it is now clear that the rules that accompanied this process were not sufficient to prevent it from causing severe distortions. Open markets have heightened economic insecurity for people exposed to intensified competition, and added to their sense of being “left behind” in a world where the great wealth created has been concentrated in a few hands.

From the outset, however, the Single Market was designed to reap the benefits of openness while also tempering its costs for the most vulnerable; to promote growth while protecting the people of Europe from the injustices of untrammelled free markets. This was undoubtedly also the vision of Jacques Delors, the architect of the Single Market.

Unlike the wider process of globalisation, the Single Market allowed Europe to impose its values on economic integration – to build a market that, to the extent possible, was free but just. Product rules could be used to protect consumers from lax standards in other countries, and protect producers from unfair competition. And production rules could be used to protect workers by putting a floor on “social dumping” and upholding labour standards.

This is why the launch of the Single Market agenda in the mid-1980s went hand in hand with a strengthening of common rule-making in the EU and of powers of judicial review. The opening of markets was accompanied by the creation of a strong European authority to safeguard fair competition; product standards became tighter, with the introduction of the geographical indication protections for specific foods, for example. And safeguards central to the European social model were progressively embedded in EU law, in areas where the EU had the power to act.

The Charter of Fundamental Rights has prevented a “race to the bottom” in terms of workers’ rights. Legislation was adopted to curtail unfair labour practices, such as the revision of the Posted Workers Directive this year. EU legislation also protects those in less secure employment. One example is the Directive on part-time work in 1997, which sought equal treatment for part-time and fixed-term employees. Last year the EU institutions endorsed the European Pillar of Social Rights to support equal opportunities and access to the labour market, fair working conditions, social protection and inclusion.

EU legislation has not led to a complete harmonisation of labour protections across Europe. But it has meant that the gap in labour standards across countries has gradually narrowed, even as lower-income countries have joined the EU. Research finds a process of upward convergence in significant areas of social expenditure in the EU since 1980, although this has tailed off in recent years.[3] The same cannot be said at the international level.

Hmm..

The single market led to inconsistent quartet:

But the Single Market required greater exchange rate stability than a free trade area, and this resulted in significant trade-offs for economic policy. These were well-articulated by Tommaso Padoa-Schioppa in his famous “inconsistent quartet”.[4] If European countries wanted to have the benefits of managed open trade, they could not simultaneously have capital mobility, independent monetary policy and fixed exchange rates.

Governments initially responded to this conundrum by maintaining fixed exchange rates and introducing capital controls on short-term flows, which allowed a degree of monetary policy autonomy. But as financial integration deepened and capital controls were progressively eliminated during the 1980s, fixed exchange rates became unsustainable.

Due to the international financial storms raging at the time, the countries that had pegged their currencies to the Deutsche Mark (DM) within the European Monetary System (EMS) had to periodically decide either to maintain an independent monetary policy and devalue, or to maintain parity with the DM and lose any sovereignty over their monetary policy.

Given the frequency with which policymakers had to make these decisions, some countries lost both the benefits of exchange-rate stability and their monetary policy independence. The social costs were high. This process came to an end with the ERM crisis in 1992-3, when it ceased to be credible for countries entering a recession to follow German interest rate rises.

At the same time, devaluing repeatedly was becoming incompatible with the deep Single Market that countries were trying to build.

….

From the launch of the EMS in 1979 to the ERM crisis in 1992, the Italian lira was devalued seven times against the DM, losing around half of its value cumulatively vis-à-vis the German currency. Yet average annual productivity growth[7] in Italy was lower than in the euro area 12 over this period, Italy’s GDP growth rate was roughly the same as that of its European peers, and its unemployment rate went up by 1.3 percentage points. At the same time, consumer prices in Italy grew cumulatively by 223%, compared with 103% in the euro area 12.[8]

This led to moving towards a common currency. He then points how in the first phase of single market

He says it is not obvious that countries have lost monetary sovereignty by joining the Euro. Infact they have gained compared to previous regime.

First, the single currency has actually allowed countries to regain monetary sovereignty compared with the fixed exchange rate regimes of the past. Decision-making over monetary policy, which effectively belonged to Germany under the EMS, is now shared among all euro area countries. And the size of euro financial markets has made the euro area less vulnerable to US spillovers, even as global financial integration has accelerated.

Second, it is worth noting that the supposed advantages of monetary sovereignty – such as the ability to engage in monetary financing of government spending – do not appear to be valued highly by countries that are members of the Single Market but not the euro. Such countries have a weighted average public debt of 68% of GDP (44% of GDP if the United Kingdom is excluded), compared with 89% for countries that use the single currency.

In any case, as the history of Italy has shown, monetary financing of government debt did not lead to real long-term benefits.[26] In periods where debt monetisation was more common in Italy, such as in the 1970s, maintaining a growth rate similar to its European peers required repeated devaluations. Inflation reached unsustainable levels and hit the most vulnerable in society.

The Euro project has also led to convergence amidst member countries barring Greece and Portugal.

In the end, he says the solutions for current problems is not less but more Euro:

It is not a technocratic desire to see convergence across countries and the smooth functioning of Monetary Union that has led me to frequently mention the importance of structural reforms in recent years. Each country has its own reform agenda, but such reforms are the only way to create the conditions for sustainable growth in wages, productivity and employment and to underpin our welfare state.

In large part these measures have to be undertaken at the national level, but they can be supported at the European level by the recent decisions to launch an instrument for convergence and competitiveness.

However, to tackle future cyclical crises, the two layers of protection against shocks – the diversification of risk through the private financial system on the one hand, and public countercyclical support through national budgets and the fiscal capacity of the EU budget on the other – need to interact in a complete and efficient manner.

The more progress we make in completing the banking union and capital markets union, the less urgent – although still necessary – it becomes to construct a fiscal capacity, which could at times serve to complement national stabilisers. Inaction on both fronts heightens the fragility of Monetary Union in times of great crisis and the divergence between countries increases.

It is clear that completing Monetary Union is the best way to prepare the transition to a form of union that is more complete. Monetary Union, a necessary consequence of the Single Market, has become an integral and defining aspect – with its symbols and its constraints – of the political project whose central aim is a Europe that is united in freedom, peace, democracy and prosperity.

It was an exceptional response – or to paraphrase Robert Kagan[36] an anti-historical response – to a century that had seen dictatorships, war and misery, and in that respect was not dissimilar to previous centuries. A unified Europe was part of that world order, itself the result of exceptional circumstances, which followed the Second World War.

The intervening years have confirmed the rationality of the choices made at the European and the global level. The challenges that have arisen have become ever more global in nature and need to be tackled together, not alone. And this is even more true for Europeans, both at the level of their individual nations and for the continent as a whole: rich but relatively small; strategically exposed, militarily weak.

Yet today, for many, the memories that inspired those choices seem distant and irrelevant, and the rationale behind them has been undermined by the misery created by the great financial crisis of the past decade. It does not matter that we are emerging from the crisis. Elsewhere in the world, the fascination with illiberal prescriptions and regimes is spreading; we are seeing little steps back in history.

And this is why our European project is even more important today. It is only by continuing to make progress, freeing up individual energies but also fostering social equity, that we will save it through our democracies, with a unity of purpose.

Nice coverage of overall issues. Though, Euro dissenters will disagree..

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