I. The Main Stages of Europe’s Construction

During forty years the construction of Europe was mostly economic, based on free trade. The idea of liberalizing trade between Western European countries arose immediately following World Was II, parallel to the Marshall Plan, as a way of avoiding new conflicts between these countries and anchoring them as a group to the Western world. The countries that had been traumatized the most by the war were slow in accepting the project. Nevertheless, with the signing of the Treaty of Rome in 1957, the project derived into the Common Market. In 1968, following a relatively long period of transition, all customs tariffs and quantitative restrictions on trade in goods between six Western European countries (Germany, Belgium, France, Italy, Luxembourg and Holland) were abolished and their trade policies were unified.

The Treaty of Rome led to the Common Agricultural Policy (CAP), whose objective was to insure Europe’s self-sufficiency in foodstuffs and transform it into a world agricultural power.

In 1987 Europe’s Single Act was adopted in order to insure the four basic freedoms embodied in the Treaty of Rome (free trade in goods and services, free circulation of people and capital). The Single Act established the principle of mutual recognition between European countries and began the vast task of harmonizing rules and regulations. It also established a European policy regarding competition that has played an active role in opening up public markets, as well as in the struggle against the distortions caused by government subsidies. Finally, it imposed a minimum harmonization of value added taxes. By allowing the creation of a true no-boundaries area  (at the moment, with few notable exceptions such as the free circulation of people and the supply of financial services), the Single Act represented, on February 1, 1993 and ever since then, the natural extension and the crowning of the Treaty of Rome.

A sign of its success: parallel to the above developments, the European Community had expanded with the incorporation of Denmark, Ireland and the United Kingdom in 1973, Greece in 1981, Spain and Portugal in 1986. In 1995 it expanded again to include Austria, Finland and Sweden. With the incorporation of countries with a lower standard of living than that prevailing, on average, in Europe, the construction of a united Europe entered a new phase. Since the preamble of the Treaty of Rome established as a principle the need to struggle against different development levels, a real effort had to be made to integrate such countries. With the Single Act the objective of economic and social cohesion between European countries was included in the statutes of the European Community. In 1988, the structural fund’s budget was doubled following the reform of the cohesion policy, and later increased by 50% in 1993.

The final stage of the construction of a unified Europe through the economy was the Monetary Union. Ever since the disintegration of the Bretton Woods system, monetary cooperation was seen as a necessary corollary to the Common Market and the CAP, since both, free trade and the free movement of capital do not easily adapt to total exchange rates flexibility. Europe’s monetary policies were increasingly related within the European Monetary Serpent (1972) and later the European Monetary System (1979). With the Treaty of Maastrich, signed in 1992, monetary cooperation led to the establishment of an Economic and Monetary Union (EMU). On January 1, 1999, after a long and difficult process of monetary unification, eleven countries of the Union adopted a single currency, the euro.

In the social area, beginning at the last quarter of the eighties, some progress was made to insure, on the one hand, a minimal harmonization of practices, needed for fair competition and on the other, to stimulate a social dialogue and address the growing concern with unemployment levels in Europe. Eventually, the country members of the EC agreed on the need to define a common minimum platform regarding labor relations and the struggle against exclusion. They also agreed to preserve national social protection rules. With the Essen Summit of 1997, the European countries adopted the principles of coordination and progressive convergence of their unemployment policies. At the Cologne Summit of June 1999, an employment Pact was prepared, however, since countries could not agree on the strategy to adopt, its implications remained mostly symbolic.

Finally, the profound modifications Europe underwent due to globalization and the fall, at the end of the eighties, of the communist bloc, opened up new possibilities of cooperation for the countries members of the Community. In Maastrich, the Foreign and Common Security Policy (FCSP) and the Justice and Internal Affairs (JIA) one became Europe’s inter-governmental pillars, as opposed to the traditional pillar of community action. The Schengen Agreement between some of the European countries specified that the free circulation of people could not be insured without close coordination regarding police activities and immigration and asylum policies. The Treaty of Amsterdam included this “Schengen addition” to the first pillar. In April 1999, at the NATO Summit in Washington, it was agreed to grant the Western Europe Union (WEU), in charge of developing a European defense front, collective resources (particularly military units) for operations agreed upon only by Europeans, in application of the FCSP and after consultations with the North Atlantic Council. The European Council’s decision to merge the WEU and the EU, adopted at the Cologne Summit in June 1999, led many observers to conclude that a European defense front had been created within NATO.

II. A Key for Analysis

In 1950, in a historical declaration on the creation of the European Community for Coal and Steel, Robert Schuman said: “Europe will not be made all at once, nor by joint construction: It will be made by real actions that lead, first, to de facto solidarity”. In the half century since then, the process of European construction has been characterized by a gradual progression, by a community dynamics with ample autonomy regarding inter-governmental cooperation, and by a growing interference by Community bodies into the closed circuits of national policies, which has led to a redefinition of the role of the state in member countries.

The construction of Europe can be seen as a group of countries’ decision to build together a number of public goods (that is, goods the consumption of which does not limit at all the benefit others may derive from them): a free market and free and fair competition area (Common Market, Social Agreement), a monetary area (single currency), a budding redistribution and recovery mechanism (structural funds, cohesion funds), a common defense policy (FCSP), etc. By participating in each of these mechanisms or agreements, each country joins the corresponding offer of a particular good and creates a positive environment for others. It expands the circle of those participating in the agreement, increases its diversity and its weight abroad. The offer of each public good must be centralized in order to maintain standards. To avoid an opportunistic approach, member countries agree to abide by a common regime, usually determined by a central authority.

 If countries share similar characteristics, then the decisions taken by such central authority will be optimal. On the other hand, the greater the differences among them the lesser the possibilities of the central authority to offer a good convenient to all countries. Thus, the common monetary policy will be adapted to a country suffering a particular shock. Strict social rules, should they be established, will not be equally convenient  to a rich country as to one on the way to economic recovery.

A similar analytical framework allows us to determine the key elements of a cooperative process such as the construction of Europe: the positive environment that is at stake, the risks of opportunistic behavior, countries’ degree of heterogeneity. Undoubtedly, the launching of the process was the result of a political will to commit to the construction of Europe whatever the immediate costs and in spite of great uncertainties. The “communitarian method” later generated its own dynamics: the building of a public good brings countries closer, thus reducing their heterogeneity, and leads to the creation of a new public good. As we will see further on, free trade and the cohesion policy led to the Monetary Union. The expansion of the European Community has generally been accompanied by a strengthening of the process of European construction. Within this dynamics, the Commission has played the most important role among all international authorities. It is up to the Commission to define public goods, propose an agenda for their creation and expansion. The Commission plays a major role in the legislative process that determines each country’s modalities for participation in the offer of public goods and is vigilant against opportunistic behavior.

During the last forty years, this linking has led to an almost automatic integration of European countries. If a confederation is characterized by the relatively flexible coordination of national policies and a federation by the transferring of national prerogatives to a super-national authority, then we could say that Europe has embarked on a federal project. Throughout the integration process the reduction of disparities between countries has played a major role.

III. European Commonalities

Without a doubt, Europe has contributed to the convergence of its countries. The establishment first of the Common Market and later of the Single Market has increased trade flows within the community. As for trade flows between European countries, trade within enterprises has decreased somewhat, while trade between enterprises has increased. Therefore, trade integration has led to some diversification of European economies. In the case of the so-called cohesion countries (Ireland, Portugal, Spain, Greece) structural funds played a determining role in the development of infrastructures. The average per-capita income converged in European countries, in some cases in a significant way (Ireland, Portugal).

This real convergence was accompanied by a nominal convergence. During the eighties, the principle of budget austerity, wage and price controls, which had been a keystone of Germany’s economic policy since the seventies, was adopted by Holland, Belgium and France and later by the southern European countries and the United Kingdom after the Maastrich Treaty imposed it a s a condition for access to the Monetary Union. All of Europe’ central banks focused their policies on controlling inflation. Between 1979 and 1984 prices had increased by an average 10% per year in the countries of the Union as a whole, and by 4.5% in Germany. Between 1991 and 1996 prices increased by 3.3% and 3.1% respectively.

The final element of convergence between European countries was exogenous: Germany’s reunification. In the macroeconomic field, the size of Germany’s current account balance surplus, besides the different levels of inflation, justified, until 1990, the asymmetry between the mark and the other European currencies and affected, a priori, the possibilities of a monetary union. With re-unification the savings index fell in Germany, investment increased and the current account balance registered a deficit. By the beginning of the nineties the mark had lost its pull in Europe.

The monetary unification of Europe was long and difficult. The inflationary effect of Germany’s reunification and, later, the criteria for admission to the Monetary Union imposed upon the European countries, during most of the nineties, a policy mix totally foreign to their economic situation. Nevertheless, the Maastrich Treaty and the reunification of Germany also contributed to the convergence of Europe’s economies. By the time they had to commit to the Monetary Union, the European countries were more homogeneous than ever as far as their development levels and macroeconomic administration were concerned. Their structural difficulties were also more homogeneous. Hence, European economies continue to be vulnerable to asymmetric shocks, that is, shocks that affect just one country or a sub-group of countries within the Union.

Where would suck shocks come from? It should be pointed out that most of Europe’s past asymmetries were due to the evolution of the demand, particularly in response to economic policy measures. As progress is made in the coordination of macroeconomic policies, particularly in the MU, this type of asymmetry will disappear. On the other hand, the transmission channels for monetary policy, the economies’ sensitivity to interest rates, and some small countries’ type and degree of specialization (Ireland, Finland, Portugal) continue to be significant causes for asymmetries between the European countries. Even though four decades of economic integration have significantly reduced differences between the European countries, these are still strong enough to affect the functioning of the Monetary Union. This is an important issue for the future of a united Europe.

IV. Fiscal Federalism

One aspect of Europe’s construction has concluded with the EMU. As described above, this has led to other important achievements, first among them the budget and social policies.

The national budget policies affect the area’s economic environment more towards fixed exchange rates than flexible ones, and alter the context of the common monetary policy. This interdependence led to the criteria included in the Maastrich Treaty regarding debts and public deficits and, later, to the creation of the Growth and Stability Pact. By establishing a maximum level for budget deficits, one of the risks of opportunistic behavior is reduced. However, the coordination needed for the application within the Union of an adequate policy mix is not insured at all.

In view of this gap, it was decided in 1997 to inscribe national policies within the Major Orientations for Economic Policy defined each year by the Eupean Council. At the Luxembourg Summit, at the end of 1997, an Euro Council was created (Euro-11) between the country members of the EMU. Some countries envisioned it as the forefather of an economic government of the Union. These instruments offer an institutional framework for the coordination of budget and structural policies, however the modalities of such coordination continue to be vaguely defined. Moreover, it must be pointed out that the European Council later adopted a resolution establishing that the Council of Economic and Finance Ministers (CEFM) was the only body in charge of economic policies. Consequently, the Euro-11 continues to be, for now, a body without an affective coordinating capacity.

The inadequacy of current coordination procedures could become evident in the case of an asymmetric shock. Three corrective mechanisms may intervene in the areas affected by such shock: the movement of factors, price adjustments and  budget policies. The first two are practically inapplicable within the euro area. Labor mobility is limited even within each European country and more so between them. A price-led adjustment would be imperfect both within a country’s regions as between countries. This is particularly true in the labor market, where the flexibility of wages is insufficient to offset foreign exchange losses. Thus, the budget policy would have to carry by itself the weight of the adjustment in the case of an asymmetric shock. Today there is no community transmission mechanism between countries capable to play the role of automatic stabilizer. As a comparison, the federal budgets of the United States or Germany write down 30% and 50% respectively of short- term fluctuations in the regional per capita GDP. The affected country, lacking an efficient coordination with its partners, would have to rely solely on its budget policy to adjust and could even see its efforts partly neutralized by opposite policies applied by its partners.

The Monetary Union also strengthens the need for a fiscal and social harmonization that had been acknowledged as necessary and initiated within the framework of the creation of the Single Market. The disappearance of exchange rates completes the creation of a unified internal market in which goods and services, the movement of people and capital become more sensitive to disparities in obligatory contributions, the quality/cost relation of public services and social protection norms. In this case, countries would feel stimulated to enter into a dangerous competition whereby each would endeavor to increase its competitiveness by modifying its fiscal and social regimes, to the detriment of its trade partners. The redistribution of income through taxes could be hampered by fiscal rules and the most generous social protection regimes could be faced with an avalanche of demands for benefits.

As can be observed, the impact of these external factors depends on the degree of capital and labor mobility. This explains the intense competition that erupted between European countries at the end of the eighties regarding fiscal regimes on capital. This led to a lowering of the capital tax and to the transferring of the fiscal burden to labor. In order to reverse this tendency, in coming years capital could be subject to a minimum level of harmonization under the tutelage of the Commission, similar to the value added tax harmonization carried out within the Single Market. In December 1997, the ECOFIN Council adopted a code of conduct regarding enterprises’ fiscal regimes which defines (in vague terms) the damaging practices and suggests their stabilization and final elimination by the end of the year 2000. More recently, following a petition by the ECOFIN Council, the Commission presented a project for a guideline regarding fiscal regimes on income from savings. Each member state would be able to choose between retaining 20% of it at the source and supplying to other members information on income paid to non-residents.

The administration of the external budget and fiscal and social factors will greatly condition the construction of Europe. Two general fiscal systems could be adopted. In one, the heterogeneity of the European countries would be seen as a given and priority would be granted to minimizing the consequences of such heterogeneity for the functioning of the Monetary Union. Each country would have to adopt fiscal reforms aimed at increasing the flexibility of prices and wages in order to ease the adjustment in the case of an asymmetric shock and to allow national budgets to fully exercise their role as moderators. Naturally, this plan rules out any harmonization of wages or social norms between European countries, unless in the fiscal area, and opens the way to competition between national systems.

In the second system, emphasis would be placed on fiscal and social harmonization. Larger shifts in budget allocations would be carried out with a view to redistribute wealth or stabilize the economy. Such allocation transfers would be aimed at softening the risk of an asymmetric shock, for example through a fund financed by a specific “European” tax. In this way the European countries would establish an insurance mechanism against occasional shocks that would be credible and more effective than national budget policies. However, since occasional shocks are not distinguishable from structural shocks, in the long run this system would evolve, at least partially, into a redistribution mechanism. This system would, thus, accelerate Europe’s evolution towards a federal structure. The “federal” solution poses its own risks: security originates moral uncertainty and this could lead countries to abandon adjustment efforts to rely upon the solidarity of the community. As  it has been demonstrated on countless occasions throughout the world, transfers that are wrongly aimed or insufficiently conditioned to economic results in the beneficiary region can discourage economic recovery. Finally, the federal solution could bring into line Europe’s wage costs and social obligations without properly taking into account their heterogeneity.

Of course, it is highly probable that a mid-way between these two extreme paths will be adopted in the construction of Europe. However, in the long run, Europe will be closer to one or the other of these two systems. Its past will undoubtedly steer it towards fiscal federalism; however, this would imply a yet non-existent degree of solidarity and convergence between Europeans.

V. The Expansion to the East and Its Consequences

With the fall of the communist bloc Europe was naturally called upon to expand to Eastern, Central and Baltic countries. Because of its size, the different economic levels between member countries and countries candidate for accession and because of the importance of the community’s instruments that new countries must join (single market, single currency, JAI, PESC, social regulations), the European Union’s expansion to the East is one of the most ambitious steps in the history of the construction of Europe. The expansion could bring to more than thirty the number of countries members of the Union. By themselves, the ten countries of Central Europe represent 27% of the European Union in terms of population, but only 5% in terms of its GDP, with a per capita income 20% below that of the EU.

In 1988, after the Commission examined their candidatures, negotiations began with Hungary, Poland, the Check Republic, Latvia and Slovenia, as well as Cyprus. The basic difficulty encountered by Europe in its expansion to the East is to adopt a  flexible outlook as far as requirements are concerned, in order to favor economic growth and recovery. Often in the past the key to successful expansions was the classification of aspiring members.

Expansion also implies a total restructuring of the Union’s budget mechanisms, particularly as attempts are made to avoid sharp rises in the community’s budget, substantial reforms of the CAP and the structural funds, major sources of expenditures. As for the CAP, the expansion of the Union implies a faster transition from a price support system to one of direct payments, in order to open the Union’s agricultural market to the new members without massive budget transfers in favor of agricultural producers and without losing competitiveness. The impact of expansion on the cohesion policy will be to redirect aid towards entering countries, since such assistance is granted on the basis of asymmetries in the per capita GDP, compared with average figures within the Union.

Finally, expansion also requires a revision of European institutions in order to avoid their paralization due to the number and diversity of member countries. The protocol on the future of such institutions, included as an annex to the Amsterdam Treaty, identifies some of the areas that will need to be reformed upon expansion. These are: review of the weighted vote system within the Council and lowering the number of commisaries to one per country; extension of the vote by qualified majority; modernization of the Commission. In December 1997, at the Luxembourg Summit, EU countries agreed to adopt a new treaty on institutional reforms before the first wave of expansions became effective.

In 1997, in its report “Agenda 2000”, the Commission presented a number of proposals regarding the reform of the CAP and the cohesion policy, as well as the modalities of the expansion process within the Union’s 2000-2006 budget. The Agenda also referred to the institutional reform within the framework defined by the Amsterdam Treaty. These proposals, which affect important national interests, were the object of difficult negotiations. Finally, in March 1999, at the Berlin Summit, a partial agreement was reached. The proposed reforms were mostly updated or softened. Community’s expenditures were reduced except for the financing of adhesion processes. The principles of streamlining and development of the Union’s own resources were put on the back burner. Regarding agricultural issues in particular, the opportunity was not taken to completely separate assistance from production, a development which would have completed the reform of the CAP and strengthened Europe’s position at the next round of WTO trade negotiations. The general assessment was that such limited progress dampened the outlook of expansion and represented a failure of fiscal capitalism.

Paradoxically, feeling the pressure of the war in Yugoslavia, the fifteen heads of state meeting in Cologne decided to give new impetus to expansion. The Helsinki Summit, at the end of 1999, was to officially launch negotiations on the accession of a new 5 + 1 group (Bulgaria, Latvia, Rumania and Slovakia + Malta). The first accession is expected to take place by 2002-2003. Before that, an agreement will have to be reached on the reforms to the Agenda 2000 that were not solved in Berlin. Finally, the inter-governmental conference of the year 2000, which should establish the institutional reform, should limit itself to the issues mentioned in the Amsterdam Treaty.

VI. Outlook

The Europe of the XXI Century will be increasingly heterogeneus due to the expansion to the East and also to a reversal of the effects of economic integration on countries’ specialization. Indeed, some geo-economic studies foresee that Europe will evolve in a way similar to that of the USA, whose regions are highly specialized. Such evolution would cause great tensions within the European Union. Will it be able to face them?

During the last years the construction of Europe has overcome fundamental stages. However, it has also stagnated in areas that determine the future of the Union: budget coordination, fiscal harmonization, the institutional reform, and the reforms to the CAP and the cohesion policy. At the same time, the community’s method has been modified significantly. By widening the field for joint Parliament-Council decisions in the European legislative process, the Amsterdam Treaty has strengthened the powers of the European Parliament, partly to the expense of the Commission. The crisis of the first trimester of 1999, which led to the bureau’s resignation, also weakened the position of the Commission, while the growing ascendancy of the JAI and PESC ratified a return to inter-governmental action. Moreover, the Amsterdam Treaty introduced a flexibility clause that confirms the notion of variable geometry: if the majority cannot force a country to action, it is clear that one country alone cannot impede action by the majority.

Since then, many observer have concluded that the construction of Europe has stagnated due to lack of leadership, the modification of the geo-political distribution and growing nationalism. The introduction of variable geometry is seen by some as a failure of the community method, aimed at integration and consensus, and as a dangerous appropriation by governments of the process of European construction.

Moreover, the construction of Europe has been and continues to be a pragmatic process: it unfolds under the pressure of events. This means that those measures that are desirable for the Union’s good performance in the future, but are not urgent, develop slowly. Thus, there is no doubt that the need to open new fields of coordination at the community level is not yet compelling enough to do away with different views and national interests. As long as an asymmetric shock does not erupt, it is not deemed necessary to impose stricter budget coordination than the one currently prevailing. The same is true in the social or employment areas: when significant issues were at stake (recently, immigration and asylum policies, the common defense), coordination progressed and led to the adoption of centralized policies or norms. A similar scenario could occur in the near future regarding fiscal regimes on capital.

Finally, the expansion of the inter-governmental field of action does not necessarily imply the stagnation of Europe’s construction. On the contrary, as the PESC demonstrates, it could lead to a renewed impetus. Naturally, should the European countries voice fundamental disagreements, then this evolution will be more difficult and fraught with obstacles. Nevertheless, this phase is necessary for the definition of a “European model” prior to integration. Only by paying this price will Europe’s peoples and nations once again assume the leadership of the construction of Europe.

Bibliography

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·         Cangiano M and Mottu E., “Will Fiscal Policy be Effective Under EMU?” IMF Working Paper No. wp/98/176, 1998.

·         Commisariat Général du Plan, report of the group “Europe Sociale” within the framework of the reflection on the future of Europe’s institutions, 1999.

·         Hugounenqr, Le Cacheux J. And Madiés T., “Diversité des fiscalités européennes et risque de concurrence fiscale”, Revue de l’OFCE, 1999.

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