Dr. Jürgen Pfister, Chief Economist and Head of Investment Research The Pros and Cons of European Integration: the Pros A German Perspective

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1 Dr. Jürgen Pfister, Chief Economist and Head of Investment Research The Pros and Cons of European Integration: the Pros A German Perspective Global Insight s World Economic Outlook Conference Cambridge, Mass., October 26, 2005

2 The rationale behind European integration (1) European integration is mainly the result of political rather than economic considerations. After the Second World War the European nations were looking for mechanisms to rule out war among each other forever. A first step was the formation of the European Coal and Steel Community (ECSC) in 1951, consisting of the six founding members of the EU. In 1952 a treaty was signed to create a European Defence Community; but the French parliament did not ratify this treaty. Pro and Contre European Integration Chart 2

3 The rationale behind European integration (2) The important lesson from this: There is no direct route to political union (common foreign and defense policies). As a consequence it was decided that economic integration was first to be concentrated on and then pushed to a point where political integration would become inevitable, the so-called spill-over theory. This strategy bears significant risks! Pro and Contre European Integration Chart 3

4 Major steps towards economic union (1) The completion of the internal market in The four basic freedoms: free exchange of goods, services, capital and labour. The economics of 1992 (Cecchini report). Free trade within the EU did not come along with higher trade barriers vis-a-vis third countries. More than a decade after the official completion of the internal market, it is still incomplete (esp. services; labour for new members). Necessary complements to the four freedoms are competition rules (mergers, subsidies) and a certain degree of harmonization. The internal market, although still incomplete, has fostered economic integration. Competition policy has strengthened competition and has helped to open up markets (utilities, transport, postal services, telecommunication). Pro and Contre European Integration Chart 4

5 Major steps towards economic union (2) Monetary union was a goal of European economic integration from the beginning. It lends a new quality to the integration process: not just common rules, but common policies/institutions; and it makes integration irrevocable ( a community of fate ). Political considerations played again a prominent role: The then-political leaders of Germany and France Kohl and Mitterand saw monetary union as an instrument for securing peace in the 21st century. The dominant role of the D-mark and the Deutsche Bundesbank a de facto ECB became more and more of a problem for (some) EU partners in the 1980s. German unification (1989/90) intensified the fears of German dominance in Europe greatly. The approval of German unification by France and the UK was dependent on Germany s acceptance of the EMU, surrendering the D-mark. The Maastricht Treaty was signed in Pro and Contre European Integration Chart 5

6 Major steps towards economic union (3) Monetary union: Is Europe an optimal currency area? The performance so far: average consumer price inflation (HICP) : 2% p.a. Does monetary union make sense for Germany? (All the promises of the EMU a stable currency, an international currency, an independent central bank were already fulfilled with the D-mark and the Bundesbank.) A second spill-over theory? More than 40% of Germany s exports are free from currency risks (in future possibly more than 60%). The experience with the D-mark: Periods of dollar weakness were accompanied by (sharp) appreciations of the D-mark vis-a-vis other European currencies. Pro and Contre European Integration Chart 6

7 Major steps towards economic union (4) Would Germany currently be better off with an independent monetary policy? Lower inflation and lower potential output growth than in the other EMU countries on average. But lower inflation does not only mean higher real rates of interest but also a real depreciation or a gain in price competitiveness. Pro and Contre European Integration Chart 7

8 Germany: Improved price competitiveness unit labour costs for the whole economy, 1995= Germany France Italy Spain Pro and Contre European Integration Chart 8

9 Major steps towards economic union (5) The Bundesbank of the 21st century might have behaved differently as an independent central bank than what we were familiar with in the forty years up to 1998 (erosion of the stability culture). The legal basis of ECB policy the Maastricht Treaty, the statute of the ECB has a higher quality (international law) than the former Bundesbank law. Pro and Contre European Integration Chart 9

10 Major steps towards economic union (6) The Stability and Growth Pact (SGP) myth and reality. A German idea (Waigel, Tietmeyer). It does not really go (much) beyond the Maastricht Treaty (3%, 60%). Fiscal deficits in the euro area are currently much lower than they were before the EMU was introduced ( : -5%; 2005: -2.8%). The recent reform has weakened the SGP. The EMU has fostered the integration of financial markets in the euro area and has intensified competition in the financial industry. All in all: The role of the EMU in the current period of economic weakness is overrated. Structural reforms are needed to revive growth and strengthen employment. EMU has not done much good or harm from a German perspective. Pro and Contre European Integration Chart 10

11 Major steps towards economic union (7) Eastern enlargement: Ten new members since May 2004, eight of which in Central Europe. EU (and NATO) membership is very supportive in stabilizing the democracies and market economies in these countries, which were formerly controlled by the Soviet Union. Eastern enlargement of the EU is a major challenge as real convergence (per-capita income) has a long way to go. Germany is benefiting greatly from eastern enlargement because of its geographical location, historical and cultural ties and its product mix of export industries (capital goods). At the same time, eastern enlargement calls for more rapid structural adjustment in Germany (low wage and tax competition inside the EU). Pro and Contre European Integration Chart 11

12 European integration from a German perspective: Taking stock The German economy, with its prominent role in world trade, is benefiting strongly from the internal market (although still incomplete). EU competition policy has helped to break up national monopolies and has fostered privatization and competition. EMU is more or less neutral from a German perspective. Eastern enlargement is a strong plus for the German economy. The EU, with a strong influence of the British liberal, pro-market approach to economic policies, has prevented and is still curbing deviations of individual countries from the common ground. Pro and Contre European Integration Chart 12

13 Prospects: Where is Europe heading? The Lisbon strategy is the right approach but most policies fall within the domain of national governments. The constitutional treaty came at a time of disappointing economic performance; it obviously asked too much of the people. Further enlargement (apart from Bulgaria and Romania) should be handled with care. Is there a need for further deepening (transfer of sovereignty to EU level)? What does political union mean? EMU is not at risk; the likelihood of a breakdown is very low.. Pro and Contre European Integration Chart 13

14 Conclusion (1) EU integration is a (political) reality and will continue, albeit as in the past at varying speeds and not without abberations. It supports growth and it stabilizes Europe politically. The disappointing economic performance in Germany, France and Italy is due to the inability of national governments to pursue structural reforms (e.g. labour markets, taxation, social security). On balance, Germany is benefiting from the European integration process. Pro and Contre European Integration Chart 14

15 Conclusion (2) The task for Europe to regain a leading role in innovation and technical progress is supported by EU policies. EU integration is the only appropriate answer to the challenge of globalization. European companies will only be able to compete successfully with (bigger) US and Asian firms if they operate in a single market of 450 million consumers with a GDP of bn 12,800 dollars. Pro and Contre European Integration Chart 15