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Issue 4, July/August 2005
Federal Reserve Bank of Dallas
European Economic Integration: A Conflict
of Visions
Economic integration is a key
theme of the global era in which we live today. Perhaps
the single most important example of such integration
in recent decades is the European Union.
From the ashes of the wartime
years, six core European nations forged a confederation
that gradually grew to encompass 15 members and then
25. As the EU evolved into an economically freer and
more integrated group of nations, the overall European
economy has grown to the point where it rivals that
of the United States (Chart 1).
A further step toward economic
integration was at stake on May 29, when French voters
cast their ballots on a proposed European constitution.
The debate had been framed in cataclysmic terms, with
proponents arguing that a French rejection could be
a “fatal blow” to further European integration.
Proponents went on to say that there was no Plan B—implying
the French either must approve the proposed constitution
or bear responsibility for what former EU President
Romano Prodi called “the end of Europe.”
French voters rejected the constitution
by a 10-point margin, and the Dutch followed suit three
days later with an even more resounding rejection of
the document. Yet the EU did not end. Indeed, it could
not end because its existing treaties and regulations
remain in place indefinitely unless superseded by a
new governing structure. So in a very real sense, the
EU to which French and Dutch voters awoke in June was
the same Europe to which they had awoken the month before.
In and of itself, the proposed
constitution would have little effect on the overall
European economy. Indeed, primary author Valéry
Giscard d’Estaing describes its economic provisions
as a “tidying-up” of existing guidelines,
rather than a renewed effort at economic reform. But
the debate that has broken out in the wake of the French
and Dutch referendums does have important implications
for Europe’s economic future and, by extension,
the economic future of the United States. The question
is simple: To what extent and in what manner should
European integration continue?
The Benefits of Economic Integration
Economists generally support
economic integration because it eliminates certain inefficiencies.
When states in a common market choose different tax
and labor policies, for example, workers and businesses
have an incentive to move from states where taxes are
high to states where they are low. Similarly, those
who receive government subsidies have an incentive to
move from states where subsidies are low to states where
they are high. This migration punishes socially progressive
states by simultaneously raising the amount they must
spend and reducing the tax revenue available to meet
their obligations.
Some believe this competition
goes too far. The Organization for Economic Cooperation
and Development recently concluded that the developed
world should eliminate “harmful tax competition”
between states. German Chancellor Gerhard Schröder
echoed these concerns in a European Union context, arguing
that low tax rates in its newly admitted Eastern members
constitute “unfair tax competition.” French
President Jacques Chirac even coined a new term—“social
dumping”—to describe the process by which
laissez-faire states import workers and businesses from
more highly regulated EU members.
Economics textbooks reveal the
solution to this apparent dilemma. If competition between
states for individuals and businesses is undesirable,
such competition can be reduced or even eliminated through
common economic policies. Simply compel all members
of a federation to offer the same business climate and
social safety net, and neither individuals nor businesses
will migrate in search of something that better suits
their needs. This would relieve the fiscal pressure
on high-benefit states and thereby strengthen what is
often called “social Europe.” Further economic
integration, in other words, is the answer.
But there is more than one kind
of economic integration. The North American Free Trade
Agreement provides a useful example in this regard.
When NAFTA was debated in the early 1990s, many unions
felt the treaty should impose U.S. labor and environmental
laws on Mexico. Business groups vigorously disagreed,
arguing that such a requirement would weaken the competitive
forces NAFTA was intended to unleash. The argument was
not so much over whether to integrate the U.S. and Mexican
economies but how to integrate them.
Much the same rhetoric has been
heard in the debate over the European constitution.
As Chirac said in mid-April, the EU faces a conflict
of visions on how to further integrate members’
economies. “The first,” he said, is “to
go with the Anglo-Saxon and Atlantic liberal current”
of low tax rates and flexible labor markets. “That
is not what we want. The second solution is that of
a humanist and therefore organized Europe,” he
concluded, that can “stop the drift toward economic
ultra-liberalism.”
So it is not economic integration
per se that is being debated, because a uniformly low-tax
Europe with flexible labor markets would be just as
integrated as a Europe that embraces uniformly high
tax rates and inflexible labor markets. Rather, the
question is what sort of further economic integration
Europe will pursue.
If the European economy would
be equally productive under either approach, economics
would have little to say about these two visions. But
this is not the case. It may be true that individuals
and businesses could not escape a uniformly high-tax,
high-benefit Europe through migration. But individuals
could reduce their workweek or leave the workforce entirely,
and businesses that would barely survive under a low
tax burden would fail if confronted by a higher one.
Such individuals and businesses would simply cease to
exist as far as production is concerned, becoming either
welfare recipients or bankrupt enterprises.
Those are the unspoken economic
stakes behind the conflict of visions. In essence, integration
along British norms would propel EU members toward a
future of high growth and low unemployment, while integration
along German norms would drag EU members toward low
growth and high unemployment.
Liberalization Versus Economic
Integration
Does the evidence support
the notion that high-tax, high-benefit economies fare
worse than freer economies? A comparison of Europe and
the United States sheds light on this question.
Over the past two decades, the
U.S. economy has grown at an annual rate of 3.2 percent,
while the French economy has grown by barely 2 percent
per year (Chart 2). Except for a brief spike
following reunification in the early 1990s, the German
economy has fared even worse.
Unemployment is a good indicator
of labor market flexibility, and here, too, the evidence
is clear. U.S. unemployment has fallen from 8 percent
to 5 percent over the past two decades, while the French
and German rates have averaged about 10 percent (Chart
3). Although observers commonly point to the current
economic performances of France and Germany as proof
of the “Eurosclerosis” that besets Old Europe,
it is this sustained difference that suggests something
more fundamental is at work here. That fundamental “something”
boils down to competitiveness.
The various organizations that
evaluate the extent to which countries are economically
free uniformly conclude that the United States is freer
than all or most European nations. Perhaps the most
well known of these evaluations is published jointly
by the Fraser Institute and the National Center for
Policy Analysis. It ranks the United States as the world’s
third freest economy, with Germany 22nd and France 44th.
Rankings published by the Heritage Foundation and IMD
International reach similar conclusions.
Why does the U.S. fare so well
in these surveys? Simply put, America offers a lower
tax burden and a more flexible labor market than France
and Germany. The United States has fewer regulations
governing the hiring and firing of workers and fewer
governing the number of hours an employee can work.
This increases the value of workers in the eyes of firms
and thereby helps keep unemployment low—and production
high. Low tax rates have a similarly laudable effect
on the U.S. economy by facilitating business creation
and fostering business growth.
If it is well understood that
inflexible labor markets and high taxes cost jobs and
retard growth, why do some EU member states seek to
impose them at the European level? The answer may lie
in the distributional consequences of this choice. If
it’s assumed that France and Germany will not
abandon the policies that encourage businesses and workers
to flee those countries, the consequences of those policies
can be mitigated by compelling nearby states that would
otherwise attract those disgruntled workers and businesses
to adopt the same policies. Businesses and workers for
whom the economic climate is particularly oppressive
might leave the EU entirely, but that is a much more
costly decision than simply slipping from one European
state to another. On net, the more highly regulated
European economies may gain, even though the EU as a
whole loses.
Recent evidence points to the
same conclusion. Last year the European Union considered
a proposal to introduce free trade in services across
its member states.[1] With free trade having been a
core idea behind the EU’s formation, and with
the service sector having grown to the point where it
now accounts for 70 percent of European output, free
trade in services would seem like an almost automatic
extension of the ever-closer union that EU policymakers
say they seek. Yet the proposal was rejected.
In arguing against it, one European
head of state decreed that the continent “must
not become a free trade zone,” a statement consistent
with the vision that Europe must achieve economic integration
without further economic liberalization. But it is not
consistent with the agenda to which a unanimous EU agreed
in Lisbon, where Europe committed to having the world’s
most dynamic and fastest-growing economy by 2010.[2]
French Prime Minister Dominique
de Villepin opined in late June that European leaders
must either lead the charge to protect social Europe
or else “we resign ourselves to making our continent
a vast free-trade area governed by the rules of competition.”
Whether to accept or resist the “rules of competition,”
and the prosperity those rules bring, is indeed the
choice Europe now confronts.
The Conflict of Visions
These facts by no means imply
that European integration to date has been a mistake.
As mentioned elsewhere in this article, European integration
has facilitated a remarkable rise in Europe’s
standard of living. Nor do they shed light on whether
Europe should or should not voluntarily sacrifice economic
growth to achieve social goals it deems important. If
Europeans wish to be less prosperous in the future so
they can be more equal today, economics cannot call
the wisdom of that decision into question. But economics
can reveal its consequences.
Consider Singapore and the Soviet
Union, and the conflict of visions becomes clear. Singapore
is generally considered the freest economy on the planet
(even more so than the United States), and its economic
growth has been consistently strong. Yet the country
has no formal structure anchoring it to the world economy
beyond a strong business climate and membership in organizations
like the World Trade Organization that promote business
activity.
On the other hand, the Soviet
Union is generally considered to have been one of the
least free economies, and it exhibited weak economic
growth for most of its history. Yet its member states
were linked with a high degree of economic integration.
The point is that economic integration
does not promote economic growth in and of itself. Only
economic liberalization can do that. If the 25 members
of the EU were to agree to integrate along French or
German norms, the fact that the federation had achieved
further economic integration would not save its economy
from sliding into the night.
From an economic perspective,
then, the ultimate fate of the European constitution
is less important than the competing visions of the
European future the ratification debate has exposed.
On one side are countries, led by France and Germany,
that believe the European economy should become more
highly regulated. On the other are countries, led by
Britain and the Netherlands, that believe the European
economy should become less highly regulated. How can
further economic integration simultaneously satisfy
these two competing visions? The simple answer is that
it can’t.
As British Prime Minister Tony
Blair put it, “Should Europe embrace globalization
and try and make it work for us, or should we try and
ward it off?” That is the question on which the
economic future of the EU now rests.
—Jason L. Saving
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