Does Europe need strategies for exit as well as entry?

Where is Europe heading? European institutions stem from a long history of shocks and crises, but the current level of turmoil and political uncertainty is extraordinary for the continent. In different ways, both the Greek drama unfolding in the recent weeks and the prospect of a British exit down the road highlight the unsustainability of Europe’s institutional status quo.

For some time now, critics have viewed Europe’s predicaments as confirmation that forming a currency union was an economic and political error, leading to conflict and breakup (e.g. Feldstein 2012). In contrast, supporters of the euro have claimed that Europe’s woes are due to incomplete institutional arrangements – a ‘half-built house’ (Bergsten 2012) – and the solution should be more integration: banking, fiscal and full political union.

The metaphor of Europe as an incomplete house is echoed in the new “Five Presidents’ Report,” co-authored by the heads of the main EU institutions (Juncker et al. 2015). The report’s central message is that “the euro is a successful and stable currency,” but that Europe’s economic and monetary union is “like a house that was built over decades but only partially finished” and that “it is now high time to reinforce its foundations” by moving towards a financial union (including the completion of the banking union and the creation of a European deposit insurance scheme), a fiscal union, and “finally towards a political union that provides the foundation for all of the above” (Juncker et al. 2015, pp. 4-5).

The idea that Europe’s challenges should be addressed with further integration has a distinguished history, going back to the beginnings of the European project right after World War II. What are the goals and assumptions behind this strategy? What are its prospects and limitations? In two recent papers (Spolaore 2013 and 2015), I discuss these questions from a political-economy perspective, linking the political debate on the nature of European integration to the economic research on size of nations and political borders.¹

Partial integration and Jean Monnet’s ‘chain reaction’

The whole European project is based on the strategy of partially integrating policy functions and institutions in a few areas – such as coal and steel, trade, or, later, a common currency – with the expectation that more integration will follow in other areas. This strategy became the central approach to European integration in the 1950s, after the collapse of a more ambitious attempt to create a defence and political community, which would have included a common army and budget, and common legislative and executive institutions.

Frustrated in their attempt to form a full political union directly, Jean Monnet and the other supporters of the European project pursued an alternative path of gradual integration. The process took place mostly in technical and economic areas, with the expectation that deeper integration in more political areas would follow through positive but also negative mechanisms. Surely, Monnet and his collaborators were quite optimistic that the benefits from integration would lead to convergence of preferences among Europeans and demand for more integration. However, they also expected that partial integration might lead to further integration, paradoxically, because of its own shortcomings and limits. That is, they viewed incompleteness not as a bug but as a feature, as it would lead to a closer union down the road. This strategy was explicitly explained by one of Monnet’s collaborators (Ball 1994, p. 10):

“There was a well-conceived method in this apparent madness. All of us working with Jean Monnet well understood how irrational it was to carve a limited economic sector out of the jurisdiction of national governments and subject that sector to the sovereign control of supranational institutions. Yet, with his usual perspicacity, Monnet recognised that the very irrationality of this scheme might provide the pressure to achieve exactly what he wanted – the triggering of a chain reaction. The awkwardness and complexity resulting from the singling out of coal and steel would drive member governments to accept the idea of pooling other production as well.”

Later, the euro was also seen by its creators as “a further step—and as a prerequisite for yet other steps—in the political unification of Europe” (Padoa-Schioppa 2004, p. 6). And this stepping-stone role could be played in spite of – or even as a consequence of – its institutional shortcomings. The fact that the Eurozone lacked institutions historically associated with a successful monetary union – such as a formal lender of last resort, a banking union, a fiscal union, and so on – could be rationalised as part of a dynamic path that, in the longer term, would necessarily lead to a political union. For instance, in 1991 German Chancellor Helmut Kohl said: “It is absurd to expect in the long run that you can maintain economic and monetary union without political union.” In Monnet’s chain-reaction tradition, Kohl’s statement was not meant as a damning assessment of the long-term viability of the euro, but as an optimistic prediction that, eventually, political union would ‘have to’ follow economic and monetary union.

Successes and limits of the ‘chain-reaction’ method

Europe’s current economic and political crisis confirms the risks and inefficiencies of incomplete institutional integration. Up to a point, recent events have also showed that such costs and inefficiencies can create the pressure for more institutional integration – for example, in banking supervision. And it is certainly possible (but far from guaranteed) that Europeans will come out of the present predicaments with stronger and more deeply integrated institutions. Nonetheless, the crisis has illustrated the substantial dangers and limitations associated with the chain-reaction method of incomplete integration.²

• A fundamental problem with the chain-reaction approach is that it underestimates the heterogeneity costs and constraints involved when political integration is attempted among populations with different preferences, cultures, and identities.

Successful integration is more likely to take off in areas such as trade, where heterogeneity costs are relatively low and partly offset by the benefits from diversity. However, successes in areas with lower heterogeneity costs do not necessarily imply further successes in integrating more political areas with higher heterogeneity costs – such as fiscal policies or defence and security.

• In this respect, the chain-reaction approach to European integration is based on a misconception, the expectation that economic integration will necessarily lead to politicalintegration.

While political unification historically has been used to foster economic integration within a unified domestic market, the opposite does not typically occur. On the contrary, economic integration reached through international cooperation is often a substitute rather than a complement of political integration, and more economic integration tends to go hand in hand with political disintegration.³

In practice, as institutional integration takes place, and lower-hanging fruits are picked, steeper heterogeneity costs are encountered. At some point, such costs tend to become politically prohibitive, and may stop the process, or even lead to a collapse of the whole system. The risks are particularly high if the previous steps towards more integration were not taken with the broad democratic consensus of all populations involved.

In fact, high heterogeneity costs have so far prevented Europeans from forming a full political union. Attempts to integrate sensitive political functions – such as defence and foreign policy – have not gone very far. In spite of supranational rhetoric, ultimate sovereign control and the monopoly of the legitimate use of coercion have firmly remained in the hands of national governments.

Therefore, the Monnet method of gradual and partial integration has been successful when applied to areas with lower heterogeneity costs and higher economies of scale, but there is no guarantee that such gradualism can lead to further integration in areas with much higher heterogeneity costs, or that those costs would endogenously decrease as a consequence of integration.

Lessons for the future 

What lessons can we draw from the successes and limits of Monnet’s chain reaction strategy?

The first lesson is positive and relatively optimistic.

• The strategy of partial integration has provided significant benefits to Europeans when appropriately implemented in areas with relatively low heterogeneity costs and high economies of scale and scope, such as trade and capital markets.

In these areas there is still a lot to do, and supporters of European integration – such as the five presidents (Juncker et al. 2015) – are right to push for a large range of initiatives to strengthen the economic and financial integration.

However, the historical record also suggests that it will be very difficult to make significant progress towards integration in fiscal and political areas, unless there is ample democratic consensus. In this respect, the lessons are much more cautionary.

Heterogeneity stemming from different preferences, values, beliefs, and behaviours among Europeans cannot be systematically ignored or sidestepped by stealth, forcing governments and voters to accept further integration in order to reduce the high costs associated with incomplete and flawed institutions. Europe can no longer be built on the idea that a series of gradual steps can lead to an irreversible path towards an ‘ever closer union’ in the absence of extensive democratic support for the whole project. If Europeans really want a political union, they must go for it directly and explicitly. And if they don’t, the solution is not a gradual chain reaction strategy that underestimates heterogeneity costs and overestimates convergence. Going back to the metaphor of the incomplete house, if a political union is truly a necessary ‘foundation’ for a complete and effective economic and monetary union, as stated in the Five Presidents’ Report, it cannot be a ‘roof’ placed on top of a ramshackle construction at a late stage, out of necessity. Instead, it should be built right away, at the base of the building, but only if solidly grounded in democratic consensus.

And here lies the heart of the matter. As already stressed, when different groups and populations democratically form a political union, there are trade-offs between size and costs from heterogeneous preferences over public goods and policies. Hence, the supporters of the European project may have to abandon their historically held view that European integration is irreversible, and that the EU (and within it, the Eurozone) can continue to expand in size while also deepening in terms of institutional integration.

Instead, if further integration is going to take place, Europeans may have to accept a multi-speed Europe, with only a subset of countries within the EU voluntarily moving towards a much closer fiscal and political union, while others keeping looser ties, or even leaving the Eurozone and/or the EU. Rather than resisting this reality, European institutions should be built with much more flexibility, and should include explicit provisions not only for entry but also for exit.

In sum, a more realistic political-economy analysis naturally suggests a different, more effective strategy, whereby, if any further steps are taken towards European integration, they should be taken only when they are economically beneficial and politically stable on their own merits, and openly and democratically supported by the populations involved.

References

Alesina, A and E Spolaore (2003), The Size of Nations, Cambridge, MA: MIT Press.

Ball, G W (1994), “Forward” to Jean Monnet. The First Statesman of Interdependence, by François Duchêne, New York: Norton

Bergsten, C F (2012), “Why the Euro Will Survive. Completing the Continent’s Half-Built House,”Foreign Affairs, September/October.

Feldstein, M (2012), “The Failure of the Euro. The Little Currency That Couldn’t,” Foreign Affairs, January/February.

Guiso, L, P Sapienza and L Zingales (2014), “Monnet’s Error?” EIEF, Northwestern and Chicago Booth School.

Juncker, J-C, D Tusk, J Dijsselbloem, M Draghi and M Schultz (2015), Completing Europe’s Economic and Monetary Union, European Commission, Brussels.

Luque, J, M Morelli and J Tavares (2014), “A Volatility-based Theory of Fiscal Union Desirability,”Journal of Public Economics, 112: 1-11

Padoa-Schioppa, T (2004), The Euro and Its Central Bank. Getting United After the Union, Cambridge (MA): MIT Press.

Spolaore, E (2013), “What is European Integration Really About? A Political Guide for Economists,”Journal of Economic Perspectives, 27(3): 125-44

Spolaore, E (2015), “The Political Economy of European Integration”, forthcoming as chapter 26 in the Routledge Handbook of the Economics of European Integration edited by H Badinger and V Nitsch, Routledge: London and New York, CAGE Working Paper No. 221 and NBER Working Paper No. 21250.

The Economist (2014), “Goldilocks Nationalism,” 27 September.

Endnotes

[1] See The Economist (2014) for a brief overview of that literature.

[2] For a more detailed discussion see Spolaore (2013, pp. 138-139). An empirical analysis is provided by Guiso et al. (2014), who find that the 1992 Maastricht Treaty, the 2004 enlargement, and the 2010 Eurozone crisis reduced pro-Europe sentiment among European citizens, even though most Europeans still support the common currency. An interesting theoretical model of the optimal sequencing of monetary and fiscal union is provided by Luque et al. (2014).

[3] See for example Alesina and Spolaore (2003, chapters 6, 10 and 11).

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Enrico Spolaore is a Professor of Economics at Tufts University, where he served as Chair of the Department of Economics from 2006 to 2012.

Image: The headquarters of the European Central Bank (ECB) are pictured. REUTERS/Ralph Orlowski.