The threat to Europe's economies

Bill Jamieson

Contents

Germany's crisis writ large
Loss of flexibility
Expanded powers of the European Union
Reaching to outer space
Making the 'democratic deficit' even worse
Longer term problems: The EU's flawed world view
An epochal shift of global power
How discovery drives economies
Europe's demographic challenge

Conclusion

A Quantum leap for the political class

The threat to Europe's economies

A MARKED AND DEEPENING divide is spreading across the face of Europe. It is a divide between the Europe as envisaged in the draft Constitution, and the Europe as we know it today.

This divide is evident from the draft's opening sentence. It runs to more than 400 words. It describes a noble and lofty European 'destiny': billowing effusive clauses about European civilisation, humanism, equality of persons, respect for reason, culture, aspiration, inalienable rights and inviolable laws, solidarity, peace, justice, unity and, of course, 'destiny'.

But there is another Europe. It is the real Europe as we know it. And it is hard to detect anything in this draft that bears serious relation to the Europe it seeks to define and ennoble. Europe is trapped in a growing constitutional gridlock. The real Europe wrestles with stagnation, recession, rising unemployment, soaring deficits and decline on the world stage. Its institutions, such as the European Central Bank and the European Commission are locked in a war of words over responsibility for this crisis. Vitally needed reforms struggle to make headway through layers of enterprise-sapping bureaucracy.

As I write this, three euro zone economies - Germany, Italy, and the Netherlands - are in recession. Any hopes that Europe's economies might work as a locomotive to pull the world to faster economic recovery have long been abandoned. Even the deflation-struck economy of Japan looks to be overtaking Europe in recovery. The GDP of Germany, the largest and most populous country in the euro zone, has now fallen for the third successive quarter. Its budget deficit has smashed through the Maastricht Treaty ceiling. Unemployment is heading towards five million. Across the euro zone as a whole, what was supposed to be a year of recovery has seen no growth at all in the second quarter.

Recently in an impassioned plea to the German Chancellor, Ann Mettler, director of the Lisbon Council dedicated to promoting reform and liberalisation, wrote of her "profound shock" on seeing tens of thousands of German graduates out of work. Those who were in jobs were too frightened to adopt change or take risks. "'Keep your head down and hope you will escape this slump unscathed', people say." Germans, she added, were "profoundly confused about who and what we are, about where we are going and about what we might do to begin extricating ourselves from the hideous slump we are in".1 Whatever else this suggests, it hardly bears out the picture in the draft constitution of people loftily aspiring to freedom, humanism, solidarity and prosperity.

So: an "official" Europe with its vainglorious draft Constitution and what 350 million people know to be the truth. This disconnection permeates almost every page of the draft Constitution. And it begs the most searching questions about the nature of this draft, the people and the ideas behind it, and why real Europe is in such a problematic and declining state.

This Constitution describes a vast exercise. No political class in history has sought to create jurisdictional competence over so many nations and so many millions of people and to claim in doing so a democratic legitimacy. But what is this new Treaty for? Why is it blind to the manifest problems that face the peoples of Europe today? How will its operation remedy these problems? Above all, is this Constitution more likely to transform the prospects of the peoples of Europe, or compound their problems?

In this paper I will seek to answer these questions. The draft Constitution is not, of course, an economic document. It does not propound any economic philosophy or insights. But it will have profound economic effects.

First, it is likely to prejudice the economic development of the countries of Europe in several respects. This constitution is constructed on an assumption that integration and centralisation have necessarily beneficial results and that there should be more of them. But there is no evidence in the economic realm that integration has brought an acceleration in the rate of economic growth in the EU, or a growth rate higher than would otherwise have been the case through inter-governmental co-operation. Indeed the economies of the euro-zone particularly are not just lagging the global economic recovery. They are in serious policy crisis.

Germany's crisis writ large

The reasons for the EU's poor economic performance and its gathering decline on the global economic stage are many and complex. But they spring in large part from the interplay of two factors. One of these is the EU's commitment to a high level of government intervention and regulation. This commitment is driven by an innate suspicion of economic freedom and an instinctive faith in the benefits of state regulation and control.

The other is that the federal model on which the draft constitution is based has given rise to a policy gridlock and paralysis. Even where the need for reform and liberalisation is recognised, as in Germany now, the conflicting competences between federal and regional government make the adoption of reform slow and difficult, where it is adopted at all. The danger of Europe's draft constitution is that it will result in the German crisis being writ large: the exporting and enlargement of that crisis right across the whole of the EU.

A commission of academics and politicians has now been set up in Germany to sort out the constitutional logjam over the Chancellor's Agenda 2010 economic reform proposals. Without progress here, Germany may be condemned to years of delay on vital economic reform. Says Norbert Rottgen, a CDU member of parliament and the opposition co-ordinator of the project: "Over the past 50 years the competence and finances of the federation and the regions have become so intertwined that not only has reform become impossible, but the citizen no longer understands where political responsibility lies. This has contributed to discrediting politics." Sounds familiar? It is.2

Loss of flexibility

In what specific, particular ways might the adoption of this constitution be harmful? By strengthening the powers and competences of the EU at supra-national level, it would diminish policy discretion and flexibility at country level. This loss of flexibility has already damaged the economic performance of EU countries in two ways. First, it has enabled the imposition of EU-wide employment regulation that has harmed the competitiveness of the EU bloc as a whole. And second, the 'one-size-fits-all' monetary policy of the euro-zone has prevented its economies from pursuing interest rate policies more appropriate to local conditions. This has worked to deepen the recessionary forces stemming from global economic slowdown.

Across the euro-zone, as a whole, unemployment is among the highest in the OECD. In Italy it is 8.7 per cent. In France it is 9.1 per cent. In Germany it is 9.4 per cent. The comparable figure for the United States is 6.1 per cent, and for the UK five per cent.

The further loss of policy discretion and flexibility is particularly harmful to the UK. Our economy is one of the most open in the OECD, with trade and investment with non-EU countries as a proportion of GDP higher than any other EU country. Our ability to respond quickly and decisively to fluctuations in world trade and activity is vital. That response is best driven by the needs and requirements of markets than by a salariat of officials in Brussels, innocent of local circumstances and working to a quite different and separate agenda.3

This constitution has the potential to inflict damage right across the European Union. One of the key concerns of UK business is that its provisions are so vague and loosely worded that they have the potential to expand the powers of the EU to an almost unlimited extent. Thus, far from improving Europe's economic performance, the draft Constitution gives a carte blanche to forces that would work to compound the problem.

The EU's reach in the economic realm is already considerable - and damaging. The evidence of flawed integration and misguided intervention is all around. That is what makes a compounding of the forces that brought about the real Europe that we see around us so dangerous. A misconceived constitution can inflict huge damage on an economy through government heavy-handedness, misallocated resources and a relentless hail of petty interventions. And it is as much in small actions as in large ones that government can frustrate and crush the enterprise and wealth of its people.

Far from the EU's relentless drive for integration improving economic performance, it has gone hand in hand with a deterioration in performance. On macro economic measures, the EU has persistently under - performed the United States for most of the past 10 years (see chart below). There is productivity under - performance, a low rate of business investment and poor rates of business formation. The economies of the EU today are losing competitiveness, under-performing relative to the rest of the world, and have been so for years.

The draft constitution further turns the screw. And that has the potential to create wider problems. For an economy that fails to deliver what the authors of a constitution expect and demand of it, calls into public question the political process of which that constitution and the institutions are the supreme expression. Politics can destroy economics - and vice versa. That is why, looking at this constitution, the potential for damage to Europe's political and economic well-being is considerable.

Expanded powers of the Union

Taken as a whole, it represents a significant step towards the creation of a single European state. This state, as defined in this constitution, is to have its own legal system, competences, parliament and currency. Through its provisions the enlarged EU will have its own legal personality and rules. Its law will have primacy over the law of member states. The inter-governmental method of decision-making will give way to the proposed powers or "competences" of the Union.

Thus the draft treaty represents a significant extension of the powers of the Union. And these powers are wide. "Shared" competences include the internal market, agriculture and fisheries, transport, energy, social policy, economic and social cohesion, environment, public health, consumer protection and the broad and borderless spaces of freedom, security and justice. But in arguably the most significant clause in the entire document, the draft declares, "the Member States shall exercise their competence only if and to the extent that the Union has not exercised its." (Article 1-10 1. Emphasis added).

The draft would also reduce the role of national parliaments to compliance and enforcement agencies for the Union (Article 1-10 2). Article 1-11 3 gives the Union "competence to promote and co-ordinate the economic and employment policies of the Member States". And Article 1-12 1 gives the Union exclusive competence in matters pertaining to the internal market, monetary policy in the euro-zone, common commercial policy, customs union and conservation resources in the common fisheries policy.

To a casual reader there seems to be little that gives rise to particular concern: no one specific measure or proposal that business may find objectionable. But it is this very lack of specifics, coupled with the zealous ambition of the EU to expand its competence and the remit of its institutions, that is the source of unease.* The EU Committee of the American Chamber of Commerce in Belgium was also quick to make this point. "The competences of the EU and the Member States", it declared, "need to be clearly identified. In addition, any proposed legislative act should clarify the reasons for the choice of a specific legal basis and allow for a correct assessment of the application of the subsidiarity and proportionality principles."4

* There is already particular concern over the 'rubber articles': Article 95 of the present Treaty allows the Commission to bring forward measures to harmonise laws and regulations to establish the internal market.

In the words of Ruth Lea, head of policy at the Institute of Directors, "They are worrying mainly because the Constitution will almost inevitably extend the regulatory reach of the EU and the EU seems wedded to the discredited and over-regulated anti-enterprise European economic model. And it is this over-regulation that has contributed to the inexorable relative decline of the EU's economic performance as well as the euro zone's high unemployment."5

Reaching to outer space

Indeed, throughout the draft there appears to be little limit on the constitution's aims and aspirations, or on the competences of EU through the entire document. The attitude conveyed is that the Treaty institutions charged with achieving them. A declamatory arrogance runs need only to express an objective or aspiration for it to be put within reach of achievement.

This betrays not just an instinctive belief in the benign power of government and constitutions to 'will' such aspirations into being, but the fantastical vanity of those involved in the drafting. To the extent that any thought has been given as to how these ambitions may be achieved in the social and economic realm they are seen to be effected through the creation of new EU institutions or the expansion of existing ones. Thus the size, budget, resources and remit of a department undertaking the achievement of some objective becomes a proxy for the achievement itself.

In his outstanding paper on the European Constitution, David Heathcoat-Amory, the Conservative MP who was a member of the Convention that drafted the constitution, describes how the most far-reaching objectives were placed on a wish-list drawn up by a working group formed to look at 'Social Europe'. The list included lifelong learning, social inclusion, children's rights and the promotion of quality of work and 'services of general interest'.

"Most of these found their way into the draft Constitution in some form", he recalls, "together with the unexpected addition of the 'discovery of space' as a Union objective, apparently a personal interest of Giscard (d'Estaing). After some discussion, the discovery of space was dropped as an objective, although it is still included as a 'shared competence' of the Union."6 *

* It is not totally clear in the draft with whom the competence is to be shared: Zeus, perhaps.

The Social Europe Working Group also successfully requested that the existing Treaty aim of 'high employment' should be replaced by a constitutional objective of 'full employment'. The fact that unemployment in the EU currently stands at almost nine per cent does not seem to have struck the Working Group as a worthwhile point for discussion, still less an obstacle to 'full employment'.

Making the 'democratic deficit' even worse

For those who have witnessed the relentless in-tide of the EU's integrationist ambitions over the years - the tide that has swelled notably from Madrid through Maastricht, Amsterdam, Lisbon and Laeken - those expressions of noble ambition and lofty purpose will come as little surprise. For example, in Lisbon in 2000 there was a declaration by the heads of government to deliver "the most competitive knowledge-based economy in the world by 2010."

EU summits are littered with such noble declarations. Achievement is another matter. As the CBI noted with politic restraint, "such commitments have not been pursued with sufficient vigour".7 This statement generously assumes that these commitments have been seriously pursued at all: whether in fact anything was done of substance after the glow of self-righteousness faded from the impressive-seeming sound bite is moot.

This is by no means the only issue on which the CBI has expressed reservations. It raises searching questions on the direction of EU action and whether the rhetoric of the draft can be taken at face value. Indeed, the powers of the draft Constitution may be used in quite the opposite way to that indicated. For example much has been made about the aim of the draft to make good the democratic deficit. "However", the CBI notes, "given the imminent enlargement to 25 states, with obvious implications for the speed of decision-making, there may be a temptation to cope with greater diversity by enhancing the EU's powers to override the views of dissenting Member States".8

Taxation was considered by the Constitutional Convention's Working Group on Economic Governance. Some representatives argued that a 'true' Single Market requires some powers of harmonisation. Contrary to this view, the CBI "believes that - as a matter of principle and practicality - there is no compelling case." Tax competition, it says, is what encourages Member States to keep the burden on businesses low, which promotes competitiveness and job creation. *

* This is reassuring to see. The CBI's comprehension of the dangers of tax harmonisation has not always been as sure.

The forces behind the high integration, high intervention model have not been driven in the main by concern over the 'democratic deficit', though this has perhaps understandably come to be of increasing concern to the drafters. The 'democratic deficit' - most forcefully expressed in a sharp swing to Far Right parties in several EU countries - is itself a product of the integration process: the degree to which the purposes and ambitions of the EU political class have utterly failed to engage with and win popular support. There is no European demos on which this construct is being built.†

† Heathcoat-Amory is especially sound on this point: "There is no European People, no single electorate or coherent public opinion. In short there is no European demos on which to found a supranational democracy or federation. Nor can such a demos be created by artificial means such as European anthems, flags and EU information campaigns. " (The European Constitution, CPS, page 8). The Convention on the new Constitution effectively created its own artificial demos by setting up a 'civic forum' and creating a Youth Convention. It is doubtful if one in a million people in Britain have heard about these organisations, let alone what they do.

Longer term problems: The EU's flawed world view

What is it that Europe's political class so fears? Central to the idea of European economic and political union has been a belief in the inexorable rise of highly integrated regional economic blocs. For most of the post war era, global geo-political events were shaped by the emergence of three such blocs: America, Japan and 'Europe'. Technological advance destined them to enjoy a rising share of global trade and investment. In particular, this triad of America, Europe and Japan and the intricate webs of trade and investment that the multinational companies spun between them, would come to capture a growing share of the world's wealth and with it growing political influence.

The pressure for European integration and in particular monetary and political union, flows from a belief in the entity of Europe as a bloc to challenge and contain the hegemony of the US and to meet the challenge of Asia. This bloc-ist view is also seen as the only means to protect the centralised and highly politicised dispensary of state welfare and 'social solidarity'. This is the cosmology that has dominated the thinking of the constitution's leading author Giscard d'Estaing and the officials and advisers who contributed to the drafting.

But by the 1980s and as Europe further succumbed to the protectionist welfare model, it was clear that something new was afoot.* The world outside of the triad was making itself felt, not just through trade in manufactured goods but as a powerful magnet for global capital. Multinational companies were bypassing high cost Europe and acquiring or setting up plant outside the triad and producing goods at substantially less cost. By the mid 1980s the seepage of capital to the poorer, low cost economies of Asia had become a torrent.

* For a more detailed elaboration of the arguments in this following section see Bill Jamieson and Patrick Minford: Britain & Europe: choices for change, Politeia and Global Britain, 1999.

An epochal shift of global power

By the early 1990s the chief feature of global cross-border investment was the flow of direct investment and portfolio capital out of the triad blocs into the disparate economies of South East Asia and developing countries round the world. In 1983 global cross-border foreign direct investment to emerging market economies stood at $8.6 billion. By 1987 it had climbed to $14.5 billion. By 2000 it had soared to $149 billion. The same quantum leap was evident in portfolio capital flows. In net terms relatively little was flowing into the EU, and indeed in the first years of the single currency there was a capital exodus, with direct investment flowing particularly to build lower cost plants in central and eastern Europe.

This global shift is epochal. It is without precedence in scale and in its pace of acceleration. And it is re-shaping the world. It is today's flows of capital that determine tomorrow's growing industries and economies. These flows thus have enormous implications for the balance of global economic and political power over the next 25 years. In the mid 1990s Europe accounted for some 18 per cent of global GDP, Japan for 15.5 per cent, America 26 per cent and China 2.8 per cent. By 2025, according to the World Council for Sustainable Development, the US share of global output will have fallen to 20 per cent and that of Europe to just 10.3 per cent-or barely more than half the US total. China will have advanced to more than 15 per cent, while the GDP share accounted for by other developing countries will have risen from 37 per cent to 43 per cent (see chart below).

In this process the shortcomings of the 'bloc-ist' view of the world have become exposed. Indeed, the fact that the Asia Pacific region has not formed itself into an integrated economic and political bloc, and has relatively weak institutions for regional integration, is cited by the economist Harold James as a fundamental flaw in the 'bloc-ist' world view.9

As worrying for Europe as the wave of foreign direct investment to South East Asia and the developing world has been the policy response often put forward within Brussels for regulation of world markets and control of capital flows. Such a paranoid prescription is, as James noted, quite impractical short of the re-imposition of a fixed exchange rate system. That is why what is being created in Europe is an essentially 19th century response to a 21st century problem.

How discovery drives economies

Striking evidence of the EU's loss of world market share in global trade can be seen in both service and manufacturing activity, the biggest gainer being Asia-Pacific.

The two potent drivers of this change are globalisation and technological change. The first describes the process of competition between low cost poor countries and high cost rich countries, the EU in particular. This process has effectively called time on high tax, high government spend economic systems. The second works to amplify and intensify that challenge: advances in information technology and telephony explode distance as a barrier to trade, further undermining the economic rationale for highly integrated 'blocs'. What happens is that in a period of change, the more rapidly a country discovers its changing comparative advantage, the better. The only way it can be discovered is by letting markets do it for you. A regulatory, politicised salariat is not good at this.

The chief enablers of this discovery process are low regulation, low barriers to entry for new activity (regulation being the supreme barrier to entry for new activity designed to protect old activity) and low marginal tax rates so as to reward risk takers. It is precisely these discovery forces that the EU's high-cost high-regulation economic model works to discourage and which the draft constitution, a tool of the regulatory class, would do so much to enshrine.

Europe's demographic challenge

Running parallel to Europe's loss of competitiveness and global economic power are powerful demographic trends that are also set to change the economic map of the world. Europe's working age population is set to decline sharply over the next few decades. While life expectancy is similar in the US and Europe, fertility rates differ substantially, that in the US being some 26 per cent higher. Taking birth and immigration rates together, America's population, currently 100 million smaller than Europe's, is set to overtake it by 2040 and exceed it by 10 million in 2050.

Why does this matter? A country's long term growth rate is determined by the increase in its working population and the rise in productivity (output per head). The working population of the EU is broadly expected to mark time until 2010 and then to decline sharply. By contrast, America's working population will grow continuously and the rate will accelerate after 2025. As a result the European Commission calculates the US economy will grow twice as fast as Europe for decades to come-averaging 2.5 per cent a year compared with less than 1.5 per cent in Europe.

The budgetary implications, particularly in respect of state pension funding, are colossal. Projections by the European Commission and OECD suggest that state pension spending is still likely to increase on average by around three to four per cent of GDP by 2050. There are also considerable upward pressures on health and long term care costs that could add another 2-3 per cent to total EU public spending by 2050.

Private sector projections suggest increases in state pension spending between 2000 and 2050 ranging from four to five per cent of GDP in Germany and France to around nine per cent of GDP in Italy and around 13 per cent of GDP in Spain.10

For these massive sums to be available, Europe's economies have to achieve a much higher growth rate than is now in evidence. Those who believe that such funds can be met out of taxation overlook that the overall tax regime in continental Europe is already punitively high and damaging investment and growth. The demographic imperative thusunderscores the need for a much freer, more flexible model of economic development, rather than the more integrated, interventionist model envisaged by the draft constitution.

Conclusion

A quantum leap for the political class

The overall purpose of this Constitution is to create a powerful European presence on the global economic and political stage. It has other purposes. One is to pursue at home the expansion of a corporatist welfare dispensary model of social democracy. Another is quite self-serving. The process of supra-national construction creates any number of new functions and competences to advance the career opportunities, employment, resources and power of the EU salariat. Were the 'higher aims' really improved economic performance, the removal of barriers to trade and enterprise and a general 'tidying up' exercise to coin a phrase, these could be adequately satisfied through inter-governmental co-operation and liaison.

The new supra-national platform is a quantum leap for Europe's political class. It may be seen as the means to effect one of the most self-serving and self-interested seizures of power in modern times. It is draped in the justification of advancing a massive welfare and social solidarity model that has to be defended against external economic challenge.

But there has never at any time been any serious analysis or questioning of the integration model that Europe's draft constitution seeks to promote. As such, it is a product of arrogance. It speaks from a set of unquestioned assumptions about the primacy of politics over economics and the creation of a political construct that in scope and scale is gargantuan. The elite is set on building a European polity for the advancement of itself and its burgeoning salariat under the guise of appeals to civilisation, inviolable rights, fundamental laws, closing the democratic deficit, social democracy and the exercise of a European demos. All this is a rhetorical cloak for a self-interested aim. It is being further presented as a vital stage in the development of a greater and more powerful Europe on the world stage. But in this the elite is dismissive of the demographic changes that pose a great challenge to Europe and that are set to shrink it as a global economic force, not grow it. The grand ambitions are being built on sinking sand. But this is an elite that will not listen. We have been here before with Europe. For here is what at critical points in history has characterised European ambition at its worst: the gilded and fatefully misdirected arrow of insouciant power.

The fate of the EU lies largely in the hands of this small but immensely powerful political and administrative class. For this elite the proposed constitution is both a declaration of faith and a guarantor of future resources, competences, influence and power. It may well still be that the immediate pressures of problematic economic performance and an appreciation of the longer-term demographic challenges will provide the impetus for de-regulation and liberalisation in the EU. One should be careful never to rule out the possibility of change, particularly radical political convulsion from within. But recent experience in Germany and France, suggests that while there is some recognition of the need for reform and the direction this should take, the political and institutional barriers to implementation are formidable.

How then might Europe develop? Political and economic dynamics suggest that the EU is heading towards a profound and inevitable split between two camps. On the one hand there is a dirigiste, highly politicised, highly integrated and inward looking group led by France and Germany. On the other is a looser, less integrated, less interventionist and more outward-looking group comprising the UK and several of the accession countries.

It may have been possible, before the constitution, that these two blocs could co-exist within the EU (a variant, if you like, of the Chinese 'one country, two systems' model). But what the constitution does is to rule out this variable geometry approach in favour of a single, 'one-size-for-all' supra-national entity.11 By pushing ahead on this approach, the EU is taking a fateful step. For it would pave the way for a fundamental split between these two camps. That is why this is not a constitution that will enhance or ennoble the EU at all. The law of unintended consequence kicks in. Its adoption is more likely to make internal change even more difficult. It will deepen the division between these two groups and accelerate a showdown. Thus the constitution will not resolve, but intensify the very conflicts that could spell the end of the EU as we have come to know it.

Endnotes

    Open Letter to Gerhard Schröder, by Ann Mettler, Wall Street Journal Europe August 15, 2003.
    See the Financial Times report: Germany's politicians try to trim the constitutional fat, August 18, 2003.
    The adverse results of this loss of policy flexibility were most evident during Britain's membership of the European Exchange Rate Mechanism. A regime of viciously high interest rates contributed to the deepest recession in the country's post-war history. Tens of thousands of small businesses went to the wall, while millions of homeowners were caught in 'negative equity' when the value of their homes fell below the level of the outstanding mortgage.
    Press release, March 3 2003, Brussels.
    I am grateful to Ruth Lea, Head of the Policy Unit of the Institute of Directors, for her paper, The Convention on the Future of Europe and the Constitutional Treaty. The IoD is a good barometer of senior business opinion in the UK and has developed a major and insightful critique of economic policy in the EU. Many businesses are apprehensive about the implications of the draft Treaty and it would be deeply misleading for the government to claim the support of "business opinion" for the EU's constitutional ambitions.
    David Heathcoat-Amory MP: The European Constitution and what it means for Britain, Centre for Policy Studies, 2003, p. 20.
    7
    Delivering a More Competitive Europe: The CBI's view of the Convention on the Future of Europe, 2003.
    CBI, op cit. CBI criticism of the EU has always been muted, having been for so long a dependable poodle of the EU lobby. But expressions of doubt are becoming more common. This is one.
    See Harold James: Global Opportunities: liberalising world trade and labour markets, Politeia, 1997, p 16.
    see European Economic Outlook June 2003, Pricewaterhouse Coopers
    I continue to be indebted to the insights of Professor Patrick Minford of Liverpool University and the Cardiff Business School. Not only have his insights in Britain and Europe: choices for change proved prophetic, but he also continues to refresh and inform through his commentaries in the Liverpool Investment Letter.