Beyond Integration

• Author: Michael Deppler
• Position: Director of the IMF's European Department
• Pages: 8-13

Squaring Europe's Social Preferences with Robust Growth

Page 8

Ten New members joined the European Union (EU) on May 1 in the biggest enlargement of the community since its inception. Just 15 years after the fall of the Berlin Wall, eight Central and Eastern European countries joined, along with Cyprus and Malta, expanding the EU's membership by two-thirds, its land area by a fourth, and its population by a fifth (to over 450 million). This latest step in European integration is expected to further help cement peace and promote prosperity throughout the continent. But the occasion is clouded by the considerable misgivings in Europe and elsewhere about the EU's ability to adjust to changing economic circumstances.

The core economic concern is the weak growth performance of Europe-and particularly of the 12 countries at the epicenter of European integration that use the euro as their common currency-relative to the rest of the world and especially the United States. Underlying this concern are the problems of sagging long-term trends in the growth of productivity, the use of labor resources, and-looking forward-the dwindling size of the workforce because of population aging.

But these structural worries gain immediacy from fears about the short term as well. With the euro area still just emerging from a prolonged slowdown and seemingly dependent on exports for growth, the euro having appreciated steeply against the U.S. dollar, and the U.S. current account deficit at 5 percent of GDP, prospects for the global as well as the European economy rest to a large extent on whether Europe can improve its domestically generated growth performance. Adding weight to these concerns are the perceptions that the euro area's fiscal and monetary policies are excessively oriented toward preserving medium-term stability and insufficiently focused on sustaining demand in the short term. In tandem with continuing concerns about the implication of aging populations for long-term growth and fiscal sustainability, tensions stemming from immigration, and international criticism of the high levels of protection afforded to agriculture, it is clear that enlargement has occurred at a time of considerable doubt and misgiving about the integration enterprise.

To gain some perspective on these issues, it is useful to step back and look at the broad sweep of Europe's postwar economic history. This article seeks to provide a framework for understanding the main issue-whether and how the core EU social and economic model can deliver robust growth, or whether attaining robust growth requires adaptation of the European model. Looking forward, such a perspective suggests that prospects are neither as bleak as observers sometimes think nor as rosy as European policy choices might suggest.

1945 World War II ends; Allies occupy Berlin.

1947 Cold War's "Iron Curtain" divides Eastern and Western Europe.

1950 French Foreign Minister Robert Schuman proposes integrating the coal and steel industries of Western Europe

Europe's twin impulses

Although many factors played a role, postwar developments can be viewed as reflecting two broad-based, ebbing and flowing, and sometimes contrary impulses: toward social solidarity and equity, on the one hand, and financial discipline and economic efficiency, on the other. The historical roots of these preferences run deep. The solidarity dimension stems from a widely shared desire for social peace and cohesion, with roots in the welfare policies inherited from the late 19thPage 9 century, the political and social upheavals of the first half of the 20th century that culminated in World War II, and the relative homogeneity of Europe's populations. The discipline dimension, perhaps surprisingly, seems to have similar roots. Most cited is the case of Germany, where the deep desire for economic stability can be traced back to the devastating hyperinflation of the early 1920s. These twin impulses led many countries to develop increasingly generous pay-as-yougo social insurance systems-systems that took care of social spending within a disciplined, self-financing framework. Along the way, continental Europe's corporatist traditions, topped by various forms of "social partnership," cemented the structure, for good or ill, through all echelons of society.

These preferences still obtain today. Fundamentally, continental Europe is committed to a financially disciplined welfare state. Robust growth is on everyone's agenda, as exemplified by the call at the EU summit in Lisbon in March 2000 to turn Europe into "the world's most dynamic and competitive economy." But the quest for growth is also where the differences emerge. To put it simply: can growth best be achieved through discipline (and more supply-oriented approaches that would require adapting the social model) or through solidarity (and approaches that might require, if not a loosening of financial discipline, more spending)? While the differences are fundamental, the two sides are careful not to question, at least loudly, the core value of the other: the welfare state and financial discipline. The reason is simple: a combination of the two has been the revealed preference of the electorate for decades and remains so today. Hence, the general tenor of economic policies has been to call for both, as the Lisbon Declaration does.

Momentum toward integration

Solidarity and discipline have propelled European integration throughout the postwar period, with solidarity as the stepping-stone. On the heels of two disastrous world wars, it provided the momentum for removing barriers and raising living standards through convergence in per capita incomes- a process known as real convergence. In this respect, the EU's beginnings are traceable to the European Coal and Steel Community, set up in 1952. This led to two further milestones of real convergence: the Treaty of Rome (1957), which established the European Economic Community (a customs union with common external tariffs and a common agricultural policy); and the Single European Act (1986), which committed all members to creating a single EU market for goods, services, capital, and labor.

In time, this impulse toward European integration was balanced by more discipline, perhaps most evident in the institutional developments designed to ensure price and financial stability throughout the union-so-called nominal convergence...