Europe's Road to Integration

• Author: Reza Moghadam
• Position: the Director of the IMF's European Department.

Alarming headlines about Europe have been inescapable in recent years even if the latest outlook is somewhat better. Markets and the media have questioned Europe’s ability to deal with a severe financial shock and an economic downturn, even raising concern about the viability of the euro.

As bad as the crisis has been—and it has been extremely damaging, not least for the many people out of work—that should not obscure Europe’s achievement of a closely integrated region with some of the world’s highest standards of living. That this has been accomplished after two devastating world wars and the division of the continent between east and west for much of the 20th century is all the more remarkable.

Europe has experienced some crucial pushes toward integration in the past 25Â years—the fall of the Berlin Wall in 1989, the wave of central European countries that joined the European Union in 2004, and the launch of the euro in 1999. The current crisis presents an opportune time to consider Europe’s path to integration so far and what lies ahead.

While Europe is much larger and more populous than the European Union alone, the Union has been at the heart of European integration, binding countries once in conflict and offering benefits well beyond its borders—as a key trading and investment partner across Europe and as a powerful catalyst for fundamental economic and governance reforms by many entrants and aspirants.

The past few years have been rocky, and there will surely be further bumps ahead. The crisis exposed weaknesses in the regional architecture and national policies, while eroding political support for closer ties. But integration has yielded substantial benefits for Europe so far, and continues to point the way forward.

Complex origins

More than six decades ago, six countries in western Europe (Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands) decided to take economic cooperation a step further. The vision of the EU founding fathers, epitomized by the Schuman Declaration in 1950, was to tie their economies—including the reemerging West German economy—so closely together that war would become impossible.

Europe will not be made all at once, or according to a single plan. It will be built through concrete

achievements which first create a de facto solidarity.

—Robert Schuman

The history of the European Union has been one of big and small steps toward ever-closer integration. Early on, leaders decided to integrate their key industries of the war and postwar years: coal and steel production. Tariffs were reduced, subsidies slashed, and national cartels dismantled. But unlike other forms of emerging postwar economic cooperation, the integration of Europe was defined by the creation of supranational institutions. Over the years these institutions have evolved into the executive, legislative, and judicial branches of the European project. The durability and continuous strengthening of these institutions is a demonstration of the power and the success of the project. A key milestone was the first direct European vote in 1979 when the European Parliament became the legislative power.

Geographically, the European Union also went through various stages of enlargement. In 1973, Denmark, Ireland, and the United Kingdom joined what was then the European Community. The 1970s saw deep social and political transformations in Greece, Portugal, and Spain, where military regimes and dictatorships were overthrown. Inspired by the prosperity and stability of the European Community, these countries joined the European project a mere decade later, strengthening their emerging democracies. The countries benefited enormously from free trade and common policies, in particular structural funds that were set up to foster convergence by funding infrastructure and productive investments in poorer regions.

Transition from communism

The most significant episode in Europe’s postwar political and economic integration was the collapse of the centrally planned economic systems at the end of the 1980s. The fall of the Berlin Wall stands as the defining moment of a long and multifaceted process of liberalization. More than 20 countries emerged from communism to take their places in democratic Europe, presenting both the greatest opportunities and the greatest challenges in European integration since the war.

In all cases the initial challenge for the transition was stabilization. The collapse of traditional trade and investment links and dislocation of domestic demand contributed to large output collapses in the early years of transition, ranging from about 10 percent in Poland and Hungary to some 40 percent in countries such as Latvia and Lithuania. As prices were liberalized, they tended to skyrocket, partly as relative prices were set by supply and demand rather than central planning, but with especially steep increases where state revenues dried up and governments had few sources of finance other than turning to central banks to print money. Currencies across the region devalued rapidly and banking crises were widespread. In some cases, where there was adequate political and institutional support for fiscal and monetary discipline, stabilization was achieved...