7/29/98

CONTACT: Kathleen O'Toole, News Service (650) 725-1939;
e-mail kathleen.otoole@stanford.edu

Political, economic impact of European monetary union debated

In the mid-1980s when oil prices plummeted, many Texans left home for jobs in other states. In the early '90s a California recession prompted Californians to pick up stakes also. So what will happen when a regional recession hits France, Spain or Germany?

"The Germans will not move to France for jobs, and the French will not move to Germany," Michael Boskin says flatly, and that is one reason the Stanford economist is pessimistic about the long-term outcome of Europe's move to a unified currency, the Euro, on Jan. 1.

With their language and cultural differences, European workers are much less mobile than workers in the United States, he said, and there is a "substantial risk that a regional recession will turn into an economic downturn" for Europe as a whole and produce "a great deal of social unrest."

Boskin's assessment was part of a recent campus discussion about the prospects for Europe after introduction of the Euro on Jan. 1. Planned by Stanford's Center for Economic Policy Research around the late-May campus visit of Michael Portillo, the former secretary of defense of the United Kingdom and an outspoken critic of the Euro, the session featured the analyses of Portillo, Boskin and international monetary expert Ronald McKinnon, also a Stanford economist.

McKinnon, consciously sticking to what he termed a "narrow, grubby financial perspective," was the most optimistic. "Even if [the pending monetary union] fails, up to this point it has been a success," he said.

The countries have experienced a "remarkable convergence in their inflation rates" at around 2 percent, he said, largely because the Maastricht Treaty required national governments to curb their deficits in order to join the monetary union. "The interest rates came down and Europe is in a boom," McKinnon said.

Even countries that have the option of joining the monetary union but haven't done so ­ the United Kingdom, Sweden and Denmark ­ have seen the "risk premium" on their interest rates reduced, McKinnon said. The risk premium is the difference in the rate governments must pay to borrow from the rate paid by German government bonds, considered by investors to be the most stable in value.

In the 1980s, many of the European governments borrowed heavily to finance social welfare programs, he said. "They became captives of big special interest groups ­ old people, disabled people with borderline illnesses, agriculture." Because the governments had their own central banks, investors knew they would print more money to avoid defaulting on their loans and in this way pass the costs onto the next generation.

European politicians were able to get the taxpayers/voters to bear more of the costs of the government spending, he said, by appealing to the cause of European unity. Reduced debt loads led to lower interest rates and less inflation, which has stimulated the economies.

"So far, the Europeans have been very successful in getting over various hurdles, so I'm something of an optimist on this," McKinnon said. "I think it will do a lot more good than harm."

Fears of war

Portillo offered the widest-ranging, most pessimistic assessment. The monetary union could contribute to a more "un-American, even an anti-American foreign policy" in Europe and even to a world war next century, he said.

Europe's political leaders were motivated to seek a unified currency not by economics but by their political "vision of why Europe had devastating wars in this century," he said. Those leaders who fought in World War II, especially Germany's Helmut Kohl, felt the wars were caused mainly by "extremist nationalism," he said, which could be curbed if they could abolish European nation-states.

U.S. political leaders have gone along with this idea, he said, both because Americans are tired of fighting wars in Europe and because the leaders would like "one phone number to dial" when they need foreign policy decisions from Europe.

Portillo said he believed an analysis that attributed extremist nationalism to the existence of nation-states alone was flawed. He pointed to the recent dissolution of the Soviet Union and Yugoslavia as examples of "artificial political unions" that did not dissipate people's sense of grievance against other groups of neighbors.

"We are trying to make a single nation come about by giving it attributes of a nation [such as one currency], but we have no constitution, no concept of states rights," Portillo said. "Europeans simply do not have a shared set of values. The U.S. has a clear set of values articulated . . . by schoolchildren every morning when they say the pledge to the flag."

The European Union treaties permit transfer of funds from member nation-states to members that are hit with economic hard times, but Portillo predicted such transfers are unlikely because about half of Europe's gross domestic product already goes to taxes. "The Germans have already shown they are reluctant to pay higher taxes for even East Germany," he said.

Under a unified currency, individual countries will not be able to temporarily increase their money supply to lessen the impact of a recession on their citizens. They will not be able to increase trade barriers in order to keep cheaper competitors out, he said, which is likely to lead to a greater sense of "grievance and alienation" than in the postwar period to date.

"Today, the large number of democracies in Europe gives us hope they will never vote for war," he said, but the risk of the European Union is that "we will make Europe less democratic and increase the sense of grievance" that can be manipulated by power-hungry tyrants.

Voters in Italy or France won't be able to go to the polls to vote against the policies of European central banking authorities, he said, and those authorities do not have to report back to elected officials in the same way that Alan Greenspan, chairman of the Federal Reserve, reports to the U.S. Congress and serves at the pleasure of an elected national president. The Scottish people who think a national government at London is too far away, he said, aren't like to think one in Brussels is more responsive.

Boskin agreed with Portillo that forming a United States of Europe is a "deeply felt personal notion of leaders of Kohl's generation." Because of the recent economic upturn linked to monetary union, he said he feared such leaders will "kid themselves into thinking they have provided a longer term fix" to their economic problems.

The Euro will have two positive economic consequences, he said. It will decrease the transaction costs for people doing business across nation-state lines and it will produce lower interest rates. But if structural unemployment remains high, he said, it will cause unrest. Social welfare spending, he said, is likely to increase to the highest common denominator, rather than decline to the lowest.

Many Europeans see the union as a way of protecting Europe from global competition, Portillo said, by erecting high trade barriers to the rest of the world. "In the age of the Internet, this effort is doomed to failure." A political conservative, Portillo generally opposes government social welfare spending but conceded that government activism "goes very deep in the European psyche."

American impact

In response to questions from Silicon Valley business people in the audience, the two economists agreed that the economic impact on the United States will be minimal in the short term. Portillo, however, contended it will be quickly negative for U.S. foreign policy.

McKinnon said he expects no impact on U.S. interest rates, while Boskin said they could rise slightly as more people who have held U.S. Treasury notes will be willing to hold Euro-denominated ones. McKinnon said, however, that the dollar will remain "the international currency vehicle of money lending. It's got a natural monopoly that can't be displaced easily. Trade is typically dollar-invoiced. The Euro will be a very important regional currency."

Neither Boskin nor McKinnon predicted the Euro will take off in value relative to the dollar. "There is too much uncertainty about the rules of the game" under which the European central bank will operate, McKinnon said. Boskin added his impression from meetings in Europe that the French expect new monetary policy to be made by French bureaucrats transplanted to Brussels, while Germans expect Germany's fiscal policy setters will call the shots.

America will find less support for its foreign policy goals, Portillo predicted, because "in the short term, the only consensus we could have in Europe on foreign policy would be inaction." The Europeans, he said, haven't agreed on any foreign policy issue in recent history.

"In the long term, the situation is substantially more dangerous," he said. "There are elements of anti-Americanism, people who resent our dependency on the United States for defense. . . . If we eventually arrive at a consensus, it is most unlikely to be supportive of American foreign policy."

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By Kathleen O'Toole