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After the EuroShaping Institutions for Governance in the Wake of European Monetary Union$

Colin Crouch

Print publication date: 2000

Print ISBN-13: 9780198296393

Published to Oxford Scholarship Online: November 2003

DOI: 10.1093/0198296398.001.0001

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The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

(p.24) 2 The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro
After the Euro

Robert Boyer

Oxford University Press

Abstract and Keywords

The institutional deficits surrounding the single European currency are formally analysed, and a number of possible future scenarios is outlined.

Keywords:   central banks, euro, European monetary union, institutional deficit, political deficit, single currency

Throughout the 1990s, discussions of European Monetary Union (EMU) focused on the rationale of the convergence criteria set by the Maastricht Treaty, the likelihood of each specific country being part of the first wave, the opportunity to postpone its launch, or the degree of flexibility in interpreting the convergence criteria. But after the European Summit of May 1998 and still more after the launching of the euro in January 1999, all these issues ceased to be relevant; analysts began to raise the neglected but fundamental issue: does the Amsterdam Treaty design a viable configuration for European integration and national policies? This chapter proposes a structural analysis of the viability of the current phase of monetary integration.

The Seven Paradoxes of European Integration

For the key actors promoting EMU, success depends on the clarity of the objectives pursued and steadfastness in meeting the convergence criteria (de Silguy 1998). ‘On parvient toujours à ce que l'on veut quand on le veut avec persévérance pendant quarante ans’ is the quotation from Marguerite Yourcenar in the front page of the book on the EMU by the commissioner in charge of the euro. Conversely, other analysts express gloomy pessimism about this innovation and point out the lack of political will of national governments to abandon a large fraction of their sovereignty. A second distinctive feature of this chapter is to deal simultaneously with these two opposite visions of EMU. Pointing out a series of paradoxes about the current integration process might be a convenient starting point.

  1. 1. A Political Project Disguised As an Economic One

    A brief historical retrospect suggests that the European project launched by Jean Monnet was clearly a political one. In order to prevent the repetition (p.25)

                       The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

    Fig. 2.1. The Long March Of European Integration: From Polity To Economy . . . and Back To Polity?

    of the dramatic German/French conflicts, why not organize and co‐ordinate economic activity of the key sectors such as coal and steel? Given the success of this first initiative, the project was extended by the creation of the Common Market by the Treaty of Rome, which in turn has been triggering a slow process of economic integration among the founding members (Fig. 2.1). The breakdown of the Bretton Woods system brought much exchange rate instability among European currencies, hindering the ongoing process of economic specialization across national borders. The European Monetary System (EMS) was precisely designed in order to remove this source of discrepancy, but success was difficult to achieve given the huge move towards financial deregulation. The dramatic 1992 and 1993 episodes brought a confirmation of the project contemplated by the Maastricht Treaty: a single common currency would be a definite solution to the recurring instability among European currencies. This project was frequently presented as a purely economic strategy, whereas it is clearly a political project, put forward by France and Germany after the collapse of the Soviet empire and especially German reunification (Vernet 1998). This is the (p.26) first paradox: the euro is presented as a purely functional device reducing transaction costs and removing exchange rate uncertainty, whereas it is basically a political enterprise. During the early years of the European project, economics was a means and political integration the objective, whereas today the political will is assumed to be applied to purely economic, not to say monetarist, objectives. A paradox indeed!

  2. 2. A Daring ‘Constructivism’ In the Epoch Of Free Market Beliefs

    A second paradox relates to the relations between states and markets. A priori, the euro is a quite exceptional process of monetary integration. Usually, a new currency is backed by an emerging leadership over a territory, with few countervailing powers of private agents such as banks or financiers. After all, US monetary unification was made possible by the victory of the North over the South, the emergence of a unified political power solving previous conflicts of interests (Boyer and Coriat 1985). An opposite configuration prevails at the end of the 1990s: the euro is the outcome of an intergovernmental treaty, without any clear hegemonic power. To the contrary, most governments expect thus to mitigate the initiative and power of the Bundesbank and the hegemony of the Deutschmark. The potential conflicts of interests among European countries are not solved but postponed until the implementation of the Amsterdam Treaty. Furthermore, financial markets have acquired such power that they assess in real time the credibility of any economic policy, and especially such a daring experiment as the euro. Back in the 1970s the Werner Report had already proposed monetary integration, without any success, but at a period when the limitations to capital mobility would have allowed such a creation. In the 1990s, governments no longer have full control of their policy, but now wish to create a common currency. In other words, governments could have created the euro when they were not convinced of its usefulness, but now they wish to do so but do not necessarily have the power to implement it, and ‘beat the market’. Briefly stated, the euro is an ambitious example of constructivism—in the sense of Friedrich von Hayek—at the very time when a vast majority of agents operating on financial markets seem to adhere to a rather naive free‐market ideology.

  3. 3. A Euphoric Presentation Of a Complex and Contradictory Project

    A third paradox opposes the selling of a bright future and getting mediocre results. Such a disappointment had already taken place with respect to the Single Market Act in the mid 1980s. The European Commission (EC) had taken this initiative in order to overcome the crisis of European integration, and actually it changed a rather pessimistic mood into a much more optimistic one. But a series of economic studies were launched and used, showing that European growth would be 12 per cent higher, with job creation (p.27) by millions. Nearly ten years later, an ex post assessment shows far more modest achievements of the single market Act: only 1.5 per cent of extra GDP growth could be attributed to this structural reform, of course largely partial and limited to some key industrial sectors (Monti 1996). The EC seems to have reiterated exactly the same process for the single currency: early research delivered a quite optimistic message (EC 1990); but as soon as the euro had been agreed, a much more balanced view was proposed, stressing the need for difficult structural reforms, without which the benefit of EMU could not be reaped (EC 1998a). In the age of the rational expectations revolution, it might be risky to oversell the merits of a quite complex and contradictory innovation.

  4. 4. Integrating Europe . . . But Exacerbating Domestic Social Conflicts?

    A fourth paradox derives from the previous one. On one side, the politicians and civil servants engaged in European integration, along with the most privileged groups in each nation state, tend to adopt a quite positive assessment of the consequences of the euro. The official statements present this innovation as Pareto‐improving (i.e. benefiting everybody without hurting any single individual agent). For instance, in a recent published book, the European representative Yves‐Thibault de Silguy presents a very appealing picture of the consequences of the euro: it will reinforce the single market, stimulate growth, alleviate public budget deficit, enhance innovation and the profitability of European firms; and last but not least, it will speed up job creation (de Silguy 1998: 74–118). Why should anybody be against such a wonderful scenario? The paradox is precisely that on the other side, many social groups perceive EMU as a threat to their previous position or privilege. This is the case for small entrepreneurs, retailers, low skilled workers, retired people, and more generally any group strongly related to the national welfare system (see Table 2.3 p. 59). The dilemma is therefore the following: a project, which is supposed to be unanimously supported by the citizens, is actually generating strong and sometimes new divisions within most societies. Incidentally, the dividing line between pro‐ and anti‐euro frequently crosses each party, be it leftist, conservative, or even centrist. For instance, in France, both the Gaullist party (RPR) and the union of conservatives (UDF) have a majority in favour of the euro, but a vocal minority against the Amsterdam Treaty. Therefore, the very political architecture built after the World War II is challenged by EMU. Will the sharpening of domestic social and political divisions be the cost to be paid for unifying Europe?

  5. 5. Enthusiastic Southern Europe, Reluctant Northern Europe

    A similar paradox can be observed when one compares the respective support of EMU by various national public opinions (Table 2.1). In general, (p.28)

    Table 2.1. A Hidden Paradox: Countries Expected to Suffer More from EMU Have the Most Positive Attitude (Spring 1997)

    Positive Southern Europe

    Sceptical Northern Europe



    70% have a positive view on EMU

    60% are anti‐EMU

    58% consider that the benefits overcome


    the required sacrifices

    58% are anti‐EMU. But 56% UK


    businessmen wish to join

    70% have a positive view on EMU

    The Netherlands


    The change in positive view on EMU:

    53% are prepared for financial sacrifice

    1995: 73%

    in order to have their country

    1996: 46.3%

    in the first wave of EMU

    1997: 34%


    70% have a positive view on EMU

    Source: Le Sondoscope (1997), No. 129, April: 70–73.

    Southern Europe is generally quite enthusiastic about this new phase of European integration: in France, Spain, and Italy for instance, in early 1997, 70 per cent of citizens had a positive view of EMU, while in Portugal, 53 per cent were ready to bear financial sacrifices in order that their country be part of the first wave. In contrast, Northern Europe is rather reluctant, and the fraction of the population rejecting it seems to have increased as the deadline set by the Maastricht Treaty approached. Is it not surprising to note that the very countries that require the more drastic structural reforms experience the most support by the population for EMU, whereas the already integrated countries are facing a somewhat sceptical, if not opposed, public opinion? Italy is a good example of the first configuration, Germany and Netherlands of the second. The cases of the UK, Denmark, or Sweden are different again, since political leaders have followed public opinions in not joining Europe, given the large costs to be born in order to adapt national structures to the requirements of the Maastricht Treaty. Nevertheless, this fifth paradox opposes the general political assessment of the desirability of EMU to the economic costs of the transformations it requires for some countries.

  6. 6. Unifying Europe At the Risk Of Balkanization

    This leads to the next paradox. Clearly, the Single Market Act, then the Maastricht Treaty, and ultimately the Amsterdam Treaty do aim to promote European integration and unification. But the conditions for adhesion to EMU, as well as the challenging requirements for national autonomy in order to harmonize diplomacy, defence, and security, are bound to restrict the number of countries able and willing to join such an ambitious and novel (p.29) project. Therefore, the very process intending to unify Europe is likely to trigger a multiple‐tier Europe, with potentially diverging forces. By enforcing strong criteria convergence, EMU would actually split the previous integration process, either according to the opposition between core participants and new members, or by multiplying a Europe à la carte (i.e. separate agreements including a variable number countries for each domain of competence, CEPR 1995; Dehove 1997). For instance, after the European Summit of May 1998, the eleven countries elected for EMU have to organize their monetary and financial relations with those remaining outside; this may provoke new and difficult problems in the institutional architecture of the EU. Should the outsiders be admitted to the Euro‐X Council designed to co‐ordinate national budget policies? Will some countries stay out of EMU forever, or are they supposed to join as soon as their public opinion is ready for and/or satisfy the convergence criteria? Paradoxically enough, for unity's sake new divisions have been brought into the EU, and they will not be easy to overcome.

  7. 7. Democracy and Market: Trading Places?

    A final paradox concerns the interpretation to be given to the current phase of European integration. For some politicians, the final objective is to recover one form or another of collective control over exchange rates, interest rates, and more generally the ability to monitor a large continental economy in the epoch of globalization. For other politicians or analysts, the objective is strictly the opposite: to unleash the forces of the market in order to redesign the institutional forms which are now outdated, confronted with the internationalization of production, high unemployment, and the new technological paradigms. This opposition is evidence of a still deeper paradox. For a decade markets and democracy have been trading places. During the 1960s governments used to make strategic decisions, whereas underdeveloped and highly regulated financial markets were playing a quite minor role, even in allocating capital to alternative sectors or individual firms. Taking charge of the long run was the task of the state, adjusting short‐run disturbances the role attributed to the markets. Nowadays, the highly sophisticated financial markets scrutinize any government initiative, in order to check its long‐run viability and sustainability. Conversely, governments try to have an efficient short‐run management that meets the criteria set by the bond markets, which have built a large autonomy with respect to public authorities, including international organizations such as the IMF, World Bank, WTO, or OECD. In a sense, the launching of the euro does not dissipate this ambiguity: will a tentative control of the European currency be a step in the direction of a victory of collective interventions over market forces; or conversely, will it be the hidden strategic device invented in order to bring the forces of globalization into the inner domestic space of each member state?

(p.30) An Integrated Framework to Capture the Complexity of ‘Europeanization’

The current debate is polarized by strong opposition between the supporters of EMU and its opponents (i.e. a black and white picture with few nuances). Analysts should recognize the complexity of the issues at stake and develop original frameworks able to illuminate some of the major political choices, both at European and domestic levels. In order to do so, one has to recognize how contradictory the current phase of European integration is and how detrimental is the division of academic research between economics, political science, and law.

A Challenge to Conventional Economic Theory

Actually, all these paradoxes boil down to a central feature present in all the arguments in favour of EMU. They derive from an economic theory which considers that markets are the more adequate mechanisms for managing modern economies. Thus, the role of public authorities is to reform existing institutions so that they resemble more and more the ideal of pure and perfect markets. In this world, the polity per se is non‐existent, since its only function is to move the economy towards a pure market equilibrium, which is supposed to be a Pareto‐optimum. This vision is in line with the general trend of macroeconomic theorizing, which considers that markets are self‐equilibrating and that the unique rational objective of governments is to adopt pro‐market reforms. This is at odds with the Keynesian vision adopted by most governments until the 1970s. During this period, it was quite common to assume that markets are unable to deal with uncertainty, externalities, and even the simplest co‐ordination problems. It is notable that this old framework is rarely used to assess the impact of EMU, whereas its impact on effective demand is frequently discussed.

More precisely, the conventional arguments in favour of the euro run as follows (EC 1990; de Silguy 1998). The irrevocable fixing of exchange rates among the participant countries removes the basic uncertainty which was hindering the deepening of the single market. Simultaneously, transaction costs are reduced, which enhances both external trade among countries and the profitability of firms. The clause about excessive public deficit benefits the credibility of the euro, still enhanced by the large independence granted to the European Central Bank (ECB). Therefore, all members should benefit from lower interest rates, which is particularly important for countries which used to experience high inflation, such as Italy or Spain. Under the binding constraints of the Amsterdam Treaty, each nation state faces strong incentives to rationalize and modernize its tax and welfare systems. (p.31) Similarly, labour markets are made more flexible, in order to cope with the loss of the exchange rate as an adjusting mechanism, when a loss of competitiveness has to be compensated. When all these mechanisms are added up, the European Union would benefit from a renewed dynamism under the new common currency: more innovation, faster growth, more employment, higher profit, and even real wage increases. This is the charm of any Pareto‐improving reform.

But this is a drastic idealization of the consequences of the euro. Many arguments can be opposed to it, the more so since the European Summit of May 1998: now many analysts and even the experts of Commission recognize at last the costs associated with the implementation of the euro (EC 1997b, d, 1998a, b). This chapter is devoted to the investigation of the costs and benefits of the euro, which are contrasted according to each scenario. Before doing so, it is important to discuss some methodological problems, which are at the origin of conflicting assessments of EMU.

First, optimism about the deepening of the Single European Market is built on a very naive conception of the creation and functioning of any market. It is assumed that a common currency makes easier price comparisons across national borders and therefore that the law of the single price will prevail all over Europe after the completion of EMU. But, for instance, price formation in the car industry clearly shows that the very same product may have quite different prices according to the system of retailing, taxation, the relative strength of the national producers, and of course, the tastes of domestic consumers (Monti 1996). Basically, markets are social constructions (Favereau 1989), not the outcome of any ‘natural’ economic process, and they may take contrasted configurations (White 1998). Furthermore, modern economies combine markets along with private hierarchies, state interventions, communities, associations, and networks, and their performance is not related to the purity of market mechanisms but the coherence of the institutional arrangements combining all these co‐ordinating mechanisms (Hollingsworth and Boyer 1997).

A second objection relates to the concept of money. The proponents of EMU exhibit a strange schizophrenia. On the one hand, most theoretical models, such as real business cycle ones, postulate a complete neutrality of monetary creation in the medium and long term. If so, the management of any currency may only have transitory effects. Thus, the euro would not be important at all and one may wonder why governments have accepted abandoning a fraction of their sovereignty against such minimal and transitory gains. On the other hand, official statements (de Silguy 1998: 110–18) argue that job creation will result from the euro, as was previously mentioned. But then, money is no more neutral, neither in the short run, nor the long run, since monetary policy influences interest rates, credit, and capital allocation, the direction and the speed of innovation (i.e. long‐term growth (p.32) pattern). This contradiction between the technical references and the popular presentation is quite damaging for the legitimacy of the euro. Last but not least, as soon as the Monetary Council of the ECB was appointed, its very first statement was to stress that national monetary policies followed during the second phase of EMU have had no responsibility for the level of European unemployment and that, in future, EMU will have no impact at all on job creation. The Council seems to confuse the theoretical model of a market economy with actually existing capitalism, and this discrepancy may hurt the realism and acceptance of the policy followed by the ECB.

Similarly, discussion of the objectives and tools of the ECB seems to consider that all national economies resemble one another, probably because they are supposed to be market economies, bound to converge towards an idealized Walrasian equilibrium. If this assumption were true, there would be no problem for the viability of a common European monetary policy. Unfortunately, many comparative studies, institutional, statistical, or econometric, confirm that the functioning of domestic economies remains quite diverse (Crouch and Streeck 1996; Berger and Dore 1996)—even for countries as closely linked as France and Germany, not to mention the considerable discrepancy between Northern and Southern economies, or the major differences between the UK and continental Europe in the conduct of monetary policy. Therefore, these major institutional differences show up in different adjustments on the product, credit, and of course, labour markets (Crouch 1993; Dore, Boyer, and Mars 1994). Consequently, the same monetary policy may have totally different outcomes for various countries: instead of homogenizing Europe as a continent, EMU may well exacerbate national heterogeneity—even if the common European policy may remove some of the previous idiosyncratic shocks associated with the autonomy of national economic policies (Calmfors et al. 1997: 312–24). Incidentally, this argument relates to real convergence, and of régulation modes, not to the typical nominal convergence of inflation and interest rates which has been achieved by the eleven countries admitted into the first round of EMU. This benign neglect for these institutional differences may be quite risky for the future of the euro.

A fourth limit of the conventional approach to the euro is to polarize the analysis over a very specific form of uncertainty, that related to exchange rate variability in the context of full capital mobility. No doubt the fixing of the rate of conversion of each national currency into the euro will remove definitively the repetition of the European currency crises which have been so frequent. But uncertainty is intrinsic to the very process of capitalist competition, and it is enhanced when financial markets are fully developed and sophisticated. Therefore, one may expect the shift from one kind of uncertainty (about exchange rate among member states) to others: uncertainty over the exchange rate of euro with respect to the dollar and the yen, the (p.33) degree of cooperation or alternatively conflict between national budgetary policies, the credibility of the euro as a permanent feature of European integration, and so on. Will finally the degree of uncertainty be lower after the euro than before? The jury is still out. Any economic system reduces some type of uncertainty at the cost of a possible extension of another. In assessing the post‐euro configuration too many analysts tend to consider that exchange rate uncertainty is the most detrimental (De Ménil 1996) and that therefore the stability of the EU will be enhanced. But a fully convincing empirical evidence is far from available: there is no consensus among economists about the effective costs of exchange rates variability (Calmfors et al. 1997: 19–39). To paraphrase a motto of the French historical school of the Annales, ‘any economy displays the uncertainty associated with its structure’. Thus it would be risky to infer that the euro will remove any such uncertainty, since quite on the contrary it will create new sources of political conflict and economic crises.

A final, but fundamental, criticism may be addressed to the usual vision of economists about the significance and impact of EMU. The role of national governments would be to implement the reforms which are deemed necessary by European experts in order to adapt each economy to the requirements of the Maastricht and Amsterdam Treaties. Polity would be the direct expression of the economy—an economic vision indeed! Actually, the very tradition of political science and the recent resurgence of political economy convincingly convey the message that politicians deal with power relations whereas entrepreneurs are concerned with economic activity and capital accumulation. From a logical point of view, these two motives have no direct connection, even if ex post the economic and political spheres are indirectly linked (Théret 1992; Palombarini 1999). On the one hand, a stable constitutional order is essential for property rights enforcement. On the other, any state requires minimal material resources (i.e. a sufficient level of economic activity as a potential for tax basis). Therefore, any viable society has to combine these two requirements, which ex ante are not necessarily compatible. In many instances, this compatibility is the unintended outcome of structural crises, during which both polity and economy are in a sense synchronized again. If one adopts this vision, then the EMU project does not exhibit any clear viability, since the inner logic of both European and national political arenas is not taken into account. Will citizens accept this transfer of responsibility without countervailing power at the European level? If important decisions are taken by the ECB, a priori largely independent, who will control this new body? If the building of the credibility of the euro imposes some large costs, for instance in terms of slower growth, will public opinion accept such adverse outcomes, especially within the countries where EMU has been presented as a solution to the unemployment problem (Mazier 1997)?

(p.34) All these questions relate to the issue of the political aspects of the euro and its impact upon institutionally rich societies, a problem largely neglected by most research on the consequences of EMU.

Integrating Polity and Economy

For conventional theory, economic policy is assumed to be the consequence of a rational calculus operating on purely economic variables: the evolution of consumption, a measure of welfare and the rate of interest. Basically, there is no autonomy whatsoever between polity and economy, the former being the direct expression of the latter. In a sense, the old Marxian theory had the same simplification, when it stressed that the state was operating to the benefit of the capitalist class, and not for the well‐being of the society as a whole. As already mentioned, this is the implicit presentation of the Maastricht and Amsterdam Treaties by EC officials. It is a quite common vision in contemporary economic theory.

Of course, the validity of such a conception is highly problematic for the euro, which was decided after German reunification: the French government wanted to tie Germany firmly to Western Europe and proposed to launch EMU, whereas the German government was eager to develop a political integration of Europe, possibly along federal principles (Story, Chapter 3). This explains why both the Maastricht and Amsterdam Treaties display three pillars, not only the monetary side but defence and security aspects. Since German public opinion is highly attached to the Deutschmark as a symbol of monetary stability, strong requisites were imposed on the expected participants to the euro in order to preserve the same monetary stability as experienced in Germany. Clearly, the euro does not derive from a cost–benefit analysis about the reduction of transaction costs and exchange rate externalities, but it is the outcome of a political bargaining among nation states. Polity comes first, and the economy should follow—according to a second vision which is the strict opposite of the first.

But is it that certain that any decision taken by governments will be compatible with the inner dynamics of economic adjustments and their transformations—especially if the reform is as structural and far‐reaching as EMU? Since the breakdown of the Bretton Woods system, exchange rates are no longer a purely political variable since they are formed in currency markets via the interactions of various expectations. Given financial globalization, these play a bigger role than governments. Therefore, the euro has to convince the international financial community of its relevance, viability, and long‐term legitimacy. Consequently, neither the economistic vision nor the primacy of polity correctly define the future of EMU. A third vision seems much more satisfactory: the political innovation put forward by (p.35) the Maastricht Treaty sets in motion a series of economic transformations, most of them probably unintended.

Just to take one example, analysts have paid much attention to the effect of the euro on the product market. In the early stages, the most dramatic impact seemed to bear on financial markets, banking, and insurance (Davies and Graham 1998). In turn, the related concentration will influence the governance mode of industrial firms, their investments, location, and finally employment and income distribution (Froud et al. 1998). By comparison, the completion of the single market for manufacturing goods may seem of minor influence. But in democratic societies, citizens are entitled to express their feelings about the conduct of domestic economic policy. If structural changes, triggered by the euro, end up opposing losers and winners, the political regime has to take this into account, and consequently revise its economic policy. The euro will define a coherent socio‐economic regime only if it can make compatible the evolution of the régulation mode along with the transformations of the political regime.

A Complete Shift in the Hierarchy of Institutional Forms

Therefore, the current phase of monetary integration is not simply a ‘rationalization’ of previous national policies, nor an incentive to the deepening of the Single Market. Basically, it implements a major structural change in the way national economies operate and interact. It is quite partial to compute the welfare gains associated with the euro, as if it were a simple marginal reform around a well‐established market equilibrium in order to reach a Pareto‐optimum. Actually, the very adjustments governing credit, finance, capital formation, employment decisions, and even innovation will necessarily be transformed. Thus, not only are national business cycles possibly transformed, but the very growth pattern is likely to be affected. It is therefore important to adopt a long‐term view and to reassess the specific impact of the euro along with other contemporary major transformations. Régulation theory might be useful in analysing this issue (Boyer and Saillard 1995), since it is particularly concerned with the institutional transformations of capitalist economies.

1945–73: The National Labour Compromise Rules Over the Monetary Regime

It might be useful to go back to the origin of the post‐war exceptional growth. The major political and social transformations which occurred at that epoch prevented a repetition of the dramatic events of the inter‐war years (p.36) (i.e. a major financial crisis, then a depression which led inevitably to World War II). Structural and diverse public interventions were at the core of this success. Paradoxically, this was contrary to the current conventional wisdom about what should be a sound economic policy. In most countries, the central bank was highly dependent on the ministry of finance, markets were severely regulated and controlled by public authorities. Capital mobility was very low, external trade limited but growing. Last but not least, labour contracts were highly institutionalized (e.g. minimum wage, indexing of wage with respect to productivity and past inflation, surge of internal labour markets). Nevertheless, economic performance was exceptional in terms of productivity, standard of living, full employment, and even business cycle dampening.

For régulation theory this a priori surprising outcome is the result of the coherence of the institutional architecture built on the central role of the post‐war capital–labour accord. The implementation of productivity sharing allowed the development of mass production and consumption, which stabilizes the growth pattern by approximately synchronizing the extension of production capacities and the generation of effective demand, within societies where wage earners are the vast majority of the population. The state is transformed by the impact of this capital–labour accord since it then promotes the access to education, housing, health care, retirement funding. Clearly, the nominal wage is no more a price set on a typical market, but the consequence of a series of labour contracts, frequently implementing a seniority principle and a competition for internal promotion. Given this structural compatibility between the trends of supply and demand, the price of manufactured goods, specially durable ones, is set according to a mark‐up principle, with minor influence of transitory market imbalances.

In this context, monetary policy used to be the ‘servant’ of the capital–labour accord and oligopolistic competition. Capital was not really mobile across borders, and international relations were stabilized under the hegemonic role of the USA and especially the institutions defining the Bretton Woods system. Given this international stability, the exchange rate used to be set by national public authorities and it was adjusted when the previous fixed rate could no more be sustained, mainly due to trade deficit, and after the 1970s the emerging phenomenon of flight of foreign capital. If one country experienced a higher inflation than the rest of the world, a devaluation allowed a return to external trade equilibrium, while mitigating the conflicts on income distribution. In a sense, national monetary policy had the role of alleviating tensions in income distribution, and the exchange rate was a discretionary tool when inflation became too important. This pattern prevailed in the vast majority of European countries. One exception, Germany, experienced a rather different hierarchy, quite similar to the one which is now embedded into the Amsterdam Treaty.

(p.37) Therefore, an accommodating monetary policy was essential in preserving the cohesiveness of the national architecture of institutional forms and specially the primacy of capital–labour accord. This mode of régulation was very convenient for policy‐makers, since it reconciled dynamic efficiency and social justice in the direction of wage earners. Why did this system come to an end?

Three Major Structural Changes Since 1973

Basically, the very success of this style of economic management led to the endogenous erosion of its stabilizing properties. Three structural transformations explain its demise. EMU is partially a tentative answer to some of these transformations.

First, mass production techniques and organizations experienced a productivity slow‐down, initiated in the American economy, but diffused to other industrialized countries after the two oil shocks. Therefore, the conflict over income distribution became more acute, and inflation tended to speed up, triggering significant financial instability. In a sense, the monetarist counter‐revolution is a response to this potential threat, whereas the shift towards flexible exchange rate takes into account the significant heterogeneity in inflation rates. After two decades, new productive organizations are emerging and tend to replace the Fordist ones, but until now total factor productivity has not recovered the previous trends. Again, this has an impact on industrial relations, which have to take into account a slow‐down in real wages, as well as more decentralized wage bargaining in order to cope with sectoral changes and new sources of competitiveness.

Second, the significant slow‐down in growth rates, especially in Europe, affects previous political alliances, according to which even rather conservative governments had pro‐labour policies. The surge of unemployment weakens the bargaining power of unions and workers, whereas a new wave of organizational and technological innovations destabilize job demarcations and hierarchy of skills which were at the core of the post‐war capital–labour accord. Furthermore, the great freedom granted to productive and portfolio investment gives a premium to internationalized firms, which tend to look for markets and production sites far from their domestic space. Again, this destabilizes the capital–labour accord, and the wage–labour nexus has to be adapted to the new conditions for competition. This is further evidence of the shift in the hierarchy of post‐war institutional firms. Last but not least, governments themselves, whether conservative or social democratic, tend to adopt pro‐business legislation, taxation, and welfare reforms.

But the most relevant transformation is without any doubt the growing disconnection between the space on which economic activity takes place (p.38) and the territory controlled by public authorities. Since a larger fraction of production is exported and a significant part of investment may come from abroad, the domestic circuit of mass production and consumption opens up and tends to be replaced by an export‐led regime, at least for some countries (Bowles and Boyer 1995). Last but not least, the dynamism of financial innovation, the creation of world financial markets, and the difficult curbing of public debt totally change the conditions and objectives of national monetary policies. Since 1982, financial markets have promoted anti‐inflationary policies via high interest rates, and have pushed and extended such a strategy all over the world. National central banks today emphasize price stability, whatever the costs in terms of growth and unemployment. The exchange rate is then a pure market variable, with fewer and fewer controls from national or supranational public organizations. Simultaneously, the financial markets diffuse rapid changes in the formation of expectations, and they usually overreact to public statements and budgetary policies.

The EMU project, already present in discussions in the 1970s, awoke renewed interest in the 1980s, because it was an attempt to restore a minimal control over monetary policy, at the European level rather than at the national one. Speculation among European currencies is by definition forgone, whereas the density of intra‐European trade tends to synchronize the cycle of the core countries, but not necessarily that of the more recent member states. The overall exposure of the EU to external trade is similar to the level in North America and Japan. Consequently, a common monetary policy could have the same relative autonomy as that enjoyed by the Federal Reserve System or the Bank of Japan.

This historical retrospective helps in correcting a frequent misperception about the euro. For most of those opposed to EMU, it is the main culprit for all the evils borne by European countries, from financial concentration to mass unemployment. Actually, a common European currency is a response to already existing structural problems, which of course are transformed—for better or worse—but not created by its launching. Any scenario with the euro should always be compared to alternative possibilities, built on different attempts to overcome the (same) current European problems.

The Current Primacy of Monetary Regime and Form of Competition

Nevertheless, the euro is a component of the complete shift in the hierarchy of institutional forms which differs drastically from the configuration of the Golden Age (Fig. 2.2). Basically, a national territory is now inserted into dense international relations, in such a way that competition at world level permeates nearly all other institutional entities. The considerable freedom (p.39)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.2. Implications Of the Euro: A New Hierarchy and Architecture Of European Socio‐Economic Regime.

(p.40) of national competition policy is now restricted by international treaties extending the GATT to the WTO: a government may object to a fusion or absorption of one company by another, even if this concentration takes place far from its domestic territory. This process is sometimes called the globalization of competition. It takes another form within NAFTA or the EU, where a transnational organization is in charge to check the legitimacy of any concentration, under the general principle of fair and open competition. Therefore, price competition is more acute in the 1990s than during the 1960s, even if price wars are limited to a small number of sectors. Clearly, workers have to take into account this pressure of competition in nearly any component of the labour contract and wage–labour nexus.

Market forces tend to permeate production organization with such innovations as the Japanese system of Just In Time production, or more traditionally the flexibility of working time in reaction to the evolution of demand. Similarly, firms look for more rapid employment adjustments, but of course, voluntary labour mobility usually declines along with the scarcity of job opportunities, which has been observed for a decade in Europe. Perhaps one of the most numerous innovations concerns pay systems, which have been transformed in various directions: diffusion of profit sharing; individualization and decentralization of wage bargaining; reduction of seniority wage opportunities; recognition of individual merit and ability; much more than general increases decided through collective bargaining. Finally, even the welfare state is transformed since slow growth reduces the tax basis, whereas a high level of unemployment, frequently of long duration, and the rapid development of early retirement increase social expenditure. Consequently, many reforms have been implemented in order to curb the recurring tendency of welfare systems to run into deficit. In other words, the wage–labour nexus has become dominated by the logic of competition and the objective of a ‘lean state’, at odds with its central role during the 1960s.

The European single currency is part of this general picture, since it brings other pressures and opportunities to the restructuring of the wage–labour nexus. The fixing once and for all of exchange rates among members removes the ‘security valve’ that devaluation represented, and conversely appreciation of the national currency. This will bring a major change for the national régulation modes that used to solve income distribution conflicts by an accommodating monetary policy (i.e. possibly more inflation and in many instances devaluation). Some industrial relations systems already take into account the objective of competitiveness of national firms without using exchange rate variations. But others do not, and are therefore undergoing some pressure: long‐term unemployment, erosion of the extent of legal protection, and welfare benefits. The motto ‘let us make labour markets more flexible’ is adopted by many governments undertaking more or less (p.41) ambitious reforms. For instance, the French government in 1995 and the German government in 1997 tentatively changed labour laws and welfare components in order to fight both unemployment and for be ready the euro.

Such reforms are not so easy, as evidenced by the general strike in France in December 1995, or the similar mass protests in Germany. Similarly, the fact that European multinationals now optimize their production over the whole continent has caused a highly emblematic first Euro‐strike, when Renault decided to close its Vilvorde factory in Belgium. Finally, since the decision to create the euro, national governments, experts from the EC, and the Advisory Council of the ECB talk more and more frequently of the need for daring and radical reforms of labour laws and the welfare system. There is a strong presumption that the old régulation modes cannot enter unchanged into the next century, and the euro is adding one reason for such reforms. This would be the case even if, by an extraordinary conjunction of favourable factors, the wage–labour nexus became increasingly more Europeanized, in tune with the ECB policy.

This last comment raises the important issue of a new institutionalization of the wage–labour nexus, which cannot be summarized as a simple convergence towards pure labour market mechanisms, an ideal which is out of reach and not necessarily optimum for the society as a whole (Boyer 1993b). Furthermore, the euro may resemble the gold standard system, but with a major difference: during the 20th century, wage‐earners have won significant welfare benefits, concerning education, training, health care, housing, and retirement. These components definitely remain managed at the national level, but not at all at the European level. Therefore, the present European construction is threatened by a hidden but important risk. Workers may finally decide that the Amsterdam Treaty is a source of reduction in their social and economic rights and that it does not provide any new advantages. Hence, a polarization between an internationalized elite that would reap the benefits of the euro, and various social groups, nationally centred, which would bear the costs of adjustments. This is one major institutional and political deficit of EMU.

This danger has been perceived by EC experts as well as by the European Parliament. The Maastricht Treaty does display some social clauses, precisely to restore such a balance between economic objectives and social concerns. But it is to be noted that these clauses are quite few and only set minimal rights or legislation about equal treatment of men and women, work duration and shift work, as well as information procedures when a European firm closes a plant. Of course, under the aegis of the ‘social dialogue’, representatives of business associations and workers' unions periodically meet in order to define possible agreements which could become the skeleton of a social legislation at the European level. For the time being, the achievements of this dialogue have been very modest, concerning for instance parental leave, (p.42) part‐time jobs, or information disclosure by European multinationals. The closure of the Renault factory at Vilvorde has highlighted both the need for such cross‐border negotiations and legislation, and the considerable difficulties in implementing the embryo of a social Europe. The negotiation of the Amsterdam Treaty has neither fulfilled the wishes of unions, nor the statements of the President of the European Parliament, according to which the new treaty should have displayed an important social component (Gil‐Robles 1997).

This is not a real surprise, since the density of cross‐border links between unions is quite weak, whereas business associations and sectoral interest groups have far more opportunities to meet and co‐ordinate their strategy, especially when the EC is designing new rules or legislation (Schmitter 1997a,b)—not to mention the high frequency of financial transactions which tend to optimize in real time the rate of return of invested capital and therefore exert a strong influence on exchange rates, stock market indexes, and public bond interest rates. By contrast, workers are quite immobile and severely lack the dense co‐ordination procedures that would be necessary to defend their common interests at the European level. This asymmetry has another important consequence for the viability of EMU.

A Single Monetary Policy But Contrasted National Régulation Modes

Thus, monetary policy becomes European, but labour policies remain national, and quite heterogeneous. Indeed, since World War II the capital–labour accord has had many contrasted configurations, which are far from equivalent (Boyer 1988). The second structural deficit of EMU is precisely that it is difficult to have a common monetary policy in the presence of such different national interests, economic specialization, labour laws, and even business cycle patterns. Of course, this is not a total novelty: since the implementation of the European Monetary System, the Bundesbank has played the role of a Stackelberg leader in the determination of European interest rates. They were set according to the situation and needs of the German economy, and other countries had to follow even if their domestic situation was different. The management of German unification is a good example of such an asymmetry: real interest rates have been raised to finance the German public deficit, at the very moment when other economies needed an expansionary policy. The euro project intends to develop a more balanced European monetary policy. Germany has accepted abandoning the highly symbolic Deutschmark—not without significant political cost at home—provided Europe adopts a German style monetary policy. This means a highly independent ECB with the quasi‐exclusive objective of controlling inflation.

(p.43) If money was neutral, as most neo‐classical economists assume, all economic agents, being fully rational, would immediately adjust their behaviour to this new context, and in reality the ECB would not exert any influence on real economic activity, but would only curb inflation. Unfortunately, this is not the way real economies are managed. If, for instance, many unions are in conflict to attract members, or if wage bargaining is fully decentralized to enterprise unions, then casual observation as well as game theory teach that nominal wage rigidity will prevail, since no one will accept ex ante a reduction in the relative wage. John Maynard Keynes had already pointed out this configuration in the chapter devoted to the formation of a nominal wage in his book General Theory of Employment. The argument can be updated and it delivers a suggestive analysis about the dilemma the ECB is facing.

The Contrasted Institutional Architectures of France and Germany

Monetarists tend to credit the Bundesbank for German achievements in terms of low inflation and, until recently, rather moderate unemployment. They imply that the same policy implemented at the European level would deliver the same macroeconomic achievements. This might be true in a purely theoretical Walrasian world, with an exogenous monetary supply. But these two hypotheses do not fit with the basic features of contemporary economies. On the one hand, many institutional arrangements govern each market organization and deliver different adjustment processes, and the labour market is a good example of such a variety. On the other hand, credit is largely endogenous since its volume results from the behaviour of the banking system and the strategy of borrowers, and therefore the central bank only marginally affects this process by changing a series of interest rates. Consequently, the same monetary policy may deliver totally different results according to the way product, credit, and labour markets function. A comparison between Germany and France is somewhat enlightening.

In Germany, the independence of the central bank and its commitment to price stability are fully embedded in other institutional forms and internalized by other economic actors: workers, unions, firms, business associations, Länder, and the federal government itself. Consequently, a strict budgetary discipline is implemented, since the Ministry of Finance cannot ask the Bundesbank to finance any public deficit. Simultaneously, the history of the labour movement has produced a very specific process of wage bargaining, which is co‐ordinated at the sectoral level by powerful and unified professional associations. Furthermore, the German growth regime is built on the competitiveness of exports, by quality differentiation and not only price (Streeck 1997). Thus, the monetary regime enforced by the (p.44) Bundesbank is structurally compatible with the form of competition, state interventions, international insertion, and even more the wage–labour nexus. A priori, the change brought by the euro is of degree not of nature: the social partners should now look at the ECB and no longer at the Bundesbank and adjust their strategies accordingly.

For France, the picture is quite different. First, there is strong competition among rival unions not to accept any concessions. Consequently, wage formation evolves very slowly, mainly via the disciplinary role of high unemployment, and certainly not via an internalization by the social partners of the costs of poor job creation. Second, until the early 1990s, the government frequently used monetary creation in order to finance public deficits, since the central bank was basically controlled by the Ministry of Finance. Of course, the French inflation rate usually was higher than the German one, but until 1986 it was fairly simple to alter the exchange rate between the franc and the mark in order to compensate for the loss of competitiveness experienced by the French exporting sector. Furthermore, exports were conceived as a complement to sales to the domestic market and the growth regime was mainly led by the dynamism of consumption, itself related to the rapid growth of the real wage (Bowles and Boyer 1995). In this second configuration too, the accommodating French monetary policy was in tune with state interventions and the highly conflictual wage–labour nexus. Therefore, the independence given to the Banque de France in order to comply with the requirements of the Maastricht Treaty brings a real novelty into the régulation mode, far more challenging than the shift from the Bundesbank to the ECB.

This difference in national policy styles has important consequences. In Germany, growth rate and unemployment are not directly affected by EMU, and the tools available to the Länder and federal government are only marginally affected. In France, by contrast, the very core of state interventions are affected. Given the near anomie of industrial relations, a drastic reform of wage formation at the initiative of social partners is hard to imagine. Thus, unemployment has been the cost of keeping the parity between the mark and the franc unchanged. In this respect, the euro is a follow‐up of this process, with possible lock‐in effects on the future of state intervention and the form of competition. This institutional analysis delivers a surprising result: even if for a decade many macroeconomic indicators tend to be synchronized both in Germany and France, this outcome certainly does not result from a convergence of the respective régulation modes. Therefore, the same policy of the ECB will probably have a distinct impact on both sides of the Rhine. Potential political conflicts are in the making—the more difficult to solve, the more vocal have been statements about the complete independence of the ECB. But this result is not specific to the important but problem‐ridden German–French relations.

(p.45) Wage Bargaining and an Independent Central Bank

From a theoretical point of view, the opposition between France and Germany can be generalized by considering two dimensions: first, the degree of central bank independence; and second, the degree of co‐ordination of wage bargaining across firms, sectors, skills, and regions. In retrospect, one may compare the relative macroeconomic performances of OECD countries according to the four configurations obtained by combining these two criteria (Hall and Franzese 1998). It emerges that the best results are obtained when an independent central bank is facing social partners able to coordinate efficiently their decisions about nominal wage formation. The worst case (i.e. rapid inflation and relatively high unemployment is observed in the opposite case, see Table 2.2). However, the most interesting cases are the following. When central bank independence was associated with very little organization of industrial relations, inflation was nearly the same (4.8 per cent in IV and II in Table 2.2) from 1955 to 1990. This supports the now fashionable idea that central bank independence is good for price stability or at least low inflation. But, the cost in terms of higher unemployment is important, since the absence of wage co‐ordination brings increased unemployment (+ 3.3 per cent). Therefore, contrary to the monetarist vision, which assumes that money is neutral in the long run, in this configuration, monetary stability has a significant cost in terms of growth and employment. This non‐neutrality is related to the institutional structures governing industrial relations.

Table 2.2. The Independence of the Central Bank Delivers Contrasting Macroeconomic Outcomes According to the Institutions Governing The Wage–Labour Nexus (1955–90)

Degree of co‐ordination in wage bargaining

Level of central bank independence






Misery index


Misery index













Misery index


Misery index










Source: Hall, P. and Franzese, R. J. (1998).

Wage co‐ordination seems quite important for reducing unemployment, whatever the statutes of the central bank. If highly decentralized and unsynchronized wage formation could be replaced by a centralized and/or (p.46) synchronized system, then the gains in unemployment are between 2.4 and 3.4 per cent, and inflation is the same (Table 2.2, IV vs. II) or slightly inferior (Table 2.2, III vs. I). This is further evidence that monetary policy cannot be assessed independently from the prevailing institutional architecture, and that it is not necessarily the unique or the ultimate anti‐inflationary tool.

This general conclusion is confirmed by a large amount of research, which has used different tools and data: an analysis of the role of wage formation in the completion of the Single European Market (Marsden 1992); a study of governance modes and their relations with the monetary system and labour market institutions (Soskice and Iversen 1997); an in‐depth study of the origins of German macroeconomic success (Streeck 1997); an analysis of the Dutch ‘miracle’ (Visser and Hemerijck 1997); the investigation of the transformations of Italian institutions under the pressure of the euro (Regini 1997); an historical retrospect of the links between the monetary regime and labour market institutions (Boyer 1993a). Thus, there are grounds for expecting that the single European monetary policy will encounter significant difficulties in the context of very distinct industrial relations systems and especially wage formation.

This point had been completely neglected during the preparation phase of the Maastricht Treaty, but may play a key role in the future of European integration. Of course, if wage systems remain basically unchanged, it is likely that labour‐market segmentation, or still worse Balkanization, will be the implicit solution given to the inability to work out innovative labour contracts. In fact, if unions are weak and divided, if industrial organizations are heterogeneous, and if the national legacy in industrial relations has produced strong ideological opposition between firms and workers, then adverse macroeconomic outcomes are quite likely. Unemployment and social exclusion of the low skilled workers will be the particular cost to be paid for such conservatism in industrial relations. The efforts to be deployed in order to offset these adverse consequences will be greater, the more distant domestic labour institutions are from German ones. Will Germany be immune from any structural adjustment? The answer is not that self‐evident.

From the Bundesbank to the ECB: A Shift Detrimental to Germany?

If the text of the Amsterdam Treaty is to be followed strictly, the ECB should decide its monetary policy according to average European indexes and primarily the evolution of average inflation. But inflation rates remain rather different. For instance in 2000, inflation in Ireland is forecast to be around 2.8 per cent, but only 1.1 per cent in France, and 1.2 per cent for Germany. This is a significant discrepancy around the average European rate, forecast (p.47)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.3. The European Central Bank: Some Undesirable/Unexpected Consequences (Lower Inflation, But Higher Unemployment).

to be around 1.7 per cent. The heterogeneity of wage formation, productivity increases, and forms of competition across nations explains this discrepancy, which is likely to remain even if the common European monetary policy ends up synchronizing all national business cycles, which is currently not the case.

Given this heterogeneity, the ECB ought to adopt a more severe policy than the Bundesbank would have decided, even if the target for European inflation were still the German underlying inflation rate. From a more theoretical point of view, the model proposed by Hall and Franzese (1998) stresses that heterogeneity in wage formation has increased in Germany. Thus, if industrial relations outside Germany are not reformed, the following paradox could emerge from implementation of EMU (Fig. 2.3).

For Germany, the European monetary policy is no more decided according to the situation and interests of Germany. For example, an idiosyncratic shock equivalent to unification should not a priori alter the monetary supply by the ECB as the Bundesbank did after the collapse of the Berlin Wall. Conversely, if the other members of EMU grow faster than Germany, the interest rate should be higher than required to smooth the German business cycles. Thus, after the implementation of the euro, one could logically expect lower German inflation, at the cost of higher unemployment. A surprising result indeed! For other countries with highly decentralized wage bargaining, if lower inflation is to be obtained on a medium‐term basis, (p.48) more unemployment than before the euro is to be expected. Since the euro was supposed to enhance growth and promote job creation (de Silguy 1998), workers, unions, and public opinion might be disappointed by this unexpected outcome. Of course, the European boom initiated in 1997 may hide the higher underlying structural unemployment level, but as soon as a recession occurs, this basic fact will be apparent.

The unexpected result for Germany, shown in Fig. 2.3 and discussed above, originates from an econometric study for the period 1955–90 (Hall and Franzese 1998), and is confirmed by a simulation of a multieconometric model (Fair 1998). When the European economies shift from the current monetary regime to the euro, it turns out that Germany is hurt the most in terms of increased output variability. According to these analyses, the euro would be a Pareto‐deteriorating move! Social partners may perceive the origins of such a disappointing outcome and decide to synchronize wage formation in Europe overall. Since the institutional structures for such a co‐ordination are missing for the time being, they could simply decide to set wages in accordance with the German wage. This wage would itself be negotiated between IG Metall and the German metal industry employees, both of them taking into account the signals emitted by the ECB, instead of the Bundesbank. This very simple hierarchical device would prevent price stability from being obtained at the cost of higher unemployment in the majority of the eleven members of the EMU (Soskice and Iversen 1997). But this happy end is not entirely likely, because it assumes that all national, sectoral, and local unions in Europe will immediately look at the ECB's signals now, and no longer at those of national authorities, or at the domestic economic situation. For instance, the Irish or Portuguese workers' unions should not exploit bargaining power linked to a national booming economy (the respective GDP forecasted rate of growth being 7 per cent and 3.2 per cent in 2000) but take into account the preservation of the competitiveness of domestic firms, at least in the sector exposed to European competition. Such a rational calculus may take place, but it cannot be taken for granted, nor will it be general, given the strategic game which take place when many unions compete for membership (Boyer 1993a).

Will this conflict be limited to the domain of industrial relations or will it emerge in the political arena?

Emerging Conflicts Over ECB Policy

Intact, the legitimacy granted by German public opinion to the Bundesbank will not be capitalized automatically by the new European Central Bank. First, the adhesion of many European countries to the idea that the ECB should be independent is quite recent. It has to prove its positive outcome, by promoting financial stability and possibly rapid growth. This hope will be disappointed if the first steps of the ECB bring more restrictive policies (p.49)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.4. European Central Bank Management: Conflicting Interests Of Member States.

Notes: +, positive impact; −, negative impact; −−, strongly negative impact; 0, neutral impact. Symbols before diagonal lines indicate impact on Germany; those after, indicate impact on other countries.

than previously. The objectives and the tools of the ECB would become a matter of public concern, since political process may change what has been agreed by the Maastricht and Amsterdam Treaties. Nevertheless, it is not easy to change a treaty which has been signed by fifteen members, which may have conflicting views about the needed revisions, or have changed their objectives in relation to a transformed economic context. Second, even if all member states agreed the text of the Amsterdam Treaty on the statutes of the ECB, the heterogeneity of national régulation modes introduces potential conflicts concerning the conduct of monetary policy (Fig. 2.4).

Should the German principles be still applied to German evolution, the ECB being the faithful follower of the Bundesbank?—some observers have pointed out that the ECB is located in Frankfurt. But, of course, other governments and central bankers may complain that this was not the aim of (p.50) EMU, which intended, in contrast, Europeanization (i.e. more symmetry in the determinants of monetary policy).

A second option is to implement the same general concept but to apply it to European developments, which would respond to the previous objection. However, this neglects the heterogeneity of short‐term evolution and the fact that the statistical system needed to follow the impact of common monetary policy across different members states is currently not well developed. It is certainly less sophisticated than the monitoring tools available to the US Federal Reserve Board. Furthermore, the interest groups, which indirectly used to affect the policy of the Bundesbank, have no equivalent, at the moment, at ECB level. There is, therefore, much uncertainty about the weight given to each national economy in the fixing of European monetary policy. The constitution of interest groups on this issue, whether informal or formal, is also uncertain—the more so since the text of the Amsterdam Treaty seems to forbid such pressures.

A third option, seemingly rather unlikely but not to be excluded, considers that the ECB, whatever its firm statements in favour of price stability, may progressively learn by experience that the EU is in fact a somewhat closed economy with more degrees of freedom than expected. Thus it could, implicitly at least, promote not only stable growth but low inflation. Therefore, new principles would be applied to European developments. This strategy would benefit Southern Europe and industrializing countries. Even German public opinion could agree to such a move, provided it finally delivers better results for Germany. This scenario would be the most likely, the more problematic would become the German situation: sluggish innovation in sunrise sectors (Soskice 1997a) could induce a shift in German industry from largely price‐maker to price‐taker industries. A strong euro (i.e. overvalued with respect to the dollar), would no longer be rational or desirable, even from a German point of view.

These three options can be combined with two contrasted approaches of the Excessive Deficit Procedure (EDP): either the clause could be implemented strictly, the more easily the more buoyant the growth rate; or the inability of a majority of countries to fulfil the criteria during a severe recession or a long period of stagnation would lead to de facto rejection of the EDP.

In each of the scenarios, the costs and the benefits of each policy are quite differently distributed between Germany and the rest of Europe. This is strong evidence that even the implementation of the most basic clauses of the Amsterdam Treaty will bring potential acute political conflict, whatever the independent statute of the ECB. Monetary history suggests that the legitimacy of any currency is closely linked with political sovereignty. Thus, the long‐term viability of the euro cannot be warranted without a clear and stable political alliance at the European level. Again, the political deficit of EMU is pointed out. But the national policy arena is also severely challenged by EMU.

(p.51) Economic Policy Between Europeanization and Subsidiarity

How will responsibility for economic policy be shared between European and national levels? Before capital liberalization and EMU, each nation state had significant autonomy in using monetary, tax, and public spending tools in order to achieve the macroeconomic results that would satisfy a coalition of interest groups and/or a majority of citizens. This clear division of responsibility is removed and a much more sophisticated configuration is implicit in the Amsterdam Treaty. From a purely technical point of view, is this configuration coherent and viable in the medium to long term?

Back to Tinbergen's Framework

Today, analysts tend to use only neo‐classical models in order to assess the consequences of EMU. In this kind of model, markets are assumed to be self‐equilibrating, but public authorities and especially the central bank, may create some perturbations by altering money supply—quite unexpectedly with respect to the rational expectations of the private agents who have mastered perfectly the functioning of this idealized Walrasian economy. In such a framework, it is clear that only governments introduce Pareto‐deteriorating shocks. Therefore, the central bank should be independent from any political power and should be submitted to the implementation of strict principles, such as price stability or alternatively a given target monetary supply. The Amsterdam Treaty seems to be inspired by this kind of vision.

Unfortunately, such a framework hides more problems than it helps in understanding the formation of European/national economic policies. Thus, it is interesting to go back to a more conventional framework, which was at the core of Keynesian or more generally interventionist conceptions of the role of governments. Basically, markets such as those for credit or labour are not self‐equilibrating, due to uncertainty, asymmetric information and power, imperfect competition, and so on. In such a case, governments may have a positive impact on the welfare of society by promoting the return to full employment or alternatively fighting inflation and reducing external deficit.

How should a rational economic policy be decided? Macroeconomic modelling theory has proposed and implemented a useful framework (Tinbergen 1991). In essence, macroeconomic activity is largely endogenous, because consumption, investment, exports, and imports are related to wages, profits, effective demand, relative prices (i.e. variables set by private agents). But generally, involuntary unemployment is observed or an inflationary boom may endanger financial and even social stability. The government may correct these changes since it controls some instruments such as taxation rates, public spending, wage norms for the public sector, (p.52) interest rates, and exchange rates. By adequate movement of these instruments, a better macroeconomic equilibrium can be reached (Box 1).

At a very abstract level, it has to be assumed that the major macroeconomic mechanisms can be captured by modelling and estimating the related equations. Then, the government may try to decide its economic policy according to target variables concerning growth, inflation, unemployment, or external trade equilibrium. But, of course, under pressure from various social and economic groups, the government may be induced to pursue more objectives than available instruments make possible. In this case, no single objective will be maximized, but a composite of them will be optimized. Indeed, the weight given to each objective might be the solution to a political game played by various groups in order to obtain the support of public policy. If wage‐earners are part of the political game of government formation, unemployment and real wages are taken into account by the government, whereas the business community asks for low taxes and high profits, and rentiers' (large institutional investors) high interest rates and low inflation (Palombarini 1997, 1999). In comparison with neo‐classical macroeconomic theory, this framework is not without merit. First, it leaves open the question whether the government is stabilizing or destabilizing the economy. Second, it considers a large spectrum of relevant macroeconomic variables and intervention tools, and not just monetary policy. Third, such a formalization builds a bridge between macroeconomic dynamics and economic policy formation, certainly an important theme for any assessment of the euro.

Objectives and Tools of National Economic Policies: 1954–98

Concepts of national economic policy have changed considerably over time, and the emergence of the idea of a common European currency is part of this general process. Therefore, a short historical background is useful in assessing the novelty of the current European configuration.

During the Keynesian era, most governments, including conservative ones, had adopted almost the same four major targets for their macroeconomic policy: promote growth, limit external trade disequilibrium, keep inflation under control, and operate near full employment. Only the weight given to each objective used to vary according to the colour of the political coalition: more emphasis on full employment for social democrats, more importance granted to price stability for more right‐wing governments. Furthermore, the diffusion of Keynesian macroeconomics had made popular the following assignment of public intervention tools to the different macroeconomic objectives. Both monetary supply and public spending contributed to the level of output and price, whereas taxes could be used as an incentive to moderate wage demands, and therefore limit unemployment. Finally, the exchange rate was set by public intervention, with (p.53) (p.54) little influence from private capital, unless during acute external financial crises. Therefore, governments took pride in achieving a ‘fine‐tuning’ of macroeconomic activity and usually obtained political support from the public for this achievement. As the subsequent part of the story tells, this self‐attributed economic merit by politicians was partly or mainly an illusion (Box 2)!

After 1967, inflationary pressures became difficult to contain and public deficit tended to surge and therefore limit the ability to continue typical Keynesian full‐employment policies. If one of the conventional instruments came to be missing, it had to be replaced by another. For instance, various income policies: either strong and well‐organized social partners agreed on wage and price restraint in order to limit inflation and still more enhance employment; or labour markets were decentralized and uncoordinated, and a tax‐based income policy was tentatively introduced, for instance, by taxing (p.55) any wage or price increase above an upper limit. In fact, countries able to implement such a corporatist social pact usually enjoyed less unemployment and less inflation than others (Dore, Boyer, and Mars 1994). But this was certainly not the end of the story.

After 1979, a new monetarist and conservative alliance came to the fore in both the USA and UK, and this model of economic policy has spread across the world, quite independently from the colour of the government. First, unemployment is no longer a government concern because it is assumed to be voluntary and a response to a structural rise in the so‐called ‘natural rate of employment’. During this period, social deregulation has taken place in many countries and tended to destroy the very legitimacy of any incomes policy. Thus, wage formation is no longer an objective of public authority concern. Given the regime of managed flexible exchange rates, the budgetary policy loses a large part of its efficiency. The Keynesian multiplier is supposed to decrease towards zero. For supply‐side economics, any public spending is made at the cost of private consumption or investment. Thus, due to crowding‐out effects, more public spending means even lower output and employment. Again, the structure of macroeconomic adjustments has changed. So did political alliances and consequently the concept and implementation of a national economic policy.

Since the mid 1980s, a different and new concept has emerged. With financial liberalization, the multiplicity of new financial instruments, and the ‘globalization’ of some markets, the exchange rate is no longer a variable which can be significantly affected by the national central bank. The interest rate becomes an instrument which can be used to curb the inflation rate according to the so‐called Taylor rule, according to which any incipient inflation should be checked by raising the real interest rate. This same action reduces inflation expectations; it thus has a positive influence on the exchange rate. This leaves the problem of how to monitor the level of activity. The new tool for public intervention has become innovation policy, via subsidies or tax reductions for research and development expenditures. Basically, this neo‐Schumpeterian orthodoxy has been implemented by many governments. Finally, the public deficit is assumed to influence, at least partially, the external trade position of each country. The IMF frequently uses this argument in its structural adjustment plans for developing countries. It is important to note that the management of domestic effective demand is rarely taken into account today, especially in Europe. In the USA, the policy mix is much more balanced and could be a reference for the ECB, at least for some scenarios.

Thus, the euro arrives after this long‐term trajectory, and is partly explained by the quest for new intervention tools. If intra‐European exchange rates are governed by the expectations of international financial markets, the instability thus created becomes an obstacle to economic (p.56) integration. The euro might be a solution but then, what should be the division of tasks between European authorities and national governments?

An Unprecedented Configuration for European and National Policies

The situation created by the Amsterdam Treaty is radical. It is neither absolute autonomy of independent national states, nor is it a typically federalist configuration (Dehove 1997; 1998). Responsibility for economic policy is now shared at two levels and nested, in the sense that neither the supranational rules nor the subsidiarity principle exert a dominant role (Box 3).

Clearly, monetary policy is the full responsibility of the ECB, in charge of maintaining price stability in Europe. But the credibility of the euro and especially its exchange rate with respect to the dollar is significantly affected by the conduct of national budgetary policies. Given the fixed exchange rate system which is irrevocably installed by the euro between the eleven members, the Mundell–Fleming model implies that budgetary policy becomes the only efficient instrument left to national governments to control the domestic level of activity (Wyplosz 1997). Therefore, each nation state may have an incentive to free‐ride on the collective benefit produced by the wise budgetary policy taken by other nation states (Laskar 1993; Martin 1995). (p.57) Thus, the Amsterdam Treaty has extended the rule put forward by the Maastricht Treaty, and sets a 3 per cent limit to the maximum public deficit as a fraction of GDP, in order to convince the financial markets that the credibility of the euro cannot be challenged by the misconduct of any national budgetary authority.

This clause in the treaty is highly controversial. For many economists it is a symbolic and redundant rule, since the ECB is forbidden to buy any national public bond, or to bail out any bankrupt domestic bank (Wyplosz 1997). Still worse, in the case of severe recession, this clause removes an instrument from national authorities, as they are responsible for resisting unemployment and promoting high growth. Furthermore, from a purely institutional point of view, this clause violates the subsidiarity principle, which is essential in the process of European integration. A common counter‐argument states that governments should use the 1998 European recovery to build a budgetary surplus which will be useful during a future recession in order to alleviate unemployment, without hitting the 3 per cent threshold for public deficit (EC 1998a,b). But national governments, under the pressures of their constituents, seem to have different objectives, perhaps because the electoral schedule brings an intrinsic short‐termism to decisions on economic policy. In any case, this conflict of interpretation and responsibility will now undoubtedly trigger many conflicts. This dilemma will be exacerbated by the heterogeneity of national régulation modes and especially industrial relations systems.

On the one hand, the economies that enjoy wage co‐ordination still have a tool to affect the level of unemployment (see Crouch, Chapter 8): the social partners will adapt their strategy to the euro and still have an influence on the level of economic activity, even if budgetary policy were nearly neutralized by the 3 per cent limit. Eventually, the bargaining between business associations and workers' unions may concern public welfare management, with the objective of reducing the level of public deficit (e.g. by internalizing the costs of unemployment). Recently admitted member states, such as Finland, have evolved accordingly and negotiated contra‐cyclical devices concerning unemployment benefits, pension funds, and nominal wage formation (InfEuro 1998). Under this condition, the medium‐to long‐term viability of the euro is roughly warranted, provided of course, there are no major national unexpected shocks.

On the other hand, where wage formation is unco‐ordinated, the perspective is more gloomy. Frequently, the public deficit is high because the poor configuration of industrial relations has been converted into welfare spending (e.g. early retirement funding) or structural public deficit. Thus the budgetary tool is nearly neutralized, unless governments launch an ambitious plan for rationalizing and reforming the whole structure of public spending and taxation. But they often face strong social and political opposition, as (p.58) was observed in France in December 1995. However, this move towards a lean state does not solve short‐term adjustment problems, but is a means for promoting higher growth and innovation. In this respect, the incentives for research and development have exactly the same long‐term horizon as industrial relations' reform, and are unable to have a short‐term and significant impact on employment. In this case, the subsidiarity principle boils down to the crude absence of fiscal solidarity across European countries. EMU exacerbates underlying structural problems but prevents a socially acceptable solution, given the overarching principle of the need for euro credibility.

To sum up, the dividing line between the Europeanization of monetary policy and the subsidiarity of budgetary policy brings a structural disequilibrium and potential political conflict, and exacerbates the heterogeneity of national industrial relations and régulation modes. This discrepancy is not restricted to economic policy, since it is much more severe in the arena of domestic policy formation in general.

The Long‐Term Legitimacy of the Euro Within the National Policy Arena

Should any government join EMU? Within each domestic society, will anybody gain from implementation of the euro? Will politicians obtain permanent support for the current phase of European integration? Is the Amsterdam Treaty resilient to a large variety of world conjunctures, specific sectoral crises, and domestic political opposition to a part of the measures and processes set into motion by EMU? To all these questions, European officials have the same and fairly optimistic answer: the euro will bring financial stability; it will reduce uncertainty, thus enhance growth and employment, in such a way that every economic agent and citizen will eventually gain. This follows a somewhat conventional vision of institution‐building: politicians propose institutional arrangements that increase the social welfare of society (Posner 1981), and individuals accept these proposals. Only irrational activists or backward‐looking politicians could oppose such improvements.

But this view is far from satisfactory, since many Pareto‐improving innovations can be blocked in their diffusion by the prevalence of existing conventions and institutions (Boyer and Orléan 1992). Indeed, the major economic institutions require political intervention and often the permanent enforcement of law (Streeck 1996; Sabel 1997). This view explains far better the historical record (North 1990), as well as the variety of national institutional arrangements (Hollingsworth and Boyer 1997). The euro is not an exception, since it was designed and created, neither by financial markets (p.59) nor by economists, but by heads of government, in order to overcome the political disequilibrium created by the destruction of the Berlin Wall and the new dimension of Europe (Milesi 1998). But then assessment of the economic consequences of the euro is much more complex than a simple exercise in monetary theory. It becomes a debatable topic, which can be given different answers in various countries.

Until now, the European project has been mobilizing the political elite in order to convince reluctant economic or social groups to accept reforms, which would otherwise have been blocked. Such a phenomenon has been seen not only in Italy, where a European tax has been levied in order to comply with the Maastricht criteria, but also in Spain and Portugal, countries which have come to identify democratization and modernization with adhesion to the EU. Since January 1999 the issue has been transformed: how will public opinion accept the good and less palatable consequences of the conduct of budgetary policy, competition enforcement, and the implementation of a new series of norms and rules?

But there is a more structural analysis of the viability of the EMU: in the long run, will the groups benefiting from it be more numerous and politically active than the groups which will be hurt by the endogenous trends at work within each domestic society? Some French public polls give some hints: the unequal consequences across the different groups and members of society are clearly perceived (Table 2.3).

Table 2.3. France: The Euro Is Perceived to Have Different Consequences for Various Social Groups

Few problems

Transitory difficulties only

Long‐lasting problems

No opinion

Large firms





Younger people





Small‐ and medium‐sized enterprises















People with low incomes





Older people





Source: SOFRES (1997), 110.

What are the likely consequences of the euro for the following groups? (%)

On the one hand, large firms and certain younger people are considered to be able to adapt quite easily to this new configuration. All over Europe, business associations and large enterprises are the most active supporters of the euro—including those in the UK. Their strategy is already directed towards the entire continent, and monetary integration allows their choice of (p.60) location to be easier and less risky. For young people, the impact of EMU is less clear. In many countries, they are the most unemployed age group, and it may be argued that one of the hidden evils of a united Europe is to have privileged mid career workers and early retirees penalizing the entry of a new generation into the job market. However, perhaps EMU will trigger ambitious labour reforms, which would allow the reversal of this adverse selection against young people, but the jury is still out.

On the other hand, low income groups and older people are expected to experience lasting problems in coping with the new European order. The difficulties might be more transitory for small‐ and medium‐size enterprises, retailers, and small savers. Basically, most of these rely either on an extended welfare system, which has tentatively been reformed to prepare the economy for the euro, or on the domestic/local markets which may decline relatively as European integration promotes a new division of labour across borders. Those least able to deal with modern technology, foreign languages, or managerial tools will probably experience a decline of their relative income. This downgrading has been taking place for two decades in the USA, but it would be a relatively new phenomenon for European countries, where collective agreements, legislation, and a quasi‐universal welfare system has contained the widening of social inequality—although the UK has already explored such a path (Atkinson 1998).

Thus, EMU will contribute to shifting the borderline between winners and losers. In democratic societies, citizens express themselves on various occasions, including elections to the European Parliament. But turnout is especially low for these elections compared with local and national ones. This means that even the consequences of Europeanization are dealt with mainly within the domestic political arena. More generally, internationalization and globalization are still matter of domestic politics (Keohane and Milner 1996).

The Political Viability of European Integration at Stake

In a sense, both processes of globalization and Europeanization display some similarities: the more internationalized actors try to redefine the national rules of the game, using the leverage provided by their access to other territories (Boyer 1997). Of course, this group can try to influence the design of the rules of the game for the international system itself. But this second process is far more difficult than the first, due to the diversity of interests and the lack of a unified supranational state. Mutatis mutandis, the deepening of European integration has introduced equivalent tensions, but the project of a federal European state is less distant than the unification of the world under a single hegemony. Today, the European political process is subject to two contradictory forces.

(p.61) The economic and social actors who have access to the European Community benefit from extra markets, knowledge about relevant legislation and subsidies, and cross‐border networks. Thus, they are generally better off than the agents whose horizon is limited to local or regional transactions. Some of these Europeanized actors can even participate in the process of rule formation at the level of Brussels, Strasbourg, or Frankfurt. Of course, this power has to be shared with other members of the European elite and the perception of own interest are therefore transformed by this very process of interaction at the European level. Thus, there is the potential formation of a European elite and by extension polity (Schmitter 1997c), even if it is not devoid of conflicts and tensions. For instance, about 70 per cent of current national legislation is no more than the translation and implementation of rules and treaties decided at the European level. But these Europeanized actors are few in proportion to the total population.

For a vast majority of citizens, European affairs are exclusively or mainly a matter of domestic polity. First, because their contacts with foreign actors are rather episodic and superficial. Second, because their main access to political power is via national politicians who are held responsible for decisions taken both at the national and European level. Of course, since the Brussels authorities are generally far from the national politicians, this sometimes allows transferring responsibility for adverse consequences of Europeanization to the so‐called ‘Brussels Bureaucrats’. Third, and more basically, the most significant advances in European integration and especially EMU, have been decided after intergovernmental conferences, where heads of governments have signed international treaties on the model of those of Maastricht or Amsterdam. From a democratic point of view, the main voice of the average citizen is still expressed within the national political arena. Thus, an emerging risk: that nationalist movements and parties will take the lead in organizing protests against the adverse effects of European integration on either selected social groups or the majority.

In the future, these two groups with conflicting interests and visions could enter into frontal, if not violent, opposition about the trajectory to be followed by European integration: to forge as quickly as possible a true European polity where each citizen could have a say about such radical transformations as EMU, common European diplomacy, defence and security; or to reject any further Europeanization in the name of the preservation of democracy and transparency, and the defence of national identity. In some extreme cases, the destruction of previous European advances, such as the euro, could even take place. The first solution would be highly preferable; but it takes decades to build new institutions, and European political innovations might be far slower than the emergence of the major structural problems triggered by EMU. The second solution builds on already existing political institutions at national level, but seems to forget that European (p.62) economies have become so interdependent that the affirmation of national autonomy would have significant economic costs. Nevertheless, it is easier to destroy institutions than to build them, and populist arguments are generally more appealing than rational plans calling for the forging of a Euro‐polity.

But this is a crude dichotomy, and is only a starting point for a more satisfactory, but of course, complex framework. First elaborated in order to understand the origin of the 1992 Italian political crisis (Palombarini 1997), it can be extended to a stimulating analysis of the dynamics generated by EMU. Under which conditions will the euro be viable in the different domestic political arenas? Only if the economic evolution that the euro sets into motion affects the various social groups in such a way that the support for the deepening of European integration grows through time and delivers a continuous democratic support to the governments, which have proposed and implemented the current phase of Europeanization. But this process has become quite complex as it concerns monetary integration, financial deregulation, single market extension, and the limit over national public deficits (Fig. 2.5).

Basically, the very implementation of the euro shifts the boundaries between social groups or even redefines them. The large international firms have, of course, a basic interest in all four structural changes. This is not the case for medium‐size and domestic firms, which might be hurt by the deepening of the Single Market. This is according to an opposition, which can be perceived in all countries, and appears in polls and surveys (see Table 2.3). Also, welfare dependents, most civil servants, farmers, and low skilled workers are unlikely to benefit from the new concept of economic policy and state intervention, which is implicit to EMU strategy. Depending on the initial size of these groups, economic specialization, the specificity of interest aggregation via political party formation, the nature of the constitutional and political order, the same European policy may have quite different impacts on the legitimacy and durability of pro‐euro governments. Another important variable has to be added: individuals do not react only to the consequences of the euro on their material life and status, but may have general feelings about the desirability of European integration, on purely political or ideological grounds. If the launching of the euro initiates a long economic boom, its acceptance will be easier and will give more time to solve emerging problems. If, however, European growth in sluggish and uncertain, the fate of the euro could be completely changed.

But many other scenarios are opened from these interactions between economy and polity. The challenge of the euro may actually trigger a move toward more solidarity at the national level. Thus, the losers could be compensated by the winners and a new social pact and cohesion could emerge within each national state. Or, in contrast, the inertia of the past (p.63)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.5. The Amsterdam Treaty: Possible Political Consequences In the Medium To Long Term.

Note. +, positive impact; −, negative impact; 0, neutral impact Diagonal lines indicate ambiguity between two possible impacts.

(p.64) institutional architecture may deliver unemployment and social exclusion as adjusting variables to the euro. If socially excluded individuals or groups tend to be politically excluded as well, by not voting and being part of the political process, Europe could well follow the American track. Widening inequalities would not be so challenging for the stability of the pro‐European elite. But alternatively, given the ideological traditions of some countries, these groups may feed extremist parties, with drastic anti‐European results. In other words, as soon as the interplay of political, economic, and social forces is taken into account, the legitimacy and viability of the euro is a key issue for the next decade.

The future is largely open, and this hint concerns the very core of EMU (i.e. the objective and the role of the ECB). The precision of the clauses of the Amsterdam Treaty may give the impression that everything has already been decided and therefore the trajectory of the euro is already fixed—on the model of a rocket to the moon launched by NASA. This feeling is largely misleading.

The Strategic Options of the ECB

Alternative policies might be decided without altering the text of any European treaty, for three main reasons: the various clauses authorize contrasted interpretations of the need of economic policy co‐ordination; the consequences of severe and unexpected national crises; and of course, the opportunity to strengthen economic policy co‐ordination if a fraction of member states agrees to do so (Jacquet 1998; Muet 1998). Again, a brief historical retrospect is useful in order to understand the factors that shape the changes in monetary principles and regimes.

The Mundell–Flemming Impossibility Theorem Revisited

The so‐called Mundell–Flemming impossibility theorem is a good starting point. This core analytical framework about the macroeconomics of an open economy states that it is impossible to have simultaneously complete capital mobility, a fixed exchange rate, and an autonomous monetary policy. Its interest is to demonstrate the possibility of a plurality of national monetary and international financial regimes. Indeed, most of the theoretical possibilities have been realized since World War II (Fig. 2.6). The launching of the euro defines the fourth phase of a rich and interesting story.

From the end the war until 1971, the international regime was based on strong public control over international capital mobility, a legacy of the dramatic financial crises of the inter‐war period. Within the Bretton Woods system, each national government had to declare a fixed external parity to the (p.65)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.6. Stages Of European Monetary Integration: The Mundell–Flemming Impossibility Theorum Perspective.

International Monetary Fund (IMF) and stick to it unless a cumulative trade deficit, or more rarely capital flight, forced a devaluation, which was, in theory, operated under the control of the IMF. In this context, the monetary policy enjoyed considerable autonomy at the national level, and this was captured by the Keynesian IS‐LM model. Interest rates, along with tax and public spending, were the key variables in determining the level of activity by the joint action of the central bank and the ministry of finance which were frequently closely and directly linked to government strategy, and largely discretionary (Fig. 2.6A).

From 1971 to 1978, this configuration underwent some structural transformations which have been preventing such a fine‐tuning by economic policy at the national level from continuing (Fig. 2.6B). First, the creation of the Eurodollar accelerated international capital mobility and put pressure on the system of fixed exchange rates. Since inflation was quite high and heterogeneous across countries, the Bretton Woods system could not be sustained. The deconnection of the dollar with respect to gold set in motion a system of flexible but managed exchange rates. Increasingly, exchange rates were set according to the expectations of inflation by the financial markets and the domestic interest rate set by the central bank (i.e. a mixed system (p.66) where market forces and public control interacted). National monetary policies were increasingly constrained by international capital mobility, but national authorities could still influence the level of economic activity. The Keynesian ideal of fine‐tuning was decaying but not dead!

From 1978 to 1998 European countries were desperately trying to organize a minimal stability of their internal exchange rates in order to mitigate the large and frequently unexpected variations of rates observed between the dollar, yen, and other extra‐European currencies. The distant but still present origin of the euro was the European Monetary System (EMS), which was launched on December 1978 by a European Council held in Brussels (de Silguy 1998: 43–70). The underlying factor pushing towards the fixing of internal exchange rate was nothing other than the dramatic surge of short‐term international capital movements, which tended to be a large multiple of normal external trade (Palan 1998). Therefore, purely financial variables and expectations governed exchange rate formation. It is not surprising that many crises took place within the EMS, the most severe in 1992 and then 1993. How could full public control be imposed when even the alliance of major central banks was unable to go against private speculative movements? But the implementation of the Maastricht Treaty has again put exchange rate stability at the core of national economic policies. In this third configuration, the majority of European countries, with the exception of Germany, had lost any autonomy in their monetary policy (Fig. 2.6C). This is precisely the origin of European Monetary Union: set irreversibly internal exchange rates and recover some degree of freedom for a common European monetary policy.

Now a totally new configuration is scheduled. The only continuity is about private capital mobility which continues to govern the evolution of exchange rates at the world level. In a sense, the completion of financial liberalization under the euro will have a major impact on the single market and bring an optimization of the rate of return all over Europe, once the risk of exchange rate variations have been totally removed. Building the credibility of the euro will probably be the first objective of the ECB. If this is understood as preserving the exchange rate between the euro and the dollar, then the Mundell–Flemming theorem implies that the autonomy of the European monetary policy will be severely restricted. Of course, one might think that keeping a very low inflation rate is an insurance against a weak euro, but conceptually the two objectives are distinct and imply different interventions. Despite low inflation, financial markets might prefer to transfer their assets to Wall Street, which would provide higher interest rates and long‐term stability. For instance in 1998, the Japanese economy was experiencing a near deflation, but the interest rate was so low that short‐term capital was flooding into US markets. Consequently, the yen slid against the dollar. Paradoxically, if this scenario turned out to be correct, EMU would extend (p.67) to the European level the deadlock previously experienced at the national level (compare Fig. 2.6C and D).

Thus, some interesting lessons are to be learnt from this historical retrospect. First, there is no perfect monetary regime which would last for ever. On the contrary, the very success of a given international/national regime feeds destabilizing forces that call for the emergence of another configuration. Second, the euro is to be understood as an attempt to alleviate the contradiction between monetary policy autonomy, full international capital mobility, and the preservation of the single market. Third, the ECB will face the following dilemma. Should it stick to the objective of price stability whatever the consequences for the euro/dollar exchange rate? Or will it be induced first to assess the euro as a strong currency, which would later benefit the fight against inflation? Or could international capital mobility be institutionally reduced, thus opening new perspectives to the ECB?

Three Options With Contrasting Outcomes

The present situation can be extrapolated in different directions, which in the long run may make a lot of difference to European integration. It is interesting to present them from the more likely to the quite unlikely (Fig. 2.7).

Most analysts agree that price stability will be the main objective of the first decisions of the ECB, because it is essential for financial markets and

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.7. The Future Of the European Central Bank and the Euro: Three Options and Outcomes.

(p.68) for those countries that used to enjoy a strong currency, such as Germany. Initially, it was assessed that this anti‐inflationary objective would deliver, as a side effect, a smooth evolution of the euro with respect to the dollar. Nevertheless, a more careful theoretical and applied research now tends to conclude that in contrast, the volatility of the external rate of exchange will be increased. In the absence of any risk about internal exchange rates, with the same objectives of the central bank before and after the euro, monetary policy is likely to be less accommodating as soon as price uncertainty is dominant with respect to demand uncertainty (Cohen 1998). Thus, willingly or unwillingly, the ECB would converge towards nearly the same policy as the Federal Reserve System, not so much by ideological conversion to a more pragmatic view of the monetary policy (Aglietta and de Boissieu 1998), but because the ECB would take into account the continental size of the European economy after January 1999, or progressively learn to do so (Fig. 2.7A).

This first strategy has itself a pro‐growth variant. Instead of looking exclusively at the inflation rate, the ECB could try to get the best trade‐off between growth and stability. After all, a majority of European countries have complied with the 3 per cent criteria for public deficit in 1998, precisely because economic recovery has alleviated the pressures on public finance (along probably with some creative accounting). More generally, a pro‐growth monetary policy could deliver Pareto‐superior results (Fitoussi 1998). Again, the Mundell–Flemming model suggests that an adverse shock common to all European countries should be dealt by monetary policy (Wyplosz 1997). One could even imagine that an optimal policy mix emerges from an increasingly pragmatic ECB confronted with powerful Euro‐11 co‐ordinating national budgetary policies (Muet 1998). Political pressure in favour of the accountability of the ECB before the European Parliament and other European bodies would propitiate such a variant of the main scenario.

But, of course, an alternative strategy may focus on the strength and stability of the euro. If the trend towards complete capital mobility is considered as irreversible, then the will to maintain a stable euro/dollar parity would remove any autonomy from the newly created ECB (Fig. 2.7B). From a strictly economic point of view, this is not a very rational strategy, because it reproduces, at the continental level, the policy that has been so detrimental to growth and employment during the convergence toward the euro. But the pressure of some national public opinions or the perception of the actors intervening in the global financial markets make this strategy possible, if not highly desirable.

Furthermore, the notion of a strong currency is not self‐evident. There are several possibilities. First, it could mean an overvalued euro with respect to the dollar and the yen: the deflationary pressure imported would be paid for by a loss of market share and a further de‐industrialization (Munchau 1998).

(p.69) Second, and more realistically, a strong currency allows a lot of freedom in the conduct of the monetary policy, directed towards typical domestic objectives: given the credibility built during past episodes, the central bank may have a strategic effect and be relatively immune from confidence crises when, for instance, a short‐term poor macroeconomic index is released. The Bundesbank had this privilege and this explains why the reaction of financial markets differed for the same decision taken by the Banque de France. Despite all the precautions taken by the Amsterdam Treaty, it will not be easy to convert this credibility from the Deutschmark to the euro. Contemporary financial markets scrutinize any structural weakness and act accordingly. Public economic policies have to cope with this drastic requirement and it is not an easy task (Lordon 1997).

Third, a strong euro may mean that it becomes a reserve currency challenging the long‐lasting dollar hegemony. This definition is in no way equivalent to the previous one since, for instance, the Swiss franc is clearly a strong currency without aspiring to be a reserve currency. Even the Deutschmark has not developed as a real challenge to the dollar. The share of Deutschmarks in total world official reserves has been nearly constant over the last two decades (14.9 per cent in 1980, 14.1 per cent in 1996), and the decline of the dollar has been very modest, from 68.6 to 62.7 per cent during the same period (Peet 1998: 23). In 1996, the reserves in ECUs represented only 1.7 per cent, whereas the rise of the yen has been relatively modest, from 4.4 to 7 per cent. Clearly, Europe could gain a lot from a strong euro, but the road is still long before being independent from the US dollar.

Fourth, if European countries could pay their debts in their own currency, then the euro would become strong. Basically, this is the privilege of the US economy, and of course, it would help to reduce the current interest charges on public debts if countries could repay with their own currency and still enjoy low interest rates. This implies that Europe would have a powerful financial centre, which would compete with Wall Street in attracting savings and mobile capital from all over the world. In this respect, the way the current Japanese major financial and creeping economic crisis will be solved will have a long‐lasting impact on the evolution the euro and, more generally, financial intermediation at global level.

The depth of the Asian financial crises reminds the financial community itself that speculating may in some cases stabilize markets and be good for individuals who get rich—but quite dangerous for the systemic stability of the global financial system, when the game is played on highly sophisticated and abstract future indexes. This message was usually voiced by Keynesians (Minsky 1982) and critical analysts (Aglietta 1995) and the proposal of James Tobin to tax short‐term capital was then received as unrealislize by most governments and, of course, financiers. It is therefore highly remarkable that (p.70) one of the most visible speculators has written a book in order to denounce the danger of unleashed international financial speculation on the very stability of the whole system (Soros 1997). Thus, the probability of a third scenario has increased since Summer 1997: the implementation of a Tobin tax on short‐term capital (or alternatively institutional barriers to speculative capital) would give a nice issue to the Mundell–Flemming impossibility theorem. A more or less stable exchange rate of the euro could be made compatible with a relative autonomy of the ECB monetary policy. In this case, the merits of the euro would be evident (Fig. 2.7C).

However binding might seem the monetary clauses of the Amsterdam Treaty, a lot of options are open. The road actually taken will depend on the circumstances. Will the European boom be as durable as the American one? Will the Japanese major financial and creeping economic crisis be solved in 1999? Will speculation on Wall Street end in a soft or a hard landing? How quickly will a political arena be constructed around the ECB? The same wealth of futures can be contemplated for the other aspects of the European Union.

A Single Treaty: A Multiplicity of Conflicting Political Programmes

The challenge of international treaties is to try to be as precise as possible but simultaneously to compromise over important issues, where underlying representations and national interests may differ significantly. A careful reading of the European treaties brings considerable optimism about the flexibility which can be managed through a text, so difficult to agree on. The diversity among the eleven members of EMU is so great, that it would be surprising not to observe quite soon conflicts of interpretation and the forging of a jurisprudence in order to live with the Amsterdam Treaty, without negotiating a new charter. But of course, the extension to new members may call for such a drastic revision of the institutions if the EU. Some clear tensions may already be perceived under various headings.

The Links between Monetary, Budgetary, and Structural Policies

Many observers have pointed out a basic ambiguity in the launching of the euro. After all, this was a surprise nobody would had expected in early 1997. But the agreement for an independent European monetary authority, along with disciplinary rules for national budgetary policies, is located at the crossing of two strategies and visions of the world (p.71)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.8. The Amsterdam Treaty: Conflicting Outcomes Of Its Implied Dynamics.

For the French, it is a step to build a political union which would constitute the European Union as a clear economic actor, with a full capacity to govern macroeconomic adjustments. For the Germans, the objective is to remove monetary management from any political pressure and to induce the Europeans to undertake structural reforms, i.e. to substitute many bold microeconomic actions to a macroeconomic regulation, without any relevance, in the absence of any asymmetric and exceptional shock. (Bourlanges 1998: 143)

This opposition is permeating all aspects of ECB management (Fig. 2.8A). Traditionally, French governments, whatever their colour and orientation, (p.72) have an instrumental concept of monetary policy. Of course, the Banque de France has been made independent and the ECB is still more autonomous, but this was conceded to the Germans and other partners in order to convince them of French determination concerning the entire euro project. The final objective is to work out a better trade‐off between growth and inflation, under the strong impulse of intergovernmental co‐ordination. The German vision is quite opposed. The independence of the central bank is an integral part of a normative concept of a good economic system. No discretion should be left to government for influencing monetary policy, which should be submitted to transparent and firm rules. Furthermore, each domain of economic policy should be independent, at odds with French voluntarism on a need for co‐ordination of the ECB and the Euro‐11 Council.

Therefore, it is highly likely that during the initial implementation phase of the euro, both sides of the Rhine will have conflicting feelings about the policies decided in Frankfurt. But of course this is now no longer a German–French issue but a European one, which makes the matter even more difficult. The Northern countries tend to follow German principles, because they have a long experience of adjusting their policies in accordance with the decisions of the Bundesbank. But the Southern countries may be receptive to the French position according to which the euro should be submitted to a common political will. The irony is that after all, Europeans might be interested in adopting a different concept of monetary policy: the US one (Thygesen 1992). There, legitimacy is reached via the publicity of the deliberations of the Fed and a check and balance between the federal government, Congress, and the central bank. A rough comparison suggests that this accountability benefits the overall performance of the American economy, probably because the objectives are set in conformity with a large variety of interests.

The issue of the ideal governance mode under the euro is widely controversial (Fig. 2.8B). For the British, the Single Market (and if they eventually join it, the EMU), is conceived as a device to destroy or considerably erode all the institutional arrangements which have been so detrimental to British and European performance during the 1970s and 1980s. Therefore, the basic aim would be to create a free‐trade zone with competitive products, labour, and credit markets. The idea that Brussels could impose new and complex rules of the game or constraints appears as a heresy going against the victory of ‘market’ against ‘bureaucracy’. According to this position, political integration is not required; it would be even be dangerous since it could recreate, at the continental level, the regulations that have been finally terminated or eroded in the UK, a move which is assumed to have reversed its long‐run decline.

For Jacques Delors, the former President of the EC, along with a majority of social democrats, the agenda is strictly the opposite. The (p.73) internationalization of economic activity has eroded the capacity of control and monitoring by national public authorities. But a new form of control can be reinstituted at the now relevant level (i.e. the European). Also, for social democrats free markets are neither efficient nor conform with minimum social justice. They therefore have to be monitored by adequate regulations—which should be decided at the European level if strong externalities spill over across national borders, but at the national or regional level, if it is not the case. The subsidiarity principle intends to give a clear criterion for the agenda and non‐agenda of Brussels, at odds with the laissez‐faire vision, which postulates that economic performance will be better the more that the system is decentralized.

This ambiguity is no less challenging than opposition about the statutes of the central bank. For the British, the European construction is a means for implementing free trade on the continent, ultimately to be part of the larger world movement in favour of deregulation, in alliance with North America. For social democrats, by contrast, European integration means well‐organized competition and the constitution of a strong regional zone, which could become increasingly independent from the dollar, American technology, and even culture. When the French and British prime ministers meet the German chancellor, the potential sources of misunderstanding are numerous, but conversely diverse and a priori paradoxical compromises can be struck, inspired by quite opposed long‐term objectives. For instance, an alliance of the British and Germans on the issue of structural policies may coexist with an alliance between French and Germans about EMU. Until now, this kind of ambiguity has been fairly fruitful for European integration, but there is no guarantee that this happy outcome will continue with the euro (Bourlanges 1998).

Deepening of European Integration Versus Admission of New Members

There are many other sources for potential conflict, both within the Amsterdam Treaty itself and still more concerning its compatibility with the extension of memberships from fifteen to twenty‐five countries. Again, visions, objectives, interests, and strategies clash in at least two groups (Fig. 2.9).

Is the EU a matter of economic efficiency or politics? This ambiguity has long been at the core of European integration, and this paradox has already been pointed out in this chapter. Nevertheless, the euro further highlights this issue. Economic history suggests that no money can exist without clear political backing. But two contrasting conclusions can be derived from this. The defenders of national sovereignty argue, quite rightly, that the current (p.74)

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.9. The Amsterdam Treaty: Additional Potential Conflicts. The Federalist, German, and Northern Perspectives.

(p.75) status of the euro is not viable because no supranational state governs it, and that conversely a national state without its own currency is a contradiction in terms. Federalists do not disagree with the first statement, but they think that the political gap has to be overcome precisely by creating a European state, which should be the ultimate warrant of the viability of the euro (Fig. 2.9A). There is, of course, still another position, already mentioned, which insists on the radical novelty of EMU and the implicit political construction of the Amsterdam Treaty—which is neither an embryo for a European national state, nor a step towards a federalist state (Théret 1997; Dehove 1997). In this context, the treaty could well represent the zenith of European integration, since it will be quite difficult to go further and create a European polity.

Should the EU first reform its institutions and then admit new members or the other way around? This is intrinsically a rather difficult question which challenges the very significance of European integration. But again, two positions are present and difficult to reconcile (Fig. 2.9B). On the one hand, the Germans consider that the inclusion of former European ‘socialist’ countries is a high priority both for geopolitical reasons and the traditional role played by Germany with respect to Poland, Hungary, and other Central European countries. If the political project is clear enough, the economic aspect is more difficult to deal with, given the considerable heterogeneity of economic institutions and specialization of many of these countries, and their difficulty to comply with present European norms and requirements. Furthermore, the rebuttal by major Western economies to extend their contribution to the European budget makes quite problematic the survival of the present interventions for agriculture and regional structural funds. The dilemma between polity and economy is especially acute. On the other hand, Southern European countries fear being marginalized by the opening to the East. First, typical mass production may go to Poland or Hungary instead of Portugal and Spain. Second, the structural funds available for them would be drastically reduced. Third, the centre of gravity of Europe would shift towards the East, with many economic and political consequences. Still other governments, not directly concerned, may think that the greater the heterogeneity of economic and political institutions across members, the more unlikely is the success of any reform of the core European procedures, given the unanimity principle which is applied in the vast majority of decisions. A logical analysis suggests that the process of integration should be differentiated by competence and/or participant members (CEPR 1995). But this ‘Europe à la carte’ challenges the ideal of a single market and common currency, and would probably make inextricable a decision process already very slow and cumbersome.

Are structural policies a substitute for or a complement to the coordination of budgetary policies? Again, a North–South dividing line appears (p.76) (Fig. 2.9C). Northern countries (Germany has already been mentioned) consider that no active European budgetary co‐ordination is necessary. The viability of the euro depends on active structural policies on labour market institutions, financing the welfare state, tax system, education and training systems, public sector management, and so on. EMU would define the only macroeconomic mechanism at work in Europe, all other topics being decentralized to the more micro level. In the language of disequilibrium theory, European unemployment would mainly be classical (i.e. caused by an insufficient supply linked to a too low profitability). Southern countries (including France) have a different vision. Most of the difficult adjustment processes during the 1990s can be attributed, not so much to an intrinsic rigidity of European institutions, but to the strains brought by restrictive macroeconomic policies. Thus, employment would largely be Keynesian (i.e. caused by insufficient demand), itself generated by the monetary policy of high real interest rates and budgetary austerity. Co‐ordinating national economic policies would make much easier the adjustment to world trends in competitiveness and innovation. Again, a synthetic position has been proposed by a group of economists: why not reduce the social and fiscal taxes levied on low skilled labour in order to act both on the supply and demand side (Drèze et al. 1994)? Such a policy seems to have been implemented in various European countries, with a different mix of supply and demand components.

Alas, such a compromise is not always available for other topics and issues. The ambiguity of the Amsterdam Treaty is both a trump and a hindrance to the further deepening of the political institutions which is required for long‐term viability of the euro. Therefore, contrary to a common belief, the Amsterdam Treaty is not the end of European history.

The Euro: The Starting Point for Unintended Structural Adjustments

The surprisingly tranquil and smooth transition from the second to the third stage of EMU has given a false feeling of security (only shattered by the unexpected decline of the dollar during the first half of 1999). Can this success be extrapolated to actual implementation and the first steps and difficulties experienced then? Is there any firm prediction of the final outcome of the euro, or do experts disagree strongly? For some, Europe will end as a variant of laissez‐faire economy, after a de facto victory of the British vision, particularly in terms of industrial relations. The euro could contribute significantly to the evolution towards this scenario, because it strengthens competition among institutional regimes, tax systems, and of course, firms (p.77) and individuals. For others, Europe is bound to be politically integrated into a federal state, just to fulfil the requisites for a viable common currency. Opponents may comment ironically on this modern Hegelian vision (the EMU is rational therefore it will exist!), but the Europeanists reply quite rightly that since its beginning the European project has been made by the very same strategy, that the euro pushes at the extreme.

Political debates and academic controversies are built on dual oppositions, as if black and white were the only colours available—or more seriously as if the principle of ‘third excluded’ was true. If the pro‐euro group is wrong, then the anti‐euro one is right, and conversely. The central message of this chapter is that this position is erroneous and misleading and no more than a caricature of a highly complex process. Nevertheless, the conventional debate has the merit of defining a clear starting point for the more convincing scenarios.

A European Dream: Keynesianism at the Continental Level

For the Europeanists, EMU is an incentive to improve co‐ordination among economic agents and nations; ultimately it is the first step towards a fully integrated Europe. Basically, all economic units and political bodies will be constrained to take into account the new structural conditions created by EMU and to innovate in order to build the other economic and political institutions which are required for its long‐term viability. Therefore, whatever the initial ideological orientations of its advisory council is, the European Central Bank will finally adopt a Federal Reserve System style: clear political accountability and search for an optimal mix between price stability and growth. Similarly, national governments will perceive the externalities associated with domestic budget management and implement procedures to optimize the global policy mix between monetary and budgetary tools.

Given the optimistic expectations generated by this smooth handling of economic policy, firms experience strong incentives to innovate in terms of both products and processes (Boyer and Didier 1998): thus the Single Market would finally deliver the long‐term benefits which have been expected since 1985. Social partners themselves learn that wage co‐ordination is better than a myopic strategy and total decentralization. Therefore, either each national bargaining process takes into account the wage evolution set by the German social partners, who themselves respond to the signals of the ECB, or explicit European wage negotiations take place at the sectoral level or within multinationals. In both cases, job creation is preserved and is not directly affected by ECB policy. Thus, the final quasi‐neutrality of money would not be the outcome of a ‘state of nature’ but the result of a highly sophisticated institutional architecture of checks and balances between various economic and political actors (business, unions, national (p.78) governments, European Central Bank, European Parliament, European Commission).

In a sense, this is a rejuvenation of Keynesianism at the European level, which, incidentally, would preserve most national legacies in institutional frameworks. A still more optimistic vision would conclude that, in the long run, this scenario envisages a fully fledged federalism. A minimal taxation and public spending policy should exist at the continental level, in order to optimize the policy mix and organize cross‐border fiscal solidarity. This would enhance the political legitimacy of the entire European project, the common currency being a part of a broader coherent configuration.

A European Nightmare: Free Markets and the Balkanization of Societies

For the anti‐euro group, EMU is a disintegrating device of post‐war national institutions and the inception of a Europe governed by free‐market forces and ideologies, with absolute loss of collective control over economic activity and the end of the pursuit of social justice. These arguments are the exact opposite of to those above. European monetary policy is condemned to be more monetarist than the Bundesbank, because the clauses of the Amsterdam Treaty are binding and the financial community expects this. The only discussion concerns the intermediate objectives followed by the ECB: an index of aggregate monetary supply or direct European inflation rate (Aglietta and de Boissieu 1998). But well before January 1999, the debate was set: the ECB will adopt the same intermediate objective as the Bundesbank (i.e. a money supply target), even if it is not necessarily the most efficient (The Economist 1998b). Growth and unemployment indexes are not even mentioned under the phrase ‘the monetary policy is not responsible for the European unemployment problem, nor should the central bank take into account job creation as an objective’.

On the domestic side, national governments and parliaments will be possessive of their prerogatives in taxation and public spending, the more so since budgetary procedures are somewhat idiosyncratic. Thus, the freeriding of each national authority is quite rational, only limited by the 3 per cent EDP clause. When a recession occurs, no manoeuvre will be left to fight unemployment. Then, the tax levied on excessive public deficit will be unpopular in the domestic political arena. Some national governments may even challenge the orientations of the ECB, if they perceive, rightly or wrongly, that its restrictive or inadequate policy has exacerbated domestic problems, nearly impossible to solve within the constraints of the Amsterdam Treaty. In this gloomy macroeconomic context, the Single Market triggers more defensive competition than creative innovation: firms (p.79) de‐localize their activities from one country to another, in a permanent search for a more permissive institutional regime. High wage regions lose jobs, while firms put strong pressure on regional/national governments to obtain the maximum subsidy for job creation and the minimal taxation of profit and capital gains. Consequently, the tax base of the most welfare‐oriented countries is eroded, and advanced labour legislation is challenged by new industrializing regions and tends to penalize low skilled workers. Industrial relations evolve towards a complete Balkanization of wage bargaining: unions are unable to organize across borders even within the same sector or the same multinational, and domestic firms exploit their bargaining power in the context of a large pool of unemployed workers, including those who are medium or highly skilled.

Some analysts have forecast a de facto convergence of most national industrial relations systems towards a British configuration (Crouch 1994). This system is far from ideal since it allows the coexistence of a large pool of unemployed people, along with wage increases due to the scarcity of highly skilled workers. Further, rising wage inequality does not necessarily solve the unemployment issue. The fact that welfare benefits are closely linked to a limited regional/domestic space or are company‐specific, hinders labour mobility—contrary to what would be expected, given the considerable heterogeneity of national unemployment rates. Clearly, due to the inability to forge new co‐ordination mechanisms or European institutions, a market logic would govern most economic adjustments and even influence the formation of economic policy, by reducing state intervention and promoting a privatization of most welfare components and collective services. One could even imagine competitive wage reductions or, alternatively, productivity wars (Flassbeck 1998), which would give a typical Hobbesian flavour to this scenario. But of course, it can be challenged by proving that such defensive strategies are less likely with the euro than without (Artus 1998). The victory of the free market and supply‐side economics would mean an Americanization of continental Europe, a gloomy scenario for the anti‐euro group, but probably a desirable one for highly skilled professionals and European multinationals.

These two scenarios are built on the analysis of the same European treaty, a fact which by itself implies that no evident determinism is at work and that a much more complex analytical framework has to be worked out.

European Integration, Transformed Political Arena, and Changing Institutional Forms

The above developments suggest a three‐level analysis, which in turn may generate a spectrum of scenarios (Boyer 1999). Basically, the initial and (p.80) structural change comes from EMU (i.e. a new European innovation which, by definition, will alter the way national régulation modes operate in a very significant way). But the domestic political arena is itself transformed: the monetary policy which used to be decided at national level, with more or less democratic controls, has irreversibly shifted to the ECB. Simultaneously, with the other clauses of the Amsterdam's Treaty, decisions which were part of national sovereignty (e.g. the control of migration and borders) now become an issue only dealt with at the European level. Therefore, the domestic political arena is shrunk by two mechanisms. On the one hand, national legislation becomes the locus of implementation of European rules and directives, which restrict the autonomy of national interest groups. Some of them may protest and the conflict might be more acute than those already observed for fishing or migrating birds issues! On the other hand, the common monetary policy and the enforcement of a competition policy at the European level, will necessarily alter the nature of national institutionalized compromises and still more the whole architecture of institutional forms, at least for many countries. The economic strains experienced by the domestic agents will be converted into political demands, mainly addressed to national governments and in some cases European authorities.

Thus, this three‐level interdependency sets into motion a rich dynamic. It is hard to make any forecast, since the problem is similar to the famous one found in astronomy, when three planets interact and may evolve according to a whole spectrum of complex dynamics, from a smooth trajectory to a chaotic evolution, as the mathematical theory of chaos shows. Since strategic behaviour is common in political economy and innovations can always take place—contrary to astronomy where such a phenomenon cannot exist—the final dynamics of the euro will be still more complex than previously analysed. This three‐level analysis allows us to propose a taxonomy for various scenarios, including the Europeanists' dream and the Hobbesian nightmare.

Both Keynesians and federalists think that European co‐ordination or institution‐building should be proposed in order to minimize the transformations to be made in national régulation modes, even if they differ about the transfer of political sovereignty to European bodies. For Keynesians, modest co‐ordination procedures could solve the issue of national heterogeneity as well as the externalities associated to the public budget. This is not easy to implement: how to comply with the recommendations from the Euro‐11 Council given the specific timing and procedures of each national budget (Dehove 1998)? For the federalists, the subsidiarity principle should be used to minimize the responsibilities transferred to Brussels, in theory preserving the maximum autonomy of local political authorities. This scenario minimizes change at national level, but maximizes innovations at the European level.

(p.81) The laissez‐faire scenario assumes, in contrast, that European institutional construction has come to an end with the Amsterdam Treaty. Therefore, it is up to national institutions, firms' strategies, and individual behaviour to adapt to the new era. But the social costs associated with such a restructuring will strain national solidarity, transferring a fraction of the cost to the welfare state system. The domestic political agenda cannot stay unchanged—and it would be surprising if such a Hobbesian trajectory did not produce new political demands and accordingly social and economic regulations.

Thus, both scenarios adopt quite extreme hypotheses, do not take into account the positive and negative feedbacks between polity and economy, and drastically simplify a complex dynamics to two ‘attractors’ (i.e. a necessary convergence towards a single configuration, of course different). But jointly, they express most of the forces and dynamics which would be present in almost any scenario. How to elaborate richer and more diverse scenarios?

Some Strategic Parameters Governing the Future of EMU

The European Central Bank has decided its intermediate objective (i.e. a monetary aggregate target), but what will really be its final objective? The Mundell–Flemming model again helps to frame some strategies (Fig. 2.10).

                   The Unanticipated Fallout of European Monetary Union: The Political and Institutional Deficits of the Euro

Fig. 2.10. Three strategies For the Future Of European Monetary Union.

  1. The most likely strategy seems to be Euro 1, which accepts full international capital mobility but focuses its action towards purely or mainly internal objectives, whatever the consequences for the variability of the exchange rate. Some subvariants may alter the weight given respectively to price stability, growth, and in some extreme cases a modest concern for euro/dollar parity. Actually, the general statement about the desirability of the euro as a strong currency calls for a second scenario.

  2. Strategy Euro 2 aims at stabilizing the exchange rate or more generally building the euro as a competitor of the dollar for world financial intermediation. Given the extreme mobility of financial capital, this would mean that the ECB would neutralize its governance role in terms of domestic monetary and credit policy. No doubt most European actors, except modern rentiers and financiers, would object to such a strategy and would try to build active lobbies in Frankfurt in order to influence the decisions of the ECB.

  3. For completeness sake, a third option is opened and may be relevant in some rather extreme configurations. This strategy, Euro 3, could take place after a major international financial crisis, which would have shown how unstable might be a world financial system governed by short‐term speculation. If, for instance, the three members of the triad agreed to create a new international system with fixed but adjustable exchange rates, then each central bank, and of course the ECB, could obtain both a drastic reduction in exchange rate uncertainty and substantial control over domestic monetary policy. This would benefit the legitimacy of the euro, which would have been an intermediate step in the reconstruction of the new financial system.

No determinism can be invoked, since in a different world, European and national configurations, each of these strategies has a chance of being implemented and accepted.

Innovations in European Institutions in Response to Emerging Problems

European institutions and procedures will have to evolve in order to cope with the likely indirect fallout of the euro, as well as emerging political problems. Relations between the ‘ins’ and the ‘outs’ might prove problematic. For instance, small‐ or medium‐size countries at the margin of the EU may have an interest in competitive devaluation and not respect EMS rules which the ECB would like to impose on them. It has to be remembered that, after all, Italy, Spain, and the UK benefited from the devaluation of their currencies in 1992–3 following the breakdown of the EMS. Devaluation, especially in the context of slow and low nominal wage indexing, may have a (p.83) short‐ to medium‐term positive impact on growth and employment. Under some circumstances a run on the euro could well take place.

Alternatively, the very success of the euro may create positive externalities: lower interest rates, less uncertainty about the costs of selling to European markets, and greater national influence on new institutionbuilding at the European level. Therefore, one could observe a run towards the euro, as outsiders observe that members are better off, and that multinationals prefer to open new plants and branches within the euro zone. Remember the warning by Toyota to the British government if did not join the euro, and conversely the opening of a new Toyota plant in France, despite far more constraining labour laws. The euro will have definite consequences for European geography, and probably give rise to a new division of labour among member states (Krugman 1992).

Combining the orientations of common monetary policy with induced innovations concerning other economic and political European institutions delivers many scenarios, more or less coherent and promising (in theory, no less than 3 × 6 = 18 configurations). But the story is not complete since it does not take into account the political and economic process of adjustment within each member state: some societies are able (or know how) to cope with the euro, others do not.

Conclusion: A Largely Open Future—Many Surprises May Occur

Many conflicting visions can be mobilized to capture some of the consequences of the euro. The Europeanists would argue that the founding fathers always intentionally created structural disequilibria in order to obtain the required common institutions. Historians would insist on the long‐term trends governing contemporary Europe, whereas some social scientists would borrow from technological innovation analysis the concept of path dependence. Still others, inspired by Schumpeter and Popper, would insist on the radical unpredictability of this unprecedented innovation. The vast majority of analyses quite rightly use already existing theoretical tools to forecast the consequences of the euro. Each theory teaches about one aspect or another of this process. But unfortunately, many authors, by specialization, tend to take the detail for the whole picture, since they imagine that such a multidimensional innovation can be captured by formalizing the one or two features with which their pet theory can deal. By contrast, this chapter has described the spill‐over from one aspect of the euro to another, with a clear concern for the structural compatibility of the euro with existing national political and economic institutions. The theoretical interpretation borrows both from the recent advances of régulation theory (Boyer and Saillard 1995) in terms of hierarchy among institutional firms and from comparative (p.84) institutional analysis (Aoki 1996), which stresses the complementarity of economic institutions.

The rational expectations school has popularized the idea that economic agents can anticipate accurately the consequences of any change in economic policy. Otherwise, the economic system is assumed to be stationary and thus all economic agents arrive at perfect knowledge of its functioning and become as learned in economics as theoreticians are. When this framework is applied to EMU, the issue is only about the time required by individual agents to compute or learn the rational response to this new environment. These models describe macroeconomic adjustments over several periods, but they are not really dynamic in the sense of the endogenous transformations of a system which take place under the flow of permanent innovations. In fact, nobody knows if there is a viable configuration for the implementation of the Amsterdam Treaty. Therefore, this chapter has proposed a dynamic approach, which takes fully into account the disequilibria and conflicts that are generated by EMU. History matters and is more than the arrow of time taken into account by econometric models estimated over previous time series.

For a substantial majority of the economics profession, at least until the last decade, the market has been considered as the canonical and almost unique form of adjustment mechanism. They are therefore only able to describe the interactions that occur within a fully decentralized economy. By definition, almost any other organization, especially public bodies, brings inefficiency into the system. However, the conditions under which markets can deliver Pareto‐optimality have been shown to be very restrictive (Boyer 1996). However, firms, associations, communities, and even states may solve co‐ordination problems and provide benefits that the market is unable to perform or deliver (Hollingsworth and Boyer 1997). Consequently, this chapter takes full account of the fact that the euro will not operate in a pure market economy but within nationally embedded capitalisms: the outcomes are likely to be at odds with those forecast by neo‐classical models. But, of course, this makes the whole analysis difficult and some cases cumbersome by comparison with the elegance and the limited relevance of most theoretical texts about the euro.

Business Cycle Synchronization Does not Mean Structural Convergence

Since May 1998, almost all observers have to take the euro seriously, even if most were surprised by the fact that no less than eleven countries could comply with the convergence criteria. Looking carefully at national business cycles has nevertheless highlighted some basic questions (Peet 1998). One could always exert pressure on a spring so that it is reduced to a small size, but as soon as the pressure ceases, expands dramatically! Mutatis mutandis, the same (p.85) story could be told about the convergence of the eleven members of EMU. Of course, all governments wanted to be part of the first wave and to avoid the political cost of inability to comply. Therefore, these governments have taken short‐term decisions and sometimes structural reforms in order to be ready.

But what will happen next? Will inflation rates be more heterogeneous than in 1997 and early 1998? Will not the underlying diversity in régulation modes imply a permanent lack of synchronization of national business cycles? Synchronized or not, the eleven members do not enjoy the same social, political, and economic régulation. Therefore, the same monetary policy (or alternatively competition enforcement or labour law) will not have the same impact. From a purely technical point of view, the channels of monetary policy differ quite significantly across Europe. For instance, in the UK, an increase in interest rates has a much more important impact on real economic activity, due to the structure and the organization of the mortgage financial markets, whereas a similar influence is not present in Germany or France (Dornbusch, Favero, and Giavazzi 1998). This heterogeneity could persist over several decades and pose acute political problems.

This structural and institutional analysis brings a series of interesting results concerning some paradoxes of European integration. It may explain why implementation of the euro is so frequently associated with a plea for labour market flexibility. Furthermore, it brings some complexity into the debate. Last but not least, this chapter provides some hints about what should be at the top of the agenda for the next European negotiations, in order to adapt institutions and procedures.

The Seven Paradoxes Revisited

Conventional neo‐classical theory is unable to explain some basic facts about European integration. Now, a better integration of political and economic factors allows some interpretation of the paradoxes that emerge when a monocausal analysis is applied to EMU.

  1. 1. Why do most governments and the European Commission present EMU as a purely economic project aiming at transaction cost reduction and exchange rate uncertainty removal? Mainly because European integration has been realized by intergovernmentalism and not by a clear agreement on the constitution of a supranational state. Also, structural reforms, which would have been opposed in the domestic political arena, have been presented as constraints imposed by EMU. This strategy cannot last for ever.

  2. 2. Why did the Werner plan fail in the 1970s, whereas EMU was actually launched at the end of the 1990s, in the context of free‐market ideologies and a huge distrust of the ability of governments to have any positive influence on macroeconomic activity? Such a daring ‘constructivism’ is at odds with contemporary beliefs. It is precisely because the full deregulation of finance had so severely restricted the autonomy of European nation states, (p.86) that this proposal became timely. Still more, the apparent neutrality of monetary management makes more necessary a complete reform of post‐war economic institutions. For some governments it is a method for making free‐market economics more acceptable to a reluctant public opinion.

  3. 3. Why did European officials present such a bright picture of the consequences of EMU? In the absence of a European polity, this was the only method to build support and prevent any political conflict. If the welfare of any economy and individuals is increased, it would not be difficult to work out political compromises in order to share the benefits of EMU! Furthermore, a degree of functionalism has always been present in the European integration process and this kind of optimism has often been helpful and crucial.

  4. 4. Why are social and economic elites in favour of EMU, while modest social groups are generally against? Even when intensive pro‐European propaganda has been pursued by governments, most citizens perceive that EMU will have some costs for lower social groups. Why? First, the last two decades have seen an erosion of solidarity within most European societies. Second, the absence of a European welfare state is clearly perceived. This asymmetry in European construction provides a premium to nationalist and/ or nostalgic movements which defend previous forms of solidarity, via domestic welfare systems.

  5. 5. Why is Southern Europe so enthusiastic about the euro, despite the considerable adaptation costs, whereas Northern Europe is somewhat reluctant, even though its basic institutions are almost in tune with EMU? For the first group, monetary integration means economic modernization and political democratization. Polity comes first, economy second. For the second group, these achievements have been obtained for a long time. Thus, EMU is basically considered as a domestic issue, around which political oppositions are redeployed.

  6. 6. Will not the voluntarism deployed in the implementation of EMU have adverse political effects such as splitting the European countries between ‘ins’ and ‘outs’? Within each domestic society, will not the euro exacerbate political and social divisions, giving again a premium to nationalistic ideologies? The benign neglect of the political foundations of EMU certainly jeopardizes the economic viability of European integration. Pure economic forces could well disintegrate European social space, in the absence of a clear principle of solidarity, brought by intergovernmental political agreement.

  7. 7. Conventional wisdom teaches that politicians should govern and markets should allocate scarce resources. Events during the last decade suggest the opposite division of labour: the financial community assesses each day the relevance and sustainability of governments' projects, and conversely, governments are proud of their rational and sound management of economic resources. Basically, modern rentiers (pension funds, large (p.87) institutional investors, mutual funds) exert their hegemony by promoting financial stability and high rates of returns on invested capital, and they discipline accordingly industrial firms as well as governments. In many countries, wage‐earners seem to be out of the political game, even if they represent a majority of the population.

The merit of an institutional and structural analysis is to give some general interpretation of such diverse facts, starting from the same premises. Of course, the explanations are far from complete, but there is necessary trade‐off between the precision of a theory and the extension of its explanatory power.

Another conclusion of this chapter is to challenge the frequent and superficial opposition between pro‐ and anti‐euro. For the former, all economic and political actors will learn to take into account the functional constraints inherent in EMU and will decide collectively to design and implement a completely coherent system. For the latter, EMU is no less than a free‐market ideology in disguise, obtaining horrific results in terms of growth, employment, inequalities, and even citizens' rights. Both visions oversimplify a complex interaction process between forging a new European political arena, the transformation of national institutions, and the feedback of both these into the national political arena.

These interactions are so rich that a pure combinatory approach delivers more than hundred more or less coherent scenarios, unequally appealing and sustainable in the long run—not to mention the induced radical innovation in domestic and European institutions which will quite likely take place in response to strong political conflicts, contradictions between economic and political rationales, and possibly severe structural crises.

Preparing the Next Reform of European Institutions

A final conclusion is that the current configuration is not necessarily stable, and therefore every one needs to think seriously about the next phase of European negotiations. There are at least nine analytically distinct but actually closely interrelated issues with respect to the final architecture of Europe.

  1. 1. Since the European Central Bank will never be fully legitimized and credible without clear accountability, it is essential to consider the embeddedness of European monetary policy in national and European political arenas.

  2. 2. The excessive deficit procedure is not a real co‐ordinating procedure among national budgetary policies. It is therefore essential that a better policy‐mix should be aimed at, by creating more or less challenging coordinating procedures, not to speak of a minimal fiscal federalism.

  3. (p.88)
  4. 3. European institutions and decision‐taking procedures have become obsolete and inefficient. They cannot be reformed and rejuvenated without a clear recognition of the political project implicit in EMU and accordingly the development of a fully fledged political arena.

  5. 4. It would be daring to assume that the national institutional architecture inherited from the Golden Age could persist unchanged into the 21st century. EMU makes more urgent, reforms which should be undertaken under the pressures of the production paradigm shift and the new configuration of the international division of labour. But this does not mean an inevitable return to a mythical state of pure and perfect competition. A spectrum of alternatives already exists, and new ones will created under the pressures created by the euro.

  6. 5. The admission of new member states should be carefully assessed and designed. On the one hand, it is an opportunity to redesign completely obsolete European institutions, but on the other, it brings back such an heterogeneity that any common ambitious policy will be difficult to achieve in one or two decades (i.e. the time required to forge a minimal compatibility with the core of European integration).

  7. 6. The euro as a world currency may create as many problems for the international system that it solves at the continental level. The American, Japanese, and European monetary policies cannot try to be autonomous simultaneously, without creating major structural instability.

  8. 7. The Asian financial crises show that a little speculation is good for financial market stability, but too much may destroy them and provoke major recession. The fate of the Japanese major financial and creeping economic crisis will strongly interfere with the final status of the euro and the willingness of the EU to accept complete financial mobility.

  9. 8. European authorities should be ready to make proposals in order to redesign a complete international system in which public authorities will monitor the rules of the game, for finance, trade, foreign investment, intellectual property rights, and innovation.

  10. 9. In order to foster a lively political debate across Europe, but also in order to cope with contemporary sources of competitiveness, the subsidiarity principle should really be put to work to prevent an ultra‐nationalist backlash, always possible as soon as the success of integration falters. Paradoxically, subsidiarity might well be one solution to the long‐term viability of the euro.