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The Future of the European Project, and the Future of the Eurozone: A Talk from 2013: The Honest Broker for the Week of January 25, 2015

The Future of the European Project, and the Future of the Eurozone

J. Bradford DeLong :: U.C. Berkeley and NBER :: April 16, 2013

Framed picture John Harris Valda The Battle of Aquae Sextiae 102 B C 80 x 54 Wood Corum S Gold Amazon co uk Kitchen Home

My problem this morning is that I have four starting points. Or maybe my problem is that I have five starting points:


I. A Little Dutch History

My first starting point is the history of the Netherlands.

I would have to be more rash indeed than the fifteenth century's Charles de Valois-Burgogne,2 the last sovereign Duke of Burgundy, to dare to opine about classical Dutch history with Jan de Vries in the room. But my read of it tells me that "political union" is a very vague and sketchy concept indeed. Consider the "political union" of what was surely the strongest power in seventeenth-century Western Europe: the seven United Provinces of the Netherlands that dominated the economy and were the political-military lynchpin of the coalition to contain the aggressive King Louis XIV Bourbon of France. READ MOAR

As I understand it, the Dutch political union then consisted of:

  1. A talk-shop in the Hague, with rather less power than currently held by the organs of the European Union in Brussels and Strasbourg.
  2. The holding of the seven offices of stadthouder of each of the provinces by the then-current Prince of Orange, whoever that happened to be.
  3. The fact that the single province of Holland had 60% of the GDP of the whole; and thus could credibly threaten to go it alone, do what was necessary, make a little list of those who had not enthusiastically contributed their share of the resources needed for the common good, and remember.3

That was enough of a political union to support a great power in the seventeenth century that could dominate the seas and orchestrate the best-funded and most powerful military coalition on land as well. Certainly the most memorable piece of bureaucrat and raconteur Samuel Pepys Diary of his life in Stuart-Restoration England is his lament, one night as he watched the warfleet he had spent so much of his career trying to build burn in the Thames estuary, that it seemed to him "the Devil shits Dutchmen!"4

It was enough then. Will that amount of "political union" be enough for Europe today? I do not know. That is my first point--that "political union" is a vague thing, and often you only know that you had it after the fact when you look back, and see that things worked, and that in fact it did not all fall apart.


II. The Classical Political Theory Tradition (and James Madison)

My second starting point is to ask whether a stronger political union than what Europe has now--or than the Dutch Republic of the seventeenth century--is even possible.

Here the place to start is with the classical political tradition plus James Madison. Aristotle of Stagira5 believed that there were and could be no stable democracies, and certainly no good democracies. They were, he thought to the innermost core of his bones, inevitably ruled by faction--so much so that the end-state of democratic politics was a downward spiral of street-fights and purges ending in tyranny. And while this process worked itself out, he thought, at those times when you could get enough people assembled in the Assembly to make a decision, the policies that resulted would be irrational and random. They would decide today that they should execute every adult male in the recently-recaptured city of Mitylene because even the demos had been unwise enough to follow the lead of the aristoi when they had decided to rebel and affiliate with Sparta. They would decide tomorrow--after what must have been an incredibly intense night of bribery by Mitylene's ambassadors and well-wishers in Athens--that their decision of today had been unwise, reversing themselves, and sending a second messenger-ship across the Aegean to tell the occupying fleet not to do what the previous day's messenger-ship had commanded them to do.6

Moreover, a democracy would be a bad neighbor. It would be always prepared for aggressive war, for war would bring the demos paid employment in the fleet and their share of plunder as well. Since those who were prosperous and had something to lose did not have a big voice in the government, the government would not pay proper attention to the destructive side of war.

Faction-ridden, irrational, aggressive, militaristic--the classical Athenian democracy, Aristotle said, and for good reason, was very bad news for its neighbors and for itself.

A better alternative government, Aristotle thought, would contain an element of "monarchy"--top-down direction of an elite competition for winning zero-sum status in serving the government and the people--an element in which the ruling principle of politics was "honor", as Montesquieu would put it 2000 years later7. A better alternative government, Aristotle thought, would even be one of despotism--under despotism the ruling principle would be fear, but at least order would be maintained, and life and prosperity could proceed for all except the few who got crosswise of the despot. Perhaps the best regime would be a "republic"--a government where, again in Montesquieu's words, the ruling principle would be a positive-sum contest for displaying "virtue" in serving the republic. But such needed to be small--the virtuous cycle of public spirit and public-spirited action could only be maintained in a small community where the behavior of all could be seen. Thus a small city-state with a not-very-democratic mixed-constitution virtue-oriented regime could approximate the Just City, for a while, if you were lucky, if you had a good initial lawgiver, but only as long as the extent of territory did not grow too great.

And if territory did grow too great? Then the good republic was unsustainable, and you would oscillate between monarchy and despotism--as Aristotle must have reflected many times during his life first as tutor to and then as subject of Alexander III Argeios of Macedon, called "the Great".

Thus the classical tradition says that something like today's "Europe"--a highly-democratic republic on a continent-wide scale--cannot be a possible good regime. To this James Madison, writing in The Federalist, says: "Not so! Look at the institutions of the second-century BC Aeolian League."8 (I have not found any other references in secondary works that might have been read by James Madison: he must have trawled deeply indeed to come up with this one as a possible model for what he hoped the United States would become.) It is true that democratic politics tends to be faction-ridden. It is true that political decision-making tends to be irrational--ruled by transitory passions rather than durable interests. But start with a large enough territory, add enough cooling constitutional elements to the orrery of government, construct an eighteenth-century Enlightenment mechanical system of political order with the right properties, and if in its division of power between president, senate, and house of representatives it just happens to mimic the division in Great Britain of power between king, lords, and commons at the accession of King George III Hanover of Great Britain--well then, says Madison, it just might work. The constitutional cooling-off elements tame the irrationality. The extent of territory makes it more difficult for factions, limited to one class in one region, to out-organize the rational upholders of good government.

So Madison, trying to correct Aristotle and found the United States, raises at least the possibility that "Europe" could work--with the right constitutional order.


III. The Necessity of Political Union in the Dark Continent

My third starting point is the absolute necessity of political union in Europe today. It is just too costly and too terrible not to have one: the history of the first half of the twentieth century and then the edge-of-nuclear-terror decades of the Cold War teach that very strongly.

Was it 111 BC that the Kimbri and the Teutones, having moved down from Jutland to what is now Austria and crossed the Danube, decided they would rather cross the Rhine into the land of feta and olives in the Rhone Valley rather than eat Sauerkraut and sausage--or, back then, probably auroch jerky--in Noricum, near what is now Salzburg? So they went. And so they looted, burned, ravaged, killed, and ruled until a decade later they were broken at the battles of Aquae Sextiae and Vercellae by the new-model Roman Republican army commanded by Gaius Marius C. f. seven times consul.9 Ever since then, by my count, it is every thirty-seven years that a hostile army crosses the Rhine going one way or the other bringing fire and sword. The original Swiss--the Helvetii. Julius Caesar. All of those who claimed to be Julius Caesar's adoptive descendants. The Visigoths heading for Andalusia. Louis XIV commanding his armies to make sure that nothing grows in the Rhinish Palatinate so that his armies attacking Holland have a secure right flank. And, last, Remagen bridge in 1945. Every thirty-seven years, with increasing destructiveness as time passes.

Thirty-seven years after 1945 carries us to 1982. Thirty-seven years after 1982 will carry us to 2019. By 2019 we will have missed two of our appointments with slaughter. We desperately need political union in Europe lest the bad old days from 111 BC to 1945 come again as we once again fall victim to the tragedy of great power politics10. That means that politicians find some way to union--so that differences are thrashed out in conference rooms in Brussels and Strasbourg rather than in the streets with Molotov cocktails, submachine guns, armed drones, and worse. That is the necessity.


IV. Kindlebergian Hegemony?

The fourth starting point: return to the question of the possibility of a unified Europe. A presupposition of the Madisonian hope for a durable and well-functioning democratic government of great extent and territory was a certain original cultural not homogeneity but affinity: people in Georgia had to look at people in Maine as friends and allies by default, with the growth of faction needed to convince them otherwise. Suppose that is lacking. What then?

You then have to jury-rig something. You then have to hope for or to somehow generate a benevolent Kindlebergian hegemon11--some actor large enough to be the first-mover, to set the policy, because it is our way or the highway. This requires a willingness on the part of the hegemon to follow-through on its policy commitments--to mean it when it says "our way or the highway". This also requires a willingness on the part of the hegemon to be exploited to some degree--to let others free-ride on the public goods of international civil, political, and economic order that it establishes and provides. The hegemon has to be large and powerful enough to have an overarching interest in those international public goods. And it has to value public order, or public order plus various exorbitant-privilege12 benefits of hegemony, more than it feels taken advantage of by the free-riding.

Absence of a hegemon is, in brief, Kindleberger's theory of why the history of the North Atlantic economy between 1919 and 1939 was such a tragedy: Britain no longer but the United States not yet willing and perhaps not yet able to be the hegemon. That leads one to fear that perhaps, at the deepest level, the central problem with Europe today is that the United States is no longer the Cold-War North Atlantic benevolent hegemon it once was, but that Germany has not or has not yet stepped into that benevolent-hegemon role--or because of German history and German attitudes would not be tolerated by the rest of Europe in that role.


V. External Pressure?

The fifth and last starting point is what Madison left out: who the Aetolian League actually worked. It did work. It was remarkably stable. It had an executive. Its executive had powers and made decisions. It could command rather than request from its city-state members--and its commands were obeyed. But the Aetolian League was impossible to imagine without Macedon to the north. A hostile great power on its borders was essential to induce the surrenders of sovereignty needed for the Aetolian League to function. Analogously, a hostile Great Britain that would not have minded scooping up an ex-colony or two that wished to return to the bosom of Westminster--and confiscate the fortunes, and perhaps the lives and sacred honor--of the politicians who had led them astray into independence was essential to induce the surrenders of sovereignty needed for Madison's constitution and Madison's United States. In the absence of potentially hostile Great Britain, it is very difficult to imagine the politicians of Rhode Island agreeing to their voice being all-but-drowned-out in the lower house of representatives, and impossible to imagine the politicians of Virginia and Massachusetts agreeing to their voice being reduced to no louder than Rhode Island's voice in the upper house of the senate.

There is a story that when Paul-Henri Spaak was Secretary-General of NATO, he was asked if it would not be a good idea to erect statues to the founders of what was then becoming the European Union--the ECSC, the EEC, the EC, et cetera. His response, supposedly: "What a wonderful idea! There should be a fifty-foot tall statue of Josef Stalin in front of the Berlaymont Palace to remind us of why we are all here!" It was the Red Army's Group of Soviet Forces in Germany at the Fulda Gap that concentrated people's minds behind the ideas of the Monnets and the Schumanns most powerfully in the decades after World War II. That potentially-hostile superpower created a powerful desire on the part of many to make sure the ECSC, then the EEC, then the EC, and finally the EU succeeded.

And all of that vanished at the start of the 1990s--although there is a chance that we may in a few years be thanking Vladimir Putin for bringing it back.

Where do all five of these starts leave us?


VI. The Euro and the Lessons of 1919-1939

We ought, when we started the euro, have remembered the principal lessons of 1919-1939.

First, there is the lesson that John Maynard Keynes tried unsuccessfully to teach Harry Dexter White at Bretton Woods: that in order for an international market economy to be stable and prosperous, adjustment to macroeconomic disequilibrium needs to be symmetrically undertaken by both surplus and deficit regions, and not by deficit regions alone.[][]

When Christina Romer was in office back in 2010, she would stand up at OECD meetings and say: "What Europe needs to do in order to solve its financial and structural crises is not just a shift to sounder finance and more public austerity in the periphery, but pro-growth policies in the core." Everyone would say "yes, yes" and applaud. But what Christie would mean by "pro-growth policies in the core" is for a proportional share of the adjustment burden to be undertaken by surplus regions, which would mean 4%/year inflation in Germany and Holland. That would have been required for 2%/year inflation in the Eurozone as a whole, and thus for structural adjustment in Southern Europe to take place without grinding wage deflation. Deflation in the periphery and only 2%/year inflation in Germany means you won't hit your 2%/year inflation target for the Eurozone as a whole. And you won't get structural adjustment until generations have passed.

Second, if an international economy is to have any chance of avoiding crises, an integrated banking system requires an integrated banking supervisory system. Either you have to cut banking systems off from each other and run credits and debits through sovereigns--and then backstop those sovereigns, as the government of Austria was not backstopped when it tried to support the Credit-Anstalt back in 1931--or if you let banks hold assets and liabilities across national borders the supervision with an eye toward minimizing and then dealing with systemic risk needs to cross national borders and be global as well.

Third, for crises to be successfully managed, the lender of last resort must truly be a lender of last resort. The first part of the Bagehot rule is lend freely--and the lending must be truly free, and truly unlimited in quantity. The lender must be able to create whatever asset the market thinks is their port-of-safe-refuge and do so in whatever quantities the market thinks it might every possibly demand. It cannot get hung up on, say, Pierre Laval's desire to win points for himself in French domestic politics by vetoing Austro-German plans to increase the tax base via customs union as a way of making it sustainable for the German Weimar Republic's Reichbank to rescue the OeNB which was trying to rescue the Credit-Anstalt which had tried to moderate the Great Depression in the Danube basin by continued lending into the post-1929 downturn.

Fourth, in order for any monetary union or fixed exchange-rate union larger than the size of a true optimum currency area to survive, it must be willing to undertake large-scale fiscal transfers to compensate for the absence of the prohibited exchange rate movements that would otherwise shift terms of trade and rebalance the economy. Monetary union on a scale as large as the Eurozone requires large fiscal transfers, which are unthinkable without some operating and functioning form of political union.

I do know that those of us who were, back at the start of the 1990s, watching the project of the establishment of the Eurozone assumed that the establishment was being carried out by people who had learned these lessons. They were, after all, obvious--or maybe obvious only to people who watched international finance, or maybe obvious only to people with Ph.D.'s in economics who had written their dissertations in international finance, or maybe obvious only to those few of us who had made a relatively deep study of 1919-1939. We now find that the Princes and Princesses of Eurovia today do not appear to have learned these lessons. History taught the lessons. It taught them, I thought, fairly convincingly. But were the Princes and Princesses of Eurovia listening?

How did this come about? Why didn't Maastricht set up a single Eurovia-wide banking supervisor to align financial regulatory policies across the Eurozone? Why didn't Maastricht explicitly set up the fiscal transfer funds that, it was clear then, would be needed whenever some regional component of Eurovia were to fall into a deep recession--as some regional component surely would at some time? Why did Maastricht leave a good deal of lender-of-last-resort authority in the hands of national governments that could not print money--could not create the safe asset for the system--and implicitly task them with responsibility for their banking system? And why, given that one country's exports are another country's imports by necessity--and given that the United States will not always be enthusiastically the possessor of a hyper-strong dollar and the importer of last resort to guarantee full employment throughout Europe--does not the adoption of policies in Eurovia deficit regions to shrink their imports automatically trigger the adoption of corresponding policies in Eurovia surplus regions to boost their imports?

Part of the reason was the general belief in the Berlaymont and elsewhere that requiring the specification of what were seen as ancillary details at Maastricht would postpone the project for years if not decades. The logic of events, it was thought by many, would inevitably lead to the development of the missing pieces: first the common banking regulatory union, then over time the fiscal union, and then the political union necessary to make the fiscal union durable and acceptable, and then the making of the Europeans needed to populate the political union and keep it stable against centrifugal tendencies. And as for the fear that surplus countries might be reluctant to share in adjustment--well, back in 1992 it must have seemed extremely unlikely that politicians anywhere in Europe would ever have turned down an IMF-blessed demand that they expand their economies and reduce their levels of unemployment.

Surely when the crisis came we thought--at least those of us who worked in the U.S. Treasury and talked to the IMF thought--if it is indeed necessary that some European countries expand in the interest of structural adjustment, the IMF blessing of that expansion would neutralize any domestic political opposition to "sound finance". Yet we seem today to live in a very different world indeed from the world that we thought then that we did.

And, of course, underlying everything at Maastricht and in those Helmut Kohl post-Cold War years was a background gestalt that Maastricht was in large part Germany renewing its commitment to the continued and further integration of Europe in the aftermath of the very strong support given by the rest of continental Europe to the Bundesrepublik's absorption of the German East. If it turned out that someone had to pay somehow somewhen for the sin of not clearly foreseeing the consequences of the single currency and the Eurozone, this political support by the rest of continental Europe in the face of some skepticism as to the wisdom of immediate German unification from the United States and Russia meant that the rest of Europe had a very deep well of credit with Germany on which it could draw. Germany would remember. And Germany would be eager to pay.

It may well all work out. Fifty years from now historians may well be writing that Maastricht was a gamble--and was, like Waterloo, a near-run thing--but a gamble that in the end paid off after all. "After all", historians may say in 2063, "it has now been 108 years since an army crossed the Rhine with fire and sword, and the unforeseen costs of Maastricht are a very small payment for an insurance policy against that eventuality". There may still be large differences in prosperity between Europe's core and its periphery. But come 2063 Europe as a whole may well be so rich that these are and are seen as second-order concerns at most. In 2063 Northern Europeans may still grumble that Southern Europeans lack a proper work-ethic, but when they do so they may do so as they pay through the nose for the amenities of all of their Mediterranean vacations.

After all, being taxed a bit to support the common European project has large benefits. The Kimbri and the Teutones never got to enjoy the feta and the olives and the sunshine. We have every reason to think that the Northern Europeans of 2063 will.


Perhaps not.

But right now, it looks to me as though history did indeed teach the lesson, but that while history was teaching the lesson the Princes and Princesses of Eurovia today were too busy texting on their cell phones to pay any attention. | Notes

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