All entries for Tuesday 31 January 2012

January 31, 2012

The EU Shows the Risks of Selective Intervention

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As Europe's leaders leave Brussels with a new fiscal treaty, I found myself thinking back to last June when Nicolas Sarkozy said:

Without the euro there is no Europe and without Europe there is no possible peace and security.

It makes you wonder how we got to this. If true, it would make the well-being and security of all Europeans hostage to the future of the Euro. Yet the euro is a relatively recent invention. It was not around for the first half century of the postwar era. Europe was peaceful and the European Union was working effectively long before the euro was brought in.

Given the model was already working reasonably well without the euro, you could understand Sarkozy to mean that Europe's architects willfully introduced a new feature that, if then removed one day, would bring it crashing to the ground. How dangerous is that!

Confronted by the possibility of eventual Eurozone disintegration, which the new fiscal treaty does not remove, I caught myself thinking:

If only Europe's builders had stopped with the single market.

The single European market, enacted between 1987 and 1992, was a huge achievement. The single market eliminated physical, technical and tax-related barriers to free movement [of goods and people] within the Community. The single market was enforced by tough laws that improved competition. In turn, competition and free trade within the community raised average productivity and incomes.

The European economy wasn't perfect. The common agricultural policy remained a blot on the European rural landscape. There was continual pressure on the member states to harmonize national social, employment, and fiscal policies. Within the single market itself there were still national currencies. The single market was marked by regional price differences arising from exchange rate fluctuations, currency exchange costs, and the lack of transparency associated with pricing in different currencies. The transaction costs alone might have been worth a few billion euros.

But perhaps it would have been better to have stopped there with the single market, and gone on paying those billion-euro costs, than to move on to the next stage of currency unification, ultimately facing today's trillion-euro costs of Eurozone bailouts and possible collapse.

Why didn't we hold the line there? What I forgot for a pleasant moment was the logic of the time. This logic led remorselessly onward from the single market to the single currency.

With hindsight the logic is sometimes portrayed as a simple economic inevitability, as if the single market just demanded to be made even better by a single currency, and would have been forever incomplete without it. "Without the euro there is no Europe"? Not so. There was an inevitability at work, it's true, but this was determined by politics, not economics.

You can think about it on the lines of what Oliver Williamson once called the impossibility of selective intervention. We'd like selective intervention to work like this. We live in a market economy, but from time to time the market fails. Then, when it fails, and only then, we'd like the government to step in and sort it out. When they've done that, we'd like them to stop.

In other words, in the best of all possible worlds, government intervention would be limited selectively to those measures that can improve social welfare over the results of the market economy. That way, surely, we would have the best of everything: the market when it succeeds, and government intervention to fix it when the market fails.

What could be wrong with that? Why can't we have the best of everything? The fundamental reason why selective intervention is impossible can be put like this:

A government that has the power to intervene when it chooses in the interests of the community also has the power to intervene when it chooses to serve its own interests.

In the case of the single market, Europe's leaders once saw an institutional deficit. For centuries, the competing nations of Europe were sources of technological, cultural, commercial, and industrial revolution. Revolution was spurred by rivalry. Too often, rivalry led to war. There was an institutional deficit, Adenauer, Schuman, and Spaak believed, that led European countries to make war, not trade. They decided to intervene to fix it.

The solution they sought was to bind Europe's nations together commercially. The European Economic Community, the forerunner of today's European Union, was the means to fill the institutional deficit that they perceived. But that turned out not to be enough. The next project was the European Union and the single European market.

In the process, they created a self-serving international bureaucracy. The European Commission in Brussels was supposed to oversee the single market. A legislature in Strasbourg was supposed to oversee the bureaucracy. But the lack of a strong popular European identity that could frame political competition on a continental scale led to Europe to exchange one institutional deficit for another.

Instead of an institutional deficit there was now a growing democratic deficit. That deficit became a refuge for politicians that had failed on the national stage or, as we sometimes call them, "elder statesmen." Defeated in a national election? Stand for the European Parliament. Just lost your party leadership? Become a European Commissioner. With a few exceptions these were vain, limited people. Unlimited only in their ambition, they tried to take control of Europe's destiny and shape it in their own interests.

What were the interests that the single currency served? It was another grand project. The worst fate of any political bureaucrat must be to enter office and be told there's nothing to do. Whoever got reelected or promoted by doing nothing? Every politician needs a stream of projects to oversee, institutions to build, offices to fill, and funding to allocate.

For such people, building the single market could never been enough. They needed something more to build after that. The single market was just a phase that added to their momentum. The logic of selective intervention is that nobody tells you when it's time to stop, and there is always good reason to go on. We could never have just "stopped there."

Not knowing when to stop is at the core of the impossibility of selective intervention. Selective intervention is supposed to improve things. And it can do this, up to a limit. But in the real world the limit of improvement is always fuzzy. If the government fixed one thing that needed fixing, this creates the justification for it to go on to fix something else. If that turns out to have made things worse, then this too becomes justification for another fix. There's never a reason to call a halt.

This is how a beautiful dream went too far, and so became a bit of a nightmare.

I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).

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