An Uncoupled Europe Ahead?

June 30, 2004 • Commentary
This article was published in the Washington Times, June 30, 2004.

The EU-U.S. summit comes at a time of great changes in Europe. On May 1, the European Union underwent the greatest expansion in its history, and negotiators are putting final touches on the European constitution.

Territorial “widening” and constitutional “deepening,” however, may not symbolize Europe’s growing strength.They may represent the zenith of its integration. The Bush administration should be aware of the troubles Europe faces and fashion U.S. foreign policy so as to minimize the negative consequences of Europe’s probable break‐​up.

Despite bringing some important benefits, such as free movement of goods, services, capital, and people, the EU faces serious challenges stemming from its redistributive and regulatory nature. Most of the EU budget consists of financial transfers among the member states. Such transfers may work relatively well in homogenous societies, but they create serious problems in heterogeneous communities. The breakup of European federations, such as Czechoslovakia and Yugoslavia, is relevant. Both countries consisted of two or more distinct nationalities and both engaged in resource transfers.

In order to work, large financial transfers require a cohesive “demos” with a highly evolved sense of common identity and, concomitantly, altruism. The more people identify with a particular group, the more willing they are to make sacrifices; witness the family. But Europe has no such common identity.

According to a 1999 poll by the EU Commission, on average, only 4 percent of the people in the pre‐​enlargement EU felt “European.” As a consequence, resource redistribution often leads to accusations of free riding and selfishness.

Take the current debate about falling corporate tax rates in new member states. Fearing tax competition from the east, Messrs. Nicolas Sarkozy and Hans Eichel, the French and German finance ministers, proposed a minimum corporate tax rate for the whole of Europe, saying it “would in no way stand in the way of healthy competition between member states.” The proposal may well become a serious option when the Dutch, whose finance minister has signaled support for it, assume the EU presidency next month.

Messrs. Sarkozy and Eichel are disingenuous. The entire point of a minimum corporate tax is to make the new members less competitive. Alas, that kind of economically suicidal policy is not likely to be accepted in Central and Eastern Europe, whose people were constantly asked to make sacrifices under communism. Altruism was lauded as the highest of civic virtues. But by the late 1980s the new members had little to show for it. They are unlikely to sacrifice their economic prosperity to help France and Germany balance their budgets.

In addition to taxation, there are divisions over other policies. The EU’s social liberalism, for example, is treated with suspicion by more conservative nations, such as Italy and Portugal. Environmental regulations have a disproportionate impact on post‐​communist countries like Poland, which is required to come up with $40 billion for environmental improvement. In other words, pan‐​European laws and regulations, which benefit some members but hurt others, is a powerful centrifugal force.

The breakup of the EU may not be immediate. But the event that may push it over the edge has already become apparent. In the past, when a country experienced a recession not shared by other countries, a well‐​run central bank could expand the money supply and moderate the recession without causing runaway inflation. With the arrival of the euro and monetary policies of the member states turned over to the European Central Bank, this kind of response is no longer possible.

A common monetary policy will be useful for moderating only Europe‐​wide business cycle fluctuations. When the members of the EU experience cyclical expansions and contractions at different times, some countries may come to regret the sacrifice of their monetary autonomy.

An economic shock, such as a terrorism‐​precipitated oil crisis, could have an asymmetrical or “uneven” effect on the EU economy. Some EU states export oil, while others import it. The EU countries also differ in the intensity of oil use. As such, they will likely need very different interest rates.

A single interest rate could hypothetically be preserved if the “asymmetry” of the economic shock were to be offset by massive labor inflows to countries economically expanding and large financial transfers to countries economically contracting. The first seems unlikely, because European labor is, in part due to language barriers, famously immobile. The second is impossible because the member states lack both the political will and the necessary resources. As Milton Friedman recently put it, “there is a strong possibility that the euro zone could collapse in the next few years because differences are accumulating between countries.”

It is feasible that, as a result of troubles with the common currency and rising costs of belonging to the EU, some members may decide that staying in the “club” is not worth the candle. The potential EU breakup could destabilize the world economy. But it also could provide an opportunity to bridge the trans‐​Atlantic divide.

It is unfortunate that at the start of the 21st century, Europe and North America form two separate trading blocs. The Bush administration could rectify that situation by declaring that, in principle, the North American Free Trade Agreement could expand to include interested Europeans, thus transforming NAFTA into a North Atlantic Free Trade Agreement.

The new bloc could offer many benefits, including improved market access for exports from Europe and North America, increased economic efficiency and greater global economic stability. It could thwart the plans of those in Europe who want to pursue a policy of economic centralization and unify the Continent around anti‐​Americanism. In short, for the U.S. and much of Europe, it could be a winning strategy.

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