The Euro as Catalyst for European Reform

Looking back, it is hard not to be struck by the contrast between the skepticism prevailing among academics and international experts at the mere thought of a supranational currency, and the credibility which the Euro acquired over a period of a few months even before its official launching on January 1, 1999.

Indeed, the world’s economic turmoil of 1998 (especially in September and October) could have been expected to cast a shadow over the creation of this new currency. In fact, quite to the contrary, the very prospect of the disappearance of exchange rate fluctuations within the Euro-zone actually deterred markets from upsetting the European monetary scene. The convergence of interest rates of our central banks became a reality in the most harmonious way. As to the delicate conversion to the Euro on December 31, 1998, it took place without a glitch.

But if the Euro started so successfully, less than three months after its birth questions are now surfacing again. While many had predicted a strong Euro, its value has initially depreciated vis-à-vis the dollar. The jostling over the right “policy mix” between the European Central Bank and various Euro-zone governments has been widely publicized. The multi-year budgetary programs put forth by the member-states a few weeks ago to meet the requirements of the “Pact for Stability and Growth” have not all been deemed convincing by the European Commission.

However, there is nothing to justify that the initial euphoria should now give way again to doubts. Indeed, we have entered a new era. Roles have been redistributed. On the one hand, European Central Bankers, now fully and independently in charge of monetary policy, read the Maastricht Treaty as giving them the mandate to ensure price stability. On the other hand, governments share among themselves the responsibility for economic policy in the Euro-zone. We are at the beginning of a learning period, of a long process, still filled with many unknowns. This will require on the part of European leaders courage, and a sense of vision and reform—which is precisely what they had to show, too, in order to place the Euro into orbit. That, in and of itself, is promising for the future.

Let me submit to you a few observations about the Euro’s international dimensions before I give you my views on the kind of reforms which the Euro ought logically to promote in Europe.

The Euro’s International Dimensions
The champions of the Euro, especially in France and Germany, whether they belong to the Left or the Right, all share the same culture on international economic relations—a culture based in particular on the virtues of free trade. True, since most of member-countries’ external trade takes place within the so-called Euroland, some have seen in the creation of the Euro a means of reinforcing the supposed “fortress Europe.” Yet such impressions are misleading. For us to yield to the temptation of protectionism is, let’s face it, inconceivable. We simply have too many economic interests and too many jobs which directly depend on our exports. Too many global companies have spread out their resources in accordance with the costs and characteristics of each and every region—and their very existence in Europe now depends on the durability of a freemarket economy on a world scale.

In the very logic of the previous “Single Act,” we created the Euro precisely in order to improve the workings of European markets. We created it also because it meant over time a closer European integration. We created it, finally, because we hoped it would quicken and strengthen Europe’s industrial and financial power.

Indeed, this is happening. As Hervé de Carmoy has pointed out, financial concentration is now intensifying within our countries—in Portugal, in Spain, or more recently in France, with the mergers between several large banks—and also on a European scale. That trend is also significant in other sectors which demand large-scale operations to secure the creation of value expected by financial markets, which internal growth can no longer promise everywhere by itself. That is now true in heavy chemistry, insurance, automobiles, pharmaceuticals, aerospace, and even in the multimedia industry. All this enhances our European capacity to be “global players.” In addition, a greater convergence of the rules of the game on such matters as accounting, corporate governance, and the monitoring of financial markets—largely influenced by American practices based on common criteria of transparency and business ethics—contribute to a better understanding among all involved. Such an evolution will improve the quality of exchanges among the main industrialized countries and enhance their growth potential.

This evolution will culminate in a “Millennium Round” of multilateral trade negotiations in search of a balanced partnership and fair trade among the main world economic actors. This Round must integrate all the components of today’s competitiveness—including the essential accelerator of R&D in all its forms, through information and communication technologies—triggered by a Schumpeterian process which we have seen at work over the last eight years in the United States, and which is now emerging as the prerequisite for faster development in Europe.

On the international scene, the Euro, far from being a weapon in some mythical struggle against the dollar, should help the European countries better shoulder their global economic and financial responsibilities.

Every day more global, our new world is characterized by gigantic—and growing—capital flows, and by persistent current account payments imbalances. America’s considerable deficit coexists with a strong dollar, while the Euro-zone’s surplus goes for the time being with a somewhat weakened Euro in spite of its recent rebound. Japan’s economic and monetary evolution raises a number of questions. Thus, on a Trilateral level, too, factors of market instability remain latent. In such a context, to insure the greatest possible stability, we need first to pursue domestic monetary policies geared to stability, as has been the constant philosophy of the G7. But will that be sufficient?

Last year, we have witnessed the role played by the Federal Reserve System in responding to the deterioration of the international financial climate. How much longer can the European Central Bank and Europe’s political leaders continue to be unwilling to respond to the United States’ call? When it comes to sharing, through a balanced and constructive dialogue, the responsibilities of great powers in the face of potential worldwide turmoil, how could Europe refuse the call of duty? It must be said, however, that to follow this path might entail a redefinition of the missions of the European Central Bank, and perhaps at least a rereading of the rules set forth in the Maastricht Treaty. This is a crucial issue

There is at least one other essential question: the Euro’s gradual move towards the status of a “reserve currency,” which will inevitably have repercussions on the management of the dollar. As we can see, the emergence of this new European currency profoundly alters the functioning of the financial world. It calls for a deepening of the Trilateral dialogue, which, as Peter Sutherland puts it, will be all the more constructive in so much as “the pooling of sovereignty has fostered a more reliable and accountable Europe within the Trilateral partnership.”

The Euro and Reform in Europe
Let me come now to the heart of the issue: I am convinced that the Euro will lead Europe over time into radical reforms: to reduce public and social expenditures, to increase the flexibility of labor markets, to favor productive investments and job creation and thereby reduce unemployment.

To be sure, as we seek to empower the European economy to create jobs as the American economy has done, many obstacles will have to be overcome, which are readily identifiable.

The first difficulty is of a conceptual nature. A number of economists tell us that the Euro zone is not an ideal monetary zone. In other words, in the event of a shock in a given country which could worsen unemployment, this country lacks cross-border labor mobility, and no longer has the ability to adjust its exchange rate. Under such circumstances, these economists argue, budgetary transfers must be facilitated to help the troubled areas. Some even go as far as to question the wisdom of the “Growth and Stability Pact” which strictly limits budget deficits. Clearly, such an analysis is debatable. Within any country of the Euro-zone, disparities in unemployment from one region to another may be greater than between two different countries in the zone. After all, no single European country—be it France, Germany or Italy—has ever been an “optimal” monetary zone in the past! And yet, no one ever thought of allowing several different currencies on his territory!

Let’s not, however, underestimate the impact of such an approach which, in its pessimistic version, conveys a defensive, downright defeatist vision of the future that spells permanent, intractable unemployment, together with ever more widespread social protection. In such a scenario, since it eliminates the exchange-rate constraint, the Euro could appear as an opportunity, since it discharges governments from enforcing the discipline attached to balance of payments disequilibria. Euro-zone trade being primarily intra-EU, it would become much easier to sustain economic activity through budgetary policies, since they would be conducted simultaneously by member-countries. In such an approach, the temptation would also be strong to harmonize fiscal policies through higher taxes, and thus to extend to all member-countries the most favorable conditions of social protection.

In spite of today’s predominance of social democratic parties on the European political scene, it is by no means obvious that we will take this path. For at least four reasons:

• First, the facts are before us: The European countries which did best in containing unemployment are not those using budgetary and monetary policies. Rather, they are those which courageously engaged in reforms—especially in order to improve the workings of their labor markets, and to eliminate the systemic “unemployment traps” built into their systems and thus provide a favorable environment to entrepreneurship and innovation.
  
• Second, our governments’ firm commitments to the Pact for Stability and Growth deter those who might still wish to resort to budgetary growth stimulation. Such a stimulation, unacceptable to member-countries as a whole, would in any case have limited effects in any particular country.
  
• More decisively, the kind of fiscal competition which already goes on among the states of Europe is only enhanced by the Euro. Indeed, by giving it greater visibility, the Euro intensifies this competition. On such a sensitive subject, it helps indirectly to mobilize public opinion. In some of our nations, the disincentives in the tax system lead the young, educated at great costs in the best of universities, to seek employment in other countries where their prospects look brighter. Faced with the prospects of a heavier tax burden, some companies no longer hesitate to threaten a relocation of their headquarters. When the Financial Times polls the leading Employers’ Associations of Europe about the harmonization of corporate taxes, an overwhelming majority of them react negatively. Clearly, they wish for the continuation and accentuation of fiscal competition which can only benefit over time European firms and citizens at large.
  
• My last reason for optimism lies with the gradual awareness within political circles. This is illustrated in France by the statements to this effect of President Chirac and Prime Minister Jospin. At the Congress of European Socialist Parties in Milan, on March 2, British Prime Minister Tony Blair welcomed the emergence of a “third way” which reconciles “the culture of entrepreneurship” and a modernized European social model, a third way which “equips people for work by improving education and infrastructure, combines a tough approach to youth crime and far greater emphasis on the duties of parenthood, while enhancing family support to meet the needs of children and to help families, particularly the most vulnerable.” Thus, the prospects for such changes overcome political boundaries as well as the strict confines of Euroland. Furthermore, recent political developments in Germany don’t seem to contradict this desirable evolution.

To be sure, this is only the beginning of this new evolution. We all know the challenges before us: They boil down to nothing short of the modernization of our social protection systems in ways which reconcile greater individual responsibility with better coverage for those most in need of collective solidarity, and at a lower cost. What is at stake is the restructuring of our public sector, and its heightened responsiveness thanks to privatization and the use of the technologies of information; the lifting of obstacles which hamper the fluidity of the labor force; and a true competition, already largely into place, among major infrastructure network operators. All these changes will have to take into account the values of our European social model which are crucial to its cohesion. As Peter Sutherland has underlined rightly, they will not simply duplicate the American Way. But they are unavoidable. It was already so before the birth of the Euro; it is even more so today.

It is all the more so since the European economy now tends to slow down, and inflation to disappear. Price increases in Euroland have declined to 0.8 percent per year as of December 1998. Europe might require sooner or later a more accommodating monetary policy. But the best environment to allow for such a move requires precisely such an acceleration of structural reforms.

True, the public declarations of some of today’s Euroland leaders do not seem quite to point in this direction. But minds often change faster than some dare imagine. Let us recall the dramatic turnaround we have witnessed in the past, when reality became inescapable.

The Euro is now well on track. Almost everybody in Europe is convinced, rightly so, that there will be no going back. Under these circumstances, the sooner the structural reforms are implemented, the more quickly Euroland will reap the fruits of an economic and social upswing fostering growth and employment. Europe has been over the last years a land of opportunities for investments coming from abroad and this movement has been profitable for all of us. I am sure that these reforms will give further opportunities for investment in Europe.

Let us hope that our “trialogue” will contribute to the ripening of these ideas in Europe—for our own good, and also for that of our Trilateral partners.