EMU - the key to the crucial German question

ECONOMIC VIEW

In spite of the sceptics, EMU is sailing on. The Verona meeting of the European Union finance ministers, on 13 April, made more progress, filling in the remaining details of the single currency project. In the face of opposition from Sweden, Finland and the UK, the Ecofin Council decided that the new ERM will stabilise exchange rates in Europe until all national currencies will have ceased to exist. To accommodate national pride, it was also decided that the new currency, the euro, will bear on one side a national effigy - Christopher Columbus, Leonardo Da Vinci, Marie Curie or the Queen - while a European symbol will appear on the back. This is going a long way from just a few months ago, when the sceptics were denying that the EU would be able to agree on a name for the new currency.

Why are the sceptics constantly wrong? Some are wrong because they fail to understand that the project has much more to do with politics than with economics. Others recognise that politics is what is driving EMU, but they fail to understand the important political issues on the Continent.

The "economists" keep repeating that the Maastricht criteria - the conditions for being admitted to the single-currency club - make no economic sense, and that the treaty must be rewritten from scratch. Of course the criteria make no economic sense! But macro-economics can do very little to help you understand the treaty, as argued in a recent report from the Centre for Economic Policy Research, Flexible Integration: Towards a More Effective and Democratic Europe*. The four criteria (on inflation, the budget deficit, interest rates and exchange rates) were the outcome of a difficult political bargain, and they have little to do with economics. They represent the conditions Germany asked for when agreeing to give up the two symbols of post-war economic stability - the mark and the Bundesbank.

The German question is at the centre of the political concerns on the Continent. At the end of the Second World War, when Germans were occupied in reconstructing, along with their economy, new democratic institutions, the big question for Western Europe was how to make sure that this country would not, once more, be attracted by big-power policies that would prevent it being a good citizen in Europe and might cause it to drift away again from democracy. This is no longer the concern today. The more concrete risk, after the fall of the Berlin Wall and the reunification of Germany, is that Europe, right at the time when it is making the crucial steps towards its political and economic integration, will be unable to attract Germany in this project, and will condemn itself to disintegration.

Europe today - after the return to democracy of the countries east of the Elbe river - reminds one of what happened three centuries ago, at the end of the Thirty Years' War and, more recently, after the First World War. The Peace of Westphalia, in 1648, and the Treaty of Versailles, in 1919, both left a large power vacuum along the borders of the strongest states. France with Louis XIV, and Germany with Adolf Hitler used these occasions to expand their influence towards the east. These historical experiences can help in understanding the problems Europe faces today.

If the project of unifying Europe is derailed - and today the fate of this project is intimately linked with that of the single currency - in the scenario that would emerge if Europe failed to attract Germany, then Germany would rapidly and inevitably emerge as the natural attractor, both politically and economically, for a vast grouping of countries which today are already closely linked with Germany, including not only Austria and the Benelux stales, but also Poland, Hungary, Croatia, Slovenia and the Czech Republic. Before the Second World War the countries of central and eastern Europe had close economic links with Germany: in 1938, 30 per cent of total Hungarian imports came from Germany, 28 per cent of Romanian imports, 56 per cent of Bulgarian imports and almost 30 per cent of imports of Poland. These economic links vanished after the war but are rapidly being rebuilt. Language links - many in these countries still speak German - and the urgent need for capital goods, the speciality of German industry, have helped in rebuilding these economic links surprisingly quickly.

Compared with such an aggregation of states, likely to exert an influence that would extend beyond Europe, even France would find it hard to compete - politically and economically. Countries such as Spain and Italy would find themselves isolated, excluded from all big decisions concerning the future of the Continent, confined to the role of suppliers of low-tech parts for German industry, and to that of attractive vacation sites for rich central Europeans. In Italy the prospect of German hegemony in Europe would further exacerbate the differences between the regions in the North- east - which would integrate further in a "Europa" in which they would, however, have no political representation - and those in the Mezzogiorno. The same is likely to happen in the Catalan region relative to the rest of Spain.

This explains why France so stubbornly pursues the single-currency project, whatever the price in terms of unemployment and low growth. But Germany too is concerned by the prospect of drifting away from the countries that have been the traditional core of Europe. The battle that Chancellor Helmut Kohl is staging against the Bundesbank and those - probably a majority - among his fellow citizens who oppose giving up the mark, is inspired by a vision of Europe in which Germany is strong, probably the strongest country, but whose power is diffused in a wider political and economic community.

In one respect the sceptics are right. EMU is not simply an economic project; it is the Trojan horse for further political integration of Europe - and one must concede that Chancellor Kohl keeps repeating that a single currency and a single central bank will not survive in the absence of stronger European political institutions. But such are the choices we confront at the end of this century. Either we accept the German offer to participate in the design, construction and administration of new political institutions for Europe - an offer that comes at some cost, especially in the short run, politically, for countries such as the UK where opposition to the single currency is still very strong, and economically, for countries such as Italy that are still far from satisfying the Maastricht criteria. Otherwise we must prepare to live in a Continent that, in any case, will dance to the tune of Germany, but where other countries will find their views much more difficult to be heard.

Francesco Giavazzi is Professor of Economics at Bocconi University in Milan and a co-director of the International Macroeconomics Programme at the Centre for Economic Policy Research, which takes no institutional policy positions.

* "Flexible Integration: Towards a More Effective and Democratic Europe", published by CEPR, 25-28 Old Burlington Street, London WlX 1LB Tel 0171- 878 2900