The History and Evolution of the EMU and its Impact on Globalization

Abstract

Throughout the last century European officials have been attempting to duplicate the economic prosperity found in the United States, which has been attributed to America’s successful monetary union. From the end of World War II till today economic unification has been steadily advancing, from limited trade partnerships to the current Economic and Monetary Union (EMU) of the European Union, with its crowning achievement: the currency union, known as the euro area. While the EMU is a powerful economic force, the inherent imbalances in fiscal policies at the national level had been exposed during the recent euro crisis, leading to the conclusion that the union needs to either take more steps toward centralizing economic policy; or begin to disintegrate the union, in whole or in part. A review of the existing literature will show that the preferable solution is radically less integration, including the possible disintegration of the entire euro area and a return to national currencies.

The Economic and Monetary Union (EMU) of the European Union is the largest such union in the world. It encompasses all 28 member states of the European Union regardless of whether they have adopted the euro as currency. The EMU is the end product of a century of modest steps toward unification of the EU economies, whose sheer numbers are impressive with more than 500 million people and a combined GDP larger than that of any nation on earth. The EMU and its single currency area are undoubtedly major advancements in globalization, but the heightened prosperity comes at a price. The amalgamation of so many disparate economies threatens to dissolve long-standing democratic institutions and perhaps the very concept of the nation-state itself.

WHAT IS E.M.U.?

EMU is the economic pact that all member states of the EU must abide by. Even the nine EU countries that continue to use their own national currency and are therefore not part of the Eurozone (officially known as the euro area) are fully part of the EMU, which is defined by three primary elements. The first is customs union—an international tariff-free zone with a common external tariff—and single market, meaning virtually all restrictions on internal trade have been removed. These two arrangements can be realized without political realignment, but the third and most important plank of the EMU (while still optional for EU countries) is monetary union—the sharing of an international currency—and this cannot be sustained without radical changes to existing political systems.

Noticeably absent in the EMU and the euro area is a centralized fiscal policy or common treasury (Selvaraj 2015, p. 20), both of which are needed to prevent imbalances in the common currency. Without those two critical institutions the monetary union could disintegrate or degenerate into a permanent vehicle for transferring wealth from the stable economies to the ones that need relief. If the EU goes ahead with its plans to create its own Eurozone treasury—which would invariably lead to a centralized fiscal policy—that could mean the end of nearly 400 years of traditional Westphalian nationhood in Europe. Legitimate concerns over the loss of national sovereignty have made the institutionalization of the euro—a single currency regulated by a single central bank—the most controversial aspect of EMU. The intricacies of the monetary union will therefore be the primary focus of this report.

MONETARY UNIONS PRIOR TO THE E.M.U.

The modern concept of economic integration could be said to have begun with the former British colonies in America, whose history of assimilation is remarkably similar to that of the EU and will be explored in detail later. There have been several other attempts at monetary union in one form or another in the last two centuries but none was of comparable size or scope to the US or the EMU. Beginning in the 1870s, the Scandinavian countries experimented with a mutual exchange rate tied to gold but the agreement was merely intended to be a pact between neighbors and not an expansionary scheme like the EMU (Tache 2013, p. 167). The ill-fated Hapsburg Empire produced a relatively successful currency union from 1878 through World War I but disintegrated after the resurgence of national currencies in the 1920s (Gross & Gummer 2014, p. 252). The most intriguing case study for the EMU has to be the Latin Monetary Union, an organic arrangement formed in 1865 between France, Belgium, Italy, and Switzerland (Tache 2013, p. 166). Prophetically, the LMU was put in jeopardy after Greece—a fiscally toxic nation even back then—joined in 1867 over objections that this would pollute the other economies in the union. Despite this, the strongest LMU nation, France, got wide-eyed about what it perceived to be an opportunity to increase its currency area and therefore its wealth (Tache 2013, p. 166). The LMU eventually comprised eighteen nations but had neither a central bank nor a single currency, so it eventually succumbed to the inflationary pressures caused by currency devaluation and the massive expenditures of World War I (Tache 2013, pp. 166-167). Interestingly, fear of hyperinflation was a reason for starting, not ending, the somewhat successful Benelux Union, which actually predated and overlapped some of the primitive predecessors of the EMU.     

EARLY ATTEMPTS AT UNIFYING EUROPE

The idea of integrating the continent had been around for ages, but it took the devastation of two World Wars and everything that accompanied them for European leaders to talk seriously about exploring the possibility of unification (Marshall 2012, p. 16). Preliminary plans for economic union had broad appeal. In 1945, Churchill reportedly encouraged the nations of Europe to emulate the American example of unification to promote, among other virtues, “economic cooperation” (Mauter 1998, p. 67). Significant figures in the government of the United States, motivated by a desire to prevent war and thus avoid future costly interventions in Europe, shared the same federalist vision (Gavin 2010, p. 35). In 1948 European luminaries of every stripe attended the Congress of Europe and produced a proposal for a unified continent with its own parliament (Marshall 2012, p. 16). In 1950 French premier René Pleven’s proposal for military union ultimately went nowhere, but in that same year his foreign minister Robert Schuman proposed the creation of the seminal European Coal and Steel Community (ECSC), which became the first step on the road to the modern EMU.

THE ROAD TO E.M.U.

The ECSC began in 1952 with only France, Belgium, Italy, West Germany, Luxembourg, and the Netherlands, but the idea of further economic integration was already gaining steam. In 1957 the same six countries signed the Treaty of Rome that established the European Economic Community (EEC), which later became the European Union.

The unofficially connected monetary system of the EEC enjoyed relative stability until the world’s currency markets became unhinged in the late 1960s. In 1970, the Werner Report was the first expression of the nations of Europe to establish an official monetary union (Fichtner & König 2015, p. 376). The Werner Report outlined three stages in the ten-year plan to realize EMU by the year 1980. Unfortunately, the gold standard—which is itself a type of monetary union (Tache 2013, p. 162)—was thrown out in 1971 and this unleashed a global pandemic of currency destabilization which, combined with the energy shocks of the 1970s, made the idea of monetary union less attractive (Fichtner & König 2015, p. 377).

The next decade nevertheless saw major advancements toward European economic unification. In 1979 the European Monetary System (EMS) was created to keep exchange rate volatility within certain limits (Fichtner & König 2015, p. 377). By 1986, the single market had been established (Fichtner & König 2015, p. 377). In 1988, European central bankers and European Commission President Jacques Delors finalized yet another three-stage plan for economic and monetary union known as the Delors Report (Fichtner & König 2015, p. 376).

 Not everyone was enthusiastic about the idea, however. An ideologically eclectic assemblage of skeptics—led by some prominent politicians and economists such as Margaret Thatcher and Milton Friedman, as well as various media outlets and think tanks in Europe and America—openly doubted the survivability of European monetary union (Perpelea, M., Duţă & Perpelea, O. 2013, p. 139).

THE BEGINNINGS OF E.M.U. AND PREPARATIONS FOR THE EURO

The EMS was retired in 1991 by the Treaty of Maastricht which formally established the EMU. This new economic structure for the EU was to be supervised by a menagerie of the EU member state governments, a handful of EU bureaucracies, and the European Parliament. In keeping with the evolutionary trend, the process was to be accomplished through the stages specified in the Delors Report (Schwartz 1996, p. 30).

The first stage (1991-1994) involved completing the single market through the removal of internal barriers to the flow of capital. The second stage (1994-1999) set up the European Central Bank (ECB) and the European System of Central Banks (ESCB) to co-ordinate central banking at the national level (Schwartz 1996, p. 30). Note that all EU members’ national central banks are part of the ESCB, but only the ones from euro area nations comprise—in conjunction with the ECB—the Eurosystem that is tasked with regulating the euro.

The ECB has a notably high degree of independence. An elite Governing Council of the ECB, composed of high officials from the Eurosystem, has control over monetary policy for the entire euro area. The edicts from the Governing Council are expected to filter down to the non-euro countries through the ESCB. The third and final stage (1999 and after) sought to fix exchange rates and begin the era of the euro. Additionally, an informal body known as the Eurogroup, composed of administrators from the euro area member states, holds regular meetings to discuss and co-ordinate policies affecting the euro.

            Maastricht also spelled out the convergence criteria for countries that want to enter the monetary union: a deficit-to-GDP ratio of no more than 3% and a debt-to-GDP ratio of no more than 60%, along with fairly stable rates of exchange, interest, and inflation (Schwartz 1996, p. 30). In 1997 the Stability and Growth Pact intended to enforce good fiscal behavior in potential euro area member nations, as well as create new exchange-rate guidelines for those in the second stage (ERM II) of the transition process to the euro.

Eleven countries comprised the euro area at the start (said to have reached the third and final stage of EMU) and seven more were added from 2001-2015, beginning with Greece. The fateful decision to let Greece into the euro area would have profound repercussions for the monetary union.  

THE CURRENT E.M.U. AND THE EUROZONE

While there is no way to determine if the EMU is anything more than the sum of its parts, it is collectively a global powerhouse. The EMU has been a success at facilitating free trade within the member states and perhaps outside of them—a dynamic that not only increases prosperity but also decreases the likelihood of conflict (Alves 2011, p. 51). The EU nations have experienced a refreshing era of peace—at least in terms of major military actions between member nations—but just how much of this is because of EMU is uncertain.

In the early days of the euro area, the idea of pegging some African currencies to the euro was already being entertained, as was the notion of forming other monetary unions in Southeast Asia, Latin America, or North America (Mundell 2000, p. 225). Even the idea of a global monetary union had a degree of support (Mundell 2000, pp. 255-256),  but a worldwide single currency is not feasible. There would be no benchmarks to compare it with, so it could never be corrected except by inflating it or manipulating it monetarily (Mundell 2000, p. 231). Nevertheless, the plausibility of other potential projects in monetary union, and globalization in general, would hinge on the performance of the European monetary union.           

THE PROBLEMS OF GLOBALIZATION

Problems with the EMU were apparent—or should have been—from the very beginning. The conventional economic mentality that guided the EMU’s key institutions, namely, the European Commission and the ECB, rendered them inadequate to govern such an unconventional project so the system was destined to grow out of control (Flassbeck & Spiecker 2011, p. 180). There is evidence to support the claim that the architects of the EMU were willing to accept economic crises and social strife as part of their experiment because they believed these maladies could make further unification appear desirable (Fichtner & König 2015, p. 376). On the contrary, some of the euro area governments have taken advantage of the deficiencies of the euro to advance their own selfish ambitions at the expense of the other member states, while the impotent EU institutions find themselves unable to do anything meaningful about the lack of co-operation (Orphaides 2014, p. 262).

            The hope was that the monetary union would serve as a vehicle to transmit salubrious economic practices throughout all of its member states, but instead it became a way for the less responsible economies to free-ride on their more circumspect neighbors (Alves 2011, p. 48). Because of its institutional structure, the euro area can serve as an enabler for the member states obsessed with the counterproductive economic habits of profligate spending and heavy regulation, because there is an expectation that the debt incurred as a consequence of these policies will be shifted to the rest of the monetary union (Alves 2011, p. 50). Not only are the bad fiscal policies of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries offset by the protections afforded by the single currency, they are actually incentivized (Alves 2011, p. 47). It did not take long for a severe debt crisis to develop.

THE EUROZONE CRISIS

The worldwide panic of 2008 set off a chain of events that ultimately exposed serious underlying structural problems in the monetary union. The root cause of the Eurozone crisis was actually not the currency, but numerous other issues stemming from a pervasive lack of growth and unwieldy public debt (Weber 2015, p. 247), much of which is a direct result of the excessive social welfare spending throughout the EU (Lemieux 2013, p. 227). The currency union comprises strong economies that implement pro-growth measures such as Germany as well as sluggish Southern European economies whose populations nonetheless continue to receive increased nominal wages (Flassbeck & Spiecker 2011, p. 182). There had long been evidence that Greece acted unscrupulously by not disclosing its shaky financial situation in the early 2000s in order to meet the convergence criteria necessary for entrance into the monetary union, but after the crisis it was revealed that Greece also concealed its budget deficit during the financial crisis (İmre 2011, p. 74).

The countries that had already been running huge deficits in a desperate attempt to keep their economies afloat finally sank during the crisis, causing all kinds of financial problems related to public debt that are still unresolved (Fichtner & König 2015, pp. 381-382). With the stronger EMU nations having to bail out the fiscally troubled members of the union such as Greece, Ireland, and Portugal, the inherent imbalances of the flimsy system could no longer be dismissed (İmre 2011, p. 74).

CONSEQUENCES OF THE CRISIS

Throughout the 25 years of its existence, EMU planners have over-relied on manipulating the common currency as a means to achieve further integration and accustom the populations to the inherent disruptions caused by monetarily combining unequally yoked economies (Fichtner & König 2015, p. 383). This has not only led to economic crises, but severe social and political upheaval as citizens rebel against the policies of a system that seems to be perpetually advancing away from the constraints of democracy (Fichtner & König 2015, p. 383). No country has exemplified this outrage more than Greece, whose people—having recently elected a government stridently opposed to the status quo—are strongly considering leaving the euro area (Fichtner & König 2015, p. 383). Conversely, the populations who are shouldering most of the load in the EMU are undoubtedly pressuring their officials toward re-thinking the whole idea of monetary union.

The conventional approach to the European crisis has been to think of it solely in economic terms, but at the core of the crisis is the issue of the viability of the European Union itself (Lehmann 2014, p. 33). The economic crisis has exacerbated a great deal of pre-existent animosity toward the EU that its leaders had been ignoring, but they must now acknowledge the opposition’s frustration and make the needed reforms or risk jeopardizing the plans they have for further integration (Lehmann 2014, p. 33). The currency union that was supposed to unite Europe has instead produced seismic rifts in the EU, and the flaws in the euro are threatening the future of the entire experiment in European unification (Orphaides 2014, p. 262).

POSSIBLE SOLUTIONS

The competitiveness gap between the stronger economies such as Germany that keep wages closer to the market level, and the weaker Southern European economies where wages have experienced artificial inflation, has led some to conclude that the only answer is the EU-wide regulation of wage policy (Flassbeck & Spiecker 2011, 180). To mitigate the consequences of a financial crisis that affects each country differently, one recommendation is to have a centralized insurance framework in place (İmre 2011, p. 74).

The official plan to correct some of the flaws in the EMU has already been outlined. The unending evolution of the EMU is apparently set to continue in at least two more stages. The first stage (2015-2017) consists of using the mechanisms currently in place to better co-ordinate national and system-wide economic policies; and the second stage (to be completed by 2025) is a more aggressive vision that includes the establishment of a single treasury for the euro area.

The creation of a single treasury would have profound implications for the monetary union. This would potentially place all decisions regarding the member nations’ fiscal policies in the hands of EU officials. The Eurozone crisis could lead to the EU taking complete control over economic policy, but unless changes are made to the existing order this could prove disastrous (Alves 2011, p. 51). The euro—and the entire EMU—could be put in serious jeopardy if a fully centralized supergovernment were ever given the power to use the common currency as a tool to reallocate wealth through currency manipulation (Alves 2011, p. 51).

THE FUTURE OF THE E.M.U.

The success or failure of the monetary union is dependent on whether the euro area is an optimal currency union—a collection of territories in which a single currency would maximize economic potential. While the European Commission still believes the Eurozone will eventually become an optimal currency area (İmre 2011, p. 74), this was a question that should have been answered before the monetary union was created. It should be noted that the decision to form the Economic and Monetary Union was entirely voluntary, and support for the idea came almost exclusively from the elites and not the people (Perpelea et al 2013, pp. 137-138). EMU is a solution in search of a problem, and now the biggest problem in Europe is the EMU itself.

The EMU is anomalous in the history of monetary unions because it has heretofore functioned without a binding political arrangement for fiscal decision-making; in nearly every other case, political union has preceded monetary union (Tache 2013, p. 166). The Latin Monetary Union exemplified how monetary unions among large, independent nation-states will fail sooner or later if they do not unify politically (Tache 2013, p. 167).

WHAT WOULD FURTHER INTEGRATION MEAN?

The comparison between the United States and the euro area deserves further evaluation, as both unions are economically alike despite obvious differences in organizational structure (Orphanides 2014, p. 244). The dramatic story of the United States is, at heart, an account of the vicissitudes and perturbations of a monetary union. It should not be assumed that the formation of the United States was inevitable, nor should anyone forget that unification was a long process, not a single event. There had been attempts to unify the colonies going back to Ben Franklin’s Albany Plan of Union in 1754. From the Articles of Association up till the present day, the union continues to evolve in ways that Europe should take note of because not all of the developments have been positive.

Europeans who believe that further integration can be accomplished without giving over national sovereignty to a continental government should know that present-day America is far removed from what the Founders intended to create. The United States was not a nation (and still is not); the United States were thirteen sovereign nations (Young 1977, p. 1572). The people considered themselves citizens of their respective states, as federalism was never intended to eviscerate state (national) sovereignty (Young 1977, p. 1575).

“A MORE PERFECT UNION”

Aside from a disastrous experiment with the Continental currency during the Revolutionary War, the road to the American version of monetary union began in earnest with the Articles of Confederation, which have been unfairly charged with setting up a failed form of union (Young 1977, p. 1975). The Articles gave Congress the power to borrow money, issue currency, and regulate foreign trade (Young 1977, p. 1574). The centralization of monetary policy was furthered by the Constitution, whose framework to create “a more perfect Union” included giving Congress exclusive authority to issue fiat money and regulate its value. It was not until after the Civil War, however, that the federal government took complete control over monetary policy (Tache 2013, p. 164).  Subsequent Progressive Era corruptions of the Constitution such as the Sixteenth and Seventeenth Amendments greatly tilted the balance of power away from the states toward what looks suspiciously like the type of national government the Founders feared would eventually eviscerate the federalist system. More than two centuries of sustained efforts to concentrate more power in the hands of federal officials rendered the state governments an afterthought, just as the procession of Treaties, from Rome to Maastricht to Lisbon, has groomed the heterogeneous peoples of Europe into forsaking their national pride and accepting complete consolidation.

It is not easy to ascertain precisely which stage in the development of the American monetary union most accurately reflects its European counterpart at this moment, or exactly which incarnation of the United States most closely resembles the ideal that the grand designers of the EU are trying to emulate, but the paths the two unions have taken thus far are strikingly similar and the result in both cases is a substantial loss of sovereignty.

THE UNITED STATES OF EUROPE?

Even during the heyday of federalism in the post-World War II years, it is still uncertain just how far Churchill and his peers wanted to go toward European unification, and the evidence suggests the great British leader would never have been in favor of unification if it came at the expense of political sovereignty (Mauter 1998, p. 83).

The idea of monetary union is inherently antithetical to state sovereignty. One of the reasons why the federal government of the US took control of the currency was to disempower rogue states after the Civil War (Tache 2013, p. 164). Coincidentally, one of the goals of the architects of the European monetary union was to prevent wars between the countries (Tache 2013, p. 164), but soon there may be no more countries. It is unlikely that the EU can continue on its current trajectory much longer without federalizing the Eurozone nations under a single government, which, as the American experiment has demonstrated, will eventually result in nationhood. This would obviously be a colossal disruption, as the Eurozone does not have the same natural conduciveness to nationhood that early America had. The former colonies had a population of perhaps 3 million, not 300 million-plus; were bound by a common language and culture, not dozens of these; and their borders were newly minted, not hundreds of years old. Even in those fortuitous circumstances, the greatest assemblage of statesmen the world has ever produced in its history could not reconcile fundamental differences between the states at the time of union, and many of these were economic in nature. There were northern states that had transitioned to a burgeoning form of capitalism and southern states whose economies were still heavily reliant on a system of plantation slavery that would later be called communism, but the Eurozone contains nations that have differences rivaling even these infamous quandaries. Americans from different states have a fraternal bond that makes union possible (Buccola 2014, p. 262), but it will take an extreme effort to get Greeks and Germans—to name just one example of an awkward pairing—to identify as countrymen. Perhaps the Europeans can resolve their economic discrepancies diplomatically, but the consequence for the United States was Civil War, and even that did not resolve all of the internecine disputes.

The most instructive American history lesson for modern Europeans is that homogenization has not solved the kinds of economic imbalances currently afflicting both the United States and the euro area. The debt crises in America and the EU are strikingly similar (Gokhale & Partin 2013, p. 193). Europeans should know that even in the United States, wages and consumer prices are not uniform either, and attempts to federalize wage floors and price ceilings would only further distort local markets. Europe would have an exceedingly difficult time trying to overcome fully federalized economic regulations because the Old World does not have the labor mobility found in the United States. Largely for economic reasons, Americans routinely migrate across state lines, to the tune of approximately 8 million people, or 3% of the population, annually (Perpelea et al 2013, p. 141).

BAIL OUT OR FORCE-OUT?

In the EMU, or any other type of economic union, there is always the inherent problem of risk externalization: The tacit understanding that at least some of the consequences of any one state’s irresponsible fiscal policy will be borne by the other member states (Buccola 2014, p. 262). If a bailout is given to the financially troubled state, this only heightens moral hazard and therefore the likelihood of future reckless spending for all the states in the economic union (Buccola 2014, p. 262). This economic law is more applicable now in the United States than ever before, even though the fiscal policies of the states have been placed in the hands of the federal government to a considerable extent. The largest state in the union—California—and some mid-size ones such as Illinois, Michigan, and New Jersey are riddled with overwhelming public debt to the point where they may never be able to meet their obligations (Buccola 2014, p. 237).

No state has ever been kicked out of the United States and, although some have infamously tried to escape, none successfully has. No EU country has left the euro area thus far, but since reliance on perpetual bailouts is unsustainable there are only two long-term options for the stronger Eurozone nations: either impose radical fiscal restraints on the troubled member states or force them out of the currency union. If neither of these reforms is made, the net givers—the states for whom monetary union is a losing proposition, such as Texas or Germany—may have no choice but to uncouple their economic locomotives from the dead weight they are pulling and leave the currency union. Since the remaining member states in that case would be net takers—the ones that receive more than they give—the result would be a monetary union with no money, which would of course disintegrate.      

THE FUTURE OF GLOBALIZATION

The monetary union in the United States has undoubtedly contributed to the unmatched prosperity of that great nation, but it is not the reason for the success. The font of American prosperity is capitalism, and if Europeans wish to emulate anything about the United States it should be this. The most well-designed economic union in the world will never make up for bad macroeconomic policy, and Americans—who had long taken their free-market blessings for granted—are beginning to learn this the hard way.

Monetary union is the economic application of the old adage that postulates there is safety in numbers. The smaller members in the union believe they can piggyback on the larger economies, and the giants view the smaller states as places where they can impose economic hegemony and advance their own national interests. History has shown that in the long run neither situation is tenable for all parties involved.

Disintegration is not something to be feared. EU member states can rediscover their sovereignty while still having beneficial economic partnerships and retaining many of the advantages they have now. Switzerland and Norway, for example, are not even EU members but are part of its more intelligently designed trade agreements such as the single market.

The future lies not in further globalization but in separation. This will take place either voluntarily or as the result of a monstrous crisis that de-integration might have prevented. The benefits of monetary union in terms of increased efficiency are simply not worth a suicide pact. In both America and Europe, centralized policymaking has led to central planning on a level that Westerners should be uncomfortable with. For these nations, some of which once ranked among the greatest the world had ever known, the solutions will come not from Washington or Brussels, but from within.

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