The Politics of European Economic Policy- Making

1. The Politics of European Economic Policy- Making Francesco Stolfi Seminar 5 April 16, 2010

2. The Politics of Creating the EMU • Weak economic rationale • The ironic influence of the US • The international impact of US neglect/pressure • The liberal model of international politics • The two-level game • Germany • France • UK • Italy • Other considerations • Winners and losers

3. Weak economic rationale • Costs, if: • Labor market is not flexible • Uncoordinated economies (asymmetric shocks) • Benefits: • Increase in trade • Increase in price transparency • Reduction in transaction costs • Having an international currency (main benefit for financial/banking sector) • Increase in financial stability • Reducing the risk of exchange rate bubbles • Borrowing low inflation credibility (only for high inflation countries, and it is risky)

4. The ironic influence of the US The international impact of US neglect/pressure Examples: US adopts an expansionary fiscal policy: • US interest rates tend to rise • Capital flows out from Europe • The exchange rates of European currencies devalue • Unwanted expansion (inflation) in Europe (two channels)

5. This is magnified by the fact that the US impact on European countries is diversified • Example: Expansionary US monetary policy • Capital flows out of the US, and flows not to Europe in general, but specifically to Germany, leading to the appreciation of the DM and the disruption of trade flows in Europe

6. US-Europe Relations • Late 1950s: US trade deficit; the US tells Germany: “if you don’t want us to devalue, contribute to the bill for the stationing of US troops in Germany” → Europeans start to talk about monetary integration • Late 1960s: The US embarks on an inflationary policy (in the context of the Vietnam war), passing it on to Europe → Europe produces the first plan for monetary integration (Werner Report, which included many of the feature of the future EMU)

7. 1977: The US says to Germany: either you increase your economic growth or we devalue the dollar → 1978: The EMS is created • Early 1980s: the US under Reagan embarks on a combination of expansionary fiscal policy and tight monetary policy, sending US interest rates sky high; Germany is forced to have the “highest interest rates since the birth of Christ” in order to defend the DM; the French Franc devalues, further increasing inflationary pressures in France → European countries decide to tighten cooperation in the EMS • 1987: New US pressures (dollar devaluation and revaluation of DM) → 1988: European states begin to work towards the EMU

8. The liberal model of international politics (Andrew Moravcsik) Domestic interest 1 Domestic interest 2 Domestic interest 3 Government B Bargaining Government A Domestic interest 1 Domestic interest 2 Domestic interest 3

9. The two-level game Table I (international) Executive Table II (domestic)

10. Reasons why the executive might be strong at Table II: institutional, unclear implications of international negotiations, bad status quo for domestic actors, domestic actors that are allied with the executive → big winset • Strong executive at Table II (big winset) → weak executive at Table I (weak bargaining hand) → outcome of negotiations will probably favour the other countries • Weak executive at Table II (small winset) → strong executive at Table I (strong bargaining hand) → outcome of negotiations will probably favour the country • weak executive at Table I (weak bargaining hand) → outcome of negotiations will probably favour the other countries → strong executive at Table II

11. Germany • Banks in favour if EMU to expand their markets • Business interests: in favour (but less than in other European countries) in order to avoid the risk of appreciation of the Mark (ie devaluation of the other currencies). In the late 1980s both France and Italy had threatened Germany that they would leave the EMS if Germany would not to take their interests in greater consideration or they would stop the process of capital liberalization. • Unions: in favour in order to loosen the tight policy of the Bundebank • Chancellors: in favour for the same reason as the unions • Bundesbank and the public: against (small winset)

12. France • French inflation had been converging towards the German one in the 1980s • The French said: now we do not have a vote in the Bundesbank. At least in the ECB we will have a vote

13. UK • British industry was against immediate entry because British inflation was very high (10%) • British financial sector was against EMU root and branch, because it saw it as an aid to its continental competitors (Paris and Frankfurt)

14. Italy • A limited group of negotiators from the central bank and the Treasury used the EMU to impose an external constraint on Italy in order to force it to shape up (in particular to reduce inflation) • Strengthening the executive based on a two-level game (large winset from the domestic table) • Tightrope: Italian negotiators on the one hand wanted the EMU to impose constraints, on the other hand they needed to make sure that these constraints were not too tight as to prevent Italy from joining in the first place

15. Outcome of negotiations • It reflected the different bargaining power of the countries: Germany essentially won on the whole front, from the exclusive focus on inflation, to the very high independence of the ECB, to even the location of the ECB (Frankfurt instead of Paris) and the name of the currency (Euro instead of Ecu)

16. Side payments • Quid pro quo between EMU and German integration. It was probably used by France and Kohl to put pressure on the Bundesbank and other German opponents of EMU • Germany accepted the British opt-out in exchange for British backing of German recognition of Croatia • Increased transfers to Ireland, Greece, Spain, Portugal

17. Britain’s poor play • In Britain, Thatcher was virulently against European integration, to the point of preferring exclusion from the EMU than participation in it. • It allowed itself to be sidelined in negotiations and in the drafting of the technical blueprint

18. Winners and losers • Winners • Banks • Employers • Losers • Some producers • Labor