European integration - achievements and challenges - Otmar Issing
Central bank: ecb | Type: speech | Date: 2005-06-16

European integration – achievements and challenges

Speech by Otmar Issing, Member of the Executive Board of the ECBat the Workshop on “What effects is EMU having on the euro area and its member countries”, 16 June 2005 I wish to thank you all – as presenters, discussants, participants and organisers – for your valuable contributions to the analysis and discussion of a difficult topic: the effects that European Economic and Monetary Union (EMU) – and the euro in particular – is having on the euro area and its member countries.

For the ECB, understanding these effects is extremely important and over the past years, we have paid a lot of attention to this topic.

In fact, this workshop follows on from a series of previous exercises we have undertaken over recent years, such as the Workshop on Monetary Policy Implications of Heterogeneity in a Currency Area of last year.

You are all familiar with the terms of the debate – to what extent EMU is contributing to the functioning of the single market.

In fact, experience is showing that many of the conditions for a well-functioning currency area have emerged as a result of the monetary integration process itself.

Tonight, however, I would like to set the workshop in a broader context and reflect on the relationship between political, economic and monetary integration in Europe.

This has been called the “triangle” between the state (or States!), the market and the currency.

I am aware that this is not an easy subject for a dinner speech, especially during these difficult times with the recent rejection of the Constitution in France and the Netherlands.

However, it is in difficult times that we have to address the fundamentals and that is what I intend to do tonight.

I will start with a confession.

I always felt uneasy talking about “European integration” when this project included only a small part of continental Europe.

At the beginning, there were six founding countries that established a customs union and a common market.

Later, more and more countries joined in several waves of enlargement.

At the same time, more elements and functions were shared at the level of the European Union.

Hence, over time, joining the terms “European” and “integration” became more meaningful!

Economic integration took the lead

In September 1946, Winston Churchill, in his memorable Zurich speech, called for the re-creation of the “European family”.

This included the setting-up of a structure permitting Europe to live in peace, safety and freedom.

Although political integration proved to be over-ambitious, some visionary political leaders decided, nevertheless, to pursue the path of economic integration.

This led to the founding of the European Coal and Steel Community in 1952 and the establishment of the European Economic Community with the Treaty of Rome in 1957.

The first step was a customs union among the six founding countries.

At the time, probably nobody could have guessed that economic integration would advance through various phases and over such a long period of time.

But the Single European Act followed in 1986 and the “Single Market Programme” in 1992.

In short, the Single Market is now becoming a reality and we can say that the economic side of the “triangle” has indeed progressed enormously.

Work on the remaining imperfections of the Single Market is also advancing.

We must not forget that this process has required many decades and continuous political support.

Why, in the last 50 years, did economic integration face fewer obstacles and actually keep in motion the process of European integration?

The main reason is that, from the outset, economic integration removed barriers and thereby secured material and economic benefits.

In fact, it has brought widespread benefits by promoting reciprocal trade.

And as we heard from Richard Baldwin in Session I this afternoon, trade has grown by several multiples.

Economic integration has also helped to establish a more competitive environment.

We must also not forget that economic integration has rendered all EU countries more interdependent than in the past.

Under these circumstances, spillovers from national policies could be significant.

Each country has a stake in the well-being and, let me say, “good behaviour” of its partners.

Given such circumstances, the conviction underlying the Maastricht Treaty was that nominal exchange rates should be irrevocably fixed to achieve and maintain a truly unified single European market.

Without a single currency, it was felt that the achievements and deepening of the Single Market could be endangered.

At the same time, the move to Monetary Union was not only “defensive” but also, at least implicitly, “expansionary”.

Monetary Union then followed

Monetary Union in Europe was launched in January 1999.

The single currency eliminates, once and for all, internal nominal exchange rate fluctuations.

It also secures and reinforces the continuation of economic integration.

The creation of a single currency for now more than 300 million people has increased the efficiency of currency use in a manner unprecedented in Europe.

Monetary Union also has a clear political dimension.

It entails the transfer of national monetary policy decision-making powers to a supranational entity, the European Central Bank.

Relinquishing national sovereignty in such an important field is a contribution to political integration – a central bank is, after all, an element of statehood.

This step was only possible because EMU members had achieved a high degree of convergence in monetary policy attitudes and preferences.

Moreover, the launch of the euro marked a deep change in the way participating countries see themselves.

Thus, the monetary side of the “triangle” has also been completed.

It was a political decision to launch European Economic and Monetary Union among a group of countries which did not form a fully-fledged political union.

Taking stock, we may ask: was this move appropriate and well founded from an economic standpoint?

In the 1960s, a group of researchers – following the pioneering contributions of Mundell, Kenen and McKinnon (all of whom we have the honour of hosting here) – started posing a crucial question: from a purely economic point of view, what is the optimal area for a single currency?

The Optimum Currency Area (OCA) theory that ensued is well-known to you all and I don’t have to say much about it.

It is not easy to summarise the many views on the euro area as an OCA, or to sum up the vast volume of empirical studies of all OCA criteria for European countries.

The euro area may not yet be an optimum currency area in all respects to the extent that, for example, the United States is.

On the other hand, it scores quite highly under several OCA criteria – such as economic openness, diversification in production and consumption, degree of price stability, and several elements of financial integration.

In the areas where it scores less well – such as price and wage flexibility, and some facets of financial integration – remedies are being sought.

We can expect contributions on these issues in all the sessions of the workshop.

How could EMU affect the optimality of the euro currency area over time?

Andrew Rose and Jeffrey Frankel (who also contributed to this conference) offered an important new forward-looking perspective strengthening the OCA argument in the euro area.

By studying the effects of several currency unions that occurred in the past, they showed that monetary integration leads to a significant deepening of reciprocal trade.

The implication for EMU is that the euro area may turn into an optimum currency area after the launch of monetary integration, even if it was not an OCA before.

In other words, to quote Rose and Frankel: “countries which join EMU, no matter what their motivation may be, may satisfy OCA properties ex-post even if they do not ex-ante!” This has been termed the “endogeneity of optimum currency area” effect.

Several authors have brought forward concepts similar to the above hypothesis of the “endogeneity of OCA”, but in areas other than trade.

Artis and Zhang have discussed the endogeneity of symmetry of shocks.

Blanchard and Wolfers, and Saint Paul and Bentolila, have discussed the endogeneity of labour market institutions.

Kalemli-Ozcan, Sørensen and Yosha discuss the effects of sharing a single currency on financial markets and insurance schemes.

Therefore, there may be diverse sources of “endogeneities of OCA.”

Such endogeneities can be seen as a set of processes triggered by the start of a monetary union.

Hence, monetary union may help to set in motion forces bringing countries closer together, forces that were not present (or strong enough) before.

To be fair, various other issues may arise in the years ahead that could render the verdict more complex.

Some authors, such as Krugman in his “Lessons from Massachusetts”, postulate a “concentration” hypothesis: the euro, together with stronger trade and financial ties, will result in greater specialisation of euro area countries.

This may gradually intensify inter-industry trade, and cause each country to become more sensitive to industry-specific shocks.

In turn, more idiosyncratic business cycles would result.

Hence, if the forces of concentration prevail, euro area countries may witness more pronounced growth, employment and inflation differentials than in the past.

This could be a concern in view of the generally limited price and wage flexibility, low labour mobility and the lack of a risk-sharing mechanism due to the still incipient financial integration.

Time will judge the severity of this potential effect.

European political integration

I now turn to the third side of the original triangle: political integration.

With EMU, the Maastricht Treaty has created a unique, asymmetry in history.

On one hand, there is a supranational European monetary order, but on the other hand, there are predominantly national sovereignties in other policy areas.

Given my previous reflections, I would like to distinguish between two complementary aspects of political integration, namely:

the political will that has been at the base of the process of European integration; and

the institutional side of political integration that consists of the political arrangements, laws and rules regulating economic policies.

I shall now pose two questions and try not to give real answers but share with you some reflections:

a) Given that we now have an economic and monetary union but do not yet have a definitive form of political union, can Monetary Union continue to thrive?

My answer is a resounding and clear YES.

EMU can proceed for the time being without a fully-fledged political union.

For my contribution to the International Research Forum, which we organised a few weeks ago, I chose the title: “One size fits all!” However, for “one size to fit all” and the lasting success of the single monetary policy to be guaranteed, we need a steady political support from all member countries.

This will is necessary not least in order to further raise the OCA rating of euro area countries.

At present we see tensions concerning the impact of the single monetary policy on countries in economic and political terms.

The ECB’s stability-oriented approach is perceived by some as a “straitjacket.” The fiscal framework – i.e. the Stability and Growth Pact – is being heavily tested in several countries, including Italy, France and Germany.

This is only partly surprising: a critical situation had to be expected sooner or later.

In my view, several countries did not fully understand what signing the Maastricht Treaty and joining EMU would imply in many areas – from fiscal policy to product and labour markets, and price and wage-setting.

A relatively low score for some OCA criteria – such as price and wage flexibility and labour mobility – must not be a “given”.

Instead, it can and must be corrected.

It is now high time for national governments that have not done so convincingly to undertake the urgently needed structural reforms.

These reforms are fundamental to enhance price and wage flexibility and adaptability, as well as to foster innovation.

Hence, EMU needs to catalyse reforms.

We will hear tomorrow in Session 4 the extent to which this may or may not happen, and the reasons why we need to understand to what extent monetary union can be a “catalyst” for reforms.

The Lisbon agenda must be actively pursued; this agenda is important by itself, but also with regard to improving conditions for a single monetary policy.

b) To what extent can EMU be supported by the current stage of political integration?

My answer is: substantially.

Euro area countries have already transferred diverse areas of national sovereignty to the supranational level.

This includes sovereignty over monetary and exchange rate policies, as I have already mentioned, but also the framework for microeconomic policies in the areas of the Single Market, competition and trade policies.

Hence, the euro area (and the other EU) countries already share important elements of state formation.

Despite the recent rejection of the new Constitutional Treaty in France and the Netherlands, political integration is bound to deepen over time: it must because of the interdependencies that I referred to previously.

Let us not forget that EMU is not the only vehicle driving change.

In all countries, some of the main traditional functions of the state are steadily changing under diverse pressures.

The pressure of globalisation, the growing role of knowledge and innovation, and the deepening of economic and financial interdependence are now affecting economic sovereignty and security, as well as national identity and culture.

This has led to tensions and adjustment processes: that is why we now have the current “crisis”.

Some final reflections

Coming to the end of my reflections, I shall return to the beginning.

European integration started with a small group of countries and, for several years, it was nurtured as a “western European project” that achieved a high degree of economic integration, a functioning monetary union and several elements of political integration.

On the final stage of the integration process, the steady state of political union in Europe, one could only speculate.

For me, none of the examples of history, be they a federation of states or a union of nations, can serve as a blueprint for shaping political union.

The EU has always been, and will remain for quite some time, a unique undertaking for which no models exist that can easily be adopted.

Something new will emerge – and it is important to allow a process which is open for further steps forward while at the same time safeguarding what is already in place and working properly.

The fall of the iron curtain cleared the way for the major enlargement that took place last year.

Now European integration encompasses a large part of Europe.

Where does this leave the ECB and the Eurosystem?

We are very eager to hear your views on what effects EMU is having on the euro area and its member countries.

If Europe is to seize the opportunities that Monetary Union presents, it must use EMU as a catalyst for necessary reforms.

The lasting success of EMU and the chance to reap its benefits now depend primarily on the ability of each country to undertake its own reforms.

At the same time, the single monetary policy would, of course, be facilitated by greater homogeneity and greater flexibility.

If we think in terms of European history, the fact that we have come this far is an incredible achievement.

We should never forget that European integration has been driven by the political will to overcome centuries of hostility and war.

Moreover, we have had difficult times and crises before.

And we have always found ways to overcome them.

If the past is our guide to what the future will bring, we should remain confident that we will also find answers to our current problems.

Germany is currently celebrating “Schiller Year”.

In his inaugural lecture at the University of Jena in 1789, Schiller stated:

“Die europäische Staatengemeinschaft scheint in eine große Familie verwandelt.

Die Hausgenossen können einander anfeinden, aber hoffentlich nicht mehr zerfleischen.” [1]

“The European community of states seems to have turned into a big family.

Although hostile attitudes may prevail among the fellow tenants, they shall, hopefully, no longer tear each other apart.”

Schiller was unfortunately wrong as far as the subsequent centuries were concerned.

But it is now time to make sure that Schiller is right in this century and beyond.

[1] Source: “Was heißt und zu welchem Ende studiert man Universalgeschichte?” Antrittsrede Universität Jena 1789.

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