Europe’s Earthquake

Geologists have demonstrated that an earthquake is the end-product of many minor episodes of seismic slippage along a fault line; each smaller event increases the tension until finally the whole shebang erupts.

History proceeds forward in a similar seismic fashion, and recent events in Europe bear this out. In fact, September 2012 may one day be recognized as the breakthrough month in which the foundation of Europe’s future was laid. After being stuck for more than two years, Europe’s political leaders finally dropped their indecisiveness and took greater strides toward further economic and political union. The “f-word” — federalism — even has been broached, unleashing controversy yet also badly needed public debate. The recent breakthroughs are being greeted with excitement in some quarters, but dread in others.

The most applauded breakthrough was that of European Central Bank chief Mario Draghi to allow the ECB to use its considerable firepower to act as a financial backstop for troubled eurozone states trapped in spiraling debt. German Chancellor Angela Merkel even sided with the ECB over Germany’s own hallowed Bundesbank in supporting the bond buying program, a remarkable turn.

That was followed a few days later by a more detailed plan for the creation of a European wide banking union, designed to make the financial system more stable. And then European Council president Herman Van Rompuy made several astonishing proposals about how to further integrate the eurozone, including ones for a common eurozone budget, limited debt mutualisation (such as Eurobonds) and a eurozone parliament  – potentially more powerful than the European Union’s current parliament — that would bring greater democracy and accountability to federalized eurozone economies.

European Commission President José Manuel Barroso capped it all off with a dramatic speech that may one day be viewed as historic. He outlined more details and steps towards greater integration and capped it all off by calling for a “federation of nation states.” The president did not shrink from using the “f-word” in his memorable moment.

But even as these recent changes and reforms have resolutely set Europe’s course into forward gear, they have unleashed a new debate across Europe. Many are asking, quite rightly: “Why is more European integration necessary? Is more federalism really desirable?”

How much federalism is too much?

There are at least two crucial answers to these questions, both of them centered on what Europe will look like, not just in 2015 but also in 2035 and beyond.

First, it’s important to remember that these decisions are being made in reaction to the ongoing economic crisis and the perils of austerity economics. Economists and commentators have tended to view austerity on both sides of the Atlantic through the same prism, yet the situation in Europe is quite different than in the United States.

In the US, there exists a long-standing federal system that collects large amounts of taxes from Americans in all 50 member states into a national treasury that is spent on various nationwide priorities, as decided by the elected federal representatives in Washington DC.  Little protest is made over which states contribute more to the national pot, or whether Californians or New Yorkers transfer some of their wealth to poorer Alaskans or Mississippians – which they do, year after year, federal budget after budget.

This arrangement even has partisan ramifications, since by and large the “blue states” bail out the more conservative “red states” on a regular basis. Yet rarely is an outcry expressed along either partisan or geographic lines about freeloading red states that are dependent on the federal government – even though they are. Instead, the prevailing philosophy is “a rising tide floats all boats,” and “E Pluribus Unum”: “out of many, one,” as it says on every U.S. dollar bill. Though it must be said that this sentiment has not always been so dominant in America and it took decades and much strife – including a bloody civil war in the mid-19th century – to round off the sharp edges of this creation to arrive at the current state of union where most of these basic precepts are hardly questioned.

But in the so-called European “union”, the federal institutions – whether the chief executive, parliament, central bank or regulators – are in their infancy. There is a small treasury – the E.U. collects about 1% of the member state’s GDP, compared to the US federal government absorbing about 24% of America’s GDP – so there are far fewer resources at the European level to deal with a crisis.

Indeed, a federal European consciousness that would allow such crisis intervention barely exists. Instead, national and even regional interests jealously track which EU member states are the economic drivers and which are the alleged slackers. The Germans, Dutch, French and others suddenly find themselves in the very foreign situation of having to extend financial assistance not only to the Greeks but also the Portuguese, the Irish, the Cypriots and increasingly the Spanish.

In the US, such geographic spreading around of the wealth is normal, but on the European continent, where nations fought bloody wars against each other not that long ago, such transfers from the wealthy states to the poorer ones are still very controversial. Expecting member states to suddenly shelve their history and culture and start transferring buckets of euros from the wealthy to the poorer states, or asking the Germans or the Dutch to stimulate their economies to help the south, was never realistic. The tense and even bitter relations this dynamic has unleashed has saturated the politics of Europe in a way that is scarcely imaginable in America today. So it hardly makes sense to view the American and European situations through the same lens; and specifically it makes little sense to criticize Europeans for failing to enact Paul Krugman-like stimulus in Germany and France to help the Italians, the Spanish and the Greeks when the institutions and continental consciousness that would allow that to happen are in their infancy. It’s like asking pigs to fly.

Ironically, Europeans have always been known for showing a much higher degree of “solidarity” than Americans, especially between different economic classes, which has resulted in far lower rates of inequality, poverty and a more broadly shared prosperity. But that solidarity for the most part has been confined to within national member state borders. Continental solidarity that extends across member states is much less developed. Whereas in America, solidarity between classes is rather stunted – many Americans have little patience for redistribution policies that would alleviate the scandalous level of poverty in the US, 50 million people and counting – but solidarity across state lines is far more developed than it is in Europe. Economic indicators for the eurozone as a whole compare favorably to those from other developed countries, such as the US and Japan, but it’s the economic imbalances within the eurozone that are causing the difficulties. And that’s because the eurozone does not have the unitary federal institutions or continent-wide consciousness to smooth out those differences very easily.

So unlike in America, Europe’s crisis has not been simply a policy debate over “austerity versus stimulus,” or whether the political will exists to mobilize for a Keynesian intervention. It has been an existential crisis over union, cross-border solidarity and how to define “self interest.”

Unfortunately, pundits and analysts, including Nobel prize-winning economists, have tended to conflate and confuse these issues, which has stirred up much misunderstanding. The challenge for America is to figure out how to use the union it has – and its antiquated federal system that has resulted in political paralysis – to respond to the current economic difficulties. But the challenge for Europe is to figure out whether or not it wants to create this federal system at all. While economic growth is always an important challenge to wrestle with, it will continue to be hampered by these larger existential questions over European identity.

Despite Europe’s hardwired historical and cultural path dependency, over the past two years of the euro zone crisis such transfers between member states increasingly are being seen as an important tool for keeping the continent economically — as well as politically — stable. Already hundreds of billions of euros have been sent to the debt-plagued states, in one form or another. It has become increasingly clear that if Greece or Portugal, for example, were to sink to “failed state” status, it would have a destabilizing effect in other parts of Europe. But it’s also becoming clearer that if Greece and Portugal can’t keep up competitively, and also have lost the capacity to devalue their currency as a way of regaining some of its competitiveness, assistance from wealthier states becomes essential to prevent Greece and Portugal from sinking further. The only way to avoid this would be to expel them from the eurozone, but that entails risks as well, not only short-term contagion risks but also long-term if they can’t adequately police their borders or become further destabilized.

In short, America has its Mississippi, Alabama and Alaska member states that need perpetual assistance from California, New Jersey and Illinois; Europe has Greece, Portugal, Ireland, Cyprus and Spain – will Germany, the Netherlands and France step up to the line? If the right federal political institutions existed, then these transfers could be done as an ongoing part of the federal appropriations process, including infrastructure projects, family supports and poverty reduction programs, and they would be less controversial and hardly noted by the media or the public. The way it’s done now – amidst threats and warnings over bankrupt governments – it creates numerous flashpoints, headlines and controversy.

The Chindia Question

The second answer to “why more integration and federalism” is:  Chindia.  China and India’s rise as two of the world’s largest economies highlights a new 21st century reality:  size matters. In today’s world, population counts as much as productivity toward determining economic power.  Going back as far as the industrial revolution, worker productivity levels in Germany, the United Kingdom, the U.S., and Japan made those countries both rich as well as the world’s largest economies, despite having far smaller populations than places like China and India.  Today, even though most Chinese remain poor, China’s rise to the ranks of the world’s second largest national economy makes it one of the world’s largest traders, creditors, consumers, carbon belchers and market for commodities. The decisions it makes and policies it pursues shapes global markets and resource challenges.

“GDP and size matters in crude superpower terms,” says economist Arvind Subramanian. “It shows what resources you can bring to the table.”

A Europe composed of dozens of diffuse member states, none of them more than seven percent of the population of China or India, would slowly see many of its competitive advantages chipped away. Member states would soon be in competition with each other, even more so than today, small fry states trying to export to the big kids on the block, instead of fostering continental cooperation and development.

But if Europeans can band together and form some kind of federated Europe, with a population of anywhere from 350 million to 500 million people, they have a chance to maintain their quality of life and broadly shared prosperity. Unfortunately, the reality is that the current economic and political structures of the European Union, which were fine for a loose confederation of states, are inadequate for a monetary, fiscal and transfer union. Hence, major institutional change enacting more federalism is a requirement for maintaining the “social” in Europe. And it will probably mean evolving the eurozone into a more federated United States of Europe, while the European Union quietly slips into its senescence stage as an important link between the USE and the UK, Sweden, Poland and other non-USE states. Of course EU members would be free to join the USE and its euro currency.

Of course the devil is in the details, and already there are mutterings coming from Germany, France and elsewhere over certain specifics. But some of that is certainly pandering to their respective voters, as their leaders slowly coax their populaces toward more federalism. Europe has kicked the can down the road and done only the minimum necessary so many times that it’s easy to assume this is more of the same. Time will tell.

European leaders have created a timeline for the proposed reforms that will allow for lots of public debate leading up to the German elections in the autumn of 2013 and the European parliamentary elections in 2014, when voters will have their say. But they are not waiting for the roar of a popular mandate. Already they are pushing forward toward more integration and democratically accountable federalism, because they believe it is the best hope for Europe in the 21st century. They also apparently believe that this is what most Europeans want, notwithstanding the doubts and confusion expressed in opinion polls.

At this point the outlines of a viable federal Europe are increasingly clear. If Europe is able to pull that off, it will be able to continue its role as the most important model for global development capable of fostering both economic and environmental sustainability.