Europe, Globalization and the Future of the Eurozone

The main argument in The Globalization Paradox is that we can’t simultaneously pursue economic globalization, democracy and national determination, but at most have two out of three. You also write that the EU was the exception that tests the rule. Well, hasn’t the on-going crisis shown that this trilemma definitely also holds true for the EU? And hasn’t the crisis revealed that the European nations are not so similiar as it may have appeared? The differences between North and South Europe are perhaps so great that such a large union is an unrealistic project, not to mention the Eastern Europe?

Indeed. When I wrote that the EU was the “exception that tests the rule” I meant that the trilemma applied equally well there, and that the Euro zone was in fact a case in extremis of the trilemma. My thoughts have been further confirmed by developments since the book was completed.  Assuming that European nations do not want to give up democracy, the only choice that exists is the one between political integration and economic disintegration. Either Europe will make the leap to a fiscal and political union, or it will have to give up on a common currency and the dream of a truly unified single market.  That is what the trilemma suggests and the reality that the region has been living.

You are right that I may have exaggerated the similarity and unity that exists within Europe – or even the Euro zone. Perhaps I did not emphasize sufficiently the tension between deepening the union and broadening it with increased membership.

Building a political community, without which fiscal union cannot happen, requires the development of a sense of common political fate and destiny. Historically, this has been always an elite-driven project. France was not born a nation; it became a nation because it was made into one by its political and intellectual leaders through education, ideology, and a common narrative. In Europe, unfortunately, the reaction of leaders like Angela Merkel, at least at the outset of the crisis, was to emphasize the differences between North and South instead of the commonalities.  She allowed the crisis to be presented as a narrative of profligate, lazy Greeks versus hard-working, thrifty Germans – and not as a story of mutual dependence.  With that as a background, it is hard now to change course and make the case for a common political destiny.

So, even though the differences between nations are real, it is also the case that political leaders have fallen short in rising above their very short-term interests.

Globalization can perhaps be said to have reduced inequality in the world. Large parts of the Chinese population has risen out of poverty – if that can be attributed to globalization as such and not the Chinese way of adapting to it. But is there a connection between globalization and inequality within countries? It seems much easier to further accumulate wealth for the very rich in a deregulated economy.

There is no question that globalization has aggravated inequality within countries.  But we need to think of globalization in this context as part of a cluster of developments: new technologies, greater emphasis on markets, decline in unionization, and fiscal paralysis of many states. All these have had the consequence of raising the returns to skills and talents and reducing the bargaining power of blue collar workers and those who are unable to move across national borders with the same ease as capital.

But there are exceptions too.  One of the most encouraging trends in the last couple of decades is the decline in inequality in Brazil, Chile, and many other Latin American countries, which have traditionally been among the most unequal in the world. This shows that broad social programs as well as more narrowly targeted anti-poverty programs can still be pursued and are effective in open economies.

This interview for the magazine Respons is intended to follow after a review of 4 new books in Swedish about the crisis of the EU, written by Sverker Gustavsson, professor of political science at Uppsala. The four Swedish authors he is discussing – Mats Persson, Johan Norberg, Stefan de Vylder and Björn Elmbrant – write from different political positions, but all agree that it was a fundamental mistake to create a monetary union without a fiscal union. A fiscal union would have made it possible for the EU to transfer resources between countries and reduce the tensions that the common currency creates. Do you agree with this assessment, that a monetary union ought to have been accompanied by a fiscal union? Is a fiscal union a realistic project? Is it even desirable, or ought EU to take a different course, perhaps aim for a more limited economic union, which would allow the nation states to protect their social arrangements? Further, would a collapse of the eurozone necessarily be a bad thing? The nation-states may then perhaps be able to adopt policies more suited to their actual conditions and interests? Sweden for instance is doing fine outside the eurozone.

Pretty much all my economist friends in Sweden were in favor of joining the Euro. I haven’t encountered one who hasn’t changed his mind.

Yes, the idea that monetary union requires fiscal union has now become conventional wisdom. But it doesn’t go nearly far enough. What makes the U.S. a sustainable monetary union is not just that it operates within a fiscal union.  It is also that there is a common legal system (to deal with bankruptcy and cross-state bank liabilities), common deposit insurance and financial regulation, a true lender of last resort (in the form of the Federal Reserve), much greater labor mobility across state borders, and a federal constitution that severely curtails states’ sovereignty.  Perhaps most importantly, the system is underpinned by a federal political system which allows the residents of each state to directly elect their representatives in Washington, D.C., who can then represent their interests and argue for the kind of economic policies that these residents want pursued.

European political integration need not directly follow this model, but whatever form it takes, there is a very long way to go. Fiscal union in itself will not do the trick unless there are democratic mechanisms of accountability and representation that backs it up.

Which of course forces us to ask the question whether we can and really should try to go that far.  It turns out Sweden did do the right thing by staying out of the Euro zone. Now it benefits from having its own currency, its own fiscal policy, and its own financial regulations.  It remains the master of its own fate to a much greater extent. It remains a highly globalized economy, but has set its ambitions on this score at a somewhat lower level than the Euro zone countries.

Perhaps the Euro zone should similarly take a step back. Ultimately, that may well be the right answer.  The difficulty is how to engineer a retreat from a single currency when there is no obvious legal mechanism for doing so and when so much debt would have to be redenominated, reconfigured and redistributed. And how to do this in a manageable way when the slightest indication from governments that they are considering a break-up of the euro zone would cause a market panic and stampede out of the weaker economies.

It’s a nightmare just to think about it.  And yet, it is not clear if there is a realistic alternative.  That is Europe’s dilemma. Either more political Europe, or less economic Europe.  There is no stable in-between.

The support for such a fiscal union, which also would be a transfer-union, seems rather eager among the populations in Europe, especially in those countries that will be paying, like Germany and Finland. To be politically possible, redistributions of this kind seem to demand a strong sense of affinity between those involved. It could be done between East and West Germans, but perhaps not between Germans and Greeks or Italians. If you look at the welfare states historically, they were able to transfer resources among the populations, but those nations were also homogeneous, like Sweden. Isn’t it dangerous to aim for a fiscal union when popular support for crossnational transferences is so weak – dangerous in the sense that it might create a general backlash against the union?

Yes you are right, but as I explained earlier, the difficulties are in part due to the framing of the crisis by Northern European leaders at the outset. Once you present the crisis as a result of Greek duplicity and profligacy, it becomes difficult to go back to your constituency and ask that you help the Greeks out with yet another bailout.

At its bottom, this has nothing to do with morality. The economic fact is that the assumptions on which German lenders and the Southern borrowers acted have proved to be wrong and now both are in trouble. Neither Greek and Spanish borrowers, nor German and Dutch lenders can be absolved. This is a crisis of economic interdependence, not of morality.  Political leaders missed the chance of explaining this to their electorate.

So the result is that we are where, as you suggest, the backlash is as likely to come from exasperated Northern countries as from Southern countries deep in economic crisis.

It is easy for an economist like me to blame it all on lack of political leadership – and God knows economists were at fault too, by consistently making over-optimistic projections on Greece, Spain, and so on – but this is where the ultimate blame lies.

Your position is that democracies have the right to protect their social arrangements. However, the European Court of Justice has consistently decided against the national arrangements, forcing the countries to adapt to globalization, according to a report by Martin Höpfer Armin Schäfer at Max Planck Institute.

In your book, you point to the fact that a small group of central bankers made all the important decisions concerning financial globalization before WWI. They didn’t need to consult the people. Isn’t this a parallell to EU today? A small elite, far removed from people in general, makes all the important decisions? And won’t this also this time provoke a reaction?

Precisely.  That is why we have the trilemma. The more Europe has moved in the direction of the single market without Europeanizing its politics, the greater the democratic deficit has become, and the bigger the backlash.

That is why the new fiscal compact is problematic. It represents the same technocratic mindset that tries to squeeze all countries into the straitjacket of common rules, without simultaneously enabling democratic discussion and deliberation over those rules. Inter-governmental agreements are no substitute for democratic practices that transcend national borders.

Let me clarify something on the relationship between democracy and economic integration.  It is perfectly OK for executives and legislatures in democracies to sometimes restrict their freedom of action – through delegation to autonomous bodies or signing of international agreements. In fact, such restrictions may enhance the functioning of democracies.

But there is no guarantee that the delegation/restriction that takes place to advance economic globalization necessarily improves the functioning of democracy.  Globalization-enhancing rules may overlap, but are not the same as democracy-enhancing rules. Europe is now at the point where it is single-mindedly pursuing the former agenda, not the latter one.

The world was globalized before WWI and then a disastrous backlash set in. Are we heeding for a I backlash today? Many things are different of course. Europe has not been devastated by a war like WWI. Since fascism and national socialism were closely connected with the war experience, this backlash will perhaps not be so extreme. But it could still be a dangerous reaction, fueling intolerance and political extremism. In your article The end of the world as we know it you seem to be considering such a prospect. What can be done to avoid it?

There are reasons to be optimistic that a generalized cataclysm of that sort is less possible today. Too many things have changed: states and their social protections are stronger (which limit the social costs and disruptions) while political support for market mechanism is also stronger (making a generalized return to protectionism less likely).  And these are two sides of the same coin: generally markets have expanded alongside government-provided social insurance.

One of the interesting things after the 2008 financial crisis was how little trade protectionism ensued. This was the most significant crisis since the Great Depression, and yet there was very little increase in trade barriers.  We can attribute this to that double development.

The exceptions are societies such as Greece and Spain which are in extreme distress, and are rapidly losing both of the advantages I just mentioned.  The radicalization of politics in these countries is quite a realistic possibility.

As for Europe at large, I do think an eventual break-up of the Euro zone can have serious political repercussions as well.  This will be seen inevitably as the collapse of the European project, and will severely tarnish the credibility of centrist politicians, who have been the project’s main supporters. It will be extremist groups that will benefit.

This is the English-language text of an interview published in the Swedish journal Respons. It was first published on Dani Rodrik’s Blog.

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  • Kathleen McMullen

    What are MEPs for? Not all are for Europe! Nigel Farage MEP for the South East Counties, is ‘leader’ of the UK Independence Party. WHAT is he doing as an MEP? He is anti-Europe, a de-Europeanizer. Actually, a time waster.

    Leaders of political parties should be prohibited from standing as MEPs. The UK has 73 MEPs and they are rarely interviewed on TV.