GAC Berlin 2000 - The European Union: Progress and Challenges

By Kenneth Liss, Editor, HBS Working Knowledge

The countries of Europe, countries that fought the worst possible wars among themselves in the first half of the 20th century, have, in the last 50 years, demonstrated the importance of appropriate governance structures and institutions not just for the region but for the world economy.

That, said Tommaso Padoa-Schioppa, a member of the executive board of the European Central Bank, is the most important global lesson to be learned from the post-war development of the European Community and the emergence, in the last two years, of the Euro system.

"The European countries, which have been collectively responsible for some of the disasters of the world, have also shown, not only to themselves but to the world, some of the ways to correct those mistakes," he said.

These include, he said, the full acceptance of a degree of supranationality on decisions that are of common interest and the creation of significant regional organizations. "I think that both these inventions that were successfully developed in Europe over the last 50 years point to elements that are necessary for a better organization of world relations.

"Without the acceptance of some degree of supranationality, world governance is impossible. And 200 countries in the world make it impossible to pursue organized relations without some degree of cooperation at the regional level."

Padoa-Schioppa's presentation, "The European Union: Progress and Challenges," was aimed primarily at the non-European members of the HBS alumni audience. In it, he offered a look back at the road to monetary union and the first two years of the system, plus a look ahead at the economic and political challenges to come and the international impact of the Union and the new economic and monetary order.

From the Treaty of Rome to the Euro

The development of the Euro, said Padoa-Schioppa, is in many ways the culmination of a process that began with the Treaty of Rome in 1957, which was constructed around the idea of establishing what the treaty called the Four Freedoms: freedom of circulation of goods, services, persons and capital.

"The objective of establishing the Four Freedoms is a far-reaching objective that is well beyond the field of international relations and into the fields of domestic economics," he said. "It took several decades to implement those four freedoms, partly because the implementation of them implied the rewriting of most of the legislative basis under which those freedoms can be exercised.

"To complement this construction with a single currency was, in a sense, a completion, a crowning of a longer construction."

With the coming of the Euro, he added, "Europe has moved outside the schemes of international cooperation to go into the institutional model of, say, the organization of the economy in a domestic system. The Euro means that this domestic model has been completed with its own currency and its own central bank."

Challenges Faced and Met

The first two years of the Euro system and the European Central Bank, said Padoa-Schioppa, can be divided into seven months of preparatory time and a year and a half of running the system. In this period, five principal challenges emerged. Three of these, he said, passed largely unnoticed due to the lack of any problems.

First was the challenge of redenominating the national currencies of the individual nations to the Euro, which took place over three days. (It was good preparation for Y2K, said Padoa-Schioppa, as there was no way of knowing if it worked until the day it took effect.)

The second challenge was market acceptance, the belief from the first day that the Deutsche mark, the lira, the franc, etc. had become simply the local names of the Euro.

The third challenge was to see if the "instrument panel" that was necessary to conduct monetary policy—with unified statistics and the like—was in place. "The risk for us in Frankfurt," said Padoa-Schioppa, "was to discover that those statistics were so difficult to read as to make the job of the Central Bank extremely difficult. It took some months to see that this was not the case."

Two other challenges, he added, were even more profound. One was the challenge of creating a new kind of collegial body. The old collegial body, composed of the governors of the national central banks, involved, quite naturally, a weighing of interests. That had to be transformed from a "negotiating table" into a body "to take common decisions for a common good."

That's a huge mental change, said Padoa-Schioppa. "The good you are supposed to pursue has to change fundamentally."

The final challenge was to deliver the objective for which the system was created, namely price stability.

"Of these five challenges," said Padoa-Schioppa, "four were typically challenges of the initial period. Only the fifth will accompany us forever. The others were risks, potential diseases of the infancy system. The infancy is over. The system is a healthy two-year-old child. But it is still a young system."

New Challenges

Moving forward, the economic challenge, said Padoa-Schioppa, is to prolong and possibly even increase the current rate of economic growth while maintaining price stability. The example of the U.S., he said, has shown that this is possible, and "there is no reason Europe cannot do the same."

On the policy front, that involves a matrix of policy decisions at the European, national and subnational levels. The keys are still primarily in national hands, he said. Some may say this is bad, but it also allows "a degree of competition among national approaches that allows experimentation, emulation, demonstration for effect" and results in a configuration of policies that is conducive to the possibility, even the probability of enhancing and prolonging growth.

Finally, there is the question of political union. Padoa-Schioppa said he agreed with the common wisdom that while there is economic and monetary union, there is still no political union in Europe. But, he added, that doesn't mean there has been no progress toward political union.

"First, economic matters are a major part of the content of politics and the political process. Economic matters, particularly the completion of a new legislative system for the functioning of economic life in Europe, have effectively been in the hands of the European Union now for several decades."

Second, he said, having made the European Union competent for most economic matters implies, inevitably, going beyond pure economics. "The economic aspect of life is not totally segmented from other aspects of life which are not predominantly economic but are relevant for the economy."

Third, he said, "the European Union now has a complete set of institutions to exert its legislative capacity, its executive function and its judiciary function, which are effectively a full-fledged system that can be enriched with new tasks.

"I think it is right to say there is no political union, but it would be a mistake to say that we are at time zero in the creation of a political union."