| By: Jason L. Saving Southwest Economy. Federal Reserve Bank of Dallas |
Economic integration is a key theme of the global era in which we live today. Perhaps the single most important example of such integration in recent decades is the European Union.
From the ashes of the wartime years, six core European nations forged a confederation that gradually grew to encompass 15 members and then 25. As the EU evolved into an economically freer and more integrated group of nations, the overall European economy has grown to the point where it rivals that of the United States (Chart 1).
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A further step toward economic integration was at stake on May 29, when French voters cast their ballots on a proposed European constitution. The debate had been framed in cataclysmic terms, with proponents arguing that a French rejection could be a "fatal blow" to further European integration. Proponents went on to say that there was no Plan B-implying the French either must approve the proposed constitution or bear responsibility for what former EU President Romano Prodi called "the end of Europe."
French voters rejected the constitution by a 10-point margin, and the Dutch followed suit three days later with an even more resounding rejection of the document. Yet the EU did not end. Indeed, it could not end because its existing treaties and regulations remain in place indefinitely unless superseded by a new governing structure. So in a very real sense, the EU to which French and Dutch voters awoke in June was the same Europe to which they had awoken the month before.
In and of itself, the proposed constitution would have little effect on the overall European economy. Indeed, primary author Valéry Giscard d'Estaing describes its economic provisions as a "tidying-up" of existing guidelines, rather than a renewed effort at economic reform. But the debate that has broken out in the wake of the French and Dutch referendums does have important implications for Europe's economic future and, by extension, the economic future of the United States. The question is simple: To what extent and in what manner should European integration continue?
The Benefits of Economic Integration
Economists generally support economic integration because it eliminates certain inefficiencies. When states in a common market choose different tax and labor policies, for example, workers and businesses have an incentive to move from states where taxes are high to states where they are low. Similarly, those who receive government subsidies have an incentive to move from states where subsidies are low to states where they are high. This migration punishes socially progressive states by simultaneously raising the amount they must spend and reducing the tax revenue available to meet their obligations.
Some believe this competition goes too far. The Organization for Economic Cooperation and Development recently concluded that the developed world should eliminate "harmful tax competition" between states. German Chancellor Gerhard Schröder echoed these concerns in a European Union context, arguing that low tax rates in its newly admitted Eastern members constitute "unfair tax competition." French President Jacques Chirac even coined a new term-"social dumping"-to describe the process by which laissez-faire states import workers and businesses from more highly regulated EU members.
Economics textbooks reveal the solution to this apparent dilemma. If competition between states for individuals and businesses is undesirable, such competition can be reduced or even eliminated through common economic policies. Simply compel all members of a federation to offer the same business climate and social safety net, and neither individuals nor businesses will migrate in search of something that better suits their needs. This would relieve the fiscal pressure on high-benefit states and thereby strengthen what is often called "social Europe." Further economic integration, in other words, is the answer.
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Much the same rhetoric has been heard in the debate over the European constitution. As Chirac said in mid-April, the EU faces a conflict of visions on how to further integrate members' economies. "The first," he said, is "to go with the Anglo-Saxon and Atlantic liberal current" of low tax rates and flexible labor markets. "That is not what we want. The second solution is that of a humanist and therefore organized Europe," he concluded, that can "stop the drift toward economic ultra-liberalism."
So it is not economic integration per se that is being debated, because a uniformly low-tax Europe with flexible labor markets would be just as integrated as a Europe that embraces uniformly high tax rates and inflexible labor markets. Rather, the question is what sort of further economic integration Europe will pursue.
If the European economy would be equally productive under either approach, economics would have little to say about these two visions. But this is not the case. It may be true that individuals and businesses could not escape a uniformly high-tax, high-benefit Europe through migration. But individuals could reduce their workweek or leave the workforce entirely, and businesses that would barely survive under a low tax burden would fail if confronted by a higher one. Such individuals and businesses would simply cease to exist as far as production is concerned, becoming either welfare recipients or bankrupt enterprises.
Those are the unspoken economic stakes behind the conflict of visions. In essence, integration along British norms would propel EU members toward a future of high growth and low unemployment, while integration along German norms would drag EU members toward low growth and high unemployment.
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| About the Author Saving is a senior economist in the Research Department of the Federal Reserve Bank of Dallas. Note: 1. Information about the proposal can be found at: http://europa.eu.int/comm/internal_market/services/docs/services-dir/com-2000- 888/com-2000-888_en.pdf. 2. For more information on the so-called Lisbon strategy, see: http://europa.eu.int/growthandjobs/index_en.htm. About Southwest Economy Southwest Economy is published six times annually by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. |