Back to Rome? edit

March 26, 2007

The fiftieth anniversary of Treaty of Rome on March 25th was a day of celebration. The entity created by the treaty, the European Economic Community (now the European Union), has endured for half a century. What started as an undertaking of “the Six” (France, Germany, the Netherlands, Italy, Belgium and Luxembourg) now has 27 members. So deeply embedded is it in Europe’s collective consciousness that it is hard to imagine that the EU will not still be here when the time comes for its centennial.

To understand the treaty, it is important to appreciate how far Europe remained behind the United States in the 1950s. GDP per person was still barely half American levels. The modern mass-production methods that the U.S. had pioneered in the first half of the 20th century had only begun to arrive in Europe. Automobiles and modern household appliances, items that typical American families already took for granted, were still exceptional.

Fifty years later, the countries of Western Europe are within hailing distance of the United States in terms of per capita GDP. If one instead compares income per hour worked, France, Germany, Ireland, the Netherlands, Norway, Belgium and Luxembourg have surpassed the U.S., reflecting Europeans’ shorter work weeks and longer holidays. The transatlantic difference in the quality of life is gone.

The institutions of European integration played a key role in this transformation. They locked a peaceful Germany into Europe, allowing that country’s considerable industrial might to be unleashed. They led to the creation of the Common Market, prompting an enormous expansion of trade and increases in efficiency. With the Single Market Program in 1986, Europe created continental economy capable of supporting global champions – firms with the scale and scope needed to compete internationally. And with the advent of the euro, Europe banished the inflation problem that plagued it for much of the 20th century.

These arrangements were part of a larger constellation of institutions ideally suited for the process of catching up to the United States. Workers assured of employment security and an extensive social safety net moderated their wage demands while firms plowed their profits into investment. Banks with long-term relationships to their industrial clients provided patient finance. Cohesive employer’s associations encouraged firms to invest in training without fear that their skilled workers would be poached by competitors. These institutions were ideally suited to a period when growth depended on high levels of investment and on exploiting the backlog of technology that had developed in the first half of the 20th century.

But once the backlog of technology was gone, growth became dependent on innovation. And now the same institutions that had been part of the solution became part of the problem. Norms limiting wage differentials made it hard to offer generous rewards to risk-taking entrepreneurs. Banks accustomed to lending to familiar customers hesitated to take bets on unproven technologies. Laws providing for employment security discouraged start-ups, since investors in new firms that did not pan out might end up with substantial liabilities to their former workers. The high taxes needed to support an elaborate welfare state made it hard to compete in a globalized world. European societies appreciate the need for more flexible labor markets, the development of securities markets, lower taxes, and more efficient delivery of welfare-state services. But it is not easy to restructure a system of interlocking parts.

One worries that the European Union is similarly a solution to yesterday’s problems. High inflation has been vanquished, but the European Central Bank, the guardian of the euro, remains fixated on its inflation target. The efforts of the European Commission to advance the “Lisbon Agenda” of reforms intended to make Europe the world’s most competitive region by 2010 has been heavy on rhetoric and short on accomplishment. Indeed, the idea that the Commission is supposed to point the way toward productivity-enhancing reforms has had the effect of relieving national governments of responsibility for doing so. And the members’ inability to agree on a constitution that would enhance the powers of the European Parliament means that there is no one capable of holding Commissioners accountable for their actions and therefore no willingness to give the Commission meaningful executive powers.

The solution is not to abolish the EU but to update it for the 21st century. There needs to be a clear division of responsibilities between the Union and the member states. The EU should be responsible for Europe’s border security, foreign affairs, and competition policy. The member states should assume responsibility for their own economic reforms. Each country has its own distinctive economic structure and institutional inheritance. Each needs different reforms. Making economic reform a competence of the Union encourages one-size-fits-all advice and allows governments to abrogate responsibility. Making clear what the EU cannot do as well as what it can will put that responsibility squarely where it belongs. Maybe it is even time for a new Treaty of Rome to make that assignment of responsibilities clear.