European Union: The Emerging International Superpower

By Arihant Jain and Russell Kizor

Ethics of Development in a Global Environment

Professor Bruce Lusignan

December 5th, 2003

Introduction

The path to European economic union has been a tumultuous one, leading to

the historically unprecedented creation of a common European currency on January 1,

1999. The Commission of European Communities drafted its first plan for such a

union in 1962, the idea gained momentum in the late 1970s and the early 1990s still

saw the European Community struggling to establish the groundwork for economic

unification through a common currency. Regardless, the monetary unification of the

European Union (EU) was, and continues to be, viewed as a bold move with several

possible benefits as well as downfalls. This ambitious plan will change the global

economic landscape forever one way or the other, but many believe this to be a big

gamble at best.

Euro Currency

The European Countries had several important reasons for implementing

monetary union. Firstly, the elimination of exchange rate fluctuations between EU

countries would remove uncertainties in cross-border transactions by fixing the

nominal rate of exchange across countries. Also, this would eliminate the threat of

speculative attacks on individual currencies. Secondly, monetary union also

eradicated the transaction costs associated with exchanging currencies. This is

2

important in view of large movements of goods and capital across borders, paving the

way for better trade unification. Thirdly, there was the potential of the Euro’s rise to

international currency status. Given the better exchange rate that the Euro enjoys over

the US Dollar today, one can see the gaining importance of the Euro as the stable

international currency of trade.

On the other hand, the member countries had to surrender their control over

national monetary policy over the European Central Bank (ECB). Thus, individual

countries were only left with fiscal policy as the only stabilizing tool with which they

could combat unpredictable and asymmetric exogenous economic shocks. However,

one of the four pre-conditions defined by the Maastricht Treaty for EU admittance

was to limit the debt and deficits of a county in terms of a percentage of the member

country’s GDP (The others were stable exchange rate and required levels of inflation

and interest rates). Hence, governments were limited in their ability to use deficits to

finance economic downturns, effectively tying the hands of fiscal policy in terms of

government spending.

The disadvantages of monetary unification were clear, but it was up to the

individual members to realize the potential advantages. One of the most important of

these advantages was perhaps the irreversibility of a common currency. The implied

commitment to one Europe and one money would force the national governments to

think in terms of the bigger picture. The policymakers would have to ignore their

differences and develop growth strategies that would transcend their own economies

towards the growth of the EU as a whole.

3

The monetary unification of the EU and its implications had tremendous

potential in terms of economic and political gains. The economic unification of

Europe would increase its global influence and make it an important player in setting

global policies. As Cohen states in his “The Political Economy of Currency Regions”,

[monetary supremacy] confers substantial political benefits on the hegemon. At home, the country should be better insulated from outside influence or coercion in formulating and implementing policy. Abroad, it should be better able to pursue foreign objectives without constraint as well as to exercise a degree of influence or coercion over others. The expansion of its currency’s authoritative domain, in principle, translates directly into effective political power.1

In this paper we argue that due to the accelerating path towards European unification,

we believe that in the near future the EU will be able to economically and politically

challenge the United States’ current global position as sole superpower.

Economic and Trade Implications of European Unification

The adoption of a common currency for multiple countries in Europe is an

unprecedented historical event and an economic experiment. Currently, no one can

precisely predict the economic and political outcomes of the formation of the

European Union. However, using modern economic analysis, we can examine the

benefits and costs of the EU in order to roughly forecast the net gains or losses for the

countries involved.

1 Richard Portes and Hélène Rey. “The Emergence of the Euro as an International Currency”. National Bureau of Economic Research, Working Paper 6424, Feb. 1998, 5.

4

There exist several incentives for European countries to join the EU and adopt

Euro as common currency. The most obvious benefit is that the citizens of

participating countries are no longer obligated to convert their currencies from one to

another within the European borders. For large countries, this tends not to be such a

problem, but for smaller countries such as many of those in Europe who tend to

conduct frequent cross-border business, this tends to become problematic. A 1990

study by Emerson et al estimated that conversion costs accounted for 0.4% of GDP

for the current fifteen countries in the EU.2 This figure may seem negligible, but

when one considers that in sum, this is a shocking $334 billion US per year, it seems

much more significant. So then, the eradication of conversion costs clearly lowers

barriers to trade and leads to greater economic efficiency.

Another barrier to trade is the uncertainty associated with foreign exchange

markets. For example, when businesses sell products to countries with different

currencies, they usually write contracts in terms of the buyers’ currencies. If the

contract states that the vendor does not receive his compensation for the products for

six months, and the buyer’s currency decreases in value over that time period, then

the vendor receives less money for the products than he or she had previously

expected. Some economists would argue that this loss of efficiency is not significant

due to the existence of forward markets that work to reduce foreign exchange risk.

This is somewhat true. However, the insurance that a forward market affords is only

available at a cost or transaction fee; else the forward markets would not exist.

Hence, the adoption of the Euro would help to reduce this inefficiency as well.

2 Eichengreen, 1327.

5

The final and most significant incentive for European countries to join the EU

is the ability for a country’s constituents to freely work and start a business in any one

the countries in the EU. According to The Economist, constituents are given “a

‘single passport’, issued by any one of the member countries, [which] allows a

financial firm to operate anywhere in the EU as long as it is registered in one of the

countries.”3 There are two primary benefits to this flexibility. First, this implies that

capital is potentially perfectly mobile within the EU, meaning that firms can place

their factories wherever is most profitable instead of just within the confines of their

own countries. There are vast cost advantages to this system. For instance, if a firm

manufactures a product that does not require much human capital, or college

graduates, the firm can build its factory in a country where there are more laborers

searching for work in such a factory.

Obviously, it can be difficult for firms to rapidly relocate their factories, so the

effects of this first benefit take place over several years. However, the second benefit

of this system is that labor has the potential to be perfectly mobile as well, which

could have profoundly positive effects on the EU as whole quickly. So, in addition to

a firm’s ability to position its factories anywhere, laborers can also seek out the firms

for which they wish to work; and conversely, firms can seek laborers anywhere in the

EU. This will undoubtedly lead to less structural unemployment, the unemployment

of those whose skills did not meet those of their job functions, throughout the EU, and

thus, to more efficient work outcomes. Additionally, this will lead to greater

economic specialization in production. That is, a good match between worker and

3 The Economist, Nov 19, 1998: “Europe’s American Dream”.

6

firm will be more easily attainable, thereby increasing efficiency of both workers and

firms.

As we have seen, the benefits from being a member of the European Union are

multiple. But what are the major drawbacks? There is one significant cost to joining

the EU: the loss of national monetary policy, a key tool that central banks employ in

order to fine-tune an individual country’s financial system. The European Central

Bank (ECB) now assumes control over monetary policy for all EU nations after

joining the EU. According to Article 105 of the Maastricht Treaty, “the primary

objective of the ECB shall be to maintain price stability”; the needs of individual

countries were secondary to this larger goal, such that “without prejudice to the

objective of price stability, the ECB shall support the general economic policies in the

Community.”4

European Central Bank

Clearly, this could prove harmful to a member country of the EU if it required the use

of monetary policy, but the remainder of the EU did not. However, this downside is

somewhat dampened due to the free capital and labor markets discussed earlier. If

4 Charles Bean. “Monetary Policy Under EMU”. Oxford Review of Economic Policy, Vol. 14, No. 3, 1998, 43.

7

one country was not well economically, the citizens of that country could easily

relocate themselves and their businesses, and enjoy the prosperity of the other

member countries. Thus, even in a national economic downturn, unemployment

could remain much lower than it was before a member country joins the EU.

Now we understand that the economic benefits of joining the EU probably

outweigh the drawbacks for most European countries. Now, how will the EU as a

whole compare economically to the United States? Let us take a glance at the EU

GDP and its populations.

As we can see, the fifteen countries currently in the EU produced $8.357 trillion from

a population of 373.9 people as opposed to the US 1998 GDP of $8.79 trillion and its

population of 290 million.5 And when we consider that the GDP of the joining twelve

nations which is expected to take place by 2007 (ten in 2004 and two in 2007), the EU

will have a GDP of $8.70 trillion and a population of 480 million. Obviously, the

economics of the EU are comparable to those of the US. We should not ignore the

growth rate of both entities, and while the growth rate of the US is higher than that of

the EU, we might expect this to change. This may occur because after labor and 5 The Economist, Oct. 21st 1999: “Wider, Still, and Why”.

8

capital markets become more mobile, the economic specialization discussed earlier

will occur, and we can expect the productivity of those 480 million people to rise, and

thus raise the growth rate of the EU in excess of that of the US.

This will lead to the EU actually having more economic power than the US,

and could have interesting economic effects on the whole globe. For example, if the

EU is more economically powerful, or even as powerful, as the US, we could expect

the EU to challenge the US in its economic decisions instead of giving in to its

demands. This seems like another benefit of joining the EU. When all the countries

join together, they must no longer do as the US would like because they, together as

the EU, have just as much power to influence decisions as the US.

There are not many easily perceivable examples of this expected phenomenon

as it is currently just occurring. However, there is one instance that stands out as a

clear example. In March 2002, the Bush administration employed the use of tariffs on

steel imports in order to protect national steel producers that are unable to meet the

low costs of their international counterparts. The World Trade Organization (WTO)

deemed these tariffs as illegal, but Bush decided to leave them in place without any

regard for the WTO. However, when the European Union gave the US a mid-

December deadline to drop the steel tariffs or face retaliatory export tariffs of over $2

billion, President Bush decided to back down and drop the steel tariffs on December

4, 2003. “The president said his decision was based on his ‘strong belief’ that

America was ‘better off with a world that trades freely and a world that trades

fairly’”.6

6 The Economist, December 6th 2003: “Rolled Over”.

9

Evidently, though, this was not the case. If President Bush had really thought

that America was ‘better off’ with free trade, he never would have implemented the

tariffs in the first place, and needless to say, would have removed them when the

WTO deemed them illegal. Obviously, it was the $2 billion tariffs from the EU that

convinced Mr. Bush to remove his internationally harmful tariffs. Before the EU was

in existence, one member country alone probably would have been unable to credibly

pressure the US into such an action due to its much smaller size and dependence on

the US economy. We will probably see more examples like this one in the future.

Thus, due to the formation of the EU, European countries are able to economically

challenge the US when it does international damage. In other words, the US is no

longer the world’s economic monopoly – the EU is now giving the US significant

competition in its status as the world’s sole superpower.

The European Heritage of War

It is hard to ignore the fact that politics was the substantial motivation behind

the formation of the EU. Although a lot of the tangible impact was and will be felt on

economic grounds, the foundation for the EU lies in the post- World War political

relationships that existed between the European countries. For example, commitment

to the economic union was used to secure peace between France and Germany and

smooth over international tensions in the wake of World War II.7 The bloody past of

Europe’s involvement in the two world wars serve as a constant reminder of the evils

7 Helm and Smith. “Economic Integration and the Role of the European Community”. Oxford Review of Economic Policy. (Vol. 5, No. 2, Summer 1989) 1.

10

of war and provide the motivation for an integrated Europe far removed from the

possibilities of intra-European conflict. Europe has created for itself a common

currency, a flag, a newspaper (the European), TV station, a European Champions

League for soccer, film festival, parliament, court and law; and a ‘Eurovision’ music

festival. These are a result of a new level and intensity of integration that has been a

reaction to the destruction and deaths of the first and second world wars. The wars

were followed by the secular division into East and West Europe during the Cold

War. Now, instead of the earlier Americanization vs. the Sovietization of Europe, the

Europeans want their own continental identity. This “Europeanization” is spurred on

by the post World War II triangulation of the continent – where the United States and

the Soviet Union had picked over the post-war European corpse to influence its

resurrection. However, now Europe is without any immanent invaders, no colonies,

no occupiers and no superpower alignments. The stage is set for its resignification.

There has been more progress on European security and defense issues since 1998

than in the past 50 years. This is no accident. Powerful historical forces are at work

that appear to have already had a transformational effect on policy formation and

policy preferences of governments which, for decades, had remained entrenched in

sovereign national dug-outs. The end of the World Wars, the end of the Cold War, the

wars of Yugoslav succession and the advent of globalization are some of the factors

that have made important contributions towards the precipitation of a new European

policy outlook on security issues. The accelerated and intensified progress of

European integration is concomitant to the need for the EU to become a political

player commensurate with its economic and commercial clout.

11

The European Parliament

The EU Parliament is the assembly of the representatives of the 374 million

Union citizens. Since 1979 they have been elected by direct universal voting every

five years. At the moment, the EU Parliament has a total of 626 members distributed

between Member States according to the sizes of their populations. After

enlargement, with the addition of 10 countries, the number of members of the EU

Parliament will increase to 732.8

European Union Parliament

Currently, the EU Parliament considers the EU Commission's proposals and is

associated with the Council in the law-making process, in some cases as co-legislator.

Under this procedure it can amend laws by an absolute majority of its members

(314/626) and veto decisions. It also shares budgetary authority with the Council,

supervises the European Commission and has political supervision over all the EU

institutions. However, there is a trend towards granting increasing powers to the

European Parliament as the EU moves towards more pervasive consolidation. Many

observers have expressed skepticism about granting more power to the European 8 http://www.euabc.com/index.phtml?word_id=355#

12

Parliament. The skeptics believe that Members of the European Parliament (MEPs)

do not vote in a disciplined way and that they vote more often with their country

group than with their European Party. Using a unique database consisting of all roll

call votes by each individual MEP between 1989 and 1999 (over 6000 votes by over

1000 different MEPs), Noury et all show that the skeptics are wrong9. The data shows

clearly that MEPs vote more along party lines than along country lines. Party

cohesion is comparable to that of the US Congress and is increasing over time

whereas country cohesion is low and declining. In short, politics in the European

Parliament generally follows the traditional left-right divide that one finds in all

European nations. These findings are valid across issues, even on issues like the

structural and cohesion funds where one would expect country rather than party

cohesion. In votes where the EP has the most power, MEPs participate more and are

more party-cohesive. This study goes to show the effective voting patterns in the

European Parliament and its close resemblance to most democratic parliaments in its

functioning.

“The Union's aim is to promote peace, its values, and the well-being of its peoples” – Constitution Article 3(i)

9 Noury, Abdul G.; Roland, Gerard, Economic Policy: A European Forum, October 2002, v. 0, iss. 35, pp. 279-312

13

Foreign policy and Defense Aspirations

Due to its experimental nature, the EU is a system in constant transformation

and thus it is hard to understand the characteristics of EU political integration. The

political dynamism is largely because the very fabric of the EU rests upon a form of

coexistence with established polities in the member states and with the constant mire

of international relations coupled with what we now call globalization. A crucial

element of the EU’s evolution is the creation of a common foreign and security policy

(CFSP). However, a defense dimension is being added through the implementation of

a common European security and defense policy (CESDP; launched in 2000) and a

European Rapid Reaction Force (ERRF). The creation of a Rapid Reaction Force was

finally agreed by the EU’s defense ministers in February 2000, who re-affirmed their

commitment to the formation of a 60,000-strong force by 2003. This Rapid Reaction

Force is intended to work alongside NATO as a complimentary force. Its strongest

supporter is France who has been pushing for an independent European Army. Other

Member States worry about upsetting the Americans through a possible split of the

NATO alliance.10 Western Europe and the United States have held a close alliance

since the end of World War II and have often coordinated military operations under

the NATO framework. Now, however, many Europeans in positions of responsibility

feel that their economic interests and foreign policy objectives are at variance with

those of the United States. This is especially true in regard to policies concerning

many parts of the world, including Eastern Europe, Africa, the Middle East and even

10 http://www.euabc.com/?word_id=788

14

Latin America. The French and German governments feel particularly strongly about

developing and maintaining an independent military capability that can operate

without US cooperation or consent. The Germans have also suggested that the EU's

nuclear capabilities should also be "integrated within the European defense system".

At present, Britain and France are the only EU countries with a nuclear deterrent.11

European Rapid Reaction Force

Europe’s desire for a continental strike force antedates its present rift with the

United States. It can be traced back to Europe’s shame in being unable to prevent the

bloody disintegration of Yugoslavia in the 1990s. But the notion of a European army

can be seen as inevitable with the European unification gathering strength and focus

steadily. As the EU increasingly plays a pivotal role in setting and enforcing the trade,

societal and environmental policies for the Continent, it would be outlandish if it

failed to move towards a common defense policy- and inevitably a common defense

force as well. If Europe wants any say in the nascent new world order, it needs to be

able to substantiate the values it upholds. There is certainly a perverse irony in Europe

needing to develop an armed force to project its pacifistic values. However, an armed

force that is controlled by democratic nations and employed only in instances of

11 http://www.euobserver.com/index.phtml?sid=13&aid=13185

15

genuine threats will definitely be a welcome addition to the forces pursuing peace in

his world. More importantly, it is almost necessary to create a democratic alternative

to the military monopoly of the United States. This is especially true since the Bush

administration does not seem to be successful in using their forces for intrusive

inspections of rogue states or for nation-building.

Implications and Reverberations of the War on Iraq

In light of the recent invasion in Iraq by the United States, we are witnessing

one of the most serious European-US political divide on global issues since the end of

the Second World War. Not only has it sparked off EU initiatives to develop its own

foreign policy with the backing of a ‘Euro-army,’ but has also taken its toll on

transatlantic trade with the expected economic spill-over. The war on Iraq has caused

a significant strain in transatlantic political relations because it seems to be the final

straw in continuous differences in EU-US policy outlooks. The war comes right after

the Bush administrations unilateral withdrawal from the Kyoto Protocol on Global

Warming, the ABM Treaty, and the International Criminal Court. Essentially, it has

caused the exposure of profound differences with Europe over threat assessments

regarding weapons of mass destruction; the proper way to handle "rogue" nations

such as Iraq and Iran which act contrary to international norms; the role of

multilateral institutions such as the United Nations; and the use of military force.

The American business community should be as worried as their European

counterparts about the potential damage to transatlantic trade relations. The

economies of the US and Europe are not only interdependent but also well-integrated.

16

Through their respective affiliates, US and European companies each employ over

one million workers in the other's market. The US has over a $1000bn annual trade

and investment relationship with Europe. Over 60% of US exports to Europe are from

US parent companies to their European affiliates.12 On the US side, the huge subsidy-

laden farm bill and the imposition of tariffs on European steel products still hang as

impediments to improved trade relations. The Bush administration has to determine

how it will tackle a politically charged WTO case to void the EU moratorium on

Genetically Modified Organisms (GMOs). On competition policy, the European

Commission takes a more suspicious view of mergers, as shown by the denial of the

US-government approved GE-Honeywell deal, looking more at the impact on

competitors, while the US focuses on efficiencies to consumers. Such ideological

differences in EU-US economic outlook is the basis of current and future transatlantic

trade rifts.

Conclusion

We have now seen how the European Union has and will continue to

challenge the United States both politically and economically. This is a fortunate

result for the remainder world’s nations because the US has waged its monopolistic

power in order to better its own interests instead of interdependently considering the

interests of others. Political and economic examples of this abound such as when the

12 Eizenstat, Stuart E .The Economic Effects Of US Foreign Policy. Financial Times Business Edtion, The Banker, June 1, 2003

17

US breaks international treaties and invades Iraq, or when the US breaks international

law according to the World Trade Organization.

Map of European Union

Now that the EU is firmly positioned and growing in power, the US will no longer be

able to commit such acts that are in the interests of the US but harmful to the

remainder of the international community.

Now we must question how the EU’s newly acquired power will cause it to act

in the future. Currently, the EU just challenges the US in its internationally harmful

decision-making. But one may wonder if after the EU has surpassed the US in its

18

political and economic authority, it will begin to make decisions solely in its own

interest like the US has in the past. While it is currently impossible to predict the

outcome of the EU’s growing power and how it will be waged, two factors lead us to

believe that the EU will act internationally more responsibly than the US. First, the

US is only one nation, so it employs its power for in order to promote national

interests when making decisions. The EU, on the other hand, is comprised of

multiple nations, each with a different set of national interests. Therefore, when the

EU begins to set global policy, it will already have at least twenty-seven nations

attempting to create that policy, which will lead to more internationally-based

decisions. This will reduce the risk that the EU will break international laws when

setting policy. Secondly, while the EU may grow stronger than the US, the US will

probably continue to be a worldwide presence, and thus, will keep the EU’s power in

check.

It is now clear that the EU will become a globally powerful institution and the

international implications will be positive overall. It is a comforting thought that

global policies in the future will not be solely determined by one nation, especially

one that is motivated by selfish gains. After perceiving the wrongdoings that has

been unleashed under the Bush administration, we, as members of the world

community, can all be extremely gratified to know that there is hope in the future of

global policy making in light of the emerging European Union.

19

Bibliography

Richard Portes and Hélène Rey. “The Emergence of the Euro as an International Currency”. National Bureau of Economic Research, Working Paper 6424, Feb. 1998.

Helm and Smith. “Economic Integration and the Role of the European Community”. Oxford Review of Economic Policy. (Vol. 5, No. 2, Summer 1989)

Noury, Abdul G.; Roland, Gerard, Economic Policy: A European Forum, October 2002, v. 0, iss. 35.

20

EU ABC. 21 November 2003. http://www.euabc.com

The EU Observer. 1 December 2003. http://www.euobserver.com/index.phtml

Eizenstat, Stuart E .The Economic Effects Of US Foreign Policy . Financial Times Business Edition, The Banker, June 1, 2003.

Eichengreen, Barry. “European Monetary Unification”. Journal of Economic Literature, Vol. 31, Issue 3 (Sep., 1993), 1321-1357.

Eichengreen, Barry and Charles Wyplosz. “The Unstable EMS”. Brookings Papers on Economic Activity, Vol. 1993, Issue 1 (1993), 51-143.

Fitoussi, J.P. et al. Competitive Disinflation: The Mark and Budgetary Politics in Europe. Oxford: Oxford University Press, 1993.

Gros, Daniel and Niels Thygesen. European Monetary Integration. London: Longman Group, 1992.

Artis, Michael J. “The Unemployment Problem”. Oxford Review of Economic Policy, Vol. 14, No. 3, 1998.

Bean, Charles. “Monetary Policy Under EMU”. Oxford Review of Economic Policy, Vol. 14, No. 3, 1998.

Calmfors, Lars. “Macroeconomic Policy, Wage Setting, and Employment—What Difference Does the EMU Make?” Oxford Review of Economic Policy, Vol. 14, No. 3, 1998.

Dornbusch, Rudiger et al. “The Immediate Challenges for the European Central Bank”. National Bureau of Economic Research, Working Paper 6369, Jan. 1998.

Eichengreen, Barry. “European Monetary Unification: A Tour D’Horizon”. Oxford Review of Economic Policy, Vol. 14, No. 3, 1998.

Frankel, Jeffrey A. and Andrew K. Rose. “The Endogeneity of the Optimum Currency Area Criteria”. National Bureau of Economic Research, Working Paper 5700, Aug. 1996.

Obstfeld, Maurice and Giovanni Peri. “Regional Nonadjustment and Fiscal Policy: Lessons for EMU”. National Bureau of Economic Research, Working Paper 6431, Feb. 1998.

21

Portes, Richard and Hélène Rey. “The Emergence of the Euro as an International Currency”. National Bureau of Economic Research, Working Paper 6424, Feb. 1998.

Soskice, David and Torben Iversen. “Multiple Wage-Bargaining Systems in the Single European Currency Area”. Oxford Review of Economic Policy, Vol. 14, No. 3, 1998.

Calmfors, Lars. “Unemployment, Labor Market Reform, and Monetary Union”. Journal of Labor Economics, Vol. 19, Iss. 2 (Apr. 2001), 265-289.

Debrun, Xavier. “Bargaining Over EMU vs. EMS: Why Might the ECB Be the Twin Sister of the Bundesbank?” The Economic Journal (Jul. 2001), 566-590.

Drèze, Jacques H. “Economic and Social Security in the Twenty-First Century, with attention to Europe”. Scandinavian Economic Journal (2000).

Dyson, Kenneth. “EMU as Europeanization: Convergence, Diversity and Contingency”. Journal of Common Market Studies, Vol. 38, No. 4 (Nov. 2000), 645-666.

Gros, Daniel. “How Fit are the Candidates for EMU?” World Economy (2000), 1367-1377.

Tamborini, Roberto. “Living in EMU: Prices, Interest Rates and the Adjustment of Payments in a Monetary Union”. Journal of Common Market Studies, Vol. 39, No. 1 (Mar. 2001), 123-146.

Taylor, Mark P. “Taking Stock of EMU: Editorial”. Journal of Common Market Studies, Vol. 38, No. 4 (Nov. 2000), 557-561.

The Economist “Rolled Over”. December 5th, 2003. www.TheEconomist.com.

The Economist “Wider Still, and Why”. November 22nd, 2003. www.TheEconomist.com.

The Economist “Europe’s American Dream”. November 22nd, 2003. www.TheEconomist.com.

22

23