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Joachim Fels: One money - but many nations

Experience shows that the integration of markets for capital and goods, which will be helped by introducing the euro, goes hand-in-hand with political decentralisation, not centralisation. If anything, political power will devolve from the nation state to the regional level.

This would increase the scope for institutional competition in Europe and should, for instance, result in labour market deregulation and lower taxes on mobile factors such as capital. As a consequence, investment would improve and structural unemployment would be reduced.

When the Maastricht Treaty was signed in 1991, European economic and monetary union was widely seen as a precursor to European political union. Federalists across Europe hoped that merging European currencies would force governments and parliaments to transfer the bulk of their legislative and executive powers to Brussels. Therefore they supported Emu.

The Eurosceptics, including many free-market economists such as myself, opposed Emu because they dreaded (and still dread) the idea of a federal superstate interfering with social and economic policies. These, they believe, would be better conducted on a national or regional level.

The crucial assumption by the proponents and opponents of Emu was - and, in many cases, still is - that monetary union would lead to political union. Yet that assumption is no longer valid: while the introduction of the euro in 1999 is more likely than ever, the chances for a federal political Europe are increasingly remote.

The drive towards political union has stalled. One reason is that politicians with a perceived taste for the federalist approach, such as Helmut Kohl, the German chancellor, find it hard to relinquish to a higher authority the final word on various policy issues. Take, for instance, the German insistence on a veto right for nation states in asylum matters at the European summit in Amsterdam last June. Most other European Union governments are equally reluctant to move from the unanimity requirement in important matters to a majority voting system.

Much of this reflects the European electorate's disenchantment with the idea of transferring political decisions to yet another, higher level of government that is even further detached from local conditions than national governments. This distrust is not just a British or Danish peculiarity. It is widespread, also present in Germany and France, the two countries thought to be the motors of European political integration. The drive towards political union has stalled just when the effort towards monetary union has intensified.

Research on the link between economic integration and political separatism helps explain why politics become more local as markets become more global. In a recent paper, Alberto Alesina, Enrico Spolaore and Romain Wacziarg argue that the two go hand-in-hand.

In a world of trade restrictions and capital immobility, small states are economically unviable since the size of the market is determined by the size of the country. Nation-building or even empire-building makes sense in such a world, as it is the only way to reap the economic benefits of market size. Conversely, in a world of free trade and capital flows, the size of the market is global. Political separatism becomes less costly in a globalised economy. There will thus be a trend towards smaller political units based on cultural or ethnic identities, embedded in an open world economy.

As the authors point out in their paper, there has been a strong positive correlation, from 1870 onwards, between the degree of economic openness and the number of countries in the world. The relationship also holds for the post-war period. Trade volume as a share of world gross domestic product rose by 40 per cent between 1946 and 1995; over the same period, the number of countries increased from 74 to 192. Today more than half of the countries are smaller in population than the state of Massachusetts, suggesting that globalisation encourages political disintegration.

So what are the lessons for Emu? Consider that the single currency secures the internal market, and thus the free flow of goods and services, and enhances the mobility of productive capital - foreign direct investment. Combining this with the analysis by Alesina, Spolaore and Wacziarg, the closer economic integration should militate against a move towards political union. If anything, the trend towards devolution - under way in many EU countries - can be expected to accelerate. With the common market for goods, services and capital secured by Emu, regions will seek to gain a greater say in economic and social policies.

If devolution of power to the regions is the answer, it becomes unlikely that a European federalist agenda of harmonising social security standards, taxes, and labour market regulations can be put into practice.

Nor should it. The various nation states, regions and cities would rather compete for mobile jobs and investment by offering higher after-tax returns on capital. As a consequence, taxes on capital and skilled labour will fall and labour markets will become more flexible. This is what Europe needs to fight structural unemployment. And this is why I have developed from a Euro-sceptic dreading a federalist political Europe into a Euro-optimist. One money for Europe - yes; one government for Europe - no.

The author is senior economist at Morgan Stanley Dean Witter.

Alberto Alesina, Enrico Spolaore, Romain Wacziarg, Economic Integration and Political Disintegration, NBER Working Paper 6163, Cambridge, Mass., September 1997.