What Ails Europe and Japan

The intellectual tradition with which I am the most comfortable argues that politics and economics are two sides of the same coin. Yet it can be helpful to consider the two separately. And just such a distinction helps shed light on developments in Europe and Japan.

The euro is an economic solution to a political problem. The political problem is a function of the end of the Cold War. The problem was the integration of a united Germany into Europe. As a victim of German aggression three times in fewer than 70 years, France needed extra assurances that a united Germany would not pose a threat.

French fears of Germany were really twofold. The first was that Germany would dominate Western Europe. The second was that it wouldn't, that Germany would see its future in the East, where it traditionally had strong trade and cultural ties, rather than the West. Toward the end of the Cold War, German pursuit of Ostpolitik (or East Politics) had already sparked concern.

France knew that tying Germany into a network of economic and political institutions, like the European Community, was insufficient to check a drift eastward, and that stronger measures would be needed if Germany were to become reunited with Western Europe. The French proposed an economic solution to this political problem: Have Germany share its beloved mark with France and Western Europe. West German officials were willing to do almost anything to fulfill a generation's dream of reunification -- even converting the East German mark into Deutsche marks on a one-to-one basis. Voila, the euro!

With a strong Paris-Bonn axis, other officials in what used to be regarded as the European core countries -- like the Netherlands, Austria, Luxembourg, Belgium -- whose economies had already largely converged with the German cycle, also saw their future in participating in greater integration. It will be readily recalled that many German officials were not sympathetic to the Italian bid for membership at the beginning, or warm to the idea of Spain and Portugal joining the single currency. But Germany lost the moral high ground when it had to resort to creative accounting to achieve a narrow interpretation of the Maastricht criteria.

An Irreversible Step

Observers who speculate on the demise of the European economic and monetary union because of the weakness of the euro fail, I believe, to appreciate the political challenge it is meant to address. As long as the two pillars are in place, that is Germany and France, it is difficult to see what any other country would gain by dropping out. Moreover, the costs for dropping out appear high. That country's interest rates would likely rise, as Denmark's recent experience demonstrates, but they would still, like Denmark, remain in the orbit of the eurozone and thus likely feel compelled to shadow the European Central Bank's monetary policy anyway.

One of the truths that follows from the argument that at the heart of the European Economic and Monetary Union is a political challenge is that the solution to many of its problems will be addressed by greater integration rather than less. Using a loose analogy, the eurozone has the Articles of Confederation and needs to evolve toward a Constitution. (You'll recall the Articles of Confederation, which organized the 13 colonies for a successful war for liberation. The confederation was weakened, however, by the lack of a strong central government and a laborious decision-making process.)

Starting with the intergovernmental summit in Nice this December, several European countries, mostly from the old core, will likely push more earnestly and effectively for majority decision making in some areas, rather than the unanimity that now is the case. It is also possible that some sort of executive body will be created, which may at first simply consist of a eurozone chief executive officer and a small staff. It may be more palatable for the markets and the European Central Bank if it is not marketed as a political counterweight to the ECB.

To read Chandler's analysis of the lingering economic woes in Japan, click here.