For one thing, it is quite clear that the expected benefits will be the greater the more countries join in the contemplated exercise.
A generation ago, Alfred Marshall said that it is difficult for an economist to be at once a good patriot and to have the reputation of a good patriot. Economic sense urges the trained mind to seek national welfare in measures that are sure to be rejected by superficial patriots; enlightened patriotism, for instance, often calls for free trade rather than national barriers. What Marshall said is true still; and more, it is not easy for an economist both to be a good European and to have a reputation as a good European.European patriotism needs to be guided by good sense
Mere enthusiasm will not suffice to accomplish the desired European unity. Enthusiasm, true enough, is indispensable for overcoming the obstacles that still are in the way of a united Europe, but here patriotism alone is not enough. European patriotism — if it is not too soon to use this phrase — needs to be guided by good sense, lest damage be wrought by a well-intentioned but misguided impatience to see things done. This applies especially to the economic realm; and this is why the present writer, an economist who has sympathy and understanding for the efforts toward European economic integration, feels impelled to put the case of economic sense without a sugar coating. In doing so, I do not intend to discourage the political enthusiasm at work in the European endeavor; but I indulge the hope of serving the best interest of Europe by contending against errors and illusions.
Regional Free Trade: A Two-Faced Proposition
Several questions arise and are put here in Order of their importance. The most important is this: In what circumstances will the contemplated common market —whether it be the economic and tariff union of “Little Europe” (the six Messina countries) that is meant by the phrase, or the looser “Free Trade Zone” of all OEEC countries — bring about the expected benefits from a more advantageous trade, a more advanced division of labor, and a general European increase in wealth?It is quite clear that the expected benefits will be greater the more countries join in contemplated exercise. To ask this question is to correct the widely-held unqualified view that these benefits are to be expected in any event; and that any regional removal of tariff barriers, in liberating trade and increasing wealth, would differ only in quantity (not in quality) from a general abolition of trade barriers. In point of fact, this view is quite erroneous, and it is of the greatest importance that this should be recognized.
For one thing, it is quite clear that the expected benefits will be the greater the more countries join in the contemplated exercise. Since the more ambitious proposition, that of an economic and customs union, is even in the most favorable circumstances not likely to be achieved over the whole geographical area, a Free Trade Zone could well cover it (being a mere preference system without a unified external economic policy), it stands to reason that the less ambitious scheme has decided advantages over the more ambitious one.
Moreover, it is obvious that the benefits of an internal trade liberalization are offset to the extent to which barriers are erected against third countries. The smaller a country and the greater its dependence on foreign trade because of the density of population and intensity of economic activity —the rule in Western Europe — the more such a country will be subjected to a wholesome compulsion to encourage free international trade relations and to moderate its own protective policies. Thus Switzerland, the Netherlands, and Belgium are known as low-tariff countries. If now several such countries unite to form a common economic area, there is a certain chance — which is yet to be examined in detail — that a more advanced division of labor and economies of scale will help to increase productivity in that area. Against this chance, there is the danger that economic nationalism, which is more virulent than ever, will make tariffs and other barriers against the outside world go much higher.
Possible Disadvantages
Where such a disadvantage outweighs the benefits — and this possibility is anything but an academic concern in Western Europe — the whole scheme may prove to be a catastrophic misfire. Terms like “Common Market” and “Free Trade Area” become catchwords which serve to concentrate our attention on the internal goings-On and — similar to the catchword of “Empire Free Trade” which Lord Beaverbrook used to propagate a closed Commonwealth economy —excuse the suspicion that it is their purpose to serve as a red herring or to camouflage the whole thing. What happens if the external tariff of a common market is higher than the previous national tariffs of a number of participating countries is that the internal “common market” (if, indeed, it is real and not itself partly fictitious) comes into existence at the cost of a “less common” external market.
The Line of Least Resistance
It is for several reasons very much to be expected that a customs union will adopt a common tariff whose rates are higher than they used to be on national levels. The ever-present danger of increased external barriers is particularly grave in cases where one of the uniting countries is greater than most others, of considerable political weight, and with a protectionist tradition, and where this country refuses to join unless a high common tariff — the natural line of least resistance — is agreed upon. This is exactly what is happening, unfortunately, in the negotiations about the Common Market of the Messina countries, with France as the country which pushes the common tariff up. In consequence, the Netherlands, Belgium, and Germany, which had raised its tariffs — some excessively, only a few years ago — must accept not only considerably higher protection against third countries but even tariffs for raw materials which have so far been duty-free. If this danger, with its very serious implications, cannot be averted, it would be a lot better to drop the whole scheme of a common external tariff, and try to achieve European economic integration solely by the OEEC’s method of establishing a “Free Trade Area,” despite the embarrassing complications (continuance of Intra-European frontier controls, certificates of origin, and the like) which this less ambitious system would entail.
Internal Freedom—External Seclusion
A third point requires consideration if one tries to drop wishful thinking and get a sober idea of the actual possibilities of European economic integration, a point, it is true, which is a lot more difficult to render plausible than those made so far.Even without external barriers, regional free trade may disturb international trade At first sight, it looks like a paradox: Even without external barriers, regional free trade may disturb rather than help international trade. The idea seems less paradoxical as soon as we realize that any system of regional free trade — be it a customs union or a preference system — is two-faced; while it means internal freedom, it brings about external seclusion. While a producer in country A, who so far had to overcome the tariff barriers of country B, is now able to compete freely with the producers there, a producer in country C, which remains outside the free trade system, may have to give way to country A’s producer in country B’s market as he has to overcome a tariff barrier which does not exist for the latter. While one door is opened, another is closed.
Gains vs. Losses
The one thing that matters is thus whether more doors are opened than are closed, whether or not the effect of liberalization outweighs the effect of seclusion. Let us take a concrete example. Let us suppose a common market is established — which Switzerland could, in any case, join only as a member of a Free Trade Zone (a point made recently in the excellent series “Switzerland and the European Economic Integration” [Neue Zürcher Zeitung, Nos. 331and 342 of February 5 and 6]) and the effect is that the Swiss watchmaking industry can enter into free competition with German and French watchmakers in the German and French markets. So far, so good. In this event, those two competing countries will probably have to put up with a considerable curtailment of their watchmaking industries in favor of Switzerland, while in Switzerland the same will happen to other industries. These shifts of industries to the most profitable location, though painful to the affected producers, bring about that increase in over-all productivity which is the purpose of any economic integration. It is, however, quite a different proposition if one Swiss producer found it more profitable, in the past, to buy crude silk from Japan rather than from Italy, but is now compelled to resort to a less advantageous source of supply, as under the new arrangement Japanese silk would be subject to a duty while Italian silk would not. In this case, regional “free trade” would result in the substitution of a less favorable for a more favorable flow of trade. International division of labor would be less advantageous than before, and “free trade” would be little less than the facade of a very clever protectionism.
The more the average benefits to be derived from a customs union promise to outweigh its setbacks, the greater will be the anticipated unshackling of international trade and the resulting improvement in the international division of labor. But if things work the other way, the fusion will be a mere make-believe and quite a disappointment. Which turn events will take depends on the circumstances, which in the case of the present European integration require very thorough examination —more thorough than the heat of preparations so far permitted.
The over-all balance of the integration, when seen from this angle, will be the more favorable, the lower the external tariffs are. It has already been mentioned that the contemplated common market does not look promising in this respect, and this will be hardest on those countries which have particularly close trade relations outside the common market area (e.g., the Netherlands).
Compatibility of Participants
Another important feature which will decide whether the effect of freedom or that of seclusion will prevail is the economic structure of the countries involved. If there is a great similarity, so much the better, for then it will be likely that “inside” producers will take the place of other, weaker “inside” producers and not supplant equally or more efficient “outside” suppliers; in other words, there will be good prospects for an improved international division of labor. If, however, the national economies are complementary rather than similar, the outlook is not so bright, as witness the former economic union of France and Indochina, under which Indochina had to buy the more expensive industrial output of France instead of getting cheaper supplies from Japan. If the sense and purpose of international trade is to allow for a more advanced division of labor, it stands to reason that a customs union of complementary economies will result in an artificial and wasteful distortion of the already existing international division of labor, whereas a union of competing economies permits a regrouping of production which will ensure the desired higher efficiency that an improved international division of labor is expected to bring about.
As far as this is concerned, European integration certainly seems promising. But there is something else to be taken into account: Even in favorable circumstances a fusion will be trade-diverting rather than trade-creating if the abolition of tariffs is riddled by exemptions, with the result that goods which are in any case bought from third countries are duty-free, while goods produced inside the union’s territory remain protected.Trade-creating tariff reductions will hurt inside producers. As trade-creating tariff reductions will hurt inside producers, while trade-diverting reductions operate against outsiders, it is only to be expected that the items which will be freed in the course of a step-by-step abolition of tariffs will be so selected that the over-all effect is trade-diverting rather than trade-creating. If a customs union is to fulfill its purpose, namely, to increase the over-all gross regional product, the abolition of tariffs must hurt, and that is precisely why it is so difficult to get it done. It follows that a common market in Europe can in good faith only be advocated if it provides for as nearly as possible a complete “community.” Otherwise, a general reduction of tariffs for the benefit of all supplier countries would be preferable.
A nearly complete abolition of tariffs, without which a customs union will not yield its full economic benefits, is for political and psychological reasons very difficult to achieve; in addition to this, it is an economic tour de force which has little to recommend it. On the other hand, it has been shown that a too timid advance will fail to produce the full economic effect of the exercise. This is the dilemma of any regional (as against a universal) abolition of tariffs. To mitigate hardships, a very complicated apparatus has been designed at Brussels with the purpose of assisting the necessary adjustments in the affected industries. Apart from the general consideration that such a device will add to the already strong “planning element” in the whole setup, the experience so far gathered in the coal and steel community with such a “death-bed insurance” is not exactly encouraging.
Other Major Problems
As any customs union has two faces, it becomes understandable why this is a proposition in which both free-traders and protectionists hope to win their case. Who actually wins depends, as we have seen, on the way the union is set up, and it is for this very reason that our judgment of the economic merits of the contemplated common market — bound up as they are with the political merits and demerits — must be kept in abeyance. We will not, however, deny that there seems to be more ground for pessimism than for optimism. If the common market is to fulfill its promises, if it is to be a real step ahead toward a genuine and productivity-increasing integration of the various national economies, then it must meet requirements which are far above what has been planned to date and which probably have little chance of being met anyway, as they exceed the limits of what can possibly be done in a customs union. If they cannot be fulfilled (particularly the requirements of low external tariffs and a far-reaching tariff reduction), it would be better to confine the present efforts to the less ambitious scheme of a regional preference system (Free Trade Zone) or to devote the more energy to the liberalization of trade so far pursued in OEEC and GATT. No less strange than the fact that preference systems and customs unions are a field where economic nationalism and internationalism meet, is another: the project of the common market is a combination of tendencies toward both a market economy and economic planning.
Protecting the Inefficient
The story of the establishment of the Coal and Steel Community repeats itself; it is as necessary now as it was before to be watchful lest the “common market” turn into a “common dirigism.” It has already been stressed in another contact that this danger — particularly as regards a European control of investment — must not be underrated. Here as elsewhere, political enthusiasm may well lead to a disregard for economic sense.
Another danger became apparent when the French demanded a “harmonization” of labor cost, in particular, welfare burdens, to precede the actual setting up of the common market; in other words, all other countries were asked to hoist their labor costs (wages and welfare expenditure) up to the French level. It should not be necessary to point out that this demand for an a priori harmonization of labor costs is incompatible with the most elementary conclusions of political economy and is for its economic insight on a level with the request of American protectionists to be shielded against imports from countries with lower wages by a tariff that makes up the difference. No responsible economist has ever claimed that free trade presupposes equal costs of labor (or capital), as this is not even true in a national market. On the contrary, it is free trade that will reduce existing differences of labor and capital cost. This applies even where free movement is limited to commodities and will apply even more when the migration of manpower and the flow of capital are just as free; this, of course, marks the ultimate highest degree of integration which Europe, with all its good intentions, will be able to reach only after long development.
Let us hope we would wrong the propagators of this French position, were we to assume that they are lacking this elementary insight. The problem is not quite so simple. The cost of labor (wages and social benefits) in France, which today appears higher than in other countries (on the basis of the existing rates of exchange) does not indicate a corresponding superiority in productivity; it is even less a measure of productivity than in other countries. French wages and social benefits have rather been pushed up and out of proportion with productivity by political and social forces, particularly in the more recent past, with the result that they have become a spearhead of inflation, as in other countries, only more so. Since France has thus become the country where this process has been going on with most momentum, inflationary pressure there has become stronger than elsewhere, so that the country suffers from a chronic and quite severe balance of payments disequilibrium and its gold and exchange reserves flow to countries with a lower inflationary pressure, in particular, Germany. How bad this is will be seen from the fact that the situation cannot be even tolerably redressed by a system of import obstacles, deliberalization, and export subsidies.
The Basic Problem Remains
Thus the French demand for a “social harmonization” really means something quite different. For one thing, it is guided by the quite correct conclusion that French wage and welfare policies, highly inflationary because particularly oblivious of economic reality, have created a serious disequilibrium in the national economy which must be put right if there is to be anything like a genuine common market.Indispensible minimum of an international balance in the union is to be secured by making the highest inflationary pressure. On the other hand, it implies that equilibrium is to be restored along the line of least political resistance which happens to be at the same time the line of least economic sense. The most reasonable and fair procedure would be for France to adjust its fictitious rate of exchange to the inflated internal cost-and-price structure — in other words, to devalue the franc in the face of all political and rhetorical make-believe, to abolish the system of import obstacles and export aids which will become unnecessary and forthwith keep wage rounds and social benefits within reasonable limits. Instead, the spokesmen of France insist that there will be no devaluation, that the system of import obstacles and export aids must be retained to the maximum extent even in a common market, and that their own wage and welfare policies must be imitated by other countries which have so far been more moderate in sinning.
What this means should be quite clear. It means that the indispensable minimum of an international balance in the union is to be secured by making the highest inflationary pressure — the “marginal pressure” of inflation, as one might call it — the standard for all. Thus “social harmonization” means in the last analysis “harmonization of inflation.” This would set a precedent for all later instances in which one single country would be permitted to dictate the pace in inflationary wage and welfare policies.
An Ugly Skeleton
This example is highly instructive. It indicates the direction in which a solution will be sought in the future common market for a general problem which has from the very beginning been the central problem of European economic integration, a most uncomfortable subject which has again and again been ignored or pushed beneath the surface only to come up again, like a dead body one throws in the river in the fond belief that that is the way to get rid of it. It will not help either to tie stones to it, not even as weighty ones as the European Payments Union. It is again significant to note that this ugly skeleton has been passed over in eerie silence during the recent common market negotiations.
Monetary Discipline Needed
It need not be explained to those who know the story that the real question is this: How can free trade in Europe be conducted with countries which, by their economic policies, allow an inflationary pressure to develop that will disturb the balance between the various national economies and thus create conditions which are incompatible with the restoration of free currency convertibility? That this problem has not been solved, not even by the European Payments Union will be seen from the fact that the EPU can only keep itself going by tolerating contraventions against the principle of free trade, of which those of France are the most serious; by a continuous flow of gold and foreign exchange from high-pressure to low-pressure countries, and by the not unlimited compulsory credit granted by those countries which have external surpluses ; the most important creditor country being Germany. There just is no ersatz for convertibility, or rather for the conditions which alone render the free convertibility of currencies possible, viz., the equal monetary discipline of all countries, unless, of course, a hardly tolerable amount of obstacles to trade or else freely fluctuating rates of exchange are preferred.
In trying to create today a common market — even for capital —in Europe, and in considering it as substitute for the listlessly abandoned aim of convertibility, one should realize that it is impossible to have all of the following three things: free trade, national differences in monetary discipline, and stable rates of exchange. One of them must be sacrificed, as will eventually be found out, and we can only consider which combination is most advisable and likely to be achieved in practice. In other words: What is the best thing to do and what will probably happen if there are serious balance of payment difficulties within the common market? Should uniformity in monetary discipline be aimed at and is it likely to be achieved? Or should a restoration of the balance rather be sought in an adjustment of rates of exchange?
Little Prospect for Sound Action
This should be the subject of a long and useful discussion. However, there can be hardly any doubt as to what would be desirable and what is likely, and it is unfortunately already quite clear that that will not be one and the same thing. It is most devoutly to be wished that a solution be sought in an equal and high monetary discipline by all parties who would take up a determined fight against the inflationary tendencies of our time and thus get ready for convertibility. But this is unfortunately not likely to happen. Now that, furthermore, the latest example of Germany and France has shown how hard it is to get a country to revalue or devalue its currency, even if all circumstances speak for such a step, it is not likely either that the solution would be sought in an adjustment of rates of exchange which would rank second in the order of desirability.
Taking the Brakes Off Inflation
If, therefore, the common market is not to become a farce but a serious reality without a new “seesaw of liberalization,” the most likely thing to happen — in particular, if we think of France — is a solution sought or at least accepted along the line of least political and social resistance, namely, a general adjustment to the highest existing degree of inflation and to the lowest existing monetary discipline. That is the road on which we are already traveling, albeit with brakes which will then disappear. There is another danger that the outcome may be a common inflation.Just as there is a danger that the common market will give rise to common regimentation, with so much less external “community” of markets, there is another danger that the outcome may be a common inflation.
The problem of European economic integration should not make us forgetful of the existing threat of inflation. Fortunately, brakes and counter-forces are not lacking so far. As Dr. M. W. Holtrop, president of the Bank of Netherlands, recently pointed out in a remarkable lecture at Brussels, the most effective and anti-inflationary impulse comes from the fact that a country which goes rather too far in its lack of monetary discipline will run into a balance-of-payments deficit and external illiquidity as a direct consequence. The smaller a country is — let this be repeated — the more it must rely on foreign trade, and the less it is relieved from its responsibility for consequences of its policies, the more effectively the brake will operate. The credit arrangements of the European Payments Union served rather to weaken this brake to some extent. The common market, as it seems at present to take shape, threatens to put it altogether out of operation. Who dares take this lightly?
