Introduction – Does it Pay to Pay Less?

Whither Europe? The European Union began as the project of leaders hoping to create an economically and politically harmonized Europe. A centuries-long legacy of continental conflict and the devastation of two world wars spurred leaders to explore the possibility European integration. France and neighboring countries especially feared the resurgence of a militarily and economically potent Germany. Precluding the resurrection of a Europe divided by balance-of-power politics, European leaders moved to realign national interests in accordance with the interests of a supranational community. This began with the French-led creation of the European Coal and Steel Community (ECSC), a common market for coal and steel, in May 1950, and culminated in the agreement that birthed the Euro; the ratification of the Treaty of Maastricht in 1993 by 12 nations.[i] This treaty outlined convergence criteria for member states and established the euro as the common currency. To join, countries would have to demonstrate price stability, not allow government deficit to exceed 3% of GDP, keep government debt below 60% of GDP, maintain long-term interest rate stability, and sustain a stable exchange rate.[ii] The essence of the European Monetary Union (EMU) project lay in the supranational consolidation of monetary policy; it was promoted as an effort to integrate exchange rates, reducing transaction costs, eliminating exchange rate uncertainty, to encourage tourism and foreign direct investment.  Project organizers promised an increase in global competitiveness, citing the potential for increased labor mobility and lower costs of migration. While the goals of the EMU were to merge and individually strengthen member states’ economies, its creation glossed over disparities between core and peripheral economies. Despite concerns that a single monetary policy would not best suit the needs of individual countries’ economies, the project advanced. Proponents argued that the vision of a politically unified Europe contained the unspoken promise of eventual economic convergence.  They assured skeptics that through political cooperation; future difficulties in aligning countries’ economies could be resolved.

For experienced economists, this issue of economic convergence was déjà-vu all over again. Mourlon-Druol (2010) notes that while there existed no precise analogue for a monetary union among sovereign states, virtually the same debates took place concerning convergence throughout the late 1970s with the establishment of the European Monetary System (EMS).[iii]  The French and the Italians favored the economist argument: economic convergence would follow monetary union, while the Germans believed that economic convergence was a prerequisite to monetary union.  Following the abandonment of the gold standard in 1971, exchange rates moved unpredictably. In the 1970s the French and the Germans under President Valery Giscard d’Estaing and Chancellor Helmut Schmidt established the Snake to replicate the stability that the gold standard had elicited. Members’ currencies would float against each other on foreign exchange markets, but against another member’s currency, member governments would only allow a certain level of fluctuation before intervening to restore the exchange rate. Stability among member European currencies would encourage trade among European countries due to their interlinkages. However, it pitted the central governments against the weight of currency markets. After the Snake’s failure, European leaders pursued another method of aligning European economies: the EMS created a currency unit, the ECU (European Currency Unit), a weighted average of member currencies tied to the size of their economies. EMS currencies could float within 2.25% of the ECU, with a broader range for weaker economies, but would float freely against the rest of the world’s currencies. Ultimately, the EMS became a victim of its broad mandate: the European economies proved too divergent for the system to manage.  Following the collapse of this system, one would expect the disparate countries of Europe to abandon the idea of a single European economy. But leaders only became more determined to jointly harness the economies of Europe, and thus the Euro was born.

Economic theory fragmented on the role of governments under a shared currency. One theory, Robert Mundell’s optimal currency area, argued that countries must fulfill three requirements to feasibly share a currency. The countries must have a high degree of integration; they must be in common contact with each other, largely through trade. Sharing a common currency can help to reduce the costs associated with trade such as the conversion costs of different currencies. The second criterion he highlighted was that two countries should not have a high degree of asymmetry. When two countries produce similar goods and services, like the states in the United States of America, they will require similar economic policies that make it a beneficial for them to form a union. Finally, countries should have a mechanism in place to correct for divergences. If Europe proved to be an optimal currency area, then it would not need a central government to bring the different countries into alignment.

The opposing view was that a single currency would induce economic convergence. Over time, a strong central authority would develop in response to needs for bureaucratic organization to manage a continental economic entity. The Euro followed this pattern of development. After establishing the institutions necessary to facilitate everyday European commerce, a central government would emerge in Brussels before Europeans were any the wiser.

[i]  Shigeyuki Hamori and Naoko Hamori. 2010. Introduction of the Euro and the Monetary Policy of the European Central Bank. Singapore: World Scientific Publishing Company, 2010. eBook Collection (EBSCOhost), EBSCOhost (accessed October 14, 2015).

[ii] European Commission Economic and Financial Affairs, “Who can join and when?” (accessed January 16, 2016)

[iii] Edmond Mourlon-Druol. (2014). “Don’t Blame the Euro: Historical Reflections on the Roots of the Eurozone Crisis.” West European Politics, 37 (6). pg 1283.