Introduction: the European vision

Every stage in the evolution of the EU has been extraordinary – it’s a unique experiment in developing a framework of ties between nation states in order to guarantee lasting peace and prosperity.

The Union has been evolving constantly but the vision has never fundamentally changed. The institutions and politics of the EU are built on an unswerving commitment to fundamental values such as freedom, democracy, human rights; and to peaceful co-operation between the nations of Europe.

However, the EU is now at an even more challenging stage than ever thanks to virtually unprecedented political and economic innovations. First, the newly launched single currency, creating the world’s biggest integrated market; secondly, the historic enlargement by another 10 members, consigning the Iron Curtain to the dustbin of history.

This has been the aim of our greatest statesmen for the past half century:-

Churchill’s ‘Iron Curtain’ speech, 1946: “The safety of the world requires a new unity in Europe.”

JFK in Berlin, 1963: “Freedom is indivisible….When all are free, then we can look forward to that day when this city will be joined as one, and this country, and this great continent of Europe…”

That prize is within reach. But there are great challenges too, so I want to look today at the unfinished business.

The context

EU now on the road to its biggest enlargement since 1973. New members will increase population by 28% to nearly 500m, although the increase in GDP will be just 9%.

[As an aide memoire, the 10 countries are: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia]

Since Ireland at last voted yes to the Nice Treaty last month, the road is clear to final negotiations which will now be able to take place in Copenhagen in December. The Danish Government said to have booked conference centre for a few extra days beyond the 12-13^th – they’re not going to let anybody out until deal agreed!

Still a few difficult areas to agree – agriculture and budget matters are top of the list.

Agreement amongst leaders will be followed by ratification by 25 parliaments, aiming towards accession in mid-2004 or 1 January 2005.

Institutions and constitutions

The Nice Treaty is better than nothing, as institutions designed for 15 clearly wouldn’t work for much larger number of members, but it is flawed. It didn’t go nearly far enough in institutional reform or promoting closer integration.

For example:

European Council: decision-making is more unwieldy than ever, post-Treaty. It failed to extend QMV, and blocking coalitions are easier than before. Majority threshold urgently needs to be reduced to, say, 2/3 (from 74%) to un-jam decision-making.

European Commission: reforms were makeshift, and will need to be revisited soon – including the number of commissioners and the issue of rotating membership for smaller countries.

ECB: Will have the same ‘numbers problem’ as the Commission on its Governing Council as more countries join Emu. One of several ECB reforms that are either necessary or desirable.

The point is that recent constitutional changes, those introduced through the Maastricht and Amsterdam and Nice treaties, have taken us much further forward in economic integration than political integration. It has been a dangerously lopsided evolution.

One of the great ironies of the debate conducted in some parts of the media in this country is that the concern is that Europe has advanced too far too fast, whereas for me at least, it hasn’t advanced far enough or fast enough.

The subject of reforming the European Union has been receiving much press attention in recent times, and particularly with the constitutional convention. The debate tends to operate on the basis that we are trying to duplicate something that has gone before, or that we are going to try to deal with some model that has been provided to us by history. I thought that the whole idea was to create something new.

The European Union is sui generis. It has a unique institutional framework, fitting no established constitutional model, and it is that which we are trying to further develop and advance.

What worries me is that we seem to be living in a Europe today that has not provided leaders who understand, let alone are imbued by, the spirit of the achievements which have already taken place in the European Union, which are quite remarkable.

But we are also aware that reform of the European Union’s institutions is critical for the Union’s future. The institutions were designed at a time when the Union’s membership was less than half its present size. They are already creaking beneath the weight of fifteen member states. They will not bear the strain of enlargement to a possible thirty members in future without substantial changes.

The aim has to be further sharing of sovereignty, and not a return to the dead end of intergovernmentalism, which Europe’s leaders were so keen to put behind them after the war. This is the kind of Union the accession countries want to join.

The old model of inter-governmentalism is one where nation states debate amongst themselves and reach agreement, on a voluntary basis, without any question of majority voting and without a single civil service, proposing the ideas and the policies. This is a failed model. It led to hundreds of years of distress and discord in this old continent of ours.

I believe in a concept of gradually, and in defined areas, sharing sovereignty. In certain areas there should be majority voting, and the policy should come from a civil service, the Commission, dedicated to producing European policies, in the interests of all the citizens of the Union.

The key to the EU structure is and should remain the Commission. It is the heart of the EU supranational system, and it has been uniquely responsible for the EU’s major successes.

The European Commission, often in the teeth of opposition from virtually every member state in the Union, has driven the liberalisation process in Europe. It has been central to the development of the internal market, without which this continent would be a total economic backwater.

It has played a pivotal role in conceiving and executing the single currency’s development, which I consider a major success, and also the whole process of enlargement.

Its critics argue that it is an outdated bureaucratic, corporatist relic, and that it should be downgraded to a secretariat for the Council of Ministers, and made subject to democratic control exercised by national parliaments and the European Parliament. They are profoundly wrong.

Of course it is a bureaucracy which should not make laws. But it does not make laws, it merely proposes laws. The democratic deficit is a problem to be dealt with by parliaments – national parliaments and the European Parliament – and by the proper control by national parliaments of their ministers in the Council of Ministers.

Recent inter-institutional power conflicts are driven less by the needs and tasks of the Union, or legitimate concerns about promoting transparency and democracy, and more by the tendency of existing bureaucracies to struggle over their own prerogatives of power, to wrestle back powers in one area or another from the Commission. Survival of the Commission’s role is vital, therefore, to the future success of the EU.

If it recedes into inter-governmentalism, all will be lost. In an inter-governmental system, fixed positions are negotiated based not on Community but on national interest. This would result in the most powerful states ultimately creating a directoire of interests and creating their own dynamics, which often would create conflict of one kind or another.

This is one of the key issues for the constitutional convention, which will continue its work until June. It has got much further than cynics expected. Few would argue with some of its preliminary conclusions, such as incorporating the EU’s Charter of Fundamental Rights into a constitution to give it legal force, or simplifying the EU’s legal jargon.

The fundamental question of what kind of Union it will be is still wide open, though. To illustrate my point, I want to look more closely at one area where we have inter-governmentalism and it is failing.

Foreign policy

I think that it is imperative for global peace and security that the EU should be a major factor in the global balance of power. This in turn necessitates a common security and foreign policy developing far more effectively that it has to date.

Opinion polls show the public sees a common foreign and defence policy as a key task for the Union. But there’s a huge gap between these expectations and delivery.

It was a serious mistake to inter-governmentalise the Common Foreign and Security Policy and place it under the Council’s authority. We could have moved much more slowly and cautiously, but with the Commission in the driving seat in a way which would have been more effective. The Commission should have been used as a central vehicle for that policy area. The integration of foreign policy, security and defence policy and home affairs and justice, needs to be addressed.

At the moment our structures do not provide the EU with any real prospect of developing a policy that really works. They are confused and reactive. They do not create any diplomatic leverage.

There has been some improvement in EU policy in the recent past – contrast the humiliating disagreement over Bosnia in the early 1990s with the consensus over action in Macedonia in 2001.

But one major example of the EU’s relative irrelevance to unfolding world events is in regard to the Israeli/Palestinian conflict. It is readily apparent that Europe should and could be relevant here. Yet it is abundantly clear that even the Palestinians recognise that the only important external interlocutor, when it comes to the crunch, is the United States. That this should be the case when the EU is the largest contributor of economic aid to Palestine is surprising to say the least.

A large part of the explanation lies in the fact that Mr Solana, who is himself a very good man, works for the Council of Ministers rather than being a Commissioner. This is a recipe for failure. Some big member states want to see a President of the Council who would retain the foreign policy role. But the tried and tested method of developing policies through the Commission in the common interest is the only way to proceed and is vitally important for the smaller Member States.

As things stand, the effectiveness of European foreign policy depends on the effectiveness of the individual. It’s essential to get away from the short-term pressures of the rotating Council of Ministers presidency. We also need better co-ordination, clearer priorities and more diplomatic resources based in Brussels rather than national capitals.

Importance of reform

Wherever you stand on this debate – retreat into inter-governmentalism versus further sharing of sovereignty – the importance of institutional reform cannot be underestimated or ignored.

The world badly needs balance and Europe can provide some of this balance only if we combine far more effectively that we already have. Individually even the most powerful of our Member States can’t pretend to affect global events significantly unless they do so in concert with the other Member States.

The story of Europe is not simply, not even mainly, about the bread-and-butter economic issues. The tale is one of institutional creativity and political vision, and there is much more of it to unfold.

Jean Monnet keenly understood the importance of sound institutions and the potential influence of personalities when he stated that “Nothing is possible without men, but nothing is durable without institutions.”

With the resounding exception of EMU, the European Union has made precious little progress in deepening its scope during the 1990s.

And yet there is a surprising degree of support, it must be said, however much one might not expect this from some reports in newspapers, there is a surprising degree of support for further European integration amongst the citizens of Europe. It shows how sensible they are, notwithstanding the barrage of publicity and propaganda that they are subject to about the institutional and personal wrangling, which is so negative and unconstructive. For example, a recent Euro barometer survey showed well over 50% of European citizens in favour of a European constitution, with majorities in favour of such a move even in Denmark and the UK.

The discussion should not therefore be allowed to sink into the morass of institutional detail, the jargon of QMV and Lisbon Process and Stability Pact. Without an emotionally inspired vision, or somebody to inspire that vision in the peoples of Europe, how can we hope to cultivate the response that is now needed for the formidable challenge and the moral imperative of opening up the enlargement process to those who, through no fault of their own, could not participate in the original design?

That emotional vision is not something to be ashamed of, not something to be derided as in some way failing to be a “pragmatic” response to the events of modern times. Emotion is part of politics, and so is vision. And nobody is talking of these super-state models that are sometimes postulated.

We will always be what we are, as national of our member states, and we will be proud to be what we are. We will continue cheering our own teams on a football field, and we will continue to feel just as great an affection for our own place as we did in the past, but perhaps within a different context. More importantly, essential aspects of sovereignty in significant areas will remain in the Member States

Enlargement will seriously challenge the institutions of the EU. They are not the ones anybody would design, starting with a blank sheet of paper. Adding up to 12 more countries eventually will make more urgent than ever the need to speed up decision-making, diminish the threat of the national veto, and pool sovereignty effectively.

Institutional reform is about enabling efficient decision-making. Effective institutional reform is crucial for ensuring the European institutions do not collapse or seize up and fail to function.

To date, much of the debate about institutional reform has been academic and sterile, focusing on the mechanics of the reforms, how decisions will be taken.

While discussing the minutiae of the reforms, it is important not to lose sight of the real policy objectives – which decisions must be taken, and why must those decisions be taken. Institutional reform, therefore, is vital, but it is the tool, the framework to enable decision-making on the common items of the policy agenda.

Robert Schuman said in 1950, “Europe will not be built at a stroke, nor constructed in accordance with some overall plan; it will be built upon concrete achievements, which will create a de facto solidarity”.

This solidarity, notwithstanding much that one reads, has been largely achieved. The challenge now is to build on it. Now we need to articulate, with greater clarity, what our vision for the future actually is.

I believe having a constitutional document is one way of doing that – defining in broad terms where we are going, no longer having an undefined destination, but having a defined destination, clearly explained to the peoples, all the peoples, of Europe.

This does not mean that we are creating a single state, nor does it mean that we are retaining the untrammelled powers of national sovereignty of the nation state. It means that we are developing our own Europe, a different Europe, which is not easily compartmentalised or structured in the terminology of the sound bite or the negative headline.

The economic challenges

The approach of enlargement has brought us closer to a decision point on the institutions of the European Union, and hence our political vision of Europe. Enlargement is also creating economic challenges and opportunities.

On the positive side, enlargement will create the world’s biggest economic unit, creating scope for economies of scale and improved competition and efficiency as the new members become more closely integrated.

The economic convergence of new Member States to existing members is likely to occur, just as in previous enlargements. In 1960 the later ‘poor’ members had GDP/head equal to 40-60% of the EU15 average; by 2001 Ireland was at 117% of the average, Greece 68%, Portugal 76% and Spain 82%. The lesson is that the accession of poorer members will not impoverish the EU, but rather that their membership will enrich us all.

However, the gap in economic development is larger this time: accession countries have GDP/head 30-50% of EU average. (It ranges from about Eur5,000 in Romania to Eur 17,000 in Slovenia.) Economists estimate the catch-up to low-income EU countries such as Greece might take the Czech Republic 10-15 years but Romania 40 years.

Nor are they fully-formed market economies – their economic structure remains very different from EU15 – for example, more heavily agricultural and (traditional) industrial, with much less high-tech industry and services.

And the bar is higher – they are not joining a simple customs union but an increasingly fully integrated market with a single currency. Most aim to join EMU as rapidly as they can.

They stand at an advantage in terms of attracting inward investment, with low wage costs, relatively skilled labour and physical proximity to the core of the European market. The investment is vital for them in terms of transferring technology, managerial know-how and export links to the main EU markets.

Some have already enjoyed a surge in direct investment. The share of central and Eastern Europe in global FDI has jumped in the past two years to reach 5% – which is, of course, a challenge to those Member States which have traditionally been the main recipients of foreign direct investment.

How else can the accession states ensure that repeat Ireland’s or Spain’s catch-up? They need more than international openness to attract investment and boost trade.

They will also need key domestic policies such as: a stable macroeconomic (and political) environment; improvements to their education and skills levels; an improved physical infrastructure; policies to aid business such as lower utilities & telecoms costs (appropriate liberalisation and regulation), marketing & FDI services, and tax reform.

The economic integration will take place, sooner or later, but won’t necessarily be a smooth process. Some big problems need to be overcome at the negotiation stage, such as payments under the CAP.

Currently there is some variation in the importance of the agricultural sector between Member States, even the biggest. Agriculture accounts for less than 2% of UK GDP but 3% in France (and more for Greece). What’s more, their farm lobbies have different degrees of influence. Hence the recent spectacle of Tony Blair and Jacques Chirac dramatising their genuine disagreement over CAP reform for the purposes of domestic consumption.

But in most of the 10 new Member States agriculture is more important, running from about 3% in the Czech Republic to about 5% of GDP in the Baltic States. However, this understates the divergence because their agricultural sectors are inefficient, and a much higher proportion of the workforce is employed on the land.

This is a huge headache for Poland, for instance, where agriculture accounts for 20% of employment. The more rapidly the eastern European economies integrate, the faster this ratio can fall but it is easy to see why negotiations over the extent to which CAP supports should be extended are going to be thorny. And while Britain would like to use enlargement as a lever to reform the costly and inefficient CAP, France is clearly of a different opinion.

Agriculture just the most obvious of a whole range of structural adjustments that will be demanded by enlargement. Another is joining EMU.

The accession countries are mostly eager to go ahead and join the single currency but it will be problematic for them – the kinds of adjustment that worry UK sceptics actually do apply to the new member states.

In particular, the level of the exchange rate is a real worry. Economic convergence requires joining at low level which appreciates over time as the economy catches up in its level of prosperity. Does this open up the possibility of future adjustment crises if they fix their exchange rates irrevocably too soon?

For instance in Hungary, the public sector debt is more than 50% of GDP, the fiscal deficit is about 6%, growth is 4%, consumer price inflation is 5.5%. The exchange rate is pegged to the euro with a wide band of plus or minus 15%, but the forint is now strong within that band, in part, because Hungary’s short-term interest rate is 9.5% compared with 3.25% for the European Central Bank.

Hungary has set a very optimistic timetable for fiscal convergence, to bring its debt and deficit into line with the Maastricht criteria. Even if it achieves that, it will be faster growth, higher inflation than the EMU core, and also the recipient of substantial capital inflows. These conditions – not the recipe for exchange rate stability – will remain in place for some years beyond the date at which they would like to join the single currency, in 2005.

Differences in economic structure certainly don’t preclude membership of the single currency. But they do place a greater burden of adjustment elsewhere. For the accession countries that points to much more structural economic reform than we have seen so far.

Monetary union

So far I’ve spoken about the challenges facing the new member states, but there are equally daunting challenges ahead for the rest of us.

The launch of the Euro has been a tremendous success.

Despite the scale of the operation and the potential for confusion and delay, there was none of the feared chaos with the introduction of Euro notes and coins nearly a year ago.

What’s more, putting the euro physically in people’s hands is without doubt a hugely important symbolic step. Nobody should underestimate, either, what the public’s swift acceptance of the new currency signifies about their belief in the reality of European integration.

Consumers are suspicious that shops have used the physical introduction of notes and coins to raise prices this year, and research by several of the central banks has found small one-off rises of this kind. It is clearly a one-off, as consumers well understand despite the media attention. A Euro barometer poll has recently found that 75% of respondents in the Euro zone are happy with the Euro.

Surveys also show that prices for a wide range of goods in different euro-area countries had already started converging towards the lowest prevailing level. This process is undoubtedly still in its early stages.

The prize offered by the creation of a single currency is that it will create a genuinely integrated market helping Europe match one of America’s biggest historical economic advantages, the scale and depth of its domestic market. The EU as a whole, even before enlargement, has a population of 375 million and GDP of $10 trillion, compared to a US population of 280 million and a GDP of $8 trillion.

It’s still early days but the signs are that industries are reshaping themselves to adjust to a truly European market and take advantage of the opportunity to become more efficient.

One sign is the big increase in trade between member countries. In most cases the share of exports going to other countries in the euro area has jumped by three or four percentage points in two years, which is a significant change. For example, France’s trade with the rest of the EU has risen from 28% to 32.2% of GDP between 1998 and 2001. This pattern almost certainly reflects a big expansion in trade in components, as companies reorganise their operations on a truly Europe-wide basis.

Another aspect of this reorganisation is the wave of mergers and acquisitions when the Euro was launched. Restructuring is an inevitable result of the creation of a genuine single market.

In many industries the EU has more centres of production than the US. Manufacturing plants in Europe, geared towards national markets, correspondingly tend to be smaller and less able to exploit economies of scale. This will probably change in the direction of the specialisation that’s typical of American states. Specialisation is what will boost efficiency and growth.

Yet of course, adjustment to EMU is posing a few problems for its existing members. The one that is getting the most press right now is the stability and growth pact.

The undiplomatic intervention by Romano Prodi has given it a new nickname, the Stupidity Pact. Why did he speak out? Because politicians in France and Germany essentially unwilling to abide by it in its current form – and that means the pact as its stands isn’t working politically.

But the ECB was right to insist, shortly afterwards, that the stability pact is an economic necessity. Without an agreed mechanism whereby every member government has to limit its budget deficit, the common monetary policy is unworkable – because one excess fiscal deficit would mean tighter monetary policy, higher interest rates for everybody.

That’s the last thing Germany needs right now, as Chancellor Schroder ought to appreciate. It’s why Germany was so insistent on creating the stability pact in the first place.

It is therefore urgent to restore the credibility the pact. One possible compromise would be to make it a rule for the whole business cycle without any set limit on the size of the deficit in a single year – this is not without dangers in terms of imposing fiscal discipline but it would mean governments did not find themselves having to cut spending or raise taxes during an economic slowdown, in a destabilising way.

Deficit limits could also be related to the level of public debt relative to GDP, as that has a direct bearing on the sustainability of the government’s fiscal position, but such an amendment would be opposed by high-debt countries like Italy or Belgium.

But it’s not obvious that reform of the pact is either feasible or even needed. Of course the French, German and Italian governments would rather not raise taxes or cut spending when their economies are weak, but if they had corrected their structural budget deficits much earlier, when their economies were strong, they would not be in this situation today. They must tackle the high underlying level of spending next time an economic upturn makes it practicable, especially on pensions and welfare given their unfavourable demographic trends.

It’s often said that managing fiscal policy is the Achilles heel of monetary union. But co-ordination of monetary and fiscal policy is difficult at the national level too.

The claim sometimes made that there is much more fiscal flexibility within the US is simply false: individual US states have far less freedom to make their own fiscal adjustments than the nation states of Europe within the Euro. Most American states have to achieve a balanced budget over a one or two year horizon. Members of the European single currency will have to accept budget discipline too.

The economic reform agenda

Why is the stability pact such an issue at the moment? It’s because of the disappointing growth performance of key EU economies. The global economic slowdown has contributed to extremely sluggish growth in the core European economies apart from the UK.

GS forecasts are somewhat on the gloomy side of consensus. They foresee Euro land growth of 0.7% in 2002, after a slow enough 1.5% in 2001, and little pick-up through next year either. The picture would be bleaker still if government spending were not rising to offset some of the weakness in private spending and investment. Little wonder governments are unwilling to follow advice of the Commission or the ECB to cut back in order to satisfy the stability pact.

This is not in fact an unusual pattern. In a typical European business cycle it does take two or three years for GDP growth to recover back to its trend path. The question is why is growth in so many Member States stuck in a long-term rut? The answer is that the growth potential is lacklustre.

It is rather fashionable, since the NASDAQ collapse and WorldCom, to point out that Europe outperformed the US economically before the 90s boom, with the implication that perhaps we will now return to that state of affairs, post-boom. However, even the biggest pessimists about the US believe its potential growth rate is 3-4% a year, compared to around 2% in Euro land – and only 1.5% in Germany. This doesn’t depend on silly assumptions about technological improvements. These are consensus estimates based on demographic trends and the decade-long productivity record in each case.

The bottom line is that the trend rate of growth in the United States is at least equal to the best growth performance achieved in Europe in recent years.

So it is no surprise that economists find themselves in rare agreement on the need for further structural economic reforms in much of Europe. After all, the experience of some member states such as Ireland and the Netherlands has proven how dramatic the effects on growth of supply-side reforms can be.

Depressingly, it’s 20 years since the German economist Herbert Giersch coined the term euro sclerosis and it’s with us still. It’s difficult to be optimistic about the commitment to key reforms in the big Member States because even though some politicians do speak of the need to reform expensive pension and welfare systems, for example, they have not won the battle of public opinion.

As I said earlier, the signs are in figures on trade and investment that businesses are responding to the opportunities the single currency is offering them. Throughout the late 1990s, when it was clear the Euro would become a reality, they invested heavily across EU borders in order to take advantage of the coming to fruition of a single market. In 1999 and 2000 flows of FDI inside the Euro area accelerated dramatically, while they declined in the non-Euro countries of the EU.

Restructuring is an inevitable result of the creation of a genuine single market. In many industries the EU has more centres of production than the US. Manufacturing plants in Europe, geared towards national markets, correspondingly tend to be smaller and less able to exploit economies of scale. This is precisely the source of the economic gains predicted from the creation of the Euro.

Tapping into the potential for greater efficiency offered by the single currency will be disruptive, sometimes painful. Some jobs will be lost even though many more will be created.

This adjustment will be essential, though. Without it there will be no market integration and improvement in productivity as a result of the single currency.

We already have some examples of what market liberalisation can achieve. For example, In countries like the UK that have gone down this road regarding energy supply already, the households have seen their gas bills fall by up to 15% in five years, for instance, while the producers are selling twice as much gas as they were before the liberalisation process started.

Whatever the hurdles in particular markets, whether it’s energy or financial services, the blue touch paper on economic reform in general has been lit. Businesses and consumers are already responding to the new opportunities they can see.

Enlargement will increase the pressure for economic reform. Just as it will make further institutional integration essential, so with the structural measures needed to achieve economic integration.

We must certainly hope so, anyway, for these are changes that are desirable in themselves. They are vital for a Europe that is less sclerotic, and more dynamic, politically and economically.

The prize is enormous – it is, just as it always has been, peace and prosperity for the half billion people who live on this continent. And, as always, in seeking that prize, the status quo is not a viable option.

This is the text of a speech first delivered by Peter Sutherland as Deans Seminar of Said Business School