ARTICLE

Some Comments On: European Economic Integration

AUGUST 01, 1958 by WILHELM ROEPKE

Professor Roepke teaches at the Graduate School of International Studies, the University of Geneva. This essay was a lecture to the Tenth Anniversary Meeting of the Mont Pelerin Society at St. Moritz, Switzerland, and was first published in Modern Age, Spring 1958.

 
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.

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? 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 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. 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. 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 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. 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., 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. 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?