Abstract

“Democracy … is a charming form of government, full of variety and disorder, and dispensing a sort of equality to equals and unequals alike.” Plato “If we cannot end now our differences, at least we can make the world safe for diversity.” John F. Kennedy

Events in Europe have been moving so fast that it is proving hard to keep up with them. They are, moreover, unfolding on all sides of the continent. Remarkable progress has been made in Western Europe toward economic and monetary union, a process that has gained great momentum and dynamism in recent years. But even more remarkable—at least in the sense of being unexpected—have been the events that began in Central and Eastern Europe approximately two and a half years ago, continued in the republics of the former Soviet Union, and are still evolving, from some perspectives (politics) at a startling pace and from other standpoints (economics) at a sometimes frustratingly slow speed. These events are lending an extra dimension to continental economic integration by raising the possible need for multiple tracks, or for “I’Europe á plusieurs vitesses” (a Europe at several speeds), in the process of building an economically unified Europe.

The progress that has been made to bring down national economic barriers in Western Europe and the reforms currently being undertaken in Central and Eastern Europe are closely related. But whatever the degree of closeness in their relationship, it is clear that an important page of history is being written: for the present and the foreseeable future, neither the western nor the eastern front is likely to remain quiet. History should also note, however, that important though these developments are, they are part of an even broader evolution in the world economy. The efforts toward European integration—the goal being a Single European Market by the end of this year—and those toward European economic and monetary union represent the outer edge of a long process of growing international economic interdependence that has been under way—albeit, with recurrent intervals of progression and retrogression—for more than four decades.83

Progress in Europe owes much to the establishment of an international code of conduct governing financial, exchange, and trade relationships in the wake of the Second World War.84 But Europe has also contributed much to the design, development, and implementation of that code. And as this paper will make clear, Europe continues to contribute to the international order on a wide range of issues.

To analyze this broad subject of integration, this section first addresses the setting against which the notion of an integrated Europe that can accommodate nations at various speeds or on several tracks must be examined. Second, it examines the country differences that have given rise to the desirability or inevitability of potentially diverse approaches to an integrated Europe; the central focus of this discussion is the “peripheral” economies, those that appear unlikely to achieve complete integration within Europe on the current schedule. Third, the fundamental issues to be addressed when taking a differentiated approach to a common goal are presented. Next, the characteristics of the Single Market are briefly discussed, particularly as seen from its periphery, and the policy constraints that result from participation in an integrated system are addressed. The events in Central and Eastern Europe and Eurasia are then placed within the framework of European integration. Finally the section examines Europe’s ongoing contribution to the international economic order in the context of its integration. The paper concludes with a few remarks pointing out the limitations of a differentiated approach to economic integration, showing how the need for policy coordination and convergence can conflict with the need for national autonomy, especially when the structures of economic activity, the stages of development, and the levels of national wealth differ across the countries.

Setting

Efforts to create an enlarged market—a Common Market—in Europe go back more than three decades. The Treaty of Rome that established the European Economic Community (EEC) and launched the Common Market was signed in 1957 and went into effect in 1958. A precursor to this important covenant had been an even earlier agreement establishing the European Coal and Steel Community (the Treaty of Paris of 1951).

The first stage of integration encompassed the Europe of the Six (Belgium, France, Germany, Italy, Luxembourg, and the Netherlands), which sought to create a large, unencumbered, and tariff-free market where production and economic transactions would take place according to comparative advantage and where economies of scale could be exploited across national frontiers. From the very start, issues arose similar to those currently under discussion—issues concerning the implications of diverse economic structures and uneven development across the European countries for the feasibility of a single approach to the unification process. Though there were obvious differences among the Europe of the Six, the question of country differences acquired particular relevance with the potential enlargement of the EEC to include the rest of the western European countries, particularly those in the southern region of the continent.85

Since that early period, Europe has nearly transformed itself. The scope of the European Community has expanded to encompass the Europe of Twelve (the original six members plus Denmark, Greece, Ireland, Portugal, Spain, and the United Kingdom). And the pace of the integration has accelerated, as made evident on the monetary front by the establishment of the European Monetary System and the ongoing plans for European Monetary Unification, including those for the creation of a European Central Bank.86 On the general economic front, the pace is evident in the effort to establish a Single Market by the end of 1992.

As if these were not sufficiently ambitious goals, more daunting challenges lie ahead for Europe: reforming the economies in Central and Eastern Europe, including republics from the former U.S.S.R., and accommodating those reforms in the continued evolution of European economic integration. The outlook for Europe, therefore, depends on a diverse group of countries, indeed. And yet, rarely, if ever, have better conditions prevailed for an effective (voluntary) integration of the continent at large.

Meaning of Country Differences

The whole question of an integration requiring separate tracks or speeds of implementation presumes that national economic circumstances are sufficiently diverse to warrant such an approach. In its simplest version, the question presupposes that two basic country groups exist: a “center,” or a core of countries with enough similarities to assume a common approach and schedule for economic integration; and a “periphery,” a set of other countries with characteristics that suggest a different approach—typically less ambitious and slower.87

At first impression, the term periphery connotes a region of limited influence with regard to the center. A related interpretation relates periphery to the size of those economies, in the sense of their being small. Since the relatively large countries can be seen to determine the nature and direction of the international economic system, the small countries, with little, if any, systemic influence, would represent the periphery. In certain other contexts, center and periphery conform to the dichotomy often made between North and South. But when it comes to the economic domain, the term periphery relates more to size than to geographical location.

A possible set of distinguishing criteria can be developed that classifies economies according to the degree of flexibility they exhibit to external shocks, or more broadly, to external influences. To one extent or another, all economies are open, but not all of them exhibit the same degree of resilience. Another possible perspective would be to distinguish by degrees of economic development, though such a criterion may not be very useful for particularly homogeneous groups of countries. The merit of such a perspective, however, is that it emphasizes that the issue of peripheral countries in an enlarged common market does not differ conceptually from that of developing countries in the broader, interdependent world economy.

All these possible classifications are among the factors that motivate the debate over the pace of integration in Europe. In fact, the criteria often reflect the fact that some of the Europe of Twelve joined the European process at a relatively late stage and with relatively inflexible economic structures. Thus, it might have been considered unreasonable to expect them to move on the same track or at the same speed as those that began with relatively uniform situations and had already undertaken many of the measures required for integration.

As a first approximation, a periphery typically includes economies with some or all of the following features: high levels of protection from external competition; relatively inefficient industries, characterized by small size and less advanced technology; overly regulated and inflexible financial markets; and rigid labor markets with relatively low productivity. By these criteria, the Single European Market will encompass peripheral areas or regions. (The phrase “areas or regions” is warranted since not only countries, such as Greece and Portugal, can be considered peripheral; areas like the Italian Mezzogiorno also qualify.)

As noted above, the distinction between central and peripheral economies is relevant not only in the European context. A European integration at various speeds recalls issues similar to those that arose in the international economy when it agreed that global economic integration could occur at different rates for different countries. A very clear illustration of this principle is contained in the Articles of Agreement of the International Monetary Fund. When nations join the institution and subscribe to the code of conduct contained in the Articles, they make a commitment to eliminate exchange restrictions. But the Articles also allow for the temporary retention of such restrictions if an actual or potential balance of payments problem would result from their removal. Countries that avail themselves of such provisions are in effect allowed to reach conformity with the Articles of Agreement at varying speeds and according to their particular circumstances.

It must be noted, however, that the difference between central and peripheral economies is a matter of degree, not of essence. For example, in the European Monetary System, even an economy as large and advanced as Italy may be considered peripheral relative to Germany, the nominal center of the system.88 And in the European Community, Spain—with an economic structure rapidly approaching that of larger European countries—may be considered central relative to Greece or Portugal. In this sense, there is as much a periphery in the center as there is a center in the periphery.

Fundamental Issues

When a country contemplates participation in an enlarged common market, the basic considerations revolve around how much scope such participation would leave for national policy choices, in particular, those relating to the pace of economic adjustment. Completion of the Single Market will entail the abolition of all barriers to trade in goods and services and to the movement of factors of production; it also involves the complete removal of physical, technical, fiscal, and other obstacles to economic transactions within the European Community. For countries with economies that exhibit characteristics typical of the periphery, participation in such an open market carries risks while it also provides opportunities.

Convergence and Divergence

Unifying and broadening a market brings convergence in a number of variables, such as prices and the regulatory and institutional environments within which economic agents operate. This convergence does not mean, however, that complete uniformity will be established among all the activities and variables in the market. On the contrary, some divergence is also likely to result from the integration process. For example, although freedom of trade and exchange among the various countries should lead to converging standards of living, they will also foster comparative advantage and specialization in productive activities, thus leading to diverging patterns of production. Not surprisingly, arguments based on these two concepts tend to lead in opposite directions. According to one line of reasoning, the creation of an enlarged free market will foster regional equilibrium, that is, convergence in welfare and income levels. Another strand of reasoning contends that forces will develop in such a market that will widen existing gaps among regions.89

Adjustment and Integration

The particular characteristics of the peripheral countries will inevitably influence the nature and pace of their adjustment and integration into the Single Market. The extent of their influence will depend on a variety of factors: the level of initial protection, the degree of external financial imbalance, and the depth of the distortions resulting from overregulated and segmented financial markets, inefficient industries, and rigid labor markets. While this proposition is general in character, in the European context it is particularly interesting because current European economic events are at the forefront of a growing global interdependence and represent a clear illustration of the potential benefits to be derived from an ambitious effort at integration.

Indeed, the leading frontier of international economic relations at this time is Europe. There has been a great leap from the “Europessimism” (or “Eurosclerosis”) of only a few years ago to the “Europtimism” (or “Europhoria”) recently. Still, serious challenges will yet confront the European Community as the less flexible economies in the region adjust to a dynamic, growing, and closely interconnected European-wide market.

Problems Ahead

The integration of peripheral economies into the European market cannot and should not be expected to be smooth. These countries will have to contend with financial shocks and with shocks to the real economy, many of which will be permanent and will therefore require extensive adaptations in economic regime and policy. Consequently, prompt and clear identification of the largest potential problems in the adjustment process is needed.

The problems to be addressed over the short to medium run include the consequences of opening the economy for the balance of payments—for both the current account and the capital account—and for the country’s economy at large as it is exposed to external competition. This exposure affects the patterns of demand and production, the financial and capital markets, and the labor market.

Important conceptual and practical issues are involved here. They include the appropriate sequence for the opening of the economy, that is, in what order current account transactions or capital flows are to be liberalized. They also involve an assessment of the risks and opportunities associated with integration, of their real or financial character. In addition, the structural aspects of the various markets in the economy (for goods and services, for factors of production, and for financial services and capital) that can affect integration must be identified. Closely related to this is the role that market forces (for example, price adjustments and quantitative resource flows) play in steering the economy toward a large, open market. And finally, but most important, the role of economic policies in minimizing the costs of the required adjustments must be specified.

Over the long run, the permanent benefits or costs of integration can be more properly evaluated. Investigation into the scope of the net benefits has been increasing—much of it under the sponsorship of the Commission of the European Communities—and the findings indicate that the benefits are significant (a subject that is discussed later in the paper). But more broadly, the world economic experience over the past nearly 50 years has illustrated vividly the benefits of integration and interdependence, both in Europe and in the international economy.90 Of course, costs also arise, such as those from the limitations imposed on national autonomy, but it is generally recognized that the benefits outweigh them, at least when measured over extended periods of time.

Possible Responses

A point that needs to be stressed when discussing economic integration and its consequences is that the problems confronting integrating economies do not always arise from their actual or prospective participation in a common market. Often, they reflect distortions and imbalances already present in their economic systems. In those circumstances, the problems have to be confronted whether or not integration is occurring. The only difference would be the specific modality and pace of the adjustment to be undertaken. All of this seems clear from the parallel experiences of peripheral economies in the European setting (where the final aim is integration in the Single Market) and in the world economy at large (where full integration is not being considered).

An attractive angle for the design of policy responses to integration is to use the process to maximize comparative advantage, reduce existing distortions, and redress imbalances. Such a design would contribute to an appropriate allocation of resources, increase efficiency, and lower pressure on global resources. The process of integration, however, will not be painless, if only because it will force some sectors to contract, or lose relative weight in the economy. It is true enough that other sectors will expand, but the required reallocation of factors of production from contracting to expanding sectors will not always be commensurate or smooth.

A possible way to soften the bumps is to keep the economy growing while the adjustment takes place. This will not always be easy because participation in a common market typically constrains not only the available range of national policy tools but also the ability to contain their effects domestically. For example, those European countries participating in the exchange rate mechanism of the European Monetary System cannot use the exchange rate as an independent policy instrument.91 And more broadly, participation in a common market prohibits the use of tariffs and other trade barriers. This means that competition from other areas within the common market can make deep inroads into other participants’ economies. For this reason, it becomes imperative that existing distortions not prevent such competition from highlighting areas of respective comparative advantage or from identifying activities that should be curtailed or abandoned on efficiency grounds. Policy must be geared at improving resource allocation through flexibility in the labor and capital markets in order to minimize unemployment and idle productive capacity during the change in production patterns called for by market integration.

Typically in the peripheral economies, the labor market is characterized by a lack of functional and geographical mobility as well as by a rigid wage-setting process. Though wages are often low, they are not necessarily low in relation to productivity levels; and unemployment is high. In these circumstances, a number of steps can ease the process of integration: wage-cost moderation to stimulate demand for domestic labor and enhance labor competitiveness, thereby helping to attract foreign investment; the development of sufficient differentiation within the wage structure to encourage functional as well as geographical labor mobility—indeed, marginal wage equalization should be the result of such mobility not the cause that prevents it from taking place; and the establishment of incentives for the unemployed to search for jobs—training policies, flexible work contracts, well-defined, temporary unemployment benefits, and the like.

As important as a properly functioning labor market is the attainment and maintenance of an appropriate rate of domestic capital formation, which requires the existence of a capital market capable of allocating resources efficiently and of buttressing the economy’s dynamic sectors. In this context, several actions will be required: the maintenance of adequate profitability (yet another reason for the establishment of wage-cost moderation); efficient financial and credit markets to channel available resources to those sectors with comparative advantage; an appropriate stance and mix in domestic economic policies to keep real interest rates from diverging widely from their equilibrium levels; and openness to foreign investment flows.

All of these measures will help restructure the pattern of domestic production in favor of the relatively more competitive sectors, which given the characteristics of the economies under review will typically be labor intensive. In addition, foreign capital flows and technology imports will encourage the modernization of production, thus reducing the gaps among the economies in the common market.

Evolution of the Periphery

The peripheral nature of some of the economies in Europe is likely to persist for some time, and with it, the perception that European integration requires different tracks or speeds. Here again, the similarity with other developing countries is clear; nowhere has the process of economic transformation been an overnight affair.

In the early stages of European integration, the periphery of the continent provided a pool of labor from which the more advanced industrial economies—the center—could draw; high “peripheral” unemployment levels and high “central” wage rates made this feasible. This phenomenon was clear in the first decades of the European Common Market, when the Europe of the Six drew substantial migrant labor from Spain, Portugal, and Greece (and had been the case earlier with Italy and later with Turkey).

As integration has proceeded, most of these peripheral economies have become full partners in the European experiment, and a trend has developed accordingly in which capital flows replace labor migration. Such a trend reflects not only the progress made by the periphery itself (witness, for example, the case of Spain) but also the potential gains to capital-intensive (and high-saving) regions from investing in capital-scarce areas. Ultimately, these developments build up capital in the periphery, thus creating job opportunities and enhancing productivity and output. In this manner, foreign investment flows can assume the role played earlier by labor flows. The potential benefits for both the center and the periphery are clear: access by the periphery to the savings of the center and access by the center to high yields from investing in capital-scarce peripheral areas; increased technology transfers; access by all areas to a wider and more open market, which allows for efficient division of labor and specialization; the prospect of rising growth potential; and the related prospect of low unemployment.

The Single Market: A Positive Sum Game

It is clear from the discussion so far that adjustment in the periphery to the shocks of integration will not be costless. But it is also true that if the process is handled well, the benefits will more than compensate for these costs.

Central Aspects

The Single Market is expected to yield significant net benefits to the European Community over the medium term. Studies sponsored by the Commission of the European Communities provide quantitative estimates of the possible scale of welfare gains in the region and they amount to a significant percentage of the European Community’s gross product. In addition, further welfare gains will result from improved price performance and additional employment growth in the region.92

Briefly, the economic effects of integration will span a variety of areas. They will influence efficiency and growth performance in the European setting by eliminating exchange rate variability, reducing uncertainty, and lowering related transaction costs by improving the potential for economies of scale and by improving price as well as public finance performance. All these will come at the expense of national policy autonomy, especially with regard to the exchange rate instrument. As a result, wage and price flexibility in Europe is imperative to reap the benefits of integration.

There are grounds to contend, therefore, that all participating economies stand to benefit from the process of market integration,93 but that collecting those benefits will depend on complex factors and will require an important measure of vision on the part of national governments. At a minimum, domestic economic policies must be kept on a sound path to limit wasteful imbalances. And governments must be able to assess properly intertemporal choices so as to ascertain when today’s adjustment cost is worth tomorrow’s welfare gain.

Peripheral Aspects

Besides these general effects, a number of significant steps are needed to support the completion of the Single Market. Many of them are intended to assist peripheral economies in their integration efforts, such as actions to reform the Community’s Structural Funds—with a prospective doubling of their resources—in order to promote regional development and correct prevailing regional economic imbalances.

Behind these steps there is a notion that the Structural Funds can be used to mitigate transitory problems associated with the adjustment. This is a modality of lending intended to support needed policy corrections and other efforts to reform. As such, the structural assistance responds to a rationale similar to that underlying International Monetary Fund conditionally or World Bank structural adjustment lending.

In principle, the provision of assistance to countries or areas affected adversely by adjustment and reform processes is hardly a controversial proposition. In practice, however, the idea can become more contentious for a variety of reasons, two of which are discussed below.

Recipient Identification

Proper use of structural resources in the adjustment and reform process means identifying the countries or groups of countries that qualify for the assistance. Such identification can pose difficult problems. It is not always easy to distinguish those that truly stand to lose from the reforms from those that have a vested interest in the status quo, that is, those that gain from the absence of reform. While conceptually the distinction is clear, in practice the borderline often turns out to be blurred. To some extent, this reflects the fact that external financial assistance can serve either to support reform efforts or to perpetuate the pursuit of inappropriate policies, particularly when the linkage between the disbursement of funds and progress in policy implementation is not sufficiently precise, as is typically the case. Thus the fundamental challenge of conditional lending is to segregate borrowers or recipients willing and able to undertake corrective policies from those unwilling or unable to do so.

Compensation and Inequality

Compensation for losses incurred in the process of adjustment and reform is a natural enough concept. The European Community also aims at reducing inequalities across regions.94 This is also a legitimate goal, though a separate one from compensation for adjustment. The distinction between these two objectives can hardly be overstressed because the combination of adjustment compensation with redistributional assistance may lead to inefficient use of structural resources. The possible conflict would pit effective economic adjustment, which often calls for factor mobility (and typically gives rise to some costs), against the search for equality, which may involve halting such mobility. Thus, the two types of assistance may act at counter purposes.

These are not novel problems and they arise in domestic national settings frequently. What is clear is that the effective use of the European Community’s Structural Funds will depend on the adoption of transparent criteria to separate between different types of lending, as well as between types of recipients, in order to prevent one form of assistance from frustrating the objectives of another.

Policy Constraints

As a general proposition, participation in an open and growing market diminishes the effectiveness and insulation of domestic policy because market forces acquire a predominant role as guides of economic behavior. It is also true, however, that in a common market a relatively minor domestic policy action (a small increase in interest rates, for example) can have a significant effect on the larger market (substantial capital flows).

Though in apparent contradiction, these two statements are consistent in that the capability of national policy to influence the domestic economy is severely limited by participation in a common market. But precisely this inability to contain policy effects within a limited geographic segment of the market is what explains the dispersion and potentially large effect that any one country’s policy actions can have on the market at large.

Apart from these “environmental” market-determined constraints, a few specific limitations also bind concrete policy areas.

Exchange Rate Policy

As the process of integration advances, the scope for independent exchange rate policy will progressively decline and eventually disappear. This is already the situation for those economies that participate in the exchange rate mechanism of the European Monetary System. But it will also affect countries outside the system, even more so as Europe moves toward monetary union.

The implications of this exchange rate constraint are pervasive. This is because it renders national economic policies endogenous—that is, it makes it necessary for these policies to be consistent with the exchange rate constraint, or, in keeping with the fundamental theme of this paper, it requires national policies to conform to the exchange rate rule. An immediate consequence is that challenges to a particular economy’s competitiveness will have to be met by means other than exchange rate variations.95 In concrete terms, when competitiveness is eroded, it must be restored through lower wages, costs, and prices, a true departure from the upward adjustment those variables usually exhibit.

Monetary Policy

The exchange rate constraint also eliminates the independence of monetary policy. It makes it impossible to pursue the single objective of price stability (except when it is compatible with the exchange rate constraint). In effect, endogeneity of national monetary policies sets price stability in the common area as the standard to be achieved. Thus, any regional divergences can only cause resource flows because adjustments in the exchange rate are precluded. And, more importantly, monetary policy will not be available as a source of government revenue through the inflation tax. In effect, commitment to virtually fixed exchange rates requires monetary policy coordination so as to bring about convergence in price performance within the common market. Any inflation differentials that arise can be maintained only temporarily through interest rate flexibility. As far as the European integration effort is concerned, the close linkage among monetary policies will be even tighter now that a substantial liberalization of capital movements across national borders has been completed among the major European economies.96

All these constraints have operated in a setting of broad, fundamental changes in financial markets, and consequently one of increased competition among financial intermediaries. Those changes have resulted (at least for a transitory period) in less predictable monetary behavior than in the past. Thus, while an exchange rate anchor may have helped to sidetrack some of the difficulties confronting domestic monetary management, the latter has not become totally immune to them.

Fiscal Policy

A topic of particular importance for peripheral countries is fiscal policy, given the relative importance of the government in their economies. At first glance, it could be argued that fiscal policy independence is less threatened by participation in a common market than is the independence of monetary policy. But the force of this argument may prove more difficult to substantiate upon closer inspection.

In principle, consistency with a nominal exchange rate anchor only requires that aggregate demand be kept on a path commensurate with aggregate supply. And barring the difficulties noted earlier, the level of demand can be controlled by monetary policy. If so, fiscal policy should not be strictly bound by the fixed nominal exchange rate, and over the short term this line of reasoning is basically accurate.

As the time horizon lengthens, however, other target variables come into play.97 Attainment of growth potential in a setting of price and exchange rate stability calls for a more multifaceted equilibrium than that of simple aggregate demand-supply balance. Not only must supply potential be maintained, but both the level and composition of demand must be sustainable.

Maintaining supply potential will require relative cost-price flexibility, efficiency in resource allocation, and responsiveness to market signals. Demand management, in turn, will have to keep aggregate spending in line with the available resources and the composition of demand on a reasonably balanced path between consumption and investment components, domestic and foreign sources, and private and public sector shares.

The importance of the interest rate for the consumption-investment choice is obvious, as is the importance of competitiveness for the mix of foreign and domestic demand components. Finally, the relevance of the public finances for the distribution of demand between the private and public sectors is obvious.

Taking these considerations into account, it is clear that coordination of fiscal policy is another constraint imposed by participation in a common market. As far as Europe is concerned, patterns of domestic fiscal policies are likely to require a measure of consensus on public sector debt management, public sector deficit control, expenditure reform, the structure and harmonization of taxation, and the government contribution to capital growth.98

Final Balance

Opportunities to increase welfare will undoubtedly open up for the periphery as a result of its participation in an enlarged common market. But exploiting them will mean taking adequate measures: to increase the flexibility of the structure and production patterns of the economy, as well as of the reactions of market agents to price signals; to accept that domestic policymaking is subject to constraints, particularly when policies are geared exclusively to internal aims; and to acknowledge that policy effectiveness to attain marketwide objectives (if coordination of policy positions exists among participating countries) is likely to increase significantly. As far as participation is concerned, the key question for peripheral countries is whether they have any other choice. Arguably, these economies cannot insulate themselves from the common market’s influences, in which case membership emerges as the only practical option.

A Periphery Beyond the Periphery

The events under way in Central and Eastern Europe and the former Soviet Union add—at least, potentially—a dimension to the discussion of peripheral countries and to the question of approaching European integration on different tracks or at different speeds. In other words, those events raise additional grounds on which to argue the importance of diversifying the tracks available to complete the integration. The characteristics of the economies in this region conform closely to those typical of the periphery: they are inward-looking and protected systems dominated by the government or public sector and exhibit narrow or nonexistent markets and extensive distortions. Thus, the very nature of the widespread reforms that must be completed in the area will dictate that diversity prevail in the possible approaches to integration.99 Nonetheless, it may be argued that to link the process of reform unfolding in Central and Eastern Europe and beyond with the process of integration in Western Europe is premature. A response to this argument has been that both sides of the continent have “the same last name,” that all European countries share some common ground.100 In addition, the vertiginous speed of change in Central and Eastern Europe may not stop with market reforms. The transition to market regimes is probably only a precursor to further engagement in the European Community.

The prospects ahead also give rise to risks and opportunities in the relationship between the “old periphery” and the “new periphery.” The risks derive from two main facts: there will now be additional claims on available resources in the system, as the rate of resource absorption in Central and Eastern Europe outpaces that region’s rate of production; and the economies of Central and Eastern Europe will offer competition to the rest of Europe on account of their supplies of relatively cheap and skilled labor. The opportunities follow from the potentially higher demand for the output of the economies already in the common market, thus increasing their exports to the “new periphery” and contributing to its integration. On balance, then, European policymakers face a rather unexpected but generally positive challenge—a “new frontier” on the “old continent,” which is dramatically changing the shape of relationships.

The contrast is also vivid when viewed from a broader historical perspective. Though fast receding in memory, the specter of the American Challenge, which was raised in the late 1960s, contributed to the Europessimism of the 1970s and early 1980s.101 Later, the notion was that economic progress had bypassed and surpassed not only Europe but also the Atlantic, and the prospect that the Pacific Rim was the future gained currency. Now, the pendulum may be swinging back, with the Pacific Rim facing competition from a Europe that promises strong growth and contributions to the international order on the scale to which the system had once been accustomed but had had to give up.

Europe’s Continued Contribution to the International Order

For some time now, Europe has been searching for a balanced blend of national and international considerations as the basis for economic relationships on the continent. With regard to the real economy, the Europe of the Six sought to lower barriers to internal trade by establishing a Common Market. The Europe of Twelve is pushing toward the creation of a Single Market in which goods, services, and factors of production can move freely. On the monetary front, Europe sought a measure of exchange rate stability soon after the collapse of the Bretton Woods par-value system through the adoption of the “snake arrangements.” Later, the European Monetary System was established, based on a fixed (but adjustable) exchange rate mechanism which has helped integrate the participating economies and has laid the ground for monetary unification.

If revealed preference is a guide, Europe has been betting for a long time that an international order fundamentally based on rules is the one most conducive to harmony and cohesion among countries. By favoring rules, European countries have expressed the willingness and, more importantly, the ability to set explicit constraints on their national autonomy. Within its preference for rules, Europe also seems to be searching for a reasonable degree of discretion in the actual operation of the continental order. By seeking a measure of discretion, the Community recognizes national considerations to the extent required to foster cohesiveness.

But there is a question as to how well rules will serve a periphery that has little say in either their design or their implementation. My impression is that rule-based systems particularly benefit peripheral countries because they limit the freedom of the center and thus enhance economic certainty and predictability. Another important question is whether Europe will be able to integrate its central and eastern regions without slowing the momentum present on the western front. The task imposes difficult, but not impossible, challenges. Keeping the process on track in both spheres will mean looking beyond short-term obstacles and focusing on long-term benefits. The bias toward rules should also convey to Central and Eastern Europe a measure of certainty and order, thus fostering the process of reform. Thus, a key contribution by Europe to the broad international order is the need for balance between rules and discretion.

It must be stressed that closely integrated systems disseminate the costs and benefits from one country’s economic policies to the other participants. In the process, incentives can arise to “export” costs induced by domestic policy and “import” benefits from other nations’ policies. If so, this prospect can only be a source of permanent tension in interdependent regimes. The challenge is to recognize from the outset how futile a deliberate attitude of exporting internal costs and importing external benefits would be since it only dooms the system itself. To avoid such an attitude, nations must realize that there are no sustained free rides within any system, regardless of the room given for national autonomy. Taking the European Monetary System as an example, some members saw an imported benefit in the introduction of price discipline. But the benefit was purchased at a price—the risk of losing competitiveness.

In a nutshell, integration in a broad market is a positive sum game, no participant needs to lose. However, it does pose important distributional problems; to resolve these in a constructive fashion requires vision or its equivalent, “enlightened self-interest.”102

Final Remarks

There are good grounds to argue that European integration will require a variety of tracks and speeds to accommodate the diversity of initial economic situations. The argument can be coherently made with respect to the present membership of European Community, which encompasses a relatively new periphery with characteristics quite different from those of the core members, but it acquires even more strength with the prospect of the Community expanding beyond the Europe of Twelve to encompass the reforming economies of the central and the eastern regions of the continent.

The concept of a journey toward a unified Europe that occurs at different speeds is not new. A recent illustration in the area of monetary integration is provided by the differences that prevail among the countries participating in the European Monetary System: one group has virtually achieved convergence in economic performance, in particular with respect to inflation (France, the Netherlands, Germany), and another group has yet to attain convergence on inflation and on other fronts (Italy, Spain, the United Kingdom).

Perhaps the central issue here is the appropriate balance between two positions that have characterized many discussions of European monetary integration. One position stresses the importance (even the necessity) of having achieved convergence before undertaking commitments that seriously reduce the independence of national policy (an example is the United Kingdom’s former position that joining the European Monetary System would be completed only when conditions allowed). The counter position maintains that undertaking at the outset commitments that constrain domestic policy independence constitutes the surest way of attaining convergence. This latter reasoning underscores the point that waiting for the “right time” may be the best way to ensure that such a time never materializes.

On the broader objective of European economic integration, a variety of tracks or speeds has actually been in effect: different time schedules have been allowed for reducing and eventually eliminating trade and financial barriers within the Community; and the structural funds have been made available to support adjustment efforts and help create uniform economic conditions among member countries. Differentiation in the approach to economic integration will probably be even more necessary with the prospect of an enlargement of the economic union of the Europe of Twelve. This prospect, remote until recently, has now acquired real potential with the reforming economies of Central and Eastern Europe, including former republics of the U.S.S.R. The transition of these countries from central planning to market-based regimes will be disruptive, not smooth, and it will be drawn out. Accordingly, specific means to assist their reforms and support their efforts at integration with the rest of Europe will be required.

Valid though the arguments for differentiation are, they should not be carried too far; there is a flip side to the case for diversified approaches. As a general proposition, the ultimate aims of a unified Europe will mean the elimination of fundamental differentiation among its member countries. Concepts, like the principle of universality, that eschew country groupings or those, like the principle of uniformity of treatment, that reject preferential status are probably crucial for the long-term cohesiveness of the system.103

Advocacy of such fundamental principles need not preclude the existence of transitory arrangements that recognize the diverse capacity of countries to withstand exogenous shocks. These arrangements typically allow for a gradual approach to the requirements of integration or assist with the costs of integration. But to ensure compatibility with principles such as universality and uniformity of treatment, the transitional arrangements must exhibit certain characteristics. They must be shortlived; the criteria for their use must be simple, transparent, and, to the extent possible, objective; and, in principle, their availability should extend to all members.

In sum, it seems clear that diverse tracks toward European economic integration are virtually unavoidable. Perhaps less evident, though certainly not less important, is that such tracks can lead to a common setting that de-emphasizes particular country differences. In essence, the success of diversified approaches will best be measured by their ability to become redundant, to self-destruct. In other words, the tracks must all flow along a common route on which the same rules apply to all. And as with traffic, a common path and common set of rules do not preclude differences among travelers; economies, as drivers, can and will differ. It is the rule of law that cannot and should not waver.

83

For an extensive analysis of international economic interdependence, see Cooper (1968, 1987). An examination of periods of increasing and decreasing interdependence is contained in Section II; also see Dam (1982). The related issue of economic policy coordination has been studied recently by Dobson (1991).

84

The development of the code of conduct was examined in depth in Horsefield (1969) and de Vries (1976, 1983). Also see Dam (1982), Gilpin (1987), Guitián (1981), and Kenen (1986, 1987).

85

This was most clearly the case with the eventual accession to the Common Market of the southern European countries; see the chapter on “The Underdeveloped Countries of Emigration: Portugal, Spain, Greece, and Turkey” in Kindleberger (1967).

87

The distinction between a “center” and a “periphery” is not unique to the European context; on the contrary, it is a well-established classification long used in discussions of relationships between developed and developing countries. The terms acquired broad currency in the 1950s and early 1960s in the context of the structuralist-monetarist controversy in Latin America; see, for example, United Nations (1950) and Prébisch (1959). Also see Pinder (1983) and Clout (1986) for a discussion of these concepts in the context of the European Community.

88

For an excellent discussion of the related issue of asymmetries in the European Monetary System, see Wyplosz (1989).

89

Basically, these two lines of reasoning argue that a common market area can give rise to a virtuous (convergence) or vicious (divergence) circle regarding regional welfare. See Pinder (1983) and his cited sources for further details.

90

See, for example, Solomon (1982) and Frenkel and Mussa (1984). For a discussion of this subject in a European setting, see Guitián (1988b) and Gros and Thygesen (1988).

91

At present, the participants in all aspects of the European Monetary System (including the exchange rate mechanism) are Belgium-Luxembourg, Denmark, France, Germany, Ireland, Italy, the Netherlands, Spain, and the United Kingdom. For a recent examination of developments and perspectives in the European Monetary System, see Ungerer and others (1990).

92

See Commission of the European Communities (1988, 1989a, and 1990b) for a detailed examination of the benefits and costs of integration both for the European Community at large and for each country.

93

As already noted, theories of regional imbalance do not always reach this conclusion. For a survey of theoretical arguments of regional equilibrium and disequilibrium, besides Pinder (1983), see Wilhelm Molle’s “Regional Policy” in Coffey (1990) and Padoa-Schioppa (1987).

94

These issues were taken up forcefully by Spain during the December 9–10, 1991 summit meeting of the European Community countries in Maastricht, the Netherlands.

95

Section IV of this paper contains an extensive discussion of the potential dilemma between protecting competitiveness and ensuring price stability in the context of an exchange rate constraint. An excellent discussion of the role of exchange rates in balance of payments theories can be found in Mundell (1991).

96

This liberalization represents a quantum jump over the Bretton Woods par-value regime, with which the European Monetary System is often compared. The Bretton Woods regime envisaged the need for, and therefore allowed for, controls on capital movements, a provision that was included in the Articles of Agreement of the International Monetary Fund. See Folkerts-Landau and Mathieson (1989) for an extensive discussion of European financial integration. The issue of an aggre-gate demand for money in the European Monetary System has been examined by Kremers and Lane (1990).

97

For further elaboration of the issues of fiscal policy coordination, see Guitián (1988a, 1988b) and Tanzi and Ter-Minassian (1987).

98

Further informative analysis of those issues may be found in Commission of European Communities (1989b).

99

For a discussion of reform issues in Central and Eastern Europe, see Blanchard and others (1991), Dornbusch (1991), Guitián (1991c), and Calvo and Frenkel (1991). Some lessons can be drawn from the experience of other countries that also faced the challenge of developing a market. For a discussion of the Turkish experience, see Guitián (1991a). For a discussion of the impact of Eastern Europe on European integration, see Centre for Economic Policy Research (1990).

100

See Silva and Sjogren (1990), where the importance of the impetus toward Europe 1992 is examined and the point is made that as “we stand in awe of the domino decline of communist governments, we should not overlook the fact that Western and Eastern Europe share the same last name” (p. 15).

101

See Servan-Schreiber (1968), where the issue of a technological gap between the United States and Europe is raised and a call for a concerted European response is made.

102

In December of 1991, the countries in the Europe of Twelve met in Maastricht, the Netherlands, and made a number of decisions leading to their monetary, economic, and eventual political integration. The “after-Maastricht” prospects include national parliamentary debates for ratification of the Maastricht Treaty and the introduction of a common European currency before the end of the century.

103

There is a potential conflict between the principle of universality (all-encompassing participation) and the principle of uniformity of treatment. For an insightful discussion of this interesting subject, see Gold (1979).

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