The Relationship between Identity and the Political Economy in the Eurozone POL382H1F Professor Janique Dubois June

21, 2012 Nikolai Boboshko On February 7, 1992, members of the European Union signed the Maastricht Treaty agreeing to the creation of a common currency. In 2002 the common currency, neutrally named the Euro became a reality as it went into full circulation.1 This creation of an economic institution by a supranational body affords an opportunity to study the relationship between economics, state politics and identity. While economics and politics are often combined in the field of political economy, comparisons and combinations with identity have been limited. Introducing identity can possibly provide a unique perspective on the political economy and political economy can do the same for identity. This paper will focus on the Eurozone states France and Germany. The two states were chosen because they are considered as the driving forces of the Eurozone and afford an in depth comparison.2 Thus, the research question of the paper is; what is the interrelationship between identity and the political economy in France and Germany in regards to the Euro? First, the paper will consider the impact of identity on the creation and the structure of the Eurozone. Then the focus will shift to the impact of the Eurozone structure on identity during the Eurozone sovereign debt crisis. The analysis suggests that national and European identities were important factors in the creation of the Euro and the Eurozone structure. However, the introduction of a monetary union across Europe before a common identity hurt the creation of a European identity. During the debt crisis, different experiences with the Eurozone resulted in different narratives for France and Germany.

Due to these differences, state actions appear to be based on their own interests instead of common good or mutual benefit.

The Creation of the Eurozone and its Structure Initially, it appears that French identity had no impact on Frances decision to join the Euro. That decision can be explained by a combination of politics and economics. After the Golden Era, from the end of World War II to the 1970s French economy was in stagnation. Economic globalization and liberalism, supported by the US, were considered to have to be a threat to the welfare state. Under a socialist president, Franois Mitterrand, the Euro was considered by the French intellectuals and the elite as a tool to keep globalization under control. According to Hubert Vdrine, the diplomatic advisor to Mitterrand, France would use the Euro to create a deeper union that would lead to a stronger France and counter US hegemony.3 The weakness of the Euro, the lack of a common fiscal policy, was according to a study by Professor Amy Verdun known to all the French political actors. French efforts to create a deeper fiscal union in the future would counter that.4 This suggests that the French expected future homogenization in Europe that would favour the welfare state as opposed to the race to the bottom critique of trade liberalization. However, the political and economic rationale does not explain why those goals were set. Why were French influence and the welfare state important? A reason could be that they were tied to French identity. Politically, unlike other European states after WWII, France never gave up its longing for global influence. Globalization was seen by political leaders as Americanization and a threat to French stature. France also has a strong statist

tradition and the expectation is that the state and not the market determines economic relationships. Government spending and transfers account for 54 percent of French GDP, and nearly 25 percent of the labour force is employed by the state. Furthermore, the economic and political impact of globalization was seen as having an impact on French culture. For example, polling results reveal that 65 percent of French believe that there is excessive US influence on French television. About 57 percent believe the same for French cinema. Philip H. Gordon & Sophie Meunier in their study on the French relationship with globalization draw the conclusion that The real threat to France from globalization is thus not economic but cultural: It is not so much the disappearance of dirigisme that worries the French, but the disappearance of France itself.5 Thus, the economic and political reasons of France can be strongly tied to French national identity. Unlike in France, the concept of an identity and especially a shared memory of the past played a clearer role in the German decision to join the Euro. In the early 90s the German public was more receptive to a European identity. According to a study by Neil Fligstein it is possible that identification with Europe has an inverse relationship with national identity.6 Thus, a weaker German identity would suggest people are more receptive to a European identity. After the end of World War II, strong German nationalism was discredited due to its association with the Nazis. Politicians and intellectuals on the left believed that by being a part of a European system Germany can atone for its past.7 They were against a strong nation state, with Germanys most popular writer, Gnter Grass, calling a reunited Germany a monster that would become an aggressive state. At that time the New right was falling apart due to its disagreements on what German interests actually were.8

This notion of a German identity that is compatible with a European one does not extend fully to the issue of a common currency. The Deutschmark was a strong national symbol of German economic recovery. A new European currency would not have that association. Furthermore, currency had a strong role to play in the German collective memory. The hyperinflation if the inter-war period created a preference for a strong and stable currency.9 By giving up control of monetary policy, Germany was left open to inflationary pressure that the Deutschmark would not be. Thus, while it is possible that German people at the time were more open to European integration, monetary integration was unpopular. For example, a group of 62 leading German economists attacked the treaty after its inception.10 There was a serious constitutional challenge that led Germany to be the last country to accept the treaty.11 Most importantly, popular support for a common currency was at 30 percent.12 In spite of this, the ruling Christian Democratic party supported a common currency. With the constitutional challenge defeated and a Bundestag majority, Germany agreed to the Maastricht treaty.13 Thus, both France and Germany, or at least the political elites wanted a common currency, but it is the interplay between the pro-European and pro-deutschmark aspects of German identity that strongly determined the structure of the monetary union. The two states disagreed on how the monetary union should look like, especially the structure of the European Central Bank (ECB). France preferred a more politically dependent central bank that would have equal focus on keeping unemployment low, maintaining steady growth and low inflation. Germanys preference was for strongly independent central bank whose main focus would be just on low inflation.14 In political bargaining France was at a disadvantage because both the elite and the population supported a monetary union. In

contrast, due to the pro-deutschmark identity, the German political elite had to face limited public support. This weakened the French bargaining position because they preferred a monetary union with Germany more so than the Germany did with France. In order to achieve German backing, the French had to concede on several issues in order to alleviate German fear of inflation. As a result of this, and in combination with other factors, the European Central Bank policy, location and president were based on German preferences.15 Thus, identity strongly impacted the decision to join the Euro and its structure.

The Response to the Eurocrisis In regards to the effect of the Euro on identity, it is possible to identify it by studying the current Eurozone sovereign debt crisis. The crisis is an example of an asymmetric shock; an economic downturn in certain regions of a monetary union. The inclusion of a European currency ahead of a fiscal union and high labour mobility leaves affected regions with limited options. Debt is too high for fiscal stimulus and the European Central Bank is unlikely to provide aid with monetary policy due to its strong anti-inflation mandate. The reaction of France and Germany can provide information about the state of identity in the Eurozone. According to both thick and thin conceptions of citizenship, there should exist either an orientation towards a common good or at least regulation for mutual benefit among citizens. These concepts of citizenship that relate to identity are not present in the Eurozone crisis. The actions of states appear to be more so based on state interests and relative power. Introduction of a monetary union before common identity and economic homogeneity hurt the creation of an orientation towards common good and mutual benefit during a crisis.

As Eurozones largest state any economic response should ideally involve Germany. Thus, their position is rather important. The German reaction to the Eurocrisis has two broad components. First, Germany does not support bailouts and any type of fiscal transfers unless absolutely necessary. Second, there is a strong insistence on austerity measures as the solution. This reaction also has two rationalizations. There is the economic rationale. This includes the argument that bailouts or any form of support create a moral hazard and highly in debt states are unlikely to undergo the necessary structural changes. For example, once Italy received ECB support they abandoned their structural plans.16 Then there is the national rationale. Germans are unwilling to provide funds to other countries because they are not German. Volker Kauder, head of Chancellor Angela Merkels Christian Democratic Union party stated that Germany is not here to finance French election promises.17 Christoph Weil, the Greece specialist at Commerzbank mentioned that The German public is not ready to pay [Greece] forever18 About 60 percent of German voters favour Greek exit from the Euro.19 Only 16 percent supported the Greek bailout.20 Chancellor Merkels and Christian Democrats popularity tends to fall as they agree to more fiscal transfers. The important Northrhine-Westphalia region was politically lost after the first Greek bailout was agreed too.21 In order to identify if there is an orientation towards a common good in Germany, it is necessary to identify which rationale is more legitimate. Is national self interest or rational economic theory a stronger driver for German Eurozone policy? If German actions are driven purely by national self-interest, then an orientation towards a common good or mutual benefit does not exist. However, if there is a strong economic rationale than no

clear conclusion can be drawn. German self-interest could also be a rational economic response for the Eurozone. The economic term for the European austerity measures is Expansionary Fiscal Consolidation (EFS). According to the theory, decreasing deficits produces expectations of lower taxes and increases consumption. This is against the opinion of the majority of US economists who believe that expansionary fiscal policy is necessary. A study by Michael U. Bergman and Michael M. Hutchison analyzed 15 countries from 1975-95 that implemented EFS. Out of the 15, 12 went into a recession. Two countries that avoided a recession during the period, Denmark and Ireland, were found to have significant factors other than EFS that contributed to their performance. A success rate of 1/15 does not make EFS a very rationale policy.22 German voters and political elites also oppose other joint solutions to the Eurozone crisis. The issue of Eurobonds, sovereign debt covered by all of the Eurozone states, is not an accepted solution in Germany. Polling data suggests that German voters are overwhelmingly against them.23 German ruling politicians share that sentiment. An especially firm position was taken by Finance Minister Wolfgang Schuble that There will be no communitisation of debts.24 The reason is that Eurobonds create a moral hazard, states issue debt individually but all of the Eurozone is responsible for them.25 Furthermore, the Eurobonds avoid the issue of structural change that Germany views that European states must undertake. Despite these concerns, economic research suggests that Eurobonds are a possible solution as they would result in a significant fall in the interest rates of the troubled countries.26 Furthermore, provided that they cover a fraction of government debt, Eurobonds can be structured in such a way as to avoid creating moral hazard.27 From this it

can be concluded that German policy is not the most economically rationale solution for the Eurozone. As German actions are not the most economically rational for the Eurozone, national self-interest could be a better explanation for them. Any transfer payments or bailouts would be paid for by Eurozone members. As states like Italy and Spain are facing economic difficulties it is unclear if they could provide transfer funds. Due to this, the portion of any bailout or transfer paid for by Germany would be higher than if Eurozone states contributed equally based on their GDP. And as one of Europes strongest economies, Germans are less likely to receive transfers in turn. Thus, Germans stand to contribute more than they receive if fiscal transfers or bailouts become an explicit policy.

The Inability to Create a Common Identity That Germany is acting in self-interest is a sign of the failure of the Euro to create a European identity that is conductive to an orientation towards a common good. Different economic systems have led different national memories and narratives of the Euro that are not conductive to cooperation. In Germany the introduction of the Euro in 2001 occurred among economic problems, including GDP growth of only 0.6 percent, the worst in a decade.28 From 2001 to 2005 the economy grew only 3.5 percent.29 Unemployment rose to a high of 12 percent by 2005.30 The country received limited help from the ECB as its key lending rate, at its lowest was 3.0 percent. In comparison, during the current crisis the rate is at 1.75 percent.31 A lower rate is beneficial to economic recovery. Although German fiscal deficit exceeded the three percent limit that all Eurozone states had to abide by, the

country did not use fiscal stimulus to spend out of the recession. Tax cuts were actually put on hold to meet Eurozone deficit targets.32 Instead, Germany underwent structural changes. Generous unemployment benefits were reduced, new legislation made the labour market more flexible. Collective bargaining structure changed from national to company level, weakening labour power. In new collective agreements, wages were tied to productivity, creating an incentive for efficiency.33 As a result, Germany became a more competitive country. Data from the Organization for Economic Cooperation and Development shows a 10 percent increase in German competitiveness against all other countries.34 Unemployment decreased below 8 percent in 2008 and continued to decline until 2012.35 Before the current global economic crisis hit Europe, German economy grew 5.6 percent from 2006 to 2008.36 This created a narrative in Germany of a tough period under which the country revived itself through difficult, but necessary changes with no outside help. In contrast, although the same period was not stellar for France, it did not experience economic problems to the extent that Germany did. From 2001 to 2005 French GDP expanded by 6.5 percent, nearly double the German rate. In the period of German recovery from 2006 to 2008, Frances GDP expanded by a reasonable 4.5 percent. 37 Furthermore the structural changes the France undertook were the opposite of Germanys. The government used the Euro as an opportunity to expand the minimum wage. The key issue for collective bargaining became working hours, not productivity. Nearly 75 percent of all agreements mainly revolved around the issue. The government passed the Aubry I and Aubry II legislations that created the 35 hour work week.38 Thus, the French narrative is very different from the German one. Economic sacrifices occurred prior to the Euro to

achieve entry into the Eurozone. The period after that was supposed to be one of increased economic benefits, not one of more sacrifices to improve productivity.39 This difference of narrative prevents an orientation in Germany towards a policy that would benefit the Eurozone as a whole at its expense. The French perception, according to former Prime Minister Laurent Fabius, is that The Germans do not suffer much from the expensive Eurowe need to find a policy that is good not for just one country, but for the whole of Europe.40 However, French GDP grew more than German after the inception of the Euro.41 Stating that the Euro only benefits Germany ignores past history and creates an argument that Germans can view unconvincingly. There is a sentiment best summed up by former German chancellor Gerhard Schrder that Germany has gone through a difficult time, lowered its costs and has recovered competitiveness, the other countries have to do the same.42 This German self-interest is informed by their experience with the Eurozone. During the tough German transition from 2001 to 2005 aid was not provided from other states or Eurozone institutions. By not providing aid, the Eurozone created a narrative that is based on self-interest. Common good or mutual benefit, are based on reciprocity. Citizens of a single state receive aid when they are experiencing difficulties and in turn are expected to provide aid to others when they are better off. This relationship clearly did not exist in Germanys case. At the same time the French are not able to relate to the German narrative of the Eurozone that calls for making changes and tough sacrifices to improve growth and competitiveness. For them, the Eurozone was supposed to be the end of that, instead it was about not taking those actions. As the two major states in the Eurozone are not able to coordinate their actions, the resulting policy is due to their relative power. This is a strong sign of a weak common

identity. A common identity, in relation to citizenship, has some egalitarian concept of extending civil, political and social rights equally among group members. Relative power is un-egalitarian. In 2013 a permanent European Stability Mechanism (ESM) will be established to aid Eurozone states. It will operate on a strictly German model by forcing any state that receives funding to undergo a stringent programme of economic and fiscal adjustment. Voting power in the ESM is proportional to member monetary contributions and is a departure from previous Eurozone policy of protecting the smaller states. In the ESM the larger states will have more power.43 So, even though the Eurozone sovereign debt crisis is prompting more institutional integration, the nature of it is actually a sign of a weaker common identity. Data from Eurobarometer supports declining European identity. Support for the Eurozone decreased from 63 percent in 2007 to 53 percent in 2001. Trust in the European Union decline by seven percent across the Eurozone, 5 percent in Germany and 9 percent in France.44 It appears it is a mistake to separate economic institutions and identity. In France, Germany and likely in other states, they are closely interrelated. By introducing a monetary union before a strong sense of common identity and economic homogeneity, France and Germany developed different narratives of the Eurozone. This led to stronger divergence in their economic systems and a weaker identity with Europe. The resulting differences made cooperation for the benefit of the whole Eurozone less likely to occur. Instead, the new institutions like the ESM, are the result of the relative power among the states and weaken a common identity further. It is ironic that even though identity played a strong role in the creation of the Eurozone it is also one of the main reasons that it could unravel.

1
2

Marsh, David. The Euro; The Politics of the New Global Currency (United States: Yale University Press, 2009), 177. Checkel, T. Jeffrey and Peter J. Katzenstein, eds. European idenity. (United Kingdom: Cambridge University Press, 2009), 43. 3 Mnch, Richard. European Governmentally: The Liberal Drift of Multilevel Governance. (Oxon: Routledge, 2010). 97. 4 Verdun, Amy. European Responses to Globalization and Financial Market Integration. (United States: St. Martins Press, 2000), 211. 5 Gordon, H. Philip, and Sophie Meunier. "Globalization and French Cultural Identity." (French Politics, Culture & Society 19, no. 1 (2001): 22-41), 22 to 24. 6 Checkel and Katzenstein, European identity, 136. 7 Lacroix, Justine and Kalypso Nicoladis, eds. European stories : intellectual debates on Europe in national contexts. (New York : Oxford University Press, 2010), 89. 8 Ibid, 93. 9 Boyes, Roger. Bonn Left pledges to renegotiate Maastricht. The Times. http://search.proquest.com.myaccess.library.utoronto.ca/docview/318184783 (accessed June 20, 2012) 10 Narbrough, Collin. "Germans attack treaty." The Times. http://search.proquest.com.myaccess.library.utoronto.ca/docview/319060503 (accessed June 20, 2012). 11 Laughland, John. The German Case Against Maastricht. The Wall Street Journal Europe. http://search.proquest.com.myaccess.library.utoronto.ca/docview/308093762 (accessed June 17, 2012). 12 Marsh, The Euro, 201. 13 Crawshaw, Steve. The Independent. Maastricht approved by German court. The Independent. http://search.proquest.com.myaccess.library.utoronto.ca/docview/312989029 (accessed June 18, 2012) 14 Marsh, The Euro, 178-182. 15 Ibid, 178-182. 16 General One File. The Future of Eurobonds. http://go.galegroup.com.myaccess.library.utoronto.ca/ps/i.do?action=interpret&id=GALE %7CA270251972&v=2.1&u=utoronto_main&it=r&p=ITOF&sw=w&authCount=1 (accessed June 17, 2012) 17 Allen, Caroline. Markets await detail of Hollandes 'pro-growth policies. Investment Europe. http://www.investmenteurope.net/investment-europe/feature/2180351/markets-await-hollande-s-pro-growth-policies (accessed June 17, 2012) 18 Harriet, Alexander. Frankfurt's Greek bankers are torn over Germany's attitude to their homeland. The Telegraph. http://www.telegraph.co.uk/finance/financialcrisis/9336321/Frankfurts-Greek-bankers-are-torn-over-Germanys-attitude-to-theirhomeland.html (accessed June 18, 2012) 19 Shaughnessy, Haydn. What Germans Really think about Greek exit from the Euro. Forbes. http://www.forbes.com/sites/haydnshaughnessy/2012/05/28/clear-majority-of-germans-now-favor-a-greek-exit/ (accessed June 20, 2012) 20 Graydon, Eric. "Germany finds bailing out is hard to do." BBC News. http://www.bbc.co.uk/news/10090578 (accessed June 20, 2012).
21

Belke, Ansgar. The Euro Area Crisis Management Framework: Consequences for Convergence and Institutional Follow-ups. (Journal of Economic Integration 26, no. 4 (2011): 672-704), 696. 22 Dadak, Casimir. Political Economy of the Euro Crisis. (Panoeconomicus 58, no. 5 (2012): 593-604), 597 to 598.
23

Bloomberg Business Week. Poll: Germans strongly against eurobonds. http://www.businessweek.com/ap/financialnews/D9R7R5J81.htm (accessed June 20, 2012) 24 The Local. Germany fights growing support for Eurobonds. http://www.thelocal.de/money/20110815-36963.html (accessed June 19, 2012). 25 Market News International. BBK Dombret: Eurobonds 'Overwhelming Moral Hazard Problems. https://mninews.deutscheboerse.com/content/bbk-dombret-eurobonds-overwhelming-moral-hazard-problems (accessed June 20, 2012) 26 ProQuest. Was kosten Eurobonds? http://search.proquest.com.myaccess.library.utoronto.ca/docview/910021041/abstract (accessed June 19, 2012). 27 Baglioni, Angelo and Umberto Cherubini. A Theory of Eurobonds. SSRN Working Paper Series. September 2011.
28 29

CNN Money. German Economy Stalls. http://money.cnn.com/2002/01/17/international/germany/ (accessed June 20, 2012).

Index Mundi. Historical Data Graphs. http://www.indexmundi.com/g/ (accessed June 19, 2012).

30

Trading Economics. German Unemployment Rate http://www.tradingeconomics.com/germany/unemployment-rate (accessed June 19, 2012). 31 European Central Bank. "Key ECB interest rates." http://www.ecb.int/stats/monetary/rates/html/index.en.html (accessed June 19, 2012).
32
33

The Economist. Germany Not Working http://www.economist.com/node/1521165?story_id=1521165 (accessed June 20, 2012). Pochet, Philipped, ed. (Wage Policy in the Eurozone. Brussels: P.I.E.-Peter Lang, 2002), 131, 145 to 146, 249. 34 Marsh, The Euro, 229. 35 Trading Economics. German Unemployment Rate
36
37

Index Mundi. Historical Data Graphs. Ibid

38
39

Pochet, Wage Policy, 258 to 274. Marsh, The Euro, 184. 40 Ibid, 220. 41 Index Mundi. Historical Data Graphs. 42 Marsh, The Euro, 252. 43 Dadak, Political Economy of the Euro Crisis., 597. 44 See the Eurobarometer data.

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