Will the debt crisis strengthen European multilateralism?

Posted By Daniel W. Drezner Wednesday, November 3, 2010 - 9:30 AM

Hey, remember the rest of the world?

The Financial Times' Ben Hall and James Blitz report on a surprising degree of defense cooperation between London and Paris:

David Cameron, British prime minister, and Nicolas Sarkozy, French president, hailed their summit in London on Tuesday as an unprecedented move towards closer integration between Europe's pre-eminent military powers brought on by budgetary austerity but also a closer alignment of the two countries' foreign policies.

They signed two treaties: one covering the sharing of technology used to maintain nuclear warheads and another on initiatives about conventional forces.

Mr. Sarkozy said the agreement to share a new research facility in France for the testing of nuclear warheads was testament to a "level of confidence between our two nations unequalled in history".

Until now, France and Britain have closely guarded the secrets of their nuclear deterrents, regarding them as the bedrock of their independence.

Mr Cameron said the two treaties would commit the French and British armed forces to working "more closely than ever before".

Paris and London also agreed to set up an "integrated carrier strike group", allowing each to fly combat aircraft from the other’s carrier once Britain has an operational ship equipped with its U.S.-built Joint Strike Fighter jets, by the beginning of the next decade. In the next 10 years, the French and British navies would centre co-operation on the Charles de Gaulle, France’s only carrier.

What's interesting about this is not the military effects -- in the end, this is about trying to do more with less -- but the political ones. In a world of austerity, there is some logic in close allies working together to eliminate redundant platforms and/or other fixed costs that could be pooled across countries. Furthermore, this kind of defense integration, once started, would strike me as very hard to reverse.

This year has seen a lot of people predicting the end of the EU and NATO as Europe struggles with its economic misfortune. I wonder, however, if hard times are actually having the opposite effect of forcing European and NATO countries closer together. This might not be popular, but it's the only viable policy option in some instances.

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The currency war starts not with a bang, but with buckpassing

Posted By Daniel W. Drezner Friday, October 8, 2010 - 9:19 AM

The past week has seen an escalating series of news stories about a looming "currency war," as country after country tries to drive their currency downward, the United States blames China as the source of original sin on this, and China ~~pisses off yet another country~~ responds by digging in its heels, and the IMF wrings its hands.

If you need to read one article on why things are going down the way they are, it's Alan Beattie's excellent survey in the Financial Times of how countries as responding to this situation:

Washington is looking for allies -- particularly among the emerging economies, who complain about their own competitiveness and volatility problems -- in its campaign for exchange rate flexibility. Trying to take on Beijing single-handed makes the US vulnerable to the charge that it is a lone complainant blaming its own profligate shortcomings on the country that is kind enough to lend it money, holding the best part of $1,000bn in U.S. Treasury bonds…

Yet despite U.S. claims of broad support, backing appears sporadic…

[S]ome U.S. policymakers privately complain that European backing is patchy and tends to go up and down with the euro. In the first half of the year the euro was pushed lower by the gathering Greek crisis, by early summer falling 17 per cent below its January level. Focused on local difficulties, and with the German export machine powering ahead, European officials saw little need to take on Beijing over currencies and had little energy to do so…

Across the emerging economies, the plan of attack seems to be to keep quiet and pass the ammunition. Despite widespread recognition of the distortions China’s exchange rate policy appear to be causing, governments have generally preferred unilateral intervention to a public slanging match.

True, in April the governors of the Reserve Bank of India and the Central Bank of Brazil complained that Beijing was hurting their exporters.

But recently Celso Amorim, Brazil’s foreign minister, told Reuters: "I believe that this idea of putting pressure on a country is not the right way for finding solutions." Significantly, he added: "We have good co-ordination with China and we’ve been talking to them. We can’t forget that China is currently our main customer…"

With the prospect of diplomatic progress limited, currency policy in the U.S. and Europe may end up being conducted through domestic monetary policy. If, as seems possible, the U.S. Federal Reserve, the Bank of Japan and the European Central Bank return to quantitative easing in order to boost growth, their currencies are likely to weaken -- as the yen briefly did after the Bank of Japan’s announcement of looser monetary policy this week.

So, to sum up:

1) Every country is free-riding/buckpassing on this issue, hoping that the United States can dislodge China on its own.

2) The international regimes designed to prevent free-riding like this -- namely the G-20 and the IMF -- are not up to this task. [What about the WTO? -- ed. Fuggedaboutit.]

3) The source of China's rising power is not its hard currency reserves or its command over scarce rare earths, but its burgeoning domestic market.

4) Ironically, the United States and other countries want China to accelerate the growth of its domestic market, which would in turn give it more power. Even more ironically, China doesn't want to do this right now.

5) The sum effect of all of this will be a series of uncoordinated interventions into currency markets that will increase market volatility, political posturing, and eventually lead to the erection of capital and/or trade controls.

Developing… in a very disturbing manner.

MANDEL NGAN/AFP/Getty Images

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The muddled future of the eurozone

Posted By Daniel W. Drezner Thursday, September 30, 2010 - 9:11 AM

Europe's debt crisis is not going away anytime soon, which means that the crisis over European monetary union won't be going away either. As it turns out, the European Commission is on this, proposing things like "excessive deficit procedures" and the like.

Will this work? Well … let's go to the Economist's explanation for why the previous set of rules failed to prevent this from happening:

The “stability and growth pact” was supposed to limit each country’s budget deficit to 3% of gdp and public debt to 60% of GDP. It failed, in part because France and Germany refused to abide by it -- and even rewrote the rules when they breached the deficit limit.

In contrast, the problems that arose because different economies responded differently to the zone’s common monetary policy were underestimated. The sudden drop in real interest rates on joining the euro in Greece, Ireland and Spain fuelled huge spending booms. (Portugal had enjoyed its growth spurt in the late 1990s in anticipation of euro membership.) Rampant domestic demand pushed up unit-wage costs relative to those in the rest of the euro area, notably in Germany, hurting export competitiveness and producing big current-account deficits.

The euro allowed these internal imbalances to grow unchecked and now stands in the way of a speedy adjustment, because euro-area countries whose wages are out of whack with their peers’ cannot devalue.

So, what is to be done? In the past, European integrationists have been quite adroit at using periods of crisis and malaise to jumpstart further integration efforts. It's possible that this could happen again.

In this case, however, integration efforts are going to be very costly. The Economist explains:

[T]here are three ways for a country to restore competitiveness: devaluation (which reduces wages relative to those in other exporting countries), wage cuts or higher productivity. In the euro area, the first option is out. The other two rely on easing job-market rules so that pay matches workers’ efficiency more closely, and workers can move freely from dying industries and firms to growing ones.

I'm thinking unions will ~~develop breakout nuclear capabilities~~ aren't going to be big fans of that second option. The third option seems like the ultimate political dream, except it involves eliminating regulations that likely benefit a lot of entrenched interest groups.

Another possibility is greater fiscal centralization. The Economist is not keen on this, but that's besides the point -- as Mary Sarotte points out at Foreign Affairs, there's a Very Important Country that's not going to go along with the move:

The challenge now is governance reform, not expulsion of member states. Reverting to national currencies would drive the values of reissued southern currencies into the ground and the deutsche mark into the sky, thereby undermining Germany's export competitiveness and job market, to say nothing of the collateral damage to the European Union and the single market. The eurozone crisis should not signal the end of the euro but rather the start of a long-overdue overhaul. The idea of a European Monetary Fund, endorsed by Wolfgang Schäuble (an elder statesman from the days of German unification and now a subordinate of Merkel), faded after Merkel dismissed it but deserves broader support. Germany also needs to reconsider its calls for painful fiscal discipline on the part of the weakest countries until their economies regain footing. Ideally, but perhaps not realistically, Merkel should return to previous German form and spearhead a revision of the Maastricht Treaty, leading a fresh effort to do for political union what Kohl and Mitterrand did for monetary union.

The unlikelihood of such a move exemplifies a fundamental problem within the whole European Union: there exists a built-in tension between the lofty goals of integration and member states' collective unpreparedness to think through the consequences of their ambitious project. The great achievement of the past has been to reconcile these contradictory impulses by focusing on practical agreements. It is time to do so once again and realize that the necessary consequence of monetary union is greater political union.

In some ways, what happens from here on out will be an excellent test of whether economic interdependence really alters national incentives. As I blogged a few months ago, "When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project."

Of course, the European have spent the past few months muddling through some more. Given current trends, however, that option is going to disappear sooner rather than later.

Developing …

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