Many readers will share these emotions: an intense and unexpected elation at the result of the election, and an extraordinary sense of pleasure at the departure of the Conservatives. But then comes the deflating question: what is this government going to do? It is not a government without ideas or policies. Leaving aside all the constitutional measures, important work went on in opposition on the transition from a welfare state based on income redistribution to one based on education and re-education. Moreover, as a pointer to what stronger prime ministerial control may be able to achieve, much of this came not from left-wing intellectuals, but from Tony Blair's own policy unit.
None the less, many of the important issues remain open. One is Europe: being friendly at the first meeting is a good start (John Major was too), but it does not amount to a strategy. Another is the nature of British capitalism: is it an irretrievably Anglo-Saxon type of economy or should it try to evolve towards a more regulated "stakeholder" system like that of Germany? What about macroeconomic policy? Gordon Brown's initial moves appear to have tied his hands on both fiscal and monetary policy.
These issues have scarcely been debated publicly by the Labour leadership in the past 12 months for electoral reasons. But the argument has continued without them. Indeed, the current British debate over Europe differs in important ways from the past. It has taken Emu as a central question, but it has also brought the British attitude to Germany to centre stage. In fact it has pitted against one another two different types of capitalism: Anglo-Saxon and German.
The prevailing Conservative orthodoxy is that Britain has found in deregulation the economic cure for all ills: Germany and the rest of the EU should follow suit and adopt this Anglo-Saxon model. This is not just the view of Eurosceptics but also of Kenneth Clarke, John Major and intellectuals such as David Willetts. Behind this optimism there is a darker side identified by the Eurosceptics. The EU is an embryonic superstate, manipulated by Chancellor Kohl. Germany and the European superstate are elided-witness the Conservative election poster of a diminutive Blair sitting on Kohl's knee.
Radically different views have been held over the last few years in the Labour party. Germany, displacing Sweden as most favoured nation, has been seen as the home of patient finance, apprenticeships, egalitarian income distribution and employee participation. Moreover, these benefits have not come at the price of successful export performance; rather, they have reinforced it. Opting into the social chapter will thus be an important step in the building of a more "European" society and a stakeholding economy.
On Emu, there is a curious rapprochement between these two sides. For Eurosceptics Emu stands for German hegemony exercised through a European superstate. But for many on the left Emu exemplifies the deflationary policies of the Bundesbank and there has been some relief at the apparent rejection of early participation in the single currency.
many of the above arguments from both left and right are out of touch with reality. I will argue that, with the Chancellor's foreswearing of monetary policy, the economic case for early entry into Emu to help shape its operation is now compelling. But first some misunderstandings about both the German economy and European federalism need to be cleared up.
Many observers claim that Germany is failing to compete in the new world economy because companies have insufficient freedom and flexibility. There is a German problem, but it is macroeconomic not institutional. The export-driven German economy continues to perform exceptionally well, generating far higher living standards than in Britain, despite the enormous burden of unification. It does so moreover because a range of German institutions provides many of the public goods companies need in the world markets in which Germany excels: special chemicals, sophisticated engineering, advanced cars and so on. These products require a highly skilled workforce as well as close links between companies-notably with suppliers-to foster technology-based joint developments.
In deregulated markets these links with employees and other companies are difficult to build. Skilled employees, from manual workers through to engineers and scientists, have considerable bargaining power, especially if the results of their work cannot easily be monitored and if proper effectiveness requires giving them substantial autonomy. These employee relations are difficult to manage without an effective system of employee "voice." In Germany this is provided by works councils with real powers, backed by trade unions. To make employers comfortable with this powerful employee representation, unions are balanced by powerful employer associations. Together, industry-based unions and employer associations solve the disincentive problem for investment in training by discouraging the poaching of highly trained people. Companies entering such longterm contracts need longterm finance. The German corporate governance system makes that possible for quoted companies by making hostile takeovers difficult. For smaller companies, the system of local banks performs a similar function.
German companies are thus embedded in complex interlocking institutions-from industrial relations to training and corporate governance-which provide the right environment for high quality production. Something like the German system of longterm finance, co-operative industrial relations and close links between companies also operates in the other northern European economies.
The German or northern European model has many flaws. Important groups are not stakeholders, notably immigrants. Women, even in Sweden, are second class stakeholders. Moreover, northern European economies are not competitive in areas which require companies to take rapid or high-risk decisions. Such decisions place the stakes of stakeholders-employees, customers, suppliers-at risk. Hence these economies do not perform well in the new technologies. Biotechnology, semiconductors and software have not taken root in Germany; nor does Germany have a comparative advantage in analogous areas in the service sector, such as entertainment, advertising and investment banking. To keep a foothold in these sectors German companies have to buy into biotech startups in the US or investment banks in the City of London.
But the standard criticisms of the German model are wide of the mark. I recently completed a study for the National Institute of Economic and Social Research with Wendy Carlin which showed that, despite institutional inflexibilities, large German companies have been able to achieve most of the reduced employment and increased efficiency they wanted. The regular bouts of anguished self-criticism within Germany itself does not mean the system is collapsing: for the foreseeable future there will continue to be huge global demand for the products in which Germany retains a comparative advantage.
Germany's real problem is the deflationary impact of the Bundesbank's monetary policy. It is a problem not only for Germany but for the whole of western Europe. By contrast to the US Federal Reserve, which responds fast to both deflation and inflation, the Bundesbank is slow to reduce interest rates when unemployment is rising, but quick to put them up when inflation rises. This is not irrational behaviour given the strong bargaining positions of trade unions, and of local, state and federal governments.
In the past, this system worked well because external factors were able to lift Germany out of deflation-in the 1980s it was the US boom, in earlier times the rapid growth of other European economies. Indeed, Germany's unemployment performance was even better than that of the US in the late 1980s. But as the rest of western Europe has become more integrated into the German economy, so German deflation has constrained growth elsewhere. The external locomotives have ceased to function and unemployment has consequently risen throughout western Europe.
Contrary to received wisdom, employment in the exporting sector of the German economy has held up well. The Bundesbank-led deflation, combined with the shock of reunification, accounts for most of the rapid recent increase in German unemployment. Tightly regulated labour markets and a relatively undynamic service sector are not the cause of the problem, but they do make it more difficult to bring down the number of unemployed rapidly.
A British government would be ill-advised to introduce those negative aspects of the German model unless it can be sure of implanting the positive ones. But it cannot be sure. Tony Blair's withdrawal from stakeholder capitalism, at least on German lines, is fully justified. Neither the problems nor the opportunities facing Britain's individualist, market-driven financial capitalism would be helped by importing German institutions. Blair recognises this, as have left of centre parties in similar Anglo-Saxon economies such as New Zealand, Australia and the US.
The reasons why Britain needs to follow the Anglo-Saxon model are twofold. First, it is not feasible to develop the complex institutions necessary for developing stakeholder capitalism. Second, despite all the problems of Anglo-Saxon capitalism, it has great benefits. The US has close to the highest productivity in the world; and it is also the source of much of the most radical innovation. The keys to this are a strong emphasis on deregulation which allows small companies to be set up easily, gives flexibility to the top management of large companies and allows incentives to be set to encourage risk-taking; and a stress on higher education, both in providing mass higher education for 60 per cent plus of the age cohort, and in the concentration of world elite universities.
These are already areas in which Britain has a relative advantage within Europe. Our universities and research institutes are far more innovative than those in Germany and other EU countries. The strength of venture capitalism in Britain and its relative weakness in the rest of Europe reflects the depth of innovative ideas as much as the sophistication of the financial markets. Britain must capitalise on this advantage in shaping the future of Europe. It must become the centre of radical innovation in the EU, with German and other EU multinationals establishing research institutes and buying into British startups, and young EU scientists doing doctorates in Britain. This is not against the longterm interest of Germany or France, which have comparative advantage in other fields.
The other challenge for Britain is this: how can the downside of the US model, the underclass, be avoided? The expansion of higher education will, in the short term, adversely effect the underclass problem. The Australian, US and Canadian experiences suggest that students will work their way through college on part-time jobs; this will take work away from young people with limited skills.
The underclass problem will be neither helped nor hindered by signing the social chapter. The latter has no teeth, and for good reason. The setting of common standards in industrial relations, working hours, holidays which have to apply to all EU countries-from Portugal to Sweden-will always be a matter of the lowest common denominator. Portugal, Greece, Ireland and Spain are put at a competitive disadvantage by workplace standards which rich countries take for granted. Moreover, standards such as co-determination rights in works councils may be workable in northern European stakeholder economies, but not in Anglo-Saxon ones. Thus, so long as the social chapter seeks to get agreement on uniform standards it will be unable to do so.
But the fear of widening differences in social and employment conditions across Europe and the related danger of social dumping cannot be dismissed out of hand. Europe's greatest longterm challenge is the maintenance of the welfare state. Pressures arising from globalisation and the European single market have forced EU countries to compete against each other in reducing business costs. And the related pressure from financial markets has forced governments to squeeze public expenditure.
Fritz Scharpf, one of Germany's leading political scientists, argues that the EU needs to think about a new type of agreement to prevent national competition from undermining the welfare state. Instead of imposing uniform standards, he argues, standards should be linked to levels of national wealth. Thus Portugal and Greece, and perhaps subsequent east European member states, would face lower requirements than Denmark and Germany. Moreover, standards should not be institutionally defined. Instead, they should be set in simple but precise financial terms. Scharpf's proposal is an agreement that economies should spend a proportion of GDP on the welfare state (social security, pensions, education and health added together) which would rise as GDP per capita rises. While there are problems with its details, this represents an imaginative and important approach.
the eu is not a superstate, nor on the way to becoming one, as the weakness of the social dimension illustrates. Where Eurosceptics see a superstate, the French elite sees a chance to wrest control of European demand management from the Bundesbank. Certainly, German and French governments would like to ensure their economies are locked together so that future conflict between them cannot arise; but this is not the same as wanting a federal superstate.
The way the EU works in almost all policy areas is that the relevant commissioner has the sole right to propose measures; and the relevant council of national ministers has the sole right of decision by absolute or qualified majority voting. It is a give-and-take system designed to take into account important national interests. Policy-making usually reflects a broad cross-governmental compromise.
France and Germany acting together have played a central, but not all-powerful role in EU decision-making. But they hold very different views in key areas. Movement forward has required substantial compromise on both sides. That will be even more true once a single currency is under way. The German government, reflecting the need to keep the Bundesbank on its side, insists on the European central bank (ECB) imitating the Bundesbank in its strictly anti-inflationary goals and on a rigid stability pact which rules out expansionary fiscal policies. The French want exactly the opposite: the ability to influence the ECB and the capacity to develop co-ordinated fiscal policies at EU level.
This is where a Labour-governed Britain comes in. Britain can have a decisive influence on this debate-on the French side-but only if it shows it is committed to a new European engagement. Britain cannot come and go as it pleases-as the previous government did. Both France and Germany are suspicious of the strength of British commitment even under new leadership. This is not just because of recent history but for structural reasons: the elites, the civil service and the powerful interest groups on either side of the Rhine are intimately connected. Neither the French president nor the German chancellor can decide by himself-overnight, on a whim or at a press conference-what their country's European policy will be. Britain is rightly seen as different: a unified political elite does not exist in the same way, the civil service is at the beck and call of ministers, and interest groups have little influence. If the prime minister chooses to sabotage the EU decision-making process, ministers and civil servants will obey. There is a deep nervousness that British politicians can take unpredictable decisions on important European issues in response to short-term electoral concerns.
The benefits for Britain of joining the Franco-German club are great: the enlargement of the union and the form it will take, the future development of external trade policy and the common agricultural policy, key decisions inside Emu, as well as the evolution of foreign and defence policy, will all be partially or substantially shaped within such a triad.
France and Germany have good reason for wanting Britain to join this inner core. For each gains from Britain countering what each sees as the most problematic aspect of the other. Germany has a fundamental interest in reducing the direct control of government over markets, which it sees as a central element of French Colbertisme. France needs a strong ally to break the German hold on Emu. Committed to the inner core, Britain would stand with Germany as a guarantor of market liberalisation, and with France for a non-deflationary macroeconomic policy.
The two areas in which Britain can make it clear that its new commitment is not temporary are qualified majority voting and Emu. If the new Labour government agrees to an extension of qualified majority voting, it would help to speed up the working of the EU in key areas and would make enlargement more feasible. Critically, it would signal a commitment which would be difficult to reverse.
The same is true if Britain were to consider joining Emu in the near future. The first two or three years of Emu will involve intense political activity in the shaping of its rules. This will be true both of the ECB and its executive, which will be responsible for monetary policy, including interest rates and the exchange rate; and of the council of finance ministers which will be responsible for fiscal policy rules.
British influence could be decisive if it joins Emu or if it is at least in the process of doing so. The interests of the British and French governments are similar. They want to avoid the prolonged deflation periods to which the Bundesbank has subjected much of western Europe. This means that the ECB should operate more like the Federal Reserve than the Bundesbank, and that fiscal policy should be allowed to operate in anti-cyclical fashion. It is also in the interest of both governments to avoid inflation and rising public spending. The new Labour government sees its recent electoral success and future electability as based on low inflation and an end to a high-tax high-spend image.
The Oxford economists, Christopher Allsopp and David Vines, have argued that Emu will operate in a deflationary way if members believe the stability pact will be enforced as a "quasi-automatic mechanism" (Theo Waigel's phrase). According to the pact, member states which run a public sector deficit above 3 per cent will be fined (unless GDP has fallen by 2 per cent). Most members will join Emu with deficits close to 3 per cent, so they will either be forced to raise taxes if their deficit moves above 3 per cent, or prudence will dictate immediate retrenchment to avoid being forced into retrenchment later. The result will be a slowdown of growth throughout western Europe, raising public sector deficits and precipitating further cutbacks.
The Allsopp-Vines argument is highly plausible. But if Emu started in such a deflationary way, the likelihood that France and Britain could combine to develop more sensible fiscal policies is high. Although Germany would object, the death of the Bundesbank is likely to weaken its resistance. The stability pact allows for different interpretations; such documents are never completely watertight. Moreover, France and Britain may be able to influence monetary policy if the ECB seeks to pursue deflationary policies in an already deflationary environment. The governor of the Bank of England would almost certainly be a member of the five- person executive board, perhaps the swing voter.
Within Emu British interests would align more closely with those of the French than the Germans. But Britain could balance this by siding strongly with Germany on market liberalisation. Despite the completion of the internal market, there are many de facto restrictions, concerning market access, which are damaging to British companies. A well known example is the provision of airport slots. But there are other examples in entertainment, gas and water, roads and rail transport. These restrictions are often hidden by regulations, as in insurance and parts of retail banking. No member state is immune from this, but France probably has the worst record of the large member states. France remains tempted by protectionism at the EU level and by the desire to promote "European champions" at the national level. By contrast, northern European countries, including Germany, attach the highest importance to market access.
despite what i believe to be the substantial benefits from Britain joining Emu, the main concern of the new government will be to ensure that it is re-elected in 2002. The idea of staying out and retaining an independent monetary and fiscal policy is therefore attractive. But if Emu proves deflationary and slows down European growth, the slowdown will affect Britain whether it is in Emu or not. Being outside Emu means being inside the highly restrictive world currency markets and, in any case, most control over monetary policy has now been ceded to the semi-independent Bank of England.
For Labour, the key question of European political strategy concerns its effect on the Conservative party. In the run up to the general election, Labour played the Europe card with kid gloves. Accepting a referendum on Emu; allowing Robin Cook to doubt the possibility of entering Emu in the lifetime of this parliament; and using forceful language on the British veto: all made sense in a pre-election environment of uncertainty about how the electorate would react to a pro-EU Labour party fighting a Eurosceptic government.
The results of the election have dissipated this uncertainty. The failure of the Referendum party to make the slightest headway, and the indifference of the Conservative electorate on Emu-Eurosceptic candidates performed no better than others-have neutralised the European issue for now. The government can go on to the offensive and use the single currency to split the opposition. During the rest of this year the government will enjoy considerable support. It should move for a referendum sooner rather than later, asking the question: "Do you agree with Britain joining Emu if satisfactory terms can be negotiated?" If the terms were attractive, the Conservatives would suffer great internal dispute. If the Conservative leadership rejected Emu entry with some senior figures openly advocating withdrawal from the EU, Labour would face the tempting prospect of holding on to power for a generation.
