Orchestrating Europe (Text Only)

In the years 1989–93, many of the vestiges of post-War settlements, in welfare programmes, industrial relations and state benefits, also died. Each country described its own parabola of declension: the new – or perhaps nineteenth-century Liberal – thought, first enunciated by the new right in Britain and the United States, passed through a sort of contagion, causing questioning, then fiscal and moral panics, and finally a scaling down of promises and expectations. The true fiscal crisis of European states, heralded in academic literature in the early 1980s, burst a decade later. Coinciding with disillusion after Maastricht, it had a corrosive effect on what remained of late-1980s’ aspirations.

Four Summit meetings stand out as markers on the road from Hannover to Maastricht. The first, in Madrid in June 1989, brought together the Delors Committee’s report on Monetary Union and the first draft of the Social Charter. The meeting was noted for Nigel Lawson’s attempt (speaking for a divided leadership) to be explicit about the terms for Britain to enter the ERM, though his government opposed both EMU at any point beyond stage I and the Social Charter. Defeated on the question of whether to have an IGC, and reduced to near-isolation by the accommodations between the Spanish Presidency, Germany and France (which had been made explicit in the Kohl-Mitterrand letter in favour of political union) Britain had to accept not only the IGC but EMU stage I in July 1990.

At the next Summit in Strasbourg in September 1989, with overwhelming support from the Parliament and smaller states such as Belgium, the French version of monetary union was accepted, with a date for that IGC (but not for the one on political union) after the West German elections and under the Italian Presidency at the end of 1990. Mitterrand had won his second seven-year term in 1988, and although his narrow Socialist majority forced him to govern with centrist approval, he had the firm support of his finance minister, Pierre Bérégovoy, in a period of stability, growth and falling unemployment – which he used to get the European Bank for Recovery and Development (EBRD) off the ground, with his protégé Jacques Attali as head. By then, the Commissioner for Social Affairs, Vasso Papandreou, had seventeen draft directives ready on all the aspects of industrial relations and conditions of work which had been stultified since the early 1970s.

The third meeting, in Dublin in June 1990, took place very much in the shadow of the Franco-German commitments to common foreign and security policy and to a second IGC on political union set out jointly by Kohl and Mitterand in April. The Irish prime minister Charles Haughey capitalized shrewdly on Ireland’s affinity with France, which was seeking to strengthen the European Council, extend QMV and inhibit the pretensions of the Commission and the Parliament. This also suited Helmut Kohl, whose government was prepared to pay the price so long as political union could be kept in tandem with its monetary counterpart.

Once again, the British Cabinet hesitated on the margins, its prime minister profoundly uneasy at the implications of the Kohl-Mitterrand agreement which had been made without consultation with either NATO or their EC partners. That lack of consultation had offended other governments as well: however the weight of the Franco-German entente lay heavy on them all, and was on the basis of this declaration that EC foreign ministers prepared for Dublin and its sequel, the summit in Rome, which to a large extent set the IGC’s agendas. All Thatcher could do, given Britain’s eleven to one minority, was – sensibly enough – to veto a Franco-German proposal for a large dollar loan intended to prop up the collapsing Soviet Union.

Italy took over the Presidency in July, before the Conference on Security and Cooperation in Europe (CSCE) meetings with the Soviet Union. Soon after, Giulio Andreotti became prime minister (Craxi having destroyed de Mita’s liberalizing government of 1989, together with the DC’s reformist programme which, in retrospect, was Christian Democracy’s last chance to save itself from shameful eclipse). Under his direction, the principle of two concurrent IGC’s for monetary and political union was established. After careful consultation with the German and French governments, Andreotti proposed a special ‘informal’ Council, to meet in Rome in October: his intention being to agree a target date for EMU stage II in 1994, with a further wide-ranging IGC the following year.

So hot was this pace that the Italian leader’s motives need analysis. It has been argued that, with the help of his own MEPs and other Christian Democratic parties, Andreotti set a truly Florentine trap for Margaret Thatcher, while her attention was diverted by the July G7 meeting in Houston and by GATT negotiations, so that she went largely unprepared into the October special Council.11 Certainly her political nemesis was welcomed widely across the EC – in what one French diplomat described as a mood of soulagement. Yet there is no evidence among member states, whose policies were much more finely balanced than their leaders’ statements usually allowed to appear, of a desire to marginalize Britain. Concessions on stage II, and even some consideration of the chancellor of the exchequer John Major’s ‘hard ecu scheme’ had not been ruled out. But the Italian coalition was committed to transferring power to the Parliament. Andreotti may also genuinely have been concerned that the agenda for December was too vast for one meeting, since he attempted to agree much of it in advance at bilateral meetings and in the encounters of Christian Democratic parties in the late autumn. The German government had agreed not to bring forward the subject of the next set of GATT negotiations, hoping thereby to avoid antagonizing France (whose farming lobby passionately opposed the Blair House Agreement), while helping Andreotti’s fragile pentapartito administration. The German government’s concession of a firm date for EMU stage II, made during the October special Council, certainly strengthened France’s tentative acceptance that the two IGCs on monetary and political union should coincide.

Some of this can be ascribed to German and French governments’ calling in of past favours to Italy. But Italy also provided a skilful chairmanship which falsefooted British and Danish opposition. There was no discussion of GATT. Instead, proposals on political union and EMU stage II for January 1994 were confirmed, in advance of the IGCs. Thatcher had failed to seek alliances for her point of view and found no support except from Ruud Lubbers of the Netherlands.

France and Italy emerged with their governments’ main aims agreed. The real winner was Helmut Kohl who had been hoping for an uncontroversial reunification after the successful East German elections in March, and before public opinion during the West German elections began to question the terms. At the year’s end, Germany in effect paid for USSR approval of reunification and the new Germany’s continuing NATO membership with a massive hard currency sum to cover the withdrawal of Soviet troops from the former East Germany. In the same month, the five new Länder were absorbed in the enlarged Federal Republic, under Article 23 of the 1949 Basic Law; and once Kohl belatedly acknowledged the existing Polish border (cutting off the original pre-1914 East Germany for ever), the Soviet Union was excluded from central Europe for the first time since 1944.12

The fact that the two IGCs which began after the Rome meeting were to be concurrent, starting under the Luxembourg Presidency and ending under the Dutch one at Maastricht a year later, did not imply that they would resemble each other. The one on political union and Interior Ministry questions remained very largely a matter for inter-governmental negotiations. The question of monetary union involved the Commission to a far greater extent, and its influence permeated many of the texts. But the two were intimately linked, as Andreotti had argued; at the same time, the agenda was complicated by the issue of the reform of EC institutions, and by cohesion and the budget cycle after 1992 (which was essential for future cohesion funds), together with the Social Chapter, to which both were closely related.

I. EMU

The EMU IGC’s history is inextricably linked to that of the ERM.13 Even though the Single European Act stated the goal of eventual monetary union, nothing precise had been set down or accepted on the detailed matter of how transition to a single currency would take place, or when, or the shape and rules of the eventual European Central Bank which would administer it. The devil lay in precisely this detail, for which the ERM provided the only non-theoretical guide. Yet the ERM was the product of a very different conception, and had been disputed during its ten-year course between France and West Germany. The conclusions on which EMU’s architects would build were to become further confused by the entry of Spain and Britain.

The EMS had been created by decisions of the Council. But the ERM was formally an agreement between central banks (and therefore not part of the Community). Yet it had always had a high political content, whatever its economic effect on the economies of participants; and in that sense was to be compared not with the Gold Standard, as it had operated in Europe in the four decades up to 1914, but with the Gold Standard as governments rather than central banks had manipulated it in the 1920s.

Having been affected principally by movements of the French franc during the frequent realignments of the early 1980s, the ERM had been mistrusted by the Bundesbank for reasons expressed during Otmar Emminger’s tenure of office. But in the years after the French economic grand tournant of 1983, the ERM became a DM zone. Mitterrand and Delors, as his finance minister, took a decision which was politically strategic, as well as economic – a decision followed in due course by the Belgian and Danish governments and rather later by Italy and Ireland. For four years, in what can be seen as its ‘classic period’, the ERM rested on the Bundesbank’s credibility, together with West Germany’s willingness to behave as if the DM were indeed the anchor currency; and it achieved a generally accepted and widely welcomed reduction of inflation and state borrowing among members. It thus served as the monetary agency for what were becoming accepted concepts of prudence and discipline, necessary components of economic restructuring. Whether or not causation actually worked in this sequence is another matter: the gains appeared, at a time of rapid growth, to justify the sacrifices in output and employment that accompanied it.

France’s January 1987 devaluation however, which was forced on an unwilling government by the international markets as the American dollar fell steadily, altered this benign pattern.14 As Bernard Connolly observes, ‘the ERM had become an inescapable symbol of attachment to sound policies. But lack of complete credibility made it economically costly.’ French acceptance of the price for hard currency status was overtaken by a desire not to peg the franc to the DM, like the guilder or krone, which would have been politically unacceptable to French public opinion, but to fence the DM inside an increasingly rigid ERM structure which would lead logically and remorselessly to monetary union and a single currency – and thus to the disappearance of deutschmark primacy. French ministers evidently believed that this could be done, despite the global development of money markets where billions could flow across the exchanges in a matter of hours. They assumed continuation of the climate of opinion that had seen the G7 arrange the Louvre Accord in February 1987, in order to stabilize the dollar and yen against European currencies, whilst promoting world economic growth.

But the Bundesbank objected because of the implications for West Germany, and its criticisms carried great weight so long as the Reagan administration did nothing to remedy the dollar’s fall and the American budget imbalance. Having been pressed by Bonn to loosen its monetary stance, the Bundesbank reacted instead by raising interest rates in early October 1987, an action which helped to precipitate the New York Stock Exchange crash on ‘Black Monday’. The clash between Bonn and Frankfurt did not diminish until Hannover in July 1988, when the heads of government agreed on progressive reduction of interest rates. But this added new pressures to currencies in the ERM, since it had been agreed that capital would become fully mobile in France and Italy by 1990; so that it would cost their governments and central banks more and more, in each year before EMU took effect, to resist currency flows and speculation, particularly by the vast American ‘hedge funds’. Strengthening the ERM’s operations failed to limit these accumulating risks.15

Edouard Balladur had already proposed, in conjunction with Giscard, during the period of cohabitation, that a prototype of the European Central Bank (ECB) should start work before the final move to monetary union; and to plan it, the Committee of Central Bankers, under Delors’s chairmanship, was to be appointed at Hannover. But in the shorter term, two years of overshoot in West German money supply, together with signs of a speculative bubble in Japan, rapid overheating in Britain, and the Netherlands’ government’s unease about shadowing the deutschmark, presaged trouble which the G7’s pardonable overreaction on ‘Black Monday’ did nothing to allay.

With the Bundesbank apparently sulking on the fringe of a political vortex, stubbornly pushing up German and therefore ERM interest rates, the ERM’s deflationary classic phase ended in recrimination between Bonn and Frankfurt, and growing signs of inflation in Britain and Spain. (Denmark, isolated in its own peculiar cycle, experienced both inflation and stagnation, with repercussions on public opinion which were to be of great significance in 1992).

Meanwhile, the Committee of Central Bank governors, chaired by Delors, met between autumn 1988 and April 1989. They took part already having much common ground, both as professionals of a high order with a common discipline and as believers in the ERM’s proven effects on inflation, as well as the likely benefits of lower transaction costs and risks to be gained from monetary union. It is inherently unlikely that they ignored the political effects of a future ECB on members’ national sovereignty; but the possibility of national divergencies was offset by a measure of theoretical agreement: the conceptual ground had been well prepared in economic terms by the Padoa-Schioppa Report.16 This highlighted a basic inconsistency: following the completion of the internal market after 1992, which would be accompanied by full capital mobility and a more or less fixed exchange rates in the ERM, member states would still retain monetary autonomy in their national spheres.

Put simply, Padoa-Schioppa argued that it would not be in the interests of weaker economies to conform and bear the pain; instead they would act as backsliders or deviants, forcing the stronger partners to react, and thus prejudicing the whole. Prudent central bankers, inherently suspicious of what politicians would do to appease their electorates after the experience of the fifteen years since 1974, rated the collective good higher than national sovereignty. The fact that Karl-Otto Pöhl chaired the technical group and both he and Robin Leigh-Pemberton, governor of the Bank of England, signed the Delors Report seemed to indicate that unanimity had been achieved.17

To a large extent it had: all the governors accepted that a prototype ECB should start work, in order to begin the process of inducing equality of discipline and practice in reducing inflation as soon as possible. All could reasonably expect their governments to have accepted by then that no one country could bear the costs of doing this alone especially when taken together with contingent problems, such as wages and other labour market rigidities, and that if collective action were not initiated, at the next recession the EC might lapse into another sauve qui peut like 1974. The differences between them related mainly to highly technical problems. But the political issues of whether this new single currency, provisionally styled the ecu, would be too soft (as the Bundesbank feared) or too hard, as the British government suspected, and whether it would eventually be intended to stand up against the dollar and yen as an equivalent world currency, were not and probably could not be argued out.

The one fundamental disagreement in the Delors Committee concerned the mode of transition to EMU. It was finally concerted between Pohl and de Larosière (Banque de France) with some mediation from Carlo Ciampi, governor of the Banca d’ltalia, and help from the Netherlands and Spanish central banks, in time for Delors to present his report on 19 April 1989, in advance of the Madrid Summit. At that stage, it was sufficiently uncontentious to convince ‘respectable financial opinion’ in the EC, which in Britain included both The Economist and the CBI. But when Delors introduced it later that month to Ecofin, he added a timetable: there should be three stages, the first to begin as soon as possible. All twelve currencies should move within the ERM’s narrow bands by 1 January 1993, the date for completing the internal market. In stage two, exchange rates in the ERM should become almost rigid, and all central banks should be given the same degree of independence as the Bundesbank. Finally, in stage three, exchange rates would be permanently fixed, under an ECB entirely responsible for the monetary policy of the single currency. There would then be binding conventions on member states’ budgetary deficits, modulated – for example in the Spanish, Portuguese or Greek cases – by new EC cohesion funds.

Little debate took place in Ecofin, which had rarely been a forum for technical monetary matters, and the Spanish Presidency pushed ahead to start stage one on 1 July 1990. The governments of France, Germany, Spain, Italy and Belgium concurred in this timetable (though the Bundesbank held strong reservations); those of Italy, Greece and Portugal were appeased with cohesion promises. Finance ministers from Denmark, Netherlands and Luxembourg argued only over the detailed schedule. British delegates again were isolated. At Madrid, the whole package went through in the wake of Spain’s ERM entry within the 6% bands, (at a surprisingly low rate because Carlos Solchaga, the finance minister, had previously ‘talked the peseta down’). Meanwhile, as Lawson told in his autobiography, he and Howe jointly forced Margaret Thatcher to set out the conditions for British entry, despite her protests up to the last moment of arriving in Madrid.18 The Bundesbank gloomily went its way, raising West German interest rates further to contain domestic inflation.

Then the Berlin Wall came down. Very large numbers of East Germans had already escaped, mainly through Hungary’s unofficially opened border, raising the spectre of mass migration from East to West Germany. The situation could be compared with the strong, demand-led inflation experience before the Wall had been built in 1960–61. Bonn poured huge funds into East Germany to forestall such a threat to the DM, and later promised to exchange one deutschmark for each individual’s now almost worthless ostmark at a rate of one to one, a burden on West Germany which ensured high domestic interest rates for the foreseeable future.

Neither of the logical consequences, an ERM realignment or revaluation against the DM, or very high interest rates for all other member currencies, actually occurred. The first broke on French objections, since the franc fort policy had not yet acquired complete credibility, the second on German political reality. Karl-Otto Pöhl’s outspoken protests against the currency swap were ignored, being politically inconvenient before the crucial autumn elections. He was, in fact, threatened with constitutional revision of the Bank’s statutes if he did not give in. As a direct result, the DM’s credibility was impaired.

ERM partners in 1990, however, concerned themselves more with the effect of rising German interest rates on their own borrowing and their domestic economies, for while the German government expected to bear 80% of unification costs, it was not willing to internalize the consequences for other Community members. The result, if the Bundesbank held to its primary duty of monetary stability, could only be a steady rise in German rates to which the rest would have to adjust. Yet the British government – or rather its chancellor, John Major, fearful of losing the chance should Thatcher change her mind – chose this moment finally to enter the ERM in the narrow bands, on 5 October 1990. It was a bad time, with the dollar still falling and the ERM now nearly rigid, and a worse choice of parity. Yet the British chose not to take the advice of other member states which the ERM’s informal conventions prescribed – and which might perhaps have counselled caution.19

Meanwhile, despite these huge potential sources of tension, member governments concerned above all with passage to EMU went ahead, like Captain McWhirr in Conrad’s Typhoon, hoping to win through the storm to the hypothetical calm beyond. The German government’s price for accepting the principle of EMU in such conditions was to be France’s overt support for reunification and rapid progress to political union, so that the new, larger Germany could cement itself firmly into the Community. This can be read as the second stage of the Franco-German bargain made in 1987.

France’s government could accept this, whatever Mitterrand’s initial doubts about reunification, and whatever the impact on French public opinion, because few wished to unleash visceral images of Germany’s past being propounded at this time by Thatcher herself and Nicholas Ridley (except, that is, in languages such as Dutch and Danish which the international press agencies did not read). On that basis, Kohl and Mitterrand agreed their highly important joint declaration of April 1990. It followed, apparently naturally, that EMU would come about via the ERM-convergence path, and according to Delors’s timetable. Franco-German clarity of aim contrasted with Britain’s disarray at the top as Margaret Thatcher fell from power in November 1990, the result of a palace coup within her own Conservative party.

All this time the Bundesbank was constrained not only by its duty to the currency but by its charter obligation to support the Bonn government’s policy in the last resort. Whatever its Directorate felt about Kohl’s pre-election promise that reunification would cost the West German electorate nothing, the bank could not oppose the chancellor’s direction outright. In due course, with the CDU/CSU triumphant in the elections, Pöhl resigned. His lonely gesture and his subsequent explanation, though cogent, had less general effect on events than the new British prime minister’s tone; for John Major’s talk of bringing Britain to a more pro-EC orientation, and signs that his Conservative party might even align with Kohl’s CDU and the European People’s party parliamentary grouping, seemed remarkable after eleven years of marching in another direction.

It was widely assumed during the IGCs that year that the ERM had become the ‘glide path to Monetary Union’.20 But that this represented a political as well as an economic judgment was not clear until after Maastricht, in spite of the most unwelcome paradox that developed shortly afterwards, when the peseta went to the top of its ERM range and the French franc to the bottom – the exact reverse of what their relative stabilities indicated should happen. France encountered the greatest economic pain, for despite inflation being almost as low as in Germany, interest rates stayed higher and contributed both to slow growth and persistent high unemployment, and to the government’s repeated attempts to reduce rates rather than let the franc rise.21

At the heart of the problem lay the fact that with reunification of Germany costs and prices would eventually rise; unless the Bundesbank permitted higher domestic inflation, France and the other members would pay the price via the ERM. Acceptable though the arrangement might be in 1990–91 while Bérégovoy pursued the franc fort, and while Mitterrand sought to reincorporate Germany coute qui coute, its long term survival could not be taken for granted during the next three years. It also depended entirely on monetary union remaining the agreed end. Yet twelve years of ERM practice offered no precedent for resolving such tension. Any realignment at this stage – even by Britain, now locked into its initial misjudgment – would imperil the ‘glide path’ thesis. As for the Spanish paradox, the others could neither ignore the thesis nor rethink the ERM’s logic. Only the Bundesbank’s council dreamed, as they had since 1987, of a different path to EMU through gradual evolution of a cluster of low-inflation currencies such as the guilder, Belgian franc, Danish krone, and now the French franc, linked to the DM.