Thursday, September 25, 2008

The EU Needs a New Business Model

Note: A keynote speech delivered on 19 September 2008 at the
European Business School Symposium in Frankfurt.

Words ought to be a little wild, for they are the assault of thoughts upon the unthinking.
J. M. Keynes

The rejection by the Irish of the Lisbon Treaty has led to much soul-searching in Brussels and elsewhere in Europe. Putting aside the question how the EU got itself in this particular predicament, namely, allowing 1 million voters, accounting for 0.2 percent of the EU's total population to veto a 269-page treaty teeming with bureaucratese of mind-boggling opaqueness, the debate-still on going as we speak-is not likely to go very far. The fact is that it is not the Irish that are to be blamed-one should in general not put to referenda questions which cannot fit in less than one page and even that is risking it.

It might be useful to review briefly here, at the outset, the content of some of this soul-searching. One can identify several schools of thought.

• There are some who think that the problem with the EU is that it is too diverse to expect that all member states will ratify any given treaty or wholeheartedly approve any given policy. Unanimity and uniformity are relics of the past and the sooner the EU abandons them, the better. This, by the way, would be making explicit what is already implicit, when you remember that the United Kingdom and Denmark opted out of the Maastricht Treaty, that the Schengen open-border area includes Iceland, Norway and soon Switzerland, but excludes the UK, Ireland, Bulgaria and Romania, that the eurozone has 15 members, not 27, that the Lisbon Treaty would exempt Britain and Poland from the Charter of Fundamental Rights, and so on.

The list is long. So, from this perspective, the way forward is to abandon the unanimity rule for treaties, and accept a process of integration that allows for different speeds. All members must be democracies, there must be respect for human rights and countries must participate in the single market, but, beyond this, countries may choose which policies they are able to participate in, depending on their individual circumstances.

• A second school of thought goes as follows: the Lisbon Treaty is a side show. The problem with Europe is that, notwithstanding impressive achievements during the past several decades, its influence in the world is waning because it has failed to implement the sorts of reforms which will make it the most competitive economy in the world. All this hand wringing about Lisbon misses the fact that the EU continues to be saddled with inefficient policies-the Common Agricultural Policy, obsolete regulatory regimes, a system of higher education which, long ago, abdicated leadership to the United States.

Former Swedish Trade Minister Leif Pagrotsky put it very well recently when he said that "today, when US or Swiss banks risk collapse, nobody approaches Europeans for support. They go to the Middle East, Singapore, or China for lifelines." Yes, he adds, "democracy and the market economy have been consolidated and the lives of millions of people improved", but "increasing irrelevance is staring us in the face."

From this perspective the focus should shift from Treaty negotiations-a favorite pastime of politicians-to ensuring that the EU stops spending more on declining industries than in research and development (Israel, with 6 million inhabitants, has more companies listed in the Nasdaq than any other country in Europe, by a huge margin), that it makes it easier to facilitate cross-border mergers to build world champions instead of capitulating to national interests, that it creates a European patent. In other words, put aside the glamorous work of Treaties and Constitutions and get to work on the nuts and bolts of economic and institutional reforms. Concentrate on the content and not so much on the glamour and the form.

• No, actually, the problem with the EU say others is not that its citizens are confused-such as the Irish-rather they are cynical and the leadership is to be blamed because they themselves are cynical. EU policies do not particularly address citizen's concerns. "There is now a widespread impression across Europe-and especially among the young-that it is in danger of offering pseudo-democracy, remote bureaucratic government thinly disguised by a European parliament," is how an Oxford professor put it (Larry Siedentop, FT, 2 July 2008). So, the problem is one of political legitimacy.

I think that there is much in some of these observations that is probably on target. There is a lot in these schools of thought-as I have called them-that makes much sense. My thesis, rather, which I would like to share with you is that the EU's business model is broken and until a new one is brought out the EU will simply continue to find itself plunged into crises of this sort, as happened in 2005 when the French and the Dutch rejected the EU's first Constitution-another phonebook of a document that even senior politicians admitted not having read.

For the past half century the two driving forces of the EU have been history and geography. The EU was born out of the ashes of World War II and reflected an understandable and rational desire on the part of Europe's leading politicians to secure a more stable basis for peace and prosperity, and to anchor Germany in formal schemes of international cooperation. The creation of the European Coal and Steel Community in 1951 was an inspired start, as was the goal, years later, under the Treaty of Rome which created the European Communities to focus largely on liberalizing the trade regime and facilitating access to each other's markets.

This is not to say that the Treaty of Rome did not have overtly political undertones and it is clear that Jean Monet, the Community's father and chief ideologue was, then, seeing well into the future. I have always found his statement that "for national sovereignty to be effective, in an expanding world, it needs to be transferred to larger spheres, where it can be merged with the sovereignty of others who are subject to the same pressures" and that "in this process, no one loses; on the contrary, all gain new strength" to be a particularly effective roadmap for the EU's evolution.

The second driving force for the EU has been geography. As time went by new members were brought in, able to abide by a set of common policies. Naturally, this process took in countries in the periphery and it came to a climax in 2004, with the accession of 10 new members. There is little doubt that this first phase of growth has been brilliantly successful.

War among member states has been vanquished, its members are among the most prosperous nations in the world, differences are settled-in not always efficient ways-through negotiations and boring committee meetings, and a set of supranational institutions has been created which, for all their limitations, are showing increasing degrees of maturity and effectiveness. Witness the largely positive assessments in recent weeks of the first 10 years of the European Central Bank.

But there are several reasons why this model is not likely to work anymore. Here is why.

Globalization has reduced the relative importance of geography as a determinant of economic growth and prosperity. Sharp reductions in the cost of transport and communications have drastically reduced the importance of location. More and more, the most competitive economies in the world are those that have managed to boost the skills of the labor force, that have develop open, transparent, and reliable institutions, and that offer a measure of political and social stability. Success seems to depend far more on policies and institutions than on where the country happens to be located.

In light of this, it would appear then that the EU ought to be thought of less as a political geography and more as a group of member states sharing mutually agreed rules, policies and institutions which, to a great extent, have less and less to do with location. The recent voter fatigue with EU expansion may have less to do with a waning of EU citizen's commitment to the sense of community that underpins the EU and more to do with the perception that, since political leaders have largely seen expansion as a process fuelled by geographical considerations, they have been forced to take in members which are not yet ready to assume the full responsibilities of membership.

The recent incorporation of Bulgaria and Romania is a case in point-two countries with levels of transparency in government far behind the rest of the EU. If the EU were to be seen increasingly as a union based on shared policies and institutions and respect for commonly agreed rules, it is doubtful that it would have expanded quite so quickly, opting perhaps for a longer period of institutional consolidation in some of its candidate states. Similar comments apply to Turkey, a country where only recently there was high likelihood that the constitutional court could have banned the country's main political party and, hence, its duly elected government, a decision that would, no doubt, have led the European Court of Human Rights to rule that its charter on human rights had been violated.

The above suggests that EU leaders intent on consolidating the achievements of the past 50 years should not confine their vision for the EU to bringing in those states currently in its periphery but rather should focus their attention on those states which, having established a credible track record of good policies, sound institutions and shared political values, would agree to submit themselves to the competitive pressures of the EU market, the discipline of its institutions and its agreed rules, regardless of where they may be located.

Let the EU turn itself into an open club of like-minded nations. Let it change its name, if necessary, from the EU to the UNW-a union of the nations of the world. Rather than sowing the seeds of a dozen crises in the future-on Turkey, on Ukraine and the many aspirants currently on its periphery but which are not likely to be ready for a long time to come, on whether the Irish will eventually bend to pressures and approve the Lisbon Treaty, on whether the EU will find a coherent way to deal with an emerging and authoritarian Russia on which it is dangerously energy-dependent, let it focus instead on inviting the Koreas and the Chiles of this world, countries that, except for (increasingly irrelevant) geography are already operating at levels of efficiency and competence well above the EU average.

Let me focus, for a minute or two, on these two countries, purely by way of an example. On why Chile might be an ideal candidate: It has already surpassed most EU members in the quality of its macroeconomic management. Chile's institutions: property rights, a judicial system, a regulatory framework, a trade regime, and social security system are already operating at well above average EU levels. In terms of corruption, the clarity of its rules, the general investment climate-Chile is already well ahead of such EU members as Italy and Greece and most of the new EU states in Central and Eastern Europe. Aside from the obvious fact it does not share a physical border with the EU, Chile-the only country in Latin America to have a free trade regime with the EU-is already an EU member in spirit.

As for Korea, well, it is a powerhouse for technology and innovation-a huge market with a sophisticated and highly trained labor force, already well ahead of much of Europe in such areas as the quality of its higher education, company spending on research and development, patents registration, the penetration of all the latest technologies-internet, broadband, mobile telephones. Korea is, without doubt, one of the most successful development experiences of the past 50 years.

Chile's membership in the EU would have implications that go well beyond the addition of one more small state to its growing list of small economies. It would give the EU an important institutional presence in Latin America, a region with which it has rapidly growing trade links. The EU would benefit from bringing into its midst an economy with an enviable growth record and in a privileged position in all competitiveness rankings.

Most important, Chilean membership in the EU would unleash a powerful chain of incentives in Latin America, as happened in Central and Eastern Europe during the past decade and a half. With Chile in, one can easily foresee that the political debate in Latin America would take on a more high-minded character. Uruguayans and Costa Ricans might immediately ask themselves: "what do we need to do to qualify?"

This is exactly the sort of question that should be raised in the region, to shift the focus of attention away from the sort of populist demagoguery of recent years, which, if allowed to run its course, could well turn the region into an increasingly irrelevant appendage of the global economy.

Looking ahead one thing is clear: the relentless pace of technological change is rapidly creating an integrated global economy and leading to a growing consciousness of global citizenship. As EU political leaders seek to address the consequences of the Irish veto, they might well discover that the time has come to think of "Europe" less in the traditional-and necessarily limiting-paradigms of physical proximity and more in the new language of the 21st century, where physical barriers, borders and notions of distance, are giving way to the realities of the oneness of mankind.