EUROPEAN ECONOMIC AND MONETARY UNION

Europes Economy Since 1945Based on Barry Eichengreens article Innovation and Integration: Europes Economy Since 1945EUROPES ECONOMY SINCE 1945INTRODUCTION2nd half of the 20th century was a period of unparalleled growth in Europe:

Real GDP per capita more than tripled in the Western countries and more than doubled in the Eastern countriesQuality of life improved hours worked per year declined by more than one-third giving way to leisure time and lengthening life expectantcy

However unemployment rose over the period and taxes also soared

BUT, by any standard, Europeans are better off today than their parents and grandparents

Introduction (cont.)Southern Europe grew faster than Northern Europe

Western Europe grew faster than Eastern Europe

Growth was faster in the 2 decades before 1973 than the 2 decades after

HOWEVER, the postwar period is regarded as the golden age of economic growth

Introduction (cont.)2 exogenous conditions stimulated growth in the second half of the 20th century:

Backlog of unexploited technological and organizational knowledge with which Europe entered the periodMilitary had to innovate to survive the world wars (for ex. t had to invent jet engines, radar and computing)

The great power conflict between the USA and Soviet Union forcing countries to conform to the form of economic organization as their dominant partner

Their choice determined their subsequent economic performanceWestern Europe Market CapitalismEastern Europe State SocialismIntroduction (cont.)Principal Features of the International Economic Environment of the Postwar Period:

Marshall PlanBretton Woods International Monetary SystemGeneral Agreement on Tariffs and Trade

These were all molded by the US Soviet conflictExogenous Actions Endogenous ProcessesTo the 2 exogenous actions there were 2 reactions 2 endogenous processes

Transition from extensive to intensive growth

Extensive growth: growing on the basis of known technologies raising output by putting more people to work at familiar tasks and raising labor productivity by building more factories along the lines of existing onesRising capital/labor ration = extensive growthIntensive growth: growth through innovationEurope relied more on extensive growth before 1973 and more on intensive growth thereafterExtensive GrowthFacilitated by the backlog of technologyLess important to innovate so long as there were known technologies still to be acquired and commercializedEasy as long as there were elastic supplies of labor (refugees from the east; repatriates from the colonies; underemployed workers from the agricultural perihery) who could be added to the industrial labor force without putting upward pressure on wagesExtensive Growth (cont.)Extensive growth was what planned economies organized on Soviet lines did best

Government decides how many factories to build; directs state banks to mobilize the resources; limits consumption to what is left; decides what foreign technologies to acquire...

This was a successful strategy for Eastern European countries for a while

The more successfully European countries pursued this model, the more quickly they exhausted the backlog of technological and organizational knowledgeExtensive Growth (cont.)As European countries depleted backlog of technology and organizational knowledge they were forced to switch to intensive growthThe centrally-planned economies were the least good at innovation because new knowledge bubbled up from below instead of raining from aboveThis became a problem for the centrally planned economies once the technology was used and the labor force was fully employedExogenous Actions Endogenous Processes (cont.)European Integration

Globalization for Europe meant regional integration

European integration was encouraged by the U.S. To fight off the Soviet influence

The Soviet Union prohibited the participation of Eastern European countries to integrate with Western EuropeHow Can Europe Avoid Another War? The Question and IdeologiesThe solution to this problem differed on beliefs about the cause of WWII and the three schools of thought in existence were:Germany was to blame: The so-called Morgenthau plan of 1944 proposed to avoid future war by turning Germany into a country primarily agricultural and pastoral in nature. The same thinking existed after WWI where the victors were rewarded with German territories and financial reparations this led to the German cycle of resentment and economic downturn that led to WWIICapitalism was to blame: Marxism-Leninism blamed capitalism for WWI and II and offered communism as a solutionNationalism was to blame: Excesses of destructive nationalism was blamed for the war and European integration was offered as a solutionThe 3rd view ultimately prevailed but this was far from clear in the 1940sEuropean Integration (cont.)Before 1913 Western Europe was at the heart of the global trade and financial systemWorld War I (1914-1918) disrupted thisThe Bolshevik Revolution (1917) and the Treaty of Versailles (1919) also disrupted trade and financeWorld War II (1939-1945) also had negative effectsEurope had to rebuild its international economic position from a very unfavorable starting point

PHASES OF GROWTH, 1820-1992

Europes Economic GrowthWestern Europe (Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland and the UK) during 1950-1975 grew twice as fast as 1820-1970Southern Europe (Greece, Portugal, Spain, Turkey and Ireland) acceleration and decelaration is more dramaticEastern Europe (Bulgaria, Czechoslovakia, Hungary, Poland, Romania, Yugoslavia and the USSR) grew faster than Western Europe before 1973 because this region lagged behind the West in the 19th centuryGrowth halts after 1973 not evident in any other region Per Capital Real GDP Growth in 56 Countries, 1820-1992

European Growth (cont.)Per Capita GDP Growth = (Rate of Growth of Output) (Rate of Growth of Population)Per Capita GDP Growth is a better measure of the change in living standardsWestern Europe fares better due to lower rates of population growthOut of the 12 Western European countries extensive growth was fastest in Germany, Austria and ItalyThe slowest in the UK after 1973 the UK continued to underperform the W. European average1973-1992 : period of intensive growthSwitzerland, Sweden and the Netherlands performed even worseEuropean Growth (cont.)Southern Europe: Greece and Iberia (Spain and Portugal) performed better than Turkey and IrelandBut the post-1973 slowdown was the least dramatic in Turkey and Ireland (best performers in S. Europe in the years of intensive growth)Eastern Europe: Growth of output per capita was relatively uniform reflects the heavy hand of planningIn the extensive growth years it was the slowest in those countries that started out with high levels of output per person (Czechoslovakia and the USSR)Central planning and state trading were important in this convergenceIntensive growth years led to stagnation in the regionEconomic Impact of WWIIWWII destroyed economic capacity (persons, factories, farms, roads, bridges, ...) and economic relationsRoads and etc. could still be fixed but economic organization was interruptedDuring and after the war:There was rationing and controlsLabor and raw materials were directed to production of critical commoditiesWages were frozenGovernment froze the prices of consumer goods like food, fuel and clothing and rationed purchasesBanks were regulatedCommodity imports and capital exports were controlledEffects of Rationing...

Early Post-War PeriodIn 1945 a family almost anywhere in Europe found themselves in a nation which was or had recently been:Ruled by a brutal fascist dictatorOccupied by a foreign army ORBothAs a result of these governmental failures thens of millions of Europeans were dead and Europes economy lay in ruinsThe 2nd WW was the fourth time in 130 years that France and Germany were at the core of increasingly horrifying warsAftermath of WWII(Germany 1945)

Aftermath of WWII(London 1944)

Death and Destruction in WWIIDeath TollPre-war year when GDP equalled that of 1945Austria525.0001886Belgium82.7501924Denmark4.2501936Finland79.0001938France505.7501891Germany6.363.0001908Italy355.5001909Netherlands250.0001912Norway10.2501937Sweden0GDP grew during WWIISwitzerland0GDP grew during WWIIUK325.000GDP grew during WWIISource: Baldwin & Wyplosz, p. 5)Europe, Post-WWII

Economic Effects of WWII (cont.)At the conclusion of hostilities, industrial production was no more than 40% of prewar levels in Belgium, France and the Netherlands and less than 20% in Germany and Italy

From this position it was possible to boost output quickly by restoring essential infrastructure and freeing resources for peacetime useProduction in Western Europe

Rebuilding EuropeBuilding infrastructure was the easy part

Making growth self-sustaining was a difficult task

3 obstacles to self-sustaining growth:

Resource bottlenecksPrice controlsPolitical uncertainty1. Resource BottlenecksEurope tried to increase its industrial capacity

Due to national security issues industries like steel and iron were given priority

Governments wanted to increase output and capacity

Problem was that Europe produced limited inputs of capital goods in this process1. Resource Bottlenecks (cont.)Germany was the traditional producer and exporter of capital goods and its production was now limited by the occupying powers

Inputs could still be purchased from the U.S. but only for dollars

By 1947 Europe had no dollar reserves

Since inputs need to come before outputs Europe could not use its exports to finance inputs

Borrowing abroad was not possible due to the uncertain political situation

2. Price ControlsSo long as prices of goods were frozen below free-market levels, producers had little incentive to bring their goods to marketFor ex. They fattened their cows instead of slaughtering themWorkers were not able to purchase goods so they spent their time not at work but with other activitiesBlack market took off as governments ran deficits and printed moneyIf governments left their control, then inflation would come about3. Political UncertaintyCommunists had key positions in French and Italian governments in 1947

Denmark had a weak minority government

UK had embarked upon industrial nationalization

It was not clear that governments in these countries would respect private property, resist to temptation impose taxes and let markets workNationalization in Britain...

Rebuilding Europe (cont.)Because of resource bottlenecks, price controls and political uncertainty, there were no individual investments, bank lending was minimal and companies did not invest in training their employeesMarshall PlanAid initiative launched by the US in 1947 removed all of these obstaclesU.S. Provided $13 billion of U.S. Government grants over a period of 4 yearsThis solved the problem of having to export to import but unable to import without first exportingCountries accepting Marshall Plan aid had t osign bilateral pacts with the U.S. Agreeing to:Decontrol pricesStabilize exchange ratesBalance their budgets

This prepared them for the market economy

Marshall Plan

Map of Cold-War era Europe and the Near East showing countries that received Marshall Plan aid. The red columns show the relative amount of total aid per nation. Marshall Plan (cont.)Helped to resolve political uncertainty by tipping the balance of political power toward centrist partiesThe US did not want to give aid to socialist governments so countries with communist and socialist governments saw the exit of these politiciansMarshall Plan was the choice between plan and marketThe Plans effects on price decontrol were immediate:Stores empty one day were fully stocked the next dayAbsenteeism among workers fellImport restrictions were slowly liftedMarshall Plan (cont.)

The Plan became the choice between plan and market USSR refused to allow its satellites to take any aidMarshall Plan (cont.)

Those nations accepting Marshall Plan aid saw the exit of socialist and communist politicians and policies ...Marshall Plan (cont.)Also encouraged European integrationU.S. Aid was given on the basis of a collective strategy for using the fundsMarshall planners envisioned a United States of Europe where war would be inconceivableEuropean integration was a way of reconciling other countries, France in particular to higher levels of German industrial production andOf disarming those who insisted on pastoralizing the German economyMarshall Plan helped to eliminate ceilings on German industrial production and cancelling its debt due to reparationsGermany could now go back to being the heart of the European economyMarshall Plan (cont.)

As seen vividly in this poster for Marshall Plan aid, the aim was European integration...Marshall Plan (cont.)Marshall planners also wanted to stimulate Europes trade

In the immediate postwar years, there was bilateral trade

But bilateral trade agreements made it hard to move towards the free-market (multilateralism)However, liberalization needed to be taken by all of the European countries at once.If one liberalized and others did not, that one country would be flooded with importsTHIS PUT THE MARSHALL PLAN IN JEOPARDY!European Payments Union (EPU)Each countrys net balances with each other country were reported at the end of each month to the Bank for International Settlements the EPUs fiscal agent which cancelled ofsetting claims

Countrys now had liabilities/claims not on other countries but on the EPU as a whole

Countries no longer cared who they did trade with

Countries could also run temporary deficitsEuropean Payments Union (cont.)U.S. Contributed $350 million of Marshall Plan funds to the EPUThis helped to stimulate trade (from $10 billion in 1950 to $23 billion in 1959)Also made sure that Germany committed to free and open tradeEPU was a stepping stone toward collective governanceThe next move towards collective governance was the European Coal and Steel Community (ECSC)Laid the seeds for the European Economic CommunityEuropean Payments Union (cont.)ABCExportsTotal Payments: 1820100120290320520470ABC203040Bilateral SettlementsTotal payments: 90EPUABC102010ClearingTotal Payments: 40Investment and the Labor MarketIf trade was needed for European growth, the second thing that was needed was investmentPlant and equipment were needed to implement new technology requires investment

Countries used their money differently, for ex.:Norway used its money to rebuild its infrastructureBelgium used its money to keep declining industries alive

Countries with high returns on investment experienced high rates of growth of the labor forceInvestment and the Labor Market (cont.)Payoff on investment high where ther is expanding labor force with which additional capital could be put to work

Growing labor force also helped curb wage increases

Firms could put the money saved back into the company as investmentInvestment and the Labor Market (cont.)Germany had expanding labor force due to East Germany until the erection of the Berlin Wall

Netherlands had expanding labor force due to the return of Dutch settlers from the East Indies colonies

France and Italy underemployed agricultural workers had the same effect as they shifted to manufacturing and services

Postwar Social ContractEuropean societies also developed corporatist structures to restrain wage growth and see that profits were put back into investmentGovernments wanted to guarantee that the union strikes over wages and work conditions would not happen againThey needed to guarantee to the unions that in exchange for a limit on their wage demands, the industrialists would put the profit they received back into the firmGovernments were concerned that if unions pursued wage increases and management paid out profits, investment and growth would sufferPostwar Social Contract (cont.)Government implemented a series of negotiations with capital and labor resulting in a few different institutions:

Firms agreed (by law) to put profits back into the firm and workers had more say (both in supervisory boarda dn investment policies of firms)This was the set of institutions that monitored the compliance of the parties to their agreement to exchange wage moderation for the reinvestment of profitsPostwar Social Contract (cont.)The second set of institutions created bonds that would be lost in the event that either party reneged on its agreement

Firms received industrial input from government at submarket prices, investment-friendly monetary policies were implemented by the central banks to encourage more investment

Labor was also bonded by a parallel set of government programs: paid vacations, limited work hours and social security structures were adopted in exchange for wage restraint sick pay, retirement incomes, tax and social insurance concessions...Postwar Social Contract (cont.)Third set of institutions coordinated bargains across firms and sectorsBargaining was centralized in the hands of a trade union federation and national employers association and governments intervened to harmonize the terms of the bargains reached by different unions and employersDeparture from laissez-faire

There was a shift from low-production agriculture to high-productivity manufacturing and services in the Western European countriesEastern Europe and the Planned EconomyEastern Europe was more heavily agricultural than the WestEastern European State Planning Offices saw the expansion of the industry as the most direct way of raising labor productivityGovernment did not support agriculture like the West didIn fact, Eastern European planners set lower prices for agriculture and high prices for manufacturing to shift laborEastern Europe and the Planned Economy (cont.)During the 1950s Eastern Europe started to report impressive rates of growthHowever, those produced were not always of good quality

By 1949 most major branches of industry and finance were owned and operated by the state they allocated a majority of their investment to industry

However, they built along the lines of existing factories (extensive growth) innovation was not rewarded

Achievements and Limitations of Central PlanningThe Cold War and Stalinist ideology led planners to push the industrialization process too far

Traditionally Central and Eastern Europe had been the continents agricultural resource Planners starved these regions of these resourcesLight crafts (like cobblers, masons, balcksmiths, tailors...) also began to dissapear

In the West, increases in output also meant increases in living standards this was less so in Eastern EuropeAchievements and Limitations of Central Planning (cont.)Resources were wasted in central planning since managers protected themselves against the risk of missing production by over-ordering raw materials and employing too many people

This over-production did not improve the quality of the goods produced or the variety (ex. The Hungarian footwear industry in the 1950s produced just 16 different types of shoes)Achievements and Limitations of Central Planning (cont.)Public dissatisfaction, Stalins death and a slow-down of growth led planners to experiment with decentralizing the planning mechanism

Managers were given more freedom and given rewards on economizing resources

However, this did not increase innovation

Also, prices at home and abroad where free-market principles dominated made free trade with the rest of the world difficult if not impossibleAchievements and Limitations of Central Planning (cont.)Self-sufficiency was also not desirable since each country had different resources

The solution was to encourage trade within the Eastern Bloc

The Council for Mutual Economic Assistance (CMEA) or Comecon was established in reaction to Western European integration under the Marshall PlanCMEA / Comecon

CMEA / Comecon (cont.)CMEAs founding members:Bulgaria, Czechoslovakia, Hungary, Poland, Romania and the Soviet Union (in 1949)East Germany joined in 1950Moscows idea: Czechoslovakia and E. Germany: concentrate on the production and export of industrial goodsRomania and countries like it: concentrate on agriculture in international socialist division of laborRomanian leadership was not pleasedRelations within the CMEA were strainedHowever, intra-bloc trade expanded under the CMEACMEA / Comecon (cont.)

A Soviet poster reading "COMECON: Unity of Goals, Unity of Action" Regional Integration in Western EuropeEastern Blocs commitment to Comecon was strengthened by regional integration in the WestWestern European Integration: European Economic Community, established in 1958 allowing free trade among France, Germany, Italy and the Benelux countries in less than 10 yearsFree trade allowed these countries to specialize in goods they had a comparative advantage in and to better exploit economies of scale and scopeIt eroded the power of monopolies and cartels forcing sheltered producers to shape up or ship outRegional Integration in Western Europe (cont.)U.K. Declined to join the EEC rejecting the Franco-German call for deeper integrationYet, attraction of a Common Market, proved irresistable and Britain and 6 smaller European countries (Austria, Denmark, Norway, Portugal, Sweden and Switzerland) established the European Free Trade Area (EFTA) in 1959 a more limited entityFinalnd joined in 1961, Portugal also joined at a later dateSpain and Greece negotiated with the EEC and the EEC chose to open itself to these 2 countriesGrowth accelerated in both the EEC and EFTARegional Integration in Western Europe (cont.)Britain remained the sick man of EuropeThe corporatist system of wage restraint never took hold in BritainThis was due to early industrialization which had left behind a fragmented system of industrial relationsMany small trade unions fought the efforts to coordinate an economy-wide wage bargainPoor wage constraint, resistance to the introduction of new technologies and forms of work organization produced poor results for BritainBritain had the lowest investment rates in Western EuropeGovernment tried to get additional output but it led to inflation and balance-of-payments deficit so the authorities raised interest ratesEconomics of Intensive GrowthAs the backlog of technology inherited from WWII dissapeared, the challenge became to innovate new products and processes

The U.S. Had a leg up on this process. In 1963 it devoted 3.5% of its GDP to R&D spending.By the mid-1960s the U.S. Was spending 5 times as much as all of Western Europe on R&D in the computer industry

European governments took steps to close the gapWith increased spending the countries of Western Europe increased their share of global exports of research-intensive goods