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The Wall Street Journal Interactive Edition -- October 21, 1997

Global View
Can 11 Eurostates Find
Harmony? Does It Matter?


A Journal editorial last week described how Brussels bureaucrats are pressuring the Irish to raise taxes, a move that would surely slow Ireland's rapid progress toward unaccustomed prosperity. Imagine that. Trying to boss the Irish around. What can the world be coming to?

Well, that part of the world called the European Union is pursuing something it calls tax "harmonization." As the EU moves toward replacing national currencies with a single "euro," its movers and shakers are concerned that some nations will end up more equal than others under a single currency regime. For six years the EU has been attempting to harmonize the tax and budgetary policies of its members so that when single currency fusion occurs, the more virtuous low-spending states won't have an economic advantage over those that prefer to tax and spend.

Hence Ireland, an EU state blessed with relatively low taxes for industry and an economic growth rate approaching Asian Tiger levels, is being threatened with curtailment of EU subsidies if it continues to provide investors with tax incentives. It also is being told not to follow through with its plan to cut the overall 36% corporate rate sharply.

Ireland is not as virtuous as it might be. It is a beneficiary of large farm and regional subsidies from Brussels. Indeed, its per-capita income from the commission is the highest among EU member states. So the commission does have a weapon. But what about the soundness of this harmonization policy over all? Aside from the difficulties of making it work, the principle is flawed.

Harmonization was implicit in the Maastricht Treaty of 1991 that pointed the EU toward a single currency. The treaty's much discussed "convergence" criteria conditioned entry into the European Monetary Union on national budget deficits of no more than 3% of gross domestic product and government debt of 60% or less. Those conditions will most likely be reinterpreted next year to admit countries that are at least heading in the right direction. As many as 11 of the 15 member states could be admitted to the EMU. Britain, Sweden and Denmark expect to reject first-round membership and Greece is not likely to qualify.

While these Maastricht requirements have often been cited as a strong, coordinated effort to achieve budgetary discipline in Europe, we now know that didn't happen. Governments didn't cut spending. They raised taxes. The commission reported last month that taxes in the EU set a new record as a percentage of GDP in 1996. Governments siphoned off 42.4% of economic output, compared with 41.7% in 1995 and 38.7% in 1980.

So Maastricht harmonization has simply fed welfare statism, which explains the EU's overall slow growth. France now collects 19.5% of its GDP in what the EU euphemistically calls "contributions" to social programs, such as national health. That's the highest take in the EU and not far below what the U.S. government collects in total federal taxes.

France's total national tax take, at just under 30%, is far below the 50% of Denmark, the EU tax champion. But France, unlike Denmark, wants to be a kingpin of the EMU and it is highly protective of its current rate of social spending. Indeed, its present Socialist government wants to further expand spending, not reduce it, as its dubious answer to high unemployment. It thus is not surprising that France has been a driving force for harmonization--or, in other words, for bringing all EMU members up to its taxing and spending levels.

The Maastricht treaty would have been more effective as a discipline if it had focused on curbing government spending. But few of the member governments were willing to bite that cannon ball, so they decided to describe virtue in other terms. Now, of course, they are prepared to push the single currency project ahead by defining virtue in a still more liberal way--as, in essence, good intentions.

All of this has a bearing on the future of the euro. The new European Central Bank will start creating euros as a unit of account on Jan. 1, 1999, locking national currencies to the euro at a fixed rate of exchange. Coinage and currency won't be issued until 2002, at which time, it is proposed, national currencies will cease to exist. Ultimately, the ECB will be responsible for determining the money supply for EMU countries, functioning for them in much the same way as the Federal Reserve functions for the U.S.

But there's a big difference. The ECB will be assuming the role of the central banks of sovereign states, with the existing central banks subordinated. Theoretically, the national banks will not be able to finance national deficits by printing money. National governments will have to borrow euros in the market, and the rates will vary according to their perceived fiscal and budgetary soundness. The high-spending, high-debt states will be at a disadvantage, faced with higher borrowing costs than the low-spending states. Can the more profligate welfare states permit such a condition to exist?

That is not clear. What is clear, however, is that France in particular is pushing a plan to ensure that the ECB does not totally escape political influence. French Finance Minister Dominique Stauss-Kahn met with German Finance Minister Theo Waigel in Munster, Germany, some days ago to formulate plans for a special council that would consist of the finance ministers of EMU member countries only. It would meet in advance of the meetings of finance ministers of all the EU countries and would thus be in a position to pre-empt the full council. It would give special attention to the management of the euro, that is to say the operations of the European Central Bank. So don't be too sure that the ECB will follow a hard line on monetary policy when the heavily indebted European states are faced with the problem of financing their debts.

All of the above efforts have a single political goal: to prevent competition among governments to provide more hospitable environments for work and investments. This is quite the opposite of what happens in America, where the states compete freely to the overall benefit of the total economy. It is also counter to the most powerful argument for the European single market. It is to be a place of sharpened business competition, with companies achieving greater efficiencies in their bid for a share of a huge continental market. The missing element is any encouragement for more efficient government to provide better economic incentives through less spending, taxing and regulation. That may happen anyway through natural causes, but "harmonization" certainly doesn't point Europe in that direction.

Copyright © 1997 Dow Jones & Company, Inc. All Rights Reserved.