June 6, 1997 Review & Outlook EMUsculation With stunning political setbacks for both Jacques Chirac and Helmut Kohl, Europe's planned single currency no longer looks like a sure thing. Proponents of course argue that that EMU is still on track as a result of sheer political momentum. Even, indeed, that since Mr. Kohl has lost the moral authority to say no to Italy, it will be a wide currency area rather than one limited to a "hard core" of Germany, France and the Benelux. Yet it's clear enough that neither Germany nor France is likely to meet the deficit criterion set by the Maastricht agreement. And with President Chirac's right losing to the Socialists in elections, and Chancellor Kohl losing to the Bundesbank over his proposal to book imaginary income by revaluing gold reserves, delay again emerges as a real possibility. Consider for a moment the post-election outlook in France. With its spread-the-work schemes and a higher minimum wage, the new Socialist government's economic ideas are worrisome enough, but its incentives to do mischief are positively frightening. The coming cohabitation will not be nearly so amiable as the 1980s liaison between Mr. Chirac as a rightist Prime Minister and an aging, foreign-policy oriented Francois Mitterrand as a leftist President. Mr. Chirac now has a European agenda of his own, and will surely be tempted to call new elections (after a minimum of 12 months) as soon as he thinks the right can win. That means the Socialists will want to spend, spend, spend in an attempt to stimulate the economy enough to have a chance of retaining power. Even worse for Mr. Kohl, the Socialists will be tempted to outflank Mr. Chirac by rejecting the Stability Pact imposing Maastricht-like budgetary limitations after unification, by demanding the inclusion of southern countries and by calling for even more political control of the European Central Bank. For our own part, we've never been very enthusiastic about the Maastricht criteria. While the level of debt may be a relevant concern, the level of public borrowing in any given year is far from the heart of Europe's economic problem. In Germany, meanwhile, Mr. Kohl faces an unruly and disenchanted coalition, elections due next year and a powerful and hostile Bundesbank. Central banker Hans Tietmeyer succeeded in squelching the gold revaluation plan with a mere public utterance. Mr. Kohl and Finance Minister Theo Waigel had proposed to write up gold reserves to market value, then book some of the bookkeeping gain as current government income, a cushion to meet the Maastricht goal of a current deficit of less than 3% of GDP. Mr. Tietmeyer and his colleagues, fearing loss of credibility and outright inflationary impact, went public with their opposition. Mr. Kohl was forced to back down; values will be written up, but nothing will be included in this year's income. The result of these shenanigans is that Mr. Kohl has lost the credibility to assure the German public that a wide EMU will create a currency as strong as the mark. While Mr. Tietmeyer has been an advocate of monetary union, he also has been a stickler for meeting the announced criteria. Given what is happening in France, he understandably could conclude that the EMU should not go forward on schedule, and his verdict would be likely to stand. If he needs it, Mr. Tietmeyer probably could count on the support of the German Constitutional Court. The Bundesbank is constitutionally empowered as the guardian of the currency, and the court has said the Maastricht criteria must be interpreted strictly. Chancellor Kohl is of course as committed as ever to launching EMU on time. It's still possible that he can cobble together some combination of tax increases that will help Germany meet the Maastricht criteria without costing him the next election. And it is possible that the advice of former European Commission President Jacques Delors will carry enough weight for the Socialist government to forge a pro-EMU compromise with President Chirac. For our own part, we've never been very enthusiastic about the Maastricht criteria. While the level of debt may be a relevant concern, the level of public borrowing in any given year is far from the heart of Europe's economic problem. Look instead to sclerotic welfare systems, burdensome taxes, national legal and regulatory obstacles and the lack of flexible labor markets. The most relevant number is public outlays as a percent of GDP, not the deficit, which only makes Europe's politicians think of higher taxes. Chancellor Kohl, President Chirac and others have spent enormous political capital on the EMU, and its delay would be a loss. On a theoretical level, we enthusiastically support the idea that there are important gains to a unified currency, preferably a world currency like the dollar under Bretton Woods or bullion under a true gold standard. On a practical level, conceivably the EMU would force European governments to do something about their fundamental economic problems. But we have to wonder whether it would have turned out better if the Chancellor and the President had spent their capital attacking those problems directly.