June 8, 2005

What does the vote against the constitution of the European Union mean to Europe and to the rest of the world?


In one sense, little has changed.  The French people have showed their ire toward their current government. The French electorate also indicated that they did not like the reduced economic and political role that France would play in the New Europe.


Attempts to modify the constitution and still coax a favorable outcome in some western European countries certainly will follow. 


In the meantime, more countries will come under the umbrella of the confederation of European states called the European Union.  Those countries will have a common monetary policy, many common regulations, and increased flows of goods, services, and European tourists across borders. 


Apparently, that is all that the majority of Europeans want. 


Unfortunately, their current system soon will not be able to give them even that. 


As more countries with substantially different legacy costs, technology, and skills are introduced to the confederation, pressures will rise. 


Already, most of the western countries are struggling to keep their deficits within EU guidelines even as their unemployment rates rise to levels not seen since the Great Depression.  The lower income people in those countries are convinced that even lower wages in the new members will put them out of work. 


In fact, the high payroll costs make the hiring of new workers a risky business in Western Europe.  Furthermore, unemployment payments that go on for up to two years reduce the speed with which the unemployed adjust to new opportunities. 


In some countries, board positions are held by union members, making cost cutting a very difficult process to approve.  Not surprisingly, companies in those countries are only considering expansion outside their countries. 


When Eastern European countries and Turkey join the Union, their lower cost labor will attract old Europe capital.  To be sure, common regulations and ease of travel will aid the expansion to those new countries.  Undoubtedly, the unemployed, who are at double digit percentages in several European countries, will blame the new members for inflicting job losses on them. 


Certainly, we blame the Mexicans for “taking” American jobs and our unemployment rate is nearly the envy of the industrialized world. 


In fact, however, the subsidies of agriculture, the costly subsidies to favored businesses, such as Airbus, the lack of labor market flexibility, and the high unemployment payments are creating the unemployment problem.  If Turkey is denied EU entrance, then old European capital will go to Asia. 


If capital flees the host country, does it matter where it goes?  If capital builds up economies within the federation (I know it’s the EU but without a constitution and accountable—meaning elected—officials, the union is little more than our Confederation of States following our Revolution), then markets are near for old industry.  Furthermore, some of that industry may profitably service Eastern Europe but not Eastern Asia.


To be sure, removing the restrictions that are distorting resource allocations within Western Europe would be even better.  Labor then could find alternative activities more quickly and new industries could flourish.  Lower product costs would hold down wage growth even as purchasing power improves, just as opening our borders to the world has done for the U.S. 


Without the stronger bounds of elected officials and constitutional provisions, the united monetary policy will become increasingly at odds with domestic government policies.  High unemployment, high deficits and a monetary system that cannot control asset speculation is inevitable in this environment.  Eventually, such a system will fail. 


In the meantime, watch out for your investments in Western European companies.  Unless they are serving their shareholders by only building new capacity elsewhere, they may no longer be good investments.



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