Documentation
Centre
European
Documentation
Centre
Esko Antola
Jean Monnet Professor
Jean Monnet Centre of Excellence
University of Turku
Finland
The EU as an International Actor: The Impact of the Euro
1. EU as an International Actor
The European Union is in many ways a sui generis institution. In international relations it is a civilian power. The concept implies that it is an international actor which does not base its international actions on the use of military force. Its capacity to act rests on the political and economic power in its possession, which can be converted into influence. The European Union as a civilian power has its foundation in the notion that integration signifies the absence of the use, or even the threat of use, of force in relations between the Member States.
The civilian power concept has shaped the effectiveness with which the European Union is able to act out its presence in world affairs (Hill 1990). The European Union is not a state-like actor, but it has a considerable impact on international relations. The European Union has a variable and multi-dimensional presence. It is active in some areas and less active in others. The main components of a civilian power presence are credentials and legitimacy, the capacity to act and mobilise resources, as well as the place it occupies as an actor in the perceptions and expectations of policy-makers. (Allen and Smith 1990, 21).
The main foundation of the international power of the EU is its economic weight. Comparison to the United States and Japan, the two other major economies of the world show this. The share of the EU of the GDP of the world is 16 per cent, less than the United States (21 per cent) but twice as much as Japan. In the value of world exports the share of EMU area is even larger that that of the United States. The European Union also has a visible role in world trade organisation. Trade policy is also in the competence of the European Community indicating the Union speaks with one voice in international trade organisations such as the WTO. The European Union also maintains extensive global bilateral and multilateral trade arrangements.
Euro fits well into the civilian power actorness of the EU. It increases the weight of the Union in the international economy. The channelling of the increasing importance of the Euro into a dimension of power is conditioned by many elements. The central issue is obviously whether the ECB will be able to pursue stable monetary policies that maintain the international attractiveness of the Euro. Seen from outside the European Union the exchange value of the Euro is a key question. A strong Euro may improve its position as a pegging currency and as a reserve currency. A weak Euro, on the other hand, is a weapon of improving the European competitiveness, and may cause turmoil and protective reactions in the world economy.
The functions of a currency are conventionally divided into three: it is a unit of account, a medium of exchange and a store of value. The Euro plays all these functions. It is a common unit of account for the twelve Member States of the Euro12, and it serves as the currency of transaction and accounting for the European Union, as well as for those Member States who are not members of the Euro core. As a unit of account, it also serves as a pegging currency for outsider countries.
Euro is also a medium of exchange in trade and currency exchange, being already the second currency most widely used at the international level, after the US dollar. More than one third of international trade currently takes place in Eurasia. As a unit of storing value, it serves the Central Banks as a reserve currency and also as an investment and financing currency for private actors. The Euro serves all these functions, but obviously its weight and usefulness will be determined only in time.
The introduction of the Euro moves the international economy towards a dual currency system. It fundamentally affects the position of the European Union on the world scene. It is bound to have implications, which will transform its current status and ultimately push the EU towards being an international actor of much greater political weight as well. A comprehensive reform of its institutions is needed before it can assume a more weighted role in political and security dimensions. The EU is moving in that direction nonetheless, as the ongoing discussion on the defence policy dimension demonstrates.
However whether the Euro should be seen as an instrument of power and power politics, or whether it is an instrument of co-operation between the governments pursuing a common good, is a contested issue. In the real world it has both of the elements. It is an instrument of power, both in relations between the nations subscribing to a single currency, as well as in global economic relations. It may also serve as a powerful element in promoting international co-operation simultaneously in both dimensions.
These dimensions are probably not seen more prominently anywhere than in the European Union. The Single Currency is a forceful expression of common wills that extends now to the core area of the national sovereignty of the Member States. At the same time, it is a powerful instrument in enhancing both the widening and deepening of integration. It drives at new institutional reforms, in particular in the area of common economic policy. As a first expression of widening integration, attempts to harmonise taxation surfaced in European politics after the first eight months of Euro use.
But there is also a danger that attempts at a single monetary policy will generate conflicts in the Union. The fifteen Member States are divided into two groups: “the ins” and “the outs”. This division is a disturbing fact in the Union. National interests could also emerge concerning the content of both the monetary policy and the economic policy. Economic policy cycles have not been harmonised by the single currency, as the monetarists would argue. A single monetary policy serves countries, which enjoy economic growth in different ways than those with economies that are on a downswing. Extreme arguments even claim that this may result in a war between the Member States.
In global economic and financial relations, the introduction of the Euro works to both directions. It is likely to create tensions between the hegemonic international currency, the US dollar, and the challenging currency, the Euro. At least, it results in a situation of competition. The Euro shows that there now is a reliable alternative to the US Dollar and dollarisation for countries that would prefer an alternative.
On the other hand, the emergence of a new important player in the world financial system may furnish monetary co-operation, in the long run on a bilateral basis. The turmoil on international financial markets which occurred towards the end of the 1990’s demonstrated that the dominant currency, the US $, and its home government are no longer capable of controlling the financial structure and the political consequences of the turmoil. This is largely due to the expanded process of global deregulation and the expansion of the international financial market.
The future of the EMU depends very much on the ability of the Member States to adjust to the new situation, and success rests on their political will to reform national institutions and national policies. Critical points are the necessary reforms in the labour market, deregulation in still nationally controlled sectors of energy and telecommunications, as well as improvements in the competitiveness of European industry. The Euro has already given dynamism to capital markets. The restructuring of the European economy is underway. The main challenge, however, is the will and ability of the European governments to limit public spending.
Concentration will be a natural result of the Euro replacing 12 national currencies, some of which had relatively extensive use also outside their national economies. The number of invoicing currencies in international trade and investments will become smaller. On the other hand, however, a new and internationally recognised currency offers an alternative as an instrument of diversification. The Euro offers a real alternative to the US dollar, for instance, as a reserve currency.
2. A Challenge to Transatlantic Relations
Transatlantic relations are an area in which the impact of the Euro can already be seen. The American attitude toward its emergence has changed rapidly. The first American reaction was inattention. American investors and institutions regarded the Euro in the financial business as an obscure financial undertaking of no relevance to the USA. It was not taken seriously until the mid-1990’s, until the opening of the second stage of the EMU. American realists see the threat of an emerging new hegemon (Germany or France or the two together) rather than the challenge of a multilateral EU, argue Wallace and Zielonka (Wallace and Zielonka 1998, 67).
In the final stages of the conversion phase, until the actual selection by the European Council of the countries entering the third stage of the EMU, the American approach shifted from inattention to a downplaying of the attempt. The American scholarly community supplemented the American discussion with arguments about an optimal currency area. The argument was that the EMU couldn’t work because it does not meet the condition set by economic theory.
The third wave of American reactions argues that the successful introduction of the Euro is a growing danger to US interests and the position of the US dollar as the dominant currency in the world economy. Euro may quickly erode the position of the dollar and consequently the leadership role of the United States will be eroded as well (Gomel 2001, 13).
Although the Euro has the potential to develop into a realistic alternative to the US dollar in international transactions, realistically several years may pass before the Euro is equal to the dollar. The time estimates for this range from a few years to twenty years. A wait-and-see strategy will probably dominate in the adaptation of various actors to the new currency. Some arguments even stress that this requires a major shock in the international economic system. The introduction of the Euro may, as such, be a significant shock. In addition, the decision-making system of the European Union does not support the emergence of the Euro into a position of a dominant currency.
From an American perspective, C. Randall Henning sees the introduction and consolidation of the Euro as a positive factor in political, economic and institutional terms (Henning 2000, 51-52). In geopolitical terms, he sees the Euro as a factor contributing to the stability in Europe. A more powerful European Union will be more able to bring stability, which is in the interest of the US. He also assumes that the Euro will bring about structural reforms in Europe, thus contributing to growth in Europe and in the world economy. Consequently, Henning sees problems for the US if structural reforms are not fostered in the EU, or if monetary preferences diverge across the Atlantic. A further element in the American assessment is the effectiveness and transparency of the decision-making concerning the Euro and economic policy co-ordination in general.
The role and weight of the US dollar serves an example of the importance of the currency in making of a Great Power. The fact that the US dollar has been the most highly valuated international currency is an integral part of the power and leadership of the United States. Between 1944 and 1971, the dollar was the anchor currency in the world financial system through the Bretton Woods arrangement. It has retained its central position. Roughly half of the value of international trade is invoiced in dollars. Even more importantly, the dollar is seen globally as a currency of a store of wealth.
Ultimately the Euro shall become a competitor to the dollar. Should the Euro become a real competitor to the dollar, the position of United States will be affected. Fred C. Bergsten points out that the existence of a real competitor would mean that the United States would have to pay higher interest rates to attract foreign capital to finance its large external deficits (Bergsten 2001). Through dollarisation the United States has been able to finance its public deficits. The emergence of an alternative international currency will make this more difficult and also cause American decision-makers to exercise more restraint in increasing the deficit.
3. Euroisation – the Next Step?
Obviously, the Euro as an international currency is far from the position that the US dollar holds. Dollarisation has advanced as a global phenomenon. IMF Statistics from the year 1998 show that there were seven countries that had programmes with the IMF, where the volume of US dollars exceeded 50 per cent of the national money supplies. In addition, there was about a dozen highly dollarised countries where the dollar accounted for 30-50 percent of the money supply (Monetary Policy in Dollarised Economies 1999).
The traditional form of dollarisation is informal external dollarisation. This means that the US dollar circulates parallel to the national currency of the foreign country. This type of dollarisation is a widespread phenomenon in Asia and Latin America and, during the 1990’s in particular, in a group of European transition economies. Dollarisation has taken hold in Russia as well. During the late 1990’s, another version of dollarisation, formal dollarisation, emerged. In this system, the US dollar becomes the sole legal tender in the adopting country (von Furstenberg 2000, 110). Panama, Argentina and Ecuador are examples of full dollarisation (Berg-Borensztein 2000, 4-5).
The US dollar occupies also a central role also in transition countries. IMF estimates from the year 1999 that by using its proxy dollarisation index in most of the transition economies the circulation of dollar covers more than one third of the money in circulation. The unofficial dollarisation index offered by Edgar L Feige and James W. Dean offers much higher figures. They calculate that Croatia and Russia exhibit the highest degree of de facto dollarisation, i.e., the fraction of the effective broad money supply in the form of foreign-denominated assets with figures over 60 per cent (Feige – Dean 2002, 14-15).
Although the position of the dollar as the anchor currency in the world financial system brings about burdens, it is seen predominantly as an asset. The United States benefits from the willingness of foreign investors to hold assets as well as investments denominated in dollars. The American economy is the main area of foreign investors, which strongly enhances its dynamics. In order to maintain that position, the monetary strategy of the United States has been, since the early 1980’s, a non-inflatory, strong dollar policy.
In principle, the merit of a position of a reserve currency allows the United States practically a full freedom to decide on its macroeconomic policy. In the floating rate system, however, the United States hardly has any other option than to keep sound and restricted monetary policy. A failure to maintain reasonable monetary policy would be reflected in a depreciating exchange rate, which could result in greater domestic inflation (Dam 2001, 202-203).
The circulation of Euro notes can potentially have an important impact on the international position and valuation of Euro. “Euroisation” of the world monetary system is a viable course. If all 15 Member States join the Euro, and the enlargement of the EU, the Euro will become a currency of significant weight. It will become the currency of a very large economy, outweighing the US in all respects. It will also become a key reference currency for a large number of countries. It already serves that purpose for over 50 countries (Gomel 2001, 6). An extensive Euro-zone, covering neighbouring non-member countries of the Mediterranean region, the CIS countries, several countries in the Middle East and most of Africa, may be a reality in the course of the first decade of the millennium.
The ECB calculates that over 50 countries maintain exchange regimes that involve a link to the Euro or to a basket of currencies that include the Euro. Among these countries are all the applicant countries. These arrangements extend from currency boards to pegging arrangements and managed floating. Recent development shows that the Euro has begun to erode the position of the dollar also in Russia. Imports of Euros by Russian banks have doubled between June 2001 – July 2002. In July 2002 over 700 million worth of Euros were imported in July 2002 compared with less than 600 million US dollars (BBC News September 17, 2002).
The advance of the Euro in the CIS countries is also likely to take place. Shagalov, Kivikari and Brunant predict that due to weaknesses of their national currencies the most acceptable option would be the use of hard currency and the best alternative would be the Euro. They support the argument by pointing to the fact that Euro is the currency of trade in the rest of Europe. Euro is made attractive also because transition economies base their economic strategy on co-operation with the EU (Shagalov – Kivikari – Brunat 2002, 6).
The enlargement will enhance the international role of the Euro and euroisation further. Applicant countries have indicated a strong commitment to join the euroland as soon as possible. However, no immediate extension of the Euro-area is likely. The Maastricht Treaty requires that a country wishing to join the Euro-area must show exchange rate stability for two years (Art 121.1).
The enlargement shall enhance the process of euroisation further. It shall also grow the weight of the European economy. However, one should to keep in mind that the combined value of the GDP of the applicant countries barely exceeds that of the Netherlands. On the other hand, the reconstruction of the economies serves as a platform for investments and private consumption that shall give a boost the economy of the EU. Enlargement shall also bring challenges to the Euro. New Member States shall increase the disparity in the EU and create new sources of instability.In all the enlargement of the EU shall, at least in the beginning, add risks to the economic stability in the Euro-area thus challenging the stability of Euro as such. Much depends on the ability of the Member States to maintain their commitment to economic stability programmes.
4. Who Shall Speak for the Euro?
The foundations of the international financial world date back to the post-war years and are subject to hegemony baggage. The Bretton Woods system remained the core institution for monetary co-ordination until the early years of the 1970’s. The Bank of International Settlement (BIS) operates on a technical level. The International Monetary Fund (IMF) is also a post-war institution, the focus of which lies increasingly in developing countries. The IMF is still a key institution in the surveillance of monetary policies, and as a crisis management body in international monetary matters. In general macroeconomic co-ordination, the G-group institutions have an increasingly important role.
The Euro has institutional impacts on both the IMF and the G-group institutions. The representation of the Euro in these bodies is complicated and largely unresolved. At first, the representation of the Euro in the IMF looks like a natural arrangement. Although the 12 Member States of the Euro area have given up their monetary sovereignty, they have not been willing to relinquish their representation to the ECB. Moreover, Membership in the IMF is, according to the statutes, reserved only for countries. The solution thus far has been that the Member States of the European Union being represented in the IMF with a commitment to co-ordinate their policies.
The European Central Bank, however, has had the status of an observer in the IMF since 1998. The ECB has been welcome to send a representative to the Executive Board meetings of IMF surveillance of the common monetary and exchange rate policies for the Euro area and individual Member States of the Euro area. The Representative is also welcome at Board meetings regarding issues of general importance in the international monetary system (IMF Survey 1999).
The issue of the representation of the Euro in the IMF bears a direct element of power.A single seat for the Euro would make the Euro area the most powerful shareholder in the IMF, thus replacing the United States in that position. This is ultimately a matter of high prestige. The representation of the Euro in the Executive Board of the IMF is at least temporarily arranged through the EU Presidency. However, the representation of the Commission in the IMF has not been made possible largely because of the resistance of larger EU Member States. This represents a dimension of prestige within the EU.
The European Union, however, is bound to speak with one voice in international economic and, in particular, monetary matters. The Euro has already had a major impact on the international financial system. Three of the four European members of the G-7 group are members of the Euro 12 group as well. This will change the nature and composition of the G-7. The immediate question is who represents the Euro? And what shall be the role of individual Euro countries in that framework? Or shall the G-7 be transformed into the G-4 and, ultimately, into the G-3, between the dollar zone, the Euro zone and the yen area?
Politically, the representation of the Euro in the G-7 is even more sensitive than it is in the IMF. The G-7 is an informal body with participation from four European Union Member States (France, Germany, Italy and the UK). Three of them are Members of the Euro group. The Europeans have two problems. One internal problem is the question of how the Euro countries which are not Members of the G-7, but which subscribe to the Euro, will have their interests represented. In a similar way, the representation of the ECB, the Commission and the ECOFIN is a problem.
The final solution has still to be worked out. The European Council in Vienna in 1998 established a practise whereby the Member of the Commission, the President of the Euro 12 (if not one of the three G-7 Member States), and the President of the ECB take part in the G-7 meetings. Since four Finance Ministers and the Central Bank Governors from four European G-7 members would also be present, the total number of European representatives around the table could rise to 11. This is almost twice the number of representatives from the rest of the G-7 countries (6) (Everts 1999, 22-23).
The extended participation of Europeans has provoked criticism in particular from the United States. Since 1999, a practical arrangement was reached, according to which the three representatives of the European institutions should be present when “issues concerning the international financial system” are on the agenda. The President of the ECB has the right to be present when the hard issues of international economic outlook, multilateral surveillance and the exchange rate are on the agenda (Thygesen 2000).
The external representation of the Euro does not please anybody. In particular, the United States is discomforted by the over-representation of the European Union. Claims have been echoed that much of the flexibility and confidentiality of the G-7 shall be lost by the increase in number of participants. On the other hand, the European Members of the G-7 are also unhappy with the participation of European non-members for reasons of prestige. The Member States of the European Union are not in agreement over who should represent the Euro. It seems that a combination of the ECB and ECOFIN should be established. The ECB speaks for the monetary aspect of the Euro, but the ECB has neither the mandate nor the legitimacy to speak in economic policy matters.
5. Can a Dwarf Grow Up?
Even as a civilian power the European Union meets many of the traditional criteria of a Great Power. It has a global interest. It is the largest exporter in world trade, it maintains a global diplomatic network and is represented through over 130 Commission representations.
The abilities of the European Union to take part in the management of international and global relations has improved gradually. In particular the establishment of the office of the High Representative has made the more visible in world politics. The European Union now has a phone number which to call. On the other hand, the division of labour and competence between the Commission and the High Representative has surfaced. The instruments for political influence are still weak. The decision-making system of the CFSP is slow and rests on unanimity. The ability of the Union to take actions depends on the willingness of the Member States.
The civilian power concept holds much value for economic and political instruments of diplomacy. But the European Union as a collective actor does not have necessary military instruments or a common strategic vision to be applied. The diplomacy of the European Union rests on the use of economic and political instruments of power. Its diplomatic culture favours persuasion rather than coercion. The European Union lacks some of the key prerequisites for being a great power proper. The Union also lacks a consensus on whether a great power status actually should be seen as a common aim.
However, as the biggest trading power in the world, the European Union occupies a central role in international trade relations. Historically, trade policy has been in the competence of the European Community since the establishment of the EEC in 1958. In fact, trade policy was practically the only area of external relations in the legal competence in the Treaty of Rome. As an element of the civilian power concept, the European Union has its main focus in trade relations and trade-related international agreements. The single market emphasises the power of the European Union in trade matters and expands its scope to new areas such as investments and services. Finally, the single currency has made the EU a full-fledged actor in international economic relations beyond traditional trade relations. Euro is a key factor in enhancing the global interest being clearly number two currency in world economy after the US dollar.
Institutional problems still persist. Trade and economic policies, including the EMU, are in the competence of the European Community while foreign and security policy is managed intergovernmentally under pillar II of the EU. The future is not at least made any clearer by the emergence of the defence dimension. The Euro most probably shall strengthen the economic power and the weight of the European Union provided that the Member States are able to maintain the stability oriented economic policy that shall support the stability of the value of Euro. An important precondition is that the Member States find a solution to institutional problems concerning the representation of the Euro in international for a: Euro must speak with one voice.
One of the most challenging problems is how the Euro is seen to shape the international position of the EU by the outside powers. No doubt the United States is in a key position. Euro, more than anything else, shapes the future of transatlantic relations. But Euro may as well be a decisive factor in shaping the EU – Russia relationship. If Euroisation advances as it does at the moment, the Euro shall develop in to a key element in the EU – Russia relations as well.
No doubt in EU – Russia relations tensions are created by the differences in the nature of the two actors. Russia and EU are in many ways contradictory powers: Russia is a political and military Great Power but an economic dwarf, while the EU is of an opposite nature as an international actor. The two powers differ also institutionally. Russian foreign policy is managed in a centralized way through the institution of the President. In the European Union, on the other hand, the Presidency is based on a rotation of six months and the decision-making in external relations is decentralized.
The political consultation mechanism with Russia imitates the decentralized system of political leadership and decision-making system of the EU. The six months cycle of political leadership is institutionalized in the EU-Russia Summits as well as in the sequence of co-operation Councils. In particular the Summits suffer from the arrangement. Sometimes they lack political substance, sometimes they are overtaken by events that have little to do with actual co-operation between the partners. It remains to be seen how the increasing weight of Euro as an international currency fits into the EU-Russia institutional framework.
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