How to strenghten the EU's external representation: A modest proposal

By: Barry Eichengreen, University of California, Berkeley

In foreign financial affairs as in foreign affairs generally, Europe punches below its weight.  Despite the fact that the European Union is larger economically than the United States, it exerts less influence in international monetary and financial negotiations.  In part this reflects the fact that its representation is fragmented.  Largely for historical reasons, European countries have eight seats on the 24 member Executive Board of the International Monetary Fund (nine when Spain periodically chairs its predominantly Latin American constituency).  Seven of the members of the Group of Ten are European, again for historical reasons.  The G7 is made up as it is, with a majority of European members, because the states in question formed a logical steering committee for the international monetary and financial system when the latter entered a period of flux in the 1970s.  Thus, there are many European representatives in all of these forums.  Rather than speaking with a single voice, Europe’s voices create a cacophony.

 

Not only does this situation prevent the member states from projecting a cohesive European position, but it is untenable in a world where the balance of economic power is shifting toward emerging markets.  The underrepresentation of emerging markets on the boards of the IMF and World Bank is the mirror image of Europe’s overrepresentation. The danger is that emerging markets, having accumulated massive international reserves, will set up regional rivals to these multilateral institutions so that they have more voice in deciding their financial fate.  In addition, in September 2006 the United States and China agreed to conduct regular bilateral consultations; the first of these talks took place in Beijing in mid-December 2006 and the US delegation included senior officials such as Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. One can imagine how these consultations could develop into an alternative to the G7 process, since China – soon to be the world’s second largest national economy – is unrepresented there.  Thus, if Europe refuses to share its place at the table, the latter may become one where no one of consequence wishes to dine.

 

One can imagine a number of possible responses to these problems.  Financial and monetary policy could remain a national competency, since there is no more appetite in Europe for a single foreign financial policy than for a single foreign policy generally.  This implies at most updating the prevailing state of affairs to remove the worst inefficiencies but not changing it fundamentally.  Alternatively, EU member states could attempt to more closely coordinate their international monetary and financial policies in order to more effectively counterbalance the United States and advance the common European position – on the assumption that there in fact exists a common European position.  Most ambitiously, Europe’s representation in international forums could be unified.  This would entail delegating responsibility for its formulation to the European Commission and appointing a single EU representative to communicate with the Union’s interlocutors in the various global forums. 

 

This is, of course, just a specific instance of the larger debate over what competencies should be assigned to the European Union and what responsibilities should, instead, continue to reside with the member states.  The constitutional convention that met from 2002 through 2004 and subsequent difficulties in ratifying the draft constitution remind us that Europe has not yet reached the nirvana where there exists agreement on a particular approach.

 

How then should European countries and their citizens go about reaching such agreement?  The theory of fiscal federalism provides tools for deciding how responsibilities should be allocated across levels of government.  It suggests assigning to the most encompassing level of government, in this case the EU, issues where tastes are homogeneous and where there exist economies of scale associated with centralized provision – and, conversely, leaving to lower levels of government, in this case the member states, issues over which national tastes diverge and economies of scale are absent.  In the present context, the existence of economies of scale in provision means that Europe’s positions in international forums can be represented more effectively when representation is centralized; Europe will be better able to express and achieve its goals.  Homogeneity of tastes means that European countries have similar objectives and foreign policy goals.  Foreign monetary and financial policy comes reasonably close to qualifying on both grounds.  This implies that Europe should move toward closer coordination and greater centralization of its representation in external monetary and financial affairs.

 

If this hypothesis is correct, then it points to the difficult question of why the EU has not already delegated responsibility for formulating a common position on monetary and financial affairs to the Commission and unified its representation.  The answer is that policy makers are risk averse.  Uncertainty about whether change will really deliver a welfare improvement lends inertia to existing arrangements.  Thus, even though consolidated European representation would be better, inertia has prevented it from taking place.

 

This interpretation points to the need for a strategy for overcoming status-quo bias.  Together with Alan Ahearne of Bruegel in Brussels, I have developed a scheme for going about this.  We build on theoretical work inspired by the problem of transition from plan to market in the formerly centrally-planned economies.  It has been argued in this context that experience with limited reform may help to convince otherwise skeptical stakeholders of the positive effects of further reform.  This suggests investing first in the development of unified representation and common policies toward a set of issues and in a venue where the case for doing so is strongest.  If the results convince the skeptics that this enhances the efficiency and effectiveness of Europe’s voice and influence without forcing unacceptable compromises in national positions, it then may be possible to emulate this example subsequently in other venues and issue areas.

 

Concretely, we recommend starting by consolidating Europe’s representation at the IMF.  One can imagine consolidating Europe’s representation into a single chair or a pair of chairs, one for the members of the euro area and the other for other EU countries.  Our incremental approach emphasizing the advantages of learning by doing suggests starting with a pair of chairs. 

 

The rationale for consolidating EU representation at the IMF is stronger than the analogous rationale for doing so at the World Bank, G7, G10, G20 and Financial Stability Forum.  For one thing, the infrastructure needed to establish a single European position is relatively well advanced.  It has created SCIMF, a Subcommittee on IMF-related issues in the Economic and Financial Committee, for which Directorate General EcFin (DG2) of the European Commission acts as secretariat, and EURIMF, an informal committee of EU countries’ representatives in the IMF.  In addition, the reluctance of EU member states to give up their seats on the IMF Executive Board is seen as a major obstacle to comprehensive governance reform and thus as undermining the legitimacy of the institution, something that is of independent concern to European countries. 

 

The IMF is also the right place to start because preferences on IMF-relevant issues are relatively homogenous.  To the extent that the IMF is historically concerned with issues revolving around exchange rates, the fact that half of EU members have the same currency and therefore the same exchange rate points strongly in this direction.  That the euro area and not individual member states has been invited to participate in the IMF’s first multilateral consultation on the topic of global imbalances is more evidence of the point. 

 

Finally, the IMF is the right place to start because economies of scale in representation are strong.  Analytical work suggests that a single seat, or even a pair of EU seats, will make the EU, with its cohesive block of votes, a key swing voter.  The EU will be better able to achieve its goals, which is precisely what is meant by economies of scale in provision and representation.

 

Europe is going to have to negotiate over these issues whether it commits to unified representation or not.  It might as well make the most of the process.

 

 

For more details, see Alan Ahearne and Barry Eichengreen, “Europe’s Foreign Monetary and Financial Relations: A Survey and Proposal,” prepared for the Bruegel project on Europe and the Global Economy and downloadable from http://www.econ.berkeley.edu/ ~eichengr/index.html.

 

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