The making of European Monetary Union

Policy making in the European Monetary Union Enrico Colombatto (Università di Torino and ICER) Abstract It is well known that the European Union is far from being an optimum currency area. The introduction of the Euro is in fact a political issue, which may indeed be analyzed in a public-choice perspective. In this light, this paper argues that by transferring monetary sovereignty to a federal authority, national policy makers try to protect their rent-seeking prerogatives. In the short run, the nature of political and bureaucratic rent-seeking is however likely to change, especially in the so-called "weak" countries, where policy-making will be less concerned with taxation, and more with spending federal funds. In the long run, as the gap between payments and receipts for each EU country shrinks, tensions are likely to come to the surface again. Keeping EMU together in the future will therefore be a much more challenging task than creating it. Forthcoming in Henrik Overgaard-Nielsen (ed.), The Single Currency - an Experiment We Don't Need, TEAM, London 1998. I am deeply grateful to the John Olin Foundation, which made it possible for me to be a scholar in Law and Economics at Cornell University, where this paper was written. I am also indebted to Prof. R. Vaubel, who was kind enough to read a version of this paper and let me have valuable comments. January 1998 2 Policy making in the European Monetary Union (Enrico Colombatto) 1. Introduction The many problems and disputes which still characterize the birth of the European Economic and Monetary Union (EMU) give more and more credit to those who believe that this undertaking 1 lacks adequate economic foundations . Indeed, the list of undisputed benefits associated with EMU is surprisingly limited. The reduction in the cost of dealing with several currencies may well be of some concern for tourists. The gains for business, on the other hand, seem to be minimal. Today bank fees on foreign-currency transactions are already relatively low for large-enough operations; whereas the exchange-rate risk can be sterilized fairly easily by using futures markets. Of course, additional improvements could be obtained, if access to world financial and insurance services was further liberalized. 2 As for its costs, the very fact that the EMU is not an optimum currency area implies that the loss of monetary and exchange-rate sovereignties is more than a matter of national pride and identity. When institutional rigidities are in place, as happens to be the case in most EU economies, their absence leads to sharper imbalances at a national level, and other, more distortionary policy instruments become increasingly appealing. Moral hazard might also increase. In the past the differences in the rate of inflation across countries and currency depreciation were usually perceived by public opinion as reliable indicators of the quality of domestic policy making. By removing such indicators and by transferring responsibilities to a super-national entity, policy makers will feel less 1 2 See Wihlborg (1994) and Vredin (1994) for synthetic, yet comprehensive reviews. For simplicity, the terms monetary union and currency area will be here used as synonymous. A currency area includes all the countries which adopt the same currency, either spontaneously, or through a formal agreement. A desirable currency area is one where the net benefits of the single currency are positive. In particular, for a currency area to be optimum, the cost of labour must be perfectly flexible in all the countries involved, or production factors perfectly mobile across the whole region. See De Grauwe (1994) for a survey of the literature. 2 3 accountable . Although there exists a substantial body of literature on the economics of currency areas, as well as on many features of the European Monetary Union, two sets of questions have been devoted relatively modest attention. One regards the way the different EMU economies are going to behave, once their sovereignty becomes limited and policy making takes place within the new "federal" regime. Secondly, and more generally, one may also wonder why the European political élites have been so eager to obtain EMU, in spite of the highly dubious net economic gains for the participating economies; and with little concern about the questionable legitimacy of the European Union as a 4 political entity . To this purpose, this paper reviews from an orthodox viewpoint how monetary integration affects some features of policy-making (section 2.), and then proceeds to suggest a public-choice approach to EMU (section 3.). In particular, an effort is made to explain the role of politicians and selected interest groups and clarify the role of policy making in "strong" and "weak" EMU countries (section 4.). Finally, the main conclusions are summed up in section 5. 2. Some lessons from the standard economics of EMU When two or more countries agree to establish a monetary union and choose to use a new common currency, they agree on giving up their sovereignty as regards both monetary and exchangerate policies. This turns out to be of little consequence either when such policies are irrelevant, so that the decision about who is in charge of them is trivial. Or when the members of the Union-to-be share the same preferences, and present almost identical economic and institutional features. Then, there is little difference between what the national policy makers would do, and what the Union authorities actually do. Unfortunately, the economic features and preferences of the countries which are going to form EMU are such that the money supply and the exchange rate are far from being trivial issues. 3 See for instance McKinnon (1995) and Muet (1995) on the effects of the EMU as regards the fiscal discipline in the member countries; and Feldstein (1997, pp.25-26) on the deliberate ambiguities and weaknesses of the so-called "stability pact", which was originally designed to control fiscal policies in the EU economies. 4 See Obradovic (1996) for a recent analysis of the issue. 3 2.1 M onetarypolicy By and large, monetary policy qualifies the behaviour of the authorities with respect to inflation. Whenever the dynamics of prices is relevant, so is monetary policy. That may obtain both when variations in the money supply are the cause of price changes; and to situations where monetary policy is supposed to accommodate exogenous shocks. The very fact that monetary policy is widely believed to be crucial for policy-making implies that the dynamic of prices has real repercussions on the economy, at least in the short run. Put differently, both expected and unexpected inflation have real consequences. In fact, policy-makers usually find inflation appealing for different reasons. It makes it easier to transfer resources to friendly coalitions and interest groups. It enhances the role of government intervention and protection in regulated markets, so that the authorities can extract rents from agents, either by promising protection, or by enhancing their position. Furthermore, the so-called inflation tax allows the public sector to grow without increasing other, more visible forms of taxation. Finally, upwards changes in nominal prices make it easier to correct real wages and, generally, the relative price structure. Of course, this is particularly relevant when prices or wages present some rigidities, and adjustment in real terms is required. When this is the case, the positive effects on growth due to a more efficient price structure may well outweigh the losses provoked by the negative impact of (high) 5 inflation on investments . On the other hand, it will later be explained that policy makers may choose not to pursue an accommodating monetary policy, and keep inflation low. That may occur even when real GDP growth is disappointing. That is, when a significant amount of resources remains unemployed or is committed to inefficient industries and firms; or when production factors have little incentives to increase their productivity, and returns to innovation are modest. Of course, low real growth and stable prices imply low nominal growth. 5 There is evidence according to which inflation seems to affect growth only through (lower) investment, and only when the yearly price rise is greater than 30-40%. See on this Barro (1995) and Bruno-Easterly (1995). 4 This is what makes it difficult to correct distortions in relative prices, unless product and factor prices are flexible downwards, which is clearly not the case in the EMU area today. In fact owners of lowproductivity factors successfully resist nominal reductions in their revenues, whereas low growth does not allow a high enough rise in the performing agents’ nominal incomes. The relative price structure thus remains distorted, and higher-productivity factors are impaired. Imbalances could still be corrected by labour mobility. But in today’s Europe such mobility is low within countries, and almost insignificant across. Language and culture barriers provide a good explanation, of course. But one should also consider the very serious institutional restrictions in place, for labour markets are still highly regulated almost everywhere in the region. The bottom line is that if the EU countries want high growth and low inflation, factor markets are to be liberalized fairly quickly. Unfortunately, the very fact that EMU is going to be enforced in spite of the economic costs it entails reveals that factor-market liberalization is not really a priority for the near future. For otherwise mobility would be accomplished beforeEMU, so as to approximate the optimum-currency-area requirements and enhance smoother transition towards monetary integration. A preliminary conclusion can thus be reached. As recalled by Merusi (1997, pp.10-11), the architects of the European Monetary Union have been stressing time and again that the primary goal 6 of monetary policy in the Union will be price stability , not unlike Diocletian some twenty centuries ago. As a matter of fact, nothing else would have been acceptable. Voters in countries with a lowinflation record would have never given up their own currency for a weak Euro. Similarly, public opinion in the remaining countries would have failed to perceive the advantage of the Euro vis-à-vis their own domestic currency. But that should not screen the fact that within the present institutional framework, a tight monetary policy rules out quick adjustment in the price structure of the production factors, feasible only when nominal GDP grows fast enough. Put differently, at present a strong Euro is incompatible with higher growth. 2.2 6 Exchangeratepolicy This mission was spelled out in art. 105 of the Maastricht Treaty. But according to the revision following the Amsterdam Summit (June 1997), the acknowledged priorities are now price stability, job creation and growth. The latter two are "political" priorities, in that they are fixed by the Council of the Union, and must be accepted by the European Central Bank as well. Furthermore, the very notion of price stability is not totally free of ambiguities. Literally, it implies that the price of a representative basket of goods and services should stay constant. It is unlikely that the European Central Banker will pursue a zero-inflation target, though. Indeed, if that had been the intention, such rule would have been made clear in official documents, so as to boost the credibility of the newly-born Euro. One feels that many would consider a Swiss- (or German)-style monetary policy more than enough, even if their currencies suffered a 72% (67%) loss in purchasing power between 1950 and 1990. 5 7 In a free-market economy the role of the nominal exchange rate is relatively modest . Since domestic prices are perfectly flexible upwards and downwards, it doesn’t really matter whether equilibrium is obtained through changes in the domestic price level or in the nominal exchange rate. Hence, the loss of sovereignty generated by a monetary union would be of little consequence. Unless the shift to this new institutional arrangement implied a movement away from the free-market rules, the economy would adjust anyway. On the other hand, in a mixed economy the nominal exchange rate is important, for it is instrumental in maintaining equilibrium when the domestic price level is subject to changes as a result of a shock, or of an "active" monetary policy. In particular, loss of sovereignty becomes relevant from two points of view. First, because a federal monetary policy is going to affect volumes and prices in the various industries to a different extent, whereas the exchange-rate variations generated by such a policy are obviously the same for all industries. Then, unless such industries are evenly distributed across the Union, imbalances are likely to come to the surface. They may not be too worrying for those economies which experience excess demand, for prices are surely flexible upwards. At most, some concern may be expressed about inflationary pressures. But such imbalances may be a more acute source of trouble where excess supply comes to the surface, for in these cases equilibrium will be obtained through even lower - possibly negative - growth. Problems might also arise if the Union authorities make use of the exchange rate in order to pursue their own goals; for instance, to acquire credibility, or to stimulate demand for industrial and 8 trade policies . Clearly, in this scenario the exchange rate would no longer be the endogenous variable which ensures equilibrium among the various areas of the Union, but rather an exogenous variable which creates a political market for "appropriate policies" whenever adjustment is required. Losers and winners in a newly formed monetary union would then be defined according to their political lobbying power at the federal level. 7 8 See for instance Muet (1995) for a formal analysis. See Colombatto and Macey (1995) for an analysis of the effects of different exchange-rate regimes in a public-choice perspective. 6 3. Political self-interest in a federal perspective The assessment presented above shows that the creation of an artificial monetary union such as the EMU is necessarily an act of political will, which deprives local (national) policy makers of their sovereignty in the domains of monetary and exchange-rate policies, and is likely to increase the cost of institutional rigidities. Of course, that doesn’t mean that the national authorities would be making good use of such sovereignty; in fact in the past the opposite was closer to the truth. But it does mean that policy makers of all the countries willing to enter the European Monetary Union find it expedient to be no longer responsible for such policies. The tendency to elude responsibility became more prominent in the Eighties, as policy makers realized that (1) high inflation was meeting increasingly firm opposition by the voters; (2) the inefficiencies of government intervention were magnified by low growth, and yet growth could not occur without prior removal of government intervention; (3) in turn, the size of government intervention remained crucial both for electoral success, and to enhance the rent-seeking activities of politicians and bureaucrats. As will be explained shortly, in this light the European Monetary Union has turned out to be an appealing solution from a rent-seeking perspective, in that it allows the rent-seeking game to continue, without jeopardizing the power and privileges of the incumbent coalitions. 3.1 Deflation in thelateEightiesandearlyNineties The data show fairly clearly that in the late Eighties and early Nineties concerns about inflation have been stronger than in previous years. It is here believed that much demand for low inflation originated from those who relied on welfare-state transfers (including state pensions) for 9 their living . Their number had been rising significantly with unemployment and ageing, but their purchasing power had declined during the years of relatively high inflation. This was due to institutional reasons (indexation is often well below 100%); and to the fact that the recipients of indexed incomes usually have a weak bargaining power when the time comes to protect their purchasing power. Trade liberalization may have also enhanced losses, for it led to an increase in the relative price of non-tradeable goods, these being relatively heavy in the consumption baskets of those dependent on the welfare state. In short, it is plausible to claim that indexation has often been weak for an increasingly large share of the population; and in most cases it has referred to the price of a nonrepresentative consumption basket. Put differently, the expansion of the welfare state generated by past, deliberately short-sighted 9 See also Colombatto-Macey (1997, section 5) and Shiller (1996). 7 legislation, unemployment-enhancing policies and demographic change contributed to creating a fairly powerful, risk-averse interest group opposing inflation. This group included an increasingly large number of individuals who had difficulties to benefit from the microeconomic gains of moderate inflation, but had to incur considerable costs in order to neutralize its negative effects. As a result, incumbent politicians had to engage in tighter monetary policies, so as to satisfy this relatively new coalition. Even when that implied lower growth. 3.2 Thesizeofgovernmentandgrowth During the Fifties and part of the Sixties the post-war catch-up process and the first wave of trade liberalization were still under way. Growth was high enough. The median voter considered the persistence or even the deepening of some inefficiencies tolerable, if not welcome. Later on, inflation in the Seventies and early Eighties allowed smooth adjustment in relative prices, so that crisis could still be averted. Once again, politicians and bureaucrats successfully advocated a greater role for government, although this time the emphasis shifted from efficiency to equality, that is from the alleged benefits of government as a producer, to the role of government in the domain of income redistribution. During the late Eighties and the early Nineties, however, the low-inflation constraint forced many European policy makers to realize that the time when the size and growth of the government sector could be accepted with relative ease was coming to an end. In the recent past, low inflation has aggravated the consequences of the increasing inadequacies provoked by government intervention. Relative prices have found it hard to adjust, as argued earlier. At the same time, policy makers could not afford reducing the role of the government sector. If they did, their activities would be ostracized by the state and state-dependent bureaucracy, as well as by those coalitions which had been enjoying privileges, and invested resources in order to enjoy such privileges. The economic climate would have deteriorated further, at least in the short run. And the incumbent politicians would have been voted out. Similar comments apply of course to the opposition, which had to make sure that the role of government remained large enough to satisfy the interest groups decisive for electoral success. In other words, rent-seekers wanted to maintain extensive government intervention: that applied to government employees, to selected industries, to some layers of the population (state pensioners, for instance). But low growth made it increasingly difficult for the incumbent policy maker to compete successfully in the political arena. In order to try to create growth opportunities in the medium run, he should have foregone his chances of political survival in the short run, which would have been irrational on his part. 3.3 ThefeaturesoftheEM U solution 8 According to the view suggested so far, it should be apparent that policy makers operate by pursuing one objective, subject to two constraints. Their goal is to preserve a satisfactory amount of room for law-bargaining activities, so as to keep their own welfare high enough, and guarantee electoral success. But this can only be pursued when one of the following holds. Either in a context of relatively high GDP growth, which in turn would require quick liberalization of the factor market and/or higher inflation. Or in a context where political transparency is reduced, so that voters find it harder to assess whether the incumbent politicians have served the national interest satisfactorily. Growth-enhancing policies in a national context would draw widespread disapproval, irrespective of how the policy-maker plans to proceed. Criticism would come from the concentrated interest groups benefitting from those institutional arrangements which slow down labour mobility. But should the inflationary choice prevail as an alternative solution, then criticism would come from the groups affected by the price rise. However, if it is made clear that decisions about monetary policy (i.e. inflation) and possibly regulation are taken somewhere else - say, in Brussels - then politicians would no longer be forced to 10 face unhappy coalitions at home . And it is of course unlikely that the Commission (or the European Central Bank) will stand in the way, as the Commissioners (and the Executive Board of the ECB) are appointed by the political leaders of the member countries, so that their activity is (and will be) monitored by the national politicians. True, the lack of sanctions against "undesirable" policies leaves the Commission and the ECB by and large unaccountable for what they do; but that does not 11 necessarily imply independence . Of course, national policy-makers are not going to be indifferent between a European policymaking framework whereby growth is enhanced through inflation, as opposed to deregulation. The choice is determined by the fact that the anti-inflation coalition is large, but highly fragmented. It can be and is powerful locally, where the cost of galvanizing into an effective pressure group is smaller and the policy-maker is thus accountable to his electorate. But it can turn out to be a much weaker pressure group within a European context, where the policy-maker is far away, more difficult to identify personally, and much less accountable. It is true that European Mps are not appointed, but 10 11 See Vaubel (1986) on what is now known as the "shield-effect" role of the European Union. As regards the ECB, Feldstein (1997, p.28) appropriately points out that the ambiguities concerning its alleged independence are further enhanced by the fact that the responsibility for the exchange-rate policy of the Euro falls jointly on the ECB and on the ECOFIN Council (formed by the Economics and Finance Ministers of the member countries). Not to mention the informal Committee known as "Euro-X", created at the end of 1997, despite fierce opposition by the UK. More generally, there is growing support for the notion whereby institutional arrangements are of little importance as a guarantee for low inflation. See for instance McCallum (1995), Campillo and Miron (1996). 9 elected: and therefore to some extent answerable to diffused interest groups. But it is also undeniable that the power of the European Parliament is extremely limited. Despite their lack of legitimacy, the legislative and decision-making powers of the non-elected component (the Commission) prevail. Indeed, very little has been done to endow the European Parliament with real powers, and to curb the prerogatives of the Commission. The disappointing results contained in the 1995 "Code of Conduct" are telling. Surely, this is hardly surprising from a public-choice standpoint. The lack of political will to take action in this context is indeed rationale, for it serves the purpose of taking the responsibility away from the national arenas, and yet at the same time limits the possibility that pressure builds up at a European level. On the other hand, most groups which favour regulation and heavy government intervention are highly concentrated. By shifting some policy-making from the national peripheries to the European centre the marginal cost of preserving the power of the coalition is small, but the 12 opportunities to obfuscate the cost imposed on the rest of population are raised substantially . There is little doubt that the Commission would be almost insensitive to public opinion pressing for liberalization (deregulation) and low inflation: bureaucrats are appointed, and therefore elude control by the electorate. However, the Commission would certainly be reactive vis-à-vis a limited set of compact interest groups asking for centralized decision-making, thereby offering some arguments for utilitarian legitimacy to the European authorities as a whole, and opportunities to enhance the role for the so-called Eurocracy. 3.4 Thepoliticalquestforcentralization Put differently, according to the public-choice view presented here, the rationale for the 13 accomplishment of the EMU implies a drive towards centralization , and deep changes in the size and features of the traditional rent-seeking scenarios. The balance of pressure groups will necessarily lead towards more federal regulatory legislation, but perhaps not much monetary discipline. Indeed, the principle of centralized policy-making, which is at the core of the European integration process, seems to be the almost perfect solution to the problems faced by national policy 14 makers. The apparently nonsensical Maastricht criteria were certainly instrumental to this purpose . In order to decline responsibility, national policy makers had make sure that their hands were tied. This is the role of the 3% budget-deficit, of the 60% debt-ratio criteria for convergence, as well as of 12 See also Vaubel (1992, p.14). 13 See Vaubel (1995) for an exhaustive analysis of the process of policy-making centralization embedded in the process of European integration. 14 See De Grauwe (1996) for an analysis of such criteria in the context of the optimal-currencyarea literature. 10 the so-called "stability pact", which should prevent governments from running major counter-cyclical policies in the presence of negative shocks. The Maastricht Treaty served this purpose well. The very fact that macroeconomic stabilization took place in the EU does not mean that the criteria described in the Treaty forced governments to take action. Rather, they provided a suitable justification for the adoption of measures which otherwise would have been politically costly at home. But at the same time they created plenty of room for discretionary policies - perhaps including some forms of protectionism - at a federal level; especially in the aftermath of exogenous asymmetric shocks. In fact, whereas a symmetric shock could be offset through variations in the exchange-rate of the Euro vis-àvis other currencies, an asymmetric shock would require massive transfers and/or counter-cyclical policies, presumably to be decided and managed at a federal level. Given the high tax rates already in place today in the various countries, pressure would build up either to increase taxation through federal legislation, or to run a federal budget deficit, to be financed through indebtedness (possibly via 15 the European Investment Bank) or through monetization . 4. Weak partners in a strong Union? In this light, it appears that political élitesin the EU have a strong interest in delegating more policy-making responsibilities to Brussels. With the significant exception of the United Kingdom, where distortions are lower than in the rest of the Union, the problems policy-makers have been facing in recent years have been roughly the same all over Western Europe. That explains the widespread consensus shared by politicians vis-à-visthe EMU idea. Governments were willing to redress the macro-imbalances, but determined not to give in to pressure and eliminate microeconomic inefficiencies. Brussels was the willing scapegoat to blame for at least some of the unpalatable consequences. As a consequence, it should not be surprising that the real imbalances have not disappeared. On the contrary, they will continue to be an important source for domestic policy-making, to an extent which may vary across countries. In particular, the future difference between "weak" and "strong" economies in the EMU will no longer depend on inflation rates or on the state of the government budget. But will hinge on the amount of domestic distortions required to maintain or even expand the law-bargaining game, as well as on the fiscal and regulatory policies which enhance political rents. In this light, a country may thus be defined as "strong" (1) when the amount of tolerable distortions is low (so that growth is satisfactory) and (2) when its vulnerability vis-à-visthe federal decision-making process is relatively modest; that is, when its political power is considerable and/or its dependence on the Union policies (including the shield-effect) is low. Of course, the 15 See von Hagen and Eichengreen (1996). 11 opposite would hold for the "weak" country. It is clear that today no EMU country can be characterized as "strong" with reference to growth. Some politicians will surely ask for monetary restraint and exchange-rate stability with more intensity than others. But that should not be considered as a sign of strength. Rather, it reflects the fact that in some matters and in some countries voters hold their representatives more responsible for what is being done in Brussels (or in Frankfurt). As mentioned above, "strength" comes from the fact that in some countries the shield effect is lower than in other areas of the Union. The public is more difficult to be fooled. 4.1 Nationalpolicy-makingwithin theEM U framework Let us now focus on domestic policy making in the presence of a federal government in Brussels. At present national authorities engage in their rent-seeking game by spending and redistributing money; and also by creating - or threatening to destroy - rents through regulation. There are clear signs that taxation is already very high in the EMU area, in some cases beyond what politicians perceive as the maximum which the median voter is likely to tolerate. Thus, domestic taxation can only rise marginally in the future federal context, especially if growth is slow. Actually, local tax pressure may even decline, so as to make room for more federal taxation, which will undoubtedly increase, to finance the transfers of resources which the Union will need to accommodate asymmetric shocks, and/or to support the greater institutional role the Union is required to play. 12 Once more, the above does not run against the interests of the local politicians, who are mainly concerned with avoiding the blame for high taxes, and with having large budgets to spend. Since their optimal strategy is to transfer responsibilities for revenue collection to the centre, while keeping responsibilities for expenditure, they will indeed advocate substantial federal policies. Local politicians would strive to maintain responsibility for at least some of the resources transferred from the centre, but not for their financing. In this light, one should expect local policy-making to be focused on programmes aimed at diffused interest groups. Managing the welfare state certainly falls in this category. And so would regulations affecting labour legislation, rent controls, and even government-controlled prices, since their direct impact on the median voter is likely to be greater than that generated by targeted policies. As has been said, by and large this policy-making behaviour will be common to most EMU economies. Hence, according to the definitions suggested above, one should expect a future decline in the role of national initiatives as regards industrial and trade policies, which in fact could be pursued more effectively in other quarters. However, the size of the welfare state and the amount of regulation may differ across countries, so as to reflect history, culture, preferences, political accountability of the leaders. Even more important will be the role which the electorate attributes to their local politicians and to their interaction with the federal authorities. When the shield is high and voters tend to blame the centre for poor economic performance, then national policy makers will concentrate on rent-seeking by redistributing income locally through the welfare state and regulation. When the shield is lower, local policy makers will have to be more restrained. Thus, the role of the welfare state and of "fair" regulation will remain particularly high in the "weak" economies; higher than that which would have prevailed if the shield effect had not been in place. This also implies that the net positive transfers towards such "weak" countries must be substantial, otherwise discontent with the Union is going to develop. But that may be ignored, at least 16 in a short-run perspective . First, because the cost of leaving the Union can be very high: in order for a EMU member to acquire its sovereignty again, the whole Union should break up, for a unilateral decision to drop out is not even conceived in the Treaty. And then, because national politicians will try hard to preserve their shield, which allows them to profit from rents, at a national and at a federal level. 16 Nevertheless, the lack of legitimacy be of some consequence in the long run: History demonstrates that when policy formation regimes which are weak in legitimacy are subjected to stress [...] this developsintoacrisisoftheregimeitself(Obradovic (1996, p.193)). 13 4.2 Nationalpolicy-makersin action atthefederallevel The possibility of eluding responsibility suits national policy-makers in two additional ways. On the one hand, they remain decisive if local economic agents want to take advantage of as a large a part as possible of the transfers coming from the (federal) centre. First, because national policymakers are crucial in order to lobby the Union authorities, so that the desired programmes are proposed and launched; and funds allocated according to "friendly" selection procedures, which may well involve the local authorities directly. Similarly, the role of the national intermediaries is critical for the preparation of the necessary - and inevitably complicated - documentation required to apply for the federal funds. Secondly, it should be brought in mind that the lobbying costs for the pressure groups are higher, the further away decision-making takes place, and the less transparent the procedures. Thus, centralization allows national policy-makers to segment the market for rent-seeking. It follows that the more concentrated interest groups tend to be excluded from the domestic scene, where politicians can thus engage in more profitable law-bargaining activities with the numerically larger groups. But at the Union level the opposite holds true. National politicians will assist more concentrated interest groups in their efforts to lobby the central authorities at the expense of diffused interests. Clearly, in this case the chances to suffer punishment in the ballot box are minimal. If this view is correct, in the next few years one should expect important changes in the quality of policy making. For local politicians will be evaluated according to their capacity to appropriate enough funds from the centre and - more - generally, to influence the federal transfer policy. As mentioned earlier, in "weak" countries the shield-effect is stronger, and so is the dependence on transfers and subsidies from the Union. Thus, local policy makers will have a stronger incentive to focus on distributing the resources coming from the centre, at the expense of the effort to influence the features of the federal programmes, other than welfare. In these countries, much of the European political scene will continue to be perceived as "second-order politics" and to be strongly influenced by national issues. Local policy-makers will try to keep the shield high, and claim they did their best to play an appropriate role in the EU framework. But the core of their activity will focus on accommodating diffused interest groups, on keeping the net effects of redistribution obscure, and at the same time on acting as brokers between concentrated coalitions and the federal bureaucracy. It follows that for these countries the quality of representation at the European level is likely to be relatively low. On the other hand, in "strong" countries national policy-making will become less important, and more efforts will be devoted to affecting policy-making at the European level, so as to satisfy desires and expectations by the public at large. National policy-making will still serve the purpose of creating, protecting and selling rents: but more and more intellectual and institutional resources will 14 be devoted to steer Europolitics and to keep it in check, when necessary. Whereas in the weakcountry situation policy makers would content themselves with signaling to their national electorate their efforts to occupy key-positions in the Union, and in fact accept compensation in terms of larger net transfers from the federal budget, in strong countries authorities will be required to control policies and get to the top ladders of the federal bureaucracy. 5. Concluding remarks Not long ago, a EU Commissioner claimed in public that the European Monetary Union will increase employment, enhance competitiveness, ease the way towards political union. And that lack of information is the only remaining impediment before public opinion can fully endorse the 17 introduction of the Euro . In fact, it is widely acknowledged that when a region is an optimum currency area, competitiveness and employment have nothing to do with the creation of a common currency. And that when it comes to "artificial" monetary unions - like the EMU - costs seem to be a much more fitting topic for analysis. Indeed, the very fact that Italians all want the Euro, but almost all ignore what it is that the real problem is not too little information, but too much propaganda. Put differently, today the Euro is frequently (and correctly) perceived as political/institutional issue, rather than as an economic 18 improvement perse . This paper has argued that the creation of the European currency area originates from the politicians’ attempt to maintain their power and prerogatives when economic crisis broke out in most EU countries during the late Eighties and early Nineties. The European Monetary Union will serve the purpose of taking pressure away from the domestic political arenas. In some cases - as in the socalled "weak" countries - it will also transform the rules of the rent-seeking game for the governing élites. Maybe the EMU monetary authorities will keep their word, and pursue a strict monetary policy. If so, attempts to achieve satisfactory results in the real economy will be stifled, and regional imbalances may widen. Demand for federal support, regional relief, and development programmes will increase, and the European federal authorities will then be asked to operate very substantial transfers across industries and across countries. Given their political roots, they will comply, and government intervention as a whole is likely to remain high or even expand further. 17 See de Silguy (1997, p.14 and pp.3-4). 18 See Ortona and Scacciati (1997), as well as Scacciati (1997). 15 Domestic policy making will also evolve, especially in the so-called "weak" countries, where the shield effect is more intense. Pressure will build up to transfer taxation power to the centre, and to endow the periphery with the responsibility for spending the resources made available by the centre. In addition, the power of policy makers in the law-bargaining game will decrease, but a new role as brokers for fragmented national coalitions is in the process of taking shape. It is far from clear, however, whether the policy-making strategy in the weak economies is compatible with that of the strong members of the Union. In particular, this paper maintains that the incentive structure in the two sets of countries is likely to induce the "weak" group of politicians to concentrate on domestic politics, and the second group on Union politics. The former are going to be evaluated according to their ability to capture and distribute an adequate amount of funds from the centre; while public opinion in the strong economies will react according to their leaders’ ability to minimize the net outflow of funds to the weak partners. Hence, potential conflict might arise. Various outcomes can be imagined, by and large characterized by two kinds of effects. One is the trade-off perceived by the strong-country policy-makers, who must weigh the lack of domestic consensus generated by excessive negative transfers, against the amount of rent-seeking that the EU shield allows them to carry out, free of domestic controls. The other is the role played by the difference in economic size between the net contributors and the net recipients. The larger this difference, the more likely it is that the transfers will be relatively light for the rich, and significant enough for the poor. But if the gap is closed, the cohesion of the Union may easily suffer critical tensions. At that stage there would only one way out to preserve the Union - to reduce taxation and transfers, in exchange for a less rigorous monetary policy. This could be acceptable to the strong partners, as long as their main worry is to check the federal budget; and to the weak countries, as long as their main worry is to adjust their relative price structure through higher nominal growth. This is in fact a highly likely long-term scenario, which however would eventually bring to the surface the fundamental questions which the EMU advocates should have dealt with at the very birth of the union. Once again, the alleged political benefits of the Union seem dominant, for lack of other arguments. Some caution is in order, though. In the past some politicians have indeed cherished the 19 idea of a politically integrated Europe . 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