Europe’s Federalist Future

WASHINGTON, DC – A quiet breakthrough occurred recently in Europe. After more than two years of vacillation, policymakers have moved decisively toward economic and political union. Some have even used the “f-word” – federalism – igniting controversy and fueling urgently needed debate.

European Central Bank President Mario Draghi has decided to use the ECB’s considerable firepower as a financial backstop for indebted eurozone countries. Additional plans aimed at increasing eurozone countries’ accountability and effectiveness have followed, including a Europe-wide banking union, a common eurozone budget, limited debt mutualization (such as Eurobonds), and even a eurozone parliament separate from the existing European Union parliament. European Commission President José Manuel Barroso capped off the developments with a dramatic – even historic – speech, in which he called for a “federation of nation-states.”

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But Europe’s new course has left many wondering whether more integration is really necessary. Reacting to the global economic crisis and the perils of austerity is a complex issue for Europeans. Although economists and commentators have tended to view austerity in the United States and Europe through the same lens, conditions in the world’s two largest economic areas are very different.

The US has long had a federal system. Americans in all 50 states pay federal taxes into the national treasury, and elected federal representatives then allocate the funds to the states. Little protest is heard over which states contribute more to the national pot, or from Californians and New Yorkers, for example, who transfer some of their wealth to Alaskans and Mississippians year after year. Indeed, in the US, the prevailing philosophy is printed on every dollar bill: E pluribus unum (out of many, one).

But Europe’s supranational institutions – the European Commission, the European Parliament, the ECB, and regulatory authorities – are in their infancy. And, given that the EU collects roughly 1% of member states’ GDP, compared to 24% in the US, few resources are available to cope with a crisis.

Instead, national and regional interests jealously track which EU member countries drive the economy, and which are the alleged slackers. Suddenly, Germany, the Netherlands, and France have to extend financial assistance to Greece, Portugal, Ireland, Cyprus, and, increasingly, Spain. While wealth transfers are usual for Americans, they remain controversial  in Europe, where countries fought bloody wars not long ago.

In other words, Europe is not embroiled in a simple policy debate about "austerity versus stimulus." Rather, Europeans are facing an existential crisis over cross-border solidarity and the definition of "self-interest."

But, in order to maintain the continent’s economic and political stability, wealth transfers are crucial. Given that eurozone countries have lost the capacity to devalue their currency in order to regain competitiveness, any country that cannot compete must rely on assistance from wealthier states. The only other option – expelling struggling countries like Greece or Portugal from the eurozone – carries serious short-term risks of contagion, as well as long-term social, economic, and security risks, such as the inability to police their borders. 

Further raising the stakes for European integration is the rise of China and India, which highlights the twenty-first-century reality that population matters as much as productivity in determining economic might. As the economist Arvind Subramanian has put it, “GDP and size matter in crude superpower terms. It shows what resources you can bring to the table.”

Although most Chinese remain poor, the country boasts the world’s second-largest economy. As one of the world’s largest traders, creditors, carbon emitters, and consumers of commodities, China’s actions shape global markets.

A fragmented Europe composed of dozens of disconnected states, none with more than 7% of the population of China or India, would slowly lose its competitive advantages. Rather than fostering continental cooperation and development, countries would compete against each other – even more than they already do. A federalized Europe, with a population of 350-500 million people, is more likely to prosper – and thus maintain its citizens’ quality of life.

European leaders have created a timeline for the proposed reforms that will allow for substantial public debate before voters have their say in the German elections next fall, and in the European parliamentary elections in 2014. But they are weary of indecisiveness, so they are already pursuing more federalist policies. They believe that it is Europe’s best hope for the future.