Consider some examples. Within industry, all manner of regulations restrained price competition. Since being set up in 1938, the US Civil Aeronautics Board assumed powers to award routes to carriers, to regulate the entry of new carriers, and to approve fares. In exercising these powers, it typically favored incumbents. Ticket prices were high, service was good, and pay as well as travel perks were excellent for those who could get jobs in airlines. Airline pilots and air stewards led a glamorous and much-envied existence.
Airline deregulation in 1978, driven by economist Alfred Kahn under the Carter administration, changed all this. Prices of tickets fell steadily, airports became more congested as air travel was no longer a preserve of the elite, service quality fell as airlines cut out the frills and focused on getting people from point to point on time, and airline worker benefits were cut steadily as new airlines entered and challenged existing ones. As measured by growth in travel, and the reduction in prices to the consumer, deregulation was a tremendous success. It certainly has democratized air travel. Of course, one can also complain about surly airline staff, narrow seats, and the tendency of airlines to contemplate charging for everything including bags, meals, and (fortunately not yet implemented) visits to the restroom. In a sense, airlines are only responding to what the market wants, and those who want (slightly) better service only have to pay for it. The terms of engagement have, however, also changed for airline staff, something we will return to in the next chapter.
The United States, first during Jimmy Carter’s presidency, then under President Ronald Reagan, deregulated a number of other industries such as electric power, trucking, and finance. Both Ronald Reagan and Prime Minister Margaret Thatcher in the United Kingdom gained substantial public support by facing down powerful unions. In 1981, Reagan fired over eleven thousand striking unionized government air-traffic controllers, and banned them from federal service for life. Thatcher went against unionized public-sector coal miners, who were protesting the closure of collieries. The self-defeating yearlong strike that started in 1984 broke the back of the poorly led union, and freed the government to close coal mines. It eventually privatized a much-diminished coal sector. The Thatcher government also put a large number of public-sector firms like British Telecom and British Airways up for sale. In a further attempt to spread private ownership, Thatcher reserved some of the shares sold in privatized firms for the small shareholder, while she also sold off much of the public housing stock to current occupants, and then more broadly.
Paradoxically, for someone who spoke about returning power to the people, Thatcher centralized government, taking away both the funding and powers from local government through the 1986 Local Government Act.27 Thatcher did not believe in the value of community, preferring individuals and families to navigate the world alone. She had a vision of an individualistic market economy, shepherded by a strong but limited state, with no real place for social structures, the community, that might balance the two. She pushed toward this goal whenever opportunities arose. As she put it to the doubters in her party, “You turn if you want. The lady’s not for turning.”
Across developed countries, states liberalized not just the industrial sector but also financial markets. As with airline deregulation, competition among financial institutions and on market exchanges reduced the public’s costs and improved its access to financial services. It also led to narrower margins and lower intrinsic profitability for financial-sector firms, greater volatility in financial markets, and greater pressure to innovate and take risks. The right state response to such pressures would have been for better, more thoughtful regulation. There was, unfortunately, no room for nuance.
The Conservative and Libertarian academics and intellectuals who had been preaching in the wilderness since the Depression did not expect to ever have the ear of policy makers. Now that they had it, they did not want to let it stray. Their reaction to the postwar state overreach was often ideological, and sometimes untainted by the realities of the world. The market had to be given full and unfettered reign, and liberated from the shackles that had been imposed on it, they asserted. Only then would it achieve its full potential and the strong economic growth that everyone desired. Regulation was unwarranted, they claimed, because competition would punish the incompetent, as well as the excessive risk-takers. Indeed, if given a chance, they stressed, incumbents would influence regulators in ways to restrict competition.
There was some truth to all this. Equally, though, the complete absence of regulatory oversight could lead to cartelization or excessive risk-taking, both diseases that the unfettered market is prone to. The public debate needed balance, but the decades of past state overreach had fostered a strong, hitherto silent, opposition. The regulatory pendulum was swinging back, and it gained momentum as the initial liberalization proved successful. The pervasive sentiment on regulation among the liberalizing governments was “less is more.”
FULL SPEED AHEAD ON INTEGRATION IN EUROPE
Unlike the United States and the United Kingdom, continental Europe did not react to the slowdown in the 1970s with a wholesale move toward deregulation and liberalization. While market “fundamentalism” along with individualism were seen as Anglo-American fetishes that were not conducive to civilized conduct or social harmony, European politicians were also reluctant to confront the electorate after thirty glorious years of growth with the reality that they had promised too much.
The kinds of protections that Europe had built for incumbent workers were also not conducive to social harmony. So long as immigrants from Southern Europe and Turkey bore the brunt of job losses in business cycle downturns, Western European workers could have it all. As growth slowed significantly in the 1970s, however, unemployment mounted even among the native born. Eurosclerosis was the term German economist Herbert Giersch used to describe Europe’s slow growth and high unemployment, brought about by the postwar accumulation of regulations and social protections. While the incumbent “insider” workers who had jobs were well protected, the unlucky few who lost their jobs or the youth who entered the labor market were shut out.
So continental Europe faced pressures to change. It now received a push. The deregulation of financial markets did much to spread further market reforms, from the Anglo-American economies, across the developed world. As capital started moving rapidly across borders and became hard for any single state to control, it limited the extent to which individual states could buck the liberalizing trend. For instance, François Mitterrand was elected president of France in 1981 on a traditional Socialist platform of raising wages, lowering working hours and the retirement age, adding a fifth week of holiday, and, most important, nationalizing banks, financial houses, and the largest industrial corporations.28 These measures were, in part, meant to reassure Mitterrand’s coalition partners, the Communists. They were certainly not calculated to improve business confidence. As French growth slowed further, unemployment increased, and fears of larger fiscal deficits (in part to pay for the nationalizations) and additional taxation to bring them down took hold of markets. Capital started fleeing the country. The franc was devalued multiple times in the European exchange rate system.
France had to choose between continuing with its statist policies, clamping down on cross-border flows, and withdrawing from closer economic ties with its European neighbors, or doing a volte-face. The ever-pragmatic Mitterrand chose the latter, freezing wages, cutting public spending and raising taxes, and thus stabilizing the inflation rate and the exchange rate. He used the crisis to end his cohabitation with the Communists in 1984, and shifted toward market-friendly policies.
The European integration project was running out of steam in the mid-1980s, and Mitterand’s government now transferred its energies to reviving it. Three important impediments to a unified European market were a plethora of rules and regulations that differed across countries, impediments to the movement of firms and labor across countries, and currency fluc
tuation. In a series of negotiated agreements, starting with the Single European Act in 1986, the Maastricht Treaty in 1991, and the Treaty of Amsterdam in 1997, much of Europe agreed to merge into a Union which would implement the four freedoms—the freedom of movement of goods, services, people, and capital across the borders of the signatories. They agreed to a common European citizenship, over and above national citizenship. In addition, a subset of the countries decided to adopt a common currency, the euro. The hope was that as barriers came down between countries, new sources of growth would emerge that would relieve the politicians of hard decisions. Moreover, as cross-border competition picked up, countries would reform, but they hoped in a more gentle way.
CURRENCY INTEGRATION
The most important step toward integration in continental Europe was the movement toward a single currency. Historically, France and the other “southern” countries like Italy and Spain were politically more willing to accommodate worker wage demands and less quick to tighten budgetary deficits than Germany, which still remembered the hyperinflation in 1923. As a result, these countries had a higher propensity for inflation. In addition, the independent German Bundesbank enforced tight monetary policies that kept inflation in Germany much lower than in France and Southern Europe. As wages in domestic currency rose faster in France and Southern Europe compared to Germany, they needed a steady depreciation of their exchange rate in order to retain competitiveness. Corporations disliked having to manage the resulting exchange rate volatility—it was costly to hedge exchange risk, and unhedged contracts could become unprofitable overnight. Therefore, after the breakdown of the Bretton Woods system of fixed exchange rates, a number of countries in Europe tried to tie their currencies to the deutsche mark under the European Exchange Rate Mechanism (ERM), hoping to inherit Germany’s low inflation and low interest rates, even while reducing currency volatility with respect to their most important trading partners.
Unless they implemented Germany’s conservative fiscal and wage policies, though, countries were likely to have to adjust their exchange rates periodically, even under the ERM—as France did in the early 1980s. Rather than quit, France and Southern Europe decided to double up. In a classic example of the triumph of hope over experience, France persuaded Germany to adopt a common currency, the euro, as the price for accepting German reunification. A common currency required similar national policies on government budget deficits and on wages. Governments were, in effect, promising to be less sympathetic to union wage demands. Similarly, a sovereign government that agreed to rules on its ability to spend more, or tax less, was giving up some ability to respond to the democratic demands of the people. Nevertheless, in the Stability and Growth Pact in 1997, European Union countries agreed to common rules on the size of the deficits they could run (3 percent) as well as the stock of debt they could issue (60 percent), beyond which they had to implement corrective measures.
THE PROBLEMS EMERGE
In their rush to integrate, leaders were all too willing to suspend disbelief about one another’s behavior. The Stability and Growth Pact was intended to make sure that no country became a charge on the others by overspending and running large fiscal deficits. The pact, however, imposed little fiscal discipline when truly needed. Some countries like Greece hid the true extent of their deficits before they entered. Moreover, there were sixty-eight violations of the terms of the pact before the Global Financial Crisis without any action being taken against the violators.29 Large countries like France, and yes, even Germany, ignored the rules imposed by the Stability and Growth Pact when it impinged on their policies. Without discipline on wages or fiscal deficits, the countries in the euro area had very different levels of inflation. The overspending southern periphery, not surprisingly, had higher inflation. Nevertheless, all countries had similar interest rates since they had one common central bank, and no one believed any country would default. Greek government bond rates approached German government bond rates. As we will see, differing inflation and common interest rates was a recipe for disaster because it made borrowing seem very cheap in the high-inflation periphery.
Another source of potential friction was the free movement of people within the Union. With widely differing social protections, countries worried that those with stronger social protections would attract the needy from elsewhere. The Union simply did not have the mutual empathy to absorb such flows. It was not that the leaders were unaware of the consequences of their push to integration. Yet they seemed to be confident they had the solutions.
For instance, to facilitate trade and investment, leaders agreed to the harmonization of rules and regulations. The agreements could be intrusive and impinge on national sovereignty. Therefore, the Union agreed to the principle of subsidiarity—in which, except for matters that fell within its explicit jurisdiction, the Union would not attempt to override national, regional, or local policies unless its intervention was deemed more effective. At best, this was vague, for how would effectiveness be determined?
At the same time, national policies were undercut in two immediate ways. First, the Union agreed that a country could not ban an imported product that conformed to quality and safety standards in the member country in which it was produced. For example, Germany could no longer keep out Belgian beer because it violated the Bavarian purity law of 1516 banning additives.30 Second, in order to expedite policy agreement as the membership of the Union expanded (and to prevent small countries from blackmailing the Union for extra funds, as had been the practice for some), the Union did away with vetoes for each country for many policies and went to majority rule. Countries now had to implement commonly agreed Union policies, even if they were against it. All this introduced a new form of inequality and resentment in the Union. Essentially, small countries had given up some of their sovereignty to the Union bureaucracy and to the powerful large countries that could influence Union policy.
In summary, then, Europe bet more on integration, on a supranational Union with a common integrated market to deal with slowing growth. While the European Union harmonized rules and regulations, national governments still took major decisions. Europe was trying to have it both ways—enjoy a seamless common economy while retaining some degree of national political autonomy. It did not work well.
THE LOSS OF SOVEREIGNTY
European integration was fundamentally a political project, driven by leaders who initially wanted to entangle Germany economically so that it could prosper without becoming a threat once more. Germany was happy to go along, with Europe becoming the vehicle for the national ambitions it could not express, and its financial contributions the price of atonement. Over time, as the war became more distant in memory, a new rationale became more prominent: Integration in Europe could be a way of generating stronger growth without taking hard decisions, and might even generate enough growth to allow Europe to fulfil the promises made in the years of plenty. Intra-European immigration could supplement aging populations, and avoid the need for culturally very different immigrants. Moreover, to the extent that reforms were pushed by the bureaucrats of the European Union, they could also be a convenient scapegoat for unpopular decisions. “Brussels made us do it” became a convenient mantra for pusillanimous politicians. As economic integration progressed, yet another rationale came to the forefront. Integration allowed the Union’s leaders to be taken seriously by the United States and China in a way that no country leader on their own could hope to be. European integration was, in sum, a top-down project of the elites.
The problem was that no one asked their people how much more Europe they wanted, and how much sovereignty they were willing to give up—so long as the economic benefits added up, leaders took assent largely for granted. The process of integration was, therefore, profoundly undemocratic. As the then prime minister of Luxembourg, and currently the president of the European Commission, Jean-Claude Juncker, put it, “We decide on something, leave it lying around and wait and see what hap
pens. If no one kicks up a fuss, because people don’t know what has been decided, we continue step by step until there is no turning back.”31 As integration moved forward, few among the public knew what they had signed up to. Indeed, sometimes leaders themselves did not know, since in the interest of quick integration, the terms of agreements were often left deliberately vague.
Ultimately, though, integration succeeds only when there is deep social empathy between people. The leaders and top bureaucrats, for the most part, understood one another well, and were even friends, after countless meetings in Brussels, Frankfurt, or Paris. As poorer countries with different historical experience and cultural attitudes came into the Union, the ties between ordinary people of different nationalities became more tenuous. At any rate, it was not clear that people across Europe felt that they were in anything more than a common, barrier-free single market. Instead of emphasizing markets, as did the United States and the United Kingdom, Europe had emphasized a European superstate. Neither solution quite worked, as we will see, because both neglected the community.
CONCLUSION
The postwar consensus in favor of the state and against the market worked for a while. The market expanded through trade, but it was heavily regulated. Growth was strong, not because the market was hog-tied but because of other factors that came to an end by the early 1970s. The years of strong growth entrenched democracy in the developed economies. These countries also made two important sets of commitments that will continue to reverberate into the future. They made substantial promises of social security to their populations. Many also expanded immigration, and over time, emphasized their respect for the civil rights of both their minority and immigrant populations. These were commitments made by prosperous confident societies based on projections of continuing strong growth.
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