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(The online version of this article appears in two parts. Click here to go to part one.)

FOR now, the major players are France and Germany. Italy is virtually tied with France for second largest GDP in the union, but the Italians won't fight their weight until they've resolved their political situation. Britain will remain an influence even if it doesn't join, but will be a major player only if it does. Meanwhile, the European Central Bank, granted political independence by Maastricht, plays its own role, representing the conservative legacy.

France has become the economic dynamo of Western Europe -- at least in perception. Its growth has accelerated, although unemployment has been reduced only slightly. Since his upset election in 1997 Prime Minister Jospin has used his political skills to replace despair with optimism. Jospin had an easy act to follow: his right-wing predecessor, Alain Juppé, stumbled through every issue, talked down to the French, and came to be thoroughly disliked by them. The rightist President Jacques Chirac, who committed the political blunder of calling the snap election that ended Juppé's career, remains popular, but the right is disintegrating.

Jospin's most publicized measures have been economic sleight of hand. The reduction of the work week from thirty-nine to thirty-five hours for purposes of job-sharing is being implemented in meaningless ways amid great confusion. The creation of 350,000 public jobs for youth has put attractive young men and women into post offices but is having little real economic impact, and is not being matched by the private sector, as originally intended. Jospin's enemies accuse him of substituting chicanery for action; older Americans may recall that Franklin Delano Roosevelt saved America from fear itself well before the New Deal effected real change.

The thirty-five-hour week and other magic measures are associated with the Employment Minister, Martine Aubry, a name spat out by bourgeois Frenchmen. France's real steps toward economic change are directed by the respected Finance Minister, Dominique Strauss-Kahn. Although France's markets are far from unfettered in the American style, structural reform is under way. Privatization, which caused major confrontations under previous governments, is happening with little controversy at Air France, banks, and aerospace and other firms. Social spending, though still not under control, is moving in that direction; hiring and firing regulations are being evaded in the American way -- with temporary contracts. True, such bastions of proletarian conservatism as the civil service remain unchallenged, but a strong start has been made.

Macroeconomically, exports derived from the American boom that now sustains all the world, plus increased French consumption stemming in part from Jospinian optimism, have provided a base for Strauss-Kahn's cautious policies. France has supported interest-rate cuts by the European Central Bank and would not object to more. Most expenditures have been strictly controlled, and economic growth has converted the budget deficit to a surplus, as in the United States; also as in the United States, the talk is of spending part of the surplus for tax cuts. It is significant, however, that if revenues fall again because of a downturn, the Finance Ministry stands ready to maintain expenditures even at the cost of renewed deficits -- a compensatory stimulus that economists call an "automatic stabilizer." A number of French economists, including several on Jospin's Council for Economic Analysis, have favored going even further, using deliberate tax-cut stimuli to break the continuing inertia of unemployment.

Germany's growth has been more irregular, its policies more uncertain, and its mood darker. Its unemployment rate is comparable to France's, but nobody seems to be doing anything about it. Successful reconstruction of the eastern economy remains a distant goal. Most German economists, and the powerful bankers of Frankfurt, stand firmly in the structural camp, believing that if taxes and social benefits are reduced and regulations relaxed, the free market will reduce unemployment.

Helmut Kohl's conservative government was ideologically attuned to Frankfurt but achieved little. Schröder's government started out confused. His first Finance Minister, the old-time radical Oskar Lafontaine, seemed sometimes to revert to his socialist roots, sometimes to follow the learned Keynesianism of his chief economist, Heiner Flassbeck. The result, although moderate in practice, scared the European Central Bank and German banks and businesses. Lafontaine pressed the ECB to reduce interest rates; although few disagreed that such cuts were needed to combat Euroland's sluggish growth, critics saw his pressure as violating the ECB's independence. Domestically, the projected budget deficit stayed within EMU limits, but Lafontaine proposed increased progressivity in the tax and benefit systems. And Lafontaine and Flassbeck deepened the fright by talking a more radical policy than they proposed for the government program.

Last March, Lafontaine suddenly resigned, for political reasons that were only partly related to his economic policies. Schröder, a political pragmatist already in trouble for reasons other than the business community's hard opposition to Lafontainism, replaced him with a recently defeated but respected politician, Hans Eichel.

Eichel, also a pragmatist, lacked Flassbeck's intellectual support, which had enabled Lafontaine to stand up to Frankfurt. He quickly turned right, responding to the reduction in tax revenues that resulted from slowing growth by proposing drastic cuts in spending, thus risking an aggravation of the slowdown by abandoning automatic stabilizers. Schröder and Eichel promised structural change, but their ability to carry it through is in doubt. Indeed, a series of stunning autumn electoral defeats casts doubt on their ability to carry anything out.

The economies of the other nine EMU members vary, from the social compact of the Netherlands, which has seemingly resolved the tension between structural flexibility and social stability, to the growing but still relatively small economies of Spain and Portugal. The nine will remain followers.

THE United Kingdom will not be a follower, even as a nonmember. Its potential membership hangs over the existing EMU; its potential competition limits Euroland's options; its membership in the European Union's other institutions entangles it with the EMU's strings. If Britain does join, it will become an instant leader.

British membership will depend on two factors, one economic and the other political. If its economy remains as different from the EMU's as it is now (Britain's unemployment rate is about six percent, for example), the UK is unlikely to join: success does not sign up to join failure. And if Britons believe that EMU membership will lead to political integration with the Continent, they are unlikely to join. Lord David Owen, who is pro-European Union, as he was when he served as a Labour Foreign Secretary in the 1970s, leads an anti-EMU movement based on the premises that political integration will inevitably follow EMU membership and that Britain wants none of it.

The final player is the European Central Bank. For the ECB the inherent orthodoxy and supposed political independence of central banks is reinforced by the Maastricht criteria and the charter guarantee of independence; the Federal Reserve, in contrast, is governed by laws specifying attention to growth as well as to price stability, and reports regularly to Congress. The real question, however, is how much the ECB's governors will differ from Alan Greenspan, whose deliberate mumbles sound orthodox whereas his adept actions show far more flexibility. The current ECB president, Wim Duisenberg, of the Netherlands, sounds quite conservative, but he did lower interest rates once he was rid of Lafontaine. The agreement whereby Duisenberg became president calls for his replacement halfway through the first presidential term by Jean-Claude Trichet, who is French and thus perhaps flexible.

New policies are unlikely in the current situation. Should the situation deteriorate in a cyclical downturn, France is ready to adapt, and the ECB's actions may be more flexible than its pronouncements. If Germany can solve its problems, the EMU, which makes it possible to transcend "Keynesianism in one country," may ease the fall by applying an economic stimulus across the Continent. If not, Euroland (without Britain, which certainly would not join under those circumstances) will resemble the Europe of the 1920s -- depressed, contentious, and vulnerable to the politics of despair.

ONCE the euro is in place, not even 1920s-style failure should cause the collapse of the EMU. But failure will not lead to political integration; crisis is more likely to encourage nationalism.

Success, on the other hand, will both require and engender further integration. Although the ECB already sets a single monetary policy, that policy will not necessarily suffice, particularly in case of crisis; a crisis would call for increasing deficits. And that would require substantial coordination (read "integration") within the EMU -- which is why Strauss-Kahn's Finance Ministry proposes setting up coordinating machinery now.

Coordinated decision-making on deficits would be a major step in integration. It would increase the power of the managers of the machinery, making them proto-decision-makers for the EMU as a whole, but raising questions of democratic control that would suggest the need to increase the power of the European Parliament or to create other mechanisms for political responsibility. All this would not suddenly introduce a federation; instead it would encourage a re-evaluation of the EMU's division of powers.

But whatever combination of old American and new European ideas set the model, the success of the EMU would lead toward a Europe that can be defined at least as loosely confederal if not more tightly federal. Whether that is desirable is up to Europeans to say. Helmut Kohl certainly thought it was desirable for Germany. Lord Owen considers it undesirable for Britain. But they agree that it is the real potential of the European Monetary Union.

And if the potential is realized, the United States will have a powerful new competitor -- but also a partner to share the burdens of world leadership.

The online version of this article appears in two parts. Click here to go to part one.

Robert A. Levine is a senior economic consultant at the Rand Corporation.

Copyright © 1999 by The Atlantic Monthly Company. All rights reserved.
The Atlantic Monthly; November 1999; Euroland, Open for Business - 99.11 (Part Two); Volume 284, No. 5; page 36-40.