The Economics of Post-Atlantic Europe

To understand what impact the Trump Administration will have on European economic performance you have to start by re-examining the lessons of the past. Almost 50 years ago, Richard Cooper published a ground-breaking book in the United States called: The Economics of Interdependence. He conceived this book during the early 1960s while he was working as an economic policymaker in the Kennedy and Johnson Administrations, and he developed the argument as part of a high-level study group within the Council on Foreign Relations. These details are important because the message Cooper had to communicate was controversial, particularly coming from a member of the foreign policy establishment. No country, he argued, not even the United States, can ignore how other countries react to their economic policies. The problem is not good diplomacy (or good manners). It is structural. If policymakers ignore how other countries react to what they do, then they will never achieve their objectives – because the reactions of others can do much to offset any benefits a discrete policy action may deliver. Indeed, a country will be worse off going it alone than working with others. Compromise and cooperation are always better than having countries set their economic policies at cross-purposes.

The Atlantic Community

The subtitle of Cooper’s book underscored the geographic focus of his attention. He called it ‘the economics of the Atlantic community’. If the United States needed to worry about how some other part of the world would respond to its policy actions, that other place was Europe. Moreover, Cooper had good reason to be concerned. At the time he was writing, Britain was going through a painful devaluation of the pound and a second rejection of its bid to join the European Economic Community, Germany was flirting with Keynesianism and struggling to fend off speculative capital inflows, France was experiencing an outburst of student unrest and openly challenging the role of the dollar at the centre of the Bretton Woods system, and Italy was dealing with a dramatic upsurge in strike activity and a rapid acceleration of price inflation. Such problems not only complicated how the U.S. made its economic policy but they also could not be solved in isolation. The countries of Europe’s needed to learn how to work together and U.S. policymakers needed to work with Europe.

Neither side of the Atlantic was eager to embrace that lesson about the importance of cooperation and compromise in economic policymaking. As the French economist and statesman Robert Marjolin explained in a report commissioned by the European Commission to explain the failure of Europe’s first attempt at monetary integration, the crisis of the 1970s was the result of the divergence among the countries of Europe and across the Atlantic. Ultimately, however, both sides relented. That is why we have the euro today; it is also why we have the Group of Seven leading industrial countries (G7). You will find the origins of both institutions in the crisis of the 1970s. Neither arrangement is perfect, nor were their predecessors. But the logic of Cooper’s argument was compelling: Any framework for cooperative economic policymaking is better than the alternative.


America First

Donald Trump’s administration represents a significant departure from the legacy of Cooper’s argument – abandoning consideration of others together with the multilateral framework for policy coordination. Trump campaigned on an ‘America first’ platform that denies any need for cooperation in mutual interest. Instead, his rhetoric privileges transactions, deal-making, and zero-sum games. He also campaigned on the assertion that previous arrangements were disadvantageous to American interests. His administration can and will consider every agreement for renegotiation. If this attitude should encourage other countries to push back against the Trump administration and try to undercut its economic policies, then the new president would welcome the challenge. Unfortunately, it also invites the consequences.

The Trump Administration’s policies will ultimately damage American economic performance. That conclusion flows directly from the economics of interdependence. By abandoning the Transatlantic Trade and Investment Partnership (TTIP), the Trump Administration ensures that that U.S.-based multinationals do not benefit from the efficiency gains associated with broadly-accepted industrial standards or streamlined certification and testing requirements. By withdrawing U.S. support from global financial regulation, he threatens to complicate the cross-border movement of capital and to bring back financial market instability. By downgrading forums for macroeconomic policy coordination, he makes it more likely that macroeconomic policies deployed on both sides of the Atlantic will work at cross-purposes. As Trump’s critics are quick to point out, working-class Americans will be among the first to suffer the consequences of these actions, but the whole of the American economy will be affected and so will the broader Atlantic community.


European Ambiguity

The implications of Trump’s policies in Europe are more ambiguous. The suffering of the Atlantic economy does not necessarily imply a downturn in European economic performance. The situation is very different now from the 1970s, both within Europe and across the global economy. The European Union is more tightly integrated than the economic community that preceded it. The transatlantic economy is important and yet the world’s centre of economic gravity has shifted from West to East. The collapse of communism has expanded the European marketplace. China is a major source of trade and investment. And while many emerging market economies are wrestling with important problems they also present significant opportunities that did not exist in the 20th Century.

Hence it is possible to imagine that Europe could develop beyond its dependence across the Atlantic, that Europeans my see the new U.S. administration as a reason to strengthen their cooperation with one-another and with other potential markets, and that Europe might even emerge with strengthened leadership in the global economy. There is a plausible scenario in which the failure or distraction of political leadership in the United States becomes a positive (if painful) opportunity for the European economy. Unfortunately, that opportunity is unlikely to come to pass. The reasons are bound up with the structural problems identified in Cooper’s original argument. To see why, it is enough to look at the implications for money and trade.


The Trouble with Money

Europe has achieved its goal of monetary union, with seventeen member states sharing a common currency. Compared to any participating country, moreover, the euro area is much more self-reliant in terms of trade and production and much richer in potential for connecting savings to investment. This should insulate European countries from the kind of volatility they used to experience as a result of movements in the dollar against other currencies – and it does to the extent that such movements no longer have second- or third-order implications for intra-European exchange rates. Nevertheless, even before the financial crisis, movements in the euro-dollar exchange rate quickly emerged as a major source of shocks for Europe’s national economies, creating losers as well as winners. During and after the crisis, the euro-dollar exchange rate has often frustrated Europe’s monetary policymakers, particularly when market participants anticipate a divergence in macroeconomic policy decisions across the Atlantic and so move funds from one side of the Atlantic to the other in order to capitalize on expected exchange-rate movements.

Trump’s election as president has enhanced the conflict between changes in the euro-dollar exchange rate and monetary policymaking. The dollar appreciated strongly against the euro after Trump’s surprise victory and on the back of expectations that the new administration would work quickly to streamline regulations, revise the health care system, and undertake sweeping tax reform. European exports benefited from the resulting change in relative prices and yet the results were uneven across countries and industries. Meanwhile, the effective loosening of European monetary policy collided with the European Central Bank’s (ECB) efforts to begin slowing down its large-scale asset purchasing program as a first step to normalising monetary policymaking, fuelling arguments, particularly in Germany, that the ECB should move more quickly to bring an end to its monetary accommodation.

The result of the euro’s depreciation against the dollar was an increase in inflation divergence across the euro area. It also widened gap between the headline rate of inflation and the core rate that excludes energy and processed food prices that tend to rise under the influence of a depreciating currency. These impacts were more inconvenient than unexpected; Europe’s monetary policymakers do not target the exchange rate but they are adept at building exchange rate movements into their analysis of macroeconomic performance and monetary conditions. Once the ECB adapted to the change in global economic circumstances, however, the lustre began to come off the Trump Administration’s policy agenda and the dollar began to depreciate against the euro.

Again, Europe’s monetary policymakers found themselves wrong-footed as the appreciating euro began to tighten European monetary conditions, creating the danger that market participants will lose confidence in Europe’s recovery and so continue to expect prices to rise more slowly that the ECB believes is necessary for growth and employment. What remains unclear is whether the ECB will have to delay any further reduction in its large-scale asset purchasing program as a result of the euro’s appreciation. This is not a new problem for Europe’s monetary policymakers. They faced a similar dilemma when the euro depreciated strongly against the dollar soon after the monetary union was created and when the dollar collapsed against the euro in the period from 2002 to 2006. Nevertheless, the exchange rate volatility induced by the Trump administration is a painful reminder that cooperation across the Atlantic is better than the alternative.


Trade (and Brexit)

The politics of trade provides another illustration of this structural interdependence. The British government is currently negotiating an exit from the European Union (EU); subsequently it plans to negotiate both how it will retain access to European markets and how it will trade with other countries, including the United States. Britain’s European partners are unhappy that the UK is leaving the EU and they are worried that Britain’s departure will set a precedent for other disgruntled member states – either now or at some point in the future. Nevertheless, Britain’s European partners have a strong interest in maintaining close economic relations with the United Kingdom; they also have an interest in ensuring that Britain’s departure does not disrupt European manufacturing ‘value chains’ or result in the reintroduction of customs borders as, for example, between Northern Ireland and the Irish Republic.

The problem is that any trade arrangement that Britain negotiates with the rest of Europe will hinge in many respects on the trade relations that Britain negotiates with the United States. The issues here are technical and run from the sanitary and phytosanitary standards that govern the trade in agriculture to the certification of regulatory compliance in manufacturing and the documentation required for tracing the rules of origin for complex products. If the UK makes it easier for US firms to export genetically modified organisms into British agricultural markets, that could make it harder for British farmers to send their own produce for sale in the rest of Europe. Other regulatory standards including record keeping for ‘rules of origin’ are a further complication. The issue is not that the British will be unable to show equivalence or to meet European reporting requirements; rather it is that the translation of one set of standards into another is precisely the kind of activity that takes place at customs facilities (and that constitutes the ‘friction’ in the global marketplace). Regulatory convergence across the Atlantic would make this situation much easier to manage. The kind of transactionalist deal-making favoured by the Trump administration will make it harder.


Post-Atlantic Europe

The failure of the Trump administration to work with its European allies in a multilateral framework for macroeconomic policy coordination or trade negotiations will do much to divide the Europeans even as it slows down economic performance across the Atlantic economy. If we expand the conversation to include areas like corporate taxation and financial regulation, the situation only becomes more challenging and not better. There is nothing surprising about this situation. The Atlantic economy experienced these problems already in the 1960s and 1970s. The difference now is that the US government is turning away from the lessons that were learned from that previous period. And while the governments of Europe are more inclined to resist that temptation and to hold onto to the conventional wisdom about the economics of interdependence, the consequences of US policy actions are too great to be ignored.

Europeans are certainly capable of confronting this new challenge as a united front and yet doing so will depend upon their willingness to strengthen the solidarity between those who stand to win and those who stand to lose from this new post-Atlantic economic arrangement. European economic performance depends upon close cooperation. That has been true at least since the 1960s. Faced with the turbulence coming out of the Trump administration, such cooperation is imperative.


This essay was commissioned by the Aspen Institute in Italy and will be published in Italian later this autumn.  I will add a link to the Italian publication once that is available.  I have reproduced the English-language version of the essay here with their permission.