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Bigger Is Better

The Case for a Transatlantic Economic Union

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Throughout history, states have generally sought to get larger, usually through the use of force. In the 1970s and 1980s, however, countervailing trends briefly held sway. Smaller countries, such as Japan, West Germany, and the "Asian tigers," attained international prominence as they grew faster than giants such as the United States and the Soviet Union. These smaller countries -- what I have called "trading states" -- did not have expansionist territorial ambitions and did not try to project military power abroad. While the United States was tangled up in Vietnam and the Soviet Union in Afghanistan, trading states concentrated on gaining economic access to foreign territories, rather than political control. And they were quite successful. 

But eventually the trading-state model ran into unexpected problems. Japanese growth stalled
during the 1990s as U.S. growth and productivity surged. Many trading states were rocked by the Asian financial crisis of 1997-98, during which international investors took their money and went home. Because Indonesia, Malaysia, Thailand, and other relatively small countries did not have enough foreign capital to withstand the shock, they had to go into receivership. As Alan Greenspan, then the U.S. Federal Reserve chair, put it in 1999, "East Asia had no spare tires." Governments there devalued their currencies and adopted high interest rates to survive, and they did not regain their former glory afterward.

Russia, meanwhile, fell afoul of its creditors. And when Moscow could not pay back its loans,
Russian government bonds went down the drain. Russia's problem was that although its territory was vast, its economy was small. China, India, and even Japan, on the other hand, had plenty of access to cash and so their economies remained steady. The U.S. market scarcely rippled.

Small trading states failed because the assumptions on which they operated did not hold. To succeed, they needed an open international economy into which they could sell easily and from which they could borrow easily. But when trouble hit, the large markets of the developed world were not sufficiently open to absorb the trading states' goods. The beleaguered victims in 1998 could not redeem their positions by quick sales abroad, nor could they borrow on easy terms. Rather, they had to kneel at the altar of international finance and accept dictation from the International Monetary Fund, which imposed onerous conditions on its help.

In the aftermath of the crisis, the small trading states vowed never to put themselves in a similar position again, and so they increased their access to foreign exchange through exports. Lately, they have proposed forming regional trade groups to get larger economically, by negotiating a preferential tariff zone in which to sell their goods and perhaps a currency zone in which to borrow cash.

CHALLENGE AND RESPONSE

Global markets have grown dramatically in recent decades. The international consulting firm McKinsey & Company calculated that in 2007, world financial assets (including equities, private and public debt, and bank deposits) amounted to $194 trillion, or 343 percent of the world's GDP. It is easy to see why smaller economies can be defenseless against shifts in the global market. Money coming into a country can be an unexpected (and sometimes unwanted) boon; money going out can spell disaster. Local inflation and deflation can occur as a result of the whims of untutored but powerful investors based far away on Wall Street or in the City of London. Should foreign investors lose faith in a small country's economy, for whatever reason, that country is in trouble.

During the recent global economic crisis, moreover, even the largest economies confronted huge
losses as foreign and domestic investors removed funds or sold their holdings. From 2007 to 2008, stock markets worldwide depreciated by 50 percent. U.S. interest rates remained low only because China, Japan, and Europe continued to buy and hold U.S. securities; had these funds been removed, no amount of domestic spending (or printing of money) could have compensated. Even the biggest players, in other words, were too small to surmount the crisis on their own.

The world market, of course, has always been larger than its component parts, and it was in part to protect themselves from economic vulnerability that the great powers of the past sought to increase their size and strength. By 1897, the United Kingdom controlled an empire that covered one-quarter of the globe and included one-seventh of the world's population, as the historian Patrick O'Brien has documented. But even the British Empire did not control Russia, the United States, or the rest of Europe, and in 1929, an economic crash originating on Wall Street undercut British imperial self-sufficiency. This proved that no purely political instrument could bring together the world market.

The Great Depression and World War II forced even the major powers to recognize the limits of their individual capabilities. In the aftermath of these traumas, Jean Monnet, a hitherto obscure broker from Cognac, convinced his French and, later, German colleagues that the Western European states were too small to contend with the Soviet Union's huge landmass or the United States' vast industrial heartland. They could compete only if they came together, he argued. And thus began the process of European integration.

The 27 states that now compose the European Union will soon be accompanied by almost ten others, making Europe stretch from the Atlantic to the Caucasus. Member states have benefited from participating in an enlarged market extending beyond their national borders. The absence of tariffs in the EU allows greater cross-border commercial cooperation, which promotes specialization and efficiency and provides consumers in the member states with cheaper goods for purchase. Over time, as economists such as Andrew Rose and Jeffrey Frankel have shown, such trade zones increase their members' trade volume and GDP growth. There are also administrative advantages: southern and eastern European states with less advanced economies have found help and tutelage from veteran EU members and have not been allowed to fail (even if their fiscal policies have been reined in).

Something similar, if more gradual, has been occurring on the other side of the Atlantic as well,
with the formation, in 1988, of the free-trade area between Canada and the United States and of the North American Free Trade Agreement, including Mexico, in 1994. In the 1980s, Canadian Prime Minister Brian Mulroney had worried that the Reagan administration, which was in financial trouble, might reduce Canada's access to the U.S. market. When Ronald Reagan agreed to a preferential trade agreement with Canada, Mexico's president, Carlos Salinas de Gortari, felt compelled to join, lest Mexican exports be excluded from the North American market. Although NAFTA is at best a pale replica of the EU (without courts, decision-making bodies, or a common currency), it paved the way for other efforts in Central and South America. The vaunted Free Trade Area of the Americas has not yet emerged, but there has been a proliferation of bilateral trade agreements containing implicit provisos that they could be merged into a larger unit later on.

In Asia, meanwhile, the Association of Southeast Asian Nations has become increasingly focused on
economic unity since emerging in 1967 in the wake of a regional military crisis. As Europe further united, and particularly after the Asian financial crisis of 1997-98, ASEAN broadened its reach: China, Japan, and South Korea joined an ASEAN + 3 grouping in 1999, and Japan has proposed an Asian regional fund and has even floated the concept of an Asian currency union. These efforts
have floundered on the inability of China and Japan to forge a consensus akin to that between France and Germany in Europe, but that does not mean they could not succeed at some later date, if there were to be a deeper Chinese-Japanese rapprochement.

Finally, in 2006, German Chancellor Angela Merkel -- recognizing that the World Trade Organization's Doha Round of international trade negotiations would fail to reduce tariffs overall -- proposed the establishment of a transatlantic free-trade area composed of the EU and the United States. If realized, this trade arrangement would encompass more than 50 percent of the world's GDP, providing a stimulus and an enlarged market for both U.S. and European industry. hemmed in by Congress (which still has not ratified pending free-trade agreements with Colombia, Panama, or South Korea), U.S. President George W. Bush could not seriously take up Merkel's offer. But the deal might become more popularly attractive should the United States confront a slow economic recovery or even dip back into recession.

SIZE MATTERS

Before the twentieth century, states usually increased their power by attacking and absorbing others. In 1500, there were about 500 political units in Europe; by 1900, there were just 25 -- a consolidation brought about partly through marriage and dynastic expansion but largely through force.

In 1914, many statesmen thought that the Great War would consolidate the world even further,
both within Europe and outside of it. Instead, the conflict led to the breakup of the Austro-Hungarian, Ottoman, and Russian empires and dealt their British and French counterparts a serious blow. Military force remained a successful means of territorial expansion outside Europe, however, and in the 1930s, Germany and Japan sought to establish new empires of their own. Their efforts were stopped during World War II, and the remaining European empires disintegrated during the 1950s, 1960s, and 1970s. The Soviet Union was the last to concede, emancipating all of its territories by 1991.

This splintering of global politics into more and smaller pieces, however, was inconsistent with
the functional demands of global economics, which put a premium on size. The question of the late twentieth century, therefore, was how to construct larger economic units despite the discrediting of military expansion. Economic growth seemed a good bet, having worked for various powers in the past, and during the postwar era, the trading states had their heyday. But with that model having recently run into trouble as well, negotiated economic integration is becoming increasingly attractive.

Although the results of negotiated amalgamation are not the same as those of military conquest, they are likely to be more satisfactory and longer lasting. To be sure, an agglomeration of markets within a tariff zone does not guarantee political unity: as the EU shows, political disagreements still intrude, and participants often disagree on external policy. Yet the error is likely to be too much quietude, not aggression.

In the 1950s, the political scientist Karl Deutsch described how groups of countries could become so closely connected through the exchange of messages, values, migration, and trade that military conflict between them would essentially be ruled out. Norway-Sweden, Benelux, and the United States-Canada were cited as examples of such "pluralistic security communities." Since Deutsch's day, the EU has created another, forging a comparable connection between France and Germany and bringing others into their association. Subscription to the EU's acquis communautaire (its current body of law) has a social impact among members. They do not think of breakup but rather think of the prospect of others' joining.

Although the continent has no single decision-making center, its network has multiple nodes that hold the total complex together. The London-Frankfurt and Zurich-Milan corridors offer crucial economies of scale, as concentrations of expertise in finance, technology, and crafts greatly enhance efficiency. And in eastern Europe, a low-cost manufacturing sector is developing with links to hubs in France, Germany, and Italy. In 2008, 168 of the world's 500 largest companies were based in the EU, compared with 153 in the United States.

Europe has fashioned a cost-effective response to the need for size that avoids the mistakes of
yesteryear. The EU's total GDP is higher than that of the United States and will remain so. And in addition to its internal growth, Europe can continue to expand geographically. China cannot take over India, Japan, or South Korea, but Europe can peacefully absorb its neighbors.

RESISTANCE IS FUTILE

The United States cannot ignore the need for size and the new means of attaining it and should
recognize the developmental stimulus that would come from joining forces with Europe, the strongest economic power on earth.

A transatlantic economic association would not involve a political union. Nor would it mean a
gathering of the world's democracies, which do not necessarily have overlapping economic interests. Rather, it would mean combining the two most powerful economic regions of the globe, so that they could prosper more together than they would separately.

There are many theorists who still argue that geographic economic blocs are disadvantageous and potentially dangerous, providing little help for their members while increasing the risks of conflicts like those of the 1930s. Rather than paving the way for broader trade and political accords, these critics argue, such blocs hinder progress as they jockey for position with one another. Critics are right that the British, German, Japanese, and U.S. blocs did not cohere in the 1930s. But there was little foreign direct investment between them, nor production chains of the sort that join great economic powers today. Then, major countries sought to find and monopolize new sources of energy and raw materials, often following a mercantilist path in order to escape the constraining effects of foreign trade. The authoritarian powers also used violence as a tool for achieving economic and territorial gain.

But no great power today would think of solving its economic problems by military expansion. It
could occupy neighboring areas but not assimilate large ones. It definitely could not guarantee extracting their raw materials, oil, or other natural resources, as such attempts would be vulnerable to local subversion. Military expansion, in other words, poses difficulties today that it did not 75 years ago, making the potential dangers of regional economic blocs less of a concern today.

The peaceful expansion of trade blocs today, moreover, is likely to bring outsiders in rather than keep them out. It has done so in Europe and to some degree in North America and Asia as well. Self-sufficient trade blocs are impossible and will not be sought after. The key to a successful trade group, in fact, is that as it grows, it attracts sellers from the outside.

What would China, India, and Japan do if the United States and the EU formed a trade partnership?
They would not find an Asian pact a satisfactory rejoinder to the transatlantic combination. Since the major markets of the world are located in Europe and North America, Asian exporting nations would have to continue to sell to them. And if Japan eventually joined the partnership, the stakes for China and India would rise. China and India might not be significantly challenged if they could substitute domestic sales for exports. But even they, as big as they are, could not do so entirely. However important Chinese consumption becomes, it will not be able to sop up all the goods that China currently exports to technologically advanced and luxury markets in Europe, the United States, and Japan. To avoid falling behind, Beijing and New Delhi would need a continuing association with markets elsewhere.

What all this means is that the patterns of global politics and economics that have prevailed for
the last half millennium are increasingly outmoded. During that period, eight out of the 11 instances of a new great power's rise led to a "hegemonic war." With a potential Chinese challenge looming in the 2020s, the odds would seem stacked in favor of conflict once again, and in other eras it would have made sense to bet on it.

Yet military conflict is not likely to occur this time around, because even if political power
sometimes repels, today economic power attracts. The United States does not need to fight rising challengers such as China or India or even to balance one off against another. It can use its own market capacity, combined with that of Europe, to draw surging protocapitalist states into its web.

During the Cold War, the economic force of the West eventually surpassed and subverted even the heavy industrial growth of the Soviet economy. In the 1980s, the attractions of North Atlantic, Japanese, and even South Korean capitalism were a critical factor in Soviet leader Mikhail Gorbachev's decision to renew his country's economic and political system -- and end the Cold War. They also helped stimulate Deng Xiaoping's reforms in China after 1978.

Now that the formula for capitalist economic success has become widely understood and been replicated, Western economic magnetism will stem not just from the triumphs of individual economies but from their development as an increasingly integrated group. The expansion and agglomeration of economies in Europe -- and perhaps also across the Atlantic -- will serve as a beacon for isolated successes such as those in Asia.

SCALE EFFECTS

The need for a transatlantic economic union will become clearer should the U.S. economic recovery begin to flag. At some point, U.S. policymakers will recognize -- and find a way to convince the country at large -- that trade agreements with other nations are not a means of transferring U.S. production overseas but rather part of a robust recovery strategy to gain greater markets abroad. The crucial factor may be a recognition that such markets will not continue to open up without dramatic action. The failure of the Doha Round will become apparent, as will the fact that the only realistic response to that failure is to accept the EU's invitation to form a transatlantic free-trade area and essentially extend the U.S. market by almost half a billion people.

Such a move would be in keeping with broad and deep historical trends. The great French historian
Fernand Braudel attributed countries' success in the Commercial Revolution of the sixteenth and seventeenth centuries to the size of their national markets. England gained over France and Holland because its market was large and undivided by internal tariff barriers. With the Industrial Revolution, international markets became central to economic success, and attempts to expand markets abroad became one of the driving factors in European imperialism.

Military conquest lost its attraction following the two world wars, and for a period thereafter
it seemed that trading states were charting a new path forward. But small was not beautiful, and as the world market continued to grow, trading states could not master it. Even great powers found themselves needing to negotiate larger markets through economic associations with others.

Given the failure of a truly global attempt at international commercial openness, the way to extend the range and vitality of the U.S. economy is through new customs unions and currency arrangements. These are important not only to overcome the recession's enduring effects but also to match the growth of rising powers. Combining forces economically increases growth for the countries involved, and in the twenty-first century, that can be done without the risk of economic fragmentation or geopolitical conflict. A transatlantic free-trade agreement would provide its members the economic scale they need now and attract others in the future.

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