Is the European Union (EU) crumbling before us?

Over the past few weeks, Europe has not dominated the headlines even though there is widespread feeling that the EU is now at a crossroads. The public debate, however, seems at times to confuse several separate issues – the proposed constitution, the single currency and the performance of the European economy. From the UK’s perspective, they are in many ways inter-related.

When this government first came to office in 1997, it was transparently Europhile, committed to placing the UK at ‘the heart of Europe’. Now, as Tony Blair starts on his final term, that stance has shifted almost 180 degrees. Hostility to the constitution and talk of the single currency area breaking up both appear to be the result of the continuing stagnation of the eurozone economies. The British public’s scepticism about closer integration seems justified and the politicians are following suit.

Since the single currency was conceived at Maastricht, the eurozone’s economic record has been deplorable. In terms of growth and job creation, the 11 members have consistently lagged behind the UK. As a result, in 2004 the unemployment rate averaged 8.6% in the eurozone (and even higher in France, Germany and Spain), compared with the UK’s 2.7%.

In the search for the guilty, European fingers point to the single currency. Polls in several countries suggest that a majority would favour the restoration of their original currency. While this is technically difficult and expensive, the sentiments are understandable. As many claimed at the time, the eurozone countries are very different from each other and at different points in their respective business cycles: they do not form an optimal currency area. It is not surprising, therefore, that a policy designed to suit the average works for hardly anyone.

The eurozone interest rate is set by the European Central Bank, which has an inflation remit less flexible than the terms of reference set by Gordon Brown for the Bank of England. As a result, the ECB has been inflexible and cautious, focusing more on inflation than growth. Fiscal policy has also been a problem. By locking themselves into the growth and stability pact, governments gave up a weapon to counter cyclical downturns in their own countries. In fact, during the long gestation period between Maastricht and the launch of the euro in 1999, too much policy attention was paid to getting countries ready in terms of the inflationary and budgetary convergence criteria and not enough on the structural issues which determine economic performance.

While euro-related policies are partly responsible, the so-called structural issues are a much bigger factor in Europe’s deep-seated malaise. In the period since 1945, Europeans enjoyed a rising standard of living, improvements in social protection, longer holidays, high social benefits and shorter working weeks. Any threat to reform this social model is fiercely resisted by electorates.

But the global economy has moved on from the time when Europe was a dominant economic force. Today, European workers cost about 20 times as much per hour as the Chinese, even though China produces increasingly sophisticated goods in direct competition with Europe. In the modern world, it is not enough for Germany or France to be more competitive than Italy or Spain: they have to be able to take on China and other Asian suppliers. This means wholesale changes, liberalising many parts of their economies, particularly the labour market. To many Europeans, such reforms are seen as an attack on the coveted social model. This was a major factor in the French rejection of the constitution – the feeling that they would have to embrace the Anglo-Saxon market approach to life.

It is something of an irony that while sentiment in Britain seemed to be opposed to the constitution, many Europeans were against it because it appeared to threaten them with the free market principles that have served the UK well since our own painful reforms of the 1980s. European politicians are caught in a classic catch 22. Many governments are unpopular because of slow growth, declining living standards and unemployment. Radical restructuring of welfare states, tax systems, labor markets and public sectors are a necessary prerequisite to reverse the downward trend, but this would only make politicians even more unpopular. Those not brave enough to face up to the need for change have one alternative – protectionism – and this promises an even faster slide downhill.