Before the currency turmoil of the past year, the likeliest way forward for European integration seemed to be that the core would gradually admit the periphery. First, the Single Market and the Maastricht Treaty would deepen integration within the EC. Then, once that prospect was secure, EFTA countries would be admitted to the Single Market, and later to the monetary, fiscal and political framework of the EC. On this view, access to West European markets would be painfully slow for the countries of Central and Eastern Europe (CEECs), and full admission to the western club much slower still.

This is the Old View of a wider Europe. Its implications were discussed in the 1992 edition of the annual CEPR Report, "Monitoring European Integration". My purpose here is to consider whether the turmoil of the last year should cause us to think again.

It would be nice to be precise about what has changed, but this is not so easy. Referendums and speculators have attacked the heart of the Old View in the most dramatic way but its assumption that closer integration would provide the foundation on which the rest could be built was already questionable, as the 1990 and 1991 editions of "Monitoring European Integration" made clear. Those reports argued that the German economy would require German interest rates which were too high for comfort in any other ERM country, and that the Maastricht Treaty's fiscal straitjacket was not merely unnecessary but undesirable. The Old View was going to meet trouble sooner or later: it turned out to be sooner.

Europe still needs a New View. However, now it must be one that takes account not only of defects in its predecessor, but also of the changed circumstances since the breakdown of the ERM.

The eventual monetary integration of Western Europe is inevitable. Greater integration of product and factor markets will gradually undermine the case for formulating monetary and exchange-rate policy at the national level. However, the currency turmoil of the past year has forced the blindly optimistic to recognise that the previous strategy for attaining EMU was hopelessly flawed. What follows from this? For a start, progress to monetary union will now be slower than many had previously believed. We still lack a good plan for getting there. Since Germany was never willing to jeopardise its own price stability, Stage 2 of the Delors/Maastricht strategy was always an empty box: there would be no German participation without German control (the old ERM) or binding controls (a European central bank that is, in effect, a bigger Bundesbank). Recent events have diminished prospects for an early EMU even further. Euro-enthusiaists have lost something of their self-confidence. Now, the EC is not just uncertain how long it will take to reach EMU, it is unsure whether all its members wish to arrive.

So EMU is further away. Confidence in rapid deepening of the EC is reduced. And, as national self-interest proclaims itself more loudly, the richer countries will be less willing to transfer resources to their poorer partners. What does this mean for proposals to widen the EC to the countries of EFTA and the CEECs? The Old View distinguished admission of EFTA countries to the Single Market (in the so-called European Economic Area) from admission to the EC's monetary and fiscal arrangements. The creation of the EEA conferred large gains on EFTA through greater competition and economies of scale. However, these factors had a negligible effect on the EC, whose Single Market was already big enough to have exhausted most such gains. In bringing in the EFTA countries, the EC stood to benefit in two other ways. The newcomers were prosperous; they would therefore be net contributors to the ECbudget. Also, they were in good macroeconomic shape; they would therefore increasethe number of countries likely to meet the Maastricht conditions and be eligible for EMU.

Barring an outbreak of competitive devaluation, which would threaten the Single Market itself, the main effect of recent events, therefore, will be to tilt the benefits of European integration in the EFTA countries' favour. The newcomers will gain from participating in the Single Market, whereas the next stage of integration, in which benefits would accrue to the EC, has been delayed. If recent events strengthen those who wish a stricter form of subsidiarity to be applied in the EC--and this too seems likely--that next stage of integration may also seem more attractive to EFTA.

EFTA, it seems, should therefore be a more ardent suitor, and the EC even more cautious than before about the terms of their eventual union. This will exacerbate the asymmetry in bargaining power that had already allowed the EC to insist on pretty tough terms for creation of the European Economic Area. Since a period of EC reflection is also likely, the result is likely to be that full admission of EFTA countries to the EC will be further delayed.

Clearly, the bargaining power of the CEECs has been far weaker than that of the EFTA countries. In last year's "Monitoring European Integration", we argued that early admission of the CEECs to the EC is unrealistic. If the CEECs were to be eligible for transfers under the Community's structural funds and CAP, their admission would be prohibitively expensive. Limiting their eligibility for such support, however, would undermine the principle of horizontal equity, according to which EC rules apply across the whole Community. This principle has served the useful purpose of limiting the extent of rent-seeking by producer groups, against which diverse consumers cannot act as an effective counterweight. Governments will not lightly cast this principle aside.

Access to the EC's markets remains the best assistance that the Community can give its cousins to the east. Trade not aid is the right slogan. (Jim Rollo and Alasdair Smith have recently refuted claims that freer trade with Eastern Europe would damage the EC.) As Alan Winters argues in the previous artcle, preventing a slide towards even greater external protection in the EC remains the most important task for the Community's governments.

Exchange-rate policy has been an important instrument of macroeconomic stabilisation in the CEECs. Pegging to (a basket of) western currencies has helped to anchor inflation expectations during the transition to the market. Should the CEECs have been hoping for early membership of the EMS as a stepping stone to their own macroeconomic credibility? This was never remotely feasible. Inflation in these countries is often a symptom of deep-seated problems: an inadequate tax system (typically rudimentary in design, with a shrinking base and no history of successful collection), urgent demands for public expenditure, and infant financial markets in which to finance deficits. These are structural problems; they call for structural solutions. In the meantime, further commitments are simply constraints to be smashed--and the inflation tax may be better than no tax at all. The breakdown of the ERM in its current form is largely irrelevant to the CEECs.

But if western exchange rates are now more uncertain, will this pose additional difficulties for strategies based on pegging exchange rates in the east? Not to any great extent. The CEECs face much larger adjustment pressures than a few percentage points here and there on their nominal exchange rates. Indeed, if the breakdown of the ERM allows lower interest rates outside Germany, and therefore promotes a stronger European recovery, its short-term impact on the CEECs will be beneficial.

The benefits of moving from relatively stable exchange rates to full monetary union were always much smaller than the benefits of achieving the Single Market. So long as that greater goal is not jeopardised, the breakdown of the ERM need not stand in the way of a wider Europe. Its effect on Eastern Europe and the EFTA countries will be indirect: everything depends on the EC's determination to maintain the momentum of change.

Begg is Professor of Economics at Birkbeck College, London and a Research Fellow in CEPR's International Macroeconomics Programme.

David Begg and Charles Wyplosz `The EMS: recent intellectual history', in The MonetaryFuture of Europe, CEPR (1993)

CEPR (1990) Monitoring European Integration: The Impact of Eastern Europe

CEPR (1991) Monitoring European Integration: The Making of Monetary Union

CEPR (1992) Monitoring European Integration: Is Bigger Better? The Economics of EC Enlargement

Jim Rollo and Alasdair Smith `The Political Economy of Eastern European Trade with the European Community: Why so sensitive?' Economic Policy (1993).

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