The Influence of International Capital Mobility on the French Road to EMU

The Influence of International Capital Mobility on the French Road to EMU

Master Thesis written by:

Thomas Friis

Aalborg University, April 3 - 2008

Supervisor:

Poul Thøis Madsen

Aalborg University April 2008

Contents

1. Introduction

1.1 The process of increasing international capital mobility

1.2 The French EMU process

1.3 Conceptualizing the field of examination

1.4 Narrowing the scope

1.5 Problem formulation

2. Some important methodological considerations

3. The theoretical framework

3.1 Introduction

3.2 Integrating structure and agency

3.3 The theories which constitute the framework

3.4 The Capital Mobility Hypothesis

3.4.1 Introduction

3.4.2 Important assumptions

3.4.3 The CMH

3.5 The power of ideas

3.6 The dynamics of ideas

3.6.1 Introduction

3.6.2 The ideational life-cycle

3.6.3 The ideational equilibrium

3.6.4 The ending of the ideational equilibrium

3.6.5 New ideas become embedded

4. Analysis of the French economic tradition in 1970s

4.1 Introduction

4.2 The French economic and monetary policy development in 1970s

4.3 How to understand the French economic and monetary policy development in the 1970s

5. Analysis of the French conversion

5.1 Introduction

5.2 Everything seems normal

5.3 The failure of the recovery program

5.4 The ideational crisis

5.5 Ideational conversion process

5.6 The repercussions of the introduction of the politique de rigueur

6. Analysis of the asymmetry

6.1 Introduction

6.2 The asymmetrical structure of the EMS in the 1980s

6.3 The interpretation of the asymmetry in general

6.4 The interpretation of the asymmetry prior to the co-habitation

6.4.1 Delors’ and Bérégovoy’s interpretation

6.4.2 Mitterrand’s interpretation

6.5 The interpretation of the asymmetry during the cohabitation

6.5.1 Introduction

6.5.2 The neo-Gaullist interpretation of the asymmetry

6.5.3 Demanding EMS reforms

6.5.4 Basle-Nyborg agreement

6.5.5 French disappointment

7. Analysis of the choice of the EMU design

7.1 Introduction

7.2 Two positions on the design of the EMU

7.3 The economic context the French were faced with in the period 1988-91

7.4 The French reaction and interpretation of the economic context

7.5 The German attempt to expand their power position

8. Conclusion

9. References

1. Introduction

Of all the changes of international political economy since the end of the Second World War (WWII), few have been as radical as the renaissance of globalization of the financial markets. Every financier tells the same story about an international capital market that has been transformed over the last decades. Someone who started as a junior financier in the 1960s and is now approaching retirement will have witnessed radical changes in the financial system and structure on several fields. Modern globalized financial structure brings memories about the early 20th century where international flows of capital flourished with few restrictions.

The general theme of this thesis is how financial globalization has influenced the European integration process with a particular focus on the French Republic. The objective is to understand the French involvement in the EMU in the light of the exponentially increased capital mobility over the recent decades. The study concerns the period between the early 1970s to the signing of the Maastricht Treaty in December 1991. The puzzle is conceptualized as a relationship between two processes or to be more concrete; how the process of increasing international capital mobility has influenced the process of the French involvement in the EMU.

Why this separate analytical focus on the French Republic? In short, it is because France matters for the European integration process. France, together with Germany, has since the ending of WWII been at the center of the regional integration process. No one could imagine any major step in the European integration without French participation and without a clear French fingerprint. Hence, in order to understand the European integration process in general, it seems reasonable to focus on France.

Yet, one event in particular triggered my curiosity for France in the European integration process:an event that appears to be an important turning point for the European integration process. This is what in this thesis is termed‘the French conversion’ and it is event that started in 1981 and lasted only about twenty months. During this short period most of the traditional French economic way of thinking and the political and economic strategies and priorities were radically transformed. Prior to the conversion the French strategies and priorities were centered on ensuring growth and modernization. Most French governments employed expansive credit policies to finance growth which together with low employment were the number one priorities. In practice, nearly all other objectives were subordinated to this. Several devaluations counteracted the effects of inflation on the price competitiveness of French companies. One might say that inflation and devaluation were staples of French economic policy (Sandholtz, 1993, p. 6).

After the conversion, this economic policy changed radically in that the focus was now primarily on disinflation and general economic and monetary austerity and the franc had to be stable regardless of nearly all other priorities and consequences. It was an important turning point, among other things because this new French way of thinking meant that the French and German economic philosophies no longer in contrasted to each other, which to a large degree was the case prior the French conversion. Hence, the conversion can be seen as an event which removed one of the discrepancies between the two EC-member states, thus enhancing the possibility for further monetary and economic integration.Having read a lot of the literature on this subject, it crossed my mind that it would be interesting to analyze how and to what extent the conversion was related to the process of increasing international capital mobility which achieved momentum in the years prior, during, and after the conversion. Hence, the time frame of the study is centered on this event - from the early 1970s to the early 1990s.

1.1 The process of increasing international capital mobility

The subsequent section is a short review of what is here termed the process of the reappearance of international capital mobility. The section depicts a process where the level of international capital mobility increased dramatically over a period of thirty years starting from a relative low level (compared to the early 20th century level) in the decades after the ending of WWII.

To begin with, global financial markets flourished in the late 19th and early 20th centuries. The period is termed the ‘classical gold standard era’ and is typically considered the longest period of high international capital mobility and lasted roughly from 1870 to 1914. (IMF, 1997, p. 234). Some scholars even argue that the classical gold standard era had relatively higher levels of international capital movements than contemporary eras, see e.g. Taylor (1996) and Turner (1991). The period between the end of the classical gold standard era and the ending of WWII was characterized by a fluctuating degree of capital mobility. During World War I, capital mobility was restricted by control and in the period from 1919 to 1930, the world witnessed a relatively high level of capital mobility which was ended by the Great Depression (IMF, 1997, pp. 234-238).

In the years after the negotiation of the Bretton Woods Agreement in 1944 there was a widespread skepticism towards the financial international liberal order which had prevailed in decades before. It was a skepticism which was growing in strength and dissemination in the early post-war period. It stemmed from the perceived experience of the interwar period, when speculative flows of capital had severely disrupted international trade and exchange rates stability (Helleiner, 1994, pp, 1-50). The Bretton Woods Agreement marked the beginning of a period with historical low capital mobility in comparison to the eras prior to Bretton Woods (the classical gold standard era in particular) and the later periods during the monetary regimes of the Snake and the EMS. Mainstream policy-makers and economists believed that capital mobility was unnecessary - and even undesirable. The Western European governments implemented capital control to prevent flows of speculative capital which many believed could disrupt the already tenuous economic situation in many countries. The control mechanisms became a central part of a new and more interventionist economic policy in the early post-war years (McNamara, 1998, pp. 72-93).

However, things started to change in the early 1960s which brought memories of the classical gold standard era. As Cohen argues in a rather poetic phrase: “Like a phoenix risen from the ashes, global finance took flight and soared to new heights of power and influences in the affairs of nations” (Cohen, 1996, p. 268). According to Cohen, investment and private lending gradually started to gather momentum, producing an exceptional growth of cross-border capital flows and an increasingly close integration of domestic financial markets (Cohen, 1996, p. 268). It was a development which was a consequence of a remarkable confluence of events. Events which includes the demise of the Bretton Woods fixed exchange rate system was impelled by the increase of foreign exchange markets; the balance of payments crises caused by the OPEC oil shocks; the development and use of new financial instruments; technological innovations; and the gradual elimination of capital controls (McNamara, 1998, pp. 50-52).

Unfortunately, the exact scale and nature of this phoenix risen is difficult to estimate precisely. As Cohen states; “comprehensive statistics on global currency circulation do not exist” (Cohen 1999, p. 449). However, there are some surveys that give us insights into the reappearance of globalized finance. One indicator of this development is the tremendous increase of the daily turnover on the worlds exchange markets. In 1973 $3 billion were converted into European currencies in one day. Later in this decade, the daily turnover was about $10billion and at the end of the 1980s that figure had reached $65billion (Goodman Pauly, p. 57, 1993). Another indicator is a survey by Thygesen, et al. Using data from a range of sources, Thygesen et al. worked out what they term global financial wealth; the world’s total portfolio of private international investments. From just over $1 trillion in 1981, aggregate cross-border holdings quadrupled to over $4.5 trillion by 1993. What is particular interesting here is the fact that this increases much faster than that of world output or trade in goods and services (Thygesen et al. 1995)

According to Cohen, this reappearance of globalized finance fostered two characteristics in particular: Firstly, the scale of cross-border currency use is extensive as well as growing rapidly, reflecting both the scope and intensity of market-driven competition. Monetary circulation actually is no longer confined to the territories of issuing countries. Strict autarky in currency relations is indeed a special case. Secondly, while the number of money in reality used for either international or foreign-domestic reasons tends to be rather small, the number of those routinely facing rivalry at home from currencies abroad emerges to be significant large (Cohen, 1999, p. 450).

From the point of view of this author, the degree of international capital mobility is a fundamental attribute of the terrain within both domestic and international economic politics unfold. When the level of this capital mobility is altered, the terrain is altered. As McNamara points out; “At the international level, capital mobility plays a critical role in determining the conditions under which international monetary agreements can be sustained” (McNamara 1998, p. 4). The point is:When an increased level of cross-border flows of capital boost the financial integration among states, ceteris paribus, monetary authorities and policy-makers find it more difficult to conduct their independent economic policy. Likewise, Thygesen argues that when international economy is characterized by a high level of capital mobility, the financial markets will react to even minor differences between the economic and monetary condition among states and thereby put pressures on the exchange rates which otherwise were well-founded (Interview: Thygesen). Hence, it seems reasonable to argue that the phoenix risen is important as it is a profound alteration of the context in which the French road to EMU was to unfold.

1.2 The French EMU process

The process of the French involvement in the EMU is here perceived as two related issues; the French role in the political and economic process that led to the EMU and the French decision to become a member of this new economic and monetary regime. This section conceptualizes in a few words what this in general means. Yet, it is important to notice that the exact presentation of the content of this process is beyond the scope of this section as it is the purpose of the later analysis.

The process is understood as:

The development of the French attitudes towards EMU,i.e. the French perception and ideas about the usefulness of the EMU and how the French perceived their self-interest in the creation of the EMU and how both these aspects changed over time.

The process also involves which objectives, means, and strategies the French had towards the creation of the EMU and how they evolved.

The process is also about power and how power developed, i.e. to what extent the French was able to influence the timetable and design of the EMU and the extentto which the French had to compromise on this. In other words, this is about the relative power position in the EMU process (relative in relation to other actors in the EMU process). This process is in the following also referred to asthe French EMU process.

I have chosen to conceptualize the field of examination as processes because the French road to the EMU probably was caused by a sequence of events and factors that seems, in some way, to be interrelated. Moreover, as Andersen argues, the use of the concept of process enable us to understand human behavior as not only based on conscious or well-considered reflections, but often as a result of uncertainties and mixed motivations. The point is that things happen in the social world not because of plans or intentions, but as a result of complicated and unpredictable social processes in which unexpected events prove to be decisive (Andersen, 1990, pp. 80-81).

1.3 Conceptualizing the field of examination

From the outset it cannot be excluded that the process of increasing international capital mobility has influenced the French EMU process in several ways and that the influence has changed throughout the 20 year period which isthe focus of this thesis. E.g. one can imagine that the influence has varied in intensity, manner, and direction. To cover this complexity it is therefore necessary to analyze simultaneously several aspects of the relationship between this reappearance of international capital mobility and the French EMU process; aspects which are presented later in the problem formulation.

This study is based on one central assumption; that there exists some kind of causal relationship between the two above mentioned processes. It is thus implicitly assumed that international capital mobility has influenced the French road to the EMU in one way or another and the overall purpose is implicitly to confirm or disconfirm this general causality. Beside this overall purpose, the objective of this study is to increase our understandings of the nature of the causality between the process of increasing international capital mobility and the French EMU process. The study is based on the normal informal and everyday understanding of the concept of causality; a directional relationship between one event (termed cause) and another event (termed effect) which is the consequence or result of the first. At the outset, the process of international capital mobility can be seen as the cause whereas the French EMU process can be seen as the effect.

As the concept of causality is an essential part of the present study, it is appropriate briefly to discuss the nature and character of the concept. Yet, it is only a short discussion based on the everyday understanding of the concept as an in-depth philosophical discussion of the concept is beyond the scope of the study. (for further discussion of the concept see for instance: Harre (1972), Sosa (1974), Mackie (1986) and Strawson (1996). In general, the concept is defined as the relationship between cause and effect or more specifically as the relating of causes to the effects they produce. The concept is based on the notion that in principle, all events have adequate causes. We can say that discussions of causality concern various ideas about the nature of the relations of cause and effect. If the relationship between cause and effect is high, one could argue that the causality is distinct and vice versa. For example, there is probably a high causality between having smoked in ones entire lifetime and developing lung cancer. However, there is nothing certain about this relationship between cause and effect within social science. In fact, the notion of causality can be seen as just a theory itself as it is - strictly speaking - impossible to understand or determine definitely what causes what in human life. A neutral or universal definition is notoriously difficult to formulate since every aspect of causation can be subject to substantial debate.

Hence, this study is about mapping, understanding, capturing and identifying the causality between a changing international economy, in which cross border flows of capital has increased and the French EMU process.