The Political Economy of EU Financial Integration: The Battle of the Systems

Here is an unpublished paper, which I presented at a conference at Baltimore in 1999. The title is the same as my book with Ingo Walter on European financial integration and monetary union. The theme is the tension between the member states battling to retain control over their financial affairs, while simultaneously seeking to strengthen those same powers by co-operation through the institutions of the EU.
The title “battle of the systems” refers to competition in market and political arenas between national financial institutions which are embedded in very different national contexts. The paper presents in schematic form key elements of national financial systems fromFrance,Germany, and the UK/US. I argue that the German and French financial systems are key components in  national embedded mercantilisms: their different institutional configurations have evolved with a purpose of fostering national, social cohesion, while reducing national vulnerability to world politics and markets through running trade surpluses and accumulating corporate and central bank reserves. In particular, a central feature of their financial systems has been to protect national corporate property as far as possible from bankruptcies and from foreign takeover. The UK/US by contrast have pursued internationalist policies, predicated on flexible labour markets, open markets for products and corporate assets, and liberal trade policies where, as John Stuart Mill argued, the objective of international trade is imports, not exports, as countries trade because they are different. In the first, corporate financing derives from retained earnings and bank borrowing, supplemented by share issues with restricted circulation; in the second, corporate financing is notoriously more dependent on share issues and on secondary market trades. The paradox of EMU is that France and Germany, two countries with embedded mercantilisms, are the principal protagonists of a measure which can only accelerate the victory of shareholder capitalism on the European continent.

Different types of  financial system.

How a financial system has come to be designed influences the character of the capital-allocation process, national economic performance, and international economic and financial relationships. This is done through the process of control over corporations and organisations. In Europe, and besides the now moribund Soviet mono-bank, there are three alternative financial-industrial control structures, which have been on offer as models for imitation this century: the state-led financial system, found in France; the German bank-based system; and the Anglo-American shareholder system.

All financial systems are active intermediaries between political and social structures and relationships, and corporations or organisations operating in some form of market arrangement. In the four types of financial regime, the role of public officials range from laissez-faire to active participation in a political market for resources of all types. At one extreme, public officials enjoy autonomy, set the macro-economic policy, competition policy and international trade parameters under which enterprises operate, and essentially all other industrial outcomes are left to markets. These outcomes are considered legitimate precisely because impersonal forces are at work. Quite simply, the argument runs, corporate restructuring is called for because the consumers decree it, and the shareholders have  heeded their cry. At the other extreme, public officials become full-fledged participants in the market process. Their involvement on behalf of “the government” may include full or partial ownership of corporations, public stakes in financial institutions with major influence on investment or lending decisions, influence on credit allocation through the process of bank regulation and supervision, or some combination of these channels. The nature of the corporate control structure and bank-industry linkages may have a significant bearing on the willingness and ability of public officials to affect industrial outcomes. In the last analysis, the financial system provides the arteries of the state’s resource flows. Politics and markets are inseparable.

The State-led Financial Market System

France is the reference-point for the state-led financial market system,( Zysman, 1983: pp. 99-169) as providing some “third way” between US capitalism and the Soviet system. As with Germany, the years prior to 1945 cast a long shadow over post-war financial arrangements. The defeat of 1940 was blamed by both Vichy and the Resistance on the failings of France’s pre-war “stalemate society,”(Hoffman 1963) where the influence of the 200 families who elected delegates to the Regency Council of the Bank of France, created by Napoleon in 1800,(Bonin 1989, Goodman 1992). had become a symbolic “wall of money” standing in the way of national reconstruction. The Council was abolished by the left government of 1936. Marshall Pétain’s Vichy regime in 1940 then launched its own national revolution, creating professional associations to organise and modernise the economy under state direction(Burrin 1995, Sternhell 1978).It was guided in part by Catholic social doctrine, which condemned both free market liberalism and the class struggle of Marxist doctrine. The regime sidelined “apatride bank capitalism,” associated with the older Protestant and Jewish banks, and provided the opportunity to restrict competition in favour of the large, Catholic banks.[1]

The state-corporatist mechanisms, rooted in legislation of 1941 and 1945, were designed to overcome the hesitancy of bourgeois France to invest in the nation’s industrial regeneration. Central to the inflationary growth policies pursued under the aegis of the Finance Ministry in the four decades following the end of the war was the idea that state influence alone could transform short-term savings into long term investments. Equity markets were sidelined on quasi-Marxist grounds that the interests of a narrow class of shareholders were not compatible with those of the nation as a whole, in a vibrant economy based on high levels of employment, the near-equal ofGermany. This overdraft economy(Loriaux 1991) was constantly modified by shifts in public policy and by the economic and social forces which its successes generated.

The Ministry of Finance became the dominant focus for savers and borrowers as it regulated the capital market directly. Deposit taking institutions with surplus funds placed them in the capital markets, and were taken-up by public-sector institutions which lent them to specific industries, such as housing, agriculture, nuclear energy, or regional investments. Both lending and borrowing institutions fell under the tutelage of the Ministry of Finance, which formally drew-up investment priorities through elaborate consultations with trade associations recorded in “The Plan,” through negotiations with the Ministry of Industry or in response to requests filtered through the political parties. Public officials in the Finance Ministry enjoyed prestige conveyed by their position in the state hierarchy, and because of the value of their contacts across the extensive state sector to those seeking access to it.

France’s financial system had never been free of political controversy. As resources of personnel and time in the Finance Ministry were scarce, such a state-centred administrative mechanism at the heart of the financial system promoted a queue. Organisations with close contacts and claims on the loyalties of public officials, such as state-controlled economic enterprises or large private firms, got served first. Small and medium-size firms were squeezed aside, so their representatives joined one or another of the political armies contending for privileged access to the state’s resources through elections. The regular cycle of local, regional or national elections thus also became contests between competing producer coalitions for a silver key to public finance.

Reforms had been introduced in 1966 to ease the budgetary burden of financing of the state-influenced corporate sector, and to create French universal banks on the “German model.” But it was in the early 1970s that the system ran into serious difficulties as inflation rates rose, followed by world oil prices. In 1972, the left-wing parties under Mitterrand’s leadership signed the Common Programme of the Left. This programme proposed extensive state ownership as well as control over the financial system, and launched France into two decades of partisan and electoral struggle where control of banks, insurance companies and capital markets were among the major stakes.

The French state-led financial system promoted inflationary growth, compensated by regular devaluations. The rising cost for the Ministry of assuaging  demands for subsidised credit was measured in the 1970s by the sharp rise in external debt, and the widening trade deficits withGermany. The whole edifice ground to a near halt, when in 1981 the new Mitterrand administration extended the public sector just as the external debt exploded, and domestic savings shrank.France’s financial market reforms of 1984-88 along US lines were introduced in order to promoteParis as an international centre, and above all to lower the cost of government financing. In particular, the financial market reforms would facilitate foreign private or public investment in French paper: it would allow the Bundesbank to buy French Treasury paper, much as the Bundesbank re-invested the dollars in its abundant reserves in theUST-bond market.

In a state-led financial system, financial resources are not alone in flowing through the hands of public officials. Patronage flows too, in the form of appointments to the management and boards of state enterprises or to large private enterprises in receipt of various state benefits. Public officials enter into competition among themselves, through their own organisations and to a lesser extent through their proclamations of party political fealty. Their legitimacy derives from a claim to act in the public interest, expressed in the extension of rights for employees within the public domain. Institutions whose resources they deploy directly or indirectly expand their stakes in business enterprises, extending further the field open to public patronage in the pursuit of private promotion. Corporate cross-shareholdings centre around state financial institutions. Indeed, a cynic could argue that such a state-led system has a vested interest in nationalising private enterprise in order to expand the reach of public officials, and then of privatising the assets in exchange for comfortable positions in the management or on the boards of companies. Ownership of these corporations is less significant than the fact that they remain on the career circuit, and that they stay within the bounds of what is in effect a political market for economic control. Such a political market extends throughout the multiple levels of government, as local mayors become businessmen and bankers for their local communities through resources obtained through the political process. Ultimately, the state can lose its status as acting in the public interest, and merges into the surrounding maze of non-transparent political markets.

The fear and then the reality of financial dependence informed the prolonged political struggle in France between the vision of bank-industry relations, introduced by Finance Minister Debré in 1966 with his chef de cabinet, Haberer, and Mitterrand’s commitment to an extensive nationalised sector. Debré’s bank reforms enabled two investment banks to form federations of companies, accounting in the aggregate for 48% of industrial value added and 60% of exports(Bellon 1980: 74). Their nationalisation would bring the greater part of industrial and commercial property directly or indirectly under state control. This prospect after 1972 hitched economic policy to the electoral timetable, discouraged private sector investment, and delayed reform of the financial system. The 1982 nationalisations then mobilised the conservative parties in favour of sweeping privatisations, which the socialist government initiated by stealth through allowing state enterprises to issue non-voting preference shares on the capital market. The 1986-88 conservative government’s vigorous sale of state enterprises was interrupted by the October 1987 stock market crash and by Mitterrand’s second presidential victory(Bauer 1988:.49-60; Dumez, Jeunemaitre, 1994: 83-104). His defense of the status quo on ownership effectively starved state-owned companies of capital, and prompted successive socialist governments to promote cross shareholding, jointly-owned subsidiaries, or the sale or issue of state shares on the markets. With the return of the conservatives in the April 1993 elections, privatisation was resumed but cross-shareholdings were maintained.

The driving motive behind the creation of cross-shareholding groups was to prevent nationally owned industries being “dissolved in Europe”( Olivier Pastré 1992). This view was widely held. The limits to France’s commitment to the EU’s internal market became evident when the Chirac government in 1986 imposed limits on foreign ownership of denationalised corporations. Re-elected in 1988, Mitterrand invited the legislature to protect French corporations against “roving, predatory money which grabs everything without effort”( Financial Times November 2, 1989). The idea of national majority ownership in large corporate groupings took a number of forms. First was the old Gaullist idea of “participation” whereby employees would own shares and acquire an indirect stake in management. The idea appeared in a variety of guises, such as the 1993 law offering shares to employees at a 20% discount. Second was the modified socialist strategy of 1983-86 to constitute industrial poles centred around nationalised banks. As former Prime Minister Mauroy explained, the formula would enable nationalised firms “to conquer foreign markets”( L’Année politique 1987 :125). Third was the “hard core” concept of the 1986-88 conservative government, whereby the law reserved 25% of privatised firms’ capital to major bank or corporate shareholders, selected by the state. The socialist governments of 1988-93, trapped by Mitterrand’s refusal privatise state corporations and by the banks’ shortage of own capital, to  sought to harness the major state insurers to the same purpose. The EU’s second banking directive, finally adopted in December 1989, opened the door to EU-wide banking for US or Japanese banks licensed in a member state, while the tripartite social security system acted as a restraint on the growth of funded pensions products in an open capital market. That left the state insurers as the bastions of national ownership(Story, Walter 1997:261-262), in France as inGermany. The largest cross-shareholding pole in French capitalism was created in 1994, with the privatisation of UAP(Union Assurance de Paris)  by, for and with the support of the state. But in 1997, AGF (Assurances Générales de France) sold out to the giant, Allianz, which lay with its sister re-insurer Munich-Re, at the heart ofGermany’s national cross-shareholding structure.

The contradiction at the heart of French policy was thus to seek to embrace Germany in the EU and in the North Atlantic alliance, while promoting a national capitalism  strong enough to compete on a footing of equality with Germany’s. The novelty in the EU’s internal market programme, and even more so in the ambition to create a single currency, was the French élites’ determination to use the EU as the vehicle for cracking open the German financial system for corporate governance, while keeping as much control and ownership over their own. But cracking open the German financial system also required the support of the “Anglo-Saxons,” support that clearly was conditional. And it meant opening up further the domestic market for corporate assets. The burden of this struggle between France and Germany for leadership in Europe, while preserving national cohesion for some at home, was borne internally, by the widening numbers of “outsiders” among its own citizenry as unemployment rose inexorably.

The Bank-based System

The bank-based system of corporate control is  associated with Germany, where the rules of the game have traditionally enabled banks to take deposits, extend loans to firms and issue securities on capital markets in a tight relationship to clients. The foundations were laid at the time of the Franco-Prussian war by German industrialists, eager to convert depositors’ short term savings into long-term corporate lending by banks. Germany’s dramatic history as a unified state from 1870 to 1945 casts a long shadow over  financial markets in the FederalRepublic. Association between Jewishness and finance capital first erupted in the 1873 Berlinfinancial crash, following hectic speculation fuelled by the five billion franc indemnity paid by France to Prussia for the war of 1870. Catastrophic losses were incurred. As Fritz Stern has written, after 1873 Germans of right and left never lost a powerful sense of anticapitalism (Fritz Stern 1990:.240-242). German economic policy turned to protection against foreign competition, and to state promotion of cartels. In the 1920s, war reparations, inflation, and reconstruction kept German banking fragile, and interest rates high. National Socialism derived much of its ferocity from the promise to deliver Germany from the tyranny of “cosmopolitan” finance, symbolised in Berlin as Germany’s financial metropolis.As Dr. Kopper, the speaker for the Board of the Deutsche Bank, said in 1994, both communism and national-socialism saw the interest rate as a source of exploitation.”The systems collapse and the prejudices survive”(Handelsblatt, June 15,1994).

Capital markets, located especially inBerlin, grew up alongside, so that much of German corporate external financing prior to 1914 came through equities, whose shareholders received sizeable dividends. At the end of the war, and again after 1945, loans outstanding to corporations were converted into bank equities at knock-down prices. Bank and insurance laws from the 1930s were designed in part to stabilise the system, while capital markets were decentralized fromBerlinto the states. This decentralized structure of the financial system was strengthened after the war by the growth of the savings and communal banks, which lent to local businesses and then from 1969 on, to governments. They account for over four-fifths of banking activity, and provide commercial bank, consultancy and market support for Germany’s small and medium-sized businesses(Deeg 1998: 93-101). Given the strong reliance of these companies, as well asGermany’s large limited liability companies, on borrowing as the prime source of external financing alongside internally generated funds, the German system flourished best when interest rates were low. Low interest rates were best assured in post-warGermanywhen the trade sector showed a solid surplus. In short, there was a very close association indeed inGermanybetween the macro-economic management of the currency, and the micro-economic management of firms.

Between 1970 and 1993,Germany’s accumulated trade surplus amounted to over DM 1,420 billion.( OECD 1994).Western Europe absorbed 70% of total exports, and was the overwhelming source of the cumulative surplus. The heart ofGermany’s strong position was quality engineering, notably in machinery and transport. The Federal Monopoly Commission reckoned that 100 of Germany’s largest companies accounted for one half of total exports (German Monopolies Commission 1987:15) with 88 of the largest companies run as joint stock companies and the three large banks and Allianz, as major shareholders–a stakeholding source of the surplus which was a main target of the “liberal camp”—all those states confronted with the challenge of absorbing Germany’s exports– in the negotiations on the European financial area in the years 1973-1992.

‘Bank power’ was a recurrent theme in the politics of the FederalRepublic, much like the ‘German model” was in French politics. And as in the French debate, the ‘bank power’ arguments in Germanyprovided a very partial view of German corporate financing.  The “bank power” debate was essentially about the role of the “big three”—Deutsche, Dresdner and Commerz. Significant equity stakes in non-financial companies were said to be held by banks and by investment companies run by banks, who act as both commercial and investment bankers to their clients. In effect, the major German banks’ functions altered considerably from the 1970s on, as their securities’ activities expanded, and corporations became flush with cash. By the early 1990s,Germany’s ten largest banks had reduced the number of their participations over 10% from a cumulative value of 1.3% of all capital of non banks in 1976, to .5% in 1993.[2] The large banks held only 11% of supervisory board (Bundesverband Deutscher Banken 1990).

The major banks muddied the waters by maintaining that, with equity as well as debt exposures to their clients, banks exerted a vital monitoring role in the management of corporations, including active supervisory board participation and guidance with the benefit of non-public (inside) information. Yet in each recession, supervisory boards were charged with incompetence. In the case of AEG in 1982, of Metallgesellschaft  in the winter of 1993, and of the Schneider construction group in April 1994, the impending disaster had not been monitored;  the banks were seen as ready to lend to large groups, regardless or unaware of the risk; supervisory boards were accused of operating as closed shops (Financial Times, July 7,1982, Manager Magazin, August 1993; Die Zeit April 22, 1994) .In the last resort, bankers were co-guardians of a stable, property-holding democracy which co-opted labour unions through their representatives’ acquired positions on works councils and on corporate supervisory boards.

The ‘big banks’ key role towards the corporations was as managers of proxy votes at the annual general meetings of Germany’s AGs. One study on proxy votes in annual general meetings of 32 of the 50 largest firms showed that 72.7% were wielded by the private banks(Gottschalk, A. 1988: 294ff). Banks, in other words, are part of a nexus of banks, insurance companies and industrial corporations(Ziegler et al 1985: 91-111; Esser 1990: 17-32; Jenkinson, Meyer 1992:1-10) which own each others’ shares and share each others supervisory board seats. At the heart of this nexus lie Allianz and Munich Reinsurance, the two Munichinsurance and re-insurance giants.As  Wolgang Schieren, the head of Germany’s leading insurance firm, admitted, “Allianz is today a holding company, whose objective is to hold participations”( Die Zeit, September 12, 1991).

Protecting Germany’s listed corporations from takeover constitutes the heart of the commercial banks case in the permanent debate about “bank power” (Auschuss für Wirtschaft des Deutschen Bundestages May 1990: 9).Their legitimacy derives from their vital protective function against foreign marauders.The argument was most clearly laid out by Alfred Herrhausen, speaker for the Board of the Deutsche Bank(a few days before his assassination), in an address to the “prominenz” of German politics and business in October 1989. It would be inadvisable, he declared, for legislation to oblige banks to sell their stakes. “I can anticipate excited protests if banks sell our stakes in important German firms to foreigners on the grounds of the continuing and in principle welcome trend to the internationalisation and globalisation of the economy” (Die Welt, October 27, 1989). Banks, he said, could abandon their voting and proxy powers. But who would replace them? “I do not have to illustrate to you what would happen if,on the basis of a clear decline in attendence, annual general meetings were to become dominated by active minorities. We have repeated experience of such active minorities.God help us,if our economy should become their plaything”. In other words, German capitalism was legitimate only within a national community.

Walter Seipp, Speaker of the Commerz Bank, put the point more bluntly:”If today you restrict or forbid stakeholding for German banks, the Federal Republic will become a sports arena for foreign banks, then you have Jimmy Goldsmith and other people here, and they will demonstrate to you how to buy, sell and strip industrial stakes in a market economy on the American model”.( Ausschuss für Wirtschaft des Deutschen Bundestages.Offentlicher Anhörung. May 1990. Protokoll Nr.74: 130-31). In the German context, this argument was impregnable. It flattered the fears of trade unions, the concerns of politicians, and the vehement hostility to an open market in corporate assets. It was rooted in German labour, social or corporate law. It described government and business practice to stall foreign takeover bids.It appealed to national pride in the manufacturing strength that underpinned the DM. It equated open share markets with the split banking systems of “the Anglo-Saxons”.

The major advantage claimed for the financial system of corporate governance in Germany is that it has provided stable long term finance for German firms—large, medium, and small. Private limited companies in particular expanded in number from 70,000 in 1970 to over 370,000 by the early 1990s. These family-owned firms form the bed-rock of German business, being highly specialized on world export markets, tied in often as sub-contractors to the large corporations, and financed largely through retained earnings or borrowing from banks when the occasion requires. They are notably averse to public listing on the German stock exchange, for fear of diluting their owners’ control over the business. In particular, they are embedded in local policy networks, where local banks play a key mediating role between local politicians, firms, trade unions and trade associations. Their battle field resides in competition on product markets, as the national economy remains open to foreign suppliers.

But the system has two serious disadvantages, one effecting all those firms dependent on bank borrowing, and the other relating to the propensity of insiders to the senior management of large corporations to collude.

Firms dependent on external bank borrowing benefitted by cheap finance when interest rates were low. These macro-economic conditions were secured when the Bundesbank could manage domestic monetary policy, relatively autonomously of international financial flows, as was the case from 1975 to 1979. But in 1981, the Bundesbank decided to jack up interest rates. Firms with high debt exposures died like ninepins, 12,000 in 1982 alone. In the 1980s, interest rates came down slowly again, while the Bundesbank sought to promote equity markets in order to reduce the vulnerability of firms to bank borrowing. Then came German unity, the surge in interest rates to contain related inflationary pressures, and a further spate of bankruptcies. Worse, the French government’s decision to keep the franc’s parity with the DM meant that French interest rates were pulled up to German levels. In France, 70,000 firms declared bankruptcy in 1993 alone. UK firms endured a similar punishment on account of the government’s insistence on hitching the pound sterling to the tight exchange rate mechanism(ERM) of those years.

To function well, the insider élites of corporations—the managers—must duplicate the market disciplinary functions performed by impersonal capital markets in the UK and theUS. As mentioned, this task is all the more difficult to achieve as German firms’ dependence grows on more volatile, and less predictable world markets. Because they have to satisfy the demands of their stakeholder constituency of workers, suppliers, clients and the local community, there is an incentive for firms to invite shareholders to patience and to reduce dependence on banks through strategies aimed at conquering market shares. There is a marked propensity for senior managers to defend the status quo, and to lay the blame for failures not at on the financial system of corporate governance, but on personalities(HBS 1996: 9-495-055).

The financial system as a whole must be prepared to deal with the consequences of large trade surpluses, which flow from joint corporate interest in market shares. Domestic inflationary pressures have to be kept down through rapid recycling of funds earned from exports. This entails the building up of portfolio investments in other markets around the world. Revaluations of the currency from exports and investment income abroad may be delayed by further external portfolio investments, as well as by corporate direct investments abroad as domestic production costs continue to rise relative to other locations around the world.

The central paradox of such a crossholding system for large corporations, with close ties in to medium and small subcontractors, is that it seeks to limit foreign ownership and market access, while requiring open markets for corporate assets in other countries alongside open access for exports including heavy reliance on export finance. Not least, corporations become detached from banks as their external sources of funds on world markets grow, while regulatory segmentation within the financial system breaks down as financial institutions compete across boundaries for new clients.Germany’s embedded mercantilism, in other words, began to unravel within on account of its external successes, while its external successes were envied inFranceas an expression of Germany’s rise to hegemonial power inEurope.

The Equity-market System

In this essentially Anglo-American approach, bank functions are split by legislative action between commercial banking and financial market institutions. The former may provide short-term financing for firms, but the major source of external financing for firms is the capital market. Though both the US and Britain adopted their own specific responses to the Depression of the 1930s, both followed similar lines of development, despite the “socialist” rhetoric of post-war Britain and the “capitalist” megaphone of the US. The theoretical basis of government policy for both had  been provided for more than 200 years by the concept of “laissez-faire”, the doctrine opposing government intervention in the economy except when necessary for the maintenance of law and order. Companies are owned by proprietor shareholders, who are considered as the principal beneficiaries of an enterprise. This attitude started to change during the latter part of the 19th century, when small business, farm and labour movements began asking the government to interfere on their behalf. Further modifications came with the experience of World War I, and then following the Wall Street Crash when the Senate in 1933 adopted the Glass Steagall Act, which separated US commercial and investment banking, and was intended to break-up the House of Morgan, which operated as a “universal bank” for US corporations and took the blame for the Great Depression.  As a result, commercial banks were placed at a disadvantage in dealings with non-bank financial institutions. This became a serious handicap in view of the growth in theUSbond markets, which benefited securities houses.

In the capital markets, shares of corporations are held by the public, either directly or through institutional vehicles like funds managed by insurance companies, mutual funds and pension funds, and are actively traded. Corporate restructuring, involving the shrinking of the firms assets or their shifting to alternative uses or locations (Ergas 1986) is triggered by exploitation of a control premium between the existing market capitalisation of a firm and that which an unaffiliated acquirer (whether an industrial company or an active financial investor) perceives and acts upon by initiating a takeover effort designed to unlock shareholder value through management changes. There is a high level of transparency and reliance on public information provided by auditors, with systemic surveillance by equity investors and research analysts. Concerns about unwanted takeover efforts prompt management to act in the interests of shareholders, many of whom tend to view their shares as put-options (options to sell). The control structure of this essentially outsider-based system is mainly confined to arm’s length financing, including takeovers and internal corporate restructuring, although investment banks may be active in giving strategic and financial advice and sometimes taking equity positions in (and occasionally control of) firms for their own accord.

This model, to operate to maximum effect, assumes that the more powerful stakeholders in the firm(shareholders, managers and customers) regard this process as legitimate. Its central claim to that legitimacy resides in an assertion that, everything else being equal, it is the most efficient to maximising wealth. Its supporters also argue that free markets are the most compatible of all systems with democracy as a system of limited government. If, for instance, financial markets are free to allocate savings to the most efficient rather than the most politically influential users of capital, then the returns for the savers will be higher than if some of them use their vote to extract rents from less remunerative, but politically-determined investments. Labour market legislation in particular has to be supportive, so that labour forces may be shrunk or shifted in task or location with the minimum of friction. The model also assumes that the government will not prove a light touch for corporate lobbies seeking to avoid restructuring or takeover through access to the public purse, as a less demanding source of funds. Government’s major task is to provide the regulatory and legal structure within which open capital markets may function, and to supply a safety net for the unemployed, the infirm or the old. Not least, this Anglo-American approach assumes that the two kings of the corporate roost are shareholders and customers: if other types of financial systems in world markets have different priorities, benefitting other interests, they will eventually be forced to adapt or to lose market share to rivals focusing firmly on consumer and shareholder interests.

Major reforms were implemented in the US securities markets in 1975, followed a decade later by the “Big Bang” in the London markets, ending the separation of brokers and jobbers, and opening the markets to full participation by US or Japanese investment banks and European universal banks. In the UK, equity ownership became much more widely diffused. Labour market legislation was liberalised. Corporate profits improved, and non-residential investment took off.Londonbecame the EU’s prime city of capital, and the “third leg” in the triad of world financial centres, together with New York and Tokyo (Hamilton 1986; Goldfinger 1986). AsLondonlacked the economic base ofJapanor theUnited States, its hinterland could only be supplied through integration with the EU. The major alliance was forged with Germany. Deutsche Bank moved its Eurocurrency operations fromLuxembourgtoLondonin 1984, and then acquired  theUK merchant bank, Morgan Grenfell. The move signified Deutsche Bank’s recognition of “the preeminence of theLondonmarket in the domain of corporate finance and money management”(Financial Times, November 28,1984). Other British-based investment banks were later bought up by German, Dutch and French universals.

The London markets were notably different from Paris and Frankfurt. They were wholesale markets, servicing businesses from all over the world: they were not domestic markets, primarily funding national corporations. British companies therefore looked often with envy at the financial services provided their counterparts inGermany. Whereas German corporations distributed rather modest proportions of earnings as dividends, British corporations paid out high proportions, obliging them to earn high rates of return in order to retain the loyalty of investors on whom they remained dependent for future capital.  Their managers did not have the retained earnings to invest in the human capital of their workforce, or to invest in risky developments of products and processes. Their attention was permanently fixed on their corporations’ share price, for  fear that a reduced dividend could have serious consequences in terms of a lower share price and a predatory takeover.

Yet German or French financial institutions used the London markets where they could lend on their surpluses, borrow for their customers or speculate on the booming markets for foreign exchange, equities, or futures and options. Simultaneously, they, or their governments, sought to protect their national markets from the “cosmopolitan” influence of London. As the Bundesbank stated with uncharacteristic forthrightness, Germany’s universal banks must not be forced “by virtue of the EU regulations to switch over to a system of functional operation in the financial services sector, such as predominates in the Anglo-Saxon countries.”( Bundesbank Yearly Report 1989). Mitterrand’s hostility to “predatory, roving” finance was interpreted into the  reformed French insurance law of December 1989, enabling state insurers to have up to 25% of capital held by private investors. Under the French presidency, the second bank directive allowed bank-insurance tie-ups, opening the way in EU legislation to recognise national financial conglomerates.( Story, Walter 1997: 261,262). As the policy’s defenders claimed, such cross-shareholdings created “a powerful and organised financial heart” of corporate ownership”( Le Monde, October 8,1991).

Anglo-American capital markets, then, were incompatible with the inherited institutions and national political cultures of Germany and France. In different ways, shareholder capitalism was held at bay in favour of managerial prerogatives, which were formally justified in terms of their contribution to national welfare.  Yet the advantage of the Anglo-American financial market system of corporate governance is that it places competition between corporations before competition between states. Shareholders reward or punish corporations, and are indifferent to whether the reward or punishment is meted out to workers and managers in one country or another. As its opponents, ranging  from German business to the French communist party,  repeatedly have pointed out, it is a-national, or in the language of an earlier generation of Europeans, it is “apatride”. 

                                            The Paradox of EMU.

The paradox of EMU is that France and Germany, two countries with embedded mercantilisms, are the principal protagonists of a measure which can only accelerate the victory of shareholder capitalism for large as for medium-sized corporations. This requires some explanation, because had the preservation of national ownership of large corporations been an over-riding priority inBonnandParis, a more moderate alternative to monetary union would have been negotiated that allowed capital markets to remain separate, and shareholders to stay mainly national. Such a measure was in effect proposed by Finance Minister Balladur in early 1988 along the lines of a common currency, whereby the EU unit of account would have been used in the settlement of intra-central bank accounts to sustain a commonly managed confederal exchange rate regime—much along the lines of the original design negotiated in March 1979 by Chancellor Schmidt and President Giscard d’Estaing.

The background to Balladur’s proposal was provided by theParisfinancial market reforms, and the adoption in January 1987 by Prime Minister Chirac of the ‘hard franc” policy, following an eleventh and acrimonious parity realignment of the franc in the ERM. The French government was convinced that the fundamentals of the French economy were now sound, and that the problem lay not inFrancebut in German mercantilist practices. Rather than have the Bundesbank accumulate dollars as the counterpart to German external surpluses, the French Finance Ministry sought to have the Bundesbank hold ECUs, and use them  to subscribe to French Treasury bonds (Le Monde, September 27,1987)–as the Bundesbank had done since the 1960s with regard to US Treasury bonds. The French government, in other words, was requesting that the German government treat it on an equal footing with theUS. The use of the écu as central bank unit of account would also avoid the convergence demands that the Germans had appended to the single currency discussions of the early 1970s. A recycling of German trade surpluses through German écu investments in French Treasury bonds would permit a relaxation of macroeconomic policies, and a rapid easing of pressures on the European labour markets. This was the intent behind the creation in January 1988 of the Economic and Financial Policy Council, within the bounds of the 1963 Franco-German Treaty.

Finance Minister Balladur expressed the French position in a memorandum of February 1988 to the EU Finance Ministers, proposing a “common currency “,and a European Central Bank(ECB):the ERM, he wrote, effectively exempted “any countries whose policies were too restrictive from the necessary adjustment.”( Gros, Thygesen 1992: 312). The proposal entailed the progressive construction of a “European Reserve Fund”, with the task of keeping EU currencies stable. This Fund would have foreign exchange reserves placed at its disposal by the central banks. In the longer term, it would prepare the way for completion of the monetary union(Aeschimann, Riché 1996: 88).

Kohl recognised that French dissatisfaction with the ERM would have to be accomodated( Balkhausen 1992: 71), but Finance Ministry and Bundesbank were reserved. The German Cabinet hammered out a common position, presented in a February 1988 resolution. “The longer term goal is economic and monetary union in Europe, in which an independent European Central Bank(ECB), committed to maintaining price stability, will be able to lend effective support to a common economic and monetary policy”(Financial Times, June 23, 1988). Foreign Minister Genscher summarised the German government’s position (Genscher 1989: 13-20): free capital movement, priority accorded to price-stability, political independence of the ECB, no inflationary financing of government deficits, and a federal structure, in the manner of the institutions of the Federal Republic or theUnited States. In effect, the German government countered with a maximalist proposal, even more maximalist that the 1970 Werner Report, which had suggested a federal currency and ECB, accompanied by a centralised EU economic policy body, with extensive counter-cyclical fiscal powers. The German government could reasonably expect that the French government would not accept such an offer.

The French government thus faced a dilemma: negotiations on the liberalisation of capital movements were proceeding in the context of the EU’s internal market programme, and the German government was in effect asking France either to accept continuation of the ERM under conditions of free short term capital movements within the EU, and with the rest of the world. This spelt further regular re-alignments of exchange rates, with the Bundesbank operating as de facto central bank for the EU, and making policy for other member states together with the US Federal Reserve as manager of the world’s key currency. Or the German government was suggesting EU monetary union on German terms.

At the European Council of Hanover on June 27, the EU political leaders agreed to incorporate the central bankers into talks on monetary matters. President of the Commission Delors presided their committee, which was joined by three monetary experts. As president of the committee, Delors presented the report in spring 1989.It represented a victory for the German position, not least in that the report made clear that the “transition” to a single currency represented a marathon with a receding winning post.[3] The ECB was to be independent; there were to be binding rules on government spending; the report incorporated the earlier Werner report’s proposal of a three stage transition; and the narrow ERM band was presented as providing a “glidepath” to monetary union. The bland text, replete with barely concealed differences, was vaguer with regard to timing.  Stage one in July 1990 entailed liberalisation of capital movements; stage two, to start at an unspecified date, was to witness new institutions(with unspecified powers), precise but not binding rules relating to the size of budget deficits, and a reduction in margins of currency fluctuation; the third stage, also starting at an unspecified date, would lead to “irrevocably fixed” parities, the replacement of national currencies by a single currency, and would only be embarked upon once all the instruments of the internal market were in place(an efficient competition policy, regulation of takeover bids and corporate control, a set of common fiscal policy goals and close monetary policy co-ordination).

In summer 1989, France took over the rotating EU Presidency for the second half of the year, as Germanyaccelerated towards unity. At the EU Strasburg summit of December 8-9 summit, the EU heads of state and government stated support for the German people to “refind unity through free self-determination”, and Bonn concurred in Paris’ request that a new intergovernmental conference be held prior to the German elections in 1990, with a view to incorporating monetary union into the Treaties.[4]

German unity was completed on October 3, 1990, followed by the victory of Chancellor Kohl’s coalition in the December general election, the first all-German general election since 1932. Meanwhile, at the European Council in Romeon 27-28 October 1990, Chancellor and Finance Ministry won acceptance of the  Bundesbank’s conditions. These had been circulated in an unofficial paper, ‘Compromise Proposal for the Second Stage of EMU’ among other central banks. They were presented as “non-negotiable” (my italics)demands (Frankfurter Allgemeine Zeitung, September 26, 1990): political union; price stability, completion of the internal  market; political independence of the ECB and member banks, and an ECB monopoly on all necessary instruments. Prior to union,price levels had to converge on a stable and low norm.There was to be no inflationary financing of government deficits, and there were to be binding rules on government spending.

This German position was incompatible with French demands for a “common currency”. Mitterrand therefore over-rode his Finance Minister and decided to concede, as the price to pay for Francegaining a voice in an independant ECB (Aeschimann, Riché 1996:91.). But he continued to maintain after Kohl had agreed to surrender the DM by January 1999, that the economic governance of a united Europewould have to be predicated on the Council of Ministers, and answerable to the European Parliament. Mitterrand forceably reiterated the French government’s position at the time of the September 1992 referendum on the Maastricht Treaty:`Those who decide economic policy, of which monetary policy is only one instrument, are the politicians elected by universal suffrage, the heads of state and government who make up the European Council”(Le Monde September 5 1992). At the Brusselssummit of December 1994, the EU governments welcomed Delors White Book on growth, competitiveness and employment, which proposed a growth policy for the EU through the development of EU-wide infrastructure projects, combined with an industrial policy predicated on competition in the market place and reform of labour market institutions. President Chirac returned to the theme, indicating thereby that the French concept of “economic governance” of the EU was not to be circumvented.[5]

The outcome of negotiations on monetary union was thus stacked heavily in favour ofGermanyhaving its way with regard to conditions. Both sides used the future as a place to locate their present disagreements: the German delegation had negotiated a marathon of an obstacle course, with only a distant prospect of more than a few member states reaching the finishing line on January 1,1999. But at the last moment, Mitterrand won Kohl’s commitment to override the battle of the experts as to whether the timetable or the conditions should take precedence. By agreeing to an “irrevocable” commitment to the timetable, Kohl in effect signed the DM’s death warrant.

This negotiating victory for France only compounded the price to be paid for an ECB, modeled on German lines. Continental labour markets were resistant to falls in wages as a means to absorb the unemployed, and therefore provided a prime target for Keynesian demand management. The German government suspected with reason that any French government would lobby for a continental-wide fiscal reflation, and therefore pushed in the course of 1995-96 for further EU agreements to restrict budgetary outlays. The alternative Keynesian device would be for the ECB to keep interest rates as low as possible in order to encourage investment and consumption. That option was implemented in January 1999, when eleven member countries introduced the Euro on the fixed rates to national currencies agreed in April of the previous year. Low interest rates across the EU-11 ensured a resumption of moderate growth within the year.

 In the meantime, the wholesale capital markets of all member states signing on to join the ECB in 1999 would convert out of national currencies to Euros, creating a capital market potentially the equivalent of that in the US. Financial integration and EMU thus represented a revolutionary programme which promised to de-nationalise market structures, and blow open national bond markets/ cross‑shareholdings, impact labour markets and transform national politics. It would create one Europe-wide market for bonds and equities denominated in Euros, but it would not end differential treatment of investors. Nonetheless, all financial institutions would be competing without the previous discrimination provided by trade in national currencies. The European financial marketplace would be composed of vigorously competing centres, which would have to provide a broad range of services or disappear into niche positions. Under a single currency and with an independent central bank, German, French or Italian bonds would be rated and priced as if they wereNew York or California bonds in theU.S. municipal markets. This would place significant constraints on public financing throughout the EU-11.

Highly liquid markets and contestable financial markets would  provide corporations throughout the EU with a new range of opportunities for external financing, but those opportunities would likely go hand in hand with greater scrutiny of management and work-force performances. Shakeouts, downsizing, management accountability and shareholder value along Anglo-American lines would thus continue to permeate Europe. Intensified competition spelt dissolution of national cross‑shareholdings, and an end to quasi-permanent credits generously to corporations, on a relationship basis, which fail to earn adequate returns for performance-oriented shareholders. In turn, the pressures for greater accountability spelt further moves in France and Germanyto Anglo‑American accounting, intensified political debates on corporate governance, growing pressures to develop Europe‑wide interest groups and political parties to martial demands and convert them into policy through the Euro‑policy process, and increasingly tough bargaining in the Council of Ministers.

This would not represent a triumph of market forces. Rather, it would be the probable consequence of a political decision. Were European political and business leaders quite so revolutionary? There was no indication to suggest that they were.Germanywas not a proponent of “Big Bangs” in delicate policy areas and prefered to do things consensually.Francewas ambitious, but existing arrangements and commitments weighed heavily. TheU.K.was the best-prepared as far as the capital market was concerned, but lacked political support to join the Euro-11. Meanwhile,Francesought to EuropeaniseGermany, whose political leadership in turn had to oblige business leaders and the general public who abhored financial instability and the prospects of inflationary Euro-policies beyond their control.

The prospect of repetitive cycles stretching into an indefinite future provided the central motivation to cash-in the political capital invested in the EU’s most ambitious project to date. Indeed, monetary union is seen as a catalyst for future initiatives toward political union. By contrast, the Bundesbank has argued that for monetary union to succeed, it has to be sustained by a polity capable of absorbing the inevitable and perhaps extreme tensions associated with such a revolutionary step. Only the existing states now have the legitimacy which enable them to answer to the central political question: By what right do you rule?  The EU institutions can only legislate or implement what the states agree to . It was therefore reasonable to argue that a less ambitious path to a more integrated Europe, one that resorted to the tried and tested EU negotiating technique of using the future as a place to locate present disagreements, could have proven more capable of reconciling the diverse practices of Europe’s interdependent states with the necessary constraints of cooperation on monetary and exchange rate policy, than a Big Leap to one currency and one capital market. But that way would only have been possible if financial systems of corporate governance in Germany and France were not embedded mercantilisms, in other words if they were capable voluntarily of moving the Anglo-American way on their own or in the context of the internal market legislation.

This they were not prepared to either do, or to admit to doing. Mergers in the financial or in the non-bank sector in the EU-11 in the early months of the Euro’s existence indicated clearly that the old national reflexes, to exclude foreigners taking over prized national assets, were as lively as ever. How come, then, that corporate behaviour remained national, while the Eur-11 had taken a giant step into a federal currency? One answer would hold that EU legislation regarding capital markets has to catch up with monetary policy, and end the barriers to cross-border trade inherent to the various practices of national preference. Another holds that it was national calculations which drove the EU towards a single currency, and national calculations which continued to prevail in the market for corporate assets after the Euro’s introduction.

In other words, the rationale for monetary union from the 1980s onward was the prospect of German unity, and thereby ofGermany’s emergence asEurope’s prime power, dictating monetary and exchange rate policy to other, lesser states. Both French and German political leaderships agreed that abolition of the DM was essential to further consolidation of the European peace since 1945. The catalyst for the Big Leap to Europe’s Big Bang was German unity:Francefeared that German unity providedGermanywith the temptation not to liberalise but to consolidate its national practices asEurope’s hegemon. Kohl was more than aware of what that French reading of events meant for future relations. So both governments decided to make the Big Leap into a federal currency, and away from the haunting past of 1870, 1914, and 1940.That meant monetary union, but monetary union also spelt a single capital market, ending national capitalisms.

The states were prepared for monetary union, but they were less prepared to acquiesce in surrendering national corporate ownership and control. Consolidation of a single capital market lay ahead. In the meantime, the paradox of a Euro-capital market is that it provides the means and the incentives for corporations and financial institutions to consolidate on a national basis. Such behaviour would be consistent with the history ofEurope’s competing national mercantilisms; it would not be consistent with the European states’ espousal of a federal currency.

Jonathan Story

August 1999.

Jonathan Story is Professor of International Political Economy at INSEAD. His latest book, is The Frontiers of Fortune: Predicting Capital Prospects and Casualties in the Markets of the Future (Financial Times/Prentice Hall, 1999). He is co-author, with Ingo Walter, of Political Economy of Financial Integration in Europe, Manchester University Press, 1997, and his chapter “Monetary union: economic competition and political negotiation”, appears in The Franco-German Relationship in the European Union, edited by Douglas Webber and published by Routledge, 1999.

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[1] The Catholic banker, Henri Ardant, went so far as to express his hope for a united Europe under German leadership: After the war, he stated, Germany should act “to eliminate the tariff barriers within the great economic space and move as soon as possible to a single European currency.” Quoted in Philippe Burrin, op.cit., pg. 271.

[2] The banks’ glasnost came in the form of public communications from the Bundesverband der deutschen Banken on July 25, 1987; March 29,1989; and October 29, 1993.

[3]  “The Delors Committee’ wrote Helmut Schmidt,” did not satisfactorily state why it turned down a partial solution, whereby the ecu would serve as a parallel currency alongside national currencies and gradually squeeze them out. This refusal closes a pragmatic way, which the bond markets are already taking”. “Am Sankt-Nimmerleins-Tag?” .Die Zeit, September 7,1990.

[4]“Les Douze acceptent que le peuple allemand retrouve son identité”, Le Monde, December 10-11,1989.No date was named for completion of monetary union, reflecting Kohl’s reticences and Prime Minister Thatcher’s opposition.

[5] “L’Europe selon Chirac”Le Monde, March 25,1996. “A la Banque centrale européenne, que nous avons voulu forte et indépendante, il reviendra de garantir la solidité future de la monnaie européenne. Mais c’est au Conseil des Ministres, institution répresentative des états, qu’il appartiendra de définir les orientations de la politique economique de l’Union, à l’unanimité chaque fois que c’est l’essentiel”.


About Jonathan Story, Professor Emeritus, INSEAD

Jonathan Story is Emeritus Professor of International Political Economy at INSEAD. Prior to joining INSEAD in 1974, he worked in Brussels and Washington, where he obtained his PhD from Johns Hopkins School of Advanced International Studies. He has held the Marusi Chair of Global Business at Rensselaer Polytechnic Institute, and is currently Distinguished Visiting Professor at the Graduate Schoold of Business, Fordham University, New York. He is preparing a monograph on China’s impact on the world political economy, and another on a proposal for a contextual approach to business studies. He has a chapter forthcoming on the Euro crisis. His latest book is China UnCovered: What you need to know to do business in China, (FT/ Pearson’s, 2010) ( His previous books include “China: The Race to Market” (FT/Pearsons, 2003), The Frontiers of Fortune, (Pitman’s, 1999); and The Political Economy of Financial Integration in Europe : The Battle of the Systems,(MIT Press, 1998) on monetary union and financial markets in the EU, and co-authored with Ingo Walter of NYU. His books have been translated into French, Italian, German, Spanish, Chinese, Korean and Arabic. He is also a co-author in the Oxford Handbook on Business and Government(2010), and has contributed numerous chapters in books and articles in professional journals. He is a regular contributor to newspapers, and has been four times winner of the European Case Clearing House “Best Case of the Year” award. His latest cases detail hotel investments in Egypt and Argentina, as well as a women’s garment manufacturer in Sri Lanka and a Chinese auto parts producer. He teaches courses on international business and the global political economy. At the INSEAD campus, in Fontainebleau and Singapore, he has taught European and world politics, markets, and business in the MBA, and PhD programs. He has taught on INSEAD’s flagship Advanced Management Programme for the last three decades, as well as on other Executive Development and Company Specific courses. Jonathan Story works with governments, international organisations and multinational corporations. He is married with four children, and, now, thirteen grandchildren. Besides English, he is fluent in French, German, Spanish, Italian, reads Portuguese and is learning Russian. He has a bass voice, and gives concerts, including Afro-American spirituals, Russian folk, classical opera and oratorio.
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