The short answer: Moore’s Law – the doubling of
microchips’ capacity every eighteen months or so – that kept going on and on
since the beginning of the information revolution in the early 80s without
showing any sign of slowing down.
Let me elaborate a little bit. Many
commentators have emphasized the importance of the Schengen-enhanced
immigration problem, implying that the British are xenophobes, which is clearly
false given the number of immigrants from a large sample of countries already
living there. London is a much more cosmopolitan city than most others on the
continent. Some pretend that British voters have been longing for a return to a
now defunct empire and its protected markets. But it would be hard to find a
basically protectionist demand in the public opinion. On the contrary the UK
economy is more and more integrated in worldwide, out of Europe, trading and
production. It exchanges less with the EU and more with the rest of the world
than in the past.
Few economists I suppose would object to have a
look at the benefits and costs of the British involvement in the European
Union. The ratio here has changed quite a lot since the 80s. Especially since
1986 when the “Single Act” promoted by Jacques Delors and other French
socialists transformed the Common Market, essentially a device for opening
formerly closed national markets after WWII, into an integrated single market
that, they claimed, should be complemented by a single currency and a single
regulatory apparatus to strengthen competition and become fully efficient. This
Single Act changed the nature of the European enterprise from a competitive
economic device into a politically motivated state building project detrimental
There is no evidence whatsoever in economic
theory that a single currency is necessary for free trade, or that competition
should be enhanced by regulatory unification. On the contrary a single currency
consists in suppressing markets, currency markets that is, and the price
mechanism there, the free variation of exchange rates between national currencies.
Hence competition is reduced, not augmented, by monetary unification. British
politicians understood that perfectly and rapidly decided to get out of the SME
in September 1992, while declining to participate in the creation of the euro,
in spite of the pressure exerted by the City in favor of entering the Eurozone.
On the other hand regulatory centralization is
a handsome gift granted to big business since instead of negotiating 27 or so
accesses to 27 markets, a large company can focus its efforts on only one
regulatory authority in Brussels, for a similar overall budget that accordingly
becomes huge for each negotiation (roughly multiplied by 27 at the level of
Brussels, relative to the lobbying budget available for each national
regulatory process before regulatory centralization at the European level). The
regulatory authority in Brussels also sees its bargaining power and potential
benefits multiplied by 27, creating an incentive for “cozy” relations with
All of that change favors the firms that can
best collude with each other and with the single regulatory authority, and
penalizes consumers and competition. It follows that big business in Britain as
elsewhere were strongly in favor of participating in the European Union centralization.
The drawback however was that since monetary
and regulatory centralization was put in place without the creation of a single
super state, the democratic control of political decisions was considerably
reduced. The eurocrats ruled and could create benefits and costs without
adequate representation of citizens. Instead of national voters controlling 100
per cent of laws and regulations applicable to them, these were now decided by
coalitions of foreign representatives. The best example is the recent decision
of Ms. Merkel to allow immigrants in Germany that could later migrate to
whatever member of the EU that they chose.
It follows that for citizens of member states there is now legislation
without adequate representation.
A solution to that problem that is inherent in
the process of European unification would be to create a government directly
elected by the whole of voters in the Union, and/or a President also
democratically elected. A super state in other words.
But this won’t happen. And it is the result of
Moore’s Law. Indeed following Coase’s analysis of the raison d’être of
hierarchical structures, i.e. firms, that type of organization of production of
goods and services develops when high transactions costs preclude the use of a
decentralized organization of production, that is, production through markets
exchanges between smaller and more numerous hierarchies. And since transactions
costs are basically information costs, it follows that when information becomes
abundant and extraordinarily cheap, as is the case since the beginning of the
information revolution of the 80s, the use of decentralized markets becomes
cheaper than the use of hierarchically integrated firms. Smaller firms become
more efficient than larger ones.
This is also the case of the largest firm in
our economies, the State. The state is just like other firms, a team organized for
the production of various services (police, justice, transfers) and some
industrial and private goods. Its optimal size shrinks with the new abundance
There has been accordingly a complete trend
reversal from the period of the “first twentieth century” (let’s say 1900-1975)
when production was increasing much more rapidly than information, a period of
general centralization of commercial production and political production, and
the period of the “second twentieth century” (since 1974) characterized by a
general downsizing of optimal hierarchical structures due to the vertical fall
of the cost of information and communication.
These hierarchical structures that exist and
were optimal in the past, however, tend to resist that trend for obvious
reasons (basically the interests of managers and employees). It is particularly
true in societies where democracy is imperfect because consumers and voters
interests are not well respected and producers (firms and managers) rule. It
follows also that European firms are too large, and European states have in the
main continued to grow whereas their optimal theoretical size was shrinking.
This is the cause of the underperformance of European economies, especially
since the 2008 crisis, which is a crisis of structural transformation, of
suppression of markets (currency markets) and of over-regulation of markets,
weighting mostly on small firms and giving a competitive hedge to over-large
ones. Thus stifling the productivity and dynamism of the economy.
This second twentieth century downsizing trend,
continuing in the twenty first (because Moore’s Law continues unabated),
explains why the European super state that elites everywhere on the continent
want to believe to be the key to future growth, but which would be the problem
and not the solution, won’t happen.
After declining to be a part of the single
currency venture and exiting the EMS on September 1992, British voters, in a
perfectly consistent if belated decision, have chosen to exit the regulatory an
fiscal apparatus that Europeans try to build, but much too late. The era of
large states and empires is closing fast.
The model of centralization of production and
politics that was adapted to the conditions of information scarcity and
production abundance of the late XIXth century and the first three quarters of
the XXth, what I call the American-German
model of empire building by war and political integration (the Civil
war in the US and monetary centralization by the building of the Fed in 1913;
and the German centralization under Bismarck, waged by war with many other
European nations in the 1860s and achieved by the French defeat of 1871), is
now obsolete since the 1980s. In spite of three “European civil wars” (1870,
1914, 1939) the building of a German-European empire imitating the American one
proved impossible to achieve. But our politicians did not realize that until
now, and still believe that the way to obtain more power and a faster growth is
still to imitate Lincoln and Bismarck. Their hubris alas is our burden.
The British who have a much stronger tradition
of commerce and of democracy than the other Europeans have understood that this
is not the case anymore.
Just as they did after 1992, they will be
vindicated by the coming years. Other Europeans forecast dire consequences of
the EMS exit of 1992: inflation, unemployment, and no growth. The contrary
happened, and Britain did profit from its political “clairvoyance”.
The same will happen in the following months
and years. The European state building project is dead, and the Euro will
follow. In the meanwhile the “organizational sclerosis” will continue to hamper
growth and dynamism on the continent.
There is hope however in the current crisis: as
noted by Rudiger Dornbusch, a great German economist of American culture,
crises are often long in the making, but when they happen they tend to proceed
at a very fast pace.
PS: Readers interested in the topic could have
a look at my January 2013 post, mentioning my hypothesis of an “organizational eurosclerosis”,
as well as my presentation at the Bruges Group meeting of 2012 available on my
homepage in the section “Some recent work: A. Policy: Euro and Europe”, The single market and European
organisational sclerosis. Bruges Group, London. November 10, 2012
Here is the 2013 post:
On November 10, last year, I was invited by the Bruges Group in London to deliver a speech on the “Single Market”, to which the organizers of the conference wanted Great Britain to “say no”.
I used to be quite in favor of a single market that I saw as the continuation and deepening of the “common market”, thus leading to increasingly competitive markets in the EU.
But in the process of thinking the topic over I came to realize that the Single Market, a notion invented in1986 by Jacques Delors and the eurocrats in Brussels, was quite different from the Common Market created by the Treaty of Rome in 1957. Apparently, thirty years had not been enough to open the national markets in the European Community, in spite of the suppression of tariff and non-tariff barriers to trade, and more action was needed.
What Delors wanted actually was a suppression of political and regulatory competition within the EU. This, I realized when writing “Euro Exit”, amounted to a big boost for European wide cartels, intended to replace defunct national cartels that had been stripped of their market power by the opening of the national economies, both within Europe and by globalization. Indeed, when regulations are centralized, business firms have a strong incentive to collude in order to negotiate from a common position with the regulatory authority. And the distance is short from collusion to cartelization.
Thus it appeared to me that the suppression of regulatory competition, the political centralization and the cartelization of the European industries were just one and the same transformation.
The result, as I see it, is a growing sclerosis of the organizational structure of state and firms in the EU as large and centralized units are reinforced while the underlying trend of the information society is towards fragmentation of large hierarchical organizations and general decentralization.
This is what I call the “European organizational sclerosis”. While the official diagnosis and current conventional wisdom is that labor market rigidities constitute the main obstacle to growth, I now think that excessively large public and private organizations – and thus taxes and rents - are the real barrier to growth in Europe. At the same time as I explained elsewhere, the devastating effect of high taxes on growth is not so much that of taxes on capital, but of taxes on labor, the various forms of payroll taxes that have been growing massively during the last three or four decades.
A policy to stimulate growth should thus focus first on the overall organizational structure of European countries and on realistic plans to reduce the labor tax.
Meanwhile the process of continuously expanding centralized regulation should be halted and a return to diversity would favor economic and political competition within the EU.
The text of my London speech is now available on my homepage here.