Charlemagne. The puny economic powerhouse

The European Union is not as powerful a global economic actor as its leaders sometimes pretend

"WHEN it chooses to pursue a truly federal policy, the EU can play a decisive role on the world stage. We have the ability, not only to resist initiatives that we do not support...but also to set the international agenda." So said Pascal Lamy, then EU trade commissioner but now head of the World Trade Organisation, in 2004. It is a truth almost universally acknowledged: in global economics, the EU acting together is more effective than the sum of its parts. Even those who are not interested in economics argue that trade is a good illustration of European "soft power". By helping to establish commonly agreed rules (in this example, for the world economy, but it could be done for other things), the EU wields an influence it could not otherwise hope for - and which partly offsets its scarcity of guns and resolve.

But is it really true? Next week will provide a test, when European bigwigs escape their unsatisfactory wrangling over the EU budget for a different form of wrangling at the world trade talks in Hong Kong. Even in Hong Kong, though, the Europeans will be in the dock over farm trade. So which is more important: that everybody else is resisting European policies on agriculture? Or that nothing can be done without European agreement? In other words: how much does Europe really set the agenda in global economic-policy making?

In terms of weight, the answer ought to be quite a lot. The EU accounts for between a third and a fifth of the world economy, depending on how you set exchange rates. The euro is the second most heavily traded world currency; the pound sterling is fourth. Europeans hold huge external assets and liabilities. Since the euro first came into being, gross capital flows into and out of it have been slightly greater than those into and out of the dollar. Europeans may not be able to fight wars, to cut unemployment or to integrate their minorities: but by golly they have economic heft. In a world of tigers and dragons, they are the cows: slow, useful and, above all, big.

On the face of it, too, Europeans wield economic power to go with their weight. Four of the members of the G8 group of rich countries are European. So are two-thirds of the members of the OECD, another mostly-rich-country club. Jean Pisani-Ferry, head of Bruegel, a Brussels think-tank, points out that European countries hold 30% of the seats on the executive boards of the IMF and World Bank, and over 30% of those institutions' voting rights - giving them nearly twice as much weight as the United States. Italy, Belgium and the Netherlands each have more voting power in the Bretton Woods twins than Brazil, China or India, an amazing relic from the post-war world.*

Yet despite it all, Europeans are surprisingly passive when it comes to setting the world's economic agenda. There are two exceptions: trade and climate change. Creeping protectionism may be undermining Europe's influence, especially with big developing countries such as China, India and Brazil. Still, over both trade and climate change, the EU has priorities, argues for them and has, at times, been able to bring others along - for good or ill. But these are not typical. Elsewhere in global economics, Europeans either contradict one another or have little to say, and almost no influence to boast of. When it comes to the world economy, Europe is a case of over-representation but under-achievement.

Thus Europeans have little to offer in international finance, even though, for some, the hope that the euro would rival the dollar as a reserve currency was one of the main reasons for creating it. Germany and Britain disagree about how much poor-country debt to forgive. Europeans have been silent about two of the biggest economic issues of the past few years, China's exchange-rate policy and the world's current-account imbalances.

Perhaps the Europeans hope that, because the overall EU current account has barely budged, while America's deficit and Asia's surpluses have both soared, the unwinding of global imbalances will not affect them. If so, they are wrong. Europeans have been buying dollar assets as if there is no tomorrow. Euro-area holdings of dollar-denominated assets rose by $1 trillion between 2000 and 2004 - almost as big an increase as in Asia. If the dollar fell sharply, so would the value of these assets.

It is curious that Europeans have nothing to say on a matter that could affect them deeply. Perhaps there is not much they can do. But that has not stopped the American administration from loudly demanding that China revalue its currency, for instance. In any case, as a recent paper* by Alan Ahearn and Jurgen von Hagen points out, Europeans could do something. China has said it will start pegging the yuan to a basket of currencies. The EU might influence the weight of the euro in that basket. Europe's silence seems less a realistic appraisal of limited power than a case of burying its head in the sand.

Unity is strength

The question is why. There are two plausible explanations. One is that Europeans disagree because their interests diverge too much. Britain is a large exporter of financial services, Germany a large exporter of manufactured goods. But EU countries differ just as much over trade and agriculture. Yet they manage to reach a common position on trade - albeit with difficulty. And they have a common agricultural policy (unfortunately).

That points towards the second explanation. European countries could settle their differences but they fail to do so because of dysfunctional institutions. Except in euro-area monetary policy and in trade, most macroeconomic matters are firmly in the hands of national European governments. These governments will not voluntarily give up their over-representation in the G8 or the IMF in favour of a common EU stance. In short, in the world economy as in foreign policy, Europeans cannot really agree how to distribute power among themselves.

Commentary feature which debates why the European Union, despite its economic power, is not powerful on most issues on the world economic stage. It concludes that dysfunctional institutions are the problem with not enough power at the EU level as opposed to the national level.