European drama, but a global crisis; It is not just the euro that is under threat, but our entire system of free trade

First published in the Telegraph on 20 May 2010

It is now accepted, even by Angela Merkel, that as Europe battles its financial crisis, the very fate of the euro is at stake. Her belated discovery of this home truth is welcome, but she does not go far enough. The real concern is that the crisis bubbling on the other side of the Channel represents a make-orbreak moment for globalisation. If that sounds rather exotic, consider two apparently separate events from the past couple of days. The first features George Osborne. While things have gone pretty well back home for the new Chancellor, he is already having trouble in Europe, where the Commission has been fighting not only to de-claw the hedge fund industry – against British wishes – but also to impose new rules on its member states.

The Commission’s latest idea is that every European finance minister (including Osborne) should be compelled to send his Budget plans to Brussels for approval before announcing them to his own MPs and citizens. The rationale is that if there is to be a central bail-out fund for stricken European nations, there should be someone in the middle making sure no one misbehaves. Osborne, understandably, was having none of it, using his inaugural European summit to insist that when it came to a country’s budget, “the national parliament must be absolutely paramount”.

The second event took place a few thousand miles away in Washington, where the US Senate voted 94-0 to prevent the International Monetary Fund from using its cash to help countries that are inextricably trapped in a debt spiral. Though barely reported on this side of the Atlantic, this vote could have enormous consequences – such as preventing the fund from providing its share of the grand European bail-out package announced with such fanfare last week, which amounts to a third of the trillion-dollar total.

Though superficially unconnected, the two events share a similar theme: for the first time in many years, the technocrats who run our economies are realising that the main barrier to resolving a crisis and reinstating business-as-usual is not so much our ability to afford it, but our populations’ willingness to pay.

As long as things were going well, economies were growing rapidly, and affluence was increasing, it was easy for politicians to pretend that when it came to economics, national borders didn’t much matter any more. But now the chips are down, nationalism is back.

The rule of thumb here is as follows: of the three aims we have been striving towards in recent history – democracy, national sovereignty and global free trade – you cannot have any more than two at any one time. Want to run your country as an independent state, open to the whims and volatility of the free markets? The voters will punish you at the ballot box. Insist that your nation has full control of its own affairs? Then you have to jettison any plans to play a full part in the global economy. Want democracy and globalisation? Then you have to suborn your sovereignty.

This is what Professor Dani Rodrik of Harvard University calls the “policy trilemma”, and it is what lay behind the breakdown of the last era of globalisation, which coincided with the Industrial Revolution. Under the British Empire, free trade flourished, reinforced by the gold standard (in some senses a precursor to the euro) and the Royal Navy.

However, this only came about because most politicians were able to ignore their citizens’ protectionist impulses. The first decades of the 20th century brought not only the First World War but also a mass electorate; when Churchill tried to revive the gold standard in the 1920s, at the cost of deflation and depression in the UK, the public revolted. Churchill called the blunder his “worst ever mistake”.

Scarred by the beggar-thy-neighbour policies of the 1930s, John Maynard Keynes could only contemplate a “globalisation-lite” as he rebuilt the world’s economic structure after the Second World War. But the Bretton Woods system, which intentionally suppressed the free market through capital controls, lasted only so long. Liberalisation went into overdrive with the fall of the Berlin Wall and the opening-up of China. Yet the resulting system is actually something of a patchwork. Europe exemplifies the problem: the continent is a hodge-podge of nations trying to disguise itself as a completely liberalised market. Unfortunately, its people have different ideas: the Germans are furious about the Greek bail-out; the British insist on remaining on the sidelines.

Perhaps recognising the danger of alienating her voters, Mrs Merkel has now taken what might be a first step towards curtailing economic globalisation, by banning the short-selling of German banks. Some worry that a return to capital controls is the next step in the European effort to prevent meltdown. Others suspect that the European Central Bank has already intervened in the markets to prop up the euro.

Quite what the real plan is remains to be seen. Most likely, there isn’t one – yet. But unless they intend to embrace totalitarianism, Europe’s members will eventually have to abandon either their national sovereignty or globalisation itself. Given the continent’s size, and our reliance on it as our largest trading partner, this is not a drama we can afford to ignore.