ESSAYS IN INTERNATIONAL FINANCE

ESSAYS IN INTERNATIONAL FINANCE are published bythe International Finance Section of the Department ofEconomics of Princeton University. The Section sponsorsthis series of publications, but the opinions expressed arethose of the authors. The Section welcomes the submissionof manuscripts for publication in this and its other series.Please see the Notice to Contributors at the back of thisEssay.

The author of this Essay, Barry Eichengreen, is John L.Simpson Professor of Economics and Professor of PoliticalScience at the University of California, Berkeley. ProfessorEichengreen has written extensively on the history andprospects of the international monetary system. HisGlobalizing Capital: A History of the InternationalMonetary System will be issued by Princeton UniversityPress this year. The following Essay was delivered as theFrank D. Graham Memorial Lecture on April 16, 1996. Acomplete list of Graham Memorial Lecturers is given at theend of the volume. This is Professor Eichengreen’s fourthcontribution to the publications of the International FinanceSection.

PETER B. KENEN, DirectorInternational Finance Section

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Library of Congress Cataloging-in-Publication Data

Eichengreen, Barry J.A more perfect union? : the logic of economic integration / Barry Eichengreen.p. cm. — (Essays in international finance, ISSN 0071-142X ; no. 198)Includes bibliographical references.ISBN 0-88165-105-2 (pbk.) : $8.001. International economic integration. 2. Europe—Economic integration. 3. Mone-

tary unions. 4. Monetary unions—Europe. 5. European federation. I. Title. II. Series.HG136.P7 no. 198[HF1418.5]332′.045 s—dc20[337.1′4] 96-24731

CIP

Copyright © 1996 by International Finance Section, Department of Economics, PrincetonUniversity.

All rights reserved. Except for brief quotations embodied in critical articles and reviews,no part of this publication may be reproduced in any form or by any means, includingphotocopy, without written permission from the publisher.

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International Standard Serial Number: 0071-142XInternational Standard Book Number: 0-88165-105-2Library of Congress Catalog Card Number: 96-24731

CONTENTS

1 COMMERCIAL INTEGRATION AND MONETARY INTEGRATION 3

2 MONETARY INTEGRATION AND POLITICAL INTEGRATION 12

3 CONCLUSION 21

REFERENCES 23

FIGURE

1 LOBBYING AND INFLATION: THE POSSIBILITY OF MULTIPLEEQUILIBRIA 20

A MORE PERFECT UNION?

This essay was delivered as the Frank D. Graham Memorial Lecture at PrincetonUniversity. Portions of it owe much to my teachers Sheldon Wolin and John Schaar,whose influence it gives me pleasure to acknowledge. Ron Rogowski instructed me onthe literature on legitimacy. Jeffry Frieden’s council clarified my thinking on matterspolitical. Fabio Ghironi generously allowed me to draw on joint work and critiqued myanalysis. Finally, I thank Max Corden for helpful comments; in a sense, this paper is asequel to his Graham Lecture on the same subject.

THE LOGIC OF ECONOMIC INTEGRATION

This lecture is about the connections between three types of union—customs union, monetary union, and political union. The first sectionasks whether monetary integration is a concomitant of commercialintegration.1 The second asks whether political integration is a con-comitant of monetary integration.

I use the ambiguous word “concomitant” to indicate that I am actuallylooking at several questions. One is whether monetary integration mustaccompany commercial integration before efficiency advantages can beobtained from the latter. Another is whether commercial integrationdelivers a larger increase in efficiency and welfare when accompaniedby monetary integration, and whether the welfare improvement frommonetary integration is greater when accompanied by political integra-tion. A third asks what combination of commercial, monetary, andpolitical integration is Pareto optimal. And a fourth, and different,question—concerned with the political equilibrium rather than thesocial optimum—asks whether monetary union is necessary to maintainpolitical support for commercial integration and whether politicalintegration is necessary to assemble support for monetary union.

My answer to the first question is that neither a common currencynor measures to limit the fluctuations of exchange rates are essential toderive efficiency advantages from a customs union, assuming that theunion is “natural”—that the benefits of trade creation dominate the

1 Throughout this lecture, I use the term “commercial integration” to refer tomovement toward the establishment of free-trade areas and customs unions, and“economic integration” to denote more far-reaching initiatives, such as the EuropeanUnion’s effort to establish an integrated internal market both in goods and services andin factors of production.

1

The work of the International Finance Section is supportedin part by the income of the Walker Foundation, establishedin memory of James Theodore Walker, Class of 1927. Theoffices of the Section, in Fisher Hall, were provided by agenerous grant from Merrill Lynch & Company.

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