Why Is Europe Engaged in an Inter-Dependence War, and How Can It Be Stopped?
DEM Working Paper N. 2017/06
32 Pages Posted: 11 May 2017
Date Written: May 9, 2017
There is large evidence that European countries, the EMU in particular, are engaged in an interdependence war, i.e. non-cooperative policies with huge social and economic costs due to mutual negative externalities. In this regard, the EMU as a supranational institution with the overarching end to generate and distribute collective benefits from integration and policy coordination seems off the mark. We present a policy game between two interdependent countries showing that the causes and consequences of interdependence wars lye in non-cooperative strategies dictated by the national social preferences over "good" but costly policy choices embedded into the government's policy function. By means of the model we examine what supranational policy regimes may achieve a Pareto improvement. Among the latter, one that we call "Europe", minimises the additive loss function of the two countries. The thrust of our analysis is that the supranational regimes which do not take national preferences into account, dubbed "technocratic regimes", are dominated, so that the single alternative is between Europe and "exit" for the non-cooperative regime. An important result is that Europe is the Pareto-dominant regime only within a limited range of asymmetry between countries' social preferences. The paper concludes with some political-economic implications for the reform of the EMU.
Keywords: European Economic and Monetary Union, Policy Games, Design of Supranational Institutions
JEL Classification: P15, F55, D78
Suggested Citation: Suggested Citation