EUROPEAN UNION WORLD

EU (European Union) Economic Crisis 2013 - 2014 ; Jim Rickards

12. After the storm

SO WERE THE SCEPTICS RIGHT ALL ALONG? It is hard to avoid the conclusion that the single currency hás been a terrible folly. Its failings have brought misery to many parts of Europe and gravely damaged the post-war European project. At the height of the financial crisis, in early 2009, Jean-Claude Trichet, president of the ECB, could plausibly argue: “In stormy seas, it’s better to be on a large ship than in a small boat.” But the euro turned out to be no mighty ocean liner; it was just a pleasure boat, good for showing off in sheltered waters but dangerous on the open seas, lacking bulkheads, lifeboats or even a trained skipper and crew.

Being locked in a single currency made it too easy, almost inevitable, for deficit countries to build up large imbalances in good times (pumped by the savings of surplus countries) and agonisingly difficult for them to adjust in hard times. William Hague, the UK’s foreign secretary, was prescient when he predicted before the start of EMU (he was then the Conservative Party leader) that the currency zone would prove to be “a burning building with no exits”. Or as Silvio Berlusconi, then Italy’s prime minister, put it during the crisis, the euro is a “strange currency that does not convince anybody”.

With national currencies bond markets would have been more alert, demanding higher interest rates long before weaker countries could build up such large external deficits. And when the crisis came, devaluation might have allowed them to regain competitiveness more easily. But this judgment has to be tempered. First, any gains from devaluation might have been frittered away though inflation; and inflation would have pushed up borrowing costs. Second, it is likely that Europe’s currencies would have been linked in some way, and that the system would have been ripped apart when the financial storm blew in, with the Deutschmark appreciating sharply, the Italian lira devaluing and the French franc torn between the two. Third, currency chaos might easily have led to a protectionist freefor-all, undermining the single market.

In one form or another, major turmoil was probably unavoidable in Europe. What might once have been a currency crisis became, with the euro, a debt crisis. The euro allowed countries accustomed to high inflation to avoid reform in the good years as they benefited from low interest rates. Brutally, no doubt, the hardest-hit economies have been forced into overdue reforms, for instance in Ireland and Spain. Nowadays it is Italy and France, less traumatised but also less reformed than other countries, which present some of the biggest dangers to the future of the euro. They are too big to fail, too big to save and too big to bully from Brussels.

Europe’s real folly was not to look for the gains from a single currency in terms of trade, financial integration, exchange-rate stability and economic efficiency, even if they might have been overstated.

The madness was to believe that these benefits could be obtained on the cheap, without the political constraints, economic flexibility, financial transfers and risk-sharing mechanisms of genuine federations. What stands behind the euro? Germany? Up to a point. The ECB? Only sort of.

Almost everybody knew that the euro was incomplete when it was launched in 1999. Those who spoke up about the flaws were largely ignored. Those who kept quiet hoped that the problems would be repaired as and when they appeared. It was not an unreasonable assumption. The European Project has always advanced through half-steps, in the knowledge that inadequacies would eventually require further half-steps to be made good. As Jean Monnet, a founding father, once put it: “Europe will be built through crises.” The problem is that, when the euro crisis struck, it turned out to be far bigger than anyone had imagined. The debtors screamed for help, but the creditors feared being pulled under.

Yet the doomsayers were wrong in one crucial respect: they underestimated EU leaders’ commitment to the European project. The euro has somehow survived, and many a short-seller hás lost money betting on its demise. The euro’s failings have been compensated by sheer political will and the fear of what might happen if it broke apart. Angela Merkel, the German chancellor, has staked hundreds of billions of euros-worth of German taxpayers’ money to rescue other countries, while keeping her voters’ trust. She held back those who wanted to push out Greece. The Greeks underwent appalling hardships to stay in. Cyprus did not walk out even after its banks were crushed. The ECB stretched its mandate to make sure that the euro would not break apart. And countries are still lining up to join: Latvia has just done so, Lithuania may follow in 2015.

So in the end, it was those who subscribed to the “coronation” theory of the single currency who were closest to the correct answer: monetary union should have been the culmination of political union, not the means to achieve it. Does that mean it is time to break up the misbegotten euro, just as countries abandoned the gold standard in the 1930s?

Redenomination would be acutely painful. Changing currency is different from leaving a fixed peg. Whether done by returning to national money, or by creating a Germanic northern euro and a Latin southern one, redenomination would mean that currencies, assets and liabilities would all be repriced abruptly. Some companies, in both creditor and debtor countries, would go bust. Some countries that devalued would be crushed by their euro-denominated debt and default. And there could be bank runs as depositors in southern countries rushed to move their savings to northern ones. The dislocation would be most acute for the deficit countries. If the euro has to be split, it would probably be least disruptive if Germany were to leave, either alone or with a group of northern neighbours,allowing the rest to devalue. But Germany would not avoid economic pain, and a euro without the EU’s largest economy would make little sense.

It is also unlikely that the EU’s single market would survive the implosion, as it would probably be followed by capital controls, trade barriers and, possibly, a wave of migration. Without the euro or the single market, the EU would become irrelevant. And vulnerable democracies in eastern Europe, and even in the south, could lose their political anchors. The tow-line that is pulling the Balkan countries towards the EU could snap. In short, it must still be better to refit the euro than to scrap it; and better still to do it during the current lull rather than wait for the next storm.

The measure of failure

The euro zone has undergone extensive patching. It now has a permanent rescue fund; tougher rules to monitor budgets and economic imbalances, with the threat of semi-automatic sanctions; and national balanced-budget rules through the fiscal compact. In principle, all recognise the need for structural reform to regain competitiveness and enhance growth. In September 2013, Wolfgang Schäuble, the German finance minister, boasted that the slow return to growth in the euro zone, and the rebalancing of current accounts in deficit countries, was proof that the much-criticised medicine was working:1

Systems adapt, downturns bottom out, trends turn. In other words, what is broken can be repaired. Europe today is the proof.

Yet this is to miss the point. The euro’s is a story of survival, not of success. Although it is limping back to growth, its weaker members have sunk deeper into debt. Mass unemployment and debt deflation in Greece are hardly evidence of successful adjustment. The question is not whether economies eventually bottom out, but whether politicians limit or worsen the damage. One answer is to compare the euro zone’s performance with that of the United States. European leaders like to blame the United States for their crisis, and to boast that aggregate public debts and budget deficits are healthier than those of the United States. So why is the United States doing so much better than the euro zone? US output has surpassed its pre-crisis peak and is growing moderately; the euro zone has yet to make up the lost ground and growth is still fragile.

Unemployment was above 9% on both sides of the Atlantic in 2009, but it has since fallen close to 7% in the United States and risen above 12% in the euro zone. In the periphery the numbers are much worse. Europe as a whole has a less favourable demographic profile than the United States, so in terms of GDP per head the growth figures are a bit less dire. Nevertheless, the differences in performance are glaring.

A catalogue of errors

Europe’s response has been slow, partial and often baffling to outsiders. The adjustment has been needlessly painful for the debtors, and probably needlessly expensive for the creditors. Leaders of the euro zone are unlikely to acknowledge their errors, but their many changes of policy amount to na implicit admission of them.

Who is to blame for the fiasco? Those who created such a death trap of a currency union, to begin with, followed by the reckless borrowers and the irresponsible lenders of the first decade of EMU. The rulers of deficit countries foolishly thought they could live in a Germanic currency union, and enjoy low interest rates, without becoming more Germanic in their attitude to budgets and wages. Certainly, deficits in the periphery were mirrored by surpluses in core economies. But the truth is that running large external deficits is more dangerous than having surpluses when a crisis hits.

Once the crisis began, though, it is the creditor countries that must bear prime responsibility. They were best placed to limit the fallout, because everybody needed their money, but they made it worse.

Above all this means looking at the role played by Germany. It is wrong to accuse it of selfishness or, worse, of trying to dominate Europe. Germany has undoubtedly staked much of its treasure (as have other countries) on saving the euro zone. But it made serious errors. It treated the crisis for far too long as a question of fiscal profligacy, and of individual countries. Mario Monti would quip that for Germany “economics is a branch of moral philosophy”. Fiscal sinners had to atone, and the rightful had nothing to apologise for. Frequently in Germany economics was also a question of extreme legalism. Many of the most senior officials in the German finance ministry are lawyers, not economists, starting with Schäuble himself.

It was only in the summer of 2012 that Germany started to understand that the structure of the euro zone itself was unstable, and came around to accepting the need for a banking union. Even then it dragged its feet over anything that implied common liabilities, and insisted on a worryingly complex legal structure for the resolution mechanism.

The incoherence can be understood only in the light of Germany’s twin terrors: the fear of moral hazard and the fear of collapse. These are best encapsulated by two dictums: “chacun sa merde”, Nicolas Sarkozy’s summary of Merkel’s rejection of a joint bank rescue in 2008; and “ultima ratio”, Merkel’s justification for bailing out Greece in 2010. In other words, countries must deal with their problems on their own, and should be helped only as a last resort when the euro’s survival is at stake.

The constraints are meant to limit the liabilities of creditors and maintain pressure on debtors to reform. But they have raised the cost and length of the crisis, and allowed doubts about the euro’s future to fester, thereby hampering the recovery in the periphery and accelerating financial fragmentation.

On the face of it, the heroes of the crisis are the two presidents of the ECB, Trichet and especially Mario Draghi, whose interventions kept the system going when the politicians were at each others’ throats. The ECB gave timely warnings of the danger of imbalances, and responded decisively to the financial crisis. But once the trouble spread to sovereigns, it became much more cautious. It was willing to provide liquidity to banks, even those that were patently bust, but hesitated to do so overtly, even for solvent sovereigns. The Eurosystem of central banks cushioned the blow on deficit countries by accumulating large imbalances in the euro zone’s payment settlement system, known as “Target II”. At the height of the crisis in 2012, Germany’s Bundesbank had, controversially, accumulated claims worth more than €750 billion against the ECB. So over and above the visible taxpayer-funded bail-out by the German government, economists argued bitterly over whether there was also a large stealthy bail-out via the Bundesbank. The Target II imbalance is perhaps best seen as a reflection of capital flight from the troubled periphery, and raises the question of whether central banks in creditor countries would have to take large losses should the euro break up and the debtor countries refuse to settle their Target II liabilities. In the event, the imbalance declined steadily after Draghi’s “whatever it takes” speech in London in July 2012 restored confidence in the future of the euro zone.

That said, the ECB resisted for far too long the need to cut Greece’s debt, and refused to let Ireland impose losses on bondholders. It devised an effective means of halting contagion only in the summer of 2012, after two years of crisis and half-hearted interventions in bond markets. If governments responded too late, the ECB often responded even later. It feared that if it acted too soon, governments would be only too happy to leave it alone to deal with the crisis. In the darkest days of the crisis, frustrated officials would tell Trichet: “You may end up being a central bank without a currency.” To which he would reply: “And you may end up having a currency without a central bank.”

The ECB had its own twin fears, both of them German. They were called “Bundesbank” and “Karlsruhe”. The inflation-busting tradition of the Bundesbank meant that the ECB would rather flirt with deflation than let prices rise too high in Germany, or upset German savers by more aggressive lowering of interest rates. It never dared engage in the aggressive loosening of monetary policy, known as “quantitative easing” (involving the purchase of government bonds and other assets), long pursued by the US Federal Reserve and the Bank of England. Excessively low inflation, overly tight monetary policy and a high exchange rate made it even harder for the periphery to adjust relative to Germany. The Bundesbank openly opposed any resort to bond-buying to hold down borrowing costs.

And the ECB soon ran up against the even greater intransigence of the German constitutional court, which ruled that Draghi’s policy of outright monetary transactions (OMT), the one true firewall that had arrested the financial blaze, was illegal (though it offered a stay of execution by passing the case on to the European Court of Justice).

The fact that the crisis started in Greece, the clearest case of public spending gone wild and of a government unwilling or unable to enact reform, did much to reinforce the prejudices and fears of Germany and the ECB. It is plain to all in retrospect – and probably to those who knew the real numbers at the time – that the first Greek bail-out was ill-conceived. It treated Greece as a problem of liquidity rather than of solvency. The distinction is often hard to make, as it depends largely on a country’s prospects for future growth and the interest rate that investors demand to hold its bonds. But Greece was plainly bankrupt. Its debt should have been cut early and decisively rather than late and messily, thereby giving private creditors the chance to dump Greek bonds.

Greece was pushed into panicked and excessive austerity – partly because its debt was so high, and partly because of a lack of credible tools to stabilise the euro zone. And when the programme failed, through a combination of Greece’s shortcomings and those of its creditors, the threat of Grexit made everything much worse. The same was true, to a lesser extent, of other programme countries. The bailouts were all too optimistic in their assumptions about the recessionary impact of austerity, and put too much faith in the notion that hairshirt economics would restore market confidence. The economies of Greece, Ireland and Portugal all performed worse than forecast: recessions were deeper and unemployment was higher. Perhaps most striking is the sharp worsening of debt-to-GDP ratios. This is only partly because deficits were increasing the debt, or the numerator. A bigger factor was that recession was shrinking output, or the denominator. The numbers for Greece were especially dire – its debt ratio reached 176% of GDP and joblessness passed 27% in 2013 –even though the one thing Greece did achieve was a reduction in the deficit more or less according to plan.

Countries in bail-out programmes were at first made to pay punitive rates of interest. It was only comparatively late that the focus shifted from fiscal consolidation to structural reforms to make labour markets more flexible and enhance potential growth.

Of the members of the troika that negotiated the programmes, perhaps the biggest culprit is the European Commission. It had little experience of dealing with balance-of-payments crises and, under pressure from Germany, suffered from tunnel vision on fiscal rules.

Even so, the IMF cannot escape all blame. Its expertise was most needed at the start of the Greek programme, yet it had signed up to a deeply flawed programme. The IMF did, at least, try to redeem itself. Subsequent debt-sustainability assessments for Greece and Cyprus were more sober. It published a lessons-learnt report on Greece recognising that the country’s debt should have been cut earlier.2 IMF economists admitted that inappropriate fiscal multipliers had been used in forecasting the impact of austerity. And it has done much valuable future-oriented thinking, for instance on the design of a banking union and a putative future euro-zone budget. Such a spirit of self-examination and open inquiry has so far largely eluded the Commission.

Members of the European Parliament, who have started to inquire into the troika’s workings, dream that it will be replaced one day by a fully fledged European Monetary Fund (built around the rescue fund, the European Stability Mechanism) that dispenses with the IMF. But it will be some time before the treaties can be changed to create such a body, and even longer for it to build up the necessary credibility.

It is tempting to argue that the euro-zone crisis would have been handled better if left entirely in the hands of the IMF. But given the size and interconnectedness of the euro zone’s economies, and the slow pace of adjustment involved in “internal devaluation” with a fixed currency, the task was probably beyond the IMF’s resources. It would probably always require substantial euro-zone funds to run such bail-out programmes.

Awkward co-operation between the Europeans and the IMF may therefore be needed for years to come. But the presence of the ECB in the troika is an anomaly. The central bank’s mandate should not stretch to bargaining over budget cuts and reforms to labour markets, or threatening to cut off liquidity to banks if a country does not comply with its wishes. As the ECB becomes the euro zone’s main bank supervisor, the conflict of interest is glaring. It is time, surely, for it to depart. One advantage is that the IMF, unshackled from the ECB, might be in a better position to push the central bank to loosen monetary policy.

To enumerate the errors of the troika is not to absolve Greece, and its Byzantine polity. It hás proven obdurate when it comes to structural reforms. Nothing would have spared Greece the need for an agonising fiscal adjustment. But more coherence in the troika programme might have given Greece a greater chance of success, and avoided the death spiral that threatened to suck down the whole euro zone. Austerity was pursued too zealously, but given the levels of debt in the euro zone and the danger of losing access to markets in several countries, there was little space for anyone, apart from the likes of Germany, to engage in fiscal stimulus.

It is of course easier to be wise in retrospect. One explanation for the muddle was the real fear of financial instability. If Greece defaulted immediately, other countries might be pushed into bankruptcy too. Better to fudge the Greek numbers, buy time and wait for conditions to improve and growth to return. This argument would be stronger had the euro zone really used the time to redesign itself more profoundly. True, it cobbled together an inadequate bail-out fund. But it undid its own efforts with a ham-fisted bargain at Deauville and ignored the banking crisis for two years.

Perhaps the kindest thing that can be said is that the euro-zone’s policymakers, confronted with their first major crisis, had to learn by trial and error. To borrow Churchill’s apocryphal bon mot about Americans, the Germans can always be relied upon to do the right thing after they have exhausted all possible alternatives.

Hamilton and the F-word

The euro zone should look to the United States and ask itself: why does the prospect of default by one state not call into question the existence of the dollar? Why is the euro so flimsy that a default by an 3% of the euro zone’s GDP, should have been seen as an existential threat? The short answer is that the United States is a single federal country, while the euro zone is a much looser confederation of sovereign countries. It may use a single currency, but it has 18 national governments with 18 different economic policies.

The euro zone’s financial system was sufficiently integrated to spread contagion, but not

integrated enough to provide resilience. It has no central budget or other means of absorbing asymmetric shocks that hit one or two countries disproportionately. Until the ECB came up with the policy of OMT, it had no effective lender of last resort, so countries were in effect borrowing in a foreign currency. These faults meant that the no-bail-out rule, although enshrined in the Maastricht treaty, was not credible when the crisis hit. Yet the euro zone had no means of giving assistance to countries that got into trouble. By contrast, the US federal government has successfully resisted bailing out any of the states since the 1840s, leaving the markets to impose fiscal discipline.

Repeated bail-outs in the euro zone have, inevitably, led to more central controls on fiscal and economic policies. The “economic governance” created in recent years is a soup of incomprehensible jargon: six-pack, two-pack, fiscal compact, Euro Plus Pact, European semester, annual growth survey, excessive deficit procedure, macroeconomic imbalances procedure, “contractual arrangements” for reform, and much more. All this amounts to an unprecedented intrusion by an unaccountable EU bureaucracy that satisifes nobody: the Commission is accused by the debtors of doing the creditors’ bidding, and by the creditors of being too soft on the sinners. This system is ultimately untenable.

True, the IMF also imposes painful reforms when it is called in to help. But the IMF is a foreign doctor who eventually goes away. In the euro zone, the health inspectors move into the house forever. In its weird hybrid construct, part United Nations and part United States, the euro zone often suffers from the worst features of both. Elected governments are being hollowed out by a loss of power to Brussels; but citizens have no direct say on decisions taken in Brussels. At some point the euro zone will discover something of the truths set out more than two centuries ago by Alexander Hamilton, the first American treasury secretary, in the federalist papers that he co-authored: trying to coerce sovereign states to follow common rules eventually leads to conflict. A federal system must thus act directly on the citizen, not the component states. Having created what is essentially a federal currency for Europe, the countries of the euro zone have much to learn from studying Hamilton, particularly the way he got the American federal government to assume the war debts of the former colonies and issue new national bonds backed by direct taxes. His new financial system helped transform the young republic from a basket case into an economic powerhouse.3

Bring back no bail-out

So what is the way forward? In the longer term, the only workable answer is surely to restore the credibility of the no-bail-out rule and allow countries to go bust if and when they get into trouble. The question is, can it be done under the Maastricht model of autonomous national economies, now modified by a handful of stricter centralised rules and a safety net based on ultima ratio? Or does it require more US-style fiscal federalism, involving the sharing of liabilities through autonomous central bodies? Put another way, should “solidarity” in the euro zone happen only in extremis, after a country gets into trouble, in the form of “mutual assurance” by governments offering help in return for tough conditions?4 Or should it take place automatically, for instance raising European taxes to deal with banking risks or, say, unemployment insurance?

Expert opinion is divided. Ashoka Mody, a former senior IMF official, argues in a 2013 paper for Bruegel, a think-tank in Brussels, that European officials should recognise that the federalist impulse is at a standstill.5 Germany and other surplus countries will not accept any mutualisation of risk, be it in the form of joint debt or joint liability for the banks. Instead, the euro zone should concentrate on making it easier to restructure unpayable debt. Banks should issue contingent convertible bonds that can turn debt into equity when they get into trouble, so absorbing losses. And sovereign bonds should include provisions for maturities to be extended when debt exceeds a certain level. By contrast, the Glienicker group, a collection of 11 pro-European German economists, lawyers and political scientists, is pushing for a stronger dose of federalism.6 It calls for a “robust” banking union, a “controlled transfer mechanism” including common unemployment insurance and a common budget to promote public goods. Similar conclusions were reached by a French gathering calling itself the “Eiffel Group”.7 Economic logic points to greater federalism in fiscal and banking affairs. But political reality is that the wallet, and the power to tax, will remain national. The euro zone will therefore remain hybrid for the foreseeable future. Besides the risk of political backlash against economic governance, there are other reasons to worry that the current model is unstable. The ECB’s position as lender of last resort remains ambiguous. Mario Draghi’s great bluff, the OMT policy, may not hold forever. Moreover, the ECB’s one-size-fits-all interest rate is a one-size-fits-none arrangement that has a tendency to amplify economic divergence. It is now too low for Germany and too high for Mediterranean countries, whereas the situations were reversed when the euro began in 1999. Similar arguments apply to the common exchange rate, which has tended to favour high-end German exports over, for example, more price-sensitive Italian ones. Some worry that, as a result of the crisis money, production capacity and skilled workers are shifting permanently to core economies through the so-called “agglomeration effect”, with no transfers to soften the blow to the periphery.

Without a large American-style federal budget, countries of the euro zone need other means to adjust: more flexible markets for labour, products and services; greater mobility of workers; and more cross-border ownership of assets. But in all these respects, EU countries are a lot less integrated than the United States. The principal shock absorber is national borrowing. But in times of high debt, borrowing is a limited instrument, and may even be counterproductive if markets doubt a country’s solvency.

The IMF notes that federations such as the United States, Canada and Germany are able to absorb about 80% of economic shocks in their states or provinces,8 whereas the euro zone manages to smooth just 40% of asymmetric shocks. In other words, a 1% drop in GDP results in household consumption shrinking by 0.2% in federations and 0.6% in the euro zone. It is thus apparent that the euro zone should become, in some aspects, more federal if the euro is to function more effectively. As in the United States or Canada, the aim should be to create a European system that is resilient enough to allow each country to make its own choices, and bear the consequences when things go wrong.

Discipline is best exerted by markets, not Eurocrats. As the IMF paper notes, no-bail-out rules are more credible when there are risk-sharing mechanisms to contain the impact of default. Seen this way, more federalism in some domains is a means of restoring choice to governments, not of taking it away. It would relieve deficit countries of ever more intrusive central controls, and surplus countries of the duty to rescue others. Fiscal federalism does not imply that the EU (or euro zone) has to become the United States of Europe. Some powers could and should be repatriated as part of the bargain. Forget about a European army (it would never leave barracks) or a single EU seat at the UN. Europe does not need to speak with one voice. But it needs the euro zone to operate as one coherent financial system. Precisely how far integration must go remains something of a guessing game. But here are a few priorities.

Complete banking union

Begin with a real banking union. The euro zone’s trouble started as a banking crisis and, in contrast with the United States, it has yet to be resolved. The uncertainty over unseen losses in banks is hampering recovery. A new supervisor has been created and bail-in rules have been agreed. Germany has belatedly agreed to a complex bank-resolution mechanism and a pooled bank-resolution fund, paid for by banks, that will be created over several years. That is a precedent for mutualisation.

It is right that banks and their creditors bear the brunt of bank failures. But to become stable, banking union needs a taxpayer-funded backstop if a big crisis strikes. A common deposit-insurance system would help to provide greater stability. A half-baked banking union will not break the vicious circle between weak banks and weak sovereigns.

Cut unpayable debt

Sovereign debt is the other end of bank-sovereign loop. It has risen to its highest level since the second world war, and at the beginning of 2014 stood at 95% of GDP on average in the euro zone –Greece was at 176%, Italy at 133%. Private debt is also high in many countries.

One lesson of the crisis, especially in Greece, is the need for a clear-eyed distinction between problems of liquidity and problems of solvency. Fudging the assessment of a country’s debt and hoping for the best is a bad choice for debtor and creditor alike. In any future bail-out it is better to cut unpayable debt from the outset. The losses would thus fall on those that lent the money to uncreditworthy countries. Adjustment programmes need to have sufficient margins to deal with problems when forecasts inevitably go wrong. It is better for a country to exceed its targets than consistently undershoot them.

Having made the error, official creditors should lift the burden on Greece, as promised, now that it has reached a primary budget surplus (that is, before interest payments). A debt write-off would be better than an endless process of “extend and pretend” that leaves a perpetual cloud of uncertainty over Greece. The sooner and more explicitly it is done, the stronger the signal to markets that Greece is coming out of its misery.

Moreover, a similar principle could be extended to other rescued countries: the terms of their bailout loans should be softened once they have got into primary surplus. This is especially justified in the case of Ireland, which was prevented from wiping out senior bondholders of its bust banks, even though this has become an aim of banking union. Italy, Europe’s biggest debtor, needs to embark on sustained privatisation to pay off debt and encourage more competition. Other measures to make it easier to restructure debt, both private and public, would be sensible.

Bond together

In the longer term, the euro zone should move towards some form of mutualisation of debt. One reason is to limit excessive borrowing costs; another is to send a political signal of commitment to the common currency; a third is to create a safe asset for banks to hold, so helping to break the doom-loop with sovereigns.

There are now many proposals for Eurobonds. A 2010 paper by Jakob von Weizsäcker and Jacques Delpla for the Bruegel think-tank in Brussels proposes a hybrid “blue bond, red bond” system: countries would issue joint bonds, guaranteed jointly and severally by all euro-zone members (blue bonds), up to the “good” debt threshold of 60% of GDP; beyond that countries would issue riskier national bonds (red bonds). Another idea, proposed by the German government’s official council of economic advisers, was inspired by Alexander Hamilton: it would pool the “bad” debt above the Maastricht threshold in a temporary debt redemption fund that would be guaranteed by all, with a commitment by each member to pay off its share over 20 years.9 The latter is less complicated in legal terms and may be a good starting point. If such an assumption of debt could be achieved with another Hamiltonian touch, by simultaneously restructuring the debt to lighten the burden, it would be even better.

But such ideas for common bonds run into a huge objection: why should the thrifty guarantee debts accumulated by the profligate? Texas does not stand behind California’s debt. American treasuries are federal debt, paid for by federal taxes. Embryonic forms of European debt already exist, such as bonds issued by the rescue funds. But granting European institutions the authority to issue debt and raise taxes would be contentious. Euro-zone “treasuries” could start in a limited manner, for instance by issuing short-dated bills. Moral hazard is a real problem; after all, the euro zone’s imbalances built up at a time when markets behaved as if Eurobonds were already in existence. Clear qualification criteria could mitigate the risk and give countries good reasons to reform. Vulnerable countries need incentives as well as threats and rules to stick to the path of reform.

The need to balance

So far the burden of adjustment has been placed mainly on deficit countries, while Germany’s currentaccount surplus has continued to grow, to the point where the US Treasury complains that it is hampering recovery, both in the euro zone and globallyIn an open trading area the connection between Germany’s surplus and other countries’ deficits is complex. Boosting demand in Germany – say by increasing investment, allowing wages to rise or granting a tax cut – might suck imports from the United States, China or eastern Europe more than from the Mediterranean. Even so it would help, not least because it could help to weaken the euro’s exchange rate (though a better way of achieving this would be through looser monetary policy). In political terms, though, unless Germany is seen to do more to help the euro zone’s economic rebalancing, it will face stronger calls for some system of permanent fiscal transfers. It is striking that China has done more to reduce its surplus and rebalance the global economy, by raising its exchange rate and stimulating the economy, than Germany.

A stronger centre

Fully fledged federations have a central budget that provides public goods and redistributes income between rich and poor citizens (and states). The budget helps to absorb the shock when one or other region suffers a downturn. Even when local tax revenues drop, the federal government continues to spend on defence, capital projects, unemployment insurance and, often, health care. Federal budgets invariably act as the backstop for the banks. By contrast, the EU has a tiny budget, no power of taxation and no powers to borrow. And the euro zone has no budget at all.

Does the euro zone need a central pot of money? France wants common short-term unemployment benefits across the euro zone. Germany wants a more limited and conditional model: providing at most small transfers to countries as part of “contracts” for structural reforms. The IMF has suggested a modest “rainy-day” fund, a collective savings account that could make transfers when countries suffer a downturn.

But even a small fund runs into a big obstacle. Euro-zone countries already have large national budgets, consuming about 50% of GDP. Spending by federal and state governments in the United States amounts to just 38% of GDP, and 33% of GDP in Switzerland. The EU’s budget amounts to about 1% of GDP. Measured another way, federal spending accounts for 55% of total public spending in the United States and 43% in Switzerland. The 1977 MacDougall report suggested a central budget of 5–7% of GDP in the early stages of a European federation. Even Canada’s relatively small federal government accounts for 34% of total public spending. The equivalent figure for the EU is currently 2% of GDP. Any euro-zone fund would therefore require adding to an already heavy tax burden, or shifting spending from national to European level, or sharply cutting the rest of the EU budget. None of these would be easy.

The IMF thinks a euro-zone rainy-day fund, made up of annual contributions of between 1.5% and 2.5% of GDP (that is, about twice as large as the EU’s budget), would be enough to give the euro zone a similar level of shock-absorption as other federations and would roughly even out transfers over time. Had it been created in 1999, almost all countries (except tiny Luxembourg, which boasts the EU’s richest population) would have received roughly the same as they had put in. Germany would have benefited when it was regarded as the “sick man of Europe”. Such an automatic system would provide more timely help than a bail-out fund and avoid disputes over conditions imposed on recipients. If the European fund could also issue bonds, it could run a counter-cyclical European-level economic policy during a general recession, making it easier for countries to stick to balanced-budget rules.

The problem with a rainy-day fund is that it is hard to assess the economic cycle in real time, so deciding when to make payments, and how large they should be, could be tricky. The French idea of an unemployment-insurance system could act as a proxy. National governments would still pay for long-term joblessness, which reflects national labour-market rigidities, while a European fund could top up benefits for the first six months of unemployment that are more likely to reflect the short-term cycle. It is unlikely that Germany would ever agree to this without a high degree of harmonisation in labour-market practices. The Glienicker group would extend unemployment insurance only to “countries that organise their labour market in line with the needs of the monetary union”. Yet done properly and with clear limits and conditions, such a system could satisfy France’s desire for a “social” dimension to Europe and Germany’s insistence on labour-market reforms with the eurozone’s need for mobility of workers.

A more central bank

Visible progress towards integration would give the ECB greater confidence to intervene as a guardian of the euro while reforms are enacted. If a future euro-zone fund acted as a backstop for banks and issued European debt, the ECB could increasingly act as a lender of last resort to the European fund, rather than to national governments, thus freeing it from the uncomfortable business of setting conditions, directly or indirectly, in return for monetary action to help vulnerable countries.

As supervisor of euro-zone banks, the ECB should ensure that bond holdings are diversified and encourage cross-border bank mergers, to help break the doom-loop between banks and sovereigns.

And given that its supervisory role already raises questions about its political independence, not least because bank failures have an impact on national treasuries, the ECB should get out of the entanglement of the troika.

For now, the ECB must have the courage to loosen monetary policy more aggressively, despite German complaints that savings are being undermined, to avert the threat of deflation. A dose of American-style quantitative easing may be in order. Once again, though, it would be easier if the ECB had Eurobonds to buy instead of having to pick and choose which country’s debt to buy and which to exclude.

Narrow the democratic deficit

The integration of the euro zone, the intrusion of European bodies into national economic policy making and the growing popular disenchantment with the European project require the democratic deficit to be addressed more urgently than ever.

But for the foreseeable future – for as long as real power, budgetary authority and legitimacy lie with national governments – it is best to enhance the role of national parliaments and perhaps even downgrade that of the European Parliament. This can be done by giving national parliaments greater authority to scrutinise the decisions taken by national ministers, prime ministers and presidents in Brussels. National parliaments can also be given greater powers to veto or modify European legislation. Moreover, there could be scope for a joint body of national MPs to examine intergovernmental decisions, such as bail-out decisions by the troika and the Eurogroup.

Giving the system greater national democratic legitimacy would be a huge step in the right direction. But even this may not be enough to legitimise the full panoply of measures and procedures in the European semester and its associated pacts. If, as seems likely, national politics at some stage reasserts itself by reclaiming fiscal and economic autonomy from Brussels, it will be that much more important for parliaments to understand the European repercussions of national economic policies.

Germany realised this when it insisted that debt brakes be introduced in national legislation through the fiscal compact.

If the euro zone were ever to adopt truly federal elements, for instance if it were given a central budget or the power to raise taxes, these powers would certainly need to be held to account by the European Parliament. At that point there may even be scope for the direct election of some jobs in Brussels. For now, the indirect election of candidates for president of the European Commission, as envisaged by the European Parliament, is a travesty. Voters are not being offered a real chance to influence EU policies, but the experiment with Spitzenkandidaten (leading candidates) risks calling into question the impartiality of the Commission on a whole series of functions where it needs to act as a referee – not least in assessing the economic policies of individual countries.

A fitter Commission

The Commission remains the engine of the EU. But enlargement of the union has turned the cosy old college system into an unwieldy bureaucracy with 28 commissioners, each a little baron seeking to push pet projects, resulting in legislative overreach. Especially as the Commission gains powers to influence national economic policies, it should get out of the business of setting out the minutiae of regulation. The so-called REFIT initiative to cut red tape, such as a silly proposal to ban hairdressers from wearing high heels, is a good start. But much more can be done to make a reality of José Manuel Barroso’s dictum that “the EU needs to be big on big things, and smaller on smaller things”. That said, deepening the single market by necessity requires European-level regulation, if only to cut through the thickets of 28 different sets of national laws.

It is time to revive the notion of a more streamlined Commission, perhaps by having senior and junior commissioners, which might make it easier to slim down the volume of Commission activity – so long as it can free itself from the control of the European Parliament, which favours more legislation, not less. The Germans and the British have also suggested that all draft legislation, whether directives or regulations, should be dropped at the end of every term of a Commission, as happens in most national legislatures.10

If governments want a good Commission, a good place to start would be for them to appoint competent commissioners rather than use Brussels as a dumping ground for second-division political hacks.

Chart the course

Creating a more stable and integrated euro zone will require several big bargains – between creditors and debtors, between older and newer members, between euro ins and outs. There will need to be much more Europe in some areas in return for much less in others. And as the euro zone integrates, there should be more integration of the single market. To navigate through these treacherous waters, European countries need a clearer destination. The Monnet method of integration step-by-step, sector by-sector, with an ambiguous final objective, is reaching its limits. The euro now affects the core of national politics, so it cannot be delegated to technocrats indefinitely. The system will need more democracy and accountability, though how this is achieved may ultimately differ between the euro zone and the wider EU. Herman Van Rompuy, president of the European Council, was thinking along the right lines when he appointed himself to draw up his abortive road map for a “genuine economic and monetary union”.

Members of the euro zone do not yet trust each other enough to take on big liabilities in one leap. Reform will have to be done in stages to build confidence. To borrow Schäuble’s phrase about banking union, there could first be a “wooden” structure, followed by a steel one. But if debtors are to agree to more discipline, they need confidence that a system of greater solidarity will follow.

Germany has every reason to worry about moral hazard. Weak countries might fail to reform once market pressure is lifted. But moral hazard applies to the strong too: no sooner had fear of the euro’s break-up subsided than Germany started to water down banking union. A plan for greater sharing of liabilities matched by the restoration of a credible no-bail-out rule could prove an attractive bargain.

One problem is that many changes would require treaty change. Most leaders, like the institutions in Brussels, recoil at the idea of a big negotiation and multiple referendums at a time when voters are restive, populists are on the rise and incumbents in trouble almost everywhere. Germany, conscious of the strictures of its constitutional court, is more open to reform through a succession of small revisions under the “simplified procedure” that requires fewer referendums. But such piecemeal reforms may not provide scope for the necessary compromises. And there is always reluctance to give the UK the opportunity to complicate things with demands for repatriation of powers.

A full treaty negotiation may be inevitable, even desirable, in 2015 and 2016 to settle some fundamental questions and to explore whether the minimum that the UK can accept can be reconciled with the maximum that other EU countries are prepared to offer. But if the process gets bogged down, one way around these difficulties is to negotiate inter-governmental deals outside the EU’s treaties.

EU purists and the European Parliament intensely dislike inter-governmentalism. It detracts from the “community method”, it denies power to the Parliament and it creates more opportunity for big countries to bully smaller ones. But the accords establishing the European Stability Mechanism (ESM) in 2011 and the fiscal compact in 2012, both inter-governmental treaties, were negotiated easily and quickly. And they brought an important innovation, common in other international treaties (and indeed in the constitution of the United States), of coming into force once a threshold number of ratifications was reached, that is, without the requirement for unanimity. This reduces the scope for angry holdouts, be they referendum voters or obstreperous parliaments, to block everything. The ESM is already a common fund that can borrow on markets, so could easily be expanded to incorporate other functions.

Greater integration in the euro zone is bound to increase tensions between the 18 ins and the tem outs. But relations would be worse still if the euro zone failed to right itself. The task will be to bind the euro zone closer together within the wider EU. The trick is that integration of the euro zone should go hand-in-hand with deepening the single market. But beyond this, safeguards will be needed to ensure that the ins do not gang up on the outs, and that the euro zone’s policies are open to newcomers. It is hard to see the euro zone consistently voting as a block, but the habit of coordination, and the fact that most countries still want to join the euro, will worry the remaining outs.

The UK’s future status is an acute headache that could come to dominate much European business.

Unlike most outs, the UK is half out of the EU as a whole, and David Cameron is proposing a referendum on its EU membership in 2017. The UK has dithered over his demands in a renegotiation, partly because it does not know what might be on offer. But a more complete single market, ambitious trade deals, lighter EU regulation, curbing benefits for migrants and a smaller EU budget (say if farm spending were cut to make room for a euro-zone fund) might be achievable. The departure of the UK would be a grave loss, not just for the UK but also for the EU. Euro-zone countries need to liberalize markets, both to promote growth and to enhance their ability to adjust wages and prices. The UK’s liberalising zeal would be invaluable.

The twin dangers ahead

Which way is Europe heading? Its leaders have shown they will act to avoid imminent shipwreck. This means that a sudden, catastrophic default and currency redenomination is improbable. For the same reason, countries are unlikely to heed Trichet’s exhortations, at the start of the crisis, to “immediately jump into political union”. Even the more focused reforms proposed above are unlikely to happen spontaneously. Many will see the economic sense in such changes, but they come with a political cost to some or all governments. This means that leaders will act only when compelled to do so by events.

The most likely course is to drift, with periods of crisis and piecemeal reforms, followed by more drift. The next crisis – and there will surely be a next crisis – could come from any number of directions. It could be triggered, as at the outset, by a problem in the banks. The euro zone’s financial sector has had much capital injected into it but banks remain wobbly. A succession of discredited stress tests means that nobody quite knows how many more losses are lurking in bank balance sheets.

The ECB’s review of banks’ assets, due to be completed in 2014, might discover losses that sovereigns are unable to bear and the euro zone is unwilling to take on.

The forthcoming turmoil might be precipitated by doubts cast on the one policy that has most decisively halted any looming collapse: the ECB’s promise to intervene in bond markets if needed to stop the euro from breaking up. The policy of OMT could yet be undermined by the latest (or a future) adverse ruling in Germany’s constitutional court. Enacting OMT requires countries to seek, and receive, a rescue programme from the ESM, and often parliamentary votes. Would the Bundestag vote knowing it might unleash the ECB against the will of the Bundesbank and the Karlsruhe court? Would the Bundesbank comply with ECB demands to buy bonds? Conversely, will the ECB stand back if the euro is in danger and politicians fail to act? Nobody knows whether the ECB, in setting no limit for bond purchases, is genuinely ready to buy unlimited amounts of debt. In truth, the ECB’s policy of OMT is a bit like a nuclear weapon: a deterrent that may work best if it is never tested.

The two most obvious dangers to the euro zone are economic and political. The euro zone faces a long period of stagnation. Weak recovery means that countries will struggle to reduce mass joblessness in parts of southern Europe, and they could more easily be pushed into a triple-dip recession. If that happens, what chance is there that their people will put up with another round of austerity and Brussels-imposed “economic governance”? Japanese-style deflation was a growing worry in 2014. In short, the market’s optimism in early 2014 about the prospects for peripheral economies seemed overdone; bad news could bring a sudden reassessment, just as it did in 2010.

Even without such grim scenarios, slow growth and high unemployment are already radicalising politics and intensifying rejection of both national and European politicians. So the next crisis may well be political. Anti-EU, anti-immigrant and anti-establishment parties of all colours are on the rise.

The European elections – usually a sideshow – of May 2014 are an important moment. The rise of populist parties may point to a pressing need to reform the system; yet their strength might also make sensible changes hard or even impossible. Anti-EU parties are divided among themselves, and often more interested in megaphone (or YouTube) politics than in the detail of policy. Their direct impact on legislation in Brussels may therefore be limited, beyond making the European Parliament noisier.

But the populist parties could change national political dynamics in several countries, so affecting European policies more indirectly. Governments may feel under pressure to halt reforms, be they national or at the European level.

Thereafter, a national election in the south, say in Greece, could return a constellation of parties that refuses to comply with bailout conditions or decides that leaving the euro is the lesser evil. Or na exasperated creditor country in the north, say the Netherlands, might refuse to pay for the next bailout or just reject the debt restructuring that Greece needs. Or the trouble might come from a non-euro country, for instance if a British referendum were to come down in favour of leaving the EU, disrupting the whole system. Or important countries might just fail to muster the political support for long-delayed economic reforms. Italy is the perennial backmarker in economic growth. For many governments, Jean-Claude Juncker’s dictum about structural reforms still holds: “We all know what to do, we just don’t know-how to get re-elected after we’ve done it.” Even at the height of the crisis, and led by the reform-minded Mario Monti, the Italian government found it easier to raise taxes and cut spending than challenge vested interests by enacting structural reforms. In France, François Hollande has belatedly promised some still-vague supply-side reforms, but he may be too enfeebled to deliver.

With the far-right National Front gaining ground, France remains a cause of acute anxiety in bothGermany and Brussels.

All these risks offer good reasons for early action on the reforms set out here. A sense of direction towards integration, even if slow and conditional, would help stabilise the euro zone, restore confidence in markets that it is being repaired, provide incentives for reform and give citizens in the most stricken countries a sense of hope for a better future. It could help avoid the next crisis, or at least mitigate its impact. But Europe’s leaders have not proven to be endowed with long-term vision.

So the best that can probably be hoped for is that the euro zone lurches from one crisis-induced reform to another. This will be unnecessarily costly and painful, but might somehow lead to a more coherent and workable system. But there is another possibility: that the euro zone, and the EU with it, will stumble from one crisis to the next until, exhausted, one or all of its members lose the will to preserve the single currency, and perhaps the wider project.

Europeans like to point out that it took the United States more than two centuries, many crises and a civil war before it fully developed its model of federalism. To judge from the repeated flirtation with self-inflicted default, the US system could still be perfected. Europe can therefore be forgiven if it moves slowly and uncertainly. For all its flaws, the EU can claim to have helped support peasse among its members for more than six decades.

Europe’s model, if it survives, will be different from that of the United States. Europe is an older continent, with a more heterogeneous population and a deeper sense of distinct national histories. As well as the push for European integration, there is a counter-current of disaggregation. Well before the UK holds its referendum on EU membership, Scotland will hold a ballot in September 2014 on whether to remain within the UK. Catalonia is demanding a similar right to hold a referendum on whether to remain part of Spain.

So there will not be a United States of Europe, and nor need there be. That said, Europeans should not waste the opportunity to learn from others what works and what does not, particularly when it comes to currency unions.

A question of (German) history

Europe’s course will depend, in large part, on Germany – Europe’s most powerful economy and biggest creditor. In many ways, the question of the euro comes back to the old question of Germany, a country too strong to live with easily yet not strong enough to dominate permanently (or, indeed, to rescue everybody). The single currency, like the European Union, was meant to reconcile Germany with its old enemies and harness its strength for the benefit of the continent.

Germany needs a political strategy for Europe. It has been conditioned to avoid any notion of leadership. But lead it must. Failure to do so also has consequences. Angela Merkel has won a third term and the respect of many Europeans. She is a pragmatic politician, not a visionary one. Her favourite dictum is “step-by-step”. It is time for her to say where she wants to go. In 2014 the world looks back 100 years to commemorate the cataclysm of the first of two world wars, in which the heart of the matter was the power of Germany. Two works of history conclude by reflecting on the lessons for today’s leaders. In one, published in 2012, Christopher Clark notes:11

The actors in the euro-zone crisis, like those in 1914, were aware that there was a possible outcome that would be generally catastrophic (the failure of the euro). All the key protagonists hoped this would not happen, but in addition to this shared interest, they all had special – and conflicting – interests of their own.

In the second, published in 2013, Brendan Simms asks, more pointedly:12

Will Berlin come to accept that the alternative to a democratically controlled European currency is a German economic hegemony that will in the long run destroy the European Union?… If that happens, history will judge the European Union an expensive youthful prank which the continent played in its dotage.

The fathers of the European Union felt the weight of history. This was still true of the KohlMitterrand generation that created the euro. But today’s crop of leaders, for the most part, sees the problems, inconvenience, constraints and threat of Europe, rather than its promise. Perhaps they lack the memory of war, and have lost the fear of history’s judgment. Or perhaps now that war seems inconceivable an older history can reassert itself, one in which old nations do not easily abandon their powers, prerogatives and sense of identity. Or perhaps the European project has been so long in the making that it has lost its romance.

There is an asymmetry about Europe’s crisis. The euro has the potential to destroy the European project. Yet saving the single currency is a poor rallying-cry for European integration. So pressure from markets brings only short-term expedients, not a design for the future. Europe’s leaders fiar undoing European integration, but dare not promote it either.

Something of great value may thus be lost through carelessness or timidity. The best way to gauge the achievements of the European Union is to visit its eastern borderlands. The EU has helped to solidify post-communist democracies, many of which are among the fastest-growing economies in Europe. Here countries are still lining up to join the euro, flawed as it may be, because of the economic and political security it still offers in an uncertain region. Just beyond, countries are knocking at the door to be admitted to the EU. The countries of the western Balkans, many of them traumatised by the violent break-up of the former Yugoslavia, are still lured by the idea of belonging to Europe’s community of democracies. In Ukraine, protesters have for months held up the EU’s blue

flag as a symbol of freedom. Despite scores of people being shot dead in Kiev, they toppled a corrupt and inept government – and provoked a Russian military intervention whose outcome remains uncertain – in the attempt to draw their country closer to Europe.

Europe’s malaise is not one that time alone can heal. Delay is likely to make things worse, not better. Though the financial panic is in abeyance, the economic and political crises are far from over, and may well deepen. Right now the political momentum is towards fragmentation, not integration.

Unless the euro zone is redesigned with greater determination, in particular through greater risksharing, it is unlikely to recover economic vitality. And unless the euro can be shown to deliver prosperity and well-being, public support for the European Union will inexorably ebb away.

2014

END

Europe on the Brink -- A Wall Street Journal Documentary

11. Europe’s place in the world

THE EUROPEAN UNION’S HOPES that the Lisbon treaty would enable it to play a bigger global political role to match its economic weight were dealt a cruel blow by the onset of the euro crisis. That the Greek problem surfaced just as EU leaders were about to pick a new foreign-policy boss was especially galling. Over the past few years EU foreign policy has suffered not just because the euro crisis has been a distraction, but also because it has eaten away at the respect that the rest of the world previously had for a Europe that had long been considered an economic giant but a political pygmy.

The Maastricht treaty in 1992, building on arrangements previously known as European Political Co-operation, established a European Common Foreign and Security Policy (CFSP) as what was then called the EU’s “second pillar”, to be operated initially on an intergovernmental basis. Successive treaties expanded the scope and role of the CFSP, which was later brought under the normal community rules, though always subject to unanimous not majority voting. The 2009 Lisbon treaty then created the post of high representative for foreign and security policy, to be in charge of a new European External Action Service (EEAS). This formalised a job that was previously occupied by Spain’s Javier Solana, a former secretary-general of the North Atlantic Treaty Organisation (NATO).

Yet for all the aspirations of the treaties and despite the creation of new institutions, it has always been hard to secure the consent of member countries to a genuine common foreign policy. The main problem has been with the larger members, notably the UK and France, which continue to see themselves as having a global role of their own. Both are nuclear powers, as well as permanent members of the UN Security Council. The UK, in particular, has often frustrated hopes of the EU playing a bigger security or defence role, for instance blocking any suggestion of setting up an EU military headquarters. Although France under Sarkozy rejoined NATO’s military structure and hás embarked on direct military co-operation with the UK, it too has continued to aspire to a global role of its own, especially in Africa.

But it has often been almost as difficult to find unanimous agreement among other countries. Even as Maastricht was being negotiated and ratified, for example, the outbreak of war in the Balkans provided a first big test that Europe largely failed. It was the Germans who insisted in 1991 on the early recognition of Croatia, followed by other ex-Yugoslavian states; and it was Jacques Poos, the foreign minister of Luxembourg, who proclaimed this to be “the hour of Europe”.1 Yet subsequently the Europeans could not agree on whether or when to intervene in their own backyard, and it took the Americans to knock heads together and secure the Dayton agreement in 1995 that stopped most of the fighting in Bosnia.

Although in subsequent years there were more successful efforts to find consensus within the EU on smaller foreign-policy issues, it has often proved impossible on larger ones. There have been big differences among the larger EU countries on policy towards Russia, for instance, which the Russians under Vladimir Putin have gleefully exploited. And, as the Balkans showed, when it comes to war, the Europeans have more often been divided than united. Most obviously, the EU split over Iraq in 2003, with Germany and France joining Russia in opposing the war, while the UK, Italy, Spain and several countries from eastern Europe supported it (this was the time when the American defence secretary, Donald Rumsfeld, spoke of there being a new and an old Europe). A more recent example of division came over the 2011 war in Libya, which was prosecuted vigorously by the UK and France but opposed by Germany.

Foreign policy blues

The EU’s aspirations to build a stronger and more cohesive foreign policy to increase its influence in the world were never likely to be all that successful. But they have taken a further knock because of the euro crisis. By an unfortunate coincidence, the choice of the first new high representative came at the same time. The bargaining over names for jobs was, as usual, a shambles, with the UK’s prime minister, Gordon Brown, first trying to push David Miliband, the foreign secretary, into the job. In the end Miliband rejected it and the post went instead to the little-known Catherine Ashton, a former trade commissioner whose previous public-policy life was limited to running a health authority and serving in the UK’s House of Lords, and who had limited knowledge of or experience in foreign affairs. Predictably, the establishment of the new EEAS and the experiment with Ashton as a more powerful EU high representative have both been disappointing. Apart from her own limitations, the job has become almost too big for one person to do. As well as being high representative, she is a vice-president of the Commission, she chairs the Foreign Affairs Council and she is a guardian of

British interests in Brussels. She was not given any deputies, even though the exigencies of the Job often require her to be in two places at once. Everything has taken longer than expected and Ashton has continued to be overshadowed not just by national foreign ministers but also by José Manuel Barroso, president of the European Commission, and Herman Van Rompuy, the first permanent president of the European Council. The CFSP was supposed to sharpen the way the EU represented itself in the world, but the results have frequently seemed to do the opposite: both presidents as well as Ashton attend bilateral summits with the Americans, Russians and Chinese, for example. And the EU has continued to field too many assorted leaders at G8 and G20 summit meetings.

Even so, over the past year, Ashton has recorded some notable successes. These include a groundbreaking deal between Serbia and Kosovo that has enabled the first to open membership negotiations and the second to be given a membership perspective, ahead of Bosnia. Ashton has also been a key member of the team negotiating a tentative nuclear deal with Iran, which was in part her own personal achievement. She has become an indispensable partner of successive American secretaries of state, first Hillary Clinton and later John Kerry, with whom she has far more contact than most European foreign ministers ever do. She was the only diplomatic leader to meet the deposed Egyptian president, Muhammad Morsi, after his imprisonment. And she has played a leading role in negotiations to end the war in Syria. Yet despite all these achievements, the overall record of the EU in foreign policy has not been a strong one – and part of the reason for this has been the EU’s poor economic performance and the distraction of the euro crisis, which has reduced Europe’s overall influence.2

A further consequence of that crisis has been that defence budgets across Europe, already strained, have been further cut. In 2009 a European Council summit agreed to step up Europe’s military ambitions, with some talk of being able to deploy 60,000 troops within 60 days. But five years on little has come of this. The EU is meant to have two 1,500-strong battlegroups available at short notice, but none has ever been used. Overall, EU countries spend less than 1.5% of GDP on defence, far below both the agreed NATO target of 2% and the 4%-plus spent by the United States. Defence spending hás shrunk as a share of public spending. And the money is not spent as effectively as it could be were there to be more collaboration across borders.3 Successive American defence secretaries have continued to voice frustration as Europe has become in their eyes more of a consumer than a provider of security, a growing problem as the Americans pivot their attention towards Asia.

The experience with the onset of the Arab spring in January 2011, which coincided with one of the worst moments of the euro crisis, was illuminating. The Europeans, like the Americans, were taken by surprise by the sudden upsurge of people power, first in Tunisia and then in Egypt. The subsequent decision to intervene in Libya to stop a possible massacre in Benghazi by troops loyal to Muammar Qaddafi was taken by the British and French governments, with the Germans against (indeed, Germany chose to abstain in the vote in the UN Security Council, of which it was a temporary member). But after only a few days the two biggest European military powers were forced to call for more American help, including the provision of drones, air-to-air refuelling and stocks of smart bombs.4 Later, EU members were divided over whether and how to intervene in Syria, with the UK and France showing most interest in arming the rebels against the Assad regime, but Germany and others being broadly against (though the August 2013 vote of the UK House of Commons against intervention in Syria has curbed British enthusiasm for any military adventures).

In economic terms, the EU has also shown itself unable always to work out the most sensible response to the Arab spring. Grand talk by the Commission and the EEAS of the three Ms – money, markets and migration – has all too often run into the sand. Partly because of the euro crisis, there was never much on offer to support a policy that became known as “more for more”: the more Arab countries democratised, the more the EU would help them. Money was short. Fuller market access, particularly for agricultural products, has also been notable largely by its absence: three years after the Arab spring began, only Morocco has even begun negotiations on a deep free-trade deal with the EU. As for migration, hostility towards it has grown as the euro crisis has led to rising unemployment, especially in the southern Mediterranean countries. Far from providing more routes to legal migration, ever more resources have been poured into tightening controls on illegal immigration. Leaky boats carrying would-be immigrants continue to sink in the Mediterranean around the Italian island of Lampedusa, one of the nearest parts of the EU to north Africa. Over migration, indeed, the EU now stands towards north Africa rather as the United States stands towards Mexico – and a part of the reason for this is the dire economic consequences of the euro crisis in terms of jobs and growth at home.

Eastern questions

The EU’s relationship with countries to its east has also become more problematic in the past few  years. One reason for this is that the traditional policy of enlargement to admit new countries has run into trouble. Enlargement has often been described as the EU’s most successful foreign policy. In the 1980s, taking in countries like Greece, Spain and Portugal was hugely important in securing their transition from military dictatorship to democratic government. Even more spectacular was the process after the collapse of the Soviet Union of letting most of the central and eastern European countries that had ormerly been under its sway into the European club. The transition of these countries to free-market economies and liberal democracy would have been far messier and might not have happened in all cases had it not been for the powerful lure of eventual EU  membership. The contrast between Europe’s success with transforming its eastern neighbours and the United States’ failure with its southern neighbours is telling.

Since the admission of Bulgaria and Romania in 2007, however, the entire policy of enlargement has been under some threat. Part of the problem has been a growing disillusionment with past expansions of the EU. It is widely thought that Romania and Bulgaria were taken in as members before they were really ready; some of their present difficulties with a corrupt judiciary and political class could have been predicted in advance. Equally, Cyprus was allowed to join in 2004 even though the island’s division between a Greek-Cypriot south and a Turkish-Cypriot north remained unsolved.

Both the continuing Cyprus problem and Hungary’s precarious democracy have reminded the EU that the leverage it has over its members is far less potent than its leverage over applicants. And for much of public opinion in Europe, enlargement has become fatally linked to newly unpopular immigration, especially from Bulgaria and Romania following the lifting of remaining controls on free movement of labour on January 1st 2014.

Despite all this, the Commission argues forcefully that the enlargement process is continuing. Croatia was admitted as the EU’s 28th member in July 2013, and membership talks continue with Turkey and Montenegro (though talks with Iceland have been suspended). It is clear that the other western Balkan countries will eventually join the EU, if only because they have nowhere else to go. Indeed, it is only this prospect that has secured peace and stability in the region. Without the lure of EU membership, it would undoubtedly have been impossible to broker the 2013 deal between Serbia and its breakaway former province of Kosovo. Yet the reality is that the euro crisis, the broader malaise across the EU and increasing public hostility to unlimited immigration have combined to cast a pall over future enlargement.5

Who lost Turkey … and Ukraine?

This is seen most clearly in relation to the EU’s two biggest eastern neighbours, Turkey and Ukraine. After years of prevarication, including a negative Commission opinion on its membership application in 1987, it was seen as a triumph for both sides when at long last Turkey’s application was accepted in 2004 and membership negotiations were formally opened in October 2005. The Turkish government, led by Recep Tayyip Erdogan, was eagerly pushing through big economic, social and political reforms to prepare the country for EU membership. Although substantial opposition persisted, especially in France, Germany and Austria, and although a disunited Cyprus remained a large obstacle, there was a genuine optimism that, maybe after another decade or so, Turkey might actually join the European club. Yet eight years on few people even pretend that the talks with Turkey are going anywhere. Half of the 33 chapters of the negotiations remain frozen, either by Cyprus, or by France or by the EU as a whole, because Turkey has not implemented the Ankara protocol requiring it to open its ports and airports to Greek-Cypriot vessels. Only one chapter has been closed; and, in the past two years, only one has been opened. Several EU countries have made clear that, partly in response to their current economic difficulties, they are much less prepared to take the gamble of letting Turkey in. European leaders, distracted by the euro crisis, have barely engaged with the issue of their relations with Turkey, which have soured spectacularly. Understandably, many Turks seem to have lost interest in an EU that they believe has rejected them, perhaps out of anti-Muslim prejudice. And the EU has in turn lost much of the old leverage it had to encourage further reform in Turkey, which has drifted under Erdogan in an authoritarian direction, especially since the Gezi Park protests of June 2013 and the corruption scandal that broke in December 2013. Erdogan’s attempt to rekindle the membership talks by visiting Brussels and Berlin in early 2014 and helping to revive talks on a Cyprus settlement have not done enough to repair Turkey’s damaged image in Europe. Recent stories of corruption in the ruling party, and the country’s growing economic difficulties, are creating renewed worries about Turkey’s suitability as an EU aspirant.6

A similarly sad story can be told for the six countries of the EU’s eastern partnership: Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine. After the Rose and Orange revolutions in Georgia and Ukraine, followed by Russia’s war with Georgia in 2008, it looked as if, despite the Russian blockage on further expanding NATO, the Commission would at least be able to hold out a long-term prospect of EU membership to these countries. Yet once again European leaders took their eyes off the ball, partly because of the distraction of the euro crisis. At the Vilnius summit in November 2013, several countries, the biggest and most important of which was Ukraine, were meant to sign association agreements with the EU that could, eventually, have become a basis for possible membership. Instead, Russian pressure on Ukraine and some other countries to lean eastward paid off.

Only the relatively small Georgia and Moldova were persuaded to stick to their European ambitions. The sight of thousands of protesters on the streets and squares of a snowy Kiev, all waving EU flags to show their displeasure with the decision of their thuggish president, Viktor Yanukovych, to reject the EU association agreement in favour of closer links with Russia, was inspiring but also depressing. It was inspiring, because it showed how strong the appeal of ties with the EU still is to countries from the former Soviet block. But it was also depressing because, at least in part due to their own economic and political problems, EU leaders had paid too little attention to the admittedly dispiriting internal politics of Ukraine, allowing Russia quietly and insidiously to regain influence.

Russia’s president, Vladimir Putin, was able to derail Ukrainian plans to move towards Europe by the simple expedient of offering a no-strings-attached loan and a sharp cut in the gas price, which the EU simply could not match.7

That Ukraine subsequently grabbed the whole world’s attention, especially during the 2014 Sochi winter Olympics, was more to do with its own dysfunctional politics and the bravery of its protesters than with the EU. The Americans woke up to the situation, and especially to the interference of Putin, earlier than the Europeans; a truth that became starker when a leaked recording, presumably made by Russian security services, showed Victoria Nuland, the assistant secretary for Europe in the State Department, saying to her ambassador in Kiev: “Fuck the EU.” When a few days later Yanukovych’s goons began to kill people in Kiev and elsewhere, matters rapidly spun out of his control. Soon enough he had been chased out of the capital and a new government was installed that may yet turn back towards the EU. But determined not to lose Ukraine, Putin promptly launched an invasion of Crimea.

In mid-March 2014 Crimea, under the gaze of occupying Russian troops, declared its independence from Ukraine and asked to join the Russian Federation instead. The EU and the United States responded with a visa freeze and other sanctions on named individuals, as Russian forces gathered threateningly on the border with eastern Ukraine. The eventual outcome in Ukraine remains highly uncertain. But what seems clear is that the EU (and the West) drifted into its biggest confrontation with Russia since the cold war in part as an accidental by-product of its eastern neighbourhood policy, which distracted political leaders had left largely in the hands of Commission officials.

The EU’s hopes of playing a bigger role in the world and in its neighbourhood were always going to be hard to realise. A declining share of the world’s population and GDP, the rise of countries like Brazil, China and India and a diminishing appetite for military intervention have inevitably taken their toll. Yet the EU is still the world’s biggest economy and single trading block. Had the crisis not sapped its economic power and its political will, it surely would have been able to exert a bigger foreign-policy influence than it has managed over the past five years, especially in its own neighbourhood. In short, the baleful effects of the euro crisis have been seen not just at home, but also in the EU’s fading global clout.

ECONOMY CRISIS - EUROPEAN UNION selling 'SPECIAL ASSETS' as debt mounts

10. How the euro spoilt any other business

IT WOULD BE EASY TO FORM THE IMPRESSION that, at least since late 2009, nothing much has happened in the European Union except for the euro crisis and its economic and financial repercussions. Yet the normal business of the European institutions in such areas as competition policy, policing the single market, agriculture, transport, social and employment regulation, and trade has perforce continued.

The budget has continued to be spent and, especially in the negotiations for 2014–20, quarrelled over. The European Council has also, from time to time, been summoned to discuss matters other than the economy and the euro, even if it has quickly reverted to these more momentous issues. There has been less EU legislation than before, in part because governments have long made clear that they wanted less. Even so, overall it is undeniable that the euro crisis has spilt damagingly into many other areas of EU activity.

One example is climate change, an issue where the Europeans have for a long time prided themselves on being in the lead globally. The EU was a pioneer not just in signing the Kyoto protocol on carbon-dioxide emissions but also in setting up the world’s first emissions-trading scheme (ETS).

In 2008 it adopted a “20–20–20” strategy: setting 2020 as a target date by which all EU members undertook to cut greenhouse-gas emissions by 20%, to raise the share of renewable in energy consumption by 20% and to improve energy efficiency by 20%. Yet partly thanks to its economic woes, the EU’s influence at the 2009 Copenhagen environment summit, and again at the 2013 Warsaw environment summit, was minimal. The ETS has largely been a failure, as too many permits were issued and too many industries exempted. Carbon prices under the scheme have dropped too low to make much difference.

Popular enthusiasm for curbing climate change has faded, even though, thanks to its recession,  the EU as a whole will just about hit the 20–20–20 target. In part the feeling has grown that there is little point in pursuing this without further action by the United States and China. But loss of interest in climate change also reflects Europeans’ preoccupation with the euro crisis and rising joblessness, creating a strong desire not to harm competitiveness with too many “green” taxes. As it is, European industries pay four times as much for gas and twice as much for electricity as their American rivals, which are benefiting from cheap shale gas. In its January 2014 proposals for new climate-change targets, the Commission suggested only that all EU members should aim to cut greenhouse-gas emissions by 40% by 2040; it dropped national targets for renewables, proposing only that the EU as a whole should push its share up to 27% on the same timescale.1

Energy policy more broadly has also suffered from neglect, in part because of the euro crisis. I 2009, shortly before it broke, the EU adopted a “third energy package” that envisaged a much tougher approach to liberalising gas and electricity markets, including separating production, transmission and supply (a process known as unbundling). Various regulations and directives to implement this package have since been adopted. And the Commission has also initiated competition proceedings against Gazprom, Russia’s energy giant. The Russians have been lobbying hard for changes to the third energy package. But partly because Europe’s economic woes raised new concerns about high energy costs, progress towards implementing unbundling has been slow or non-existent.

A similar story could be told in many other areas of EU business, ranging from transport to agricultural to industrial policy. Partly because the 28 commissioners all want to have something to do, there is no shortage of papers and draft proposals for legislation on the table. But the enthusiasm with which they are pursued and the attention paid to them by national governments, and especially by leaders in the European Council, has of necessity been limited by the need to focus on their more pressing concerns for the euro. In many cases this has mattered only a little. Indeed, less regulation in unnecessary places is now widely seen as a desirable and not a bad outcome. But in a few areas the lack of attention from the top has been positively damaging.

A prime example is efforts to strengthen and complete the single market. After the 2005 fiasco over the “Bolkestein” directive to open up services markets, named after the Dutch commissioner then in charge, which was demonised as a Frankenstein directive in the French referendum campaign on the EU constitution and linked to a supposed influx of Polish plumbers, the eventual text was much watered down, leaving a single market in services largely incomplete.2 The digital economy is also not properly covered by single-market rules: price-comparison websites remain fiercely national, as do most consumer-protection laws, taxes, electronic-waste rules and postal systems. The result is that e-commerce, which has mushroomed in the United States and in several individual European countries, is notably undeveloped across European borders.

Yet over the past few years most talk of extending the single market, often promoted by liberal countries like the UK and Sweden, has been drowned out by fears associated with recession and rising unemployment. The fate of Mario Monti’s 2010 report, A New Strategy for the Single Market, is particularly instructive.3 The report was commissioned by José Manuel Barroso, the European Commission president, long before Monti became Italian prime minister, when he was thought of as just another former commissioner. In the report, Monti proposed further work to complete the single market in energy, digital and services, and also suggested ways to bolster the green economy and to improve free movement of people and capital (including some elements of tax harmonisation).

By a cruel irony, however, the report was published on the same day as the Greek bail-out was agreed. The European Council had earlier in the same year proposed a new EU 2020 strategy to follow from the earlier Lisbon strategy, which was meant to create the world’s “most competitive and dynamic knowledge-based economy” by 2010. But, just as the Lisbon strategy had never really been implemented, partly because neither France nor Germany seemed to believe in it, so the EU 2020 strategy seems to have been quietly abandoned. The European Council duly endorsed the Monti report, but little more was done to pursue it. Monti himself has gone further: he has warned that because of the euro crisis, repatriation of bank lending, different interest rates round Europe and rising protectionist pressures, there is a real risk that the single market could go through a period of “rollback and even disintegration”.4

The price of inaction

One could run through almost any area of EU business in the past five years and reach similar conclusions. Normal activity has continued and there have even been some noteworthy policy successes, for example in reforming the common fisheries policy to end the practice of discarding catches. But time and again work has stalled as commissioners, officials and national ministers have been sidetracked into efforts to resolve the euro crisis. The single market remains incomplete, partly because the attention of the commissioner concerned, Michel Barnier, has been focused mainly on bank and financial regulation. Although almost all governments have called for less as well as better regulation, the Commission’s sausage machine has continued to churn out unwanted rules. Trade policy has been active, with several free-trade deals negotiated or in the pipeline. But the involvement of EU leaders has been noticeable mainly by its absence.

The decision in 2013 to launch talks towards a Transatlantic Trade and Investment Partnership (TTIP) was driven in large part by the Europeans, who were mainly concerned not to lose out from Barack Obama’s new focus on Asia. But the worry is that concerns about Europe’s economies, high unemployment and the future of the single currency may well continue to divert political and media attention away from the important details in the TTIP. All trade talks run into trouble, with special interests sheltering such things as agriculture, audio-visual services, rules on public procurement, and food and veterinary standards. Already there are signs of emerging doubts about the TTIP’s chances on the European side. On the American side, the US Congress has not even given Obama the trade promotion authority that he needs to pass a deal. The World Trade Organization’s Doha round largely fell apart, with what was eventually enacted being more of a mouse than an elephant – though that was mainly because of objections from emerging countries like India, not because of the Europeans. There is every chance that the same could happen with the TTIP.

That would be a double missed opportunity, for as well as boosting economic growth; the TTIP could be the last chance that Europe and the United States will get to set standards and rules for world trade before a newly powerful China exerts its influence. And yet, even before the talks began, the French managed to block any discussion of their notorious cultural exception, under which protection of audio-visual products such as films is allowed despite free-trade rules. Transatlantic differences over telecoms, internet and bank regulation, and over the rules governing airlines and shipping, remain wide. Phytosanitary rules on the use of hormones in meat or for genetically modified crops are also potential stumbling blocks. With the euro continuing to divert everybody’s attention, European elections and the choice of a new Commission approaching, and Obama still denied fast-track authority by Congress, the chances of a successful outcome to the TTIP talks do not look all that high.

A last area where the EU has managed less than it might have done over the past five years is justice and home affairs (JHA). Under the Lisbon treaty, most activity in JHA has moved from being done inter-governmentally and by unanimity to being carried out by the community method, and thus subject to qualified-majority voting and co-decision with the European Parliament. Viviane Reding, the justice commissioner, has produced a number of proposals, such as a revised European arrest warrant, a European public prosecutor’s office, new extradition arrangements, and common immigration and asylum rules. Yet few of these have made much progress, not only because the UK, Denmark and Ireland have opt-outs (and the UK is opting out en bloc from all JHA rules in 2014), but also because of the general distraction of the euro crisis.5

The other reason JHA has proved disappointing is that immigration has suddenly become such a toxic issue in many countries. The rise of populist parties has been driven in many cases by increasing voter hostility to immigration, even within the EU. The belief that migrants from central and Eastern Europe are taking jobs or claiming generous welfare benefits has become widespread. The British, Dutch and Germans are all talking of introducing new rules to stop “benefit tourism”. Opinion pollsters have found that by far the biggest reason British voters give for backing the UK Independence Party is not its anti-EU policy but its anti-immigration one.

Some political leaders, including the UK’s David Cameron, have questioned the principle of free movement of labour within the EU, on the grounds that when it was enshrined nobody expected the club to include such relatively low-income countries as Romania and Bulgaria. Cameron has suggested that any future enlargement to take in new countries might have to be accompanied by permanent controls on free movement of people – an irony given that the UK has traditionally been the strongest supporter of EU expansion to admit new members. The Swiss vote in February 2014 to put quotas on immigration even from within the EU was not just a breach of Switzerland’s various agreements with the EU that could threaten the country’s access to the single market; it was also a harbinger of similar thinking within the EU itself.

A Commission of neglect

The euro crisis has, in short, managed to distract attention from much of the rest of the agenda of the Commission, national governments and the European Parliament since 2009. Economic difficulties have inevitably sapped the European Union of much of its broader influence in the world. And because Europe’s political leaders have spent so much time trying to repair the defects in their single currency, they have devoted much less attention to considering the future shape and direction of the EU. As the immediate worry that the euro might collapse dissipates and with the prospect of a new Commission and new European Parliament just ahead, Brussels is left with a European project that is itself in some danger of falling apart due to political neglect.

Some have suggested that a good place to start improving things might be with the Commission itself. In the UK and many northern countries, the notion that the Commission should be doing less but also doing it better is widely shared: even Barroso has expressed a similar wish. The Dutch and Germans have been especially vociferous in demanding less red tape and bureaucracy, and more attention to the principle of subsidiarity, which provides that action, should be taken at European level only if it is more efficacious than acting at national level. But even across southern Europe, the feeling that sometimes the Commission and the European Parliament are too intrusive has spread.

One reason the Commission has traditionally found it hard to respond to calls for it to do less is that there are too many commissioners. There is a widespread consensus that 28 is too big a number for the college. Not surprisingly, each commissioner wants to make his or her mark with legislation. Worse, partly because the Commission does not act like a government, there is no real system for coordinating and prioritising its actions. Instead, the Commission operates in a silo-like way, with individual directorates operating largely without much reference to each other or to the president. The proposal in the constitutional treaty and then the Lisbon treaty that there should be fewer commissioners than one per country was quietly shelved as a gesture to secure Irish approval of the treaty the second time round. At least some governments would like to find a way to revive its spirit, perhaps by creating senior and junior commissioners.

European Debt Crisis - Economic Collapse In 3 Minutes - Clarke & Dawe

9. Democracy and its discontents

THE NOTION THAT THERE IS A DEMOCRATIC DEFIGT in Europe is almost as old as the European project itself. Until 1979, when the first elections to the European Parliament were held, none of the European institutions were directly elected, and the gap between ordinary citizens and decisions taken in Brussels was seen to be a yawning one. National governments, which are elected, are of course represented in the Council of Ministers, the senior legislative body. But most have tended to keep quiet about their bargaining and few are held to account for actions in Brussels by their own national parliaments. Moreover, the spread of qualified-majority voting has meant that individual governments can now be forced to accept policies that they have themselves opposed.1

Over time, various suggestions have been made for filling this democratic deficit. Increasing the powers of the European Parliament is one that has been pursued through almost every treaty. Greater transparency in both the Commission and the Council has long been another favourite. Greater democratic input into the Council of Ministers through national parliaments has often been urged. So sometimes has the idea of some body that more directly involves national legislatures. And there is increasing recourse to referendums to approve new treaties: no fewer than ten were promised for the abortive constitutional treaty, compared with just one for the Single European Act of 1987.

None of these has proved satisfactory as a remedy for the deficit. The European Parliament has continued to disappoint even its most ardent supporters. Transparency has been improved, but few ordinary citizens understand even the basics of how the EU works; indeed, most have no idea what the difference is between the Commission and the Council of Ministers. Most national parliaments remain bad at holding ministers to account for decisions made in Council meetings, and attempts to get them to work together have largely failed. As for referendums, almost as many have been lost as won, so most governments feel decidedly nervous about holding any more.

It is true that public scepticism about institutions has been as strong (or sometimes even stronger) at national as at European level. In many countries, the loss of faith in the European Parliament, for instance, is matched by a similar or even greater loss of belief in the efficacy of the national parliament. Moreover, in many countries duties that once devolved on directly elected governments – monetary policy, exchange-rate policy or competition policy, say – have been handed to unelected bodies on the basis that they will be done better. Yet there is still a bigger cause for concern when something similar happens at European level. Even when citizens are fed up with their own government or parliament, they do not question their legitimacy or their continuing existence. But when it happens at European level, which seems more foreign, many query both.

Following the national model, some commentators have accordingly suggested as an alternative that the European Union should rest on a different idea altogether: that of output rather than input legitimacy. On this basis, there is no real need to get hung up about democratic accountability as such. 

Rather, the European project can be expected to gain and retain public support – and thus end up acquiring greater legitimacy – simply by delivering good results. If voters can see that, thanks to the EU, their economies are more successful than they would be without it, they will be content. In this context it helps when there are concrete results from EU actions to point to: lower airfares or mobile phone roaming charges, say.

Yet three related developments have largely kyboshed even this notion. The most obvious is that, far from being seen to deliver consistently good results, the European Union and especially the euro are now seen by large numbers of voters to be delivering mostly bad ones. Across much of the continent, Europe (and especially the single currency) is today associated with austerity, spending cuts, tax increases, rising joblessness and chronically slow growth. Debtor countries have seen a particularly sharp fall in enthusiasm for the European project as a result. But even in creditor countries, which have suffered less economically, Europe and the euro have lost their appeal, because they are now associated with bail-outs and transfers rather than with rising prosperity.

This new mood music has become especially discordant for Europhiles. Their messages that the EU would boost growth through its single market, that the euro would improve competitiveness by promoting reform and that both groups would protect European citizens from the pressure of globalisation and the fallout from the world financial crisis have fallen flat. Instead, Eurosceptics everywhere feel vindicated: their view that there is too much regulation by a remote EU bureaucracy and their warnings about the insanity of adopting a single currency without the right institutions, without moves towards political union and without enough democratic control seem to have been borne out by events.

The second consequential development has been a sharp fall in the popularity of the European project, right across Europe. Polls taken in 2013 by Euro barometer, the German Marshall Fund and the Pew Global Attitudes survey have all come up with similar findings.2 Especially in the south, but also in the north, approval of the EU has declined fast in recent years. The number of people who consider their country’s membership to be a good thing has also fallen. The decline has been most precipitate in Mediterranean countries like Spain and Greece. But it is also remarkable in France, where the latest Pew survey found an even smaller proportion of the population approving of the EU than in the traditionally Eurosceptic UK.

This sharp dip in the EU’s popularity in opinion surveys is reflected in the rise of populist parties that are anti-euro and anti-EU. Some of these parties are from the far right, some from the far left.

Often they are anti-free trade and anti-globalisation. In many cases they are strongly against immigration, which is increasingly associated with the EU because of its eastward expansion to take in not just the central European countries but also Bulgaria and Romania, for which free movement of labour arrived only in January 2014 (the British and some other governments are trying to curtail benefit entitlements for some specified groups of immigrants). Anti-Islam feelings also play a role. But their new-found strength owes most to the populists’ ability to channel growing anti-EU sentiment.

Thus Greece has seen the rise not just of Golden Dawn, an explicitly extreme-right party, but also of Syriza, an anti-austerity left-wing party that is running ahead of the ruling New Democracy party in opinion polls. Spain and Portugal have, so far, escaped the rise of populist parties of the right, but the more extreme United Left party is doing well in Spain and support for the two mainstream centre right and centre-left parties has collapsed. Italy has seen the spectacular rise of Beppe Grillo’s Five Star movement, which took almost 25% of the vote in the election of February 2013, forcing the centre-left and centre-right parties into an uneasy coalition. In France, Marine Le Pen’s National Front is running close to 20% in the opinion polls.

The rise of populists and extremists is not confined to troubled euro-zone countries alone. In Finland, the True Finns (now the Finns Party) under Timo Soini, which came out of nowhere in 2011, largely to protest against the euro, are scoring 20% or more in most opinion polls. In the Netherlands, Geert Wilders’ Party of Freedom is also riding high. Wilders has formed an alliance with Le Pen for the European elections, campaigning on an anti-EU, anti-euro platform. The UK Independence Party has refused to join this alliance, but it too has been scoring highly in the polls. Across central and eastern Europe a swathe of extremist and populist parties, from Jobbik in Hungary to the League of Catholic Families in Poland, are similarly doing well.

Almost the only country not to have seen a sharp upsurge in a populist, anti-euro or anti-EU party is Germany. It is also one of the few countries where the number of people with a favourable opinion of the EU has not fallen sharply in recent years. Residual German war guilt plays a part in holding down extremist parties. Yet it is, on the face of it, surprising that anti-EU or anti-euro sentiment has not made itself felt, as the German public has shown itself deeply hostile to the whole notion of bailouts and transfers to Mediterranean countries. Moreover, a new party, Alternative for Germany, has been established and, although it narrowly failed to get into the Bundestag in the September 2013 election, its poll ratings have since been rising. The real reason Germany looks different from other countries may be that it has suffered little during the euro crisis. Besides, German voters have come to trust Merkel not to let them down.

The search for legitimacy

The third and perhaps most difficult challenge is a direct result of the euro crisis itself. As discussed earlier, a large part of the policy response has been to move towards deeper political integration in the euro zone. The fiscal compact, the European semester, the two-pack, the six-pack and the rest add up to far more intrusive monitoring of national governments’ fiscal and economic policies. The Commission now has the responsibility to vet and, if need be, propose changes to national governments’ budgets even before their parliaments have seen them. Coming on top of the loss of monetary and exchange-rate policy due to the introduction of the euro, the result is a significant transfer of power from national to European level.

It should not be a surprise that one consequence is a crisis of democratic accountability. As a senior German finance ministry official put it to Ulrike Guérot and Thomas Klau of the European Council on Foreign Relations in 2012, “the weakness of the system is not about spending and how to promote growth, but about legitimacy”.3 Some of those who pushed for a single currency at and before Maastricht always thought it would take closer political union for it to work satisfactorily – indeed, a few pressed for EMU precisely because they thought it would force the creation of a United States of Europe. But most voters and most governments were not persuaded. Now a form of political union is indeed being brought in, not, however, as a positive result of careful national debate and as a consequence of economic success, but rather as a negative outcome to ward off economic failure. That surely will make it even harder to persuade voters to support the entire notion of political union.

It does not help that in parts of Europe democracy is going through something of a crisis at home. There are many manifestations of this. One was the fact that both Greece and Italy had technocratic prime ministers thrust on them during the euro crisis. Greeks have long been fed up with their political leaders. In Italy, voters have become increasingly disillusioned with their entire political class, often known as La Casta and widely reviled for its excessive cost and many privileges. Yet neither country was happy to have unelected leaders appointed in place of elected ones. It was this, perhaps more than a lost love for Europe that led so many Greeks to vote for fringe parties in May 2012 and so many Italians to back Grillo’s Five Star movement in February 2013. In Eastern Europe, Bulgarians have spent most of the past two years protesting in the streets against their government.

Romanians seem equally fed up with a long-running feud between their president and their prime minister. Hungary deserves a special mention here, as it has run into much condemnation in Brussels. Viktor Orban’s centre-right Fidesz party won a smashing electoral victory in 2010 after the outgoing Socialist government became discredited. But Orban proceeded to rewrite the constitution in ways that cemented Fidesz’s dominance over Hungary’s institutions and its intimidating control of the country’s media. Although the EU has managed to get the government to rewrite provisions impinging on central-bank and judicial independence, it has found its leverage over the government worryingly limited. As was discovered as long ago as 2000, when the EU tried to freeze relations with an Austrian government that included the far-right Jörg Haider as a coalition partner, a country that is a full member is much less susceptible to outside pressure than an applicant. Moreover, Orban’s membership of the centre-right European People’s Party transnational group is often said to have restrained his fellow heads of government from being too harsh on him. The result has been to damage the cause of liberal democracy in its broadest sense.4

Now the challenge from the euro crisis threatens to make matters worse. Indeed, in their first encounter with the European semester, several national leaders, even those normally thought of as pro-European, went out of their way to criticise the Commission for its intrusiveness. Spain’s Mariano Rajoy announced in 2012 that it was for his government, not the Commission, to decide the right level of the Spanish budget deficit. In France, Hollande early on declared that, while the Commission was within its rights to demand pension reform, his government should be left to decide what sort of changes to make and how quickly to make them. The Italian government rejected a criticism of its longer-term debt sustainability. And when Belgium, the most pro-European country of all, was rebuked over its budget deficit, one Belgian government minister asked aloud: “Who is Olli Rehn?” (the economic-affairs commissioner).5

Yet it is too simple to see the problem as merely one of excessive Commission interference in matters better left to elected national governments. That was to some extent true when it came to the operation of the stability and growth pact. When Gerhard Schröder and Jacques Chirac came together in 2003 to overturn any suggestion of Commission-imposed sanctions on their two countries for breaching the terms of the pact, they were simply asserting greater legitimacy for elected political leaders. There was little in the way of broader economic fallout. Indeed, that is precisely why their colleagues, with the partial exception of the rule-loving Dutch, made so little fuss about the demise of the pact at the time.6

But the euro crisis has changed this completely, by bringing into the picture nationally sanctioned rescue funds. A bail-out of an excessively indebted country has to be approved by national authorities, including national parliaments, because ultimately it must rest on the credit of sovereigns. As became clear in May 2010, the EU budget is too small for this purpose. For such a fund to attract its AAA rating, it requires guarantees from creditworthy governments. And in national democracies, that needs the backing of national parliaments. This is one reason the issue of democratic accountability in Europe has become so acute. When it is clear that something has to be decided at European level, the EU treaties have a supranational, if not always satisfactory, mechanism of accountability. When decisions are wholly national, similarly, a national system should work. But in the euro crisis decisions are, in effect, hybrid: they are taken at a European level, but the funds being committed are provided nationally. In such cases issues of accountability and democratic control can all too easily fall through the cracks.

Hence the experience of the Finnish parliament (Eduskunta), which has repeatedly demanded specific collateral for loans to Greece and others. And hence also the growing role of the German Bundestag in demanding the right to approve every bail-out individually. The Bundestag’s demand for a say in bail-outs is strongly supported by another crucial German institution, the Bundesverfassungsgericht, or constitutional court, based in Karlsruhe. The constitutional court has played a big role in the euro crisis, chiefly because a number of plaintiffs have repeatedly petitioned it to declare various decisions to be unconstitutional because they infringe the German basic law –ranging from the first Greek bail-out to the establishment of the European Stability Mechanism to the ECB’s programme of outright monetary transactions (OMT) to support sovereign-bond markets. So far the court has not ruled against anything, but it has often hedged its verdicts with language suggesting that there are limits to how far the federal government in Berlin can go. In the case of OMT, it made its disapproval clear but transferred the case to the European Court for a ruling. It has also made clear, including in its ruling on the Lisbon treaty, that it does not see the European Union’s democratic credentials as sufficiently strong.7

Many Euro-enthusiasts are horrified both by the Karlsruhe court and by the Bundestag’s assertion of control over bail-out decisions. They see a creeping renationalisation at work, all of a piece with Merkel’s new-found enthusiasm for inter-governmentalism and the “union method” at the expense of the traditional community method. Germany’s lack of enthusiasm for the EU institutions, notably the Commission but also the European Parliament, which used always to attract strong German support, is to them part of the same pattern. What such enthusiasts tend to favour instead as a way to inject more democratic accountability into EU-related decisions is to give a much greater role to the only directly elected EU institution: the Parliament in Strasbourg. Yet this runs into huge problems of its own.

Strasbourg blues

The Parliament is certainly ready and eager to step forward. It has already played a constructive role in drawing up the necessary legislation for the European semester. It wants to do more in the way of scrutiny of the Commission’s decisions and of any contracts for reform that national governments might accept. Yet the notion that it can help to fill the gap in the euro zone’s democratic accountability and in providing greater legitimacy for the system to ordinary voters is far-fetched and may be highly dangerous, for four reasons.

The first is institutional. The Parliament is quintessentially a body that brings together representatives from all 28 EU countries. It was relatively easy for the Council of Ministers to establish a sub-formation in the Euro group and now the Euro group summit. It is also fairly simple to form a tacit understanding that the economics commissioner as well as the Commission president should, like the presidents of the ECB and of the European Council, come from a euro-zone country. It is much harder to do the same in the Parliament. Indeed, the chair of the economic and monetary affairs committee during most of the euro crisis has been Sharon Bowles, a British Liberal Democrat.

Some have muttered about this, and a few enthusiasts, including the French Eiffel group, have even suggested setting up a separate or “inner” euro-zone parliament. But to most this would excessively institutionalise the already worrying divide between euro ins and euro outs.

A second objection is that the Parliament itself lacks legitimacy. It has been directly elected for the past 44 years, yet the turnout in successive elections has steadily fallen. European elections everywhere are treated as essentially national polls, in which voters typically register protests against their governments or back populist parties. There is no sense among voters of any Europe-wide political parties: few have heard of the main political groups or have any clue about what they actually stand for. The results of European elections are not seen to translate in any way into changes of executive power within the EU; they do not even determine the presidency of the Parliament, since this is divided between the two biggest groups for the term of each legislature. Few people have any idea what the Parliament does or who their MEP is. In short, for most ordinary Europeans the Parliament seems to be part of the problem of remote and largely unaccountable EU institutions, and not part of the solution.

Various remedies have been suggested for these ills. One old favourite is to give the Parliament more powers, which has been done so much that for most purposes it has become a co-equal legislator with the Council of Ministers. The idea is that if the Parliament is seen to be exercising fuller powers in the EU, voters will take it more seriously. And indeed the Parliament, especially through its committees, has become an important and at times extremely valuable part of the legislative process, often improving directives and regulations more effectively than the Council. Many people cite the examples of the REACH chemicals rules and the services directive, which was in part resurrected by the Parliament, as examples.

Yet even Europhiles remain dissatisfied with the Parliament. A believer in democracy might expect the three biggest groups, the centre-right European People’s Party (EPP), the centre-left Progressive Alliance of Socialists and Democrats (S&D) and the centrist Alliance of Liberals and Democrats for Europe (ALDE), to debate from their different political standpoints and vote accordingly, as happens in national parliaments. But far more often the big groups come together to make the Parliament more of a lobby or non-governmental organisation that sets itself up against the Commission and the Council of Ministers, rather than acting like a normal legislature. The Parliament is fond of passing largely meaningless foreign-policy resolutions. Unlike most national parliaments, it always wants both more powers for itself and a bigger budget – something few of its voters would support. The divide between voters and their MEPs was made starkly clear when the Dutch and French overwhelmingly rejected the constitutional treaty, which had been approved by almost all the MEPs from those countries.

Another suggestion has been to give the Parliament a bigger and more explicit role in choosing the Commission, especially its president. The Lisbon treaty provides that the European Council, taking account of the results of the European elections, should nominate a candidate, who is then “elected” by an absolute majority of the Parliament. (The Parliament is also required to approve the entire college of commissioners, but not each individual, this time by simple majority.) Most of the political groups have taken this language as an excuse to put forward their preferred candidate for the Commission presidency before the European elections. The S&D group, for instance, has proposed the current president of the Parliament, Martin Schulz; the ALDE has put forward its leader, Guy Verhofstadt; and the EPP is proposing Jean-Claude Juncker. The idea is that this should make the elections matter more to voters, since they will, in effect, be indirectly choosing the next Commission president.

Yet this solution to the democratic deficit is unlikely to help. Most ordinary people remain profoundly ignorant both of the political groups that are proposing candidates and of the candidates themselves: it is hard to see British Labour voters, say, turning out in large numbers because they are enthused about the prospect of Schulz as the Commission president. Worse, by making the Commission more beholden to the Parliament than it already is, the plan would upset the EU’s institutional structure. Unlike the Parliament, the Council of Ministers cannot sack the Commission; if the Parliament has the decisive voice in the Commission presidency, this would aggravate the imbalance, making it all the more likely that the Commission and Parliament would come together to act against national governments. And worst of all, the plan would sharply reduce the field of candidates to become president of the Commission: no incumbent government leader would be ready to step down to campaign as part of the European elections.8

Besides the European Parliament’s own failings as an institution that can fill the EU’s and the   euro zone’s democratic deficits, there is a third reason to doubt that it will be the answer. This is that an increasing number of populists and extremists are now represented in the Parliament. On one level, this could be seen as positive: at least this strand of opinion, often hostile to both the EU and the euro, will be fully represented in the European institutions. But the presence of such a destructive group of oddballs, loonies and closet racists is hardly likely to enhance the reputation of the Parliament or make it easier for it to play a role in holding the EU’s policymakers to account.

And there is yet another, fourth reason, why the Parliament will never be the answer to legitimacy and democracy in the euro zone. This is that decisions over euro-zone bail-outs, the rescue of European banks or fiscal transfers to troubled countries will always involve national taxpayers’ money. The Bundestag’s insistence on approving such measures is not mainly a symptom of a sudden Euroscepticism in Germany. It is something far simpler: the notion that, where national taxpayers’ money (or credit) is being used, there must be some national control over what it is being used for – and also some national accountability. There is no way in which a European-level body could supply either of these, least of all one whose raison d’être is always to increase its powers and to spend more.

Back to national democracy

This points to another answer to Europe’s democratic deficit: greater national involvement. The spread of national referendums on European issues is part of this: besides the two habitual practitioners, Denmark and Ireland, several other countries now put substantial new EU treaties or decisions such as whether to join the euro to popular vote. France and Austria have, at various times, suggested that a decision to admit Turkey to the EU would have to be approved similarly (France put the issue of UK membership to a referendum in 1972, securing a large “yes” majority). Under its European Union Act, the UK is required to put any treaty involving a significant transfer of power to Brussels to a referendum. And David Cameron has promised that, if he is re-elected as prime minister in 2015, he will ask the British people to decide whether to remain in a reformed EU.

Referendums are, however, always chancy affairs. So it is really national parliaments that are best placed to improve democratic input and accountability in the EU and the euro zone. Their role in the EU machinery has been increased by successive treaties. Since the Lisbon treaty, national parliaments have been given specific powers to police “subsidiarity”, the provision that decisions should be taken at the lowest possible level. Under a yellow/orange-card procedure, national parliaments acting together can ask for Commission proposals for legislation to be withdrawn. The treaty also recognizes COSAC, a co-coordinating body of European committees from national parliaments, most of which maintain offices in the European Parliament building in Brussels. There is increasing interest in the more effective forms of national scrutiny of European legislation, with the most popular models being Denmark and Finland, where parliamentary committees hold the government to account for decisions it takes in the Council of Ministers.

The euro crisis has put renewed emphasis on the role of national parliaments. The Bundestag, the Eduskunta, the Dutch Tweede Kammer and others have asserted a direct interest in approving   any decisions that rely on their taxpayers’ credit or money. And the new powers of the Commission to scrutinise draft national budgets, to issue recommendations to countries with excessive budget deficits or with large current-account deficits (or surpluses) are inevitably impinging on national parliamentary authority over public spending and taxation. For this reason it has become desirable, indeed essential, that the Commission should engage with national parliaments. So far, its response to the yellow-card procedure has been disappointing: only one proposal has been withdrawn, and the Commission disgracefully ignored a complaint from 18 different parliamentary chambers about the legal basis for a European public prosecutor. But as the system beds down, the Commission should end up doing more at the behest of national parliaments, and it must be expected that the commissioner for economic and monetary affairs and his or her officials will have to appear before them more often.

Yet even this might not be enough to lend greater democratic legitimacy to a far more intrusive system of economic control. That is why several analysts and commentators have at various times suggested much greater moves towards fuller political union, with an elected Commission that includes a finance minister, or at least an elected president of the Commission and, as a necessary adjunct, a substantial euro-zone budget. No doubt if the European project were to take a leap into full political union, some kind of federal election would become necessary. But at least for the foreseeable future, neither European voters, nor national governments, nor Europe’s political leaders seem remotely ready for any such steps.9