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European Democracy in Crisis

The financial-cum- sovereign-debt crisis in the euro zone and the emergence of the troika have led to the perception that Europe is failing to deliver. There is no narrative beyond cuts, bailouts and fiscal austerity. Unemployment in the euro zone is at an all-time high. Growth is stagnant. In some countries such as Spain and Italy, youth unemployment has reached a staggering 50 per cent.

There is a growing divergence between the economic and educational performance of northern and southern economies. New cross-national tensions are emerging. Europe is becoming increasingly politicised.

This is unsurprising. Whole rafts of policy reforms and institutions have been created that directly affect domestic budgets. These include the European Stability Mechanism (ESM), the fiscal compact, the European semester; the two-pack, the six-pack, not to mention the outright monetary transactions of the European Central Bank, and proposals for a banking union.
These reforms may be necessary to enhance the strategic capacity of the union to deal with the crisis. But they also imply transferring more sovereignty to Europe than was ever previously imagined.

The policy choices faced by national governments are becoming increasingly narrow. This weakens and undermines the importance
of electoral competition. These policy reforms affect taxpayer resources, which makes them highly-salient political decisions.

Weak legitimacy
But perhaps more importantly, most of the post-crisis policy reforms have taken place outside the EU treaties. They occurred through intergovernmental euro zone summits. This means they have weak formal legislative legitimacy. The outcome is that they give ultimate priority to the interests of bigger and more powerful states.

The commission is increasingly relegated to the sidelines. In Germany, there is growing concern with the ECB’s enhanced authority.

If this were not enough, the EU put pressure on directly elected governments in Italy and Greece to be replaced by technocratic administrations. National executives are being increasingly empowered at the expense of parliament. This reduces the influence of political parties and local governance structures, not to mention civil society organisations, in shaping policy choices. It gives priority to market confidence over citizens. Populist and Eurosceptic parties are on the rise, and look set to make significant gains in the European parliamentary elections.

Even before the euro zone crisis there was a hotly-disputed debate over the democratic legitimacy of the EU.

Many voters believe the EU was taking sovereignty away from directly-elected governments to unelected technocrats in the European Commission and the ECB. These were then blamed for directly imposing either a neoliberal or social market agenda.

Others argued this was a democratic choice by elected governments, and reflected the preference of voters. Delegating decision-making to regulatory agents such as the ECB was a general trend in western societies. The EU, policymakers pointed out, has no capacity to interfere with domestic tax and spending priorities.

Political stability
The raison d’être of the EU was to guarantee political stability and to improve the economic and employment performance of member states, through shared sovereignty and mutual recognition. The treaty of Rome, the single market and economic and monetary union were perceived to have achieved these objectives. Furthermore, even if there was a democratic deficit, it was assumed that this would be resolved by the Lisbon treaty. Not so.

The recent turbulence is reflected in Eurobarometer data. The percentage of citizens dissatisfied with how the EU works has grown substantially. Distrust in European institutions is at an all-time historic high. Citizens are losing trust in both the function and democratic nature of institutions. If history teaches us anything, this does not bode well for social cohesion or economic stability. It is not unreasonable to suggest therefore that European democracy is in crisis. It is increasingly perceived as being neither effective nor democratic.

Social contract
The forthcoming European elections will probably be the most politicised in the history of European integration. Europe needs a new social contract to offer its citizens. This can only come about through political contestation and the forging of new social coalitions. A debate on these issues and a keynote address by President Michael D Higgins will be streamed live from a Dublin European Institute symposium and relaunch in Dublin today (www.europedebate.ie).

This article originally appeared as an open-ed in the Irish Times.

The Fairytale of Europe’s Magic Improving Dust Formula

There are four actors who have dominated the political and policy response to the Euro crisis: the executive of the German Federal Republic (now a super majority between the Christian and Social Democrats), Finance Ministers who make up the Economic and Financial Affairs Council (ECOFIN) of the European Union (EU), the European Central Bank (ECB), and the executive of the Economic and Financial Affairs Commission (basically the Department of Finance of the European Commission).

This is a complex institutional relationship with overlapping power asymmetries. Two of these actors (Germany and Ecofin) represent national interests. They bargain and defend what they consider to be the comparative advantage of their own nation-states. For Ireland this means a willingness to veto anything that would lead to corporate tax harmonisation. For Germany it means a willingness to veto anything that would lead to Eurobonds or debt mutualisation. These strategic positions, like any preference, are not set in stone and could, in principle, change. In this matrix German interests dominate for obvious reasons – they are the biggest and richest member-state of the EU.

The other two actors (the ECB and the Economic and Financial Affairs Commission), in theory, represent pan European interests. They are supranational actors that are supposed to defend the shared interests of the 18 member-states of the Euro currency, and the 28 member-states of the EU. They favor more fiscal harmonisation and generally support more political integration than Germany is willing to concede. But given the huge heterogeneity among the 28 member-states it is becoming increasingly difficult to identify what a ‘common interest’ actually is.  Despite this, it is not unreasonable to assume that these supranational actors would have some conflict with powerful member-states, such as the Conservative German government, over how to handle the Euro crisis.

This, however, is not the case. Why has there has been no serious confrontation between these actors on how to resolve the crisis? The easy answer is that supranational actors such as the Commission have simply internalised the preference of Germany. But differences have emerged, particularly between the German government and the ECB. Furthermore, these actors are not homogenous agents with a single preference. They fight like cats and dogs within their internal systems, particularly within the European council. But it must be observed that the level of policy consensus between the national and supranational is remarkable. What explains this, other than ‘Germany gets what it wants’?

One potential answer is ideology. Ecofin (Finance Ministries) is primarily represented by Wolfgang Schauble (the German Finance Minister), the German Executive is primarily represented by Angela Merkel (the Federal Chancellor and chief executive of the Christian Democratic Party), the ECB is led by Mario Draghi, and the EU Finance Commission is headed by Oli Rehn. What these elite actors share is a political preference for a certain economic idea. I do not mean this in the narrow sense that they are all neoliberals who want ‘austerity’. The Commission and the ECB are perfectly aware that fiscal contraction, in the long-run, is a self-defeating strategy for the Eurozone as a whole. Nor is it a case that they are all ardent libertarians. They differ on the speed of European banking Union, the mutualisation of debt, fiscal harmonisation and social policy. The German executive would never argue against the need for social insurance, even if they want a radically reduced welfare state.

So what is the core economic idea that they share? It is the magic economy dust formula of ‘structural reforms’. It is the idea that if national governments just sprinkle enough structural reforms into the economy to enhance market competition they will, eventually, generate the conditions for employment growth. This is captured perfectly in a recent analysis by Marco Buti, the Director General (DG) of the Economic and Finance Commission. He outlines a trilemma for the Eurozone: we cannot have the welfare state in a fixed monetary union that requires reducing fiscal deficits to 3 per cent of GDP. This is true. In order to keep the welfare state he proposes a consistent policy ‘trinity': banking union, symmetric adjustment (i.e. inflation in the core) and deep structural reforms. These, we are told, will generate the conditions for economic growth. In turn, with full employment, the welfare state is secure.

This is the core idea behind the policy response to the Euro crisis and it is worth stating clearly if its merits can be tested against rational argument and empirical evidence. The argument is as follows: the only way to keep the welfare state in a single currency is to generate full employment. This cannot come about through fiscal or monetary policy unless a member-states leaves the Euro. The only solution is structural reforms. Hence – the most important European policy in responding to the crisis are deep structural reforms. But Buti never defines, measures, compares or even vaguely outlines what this actually means. And if you read ECB, ECOFIN, and EU commission policy statements, none of them ever do. The only actor who has a clear idea of what structural reforms are is the German Federal government. They make no apology for arguing that holding down wages, cutting pensions, liberalising employment protection, creating non-paid jobs and reducing government administration will solve the Eurozone crisis. Politics is the problem.

But the point to be noted is that the empirical non-falsifiability of structural reform policies is the idea that underpins the consensus between the national and supranational. It enables all of the actors to sell a policy that no one understands or can even refute. It is a fairytale. Promoting structural reforms as a panacea for unemployment is the equivalent of a political party saying we need votes to win an election, or a trainer saying to an athlete, just run faster. Structural reforms are, ultimately, a short-hand to say more markets and less politics. In an ideal world of perfect competition, within a single market with no transaction costs or rigidities for capital and labour, we probably would create full employment. But to propose this as a serious policy-strategy that will lead to full employment and strong economic growth is no different to those self-proclaimed revolutionaries who argue that nothing can change until everything changes i.e. abolish capitalism.

Where does Europe’s magic improving economy dust formula lead us then? The German government will not change their preference for ‘structural reforms’ because they are convinced that the Hartz Reforms (I-V) is what underpins the competitive resilience of the German economy. I have argued elsewhere that this is not the case. ECOFIN wont change their preference because it would require spending resources and reversing a Treasury mentality of permanent austerity. The ECB wont change as they want the Karma of an optimal currency area – total flexibility of adjustment in prices and wages. This leaves the Commission, which is currently dominated by the Economic and Financial Commissioner, Oli Rehn. He is, contrary to Angela Merkel, a classic neoliberal, and not likely to change his preference for pure markets any time soon. But contrary to some fatalistic predictions (surprisingly popular in Germany), it seems to me that the Commission is the only actor capable of challenging the structural reform agenda, and therefore overcoming the ‘joint decision’ trap of the European Council.

This brings me to the European parliamentary elections in May. Given the treaty changes introduced after Lisbon, the European parliament will have the final say on the next President of the European Commission. This means that the political group who can create a majority in the European parliament will nominate the executive. Presently the European Peoples Party (Christian Democrats such as Enda Kenny and Angela Merkel) have a majority. But if this changes, everything is up for grabs. Would it make sense for opposing parliamentary groups to politicise the structural reform agenda? Or at least confront it with empirical evidence? All of this assumes, however, that a new Commission, under new leadership, would have the political capacity to create a dissensus in the context of a German dominated consensus. It also assumes that the elections won’t result in a victory for the populist right, which, I fear, is where the magic dust formula is likely to lead us.

Toward a New Research Agenda on European Integration

Why do democratic nation-states transfer sovereignty and power to regional and international organisations? This is the fundamental question, whether made explicit or not, that lies behind most research on European integration.

One of the dominant explanations is neo-functionalism. This theory postulates that nation-states will gradually transfer most policy functions to supra-national authorities such as the European Union (EU) as a functional response to growing international economic interdependence. The argument was that, over-time, the EU will develop the capacities akin to a federal state.

The eurozone crisis has clearly shown that this is not the case. Politics matters.

The second dominant explanation for European integration, which emerged in reaction to neofunctionalism, is intergovernmentalism. This theory postulates that all decision-making on the process of European integration is determined by national governments in response to domestic economic interests. Power remains with national executives not supranational authorities (who simply act in the interest of powerful states).

Why then is the most important actor in responding to the crisis the European Central Bank (ECB)?

The third quasi-descriptive theory to explain European integration is ‘multi-level governance‘. In reaction to the rational choice assumptions of intergovermentalists, this theory argues that the nation-state no longer has monopoly over decision-making. Political and legal authority is now diffused across the national, sub-national and supranational levels.

In essence, this approach is primarily interested in illustrating that ‘euro governance’ is more important than ‘state-centric’ analyses in explaining policy outcomes. The process and outcomes of European integration are the independent not dependent variable.

The problem with multi-level governance theory is that the core policy areas that concern the preference of citizens such as fiscal, welfare, and the labour market, all remain organised and coordinated at the level of the nation-state. National governments have a veto on these policies.

However, in the aftermath of the eurozone crisis, the EU has developed new competencies to influence national budgets and monitor fiscal and labour market outcomes. Interpretations of existing legal treaties, such as the no-bailout clause, have become significantly stretched. National governments in the Council have emerged as the executive of the EU. But simultaneously, given the monetary constraints of EMU, they lack the instruments to condition policy outcomes at the domestic level.

The outcome is a form of post-democratic executive federalism with Germany sitting at the top.

This leads to the observation, and made obvious in the aftermath of the Euro crisis, that neither national governments nor the multi-level polity of the EU have the coordinating capacity to deal with the empirical problems facing Europe today. This is because none of the theoretical frameworks outlined above took nearly seriously enough the impact of global financial liberalisation on politics.

This is the real crisis facing decision-makers in the ‘multi-level’ polity of Europe.

Political scientists studying European integration need to confront the question: what sort of political economy is emerging in response to financial globalisation? Furthermore, in a world of increasing economic integration can member-states of the European Union construct an effective monetary system that responds to the normative considerations of a democratic polity?

This type of research requires re-integrating comparative and international political economy with European studies. It requires taking comparative difference seriously.

On the one hand politicising the European demos risks intensifying nationalism (as opposed to cross-national federal transnational alliances). But on the other, more supranational economic technocracy (and less politicisation) risks undermining the democratic legitimacy of the European Union itself.

The Imbalance of Capitalisms in the Eurozone. Can a One Size Fits All Adjustment Work?

The focus of adjustment to the crisis has been on structural reforms of Southern labour markets. Yet in the Northern economies, one of the core factors explaining their economic success is coordinated collective bargaining and high levels of investment in research, training and education. Can a narrow focus on labour market liberalization really improve the economic and employment performance of weaker member states?

The defining moment that led to the creation of the Economic and Monetary Union (EMU) in Europe was the publication of the Commissions 1990 study: “One market, one money”. This was based on the ‘new classical macroeconomic assumptions’ of rational expectations and denied the capacity of monetary and fiscal policy to affect real employment and economic outcomes in the long term.  The core argument was that a single monetary policy would increase trade, equalise prices, enhance competition and discipline wage inflation across member-states. It was assumed that the EMU (a single currency with a single interest rate) in-itself would lead to macroeconomic convergence in policy outcomes across member-states with institutionally diverse capitalist democracies. 

This has since proven to be a fundamental mistake, and recognised as such in the 2010 Commission report on “Intra-Euro-Area Competitiveness and Imbalances”. But instead of the rational expectations of market actors it is now assumed that economic convergence will come about through disciplined state action. It is the national executive of member-states that must now reduce welfare spending, liberalise collective bargaining and introduce structural supply-side reforms of the labour market. The 2010 report clearly outlined the new Euro governance regime and was soon followed up by the “Excessive Imbalance Procedure” which created two new regulations for the correction of macroeconomic imbalances (EU 1174 and 1176/2011). These new rules in addition to the ‘two pack’, ‘six pack’ and ‘fiscal compact’ all assume that a loss of competitiveness is the source of the Euro crisis. It is assumed that all member-states can converge on an export led growth model if national governments cut public spending and impose supply side reforms in the labour market. 

This assumption of convergence, however, is not possible if we accept the core research finding of comparative political economy over the past thirty years, namely that there are different varieties of capitalism in Europe, with qualitatively distinct domestic institutions that cannot converge. The core empirical finding in this research is that what governments do is conditioned by the structure of the domestic economy. Within the Eurozone there are seventeen countries with qualitatively distinct national welfare states, fiscal policy regimes, wage-setting institutions and labour markets. In this perspective, imposing a one size fits all adjustment aimed at fiscal consolidation and structural reforms of the labour market will perpetuate rather than resolve the economic divergences in the north and south of Europe.

The Imbalance of Capitalisms within the Eurozone

In the Eurozone, one can argue that there are two variants of capitalism. Northern European countries; Germany, Austria, Netherlands and Finland are often described as coordinated market economies (CMEs). They have centralised and economically sophisticated employers and trade union associations with the capacity to autonomously coordinate and solve complex labour market problems. In addition, they have embedded welfare state traditions committed to social protection and income security. They have traditionally relied upon export-led growth as a mechanism to generate employment. Hence their macroeconomic structure supports a preference for stable fiscal policies and supply-side labour market reforms. 

One the other hand, southern European countries in the Eurozone; Spain, Italy, Cyprus Greece and Portugal, are often described as mixed-market or Mediterranean varieties of capitalism. They have fragmented trade unions and employers with limited capacity to coordinate labour market outcomes. They have weak welfare states and a significant amount of social security occurs through family relations. Traditionally, they have generated economic and employment growth through domestic consumption. This gives priority to domestic demand over export-profits. Prior to EMU this structure lent itself to an accommodating monetary and fiscal policy, with governments regularly devaluing the currency to offset a loss of competitiveness and the inflationary impact of domestic prices. 

The organisation of the political economy in southern Europe is conducive to a growth model based on domestic consumption. In contrast, the organisation of the political economy in northern Europe is conducive to a growth model based on export markets. Both of these regimes became systematically connected through the single currency and euro-financial markets. The strong export base of northern Europe depended on high-levels of domestic consumption in the south. The EMU is a semi-closed trading economy with less than ten per cent of trade leaving the Eurozone but predominately going to other EU countries. The EMU was designed as an unaccommodating currency regime that provided unprecedented autonomy to the European Central Bank (ECB). This primarily benefited the export driven model of northern Europe. 

The conditions for competitiveness in comparative political economy

Membership of EMU compels member-states to pursue an internal devaluation as an instrument of adjustment. This is precisely what occurred in Germany from 2002 and underpins the EU’s strategy in southern Europe today. The context specific conditions of the German political economy enabled unions and employers to institutionalise wage-restraint and facilitated government-led supply side reforms of the labour market (usually captured under the ‘Hartz Reforms’). These were all aimed at enhancing export-led growth (even if it came at the cost of increased inequality and a growing low-wage economy). This is perhaps the proximate cause of Germany’s capacity to internalise the monetary constraints of EMU. But it is certainly not the ultimate cause of Germany’s competitiveness. The core insight from comparative political economy is that this can be traced to high levels of investment in research, training and education. These provide the conditions for a path dependent industrial infrastructure in highly specific niche export markets. This cannot be easily replicated. 

Internal devaluation cannot, by definition, work in countries reliant upon domestic consumption for economic and employment growth. In southern Italy, Spain, Portugal and Greece, employment is predominately created by domestic demand. It should come as no surprise therefore that, despite successive labour market reforms and cuts in public expenditure, youth unemployment in these countries varies between a staggering 42 and 56 per cent. Many economists argue that Germany should reflate their domestic economy and pursue a Keynesian response to the Euro crisis. That is, they should spend more, allow wages to rise, let banks fail, create inflation and encourage precisely what is occurring in the US. But this ignores the path dependent export model and the domestic political coalitions underpinning the German political economy. These are not likely to change anytime soon. 

The attempt to join together different varieties of capitalism into the single currency is the real source of the Eurozone crisis. It is not a loss of competitiveness per se that is the core problem facing EMU but the heterogeneity of capitalisms within Europe, and the absence of a European wide problem-solving capacity to deal with this. The one size fits all adjustment, aimed at structural supply side reforms of the labour market, perpetuates the myth of economic convergence because it continues to assume that all member-states can generate the conditions for export-led growth. This, however, is systematically impossible is a semi-closed trading area such as the Eurozone. The structural effect of the single currency, therefore, is to exacerbate the imbalance of capitalisms within Europe. 

The continued belief in the assumption of market convergence, implicit in the design of the EMU, is leading to a crisis of the democratic state in southern Europe. If European policymakers are serious about enhancing the competitiveness of these countries it will require huge levels of social investment in education, training and research, not to mention institutional capacity building. All of this expenditure implies that member-states should ignore the political and legal treaties of the European Union. Examining the empirical oriented research of comparative political economy, rather than following the hypothetical assumptions of rational expectations would better serve European decision-makers.

German Perspective on Irish Debt

A letter of mine in the Irish Times:

Sir, – Arthur Beesley and Suzanne Lynch (“Irish debt linked to Angela Merkel talks on Coalition”, Business This Week, October 11th) present a somewhat misleading analysis of the Social Democratic (SPD) position in Germany.

What the SPD is calling for is a co-ordinated European financial transaction tax to fund a common European banking resolution scheme. This is because it wants the financial sector rather than the taxpayer to cover the cost of failed banks.

The Irish Government has adopted a beggar-thy-neighbour position in European policymaking. It supports a European-wide resolution scheme to pay the costs of failed banks, but opposes a co-ordinated financial transaction tax to fund this.

It is the Irish Government which wants the taxpayer to pay for the financial crisis, not the SPD. The German position will benefit all European taxpayers whereas the Irish position only benefits the Irish financial sector.

I am pretty confident that most Irish people, if given a choice, would prefer corporate creditors rather taxpaying citizens to pay for the crisis. In this sense they are closer to the German Social Democrats than their own Government. – Yours, etc,

Dr AIDAN REGAN

Max Planck Institute for the Study of Societies,

Paulstrasse, Cologne, Germany.

Political Tensions in Euro-Varieties of Capitalism

My latest working paper published at the EUI:

“The European response to the financial cum sovereign debt crisis in the Eurozone is leading to a democratic crisis of the state. It has exposed a tension between the national and the supranational in a multi-level polity whilst opening up new political cleavages between the core and periphery of Europe. This dilemma has become particularly acute for programme countries that are either directly or indirectly in receipt of non-market financial funding from the troika?. In the absence of exchange rate adjustments, Ireland and southern European countries must pursue an internal devaluation that shifts the entire burden of adjustment on to fiscal and labour market policy. National governments, regardless of political partisanship, are required to comply with external EMU mandates and liberalise their welfare states, cut public spending and impose structural reforms in the labour market. The core argument of this paper is that imposing a one-size-fits-all adjustment to diverse economic problems across different varieties of capitalism is the real source of the Eurozone crisis. By using a crosscountry comparative analysis of Greece, Ireland, Italy, Portugal and Spain, I conclude that this is an outcome of inbuilt institutional and macroeconomic asymmetries in the EMU. But it is leading to unprecedented electoral volatility and a legitimation crisis of the democratic state in Europe”

President Higgins and the ‘Neoliberals’

A recent letter of mine in the Irish times:

Sir, – Dan O’Brien clearly took offence at President Michael D Higgins’s recent speech at Dublin City University (“Presidency ill-served by economic partisanship”, Business, September 20th). In particular he was offended by the use of the concept “neoliberal”. I agree with your columnist that this is a relatively innocuous term but Mr O’Brien’s analysis was more polemic than analytic. The term “neoliberal” is increasingly used in political science to describe the paradigm shift away from demand-managed macroeconomics, during the Keynesian era, to the supply-side oriented revolution in economics during the period of financial market expansion.

Using the concept to describe broadly a paradigm shift does not imply that there is no variation in how economies are organised in contemporary capitalist societies, nor does it imply an “us” versus “them” mentality. It is used extensively in many European-based political economy research projects. The international financial cum sovereign debt crisis was caused by the reckless behaviour of private market actors.

President Higgins should be commended for his bravery to confront the intellectual hubris that accompanied this. – Yours, etc,

Dr AIDAN REGAN,

Max Planck Institute for the

Study of Societies,  

Cologne,

Germany.