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.

An Empirical-Economic Theory of the Eurozone

Labour Market Policy
The most erroneous liberal-market premise of the EMU is the assumption that labour market actors, particularly trade unions, either do not exist or are too weak to resist competitive downward pressure on wages. The design of Europe’s shared currency is premised on the non-existence of collective bargaining (Crouch, 2000) and shares the neoclassical assumption that labour markets can and do operate in perfectly competitive markets. This implicit design of the monetary union assumes that if asymmetric shocks hit, national economies, regions and sectoral industries will automatically adapt through a reduction in labour costs. This reduction in labour costs is presumed to act as a functional equivalent to currency devaluations at a macro level (see Hall and Gingerich, 2004).

Currency devaluation traditionally externalized excessive endogenous labour costs to the main trading partners of a given national economy (Crouch, 2000). Devaluation and exchange rate adjustments acted as a cushion to avoid social dislocation when national economies became over inflated. This option is no longer available for countries of the Eurozone. The implication is that an ‘internal devaluation’ must be pursued by Member States when confronted with an economic shock. This does not take into consideration the structural and current account imbalances within the Eurozone nor the distributional implications of shifting the burden of adjustment on to wages and public spending. But it is central to the Troika austerity program.

The assumption that the entire burden of cost adjustment can fall on labour market actors completely ignores the embedded and historically diverse institutional structures of collective bargaining in European economies. Collective bargaining and negotiated wage setting is one of the core features of coordinated market capitalism or ‘social Europe’.  Every economy, with the exception of Ireland, Estonia and Slovakia, has collective bargaining coverage of over 60 per cent in the Eurozone. Austria, Belgium, Finland, France, Greece, Italy, the Netherlands, Slovenia and Spain all have collective bargaining coverage at 80 per cent or more (see Visser, 2009). This involvement of organized labour in wage setting makes it difficult to impose downward labour cost reductions across the economy. Neither will adjustment be so extensive that it can act as the functional equivalent to currency devaluation. Any adjustment in labour costs will be negotiated between labour market actors (at sectoral or national level) unless labour is so weak that it cannot resist a unilateral imposition of wage cuts. However, the rigid constraints of the EMU’s budget deficit requirement, and the newly proposed fiscal treaty, means that government as employer may have no option but to impose a reduction in pay rates in the public sector.

Given the institutionally and historically evolved structure of coordinated wage setting in Europe, one should not assume that organized labour markets are strategically incapable of reducing labour costs through collective bargaining. Most research indicates that those sectors most exposed to international competition have been capable of concession bargaining and internalizing significant levels of wage restraint (Hancké & Johnston, 2009, Traxler & Brandl, 2010, Crouch 2000) or adopting alternative labour market policies such as short-term working to reduce costs. The question for governments, however, is under what conditions can those sectors not exposed to international trade, particularly those within the public sector, do the same? This is a significant problem for countries under the conditions of a severe public finance crisis where public sector pay bargaining is systematically associated with national social partnership arrangements, as is the case in Ireland and much of southern Europe.

The Calmfors and Drifill (1988) model presented two scenarios for non-inflationary wage growth. On one side of the u-trough are self-clearing liberal markets. There is no empirical evidence to support this scenario (outside the US and the UK) even if it is deduced to be the most efficient mechanism of coordinating wages (see Soskice, 1990). On the other side of the u-trough are peak level wage bargaining actors who coordinate wages at a national level. This national level coordination is a required incentive for trade unions to internalize the costs of inflationary wage agreements. Most corporatist economies, however, have evolved away from national level coordination. This led many economists to conclude that the advent of the EMU would provide an incentive for the complete deregulation of wage setting akin to self-clearing markets. This did not occur. As illustrated by Crouch (2000), wage setting institutions evolved and adapted to new economic constraints. Most labour market actors adopted an ‘organized decentralization’ (Austria, Germany and Sweden) of collective bargaining whilst some integrated centralized wage negotiations into national tax-based income agreements (Finland and Ireland). Hence, whilst the new monetarist paradigm acted as a stimulus for institutions of coordinated wage setting to evolve, these institutions did not disappear. Wages and labour markets are still institutionally regulated by collective organizations.

The design and intellectual underpinnings of the EMU simply assumes that embedded institutions of collective bargaining do not exist, or if they do, the State and employers can effectively ignore them. No government in Ireland or southern Europe internalized the monetarist constraint that if confronted with a macroeconomic shock, and lacking the capacity to engage in currency devaluation, the entire burden of adjustment would have to fall on wage, labour and fiscal policy. Nor did they provide for collective buffers to offset the negative effects of an economic shock, as provided for in the Finnish income agreements.

Fiscal policy
The EMU was designed for a symmetric pan-European economy but operates in an asymmetric way (see Hancké et al., 2009). The narrow focus on wage-cost competitiveness and fiscal consolidation, central to the prescribed austerity programs in southern Europe, ignores the institutional diversity, complex problems and structural imbalances both across and within eurozone economies. Policy-makers in the ECB assumed that all eurozone economies would converge in both price and wage costs. Most of the evidence indicates, however, that post-EMU, national and regional economies increasingly diverged on these indicators (see Lane, 2009). Countries in the north and south shared a monetary currency but not the corresponding institutional governance required to coordinate economic policy. Market processes alone, and a narrow focus on liberalisation, have proved to be an ineffective means of European integration (see Scharpf, 2011).

From 1999 to 2008, large export countries at the centre of the eurozone (Germany) continued to run current account surpluses. This surplus capital and savings was channelled into peripheral economies of the eurozone (Ireland and Spain, in particular) creating an unnecessary oversupply of credit (facilitated by low ECB interest rates) that was channelled into a poorly regulated domestic financial market, which in turn channelled the cheap credit into real estate, as will be shown in later sections. This structural divergence cannot be accommodated by monetary policy alone. In the absence of a central government or a functional equivalent, each national economy operates as though it is institutionally independent. The crisis in the sovereign bond markets that emerged in 2008, however, provided an exogenous stimulus for all governments in the eurozone to recognize the extent of their financial interdependence and the instability of integrated European finance-capital markets. Yet the policy prescriptions adopted were oriented toward nationalistic austerity packages, not coordinated strategies of collective action to tackle structural trade and labour imbalances that had accumulated since 2000 (see Felipe & Kumar, 2011).

The implicit assumption of the EMU is that economic problems only emerge from budgetary indiscipline, not risky and unsustainable economic behaviour in the private market (see Pissani-Ferry, 2010). The growth and stability pact was designed on the basis that public spending is the primary problem facing national governments. The sovereign debt crisis, however, was the direct result of a collapse in a financial binge that fuelled asset price booms and the associated tax revenues the government had come to depend upon. Both Ireland and Spain experienced an asset price (housing) boom upon entry to the EMU. Non-fiscal asset price bubbles facilitated by cheap credit and low ECB interest rates created this problem, not government spending. Or, more precisely, the problem is not labour costs and government spending but the mismanagement of private capital by private actors coupled with an unsustainable tax base. The ECB, however, operates according to average (mean) indicators of labour costs and inflation across seventeen eurozone economies. Hence, whilst the Irish economy was overheating internally, the ECB continued to cut interest rates to encourage higher levels of economic growth in what was perceived to be the underperforming economies of France and Germany.

Furthermore, during the period 1999–2009, it was Greece, Germany, Italy and France that regularly exceeded the 3 per cent deficit requirement of the growth and stability pact. Ireland went from a stable budget balance to a fiscal deficit of 14.7 per cent in less than two years. Spain went from a stable budget surplus to a deficit of 10.1 per cent in less than 18 months. Spain actually ran a fiscal surplus in 2005, 2006 and 2007 (European Commission, 2010). This begs the question as to whether it is empirically feasible to use the statistical mean of the growth and stability pact, and the new fiscal compact treaty, as a basis for how national economies should manage their budget deficits in an economic crisis. With the exception of Greece, all European political economies, by this ‘fiscal’ indicator, behaved relatively prudently in the post-EMU era.

These fiscal indicators, however, mask the type and level of government tax and spend policies specific to particular national economies. Countries with property booms such as Ireland and Spain did not run a significant deficit but successive governments institutionalized an unsustainable low tax regime based around ‘political budget cycles’ (see Cousins, 2007). Government revenue became reliant upon consumption and pro-cyclical taxes (i.e. stamp duty on property) that evaporated when its liquidity-rich and credit-fuelled housing bubble burst. Furthermore, in the Irish case, successive tax-based incomes policies legitimized this process. The EMU is not designed to tackle unsustainable growth strategies of national economies or the structural composition of tax revenues. It simply assumes that government spending in itself is the problem. Therefore, the European Commission and international rating agencies never questioned the underlying economic growth or fiscal policy regimes of Ireland and southern Europe. They bought into the myth of market convergence.

The narrow focus on fiscal and cost competitiveness (central to European monetary policy and the Troika adjustment programmes) meant that when the crisis emerged in 2008, it was assumed the problems facing ‘peripheral’ economies of the eurozone (Greece, Ireland, Italy, Portugal and Spain) were the same. This was not the case. The Greek problem was definitively fiscal, related to government spending and specific to its own national economy. On the other hand, Ireland and Spain regularly ran budget surpluses and institutionalized a low tax regime that was supported by international bodies such as the IMF and the OECD. Both countries rank below the EU-27 average on two policy indicators that normally impact upon budget deficits: total government expenditure as a percentage of GDP, and total spending on social protection as a percentage of GDP. Total taxation as a percentage of GDP is also significantly below the EU-27. Yet given the neoclassical intellectual underpinnings of the EMU, both countries must cut expenditure to tackle their deficits despite having relatively low levels of public spending as a percentage of national income. The design of the EMU compels policymakers and national governments to pursue austerity even though empirically it is not making the economic problem worse. What is required is an intellectual paradigm change in how we approach economic problems in the Eurozone.

Coordinated Wage-Setting
In a stochastic world, monetary constraints are the primary collective action problem facing countries in the eurozone, not fiscal deficits or wage competitiveness (Darvas, Pissani-Ferry, 2011). But the politics of fiscal adjustment is mediated through country-specific institutions of collective bargaining, industrial relations and social policy regimes (i.e. the historically embedded institutions in the labour market that provide the strategic capacity for trade unions, government and employers to engage with one another as social partners), which I will now examine.

The legal and institutional framework of collective bargaining is the most important variable in accounting for the diversity of responses to the economic crisis across Europe (Glassner & Keune, 2010). It is also the most important variable in accounting for the variaiton in national labour market regimes. National social pacts, as they evolved in Ireland and the southern European periphery in the build-up to EMU, were a particular mode of governance that can be distinguished from sectoral and firm negotiation in wage bargaining. They were a government-led process to involve organized interests in the formulation of public policy but systematically tied to the negotiation of wage restraint in sheltered sectors of the economy (Traxler & Brandl 2010). In the absence of this wage-setting or industrial relations function, social partnership provides an ‘expressive’ function that acts as a symbolic legitimation of government policy (see Traxler, 2010). The social dialogue arrangements of Central and Eastern Europe arguably fall into this latter category.

If government-led wage coordination is a political strategy to coordinate income policy in sheltered sectors of the economy (in particular, the public sector), then it is this form of centralized wage coordination that will come under greatest pressure for downward wage flexibility in the current crisis. Governments faced with the requirement to cut budget deficits have very little to trade with trade unions when public sector pay is a significant portion of general government expenditure. If centralized wage agreements only cover the unionized sectors of the economy (as is the case in Ireland and Italy but not Finland, the Netherlands or Slovenia), then wage-setting excludes the majority of the workforce. It is this structure of ‘inclusive’ and ‘exclusive’ bargaining that conditions whether the social partners adopt a market or collective bargaining response to the crisis. Governments operating within a labour market with ‘exclusive’ bargaining are more likely to pursue a unilateral strategy of adjustment. They can opt out of a social partnership agreement with little repercussion because trade unions have neither ‘carrot nor stick’ to be considered a necessary political partner. Governments only have to engage with public sector unions as an employer.

Coordinated wage bargaining that is inclusive across the economy confers significant bargaining power upon the social partners to negotiate labour cost reductions. This multi-employer type of bargaining (as witnessed in Austria, Germany, and the Netherlands) confers bargaining coverage of over 70 per cent and empowers trade unions and employer associations to coordinate their interests autonomously. Given this institutional structure, labour market actors are likely to use internal (firm/sectoral) and external (national) collective bargaining strategies when negotiating a cost adjustment, despite the constraints of the EMU. In this regard, it is those economies that have exclusive bargaining coverage (only Ireland, Estonia and Slovakia have collective bargaining coverage below 45 per cent in the eurozone) that are more likely to experience a fragmented collective bargaining regime. The microconditions in these labour markets do not act as a counter-force to asymmetric macroeconomic shocks, and limit the capacity to adopt a coordinated response. This is particularly the case when negotiated wage agreements are not just exclusive to particular sectors of the economy but contain no legal requirement on multinationals or small firms to implement negotiated wage settlements. This voluntarist dimension complements a market-based adjustment. Employer associations do not encompass the majority of firms covered by national wage agreements, making tripartite structures of social dialogue dependent upon the political preference of the government. This explains the ease with which the State eviscerated social partnership in many those countries most affected by the Eurozone crisis.

Hence, voluntarist institutions of social partnership that are primarily applicable to unionized sectors of the economy (periphery of the Eurozone), as opposed to inclusive and legally binding institutions of wage setting (core of the Eurozone), weaken the capacity of trade unions to be included as an encompassing actor in the politics of adjustment, and decrease the possibility of a negotiated response to the economic crisis. Higher levels of trade union and employer density increase the capacity for negotiated labour market cost reductions when combined with high levels of collective bargaining coverage. From the perspective of the government and employers, weak institutional foundations in the labour market make it easier for them to avoid social partnership, even if this is less effective than a negotiated adjustment based on deliberative agreement. Employer associations are organized on the basis of business lobby groups and their labour market strategies are primarily mediated by employment rights legislation (i.e. individual-based adjudication rather than collective bargaining).

Conclusion
Liberal market political economies (where market processes act as the main incentive for employment coordination) are supposedly better placed to internalize the macroeconomic shocks in the eurozone (this is not to say it is normatively preferable). In the EMU, only Ireland falls into this category. The neoliberal orientation of the Irish economy makes it easier to implement orthodox adjustment policies as the institutional complementarities governing the labour market, fiscal and wage policy fit the neoclassical design of the EMU. Conflict is primarily mediated through dialogue and adjudication via the voluntarist Labour Relations Commission. This dimension of social partnership has remained intact during the crisis whereas the national consensus-based approach to incomes policy and pay bargaining has collapsed, leading to the absence of coordination and increased deregulation of the labour market.

The  implication is that there is no coordinated approach to the crisis aimed at a series of trade-offs to maintain employment in those countries, such as Ireland, lacking the institutional foundations characteristic of Cordinated Market Economiess (CMEs) in northern Europe. Southern European countries are in the worst of all worlds. They have neither flexible-liberal nor coordinated-market institutions to internalise a coherent labour market response. The outcome of the current labour market adjustment in these countries is to exacerbate the divide between insiders (usually young) and outsiders (usually close to retirement). Whether these countries can develop a new ‘third’ equillibrium is an empiricial question. But presently the conditions for such a social market response are non-existent. This does not bode well for the future employment prospects of those living in southern Europe – and the EMU as a whole.

The Crisis of the Democratic State in Europe

This working paper titled ‘Political Tensions in Euro-Varieties of Capitalism’ argues that the European response to the financial cum fiscal 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 program 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 liberalize their welfare state, cut public spending and impose market conforming structural reforms. The core argument of this paper is that imposing a one size-fits-all neoliberal solution to diverse economic problems across different varieties of capitalism is the real source of the Eurozone crisis. Using a cross-country 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 Southern Europe.

Critical feedback most welcome: aidan.regan@eui.eu

Machiavelli and the Political Response to the Eurozone Crisis

This year is the 500 anniversary of the publication of Niccolo Machiavelli’s Il Principe (The Prince). The European University Institute (EUI) will hold a conference next week to discuss various interpretations of this infamous book. I will present a paper that attempts to ask what Machiavelli would say about the political response to the current Eurozone crisis. It is not an attempt at democratic normative theory but an inquiry into what Machiavelli can contribute to comparative political economy. More precisely it asks why citizens in Europe should comply with external mandates of the EMU.

The paper argues that Machiavelli has been influential in political science because he systematically analysed the strategies pursued by leaders to consolidate their power. In this regard it was shift away from normative to empirical political theory. I argue that political leaders in Europe today must legitimate their policy decisions to the electorate. There are two ways to do this: input or output legitimacy. Input legitimacy means that governments respond to the preference of the electorate by designing policies that satisfy their interests. This is currently lacking for countries in Troika adjustment programs.

In the absence of input legitimacy national governments can legitimate their policies if the outcomes lead to effective performance such as strong economic growth or full employment. The crisis of the Eurozone is a causal outcome of an absence of both input and output legitimacy. The European response has been to promote technocratic economic policies insulated from politics. The lesson to be learnt from Machiavelli is that such a response is not viable. Incumbent governments will be punished by their electorates leading to unprecedented political volatility in the Eurozone.

The paper concludes that it would be perfectly legitimate for heads-of-state in Ireland and Southern Europe to make a credible threat to leave the Eurozone.