The Troika, Structural Adjustment and Democratic Tensions in the Eurozone

The political and policy response to the Eurozone crisis can be summed up as follows: centralise fiscal and economic authority at European level and impose structural reforms in product and labour markets, to enhance employment and competitiveness, at national level. This structural adjustment is opening up new tensions between member-states of the Eurozone and between member-states and European institutions. The main driver of the new public policy regime is Germany and the ECB-EU Commission.

The new public policy regime is being imposed upon peripheral member-states, and explicitly stated in the Troika structural adjustment programs of those in receipt of financial aid. The political and policy consequences have created a serious democratic legitimation crisis. But to really understand this new governance regime of centralisation and structural adjustment, and the shifting power relations in Europe, we have to examine the conflict between national fiscal, labour market and macro-economic policies in the core and periphery of the Eurozone before and after the crisis.

Understanding the New Eurozone Governance

The overall objective of the structural adjustment program is to create a ‘real’ Economic and Monetary Union (i.e a genuine optimal currency area). This was made explicit in the recent report by the European Council which outlined four integrated frameworks for the future governance of the Eurozone: financial, budgetary, economic and democratic.

The financial framework is aimed at establishing a centralised supervisory mechanism, affiliated to the ECB, to regulate national banking systems. Once this is established the European Stability Mechanism (ESM) will be tasked with re-capitalising failed banks. It will also enable the harmonisation of national bank deposit schemes.The objective is to overcome the balkanization of Eurozone banking. But there is little empirical evidence to suggest that more centralisation will actually improve the behaviour and credit provision of national banks. In Ireland, the government guaranteed the unsecure debt of Anglo-Irish Bank, because of ECB pressure. More centralisation of regulation does not necessarily produce better decision-making.

This attempt to move toward a European banking union, however, is premised on the implementation of the new budgetary framework. This is primarily about imposing fiscal discipline on national governments by granting stronger rules of surveillance, enforcement, compliance and implementation to a centralised European body. The Eurozone crisis has exposed the interdependence of countries within the Eurozone. National governments, it is argued, are incapable of internalizing the consequences of this. Hence, a centralised budgetary authority will monitor the fiscal behaviour of each country to ensure they do not externalize their reckless behaviour on to other countries. The underlying assumption is that fiscal indiscipline and excessive public spending by peripheral countries is the cause of the Eurozone crisis. The only way to resolve this is to build upon the fiscal stability pact and impose discipline from above.

This attempt to move toward a centralised fiscal union, it is argued, needs to be complemented by economic policies to enhance growth and improve national competitiveness. The ‘economic framework’ aims to do this through building upon the ‘macro-economic scorecard’ by imposing structural reforms in national product and labour markets. To achieve this, European policymakers need to centralise their ability to monitor excessive imbalances between member-states. Imbalances are traced to divergences in national competitiveness. Divergences in national competitiveness are traced to a lack of market flexibility in the price of labour and non-tradable goods. Hence, to remove these structural imbalances, member-states are encouraged to engage in a contract with a centralised European authority to impose structural adjustments. Simultaneously, Europe will push for greater coordination in achieving a unified single market.

Finally, the new centralised power of European institutions and their proposed policy of structural adjustment needs to be legitimated. The ‘democratic’ framework aims to do this through enhancing the co-operation between national and European parliament. Article 13 of the Treaty on Stability, Coordination and Governance will enable this dialogue to take place, and subsequently provide the space for national governments to legitimise, ex-ante, the imposition of pre-established economic policies. In other words, the national and European parliament need to find ways to legitimate economic decisions that have already been taken.

So, to summarise, the newly proposed governance of the Eurozone can be described as follows: at national level fiscal consolidation is designed to reduce the budget deficit which is assumed to be a necessary pre-condition for reducing public debt. Structural adjustment in labour and product markets is designed to offset the effects of this fiscal austerity on economic growth. Economic and employment growth is being blocked by national wage rigidity and employment protection. If these are liberalised, it will enable greater intra and inter-labour market mobility (Blanchflower et al 2010)

Making these more labour markets more flexible will reduce the price of wages and encourage employers to re-invest in job creation. The outcome will be a ‘real’ monetary union with centralised fiscal discipline, flexible labour markets, labour mobility and wage/price flexibility. If this sounds familiar then you have probably read an introduction to neoclassical economics: free markets require supply side structural reforms to enhance price flexibility (primarily labour) to offset the effects of a macroeconomic shock. The problem with this assumption of market convergence is that it does not confront the deep structural, political and cultural differences between member-states of the Eurozone.

The newly proposed Euro governance framework, however, is a step-forward in that it recognises that the problems of the Eurozone are internal macro-economic imbalances between core and peripheral regions that have been built up since the establishment of the EMU. The problem is it places all of the adjustment on deficit countries, ignores the real source of the Eurozone crisis: a dualised macro-economic growth pattern in core and peripheral regions of the Eurozone, perpetuates the myth of institutional convergence across radically diverse political economies, and ignores the distributional implications that have to be internalised by the democratic state.

To tease out these tensions in the Eurozone I will examine the conflict between national fiscal, labour market and macro-economic policies in the core and periphery of the Eurozone before and after the crisis.

Understanding the Eurozone Crisis – Macroeconomic, Labour and Fiscal Policy in the Core

The core problem at the heart of the Eurozone crisis is a structural imbalance between export led economies with current account surpluses (Germany, Netherlands, Austria and Finland) and economies with current account deficits (Italy, Spain, Greece, Portugal and Ireland) that emerged after EMU in 2000. This is a structural problem. The divergent trends are usually used to show the under performance of export economies in the Eurozone. But what they actually reflect is an imbalanced relationship within the Eurozone. Ireland and Spain imported more than they exported. Capital flew out of countries were exports exceeded imports, such as Germany, to purchase assets located in countries with the opposite situation – fuelling domestic prices.

Since 2000 Germany’s current account surplus (€192.2bn) is identical to the combined current account deficit of Greece, Italy, Portugal and Spain. This is an internal trade imbalance between regions of the Eurozone. Not every country can be an export economy. A gain for one is a loss for another. These imbalances are usually attributed to the loss of competitiveness in deficit countries (Ireland and Spain) and traced to either the Euro-currency and monetary union itself (Fritz Scharpf, 2011), wage setting institutions (Hancké, 2011) or protected insiders in the labour market (Blanchflower et al, 2011). There is truth in all of these arguments. But none make explicit that it was domestic policies aimed at resolving the problem of aggregate demand in these regions that caused a divergence within the Eurozone. For a detailed discussion on the role of monetary policy and ECB interest rates in fuelling these divergences between core and periphery see Fritz Scharpf (2011), De Grauwe (2011) and Ux, Paul and Febrero (2012).

The most interesting story behind the macro-economic imbalances in the Eurozone were the unintended side effects of structural reforms implemented in Germany since the establishment of the EMU. These can be described as follows: coordinated wage restraint in industrial relations and supply side reforms aimed at loosening employment protection in social welfare. These policies decreased internal domestic demand, increased employer profit and contributed to the impressive current account surplus built up in Germany over the past twelve years. It is only by examining these labour market and wage bargaining reforms if we are to fully understand the macro-economic imbalances at the heart of the Eurozone crisis.

The defining feature of the German labour market (and increasingly across Europe) is dualisation. This manifests itself in different ways in different countries, and particularly pronounced in southern European countries. The labour market changes introduced under the German Hartz reforms(2002-2005) primarily affected the growing marginal and unemployed sectors of society not the core industrial workforce. Labour market changes were introduced incrementally over ten years and led to an explosion in ‘mini-jobs’ – state subsidised low wage employment. Government led supply side reforms were an attempt to tackle unemployment and low levels of economic growth. But it led to a paradigm change in the German welfare state. Flexible employment contract expanded, low wage jobs grew, and unemployment benefits cut. This liberalisation prepared Germany for the impact of a maro-economic shock in the EMU – a flexibilised labour market.

In terms of wage policy. Centralised union and employer confederations complemented the government led reform agenda by instituting an aggressive regime of wage restraint. This was achieved through collective bargaining with the implication that German employees have not had a real wage increase for over fifteen years. Employers were given greater scope to opt out of collective agreements, leading to a paradigm change in German industrial relations. This negotiated adjustment (or social partnership) was used again during the 2008-2010 recession. Employers and unions negotiated a reduction in working time as a mechanism to avoid an increase in unemployment. These schemes were primarily used by the core workforce in the engineering, chemical and metal fabricating sectors.

The general point is that these fiscal, social and labour market policy changes facilitated a shift in the German macro-economic growth model away from domestic demand toward export market expansion. Similar policies were pursued in the Netherlands, reflected first in the 1999 law on flexibility and security, and various tri-partite agreements since then. This require a significant shift in the underlying policy bargain of trade unionism in these countries, with a very public and political split in the Netherlands. The emergent trajectories of liberalisation, underpinning this process of institutional change has led to what Wolfgang Streeck describes as the ‘transformation of the Germany’s political economy’. Germany adapted to the constraints of EMU and global market competition by shifting toward a neoliberal economy. But they did it through a democratic dialogue within society.

In Ireland and Spain, the opposite occurred. Their macro-economic growth model shifted toward domestic demand and away from market expanding exports. The sudden surge in cheap money was made possible because of low ECB interest rates and de-regulated property, mortgage and finance markets. Capital inflows from the export driven core fuelled a domestic construction boom. Full employment, an expanding labour force, inward migration and unprecedented fiscal resources led to a loss of competitiveness in states. This was less an outcome of wage bargaining institutions, inflexible labour markets or a one size fits all monetary policy but differential rates of growth in domestic demand. We will now assess the trajectory and process of labour market reforms introduced since the crisis in these countries.

Responding to the Crisis – EMU Imposed Fiscal Austerity and Structural Reforms in the Periphery

Employment creation has been the core challenge facing Ireland and Spain since the 1980’s. The post-EMU construction enabled full employment in both countries, even leading to labour shortages. Most reforms have focused on passive rather than active measures. In terms of the Spanish labour market, most of the policy has focused on ending the duality between temporary/fixed term and open-ended contracts, whilst enabling more opening clauses in sectoral based collective bargaining. From 2000-2008, some changes were made to these policy areas, enabling more wage flexibility. But, in general, when compared to what happened in Germany, very little change occurred.

Since 2008, and under increased vertical pressure from Europe, Spain has adopted a structural reform agenda to liberalise its labour and industrial relations regime. Since 2010, the focus has shifted away from policies to enhance the hiring of new employees to policies enabling the firing of employees, primarily through a reduction in collective dismissal costs. Individual firms can opt for company level negotiation, moving the industrial relations regime away from sectoral based collective bargaining. The government have also introduced a new open-ended contract for the promotion of entrepreneurship. All of the focus is supply side reforms despite the fact that Spain is suffering from a crisis of demand. Youth unemployment is 52 percent, the highest ever recorded in Europe.

In Ireland, the employment crisis, much like Spain, has been directly associated with a collapse in demand. The policy reforms, much like what occured in Germany since 2002, is firmly focused on introducing stricter conditions for unemployment benefit, reducing employment protection, and pursuing an internal devaluation through either holding down labour costs or directly cutting wages. The average public sector pay cut has been 18 percent. The tradition of negotiated adjustment between the social partners on labour market and industrial relations reform has been scrapped in favour of unilateral legislation, under the political cover of the Troika structural adjustment program.

Conclusion – The Democratic State in Crisis

Coordinated fiscal austerity and unilaterally imposed structural reforms are leading to an input and output crisis of the democratic state in Europe (Scharpf, 2012). The reforms are being imposed from above (input crisis) yet are not leading to an improvement in economic and employment growth (output crisis).  ‘Responsible’ governments are not responding to the interests of citizens but internalising the policy preference of unaccountable external actors (IMF-ECB-EU) . The outcome is the implementation of what can only be described as ‘irresponsible’ economics, particularly in relation to employment.


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