On the EU reflection paper about euro reform

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On May 31, 2017 the European Commission published its third reflection paper about the future of the integration process. This one concerns the reform of the Economic and Monetary Union.¹ Overall, it is a decent piece of work, one that combines constructive self-criticism, factual accuracy, and pragmatic suggestions for the way forward. The Commission has recognised the shortcomings of the initial EMU setup, has internalised the relevant debates on past mistakes and future prospects, and is showing willingness to act.

While an official document, the reflection paper on EMU reform, reads like an independent analysis of the state of play and of the potential states of affairs.² That is a great positive, for it does not commit the fallacy of withdrawing the EU level from scrutiny. Indeed, reform can only be made possible first by recognising the problems and their source, then by figuring out the best course of action for the promotion of the general good.

As with all of the reflection papers, this one can be found lacking in terms of its overall ambition. The Commission has decided to perform the role of mediator between the various national interests. It is not attempting to set the tone of the debate, but to draw the outlines of any future blueprint on EU/EMU reform. Perhaps this is a sign of pragmatism, where the Commission recognises the central function of intergovernmentalism. Though, given how topics relating to the EMU are either an exclusive or shared competence of the Union (i.e. not just intergovernmental), the Commission’s approach is better described as conformist. It asks for too little, which makes it more likely to get even less from a possible compromise between competing national agendas.

It is in this light that we may develop further thoughts on the themes of this paper and the various elements of a reformed Economic and Monetary Union.

Economic governance needs a central authority

The most apparent persistent flaw of the EMU is its decision-making framework. The rules are supranational, but the political process hinges on inter-state coordination. Macroeconomic policy for the system as a whole does not exist. In its stead lies a set of procedures for coordinating the fiscal stance of the Member States. This “European Semester” is where economic governance takes place. The key word is “governance”, rather than government. It is a [complex and multi-faceted] process, not an institution. EU institutions provide the ancillary functions for the coordination of national positions, but there is no central authority that can claim ownership over decisions and their outcomes.

This creates a certain mismatch between the homogeneity of rules, which apply system-wide, and the heterogeneity of accountability, which remains confined to the national domain. Such sovereignty mismatch, as I have termed it, hampers any effort at fully democratising the EMU. No body of citizens, no one parliament can hold accountable a process of collective decision making. What is needed for making the decisive step forward is a shift in approach, so that economic governance remains a shared competence between the Union and the Member States while being directed from the supranational level.

A special commissioner for EMU governance—or else a European Finance Minister—would be tasked with drawing the macroeconomic policy of the EU, be the one to mediate with the European Parliament and the Council, and be in charge of any future EMU fiscal capacity (including a European Treasury with powers to issue debt—eurobonds—and engage in counter-cyclical spending). That office would also be the representative of the EMU at international settings, such as at the IMF. It would also offer a unique opportunity to repurpose the Eurogroup, by turning it into a formal Council formation (which would, inter alia, address its problems with transparency).

From a normative perspective, the presence of a central authority makes it clear that (i) there is democratic input for executive functions of EMU governance, and (ii) intergovernmental policy making is complementary to a Union-wide, longer-term agenda. In terms of economics, the simplification of procedures and concomitant improvements to the transparency of the EMU architecture, open opportunities for policies that are timely, more efficient, and which properly address issues with a cross-national dimension. Enhanced inter-state coordination alone cannot deliver such tangible benefits, especially since the rules are heavily skewed towards fiscal discipline.

The overarching telos of tight spending at the national level is not a problem per se, provided it is balanced out by active macroeconomic policy at the supranational level. Recessions with cross-country causes require counter-cyclical measures that are taken either in concert between the affected parts, which is practically difficult to achieve, or by a more appropriate authority at the supranational level.

A multi-pronged method of conducting macroeconomic policy can emancipate debates over fiscal matters from the obsession with austerity. National fiscal discipline can only be prudent when it is complementary to proactive EU-wide spending, otherwise it reinforces the downward spiral of recession and prolongs the effects of the economic downturn.

Macroeconomic stabilisation can happen now

There is this notion that the EMU’s reform can only move to the next phase following amendments to the Treaties. While based on a kernel of truth, this view ignores important elements of the existing framework which provide sufficient scope for promoting the common European good.

At first, an EU-level fiscal capacity does not need to be presented as some exotic, far-fetched goal. It already is a feature of the Union’s budget (Multiannual Financial Framework), in particular under the system of own resources. This may not entail powers of running debts/deficits and allocating funds in accordance with the fluctuations of the business cycle, but it does offer the Union means of resource management. The next MFF could, for instance, earmark a portion of own resources for such operations as a system-wide unemployment insurance scheme (an automatic stabiliser). This would technically be the realisation of the much-touted EU/EMU fiscal capacity. What is really needed is political will to act, not Treaty change.

Secondly, and notwithstanding the above, a dedicated fiscal capacity for the EU/EMU could be envisaged in a new intergovernmental agreement, in the same way the European Stability Mechanism came to be. The main upside is the possibility to proceed without reaching unanimity among Member States. A coalition of willing and capable governments is all that is needed. The potential downsides of differentiated integration should be mitigated by a clear commitment to incorporate any new institutional arrangements in the EU acquis, and to maintain a path for other countries to join at a later stage. This is common practice in European politics, from the creation of the euro, to the ESM, and even on matters of security and defence. Again, the challenge is to muster the necessary political will.

The potential of the Lisbon Treaty has not been fully realised. It would be premature to rewrite the Union’s primary law, especially since the main constraints are political. Where Treaty amendments would really be needed is on matters of taxation. Without the power to raise tax revenues, any central fiscal capacity will be contained to the role of a special-purpose mechanism for countering severe economic downturns. Better than nothing, yet leaving much to be desired. Whereas a fully fledged European Treasury could leverage tax policy to achieve convergence during favourable economic conditions, and to decisively ameliorate the effects of an economic crisis by easing the burdens on the most vulnerable parts of the system.

The Banking Union is central to EMU viability

One of the reasons the euro came under threat of collapsing amidst the Great Recession, was the vicious cycle—indeed the symbiosis—between nation states and their domestic private banks. Sovereign bonds were treated as risk free assets (as if there really is such a thing), while core tier capital requirement rules effectively rewarded banks for holding such assets in their portfolios. Governments enjoyed the very favourable climate of low interest rates, while banks leveraged their positions in pursuit of further profits. The resulting interdependence was further compounded by the lack of supranational mechanisms for diffusing risks and distributing the burdens of the crisis in a more even fashion. The supervisory functions of the EU, which include the authorities that regulate banks and securities markets, as well as the macro-/micro- prudential powers of the European Central Bank, were only developed during the crisis when much of the damage was already inflicted.

All instances of the euro crisis contained elements of a sovereign that became exposed to severe market pressures because it bailed out its banks or banks that failed because the sovereign’s bonds no longer enjoyed their risk free status and losed value accordingly. Apart from the case of Greeece and to a lesser extent Portugal, we witnessed the occurrence of phenomena such as in Ireland, Spain, and Cyprus, where the economic shock originated in the financial sector to eventually develop into a broader economic crisis. The much-exaggerated, indeed the stereotypical, character frailty underpinning frivolous spending has little to do with the facts of the EMU’s severely flawed design (the irresponsible spending on “alcohol and women” as Eurogroup President Jeroen Dijsselbloem infamously claimed).

The lesson to be drawn is that differentiation of portfolios is key to ending the symbiotic relationship between banks and sovereigns. Ongoing and envisaged reforms are intended to address previous mistakes, but again there seems to be insufficient political will for delivering on what is truly needed. The idea of bail-in schemes as a default option is sound, but it will not be sufficient in the case of another Great Recession, unless the Single Resolution Mechanism is outfitted with a dedicated fund. Such fund needs to be the equivalent of the ESM for banks, i.e. a last resort of financial support that is contingent on strict conditionality. The kind of sloppy bail-outs we experienced should never again be the preferred course of action.

On the risk diffusion front, the proposed European Deposit Insurance Scheme and the various suggestions along those lines are interesting and fecund. Without such mechanisms, there is no credible way of easing market concerns of any possible ‘tail risks’. These are premia attached to the perceived difference in value between a euro deposited in one part of the euro area, say Greece, and a euro in another part, say Germany. Tail risks are fears of the single currency’s break up and were the primary reason why the ECB introduced its Outright Monetary Transactions.

A fully fledged EMU cannot expect monetary policy to solve problems that lie outside its scope. Risk diffusion must become a priority, both in the immediate sense of decoupling the fates of nation states and banks, and in the broader sense of developing the fiscal capacity of the supranational level to provide for effective solidarity whenever necessary.

Any sign of economic growth should not lead to complacency. The system is still not robust to a range of shocks.

The EMU must become a state

The reflection paper on the reform of the EMU is a solid piece of work on where things stand and what will likely happen over the short to medium term. While the Commission could have elaborated more on such issues as democratic legitimacy and accountability, and on a supranational fiscal capacity, it has made its preferences quite clear. The deepening of EMU integration is a prerequisite to realising the stated objectives of the Union. It also is necessary for preventing another eurocrisis.

What remains constant in the Commission’s publications about the future of the integration process is the lack of ambition. A conformist approach is adopted instead, disguised as false objectivity and indifference to the various scenarios on EU reform. The Commission’s main duty is to promote the good of the Union (the “guardian of the Treaties”), while the Juncker presidency is the first to enjoy democratic legitimation. Providing grist to the mill of intergovernmentalism is not the Commission’s work. Let national governments care for their own agendas.

At any rate, the thinking on EMU reform has enjoyed several years of refinement. There is growing acceptance that the original design was fundamentally flawed and unsustainable and, implicitly, that anything akin to it would be atavistic and misguided. The shared competence between the Union and the Member States on matters of economic governance needs to be broadened in scope and further substantiated. A central authority in charge of system-wide macroeconomic policy is a prerequisite to the democratisation of the EMU. Reforms can be enacted within the existing legal framework for introducing a supranational fiscal capacity with the concomitant powers of macroeconomic stabilisation.

About a decade ago these ideas would be treated as illusory. The prospect of turning the EMU into a state was depicted as a federalist utopia. Apologists of the original EMU design would rather laud the ostensible decentralised Europeanisation that was enabled by their achievement, where monetary affairs were detached from any kind of democratic scrutiny, while the Stability and Growth Pact offered the rules/guidelines for nations to pursue their own policies. An integrated system cannot afford such heterogeneity and path divergence. The eurocrisis proved as much. And it is encouraging that we are moving towards a proper Europeanisation of the relevant policy instruments and institutional arrangements rather than continuing to pursue neoliberal chimeras from the late 20th century.

The Commission’s work has to be recognised as largely positive. It would be even more so if alongside those reflection papers, some thematic documents were also drafted. Perhaps we could get concrete ideas on a European Treasury, a European Finance Minister, the incorporation of the Eurogroup in the wider Council framework, a redesign of the ESM’s governance, and so on. The point is to keep the debate going and to demonstrate that major reforms in Europe can enjoy input from citizens and their representatives at all levels of government. The opportunity to offer feedback such as with this blog post should not be underestimated. The more we discuss the EU and learn about it, the greater the likelihood of improving it.

Reflection paper on the deepening of the economic and monetary union. Published by the European Commission on May 31, 2017. [^]
Perhaps it is worth noting that much of the reflection paper’s content has already been discussed over an extended series of articles on this website. Regular readers will notice as much. Any new ones may want to subscribe to this blog via RSS. [^]