Are Europeans starting to accept the need for federalism?
by Philip Whyte
10 October 2012
A more federal language is starting to emerge and there is more acceptance now than there was two years ago that EU widening and deepening may be necessary – says think-tank
The underlying purpose of the 'European project' has always been clearer than its ultimate destination. Its purpose - to escape a traumatic past disfigured by dictatorship and war - has never been particularly contentious. What sane European would want a return to that? But the same cannot be said of the European Union's final destination. For much of its history, the EU has hidden behind the foggy ambiguity of its aspiration to build an 'ever closer union among the peoples of Europe'. The trouble is that this worthy aspiration has always meant very different things to different people. Those of a minimalist disposition, often to be found among the British, have usually understood it to mean little more than the removal of cross-border barriers to the free movement of goods, services, capital and people. Those of a more ambitious bent, more often to be found in continental Europe, have seen the ultimate goal of the project to be some sort of 'political union' however understood.
The eurozone crisis has once again exposed the gulf between British and continental visions of the EU. But it has done a lot more. It has also forced European leaders to speak a little less airily about political union than they have become accustomed to in the past. All agree that the single currency must be embedded in a real political union, if it is to survive. But they are being forced to define their terms. Roughly speaking, two schools of thought have emerged. One, mostly northern European, school thinks that the crisis resulted from errant behaviour. For it - political union means tighter rules, more strictly enforced. The second school believes that the architecture of the eurozone is flawed. For it, political union means transferring a number of critical responsibilities from national to European level. If the first school frets about moral hazard, the second worries about a dearth of solidarity. The first school emphasises collective discipline, the second mutual burden-sharing. Which of the two schools has the better story to tell?
Although Greece is a convincing poster child for the first school, the balance of evidence weighs heavily in favour of the second. To start with, compliance with rules before 2008 turned out to be a poor predictor of countries' subsequent plight. Like Mark Twain's stories, the single currency had its good little boys to whom bad things happened and its naughty boys who prospered. Ireland never broke the fiscal rules before 2008 but is now in a slump, while Germany did and is not. Second, despite having lower levels of debt in aggregate, it is the eurozone, not the United States, which has been in the eye of the storm. Strong evidence that it is the single currency's architecture, rather than the behaviour of its constituents, which is to blame. Third, the more the principle of collective responsibility has been asserted, the worse the eurozone's plight has become.
Efforts to instil discipline have signally failed to restore confidence. The symptoms of this failure are numerous. Financial markets within the union have fragmented as private-sector capital has drained out of countries in the periphery. Long-term borrowing costs inside the union have become unsustainably polarised, pushing systemically important countries such as Spain and Italy perilously close to insolvency. Target two balances within the European system of central banks have ballooned as public-sector capital flows have replaced private ones. Countries experiencing private-sector capital flight have been forced to pursue self-defeating policies of fiscal austerity. Sound banks domiciled in countries with stressed sovereigns have become vulnerable to depositor flight. And so on. The countries under strain partly have themselves to blame. But they are also victims of the eurozone's structure. Spain's borrowing costs are vastly higher than those of euro 'outs' such as the United Kingdom; even though Spain's public finances are in no worse shape. European policy-makers have been slow to accept that the institutional configuration makes the euro structurally unstable.
But in June 2012, the so-called 'gang of four' – a group consisting of the presidents of the European Council (Herman Van Rompuy), the European Commission (José-Manuel Barroso), the European Central Bank (Mario Draghi) and the Eurogroup (Jean-Claude Juncker) – submitted an important plan to set the eurozone on a more stable long-term footing. It marked an important departure, because its focus shifted to correcting the eurozone's architectural flaws rather than the behaviour of its members. The policy areas covered - banking supervision, resolution regimes, deposit protection - may have been dry and technical. But the plan was deeply political. It proposed that the stabilisation of the eurozone required key functions to be moved from national level to European level. It was, in other words, a plan to federalise the eurozone.
Why is the federalisation of certain functions necessary to restore confidence in the eurozone? The answer is not that the tasks concerned will necessarily be carried out more competently at European level - the reverse may even be the case. It is that the existence of federal powers and instruments is both a symbol and a guarantee of member-states' commitment to the union. The reason the eurozone faces an existential crisis while the US does not is not the result of a financial market conspiracy orchestrated by Anglo-Saxons - as some Europeans darkly claim. It is that the single currency's decentralised configuration raises doubts about individual states' commitment to the union. Unlike in the eurozone, bank failures in America did not push any of the constituent states, such as Delaware, into insolvency because the associated costs were mutualised. No one thinks that the parlous state of California's public finances will result in its exit from the US - unlike, say, Greece from the single currency area. A currency union embedded in a fiscally decentralised confederation, it turns out, has been a highly unstable arrangement; particularly in the aftermath of a financial crisis.
The adoption of new rules that constrain national sovereignty have not really helped to restore confidence or stability. Indeed, as new rules have proliferated, the eurozone has come to look less like a single currency and more like a rigid fixed exchange rate system on life support. For much of the last two years, redenomination risk has stalked the eurozone. So the 'gang of four' is right. The eurozone needs a degree of federalisation to persuade investors and depositors that its members are committed to the currency union's integrity and survival. Far from being some obscure technocratic fix, a banking union is better understood as an essential pillar of the sort of political union that the eurozone needs if it is to endure and prosper.
The question, then, is whether the member-states now accept this. The answer is that they are still split. The recent report by EU foreign ministers on the future of Europe - the Westerwelle report - hinted at a number of unresolved arguments between confederal and federal visions of Europe. A striking feature of the report was the number of reservations placed by certain member-states on the proposals of the Gang of Four. On the subject of a banking union, for example, the report said that "some members of the group underlined the importance of a common deposit protection scheme and of a restructuring and resolution scheme". By implication, other member-states still think that such steps are unnecessary. Indeed, the impression created by the Westerwelle report is that there is more agreement among member-states about the need to develop the foreign policy than the economic dimension of political union. If this is what EU leaders end up doing, they risk creating a Potemkin village rather than a political union that stabilises the eurozone.
Words can be made to mean very different things. Since the onset of the eurozone crisis, two meanings of political union have done battle. The first has emphasised collective discipline, or the need for rules that bind member-states. This is the language of confederalism. The other has emphasised mutualisation, or the need for solidarity and common institutions. This is the language of federalism. For much of the last two years, the language of confederalism has dominated: reforms have focused on improving behaviour rather than on fixing the eurozone's flawed structure. But a more federal language is starting to emerge. There is more acceptance now than there was two years ago that rules may be necessary to curb moral hazard, but that they are insufficient to eliminate redenomination risk - and so restore confidence in the eurozone's stability. This view, however, is still far from being universally shared by the member-states.
Philip Whyte is a senior research fellow at the Centre for European Reform think-tank, which first published this article Alice in Euroland: What political union for the single currency?
The underlying purpose of the 'European project' has always been clearer than its ultimate destination. Its purpose - to escape a traumatic past disfigured by dictatorship and war - has never been particularly contentious. What sane European would want a return to that? But the same cannot be said of the European Union's final destination. For much of its history, the EU has hidden behind the foggy ambiguity of its aspiration to build an 'ever closer union among the peoples of Europe'. The trouble is that this worthy aspiration has always meant very different things to different people. Those of a minimalist disposition, often to be found among the British, have usually understood it to mean little more than the removal of cross-border barriers to the free movement of goods, services, capital and people. Those of a more ambitious bent, more often to be found in continental Europe, have seen the ultimate goal of the project to be some sort of 'political union' however understood.
The eurozone crisis has once again exposed the gulf between British and continental visions of the EU. But it has done a lot more. It has also forced European leaders to speak a little less airily about political union than they have become accustomed to in the past. All agree that the single currency must be embedded in a real political union, if it is to survive. But they are being forced to define their terms. Roughly speaking, two schools of thought have emerged. One, mostly northern European, school thinks that the crisis resulted from errant behaviour. For it - political union means tighter rules, more strictly enforced. The second school believes that the architecture of the eurozone is flawed. For it, political union means transferring a number of critical responsibilities from national to European level. If the first school frets about moral hazard, the second worries about a dearth of solidarity. The first school emphasises collective discipline, the second mutual burden-sharing. Which of the two schools has the better story to tell?
Although Greece is a convincing poster child for the first school, the balance of evidence weighs heavily in favour of the second. To start with, compliance with rules before 2008 turned out to be a poor predictor of countries' subsequent plight. Like Mark Twain's stories, the single currency had its good little boys to whom bad things happened and its naughty boys who prospered. Ireland never broke the fiscal rules before 2008 but is now in a slump, while Germany did and is not. Second, despite having lower levels of debt in aggregate, it is the eurozone, not the United States, which has been in the eye of the storm. Strong evidence that it is the single currency's architecture, rather than the behaviour of its constituents, which is to blame. Third, the more the principle of collective responsibility has been asserted, the worse the eurozone's plight has become.
Efforts to instil discipline have signally failed to restore confidence. The symptoms of this failure are numerous. Financial markets within the union have fragmented as private-sector capital has drained out of countries in the periphery. Long-term borrowing costs inside the union have become unsustainably polarised, pushing systemically important countries such as Spain and Italy perilously close to insolvency. Target two balances within the European system of central banks have ballooned as public-sector capital flows have replaced private ones. Countries experiencing private-sector capital flight have been forced to pursue self-defeating policies of fiscal austerity. Sound banks domiciled in countries with stressed sovereigns have become vulnerable to depositor flight. And so on. The countries under strain partly have themselves to blame. But they are also victims of the eurozone's structure. Spain's borrowing costs are vastly higher than those of euro 'outs' such as the United Kingdom; even though Spain's public finances are in no worse shape. European policy-makers have been slow to accept that the institutional configuration makes the euro structurally unstable.
But in June 2012, the so-called 'gang of four' – a group consisting of the presidents of the European Council (Herman Van Rompuy), the European Commission (José-Manuel Barroso), the European Central Bank (Mario Draghi) and the Eurogroup (Jean-Claude Juncker) – submitted an important plan to set the eurozone on a more stable long-term footing. It marked an important departure, because its focus shifted to correcting the eurozone's architectural flaws rather than the behaviour of its members. The policy areas covered - banking supervision, resolution regimes, deposit protection - may have been dry and technical. But the plan was deeply political. It proposed that the stabilisation of the eurozone required key functions to be moved from national level to European level. It was, in other words, a plan to federalise the eurozone.
Why is the federalisation of certain functions necessary to restore confidence in the eurozone? The answer is not that the tasks concerned will necessarily be carried out more competently at European level - the reverse may even be the case. It is that the existence of federal powers and instruments is both a symbol and a guarantee of member-states' commitment to the union. The reason the eurozone faces an existential crisis while the US does not is not the result of a financial market conspiracy orchestrated by Anglo-Saxons - as some Europeans darkly claim. It is that the single currency's decentralised configuration raises doubts about individual states' commitment to the union. Unlike in the eurozone, bank failures in America did not push any of the constituent states, such as Delaware, into insolvency because the associated costs were mutualised. No one thinks that the parlous state of California's public finances will result in its exit from the US - unlike, say, Greece from the single currency area. A currency union embedded in a fiscally decentralised confederation, it turns out, has been a highly unstable arrangement; particularly in the aftermath of a financial crisis.
The adoption of new rules that constrain national sovereignty have not really helped to restore confidence or stability. Indeed, as new rules have proliferated, the eurozone has come to look less like a single currency and more like a rigid fixed exchange rate system on life support. For much of the last two years, redenomination risk has stalked the eurozone. So the 'gang of four' is right. The eurozone needs a degree of federalisation to persuade investors and depositors that its members are committed to the currency union's integrity and survival. Far from being some obscure technocratic fix, a banking union is better understood as an essential pillar of the sort of political union that the eurozone needs if it is to endure and prosper.
The question, then, is whether the member-states now accept this. The answer is that they are still split. The recent report by EU foreign ministers on the future of Europe - the Westerwelle report - hinted at a number of unresolved arguments between confederal and federal visions of Europe. A striking feature of the report was the number of reservations placed by certain member-states on the proposals of the Gang of Four. On the subject of a banking union, for example, the report said that "some members of the group underlined the importance of a common deposit protection scheme and of a restructuring and resolution scheme". By implication, other member-states still think that such steps are unnecessary. Indeed, the impression created by the Westerwelle report is that there is more agreement among member-states about the need to develop the foreign policy than the economic dimension of political union. If this is what EU leaders end up doing, they risk creating a Potemkin village rather than a political union that stabilises the eurozone.
Words can be made to mean very different things. Since the onset of the eurozone crisis, two meanings of political union have done battle. The first has emphasised collective discipline, or the need for rules that bind member-states. This is the language of confederalism. The other has emphasised mutualisation, or the need for solidarity and common institutions. This is the language of federalism. For much of the last two years, the language of confederalism has dominated: reforms have focused on improving behaviour rather than on fixing the eurozone's flawed structure. But a more federal language is starting to emerge. There is more acceptance now than there was two years ago that rules may be necessary to curb moral hazard, but that they are insufficient to eliminate redenomination risk - and so restore confidence in the eurozone's stability. This view, however, is still far from being universally shared by the member-states.
Philip Whyte is a senior research fellow at the Centre for European Reform think-tank, which first published this article Alice in Euroland: What political union for the single currency?
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COMMENTS
I quite agree with Liam. Greece would benefit greatly from a devaluation but it cannot do so. It never should have been accepted in the eurozone. In fact, the eurozone should never have been introduced. It was supposed to be competition to the dollar on the financial market.
So yes, it was a political decision. The Germans themselves are not happy about it - the people who pay the daily bills, not the banks and the governments - they call it the 'teuro' (the expensive-maker).
In the Netherlands too, where a euro used to be 2,20 florins, prices have rocketed to 1 florin = 1 euro. But not the wages. Before the introduction of the euro, there were harsh cutbacks in healthcare, care for the handicapped, education and a rise in taxes.
Then there was a new round of cutbacks and taxes because of the failing banks and home prices. And now there is a third round of taxes because Greece, Spain, Portugal and Italy can't meet their obligations. And in a few years' time Poland and other East European countries will cause a fourth round.
It's not because we are a rich country. We were. Now good education and healthcare are well nigh unaffordable for the hard working middle classes who are slowly disappearing in favour of the rich and joining the ranks of the poor. You never saw so many homeless people, beggars and people without health insurance and people who are dependent on food banks as since the introduction of the euro.
So please don't point the finger the peoples of the northern countries. No one asked them if they wanted the union. On the contrary: the people who were consulted voted against and stayed out of the eurozone.
Suzy
