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June 29, 2012

Passing the Parcel: Who Will End Up Holding Europe's Democratic Deficit?

Writing about web page http://www2.warwick.ac.uk/knowledge/business/eurodead

It is widely thought that Europe has a democratic deficit (Follesdal and Hix 2006; The Economist 2012). This means that the European Commission and European Parliament exercise powers in the name of a European community and identity that do not really exist. In reality, these bodies are accountable only to national electorates. There are no true European parties, and national electorates make their choices on national, not European calculations. As a result, European institutions hold powers that are neither accountable nor legitimate. This is one source of the current crisis.

Since the Euro is unworkable in its current form, it must change. An interesting question is what will happen then to the existing democratic deficit. Whatever changes, the democratic deficit will not go away. Instead, it will be redistributed across the terrain of the Eurozone. Different upheavals will pass it around in different ways. Two scenarios illustrate the point.

  • Scenario 1

If current proposals for a fiscal union across the present Eurozone are adopted, member states will lose much of their already limited sovereignty over public spending and taxes. Their remaining sovereignty will be pooled in Brussels and Strasbourg. Thus, the democratic deficit will continue to be Europe-wide.

Many citizens will get the feeling that the democratic deficit has widened, but this will be more apparent than real. The democratic deficit will be felt more, because its true scale will have been formalized in new unaccountable powers, whereas in the past the deficit was merely implicit in powers that were often deployed ineffectively. This feeling, however, will be particularly acute in the two poles of the Eurozone, Germany and Greece. This is because German voters will contribute most to the new fiscal transfers against their will, and because Greek voters will lose most sovereignty to new fiscal controls.

  • Scenario 2

Suppose instead that one or more Club Med countries are ejected from the Eurozone, as may still happen. Provided the Euro itself survives, in the Eurozone core the democratic deficit should then shrink for two reasons. First, the required severity of new fiscal controls and the scale of new fiscal transfers within the Eurozone will be less, so Brussels and Strasbourg will acquire fewer new powers. Second, the sense of a shared European identity among the core countries may well be greater than at present, because the national electorates that remain will be those that feel more affinity with Germany.

Under this scenario the democratic deficit may shrink in the core of the Eurozone but expand in the countries that exit. Again there are several reasons. In theory, the exiting countries will regain sovereignty over their own affairs. In practice they will have less sovereignty even than now, because their financial systems and their international credit will have been wrecked in the process. As a result, their voters will face few, if any, good choices. In the face of national humiliation, the voters may well turn to anti-system, anti-democratic parties that will steal power first from the discredited democratic leaders, and then from the voters themselves.

In short, there do not seem to be any easy ways to make good the democratic deficit that has been built into European institutions. At best, all we can do is pass it round.

References

Economist, The. 2012. The Euro Crisis: An Ever Deeper Democratic Deficit. The Economist, May 26. Weblink: http://www.economist.com/node/21555927.

Follesdal, Andreas, and Simon Hix. 2006. Why There is a Democratic Deficit in the EU: A Response to Majone and Moravcsik. Journal of Common Market Studies 44:3. pp. 533-562. Repec handle: http://ideas.repec.org/p/erp/eurogo/p0002.html.


January 31, 2012

The EU Shows the Risks of Selective Intervention

Writing about web page http://www.bbc.co.uk/news/world-europe-16803157

As Europe's leaders leave Brussels with a new fiscal treaty, I found myself thinking back to last June when Nicolas Sarkozy said:

Without the euro there is no Europe and without Europe there is no possible peace and security.

It makes you wonder how we got to this. If true, it would make the well-being and security of all Europeans hostage to the future of the Euro. Yet the euro is a relatively recent invention. It was not around for the first half century of the postwar era. Europe was peaceful and the European Union was working effectively long before the euro was brought in.

Given the model was already working reasonably well without the euro, you could understand Sarkozy to mean that Europe's architects willfully introduced a new feature that, if then removed one day, would bring it crashing to the ground. How dangerous is that!

Confronted by the possibility of eventual Eurozone disintegration, which the new fiscal treaty does not remove, I caught myself thinking:

If only Europe's builders had stopped with the single market.

The single European market, enacted between 1987 and 1992, was a huge achievement. The single market eliminated physical, technical and tax-related barriers to free movement [of goods and people] within the Community. The single market was enforced by tough laws that improved competition. In turn, competition and free trade within the community raised average productivity and incomes.

The European economy wasn't perfect. The common agricultural policy remained a blot on the European rural landscape. There was continual pressure on the member states to harmonize national social, employment, and fiscal policies. Within the single market itself there were still national currencies. The single market was marked by regional price differences arising from exchange rate fluctuations, currency exchange costs, and the lack of transparency associated with pricing in different currencies. The transaction costs alone might have been worth a few billion euros.

But perhaps it would have been better to have stopped there with the single market, and gone on paying those billion-euro costs, than to move on to the next stage of currency unification, ultimately facing today's trillion-euro costs of Eurozone bailouts and possible collapse.

Why didn't we hold the line there? What I forgot for a pleasant moment was the logic of the time. This logic led remorselessly onward from the single market to the single currency.

With hindsight the logic is sometimes portrayed as a simple economic inevitability, as if the single market just demanded to be made even better by a single currency, and would have been forever incomplete without it. "Without the euro there is no Europe"? Not so. There was an inevitability at work, it's true, but this was determined by politics, not economics.

You can think about it on the lines of what Oliver Williamson once called the impossibility of selective intervention. We'd like selective intervention to work like this. We live in a market economy, but from time to time the market fails. Then, when it fails, and only then, we'd like the government to step in and sort it out. When they've done that, we'd like them to stop.

In other words, in the best of all possible worlds, government intervention would be limited selectively to those measures that can improve social welfare over the results of the market economy. That way, surely, we would have the best of everything: the market when it succeeds, and government intervention to fix it when the market fails.

What could be wrong with that? Why can't we have the best of everything? The fundamental reason why selective intervention is impossible can be put like this:

A government that has the power to intervene when it chooses in the interests of the community also has the power to intervene when it chooses to serve its own interests.

In the case of the single market, Europe's leaders once saw an institutional deficit. For centuries, the competing nations of Europe were sources of technological, cultural, commercial, and industrial revolution. Revolution was spurred by rivalry. Too often, rivalry led to war. There was an institutional deficit, Adenauer, Schuman, and Spaak believed, that led European countries to make war, not trade. They decided to intervene to fix it.

The solution they sought was to bind Europe's nations together commercially. The European Economic Community, the forerunner of today's European Union, was the means to fill the institutional deficit that they perceived. But that turned out not to be enough. The next project was the European Union and the single European market.

In the process, they created a self-serving international bureaucracy. The European Commission in Brussels was supposed to oversee the single market. A legislature in Strasbourg was supposed to oversee the bureaucracy. But the lack of a strong popular European identity that could frame political competition on a continental scale led to Europe to exchange one institutional deficit for another.

Instead of an institutional deficit there was now a growing democratic deficit. That deficit became a refuge for politicians that had failed on the national stage or, as we sometimes call them, "elder statesmen." Defeated in a national election? Stand for the European Parliament. Just lost your party leadership? Become a European Commissioner. With a few exceptions these were vain, limited people. Unlimited only in their ambition, they tried to take control of Europe's destiny and shape it in their own interests.

What were the interests that the single currency served? It was another grand project. The worst fate of any political bureaucrat must be to enter office and be told there's nothing to do. Whoever got reelected or promoted by doing nothing? Every politician needs a stream of projects to oversee, institutions to build, offices to fill, and funding to allocate.

For such people, building the single market could never been enough. They needed something more to build after that. The single market was just a phase that added to their momentum. The logic of selective intervention is that nobody tells you when it's time to stop, and there is always good reason to go on. We could never have just "stopped there."

Not knowing when to stop is at the core of the impossibility of selective intervention. Selective intervention is supposed to improve things. And it can do this, up to a limit. But in the real world the limit of improvement is always fuzzy. If the government fixed one thing that needed fixing, this creates the justification for it to go on to fix something else. If that turns out to have made things worse, then this too becomes justification for another fix. There's never a reason to call a halt.

This is how a beautiful dream went too far, and so became a bit of a nightmare.


December 08, 2011

The Euro: What If …

Writing about web page http://blogs.ft.com/the-world/2011/12/eurozone-crisis-live-blog-19/#axzz1fweCvEJB

What if the Euro collapses? There's already more than enough speculation about that. I'm wondering what will happen if the Euro survives.

Since survival is always conditional, let's ask: What happens if the Euro survives the next three years, which should be enough to take us into the next upswing. Also, we know for sure that the Euro cannot survive in its present form, but let's say there is just enough peripheral shake-out (say, a Greek exit), enough extra liquidity (a "wall of money" to shield the other vulnerable countries from contagion), and enough institutional reform (movement towards a fiscal union) that in 2014 a currency union is still in place with most of its current members.

What then? With all eyes focused on financial and fiscal turmoil, the underlying problem is being forgotten: The Eurozone is still not an optimum currency area.

Robert Mundell (1961) first set out the conditions for a group of countries to benefit from monetary integration: He argued that, to make an optimum currency area, the member states must be convergent in at least one of the following:

  • They should experience similar shocks, and respond similarly to them.
  • Or. they should have flexible (high-mobility) labour markets.
  • Or, they should have competitive (flexible-price) product markets.

If these conditions were met, the real exchange rates of the different member states of a currency union would remain aligned. Without them, a structural mismatch would inevitably evolve. Full employment with low, stable inflation in all parts would be impossible. Unless some parts of the currency union would accept rising inflation, other parts would risk permanent depression.

Using forecast bilateral exchange rate volatility with Germany to measure convergence, Bayoumi and Eichengreen (1997) showed that, from the start, many current Eurozone member states did not not "fit" the Eurozone. Encouragingly, they did find a pre-existing trend towards convergence on the part of countries like Greece, Italy, Spain, and Portugal (but not France or the UK).

There was then a short debate about whether the Eurozone might experience continued convergence so that, although not an optimal currency area at the outset, it might become one. Frankel and Rose (1997, 1998) were for. Feldstein (1997) was against. Then, the Euro was launched. For a while everything seemed fine. But we know now that Feldstein was right.

Behind the scenes, with the Euro in place, previous efforts towards convergence stopped. Greece, Italy, Spain, and Portugal moved further and further away from Germany, not towards Germany. This is shown by statistical series from productivity growth to real exchange rates, trade integration, and fiscal imbalances.

In other words, the Eurozone today is no more of an optimal currency area than it was in 1999 when the Euro was launched. The peripheral countries have not made their markets more competitive. With rare exceptions, labour is unwilling to move across frontiers. The economies of the Eurozone remain "otherwise different" in fundamental ways.

Behind current efforts to save the Euro is still the theory that Greece and Italy can eventually be made more like Germany. If fiscal union is not to commit Germany to subsidize the periphery forever, then it can only mean the application of ever more pressure. German prices must be allowed to bear down cruelly on Mediterranean costs. Their public finances must be topped and tailed to fit the Procrustean bed of German frugality. In the face of ever increasing pressure, the culture of the periphery must surely give way.

But this is almost exactly the same theory that was applied from 1999 to the present, and was found wanting. Pressure was tried before; the only difference in current efforts is the addition to "pressure" of the words "ever increasing."

In other words, whatever their short run expedients, in the long run, Merkel and Sarkozy plan to hold the Eurozone together by the exercise of pure will. Just as Europe's leaders ignored the Mundell criteria in 1999, they will continue to do so. They believe politics can trump economics.

Leadership matters. The price tag of a disorderly collapse of the Euro looks large enough that its leaders should try to avoid our having to pay it. But what can one say of leadership into a cul de sac? The willpower required to hold the Euro together in anything like the form currently envisaged is completely lacking in any Europe-wide popular mandate. The belief that Europe's leaders can look each others' national cultures in the face and remake them arbitrarily goes against all evidence.

In short: What if the Euro survives its present stage? Current efforts will buy time, at best. When time has been bought and paid for, the original flaw will still be there. A Eurozone that is sustainable indefinitely will be limited perhaps to Germany, Austria, and Benelux. It might not even include France, however hard that is to imagine. It will not include the UK.

References

  • Bayoumi, Tamim, and Barry Eichengreen. 1997. Ever Closer to Heaven? An Optimum-Currency-Area Index for European Countries. European Economic Review 41:3-5, pp. 761-770.
  • Feldstein, Martin. 1997. The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability. Journal of Economic Perspectives 11:4, pp. 23-42.
  • Frankel, Jeffrey A., and Andrew K. Rose. 1997. Is EMU More Justifiable Ex Post Than Ex Ante? European Economic Review 41:3-5, pp. 753-760.
  • Frankel, Jeffrey A., and Andrew K. Rose. 1998. The Endogeneity of the Optimum Currency Area Criteria. Economic Journal 108:449, pp. 1009-1025.
  • Mundell, Robert. 1961. A Theory of Optimum Currency Areas. American Economic Review 51:4, pp. 657-665.

I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).



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