Reforms in the EU Following Debt Crisis

Many skeptics over the years have doubted the EU’s ability to continue to exist as a supranational organization, built around the common European identity and interests. The skeptics found themselves in a strong position after the financial and the sovereign debt crises that plagued EU member states. However, many still believe that the EU can survive its troubles, albeit with necessary intervention to change the EU’s policies and the powers it projects over member states. EU leaders and policy makers are pushing for more political and economic integration that allows the EU to homogenize budget, spending, and bond policies among member states. Moreover, the post-crisis EU seeks further supervision, and stricter supervision policies, over its member states’ economies and economic policies. Furthermore, the EU seeks tighter banking regulations, with a contest between macro-prudential – with more focus on the larger ’systemic risk’ to the whole EU economy – and micro-prudential – more central oversight over financial intermediaries. In the time that will take the EU to adopt these changes, something needs to be done about the crises in Greece, Ireland and Spain. A short-term policy of bailouts for struggling states is put in place to prevent a country like Greece from defaulting on its debt. Additionally, the EU is using these bailout packages as anchor to effect policy change in struggling countries. The EU, then, is forging its way ahead to becoming a more integrated quasi-federalist system, with the government of the EU taking on more powers, and member states’ borderlines mattering less.

 

Before the European Union attempted to untie monetary policy from fiscal policy, virtually every sovereign country dealt with both as very interconnected matters that couldn’t be separated. The EU decided to break that connection. The founders of the EU decided that a central bank for Europe could manage the supply of currency in the Union while delegating to member states the management of their economies. The founders assumed that uniting monetary policy would lead to voluntary union of fiscal and economic policy[i]. However, as later became evident, member states had very different fiscal policies. While Germany maintained a tight system of checks and balances, the government of Greece was untamed with its budget and spending, and manipulated the numbers to give EU budget supervisors no reason to question the government’s solvency.[ii] The belief that fiscal union would naturally follow monetary union was costly for the EU, as it became evident to the major European powers – Germany and France – and solvent EU countries – like Finland – that their neighbors on the periphery were rather reckless. What needs to be done in the EU is that an agreement has to be reached on how to move forward. Specifically, how to prevent governments from behaving recklessly, like Greece’s did, or banks investing recklessly, like Irish and Spanish banks?

 

            The answer came in member states ceding more powers to the EU. In a momentous step towards political and economic union, EU countries signed the new, reformed version of the Stability and Growth Pact (SGP), which takes the name of Euro Plus Pact (Euro+), which gives the EU the power to review fiscal policies before these policies are put before member states’ parliaments[iii]. In terms of union, the SGP provides the EU with federal powers, with the ability to strike down policies even before parliaments can see them, and potentially dictate fiscal policy for each member state. The policy supervision powers of the EU seem to grant it powers of member states parliaments. It is very clear that members states value the economic benefits of being in the Union more than they pride their sovereignty, which they undoubtedly lost a piece of by giving the EU the power to control their fiscal policies. Further, the pact established the Excessive Imbalances Procedure (EIP) which is a mechanism that allows the EU to conduct “in-depth country studies,”[iv] and measure whether a country is on track to meet its budget, spending, and deficit reduction goals or not. If a country is found to be missing its targets, financial sanctions are implemented to force the country on the right course[v]. Such measure is in order to prevent the budget manipulation that became clear after the Greek debt crisis erupted, and incentivize governments into bringing their budgets in control or otherwise face the penalties. To prevent the reoccurrence of such a crisis, the EU won’t accept budgets as they are presented to it, but will do its own assessment of spending and tax collection to identify manipulation early. With such powers, the EU ceases to be a supranational organization, and increasingly takes the role of a supra-government.

 

            The challenge the EU faces when it acquires such powers is to avoid creating a two-tier EU. Under EU regulations, the countries that can be penalized for not meeting their budgetary goals are euro-zone countries[vi]. Member states such as the UK and Sweden don’t have to abide by these rules, and are subject to less EU scrutiny than euro-area countries, since they don’t use the common currency. Non euro-area countries, for example, don’t have to face a 0.2% penalty if they miss their budget and spending goals, and giving them more leverage in terms of fiscal policy, debt-to-GDP ratio, and a potential competitive advantage over euro-area countries. To make this clearer, a country like Germany, with a stable, strong economy, can and will meet its budget targets with very little budget deficit. While a country like Greece, struggling to overhaul its economy is forced to invest less in public projects in order to meet deficit reduction targets. Already, Greece will be at a competitive disadvantage to Germany, and its competitiveness will be reduced even more when a country like UK has no EU-imposed targets to meet. The risk here is of creating a two-tier EU, in which countries like Greece, which entered the EU for economic competitiveness reasons, are less competitive than euro-area counterparts and non-euro-area EU members countries as well. In essence, this positions the Greek economy on track for another failure. However, the matter hasn’t been settled yet. The debate on how to harmonize the EU-27 is still indeed very live. Certainly, the European Commission is moving in the direction of aligning, at least creating some sort of harmony, all member states’ fiscal policies. I am certain euro-area members along with the European Commission will push non euro-zone members to surrender some of their sovereignty to EU.

 

There is one proposal that has struck as the most far-reaching in terms of political and economic union. Simon Hix, an economic and political analyst and a professor at London School of Economics wrote of the European Central Bank (ECB) establishing a central authority that sells each member state’s government bonds. These bonds will be issued by the ECB, and weighing on the stable economy of countries such as Germany, the bonds will be sold at lower interest rates. At face value, this proposal might be the best option of struggling countries like Greece. However, it completely nullifies the role and authority of member states’ central banks and treasuries, and paves the away for countries giving up more and more sovereignty in the face of economic challenges. Such a proposal would surely be rejected by many member states, first of which is Germany. Germany’s Federal Constitutional Court has struck down more moderate proposals in the past for their unconstitutionality according to the German Constitution. A proposal like this one is likely to be struck down as well, but it is a case in point that proves how strong the political will is behind the more union in the EU. The wave seems very much to be carrying statesmen in that direction. It won’t be very soon before another proposal is put on the table that unites members of the Union ever further.

 

            The political will behind the Union has maintained its momentum extremely well. Many European academic and political voices have spoken in favor of more political union among member states. Analysts, academic and otherwise, suggested EU control to go as far as dictating levels of corporate and personal taxation[vii], strengthening the image that more union is the foundation for a better future. However, a division between the political and academic elites on the one hand, and the masses on the other is widening. The elites are unwavering in their belief that more union is the answer to the economic problems of today, and the safeguard against the economic problems of tomorrow, while the masses have expressed and continue to express their angst against the power politics exercised at the EU level. Some forces for the breakup of the EU have come alive, like the KKE – the Greek communist party. For the EU to move forward, it must navigate the complex of making a sustainable policy framework while keeping the political elite and the masses satisfied. The EU task is further complicated by the need to tighten banking regulations, in the aftermath of the financial crisis of 2008, and the Irish banking meltdown.

 

            Following in the wake of the United States introducing tighter regulations on banks, investment banks and hedge funds, the EU has moved, albeit much slower, to tighten its regulations as well. There are two ways in which the EU is tackling the banking regulation question. First, the macro-prudential way, which focuses more on the systemic risk to the whole EU economy. Second is the micro-prudential way, which focuses on supervising individual financial intermediaries. Among the EU’s first reactions to the crisis was the creation of European Systemic Risk Board, tasked with reducing the ‘systemic risk’ of the whole EU economy, and possibly excessive government budget deficits[viii]. The case of the centralized EU supervision is that it goes long with the cross-border increase in trade, and as new states gain EU membership, it makes sense to have one supervisory body to keep all member states in check. The logic behind it is to have supervision done at the same level as monetary policy. But that approach is problematic in determining where is the line between member states and financial intermediaries (banks) are being accountable to an independent body, and the EU becoming a government that governs a subset of governments. From the literature reviewed, and my own assessment, it becomes clear that the latter case is true, but the EU is taking incremental steps towards uniting all governance under one large body.

 

            The second approach to supervision of financial intermediaries is the micro-prudential approach, which gives the EU even broader supervisory powers. The micro-prudential supervision focuses more closely on individual financial intermediaries, which comes with its own set of problems and questions. The EU has set up three separate bodies to regulate banks, pension and insurance funds, and securities and bonds markets. The EU seems intent, then, on regulating banks across sectoral lines, not borderlines as countries wished. If financial intermediaries are regulated across sectoral lines, this will signal a step in the direction of political, economic, and financial union, since a country’s own supervision of banks operating within its borders will matter less, and essentially become a redundancy, the focus and power of will be given to the EU supervisory bodies. However, the UK has strongly opposed such supervision, fearing that would negatively affect the City of London’s competitiveness[ix]. Germany, on the other hand, is pushing for such integration arguing that supervision of financial intermediaries is critical for a monetary union to work.[x] The issue of micro-prudential supervision is as hotly debated as any other matter, as states hope to maintain their presence in the EU and keep reaping the benefits, while not losing a competitive advantage to each other or other financial centers like Wall Street. In this matter as well, the EU seems to be moving in the direction of more political and economic union. In November of 2010, the European council adopted regulations that established the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA) to regulate all financial intermediaries[xi]. These bodies are equivalent to the Securities and Exchange Commission (SEC) of the United States, and give the EU the ability to project its power over financial intermediaries operating within EU borders with little regard to member states[xii]. The framework of each of these bodies is yet to be finalized, but the intentions are clear, sectoral supervision is moving ahead, eliminating the importance of borderlines between member states, as more states are choosing to relinquish more powers to the EU.

 

            The reforms, new policies, and new regulations being put in place, or tabled for future implementation are rather long-term reforms. Short-term solutions were necessary to save the integrity of the EU and prevent the common currency from being undermined due to Greece, Spain’s or Ireland’s debt problems. The necessary measures put in place were bailouts, which the EU used to achieve more structural and policy reforms in member states. The ECB and IMF agreed on a €110bn bailout package to Greece, after austerity measures and institutional reforms were institutionalized and agreed upon by the IMF and the EC[xiii]. The EU, then, utilized Greece’s need for bailout money to push forward the reforms it wants to see in the country. The EU is taking on a role akin to a country’s own legislative body, or even completely replacing it, since Greece’s parliament was likely, and did pass the required legislations, to receive the funds it knew Greece deeply needed. Moreover, the EU capitalized on the bailout opportunity and created the European Financial Stability Facility (EFSF), a body with €750bn of bailout money at its disposal to help indebted countries. To receive its requested funds, a country has to present to the EFSF its proposed economic reforms. If the IMF and EC, in liaison with the ECB, approve of them, the country is eligible to receive the requested funds.[xiv] Therefore, the EU utilized the debt and financial crises facing some of its member states to institute policy change in these countries. It is acting as an enforcer of policy on member states to make the whole Union more competitive, and more importantly, to give the Union more union.

 

            The debate over whether the EU will be able to weather the pressure of indebted countries continues, and much will be said after the December 2012 summit, and the scheduled reforms of June 2013. Some critics claim that more political integration might make the EU too cumbersome for its own good, but there is enough demonstrated political will to preserve the Union and strengthen its structure. As we have seen throughout this paper, the political will to strengthen the union is taking precedence over the doubt and reforms intended to prevent future occurrence of countries needing to be bailed out are slowly being put in place. As a result of these measures, a more integrated future for the EU looms large, and the Union proves day after day its ability to bring European identity an interest together under one large organization, and the nation-state of Europe becomes less convinces. No analyst or futurist could have predicted this development 70 years ago when European countries annihilated each other in two World Wars. However, we are well into the 21st century, and the European experiment is forging into untested waters of intra-national governance.


[i] Otmar Issing, “The Crisis of European Monetary Union,” Journal of Policy Modeling, 2011

[ii] Philip R. Lane, “The European Sovereign Debt Crisis,” Journal of Economic Perspectives, 2012

[iii] Aneta Spendzharova, “Is More ‘Brussels’ the Solution?,” Journal of Common Market Studies, 2012

[iv] European Commission, “EU Economic Governance,” at EC.Europa.eu

Oct 26 2012 <http://ec.europa.eu/economy_finance/economic_governance/index_en.htm>

[v] European Commission, “EU Economic Governance,” at EC.Europa.eu

Oct 26 2012 <http://ec.europa.eu/economy_finance/economic_governance/index_en.htm>

[vi] European Commission, “EU Economic Governance,” at EC.Europa.eu

Oct 26 2012 <http://ec.europa.eu/economy_finance/economic_governance/index_en.htm>

[vii] Klaus Busch, “The Crisis of the Euro Area and the Need for a Structural Reform,The Journal of the European Left, 2010

[viii] Iain Begg, “Regulation and Supervision of Financial Intermediaries in the EU: The Aftermath of the Financial Crisis,Journal of Common Market Studies, 2009

[ix] Public Policy Research, “Where is the EU Going?” Public Policy Research, 2011

[x] Iain Begg, “Regulation and Supervision of Financial Intermediaries in the EU: The Aftermath of the Financial Crisis,Journal of Common Market Studies, 2009

[xi] Alternative Investment Management Association, “European Supervisory Authorities,” at AIMA.org, 2012 

<http://www.aima.org/en/regulation/asset-management-regulation/supervision/european-supervisory-authorities.cfm>

[xii] Mark Hallerberg, “Fiscal Federalism Reforms in the European Union and the Greek Crisis,” European Union Politics, 2010

[xiii] Otmar Issing, “The Crisis of European Monetary Union,” Journal of Policy Modeling, 2011

[xiv] Otmar Issing, “The Crisis of European Monetary Union,” Journal of Policy Modeling, 2011

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