The Case for a Change of Course in European Policy: by Peter Bofinger, Juergen Habermas and Julian Nida-Ruemelin

Peter Bofinger

The euro crisis reflects the failure of a dead-end policy. The German government lacks the courage to move beyond a status quo that has become untenable. This is why, despite extensive rescue programs and countless crisis summits, the situation of the eurozone has steadily deteriorated over the past two years. In the wake of its economic crash, Greece faces the prospect of leaving the eurozone, which would have incalculable knock-on effects for the other member countries. Italy, Spain and Portugal are all in the grip of a severe recession, which is driving up unemployment. The economic downturn in these problem countries is making the fragile situation of the banks even more precarious, and the growing uncertainty about the future of monetary union is undermining the confidence of investors, who are increasingly reluctant to buy bonds issued by the problem countries. Rising interest rates for government bonds, coupled with the steadily deteriorating economic situation, are hampering the processes of consolidation – which were never going to be easy in the first place.

Juergen Habermas

This self-reinforcing destabilization is largely the product of ad hoc crisis management strategies, which have barely begun to address the challenge of consolidating the European institutions. The fact that the attempts to deal with the crisis over the years have been characterized by a hand-to-mouth incrementalism that has only made things worse serves to highlight the lack of political creativity.

However, the justification for taking a major step forward on European integration does not derive solely from the current eurozone crisis, but also from the need to curb the evil practices of the shadowy parallel universe that the investment banks and hedge funds have built up alongside the real economy of goods and services. This requires our politicians to get a grip and take control again. The measures needed to bring back proper regulation are obvious enough. But they are not being applied, firstly because an implementation of these measures at a national, state level would have counterproductive consequences, and secondly because the regulatory agenda that emerged from the first London G20 summit in 2008 would require globally coordinated action, which for the present is rendered impossible by the political fragmentation of the international community.

Julian Nida-Ruemelin

A major economic power like the EU, or failing that the eurozone, could become a standard-bearer for the way forward here. Only a significant consolidation of European integration can sustain a common currency without the need for a never-ending series of bail-outs, which in the long term would strain the solidarity of the European national populations in the eurozone on both sides – donor countries and recipients – to breaking point. This means, however, that a transfer of sovereignty to European institutions is unavoidable in order to impose effective fiscal discipline and guarantee a stable financial system. At the same time we need closer coordination of financial, economic and social policies in the member countries, with the aim of correcting the structural imbalances within the common currency area.

The Current Problems

The escalation of the crisis shows that the strategy previously pushed through by the German government in Europe is based on a false diagnosis. The current crisis is not a crisis of the euro. The euro has shown itself to be a stable currency. Nor is the current crisis a debt crisis specific to Europe. Compared with the USA and Japan, the EU – and within the EU the eurozone – has the lowest level of debt of all three economic regions. The crisis is a crisis of refinancing affecting individual countries within the eurozone, and is primarily due to an inadequate institutional underpinning of the common currency.

The deepening of the crisis makes it clear that the solutions tried so far have all been found wanting. So the fear is that monetary union in its present form cannot survive much longer without a fundamental change of strategy. The starting point for a change of direction in our thinking is a clear diagnosis of the causes of the crisis. The German government seems to assume that the problems have basically been caused by a lack of fiscal discipline at the national level, and that the solution is primarily to be sought in a rigorous policy of spending cuts by individual countries. At the institutional level the Germans want this approach to be underpinned by stricter fiscal rules in the first instance, supplemented by bailout funds that are quantitatively limited and subject to conditions – thereby forcing the countries concerned to adopt policies of extreme austerity, which have weakened their economies and driven up unemployment.

In actual fact the problem countries have so far failed to limit their refinancing costs to a manageable level, despite extensive structural reforms and a policy of spending cuts that are unusually severe by international standards. The events of the last few months point to one conclusion: that the German government’s diagnosis and therapy have been too one-dimensional in conception from the beginning. The crisis has not come about just because individual countries have behaved badly, but is due in large measure to systemic problems. These cannot be solved by greater efforts at the national level; they require a systemic answer.

The current instability of the financial markets is driven by the risk that an individual country might become insolvent, and that risk can only be eliminated, or at least limited, by collective guarantees for government bonds issued within the eurozone. There are concerns that this could create disincentives, and these should be taken very seriously. The only way to allay these concerns is to ensure that collective guarantees are combined with strict collective control over national budgets. This means, however, that the degree of fiscal control necessary to underpin collective guarantees is no longer achievable within the context of national sovereignty via contractually agreed rules.

The Alternative Options

There are only two coherent strategies for dealing with the current crisis: a return to national currencies across the EU, which would expose each individual country to the unpredictable fluctuations of highly speculative foreign exchange markets, or the institutional underpinning of a collective fiscal, economic and social policy within the eurozone, with the further aim of restoring to policy-makers their lost capacity for action in the face of market imperatives at a transnational level. And looking beyond the current crisis, the promise of a “social Europe” also depends upon this. Only a politically united core Europe offers any hope of reversing the process – already far advanced – of transforming a citizens’ democracy built on the idea of the social state into a sham democracy governed by market principles. For this reason alone – because it leads on to this broader perspective – the second option deserves preference over the first.

If we wish to avoid both a return to monetary nationalism and a permanent euro crisis, then we need to do now what we failed to do at the time of the euro’s launch: we need to begin the process of moving towards political union, beginning with the core Europe of the 17 EMU member countries.

We believe that we should be entirely open about this process. It is simply not possible to retain the common currency without also espousing the idea of collective responsibility and redressing the institutional deficit in the eurozone. The proposal by the Council of Economic Experts to set up a collective debt redemption fund has been rejected by the German government, but its appeal lies precisely in the fact that it puts an end to the illusion of continuing national sovereignty by openly establishing the principle of collective responsibility. It would, however, make more sense to mutualize eurozone debt within the Maastricht criteria – so up to the 60 % threshold, rather than above that level.

As long as European governments fail to state clearly what they are really doing, they will continue to undermine the already weak democratic foundations of the European Union. The battle cry of the American War of Independence – “No taxation without representation” – has a new and unexpected resonance today: once we create scope in the eurozone for policies that result in redistributive effects across national boundaries, European legislators who represent the people (directly through the European Parliament and indirectly through the Council) must be able to decide and vote on these policies. Otherwise we would be violating the principle that the legislator who decides how public money is to be spent is one and the same as the democratically elected legislator who raises taxes to fund this spending.

No Political Communitarization through the Back Door

Nevertheless the historical memory of a unification of the German Reich that was forced upon many parts of the country for dynastic reasons should serve as a warning to us. The financial markets must not now be pandered to with complicated and untransparent structures, while governments meekly accept the imposition on their peoples of a centralized executive power that takes on a life of its own above their heads. Before it comes to that, the people themselves must have their say. As the representative of the biggest donor country in the European Council, the Federal Republic should take the initiative and table a resolution for summoning a constitutional convention. This is the only way to bridge the unavoidable time gap between the immediate economic measures that are due to be put in place, but which can still be revoked in the meantime, and the retrospective legitimation that may be required. If the results of the referenda are positive, the peoples of Europe could regain, at a European level, the sovereignty that was stolen from them by “the markets” a long time ago.

The strategy of treaty change is designed to bring about the establishment of a politically unified core European currency area, which other EU countries – in particular Poland – would be allowed to join. This calls for clear thinking about the political make-up of a supra-national democracy that would allow collective government without assuming the form of a federal state. The European federal state is the wrong model, demanding more solidarity than the historically autonomous European nations are willing to contemplate. The consolidation of the institutions that is now required could be guided by the principle that a democratic core Europe should represent the totality of citizens from the EMU member states, but each individual citizen in his or her twin capacity as a directly participating citizen of the reformed Union on the one hand, and an indirectly participating member of one of the participating European nations on the other.

It is not out of the question that the Federal Constitutional Court will seize the initiative from the political parties and announce a plebiscite to amend the constitution. That would mean that the parties could no longer avoid taking a position on the choice of options that has been kept in the dark until now. A joint initiative backed by the SPD, CDU and Greens to set up a constitutional convention, the results of which could be voted on at the same time as the plebiscite on the constitution (but not before the end of the next parliamentary term), would not then be an unrealistic prospect. This would be the first time that Germany has conducted a public debate of this kind, in which opinions are formed and decisions taken about the different political options for Europe’s future: and we believe there is a good chance that in the course of this debate an alliance of political parties would be able to persuade a majority of the electorate of the advantages of a political union.

A broad Public Debate is needed

The four-year crisis has brought all kinds of issues to the fore and focused the attention of national publics on European questions as never before. One result has been the awakening of an awareness of the need to regulate the financial markets and correct the structural imbalances within the eurozone. For the first time in the history of capitalism a crisis triggered by the most advanced sector, the banks, could only be resolved by governments getting their citizens, in their capacity as taxpayers, to stump up for the losses incurred. At this point a barrier between systemic processes and real-life processes was broken down. The citizens are rightly outraged. The widespread feeling of injustice derives from the fact that faceless market processes have assumed a directly political dimension in the popular perception. This feeling is combined with a sense of rage, suppressed or otherwise, at one’s own impotence. To counteract this we need a new politics of self-empowerment.

A discussion about the purpose and aim of the unification process would present an opportunity to broaden the focus of public debate, which has hitherto been confined to economic issues. The awareness that global political power is shifting from the West to the East, and the sense that our relationship with the USA is changing, combine to present the synergetic benefits of European unification in a new light. In the postcolonial world the role of Europe has changed, and not just with reference to the dubious reputation of former imperial powers, to say nothing of the Holocaust. Future projections backed by statistical data indicate that Europe is headed for further change, destined to become a continent of shrinking population numbers, declining economic importance and dwindling political significance. The peoples of Europe must learn that they can only preserve their welfare-state model of society and the diversity of their nation-state cultures by joining forces and working together. They must pool their resources – if they want to exert any kind of influence on the international political agenda and the solution of global problems. To abandon European unification now would be to quit the world stage for good.

A German version of this column appeared in the FAZ. Translated by Allan Blunden.

  • Peter Davidson

    This comment cross-posted from the Guardian’s “Comment is Free” site
    Many thanks to the authors for this informative article – I’ll summarise my responses thus;
    1. A multi-speed Europe (officially acknowledged or not by political elites) is now a de-facto state of affairs. Within this new political reality the Eurozone (EZ) currently represents the most credible geo-political vehicle for the prosecution of deeper political integration. Britain is highly unlikely to join the EZ at any time in the foreseeable future – next twenty years? – therefore, the UK (and its constituent elements, although some might break away in their own right) will NOT participate in moves towards Deeper European Integration. Effectively, Blighty will remain an interested bystander.
    2. Monetary Union is eventually doomed to failure in the absence of corresponding action to create a true Fiscal Union and ultimately a significant degree of Political Union amongst the participating geo-political constituent elements of said Union
    3. The framework of governance upon which the wider process of European Integration has been premised from the outset, ie. Treaty of Rome et al, is fatally flawed because it does not involve a significant degree of Fiscal Union, let alone moves toward an effective form of Political Union – in short what we now label the European Union has been predicated on a flawed geo-political model; the Europe of Nations template. In the long-term, creation of a sustainable entity requires a radically different model; one which empowers a Federal tier of governance to direct policy of specific (exclusively) pan-European resonance, thus irrevocably reordering the status of all participating geo-political elements (and their relationships) within any new, more deeply integrated European political entity.
    4. Political Union is only sustainable if it is founded upon the bedrock of democracy. Any form of deeper integration must create a meaningful perception of affinity between those who govern and the governed. This relationship does not necessarily require affection but it must display a degree of mutual respect. This form of relationship does not yet exist between the ordinary peoples of Europe and any nascent tier of European governance because the integration process has, to date, been viewed almost exclusively through the prism of individual member (Nation) state constituencies. This general perception cannot evolve until an effective Executive arm of governance, directly accountable to the electorate it purports to represent, actually exists in some meaningful form.
    5. In conclusion, a radically different strategy is required to deliver any, potentially sustainable, European integration process and that different direction can only begin to take effect in an environment boasting far greater public recognition and understanding of Federalist principles; a vastly improved comprehension of the relationship between different fields of governmental activity and their respective geographical impacts. For example, the delivery of education policy is inherently more localised in scope than defence – it is more effective (in democratic terms) to manage some policies at local level than others. Applying this general principle to all areas of normally accepted government activity, ie. in the provision of public goods and services dictates that some policy fields should necessarily devolve downwards to more localised tiers of accountable (through the ballot box) governance and others should transfer upwards to more centralised tiers of (equally) accountable governance – this concept of multi-tiered governance pervades Federalist thinking.

    The general tenor of readers comments (on the Guardian’s Comment is Free webiste) indicate that there is a proverbial “mountain to climb” before the deeper integration advocated by the authors is remotely feasible – whilst the vast majority of those comments emanate from UK citizens it’s likely that this level of public ignorance is replicated across Europe?

    Perhaps the scale of this obstacle (public perception wise) is best demonstrated by an early comment in this thread, posted by @Pagey, 9 August 2012, 14:32 who said:
    There are no “problem countries”, only a single currency that hasn’t worked.
    His/her comment received a large number of endorsements so it cannot be dismissed as unrepresentative?

    Clearly readers currently accept the legitimate exercise of sovereign democratic political power and the political identity associated with said “sovereignty” to be the exclusive preserve of extant, individual Nation States – these geo-political entities are perceived as immutable, fixed for ever in time.

    I can only recommend those (a clear majority of public opinion in the UK?) convinced of the veracity of this circumstance to read chapter one of “Size of Nations” by Alesina & Spolaore, in which they demonstrate with absolute clarity the folly of such flawed thinking?

  • http://www.Steven-Hill.com Steven Hill

    Dear Peter Davidson, I couldn’t agree more. It should be clear by now that a fiscal union must be supported by a well-designed political union. The eurozone crisis has stretched E.U. governance capacities to its limits because the EU’s current political institutions are mostly adequate for a loose confederation of member states; but a loose confederation is inadequate for a monetary union. Europe must begin addressing the political defects as well as the fiscal/monetary defects. Without greater democratic legitimacy, it’s not likely that the European populace will agree to a more integrated economic union. The political union must be influential enough to both facilitate as well as popularly legitimize economic decisions. These are two sides of the same coin.

    In one of my Social Europe Journal columns, I proposed a redesign of Europe’s political institutions in a way that accounts for the de facto two speed Europe. You and others might find it of interest. See “Europe 2.0: A Blueprint for Redesigning European-level Parliamentary Democracy” at this link:

    http://www.socialeurope.eu/2012/04/europe-2-0-a-blueprint-for-redesigning-european-level-parliamentary-democracy/

    All best,
    Steven Hill
    http://www.EuropesPromise.org

  • John Clamp

    Where to start? The Euro was a compromise, and a gamble, from the beginning: Kohl and Mitterand both knew that without swift political and fiscal union the Euro project was doomed. They gambled that political union was achievable, but for good or ill, the Westphalian system proved too robust, European political institutions too weak, remote, and unrepresentative, and most egregiously of all, opted for total political amnesia in relation to Europe’s history. Citizens of its member states, on the other hand, did not forget, and have since 1871 always sought to limit or subvert Germany’s potential for continental hegemony. Political union seems logical from a German perspective; hardly surprising given that the Federation could not be eclipsed by another European power.

    From elsewhere, the view is quite different. ‘Pooling’ sovereignty, to the populations of other European states, broadly means ‘subordinating’ sovereignty to Germany’s undisputed economic and political primacy. Given that virtually all of those other states have a political and cultural unity of much greater longevity than the youthful Federal Republic, the resistance of their populations to political union is understandable, quite excusable, and most importantly, utterly impervious to the misplaced idealism which has dominated the geopolitical discourse of the Franco-German elite since the Second World War. It’s all very well to say that the argument can be made for political union, and that people can be persuaded to agree on the basis of Europe’s diminishing global traction, but the argument has been made, and it has been rejected, quite democratically, in referenda across the continent. A ‘broad public debate’ has been raging without cease for decades, too, and its central concerns are not global but regional. These concerns cannot be rendered peripheral by altering the parameters of the argument, however well intentioned the guidance may be, away from intra-European matters towards intercontinental ones. It is patronizing in the extreme to assert that citizens of European nations are not already cognizant of the global context. They are, and yet they have consistently rated more localized issues of sovereignty and democratic will as being a higher imperative.

    The peoples of Europe rightly view the bureaucratic institutions in Brussels as too remote and unaccountable and do not perceive them to be tractable to their democratic will. The imposition of unelected technocrats in an attempt to untangle the entirely forseeable and widely predicted (particularly by German economists) failure of the single currency, only confirms the people of Europe in their views. They know, because it is quite evidently true, that the Euro was a top-down imposition concocted as a quid pro quo of German unification, and they recognize that the political will which begat the common currency lacked the mandate that derives from commonly agreed political consensus at the grass roots.

    Europe’s polities have not held back in expressing their preferences, either, freely voting in governments across the continent that are, to say the least, ambivalent towards the ‘European Project’. Granted, their opinions may change, but the time frame required for this seismic political shift, which must evolve at the pace of all such shifts – a considered, incremental pace – is too long, given the pressurized political context. Europe, until very recently lauded as an shining example of humanity’s ability to overcome conflict through a sense of shared supranational ethical and political concerns, is rapidly returning to form: anxiety over unacknowledged hegemonic ambitions; economic and political upheaval; social unrest and dislocation; lack of democratic accountability.

  • Arbitrot

    As an American and a KSO (Krugmanite of the Strict Observance), I would say our three estimable authors are smoking something.

    Not that the US is any better off. Indeed, we could really fall of a cliff this November if the Republicans were to get a Democratic “legitmate rape” moment at the wrong time — or Netanyahu were to decide it was time to grant Sheldon Adelson’s wish and drag the US into a war against Iran.

    But no grand scheme is going to help the Euro Zone at this time. Spend your time trying to muddle through — and pray.