It is important to make a measured assessment of the European Union reaction to the 2008 financial crisis. A survey of the constraints, response measures and criticisms demonstrates the totality of what has been done: the EU has put in place a multifaceted reform, combining institutional pressure, peer pressure and market pressure. It has changed treaties, legislation, supervision and behaviour. The sum of all these changes is not yet widely perceived
Europe was hit four years ago by the biggest economic tsunami since the Great Depression. Stepping back a little from the tumultuous ups and downs of the current period, it is vital to take account of the road we have travelled. To start with, we must not to lose sight of some of the positives. Europe did at least avoid two of the biggest mistakes that were made in the 1930s: we avoided protectionism - in no small part thanks to Single European Market; and we largely avoided competitive currency devaluations - in no small part thanks to the euro.
Likewise, we must not play down the extent of the constraints under which we operate. Since the 1930s, the main response to an economic downturn has been a fiscal stimulus: deliberate deficit spending by governments to boost demand. Indeed, in 2008, a co-ordinated fiscal stimulus was agreed, which undoubtedly helped. Even now, most EU countries are running significant deficits.
However, the ability to use this instrument is limited, in some countries because of their already excessive (and in some cases unmanageable) debt levels, and in others because of political unwillingness to use this instrument.
The reasons behind the debt problem are diverse. Only Greece is unambiguously the result of gross profligacy in public spending. In others, such as Ireland, (or, outside the EU, Iceland) it is because of large banking sectors, insufficiently supervised, which collapsed and had to be rescued by the taxpayer.
But for several, it is because of debt levels that accumulated gradually over time (leaving most member states with debts well over the agreed maximum of 60% of GDP). They practised Keynesianism in a lop-sided way: deficits during a slowdown were rarely eliminated during peaks - let alone replaced by surpluses. Countries like Italy made little progress in reducing their already dangerously high levels of public debt, even when they had promised to do so when joining the euro. They were left with no safety margin when the crisis hit.
At the same time, we also have governments which do not wish to stimulate their economy, even though they have a margin to do so. They have lower debt levels that would allow them to sustain a deficit for longer, and/or a low deficit level that could be raised for a while. There is a discussion in the EU and at the G20 about Germany’s potential to do more and there is a lively debate in the UK, which went into this crisis with debt levels even lower than Germany, about the speed of its retrenchment. The March European Council conclusions, that “fiscal consolidation…must be differentiated according to member states’ conditions”, may perhaps have added some pressure.
The crisis has also exposed underlying structural problems such as the loss of competitiveness in some countries, asset bubbles, and current account divergences, as well as regulatory problems such as divergent banking rules and insufficiently coordinated financial sector supervision. Member states, for too long, considered such problems to be their neighbour’s problem, not their own. No longer!
The EU response
The debate over the last two years has been about all these issues, but in terms of media coverage has been dominated by the sovereign debt crisis in countries unable to borrow on the market at affordable rates. The potential for contagion, or even worse, a disorderly default, focused minds by threatening major economic consequences in other EU countries - whether inside the euro or not (the maintenance of a separate currency is no protection). No one can escape this interdependence, accentuated by the single market.
Short term measures
In the short run, mechanisms have been set up to lend substantial sums to the countries in greatest difficulty: at first, bilateral loans, then the temporary EFSF and, for the future, a permanent European Stability Mechanism (ESM). This gives the countries concerned more time to turn their domestic situation around.
There has been much comment on the speed of retrenchment in those countries and whether it might be counterproductive. But without the loans, they would have been in a far worse situation. For example, in many cases this has taken the form of an argument about the EU “imposing” austerity on Greece. In fact, eurozone countries and the IMF are to provide another €130 billion (on top of the fist package of €110bn) long-term low-interest loan to Greece, and also helping it secure a write-down of over 50% of its debts to private banks, without which Greece’s situation would be far, far worse. Besides these loans, the ECB has stepped in, buying bonds on the secondary market and lending at low rates of interest to the banking sector.
Long term measures
Addressing the long term is necessary both to avoid repeating past mistakes, and to show that short term measures are not temporary sticking plaster. In that respect, long-term measures also facilitate further short term measures, by providing the necessary assurances for the ECB to be more willing to intervene and for the more reticent member states to be willing to contribute to strengthening the EFSF/ESM “firewalls”. Without the longer term reforms, these short term measures would have been politically impossible, even though it can be argued that more has been done on the long term than has been done to overcome the legacy of the past, where there are, for instance, still questions on the sufficiency of the “firewall” lending mechanisms.
Certainly, the longer term reforms, because they have been cumulative over successive European Councils and EU legislative procedures, have been underestimated. What has been put in place is a set of tools that were totally lacking when the crisis first hit us. They involve a combination of institutional (that is, legally binding) reforms and enhanced peer pressure, in a context where market pressure has also increased.
Institutional and legislative reforms have included:
• Legislation establishing or strengthening common rules for our common market in the financial sector: on capital requirements, legal certainty of securities, derivatives, naked short selling, deposit guarantee schemes, market abuse, UCITS, remuneration principles, and others. These aim notably at increasing transparency, creating a level playing field (single rule book) across Europe, avoiding the multitude of problems (and costs) that arise from divergent standards and rules [and it is worth noting, in light of alleged “threats” to the City of London, that no significant financial sector legislation has been adopted with the UK voting against]
• The establishment of the three financial sector supervisory authorities (European Banking Authority, etc) and the European Systemic Risk Board. We previously left supervision almost exclusively to national authorities, despite having a highly integrated market with vast trans-border integration.
• A requirement that euro area members have a “golden rule” and a “debt-brake”, preferably in their constitution. The transposition of this requirement into legislation (but not annual budgets) can be tested at the European Court of Justice. Member states should not normally have a structural deficit (over the economic cycle) of more than 0.5% of their GDP (or 1% if they have lower overall debts of under 60% of GDP).
• The reform of the Excessive Deficit Procedure (EDP), providing for shorter deadlines, greater focus on debts (and not just on deficits), and on prevention. Furthermore, the procedure is now triggered automatically unless there is a qualified majority against: a reversal of the onus compared to the previous situation where a qualified majority was needed to establish that a country had an excessive deficit, making it all too easy, for larger member states in particular, to organise a blocking minority (as France and Germany did in 2003-2004)
• Adding a new Macroeconomic Surveillance Procedure, looking at other imbalances, recognising that debt is only a part of a wider economic picture. We will now jointly monitor, and act apon, asset bubbles, current account divergences (including surpluses), trends in employment, unit labour costs, etc. This is a key (yet rarely mentioned) development.
• The already mentioned EFSF and the ESM: loans subject to the powerful tool of conditionality.
• Requiring that statistical offices be independent from ministries and that national budgets are based on independent growth forecasts.
Peer pressure has been enhanced, in context where all governments more acutely aware than before of how the conduct of others can have an enormous economic impact on them, notably through:
• The European Semester (comparing economic assumptions on growth, trade, inflation etc before national budget plans are drawn up by governments to present to their parliaments)
• The Europe-2020 programme, on improving key structural aspects of our economies.
• The “Euro-plus Pact” on issues affecting competitiveness (agreed by 23 member states).
• Agreement to consult before the adoption of any major fiscal and economic policy plans with potential spillover effects
• Regular Euro Summits, so that peer pressure will be exerted at the highest political level.
Market pressure will complement the above. The markets slept during the first decade of the euro, rating Greek bonds at the same level as German bonds. Markets may now be over-reacting, but they will not go to sleep again. This in turn enhances institutional and peer pressures, because even a Commission warning could have a market effect.
Some aspects of all this involved treaty changes or new treaties. The ESM required it for legal certainty. The issue of reverse QMV could only be addressed at treaty level, as the treaty itself said otherwise for triggering the EDP (even if subsequent steps could be done by reverse QMV). There was also a desire to entrench the “debt brake/golden rule” at treaty level, as a powerful signal of long term commitment.
These last two elements were included in the “Treaty on Stability, Coordination and Governance in the EMU”. Most member states would have preferred to amend the existing EU treaties, or even the simple revision of Protocol 12. However, as we well know, the necessary unanimity was not forthcoming for this.
Is a separate treaty, not signed by all, a threat to the integrity of the EU? No, it will reinforce it. One of the best descriptions2 draws its inspiration from architecture. The EU and its treaties are like a cathedral - a large solid structure, built to endure. It has chapels inside for the more fervent members (euro, Schengen etc). Crucially, these are inside the cathedral, not outside. We had a problem with a weakness in part of the foundations, but one of the owners would not let us work on them. So we are building a buttress, strengthening the cathedral from the outside. It is not a separate cathedral, nor a chapel, nor a separate building of any kind - it is a means of external support, reinforcing the cathedral that is the EU.
It is worthy of noting en passant that this treaty, as a traditional international treaty, can enter into force without needing all to ratify (so the choice for a hesitant country is whether to join or not, not whether to block or not, bearing in mind that not joining will in due course render it ineligible for ESM loans).
Criticisms of the deficit and debt part of the reforms
Fiscal discipline is not the same as “austerity” - no limits are set on public expenditure, only that it must not be financed by excessive borrowing and debt that risks destabilising your public finances and those of your neighbours. Member states remain as free as before to tax what they want at the level they want (and to choose what to spend on). Excessive debt is anyway undesirable, as it means a greater proportion of tax revenues are spent, not on public services or investment, but on servicing debt. Wasting a high proportion of tax revenue on debt servicing is the ultimate austerity.
“An end to Keynesian economics?”
The debt limit concerns the “structural deficit”-- that is, over the whole economic cycle. There can be higher deficits in slowdowns, but balanced by lower ones (or surpluses) during upturns: a better balanced Keynesianism that prevents the growth of excessive debts which ultimately make Keynesian policies impossible. There is also an exceptional circumstances clause. However, in the immediate, there is, as indicated earlier, a case that certain countries do have a fiscal margin that they are not using sufficiently.
“A threat to national democracy?”
A deficit limit is decided jointly by our democracies, but within that, each one is individually free to choose what to tax, and at what level, and what to spend on. The only exception is where countries have got into such unsustainable debt situations that they require loans, and conditionality is set for those loans (IMF or European). Even then, such conditionality usually focuses on the deficit levels and the timing of consolidation, rather than the content. The exceptional case of Greece should not be taken as typical.
“Not enough focus on growth”
This criticism ignores several of the above mentioned reforms that have not been so prominent in the media, not least the Europe-2020 strategy, and the fact that restoring confidence will itself be of decisive importance.
In addition, with little room (in most countries) for budgetary stimulus to growth, EU leaders agreed in January 2012 to focus on: ensuring that fiscal consolidation is not at the expense of growth-enhancing investment (research, education, training, infrastructure, etc); channelling credit to SMEs; deepening the single market: services, digital market, etc, and the pending decision on patents which can cut the costs of registering Europe-wide patents by nearly 90%; Trade: including new trade agreements with India, Japan, our Eastern neighbourhood etc that have the potential to add €90 billion to EU GDP, as well as taking advantage of the slightly lower exchange rate of euro.
Importantly, monetary policy remains accommodative, with the ECB now more willing (see below). Now that most of the procedural reforms are agreed, the ability to focus on growth and employment will be enhanced. It is vital, as Europe faces the common challenge of ageing societies.
“The firewall is not big enough”
The overall size of the EFSF and future ESM is €500bn. It has easily been enough to cater for Greece, Ireland and Portugal (with EU lending facilities catering for non-euro Latvia, Hungary, Romania etc).
To secure even higher sums from member states (the EU’s own budget is too small) is politically difficult in certain countries, unless there is a manifest urgency. Instead, various schemes to leverage the firewall have been examined. Some have had a degree of success, but others, such as turning it into a bank, or enabling it to draw on European SDRs at the IMF, have been turned down notably by Germany, as have more ambitious ideas for eurobonds. The issue will be re-examined by the end of March.
In the meantime, the intervention by the European Central Bank, first in the secondary bond markets and then through three year cheap loans to banks, have been important. The ECB decides independently, through internal procedures where there are no vetoes. It is by nature cautious, and there is no doubt that it felt more able to act once longer term reforms were agreed.
Criticisms of institutional aspects of the reforms
“It has all been done too slowly”
The need to find consensus - if not at 27, then at 17 or 17plus - on measures that often needed national ratification meant that all this had to be done step by step. Political (democratic) processes are unavoidably slower than markets - that is not a reason to abandon democracy!
The work that had to be done was difficult and very political. The most difficult parts involved convincing public opinions in stronger countries to step in with loans for weaker economies, and convincing public opinions in the latter to accept difficult reforms. It required political courage, illustrated by the fact that more than half of the presidents and prime ministers who chose President Van Rompuy just over two years ago are no longer in office. et, as an American friend said to me: “On these matters, Europe has managed to do more, needing agreement among 27 countries, than the US has done just needing agreement among 2 political parties.”
“Intergovernmental decision taking has undermined EU institutions and procedures”
The European Council normally “keeps out of day-to-day business which the other institutions do much better…springing into action to deal with the special cases – changing the treaty, letting new members in the club, dealing with a crisis” 3.
In the case of this crisis, the Maastricht treaty simply did not cater for the situation. As President Van Rompuy has said, he found an “Empty toolbox” when he took office.It was therefore unavoidable that the European Council was at the centre of decision taking. Much of the action needed and most of the policy instruments are at national level (the EU budget is far too small, just 2% of public spending, and by law balanced). Where EU policy instruments were needed, they often had to be created, needing to be agreed by all and requiring national parliamentary approval.
We were fortunate to have had the Lisbon reforms giving the European Council a full-time President just in time for the crisis - and even more fortunate to have a President who is well versed4 in the subject matter and is so skilled at building compromises from what were very divergent national positions.
Yet this “intergovernmental” road has actually resulted in stronger EU institutions. The Commission has received unprecedented supervisory power and its proposals under certain procedures will now stand unless rejected by QMV. The Court will control the transposition of the debt brake. The European Parliament changed and adopted the EU legislation required, from the so-called “six-pack” on budgetary and macro-economic surveillance (the backbone of the reforms) to the financial sector regulations and the setting up the supervisory authorities. (And its powers to elect the Commission President and to dismiss the Commission become even more significant.) The fiscal compact treaty is subordinate to the EU treaties, and provision is made for its eventual incorporation into them.
A toolkit for interdependence
Almost by definition, no crisis is ever handled “well”: think of Fukushima, Syria, mad cow disease, Katrina, the US deficit, whatever. But if you stand back and look at the totality of what has been done in the EU over last 18 months, it is in fact a lot.
We’ve put in place a multifaceted reform combining institutional pressure, peer pressure and market pressure. We have changed treaties, legislation, supervision and behaviour. Faced with biggest economic challenge for 70 years, Europe did some things right, but the EU initially lacked a toolkit to do anything like enough. We have been building that toolkit, step by step, despite enormous political difficulties. In doing so, we were learning a lesson on how interdependent we all are, whether we like it or not.
Richard Corbett is adviser to the president of the European Council, Herman van Rompuy
This essay is part of Policy Network's publication The future of economic governance in the EU
1.What to call the crisis? The sovereign debt crisis? The euro crisis? The euro as a whole, as a currency, remains stable on exchange markets (unlike the pound which devalued by over 20%), has a far lower overall level of public debt than the US or Japan, has a balance of payments/trade in balance and has had steady low inflation of about 2% since it was launched. None of the countries that are members have expressed any regret or desire to leave.
2 By Dutch philosopher and colleague Luuk Van Middelaar
3 Herman Van Rompuy, Humboldt lecture, Berlin, February 2012
4 For example, he was Belgian budget minister when Belgium had a debt level of 138% of GDP, a situation which he turned around