The European Union beyond the Crisis: Evolving Governance, Contested Policies, and Disenchanted Publics 1498503470, 9781498503471

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The European Union beyond the Crisis

The European Union beyond the Crisis Evolving Governance, Contested Policies, and Disenchanted Publics

Edited by Boyka M. Stefanova

LEXINGTON BOOKS

Lanham • Boulder • New York • London

Published by Lexington Books An imprint of The Rowman & Littlefield Publishing Group, Inc. 4501 Forbes Boulevard, Suite 200, Lanham, Maryland 20706 www.rowman.com Unit A, Whitacre Mews, 26–34 Stannary Street, London SE11 4AB Copyright © 2015 by Lexington Books All rights reserved. No part of this book may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without written permission from the publisher, except by a reviewer who may quote passages in a review. British Library Cataloguing in Publication Information Available Library of Congress Cataloging-in-Publication Data The European Union beyond the crisis: evolving governance, contested policies, and disenchanted publics/edited by Boyka M. Stefanova. pages cm Includes bibliographical references and index. ISBN 978-1-4985-0347-1 (cloth: alk. paper)—ISBN 978-1-4985-0348-8 (electronic) 1. European Union—History—21st century. 2. Global Financial Crisis, 2008–2009. 3. European Union countries—Economic conditions—21st century. I. Stefanova, Boyka, 1960– JN30.E94152 2014 341.242’2—dc23 2014037456 ™ The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences—Permanence of Paper for Printed Library Materials, ANSI/NISO Z39.48-1992. Printed in the United States of America

Contents

List of Tables List of Figures and Graphs

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1 Beyond the Crisis: Governance and Politics in the European Union between Crisis and Opportunity Editor’s Introduction by Boyka M. Stefanova Part I: European Governance in a Time of Crisis: Limitations and Prospects of the EU’s Economic and Monetary Union 2 Collaborative Federalism in the European Union: Intergovernmental Relations and the Allocation of Powers in the Economic and Monetary Union Robert Csehi

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3 Trust and Currency: The Functional Preconditions and Problems of the Euro Jenny Preunkert

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4 European Monetary Union or European Clearing Union: An Application of Keynes to Regional Monetary Systems Ashley A. C. Hess

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5 Why The Euro Will Survive: The Institutionalization of Accepted Policies through Key Actors Leif Johan Eliasson

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Part II: The Politics of Crisis Response: European Governance Meets Public Policy 6 The Sovereign Debt Crisis, Bailout Politics, and Fiscal Coordination in the European Union Hilary Appel and Carissa T. Block v

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7 A Discernible Impact? The Influence of Public Opinion on EU Policymaking During the Sovereign Debt Crisis Jennifer R. Wozniak Boyle and Chris Hasselmann

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8 Informal Governance and the Eurozone Crisis145 Alexandra Hennessy 9 Coping with Financial Crisis: Crisis Response, Institutional Innovation, and the Variety of Finance Capitalism in Italy and Spain Boyka M. Stefanova

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10 EU Affairs in Spanish Electoral Competition at the Height of the Crisis Cristina Ares Castro-Conde

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11 Testing the Resilience of Civil Society: The Euro Crisis, Portugal’s Welfare State, and the Third Sector Miguel Glatzer

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Part III: Democratic Politics in the Context of Crisis: A Citizens’ Perspective

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12 Public Attitudes and Support for the EU in the Wake of the Financial Crisis Jennifer R. Wozniak Boyle and Chris Hasselmann

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13 Implications of the Greek Crisis: Nationalism, Enemy Stereotypes, and the European Union Zinovia Lialiouti and Giorgos Bithymitris

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14 Identity and Economic Rationality: Explaining Attitudes towards the EU in a Time of Crisis Simona Guerra and Fabio Serricchio

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15 People’s Perceptions of the European Union and the Effect of the Crisis: A Persistent East-West Divide? Borbála Göncz

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16 Satisfaction with Democracy in Times of Economic Crises Evelyn Bytzek

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Index333 About the Editor 339 About the Contributors 341

List of Tables

Table 4.1 Table 7.1 Table 7.2 Table 7.3 Table 7.4 Table 7.5 Table 9.1 Table 9.2 Table 10.1 Table 10.2 Table 10.3 Table 10.4 Table 10.5 Table 10.6 Table 12.1 Table 12.2 Table 12.3 Table 12.4

ECU-GB Voting Rights, per Country 76 Public Support for EU Financial Assistance to Greece 127 Public Support for EU Financial Assistance for all 130 EU Member States Public Support for Deficit Reduction v. Job Creation 130 Public Support for Enhanced Economic Coordination 134 Public Support for Regulation of the Financial Industry 136 Mediobanca: A Persistent Model of Cross-shareholding in the Process of Reform 177 Foreign Investment in Italy during the Financial Crisis, 2011–2012178 Coded Programmatic Proposals on Economic and Monetary Affairs and the Euro 197 Coded Programmatic Proposals on Tax System 199 Coded Programmatic Proposals on Agriculture 200 and Rural Development Coded Proposals Introduced by M. Rajoy and A. P. Rubalcaba in the only televised debate 204 (2011 Spanish General Election) Coded Proposals Published in the Twitter Accounts of M. Rajoy and A. P. Rubalcaba (2011 Spanish 205 General Election) Classification of Party Proposals on EU Affairs  208 A Timeline of the Crisis (2007–2011) 234 Multilevel Models of Support for the EU 239 Variables with the Largest Change in Effect 240 on Support for the EU: 2011 vs 2007 The Actor Most Able to Take Effective Action 241 to Combat the Crisis vii

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List of Tables

Table 12.5 Regulation of the Financial Industry (2011) 242 Table 14.1 Socio-demographic Correlates of European Support (0–10 Scale)  276 Table 14.2 Correlates of European Support (0–10 scale) 277 Table 14.3 OLS Regressions: West and East, Italy and Poland 282 286 Table 14.4 Hypotheses and Findings Table 14.5 Description of the Variables 287 Table 15.1 Trends in Support towards the EU at the Aggregate Level (2004–2011, OLS regression, unstandardized coefficients)307 Table 15.2 Determinants of Support towards the EU at the Aggregate Level (2004–2011 pooled data, OLS regression, unstandardized coefficients) 310 Table 16.1 Summary of Explanatory Variables 324 Table 16.2 Change in Satisfaction with Democracy by Country 325 Table 16.3 Comparing Perceptions of the Economic Situations to Real-world Developments 326 Table 16.4 Results of Logistic Multilevel Regression Models 327 Table A16.1 Relative Change in Explanatory Factors 329

List of Figures and Graphs

Figure 6.1 Figure 6.2 Figure 8.1 Figure 8.2 Figure 8.3 Graph 10.1 Graph 10.2 Graph 10.3 Graph 10.4 Graph 10.5 Graph 10.6 Figure 12.1 Figure 12.2 Figure 12.3 Graph 13.1 Graph 13.2 Graph 13.3 Graph 13.4 Graph 13.5 Figure 13.6 Figure 14.1 Graph 15.1

Large Country CIT Revenue (% of GDP) Small Crisis Country CIT Revenue (% of GDP) Politicians’ Approval Ratings Most Challenging Problems Parties’ Competence as Crisis Managers Evolution of Spanish Parties’ Aggregate Position on the EU Evolution of Individual Spanish Parties’ Positions on the EU Evolution of Partido Popular’s Position on the EU Evolution of Partido Socialista’s Position on the EU Programmatic Proposals on EU Affairs Partido Popular (PP)—Main Categories (2011 Spanish General Election) Programmatic Proposals on EU Affairs Partido Socialista (PSOE)—Main Categories (2011 Spanish General Election) Declining Support for the EU Change in Support 2011 vs 2007 The Declining Trust in Political Institutions The Image of the EU in Greece Levels of Trust Concerning the EU EU Membership Assessments Exit Scenarios and the Feeling of Closeness to Other EU Citizens Levels of Trust and Attachment towards the EU by Professional Category (Greek respondents only) SYRIZA’s Poster for the 2014 European Elections EU Support (1992–2011) Economic Performance of EU Countries in 2004 and 2011 ix

115 115 153 154 156 193 194 195 196 202 203 236 237 244 254 254 255 256 256 259 280 298

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List of Figures and Graphs

Graph 15.2 Trust in Government in the EU Member States in 2004 and 2011 (%) Graph 15.3 Perceptions of the European Union in the 27 Member States, 2004–2011 (%, weighted data) Graph 15.4 Perceptions of the European Union by Country, 2004–2011 (%)

299 300 301

Chapter 1

Beyond the Crisis Governance and Politics in the European Union between Crisis and Opportunity Editor’s Introduction by Boyka M. Stefanova

By the end of 2008, most of the European Union had entered a deep recession caused by an increasingly globalized financial and economic crisis. The crisis ushered in an exceptional new period in European politics. It brought about unprecedented economic decline, banking crises, financial and sovereign debt crises, and anti-austerity protests which led to the collapse of governments and parliamentary majorities. The crisis was a challenge and a puzzle for the social sciences to understand and to cope with. The history of the European Union has known a variety of crises of institutions, policy, and public trust. It has been traditionally regarded as a system suffering from chronic democratic deficit. But no critical event so far, from the empty chair crisis to the failed referendum on the EU Constitutional Treaty, has simultaneously affected all three domains of public life in the EU and its member states—institutions, policy process, and polity—as intertwined systemic developments. The political dynamics emerging as a result of the crisis have been significant, reflected in the politicization of crisis response, removal of traditional methods of policymaking and reform, and increased levels of contestation in the polity. The reduction of policy space as a result of austerity policymaking represents a major challenge for European societies and the functioning of democratic politics. Changes in electoral and party politics have altered the way in which politicians interact with the executive apparatus of the state. Elite effectiveness in steering societal and economic actors has declined. In the wake of that critical test of social, economic, and political systems, policy makers and academics should be (and they, hopefully, are) asking the right questions—not just learning the lessons from the ways the crisis response was mobilized and implemented, or whether it had success in helping the EU and its member states adjust and reform. While these are legitimate areas of inquiry, the continuity versus change dichotomy recasts the crisis into 1

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an event of success or a failure of transformation: either working within established models or introducing new tools of governance. Such dichotomous thinking does not change the underlying assumptions of actor- or structurally based theoretical thinking: either that political actors adopt a model of rational adjustment, or that economic policies are structurally defined and reflect the interdependencies of the European economies. Consequently, a type of “one size fits all” reform may be necessary and a federal Europe may be in the making. Alternatively, the comparative institutionalist varieties, reflected in the varieties of capitalism (VoC) framework, demonstrate that national differences matter and that national structures and legacies resist the push toward convergence. What we have observed is that the interests of political elites selectively filter both the top-down pressures and homogenizing dynamics of Europeanization and bottom-up demands for more Europe, as shown in case studies of domestic policies of reform and adjustment. How do crisis politics take place? Is public policy the result of democratically aggregated public preferences, validated through the electoral process, or is it a directly imported EU-negotiated blueprint for domestic reform? How successful are the electoral strategies of elites in gaining public support for austerity and reform? Scholars and policy experts alike are intrigued by such questions, as well as numerous others, all worth exploring and finding answers to. But if we ask the question about what is most important to Europe, to preserve and safeguard at a time of crisis, and maintain as a system of crisis response and transformation, then, undoubtedly, we should focus on three points: the EU institutions as the anchor of Europe’s organized society, the domestic policy process, indispensable to the provision of public goods, and the democratic political order whose legitimacy is maintained by the European publics. Led by such considerations, this book aspires to look beyond both a critical-issue approach to the crisis and a comprehensive study. It builds an argument that, while there is no single focal point of crisis, notwithstanding the Euro—or the Greek crisis, we should focus our analysis on the EU institutional order, and especially the Economic and Monetary Union (EMU), the capacity of public policy to provide public goods, and the quality of democracy in Europe. Moreover, we propose to expand the analytical boundaries of those systems and treat them as interrelated arenas. Following such premises, this book provides a post-crisis perspective on European politics by studying interactions within and among domestic and EU political spheres: the institutional setting of European governance in the post-Lisbon environment, profoundly reshaped by the economic and financial crisis since 2007, domestic policymaking and its relative embeddedness and disconnect from EU templates and institutionalized interaction towards less formal models of rule-making, reform, and leadership, and the public perspective on the crisis reflected in crisis-driven responses and long-term trends



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in European public opinion. The contributions to this volume address concrete aspects of all three domains: EU institutions, domestic policymaking, and public opinion. They focus primarily on the political dynamics associated with the policy decisions and outcomes of crisis response. While insightful and necessary, research to date has not examined the connection between the policy response and public reactions to the crisis. The majority of published work stops short of examining public preferences and political attitudes as an integral dimension of the study of crisis response. While most observers concur that national and especially EU-level democracy is not a meaningful reality or an anchor of legitimacy for many European citizens, such perceptions have not been systematically studied in parallel with institutional and policy trends. What is the public perception of Europe? Has the crisis further delegitimized the EU, or has the public realized that the EU is not a direct threat to national sovereignty and the welfare state but is rather another resource of crisis response, bailout, and opportunity; in short, a renewed version of the European rescue of the nation-state?1 This introduction outlines the rationale and objectives of the book in illuminating the consequences of the post-2007 crisis for governance and politics in the European Union. It conducts a preliminary review of the literature on the crisis at the intersection of economic, institutionalist, and policy approaches, and provides an outline of the main themes and their significance. It then turns to examine the analytical advantages of the proposed tri-partite framework for the examination of politics and governance in the European Union in the wake of the crisis as the meeting place of institutions, policy processes, and democratic politics. A separate section discusses the topics, cases, and methods of inquiry. The last section presents the structure and content of the chapters that follow. Untangling the Policy/Politics Nexus in a EU Context The growing literature on the European and Eurozone crisis will benefit from a more systematic account of the politics of crisis response. The first wave of publications on the crisis (2009–2012) explored its origins and evolution, as well as the policy means to address it. This research tends to emphasize the general causes of the crisis embedded in global and regional economic imbalances, the experience of governance failure to restore an economic equilibrium, and the relative capacity of the EU and of the national level of decision-making to resolve macro- and socio economic problems. Most studies provide an international political economy, an economics, or a policy perspective on the crisis (Arestis and Sawyer 2010; Berend 2013; Cline

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and Wolff 2012; Haynes 2012; van der Noord and Székely 2011; Reinhart and Rogoff 2009). More recent work has turned to the study of institutional change and policy reform (Borooah 2014; Della Posta and Talani 2011; Laursen 2013; Moschella and Tsingou 2013; Rodriguez and Xiarchogiannopoulou 2014), the internal-external nexus of the consequences of the crisis (De Bardeleben 2013), and its political implications (Kröger 2014; Lapavitsas 2013; Petrakis 2014). At the policy level, the political approach now seeks to understand the contextual determinants of political decisions. However, most studies remain focused predominantly on institutional and policy responses, such as the successes and failures of innovation, regulation, and reform (Archibugi and Filippetti 2012; Arestis et al. 2011; Bilbao-Ubillos 2014; Burroni et al. 2012; Della Posta and Talani 2011). The link between the institutional and policy arenas, on the one hand, and democratic politics, on the other, has so far remained under represented in scholarly publications (but see Bastasin 2012; Schäfer and Streeck 2013). Schäfer and Streeck (2013) examine democratic politics from a supply-side perspective. They discuss a variety of social systems and functional domains, such as public finance and tax systems, the EU monetary union, institutions, political parties, and the rule-making structures of economic liberalization. Similarly, Burroni et al. (2012) study the impact of the crisis with regard to their social impact, the evolution of social institutions, in particular in domains such as industrial relations, welfare regimes, families, the labor market, universities, and local governance. These analyses provide an assessment of the consequences of the crisis for democratic capitalism, but rarely address the citizens’ perspective outside insights into the pressures and limitations that the crisis response has imposed on democratic politics. The politics of crisis response, however, is more than elite bargaining at the EU and national level. It also reflects the citizens’ preferences and responses to policymaking and trust in the democratic institutions responsible for it. Rationale A political approach to understanding the crisis and its consequences is analytically appropriate. Bastian (2012) has argued that there was no invisible hand behind either the escalation or the resolution of the crisis, and that the crisis of the Euro was a story of developments in politics, not only markets. Bastian (2012) reaches the conclusion that more EU political integration is required, as politics is intertwined with economics at every stage of the evolution of the crisis. Petrakis et al. (2014) share the view that transforming the EU into a political federation is necessary.2 These analyses, while political in nature, are primarily elite-centered. Very few studies have so far integrated the citizens’ perspective on the crisis,



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outside case-study research and regionally focused editions on electoral politics and anti-austerity protest (Bosco and Verney 2012). Studies of public opinion have remained isolated from the discussion of institutional change, policy reform, and electoral politics (Kröger 2014). We believe that considerable work remains to be done in order to broaden our understanding of the wider implications of the crisis for key social and political actors and for the quality of democracy in Europe. This volume aspires to significantly advance such examples of politically focused analyses by introducing the third political dimension, that of European public opinion and the democratic legitimacy of public policy, and by presenting it as integral to the crisis and the politics of crisis response. To what extent is the relationship between the European and the domestic level of policymaking defined by the imperatives of EU-level regulations, and to what extent is policy the result of a democratic process, reflecting the preferences of the European citizens? What have been the main social and political responses to the crisis? Which actors have been empowered, or have acquired or lost legitimacy? Answering these questions requires a political understanding of European governance and national policymaking as a crisis response. The political dimension of the crisis, reflected in increased levels of contestation in the polity, lack of public trust, and rising Euroskepticism has the potential to significantly undermine the legitimacy of policy decisions and the institutional and policy responses to the crisis. The core of our approach to examining the EU institutional and governance process, national public policy, and public response to the crisis is the proposition that the EU system of governance, national policymaking, and democratic politics constitute interrelated and interdependent public spheres. No prior work has made that argument in the study of the aftermath and consequences of the crisis from the point of view of the interconnected spheres of European governance, national level decision-making, and democratic politics. The need to examine the coterminous evolution of institutions, policies, and politics in the context of the crisis, has already received attention in the literature. Della Posta and Talani (2011) examine both the general effects of the crisis on the EU institutional setup and public policy in individual country studies. The proposition of interconnectedness, albeit in a different sense, is present in DeBardeleben and Viju (2013). The focus is on sociopolitical implications to examine interactions across the external-internal domain of the EU and functional relationships between financial integration and trade and the impact of the crisis on adjacent countries outside the EU membership. In contrast to these works, we apply interconnectedness with regard to public spheres, across-level interactions, and, ultimately, the

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relative disconnect in structuring and implementing crisis response and, especially, policy reform. That the response to the crisis has not been transformative is evident in policy continuity at the national level, as the intergovernmentalist version of EU federalism is redefined from a hierarchical principle of the division of powers to a shared responsibility for survival, deliberation, and leadership. Moschella and Tsingou (2013) demonstrate that, instead of a corresponding reform to counter the crisis as an abrupt, systemic shock, the relationship between levels of decision-making shows shifts in rule-making and policy models in the direction of incrementalism and continuity in the system of rules in global financial regulation. The book is thus well positioned within the literature on the crisis. It addresses issues and discourses that have received broad attention and are considered relevant to academic study, scholarly analysis, and public policy. At the same time, it introduces a significant new dimension to the existing literature. The volume aspires to bring new insight into public response to the crisis through questions about political trust and democratic legitimacy. What are the consequences of the crisis for democratic politics: for the place of the individual in the political system, individual and group preferences, expectations for leadership, interactions between elites and the public, and between the public and the EU institutions? Themes and Objectives The book explores three major themes. The first examines the legalinstitutional space of European governance with a focus on the EMU, the Euro, and the limitations and opportunities of the post-Lisbon model of decision-making. The second dimension is that of the reconfiguration of domestic political space due to the repositioning of issues and policymaking processes. Third is the public sphere, comprised of evolving political attitudes, public trust for the European and national institutions and actors, and the democratic legitimacy of political order. The book has two fundamental aims. The first is to demonstrate the interconnected nature of European governance, domestic reform, and democratic politics. The unprecedented complexity of the financial, sovereign debt, economic and social crises in Europe has led to a political crisis that reflects the struggle to effectively address its various causes and effects. There are compelling reasons for applying the interconnected public spheres approach to the study of the European economic and financial crisis. The Euro has emerged as its central component, linked not only to the functioning of the EU’s institutional order but also to principal areas of European governance and domestic policymaking, such as competitiveness, austerity, redistributive policies, and political credibility.



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The second objective is to present a theoretically informed assessment of the consequences of the European crises for state-society relations and democratic legitimacy. We structure our discussion by emphasizing political dynamics. We argue that the politics of crisis response are embedded in the limitations of EU institutional framework and governance mechanisms leading to contested austerity policies and public reaction. Our analysis of the crisis in a variety of national contexts and European governance highlights the difficulties faced by political decision-makers. We find that public opinion still matters in the process of policy formation and EU crisis response, that public policy relies on informal governance in key areas of crisis management (thus weakening the rule-based model of policymaking), and that the salience of the EU agenda in the domestic public sphere increasingly depends on the preferences of political actors. In contrast to the Europeanization literature, we find that the domestic policy process is selectively affected, open to, or disconnected from the process of rule-making at the EU level. Such variation in outcomes is not only an aspect of institutional innovation and policymaking. Public response to the crisis has become increasingly complex as well, ranging from declining trust in the political institutions, emerging national stereotypes, changing expectations of the EU level of crisis response, growing disconnect between political parties and voters, and evolving intra-regional distinctions across the EU’s east-west divide. Research Strategy The book builds on the proposition that European governance, domestic policymaking, and public opinion constitute interconnected public spheres. This analytical lens blends together several medium-range perspectives derived from institutionalism, policy analysis, and behavioral studies. The selection of 15 chapters covers case study, comparative, and synthetic analyses to produce a multifaceted work. While the book is relevant to sociological, policy, and institutionalist perspectives, the organizing framework of the volume is anchored in arguments drawn from political science and key concepts of political inquiry. A political approach permits to examine complex relationships between the principal institutions of European governance, such as the post-Lisbon Treaty environment and the EMU—both captured in the evolution of the Euro crisis, the capacity of national level decision-making to perform under crisis in accordance with the underlying distribution of societal preferences and interests and ultimately, the functioning of democratic society reflected in citizens’ trust and the legitimacy of public policy in a EU context. There are a limited number of books available to both scholars and practitioners that span across institutionalist and policy analyses to provide a political account of the crisis, despite the widely shared view that its political

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consequences are crucial for the democratic legitimacy of European governance and domestic policymaking. While select thematic analyses adopt an enhanced political perspective and discuss the political consequences of the crisis, less attention has been devoted to cross-level interactions based on an understanding of the interconnected nature of policy choices, institutional change, and public response. The volume contributes to filling this gap in the literature by exploring institutional and policy developments in the EU and its member states in a parallel examination of citizens’ views of the effectiveness of crisis response reflected in public trust, output legitimacy, and satisfaction with democracy. Our approach to understanding the crisis posits EU-level governance and institutional change, national-level policymaking, and domestic politics as interrelated, interdependent domains of political action and public spheres that collectively shape the political landscape of post-crisis Europe. The volume thus sheds new light on the relationship among the institutional, policy, and polity consequences of the crisis. Furthermore, the book discusses important political concepts in an applied framework. We work with data sources that are representative of political trends across the EU, derived from the 2009 European Election Studies, IntUne research data, party manifestos, and Eurobarometer surveys. The geographic range of the content is the European Union as a system of governance. This coverage is strengthened by a number of case studies of a variety of countries and public domains: institutions, policymaking, and public opinion. Cases include Germany (policy), Greece (public opinion, polity, policy), Italy (public opinion, policy), Ireland (taxation), Spain (policy, political actors), Portugal (state-society relations), Poland (public opinion), the Euro, decision-making in the European Council, and EU-wide comparative analyses (taxation, public opinion). Volume Structure and Chapter Details The European Union beyond the Crisis is structured as follows. Part 1 is devoted to the institutional arena. It reviews the changing decision-making agenda of EU economic governance in the post-Lisbon environment. While the literature has focused on the economic origins of the crisis, the structural faults of the Euro (Arestis and Sawyer 2010; Arestis et al. 2011; Authers 2013; Meeusen 2011), and the process of institutional change, emphasizing the incremental nature of reform and lack of transformative policy change (Moschello and Tsingou 2013; Rodriguez and Xiarchogiannopoulou 2014), the (almost inherent) limitations of the functioning of core EU institutions and policies, the conceptual underpinnings of the Euro as a political construct, and alternatives institutional blueprints deserve further study.



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Part 1 thus explores the EU institutional setup and models of decisionmaking by studying governance in the post-Lisbon institutional environment (Csehi, Chapter 2), the political nature of the Euro characterized by duality and discontinuity between the regional and domestic level (Preunkert, Chapter 3), the ways in which the EU institutional mechanism has addressed the major events of the crisis and the counterfactual alternatives to the functioning of EMU and the single currency (Hess, Chapter 4), and the ways in which the European Union has fared out of the crisis (Eliasson, Chapter 5). The chapters uncover the EU-level dynamics that define the crisis not simply as a crisis of the “Euro” but of imbalances between the competitive north and the selective south, and demonstrate how critical points of sovereign debt crisis emerge in several contexts but not others, thus revealing the disconnect between the EU and the domestic level of decision-making. In Chapter 2, Robert Csehi demonstrates the disconnect between the legal and political aspects of integration in the creation of the EMU. This condition has resulted in a paradox whereby the constituent units recognize the need to further coordinate their respective jurisdictions without formally transferring more responsibilities to the federal level. The attempts of the EU member states to resolve this paradox have brought about a renaissance of intergovernmentalism, despite a history of over fifty years of integration and federal institutionalization but, at the same time, have moved in the direction of enhanced deliberation typical of collaborative federalism. The chapter traces the challenges of the economic and financial crisis for the existing economic and monetary framework of the European Union. While the EU member states were clearly in need of system-wide policy solutions, they continued to demand autonomy in decision-making. This internal tension led to a changed character of intergovernmental relations which came to substitute a formal transfer of legislative competences to the European level. Based on an analysis of the Euro Plus Pact and the Treaty on Stability, Coordination and Governance, the chapter concludes that although certain intergovernmental mechanisms did not change the formal distribution of powers among the member states and the EU level, the resulting institutional framework did lessen the capacities of individual governments to act unilaterally in fiscal affairs. Chapter 3 (Jenny Preunkert) begins with the observation that while it is a widely held view that the Euro is in the midst of the most difficult crisis since its introduction, it remains unclear what constitutes an Euro crisis. This chapter analyzes the Euro and its current political challenges in two steps. It first develops a sociological understanding of currency. The chapter posits currency as a politically framed institution, which means that political actors are seen as responsible for the functioning of a currency. Previously this responsibility has been defined primarily as a nation-state responsibility.

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With the Euro, European societies broke new ground, as the common currency operates as a transnational currency with fragmented responsibility structure, i.e. the responsibility lies partly with a transnational actor and partly with a number of national actors. The Euro is therefore a currency with transnational validity, still dominated by the idea of a nation-state-based responsibility; that is, transnational solidarity was explicitly excluded from the legal framework of the common currency. This multipolar structure, with its transnational and nation-state allocations of responsibility, was unproblematic for the political actors as long as there was the same (high) degree of trust in the Euro as a construct and especially in the political actors that created it. However, as a result of the financial crisis, a differentiation arose in public perceptions and assessment of the credibility of political actors. Empirical results show that the crisis of trust in most Eurozone members has led to an institutional crisis of trust. Not only was trust lost in the financial solvency of member states, such as Greece and Ireland, but also in the crisis resolution strategies of the Euro partners. As a reaction to the crisis, transnational responsibility has now been institutionalized, reflected in the blueprint for a European Banking Union. The chapter concludes that the common currency continues to depend on the constituent political systems. At the same time, the latest developments suggest that crises of economic trust can also lead to a crisis of political trust. The Eurozone is therefore faced with the challenge of not only winning back the trust of the markets but also of preventing a loss of political trust in the states affected by the crisis, as well as in the Eurozone as a whole. Chapter 4 (Ashley A. C. Hess) reviews the development of the euro and the recent Eurozone financial issues with a view of conducting a comparative examination of another viable institutionalization option that could be helpful to future monetary unions. In particular, the chapter assesses John Maynard Keynes’ “Proposals for an International Clearing Union,” presented at the 1944 Bretton Woods conference, that would have created a universal currency valid for trade transactions with all member countries via a supranational bank-like clearing union. Keynes’ proposal is applied to the Euro’s development as a counterfactual example to support the argument that an International Clearing Union presents a strong institutional alternative for monetary unions. Though it is likely too late for the Euro to reformulate its entire monetary system, the lessons learned from its development and performance have a potentially global relevance. The chapter argues that Keynes’ 1944 proposals could potentially provide a more solid alternative to the European monetary system for regional monetary integration. Chapter 5 (Leif Johan Eliasson) defines the financial-turned-sovereign debt crisis in the Eurozone as unprecedented in scale for a monetary union of sovereign states. However, it also finds that the current crisis shares several



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identifiable features with previous crises in European integration; crises in which pundits had declared the European project dead, only to be proven wrong by European leaders agreeing on even deeper, wider, and stronger integration. The chapter explores what drives this remarkable capacity of the EU to survive and looks beyond the resilience of its institutions and opens up the institutional process to an actor-centered approach. Here actors shape institutions by expanding the limits of accepted practice with regards to commenting on, and attempting to directly influence policy in the member states. In the face of a changing external environment doubtful of the Euro’s survival, an emerging model of leadership worked within the EU’s traditional logic of continuation of policies and incremental adjustment to introduce internal modifications and cement changes conducive to greater efficiency, growth, and stability. The chapters in Part 2 are devoted to the arena of domestic policymaking embedded in the rule-making mechanisms of European integration. The individual contributions explore important aspects of the relationship between the EU and the national public policy arena by studying the strategies and responses of political actors. While many accounts of the crisis have thus far noted the imposition of austerity measures, provided critiques of the institutional and policy responses to the crisis, and sought to propose alternative policy measures, there has been much less focus on the politics of crisis response shaped by institutional frameworks, electoral campaigns, and policy choices reflecting broader patterns of political contestation. As they continue to focus on the interactions between the domestic and the EU level of decision-making, the chapters in Part 2 reveal various aspects of the relative disconnect between the two levels and the role of political dynamics in shaping policy response. Chapter 6 (Hilary Appel and Carissa Tudor Block) explores the crisis response as an interaction between the national and EU level of decisionmaking on the example of tax policy. At the peak of the crisis, countries facing growing deficits and severe revenue shortages had to identify new cuts to budgetary expenditures and find sources of revenue to tax more heavily. The chapter focuses on two major fiscal harmonization initiatives in Europe at the time of the crisis: corporate income tax reform and the establishment of a financial transaction tax, and it does so from the perspective of the preferences of individual EU member states. It argues that Europe’s recent financial crisis was not merely contemporaneous with progress in tax coordination. Instead, the financial and debt crises were absolutely central to these policy advances. The crisis changed the incentives of certain countries to resist the movement for greater coordination and it invigorated efforts by large countries like France and Germany to pursue harmonization. Moreover, the crisis brought salience to EU fiscal issues and made the public more aware

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of tax avoidance in the corporate and financial sectors. Finally, as the chapter argues, the crisis created a willingness of many more actors to consider new ideas in fiscal coordination and transnational harmonization vis-à-vis banks and corporations. Chapter 7 (Jennifer R. Wozniak Boyle and Chris Hasselmann) examines the democratic sources of EU policymaking during the economic and financial crisis in Europe. Scholars differ as to the relative influence of public opinion and elite opinion on European integration, captured in the “constraining dissensus” versus the “permissive consensus” thesis. The former model holds that the generally pro-integration elite has been obstructed in forging EU solutions to European economic woes by an increasingly Euroskeptic public. In contrast, the model of “permissive consensus” suggests that EU policymaking is influenced more by elites than by public opinion. The chapter conducts analysis of public opinion on austerity, spending, and new regulation against the evolution of member state positions in the European Council. It finds that public opinion has a discernible impact on member state positions on EU initiatives when member state governments confront elections, as well as intra-party and intracoalition ideological divisions. It also demonstrates that member state preferences more often than not follow elite interests over public opinion. Chapter 8 (Alexandra Hennessy)3 discusses the concept of informal governance on the example of Germany’s role in EU decision-making on financial matters. Germany has been unable to safeguard its core objectives, which the chapter defines as: stabilizing the eurozone, limiting taxpayers’ financial guarantee exposure, and keeping inflation low. According to this analysis, such an outcome is at odds with the expectation of the informal governance literature that the dominant country will always be able to protect its core interests after overriding the ordinary procedure. To restore investor confidence in the eurozone, Germany was under international pressure to provide credible backstops to shore up the bond markets of vulnerable member states on the brink of losing access to capital markets. The chapter finds that paying attention to temporal trade-offs in the study of informal governance allows us to capture incentives for shortsighted behavior that helps explain this hitherto unexamined puzzle. It hypothesizes that political leaders lack incentives to invest in addressing problems that appear manageable at first, but may cause escalating costs as they continue to fester. If an effective crisis resolution requires the dominant country to incur high upfront costs, but the principal responds to an incentive structure that rewards delay, the dominant agent may unintentionally sacrifice its core interests in the process. Following such premises, the chapter explains Germany’s quandary through two interrelated factors. First, policymakers were subject to an incentive structure that encouraged crisis mitigation efforts, but not preparedness, which explains Germany’s long hesitation before offering any assistance



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to its partners. Second, once financial guarantees were provided, political disagreements over the sequence of reform steps as well as instruments and conditionality of financial assistance programs prolonged investor fears of a eurozone breakup, further compromising Germany’s interests. This chapter is also an attempt to build a bridge between comparative politics studies and international relations perspectives on the debt crisis. Scholarship with a comparative perspective has productively located the origins of the turmoil in the Euro’s birth defects (the absence of economic and political union), but no efforts have been made to explain the EU’s failure to stabilize the eurozone. International relations scholars, on the other hand, have refused to engage with the debt crisis, despite the field’s longstanding concern with economic crises, incentives for international cooperation, and the effectiveness of international institutions. Chapter 9 (Boyka Stefanova) conducts a comparative examination of the impact of the banking and sovereign debt crisis in Spain and Italy, respectively, from a varieties of capitalism (VoC) perspective. It seeks to understand whether and how the VoC framework may explain recent institutional and policy developments pertaining to the crises. The chapter advances analytical claims regarding the mutually reinforcing effects of the “twin” cases of a banking crisis in Spain and a sovereign debt crisis in Italy, their common premises within the respective national bank-centered models of finance capitalism, the policy relevance of the crises to selective institutional innovation both at the level of national adjustment and within the EU’s economic and monetary union, and the opportunity to refine the varieties of capitalism framework by emphasizing the multidimensional nature of institutional complementarities. The chapter empirically validates these claims by establishing the common context of the two crises. It discusses national-level policy responses by tracing their coterminous evolution. It then turns to analyze recent EU-based institutional innovation in the context of the proposed European Banking Union and the 2020 European Growth and Convergence Strategy. The chapter concludes that the premises of multidimensionality and institutional complementarities of the varieties of capitalism framework have maintained their relevance to the sources of growth, crisis, and policy response in the European political economy. Chapter 10 (Cristina Ares Castro-Conde) provides yet another political perspective on public policy through a political lens. It links the debate on the EU democratic deficit to the opportunity for European citizens to monitor public policy. The chapter examines political parties as the filter between public preferences and policy outcomes. It argues that, in spite of the notable democratization of the supranational institutions of European integration, in certain countries such as Spain, the legitimacy of the EU continues to be weak, among other factors, because of the way in which national parties have

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adjusted to “Europe” and the ways in which political elites serve as a transmission mechanism between EU-level policymaking and governance on the one hand and the domestic political arena, within which such outcomes are negotiated and implemented, on the other. The chapter examines the salience of European issues in Spanish politics reflected in the discourse of the political parties competing in the 2011 general elections that took place at the height of the economic and financial crisis in Spain. It traces the saliency of EU affairs in Spanish politics and the positioning of Spanish national parties in the context of the 2011 election campaign. Methodologically, the study relies on content analysis of party programs, public speech, and campaign messages in the social media in order to measure the positioning of national parties and principal contestants. The chapter builds an argument with regard to the role of the party system for enhancing EU legitimacy in parallel with strengthening national democracy. It concludes that, from the perspective of democratic politics, national parties should be responsible for incorporating the EU agenda into their programmatic outlook and for providing cues on EU affairs, which would allow citizens to influence EU public policy through voting and other forms of participation in the domestic political arena. Chapter 11 (Miguel Glatzer) examines a critically important aspect of crisis effects: adjustment and reform in the institutions and workings of the welfare state. It examines the case of Portugal not only in a policy perspective, through the provision of public services but also in a political context, as implications for civil society and associational life. The chapter provides an overview of the consequences of the crisis for Portugal with a special emphasis on social services and state-society relations. It uses a historical perspective to analyze a reform in the system of social protection that was explicitly aimed at fostering the development of a more vigorous civil society while, at the same time, solving important problems in social protection. In then moves on to describe the challenges brought by the current crisis to the delivery of social services and to the relationship between nonprofit organizations and the state. Finally, it examines responses by both the state and these organizations to the crisis. As it studies the relationships between the state and para-public organizations with regard to the relative retreat of the state in the context of the crisis, the chapter also discusses the potential of the crisis to emerge as a catalyst for the strengthening of civil society in Portugal. The chapters in Part 3 discuss the impact of the crisis on democratic politics in the EU examined through the lens of political trust and democratic legitimacy. The European varieties of crisis—banking, financial, fiscal, economic, and sovereign debt crises in the Eurozone and the peripheral economies— have adversely affected European democracy and led to a decline in public trust in the EU and national institutions. The chapters address an important



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question: Is European democracy weakened as a result of the economic and financial crisis? The main task is to examine the patterns of public opinion in response to the European economic and political crisis. Chapter 12 (Jennifer R. Wozniak Boyle and Chris Hasselmann) explores several questions related to the effect of the crisis on European public opinion. It studies trends in support for the EU, tests the ability of existing theories to model and account for this change, but also addresses a largely overlooked question, that of the leadership expectations of the public in the wake of the financial crisis, and how these expectations relate to the state of support for the EU. In line with prior research, the chapter finds that support for the EU has been negatively affected and that the variables traditionally used to explain public support are able to capture this downward trend sufficiently well. The chapter contributes new insights to the literature by demonstrating that despite this drop in support, the EU remains seen as the actor best suited to craft a solution. It concludes that it is the failure to live up to this expectation that accounts for the narrowing of the trust and support gap between the EU and national-level institutions. Chapter 13 (Zinovia Lialiouti and Giorgos Bithymitris) discusses the ideological and political implications of the Greek economic crisis since 2009. Its focus is on the perception of victimhood within Greek public opinion as an important aspect of these developments. The rise of Greek nationalism has emerged as a prominent manifestation of the public response to the crisis. Even though the ideological and conceptual connotations of victimhood are not homogenous, its association with the image of an external enemy has become increasingly popular. The chapter explores general trends from the perspective of political mobilization. It thus demonstrates that public attitudes do not appear spontaneously in response to the rigidities of social life induced by the crisis. Once again, there is a political link to individual and group identities, found in the politics of belonging. The chapter argues that the instrumental use or misuse of the sense of dominant narratives, master frames, and political contestation around the exclusion or inclusion of members reshapes identity boundaries. In times of crisis, political actors tend to repackage such instrumentalities in multifold ways. In the Greek case, during the years of economic and social turmoil, contestation both with regard to the participatory dimension of citizenship, as well as in relationship to the meaning of EU membership, deepened significantly within the party system and among social actors. The political discourse of the Greek parties during their campaigns for the 2014 European elections is indicative of their strategic positioning in the contested terrain of the politics of belonging. A typical example of this tendency is the emergence of anti-German discourse and of a perception of the European Union as an institutional

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setting under German hegemony. While Greece has been a traditionally proEuropean country, the economic crisis has put pressure on public attitudes. For the first time in recent history, opinion polls demonstrate the rise of antiEuropean attitudes in Greek public opinion. The austerity measures dictated by the international loan agreements have been denounced by a large part of the political and media elites as foreign intervention and suppression of national sovereignty, shaping the discursive construction of “occupation.” Far from being marginal, the interpretative scheme of occupation has penetrated both right- and left-wing political discourse. It has continued to expand in the context of persisting instability and restructuring of the Greek party system, as well as under pressures stemming from the revival of nationalism and populism. In order to highlight the interaction between elite and mass perceptions, the chapter relies on a variety of survey data, such as Eurobarometer and national studies of Greek public opinion. The principal finding of this research is that through electoral politics, the crisis and its rhetorical negotiation within public beliefs marks a turning point for the discursive practices centered on Greek national identity. Chapter 14 (Simona Guerra and Fabio Serricchio) tests principal theoretical propositions on public attitudes towards the EU following Matthew Gabel’s seminal work on support for European integration. Gabel’s findings show that public support for European integration may be explained by cognitive mobilization and political values (affective dimension), in particular across the original member states, and welfare policy preferences, partisanship, and government support (utilitarian dimension), prevalent in the new member states. The chapter sets out to test these findings using IntUne survey data. It reviews the literature on public opinion and European integration and discusses its most recent findings. The chapter proceeds with testing key hypotheses on public attitudes towards the EU by maintaining an east-west distinction among the EU member states. Analysis then turns to a comparative examination of two representative case studies: Italy, a founding member experiencing economic recession and sovereign debt crisis for four consecutive years, and Poland, a new member state representative of the 2004 EU enlargement and the eighth largest EU economy. The chapter presents contextualized findings on the role of utilitarian and cognitive determinants of European public opinion in the context of the crisis relative to Gabel’s original conclusions and the diversity of factors across the EU’s east-west divide. Chapter 15 (Borbála Göncz) explores the evolution of the financial and sovereign debt crisis in the European Union and its member states from the perspective of public opinion. Prior research has found that economic performance, domestic politics, and individual perceptions of the national and personal economic situation are important determinants of attitudes



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towards the EU. As all of these factors are related to the economic cycle, it hypothesizes that the post-2008 crisis has affected public perceptions of European integration. The crisis and the recession that followed, however, did not affect the individual countries to the same extent, regardless of whether they were old or new member states that joined the EU in 2004. It thus further expects that the crisis has blurred the initial differences in public attitudes towards the EU across the old/new member states divide. In order to test for potential gradual convergence of attitudes towards the EU, the chapter examines the short-term effects of the crisis in a long-term context. It reports findings based on Eurobarometer longitudinal data. This research improves the conventional approach to the study of public attitudes by including indifferent or neutral opinions, in addition to positive and negative ones. The results show that the short-term effects of the crisis have not significantly blurred existing east-west differences in public attitudes towards the EU, as convergence of opinions has not taken place since the 2004 enlargement. Chapter 16 (Evelyn Bytzek) proceeds from the assumption that the degree of satisfaction with democracy is a crucial indicator of diffuse support for the political system, without which it would not be able to function and survive. The factors influencing the levels of satisfaction with democracy in a polity reflect three strands of explanations: individual-level determinants (e.g. social trust), factors at the systemic level (e.g. the responsiveness of political actors), and long-term trends in the degree of satisfaction with democracy over time, explained by events such as political and economic crises. However, the potential link between individual and systemic factors, on the one hand, and events, on the other, has not been adequately explored. It remains unclear why and how events may have an effect on satisfaction with democracy: whether this effect is due to changes in individual or systemic factors, or to cross-level interactions. The chapter fills this gap by examining the recent worldwide financial and economic crisis as a case study of the impact of individual-level and systemic factors and context on the degree of satisfaction with democracy. It compares levels of diffuse support before (2008) and during the crisis (2010) in more than 20 European countries. Methodologically, it performs multilevel regression analysis, incorporating interaction effects between individual- and system-level variables over time. This research adds to prior findings on the determinants of satisfaction with democracy, especially with regard to cross-level factor interactions and the study of the political and economic context. The diversity of analytical approaches and findings presented in the individual chapters collectively provide a fine-grained analysis of the implications of the crisis for the evolving system of European governance, the politics of crisis response, and public trust in the institutions of democracy.

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Notes 1. Reference is made to Alan Milward’s seminal work titled The European Rescue of the Nation State. See Milward (1992). 2. On the future of European integration, see also Daianu et al. (2014). 3. Chapter Eight by Alexandra Hennessy was published under the same title in Journal of Contemporary European Studies 21 (3): 430–447 (2013). Copyright Routledge/Taylor & Francis Group.

References Archibugi, Daniele and Andrea Filippetti (eds). 2012. Innovation and Economic Crisis. Lessons and Prospects from the Economic Downturn. London and New York: Routledge. Arestis, Philip and Malcolm Sawyer (eds). 2012. The Euro Crisis. Basingstoke and New York: Palgrave Macmillan. Arestis, Philip, Rogerio Sobreira and Jose Luis Oreiro (eds). 2011. The Financial Crisis: Origins and Implications. Basingstoke: Palgrave Macmillan. Authers, John. 2013. European Financial Crisis: A Short Guide to How the Euro Fell into Crisis and the Consequences for the World. Upper Saddle River: Pearson Education. Bastasin, Carlo. 2012. Saving Europe: How National Politics Nearly Destroyed the Euro. Washington, DC: Brookings Institution Press. Berend, Ivan. 2013. Europe in Crisis: Bolt from the Blue? Abingdon: Routledge. Bermeo, Nancy and Jonas Pontusson (eds). 2012. Coping with Crisis: Government Reactions to the Great Recession. Cambridge: Cambridge University Press. Bibao-Ubillos, Javier (ed). 2014. The Economic Crisis and Governance in the European Union: A Critical Assessment. London and New York: Routledge. Borooah, Vani. 2014. Europe in an Age of Austerity. Basingstoke: Palgrave Macmillan. Bosco, Anna and Susannah Verney. 2011. “Elections in Hard Times: Southern Europe, 2010–2011.” South European Societies and Politics 17 (2) (Special issue). Burroni, Luigi, Maarten Keune and Guglielmo Meardi (eds). 2012. Economy and Society in Europe: A Relationship Crisis. Cheltenham; Northampton, MA: Edward Elgar. Cline, William and Guntram Wolff (eds). 2012. Resolving the European Debt Crisis. Washington, DC: Peterson Institute for International Economics and Brussels: Bruegel. Daianu, Daniel, Carlo D’adda, Giorgio Basevi and Rajeesh Kumar. 2014. The Eurozone Crisis and the Future of Europe: The Political Economy of Further Integration and Governance. Basingstoke: Palgrave Macmillan. DeBardeleben, Joan and Crina Viju (eds). 2013. Economic Crisis in Europe: What It Means for the EU and Russia. Basingstoke and New York: Palgrave Macmillan.



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Della Posta, Pompeo and Leila Simona Talani (eds). 2011. Europe and the Financial Crisis. Basingstoke and New York: Palgrave Macmillan. Haynes, Philip. 2012. Public Policy beyond the Financial Crisis: An International Comparative Study. London and New York: Routledge. Hemerijck, Anton, Ben Knappen and Ellen van Doorne (eds). 2009. Aftershocks: Economic Crisis and Institutional Choice. Amsterdam: Amsterdam University Press. Kröger, Sandra. 2014. Political Representation in the European Union: Still Democratic in Times of Crisis? Abingdon, Oxon and New York, NY: Routledge. Lapavitsas, Costa. 2012. Crisis in the Eurozone. London and New York: Verso. Laursen, Finn (ed). 2013. The EU and the Eurozone Crisis: Policy Challenges and Strategic Choices. Farnham: Ashgate Publishing. Milward, Alan. 1992. The European Rescue of the Nation-State. Berkeley and Los Angeles: University of California Press. Moschella, Manuela and Eleni Tsingou (eds). 2013. Great Expectations, Slow Transformations: Incremental Change in Post-Crisis Regulation. Colchester, UK: ECPR Press. Petrakis, Panagiotis, Pantelis Kostis and Dionysis Valsamins. 2014. European Economics and Politics in the Midst of the Crisis: From the Outbreak of the Crisis to the Fragmented European Federation. Heidelberg: Springer. Rodriguez, Maria Joao and Eleni Xiarchogiannopoulou. 2014. The Eurozone Crisis and the Transformation of EU Governance: Internal and External Implications. Farnham, Surrey and Burlington, VT: Ashgate. Reinhart, Carmen and Kenneth Rogoff. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton and Oxford: Princeton University Press. Schäfer, Armin and Wolfgang Streeck (eds). 2013. Politics in the Age of Austerity. Cambridge and Malden, MA: Polity Press.

Part I

European Governance in a Time of Crisis Limitations and Prospects of the EU’s Economic and Monetary Union

Chapter 2

Collaborative Federalism in the European Union Intergovernmental Relations and the Allocation of Powers in the Economic and Monetary Union Robert Csehi The globalization of finance, the changed credit conditions, lending and borrowing practices combined with weak public finances led to an alarming level of gross public debt in several countries of the European Union (EU) by 2008. As uncertainty with regard to the ability of countries to service their debts increased, against the background of persisting high levels of cross-border bank investments in the Eurozone the fear of contagion spread. These developments placed the Economic and Monetary Union (EMU) into the center of the crisis. Facing its most severe challenge yet, the scope of European integration and the EU decision-making model in the area of economic governance were significantly affected. The purpose of this paper is to conduct an in-depth analysis to understand such institutional dynamics. The crisis once again highlighted a peculiar situation in which the EU member states faced the dilemma between the need for further coordination in areas under their own jurisdiction and their reluctance towards further competence transfers (see Chryssochoou 1997; Koslowski 1999; Neyer 2006; Puetter 2012). Instead of relying on the traditional Community method to settle cross-jurisdictional challenges, the member states turned to an intergovernmental method, according to which “all the major stakeholders— the Union institutions, the member states and their parliaments—complement each other by acting in a coordinated manner in the areas for which they are responsible (. . .) but all working towards the same goal.”1 As a result, the nature of intergovernmental relations in fiscal policy matters significantly changed: discussions became more open, new institutions and procedures were established, there was greater activism and more involvement on behalf 23

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of the highest political levels. Gradually, intergovernmental relations came to substitute a formal transfer of constitutional powers and with it, collective, centralized legislative decisions (e.g. Treaty on Stability, Coordination and Governance). At the same time, intergovernmentalism has affected the actual allocation of powers among the different orders of government without changing the constitutional framework. The question arises: under what conditions and how does such a development occur? What does it mean for the nature of intergovernmental relations and what impact does it have on the allocation of powers? Since the nature of the original dilemma coincides with the internal tension of federalism known as “unity and diversity” (see Jachtenfuchs and Kraft-Kasack 2013), it is argued that the study of federalism can provide important insights into the changing character of intergovernmental relations reflected in the collective response to the financial crisis within the EMU. Instead of defining the principles of federalism in terms of formal, constitutional division of powers, it is suggested that those principles may also emerge and develop within a framework of intergovernmental relations, so that the coordination of constituent unit jurisdictions can be ensured. Federal studies applied to the EU have previously focused on the analysis of the constitutional distribution of powers, and have largely neglected the role of intergovernmental relations within such a framework.2 However, as the relevance of intergovernmental interactions increased in parallel with the tension described above, there has been a call for a renewed theory of federalism that could incorporate the latest developments, in order to understand their role in power allocation mechanisms. It should be noted that the framework advanced here is not primarily concerned with governance techniques based on intergovernmental relations, but rather with the process of change within the allocation of competences (see Nicolaidis 2001) and the role that intergovernmental relations play in that procedure. The chapter unfolds as follows. First, it advances an alternative federalist framework within which the diverging character of intergovernmental relations can be explained through the prism of federal principles. This part also relates the proposed theory to other approaches in the field to highlight its value added. The subsequent section reviews the emergence and development of federal principles in intergovernmental relations among the EU member states in the domain of economic governance, while Part 3 demonstrates how the latter has changed its institutional and procedural structure. This section also traces the impact which the evolving nature of intergovernmental relations has influenced the allocation of powers among the different orders of government. The study is based on document analysis, media coverage, and personal interviews conducted at the EU institutions. The interviewees were European and EU member-state officials closely connected to the



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economic governance portfolio. Even though they asked for anonymity, they consented to the reproduction of their thoughts. Collaborative Federalism in the European Union Approaches to EU integration based on grand theories of international relations (IR), such as liberal intergovernmentalism (LI) (Moravcsik 1993, 1998; Moravcsik and Schimmelfennig 2009), have studied intergovernmental relations in order to understand the evolution of regional integration. LI is “a theory of intergovernmental decision-making under anarchy” (Moravcsik and Schimmelfennig 2009, 73), which implies that the character of intergovernmental relations does not change over time (i.e. the logic of anarchy prevails). The LI perspective is based on the assumption that member states are always capable of establishing preferences prior to the bargaining process. However, as more and more sensitive areas (e.g. fiscal, energy, social, and employment policies) require coordination, the complexity of policy challenges is likely to limit the preference-building capacities of the member states. Furthermore, LI comes short of understanding delegated or pooled sovereignty and decisionmaking among the actors as it “neither describes nor explains the context within which intergovernmental bargaining takes place” (Sbragia 1993, 26). Consequently, LI pays little attention to the emergence and development of norms, values, and principles that may structure intergovernmental relations within a given context. As a response to this gap in the literature, Puetter (2012) advanced the analytical concept of deliberative intergovernmentalism (DI). He argued that there was an “integration paradox” whereby member states have had to coordinate their respective policies without formally transferring competences to the European level. As preferences were hard to construct, intergovernmental relations became increasingly dependent upon deliberative processes of policy formation, which in turn had a considerable impact on intergovernmental procedures and on the institutions themselves. However, DI lacked an in-depth consideration of the actual process that led to changes in the nature of intergovernmental relations and an analysis of its impact on the allocation of powers. This is also due to the fact that DI focuses on intergovernmental relations from the perspective of policy solutions and decision-making techniques.3 Even though it emphasized the role of deliberation,4 it did not reflect on the values and principles that emerged and developed as a result, which could affect intergovernmental relations as well.5 Since Puetter’s “integration paradox” resonates with the federal idea of selfrule and shared rule (see Elazar 1979) or “unity in diversity” (Jachtenfuchs and Kraft-Kasack 2013), it may be argued that incorporating the emergence and

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development of federal principles within a federalist theoretical framework could enrich our understanding of how intergovernmental relations come to substitute collective, centralized legislative decision-making to address crossjurisdictional policy challenges. The “new governance”6 literature emphasized the increased role of “alternative approaches to governance that are more accepting of diversity and encourage voluntary forms of co-ordination” (Mosher and Trubek 2003, 63). The latter marked “a shift in emphasis away from command-and-control in favor of regulatory approaches which are less rigid, less prescriptive, less committed to uniform outcomes, and less hierarchical in nature” (de Búrca and Scott 2006, 2). New governance argued that the Open Method of Coordination (OMC) was “an appropriate tool to use in situations when common problems exist[ed] (. . .) but conditions ma[de] uniform policies impossible” (Mosher and Trubek 2003, 84). Consequently, the concept of “soft law” was advanced to describe arrangements “that operate in place of or along with (. . .) ‘hard law’” (Trubek et al. 2006, 65). However, the new governance approaches analyzed these developments under the traditional Community method (see Mosher and Trubek 2003) and did not consider the impacts of soft mechanisms on intergovernmental institutions and processes. As DI, the new governance literature also assumes that member states adopt certain norms during the process of coordination, yet they fail to specify which norms come to matter and how they emerge over time. As argued before, the European Union started its journey as an experiment in regional integration and thus, intergovernmental relations were originally studied from an IR perspective. Taken that federalist approaches by that time had lost their international components (see Riley 1973; Burgess 2006) and turned towards analyzing federal states, intergovernmental relations in the EU were not studied through a federalist lens.7 Furthermore, most federal analyses focused on the legal, constitutional aspects of the European polity (Burgess and Gagnon 1993; Burgess 1996, 2006, 2009), and have dedicated little attention to the political dynamics of intergovernmental relations8 and their role in the process of competence transfers. In sum, even though it was argued that “a shift of focus towards the study of intergovernmental relations in federations could conceivably facilitate valid comparisons” (Burgess 2006, 138), intergovernmentalism has remained surprisingly understudied in the European federalist literature. From a comparative federalist perspective, intergovernmental relations have been analyzed from different angles. Most studies have argued that intergovernmental relations are either the result of the constitutional arrangement (e.g. Hueglin and Fenna 2006; Watts 2008), or the response to the existence and type of power-sharing mechanisms at the constituent unit level (Bolleyer 2009; Bolleyer and Börzel 2010). Both approaches



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emphasize the influence of either the macro- or the microstructure on the nature of intergovernmental relations.9 However, if neither the constitutional framework at the macro level, nor the legislative-executive relationship at the micro-level change, there would be little change in the overall conduct of intergovernmental relations. As “Canada is the state that comes closest to the EU in several critical aspects” (Fossum 2009, 498),10 and the literature on Canadian federalism deals extensively with the topic of intergovernmental relations, it is argued here that it could enhance a federal theory approach to intergovernmental dynamics in the EU. Intergovernmental relations in Canada, also understood as “federal-provincial diplomacy” (Simeon 1973) or “executive federalism”11 (Smiley 1974, 1987; Verney 1989; Watts 1991), were originally analyzed extensively from a constitutional perspective.12 Even though most studies agreed that particular norms, attitudes, goals and principles also had an impact on intergovernmental relations, their role remained rather marginal and understudied. Furthermore, no distinction was made between intergovernmental relations as a tool to facilitate law-making and as a substitute for legislative decisions. Most analyses were rather descriptive and lacked a dynamic element that would differentiate between various forms of executive leadership in policymaking depending on whether it led to federal legislative decision-making or not. In fact, paradoxically enough, executive federalism is a concept very much connected to centralized legislative decision-making inasmuch as it aims to understand intergovernmental negotiations outside the parliamentary processes that would nevertheless facilitate federal legislation. This observation is made by Verney (1989) who considered executive federalism as half-federalism, or a transitional stage on the road to full-blown legislative federalism, which he described as a federal system where regional interests were represented and accommodated in a federal legislative body (i.e. an elected Senate). In 2002, Cameron and Simeon advanced the idea of collaborative federalism to describe the changing nature of intergovernmental relations in Canada. Faced with a dilemma similar to the EU’s case, the authors argued that the practice of “co-determination of broad national policies” (Cameron and Simeon 2002, 49) by the different orders of government was becoming more and more salient. Even though they described the institutional changes collaborative federalism initiated, they failed to provide a general theoretical framework within which such intergovernmental dynamics could be embedded. Since they were “not positing a dramatic break with the past” (Cameron and Simeon 2002, 50), they repeated Simeon’s legalistic perspective from the 1970s with regard to the factors affecting intergovernmental relations (see also Bakvis and Skogstad 2012, 8). Despite the growing sensitivity of policy matters, there was no discussion of policy

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deliberations and their impact on intergovernmental relations. Furthermore, there were no propositions explaining the process through which collaborative federalism might emerge or the underlying norms, values and principles that could affect such a process. To understand how intergovernmental relations substituted collective legislative decisions in settling cross-jurisdictional policy matters within the EMU as a response to the crisis, this study advances a revised understanding of collaborative federalism that combines essential elements of the literature on federalism and European integration theory. It will be argued that the sensitivity of a policy challenge (i.e. which originates under member state jurisdiction) increases skepticism among the EU member states towards centralized decision-making, while complexity (i.e. great level of policy interdependence) of a policy area pushes governments towards open deliberations, which in turn allows for the adoption of federal principles in areas of separate member state jurisdictions. Consequently, the nature of intergovernmental relations changes, which in turn affects the allocation of powers among the different orders of government. Instead of arguing that the constitutional arrangement determines the nature of intergovernmental relations, it will be demonstrated that the emergence and development of federal principles in response to specific policy challenges often has a greater impact. Contemporary research shows a revival of intellectual interest in the cultural aspects of federalism understood as shared knowledge of basic norms, principles, and patterns of behavior. However, “its conceptual and empirical implications have never been fully explored” (Burgess 2013, 3). The special emphasis on the cultural dimension is supported by the fact that federalism is essentially a normative concept. The term “federal idea” (Courchene et al. 2011) or “federal spirit” (Burgess 2013) is used frequently in scholarly and political discourse, highlighting the importance of values, visions, beliefs, principles, norms and the corresponding language and behavioral patterns that define federalism. The analysis of institutional and procedural developments could therefore start with a closer look at these components and then move on to explore their potential in helping us understand the character of intergovernmental relations. After all,13 according to the existing literature, federalism is a sentiment (Riker 1964, 111), a behavior (Friedrich 1968, 39; Elazar 1987, 154) which entails “the spirit of cooperative enterprise and mutual respect” (Livingston 1956, 316). It is based on a compromise and requires “a firm determination to maintain both diversity and unity by way of a continuous process of mutual adaptation” (Friedrich 1968, 175). In sum, federalism is “a form of political will designed to forge a particular kind of constitutional bargain based upon elite negotiations and compromises, and secondly (. . .) a culture of political



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attitudes, habits, beliefs, and orientations that sustained a mode of behavior appropriate to the maintenance of that bargain” (Burgess 2013, 12). As there is a “need to reassert the importance of process over substance, the need to move beyond comparative statics, in the study of competence and federalism” (Nicolaidis 2001, 448), federal principles are to be analyzed with regard to intergovernmental relations, as well as constitutional arrangements. Consequently, this analysis concurs that federalism needs to be understood as “a combination of self-rule and shared rule” (Elazar 1979, 2), which combines both structure (i.e. self-rule manifested in legislative decision-making) and process14 (i.e. shared rule manifested in supranational institutions or intergovernmental arrangements). Even though Nicolaidis (2001) highlighted the importance of a more sophisticated way of shared competences (from reserved through national but coordinated to partially or mostly transferred powers), this analysis left the question of “when various components of ‘shared competence’ are activated and under what conditions” open to discussion (Nicolaidis 2001, 451). Sbragia (2004) went further to stress the possibility of shared rule achieved through intergovernmental coordination. However, this analysis did not address the conditions under which such a sharing should take place. It may be argued that complex and sensitive policy challenges often push member states towards open discussions while stressing the relevance of intergovernmental exchanges which allows for the adoption of federal principles in areas under member states’ jurisdiction. Once a particular combination of these principles is established, competitive intergovernmental interactions give way to collaborative ones, which will have a major impact also on the allocation of competences. However, the sharing of a competence (i.e. redistribution of powers) is not guaranteed through a legal, constitutional framework but rather through an informal, political process of intergovernmental collaboration. This feature distinguishes collaborative from cooperative federalism (see Schütze 2009), and allows for an alternative or complementing development path for federal political systems. Depending on the federal principles adopted in intergovernmental relations federal political systems may evolve from competitive to collaborative as opposed to cooperative federalism, making collaborative federalism a mezzanine towards a full-blown cooperative federalism based on the constitutional sharing of legislative competences. What are these federal principles? Building upon and complementing Burgess (2013), this study argues that the combination of the following federal principles indicates the existence of collaborative federalism. 1. Self-determination and autonomy refers to the assumption that “national interests” in relation to specific policy questions can be achieved by

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self-defined communities which accommodate distinct identities with regard to common pursuits. 2. Partnership is based on the value of equality among the different actors, and it means a voluntary relationship that is of non-hegemonic nature which implies both openness and consensus-orientation. 3. Loyalty refers to an expectation that constituent units commit themselves to the overall needs of the federal system. 4. Comity implies fair play among the different actors to be ready for compromise and to be pragmatic on cross-jurisdictional matters. 5. Unity in diversity refers to the idea of unity without uniformity and diversity without fragmentation, or the indestructible union of indestructible parts15 which also speaks to the idea of non-centralization. 6. Proportionality and mutuality are based on the values of toleration, recognition and respect for the others. While proportionality is “the operational core of subsidiarity” (Nicolaidis 2001, 453), mutuality refers to an “obligation (. . .) in joint decision-making to foster the legitimacy and capacity of the other” (Nicolaidis 2001, 462). 7. Flexibility and open-endedness are essential in maintaining a federal polity that requires the ability to respond quickly to changing policy challenges. It also implies being susceptible to influence or persuasion, therefore it emphasizes the role of iterations that foster deliberations. In competitive or dual federalism, self-determination is the dominant principle driving intergovernmental relations with regard to constituent unit competences. However, here autonomy refers to independence of policymaking authority. There is no partnership since hegemony is guaranteed in areas under constituent unit responsibilities. There is no sense of loyalty, as the policy field in question is considered to be separate and independently regulated from others. Since loyalty and partnership are missing, there is little room for comity. Diversity is emphasized over unity and consequently, there is little consideration of either proportionality or mutuality. Constituent units aim for flexibility. However, it lacks a cooperative component inasmuch as it is guaranteed by single actors. As far as cooperative federalism is concerned, intergovernmental relations are driven more by federal principles. In the cooperative scheme, selfdetermination and autonomy as a principle correspond with the accommodation of national interests in the pursuit of common goals. However, as collective, legislative decisions are to guarantee the coordination of cross-jurisdictional areas, the partnership principle is partially violated. Instead of nonhegemonic and heterarchical relations, cooperative federalism implies some hierarchy among the different orders of government. Loyalty and comity are both relevant principles of cooperative federalism, the former referring



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to a common understanding that a given policy challenge is considered as a federal issue, while the latter is assured through the participation of the constituent units in procedures leading to legislative decisions. Unity in diversity is generally reflected in the legislative framework. While federal law assures unity, constituent unit implementation guarantees diversity. Since cooperative federalism is based on the constitutional distribution of legislative powers, there is very little room for flexibility and open-endedness, which also affects the principles of proportionality and mutuality (if one is to police where a power is exercised instead of how it is exercised, there is little need for these principles). Instead of looking at federalism from a systemic point of view, the concept of collaborative federalism reflects the need to consider individual policy areas and look for the structural and procedural elements of federalism. In other words, collaborative federalism supports the understanding of the federalization of sensitive and complex constituent unit competences. Once again, this study argues that the sensitivity of the EMU file created skepticism among member states towards centralized legislative decisions, while the complexity of the policy area created incentives for the adoption of federal principles underlying collaboration. Personal interview materials with EU and member state officials, European Council and Commission documents, and media accounts provide evidence of the emergence and evolution of intergovernmental relations in the EU. The empirical data reconstructs a narrative which explains intergovernmental development from the Rome Treaty to the adoption of the Treaty on Stability, Coordination and Governance (TSCG) and how the allocation of powers changed correspondingly. Intergovernmental Relations and the Development of Federal Principles in Economic Governance Economic governance is a complex concept that was once described as an “equivalent of fiscal federalism based on much stronger surveillance of budgetary and competitiveness policies since a truly federal system would require a treaty change.”16 Interestingly enough, references to the integration of economic policies remained rather vague in the earlier treaties of the European Union. The Treaty of Rome talked about the promotion of “a harmonious development of economic activities” (Article 2) and coordination of economic policies was mentioned several times (see Article 6, 105[1]). More attention was given to exchange rate mechanisms and monetary issues while substantive elements of fiscal matters remained rather undefined. As one EU member state official indicated “there was something specific

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about fiscal policy . . . it wasn’t necessarily more complicated than other areas but still, the situation was rather difficult as it [i.e. fiscal matters] was considered to be the primary responsibility of the state.”17 Consequently, intergovernmental relations were dominated by the principle of self-determination and autonomy. As another official explained, “during the first years we [i.e. member states] did not understand the interconnectedness of economic issues . . . macroeconomic considerations have not been taken seriously.”18 Not until the Delors Report19 in 1989 was there a firm official call to coordinate fiscal policies across the EU member states in order to deal with economic interdependencies. To be able to create a real economic and monetary union, the document proposed a transfer of decision-making powers in the area of monetary policy to the Community level while stressing that “in the economic field a wide range of decisions would remain the preserve of national and regional authorities” (Delors Report, 14). In order to fulfill the aim of economic union, the text proposed binding rules in the budgetary field (i. e. limits on deficits) while allowing for discretionary coordination to ensure effective implementation (Delors Report, 24). The Report admitted that “under present national legislations no member country is able to transfer decisionmaking power to a Community body, nor is it possible for many countries to participate in arrangements for a binding ex ante coordination of policies (. . .) [consequently] there is at present no transfer of responsibility for economic and monetary policy from Member States to the Community” (Delors Report, 36–37). As the members of the Delors Committee were mainly central bank governors, “the Delors report advance[d] the European Commission further than ever into (. . .) monetary affairs.”20 However, it also contributed to the debate leading to the Maastricht Treaty. Although the new treaty repeated the provisions of earlier treaties concerning fiscal policy, it also clarified and further specified certain elements of it. Article 103 repeatedly argued that the “Member States shall regard their economic policies as a matter of common concern” (Article 3(1)), yet the role of the Council was explicitly mentioned in the text as the body within which such coordination should take place. The most significant development that the Maastricht Treaty initiated was the establishment of “broad economic guidelines” and the related monitoring and assessment procedures designed to ensure closer coordination of economic policies among the EU member states. However, these measures came in the form of recommendations based on qualified majority decisions within the Council. They therefore represented non-binding acts, and thus could not be equated with legislative decisions at the federal level, such as regulations, directives or decisions. Furthermore, Article 104(c) established a procedure to resolve excessive deficit problems occurring in any given member state. This provision was based on monitoring of the ratios of government deficit and government debt to gross domestic product carried out by the



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Commission. Once again, Council recommendations were to be used (Article 104[c], 6–7) in case a member state did not comply with the rules set out in the Protocol on macroeconomic data. Even though the recommendations introduced a deficit rule into EMU, it proved to be a half-hearted measure and remained inconsistent, hardly internalized by the EU member states. In fact, when some of the large states themselves faced excessive deficit problems, the established system and enforcement mechanisms of the rules did not pass the ultimate test. As one financial counselor noted, “the aim of the Maastricht Treaty was to set the rules for the scene . . . however, it was imperfect because it was very theoretical and very political, and everything had to be done not to be politically rude on member state sovereignty in these areas (. . .) right at the beginning the idea was to do some kind of soft coordination.”21 In terms of legislative competences, the integration process seemed to have reached its peak concerning monetary and especially economic policy matters. In fact, “neither the Amsterdam Treaty, nor the Nice Treaty touched the issue. Finally, the negotiations about the Constitutional Treaty and the Lisbon Treaty clearly revealed that there would be no scope for further transfers of formal decision-making competences in the foreseeable future” (Puetter 2012, 167). Even though the Lisbon Treaty updated the existing framework with texts that reflected the establishment of the Eurozone (Article 3(4) of the TEU), in reality it consolidated the system which the Maastricht Treaty had created with regard to fiscal policy. The major development came with Article 136 of the Treaty on the Functioning of the European Union (TFEU) which described special elements concerning the relations among member states which shared the common currency, the euro. Interestingly enough, this did not go further than a reference to “economic policy guidelines” and the need “to strengthen the coordination and surveillance of their [i.e. member states] budgetary discipline” (Article 136[1a]). An important novelty was an extra protocol (Protocol No. 14) establishing the Euro Group (Article 137), which allowed for deliberative procedures to flourish (see Puetter 2012). This was the institutional and procedural structure pertaining to EMU introduced by the Lisbon Treaty, which, as argued earlier, introduced little change compared to the Maastricht Treaty. However, more general developments, such as the formalization of the European Council as an EU institution and the establishment of a permanent President of the Council also took place. Although these are important elements of institutional evolution, they were not directly connected to EMU. Nevertheless, the economic and financial crisis once again accentuated the unbalanced nature of economic and monetary affairs within the EU. The crisis put the existing institutions and procedures under a severe test followed by innovation. Beyond more formal institutional change, the only value added in the economic field before the crisis came from the Stability and Growth Pact

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(SGP) in 1997. The legal basis for the SGP was to be found in Article 99(3) of the Amsterdam Treaty which called for multilateral surveillance, Article 104 which dealt with the excessive deficit procedure (see also Protocol 20), and Article 211 which gave the Commission power to policy advice. Even though the regulations connected to the SGP had a legally binding nature, they had not been internalized by the member states. As one EU official argued, “the SGP was too weak in the potential application because the means were not there (. . .) because member states were not ready to transfer the prerogatives to the central institutions.”22 Another EU official from a small member state explained that “there was clearly no sufficient power given to the center to apply the rules in a consistent way (. . .) the political will has not moved with the rules.”23 This ambiguity was also manifest in the 2003–2004 deficit crisis, in which France and Germany did not comply with the deficit rules set out in the Maastricht Treaty. Ultimately, the sanctions invoked by the SGP were voted down, effectively “destroying the pact in the process.”24 Even though it was stated that “responsibility for making the member states observe budgetary discipline lie[d] essentially with the council,”25 the SGP framework was reformed in 2005. The period between 1989 and 2005 may be characterized as a rather ambiguous time from the point of view of intergovernmental relations. The complexity of economic policy was partially acknowledged by the EU member states, as they began to examine fiscal policy matters in relation to monetary ones. However, as budgetary affairs were still regarded as the most important responsibilities of the state, the topic was not considered in detail from a community perspective. As one financial counselor argued, “national politics weren’t ready for a full transfer of sovereignty . . . European politics wasn’t ready for more EU.”26 As both complexity and sensitivity of the fiscal issue was only recognized in principle by the member states, selfdetermination and autonomy still dominated intergovernmental interactions, while other federal principles could only partially develop. Even though the member states voluntarily began to coordinate their economic policies, as autonomy was equated with independence, the partnership principle remained rather limited in intergovernmental relations. As an EU member state official explained, “national interests prevailed over community interests (. . .) [and] procedures did not help to change that either.”27 Loyalty was emerging as the treaties referred to economic policy as a common concern of the member states. However, the deficit crisis demonstrated how fragile the commitment to implementation of the fiscal rules was. As loyalty was only partly developed, the comity principle was applied in a restrained manner as well. Although unity was guaranteed by the fixed deficit and debt rules, diversity prevailed due to the dominance of the autonomy principle. Flexibility and open-endedness were adopted as principles in intergovernmental relations,



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although the role of deliberations was constrained since “national interests” prevailed. Despite the resolution on the SGP and its corresponding regulations, the member states remained reluctant to transfer decision-making powers to a central, collective body. As one official rightly claimed, “the rules were not the problem, but authority was really weak . . . it needed to be reinforced by someone else . . . a referee with authority to apply the rules.”28 The financial crisis revealed how fragile the framework established by the Maastricht Treaty and preserved in the Lisbon Treaty was. The complexity of economic policy was finally fully acknowledged by the member states: “the economic framework has been hit by an instable situation where clearly the institutions were not ready, the member states were not ready, and the union was not ready to deal with it, because they realized it was too soft of a system.”29 Once the EU member states recognized the interconnectedness of the European economies, fiscal policy coordination became a sensitive issue that made pre-negotiation preference setting difficult. Consequently, intergovernmental processes changed. As a financial counselor from a member state argued, “it was something new compared to the situation before, I remember clearly a session of the Economic and Financial Committee [EFC] in March [2010] (. . .) there was a kind of open discussion which rarely happens in this kind of format because everything is driven by an agenda.”30 These deliberative settings allowed for the development of federal principles. As the complexity and sensitivity of fiscal policies was recognized, national interests were to be pursued with regard to common goals. Consequently, the partnership principle was enhanced as member states aimed to resolve the crisis through strengthened horizontal means instead of relying on proposals made by the European Commission. As one official argued, “the more you went into the negotiations, the more you moved towards partnership.”31 The Commission came to follow up on the intergovernmental agenda. A senior COREPER official described the significance of the European Council for intergovernmental decision-making: “[T]he European Council is among the institutions now but is freer to see itself coming up with dossiers without a legislative angle (. . .) it represents another work-stream along the Commission with its own working and guiding principles.”32 With regard to economic governance, a financial counselor from an EU member state argued that “going the intergovernmental way was clearly a political decision that reflected certain member states’ skepticism on legal issues right from the beginning.”33 The preference for consensus was echoed in the move to unanimity rules and the almost complete closing out of the European Parliament from the procedures. The reforms initiated on the SGP by the Six Pack also reinforced the commitment of the member states towards reaching resolutions at the community level (loyalty). According to one official, “there was a clear sense of respect for the rules as the governance structure

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was reinforced (. . .) the commitment was there, but the application of the rules was still questionable.”34 With attempts to reform the SGP, there was clearly more pragmatism injected into the system, and the member states were generally ready to compromise as most officials argued. It was noted that, “the principle of ‘unity in diversity’ was becoming a relevant approach under the idea and practice of ‘constrained discretion’”35 which related to autonomous decisions within the established common standards. As far as flexibility was concerned, it was argued that “legislative deliberations now often lead to non-legislative decisions”36 in the form of intergovernmental agreements (e.g. TSCG). In general, intergovernmental institutions and processes began to dominate. Informal procedures gained relevance over time, which led to a reversed community method whereby the European Council invited the Commission to make proposals in relation to the problems that needed to be addressed. The Commission actually tried to reserve the right of initiative by coming out with a package of proposals37 (Six Pack) before the Van Rompuy Task Force finished its report.38 However, as one member state official suggested, “the idea of the European Semester was first put forward by Luxembourg [in the EFC], two months before the Communication of the Commission.”39 By 2011, the situation was ripe for a new set of measures. First, the President of the European Council once again demonstrated leadership by putting forward the proposal of the Euro Plus Pact. It was created under his personal guidance and was endorsed by the Euro area countries, and later by some of the non-eurozone countries. The Pact was based on an OMC and marked a move towards intergovernmental resolutions that would substitute centralized, collective legislative decisions. In November 2011, the European Commission proposed two further regulations (known as the Two Pack) to further surveillance and monitoring procedures for euro area member states. The Two Pack, in many ways, reflected coordination demands initiated by the Euro Plus Pact. The dominance of the intergovernmental bodies was summarized by Herman Van Rompuy as follows: Until recently, it seemed natural to imagine that Europe would become more centralized. Instead we are seeing member states and national leaders take centre stage in particular in dealing with the public debt crisis. In my view this is not contradictory. Unlike some, I do not see the return of the ghosts of the past and the “renationalization of European politics.” No, in my view, what is in fact happening is the “Europeanization of national politics.”40

On March 2, 2013, the Treaty on Stability, Coordination and Governance (TSCG) was signed by 25 of the 27 (now 28) EU member states. As an intergovernmental agreement (and therefore not part of EU law), it did not change



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the formal distribution of competences between the EU and its member states. Article 2.2 of the Treaty suggests that it merely aimed at helping member states coordinate their fiscal policies in order to ensure the stability of the euro. Yet, the Fiscal Compact has important implications as far as measures relating to fiscal policies are concerned. It requires member states to enshrine a balanced budget rule with a lower limit of a structural deficit of 0.5 percent of GDP into national law,41 The Compact is centered on the concept of the country-specific mediumterm objective as defined in the SGP. It was a clear result of “institutional fatigue,”42 as one official expressed it. The TSCG was an indication of a situation in which “member states had to start coordination in areas where the Union had no explicit competence, but there wasn’t much possibility for going beyond the existing allocation of competences.”43 As a number of EU officials have argued, even though it was a minor extension to the existing framework, it reinforced many of the federal principles that came to drive intergovernmental relations. Institutional Change and the Allocation of Powers The previous section demonstrated how the growing complexity and sensitivity of the economic policy portfolio pushed the EU member states to adopt federal principles in an area under their own jurisdiction (i.e. fiscal policy) and how this development affected the conduct of intergovernmental relations seeking resolutions. Although certain elements have been discussed above, this last section will summarize the major institutional and procedural changes and analyze to what extent the newly established framework has formalized these new principles. This analysis will also contribute to an assessment of the changes in the allocation of competences, implemented without formally altering the constitutional framework established by the Maastricht Treaty. As for the institutional changes, the working methods of European Council were somewhat modified. Whereas between 1993 and 2008, there were an average of four European Council meetings per year (with the exception of 2003) and only five extraordinary and eleven informal meetings, between 2008 and 2013 these numbers increased considerably. There were around 6 to 7 European Council meetings annually with additional Euro summits. As a new development, bilateral discussions over the phone and in person have become rather regular between the President of the Council (Van Rompuy) and individual heads of member state governments for the purpose of “pre-baking the pie”44 as one British official put it. In general, strong interaction and real discussions prevailed which have been actively supported by the ECOFIN and the Euro Group meetings as well which contributed greatly to the deliberations.

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Changes in the Euro Group have also been instrumental in furthering the deliberative mechanisms of existing institutions, in order to fulfill the responsibilities of policy coordination . The Lisbon Treaty merely formalized what had already been a practice before among the finance ministers of the Eurozone countries. Yet, the crisis had a huge impact on the Euro Group itself. As one European official from the Commission noted, “during the crisis, the Euro Group has been acting like a firefighters’ meeting, (. . .) it has become a better functioning institution with a Secretariat and a permanent chair.”45 In general, as one official from Luxembourg claimed, “Euro Group meetings have become more important than ECOFIN meetings.”46 As to the Council (ECOFIN), its importance should not be downplayed. In fact, its relevance increased as far as policy coordination and deliberation is concerned. However, as one official argued, “informal meetings of ECOFIN are more essential now . . . formal settings are rather useless as there are too many people and very seldom debates on substantive issues.”47 As a UK official argued, “ECOFIN changed ways how things work, and fundamentally it became responsible for a supervisory policy.”48In a similar manner, DG ECFIN within the Commission took up the role of “surveillance police.”49 The sherpa meetings emerged as another example of increased reliance on informal institutions and procedures. Their importance cannot be overstated. As an official from Luxembourg explained, sherpas are one of the members of the delegations during COREPER meetings, however “sherpas meet on a regular basis as well, and there are important discrete side meetings before each Council meeting.”50 As an Eastern European official claimed, “sherpa meetings could be rather powerful . . . sometimes it feels almost like important decisions are taken there.”51 The working methods, in general, have shifted towards more discussion whether in a formal or an informal setting, whether in the European Council, the Council, the Euro Group or COREPER meetings. As Herman Van Rompuy concluded: All the members of the European Council were willing to take more responsibility for these economic issues. Such personal involvement is indispensable. I was glad to find a high level of ambition around the table. The first result is that the European Council becomes something like “the gouvernement économique” of the Union, as some would call it. (. . .) The financial and economic crisis obliges us to take steps on this road (. . .) To help find consensus among Member States, new institutions and new offices were created (. . .) However, it does not suffice to create a new institution to solve a problem, certainly, not immediately. This requires consultation between Member States and time.52

The institutional and procedural changes reflect the development of the federal principles outlined in the previous part. As a last task, it is important to



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assess how these principles were introduced and how the actual allocation of competences changed despite the fact that intergovernmental relations came to substitute centralized legislative decisions. It was already signaled that the Six Pack and the Two Pack, which consisted of different regulations (and one directive), did not change the framework established by the SGP. Rather they contributed to the strengthening of budgetary surveillance and coordination of economic policies (i.e. multilateral surveillance, European Semester, macroeconomic imbalances procedures, excessive deficit procedures, etc.). Even though they came in the form of regulations, they did not create legislative powers concerning fiscal policy coordination. The recommendations were used to ensure the correction of excessive deficits, and delegated acts were only referenced in connection with administrative matters of reporting. All substantive decisions were to go through the intergovernmental institutions and procedures of the EU, which nevertheless reflected the federal principles highlighted previously. As for the Euro Plus Pact, it enshrined the autonomy and loyalty principles as it aimed to “strengthen the economic pillar (. . .) [while focusing] primarily on areas that fall under national competence.”53 Loyalty and comity were also carved into the text as the whole pact was to be monitored politically by the heads of state or government, and “Member States commit to consult their partners on each major economic reform having potential spill-over effects.”54 “Unity in diversity” was preserved through the freedom of policy actions while maintaining common objectives, which reflected the principle of proportionality. The agreement on the European Stability Mechanism (ESM) was built upon the partnership principle embodied in the “mutual agreement” requirement in most decisions. The TSCG further reinforced the partnership principle inasmuch as it called on member states to police each others’ compliance by means of the correction mechanism (Article 8). The provisions for “economic partnership programs” were designed for the same purpose. The Treaty enshrined the flexibility principle as it left the formalization of the intergovernmental agreement open. All things considered, even though the different intergovernmental elements from mechanisms in the reformed SGP through the Euro Plus Pact and to the TSCG did not change the formal distribution of powers among the member states and the European level, it did lessen the capacities of individual governments to act unilaterally in fiscal affairs. Conclusion The European financial and economic crisis challenged the existing economic and monetary framework of the European Union once again. Member states

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were clearly in need of system-wide policy solutions, yet they demanded autonomy in decision-making. This internal tension led to a changed character of intergovernmental relations which came to substitute a formal transfer of legislative competences to the European level. Questioning the age-old dichotomy of intergovernmentalism versus supranationalism in the EU integration literature, this study argued that despite an established pattern of reliance on intergovernmental relations, a federalist approach can help us understand how such a development can occur. It was argued that, as the internal tension corresponds to the basic federal idea of “unity and diversity,” the process can be explained from the perspective of federal principles. It was hypothesized that the growing complexity and sensitivity of fiscal policy pushed the EU member states towards open deliberations which allowed for the adoption of basic federal principles and in turn affected the nature of intergovernmental relations. The relevance of the topic cannot be overstated. As the European Union is destined to face a similar dilemma in other areas as well (e.g. employment policy, energy policy, social policy), it is important to study the dynamics of intergovernmental relations. It could help us determine the conditions under which policy coordination without formal transfer of constitutional powers is likely and legislative decisions are likely to flourish as well. This latest development also suggests that the European Union has reached yet another step towards a type of a federal political system. Consequently, comparative federalist studies using the EU as a case may prove to be theoretically better grounded if they turn their focus away from the constitutional distribution of powers and instead pay more attention to intergovernmental processes.

Notes 1. Speech by Federal Chancellor Angela Merkel at the opening ceremony of the 61st academic year of the College of Europe in Bruges on 2 November, 2010, p. 7. http://www.bruessel.diplo.de/contentblob/2959854/Daten/ (accessed March 10, 2012). 2. As Burgess (2009, 33) has argued: “the role of EU member states as propulsive forces in helping to build a federal Europe has actually been underestimated by federalists themselves and should be much more effectively integrated into federalist theory.” 3. In this, it reflects the “governance turn” within EU integration studies (see Bulmer 1993; Hix 1994; Hurrell and Menon 1996; Pollack 2001; Jachtenfuchs 2001). Governance approaches analyzed the European integration process from the point of view of effective and legitimate governance capacities (Peters and Pierre 2009), and studied how complex policy decisions required creative institutional designing.



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4. As a response to the “deliberative turn” (see Neyer 2006) in EU integration studies. 5. Consequently, it lacks a contextual element such as LI did. 6. See also the White Paper on European Governance, COM(2001) 428, (2001/C 287/01). http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52001D C0428&rid=2 (accessed May 8, 2010). 7. This is also due to the intergovernmentalist—supranationalist dichotomy within European integration theory (see e.g. Wiener and Diez 2009, 8–9). 8. However, it is argued by some scholars that intergovernmentalism “is an inherent part of a genuine federal vision” (Nicolaidis 2001, 454). 9. Therefore these studies all considered intergovernmental relations as the dependent variable. 10. It is noteworthy that Jean Monnet, one of the most prominent figures around the establishment of the European Union (Community back then) has spent some of his most formative years in Canada, and his ideas about European integration has been greatly influenced by his experience overseas (see Ugland 2011). 11. ’Executive federalism’ refers to a “pattern of interaction in which much of the negotiating required to manage the federation takes place between the executives, elected and unelected, of the main orders of governments” (Bakvis et al. 2009, xii). However, there was an alternative understanding of the concept “executive federalism” advanced by Dawson (1987) which argued that the federal cabinet represented regional interests as opposed to the Senate in “legislative federalism” or separate external mechanisms such as First Ministers’ Meetings (Smiley’s understanding of executive federalism). 12. Since the Senate does not accommodate provincial interests in national legislative matters and the parliamentary form of government emphasizes the role of the executive over the legislative branch (see e.g. Bakvis et al. 2009, 71) ongoing negotiations between provincial executives is to work out legislative decisions outside the parliamentary system. 13. Emphases within this paragraph were added by the author. 14. See Elazar (1987). 15. Texas v. White, 74 U.S. 700 (1868) Supreme Court decision, http://supreme. justia.com/cases/federal/us/74/700/case.html (accessed February 15, 2014). 16. http://www.europarl.europa.eu/sides/getDoc.do?language=en&type=IM-PRE SS&reference=20100621IPR76407 under the section: The new economic governance architecture (web source accessed May 12, 2014). 17. Anonymous interview conducted in Brussels, 24 March, 2013. (MS_EFC01) 18. Anonymous interview conducted in Brussels, 14 June, 2013. (MS_EFC08) 19. Officially known as Report on economic and monetary union in the European Community. Source: http://aei.pitt.edu/1007/1/monetary_delors.pdf (accessed January 20, 2013). 20. The Delors Report; Summit hurdles loom for report, in Financial Times, 18 April, 1989. 21. Anonymous interview conducted in Brussels, 11 April, 2013. (MS_EFC04) 22. Anonymous interview conducted in Brussels, 11 April, 2013. (MS_EFC04) 23. Anonymous interview conducted in Brussels, 28 March, 2013. (MS_EFC02)

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24. Flexible rules for Europe, strictly enforced, in Financial Times, 19 January, 2004. 25. Point 76 of the European Court of Justice Case C-27/04. 26. Anonymous interview conducted in Brussels, 24 March, 2013. (MS_EFC01) 27. Anonymous interview conducted in Brussels, 24 March, 2013. (MS:EFC01) 28. Anonymous interview conducted in Brussels, 11 April, 2013. (MS_EFC04) 29. Anonymous interview conducted in Brussels, 10 April, 2013. (MS_EFC03) 30. Anonymous interview conducted in Brussels, 24 March, 2013. (MS_EFC01) 31. Anonymous interview conducted in Brussels, 28 March, 2013. (MS_EFC02) 32. Anonymous interview conducted in Brussels, 31 May, 2013. (MS_EFC05) 33. Anonymous interview conducted in Brussels, 24 March, 2013. (MS_EFC01) 34. Anonymous interview conducted in Brussels, 28 March, 2013. (MS_EFC02) 35. Anonymous interview conducted in Brussels, 24 March, 2013. (MS_EFC01) 36. Anonymous interview conducted in Brussels, 6 June, 2013. (MS_EFC07) 37. COM(2010) 522–527. See links at http://ec.europa.eu/economy_finance/articles/eu_economic_situation/2010-09-eu_economic_governance_proposals_en.htm (accessed February 17, 2013). 38. http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ ec/117236.pdf (accessed December 15, 2012). 39. Anonymous interview conducted in Brussels, 24 March, 2013. 40. Beyond the institutions: Why Europe today?, a speech delivered by Herman Van Rompuy, President of the European Council at the Europe Conference in Copenhagen, 11 May, 2012. http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/130149.pdf (accessed March 5, 2013). 41. Of binding force and permanent character, preferably constitution. 42. Anonymous interview conducted in Brussels, 25 July, 2013. (CAB_REHN01) 43. Anonymous interview conducted in Brussels, 31 May, 2013. (MS_EFC05) 44. Anonymous interview conducted in Brussels, 23 July, 2013. (MS_EFC01) 45. Anonymous interview conducted in Brussels, 25 July, 2013. (CAB_REHN01) 46. Anonymous interview conducted in Brussels, 2 July, 2013. (MS_EFC02) 47. Anonymous interview conducted in Brussels, 31 May, 2013. (MS_EFC06) 48. Anonymous interview conducted in Brussels, 23 July, 2013. (MS_EFC01) 49. Anonymous interview conducted in Brussels, 23 July, 2013. (MS_EFC01) 50. Anonymous interview conducted in Brussels, 6 June, 2013. (MS_EFC07) 51. Anonymous interview conducted in Brussels, 25 July, 2013. (CAB_REHN01) 52. “The challenges for Europe in a changing world.” Speech delivered by Herman Van Rompuy, President of the European Council at College d’Europe, Bruges, 25 February, 2010. http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ ec/113067.pdf (accessed March 5, 2013). 53. European Council. 2011a. Conclusions, 24–25 March, 2011. http://www. consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/120296.pdf, p. 13 (web source accessed January 6, 2013). 54. European Council. 2011b. Conclusions, 24–25 March, 2011. http://www. consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/120296.pdf, p. 14 (web source accessed January 6, 2013).



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References Bakvis, Herman, Gerald Baier and Douglas Brown. 2009. Contested Federalism: Certainty and Ambiguity in the Canadian Federation. Toronto: Oxford University Press. Bakvis, Herman and Grace Skogstad, eds. 2012. Canadian Federalism: Performance, Effectiveness, and Legitimacy. New York: Oxford University Press. Bolleyer, Nicole. 2009. Intergovernmental Cooperation. Oxford: Oxford University Press. Bolleyer, Nicole and Tanja Börzel. 2010. “Non-hierarchical Policy Coordination in Multilevel Systems.” European Political Science Review 2(2): 157–185. Bulmer, Simon. 1993. “The Governance of the European Union: A New Institutionalist Approach.” Journal of Public Policy 13(4): 351–380. Burgess, Michael and Alain G. Gagnon. 1993. Comparative Federalism and Federation. New York: Harvester, Wheatheat. Burgess, Michael. 1996. “Federalism and Building the European Union.” PUBLIUS: The Journal of Federalism 26(4): 1–15. Burgess, Michael. 2006. Comparative Federalism: Theory and Practice. London: Routledge. Burgess, Michael. 2009. “Federalism.” In European Integration Theory, edited by Antje Wiener and Thomas Diez, 25–44. Oxford: Oxford University Press. Burgess, Michael. 2013. In Search of the Federal Spirit: New Theoretical and Empirical Perspectives in Comparative Federalism. Oxford: Oxford University Press. Cameron, David and Richard Simeon. 2002. “Intergovernmental Relations in Canada: The Emergence of Collaborative Federalism.” PUBLIUS: The Journal of Federalism 32(2): 49–71. Chryssochoou, Dimitris N. 1997. “New Challenges to the Study of European Integration: Implications for Theory-Building.” Journal of Common Market Studies 35(4): 521–542. Courchene, Thomas J., John R. Allan, Christian Leuprecht and Natalia Verrelli, eds. 2011. The Federal Idea: Essays in Honour of Ronald L. Watts. Montréal: McGillQueen’s University Press. Dawson, Robert MacGregor. 1987. The Government of Canada. Toronto: University of Toronto Press. De Búrca, Gráinne and Joanne Scott, eds. 2006. Law and New Governance in the European Union and the United States. Oxford: Hart Publishing. Elazar, Daniel J. 1979. Federalism and Political Integration. Jerusalem: Turtledove Publishing. Elazar, Daniel J. 1987. Exploring Federalism. Tuscaloosa: University of Alabama Press. Fossum, John Erik. 2009. “Europe’s American Dream.” European Journal of Social Theory 12(4): 483–504. Friedrich, Carl J. 1968. Trends of Federalism in Theory and Practice. New York: Frederick A. Praeger Publishers. Hix, Simon. 1994. “The Study of the European Community: The Challenge to Comparative Politics.” West European Politics 17(1): 1–30.

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Hueglin, Thomas and Alan Fenna. 2006. Comparative Federalism. Peterborough: Broadview Press. Hurrell, Andrew and Anand Menon. 1996. “Politics Like Any Other? Comparative Politics, International Relations and the Study of the EU.” West European Politics 19(2): 386–402. Jachtenfuchs, Markus. 2001. “The Governance Approach to European Integration.” Journal of Common Market Studies 39(2): 245–264. Jachtenfuchs, Markus and Christiane Kraft-Kasack. 2013. “Balancing Unity and Diversity. Exit and Voice in the EU and in Federal Systems.” Paper presented at the ECPR General Conference, Bordeaux, 5–7 September. Koslowski, Rey. 1999. “A Constructivist Approach to Understanding the European Union as a Federal Polity.” Journal of European Public Policy 6(4): 561–578. Livingston, William S. 1956. Federalism and Constitutional Change. Oxford: Clarendon Press. Moravcsik, Andrew. 1993. “Preferences and Power in the European Community: A Liberal Intergovernmentalist Approach.” Journal of Common Market Studies 31(4): 473–524. Moravcsik, Andrew. 1998. The Choice for Europe: Social Purpose and State Power from Messina to Maastricht. Ithaca: Cornell University Press. Moravcsik, Andrew and Frank Schimmelfennig. 2009. “Liberal Intergovernmentalism.” In European Integration Theory, edited by Antje Wiener and Thomas Diez, 67–87. Oxford: Oxford University Press. Mosher, James S. and David M. Trubek. 2003. “Alternative Approaches to Governance in the EU: EU Social Policy and the European Employment Strategy.” Journal of Common Market Studies 41(1): 63–88. Neyer, Jürgen. 2006. “The Deliberative Turn in Integration Theory.” Journal of European Public Policy 13(5): 779–791. Nicolaidis, Kalypso and Robert Howse, eds. 2001. The Federal Vision: Legitimacy and Levels of Governance in the United States and the European Union. New York: Oxford University Press. Peters, B. Guy and Jon Pierre. 2009. “Governance Approaches.” In European Integration Theory, edited by Antje Wiener and Thomas Diez, 91–104. Oxford: Oxford University Press. Pollack, Mark A. 2001. “International Relations Theory and European Integration.” Journal of Common Market Studies 39(2): 221–244. Puetter, Uwe. 2012. “Europe’s Deliberative Intergovernmentalism: the Role of the Council and the European Council in EU Economic Governance.” Journal of European Public Policy 19(2): 161–178. Riker, William H. 1964. Federalism: Origin, Operation, Significance. Boston: Little, Brown and Company. Riley, Patrick. 1973. “The Origins of Federal Theory in International Relations Ideas.” Polity 6(1): 87–121. Sbragia, Alberta M. 1993. “The European Community: A Balancing Act.” PUBLIUS: The Journal of Federalism 23(3): 23–38.



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Sbragia, Alberta M. 2004. “The Future of Federalism in the European Union.” Keynote Address Delivered at the European Community Studies Association Canada (ECSA-C) Biennial Conference “A Constitution for Europe? Governance and Policy Making in the European Union,” Montréal, Québec, 27–29 May. Schütze, Robert. 2009. From Dual to Cooperative Federalism: The Changing Structure of European Law. Oxford: Oxford University Press. Simeon, Richard. 1973. Federal-Provincial Diplomacy. Toronto: University of Toronto Press. Smiley, Donald V. 1974. “Federal-Provincial Conflict in Canada.” PUBLIUS: The Journal of Federalism 4(3): 7–24. Smiley, Donald V. 1987. The Federal Condition in Canada. Whitby: McGraw-Hill Ryerson. Trubek, David M., P. Cottrell and M. Nance. 2006. “Hard and Soft Law in European Integration.” In Law and New Governance in the European Union and the United States, edited by Gráinne De Búrca and Joanne Scott, 65–94. Oxford: Hart Publishing. Ugland, Trygve. 2011. Jean Monnet and Canada: Early Travels and the Idea of European Unity. Toronto: University of Toronto Press. Verney, Douglas V. 1989. “From Executive to Legislative Federalism.” The Review of Politics 51(2): 241–263. Watts, Ronald L. 1991. “Canadian Federalism in the 1990s: Once More in Question.” PUBLIUS: The Journal of Federalism 21(3): 169–190. Watts, Ronald L. 2008. Comparing Federal Systems. London: McGill-Queen’s University Press. Wiener, Antje and Thomas Diez, eds. 2009. European Integration Theory. Oxford: Oxford University Press.

Chapter 3

Trust and Currency The Functional Preconditions and Problems of the Euro Jenny Preunkert

The crisis of the eurozone has dominated European debates since the year 2010. Both the public and the scholarly debate reflect arguments that the common currency is a political and not an economic project. The underlying assumption is that the euro and its institutional framework do not follow an economic logic, but have been implemented on the basis of political interests. The thesis of this article goes in the opposite direction, positing every currency as a political project. Even if a currency can be used globally today, political actors in various roles are responsible for its functioning. A currency is defined here as a politically framed institution. Until now this responsibility has been seen in terms of the nation-state, with state actors always having to ensure a stable currency and prevent possible crises. The allocation of responsibility has been legitimized by state sovereignty. The advent of the euro opened up new territory: different sovereign nation-states joined together voluntarily to form one currency zone, without completely foregoing their sovereignty. The euro is therefore not a currency with a clear supranational responsibility structure; instead, the political responsibility is shared by a supranational central bank and the governments of the euro member states. The argument with regard to current developments is that, due to this actor constellation, mistrust in the financial solvency of individual governments has now become a crisis of the euro itself as a credit money system. The chapter goes on to argue that the current crisis of the euro area does not show the abundance, but a lack of political structures for the common currency. The approach is as follows: The chapter develops a sociological concept of trust and, on this basis, a sociological understanding of currency. Based on these preliminary theoretical considerations, it examines the euro and the current crisis. The chapter concludes with a summary of the argument and its significance for understanding the EU crisis. 47

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Trust and Currency The observation that trust is a core prerequisite for the functioning of money is not an insight gained from current developments, but one that has already been addressed by Simmel (1990) and, later, Luhmann (1990). For Simmel, modern money is a fiction without any substance of its own. The value of money is relational and, to a considerable extent, uncertain. As the use of money involves a high degree of uncertainty, the recirculation of money or the meaning ascribed to money can only be understood if we consider the relationship of trust which money users have towards money. “Without the general trust that people have in each other, society itself would disintegrate. (. . .) In the same way, money transactions would collapse without trust” (Simmel 1990, 178). Simply said, people who use money must have confidence in it. If they withdraw their trust from the money, it loses its functionality and is replaced by an equivalent. According to Simmel, trust is the most important precondition for a functional monetary system. But what is trust? And what is the relationship between trust and currency? In sociology, trust means “[i]f you choose one action in preference to others in spite of the possibility of being disappointed by the action of the others” (Luhmann 1990, 97). Trust is a precondition for being capable of decisionmaking in spite of a lack of knowledge. Trust is considered to be fundamental for interactions, as hardly any interaction can take place without a minimum of trust. Each trust-based interaction is socially embedded, i.e. there is no such thing as trust in itself, but rather every relationship of trust is contextdependent. Trust allows stable conditions of interaction for a certain constellation of actors in a context that is specific to each case. For example, it is possible to trust a work colleague professionally, but to distrust him personally. Using this example, it also becomes clear that there are two types of trust: personal and institutional trust. Personal trust is considered to be closely related to familiarity. In cases of personal trust, the trust-giver thinks that he or she knows the trust-taker very well, and expects his or her counterpart to regard him or her with favor (Luhmann 2001). Intimate relationships between spouses, but also relationships between parents and children or between friends are based on the assumption that each party regards the relationship as unique and can be expected to protect it. In a personal context, trust means not only thinking that one can predict the actions of others, but also expecting protection and care from the trust-taker. These expectations are taken for granted, which implies that in a personal trust-based relationship the possibility of cheating and betrayal is excluded. Contrary to the concept of personal trust, institutional trust is trust among actors who do not know each other. Trust in this context therefore refers less to the expectations addressed to the counterpart as a unique person, than



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to the fact that the other is fulfilling an institutionally defined role. Institutions cause actors to enter into relationships with each other, guided by the expectation that each party will follow the institutional rules. When actors trust within an institutional context, they do not expect privacy. Rather, they rely on compliance with the institutional rules. This trust enables actors to interact with strangers despite a lack of knowledge about each other, and to overcome the problem of double contingency. Institutional trust means transforming unmanageable uncertainties into risks, whereby residual uncertainty is intrinsic to trust; trust creates stability, but it contains uncertainty due to the fact that the alter behaves differently to the ego (Sztompka 1999). For the establishment and preservation of institutional trust, it is therefore necessary to reduce this uncertainty by introducing internal or external controlling mechanisms to a degree that is tolerable for each context and constellation (Barber 1983; Sztompka 1999, 140). Mistrust is not seen here as the opposite of trust; instead, strategic use of mistrust facilitate relationships of institutional trust. The installation of control mechanisms is essential for the establishment of stable, predictable patterns that can reduce the risk of disappointment, although not remove it completely. In each institutional context, internal or external controllers are given the task of stabilizing the relationship of trust with the help of particular instruments. But the question arises: “Who guards the guardians?” (Shapiro 1987, 645). Two solutions are conceivable (Shapiro 1987): one can either simply trust the controllers, or install additional controlling authorities, although the question of who will control them remains. Thus institutional trust can be defined as a trust-based relationship among strangers, who trust both that their counterpart will comply with the institutional rules, and that the controllers will monitor this compliance. Coming back to the relationship between trust and money, it can be said that trust is the basis for any monetary interaction, since the actors will only be prepared to use the money if they trust in its value and stability. However, as money is a fiction without any value of its own, the creation of a continuous and therefore permanent relationship of trust between money and its users requires an additional authority, namely politics. “[T]he basis and the sociological representative of the relation between objects and money is the relationship between economically active individuals and the central power which issues and guarantees the currency” (Simmel 1990, 177). The institution of money is thus based on the trust of the actors both in the money itself and in the political system charged with ensuring its stability. Money can be endowed with various values or functional meanings, and can therefore be based on different institutional settings and attributions of responsibility. Worldwide, the most important and most widely used type of money is currency, which is also the focus of this analysis. Unlike other types of money,

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a currency is traditionally closely connected to the nation-state. This means that national political actors are responsible in various roles, yet to be defined more precisely, for the functioning of a currency. They have to ensure a stable currency and prevent possible crises, thus providing a basis for institutional trust in the currency. This allocation of responsibility is legitimized by nation-state sovereignty. Trusting a currency means trusting the national political actors behind it. However, even the most powerful political actors cannot force people to trust a currency, but can only exert indirect influence. So the political actors are faced with the challenge of being responsible for the reproduction of an institution without being able to guarantee it. Furthermore, in fulfilling this function, they bear responsibility for institutional failures that they themselves do not cause. In summary, we have used Simmel’s work to define money in general and currencies in particular as fictions whose value and stability have to be ensured externally. Because of its intrinsic uncertainties, it seems paradoxical that money plays such a central role in modern societies. But this definition also makes it clear why trust has to be called the basis of a functional monetary system. The use of money only makes sense if one can have confidence that third parties will reduce the uncertainty described and grant at least temporary stability. These third parties need to be assertive and powerful in order to be able to handle this requirement. This makes it easier to understand why currencies have, so far, been closely linked to the nation-states. Trust in a currency or in the functioning of a currency means trusting that national public actors can stabilize the currency and overcome crises. In the next section, the historical relationship between nation-state, currency and trust will be examined in detail. State and Currency The fact that the creation of money is linked to power and sovereignty is not a modern phenomenon. Even in the Middle Ages and the early modern period, the privilege of minting money was held by the monarch, who relinquished the task to private actors in exchange for a fee (Carruthers and Ariovich 2010, 23; Graeber 2011). Beginning in the 18th century, however, with the emergence of the modern nation-state, the situation started to change. The sovereign territory of the nation-state became a vertically and horizontally unified currency area, and the political leaders of the young nation-states monopolized the responsibility for the emerging national money systems (Helleiner 2003), even if they delegated part of the responsibility to other actors in some cases (Graeber 2011). For instance, the British monarchy assumed a monopoly over the production of notes and coins and delegated



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it to what would become the Bank of England (Graeber 2011). On the horizontal level, private (often locally organized) forms of money were forbidden, and foreign currencies were displaced, while the monarchs of the nation-states established currencies that became the statutory means of payment within their national territories (Helleiner 2003). On the vertical level, the new currencies included not only the gold and silver coins of the upper class, but also the copper coins of the lower classes; the new money was the means of payment for all citizens of the nation-state. “It was also a vertical one involving incorporation of the poor within the new national market in a comprehensive way for the first time” (Helleiner 2003, 66). The modern currencies were based on the standardization and unification of formerly fragmented local currency systems into one national monetary area. They arose in the context of nation-state formation, industrialization of the economy, and enforcement of the principle of the capitalist market (Polanyi 2005). The introduction of currencies reduced economic transaction costs and helped to intensify economic interactions within the nation-states (Helleiner 2003). At the same time, the new form of money became an expression of a new political understanding: the political powers, be they monarchs or governments, assumed responsibility for the implementation and institutionalization of the monetary system, and legitimated this by pointing out that they were the representatives of national sovereignty (Helleiner 2003; Ingham 2004). According to this new political understanding, it is the duty and responsibility of the political leadership, as the representative of national sovereignty, to create the legal and political framework for currency and to ensure the long-lasting existence of the monetary system. Thus the functionality of the currency came to be inevitably linked to the political elites of the nation-states and the actions of these elites. At the same time, the political heads of state started to use the currencies to strengthen national cohesion by decorating money with national symbols (Helleiner 1998). The modern nation-states are spaces in which policy, currency and economy are closely linked (Dodd 2005, 394). The national currencies of all European states are based on a politically defined framework; however, their anchor of value and thus the constellations of their political actors have changed over time. The European currencies began as metallic currencies, were then bound to a gold standard, and finally became the pure credit money we know today. Thus, at the beginning in the 19th century the newly introduced monetary systems of the national states had been metallic currencies. In such currency systems based on gold or silver, there is what is known as a “nominal anchor” (Bordo and Flandreau 2001, 43), which means that the value of the money is seen as equal to the value of the metal, and that the metal is regarded as a guarantor for stability and continuity. Even though the price of the metal obviously varies over time, it was taken for granted at that time that the value of money could be guaranteed

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by the metal (Bordo and Flandreau 2001). As long as the basis of the currency was gold and silver coins, the task of the political actors was limited to ensuring that the metal coins always had the correct metal content and therefore their assumed value, and to fulfilling the promise that each circulating banknote could be exchanged for the leading metal. With the introduction of the gold standard system, the role of political actors changed and grew. Now the representatives of the nation-states had to ensure that each circulating note and coin could be exchanged for a promised metal on the basis of a defined rate of exchange. People who used the money as an economic means of payment had to trust the political actors to fulfill this duty, linking money with metal (Helleiner 2003). In the case of metallic currencies, the people’s trust in the political elite is based on the assumption that politicians will comply with the rules, while in the case of the gold standard the trust is predicated on a promise which can scarcely be verified. However, in both cases the responsibility of political actors consists mainly in guaranteeing stable conditions, whereas the value of the money is guaranteed by the metal anchor. After the end of the Bretton Woods system, most of the Western national states introduced unbound credit money systems. This meant that the value of a currency was now theoretically the result of free market-based interactions, while the idea of a metal anchor was given up. The political actors were now in charge of the stability of the currency, and it was their duty to intervene and to stabilize it. With this transition from the gold standard to unbound credit money, the value of money becomes insubstantial and abstract, as it arises from two complementary actions: its internal and external exchange rate, and the promise of political actors to intervene on the market in order to keep the money valuable and stable (Luhmann 1984; Giddens 1994). Believing in the value of a currency now means trusting the public actors to fulfill this task. This transition has made trust in political actors the central precondition for the continuity of a currency, and has therefore made political actors more important for the reproduction of the institution. The former anchor, gold, is replaced by a new anchor, the nation state. Without trust in the public actors of the nationstate and in their responsible handling of their tasks, it is impossible to believe in the value of a currency. By relinquishing the link with metal, the political actors have not only given the banks more room to maneuver; they have also taken on more responsibility for the functioning of the currency, though they are unable to determine or guarantee its stability or value. Having analyzed the different steps in the development of the European currencies, it becomes obvious that the relationship between trust, currency and the nation-states has changed considerably over time. The processes of unification and standardization to one national currency meant that local or foreign money systems were replaced. The nation-states assumed responsibility for the nationwide currency areas, and in doing so staked a claim to being



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the only entities entitled to establish currency systems. This was attended by a new relationship of trust. Previously, most money systems were local or limited to a particular, closed group; their basis used to be personal rather than institutional trust. People were only prepared to do business with and to use money from people they knew, or members of a certain group. The introduction of national currencies meant that people had to be prepared to trust strangers and to trust an anonymous state. The new national currency went hand in hand with the change from personal to institutional trust. The representatives of nation-states became the main actors for the currency system. A currency can only be functional if the public actors are able to gain the trust of the money users. At the same time, it has to be stressed that the importance of the public actors for the currencies does not imply that these actors have unlimited options. On the contrary, the range of actions available to political actors has always been limited by the institutional framework of the currency. To begin with, the anchor used to be a metal such as gold or silver. Later, the metal anchor was abandoned at a time of liberalization, when the options available to non-governmental actors were increasing and the power of the public actors was decreasing. Although, as we have seen, modern currencies are closely linked to the nation-state, governmental actors have never been omnipotent; instead their power has always been restricted by changing constellations of actors. So far we have said a great deal about the relationship of trust between the nation-state and its representatives on the one hand, and the currency and its users on the other. This raises the question of who these political actors are, and what their exact tasks are. Focusing on currency as unbound credit money, we see that the two main actors within any given state are the central bank and the government. The central bank has the monopoly over minting coins and printing banknotes, and it is the lender of last resort to other banks. As modern currencies are credit money, the banknotes and coins are passed by credit from the central bank to other banks (or sometimes the government). Moreover, the bank can create more (bank) money by lending money to further actors. Thus, modern currencies are created on the basis of credit (Ingham 2004; Dodd 2005; Bell 2001). It is the task of the central bank to influence and intervene in this credit system in order to keep the value of the currency stable. However, as the banks can lend money independently, the central bank can only give incentives but cannot control the amount of money that circulates. The responsibilities of the central bank and the accompanying monopoly have been awarded to the bank by the government. The government and the parliament are the actors that define and institutionalize the legal framework of the currency, and decide what the exact responsibilities of the central bank are and on what policies the national economic and monetary system should be based.

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Furthermore, both define themselves as the guarantors of economic order, i.e. they have the responsibility for the economic dynamics in their territory without having the power to determine this process. In the case of financial and economic crises, which can damage the credit system and thus the flow of money, the central bank and government see themselves as crisis managers. Thus, based on empirical experience, national economic actors and citizens can be confident that public actors will become active in times of crisis and will try to overcome this period of uncertainty. However, these roles of the government (and the central bank) as guarantor and crisis manager also imply that if the public actors have monetary difficulties, this is highly likely to have negative consequences for the currency. The payment problems of public actors can therefore easily jeopardize the continued existence of the currency. Thus it becomes obvious that there are two public actors that ensure that the currency system is working. However, it has also been shown that this public responsibility means that a currency is only safe as long as both actors are functioning successfully. Trust in a currency implies, for an unbound credit money system, trusting in the work and the stability of the central bank and the government of one state. “The working fiction is now more clearly a function of the assessment of both the government’s fiscal practice and its central bank’s monetary policy. It is the role of the central bank to establish credibility in an invariant monetary standard in relation to the creditworthiness of fiscal policy and practice” (Ingham 2004, 145). In summary, until the introduction of the common currency, modern currencies used to be closely linked to the nation-states, which means that trust in a currency used to be linked to trust in the respective nation-state. As a result of the process of standardization and unification to a national currency zone, closed national economic and monetary areas were created and, at the same time, the relationship of trust changed. While in the past money circulated among small groups on the basis of more or less personal trust, the use of money is now based on institutional trust. This step—from trusting known persons to trusting anonymous public actors—was cushioned at first, since metals such as gold or silver were used as the anchor of the currency. Step by step, however, the importance of the public actors for the currency has grown. Now that the idea of the gold standard has been abandoned, the currencies have become pure credit money. The nation-states and their representatives are now the anchor of the currency, serving to provide continuity and stability. The latter, in particular the government and the central bank, are responsible for the national economic and monetary area, and have a duty to fight against crises, even though they cannot determine the nation’s economic or financial development. Trust in a currency therefore means trusting the public actors to fulfill their responsibilities and not abuse their power. This also means, conversely, that issues of trust in 1



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relation to public actors are very likely to result in serious disturbance of the currency. The Euro: An Experiment to Separate State and Currency A national currency serves as the basis for economic interactions, and at the same time as a financial symbol of the particular nation-state. The introduction of the common currency not only pushed European integration forward, but it also called into question the close connection between currency and the nation-state. The euro is an unprecedented and unique experiment, as it is the first time in history that several national states have freely decided to join a common currency, without giving up their sovereignty in favor of a new state. To do this, the participating governments had to develop an institutional framework for the new currency, governing the structure of responsibilities of the public actors within the new currency area. The following section will argue that the euro is based on an institutional framework which is critical of government, that is, its framework is influenced by the idea that its anchor of value must be as free as possible from any government influence. Thus the euro can be regarded as an experiment to disconnect money from the state. The previous section showed that the modern currencies were established by national public authorities, which created the institutional framework for the currencies. It also became clear that this political involvement was justified by reference to national sovereignty. For the euro as a transnational currency, this connection does not work. The common currency is divided into different policy areas with various structures of responsibility and trust. In order to implement European monetary policy, the European Central Bank (ECB) was created as a supranational actor. The ECB follows the tradition of the German central bank, that is, it is independent to a large degree and concentrates solely on a stable price level. Its top priority is monetary stability for the whole Euro area. In comparison to other central banks, its aim is defined very narrowly from a macroeconomic perspective: it does not have a mandate to concern itself with questions of economic growth or developments on the labor market (cf. Heine and Herr 2008; De Grauwe 2009). But the ECB is also more politically independent than any other central bank (De Grauwe 2009). This political independence is intended to protect the bank from political influence and therefore help it fulfill its task. Thus the ECB is responsible for the stability of the common currency’s value. In other words, trusting the euro means trusting the ECB. The bank is considered to be the anchor of value of the common currency.

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Contrary to this clear understanding of the role of the ECB, the role of the still-existing nation-states and their representatives is ambivalent and ambiguous in the common currency area. On the one hand, the national governments are important actors within the euro area, but on the other hand, their influence on the monetary policy of the common currency has been minimized. As mentioned above, the legal framework of the common currency precludes close cooperation between the national governments and the European Central Bank. The idea behind this rule is that it makes it impossible for a government to influence the central bank in favor of national interests, or to subordinate the monetary stability of the union to the attainment of national goals (Jones 2012). The governments can work together to define the conditions under which the European Central Bank has to operate, but they have no control over its work. At the same time, the aspect of national sovereignty has always been emphasized within the political debate, and governments as elected representatives are seen as having an obligation to take care of the economic and social well-being of their voters. In addition, they have been made responsible for the economic dynamics of the national markets and the social protection of their “own” populations. According to this understanding of national responsibility, public expenditure and its funding have to be calculated and organized on a national level. Thus fiscal policy remains in national hands; governments have the duty to refinance themselves on the financial markets under conditions that should correspond to their national economic and fiscal performance. In other words, the state’s fiscal difficulties have to be solved nationally. The ultimate guarantor of the state budget has to be the national taxpayer (Ingham 2004). Instead of a bipolar constellation of actors, with one central bank and one government, the eurozone functions through a multipolar constellation. This also means that the governments find themselves in a new relationship of dependency and competition with each other, something unknown in a national context. Against the background of this diffuse responsibility it was decided, upon the introduction of the common currency, that each state must refinance its own debts itself. European regulations explicitly stipulated that there was no transnational responsibility between political actors within the common currency area. Governmental debts were not allowed to be assumed jointly. The ECB was forbidden to sell government bonds on the primary market. Furthermore, the so-called “no bail-out clause” established that states would not help each other (De Grauwe 2010). The reason for this rule was that the political actors wanted to avoid a moral hazard problem. Individual governments, in their role as debtors, should not be able to gain national advantage from the common currency, i.e. there should be no transnational assumption of costs for the debts of individual states by the population of the eurozone as guarantors or consumers. It therefore comes as no surprise that



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no crisis management system was introduced at the beginning of the common currency. The implementation of a crisis policy would have meant accepting the relevance of the governments for the euro, accepting shared responsibility for fiscal policy, and thus resolving the moral hazard problem in favor of the government. The euro was based on a multipolar allocation of responsibility with a strong nation-state focus, without institutionalized transnational cooperation. This does not pose a political problem as long as the trust in all state actors is equally high and the governments receive loans that can be financed. During the first ten years of its existence, a high level of trust was placed in the euro as a credit money system, as can be seen in the alignment of interest rates for government securities at a low level. Despite the economic differences that still remained, all euro member states were allocated an almost identical level of creditworthiness and therefore trustworthiness (Bearce 2009). This positive assessment of all government bonds of the euro area on behalf of the financial markets meant that states with previously high interest rates now had access to more credit at better conditions (Eichengreen 2012). So the success story of the euro was largely based on the fact that the financial markets gave similar (and positive) ratings to all its members, despite the economic differences that continued to exist, or indeed grew over the ten years. The financial markets crisis of 2007 put the creditworthiness of both private and public debtors to the test; trust in the state debtors also became differentiated for the first time since the introduction of the common currency. While states such as Germany had to pay less interest for government securities, the interest rates increased for states such as Greece, Ireland, and later Portugal, Italy and Spain. The euro governments are now divided into weak and strong debtors. But it is not only some states that are seen as “safe havens” by investors; the ECB is also considered to be one, as shown by the popularity of its deposit facility. A distinction is therefore made between political actors whose creditworthiness inspires very little trust, political actors considered to be safe havens, and those that fall between the two extremes. The following section reconstructs the political debates and reforms, showing that the introduction of a European crisis management strategy has successfully averted state insolvencies, but that the crisis policy has not been able to overcome the inherent contradictions of the euro. At the beginning of the crisis, the spread of the interest rates for public debts and the resulting higher costs for some members of the euro area were defined as the problem of the individual governments affected. Later, however, it came to be generally believed on the Euro level that, firstly, the affected governments were not able to handle the rising interest over a medium- to long-term time period without risking state insolvency, and that, secondly, a possible default of one euro member state would bring incalculable consequences for the euro area (Preunkert and Vobruba 2012).

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The previously ignored possibility that a euro member state might declare bankruptcy became, at least in the longer term, a realistic option for some countries. Thus the financial market crisis resulted not only in a re-evaluation of the euro members as debtors and higher risk premiums for some states, but also in a reinterpretation and re-evaluation of the responsibilities of the actors for one another. This raises the question: who are now the actors in power who can overcome the crisis? In the scholarly and public debate, some voices have highlighted national sovereignty and thus the national responsibility of individual governments. According to this position, the national economies are too different—in terms of competitiveness as well as their cultural framework—to maintain a common currency. The governments of the euro area are criticized for having given up their sovereignty or being about to do so. In this context, sovereignty means that the nation’s taxpayers are obliged to pay for the government’s problems. But the role of the European Central Bank in the crisis has also been subjected to criticism. Critics have reminded the national central banks of their supposedly primary responsibility for each national economic area. Dissolution of the common currency was seen as the necessary step to solve the current crisis. Other options discussed were the exit of individual members of the Eurozone or the division into a northern and a southern euro (e.g. Blankart and Bretschneider 2012; Born et al. 2012). The opponents of this approach argue in the opposite direction, stressing the need for a strengthening of European responsibility (e.g. Krugman 2012; Habermas 2013). They argue in favor of an expansion of the powers of the European Central Bank and/or a supra-nationalization of fiscal policy. The problems of the common currency, they argue, should be overcome by political integration. While the public debates have focused on fundamental reforms and radical changes, the political reactions have been ad hoc and situational. The European crisis management strategy has been developed step by step, in light of the situation and on the basis of previous experiences. Firstly, Greece was granted unique bilateral aid; however, this approach proved to be too narrow. After it became clear that other countries needed help, a general but temporary assistance program was introduced with the European Financial Stability Facility. This temporary alignment is intended to show financial markets that this was a unique and exceptional situation and to convince creditors of the medium- to long-term solvency of the states. However, this crisis policy was not able to resolve the situation despite an increase in the aid volume (see Advisory Council 2011). With the European Stability Mechanism, a permanent aid fund was established to assist states now and in the future, and to provide permanent protection against the threat of sovereign defaults. All transnational aid programs comprise guarantees and loans coupled with conditions. Governments which receive European aid have to



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be prepared to make efforts such as consolidating their budgets, reforming their labor markets, or promoting the privatization of state-owned enterprises. In addition to the crisis management by the euro members, the European Central Bank began to buy government bonds on the secondary markets (see Gros 2012; Salines, Glöckler, and Truchlewski 2012, 669). This measure was introduced ad hoc and then gradually became institutionalized. Between May 2010 and September 2012, the central bank bought private and government bonds with the Securities Markets Programme (Advisory Council 2012). The program ended with the introduction of Outright Monetary Transactions. This program, which has not yet been used, only offers help to those states which apply for assistance under the European rescue fund and undertake measures to meet the terms stipulated. So not only do the euro members help each other, but the central bank also acts as a crisis manager. However, both forms of assistance entail negotiation of and compliance with terms, e.g. national austerity measures and structural reforms. As to the question of how the multipolar responsibility structure is dealt with in the course of the crisis, the following can be stated. The crisis has called into question the previous allocation of political responsibilities, and it has become a political commonplace that governments are systemically important actors for a common currency, and that their solvency is therefore a precondition for the sustainability of the currency. For the first time, crisis management has been introduced to the Eurozone. Now, states with financial problems can get help from their euro partners, i.e. the other governments and the ECB, under certain conditions. However, this analysis has also shown that even though the danger of a collapse of the currency has been acknowledged, no supranational responsibility of the political actors for the euro as a credit money system has been introduced. The relationship between individual governments and the financial markets remains untouched, and governments are still expected to secure loans independently on capital markets. Conclusion The argumentation can be summarized in the following theses: first, a currency is defined as a politically framed institution. Its reproduction is based on the trust of the actors both in the currency itself and in the political system that ensures the stability of the currency in different roles. Political actors have the responsibility for the functioning of the currency, without being able to fully control the use and reproduction of the currency. Secondly, building on this understanding of currency, it can be argued that in the context of a nation-state, the political tasks are taken on by state authorities, whose allocation of responsibility is institutionalized to a high

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degree. The political and state responsibility is regarded as the same. As representatives of the nation-state’s sovereignty, state actors are seen as the only legitimate actors. They are given responsibility for the stability of the economy and thus also the currency within the territory of the nation-state. With unbound credit money there is trust that loans will be granted continuously, whereby the central bank assumes the role of the lender of last resort and the government—the role of the economic guarantor and crisis manager. Until now currencies have been considered in national containers, and the political responsibility is closely connected to the sovereignty of the nation-state. The third thesis discussed here is that the euro is in a crisis of trust. The common currency is a transnational currency with a fragmented responsibility structure, i.e. the responsibility lies partly with a transnational actor and partly with different national actors. The euro is therefore a currency with transnational validity, which however continues to be dominated by the idea of a nation-state-based responsibility; transnational solidarity was explicitly excluded in the legal framework of the common currency. This multipolar structure, with its transnational and nation-state allocations of responsibility, was unproblematic for the political actors as long as there was the same (high) degree of trust in the euro as a whole and especially in the political actors. However, as a result of the financial markets crisis, differentiation emerged in the perception and assessment of the political actors. Empirical results show that the crisis of trust in some euro members has led to an institutional crisis of trust. Not only was trust lost in the financial solvency of states like Greece and Ireland, but also in the solution strategies of the euro partners. As a reaction to this crisis, transnational responsibility has now been institutionalized, although it will be shown in the future whether this approach will be successful. The common currency and its current developments show that the functioning of currencies is greatly dependent on the political actors responsible. The currency is trusted only when the political system and its economic ability to act are also trusted. Conversely, the latest developments in particular also suggest that economic crises in trust can also lead to political crises. The eurozone is therefore faced with the challenge not only of winning back the trust of the markets but also of preventing a political loss of trust in the states that are especially affected, as well as in the eurozone as a whole. Note 1. However, the question of how the legal framework of the monetary policy is implemented and what kinds of instruments are chosen in order to fulfill the legal requirements is one that has to be answered autonomously by the central bank. In addition, it has become a well-known tradition in European societies that the central



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bank has to be independent of the will of the executive and the legislature in order to be able to comply with its duty to stabilize the currency.

References Advisory Council. 2011. Verantwortung für Europa Wahrnehmen 2011/12. Wiesbaden: Statistisches Bundesamt. Advisory Council. 2012. Stabile Architektur für Europa - Handlungsbedarf im Inland 2012/13. Wiesbaden: Sachverständigenrat. Barber, Bernard. 1983. The Logic and Limits of Trust. New Brunswick, NJ: Rutgers University Press. Bearce, David H. 2009. “EMU: The Last Stand for the Policy Convergence Hypothesis?” Journal of European Public Policy 16(4): 582–600. Bell, Stephanie. 2001. “The Role of the State and the Hierarchy of Money.” Cambridge Journal of Economics 25: 149–63. Blankart, Charles B., and Sven Bretschneider. 2012. “Nutzen und Kosten eines Austritts Griechenlands aus dem Euro.” ifo Schnelldienst 65(9): 12–16. Bordo, Michael D., and Marc Flandreau. 2001. “Core, Periphery, Exchange Rate Regimes, and Globalization.” NBER Working Paper Series 8584. Born, Benjamin, Teresa Buchen, Kai Carstensen, Christian Grimme, Michael Kleemann, Klaus Wohlrabe, and Timo Wollmershäuser. 2012. “Austritt Griechenlands aus der Europäischen Währungsunion: Historische Erfahrungen, Makroökonomische Konsequenzen und organisatorische Umsetzung.” ifo Schnelldienst 65: 9–37. Carruthers, Bruce G., and Laura Ariovich. 2010. Money and Credit: A Sociological Approach. Cambridge [etc.]: Polity. De Grauwe, Paul. 2009. Economics of Monetary Union. 8th ed. Oxford: Oxford University Press. De Grauwe, Paul. 2010. “The Fragility of the Eurozone’s Institutions.” Open Economy Review 21: 167–74. Dodd, Nigel. 2005. “Reinventing Monies in Europe.” Economy and Society 34(4): 558–83. Eichengreen, Barry. 2012. “European Monetary Integration with Benefit of Hindsight.” JCMS: Journal of Common Market Studies 50(1): 123–36. Giddens, Anthony. 1994. The Consequences of Modernity. Cambridge: Polity. Graeber, David. 2011. Debt: The First 5,000 Years. Brooklyn, NY: Melville House. Gros, Daniel. 2012. “On the Stability of Public Debt in a Monetary Union.” JCMS: Journal of Common Market Studies 50 Annual Review: 36–48. Habermas, Jürgen, ed. 2013. Kleine Politische Schriften. Frankfurt am Main: Suhrkamp. Heine, Michael, and Hansjörg Herr. 2008. Die Europäische Zentralbank: Eine Kritische Einführung in die Strategie und Politik der EZB und die Probleme in der EWU. Marburg: Metropolis. Helleiner, Eric. 1998. “National Currencies and National Identities.” American Behavorial Scientist 41(10): 1409–36.

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Helleiner, Eric. 2003. The Making of National Money: Territorial Currencies in Historical Perspective. Ithaca: Cornell University Press. Ingham, Geoffrey K. 2004. The Nature of Money. Cambridge, UK, Malden, MA: Polity. Jones, Erik. 2012. “The JCMS Annual Review Lecture European Crisis, European Solidarity.” JCMS: Journal of Common Market Studies 50 Annual Review: 53–67. Krugman, Paul. 2012. “Europe’s Austerity Madness.” The New York Times, September 27. Luhmann, Niklas. 1984. “Die Wirtschaft der Gesellschaft als Autopoietisches System.” Zeitschrift für Soziologie 13(4): 308–27. Luhmann, Niklas. 1990. “Familiarity, Confidence, Trust: Problems and Alternatives.” In Trust: Making and Breaking Cooperative Relations, edited by Diego Gambetta. 1st ed., 94–107. Oxford: Basil Blackwell. ————. 2001. “Vertrautheit, Zuversicht, Vertrauen. Probleme und Alternativen.” In Vertrauen: Die Grundlage des sozialen Zusammenhalts. Edited by Martin Hartmann and Claus Offe, 143–60. Frankfurt, New York: Campus. Polanyi, Karl. 2005. The Great Transformation: The Political and Economic Origins of Our Time. Princeton, NJ: Recording for the Blind & Dyslexic. Preunkert, Jenny, and Georg Vobruba. 2012. “Die Eurokrise - Konsequenzen der Defizitären Institutionalisierung der Gemeinsamen Währung.” In Entfesselte Finanzmärkte: Soziologische Analysen des Modernen Kapitalismus, edited by Klaus Kraemer and Sebastian Nessel, 201–23. Frankfurt am Main: Campus. Salines, Marion, Gabriel Glöckler, and Zbigniew Truchlewski. 2012. “Existential Crisis, Incremental Response: the Eurozone’s Dual Institutional Evolution 2007–2011.” Journal of European Public Policy 19(5): 665–81. Shapiro, Susan P. 1987. “The Social Control of Impersonal Trust.” American Journal of Sociology 93(3): 623–58. Simmel, Georg. 1990. The Philosophy of Money. 2nd ed. London, New York: Routledge. Sztompka, Piotr. 1999. Trust: A Sociological Theory. Cambridge, UK; New York, NY: Cambridge University Press.

Chapter 4

European Monetary Union or European Clearing Union An Application of Keynes to Regional Monetary Systems1 Ashley A. C. Hess Despite the European economic and financial crisis, the euro has maintained a central relevance to the global financial infrastructure. At the same time, the euro’s contribution to the crisis has been considerable, testing the European Union’s (EU’s) institutions, governance, and political support. The Eurozone continues to see negligible growth, with even the stronger European economies struggling and unemployment high throughout the EU. Because of the limitations of a single currency, monetary policy can do little to assist the European Monetary Union’s (EMU’s) weak economies. Political solutions to these issues are widening intra-European differences in the midst of increasing resistance to further austerity measures. While many have traced the exact process that created the euro as a monetary union lacking a parallel fiscal or political union, alternative institutionalizations the EMU could have taken are less often assessed. Though it is improbable that the system will be completely reformatted, the lessons of the euro have global relevance—impacting other potential future regional currency associations, such as in Northeast Asia or South America. Having witnessed the recent economic, political, and social issues in Europe, these countries are likely less attracted to the idea of pursuing a monetary union; yet it should be made clear that the euro system is not the only option for further, potentially very beneficial, monetary integration. Thus, an investigation into why the euro developed in its current form and if there were and are other viable options could be helpful to future monetary unions. To that end, this chapter will assess John Maynard Keynes’ International Clearing Union (ICU), formally proposed at the 1944 Bretton Woods conference as a framework to re-order the international financial system after World War II. Although Keynes’ ICU was envisioned as a global system, the economics of the ICU do not necessarily preclude its application to a smaller system. 63

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This chapter proceeds as follows: section two assesses the crisis in the Eurozone and Greece. Section three provides background on the Eurozone, while section four provides a brief overview of Keynes’ proposal. The fifth section offers a sketch of what Keynes’ ICU could have looked like for Europe and a general comparison of such a regime with the current Eurozone format. The chapter concludes with implications for future study.

Greek Crisis and Contagion Joining the EMU was a large shock for peripheral European states, especially as their long-term interest rates had been relatively higher prior to the nominal rate convergence process that was part of the EMU. Ongoing disparities in national inflation rates lead to real interest rate differences across the Eurozone, resulting in the EMU acting as an asymmetric shock amplification mechanism. The EMU did not eliminate nominal exchange rate volatility problems. Shifts in the real exchange rate, either due to endogenous cost shocks or exogenous factors, indicate that some member countries had unsustainable wage growth levels. This was especially problematic in the EMU because the traditional adjustment solution was depreciation of a nation’s currency. Some of the EU’s slower-growing countries thus had significant inflation—for example, although Italy did not grow faster than Germany over the 1999–2004 period, Italy’s consumer price level increased by a cumulative 6.8 percent above the German level, while unit labor costs increased 17 percent relative to Germany (Lane 2006, 4). Wages in Germany were only allowed to grow slowly, giving Germany lower labor costs and a competitive advantage. By 2011, German unit labor costs had risen only 6 percent over the prior decade, while the average increase in the rest of the Eurozone was 20 percent (Paus and Troost 2011, 3). One ostensible benefit these peripheral countries gained by joining the EMU was that their long-term credit rates dropped dramatically. This also led to significant increases in lending and borrowing, local housing booms, and growth in demand that all resulted in inflationary pressures. Membership in the EMU has allowed member states such as Greece, Spain, and Portugal to have larger external imbalances than before; these three countries had average current account deficits that increased by 3.5 percent of GDP over 1995–2004 and a 36.4 percent of GDP average increase in the stock of net external liabilities from 1998–2004. As members of the Eurozone, their currencies were insulated from pressures they would have had previously: for instance, investors would have required larger risk premiums in order to fund such deficits, increasing the risk of a speculative attack (Lane 2006, 8).



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The Case of Greece Despite joining the EU in 1981, Greece was the only EU member country that wanted—but was unable—to join the Eurozone when exchange rates were finalized leading up to 1999. Greece did show significant reductions in debt, inflation, and other convergence criteria in the 1990s. Greece was able to accomplish this in part due to temporary factors;2 combined with dishonesty and false bookkeeping, the drachma was able to stay within the European Monetary System (EMS) bands. The 1999 government deficit ratio was reported as 1.6 percent, considerably below the 3 percent Maastricht target. The debt-to-GDP ratio was 104.4 percent, significantly above the 60 percent criterion, and had grown by 24.7 percent over the 1990s (Dinopoulos and Petsas 2000, 11–13). Even though it was still far from meeting several of the benchmarks and there were doubts about the validity of its statistical reporting as well as whether the positive macroeconomic trends could be sustained, Greece was allowed into the Eurozone in 2001 (Hochreiter and Tavlas 2004, 15–20). After the introduction of the euro, the market assumed an implicit bailout guarantee in EMU countries despite Maastricht provisions to the contrary3 and valued all euro-denominated debt as having a similar risk status. As a result, all European governments could sell their debt for approximately the same low-interest rate. Greece was able to access capital markets more cheaply than previously, encouraging a rapid increase in “easy” borrowing, the interest payments of which could be covered through further loans. In such a situation, governments had few incentives to undertake imperative domestic structural reforms. The Eurozone’s monetarist policies led to governments, consumers, and businesses in countries like Greece overspending, over-borrowing, and receiving no punishment in financial markets. At the same time, Greeks reduced their savings rate considerably,4 meaning that most of the financing for the debt was external (Rossi and Aguilera 2010). Greek negative net foreign assets as a proportion of GDP rose from 3 percent in 1997 to 86 percent in 2009, while the public debt-to-GDP ratio rose from 102 percent to 115 percent over the same period, and public sector wages increased 50 percent between 1999 and 2007 (Marsh 2011, 11–14; Katsimi and Moutos 2010, 574). Concurrently, Germany suppressed wage growth and maintained exchange rates that were effectively too low, leading to increased German competitiveness and a huge current account surplus—which was then lent to the peripheral EU states. Conversely, the periphery had higher inflation, higher wages, and lower productivity, and thus effective exchange rates that were too high, pricing their goods and services out of international trade and providing little income with which to repay loans.5 Moreover, the borrowing undertaken by Greece in particular was not used to build up productive capacity or reform the economy. Instead, the money was used for wasteful

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consumption and speculative assets; these bubbles burst during the global financial crisis, resulting in an economy-wide shock (Marsh 2011). Greece and the other southern tier countries, left with huge debts and contracting economies in the financial crisis, were forced to borrow at increasingly higher rates to keep their governments functioning. Greece also had several country-specific factors that increased instability. The most important was the revelation in October 2009 by newly-elected Prime Minister George Papandreou that the budget deficit for 2008 had been revised from 5 percent to 7.7 percent of GDP and the planned deficit for 2009 was actually 12.8 percent of GDP (later recalculated to 13.6 percent), rather than the 6 percent claimed by the previous government and far from the 3.7 percent promised to the European Commission in early 2009 (Featherstone 2011, 199–204). Eurostat had noted problems with the quality of Greek fiscal and macroeconomic statistics since 2004;6 in fact, there had been credibility issues with Greek statistics since at least the 1990s. Eurostat blamed the 2009 statistics revision on Greek statistical weaknesses in methodology and technical procedures as well as broad failures of Greek institutions, especially in their lack of cooperation, clear division of responsibilities, and tendency for statistical quality to be subject to political pressures and elections (European Commission 2010, 4). Greece has not had a budget surplus since 1973 and since 1981 consistently maintained deficits in excess of 3 percent of GDP (OECD 2012). Greece’s excessive underlying budget deficits were due in large part to poor tax administration,7 a huge informal economy estimated to be almost 30 percent of GDP (Featherstone 2011, 197), abnormally high special interest influence over the government, growing industrial uncompetitiveness, a bloated public sector, expenses related to the 2004 Summer Olympics, and high age-related and entitlement spending (Buiter and Rahbari 2010). The Greek Ministry of Finance cited an “‘economic cycle’ effect due to the economic downturn and a bigger than expected fall in real GDP . . . an ‘electoral and political cycle’ effect due to the laxness of the revenue collection mechanisms and the expenditure overruns,” and a “deficiency or structural” effect because of “endemic structural deficiencies on collecting taxes, controlling expenditures and recording data” (2010, 15). After the revelation of fudged statistics, Greece committed to significant financial adjustments in return for external aid.8 The EU and the International Monetary Fund (IMF) provided Greece an initial €110 billion rescue package in May 2010. The EU established a €750 billion European Financial Stability Facility (EFSF) to guarantee loans to member states in financial difficulties, further increased to €1 trillion in 2011. A second, €130 billion bailout was agreed in early 2012, and a permanent bailout fund called the European Stability Mechanism (ESM) was set up with a reintroduction of the “no bailout” clause along with stricter debt and structural



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borrowing rules. Greece carried out a debt restructuring in early 2012, erasing €100 billion of government debt. Delays in the implementation of the economic adjustment program, a poor macroeconomic environment, and continued statistical revisions to GDP have resulted in a deeper- and longer-than-expected recession and adjustment process (European Commission 2012, 1–4). Greece has been caught in a debt deflation trap since the crisis started, in which the austerity policies imposed by the rescue packages force cuts in spending, increases in taxes, and more borrowing to cover deficits; meanwhile, the economy continues to stagnate and real incomes decline, while an ageing population increases the burden on public finances. The Greek economy shrank by a quarter between 2008 and 2013. At one point discussed as a viable option, a “Grexit” would have involved government debt default, meltdown of the country, bank runs, business bankruptcies, a sovereign debt crisis, market turmoil, political backlash, and a deep recession which the Institute of International Finance estimated would likely exceed €1 trillion (Davis and Christie 2012). Structural Changes and the Road to Recovery The institutional response of addressing only liquidity, not solvency, created the unintended consequences of worsening Greece’s solvency and increasing the chance of contagion (Corno 2011, 11). To avoid similar issues in the future, as well as create a better system to deal with bank failure and resolution, the European Commission has proposed almost 30 new rules since 2010 to increase supervision and regulation of financial actors, products, and markets. This financial framework is intended to preserve and strengthen the EU’s Single Market. In late 2012, Eurozone governments agreed to develop a banking union that would increase centralized policing of the EMU’s banks and stop them from embroiling states in a banking crisis. To this end, the European Parliament approved the Single Supervisory Mechanism (SSM) in September 2013, followed by the Single Resolution Mechanism (SRM) in April 2014. Stricter fiscal discipline will also be promoted via the single rulebook, applied to all banks in the EU. The new regulatory framework of the banking union is a significant step towards monetary and economic integration of the EU (European Commission 2014a, 1–3; 2014b, 1–2). The SSM will become effective in November 2014 after the European Central Bank (ECB) completes a comprehensive assessment of EMU banks’ financial health. The SSM will transfer new supervisory powers to the ECB, which will have direct supervisory responsibility to monitor the health of and risks taken by approximately 130 major Eurozone banks that hold 80 percent of Eurozone banking assets, with the correlated ability to intervene. Around 6,000 smaller banks will remain under the aegis of national supervisors, but

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the ECB will be able to intervene if necessary (European Commission 2014a, 2–8; 2014b, 5–6). The SRM applies the Bank Recovery and Resolution Directive to Eurozone countries, ensuring consistent bank resolution processes via a Single Resolution Board (SRB) as well common resolution financing arrangements. If a bank anywhere in the EMU is in trouble, a €55 billion Single Resolution Fund (SRF) financed by bank fees would be used to resolve the situation. All EU banks will need to contribute to the SRF over the next eight years, during which national resources will be progressively mutualized; the SRF will also be given some leeway to borrow in the markets if necessary. The resolution process would involve the SRB, European Commission, European Council, ECB, and national resolution authorities—and should be able to be completed over the course of a weekend. The SRM, effective from January 1, 2015, is set to implement the bail-in and resolution functions from January 1, 2016. Banks will draw up recovery and resolution plans to prepare for a deteriorated financial situation or an orderly resolution by the ECB. The concept of a “bail-in” is emphasized, in that creditors and shareholders would pay a share of the costs of winding down a failed bank (European Commission 2014a, 8–9; 2014b, 6–10). However, the banking union has been called a disappointing, insufficient, unwieldy, and flawed compromise. More than 100 decision-makers and multiple panels would be involved in a decision to resolve a troubled bank, along with national governments (Bini Smaghi 2013; Fairless 2014). Moreover, the possible losses to be covered by the Eurozone—and ultimately, European taxpayers—could be enormous: the total bank debt of the six countries most affected by the crisis is €9.4 trillion, plus a combined government debt of €3.5 trillion. Even taking on a small fraction of this debt would be a huge burden, and the €55 billion resolution fund has been criticized as inadequate (Sinn and Hau 2013). With bond yields rising in other Eurozone countries and ratings agencies announcing downgrades, the risks of contagion from Greece presented significant problems for the EMU, implicating countries such as Italy, Spain, Portugal, and Cyprus. Even France lost its top credit rating in November 2012, and Italy has one of the largest public debt burdens in the Eurozone. Low inflation and stagnation are projected to last for years, while the political anti-EU backlash seen in the May 2014 European Parliament elections will make it even more difficult to pursue necessary economic reforms and deepen integration. Greece’s harsh austerity measures mean that the economy has not healed and Greeks are increasingly unhappy with austerity—as are the other countries that received bailouts. Public and private debt remain high. Violent protests and strikes have become increasingly common, as have falling birthrates and mass emigration. Unemployment, a problem throughout the EU, has been especially high in the bailout countries. The IMF believes that



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further debt relief valued at 4 percent of GDP will be required if Greece is to reduce its debt to 124 percent of GDP by 2020. On a more positive note, several Eurozone countries have taken positive steps in reforming labor markets, welfare systems, pension systems, fiscal policies, and cost competitiveness. Ireland was able to leave its €85 billion bailout program in late 2013, while Portugal and Spain exited their bailout programs in early 2014. Cyprus, which needed a €10 billion bailout in March 2013 due to bank exposure to Greek debt, eliminated all capitol controls by mid-2014. Greece posted its first primary budgetary surplus in 2013; the economy is expected to grow in 2014. In April 2014, Greece also had its first successful bond sale in four years and has announced it will leave its bailout program at the end of 2014. Economic Foundation and Critique of The Euro The economic theory underlying the EMU was in large part a reaction to the international financial turbulence of the 1970s following the breakdown of the Bretton Woods system. The EU’s steps towards monetary union—such as the 1979 European Monetary System and the 1993 Maastricht convergence criteria—were formed based in part on the Keynesian belief that economic convergence was necessary for monetary union combined with the monetarist belief that union should be created as fast as possible with convergence following naturally (Mills 1998). It was further argued by European leaders that the Eurozone would constitute an optimum currency union. In 1961, Robert Mundell argued that an optimum currency union needed to have rare asymmetric shocks; single monetary policy affecting all in the same way; a system of stabilizing transfers; and no cultural, legal, or linguistic barriers to labor mobility—though these conditions are not necessarily sufficient. Given certain conditions, gains from a common currency and monetary unification would be based on the elimination of variability in the exchange rate, lower transaction costs, price convergence and parity, trade and investment increases, and macroeconomic stability (Mundell 1961, 657–664). In the European context, a single currency could also end conflict; integrate Germany into Europe; promote social progress; provide an alternative to the dollar; improve Europe’s world standing; and increase growth, wealth, trade, employment, and investment (Marsh 2011, 11). However, the inability to use the exchange rate as a means of adjustment or pursue independent monetary policies would result in losses. The relative balance of gains and losses depends on how often there are economic disturbances and how quickly the member economies adjust. Asymmetrically distributed disturbances or dissimilar adjustment speeds would result in the

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monetary union as a net negative (Bayoumi and Eichengreen 1994, 6–7). The so-called “Rose effect” posited that optimal currency unions could increase bilateral trade by over 300 percent, later revised to 50 percent (Lane 2006, 10). Yet, controlling for other variables, others have found that the EMU has increased intra-Eurozone trade by 4–10 percent (Micco et al 2003, 318), or even that the euro’s trade-promoting effects are statistically insignificant or economically unimportant (Havranek 2010, 21). Despite a lack of in-depth analysis as to whether the EU met the conditions for a successful monetary union, European leaders hoped that the monetary union would drive increased economic integration, resulting in a stronger political union. What was judged to be good politically was assumed to be good economically (Paus and Troost 2011, 2–3).9 There were significant disadvantages to the economic structure of the EMU, highlighted in particular by economists in the US and Britain. The most important objection was that a monetary union (control of interest rates and monetary supply) without financial (centralized treasury and budget management) or political union was inherently unstable and unable to respond well to crises. States also lost policy independence to deal with domestic economic problems. Without a fiscal union, there would be no central budget in any future asymmetrical shock to transfer funds to states in crisis (McCormick 2011). The ECB would follow policies that benefited the majority, further damaging an asymmetrically-hit country (Issing 2008, 207–8). Psychological and social barriers to movement would not allow domestic markets to adjust to imbalances in currency valuation; countries would no longer have monetary policy control as a safety valve (McCormick 2011). Krugman emphasized that the EU did not constitute an optimum currency union because European asymmetric shocks were large; there was limited labor mobility due to language, cultural, and social differences; and an attempt to form a currency union without fiscal union would be highly inadvisable (1992, 187–200). Moreover, a European study on whether the EU was an optimum currency union found that the Eurozone as created in 1999 “fell quite a long way short of meeting the conditions for an optimum currency union” (Issing 2008, 49). As one scholar noted, [T]he euro area is still some distance from the definition of an optimum currency area: market-based risk sharing arrangements are likely not an adequate substitute for a US-style federal fiscal transfer system; although increasing, labor mobility remains low; structural rigidities still permeate product and labor markets; and the likelihood that national fiscal policies will contribute much to stabilization remains unproven. Moreover, there is little sign that political integration among the member countries will increase any time soon. (Lane 2006, 17)



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Moreover, it was argued that a single monetary policy for a diverse group of countries that experience different types and timings of shocks could not be optimal, while higher unemployment and the risk of higher longterm inflation would outweigh any advantages, resulting in lower growth, increased trade deficits, and economic isolation as export demand would be reduced due to a lack of natural exchange rate adjustment (Feldstein 2009, 4–7; Arestis McCauley, and Sawyer 2001, 122–7). The EMU could also lead to political conflicts, within the EU and with the EU’s important trading partners—such as the US. The lack of any exit option meant that the EMU was a “marriage made in heaven with no possibility of divorce” (Feldstein 2000). The many national-level differences10 of countries in the EU mean that the ECB’s pursuit of price stability instead of output or employment would not allow for the different inflationary tendencies in the member states. The length of adjustment lags and disparities in economic performance would also likely be different, reinforcing any economic problems. The peripheral countries already had higher inflationary tendencies, tax evasion, underground economies, and inefficient public sectors. In their attempts to meet the convergence criteria, the high costs of convergence would result in economic crises for these countries and further divergence from the core countries (Arestis and Sawyer 1997, 359). A lack of recourse to exchange rate variations as an adjustment mechanism would result in countries responding to differential economic performance and shocks in other ways, such as lowered standards of living, emigration, or reduced economic activity. The EU budget would be too small to provide significant fiscal redistribution from richer to poorer countries or stabilize the Eurozone in the case of a crisis (Arestis, McCauley, and Sawyer 2001, 116–127). The Eurozone, argue its critics, was flawed from the beginning. An International Clearing Union During World War II, John Maynard Keynes developed a post-war plan for an international financial mechanism that would promote trade and assist war-torn Europe in rebuilding nations and currencies. A final version of his plan was published in April 1944, forming the basis of the British negotiating position at the Bretton Woods conference in July.11 The International Clearing Union’s (ICU’s) primary objective was to provide a more stable system in which “money earned by selling goods to one country can best be spent on purchasing the products of any other country . . . a universal currency valid for trade transactions in all the world” (Keynes 1943). His proposals in particular emphasized that,

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The idea underlying such Union is simple, namely, to generalise the essential principle of banking as it is exhibited within any closed system. This principle is the necessary equality of credits and debits. If no credits can be removed outside the clearing system, but only transferred within it, the Union can never be in any difficulty as regards the honouring of cheques drawn upon it. It can make what advances it wishes to any of its members with the assurance that the proceeds can only be transferred to the clearing account of another member. Its sole task is to see to it that its members keep the rules and that the advances made to each of them are prudent and advisable for the Union as a whole. (Keynes 1981 [1943], 22)

Keynes proposed creating a new international unit of account, a “bancor,” to be defined in terms of a certain weight in gold, and thus able to supplant gold while being much more reliable. There was to be a one-way convertibility between gold and bancors (Keynes 1943). Keynes noted that each nation’s central banks would control provision of foreign exchange, dealing with individual citizens through the domestic banking system, while any foreign transactions would be cleared through the central banks via the ICU; accordingly, the limited role of private financial institutions internationally would decrease exchange rate volatility and speculative flows (Iwamoto 1997, 183; D’Arista 2004, 568). Keynes argued that international financial imbalances are not always due to the profligacy of debtor countries; creditor nations also play their part in that they withdraw money from circulation and hoard it as reserves. Refusing to spend this income on either domestic consumption or overseas investment reduces the international supply of money, leading to global unemployment and a stagnating industrial system. Under the non-politicized ICU, every member state’s central bank would exchange domestic currency for an initial reserve of bancors and a corresponding quota of overdraft facilities based on loose calculations of the previous three-to-five years’ trade volume. Upon accession to the ICU, member states would agree on the values of their currencies in terms of bancors, maintaining their national currencies for domestic use. While this value could later be altered, Keynes envisioned a system of relatively fixed exchange rates. International trade between countries would be done in bancors, deposited or debited to a country’s ICU account (Keynes 1981 [1943], 19–35). In addition, a Governing Board (GB) would be appointed based on quota size—those with larger quotas could appoint one member, while those with smaller quotas could group geographically or politically to appoint a member. Each representative would have a vote in proportion to a state’s or coalition’s quota size. Furthermore, all members of the ICU could send one delegate as a liaison for information exchange and to deal with daily business. The GB would have the power to ask for and receive statistical or other relevant information from any member state, expel members in breach of ICU



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agreements, and should distribute an annual report and convene an annual Assembly (Keynes 1981 [1943], 24–25). If a country has a surplus, parallel to the national banking system, the ICU could loan the money to other countries that needed short-term funds. In this way, even if a country hoards its surplus, this will not remove the money from circulation; instead trade and production would be promoted and expanded via a multiplier effect. Countries that did not wish to take part in the ICU could still trade with members—the non-member would maintain a bancor account, but not be allowed a deficit or receive voting rights. Moreover, countries could resign from the ICU provided they gave appropriate notice and cleared all negative balances (Keynes 1981 [1943], 24–32). To promote a reasonable balance of international trade, there were penalties12 against exorbitant debts or hoarding—Keynes’ goal was that each country’s account should balance exports and imports. If a creditor country was accumulating too many bancors, the country would be made known internationally as an antisocial hoarder; thus, Keynes believed moral pressures and self-interest would bring the creditor nation to increase imports, raise the value of its currency, introduce inflation, encourage foreign capital investment, or relax restrictions on trade. Debtor countries could be forced to devalue their currencies, undertake domestic measures to restore equilibrium, or pay liquid assets into their ICU account. In extreme cases, the GB could expel deficit countries. Countries would be discouraged from maintaining excessive surplus or debit balances and instead be encouraged to seek equilibrium in their current accounts, while the utilization of surpluses could promote poorer countries’ internal investment and discourage both exportled investment strategies and currency devaluations to gain trade advantage (Keynes 1981 [1943], 23–25). Overall, the ICU retained the positive aspect of the gold standard—foreign exchange rates’ short-term stability—while also promoting domestic stability through creating conditions for high employment (Dillard 1948). Each state would still retain significant national sovereignty in that “no greater surrender is required than in a commercial treaty” (Keynes 1981 [1943], 36), and the ICU could facilitate trade liberalization while assisting countries that were having balance-of-payments problems, especially in the tumultuous post– World War II era (Markwell 2006, 241–2). A European Currency Union: A Better Way This chapter holds that a regional system, based on Keynes’ International Clearing Union, could have provided a better framework for European monetary integration. The ICU addresses key issues regarding the inherent

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instability of the international monetary architecture and the development of global imbalances due to multilateral imbalances in trade, which have been increasing in the past several decades and have been linked with growing financial vulnerability (Piffaretti 2009, 12–20). Both of these issues have been key in the Eurozone’s recent troubles. This section details what an ICU for Europe would have looked like and provides a counterfactual example, juxtaposing the results of the EMU with the likely outcome of an ICU-based Eurozone. In an ICU-based system, the euro would be the unit of regional account, only used in Eurozone countries’ intranational trade, while the idea of a domestic two-tier banking system would be expanded to a European exchange. Each country would continue to use its own currency domestically, meaning that each would still have fiscal and monetary control, allowing it to devalue or adjust exchange rates when needed. The lack of national of fiscal and monetary policy control is one of the current problems in the Eurozone; in asymmetrical crises, the ECB chooses a monetary course that is best for the EU as a whole, often worsening a crisis-hit country’s situation. An EU ICU (renamed the European Clearing Union, or ECU13) would sidestep the monetary union requirement for a concurrent fiscal union because each country would maintain its own domestic currency, and thus monetary and fiscal control. If a country such as Greece had large current account imbalances, it would be allowed to devalue its currency in consultation with the ECU without having to endure many years of painful austerity measures or declining economic health and worsened financial markets for other Eurozone countries. Similarly, Germany would be held responsible for balancing its current account surpluses, such as by increasing imports or providing loans—both of which could in turn help Greece. The framework of the ECU would also give a deficit country such as Greece or a surplus country such as Germany breathing space in which it could work on domestic measures to reduce the imbalances. The first phase of the ECU would be to convert all Eurozone reserve currency holdings by national central banks into euro credits at the ECU, which would then be available for lending to deficit countries and therefore multilateralize those surpluses not invested in foreign obligations. The ECU would manage both the settling of international transactions among central banks as well as the disposition of any imbalances. Unlike in the current EMU and international financial structure, surpluses could not transfer into a country’s internal financial market and be used to finance internal imbalances that dampen international trade like the situation in Greece in the 2000s. Instead, surpluses could be used for the country’s own international trade and as loans to deficit countries to use in such trade. Because there would no longer be a need to accumulate significant reserves in case of a drop in exports or financial crisis, these balances could be used as loans,



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increasing the money stock and resulting in a continuous stimulus of the global economy. Double-entry bookkeeping would be carried out through each country’s central bank’s account at the ICU, allowing a clearance of balances without money leaving the system. Greece could have much more easily received regional institutional help without the political cost and time spent in EMU deliberations over assistance. In addition, Greece would have been unable to borrow as much money at low rates during the 2000s as it did, because under an ECU it would have maintained its own currency and thus the bond markets would have more correctly evaluated default risk. When countries in the Eurozone trade with each other, they would do so based on euro balances in their ECU bank accounts—retaining important advantages of the euro for the currency union, in that transparency is increased and costs of business are decreased. As the ECU would still be a regional institution with a special currency, a sense of European identity would also be promoted. Furthermore, when trading with Eurozone nations, non-European countries could set up accounts at the ECU, exchanging their currencies for euros to be used in trade with the ECU. The ECB would become the ECU’s Governing Board (ECU-GB), with membership based on current ECB procedures or a format based on Keynes’ original formulation—each Eurozone member could have one representative with voting power based on trade quota percentages, tweaked by political concessions. Table 4.1 provides an example of what the voting power would look like. The calculations in the table were based on trade among the EMU countries for the five years prior to the 1999 introduction of the EMU (1994–1998), averaging each country’s trade volume over the period. The third column shows the percentages recalculated for the five years prior to the 2001 Greek entry to the EMU (1996–2000). While some of the smaller economies would have very little voting power, these percentages could be adjusted as part of the political process to set up the ECU, and countries could form voting coalitions or blocs. Also, rules for what types of majority votes would apply in which specific situations could be drafted—for instance, in the case of a country receiving disciplinary measures, a two-thirds or even threefourths percentage of votes would be needed. In this way, smaller countries would be better protected from the larger economies ganging up on them. It should also be noted that, based on this chart, there would be no one country that could dominate decision-making in the ECU-GB, as no country has more than 20 percent of the EMU’s trade volume, and five countries have between 10 percent and 20 percent of the volume, making consensus on important issues a likely necessity in the ECU-GB and contributing to de-politicization of the decision-making processes and actions. The ECU-GB would be tasked with overseeing the system and ensuring that no country built up too much of a surplus or deficit. In those cases, as

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Table 4.1  ECU-GB Voting Rights, per Country Country Austria Belgium* Finland France Germany Ireland Italy Luxembourg* Netherlands Portugal Spain Greece

Voting Percentage in 1999

Voting Percentage in 2001

6 12 1 12 20 6 10 – 20 4 9 –

5 10 1 12 20 6 10 2 19 3 9 4

*Until in 1999, Belgium and Luxembourg were grouped together in EU trade data. Note: Due to rounding, percentages may not add up to 100%. Source: Eurostat data (1994–2000), author’s calculations.

explained previously, the ECU-GB could take legal action against the country based on Keynes’ detailed rules to limit imbalances and facilitate adjustment. Every member would have a maximum allowable debit, determined by a quota based on its volume of trade. Countries could carry debits up to a certain amount, giving them time to stabilize their regional position. Specific rules regarding these issues could be decided before the implementation of the ECU; using Keynes’ formulation as a basis, any country with a surplus or deficit more than one-quarter of its quota must pay the ECU 1 percent per year on the average excess or debit balance and a further 1 percent if that amount exceeds one-half of its quota. Thus, both Germany and Greece would have been penalized for large account imbalances and encouraged, with the help of the ECU-GB, to redress these imbalances through internal and external measures. In the case of a debtor country, the ECU-GB would consult with the country and could force devaluation or require the exchange of liquid reserves. If a country’s deficit exceeded three-quarters, it could be declared in default, denied further loans, or forced to leave the ECU. Therefore, in the case of a country with persistent deficits and profligate borrowing or spending behavior such as Greece, the ECU-GB would have the legal authority to devalue the currency or expel the country from the ECU. Alternatively, any country would be able to leave of its own free will, as long as it had paid off its deficits and given appropriate advance notice. And, it would be able to leave without causing a Eurozone-wide shock, like the estimated 1 trillion euro cost and resulting insolvency of the ECB in the case of a “Grexit.” As Keynes recognized, states in the international financial system with low domestic growth that export excessively, such as Germany, are basically forcing other countries to have complementary unbalanced imports and



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domestic overconsumption. This is what happened in Europe: with the German euro in particular undervalued, Germany built up a large current account surplus through exports, meaning that others had to run deficits to even out the imbalance. From 1995 to 2008, Germany was the second largest capital exporter in the world, after China (Corno 2011, 4). Germany had a current account deficit of −1.7 percent in 2000 and a surplus of more than 7 percent over the following decade; at the same time, these surpluses were balanced by deficits in other countries, such as Spain, Greece, and Italy (Paus and Troost 2011, 3). By December 2009, German banks had lent $704 billion to Greece, Ireland, Italy, Portugal, and Spain, more than the German banks’ aggregate capital. As Bloomberg has noted, the Eurozone bailouts also bailed out Germany’s banks and taxpayers. Germany has essentially followed a beggar-thy-neighbor policy, with a major role in creating “imbalance in the Euro area, the present euro crisis and the threat of deflationary stagnation” around Europe (Hein and Truger 2010, 3; Hein et al 2012, 37). Under an ECU, these situations would be penalized early on and Eurozone trade would be brought into better balance, leading to increased economic stability. In Keynes’ ICU, the burden of adjustment is not solely on the alreadyweakened debtor country as is the case in the current international financial system and generally in the EMU. As Keynes wrote, “Excessive credit balances necessarily create excessive debit balances for some other party. In recognizing that the creditor as well as the debtor may be responsible for a want of balance, the proposed institution would be breaking new ground” (1981 [1943], 20). In an ECU, a Greece with significant trade imbalances would have needed to undertake domestic measures—likely in the mid2000s—in order to balance its ECU account, restructuring its economy to become more sustainable and balanced. At the same time, Germany would also have needed to introduce long-term structural changes that would reduce its current account surplus, moving away from an excessive focus on exports in addition to expanding domestic demand, such as by increasing wages and social security in the service sector while deemphasizing the industrial sector (Paus and Troost 2011, 15). Under the EMU, Greece alone has had to undergo extensive rebalancing measures. Furthermore, the system of relatively fixed exchange rates between domestic currencies and the euro, held only by the ECU and national banks, would lead to better-stabilized foreign exchange markets. Exchange rates would as a general rule only be changed to reflect permanent increases in efficiency wages, which would offset domestic inflation. In this context, nations such as Germany would be prevented from implementing beggar-thyneighbor policies because the exchange rate between the Deutschmark and the euro would have been adjusted due to the increase in German efficiency wages, an increase that in the EMU was not translated into actual wage or

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price increases over the past decade. Also, exchange rate variability would not have resulted in a loss of competitiveness because of an overvalued currency for Greece. In an ECU, the drachma could be devalued in relation to the euro to reflect declining competitiveness over the course of the 2000s. Conclusion In developing the concept of a European Clearing Union, this chapter has explained the mechanisms of Keynes’ ICU, the evolution of the euro and EU, and the basics of the current Greek predicament. In particular, the chapter has argued for the idea of a Keynesian ICU as a format for regional currency integration. When juxtaposed with the experience of the Eurozone over the past several years, it would appear the Keynes’ framework could have been significantly more successful than the EMU has proven to be. And as is important in the European project, Keynes’ institution would have furthered not only economic goals, but also political goals, which are often the primary rationale for many European Economic Community (EEC) and EU integration moves. While it is unrealistic to believe that the Eurozone might be almost totally restructured to take advantage of the ICU format, other regional organizations considering further monetary union would be well advised to investigate the matter more thoroughly, as the ICU provides the advantages of international monetary unification while maintaining domestic fiscal and monetary control. As such, further research should be undertaken to construct detailed proposals for specific regional ICUs, along with analyses of areas that could likely benefit—and projections of how much—from such an institution. The EMU was an economically flawed construction from the beginning. And, while the recent global financial crisis was certainly a catalyst, the structure of the EMU led to the crises in Greece and other Eurozone countries. The EU’s new banking union should lead to a more stable financial system in Europe, reducing the likelihood of a systemic banking crisis, decreasing financing costs, and supporting Europe’s economic recovery. However, there are still many weaknesses in EMU policy reforms like the banking union. These recent policy changes do not in any way negate or undermine the argument that an ECU could have been a better system for Europe. If the Eurozone had implemented an ECU instead of the EMU, the results would likely have been quite different. Each country would have retained its national currency, along with fiscal and monetary control. If Greece’s economy had heated up, the nation’s leaders would have been able to devalue the currency, decrease interest rates, or impose capital controls. Likewise, if Greece had an excessive deficit or if Germany had an excessive surplus in their respective ECU accounts, the ECU-GB could have instituted fines



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and procedures against these countries to reduce these imbalances. In the Greek case, the country could have chosen to leave the ECU without any unplanned exit procedures or ECU-wide pain, as opposed to the complexity of the mooted “Grexit” in the current Eurozone framework. Other countries wishing to trade with the ECU, such as the United States or China, could have easily set up an ECU account, exchanged their domestic currencies into euros, and continued trading. The possibilities for trade between the ECU and non-ECU countries would have remained just as likely as they are now; only the specific mechanisms would have been slightly different. The advantages of an ECU are multifold. Many current economic and political benefits of the EMU would be retained in this system: • Transparency and stability for businesses • Binding Germany to an economic union • Promotion of trade through a single currency • Exchange rate stability • Increases in social progress via income from the fees charged to those countries which exceed their deficit and surplus quota limits, as well as interest from the loans made to those with deficit accounts • Moderate loans that could be made at lower-than-market rates to member countries who wish to modernize or build up industrial capacity; and, because the ECU-GB would be closely monitoring deficit amounts, the loans would have the desired multiplier effect without the attendant moral hazard of a Greek-style spending spree • A currency that can improve European status and sense of unity while challenging the US dollar At the same time, many deficiencies of the EMU, primarily the lack of fiscal or political union, would be avoided due to nations maintaining their fiscal and monetary control. Thus, there are added benefits to an ECU as well, including: • Discouragement of exorbitant surpluses or deficits which imbalance the union • National control over fiscal and monetary policy and thus no need for a supranational fiscal union or Eurobonds (which are politically sensitive) • Built-in procedures for expulsion or peaceful exit from the union • Potentially increased employment and higher growth rates throughout the ECU Therefore, an ICU-type system has distinct advantages over the EMU as it developed and currently exists. It could also be seen as a way to more slowly ease into a tight monetary union, providing countries with more time

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to realize conditions approximating those of Mundell’s optimum currency union. If a regional ICU was able to achieve more convergence in terms of rarity of asymmetric shocks; a single monetary policy affecting all in similar ways; a system of stabilizing transfers; and reduced cultural, legal, and linguistic barriers to labor mobility, the ICU could eventually transition into a stronger and more stable monetary union. Regions that are considering further economic union in the future would do well to carefully consider the ICU as a significant improvement over the current EMU experiment and a way to enjoy many benefits of a monetary union without a giving up a large part of their sovereignty. Notes 1. Special thanks to Stefan Niederhafner and Jason Roffenbender for their comments and assistance. An earlier version of this chapter was presented at the 2013 Western Political Science Association Conference. 2. These temporary factors included cuts in indirect taxes with effects that would disappear after one year, negotiating a number of agreements with service providers and commercial and industrial enterprises to increase price stability by reducing the retail prices of a group of goods equal to 1/10 of the Consumer Price Index basket, fiscal policy adjustments that led to lower public deficit ratios and long-term interest rates, and an overall tight monetary stance during the 1990s (Dinopoulos and Petsas 2000, 10–11). 3. At German insistence, the Maastricht Treaty enshrined a “no bailout” clause, technically forbidding other countries from assuming liability for the commitments and debts of other EU members—which, as The Economist noted, is not quite the same as an inability to provide aid: Maastricht Treaty Article 125 states, “The Union shall not be liable for or assume the commitments of central governments.” Other EU rules do allow for financial aid to countries in exceptional crises. Article 122 of the 2009 Lisbon Treaty has two pertinent clauses; the first is that EU governments can help each other if there are severe product supply difficulties. The second clause declares that when a member state “is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council [of national governments], on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member-state concerned” (Barber 2010). 4. Between 1990–2010, the national Greek savings rate was an average of 11 percent, compared with 20 percent for Portugal, Italy, and Spain; in 2009 the Greek rate was 2.6 percent (Eurostat 2011, 37–39). 5. In 2006, Greece had a deficit of 11 percent; Germany had a surplus of 6.5 percent and the Netherlands 9 percent. While Germany improved overall competitiveness against all countries by 9 percent from 1999–2010, Italy’s competitiveness decreased 29 percent (Marsh 2011, 200–210). 6. At that time, the government of Costas Karamanlis disclosed that the previous administration, led by Prime Minister Costas Simitis, had cheated on its bookkeeping, claiming that its deficit was less than 1 percent of GDP.



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7. In 2006, uncollected tax revenue was estimated to be about 30 percent, or 3.4 percent of GDP (Featherstone 2011, 196). 8. Greece implemented measures such as raising indirect taxes like VAT, luxury, and consumption taxes; public sector pension, employment, and wage cuts; an increase in the minimum retirement age; reform of the labor market and tax administration; and privatization of several state enterprises (Kouretas and Vlamis 2010, 397–8). 9. For example, internal German government documents from 1994–1998 revealed that, based on economic requirements, Italy should not have been accepted into the EMU: “The decision to invite Rome to join was based almost exclusively on political considerations at the expense of economic criteria. It also created a precedent for a much bigger mistake two years later, namely Greece’s acceptance into the euro zone” (Boll et al 2012). EMU officials ignored data that showed Italy had almost twice the maximum allowed GDP debt of 60 percent. Germany itself, with debt levels slightly above 60 percent of GDP and increasing due to reunification costs, was not in a position to judge Italy without proof of violations. Due to creative Italian accounting and one-off measures, the deficit criteria of Maastricht were “satisfied” despite many EU officials knowing that the figures were massaged and did not represent any real reductions in debt (Boll et al 2012). 10. For example, “wage- and price-setting arrangements, the nature of the financial system, [and] past experience of inflation, none of which will change rapidly just because of monetary union” (Arestis and Sawyer 1997, 358). 11. A copy of both Keynes’ final ICU draft and the UK Bretton Woods proposal can be found here: http://www.imsreform.org/reserve/pdf/keynesplan.pdf 12. Any country with a surplus [or deficit] greater than one-quarter of its quota must pay the ICU 1 percent per year on the average excess [debit] balance, and a further 1 percent if the surplus [deficit] exceeds one-half of its quota. In the case of a debtor country, the Governing Board would then consult with the country and could force minor devaluation or require liquid reserves to reduce the deficit, while also recommending other internal measures to restore equilibrium. In the case of a creditor, the Governing Board would discuss with the country ways to restore equilibrium of its trade balances, such as by expanding domestic credit and demand, encouraging an increase in money rates of earnings or appreciating the national currency in terms of bancor, reducing tariffs or other bars to imports, or international development loans. If a country’s deficit exceeds three-quarters, it can be declared in default, denied further loans, or even forced to leave the ICU (Keynes 1981 [1943], 23–24). 13. Several other scholars have proposed similar institutions on a regional scale. For example, Triffin (1960) proposed the idea of an ECU or similar mechanism as an internationalized payments framework that could eventually lead to currency merger in Europe.

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Fairless, Tom. 2014. “Political Deal on EU Banking Union Completed.” The New York Times, March 20. Featherstone, Kevin. 2011. “The Greek Sovereign Debt Crisis and EMU: A Failing State in a Skewed Regime.” Journal of Common Market Studies 49, 2: 193–217. Feldstein, Martin. 1999. “The Euro Risk.” TIME Magazine, January 15. ———. 2000. “Europe Can’t Handle the Euro.” The Wall Street Journal, February 8. ———. 2009. “Reflections on Americans’ Views of the Euro Ex Ante.” NBER, January. Fontevecchia, Agustino. 2013. “Spain, Italy, and Even Greece Sell Bonds, but Europe’s Crisis Is Far from Over.” Forbes, January 10. Greek Ministry of Finance. 2010. “Update of the Hellenic Stability and Growth Programme.” Athens, January. Harris, Seymour E., ed. 1960. The New Economics: Keynes’ Influence on Theory and Public Policy. London: Dennis Dobson. Havranek, Tomas. 2010. “Rose Effect and the Euro: Is the Magic Gone?” Review of World Economics 146, 2: 241–61. Hein, Eckhard, Achim Truger, and Till van Treeck. 2012. “The European Financial and Economic Crises: Alternative Solutions from a (Post-)Keynsian Perspective.” In The Euro Crises, International Papers in Political Economy, edited by P. Arestis, Sawyer, M. Basingstoke: Palgrave Macmillan. Hein, Eckhard and Achim Truger. 2010. “Finance-Dominated Capitalism in Crisis – the Case for a Keynesian New Deal at the European and the Global Level.” 7th International Conference, Developments in Economic Theory and Policy. Bilbao. Hochreiter, Eduard and George S. Tavlas. 2004. “Two Roads to the Euro: The Monetary Experiences of Austria and Greece.” In Euro Adoption in the Accession Countries – Opportunities and Challenges, 1–26: IMF. Issing, Otmar. 2008. The Birth of the Euro. Translated by Nigel Hulbert. Cambridge: Cambridge University Press. Iwamoto, Takekazu. 1997. “Keynes Plan for an International Clearing Union Reconsidered.” Kyoto University. Katsimi, Margarita and Thomas Moutos. 2010. “EMU and the Greek Crisis: The Political-Economy Perspective.” European Journal of Political Economy 26, 4: 568–76. Keynes, John Maynard. 1943. “International Clearing Union.” Paper presented at the House of Lords, London, England, May 18. ———. 1981 [1943]. “Proposals for an International Clearing Union.” In The International Monetary Fund 1945–1965. Washington, DC: IMF. ———. 1981 [1942]. “Proposals for an International Currency (or Clearing) Union.” In The International Monetary Fund 1945–1965, ed. J. Keith Horsefield. Washington, DC: IMF. Kouretas, Georgios P. and Prodromos Vlamis. 2010. “The Greek Crisis: Causes and Implications.” Panoeconomicus 4: 391–404. Krugman, Paul. 1992. “Second Thoughts on EMU.” Japan and the World Economy 4: 187–200. Lane, Philip R. 2006. “The Real Effects of EMU.” IIIS Discussion Paper No 115.

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Markwell, Donald. 2006. John Maynard Keynes and International Relations: Economic Paths to War and Peace. Oxford: Oxford University. Marsh, David. 2011. The Euro: The Battle for the New Global Currency. New Haven: Yale University Press. McCormick, John. 2011. Understanding the European Union. London: Palgrave Macmillan. Micco Alejandro, Ernesto Stein, and Guillermo Ordonez. 2003. “The Currency Union Effect on Trade: Early Evidence from EMU.” Economic Policy 18, 37: 315–56. Mills, John. 1998. Europe’s Economic Dilemma. Houndmills: MacMillan Press. Mundell, Robert. 1961. “A Theory of Optimum Currency Areas.” American Economic Review 51, 4: 657–65. OECD. 2012. “OECD Economic Outlook No. 91.” OECD Economic Outlook: Statistics and Projections (database). Paus, Lisa and Axel Troost. 2011. “A European Clearing Union – the Monetary Union 2.0.” Finance Committee, German Parliament. Piffaretti, Nadia. 2009. “Reshaping the International Monetary Architecture: Lessons from Keynes’ Plan.” In World Bank Policy Research Working Paper Series: World Bank. Pollard, Patricia S. 1995. “EMU: Will It Fly?” In Review. St Louis: Federal Reserve Bank of St Louis. Robinson, Joan. 1943. “The International Currency Proposals.” In The New Economics: Keynes’ Influence on Theory and Public Policy, edited by Seymour E. Harris. London: Dennis Dobson. Rossi, Vanessa and Rodrigo Delgado Aguilera. 2010. “No Painless Solution to Greece’s Debt Crisis.” Chatham House. Santa, Martin and Robin Emmott. 2014. “Greek 2013 Fiscal Outcome May Be Better Than Expected.” Reuters, February 17. Sinn, Hans-Werner and Harald Hau. 2013. “Eurozone Banking Union Is Deeply Flawed.” Financial Times, January 28. Thirlwall, AP. 1976. Keynes and International Monetary Relations. London: Macmillan. Triffin, Robert. 1960. Gold and the Dollar Crisis: The Future of Convertibility. New Haven: Yale University.

Chapter 5

Why The Euro Will Survive The Institutionalization of Accepted Policies through Key Actors Leif Johan Eliasson

A lengthy, contested, and sometimes acrimonious process unraveled in the 1990s before agreement on the structure of the European Central Bank (ECB) System and the launch of the euro. The external pressure (recession of the early 1990s), along with the treaty provisions on European Monetary Union (EMU), existing norms, and some skillful leadership by key actors meant that most states who wanted to join the final stages of the EMU (the euro) undertook enough reforms and practiced sufficient budget discipline to meet the self-established “Maastricht criteria” on maximum deficits (3 percent of GDP), debt (60 percent of GDP), and inflation (within 2 percent of the best performing members). Initial decisions in the construction of the euro set it on a slow path of divergent developments vis-à-vis the international markets and investor tolerance. For example, the euro initially increased cross-border bank lending (as intended) but left unclear the responsibility towards depositors and creditors if a bank faced a liquidity crunch or insolvency, and cross-national contagion became a real problem absent uniform Eurozone rules and deposit guarantees. The penalties for breaching the Stability and Growth Pact (SGP) under the Maastricht Treaty were politically unfeasible, and the lack of automatic enforcement mechanisms for breaches contributed to the emergence of an accepted practice of flaunting agreed deficit criteria. There were also no common rules for transfer funds, bank resolution criteria, common deposit insurance guarantees, or budgetary oversight mechanisms for Eurozone members. These became clear problems during the financial crisis. The external shock of the 2008 financial crisis (originating in the US subprime mortgage market and spreading into the financial sector) resulted in an altered international environment and prompted initial action by the ECB (cutting interest rates and providing liquidity), but no significant changes to Eurozone 85

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institutions occurred as a direct and immediate result of the US financial crash. The global financial crisis in 2008 morphed into a severe European fiscal and sovereign debt crisis at the beginning of 2010, at times raising questions about the continuation of the euro, and even the European Union (EU) itself. European states at first reacted timidly, engaging in heated and protracted debates, with the prospects of Euro and EMU disintegration hinted at more than once by both press and policy makers; change came incrementally as existing practices proved unviable and certain ideas gained traction, promoted by key leaders. The crisis in the Eurozone was unprecedented in scale for a monetary union of sovereign states. However, it also shared several identifiable features with previous crises in European integration; crises where pundits declared the European project dead, only to be proven wrong by European leaders agreeing on even deeper, wider, and stronger integration (see Dinan 1999). Given the severity of the latest crisis, with high unemployment, large deficits and sky-rocketing debts in several (but not all) EU member states, and in particular many Eurozone members, it is important to understand why and how integration resulted from the latest crisis. This chapter focuses specifically on the Eurozone, and how institutions and influential individual actors within—and using—existing institutions reformed and strengthened the European Monetary Union in 2011–12. It is not argued that looking at how previous decisions and existing institutions constrained (limited) what leaders perceived as possible options, and how individual actors could steer developments, modifying existing institutions or creating new ones, often modeled on existing institutions, can be exhaustively explanatory. Rather, such an approach sheds light on key factors, which enhance our understanding of the overall institutional and political design and governance of the Eurozone. The reader will find that this chapter reinforces or compliments some arguments and findings in other chapters, while at times shedding a different perspective on developments in the crisis (compare e.g. Csehi, chapter two). It is also assumed, much like Preunkert (chapter three), that the euro is a “politically framed institution” and that “political actors are seen as responsible for the functioning of a currency.” Thus, to fix the problems of gaps in the institutional structure of the Eurozone leaders had to find politically acceptable, not just economically necessary, solutions. This required astute individual actions. The first part of the chapter lays out the theoretical framework, which draws from different strains of institutionalism, as well as the literature on ideas and the role of individuals. This approach builds on the recognition that we lack an all-encompassing theory of European integration, and that an eclectic approach drawing on different theories may be necessary (Rosamond 2000; Dente, Dossi and Radaelli 2012). The hybrid, or eclectic, theoretical framework is used to unpack, shed light on, and explain empirical developments in a novel and complex crisis.



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The second part begins with outlining the background to the crisis itself. This is followed by a narrative of the crisis, focusing on the importance of two key individuals, German Chancellor Angela Merkel and European Central Bank (ECB) President Mario Draghi. These two were central to shifting patterns of expected and accepted behavior in the Eurozone. The ECB had never been tested in a crisis, and Draghi’s ability to mix novel economic remedies with politically astute statements, remaining within the treaty language on the ECB while pushing the accepted understanding of what could be done within that legal remit, was crucial. As head of the largest and richest Eurozone member Merkel’s approval was necessary for any substantive political decisions. Her ability to incrementally move member states to reform, assume greater domestic fiscal responsibility, and accept Commission supervision, and doing so by insisting on adhering to, but slowly expanding on, exiting institutions, was critically important. The last part of the chapter revisits the theoretical framework, linking it to the empirical developments presented. Theoretical Framework: Hybrid Institutionalism The literature on new institutionalism has progressed significantly since its initial steps in the late 1980s, and has played a vital role in the comparative, as well as parts of the international relations, literature (Hall and Taylor 1996; Dente, Dossi and Radaelli 2012). Yet debate on how to define the various institutional “isms” (historical, rational choice, sociological, constructivist) continues, and in the field of EU studies an inclusive theory explaining why and how European integration occurs remains elusive (Fioretos 2001; Rosamond 2000; Dente, Dossi and Radaelli 2012). Neo-institutional theory challenges, but also borrows, ideas, insights, and assumptions from other theories such as realism, liberal intergovernmentalism and functionalism (in its many varieties). People can certainly be assumed to take decisions in their best interest and the interest of the entity they represent, but they do so within constraints: existing rules, past decisions, norms, accepted behavior, limited knowledge. Liberal intergovernmentalism may be well equipped to explain specific negotiating sessions, e.g. summits, by comparing positions as they enter a summit with the outcome (declaration/treaty), but is less apt at explaining how the system works over time. That is, how the ideas and norms policy makers hold or reject influence, and are affected by, “workings of the union,” the institutional structures (Pierson 2000, 484; Krasner 1999, 10; Eliasson 2004, 2005). Additionally, decisions in area A may require integrative steps in area B, but the process of arriving at the latter require intervening variables or actors. Institutionalism shares some common assumptions. Institutions provide cognitive frames, opportunity structures, normative assessments of behavior,

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physical boundaries for sense making, action, institutional allegiances and role perceptions (March and Olsen 1989). Institutions are man-made constraints, consisting of formal institutions (laws, rules, organizations), and informal institutions (expected and accepted patterns of behavior, norms), which shape choices and behavior by limiting what is perceived as appropriate. In the EU, as in national legal systems, a body of law (formal institutions) provides a basic starting point for interaction between parties within which informal institutions develop (Farrell and Heritier 2003). Because “[i]nstitutions do not affect simply the strategic calculations of individuals, but also their most basic preferences and very identity” (Knill and Lenschow 2001, 124), the rules and accepted behavior in place act as “self-reinforcing feedback mechanisms that reproduce existing patterns of organizational structure and behavior, limiting alternative options” (Pierson 2000, 490–2). And so “[f]or these reasons, historical institutionalists highlight what they see as the historical and evolutionary nature of institutional design and change” (Bell 2002, 6); where historical experiences are “embedded into rules, routines, and forms that persist beyond the historical moment and condition” (March and Olsen 1989, 167), and where the impact of institutions lie in “. . . the legacies of founding moments in shaping long-term power relations and whether new ideas become consequential, the ubiquity of unintended consequences, and especially the prevalence of incremental reform over stasis and fundamental transformations” (Fioretos 2001, 369). This logic differs from structuralism in two fundamental ways. First, it explains individual action as a reaction to man-made organizations, rules, or conventions, not vis-à-vis non-manipulable, “given” material structures. Second, an implication of focusing on man-made constraints is that people can affect their own constraints to some degree; institutionalism differs from pure structuralism by incorporating feedback between action and constraints (Parsons 2007). In the EU there are also socialization processes at the macro (public) and micro (individual/private) levels, facilitated by the recursive relationship between formal and informal institutions (Héritier 2001; Moral Soriano 2005). At the macro level “state socialization is promoted through a politicized and public process” (Checkel 2001, 12; Haagerup and Thune 1983; Jörgensen 1997). It is visible in EU decision-making: member states initially opposed bailouts, accepted them, and then advocated for expanded ECB action and authority, as well as integrated governance as the way of stabilizing the Eurozone (Zeitlin and Vanhercke 2014). There is also socialization at the micro (individual) level. Studies show that if there is an existing predominance of norms and values (e.g. retaining the euro, fiscal responsibility, democratic processes), day-to-day practices of political cooperation frequently lead newcomers to adapt and follow, and diplomats to internalize, policy coordination (Glarbo 2001, 148, 155; Forster 2000, ft. 21).



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Discussion on the “inevitability of the internal market” and the emergence of “European-ness” permeate EU committees, groups, and agencies, where continuous and obligatory repeated interactions within a group of individuals with a stated objective promotes a greater sense of “we-ness” and common perspectives; individuals begin to see things from a group or organizational perspective rather than a strictly individual or national perspective (Checkel 2001; Van de Kragt, Orbell and Dawes 1983; Dawes, Van de Kragt and Orbell 1988; Eliasson 2005). In other words, they perceive policy cooperation and coordination as the natural thing to do. The effects of this process are more prevalent if institutional arrangements enable representatives to discuss alternatives to official policy rhetoric through frequent informal interactions, insulated from public scrutiny, as occurred frequently during the crisis (cf. Spiegel 2014). In such circumstances the likelihood of compromise, and even changes in preferences through persuasion—an “activity or process in which a communicator attempts to induce a change in the belief, attitude or behavior of another person . . . in a context in which the persuadee has some degree of free choice”—increases (Brody, Mutz and Sniderman 1996, 5–6; cf. Black 2002). The Question of Change and the Role of Individuals Constructivist institutionalists share the acceptance of socialization, norms, and that ideas can be the source of change through active, interpretative agents who, in “fluid ideational and discursive contexts,” reinterpret appropriate and accepted behavior (Bell 2011, 884). Change in institutional development can thus occur incrementally, through small steps, which for an extended period of time conform to broader institutional patterns before reaching a point of incompatibility with the environment in which they operate (Dimitrakopoulos 2001, 407; Dente, Dossi and Radealli 2012). Although “[t]he structure of existing institutions affects the type of interests and ideas that enter into political debates and the kinds of policies that countries adopt” (Hacker 1998, 62), institutions are not determinative, there is room for strategic individuals’ ideas to shape specific policies (Scharpf 1997; Kuipers 2009, 165). As individuals interact, certain behavior or procedures become accepted and dominant, even as the neo-institutionalism literature admits that new institutions must necessarily reflect some aspects of previous institutions (no institution can start completely from scratch as individuals cannot rid themselves of all their experiences or change all behavior, cf. Hall and Taylor 1996). Individuals’ ideas, different norms, and values, can act in ways that alter rules, norms, patterns, practices (the informal institutions), over time. Ideas held by individuals may serve to alter the path through a novel proposition, the origin of which may lie inside or outside of the organization in question, as in 1998 when British Prime Minister Blair, mainly in reaction to Britain’s exclusion

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from the EMU and his wish to place the country back in the heart of Europe, reversed Britain’s longstanding opposition to EU defense cooperation (Eliasson, 2005). Institutional change is thus endogenous, even if external events may influence the exact direction taken. The importance of individuals is central to actor-centered institutionalism (ACI), which Scharpf (1997, 37) explains as a “framework on how to proceed with empirical studies . . . focused on actors and their interactive choices.” ACI recognize that although [i]nstitutions—broadly intended as formal rules and social norms—undoubtedly influence actors’ perception of reality, structure their interaction, and therefore condition policy outputs, it is simply actors that make policies. Therefore, ACI encourages scholars to cast deeper theoretical and empirical attention on actorrelated factors as possible explanatory variables in their own right to political phenomena, to be treated distinctly from the effects that institutions exert on them. [and] actor-centered research has overcome the original game-theoretic imprinting . . . and adapted its insights to rational-choice as well as historical and sociological institutionalist approaches. (Pancaldi 2012, 4)

While ACI conceptualizes institutions as remote, as “background,” they nonetheless shape the environment in which actors engage. As Scharpf (2000, 3) notes, “[i]f the dependent variable is to be policy responses, interaction-oriented policy research must also consider at least two additional sets of factors that are likely to have causal influence—the characteristics of the policy problems faced, and the characteristics of the policy actors involved.” The theoretical framework in this chapter assumes that developments are restricted but not determined by the boundaries of existing institutions, and that a central actor can drive a new idea for which there is an existing seed of receptivity sufficient to restart developments in an altered direction.1 The Eurozone policy problems lent themselves to innovation since the institutional structures were limited and vague at the onset of the crisis, and the central actors were policy innovators with the same political goal: saving the euro. Fiscal and Sovereign Debt Crisis Back in 2006 the ECB noted some potential Eurozone vulnerabilities, but found no reason to alter policies; banks and Eurozone financial markets were deemed largely healthy and stable: [The] central scenario for euro area financial stability remains broadly favorable but there is no room for complacency as several sources of risk and vulnerability can be identified. On the positive side, the resilience of the system was



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confirmed by its ability to comfortably absorb adverse disturbances over the past six months. In addition, global economic activity is becoming more evenly balanced. (ECB 2006)

Six months later, while noting the potential of a “low probability—high impact event” which could negatively affect global markets and the Eurozone, the ECB still maintained a stable outlook (ECB 2007a). With such warnings seen as part of normal central bank cautionary positioning, they found little receptivity in member states; with no alternative ideas by leading actors, and no external pressure on the euro, the embarked upon path continued. Even if the ECB had urged states to rein in spending it lacked proper tools; there was also no accepted practice of advising states on policy, nor could they call on the Commission to act; the Stability and Growth Pact (SGP) had been discredited at this point. When the ECB injected €500bn into the euro market through two Long Term Refinancing Operations (LTRO) in August 2007 they believed it was a temporary liquidity problem, referencing short-term volatility and a near “return to normal behavior” (ECB 2007b). Even the December 2007 dollar liquidity providing operations (coordinated with the Federal Reserve, Swiss National Bank, and the Bank of England) were not deemed associated with fundamental core problems in the Eurozone. So confident was the ECB that little else would emerge that two months prior to the 2008 Lehman Brothers’ collapse the ECB raised interest rates to counter a potential overheating of the Eurozone economy. Following Lehman’s collapse and the bailout of AIG things began changing. Coordination with the US Federal Reserve and other central bankers intensified as the effects of the American liquidity crisis spread across the Atlantic; the ECB lowered rates and provided unlimited liquidity to Eurozone banks. ECB interest rates were cut from 4.25 percent to 1.25 percent in six months. The broader effects of the external crisis seeped through Europe slowly in 2009 and 2010. The De Larosière Group’s report on financial supervision (a proposal for a European Financial Stability Fund, EFSF), was presented to the EU Commission in February 2009; it failed to change the belief permeating the EU that EU members and banks were not as embroiled in the subprime market as their American counterparts, nor that banks would be in such desire straits as to jeopardize national finances. The April 2009 ECB report spoke of medium-term return to normal markets, with Eurozone GDP still projected better than in the US (ECB 2009a). By June the markets were in trouble and the ECB resorted to year-long refinancing operations to spur bank lending. It also began purchasing sovereign covered bonds. European GDP and deficit numbers remained relatively better than America’s and most other regions,’ but soon after the US had swiftly and forcefully addressed its banking sector woes, the crisis moved across the

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Atlantic. The results of exuberant lending practices and European purchases in the subprime mortgage market (the absence of any capital controls on funds into or out of the EU is a core legal right) exposed weaknesses in the banking sector. The Eurozone’s structural and institutional deficiencies, meaning its inability to recapitalize banks, cut the link between national budgets and banks’ need for liquidity, or address cross-national imbalances, became clear. While most policy makers were now in agreement about certain weaknesses in the original construction of the euro, there was insufficient pressure to fundamentally overhaul its structures or institution; some additional oversight was all that was deemed necessary, thus the resulting European Banking Authority and European Systemic Risk Board by early December (Council 2009). Despite Hungary and Latvia’s 2008 loan programs, ECB rate-cutting, and some coordinated national responses, there was not yet a recognition of incompatibility between the Eurozone’s fundamental institutional or structural weaknesses and its external environment; only two weeks later member states declared that the economic situation [that] is starting to show signs of stabilization, . . . the importance of developing credible and coordinated strategies for exiting from the broad-based stimulus policies once the recovery is fully secured . . . . the EU has made good progress in strengthening its regulatory framework, in particular with the agreement reached by the Council on a fundamentally new structure for financial supervision in Europe. Forecasts suggest a weak recovery in 2010, followed by a return to stronger growth in 2011. (European Council Conclusion 2009)

The crisis of bad banks and rising national deficits continued petering despite the agreed organizational changes to be implemented over the coming year. By 2010 there was a divergence between accepted Eurozone policies and the external environment; the former were proving increasingly untenable vis-à-vis the international environment. European and international stakeholders and observers were urging changes in EU and Eurozone policies. The initial Greek bailout and the European Stability Mechanism (the successor to the EFS) were deemed too weak (e.g. unrealistic potential capital contributions from, and reliance on, the backing of states which may need funding themselves). The perceived internal institutional weaknesses of the Eurozone and lack of member state commitments to collective fiscal responsibility meant attacks on peripheral countries intensified. Key Actors Step Up Unlike normal times when the EU Commission or Council presidency set the agenda, the crisis led to openings for individuals to propose and promote



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ideas. Merkel (driven by Germany’s preferences for economic order and its historical commitment to Europe, as well as Merkel’s own convictions of the benefits of deeper European integration) saw an opportunity for moving integration closer in line with German preferences. She would not rush in to stave the crisis, but steer developments towards closer integration, more oversight, and greater structural reform (Mahoney 2010; Paterson 2010). In early spring 2010 Merkel first broached the issue of treaty change to address structural weaknesses, all while attempting to revamp the narrative by emphasizing how changes in the surrounding (international) environment made impossible a continuation of current practices. The British opposed changes affecting the UK, while urging the Eurozone to act to ensure its survival (Paterson 2010). Merkel secured support from French President Sarkozy in exchange for laxer EU budget rules—a necessary concession but one which would ensure further doubt of Eurozone survivability, even as the European Council President now openly expressed support for EU-level reforms (Mahoney 2010). The Greek IMF/EU loan agreement was initially deemed a one-off since Greece’s problems were uniquely complex and difficult due to internal financial irregularities (The Observer 2010; Rossi and Aguilera 2010). However, by May 2010 the European Council agreed that “[i]n the wake of the crisis in Greece, the situation in financial markets is fragile and there was a risk of contagion which we needed to address. We have therefore taken the final steps of the support package for Greece, the establishment of a European stabilization mechanism and a strong commitment to accelerated fiscal consolidation, where warranted” (Council 2010a). Austrian Foreign Minister Michael Spindelegger, agreeing to the ESM by way of amending Art 136 of the TFEU, later said the decision “[I]t underlines the need to find a solution—but the result was not the solution ‘big treaty change’” (Pawlak 2010). After the first Greek rescue package the Commission in September responded to German and Northern European calls, launching a total of six proposals for regulations and directives, the core of these reforms was the introduction of a Reversed Qualified Majority (RQM) in the EU Council to enhance the enforcement mechanism of the SGP, and Commission oversight of national budgets, better known as the European Semester (Council 2010b). These changes were initially met with skepticism. As markets realized the reforms would not be implemented swiftly, but rather subjected to familiar debates and redrafting; the vague incrementalism dominating the EU’s response to the growing crisis proved unconvincing to investors and toothless in addressing domestic structural problems. As Ireland looked to be next in line in need of a loan Germany’s Foreign Minister Westerwelle and his French counterpart Lellouche approached the fall determined to, in their own words, “continue now day and night to find common ground . . . to save our common currency” (Pawlak 2010). Yet resistance to far-reaching change

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was evident, both because of southern and peripheral states’ opposition to much of the German-influenced and German-led advocacy for austerity and domestic structural reforms, and because the German-led northern European coalition held domestic reforms to be preconditions for backing loans and even discussing any type of future European mutualization of debt (Connolly and Traynor 2012). Merkel’s preferences were clear. “Our target is a fiscal union in the Eurozone, but as long as member states have full responsibility for their national budgets, there won’t be any common liability” (Steinegger 2011). She was keenly aware of the need to placate her own party and country’s insistence on fiscal responsibility and structural reforms in recipient countries (like those undertaken in German between 1999 and 2004), while fully cognizant of the economic value of the euro to Germany’s exportdependent national economy. Merkel skillfully satisfied a traditionally strongly pro-European but increasingly skeptical German public fed up with serving as the paymaster of Europe, while keeping at bay the even more pro-European Social Democratic opposition. For example, by unilaterally deciding to ban naked short-selling of certain financial instruments in 2010, Merkel was perceived domestically as cracking down on frivolous financial behavior, thereby building domestic capital to use in finding support for German contributions to loan guarantees for other Eurozone countries. The root causes of the troubled states (Ireland, Greece, Portugal, Spain) differed, thus requiring multifaceted and multi-stage responses to ensure that neither banking problems nor labor market rigidity, or corrupt and inefficient government sectors, remained simmering, threatening future economic stability. These differences helped Merkel build support stepwise, carefully monitoring and calming domestic critics opposed to bail-outs, while cultivating receptivity among other northern EU states for further integrated fiscal responsibility.2 Contrary to arguments that this reflected an unwillingness to undertake bold preventative measures to avert disaster, such positions reflected an understanding that preventing future crises required both domestic structural changes in troubled countries and EU-level enforcement powers. She was not seeking harmonious relations to just calm markets; she was convinced Europe required a strong institutional foundation which necessitated “[a] culture of stability and that’s why we need shared values” (Merkel 2010). Having stated that euro-survival was essential and that if it fell so would the EU Merkel also narrowed her subsequent options, leaving little room for explicit threats, since such would contradict her own preferences. Merkel’s advocacy of conditionality-premised support along with a supervisory role of the Commission, and her continued emphasis on a deficitbreak, came to dominate the debate in 2011. Working with Sarkozy of France to build support for institutionalized fiscal responsibility but unwilling to exceed



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the parameters of existing EU treaty law, Merkel displayed determination and resolve, seeking incremental integration to stabilize and secure the euro. She rejected American and French calls for a Eurozone bazooka, a joint firewall of funds to calm markets, insisting that states must first act responsibly (meaning fiscally prudent) if they desired help, in different ways emphasizing “we could (reform) and so can you“ (Elliott 2012). This message implied that the Eurozone consists of individual members who must all act responsibly for the institution as a whole to survive, thus laying the groundwork for the later “Fiscal Pact” (a German initiative). Merkel’s position met with continued resistance in peripheral and southern Europe. Banks and labor markets were increasingly strained, and many citizens perceived fiscal restraint and extensive labor reforms as threats to their jobs and security since public social safety nets are far less generous in Spain, Italy or Portugal vis-à-vis northern European states. The Chancellor steadfastly cultivated her ideas, pressing the need for unity in purpose. With support of fiscally conservative northern European states, she was instrumental in promoting several EU regulations to correct macroeconomic imbalance and strengthen and budget surveillance (the so-called “six pack”). In a private meeting on the sidelines of a G20 summit in Cannes she told the other EU, US, and IMF officials that “We either solve this ourselves here or we fail in the eyes of the world” (Spiegel 2014a). She overrode Finance Minister Schäuble, who was willing to let Greece go in order to save the Eurozone (Spiegel 2014b).3 Referencing EU law on the EMU she used it as a tool to reject outright ECB funded bailouts (“that is illegal”), while simultaneously insisting that any loans, bi-or multilateral, would require holding recipients’ feet to the fire; that is, demanding reforms in exchange for bail-out loans, “I am not going to take such a big risk without getting anything from Italy” (Spiegel 2014a). Merkel was stating in private what she consistently advocated in public: that states suffering in the crisis had to assume responsibility for reforms even as all members shared a European responsibility (Merkel 2010). Her references to the ECB remit, Germany’s successful structural reforms while in the Eurozone, insistence on conditionality (having also learned from previously unfulfilled promises of reform in southern states) when France and Italy wanted to pump money into the southern states, calmed much of the domestic opposition and secured support from the opposition SDP. This in turn strengthened her simultaneous work to keep the Eurozone intact. Prime Ministers Rajoy of Spain and Monti of Italy had come around to accepting that austerity and reforms were not optional but necessary, and the only way forward, implying that the alternative of a breakup and devaluating their countries out of the crisis was not contemplated; that existing European and euro institutions made that unthinkable (Mallet and Spiegel 2012; BBC 2012; Barber and Buck 2013).

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After Draghi’s ECB staff spent the summer constructing a plan for ECB bond purchases Draghi used back channels to seek Merkel’s approval. The Chancellor’s objections were rooted less in the end goal (Eurozone stability) but in her belief that politicians should not interfere with central bank policy. If the ECB took the decision on its own it was acceptable, and she could use this new ECB assistance to struggling countries, as well as Draghi’s public urging of political agreements on reforms to push further institutionalization of fiscal responsibility (Spiegel 2014b). The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (“Fiscal Compact”) was Merkel’s vision of individual state responsibility in order to strengthen the whole. “[A] coordinated European position can be arrived at not just by applying the community method; sometimes a coordinated European position can be arrived at by applying the intergovernmental method. The crucial thing is that on important issues we have common positions, “[a]ll working towards the same goal” (Merkel 2010). The Fiscal Compact saw TFEU articles 136 and 326 applied in a new expansionary way to allow budgetary and economic policy coordination through “enhanced cooperation” (Lannoo 2012). Though based on the existing SGP, it was stricter, requiring members to enshrine in domestic law the treaty’s definition of a balanced budget (from 2014), thus institutionalizing fiscal responsibility in order to diminish the likelihood that the ESM would have to be used. The agreement firmly changed the narrative from bailouts and Eurozone demise to structural and political reforms, responsibility, and competitiveness. The Fiscal Compact, approval of ECB assets purchases, and outlines for banking union convinced markets that most EU leaders were prepared to undertake the structural reforms necessary to bring down debts levels and prevent a resurgent banking crisis. Another Key Actor The October 2011 EU Council summit, which included a farewell gathering for outgoing ECB President Trichet, was preceded and overshadowed by vast disagreements over how to boost the EFSF and the continued problems with Greece’s debt burden. While France wanted to give the EFSF a banking license (backed by the ECB) in order to leverage member state contributions, Germany refused, pushing Greece harder on implementing previously agreed structural changes and pushing banks to accept higher losses on Greek loans (a “bail in”) (Gow et al. 2011). The end result was a promise to increase the EU bail-out (loan) fund to at least €1 trillion; how and when was left unstated. When Mario Draghi assumed control of the ECB in November 2011 the bank began commenting on member state policies, promising accommodative



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monetary action in return for domestic reforms. New informal ECB-Council discussions ensued after Draghi and Merkel signaled their agreement on ECB activity. Italy, facing upward pressure on its borrowing costs, rejected an IMF “precautionary fund’ with conditionalities, but was told by Draghi it would not receive any ECB assistance absent structural reforms; the parliament voted through a set of reforms and Prime Minister Berlusconi (opposed to the action whom Merkel made clear she did not trust) resigned. Following a display of unity at the June 29 2012 EU summit, where leaders unanimously endorsed structural reforms as necessary for growth, Draghi began expanding the limits of accepted practice with regards to commenting on, and attempting to directly influence policy in the member states. Draghi, as one external adviser confided, was aware of more than formal constraints (the treaty language): he was an Italian holding a job reliant on German support, but showed himself to be a skilled navigator with a keen understanding of the political process. He was determined to incrementally move towards more financial integration because he saw no alternative for the EU. In the summer of 2012 Draghi ensured that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” (Draghi 2012a). However, he later insisted ECB action would only follow state policy changes, clarifying that “we [ECB] cannot repair unsound budgets. We cannot clean up struggling banks. We cannot solve deep-rooted problems in the structure of Europe’s economies” (Draghi 2013). In September 2012 the ECB released its Open Market Transactions (OMT) program, where the bank would, after a country agrees with the Commission on structural reforms, purchase potentially unlimited government bonds in the secondary market in order to bring down interest rates, and thus borrowing costs, while reforms are implemented. Draghi was thus acknowledging the ECB’s formal limits, calling for political action to break the institutionalized links between bad banks and sovereigns, while simultaneously redefining the ECB’s role within the Eurozone by modifying what could and should be accepted state practice in ensuring Eurozone stability. Draghi has continuously redefined the limits of ECB powers, inviting political decisions to match the ECB actions, while retaining the institutional base of the euro. During 2011 he privately oversaw emergency plans to address a Greek exit from the Eurozone, while simultaneously working with Merkel to further integration, and publicly speaking up on the need for fiscal union (Thesing 2013; Draghi 2012b). He took action. Gaps in legislation when setting up the euro enabled new and ingenious funding structures within existing rules, while preventing direct government funding and increasing the opportunities and likelihood of purchases in the secondary market. Draghi’s decision was thus path-breaking in numerous ways. It was both “unique and successful” (cf. Moravscik and Nicolaidis 1999) in that an individual in an

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EU institution undertook an observable action which changed the outcome from what it would otherwise have been, and where its success changed the accepted and expected behavior of said institution. The ECB can now buy in secondary markets when governments have agreed to reform packages and Commission oversight, while the ESM may also debt directly from governments. When Cyprus needed a bailout in March 2013 and initially refused to force unsecured creditors and depositors to contribute (bail-in), the ECB stood firm, unable to back away from its previously redefined position on collateral requirements and OMT rules without jeopardizing its own influence, even existence. Likewise the Merkel-led northern states could not renege on the structural reform and bail-in requirements in exchange for an EU-IMF loan without losing credibility domestically and in the financial markets. Implications and Conclusion The logic of internal adjustments to enable a continuation of policies in the face of changing external environment doubtful of the euro’s survival necessitated internal modifications to cement changes conducive to greater efficiency, growth, and stability. The anticipated benefits of EMU, both positive (improving EU’s global competitiveness) and negative (averting a major political crisis if the venture failed), focused governments’ attention and made it necessary for them to stay the course. A public backlash, driven in part by the perception that EMU exacerbated unemployment, increased the EU’s unpopularity. Member states’ determination to proceed with EMU regardless was one of the most striking aspects of European integration in the 1990s. Much of the credit belongs to Helmut Kohl, who doggedly advocated EMU despite major misgivings in Germany and weak political leadership elsewhere in the EU. (Dinan 1999, 175)

Substitute 2011 for 1990s and Angela Merkel for Kohl in the above paragraph and it could be referring to the most recent crisis. The absence of specific provisions in the Maastricht Treaty for addressing national fiscal and banking problems enabled individuals and ideas to take root. Portugal, Ireland, Italy, and Spain could, if national interest and power mattered more than institutions, have withdrawn, devalued, and regained short-term advantages. However, policy makers themselves did not seriously contemplate the option, although bantered about by commentators; costs were deemed irresponsibly high, as labor markets would remain unreformed, workers purchasing power would suffer, and markets would soon punish these states again. Bergsten (2012, 18) wrote “. . . every policymaker in Europe and even the European publics know that the collapse of the euro would be a political and economic



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disaster. And fortunately, since Europe is an affluent region, solving the crisis is a matter of mobilizing the political will to pay, rather than the economic ability.” Merkel and Draghi were influential in creating the political will and altering the accepted practices, which enabled debts to be paid, and reforms to be implemented in ways that strengthened the Eurozone. The latter has been set on an even narrower internal path of fiscal integration while improving its conformity with the external environment. European Council President Van Rompuy declared there should be “no taboos concerning the longer-term perspective” [and] “it is not too early to think ahead and to reflect on possible, more fundamental changes within European economic and monetary union” (Watts 2012). By 2013 fiscal governance, banking union, and peer-oversight were part of common European parlance.4 Active, unorthodox ECB action was now expected, and Draghi’s skillful political handing of the crisis recognized by observers (Thesing 2012). Citizens and investors have also taken note. The support for the euro never fell below 52 percent throughout the crisis, and as many Europeans believed the EU level was the most appropriate level to address the crisis as preferred the national level (European Commission, 2013). In 2012, 84 percent of EU citizens believed the crisis has made cooperation a necessity, with closer integration to follow. 60 percent said EU has the tools to succeed, and 53 percent believed the EU would be stronger in the future (European Commission 2012). By 2013, nearly two-thirds of EU citizens believed the economy would remain flat or improve; only a third believed it would worsen. There was also much greater optimism in financial markets. Investors were increasingly convinced that labor market and public sector reforms pushed through in Spain, Portugal, Italy, and even Greece, would yield positive economic effects over the long term, with lower borrowing costs From the start of the crisis Merkel insisted on incremental integration with rules and obligations, even as other objected, as she admitted, “I’m pretty much alone here. But I don’t care. I’m right” (Spiegel Online 2013). Whether she was right or not, along with Draghi, she reshaped perceptions of expected and accepted behavior, modifying the path Eurozone development. A conviction that European leaders and the ECB charted a new, more stable path of Eurozone integration is now pervasive.

Notes 1. I assume that individuals are rational yet constrained (“bounded”) in their knowledge, meaning outside observers may see more options than the policy maker(s), and employ a largely positivist epistemological approach, using statements of intention as indicators of preferences.

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2. For the empirical part I also met and spoke with several German officials “on background.” 3. Schäuble’s intention was only to put additional pressure on countries to reform, as he stressed his references for Greece to reform and stay in the euro area. Another example of this strategy was the fact that the Finnish backed off in the last minute on their request for extensive collateral in exchange for more financial assistance to Greece, as did the Dutch and Austrians (on their request for collateral). 4. EU Commission evaluates budgets progress on reforms, and Council members critique each other’s proposed budgets.

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Part II

The Politics of Crisis Response European Governance Meets Public Policy

Chapter 6

The Sovereign Debt Crisis, Bailout Politics, and Fiscal Coordination in the European Union Hilary Appel and Carissa T. Block

Europe’s economic crisis had multiple dimensions, including troubled financial sectors, inflated real estate prices, a contraction in economic activity, the ballooning of government deficits and high borrowing costs. Countries in the greatest distress saw the yields on their government bonds skyrocket in private capital markets (Lierse 2012). While the European Central Bank and the IMF ultimately stepped in with bailout packages to deal with debt and liquidity problems in several economies, those countries facing severe revenue shortages had to find budgetary expenditures to cut and revenue sources to increase in the short term; and EU member states collectively had to find ways to avoid similar fiscal crises in the future. One of the most common policy responses on the national level to address immediate revenue shortages was to increase taxes on goods and services. By contrast, tax hikes on other sources of income, like direct taxes, were much less common. This is not surprising given the problems surrounding tax competition in Europe. Indeed most EU states strongly resist individually raising their taxes on corporations or increasing the tax wedge through higher labor taxes, given the negative repercussions for a country’s regional (and global) competitiveness. During the crisis, EU bodies devoted serious attention to advancing European initiatives to promote fiscal responsibility. As the economic downturn exacerbated already weak national balance sheets, member states collectively recognized that the existing agreements to protect fiscal responsibility at the regional level were inadequate. At the height of the crisis, leaders came together to commit themselves to a much more stringent set of rules on public finances. Much attention has been paid to the Euro Plus Pact, which sought to rectify some of the problems with the Stability and Growth Pact, since the latter did not have the teeth to enforce limits on deficit 107

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spending (Gabrisch and Karsten 2014). However, there were less prominent fiscal initiatives that gained momentum during the crisis as well—initiatives that had the potential to change dramatically the fiscal order in Europe. The most significant initiative involved EU-wide coordination of corporate taxation. If new rules could be established regarding how transnational companies were taxed in Europe, then some of the constraints on taxing corporations noted above could be lessened. Indeed as the fiscal challenges related to tax competition were ameliorated, individual states might feel a little freer to increase their reliance on the corporate and financial sectors for government revenue, in normal and in crisis periods. The hesitation of governments to increase taxes on corporations, and instead rely more on consumers for revenue, is evident even in times of great budgetary stress. Between 2008 and 2010, fifteen countries increased their value added taxes; and in 2013 alone, nine countries raised their value added tax rates (Eurostat 2013, 31). At the same time, European governments kept taxes on corporations and banks extremely low. States in crisis like Greece and Portugal had accumulated large national debts while experiencing some of the sharpest declines in corporate taxes. Between 1985 and 2012, they both cut their corporate profits tax rate by more than half. Portugal’s share of revenue from corporate taxes declined steadily from 2007 to 2010 falling by 17.4 percent (Eurostat 2013, 31). Even more striking, Greece’s corporate tax revenue as a percentage of total taxation also fell nearly 36 percent over the same period. Slovenia, a country whose debt has more than doubled between 2007 and 2012, also lowered its CIT rate by 20 percent, from 25 percent in 2006 to 20 percent since 2010. While teetering on the brink of default, Slovenia’s corporate tax revenue as a percentage of total tax revenue fell 41.8 percent from 2007 to 2010 (Eurostat 2013; Statistical Office of the Republic of Slovenia). As these shifts in the tax burden received more attention by political parties and national media, a backlash began to emerge (International Herald Tribune, November 19, 2012; BBC, November 6, 2012; Irish Independent, May 17, 2012; Irish Examiner, March 22, 2012). In the aftermath of the economic crisis, serious questions arose: Given that consumers are absorbing more of the costs of government shortfalls, are companies and banks shouldering their fair share of the tax burden? What new fiscal responsibilities should banks assume in the future, given the public bailouts of banks during the financial crisis? Why should taxes collected from citizens and corporations in high-tax countries support crisis countries with low corporate taxes? Specifically, the question arose in France and Germany why should larger countries support major bailout packages for countries that cannot meet their fiscal obligations, when they refuse to tap important revenue sources at home? Why should a country like Ireland—one of the countries that is most responsible for the region-wide downward pressure on



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corporate taxes—receive bailout money when it refused to support efforts to ameliorate the effects of tax competition in the region? With a bright spotlight focused on the challenges of revenue collection and tax fairness issues, finding a solution for how to deal with profound fiscal challenges in Europe took on a renewed sense of economic urgency and political salience. Major initiatives—such as setting penalties for surpassing deficits and debt ceilings (Euro Plus Pact), creating a financial transaction tax (FTT directive), and coordinating corporate income taxation (CCCTB directive)—began to advance quite quickly. In fact some of the low-tax countries that had resisted EU-level reform in the past became active and constructive participants in Brussels policy discussions on tax harmonization. This chapter focuses on two major fiscal harmonization initiatives in Europe at the time of the crisis: corporate income tax reform and the establishment of a financial transaction tax. The chapter argues that Europe’s recent financial crisis was not merely cotemporaneous with progress in tax coordination. Instead the financial and debt crises were absolutely central to these policy advances. The crisis changed the incentives of certain countries to resist the movement for greater coordination and it invigorated efforts by large countries like France and Germany to pursue harmonization. Moreover, the crisis brought salience to EU fiscal issues and made the public more aware of tax avoidance in the corporate and financial sectors. Finally, the crisis created a willingness of many more actors to consider new ideas in fiscal coordination and transnational harmonization vis-à-vis banks and corporations. The Pursuit of Corporate Income Tax Coordination: The Emergence of the CCCTB For decades European officials have found it difficult to reach any agreement on an EU tax policy that limits national control over how individuals and firms are taxed. While European treaties have gone far in coordinating and harmonizing indirect taxes (like taxes on goods and services, excise taxes and import taxes), the EU does not have the authority to pass new rules governing direct taxes, like taxes on corporate profits. Article 115 of the Treaty on the Functioning of the European Union stipulates that the Council may adopt new directives for direct taxes only when members states agree unanimously and when these directives directly affect the functioning of the internal market (European Commission 2014b). There were many factors making corporate tax reform in Europe necessary well before the crisis. On a practical level, the existing corporate income tax regime was highly inefficient. Companies had to learn and adhere to the tax codes for every EU country in which they operated. The mutually incompatible

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rules across Europe meant high compliance costs for companies as they navigated the different systems. The complex multi-country arrangements wasted resources for national tax administrations and for firms, and in many instances led to double taxation. On a political level, larger high-tax countries felt that the current regime encouraged aggressive tax planning, such that firms faced major incentives to shift their taxable profits to low-tax jurisdictions and their deductible expenses and losses to more favorable tax environments. While improved rules governing transfer pricing and treaties on double taxation aimed to reduce aggressive tax planning and unfair tax practices, the multiple regimes by which companies calculated their tax obligations preserved inefficiencies and fueled abuse. Moreover, the variation in national tax systems led to distortions in investment decisions, such that tax obligations could dominate investment calculations, eroding the core logic and primary purpose behind creating a common market. Given strong disagreements over how to cope with these fiscal challenges, past efforts to expand the EU’s authority over direct taxes proceeded with great caution and care. Nonetheless, strong opposition from dissenting member states thwarted progress in tax coordination. For decades, the European Commission attempted to reform Europe’s corporate tax regime to no avail. Many years have passed since the Neumark Report (published in 1962) and the Tempel Report (published in 1970) and the European Commission’s draft directive of 1975 identified the need for greater coordination of corporate taxation as a way to improve the functioning of the internal market.1 Since the 1960s, the Commission has attempted to bring greater coherence to company taxation in Europe and to solve problems related to double taxation, transfer pricing, aggressive tax planning, high tax compliance costs and harmful tax competition. While several of the Commission’s past efforts were abandoned or postponed, some limited progress was made in particular areas, such as the agreement among member states to provide mutual assistance between national tax authorities.2 Quite significantly, member states also reached a consensus to abide by a voluntary Code of Conduct (Europa 1997) to minimize specific beggar-thy-neighbor tax programs, like targeted tax holidays. However, the harmonization of corporate income taxation remained elusive. In the early 2000s, the European Council called again on the European Commission to intensify its efforts to develop a proposal for a consolidated corporate tax base for companies engaged in transnational economic activity (European Parliament and the Economics and Social Committee 2001; 2003). Following a 2003 analysis of the use of international accounting standards as a starting point for developing a common corporate tax base, the European Commission established a working group to develop a tax harmonization proposal. Between 2004 and 2008, the Commission’s official Working Group



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on the Common Consolidated Corporate Tax Base convened over a dozen times, followed by a capstone workshop in October 2010. Having consulted numerous times with representatives from national governments, with fiscal specialists from academia, accounting firms and law firms, as well as with representatives from small, medium and large enterprises, the Commission completed its proposal for a Council directive on a Common Consolidated Corporate Tax Base (CCCTB) in March 2011 (COM/2011/121/4).3 The proposed CCCTB Council Directive allows firms the option of filing one tax return covering all of their tax obligations across the treaty states. States could continue to set their own tax rates, but they would have to agree both to a sharing formula based upon a set of variables and a common way of calculating the tax base. No longer would a company in Europe have to file separate income tax returns in each state where it conducted business, subject to diverse national rules, filing dates and rates. Representatives of the business community were deeply involved in the drafting of the CCCTB proposal and there is evidence of its substantial support for harmonization. A 2007 KPMG Survey of 400 companies from 27 EU countries and Switzerland found that 78 percent of respondents heavily favored the European Commission’s proposals for a common system of corporate taxation (European Commission, 2011a). In developing materials for the public on CCCTB, the Commission highlighted and justified this directive as a means to make Europe more efficient and more business friendly. For example, the press release at the completion of the CCCTB proposal stated: The aim of the proposal is to reduce the administrative burden, compliance costs and legal uncertainties that businesses in the EU currently face in having to comply with up to 27 different national systems for determining their taxable profits. The proposed Common Consolidated Corporate Tax Base (CCCTB), would mean that companies would benefit from a “one-stop-shop” system for filing their tax returns and would be able to consolidate all the profits and losses they incur across the EU. Member States would maintain their full sovereign right to set their own corporate tax rate. (European Commission 2011b)

While the Commission’s press releases did not emphasize CCCTB as a means of creating a more just tax system, for many of CCCTB’s supporters, tax fairness between and within countries was of crucial importance. Leaders in France and Germany have long spoken out in favor of coordinating national approaches to corporate income tax, with the notion that Europe’s smaller, low-tax countries were unfairly using their favorable corporate tax systems to lure investors interested in being located in Europe’s common market.4 Indeed for many years, countries like Greece, Portugal, Estonia and most notably Ireland have deliberately used low corporate taxes to make

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their countries more attractive to foreign investors. As a result, successive Irish governments have resisted tax coordination, with the argument that low taxes have been a crucial component of the country’s economic development strategy. In much the same vein, many new EU member states from Eastern Europe adopted a comparable low-tax approach to woo corporations, offering rates far below what is found in many of the older and larger EU member states. Repeated efforts by France and Germany to harmonize corporate taxes, or even to promote greater fiscal coordination within the European Union, were rebuffed by low-tax states. However, Europe’s most recent economic crisis allowed France and Germany to bring salience to what they saw as the unfair consequences of diverse national systems of corporate taxation (Appel 2011). Despite pragmatic reasons behind efforts to promote CIT coordination, issues related to tax fairness were important for the public and for the Parliament. Indeed debates in the European Parliament repeatedly raised questions about tax fairness. In particular, members of parliament (MPs) on the left saw tax harmonization as a way to cope with tax avoidance by corporations (as opposed to MPs on the right who also tended to emphasize the proposed directive as making Europe more business friendly). For the left, corporate tax harmonization would help prevent corporations from relocating their businesses to avoid high tax rates or unfavorable treatment of expenses and losses.5 The parliamentary debate over the directive was lively and attracted significant media attention.6 Members of Parliament on both ends of the political spectrum collectively proposed nearly 500 amendments to the Commission’s proposal with the hope of tilting the proposal in one direction or another. In the final draft only 38 amendments survived, many of which reemphasized certain salient concerns, like the rights of national states to retain the power to use tax credits as incentives and to set their own rates (amendments 9 and 10), or the need to make taxation fairer by allowing states to rectify unexpected losses in revenue (amendments 4 and 13). Two important amendments distinguished the Parliament’s version from the Commission’s version. Amendment 14 made compliance obligatory for companies within five years, rather than voluntary as in the Commission’s version. Furthermore, amendment 16 changed the formula for apportioning the tax base among countries. The Commission’s proposal valued equally three economic factors (labor, assets and sales) in determining the sharing formula of corporate tax revenues among countries. In recognition of the interests of countries with smaller domestic markets and lower labor costs, the Parliament’s amendment set labor and asset factors at 45 percent and sales at 10 percent. This revision disfavored large hightax countries that had substantial domestic markets, to the advantage of the countries of origin (where goods are produced). These amendments—even



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if not enforceable—were necessary to ensure support for the proposal’s passage. MPs on the left strongly wanted to make CCCTB a non-voluntary regime, and made this a condition of their support.7 Revisions to the sharing formula increased support from MPs from small (low-tax) countries and countries with lower labor costs who feared significant losses in revenue as a result of harmonization. On April 19, 2012 the European Parliament voted 452 in favor and 172 against (with 36 abstentions) in a special legislative procedure to support the Council directive. These compromises were important since there was good reason to fear that the European Parliament would fail to pass the directive. During the first two months of the European Parliament’s legislative procedures, national parliaments could have derailed the process by challenging the CCCTB directive’s compliance with the EU’s subsidiarity principle. If one-third of the member states had challenged the directive through the “yellow card” procedure, the proposal would have been sent back to the Commission (European Commission 2012). This almost never occurs; and therefore as the yellow cards were accumulating, proponents of CCCTB in the parliament grew quite concerned. 8 Despite at least one yellow card being submitted by Great Britain, Ireland, the Netherlands, Sweden, Malta, Poland, Bulgaria, and Romania, the parliamentary procedure fell five cards short of the required number of yellow cards to stop the Parliament from voting (Loyens Loeff 2012). The European Council determines the fate of the Commission’s proposal and decides which if any of the Parliament’s amendments to keep in the final version. The Parliament could not independently change the directive with its amendments, since on tax matters the Parliament only plays a “consultative role.” Directives involving taxation require unanimous support by member states in the European Council. That said, the Parliament nonetheless played an important role in bringing both legitimacy to the Commission’s proposal and media attention to the issues at stake, putting pressure on the European Council to reach an agreement. While the deliberations of the Council are less transparent than those of the Commission and the Parliament, several rounds of compromise proposals have emerged. Each new presidency of the Council has built on the previous compromise proposal of the previous six-month presidency. Achieving the support needed to adopt a revised CCCTB proposal is not easy. Unanimity is required. If the Council approves the CCCTB in any version, however, the significance cannot be overstated: a major step toward fiscal harmonization has occurred. As one previous European Council official explains, the “CCCTB is a revolutionary proposal. You cannot expect that everything proposed in the Commission can happen.”9 Yet even if unanimous support cannot be ultimately reached, near unanimous support could still lead to a radical transformation. In this case, the procedure of “enhanced

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cooperation” is invoked and participating member states will agree to a common corporate tax regime. That is, if the most likely defectors, Ireland and the United Kingdom, ultimately fail to support the proposal, the other twenty-six member states could agree to abide by the proposal through the enhanced cooperation procedure, thereby dramatically changing the nature of corporate tax competition in Europe. The will to coordinate corporate taxes even without unanimous participation is evidenced by an early bilateral effort by France and Germany to harmonize their CIT systems. In late 2010 French and German leaders established a working group to draft a Green Paper on Harmonization (Loyens Loeff 2012). Then in August 2011, in the midst of summit meetings to cope with the growing debt crisis, Chancellor Angela Merkel and President Nicolas Sarkozy announced that France and Germany would establish a common corporate tax regime that would not only include a common way of calculating the corporate income tax base, but also the harmonization of the rates themselves (Reuters, August 16, 2011; Telegraph, February 21, 2012). Their enthusiasm for corporate tax coordination stemmed from the fear that larger countries were losing out to small states with low corporate taxes and small domestic tax bases. Tax competition was not a game that large states could possibly play and win. Whereas small states had little to lose from lowering corporate income tax rates, large states would risk significant losses if taxes from new entrants did not compensate for losses from domestic firms paying lower rates (Genschel and Schwarz 2011). Longstanding fears of falling revenues due to tax competition were intensified by recent significant drops in corporate income tax revenues. Leading up to the crisis, France and Germany suffered dramatic declines in corporate income tax revenue. Although corporate income tax revenue as a percentage of GDP fell for all countries, the comparative magnitudes are significant. As plotted in Figures 6.1 and 6.2, France and Germany experienced a dramatic loss (55 and 31 percent, respectively) from 2007 to 2009, Ireland experienced a significant loss (28 percent) and Greece and Cyprus experienced minor losses (about a 4 percent decline in both countries) (Eurostat 2013). From the perspective of Germany and France, those countries with high corporate taxes suffered from external pressures to lower corporate income tax rates—pressure that came from the low tax policies of some of the very countries that they were bailing out with common resources. Since ordinary taxpayers (who are also voters) became the group absorbing the shift in the tax mix with tax hikes on consumption taxes, it is not surprising that political leaders pushed for regional policies that they believed would help reverse this trend. The German and French plan for harmonization did



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Figure 6.1  Large Country CIT Revenue (% of GDP). Source: European Commission: Eurostat. Tax revenue statistics.

Figure 6.2  Small Crisis Country CIT Revenue (% of GDP). CIT Revenue shown for small countries with especially low (or dramatically declining) CIT rates that have also accepted a bailout package (Cyprus, Greece, and Ireland) or have been involved in bailout discussions with EU and IMF officials (Slovenia). Source: European Commission: Eurostat. Tax revenue statistics.

result in some convergence in corporate income tax rates between the two states, but did not lead (as of yet) to a common regime for calculating the tax base. However, the timing of the announcements and the initial steps lent credibility to efforts at the European level to achieve greater coordination with the Commission’s CCCTB proposal. The bilateral effort also lends credibility to promises of using the enhanced cooperation procedure, if unanimity cannot be achieved.

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The Financial Transaction Tax Initiative Policy efforts to harmonize taxes on financial transactions have a much shorter history, but work on the FTT initiative coincided partially with work on corporate income tax harmonization. The Commission began work on introducing a financial transaction tax through its discussions with the G-20 in 2009, and continued its efforts on the regional level into 2010. The European Commission completed its proposed Financial Transaction Tax Council directive (COM/2011/594) (European Commission 2011c) for the European Union in late September 2011. The purpose of the proposal was to harmonize the financial tax base and establish minimum rates on all transactions on secondary financial markets. The set minimum rates would apply to trades in stocks, bonds, options, futures, and interest rate swaps that included a European entity. The approach was to be as inclusive as possible so that all financial markets, instruments, and actors would be affected, thereby minimizing distortions in investor decision-making. The Commission justified the proposal by stressing fairness. Following the financial crisis in Europe, individual member states and the voting public, according to the Commission, wanted to see that banks were not only contributing adequately to public finances, but that financial institutions “pay back at least part of what the European tax payers have pre-financed in the context of the bank rescue operations” (European Commission 2014a). Moreover, the Commission also asserted that there were inefficiencies in the taxation of financial transactions that could be rectified, at least in part through the harmonization of national approaches; and, furthermore, the FTT directive could also alleviate instances of double taxation and double non-taxation. Despite strong opposition from banking lobbies and employers unions, the support for the financial transaction tax proposal, especially from large countries, strengthened as politicians observed the proposal’s popularity among the general public. During and after the crisis, many citizens were angry with seeing their sales tax increase and public welfare programs cut through austerity measures, while large banks received bailouts following years of reckless lending behavior. For these reasons, the FTT became known in the media as the “Robin Hood tax” (Financial Times, February 19, 2014). Algirdas Šemeta, the Commissioner of the Taxation and Customs Union, highlighted the importance of the FTT initiative for building trust with the public after the crisis. In a recent speech, the Commissioner tried to rally support for the proposal stating: Europe needs to reconnect with its citizens. And the FTT is a prime example of a project which can help to achieve this. 64% of EU citizens support the Financial Transaction Tax, according to the latest Eurobarometer survey. This is a highly



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popular initiative, which Europeans believe in. Our leaders should keep this in mind when considering the proposal, especially as the May [EU parliamentary] elections come ever closer. (Šemeta 2014)

As in the CCCTB directive, not all EU members supported pursuing a harmonized financial transaction tax. France and Germany have been strong supporters of increased fiscal coordination, whereas the United Kingdom, Sweden, and Estonia have not. It became clear by September 2012 that FTT adoption by the whole European Union was unlikely to clear the unanimity hurdle required of all tax measures in the Council, and thus proponents began to pursue other avenues for adoption. With the support of the European Commission and the European Parliament, a group of eleven member states decided to proceed through the enhanced cooperation procedure. While it will not be simple to iron out the details of the final directive given differing national interests and the tireless efforts of lobbies to prevent an agreement on the Financial Transaction Tax proposed directive, the momentum to reach an agreement among larger EU states, and left-wing groups from an even a broader set of states, remains quite strong.

The Impact of the Crisis What role has the crisis played in fiscal harmonization and policy coordination? While the rise of the FTT’s popularity may seem intuitively linked to the European financial crisis, the same cannot be said of corporate tax reform. After all, the Commission’s work on the CCCTB came to a close rather naturally in the late 2000s. While it might seem plausible that the crisis was simply a backdrop for a project that was many years in the making, in fact the crisis for many reasons was important for the CCCTB proposal’s advancement. First, the economic crisis hit several low-tax countries particularly hard, including some of the greatest opponents of tax coordination. The case of Ireland provides a poignant example. Ireland in 2003 set its corporate income tax rate at 12.5 percent. This was by far the lowest rate among West European member states, with nominal tax rates in France, Italy, Spain, and Germany all above 30 percent (2009 figures). Mid-level CIT states in the EU-15 like the United Kingdom and the Netherlands levied corporate tax rates at 28 and 25 percent respectively (in 2009) (Eurostat 2013). Not surprisingly, given Ireland’s relatively favorable low CIT rate, its leaders had a strong incentive to resist tax harmonization with high-tax states in the 2000s. However, in the midst of a financial crisis that impacted Ireland profoundly, the French and Germans succeeded in persuading Ireland to be more supportive in EU

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efforts toward CIT coordination. As Appel and Block discuss, Irish Premier Edna Kenny pledged to “engage constructively” in talks on the CCCTB exactly when Ireland joined the European Competitiveness Pact (Appel and Block 2014), and again when the interest rate on its bailout was cut (Irish Times, January 19, 2012, 10). The Irish Press was explicit in linking Ireland’s 85 billion euro bailout to its cooperation in advancing the CCCTB initiative (Irish Times January 19, 2012; Telegraph, February 21, 2012).10 Informal discussions with fiscal specialists in Brussels similarly linked the bailout to Ireland’s willingness to participate actively and constructively in the EU tax base harmonization effort. In addition, worsening economic conditions at the time of the crisis may also account in part for Irish participation in a coordinated tax regime. While the country’s tax rate has remained persistently low, CIT income as a percent of GDP was at its lowest point in 2009 since 1995. Although it increased from 2.4 to 2.5 percent in 2010, the 2010 number is still nearly 36 percent lower than the peak in 1999. Other taxes did help compensate for falling corporate tax revenue; nonetheless the total revenue in 2011 was about 11 percent lower than the average total tax revenue (as percent of GDP) from 1985 to 2010. Indeed, as budgetary shortfalls grew worse throughout Europe, governments found tapping more significantly this important source of revenue increasingly appealing.11 Furthermore, in the midst of Europe’s deepening economic crisis, politicians did not want to appear indifferent to tax avoidance by corporations or to tax evasion facilitated by banks. On the contrary, politicians from a wide swath of the political spectrum wanted to demonstrate their toughness on corporations and banks that were shirking their responsibility to pay for some of the costs of a crisis they helped to fuel. The very sudden popularity of the Financial Transaction Tax directive exemplifies this well. While the CCCTB took years to design and included exhaustive efforts to study all of the potential impacts of harmonization, the proposal for a FTT was written very quickly under time pressure. As attention from the media intensified, and as political elites, like President of the European Commission, José Manuel Durão Barroso, French President François Hollande and German Chancellor Angela Merkel expressed their support for the FTT, many actors rallied behind it, including those who had previously withheld support. Due to the crisis, the tide of reform turned, and politicians were racing to catch up and show they shared the sentiment of the voting publics and key elites. Understanding the mood of the times, politicians recognized that the popular advantages of demanding that banks and corporations pay a larger share. The recent financial and sovereign debt crises in Europe put the challenges of fiscal coordination in Europe in stark relief. In the years prior to the crisis,



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EU leaders lamented openly the inability of different countries to reach and enforce agreements on deficit spending, debt accumulation, and company and banking taxation and regulation. Indeed when the Commission once again returned to the goal of corporate tax harmonization in 2001, member states were skeptical of its potential for success (Krotz and Schild 2013). Some thought the unanimity hurdle would be too high to overcome and others thought the difficulty of reaching an agreement on a tax sharing mechanism given divergent state interests would be too great (Pirvu 2013, 28). Yet after more than a decade of serious engagement, not to mention more than a decade of great skepticism, the crisis opened up a political space for attitudes about the existing tax system to change. According to Uwe Ihli, an official in the European Commission’s Directorate General for Taxation and Customs Union, the crisis made leaders reconsider the existing system, not only because they needed revenue, but also because the crisis opened their minds to new possibilities. He explained, “You know the expression, ‘don’t fix an engine while it is running’? Before the crisis, these fiscal systems were generating enough revenue and it seemed risky to reform them. But the crisis forced people to consider change since it triggered the need to increase taxes for the budget and increased their willingness to go for new ideas.”12 The severe economic contraction also altered public sentiment and media interest in fiscal affairs. The debates in the European Parliament on CCCTB and the Financial Transaction Tax directives were well covered, thereby supporting the efforts of the Commission and members states in their pursuit of reform. Although the Parliament could not determine (or even co-determine) new tax policies, its deliberations lent credibility and directed public attention to European fiscal challenges at the height of the crisis, and forced the European Council to actively work toward consensus and passage. And while corporate tax harmonization, like the FTT directive, may not win the support of all member states, the impact of adoption by a critical mass of states would nevertheless be highly significant. After all, the creation of the Eurozone with the participation of only a subset of the European Union’s members nonetheless represents a radically new monetary order and a tremendous feat of policy coordination. This must be recognized, especially as the Eurozone is exiting a period of instability and tumult. An extraordinary amount of skepticism surrounded the feasibility of introducing a single currency and harmonizing monetary policy among a diverse set of economies and polities. If the Commission’s directives harmonizing the calculation of the corporate tax base and the directive imposing a harmonized tax on financial transactions prevail, then the crisis will have caused the EU to have achieved profound reform of its fiscal order.

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Notes 1. As early as 1962, the Newmark Report summarized, “the current situation is at such a point of confusion that an analysis in a systematic way is required. It goes without saying that harmonisation will have to be achieved.” Quoted in Chetcuti 2001. Also see Vanistendael (1992). 2. For a summary of EU legislation related to direct taxation, see http://europa. eu/legislation_summaries/other/l33029_en.htm (Accessed July 15, 2014). 3. For the text of the proposal, see “Proposal for a Council Directive on a Common Consolidated Corporate Tax Base” 121/4 (2011). Brussels. http://ec.europa. eu/taxation_customs/resources/documents/taxation/company_tax/common_tax_base/ com_2011_121_en.pdf (Accessed April 15, 2014). 4. On German and French efforts to impose minimum corporate tax rates, see Krotz and Schild. 2013, 174–5. 5. Author interview with Marcus Scheuren, European Parliament official, Committee on Economic and Monetary Affairs. Brussels, December 18, 2013. 6. For the text of CCCTB debate in parliament see: http://www.europarl.europa. eu/sides/getDoc.do?type=CRE&reference=20120418&secondRef=ITEM-016&lang uage=EN&ring=A7-2012-0080 (Accessed April 21, 2014). 7. Author interview with Marcus Scheuren, Ibid. 8. Author interview with Marcus Scheuren, Ibid. 9. Author interview with European Council official. Brussels, December 18, 2013. 10. As one commentator put it, Germany “bullied” Ireland into constructively engaging in discussions on the corporate tax base “in return for lower interest rates on its bailout loan.” Irish Times, May 16, 2012. 11. Author interview with Uwe Ihli, European Commission official in Unit D1 Company Taxation Initiatives. Brussels, December 17, 2013. 12. Ibid.

Bibliography Appel, Hilary. 2011. Tax Politics in Eastern Europe: Globalization, Regional Integration and the Democratic Compromise. Ann Arbor: University of Michigan Press. Appel, Hilary and Carissa T. Block. 2014. “Who is to Blame for Falling Corporate Taxes in Europe? The Politics of Tax Competition from EU Enlargement to the European Fiscal Crises.” Mimeo. Chetcuti, Jean-Philippe. 2001. “The Process of Corporate Tax Harmonisation in the EC.” Inter Lawyer (Accessed April 8, 2014). Europa. 1997. “Towards Tax Co-ordination in the European Union.” Last modified October 10. http://ec.europa.eu/prelex/detail_dossier_real.cfm?CL=en&DosId=108026 (Accessed April 8, 2014).



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European Commission. 2011a. “Commission Staff Working Document Impact Assessment SEC 315.” Last modified March 16. http://ec.europa.eu/taxation_ customs/resources/documents/taxation/company_tax/common_tax_base/com_ sec_2011_315_impact_assesment_en.pdf (Accessed July 1, 2014). ———. 2011b. “European Corporate Tax Base: Making Business Easier and Cheaper.” Last modified March 16. http://europa.eu/rapid/press-release_IP-11319_en.htm?locale=en (Accessed July 1, 2014). ———. 2011c. “Proposal for a Council Directive on a Common System of Financial Transaction Tax and Amending Directive 2008/7/EC.” http://ec.europa. eu/taxation_customs/resources/documents/taxation/other_taxes/financial_sector/ com(2011)594_en.pdf (Accessed April 14, 2014). ———. 2012. “Ordinary Legislative Procedure ‘Step By Step.’” Last modified January 31. http://ec.europa.eu/codecision/stepbystep/text/index_en.htm (Accessed July 1, 2014). ———. 2014a. “Taxation of the Financial Sector.” Taxation and Customs Union, Last modified October 7. http://ec.europa.eu/taxation_customs/taxation/other_ taxes/financial_sector/index_en.htm#fate (Accessed July 1, 2014). ———. 2014b. “The Lisbon Treaty and Tax Legislation in the EU.” Taxation and Customs Union, Last modified October 7. http://ec.europa.eu/taxation_customs/ taxation/gen_info/tax_policy/article_6759_en.htm (Accessed July 1, 2014.) European Parliament and the Economics and Social Committee. 2001. “Towards an Internal Market without Tax Obstacles: A Strategy for Providing Companies with a Consolidated Corporate Tax Base for their EU-wide Activities.” Communication from the Commission to the Council, the European Parliament and the Economics and Social Committee 582. Last modified October 23. http:// ec.europa.eu/prelex/detail_dossier_real.cfm?CL=en&DosId=168921 (Accessed July 1, 2014). ———. 2003. “An Internal Market without Company Tax Obstacles Achievements, Ongoing Initiatives and Remaining Challenges.” Communication from the Commission to the Council, the European Parliament and the Economics and Social Committee 726. Last modified November 23. http://ec.europa.eu/prelex/ detail_dossier_real.cfm?CL=en&DosId=187013 (Accessed July 1, 2014). Eurostat. 2013. Taxation Trends in the European Union, Brussels. Accessed April 9, 2014. Gabrisch, Hubert and Karsten Staehr. 2014. “The Euro Plus Pact: Cost Competitiveness and External Capital Flows in the EU Countries.” European Central Bank Working Paper No. 1650. http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1650. pdf (Accessed August 4, 2014). Genschel, Phillip and Peter Schwarz. 2011. “State of the Art: Tax Competition: A Literature Review.” Socio-Economic Review 9:339–370. Krotz, Ulrich and Joachim Schild. 2013. Shaping Europe: France, Germany, and Embedded Bilateralism from the Elysée Treaty to the Twenty-first Century. Oxford University Press. Lierse, Hanna. 2012. “European Taxation During the Crisis: Does Politics Matter?” Journal of Public Policy 32(3):207–230.

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Loyens Loeff. 2012. “Green Paper German-French Harmonization Corporation Tax; A Further Step to a Common Tax Base Within the European Union.” Last modified February 21. http://www.loyensloeff.com/nl-NL/Practice/Documents/Green%20 Paper%2021%20February%202012.pdf (Accessed July 1, 2014). Pearse Trust. 2011. “CCCTB Gets Yellow Card From 8 Member States.” Last modified May 30. http://www.pearse-trust.ie/blog/bid/62728/CCCTB-GetsYellow-Card-From-8-Member-States (Accessed July 1, 2014.) Pirvu, Daniel. 2013. “Why CCCTB Disadvantages Less Developed Countries of the European Union.” Cross-Cultural Management Journal, 15:2. Šemeta, Algirdas. 2014. “Financial Transaction Tax: Time to Engage, Compromise, and Deliver.” Speech to the European Parliament, February 4, 2014. http:// europa.eu/rapid/press-release_SPEECH-14-92_en.htm?locale=en. (Accessed July 16, 2014). Statistical Office of the Republic of Slovenia: Government Deficit and Debt. Available at: http://www.stat.si/eng/ (Accessed June 30, 2013). Vanistendael, Franz. 1992. “The Ruding Committee Report: A Personal View.” Fiscal Studies 13(2):85–95.

Chapter 7

A Discernible Impact? The Influence of Public Opinion on EU Policymaking During the Sovereign Debt Crisis Jennifer R. Wozniak Boyle and Chris Hasselmann

The European sovereign debt crisis provides an excellent opportunity for examining the extent to which public preferences constrain member state preferences for EU policy solutions. We examine the influence of public opinion on austerity, spending, and regulation on member state preferences on 4 major EU solutions to the crisis from 2010–2011: the initial Greek financial rescue, the creation of the European Stability Mechanism, the reform of the Stability and Growth pact, and enhanced EU financial regulation. Our analysis reveals that prior to elections and/or when there is a degree of fragmentation in the governing party or coalition public opinion constrains member state preferences. In the absence of these conditions, however, member states ignored public opinion and followed elite preferences concerning solutions to the sovereign debt crisis. Literature Review How, when, and to what extent does public opinion matter for EU policymaking? Two paradigms have been put forth to explain the role of public opinion in European integration: Lindberg and Schiengold’s “permissive consensus” and Hooghe and Marks’ “constraining dissensus.” Lindberg and Scheingold’s (1970) contention that public opinion is not a significant explanatory factor in European integration has been the dominant approach. This model maintains that public opinion, while generally favorable toward European integration, does not directly influence institutional or policy development in the EU. According to this view, European governmental elites receive a permissive 123

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consensus in favor of European integration, and then determine the specific details without public input, scrutiny or censorship. In accordance with this perspective, Sanders and Toka (2013) argue that EU heads of state and government are influenced more by economic elites and by extrapolation economic interest groups than by public opinion. Sanders and Toka (2013, 22) find that: [P]olitical elites’ primary sources of opinion cues are not their respective mass publics but their respective national economic elites. In sum, in determining their own stances towards the EU, political elites appear to place more weight on the views of the economically rich and powerful than they do on the views of their own constituents. They respond to mass opinion, but not as much as they respond to other national elites.

Hooghe and Marks (2009) agree that the model of “permissive consensus” successfully explained the role of public opinion in the European Union from 1957 through 1991. However, they contend that this was because European integration was primarily concerned with economic policy coordination, and did not directly impact the majority of Europeans. After 1991, however, they maintain that the model of “constraining dissensus” best explains the relationship of public opinion and European integration. As the EU came to encompass monetary and political union, it “spilled beyond interest group bargaining into the public sphere” (2009, 5). Public opinion on European integration became more structured and salient in national politics due in large part to national political parties assembling positions on EU institutions and policies to suit their national electoral, governing, and policy objectives (2009 13, 19). As a result of partisan calculations on economic and identity issues, they contend the pro-integration elite has been constrained in pursuing increased integration by an increasingly Euroskeptical public (2009, 9). Hooghe and Marks argue that “[m]ass politics trump interest group politics when both come into play” (2009, 18). However, while interest groups will always seek to influence European integration, public opinion must be mobilized by political parties. Hooghe and Marks maintain that political parties are more likely to mobilize public opinion on an EU issue if their stance on the issue fits with their ideological tradition, if their members are united on it, and if they anticipate electoral success from their stance on the issue (2009, 19). Research Design The foregoing models lead to alternative predictions about the relative influence of public and elite opinion on member state preferences in EU



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policymaking. The model of permissive consensus maintains member state preferences are not a function of public opinion but influenced predominantly by economic elites. Member state preferences on EU policies reflect elite calculations of the economic costs and benefits of specific EU measures. Member state preferences on proposed EU measures are expected to vary according to whether a member state is an expected net contributor or net beneficiary of proposed EU funds and regulations. For example, preferences in net contributor states are predicted to be against EU spending measures and in favor of enhanced austerity and regulation; preferences in net recipient states are likely to be in favor of spending and against austerity and economic regulation. Member state governments may defy public opinion and embrace EU policies that contradict it when economic elites oppose public opinion. Alternatively, according to the model of constraining dissensus, member state preferences are influenced primarily by governing party ideology and politics. Governing party ideologies vary from market liberalism on the right to regulated capitalism on the left (see Hooghe and Marks 2009, 14–15). Liberal and conservative governments should favor austerity and oppose spending and regulation; and socialist governments should favor spending and regulation as solutions to the debt crisis. Member state preferences will be responsive to public opinion when it contradicts governing party ideology prior to elections and during coalition governments. In order to explore these models, we examine public opinion, elite preferences and member state preferences in Germany, France, the UK, Spain and Italy on (1) the Greek financial rescue; (2) the European Stability Mechanism; (3) the reform of the Stability and Growth Pact; and (4) EU regulations on the financial sectors. Public opinion on spending, austerity, economic coordination and financial regulation is measured during Council negotiations over the initiatives via Eurobarometer surveys. Elite preferences include opinions of national economic and financial actors and are derived from news reports. Member state preferences on the four EU initiatives are ascertained from news reports and public documents concerning Council meetings on the initiatives. Following Timus (2006) and Nguyen (2008) we seek to understand the interaction of public, elite and member state preferences. Comparing public, elite preferences and member state preferences on major EU initiatives allows us to discern the conditions of public influence on EU policymaking. The Greek Financial Rescue The debt crisis became apparent in the fall of 2009 when Greece announced that its budget deficit was 12.7 percent–more than twice what it had previously

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reported and more than four times the prescribed EU limit (Agence France Press, January 24, 2010). The Greek announcement presented an immediate threat not only to the solvency of the Greek government and the people of Greece, but to Greece’s creditors and the stability of the euro. The Greek announcement also revealed the weaknesses of the economic coordination between the euro economies, in particular the lax monitoring and enforcement of the convergence criteria and the stability and growth pact. In short, the Greek debt crisis ushered in what has since been termed “the euro crisis.” Member state and Commission solutions for the Greek debt crisis included spending and austerity measures to address the Greek budget imbalance and economic and financial regulation to prevent the reoccurrence of similar crises. Given the sensitivity surrounding such solutions, one might expect the Commission to probe public sentiments in its crisis-specific Eurobarometer surveys. However, no such question was included prior to the adoption of the first Greek financial rescue. Fortunately, the Financial Times was less inhibited. In its March 2010 survey of France, Germany, Italy, Spain, and the UK respondents were queried on the use of public money to rescue cashstrapped members. The results in Table 7.1 follow expectations as countries can be divided in two groups based on whether they were likely to be a provider (Germany, the UK, and France) or a possible recipient of such funds (Italy and Spain).1 First, while there was solidarity in general, in that the EU and its members were seen as having a responsibility to help members that encounter financial and/ or fiscal trouble, there was considerably less solidarity when it came to helping the Greeks in particular. In the latter case, there was particular opposition to be found in the UK (56% opposed) and in Germany (61% opposed). French public opinion was nearly evenly split on the question of EU help for Greece with 40 percent supportive and 39 percent opposed. Second, there was little interest in guaranteeing the debts of another EU member; over 60 percent of the respondents in France, the UK, and Germany were opposed to a measure that would have placed them at risk of paying off the debts of other members. In short, there appear to be limits to EU financial solidarity, especially if defined as taking on the obligations of another country’s deficit spending. Third, in more positive news, there was also little interest in requesting Greece to leave the Eurozone while it sorted out its problems. While such a “Grexit” was a widely discussed option at the time (spring of 2010), it was not widely seen as desirable. Finally, and somewhat disconcertingly for Brussels, a plurality of Germans (40%) believed their country would be better off if it left the Eurozone. In the other 4 Eurozone countries, the plurality felt their country would actually be worse off in leaving the Eurozone. These attitudes are reflected in member state preferences at the onset of the crisis. Germany and France—who held substantial percentages of



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Table 7.1  Public Support for EU Financial Assistance to Greece Germany The UK France Italy Spain The EU & its members have a responsibility to help other members in financial/fiscal trouble Support EU efforts to help Greece cope with its budget deficit Your government should guarantee the debts of another EU member Greece should be asked to leave the eurozone while it sorts out its finances Would your country be better or worse off if it left the eurozone?

Agree Disagree

32% 46

34 35

46 24

59 17

65 20

Support Oppose Support Oppose Agree Disagree

20 61 8 76 32 40

25 56 15 61 27 32

40 39 16 60 19 55

44 33 26 44 20 53

60 34 30 44 23 50

Better Worse

40 30

— —

26 39

25 47

31 39

Source: Financial Times, 2010.

Greek sovereign debt and were the likely largest contributors to a Eurozone rescue—preferred Greek budget austerity and not a financial rescue (Barber, Wiesmann and Hall 2010). Germany’s initial response to the crisis was to insist Greece stabilize its budget by cutting expenditures (Agence France Presse 2010a; Tilford 2010). Germany rejected calls for an EU or IMF rescue package for Greece, arguing that the EU was prohibited from granting financial bailouts to Eurozone states and that IMF involvement would compromise the European Central Bank (ECB) and thereby EU sovereignty (Barber 2010a; Peel 2010a). France recommended austerity and initially opposed an EU and/or IMF bailout (Barber and Hall 2010; Barber et al 2010; Barber 2010). The ECB also opposed EU and/or IMF bailouts and favored Greek budgetary austerity (Atkins 2010a; Atkins et al. 2010). Spain, Italy and the Commission supported a financial rescue of Greece (Agence France Presse, 2010d). As sovereign default became an increasingly likely possibility for Greece, France and Germany came under increasing domestic and international pressure to support a financial rescue of Greece. Despite lukewarm public support for EU assistance to Greece and opposition to securing Greek debt, French President Sarkozy came to embrace an EU bailout of Greece. His reversal–which contradicted French public opinion and his partisan ideology–was in line with French economic elites and interests. French banks held $67 billion in Greek debt—the largest percentage of any member state (Ewing 2010). BNP Paribas and Société Générale had among the largest exposures of any bank. French bankers, while sanguine in public statements, were supportive of the Greek bailout to avoid immediate losses and possible contagion to other member states (Fuhhrmans and Moffett 2010). Sarkozy not only endorsed an EU-led rescue but sought to convince German Chancellor

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Merkel of the necessity (Thomson 2010a; 2010b). Merkel was initially opposed to an EU bailout. Her position was in line with public opinion and her FDP coalition partners against an EU bailout (Barber and Wiesman 2010). Merkel was reported to be persuaded that an EU bailout would not survive the German Constitutional Court (Peel and Tait 2010). Additionally, her position was likely constrained by her need to secure a CDU-FDP victory in the pending North Rhine-Westphalia elections in order to maintain a majority in the Bundesrat (Peel 2010c). She, however, faced pressure for a bailout from German economic elites and interests. Deutsche Bank and Commerzbank officials warned of the contagion effects of a Greek default (Barber 2010c; Barber, Wiesman and Hall 2010). Finance minister, Wolfgang Schäuble, also supported an EU bailout of Greece (Economist Intelligence Unit 2010). Ultimately, Merkel conceded to a Greek rescue package tied to austerity involving both the EU and the IMF. Greece would receive €110 billion in loans over three years (€80 billion from Eurozone states and €30 billion from the IMF) in exchange for fiscal consolidation including increased sales taxes, and cuts in government salaries and pensions to bring the government deficit down to less than 3 percent GDP by 2012 (European Commission, Occasional Papers no. 61). The EU portion of the bailout would be disbursed in the form of bilateral loans from Eurozone states proportionate to their ECB contributions contingent upon Commission and ECB assessment of conditionality and by unanimous agreement of Eurozone states (European Council, 2010c). An examination of public, elite and member state preferences surrounding the Greek financial rescue reveals that in 3 of the 5 countries, public opinion and member state preferences were aligned in the direction predicted by economic cost/benefit considerations. Public, elite and member state preferences in Spain and Italy were aligned and supportive of the bailout. Public, elite and member state preferences in the UK were aligned and opposed. While public opinion in France and Germany was opposed to the bailout, member state preferences ultimately reflected elite calculations that the costs of refusing a rescue were too high. Public opinion against an EU bailout in Germany and lukewarm support in France did not prevent member states from adopting one. While German public opinion was ultimately overruled, it definitely influenced the content of the final rescue package. Reflecting German public sentiments, Germany secured increased fiscal austerity for Greece and a veto over temporary, intergovernmental Eurozone funding. Greece did not receive “free money” but rather loans tied to strict conditionality and austerity. German public opinion also influenced the timing of the Greek bailout. Merkel maintained opposition to the agreement until as close to the North Rhine-Westphalia state election on May 9th as possible. The election would not only decide her party’s strength in the Bundesrat, but was also a precursor to the next national election and referendum on her



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handling of the crisis. In general, public opinion set the broad contours of member state policy preferences, and affected the timing of the deal. The interaction of public opinion, elite and member state preferences in Germany demonstrates that when public opinion competes with interest group and economic elite opinion, it has more sway prior to elections and more sway with respect to coalition governments. The European Stability Mechanism Negotiations over the Greek rescue were complicated by the fact that the EU did not have an existing mechanism for coming to the aid of a Eurozone member state facing financial difficulties. The Treaty on the Functioning of the European Union explicitly prohibited the ECB (Article 123) and EU institutions (Article 125) from financially assisting Eurozone member states facing budget constraints. However some analysts argued that the EU could mount a rescue based on Article 122.2 which states that when a member state “is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the Member State concerned” (see Barber 2010c, 12). Given the ambiguity in EU law, there was disagreement on how to proceed with an EU rescue. Public opinion on EU financial assistance was measured in the fall following the Greek financial rescue and prior to the creation of the European Stability Mechanism. While respondents were not asked about treaty revisions, they were asked the extent to which they agreed that “in times of crisis, it is desirable for (our country) to give financial help to another EU Member State facing severe economic and financial difficulties?” (EB 74.1, QC10). As the results in Table 7.2 indicate public opinion across the member states is supportive. However, the intensity of support continues to reflect whether countries would be likely providers or recipients of financial assistance. France, Spain and Italy have majorities that support the fund. German and UK public opinion are evenly split with roughly 45 percent in favor of funding financial support. If public opinion were supportive of EU financial assistance, would they require austerity and conditionality in return? While respondents were not queried about conditionality of financial assistance, in May of 2011 they were asked about their support of deficit spending to create economic growth (EB 75.3 QC6). Table 7.3 indicates that public preferences in France and Germany continued to support budget stabilization and austerity over deficit spending to address the economic recession. In Germany and France

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Table 7.2  Public Support for EU Financial Assistance for all EU Member States Germany United Kingdom France Italy Spain EU-27

Agree

Disagree

dk

45.96% 45.42 51.20 53.26 48.65 48.36

44.83 41.94 41.03 28.86 36.22 39.70

9.20 12.64 7.77 17.88 15.12 11.95

Source: European Commission 2013a, QC10.

Table 7.3  Public Support for Deficit Reduction v. Job Creation

In an international financial and economic crisis, it is necessary to increase public deficits to create jobs.

Less than 40% Agree

Between 40–60% Agree

More than 60% Agree

Germany France

Italy Spain

UK

Source: European Commission 2014, QC6.

respondents were largely unwilling to take on additional debt in the name of job creation. At the other extreme, more than 60 percent of respondents in the UK supported deficit spending to create jobs. In Italy and Spain, 40–60 percent of the population was willing to increase their country’s indebtedness to promote job creation. It is essential not to read support of a national stimulus approaches to national economic woes as translating into support for EU-wide Keynesian policies. However, it is reasonable to assume that France and German publics who opposed such policies in their own countries would oppose them for the EU in general. Germany had first proposed a permanent EU bailout mechanism, the European Monetary Fund (EMF), in spring 2010 (Peel, Hall and Barber 2010). The German proposal, which would require treaty revision, was to give the EU an IMF-like institution that granted loans upon strict conditionality to any Eurozone state experiencing financial and economic imbalances (Agence Europe 2010d). The EMF proposal was Merkel’s attempt to reconcile increased pressure from German economic elites, France, and the Commission for a financial rescue of Greece with German public opinion preferences for budget stabilization and austerity, ensure that rescue conform to TEU requirements, and pass muster with the German Constitutional Court. While the German suggestion was weakly endorsed by the Commission and France, both were skeptical of pursuing treaty revisions (Peel, Hall and Barber 2010). Although member state preferences were not emphatically opposed to the EMF proposal, the latter was tabled in favor of a temporary, largely intergovernmental €750 billion Eurozone stabilization



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package due to concerns that a permanent EU fund would require amending the EU treaties, a lengthy process that would bring unwanted public scrutiny and oversight into member state efforts to stabilize the euro (Pop 2010; Mahoney 2010.) Discussions over a permanent EU rescue mechanism were re-initiated by Germany in the fall of 2010, in the midst of negotiations over a financial rescue package for Ireland. France and the UK immediately objected on the grounds that a permanent fund would require treaty changes (Peel 2010d). Merkel however, successfully convinced Sarkozy of supporting treaty change to bring forth the permanent EU rescue fund by conceding the German demand for adding automatic national penalties for states violating targets set in a new Stability and Growth pact (Chaffin, Hall and Peel 2010a). Despite the Franco-German deal, the Commission publicly opposed treaty revision (Agence France Press 2010e). British Prime Minister David Cameron also opposed treaty change for a new permanent fund, and was in favor of a total budget freeze (Thomson 2010c). Merkel agreed to support a limit on EU budget growth in exchange for the UK supporting treaty change (Wiesmann and Barker 2010). While willing to forgo automatic sanctions for undisciplined spending, Merkel was unwilling to compromise on treaty revision as a prerequisite for a permanent funding mechanism (Peel 2010e). Undoubtedly, the threat that Germany might not agree to future bailouts without the treaty change convinced the majority of member states to agree to the permanent bailout fund via a minor treaty revision. Furthermore, the possibility of utilizing an abridged procedure of unanimous approval by European Council for minor treaty revisions, which was allowed by the Lisbon Treaty, likely convinced reluctant member states that they could avoid the time-consuming—and ultimately risky–process involving an intergovernmental conference followed by national referendums (Phillips 2010). The European Council agreed to create a new permanent rescue fund, the European Stability Mechanism (ESM), to guarantee financial solvency of euro member states by following the abbreviated procedure for minor treaty changes (European Council 2010a). The ESM would be an intergovernmental organization able to grant loans to Eurozone states on the basis of unanimity and conditionality, including “haircuts” for private bondholders (ibid). Discussions over the lending capacity of the fund were settled relatively quickly, with Germany, the Netherlands and Finland conceding to a €500 billion lending capacity of the fund (Spiegel and Pignal 2011). While Germany conceded on the size of the fund, it successfully negotiated a lower annual contribution over a 5-year period (Agence Europe 2011b). Germany also conceded with respect to financial instruments of the fund. While France was in favor of the ESM being able to buy government bonds

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and engage in bond swaps, Germany and the ECB were less enthusiastic on this item (Hollinger and Spiegel 2011; Weber 2011). Ultimately, Germany agreed to allow the ESM to buy government bonds from member states and on secondary markets (Spiegel 2011b; Reuters 2011). Despite the minor concessions, Merkel successfully accommodated the German public’s desire for fiscal discipline, the German Constitutional Court’s requirement of EU treaty revision, and the need to stabilize the euro and prevent the spread of sovereign debt crisis. The creation of the ESM indicates an approximate alignment of public, elite and member state preferences in favor of an EU fund to assist member states facing economic and financial crises. Preferences ultimately reflected the calculation that the costs of failing to create a fund to address budgetary imbalances and fiscal crises across EU member states and stabilize the euro were too high. The ESM was to involve strict conditionality and was not a stimulus package. Therefore, it did not contradict French and German public opinion against stimulus spending. Most importantly, German public opinion on financial assistance for member states had evolved. While in March 2010 only 32 percent had supported “EU efforts to help member states in financial/ fiscal trouble” (Table 7.1), by September 2010, 45.96 percent were supportive of EU financial assistance (Table 7.2). Prior to the Greek bailout, the German public did not support EU financial assistance. While Chancellor Merkel dropped her EMF proposal in spring 2010, she acceded to German financial and banking interests to agree to a Greek bailout against public preferences. Merkel was constrained by public opinion on the Greek rescue in spring 2010; but by the fall of 2010 German public opinion had come closer to the preferences of German economic elites. Reforming the Stability and Growth Pact While recipients of bailout funds could have austerity forced upon them as a condition of receiving aid, the question remained how best to regulate the behavior of all Eurozone members to avoid a repeat of the crisis in the future. This need to regulate state behavior had been the logic behind the first Stability and Growth Pact introduced alongside the euro in 1999. The failings of this first pact are well known and not addressed here; however, following the creation of the ESM, attention swung back to how best to regulate state behavior. In fact, the paucity of rules governing member state economic and financial policies, the weaknesses of EU supervisory and enforcement powers, and the lack of member state compliance with the Stability and Growth Pact were widely seen as having contributed to the crisis (Barber 2009; 2010a; Agence Europe 2010b; Nelson et al. 2010).



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In the winter of 2010 Spanish Prime Minister Zapatero, who held the Presidency of the Council of Ministers, put enhancing economic coordination at the top of his agenda, arguing that the EU should consider adopting sanctions for states that failed to meet agreed upon targets (Europolitics 2010). The Commission also announced that it would seek to strengthen economic coordination by reforming the Stability and Growth Pact (Chaffin 2010; Agence Europe 2010a). Germany supported increased economic coordination for Eurozone member states in line with Spain’s initial call for sanctions. Germany was reported to be in favor of a range of sanctions including the withholding of EU Structural or Cohesion funds, and suspending voting rights in the Council for states that violated fiscal rules (Agence Europe 2010d; Wolf 2010; Chaffin, Hall, Hope and Wiesmann 2010). The UK was not opposed to increased fiscal discipline by member states but was opposed to increasing the enforcement power of EU institutions (Mallet 2011). On the other side of the debate stood France, which remained opposed to more stringent automatic sanctions (Chaffin, Hall, Hope and Wiesmann 2010; Hall 2010). Faced with an impasse, Eurozone members tabled the discussion for future negotiations (European Council 2010c). Tabling the negotiation over tougher sanctions was a concession by Germany that contradicted German public’s insistence on more stringent fiscal discipline as a way out of the crisis. Recalling that at the very same March 2010 summit, Germany conceded to EU involvement in the Greek financial rescue without treaty revision makes the German capitulation on tougher sanctions all the more remarkable. While initially constrained by public opinion in both cases, Chancellor Merkel ultimately disobeyed it. Pressure from economic elites and other EU member states to agree to an immediate Greek bailout took precedence over enhanced economic coordination. Public opinion on enhancing the economic and budgetary coordination of EU member states was overwhelming supportive across all member states. Respondents were asked whether they favored or opposed strengthening “. . . European economic governance and . . . . the convergence between the budgetary policies of the EU Member States” (EB 76.1 QA10_2). Table 7.4 indicates overwhelming public support for strict penalties to enforce debt and deficit limits on member states. Solid majorities in France, Germany, Italy and the UK support automatic sanctions. The EU average public support is 78%! German public support mirrors the average EU support. Public preferences in Germany for automatic sanctions are consistent with the German public’s support of fiscal discipline at home and for other member states. Majority public support in France, the UK and Spain flies in the face of the budgetary practices of these states which ran deficits, many times in excess of the stability and growth pact measures from 2007–2010. In all

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Table 7.4  Public Support for Enhanced Economic Coordination France Germany Italy Spain UK EU Average

Strongly in Favor

Fairly in Favor

Fairly Opposed

Strongly Opposed

35.1% 42.1 25.0 40.1 22.9 32.15

46.1 34.4 61.0 41.6 44.7 45.85

13.5 16.8 11.4 11.6 20.5 16.08

5.3 6.7 2.7 6.8 11.9 5.93

Source: European Commission 2013b, QA10_2.

likelihood, respondents were not imagining that penalties would accrue to their own countries, but apply to the Greeks. The Commission re-instigated discussion of reforming economic governance and coordination by proposing six legislative proposals (“sixpack”) aimed at augmenting the scope and enforcement of the Stability and Growth Pact targets. The legislation would subject Eurozone member states to near-automatic fines for not meeting debt, deficit and competitiveness targets (European Commission 2010b). Member states were divided into two camps on the Commission proposals. Germany and the UK (joined by the Netherlands, Sweden and Finland) argued that the Commission’s proposed sanctions were too soft and needed to be more aggressive and more automatic (Spiegel 3010; Peel, Parker, Chaffin and Hall 2010; Chaffin and Spiegel 2010). The European Central Bank also favored tougher sanctions, as did the European Parliament (Chaffin, Peel and Wilson 2010, Agence Europe 2010g). France, Italy, Spain and Belgium were opposed to automatic sanctions (Chaffin, Peel and Wilson 2010). Significant progress on the Commission proposals was made when Germany agreed to drop its insistence that the legislative proposals contain automatic sanctions in exchange for France supporting treaty revision to create the ESM (Chaffin, Hall and Peel 2010). The European Council endorsed the Commission’s proposal for near-automatic sanctions (Agence Europe 2010h). Member states haggled over the details of the fiscal targets and enforcement mechanisms for another full year until finally adopting the Commission proposals in November 2011 (Agence Europe 2011c). The new proposals kept the Stability and Growth Pact national deficit limit of 3 percent GDP and debt limit of 60 percent GDP but enhanced monitoring and surveillance mechanisms to prevent states from breaching these limits and enhanced corrective mechanisms to encourage states that had exceeded the limits to bring spending back in line. States agreed to pace spending growth to GDP growth, and to allow the Commission to impose fines of 0.2 percent GDP upon Eurozone members that did not bring their debt and deficits back into conformity unless states agreed by qualified majority to prevent the fines (Council 2011). While a definite enhancement of economic



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coordination and governance procedures, the six-pack reform of the Stability and Growth pact was definitely less comprehensive and less forceful than Germany would have liked. Having achieved a significant but not dramatic increase in economic governance via the six-pack regulations, Germany and France proposed a more ambitious set of fiscal coordination measures known initially as the “pact for competitiveness” for the Eurozone countries (Peel 2011). The proposal included recommendations for member states to coordinate wage and tax policies, pension systems, and to adopt balanced budget legislations (Hollinger and Spiegel 2011a). Initial responses to the Franco-German initiative were negative: Austria, Belgium, Ireland, the Netherlands and Poland were among the states objecting to specific provisions and/or to the exclusion of non-euro member states (Hollinger and Spiegel 2011b). EU trade unions were also reported to be against the initiative (Agence Europe 2011a). Commission President Barroso and European Council President Van Rompuy put forward a slightly revised “pact for the euro” that retained most of the Franco-German provisions but substituted Commission for member state oversight (Spiegel 2011a). Eurozone member states plus Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania agreed to the intergovernmental, non-binding euro plus pact at the March 2011 European Council (European Council 2011, Annex I). Participating member states committed themselves to pursue specific targets aimed at increasing competitiveness and promoting employment, fiscal discipline and the stability of financial institutions. The Commission would monitor and make recommendations for member state regulation and compliance, but compliance would be wholly voluntary. While definitely an expansion of the scope of economic coordination, since the pact did not include any requirement of compliance, member states were not bound to implement it. Given that Germany had fought for tough fiscal targets and sanctions for violators in the six-pack negotiations, it is difficult to view the euro plus pact as a clear, resounding victory for Germany. Nonetheless, recalling that Germany conceded to a larger than desired ESM contribution (albeit over a longer time period) at the very same summit that it won agreement to the euro plus pact leads one to conclude that it exchanged greater EU spending on its part to secure the promise of stricter fiscal discipline on the part of other member states. Public opinion and member state preferences are strikingly divergent on the six-pack and euro plus pact reforms to the Stability and Growth pact in all cases except Germany. In all member states public opinion favored tough penalties for states failing to meet economic and fiscal targets. Despite public support, France, Spain and Italy were initially opposed to tough, automatic sanctions. Their preferences likely reflected economic analyses indicating the likelihood of their accruing penalties. Only in Germany did the member state preference reflect public sentiments. Yet, the German government

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compromised on the size and enforcement of the targets and penalties originally desired. Intergovernmental bargaining actually brought the EU reforms on the Stability and Growth pact closer to average EU public opinion on economic coordination. Regulation of the Financial Markets The six-pack and the euro plus pact were focused on regulating the economic and fiscal discipline of states. A second line of policy was squarely aimed at regulating the behavior of private financial actors, who were widely seen as having caused the crisis in the first place. Setting aside the assessment of blame, much of 2010–2011 was spent debating how best and how much to regulate the financial markets so that this kind of banking turned sovereign debt crisis would never repeat itself. This kind of policy search is part and parcel of any bailout effort due to the moral hazard created by the bailouts themselves. As Table 7.5 makes clear, the public was quite adamant that the financial sector be brought to task for its role in crisis. Almost any proposal to curb the financial market was going to be embraced loudly and with considerable shadenfreude. It is also clear that the British were essentially in lockstep with their continental cousins. So while the British government remains the most vocal critic of such measures, there is little evidence to suggest that the British public shares its government’s concerns. In fact, when it comes to regulating wages in the financial sector, the British are more virulent supporters than the EU as a whole (53.4% vs. 48.6%). The Commission initially recommended strengthening the regulation and supervision of financial sectors including banking, insurance, pensions Table 7.5  Public Support for Regulation of the Financial Industry

Tougher rules on tax avoidance and tax havens The introduction of a tax on profits made by banks The introduction of tax on financial transactions The regulation of wages in the financial sector (i.e., trader’s bonuses) Increasing transparency of financial markets

Strongly in Favor1

Fairly in Favor

Fairly Opposed

Strongly Opposed

EU: 62.5% UK: 64.0 EU: 52.0 UK: 56.3 EU: 33.1 UK: 23.2 EU: 48.6 UK: 53.4

30.5 29.2 35.6 31.3 37.8 36.0 39.1 33.8

5.4 4.5 9.0 8.5 20.2 25.2 9.2 8.7

1.6 2.3 3.4 4.0 8.9 15.6 3.1 4.1

EU: 57.0 UK: 54.3

38.0 40.4

4.0 4.1

1.0 1.2

The percentage of respondents across the EU, excluding the UK, with the UK figures provided separately. Source: European Commission, 2014, QC8.

1



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and hedge funds in 2009. EU regulatory standards for hedge funds were aimed at improving their transparency (European Commission 2009f). The Commission proposed a European Systemic Risk Board (ESRB) to identify potential threats to the stability of the EU financial system; and a European System of Financial Supervisors (ESFS) for banking, insurance and pensions industries (see European Commission 2009b-e). The ESFS would be made up of existing national level supervisors working in conjunction with three new agencies: European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and markets Authority (ESMA). Negotiations over the creation of the European System of Financial Supervision, including the European Systemic Risk Board and three European Supervisory Authorities for banking, insurance and pensions proceeded quickly with the Council agreeing to significantly diluted Commission proposals in December 2009 (Willis 2009). The European Parliament, which shared legislative power with the Council, objected to the member states giving—largely at the behest of the UK—national financial authorities veto power over the European authorities (Willis 2010a). The European Parliament largely conceded to the Council position, approving the regulations despite failing to secure desired direct and independent enforcement authority for the ESRB and ESAs (Willis 2010b). Council negotiations over the hedge funds directive did not begin until spring 2010. Member states were in two camps. The UK led the opposition to the proposed standards. The UK argued that the regulations would disadvantage EU hedge funds in international competition and make it more difficult for non-EU funds to do business in Europe thereby putting a serious damper on the industry in Europe (Financial Times 2010a). Joining the UK in opposition to the hedge funds directive were Austria, Czech Republic, Ireland, Malta and Sweden (ibid). France and Germany both supported the hedge fund directive (Financial Times 2010b). In May of 2010, the Council of Ministers approved the hedge fund directive, outvoting the UK and other opponents in a qualified majority vote (Financial Times 2010b). Member state preferences and public opinion on EU Regulation of the Financial Sector were aligned and favorable to enhanced EU regulation in Germany, France, Italy and Spain. However, the UK government position was not aligned with UK public opinion. Prime Minister Cameron’s consistent opposition to enhanced regulation defied UK public support for it. Negotiations over the European System of Financial Supervision regulations and the hedge funds directive followed similar trajectories. In both negotiations, the UK was able to water down the Commission proposals to a greater extent than France, Germany or the European Parliament initially desired. The question of why member states agreed to less stringent financial regulation when EU public opinion was strongly in favor of regulation can be understood if one understands

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public opinion as constraining but not determining member state preferences. Heads of state and government in France and Germany had a “permissive consensus” broadly in favor of enhanced regulation, but they also needed to be accountable to the noisy and persistent lobbyists for the wealthy and powerful financial industries. A watered-down set of regulations allowed them to accommodate both public and elite opinion. The lack of impact of British public opinion on the UK position is an example of public opinion losing to elite interest. Despite being in a coalition government, Prime Minister Cameron was not facing elections. Furthermore, Cameron would be unlikely to face public reprisal for defending UK financial and economic interests in Brussels.

Conclusion The foregoing exploration of public opinion and government preferences during EU negotiations on the financial and sovereign debt crisis has sought to clarify the influence of public opinion on member state preferences and intergovernmental bargaining. We found that the “permissive consensus” granted to heads of state or government specifies a general policy preference and sets broad parameters within which they seek to stay. However, member states must also be responsive to economic elites and interests, which may have demands that run counter to majority public opinion. In such instances, we found that government preferences and intergovernmental agreements drifted beyond the parameters predicted by majority public opinion. For example, while majority public opinion in Germany, France and the UK was more supportive of austerity over spending during the financial crisis, the EU utilized both remedies in tandem, to bolster the banking and financial industries and stabilize the euro. Similarly, with respect to increased financial regulation, the final EU regulations were far less aggressive than public opinion in Germany, France and the UK would have predicted.

Note 1. It should be noted, however, that France is also considered among the group of countries that might, if things get bad enough, end up needing assistance too. Forbes has gone as far as to say that “In fact, it’s France—not Greece or Spain—that now poses the greatest threat to the euro’s survival” (Tully 2013, 1). A similar concern was raised a year earlier by The Economist (see Economist 2012). So while the crisis was primarily about Portugal, Ireland, and Greece (the PIGs) at the outset, and that Italy and Spain were the two large countries seen most at risk of a contagion effect (making it PIIGS), France has been seen as a distant and horrifying prospect given its debt and



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competiveness issues. It should also be noted that the French government rejects this point of view (see for example The Telegraph 2012).

References Agence Europe. 2010a. “Oli Rehn believes consolidating public finance and investment in sectors.” January 13. Accessed January 7, 2013. Factiva. http://global. factiva.com. ———. 2010b. “Re-appointed Eurogroup leader, Juncker presents work programme for next two and half years.” January 20. Accessed January 7, 2013. Factiva. http:// global.factiva.com. ———. 2010c. “What support for Greece?” January 29. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010d. “Commission ready to propose European monetary fund and improved Euro-zone economic governance.” March 9. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010e. “Eurozone’s financial stability mechanism in place.” June 9. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010f. “Tough-going on hedge fund negotiations.” October 15. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010g. “EP to put all its weight behind reform of Pact.” October 21. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010h. “Taskforce recommendations are endorsed.” October 30. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2011a. “Three colours, optimism, concern and determination.” February 5. Accessed January 8, 2013. Factiva. http://global.factiva.com. ———. 2011b. “Crisis in Portugal overshadows response to crisis.” March 26. Accessed January 8, 2013. Factiva. http://global.factiva.com. ———. 2011c. “Formal adoption of new Stability and Growth Pact.” November 10. Accessed January 8, 2013. Factiva. http://global.factiva.com. Agence France Presse. 2010a. “Cracks emerge in the Eurozone over Greek promises.” January 18. Accessed February 25, 2013. Factiva. http://global.factiva.com. ———. 2010b. “Greece to submit economic reforms to EU end-January.” January 4. Accessed February 25, 2013. Factiva. http://global.factiva.com. ———. 2010c. “Germany says IMF aid an option for Greece.” March 19. Accessed March 8, 2013. Factiva. http://global.factiva.com. ———. 2010d. “Germany fights EU pressure to aid Greece.” March 22. Accessed March 4, 2013. Factiva. http://global.factiva.com. ———. 2010e. “EU commission cautions against treaty rewrite.” October 26. Accessed March 11, 2013. Factiva. http://global.factiva.com. ———. 2011. “EU strikes deal for 700-billion-euro financial rescue fund.” March 21. Accessed January 8, 2013. Factiva. http://global.factiva.com. Atkins, Ralph. 2010a. “No help for Greece from the ECB.” Financial Times, January 7. Accessed January 7, 2013. Factiva. http://global.factiva.com.

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———. 2010b. “Weber dubs monetary fund idea a ‘sideshow’.” Financial Times, March 9. Accessed January 7, 2013. Factiva. http://global.factiva.com. Atkins, Ralph, Kerin Hope, and David Oakley. 2010. “ECB warning to debt-ridden governments.” Financial Times, January 14. Accessed January 7, 2013. Factiva. http://global.factiva.com. Barber, Tony. 2009. “EU is reluctant to discipline members.” Financial Times, December 11. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010a. “Spain aims to bring EU states into line” Financial Times, January 7. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010b. “EU turns spotlight on Greek deficit” Financial Times, January 19. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010c. “EU has the power to rescue Greece.” Financial Times, January 27. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010d. “EU divided over Greek IMF bailout.” Financial Times, February 9. Accessed January 7, 2013. Factiva. http://global.factiva.com. Barber, Tony and Ben Hall. 2010. “Eurozone ministers step up efforts to align economic policy.” Financial Times, January 18. Accessed March 14, 2013. Factiva. http://global.factiva.com. Barber, Tony and Gerrit Wiesmann. 2010. “Note of discord in Europe’s position on Athens.” Financial Times, March 18. Accessed January 7, 2013. Factiva. http://global.factiva.com. Barber, Toney, Gerrit Wiesmann and Ben Hall. 2010. “Athens’ salvation lies in Paris and Berlin.” Financial Times, February 8. Accessed January 7, 2013. Factiva. http://global.factiva.com. Chaffin, Joshua, 2010. “Weak states threatening stability of the euro.” Financial Times, January 11. Accessed January 7, 2013. Factiva. http://global.factiva.com. Chaffin, Joshua, Ben Hall, Kerin Hope and Gerrit Wiesmann. 2010. “Eurozone works on rescue plan for Greece. Financial Times, March 12. Accessed January 7, 2013. Factiva. http://global.factiva.com. Chaffin, Joshua, Ben Hall and Quentin Peel. 2010a. “Eurozone budget deal would reopen treaties.” Financial Times, October 18. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010b. “UK to Consider altering EU treaties.” Financial Times. October 19. Accessed January 7, 2013. Factiva. http://global.factiva.com. Chaffin, Joshua, Quentin Peel and James Wilson. 2010. “Trichet opposes deal on EU budget rules.” Financial Times, October 20. Accessed January 7, 2013. Factiva. http://global.factiva.com. Chaffin, Joshua and Peter Spiegel. 2010. “Franco-German bail-out pact divides EU.” Financial Times, October 24. Accessed January 7, 2013. Factiva. http://global. factiva.com. Council of the European Union. Economic and financial affairs. 2010. “Press Release.” 9596/10 (Presse 108). Brussels, May 9/10. ———. 2011. “Press Release.” 16446/1 (Presse 410). 1, Brussels, November 8. Ewing, Jack. 2010. “Already holding junk, Germany hesitates.” The New York Times, April 28. Accessed November 27, 2013. http://nytimes.com/2010/04/29/business/ global/29banks.html.



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The Economist. 2012. “The time-bomb at the heart of Europe: why France could become the biggest danger to Europe’s single currency.” November 17. Economist Intelligence Unit. 2010. “German/EU Politics: Hoping for the best, but fearing the worst.” February 23. Accessed February 25, 2013. Factiva. http://global.factiva.com. European Commission. 2009. European Financial Supervision. COM (2009) 252 final. Brussels, May 27. ———. 2009b. Proposal for a Regulation of the European Parliament and of the council on Community macro prudential oversight of the financial system and establishing a European Systemic Risk Board. COM (2009) 499 final. Brussels, September 23. ———. 2009c. Proposal for a Regulation of the European Parliament and of the council on Community establishing a European Banking Authority. COM (2009) 501 final. Brussels, September 23. ———. 2009d. Proposal for a Regulation of the European Parliament and of the Council on Community establishing a European Insurance and Occupational Pensions Authority. COM (2009) 502 final. Brussels, September 23. ———. 2009e. Proposal for a regulation of the European Parliament and of the Council on Community establishing a European Securities and Markets Authority. COM (2009) 503 final. Brussels, 23. September. ———. 2009f. Proposal for a Regulation of the European Parliament and of the Council on Community on Alternative Investment Fund Managers and amending Directives 2004/39/EC and 2009/.../EC. COM (2009) 207 final. Brussels, April 4. ———. 2010a. “The economic adjustment programme for Greece.” Occasional Papers No. 61. May. ———. 2010b. “EU economic governance: the Commission delivers a comprehensive package of legislative measures.” IP/10/1199. September 29. ———. 2012. “Public opinion in the European Union: Standard Eurobarometer 77, first results”. Accessed March 4, 2013. http://ec.europa.eu/public_opinion/ archives/eb/eb77/eb77_first_en.pdf. ———. 2013a. Eurobarometer 74.1 (2010). TNS OPINION & SOCIAL, Brussels [Producer]. GESIS Data Archive, Cologne. ZA5237 Data file Version 4.2.0 ———. 2013b. Eurobarometer 76.1 (2011). TNS OPINION & SOCIAL, Brussels [Producer]. GESIS Data Archive, Cologne. ZA5565 Data file Version 3.0.0 ———. 2014. Eurobarometer 75.3 (2011). TNS OPINION & SOCIAL, Brussels [Producer]. GESIS Data Archive, Cologne. ZA5481 Data file Version 2.0.1 European Council. 2010a. Conclusions of 16–17 December 2010. Brussels, January 25. ———. 2010b. “Statement by the heads of state or government of the European Union.” Brussels, February 11. ———. 2010c. “Statement by the heads of state and government of the Euro Area.” Brussels, March 25. ———. 2010d. “Statement by the heads of state and government of the Euro Area.” Brussels, May 7. ———. 2011. Conclusions, 24/25 March 2011. Brussels, April 20.

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Europolitics. 2010. “Council/Commission: Three Presidents prepare 11 February Summit.” January 11. Accessed March 1, 2013. Factiva. http://global.factiva.com. Financial Times. 2010. “The Harris poll global omnibus Pan Euro 2010.” March 3–10, 2010. Accessed March 8, 2013. Harris Interactive, http://www.harrisinteractive.com/vault/HI_FT_HarrisPoll_GlobalOmnibus_ Eurotables_Mar2010_2.pdf. ———. 2010a. “France and UK seek hedge fund deal.” March 11. Accessed March 20, 2013. Factiva. http://global.factiva.com. ———. 2010b. “UK suffers hedge fund blow.” May 13. Accessed March 20, 2013. Factiva. http://global.factiva.com. Fuhrmans, Vanessa and Sebastian Moffett. 2010. “Exposure to Greece weights on French, German banks.” Wall Street Journal. Februrary 17. Accessed November 27, 2013. http://wsjonline/wsj.com/news/articles/SB100014230527487037989045 Guha, Kristina and Joshua Chaffin. 2010. “IMF to advise Greece on public finances.” Financial Times, January 11. Accessed January 7, 2013. Factiva. http://global. factiva.com. Hall, Ben. 2010. “Germany urged to aid Eurozone.” Financial Times, March 15. Accessed January 7, 2013. Factiva. http://global.factiva.com. Hollinger, Peggy and Peter Spiegel. 2011a. “Paris and Berlin call for EU economic summit.” Financial Times, February 4. Accessed January 8, 2013. Factiva. http:// global.factiva.com. Hollinger, Peggy and Peter Spiegel. 2011b. “Franco-German reforms prompt fierce opposition.” Financial Times, February 5. Accessed January 8, 2013. Factiva. http://global.factiva.com. Honaker, James et al. 2011. “Amelia II: a program for missing data.” Journal of Statistical Software 45(7): 1–47 Hooge, Liesbeth and Gary Marks. 2009. “A postfunctionalist theory of European integrations: from permissive consensus to constraining dissensus.” British Journal of Political Science 99: 1–23. Lindber, Leon N. and Stuart A. Scheingold. 1970. Europe’s Would-be Polity: Patterns of Change in the European Community. New Jersey: Prentice Hall. Mallet, Victor. 2010. “Spain backs down on economic enforcement plat.” Financial Times, January 11. Accessed March 18, 2013. Factiva. http://global.factiva.com. Mahoney, Honor. 2010. “Barroso says German calls for treaty change are ‘naive’.” EUobserver.com, May 25. Accessed March 20, 2013. Factiva. http://global.factiva. com. McLaren, Lauren. 2006. Identity, Interests and Attitudes to European Integration. Houndsmills: Palgrave MacMillan. ———. 2002. “Pupblic support for the European Union: cost/benefit analysis or perceived cultural threat?” Journal of Politics 64: 551–66. Nelson, Rebecca M., Paul Belkin, and Derek E. Mix. 2010. “Greece’s debt crisis: overview, policy responses and implications.” CRS Report for Congress. April 27. Nguyen, Eric S. 2008. “Drivers and brakemen: state decision on the road to European integration.” European Union Politics 9(2): 269–293. Peel, Quentin. 2010b. “Germans wary of EU baring gifts to Greeks.” Financial Times, February 10. Accessed January 7, 2013. Factiva. http://global.factiva. com.



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———. 2010c. “Merkel raises defence shields.” Financial Times, March 24. Accessed March 8, 2013. Factiva. http://global.factiva.com. ———. 2010d. “Backing for EU insolvency pact.” Financial Times, October 14. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2010e. “Merkel insists EU treaty change is essential.” Financial Times, October 24. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2011. “Berlin nears deal on Eurozone governance.” Financial Times, February 1. Accessed January 8, 2013. Factiva. http://global.factiva.com. Peel, Quentin, Ben Hall and Tony Barber. 2010. “Merkel warns of hurdles in EMF plan.” Financial Times, March 8. Accessed January 7, 2013. Factiva. http://global. factiva.com. Peel, Quentin, George Parker, Joshua Chaffin, and Ben Hall. 2010. “Germany confident of ‘crisis resolution’ deal.” Financial Times, October 19. Accessed January 7, 2013. Factiva. http://global.factiva.com. Peel, Quentin and Nikki Tait. 2010. “Germany backs IMF bail-out for Greece.” Financial Times, March 18. Accessed March 8, 2013. Factiva. http://global.factiva. com. Phillips, Leigh. 2010. “Van Rompuy: EU could avoid full treaty change via legal trick.” EUobserver.com, December 7. Accessed March 11, 2013. Lexis Nexis. http://lexisnexis.com. Pop, Valentina. 2010. “Merkel and Cameron disagree on EU treaty change.” EUobserver.com, May 21. Accessed March 20, 2013. Factiva. http://global.factiva. com. Reuters. 2010. “EU, IMF agree 110 bln euro bailout for Greece.” April 30. Accessed March 20, 2013. Factiva. http://global.factiva.com. ———. 2011. “Euro zone bailout fund to get new powers by end-Sept.” September 6. Accessed March 20, 2013. Factiva. http://global.factiva.com. Sanders, David and Gabor Toka. 2013. “Is anyone listening? mass and elite opinion cueing in the EU.” Electoral Studies 32: 13–25. Spiegel, Peter. 2010. “Germany backs tough deficit rules.” Financial Times. September 26. Accessed January 7, 2013. Factiva. http://global.factiva.com. ———. 2011a. “EU presidents draft competitiveness pact .” Financial times. February 27. Accessed March 15, 2013. Factiva. http://global.factiva.com. ———. 2011b. “Leaders cut surprise deal on key reforms.” Financial times. March 13. Accessed March 15, 2013. Factiva. http://global.factiva.com. Spiegel, Peter and Stanley Pignal. 2011. “Deal to boost Eurozone bail-out fund.” Financial times, February 14. Accessed January 8, 2013. Factiva. http://global. factiva.com. Tait, Nikki and Martin Arnold. 2010. “Brussels agrees hedge fund rules.” Financial Times. October 27. Accessed March 20, 2013. Factiva. http://global. factiva.com. Thomson, Roddy. 2010a. “Pressure mounts over IMF role in Greek crisis.” Agence France Presse, March 19. Accessed March 8, 2013. Factiva. http://global.factiva. com. ———. 2010b. “EU ups pressure on Merkel to aid Greece.” Agence France Presse, March 22. Accessed March 4, 2013. Factiva. http://global.factiva.com.

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———. 2010c. “EU leaders tackle vexed question of treaty change.” Agence France Presse, October 27. Accessed March 11, 2013. Factiva. http://global.factiva.com. Tilford, Simon. 2010. “Europe cannot afford a Greek default.” Financial Times, January 14. Accessed January 7, 2013. Factiva. http://global.factiva.com. Timus, Natalia. 2006. “The role of public opinion in European union policy making: The case of European union enlargment.” Perspectives in European Politics and Society 7(3): 336–347. The Telegraph. 2012. “Economist time-bomb cover sparks French ire.” November 16, 2012. Accessed March 13, 2013. http://www.telegraph.co.uk/finance/financialcrisis/9682594/ Economist-time-bomb- coversparks-French-ire.html. Tully, Shawn. 2013. “The euro crisis no one is talking about: France is in free fall.” Forbes. Accessed March 13, 2013. On-line. http://finance.fortune.cnn. com/2013/01/09/france-economy-crisis/. Wagstyl, Stefan. 2010. “Hungary urges Europe to help Athens.” Financial Times. March 23. Accessed January 7, 2013. Factiva. http://global.factiva.com. Weber, Axel. 2011. “Europe’s reforms may come at a high price.” Financial Times, February 21. Accessed March 5, 2013. Factiva. http://global.factiva.com. Wiessmann, Gerrit and Alex Barker. 2010. “Merkel reassured UK will back treaty change.” Financial Times, 31 October. Accessed January 7, 2013. Factiva. http://global.factiva.com. Wiessmann, Gerrit, Ben Hall and Jennifer Hughes. 2010. “Europe urged to back Greece rescue.” Financial Times, February 10. Accessed January 7, 2013. Factiva. http://global.factiva.com. Willis, Andrew. 2009. “EU states clinch painful deal on financial watchdogs.” EUobserver.com., December 3. Accessed March 20, 2013. Lexis Nexis. http://lexisnexis.com. ———. 2010a. “Parliament delays crucial vote on European financial supervision.” EUobserver.com, July 7. Accessed March 20, 2013. Lexis Nexis. http://lexisnexis. com. ———. 2010b. “Europe seals deal on financial supervision.” EUobserver.com, September 22. Accessed March 20, 2013. Lexis Nexis. http://lexisnexis.com. Wolf, Martin. 2010. “The eurozone crisis is a nightmare for Germany.” Financial Times, March 9. Accessed January 7, 2013. Factiva. http://global.factiva.com.

Chapter 8

Informal Governance and the Eurozone Crisis Alexandra Hennessy

A rich literature on flexibility in international organizations has shown that occasional violations of formal rules are tolerated when the costs of compliance are excessive (Koremenos et al. 2001; Rosendorff and Milner 2001; Rosendorff 2005; Koremenos 2005). Stone’s (2011) work has been particularly insightful by demonstrating that dominant states can renegotiate the rules of international organizations in informal ways when the costs of adhering to legal rule revision procedures are prohibitive. In ordinary times, international institutions generate predictable policies that reflect the distribution of formal influence among their members, but when the dominant players perceive the content of treaties as harmful they may override existing rules to safeguard their core interests (Stone 2011). However, this research also raises new puzzles. This chapter highlights the inability of the informal governance literature to explain why hegemons may be unable to safeguard their core interests, despite the capability to override the formal procedure. The very definition of “hegemon” suggests that the dominant agent should always be able to impose its will on other members in the system. Yet, if the dominant agent is confronted with timeinconsistency problems, an override of the formal procedure may not yield a satisfactory solution to the problem that gave rise to informal governance in the first place. It has been shown that some leaders impose short-term costs to mitigate long-term problems while others merely choose to delay the pain (Pierson 2004; Jacobs 2011). If the dominant country is faced with a crisis that requires high upfront costs, but responds to an incentive structure that rewards delay, the hegemon may be unable to protect its core interests. Initial emergency measures may constrain future moves in ways that can cause the top dog to lose out in the distributive struggle. Conflicting interests over the 145

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sequence of policy change, as well as instruments and conditionality of crisisfighting measures may leave the dominant actor unable to exploit the benefits of informal governance. Thus, to understand why a dominant country may be unable to safeguard its core objectives it is important to analyze the incentive structure policymakers react to and how previous moves may constrain the hegemon’s subsequent room of maneuver. This chapter uses the example of the eurozone sovereign debt crisis to show why the dominant country may be unable to protect its core interests. The eurozone debt crisis has left no doubt that Germany has the ultimate authority over financial matters in the EU. This outcome is consistent with Stone’s (2011) view of power in the EU. What is puzzling is that, between 2009 and 2013, Germany proved incapable of using its political and economic resources to satisfy key domestic and foreign policy ends, which we define as follows: (1) stabilizing the eurozone, (2) limiting taxpayers’ financial guarantee exposure, and (3) keeping inflation low. Germany’s foreign policy after the end of the Cold War was driven by the idea that a united Germany would reassure other states of its peaceful intentions by being firmly embedded in European institutions. But as agents for the taxpayers, reelection-seeking officials understandably considered it their duty to limit the financial risks domestic constituents assume for other countries. Berlin’s strong commitment to price stability is rooted in the experience with inflationary processes in the 1920s, and the European Central Bank was modeled after the German Bundesbank because of the latter’s success in keeping inflation rates under control. According to the informal governance perspective, Germany’s authority as creditor-in-chief, stability anchor and growth engine in the EU should have enabled political officials to safeguard these objectives. Yet, the rising price tag of eurozone rescue programs foiled the goal of limiting taxpayers’ financial guarantee burden. The European Central Bank (ECB) has injected over €1 trillion into the financial system although it lacks the formal authority to purchase sovereign debt from troubled states. German inflation is expected to rise as a result of the structural adjustments the peripheral member states are making. And in spite of manifold rescue measures, the breakup of the eurozone was considered a real possibility by financial market participants, policymakers, and EU officials. We argue that Germany’s failure to safeguard its core interests can be explained by two interrelated factors. First, policymakers were subject to an incentive structure that encouraged crisis mitigation efforts, but not preparedness. This explains Germany’s long hesitation before offering any assistance to its partners. Second, once financial guarantees were provided, political disagreements over sequence of reform steps as well as instruments and conditionality of financial assistance programs prolonged investor fears of a



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eurozone breakup. Since the price for calming financial markets tends to rise as the market panic increases, the government gradually sacrificed the objective of limiting the taxpayers’ financial guarantee exposure. It is not this chapter’s goal to challenge Stone’s model; least of all with a single case study. But the discussion of an anomalous case presents an opportunity to refine the informal governance theory by explicating the circumstances under which the dominant country can lose out in the distributive struggle within the international institution, despite the capacity to override the formal procedure. Since the debt turmoil is the most severe eurozone crisis to date, it constitutes an important case that sheds light on incentives to cooperate within the EU during shock times. This chapter is also an attempt to build a bridge between comparative politics studies and international relations perspectives on the debt crisis. Scholarship with a comparative perspective has productively located the origins of the turmoil in the euro’s birth defects (the absence of economic and political union), but no efforts have been made to explain the EU’s failure to stabilize the eurozone. International relations scholars, on the other hand, have refused to engage with the debt crisis, despite the field’s longstanding concern with economic crises, incentives for international cooperation, and the effectiveness of international institutions.1 In what follows, we first describe the core interests Germany sought to protect during the debt drama. The subsequent section identifies the incentive structure that explains Germany’s long hesitation before providing any financial assistance. We then explicate how member state disagreements over the sequence of reform steps as well as instruments, scope and conditionality of financial assistance programs maintained investor fears of a eurozone breakup. The final section concludes with a review of the findings and a discussion of the implications.

Germany’s Core Interests A Stable Eurozone Throughout the post–World War II period, a strong commitment to EU integration has been a matter of national interest for Germany. German chancellors were frequently willing to subordinate domestic interests to greater European integration (Heisenberg 2006). Although European citizens remain primarily attached to their nation-state and some harbor skepticism towards certain EU projects, the notion of a European identity is very strong in Germany and support for the EU is high (Fligstein 2008, 157). Policymakers wanted eurozone entry to be irrevocable, and therefore spelled out no path

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to exit. When the Greek debt crisis threatened to wreck the entire system, German policymakers treated the defense of the eurozone as a fundamental national interest. The government’s message was that a broken eurozone would not only threaten Germany’s economic interests, but more than half a century of European integration, the anchor for German foreign policy. Shortly before a vote on eurozone rescue measures, Angela Merkel told the German Parliament: “If the euro fails, Europe fails. That’s why the most important goal for the government must be that Europe emerges stronger from the crisis. This means Europe must become a stability union.”2 Limiting The Taxpayers’ Financial Guarantee Exposure Germany agreed to provide financial assistance programs for its partners, but political incumbents understandably considered it their duty to limit the risks for the German taxpayer. The Maastricht criteria and Stability and Growth Pact had been designed to commit the member states to fiscal discipline, and Article 125 of the Lisbon Treaty was supposed to preclude bailout-outs of other member states. However, a rigid enforcement of the acquis communautaire in the wake of the upheaval would have been politically unacceptable and systemically threatening to the eurozone and even the EU itself. Rifts in the German Bundestag, but also within the governing coalition, over the size and conditionality of bailouts and financial guarantee programs reflect the difficulty of justifying this kind of solidarity to domestic constituents, despite the pro-EU attitude in the country and competitive export sector that benefited from the common currency. Low Inflation Rates Securing low inflation rates has been central to German monetary policy in the post–World War II period, as inflationary developments have been associated with the impoverishment and radicalization of the middle class, the triumph of National Socialism, and the demise of the Weimar Republic. The Bundesbank was created with the primary objective to maintain price stability. Other countries that have long had relatively dependent central banks, such as Britain, Ireland and France, were more tolerant of inflation than high unemployment levels (Hall and Franzese 1998). The European Central Bank was modeled after the Bundesbank because of the latter’s independence and focus on price stability (Alesina and Grilli 1992). While other central banks, such as the Bank of England and the US Federal Reserve, regularly carry out large-scale purchases of sovereign bonds, EU treaties have been interpreted to prohibit this practice. In addition, the ECB does not have a strong financial stability mandate that could justify intervention to prevent turmoil on the bond markets.



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Core Interests and Incentive Structures How did Germany’s core interests translate into actions? In ordinary times, the distribution of power in the EU is relatively flat, legal procedures defuse conflicts (Thomson et al. 2006), and Berlin’s preferred mode of presenting EU initiatives is in cooperation with France (Stone 2011). During businessas-usual negotiations, the EU countries often rely on the agenda-setting powers of the European Commission (Princen 2009; Hennessy 2011) or the Council presidency (Tallberg 2006; Kleine 2013) to adjudicate between divergent member state demands. However, the debt crisis constituted a major shock that affected the core interests of both strong and weak member states, pushing a reluctant Germany into the role of hegemon (Paterson 2011; Matthijs and Blyth 2011). Procedural approaches modeling the legal sequence of EU decision-making offer little purchase on explaining Germany’s quandary as rule violations occurred on an unprecedented scale: the no-bailout clause of the Lisbon Treaty (Article 125) was voided through fiscal transfers to debt-ridden member states. The ECB conducted several long-term refinancing operations although it lacks the formal authority to purchase sovereign debt from troubled states. The International Monetary Fund has shifted its emphasis from providing balance-of-payments support to offering budgetary support, which is seen as illegal. The Copenhagen criteria, which specify that member states must preserve democratic governance, have been brushed aside by the installation of caretaker governments in Greece, Italy, and Spain. Representatives of the European Commission, European Central Bank and International Monetary Fund have monitored the implementation of austerity programs in recipient countries, stripping them of budgetary sovereignty. Emergency measures and institutional change were crucially shaped by Germany while EU officials took the back seat. It is therefore more fruitful to analyze the options available to German policymakers, the incentive structure they reacted to, and how core interests translated into eurozone rescue measures and eventually caused Germany to sacrifice its core interests. If fundamental preferences were fully deterministic, German officials would have provided credible backstops for the large eurozone economies right after the Greek debt crisis became acute in late 2009 and pursued steps towards fiscal and banking union all at once. This claim relies on a counterfactual that can never be proven. However, there are reasons to believe that an alternative crisis management could have eliminated self-fulfilling expectations of contagion. Specifically, instantaneous financial guarantees for the EU’s large economies may have stabilized the eurozone sooner, and more cost-effectively, than two and a half years of ad hoc emergency measures that kept investors guessing about redenomination risk.3 Gray (2009)

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has demonstrated that the EU can send strong signals to financial markets about the trajectory of a particular country. Closing negotiation chapters on domestic economic policy (receiving a seal of approval from Brussels) substantially decreases perceptions of default risk in those countries. This means that the EU can confer investor confidence that domestic economic reforms alone cannot accomplish. However, EU mandated rescue measures will be tested when market participants doubt their effectiveness. Financial crises can be driven by economic fundamentals, but the actual trigger may be the beliefs of financial market participants (Krugman 1996). In this sort of environment, investor expectations about government actions have an important feedback in determining what those actions should be. Once self-fulfilling expectations coalesce around a crisis outcome, it will be extremely difficult for policymakers to enforce their preferred equilibrium. This dynamic entails a potential for contagion that need not have occurred but does so because market participants expect it to (Obstfeld 1994). Gärtner and Griesbach (2012) found evidence that Europe’s sovereign debt crisis has been driven mainly by self-fulfilling forces. Undoubtedly, the provision of sizable backstops for Spain and Italy would have increased German taxpayers’ financial guarantee exposure as well. Fiscal and banking union take time to implement and required far-reaching legal changes, too. However, rule violations between 2009 and 2013 were ubiquitous, and deeper fiscal integration became a reality with the Greek bailouts, the creation of a European rescue fund, and surveillance of austerity programs by the troika.4 In June 2012 the European Commission proposed a framework for establishing a banking union with centralized powers to supervise banks and plans for sharing the costs of recapitalizing cross-border banks. The point is that an instantaneous commitment to deeper integration would have sent a more convincing signal to financial markets than limited, piecemeal emergency measures. Credible backstops in the immediate aftermath of the turmoil would have alleviated the need for additional financial guarantees Berlin made available to several member states on the verge of losing capital market access. Whether such radical measures would have been politically feasible in the immediate aftermath of the Greek debt crisis will never be known, but weak competition in the electoral arena5 and opposition parties urging more comprehensive rescue measures suggest that the government should have been able to incur higher upfront costs to shore up the bond markets of the large eurozone economies. But German policymakers did not choose this route. Instead, they agreed to piecemeal emergency measures only after long periods of indecision and in contradiction to previous announcements, triggering contagion and creating a permanent state of emergency. Rising risk premiums for Greece, Ireland, Italy, Portugal, Spain and Cyprus, outflows of capital and bank deposits in



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Europe’s periphery, and the threat of sovereign bankruptcies perpetuated investor fears of a eurozone breakup. German taxpayers have provided sizable financial guarantees for other eurozone countries, and the Bundesbank is preparing to accept higher inflation rates. This means that, despite the renationalization of decision-making and growth of executive powers, Germany was not capable of safeguarding its core interests. We propose that this outcome is the result of policymakers responding to an incentive structure that encouraged crisis mitigation efforts rather than spending on preparedness. From the literature on natural disaster policy we know that political officials are not very good at investing in disaster preparedness (Healy and Malhotra 2009). Public policies are often characterized by shortsightedness and inefficiencies because politicians are incentivized to invest in policies that produce short-term benefits. In the same vein, political leaders lack incentives to invest in solving problems that appear manageable at first, but may cause escalating costs if they continue to fester. As agents for the taxpayers, political officials understandably consider it their duty to limit the financial risks of crisis resolution mechanisms. But this means that officials lack the mandate to implement costly and comprehensive measures as long as the costs of inaction appear bearable. If citizens are unaware of the potentially exploding costs of inaction, they may punish officials for incurring large upfront costs to address the problem. Even if political incumbents had the foresight to avert a major crisis before it became acute, voters oblivious to the forestalled disaster might still punish incumbents for the immediate costs incurred to control the turmoil. Domestic constituencies do not want elected officials to spend on crisis prevention before the disaster has occurred because it is impossible for citizens to observe the counterfactual: what would have been the impact of the turmoil in the absence of preparedness spending (Healy and Malhotra 2009). Conversely, spending money on mitigating a disaster is observable through the news media, and citizens can more easily reward or punish policymakers’ crisis management skills.6 Imminent reelection pressures often induce politicians to enact quick fixes with short-term benefits rather than more comprehensive measures that require higher upfront costs (Sobel and Leeson 2006). The government’s room for maneuver grows, however, as the costs of inaction or ineffective quick fixes become visible and increasingly intolerable. Once citizens are convinced that the consequences of inaction will be harmful they will approve of drastic government intervention, but not before. While officials can still take corrective measures as the market panic increases, the price for calming financial markets will be higher (Featherstone 2011). By the time decision-makers finally obtain a mandate for investing in crisis resolution mechanisms, it may be too late if the costs of inaction have grown exponentially. Ironically, a delayed crisis management resulting from

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the desire to limit the financial risks for the taxpayer may in fact increase the fiscal outlays required to solve the problem. Dilatory Crisis Management The dynamics of Germany’s crisis management between 2009 and 2013 indicate that government officials responded to such an incentive structure. Political incumbents provided financial assistance programs to debt-ridden member states, but only after the costs of inaction had become visible and increasingly intolerable. Limited financial guarantees were offered or augmented only after frontpage headlines shrieked of rising government bond yields, sovereign downgrades by rating agencies, outflows of capital from weak banks, and imminent eurozone breakup. The German government initially refused to provide financial assistance to Greece because such a move “would be against the rules.”7 Germany eventually reached an agreement with France on a bailout package for Greece, but only in May 2010—seven months after the Greek debt drama first shook European markets. For the majority of German citizens, the first bailout was already a step too far. Figure 8.1 shows that the biggest drop in Angela Merkel’s approval ratings occurred right after the first Greek bailout, from 1.8 points to 0.5 points. For many German citizens, bailing out another member state crossed the line into an unacceptable “joint liability union.” Media headlines conjured up images of lazy, corrupt, spendthrift Greeks as the villains who brought the eurozone to ruin (Jones 2010). In February 2010, a survey showed that 53 percent of Germans wanted Greece to be kicked out of the eurozone (Chambers 2010). The dire consequences of failing to address potential systemic risk, by contrast, were underrepresented in the media. However, Merkel’s approval ratings recovered and even surpassed those of her opponents seventeen months later, despite unpopular eurozone emergency measures for Greece, Ireland, and Portugal. In May 2010 the European Financial Stability Facility (EFSF) was created in order to provide financial assistance to euro area member states. After Germany had vowed to support Greece only once, Athens was soon unable to access capital markets, fueling concerns that Greece might have to default. Berlin bowed to international pressure to increase the size of the EFSF, but only in June 2011, after both Ireland and Portugal had been on the brink of losing access to capital markets. The ESM replaced the EFSF in 2013. It is expected to have full lending capacity of €500 billion by 2014.8 Figure 8.2 shows that, by June 2011, German citizens considered the eurozone debt crisis the most important problem facing their country. However, the perception that the eurozone crisis was a bigger challenge than, for

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Figure 8.1  Politicians’ Approval Ratings



Figure 8.2  Most Challenging Problems

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example, high unemployment or shrinking public pension levels materialized only after Greece, Ireland, and Portugal had received EFSF bailout funds and rumors about Greece requiring a second bailout had contributed to negative market sentiment. In October 2011 Greece received a second bailout, and policymakers reached a settlement with private banks on a “voluntary” 50 percent reduction of Greece’s debt in the hands of private investors. Germany agreed to provide the lion’s share of the bailouts and financial guarantees for its partners,9 but these measures did not shore up the larger Spanish and Italian bond markets. As the full scale of Spain’s weak banking sector gradually became apparent, financial market participants did not believe that Madrid could afford to guarantee 12 percent of EFSF resources. In June 2012, Spain was promised €100bn in EFSF funds and Cyprus obtained €10bn to shore up failing banks. Since policymakers failed to put in place persuasive backstops the eurozone breakup risk rose notably during the second half of 2011 and 2012. Even in the midst of the 2013 election campaign, German finance minister Wolfgang Schäuble conceded that Greece would need a third bailout from its partners (Steen 2013). Consequently, the costs of stabilizing the eurozone have grown steeply, compromising Germany’s objective to limit the taxpayers’ financial guarantee exposure. Germany’s piecemeal response to the sovereign debt crisis was criticized on several fronts. Poland’s foreign minister declared that he feared German inaction more than German power (Sikorski 2011). Belgium’s former prime minister complained in early 2012 that “(. . .) we are no nearer solving the crisis than in December 2009, when Greece’s debt situation first became apparent” (Verhofstadt 2012). The German social democrats accused the governing coalition of taking a myopic view of Germany’s interests in the effort to save the eurozone, but nonetheless voted with the conservativeliberal parties in support of every eurozone rescue measure. And the British chancellor suggested that German incumbents might be incentivized to enact shortsighted policies when he mentioned that a Greek exit could be necessary to convince German voters that it was worth spending more money on firewalls for other member states (Elliott et al. 2012).10 Remarkably, neither the social democrats nor euroskeptics in Merkel’s own governing coalition, were capable of exploiting the eurozone crisis between 2009 and 2013 to their advantage. Although popular resentment toward sovereign bailouts ran deep, citizens consistently considered the Christian democratic union more competent in dealing with the debt crisis than the opposition social democrats, as Figure 8.3 shows. In contrast to the limited, piecemeal rescue measures offered by the government, the social democrats had called for more comprehensive eurozone rescue measures early on. While the government’s eurozone policies had failed to stabilize the eurozone and progressively increased taxpayers’

Figure 8.3  Parties’ Competence as Crisis Managers

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financial guarantee load, the small-step approach evidently paid off in terms of Merkel’s approval ratings and, ironically, her party’s reputation as effective crisis manager. Although the Christian democrats had to stomach electoral losses in several regional elections, particularly in the most populous state of North Rhine-Westphalia in May 2010 and May 2012, it was not the social democrats that benefited from disaffected Christian democratic voters, but smaller political parties such as the greens and the pirate party.11 Disputes over the Sequence of Reform Steps The peculiar incentive structure German policymakers faced explains the government’s long hesitation before it agreed to offer financial assistance to troubled member states, but the failure to stabilize the eurozone after financial support was granted requires an examination of the sequence and process by which goals were pursued. It is well known that the negotiation processes generate their own stakes for the actors involved. A long “shadow of the future” can inhibit cooperation by raising the stakes over which the actors are bargaining (Fearon 1995). Conversely, previous moves may shape future incentives for cooperation. Arguing hard against a particular solution is likely to increase the political costs of accepting that solution later in the game. Having yielded to pressure on previous occasions tends to increase the political costs of further concessions (Underdal 1992). In the EU, incentives to cooperate depend on the expected size of the reward and the likelihood that it will actually materialize before too long ( hler et al. 2012, 140). If the rewards of EU agreements appear too distant, incentives to cooperate will weaken (Grabbe 2001). But cooperation will also be difficult to sustain if one state unexpectedly bears a larger share of the costs (Koremenos 2001; Koremenos 2005). Throughout the eurozone crisis, EU diplomacy was characterized by disputes over the sequence of reform steps as well as instruments, scope and conditionality of emergency measures. Permanent renegotiations of financial assistance programs reflect a long shadow of the future in a high-stakes bargaining process. Once Germany had decided to offer financial guarantees to its partners, the succession of policy change became a source of contestation between the member states: before pooling debt liabilities with other countries, Berlin sought to pool control over economic policies and initiate concrete steps towards political union. However, debt-ridden member states demanded more solidarity before surrendering budgetary sovereignty. In the eurozone’s periphery, resentment grew over the quid pro quo Germany extracted in exchange for financial assistance programs. Germany’s contribution to the two Greek bailouts as well as financial guarantees provided

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through EFSF were conditional on recipient governments implementing farreaching austerity measures and structural reforms. In exchange for agreeing to make the temporary EFSF permanent, Germany insisted that all eurozone states adopt a fiscal pact that envisages automated, rather than negotiated, sanctions for violating fiscal discipline. The pact also mandates the incorporation of a constitutional debt brake enforcing a balanced budget. The purpose was to ensure that more German support will not be pledged in guarantees to eurozone states without the strict budget discipline enshrined in the fiscal pact. Yet, whenever a member state was on the brink of losing access to capital markets, Germany was under international pressure to provide more guarantees quickly, leaving lengthy treaty reforms for the period after the financial guarantees had already materialized. EFSF and IMF made €78bn available to Portugal in April 2011, and provided €85bn to Ireland in November 2011, of which €35bn was supposed to be used for recapitalizing failing banks. Spain was promised €100bn in EFSF funds, but failed to obtain direct capital injections for its failing banks. The full weakness of Spain’s banks, which are loaded with bad real estate investments, became apparent only gradually as Spain’s national supervisor had repeatedly underestimated the amount a rescue would cost. Several reassessments of the total costs of a bailout reinforced investors’ concerns that Spain might be next in line to seek a full sovereign bailout, prompting an angry response from the ECB president: “There is a first assessment, then a second, a third, a fourth. This is the worst possible way of doing things. Everyone ends up doing the right thing, but at the highest cost” (Jones 2012). Disputes over the sequence of crisis-fighting measures were particularly intense when member states negotiated assistance for the Spanish banks. Spain lobbied hard for the direct injection of eurozone rescue funds into Spanish banks in order to break the damaging feedback loop between weak sovereigns and weak banks. ECB and policymakers in peripheral countries shared Spain’s concern that EFSF funds channeled through the Spanish government would add to Madrid’s debt, pushing the country towards a fullscale bailout that might eat up almost all of the eurozone’s rescue funding. At a summit on 29 June 2012, the European Council announced that Spanish banks would receive aid from the EFSF as soon as the details of EU-wide banking supervision were sorted out. Financial markets rejoiced (Carnegy et al. 2012)—until German finance minister Schäuble clarified later that he interpreted the agreement to mean that the Spanish government would be liable for the repayment of the funds borrowed (Spiegel Online 2012a).12 This exacerbated concerns over Madrid’s ability to avoid a full bailout, and Spanish ten-year bond yields soared to new heights (Castle 2012). Germany’s refusal to grant Spanish banks direct capital injections is rooted in the desire to break the cycle of “financial assistance today in



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exchange for legal changes and clarity later.” Angela Merkel insisted on the creation of EU-wide banking supervision before providing more solidarity: “If I am giving money to Spanish banks (. . .) I am the German chancellor but I cannot say what these banks can do” (Dinmore and Spiegel 2012). The European governments are still working out the details of how direct bank recapitalizations will operate in principle. The Commission, however, is worried about further delay and the potential repercussions of not following through on already promised bank recapitalizations. Commission president Barroso was eager to see an agreement on future direct European bank rescues before the German elections in September 2013. German anxiety about financial assistance first and legal clarity later is also reflected in the government’s rejection of a debt redemption fund. Germany’s Council of Economic advisers suggested that such a fund could cover all public debts of member states above the ceiling of 60 percent laid down in the Maastricht treaty and would pay down the debt over 25 years. However, the Bundesbank doubted the compatibility of such a fund with European treaties or German constitutional law, warning that a mutualization of debts would lower the pressure on states with higher financing costs to engage in sound fiscal policies (Eubusiness 2012). Disputes over Instruments of Crisis-Fighting Measures To avoid a major credit crunch and possible meltdown of Europe’s banking system, the ECB injected €1tn of liquidity into the eurozone banking system, known as longer-term refinancing operations (LTROs), between December 2011 and March 2012.13 In each case, the ECB’s intervention led to a significant drop in the bond yields of troubled states. The ECB’s willingness to act as lender of last resort was praised by European leaders in the eurozone’s periphery. But the bond-buying program triggered a controversial debate about the expansion of the ECB’s mandate beyond the traditional inflation-fighting role. The German member of the ECB’s board, Jürgen Stark, resigned following the ECB’s decision to buy Italian and Spanish bonds in October 2011. Likewise, Axel Weber resigned his position as president of the German Bundesbank to protest the ECB’s bond-buying program, effectively throwing open the candidacy for president of the ECB. To Stark and Weber, the ECB’s bond-buying program was tantamount to direct monetary financing of eurozone member states and therefore a violation of EU law. According to Mario Draghi, however, LTROs are within the ECB’s mandate if bond risk premiums hamper the effectiveness of ECB monetary policy.

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Others have criticized the ECB’s first intervention in bond markets between December 2011 and March 2012 as insufficient. De Grauwe (2012) has argued that the LTROs were ineffective because the ECB intervened only indirectly in sovereign bond markets. Since EU treaties prohibit the ECB from intervening directly, the ECB decided to delegate the power to buy government bonds to the weak banks. But because the trembling banks channeled only a fraction of the liquidity they obtained from the ECB into the government bond markets and the real economy, the ECB had to pour much more liquidity into the system than if it had decided to intervene itself. Even ECB president Draghi lamented that the LTRO had not been successful in encouraging the banks to lend: “Several months have passed and we see that credit flows remain weak.”14 De Grauwe (2012) argues that a direct ECB intervention is a more effective way to restore bank lending, but acknowledges that longstanding German opposition to this idea may be difficult to overcome. Although ECB, national central bankers, and European leaders joined Angela Merkel’s calls for an EU-wide bank supervision, it took a long time to resolve political disagreements about the legal details of the single rule book, a common backstop for financial assistance, and single resolution mechanism. The main bone of contention concerned the ECB’s credibility as guarantor for price stability and banking supervisor. In 2009, the Larosiere report recommended that the ECB assume responsibility for macroprudential supervision (overall financial stability) but warned against giving it the power of microprudential supervision (individual banks). The main reason the authors counseled against microprudential supervision is that “this could result in political pressure and interference, thereby jeopardizing the ECB’s independence” (Larosiere 2009). According to the Larosiere group, but also the German Bundesbank, the LTROs effectively represented a rescue mechanism for weak banks, generating a conflict of interest: the ECB cannot credibly claim to maintain independence and price stability while at the same helping weak banks and acting as the banks’ supervisor (Klasen 2012). However, the separation of macro- and microprudential supervision was suboptimal from an efficiency perspective: too many supervisory layers resulted in a delayed response to the banking crisis as national supervisors tended to underestimate the weakness of their national banks. Subsequent assessments of what a bank bailout might cost scared financial markets, driving up bond yields. Disputes over Conditionality of Financial Assistance Pressing needs for emergency capital in the eurozone’s large economies, in turn, fueled concerns among German policymakers that the conditions



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attached to financial assistance—structural reforms and austerity measures in the eurozone’s troubled member states—were put at risk. Troika representatives have repeatedly criticized Greece for delays in implementing structural reforms, and eurozone ministers have threatened to withhold already promised aid to keep up the pressure on the government. In their fifth review report, troika officials acknowledged that the recession in Greece would be deeper than originally anticipated, but attributed Athens’ failure to improve investor sentiment to delays in privatizations and structural reforms (European Central Bank 2011). In March 2012, Greece committed to cut the public debt to 120 percent of gross domestic product by 2020, but the program has gone off track following Greece’s tumultuous elections in May and June 2012. The troika therefore demanded that the governing coalition under prime minister Antonis Samaras come up with an additional €2.5bn in savings to meet the €11.5bn target set by the troika for 2013 and 2014 (Rooney 2012). Structural reforms in the eurozone’s troubled member states will likely result in higher German inflation rates in the long run. German wage costs have lagged those in other eurozone countries for years. Workers’ acquiescence to wage moderation has boosted the competitiveness of German exports, but left Southern Europe struggling to transform their stagnating economies. The IMF therefore suggested that more spending by German consumers should be encouraged, helping to generate demand for exports from other countries. According to the IMF, Germany is pivotal in reducing euro area and global imbalances. As the eurozone’s debt-ridden member states undertake adjustments to improve their competitiveness, upward pressure on German wage costs and property prices are likely to result in German inflation rates above the union’s average. But the economic contraction in the periphery implies that those countries face downward price pressures while Germany will have to live with higher inflation rates as a result of austerity (Handelsblatt 2012). Unsurprisingly, the belt-tightening policies had been widely unpopular with the citizens in the affected countries. Austerity measures led to the collapse of governments in Ireland, Greece, Portugal, and Italy and contributed to the defeat of governments in Spain and France. The election of French president Francois Hollande forced the German chancellor to adopt a more proactive policy to stimulate economic growth in the eurozone. European leaders saw this as an opportunity to renegotiate the rigid conditions of the financial assistance programs and a chance to push for jointly issued euro bonds and other forms of shared debt. While Merkel agreed to a modification of the fiscal compact to add growth boosting initiatives, she rejected calls for jointly issued euro bonds, declaring that “Germany’s strength is not infinite.”15 Her statement came after mounting dissent in her governing coalition over the rising price tag of the bailouts and one month before Moody’s changed its

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outlook for Germany’s AAA credit rating to negative, the first step towards a possible downgrade, due to the increased likelihood of a Greek exit from the euro and concerns that Spain will have to seek a full bailout (Moody’s 2012). Since German policymakers had continuously defined the defense of the eurozone as a fundamental national interest, many worried that threats to withhold financial assistance to countries that did not fulfill reform promises were unconvincing. Consequently, political incumbents began to assert that a eurozone exit was a real possibility. The prospect of a Greek exit was first floated by the German finance minister after Greece’s then Prime Minister Papandreou proposed to hold a referendum on the bailout in November 2011. The debate was rekindled after the first Greek election in May 2012, which produced stalemate, and continued after reform-willing political parties came to power in Athens in June 2012. After the IMF was rumored to refuse further aid to Greece in July 2012, Germany’s vice chancellor remarked that a Greek exit from the euro had long ceased to be a frightening prospect for him (Spiegel Online 2012b). Cyprus became the next flashpoint in crisis when the insolvency of the island’s oversized banking sector briefly raised the specter of a new doctrine that would put the burden of future bank restructurings on depositors rather than taxpayers. While ESM funds had been used to directly recapitalize weak Spanish banks, there was no political willingness to rescue a “moneylaundering paradise” in this way. Bailout fatigue was particularly evident in Germany in light of the forthcoming 2013 federal elections. The initial proposal to introduce a tax on deposits, even those covered by the EU-wide deposit insurance, was withdrawn after the Cypriot parliament rejected it and several eurozone governments had loudly denounced the plan. After the ECB threatened to withhold emergency support for Cyprus’ banks, a new agreement was reached wherein the ESM made €10m euros available. In exchange, the two largest Cypriot banks were wound down. Depositors holding more than €100,000 at these institutions lost up to 60 percent of their funds, while deposits under this amount were spared. In order to prevent a massive outflow of euros, the Cypriot government introduced severe capital controls, the first eurozone country ever to do so. This measure breached one of the key pillars of the single currency. While the instant risk of contagion receded, uncertainty over the broader ramifications of the Cyprus case kept the euro under pressure. Relentless redenomination risk indicates that the eurozone crisis management failed to generate the EU’s “seal of approval” signal (Gray 2009). One might have expected consecutive bailouts by the member states and IMF, the creation of a permanent rescue fund, and subsequent boosts of the rescue fund’s resources to lend credibility to the EU’s “no eurozone exit” declarations. However, the delayed response to the sovereign debt turmoil as well as



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permanent renegotiations of size, instruments, and conditionality of financial assistance programs failed to reassure market participants, preventing the restoration of the “EU glow.” Conclusion The eurozone debt drama constitutes the biggest shock in the history of European integration. The crisis is a particularly good case for examining informal governance in the EU as the eurozone was in a permanent state of emergency between 2009 and 2013. Rule violations occurred on an unprecedented scale, and emergency measures were crucially shaped by Germany while EU institutions took a back seat. However, Germany was unable to protect its core objectives—stabilizing the eurozone, limiting the taxpayers’ financial guarantee load, and keeping inflation low. Germany’s authority as creditor-in-chief, stability anchor and growth engine in the EU should have enabled political officials to safeguard these objectives. The fact that Germany failed to do so is inconsistent with the expectation of the informal governance literature that the dominant country will always be able to act on its core interests when the stakes are high and the costs of adhering to legal rule revision procedures are prohibitive. We found that paying attention to temporal trade-offs in the study of informal governance allows us to capture incentives for shortsighted behavior that helps explain this hitherto unexamined puzzle. We hypothesized that political leaders lack incentives to invest in addressing problems that appear manageable at first, but may cause escalating costs as they continue to fester. If an effective crisis resolution requires the dominant country to incur high upfront costs, but the principal responds to an incentive structure that rewards delay, the dominant agent may unintentionally sacrifice its core interests in the process. To restore investor confidence in the eurozone, Germany was under international pressure to provide credible backstops to shore up the bond markets of vulnerable member states on the brink of losing access to capital markets. However, policymakers responded to an incentive structure that rewarded crisis mitigation efforts rather than preparedness. This explains Germany’s long hesitation before offering any financial assistance. Once Germany agreed to provide financial guarantees to its partners, political disagreements over the sequence of reform steps, instruments and conditionality of financial assistance programs undermined the effectiveness of the rescue measures and increased the costs of stabilizing the eurozone. Our finding is important for the literature on international institutions. It shows that the EU’s power to confer investor confidence was limited to ordinary times. It fell apart when a reluctant hegemon tried to make the best

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of conflicting core interests, with market participants attempting to secondguess policymakers’ intentions as well as capabilities. Our analysis suggests that German voters may consider investment in more large-scale eurozone rescue measures a public good only after the effects of contagion are palpable in Germany or once relentless debate of a eurozone exit make clear the costs of inaction. Alternatively, it is possible that self-fulfilling forces coalesce around a crisis outcome that leave the dominant country powerless to enforce its preferred policy solution. Our analysis shows that attention to the hegemon’s incentive structure can provide additional insights into international and domestic trade-offs strong players face. Leading states are always confronted with competing pressures, but the dynamics of informal interactions are contingent upon how domestic audiences perceive the stakes of the game. Specifically, domestic audiences are less likely to worry about the dominant country’s actions when the costs of a rule override are deferred into the future. However, when the immediate costs of informal governance are high and redistributive, domestic audiences are expected to be highly engaged and may constrain the hegemon’s subsequent moves and room of maneuver. Future research may examine whether this finding carries to other international organizations where the dominant player is subject to an incentive structure plagued by time-inconsistency problems. Acknowledgments For helpful comments on previous drafts, I wish to thank Jennifer R. Wozniak Boyle, Johan Eliasson, Gabriel Glöckler, Deborah Mabbett, Daniela Schwarzer, Martin Steinwand, Zoe Walker, the participants of conferences at the 2013 Midwest Political Science meeting, the 2013 EUSA meeting, two anonymous reviewers, and the students in my West European Politics seminar that was taught at Seton Hall University in fall 2012. Financial support from the Fritz Thyssen foundation (Az. 50.11.0.010) is gratefully acknowledged.

Notes This chapter was previously published as an article in the Journal of Contemporary European Studies, vol. 21, issue 3, December 2013. www.tandfonline.com. 1. Manokha and Chalabi (2011) have declared the international relations literature “bankrupt” due to the dearth of IR scholarship on the eurozone crisis. 2. Regierungserklärung von Bundeskanzlerin Angela Merkel; Europa muss Stabilitätsunion werden, 26 October 2011, http://www.bundesregierung.de/Content/DE/ Artikel/2011/10/2011-10-26-merkel-regierungserklaerung-er-euro.html.



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3. Redenomination risk signifies the fear that investors’ deposits could be restated in units of a new currency that would devalue massively. 4. The troika consists of representatives of the European Commission, European Central Bank and International Monetary Fund. 5. Garrett (1993) has argued that political leaders facing substantial competitive slack are more willing to adopt policies that are not electorally optimal in the short run in order to achieve longer-term policy change. 6. We are not suggesting that the potential consequences of a eurozone breakup are equivalent to the destruction caused by a hurricane or flooding, as damage by the latter can be more easily repaired. However, the incentive structure politicians respond to are similar in both cases. 7. Statements by A. Merkel and N. Sarkozy, 11 February 2010, http://www. bundesregierung.de/Content/DE/Mitschrift/Pressekonferenzen/2010/02/2010-02-11pk-europaeischer-rat.html. 8. Only €80bn are deposited in the ESM, the rest are financial guarantees. The biggest hurdle to the establishment of the EMS was cleared in September 2012 when the German constitutional court dismissed attempts to block it. 9. Germany agreed to provide 27 percent of EFSF financial guarantees. France provided 20, Italy 18 and Spain 12 percent of EFSF financial guarantees. See EurActiv.de, October 2011. 10. “I ultimately don’t know whether Greece needs to leave the euro in order for the eurozone to do the things necessary to make their currency survive. I just don’t know whether the German government requires Greek exit to explain to their public why they need to do certain things like a banking union, eurobonds and things in common with that” (Elliott et al. 2012). 11. Forschungsgruppe Wahlen, www.forschungsgruppe.de. 12. Der Spiegel, Schäuble wirbt für Milliardenhilfe für Spanien, 19 July 2012. 13. In March 2012 the ECB discontinued the LTRO, asserting that it was now the eurozone governments’ turn to implement more crisis-fighting measures. However, in July 2012 ECB president Mario Draghi announced that the program would be reactivated after Spanish and Italian bond yields soared to levels that risk making borrowing unsustainable over the long term (Wilson et al. 2012). 14. Financial Times, Draghi running out of wiggle room, 5 July 2012. 15. Regierungserklärung von Bundeskanzlerin Merkel zum Europäischen Rat, 27 June 2012, Brussels, Belgium.

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Hall, Peter A. and Robert J. Franzese. 1998. “Mixed signals: Central bank independence, coordinated wage-bargaining, and European Monetary Union.” International Organization, 52: 505–535. Handelsblatt. 2012. “Bundesbank sieht keinen Anlass zur Panik.” May 10, 2012. Available online at: http://www.handelsblatt.com/politik/konjunktur/nachrichten/ inflation-bundesbank-sieht-keinen-anlass-zur-panik/6614182.html. Healy, Andrew and Neil Malhotra. 2009. “Myopic voters and natural disaster policy.” American Political Science Review 103: 387–406. Heisenberg, Dorothee. 2006. “Merkel’s EU policy.” German Politics and Society 24: 108–118. Hennessy, Alexandra. 2011. “The role of agenda setting in pension market integration.” Journal of European Integration 33: 577–597. Jacobs, Alan M. 2011. Governing for the Long Term: Democracy and the Politics of Investment. Cambridge: Cambridge University Press. Jones, Claire. 2012. “Draghi calls for EU-wide bank oversight.” Financial Times, May 31, 2012. Jones, Erik. 2010. “Merkel’s folly.” Survival, 52: 21–38. Klasen, Oliver. 2012. “Draghi und Weidmann ringen um EZB-Linie.” Sueddeutsche Zeitung, July 30, 2012. Available online at: http://www.sueddeutsche.de/wirtschaft/ streit-um-euro-rettung-draghi-und-weidmann-ringen-um-ezb-linie-1.1425981. Kleine, Mareike. 2013. “Knowing your limits: Informal governance and judgment in the European Union.” The Review of International Organizations, 8: 245–264. Koremenos, Barbara. 2001. “Loosening the ties that bind: a learning model of agreement flexibility.” International Organization 55: 289–325. Koremenos, Barbara. 2005, “Contracting around international uncertainty.” American Political Science Review 99: 549–565. Koremenos, Barbara, Charles Lipson and Duncan Snidal. 2001. “The rational design of international institutions.” International Organization 55: 761–799. Krugman, Paul. 1996. “Are currency crises self-fulfilling?” NBER Macroeconomics Annual, Volume 11. National Bureau of Economic Research. Manokha, Ivan and Mona Chalabi. 2011. “The latest financial crisis: IR goes bankrupt.” Working paper. Matthijs, Matthias and Mark Blyth. 2011. “Why only Germany can fix the euro.” Foreign Affairs. Moody’s. 2012. “Moody’s changes the outlook to negative on Germany, Netherlands, Luxembourg, and affirms Finland’s AAA stable rating.” July 23, 2012. Available online at: https://www.moodys.com/research/Moodys-changes-the-outlook-tonegative-on-Germany-Netherlands-Luxembourg--PR_251214. Obstfeld, Maurice. 1994. “The logic of currency crises.” National Bureau of Economic Research; NBER Working Paper 4640. hler, Hannes, Peter Nunnenkamp and Axel Dreher. 2012. “Does conditionality work? A test for an innovative US aid scheme.” European Economic Review, 56: 138–153. Paterson, William E. 2011. “The reluctant hegemon? Germany moves centre stage in the European Union.” Journal of Common Market Studies 49: 57–75.

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Pierson, Pierson. 2004. Politics in Time: History, Institutions, and Social Analysis. Princeton: Princeton University Press. Princen, Sebastiaan. 2009. Agenda-Setting in the European Union. London: Palgrave Macmillan. Rooney, Ben. 2012. “Greece: Here we go again.” CNN, July 24, 2012. Available online at: http://money.cnn.com/2012/07/24/investing/greece/index.htm. Rosendorff, B. Peter. 2005. “Stability and rigidity: Politics and the design of the WTO’s dispute resolution procedure.” American Political Science Review 99: 389–400. Rosendorff, B. Peter and Helen V. Milner. 2001. “The optimal design of international trade institutions: Uncertainty and escape.” International Organization 55: 829–857. Sikorski, Radoslaw. 2011. “I fear Germany’s power less than her inactivity.” Financial Times, November 28, 2011. Available online at: http://www.ft.com/intl/cms/s/0/ b753cb42-19b3-11e1-ba5d-00144feabdc0.html?siteedition=intl#axzz2drfALTnT. Sobel, Russell and Peter Leeson. 2006. “Government’s response to hurricane Katrina: A public choice analysis.” Public Choice 127: 55–73. Spiegel Online. 2012a. “Schäuble wirbt für Milliardenhilfe für Spanien.” July 19, 2012. Available online at: http://www.spiegel.de/politik/deutschland/spanien-hilfeschaeuble-gibt-regierungserklaerung-ab-a-845324.html. Spiegel Online. 2012b. “Rösler: Euro-Austritt Griechenlands hat Schrecken verloren.” 22 July 22, 2012. Available online at: http://www.spiegel.de/wirtschaft/soziales/ roesler-euro-austritt-griechenlands-hat-schrecken-verloren-a-845779.html. Steen, Michael. 2013. “Greek myths and reality in Germany’s election.” Financial Times, August 28, 2013. Available online at: http://blogs.ft.com/the-world/2013/08/ greek-myths-and-reality-in-germanys-election. Stone, Randall W. 2011. Controlling Institutions: International Organizations and the Global Economy. Cambridge: Cambridge University Press. Tallberg, Jonas. 2006. Leadership and negotiation in the European Union. Cambridge, New York: Cambridge University Press. Thomson, Robert, Frans N. Stokman, Christopher H. Achen and Thomas König. 2006. The European Union Decides: Testing Theories of European Decision-Making. New York: Cambridge University Press. Underdal, Arild. 1992. “Designing politically feasible solutions.” In Rationality and Institutions, edited by R. Malnes and A. Underdal. Oslo: Scandinavian University Press. Verhofstadt, Guy. 2012. “Germany knows way to solve crisis.” Financial Times, February 29, 2012. Availble online at: http://www.ft.com/intl/cms/s/0/92a6e2ec62f2-11e1-b837-00144feabdc0.html#axzz2drfALTnT. Wilson, James, Robin Wigglesworth and Brian Groom. 2012. “ECB ready to do whatever it takes.” Financial Times, July 26, 2012. Available online at: http://www.ft.com/intl/cms/s/0/6ce6b2c2-d713-11e1-8e7d-00144feabdc0. html#axzz2dsp2YtVa.

Chapter 9

Coping with Financial Crisis Crisis Response, Institutional Innovation, and the Variety of Finance Capitalism in Italy and Spain Boyka M. Stefanova This chapter deals with a less discussed aspect of policy reform and institutional change in response to the financial and economic crisis in the Eurozone. While the role of the Greek crisis in shaping the EU-wide response has been widely acknowledged, the potential impact of the crisis in Spain and Italy on the direction of reform of the institutions of European governance, the Economic and Monetary Union (EMU), and the mixed market (Mediterranean) model of European capitalism has yet to be established. Theoretically, the chapter adopts an institutionalist framework centered on finance capitalism (Mettenheim 2013) and examines the interplay between context and autonomy in structuring the domestic and EU-level policy responses to the crises (Casper 2001). This analysis demonstrates that the overlapping and mutually reinforcing dynamics of the banking crisis in Spain and the sovereign debt crisis in Italy are embedded in their respective national bank-centered models of finance and state-enhanced capitalism. The paper further argues that the two key institutional innovations at the EU level, the blueprint of a European Banking Union (EBU) and the policy review and reform measures of the European 2020 Growth and Convergence Strategy constitute yet another set of instruments which states collectively apply in order to benefit from the comparative institutional advantages associated with their national models of political economy. Although the policy process at the national level is different from that at the EU level, from a relational perspective they share common premises of mutually reinforcing loops of institutional complementarity. The policy discussion has referred to certain aspects of this mutually reinforcing complementarity as “doom loops” (Venon 2013). The linkages between sovereign debt and bank crises addressed in the proposal for a European Banking Union represent one such vivid example of “doom loops.” 169

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The selection of Italy and Spain as reference cases is based on their similar clustering within the mixed market (Mediterranean) economies (MME) model and, more importantly, due to their somewhat contrasting relevance to the EU banking and financial crises. While Spain experienced a fully-fledged banking crisis that required external bailout resources, a banking crisis in Italy never fully materialized and was at best contingent upon the evolution of a sovereign debt crisis. The allegedly different scope and nature of the two crises has led scholars and practitioners to explore the idiosyncratic nature of their domestic systems against the background of destabilizing global trends (Deeg 2013, Hardie and Howarth 2013, Quaglia and Royo 2013, among others). At the same time, the literature agrees that they represent an instance of “twin” crises, a phenomenon originally examined in Kaminski and Reinhart (1999). The “twin”-crises proposition suggests that the Spanish and Italian cases are based on similar premises. The common underlying structure of the two cases has so far remained unexplored. Prior research has adopted a predominantly factor-based approach to the study of the crises. The argument presented here builds upon the “twin”-crises proposition to present a relational account of banking crisis in Spain and the sovereign debt crisis in Italy. It applies a varieties of capitalism (VoC) approach to suggest that the two crises represent the “two sides of the same coin.” They share common origins in the institutional complementarities of the mixed-market variety of finance capitalism, not only negative feedback loops between the banking system and sovereign debt. Furthermore, both cases are crucial to the blueprint of a European Banking Union and policy reform at the national level, both of which largely exceed the scope of crisis response. Market expectations as to the interconnected nature of their respective institutional arrangements, and especially institutional complementarities within the varieties of national finance capitalism, produced the contagion effect of progressive increase in their borrowing costs. Furthermore, EU institutional innovation advanced as a form of crisis response, such as the blueprint for a European Banking Union and the European Semester, has been centered on policy instruments targeting the tenets of finance capitalism, corporate governance, and labor relations. According to the VoC approach, these are precisely the areas that distinguish the Mediterranean model from a coordinated market economy due to its state-dominated nature. In order to validate these claims, the chapter proceeds with an overview of the two crises from the perspective of the institutions of finance capitalism (Mettenheim 2013). It then turns to examine EU-level institutional innovation on the example of the policy prescriptions of the 2013 cycle of the European semester1 and the blueprint of a European Banking Union, as components of policy reform addressing the institutional complementarities of the national varieties of finance capitalism. The chapter concludes that the premises of



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multidimensionality and institutional complementarities of the VoC framework have maintained their relevance to the sources of growth, crisis, and policymaking in the European political economy. The Varieties of Finance Capitalism Model Although the VoC framework is a conventional analytical tool for gauging the responsiveness of unemployment to changes in output, it is also well positioned to explore the interactions among institutional reform, output, employment, and performance, as well as between the systems of monetary and industrial relations (Schroeder 2013). Current trends in all of these systems are the result of past institutional reform and the set of principles of adjustment they prioritize, either market or hierarchy. The universalization of neoliberalism as a political economy orthodoxy has obscured the fact that national distinctions have persisted not only among corporate governance, industrial relations, and welfare policy, but also within the market-based internationalization of production regimes and the social purpose of economic institutions (Becker 2010, Ido 2012, Weiss 2010). The tension between the universalizing dynamics of globalization and market liberalization on the one hand, and the distinctiveness of the national system of political economy, on the other, has been most pronounced in Europe, where national models have had to adapt to the homogenizing influences of European integration. Still, certain deeply entrenched institutional distinctions have been preserved. Fundamental institutional complementarities exist within the national systems of long-term employment, capital provision, contract law and inter-firm collaboration, coordination of industrial relations, and welfare systems (Allen and Gale 2001, Hall and Soskice 2001, Hancke et al. 2008, Sabel 2006). Based on the level of coordination among social actors, such stable institutional complementarities create different comparative institutional advantages and affect state performance in the area of employment, economic growth, macroeconomic stabilization, and redistributive policies. Coterminous with the process of Europeanization of the national economies, several clusters of countries with similar systems of coordination across financial and industrial systems have persisted in the European Union: liberal market economies (LMEs), which rely on markets to coordinate firm endeavors and state participation in the economy; coordinated market economies (CMEs), characterized by institutions reflecting higher levels of non-market coordination; the Nordic model of capitalism, which maintains institutionally sustained high levels of employment and economic growth; and mixed market (Mediterranean) economies (MMEs), which have relied historically on a larger agrarian sector and extensive state intervention. The institutional complementarities of the

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MMEs create diverse opportunities for non-market, state-dominated coordination in the sphere of corporate finance and selective liberal arrangements in the sphere of industrial relations (Hall and Soskice 2001: 21). What governments do in the face of economic challenges depends on their access to resources and participation in financial and industrial relations systems, which may be market- or actor-based. A state’s capacity to meet such challenges depends on the application of corrective instruments that address the institutional complementarities of national political economy, rather than individual priorities.2 Policies that foster market-based coordination may not be applicable to cases in which market and non-market principles coexist and generate a particular form of institutional advantage. The VoC approach therefore explains both the persistent institutional varieties of European capitalism and the susceptibility of individual systems to crisis. These features are particularly pronounced in the MMEs due to their limited opportunity to apply across-the-board policy reforms that foster marketbased coordination. As a result of the interplay of market-based and non-market institutional arrangements in their financial and industrial sectors, production regimes in the mixed-market economies have remained compatible with premises drawn from both the LMEs and the CMEs model. MMEs combine liberal principles of internationalization of production and capital market-based financing of firms with industrial relations that are dependent on public spending for employment and pension protection. In the context of low level of coordination among social groups, the type of mixed-market model of Southern European capitalism has persisted along the dimensions of social policy (Hay and Wincott 2012: 62, Sapir 2006, Royo 2008) and corporate governance. At the same time, the model reveals the multidimensional nature of institutional clustering according to sectors, firm size, and social groups. The VoC perspective thus needs to be deconstructed into individual dimensions based on the configuration of banking, finance, industry, and corporate structure. By taking into account variation in the long-term patterns of performance and distribution of well-being, a multidimensional definition offers better explanatory power than quasi-ideal models defined along the continuum of liberal versus coordinated market economy. It is therefore analytically necessary to contextualize the MMEs model according to its distinctive features in the domain of banking and finance. Banking is not a straightforward market-based activity. In a minimalist sense, the core business of a bank is to accept deposits and make loans (Mettenheim 2013: 5). Outside the market-based financial systems of the liberal market economies (LMEs), the model of bank-centered capitalism is based on different premises. In this model stock markets have less importance. Financial markets are primarily for government debt. Firms obtain



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funds through capital markets or bank loans. Mettenheim (2013: 11) concludes that the traditional view of markets as efficient allocators of resources is inaccurate. One of Mettenheim’s core propositions is that bank-centered capitalism is a system in which banks are essential intermediaries. It follows that the production regime depends on banks and not predominantly on market mechanisms for outcome creation. Mettenheim (2013: 13) has argued that in bank-centered capitalism, the competitive pressures of liberalization, monetary union, globalization, shadow banking and capital markets have not led to market-centered finance and private banking. Due to the prevalence of institutional complementarities, reform and restructuring aimed at improving competitiveness at the national level have not resulted in unqualified liberalization even within the Single European market and the EU monetary union although a trend of cross-border banking has intensified (ECB 2013). The transition to a single European banking market, according to Mettenheim, has led to internationalization of the business activities of large banks but it has allowed non-joint stock banks, such as savings banks, cooperative banks, and public special-purpose banks to modernize, merge, and integrate while also preserving their social purpose. As a result of the bifurcation of the national banking systems of the MMEs, the evolution of the EMU has not only created uniformity, as in the case of the Euro, but has similarly maintained the principle of harmonization. Market liberalization has strengthened the premises of comparative advantage only in sectorally specific areas led by national champions, while other sectors have remained protected due to existent institutional complementarities. Deviation and expansion of the core business of banks is thus at the origin of crisis and bank collapse. Conversely, exposing banks to market competition has led to the concentration of banking transactions and agents, the opposite of a system of decentralized and dispersed entrepreneurs (Arestis et al. 2011). This development produces the “too big to fail” doctrine with regard to systemically important financial institutions (SIFIs). Under neo-classical and liberal premises the SIFIs should be amenable to market principles of efficiency deregulation but also open to failure due to their sheer size (Bastasin et al. 2012). As a result, market-based principles cede way to correction through political and policy means, such as the capture of public funds for the purpose of bailout. The Comparative Political Economy Context of The “Twin” Crises in Italy and Spain: Two Versions of Bank-Centered Finance Capitalism Through its premises of tiered application of market principles and institutional complementarities, the VoC framework is relevant to the conceptualization of

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the parallel banking and sovereign debt crises of Spain and Italy. Although the timing and domain of crisis in the two countries differed, they both experienced several parallel and mutually reinforcing developments, anchored in links among public spending, sovereign debt, and the role of the banking system in the mixed-market model of finance capitalism. Research shows that the crises were the result of a combination of domestic and external factors (Quaglia and Royo 2013, Hardie and Howarth 2013, Deeg 2013), associated with structural weaknesses, the low-interest rate environment of the EU’s Economic and Monetary Union, and policy failures. These studies, however, underestimate the extent to which the development of the Spanish and Italian banking system was based on selective adoption of the principles of liberalization only with regard to the international operations of firms and financial institutions. The domestic economic environment was dominated by a bankcentered model of capitalism. According to Mettenheim (2013: 14), the shareholder model of marketcentered banking is more of an outlier in Europe, and Spain and Italy present evidence to that effect. The visible modernization of the tier of savings and cooperative banks and the internationalization of the large banks have concealed the fact that these systems have retained a pillar structure in which banks present nonmarket-based services. Even Banco Santander, considered a successful example of international competitiveness and named the best performing bank in 2008, has relied on an expansion of its retail banking (rather than investment banking and brokerage) while maintaining its social embeddedness through a stakeholder-based approach to dialogue with social groups (Parada et al. 2009, Ordeix 2009: 354). Large market-centered competitive banks still constitute only one pillar of the banking systems of Spain and Italy. Savings, cooperative, and specialpurpose banks continue to exist, with that tier occupying up to 50 percent of the Spanish banking sector. Prior to the economic and financial crises that started in 2007, the cajas, or savings banks, had formed a system of particularly successful community serving credit institutions. In Italy, the persistence of a corporate governance model based on cross-shareholding, while on the decline, has had significant implications for export competitiveness and the way public policy addresses the banking system. This model was under significant pressure from European integration. On the one hand, EU membership has been conducive to economic growth in Spain through increased foreign direct investment. European integration has similarly helped the second tier, select-purpose banks to modernize and gain competitiveness. On the other hand, however, the process has preserved the existing institutional complementarities of the banking system, corporate governance, and industrial relations consistent with the national model of finance capitalism.



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As Mettenheim (2013: 17) has argued, the bank-centered model of institutional complementarities in the sector of corporate governance has reinforced political relationships between governments and a select number of large private banks. Locally, especially in view of the tiered system of local and regional government in both Spain and Italy, government-banking sector relationships have persisted. Although Italian banks were regarded as well capitalized, competitive, and among the most solid banking institutions in the EU (for example, Intesa Sanpaolo and UniCredit), even the large credit institutions failed to fully reform their governance systems. Most large Italian banks still participate in cross-shareholdings, which creates a selfperpetuating dependency due to industry concentration. The institutional continuities of political economy in Italy’s quasi-federal state structure also serve as a protective belt of regional interests against the central government. The possibility for reform is further limited due to the lack of coordinated labor policy in the south. The resulting salotto buono (“fine drawing room”) club-style interconnectedness of business and politics has made it possible to internationalize large companies and gain international competitiveness while maintaining rigid medium-size corporate structures at home. Although the systems of corporate governance in Italy and Spain differ, the crisis highlighted the common bank-centered and interconnected economic structures in both countries. It demonstrated that the MMEs were more susceptible to systemic risks than the market-centered corporate governance structure of liberal market systems and the cooperative model of social relationships under the coordinated market economies (Vitols 2001, 2004). As Royo (2008) notes, the mixed market systems are characterized by a low level of coordination among social actors. The opportunities for success of government reform in such systems are more limited. During the property boom in the Spanish economy that accelerated after 2000, the cajas accumulated significant interbank liabilities and mortgage loan portfolios. As a result of the unfolding global economic and financial crisis that commenced in 2007, they were left with large portfolios of bad mortgages, which increased their dependence on international wholesale financing. The liquidity issues of the cajas intensified also due to their complex regulatory framework, dependent on national, regional, and local authorities. The presence of political parties in their governance structures made the cajas susceptible to power influences within their governing bodies. State-sponsored bank reforms sought to recapitalize banks with significant loan exposure and solve liquidity issues but failed to increase the level of coordination among social actors. In an effort to consolidate the cajas pillar of the banking system, seven regional savings banks merged in December 2010 to form Bankia which became Spain’s fourth largest bank. Spanish banks significantly increased their borrowing from

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the ECB after June 2011. In May 2012, the Spanish government nationalized Bankia, at the time the largest real estate asset-holding institution in Spain. The estimated loss was posted at €19 billion. In June 2012, ECB announced plans for bank recapitalization in Spain of up to €100 billion (about $130 billion). The European Council (June 28–29, 2013) adopted policy measures that addressed critical debt levels in Spain and Italy. Allowing direct bank recapitalization through rescue funds was important especially for Spain, as its banks could benefit from up to €100 billion ($130 billion) (Nelson et al. 2013: 2). In addition, the Council approved €120 billion to support economic growth. Successive recapitalizations introduced significant amounts of public funds into Spain’s banking system under the approved EU line. The commitment of Eurozone assistance through the state redefined Spain’s crisis from one originating in the private sector, driven by excessive continuous borrowing in the low-interest rate environment of EMU (Quaglia and Royo 2013) into a destabilizing factor for the public sector. ECB financing of the bailout required significant domestic reform. However, restructuring produced inconclusive outcomes. Due to declining revenue, the economic crisis undermined the financial position of the regional governments. The situation required additional emergency financing. In parallel with the growing borrowing needs of the central government, its credit rating deteriorated, reflected in steadily increasing borrowing costs. By contrast, the source of financial crisis in Italy was the excessive amount of public debt, accumulated due to persistent institutional complementarities between the welfare system, corporate governance, and public finance. The state-dominated nature of the welfare system relied on massive public spending which historically was maintained through levels of public debt exceeding 100 percent GDP. That debt was held primarily by Italian credit institutions. The crisis evolved due to sustainability concerns emerging as a result of the post-2007 economic downturn and the declining international competitiveness of the Italian economy. The net position of Italian banks was undermined by both financial and economic constraints. The banks held a growing portfolio of bad loans as a result of the low export competitiveness of Italian firms. Through the system of their interconnected holdings, the principal bank holding companies, also holders of government debt, suffered significant losses in terms of market capitalization. Aggregate write-offs exceeded €300 billion between 2007 and 2011.3 While the international expansion of the large banks has served as a market-based tool for limiting their corporate exposure, it remains contingent upon market-based competitive advantages which are not clearly defined, either for the Spanish or Italian banks. The case of Mediobanca, the second largest Italian bank, presented in Table 9.1, is indicative of the persistence



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Table 9.1  Mediobanca: A Persistent Model of Cross-shareholding in the Process of Reform Selection of Mediobanca board members sitting on other boards Gilberto Benetton •  Autogrill •  Benetton Group •  Edizione Holding •  Edizione •  GE Capital Interbanca •  Atlantia •  Olimpia •  Pirelli & C. •  Schernaventotto •  Sintonia S.A. •  Sintonio S.p.A. •  World Duty Free Group España Renato Pagliaro •  Pirelli & C. •  Telecom Italia

Angelo Casò •  Edizione Holding •  Edizione •  International Federation of Accountants •  Italmobiliare •  Benetton Group Carlo Pesenti •  Italcementi •  Italmobiliare •  Ciments Français •  RCS MediaGroup Pier Silvio Berlusconi •  Mediaset España Comunicación •  Arnoldo Mondadori Editore •  Mediaset •  Medusa Film

Source: Adapted from Financial Times graphics, August 21, 2013, online edition.

of cross-shareholding against the background of successful market-based expansion.4 In addition to erosion of bank capital base, the system of institutional complementarities was reflected also in the increasing vulnerabilities of the nonfinancial corporations (NFCs). Most of their competitiveness losses were due to an institutionalized, over-regulated system of industrial relations sustained by publicly funded and guaranteed pensions and employment provisions. The crisis revealed that the basic institutional complementarities of the Italian political economy differ from the fully corporate-centered VoC framework of coordinated market economies (CMEs) and from its statist mixed-market version in France, where strategic national priorities are set and pursued through public instruments. The Italian VoC model did not make a definitive turn towards a liberal market economy, especially in the dimension of corporate governance, despite a competitive export sector and successful internationalization of large banks. Changes in the regulation of corporate governance through market-strengthening instruments created rules that made shareholder pacts redundant and facilitated the takeover of Italian companies by foreign investors. As Table 9.2 shows, foreign acquisitions in the Italian economy continued to grow despite the crisis. Regardless of individual factor interactions, comparative data indicate that the two crises share similar triggering mechanisms and paths. They both refer to the low-interest rate environment of the EU monetary union. At the same

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Table 9.2  Foreign Investment in Italy during the Financial Crisis, 2011–2012 Foreign takeovers of Italian companies Amount

Date

$.5.5bn March 7, 2011 $3.6bn $2.6bn $1.6bn $1.1bn

Target

Acquirer

Bulgari (88.3%)

LVMH Moët Hennessy Louis Vuitton (France) April 26, 2011 Parmalat (54.4%) Lactalis Group (France) July 8, 2013 Loro Piana (80%) LVMH Moët Hennessy Louis Vuitton (France) December 20, 2012 Marazzi Group Mohawk Industries, Inc. (U.S.) April 18, 2012 Ducati Motor Porsche Automobil Holding Holding (Germany)

Source: Adapted from Financial Time graphics, August 21, 2013, online edition.

time, market response to the fundamental weaknesses of the model of bankcentered capitalism in Italy and Spain led to prohibitively high borrowing costs reflected in growing sovereign spreads relative to the baseline levels for the Eurozone. Banks and the structures that they develop, whether through a system of cross-shareholding (as in the case of Italy) or a tiered structure based on social purpose (as in the case of Spain), depend on the resources and frameworks that national models of involvement in the economy provide. In both cases the crisis demonstrated the link between bank and public sector borrowing patterns. Such market developments are the result of stable institutional relationships (or institutional complementarities) between the banking sector and public spending, both of which sustain a system of bank-centered corporate governance. The common premises of the two crises are reflected in the similar structure of market expectations with regard to Spain and Italy, as well as their relevance to the direction of reform of the EU’s economic and monetary union.

The European Context of the “Twin” Crises: Markets and Institutions The European context was integral to the domestic policy response to the crises in Spain and Italy. In turn, the “twin” crises had a significant impact on the relationship between the European Central Bank (ECB) and the national banking systems in the Eurozone. Two aspects of institutional innovation demonstrate the problematic nature of mixed-market models for financial relations in the Eurozone and for industrial relations and welfare systems in the Single European market: the proposal for a European Banking Union and the 2020 European Growth and Convergence Strategy, or European Semester.



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Prior research has noted that the European context aggravated the banking crisis in Spain and the sovereign debt crisis in Italy (Quaglia and Royo 2013). While this work points to international systemic factors and market instability in the Eurozone, it does not examine the nature of these short-term and long-term imbalances, focusing instead on the net positions of Italy and Spain within the relatively homogenous regional bloc of the Eurozone. In reality, segmented markets in the Eurozone have persisted, both in terms of economic agents and financial products. The unequal position of the member states has become one of the principal features of the Eurozone, although its overall external balance had improved. The ECB 2013 Convergence Report found that the different types of sectors—households, nonfinancial sector (NFCs), financial corporations, and governments—contributed differently to the imbalances across the Eurozone (ECB 2013: 94). Serious fragmentation within the Eurozone occurred after 2008 due to reassessment of the creditworthiness of market participants, in particular with regard to cross-border trade (ECB 2013: 67). In the context of greater information asymmetries, the loss of confidence led to growing spreads between crisis-threatened economies, such as Italy and Spain, and those considered close to a EU safe haven environment, such as Germany. Reform in the bank-centered model of finance capitalism imposed by EU-based financial instruments, including ECB buy-back programs, marked a turning point in the public policy response towards the crises. In parallel with the unfolding of national financial crises, in December 2011 the ECB launched a three-year Long Term Refinancing Operations (LTRO) program at a 1 percent interest rate, over 60 percent of which was subscribed by Spanish and Italian banks. The Program accepted the banks’ portfolios of government bonds, mortgage securities, and commercial paper as collateral. Banks thus bought more government debt, in turn using it as collateral. Shortly after the ECB cut interest rates to a historically low level in July 2012, it announced the Outright Monetary Transactions (OMT) aimed at stabilizing secondary sovereign bonds markets. It is notable that despite differing economic fundamentals and individualized policy prescriptions, the funding costs for Spain and Italy followed a similar path. The two countries did not benefit from the reduction of Eurozone interest rates in 2012 (see also Zoli 2013). The escalation of borrowing costs for Spanish and Italian public and private actors reflects not only the high-risk environment of the two crises, but also a similar market assessment of the institutional model of capitalism in Italy and Spain and the mutually reinforcing links between sovereign debt and bank borrowing (Kaminski and Rogoff 2011). Not surprisingly, market expectations reflected their similar structural weaknesses reflected in borrowing rates, real exchange rates, and economic competitiveness.

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By comparison, borrowing rates for the nonfinancial sector in France and Germany significantly declined after 2011. The persisting lending rates differentials reflect the institutional rigidities of the Spanish and Italian models of corporate governance, as a practically separate sector of the Eurozone credit market. They further tighten the credit crunch with the potential to affect even large corporations under the prevalent model of bank-centered model of corporate financing. Spain and Italy were part of growing competitiveness imbalances across the Eurozone, emerging as a result of variation in unit labor costs (ULC). The ULC gap was due to cumulative wage growth in excess of what could be supported by productivity gains, putting downward pressures on business margins that deteriorated the current account balances in countries with lagging productivity gains, such as Italy and Spain (Franzese 2001). The internal imbalances (“home bias”) were produced by the uneven structure of competitiveness of the national economies (export-oriented versus domestic sectors) and relative institutional advantages across sectors due to the prevalent arrangements of interest representation (ECB 2013: 94). In a parallel development, the real exchange rate gap between external deficit and external surplus countries in the Eurozone also continued to grow. Over the period 1999–2008 the real exchange rate of Italy grew from 100 to 110. It similarly increased from 100 to 112 for Spain and above 115 for Ireland. Conversely, Germany’s real exchange rate declined from 100 to 88, leading to a significant loss of competitiveness for the countries experiencing banking and financial crises after 2008 (ECB 2013: 101). All these development suggests that the “twin” crises in Spain and Italy had an important European dimension which has not been (and may not be) consistently addressed through one-size-fits-all policy instruments. It is embedded in the institutional complementarities between the national models of corporate governance and industrial relations. Institutional Reform towards an EU Market-Centered Model? The European financial crises, including the cases of Spain and Italy, resulted in negative market expectations as to the ability of the national governments to deal with bank failure. The financial markets have reinforced the feedback loop between banks and sovereign debt and produced fragmentation and competitive distortion. The crises made it clear that the Eurozone needed a stronger financial framework combining regulation, supervision, and rules for bank resolution in order to sever the self-perpetuating relationship between bank and sovereign debt crisis and the capture of public funds for SIFIs



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bailout (European Commission 2012c). Based on such considerations, the European Council (June 28–29, 2013) took a decision to introduce a single bank supervisor for the Eurozone, create a fund that would allow direct support for aiding banks without recourse to public bailout, and include a deposit guarantee scheme under the blueprint of a European Banking Union. This policy innovation was adopted in parallel with EU-wide anti-crisis measures with regard to Spain, The European Banking Union (EBU) is comprised of four pillars ensuring the stage-like creation of a single EU rulebook for financial supervision and prudential regulation. The EBU includes a deposit insurance scheme and a Single Supervisory Mechanism (SSM) that confers supervisory authority to the European Central Bank (ECB). After a process of assessment, the ECB will be able to directly recapitalize failing banks. Key for the SSM is the ability to maintain principles for state aid, including in cases of bank resolution. Upon entry into force of the proposed Directive for the Recovery and Resolution of Credit, the EBU will put in place a Single Resolution Mechanism to deal with failing banks. The Directive is integral to that process by determining the types of restructuring available, maintenance of the vital functions of the economy, and allocation of costs and losses among bank shareholders, creditors, and uninsured depositors. The Single Resolution Mechanism complements the Single Supervisory Mechanism, originally proposed by the Commission in September 2012, by centralizing key competences and resources for managing bank failure in the Eurozone and other member states participating in the banking union (European Commission 2013). In contrast to the conventionally applied method of a bailout, the Mechanism acts as a bail-in. It sequentially allocates losses and writes down claims of shareholders, subordinated credits, and senior creditors. This mechanism is linked to the deposit insurance component of the banking union which maintains protection for deposits of up to €100,000. Compared to the network of existing resolution authorities, the Single Resolution Mechanism removes potential ambiguity and tensions between the bank resolution competences of national authorities and the ECB as supervisor (European Commission 2013: 5). The scope of EU institutional innovation was extended by means of additional measures for member states that signal major deficiencies in their financial and banking sectors and need measures simulating economic growth. The European Growth and Convergence Strategy, or European Semester, is a process aimed at securing lasting economic and financial stability through a system of economic policy coordination among the EU member states. It is designed to ensure the alignment of national budgetary and economic policies with obligations within the economic and monetary union. The Semester’s ultimate purpose is sustainable economic growth which enables job creation

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and renewed social cohesion across Europe, in line with the Europe 2020 Strategy. In the context of the European Semester, the Commission carried out a series of country-level analyses, on the basis of which the European Council issued recommendations to Italy and Spain and National Reform Programs were designed (European Commission 2012a and b, Government of Italy 2013). Both the recommendations and the national programs were tailormade and outlined the steps in the national reform process. The common features of the sovereign debt crisis in Italy and the banking crisis in Spain logically resulted in a number of similar recommendations.5 Both member states were recommended to ensure lower deficits by implementing the measures adopted in their respective budgets. Special emphasis was placed on regular in-depth spending reviews at all levels of government (Italy) and monitoring fiscal policy (Spain). Taylor-made measures were designed for the Italian banking sector. The prescriptions for policy reform include support for the flow of credit to production activities, asset-quality screening across the banking sector, and resolution of non-performing loans on banks’ balance sheets, among others. Although the crisis in Italy is not defined as a banking one, this recommendation is an indication of the real problems in the banking sector and the threat it poses to the economy and public spending. Taxation occupies a prominent place in the recommendations. Shifting the tax burden away from labor and capital to consumption is common for both member states. Market opening in the services sector and specifically in the professional services is another common recommendation, implying still-existing protectionist measures in both states. Common labor market measures include efforts to prevent early school leaving, counter poverty, and improve the employability of vulnerable groups.6 This more detailed review of the policy prescriptions aimed at economic growth through a desirable mix of market and nonmarket-based coordination of financial and industrial relations shows that, in fact, the proposed measures work in the direction of strengthening institutional complementarities of national models outside the liberal market one. These proposals reinforce concentration in the banking sector through regulation and supervision. Despite the liberalization bias of the recommendations, the latter require more coordination among social actors and tend to stabilize institutional linkages within the economy and prevalent systems of corporate governance. The EU-sponsored policy reform thus may be expected to facilitate the concentration of power among principal stakeholders in the respective models of national political economy, rather than strengthening the institutions of the economic and monetary union.



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Conclusion This chapter has argued that the varieties of capitalism framework remains relevant to the study of institutions, governance, and national performance in the context of the European crises. It demonstrates that the policy responses to the crises in Spain and Italy were shaped by the institutional complementarities of the bank-centered model of finance capitalism in the two countries. By highlighting the interconnectedness among the domains of finance, corporate governance, and public policy, the varieties of finance capitalism model offers significant analytical advantages in explaining the mutually reinforcing effects of the European financial crises relative to propositions about the structural deficiencies of the Economic and Monetary Union, the homogenizing influences of liberalization, financialization of the economy, or institutional isomorphism. Building upon the “twin”-crises proposition in the literature (Kaminsky and Reinhart 1999, Quaglia and Royo 2013), this chapter has argued that the origins of the crises and the patterns of crisis response are anchored in stable institutional complementarities within the national production regimes and interdependencies between public and private actors. In contrast to prior research that considers the VoC framework only partially relevant, due to national distinctions even within the broad, quasi-ideal types of liberal market, coordinated market, and state-dominated market economies, this analysis underscores the relevance of the VoC model in explaining both institutional continuity and institutional change (Morgan et al. 2010, Streek and Thelen 2005, Thelen 2010, Mahoney and Thelen 2003). The chapter shows that the national models of bank-centered capitalism coexist with both the liberalization and monetary union aspects of the EU financial architecture and that the homogenizing dynamics of financial integration have failed to induce convergence in the national systems of political economy. Notes 1. The European semester represents an annual cycle of economic policy coordination. It is comprised of an Annual Growth Survey adopted by the European Commission in which it sets priorities for growth and job creation. The European Council issues guidance for national policies on the basis of the Annual Growth Review. Member states submit Stability and Convergence Programs in which they outline measures for growth and sound finances in areas such employment, research, innovation, energy, and social inclusion. The Commission conducts an assessment of these programs and issues country-specific recommendations.

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2. In contrast to the argument about the need for reform based on all dimensions of institutional complementarity, Deeg (2013) has argued that states use international regulation in areas in which their domestic systems are dysfunctional. This refinement of the VoC thesis is captured in the concept of national economic liberalism. 3. See Rachel Sanderson, “Time is being called on the cross-shareholdings that have bound the top companies together.” Financial Times, August 20, 2013 (online edition). 4. Mediobanca holds the strongest tier one capital ratio (12%) among Italian banks. Its credit standing, however, is undermined by the cross-shareholding model of corporate governance in the Italian economy. 5. Along with similarities, there are also distinct measures reflecting legacies and different institutional culture in place. 6. A separate recommendation to Italy, not noted in regard to Spain, is fight against tax evasion (European Commission 2013c).

References Allen, Franklin and Gale Douglas. 2000. Comparing Financial Systems. Cambridge: MIT Press. Archibugi, Daniele and Andrea Filippetti. 2012. Innovation and Economic Crisis: Lessons and Prospects from the Economic Downturn. London and New York: Routledge. Arestis, Philip, Rogerio Sobreira and Jose Luis Oreiro, eds. 2011. The Financial Crisis: Origins and Implications. Basingstoke: Palgrave Macmillan. Bastasin, Carlo. 2012. Saving Europe: How National Politics Nearly Destroyed the Euro. Washington, DC: Brookings Institution Press. Becker, Uwe. 2009. Open Varieties of Capitalism: Continuity, Change and Performances. Basingstoke: Palgrave Macmillan. De Bonis, Riccardo, Alberto Pozzolo and Massimiliano Stacchini. 2012. “The Italian Banking System: Facts and Interpretations.” Economics & Statistics Discussion Paper No. 068/12. Universita degli Studi del Molise.Dipatimento di Economia, Gestione, Societa Institucioni. Casper, Steven. 2001. “The Legal Framework for Corporate Governance: The Influence of Contract Law on Company Strategies in Germany and the United States.” In Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, edited by Peter, A. Hall and David Soskice, 387–416. Oxford: Oxford University Press. Cosma, Stefano and Elisabetta Gualandri. 2012. The Italian Banking System: Impact of the Crisis and Future Perspectives. Basingstoke: Palgrave Macmillan. Deeg, Richard and Gregory Jackson. 2007. “The State of the Art: Towards a More Dynamic Theory of Capitalist Variety.” Socio-Economic Review 5: 149–179. Advance Access Publication September 8, 2006. Deeg, Richard. 2010. “Institutional Change in Financial Systems.” In The Oxford Handbook of Comparative Institutional Analysis, edited by Morgan, Glenn, John



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L. Campbell, Colin Crouch, Ove Kaj Pedersen and Richard Whitley, 309–334. Oxford: Oxford University Press. European Central Bank. 2013. Convergence Report. Frankfurt am Mein: ECB. European Commission. 2012a. Recommendation for a Council Recommendation on Spain’s 2012 national reform programme and delivering a Council opinion on Spain’s stability programme for 2012–2015. COM(2012) 310 final. Brussels, 30.5.2012. ———. 2012b. Recommendation for a Council Recommendation on Italy’s 2012 national reform programme and delivering a Council opinion on Spain’s stability programme for 2012–2015. COM(2012) 318 final. Brussels, 30.5.2012. ———. 2012c. Communication from the Commission to the European Parliament and the Council “A Roadmap towards a Banking Union,” COM(2012) 510, 12.9.2012. ———. 2012d. Communication from the Commission: “A blueprint for a deep and genuine economic and monetary union Launching a European Debate”, COM(2012) 777 final/2, 30.11.2012. ———. 2013. Proposal for a Regulation of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) No 1093/2010 of the European Parliament and of the Council /* COM/2013/0520 final - 2013/0253 (COD). Fioretos, Orfeo. 2001. “The Domestic Sources of Multilateral Preferences: Varieties of Capitalism in the European Community.” In Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, edited by Peter A. Hall and David Soskice, 213–244. Oxford: Oxford University Press. ———. 2011. Creative Reconstructions: Multilateralism and European Varieties of Capitalism after 1950. Ithaca and London: Cornell University Press. Franzese, Robert J. Jr. 2001. “Institutional and Sectoral Interactions in Monetary Policy and Wage/Price-Bargaining.” In Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, edited by Peter A. Hall and David Soskice, 104–144. Oxford: Oxford University Press. Government of Italy. 2013. Economic and Financial Document 2013. National Reform Program (abridged version). Hall, Peter A. and David Soskice, eds. 2001. Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. Oxford: Oxford University Press. ———. 2001a. “An Introduction to Varieties of Capitalism.” In Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, edited by Peter A. Hall and David Soskice, 1–68. Oxford: Oxford University Press. Hancké, Bob, Martin Rhodes and Mark Thatcher, eds. 2008. Beyond Varieties of Capitalism: Conflicts, Complementarities and Institutional Change in European Capitalism. Oxford: Oxford University Press. Hardie, I. and David Howarth, eds. 2013. Market-Based Banking, Varieties of Financial Capitalism and the Financial Crisis. Oxford: Oxford University Press. Hay, Colin and Daniel Wincott. 2012. The Political Economy of European Welfare Capitalism. Basingstoke: Palgrave Macmillan.

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Hemerijck, Anton, Ben Knappen and Ellen van Doorne, eds. 2009. Aftershocks. Economic Crisis and Institutional Choice. Amsterdam: Amsterdam University Press. Ido, Masanobu, ed. 2012. Varieties of Capitalism, Types of Democracy and Globalization. London and New York: Routledge, Taylor and Francis Group. Kaminsky, Graciela and Carmen Reinhart. 1999. “The Twin Crises: The Causes of Banking and Balance-of-Payments Problems.” The American Economic Review 89(3): 473–500. Von Mettenheim, Kurt. 2013. “Back to Basics in Banking Theory and Varieties of Finance Capitalism,” AEL: A Convivium. Morgan, Glenn, John L. Campbell, Colin Crouch, Ove Kaj Pedersen, and Richard Whitley, eds. 2010. The Oxford Handbook of Comparative Institutional Analysis. Oxford: Oxford University Press. Nelson, Rebecca, Paul Belkin, Derek E. Mix and Martin A. Weiss. 2012. “The Eurozone Crisis: Overview and Issues for Congress.” CRS Report for Congress. Washington, DC: Congressional Research Service (R42377). Pagoulatos, George and Lucia Quaglia. 2010. “Italy and Greece: Financial Crisis as Sovereign Debt Crisis”. Conference Paper, University of Victoria, October 2, 2010, Parada, Pedro, Luisa Alemany and Marcel Planellas. 2009. “The Internationalisation of Retail Banking: Banco Santander’s Journey towards Globalisation.” Long Range Planning. Vol 42: 654–677. Elsevier ltd. Quaglia, Lucia and Sebastian Royo. 2013. “The Comparative Political Economy of the Sovereign Debt Crisis in Italy and Spain.” Paper read at the 2013 Biannual Conference of the European Union Studies Association. Baltimore (May). Reinhart, Carmen and Kenneth S. Rogoff. 2011. “From Financial Crash to Debt Crisis.” American Economic Review 101(5): 1676–1706, August. Royo, Sebastian. 2008. Varieties of Capitalism in Spain: Remarking the Spanish Economy for the New Century. Basingstoke: Palgrave Macmillan. Sabel, Charles F. 2008. “Learning from Difference: The New Architecture of Experimentalist Governance in the European Union.” European Law Journal 14(3): 271–327. Sapir, Andre. 2006. “Globalization and Reform of the European Social Models.” Journal of Common Market Studies 44(2): 369–90. Schroeder, Martin. 2013. Integrating Varieties of Capitalism and Welfare State Research: A United Typology of Capitalisms. Basingstoke: Palgrave Macmillan. Streeck, Wolfgang and Kathleen Thelen, eds. 2005. Beyond Continuity: Institutional Change in Advanced Political Economies. Oxford: Oxford University Press. Thelen, Kathleen. 2001. “Varieties of Labor Politics in the Developed Democracies.” In Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, edited by Peter A. Hall and David Soskice, 71–103. Oxford: Oxford University Press. ———. 2010. “Beyond Comparative Statics: Historical Institutional Approaches to Stability and Change in the Political Economy of Labor.” In The Oxford Handbook of Comparative Institutional Analysis, edited by Morgan, Glenn, John L. Campbell, Colin Crouch, Ove Kaj Pedersen and Richard Whitley, 41–61. Oxford: Oxford University Press.



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Chapter 10

EU Affairs in Spanish Electoral Competition at the Height of the Crisis Cristina Ares Castro-Conde1

This chapter links the debate on the democratic deficit of the European Union to the Europeanization, or adjustment to “Europe,” of party politics in the EU member states. It argues that, in spite of the notable democratization of the supranational institutions of European integration, in certain countries such as Spain, the legitimacy of the EU continues to be weak, among other factors, because of the way in which national parties have adjusted to “Europe.” The negative impact of the euro crisis in citizens’ attitudes towards the EU has been dramatic throughout Europe. Eurobarometer results illustrate that in many member states, citizens support the EU project with less intensity. In November 2012, the difference between the share of respondents mostly in favor and those quite in opposition to the European Union, by order of decreasing trend since May 2007, was 52 percentage points in Spain (as opposed to 42 in May 2007), −22 percentage points in Italy (as opposed to 30), −29 points in Germany (as opposed to 20), 6 percentage points in Poland (as opposed to 50), −49 points in the United Kingdom (as opposed to −13), and −22 points in France (as opposed to 10).2 In this chapter, we focus on the case of Spain, one of the EU member states deeply affected by the crisis. Positive public perceptions of the EU experienced significant decline. From the perspective of domestic politics, such negative trends raise a number of questions. However, the process through which the evolution of the crisis as a EU-wide phenomenon was reflected in public attitudes remains largely unexplored. The way political parties serve as a transmission mechanism between EU-level policymaking and governance on one hand and, on the other, the domestic political arena within which such outcomes are negotiated and implemented, is a largely overlooked issue. The purpose of this analysis is to examine the salience of European issues in Spanish politics reflected in the discourse of the political parties competing in 189

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the 2011 general elections that took place at the height of the economic and financial crisis in Spain. In August 2011, Socialist Prime Minister José Luis Rodríguez Zapatero, supported by the Partido Popular (PP), promoted constitutional reform for the purpose of introducing the concept of “budgetary stability” into article 135 of the Spanish Constitution. This extraordinary constitutional change seriously damaged Partido Socialista Obrero Español (PSOE)’s reputation. Three months later, in November 2011, Spain went to the polls. This major political event took place against the background of political developments in Greece and Italy, EU member states also seriously affected by the economic and financial crisis, in which changes in the government took place without popular voting. As a result of the 2011 elections, PSOE was dramatically pulled out of the national government and entered a deep and enduring crisis. In Spain, the salience of EU affairs in the national electoral competition has traditionally been modest (Ares 2014). Nonetheless, taking into account that most of the policy measures implemented at the national level in response to the crisis had been designed at the EU level of decision-making, an increase in the emphasis on these matters in the course of the election campaign could be expected. Hence, the main research question of this chapter is: How visible were EU-related issues in the 2011 Spanish general elections? The short answer is they were almost absent. This research applies content analysis in order to trace the presence of EU affairs in political discourse and electoral mobilization during the 2011 Spanish general elections. Party proposals are coded by means of “quasisentences,” using the author’s classification scheme for the study of party documentation related to EU affairs (Ares 2013 and 2014). The materials used are: (a) data for the 2011 Spanish general elections from the Manifesto Research Group—Comparative Manifestos Project— Manifesto Research on Political Representation (hereinafter referred to as MRG-CMP-MARPOR);3 (b) programs of the parties obtaining representation at the Congreso de los Diputados on 20-N (with the exception of Amaiur, whose manifesto, according to the dataset, contained no reference to the EU “issue”);4 (c) the transcription of the only face-to-face televised debate; and (d) the accounts in the twitter social network of the candidates of the PP (Mariano Rajoy) and the PSOE (Alfredo P. Rubalcaba). The chapter is structured as follows. The first section briefly introduces the impact of the euro crisis on EU legitimacy. The next section demonstrates the declining salience of EU issues in Spanish electoral competition since it acquired membership in the then European Community in 1986. The third section discusses the evidence on the shortage of EU-related matters in the 2011 Spanish general election as well. And finally the fourth one gives the conclusions.



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The Impact of the Euro Crisis on EU Legitimacy The legitimacy of the EU, as that of any other democratic political system, rests on three pillars: the results when satisfying the needs and values of citizens (efficiency); public control from a position of political equality (democracy); and a certain feeling of belonging to the political community (identity) (Lord and Beetham 2001, 444). Legitimacy, according to the efficiency in answering social demands is known as “legitimacy of result,” and the axiological requirements and democratic procedures together with the identification of the political community are considered to be sources of “legitimacy of origin” (Scharpf 1999). Throughout the process of European integration, the good results of EU policies were sufficient to legitimize public decisions adopted at the supranational level. However, the Euro crisis has put the fragility of both sources of legitimacy of origin (identity and democracy) at stake, placing the debate on the EU democratic deficit on the agenda of many member states. Historically, the EU democratic deficit has had an institutional and a sociological dimension. The institutional dimension was originally related to the form of investiture and lack of accountability of the European Commission, the opaqueness of the meetings of the Council of Ministers, the weakness of the European Parliament and of political parties at the European level, and the hollowing out of responsibilities of the national parliaments. The second dimension was related to the absence of a European demos (a political community throughout the EU with a collective political identity), as well as a common public sphere. However, the deepening of European integration from Maastricht to the coming into force of the Lisbon Treaty in December 2009, and indeed later developments have significantly improved the democratic credentials of the EU. The European Parliament is today an undoubtedly strong institution: under the ordinary legislative procedure, which applies to most matters, it co-legislates on an equal footing with the Council of Ministers. It has also gained power as a budgetary authority (shared equally with the Council). The appointment of the Commission President is determined by the oucome of the European elections. Similarly, the transparency of the meetings of the Council of Ministers has been guaranteed when acting as a legislative chamber. The European citizen’s initiative has also been constitutionalized and developed legislatively. The Lisbon Treaty has given more power to National Parliaments. From a sociological point of view, the euro crisis has also contributed to the emergence of a public European sphere. If we understand democracy as political equality and civil capacity to influence and control public decisions, it is true that even today, in spite of many institutional improvements as well as the emergence of a public

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space at European level, the EU has a problem of democratic legitimacy. In certain Member States, such as Spain, the persistence of this situation seems to be caused, among other factors, by the deficient treatment of EU affairs by national political parties and the lack of salience of these matters in electoral competition. This shortage of political information (policy positions, proposals, and messages) on EU issues reduces citizens’ aptitude to influence supranational decisions also be means of voting at national elections. The Salience of EU Issues in Spanish Electoral Competition since 1986 The series of graphs below trace the evolution of the position of Spanish parties on EU affairs starting with the accession of the country to the then European Community in 1986. MRG-CMP-MARPOR data has been used, tracing the combined with salience position (not a “pure” position) in the programs of political parties that obtained parliamentary representation in at least two of the eight general elections held since then, namely in 1986, 1989, 1993, 1996, 2000, 2004, 2008 and 2011. For the purpose of Graph 10.1 below, we calculated an average “position” (the combined with salience position) on the EU of parties that obtained parliamentary representation in each national election.5 This graph shows a clearly descending trend in the salience that Spanish political parties grant to the EU, as well as in their policy positions in favor, which reflects an inverse relationship with the deepening of European integration over that period. In addition, Graph 10.2 illustrates the evolution of the “position” on European affairs of each party individually. There is evidently a normal descending pattern. The position of the Spanish parties on the EU reaches its maximum in the 1989 elections for PSOE, IU, PNV and ERC, in those of 1996 for PP and CiU, and in 2000 for CC. Only one party, the BNG, behaves differently: (1) it is the only party with negative policy positions in all the elections we studied; (2) BNG’s position improves on the EU in the 2004 and 2008 elections, but its policy positions on the EU worsens again in the 2011 elections. Finally, Graph 10.3 and Graph 10.4 show the respective patterns for the leading political parties in Spain, PP and PSOE, the usual parties in government. Besides the combined with salience position, the graphs show the share of favorable and unfavorable references to European integration in separate categories.



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Graph 10.1  Evolution of Spanish Parties’ Aggregate Position on the EU. Source: Prepared by the author, using data from the Manifesto Project, accessible from https:// manifestoproject.wzb.eu/elections/206 (Budge et al. 2001, Klingemann et al. 2006, and Volkens et al. 2012).

In both cases, there is no increase in unfavorable references towards the EU, but only a loss of relevance of EU affairs in party discourse, as opposed to the increasing number of public decisions adopted, together with EU counterparts and under EU decision-making procedures, by the Prime Minister (selected based on the results of these elections), as well as other members of the Cabinet. The Salience of EU Affairs in the 2011 Spanish General Election Coded by means of “quasi-sentences,” this section provides the programmatic proposals related to matters decided at EU supranational level of parties that obtained representation in the Congreso de los Diputados in the 2011 General election.6 As predictable in the context of the euro crisis, many EU-related offers in these manifestos dealt with economic and financial matters. Almost one in three programmatic proposals (29%) concerns Economic and Monetary Affairs (EMU) and the Euro, plus Taxation (categories 304 and 305). The third main category was Agriculture and Rural Development (11%).

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Graph 10.2  Evolution of Individual Spanish Parties’ Positions on the EU. Source: Prepared by the author, using data from the Manifesto Project, accessible from: https:// manifestoproject.wzb.eu/elections/206 (Budge et al. 2001, Klingemann et al. 2006, and Volkens et al. 2012).

Furthermore, in line with our classification, we compare party proposals in order to analyze the differences in party positions of EU-related matters. As far as the EU construction is concerned, all the Spanish parties, except for BNG, are in favor of deeper European integration; the only reference opposing “more Europe” appears on page 8 of the BNG program in a proposal for the issuance of eurobonds “without implying additional transfers of sovereignty or competences to community institutions.”



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Graph 10.3  Evolution of Partido Popular’s Position on the EU. Source: Prepared by the author, using data from the Manifesto Project, accessible from: https://manifestoproject. wzb.eu/elections/206 (Budge et al. 2001, Klingemann et al. 2006, and Volkens et al. 2012).

On the whole, the proximity of party proposals in most categories of EUrelated matters is highly significant. We focus here on the leading EU issues in the 2011 general elections: EMU and Euro, Tax policy, and Agriculture and Rural Development. Firstly, Table 10.1 provides evidence on the salience of EMU and the Euro, issues critically important to structuring a EU-level response to the crisis.7 It is worth noting that PP and PSOE, as well as CiU and PNV, proposed measures to deepen European economic integration without abandoning the Stability Pact, while left parties suggested a complete change of it (IU) or its cancellation (BNG). Left parties also wanted to revise the status of independence of the European Central Bank (ECB) (ERC, BNG), while certain others recommended to broad ECB’s objectives (CC) or streamline its instruments to finance debt (PNV, Geroa Bai). A European Credit Rating Agency was offered by PSOE, CC, Compromís-Q or Geroa Bai, and eurobonds by CiU, PNV, BNG or CC. Focusing on the comparison between the PP and the PSOE, the only undertone on EMU and the Euro was the greater relevance that the PSOE granted to the more active role of supranational institutions in the economic

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Graph 10.4  Evolution of Partido Socialista’s Position on the EU. Source: Prepared by the author, using data from the Manifesto Project, accessible from: https://manifestoproject.wzb.eu/elections/206 (Budge et al. 2001, Klingemann et al. 2006, and Volkens et al. 2012).

governance of the Eurozone, as well as its suggestion to broaden the mandate of the European Stability Mechanism (ESM) by adding economic growth and employment to its current objective of guaranteeing financial stability. Secondly, Table 10.2 presents party proposals on another key issue in a time of crisis: integration in taxation policy. Two significant differences should be highlighted in the area of taxation. On the one hand, many parties supported greater fiscal integration (PSOE, IU, PNV, UPyD) or at least fiscal harmonization (CiU, Foro Asturias), whereas the winning party (PP) included no proposal on taxation in its program. On the other hand, PSOE an IU placed more emphasis on the European tax system in their manifestos, recommending various detailed measures on this category (7 and 5, respectively). Finally, Table 10.3 contains coding proposals on the third more salient category in party programs in the 2011 Spanish general election: Agriculture and Rural Development. While there was no meaningful difference between the mainstream parties, PP and PSOE, the regional parties (CiU, ERC, BNG, CC, Compromís-Q,

IU

CiU

PSOE

PP

Agent

–  Achieve greater economic coordination (page 198) –  Improve governance criteria in the Eurozone (page 198) –  Achieve greater economic integration (page 198) –  Increase the general level of transparency (page 198) – Create an effective capacity for supervising and the common guarantee of deposits (page 198)/Advances towards authentic integrated supervision (page 199) –  Strictly observe the stability and growth agreement (page 199) –  Rescue European banks (page 199) –  Regulate by-products and short-term sales (page 199) –  Transparency in the relations between financial institutions and their clients (page 199) –  Establish funds guaranteeing deposit at European level (page 199) –  Create a specific instrument to finance SMEs in the EU (page 199) –  Reinforce the institutions of economic government (page 133) –  Better coordination of economic policies (page 133) –  Construction of an authentic economic union (page 133) –  Ensure flexibility of the European Stability Mechanism (ESM), so that, besides structuring aid to countries undergoing financial difficulties, it funds investment and stimulus plans to provide a solution not only for the debt problem, but also for the lack of economic growth required to create employment (page 134) –  European Credit Rating Agency, which independently assesses the true state of the finances of member states (page 134) –  Improve regulation of private risk evaluation agencies in order to increase European competition in this sector (page 134) –  Extend the competence of the European Parliament in economic and financial sectors, with which we can gain efficiency, speed and margin of maneuver, as well as democratic legitimacy (page 134) –  Ensure economic harmonization to consolidate the Eurozone, eliminating currently sustained imbalances (page 19) –  Start-up of the Eurobonds, which, together with fiscal consolidation, will help the country come out of the crisis (page 19) –  Commit to the Euro and financial stability of the Monetary Union (page 19) –  Strengthen existing policy (page 19) –  Complete change of the Euro Pact (page 17) –  Support proposals to increase the term for reducing the deficit to 3 percent in 2016 as a temporary measure (page 17) (Continued)

Proposal/s

Table 10.1  Coded Programmatic Proposals on Economic and Monetary Affairs and the Euro

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–  Increase supervision of financial institutions by the European Central Bank and the Commission (page 23) –  Create a Ministry of Economy at European level, with the resources and suitable instruments of economic policy, that manages resources from the European Financial Stability Facility (page 30) –  Ensure that resources be sufficient to guarantee paying the debt of those countries requiring aid (page 30) –  Create Eurobonds with a European debt rating to finance the deficit of various countries, reducing the cost of indebtedness of the countries that pay an enormous differential in relation to the German debt (page 30) –  Ensure that The European Central Bank provides financial institutions with the liquidity they need to be able to grant loans to families and companies (page 30) –  Promote the improvement of regulation and supervision of the European financial system framework (page 12) –  Influence the monetary policy applied by the European Central Bank (page 17) –  Link the monetary policy to democratic institutions, addressing the conversion of the current status of independence of the ECB (page 8) –  Support the priority objective of the monetary policy as being the economic stability and creation of employment (page 8) –  Cancel the Stability Pact, giving way to the application of other governing criteria concerning the economic policy based on supporting productive investment through economic promotion of strategic sectors, peoples’ right to production, the guarantee of social policies, as well as the promotion of economic, social and territorial redistribution (page 8) –  Ensure strict supervision of entities and agencies in the financial sector (page 8) –  Emit Eurobonds, with direct support from the ECB to the funding needs of the States, without involving any additional transfers of sovereignty or competence to community institutions (page 8) –  Increase the financial capacity and flexibility of the use of the European recovery fund (page 88) –  Include economic sustainable development in the objectives of the ECB (page 88) –  European Rating Agency (page 88) –  Hold that a Eurobond market must be created at this time (page 88) –  Economic Rating Agency within Europe (page 68) –  Obligate EU members receiving economic aid, besides practising fiscal discipline, to adopt measures of structural growth in the medium and long term (page 68) –  Endorse a European Rating Agency which addresses public interest (page 17) –  Reform the ECB so that money can be loaned directly to the states to finance their debt (page 17) –  Change the interest rate that the ECB charges banks, so it continues to be 1 percent only for funds used to increase company credit, including SMEs and the self-employed. Increasing the rate significantly for funds that banks use to purchase public debt (page 17)

Source: Prepared by the author.

Geroa Bai

Compromís-Q

CC

UPyD ERC BNG

PNV

Table 10.1  Coded Programmatic Proposals on Economic and Monetary Affairs and the Euro (Continued)

198 Cristina Ares Castro-Conde



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Table 10.2  Coded Programmatic Proposals on Tax System Agent

Proposal/s

PSOE

–  Achieve greater fiscal integration (page 133) –  Own European Tax System drawn up with progressive criteria (page 133) –  Tax financial transactions, for the purpose of reducing speculation (page 133) –  Ensure a harmonized imposition on CO2 emissions, assisting the transition to a Europe without any CO2 (page 133) –  Establish a European Exchequer, a Finance Ministry whose duties include taking charge of administering the funds obtained from European taxes and issuing European national debt (page 133) –  Emit Eurobonds. By doing so, the EU would obtain at least three objectives: reduce speculation in financial markets, obtain more funding and reduce the price of financing the EU (page 133) –  Fiscal harmonisation. The EU needs greater capacity to avoid competition in fiscal affairs (page 134) –  Promote European fiscal harmonization to consolidate the Eurozone (page 19) –  Intervene in processing the future Directive on the Financial Transaction Tax (FTT) to advance its entry into force on 1 January 2013 and so that the minimum tax rate is 0.1 percent for buying or selling bonds and shares and 0.05 percent for by-products, and include operations with currencies in the FTT (page 10) –  Raise before European institutions changing Article 56 of the Treaty of Functioning to establish it as an exception at the start of free movement of capital, movements carried out between member states and the territories qualified as tax heavens (page 12) –  Support the idea that European institutions should lead negotiations with different international Organizations of political or financial nature to control and identify the true titleholders of these capital movements (page 12) –  Eliminate the EUR 500 bank note (page 13) –  Hold that invoices paid in full or in part in cash or bearer documents over EUR 1,000 cannot be used as deductible expenses (page 13) –  European tax on financial transactions, whenever first and foremost, this involves movements of capital of a speculative nature and its cost is not transferred to the basic daily operations of citizenship and small enterprises (page 25) –  Promote a Common European fiscal policy that complements the single currency (pages 14 and 45) –  Create a EU Exchequer capable of intervening efficiently in the monetary policy and in funding crisis (page 45) –  Harmonize certain aspects for regulating Corporation Tax (page 47)

CiU IU

PNV

UPyD

Foro Asturias

Source: Prepared by the author.

PNV

IU

CiU

PSOE

Agent PP

Proposal/s –  Defend a strong Common Agricultural Policy (CAP), enjoying sufficient means for the agricultural and cattle sector (page 199) –  Guarantee food safety of Europe (page 199) –  Defend a stronger, simpler CAP, with sufficient financial assignation and set upon three basic instruments: revenue support, management of markets and rural development (page 32) –  Ensure the 2014–2020 CAP is as suitable as possible for the production characteristics of the Catalan agricultural and rural means giving content in the regulatory frame to the singularities of Mediterranean reality (page 29) –  Regionalize the CAP, thereby giving regions the capacity to make decisions and increase management autonomy so they can adapt certain decisions to regional production systems and benefit from more agile management (page 30) –  Territorialize European aid and subsidies, transferring final endowments immediately to the Autonomous Communities (page 30) –  Support a new CAP capable of defending family agriculture, protecting the environment and curbing control of the agro-food chain by big companies (pages 31 and 68) –  Take advantage of the CAP reform to reorient the agricultural-farming model and to ensure agricultural and food policies are established in the framework of food sovereignty (page 31) –  Ensure the CAP includes instruments to regulate the market which put an end to food speculation, the volatility of prices, and the abuse of power by the agro industry and great distribution (page 68) –  Reject Agreements with Morocco and Mercosur (page 69) –  Reject the 15 percent cut back of the CAP for 2014–2020 (page 69) –  Correct the cut of direct aid of the first pillar of the CAP (page 69) –  Continue working to obtain the best conditions for the agricultural, farming and associated transformation sectors, considering the CAP reform is a threat for our producers (page 15)

Table 10.3  Coded Programmatic Proposals on Agriculture and Rural Development

200 Cristina Ares Castro-Conde

–  Promote CAP reform that defends agriculture according to a series of criteria concerning direct payments, such as: the possibility of linking them to the number of workers per farm and not per hectare (re-defining the concept of the “active farmer”), a compulsory ecological component, a minimum for small farmers, etc. (page 20) –  Ensure CAP market measures reinforce the position of the farmer in the food chain, through a series of dispositions such as: a European standard that controls the power of large distributors, the promotion of self-management organizations in small and medium developments, concretion of the notion of “food stock” to guarantee food safety, price trigger most related to real markets, etc. (page 20) –  Support and reinforce rural areas through: aid measures for young farmers, ease for the exchange of good practices, the development of an efficient and competitive agricultural sector that contributes to sustainable development; etc. (pages 20 and 21) –  Promote the representation of Catalonia in the EU with the right to speak in debate and to vote for Agriculture (page 177) –  Maintain the mechanisms of public intervention in agricultural markets that are efficient in smoothing price oscillations (page 22) –  Support standards that improve the regulation of the milk price reference and extend to other food products, in a way which limits production costs and transparency is guaranteed in forming prices that eradicate speculative profit (page 22) –  Support treatment differentiating the ultraperipheral regions (UPRs) from future CAP reforms. For example, the design of specific rural development policies for UPRs or flexibility of applying European directives on state aid to the agricultural and forestry sectors (page 38) –  Prioritize the defence of the interests of the Valencian agricultural sector in negotiating and applying the new CAP, foreseen for the period 2014–2020 on signing agreements with third countries and in areas of the WTO (page 20) –  Endorse CAP reform that recognizes the singularities of the agricultural activity in Spain (page 30) –  Promote the active participation of Navarre in European forums which set the main lines of agricultural policies (page 38)

Source: Prepared by the author.

Foro Asturias Geroa Bai

Compromís-Q

CC

BNG

ERC

UPyD

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Geroa Bai) tended to bring more focus on territorially specific demands and policies. IU emerged as the party that placed more emphasis on Agricultural and Rural Development than other contenders (with 6 detailed proposals). The question arises: how have the two political actors with aspirations of leading the Government of Spain, PP and PSOE, internalized the main EU topics [EMU and the Euro and Taxation (29%), and Agriculture and Rural Development (11%)]? Did they develop similar proposals, or did they maintain significant differences in the context of the euro crisis? The short answer is that there were meaningful differences between the two parties in the 2011 elections. Firstly, the PP’s emphasis on EMU and the Euro (32%) is 11 points greater than the average (21% without Taxation) and 12 points than PSOE’s (20%). Secondly, the two parties significantly differ with regard to taxation policy. The absence of any proposal on taxation in the PP’s program may be contrasted with the notable salience of this topic for the PSOE (17%), 9 points greater than the average (8%). Finally, both PP (6%) and PSOE (3%) paid less attention to Agricultural and Rural Development than the average (11%). Due to their different priorities, PP and PSOE in reality did not directly compete based on different policy positions on the same EU issues. Graphs 10.5 and 10.6 represent the distribution of distinct policy preferences of the two parties. A comparative examination of the graphs shows that for the PP, EMU and the Euro were top priorities in the election, whereas for the PSOE, the EMU and the Euro were at par with Taxation, and close to the Foreign Policy and Neighbourhood Policy. In order to present a conclusive argument on the visibility of EU-related issues in the 2011 Spanish general elections, political proposals and messages

Graph 10.5  Programmatic Proposals on EU Affairs Partido Popular (PP)—Main Categories (2011 Spanish General Election)



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Graph 10.6  Programmatic Proposals on EU Affairs Partido Socialista (PSOE)—Main Categories (2011 Spanish General Election)

communicated through other channels were examined in addition to the measures of salience and policy positions derived from party manifestos. We present results on the visibility of EU-related issues in the 20-N (November 20) campaign by the two political parties with aspirations of leading the Government of Spain, PP and PSOE, through the televised face-to-face debate between their leaders and in their Twitter social network accounts. Firstly, we studied the televised debate between the PP and the PSOE’s candidates for the Presidency of the Government, Mariano Rajoy and Alfredo P. Rubalcaba. The debate was held on November 7 and was structured on three blocks of issues: (1) economy and employment (20 minutes for each candidate); (2) social policy (15 minutes for each); and (3) the quality of democracy and Spain’s position worldwide and politics in general (10 minutes for each contender). As far as EU affairs were concerned, the PP candidate insisted on one of his main campaign messages: the importance of “doing homework at home” while pointing out the programmatic proposals of his party regarding the EU. By contrast, the Socialist party candidate took advantage of discussing certain economic measures. The policy proposals of the two candidates are shown in Table 10.4. The evidence from the debate suggests that both PP and PSOE were reluctant to introduce EU affairs in the campaign, despite the high visibility and critical importance of these matters at the height of the euro crisis. Furthermore, taking into account that this was the first general election in Spain in which Twitter was used as a channel of communication and electoral mobilization, the Twitter accounts of party leaders Mariano Rajoy and

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Table 10.4  Coded Proposals Introduced by M. Rajoy and A. P. Rubalcaba in the only televised debate (2011 Spanish General Election) Agent M. Rajoy A. P. Rubalcaba

Category None Economic and Monetary Affairs and Euro

Proposal/s None –  Delay the adjustment of the deficit in Spain for two years (until 2015) –  Decrease interest rates by the European Central Bank –  With EUR 70,000 million, the European Investment Bank has to undertake a huge investment plan, which would be like a European Marshall Plan for which SMEs can compete

Source: Prepared by the author.

Alfredo P. Rubalcaba were also examined. As we are only interested in the introduction of European issues in the campaign through this social network, the replies to other networks’ users are not taken into account when examining the tweets.8 We collected tweets up to November 18, 2011 (inclusive), the last day of the campaign. Table 10.5 outlines proposals outlined by the PP and the PSOE on Twitter. The table follows a chronological order of presentation of issue areas, starting with the winning candidate, M. Rajoy. The evidence from Twitter suggests that this communication channel replicated strategies pursued during the televised debate. The two parties remained reluctant to introduce EU issues in the election campaign, despite its embeddedness in the dynamics of the euro crisis. Apart from that, their respective announcements rejecting a CAP reform may be explained by the mobilization of influential domestic agrarian groups during CAP negotiations at the EU level. Beyond party proposals on EU affairs, we also coded additional data from the PP and PSOE’s candidates Twitter accounts. M. Rajoy made a number of politically relevant observations on Twitter. On October 29, he tweeted this political message: “I do not want to be in Europe in the gang of blunderbusses, I want Spain to be with the best.” In the context of his face-to-face debate with A. P. Rubalcaba, he tweeted: “Spain is the 4th country in the Eurozone and must have a more important role than it has now.” On November 14, a link to the article published in the Política Exterior magazine, titled “My vision of Europe and Spain in the world,” was made available to users. Moving to the account of A. P. Rubalcaba, we also found significant data. First, suggesting that the solution to the crisis lies in Europe, M. Rubalcaba wrote on October 9: “We claim unity to Europe to be stronger, to generate employment, we must all join together at all levels.” On account of a visit to Strasbourg, on October 25, he tweeted: “Europe can continue summoning a



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Table 10.5  Coded Proposals Published in the Twitter Accounts of M. Rajoy and A. P. Rubalcaba (2011 Spanish General Election) Agent M. Rajoy A.P. Rubalcaba A.P. Rubalcaba

Category

Proposal/s

Agriculture and Rural Development Agriculture and Rural Development

–  Reject the CAP reform proposal (14 October) –  Defend a restrictive CAP (10 October) –  Reject the CAP reform (14 and 25 October, 16 November) –  Reduce interest rates from the European Central Bank (ECB) (11 October; 7, 9 and 15 November) –  Eurobonds (11 October; 15 and 17 November) –  Common economic policy (13 October) –  Strengthen the ECB (26 October) –  Bank recapitalization (28 October) –  Delay the deficit adjustment till 2015 (7 November) –  European Marshall Plan (7, 9 and 14 November)

Economic and Monetary Affairs and Euro

Source: Prepared by the author.

meeting to self-organize herself [. . . ] or we can advance decisively, confronting the problems.” On November 9 he wrote: “If we have learned something in the EU about this crisis it is that either we all come out of it together or we are going to have a very bad time.” The candidate also defended the policies of the previous Socialist government, of which he was an outstanding member, as a contribution to advancing Spain’s position in EU affairs: “The Minister of Development, José Blanco, has managed to include five Spanish corridors in the Trans-European Transport network” (October 19) and “It is evident that the intervention of the Spanish government in 2010 took us out of the tense financial limelight (Greece, Portugal, Ireland, Italy)” (November 14). As these examples demonstrate, the Twitter messages of both PP and PSOE were sporadic, too general, and not substantively engaging with EUrelated issues in campaign politics. Moreover, the evidence from this social network suggests that both parties preferred addressing the crisis through national, rather than EU-level decision-making. Conclusion This chapter shows that despite the penetrating political effects of the crisis in Spain, EU issues have continued to be almost absent from Spanish electoral competition, a result that is noticeably counter-intuitive.

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In contrast to the continuous deepening of European integration and an increasing number of public decisions adopted at the supranational EU level (or in an intergovernmental format by Prime Ministers and other members of the national governments), Spanish political parties have gradually limited their attention to EU affairs. The combined with salience position on the EU of the various configurations of parliamentary parties reached its maximum of 5.2 in the 1989 elections and has been on the decline ever since until it reached 0.9 in the 2011 elections. This decline is especially pronounced at the time of the 2011 elections when the Euro crisis was at its height, although the party elites understood well that both the sources and the solutions to the crisis were inseparable from and basically dependent on EU politics. Spanish political parties continued to avoid introducing political information about EU affairs in their electoral mobilization campaign and political discourse. There has been a clear narrowing of electoral competition, not as a result of European integration itself but due to the performance of political parties that have continued to advance only a limited number of largely similar proposals on all EU issues, from economic affairs to domestic and foreign policy to the future of Europe. The chapter illustrates above all how the PP and the PSOE restricted the number of policy positions, proposals, and political messages concerning the EU not only in their manifestos but also in other campaign communication channels, such as the Twitter accounts of their candidates, M. Rajoy and A.P. Rubalcaba, and during the only televised debate. M. Rajoy did not make even a single proposal on supranational-level decisions in this face-to-face debate and only took advantage of the Twitter network to remind the opposition about the reform of the Common Agricultural Policy (CAP), under negotiation in Brussels at the time. A.P. Rubalcaba, besides also expressing an identical opposition to CAP reform on Twitter, used the debate and the social network to make public some of his party’s proposals on “Economic and Monetary Affairs and Euro,” especially the possibility of negotiating a two-year delay for adjusting the deficit and granting a major role of the European Central Bank and the European Investment Bank in stimulating the economy. A more abundant supply of political information about EU matters by the PP may have been counter-productive from the point of view of their election interests; however, it is surprising that the Socialist candidate did not forcefully introduce these issues into electoral competition, taking into account that he started the campaign at a significant disadvantage and had to minimize the effect of the previous government’s economic mismanagement, of which he was a part.9 In summary, this chapter has linked the discussion of the EU’s democratic legitimacy to the Europeanization of national electoral competition. It has



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demonstrated that the democratic deficit of the EU today is explained above all by the (non)adjustment to “Europe” of national democracies. While being aware of the effects of other factors, such as the complexity of the EU’s supranational institutional configuration and, in some cases, the lack of linguistic competence, it may be concluded that the limited political information about EU affairs drawn up and supplied by the national parties is problematic, and remains a key explanation of the poor image of the Union in domestic politics and its persisting democratic deficit. The lack of policy positions, proposals, and relevant political messages on European integration, the institutions and actors, and EU public policies significantly limit the capacity of civil society to influence and control public decisions adopted in Brussels and Strasbourg. Prior research has argued that strengthening EU democratic legitimacy depends on continued institutional reform at the supranational level, such as providing the EU institutions with more powers over tax issues that would allow them to promote ambitious redistribution policies, or the establishment of a genuine European executive (Raunio 2007). Without dismissing these desirable institutional changes, and especially taking into consideration the difficulty of reaching a consensus necessary for their implementation, given the persisting differences among the EU member states regarding the future of “Europe” and the “final” institutional model, the evidence discussed in this chapter points to the role of the party system for enhancing EU legitimacy in parallel with strengthening national democracy. From the perspective of democratic politics, national parties should be responsible for incorporating the EU agenda into their programmatic outlook and for providing cues on EU affairs, which would allow citizens to influence EU public policy through voting and other forms of participation in the domestic political arena. Methodological Appendix: Classification of Party Proposals on EU Affairs The three dimensions of the concept “European Union” are: European integration process, EU institutions and actors, and EU policies. Consequently, the classification scheme is structured according to three areas. It has 29 inclusive and exclusive categories as indicated in Table 10.6 below. This scheme was inductively elaborated by coding party proposals for the 2011 Spanish general elections, although starting with a preliminary deductive scheme, which sustained notable variations in view of the data contained in the 12 manifestos examined. For further methodological information see Ares (2013) and (2014) or contact the author directly: [email protected].

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Table 10.6  Classification of Party Proposals on EU Affairs Areas Area 1: INTEGRATION PROCESS Area 2: INSTITUTIONS AND ACTORS

Area 3: PUBLIC POLICIES

Categories 101 102 103 201 202 203 204 205 301 302 303 304 305 306 307 308 309 310 311 312 313 314 315 316 317 318 319 320 321

Widening Deepening Democratization Multilevel Government EU Institutions and Organs Political Parties at European Level Groups of Interest Legitimacy Financial Programming and Budget Internal Market and Competition Trade Economic and Monetary Affairs and Euro Tax System Social Affairs and Inclusion Agriculture and Rural Development Maritime Affairs and Fisheries Environment Regional Policy Space of Freedom, Security and Justice Foreign Policy and Neighbourhood Policy Security and Defence Policy International Cooperation, Humanitarian Aid and Crisis Response Education and Youth Research and Innovation Digital Agenda Energy Transport Industry Other Policies or Cross-Cutting Issues of Public Policies

Source: Prepared by the author.

Notes 1. Acknowledgments: I wish to thank the editor of this volume, Boyka Stefanova, for her valuable insights and constructive remarks. 2. Information published in issue number 4 (“Shock of democracies”) of the Europa booklet, edited in conjunction with the main newspaper headers of the six largest countries of the EU. This was published in the El País newspaper on 25 April 2013. 3. Available at: https://manifestoproject.wzb.eu/elections/206 [Budge et al. (2001), Klingemann et al. (2006) and Volkens et al. (2012)]. 4. The parties that obtained representation in the Congreso de los Diputados in the 2011 General election (vote share in percent and number of seats) are: Partido Popular (PP, 45.24, 163 seats), Partido Socialista Obrero Español (PSOE, 29.13, 110 seats), Convergéncia i Unió (CiU, 4.24, 16 seats), Izquierda Unida (IU, 7.02, 11 seats),



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Amaiur (1.39, 7 seats), Partido Nacionalista Vasco/Eusko Alderdi Jeltzalea (PNV/ EAJ, 1.35, 5 seats), Unión Progreso y Democracia (UPyD, 4.76, 5 seats), Esquerra Republicana de Catalunya (ERC, 1.07, 3 seats), Bloque Nacionalista Galego (BNG, 0.77, 2 seats), Coalición Canaria (CC, 0.6, 2 seats), Compromís-Q (0.52, 1 seat), Foro Asturias (FAC, 0.41, 1 seat) and Geroa Bai (0.18, 1 seat). Total number of seats: 350. Source: Spanish Ministry of Home Affairs. 5. Besides an authoritative account of MARPOR in Budge et al. (2001), Klingemann et al. (2006) and Volkens et al. (2012), Alonso et al. (2012a and 2012b) are recommended. MRG-CMP-MARPOR’s classification was created more than 30 years ago to study party competition at the national level by coding manifestos. It has been widely used for classifying units of analysis of heterogeneous political texts, including speeches or governmental statements, dating back from the Second World War. This scheme for systematizing programmatic preferences concerning the polity, politics and policies counts 56 categories, structured in the following 7 areas: “External Relations,” “Freedom and Democracy,” “Political System,” “Economy,” “Welfare and Quality of Life,” “Fabric of Society,” and “Social Groups.” Two of these categories, classified under area 1 “External Relations,” are linked to the EU: “European Community/European Union: positive” and “European Community/European Union: negative.” The combined with salience position on the EU is calculated by reducing the percentage of category 110 to the percentage of category 108. The pure position is achieved by dividing the result of the above subtraction from the sum of the percentages of categories 108 and 110. 6. Coding the “programmatic proposals related to matters decided at EU supranational level” means that those measures regarding adjusting polity, politics and policies to “Europe” at the domestic level are excluded; similarly, not analyzed in this section are “quasi-sentences” that do not refer to the content of a proposal, although they express a party preference on a EU issue. 7. These are all coded programmatic proposals. The ordering criterion for the parties is the voting percentage (in descending order); for the proposals, the order of appearance in each manifesto. A complete list of the proposals by party is provided in Ares (2013: 18–32), Table 4.2. 8. If we had included responses, we would have collected redundant information, identical to entries obtained when analyzing the content of the PP and PSOE manifestos. This is because the campaign teams respond to tweets by reproducing content from electoral programs. 9. An insightful analysis of the 2011 Spanish elections, beyond matters concerning the EU, may be found in Martín and Urquizu-Sancho (2012) and Sánchez-Cuenca and Dinas (2012). On electoral competition in Spain, see Anduiza et al. (2010), Cordero and Martín (2011), Martínez i Coma (2008).

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State Processes of Democracy, edited by R. Holzhacker and E. Albaek. Cheltenham: Edward Elgar. Sánchez-Cuenca, I. and E. Dinas 2012. “Introduction: Voters and Parties in the Spanish Political Space.” South European Society and Politics 17 (3): 365–74. Scharpf, F.W. 2000 [1999]. Gobernar en Europa, ¿Eficaz y Democráticamente? Madrid: Alianza Editorial. Schmidt, V.A. 2004. “The European Union: Democratic Legitimacy in a Regional State?” Journal of Common Market Studies 42 (5): 975–97. Schmidt, V.A. 2006. Democracy in Europe: The EU and National Politics. Oxford: Oxford University Press. Steenberg, M. and D.J. Scott 2004. “Contesting Europe? The Salience of European Integration as a Party Issue.” In European Integration and Political Conflict, edited by Gary Marks and Marco Steenbergen. Cambridge: Cambridge University Press. Urquizu, I. 2012. La crisis de la Socialdemocracia: ¿Qué Crisis? Madrid: Catarata. Vink, M.P. and P. Graziano 2007. “Introduction: Challenges of a New Research Agenda.” In Europeanization: New Research Agendas, edited by P. Graziano and M.P. Vink. Houndmills: Palgrave Macmillan. Volkens, A. 2002. Manifesto Coding Instructions (2ª ed. rev.), Discussion Paper FS III 02–201, Berlin: WZB. Volkens, A. et al. 2012. The Manifesto Data Collection. Manifesto Project (MRG/ CMP/MARPOR), Berlin: Wissenschaftszentrum Berlin für Sozialforschung (WZB). Zimmermann, H. and A. Dür (eds.) 2012. Key Controversies in European Integration. Houndmills: Palgrave Macmillan.

Chapter 11

Testing the Resilience of Civil Society The Euro Crisis, Portugal’s Welfare State, and the Third Sector Miguel Glatzer

The global financial crisis has hit Portugal hard. After an initial period of stimulus, interest rates on government debt started to soar. Portugal passed austerity budgets in 2010 but was soon forced to seek an international bailout. In May 2011 the troika (the European Commission, the European Central Bank and the International Monetary Fund) approved a bailout package of 78 billion Euros, the third after Greece and Ireland. Induced by tightened credit, reduced private sector demand, government austerity, and a slowdown in growth and slide into recession among most of its European trading partners, the Portuguese economy has registered negative or zero growth in five of the six years since 2008. By the end of 2013, it is estimated that the crisis had caused a decline in GDP of close to 8 percent. GDP growth in 2014 is forecast as weak at best. Having risen from 80.8 percent of GDP in 2008 government debt is expected to reach 141.3 percent of GDP in 2014 (OECD 2014). While government austerity budgets have repeatedly raised taxes and reduced spending, meeting budget deficit targets is difficult in a declining economy. The future looks grim, as long-term growth forecasts remain low. With recession has come soaring unemployment. As of this writing, Portuguese unemployment has hit 17.5 percent. Youth unemployment is more than double, having reached 38.2 percent. The employment rate has also fallen steeply. At 66.1 percent in 2007, Portugal before the crisis had an employment rate substantially above the EU-28 average (Bank of Portugal 2014). By 2013 it had fallen to 61.1 percent, below the EU-28 average. For those lucky to still be employed, cuts in wages, tax hikes and higher user fees in areas such as health have resulted in lower take-home pay. While a particularly active constitutional court has reversed a number of the government’s measures with respect to public sector pay and benefits, these have tended to be offset by other tax increases or cuts in expenditure in response. 213

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These cuts have resulted in fewer or less affordable services for vulnerable populations and fewer resources in family and social networks that once could have provided an informal buffer. As a result, reports of hunger have become more common. An estimated 13,000 students come to school hungry (Sol 2012). Although the at-risk-of-poverty rate rose modestly from 24.9 percent in 2009 to 25.3 percent in 2012, it is important to note that the poverty line cutoff of 60 percent of median income has fallen, due to the drop in incomes. The crisis has thus exacerbated a need for social services that had been growing, both because of demographic change as well as because of new social needs. As in most West European countries, the number of elderly is rapidly growing as is the percentage of elderly living alone. New social risks, such as drug addiction or HIV/AIDS as well as recognition of the rights of the disabled, have also increased the demand for services. The Portuguese welfare state grew rapidly during the last forty years of democracy. Although progress in social policy has been substantial with massive expansion of secondary school enrollment, greatly expanded access to higher education, and universal access to health care and pensions, important challenges remain (Glatzer 2013). One of these is the very low level of minimum pensions, the result in part of low minimum wages as well as the decision to extend coverage to elderly populations with little or no history of contributions. Because wage inequality is high and the pension system is Bismarckian, reproducing wage inequalities in pensions, Portugal is in the unenviable position of having both a substantial welfare state and a high level of poverty. Portugal’s welfare state is Bismarckian in another sense as well, as a relatively high share of spending is spent on transfers rather than services. Recent cuts in social spending have thus exacerbated a growing need for social services in a welfare state that has underprovided services and that has relied rather heavily on nonprofit organizations for service delivery. These nonprofit organizations are worthy of study not only for the services they provide to vulnerable populations but also because they are a vital example of associational life in a country where civil society has historically been weak. The quality of Portugal’s democracy remains fiercely debated. Lower rates of electoral participation and rising degrees of cynicism about party effectiveness in public opinion polls provide evidence of feelings of dissatisfaction not with democracy itself, but with its quality. At a deeper level of analysis, political scientists have bemoaned the relative weakness of civil society. The lack of associational life—in associations both political and non-political—is viewed as weakening democratic governance and impairing effective policy implementation (Putnam 1992). Despite a flourishing of community and voluntary associations during the heyday of the revolution, membership in both formal and informal associations remains low. In 2011 only 12 percent of Portuguese engaged in



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voluntary activities, half the rate of the EU-27 average (Instituto Nacional de Estatística 2013, 71). However, it is notable that 45 percent of Portuguese volunteers were involved with social service delivery, whereas only 12 percent of EU-27 volunteers were so engaged. EU-27 volunteers were more likely than their Portuguese counterparts to be involved in the fields of sports, culture, arts, education, human rights, animal rights, the environment or professional organizations. This chapter uses a historical perspective to analyze a reform in the system of social protection that was explicitly aimed at fostering the development of a more vigorous civil society while, at the same time, solving important problems in social protection. The reform concerns the development of a system of contracting out of social services to the private nonprofit sector—the instituições particulares de solidariedade social, or IPSS. It describes the challenges brought by the current crisis to the delivery of social services and to the relationship between nonprofit organizations and the state. Finally, it examines responses by both the state and these organizations to the crisis. The Rise and Partial Fall of Associational Life under Democratization Portugal’s oldest social service organizations have religious origin in the Catholic church and in church-related beneficent societies, some of which date to the early Middle Ages. This is typified by the important roles played by both the Misericórdia as well as more recently developed parish-based organizations. These institutions provide a high number of the retirement homes, particularly in rural areas. The nineteenth century witnessed the rise of secular mutual-help societies, which started some of the first insurance programs in Portugal (Quintão 2011). Under Salazar’s long dictatorship, the lack of a vigorous social policy gave prominence to a set of institutions, such as housing and community improvements for workers and fishermen (the Casas do Povo or Casas dos Pescadores), that nonetheless remained feeble, as their sources of funding were meager. In addition, these organizations functioned as regulatory and monitoring institutions. Controlling social problems was their main goal (Patriarca 1995). At times they might ameliorate localized problems, but rarely would they provide comprehensive solutions. Like the vertical union syndicates of the dictatorship, the social policy initiatives of the government were top-down affairs that provided little room for autonomous action or even the airing of local grievances. The long dictatorship certainly proved harmful to the development of a rich civil society in Portugal. This was by design, not accident, as the regime was suspicious of social movements and associational life. Even

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historic institutions such as the mutual aid societies were looked upon as “public enemy number one” for they were the very definition of associational life (Leal 1997, 340). The well-known Montepio Geral, for example, was allowed to survive only because it allied itself with a savings bank (the Caixa Económica) that was an important source of capital for the economic policies of the regime. Poor education policies resulting in high illiteracy rates, censorship of the media, and the monitoring of associations by the secret police all provided an inhospitable environment for the flourishing of civil society. This was all the more case in the field of social policy, as the regime had a deep and abiding suspicion of social programs that smacked of socialism or communism.1 The 1974 Portuguese revolution unleashed an astonishing array of associational life. This eruption of associations and voluntary organizations was not limited to the takeover of plants by worker groups, or of landholdings by landless agricultural workers, but also included the emergence of numerous neighborhood improvement groups (Bermeo 1986; Downs 1989). These latter groups were frequently involved in the voluntary and shared construction of local infrastructure, including the building of schools, sheltered bus stops, community centers, primary health care buildings, and public fountains and clothes-washing facilities (important in many villages whose houses then lacked indoor plumbing). Many of these activities consisted of improvements in physical infrastructure related to social services, particularly in health and education. Normally described as autonomous, spontaneous, and “from below,” these associations nonetheless often received belated support from the state. Although the early governments and even the Communist party worried about not being able to control the more radical of these groups, the state frequently provided material aid (often in the literal sense of bricks and cement) for the construction of local infrastructure. However, this flourishing had only a brief life. Associational movements in the countryside and in the industrial sector, as well as within local communities, experienced a deep and prolonged decline (see Baum 1997). Once the wave of associational life experienced in the two-year aftermath of the revolution had ebbed, the density of civil society in Portugal dropped to a low level, by Northern European standards. The reasons for this decline are complex, and involve sociological, economic and political factors. Many point to the temporary ebullience, the evanescent enthusiasm, that accompany popular revolutions. Spontaneous celebrations of the rupture of an oppressive social order rarely last too long. The dancing in the streets, the chipping of a Berlin Wall, soon give way to a more sober and routine preoccupation with daily life. On the economic front, the shocks of the mid-1970s and the hard times that ensued could not have helped. High inflation and reduced demand led to the sober realization that worker



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takeovers of factories and latifundia were no silver bullet for prosperity. Finally, it is clear that government policy had much to do with the failure and eventual demise of worker-run establishments. Foremost among these were debates over property rights. The widespread nationalization of large sectors of the economy reduced the scope for autonomous worker-led movements: the state was now in control. The Reforma Agrária had the explicit purpose of reducing the landholdings taken over by rural workers. Establishments with unclear property rights found it hard to borrow and to enter into contracts. In later years, the settlement of property disputes in favor of former owners dealt a further blow to the cooperatives and worker-run takeovers that had been such a distinctive feature of the popular mobilization of the revolution. As in many other countries, rates of unionization have also suffered long-term declines. If associations of workers with specific economic aims (the takeover of factories and large landholdings in the south) withered, what of that part of associational life aimed at improving local infrastructure or providing social welfare?

Consolidated Democracy The Fostering of Associational Life and a Non-Profit Social Services Sector by the State If the state was wary, suspicious and at times fearful of the upsurge in autonomous social movements and civil associations in the aftermath of the revolution, consolidated democracy brought about deep and lasting change. In several domains, the state would now try to find partners in civil society that could advise it in the formulation of policy, participate in program implementation, and help monitor the effects of government policy. When the state could not find such groups in civil society, it fostered them. This is true in a variety of policy areas, including education and immigration, but is particularly salient in the field of social services (Moren-Alegret 2002). The main vehicle for state support of associational life in this area is through the complex set of relationships it has established with organizations of social solidarity known as IPSS, the instituições particulares de solidariedade social. In a 1997 speech, Rui Cunha, the deputy minister for social inclusion, provides a useful summary of the government’s position on social services. “Although a responsibility of the state, social services in Portugal are primarily delivered by private nonprofit social service organizations. This method has proven particularly efficacious in improving community and individual welfare. The Cooperation Pact for Social Solidarity has provided the framework for this dual system of responsibility for social services, in which great emphasis is given to finding local solutions for social problems. The

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government’s goal is an efficient delivery of social services that meets the criteria of equity and social justice” (Cunha 1997, 9). This passage captures many of the reasons animating state support for strong civil associations but also reveals many of the tensions inherent in such a policy. If civil associations vary by region, how can equity be achieved? If the state delivers services through religious organizations, how does it make sure that services are provided free of religious bias? If social service delivery relies upon civil society organizations, how does the state monitor efficiency? The number of these organizations has continued to grow. By 2010 there were 5022 IPSS (Instituto Nacional de Estatística 2013). They alone account for half of the nonprofit economy in Portugal. The total number of nonprofit social service organizations (IPSS and others classified differently) were estimated to account for 2.9 percent of wages and 1.7 percent of gross value added. Although the state has long recognized occasional benevolent societies (the medieval Misericórdia being the most ancient and prominent of these), the current relationship of the state to social service organizations in civil society is a very recent phenomenon. IPSS are first mentioned in the 1976 Constitution government. The largest initial set of regulations is found in a 1983 statute (Dec. Lei 119/83). Prior to this, the relationship of the state to civil society organizations in this field was unsystematic and based on a relatively high level of discretion. The IPPS statute gave qualifying organizations legal recognition. Additional laws passed since then have established the rights and responsibilities of the state and the IPPS in greater detail. Article 1 of the 1983 statute defines IPPS as nonprofit institutions, created by individuals and not administered by the state or municipal authorities, whose aim is to express moral duties of justice and solidarity between individuals, and which provide goods or services related to children and youth, family, social integration, old age and disability, health, education and training and housing (Barroco 1997). This list clearly encompasses the areas of responsibility covered by comprehensive welfare states. The 1984 law on social security (Lei 28/84) further specified the relationship between the state and these nonprofit social service institutions. The state is not neutral with respect to these organizations but rather plays an oversight role. The law established the rules governing state contracts with IPSS. To protect beneficiaries and users of the IPSS, as well as to ensure proper use of funds, the state can inspect and audit the IPSS. Finally, IPSS that provide health or educational services (principally pre-school) are subject to approvals from health and education authorities. Disputes can be resolved through recourse to arbitration as well as by administrative law judges. The IPSS statute contains a separate chapter for religious organizations, and within this a special section covers affiliates of the Catholic Church. This section reflects elements of the Concordat between the Vatican and Portugal. The Santa



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Casa da Misericórdia de Lisboa, a large, historical organization that remains a vital part of social service delivery in Lisbon, is treated separately under the law. A 1992 regulatory instrument, Despacho Normativo (75/92), further specifies the relationship between the state and municipal authorities, on the one hand, and the IPSS, on the other. In addition to technical help, the state can subsidize the activities and services carried out by the IPSS. Subsidy amounts are determined through agreement between the relevant ministry (social services, health or education) and a body representative of all IPSS—the IPSS union. These amounts are revised annually, again through agreement. State subsidies can also include funds for the development of physical infrastructure or take the form of the leasing of state-owned facilities for use by the IPSS (Barroco 1997). The Portuguese state also supports IPSS through a variety of provisions in the tax code. These include reimbursement of value added taxes (VAT) and exemptions from having to pay property tax on buildings used for social services. The code also includes tax abatements for people and corporations that donate to IPSS. The Despacho Normativo also gave users of IPSS specific rights. IPSS cannot discriminate against their beneficiaries on political, religious or racial grounds, and must also respect their beneficiaries’ dignity and private lives. In 1996 a cooperation agreement for social solidarity was signed between the national government, the Associations of Municipal and Civil Parish Governments (Associacao Nacional de Municipios Portugueses—ANMP, and the Associacao Nacional de Freguesias—ANAFRE) and the respective unions of IPSS, Misericordia and Mutual Association members. This accord is the basis for all further working models coordinating the activities of national and local levels of government and civil society organizations in the field of social services. Law 51/96 which regulates the cooperative and mutual help sector was passed the same year (Cardona and Gomes Santos 1997). The legislative trajectory is clear. Since the early 1980s, the Portuguese state has passed laws and adopted regulations that have promoted the growth of social service organizations rooted in civil society. By 1994, 70 percent of the central government’s social assistance budget was dispersed through the IPSS (Santos Luis 1997, 134). By 1996 IPSS and CERCIs numbered over 3150 organizations. Together they served 260,000 people (author’s calculations based on data in Paiva 1997 and Santos Luis 1997). In other words, about one in every forty inhabitants of Portugal was a beneficiary of these organizations. Following a long period of state suspicion and wariness of civil society organizations, straddling both the dictatorship and part of the revolutionary period, the Portuguese state had reversed course. In just over twenty-five years, Portugal developed an impressive range of social serviceoriented civil society organizations. As far as social services were concerned by the late 1990s state and civil society organizations were intricately linked.

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The costs and benefits of this arrangement have been the subject of some debate. Proponents such as Cardona and Gomes Santos argue that these organizations produce public or quasi-public goods with positive externalities and as such deserve tax relief or public subsidies. They are also efficient because they are decentralized, closer to the problem, and better able to identify and meet the needs of their users. The state, either through contracting out or through other means, should foster them. They act as “social stabilizers” partially compensating social risks, using voluntary and altruistic behavior (Cardona and Gomes Santos 1997, 77, my translation). Similarly stressing the virtues of a vibrant civil society, Barroco views IPSS as being “in a particularly good position to foster active social involvement in the definition, contours and development of social policy” (Barroco 1997, 73, my translation). Finally, Silvestre praises the ability of the IPSS to react much more quickly than the state to new social problems such as drug addiction, Aids, homelessness, and other forms of social exclusion (Silvestre 1997). Challenges and Vulnerabilities Although it is certainly true that these organizations play an indispensable role in social service delivery and have frequently been at the vanguard in mobilizing public opinion and pressuring the state to improve social policy, there are areas of considerable weakness. Among these are the relatively low degree of charitable giving and the resulting heavy dependence of Portuguese social service organizations on the state. Another area of concern about this form of social services delivery has to do with the uneven regional distribution of these civil society associations (Silvestre 1997). CERCIs also suffer from the same problem. For example, some large districts have no CERCIs whatsoever (Paiva 1997). Silvestre also finds disparities in social services expenditure per capita and per user. Some of these disparities have to do with the relative emphasis of Portuguese social services (and the associations that deliver them). Social services are weighted primarily towards the elderly and secondarily to children. Services for family and general community needs are relatively underdeveloped. In part because of this, Silvestre finds that social expenditure per capita and per user is higher in the interior of Portugal than it is in the large cities and the coastal areas. The Portuguese hinterland is demographically distinct as it has a heavy proportion of elderly and in some cases children. This is the result of the migration of a significant proportion of the working age population to the coastal cities and, farther afield, to Europe. Uneven distribution of services presents a normative problem for the state, as this conflicts with principles of equity and equal treatment. A third source of concern involves the relationship of state and church. IPSS that have their origin in the Catholic Church face particular problems.



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As these organizations increasingly rely on state funding, and the regulations that come with them, discomfort in the Church rises. The Church does not want to have under its aegis organizations that it cannot control, and whose rules may violate Catholic dogma. So far, this issue has not been of paramount concern to the state. There are three probable reasons for this. Clearly the issue of separation of state and church is not nearly as salient an issue as it is in the United States, where state funding of religious organizations for social service delivery remains highly controversial and the subject of much public debate (Walsh 2001; Dionne and Chen 2001). In this regard, Portugal resembles the European norm of frequent state support for religiously-based organizations in the delivery of social services (Glenn 2000). Additionally, the state argues that it does not finance these organizations; rather it finances their activities. Through contracting, it pays for the social services these organizations deliver, not for the organizations themselves. Furthermore, the state argues that through regulations in these contracts it can ensure that church teaching remains absent from the social services provided. Although the complaints about these regulations from some church-affiliated IPSS indicates that these regulations have some bite to them, it is also unclear to what extent the state is able to monitor violations of these rules and enforce sanctions (such as the withholding of future contracts) on offending organizations. Finally, it is important to note that the state has an important financial interest in delivering social services through the IPSS. Employment growth is relatively high in the IPSS but average IPSS salaries are considerably lower than those for similar positions in the state (Maia 1997, 330). As social services are labor-intensive, the cost savings of delivery through these organizations is considerable. It is thus not surprising that as the state has moved towards greater emphasis on social services, employment growth in the IPSS has been substantial. The fourth area of concern involves the intrusion of state mandates on these organizations. IPSS worry that the contracts with the state impose rules and regulations that reduce the very virtues and vitality that the state recognizes and wishes to foster. IPSS complain that these rules introduce rigidity and inflexibility into their organizations and suffocate not only the volunteers but also the capacity for concrete humane intervention. They complain about the number of regulations and the effects of having to comply with them. They fear their organizations are becoming bureaucratic, routinized and professionalized. They note that IPSS have had to hire accountants to meet governmental standards (the Plano Oficial de Contabilidade), and that employees must increasingly have state-approved social service degrees or training. There is also pressure to make sure that teachers are state-certified. In the words of one discussant, “Hoje temos que ter tecnicos para tudo”—nowadays everything requires a degree (Maia 1997, 329).

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These rules make it harder for IPSS to rely on and foster voluntary activity. Technical staff (those with degrees) do not always establish good relationships with the volunteers. The academic literature on civil society organizations suggests that one of the reasons these organizations are important is that they promote patterns of sociability and generalized trust. However, a frequent complaint voiced by IPSS directors is that, in imposing rules on the very civil society organizations it wishes to see develop, the state inadvertently produces bureaucratic structures and tecnica that are “dehumanizing” and antithetical to the spirit behind many of the IPSS (Melícias 1997, 337). As a result of this problem, some IPSS have asked that the state make it possible for volunteers to receive training, which would lower the gap between technical staff and the volunteer corps. The regulatory burden also causes some IPSS to worry that they are losing one of their great strengths, which is the ability to react swiftly to new needs. The Effects of the Euro Crisis The role of the nonprofit social sector has been praised during the crisis. For Jorge Sampaio, a former President, the dense network of IPSS has prevented an internal humanitarian crisis and has been remarkably resilient. In his view, the third sector can “test solutions, address issues that have not yet made it on to the public agenda as well as influence public policy and governmental decision-making” (Diário de Noticias 2014). In reaction to this increased social need, the government adopted a thirty point Social Emergency Plan which relies in part on greater funding and a greater role for IPSS. The plan includes placing teachers in IPSS, increasing the number of meals served by IPSS, boosting their roles in food banks and food distribution, simplifying legislation to reduce the regulatory burden on IPSS, and promoting greater volunteering by encouraging firms to adopt time banks to give workers greater flexibility. Nonetheless, the additional funds allocated to IPSS under the plan have failed to keep pace with the growth in need. A number of IPSS have needed emergency financing. This is particularly the case for organizations that had recently invested in equipment or infrastructure but which found their budgets under severe stress as a result of the crisis. To prevent the closing of these IPSS the government initially budgeted 50 million Euros, later expanded to 150 million Euros. The decisions to continue the tax exemptions these nonprofit organizations receive and to refund half of the value added tax they spent in construction and infrastructure improvements was described by Mota Soares, the Minister of Social Affairs as “emergency oxygen” (Tiago 2012).



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Recognizing increased rates of hunger among schoolchildren, in November 2012, the Ministry of Science and Education announced an additional food assistance program in the schools (Programa Escolar de Reforço Alimentar or PERA), designed to provide breakfast to needy children. It relies heavily on coordination with local government, local schools and, crucially, IPSS such as the Food Bank as well as local corporate sponsors. Rather than acting as a provider or supplier, the government’s role in this program is to facilitate links between needy families and local networks of community assistance. Because of this reliance on local networks, geographical variation in the quality of the response is a serious risk (Truninger, Teixeira, Horta, Alexandre and da Silva 2014). In August 2010, the government also created the National Council on the Social Economy (Conselho Nacional para a Economia Social, or CNES), a body composed of experts and representatives from many different nonprofit groups. It functions as a high-level advisory body, evaluates the health of the social economy, and assesses the impact of policy proposals on the sector (Silva 2010). To promote the social economy, the Institute for the Cooperative Sector (INSCOOP) was reorganized and renamed the Antonio Sergio Cooperative for the Social Economy (or CASES). This public body promotes the social sector, facilitates social sector entrepreneurialism, and offers grants and micro-credit loans through programs such as SouMais, SocialInveste and ESJovem Among the goals given emphasis is the creation of self-employment in the social economy, with young unemployed people a particular target group. To these ends, a financing program for the development of the social economy (PADES) was introduced. The great challenge facing the IPSS is thus how to respond to the dramatic increase in social need in the face of tightly constrained financial support from the state. Not surprisingly, IPSS have argued for both larger funding streams as well as regulatory changes that would minimize the impact of the crisis on their budgets. Co-payment schedules are a common complaint. Based on a sliding scale of household income, co-payments are designed to save public expenditure while still making services accessible to families. However, the rules governing co-payments are rigid and individual household needs aren’t always reflected in the setting of the co-payment. As a result, co-payments during the crisis pose a problem both for potential users of the services (who may find them unaffordable) and for the IPSS providing the services. This is particularly the case when the IPSS client base includes a high concentration of households unable to afford their co-payments, either because of drops in income or because of additional, unexpected household needs and expenditures. IPSS in such situations are likely to run serious deficits as their costs will only partially be covered by the state. Allowing greater flexibility in the co-payment schedule, with greater responsiveness

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to households’ changing needs and capacity to pay, is thus a common plea (Marques Leandro, no date). A recent report commissioned by the National Confederation of IPSS suggests a number of strategies to diversify revenue and to contain costs (Sousa et al 2013). On the revenue side, some IPSS may be able to rent or lease assets such as buildings, vehicles or medical equipment when these are underutilized. In other cases, they might share these resources with other IPSS or other entities in exchange for services. Charging for some services, paid either by direct users or by the state as in a school lunch program or after-school services, may be an option for some IPSS. This would provide a revenue stream that would allow continued activity in areas where funding has been cut. The study argues that many IPSS are not very well known and that developing a communications and social media strategy that would raise general awareness and attract charitable giving is key to lessening financial dependence on the state. Recommendations include more effective fundraising strategies, such as the cultivation of relationships with donors (both firms and individuals) and the dissemination of information on goals and performance metrics. On the cost-control side, the report argues for the need to increase the number of volunteers with professional management experience who can help with accounting, budgeting, human resource management and IT. Additional measures include partnering with other agencies for bulk purchasing and maximum use of space and resources. Networking and coordinating with other service delivery partners is highlighted as a way to avoid duplication of effort and to allow specialization and bundling of services. Crucially, the report argues that IPSS must mobilize the broader civil society on their behalf. Gone is the era of relatively easy growth in which they looked to the state for funding. Given economic forecasts of low growth, high debt and slow exit from the Euro crisis, social needs will be remain high while the state’s ability to fund will be severely curtailed. In such a scenario, developing enhanced links with civil society is critical. Another major study, analyzing social service needs in light of both state cutbacks and demographic changes through 2020, comes to similar conclusions (Soares et al 2012). While the number of children is expected to decline, the number of elderly will continue to increase. The number of elderly living alone is also expected to increase, and this will magnify the need for a wide variety of elderly services, including programs that allow the elderly to continue to live in their homes, social and cultural activities in day centers, and retirement and nursing homes. While the need for social services will provide a source of employment growth, boosting volunteering and charitable giving are crucial as are income-generating activities and cost-cutting through bulk purchasing, IT upgrades and more professional management.



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Several social service actors—both among IPSS as well as outside of them—have taken steps in these directions. New networks, linking IPSS to one another as well as to social service nonprofits in other European countries, have been established. One example is ESLIDER Portugal, founded in 2011. This is an association of civil society organizations that promotes social entrepreneurship and improved third sector governance, advocates legislative reform and develops peer to peer learning. It is a member of EUCLID, a European third sector network. Supported by the Gulbenkian Human Development Program, another initiative consists of the development of a Social Stock Exchange within Euronext Lisbon, Portugal’s stock exchange (Grecco n.d.). In this model, which blends charitable giving with social investment, social organizations that are able to generate income but which need capital to grow can list shares and bonds on the stock exchange. A final example concerns international development aid. Recognizing that “the economic crisis continues to hit the [NGO] sector hard and sources of funding have been reduced,” the governments of Iceland, Liechtenstein and Norway opened a grant line of 147 million Euros for the 2009–2014 funding period devoted to supporting NGOs in 15 EU member states (EEA Grants 2013). Portugal was allotted 5.8 million Euros, with the Calouste Gulbenkian Foundation the local operating partner administering the grants. In the view of EEA Grants, “dynamic civil societies are a cornerstone in healthy, stable democracies.” Reflecting a broad view of the good that civil society organizations can perform, the EEA argues that “non-governmental organizations play a key role in mobilizing citizens and bringing issues to the fore in the public arena, engaging in policy debates, (and) tackling key concerns in society, both as advocates and as providers of services. The crisis is also increasing inequalities and social tensions. It is essential that NGOs are able to tackle rising intolerance and provide key services, particularly to the most vulnerable groups” (EEA Grants 2013). Conclusion Can a vibrant civil society be created by the state? Results from the Portuguese case examined in this chapter, even if restricted to the universe of social service organizations, suggests that the answer is yes. It is true that in the immediate aftermath of the 1974 revolution, Portugal experienced a flourishing of associational life from “below.” This eruption of associations and voluntary organizations was not limited to the takeover of plants by groups of workers, or of landholdings by landless agricultural workers, but also included the emergence of local neighborhood improvement groups

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(Bermeo 1986). These latter groups were frequently involved in the voluntary and shared construction of local infrastructure, including the building of schools, sheltered bus stops, community centers and the like. Nonetheless, this flourishing was brief. The associational movements in the country side and in the industrial sector, as well as within local communities, experienced a deep and prolonged decline. Once the wave of associational life unleashed by the revolution had ebbed, the density of civil society in Portugal reverted to a lower level. The evidence in this chapter, however, suggests that if the social wellsprings of civil society are weak, the state can nevertheless play a positive role. Civil society can indeed be fostered from above. Purists in the civil society debate might take issue with this position. For them, a vibrant civil society must, by definition, be separate from both the state and the market. However, when examined closely, a large number of civil society organizations are marked not by a wall of separation from the state and the market, but rather by multiple links to these two different spheres. The classification system used to distinguish among nonprofits (and which can be used to examine most civil society organizations) points to this.2 In most countries, the vast majority of these areas involve some sort of state regulation or funding, and varying degrees of competition or complementarity with market-based for-profit organizations. Furthermore, it is quite frequently the case that civil society organizations desire changes in state policy or firm behavior. The wall of separation between civil society on the one hand, and the state and market on the other, can be conceptually useful but empirically is more the exception than the rule. The Portuguese state plays an important role in funding, auditing, monitoring and contracting with nonprofit social service agencies. But if relationships with the state and the market (through user fees and competition with for-profit organizations that offer similar services at higher expense) are dense, this does not mean that these organizations have become mere subcontractors to the state. There is, certainly, a danger of this happening, as well as a risk of bureaucratization as these organizations grow and develop deeper relationships with the state. Once a nonprofit social service organization has become professionalized and bureaucratized, it is likely no longer as good an indicator of a vibrant civil society.3 Dependent on contracts from the state, and especially if it has relatively few voluntary positions, the distinction between such an organization and a for-profit agency can become one based principally in the arcana of tax law. But this is not the case in Portugal. The majority of these organizations remain small-scale local affairs (Rodrigues and Stoer 2001). Despite complaints from some of their members, they have not yet become bureaucratized organizations with rigid hierarchies and barriers to entry based on professional degrees.



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The bigger risk to these organizations comes from the current economic crisis which threatens to overwhelm their capacity to respond to social needs while facing growing constraints in government budgets. Nonetheless, there is also a possibility that the crisis will lead to a strengthening of civil society support for these nonprofit deliverers of social services. Certainly, this is part of the strategy that many IPSS are currently adopting. If this is the case, the state will have played a role in the development of civil society, both in its fostering of these organizations and now in its relative retreat. Notes 1. Coriolano Ferreira, one of the architects of Portuguese social insurance and assistance during the dictatorship and immediately thereafter, mentioned how he had to use his terms carefully during the Salazar period. He was at one point suspected of having Communist sympathies for advocating a modern system of social provision. Changing his language from social security to social provision (segurança social to previdência) allayed the regime’s fears and allowed him to breathe easier. Interview with author. 2. For the US, a common classification system consists of the following areas: health services; education/research; religious organizations; social and legal services; civic, social and fraternal organizations; arts and culture; and foundations (Hodgkinson and Weitzman 1996). A more comprehensive classificatory system used in comparative analysis breaks organizations into the following types: culture; education and research; health; social services; environment; development; civic and advocacy; philanthropy; international; religious congregations; business and professional, unions; and other (Salamon et al. 1999). 3. The transformation from traditional face-to-face participation in civil society organizations to a more distant “checkbook membership” in professionally managed organizations is an important additional problem (Skocpol 2003), but this is less applicable to local social service organizations.

References Bank of Portugal. 2014. Annual Report The Portuguese Economy. Lisbon: Bank of Portugal. Barroco, Maria de Fátima. 1997. “As Instituições Particulares de Solidariedade Social: Seu Enquadramento e Regime Jurídico.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos. Lisboa: Editora Vulgata. Barros, Carlos Pestana and Jose C. Gomes Santos, eds. 1997. As Insituições Não-Lucrativas e a Acção Social em Portugal. Lisboa: Editora Vulgata. Baum, Michael. 1997. Political Culture and the Consequences of Revolutionary Change: Workplace Democracy and Local Politics in Rural Portugal. PhD Dissertation.

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Bermeo, Nancy. 1986. The Revolution within the Revolution: Workers’ Control in Rural Portugal. Princeton, NJ: Princeton University Press. Cardona, Celeste and José C. Gomes Santos. 1997. “Apoio Fiscal do Estado as Instituições de Solidariedade Social.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 75–86. Lisboa: Editora Vulgata. Cunha, Rui. 1997. “Discurso.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 5–9. Lisboa: Editora Vulgata. Diário de Notícias. 2014. “IPSS ajudaram a evitar ‘crise humanitária interna’”. Diário de Notícias. February 20, 2014. Dionne Jr., E.J. and Ming Hsu Chen, eds. 2001. Sacred Places, Civic Purposes. Washington, DC: Brookings Institution Press. Downs, Charles. 1989. Revolution at the Grassroots: Community Organizations in the Portuguese Revolution. Albany, NY: State University of New York Press. EEA Grants. 2013. “Civil Society Fact Sheet Final March 2013.” Accessed via www. eeagrants.org April 1, 2013. Glatzer, Miguel. 2013. Welfare State Growth in the Portuguese 3rd Republic: Social Spending and its Challenges. Institute of European Studies, University of California, Berkeley, Paper Series. Glenn, Charles. 2000. The Ambiguous Embrace. Princeton, NJ: Princeton University Press. Grecco, Celso. No date. “Social Stock Exchange Portugal: A Work in Progress.” Accessed via http://euclidnetwork.netbook-world.co.uk/resources/doc_view/163case-study-social-stock-exchange.html April 1, 2013. Hodgkinson, Virginia and Weitzman, Murray. 1996. Nonprofit Almanac 1996–1997 Dimensions of the Independent Sector. San Francisco, CA: Jossey-Bass. Instituto Nacional de Estatística. 2013. Conta Satélite da Economia Social 2010, Edição 2013. Lisbon: Portugal. Jacob, Luis. 2001. A História das IPSS. Dissertação de Mestrado, ISCTE. Accessed via http://luisjacob.planetaclix.pt/IPSS.htm May 14, 2013. Leal, Cosa. 1997. “As Mutualidades e o Futuro da Acção Social em Portugal.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 339–342. Lisboa: Editora Vulgata. Maia, (Padre) Jose. 1997. “As IPSS e o Futuro da Acção Social em Portugal.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 326–331. Lisboa: Editora Vulgata. Marques Leandro, J.M. No date. “Sustentabilidade das IPSS’s.” ARCIL – Associação para a Recuperação de Cidadãos Inadaptados da Lousã. Accessed May 25, 2014 at http://www.arcil.org/docs/SUSTENTABILIDADE%20DAS%20IPSS.pdf Melícias, (Padre) Vitor. 1997. “As Misericórdias e o Futuro da Acção Social em Portugal.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 331–338. Lisboa: Editora Vulgata. Moren-Alegret, Ricard. 2002. Integration and Resistance: The Relation of Social Organisations, Global Capital, Governments and International Immigration in Spain and Portugal. Aldershot, UK: Ashgate.



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OECD. 2014. “Government Debt” Economics: Key Tables from OECD, No. 21. Patriarca, Fátima. 1995. A Questão Social no Salazarismo 1930–1947 (2 vols.). Lisboa: Imprensa Nacional Casa da Moeda. Paiva, Flávio. 1997. “CERCIS – Cooperativas de Solidariedade Social.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 139–158. Lisboa: Editora Vulgata. Putnam, Robert. 1992. Making Democracy Work: Civic Traditions in Modern Italy. Princeton, NJ: Princeton University Press. Quintão, Carlota. 2011. O Terceiro Sector e a sua renovação em Portugal. Instituto de Sociologia Universidade do Porto Working Papers 2a Série, No. 2. Rodrigues, Fernanda and Stephen Stoer. 2001. “Partnership and Local Development in Portugal.” In Local Partnerships and Social Exclusion in the European Union: New Forms of Local Social Governance? edited by M. Geddes and J. Benington, 134–151. New York, NY: Routledge. Salamon, Lester M. with Helmut Anheier, Regine List, Stefan Toepler, Wojciech Sokolowski and Associates. 1999. Global Civil Society. Baltimore, MD: The Johns Hopkins Center for Civil Society Studies. Santos Luis, António. 1997. “As Instituições Particulares de Solidariedade Social e a Acção Social em Portugal.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 119–138. Lisboa: Editora Vulgata. Silva, Manuela. 2010. “Enfrentar a Crise, Eradicar a Pobreza – O Contributo da Economia Social.” Sociedade e Trabalho 41. December 2010. Silvestre, António Luis. 1997. “Política de Acção Social em Portugal.” In As Insituições Não-Lucrativas e a Acção Social em Portugal, edited by C. P. Barros and J. C. Gomes Santos, 267–294. Lisboa: Editora Vulgata. Skocpol, Theda. 2003. Diminished Democracy: From Membership to Management in American Civic Life. Norman, OK: University of Oklahoma Press. Soares, Cândida, José Sousa Fialho, Fernando Chau, João Gageiro and Helena Pestana. 2012. “A Economia Social e a sua Sustentabilidade como Fator de Inclusão Social.” SERGA and POAT/FSE Programa Operacional de Assitência Técnica/Fundo Social Europeu. Sol. 2012. “Há 13 mil crianças com fome nas escolas portuguesas.” Sol. November 29, 2012. Accessed May 25 2014 at http://www.sol.pt/noticia/63863 Sousa, Sónia et al., 2013. As Instituições Particulares de Solidariedade Social Num Contexto de Crise Económica. Lisboa: Confederaçao Nacional das Instituições de Solidariedade. Tiago, Lucilia. 2012. “Mota Soares: Linha de Crédito de 150 Milhões para IPSS Encerrou.” Dinheiro Vivo. July 17, 2012. Accessed June 25, 2014 at http://www. dinheirovivo.pt/economia/interior.aspx?content_id=3881157 Truninger, Mónica, José Teixeira, Ana Horta, Silvia Alexandre and Vanda A. da Silva. 2013. “Estado Social e Alimentação Escolar: Criatividade na Austeridade.” Forum Sociológico. 23:13. Walsh, Andrew, ed. 2001. Can Charitable Choice Work? Covering Religion’s Impact on Urban Affairs and Social Services. Hartford, CT: The Leonard E. Greenberg Center for the Study of Religion in Public Life, Trinity College.

Part III

Democratic Politics in the Context of Crisis A Citizens’ Perspective

Chapter 12

Public Attitudes and Support for the EU in the Wake of the Financial Crisis Jennifer R. Wozniak Boyle and Chris Hasselmann

The economic and financial crisis has dominated the political agenda of both the European Union and its respective governments for the past several years. The economic effects, from rising unemployment to negligible growth rates, have been widely documented and explored. The political consequences likewise have been examined in terms of the impact on various national elections, especially in Greece and most recently in Germany. One area in need of attention, however, is the extent to which existing theories and models of support for integration are able to capture the public’s changing perception of the EU. Drawing on a series of Eurobarometer surveys before and after the crisis began in 2008, we first assess the extent to which support has been affected, as well as our ability to model such support. We then explore preferences over which actor is best suited to craft solutions to the crisis. We find that support for the EU has been negatively affected overall, but that the EU is still seen as the actor most suited to crafting a solution. We also demonstrate that the variables and models highlighted by the existing literature are capable of capturing this downward trend in an appropriate way. Our main conclusion is that it is the EU’s failure to live up to this leadership expectation that has caused its support and trust to plummet as much as it has. As Moravcsik (1998) and Pollack (2001) have argued, the EU provides a kind of two-level game (Putnam 1988), making it possible to pursue policies at the supranational level that are irrational or infeasible at the national one. We argue that one underlying basis for EU support was this alternative route to policymaking. However, the relative failure to lead during the crisis has effectively reduced this two-level game to a single playing field, and best accounts for the decline in support observed.

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The Crisis and Support For the European Union The starting point of the crisis has generally been marked by the bankruptcy of Lehman Brothers on September 15, 2008. Table 12.1 presents a chronology of some of the major ensuing events through 2011. While there were precursor events, the sudden and unexpected collapse of the Wall Street giant was the opening salvo of a global banking crisis that would subsequently evolve into a sovereign debt crisis that now appears to threaten the viability of the euro, if not the EU itself. The effect these events have had on support for the EU has been profound, and it has been getting progressively worse. For example, the Commission notes in its review of the Spring 2012 Eurobarometer (No. 77), that “trust in the European Union has fallen since the autumn of 2011 and now stands at its lowest ever level” (EU 2012, 13). Our primary goal is assess how well existing theories of support capture this decline. A common way to measure support for the EU is through an index using a fairly common set of survey questions (e.g., Boomgaarden et al. 2011; Garry and Tilley 2009; McLaren 2006, 2002; Hooghe and Marks 2005, 2004; Gabel 1998a; Gabel and Palmer 1995). We continue this drawing on Boomgaarden et al.’s (2011) notion that attitudes towards the EU should be measured on Table 12.1  A Timeline of the Crisis (2007–2011) Sept–Nov, 2007

Pre-Crisis Survey: Eurobarometer 68.1

September 15, 2008 Lehman Brothers files for bankruptcy (crisis begins) December, 2008 EU leaders agree to a 200bn euro stimulus plan December, 2009 Greece admits its debt is more than double the eurozone limit of 60% of GDP March, 2010 The eurozone approves a safety net for Greece, but provides no loans May, 2010 The first Greek bailout is announced (110bn euros) Crisis Survey #1: Eurobarometer 73.4 November, 2010 February, 2011 May, 2011

The Irish bailout is announced (85bn euros) The European Stability Mechanism is announced (500bn euros) The Portuguese bailout is announced (78bn euros) Crisis Survey #2: Eurobarometer 75.3

June, 2011 September, 2011

A second Greek bailout is announced (109bn euros) The Commission predicts eurozone growth will come “to a virtual standstill” Italy’s debt rating is downgraded from A+ to A EU Commission President Barroso warns the EU “faces its greatest challenge” UK Foreign Secretary Hague calls the euro a “burning building with no exits”

Source: Adapted from the BBC, 2012 (including quotations).



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multiple dimensions. While some of their five dimensions (performance, identity, affection, utilitarianism, and strengthening (~future integration/ deepening and widening) cannot be captured due to the lack of appropriate questions, we construct an index based on the following: 1. Generally speaking, do you think that (OUR COUNTRY)’s membership of the European Union is a good thing / neither good nor bad / bad thing? 2. Taking everything into account, would you say that (OUR COUNTRY) has on balance benefited or not from being a member of the European Union? 3. In general, does the European Union conjure up for you a very positive, fairly positive, neutral, fairly negative or very negative image? 4. Please tell me if you tend to trust [The European Union] or tend not to trust it? The resulting 8-point index has been rescaled to 0–100 for ease of interpretation and serves as the dependent variable in the models and figures that follow.1 A primary concern for any index is internal consistency (reliability): all of the components must be correlated, and measure the same underlying concept. To assess reliability, we use Cronbach’s alpha (1951), which provides a measure of the extent to which the items capture different facets of the same basic construct, in this case support for the EU. The scale reliability score (a) for the 4-item index is 0.79 for 2007; it is 0.81 and 0.73 for 2010 and 2011 respectively. While the minimum alpha required “depends on how a measure is being used,” alpha’s greater than 0.7 imply at least a modest level of reliability and values closer to 0.8 are generally accepted for the kind of survey-based scale used here (Nunnally 1978, 245; see also Lance et al. 2006).2 As an additional check, we examined how both the index and its components change over time. As seen in Figure 12.1, the index (support for the EU) declines after 2007. The concern therefore is that such movement should be caused jointly by all of the components rather than being driven solely by one factor. While Cronbach alphas around 0.8 suggest this is not the case, a conclusion backed up by examining the pairwise correlation of the components, we also compared the mean of each component (not shown) across time, verifying that each one contributes to the overall downward trend as should be expected from an index possessing sound internal consistency. Figure 12.1 shows the distribution of the mean level of support in the 27 member states in each of the three years under examination. In pre-crisis 2007, the EU enjoyed fairly robust support with a median of 66.9 points, whereas in midst of the financial crisis the median of country averages fell to 59.0 and 57.0 points respectively. Noticeably absent during the crisis years are any member states with an average level of support above 70; in 2007, there were eight.

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Figure 12.1  Declining Support for the EU. This shows the distribution of the 27 country mean levels of support before (2007) and during the financial crisis. The median was almost 67 in 2007, but had fallen to 59 by 2010 and to 57 by 2011. The crisis years also show the absence of any countries with support above 70. Although the exact number is not conveyed by the upper tail in 2007, there were in fact eight such countries, with a maximum of just over 77 points in Ireland. By 2011, the maximum was only 67.8, in Luxembourg. Source: Eurobarometer Nos. 68.1, 73.4, and 75.3.

Given that this crisis has largely affected eurozone countries, we compare the change in support in and outside the eurozone (as of 2011). Figure 12.2 shows a similar drop in support regardless of euro usage. While Greece experienced an especially large drop in support (−21.1 points between 2007 and 2011), and Sweden actually managed a small half-point increase, the average decrease in the two areas was nearly the same: −8.7 points in the eurozone, and −8.1 points outside it. A one-way ANOVA (not shown) more formally supports the claim of both equal means and variances. Explaining Support For The EU Just as attitudes towards the EU are widely measured using indexes such as this, they are also modeled as a function of a fairly widely accepted set of factors. While the actual survey questions used vary by necessity, the underlying concepts for which they serve as proxies are well established. These



Public Attitudes and Support for the EU in the Wake of the Financial Crisis 237

Figure 12.2  Change in Support 2011 vs 2007. This shows the change in the average level of support in each country between 2011 and 2007, separating the 17 countries that use the euro on the left from the 10 that do not on right. While outliers exist in both groups, overall, the decline in support is not dependent on euro zone membership. Source: EB Nos. 75.3 and 68.1.

models combine three schools of thought. First, the utilitarian perspective models attitudes towards integration as the result of cost-benefit assessments (see Christin 2005; Tucker et al. 2002; Gabel 1998a, 1998b; Anderson and Reichert 1996; Eichenberg and Dalton 1993). The central thesis is that “different groups . . . experience different costs and benefits from” integration with more educated and skilled individuals “having better opportunities to apply their talents internationally, creating a more positive attitude” towards the EU (Lubbers and Jaspers 2010, 24). The second perspective focuses on political values and the cues generally uninformed individuals use to formulate opinions on the EU (see Hobolt 2006; Gabel 1998b; Franklin et al. 1995). The central thesis here is that left parties are more hostile than right parties because they see the process as overly beneficial to the owners of capital, and of less utility and benefit to labor. In addition, those more inclined to follow and engage in political discussions are better able to comprehend and identify with the fairly abstract concept of European integration (see Inglehart, Rabier and Reif 1991; Janssen 1991). The third school of thought focuses on how integration is or is not seen as a threat to national identity (see Lubbers and

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Scheepers 2010; McLaren 2006, 2002; De Vreese and Boomgaarden 2005; Hooghe and Marks 2005). While many of the questions regarding national verse EU attachment, or views on immigration were unavailable in the three Eurobarometers used here, Lubbers and Jaspers note that those less educated tend to “feature more nationalistic attitudes and consequently express stronger fears about” the EU (2010, 25). Steenbergen and Jones (2002) show that when data cluster in groups, such as individuals clustering in countries, a multilevel analysis is preferable to linear regression as the latter produces standard errors that are too small. Therefore, we use a two-level model to accommodate the country and individual-level nature of the data. Because the dependent variable is continuous but truncated on the scale 0–100 and not normally distributed, we fit a random intercept generalized linear model with a Gaussian link function using GLLAMM within STATA.3 Since, as Tanasoiu and Colonescu note, “it is reasonable to believe that the respondents have no particular motivation to refuse to answer some questions, . . . we can safely assume that our missing data are” missing at random, and hence amenable to imputation (2008, 369). The imputation method used here is the Amelia II program available within the R statistical package (Honaker et al. 2011). Because each country surveyed has essentially the same number of respondents (~1000), but very different populations, the data is weighted at the individual-level by each nation’s share of the total EU population aged 15 and over; at the country level, all countries are weighted equally as the probability a country is included is 1.0 for all member states. The results are presented in Table 12.2. The single strongest predictor is whether or not one tends to trust one’s own government; such trust in 2007 raised an individual’s support by almost 14.5 points (holding everything else constant). Not surprisingly, once the crisis began, such continued trust resulted in even higher levels of support for the EU. If one tends to trust one’s government, then one is likely to support its intergovernmental efforts, especially in times of crisis. The next several predicators come in pairs, and each yields the expected results. Believing that the national economy will improve over the next 12 months raises support (e.g., by 3.5 points in 2010) while believing it will worsen lowers it (e.g., by −2.5 in 2010). The same is true for expectations concerning one’s own household financial situation; optimism yields higher support (by 0.78 points in 2011) while pessimism lowers it (by −5.2 points in 2011). The relative impact, however, such expectations have depends on whether the forecast concerns the national economy or one’s household situation. When asked about the national economy over the coming year, a positive expectation consistently produces a larger increase in support than the corresponding drop in support produced by a negative forecast: 5.37 vs −0.71



Public Attitudes and Support for the EU in the Wake of the Financial Crisis 239

Table 12.2  Multilevel Models of Support for the EU Tend to trust national government Expect Nat. economy to improve over coming yr. Expect Nat. economy to worsen over coming yr. Expect household Fin. Sit. to improve over coming yr. Expect household Fin. Sit. to worsen over coming yr. Higher educated Lower educated Professional Manual worker Frequently discuss politics Never discuss politics Left-Right self placement on 0–10 point scale Female Age Constant Standard deviation of the residuals at the individual level Standard deviation of the countryspecific intercepts N (individual level) Log likelihood

2007

2010

2011

14.44 (0.29)* 5.37 (0.71)*

19.10 (1.02)* 3.54 (1.03)*

17.25 (0.84)* 4.69 (0.58)*

−0.71 (0.65)

−2.51 (0.86)*

−2.70 (1.00)*

1.42 (0.38)*

0.53 (0.91)

0.78 (0.33)*

−7.72 (0.36)*

−6.34 (0.63)*

−5.20 (0.68)*

5.06 −4.04 1.73 −1.89 1.00 −3.68 0.47

7.91 −4.24 3.37 −1.40 1.14 −4.64 −0.22

7.31 −3.49 1.69 −1.42 0.87 −4.35 −0.37

(0.34)* (0.39)* (0.62)* (0.41)* (0.39)* (0.32)* (0.07)*

−1.31 (0.28)* −0.05 (.01)* 62.94 (1.03)* 21.97 6.61 26,768 −120,750.06

(1.23)* (0.69)* (1.05)* (1.30) (0.61) (1.08)* (0.29)

(0.92)* (0.93)* (0.65)* (0.96) (0.57) (1.05)* (0.32)

−2.17 (0.41)* −2.52 (0.62)* −0.06 (0.03) −0.06 (0.02)*  58.05 (2.24)*  55.00 (1.95)* 23.45 23.28 5.92 26,641 −121,903.52

6.06 26,713 −122,029.69

*Indicates p