It is obvious: Europe is in a crisis. This crisis affects the economy and the Union’s institutions, but the negative outcome of the French and Dutch referenda on the European Constitutional Treaty also reveal a profound political-ideological crisis. A way out cannot be achieved by economic reforms alone; institutional reforms are needed and they require political will.
I. The Economic Crisis
The problem with the European Economy
The project of European integration was founded on the legitimacy obtained from producing good results for citizens: Europe promised lasting peace and rising prosperity. However, this conventional view has increasingly lost its attraction in recent years. Unemployment is stubbornly high; economic growth is poor compared to the other major industrialized economies.
Figure 1: Unemployment Rates in Major G7 Countries
Figure 1 shows the unemployment rate in Euroland, the United States, Canada, UK and Japan. Compared to other G7 economies, European joblessness remains persistently high. A major reason is the insufficient growth of GDP. Employment is created if and only if GDP grows faster than labor productivity. Figure 2 shows that this was the case in the late 1980s and after the EU started in 1999, although the rate of employment growth has come down since the initial boom in the year 2000.
Figure 2: Job Creation in the Euro Area (5 year moving average)
Figure 2 also shows clearly that the insufficient job creation of the European economy is not due to high rates of productivity growth but rather to insufficient increases in GDP. In fact, productivity growth has fallen from the 2 percent of the mid1980s and 1990s to now only 1 percent. The Lisbon strategy, which was designed in 2000 to make the EU “the world’s most dynamic economy”, has neither lifted productivity nor GDP growth. The fundamental question for the European economy is how to improve GDP growth persistently in order to return to full employment. This is a matter for macroeconomic policies as supply-side reforms would essentially translate into higher productivity.
The purpose of stability-oriented macroeconomic management is to keep a balance between aggregate supply and demand. A sustainable growth performance depends largely on the interaction of monetary, fiscal and wage policies. But in Europe a successful policy mix is hampered by institutional short comings. Monetary policy has become fully integrated under the authority of the European Central Bank, but fiscal policy is the random outcome of independent national policy decisions. This causes the equilibrium interest rate to be higher than warranted.
Critics have accused the ECB of being overly restrictive, but Figure 3 shows that this is not the case. A tight policy mix represents points above the downward sloping trend line and not below. The combination of monetary and fiscal policy is looser than the strict equilibrium position would require. Since 2001, interest rates have been lower than what the aggregate budget deficit of the Euro area would require. Nevertheless, it is unlikely that such relaxed policy mix will last for long. Unless fiscal discipline improves, interest rates will go up. This will dampen investment and growth. Europe’s economic problem is not monetary, but fiscal policy.
Figure 3: Euroland Policy Mix: (y-Axis: Real long-term interest rates; x-Axis: net government lending)
In a single monetary area, fiscal policy is a major factor determining the level of interest rates in the capital and money markets. In the capital market this manifests itself in the crowding out mechanism; but monetary policy will also have to increase interest rates if the demand effect of fiscal policy becomes excessive. For this reason, the Stability and Growth Pact established the rule that all member states in monetary union should balance their structural deficits (balance their budget “over the medium term”). However as Figure 4 shows, only very few countries adhere to this rule. Many countries have structural deficits well above 2 percent and some times they even exceed the three percent, which are permissible under the excessive deficit rule for actual deficits.
The reason for this failure is a collective action problem. If all member states together adhere to the balanced budget rule, the equilibrium interest rate will be low. In fact, based on the trend line in Figure 3, the equilibrium interest rate in Euroland would be at least half a percentage point lower. However, in this case each country individually has an incentive to borrow at cheap interest rates rather than to tax its citizens. In other words, every government could free-ride on the others if they would stick to the rules. But free-riders positively harm every one else: they cause Euro area aggregate fiscal deficit to be higher than the rules permit. As a consequence, euro-interest rates are higher in equilibrium than necessary; economic growth will remain structurally low.
Figure 4: Structural Deficits in Euroland (upper group: Finland, Spain, Ireland)
Another problem for the Euro area is the diverging development of unit-labor costs. Figure 5 shows the deviation of unit-labor costs from the average Euro area unit-labor cost levels for the years 1999-2000. In a well functioning market economy regional unit-labor cost deviations should return to the European average. Although this seems to have been the case in Luxemburg, Italy, Austria and the Netherlands, it cannot be said for Portugal, Spain or Greece, or for Germany. Germany is today the most cost-competitive economy in Euroland with unit labor costs 10 percent below the average Euro area level, while Portugal and Spain are 15 percent more expensive. There is high risk that the necessary adjustment in Portugal, Spain and Greece will be a long and painful recession with high unemployment.
The handicap of the intergovernmental method of governing Europe is also obvious with respect to the Lisbon strategy. This policy agenda was meant to reinvigorate Europe’s economic growth, “making it the world’s most competitive economy by 2010”. It adapted the “Open Method of Coordination” between national governmental administrations because at the 2000 Lisbon summit it was impossible to agree on binding rules or to delegate competences to the European Commission. Not surprisingly, a group led by the former Prime Minister Wim Kok found in 2005 that “half way to 2010 the overall picture is very mixed and much needs to be done in order to prevent Lisbon from becoming a synonym for missed objectives and failed promises”. If structural reforms are politically costly (in terms of voters), each government has an interest to let others undertake the reforms that benefit everyone without making their own efforts. Again, we find that collective action problems are jeopardizing the efficient provision of public policies.
Figure 5: Unit Labour Cost Deviations From Eurozone Levels: 1999-2008
The institutional crisis
Europe’s intergovernmental governance has created an institutional disequilibrium. European governance does not function as a democracy. In a democracy, citizens express their policy preferences after common deliberation by voting for a government. In the European Union they are deprived of this right. The European Commission is not a government; it started out as a fair go-between for states, a guardian of the common interest. Today it is less and less capable to fulfill this role. It has become oversized after the recent enlargement where each country provides one commissioner. At 27, the European Commission is becoming a chamber of national interests.
The political crisis: Reemerging nationalism
With this increasingly less efficient policy output, nationalism is reemerging in Europe. Partly this may be a consequence of the changing geo-strategic situation after the Cold War. However, this political development is also a consequence of globalization. Globalization inevitably creates winners and losers. From an economic point of view this would not be problematic as long as the losers are compensated by the winners. However, in the present European context such redistributive policies are not possible.
The Way out of the crisis
Economic reforms are not enough.
Europe’s economic problems cannot be solved by simply implementing economic reforms. In fact economic policy is a public good. Some of these public goods can effectively be provided by voluntary cooperation among governments. Examples of such success stories were the creation of the single European market or specific projects of cooperation such as Airbus, or Galileo, etc… However the necessary economic reforms in the European Union can only be guaranteed by a European government that is assuming full political responsibility.
Necessary institutional reforms
Improving the EU’s governments requires fundamental institutional reforms. One of the main arguments against ratification of the Constitutional Treaty in France was that the third part of the treaty would lock the Union permanently into a neoliberal interpretation of Europe’s social model. The problem with the European Constitutional Treaty was that in some countries Europe looks too socialist, while for others it is not socialist enough.
To overcome this dilemma would require a political union that abolishes national vetoes and the gridlock which undermines output legitimacy. In other words, European public goods require a European government.
So, what would be the competences of a European government? The Belgian Prime Minister Guy Verhofstadt has proposedthe creation of a European government with responsibilities for five major policy areas: (1) economic policy (2) research and technology (3) domestic security, immigration and the fight against terrorism (4) European diplomacy (5) a European army. As Verhofstadt has shown, such a European government would be able to provide efficient policy making because it would be based on a larger democratic legitimacy. However, it is clear that the legitimacy of such a government is only possible if it is elected by European citizens. In other words, the way out of Europe’s crisis implies a political union plus full democracy.
The necessity of political will
Democratizing Europe means politicizing European policies, based on a broad constitutional consensus. European citizens must have a right to decide between the right and left of the political spectrum. In practical terms, this would imply that the electoral law for the European Parliament should be unified across the European Union. Thus, political competition will contribute to the mobilization of interests; these interests will be translated and bundled into party programs between which Europe’s citizens will then be able to choose.
However, such European democracy requires a founding coalition. The norms of freedom, equality and solidarity are the values that incorporate the great political ideologies of classical liberalism, social democracy and modern Christian democracy. They are incompatible with the backward-oriented nationalist conservative ideas of national sovereignty. As a consequence, the founding coalition for a European government at the European level must be a large coalition that goes from social democratic to political liberal parties.
To summarize, Europe is in a crisis, but each crisis offers an opportunity. The political union plus democracy is the answer for the problem Europe faces today. European citizens must become responsible for the common good they own, which is their European res publica.
Vive la République Européenne!