Introduction - Governance

EuroMemorandum 2013 www.euromemo.eu

Introduction The European Union (EU) is facing a complex crisis. The financial crisis which began in the US in 2007, and which deepened dramatically in 2008, has exposed deep rifts in the architecture of the EU’s most ambitious project, the economic and monetary union. As European governments sought to counter the danger of financial collapse and the impact of the deepest recession since the 1930s, government deficits soared. The debt crisis which broke in 2010 in Greece, spread rapidly, first to Ireland and Portugal, and then to Spain and Italy Austerity policies were first imposed on the countries of Eastern Europe and then on the peripheral euro area countries as a condition of financial support from the EU and the International Monetary Fund. But austerity policies are now also being implemented in more and more of the rich countries that make up the euro area core. Under the impact of the deeply conservative policies being adopted by European and national authorities in response to the crisis, unemployment and social hardship are rising across much of Europe. The development of the European Union has, since its inception, been driven by a powerful capitalist dynamic. The initial years, however, were characterised by full employment and it was possible to attain a significant degree of social advance for the great majority of the EU’s citizens. This began to change in the 1980s. Major capitalist enterprises adopted a more aggressive stance in relation to employees; financial capital came to play an increasingly dominant role; and the EU and the member states moved towards a neo-liberal set of policies, including de-regulation, privatisation and the promotion of competition, which involved a significant shift in favour of the interests of private capital. The expansion of the EU to the East opened up a whole new region for investment, production and sales by big West European companies while the creation of the euro area permitted a further marked deepening in the division of labour within Western Europe, enabling Germany and other Northern states to achieve a striking expansion of their exports. Now, under the aegis of the crisis, a wide-ranging process of restructuring is under way. The largest and most successful companies are strengthening their position; the social agenda is being reorganised with especially serious cuts in wages and welfare benefits in the most crisis stricken countries; and the position of the core countries is being strengthened as that of the periphery is weakened. The crisis has highlighted the deeply undemocratic construction of the European Union. The European Commission is assuming ever greater authority in overseeing national budgets, imposing the doctrinaire rules enshrined in the Stability and Growth Pact, now due to be yet further intensified with the adoption of the so-called Fiscal Compact. While national parliaments are effectively stripped of such fiscal oversight as they might have had, the European Parliament – despite a limited accretion in its competences – is still woefully unable to exercise any meaningful democratic control over economic policy at a European level. The proposal for a banking union could be an important step to achieving an effective European supervision of banks, but the way in which it is planned to do this will strengthen yet further the position of the European Central Bank, an institution that is at present completely outside any process of democratic accountability. This is a Europe of the elites, where powerful lobby organisations are able to exercise wide-ranging influence behind the closed doors of the Brussels administration, well hidden from the prying eyes of Europe’s citizens. The relation between the member states has also been significantly accentuated. The German government, together with its close allies, in particular the governments of Netherlands and Finland, has assumed an ever stronger position, sometimes inside the official structures, at other times through so-called ‘coalitions of the willing’. Any hopes that the election of a Socialist Party president in France might result in a challenge to the EU’s over-weaning emphasis on austerity policies have been disappointed. For many European heads of government, the path to a decision in Brussels now appears to pass through Berlin. The idea that the German economy can in some sense be a model for the EU is quite mistaken. Germany’s economic development since the introduction of the euro has been dependent on an aggressive export-led strategy where stagnant wage growth and weak domestic demand were compensated by a rising trade surplus. While profits increased, a low paid sector has been created that now encompasses some 20% of the workforce. At the same time, with the EU’s international trade roughly in balance, other European countries have been faced with a rising trade deficit. Inflows of capital to peripheral EU countries were supposed to promote a process of economic convergence but in many countries they merely fuelled consumption and the growth of unsustainable bubbles in asset prices. Since the onset of the crisis, the inflows have been abruptly reversed and the divergence between member states has widened. Only a major programme of investment in sustainable projects that create skilled, well-paid jobs can reverse this process. At a global level, the EU has been following a strongly neo-mercantilist global role, pushing for an extension of free trade in manufactured goods at the World Trade Organisation’s stalled negotiations. Meanwhile, developing countries that wish to maintain access to European markets have been required to sign up for so-called Economic Partnership Agreements which oblige them to open their economies to European multinational companies in a way that goes far beyond what is required by the WTO. Perhaps the most far-reaching feature of the complex crisis facing Europe is the challenge of global climate change. The United Nations Rio+20 international conference on sustainable development in July 2012 failed to reach any significant agreement. Meanwhile, aerial photographs map the retreat of polar ice caps and storms of unprecedented intensity pummel the globe from Pakistan to New York. Europe, as one of the richest regions in the world, must give the highest priority towards promoting an economic transformation that will achieve a fundamental reduction in the consumption of energy and other non-renewable resources, and in the emission of green house gasses. In the last year there have been impressive mobilisations by trade unions and social movements, above all in the peripheral euro area countries that are facing the cutting edge of austerity programmes, where the first ever coordinated general strike was organised on 14 November 2012. There have also been several important initiatives to promote greater coordination amongst movements at a European level. This EuroMemorandum is intended as a contribution to developing these initiatives and in promoting a different Europe that is based on the principles of democratic participation, social justice and environmental sustainability. In contrast to previous years, the chapters in this EuroMemorandum are organised by theme. In each we attempt to outline key developments in the past year; to identify some of the main problems with the policies adopted by European and national authorities; and to sketch the basis for an alternative approach.

1 Economic and financial policy

1.1 Key economic developments in 2012

Economic expansion in the European Union (EU) came to a standstill in 2012, with output still below the level of 2008 (see Table1).1 In most member states the official unemployment rate continued to rise in 2012, while real wages either stagnated or declined. As in previous years, however, there are important regional variations. In the peripheral euro area countries, the impact of strict austerity policies has resulted in recessions in Italy and Spain, and especially deep recessions in Portugal and above all Greece, where output has now fallen by 17% since 2007. Serious hardship is increasingly widespread: unemployment is very high in all these countries, with official rates of 25% in Spain and Greece; real wages continue to decline and, compared with pre-crisis levels, are down by 9% in Portugal and 19% in Greece; meanwhile public services are deteriorating sharply under the impact of severe spending cuts. In Eastern Europe, most countries registered some growth in 2012 although, in every country except Poland and Slovakia, output is still below pre-crisis levels. In the Baltic countries, which suffered the deepest downturns in 2008-09, output is still around 6% down on pre crisis levels in Estonia and Lithuania and 13% down in Latvia. Although unemployment has declined slightly in the Baltic countries – partly because of rapid emigration – it remains high and real wages have fallen since the onset of the crisis by 9% in Latvia and 16% in Lithuania. In Poland by contrast, output has risen by 13% since the onset of the crisis, although unemployment has risen slightly and real wages have declined by 1% from their peak. In the euro area core, most countries also registered some growth in 2012, but this was subdued as austerity policies depressed demand in other euro area markets. Core countries were also affected by a slowdown in international growth, most notably in the US and China. In Germany, where exports had helped fuel a strong expansion in 2010-11, growth in 2012 was expected to be less than 1%. Although the German unemployment rate in 2012 declined to 5.4% and real wages increased by around 1%, this will now prove difficult to sustain unless there is a major shift away from the reliance on export-led growth. The economic situation in Europe has been exacerbated by the policies pursued by the EU and national governments in response to the euro area debt crisis which broke out in Greece in 2010 and subsequently spread to Ireland and Portugal. These policies have focussed on promoting austerity and failed to respond adequately to the highly precarious financial situation. The expectation that governments would have to rescue further banks, most notably in Spain and Italy, led to an intensified selling of government bonds in the second half of 2011; at the same time the fall in bond prices deepened the losses faced by banks, due to their large holdings of government bonds. As the interaction of the debt crisis and the banking crisis intensified, the European Central Bank (ECB) became increasingly alarmed at the precarious position of the banking sector and in December 2011 it launched the Long Term Refinancing Operation, lending the banks a total of €493 billion, followed in February 2012 by a further €529 billion. The loans were for a period of 3 years at an interest rate of 1%, and – in marked contrast to the loans provided by the EU to struggling governments – there were no conditions attached. This huge injection of funds temporarily relieved the immediate pressure on the banks. Some €150 billion was used by the banks to buy government bonds, providing a degree of support for bond prices – and substantial profits for the banks as a result of the wide interest differential. But the bulk of the funds were re-deposited at the ECB, and total bank lending to businesses and households in the euro area actually declined slightly in the first nine months of 2012.

Table 1: Indicators of EU output, unemployment and wage growth GDP growth 2011-12, %* GDP growth peak- 2012, %* Unemployment rate Sep 2012, %* Real wage growth 2011-12, %** Real wage growth peak- 2012, %** Euro area (17) -0.4 -1.5 11.6 -0.1 -0.4 European Union (27) -0.3 -1.1 10.6 -0.1 -0.8 Austria 0.8 1.6 4.4 0.5 -1.4 Belgium -0.2 1.1 7.4 0.5 -0.2 Finland 0.1 -2.8 7.9 0.2 -0.1 France 0.2 0.2 10.8 0.2 2.4 Germany 0.8 2.7 5.4 1.0 1.9 Luxemburg 0.4 -0.0 5.2 -0.4 -1.0 Euro area core Netherlands -0.3 -1.4 5.4 -0.3 -0.8 Greece -6.0 -19.8 25.4 -7.8 --19.3 Ireland 0.4 -6.4 15.1 -1.2 -3.4 Italy -2.3 -6.7 10.8 -1.4 -2.9 Portugal -3.0 -6.1 15.7 -5.1 -9.2 Euro area periphery Spain -1.4 -5.0 25.8 -1.8 -5.8 Cyprus -2.3 -2.4 12.2 -3.7 -3.7 Estonia 2.5 -5.5 10.0 0.9 -6.7 Malta 1.0 3.9 6.4 -1.3 -4.8 Slovakia 2.6 5.1 13.9 -2.1 -4.8 New euro area Slovenia -2.3 -8.3 8.4 -2.2 -2.3 Denmark 0.6 -3.3 8.3 -0.5 -1.3 Sweden 1.1 5.7 7.8 1.9 1.5 Northern non-euro United Kingdom -0.3 -2.6 7.8 -0.2 -3.2 Bulgaria 0.8 -2.8 12.4 2.1 5.6 Croatia -1.9 -10.0 15.2 -1.9 -1.3 Czech Republic -1.3 -1.5 6.8 -0.5 1.7 Hungary -1.2 -5.1 10.6 -1.2 -11.6 Latvia 4.3 -13.2 15.9 0.5 -9.3 Lithuania 2.9 -5.8 12.9 0.1 -15.7 Poland 2.4 12.8 10.1 0.3 -1.1 Eastern non-euro Romania 0.8 -5.1 7.1 0.9 -6.6 Source: * Eurostat (November 2012), Peak GDP is highest of 2007 or 2008. ** Ameco (November 2012), Peak real wage is highest for 2007-2010.

As the economic situation deteriorated in the first half of 2012, euro area governments focussed on passing into national law the so-called Fiscal Compact. This had been agreed, in many cases reluctantly, by 25 countries at the end of 2011, primarily at German insistence. It requires states to introduce a constitutional rule that will restrict a government’s structural budget deficit to not more than 0.5% of GDP in the future. The measure completely fails to recognise that, in most countries, budget deficits were not the cause of the current malaise but rather the result of the financial crisis which began in the US in 2007-08. The Compact will seriously restrict the ability of governments to conduct an active fiscal policy in the future; it has also been widely criticised for the ambiguity about what constitutes a structural deficit, and when it is due to take effect. The emphasis on fiscal consolidation also signalled that the EU authorities had no effective policy to counter the recessionary tendencies in Europe and, as it became clear that countries such as Spain would continue to face difficulties servicing their debts, speculation against the countries’ government bonds intensified. At the end of July 2012, the ECB President, Mario Draghi, announced that the ECB would do ‘whatever it took’ to preserve the euro and this led to an immediate rise in the price of Spanish and Italian government bonds. In September, the ECB agreed on the details of a programme, known as Outright Monetary Transactions, to undertake large, unlimited intervention in government bond markets to stabilise the price of bonds that were under threat – as the central banks in the US and Britain have been doing since the onset of the crisis. (Previous ECB intervention in bond markets had been small scale, and limited in time.) However, it was also announced that this would only be undertaken if governments first reached agreement on the terms for a loan from the euro area’s rescue fund, a condition which is likely to imply an intensification of the austerity policies which have been driving the downturn in many countries. But even this was too much for the head of the German Bundesbank, who publicly criticised the proposal; significantly, however, the German premier, Angela Merkel, expressed her support for Draghi’s proposal. The original euro area rescue fund, the temporary €440 billion European Financial Stability Facility set up in 2010, was due to be replaced by the permanent European Stability Mechanism (ESM) in July 2012. In the event its launch was delayed until September 2012 as a result of an unsuccessful attempt to block it at the German constitutional court by a group of dissident parliamentarians. The ESM will be able to make loans totalling €500 billion, financed mainly by issuing bonds. However, this is equal to only one-sixth of Italy and Spain’s outstanding debt and by sending a clear signal of the limits of EU intervention, could actually encourage speculation in the future. EU heads of government met at the end of June 2012 for their 19th summit since the outbreak of the crisis, and appeared to agree on several significant measures. First, it was agreed to create a European Banking Union. This is a major institutional innovation in the architecture of the European Union, and will involve the creation of a single European supervisory mechanism for banks in the euro area. Second, in order to break the vicious circle between bank losses and government bonds, it was agreed that the ESM would be able to recapitalise countries’ banks directly, thereby avoiding weighing down national governments with yet further debt. This would have relieved the pressure on Spain and similar treatment was held out for Ireland. Such assistance was, however, made dependent on first establishing the single European supervisory mechanism for banks. The third measure agreed at the June summit was to provide €120 billion to promote growth through infrastructure investment. This is a positive step but it is equal to barely 1% of euro area GDP and will be spread over several years. It is also partly illusory, since it draws on existing structural funds that have not been spent because austerity-strapped national governments have been unable to raise the necessary counterpart financing, and such rules will have to be relaxed if hard pressed countries are to benefit. Proposals to make the ECB the single supervisor for all euro area banks were officially unveiled by the Commission President, José Manuel Barroso, in his annual ‘state of the union’ address in September 2012. However, after a meeting at the end of September, German, Dutch and Finnish finance ministers stated that ESM funds should not be used to help deal with pre-existing bank debts, as Spain and Ireland had been led to expect; questions were also raised about the plan for a banking union, including whether it would be possible to establish a common bank supervisor by January 2013 (a pre-condition for using ESM funds to recapitalise banks). France has supported moving ahead rapidly on the creation of a single supervisory mechanism for banks, but Germany has stressed the complicated nature of the task. At the summit in October 2012, heads of government declared that proposals for a single supervisor were a matter of urgency, but the target of January 2013 is not binding. A further source of tension arose because Eastern European countries that are obliged to join the euro in the future are angry at their restricted rights under the Commission’s proposals for the banking union. The ECBs willingness to intervene in bond markets temporarily stabilised speculative pressures against peripheral euro area bonds in the second half of 2012. Furthermore, the German government has now recognised that a Greek exit from the euro area would be massively destabilising. However, the banking systems of the peripheral euro area countries are haemorrhaging as capital is shifted abroad, in particular to Germany. In October 2012, the President of the European Council, Herman Van Rompuy, presented proposals for moving forward on economic union, including the creation of a European finance ministry. But this is to be subject to the same strict budget rules that apply to national governments, and is principally envisaged as an instrument for establishing yet firmer centralised control over national fiscal policies. By October 2012, even the notoriously conservative International Monetary Fund was questioning whether the EU’s focus on fiscal austerity was adequate. As the European economy stagnates and increasing numbers of citizens face unemployment, rising poverty and cuts in essential public services, the European Union’s principal proposal for promoting economic reactivation rests primarily on repeating its insistence on establishing fiscal discipline.

1.2 The EU’s erroneous response

Fiscal policy in the EU seems set to continue and even reinforce the course of austerity that is implied in the current institutional setting of the revised Stability and Growth Pact (SGP), the Fiscal Compact and the conditions attached to EFSF/ESM loans. If pursued further, this strategy will lead to years of stagnation for the euro area as a whole and to a protracted depression with severe economic, social and political consequences for the most troubled economies in the periphery. After the numerous hasty amendments it is difficult to disentangle which of the constraints on government deficits and debt will be most binding on member states over the next few years. Under plausible assumptions the most binding rules for the majority of countries will be the current excessive deficit procedures (EDP) and the adjustment programmes under the EFSF/ESM which will over the medium term be followed by the Fiscal Compact’s limit of 0.5% of GDP for the cyclically adjusted budget deficit. For the countries with very high public debt levels (namely Ireland, Greece, Italy and Portugal) the new debt related aspect of the EDP, which calls for debt in excess of 60% of GDP to be reduced by 1/20th each year, will require further substantial fiscal contraction. A rough estimate of the ensuing negative cumulative fiscal stance from 2013 to 2016 leads to the alarming figure of 3.5% of GDP for the euro area as a whole, of between 5% and 8% for Italy, Portugal, Slovenia, Spain and Cyprus, and of more than 10% of GDP for Ireland and Greece. Under the current circumstances (simultaneous consolidation efforts mainly on the expenditure side everywhere, monetary policy at the lower bound) the fiscal multiplier is bound to be large. Even using a modest fiscal multiplier of around one, however, is sufficient to show the destructive potential inherent in the current regime of austerity. In this case the negative fiscal stance would be transformed into GDP losses of exactly the same size with millions of jobs being destroyed. There is absolutely no evidence that this consolidation will engender any beneficial confidence effects, as claimed by some mainstream economists. In fact, a look at the economic performance of the euro area economies in recent years shows that the countries with the largest negative fiscal stance are also those countries which are currently in recession. It is also clear that austerity has not led to any improvement in the risk premiums on government bonds. The negative output and employment effects caused by austerity will result in higher government deficits (and debt levels) that will – under the current institutional and political regime – in turn increase the necessary fiscal restriction in order to reach the very low target values. The emergence of a vicious circle of consolidation efforts leading to higher deficits and debt levels and, in turn, to yet greater consolidation efforts is a dangerous possibility that can already be observed in several countries. In order to avoid such a vicious circle developing, all the three relevant institutional constraints for fiscal policy need to be reformed at the same time. If the Council decides to provide more leeway by shifting the EDP deadline, the adjustment that is necessary under the Fiscal Compact will become larger. And if the transition path to the almost balanced structural government balance is extended, then the adjustment required under the EDP-debt criterion will rise. What is presented as a tight three-layer procedure for achieving fiscal sustainability is, in reality, likely to be a three-step procedure for strangling growth in the euro area economy.

The banking union Governments in the euro area and the EU are beginning to understand that previous reforms of the financial system have been insufficient to cope with the depth of the problems. New steps have been envisaged in 2012. Attempts were made to limit the negative effects of the European Stability Mechanism (ESM), the ECB decided to enlarge its role as a lender of last resort, and it was decided to create the Banking Union in order to get the euro crisis under control. In spite of these decisions, the logic of ‘too little, too late’ persists and the muddling through will continue. There is growing consensus that the establishment of the euro suffered from the beginning from the lack of homogeneity with respect to its regulatory framework. The proposal for a European Banking Union consists of the following elements: •A regulation that appoints the ECB as the common supervisory structure for the 6,000 banks in the euro area; •Common rules for capital requirements and other reforms to implement Basel III Accords at EU level; •A common deposit guarantee scheme; •A common resolution or recovery mechanism for failing banks. According to the draft proposal, the ECB will have the right to authorise a bank or to withdraw the authorisation, to remove a bank’s management, to require any information, to undertake on-site inspections and to impose pecuniary sanctions. In order to give the impression of democratic accountability, the ECB will have to answer questions before the European Parliament and report regularly. However, the leadership of the new institution will be appointed by the Council. At first glance the project might appear reasonable. But when the details of the proposals are examined, it is clear that the Banking Union creates new problems which are not settled. It is doubtful whether the proposed scheme will be really able to get the crisis under control. First, there is the problem of the linkage of the new institution under the roof of the ECB to the already existing European Banking Authority (EBA), which was established in 2011. The EBA is responsible for the 27 EU countries while the new supervisory structure by the ECB will only be responsible for the euro area. This will deepen fragmentation in the EU. There is, furthermore, the issue of internal conflicts of interests. What happens, for instance, if the ECB in its capacity as supervisor has to close a bank which is indebted towards the ECB, which then would have to incur losses? And of course, as in all European projects, there is the tension between the national and the supranational level. It is impossible to supervise 6,000 banks with one single institution. Consequently, the new body will largely depend on national state administrations and thereby lose a great deal of efficiency. A common deposit guarantee scheme is still too politically sensitive for many countries and national interests will be even stronger, as this concerns money and its distribution. There is, for example, the case of Savings Banks, which were not engaged in widespread speculation prior to the onset of the crisis, and which do not wish to be responsible for guaranteeing the losses incurred by the speculative business models of investment banks. At the same time, the Finnish government does not want to participate in guarantees for Greek banks while the German government does not want to stand behind Italian banks. However, a common supervision, the deposit guarantee scheme and the resolution mechanism are like a tripod. If one leg is missing, the whole structure will fall down.

1.3 Promoting full employment and financial stability

Economic policy in the EU has been obsessed with the budget deficit for the past few years, but the two deficits which need to be addressed most urgently are the jobs deficit and the democratic deficit. Macroeconomic policies must be put to work to reduce the jobs deficit and the setting of macroeconomic policies changed in ways which make a contribution to the reduction of the European Union’s democratic deficit. Fiscal policy should be re-focused on reducing the jobs deficit. Enhanced public expenditure should be used to promote socially and environmentally desirable investment projects that will contribute to establishing full employment with good work. There should be an end to the attack on social welfare spending and tax policies should be re-oriented towards a more progressive system, something which would itself tend to reduce budget deficits. High incomes (say over €250,000) should be taxed at a high marginal rate (perhaps 75%). For the euro area countries, national governments should be released from the constraints of the Fiscal Compact. A co-ordinated reflation rather than generalised austerity should be the order of the day. It is important that the European Central Bank and, for countries outside the euro area, the national central banks, give full support to fiscal policies for prosperity and do not persist with their continual calls for fiscal consolidation. A single currency requires a Federal level fiscal policy with tax raising powers, substantial levels of public expenditure, and the ability to run deficits and surpluses. A Federal fiscal policy would, if properly applied and not subject to balanced budget stipulations, act to cushion downturns at both the Federal level and at the national and regional levels. It would also ensure that effective fiscal transfers occurred between the richer regions and the poorer regions. Federal taxation would replace some elements of national taxation, and must be designed in a progressive way which would aid its stabilisation properties. The precise scale of the Federal budget which would be needed for stabilisation purposes is difficult to estimate with certainly, but is likely to be in the order of 10% of EU GDP rather than the current 1%. The construction of a Federal fiscal policy is a long term project but one which is essential for the successful functioning of a single currency. Current account imbalances in the euro area ranged in 2011 from a surplus of 9.2% of GDP in the Netherlands and 5.7% in Germany through to deficits of 6.4% in Portugal and 9.8% in Greece. The resolution of current account imbalances in a fixed exchange rate system (which the single currency is par excellence) is difficult and liable to subject the deficit countries to adjustment through deflation. A current account deficit can only continue through borrowing from outside the country, and a current account surplus only if other countries are willing to borrow. The severe current account imbalances in the euro area must be eliminated and this must be done without resorting to ever more austerity. The euro area authorities must recognise that surplus countries have as much responsibility as the deficit countries for resolving the imbalances, and that surplus countries can aid that resolution by adopting policies of internal reflation. This will help expand export demand for the deficit countries and faster wage increases in the surplus countries will reduce their export competitiveness. Germany in particular should raise wages along its international supply chains into Eastern Europe, tackle the growing problem of a low wage sector, and consider a permanent reduction in working time. It should also reverse its recent aggressive switch from social security contributions to higher sales taxes, which acted like a devaluation and aggravated the problems of those countries with current account deficits. Employment policy in the EU should focus on promoting secure jobs based on high skills. The growth of precarious forms of employment, especially for young people, and the more general decline in wages as a share of national income in the last decade must be reversed. A strategy of making Europe more competitive on the basis of lower wages is socially undesirable; it also will not succeed since there are always other countries that can compete with even lower wages. In order to promote full employment, and also as part of a progressive long-term transformation towards a society in which life is not dominated by waged work, the normal working week should be reduced towards 30 hours. In place of the policies of privatisation and deregulation advocated under the Fiscal Compact, regional and industrial policies must be strengthened to ensure that deficit countries can restructure their economies on a sustainable basis. To this end, the European Investment Bank (EIB) should play an immediate role in facilitating a major programme of public and private investments, especially in those peripheral countries in Southern and Eastern Europe which have been most hard-hit by the crisis, and where unemployment is most acute. The EIB is already empowered to issue euro bonds, and by financing long-term investment can play a key role in overcoming the widening divergences within the EU.

A global framework for financial stability The major expansion of financial institutions, financial markets and financial instruments in Europe since the 1990s must be decisively reversed. Commercial and investment banking should be completely separated. Commercial banks should provide finance for major expenditure by households, and for socially and environmentally desirable investment projects by firms. Public and cooperative forms of commercial banks should be promoted and there should be strict limits on the size of private banks so that they can fail without threatening financial stability. Investment banks, together with hedge funds, private equity funds and all other so-called ‘shadow banking institutions’ should be tightly curtailed. They should not be allowed to operate with borrowed money, and all their activities should be open to public scrutiny. The spread of complex financial innovations has increased the opacity of the financial system and has been driven by an attempt to circumvent regulation. While banks use multi-layered securitisation to shift risks from their balance sheets and to avoid complying with minimum capital requirements, there has been a decline in the provision of credit for productive investments. All new financial instruments should therefore be subject to testing, and financial institutions should have to prove that a new financial instrument is of benefit for the nonfinancial sectors of the economy before it is approved. Most derivatives, while appearing to provide cover for specific risks, have actually led to an increase in systemic risk. Any derivatives that are approved should therefore be standardised and tightly controlled. All securities should be traded on approved public platforms and a publicly owned European ratings agency should be established. To reduce short-term speculative trading, a financial transactions tax should be levied on all transactions. The European Central Bank is constructed so as to be independent of political authorities but it has clearly not been ideologically independent or free from representing the interests of the financial sector. The ECB should be reconstructed to ensure full democratic accountability. This would involve requirements for the President of the ECB and others to regularly appear before the European Parliament for detailed scrutiny and for the decision-making bodies of the ECB to be drawn from a wide range of stakeholders and not limited, as at present, to central bankers. The ECB must also be integrated into the decision-making processes of the Economic and Monetary Union and to enable policy co-ordination. A new framework for financial stability is required. It should be based on an alternative paradigm of financial regulation and involve profound institutional changes. It should be recognised that, because of the fundamental instability of capitalism and the pro-cyclicality of finance, market discipline does not work. A financial stability framework in the euro area should be based on four principles: •The framework needs to be comprehensive. It should be based on all policy instruments so that prudential, monetary and fiscal policies are combined. The separation between monetary stability and financial stability must be overcome. Instead of a focus on price stability, the focus should be on promoting full employment and general prosperity in the euro area. The central concerns of the ECB should shift from price stability to financial stability. This should occur within a framework of policy co-ordination where it is recognised that fiscal and other policies have an impact on financial stability. •Policies must be countercyclical. They should aim to reduce the pro-cyclicality of financial markets and, by using fiscal stabilizers, to dampen business cycles. Macroeconomic and prudential policies need to lean against the build-up of financial imbalances during the boom. It is not sufficient to wait and clean up during the bust phase of the cycle. •The framework has to be system wide. It must take into account the mutually reinforcing interactions between the financial system and the rest of the economy. It needs to include both the supervision of individual financial institutions and the macro-prudential supervision of the financial system. •The framework has to be Europe wide. Monetary, prudential and fiscal policies should be designed at the European level, taking into account both the heterogeneity and the interactions among countries in the euro area and the EU as a whole.

2 Governance in the EU

2.1 The Surveillance Union

In response to the crisis of sovereign debt there have been major changes in the functioning of EU institutions and in the relationship between the EU and member states. These have taken the form of increased powers for the Commission, with behind it the power of dominant states in the Council, in the surveillance and control of member states and of reinforced sanctions against those judged to be in violation of the rules. Firstly, the 'six-pack' of new legislation tightens the constraints of the Stability Pact: •Sanctions (compulsory deposits first and then fines) now cover not only breaches of the deficit limit of 3% of GDP but also 'excessive' debt levels, that is, public sector debt in excess of 60% of GDP; the latter have to be reduced by one twentieth in each year; •Judicial proceedings against delinquent member states become more automatic – where before a qualified majority in the Council was needed for the continuation of litigation against a member state, such a majority will now typically be needed to halt it; •The Commission has been given the right to examine the administrative structures and practices supporting fiscal policy in the member states; •Sanctions now apply not only to 'excessive' debts and deficits but also to a wide range of 'excessive macroeconomic imbalances'. The macro variables to be used are listed in a 'scorecard' and for the most part relate to external competitiveness. Secondly, the 'two-pack', two further legislative measures currently in process, requires euro area governments to submit draft budgets to the Commission prior to their presentation to national parliaments. Although 'National Parliaments remain fully sovereign in voting the Budget Law', the Commission is accorded the right to 'require a revised draft'. For member states which have accepted credits from an emergency fund – the European Financial Stability Facility (EFSF) or its successor, the European Stability Mechanism (ESM), 'enhanced surveillance', on a quarterly basis is introduced. These states have 'an obligation on Member States to adopt measures to address the sources of instability'. Failure to comply may lead to the cancellation of disbursements from the EFSF or ESM. Even before the two-pack, a special supervisory regime for these states was already in place. The troika (composed of representatives of the European Commission, the European Central Bank and the International Monetary Fund) which disbursed emergency funds (so far to Greece, Ireland and Portugal within the euro area and Romania outside it) has used the power of these institutions as creditors to demand policy changes and 'structural reforms' which would certainly not be in the competence of the Commission if it was acting simply as an institution of the EU. For example, the troika has demanded that Greece make drastic changes to its collective bargaining system (including a 32% reduction in minimum wages for adults and 22% for youth), that it reorganise its public pension system and that it privatise specified state assets. In any case, these three states, together with Romania, are now subject to a comprehensive system of tutelage by the Commission. Because the ECB president, Mario Draghi, has made support for their bond issues dependent on the acceptance of EFSF/ESM credits, Italy, Spain and other states (both Cyprus and Slovenia are in the firing line) may find themselves compelled to accept a similar surveillance regime. Thirdly, the Treaty on Stability, Coordination and Governance, agreed in December 2011 and signed by 25 EU member states repeats the rules of the amended Stability Pact and in key respects makes them more stringent. In the Fiscal Compact which is the main part of the Treaty an additional norm for public sector borrowing is introduced – the 'structural' deficit (that is, corrected for the effect of cyclical fluctuations) is not to exceed 0.5% of GDP. Member states with higher figures have to prepare and implement correction plans under the supervision both of the Commission and of 'independent' institutions to be established in each member state. Signatory states are required to introduce these requirements, including 'automatic' fiscal corrections, into national law, preferably with constitutional force. The European Court of Justice is empowered to impose fines for non-compliance. The essential characteristic of the Fiscal Compact is to take the economic constitutionalism which began with the Maastricht Treaty to an extreme point by promulgating new rules and constraints which tend to put national economic policies on automatic pilot, with no room for manoeuvre. The Treaty allows member states to litigate against each other if its rules are deemed to have been broken and this can only make for suspicion and distrust among the member states. The Council has played a leading role in these measures, with certain of the economically stronger member states, especially Germany, proposing very tight constraints on the weaker ones. The right-wing majority in the Parliament has endorsed them while the centre-left, in spite of some specific criticisms has failed to mount a principled opposition to them.

2.2 Austerity and legitimacy

The surveillance regime briefly described above can only work to aggravate further the longstanding and deepening legitimacy problems of the European Union. These have several, closely related aspects: •The democratic deficit which shields EU decision-making from democratic forces. This relates both to the structural weakness of the European Parliament and to the dominant role of the Council, behind the Commission, in formulating policy and enacting legislation. It is clear that in the Council and especially the European Council, power relations among member states shape the key decisions. Note that the European Parliament has no decision-making power over the 'European Semester', the procedures in the first half of every year, by which national macroeconomic and 'reform' policies are reported to, and corrected by, the Commission and the Council. •The absence of a strong democracy has as a corollary the excessive influence of corporate lobbies which dominate the technical committees of the EU and are able to shape policy and legislation in their own interests. •The anomalous status of the ECB which, unlike all other central banks, is not just independent in operational terms but beyond the control of any elected bodies. This prevents the very necessary redefinition of the ECB’s mandate in response to financial instability, the sovereign debt crisis and the deepening unemployment crisis. •The social deficit which results from the absolute priority accorded by EU institutions to the single market and to the freedom of movement of goods, services and capital. This has not only meant that the EU has failed to develop significant social programmes at European level; in recent years the assertion of single market priorities and more recently the 'six-pack' and the 'two pack' legislation has led to increasingly aggressive moves against the social models in member states, whether by deregulatory legislation such as the directive on the cross-border provision of services, through decisions of the European Court of Justice (ECJ)12 or now through macroeconomic adjustment programs imposed by the troika. The loss of legitimacy of the EU arising from these factors can be seen in the growth of political forces hostile to the EU, in the falling participation in European elections and in the disillusion and scepticism of many who once supported European integration. Through the Lisbon Treaty an attempt was made to mitigate legitimacy problems by involving national parliaments in EU decision-making. However, the new procedures are insignificant because they do not enhance the role of national parliaments and do not transfer any decisional power from core European institutions to national peripheral ones. The value of the new procedures is merely formal without any substantial power transfer to national parliaments. The surveillance structures put into place in recent years can only aggravate the legitimacy crisis of the EU. The reinforcement of the Stability Pact is only on formal terms applicable to all member states. In practice the focus on competitiveness and on public sector borrowing means that it applies to the member states with the weakest economies – to the Eastern and Central European members, to the southern periphery and to Ireland. In practice, also, the demands placed upon the weaker states are heavily influenced by the stronger states acting through the Council – and it should be borne in mind that even a strong state (such as France for example) can lose a relevant amount of competitiveness in comparison with Germany, the Netherlands and so on and thus become a weaker one. As a result, the whole regime imposes the rule of the strong on the less strong and the weak. It is a hegemonic, almost a colonial, system. The massive economic dysfunctions which have followed are discussed elsewhere in this Memorandum: austerity programmes have aggravated public debt problems by reducing income and output; in response the troika and the Commission chase these policy-induced effects downwards in a vicious circle. From the point of view of governance, there is a usurpation of political power: huge changes are being enforced in employment law, in social security and pension systems and in the regulation of services; privatisations of state assets are demanded even though only fire-sale prices can be obtained in present circumstances. Notice that the troika is demanding changes to bargaining practices, for instance in Greece, although they are found, and accepted, in many other EU member states, including Germany – such as the extension of collective agreements to non-participating enterprises. 'The Memorandum of Understanding' imposed on Greece by the 'troika' as a condition for very limited refinance, permitting the government just to service its debts, is a totalitarian document which shames the EU. It not only imposes impossible targets for public finance, it deprives the Greeks of any choice at all in how they endeavour to meet the targets and it does so in a humiliating way. It strikes at the essence of the Greek employment system and at Greece's (very inadequate) systems of social provision. European leaderships are aware of the legitimacy crisis facing the EU but usually seek to suppress or bypass democratic pressures rather than respond to them with genuine policy changes. One case in point is the pressure put on Greece to avoid a referendum on the conditions attached to finance from the troika. Another is the recent report from EU foreign ministers (the Westerwelle Report) which proposes various reforms in the hope of reversing the deepening disillusionment of European citizens with the structures and policies of the EU. Some of the Westerwelle proposals may be valid. Others are crudely populist, such as the notion of directly electing the head of the Commission and then permitting her or him to appoint the other Commissioners. However, the report is completely vitiated by its endorsement of the present approach to the crisis of the periphery. The report declares: 'We believe that once the Euro crisis has been overcome, we must also improve the overall functioning of the European Union.' But if current policies towards the populations of the weaker states continue, the damage to the economic fabric and the political status of the Union will be enormous, and perhaps irreparable. The recent report from the President of the European Council, Herman van Rompuy, takes a completely technical approach to reform in the euro area. The main proposals are for an integrated supervisory regime for banks and for the EU to acquire a certain 'fiscal capacity'. These could be useful developments in the context of debt cancellation, expansion and employment recovery – as an endorsement of the surveillance regime and the drive for austerity they only add to the dysfunctionality of present policies. No meaningful procedures for the accountability of the new fiscal and banking authorities are put forward – there is merely a call to 'involve' the European Parliament and the national parliaments. The absolute priority given to the four freedoms, the single market and the rules of competition means that the only model of democracy compatible with the present paradigm of integration is a formal democracy, whose ultimate target is to neutralise opposition and legitimise the political choices of the institutionalised centre rather than represent the people. A critical survey of the current EU system of governance suggests that the construction of a democratic Europe requires not only procedural reforms but also the adoption of a different model of integration compatible with the needs and interests of the community.

2.3 Reconstructing EU governance

The most urgent change in EU governance concerns the response to the crisis in the peripheral countries. The present, hegemonic, system must be replaced by a solidaristic approach which makes economic recovery and the elimination of imbalances joint responsibilities of all member states and of the EU. This in turn will require the mutualisation and/or cancellation of much of the debt of the weakest states. Interference with the social models, bargaining systems and public services of the weakest states must cease as must the involvement of the IMF in the determination of economic policies within the EU. The macroeconomic policy process, currently devoted to surveillance of the weak by the strong, has to be given an entirely different content, centred on a coordinated drive to reduce unemployment and to correct imbalances in productivity, with responsibility equally shared among stronger and weaker states. The mandate of the ECB must be widened to include crisis management, financial stability and the promotion of employment and it must be required to support unconditionally the agreed macroeconomic stance of the EU, including, where necessary, the direct financing of member state governments. It must at the same time lose its present, quasi-judicial status and be subordinated to the democratic instances of the EU. In order to make the ECB more independent from the financial sector, the circulation of top officials between the ECB and the private financial sector should be stopped. Former top managers of private financial business should, therefore, be made ineligible for top ECB positions and top ECB officials should be barred from seeking employment in the private banking sector after the end of their ECB mandate. It is certainly possible to develop specific procedural proposals to address the democratic deficit in European institutions. One possibility would be an elected body to oversee the ECB; another could be a decision-making role for the European Parliament in the development of EU economic policies. But such reforms would mean very little, and might make policy decisions even less transparent, unless they related to a complete change of policy direction which alone could begin to restore the legitimacy of the EU. As the EU loses legitimacy, challenges to the regime it is imposing on European citizens and a refusal to comply with its dysfunctional and unjust rules, will correspondingly assume ever greater legitimacy.