Friday, November 28, 2014

Democracy versus the Eurozone

BRUSSELS – The European Union is a voluntary quasi-federation of sovereign and democratic states in which elections matter and each country seeks to determine its own destiny, regardless of the wishes of its partners. But it should now be apparent to everyone that the eurozone was designed with a very different institutional arrangement in mind. Indeed, that design gap has turned out to be a major source of the monetary union’s current crisis.

Last October, Greece’s then-prime minister, George Papandreou, proposed a popular referendum on the second rescue package that had just been agreed at the EU’s summit in Brussels. He was quickly told off by German Chancellor Angela Merkel and former French President Nicolas Sarkozy, and Greeks never voted on it.

But, less than a year later, the referendum is de facto taking place anyway. In a union of democracies, it is impossible to force sovereign countries to adhere to rules if their citizens do not accept them anymore.

This has profound implications: all of those grandiose plans to create a political union to support the euro with a common fiscal policy cannot work as long as EU member countries remain both democratic and sovereign. Governments may sign treaties and make solemn commitments to subordinate their fiscal policy to EU rules (or to be more precise, to the wishes of Germany and the European Central Bank). But, in the end, the “people” remain the real sovereign, and they can choose to ignore their governments’ promises and reject any adjustment program from “Brussels.”

In contrast to the United States, the EU cannot send its marshals to enforce its pacts or collect debt. Any country can leave the EU, and thus the eurozone, when the perceived burden of its obligations becomes too onerous. Until now, it had been assumed that the cost of exit would be so high that it would never be considered. That is no longer true, at least for Greece.

But, more broadly, EU commitments have now become relative, which implies that jointly guaranteed Eurobonds cannot be the silver bullet that some hope. As long as member states remain fully sovereign, no one can fully reassure investors that in the event of a eurozone breakup, some states will not simply refuse to pay, or at least refuse to pay for the others. It is not surprising that bonds issued by the European Financial Stability Facility (the eurozone’s rescue fund) are trading at a substantial premium over German debt.

All variants of Eurobonds come with supposedly strong conditionality. Countries that want to use them must follow strict fiscal rules. But who guarantees that these rules will actually be followed? François Hollande’s victory over Sarkozy in France’s presidential election shows that an apparent consensus on the need for austerity can crumble quickly. What recourse do creditor countries have if the debtor countries become the majority and decide to increase spending?

The recently agreed measures to strengthen economic-policy coordination in the eurozone (the so-called “six pack”) imply in principle that the European Commission should be the arbiter in such matters, and that its adjustment programs can formally be overturned only by a two-thirds majority of the member states. But it is unlikely that the Commission will ever be able to impose its view on a large country.

Spain’s experience is instructive in this respect. After the recent elections there, Prime Minister Mariano Rajoy’s new government announced that it did not feel bound by the adjustment program agreed to by the previous administration. Rajoy was roundly rebuked for the form of his announcement, but its substance was proven right: Spain’s adjustment program is now being made more lenient.

The reality is that the larger member states are more equal than the others. Of course, this is not fair, but the EU’s inability to impose its view on democratic countries might actually sometimes be for the best, given that even the Commission is fallible.

The broader message from the Greek and French elections is that the attempt to impose a benevolent creditors’ dictatorship is now being met by a debtors’ revolt. Financial markets have reacted as strongly as they have because investors recognize that the “sovereign” in sovereign debt is an electorate that can simply decide not to pay.

This is already the case in Greece, but the fate of the euro will be decided in the larger, systemically important countries like Italy and Spain. Only determined action by their governments, supported by their citizens, will show that they merit unreserved support from the rest of the eurozone. At this point, nothing less can save the common currency.

Read more from our "Are Eurobonds a Silver Bullet?" Focal Point.

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    1. CommentedRoss Clem

      Perhaps it will be financial markets that become the "enforcer" of debt obligations. A sovereign country and its people must honor their debt obligations in order to receive funding.

    2. Portrait of Asgeir B. Torfason

      CommentedAsgeir B. Torfason

      The case is more complicated than "In a union of democracies, it is impossible to force sovereign countries to adhere to rules if their citizens do not accept them anymore." The example from Iceland is illustrative, two referendums on whether to pay the minimum depositor insurance guarantee amount to UK and Netherlands for the bankrupt Icesave. If the citizens of the island do not accept the rules that granted them access to the common European market, then the case is now solved in EFTA court (as the majority of the voters did not, twice, want to accept an agreement of a solution).

    3. CommentedZsolt Hermann

      This is why the true solution to maintain the Union is a deeper integration, and eventually a supra-national democratic arrangement when all governance is lifted above individual nations.
      And while this might sound crazy, or political suicide in the present climate, in reality we already live in such arrangement while maintaining an illusion that we have some national sovereignty.
      We can vote, change governments seemingly but our lives have long decided and lead by global international interest groups, financial institutions, the election campaigns are decided solely by money and media influence, the public is simply played with all over the world. We all covet the same global products, celebrities, culture, and physically and especially virtually we are interconnected and intermingled on multiple levels.
      Today there is no nation that can be independent sustaining itself due to our mutual dependency.
      If we removed populist politicians, and the inciting mass media from the picture the general public would have no problem living in a global network, voting for supra national parliament if given a global education program explaining the nature of our interconnected and interdependent system we find ourselves in today.
      So democracy is not impossible, simply we have to change the level we apply it to.
      And then on such foundation all other systems would have sustainable future.

    4. CommentedH Gerken

      "As long as member states remain fully sovereign, no one can fully reassure investors that in the event of a eurozone breakup, some states will not simply refuse to pay, or at least refuse to pay for the others. " - That was the principle of the EU treaties which are now broken. Nations do not take the debt of others. But now that the EU contract is broken, crediotor nations insist on austerity as a condition. When France wants to give carrots without stick to other unreliable nations that is fine to me, as long as it's their own carrots.

    5. CommentedH Gerken

      Come on, the referendum was complete craziness. When you are in an emergency rescue situation and try such games the doctors give you an injection.

    6. Commenteddavid blake

      It is ot simply that "even" the Commision is fallible. So is the ECB. And the great failure of democracy in Europe is that when the ECB is wrong, democracy can do nothing about it.

    7. Commentedandrea naldini

      The issue proposed is well-known, but is not correctly presented. The lack of democracy is in the decision making process not in its implementation. When a representative european government will exist and decide the problem will be fixed. Till that moment, Italy and Spain have the same responsibility of Germany.

    8. Portrait of Michael Heller

      CommentedMichael Heller

      Daniel Gros:

      I agree with the thrust of your argument. But it's important to remember that political representatives are elected to govern, and there is a significant period of time during which decisions can be made without consulting the "sovereign people". Those representatives are formally and legitimately empowered to sign treaties in Europe. Fortunately we are modern and don't live in direct democracies. The basic issue here is the strength and expertise of the leadership, and the extent to which that leadership is prepared to take advice and act rationally for the good of nation rather than simply in accordance with the political cycle. Ironically the overburdened welfare states of Europe are committing collective suicide because of the dictates of the very political cycle that created them.