By Orsola Costantini, Senior Economist, the Institute for New Economic Thinking. Originally published at
“Populist” and right wing parties are gaining ground all over Europe, with a message of euro-skepticism and pure distrust of the so-called European establishment. The Italiangeneral electionheld on March 4, 2018 was no exception: The strongly pro-Europe Democratic Party of the previous Prime Minister Matteo Renzi registered a historic low, obtaining 18.9% of the votes (a decline of 6.5 percentage points compared to the earlier elections). Renzi almost wears this loss as a medal, proof of his loyalty to the EU, rather than as a sign of his failure at solving or alleviating the problems of the country. The populist Five Star Movement (M5S) became the largest single party in Italy (with 32.2% of the vote) and the right wing and xenophobic party Lega Nord obtained substantial electoral gains (17.7% of the vote). But the result, a hung parliament, did not indicate one electoral coalition strong enough to govern by itself, triggering a longer than usual process to arrange for a government coalition. Finally, after 90 days of negotiations, the Five Star Movement and the Lega Nord reached an uneasy alliance for a coalition government. These two parties have in common a strong rhetoric against the traditional political establishment, even though Lega was in the government repeatedly in the past and ran in this year’s elections in a coalition with Forza Italia, the party of Silvio Berlusconi. Both M5S and Lega Nord share a belief that Italian economic growth cannot be revived within the policy conditionalities imposed by the Eurozone.
As soon as M5S and Lega Nord announced that Paolo Savona, an 82-year old “Eurosceptic”, would be their appointment to the Treasury, all hell broke loose in Rome, Brussels, Berlin and Paris. Italy’s President Sergio Mattarella vetoed the proposal, arguing that he “protect the savings of the Italian people.” EU budget commissioner Gunther Oettinger that, “Markets will teach Italy to vote for the right thing.”
The threat might just be real: the artificial creation of economic and financial emergencies has often shaped the distribution of power in the Eurozone, now heavily leaning toward creditors and sur countries. But the Eurozone’s reliance on a large apparatus of quasi-technical regulations points to the absence of a yet fully defined and established hegemony.
The latest crisis can be described basically as a struggle to redefine the locus of power between nation-states, supranational institutions, and the market in the post-Bretton Woods age.
This struggle is not unique to the EU, but in a global context of reduction of public social expenditures and regulation, the EU institutions intensified this trend by providing a convenient “external constraints” excuse to national politicians who carried out fiscal austerity. But a more accurate look at the evolution of the Union clarifies that austerity was in fact a national preference and a political weapon for vested interests within and above nations. For instance, the budget rules have often been a locus of political negotiation, where different preferences could be validated by the formulation of appropriate estimates. Governments of different colors participated willingly in the game and now the “populist” Italian government might do this as well, thus covering up the real effects and amplitude of their policies.
The most important point to grasp, in fact, is that whatever party is in power, no real democratic debate can happen until technically dressed-up, closed-door negotiations about member countries’ policies and institutions stop. Way too easily, forces of all colors can dress up their preferences with the appropriate rhetoric and them to the public, avoiding a debate.
One condition to impede that is that wrong theories—such as those that claim that unemployment rates above 15% are “natural,” that public deficit spending is in itself inflationary and has negative effects on growth, that there is such think as a trickle-down effect, or that our resources are scarce and so should be our solidarity—must disappear once and for all. This amounts to fighting the imposition of an official “party-line” in economic theory and practice, which turns economics into a useless servant providing self-validation to elites and contributing to barring the debate and openness that are vital to a functional and fair society.
Between Centralization and National Autonomy
How and why did we get here? The answer lies in the peculiar evolution of the European architecture from the 1992 Maastricht Treaty onwards.
In fact, in spite of its depiction as a framework impossible to reform, the European system of economic governance has evolved substantially over the last two decades. As of 2018, after an intense period of legislative innovation, it has become a complex system of rules, deadlines and commitments supervised by the European Commission. The key element of this architecture is a large body of technical and apparently “objective” policy rules, which have become the locus of negotiation and the “revealed” expression of a supranational compromise based on underlying national preferences.
The evolution is the result of the interaction of two forces moving, as Kindleberger argued,between centralization and pluralism: first, the desire of the Maastricht architects to reduce the autonomous role of national democratic governments (and the Keynesian welfare state); and second, the power of traditional national and bureaucratic forces, unsympathetic to anything resembling true political union. The most obvious expression of the first movement was the foundation of the European Central Bank (ECB) as an independent institution, prevented from directly financing the member states.This obliterated the space for the state to enact appropriate public policies, independent of the whims of the financial markets. The second movement is recognizable in the original inter-governmental character of the EU’s political institutions, such as the European Council.
Sometimes the goals of these two forces converged; at other times they have opposed one another. In the process, and within a general view about the desirability of weakening the Keynesian state, about the of the system were overlooked. Eventually, if the arrangement would prove insufficient, a crisis would force the member countries into further action – as EU founding father Jean Monnet appears to have predicted. Yet underneath the surface, there’s been a fundamental contradiction in this institutional architecture: between a desire to be safer together, in the globalized economy, on the one hand; and a desire to be complacent (and hence, it is thought, credible) to the whims of international markets, on the other.
But whatever the initial intentions, the combination of financial deregulation, fiscal austerity, and one-size-fits-all monetary policy eventually encouraged divergent economic dynamics among Eurozone countries (see for a debate). The recent crisis further intensified this asymmetry, which has been described as a core-periphery relation between Northern and Southern Eurozone members, giving stronger negotiating power to the Northern creditors over the Southern debtors. This is reflected in the evolution of the common institutions and in the way those are interpreted and molded.
The Origins and Evolution of the Budgetary Supervision Framework
On the eve of the creation of the European Union, the contextual enactment of the new monetary and fiscal frameworks revealed itself to be crucial. In fact, the rupture of the linkages between governments and the national central bank was a strong incentive to maintain austere budget policies but was no real guarantee of the prospective sustainability of public debts and convergence of public policies. In the attempt to solve the problem, the member countries agreed on a Stability and Growth Pact (SGP), introduced in 1997. As is well-known, the accord defined ceilings for both public budget imbalances and individual country total public indebtedness (3% and 60% of GDP respectively).
The unspoken idea was that deregulated private capital markets together with fiscal rules would by themselves induce economic convergence among countries. The ECB and the TARGET2 payment system were designed to allow perfect capital mobility and symmetric access to the financial markets, under the assumption that price movements would grant perfect asset substitutability. The Stability and Growth Pact would grant efficacy to the inflation targeting strategies of the central bank. From the beginning of the process, many economists warned of the deflationary bias of the project and railed against the complete absence of concern for employment levels. A long series of efforts by post-Keynesian economists and a few policymakers to provide the Union with some sort of insurance scheme was doomed by nationalistic fears coupled with anxieties about rising inflation and public debt. What really mattered to national elites at the time was to obtain a guarantee of price stability that could help the EU become an international financial center (mainly a French aspiration) and could help the attainment of current account sures. In this regard, Germany benefited the most from a relatively undervalued (external) real exchange rate which resulted from the monetary unification.
The first crack in this rule-based macroeconomic governance system occurred in in 2005, when both Germany and France violated the SGP budget constraints. As hard it is to believe today, at that time Germany and France pushed for a relaxation if not abrogation of the Pact.
The ensuing first reform of the SGP was a key moment for the institutional and economic evolution of the Economic and Monetary Union (EMU) and it turned out to be a partial defeat for the German Chancellor Gerhard Schröder. Crucially, in fact, the reform failed at eliminating the budget rule altogether, and instead what happened was that the nominal public deficit target was redefined as a structural budget estimate. The solution became that of adding escape hatches and flexibility to the Pact, all while retaining the disciplinary effect of an external rule, as famously by Hans Eichel, Germany’s Minister of Finance at the time.
, in fact, puts actual public budget deficits in relation to the potential growth of the economy, a controversial and theory-laden concept, which for the Commission involves consideration of the effects of various political and institutional concerns, rather than those purely economic. Its ability to throw a cloak of spurious statistical precision over any mix of cross-pressures and interests make it a near perfect policy instrument for managing conflicts and negotiations behind closed doors. It helps neutralize the role of national electorates by presenting crucial policy decisions as the result of objective and scientific reasoning.
The story and details of this first reform show the degree to which austerity measures of the following years reflected shared elite convictions, rather than representing simply an imposition of one country on the others (for example: Germany) or the dictates of technocrats. Portugal, with Prime Minister Barroso, and Spain, with Prime Minister Aznar, as well as Belgium and the , were in a position to refuse the austerity reforms suggested by the Commission – simply by taking advantage of the opportunity opened by Germany and other big countries – but chose not to do so.
At that time, the idea of the Union as an assembly of sovereign nations appeared to gain strength, against the central power of the Commission. But the economic policy decisions of peripheral countries that opened up to massive capital inflows, cut public spending, and reformed labor markets, together with the new reliance on estimated guidelines, amounted to a first step that transformed European economic governance into a system that has a much deeper control on national economic policies than ever before.
Economic Alarmism and the Final Reforms
By the time the banking crisis and other economic pressures forced the question of further reform on the agenda, between the economies of the core and periphery within the Eurozone had enormously intensified, changing the political equilibrium and, in fact, nullifying the previous inter-governmental aspirations.
In the absence of a mechanism for risk sharing, a sudden reversal of massive movements of financial flows from Germany and France to Spain, Ireland and other countries resulted, inevitably, into a substantial increase in the relative power of the Northern-European creditor countries. Interest rates on the bonds of various Eurozone peripheral countries rocketed upward when they were forced to bail out private banks and financial institutions and in the immediate aftermath of the crisis, the creditor countries applied relatively relaxed standards of budget surveillance and remediation to their own cases even as they imposed much harsher conditions on their solidarity towards the others.
One event was crucial, and it recalls what, in the 1970s, Federico Caffècalled economic alarmism: the practice of misrepresenting the economic situation, exaggerating the negative aspects and creating the impression of unprecedented conditions of emergency, as a way to present a certain policy mix, often disruptive of the previous socio-economic equilibrium, as the only possible solution.
, the German chancellor Angela Merkel and the French president Nicolas Sarkozy brought the principle of economic alarmism to the next level. Bypassing the usual EU deliberation procedures, they agreed to affirm the no bail-out principle, now known as the principle of Private Sector Involvement (PIS), that is the partial bail-in of EMU governments’ bond holders. Immediately, the yields of Irish and Portuguese bonds sky-rocketed, followed by the Spanish and Italian ones.
Thus, “Merkozy” actually generated an emergency that prepared the terrain for further reform, this time to enhance the power of the Commission against the countries found faulty of compliance with the fiscal rules. The 2011 reform, the so-called Six Pack Agreement, created a much tighter framework than the 2005 Pact. This in fact is the case, but only for weaker Eurozone countries, which are now subject to specific (additional) duties and controls.
The reform intensified the explicit control of the supranational European institutions over a comprehensive range of macroeconomic and institutional practices of member countries, while maintaining flexible and asymmetric implementation of the rules. In fact, the exceptions included in the 2005 Pact still hold with even some additions, including the “case of unusual events outside the control of the country with a major impact on the financial position of the general government” and the “case of severe economic downturn in the euro area or the union as a whole.”
In this new context, the Commission has dramatically determined the policy agenda in most EMU countries, pushing from Brussels for labor market and pension reforms as well as systematic changes in national tax structures designed to increase the weight of regressive consumption taxation. The creation of a financial emergency surely is a very dangerous game, a clear example of playing with fire.
The unstable framework, the high risks, the financial fragility and the political void have given enormous power to the European Central Bank, which often acts as a further arbitrator of fiscal policy, thanks to the (arbitrary) conditionality of its support to the member countries.
The Dangerous Game and the Italian Mirror
So the dangerous game continues. The absence of a political desire to create automatic mechanisms of financial backstop has emerged again in the context of the creation of a banking union, a process started in 2012 (with results that ) and which is still ongoing. In contrast to what is stated in the European Commission’s plan of September 12, 2012, the decision of the European Council on December 13–14, 2012 to create a common system of supervision headed by the ECB was never accompanied by the possibility for the European Stability Mechanism to directly recapitalize banks. The 2012 Council also called for a harmonized regulatory setup and the adoption of the directive for bank recovery and resolution as well as a harmonized deposit guarantee scheme by June 2013 (IMF 2013). Instead, a Commission’s Banking Communication on the application of State aid rules to support measures in favour of banks in the context of the financial crisis(European Commission 2013) came out in July 2013, stating – all over again – the bail inprinciple: “the bank and its capital holders should contribute to the restructuring as much as possible with their own resources. State support should be granted on terms which represent an adequate burden-sharing by those who invested in the bank.”
If the member countries do not reach an agreement over a common deposit insurance shortly, that could be the locus of the next crisis. With a discussion of the progress of a banking union expected for this month’s Council meeting, this specter haunts the resolution of the current Italian political impasse. The reason is simple and lies all in the words of the Italian President of the Republic Sergio Mattarella when he announced that he could not accept the formation of a government that included an anti-Euro minister of Treasury. : “I need to take care of the savingsof the Italian people.” The sentence is quite revealing of the euro straightjacket. On the one hand, the core countries that dominate the negotiations are in a position to force a crisis in Italy (with, of course, uncertain results for all), thus indeed threatening the personal savings of the Italians and quite possibly of others. But it is also clear that, since the Maastricht Treaty, the common currency and the monetary union have meant for Italians, above, all a reduction of their real disposable income and of their ability to accumulate savings.
One warning is however necessary: as mentioned above, for a long time austerity was a choice and the Italian elites (and those who voted for them) cannot disavow much responsibility for the prolonged stagnation. This means also that exiting the euro area would be no guarantee of a shift in the political and economic priorities. Indeed, the chaotic debate that is now taking place between pro and anti- euro stands up for the embarrassing emptiness regarding what those priorities should be.
One important element to keep in mind is that austerity is not a symmetric concept: it does not apply equally to all sectors and groups of the economy. One case in point is the suggestions of the Commission for increases in the infamously regressive VAT taxes and for harsh labor market reforms, which reduced wages drastically. Such measures do not stimulate growth, to the point that they could well worsen the public finance position of an economy. They do however favor the rich against the poor.
From that point of view, the fiscal policy proposals of the new Italian government, such as the introduction of a “flat tax,” appear to similarly increase the unequal distribution of the tax burden. If the decision to cut taxes will be accompanied with a further reduction of public services and provisions, the overall effect of the budget could be restrictive. The risk is that the measures, as vaguely announced at this stage, reduce to a mere reshuffling of budget components in favor of various constituencies, with a basically zero effect on the budget balance.
While the 2010 crisis has most dramatically uncovered the need of European capitalism for a stronger central power, able to react rapidly to economic and financial down-swings with temporary discretionary interventions, the current inherent instability can either fuel or disrupt the process toward a unified solution. France and Germany may decide to use the discussion about the banking union to force an outcome that intensifies their control over Italian politics, but the dangerous game may have (perhaps unintended) political and economic consequences that could lead to disaster. Moreover, any toward a stable centralization implies a reduction of the involvement of electorates in crucial economic decisions, by channeling them through technocratic procedures and closed door negotiations.
National constitutions and parliaments, crucial to the post-war European democracies, are becoming increasingly disenfranchised and toothless. These democracies represented the attempt, after the totalitarian experiences of the first half of the 20th century, to build institutional guarantees for the maintenance of well-balanced democratic representation and resolution of political and economic interests. This attempt has been given up. The locus of political negotiation, now, increasingly resides in technocratic committees, where tensions between diverse national elite groups are mediated by the recombination of budget components and institutional reforms.
Nation-states are today the only institution in Europe capable of conveying any democratic preference, making it the only possible space for the political action of the electorate. But while retreating within national borders altogether might seem like an appealing solution, it would not be a guarantee of a change of direction, not least because those nation-state structures have by now been eroded by decades of policies. Now more than ever, we need to consider the difference between formal and substantial access to decisions.
Defining appropriate institutions to regulate and mediate between economic and social forces is a global and not just European challenge, but its achievement may appear too far out of reach. One way to take back the space and policy experimenting is to oppose the technocratic and scientific apparatus that supports the current deadlock. The ‘technocratic’ rhetoric of economists and central bankers convinced most people that there is no feasible alternative to (financial) market logic, to fiscal austerity, low wages, flexible labor markets and independent central banks. This way, establishment economics has constrained (and continues to constrain) political choices, stripping electorates of their autonomy in political and moral judgement. This is a dangerous game, since the only way disenfranchised electorates can express their anger, anxiety and powerlessness is by choosing self-defined “anti-establishment” forces. This has happened not just in Italy, but elsewhere in the Eurozone and in Britain as well. The U.S. is suffering the consequences of its own version of the exact same story. No one can tell where this will lead.
: They have the responsibility to help improve our current plight. The only way they can do this is by creating space for meaningful political deliberation on policy alternatives to fiscal austerity, high inequality and underpaid flexible workers. They have to give up the official “party-line” in economic theory and practice – a Politburo which turns economics into a useless servant providing self-validation to the elites and contributing to barring the debate and openness that are vital to a functional and fair society.
This article relies extensively on my paper “Political Economy of the Stability and Growth Pact,” European Journal of Economics and Economic Policies: Intervention, Vol. 14 No. 3, 2017, pp. 333–350. doi: 10.4337/ejeep.2017.0029. I am endebted to Servaas Storm, Roberto Ciccone, Thomas Ferguson, Sergio Levrero, Robert Johnson, and Annamaria Simonazzi for substantial help in clarifying and sharpening my own argument.
 Kindleberger, C.P. (1996): Centralization versus Pluralism: A Historical Examination of Political-Economic Struggles and Swings within Some Leading Nations, Copenhagen: Copenhagen Business School Press. I owe this reference to Perry Mehrling.