The political economy of (eventual) banking union
As the debate regarding banking union in the Eurozone rolls on, this column tackles the subject from a different angle – outlining the political economy ramifications of such an undertaking.
Search the site
The recent European Commission proposals for a banking union in the EU (Commission 2012; 2012a) stem from the need to take a range of short- and long-term measures to resolve the ongoing financial and sovereign debt crisis in the Eurozone, and to prevent as far as possible a reoccurrence in the future. The logic is the traditional European integration response of policy spillover fuite en avant that has often worked in the past: in a world of global market integration, the effectiveness of national policies and policy capacity are increasingly called into question, especially where cross-border capital mobility is concerned.
Open economies experience difficulty (sometimes severe) in maximising the benefits and minimising the costs of economic integration, and the pooling of sovereignty is one way to enhance state and societal capacity to manage these very real dilemmas of economic openness. Economic and Monetary Union and the Single European Market are highly developed institutional mechanisms that have proved historically effective at permitting member states to cope with a range of the policy dilemmas involved while retaining the capacity to develop a distinct national policy ‘mix’ that accommodates the often shifting preferences of national democratic processes. Just as purely national policy processes and institutions require consistent adaptation in the face of change, EMU and the single market as a policy framework were always incomplete in important respects. The crisis has exposed these weaknesses in dramatic fashion.
Member states therefore face a choice between the disintegration of the Eurozone and impairment of the single market, the two greatest achievements of the EU to date, or moving forward to fill in the relatively well-known institutional and policy lacunae in the governance of European financial and monetary space. Disintegration or indeed a failure to move forward would leave the most vulnerable states alone and saddled with the current worsening crisis and would pose significant risks, indeed uncertainties, for the global economy not to mention other EU/Eurozone members. Creditor countries would hardly escape unscathed. Indeed, there is considerable evidence that all along the principal beneficiaries of EMU have been the surplus countries such as Finland, Denmark, the Netherlands, Germany, and Austria (see Figure 1). In short, further institutionalisation of co-operation in the policy domain may indeed involve a further pooling and compromise of sovereignty (often eulogised in rather mythical and indeed Arcadian tones, as though sovereignty has always served humanity well).1 But further pooling will yield significant and indeed necessary gains for member states in terms of their capacity to deal with the consequences of integrated financial markets together with macroeconomic adjustment to internal and external imbalances. A range of solutions is possible, but choices must be made and political will and entrepreneurship is required.
This column will analyse the political economy aspects of banking union in the light of the recent Eurozone and Council commitments (Euro Area 2012) and the Commission’s ‘Road Map’ (2012). Political economy typically focuses on a particular policy domain with a view to explaining a range of factors:
Political economy also takes on issues of institutional and normative legitimacy in relation to both the challenges confronting political and economic communities, and the solutions that find their way on to the agenda. This involves examining the interface between the way in which ‘economic’ rivalries play out in a particular setting, how and by and for whom the rules of the game and terms of these rivalries and economic competition are set, and why in the face of pressures for change particular new outcomes result (or not). The setting in this case is the global financial crisis as transposed to the EU single market for financial services. This includes the peculiar arrangements adopted by Eurozone members to resolve sovereign debt problems, the overlapping institutions of governance at national and EU levels, and the increasingly volatile politics of protest and electoral competition. Given the gravity of the crisis, there are few who could not be considered stakeholders in this agonising series of events, yet unsurprisingly some are more influential than others at seeing that their preferences become institutionalised as rules of the game.
This column will argue that the battle lines over banking union is likely to mirror those of the creditor versus debtor members of the single currency to date. The various Eurozone members have adopted a self-interested policy ‘discourse’ that reflects their perceived preferences in terms of crisis resolution. These discourses unsurprisingly offer a poor explanation of the problem at hand, and thus deliver serially dysfunctional policy solutions. Attempts to implement a banking union will become a proxy for conflicts over resource transfer in the resolution of the sovereign debt crisis. So far the proposals focus mainly on issues of supervisory co-ordination and consistency, which is relatively uncontroversial. If the debate directly addresses the issue of distributional conflict, as eventually it must, progress is likely to be slow and solutions as far off as ever. Meanwhile the underlying legitimacy of the EU, and of its single currency, is draining rapidly away, potentially undermining the capacity of members to co-operate at all.The doctrines of conflict
The solutions chosen by a particular political community (of which the EU and Eurozone are a loose if complex, multilevel variety) typically imply a particular analysis of the problem and an understanding that some ideas are better suited to solutions than others. It is important to point out that the analysis of the problem remains highly contested and that arguments on causality and responsibility are typically infused with a heady mix of enlightenment and solidarity (forward with more integration, we either pull together or hang together) in constant tension with self-interest (it was your fault so you should pay the most; we have the money so we determine the terms of settlement). It is difficult to disentangle the strands of enlightenment from those of self-interest. Even the perceived need for co-operation and deeper integration is of course fundamentally self-interested or no one would have had the idea in the first place, and neither the EU nor more global forms of governance would ever have emerged as they did.
One might separate out three stylised positions that each implies a particular direction for policy in the Eurozone. These positions are not entirely mutually incompatible and the actual positions of Eurozone members overlap these caricatures. Nonetheless, one may observe through caricature where most Eurozone members fit on whichever side of the divide.
None of these three ‘policy discourses’ properly explains either the problem at hand or the minimum conditions for either the successful operation of a currency union or the resolution of the crisis. Each overlaps somewhat with the truth. Creditor and deficit countries alike have sins of commission in policy terms. Those countries with relatively high debt loads had indeed improved the situation in the lead-up to and implementation of EMU. Some of the countries now in deepest trouble were among the best performers on debt loads and fiscal deficits (Spain, Ireland). At any rate, the debt problems such as they were had been known well before the crisis, as were Greek ‘transparency problems’ (well predicted by the IMF in 2009). Some of the countries patently not affected by the crisis have a rather heavy debt load, and Dutch or German banks were neither particularly well supervised nor unaffected by the financial turmoil – on the contrary! If anyone has a property bubble still to burst, it is the Netherlands. Not long ago, Germany was the country that had the apparently fatal combination of a current-account deficit and heavy fiscal deficits. Germany consistently broke and indeed altered the rules in its own favour. So government debt problems and property bubbles in themselves are unlikely to be the cause even if they are now the focus of the crisis. The pre-crisis policy stance probably has relatively little to do with the situation, though heavy debt loads are hardly likely to help in the resolution phase.Not-so-prosaic realities
The financial crash is certainly the more likely trigger, because countries with greater or lesser structural and budgetary problems have been caught together. All countries have seen a worsening of their fiscal balance and debt loads as a result of the crisis. Bank rescues transferred billions of private debt to public-sector balance sheets, and the long recession has eaten away at tax revenues while welfare expenditures have risen along with unemployment. Recession and property market downturns (whether related to a genuine bubble or not) certainly worsened the situation of banks, even in countries not initially affected by the crisis, which includes most of those receiving bailouts or in line for the same. In the end, while a sound policy stance by domestic governments seems intuitively helpful, a good or bad policy stance does not properly determine whether a country is caught in the crisis or not.
A successful explanation as to what is going on needs to focus less on what states do and more on the patterns of cross border trade and capital flows under conditions of capital mobility and monetary union. Above all, the outcomes cannot be attributed uniquely to particular state players, though bad policy should make things worse. The outcome is above all a collective one fostered by the cross-border interaction of economic agents within the Eurozone and global economy. Capital market integration and capital flows are greatly accelerated by a monetary union where exchange rate risk is absent. The different EMU economies benefit from this in different ways, and run different sorts of risks. As one would expect, eliminating the risk of devaluation means that the benefits are certainly skewed towards the most competitive exporters – and under EMU their current-account surpluses have grown commensurately (see Figure 1). Meanwhile, the excess savings accumulated by the surplus countries flow through their banks to where returns are higher, often to the faster growing periphery with its well-known structural weaknesses. These economies gain cheaper capital and have fewer worries about the ongoing financing of their current account deficits (Jones 2003). Capital inflows spur growth but most likely also inflation, not to mention property booms driven by tourism and foreign investment. These effects potentially exacerbate competitiveness problems and may set up future bank problems in a downturn. In the boom, the situation looks positive and sustainable from both sides – a sign of investor confidence. In a downturn, however, the weaker economies fare worse because, well, they are weaker and less developed. The poorest regions of the weakest economies do the worst, which is no big surprise. This outcome is indeed inherent in the nature of a monetary union, as federal polities with domestic economies that are highly differentiated across regions know too well (Germany, with its five eastern provinces or ‘Länder’ from the former GDR, being a prime example).
Figure 1. From monetary union up to the outbreak of the crisis, the benefits of growing current-account surpluses of selected creditor countries reflect the deficits of debtor countries
The institutional weaknesses and policy failures of the Eurozone have also been important factors in igniting the sovereign debt crisis. EMU was designed without a crisis management mechanism with each country looking after its own adjustment process even though the outcome was collectively generated. There would be no bailouts,3 and on the assumption that all would adhere to the rules, market discipline would ensure stability anyway (Underhill 2002). But following the rules of the Growth and Stability Pact would have been fatal in the financial crisis, so no one did (and some, including creditors, had long played fast and loose in the first place). Market forces, supposedly a discipline, had led in fact to imbalances and growing competitiveness problems during the good times. Then the crisis struck, followed by the costly rescue of the banks, recession, and more debt for governments. There was considerable ambiguity about what would happen if a country found itself in the rather broad margins between liquidity problems and insolvency. Would the no-bailout clause be respected no matter what? The former German finance minister Peer Steinbrück had once intimated: not necessarily. Would the ECB intervene as it had in rescuing the banks? Would defaults be an option? Would economies under severe adjustment pressures leave the euro and devalue?
As the crisis gathered pace around the problems of Greece in early 2010, there were no clear answers to these questions, but plenty of ambiguity and open dissent among Eurozone member countries. When the markets began to panic, there was a bailout for Greece that clearly made the country’s predicament worse and the markets could see that. So bond spreads widened and the price of rescue grew geometrically as doubts over sovereign debt repayments worsened the predicament of the banks that held it, and vice versa. On the other hand, in a world of essentially zero and sometimes negative interest rates, the growing returns on distressed sovereign debt was a further transfer from debtor to creditor economies via the banks. The banks, at least it seemed, would consistently be bailed out by the ECB. The longer the agony went on, the less clear were the signals from the Eurozone governments, and those measures that were proposed were long-term solutions.
Debtor or creditor governments respectively settled on some variation of the three self-interested discourses above while promising underspecified reforms domestically and at the EU level. Market volatility and occasionally panic continued apace and debt loads grew alarmingly despite stupefying austerity measures. Domestic electorates lined up behind their respective governments, undermining what might have been popular support for further co-operation and institution-building. A monumental distributional conflict over the present and future of monetary union and macroeconomic adjustment had been ignited. Meanwhile, the benefits of EMU continued to accrue to surplus countries, but in lesser measure as economic growth began to falter and recession tightened its grip in the crisis countries. Contagion has made the problem immeasurably greater than if there had been prompt central intervention.Banking union: political economy of doctrinal strife
So all three ‘discourses’ were actively employed both in a self-interested fashion and as a call to particular forms of further integration and solidarity. Furthermore, and crucially, banking union fits into all three causal/policy discourses but means different things to the respective proponents of these various policy stories. The proposal is so far the only major institutional innovation to emerge from the EU reform process following the financial crisis. Banking union contributes in particular to the goal of further integration aimed at restoring confidence in the single currency, and demonstrating that the EU is serious about further measures to ensure the successful governance of the euro. As such the banking union proposal may be thought to have a range of objectives, and therefore several potential gains for Eurozone and other EU member states in terms of policy capacity in the current turmoil:
The proposal as it stands is far from definitive. In its current form, it covers these objectives to varying degrees. It is now up to the Council to decide on the balance that is desired. What should be clear from what has been argued so far is that:
The starting point of banking union must be that in a monetary union, outcomes are collectively generated by economic agents through the interaction of creditor and debtor ‘zones’ of the union alike. The solution to the crisis had better be commensurately balanced in nature and focused on fact-based problem solving as opposed to the sort of doctrinal obscurantism that characterised the unfortunate Middle Ages and Reformation. It is clear that the balance of power in the Council lies behind ‘discourse one’ and a reluctant commitment to (a limited) ‘discourse two’. This analysis will continue to yield solutions that are dysfunctional, worsening the crisis. Meanwhile, the countries that support discourse one continue to enjoy the skewed benefits of EMU.
There is also an ongoing failure to distinguish between long-run reforms, such as banking union, and the need for prompt crisis resolution. This is once again because prompt crisis resolution involves some form of ‘federal’ intervention, preferably from the ECB, in the same way that Canada or Germany stand behind the finances of their provinces.
Finally, a centrepiece of the G20 post-crisis proposals to reform policies aimed at financial stability was a commitment to a macroprudential approach to banking supervision. The current proposals do not refer to this issue at all, presumably because it too would involve questions of potential resource transfers. Banking union must surely give expression to the new, broader approach to financial supervision if it is to accomplish its goals. Without a macroprudential take on the matter, one could hardly explain how the financial crisis became a sovereign debt crisis in the first place. So there is much missing in the current proposals, and an apparently low probability that the most important aspects of a banking union will be realised on anything like the timetable envisaged by the Commission and allegedly accepted by the member states.The bottom line
There is one further, overarching element to the political economy of banking union in the EU. This concerns its political legitimacy and sustainability in the context of EMU. The serial collective policy failures since Greece first began to experience debt problems in late 2009 and corresponding failure to resolve the current crisis in a timely fashion have done little to enhance underlying support for the current form of either the EU or the single currency (or indeed open, liberal economies in general). Faced with cross-border market integration and capital mobility, the pooling of sovereignty is supposed to enhance national policy space and improve the effectiveness of national policies – albeit at a price in loss of autonomy in some domains and increasing policy interdependence with other countries. However, citizens in both creditor and debtor countries increasingly perceive rightly or wrongly that the common currency and perhaps European integration tout court have intensified economic risks and eviscerated the capacity of national political communities to shape their own societies and futures in accordance with domestic democratic priorities. Public opinion data and recent election results inform us that electorates are not unrealistic, but that support for further integration is increasingly contingent and indeed falling. Creditor country governments have not even bothered to make the case that the benefits of EMU, even net of bailouts, are skewed in their favour. They have instead drawn popular attention to the direct costs of bailout together with the alleged fecklessness of debtor economy governments and inhabitants. The failure to endorse the sorts of solutions applied in federal economies has only led to contagion, more debt, and the need for more bailouts. The EU and the Eurozone in particular are caught in a downward legitimacy vortex. Without better real-world outcomes, this will only accelerate.
Banking union clearly cannot succeed or indeed proceed without adequate levels of electoral support, any more than the common currency can survive in such an absence. The central issues of costs, benefits, and ‘who pays?’ need to be confronted directly in conjunction with a viable and shared policy discourse that has a great deal more regard for the realities of monetary union than the doctrinal jousting that is going on at the moment. It cannot be the case that the citizen-taxpayer guarantors of European financial and monetary space can be expected to lend ongoing political support to the current institutional and policy mix while they take a long-run economic hit, especially the young; that their national policy space is permanently reduced and this becomes grounded irrevocably in national constitutions; that social risks can no longer successfully be pooled due to austerity – except perhaps in a few surplus countries (but for how long?). Are we serious, as the Treaty on European Union states, about “deepening the solidarity between [European] peoples”, about promoting “economic and social progress” for the same, and fostering ‘citizenship’ in the context of “ever closer union among the peoples of Europe”? Or are we for a Europe of doctrinal smugness versus semi-permanent misery zones (in the long run we are all dead)? As I have written before, the Council and institutions of monetary union still appear more concerned with rescuing banks than citizens.References
European Commission (2012), “Communication from the Commission to the European Parliament and the Council”, COM(2012) 510 final, Brussels, 12 September.
European Commission (2012), “Proposal for a Council Regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions”, COM(2012) 511 final, Brussels, 12 September.
Euro Area Summit (2012), “Statement”, Brussels, 29 June.
Jones, Erik (2003), “Liberalized Capital Markets, State Autonomy, and European Monetary Union”, European Journal of Political Research, 42(2): 197-222.
International Monetary Fund (IMF 2009), “Greece: IMF Country Report for the 2009 Article IV Consultation”, IMF Country Report 09/244, Washington D.C., IMF, 30 June.
Underhill, Geoffrey RD (2002), “Global Integration, EMU, and Monetary Governance in the European Union: the political economy of the ‘stability culture’”, in K Dyson (ed.), European States and the Euro, Oxford University Press.
1 ‘Sovereignty’ in this context really means ‘policy autonomy’ as sovereignty is not in fact in question.
2 One may note that discourse 2 is an ‘outside-in’ variant of discourse 1.
3 Article 103, Treaty on European Community, http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/ce321/ce32120061229en00010331.pdf
4 See Financial Times 12 October 2012 among other sources.