Debt Crisis and Power Redistribution Among EU States

Jin Ling

Debt Crisis and Power Redistribution Among EU States

Jin Ling

The sovereign debt crisis in Eurozone has dragged on for almost two years. It not only put the European economy into recession by causing political and social turmoil in EU member states, but also exacerbated disagreements, disrupted existing balance of power and reshaped relations among member states to a large extent. As a result, the EU faces many difficult choices as to the European integration.

I. The Crisis Exacerbated Disagreements among EU Member States.

The division of Europe into a “new” Europe and an “old” Europe by former US Secretary of Defense Rumsfeld is no longer a viable method to summarize EU member states’ different opinions on the debt crisis. During the crisis, differences among EU member states in terms of historical experience, economic conception and political-economic situation caused them to focus on different aspects of the crisis. As a result, they have developed diversified interest demands. “The eruption of Euro Crisis and how to respond to it not only tore open old wounds, but also created new disputes.” In other words, differences in member states’ understandings and conceptions of the crisis generated not only complicated political effects, but also tensions among them. And their differences were primarily focused on aspects such as causes of the crisis, responses to the crisis, economic governance programs, etc.

1. Different understandings on the cause of the crisis

Although systemic defects in Eurozone and structural imbalances in member states’ economies were generally considered the root causes of the debt crisis, each member state had its own understanding of and focuses on such causes. And this caused political tensions among them. For example, Sarkozy, the French President, ascribed the debt crisis to anomie during the globalization process, implying that powers outside the EU and powers inside the EU which had more to profit from the Single Market than others, particularly Germany, the Netherlands and other northern countries, should do more to solve the crisis. Lagarde, the former French finance minister, shared the same opinion as Sarkozy. At the beginning of the crisis, when interviewed by Financial Times about economic imbalances inside the EU, Lagarde commented that “Germany’s trade surplus is a threat to the competitiveness of other countries in Eurozone”; therefore, she urged Germany to increase domestic demands and reduce trade surplus concretely.

Unlike France, Germany ascribed the crisis to the member states’ inability to perform duties and observe debt and deficit regulations. For example, Merkel asserted that “the lesson from the crisis is very simple: rules must be obeyed. The current debtor countries must be supervised and they must bear the consequences of rule violations”, implying that the real cause of the crisis lied in some member states’ extravagant fiscal policies and their encouragement of over-consumption out of political considerations. Faced with German criticism and social pressures brought by austerity, the debtor countries in the south chose to blame the surplus-driven trade policies and policies of wage-cut to stay competitive as the “problems”, rather than viewing it as a solution.

Different understandings on the cause of the crisis “are tearing Europe apart into a German Camp stressing fiscal austerity and financial disciplines, a Latin Camp calling for continued growth and a British Camp busy with ridding itself of the ‘euro trouble’.”

2. Member states’ different responses to the crisis reflect differences in their interests

EU member states’ different interest definitions are best reflected in their different crisis responses. “When responding to the crisis, each member state cares about its own interests only; it rarely cares about the spirit of solidarity and the EU’s overall interests.” And member states constantly found themselves in heated disputes over issues such as relief measures, the role of European Central Bank, euro-bond and the involvement of private businesses.

The first dispute was about Germany’s “austerity” recipe. After the eruption of the crisis, Germany suggested that drastic austerity policies should be applied across the EU. This made some debtor countries quite unhappy. Developed on the basis of sound German financial and economic conceptions, these austerity policies reflected Germany’s realistic interest demands. As the largest donator of crisis relief funds, Germany was under tremendous domestic political and social pressure to make sure that its fellow EU member states shoulder their own self-restraint responsibilities. In doing so, Germany could reduce its domestic political pressures on the one hand and avoid taking additional risks and responsibilities on the other. Meanwhile, it could take advantage of the crisis to promote the“German economic model” and expand its influence across the EU.

Compared with Germany, debtor countries subject to austerity pressures since the eruption of the crisis believed that the austerity recipe of Germany was only a political maneuver for Germany to shun its responsibilities. Therefore, it was neither suited to their domestic situations nor could it lead Europe out of the crisis. As they indicated, “the adoption of austerity policies sank many countries in Eurozone into recessions without solving their problems. The austerity program stresses the debt issue only, without considering promotion of economic growth and deeper roots of the debt crisis. Therefore, all counter-crisis measures recommended by Germany are wrong.”

The second dispute was about private businesses’ involvement in the relief efforts as well as the flexibility of European Financial Stability Fund (EFSF). As member states were holding different amounts of foreign debt instruments and under different degrees of market pressure, they tended to have different opinions on the role of private businesses in the relief action as well as the expansion and flexibility of EFSF. France, countries under market pressures such as Italy and Spain, and debtor countries receiving assistance believed that EFSF should be expanded and given more flexibility to purchase debt instruments and inject capital into Eurozone’s central banks. They even suggested turning EFSF into a “bank” directly. In comparison, Germany, holding less foreign debt instrument and in a better market position, was reluctant to bear the risks of EFSF enlargement and refused to grant EFSF more functions. As a consequence, Germany rejected France’s proposal and insisted that in the second round of Greece aid program private businesses must bear responsibilities as well. It was these protracted struggles among France, Germany and other actors such as European Central Bank (ECB) that eventually lent momentum to the crisis to spread to other core states of Eurozone.

Finally, there were the disputes over euro-bond and the role of ECB. Faced with the ever deteriorating crisis, many debtladen countries regarded issuing euro-bonds and making ECB lender of the last resort as the fundamental solution to the debt crisis. As this proposal conflicted with Germany’s interests, it received strong opposition from Germany who believed that such measures would raise Germany’s financing costs, elevate debtor countries’ moral hazard, weaken member states’determination to reform and thwart their efforts to implement stricter fiscal disciplines. Further, Germany concluded that euro-bond as the product of a higher stage of Eurozone’s integration could not solve the current debt crisis and that ECB which was supposed to maintain the stability of euro could not possibly rescue member states and play a more positive role in the crisis. France, though echoing the German proposition in public, privately supported ECB in playing a larger role. In contrast to Germany, the French Government believed that“ECB will not only ensure the stability of euro, but also ensure the financial stability of Europe. We believe ECB should take necessary measures to bring financial stability to Europe.”

3. Different economic governance proposals reflecting different concerns

The crisis exposed some institutional defects of the EU, which necessitated economic governance programs. Although the EU achieved some key breakthroughs in the field of economic governance last year, there were disputes among EU member states concerning the concrete measures to take for strengthened economic governance. These disputes covered not only a Package of Six Legislative Acts, but also the Euro Plus Pact and related financial contracts, etc. They reflected member states’ different concerns to a large extent.

The first disagreement was about focus of the governance. As different member states had different understandings on the causes of the crisis, they tended to focus on different aspects of the governance. Northern countries represented by Germany believed that the focuses of the governance should be on strengthened fiscal disciplines, stringent financial controls and increased penalties for offenders. However, other countries believed that besides fiscal disciplines, topics such as economic imbalance, growth and competitiveness should be included as well. For instance, due to the disagreement, the Czech premier rejected the “financial conventions”, whereas Germany tried to dissuade the Commission from discussing the topic of trade imbalance during the negotiations on a Package of Six Legislative Acts. Moreover, excessive emphases on debt and deficit issues in the EU economic governance plan made some member states quite unhappy. They believed that the plan was just a compromise to Germany to secure German support on assistance issues and therefore was not much helpful to the sustainable growth of European economy.

Secondly, there were disagreements over the distribution of economic governance power. The dispute between Germany and France over this issue was a typical example. When choosing a candidate organization for supervision of budgetary and economic policies, Germany insisted that the candidate should be a politically independent organization like the European Court of Justice or European Commission. As Merkel said,“an independent organization free from political intervention provides the best assurance of credibility. The independence of European Court of Justice and European Central Bank is the best token of democracy.” In comparison, France insisted that the European Council should play a bigger role, because“decisions must be made by European leaders, as political participation constitutes the legitimacy of democracy. A Europe lacking political participation, operating autonomously but encouraging competition and free trade aimlessly will not meet the challenges of the crisis.” In other words, France believed that the European Commission and European Central Bank lacked political strategies but were given too much freedom in taking independent actions.

II. The Crisis Changed the EU’s Internal Balance of Power.

Over a long period of time, the EU has tried to achieve an internal balance of power by means of institutional arrangements. For example, France used its political influence to balance against Germany; small countries balanced against the wills of big powers by strengthening community mechanisms; the UK tried to create a “coalition of the willing” to offset the influences of France and Germany, etc. Through these arrangements, a delicate balance of power in the EU was maintained. However, the debt crisis, by lending weight to the factor of economic power and thereby forcing the Eurozone countries to intensify cooperation with one another in the economic and financial areas, changed the original balance of power in the EU. “In the context of the crisis, negotiations among 27 Eurozone countries are becoming increasingly bilateral in nature, especially the negotiations among those big countries. This trend is quite disturbing. If it is allowed to develop further, Europe will deviate from its normal track of institutional check and balance and return to the old path of intergovernmental coordination.”

1. The balance of power between France and Germany tilts in favor of Germany.

A big power in the EU, Germany has kept a low profile in the EU politics for years due to its division and war-time legacies. In contrast, France has been using its friendship with Germany to play a leader’s role in the EU politics. This tacit division of labor between France and Germany, i.e. French political leadership plus German economic contribution, has been the driving force behind European growth over the past 50 years. However, the crisis undermined this unique model of Franco-German division of labor. With the economic power factor gaining more weight,“Germany as the largest creditor country in Europe is deemed as holding the key to the sovereign debt crisis in Eurozone”; as a result, “Europe will enter the era of German unipolarity.” This mood was mostly vividly reflected in the following statement:“now is the moment when Merkel makes decisions and Sarkozy holds news conferences to interpret her resolutions.” With the change in Germany’s position, disputes over the “German Problem” began to surface once again in Europe.

2. The further strengthening of France and Germany’s central position breaks the balance of power between large and small countries.

“During the past 20 months since the eruption of the debt crisis, Europe witnessed not only the failure of collective leadership, but also the emergence of Franco-German leadership.” The Franco-German leadership was found not only in the efforts and concrete plans for the construction of anti-crisis mechanisms, but also in the momentum with which the concept and methods of economic governance were promoted. Be it Euro Plus Pact aimed at strengthening of economic governance in Eurozone or the austerity plans in response to the crisis, and be it the expansion of EFSF or the recent motions on agreement modification, they were all result of Franco-Germany negotiations and compromises. During the past two years, discussing joint proposals from France and Germany on EU summit meetings has become a routine. On this phenomenon, some European scholars made the following comment: “Europe today is in a very interesting situation. People are expecting too much from France and Germany, as if once France and Germany reached a consensus, other member states would comply and the rest of the world would have confidence in Europe automatically.”

3. Turning Eurozone into the “core” of the EU by tipping the balance between Eurozone countries and non-Eurozone countries

The closer economic and financial coordination among the countries in Eurozone following the eruption of the crisis will inevitably spill over to other policy areas, thereby turning Eurozone into the core of the EU. On this phenomenon, some observers made the following comment: “The apparition of a ‘two-speed’Europe took shape in August 2011 when France and Germany suggested to the leaders of Eurozone countries that they should have meetings regularly under an independent Eurozone chairmanship.” Ever since the first Eurozone summit meeting called on by France in Paris in October 2008, the Eurozone summit meeting has become a mechanism for the EU to deal with debt crisis in addition to the European Council. In the recent draft of“financial contracts”, the Eurozone summit meeting was officially institutionalized as a biannual meeting for policy coordination purposes. “Brussels even created a permanent secretariat to support Eurozone meetings and Eurozone financial meetings.”The institutionalization of Eurozone’s decision making and coordination processes is gradually turning Eurozone into the“core” of the EU.

The close coordination among the Eurozone countries has caused some concerns on the part of non-Eurozone countries. On September 12th, 2011, the European Affairs ministers of Poland, Latvia, Czech Republic, Hungary, Bulgaria and Romania had a meeting in Brussels to discuss how to exercise their influences on the current debates over Eurozone. Poland, when holding the rotating presidency of the EU, published a paper titled “Strengthening Eurozone Governance to Safeguard EU Integrity”. In the paper, Poland indicated that “strengthening Eurozone economic governance should be an open process; it should incubate no exclusive structures that exacerbate the risk of EU disintegration”. Poland then proceeded to request equal rights for all EU countries to join Eurozone governance meetings.

4. The strengthening of Inter-governmentalism

The struggle for leadership between EU member states and the European Council started as early as the beginning of the debt crisis. By the time when the Rompuy Work Group convened its first meeting, the European Council had already commenced its initial negotiations on EU governance reform. And by the time when the Rompuy Work Group was terminated, the legislative proposals of the Council had been released already. However, because indirect financial transfers were needed to fight the debt crisis but related financial power was not available at the EU level, inter-governmental approaches began to play a dominant role.

More importantly, with a view to avoiding the emergence of a financial transfer coalition, Germany chose to shift its EU policy from the community approach to the new union approach, though it used to be a promoter of the community approach. After the summit meeting in October 2010, Merkel suggested better interactions with EU institutions to replace the community approach with the new union approach. She believed that the European Council should play a leading role among EU institutions. To a certain extent, the Euro Plus Pact was the very embodiment of Merkel’s “New EU” approach. France, however, chose to use the crisis to marginalize the role of the European Commission and promote the integration of inter-governmentalist forces, hoping to increase its influence in the EU in this way. Witnessing the rise of inter-governmentalist forces, the chairman of European Commission warned that“inter-governmental cooperation can no longer lead Europe out of the crisis. On the contrary, inter-governmentalism will invite re-nationalization and fragmentation.”

III. The Crisis Remodeled Intra-EU Relations.

The crisis and its resolution not only profoundly changed the relationship between EU institutions and EU member states, but also strengthened political interactions between member states and the EU and remodeled intra-EU relations.

1. Formal equality between member states was weakened.

Although there were complaints about unequal treatment of member states in the EU prior to the eruption of the crisis, the formal equality of member states was at least guaranteed and protected by institutional arrangements. The debt crisis divided member states into a core group and a peripheral group, or the group of creditor countries and the group debtor countries. These two groups enjoyed different rights and shouldered different obligations according to related crisis relief plans. The formal equality of member states was thus weakened. To a certain extent, the “conditional assistance” clause of the crisis relief plans made the EU very similar to IMF, granting creditor countries with the rights to intervene into debtor countries’domestic affairs, especially those assistance recipient states.

Take Greece as an example. Except using the troika of the European Commission, European Central Bank and IMF for regular mo-nitoring and evaluation, the EU set up a permanent Greece Work Group to supervise the implementation of Greece’s reform programs. Meanwhile, Brussels and other member states chose to squeeze Greece at each round of Greek parliamentary debate on austerity programs. “Brussels is adopting unprecedented measures to intervene into member states’ domestic affairs. Through intervention, the EU successfully formed cross-party consensuses in three EU member states.” Recently, Germany even suggested nominating a budget committee to control Greek finances. This caused great dissatisfaction on the part of the Greeks who declared that “our partner should understand that the European integration is based on member equality and respect to member states’ identities and dignities.” Similarly, Italy’s involuntary acceptance of IMF monitoring of its reform programs was also a result of the pressures from German, French and EU agencies.

Economic policy was not the only area where the debtor countries were subjected to “interventions”. As a matter of fact, both the abortion of Greek referendum and the inauguration of technocrats in Greece and Italy resulted from EU pressures. On November 1st, 2011 when the Greek Government announced a referendum on the austerity plan, Merkel and Sarkozy made a joint declaration in Cannes that the EU and IMF would not consider granting Greece the sixth tranche of relief fund until the Greek referendum result was clear and Greece agreed to adopt the package of October 27th. Meanwhile, they applied pressure on Greece by implying that Greece would be kicked out of Eurozone if it did not comply. Greece gave up the referendum consequently.

2. Economic policy power shifts closer to the EU.

In 2011, to strengthen fiscal disciplines and economic coordination, reinforce economic governance and promote further shift of economic policy power to the EU, the EU introduced a series of “soft” and “hard” measures besides the “European Semester” system.

As “soft” measures, the EU implemented the “European Semester” system and Euro Plus Pact to promote budgetary and macro-economic policy coordination at the EU level. The European Semester system required that before each member state’s fiscal and economic policies were approved by its parliament each year, they must be evaluated by the European Commission and European Council at the EU level to ensure effective coordination among member states’ fiscal and economic policies. Although this system did not hurt member states’ sovereignty on budgetary and economic matters, the European Commission obviously gained more power to advise on and supervise member states’ economic policies.

Based on the principles of competitiveness enhancement, employment improvement, fiscal consolidation and financial stability, the Euro Plus Pact aimed to “consolidate the economic pillars of the monetary union, promote the further conformity of economic policies and achieve a higher degree of convergence. The pact focused on domains that are critical to the improvement of competitiveness and removal of economic imbalances but traditionally under member states’ sovereign jurisdictions.” So far, 23 countries have signed the Euro Plus Pact. Every spring, the Pact’s signatory states would have summit meetings to evaluate the Pact’s implementation. Pressure would be exercised on those countries who did not achieve their goals. Suspicious over the EU on this point, the Czech president was quoted as saying: “the Pact is a further step towards fiscal integration of the union; however, it is also a step backwards towards weakening member states’ sovereignties.”

The “hard measures” would be applied to secure approvals for legislative programs targeting strengthened EU economic governance. These programs not only concerned fiscal policies but also included solutions for structural imbalance in Eurozone. Covering a broad range of issues, they involved policy areas that were traditionally under member states’ jurisdictions, including wage level, private and public debt, real estate bubble, resource allocation and level of consumption, etc. Through legislation, these programs would allow the Commission to play the role of a monitor and an evaluator and grant it with the power to lay sanctions on violating states. “These measures significantly increased the EU’s power to formulate fiscal, budgetary and economic policies.”

3. Increased political interactions between member states and the EU.

As the debt crisis and its resolution became dominant themes of member states’ domestic politics, crisis-relief aid programs and member states’ political and social conditions began to get intertwined. The way how they shaped and interacted with each other changed the political and social arenas in the EU considerably.

Firstly, the crisis impacted the political processes in member states. The forced early elections in Portugal and Spain and the inauguration of technocrats in Greece and Italy were both direct results of the debt crisis. To avoid the fate of begging for foreign aid, the Portuguese government pushed for the fourth austerity program in a single year. The program was unanimously blocked by the opposition parties and Socrates, the Portuguese Prime Minister, was force to resign. Similar scenarios happened in Spain too. Faced with surging bond yields and opposition pressures, the Spanish Prime Minister Zapatero was forced to announce an early election. As he indicated, the move was to “prevent political debates from being used for market speculation purposes.”

Secondly, the crisis changed the political map of Europe by promoting extreme right-wing forces. As people’s fears of globalization were greatly aggravated by the debt crisis and the resultant austerity policies, extreme right-wing forces took the opportunity to grab people’s support by inciting fears. “Because traditional rightist or leftist parties had no effective solution to the crisis, extreme right-wing forces, populist and xenophobic forces began to grow rampantly…. and extreme right-wing parties on the European political arena saw their influences growing rapidly.” Take Finland for example. During the Finnish election, EU policies and assistance to crisis-stricken states became top issues dividing Finnish political parties for the first time in history. And in the election on April 17th, 2011, there was a great surge in voters’ support to the True Finns. The party’s seats in the Finnish Parliament rose from 5 to 39. Today, if we look at the political map of Europe, we can see that extreme right-wing parties or populist parties have parliamentary representations in all open and inclusive Nordic countries.

Thirdly, the crisis increased the political connection between member states and the EU. In early 2011, the debt crisis was stabilized for some time; however, on March 23rd, with the collapse of the Portuguese Government as a result of Portuguese parliament’s unexpected rejection of the fiscal austerity plan, the debt crisis experienced a rapid deterioration. On the pretext that Germany’s domestic political conditions in Germany did not allow for assistance to Greece, the German Government only agreed to provide private relief efforts. This led to a protracted disagreement between European Central Bank and France which eventually led to the spread of the crisis. Under the pressure of Eurosceptics at home, Cameron, the British Prime Minister, rejected the Franco-German proposal on convention revision, rendering the Financial Convention only an inter-governmental agreement. Like the UK, Czech Republic also used its complicated domestic approval procedures as an excuse to reject the financial convention. Historically, the first“two-step” summit of the EU was a symbol of increased political connection between the EU and its member states. During the course of crisis-fighting, member states played the card of domestic politics and the card of EU politics alternately to secure public support at home and increase bargaining power at the EU level. In doing so, they complicated the political connection between member states and the EU.

IV. Difficult Choices on Integration

Although the debt crisis promoted the European integration process by creating consensuses among European elites, it raised a series of questions on how to remove disagreements among different EU forces, how to strike a new balance of power after the collapse of the old equilibrium, as well as how to remodel intra-EU power relationship. These would influence not only the integration process but also the direction of integration. In the current context of economic downturn, social upheaval and surging nationalism, these uncertainties would make the EU integration prospect appear very confusing.

The first choice for the EU is about how to balance austerity and growth. Austerity is a precondition of economic and financial sustainability. However, promoting growth and redu-cing unemployment are the EU’s practical economic and social needs as well. As a result, the EU finds itself caught in a dilemma in this respect. On the one hand, stringent austerity policies introduced since the eruption of the crisis have caused average European citizens to be very dissatisfied. This led to large scaled social unrests and industrial strikes in Greece, Italy, Spain and France and caused serious deteriorations in European social security conditions. For example, as a recent IMF report describes, “the austerity policies in Greece have far outreached what the Greek society can bear” and the country need to improve its economic growth and employment situations urgently. On the other hand, serious debt deficits are restricting Europe’s options for economic stimulation and growth promotion.

The second choice is about how to strike a new balance of power to combat the resurging nationalism and ease member states’worries about Franco-German leadership and the “German Problem”. Disputes, quarrels and criticism among member states caused by the debt crisis are leading to the resurrection of nationalism in Europe. On the one hand, Germany, France, the Netherlands and other north countries in Eurozone are reluctant to take over the bills of countries like Greece and Italy. For example, more than two thirds of the German population was against assisting Greece and other debt-laden countries. On the other hand, the southern countries are accusing the northern countries of their reaping the benefits of euro without bearing corresponding responsibilities. Face with this situation, the finance minister of Poland described these two opposing thoughts as two “dangerous nationalist” strands, i.e. the irresponsible fiscal policies of the southern countries and the nationalism without solidarity on the part of the northern countries.

Although the Franco-German leadership is necessary for the solution of the crisis, the Franco-German practices of forcing others to accept their concepts and policies are generating worries and centrifugal tendencies on the part of other member states. For example, when France and Germany proposed the Competition Act in early 2011, other member states were strongly disturbed. Attempting to eliminate other countries’fears, Barroso, the chairman of European Commission, and van Rompuy, the chairman of European Council, had to step in and take over the baton from France and Germany. The crisis revived the “German Problem” too. Other member states have complicated reactions to the “unipolarity moment”created by Germany in Europe: on the one hand, they wish to embrace Germany closely; on the other hand, they wish to forge a coalition to balance the German power. The Europeans are appealing Germany to play a leading role but they do not want to be put under German leadership. That is why when a German led an EU work group to Greece to assist with Greek economic reforms, he was nicknamed “Nazi governor” by unsatisfied Greeks. “If Germany could not find legitimacy for its role in the EU, then Germany should redefine and redesign its policies on and approaches to economic governance.”

The third choice is about how to create positive interactions between member states and the EU. Due to the serious impact of austerity policies, the populist parties of debtor countries in Europe are becoming increasingly anti-EU, while people in these countries are more and more suspicious of EU intentions. Meanwhile, as elites across Europe are losing authorities, member states’ governments begin to hate the European Commission and the European parliament too. “The EU and its member states are all under the influence of technocracy and populism, two conflicting but complementing forces. As the EU’s political system is now on the brink of total collapse, it will be the next big challenge after the euro crisis.” Since existing programs can no longer solve the crisis, the EU needs to explore new ways for positive interaction.

Currently, with various conflicting forces struggling for the leading position, the development of the EU has reached a critical point. As member states are forced by the crisis to coordinate their economic and fiscal policies, power is gradually shifted to the EU level. During this process, inter-governmental forces will be considerably increased. Fighting the crisis also calls for Franco-German leadership; however, worries about Franco-German leadership are on the rise across Europe. Although certain consensuses have been formed during the crisis on accelerating structural reforms to increase competitiveness, such reforms would be constrained by political and social boundaries and struggles and compromises between different forces would eventually determine the pattern and trend of European integration. In any case, the process of European integration would have been profoundly changed by the euro crisis.

Jin Ling is Associate Research Fellow at China Institute of International Studies.