Currently, the EU seems determined to hold fast to a discredited policy of ‘structural-adjustment-on-steroids’. Yet as even the IMF now acknowledges, debtor-state austerity alone is self-defeating.
The austerity produced by a dogmatic interpretation and implementation of an enhanced Stability and Growth Pact is now successfully stifling growth, even in ‘locomotive’ economies such as Germany. As the IMF has already learned from its experience with structural reforms, successful implementation of the troika’s policies remains doubtful if deficit economies cannot draw on deep-seated domestic support and in turn perceive debtor and creditor obligations as balanced and fair.
To this end, eurozone governments need to recognise the importance of providing the required ‘policy space’ to respond to domestic social and political imperatives by enhancing the ‘room to move’ for debtor-state governments.
Success also involves rebalancing the obligations of debtors and creditors: both the positive and the more negative results of capital mobility are collectively produced through market interaction, so outcomes must be collectively owned and burdens must be shared by public and private debtors and creditors alike. This harks back to the principles of Keynes’ ‘Clearing Union’ proposal: imbalances are a joint problem to be resolved through simultaneous and required adjustment by both surplus and deficit countries.
Successful crisis resolution also requires thinking about whose interests are protected by the current crisis-workout process, who pays the costs of adjustment, and whose interests should be primary to the functioning of integrated financial markets in the eurozone. This reflection opens the door to effective consensus building for the reform of eurozone governance. It cannot be that eurozone citizens in surplus and deficit economies alike are called upon to provide taxpayer guarantees for the indiscretions of private lenders (in whose lending decisions ordinary people played little part) while those in deficit economies bear a disproportionate share of the adjustment burden.
In practice the eurozone has turned out to be rather efficient at saving banks, but the mandate of the ECB excludes saving the citizen guarantors of the system should their own state’s resources become exhausted. The burden of adjustment falls on the weaker, developing and deficit economies that already benefit less from the system of capital mobility and exchange-rate stability than the more advanced economies. This context potentially undermines the ability of states to cooperate in order to sustain liberal finance at all.
This means that the range of stakeholder inputs into policy design needs to be broadened so as to produce more effective, legitimate, and balanced policy outcomes in the future. Unless the influences on policy decisions are to change, ineffective policy is likely to prevail.
The legitimacy of financial integration and regulation in the context of EMU
In the wider context of financial governance, Andrew Walter (2010) has demonstrated that even sound standards and policies may be unsuccessful if they are perceived as imposed by an unfair and exclusionary process. Thus the balanced representation of, and input from, the diversity of interests with a stake in crisis workout must be a goal both globally and at the European level. Historically, the dominant voice in national policy processes related to monetary union and European financial integration, alongside the public agencies legally responsible for regulation and supervision, has been that of private financial institutions. Unless broader stakeholder and country input can be included, skewed and ineffective policy output with a strong whiff of capture will continue. This may apply as much to adjustment policy as to financial regulation and supervision. Already the opposition of banks to ‘ringfencing’ or separation of investment and commercial banking as proposed by the Liikanen report appears to have diluted the recommendations in the implementation phase.
The voice in policymaking of the users of financial services should be increased, from small and medium-sized enterprises to pension funds and their labour-market constituency, to depositors and to savers. These constituencies currently have little say in the making of policy yet are all significantly affected by the decisions taken, especially when crisis hits. An institutionalised system of ‘corporatist’ representation of stakeholders could bring the interests of these constituencies to bear on financial supervision and regulation and the distribution of the burdens of adjustment. Technical forums such as the Basel Committee on Banking Supervision should be actively required to solicit a prescribed range of stakeholder responses leading to real policy inputs. Moreover, the transparency and accountability of the process that translates global regulations into EU directives should be improved.
This involves formalising two elements of an ‘accountability phase’ in the policy process:
– Accountability for how the input side of the policy process has functioned and whose preferences constituted inputs into policy;
– Accountability for actual outcomes achieved.
The first involves full transparency on the involvement of lobbyists and social partners, allowing agencies and parliamentarians to judge whether an adequate balance among stakeholder interests was involved in technical forums. The second involves holding public-sector agencies and private financial institutions accountable for outcomes achieved in terms of financial stability and balanced real-economy growth. As the EU develops ever more intrusive fiscal and financial mechanisms the role of the European Parliament should become ever more central too. The more that EU supervisory coordination is strengthened under the new ‘Single Supervisory Mechanism’, the more that home-host responsibilities need to be clearly defined – especially when it comes to the sharing of costs when things go wrong. Until questions in banking supervision/resolution and in macroeconomic adjustment of public-private sector burden sharing and eurozone distribution have been properly tackled in a way that is supported by EU citizens, the monetary union will not function.
Why do these issues matter? Why is the democratic legitimacy of crisis resolution and financial reform crucial? The answer lies in the long-run sustainability and legitimacy of financial openness and capital mobility. Financial liberalisation is better sustained in economies that mitigate the risks of liberalisation through welfare and other forms of compensation for the vulnerable. Nurturing financial openness requires the very policy space that austerity is closing down. Electorates are rebelling against solutions that ‘pool’ sovereignty just as market integration and crisis makes national policy less effective. Failure to think systematically about the emerging legitimacy deficit is generating centrifugal populist political forces. This context potentially undermines the ability of states to cooperate so as to sustain liberal finance at all. In short, we need a eurozone that demonstrably places citizens above banks to overcome the threat of disorderly disintegration.
This column is based on the extensive research findings elaborated in the January 2013 CEPR eBook Global financial integration, twin crises, and the enduring search for financial stability.
Geoffrey R. D. Underhill is professor of International Governance, University of Amsterdam. Jasper Blom is a research affiliate in the department of political science, University of Amsterdam.
This is an edited extract of an article originally published on www.VoxEU.org. Reproduced with permission.