Petrakis et al european economics and politics in the midst of the crisis (2013)

Panagiotis E Petrakis Pantelis C Kostis Dionysis G Valsamis European Economics and Politics in the Midst of the Crisis From the Outbreak of the Crisis to the Fragmented European Federation European Economics and Politics in the Midst of the Crisis ThiS is a FM Blank Page Panagiotis E Petrakis • Pantelis C Kostis • Dionysis G Valsamis European Economics and Politics in the Midst of the Crisis From the Outbreak of the Crisis to the Fragmented European Federation Panagiotis E Petrakis Pantelis C Kostis Dionysis G Valsamis Department of Economics University of Athens Athens, Greece ISBN 978-3-642-41343-8 ISBN 978-3-642-41344-5 (eBook) DOI 10.1007/978-3-642-41344-5 Springer Heidelberg New York Dordrecht London Library of Congress Control Number: 2013957873 # Springer-Verlag Berlin Heidelberg 2013 This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed Exempted from this legal reservation are brief excerpts in connection with reviews or scholarly analysis or material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work Duplication of this publication or parts thereof is permitted only under the provisions of the Copyright Law of the Publisher’s location, in its current version, and permission for use must always be obtained from Springer Permissions for use may be obtained through RightsLink at the Copyright Clearance Center Violations are liable to prosecution under the respective Copyright Law The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made The publisher makes no warranty, express or implied, with respect to the material contained herein Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Contents Introduction Part I The European Crisis The Evolution and the Current Status of the European Financial Crisis 2.1 Evolution of the European Union 2.2 The Historical Evolution of the Crisis 2.3 An Initial Approach to the Crisis References 7 13 16 20 The Great European Recession 3.1 The Costs of the Great Recession 3.2 The Redistribution Consequences 3.3 The Comeback Lag and the Divergence Evolution References 21 22 25 30 31 Part II The Structural Elements of the Crisis The European Suboptimal and Segment Areas 4.1 The Limitations of Eurozone Member Countries 4.2 The Segmented Economic and Social Areas References 35 36 38 42 European Stock Asymmetries 5.1 Population and Geostrategy Asymmetries 5.1.1 Population Balances 5.1.2 Geostrategy Balances 5.2 The Economic Stock Imbalances 5.2.1 Debt: Public and Private 5.2.2 Tangible and Intangible Assets References 43 43 44 47 48 48 49 51 v vi Contents European Flow Imbalances 6.1 Public Deficits 6.2 The External Accounts 6.3 Savings and Investments 6.4 Employment and Inflation 6.5 The Competitiveness Imbalances References 53 53 54 58 59 60 64 Culture, Institutions and Politics as Crisis Generators 7.1 Cultural Background 7.2 Political Balances 7.3 Governance 7.4 Institutions and Incentives References 65 65 67 70 71 75 The Growth Lag and Strategic Choices 8.1 The Long-Term Growth Lag 8.2 The Growth Priorities 8.3 The Attainment of Long-Term Competitiveness and Export Orientation 8.4 The Bank-Based Growth 8.5 Debt Management References 81 81 83 84 87 88 94 Fiscal Policy and Consolidation 9.1 The Effectiveness of Fiscal Policy 9.2 Contractionary or Expansionary Austerity Policy 9.3 Tax-Based Versus Spending-Based Fiscal Consolidations 9.4 The Size of Fiscal Multipliers 9.5 Fiscal Tightening in a Liquidity Trap 9.6 The Role of Perceived Risk of Sovereign Debt 9.7 Can Austerity Be Self-Defeating? 9.8 Synchronized Fiscal Consolidations and Spillover Effects 9.9 Fiscal Consolidation Programs After the Euro References 97 97 99 101 102 104 105 106 109 110 115 10 The Supply Side Policies 10.1 Supply Side Rationale 10.2 Structural Reforms 10.3 The Required Adjustment and the Adjustment Speed 10.4 The Effectiveness of Economic Policy in Europe References 119 119 120 123 126 131 Part III The Policy Response Contents vii Monetary Policy 11.1 The Imbalanced Monetary Policy 11.2 Rebalancing and Inflation 11.3 The Effectiveness of Monetary Policy and the Liquidity Trap 11.4 The Financial Transaction Tax References 133 133 137 12 The Policy of the European Central Bank 12.1 The Open Market Operations 12.2 The ECB as a Treaty Changer 12.3 The Multiple Bond Equilibria 12.4 The Euro’s Confidence 12.5 The Role of the Lender of Last Resort References 145 145 149 150 153 155 158 13 Restoration of the Banking System and the Banking Deleveraging Process 13.1 Contagion and Systemic Risk 13.2 The Financial Market Fragmentation 13.3 Weak European Banks 13.4 The Credit Crunch and the Financing of the Real Economy 13.5 The Deleveraging Process References 159 159 161 163 165 166 173 The Role of the IMF in the European Evolution 14.1 The Character of the IMF 14.2 Global Financial Governance and the IMF’s Role 14.3 The IMF in Europe 14.4 The IMF and Sovereign Debt Management 14.5 Conditionality and Supply-Side Policies 14.6 The IMF and Domestic Policies References 177 177 181 181 183 185 187 189 11 14 Part IV 15 140 141 142 The Political Economy of European Synthesis and the Medium Future Debates and Choices 15.1 The Political Economy Approach: Ideas and Cultural Background Diversification 15.2 The Critical Debates 15.3 The Social Model Controversy References 193 193 195 198 201 viii Contents The European Synthesis 16.1 The European Response to the Crisis 16.2 Fiscal and Macro Management 16.3 Financial Stabilization, Banking Sector Reorganization and the Deleveraging Schedule 16.4 The Structural Readjustment References 203 203 204 17 The Medium-Term Future for the World and Europe 17.1 The Medium-Term Future for the World: 2015–2025 17.2 The Two Potential Worlds 17.3 The European Evolution References 223 223 226 228 232 18 Economy and Politics 18.1 An Integrated Approach to the Crisis and Politics 18.2 The Political Economy of the European Crisis 18.2.1 Geostrategic Issues and Economic Nationalism 18.2.2 Beggar-Thy-Neighbor Policies 18.2.3 The Euro as an Exchange and Reserve Currency and the Internal Repercussions 18.2.4 The Democratic Deficit and Monetary Policy 18.2.5 Political Shift and Economic Policy 18.2.6 Towards an Indebted Fragmented European Federation References 235 235 239 239 243 16 206 213 221 244 245 247 249 258 Introduction This book reviews the Great European Recession of 2008 and monitors European developments, and particularly developments in the Eurozone, at an economic and political level until mid-2013 It is impossible to predict the future However, the more powerful the institutional framework within which action unfolds, the more powerful the prediction In the case of the European Union (EU), its institutional framework and its evolution, function together and influence each other, making projections difficult However, it is possible to assemble scenarios through which the future will emerge with a great degree of probability The assembling of scenarios is based on knowledge of the forces that determined the past and now determine the present To understand them we need an appreciation of their origins and should try to understand their nature We can thus understand the active forces that play, or will play, a role in shaping the future We can develop an appreciation for how the forces are transformed, what new forces are born of existing ones, and how and from where they integrate new elements for change and the shaping of future developments One need not necessarily be a supporter of the Hegelian theory of history to realize that reality is a fruit of the tug of war between opposite and composite forces After all, basic European imbalances and basic asymmetries drive European evolution The nature of such dialectical conflict is in fact shaping the future However, we should not seek conflicting forces solely in the economic field The fields of ideology and cultural background also constitute significant driving forces for evolution The EU, however, is above all a political creation It was not imposed through a military or civil-war conflict Its creation was not the product of the end of the Second World War The reason for this is simple: Europe was divided (east-west) and, thus, it was not possible for the western powers to impose unification as a means for preventing future conflicts Consequently, European unification is a politically voluntary process that was triggered much later Economic theory and economic policy were called on to remedy and cover the known and unknown circumstances that emerged from the political decision on the P.E Petrakis et al., European Economics and Politics in the Midst of the Crisis, DOI 10.1007/978-3-642-41344-5_1, # Springer-Verlag Berlin Heidelberg 2013 246 18 Economy and Politics which political unification could emerge and, by extension, the elimination of the democratic deficit There are five basic characteristics describing the concept of the democratic deficit (Føllesdal and Hix 2006): (a) The increase in executive power and the decrease in national parliamentary control (Raunio 1999) (b) The European Parliament is too weak (Lodge 1994), despite the fact that all the progressive interventions in its institutional operations have increased its power The gap in the European Parliament functioning is filled, at a European level, by private interest groups, which are not restrained by political parties or the organized interests of multinational enterprises On the contrary, broader unions of interests, such as consumer unions or trade unions, have less influence, and hence private sector representatives have a more serious presence (c) As of early 2013 there have been no “European elections” In other words, no European personalities are elected, and there are no political parties that present a state of the union address Even the national elections for the European Parliament are usually overwhelmed by local issues (d) There is a distance-related problem in the view of European institutions as European voters consider them as “too distant” Consequently, European citizens have many problems in understanding the functioning of the EU (e) As a result of the aforementioned factors, the EU-27 adopts policies that are supported by the majority of the citizens in the separate member states At a local level, such policies come face to face with the policies of national parliaments, the rule of law and pressure groups They include a neo-liberal regulatory framework for the single market, a monetarist framework for EMC and massive subsidies to farmers through the common agricultural policy In fact, in the aftermath of such decisions, the social democratic view that there is “systematic deviation” in the European decisions, in the sense that they are distant from the “center-left” voter The monetarist framework of economic policy, however, may have broader consequences Hence, the monetary union stems from the central banking system and is diffused through the trade and investment banking system In contrast, a fiscal policy should stem mainly from parliaments and mainly concern the relationship between politics and society Consequently, monetary policy is linked to and stems mainly from administrative centers (ECB, Central Banks), whereas fiscal policy stems from representative centers (parliaments etc.) There is also an opposing view on the existence and the extent of the democratic deficit (Majone 2002), in that the EU-27 is more of a regulatory state (Majone 1996) A regulatory state focuses on remedying market weaknesses and seeks policy results whereby some benefit, but none are worse off (Pareto-efficient), rather than redistributive results where there are both winners and losers Hence, the EU-27 operates more as a national competition commission and a Central Bank than a democratic institution By this rationale the problem does not lie with the democratic deficit, but with the credibility crisis associated with the decisions taken in the EU: the ex post 18.2 The Political Economy of the European Crisis 247 assessments (the control of the decisions and professionalism) may be more important than the democratic decision-taking process Policy results are answerable to national parliaments and the domestic mass media that act as powerful transparency control poles for policy decisions and results In relation to criticisms on the systematic deviation from the center-left, the explanation lies with the way in which decisions are taken In the majority of serious decisions the rule of absolute consensus applies, hence such decisions are inevitably more “center-oriented” and, in general, not at either of the polar extremes Over the last six decades European institutional integration evolved, in the worst case, under conditions of mild crisis However, circumstances have significantly changed, and it now evolves under deep recessionary conditions All the possible solutions to the self-developing crisis require a significant level of fiscal and political unification, not only because certain countries, such as Germany, ask for it in exchange for their participation, but also because it is claimed that the democratic deficit is the source of the big crisis and, particularly, of the debt crisis The uneven evolution of the debt-to-GDP ratio in the various countries was a manifestation of the democratic deficit, in the sense that national authorities made specific local choices The question raised here relates to the trends created in the democratic deficit on the basis of the political framework for confronting the crisis It is clear that the need for the improvement of decision effectiveness, mainly around reaction time, is not consistent or is even directly inconsistent with the requirements for improvements in European democracy The six-pack regulations and the “Fiscal Compact” clearly worsen the impact of the democratic deficit on small countries because they have deviated from the principle of consensus At the same time, the over-activation of monetary policy enhances the power of executives in the representative institutions Established interests tend to be created that will have difficulties accepting the mitigation of their power at a later stage These new circumstances increase the effectiveness of the central intellectuality and create a transfer payments context, from the wealthy to the less wealthy countries The solution clearly lies with an increase in efficacy and the broadening of European democracy through the establishment of European political institutions (such as enhancement of the European parliament) Perhaps such outcomes may emerge from 2014 onwards 18.2.5 Political Shift and Economic Policy Political institutions are the main shaper of the distribution of resources to the economy The distribution of resources, in turn, shapes the new political and, as such, economic institutions in a society Political institutions influence to a great extent the way in which the political system is organized and the degree of its acceptance by society The acceptance of 248 18 Economy and Politics the political institutions by the majority of society creates the appropriate foundations to counterbalance the pressures from various interest groups that cause problems both to the establishment of a healthy investment climate and the distribution of income and economic growth Consequently, the internal cohesion problem between political and economic institutions is distinguishable, provided that the political institutions express the power imbalances in society and, as such, influence the distribution of wealth and income The European political framework was unable to confront either the extent or the depth of the crisis If we take into account the basic conflict of “who is to blame and to what extent” (markets or institutions and, by extension, political actors) we can see that the greatest responsibility lies with political actors and political institutions This is because politicians should have already transformed institutions to confront the crisis and to react in a very direct manner They should also have knowingly rejected the economic policy suggestions deriving from economic models whose basic foundation is future repetitions of the past The fact that many countries managed to increase their borrowing to levels that they could not later serve without this being depicted in their lending cost (Greece, Portugal, Spain), constitutes an essential weakness of the markets to accomplish their mission Rightly or wrongly, however, the transformation of institutions is nothing more than the conflict between markets and politics: “In a way, it is a struggle between politics and the markets We must re-establish the primacy of politics over the markets” (Merkel 2010) Nevertheless, delays in political institution reactions to the crisis are expected The weakness of the European political system emerged during its slow response to the crisis and only when “all other choices have been exhausted” This opened the door to political extreme unconstitutional forces, setting in train new and unknown forces for the political future The Great Recession and its stabilization programs, together with the EU fiscal and competitiveness consolidation programs, had two main political impacts on European societies: they worsened democracy indices, mainly in peripheral countries, and they boosted the forces associated with the center-left (Table 18.1) These developments were observed in a series of countries, where either governance was taken over by center-left governments or the basic competitive power evolved to the center-left or left Although Germany is clearly diversified, opposition there appears to be significantly strengthened, at least in early 2013 polls (Table 18.2) The consequences of this development on economic policy are particularly significant If we accept that center-right governments are traditionally under the influence of the neoclassical economic model and the center-left ones are under the influence of the Keynesian economic model, then it is evident that reductions in the power of the supply-side politics and an increase in the power of political fiscal intervention have indeed emerged The messages in early 2013 with regard to the policy that is going to be developed and, particularly, as to whether austerity policies will be maintained, were mixed, showing on one side the exhaustion of 18.2 The Political Economy of the European Crisis 249 Table 18.1 Democracy index Belgium Finland Germany Luxembourg The Netherlands Average of creditor countries France Greece Ireland Italy Portugal Spain Average of debtor countries 2006 8.15 (20) 9.25 (6) 8.82 (13) 9.1 (7) 9.66 (3) 9.00 8.07 (24) 8.13 (22) 9.01 (11) 7.73 (34) 8.16 (19) 8.34 (16) 8.24 2008 8.16 (20) 9.25 (6) 8.82 (13) 9.10 (9) 9.53 (4) 8.97 8.07 (24) 8.13 (22) 9.01 (12) 7.98 (29) 8.05 (25) 8.45 (15) 8.28 2010 8.05 (23) 9.19 (7) 8.38 (14) 8.88 (11) 8.99 (10) 8.70 7.77 (31) 7.92 (28) 8.79 (12) 7.83 (29) 8.02 (26) 8.16 (18) 8.08 2011 8.05 (23) 9.06 (9) 8.34 (14) 8.88 (11) 8.99 (10) 8.66 7.77 (29) 7.65 (32) 8.56 (12) 7.74 (31) 7.81 (27) 8.02 (25) 7.93 Source: Economist Intelligence Unit Note: The parentheses correspond to the country rankings across 167 countries its capacity and on the other that the European Commission’s view is that austerity continues to be necessary (Buti and Carnot 2013), but in a different form As of early 2013 austerity was relaxed in France, the Netherlands, Slovenia and Poland This was when M Draghi (president of the ECB), spoke of a medium-term consolidation These movements could be considered as a preparation for the European elections of 2014 Even if we accept that the dominant policy is wrong, it is difficult to replace a failed policy Hence, a reasonable outcome would be that the front-loaded austerity policy will be replaced by back-loaded austerity A serious development emerged at an international level: “Abenomics” policies designed to end Japan’s stagnated inflation through the use of fiscal policy Japan’s experience of two lost decades is a warning to the international community to reduce the period of staying with policies that are characterized by small to zero growth At this stage we await the ultimate results of the Japanese experience The indications that exist (April 2013) are quite positive, despite the fact that “Abenomics takes Japan into uncharted territory” (Roubini and Manetta 2013) 18.2.6 Towards an Indebted Fragmented European Federation It has been a well debated point that, by finding itself at an unstable balance, the Eurozone has two prospects at its disposal It will either move towards further unification or towards its reconstitution, that is, its dissolution, removal of its weak elements, or its separation in two or more parts Whatever the outcome for Europe, it could happen within years, i.e during 2012–2017 There was a simple overall belief in the 2000s relating to the Eurozone: that the monetary policy, Growth and Stability Pact, Fiscal Compact and single exchange 250 18 Economy and Politics Table 18.2 Political changes in Europe Country Cyprus Political Previous elections position Presidential Elections, LeftFeb 2008 wing The 6th President of the Republic of Cyprus is D Christofias of the communist party AKEL Czech Parliamentary Republic Elections, Jul 2010 Coalition Government of: Civic Democracy Party TOP 09 Public Affairs Denmark Parliamentary Elections, Nov 2007 Coalition Government of: Venstre Liberal Party Conservative People’s Party Danish People’s Party France Presidential Elections, May 2007 N Sarkozy (Union for a Popular Movement) Centreright Centreright Polls/Last elections Presidential Elections, Feb 2013 The 7th President of the Republic of Cyprus is N Anastasiadis, president of the conservative party DISY Parliamentary Elections, Oct 2012 Coalition Government of: Communist Party of Bohemia and Moravia Social Democratic Party Presidential Elections, Jan 2013 Center-left-Eurofriendly M Zeman, coming from the social democrats, becomes the President of the Czech Republic, succeeding Euroskeptic Va´clav Klaus Parliamentary Elections, Sep 2011 Coalition Government of: Social Democrats Political position Centreright Population (millions) 0.9 Centre-left 10.5 European left Centre-left 5.5 Social democracy Social Liberal Party Centreright Socialist People’s Party Presidential Elections, May 2012 F Hollande (Socialist Party) Centre-left 63.0 (continued) 18.2 The Political Economy of the European Crisis 251 Table 18.2 (continued) Political position Polls/Last elections Centre- SYRIZA rises to right 26.89 % as against 5.63 % in the Oct 2009 elections Coalition Government Centre- Polls show that SYRIZA of: left is the winning party, with the vote intention New Democracy reaching 22.6 % as PASOK against 21.5 % for New Democracy Left Democracy (Kapa Research, 29/12/2012) Italy Parliamentary Centre- There was no Elections, April 2008 right to government after the elections on 24 February The People of Freedom rightwing 2013 The center-left coalition under the leadership of P Bersani prevails in the Parliament with a percentage of 29.54 % as against 29.18 % for the right of Berlusconi In the Senate, no party had absolute majority The center-left coalition gathered 31.63 % (113 seats) as against 30.72 % for Berlusconi’s coalition Malta Parliamentary Centre- Parliamentary Elections, Mar 2008 right Elections, Mar 2013 Christian Democratic Malta’s Labor Party Nationalist Party Romania Parliamentary Centre- Parliamentary Elections, Nov 2008 left Elections, Dec 2012 Coalition Government Centre- Social Liberal Union of: right (USL) Social Democratic Party Conservative Party Slovakia Parliamentary Centre- Parliamentary Elections, Jun 2010 left Elections, March 2012 Coalition Government Centre- Direction-Social of: right Democracy Social Democracy Slovak Democratic Christian Union – Democratic Party Country Greece Previous elections Parliamentary Elections, June 2012 Political Population position (millions) Centre-left 11.4 Centre-left 60.6 Centre-left 0.46 Centre-left 21.49 Socialliberal democracy Centre-left 5.5 Social democracy (continued) 252 18 Economy and Politics Table 18.2 (continued) Country Spain Previous elections Parliamentary Elections, Nov 2012 People’s Party Germany Parliamentary Elections, Sept 2009 Coalition Government of: Christian Democratic Union Christian Social Union of Bavaria Free Democratic Party Political Political position Polls/Last elections position RightFall in the popularity of Centre-left wing the governing party to reach 29.3 % (from 44.6 % in the Nov 2012 elections) The left party IU has an ascending course, which doubles its percentage (15.6 %), whereas the center party UFyD gets 10.6 % in the polls (Metroscopia for El Pais, 10/1/2013) Centre- The chancellor right A Merkel has high percentages, 41 % for CDU The social democrats (SPD) reach 28 %, liberal democrats (FDP) %, the Greens 14 %, the Left % and the Pirates % (Infratest dimap, 10/1/2013) Win of the social democrats (SPD) and the Greens over the Christian Democrats (CDU) and the Liberals (FDP) in the regional elections in Lower Saxony on 20 January 2013 Population (millions) 46.0 82.0 policy would trigger structural changes that would lead to the convergence of productivity and growth rates In reality, the cost of money convergence released fiscal indiscipline and relegated the need for structural changes in the periphery to second place The economies of the center proceeded with the restructuring of their competitiveness, which they would probably have done irrespective of Eurozone participation Hence, the Eurozone remained a broad economy, where the basic requirements for ideal monetary union were not met and, during the 2008–2012 crisis it became apparent that the forces that were developed were centrifugal instead of centripetal Therefore, the possibility of a Eurozone reconstitution returned to the fore There are a further four reasons for considering reconstitution: The fact that the non-bailout principle was breached Because European political leadership chose to bail out Greece, Portugal and Ireland during the 2008–2012 crisis, the foundations for the future dissolution of the Eurozone were set by the 18.2 The Political Economy of the European Crisis 253 skyrocketing of the moral hazard Hence it will not be possible to form an ideal Eurozone in the future because both governments and citizens will be aware that in case of fiscal indiscipline they will be rescued The alternative prospect would be for the indebted countries to restructure their debt (strategic or non-strategic default) However, moral hazard runs both ways and the manner in which it is politically managed is critical The significance of the moral hazard principle was diminished in the course of managing the European crisis, mainly because of the reduced effectiveness of the decisions of executives (see the case of Cyprus) So the “true” challenge is less between moral hazard and financial stability than it is between financially sensible and politically acceptable solutions (Pisani-Ferry 2013) Because the non-bailout principle was breached, the requirements for redistributive movements of huge amounts of capital (across countries) are set (because of the moral hazard) Nevertheless, a deviation from these levels for any reason (e.g the classification of France as a problematic country) would make the sourcing of further capital very difficult The pure conversion of the Eurozone to a transfer union (Konrad and Zschapitz 2011) would clearly be a politically unacceptable development, mainly from the perspective of the countries of the center The predictive orientation of Eurozone countries is of significance The dominant view in central counties is that their export orientation (mercantilist export leading model) should prevail during productive reorganization Therefore, countries that are far from this goal (for example Greece, and Portugal to a certain extent) cannot match them The debt problem in some Eurozone countries is so large that it possibly makes bailout and adjustment socially unacceptable This applies to countries such as Ireland, Portugal and Greece Hence a fragmentation of the Eurozone into two, one being the countries of the center and the other being those of Southern Europe, would present a homogenous prospect in terms of convergence potential for both groups A fragmented Eurozone would obviously cause enormous technical and economic problems and the derived costs (and benefits) would influence the relevant decisions If, however, the rationale behind creating two homogenous groups of countries is correct, then why should we accept, for example, that Wales is a part of the United Kingdom, or why northern Italy and southern Italy should coexist? In other words, the search for the optimal homogeneity is never-ending The bureaucratic structure of Brussels has a significant self-promotional interest in shaping future institutional prospects since its survival, and possible enlargement, will improve the position of its administrative members 23,600 people are employed in the European Commission, 6,000 people in the European Parliament and 2,600 in the ECB, with many others being indirectly employed Furthermore, the EU-27 budget is estimated to increase from €122 bn in 2010 to €150 bn in 2020, thus representing approximately 1–1.5 % of EU-27 GDP Of course, these figures are small in comparison with other unions of states, such as the United States, and correspond to an early stage of union organization It is evident, however, that both 254 18 Economy and Politics the basic administrative mechanism and the central management of the budget exert power to preserve European unification In essence, however, Eurozone summit decisions of June and December 2012 provide a clear future political prospect: the Eurozone will remain a single entity, with the potential for growth and gradually giving up Westphalian sovereignty Hence, the 2012 political decisions made it quite clear that although European political may not be able to create a central vision on the acceleration of the EU, they nonetheless stuck firmly to the political evolution of the Eurozone as a single entity Two main issues contributed to these decisions, and will have an impact on future decisions: (a) The de-structuring would very simply bring to the fore the fact that the broader political formation (the Eurozone) is not in a position to impose structural policies Such a failure, however, would mainly impact the core countries, resulting in credibility problems that would have repercussions both on the Euro and their external economic and political presence (b) There are strategic geographical interests, such as the energy relationships with the Middle East or relationships with Latin America that would not readily accept a change in the status quo These include interests on the preservation of a South-Eastern path of Europe towards the Middle East, including Israel Hence, the policy response on stocks and institutions shaped a new reality, whose basic feature is the loss of national sovereignty in the separate countries However, is this not the requirement for European unification? How is it otherwise possible for the mutuality of the debt and the anti-cyclical intervention of the European economy to exist without the member states surrendering a part of their sovereignty? However, the transfer of sovereignty from lower levels of administration (i.e states) to higher ones means the creation of a Federal-type State Fundamentally, the features of a European Federal State did not appear in the midst of crisis, they but pre-existed from when the first claims and real transfers of national sovereignty made their appearance The concept of a unique type of Federation has a strong presence in the political foreground as the vision for the EU Introducing the concept of Federation, as opposed to that of Union, suggests that future developments will focus more on the separate states forming a union of states and less on the equalization of the separate states In essence, the prospect of creating a federal-type organization is based on fiscal and macro reorganization and the banking union There will be efforts to tackle the European non-optimal currency area through these, which incidentally, in theory never included the requirements for a union in the banking sector The reduced mobility of the labor force and the diversified cultural background should also be included as opposing forces The diversified cultural background in particular plays a very important role in shaping centrifugal forces It should be noted, however, that the European cultural background was, and is, particularly influenced during times of crisis The study of such influences is of high priority, because many are negative as far as both economic growth and European unification are concerned 18.2 The Political Economy of the European Crisis 255 An interesting new reality is emerging in the European economy with the rebalancing that is mainly observed the current accounts of Southern European countries because of the serious drop of TARGET2 credits by Northern Europe (Germany) This procedure functions in two ways On the one hand it deregulates the political capacity for redefining Eurozone relationships, as Southern Europe no longer burdens Northern Europe or the rest of the world On the other hand it allows all parties to redefine their position in the new European entity, without this necessarily leading to unification Nevertheless, this rebalancing may lead to a new political equilibrium among the European nations The debate on factors favoring or not favoring European unification leads to the question of the quality of administration and, specifically, of the hegemonic influence on such procedure Bradford DeLong and Eichengreen (2012) underline that the Kindleberger’s (1978) predominant lesson is that “at the root of Europe’s and the world’s problems in the 1920s and 1930s was the absence of a benevolent hegemon: a dominant economic power able and willing to take the interests of smaller powers and the operation of the larger international system” Note that this absence is a feature of all last three major crises: the lost decade of South America (1990s), the East Asian crisis and the Eurozone crisis Therefore, whether a hegemonic power will exist and how it would operate is of great importance to the European unification process When we consider a “hegemonic power” in Europe, we should think of Germany, given that US hegemony is now depleted The German political leadership stance, which also reflects the attitude of the German people, seems to depend on the following basic factors: The preservation of employment and the level of extrovert economic activity, within the framework of a Mercantilism concept of Westphalian sovereignty This means the continuation of the funding of the German economy through the inflow of capital from the insecure Eurozone This entails zero borrowing cost for the German public and private sectors It is estimated that the specific benefit for the German economy (public sector) between 2009 and 2012 amounts to €80 bn (Broyer et al 2012) The pre-war inflow of capital from Europe to the United States, which helped it recover from the 1929 crisis, and the “mistake of 1937”, are being repeated in Europe The preservation of this model is of paramount importance to German interests The fear of hyperinflation (pre-war German experience) and the possible evaporation of the social security reserves However, given that hyperinflation is also one of the biggest risks should the Eurozone be dissolved (Aslund 2012), this fear also functions in a unifying manner The control of the deleveraging procedure in the banking and public finances If values amounting to €1 tn are going to evaporate from the European banking system in the next years, then well-grounded fears are created that such losses may be shouldered by the German taxpayers or depositors While German society should be prepared to manage the Landesbanken problems (Liikanen Report 2012), it obviously does not want to participate in the total European losses; hence there is pressure for bail-in solutions If deleveraging does not reach a visible end, then overall European unification cannot be accelerated (and when it does reach an end, then there will be no reason for acceleration) Until 256 18 Economy and Politics 0.7 0.6 0.5 0.4 0.3 0.2 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 North South Fig 18.5 Evolution of the “confidence in the ECB” in the countries of Northern and Southern Europe (Source: European Commission, Public Opinion Note: It concerns answers to Eurobarometer questions, weighted on the basis of the total population of each country [average of each year]) that time Germany will be exceptionally reluctant in relation to anything that concerns European unification One difficulty is that the excessively indebted economies surrender a much greater portion of their sovereignty than the surplus countries Consequently, European unification, i.e the relative loss of national sovereignty, evolves unevenly resulting, on a long-term basis, in the shaping of a central-European Eurozone and European Union This has two separate problems: (a) Those that face proportionally larger sovereignty losses are more skeptical to this procedure The confidence in the ECB index, according to the Eurobarometer, is characteristic (Fig 18.5) (b) The people of Central Europe realize that at some time the transfer of resources from Northern Europe to Southern Europe will take a specific form, considering that the today’s transfer of risk in the form of loans and guarantees (as a liquidity problem) may evolve into a transfer of capital (as an insolvency problem) This real transfer is the price paid for the loss of national sovereignty In actual fact, the capitals that have accumulated as liquidity measures and deleveraging agreements until now (early 2013) are much greater than the real costs (Table 18.3) Even without totaling the right-hand column, we can see that the potential cost of the Great European Recession has been transferred to the future, to the extreme detriment of future generations Only financial repression and an organized deleveraging can promise a safe future However, both options require an organized (difficult to conceive) present The image of an indebted European Federation closes the door firmly on the possibility of its structural reorganization or even its dissolution No democratic political leaderships will ever exist that will take the decision to change the aforementioned risks into costs If the fragmentation of the Eurozone was ever to be posed, then it would be much more likely to be imposed by countries facing a “strong new Euro”, rather than by those facing a “weak new Euro” Despite the 18.2 The Political Economy of the European Crisis 257 Table 18.3 Costs and risks Private sector cost (€ bn) Greece bail out 105.0 Cyprus bail in 6.0 Liquidity measures and deleveraging requirements (€ bn) State aid to banking system (end 2011) 682 Emergency Liquidity Assistance (ELA) 994 ECB liquidity providing (April 2013) 1,176 Credits of Target2 (end of 2012) 800 Stabilization programs in states 558 Deleveraging requirements 1,500 Note: The ECB Liquidity providing is the sum of: main refinancing operations, longer-term refinancing operations, marginal lending facility, and other liquidity-providing operations international trade disadvantages of a “strong new Euro”, this would be the only way to safeguard the net external international position In contrast a hypothetical “weak new Euro” would lead to country walkouts, in turn leading to the conversion of liquidity amounts to debt at a multiple loss, and then – inevitably – to huge writedowns and the destruction of the net international investment position of Northern Europe What will happen, however, when social, political and economic powers are formed that are not willing to function together towards unification? There will be no choice other than to cut them off (even temporarily) from the total dynamic of European unification; not in the sense of a structural relationship change, but their relative isolation from the total dynamic An example today may be Cyprus and possibly in the future the public sector in Greece and the UK, or even entire sectors, such as parts of the European banking system Non-financial corporations in Spain, Ireland, Greece, Italy, Portugal, Slovenia and Cyprus pay an average of 4–5 % for new loans maturing in 1–5 years; in contrast Austria, Belgium, Germany, Finland, France and the Netherlands pay % However, how different is the fragmented prospect of the European Federation from the differentiated integration prospect that forms the current base policy on European unification (united in diversity)? Differentiated forms of cooperation in the EU originally focused only on a strategy of “last resort” for European integration in the areas of common currency, justice and home affairs, Fiscal Compact, banking union and EU patent agreements It is the only means of achieving the deeper integration proposed to overcome the European debt crisis (von Ondarza 2013) In this respect two strategies have been developed: a state-centered and an EU-focused center of gravity, with the majority of member states having decided in favor of the first option However, irrespective of the two strategies addressing differentiated integration under the crisis, certain European elements would not fit in – even through loose integration procedures – and would in effect remain apart either by choice or by force This may be permanent or temporary In the best case scenario the timeframe of the reverse course of full integration is of critical importance The way in which fragmentation is formed (in all forms: financial, political and cultural) will be a determinative factor in shaping the way in which the European monetary union (the Euro) will be ultimately organized 258 18 Economy and Politics The fact that a stage of fragmental reality seems to be emerging has paramount political and economic consequences The European unification evolution concept acquires new characteristics The notion of relationship negotiations between European economies becomes broader, simply because the versions of the future include one of detachment from dominant unification In other words, the emergence of fragmentation as an extreme alternative version to diversification, functions to restrain the moral hazard caused by Euro-bailouts and rescuing banking institutions Entering these new versions leads to uncharted territories The uneven dispersion of cultural traits enhances fragmentation tendencies, which in any case have a very slow homogeneity rate A general observation is that during the first decade of the Euro the unification of Europe was quite speedy, and during the second decade it is slowing down Despite this, it ultimately seems that the long-term tendency will have positive, but weak, unification features In essence, the course towards an indebted fragmented European Federation is set References Akerlof GA (2013) The cat in the tree and further observations: rethinking macroeconomic policy II IMF conference on “Rethinking Macro Policy II: First Steps and Early Lessons”, Apr Angeloni IA, Be´nassy-Que´re´ BC, Darvas Z, Destais C, Gauvin L, Pisani-Ferry J, Sapir A, Vallee S (2011) Reforming the international monetary system: options and implications Joint BruegelCEPII report, Apr 2011 Aslund A (2012) Hyperinflations are rare, but a breakup of the Euro area could prompt one Peterson Institute for International Economics, no PB12-22, Nov Benassy-Quere A, Pisani-Ferry J (2011) What international monetary system for a fast-changing world economy Bruegel Berman N, Berthou A (2009) Financial market imperfections and the impact of exchange rate movements on exports Rev Int Econ 17(1):103–120 Betts CM, Devereux MD (2000) Exchange rate dynamics in a model of pricing-to-market J Int Econ 50(1):215–244 Bibow J (2011) Can the modest proposal save Europe? 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Evolution and the Current Status of the European Financial Crisis A useful initial examination of the European financial crisis can be based on a stock and flow analysis of critical variables, and on