JORGE RODRIGUES SIMAO

The European Financial Crisis

3. How it all works

THE EUROPEAN PROJECT (and thus the euro) suffers both from a lack of clarity over its precise nature and end-point and from the dull complexity of its institutional structure. Like a pantomime horse, it has long had a dual character, reflecting an initial compromise between those countries wanting a United States of Europe and those preferring a club of nation-states. Thus it has federalist elements such as the European Commission, a (now directly elected) European Parliament, a European Court of Justice and a European Central Bank. But it also has strong inter-governmental bodies: the Council of Ministers, representing national governments, and the European Council of heads of state and government. An important force throughout the euro crisis has been the tension between those preferring federal answers (often called the “community” method) and those favouring intergovernmental solutions (sometimes referred to as the “union” method).1

At the heart of both the EU and the euro stands the European Commission, to which each of the currently 28 national governments appoints one commissioner for a five-year term (the next Commission takes office at the end of 2014). Commissioners, based in Brussels, are legally required to be wholly independent, although in practice they usually do what they can to advance national interests. The “college” of 28 commissioners sits above a 20,000-strong bureaucracy that functions as the European Union’s executive branch. The Commission is the guardian of the treaties, has the nearexclusive right of legislative initiative, administers competition and state-aid law and conducts certain third-party negotiations, for instance on trade, on behalf of the EU as a whole.

The Council of Ministers is the senior legislative body. It consists of ministers from national governments, meeting in different formations (finance or EcoFin, agriculture and fisheries, environment, and so on). In many areas the Council takes decisions by qualified majority, a system of weighted votes that, under the 2009 Lisbon treaty, is due to change in late 2014 into a new arrangement of a “double majority” that takes greater account of population size. Council meetings are prepared by officials in the Committee of Permanent Representatives in Brussels (COREPER); EcoFin meetings are often prepared by the official-level Economic and Financial Committee; and there is also a euro working group. The Council presidency rotates every six months from one country to another, though this system has been modified, under Lisbon, by the arrival of a permanent president of the European Council and a high representative for foreign policy, who chairs Council meetings of foreign ministers as well as being a vice-president of the Commission.

The European Council is, in effect, the most senior formation of the Council of Ministers. It did not exist at the start of the European project, but over time the practice of calling occasional summit meetings of heads of state and government to give general direction and to resolve the most contentious disputes became habitual. Under Lisbon, the European Council has a full-time president, currently Belgium’s Herman Van Rompuy, who serves for a maximum of five years (his term expires at the end of 2014). Van Rompuy has set the pattern of holding European Council meetings every two months or so. These summits have often received much publicity, especially during the euro crisis when they have often drifted into weekends and the early hours of the morning. Over time, the European Council has become the strategic engine of the European Union, largely displacing the Commission, a switch that has become even clearer as a result of the euro crisis.

The Commission makes most of its legislative proposals jointly to the Council and the European Parliament, the second legislative body in the EU. The Parliament, which has been directly elected since 1979, now has 751 members. At French insistence, it is formally based in Strasbourg for most of its monthly plenary sessions, although its committees and most of its members (MEPs) are generally based in Brussels. Elections are held every five years: the 2014 ones are scheduled to take place between May 22nd and May 25th. Successive treaties have given the Parliament ever-greater powers, and it is now more or less co-equal with the Council of Ministers in legislation. The European Parliament must approve the annual budget as well as the multi-annual financial framework. It can reject the budget (it did so in December 1979). Unlike the Council, it can also sack the Commission (it used this power to force the Santer Commission’s resignation in 1999). And, again under Lisbon, the Parliament now has the power to “elect” the Commission president, after he or she is nominated by the European Council, a provision that creates an obvious risk of a huge institutional bust-up.

The most important remaining institution is the European Court of Justice, based in Luxembourg, which acts as the European Union’s supreme court and adjudicates on disputes both among the institutions and between countries in areas of EU competence (so it has no role in the criminal law, for example). The court has one judge per country, though there is also a Court of First Instance to reduce its workload. Cases are usually decided by simple majority. The Court of Justice (not to be confused with the Strasbourg-based European Court of Human Rights, part of the Council of Europe) has advanced European integration in several judgments, notably the 1963 Van Gend en Loos case, which established the principle of the supremacy of European over national law, and the 1979 Cassis de Dijon judgment, which laid down that goods sold in one country must be able to be sold in all. Other EU bodies include the Court of Auditors and the European Investment Bank, both based in Luxembourg, the Economic and Social Committee and the Committee of Regions, both based in Brussels – and a plethora of smaller agencies scattered right across Europe.2

These institutions operate collectively by the “community method”. This describes the classical path of EU legislation: a proposal is made by the Commission; it is adopted by co-decision between the Council and the European Parliament, often followed by “trilogue” between the two and the Commission to reconcile their positions; it is then implemented by national authorities and is subject to the jurisdiction of the Court of Justice. But at many times in the past, and again during the euro crisis, national governments, especially those of the UK and France, have jibbed against the community method. President de Gaulle’s Fouchet plan would have set up inter-governmental institutions alongside the Brussels machinery. The Maastricht treaty introduced two new “pillars” for foreign and security policy and for justice and home affairs, in which the roles of the Commission and the Parliament were limited and legislation was not generally justiciable at the Court of Justice, unlike most other EU activities.

In practice most such efforts to work outside the “community method” have proved unsatisfactory. The Fouchet plan did not get anywhere. The Maastricht pillars have, under the Lisbon treaty, been subsumed back within the first pillar. Yet many national governments, including now Germany, still like the simplicity of working inter-governmentally. During the euro crisis, Angela Merkel has often praised the “union method”, which downgrades the roles of the Commission, the Parliament and the Court of Justice.

Enter the ECB

Several institutions for the single currency were bolted onto the system after the Maastricht treaty was ratified. Foremost among these is the European Central Bank, which started work in June 1998 (it had a forerunner, the European Monetary Institute, set up in 1994). The ECB, which at German insistence is based in Frankfurt, home of the Bundesbank, sits at the apex of what is called the European System of Central Banks, to which all national central banks belong (even those from EU countries still outside the euro). The ECB has a six-strong executive board, headed by a president and a vicepresident, all of whom serve single eight-year terms. Its governing council consists of this board plus the governors of the national central banks of countries in the euro. It normally takes decisions by simple majority. The initial system of one vote per council member is to be superseded, most probably during 2015, by an arrangement that will give the executive board six votes, add four votes that rotate among the five biggest euro members and give the rest, no matter how many there are, 11 votes in total (this change creates at least the theoretical possibility that the Bundesbank’s president might not always have a vote on the council).

The ECB was modelled on the German Bundesbank but is in many ways even more powerful and independent. Its goal, fixed by the Maastricht treaty, is price stability (close to but below 2%), whereas the Federal Reserve, its American counterpart, is also required to pay attention to employment. Its operational independence in delivering the goal of price stability, which it defines itself, is also guaranteed by the same treaty. Unlike other central banks, it has no single government or finance ministry to interact with and report to, though its president testifies before the European Parliament and attends most meetings of the European Council and often EcoFin and the Eurogroup as well. In line with the Bundesbank model, when EMU arrived the ECB was not given overall responsibility for bank supervision, which stayed at national level, an arrangement that has since been deemed unsatisfactory, with the planned “banking union” giving supervision of most large European banks to the ECB. It also had no obligation to act as the system’s lender of last resort, a huge potential problem once it took over the operation of monetary policy from national central banks. One big difference between the ECB and most other central banks is that it is much smaller (it has a staff of less than 1,000) and also, because of the continuing role of the national central banks, a lot more decentralised. That makes the role of the president, the ECB’s public face, especially important.

Given this, it was foolish and dangerous when the European Council chose to welcome the new bank with an all-day wrangle in May 1998 over who should be its president. The job had long been intended to go to Wim Duisenberg, a former Dutch central banker who had run the European Monetary Institute. But at the last minute the French president, Jacques Chirac, put forward Jean-Claude Trichet for the job. The outcome was a botched and undignified compromise in which the term was informally split between the two men. Duisenberg stepped down in 2003, leaving Trichet to serve a complete eight-year term, until he in turn was replaced by an Italian, Mario Draghi, in 2011.

The lack of any strong political authority to act as a counterpart to the ECB was obvious from the start. The Commission has scarcely more accountability than the bank. The European Parliament is elected, but it has no executive authority. The European Council and EcoFin include non-members of the euro. From an early stage the French pushed for the creation of some form of “economic government”, but the Germans resisted the concept in order to safeguard the ECB’s independence.

Instead, in 1998 European governments came up with the idea of a “Eurogroup” of finance ministers.

Finance ministers from non-euro countries fiercely resisted the Eurogroup’s establishment. The UK’s Gordon Brown, then chancellor of the exchequer, tried hard to join as an observer at the group’s first meeting at the Château de Senningen in Luxembourg in June 1997, only to be told by his French counterpart, Dominique Strauss-Kahn, that the euro was like a marriage and that, in a marriage, one did not invite strangers into the bedroom (a precept that Strauss-Kahn has followed only erratically in his own life).

In any event the Eurogroup soon became accepted, and it even acquired its own permanent chairman: first, Jean-Claude Juncker, Luxembourg’s prime minister and finance minister, and then, from the end of 2012, Jeroen Dijsselbloem, the Dutch finance minister. By this time it had also become accepted, once again over objections from countries outside the euro, supported by Germany, that European heads of government should meet periodically in euro-zone summits, usually just after full European Councils. In either formation, the Eurogroup has no statutory basis and no legislative powers. But it has become an essential part of the single currency’s architecture.

Another component is the “excessive deficit procedure”. This began in the Maastricht treaty and was reformulated into the stability and growth pact, which was approved in 1997. However, from the very beginning the rules against excessive deficits and public-debt levels were interpreted flexibly, not least so that Belgium and Italy could join the single currency. The stability pact’s provisions for sanctions were watered down in negotiation from being automatic, as the Germans originally wanted, to requiring qualified-majority approval by the Council. Even so, the pact attracted much criticism from economists, who felt that, given euro-zone countries’ loss of an independent monetary and exchange-rate policy, more not less fiscal flexibility might be needed. It was also thought that imposing central rules might undermine the force of the treaty’s “no-bail-out” provisions, because it would imply a high degree of central intrusion. Better, many argued, to rely on the bond markets to impose discipline on any country that borrowed so much that it looked to be at risk of defaulting.3

The pact’s credibility was further dented in 2002 when Romano Prodi, president of the Commission, called it “stupid”. Portugal was the first country to get into difficulties, and it was duly required to amend its budget to comply with the pact. But it was never likely to constrain bigger countries and, in late 2003, its potency was almost entirely destroyed when France and, ironically, Germany itself persuaded the Council to override a Commission recommendation that both countries should cut their budget deficits, which had drifted above 3% of GDP.4

The gutting of the stability pact made it less of a surprise, when the financial crisis hit in 2008, that the deficits and debt levels of most euro-zone countries went above the Maastricht ceilings.

Naturally, the crisis also prompted calls for a revival of the excessive deficits procedure, but with new teeth. Its new incarnation, adopted in late 2011, includes the “two-pack” and “six-pack” and sets out a “European semester”. Euro-zone countries now have to submit their draft budgets to the Commission in advance, and the Commission can request changes before national parliaments even have a chance to consider them. A new excessive imbalances procedure has also been added, enabling the Commission to monitor and make recommendations for countries that, among other things, run large current-account imbalances (defined, with a nod to chronically underconsuming Germany, as 4% of GDP for deficits but 6% of GDP for surpluses).

In terms of sanctions, the new procedures look similar to the old except that now a Commission recommendation will be automatically adopted unless a qualified majority in the Council votes against it. Such a negative qualified-majority procedure is also enshrined in the “fiscal compact” treaty, which was approved and ratified in 2012 as an inter-governmental treaty using the “union method”, partly because several governments including France’s and Germany’s liked it that way, partly because the UK and the Czech Republic refused to sign it (the Czechs now plan to do so) and partly because it allowed the treaty’s drafters to provide that it would come into force even if some countries failed to ratify it. The fiscal compact requires all signatories to insert debt brakes into their national constitutional arrangements. It also formalises, with the Euro Plus Pact, the existence of euro summits, alongside European Councils.

The euro crisis has added a set of further, ad hoc pieces to the single currency’s institutional architecture, many of them also set up on the union method. First came the temporary European Financial Stability Facility (EFSF), an inter-governmental vehicle set up in a rush after the rescue of Greece in May 2010. Alongside this there is a smaller European Financial Stability Mechanism, which uses the EU budget as collateral. Both funds are being subsumed into the permanent treaty-based European Stability Mechanism (ESM). The ESM was set up as an organisation under public international law with a board of governors (that is, finance ministers) and a managing director, Klaus Regling, previously the Commission’s economics director-general. Although an inter-governmental body, the ESM has operational links to the Commission and is also subject to the jurisdiction of the European Court of Justice.

Treaties, treaties

One reason it is often hard for outsiders to understand how either the EU or the euro works is that, for the past 25 years or so, the entire European project has been going through a veritable orgy of treatymaking.

After the Single European Act of 1986 and the Maastricht treaty, signed in February 1992, there was but a short pause before the Amsterdam treaty of 1997 and then the Nice treaty of 2001.

Each time, it seemed, the driving force for successive treaties was a widespread feeling of dissatisfaction at what had been done on the previous occasion and at what had failed to be agreed or had been left out. The expansion of the European Union to take in Austria, Finland and Sweden in 1995 and, in a far bigger challenge, eight central and eastern European countries from the former Soviet block plus Cyprus and Malta in 2004 was another consideration.

Even as the euro emerged from infancy in December 2001, just before the date for the issue of euro notes and coins, EU leaders, meeting in Laeken in Belgium, decided to have one more go at their governing treaties. This time they set up a convention on the future of Europe, chaired by a former French president, Valéry Giscard d’Estaing, which swiftly decided, amid much excited chatter drawing analogies with Philadelphia in 1787, to draw up a complete new constitution for the EU. The text of this constitutional treaty was broadly endorsed by an inter-governmental conference and then adopted at a European Council meeting in 2004. But after that the trouble began, because no fewer than ten countries announced plans to put the draft constitution to national referendums before ratification.5

Several treaty referendums had been held before, and in some cases treaties had been rejected only to be put to the vote again (this happened in Denmark over Maastricht and Ireland over Nice). But never had so many referendums been promised at once. In the event, it should not have come as a huge surprise when two of the first four said no: in France on May 29th 2005 and then in the Netherlands on June 3rd 2005, in both cases by large majorities. The expedient of making a few modifications and asking single small countries to vote again was clearly not going to work with such large founder members. So the constitution was abandoned.

The immediate impact of this setback on the euro may have seemed slight. But it fostered a broader sense of crisis in the EU as a whole. One reason was that it made everybody leery of further attempts at treaty change, a feeling that has persisted into the euro crisis. The gloom was intensified by the coincidence of yet another row over the EU’s budget. Although the budget is small, at little more than 1% of EU-wide GDP, its excessive spending on agriculture and its skewed net benefits have caused repeated arguments at least since Margaret Thatcher came to power in the UK in 1979 and promptly demanded “my money back”. Her determined handbagging of fellow European leaders eventually produced a series of ad hoc rebates, followed by a permanent abatement of the net British budget contribution, which was agreed at a European Council in Fontainebleau in 1984.6

Despite this deal, subsequent negotiations on the EU’s multiannual financial framework have proved almost equally contentious, and the one in 2005 was no exception. The UK, which wanted a smaller budget, less spending on agriculture and to preserve its rebate untouched, was once again in the doghouse, but several other countries favoured budgetary cuts while the new members from central and eastern Europe wanted far more spending. A compromise was reached only at the end of the year, when the British prime minister, Tony Blair, gave up part of the rebate to ensure that the UK would bear a fair share of the costs of enlargement to the east. But the sour atmosphere helped to cloud much other business, including that of the euro. Juncker, as president of the Council, declared that the EU was “in deep crisis”.

The gloom also spilt over into the other big issue facing European leaders at the start of 2006: what to do about the failed constitutional treaty. On this the key person was the new German chancellor, Angela Merkel, who took office in late 2005 at the head of a “grand coalition” between her Christian Democrats and the Social Democrats. She was determined to revive as much as she could from the constitution, not least because the new voting system that it proposed at long last recognized that Germany’s population is larger than that of other EU countries. After her fellow centre-right leader, Nicolas Sarkozy, became French president in mid-2007, the two pressed ahead with what later became the Lisbon treaty, which incorporated most of what had been in the constitution but in a disguised and less comprehensible fashion.

Critics complained that reviving the treaty in this way was a backdoor route around the negative votes in France and the Netherlands. They objected even more vociferously when almost all EU leaders, including the French and the Dutch, said they would not try to ratify Lisbon by referendums but use parliamentary votes instead. The exception was Ireland, which was constitutionally required to hold a referendum. Yet again, Irish voters said no, this time in June 2008. But just over a year later, after the financial crisis had struck, they were persuaded to change their minds in a fresh vote, so Lisbon was finally approved in late 2009. The new permanent president of the European Council, Herman Van Rompuy of Belgium, and the new high representative for foreign and security policy, Baroness Catherine Ashton of the UK, were chosen at a summit shortly afterwards, after yet another wrangle. But by then the focus of attention was starting to shift to the crisis in Greece – and particularly to the fiscal problems of a newly elected Greek Socialist government.