European Union member states, either bilaterally or jointly, have provided bailouts to five euro zone countries since 2010. Other authors here in the Monkey Cage have looked at the broad lessons from the euro crisis, but why was the E.U. system unable to prevent the crisis in the first place?
There were rules, lots of rules
The E.U. fiscal framework was quite elaborate — but it ultimately failed. E.U. rules on budgets, for example, expected member states’ budget deficits to stay under 3 percent of the country’s GDP. The gross debt burden, which is the total amount of money the government owes to creditors, could not exceed 60 percent.
In addition to the formal rules, the E.U. had regular procedures in place to monitor all member states. Countries that repeatedly violated the rules could be subject to punishment. While it has never been used, the ultimate punishment according to the treaties would be a fine. The E.U.’s executive branch, the European Commission, served as the watchdog. The commission drafted annual reports that pointed out where member states were off track and sometimes suggested corrective measures.
But there were huge violations anyway
Yet despite this system of rules and oversight, Greece has run deficits above the 3 percent limit every year since joining the euro zone in 2001. Other member states have similar records, including France and Germany in the early years of the euro. The system clearly failed to prevent the crisis from breaking out.
So what went wrong? Our answer is that the E.U. failed to apply the rules uniformly.
In our new paper, “Explaining Instability in the Stability and Growth Pact,” we highlight a critical part of the E.U. economic governance system. Rather than note the failures of member states to stay below the 3 percent of GDP deficit ceiling, we focus on the quality of the supervision process.
While the European Commission wrote reports on each member state, the E.U. governments themselves collectively had to approve the final report, or text. This meant a member state had opportunities to propose changes to the text that was monitoring its performance. And a member state could work with other states to block the original commission text. This meant that the final texts might not highlight the real problems a state was facing. It also meant that potential punishments could not be imposed.
We looked at the initial commission-proposed text vs. the final text, to see how member states changed the documents. We used human coding and textual analysis to see exactly how much changed in the commission reports — and see where these changes resulted in a missed opportunity to rein in states that were in economic distress.
Yes, changes to the commission’s initial recommendations were common. The E.U. Council of Ministers, made up of heads of the member states, voted on the cases. In fact, about 30 percent of the commission reports from 1998-2012 had final texts that were weaker than the initial findings about member states.
For example, the commission wrote of France’s labor reforms in 2010/2010: “the reform … generally fell short of the measures needed to resolve the dualism of the French labor market.” Once the E.U. Council got hold of the text, this whole phrase was omitted in the final writing of the text. Such evidence suggests that once the member states were able to change the commission texts, the E.U. lost much of its economic governance role, especially its watchdog function.
Yet the changes to the texts do not appear for all countries. Our computerized text analysis indicates that France, Germany and Italy had the most frequent “edits” or “rewrites,” of their texts. While France had common “weakenings” of its texts, Denmark and Luxembourg did not. What explains this variation?
The first explanation may be obvious, but it is still worth noting. The “large” states — Europe’s four largest by population, with at least 60 million people: France, Germany, Italy and the U.K. — experienced more changes to potentially critical reports on their economies than small states. This suggests that the E.U. rules apply more to some states than others. This represents the exercise of political power — the large states like Germany are able to throw their weight around in ways that small states like Luxembourg are not.
Our second finding is perhaps less obvious. Member states with populations that were less in favor of the overall E.U. concept also had more changes to these reports in their favor. We think this happened because the European Commission can play to domestic audiences best in places where that audience is supportive of the E.U. If the audience in a country is generally skeptical of the E.U., the message that ultimately comes from the European Union on that government will be watered down.
What lies ahead?
The E.U. has tightened the rules since the crisis. For example, it now takes a reverse qualified majority of member states to block a commission recommendation. Something called the “European Semester” is an annual process to increase the scrutiny of government economic plans in ways not done before. Yet our findings have two implications for how the oversight system functions today.
First, large states (France, Italy, Germany and the U.K.) will probably still get their way — and this is what we’ve been seeing over the last two years. France and Italy, for example, continue to have difficulty pulling their deficits below 3 percent of GDP. Despite tougher rules, they have little trouble avoiding deep austerity measures to bring down their deficits.
Second, the E.U. in general has become more skeptical of the concept of a European Union. Nothing epitomizes this more than the upcoming June referendum in the United Kingdom (the “Brexit”) on whether to leave the E.U. More generally across the European Union, euroskeptic parties performed noticeably better in elections for the European Parliament in 2014, and they continue to do well in national and sub-national elections as well, be it in Poland at the national level last year or in Germany at the state level last month. This suggests that skeptical populations in some countries will pressure their governments not to honor the rules that come from distant E.U. bureaucrats in Brussels.
The euro crisis left Europe — and many E.U. member nations — with large debt burdens. Combining our two findings on state size and euroskeptic populations does not leave us optimistic that E.U. rules alone will be effective in getting countries to keep trying to reduce those debt burdens.
Nicole Rae Baerg is an assistant professor in the Department of Political Science at the University of Mannheim. She works on fiscal and monetary policy as well as immigration. Mark Hallerberg is a professor of public management and political economy at the Hertie School of Governance. He works on fiscal governance and political economy.