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26 Oct 2015


The two main developments over the summer of 2015 were the publication, towards the end of June, of the Five Presidents’ Report, setting out the latest proposals for “Completing Europe’s Economic and Monetary Union”, and the conclusion of the latest round of negotiations with Greece on a further bailout package.

In addition, the State of the Union address delivered by European Commission President Jean-Claude Juncker emphasised that the crisis in the euro area is by no means over. He listed five areas in which he anticipates rapid action to implement the plans of the Five Presidents. These were then taken further in complementary documents.

A fresh look at the euro’s governance framework and its institutions

The recasting of economic governance triggered by the years of economic crisis had already led in 2012 to proposals for moving towards ‘genuine’ economic and monetary union. These proposals envisaged initiatives in four main areas, namely banking union, budgetary matters (including the possibility of an additional fiscal capacity to support macroeconomic stabilisation), improved economic policy coordination, and enhanced political accountability. Other than in relation to banking union, progress has been limited and the obvious intention of the new report is to relaunch the process, but also to scale back some of the 2012 proposals that had met significant opposition from a number of EU countries.

The debate triggered by the Five Presidents is expected to be lengthy and heated. It has already seen the publication of many commentaries and assessments by think tanks and others: prominent examples are those from Bruegel and the Berlin branch of the Jacques Delors Institut. These assessments tend to praise the plans on reinforcing banking union, while expressing disappointment about the vagueness of the proposals for fiscal integration and for improving democratic accountability. The verdict of former Italian Finance Minister Fabrizio Saccomanni is given in the sub-title of a piece written for the Istituto Affari Internazionale: “a missed opportunity”. His view is that some of the trickier issues, such as how fiscal policy can contribute to macroeconomic stabilisation, should have been addressed more forcefully.

Contributions with a UK perspective have come in blogs from Iain Begg, Christian Odendahl and Renaud Thillaye. One area likely to be of concern to the UK, as well as some of the countries of central and eastern Europe, is whether the push towards closer integration will usher in institutional reforms that are uncongenial for states not participating in the euro. As so often, the position of the City of London particularly worries the UK.

The implementation of the Five Presidents’ report is envisaged in two stages, with the first now underway as a result of the 21 October decisions. A second stage, involving considerable additional deepening of economic governance will be presented in a White Paper expected to be published early in 2017 following a wide-ranging consultation. The five areas now launched are:

  • Refinement of the European semester, the annual economic cycle though which economic policies are coordinated, including the issuing country-specific recommendations (CSRs) aimed at influencing national policy-making. The main changes that the Commission proposes to the semester are to improve the connections between the national level and the Eurozone level, recognising that how the Eurozone economy as a whole evolves matters, and to pay more attention to the effects on jobs and social conditions. In addition, the document advocates enhanced diffusion of best practice and possibly more funding for ‘technical assistance’ to support reform.
  • A formal decision to create a European Fiscal Board which will have the task of assessing fiscal developments in the euro area as a whole and – in what could be a significant development (see article 2a of the decision) – advising on the fiscal stance of the euro area as a whole. It will also collaborate with national fiscal councils and provide ad hoc advice.
  • The establishment of competitiveness boards in each member state, intended to oversee reforms aimed at making economies more competitive and to be operational by the middle of 2016. They are to be independent of government and to have an advisory rather than executive function, but will be optional for countries not participating in the euro.
  • Collective representation of the euro area in international bodies such as the IMF.
  • Consolidation of banking union, building on the launch last year of the single supervisory mechanism, led by the European Central Bank, and the agreement on a common approach to resolving failing banks. This will entail pressure to complete the enactment of the provisions for bank resolution already passed in secondary legislation, especially the Bank Recovery and Resolution Directive. The Commission also wants a bridging facility to underpin a fund created to support bank resolution, because the existing fund, paid for by levies on banks, will take until 2025 to reach its intended size. A much more contentious proposal is to introduce a pan-European form of deposit insurance, but details will only be published later in the year. However, it is likely that the new mechanism will be in the form of ‘reinsurance’ of national schemes that will only be called upon if the national schemes fail to cope.

Another package to stabilise the Greek economy

Following the election in February of the Syriza-led coalition, with Alexis Tsipras as Prime Minister, there was an extended negotiation about the future of support for the Greek economy. This seemed to break down at the end of June when the Greek government called a referendum on the package on offer, eliciting a resounding ‘No’ vote. Yet just six weeks later agreement was reached on a new support package for the Greek economy, on terms arguably just as onerous as those rejected in the referendum.

The latest deal provides for up to €86 billion of loans from the European Stability Mechanism and requires Greece to accept a new economic adjustment programme. It will run until August 2018 and includes wide-ranging commitments to reform of public finances, privatisation of public assets, structural reforms and a modernisation of public administration.

Friction in reaching the deal was visible not just between Greece and the various EU institutions, but also between the EU and the IMF (which argued for debt relief) and among the EU member states. Much to the dismay of the UK and other non-Eurozone countries, an early stage of the process was the disbursement of a bridging loan to Greece from the European Financial Stabilisation Mechanism which the UK government thought was defunct. The latter is funded by all 28 EU members, not just the Eurozone, but is agreed by qualified majority and the resort to it in July 2015 provoked a backlash resolved only by a rapidly agreed provision for the Eurozone to compensate the other member states, should the loan not be repaid

A key point in understanding what went on between the breakdown of negotiations in June, followed by the drama of the referendum called at barely a week’s notice and the apparent climb-down required to achieve the deal agreed in mid-August is that the prospect of being expelled from the euro was seen as potentially so damaging that it dominated the end-game. In elections held in September, Alexis Tsipras’ Syriza party was again successful in obtaining enough seats to stay in power in a coalition government. Greece therefore remains in the euro and subject to governance arrangements that are broadly similar to those in place after the previous bailout.

However, difficult questions will have to be confronted. Whether or not Greece needs or should be granted debt relief is a theme which evokes strong opinions. In a colourful, though not unduly critical assessment of the prospects for the latest Syriza led government, former finance Minister Yannis Varoufakis maintains that some debt relief is unavoidable and expresses the hope that the Tsipras government can pull off the reforms needed to restore growth and break the control of the ‘oligarchy’. But he also warns that the Greek ‘government will have to slay two dragons at once: the incompetence of Greece’s public administration and the inexhaustible resourcefulness of an oligarchy that knows how to defend itself – including by forging strong alliances with the troika’. One of his predecessors as Greek Finance Minister, Nicos Christodoulakis, has argued in an article in the New Palgrave Dictionary of Economics that ‘the only viable way out of the current crisis is to strike an agreement with creditors that involves measures to restore growth, accompanied by realistic targets for privatisations, fiscal consolidation and market reforms’.

Many outside observers are sympathetic to the plight of the Greeks and critical of the severity of the conditions imposed. Some believe that excessive austerity, championed notably by Germany, has made the underlying problem worse, yet also increases the probability that creditors will not be repaid. Jeff Sachs, who has a long experience of debt crises in the developing world, asserts that ‘Germany has treated Greece badly, failing to offer the empathy, analysis, and debt relief that are required. And if it did so to scare Italy and Spain, it should be reminded of Kant’s categorical imperative: Countries, like individuals, should be treated as ends, not means’.

Against this, a manifestly powerful argument throughout the euro crisis has been that if a soft way out is offered to a country like Greece, not only will it create incentives for further laxity by that country (the classic moral hazard case), but it will also deter other countries in the EMU from sound policies. Ned Phelps points the finger of blame at ‘economic ills rooted in the values and beliefs of Greek society’ and goes on to detail a range of areas in which Greece needs structural reforms, concluding that neither debt restructuring nor debt relief will suffice to restore its economy to health. It has also been argued by Paul De Grauwe that Greece is illiquid rather than insolvent because the very low interest rates it now faces on its debt are manageable. Similarly, Andrew Watt, often highly critical of the approach adopted towards Greece, has nevertheless demonstrated empirically that Greece can live with its high debt, provided nominal growth is restored. In this regard, the renewed weakness of the Greek economy during the first half of 2015, at least part of which is explained by the uncertainty surrounding the protracted negotiations, has been damaging.

Can the Greeks make this third bailout work? According to Cinzia Alcidi and Daniel Gros of the Brussels think-tank CEPS, there are reasons for cautious optimism. In particular, although the pain of the first two adjustments has weakened rather than strengthened the Greek economy, they argue that some fundamentals are nevertheless in better shape because the worst imbalances have been corrected. Greece does, at least, now have its public deficit under control and the huge balance of payments deficit of 2009 has been reined-in, albeit mainly by lower imports rather than improved exports. The fact that most parties are now backing the current approach is also crucial. It is important to recognise that the Greek challenge is not just one of stabilising the public finances, but more so of breaking the hold of special interests – from pharmacists to ship-owners – on the Greek economy. A recent analysis by Antonis Kamaras looks at the outcome of the July negotiations through this lens and he argues that Greece is at last coming together.

We shall see….

Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative The UK in a Changing Europe



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