Decentralising and Democratising while reforming European economic governance

 Decentralising and democratising while reforming European economic governance

by Vivien Schmidt on 9th May 2021

The Conference on the Future of Europe needs to address how EU governance can be refitted to end the crisis of legitimacy.

The Conference on the Future of Europe,European governance

Vivien A Schmidt

The Covid-19 pandemic has been something of a wake-up call for the European Union. The EU finally recognised that the eurozone economic policies it had been pursuing since the 1990s—reinforced at the outset of the eurozone crisis in 2010—had been deleterious to the wellbeing of its citizens and the planet.

The obsession with ‘governing by rules and ruling by numbers’ through the Stability and Growth Pact (SGP), focused on low deficit and debts, meant that the EU had failed to invest in its future. Such rules and numbers ensured that those without the ‘fiscal space’ (read southern Europe) could not invest, while those with the fiscal space (northern Europe) did not. The EU’s eurozone governance engendered a ‘crisis of legitimacy’, in which doubling down on the procedural rules led to poor economic performance and increasingly toxic politics.

New beginning

The shift to Next Generation EU occasioned by the pandemic promises investment in the green transition and the digital transformation while addressing social inequalities. Embracing the Resilience and Recovery Fund (RRF) for countries most in need, this represents a new beginning in eurozone economic policies and governance. But the policies need to be reinforced by new instruments to promote EU-wide sustainable development, while the governance needs to be decentralised and democratised.

For the instruments, the EU needs to build on Next Generation EU—making it permanent and much bigger—while empowering the European Central Bank (ECB) to do more with regard to its secondary objectives on employment and greening the economy. For the governance, the eurozone needs to develop a process that is more democratic, with flexible guidelines and macroeconomic and industrial-policy dialogues allowing for greater participation by the social partners and citizens, along with parliaments. For any such decentralised and democratised eurozone governance to be implemented, however, we also need to reconsider the institutional arrangements.

There are many new ideas about what the ECB could do to enhance the EU’s economic prospects, through its role in monetary policy and macroeconomic co-ordination. In the pandemic, it has already gone very far through its Pandemic Emergency Purchasing Programme, but many more initiatives are possible—most under discussion, none taken up for the moment. Foremost would be for the ECB to move from an almost exclusive focus on the primary objectives set out in its charter to the secondary objectives.

This could mean the bank giving itself a target of full employment on a par with fighting inflation; ending ‘neutral’ bond-buying(meaning stopping buying the bonds of polluting industries); creating green bonds for the environment, or even providing ‘helicopter money’ to offer direct support to households in need. Finally, it would be extremely useful to create an EU safe asset, while solving the problem of national debt overhang (since debt restructuring by country is not feasible), by having the European Stability Mechanism buy a portion of the sovereign bonds held by the ECB.

Accountability and transparency

Importantly, in making any such moves, the ECB would benefit from enhancing its accountability and transparency while democratising the process. There could be greater accountability to the European Parliament, for instance, through formal requirements for dialogue between the institutions.

There could also be scope for more democratic debate and deliberation on EU macroeconomic governance. Let’s call it the ‘Great Macroeconomic Dialogue’, with a yearly conference to outline the grand economic strategies for the coming year, making a space for dialogue between the ECB and other actors—including not just the EP but also the European Commission and the Council of the EU, as well as representatives of capital, labour and civil society from across Europe.

Naturally, the ECB would retain its charter-based independence to pursue the policies it deemed most appropriate, but it would at least be able to legitimate any bolder actions with reference to ‘political guidance’ offered through the Great Macroeconomic Dialogue. Such a process would arguably furnish the legitimacy afforded to national central banks, which operate in the shadow of national politics, by putting the ECB in the shadow of EU-level politics.

Investment funds

Next Generation EU and the RRF need to be reinforced through a permanent, EU-level facility, which could provide investment funds for all member states on a regular basis. Think of it as an EU wealth fund, akin to national sovereign-wealth funds.

It would issue debt on the global markets to invest via grants to the member states—in education, training and income support, in greening the economy and digitally connecting people, and in big physical infrastructure projects. It could also invest in EU-level cross-border endeavours, as well as for redistributive purposes, through a range of innovative EU funds, including an unemployment-reinsurance fund, a refugee-integration fund (for countries taking in more asylum-seekers), an EU fund for just mobility (focused on the ‘brain drain’) or even a poverty-alleviation fund—although other EU budgetary ‘own resources’ could instead be provided for such initiatives.

The next question would be how to ensure the latter succeeded. The European Semester is the ideal vehicle for oversight and assistance but only if we rethink its purpose and rules. Clearly, the eurozone’s restrictive deficit and debt rules, reinforced during the eurozone crisis, did not work, and in any event need to be changed to meet the new circumstances and goals.

Rather than simply readjusting the rules and numbers, they should be permanently suspended—to be replaced, say, by a set of ‘fiscal standards’ to assess sustainability in context. If this were not feasible, then a much more flexible set of rules should be developed, focused on counter-cyclical economic policy, with more fine-tuned assessments of where individual member-states sit in the business cycle in relation to deficits and debt, as well as growth outlook and prospects of meeting investment targets.

Flexibility watchword

Flexibility needs to be the watchword—and sustainable, equitable growth the objective. Think of Italy, which has had a primary surplus all these years and yet, because it has had to finance its debt overhang from the 1980s, has been unable to invest in growth-enhancing areas. Indeed, it has had instead to cut back—to its great detriment, in terms of paying down the debt and responding to the pandemic.

Moreover, public investments (industrial and social) deemed to benefit the next generation should not be counted toward deficits or debt (the ‘golden rule’). In fact, in this environment of extremely low interest rates, with the ECB engaged in extensive ‘quantitative easing’, public debt can be ignored if sustainable (as it is when government can borrow at a rate lower than the average rate of growth of gross domestic product). Otherwise, raise taxes.

One of the lessons of the past decade is that you cannot cut your way out of public debt through austerity—the only way is through growth. In this vein, another initiative should be to eliminate the debt brake from national constitutional legislation. This was a major hindrance to investment even in countries with the fiscal space to invest.

Take federalised Germany, with the Länder responsible for university education and local authorities for local infrastructure. The rules limited new investment for the poorer (and therefore already more indebted) states and localities, thereby increasing inequalities among sub-federal units while stunting growth potential.

Amazing architecture

European Semester procedures also need to be reimagined. The semester provides an amazing architecture for co-ordination, but to what end? At the inception of the eurozone crisis in 2010, it was converted from a soft-law co-ordinating mechanism (akin to the ‘open method of co-ordination’) into a top-down, punitive system of control—albeit from 2013 it was applied with increasing flexibility to ensure better performance.

Today, in light of the pandemic response, the commission’s mission has changed, largely leaving behind its roles of enforcer and then moderator in the eurozone crisis, to becoming promoter of the new industrial-policy initiatives through the National Resilience and Recovery Plans (NRRPs). These are much more bottom-up exercises by member-state governments, while the commission still exercises oversight and makes recommendations for reform. Marco Buti, head of cabinet for the commissioner for the economy, Paolo Gentiloni, described this to a Harvard audience last month as a move from ‘referee’ to ‘investment enabler’.

The question then is what is the best way to exercise co-ordinating oversight while decentralising and democratising the process? For overall grand strategy—indeed, in view of building European ‘strategic autonomy’—a new industrial-policy dialogue with all stakeholders would be ideal (although it could also be part of the Great Macroeconomic Dialogue), to set overall targets and goals, say, for greener investing and addressing social inequalities.

But of equal importance would be to decentralise the planning process for NRRPs to regional and local levels while democratising it procedurally, by bringing in the social partners and civil-society actors, as well as politically, by including parliamentary representatives. In this context, the member states’ fiscal boards and competitiveness councils should be transformed into sources of industrial-policy advice.

Moreover, while national governments should take their plans to their national parliaments for approval, the EU should involve the EP much more at different stages of the European Semester (in particular because of the redistributive function of the RRF). The semester itself needs to be fully linked to the social dialogues in the context of the European Pillar of Social Rights.

Finally, with all this new investment capability at the EU level—not just the RRF but also SURE, the employment-support vehicle put in place at the time of the pandemic, and other potential funds—the EU arguably needs a more centralised institution to manage the funds. For this, a high authority for financial affairs would be another idea—one floated by the French president, Emmanuel Macron, a few years ago.

Stumbling blocks

The EU faces however many potential obstacles and stumbling blocks to implementing such ideas. Political divisions remain in the European Council—recall how the ‘frugal four plus’ insisted that the RRF be temporary and opposed any grants at all. If the RRF fails to deliver on growth or if the extra investment is not used wisely in the main countries targeted (Italy and Spain), enthusiasm will wane, and the likelihood of a permanent fund will diminish. Moreover, if associated rule-of-law issues emerge in central and eastern Europe, with money going to cronies of illiberal government leaders (especially in Hungary and Poland), concerns about use of the funds will rise.

In addition, the austerity hawks are likely to be back—in particular once the pandemic is over and things get back to some kind of (new) normal. If the fiscal rules are not changed, or at least relaxed, the exit from the ‘escape clause’ of the SGP will have deleterious consequences for those countries that still need time to grow their way out of deficits and debt. Without changes to the rules—explicit ones at that—the austerians will have formal legal grounds to take the commission to court. And we can be sure that conservative German economists and others will again go straight to the German Constitutional Court, seeking stricter enforcement.

This is equally a problem because the restrictive rules and numbers are written into the treaties and legislation in so many different places: the Fiscal Compact imposed the institution of the debt brake in national constitutions, while the ‘six pack’ and ‘two pack’ codified not just the numbers on deficit and debt but also the sanctions to be applied. And how does one change the treaties, if even one member state is against, given the unanimity rule? This can set up almost unsurpassable roadblocks, unless the passerelle clause can be used—but, depending upon the issue, this too requires unanimity in the case of the council and an absolute majority in the parliament.

Revision required

To make EU governance truly workable, the unanimity rule for intergovernmental decision-making needs to be abandoned, replaced by ‘constitutional’ treaties amendable by two-thirds or four-fifths majorities. At the same time, many of the treaty-based laws should become ordinary legislation, subject to amendment by simple majority through the co-decision method.

Thus, for example, while the Lisbon treaty would arguably remain a constitutional treaty, amendable however by two-thirds or four-fifths majorities, the various treaties involving the eurozone should become ordinary legislation. They would then be open to amendment through political debates and compromise, and subject to the co-decision method—all of which would enhance the EU’s democratic legitimacy.

Moreover, greater differentiation needs to be allowed in the EU’s policy communities. For the eurozone this would mean, for instance, that if some members were to pledge their own resources to an EU budget their representatives would be the only ones to vote on the budget and how it would be used—although everyone could discuss it. So there would be no separate eurozone parliament, but separate voting for members of a deeper budgetary union.

There can however be no differentiation in the EU’s core commitments to the rule of law and democratic principles guaranteeing free and fair elections, independence of the judiciary and freedom of the press. And representative institutions need to be reinforced. At the moment, the EU serves the purpose of the populists, by hollowing out such national institutions, enabling populists to claim that they are the true representatives of ‘the people’, responsive to their expressed concerns.

To change this, the EU needs to do more to reinforce citizen representation and participation. For the eurozone in particular, this at the very least demands more involvement of the European Parliament in decision-making, through a return to the community method, along with greater decentralisation and democratisation of European Semester governance. Turning eurozone treaties into ordinary legislation, moreover, would help break the deadlock on changing such legislation and make them subject to political debate.

But the EP would also need to find more ways to bring national parliaments into EU-level decision-making. And the EU as a whole must devise new means of encouraging citizen participation.

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About Vivien Schmidt

Vivien A Schmidt is Jean Monnet professor of European integration in the Pardee School at Boston University and honorary professor at LUISS Guido Carli University in Rome. Her latest book is Europe’s Crisis of Legitimacy: Governing by Rules and Ruling by Numbers in the Eurozone (Oxford Universit