The cracks in the EU grow larger
Euro, Refugees, Secessions, and Brexit

“People who have visions should go see a doctor.“ (Helmut Schmidt)

Europe is in crisis, both economically and politically. This is nothing new. From the beginning, the path to European integration has been paved with crises. Thus far, this has not harmed the process of integration. At least, so claim the European visionaries. From every crisis Europe has emerged stronger. The vision of an economically integrated and politically united Europe lives on. The current crises, however, casts doubt on this view of things. Today, three cracks run through Europe. The first is opening between members of sub-clubs in the EU. In the EMU it runs between northern and southern members, and in the Schengen area between eastern and western members. A second crack is evident in the member countries themselves. Regions want more (economic and) political autonomy. The desire for secession is becoming stronger. Scotland and Catalonia represent the vanguard of this development. A third crack is observable in exit deliberations among the members of the EU. With the British referendum on remaining in the EU, it is for the first time conceivable that a member will leave the EU.

The Cracks

The fathers of European integration had a vision: an economically strong and politically united Europe in peace and freedom. Economic integration should be a vehicle for political agreement. However, for a long time now there has been hardly any talk of a political union. The four presidents of the Parliament, Commission, Council, and the ECB fantasize about it at most. In comparison, national governments are increasingly reluctant to cede national sovereignty to Brussels and Strasbourg. Meanwhile, economic integration has stalled as well. Europe is in poor economic shape. The last important step in the right direction was the “single market project ’92“. With the four fundamental freedoms, important foundations were laid for more integrated product and factor markets in Europe. Here, however, the second step was taken before the first. With the introduction of the euro one rushed on ahead of real economic integration. With the Schengen area, personal freedom of movement was created which neglected heterogeneous national interests.

The financial crisis still lingered in the bones of Europe, where it was economically battered by the euro crisis. In particular, the countries on the periphery suffered. Public and private debts were no longer sustainable and competitiveness was severely damaged. With the euro crisis the euro threatened to fail prematurely. Countries and the ECB extended fiscal and monetary safety nets. They have prevented the collapse, for now. Without these safety nets, the EU would no longer exist in its current form. It would have long since healthily shrunk. Since then, however, a crack has spread through the EMU. It runs between the northern and southern members. History appears to repeat itself. Most monetary unions failed due to overwhelming governmental debt. It was almost always the smaller, richer countries which first left the monetary unions (here). In most cases they were net contributors in these monetary arrangements. If history really should repeat itself, countries such as Finland, the Benelux countries, and Austria will probably be the first to pull out of the EMU.

Another crack cuts across Europe, this time between East and West. It arose because refugees rushed into the EU in large numbers. These refugees, however, did not appear out of thin air. They had been there for quite a while, but only with the outbreak of civil war in Afghanistan, Iraq, and Syria did they cause serious difficulties in Europe. The flow of asylum seekers swelled. The EU migration policy package turned out to be a fair-weather event. It consists of two elements: Since the Schengen agreement, persons within the Schengen area can move freely. Meanwhile, the Treaty of Dublin is meant to secure the outer borders. Those who come to the EU must be registered in the country where they first set foot on European soil. Thus, the load is distributed very unevenly. When Angela Merkel broke the Treaty of Dublin (here), the burden increased further. The European Commission has thus far failed in its attempt to distribute it evenly among the members. It is primarily the Eastern European countries which are not willing to adequately participate in assuming the burden.

The risk of the EU crumbling is further increased by such cracks. For two decades there has been a global tendency of regions to secede from the central government. A large number of independent, mostly smaller countries have since emerged everywhere (here). This development has not failed to leave its mark on the EU. Some time ago, Scotland launched its first attempt to become independent. The advocates of an independent Scotland, however, failed in a referendum. For the time being, Scotland remains in the UK. Catalonia also tried to secede from Spain, but their attempts thus far have been in vain. The Spanish Constitutional Court has forbidden a referendum, but the matter is far from over. Such secessions, however, are not for the EU to stabilize. Both Scotland and Catalonia certainly do not want to leave the EU. They only want to get away from their central governments. In both regions there exists a sizeable majority in favor of staying in the EU. This is now once again evident in Scotland, where a large majority is against a Brexit (here).

Thus, the next crack in the EU also becomes visible. For the first time in the history of the EU it is possible that a member will exit. So far, the EU has been overwhelmed with new members. Economically less developed countries in particular make every effort to be accepted into the EU. The EU has always shown itself to be generous. A larger EU had absolute priority. The European Commission has already seen to this. Particularly because it was believed that both would work simultaneously: enlargement and deepening. With the referendum in the UK, it is possible that a member will leave the EU. In this case it is not just any country, neither economically, nor politically, nor militarily. The UK was admittedly always a little different. It has for the most part kept its distance from the sub-clubs of the EU. This applies to the EMU, it is true for Schengen and it is no different for the Social Charter. Nevertheless, an exit would be a serious blow to a centralized EU. The risk of domino effects could not be ruled out, and in these volatile times that certainly wouldn’t stabilize the EU.

The Causes

The EU is crumbling at the edges. It is more torn than ever. The mood is poor. In some cases members treat one another irreconcilably. Animosities are revived once more. Europe is split in various ways. There are two important reasons for this: Firstly, the EU has become more heterogeneous, both economically and politically. Secondly, it reacts to this heterogeneity with harmonization and centralization. Worldwide and Europe-wide more open product and factor markets have amplified the differences in the EU. With rising prosperity, the preferences of citizens also fan out more strongly. In a more open and prosperous world, it is not just the people who can better live out their various individual preferences. It is also clear that individuals prefer different institutional arrangements. The varieties of capitalism are manifold. This is also true for the EU. Thus, there can be no talk of a single European social model. With the policy of forced enlargement, the EU has further increased heterogeneities. The increased immigration to Europe makes the EU even more different, within the countries as well as between them.

A more heterogeneous EU is neither economically nor politically doomed. However, it gets into trouble when it reacts centrally to this development. The cracks in the EU show that it has made precisely this mistake. The Hamburg economist Wolf Schäfer has long indicated that heterogeneities are something that the EU can take advantage of (here). By virtue of their variety, differences create more choices and opportunities for competition and prosperity. However, they also generate costs when it comes to the production of public goods. It becomes more difficult to satisfy the heterogeneous preferences of citizens. Consensus building is also more difficult to organize. However, responding to greater heterogeneity with harmonization and centralization is fundamentally wrong. Doing so does not take the preferences of the citizens seriously. The costs of heterogeneity skyrocket. Dissatisfaction, conflicts over distribution, and animosities in the EU increase. Such an integrated Europe meets with ever less approval. The cracks become deeper.

The crack in the EMU which separates the “North“ and “South“, has arisen because the members of the EMU are far too heterogeneous. The countries are not only differently developed economically. They also have diverging ideas about the responsibilities of the market and the government. The (German) idea of introducing monetary and fiscal rules which gradually create an optimal currency area out of the heterogeneous euro zone has failed. It was not possible to harden the budget constraints of the members (here). Debt limits, exclusion of liability, and a ban on monetary government financing were unable to prevent most of the countries from running riot, the “Club-Med“ countries more than others. Multiple “moral hazards“ proliferated. This led to unsustainable public and private debt and damaged competitiveness, especially in the countries of the periphery. Since the euro crisis, fiscal and monetary rescue packages have been softening the budget constraints of the countries further. Necessary structural reforms and fiscal consolidation are being put on the back burner.

Since the refugee crisis, the countries of the Schengen zone in the “East“ and “West“ are divided. The burdens resulting from the influx of people seeking help due to civil wars in the Middle East are considerable. No country is readily willing to shoulder them. Only a few countries have not evaded these burdens, among them Germany, Austria and Sweden. Most of the others have shirked the burdens, and continue to do so. Some Eastern European countries have explicitly announced their intentions, while others express themselves quietly. The agreement reached with Turkey is meant to solve this distribution problem. Migration policy burdens are to be “outsourced“. However, the deal with Turkey is problematic for many reasons. It is not permanent, and Europe pays a high (political) price. Additionally, the agreement shows that not much is left of the EU as a community of values (here). Many interpret it as a “mere“ treaty community. However, even then it still holds that anyone who is a member of the Schengen area out of a desire for free movement of persons must participate in the emerging burden of the refugees.

There are more cracks in the entablature of the EU that may jeopardize its stability. Regions want to secede from their respective countries. Members consider exiting the EU. The reasons are very similar in both cases. Regions and countries strive for more economic and political independence. Regions demand more autonomy within the central government. For those who are payers, inter-regional redistribution is a thorn in their side. If their dissent is not successful in penetrating through to the central government, they opt for secession (here). This is no different with regard to the members of the EU. There are not willing to cede more national sovereignty to the EU, to the Commission and Parliament. If they fail to stop the process of centralization in the EU, they choose withdrawal from the EU. However, the secessionist developments of regions and countries can only gain momentum when access to markets remains open. If the others barricade them out of the European Single Market, then the incentives for regions to secede from the EU, and for countries to exit the EU, are significantly reduced.

The Solutions

The EU runs the risk of crumbling. This is indicated by deep cracks. These have developed between the countries as well as within them. The main drivers are heterogeneous preferences of the citizens. More open markets and greater prosperity diversify the preferences. Experience shows that economic integration accelerates political disintegration. Cracks form in the EU. They cannot be caulked through greater harmonization and even more centralization. However, that is exactly what the EU-commission and the European Parliament are doing. This is, admittedly, in their politico-economic interests, but it is neither politically nor economically efficient. What is needed is a policy which more strongly decentralizes and homogenizes. Heterogeneous preferences necessitate decentralization. In this way the desires of the public will be better addressed. Institutional competition makes policy more efficient. Nevertheless, closer cooperation between countries with more homogeneous preferences is possible. They can work together more closely in fields where their ideas better correspond (here).

The cracks in the EMU are deep. They can, however, be repaired, at least in theory. I wrote early on in a blog post: “The euro can be saved if it is depoliticized. But this is only possible if banks (financially) and countries (fiscally) are put on a leash, less emphasis is placed on horizontal and vertical solidarity in the EMU, vertical competencies are clearly distributed, and economic policy is more strongly decentralized and regionalized. This enhances institutional competition and strengthens the immune system of the euro.“ The negative experiences since the euro crisis show that this is wishful thinking. It has nothing to do with reality. A recovery is not in sight. The preferences of the members of the EMU are more heterogeneous than ever. The euro can only be saved if these preferences can be successfully homogenized. This makes it necessary to healthily shrink the EU. Only those who unconditionally accept the amended rules of a “Maastricht 2.0“ may be members of the EMU. All other countries must leave. This boils down to a hard “northern“ EMU core.

The Schengen area also has deep cracks. A number of countries once more check people at the borders. The agreement with Turkey buys time. A sustainable solution looks different. To get a handle on the problem of immigration into the EU, three things must occur (here): 1) With respect to refugees who come to the EU for economic reasons, a common immigration policy is necessary. Quantitative and qualitative restrictions are unavoidable. 2) For refugees who are politically persecuted there can be no restriction on admission. The EU needs a modern asylum law. An agreement regarding “safe third countries“ and the distribution of refugees in the EU is indispensable. 3) Refugees from war zones should receive temporary protection on humanitarian grounds. To avoid an excessive burden in a few countries, a binding distribution mechanism must be installed. Whoever shirks from absorption of refugees fleeing political persecution and civil war must leave the Schengen area. Schengen also has a hard core.

The demand for regional autonomy in the EU countries shows that some regions are discontented with the central government. An adequate answer is more economic and political autonomy. Competitive federalism (here) is a first step. The regions must receive more autonomy in tasks, expenditures and revenue. Competencies must be clearly divided between regions and the central government. Many tasks must be decentralized. Along with the tasks, expenditures should also move into the regions.  Thus regions require more autonomy in taxes and duties. Finally, vertical and horizontal financial transfers must be made more incentive-compatible and transparent. The obligation to provide assistance of the central government and other regions must be limited to absolute emergencies. A competitive federalism so designed reduces the incentives of regions to secede from the central government. However, if this step is not carried out, the greater heterogeneity in the countries will lead to a conflagration of secessions.

The EU’s integration strategy has failed. The concept of enlargement and deepening no longer works. More and more new members make the EU more heterogeneous. The European Commission has reacted to this with harmonization and centralization. The market is supplanted by the government. National preferences which deviate from the EU norm are plowed under. The EU Commission claims more and more competencies. No wonder that countries with different ideas feel less and less represented. The British referendum on 23 June 2016 regarding a withdrawal from the EU was an initial response to this development. The desire for more national sovereignty will increase. In order to keep the members of the EU in line, a change in strategy is necessary. One element of this is a clear division of competencies between members of the EU and the EU Commission. The result lies between the Scylla of heterogeneous preferences and the Charybdis of increasing returns to scale (here). However, one result is certain: The competencies of national governments must be strengthened, and those of Brussels weakened.

Conclusion

The EU runs the risk of crumbling. It is deeply divided. In the EMU, particularly since the euro crisis, the “North“ and “South“ haven’t been getting on well with one another. Things are no different with respect to the issue of refugees. The “East“ accuses the “West“ of moralistic imperialism. But that is not all. Catalonia and Scotland no longer want to share a government with Spain and the UK, respectively. Finally, the British may take the gloves off after 23 June 2016 and leave the EU. All of this is unsettling news for the future of the EU as we know it.  This development is triggered by growing heterogeneity, economically and politically. The appropriate answer is decentralization. Competencies must be shifted from Brussels back into the member countries. Subsidiarity in the EU and competitive federalism in the member countries are indispensable. The EU needs a new integration strategy. A template could be a “Europe à la carte” with many sub-clubs. The EMU would be separated from the soft shell and be reduced to a hard core around Germany. This is also possible for the free movement of persons in the EU. This would then only apply to countries that have a common migration policy.

Hinweis: Dieser Beitrag ist die englische Version von “Die Risse in der EU werden größer. Euro, Flüchtlinge, Sezessionen und Brexit” der am 31. Mai 2016 in „Wirtschaftliche Freiheit“ erschienen ist. Er wurde von Michael Labate übersetzt. Herzlichen Dank!

Eine Antwort auf „The cracks in the EU grow larger
Euro, Refugees, Secessions, and Brexit

  1. ” Only those who unconditionally accept the amended rules of a “Maastricht 2.0“ may be members of the EMU. All other countries must leave. This boils down to a hard “northern“ EMU core…..
    The EMU would be separated from the soft shell and be reduced to a hard core around Germany.”

    Dear Mr. Berthod, the imbalances within the EMU are a joint responsibility and the damage they wreak affects both sides of the transaction, North and South.
    The point is that you cannot absolve yourself of responsibility for a bad net outcome by saying that our side of this trade cycle is all virtue (thrift, hard work etc.) and their side is all faults (overspending, bubbles etc.). Without their faults your thrift would have been pointless, it provided the growth that you live off since you refuse to provide it for yourselves at home and equally without your thrift their faults would not have been so excessively funded, rewarded and reinforced.
    This is economics and the consequences of a poor economic model cannot be reduced to a morality play – us good them bad.

    Germany and other creditor countries are frozen to the spot.Germany cannot simply pick up its luggage and move itself away from EMU taking its wealth with it. There is no road map for Germany to get from the euro to a substitute currency space. Any sign that the Germans might abandon the euro would be the alarm for the others to do the same, to the instant ruin of German creditors, who are owed tens of trillions of euros.
    Ironically German currency risk is no different from Club-Med risk, because both parties do business in what amounts to a foreign currency.
    The end of the euro anywhere within the Eurozone would also cast into doubt the security of Germany’s bank deposits. Uncertainty would trigger a run on German banks just as there was a run on Greek banks some time ago. Germany would find itself bound by domestic politics to defend the euro to the bitter end to protect its depositors.
    With a non euro currency, Germany’s option would be to depreciate. Doing so at a scale that would “˜manage’ liabilities would be default by another name with the costs falling on German depositors. To choose otherwise and not depreciate would leave Germany facing the same ruin as Greece faces right now. It would “˜become’ Greece, with massive and unsupportable demands for repayments in a foreign currency, a shortage of money, the absence of liquidity and a breakdown of export trade.
    The only way for Germany to manage EU-legacy repayment claims would be to re-denominate them from euro to D-mark and then somehow inflate them away against a background of economic growth. However, jettisoning the euro would cut Germany off from its now-captive European markets. This would eliminate the growth potential.Germany would be crushed by its debts in a deflationary environment.
    What EMU needs is to turn to an Optimal Currency Union for all its members.

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