THE POLITICAL

ECONOMY 1

OF THE EUROPEAN
UNION

George Pagoulatos

AUEB, 2021
Contents
Part 1
• The Background: Key Elements of the European Project

Part 2
• What Crisis: Roots and Causes of the Eurozone Crisis

Part 3
• The Economics: Adjustment Paths and Crisis Legacies

Part 4
• EMU Trade Offs, Politics, and the Eurozone Crisis

Part 5
• After Covid-19: Two Crises Compared and the Unfinished EMU Reform Agenda

2
Part 1

The Background: Key Elements of

the European Project

3
 • 9 May 1950 Schuman declaration for ECSC
• French initiative and German problem
• economic means & political ends  ECSC
elaborate institutional structure
Key • elitist project; permissive consensus

elements of • EMU: also French initiative, German problem (tying

the GER to stronger EU)
• Also economic means for political ends
European • Disregard of policy details
project

Section draws on Loukas Tsoukalis, In Defense of Europe: Can the European Project be
Saved? OUP, 2016
 • Successive rounds of enlargement: 1973 (9), 1981
(10), 1986 (12), 1995 (15), 2004 (25), 2007 (27),
2013 (28), 2020 (27)
• Growing diversity in economic and political terms
• Numbers make a difference (less of a club, more of
a mini-UN; a weaker centre)
Ever Bigger • Trade-off between widening and deepening
–and • Surrender/pooling of sovereignties and growing
thinner? interdependence not matched by sufficient creation
of EU-level competencies and institutions
• The limits of Europeanization
• More top-down policies than participatory politics
• From permissive consensus to constraining
dissensus
 • From managed capitalism, dirigisme
• Keynes at home and Adam Smith abroad (Golden age)
• eliminating trade barriers
• domestic instruments for macroeconomic stabilization,
redistribution, insurance against risk, provision of public
goods
• Dani Rodrik: trade openness + public (social) expenditure

• European integration as market liberalization: economic growth

↔ market liberalization

More • 1970s: Bretton woods collapse, stagflation and slowdown of

integration

Intrusive • Single market program: market deregulation/reregulation

• SM program  new virtuous circle, but short-lived.
• Early 1990s: stagnation & unemployment
• SM: regulatory state & truly common market (except: labour
market –capital, digital)

• Spillover effects:
• SM  Justice, home affairs & EMU
• SM & EMU  global trade & regulatory power
 • Package deal: Single market + structural funds/ Cohesion
Fund

• When EMU debate started (1969-70), MU creation was

closely linked with a bigger EC budget and the automatic
stabilizers and inter-regional transfers of all national or
federal budgets.
Package
deals: • 20 years later, the official report that laid the ground for the
Maastricht Treaty paid much attention to the link btw
integration monetary and fiscal policy;
• but had very little to say about fiscal federalism and
and redistribution
redistribution
• No movement towards anything resembling a federal budget
• This time round, side payments were not deemed necessary

• The new monetary orthodoxy did not recognize any long-

term costs associated with stabilization;
• most poor m-s were not expected to join EMU for some time
anyway
 • Main concession offered to the economically weaker was:
• new agreement on Structural Funds, and creation of
Cohesion Fund,
• brought about a further increase in amounts to be spent
over next 7y
• This was repeated in 1999, but no net increase in total
amounts
• Same for 2007-13, 2014-20 (steady %, more recipients).
Package
deals: • Thus: redistributive policies were confirmed as integral part
of Maastricht package deal, but no major quantitative or
integration qualitative change

and • Νο expansion of redistributive objectives proportionate to

redistribution magnitude of EMU project

• After EMU, the EU has acquired new and important

functions in market regulation, redistribution, and
macroeconomic stabilization

• BUT it has only partially compensated for loss or weakening

of national policy instruments
 • After the virtuous cycles of the SM program,
things changed in the ‘90s:

• deteriorating economic environment (low

growth and high unemployment)

Economic • increasing difficulties of national welfare states

in providing an effective safety net for the losers
slowdown in & the insecure
• but: no visible reduction of social protection spending
the 1990s in EU-15

• Euro and EU integration risk becoming

associated with economic adversity and
uncertainty for an increasing number of
citizens
 The extent of EU policy involvement (N. Nugent)
Extensive EU Considerable EU Policy responsibility Limited EU Virtually no EU
policy policy shared between EU and policy policy
involvement involvement m-s involvement involvement

Trade Market Regional Health Housing

Agriculture regulation Industrial Education Domestic
Fishing Competition Foreign Defense crime
Monetary Movement Environmental Social welfare
(euro across external Equal opportunities
members) borders (esp. Working conditions
Schengen) Consumer protection
Macroeconomic (esp.
Eurozone)
Energy
Transport
Cross-border crime
Civil liberties (especially
via Charter Fundamental
Rights)
 • Convergence machine for inter-country inequalities; no
more

• Widening inequalities within countries since 1980s

• Returns on capital/GDP rising vs wages/GDP

• Top incomes rising faster than all others
Less • Technology, trade & financial globalization, tax
inclusive competition, political factors

• Winners and losers (parties; socioeconomic groups –

countries?)

• Burden of redistribution on national welfare states, but…

• Nationalists, populists; plebiscitary politics

 Real Growth & Unemployment rates in EU-
15
5%
1961-2022 (5-y moving averages) 12%

10%

4%
Real GDP Growth rate (%)

8%

Unemployment Rate (%)

3%

6%
2%

4%
1%

0% 2%

-1% 0%
65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 21
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20

Real GDP Growth - 5Y moving average Unemployment Rate (%) - 5Y moving average

*Data for 1961-1990 is for EU15 (including West-Germany) and for 1991 for EU15 (unified Germany). Source: AMECO* (Nov. 2020)
 • Three dimensions of the crisis:
Europe and • International
the Global • European
Financial • National

Crisis
The ugly Russian dolls
Part 2

What Crisis: Roots and Causes of

the Eurozone Crisis

14
 What crisis? Roots and causes
of the Eurozone crisis

Reading:
“Introduction”, in BALDWIN R. and F. GIAVAZZI (eds) The Eurozone
Crisis: A Consensus View of the Causes and a Few Possible Remedies, A
VoxEU.org eBook, CEPR Press, 2015

15
 WHY DID IT HAPPEN?
• 1. Loose monetary policy
• 2. Global trade imbalances btw US-China
2008-10 • 3. Lax financial regulation
Global • while gvnts adopted imperatives of balanced
budgets, inflation targeting, deregulation &
Financial privatization (thus constraining money supply),
the private financial sector was allowed to use
Crisis financial innovation to create unlimited quantity
of money
• 4. Economics of market efficiency & human
rationality

Source: Hemerijck et al.

Aftershocks, 2009 16
 What happened? The upside

Great Moderation
European Monetary Union
Global imbalances

Cheap and easy credit

}
Household
Financial debt & leverage increase
Public

Source: European Commission 17

 What happened? The downside
Interest rates increase

US housing bubble pops

Collapse of the banking system

Global recession

Government intervention: bailout & stimulus

EU debt crisis

EU crisis
Source: European Commission 18
 • Return of the state?

• Closer EU & global interdependence - need

for coordination (e.g. free-rider problems in
stimulus programs; beggar-thy neighbour
tax competition, wage deflation, social
Implications dumping)
of the GFC
(1/2) • Future trend: slow growth, high welfare
spending (ageing, cleaning environment).
Secular stagnation.

19
 • Global competition challenge – sustaining
welfare standards
• (Merkel 2012: “Europe 7% of global population,
25% of global GDP, 50% of global social
spending”)

Implications • EU & Eurozone crisis, debt crises, recession,

of the GFC unemployment

(2/2) • Nationalism and socio-political unrest

• EU intergov. conflict, distributional battles

20
Why the
EMU crisis
happened

21
 A currency without a state

Centralized monetary policy vs decentralized econ.

policies: no centralized fiscal policy function or fiscal
capacity
Weak EMU
Exclusive ECB mandate for price stability; ignored growth
design – or financial stability. Rules too rigid, designed for good
times
flawed
policies SGP insufficiently observed, no robust mechanism to
ensure sustainable public finances  large public
(1/4) debt/GDP. Growth not used to reduce deficits

Coordination of national economic policies beyond

budgetary, relied on soft instruments (peer pressure &
recommendations)  inability to foster structural
adjustment; competitiveness gaps and growth divergences
between m-s  macroeconomic imbalances

22
 Macroeconomic imbalances ignored, large debt
levels, losses in competitiveness;

Neglect of private-sector behavior  credit and

Weak EMU housing bubbles (IRE and ESP) and emergence of
structural imbalances [current-account deficits &
design – competitiveness losses]
flawed
Neglect of EA–wide spillover effects of national
policies economic measures.
(2/4)
Crisis-resolution mechanism for EA m-s was
absent.

An impossible trinity: no bailout, no Euro-exit,

no default of m-s governments

23
 Financial markets mispriced default risk into EA
m-s bond rates.

ECB relied on national bonds for open market

Weak EMU operations, conferring them top-quality status 
yields converged despite differences in national
design – budgetary performances.
flawed
Lethal correlation between banking and sovereign
policies debt crises.
(3/4)
Strong interdependence among EA m-s.

Gap btw EMU accelerated financial integration VS

weak EU fin. regulation and supervision (market
integration vs supervisory fragmentation)
Commission Blueprint
(2012) 24
 Lack of strong supranational EU-level
institutions for bank supervision.

Weak EMU No integrated EU-level mechanism to

design – mutualize response to risks coming from
banking sector affecting several or all m-s.
flawed
policies Absence of an effective resolution
(4/4) mechanism to provide liquidity to m-s in
distress, thus manage contagion risk and
safeguard EA financial stability.

Not just a sovereign debt and banking crisis,

but a governance crisis.
Commission Blueprint
(2012) 25
 Fiscal rules were violated

Good times not used to reduce

public debt
€uro: what
went wrong Financial instability neglected
(-2009)
Excessive private sector debt
tolerated

Macroeconomic imbalances
ignored
26
 Soft and politicized fiscal rules

Some countries not

sustainable primary budget
surpluses
Widening
macroeconomic No Eurostat control over
imbalances national statistics
1. Fiscal Deficits
No Brussels control over
national budgets

Loose coordination of
economic policies
27
 Widening macroeconomic imbalances:
2. Current Account Balance (% GDP),
2007

28
Source: Eurostat (2015)
Eurozone Twin Deficits/ Surpluses
(1999-2009)

29
Current Account Imbalances: Merry-Go-
Round

Growing
exports of
AAAs

Current
Growing GIPS
account
demand for
surpluses of
AAAs imports
AAAs

Credit
expansion Capital
financing outflows from
private demand AAAs to GIPS
in GIPS

30
 Public and Private Debt (% GDP), 2001

Public and Private Debt (% GDP), 2008

31
Source: Eurostat (2015)
 Public Debt (% GDP)
1999, 2007 & 2015
180%

160%

140%
Government Gross Debt (% of GDP)

120%

100%

80%

60%

40%

20%

0%
Euro Area Germany Ireland Greece Spain France Italy Portugal United Kingdom
Source: Eurostat (2020)
1995 1999 2007 2015

32
 Private Debt (% GDP)
1999, 2007 & 2015
300

250

200
Private Sector Debt (% GDP)

150

100

50

0
Germany Ireland* Greece Spain France Italy Netherlands Portugal United Kingdom

* Ireland: Data from 2011 and on. Source: Eurostat (2020)

1999 2007 2015

33
Private debt  Public debt

Collapse of
private
spending

Huge fiscal deficits

(ESP: 2007 surplus 1.9%
2009 deficit 11.2%)

34
 • EZ crisis not a typical sovereign debt crisis

• Rather a crisis of foreign borrowing –CADs

[CA = domestic savings – domestic
investment]

• Akin to foreign currency debt  sudden

What crisis? stop to cross-border capital inflows

Causes of the • No lender of last resort (no CB money

EZ crisis printing to service the debt)

• Large banks  “double drowning”, taking

down the government (IRE)

• Bank-sovereign doom loop (fear of gvnt

solvency  fear of bank solvency  rising
risk premiums  debt default vortex

Baldwin & Giavazzi, VoxEU Consensus View 35

VoxEU Consensus View 36
…

• (Bruegel graph)

37
 Divergence in Inflation Rates (1999-2019)
5.5

4.5

3.5

2.5
Inflation Rate (%)

1.5

0.5

0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
-0.5

-1

-1.5

-2

Source: Eurostat (Nov. 2020)

Euro Area (19 m-s) Germany Ireland Greece Spain Italy
 Divergence in Nominal Unit Labour Costs (2010 =
100)
125

115

105

95

85

75

65
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Germany Greece Ireland Italy Portugal Spain

*Data for Ireland (2015-2016), Italy (2016-2017), and Spain (2019) are provisional Source: Eurostat (Nov.2020)
 Nominal Unit Labour Cost (% change) (1999-2019)
9

0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

-3

-6

-9

-12

-15

-18

Germany Ireland Greece Spain Italy Portugal

*Data for Ireland (2015-2016), Italy (2016-2017), and Spain (2019) are provisional Source: Eurostat (Oct.2020)
 Balance on current transactions with the rest of the world (% GDP)

12.0

7.0

2.0

-3.0

-8.0

-13.0

-18.0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Euro area Germany Ireland Greece

Spain Italy Netherlands Portugal
Source: AMECO (2020)
END PART 2

42