Lessons from the European crisis.

• Author: Stark, Jurgen

Two episodes in the recent past have caused crisis management in Europe to migrate to a new level. First, the establishment of a permanent funding instrument, the European Stability Mechanism (ESM), on October 9, 2012, to finance crisis and problem countries in the euro area. Second, the decision taken by the Governing Council of the European Central Bank at the beginning of September 2012 to purchase Italian and Spanish government bonds on the secondary market on an unlimited scale--the Outright Monetary Transactions (OMTs).

These events have completed a paradigm shift in the European Economic and Monetary Union (EMU). The financial markets and political leaders 'alike welcomed and applauded dais sea change. So does dais mean Europeans have mastered or even resolved the crisis? There is evidence that the reform process at both the national and supranational level with positive results is under way, which should not be disregarded by market participants and external observers. At the same time, it is a fact that more and more eurozone countries (Cyprus and Slovenia) now require external financial assistance. It is also true that the undertaking of necessary economic adjustments, and strict conditionality on financial assistance to the crisis countries, are bumping against barriers. With groans of "adjustment fatigue" here and moans about "bailout fatigue" there, the democratic systems are struggling to cope. The costs of granting additional aid to fellow member states and of prolonging the timeline for economic reforms and fiscal consolidation is placing a growing strain on the donor economies.

Crisis management, initially characterized by panicky, ad hoc decisions, has eventually contributed to calm down markets in the short run but is becoming increasingly expensive as well. The problems currently facing Europe necessitate fundamental decisions about the future of the euro area and of European integration. By definition, these fundamental decisions must transcend the piecemeal approach to crisis management and to the new institutional framework of EMU that we have seen so far.

This article outlines the Maastricht concept of EMU as a stability union, considers the policy failures that led to the crisis, describes and analyses the paradigm shift in the context of the crisis resolution measures, and raises some questions concerning the future of European integration.

The Maastricht Concept of a Stability Union

The Economic and Monetary Union constitutes Europe's highest--and most visible-degree of integration. This applies especially to monetary integration and the introduction of a single currency: the euro. No comparable degree of integration has been reached in foreign mad security policy, or in justice and home "affairs policy. Those policies remain largely intergovernmental despite repeated attempts to develop community-based elements. Economic and monetary union is undoubtedly a political project. But it is also the logical consequence of the European integration process, particularly the monetary completion of the Single European Market and the finalization of the monetary policy aspects that were already contained in the European Economic Community (EEC) Treaty of 1957.

Yet economic and monetary union is an asymmetric construct. For one thing, economic union and monetary union represent differing degrees of integration and harmonization. For another, EMU lacks the dimension of a political union in the sense of deeper interstate integration. Consequently, the integration of economic policy and of general policy has lagged behind monetary integration. The parallel evolution of monetary union and political union, which the then German government advocated during the negotiations on the Maastricht Treaty, was opposed by some of its European partners. They were not prepared--for example, in fiscal policy matters--to accept further-going and more binding rules that would have impinged on national sovereignty. Nor were they ready and willing to move toward genuine common policy in other fields, such as foreign and security policy, which would likewise have entailed surrendering part of their national autonomy. Neither the Amsterdam Treaty nor the Nice and Lisbon Treaties brought any real progress on that front.

Nonetheless, the Maastricht concept of monetary union did lay a coherent, consistent, and solid foundation, with contractually agreed principles and rules, plus new procedures and instruments of economic policy coordination. The nub and the rub is the extent to which this concept has been implemented in practice.

The Maastricht blueprint envisaged the closer coordination of the member states' economic policies (Art. 119-21 of the Treaty on the Functioning of the European Union). To this end, "Broad Economic Policy Guidelines" were developed for the EU during 1993-94, containing country-specific recommendations. The aim of economic policy coordination was to attain lasting economic convergence among the member states and to maintain this following the start of Stage Three of economic and monetary union. The monitoring process was to embrace additional price and cost indices over and above the widely known convergence criteria, including the development of unit labor costs.

The fiscal rules were of a more binding nature, based on the principle of avoiding excessive budget deficits. The Treaty's provisions (Art. 126) were specified and operationalized by the Stability and Growth Pact. The Pact was intended to counterbalance the lack of political integration by underpinning monetary union with a set of specific fiscal rules. Its interlocking preventive and corrective arms defined medium-term targets for public finances and threatened sanctions in the event of noncompliance.

Another key provision of economic and monetary union is the no bailout clause (Art. 125 of the Treaty). It is predicated on the principle of the member states' national responsibility for their own political actions. Neither the Community nor any member state should be liable for commitments of another member state. Based on the assumption that only mature economies could quarry to join the monetary union and that any necessary adjustment efforts would have to be undertaken by each country on its own, the Treaty deliberately excluded the possibility of granting financial assistance to individual states should they suffer stress owing to membership in the monetary union. The implicit assumption was that if a country were to encounter financial difficulties or even default, the necessary adjustment and any external public funding would occur outside of the eurozone.

The founding fathers of EMU were well aware of the danger that monetary union might lead to financial transfers. It was for this reason that on May 1, 1998--the day on which the countries qualifying to embark on Stage Three of EMU were chosen--the European finance ministers, at the prompting of Germany, adopted a declaration which explicitly prohibited financial transfers that might potentially arise from membership in the monetary union. This agreement was endorsed by the heads of state or government at the European Council in Cardiff in June 1998. Although such a political statement is not legally binding, it is a political declaration of intent and should at least serve as an interpretation aid.

The Maastricht Treaty, together with the Statutes of the European System of Central Banks and of the European Central Bank (ESCB/ECB-Statutes), created a solid framework for the euro area to construct a new European monetary architecture (Art. 127-33 of the Treaty). The European Central Bank (ECB) was given a clear primary mandate to maintain monetary stability. This was reinforced by making the ECB/ESCB independent of political influence. The ECB's degree of independence is very high in formal and legal terms. Its autonomy embraces personal, institutional, financial, and instrumental independence. The ECB's mandate and independence mirror the liberal precept of macroeconomic management, which prioritizes monetary stability as the bedrock of a functioning free-market economy. The Treaty (Art. 123) also prohibits the monetary financing of government entities. Hence, the Treaty and the Statutes incorporate the paradigm of "monetary predominance" over economic and fiscal policy.

This enumeration of the Maastricht principles, with a special emphasis on fiscal rules, the no bailout clause, the independence of the European Central Bank, the primacy of price stability, and the prohibition of monetary financing, shows that Maastricht is a sound and clear stability-oriented concept. The allegation that the Maastricht blueprint is flawed and that the institutional framework contains deficits is thus incorrect. What is correct is that the Maastricht concept was never fully implemented. The real issue is, did it "fail" because it was not implemented or was not implementable? Was it perhaps too complex and too exacting for too many member states? Was too much demanded of the member states, and was this the reason why the standards were not met?

Historical examples show that the aforementioned principles and rules are essential for the smooth functioning of a monetary union. The success or failure of monetary unions has invariably hinged on the political determination and the political ability to adjust to the collective requirements of a monetary union. The Maastricht concept was based on the assumption that all parties involved the member states, the Eurogroup, and the European Commission--would duly observe and obey the principles and rules, and that peer pressure would act as a powerful reinforcement. The responsible institutions fell at this hurdle, however. In an atmosphere of "unhealthy politeness" (Mario Monti) peer pressure gave way to "peer support."

Looking at the historical record, it can be seen that "political determination" was the crucial ingredient not only for...