In the euro area, the crisis mood has somewhat calmed down. Several events in late 2012 have reduced the tensions. Among them are the European Central Bank’s announcement of its bond-buying programme OMT, the agreement on the creation of a banking union (however incomplete it may be for the time being) and the launch of the permanent European Stability Mechanism (ESM). The relief the euro area is experiencing at the moment may, however, only be temporary. Risks are emerging all over. The more obvious challenges still lie in the financial sector and in public finances – and further steps of crisis management and integration may indeed prove necessary to tackle them. Less obvious and more complex to solve are the political and social challenges.
The debate on the EU’s democratic legitimacy has gained pace. The European Union is quite used to discussing its democratic deficiencies. This post argues that the current crisis adds new dimensions to an old problem. The immature governance structures of the currency union prevent it from providing what European integration has been based on since its start: output legitimacy. While it is today (still) uncontested that European integration contributes to maintaining peace on the continent, it is hard to argue that the euro zone has sufficient instruments at hand to ensure long-term economic growth, social stability and sustainable public finances.
Economic and in particular financial openness are today seen by many as having destabilizing political effects – in particular in the EU. The single market and the Euro considerably limits governments’ ability to control economic developments in their home countries. The Euro members have handed monetary and exchange rate policy to the ECB, but have not created other instruments for macro-economic policy-making at the EMU level. There is no Euro-area budget; there are no European economic and labour policies; there are not even automatic stabilizers to buffer cyclical divergence.
Macro-economic developments are more or less a random result of national policy decisions, which most likely do not take into account the new realities of sharing a currency and economy. They generate for other member states externalities that in former times were absorbed by exchange rates. As a single currency requires an adequate aggregate fiscal policy stance that together with monetary policy preserves macro-economic stability and mechanisms to absorb asymmetric shocks, this setting is economically highly inefficient.
Meanwhile, capital mobility, in particular under the conditions of a single currency, has increased the pressure on governments to become more competitive. Monetary and financial market integration have led to a bias towards supply-sided policies at the national level in order to attract investment and corporations which are tempted to move to sites with lower taxes and production costs.
Until the sovereign debt crisis started to hit the euro zone in early 2010, low interest rates in the less competitive and less fiscally sound member states hid these new constraints. They also engendered irresponsible behavior on the part of the the political and financial elites, which now has to be paid for by the citizens. But since markets switched from an under- to an over-emphasis of country risk, these same governments are exposed to severe constraints.
All euro member governments have severely limited policy choices. Governments can no longer credibly claim that they are able to exert primary influence over growth and employment in their country. Intensified European and global competition pushes them to reduce tax-financed welfare spending. Unions have to choose whether to accept lower wages and less attractive employment conditions, or see jobs move out of the country.
The challenges to European welfare states are substantial: measures to regulate employment and production conditions are as much at stake as redistributive welfare and taxation policies, which were designed to compensate for unequal distribution effects and help build the groundwork for stable democracies in the post-war period. Given the intimate inter-linkage between the post-war concept of liberal democracies and the welfare state in the EU, the erosion of state capacity to provide social security and regulation may menace the stability of national democracies.
For the time being, the EU is not a place where partial remedies to these problems can be found. If this inertia continues, economic inefficiencies and the slow erosion of the welfare state along with rising inequalities will seriously delegitimise the European Union – and national governments with it.
My next post will look at the input dimension of the evolving crisis of legitimacy.
 One of the first to point this out was Fritz Scharpf, for instance here: Legitimate Diversity: the New Challenge of European Integration, Les Cahiers Européens de Science Po, No 01/2002.