From Chasing Gameto Symbiotic Relationship. The Position of Eurozone and non-Eurozone countries within the EU institutional framework

Paweł Świeboda

This report was funded by the British Embassy in Warsaw within the framework of its

Bilateral Programme Budget. All views expressed in this study are strictly those of

the author and should not be identifi ed with an offi cial position of the British Embassy,

or the UK Government.

Cover design:

Studio Brandingowe Bakalie

DTP:

Studio Brandingowe Bakaliewww.studiobakalie.pl

Warsaw, 2015

Paweł Świeboda*

* Author is President of demosEUROPA – Centre for European Strategy (www.demoseuropa.eu)

From Chasing Gameto Symbiotic Relationship. The Position of Eurozone and non-Eurozone countries within the EU institutional framework

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Executive Summary .................................................................... 51. Introduction: Chasing Game.................................................. 72. Dynamics of Eurozone Reform ........................................... 112.1 Bystanders By Default .............................................................133. Macroeconomic Governance Framework .......................... 153.1 Optimising Fiscal Position ......................................................153.2 Non-Eurozone Members: Reluctant Infl uencers ...................173.3 Strategic Goal: Level-Playing Field ........................................173.4 Prospect of Treaty Change ......................................................194. Future Fiscal Union ............................................................ 234.1 Non-Eurozone: Insiders in Normal Times,

Outsiders in Times of Crisis ....................................................245. First Things First: Banking Union and Financial Services ..... 275.1 Non-Eurozone: Firmly in the Trenches ..................................286. The Competitiveness Dimension ........................................ 336.1 Guarding the Single Market ....................................................357. Crisis Management Mechanisms ........................................ 378. Conclusions ......................................................................... 399. Recommendations .............................................................. 41

Table of Contents

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Executive Summary

This report examines the impact of the on-going reconstruction of the Eurozone on the non-Eurozone countries. It observes that during the crisis period, the relationship was shaped in an ad hoc fashion with no agreed master plan. The non-Eurozone countries focused on safeguarding their interests and emphasised the need to preserve broader EU cohesion. Their main objective was to pro-tect the integrity of the EU single market. As economic stability was reinstated, a more mature discussion has begun with the non-Eu-rozone countries accepting the need for further integration in the common currency area and refl ecting on its implications.

In order to defi ne the framework for the relationship, the report argues for a “Code of Conduct” to be agreed between the Eurozone and non-Eurozone countries. The document would confi rm the ex-istence of a community of interest across the currency divide and help to solve potential disagreements. It would envisage that fur-ther integration of the Eurozone could take place exclusively on the basis of the EU treaties while its impact would be closely monitored and assessed. The non-Eurozone countries would be engaged fully in the new fi scal policy system of the Eurozone as well as in the new set of measures to monitor and correct competitiveness gaps. Spe-cial safeguards would be agreed to guarantee the non-Eurozone countries’ sense of inclusion in the reform of the Economic and Monetary Union (EMU). As a result, trust would return and a symbi-otic relationship could be built.

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Introduction: Chasing Game

Key argument: Volatility of the Eurozone at the height of the crisis led the non-Eurozone countries to focus on safeguarding their interests. Preser-ving the integrity of the single market became their top priority.

The economic and fi nancial crisis has fundamentally chal-lenged a number of basic assumptions about the way the Euro-pean Union functions. This has profoundly affected the relation-ship between the Eurozone and non-Eurozone countries. From a relatively harmonious and balanced one in the fi rst years after the common currency was created, it became one of “catch me if you can”. Given the systemic nature of the Eurozone crisis, it is no surprise that developments within the common currency area became of central importance for the future of the Europe-an Union. Non-Eurozone countries have had a clear interest in ensuring that the reconstruction of the Eurozone is successful. At the same time, they have watched with utmost caution and occasional unease the impact of closer Eurozone integration on the broader EU cooperation and integration.

To be certain, non-Eurozone countries have remained a diverse group with different positions with respect to the possible adop-tion of the single currency: from the UK which rules out acces-

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sion to the Eurozone, through Sweden, which is not interested in joining in the foreseeable future but does not rule out the option (and remains legally committed to do so) onto to Poland which intends to join but fi nds the current circumstances un-favourable and faces a number of domestic constraints on the process. After the accession of the Baltic states to the Eurozone in the course of the crisis, it is unlikely that another member state will be in the position to join in the next fi ve years although Romania and Bulgaria have expressed an interest in doing so.

The relationship between the Eurozone and non-Eurozone countries has often been a turbulent one with the UK vetoing changes to the EU treaties in December 2011, meant to intro-duce more stringent budgetary discipline and surveillance, and with the former Polish Prime Minister Donald Tusk ma-king numerous emotional appeals to the Eurozone leaders “not to divide Europe”. The sense of inclusion of the non-Eurozone countries was weakened by the changes to the voting system in the Council that went into effect in November 2014. On their basis, members of the Eurozone were for the fi rst time able to form a qualifi ed majority among themselves. In addition, much controversy surrounded efforts to build an institutional identity of the Eurozone, which countries from outside of the common currency area perceived as introducing unnecessary duplica-tion to the existing EU architecture. As the British Foreign Sec-retary Philip Hammond has said, “if there were to be organised caucusing within the Eurozone to the detriment of the non-Eurozone members, that would be unfair and unacceptable to us”1. The latter, he made clear, would be an issue of fairness.

Gradually, the non-Eurozone countries have identifi ed a set of key objectives with respect to the on-going reconstruction of the common currency area. The most important one concerned preventing detrimental impact on the level-playing fi eld in the European Union at large. Any measures that could negatively infl uence the integrity of the single market, particularly in the fi eld of fi nancial services and free movement of persons, were treated as a cause for alarm. Secondly, the non-Eurozone coun-tries have aimed to preserve a reasonable degree of autonomy

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in fi scal and monetary policy and avoid excessive centralisation spreading from the Eurozone to the EU at large. Finally, coun-tries with the future intention to join the common currency area, have sought to ensure that barriers to entry would not become excessively elevated.

1 Philip Hammond in House of Commons European Scrutiny Committee, 20 January 2015: http://data.parliament.uk/writtenevidence/committeeevi-dence.svc/evidencedocument/european-scrutiny-committee/scrutiny-in-quiry-follow-up/oral/17711.html

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2Dynamics ofEurozone Reform

Key argument: Incompleteness of the Eurozone governance system has been tackled in a gradu-al, step-by-step fashion. Policy divergence within the common currency area made the engage-ment of non-Eurozone countries more diffi cult but not less relevant.

The trajectory of the Eurozone governance reform has been a refl ection of the reading of the original crisis. The main em-phasis was placed on eliminating its causes, rather than curing its consequences. Growth was to be the natural outcome of fi s-cal and economic stabilisation. Under the German infl uence and leadership structural reforms, aimed at increasing productivity and potential output, have been the main paradigm of anti-crisis response in Europe. This policy has been challenged as inade-quate, both in the Eurozone and in the EU at large.

Incompleteness of the Eurozone architecture turned out to be all the more glaring when the lack of monitoring of macroeco-nomic imbalances in the pre-crisis period became apparent. Although the Stability and Growth Pact was meant to lead to budgetary discipline, its execution was weak. Relatively little

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attention was devoted to public debt sustainability while no at-tention at all was given to the rising private debt. There was no monitoring of current account imbalances and the diverging developments with regard to labour costs.

In dealing with the two distinct dimensions of the crisis, one that had to do with macroeconomic stability and debt sustainability, and the other, which had to do with competitiveness, the record of the Euro-zone has been mixed. On the former front, the fear of fi nancial melt-down led policy-makers to introduce blanket austerity in spite of the differences in individual countries’ situations, with excessive public indebtedness being the main problem in Greece and diffi culties in the banking sector causing fi nancial havoc in Spain or Ireland.

Internal devaluation and a degree of structural reform have helped peripheral economies regain competitiveness, as re-fl ected in the rise of exports in Spain, Portugal and Ireland. However, not all the countries have been able to achieve that result, with Greece fi nding it particularly diffi cult to overcome recessionary pressures. Opponents of putting emphasis on structural reforms have argued that the latter produce effects only in the longer-term and cannot substitute more immediate anti-crisis measures. Insuffi cient demand in the surplus coun-tries has continued to contribute to the persistence of macro-economic imbalances while southern European countries have taken up much of the adjustment effort.

Monetary policy easing was part of the Eurozone’s response to the crisis from 2009 onwards. However, policy adjustments were slow. There were also two instances when the ECB clearly made wrong judgements and increased interest rates in spite of prevailing defl ationary circumstances. Legal constraints and political disagreement over the role of monetary policy limited the ECB’s room for manoeuvre although the “whatever it takes” pledge of Mario Draghi in 2012 was key to the success of stabilisation efforts.

In parallel, a number of crisis-typical problems arose, some of them imported from the US subprime crisis. They were not

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suffi ciently promptly handled, particularly with respect to the banking sector, which had an impact on economic activity. Such problems were largely a refl ection of an institutional and politi-cal weakness, given the lack of common supervision and reso-lution mechanisms in the banking sector, which augmented the bank-sovereign link and pushed the Eurozone close to the cliff in the years 2011-2012.

The astute phase of the debt crisis has now been overcome with yields for a number of Southern European bonds falling close to the level of the German bund. At the same time, there has been no signifi cant change in the volume of debt accumulated by the vulnerable countries. This means the risk of insolvency remains high should a rise in the costs of debt servicing re-occur.

The debt crisis, the competitiveness crisis and the slow pace in resolving diffi culties in the banking sector, together with a col-lapse in demand, have all combined to produce clear symptoms of defl ation which is now the Eurozone’s most pressing chal-lenge. There has been no growth in the common currency area since 2008 while unemployment has increased and the prices have fallen, as refl ected in the Eurozone defl ation of -0.2 per cent in December 2014. It is the end-result of the Eurozone re-form that is of most direct relevance to the non-Eurozone coun-tries. Regardless of their individual preferences with regard to the nature of Eurozone integration, the performance test they use is about much more than sustainability. Particularly among the catch-up economies of Central Europe, it is very much about delivering growth.

2.1. Bystanders by DefaultAs the policy response to the crisis was formulated, the non-Eurozone countries focused on preventing erosion of their own interests, rather than on co-shaping the policy consen-sus among members of the currency union. The assumption was made that given the intensive and non-consensual debate

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about policy options inside the Eurozone, the infl uence of non-members would be minimal while their ammunition would un-necessarily be wasted.

Three issues have been watched with particular attention by the non-Eurozone countries:

• The extent to which the reform measures undertaken by the Eurozone are essential for its sustainability and would not discriminate against the non-Eurozone countries.

• The degree to which stronger institutional cooperation among the Eurozone countries could inadvertently pre-de-termine broader EU policy to the detriment of the non-Euro-zone countries.

• The space for positive infl uence of the non-Eurozone coun-tries over the future direction and policy consensus within the common currency area.

These three sets of issues will now be analysed with particular fo-cus on the macroeconomic governance framework and prospects for the fi scal union, banking union and fi nancial services.

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3Macroeconomic Governance Framework

Key argument: Non-Eurozone countries have largely abstained from the macroeconomic policy debate in the common currency area. Gradual adoption of an active fi scal policy position in the Eurozone will force them to play a more engaged role.

Both the causes of the crisis as well as solutions to the Euro-zone’s sluggish growth converge on the functionality of the mac-roeconomic governance framework. Its scope and modus oper-andi have been reworked signifi cantly since the beginning of the crisis. Should the current framework be in place prior to 2008, it would have prevented much of the damage that has occurred. At the same time, it is still far from complete and fresh debate on its future will be re-launched with the report of the Four Presi-dents at the June 2015 European Council.

3.1. Optimising Fiscal PositionMuch of the Eurozone policy to date has been focused on fi s-cal consolidation and macroeconomic stability. There is much legacy behind it with the German Chancellor Helmut Kohl once claiming that a stable euro would “Thatcherize” the continent by imposing much-needed fi scal and monetary responsibility on countries such as France and Italy2.

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Although surprisingly little disagreement over policy emerged between the Eurozone and non-Eurozone coun-tries, their preferences have not been uniform. The UK, just like the US, pursued a fiscal and monetary stimulus in or-der to close the output gap, while remaining committed to longer-term fiscal discipline. Intent on continuing its eco-nomic convergence with the most advanced EU countries, Poland has also relied on a fiscal stimulus at the most criti-cal phase of the crisis, which came from lower taxation and inflow of EU funds. In parallel and under the influence of the German economic doctrine, the Eurozone put more em-phasis on structural reforms with the objective of increas-ing productivity and potential output. It can be argued that countries with better economic fundamentals benefited more from membership in the EMU while weaker countries found themselves under additional pressure.

As Klaus Regling, the Managing Director of the European Sta-bility Mechanism, has argued “Brussels reads Gordon while London and Washington are more in tune with Summers”3, in reference to Larry Summers’ argument that secular stagna-tion results from lack of demand and requires fi scal stimulus as well as Robert Gordon’s line that the challenge lies in low productivity and requires supply-side measures.

The fi scal policy position of the Eurozone was primarily a func-tion of the need to restore stability. Pro-cyclical policy was pur-sued in the years 2011-2013 and no signifi cant countercycli-cal measures were undertaken also in 2014 as the slowdown deepened. The crisis of demand expressed itself in the falling levels of private and public investment. This situation refl ected the Eurozone’s weakness in conducting an active fi scal policy as well as predominance of the stabilisation objective. The institu-tional diffi culty had to do with the lack of a coordinated Eurozone demand management, allowing for a differentiated approach depending on the available fi scal space. In addition, as André Sapir and Guntram B. Wolff have pointed out, “no institution is responsible for the area-wide fi scal stance and for the distribu-tion of fi scal policy across countries“4.

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3.2. Non-Eurozone Members: Reluctant Infl uencersThe non-Eurozone countries are affected by the results of this weakness but tend not to take a position on the need for closer coordination for fear of being excluded of the format and los-ing benefi ts that come with broader EU cooperation. However, their infl uence over the policy consensus in the EU should not be underestimated. Given that they are mostly not in the position of vulnerability, their power of conviction in the macroeconomic policy debate could be considerable. Although, as John William-son notes, getting surplus countries to change their policies has never been easy5, a more open discussion about each country’s own interests could be helpful. This is also the case with re-gard to Germany, whose surpluses, according to one infl uen-tial view,“expose the nation’s savers to huge potential fi nancial losses, bailout costs, and opportunity costs associated with low (negative) domestic real interest rates”6. Should this diagnosis be accepted, Germany should increase its public investment in the domestic economy, surpassing other advanced economies.

3.3. Strategic Goal:Level-Playing Field

Key argument: Integrity of the single market re-mains the EU’s most signifi cant achievement. Non-Eurozone countries have reasons to fear an unintentional weakening of the single market as the economic dimension of EMU is developed.

As we have seen, the non-Eurozone countries have resigned themselves to limited infl uence over the substance of macro-economic policy pursued in the common currency area. Their political fi re-power was concentrated on preserving the level-playing fi eld in the EU. The UK’s veto over the inclusion of tighter

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budgetary discipline into the EU treaties in December 2011 had more to do with the prerogative of protecting the UK’s interests than with the disagreement over the policy’s rationale. London sought at the time a separate legally-binding protocol to protect the City of London from potentially unfavourable EU fi nancial regulation. Contrary to the UK government’s intention, the then President of the European Commission José Manuel Barroso said that this type of protocol “was a risk to the integrity of the in-ternal market”7. An intergovernmental treaty, commonly known as the Fiscal Pact, was largely an unintended consequence of that disagreement. The UK had also expressed unease over the role of the EU institutions as facilitators of the Eurozone agenda, although it eventually allowed the ECJ to be involved in the moni-toring function envisaged by the Fiscal Pact.

Another non-Eurozone country, Poland, although not a big enthusiast of further treaty commitments on budgetary disci-pline, took a different view from the UK, fearful that a separate intergovernmental agreement would leave the non-Eurozone members with no infl uence over the policy-making process. For Poland, the prospect of creeping institutionalisation of the Eurozone was not only tantamount to challenging its newly ac-quired status as an important player in the EU, but was also seen as sealing the door to future accessions of sizeable econo-mies such as its own. Warsaw’s analysis linked the perceived loss of political infl uence by the European Commission and the growing irritation the latter’s policy caused in Berlin, with the eagerness of the key players in the Eurozone to create intergo-vernmental commitments and institutions. The conclusion it had arrived at suggested the risk of a powerful directorate be-ing formed outside of the EU framework, with the ESM secre-tariat becoming a nucleus of the future Eurozone secretariat. The assumption had been made therefore that inter-govern-mentalism is a risk to the cohesion of the EU.

Such fears were compounded by an intensive refl ection in Paris on the ways to cast in stone a more institutionalised Eurozone. As long as this was only France’s policy preference, the sense of alertness was limited in Warsaw. Once Germany gave its tacit

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approval, the concern became more pronounced, as was the case after the joint Franco-German position on 30 May 20138. The position paper called on Euro area ministers, for example employment and social affairs, research or economics, “to take work forward on specifi c Euro area matters” and for dedicated structures, specifi c to the Euro area, to be set up within the European Parliament.

Recommendati on:

The non-Eurozone countries should seek further guarantees, possibly by means of a separate protocol, that would reiterate that the internal market remains the EU’s key achievement, which takes precedence over other elements of economic policy. The protocol should also state that all EU members should benefi t from the internal market and any measures undertaken by the Eurozone to enhance its level of integra-tion have to be compatible with the internal market’s cohe-sion and viability.

3.4. Prospect of Treaty ChangeKey argument: Non-Eurozone countries’ inte-rests are better protected if further Eurozone inte-gration proceeds on the basis of EU treaties rather than through intergovernmental arrangements. Additional safeguards will nevertheless be neces-sary to ensure “fairness”.

The dilemma of the non-Eurozone countries with respect to the desired format of further Eurozone integration will return in the context of the commitment of the Fiscal Pact to incorporate the “substance of this Treaty within the legal framework of the European Union”9 in the course of the subsequent fi ve years. Although it can be argued that the “substance” of the fi scal ob-ligations introduced by the Fiscal Pact is already integrated into

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EU law by Six and Two Pack legislation, the exact provisions are not identical which means additional clarity would be welcome. Integrating the Fiscal Pact would remove an unusual situation in which commitments to implement obligations of EU second-ary law are undertaken in an outside format, as is the case with procedures on the breach of the defi cit criterion in the frame-work of excessive defi cit procedure10. Finally, the development of the euro governance system through the formalisation of the euro summits, election of the President of the summits and the ECJ control mechanism, would also, for the sake of legal clar-ity and rank, merit being integrated in the TEU, although the current arrangement has proved to be suffi ciently functional. In addition to the integration of the TSCG, the Commission has also suggested integrating the Treaty on the European Stability Mechanism and other intergovernmental agreements.

The key objective of the non-Eurozone countries in this pro-cess will be to ensure that they are not at a “systemic disad-vantage in the EU”11. As George Osborne and Wolfgang Schäu-ble have jointly said, future EU reform and treaty change must “guarantee fairness for those EU countries inside the single market but outside the single currency”12. Some of the most challenging issues will be the ones related to legitimacy. They will naturally arise if discretionary powers are given to the new Eurozone-level authority, capable of overruling national parlia-mentary decisions. Already the current requirement of unanim-ity in the ESM decision-making procedure, together with the need for parliamentary approval of commitments, is often seen as potentially preventing fundamental and urgent decisions from being made. Ideas to create a separate Eurozone caucus within the European Parliament or even a separate Eurozone parliament to approve decisions of the new fi scal framework, especially if they were to overrule national parliaments, fi nd no enthusiasm in the non-Eurozone countries. Given that institu-tional duplication is seen as leading in a straight way to greater Eurozone autonomy, a caucusing arrangement based on the existing membership of the European Parliament is therefore much more likely to gain tacit support.

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Recommendati on:

Intergovernmental arrangements aimed to achieve further Eurozone integration involve signifi cant risks for the non-Eurozone countries. They may bring with them loss of con-trol over the process and weaken the role of the community institutions. Therefore the non-Eurozone countries should be advocates of full integration of the existing intergovernmental mechanisms and provisions in the EU treaty framework.

2 Quoted in “New York Times”, 30 April 19973 Speech by Klaus Regling to the IIMA Symposium, Tokyo, 4 March 20154 “Euro-area governance: what to reform and how to do it”, Bruegel policy brief, André Sapir and Guntram B. Wolff, February 2015

5 “Getting Surplus Countries to Adjust”, John Williamson, Policy Brief, January 2011, Peterson Institute for International Economics

6 “What Should Surplus Germany Do?”, Jacob Funk Kirkegaard, Policy Brief 14-4, May 2014, Peterson Institute for International Economics

7 Cited in: http://www.bbc.co.uk/news/uk-politics-160860198 “France and Germany – Together for a Stronger Europe of Stability and Growth”, joint Franco-German position, 30 May 2013

9 Article 16, Treaty on Stability, Cooperation and Governance10 Article 7, Treaty on Stability, Cooperation and Governance11 See: “Protect Britain’s interests in a two-speed Europe”, George Osborne

and Wolfgang Schäuble, Financial Times, 27 March 201412 “Protect Britain’s interests in a two-speed Europe”, op. cit.

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Future Fiscal Union

Key argument: Eurozone must strive to optimise its fi s-cal position. Non-Eurozone countries should be involved in the process, although without subscribing to the spe-cial procedures applicable for the times of crisis.

It has been clear from the very outset of the economic and mone-tary union that a viable fi scal policy would eventually need to be part of the construction of the common currency. Although the euro’s founding fathers believed that they could afford delaying the creation of this missing link for some time, the crisis made it abundantly obvi-ous that the euro remains incomplete at its peril. Hence Herman van Rompuy’s blueprint for a “genuine economic and monetary union”, spoke of the need for a “qualitative move towards a fi scal union”13.

In its diagnosis of the fi scal situation, the report put emphasis on preventing and correcting unsustainable fi scal positions with the proposal to agree the upper limits on the annual budget ba-lance and on government debt levels. Issuance of debt going be-yond the agreed level would need to be justifi ed and receive prior approval. The report mentioned the possibility to explore the is-suance of common debt in parallel with the creation of a robust framework for budgetary discipline and competitiveness. In the longer-term perspective, it mentioned the development of a fi s-cal capacity at the Eurozone level as well as a treasury offi ce.

In the current phase of the reform, the emphasis has shifted towards optimising the fi scal position of the Eurozone. Among the range of

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questions put forward for discussion by the “Four Presidents”, the opening one concerns ways to ensure “sound fi scal and economic positions in all euro area Member States”14. Although tightening of the governance framework remains key, a tacit invitation is given to refl ect on ways of ensuring a more activist fi scal policy.

The context is conducive as the recent months have allowed for the bridging of the policy gap between the Eurozone members, with Germany and France seemingly coming to terms with the differences in each other’s economic philosophies. Although Germany achieved a small fi scal surplus in 2014 and France was given time until 2017 to bring its defi cit down to 3 percent of GDP, Chancellor Merkel said after a recent meeting with Presi-dent Hollande: “it is not my place to make demands, because France has its own reform agenda”. “That is a good thing, and it does not require comments from Germany”, she added15.

4.1. Non-Eurozone: Insiders in Normal Times, Outsiders in Times of CrisisAdvancing fi scal integration is the right answer to the failure of macroeconomic coordination in the course of the crisis. The cur-rent system is a rules-based framework that relies on the correct diagnosis of each country’s fi scal space in the light of the trends in the business cycle and evolution of debt sustainability. In a more closely integrated framework, countries should have their fi scal position prescribed at the federal level, both in case of the need to limit excessive borrowing and ensure debt sustainability, and also where maintaining or increasing demand is necessary.

One specifi c proposal which has been advanced to this end draws both on the logic of structural changes undertaken in Germany in 2003-2005 as well as on the traditional modus operandi of the Eu-ropean Union with its focus on mutual compromises and a system of institutional checks-and-balances. Inspired by Germany, the concept of “contractual arrangements” between the European level and the member states was meant to combine fi scal disci-pline and the commitment to improve competitiveness. The inten-

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tion was to create binding obligations to reform, going beyond the existing framework which relies largely on the power of persua-sion. From the beginning, there was an asymmetry, however, in the level of incentives offered as part of the contractual arrange-ments. The idea of a modest fi scal capacity was only fl oated with the more distant perspective in mind. As a result, no immediate conclusion had been reached and the discussion was put off to a more distant future. Given that partnership agreements envis-aged in the contractual arrangements could not be concluded on the basis of the existing legal framework, treaty revision would be necessary unless the agreements were of voluntary nature.

The non-Eurozone countries were relatively open to the con-tractual arrangements while Poland even claimed co-owner-ship of the idea, given that the mechanism mirrored its own partnership with the World Bank in times of transformation. Contractual logic was generally close to the heart of most of the non-Eurozone countries. They placed additional emphasis in the ensuing discussions on the availability of funds from the future fi scal capacity to all EU members.

More recent ideas to defi ne the Eurozone fi scal position include the one put forward by André Sapir and Guntram B. Wolff of a Eu-rosystem of Fiscal Policy with a Governing Council that would be comparable to the Eurosystem of central banks16 and involve all Eurozone fi nance ministers. Decisions of the Governing Council would have the status of recommendations to national govern-ments in normal times while they would become binding in times of crisis. Progress towards that end will be gradual and will need to rely on sound implementation of the reformed European Se-mester with more tailor-made recommendations addressed to members of the Eurozone and an improved timetable.

One possible idea to incorporate non-Eurozone countries in this process is to make the Eurosystem of Fiscal Policy open to their participation in normal times although not in the times of crisis. There is no reason to exclude the non-Eurozone countries from a largely persuasive arrangement, although recommendations given to countries of the euro area would naturally carry more weight. In times of crisis, the differentiation should become clear

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with the recommendations to Eurozone countries becoming bind-ing, while those to non-Eurozone members remaining indicative.

Proper risk-sharing among Eurozone countries might also involve the creation of a European unemployment insurance mechanism which would complement the national systems. The right environ-ment for its introduction would only be created when national labour conditions are signifi cantly harmonised. Further fi scal integration is likely to come with some indigenous resource to support the progress of reforms. In parallel, a fi scal backstop will need to be developed in case of bank restructuring and resolution. It may be established in the future through direct taxation raised by the European or Euro-zone parliament17. For the moment, the only source of fi scal support is the European Stability Mechanism. Traditionally, there is much anxiety among some non-Eurozone countries with respect to pulling sovereignty in the area of taxation, as shown by the vehement oppo-sition to the idea of the tax on fi nancial transactions. It may therefore become necessary to ring-fence Eurozone efforts in order to ensure they would not imply tax integration at the EU level.

Recommendati on:

Non-Eurozone countries should take full part in the reformed fi s-cal policy system that would aim at optimising the Eurozone fi scal position. Not being members of the common currency zone, they should not be obliged by recommendations issued as part of the system. However, they should participate in their elaboration and consider their adoption on a case-by-case basis. In exchange, they should not block the emergence of an active Eurozone fi scal policy, better aligned to deal with the macroeconomic cycles.

13 “Towards a genuine economic and monetary union”, Report by President of the European Council Herman van Rompuy, 26 June 2012

14 “Preparing for Next Steps on Better Economic Governance in the Euro Area. Analytical Note”, Jean-Claude Juncker in cooperation with Donald Tusk, Jeroen Dijsselbloem and Mario Draghi, 12 February 2015

15 “Germany makes up with France as Merkel-Hollande get along”, Bloomberg, 2 March 2015

16 “Euro-area governance: what to reform and how to do it”, op.cit., p. 617 Discussed in “Euro-area governance: what to reform and how to do it”, op.cit., p. 7

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First Things First: Banking Union and Financial Services

Key argument: Banking union was necessary to provide fi nancial stability in the Eurozone and has led to the resumption of lending. Non-Eurozone countries were deeply sceptical about the banking union’s impact and remain cautious about the dif-ferentiation it creates.

Prior to the crisis, the Eurozone’s banking sector was character-ised by a signifi cant level of integration, evidenced by the intensity of trans-border lending and cross-ownership of assets, but also lack of suffi cient supervisory and resolution structures and over-reliance on banks to the detriment of market instruments. Pres-sures of the crisis have translated themselves into a signifi cant degree of fragmentation and interruption of much of the cross-border lending. Destabilisation of the bond market has exposed European fi nancial institutions to losses and the need to search for new sources of capital or shrink their balance sheets. Rising credit risk has led to restraining the ability to provide fi nance to the real economy, contributing to the deepening of recession.

The policy response was slow and unable to prevent compartmen-talisation of banking. At the height of the crisis, the toxic link be-tween banks and sovereigns became a systemic risk to the survival

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of the common currency. As a result, the creation of an “integrated fi nancial framework” became the fi rst element of Herman van Rompuy’s “genuine economic and monetary union”18. Much effort has since been undertaken to improve the stability of the bank-ing sector, including by means of the banking union and improved macro-prudential measures. The banking union is meant to rebuild trust in the quality of fi nancial services with major implications for the free fl ow of fi nancial services across the EU market. The as-sumption of the supervisory functions by the SSM is meant to im-prove the overall quality of supervision, limit regulatory arbitrage, reduce costs of adjusting to the regulation by trans-border banks, eliminate problems in cooperation between home and host coun-tries, as well as ensure cohesion between the market of fi nancial services and the prudential measures which regulate their activity. This nevertheless remains work-in-progress.

Even though the 2014 stress tests undertaken by the ECB and the European Banking Authority in the run-up to the creation of the Single Supervisory Mechanism were much more thorough than the previous ones, they have not escaped criticism. The Basel Committee’s assessment of the EU’s implementation of the Basel III rules on bank capital from December 2014 shows a number of important loopholes and gives the EU the second lowest overall rating on a scale of four. Credit risk-rating was considered “ma-terially non-compliant” given the favourable risk weightings that SMEs enjoy in an attempt to restart lending to companies. How-ever, EU banks are also given a signifi cant room for manoeuvre in valuing sovereign debt-holding. As a result, most banks across the EU apply zero-risk weighting to sovereign debt.

5.1. Non-Eurozone: Firmly in the TrenchesAlthough there was clear understanding of the need for the bank-ing union among the non-Eurozone countries, the possible implica-tions of the adopted solutions for the latter’s fi nancial sector were an area of utmost concern. It has been feared that markets outside

29

of the banking union could face lower confi dence of depositors and investors as well as reduction of trans-border activities on the part of the banks of the Euro area. This could at the end of the day lead to the creation of two areas of fi nancial services in the EU.

The sensitivity in Britain results from the sheer size of London’s global fi nancial centre with its 600,000 employees and a 9.4 per cent contribution to the UK’s “gross value added”19. In compari-son, the Polish banking sector is relatively small and has assets which are equivalent to 1.03 per cent of the Eurozone assets and 0.73 per cent of the assets of the EU20. The sector is highly inte-grated with the Eurozone through the international fi nancial in-stitutions which creates a number of risks for fi nancial stability and potential confl ict of interests in the future between the Single Supervisory Mechanism and KNF, the Polish supervisory author-ity. Poland’s main concerns have had to do with macro-pruden-tial regulation as well as the relationship between the home and host countries within banking groups, including in such areas as the formulation of liquidity provisions (for banking groups or individual entities).

Discussions on the non-Eurozone countries’ say over the de-tailed arrangements of the banking union were from the begin-ning a testing ground for the way in which the wider Eurozone – non-Eurozone relationship would play out. The latter’s concerns have been compounded by a number of pronouncements point-ing at the risk that the banking union would distort the level-playing fi eld in the EU. Statements by Christian Noyer, governor of the Banque de France, were noted with particular attention, particularly when he said that there was “no rationale” for let-ting the euro area’s fi nancial hub to be “offshore”21. “We are not against some business being done in London, but the bulk of the business should be under our control. That is the consequence of the choice by the UK to remain outside the euro area”, Noyer said, unsurprisingly touching on a raw nerve in London.

In the course of the negotiations of specifi c legislative provisions, the ability of non-Eurozone countries to co-shape pan-European banking policy was largely preserved. The voting structure of

30

the European Banking Authority was changed as compared to the initial proposal of the European Commission to ensure that countries not taking part in the banking union will have their interests protected. A clause was also agreed to stipulate that the ECB cannot discriminate against any EU member state “as a venue for the provision of banking or fi nancial services in any currency”. Finally, the voting rules were adapted to protect the “outs” against the predominant power of the “ins”.

Although the non-Eurozone countries have largely remained outside of the scope of the banking union, their supervisory au-thorities are expected to use similar assessment criteria and re-quirements as the Single Supervisory Mechanism (SSM). Poland has taken the view that the banking union is not a closed project and fi nal decisions about accession should be taken only once its construction is fi nalised and all the risks are known. The key question has had to do not only with the transfer to the suprana-tional level of the supervisory competences but also of fi nancial responsibility by means of the European resolution fund.

The unwillingness to hand over responsibility for supervision is primarily the result of the lack of access to the mechanisms which are available in the Eurozone. Banks from the euro area can count on liquidity support from the ECB as well as capital support from the ESM, in case of an unfavourable decision of the consolidating supervisor, while no similar support is available to banks from outside of the euro area. Non-Eurozone countries should be aware that national regulatory authorities have histori-cally not been the most effi cient. They have often had rather nar-rowly defi ned competences with low ability to enforce decisions.

In the case of Poland, the decision to restrain from acceding to the Single Supervisory Mechanism has also had to do with concerns about centralisation of the macro-prudential regulation. Poland’s Central Bank governor Marek Belka has argued that the national regulatory authorities are better positioned to monitor imba-lances within the fi nancial sector and that the latter are in any case more likely to develop in single countries rather than across the entire union22. “You need national control of macro-prudential

31

policy. Crises, or tensions, imbalances, tend to show up locally, not on a global scale – or regional scale if it is Europe”, he said. Belka has drawn attention to the lack of clarity about the rela-tionship between macro-prudential supervision in the Eurozone countries and the SSM which wields its own macro-prudential instruments, including the possibility of imposing higher capital buffer requirements than required nationally. Retaining supervi-sory competences at the local level is also relevant for ensuring that capital adequacy provisions are assessed and demanded in-dividually at the level of each entity in the group.

A risk specifi c to the Central European countries has to do with the fact that much of the assets of their banking sectors belongs to fi nancial entities of the Eurozone countries, liable for SSM supervision. This points to the potential risk of host countries being discriminated against home countries. There has been a strong concern that the banking union would lead to “exporting the crisis” by making large banking groups over-active in the boom period, undertaking more risky activities in the host country and quickly withdrawing in times of diffi culty23. Particularly unfavourable situation would arise for the host countries if the new regulations would allow a free transfer of assets within trans-border banking groups. This would mean the risk of a transfer of fi nancial liquidity and destabilisation of fi nancial markets in the host countries as well as the risk of value migration for minority stakeholders in banks which are fl oated on the stock exchange.

Recommendati on:

The non-Eurozone countries should demand a number of measures to ensure that further EMU integration has no ne-gative impact on broader EU cohesion. The European Com-mission should commit itself to undertake an impact as-sessment of all the proposed measures and should report regularly on the issue. Non-Eurozone countries should also be in the position to revert a matter to the European Council should they believe that the measures undertaken could be disproportionate or discriminatory.

32

18 “Towards a genuine economic and monetary union”, Report by President of the European Council Herman van Rompuy, 26 June 2012, page 4

19 “London scents victory in EU banking union deal”, Laura Noonan, Reuters, 14 December 2012.

20 Data from KNF, Poland’s supervisory authority, September 201221 “UK’s euro trade supremacy under attack”, Josh Noble and Alex Barker, Fi-

nancial Times, 2 December 2012. 22 “Poland criticizes eurozone banking union”, Financial Times, 21 October

201423 Stanisław Kluza, “Unia bankowa. Oj, ryzykowne.”, Gazeta Wyborcza, 12 Sep-

tember 2012.

33

The Competitiveness Dimension

Key argument: Competitiveness is a shared ob-jective for all EU members. Divergences in com-petitiveness should be closely monitored and cor-rected across the whole of the EU, with special attention being given to the problems indigenous to the Eurozone.

In the run-up to the crisis, a number of Eurozone countries suffered from declining competitiveness which failed to be suffi ciently moni-tored and addressed at the political level, particularly given the ab-sence of a fl exible exchange rate. Current-account imbalances be-tween core and periphery countries widened signifi cantly as a result. Sizeable infl ows of capital, prompted by rapid changes in the interest rates, ended up going to unproductive use while the gap between wages and productivity widened. This evolution refl ected different situations of the core and periphery countries in the run-up to the crisis, and to some extent, also before the euro’s creation. The Euro-zone’s core served as the main supplier of capital for the periphery, giving ground to an unresolved discussion about responsibility for investment decisions undertaken. However, once the crisis unfolded private capital fl ows to the periphery countries were rapidly inter-rupted and enormous debt burdens were created as a result.

The Macroeconomic Imbalances Procedure has proved to be a relatively weak mechanism for monitoring diverging trends

34

in competitiveness. The evolution of labour costs is largely be-yond the infl uence of Eurozone-wide institutions with national prerogatives and market forces being dominant in the domain of wage setting. Structural reforms undertaken in individual countries are also undertaken without their Eurozone-wide im-pact being properly assessed. More effi cient macro- and micro-prudential policies and better regulation of the fi nancial system are key to avoiding unsustainable asset price booms leading to excessive increases in unit labour costs24.

Internal devaluation has produced some adjustment across the Eurozone but unit labour costs have hardly moved in some coun-tries, including Italy. Differences in competitiveness might arise from the fact that wage rises do not always follow increases in productivity. In the absence of the possibility to create a properly single labour market with workers moving freely across borders, enjoying portability of pension entitlements and other rights, di-vergences in competitiveness should be monitored and correc-ted before they become a challenge to the Eurozone as a whole. André Sapir and Guntram B. Wolff have suggested the creation of a Eurosystem Competitiveness Council consisting of both na-tional competitiveness councils and the European Commission. The Council would complement the functioning of the Macroeco-nomic Imbalance Procedure by ensuring that no country fi xes a wage norm that creates signifi cant competitiveness problems.

The objective would also be to engage national institutions in the process to ensure ownership. The point of reference for Wolff and Sapir is the Belgian framework which has been in place since 1996 to trace the evolution of wage developments in the main trading part-ners. The wage formation and bargaining system that existed prior to the establishment of the euro was preserved. However, unit labour costs have not risen excessively, keeping competitiveness in check.

Recommendati on:

In parallel to their participation in the new fi scal policy sys-tem, the non-Eurozone countries should be fully engaged in the process of monitoring and correcting competitiveness

35

gaps. The EU at large needs to understand competitiveness as a complex phenomenon that involves issues ranging from the functioning of the labour market to sophistication of busi-ness models and quality of the health service.

6.1. Guarding the Single MarketKey argument: Non-Eurozone countries should rely on community institutions, including the EC and the ECJ for robust protection of the sin-gle market.

One of the main advantages of EU integration from the point of view of ensuring competiveness is the strength and sophis-tication of the European single market. Non-Eurozone coun-tries have proved to be effective in protecting the single market against possible fallout from closer integration within the com-mon currency area. The existing European law has proven to be a suffi cient guarantee of the level-playing fi eld although an ac-tivist approach in monitoring potential excesses and recourse to the courts has been necessary.

This is well demonstrated by the reaction to the 2011 plan by the European Central Bank which required companies handling large trades in euros to base themselves in the Eurozone coun-tries. The UK has identifi ed the move as a challenge to the sta-tus of the City of London as a fi nancial hub and mounted three separate legal challenges, arguing that the plan undermines single market rules. The ECB has claimed that its move is nece-ssary to provide adequate oversight of the euro’s clearing sys-tem. Its opponents have argued that it would amount to protec-tionism with implications not only for London but for all global fi nancial centres. From the point of view of fairness, should the plan go ahead, it would be perceived as favouring the Eurozone countries and creating a dangerous precedent for the future co-hesion of the internal market.

36

In its verdict on the issue, the European Court of Justice has annulled the ECB’s Eurosystem Policy Framework in so far as it set a requirement for counterparty clearing systems to be located inside the Eurozone. This was an important deci-sion in defence of the EU single market, also pointing out the limits of the powers of the ECB. The ECJ stated that the ECB does not have the competence necessary to impose location requirements on central counterparties involved in the clear-ing of securities.

24 “Euro-area governance: what to reform and how to do it”, op.cit., p. 4

37

Crisis Management Mechanisms

As the crisis unfolded, it became clear that the Eurozone lacks a proper crisis management system. Doubts and delays in formulating the necessary response created a vicious cycle in which the Eurozone seemed to be permanently driven by events. As countries gradually lost access to the markets, mechanisms and institutions to provide fi nancial assistance were created. Conditionality was built into that system with supervision of the reform effort being performed by an institutional Troika of the European Commission, the European Central Bank and the In-ternational Monetary Fund.

Initially, the crisis management mechanism had started at the EU level, with the European Financial Stabilisation Mechanism that was used to support Greece and Portugal. The EFSM was jointly guaranteed by all the EU member states with the in-termediation of the EU budget. The Mechanism was based on Article 122 of the EU Treaties which envisages fi nancial assist-ance in times of natural disaster, hence circumventing the “no bailout clause”. Gradually, the bulk of the fi nancial backstop arrangements was organised within the Eurozone, with the European Stability Mechanism becoming the main source of emergency funding.

The non-Eurozone countries have an interest in the expansion of the fi scal space to address the crisis management needs of the common currency area. One of the issues that remains

38

on the table has to do with the possible fi scal consequences of dealing with the unresolved problems in the banking sector. Particularly, a fully-fl edged banking resolution in the Eurozone would require a fi scal backstop for which no resource exists at the moment, apart from the European Stability Mechanism.

This leaves open the question of the crisis management mecha-nisms for the non-Eurozone countries. The issue is particularly relevant for Central European countries, some of which were more vulnerable at the outset of the latest crisis, due to the build-up of external debt, housing and consumption booms. Coordination of policy between the EU and the IMF helped to substitute public for private funding at the height of the crisis25. A bigger problem emerged with access to the euro liquidity when the ECB’s emergency provisions inside the Eurozone were not refl ected outside the common currency area. With the benefi t of hindsight, currency-swap agreements should have been ex-tended more actively to at least some Central and Eastern Euro-pean central banks through its acceptance of the region’s bonds as collateral and access to euro-refi nancing facilities.

25 “Assistance to emerging Europe”, Zsolt Darvas, vox.eu, 23 February 2010

39

8Conclusions

Key argument: Rather than through ad hoc ad-justments, the relationship between the Eurozone and non-Eurozone countries should be based on an established set of principles and governed by a Code of Conduct.

When comparing the evolution of the Eurozone and the crea-tion of the US fi scal federalism, it is clear that much still needs to be done to ensure the sustainability of the common Euro-pean currency. The difference lies in the way balanced-budget and no bailout rules are anchored in the US system but also in the fact that the federal government in the US assumes pri-mary responsibility for the stability of the banking system (as a result of which this function does not confl ict with the bala-nced-budget rule at the state level). It is also able to stabilise the economy in a countercyclical fashion, through the federal budget, which exists in the US since the 1930s. State and local budget tend to behave pro-cyclically in the US, as they have in the Eurozone. What is more, maintaining the balanced budget rule at the state level would have been diffi cult without the countercyclical federal policy.

The integration agenda will advance in the Eurozone, both to eliminate the most glaring areas of incompleteness and to re-spond to new challenges. It will also inevitably affect the re-

40

lationship with the non-Eurozone countries, which has in any case changed beyond recognition. Non-Eurozone countries are a diverse group and their cohesion is unlikely to be suf-fi cient in the foreseeable future to form a unifi ed block, able to counterbalance the Eurozone’s overwhelming role in the EU. Nevertheless, they have a shared interest in ensuring a multi-tier and multi-speed Europe can coexist alongside each other, the former being sought by the UK, with variable degrees of integration depending on each country’s individual choice, and the latter being desired by Poland, whose intention is to join the Eurozone at a future point in time.

41

9Recommendations

The approach of the non-Eurozone countries should in this context aim at three objectives: a) establishing safeguards to protect their specific interests which might be affected by on-going changes in the Eurozone, b) increasing their influ-ence over the future course of the macroeconomic policy in the Eurozone, c) creating a positive-sum game, by means of which the EU at large can benefit from the diversity of policy frameworks among its members.

The following principles and mechanisms should be agreed be-tween the Eurozone and non-Eurozone countries:

• New governance system of the Eurozone should be based on the EU treaty framework. It ought to be guided by EU in-stitutions which respect the interests of the EU as a whole. All existing intergovernmental mechanisms and provisions should be fully integrated in the EU treaty framework. Entry into force of Treaty provisions which are relevant and bind-ing exclusively on the members of the Eurozone, could follow a simplifi ed procedure.

• Non-Eurozone countries should be invited to participate fully in the fi scal policy system of the common currency. In the times of crisis, the system’s recommendations should be binding for the Eurozone countries and non-binding for non-Eurozone countries.

42

• Non-Eurozone countries should be fully engaged in the cre-ation of a new mechanism to monitor and correct gaps in competitiveness.

• Treaty articles or a separate single market protocol should state clearly that the internal market remains the EU’s key achievement and takes precedence over all other elements of economic policy.

• A monitoring mechanism should be created to assess impact of further Eurozone integration on broader EU cohesion. The European Commission should be asked to report regularly on the issue.

• Impact assessment, determining the impact of new mea-sures on the non-Eurozone countries, should accompany all decisions on further integration of the Eurozone.

• Non-Eurozone countries should be in the position to revert a matter of concern to the European Council in case they believe it might be disproportionate or discriminatory.

• Eurozone countries should undertake a commitment to en-sure full transparency of their discussions about the future of the Eurozone governance system and any changes to the existing institutional architecture.

In order to confirm this new type of understanding between the Eurozone and non-Eurozone countries, a “Code of Con-duct” should be concluded to make sure all sensitive issues are addressed in a constructive and well-intentioned manner. It should contain safeguards, sought by the UK and Poland alike, to address the risk that a more closely integrated Eu-rozone could impose its terms on non-euro members26. The “Code of Conduct” would build a common denominator be-tween the Eurozone and non-Eurozone countries and provide a permanent arrangement to withstand possible sources of tension in the future.

43

A permissive spirit should characterise the approach of non-Eurozone countries to the question of shaping their relationship with the common currency area. They should refrain from pos-tulating measures that would make further integration of the Eurozone impossible. In turn, the Eurozone countries should undertake a commitment never to discriminate openly or tacitly against the non-Eurozone countries.

The relationship between the “ins” and “outs” of the com-mon currency area could either be shaped by events, as was the case during the crisis, or it could be organised in a syste-matic fashion with clear procedures and rules of the game. The experience of the crisis shows that ad hoc response carries with it the risk of new dividing lines within the EU and burden-ing further the process of Eurozone reconstruction. It would be mutually benefi cial if a clear framework was established for the relationship with agreed principles and transparent chan-nels of communication.

The UK and Poland have a special role to play in the for-ging of this relationship. They have different perspectives on the nature of their ties with the common currency area, with the UK ruling out membership and Poland retaining its commitment to join. They share a joint interest, how-ever, in making sure that the Eurozone’s future is built in a fashion which is symbiotic to the development of the EU as a whole. The UK and Poland should consult closely on each new aspect of Eurozone integration. They should also put forward joint initiatives on ways of ensuring the great-est possible degree of inclusiveness of the new arrange-ments. They ought to jointly put forward the message that a mutually supportive relationship between the Eurozone and non-Eurozone countries will be a vital reflection of the success of EU reform.

26 See Written evidence from Open Europe to the Foreign Affairs Committee, “The UK must revise its membership to save it”, 22 May 2012

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