EU financial reform and new opportunities for European integration.

• Author: Longo, Michael

ABSTRACT

To the extent that the European Union (EU) financial system is subject to structural deficiencies and constitutional challenges which render it less than optimal, the Global Financial Crisis (GFC) has brought those deficiencies squarely into view and issued the challenge for institutional reform to overcome them. While the coming into force of the Treaty of Lisbon will potentially smooth the path to further European integration and enable the new President of the EU and EU 'Foreign Minister' to communicate and pursue EU interests more vigorously, there is a need for greater fiscal power to be assigned to the EU level of governance to complement other reforms.

Introduction

1. The EU in the Global Picture

   The international regulation of financial markers--and banking in particular--presents important challenges for public authorities as globalisation increasingly strips away the capacity of national authorities to exercise effective regulatory control and oversight over those markets. Market intervention in the form of regulation serves numerous policy objectives, from consumer protection against opportunistic behaviour by suppliers of financial products and services to guaranteeing lending for activities regarded as beneficial to the economy, or society as a whole. While the arguments for and against market intervention languished for many years in a listless ideological discourse--apparently sidelined by the realities of rapidly expanding wealth--it was the shock of the Global Financial Crisis (GFC) that ultimately prompted action. It was the urgent need to avert further dangerous 'spill over' from one failed institution to another, to prevent systematic failure and to restore stability that informed the regulatory debates and motivated the unprecedented governmental action following the GFC. The debates surrounding public finances--the fiscal system and its functions of allocating, redistributing and stabilising resources--are only in part economic. The economic debates often mask political and legal disagreement, which demonstrates the dialectic between economics, politics and law. (1) This is nowhere more apparent than in the European Union (EU) where the GFC and the European debt crisis have exposed the inadequacy of national responses and the need to better locate political responsibility for economic problems.

   There is general agreement on the reasons for the financial crisis, (2) although views differ on what or who is to blame. A commonly held view is that the fundamental cause is the under-supervised capitalism that has flourished in the United States and elsewhere. A core premise of this argument is that the regulatory system put in place as a result of the great depression of the 1930s had been unsustainable' eroded by massive changes to political, social and legal environments spearheaded by state withdrawal from the economy, a pronounced shift in income distribution towards profits, a decline in the influence of trade unions and a weakening of legal regulation in favour of codes of conduct and self-regulation (3) that made excessive risk taking in financial markets commonplace.

   Not everyone would agree. Whatever views may be held privately by EU leaders, the Commission accepted the Report of 25 February 2009 of a high level group headed by former Bank of France Governor Jacques de Larosiere, in which the authors identified the main causes of the financial crisis as macroeconomic causes, risk management, credit rating agencies, corporate governance, regulatory and supervisory failures and global institutional weakness. (4) It is telling, perhaps, that the EU's preferred solution was to focus on tougher regulation and treatment of offshore tax havens and firm control of hedge funds, while the United States emphasised large stimulus packages. (5) Even if there was significant disagreement on policy priorities for reform, (6) the major players publicly acknowledged the importance of reaching global consensus from the first G20 London Summit on 2 April 2009 to the Pittsburgh meeting on 24-25 September 2009.

   The significant financial contagion experienced due to the interconnectedness of financial markets around the world has driven governments to adopt a suite of reforms to build institutions and to strengthen global regulatory frameworks. The focus on correcting regulatory and supervisory failure assumes both rational and moral superiority of the argument that inadequate regulation is indeed a major cause of the GFC. Given the acceptance of much of the EU reform agenda numerous questions arise. Will the reforms be sufficient to meet current and future challenges? If not, what else is required? What means will there be to achieve EU fiscal objectives? Certainly, the EU financial system is characterised by numerous institutional and policy constraints. The financial system features 'largely national based supervisors [in] a highly integrated financial sector with numerous cross border financial institutions'. (7) The system comprises member state fiscal systems which coordinate their fiscal policies to achieve common objectives in economic and monetary policy under the supervision of EU institutions, Though there is a single market and a single currency in the eurozone, which have necessitated the conferral of real powers to EU institutions In these and related fields, EU fiscal competence is limited. In the event of shocks such as the GFC, the EU's fiscal policies are jeopardised as deficits and public debt blow out, increasing the prospect of departure from the common rules, differentiated policy responses among the member states and disruption of the integration process.

   To the extent that the EU financial system is subject to similar underlying structural problems that have required reform of global financial systems--fragmented regulatory and supervisory structures--the GFC has highlighted the need for financial system reform and further European integration in key policy areas. However, there are many disparate voices in the EU, there is no accepted view on what the EU is or what it should become, there is a continuing crisis of identity and the EU's legitimacy is often under challenge--all of which place real limits on EU policy making. This, coupled with political uncertainty as to where the mandate for action lies, real deficiencies in resources, and a financial system that can charitably be described as incomplete, finds the EU poorly equipped to tackle financial and economic shocks.

   External shocks can promote soul-searching and often present stark choices. System failure, or sometimes the mere threat of system failure, alludes to the inevitability of change. The soul-searching of citizens in Iceland regarding membership of the EU and the second Irish vote in favour of the Lisbon Treaty are to some extent the consequence of fear--fear of being left alone in an indifferent world. Financial and economic crises may potentially generate a new wave of integration in Europe as citizens come to realise that their national institutions are incapable of dealing with global economic shocks.

   European integration may be viewed on one level as a policy response to major external and Internal events. The fall of the Berlin Wall and the end of the Cold War are often associated with the 'Maastricht' phase of integration, including the final adoption of the single currency in the eurozone and enlargement. These European political events of global proportions presented a very real and alternative vision of a united Europe which EU member states quickly capitalised on. The events precipitated further change in an emerging European polity, which is ever willing to reform itself by adding new pieces to the European puzzle and whose very existence is testimony to a spirit of innovation. The desire to maintain or enhance its economic and political position in a changing world order has always informed EU strategies towards integration. EU policy-makers have usually acted decisively to take-advantage of opportunities that have arisen in the pas.

   However, the EU has for some time been labouring to implement its vision in the face of wide-spread dissatisfaction among the citizenry. This is manifest both in public opinion polls and recent rejections of proposals in referendums in Ireland, France and the Netherlands. Indeed the citizens' failure to endorse further integration represents both a direct and indirect obstacle to further integration. Direct, because citizens who are constitutionally required to vote on referendum proposals are more likely to vote against their adoption; indirect because national institutions are more likely to withhold support for EU initiatives in response to negative public sentiment in order to preserve and sometimes shore up their own support. At the same time, the need for further integration is intensified by the reduced capacity of the member states to undertake decisive and effective fiscal action at the national level. The new financial landscape poses risks and opportunities for further European integration and invokes a discourse having clear constitutional dimensions.

   1. EU Responses to the GFC

1. Institutional and Policy Constraints

   Initial government responses to the GFC were focused primarily on domestic solutions. There was little coordination between major economies--even within the EU--a patently inadequate solution in the face of a globalised and interdependent world.

   The EU is incapable of dealing with the GFC and its aftermath on its own. The EU does not have a clear capacity for redistribution or significant powers of taxation and spending, (8) Instead, the EU is subject to significant budgetary restrictions and low financial autonomy. The EU has, as noted by Nugent, '... only 1.01 per cent of the total Gross National Income (GNI) of the member states and about 2.5 per cent of their total public expenditure." (9) The EU is further subject to a...