CHAPTER 1

Euro Zone: Can Euro-economics Survive Euro-politics?

Antonio Barroso

INTRODUCTION

As the euro zone enters its third year of turmoil, it has become ever more obvious that politics, not economics, is driving the current uncertainty. Think of the euro crisis as a disease. Last year, the patient survived an acute crisis. At the moment, it feels more like he is suffering from a chronic condition. But the potential for a full-blown crisis still exists, and political radicalization could become a primary source of infection.

In coming months, governments in peripheral countries will struggle to implement new austerity measures, and their populations will continue to suffer the pain of spending cuts and rising unemployment. Pressure will build on politicians to veer off the reformist path prescribed by European institutions (mostly the European Commission and the European Central Bank), other euro zone states (mostly Germany) and the markets. Simultaneously, leaders in core countries will face criticism at home for financing weaker countries. The next two years are likely to provide the most fertile ground for populism that the European Union has ever experienced.

How governments and political parties respond to this challenge will determine the future not only of the common currency but of the entire European project. Political scientists frequently talk about “critical junctures,” or short periods in history where there is a high probability that the institutions that have shaped political systems (like political party systems) are modified. Looking at the current course of events, the euro crisis could well constitute one of those moments that undermine the political foundations of European democracies for years to come, and not necessarily for the better.

THE INCUMBENCY CURSE

The euro zone crisis is not a purely economic or a purely political problem: it is the interaction between the two that is dangerous. When things are going well in Europe (as in the decade preceding the Great Recession), good economics breed positive politics and stability. For now, that trend has reversed, creating a negative feedback loop: bad economics provokes fractious politics, which, in turn, exacerbates economic problems.

Nothing better illustrates this problem than the fate of incumbent governments since the start of the Great Recession. Since 2010, the crisis has claimed the heads of no fewer than six euro area premiers, either through elections (Greece, Ireland, Portugal, Spain, and France) or through technocratic arrangements reached under extreme market pressure (Italy). In the current context, newly elected prime ministers can count on just two things: (a) that their popularity will significantly decrease as they implement their policies and (b) that the probability of being reelected at the end of their terms will be extremely low. As Jean-Claude Juncker, chief of the Eurogroup, the euro area’s finance ministers, said in 2005: “We all know what to do; we just don’t know how to get re-elected after we’ve done it.”

Moreover, the incumbency curse does not seem to spare ideologies. A recent study by Josep Colomer and Pedro Magalhães of Georgetown University showed that governing parties of both the left and the right have lost elections in equal proportion since the crisis started. As the authors bluntly put it, the crisis is leading voters to show a strong willingness to “fire the coach” for the poor performance of their economies, even if citizens know that current governments are not fully responsible for the economic problems facing their countries. Voters are angry, and elections are their best opportunity to express that anger.

So far, incumbents in peripheral countries have reluctantly swallowed austerity prescriptions, knowing than the costs of inaction (i.e., being remembered as the prime minister that drove his or her country out of the euro) outweigh the costs of implementing unpopular policies (i.e., political suicide in the next election). Governments in Ireland, Portugal, and Spain are pushing for fiscal and economic reform programs that have been explicitly or implicitly imposed by European institutions. And the main opposition parties in these countries have remained relatively constructive in their criticism, though not necessarily supportive, of the policies of their rivals.

But the risk that populism will infect mainstream politics is rising, especially as bottom-up pressure continues to build. For instance, in Greece, the new conservative prime minister, Antonis Samaras, repeatedly refused to support the bailout program and forced early elections that subsequently led to political stalemate and a significant surge in the popularity of Syriza, a (then-small) leftist party that has campaigned against the rescue package, austerity, and the political status quo.

However, it is not just peripheral countries that are vulnerable to political radicalization. In France in 2012, the two main presidential candidates proposed policies that ranged from removing the country from the Schengen Agreement to establish tighter controls on illegal immigration to implementing a 75 percent tax rate on the highest-income earners. In the Netherlands, the government recently lost its majority in parliament when far-right leader Geert Wilders—a staunch advocate for leaving the euro—decided not to support further fiscal retrenchment, triggering early elections. The virus of populism is spreading, and very few countries seem immune to it.

REDISCOVERING GLOBALIZATION AND DEMOCRACY THE HARD WAY

The Great Recession is largely to blame for populism’s growing appeal. The crisis has made evident two realities of the current economic and political system in Europe. First is the rediscovery of globalization. Second is the realization that Europe’s democracies are more deeply flawed than previously believed. These hard truths provide an excellent opportunity for once-irrelevant parties to return to the forefront of their respective political systems.

Learning How the Economy Works

For the first time in more than a decade, many citizens (and probably several politicians) have learned bitter lessons about “the markets,” or more specifically, that their governments and banks depend on financing from creditors to continue operating. Because the lack of financing could lead to a sovereign default and increase the risk of a euro breakup, the response of the euro zone—fundamentally shaped by Germany—has been to force austerity in order to reduce budget deficits and regain the trust of investors. The recession has also provided a powerful reminder that European countries compete in a global economy and that uncompetitive economies are bound to suffer a difficult fate. Europe has opted for promoting the adoption of structural reforms in countries with competitiveness problems, often as a precondition for receiving crisis financing. This is coupled with market pressure, which core countries continue to think is the ultimate “discipline enforcer” for profligate peripheral economies.

Whatever the merits of this strategy, it has left governments with little room to maneuver at a time when economies are deteriorating and unemployment is rising to levels not seen in many years. Current euro zone dynamics are feeding the growing perception that governments are no longer masters of their economic destiny, especially in the peripheral countries. Worse still, their leaders are portrayed as “emissaries” of Brussels, Berlin, or “the markets.” The dynamics in core countries are not positive, either. Many voters do not want to provide support for (what they consider) fiscally reckless European states, and they blame unfair competition from emerging economies and uncontrolled immigration for the rise in unemployment. They see mainstream parties as “fifth columns” of globalization and as incapable of protecting workers.

Your Democracy Is Not as Strong as You Thought

The second hard reality is the realization by citizens that their political systems were—using Warren Buffett’s analogy about how crises tend to reveal the weakest market players—“naked swimmers.” In other words, the Great Recession has shown citizens that their democracies are more imperfect than they thought. Media have accentuated this perception with story after story on the privileges enjoyed by political and financial classes, on their corruption and incompetence, and on their impotence in the face of the current crisis. The banking crisis in Ireland is a prime example as the public learned of the lack of official control over banks’ lending practices and the lack of accountability of financial and policy-making elites.

Anger at the establishment has begun to spill into the streets. In Spain, the so-called indignant movement emerged in May 2011 with attacks on mainstream political parties for corruption, rescuing banks with public money, and accepting the tyranny of markets. Protesters demanded new electoral rules and legislative powers, and similar movements have since emerged in Greece and Portugal. These movements have reduced pressure for a presence in the streets, at least temporarily, but political officials know well that their reprieve will be tested with each new announcement of bad news.

The Great Recession is creating a crisis of faith in democracy itself, and distrust of political institutions in peripheral countries has become an all-too-common phenomenon. In Spain, a recent survey showed that trust in political parties is at 9 percent, an all-time low. Some 27 percent of Spaniards have faith in the trade unions, the local councils, and the supreme court; 23 percent express confidence in the current government; and just 16 percent trust the parliament. In Italy, only 7 percent trust political parties. The numbers do not look much better in other southern European countries.

Populism’s Moment?

Parties at the extremes of the political spectrum in peripheral countries are working hard to capitalize on these emerging realities. From a political economy point of view, the crisis provides them a window of opportunity to gain a prominence and an influence they have never had. Their strategies don’t vary much from one country to another: they blame mainstream political parties for creating the current mess and portray them as mere tools of moneyed interests.

In Ireland, for instance, Sinn Féin has drawn unprecedented levels of public support by attacking the E.U./IMF bailout and the Irish government’s decision to protect unsecured bondholders. In Greece, far-left and extreme-right parties—which refuse to implement the bailout and call for a hard default—achieved their best results ever in last June’s general election. In Portugal, the Communist Party and the Left Block have surged in opinion polls, in part by blaming government austerity policies for high unemployment and the problems of the Portuguese economy. In Italy, the recently created Five-Star Movement of Beppe Grillo took about 10 percent of the vote in participating provincial capitals in recent local elections (up from around 5 percent in the 2010 regional elections). Grillo—a professional comedian—has also based his campaign on outright rejection of austerity, the euro, and the political establishment.

But antiglobalization pressures are also generating political turbulence inside core countries. No European state better illustrates the effects of globalization on the political debate than France. The country’s budget deficit and public debt have increased considerably over the past three years, and competiveness has waned. Yet, not only did the lead candidates for president (Nicolas Sarkozy and François Hollande) avoid any discussion of structural reforms during the 2012 campaign, they aggressively pandered to the country’s angriest voters in a bid to siphon off support from increasingly popular parties of the far left and right. National Front leader Marine Le Pen—who calls for dumping the euro and tightening immigration controls—got the highest level of support among young voters, while Left Front candidate Jean-Luc Mélenchon—who wants to nationalize banks—won more than 11 percent of the overall vote. In Austria, the far-right Freedom Party (FPÖ) is currently the most popular party among young voters and has run neck-and-neck with the two governing parties—the conservative People’s Party (ÖVP) and the Social Democratic Party (SPÖ)—in 2012 opinion polls.

THREE CHALLENGES

Fortunately, there are mitigating factors, structural elements in place, that can limit the metastasis of radicalization. Political institutions are one of them: though academic evidence is mixed on the issue, electoral systems in countries such as France usually produce majoritarian outcomes that limit the consolidation of extremist political forces. In some countries, 15 percent of the vote can provide a fringe party with 15 percent of seats in parliament—and significant influence in that country’s governance. But while the far-right populist Le Pen won almost 18 percent of the vote in France’s 2012 presidential election, her party gained just two seats in the subsequent general elections, limiting the influence of the far right on the country’s policy agenda.

Second, mainstream political parties, which continue to play the leading part in European democracies, remain strongly committed to the euro, and, given the advantages the common currency provides and the fear of the unknown its demise might create, they are unlikely to shift their preferences anytime soon. In Portugal, the opposition Socialist Party, while denouncing the excessive austerity implemented by the government, is building its case for a comeback based on respect for the bailout terms while avoiding excessive austerity. The situation in Greece is acting as a “vaccine” for the political system; nobody wants to see the country on the brink of exiting the euro, and mainstream parties seem to share an implicit consensus about the need to maintain the maximum level of political stability. Thus, the ability of mainstream politicians to prevent a breakdown of their political systems should not be underestimated.

Third, social contestation in most peripheral countries tends to be nonviolent. Countries like Spain and Portugal are posting the highest unemployment numbers of their recent history (around 24 percent and 15 percent respectively), yet strikes and demonstrations remain mainly peaceful. And while austerity and structural reforms are unpopular, a majority of the population in these countries seems to accept with resignation the need for fundamental changes to their economies. A recent opinion survey showed that when asked who is to blame for the current economic situation, 87 percent of Greeks mentioned the government and 42 percent placed responsibility on “themselves.” Just 39 percent mentioned the banks and 19 percent the European Union as the main culprits of the crisis.

All that said, passive resignation will not last forever. The potential for radicalization will continue to rise as long as the recovery falters. If the economic situation deteriorates further, there are three challenges that will determine whether the rise of populism is contained or whether it erupts, effectively jeopardizing the success of the euro zone’s crisis-resolution strategy and the survival of the European project itself.

Selling Austerity and Reforms

The first challenge: Can incumbent governments in peripheral countries combine fiscal austerity with social equity in order to limit the degree of backlash against reforms? History shows that austerity programs need not always damage the elected officials who impose them. Sizable fiscal adjustments can be implemented in ways that inspire public confidence in their government’s sense of fairness. For this to happen, prime ministers must address voters with uncharacteristic frankness to make clear why difficult choices must be made and what rewards they can realistically expect in exchange for another round of belt-tightening. To earn public trust, they must prove they are worthy of that trust—not simply to protect their personal political fortunes but to restore confidence in their countries’ governing institutions.

Moreover, while the current crisis provides an extraordinary opportunity to correct the imbalances and inefficiencies that have created Europe’s problems, political officials too often opt for the logic of urgency rather than efficiency. For instance, instead of streamlining the provision of public services to help them more effectively meet the public’s needs by reducing waste, governments are justifying cuts and the decrease in the quality of services as the fastest way to cut costs and appease foreign investors. In addition, seemingly haphazard across-the-board spending cuts allow citizens to believe that government is not asking those in various income groups to share the pain and responsibilities of restoring ailing economies to health in a fair way, pitting one socioeconomic group against another—and, perhaps, all against the government.

Most importantly, politicians implementing adjustments need to provide a credible long-term reform narrative that voters can understand and accept. Governments in peripheral countries have so far tended to emphasize the temporary nature of the crisis, implying that adjustments are only provisional and that “the rain will soon stop.” This tactic encourages citizens to limit their patience, exacerbates the potential for public frustration, and intensifies the risk for an outburst of public anger. Politicians must build a long-term vision of their political projects and explain clearly to voters that the benefits of the current hardship are not likely to manifest themselves in the short term, but that hard choices are necessary for the sustainable recovery of their economies. Given that the leaders’ chances for reelection are limited, voters are more likely to punish consistent policy making less severely than they punish unfulfilled promises.

Finding a Way for European Social Democracy

The second challenge: Can mainstream opposition forces avoid pressures from the left side of the electorate and implement conventional economic policies? Most social democratic parties in euro zone countries are currently in the opposition, and they continue to internally debate how best to provide a different response to the crisis. As discontent mounts, they have a strong incentive to capitalize on existing frustration with economic policies (especially when some of them were kicked out of power for implementing similar measures). They are also under increased pressure from extreme-left political parties that have captured support from some disenchanted—mostly young—social democratic voters.

However, feeding the impression that they will apply a radically different economic policy if elected will only increase the level of disappointment once they return to power. If, for example, French president François Hollande is forced to implement harsher austerity policies than he anticipated in order to respect the country’s deficit commitments, he will face a backlash from core supporters. This could increase the appeal of extreme-left parties—as we see with Syriza in Greece—and increase the potential for the further fragmentation of political party systems in European countries.

Explaining Europe

The last, but not least, significant challenge: Europe—and particularly Germany—will soon face a moment of truth. Last June, the European Council officially kicked off a process designed to lead the European Union to further economic and political integration. Specifically, member states agreed to initiate work on creating more integrated frameworks for the financial sector, fiscal policy, economic policy, and democratic decision making. These might entail a leap that the union has never dared to take before: real economic and political integration. As a result, member states will likely have to negotiate a new treaty, one that entails a significant transfer of sovereignty from individual European countries to the supranational level. This will also probably require constitutional amendments—and, in some cases, referenda—in certain states. European leaders may take care to explain why more integration is needed in order to mobilize not only large coalitions in parliament but, most importantly, their electorates. Failure to do so will likely produce institutional stalemate and significantly heighten risk of a full-blown crisis.

But beyond the procedural issues, E.U. countries must face their fundamental fears about the European project. In core countries, this will entail explaining to voters—maybe for the first time in the history of European integration—why it is necessary to safeguard the integrity of the common currency, why the benefits of the euro outweigh the costs of undoing it, and, most importantly, why European integration is essential for the economic stability of their countries.

If Europe’s leaders fail, they may lose more than the common currency. They risk unraveling the entire European project.