Can Europe Hold Together?

Remember disenchanted voters in towns “where the factories had closed their doors leaving behind only wasteland,” in a Euroskeptic heartland which “is the principal victim of unemployment, exclusion, and poverty,” “abandoned,” “fearful of the future,” and determined to derail the process of European integration?

No, those were not the Leave voters in the UK’s Brexit referendum in 2016. Instead, the quotes come from the French press in the aftermath of the country’s 1992 referendum, in which a narrow majority of French voters approved the Maastricht Treaty, which laid down much of the current shape of European institutions, including the EU’s common currency, the Euro. The ratification of the treaty proved hugely controversial in the United Kingdom, where the generation of “Maastricht Rebels” provided the initial ferment for a Euroskeptic movement that would eventually lead the country out of the EU. In Denmark, meanwhile, voters initially rejected the treaty in a referendum, forcing the government to negotiate a number of formal “opt-outs,” most prominently from the country’s membership in the Eurozone.

Clearly, the French referendum’s divide between the educated, professional avant-garde of “chic neighborhoods” and the working classes foreshadowed the turbulence that defined much of political life in the West over the past decade. However, the tale of the Maastricht Treaty and of the resistance it engendered in a number of European countries not only gives the early flavor of political realignments that became apparent much later, but it also exposes a perennial flaw of the European project: the mismatch between its potentially unbounded ambitions and the relatively modest set of tools at its disposal.

A European Federal Order or a European Project?

The tension between more and less expansive understandings of European integration dates back to the 1940s and the 1950s. For classical liberal federalists, such as Friedrich Hayek and Wilhelm Röpke, the point of common European institutions was to restrain nation states from their destructive nationalist and protectionist excesses—not to pursue state-building on a European scale. Likewise, for Christian democrats informed by the idea of subsidiarity, European integration was about recreating a more organic form of political organization that had characterized Europe prior to the consolidation of oppressive, centralized nation-states in the 19th century.

In contrast, others among the EU’s founding fathers saw their efforts as part of history’s “jump from the Nation to Humanity,“ as France’s maverick philosopher Alexandre Kojève put it in characteristically Hegelian terms which saw integration as a corollary of unstoppable forces of historic progress. Together with the dark shadows cast by the two world wars and the excesses of nationalism that had ravaged the continent, the idea of a top-down European technocracy chimed well with the scientifically minded progressive meliorism of the era, epitomized by the New Deal in the United States and the Beveridge Report in the UK, which provided a seemingly appealing alternative to Soviet communism as well as laissez-faire liberalism.

Yet, in a world in which Europe’s nation-states were nowhere near ready to retire from the stage, the latter, hyperambitious view of political integration was bound to produce unintended consequences. Already in the 1950s, the early attempt to build a defense union (EDC) between European countries, rejected by the French in 1954, made it apparent that utopias were not on offer. But if head-on political union, or a United States of Europe, was not feasible, pioneers of European integration concluded that a similar set of outcomes could be arrived at gradually, by first fostering economic ties, which would then feed an ongoing cycle of political integration, “establishing de facto solidarity, from which a federation would gradually emerge,” as Jean Monnet articulated it. The common European state would emerge not out of discrete political choices but rather out of necessity, as Europe’s institutions continued to bump against new realities, leading to an eventual completion of those institutions.

The salami-slicing method of integration proceeded through a series of discrete leaps into the dark: the Paris Treaty of 1951, the Rome Treaty of 1957, rulings of the European Court of Justice such as the 1964 Costa v. ENEL which sought to establish the supremacy of European law over national one, the Hague Summit of 1969 which led to the accession of Denmark, the UK, and Ireland, and the Single European Act which consolidated Europe’s burgeoning single market and gave the European Commission a host of new powers.

Contrary to Monnet’s vision, however, this form of integration never became a one-way street. Through the Luxembourg Compromise of 1966, for example, it became accepted that sensitive common decisions would be made by unanimity of member states—affirming thus the status of European Communities as a free association of countries, not as a novel source of political authority. Attempts at monetary integration made in the 1970s (the snake in the tunnel system) and the 1980s (the European Monetary System) fell apart instead of providing firm ground for tighter unity.

Ideology Trumps Economics

The Maastricht Treaty of 1992 came against the background of a sense of stagnation of the integration efforts as well as the collapse of communism and the reunification of Germany, which was received with a degree of nervousness in Paris. By committing member countries to monetary unification after a series of failed experiments with fixed exchange rates, it represented a dramatic doubling down on the bicycle view of European integration as a project that needed to be constantly propelled forward, lest it collapses. While, according to Ashoka Mody’s excellent account of the Euro’s emergence and its subsequent tribulations, no evidence exists for an explicit bargain between France and Germany through which the common European currency would emerge in exchange for France’s acquiescence to a bigger and stronger Germany, it is perfectly plausible, likely even, that French and German policymakers followed that reasoning tacitly, with the understanding that a successful monetary union and a “parity” between the franc and the mark, had long been a goal of successive French governments.

The decision to replace national currencies with the Euro defied warnings of economists across the ideological spectrum, from Milton Friedman to Paul Krugman. The overarching political imperative of moving the integration project forward after a long hiatus in the 1970s and the 1980s encouraged a form of groupthink among Europe’s leaders and representatives of European institutions. Illustrated by the Commission’s influential document, One Market, One Money, the EU’s officialdom vastly overstated the economic benefits of a single currency. Whereas available evidence suggested that fixed exchange rates or a single currency would have a negligible effect on cross-border trade and investment, the official narrative was keen to sell the Euro as a logical and necessary complement to the EU’s efforts at dismantling non-tariff barriers to trade. Behind the façade of perfunctory economic arguments about reducing exchange rate risks and transaction costs, stimulating competition, and deepening of Europe’s financial markets, which were advanced by the Euro’s advocates, the common currency was primarily a project intended to catalyze deeper political integration.

Those who had not accepted the premise of a European political union as a self-evidently desirable end goal were left unconvinced. Already in 1992, sixty-two German economists wrote an open letter criticizing the “lax” character of criteria for membership and the “overhasty” introduction of the Euro. In 1998, 155 German economists pleaded for a delay in light of the unsatisfactory progress in terms of economic convergence and fiscal and financial stability. The stern response from European institutions noted that the introduction of the Euro was “totally irreversible.” Presciently, Harvard University’s Martin Feldstein wrote in 1997 that the Euro, which could lead to “a much more centralized determination of what are currently nationally determined economic and social policies,” is “often advocated as a way to reduce conflict within Europe.” However, he predicted, “it may well have the opposite effect. Uniform monetary policy and inflexible exchange rates will create conflicts whenever cyclical conditions differ among the member countries. Imposing a single foreign and military policy on countries with very different national traditions and geographic circumstances will exacerbate these economic conflicts.”

The common currency has not become a steppingstone towards a European superstate, and neither has it ushered in a new age of European solidarity. If anything, it has made the EU’s operation, as the bloc has sought to address new frictions resulting from the single currency, more intergovernmental and more ad hoc than before.

Hubris and Nemesis

Introducing a common European currency into vastly different economies, without a substantial degree of labor market integration, price and wage flexibility, or fiscal transfers was bound to be a source of macroeconomic instability. Yet, the Euro’s founders were explicit in following Monnet’s gradualist prescription of making partial advances in the direction of more integration whenever possible, with the expectation that they would encourage even more integration in the future. According to the logic of “ever-closer union,” the absence of conditions that would normally make a monetary union or a system of fixed exchange rates viable only meant that the common currency would sooner or later create a pressure to set up appropriate fiscal structures or to pursue structural reforms.

To placate the skeptics, particularly in Germany, where the public was understandably concerned about a return of inflation and the risk of fiscal profligacy at the periphery, the Euro’s architects emulated the example of the Bundesbank in their design of the European Central Bank (ECB). Compared to other central banks, the ECB is meticulously insulated from any political scrutiny, its mandate prioritizes price stability over employment and growth, and its headquarters are in Frankfurt.

Furthermore, the Maastricht Treaty included an explicit no-bailout clause (Article 125) and laid down rules guiding sound administration of public finances at the national level (Article 126). The so-called Stability and Growth Pact committed countries to keep their budget deficits below 3 percent of GDP, their debt levels below 60 percent of GDP, and—in the case of exceeding the debt limit—to the pursuit of effective debt reduction policies.

The rules were deeply flawed. For one, they lacked credible enforcement mechanisms and from the outset, they were ignored by influential member states, including France and Germany. The Greek government famously cooked the books in order to qualify for membership. More fundamentally, however, the fiscal rules were inherently destabilizing by being procyclical. Instead of encouraging deficit reduction in good economic times and deficit spending in bad economic times, as normal economic logic would suggest, they did the exact opposite. Countries facing temporary economic slumps had to cut their deficit-financed spending to meet the deficit and debt-level targets, thus deepening their initial recessions. Countries that happened to enjoy temporarily high rates of economic growth, meanwhile, enjoyed the leeway to spend more instead of using fiscal policy in a countercyclical fashion and build resilience for the bad times.

To date, the Maastricht Treaty’s creation of a common European currency has been the last of the grand Monnet-style leaps forward into the dark, eclipsing in its significance any institutional changes made through the adoption of the subsequent treaties of Amsterdam, Nice, and Lisbon. The Euro amplified interdependency between European economies and the downside risks of financial shocks without creating an institutional framework for managing such risks. Unsurprisingly, following its introduction, the borrowing costs on the Eurozone’s periphery declined, leading both to an investment exuberance in the private sector exemplified by Spain’s real estate bubble and to the unsustainable expansion of public-sector entitlements in countries such as Greece.

When the 2008 crisis arrived on Europe’s shores, it became apparent that a chaotic sovereign default or a country’s crashing out of the Eurozone could have wide ramifications for the EU’s economy, far dwarfing the effects of the collapse of Lehman Brothers in the United States. Emergency financing to governments in distress, most prominently to Greece, was quickly approved, followed by the creation of more permanent rescue funds (the EFSF and, later, the ESM). The ECB took on a significant portion of the firefighting, especially after its President Mario Draghi famously vowed to do “whatever it takes” to keep the Eurozone together. In practice, the “whatever” entailed massive purchases by the ECB of government bonds, particularly of governments that faced high financing costs due to their insolvency.

At no point in the crisis did Monnet’s logic assert itself. No Hamiltonian grand bargain to create a fiscal union emerged out of the turbulent years of the early 2010s. Decisions over bailouts, the ESM, and the Fiscal Compact, an arrangement superseding the original Stability and Growth Pact, were strictly intergovernmental, relying on the institution of “enhanced cooperation” introduced by the Lisbon Treaty, which enables coalitions of countries to pursue joint integration efforts without necessarily implicating the entire EU. Unlike the simplistic Stability and Growth Pact, the new rules guiding acceptable levels of deficit and debt depend on economic circumstances and underlying debt dynamics. While intergovernmental in nature, the new system’s complexity accords a prominent role over national fiscal decisions to experts at European institutions, who themselves are concerned about the risks of further proliferation of complicated fiscal rules.

Such fixes, together with the ECB’s asset purchase programs aimed at keeping the periphery’s borrowing costs under control, were just enough for the Eurozone to muddle through unscathed. The combination of strict conditionalities needed to get around the “no-bailout” clause of the Lisbon Treaty and the understandable fear of the Eurozone’s core governments that they would be on the hook for the profligacy of the periphery has also combined the worst of all worlds. Voters in “frugal” countries see themselves as forced to acquiesce to non-transparent bailouts of distressed countries, oftentimes done through the back door—lest, they are told, the entire EU collapse. Voters on the periphery, in turn, see their democracies as constrained by opaque international bodies signing off on their national budgets and looking over the shoulders of their leaders.

Europe after Utopia

The hubris of the Maastricht Treaty is bound to cast a long shadow on European politics. The Euro remains a fact of Europe’s political and economic life—in part because few can offer appealing accounts of how monetary unions can be undone in an orderly fashion. However, systemic risk and recurrence of existential crises of the early 2010s can be reduced by breaking the nexus between sovereign borrowing and national banking systems. In other words, more than dreams of a fiscal union the Eurozone would be helped by completing a real single market in banking and financial services.

Whether such a banking union can be completed or not, it is abundantly clear that the Euro’s and the Maastricht Treaty’s ultimate ambitions remain out of reach. The common currency has not become a steppingstone towards a European superstate, and neither has it ushered in a new age of European solidarity. If anything, it has made the EU’s operation, as the bloc has sought to address new frictions resulting from the single currency, more intergovernmental and more ad hoc than before.

That’s bad news for those still committed to the idea of the European project as a state-building exercise. It is, however, good news for those critics of the EU who feared that arbitrary powers of unaccountable bureaucracies would eventually come to dominate Europe’s political landscapes at the expense of elected national governments. And just as the solutions to the Eurozone crisis were fundamentally intergovernmental rather than spearheaded by European institutions, so were the responses to other shocks that hit the EU over the past decade, such as the refugee crisis of 2015 or the geopolitical challenges that have arisen in the EU’s neighborhood. Even with the window of opportunity created by the pandemic, there has been little appetite to keep the integration machine moving forward to create a qualitatively new European polity superseding the EU as a free association of nation-states.

The downside of the status quo, of course, is that, as a result of decades of utopian efforts at European unity culminating in some ways with the Lisbon Treaty, the EU displays a number of state-like features and ambitions—most prominently the common currency but also pretensions at “strategic autonomy” in the area of defense and foreign policy. If the addiction to ever-closer union seems to be breaking, it remains unclear what, if anything, will replace it. One can imagine a hollowing out and institutional decay, or an unmitigated unravelling with member states rushing to the exit. Alternatively, could a renewed commitment of the European project to the core principles advocated by the Christian democrats and classical liberals among its founders be possible?

Arguably, the cause of Europe’s freedom and prosperity would be best served by the last option, reinventing the EU as a platform geared toward managing Europe’s inherent diversity and channeling it toward productive uses. Doing so requires returning mentally, if not institutionally, to the Europe prior to Maastricht. It was, after all, the Maastricht Treaty that enshrined the integration project as one European Union, in contrast to its previous, pluralist character as European Communities. In reality, the EU continues to be a multitude of integration projects running in parallel, with slightly different and only partly overlapping constituencies, rather than a political monolith that the more ambitious among its founders envisaged. In practical terms, embracing this pluralism requires the EU to make full use of its institution of “enhanced cooperation” instead of insisting on single, one-size-fits-all solutions to all European problems. Whether European officialdom can change its habits of mind and heart, shaped by decades of a deep belief in “ever-closer union,” remains an open question.