19 March 2013

Underhill & Blom: The case for policy change - Democratic legitimacy of EMU cannot be an afterthought in solving the crisis

Despite the achievable benefits of both EMU and financial openness, the underlying legitimacy of the crisis resolution process – or of post-crisis global financial integration in general, for that matter – has improved little over time. Reform that is more likely to provide stability in the future requires a departure from the idea-set underpinning the contemporary market-based financial order. Reform also requires considerable institutional innovation and institutionalised attention to the political legitimacy and long-run sustainability of (financial) openness in the EU. To achieve this, the policy process should be reformed to include a wider range of stakeholders, to reduce financial-sector influence, and to deepen the argument pool. The deliberative process and level of accountability for outcomes must be improved as well. Without policy ‘ownership’ by the countries undergoing adjustment and diffuse support among the population, crisis resolution and reform measures will prove politically unsustainable. Crucially, these democratic reforms should occur simultaneously with a shift towards more effective financial governance...

As the IMF has already learned from its experience with structural reforms (IMF 2007), successful implementation of the troika’s policies remains doubtful if deficit economies cannot draw on deep-seated domestic support and in turn perceive debtor and creditor obligations as balanced and fair. To this end, eurozone governments need to recognise the importance of providing the required ‘policy space’ to respond to domestic social and political imperatives by enhancing the ‘room to move’ for debtor-state governments. Success also involves rebalancing the obligations of debtors and creditors: both the positive and the more negative results of capital mobility are collectively produced through market interaction, so outcomes must be collectively owned and burdens must be shared by public and private debtors and creditors alike. This harks back to the principles of Keynes’ ‘Clearing Union’ proposal: imbalances are a joint problem to be resolved through simultaneous and required adjustment by both surplus and deficit countries.

Successful crisis resolution also requires thinking about whose interests are protected by the current crisis-workout process, who pays the costs of adjustment, and whose interests should be primary to the functioning of integrated financial markets in the eurozone. This reflection opens the door to effective consensus-building for the reform of eurozone governance. It cannot be that eurozone citizens in surplus and deficit economies alike are called upon to provide taxpayer guarantees for the indiscretions of private lenders (in whose lending decisions ordinary people played little part) while those in deficit economies bear a disproportionate share of the adjustment burden. In practice, the eurozone has turned out to be rather efficient at saving banks, but the mandate of the ECB excludes saving the citizen guarantors of the system should their own state’s resources become exhausted. The burden of adjustment falls on the weaker, developing and deficit economies that already benefit less from the system of capital mobility and exchange-rate stability than the more advanced economies. This context potentially undermines the ability of states to cooperate in order to sustain liberal finance at all.

This means that the range of stakeholder inputs into policy design needs to be broadened so as to produce more effective, legitimate, and balanced policy outcomes in the future. Unless the influences on policy decisions are to change, ineffective policy is likely to prevail...

The voice in policymaking of the users of financial services should be increased, from small and medium-sized enterprises to pension funds and their labour-market constituency, to depositors and to savers. These constituencies currently have little say in the making of policy yet are all significantly affected by the decisions taken, especially when crisis hits. An institutionalised system of ‘corporatist’ representation of stakeholders could bring the interests of these constituencies to bear on financial supervision and regulation and the distribution of the burdens of adjustment. Technical forums such as the Basel Committee on Banking Supervision should be actively required to solicit a prescribed range of stakeholder responses leading to real policy inputs. Moreover, the transparency and accountability of the process that translates global regulations into EU directives should be improved.

This involves formalising two elements of an ‘accountability phase’ in the policy process:

• Accountability for how the input side of the policy process has functioned and whose preferences constituted inputs into policy;
• Accountability for actual outcomes achieved.

The first involves full transparency on the involvement of lobbyists and social partners, allowing agencies and parliamentarians to judge whether an adequate balance among stakeholder interests was involved in technical forums. The second involves holding public-sector agencies and private financial institutions accountable for outcomes achieved in terms of financial stability and balanced real-economy growth. As the EU develops ever more intrusive fiscal and financial mechanisms the role of the European Parliament should become ever more central too. The more that EU supervisory coordination is strengthened under the new ‘Single Supervisory Mechanism’, the more that home-host responsibilities need to be clearly defined – especially when it comes to the sharing of costs when things go wrong. Until questions in banking supervision/resolution and in macroeconomic adjustment of public-private sector burden sharing and eurozone distribution have been properly tackled in a way that is supported by EU citizens, the monetary union will not function.

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