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The Eurozone Crisis: a Crisis of Democracy? An analysis of the effects of crisis policy and governance on democracy in the European Union

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The Eurozone Crisis: a Crisis of Democracy?

An analysis of the effects of crisis policy and governance on democracy

in the European Union

MA Thesis in European Studies Graduate School of Humanities University of Amsterdam

Main Supervisor: Dr. P.W. Zuidhof Second Supervisor: Dr. C.L. van Leeuwen

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I think the way we do politics is changing fundamentally. We are no longer in a paternalistic society, we are no longer in a trust-me society (…) we are in a show-me society, where citizens say to politicians: show me that you deserve my trust, show me that you are worthy of acting upon my democratic vote (First Vice-President of the European Commission Frans Timmermans, 2017).

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Only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable (Milton Friedman, 1982)

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Trapped in a limbo between a confederal and federal system, the EU is sacrificing democratic legitimacy and effectiveness (Andrew Duff, 2015)

                             

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Table of contents

Introduction 4

1. Theorizing European economic integration 8

1.1 A brief history of European economic integration 8

1.2 Grand theories of European integration 14

1.2.1 Supranationalism 14

1.2.2 Neofunctionalism 15

1.2.3 Intergovernmentalism 18

1.2.4 Liberal intergovernmentalism 19

1.3 Conclusion 20

2. The Eurozone crisis – Narratives, policymaking and theoretical lenses 22

2.1 Roots 22

2.1.1 The efficient market paradigm 24

2.1.2 Macroeconomic imbalances in the Economic and Monetary Union 26 2.1.3 Combining the narratives 28

2.2 EU Policy responses 28

2.3 Affected governance and policies? 31

2.3.1 The neofunctionalist lens 33

2.3.2 The liberal intergovernmental lens 36

2.4 Conclusion 39

3. The problem of democracy against the backdrop of the Eurozone crisis 42

3.1 Democracy and the European project 42

3.2 The concept of neoliberalism 45

3.3 Neoliberalism as a third lens to the crisis 47

3.4 Authoritarian neoliberalism and the erosion of democracy 51

3.5 Conclusion 54

4. EU crisis policies: an empirical analysis 57

4.1 The ESM 57

4.2 The Banking Union 61

4.3 Outright Monetary Transactions / Quantitative Easing 64

4.4 Conclusion 67

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Introduction

For the past few years, the image of the European Union seems to have been undergoing a change, specifically in the eyes of its citizens. The rise of populism, unexpected outcomes of referenda on important integration topics such as the association agreement with Ukraine and ultimately the unanticipated Brexit, are proof of that changed image of, and growing negative attitude towards the European project.

Whether this augmenting negative perception is deserved, is debatable. The European Union has since its establishment known alternating periods of Euroscepticism and Europhilia, mostly influenced by either times of economic crisis or prosperity. Commonly perceived reasons for Euroscepticism include: the lack of democracy within European institutions; the EU’s intransparent decision-making process, the EU’s integration trend towards supranationalism – which undermines national sovereignty –; the supposedly unmotivated drive for enlargement, the EU’s liberal free-market approach, and ultimately, the crisis of the Eurozone. Europhilia on the contrary, is marked by support for the European process of integration, usually going hand in hand with the belief that a supranational state, whether or not a political union, is the ideal outcome and final stage of European integration.

It is important to view European integration as a process, a process that officially turned sixty this year. Processes such as these are marked by periods of ups and downs in terms of economics, business cycles, politics and most importantly: people’s perception of this process, which influences the motivation and willingness to further integrate. When studying the history of European integration, one will see a collision of crises that called for further integration in the form of counter-policies, new types of governance and frameworks to prevent certain crises from happening in the future. A great role herein is reserved for integration theories such as neofunctionalism and liberal intergovernmentalism. These theories not only account for certain integrative steps, but their hegemony is also subject to change because of crisis and crisis counter-policy and governance.

The deepest lows of the Eurozone crisis may seem to have been overcome now, but its consequences have appeared far from faded away, as we now seem to be in a Union post-economic crisis, dealing with a crisis of its democratic accountability. Acknowledging the loss of faith in the European project – demonstrated by an

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increased amount of Eurosceptical political parties, demonstrations, opposition movements and negative outcomes of EU-topic referenda in national settings – makes it important to analyse how the crisis, the policies created to tackle it and this loss of faith in the European project correlate with one another. Analysing whether changed governance and policies as affected by the crisis have had serious implications on the EU’s democratic accountability, could lead to questions about the effectiveness of EU crisis-policy and governance, which could in turn lead to adequate recommendations for their future direction. This thesis therefore studies the question: in what ways did the Eurozone crisis influence EU policy and governance and how did this in turn affect democracy in the European Union? To provide an answer to this question in the conclusion of this thesis, research will essentially focus on three core elements. It will analyse whether European policy and governance have changed because of the Eurozone crisis. If so, we will analyse if these changes have had consequences for the EU’s democratic accountability. If this is the case, this will lead to a justification of the current loss of faith in the European project, as a consequence of the European Union having become less democratic.

These three core elements translate into a framework of four chapters. The first chapter will introduce the process of European economic integration, to prove the previously made claim that integration can be seen as a collusion of crises that in turn trigger new forms of governance and policies. The integration theories of neofunctionalism and liberal intergovernmentalism will be introduced to this chapter because their supranational versus intergovernmental nature provide us with better insights to the process of integration, and offer us the tools necessary to make a fair judgement of whether policies and governance have changed or not in the following chapter. Furthermore, chapter one will show us how the history of European economic integration reads like a long prelude to the problems of the Eurozone crisis. In chapter two we will study whether the Eurozone crisis has changed EU governance and policies through firstly describing different narratives to the crisis’ roots, followed by a timeline of crisis events and policy-measures and ending with a theoretical analysis of theses measures through the lenses of neofunctionalism and liberal intergovernmentalism. Analysing the crisis through these lenses will provide us with answers to the first core element of this research which questions whether the direction of EU governance and policies has shifted because of the crisis. This chapter will however also touch upon the second core element, showing us that the synthesis

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of neofunctional and liberal intergovernmental theory to explain crisis policies and governance, in fact falls short in certifying the loss of democratic accountability and therefore the current loss of faith in the European project. There will therefore be a need for introducing another perspective, under the name of neoliberalism. This theory will be elaborated upon extensively in chapter three, with specific regards to its definition of democracy. We will then possess a broad collection of three theories, different narratives to the crisis roots, and an overview of crisis events and policies. This provides us with the tools and arguments necessary to perform an empirical analysis of the three main crisis policy-measures – The European Stability Mechanism, the Banking Union and Outright Monetary Transactions/Quantitative Easing – in chapter four. The main goal of this analysis is to find out which theory – neofunctionalism, liberal intergovernmentalism, or neoliberalism – is most adequate in accounting for the direction of EU crisis policies and governance, and democracy in the European Union. The results of this analysis will be discussed in the last paragraph of chapter four. These findings will touch upon the third core element of this research, which is crucial for posing an answer to the thesis’ research question in the final conclusion.

The idea for this research was initially triggered by the apparent rise of populism in the EU, combined with the academic debate on the multiple facets of the Eurozone crisis. Many scholars have argued about the correct term for this crisis. For instance, the term “euro crisis”, has been a topic of debate as it is questionable whether the euro itself has put the European economy into recession. We would rather argue that “Eurozone crisis”, has become an umbrella term for multiple crises such as the euro crisis, banking crisis and the sovereign debt crisis. Through this research we hope to find answers as to whether “democratic crisis” might just fit in next to those other crises, still falling under the same umbrella. In other words: to research what kind of relationship there is between the Eurozone crisis and the current loss of faith in the European project.

Justification for this research relies on three arguments. Firstly, it is important for European society to research whether the media hyped blaming of the EU is justified, or unfair. If the Eurozone crisis has indeed had certain affects on EU governance and policies, making them less democratic and transparent, then this is a problem that urgently needs to be addressed, as the European Union owes its citizens to be democratically accountable. If this research points out that European policies

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and governance have not changed into a less democratic direction because of the crisis, then we are still dealing with a problem of an increased negative sentiment among European citizens towards the European project, which will call for further research as to identify the roots of this “unjustified” sentiment.

Secondly, the findings of this research will be important for the EU itself to find out whether the claims regarding its democracy and transparency are legit. If they are, and the roots of the problem are identified through this research, a change of direction in EU policy could be proposed, which could contribute to countering the loss of faith in the European project.

Finally, this research is important to science, as the relationship between the Eurozone crisis, through EU policy and governance, and the current loss of faith in the European project have not yet been researched in such an extensive manner.

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In order to research whether the Eurozone crisis has affected EU policy and governance, it is firstly important to gain a thorough understanding of the history of European economic integration along the two main integration theories of neofunctionalism and liberal intergovernmentalism. This will not only show how European integration can be seen as a collusion of crises that triggered further integrative steps, it will also show how crises have been of influence on periods of Euroscepticism and Europhilia. Furthermore, this chapter will show us how the history of European economic integration reads like a long prelude to the problems of the Eurozone crisis, providing us with an adequate stepping-stone to chapter two.

Extracting this theoretical foundation of neofunctionalism and liberal intergovernmentalism, including their concept of democracy, is important to the research of this thesis, as we will use these theories as lenses through which we can analyse crisis policy-making in chapter two and four, which will provide us with answers as to whether EU governance and policies have changed, because of the crisis, into a less democratic direction. We are well aware that there are more theories to European integration than just neofunctionalism and liberal intergovernmentalism. However, for the purpose of this research we have limited ourselves to these two theories as they reflect the opposition between supranational and intergovernmental ideas, which we believe to be at the core of the debate on European integration. Opposing these theories can help us research whether EU policy and governance have changed in either a more supranational or intergovernmental direction as a result of the crisis.

The following section will briefly describe the process of European economic integration, after which the theories of neofunctionalism and liberal intergovernmentalism will be introduced in the sections following after.

1.1 A brief history of European economic integration

The first foundation of the European project was laid down in the Treaty of Paris of 1951, which established the Economic Community of Coal and Steal (ECSC). It is debatable what principle set the core foundation of the beginning of the integration process. Some believe it was the urge to establish peace in Europe, and to encapsulate Germany’s power, whereas others prefer the narrative explaining the urge of economic integration: rebuilding a stronger society together, after national economies

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were ruined through years of war. In the 1950s and ‘60s the process of European integration developed rapidly. The future seemed prosperous and the concept of a European umbrella covering its member states was received welcoming, as the horrors of WWI and II were still vividly present in people’s minds. The Treaty of Rome signed in 1957 established the European Economic Community, and provided for “an ever closer union between the people of Europe” (Moravcsik, 2012). Next to the idea of encapsulating Germany’s unbalanced power within Europe, the idea prevailed that through establishing a process towards unity, i.e. the more united the parts of Europe were going be, the better the Community would function, specifically in an economic way. According to Topalov (2014), this principle of common enrichment, known as “pareto optimality” had to be institutionally guaranteed. Making this concrete by erecting institutions as Europe’s modus operandi, “marked the end of the outright balance of power policy that had been implemented on the Old Continent for centuries” (Topalov, 2014).

Economically, through the Treaty of Rome of 1957, a common market through a customs union was established (although not realised until 1968), to ensure the free movement of goods, people, services and capital, the abolition of quotas, and a degree of tax harmonisation. Common economic policy included the Common Agricultural Policy (CAP), and common competition policy. This generated welfare effects, i.e. the consumer surplus grew. The customs union boosted free trade and welfare within the Community. The Bretton Woods system, - established at the end of World War II to create a world trade system through pegging international currencies to the US dollar – and the Marshall Plan, both contributed constructively to Europe’s economic development. Up until the 1970s the economic system of the European Community was based on the capitalist principle of redistribution, just as in the social democratic societies that were its member states (Topalov, 2014). “ [The Community’s] mainstream economics was adapted to this socio-economic background by turning to Keynesian macroeconomics, (…) based on a recognition of market disequilibria and market failures” (Rothschild, 2009). State intervention was seen as necessary to meet widely accepted socio-economic aims such as economic growth, full employment, price stability, foreign balance equilibrium, and a fair income distribution (Rothschild, 2009).

By the end of the 1960s, this golden period of Keynes-based policies slowly started to crumble. It turned out that regulation could not fulfil all expectations

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(Rothschild, 2009). Furthermore, The Bretton Woods system was marked by exchange rate instability, leading to the collapse of the system in 1971. As European currency rates consequently started to fluctuate, trouble arose in maintaining the CAP, leading to the Community having to intervene consistently to keep prices stable. Another shock was caused by the oil crisis that hit Europe in 1973. Inflation became more insistent leading to stagflation, causing a slow in economic growth and high levels of unemployment (Rothschild, 2009). Not surprisingly, during this period, “nationalism began to first gain momentum in Western Europe quite naturally” (Topalov, 2014).

The end of the 1970s was marked by the introduction of a new mechanism to keep the Community’s exchange rates in order. Building on the idea of establishing a common currency, the European Monetary System (EMS) was founded in 1979. The system was based on an exchange rate mechanism (ERM), the European Currency Unit (predecessor of the Euro), creating a fictive common currency, and a divergence indicator. In the end the EMS worked mostly asymmetrical, as the Deutschmark appeared so strong, that other currencies perpetually had to devaluate. Between 1979 and 1983, exchange rates had to be adjusted seven times and great inconsistencies between member states’ inflation rates remained. From 1983-1987 the system was more stable, leading up to a period of exchange rate stability between 1987-1992. The enlargement of the European Community towards Spain and Portugal proved that the economic system worked, and economic growth was again a fact.

Topalov (2014) argues that this period of time was marked by two fateful changes that brought a collapse to the – at the time- fragile system of legitimacy of the European Community however, which gave impetus to the first significant occurrence of Euroscepticism. The first was this need to revise the way in which the EC had been functioning, which promoted for a further deepening of the integration process, through the establishment of the EMS, and later, the plans to complete the internal market through the Single European Act (SEA) of 1986. This treaty was seen as revolutionary, as it constituted the first comprehensive revision of the constituent Treaties of Rome (Topalov, 2014), and marked the revival of European integration after the stagnation of the 1970s. Its goal was to abolish all non-tariff barriers, turning the common market into an internal market. This change in terminology also marked the changed perception of the market as something between member states (intergovernmental), to a market as subject of joint governance (supranational).

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The SEA was the first serious step towards the transformation of the European Community from a customs union into what it is today – an integrated political, economic and cultural model of a super, supranational, sui generis organisation of an uncertain type – аn “unidentified political object” (UPO), as it was called by Jacques Delors, former President of the European Commission and main SEA initiator. (Topalov, 2014)

Compared to other constitutions such as the American or the French, the SEA was a remarkable constitution, not focusing on fundamental rights or duties of citizens, but rather on those of the market. Guaranteeing the four principles rather to serve the market, than to serve its people. Not restricting the state towards the individual, but towards the free market. As stated before, the central vision of a United Europe was to redistribute wealth, in fact to soften up the consequences of globalisation (Topalov, 2014). The CAP correcting the market through price regulation is an example of this. The integration reforms of the EC were in fact predominantly economical, instead of political or social, leading – through the establishment of the internal market – to a radical liberalisation of national markets, which were before stringently regulated (Topalov, 2014). Rothschild (2009) certifies this process through explaining how “traditional socio-economic structures had already become solidified, and therefore business interests could once again press more energetically for an agenda of deregulation, which would provide for them better opportunities on ‘free’ markets and would reduce state interference for social and other non-economic targets.” Politically this was strongly visible through Margaret Thatcher’s neoliberal policies in Britain and Ronald Reagan’s in the USA. Economically, this meant a shift from Keynesianism to an anti-Keynesian ‘counter-revolution’ marked by theoretical approaches as previously mentioned monetarism (through the EMS), Rational Expectations and Policy Ineffectiveness, that all supported deregulation policy and free-market ideology (Harvey 2005 in: Rothschild, 2009).

Topalov (2014) describes how these reforms generated winners and losers of the European integration project, and therefore led to his earlier made claim of the crumbling of the institutions’ legitimacy. He explains how the four freedoms of the internal market also posed a threat to the “ontological security of the most vulnerable and socially stagnated strata of European societies – the poorly educated workers, the agricultural owners, the small craftsmen, and the dregs that have been socially

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marginalized” (Topalov, 2014). These could be referred to as “the losers of EU integration, created by neoliberal, counter-Keynesian policies.

The second change was the collapse of the Soviet Union in 1992. The same year as in which the Treaty of Maastricht: on the completion of the internal market was established. The Treaty of Maastricht – just like the SEA – marked a revolutionary rewriting of the economic constitution of the EC, not only turning the Community into the European Union we know today, but more importantly, expanding its goals and principles. Its focus moved from a strong macroeconomic orientation of the market to the economy as a whole; from trading with each other to governing the economy together through monetary policy, budget, trade policy and social policy; i.e. economic politics. The European Economic and Monetary Union (EMU) was introduced in order to adopt the common currency – the Euro – ten years later. EMU replaced the EMS and stood above the member states, thus shifting the EU’s monetary policy from an intergovernmental to a more supranational level. EMU’s prime focus was on price stability; it implied restrictions on budget deficits, included convergence criteria, and abolished capital restrictions. Moreover, common macroeconomic goals were set. What first seemed to be a technical adoption in favour of the common currency, turned out to be a significant change of the Union as a whole, supported by the introduction of the Stability and Growth Pact in 1998 to ensure fiscal discipline to be maintained and enforced throughout EMU.

Coming back to the implications of the legitimacy of the Union, this economic process played against the backdrop of a collapsing Soviet Union, and the end of the Cold War. In order to keep the idea of a United Europe alive, the EU could do no different than to include the Eastern European countries – that used to belong to the Soviet block – because of their geographical location and the history they shared with the existing member states. The EU therefore kept these countries at the threshold on the pretext of democratic consolidation and economic development (Topalov, 2014). This unprecedented enlargement, together with the economic reforms as just described resulted in a further deepening of European integration.

At the same time, this also led to a growing sentiment of Euroscepticism. As described in the introduction, the EU’s integration trend towards supranationalism – through the SEA and EMU; the supposedly ‘unmotivated’ drive for enlargement – the East enlargement after the collapse of the Soviet Union, and the EU’s liberal free-market approach - enforced by neoliberal policies since the 1980’s- are all motives for

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a growing sentiment of Euroscepticism. According to Topalov (2014), it was between the end of the 1990s and the beginning of the 2000s that the topic of Europe “received a lasting place in the political rhetoric very quickly, however not only in positive terms…[and] each and every aspect of common European policy (…) has since become a field of electoral confrontation”.

Figure 1: Euroscepticism in France (Alibert, 2015).

Another driver for Euroscepticism is the Eurozone crisis. This argument is quite strongly visible in the chart above. The chart demonstrates the perception of French citizens towards the European Union. One sees that from 2010 and onwards, the ‘very negative’ perception exceeds the ‘very positive’ perception, which is just when the sovereign debt crisis hit France (Alibert, 2015). One also sees that the ‘fairly positive’ perception has been decreasing, while the ‘fairly negative’ perception has been growing over the course of 2003-2015.

To elaborate on this argument, the next paragraph will introduce two main theories of integration: neofunctionalism and liberal intergovernmentalism. These theories provide us with clearer answers to different periods of stronger and weaker motivation for European integration. They will subsequently contribute to the explanation of Euroscepticism as a consequence of the Eurozone crisis in chapter two. 1.2 Grand theories of European integration

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The contradiction between supranationalism and intergovernmentalism has been a strong component in the history and political discourse of European integration. Understanding their concepts and opposing ideas is essential in gaining a thorough grasp of integration and sovereignty within the European Union. Supranationalism and intergovernmentalism can bee seen as grand theories, theoretical frameworks or approaches to European integration, which have influenced later integration theories such as neofunctionalism and liberal intergovernmentalism. Both concepts try to explain and predict how member states of the European Union bargain, cooperate to develop and execute policies, and what the concept of sovereignty within the European Union is based on. Results of supranational governance are for example: the Common Market, the Schengen Zone, the Emission Trading Scheme and the Euro. Contrarily, the treaties of the European Union are of intergovernmental character (Adriaan Schout & Sarah Wolff, 2011, p.22).

One of the perennial debates in European integration literature has revolved around whether the EU is moving towards ‘an ever closer union’ – as set as main goal of EU integration by the Treaty of Rome – and therefore more specifically, whether the EU is becoming more supranational or more intergovernmental (Adriaan Schout & Sarah Wolff, 2011, p.22). Whereas supranationalists believe in the development of authoritative institutions of governance and networks of policy-making activity above the nation-state, intergovernmentalists view states as the primary actors of the integration process (Rosamond, 2000). The contradiction between proponents of the supranationalist and the intergovernmentalist school, seems to be at the core of current debates on the future of EU, demonstrated by the Brexit, the rise of populism in several member states and therewith, the current wave of Euroscepticism and loss of faith in the European project. The following paragraphs will explain supranationalism, neofunctionalism, intergovernmentalism and liberal intergovernmentalism in a more extensive matter.

1.2.1 Supranationalism

Supranationalism involves states working with one another in a manner that does not allow them to retain complete control over developments, that is, states may be obliged to do things against their preferences and their will because they do not have the power to stop

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decisions. Supranationalism thus takes inter-state relation beyond cooperation into integration, and involves some loss of national sovereignty (Nugent, 2006).

When we take a look at the history of European integration, we can identify different periods of either supranationalism or intergovernmentalism as the driving forces of integration. Supranationalism as a term was firstly mentioned between 1905-1910, and was legally used for the first time in the Treaty of Paris of 1951 (Colletaz, 2013). Within this Treaty, supranationalism defined the Community method used to create the European Coal and Steel Community (ECSC). It described the relationship between the High Authority (nowadays to be considered as the European Commission) and the other four institutions. The founding fathers of the European Community described supranationalism as the cornerstone of the governmental system. With the signing of the Treaty of Rome in 1957, the signatories of the Treaty pledged to work towards ‘an ever closer union’ (Moravcsik, 2012), going hand-in-hand with the supranational ideology providing for this process of ever further integration. As described in the first paragraph of this chapter, during this period of time, the European project was not only believed to bring peace and security, but also to provide for economic prosperity. Unsurprisingly, it was during this period of time that neofunctionalism as a new integration theory, strongly building on supranational ideas, emerged.

1.2.2 Neofunctionalism

In order to get a better understanding of supranationalism, it is important to review neofunctionalism: the integration theory most strongly building on the supranational concept. Ernst Haas developed Neofunctionalism in 1957, as an adequate explanation of European integration at that time. This relied on three factors: firstly because of the integration of the six original members of the European Community; secondly because of changed perspectives in American social sciences after WWII; and thirdly because it was a new form of functionalism, an old theory of integration that fell short in explaining the process of European economic integration (Eilstrup-Sangiovanni, 2006).

The theory of neofunctionalism relies on two fundamental principles: the concept of spillover and ‘a supranational state’ as the final outcome of European political integration. Supporters of neofunctionalism describe European integration as

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follows: integration is a process during which political actors in different national settings are convinced to transfer their loyalty, expectations and political activities to a new centre: the political arena. The bigger this arena becomes, the more problems will occur and the bigger the need for a problem-solving capacity of this arena becomes. I.e. the traditional political arenas within member states slowly shift to a greater, communal political arena overlapping its member states. Different individuals, from different nation states can find each other based on political interests and activities within this political arena. For example: a farmer from the Netherlands is more likely to share interests with a French farmer than with a Dutch businessman. When national borders fade, these people can meet each other within the political arena. Deriving from these believes, supporters of neofunctionalism do not perceive the state, but rather the rational individuals as central actors of integration: their rational interests are central, and therefore make them the most important actor in the integration process. Rational individuals have the capacity to learn from their experiences in co-operative decision-making (Haas, 1958, p.291).

Why rational individuals are willing to devote themselves to this shared political arena is explained through the theory of spillover, which neofunctionalism divides into the three sub-concepts of functional, political and cultivated spillover. Broadly speaking, spillover theory suggests that one step of integration naturally leads to further steps of integration. We will now briefly describe the three sub-concepts of spillover:

1. Functional spillover

“Functional spillover pressures come about when an original objective can be assured only by taking further integrative actions” (Lindberg, 1963 in: Niemann & Ioannou, 2015, p. 198). The theory suggests that economic sectors are strongly interdependent. Therefore, integration in one sector leads to integration in related sectors. A good example is the pooling of the production of coal and steal within the ECSC back in the 1950s. In order to realise that integration step, integration in terms of transportation also needed to be undertaken. As the economic sectors of production and logistics are functionally linked, they generate functional spillover.

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2. Political spillover

“Political spillover encapsulates the process whereby (national) elites come to perceive that problems of substantial interest cannot be effectively addressed at the domestic level” (Niemann & Ioannou, 2015, p. 198). Therefore a certain infrastructure needs to be realised, for different national actors to find like-minded actors from other nations in a political arena. Once this centre is established, a new momentum is created that leads to further integration. An example is that the erection of the European institutions in Brussels has led to the establishment of many interest groups and political organisations in Brussels.

3. Cultivated spillover

(…) Supranational institutions (…), concerned with increasing their own powers, become agents of integration because they are likely to benefit from the progression of the process” (Niemann & Ioannou, 2015, p. 199). This means that the erection of supranational institutions, such as the European Commission, leads to these institutions becoming agents of further integration. They represent the general interest of the integrated community and act as policy-entrepreneurs (Niemann & Ioannou, 2015, p. 199).

Eilstrup-Sangiovanni (2006) identifies four crucial conditions for neofunctionalism’s success as a European integration theory: all the member states of the European Community were democracies with a high rate of pluralism; their elites were compatible; external safety of the Community was guaranteed by other international institutions and most importantly; Europe was undergoing a period of industrial and economic prosperity.

The neofunctionalist hegemony started to crumble by the beginning of the 1970s however, marked by doubts concerning the theory’s relevance, as neofunctionalism appeared inapplicable to other integrative regions outside of the European Community.

As described in the first section of this chapter, the end of the 1960s was marked by a slowdown of economic development, further increased by the collapse of the Bretton Woods system and the oil crises of the 1970s. Topalov (2014) argued that nationalism subsequently first gained momentum in Western Europe during that time. Not surprisingly, this contributed to the crumbling of the neofunctionalist hegemony.

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Intergovernmentalism as an approach to European integration increasingly gained support instead, enforced by a few major political events: the French veto against the British membership in 1963 and the empty chair crisis evoked by Charles de Gaulle in 1965 (Eilstrup-Sangiovanni, 2006).

After this slowdown of European integration, neofunctionalism tried to restore itself and acknowledged that dramatic political actors such as Charles de Gaulle can indeed put a halt to integration (Eilstrup-Sangiovanni, 2006). Even though neofunctionalists adjusted the spillover theory, neofunctionalism seemed to have lost its appeal by the time of the 1970s, as globalisation in terms of international interdependencies gained more momentum.

Notwithstanding, the theory of neofunctionalism has been of major influence on studies of regional and international integration, showing that the state cannot be seen as a uniform actor in the process of integration. It secondly conceptualised the European Community as a political system. Thirdly, the intergovernmental critique towards neofunctionalism led to the distinction between supranationalism and intergovernmentalism in the European integration discourse, which is pivotal in understanding the process of European integration.

Regarding democracy, the theory of neofunctionalism entails a delegation of competences from the national to the supranational level. This subsequently means that democratic accountability is also shifted from a national, to a supranational political arena. Hence, advocates of neofunctionalism maintain the idea that the desire of rational individuals to cooperate on a supranational level, naturally leads to a desire to erect political institutions to account for this cooperation on the supranational level, leading to a voluntary transfer of power, and therewith a voluntary transfer of democratic accountability. The creation of the European Parliament, specifically since its direct elections since 1979, is a good example of this shift of powers, but yet maintenance of democratic accountability.

1.2.3 Intergovernmentalism

As described in the previous paragraph, the empty chair crisis and the subsequent stagnation period of supranational integration contributed to the boost of intergovernmentalism as an alternative to the political hegemony or “paradigm” of neofunctionalism (Hoffmann, 1966 in: Schimmelfennig, 2015). As neofunctionalism underwent a period of heavy critique as a reaction to its inability to explain those

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events that resulted in a slowdown of European integration during the 1960s and -70s, Stanley Hoffman created a counter approach, called intergovernmentalism introduced by his: The State of War: Essays on the Theory and Practice of International Politics. “Hoffman criticised neofunctionalism as he believed that integration had to be viewed in a global context, and that regional integration was a smaller part of a global system” (Bache, 2006, p. 12). Next to that, he focused on states as the prime actors of integration. According to Nugent (2006) this results in arrangements whereby nation states, in situations and conditions they can control, cooperate with one another on matters of common interest, which allows them to decide the extent and nature of this cooperation, resulting in national sovereignty not directly being undermined.

Intergovernmentalism also posed limits to the neofunctional concept of spillover, through its proposed logic of diversity, meaning that on vital issues of common interests, losses are not compensated by gains on other issues (Hoffman, 1966, p. 882). A major failure of neofunctionalism according to Hoffman was its prediction of unavoidable further integration, which was based on the belief that the international background situation would stay the same. Because of the economic developments of the 1970s, it did not. Neither did Hoffman believe that the integration process would ever include higher politics such as national security; nor did he believe in the importance of interest groups over the interest of national governments (Bache, 2006, p.13).

After the emergence of intergovernmentalism, “The new dynamism in European integration from the Internal Market Programme to Monetary Union was [again] accompanied by a revival of neofunctionalism and a reformulation of intergovernmentalism” (Schimmelfennig, 2015, p. 177). During the 1990s, the intergovernmentalist approach again gained momentum, as American scholar Andrew Moravcsik introduced a new theory of European integration that strongly built on intergovernmentalism.

1.2.4 Liberal intergovernmentalism

Compared to Hoffman’s intergovernmentalism, Moravcsik’s Liberal intergovernmentalism posed an even more fundamental critique on neofunctionalism (Bache, 2006, p. 12-15). Moravcsik fitted a liberal theory of state preferences and a neoliberal theory of international interdependence and institutions to earlier – predominantly ‘realist’ – approaches, in such a manner quickly establishing a theory

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that became the most elaborative version of intergovernmentalism (Moravcsik 1993, 1998 in: Schimmelfennig, 2015). Strongly focusing on states as the driving force behind international cooperation, and believing in globalisation as the universal condition for world politics, liberal intergovernmentalism strongly opposites neofunctionalism within the spectrum of European integration theories.

In a nutshell, liberal intergovernmentalism argues that national preferences are shaped by the economic interests of powerful domestic groups in a situation of international interdependence; substantive agreements reflect the constellation of national preferences and bargaining power; and the design of international institutions is a function of the kind and size of co-operation problems they are supposed to manage. (Schimmelfennig, 2015, p. 178)

Moravcsik has established his theory on the foundation of European integration being driven by EU member states, especially those that are relatively less dependent on other EU economies and therefore possess stronger bargaining power. The national governments are thus the key players of the integration process, responding to economic demands raised at home. Because of the globalised world, that creates interdependencies and economic activities across borders, governments bargain on an international level to manage these interdependencies (Moravcsik, 1991; 1998 in: Vilpišauskas, 2013).

In terms of democracy, liberal intergovernmentalism maintains the idea that the intergovernmental decision-making process is of rather democratic character, as national sovereignty is not being undermined. National preferences are firstly formed at home, after which national delegates bargain upon these preferences in an intergovernmental political arena. This thus ensures a ‘double democratic’, or liberal democratic value to EU bargaining outcomes, opposing the neofunctionalist concept of democracy, which entails a transfer of powers from the national- to the supranational political arena.

1.3 Conclusion

This chapter has provided us with a compact description of the history of European economic integration along the two main integration theories of neofunctionalism and liberal intergovernmentalism. The first paragraph’s brief history of European economic integration has shown that integrative steps such as the Treaty of Rome, the

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Single European Act (SEA) and the Economic and Monetary Union (EMU), were outcomes of ambitious policy-making as a consequence of certain forms of crisis that raised a need for further integration in areas up until then unexplored.

Hence, the overview has justified the argument posed in the introduction, that claimed that the process of European integration, in terms of policy-making has been a consequence of European integration being a collusion of crises that triggered further integrative steps, through either a more intergovernmental or supranational integrative framework. These crises have also proven to be of influence on the overhaul sentiment towards the European project, i.e. the motivation for further integration, under the name of either Euroscepticism or Europhilia. The integration theories of neofunctionalism and liberal intergovernmentalism, and more specifically their hegemonies, have shown to also correlate to these alternating periods of Euroscepticism and Europhilia.

Through our study of neofunctionalism and liberal intergovernmentalism we have learned about their opposing concept of democracy. While neofunctionalists believe in a voluntary delegation of democracy from a national to a supranational level, thereby maintaining democratic accountability, liberal intergovernmentalists believe national sovereignty is maintained in European integration, which creates a certain liberal democracy at the European level, as national delegates bargain upon national preferences firstly democratically established at home.

This overview of economic integration, in terms of neofunctionalism and liberal intergovernmentalism up until the setup of EMU will help us to understand the different narratives explaining the roots of the Eurozone crisis in the following chapter. At the end of chapter two, the theories of neofunctionalism and liberal intergovernmentalism, together with their concepts of democracy, will provide us with adequate tools for a theoretical analysis of the governance and policy-making of the EU during the Eurozone crisis, which will lead to conclusions as to whether EU policy and governance have become more supranational or intergovernmental, i.e. whether they have been affected by the crisis.

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2. The Eurozone crisis – Narratives, policymaking and

theoretical lenses

This chapter focuses on the first two core elements of research of this thesis as put forward in the introduction: whether European policy and governance have changed because of the Eurozone crisis, and whether these changes have led to EU policy and governance becoming less democratic. The introduction of this thesis put forward six commonly perceived elements that enforce Euroscepticism: the lack of democracy within European institutions; the EU’s intransparent decision-making process, the EU’s integration trend towards supranationalism; the supposedly unmotivated drive for enlargement, the EU’s liberal free-market approach, and the crisis of the Eurozone. As the first chapter of this thesis has shown that the EU’s integration trend towards supranationalism; the drive for enlargement and the EU’s liberal free-market approach have contributed to Euroscepticism rising from the 1990s and onwards, the following parts of research will focus on the other drivers of Euroscepticism: the lack of democracy within European institutions; the EU’s intransparent decision-making process and the crisis of the Eurozone. We will study whether EU policy and governance have shifted – into a more supranational or intergovernmental manner – and whether this shift has translated into a decrease of democratic accountability and transparency.

To execute this research, the first section will explain different narratives to the roots of the crisis, followed by a timeline of policy-measures in the second section. Both roots and policies will be analysed through the lenses of neofunctionalism and liberal intergovernmentalism, including their concept of democracy, in the third and final section.

2.1 Roots

The Eurozone crisis was one of the most extensive crises as witnessed by the European Union throughout its history of existence, in terms of the economic downturn it created, the fiscal squeeze that necessarily followed, and the major decrease in the support for European integration by the EU’s citizens it provoked (Schimmelfennig, 2015). Apart from the many questions about European integration

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the crisis raised, such as the membership of particular member states and the survival of the common currency, Schimmelfennig (2015) has argued that the Eurozone crisis also created an incentive for further financial and fiscal integration in order to stabilise the Eurozone and its common currency. Schimmelfennig’s reasoning is thus in line with the argument of European integration being a result of crises and subsequent crisis solutions. Analysing the roots to a particular crisis helps to gain a better understanding of the policy-measures taken to tackle it. Regarding the crisis of the Eurozone, economists are however divided as to the precise causes (Hodson and Puetter, 2013).

Matthijs (2011) identifies five narratives as put forward by different experts that explain the roots to the 2010 sovereign debt crisis. The first represents the view of Martin Feldstein – professor in Economics at Harvard University. Feldstein argues that the Eurozone crisis was able to occur due to EMU’s institutional design. The Eurozone not being an Optimum Currency Area – according to the theory of Robert Mundell1 – and the fact that a single-currency area without a fiscal union has never

succeeded before – are easy ingredients for the failure of EMU (Matthijs, 2011, p. 7). The second narrative – which is associated mostly with the German elite view- is that we have gone through a budgetary, or fiscal crisis, whereby peripheral member states have not committed themselves enough to budgetary discipline, instead performing fiscal profligacy (Matthijs, 2011, p. 7). The third narrative can be seen as a flipside to the second, and claims we have undergone a crisis of competitiveness of the Southern, peripheral member states. “The persistence of growth and inflation differentials across EMU have (…) led to diverging movements in international competitiveness and strong trade imbalances within the euro area. Especially vis-à-vis Germany, real appreciations in the PIIGS [Portugal, Ireland, Italy, Greece and Spain] countries led to their current account deficits” (Matthijs, 2011, p. 8). Martin Wolf – columnist for the Financial Times, has put forward the fourth narrative. He has argued that macroeconomic imbalances have been a core root to the crisis. Converging bond spreads towards the introduction of the Euro led to higher yields on peripheral bonds,

                                                                                                               

1 The OCA theory defines a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. The two main arguments for the Eurozone not being a OCA rely on the fact that there is not sufficient labour mobility (due to cultural and lingual barriers) and that there are no fiscal transfers - that could work as stabilisers - as the Eurozone is not a fiscal union.

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which allowed investment and capital to flow from Northern to Southern Europe, thereby fuelling housing booms and public spending (Matthijs, 2011, p. 9)

The fifth narrative, which is according to Matthijs (2011) often neglected in existing literature, points the finger to “efficient” financial markets, that mispriced sovereign debt holdings of differently performing European member states.

As Matthijs (2011) argued that this fifth element had – at the time – not yet gained enough academic attention, we will elaborate on this narrative in the next paragraph (2.1.1), supported by arguments put forward by De Grauwe (2009). We moreover argue that narratives one until four as put forward by Matthijs (2011) could be combined into one narrative, which will be elaborated upon in the subsequent paragraph (2.1.2). In paragraph 2.1.3 we will combine these two newly formed narratives, and use that synthesis as the foundation for our further research.

2.1.1 The efficient market paradigm

In his article: Lessons from the Banking Crisis: a Return to Narrow Banking, De Grauwe (2009) explains how excessive risk taking in financial markets has been of influence on the outbreak of the US financial crisis, which in turn had a strong impact on the outbreak of the Eurozone crisis. Central to this explanation is the concept of the efficient market paradigm, as touched upon by Matthijs (2011).

De Grauwe (2009) explains how from the 1970s and onwards, the efficient market paradigm became dominant in academia and beyond. This paradigm implies that “financial markets efficiently allocate their savings towards the most promising investment projects, thereby maximising welfare” (De Grauwe, 2009, p. 19). Because these markets are self-regulating and asset prices reflect underlying fundamentals, bubbles and booms, and consequent crashes, are believed impossible to occur. The idea prevailed that government or central bank intervention would therefore be unnecessary or even harmful (Greenspan, 2007 in: De Grauwe, 2009). As a consequence, US and European banks were progressively deregulated throughout the 1980s and -90s. Commercial banks became allowed to take on risky activities only investment banks were allowed to perform until then, such as: underwriting and holding of securities and the development of new and risky assets like derivatives and complex structured credit products (De Grauwe, 2009, p. 20). Combined with financial innovations, new ways were found to repackage investment products, so – called asset backed securities (ABSs). Together with securitisation – banks selling

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their loan portfolio thereby creating credit to buy new liquidities that can be used to grant new loans – this would lead to a better spreading of the risk over more people, which would reduce systemic risk and the need to supervise and regulate financial markets. This would boost welfare, ensure lower costs of credits and would benefit both firms and millions of consumers that gained access to cheap mortgages (De Grauwe, 2009, p.20).

Not only commercial banks got into investment bank activities, but also the opposite occurred, creating a situation of both commercial and investment banks building up a lethal combination of credit- and liquidity risks (De Grauwe, 2009, p. 22).

The point De Grauwe makes is that financial markets are in fact far from efficient, and can thus not be left without government or central bank intervention. Especially not since financial markets and credit rating agencies are very vulnerable to speculation, making them sensitive to bubbles and booms. De Grauwe (2009) explains how the US economy and specifically the housing market were subject to immense booms leading up to the financial crisis. Between July 2006 and July 2007, the US economy warranted an increase of 30% in the value of stocks accounting for 3.5 trillion dollars. GDP only increased by 5%, accounting for 650 billion. Fundamentals such as productivity and growth only rose at their normal rate, leaving the only cause for the excessive growth in the value of stocks to reflect disproportionate optimism about the future of the US economy, therefore boosting investment (De Grauwe, 2009, p. 21). Housing prices doubled over the period of 2000-2007, fuelled by the expectation that they would rise indefinitely. Building up mortgage debt was consequently believed not to create future re-payment problems (De Grauwe, 2009, p. 21). When the US housing bubble burst in 2007, housing prices started to plummet, causing both commercial and investment banks such as Lehman Brothers to default. Because of the ABSs, many European banks also held infected American assets, subsequently leading them into trouble too. As a consequence, a financial crisis soon spread throughout the European continent. Matthijs (2011) argues that the efficient market paradigm had also led to Eurozone bonds being mispriced, thus creating the same problem in the Eurozone as in the USA.

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2.1.2 Macroeconomic imbalances in the Economic and Monetary Union

As explained in paragraph section 2.1, we argue that the first four narratives as put forward by Matthijs (2011) could be combined into one narrative that explains: the crisis of the design of EMU, the fiscal profligacy crisis, the competitiveness crisis and the crisis of macroeconomic imbalances. To make things easier, we will call this the narrative of macroeconomic imbalances. Macroeconomic imbalances seem to have been of great influence on economic crises, not just in Europe, but also on a global scale. When speaking of macroeconomic imbalances, we mean that the current accounts of countries’ trade balances are out of balance, which in turn can have rather large effects.

When the Treaty of Maastricht entered into force in 1993, the common idea prevailed that the relatively weaker economies of the European periphery, i.e. Southern Europe, or the PIIGS, would converge towards the stronger standards of Europe’s Northern economies. The future of the Economic and Monetary Union (EMU) looked bright and the EU economy did flourish in the first years ahead. Already before the Treaty was officially established this positive expectation was reflected by converging bond yield spreads, which translates into all economies being perceived equally creditworthy. This certain trust was fuelled by the convergence criteria that were set in order for economies to join EMU, including a reduction of budget deficit and public debt and ensuring exchange rate stability, moderate inflation and long-term interest rates. Southern countries meeting these criteria fuelled trust in their economies and hence made them more creditworthy (Jaumotte & Sodsriwiboon, 2010, p. 10). The convergence of government bond yields towards the introduction of the euro and the following divergence after the onset of the financial crisis are clearly visible in figure 2.

Figure 2: Eurozone bond yields: Colin Lloyd (2014)

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Lending money to peripheral governments was thus perceived as safe as lending it to Germany. Next to that, the peripheral economies still had to make an economic recovery compared to their Northern peers, calling for great amounts of investment. Due to economic liberalisation that lifted trade barriers, the flow of capital in terms of investment within the Eurozone was made more easily, facilitating large investment flows from North to South (Jaumotte & Sodsriwiboon, 2010, p.8). As a consequence, real estate bubbles started to emerge, which hit not only Southern states such as Spain, but also Ireland. Even though there were different causes to their problems, as also to the problems in Italy, Greece and Portugal, these countries have in literature been addressed as the general peripheral group that have suffered most from the economic recession.

The great amount of investments in these particular countries consisting of foreign capital attracted through banks and government bonds, which led to increased government spending and sovereign debt – public profligacy narrative – , was not perceived as problematic during this prosperous economic time. The low interest rates ensured continuity of these investments on a large scale. When the current accounts of Northern and Southern Europe started to diverge by the mid 1990s, this was not perceived alarming.

Problematic to the Eurozone are its different types of economies that share a single currency. The economies of the Southern member states are much less competitive than their Northern peers – competitiveness narrative -. Devaluation can make an economy more competitive, but when a single currency is enforced, performing this trick is no longer possible – crisis of the design of EMU narrative –. Since the mid 1990s, structural deficits therefore started to emerge on the current accounts of the southern countries; leading up to 10% of GDP, while Northern countries, specifically Germany and the Netherlands, witnessed great surpluses – narrative of macroeconomic imbalances – p . A worrying trend of Northern states saving more, and southern states saving less, and thus spending more, started to emerge. Southern states attracted investments from Northern European banks to be able to invest in their emerging real estate bubbles, creating budget deficits and

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extensive sovereign debt. The amount of money being borrowed would eventually become too large to be ever paid back.

These macroeconomic imbalances are dangerous as they reflect low savings and price bubbles (Blanchard & Miles-Ferretti, 2009). Moreover, they are accompanied by economic risks. Firstly, a gradual adjustment of the imbalance can be painful: competitiveness can only be boosted through increased productivity or wage pressing, which is a very slow process usually leading to protests and strikes. Secondly, the adjustment of the imbalance can also happen abruptly, creating macroeconomic shocks (Jaumotte & Sodsriwiboon, 2010).

2.1.3 Combining the narratives

When combining the narrative of efficient financial markets with the one of macroeconomic imbalances, understanding what happened in the Eurozone becomes less elusive. What happened in Spain provides an adequate illustration of both narratives. Infected by the American financial crisis, the Spanish housing bubble started to burst by the end of 2007. At the time 13% of the Spanish working population was employed in the housing sector, causing high levels of unemployment (Jaumotte & Sodsriwiboon, 2010). The flow of investment abruptly being cut-off, made the Spanish government not only having to raise public spending on unemployment benefits, but also needing to pay enormous amounts of previously built government debt, which lead to a contraction of domestic demand, which in turn intensified the already fragile Spanish banking sector. The Spanish government had to start rescuing banks, leading to an even greater amount of sovereign debt. As were several Southern economies, Northern economies also ended up having to save their banks, leading the Eurozone into a sovereign debt crisis in 2010. The past three paragraphs have shown that in order to understand the complex structure of the Eurozone crisis, it is important to synthesise the several aspects to the crisis. Having established a foundation of the roots to the crisis, we will now discuss the policy-measures taken by the EU to tackle the crisis in the following section.

2.2 EU Policy responses

As a first reaction to the collapse of Lehman Brothers and the global financial crisis it brought about, the European Commission announced the European Economic Recovery Plan in November 2008 amounting to 200 billion euros targeting all 27

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member states to limit economic slowdown through national policies, with measures extended over a period of two years (European Commission, 2008). Fiscal stimulus had to boost demand and purchasing power, in order to protect jobs and to fore come a downward employment, demand and investment spiral that would result in deep recession (European Commission, 2008).

These Keynesian policies seemed to be logical in tackling the crisis, and particularly powerful because of their multiplier effect (The Economist, 2013). However, there is a flipside to fiscal stimulus; it generates a high amount of public debt. Combined with unprecedented high government bonds yields because of diminished credibility, countries such as Greece were forced to look into the opposite direction and impose austerity measures, as the Treaties establishing the euro expressively forbid rescue loans (Lapavitsas 2012).

Austerity strategies were firstly adopted by Ireland followed by Portugal and Spain and with increasing alacrity by Greece in early 2010. The borrowing requirements together with the greater loss in Greek credibility made the measurements harder for Greece than for the other countries. The means the Greek government gathered from cutting its citizens directly had to be paid back to its lenders (Lapavtisas, 2012). The amount of debt together with the increasing budget deficit became, despite austerity measurements, untenable. By the end of 2009, Greek debt had already appeared to amount to 300 billion euros, accounting for 113% of GDP. In May 2010, the Greek budget deficit amounted to 13,6% over four times the permitted percentage of 3% as established by the Stability and Growth Pact (Lapavitsas, 2012). Bearing this in mind, the so-called Troika – the European Commission, The European Central Bank and the IMF, i.e. the financial bailout creditors – decided to proceed to the first Greek bailout worth 110 billion euros in May 2010, in return for more severe austerity measures.

By spring 2010, Germany initiated a set of proposals to tackle the on-going sovereign debt crisis, emphasizing not wanting to establish a fiscal union in the short term, but rather to make EMU more resilient to crisis. Their proposals included: reforming the Stability and Growth Pact; erecting a European emergency bailout fund – subject to approval of the Eurogroup and the ECB – and stricter coordination of economic policies between Eurozone members.

These proposals resulted in specific policy measures to be carried out during the following three years. The first was the establishment of the European Financial

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Stability Facility (EFSF), fully operational in August 2010 as a public limited company, not incorporated within the Treaties. The board consists of representatives of each euro area member state. The Commission and ECB are represented at meetings but only as observers, meaning the body remains under complete control of member states (Hodson and Petter, 2012, p.372).

In September 2010, the European Commission decided to reinforce the Stability and Growth Pact through six legislative proposals: the so-called Six-Pack, which entered into force in December 2011. Four of its measurements targeted fiscal policy whereas the other two focused on reducing the macroeconomic imbalances. By the end of 2010 The Troika proceeded to an Irish bailout worth 85 billion euros.

Advocated by Germany and France, the Euro Plus Pact was introduced in May 2011 as an intergovernmental solution to increase fiscal and economic discipline of the Eurozone members. It implied a new political general framework for the implementation of structural reforms to improve competitiveness, employment, financial stability and fiscal strength to tackle the effects the European sovereign debt crisis had generated (European Political Strategy Centre, 2015). In May 2011 a Portuguese bailout was agreed upon worth 78 billion euros. A second bailout for Greece worth 109 billion euros became reality through the EFSF over the summer of 2011, again accompanied by drastic austerity measures. The sovereign debt crisis started to aggravate and spread to other peripheral countries like Spain and Italy as their government bonds yields kept rising due to low levels of credibility.

The turmoil in the peripheral states pressured EU leaders to consider a more radical set of policy recommendations. In order to establish balanced budgets in national law and to agree on closer coordination of economic policies in other areas, the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, more commonly referred to as The Fiscal Compact, was signed by all EU member states except for the Czech Republic and the UK. In July 2012, 100 billion euros were provided through EFSF to rescue the Spanish banking sector.

After several bailouts financed through the temporary funding programmes the EFSM and EFSF, The European Stability Mechanism (ESM), a permanent bailout fund, entered into force in September 2012. This intergovernmental organisation operating under public international law has since then been serving as a permanent firewall for the Eurozone, safeguarding and providing instant access to financial assistance up to 500 billion euros.

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