A EUROPEAN ECONOMIC GOVERNMENT

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M.Sc. International Financial Management

–

A WAY OUT OF THE CRISIS?

January 2012

MASTER THESIS BY: KATHARINA STAMM

s1933124

k.stamm@student.rug.nl

SUPERVISOR: DR. W. WESTERMAN

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Acknowledgments

I would like to thank my supervisor Dr. Wim Westerman, who facilitated this study with his feedback and support. Additionally, I am thankful to everybody who participated in the survey and hence contributed to the feasibility of the research project. In this context, I did not only appreciate the completion of the questionnaire, but also the interesting, motivating, challenging and helpful comments that have been made.

Finally, I would like to thank my family and friends who were supporting and motivating me during the research.

Bad Driburg, January 2012

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Abstract

The sovereign debt crisis and the euro crisis have prompted the Heads of State and Government in Europe to intensify supranational cooperation. However, particular political leaders and policy-makers, such as the French President Sarkozy, do not think that the actions taken are far-reaching enough and propose the introduction of a common European Economic Government that should enforce a joint fiscal, monetary, and economic policy in Europe or at least in the euro zone. The purpose of the present study is to find out whether the introduction of such a joint government is the right means to prevent Europe from experiencing further financial threats and stabilise national budgets, financial markets, as well as the euro as a currency. The results of a survey among cognoscenti imply a rather ambivalent attitude of the respondents towards this foray. While a bare majority is favouring the general idea of centralised economic governance in Europe, or in the euro zone, the concrete ideas for the designing of such a government have not received high popularity among the respondents, indicating some inherent divisiveness about this idea. Eventually, an affirmative answer to the research question can be inferred from the present study, although this affirmation is not particularly strong.

Keywords: Supranational Cooperation; European Sovereign Debt Crisis; European

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List of Tables

Table 1: Sovereign Debt (Eurostat Annual Data of 2010) – Eurostat, 26 April 2011 ... 16

Table 2: Cohen's Conventions for Cramer's ϕ ... 32

Table 3: Significance of Nationality for Statements 13 - 19 ... 43

List of Diagrams

Diagram 1: Overall answers: 1st group of statements ... 33

Diagram 2: Overall answers: 2nd group of statements ... 35

Diagram 3: Overall answers: 3rd group of statements ... 37

Diagram 4: Overall answers: 4th group of statements ... 38

Diagram 5: Responses to statement 3 per nationality ... 42

Diagram 9: Responses to statement 2 per age ... 46

Diagram 12: Responses to statement 3 per gender ... 48

Diagram 15: Responses to statement 2 per profession ... 51

Diagram 16: Responses to statement 7 per profession ... 52

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1. Introduction

In the last couple of years, many threats have appeared which are destabilizing the financial markets, including whole currency areas. This tendency can also be observed in Europe, where neither the financial markets, nor the euro as a currency have been spared from the financial turmoil of the preceding years. Particular examples of this turmoil are the transatlantic banking crisis of the years 2007 until 2009 (Brunnermeier, 2009), as well as the current sovereign debt crisis. The latter has erupted in Greece (De Grauwe, 2010), but is also threatening other member states of the euro zone. The sovereign debt crisis led Greece close to bankruptcy and is involving the remaining euro zone members in severe trouble due to an increased economic interdependency in Europe1. Additionally, these events have finally infected the stock exchanges and therewith also caused major stock indexes, as well as the euro to sway, resulting in a crisis of the euro.

The economic interdependency in Europe has increased with the foundation of the Economic and Monetary Union (EMU) and the use of the euro as a common currency in 17 out of the 27 EU member states. There are a lot of benefits that are a corollary of this increasing interdependence, such as free capital transactions, increased coordination of monetary policies, and the strengthening of economic convergence2. However, this development has simultaneously increased the risk of financial threats for all member states. This is because financial turmoil in one member state may automatically involve the remaining countries and the common currency into the difficulties. In order to account for this, further development regarding the economic coordination and integration in the euro zone is needed.

While the Economic and Monetary Union can be seen as a single market with a common currency and monetary policy, a next step towards European coalescence would be complete economic integration. This implies the harmonisation of fiscal and other economic policies3. In the presence of harmonised economic policies or a common government, economic crises and threats are expected to be antagonised more effectively (Busch, 2010). As opposed to the current structure of economic governance, a real government would require the presence of hierarchical structures where decisions, that

1

‘The Euro zone’s Deadly Domino Effect‘ in Spiegel Online International;

http://www.spiegel.de/international/europe/0,1518,798695,00.html (retrieved: 23rd of November 2011)

2_{European Central Bank; http://www.ecb.int/ecb/history/emu/html/index.en.html (retrieved: 25}th_{of October}

2011)

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2 | P a g e have been made, are going to be transmitted as instructions to subordinate bodies, which are then effectuating those decisions (Heise & Görmez-Heise, 2010)4.

As the current sovereign debt crisis has shown that economic governance in Europe has not been able to avoid this crisis, some politicians, such as the French President Nicolas Sarkozy, the German Chancellor Angela Merkel, and Jean-Claude Trichet, the former President of the European Central Bank (ECB), have proposed the introduction of a European Economic Government. Following their idea, such a government should represent the financial and economic interests of all EU member states5 6. Additionally, it should be more effective in decreasing the economic disequilibrium between the member states and in monitoring whether members actually adhere to the budget and debt targets as they have been determined in the Stability and Growth Pact.

The target of this pact, which has been adopted by the EMU member states in 1997, was to ensure a higher degree of fiscal coordination between and financial stability in the countries7. Some researchers say that the observed lack of adherence to the pact, which was prescribing a particular limit for sovereign debt and budget deficits, has been facilitated as there is no surveillance mechanism or governing institution to keep an eye on the national budgets of the European economies (Welfens, 2011). The introduction of a European Economic Government, which should also serve as a monitoring institution, is expected to combat this source of financial turmoil.

However, there is a controversial debate about the implementation of such a ‘true European Economic Government’, as Nicolas Sarkozy has called it8. This is because, at this moment in time, nobody has a clear idea of how such a government could be designed, how it could be enforced and how it could act. And even amongst the advocates of the common government, the specific characteristics of such a government are discussed controversially. Particularly, there is no consensus regarding the introduction of Eurobonds as a common source of debt financing9, regarding the use of a financial transaction tax, and

4_{An own translation has been made for this and the following German or Dutch sources that are used in the}

course of this thesis.

5_{‘ECB's Trichet: more EU economic powers next step in crisis’ in International Business Times;}

http://www.ibtimes.com/articles/156269/20110602/ecbs-trichet-more-eu-economic-powers-next-step-in-crisis.htm (retrieved: 21st of October 2011)

6_{‘Merkel and Sarkozy plan ‘true economic government’ in Spiegel Online International;}

http://www.spiegel.de/international/europe/0,1518,780630,00.html (retrieved: 15th of October 2011)

7

‘European Commission; http://ec.europa.eu/economy_finance/economic_governance/sgp/index_en.htm (retrieved: 2nd of November 2011)

8_{‘Merkel and Sarkozy plan ‘true economic government’ in Spiegel Online International;}

http://www.spiegel.de/international/europe/0,1518,780630,00.html (retrieved: 15th of October 2011)

9

‘Will Merkel change her tune on Eurobonds?’ in Spiegel Online International;

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3 | P a g e with respect to the role and independence of the European Central Bank. Another particular challenge in setting up such a government may be to balance the necessity of allocating more power to the European Union on the one hand, while simultaneously affirming the role of the national governments (Subacchi, 2005). The issue of power distribution may be relevant since in the current environment, there are six main actors within the Economic and Monetary Union among which the decisional power is distributed. Those actors are the European Council, the Council of the European Union, the ‘Eurogroup’, the member states, the European Commission, as well as the European Central Bank10. The consequence of the division of power over so many parties is a low degree of effectiveness and legal capacity.

With respect to the reform of economic governance in Europe, particular suggestions for the design of a joint government have been made already. Furthermore, Herman Van Rompuy, the President of the European Council, and his task force have compiled a list of actions that should intensify economic governance in Europe and tackle the current crisis (European Council, 2010). Additionally, the Heads of State and Government of the European Union have only recently decided to sign a fiscal compact and establish a fiscal stability union to achieve a higher degree of fiscal coordination (European Council, 2011). However, there are still more activities needed in order to increase the stability of the financial markets and national budgets. This is particularly true as we can observe that the European financial markets and the budgets of the EMU member states are still far from being stable.

The point in question that remains is, whether the introduction of a common governing institution on the European level is going to be an effective means in reducing the danger of financial turmoil in the future. Accordingly, the research question which is going to be discussed in the course of the present master thesis reads as follows:

Can the introduction of a European Economic Government actually help to prevent the European financial markets from experiencing further threats such as

high indebtedness of member states and hence assist in stabilizing the European financial markets and the euro as a currency?

This question shall be answered in a three-step procedure. In a first step, the triggers of the current crisis will be examined in order to understand why the implementation of a

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4 | P a g e European Economic Government is discussed at the moment and to show why a policy reform is needed. Additionally, the political amendments that have been made already are going to be presented in brief. What follows is an elucidation of the propositions for such a government that have been brought forward. Those two steps are going to be accomplished using the present literature. In third place, an important question is whether a European Economic Government would truly be more effective in monitoring the markets and national budgets and is hence more capable of protecting the European economies and the common currency. Since the answer to this question is not yet empirically observable, questionnaires are distributed among cognoscenti in order to obtain people’s opinion and find an answer to this question.

The topic of this study is of practical relevance, since the sovereign debt crisis is still unfolding its consequences. Politicians are under pressure to find a solution to be more capable of acting when new threats intimidate the European financial markets. Additionally, it has to be assessed whether or not the introduction of a common economic government for the euro zone is deemed to be a right measure. In academic terms, this topic is relevant for researching economists, as well as for the legal profession and political scientists. This is because the current, insufficient protection of financial markets and a lack of ability to act may finally result in more vulnerable markets and political systems. However, the introduction of such a government will have far-reaching consequences on political and financial structures in Europe, which need to be assessed by researchers.

The literature so far has only theoretically analysed the problems that the European Union is currently experiencing and the measures that should be taken up against this. However, to my knowledge, nobody has yet tried to answer the question whether the introduction of the European Economic Government will finally lead to a higher degree of stability of the financial markets and national budgets by asking a selected group of people. This is precisely what my research is going to contribute to the literature.

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2. Literature Review

2.1. Supranational Cooperation in International Relations Theory

Since the world of international relations is highly complex and consists of multiple layers, it has been found to be the most comprehensive research area of social sciences (Auth, 2008). Hence, it is difficult to choose the appropriate theory when dealing with a particular problem in this research field. One way of approaching this complexity is to employ a decision model, which has been created by Philippe C. Schmitter (2003). In his model (see figure 1), Schmitter arranges the existing theories on international relations, using two different dimensions, namely ontology and epistemology. On the ontological level, the model specifies whether the theory incorporates a process that reproduces existing structures, or whether it is transforming the behaviour and structures of sovereign national actors. The epistemological level of the model specifies whether the processes under depiction is caused by a great event, such as a crisis or a war, or whether it is more a gradual process in which particular nation states or social groups approach each other gradually and enter into cooperation (Schmitter, 2003).

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7 | P a g e Starting from this model, the foundation of a European Economic Government would be a reproductive process, where structures that are already present in the euro zone will be not be transformed essentially, but will be rather intensified. With the introduction of a European Economic Government, the common policy is going to be extended to another area, namely the one of fiscal and economic policy. The introduction of such a government is not expected to significantly change the nature of sovereign national actors, but can rather be seen as an additional mechanism of security and control. Looking at the issue from an epistemological level, Heise (2011) argues that the European convergence process has always been triggered by crises. This argument holds as well for the introduction of a European Economic Government, which is considered in the aftermath of the euro crisis. Considering the foregone line of reasoning and the decision model by Schmitter (2003), an appropriate theory to apply in this context is neoliberal institutionalism.

Neoliberal institutionalism has been developed in the 1970’s and 1980’s by its most important representatives Joseph Nye and Robert O. Keohane. The latter is the author of ‘After Hegemony – Cooperation and Discord in the World Political Economy’, a book that is regarded as the foundation of neoliberal institutionalism and has been first published in 1984. In this book, Keohane tries to answer the question, whether international cooperation has the ability to develop even in the absence of hegemonic nation states. A main idea of neoliberal institutionalism as discussed in ‘After Hegemony’ is that the increasing degree of transnational interdependency in world politics is positively correlated to actors’ willingness to cooperate with one another, which in turn triggers the creation of international institutions (Riemer, 2006).

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8 | P a g e Keohane starts his analysis of international cooperation and regimes from a systemic level, meaning that he is locating the actors in his model along two main dimensions: relative power and wealth. Keohane argues that while wealth is an essential means to power of sovereign states, the states also need power to retain the wealth, resulting in a circular relationship between those two variables. An issue which is directly related to the wealth and power of sovereign states is hegemony, a situation in which one particular state has the dominant power. Keohane finds that the extent to which sovereign states or social groups cooperate with each other depends on the existence of a hegemon. However, considering that the world political order is characterised as being ‘post-hegemonic’ (Halliday, 2009), Keohane (2005) also admits that the dominance of a single power is not a sufficient justification for the existence of cooperation. He argues that cooperation after hegemony is not only possible, but even highly likely. Pursuing this idea, the creation and maintenance of international regimes is not dependent on the existence of a hegemon, but rather on the presence of common interests between sovereign states. It is concluded that the existence of common interests and continuous interaction between partners can even replace the presence of a hegemonic power. In consistency, the foundation of the European Union and all the institutions that have been created within the frame of it have shown that cooperation between the different states has not been triggered by a hegemonic power. The same would also apply to the foundation of the European Economic Government. Hence, it is rather the presence of continuous interaction and common interests that allows for a successful cooperation regarding the monetary and fiscal policy between the EMU member states.

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9 | P a g e different nation states. Consequently, one particular reason for governments to enter into international regimes, such as the Economic & Monetary Union or, in this particular case, the European Economic Government, would be the reduction of conflict that may otherwise occur. A common fiscal and economic policy in the euro area would not only avoid conflict about diverging policies but it would also enable the reduction of macroeconomic imbalances between member states by increasing the degree of policy coordination.

Accordingly, to avoid conflict as it has been described in the foregone paragraph, nation states enter into international regimes with one another. Regimes, as they are understood by Keohane, have been defined by Krasner (1983, p. 2) who said that they are ‘sets of implicit or explicit principles, norms, rules and decision-making procedures around which actors’ expectations converge in a given area of international relations.’ Following Keohane (2005), the scope of those international regimes is closely linked to issue-areas. This is because governments enter in to regimes in order to handle particular issues that are closely linked, so that they ideally should be solved on a supranational level. In the particular case of the euro zone, the member states have a common currency. Hence they are expected to be confronted with equal problems, not only regarding the ‘issue-area’ of monetary policy, but also regarding fiscal and trade cycle policy. Therefore, the issue-area that shall be covered with the introduction of a European Economic Government is the pursuit of a common economic policy within the euro zone.

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10 | P a g e pros and cons, not support the introduction of a European Economic Government. However, since they feel the pressure from other nations to do so, or feel that their influence on the decisions is not that decisive, they are rather inclined to adopt a particular position. A particular example of this behaviour could be observed in the Netherlands, where the Prime Minister Mark Rutte was first reluctant to support the idea of a true European Economic Government. However, he adapted his mind after a while, announcing that the Dutch government is open for the introduction of a European Economic Government and the enforcement of stricter rules and punishments on non-compliant nation states11. Therewith, he was approaching the position of France and Germany – nation states that are considered to have the most influential power within the euro zone.

Examining more closely the development of regimes, Keohane (2005) observes that one reason for the creation of regimes is the expectation of actors that they will result in agreements that are mutually beneficial for the participating actors. This is because regimes are expected to increase the legal liability and the degree of information that is available, while simultaneously decreasing the uncertainty and the transaction costs that would otherwise occur. In the background of the crisis, it has become apparent that one problem in the euro zone is the absence of monitoring bodies in the euro zone, which ensure the member states’ compliance to the rules, such as the Stability and Growth Pact (Welfens, 2011). The introduction of new rules and of monitoring bodies and institutions to supervise the adherence to those rules always comes at a cost, which every single member state is confronted with. However, with the introduction of a common institution that is monitoring the activities in all member states, the particular member states can decrease their individual monitoring costs while still enjoying the full benefits of such a control mechanism.

Another issue that Keohane (2005) is pointing at is the question of whether the partners comply with the rules and norms that have been set up by the regime. Neoliberal institutionalists allege that compliance is essential to the functioning of regimes. Next to monitoring the single members, another measure to increase the probability that governments will comply with the rules and norms that have been set up by the regime are to give them incentives to do so – be they of a positive nature, e.g. in the form of bonuses, or of a negative nature, e.g. in the form of penalties. Furthermore, governments will always be concerned about their reputation and would therefore comply, since a bad reputation

11_{‘Rutte tevreden met overleg Merkel en Sarkozy’ in De Volkskrant;}

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11 | P a g e would weaken the international position of that particular country. In the case of a European Economic Government, the compliance to agreed-upon rules and norms can be reinforced by the presence of a surveillance mechanism that will supervise the compliance and adherence of the member states, as it has been proposed by the Task Force (European Council, 2010). Accordingly, the surveillance mechanisms of the euro zone have been newly defined and enhanced in September 2010, including the idea that non-compliant countries can be fined more easily12. Next to the problem that non-compliance of some states can menace the whole international regime, it will also negatively affect a particular country’s reputation. In the current euro crisis this has been the case, since those countries which are considered to have caused the euro crisis have won notoriety as the PIIGS-countries13 - a quite unpleasant title.

2.2. The triggers of the euro crisis

While the euro zone member states and the euro as such are in a crisis, the reasons for this are highly debated amongst experts, politicians and the society as such. The following section is going to elaborate on the reasons behind the crisis and explains how the euro zone members have run into the financial turmoil they are now in.

The reason which has been discussed the most is the high level of sovereign debt that some euro zone member states have incurred over the past years. For some years already, countries have engaged in extensive borrowing from mostly foreign investors. Higgins & Klitgaard (2011) argue that a result of this excessive engagement in foreign borrowing has been that some countries, such as Greece and Italy, have incurred huge saving imbalances. This means that the domestic investment spending has exceeded the domestic saving. In order to compensate for this, the concerned countries started to engage in foreign borrowing, which resulted in their economies being heavily dependent on foreign capital. This capital was mostly provided by countries where the domestic savings were exceeding the domestic investments, such as Germany. Hence, the investors, be it private investors, such as banks, or the government itself, in those countries could use their excess capital for profit-yielding foreign investment. Due to a sharp decrease in investor confidence resulting out of the transatlantic banking crisis, private foreign lending to those

12_{European Commission: http://ec.europa.eu/economy_finance/economic_governance/index_en.htm}

(retrieved: 25th of October 2011)

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12 | P a g e countries at one point ceased to exist, provoking severe turmoil due to a lack of capital in the concerned countries (Higgins & Klitgaard, 2011).

Accordingly, the second trigger of the euro crisis is the transatlantic banking crisis (Welfens, 2011; Collignon, 2010a; Heise, 2011), which started in 2007 with the rise in subprime mortgage defaults (Brunnermeier, 2009). The transatlantic banking crisis has heavily influenced the economies in the euro zone and the European Union as a whole, inasmuch as European banks had largely suffered from the crisis and its consequences. Since banks are a major source of financing for government debt in Europe, the healthiness of banks is crucial for the healthiness of national economies. Particularly during a crisis, the importance of banks and of the strategic role they incorporate is rising (Welfens, 2011). This is especially true taking into consideration that the risk of sovereign debt and the risk of bank debt are closely related. Those countries that had to recapitalise the banks during the transatlantic banking crisis were facing an increased level of government deficit afterwards. This was in turn resulting in a lower sovereign debt rating, which was not only increasing the financing costs of the government and of firms, but also of the banks, respectively (Welfens, 2011).

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13 | P a g e currency in 2002, the exchange rate could not serve as an adjustment mechanism any more, leading to increasing sovereign debt levels in particular member states (Higgins & Klitgaard, 2011). Hence, diverging economic development in the EMU is another factor which has triggered the sovereign debt crisis in Europe.

With respect to diverging economic developments within Europe, another argument refers to the fact that the economic policy reaction towards particular events has been rather slow due to a long process of coordination which is necessary, before actions can be taken. This extensive process not only causes a loss of valuable time, but, even more importantly, can reinforce the uneven distribution of wealth within the member states (Dullien, 2008). In particular, this is because all euro zone member countries have the same interest rate of the European Central Bank. This reinforces economic growth in strong countries in times of a boom and prolongs this boom artificially, while it may be restrictive on other national economies which are encountered in diverging periods of the trade cycle. Therewith, the economic conditions in strong countries and hence the economic disequilibrium in the euro zone are even reinforced. Fiscal policy, which is coordinated on a supranational level, may even be restricting particular national economies, finally resulting in an increasing gap between strong and weak national economies (Dullien, 2008). As the economic development within the euro zone is not equal, the fiscal and trade cycle policy has not been equally beneficial to all of the member states. Busch (2010) adds to this, that the EU is lacking some important characteristics which could promote a higher degree of equality within the euro zone. Particularly, he claims a financial equalisation scheme, a common social security system, and a wage-policy that is standardised within the European Union.

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14 | P a g e the euro against financial turmoil, e.g. caused by a crisis. Collignon claims that the only measure which can help in achieving a higher degree of stability is the introduction of a centralised government for the whole euro zone. In his view, voluntary coordination is not appropriate for the economic policy anymore.

That there is a need for political reforms in the economic governance within the euro zone has also been illustrated by the fact that the Stability and Growth Pact, as well as the Lisbon Treaty have not succeeded (Ioannou & Stracca, 2011). They have hence not been appropriate measures in order to achieve a higher degree of economic stability within the euro zone. Consistently, an additional trigger of the sovereign debt crisis and the euro crisis has been the malfunction of existing agreements. Ioannou & Stracca (2011) investigated whether the Lisbon Treaty and the Stability and Growth Pact have worked properly and achieved their targets. Particular goals of those two agreements have been the achievement of sound public finances, as well as the appointment of the European Central Bank to an official institution. However, the findings of Ioannou & Stracca (2011) about the effectiveness of those agreements are disillusioning, showing that neither the Stability and Growth Pact, nor the Lisbon Treaty had any effect on the primary balances and growth in the EU at all. The weaknesses of the Stability and Growth Pact that caused a lower degree of effectiveness of the pact have already been discussed by Casella (1999) briefly after the pact has been established. Her concerns have been confirmed by Ioannou & Stracca (2011) and are also supported by Welfens (2011), who argues that a missing surveillance mechanism or monitoring institution have contributed to the limited success of the Stability and Growth Pact.

Finally, De Grauwe (2010) affirms that the ultimate actuator of the sovereign debt crisis has been Greece. The Greek mismanagement, their lack of fiscal discipline and the misleading with regard to the actual economic condition of Greece have been main triggers of the crisis. As the Greek authorities have been sustaining a loss in credibility, their promises regarding a stricter budget policy and their adherence to the austerity policy are expected to face scepticism from the lending institutions and other governments in the following years (De Grauwe, 2010).

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15 | P a g e to answer this question and found that the economic-political instability of nation states is closely related to their credit risk, which is again a determinant of a currency’s exchange rate. Therefore, the economic-political instability has an impact on the currency of that particular country, to the extent that it increases its volatility and may also result in depreciation. Hui & Chung (2011) base their study on earlier findings of other researchers who propose a positive correlation between the economic stability of a country and the strength of its currency. In this context, they make a reference to the work of Carr & Wu (2007), who did a study on Mexico and Brazil and found that prices on the currency option markets already counted for a probable sovereign default of the particular country. This implies that sovereign creditworthiness can be a main determinant of a country’s exchange rate. Hui & Chung (2011) applied this idea to the euro zone countries and presented two main findings of their research. Firstly, their data analysis has indicated that the sovereign credit risk is a main determinant when assessing the risk for a currency to crash. Secondly, they showed that the risk for the euro to crash is not only influenced by the creditworthiness of the countries in a weaker fiscal condition, but also of those that have a relatively strong fiscal position.

Applying this finding to the current crisis, the fall in rate and the volatility of the euro have not only been triggered by the sovereign debt crisis in rather weak countries, but have also been influenced by the economic conditions of the strong countries. Hence, a collapse of the euro has so far been prevented by the economically stronger countries. However, in contrast to those rather strong countries, there are five member states that are currently facing a particularly weak fiscal and monetary situation. Those countries are Portugal, Ireland, Italy, Greece and Spain14 and they have three common features which make them especially vulnerable to any kind of financial threats: first of all, their national ratio of sovereign debt to gross domestic product (GDP) particularly high and in most cases has exceeded 90% during the year 2010 (see table 1), although the Stability and Growth Pact limits governments’ debt to a maximum of 60% of the debt to GDP ratio (Welfens, 2011). Secondly, they have to cope with an extraordinarily high budget deficit, as they are all exceeding the rules of the Stability and Growth Pact which limits the budget deficit to a maximum of 3% of the GDP (Welfens, 2011). Finally, Higgins & Klitgaard (2011) found that the above-mentioned countries have incurred large account deficits for a number of successive years, which resulted in increasing interest rates on national debt that those

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‘Can the Euro still be saved?’ in Spiegel International;

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16 | P a g e countries had to cope with. Accordingly, those countries have been hit the most by the current crisis. Next to the five abovementioned states another state that may encounter serious financial trouble due to large account deficits is Belgium. One additional section in the appendix (Appendix I) is dedicated to those countries and will include a brief description about the situation in those countries, the reasons for this and what measures are currently being taken to guide these countries out of the sovereign debt crisis.

GDP (mln. €) public debt (mln. €) debt/GDP budget deficit

euro zone (E-17) 9,204,316 7,837,207 85.1 % -6.0%

EU (EU-27) 12,280,644 9,828,232 80.0% -6.4% Portugal 172,546 160,470 93.0 % -9.1% Ireland 153,939 148.074 96.2 % -32.4% Italy 1,548,816 1,843,015 119.0 % -4.6% Greece 230,173 328,588 142.8 % -10.5% Spain 1,062,591 638,767 60.1 % -9.2% Belgium 352,324 341,019 96.8 % -4.1%

Table 1: Sovereign Debt (Eurostat Annual Data of 2010) – Eurostat, 26 April 2011

Taking into account the severe financial situation in some member states, the claim for the introduction of reforms becomes more understandable. In the background of the current crisis in Europe, the next section will show that the European Commission has already taken first steps towards a higher degree of economic cooperation and supervision on a supranational level.

2.3. Policy Amendments – Europe is already on the way

Although a decision whether a ‘true European Economic Government’ should be established has not yet been made and is still highly debated, the EMU is already on its way to stricter fiscal discipline, a higher degree of balanced budgets and stronger economic and budgetary coordination between the different member states15. One step towards greater convergence and an increased degree of harmonisation and coordination of the member states has been the adoption of a legislative package in September 2010. This package has been created based on the ideas of Herman Van Rompuy and his task force (European Council, 2010) and it is including four different goals which should be achieved in the near future. The first goal is to take stronger preventive action by reinforcing the Stability and Growth Pact and hence achieve deeper fiscal coordination. Secondly, this reinforced Stability and Growth Pact should result in stronger corrective actions, such as

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17 | P a g e the improvement of the Excessive Deficit Procedure (EDP), which has so far been a rather weak mechanism (Welfens, 2011; Ioannou & Stracca, 2011). Additionally, the introduction of minimum requirements for national budgetary frameworks is expected to ensure a higher degree of compliance with the reference values for deficit and debt, as they have been initially agreed upon in the Stability and Growth Pact. Finally, the legislative package also aims at preventing and correcting macroeconomic and competiveness imbalances by employing a surveillance mechanism. In consistency with this, the Excessive Imbalance Procedure has been introduced to overcome the existence of large account imbalances16.

A particular mechanism that has already been implemented is the introduction of the European Semester, as it has also been recommended by Herman Van Rompuy and his task force (European Council, 2010). The European Semester should warrant that the European Commission can supervise and influence national debates regarding budget- and economic-political decision-making (Klatzer & Schlager, 2011). Following the idea of the European Commission, this should enable more effective policy coordination and increase the degree of European policy integration on the national level. Accordingly, the idea of the European Semester is that the budget planning process on a national level will include guidance and some degree of supervision from the European Commission, the Council of Ministers, the European Parliament, as well as the European Council17.

The Euro+ Pact is another instrument which has been established in order to achieve a higher degree of convergence regarding the economic-political decision making and to address the economic imbalances between the particular member states of the euro zone (Heise, 2011). This pact is integrated into the idea of the European Semester and includes further steps to be taken towards a higher degree of convergence. Next to the establishment of a European Systemic Risk Board (ESRB) which should oversee the financial system, the rules for the financial sectors have been tightened, and banks have been put under stress tests in order to test for their reaction towards another crisis18. However, the efficacy of these stress tests is currently debated controversially, since the manner of testing the banks has been found to be inadequate19. Hence, the stress test has

16 _European _Commission; _{http://ec.europa.eu/economy_finance/economic_governance/index_en.htm}

(retrieved: 25th of October 2011)

17_{European Commission;}

http://ec.europa.eu/economy_finance/economic_governance/images/european_semester_en.htm (retrieved: 25th October 2011)

18_{European Commission: http://ec.europa.eu/economy_finance/economic_governance/index_en.htm}

(retrieved: 21st November 2011)

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18 | P a g e not been found to be a reliable indicator for the healthiness of the European banks and gives room for improvement.

Due to the ongoing financial turmoil within the euro area, the Heads of State and Government in the euro area congregated for an EU summit in Brussels on the 8th and 9th of December 2011. As a result of this summit, they have moved towards a fiscal stability union by agreeing on a fiscal compact (European Council, 2011). The fiscal compact included the setting of a targeted annual structural deficit of 0.5% of the nominal GDP. This holds for all nation states that agreed to the compact and is designed in the style of the German debt brake. Additionally, it has been resolved that an automatic correction mechanism for national budgets and a stricter extensive deficit procedure have to be enacted (European Council, 2011).

In addition, further stability mechanisms which should sustain the stability of the euro and of national budgets have already been stipulated in contracts before the summit in December 2011 and were planned to be put into place from July 2013 onwards (European Central Bank, 2011). These stability mechanisms include the provision of funding to particular member states who encountered financial distress, as well as the introduction of a European Stability Mechanism (ESM), which is going to supersede both the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM). However, another result of the EU summit in December 2011 has been an earlier coming into force of the European Stability Mechanism. While the ESM will already come into effect in July 2012, the EFSF is said to continue until mid 2013 (European Council, 2011).

Although some measures have already been implemented or are at least under way, some European governments, as well as the board of the European Central Bank are urgently calling for a reform which goes a step further and includes the introduction of a common governing institution. This body should enable the supervision of the economies of the member states, coordinate their economic activities and hence also protect the threatened countries from bankruptcy or any other kind of financial turmoil.

2.4. A ‘true European Economic Government’

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19 | P a g e Economic Government. In their view, such an economic government is expected to combat three sources of financial crises, as they have been unveiled in the course of the sovereign debt crisis. Accordingly, a joint European Economic Government is expected to ensure member states’ compliance to common conventions. Furthermore, it should account and correct for an uneven economic development in the euro zone. Finally, such a government should serve as a monitoring institution for the national budgets and financial markets in Europe. Four of the models for such a European Economic Government which have been proposed by its advocates are going to be discussed in the following.

2.4.1. A central European budget

The central element of the proposed model of De Grauwe is the introduction of a centrally set common European budget, which goes beyond the scope of the current EU budget. In his view, this is crucial, not only as a ‘redistributive device’, but also as a stabilizing mechanism (De Grauwe, 2006). In De Grauwe’s opinion for a common economic government to be effective it needs to possess some particular characteristics.

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20 | P a g e However, for these decisions to be reinforced properly, another suggestion of De Grauwe (2006) is to give more decision-making ability and accountability to the institutions in the EU and to employ politicians who serve as an economic government. Another issue which is of particular importance in this context is the relaxation of the inflation target in the euro zone in order to facilitate that countries can balance their national budgets. The proposed measure of De Grauwe (2006) would be to increase the current target from 2% up to 3%. In his view, the current inflation target is too strict and does not allow member states to regain their productivity and competitiveness once they have experienced an economic downturn.

2.4.2. The fourfold paradigm shift

Another idea for the designing of a European Economic Government has been presented by Busch & Hirschel (2011). They have proposed the introduction of a European Economic Government, the supervision of the growth strategy, the coordination of European wage, social and tax policy, and the introduction of rules on the financing of sovereign debt. Hence, they call for a ‘fourfold paradigm shift’.

In particular, the first of the four paradigms implies that the member states set up a common strategy with respect to qualitative growth and employment. Following the idea of Busch & Hirschel (2011), this includes the improvement of the infrastructure and the environment in the euro zone. Moreover, it also comprehends a strong stimulus for domestic demand in those countries, which are currently having a positive account balance. In addition, Busch & Hirschel suggest the introduction of Eurobonds, a common European bond that should enable the debt financing of all member states. Busch & Hirschel (2011) contend that the introduction of these Eurobonds can stop the counterproductive austerity policy, which has been imposed on some countries. . They consider the imposition of austerity on indebted nation states to be counterproductive, because the history has shown that states can only abandon the debt trap by reflating the market. However, in order to boost the economy, further investments are needed and they can only be made if the concerned countries are contracting even more debt.

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21 | P a g e elected democratically and will then be able to establish an economic government that is responsible for the fiscal policy in all euro zone member states. However, this requires an increase in the EU’s economic political competences. In an earlier paper, Busch (2010) has already plead for a strengthening of the role of the European Commission, postulating that it should be responsible for the basic framework of economic policy, which also includes the setting of guidelines for the national budgets of the euro zone member states. This government will subsequently help to tackle future crises, to set-up a flexible policy mix, and to avoid future unequal development in the euro zone. This framework would have to be approved by the European Council through an ‘ordinary legislative procedure’, as it has been defined in the Lisbon Treaty.

Next to this, Busch & Hirschel (2011) include the idea of a higher degree of wage, tax and social policy coordination into their model of the future economic governance in the euro zone. They require coordination aiming at achieving a common European wage policy, a common social security system and the avoidance of social and tax dumping. Herewith, they do not only tackle the problem of economic inequality amongst the member states, but also address the social dimension in their modelling. Only recently, Fischer & Hoffmann (2011) have remarked the consideration of social policy within the European economic governance, since the focus has so far only been on coordinating the economic, but not the social activities of the particular member states.

Finally, the fourth paradigm of their theoretical considerations affects the financial market and it is the introduction of common European rules on the financing of sovereign debt. Busch & Hirschel (2011) argue in support of Eurobonds, which should unite the sovereign debt of the euro zone member states in one pool. Following this idea, the Eurobonds should be used for existing and future sovereign debt. The direct result of those Eurobonds would be a decrease in debt financing costs, especially for the financially weaker member states of the euro zone.

2.4.3. A preventive and a reactive arm

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22 | P a g e macroeconomic imbalances. However, if this preventive arm proves to be unsuccessful, reactive instruments that are centrally coordinated on the EU-level become effective (Arbeitskreis Europa, 2010). Following the opinion of the working group, European economic policy is in need of a recollection to the ‘magic square’ and its virtues, as well as institutional innovations, such as the introduction of a European Monetary Fund (EMF).

The preventive arm does not include the establishment of a real government. It rather implies the extension and improvement of European governance by requiring that the member states are independently shaping their economic policy while simultaneously respecting a certain degree of obligatory coordination regarding some central macroeconomic parameters, such as wage and fiscal policy (Aus dem Moore, 2010).

However, in case this coordination is resulting in macroeconomic imbalances, the Arbeitskreis Europa requires that a reactive arm comes into force (Aus dem Moore, 2010). Its main task is the prevention of sovereign bankruptcy or the resignation of particular states from the euro zone and the main instrument will be an institutionalised European Monetary Fund (EMF). This EMF as an institution should be linked to the Eurogroup, the regular gathering of the Ministers of Finance of all EMU member states20. Furthermore, it should receive recommendations for decision making from a steering board that in turn consists of a group of experts coming from all member states (Arbeitskreis Europa, 2010). The financing sources of such a fund should be threefold, comprehending financing from a tax on financial transactions, the emission of Eurobonds, as well as payments-in of the member states, as it is also practised in the International Monetary Fund.

Conclusively, two important characteristics of the EMF are that it shall not be financed with sanction payments that have to be made by member states that did not comply with the rules. Additionally, the emission of Eurobonds should not be permanent, but only be actuated through the EMF if necessary. Hence, sovereign debt funding will be dealt with on a national level as well.

2.4.4. More democratic legitimacy

The idea of Collignon (2010b) to increase the degree of democratic legitimacy within Europe aims at the actual centralisation of macroeconomic decision-making on a European level. In his model, the European Commission is evolving to a European Economic Government that is democratically controlled by the European Council and the European

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23 | P a g e Parliament (Aus dem Moore, 2010; Collignon, 2010b). Collignon suggests that the ‘ordinary legislative process’, as it has been defined in the Lisbon Treaty, should be used as an instrument to conduct macroeconomic decision-making in Europe. He sees the necessity of introducing such a government, because in his opinion the political system of the EU is so far missing its democratic legitimacy.

The suggestion of a restructuring of the Stability and Growth Pact includes the definition of a common European budget stance, which aims at achieving macroeconomic stability through surveillance. Additionally, Collignon (2010b) suggests the introduction of so-called ‘tradable deficit permits’, as it has also been discussed by Casella (1999). Furthermore, he suggests the definition of ‘Broad Economic Policy Guidelines’ that are defining optimal borrowing requirements for the euro zone. Only if the Commission, the Council and the European Parliament have found that a country is compliant to these guidelines, they will distribute borrowing permits which allow the country to take out a particular (restricted) amount of debt. However, this amount is determined by a level of debt, which is set on a European level and will be distributed among the member states according to their contribution to the GDP of the euro zone (Aus dem Moore, 2010). Hence, this mechanism, which works in a similar way than the Special Drawing Rights Procedure of the International Monetary Fund21, is to avoid a future sovereign debt crisis by making more financing sources available to the member states. However, if countries are in need of additional capital in the short term, they will also have the possibility to trade the deficit permits with other countries and hence extend their credit line.

Examining the foregone four models more closely shows that they have some characteristics in common. First of all, all models plea for more coordination regarding macroeconomic decisions. Particularly, the authors call for the set-up of centralised or at least coordinated strategies regarding growth, employment, wage policy, social policies, etc. The authors aim at achieving higher macroeconomic stability and lower macroeconomic divergence within the member states when suggesting the centralization of macroeconomic decision-making. Another common denominator of the propositions for an economic government is the introduction of Eurobonds as a common source of financing. The Arbeitskreis Europa (2010), Busch (2010) and Busch & Hirschel (2011) include the introduction of those common bonds into their proposals. And also De Grauwe has already plead for the emission of Eurobonds (De Grauwe & Moesen, 2009), although it is not an

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24 | P a g e explicit component of the model which is discussed within the scope of this study. Hence, there is a broad consensus about Eurobonds being an adequate source of financing in the euro zone.

Accordingly, all models that propose the introduction of a European Economic Government have common denominators, although they are proposing different institutions to perform the actual work of a government. Conclusively, the introduction of an institutionalised common economic government for the euro zone would imply a common strategy of the member states regarding their macroeconomic decisions, as well as an intensification of the economic coalescence of the EMU member states inasmuch as Eurobonds are going to be issued as a common source of financing.

In addition to these specific propositions, some proposals have been made, which do not include the concrete set-up of a government, but favour the intensification of economic governance in the euro zone. Examples for these proposals, as they have been discussed by Heise & Görmez-Heise (2010), are from Mabbett & Schelkle (2010), Jacquet & Pisany-Ferry (2001), and Dullien & Schwarzer (2009). One section in the appendix (Appendix II) is dedicated to the depiction of those particular suggestions.

2.5. Against a European Economic Government

Just as there are promoters of the introduction of a European Economic Government, there are opponents to this idea as well. When discussing some of the suggestions for a European Economic Government, Aus dem Moore (2010) argues for an extension of economic governance instead of the erection of a European Economic Government. In his view, the structures of supranational decision-making and coordination in Europe do not necessarily need to be revolutionised, but rather be reformed. Next to problems of implementation, he also predicts problems with the incentive and the legitimation if a European Economic Government is going to be introduced. During a reform, which Aus dem Moore (2010) considers to be inevitable, three main aspects should be addressed: the reformation process should lead to an improved economic-political surveillance of structural deficiencies, to a reinforcement of the Stability and Growth Pact, as well as to the establishment of permanent stability mechanisms, such as the European Stability Mechanism (ESM).

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25 | P a g e preservation of national sovereignty, which he considers to be the basis of the success of improved economic-political coordination. In his view the optimal economic policy for a country can only be achieved in national responsibility. Supportingly, Fahrenschon (2010) is spotlighting three particular dangers that may arise out of the introduction of a European Economic Government. The first of those dangers he sees is that the competitiveness within Europe may be levelled instead of improved. This is because a European Economic Government involves the risk that competitiveness in Europe will only be measured against the remaining member states, where American and Asian competitors may be disregarded. Secondly, Fahrenschon (2010) fears that the independency of the European Central Bank may be threatened by the establishment of an economic government. In third place, he admonishes that Europe may be transformed into a transfer union within which economically stronger countries would be held responsible to support economically weaker ones.

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3. Methodology

Since there is yet no answer to the main research question which is empirically observable, the employment of questionnaires is considered to be an appropriate means in order to accomplish the research. The distribution of questionnaires offers a possibility to explore people’s opinion about a certain topic and therewith can help in gathering a general impression about how this topic is being evaluated by the society. The use of questionnaires as a data source may be particularly interesting in the present case taking into consideration that the German constitutional court has advised the European governments to make use of a public referendum in order to finally make a decision about whether a European Economic Government shall be introduced or not22. Consistently, the results of this study will be able to give a first intention about how the participants are evaluating the idea of implementing a common European economic government in order to improve economic coordination in the euro zone.

Although the employment of questionnaires as a source of primary data has a lot of advantages, there are also some problems connected to it. In this context, Oppenheim (1966) is especially drawing attention to possible errors in the design of the questionnaire, to the danger of choosing a wrong or too small sample, as well as contortions that can result out of a wrong questionnaire design or ambiguous question wording. He refers to ambiguous questions as leading questions, since they are designed in a way that they are subtly leading to a particular answer of the respondent. This issue receives support from Payne (1973) who stated that the phrasing of questions within questionnaires is crucial to the reliability of the results, since the wrong phrasing may manipulate the respondents’ opinion. Additionally, Payne (1973) is warning researchers not to take too much pre-knowledge for granted and not to make too many assumptions, as this is another source of biased answers.

In order to account for those possible errors, Payne (1973) has come up with a list of 100 items that have to be taken into consideration when designing and distributing questionnaires. The questionnaire that has been used for the present study has been designed following this checklist and is hence expected to be conceptualised in a way that the possibility of making common phrasing errors and receiving biased responses has been reduced beforehand as much as possible. In addition to this, some basic rules of question wording have been respected, such as the advice that the questions or statements should

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27 | P a g e not consist of more than 20 words (Thomas, 2004). In order to account for a bias due to language difficulties, the German and Dutch respondents have been provided with a translated version of the questionnaire. Hence, next to the English questionnaire that is appended to this study, two versions in German and Dutch have been literally translated by native speakers of the accordant language and distributed to the respondents.

In addition, the questionnaire has been tested by discussing it with a representative of the group of academics and a representative student before it has been sent out to the targeted group of respondents. Therewith, the questionnaire has been tested for face and content validity as discussed by Litwin (1995).

3.1. Questionnaire Design

The questionnaire that has been distributed (Appendix IV) consists out of 19 statements regarding which the respondents had to specify their level of agreement or disagreement. Each of the statements has five scales of answering. These attitude scales have been inspired by the Likert-scale (Likert, 1932) ranging from strong agreement to strong disagreement. The particular alternatives to choose from in this study are strongly disagree, disagree, neither agree nor disagree, agree, and strongly agree. In addition, the questionnaire has been designed in a way that its order follows the research framework of the literature review. The questionnaire is asking for the people’s degree of agreement regarding four different issues as they have been discussed in the foregone literature review. Hence, it is thematising supranational cooperation in Europe in general, triggers of the sovereign debt crisis, the EU’s reaction on the crisis, and the idea of a common economic government in Europe. Those four topics are used as indicators for the respondents’ overall opinion on the introduction of a European Economic Government. This structure resulted in the questionnaire consisting out of four different blocks of questions.

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28 | P a g e order to heal the beleaguered financial markets and sovereign budgets are the issue under investigation in a third group of statements. This group comprehends only two statements and serves as a link between the second and the fourth block of questions. The last group includes seven statements dealing with the introduction of a European Economic Government and aiming at unveiling people’s opinion about whether or not such a government should be introduced and, if so, how it should be designed.

Conclusively, the questionnaire also offers the possibility to leave comments in a free-text field where respondents have the possibility to make clarifications or leave any remarks. It is anticipated that the content of the text field can help to reduce uncertainty and bias in the answers and that it will further clarify the given answers.

3.2. Data Sample

A main source of difficulties when employing questionnaires as a means of data collection is that the issue under investigation may not be sufficiently known by the targeted respondents (Payne, 1973). This lack of background knowledge may create biased answers and can hence decrease the reliability of the obtained results. In order to account for this, the present study controls for sufficient background knowledge of the respondents by distributing the questionnaires among a group of people, who are expected to have a particular interest in the topic. Therewith they are expected to command a basic knowledge about the research topic. The target group of people that have been asked to fill out the questionnaires comprises students, academics, politicians and professionals who study or work in the field of finance. Thus, the target includes students, PhD students, as well as professors, researchers and teachers in that field of research. Furthermore, the questionnaires have been distributed to politicians and ‘practitioners’, i.e. in banks or the parliamentary committee for finances in the Dutch and German parliament. Additionally, the questionnaire has been distributed to employees of an audit firm, who were also expected to possess the required background knowledge to meaningfully complete the questionnaire.

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29 | P a g e and Dutch parliaments. They are expected to possess the required background knowledge, too, and to enhance the quality of the study by adding to it another perspective.

3.3. Independent Variables

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30 | P a g e opinion is anticipated. The particular options to choose from in this context were student/PhD, academic, politician, and other.

With respect to the number of respondents that have to be achieved in order to obtain robust results that are interpretable, Roscoe (1975) defined that sample sizes larger than 30 but not exceeding 500 are appropriate for most research. This is because if a sample is bigger than 30 the ‘central limit theorem’ holds. This theorem alleges that a researcher can make use of the normal probability distribution for tests and calculations, while the sample can have any form of skewed distribution (Roscoe, 1975). Additionally Roscoe argues that a sample smaller than 500 assures that the sampling error is not going to exceed a certain threshold value. For the present study, it was desirable to find at least 75 respondents. This target number of responses has been set because it was found to enable a sound and convincing analysis of the results and of the influence of the independent variables, respectively.

3.4. Data Collection

The questionnaires have been distributed from the 14th of November, 2011 onwards and the respondents were given one month to complete the questionnaire and return it. Most of the questionnaires have been distributed via email. In addition, hardcopies of the questionnaires have been distributed to a group of students in the course of a lecture which was related to the topic of this research. Throughout the inquiry period, the daily return rate of questionnaires was relatively consistent. In order to increase the response rate of this group towards the end, the politicians that had not reacted by that time received a reminding email approximately one week before the end of the inquiry period.

Overall, the response rate of the survey has been more than satisfying, summing up to nearly 65%. The final number of questionnaires that has been received on the 13th of December, 2011, after a month of data-collection, was 224. All questionnaires were returned within the scope of the predefined inquiry period. A review of the questionnaires yielded a total number of 203 questionnaires that have been filled out correctly and completely, which made them suitable for the subsequent evaluation and analysis. Additionally, another 43 of the contacted persons have responded to the email but refused the completion of the questionnaire due to various reasons, such as a lack of time or the feeling that they do not have the expertise to adequately complete the questionnaire.

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31 | P a g e been younger than 40 years, the remaining 38 participants were 40 years or older. Additionally, 69 of the 203 respondents have been female, whereas the remaining 134 questionnaires have been completed by men. Finally, the profession-wise evaluation showed that 140 students, 23 academics, 30 politicians, as well as 10 respondents that work in other professions have contributed to the study. Although the last group is relatively small, it has been retained in the study because those respondents’ opinion has indicated to add another perspective to the study.

Finally, the questionnaire included the possibility for the respondents to specify whether they are available for a follow-up interview. Although some respondents have volunteered in this context, this opportunity has not been used. This is because the comments that have been made in the free-text field have already been of high quality and therewith enabled a profound interpretation of the results that have been obtained. A selection of the comments that were made is included in the appendix (Appendix V).

3.5. Statistical Testing

Next to being analysed and interpreted, the obtained results are going to be statistically tested, too. A literature study on statistics for social sciences and questionnaire testing (e.g. Aron & Aron, 2003; Russo, 2003; Sirkin, 1999) resulted in the choice of statistical tests that are described in the following.

In first place, the central tendency of the answers is measured by determining the ‘median’ and ‘mode’ of the answers that have been given. While the median specifies ‘the value that divides that sample in two equally sized sets’ (Russo, 2003, p.21), the mode represents that particular class of answers that has been chosen most frequently by the respondents (Sirkin, 1999). In addition to that, the dispersion of the answers is going to be visualised using bar charts.

Furthermore, the ‘chi-square test’ (χ2-test)for significance is performed in order to see if the independent variables have an impact on the results. However, since the χ2-test has some prerequisites which have to be respected (see Sirkin, 1999, pp. 402ff; Russo, 2003, p. 45), an adjustment had to be made to the data: The five scales of answering have been collapsed into three scales in order to warrant the feasibility and validity of the χ2-test. Consequently, the scales of answering as they are tested are Disagree (including strongly disagree and disagree), Neither agree nor disagree, as well as Agree (including agree and strongly agree). The significance is going to be tested at a 10%-level.

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32 | P a g e

χ2

= �(fo – fe)²_fe

where, fo defines the observed frequencies in the contingency table and fe defines the expected frequencies, respectively (Sirkin, 1999).

Additionally, ‘Cramer’s V’ (or Cramer’s ϕ), is going to be calculated as a contingency coefficient for the test of significance. If the independent variables have been found to significantly influence the answers of the respondents, a contingency coefficient can measure the extent of this relationship by indicating its effect size (Aron & Aron, 2003).

Cramer’s ϕ is calculated with the following formula: Cramer’s ϕ = � χ

2

m × n

In this formula (Sirkin, 1999), n specifies the number of observations that are included in the cross table and m presents the minimum of either (rows – 1) or (columns – 1).

Effect size indices have been extensively researched by Cohen (1988), who also defined the accordant definitions for small, medium and large effect sizes. Whether an obtained Cramer’s ϕ indicates a small, medium, or large effect size depends on the degrees of freedom of the contingency table. The following table specifies Cohen’s effect size threshold values for Cramer’s ϕ, as they have been defined by Cohen (1988, p.222) and summarised by Aron & Aron (2003, p.248):

Smallest Dimension of Contingency Table 2 (dfsmaller = 1) 3 (dfsmaller = 2) Effect Size small 0.100 0.071 medium 0.300 0.212 large 0.500 0.354

A EUROPEAN ECONOMIC GOVERNMENT – A WAY OUT OF THE CRISIS?

M.Sc. International Financial Management