Is the EU falling apart – or falling together?

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The European Central Bank in Frankfurt is playing a key role in deciding the future of the Eurozone.

Europe’s choice boils down to: more federalism or lose the euro – By Steven Hill

November 9, 2012

A quiet breakthrough occurred recently, led in part by German Chancellor Angela Merkel who seems to have rediscovered her pro-Europe side. Spurred by the ongoing debt crisis and the Greece standoff, political leaders have dropped the indecisiveness that has plagued them for the past two years, and taken greater strides toward further economic and political union. Even the f?word – federalism – has been broached, unleashing controversy yet also badly-needed public debate.

The recent breakthroughs are being greeted with excitement in some quarters, but dread in others. The most-applauded decision was that of European Central Bank chief Mario Draghi to allow the ECB to use its considerable bond-buying firepower to act as a financial backstop for troubled Eurozone states trapped in spiraling debt. Merkel even sided with the ECB over Germany’s own hallowed Bundesbank in supporting the ECB’s new policy, a quite remarkable turn.

Germany has also thrown its support behind a recently proposed Europe-wide banking union. That was followed by several more proposals from European Council president Herman Van Rompuy, most notably for a common Eurozone budget, limited debt mutualisation (eurobonds), and even a Eurozone parliament that potentially could be more powerful than the European Union’s current parliament. European Commission President José Manuel Barroso put a capstone on it all with a dramatic speech that one day may be viewed as historic, in which he called for a federation of nation states.

Barroso’s call was bolstered by the Future of Europe Group, a forum of foreign ministers from 11 EU member states led by Germany’s Guido Westerwelle, which proposed a stronger EU role in foreign and defense policy. Most recently, former Belgian Prime Minister, Liberal MEP leader Guy Verhofstadt and Green MEP leader Daniel Cohn-Bendit added political heft by publishing a manifesto in which they boldly declared “there is no alternative to a federal Europe.”

So suddenly talk of a more federal and integrated Europe is everywhere. A new debate has been unleashed across the continent, and many people are understandably asking: “Why is more European integration necessary? Is more federalism really desirable?”

These doubts are particularly loud in Britain, where public sentiment seems to be running in the opposite direction. It’s possible that steps toward more integration will trigger a future “in-out” referendum on Britain’s membership of the EU. How much federalism is too much?

In weighing these fundamental changes, there are at least two important considerations, centered on what Europe will look like, not just in 2015 but in 2035.

First, it’s important to remember that these decisions are being made in reaction to the ongoing economic crisis and the perils of austerity economics. The current structures of the Eurozone have proven to be woefully inadequate, so which ones would be better?

A look at the most successful federal system for a large continent is instructive. In the United States, there exists a long-standing federal system that collects large amounts of taxes from Americans in all 50 member states into a national treasury that is spent on various nationwide priorities, as decided by a federal government in Washington DC. Little protest is made over which states contribute more to the national pot, or whether Californians or New Yorkers transfer some of their wealth to poorer Alaskans or Mississippians – which they do, year after year, as a normal part of the federal budgeting process. America is a land of considerable member state solidarity; The prevailing philosophy is E Pluribus Unum – out of many, one – as it says on every US dollar bill.

But in the European “Union,” the federal institutions – whether the chief executive, parliament, central bank or regulators – are in their infancy. There is a small treasury – the EU collects about one percent of the member states’ GDP, compared to the US federal government absorbing about 24 percent of America’s GDP – so there are far fewer resources at the European level to deal with a crisis.

Instead of trans-member state solidarity, national and even regional interests zealously track which EU member states are the economic winners and which are the alleged slackers. The Germans, Dutch, French and others suddenly find themselves in the unprecedented situation of having to extend financial assistance not only to the Greeks but also the Portuguese, the Irish, Cypriots and increasingly the Spanish.

In the US, such geographic spreading around of the wealth is normal, but on the European continent, where nations fought bloody wars against each other in the not too distant past, such transfers from the wealthy states to the poorer ones are still controversial. Yet those are an important tool for keeping the continent economically as well as politically stable. If Greece or Portugal, for example, were to sink to failed-state status, it would have a destabilizing effect on other parts of Europe.

But if Greece and Portugal can’t keep up competitively, and have also lost the capacity to devalue their currency as a way of regaining some of their competitiveness, assistance from wealthier states like Germany becomes essential to prevent them from sinking further. The only way to avoid this would be to expel them from the Eurozone, but that entails risks as well; not only short-term contagion risks but also long-term if they can’t adequately police their borders or become further destabilized by populist governments.

So unlike in America, Europe’s crisis has not been simply a policy debate about austerity versus stimulus. It has been an existential crisis over union, cross-border solidarity and how to define self-interest. Should Europeans create a United States of Europe-style, federal system? That’s the looming question. Europe’s choice boils down to: more federalism or lose the euro.

The second reason for more integration and federalism is: Chindia. China and India’s rise as two of the world’s largest economies highlights a new 21st century reality: size matters. In today’s world, population counts as much as productivity toward determining economic power. Even though most Chinese remain poor, China’s rise to the ranks of the world’s second largest national economy makes it one of the world’s largest traders, creditors, markets for commodities and carbon polluters. The decisions it makes shape markets globally. As economist Arvind Subramanian has put it: “GDP and size matter in crude superpower terms. It shows what resources you can bring to the table.”

A Europe composed of dozens of diffuse member states, none of them more than seven percent of the population of China or India, would slowly see its competitive advantages chipped away. Member states would soon be in competition with each other for export markets, even more so than today, instead of fostering continental cooperation and development.

But if Europeans can band together and form some kind of federalized Europe, with a population of anywhere from 350 million to 500 million people, they have a chance to maintain their quality of life and broadly shared prosperity. Unfortunately, the reality is that the current economic and political structures of the European Union, which were fine for a loose confederation of states, are inadequate for a monetary union.

Of course the devil is in the details, and already there are mutterings from Germany, France and elsewhere over certain specifics. And it’s very possible that some EU members, such as Britain, will withdraw rather than being drawn into a tighter union. European leaders are keenly sensitive to the criticisms over the growing “democracy deficit,” in which fundamental changes already have been launched by leaders who, because of the very nature of crisis intervention, are out in front of their publics. Europe-wide democracy has some catching up to do, and Van Rompuy’s proposal for a Eurozone parliament is designed to foster the political institutions necessary to oversee the federalizing of the economy.

European leaders have created a timeline for the proposed reforms that will allow for lots of public debate leading up to the German elections in the fall of 2013 and the European parliamentary elections in 2014, when voters will have their say. But spurred by crisis after crisis, these leaders are not waiting for the roar of a popular mandate; they already are pushing forward toward more integration and federalism. They seem to believe that it is the best hope for Europe in the 21st century, notwithstanding the doubts and confusion expressed in opinion polls.