Crisis of Command
America’s Broken Civil-Military Relationship Imperils National Security
Until recently, and with barely concealed anticipation in the Anglo-American press, it was fashionable to speculate about the imminent collapse of the euro. The idea of an impending implosion is not new; it has been floating around ever since the continent moved toward a single currency. It grew more common during Europe’s debt crisis; in 2011, for instance, analysts routinely speculated about whether Greece or Italy would suddenly be forced out of the eurozone. “Grexit” and other such departures failed to materialize, yet the idea of impending demise persisted. During the Brexit referendum campaign, talk of it reached fever pitch, especially once the result became clear. As the British prime minister improvised an exit, morning newspapers far and wide speculated about “Nexit” and “Frexit.”
History, however, moved in a different direction. In fact, ever since Brexit and the election of Donald Trump as U.S. president, a reverse domino effect has guided European politics. From small countries such as Austria and the Netherlands to behemoths such as France and Germany, anti-European populism has not translated into governments eager to follow the United Kingdom out of the EU or Trump into isolationism. On the contrary. Especially after the landmark election of Emmanuel Macron in France, a newfound enthusiasm for reform has dawned in European capitals.
It is evident even to the biggest euroenthusiasts that the current architecture of the monetary union is profoundly defective. It was imperfect from birth, handicapping not just the single currency but also the EU as a whole. Yet if the status quo is untenable and implosion is a red herring, Europe needs a new guiding principle for reform. That will be all the harder given that the permissive consensus that allowed European elites to integrate by stealth is no longer viable and the gradualist “methodes des petits pas” dear to EU founding father Jean Monnet is out of runway.
European leaders must look to the history of federalism around the world. As the Bretton Woods system waned in the 1970s, an increasingly ambitious European Community moved toward monetary cooperation. Three successive reports to the Commission of European Communities—the Werner Report (1970), the Marjolin Report (1971), and the McDougall Report (1977)—concluded that varying degrees of fiscal federalism were prerequisites for a common European currency, which would itself be necessary for ever closer union. A federal budget would be financed by common taxes and debt issuance among the member states. McDougall, for instance, foresaw a budget of 2.5 percent of GDP in a first, pre-federal phase, when Europe would work to absorb regional economic shocks and make progress toward income convergence across the region. That figure would grow to five percent in a subsequent federal phase.
The proposals set out by the three reports were politically untenable. That reality did not change, but the intellectual backdrop shifted dramatically in the early 1980s. This was when French politician Jacques Delors launched another commission to explore a European monetary system. It concluded that a “common currency unit” was achievable without the commensurate budgetary integration that its predecessors had thought indispensable. Against a backdrop of rising neoliberalism and waning Keynesianism, a “Delors consensus” emerged: it outsourced to markets questions of income convergence, trusting private markets to make up for the lack of a common budget and federal institutions. In short, the intellectual hegemony of neoliberalism made a bare-bones monetary union plausible; Delors’ brilliance was to exploit the changing intellectual paradigm to hide what were the fragile building blocks of a monetary union. Thus the euro was made flesh.
For a decade thereafter, few challenged the Delors consensus that inspired the 1992 Maastricht Treaty, which kicked off European integration with an odd combination of a supranational currency issued by a single monetary authority (the European Central Bank) with strictly national budgets and national debts. It took a global financial crisis to change all that, revealing that a currency union with free movement of capital, no lender of last resort, and no federal budget was “an impossible trinity.”
The crisis that started a decade ago in the United States spread to Europe through the financial system, necessitating gargantuan public support for teetering banks. Soon it was sovereigns that required support: bailouts were needed not only for Greece, but also for Ireland, Portugal, Spain, and finally Cyprus in 2013. Every EU summit turned into an existential panic.The euro hung by a thread.
Only through unconventional monetary and political intervention from ECB President Mario Draghi and Italian Prime Minister Mario Monti respectively did the crisis stop short of Italy, an economy not only “too big to fail” but possibly also “too big to save.” The eurozone edifice was patched, but its foundations remained flimsy. The establishment of the EFSF (European Financial Stability Facility) eventually turned into a permanent ESM (European Stability Mechanism). The banking system was strengthened with the launch of a banking union that created a common supervisor and the contours of a common resolution for banks in distress. These elements provided the tools to respond to future crises but hardly addressed the fundamental flaws of the monetary union.
Draghi’s predecessor, Jean Claude Trichet, described this new arrangement as “federalism by exception” to describe a model in which virtuous countries remain sovereign through “coordination mechanisms” but deviant ones get placed under European administration. The strategy might have sounded plausible to bureaucrats in Brussels and Frankfurt, but the political consequences have been nefarious: from violent protests in the streets of Athens to the Indignados movement in Spain (that spawned anti-establishment Podemos) down to the Five Star Movement in Italy.
In the absence of a real political response, it thus fell on the ECB—Europe’s only real federal agent—to pledge “whatever it takes” to save the euro, to borrow Draghi’s famous phrase half a decade ago. ECB action reversed fragmentation by providing a lender of last resort to the national governments. But the legitimacy crisis has not gone away: the eurozone remains what Tommaso Padoa Schioppa described as a “currency without a state.”
Fixing that problem is a matter of statecraft, not finance. For all its downsides, the pernicious dance of bailouts and monetary easing forced Europe to begin discussing a solution. France’s Macron, for example, put euro reform at the heart of his campaign and now of his agenda for Europe. German reluctance to move on the euro is profound, but not insurmountable. In an age of Brexit and waning trans-Atlanticism, Europe is more valuable to Germany than ever before. Like Bismarck pushing through progressive legislation, in her looming fourth term German Chancellor Angela Merkel is likely to have the political room for a grand bargain with France that transcends currency arrangements.
Angela Merkel will probably have the political room for a grand bargain with France that transcends currency arrangements.
If the need for eurozone reforms is recognized across both sides of the Rhine, the question now is how rather than if. Historically, disagreements between France and Germany have been framed around the idea of a France wedded to a Gaullist tradition reluctant to share sovereignty and a Germany concerned about sharing the economic costs of federal transfers to weaker eurozone members. Today, Franco-German disagreement is about the use political discretion rather than about the rules that have proven to be inadequate to govern the monetary union and the establishment of the democratic institutions to exercise and control this discretion.
Experiences around the world suggest that the eurozone’s political issues run deeper than the economics of a monetary union. This is the reason why Eurobonds—an expression commonly and loosely used to refer to the full mutualization of existing national debt, to be replaced by European debt—have never been the silver bullet that some, in particular in France or Italy, make them to be.
In particular, they either misunderstand or misconstrue the contribution of Alexander Hamilton to the history of U.S. fiscal federalism, whose example they use to argue for the creation of Eurobonds. America’s first secretary of the treasury built far more than a common debt through the one-off assumption of state debts in the Funding Act of 1790. The assumption of state debt was a means to a higher political objective—namely the kernel of a U.S. federal government with tax-raising capabilities and its basic relations with states. This came a long 13 years after independence, during which the nascent republic had been ruled by the ineffective Articles of Confederacy.
Even though state debts had been run up in the fight for independence, Hamilton needed a grand bargain with southerners to get it through Congress. It resulted in a new capital for the federal government established between Maryland and Virginia, today’s Washington. Even then it passed by a single vote. In addition to the assumption of debt, Hamilton envisaged a “no-bailout” clause for states—akin to the eurozone’s no-bailout clause that is so dear to Germany—as a fundamental organizing principle of the American republic.
Because of the political toxicity of the topic, it took no less than a century for the United States to establish the nuances of states’ rights. The American monetary union and its financial architecture came second. It was unified much later, after two wound-up national banks, when it was brought under the control of a federal institution with the creation of the Federal Reserve System in 1913 and its expansion and centralization by President Franklin D. Roosevelt in the 1930s through the deposit insurance (the FDIC) and the Federal Reserve Act. It was only during the Great Depression that the Fed was effectively allowed to perform its lender of last resort function. Without the Hamiltonian moment in 1790 and the Rooseveltian moment in the 1930s, the United States could well have unraveled, as many in the United Kingdom predicted in the 1770s.
Throughout this period, the American states’ defaults of the 1840s and the Civil War acted as catalysts for the clarification of divisions between Washington and the states. They eventually reinvigorated the no-bailout clause when the central government did not intervene on behalf of states, letting them default. But it was only because the clause was complemented by a strong federal government under Roosevelt that the United States proved capable of backstopping its financial system during the Depression, stabilizing the economy and limiting the consequences of disparate levels of domestic development. A cursory look at the ongoing Puerto Rico debt crisis suggests that there are still questions about America’s federalism that have remained unanswered in the centuries that separate Hamilton the man from Hamilton the Broadway star.
This long journey is not unique to the United States. Indeed, all federations have faced it—and some have not survived. It is difficult to agree on the right balance between state and federal expenditure, and to arrange institutions accordingly. The very Germany that has struggled to outlaw eurozone bailouts has a weak “no-bailout” clause for its own regional governments, or Länder. The law has been repeatedly tested since unification; both courts and politics have sided in favor of bailouts. The 2009 debt brake introduced in the German Constitution was meant to strengthen fiscal federalism and impose tighter fiscal rules on the Länder as well as the Federal government. Yet it has not worked according to plan. The complicated negotiations around modifications of the mechanism that organizes income-equalizing transfers between the regional government and the federal government —Länderfinanzausgleich—proves that these matters remain sensitive because they touch the heart of politics, even inside successful, unified federations like Germany.
It is striking that the model that Germany has tried to promote for the eurozone, resting on tight budgetary constraints at the local level and limits on transfers from a federal structure seems hard to sustain even inside its own federation. If anything, both the American and German experiences suggest that only a central budget with spending and borrowing capabilities allowing transfers and stabilization makes a union economically durable, while market discipline at the local level makes it politically acceptable.
Switzerland provides another enlightening precedent. Its individual cantons, which make up the confederation, regularly renew their commitments to fund a federal administration. To keep up with the times and the modern requirements of statehood, the central government in Bern has grown from approximately three percent of GDP to approximately 12 percent in the last three decades. Sovereignty remains indisputably at the canton level, but they come together to fund those activities that are best performed at the national level, including counter-cyclical spending.
All these federations follow different models but have one thing in common; they reject risk-sharing and political interaction based on conditionality and political intrusion. The model that Europe has established in the haste of the crisis does the opposite, and has no international or historical precedent. It is unlikely to have a future.
Today, Europe faces quandaries that transcend its financial architecture, in border security, defense, and migration. In all those arenas, national answers make little sense, hence the push toward common defense spending between Germany and France. Far from obviating work on the currency, however, common defense heightens the need of a Hamiltonian grand bargain beyond the confines of the euro. A new consensus should involve France extending more of its military (and nuclear) support to the rest of the EU, Germany conceding important changes to the governance of the monetary union, and both of them (with Italy) coming together to agree to a common EU migration policy to match a formidable challenge on its borders that is unlikely to go away.
This model would make the monetary union more economically secure, democratically accountable, and socially effective.
For once, the political climate is ripe. Crisis instruments such as the ESM have too narrow a scope and lack democratic legitimacy. But they could be brought under the control of the European Commission and turned into an embryonic treasury governed by an empowered eurozone finance minister, following the example of the creation of a single foreign affairs envoy (the high representative) and be controlled by a eurozone chamber of the European Parliament.
This embryonic federal budget should perform three key duties: upgraded crisis management (like the current ESM does providing a backstop to the financial system), macroeconomic stabilization in the event of regional crises in the form of common unemployment re-insurance, and a convergence fund that would ensure that the monetary union does not fuel permanent economic divergence. This model would make the monetary union more economically secure, democratically accountable, and socially effective. It would closely resemble the Swiss devolution system, in which sovereign eurozone members would endow this ministry with some spending, taxing, and borrowing capability. Assuaging a key concern in northern countries, it would not involve mutualization of members’ existing stock of debt, but only authorize the issuance of new debt that results from commonly agreed policies.
But for such daring steps to come about, one will certainly need either a radical political compromise or another crisis, one that could be triggered when the ECB’s quantitative easing comes to an end. The former is preferable. But in both cases, what is required is a policy leap guided by the Hamiltonian experiences at the birth of the American republic, strengthened by the Rooseveltian revolution of the 1930s, and enlightened by modern Swiss devolution model. A reforming France and a proactive Germany can work to hammer out the contours of such an agreement between now and the European parliamentary elections in 2019. The poll that year could serve as a de facto referendum for the new arrangement, on which leaders such as Macron can and should run.
More generally, the history of federalism should remind us that institutions are not built ex ante. They emerge out of a fragile social consensus; they grow, evolve, and eventually (can) die. Even the most stable political arrangements in the world—including the American republic and British parliamentary democracy—took many, often bloody iterations to get right. They can also decay.
Europe is no different. Its integration and possible unraveling must be taken seriously. The complacency that dominated Europe in the 1990s resulted in a feeling of “inevitability of integration.” It has not worked. Today Europe has a chance to rebuild from the ashes of the Delors consensus a new framework consistent with the history of federalism elsewhere: simple rules, but also a common budgetary authority with democratic legitimacy.
The time between now and the 2019 European election can help us choose the eurozone’s brand of fiscal federalism, with a conversation that should include the other areas of policy where pooled resources and centralized decision-making is required. It will involve external defense, border protection, and migration policy. But that requires a truer, historically informed federal framework, not a patched-up union with outdated intellectual and treaty roots. This is Europe’s most formidable challenge, yet one that at last seems wholly within reach.