Economic and Monetary Union (EUC Report)

Baroness Falkner of Margravine Excerpts

Wednesday 9th November 2016 Grand Committee

Moved by

[Baroness Falkner of Margravine]

That this House takes note of the Report from the European Union Committee ‘Whatever it takes’: the Five Presidents’ Report on completing Economic and Monetary Union (13th Report, Session 2015–16, HL Paper 143).

[Baroness Falkner of Margravine (LD)]

My Lords, I thank all members of the committee who participated in the inquiry. I took over the chairmanship of the committee some 15 months ago. It was a daunting prospect to be chairing a committee comprising a former Chancellor of the Exchequer, a former Cabinet Secretary, a biographer of John Maynard Keynes, as well as several others with a thorough grasp of financial and economic affairs. During the year, we lost the noble Lord, Lord Lawson, as the Brexit campaign made a greater call on his time. The noble Earl, Lord Caithness, and the noble Lords, Lord Davies of Stamford and Lord Borwick, stayed with us through the inquiry, leaving us only at its end. This benefited us greatly, due to their expertise, and I am very much looking forward to hearing from the noble Earl in this debate today.

I also wanted to put on record my gratitude to our specialist adviser, Professor Iain Begg, from the London School of Economics, whose knowledge of EMU is objective, deep and thorough. We are lucky to have that level of expertise in our higher education institutions, given that we are not in EMU. I also take the opportunity to thank our small secretariat—our clerk, John Turner, who like me was new to the committee and had a baptism of fire, and our now departed policy analyst, Katie Kochmann, as well as Victoria Rifaat and Susan Ryan, who were our administrative assistants during the inquiry. All rose to the challenge with admirable speed and professionalism.

In undertaking this inquiry, I was conscious of an irony: that a national parliament of a country not in the eurozone and unlikely at that time to ever join, which is now confirmed through Brexit, was looking at how the situation within the eurozone would evolve, as that was the primary focus of the five presidents’ report. I believe that our committee is the only national parliamentary committee to have produced this level of scrutiny, and I am happy to report that it has been well received in the institutions that have been the subject of our attention.

Our inquiry was a response to a report in June 2015 from five EU presidents: the president of the European Commission, the president of the euro summit, the president of the eurogroup, the president of the European Central Bank and the president of the European Parliament. The report, Completing Europe’s Economic and Monetary Union, to which I shall refer throughout the rest of the debate as the five presidents’ report, was published against the backdrop of the Greek financial crisis after a period when the future of the euro itself seemed under threat. The report sought to build on a range of new institutions and reforms aimed at strengthening economic policy co-ordination, its convergence and of course eurozone solidarity, and to set out what future economic governance was needed to build the eurozone into an optimal currency and fiscal area.

Our starting point was that while we looked at the euro from a position of distance, we wished it well, as the then Chancellor George Osborne had said, as it was in the UK’s interest that the eurozone become a prosperous and competitive currency zone. Our interest was that, as far-reaching institutional changes came about, this would have an impact on the UK’s own economic governance and regulatory environment—hence our taking a more granular look at the proposals set forth in the five presidents’ report. One of the overarching questions that we were attempting to answer was about the future of the euro. It is widely accepted that the eurozone is not an optimal currency zone even at this point in time, and the question was whether the speed and depth of convergence after the financial crisis was adequate to ensure its survival. While several of our witnesses could fault the institutional architecture and balance, it became evident fairly quickly that all believed that so much political will was invested in the project that it would eventually muddle through. I am often asked a similar question in Brussels and Berlin relating to the UK and Brexit. My answer is similar: we too will muddle through.

Among the institutional developments we looked at were: whether the stability and growth pact was being implemented as originally intended; the extent to which fiscal rules were adaptable to shocks; the creation of an advisory fiscal board and the impact of it on the balance between national policy and euro-wide convergence; and banking union, with the ongoing debate between risk aversion and risk sharing.

Lying above all this was the very real concern we had about the distinction between what was needed at a technical level to make the eurozone function better, which was more easily identifiable for us, and the issue of sovereignty and democratic accountability. This was described in the paradox identified by the then Harvard, now Princeton, economist Dani Rodrik, where global markets, state sovereignty and democracy cannot coexist, and policymakers have to pick two of them—any two, as he put it, but he thinks it is not possible to have all three.

We came up against the Rodrik trilemma, as it is known in the economic world, in this inquiry in the judgments as to how far economic, fiscal, financial and political integration could go in the context of what are still sovereign states in terms of their budgets, fiscal policy and democratic accountability. We did not come up with a definitive answer, as too much of the detail of what is needed to move towards those integrations was not spelled out by the five presidents. The key document that will seek to flesh out that detailed institutional structure will come in the form of a White Paper around spring next year, with stage 3 of deepening economic and monetary union to commence from 2025. We look forward to its publication, conscious that the Brexit decision has changed the context quite dramatically for the UK economy and financial services, and therefore our own assessment of those developments.

So what did we find? There have been substantive changes to the stability and growth pact since 2005, particularly since the financial crisis, with the implementation of the six pack and the two pack, involving greater requirements for states to stick to domestic commitments to fiscal discipline, using deficit and debt criteria as metrics, with the Commission needing to improve states’ budgets. Needless to say the measures, while necessary in technical terms, have been implemented within a political perspective. For example, by 2009, most EU countries were under the excessive deficit procedure. Financial sanctions that therefore should have been deployed were not.

The majority of our witnesses saw this as undermining the system. Professor Erik Jones from Johns Hopkins University said that the fiscal framework applied in the eurozone was “completely optional” due to the political calculations employed. Megan Greene from Manulife Asset Management told us that fiscal rules in these circumstances should be set not as binding fiscal rules, but on a case-by-case basis. She gave us the example of Spain’s deficit, which had been 5% in 2014, as opposed to the requirement under the rules to keep it under 3% of GDP, but she thought that Spain was right and needed to run a larger budget deficit to emerge from the recession, as it eventually did.

Another issue was the procyclicality of fiscal rules and their amplification of austerity on growth. Christian Odendahl, from the Centre for European Reform, picked out an omission from the five presidents’ report, in so far as it did not even attempt to suggest that fiscal policy should try to achieve a strong countercyclical stance in a downturn. The report did, however, signal an intention to establish an advisory European Fiscal Board to, inter alia, advise on the prospective fiscal stance appropriate for the euro area as a whole, based on an economic judgment. I quote:

“Where it identifies risks jeopardising the proper functioning of the Economic and Monetary Union, the Board shall accompany its advice with a specific consideration of the policy options available under the Stability and Growth Pact”.

Our witnesses’ concern centred on the extent to which this board would be independent and the extent to which it would be advisory. The board has since been established. Its composition is interesting. The chair is Danish, one of the five members is Polish and the remaining three are from France, Italy and the Netherlands, so 40% of the composition of the board designed to facilitate the functioning of the eurozone is from outside the eurozone—a sign of inclusivity on the part of the eurozone, perhaps.

The other large part of our work was to do with eurozone steps towards risk reduction and risk sharing. Again, it was evident that both entail the pooling of sovereignty. If the emphasis was on risk reduction, inevitably national fiscal stances and national budgetary oversight by the Commission, as well as other surveillance measures, needed to be tightened. On the other hand, if risk sharing was to prevail, there would inevitably be fiscal transfers from some states to others, creating moral hazard. Our witnesses were clear that there needed to be both technical and political progress. European Commissioner Dombrovskis described risk sharing and sovereignty sharing, saying a balance would have to be struck between the two. Sir John Cunliffe, deputy governor for financial stability at the Bank of England, saw this balance as a prerequisite for a further pooling of sovereignty.

The core disagreement between member states is a hindrance to completing banking union. The example of the single resolution fund as a common fiscal backstop is a case in point. Professor De Grauwe of the LSE thought that because you would eventually need very deep pockets to resolve large failing banks in a crisis, you need the fiscal capacity to raise taxes. In effect, fiscal union was a prerequisite for a backstop to work.

Likewise the question of how much sovereignty to pool was central to the success of the European deposit insurance scheme. At the heart of the five presidents’ report is the ambiguity about what is meant by fiscal union. It was obvious from our witnesses that overall they interpreted it as implying a very high degree of integrated policymaking. Several saw it as a means of transferring more power to a super euro Commissioner or, in the words of German Finance Minister Wolfgang Schäuble, a eurozone Finance Minister.

It is evident that the greater centralisation envisaged in deepening EMU will involve a significant pooling of sovereignty. We could not see a commensurate focus on measures to improve democratic accountability, and this is the greatest weakness of the five presidents’ report. The steps that currently exist in this regard, such as the European Parliament’s oversight of EMU, the economic dialogues between the Commission, the eurogroup, the Council and the European Parliament, and the European parliamentary week when national parliaments are brought together, are inadequate, and if they are inadequate in the current form they will be more so as integration deepens. The European Parliament cannot be seen in the same light as national parliaments in terms of accountability to a citizen who, first and foremost, sees his national representatives as the accountable individuals who will respond to him. The European Parliament plays as good a role as it can, but there is a danger, as moves towards a state emerge in the eurozone, that the disconnect will deepen.

I shall conclude with the words of one of our witnesses, Phillipe Legrain, who, in summarising the problems facing the eurozone, said:

“We have election after election in the eurozone in which voters reject the outgoing Government, and the first thing that happens is that voters are told that they have to stick to the old policies of the government they have just rejected because EU rules say so, and I do not think that is desirable or sustainable”.

I have managed, on this rather significant day of American elections, to avoid talking about the American election result. In concluding, however, my one word of advice—were they willing to accept it—on behalf of our committee to those forming the new architecture of the eurozone, would be that it is important to put in place the democratic structures and accountabilities that are needed to respond to citizens’ concerns that still exist at national level. I beg to move.

--- Later in debate ---

[Baroness Falkner of Margravine]

My Lords, I thank all noble Lords who have spoken in this debate. I am particularly impressed by the diligence of noble Lords who were not members of the Select Committee because the report cannot be described as a light read. I also acknowledge, in particular, the interest of the noble Lords, Lord Dykes and Lord Kerr. As chair of this sub-committee, my regret is that the noble Lord, Lord Kerr, is not there to enrich our deliberations. I have heard much about the time he was there, and I am very sorry not to have experienced it.

I cannot pick up all the very valid and rich points made, but I start by thanking the Minister for his response, which is quite comprehensive. I did not bring up the Government’s response in my opening remarks because the political situation has evolved so much since our report came out a good six months ago and since the referendum of 23 June that the committee as a whole decided to let it go. We knew that circumstances had moved on. Like the noble Lord, Lord Kerr, I am extremely relieved that the Minister has reiterated the Government’s engagement with developments that will take place.

The noble Lord, Lord Giddens, highlighted the central role of the German surplus, and it is worth picking out one fact from our evidence: the German surplus in terms of the eurozone is now only €6 billion out of a total surplus of €186 billion, so the surplus with the eurozone is very small indeed. That is why I decided that I would not comment on that.

[Lord Giddens]

My point was about the wider significance of the German economy, and how the euro is crucial to its competitiveness. It was not a point about the eurozone itself but about what it has made possible for Germany.

[Baroness Falkner of Margravine]

I noted the comment of the noble Lord, Lord Giddens, on the missing sixth president, in terms of the number of presidents. It is also interesting that the missing sixth president is a woman, on a day that women are doing rather badly in political life generally.

I also want to pick up the point made so eloquently by the noble Lord, Lord Dykes, on the speed, in a historical perspective, with which the 19 countries have come together to embark on this endeavour. There was a tone of pessimism beyond my own pessimism, which was echoed by the noble Lord, Lord Butler, and several other noble Lords. I have no electronic gadget that is charged or that seems to work in this room, so I was trying to work out from memory when the United States became a single currency zone. If I remember correctly, it was in the early years of only the last century.

[Lord Dykes]

In 1910.

[Baroness Falkner of Margravine]

I am told it was in 1910. That is when I thought it was, but I was afraid to say so in case I was wrong. Not having a reliable electronic gadget to tell me whether I was right or wrong made me feel quite insecure, so I am very glad the noble Lord, Lord Dykes, confirmed that. If you look at the span of time from when the United States became a federation to this stage, what is happening in Europe is truly remarkable. With all of us expressing doubts, as the noble Lord, Lord Butler, did, about whether this is a road map with a road that leads over a cliff, my feeling is that it will not lead over a cliff, but a core group will move at a different, faster, speed, to the rest of the 19 countries.

I turn now to the comments by the noble Lord, Lord Tunnicliffe, who seems to be most pessimistic about the whole thing. When he asked whether the Government thought that the eurozone was liable to survive another banking crisis, he must have had in mind Deutsche Bank and the parlous situation of Monte dei Paschi di Siena. I remind him that it is not the eurozone and its regulatory structures alone that are responsible for stability in our banking sector now, because the Basel rules, which were incorporated into the eurozone, are, of course, the backdrop. We have had stress tests, and we have backstops now. Obviously these are extremely large and indebted banks, but, on the whole, the tools we now have to cope with financial crises within the eurozone are very different and much stronger than they were some years ago.

I conclude by reminding the committee of one thing that I did not touch on: the title of our report. It was deliberately chosen to echo the comments of Mario Draghi, president of the European Central Bank, in the context of the Greek financial crisis and the lack of confidence of the financial markets in the eurozone. He said that it would do whatever it takes. The United Kingdom should will it to do whatever it takes in its interest and ours. We would all be better served if the eurozone survived and thrived because the consequences of it not doing so would not be good for us either.

Motion agreed.