The UK and the EU: it is an in or out choice!

by George Hatjoullis

Enlargement of the European Union (animation) ...

Enlargement of the European Union (animation) European Community European Union (Photo credit: Wikipedia)

David Cameron is proceeding with the illusion that the UK can remain within the EU but repatriate some power. Most would be happy with this so politically it is an astute approach. However, in practice the UK faces a straight in or out choice. Moreover, ‘in’ now means joining the eurozone as well. The logic of the single market, and the needs of the eurozone and banking union, all point to exit or ultimately full integration.

The Single Market

The EU is now the compelling issue of UK politics in much the same way that it was in the run-up to the 1975 EEC referendum on whether the UK should remain in the EEC. The UK had joined the EEC in 1973 under the government of the europhile Edward Heath but Labour, under Harold Wilson, had campaigned in the 1974 General Elections (there were two) on a platform of renegotiating the terms of accession. The referendum was to put the issue decisively to the British people. The renegotiation was the political subtext and by implication the europhile Heath had given away too much. My undying memory of the campaign was of Tony Benn and Enoch Powell both supporting the NO platform. The British people voted YES by 67% on a 65% turnout.

The EEC has come a long way since the 70s and is now the EU wrapped around a eurozone. The subtext is the same however; repatriation of powers from Brussels. Of course, the powers do not sit in ‘Brussels’ as such. Brussels normally refers to the EU commission which is the ‘civil service’ of the EU. Power is exercised via the various councils and groups which consist of representatives of each member state. These representatives are elected in their own nation states. The needs of the eurozone are increasingly coming to dominate these policy-making groups.

The voting structure is based on national populations. However, political influence extends well beyond formal voting rights.The most powerful member is Germany. This is also an important change as until 2010 one might have normally referred to France and Germany. The voice of France has become muted.

The issue in the UK is much like it was in 1974. There are those that want an unconditional exit (Farage). There are those that want full integration (Mandelson) and those that want to stay in but repatriate some powers (Cameron). According to Mats Persson of Open Europe ( http://bit.ly/12Nsn3O), the majority is in the Cameron camp. It would seem that David Cameron is more astute than he is credited.

The detail that I am waiting to hear is which powers will be repatriated? At a guess I would say that the power to limit free movement of labour is high up the list. The success of UKip is not simply because of the EU. The subtext is immigration and the difficulty of limiting migration whilst in the EU. A single market in labour, goods and capital is of course the whole point! If the UK is granted power to limit the free movement of labour then the single market concept is delivered a damaging blow. Moreover, this may well be a two-way street. If EU citizens are restricted in coming to the UK why should British citizens not be also so restricted in movement within the EU? Bad news for all those sunning themselves in Spain, Portugal, Italy and Cyprus methinks. I wonder if they will come back and vote?

The other issue high up the agenda, I would guess, is human rights legislation. Membership of the EU does seem to come with a modern, liberal agenda and strict adherence to the European Convention on Human Rights. This issue is inextricably associated with the free movement of labour within the EU. It would be hard to have different fundamental legal rights in principle across a single market for labour. The human rights legislation has upset Britain because it has restricted the state’s ability to remove people deemed undesirable. Something about babies and bath water comes to mind here.

The EU modern liberal establishment does occasionally act in a doctrinaire and impractical  manner. The insurance industry has recently been hit with equal gender directives. Insurance underwriting in my experience has no gender bias. It is all about risks. Women live longer and have a different pattern of car accident claims. It is logical to price these differential actuarial risks into the premium. To declare such differential pricing as discriminatory is patently absurd. This is less about repatriating powers than insisting that economic logic is not wholly ignored when discrimination directives are constructed. This might be better achieved by being fully immersed in the EU as it is hard to see how the UK could operate a different gender policy in relation to insurance within a single market.

It is clear form these three examples that the popular notion of staying within the EU and repatriating powers is so inconsistent with the principle of a single market as to make little sense. What powers can be repatriated that will satisfy the British people and yet not wholly undermine the single market? The eurozone is now complicating matters even further.

The Eurozone

The origins of the eurozone crisis lie within the Maastricht Treaty. It connected a subset of EU states through a common monetary policy (EMU) and made no treaty provision for fiscal coordination. This lack was papered over by the Stability and Growth pact (http://bit.ly/199QLRy), which took its legal authority from the Treaty on the Functioning of the European Union (TFEU).

The markets were at first sceptical of the EMU project but later warmed to it and priced eurozone sovereign debt as if it was guaranteed by some overarching EU body. It took the debt crisis in Greece to explain to the markets that it was not so guaranteed. Worse still, it became apparent that the Maastricht Treaty precluded the possibility of a collective EU institution providing assistance to debt-ridden sovereign states within the eurozone. The crisis management mechanisms have so far been constructed as bilateral commitments from member states. No single eurozone member is liable for all other eurozone member state liabilities.  Individual commitments to crisis management mechanisms such as the EFSF and ESM are limited by design.

The only institution that is genuinely a collective eurozone entity is the ECB. This is why ECB action under the crisis has been so closely scrutinised by the German Constitutional Court. The Court has been at pains to make sure that the ECB did not act in a way that implied a collective bail-out of the debt-ridden states. The ECB has been quite creative in this respect and has provided considerable collective assistance under the guise of monetary policy and of repairing the monetary transmission mechanism. The Outright Monetary Transactions (OMT) programme has been a particularly effective innovation.

The objective of Berlin has been to avoid the crisis becoming an excuse to move from bilateral action to official collective action by EU institutions. Collective actions would make, implicitly or otherwise, each member state jointly and severally liable for other member states. If a collective framework emerged then eurozone sovereign debt would become mutual and the liability of all eurozone states. This is what the markets originally thought was happening which is why they allowed countries such as Greece to borrow excessive amounts at very low-interest rates. Such mutualisation carries with it the risk of moral hazard and the behaviour of many member states in the early years of EMU suggests that moral hazard is a very real issue for the eurozone.

Germany, as the wealthiest member state, took control of the crisis (excluding France) and made avoiding moral hazard its main target. Hence all responses have been structured as bilateral arrangements. This is not to say that Berlin will not ever countenance a collective structure. However, it will not do so until it believes it has put into place safeguards against moral hazard.

The main innovation from Berlin is the  Treaty on Stability, Coordination and Governance in the Economic and Monetary Union or the Fiscal compact for shortThis is an international intergovernmental Treaty and outside of the EU legal framework. It nevertheless binds those ratifying to a Berlin-approved fiscal framework and ratification is a pre-condition for access to some bilateral eurozone arrangements (like the ESM). The intention is to incorporate this treaty into the EU legal framework but of course that will require the unanimous agreement of all EU states.

The existence of the fiscal pact reveals a fundamental problem in the EU. There is a subset of member states, the eurozone, with different needs. The EU legal framework is set up for all member states, including non-eurozone. To resolve this requires some significant treaty change and treaty change must be unanimous. This is a politically complex situation and lies behind the clumsy and cumbersome manner in which the crisis has been handled.

Banking Union

The same problem is now evident in the debate on banking union. The union requires a single supervisory mechanism (SSM) for banks. All banks in the union should be bound by the same rules and be supervised by the same entity. Troubled banks must be resolved in exactly the same manner by this authority so there is a need for a single resolution mechanism (SRM). Finally, there needs to be a central fund to finance these actions, namely a single resolution fund (SRF). All three must operate above sovereign states and the single supervisory authority must be able to intervene in member states independently of the views of the government of that state.

Such an arrangement effectively mutualises banking risk across member states. It raises a lot of questions. Will individual member states be willing to give up supervisory control of their own banking systems? Indeed in this framework there are no national banking systems, only EU-wide. The second question is the source of the SRF. The plan is for a levy on banks in the same manner as say the FSCS. Such a levy is sufficient for individual bank problems but what happens if a systemic crisis arises? Will an EU-wide body act to avoid systemic failure in the way the UK government used tax payers money to save the UK system? If so is this not a form of sovereign debt mutualisation? Finally, there is the nature of bank resolution. The Cyprus crisis revealed that the prospective banking union will place senior bond holders and uninsured depositors explicitly at risk in the SRM. They have always been implicitly at risk (that is why the deposits are called uninsured) but it has been rare to bail-in uninsured depositors in the manner we have seen in Cyprus. It will no longer be rare. This may have important implications for financial centres such as the City of London.

The important point however is that this total framework cannot reasonably be expected to operate on an intergovernmental basis. The SSM has been advanced within the Treaty of Lisbon. However, the SRM and SRF may prove more problematic.These steps may require changes to the Treaty of Lisbon. Good luck with that. The likely result will be that banking union may be less smooth in its manifestation than many seem to assume. It essentially mirrors the fiscal union issue and it is unlikely that one can be resolved without the other.

The EU project has reached its day of reckoning. An EU consisting of eurozone and non-eurozone is no longer possible. The direction is now for EU institutions to evolve to serve the eurozone and for non-eurozone states to be marginalised. The eurozone structure will also become ever more integrated and reflect a fiscal framework that is a direct copy of that of Germany. Mutualisation may eventually occur but not before all members have legally enforceable budget constraints built into their constitutions. Talk of repatriation of powers by the UK is so much subterfuge. The UK faces a straight in or out choice. Moreover, ‘in’ now means joining the euro. However popular the Cameron position might be it is a cake-and-eat-it position and thus in practice untenable and somewhat dishonest. On the other hand politics is all about illusion, or should I say delusion.

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