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06 July 2018
By Eric Lonergan
I used to believe that the eurozone was undemocratic. Now, I’m not so sure.
A simplistic view is that national European electorates have been subordinated to their membership of the common currency.
When Greek voters rejected austerity, for instance, the Greek government returned from negotiations with the European Central Bank and the European Commission only to deliver further spending cuts and tax rises. When Ireland faced a run on its banks, the ECB president sent the government a set of instructions as a condition of its ‘lender-of-last-resort’ support. These are only two examples from across the eurozone’s periphery since the debt crisis.
Today, the focus is on Italy. Elections in May delivered an anti-establishment, eurosceptic government. Markets responded in predictable fashion, demanding greater compensation for holding Italian government debt – given the perception of higher risk – and thereby sharply raising the country’s cost of borrowing money.
The eurozone’s third-largest economy has been here before. At the height of the eurozone debt crisis, in 2011, Prime Minister Silvio Berlusconi was given his marching orders and Mario Monti was appointed to implement austerity measures. This time, Italy’s president, Sergio Mattarella, exercised veto powers to reject the nascent coalition’s choice of finance minister because of the candidate’s opposition to the euro.
Is this democracy in action, or an example of supposed rule by unelected technocrats?
The facts of how the eurozone works are now clear, and no nation can really claim they walked into it blindfolded.
Eurozone governments do not have fiscal autonomy – they cannot, in other words, tax and spend how they like. Countries are not permitted to run budget deficits (the difference between a government’s spending and revenues) greater than 3% of gross domestic product (a measure of economic output).
The current fiscal rules may be a travesty of economic best practice, but they are not undemocratic. If a national government cannot print money, its budget constraint is determined by investor demand and by access to the central bank, in this case the ECB. This is precisely why several European countries choose not to adopt the euro.
In democracies, we are victims and beneficiaries of our past decisions, which are often binding on future electorates. Deciding to join the euro is a clear example.
The view that every country’s voters somehow carry divine authority is naïve and disingenuous. You cannot hold a national election and then claim a mandate to change rules across the eurozone. That would require a pan-eurozone election, or negotiation between member states.
The rules of the game for large eurozone economies like Italy look clear. Stick by the fiscal rules – namely the 3% deficit cap – and the ECB ultimately stands behind your ability to finance fiscal deficits by buying up your bonds. Reject the rules, and you could be left facing the market alone.
‘The market’ here is not only international investors, but also domestic investors and savers. Italians are as likely as anyone else to flee their banks and government bonds if central bank backing is withdrawn.
To me, this is not undemocratic in any sense. Elections rarely, if ever, reflect “the will of the people”. The Northern League, one of the coalition parties, won only 18% of the national vote. The other, the Five-Star movement, won 30% but, in my opinion, reflects a protest vote – it is easier to define the party as a rejection of the status quo than as a positive policy platform. Nobody voted for a coalition of the two – it wasn’t on the ballot paper.
In response to the structural flaws in the electoral process, mature democracies have checks and balances. Constitutions often constrain the current crop of legislators and, in Italy’s case, the president has a part to play.
Investors can also effectively act as a constraint, however unwittingly. Being unwilling to carry on lending to Italy on such favourable terms inevitably curbs the new government’s ability to pursue maverick policies. Its room for manoeuvre is especially tight since Italy’s national debt, at 132% of GDP, is the highest in the eurozone after Greece’s.
True democracy is messy. But it protects essential rights, it resolves political conflict legally and peacefully, it provides for changes in government and it checks concentrations of power.
I believe what has been happening in Italy represents democracy in action.
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The views expressed in this document should not be taken as a recommendation, advice or forecast. We are not able to give any financial advice. If you’re at all unsure about the suitability of your investment, please speak to a financial adviser.