The European Union has been a remarkably successful institution-building project. It is the first ever example of sovereign states voluntarily coming together and pooling some of their sovereignty in order to do more together than they could separately. Almost every other political unification or state-building exercise in history has involved the use of force, including the creation of the United Kingdom and the preservation of the United States. The EU came together peacefully and voluntarily. However, some might argue that European integration was necessary only in order to cement a post-war reconciliation of Germany and France, and now that this has been achieved, the EU has done its job and needs no further development. This is wrong for two reasons.

WHY THE EU IS STILL AN ASSET

First, the fact that states continue to line up to join the EU shows that the EU still provides a necessary political and economic umbrella under which reconciliation and mutual security between states can be assured in the twenty-first century.

This was why the Baltic states, Poland and other central European states joined, and it is the reason several Balkan states, and even Georgia and Ukraine, might like to do so. It is also the reason why Greece, much to the surprise of many, has favoured Turkish membership. While the United States of America is remarkably successful in many ways, there is no queue of other American states lining up to join. Even Puerto Rico has not done so after more than one hundred years of Washington’s rule. Second, the EU is the most advanced effort in the world providing a measure of democratic supervision of globalisation. Unlike other efforts to supervise globalisation, like the United Nations and the World Trade Organization, the EU has a directly elected Parliament which co-legislates for the EU alongside the 27 governments, who often decide issues by majority. Other international organisations operate on a purely intergovernmental basis, which means that there has to be unanimity in order to reach a decision, and democratic involvement only arises when a deal, already negotiated in private, has to be ratified in a national parliament without the possibility of further negotiation or amendment. As a result, other organisations like the WTO and the UN can do much less, and they have to do much more of what they do behind closed doors than is the case with the EU. My view is that the EU provides a unique model for democratic rule making at the supranational level, something which will become more—not less—necessary as we proceed into the twenty-first century. Indeed the failure of the world to deal with climate change is a good example of the weaknesses of present intergovernmental models of global governance. If the different regions of the world were unions like the EU, which could negotiate seriously and with genuine political legitimacy as the EU can, the failures of Copenhagen and other climate change summits would not have happened. If the EU were to break up, either because of the collapse of the euro or because a major country like the UK feels it has to exercise its right to leave the EU, and either event were to set off a 2 breakdown of the trust that keeps the EU itself together, we would have lost a unique instrument for security building in Europe and for problem solving in the wider world. I would now like to analyse those two potentially existential threats to the EU, the euro crisis, and the UKs possible desire to leave. Of these, a breakup the euro is undoubtedly by far the more serious existential threat to the EU, because the scale of the economic losses is potentially much greater and the means of controlling those losses are much less.

THE EURO CRISIS IS NOT SOLVED

The euro crisis has become slightly less acute in recent weeks. The announcement of a new bond buying policy by the European Central Bank has calmed the markets. But there is no doubt that the markets will test the ECB’s willpower at some stage. Meanwhile the link between the solvency of European banks and the solvency of European states has not been removed. A default by any EU state would wreck the banks of that state, because each state’s banks tend to be big purchasers of the bonds of that state. Similarly a potential collapse of a bank in a state would force that state to inject capital into banks if it did not want a run on banks generally to take place, and contagion to spread to other countries. The confidence loss caused by a major bank getting into difficulty could lead to a dramatic collapse in state revenues, leaving it with a greatly increased budget deficit at the very time it would also be having to find the money to recapitalise the bank.

FOUR THINGS THAT MUST BE DONE TO SOLVE IT

If these problems are to be resolved, four things will have to happen, more or less at the same time: 1. Greek government debt will have to be forgiven; 2. The ESM will have to be seen as big enough to stand behind Spain and other countries that might get into difficulty, on a contingency basis; 3. The new mechanisms to supervise, and if necessary rationalise, Europe’s banks will have to be put in place; 4. The already-agreed reforms to reduce deficits, and to promote growth by opening up the job and service markets to competition, will have to be demonstrated as being fully implemented in letter and spirit in order to show creditors that, if one forgives debt or enlarges the ESM, one is not throwing good money after bad. At the moment, the Greek debt issue is not being tackled, and it seems to have been postponed until after the German election in September 2013. The delay may not be the worst thing in the world if it allows time for Greek reforms to begin to establish credibility. It also allows time to educate public opinion in creditor countries like Germany, and in countries sitting complacently on the side lines, of the true consequences for themselves of a euro breakup. Greece also needs immediate help to finance itself until the end of 2013, and that bridging finance cannot await elections in Germany or anywhere else. The EU has already enacted a raft of legislation, including the Fiscal Compact Treaty, to ensure that countries reduce their deficits and liberalise their labour and service markets. One of the reasons growth potential has been low in Greece, Italy, and Spain is the lack of competition or flexibility in key sectors. But Germany is not yet satisfied. It wants to have an EU Commissioner with the power to veto state budgets, and enforceable contracts on reforms between states and the EU. But not enough attention is being paid to the fact that Germany, France and other core countries could also be doing a lot more themselves to open up their own digital, financial, energy, retail and professional service markets. While Germany has set a good example in labour market and pension reform, there are other reforms it could initiate that would help other EU countries to 3 sell more goods and services into the German market, and thereby trade their way out of their problems. There is understandable political resistance in Germany to any further debt forgiveness for Greece. But debt forgiveness within the euro is one thing. A Greek exit from the euro is an entirely different matter. It would be far more dangerous, and that needs to be explained to German public opinion.

WHAT WOULD HAPPEN IF THE EURO ZONE BROKE UP?

Even a disorderly default by a country within the euro, no matter how severe its consequences for its own people and for its creditors, would have far less severe consequences for the euro, and for the EU itself, than an exit of a country from the euro would have. I have heard a view from some northern Europeans that an orderly exit of Greece from the euro could be contemplated if it would be accompanied by building up a huge fund—much bigger than the existing ESM—to stand behind all the other euro area states so as to prevent a Greek exit leading to a loss of confidence in the financial position of the rest of the euro zone. I believe this view, that a Greek exit from the euro can be managed, is profoundly mistaken. The whole edifice of the EU rests on law. The EU has no police force to enforce its will. It relies on Member States freely respecting the interpretation of EU law by the European Court of Justice, and implementing the Court’s decision, however unpleasant that may be. The exit of a country from the euro is, quite simply, a breach of the treaty obligations, and treaty obligations have the force of law. The euro was established on the basis that it is irreversible. A Greek exit, particularly if it would be condoned or encouraged by other members, would say loudly that the euro is not irreversible. That would lead to constant speculation in the markets as to who would be next. And as speculation would increase, so too would the size of the funds or guarantees needed to check it. That in turn would lead to a heightened risk that some of the creditor countries, who would have to provide these funds and guarantees, might decide that they themselves should exit the euro and re- establish their own currencies. That would be the end of the euro. Breakups of currency unions have happened before, in Austro-Hungary after the First World War and in Eastern Europe in the 1990s when the rouble zone broke up. As described in a recent article by Anders Aslund of the Peterson Institute of International Economics, the consequences of this were disastrous.

A SCENARIO THAT MIGHT LEAD TO THE END OF THE EU ITSELF

New currencies would have to be established. The relative value of these currencies would be unknown and unknowable. Some would lose value very quickly and others would shoot up in value. Exports would become dramatically uncompetitive in some cases, and in others they would become so cheap that there would be accusations of dumping, currency manipulation, and calls for the immediate reintroduction of import duties to level the playing field. Such duties, if imposed, would end the Single Market, which would be tantamount to the breakup of the European Union itself. Open markets, the assumption on which Ireland built its entire economy over the last fifty years, would be gone. In some countries the banking system would break down, and people would have no access to credit for even the most basic transactions. In others, people would cease to trust the value of their own money, and money, after all, is based on a promise. If people can no longer trust the states standing behind the promise that underlies their money, the basis for money itself is gone. This is not fiction. It is what happened when the rouble zone broke up in the 1990s and explains why incomes fell by 50% in the former rouble zone countries. And the exporter nations within the rouble zone, like the Russian Federation, suffered just as much hardship as the importer nations like Latvia and Estonia. The political stresses that this scenario contains for the 500 million people of the EU and their governments would be such that trust between European nations would easily break down 4 completely. We see signs of that happening already, but it is being held in check by the hope that problems can still be resolved on a collective basis. A breakup of the euro would show that it was impossible to resolve matters on a collective basis, and it would then be a case of every nation for itself, with particularly severe consequences for smaller countries like Ireland.

…AND MEANWHILE IN THE UNITED KINGDOM

As if Europe did not have enough problems, one important EU country, the United Kingdom of Great Britain and Northern Ireland, is preparing to renegotiate the terms of its own membership in the EU, and hold a referendum on the outcome, which would potentially decide whether the UK would stay in the EU or leave. The first point is that the UK is entirely free to do this. Unlike other unions like the United States or the United Kingdom itself, the European Union is a union in which states are free to leave so long as they fulfil their normal obligations under international law, which arise when any country withdraws from any international treaty. The UK has been an uneasy member of the EU from the outset. While Churchill envisaged a United States of Europe, he did not envisage the UK, which still had a global empire at the time, being part of it. The UK did not attend the 1955 conference in Messina which led to the Treaty of Rome. When it eventually joined the Common Market, a decision endorsed by a referendum, the idea was sold to the electorate as an economic arrangement, whereas even the most cursory reading of the Treaty of Rome would have shown it to be much more than that.

A THREAT TO VETO THE EU BUDGET

The United Kingdom is now threatening to veto the entire EU budget, something it is legally entitled to do unless there is an absolute freeze on the size of the budget. The difficulty with this stance is not legal, it is political. The EU Single Market, which guarantees the free movement of people, goods and services, was created as a political deal. Weaker economies opened up their markets to stronger ones, and removed protection from local businesses on the basis of a promise that they would qualify for structural funds to modernise their economies. These funds are what the EU budget provides. (Some of the EU budget also goes on agriculture, but that has fallen from almost 80% of the total originally, to only 30% today.) The political difficulty with the UK stance is that of fairness. In the past, when countries like Ireland, Spain, Greece, Portugal, and even the UK itself joined the EU, we all qualified for very substantial EU structural funds in the form of aid for agricultural modernisation, general infrastructure, training, communications etc. Now, when the EU has taken in 10 central European countries, of which almost all are relatively far poorer by comparison than the rest of the EU countries were when they joined, these 10 are to be told that if the freeze the UK wants is to go into effect, they are not to get even a fraction of the help that Ireland, Spain, regions of the UK and others qualified for right after joining. This is causing resentment. I recently heard an Estonian Minister complain that, under the existing EU budget which is already an unfair compromise, his farmers have to compete in the same EU market with western European farmers who are getting three times the subsidies. Unless there are to be drastic cuts, this sort of anomaly can only be put right by an increase in the EU budget. The problem is that the UK government has made the size of the budget a red line issue without getting into any informed debate about what the money is actually spent on, or about what sort of EU budget is necessary to ensure that the EU Single Market, to which the UK itself is very much attached, works fairly and is preserved. The UK wants access to the Single Market, but is not prepared to pay any entry fee.

AND A DEMAND TO RENEGOTIATE THE ENTIRE BASIS OF UK MEMBERSHIP OF THE EU

The same problem arises in the renegotiation of the terms of membership that the current UK government wants. In preparation for this renegotiation, the UK government is now doing a 5 comprehensive audit of all EU laws in order to identify areas of activity that could be taken back from the EU and instead administered exclusively under UK law. There may be some good ideas emerging from this, on which all other members could agree, but there may also be a lot of problems. The difficulty is that the UK wants to take back, yet to also be specified, powers while also retaining full and unfettered access for all its goods and services exports to the EU Single Market. Fifty per cent of UK exports go to the euro zone, whereas only 15% of euro zone exports go to the UK, so this is important to the UK. The difficulty is that the EU Single Market, like any market, is a product of common rules, regulations and conventions. A market is a political construct. Without common rules or understandings nobody could rely on what they are buying. That is why, for example, there have to be common EU quality standards to construct a common EU market. Otherwise, one country could impose peculiar quality standards designed to exclude competitors from its market and enable its own producers to make monopoly profits at the expense of consumers. Any rulemaking power that could be abused in this way cannot be handed back to the national level without endangering the Single Market. That is the problem the proposed UK renegotiation of its EU membership terms will encounter. The competition in any market also has to be fair, and someone has to regulate that. If competitors have different environmental or product liability standards, or if some firms are operating monopolies or cartels, the competition will not be fair. These matters cannot be handed back to be decided by national authorities without also endangering the Single Market. If the UK were to draw up a list of EU rules it would like to make in Westminster rather than Brussels, the other 26 could also do the same, but they might come up with a very different list. The process could become bogged down in the serial reopening of compromises made years ago on issues that have little relevance to the urgent existential threat the EU faces today. One gets the impression that many in the UK do not really care about that. The EU is still regarded by many in the UK as a foreign country, not a union of which the UK itself has been an integral part for the past 40 years. Membership in the EU is seen as a convenience rather than as a commitment. If the price of satisfying UK voters is to cause more problems for the ‘foreigners’ in ‘Europe’, that is not seen by some UK political leaders as such a bad thing. The difficulty is that the ‘foreigners’ in Europe may not see it that way. With so many genuinely urgent things to do such as safeguarding the very existence of the EU itself, the other 26 Member States may not be inclined to devote time to a painstaking case by case analysis of a series of requests for new UK opt outs from some bits of some rulemaking authority, with UK opt ins to others, and to a judicious analysis of whether each one of these decisions might affect the integrity of the Single Market either now or at some time in the future. And the European Court of Justice would certainly have difficulty interpreting the consistency of a special EU menu for one country with the basic freedoms for all on which the EU is based. There is also the old question of whether UK Ministers and MEPs should continue to have voting rights on things they are opting out of. As it is, one has to say that it is distinctly odd that the present Chairman of the Committee of the European Parliament that deals with euro currency matters represents a constituency in the UK which has no intention of joining the euro. If, as is likely at the end of its proposed renegotiation, the UK is dissatisfied with the result, because not enough powers are being handed back to Westminster, it will have little option but to recommend that the UK withdraws from the EU. It is setting itself up now to find itself in exactly that position in 2016.

THE UK’S OPTIONS OUTSIDE THE EU

This will require careful handling because 50% of UK exports go to the EU, and London is Europe’s main financial centre, for the time being anyway. How is the UK to protect these interests if it is outside the EU? One possibility is to join Norway, Iceland and Liechtenstein in the European Economic Area, which would guarantee full access for UK goods and services to the EU market. But the price for that would be to implement all EU legislation that was relevant to the Single 6 Market, and to contribute to the EU budget, but without having any say in EU decisions. That would be worse from a Eurosceptic point of view than the UK’s present position, even though it would guarantee continued access for the UK to the EU market for both goods and services. The other possibility would be to follow Switzerland and negotiate a series of bilateral trade deals with the EU. The UK would not be entering such negotiations from a position of strength, because it relies more on the EU market than the EU relies on the UK market. Switzerland has negotiated full access to the EU market for goods, but not for services. Services are the UK’s key export sector, so a Swiss-style deal would not be attractive. Alternatively, if Britain negotiated a customs union with the EU, like that of Turkey, it would find its trade policies with the rest of the world still being determined in Brussels, but with less input from London than at present. Again it would also only have a guarantee of access for goods exports, but not for services. Finally, the UK might simply leave the EU without negotiating any special deal. That would leave it paying tariffs on its exports to EU Member States, including Ireland, and would necessitate the reintroduction of customs posts on the border in Ireland. It would undermine years of peace making by successive Irish and UK governments, and would cost thousands of jobs in export firms in both the UK and Ireland.

CONCLUSION

My sense is that the pressures that cause fracture in the EU derive from a lack of understanding among the general public of the extent to which their livelihoods depend on economic developments in other countries and of how unrealistic, in modern conditions, an ‘ourselves alone’ policy really is. Political leaders make little effort to explain this, because to do so would undermine the nationalist myths which brought most states into being in the first place and also because it is often convenient to blame the EU for the effects of decisions that were necessary but are unpalatable. For these reasons, little effort is made to forge any form of patriotic pride in the EU or its achievements. No venue has been created in which an EU-wide public opinion might be formed. This must be done if sufficient mutual understanding and support is to be established to allow the EU to create the degree of burden sharing and mutual supervision that is necessary to guarantee the long-term robustness of the euro, and thus of the EU itself. In a word, the EU needs more democratic cement to hold itself together. European Parliament elections are not truly European. They are 27 different elections in 27 different countries, in which national issues predominate. The European Parliament itself has refused to contemplate the election of some of its members from EU-wide party lists, which would begin the process of creating an EU-wide debate, because it would necessitate an EU-wide political campaign on behalf of the rival EU-wide lists of candidates. The President of the European Commission and the President of the European Council are selected in private meetings by heads of government. They do not have to win the votes of EU citizens, and consequently EU citizens do not have the feeling that they can vote the government of the EU out of office in the same way that they can vote their national governments out of office. Thus, the EU does not enjoy democratic legitimacy in quite the same way that national governments do. As a member of the Convention that drafted what eventually became the Lisbon Treaty, I urged unsuccessfully that the EU should have a presidential election on these lines. I suggested that the President of the European Commission should be selected in a multi-candidate election in which every EU citizen would vote, rather than be selected, as at present, by 27 heads of government meeting in private, the outcome of which is then approved in a single candidate vote in the European Parliament. This proposal received almost no support at the time, although it has since been adopted as policy by the German CDU. If that had happened when it was proposed, the EU would now be in a much stronger democratic position to devise a more coherent response to the euro crisis, and to find a solution to the UK’s difficulties. The UK press would not be able to argue that EU leaders were ‘unelected’. The Commission, headed by a President with a full EU-wide democratic mandate, would have more authority to propose solutions. The Council of 27 heads of government would still play a vital role, but the EU would be less constrained by the electoral timetables of individual countries, as is the case with the German elections of 2013.