Policy Research in Macroeconomics

How to transform the EU – and build solidarity between its members

Image: Robert Triffin (1911-1993), influiential adviser on original European Payments Union. Via  https://www.c2dh.uni.lu/

Image: Robert Triffin (1911-1993), influiential adviser on original European Payments Union. Via https://www.c2dh.uni.lu/

A new European Clearing Union would restore a common purpose to the European project and help defeat the rising ride of authoritarianism.

This article is cross-posted from Open Democracy

 There are many on the left who are sceptical of the European Union. And rightly so: the European Union was designed primarily as a monetary union, whose sole purpose was to “encase” the globalised financial system that operates from within Europe, and protect it from the intrusion of democratic sovereign states. The architects of the system – from the Maastricht Treaty of 1992 to the establishment of the Economic and Monetary Union (EMU) in 1999 and the introduction of the common currency in 2002 – originated in neoliberal think-tanks, mainly based in the universities of financial entrepôts like Luxembourg and London.

As Otmar Issing, the first chief economist of the European Central Bank, put it:

“many strands in [Friedrich] Hayek’s thinking… may have influenced the course of events leading to Monetary Union in subtle ways.”

As well as academics, the architects of the system included prominent British Treasury civil servants and politicians.

It is this inbuilt architecture of the European Union – embedded in present treaties – that is being resisted today by both right and left-wing populism across Europe. As it has been designed, the system is undemocratic and unresponsive to the will of the people. It is a system based on the theories and policies of out-of-touch neoclassical economists (with strong past and present links to the London School of Economics) whose attachment to permanent fiscal austerity, insecure employment, low wages and poor productivity are fuelling the fires of populism and nationalism. Their economic policies have predictably led to political and economic divergence across Europe and to the rise of ugly politics.

Yet, to the surprise and scorn of its very architects, this anti-popular architecture is now in crisis. While Europe’s neoliberal policies were intended to “encase” the private banking system from regulatory democracy, ironically their effect has been to threaten the European banking system’s solvency. As Italy’s economy continues to weaken under strains of the Eurozone’s deflationary austerity policies, and its sovereign debt to GDP ratio rises, it poses a grave threat to the French banks that hold about €385 billion of Italian debt, derivatives, credit commitments and guarantees on their balance sheets. German banks, meanwhile, hold another €126 billion of Italian debt. The financial nature of the European Union is the biggest threat to Europe’s economic stability and continuation.

Three good reasons to remain

So should the Left be backing parties that support remaining in the EU in the forthcoming European elections? We believe strongly that it should, for three reasons – all of which are political. We face three grave threats that we cannot tackle as a single, isolated state.

 The first is the collapse of the life support systems that make the earth liveable for humans. Not just climate breakdown, but also earth systems breakdown. We have been warned by the IPCC that our planet cannot stand much more warming, and that we have about ten years to transform our energy systems and restore biodiversity. Tackling that very grave threat to our futures, and the futures of our children and grandchildren, cannot be done alone by a fortress Britain or even a fortress Europe. The climate does not end at the cliffs of Dover. It requires international cooperation and coordination – and the building of alliances, especially neighbourly alliances. It is precisely those much needed alliances that could change the direction and scope of fiscal policies, both at national and EU levels.

Second, we face another grave and even more immediate security threat: the rise of authoritarianism and fascism in both Britain, the United States and Europe. Again, this is not a threat we can tackle in isolation, as we discovered in the 1930s. Facebook, Youtube and the internet provide global platforms for racists and fascists. A never-ending crisis, with its corollaries of growing poverty and unemployment, fuels their “arguments”. To fight and defeat this threat to Britain’s security, we need political allies – especially those we count as neighbours. And as authoritarianism and populism feed themselves off the economic and social distress caused by EU deflationist policies, this antiauthoritarian alliance must push decisively towards the adoption of common expansionary policies.

The third threat we face is another globalised debt deflation – after a post-crisis period of rapid debt inflation. The Great Financial Crisis is far from over. Economists and regulators were bribed by Wall Street and the City of London and persuaded to stick with ‘light touch’ regulation. Little has been done to transform or reform the globalised financial system to make it more robust and accountable. Indeed, the crisis “proved itself as a way to solidify the existing economic order”, as Professor Joseph Vogl of Humboldt University Berlin has argued. It remains safely “encased” and detached from the regulatory democracy of any state, whether in Europe or elsewhere.

But the existing economic order is far from stable. Another globally systemic financial crisis is inevitable – it is only a question of timing. Already there are signs that are worrying central bankers and policymakers, and this time the weaponry of monetary policy will no longer be effective, either in an isolated UK or in an unreformed EU.

So for political, ecological, security and economic reasons, it is imperative that Britain’s internationalist Labour Party and its supporters build alliances with like-minded socialists and social democrats across Europe – to jointly and cooperatively tackle these grave threats.

The problems of remaining

These advantages do not allow us to dismiss the problems of the EU, however. Europe has been made politically and economically unstable, first by the huge imbalances that have grown between and within countries, and then by the way these imbalances have been reabsorbed through deflationary policies. It is these dynamics that lie at the heart of the political divergences and the rise of populism. Imbalances fuel nationalistic movements in the surplus countries of Northern Europe, while deflationary countermeasures fuel populistic reactions in the South.

 Moreover, by shifting imbalances from inside the EMU to outside it, the Eurozone – following German-style neomercantilism – has become the largest surplus bloc on a global scale, with growing dependence on foreign markets. It also has an internal market which, thanks in part to austerity, is shrinking more and more.

Germany bears the most responsibility, thanks to its massive trade surplus and its dogged determination not to raise wages and stoke internal demand, or to cooperate with her partners to reflate European markets and economies. No wonder Europeans – and Britons – are angry.

But the problem is structural. It has to do with the way the EU is built, more than with the behaviour of individual countries. The EU was built on the two pillars of monetary union and financial integration. This has laid its foundations not on solid ground but on the liquid flows of capital mobility, intended to lend strength to the edifice. Essentially, the EU outsourced the enforcement of its rules to the market discipline that is allegedly imposed by financial flows. This lies at the root of the EU’s present instability: it was capital mobility that first allowed the imbalances to build up, and then refused to refinance them.

The EU architecture is threatening the break-up of the post-war project for the reunification of Europe – a project whose lofty purpose was the maintenance of long-term peace across the continent. There remains an overwhelming demand for peace and unity across Europe, and for cross-border collaboration and cooperation. But given the political and economic divergence and the rise of right-wing authoritarian parties, how can peace, balance and stability be achieved?

A different Europe

Image: ‘OEEC Favors Continuation of European Payments Union ‘ via  https://nara.getarchive.net/media/oeec-favors-continuation-of-european-payments-union-7905c4

Image: ‘OEEC Favors Continuation of European Payments Union ‘ via https://nara.getarchive.net/media/oeec-favors-continuation-of-european-payments-union-7905c4

We know that these imbalances can be resolved. We know this because Europe has done it before, when the European Payments Union (EPU) was established between 1950 and 1958.

The EPU made it possible for each country to finance its current account deficits without relying on the vagaries of capital liquidity provided by international financial markets, by providing a ‘clearing centre’. The country’s position was recorded as a net position in relation to the clearing centre itself, and thus as a multilateral position in relation to all the other countries.

A quota was set for each country corresponding to 15% of its trade with the other countries in the Union. Credit and debit balances could not exceed the respective quotas. The system therefore set a limit on the accumulation of debts or deficits with the clearing centre, and provided debtors with an incentive to converge towards equilibrium with their trading partners. The EPU also exerted strong pressure on creditor countries which, like Germany and Holland today, failed to raise imports and cut their surpluses.

The result was an extraordinary, export-driven expansion in production, in Germany and Italy in particular, and the liberalisation of trade not only within the EU, but also well beyond. But what was most extraordinary was that this expansion of trade came along with rising employment and welfare in each partner country: the EPU was a part of a superstructure that provided countries with more autonomy to foster an economy led by domestic demand.

A new European Clearing Union

A modern version of this system could be created today. Better still: it could be introduced without changing the EU treaties. It simply requires enforcing the existing rules and reinterpreting the existing monetary infrastructures.

In the Eurozone there is already a clearing house for the precise purpose of optimizing the management of payments. TARGET 2 (the Trans-European Automated Real-time Gross settlement Express Transfer) is a system that is used today to settle cross-border payments individually.

Within this system Germany, together with other surplus countries like the Netherlands, has built up substantial credits and has the highest positive settlement balance. Correspondingly, Portugal, Spain, Greece, Ireland and Italy have built up substantial debits, and therefore have negative settlement balances. These reflect the cumulative balance of payments imbalances between northern and southern Europe that were formerly financed by capital flows from the centre to the periphery, but which have since reverted in the wake of the Great Financial Crisis.

This accounting gimmick has played a crucial role in saving the system of the single currency. While not solving the problem of large interest rate spreads, the accumulation of positive and negative balances within TARGET2 has prevented the financial turmoil that resulted from the sudden stop of capital movements after the sovereign debt crisis from turning into a currency crisis.

Our proposal is to open a section of TARGET2 – call it ‘T2trade’ – designed to function, like the EPU, as a source of funding for temporary current account disequilibria, without having to rely on short-term capital movements. The result would be a new ‘European Clearing Union’. For this to work, four measures would have to be adopted:

1. Credit would have to be restricted in ‘T2trade’ solely to commercial transactions between European countries and to tourism. The idea of restricting certain facilities of the European Central Bank (ECB) to specific kinds of economic transactions is not new. It was introduced with the Targeted Longer-Term Refinancing Operations (TLTRO).

2. There would have to be a limit on the possibility of accumulating positive or negative balances, commensurate with each country’s volume of foreign trade. This principle is perfectly consistent with European rules, specifically under the Macroeconomic Imbalance Procedure (MIP).

3. Imbalances could be subjected to symmetrical charges. This option can, and we believe must, take on the form of a political proposal obliging all countries to face up to their responsibility in settling the imbalances insofar as they have enjoyed advantages in accumulating them. It would serve as a reminder to the creditor countries that they too have benefited from the single currency, thanks to the opportunity to export to the countries of southern Europe at a competitive real exchange rate. And it would serve to involve these countries in the adjustment process without having to appeal to their ‘kind heartedness’. Moreover, it would be consistent with what the ECB announced in summer 2014 when, after introducing negative interest rates on deposits, it stated that this should apply also to TARGET2 balances.

4. There should be the possibility of adjusting real, if not nominal, exchange rates, should imbalances prove persistent.


While there is scope to argue about the specific measures that would need to be adopted to make our proposed European Clearing Union work, it is critical that any mechanism is based on the following political and economic principle: solidarity between northern and southern European countries, and solidarity between sovereign debtors and creditors, in order to restore a common purpose to the European project. Solidarity not in a moral sense, but in an economic one – of shared responsibility for stability and symmetric distribution of the burden of readjustment.

If we are to restore stability within Europe, and if we are to defeat the authoritarian ambitions of extreme political forces, then restoring policy autonomy to democratic governments by managing capital mobility is essential. Economic forces cannot be detached from their entanglement with democratic, political institutions. The attempt to do so is dystopian, and has triggered the Polanyian counter-movements that are leading the people of European countries to search for protection from the predatory behaviour of self-regulating markets.

Indeed, unless mobile capital is subordinated to democratic interests (and note that our proposal would make capital movements unnecessary rather than “illegal”) then such “protection” will most certainly be offered by strong and potentially authoritarian right-wing leaders, who will likely quickly reverse the extraordinary progress made across Europe since the Second World War.

There is a great deal at stake. And there is very little time.

Ann Pettifor is Director of PRIME economics. Massimo Amato is Associate Professor, and Luca Fantacci Lecturer, at Bocconi University, Milan. Messrs Amato and Fantacci are co-authors of “The End of Finance”, published by Wiley.

4 Responses

  1. I’m still waiting for a reply to my question about who the "like-minded socialists and social democrats across Europe" are. How well did they do in the recent EU Parliament elections?

    The answer, I’m afraid to say, is no where near well enough. DiEM25 got 1 MEP, the Greens got a few more than last time, but the remarks of the leader of their German contingent shows that they are happy with the status quo.

    There is such flux at the moment that the idea of martialing the pan-European movement necessary to instigate the reform process, let along acheive anything meaningful, is preposterous.

  2. Sorry, perhaps I should have been a bit clearer in my comment below – my questions weren’t rhetorical – so if you don’t mind, I’ll ask again:

    Who precisely are these "like-minded socialists and social democrats across Europe" with whom Labour should collaborate to effect any of these (excellent) changes? How well are they doing in their own memberstate parliaments and how well are they represented in the European Parliament?

  3. These appear to be excellent recommendations, but like every other Remain and Reform argument insufficient attention is paid to the political and electoral realities of the EU.

    Who precisely are these "like-minded socialists and social democrats across Europe" with whom Labour should collaborate to effect any of these (excellent) changes? How well are they doing in their own memberstate parliaments and how well are they represented in the European Parliament?

    The plain fact is that in too many member states they simply do not exist.

  4. So who are these mysterious “fascists”? The above article doesn’t say, so I’ll make some suggestions.

    Various Oxford dictionaries claim “authoritarianism” is an element of fascism (as indeed the above article suggests). Well now, telling the people they can vote in a referendum on Brexit and then ignoring the result of the referendum is a serious form of authoritarianism. So that makes the Labour and Tory parties pretty “fascist”.

    Chambers Dictionary says “militarism” is an element of fascism. Well er – the Labour Party (backed by the Tories) took the British military to Iraq and killed tens of thousands of Muslims for not good reason. In contrast, the British “far right” (BNP and UKIP) opposed the Iraq invasion from day one.

    Oh, and as regards the "racism" referred to in the above article, looks like the Labour and Tory Parties are about a thousand times as racist as the BNP or UKIP.

    Looks like an open and shut case: not much doubt who the fascists and racists are.

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