The EU Needs to Admit Mistakes

The European Union (EU) is good at writing rules; what it needs to strengthen the capacity to suspend, ignore, or replace rules that are obviously not working or inappropriate in a given situation. In other words, the EU needs to get better at recognizing when following the rules is a mistake. This is not going to be a popular argument. Rules are supposed to be rules, after all. Nevertheless, it is vital. So long as policymakers lack perfect foresight, they will never be able to write rules that work in every situation. They will not be able to anticipate the conditions for every possible exception either. Hence they will always need some mechanism to recognize and respond to unexpected situations in a timely manner. In case of emergency, break glass. They will also need some way to hold policymakers accountable for any exercise in emergency discretion. Successful innovations will not always be rewarded but they will be accepted and used to improve the functioning of the organization; abuse will be punished. That is – or at least should be – the  measure of political union.

The EU already has the capacity to ignore the rules. We can all think of areas where the EU has made ‘exceptions’ either for specific countries (firms, etc.) or for limited periods of time. Since I write mostly about macroeconomic policy, I tend to focus on those cases but they exist in every aspect of European integration. Consider, for example, the November 2003 decision by the Council of Economic and Finance ministers (Ecofin Council) to set aside the deficit rules for France and Germany. That was not an isolated event; it was the culmination of a series of similar decisions. When Germany first started showing signs of persistent fiscal problems in February 2002, the Ecofin Council decided that it was unnecessary to start the formal procedures for monitoring German finances because it has assurances from the German government that any problem would be corrected in a timely manner.

The temptation is to regard those exceptions as errors – not just by definition, but also, and more importantly, in terms of procedure. When the European Court of Justice ruled on the Ecofin Council’s actions in July 2004, it found that the Council had acted inappropriately. As one of the Council’s lawyers explained to me many years ago, at least part of the problem was that they needed a super majority to take a decision and they didn’t have a procedure for handling situations where that majority was not present. So they improvised. Subsequent reforms to the stability and growth pact both prior to and during the recent economic crisis have tightened procedures to make things more automatic.

That is an understandable reflex. If rules are rules, then procedures should lead to their enforcement. Nevertheless, the inclination to tighten procedures is self-damaging because it makes the organization more rigid and less adaptive. In this specific case, automatic rules lock in assumptions about what the future holds in general and how those future conditions will affect different member states. The architects of the new rules for fiscal policy coordination have no more perfect foresight than the policymakers who agreed to the old stability and growth pact or the excessive deficits procedure on which it is based.

A more appropriate response to the Ecofin Council’s November 2003 decision to suspend the fiscal rules for France and Germany would have been a far-reaching reconsideration of the rules themselves. Did the fiscal deficits run by France and Germany at the start of this century threaten the solvency of either country? Was there evidence that fiscal stimulus on the part of France and Germany could ease macroeconomic conditions and improve performance across the EU as a whole? Would the same logic of exception apply to smaller countries like Greece and Portugal that had (potentially) less liquid sovereign debt markets and stood to gain less from domestic fiscal stimulus?

These are questions of substance and not procedure. Any time EU policymaker decide to set aside or ignore the rules, that should be a clear sign of the need for substantive debate. And it is possible that a substantive conversation about macroeconomic policy coordination could have led the EU to be better prepared for the current crisis. The arguments for making an exception are stronger for France and Germany than for Greece and Portugal; a better lesson to draw from the Ecofin Council’s actions would be that large and small countries should fall under different fiscal rules. If Europe’s smaller countries had engaged in more strenuous fiscal consolidation while the larger countries focused more attention on improving macroeconomic performance, we could be in a very different situation today.

Of course, that kind of substantive debate was not possible – either before or during the recent crisis. European policymakers were willing to suspend the rules for fiscal policymaking but they were unwilling to question why those rules turned out to be inappropriate to the situation they faced in the early 2000s. Instead they looked the other way until circumstances changed enough to restore their initial assumptions. The alternative of opening up a debate about the appropriateness of the rules was never contemplated (or, if it was contemplated, it was quickly rejected).

The fiscal story is a negative illustration; if we look at the evolution of monetary policy we can come up with a more positive account. At various points during the ongoing crisis, the Governing Council of the European Central Bank (ECB) has shown its capacity for innovation. Critics of the ECB complain that the institution reacted too slowly and yet such complaints must be seen in the context of the narrowly-drawn and precisely-defined rules within which the Governing Council has to operate. Each major innovation in ECB policy ran up against the limits of this rule-based framework. Many, like the promise to deploy ‘outright monetary transactions’ to prop up sovereign debt markets for member states in distress or the sustained expansion of the ECB’s balance sheet to promote ‘quantitative easing’, have sparked challenges that the ECB is operating beyond its mandate.  So far the European Court of Justice has supported the ECB in its innovations and yet it remains a subject for intense debate.

The point is that even the ECB’s critics have to admit that it has done much to stabilize European economic performance. It could have done better; but it could also have been more absent. Unfortunately, the response to ECB innovation is more likely to be procedural rather than substantive. What the European Court of Justice argued is that it is not competent to enter into a substantive debate about monetary policy. That is fair for a court of justice – as guardian of the rules – but politicians and policymakers should not be bound by the same constraints. Unfortunately, the EU has little capacity to debate the substantive issues that arise as a result of recent monetary policy innovation. Instead, we should expect EU politicians and policymakers to focus on ways to tighten the procedures for decision-making within the Governing Council and to clarify the scope for ECB discretion in both defining and fulfilling its policy mandate. This conversation will not take place immediately, although hints of it have been circulating since 2010. It will become full-blown only once Mario Draghi steps down as ECB president – since his leadership, more than anything else, explains why the ECB has been able to do so much. The result will be a more rigid and less adaptive organization. The ECB’s capacity to innovate when faced with the next crisis will be diminished as a consequence.

The EU as it is currently organized cannot avoid that fate because it lacks the capacity to legitimate exceptions to the rules after the fact. In simple terms, the EU does not admit mistakes. It also lacks the capacity to draw lessons about why the rules failed to work appropriately in the first place. If you don’t admit mistakes, you cannot learn from them – indeed, that may be the objective. Ask any EU politician whether we might want to debate the ECB’s mandate in light of recent events, and they will tell you that is not possible politically to do so. That is the same response you will get to any suggestion that we might want to reconsider some of the fundamental assumptions underpinning fiscal policy coordination – like the assumption that large states and small states should abide by the same rules. The fact that virtually every introductory macroeconomic textbook makes a large-state, small-state distinction when discussing the role of fiscal policy in an economy that is open to the outside world is irrelevant.

The EU has a political union that is good at making rules but bad at admitting mistakes. They exist – and we can all name them – but they are viewed as aberrations from the ideal of a rules-based organization. That is unfortunate. Europe’s political union should be better at admitting when it would be a mistake to follow the rules it makes, because admitting those mistakes is the first step in learning from them.

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