5. The UK can remain influential in a changing European Union

Chapter 5 - The UK can remain influential in a changing European Union

The EU a constantly evolving entity and is currently going through a particularly rapid period of change driven by the global financial crisis and subsequent crisis in the Eurozone. The new wave of integration by Eurozone members could, in theory, undermine the Single Market – as well as leaving the UK sidelined with reduced influence. However, the changes underway are also providing an historic opportunity to reshape and reform the EU.

Eurozone member states are unlikely to move any further towards federalism than is necessary to stabilise the single currency and, even in this scenario, the UK can still influence the openness of the whole EU to its advantage if it approaches this changing Europe in the right way.

Those member states looking to further integrate  understand that this process has the potential to significantly alter the landscape of the EU; they realise that they are asking to change the rules of the game for much of the EU. Securing safeguards for the Single Market for non-Eurozone members and restating a Europe-wide political commitment to the maintenance of a European Union that works for all its members – focused on flexible co-operation to take on common challenges and shape effective solutions – is achievable. 

5.1 The global financial crisis exposed underlying weaknesses in the design of the Eurozone

The EU economy has suffered a triple-dip recession since 2008, leaving GDP today still 2.3% below the 2008 peak. A rise in net trade has eased the downturn, but domestic consumption and investment languished 5.3% below their peak level. Meanwhile, public-sector debt rose from 59.2% of GDP in 2008 to 85.9% five years later, unemployment was 11.0% at the latest count and youth unemployment was 23.4%. The situation was even worse in the Eurozone periphery, with GDP over 20% below peak in Greece, 9.8% below in Ireland, 8.9% below in Italy and 7.5% below in Portugal and Spain.[1]

The global financial crisis and resulting downturn exposed a number of economic and institutional weaknesses in the Eurozone, eventually triggering the wave of sovereign debt crises beginning with Greece’s in 2010. The causes of the Eurozone crisis are complex: over-leveraged sovereigns are only part of the story and different factors lie behind the crisis in each periphery country. The common theme, however, was a lack of central oversight and functions that greatly exacerbated pre-existing imbalances among Eurozone members and provided inadequate tools to fight the crisis.

The Eurozone was not an ‘optimal currency area’ when it was established in 1999: having limited labour mobility allowed wage imbalances to persist, a lack of price flexibility allowed divergences in inflation to build, and uncoordinated business cycles made a single monetary policy a poor fit. Countries entered at different levels (and with different trends) in productivity. Furthermore, the Eurozone failed to develop the central institutions that could have helped smooth over these imbalances – notably a central fiscal fund that could redistribute income from boom regions to depressed regions and an authority that could oversee competitiveness imbalances and initiate reform.

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The global financial crisis exposed a number of economic and institutional weaknesses in the Eurozone.

As a result, the act of imposing a one-size-fits-all monetary policy in many ways worsened Eurozone imbalances. Germany’s relatively sluggish economy faced the same central bank interest rate as Spain’s construction boom. Germany’s gain in competitiveness was underpinned by labour market reform but fuelled also by tight interest rates, which supressed wages and consumption and drove up German savings, which flowed abroad to fund current account deficits in the Eurozone periphery. In the periphery, much of which already started at a productive disadvantage, relatively high inflation further eroded competitiveness. Cheap borrowing helped enable a construction boom in Spain and unsustainable fiscal deficits in the likes of Greece and Portugal. The Stability and Growth Pact (SGP) failed to keep public deficits and debts within its prescribed limits.

When the global financial crisis began to shake these weak foundations, the Eurozone lacked the central crisis-fighting tools needed to prevent meltdown. It became apparent that sovereigns with an independent fiscal policy but with no currency of their own were far more vulnerable to runs and default than others, for example the UK, which was able to bail out its huge financial sector itself despite having a much higher public deficit and debt stock than Spain. Ireland and Spain, on the other hand, were unable to guarantee their outsized banking sectors without international help, despite being in compliance with the SGP.

Furthermore, the lack of central institutions with mandates for the welfare of the Eurozone as a whole also made it difficult to stimulate the economy to ease the recession. The European Central Bank, although nominally mandated to do so, has moved more cautiously on monetary stimulus than its counterparts in the UK and the United States. Meanwhile, fiscal automatic stabilisers that might have leveraged fiscal strength in the core to offset weakness in the periphery were not in place.

The urgency and magnitude of the crisis led to strong demands for action. To stabilise the economy and the currency union, it was vital to address the banking crisis, improve public finances and increase Europe’s competitiveness. Although many changes would have to be made at national level, failures of national regulation, supervision and behaviour, the mutual Eurozone interest in avoiding a break-up and the fact that individual periphery members were losing access to the markets led a majority of EU leaders to see ‘more Europe’ as the answer, albeit in some cases reluctantly. Thus closer co-operation at both EU and Eurozone level quickly became an essential element of the solution to the crisis. The Eurozone as a whole is in a relatively strong fiscal position – its public deficit peaked at 6.4%, much lower than either the UK or United States[2] – and it has needed to leverage this combined strength in order to find a solution to the crisis.

5.2 The Eurozone crisis is pushing further integration in the EU, spurring fears that the UK could be sidelined

Discussion of further integration has once again spurred concerns in the UK regarding its role in the new Europe that will emerge after the crisis. As the Eurozone integrates to a closer core, it could start pushing through policies and take actions that are not in the UK’s interest, hitting the City or other areas of national importance. This concern is exacerbated by the prospect of the Eurozone getting larger – at worst encompassing all member states except the UK – and beginning to develop common interests across policy areas beyond those directly linked to the Eurozone. This could potentially segment the ‘ins’ from the ‘outs’ and fragment the Single Market. The process of integration could even move towards a fully federal union of which the UK wants no part.

The changing EU will undoubtedly have an impact on the UK. Any assessment of how the EU in practice supports the UK’s global role must therefore look ahead, insofar as it is possible, to determine the UK’s place in this changed EU.

Further integration in Europe is happening in four main areas – each individually bring concerns for the UK and, taken together, could potentially threaten the UK’s place at the top table in Europe

Further integration is seen as the foundation of recovery for the Eurozone. The debate has moved towards a broad consensus for reform, set out in reports put forward through 2012 spanning all the key actors at EU level: the ‘Barroso blueprint’ of the European Commission, the Parliament’s own initiative report and, most importantly, the ‘Roadmap’ developed by the four presidents of the European Council, the Eurogroup, the European Central Bank and the Commission.[3]

In the discussion about achieving a ’genuine economic and monetary union‘ (EMU) on the focus has been on four main areas where ‘deeper’ integration of the Eurozone (but also in part of the wider EU) could take place in the future: financial, economic, fiscal and political integration (see Section 5.4). A fifth area of further integration involves increasing the number of countries in the EU involved in the closer co-operation of the Eurozone, thereby bringing more members into the integrated core. The EU could, of course, also ‘widen’ through geographical integration as its external borders may change to include new member states. This would continue the historical journey of a Europe moving towards a union that is increasingly larger and which co-operates on an increasing number of areas.

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It is argued that further integration could leave the UK marginalised, undermining its historic role as one of the EU’s leading member states.

Financial integration – from common regulation and supervision of the financial services sector to the potential pooling of risk, all to increase stability in the system – could pose an added cost to the City if new harmonised rules are wrongly designed. Moreover, the UK could potentially lose the power to supervise its financial services sector independently, as well as find itself facing a European authority that could wind down UK banks and make demands on the UK to pay into a deposit guarantee scheme that would fund lost deposits in struggling Eurozone countries. In the long run, the City could be hit if the Eurozone, supported by the monetary strength of the European Central Bank and rules discriminating against London, becomes a more attractive place for banking operations than the UK.

Economic integration – designed to increase co-ordination and reduce divergences among European economies – could see control over national budgets taken away from the UK’s elected institutions, with the EU imposing budget targets and outlining reforms that have to be undertaken by member states.

Steps towards fiscal integration – following the logic that joint economic and monetary policy requires moving towards a single fiscal policy to help correct for imbalances – could see UK budget contributions increase, to be spent on permanent transfers to struggling Eurozone countries. British people may also have to pay an EU tax going directly to fund EU initiatives.

Further political integration – could take political accountability further away from Westminster to Brussels. At the furthest extreme, the UK could find itself locked into a federal Europe where it would have to give up national power in areas such as defence and education.

Finally, the Eurozone makeup could change, continuing to grow in numbers until the UK is the only country outside the zone, leaving the risk of potentially being outvoted in all areas of EU policy by a Eurozone caucus.

The discussion over the response to the crisis has led to fears in the UK about the potentially harmful impact on the UK’s role in the EU. Although unlikely, it is argued that further integration could potentially increase the disadvantages of EU membership or diminish UK influence in the EU, limiting its ability to fashion future opportunities for UK business and society. Taken together,  a package of measures along these lines – implying one of the highest levels of EU integration  – could leave the UK marginalised, undermining its historic place as one of the EU’s leading member states.

Greece

5.3 Integration measures adopted to date have not fundamentally affected the UK’s place in the EU

A number of the potential measures for integration of the EU and the Eurozone set out in the roadmap have already been enacted. However, the fears over the UK being sidelined have so far not been realised.

Following the financial crisis, the EU took steps towards EU-wide supervision of the financial services sector by establishing common EU supervisory authorities for banking, securities markets and insurance and pensions (for details, see Section 5.4). The UK has never been a strong supporter of giving supervisory power over financial services to the EU, and the creation of these authorities was met with scepticism by the UK government. However, with other member states equally hesitant to give up control over their banks, the powers of the new EU authorities were kept to a minimum, focusing on co-ordination.

The move towards creating a single supervisory mechanism (SSM) for banks from participating member states as the first stage of Banking Union, with the ECB as the common supervisor for the Eurozone, was also seen as a risk to the UK. Quickly dismissing the idea of joining the SSM, which was technically possible, the UK feared the SSM could give the Eurozone countries an in-built majority in the European Banking Authority (EBA) that develops the detailed technical rules for all banks in the Single Market. In those circumstances, the Eurozone countries could potentially outvote – or ‘caucus’ against – the UK in an area of vital national interest.  However, during negotiations, the UK gained support from other member states for a ‘double majority’, which in practice means that decisions in the EBA need a majority from both the ‘insiders’ and the ‘outsiders’ of the SSM.[4] The UK used its tools of influence to secure safeguards against a perceived threat arising from Eurozone integration.

The Eurozone has also integrated its economic policymaking. It has introduced two packages of legislation to scrutinise member states’ budgets at EU level before they are passed in national parliaments (via the European Semester), improve surveillance, and given the EU more power to sanction member states that have debt and budgets judged to be unsustainable.[5] The Eurozone has also committed to write its budget rules – the Stability and Growth Pact (SGP) – into national constitutions. This has little impact on the UK since most of the measures apply only to the Eurozone. The UK must submit its national budget for scrutiny by the European Commission, but is not obliged to take up on the recommendations, and the Commission does not have the means to sanction the UK.

It has also been necessary to assist struggling member states through a number of temporary bail-out funds and the establishment of a more permanent measure, the European Stability Mechanism (ESM). As a non-contributor, the UK has not felt a substantial impact from this measure, but it does have a small liability because part of the EU’s budget has been allocated to struggling Eurozone economies (see Exhibit 53).

Exhibit 53: UK’s limited liabilities in relation to the Eurozone crisis.

Although the UK has chosen to stay out of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), it is indirectly liable for loans made under the European Financial Stabilisation Mechanism (EFSM) through its share in the EU Budget, which was used as guarantee for the borrowing. The agreement between member states to use the EFSM was made by qualified majority and so the UK could not have unilaterally opted-out of the mechanism. However, the UK’s liabilities are small and it will only be liable if the loans default. In that event the UK would have to make further budget contributions of 12.5%, which amounts to a maximum of €7.5bn (£6.6bn), a highly unlikely event according to a House of Commons report. Based on borrowing up to 19 May 2011, the UK’s liability would be only €1.2bn (£1.1bn).[6]

Overall, this first phase of Eurozone integration in response to the crisis has, in fact, been positive for the UK. It is in the best interests of UK business that Europe and the Eurozone stabilise and take steps towards sustainable growth because Europe’s downturn hits UK trade with Europe. It has not fundamentally altered the balance of the advantages and disadvantages of UK membership in terms of fragmenting the Single Market or disturbing capital and labour flows. Nor has it diminished the UK’s ability to influence the future outcomes of the EU.  The CBI has therefore been strongly supportive of the Eurozone taking steps to restore credibility and stability to the euro-area banking system.

Nevertheless, the developments to date have shown that the Eurozone’s first priority is to save the currency. This was highlighted by the intergovernmental treaty on stricter budget rules signed in 2011 by all EU member states except the UK and the Czech Republic, after the UK’s failed attempt to block measures at the EU level which the Eurozone saw as essential for its stabilisation. The future integration of the EU will be driven by the Eurozone and, as Angela Merkel has put it: ”We cannot stand still because some do not want to go with us”. The impact that this will have on ‘outsiders’ like the UK depends on how far it is necessary, and how far member states are willing, to go to save the currency.

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The steps already taken towards EU integration in response to the currency crisis have not materially impacted on the UK’s interests.

5.4 The Eurozone is likely to integrate further, but the final degree of integration and its impact on the UK is unclear

The steps already taken towards EU integration in response to the currency crisis (primarily along the first four main axes) have not impacted materially on the UK’s interests. However, the Eurozone is likely to integrate further to resolve the crisis. The degree of integration that is both necessary economically and acceptable politically is not yet clear. More radical changes would require the reopening of the Lisbon Treaty and involve referendums across Europe to achieve the democratic mandate required for EU Treaty change. There is therefore a broad delta of possible outcomes for further integrationist moves (see Exhibit 54), ranging from those having a very limited impact on the UK to those that could substantially alter the benefits of EU membership in terms of how it supports the UK’s global future.


Exhibit 54: Steps towards integration in response to the currency crisis are proceeding along four main axes

Financial integration of the rulemaking and supervision of the financial sector

The problem to be addressed

Lack of common supervision while markets are liberalised across the EU.

Fragmentation of the banking system in the euro area along national lines, in some cases drying up credit supply.[7]

A ‘vicious circle’ between banks and sovereigns, where the failure of one could cause the other to fail – exacerbated by Eurozone’s members lack of control over their currencies.

The solutions so far

Common supervisory authorities: First, steps taken towards integrated supervision of the financial sector with common European authorities established in 2011 co-ordinating supervision of banks, securities markets, insurance and occupational pension funds, while keeping most of the supervisory power at national level.

Common rulebook: The EU created new rules for financial markets, including rules on capital requirements, further harmonisation of recovery and resolution regimes and deposit guarantee schemes.

Banking Union (Single Supervisor): These authorities proved insufficient as responses to the crisis were national causing fragmentation of financial markets. A Banking Union has been proposed to combat this while addressing other weaknesses in the bank system, and would be based on a single rulebook of bank regulation and involve a common supervisor, a common deposit guarantee scheme and common resolution rules backed up by a common resolution fund. To date, only the common supervisor has been adopted, with the ECB becoming the supervisor of the Eurozone in a new ‘Single Supervisory Mechanism’ (SSM) as of mid-2014.  

Further potential development

Common rulebook: Work to strengthen the Single Market rules on financial services could continue both across all existing areas covered by EU regulation and in new areas in the future. Moreover, to avoid divergence between member states - in particular between the euro-area and the rest of the EU - the single rulebook could be underpinned by uniform supervisory practices led by a single supervisory handbook developed by the European Banking Authority (EBA).

Stronger common supervisors beyond banking: The European Financial Authorities’ power could also be strengthened.

Resolution: Work is ongoing both on common EU rules (Recovery and Resolution Directive) and a new Resolution Mechanism to create a common resolution authority and an appropriate backstop to support the SSM.  The Commission has suggested giving itself power to shut any failing lender in Europe’s banking union, based on the advice of a ‘Single Resolution Board’, even in the face of home state opposition.[8]

Economic integration Integration of economic policymaking, including national budget procedures and structural reform

The problem to be addressed

The euro-area governance system was based on surveillance of fiscal policy to make sure countries stuck to the Stability and Growth Pact (SGP), which sets the limits for budget deficits and public debt of 3% and 60% of GDP, respectively. In the case of a country breaching this, it would be put under the Excessive Deficit Procedure (EDF) where they have to follow EU recommendations to improve the situation.

However, the governance was not effective as it lacked the right level of surveillance, co-ordination, and strong sanctioning means. In a currency union where the economic divergence was large at the start, this led some member states to thrive while others dodged structural reform and ran unsustainable levels of debt and deficit without penalty.

The solutions so far

The EU has introduced several measures to get member states’ budgets and debt under control.

  • It has created a common budgetary timeline and common budget rules for euro area member state – the European Semester.
  • Two regulatory initiatives, the ‘six-pack’ and the ‘two-pack’, have strengthened expenditure rules, altered the conditions for Excessive Deficit Procedure (EDP) to include debt developments, and introduced a new Macroeconomic Imbalances Procedure (MIP) – a surveillance mechanism aiming to prevent macroeconomic imbalances and to identify and allow the timely correction of any emerging competitiveness divergences – and strengthened the ‘corrective arm’ of the Stability and Growth Pact, including by introducing the possibility of sanctions for countries that breaks with the pact with an interest-bearing deposit of 0.2% of GDP.

Member states have also given further impetus to the governance reforms through intergovernmental agreements.

  • The Euro Plus Pact in March 2011 was signed by 23 member states, including six outside the euro-area (Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania). It commits signatories to strong economic co-ordination for competitiveness and convergence, including areas of national competence, with concrete goals agreed on and reviewed on a yearly basis by heads of state or government. It is now integrated into the European semester and the Commission monitors implementation of the commitments.
  • All EU member states except the Czech Republic and the UK have also committed themselves to a stricter version of the SGP in  the Treaty on Stability, Coordination and Governance in Economic and Monetary Union (TSCG). The Treaty obliges Eurozone countries to incorporate EU rules on balanced budgets into their national legal frameworks. Only a few parts of the Treaty formally apply to non-Eurozone countries, although they can choose to adopt the full Treaty, as Denmark has done.[9]

Further potential development

Ex-ante co-ordination: Because national reforms, especially large-scale ones, might have cross-country spill-overs, there could be a development towards greater ex-ante co-ordination of such reforms. The Commission has put forward a communication for how this could take place before final decisions are taken at national level.

Formal reform obligations: It is also being discussed whether the Eurozone should bind member countries more formally to structural reform. The Commission has put forward ideas for how contracts could be introduced between member states and EU institutions on the policies countries commit to undertake and on their implementation. Such contracts could be a quid pro quo for receiving fiscal assistance as part of the Convergence and Competitiveness Instrument (CCI) (see Fiscal integration).

Common economic government/Treasury functions: The Eurozone could also move towards creating a common economic government – potentially a European Treasury within the Commission – which would meet every month to discuss ways of promoting growth. This could also involve giving the European Court of Justice the ability to monitor national budgets.

Fiscal integration Integration of member states’ fiscal resources and how they are used and distributed across member states

The problem to be addressed

The no-bail-out clause [10] supposed to make sure that no country had to save another financially didn’t hold. Furthermore, the lack of a system for sharing the risks and the fiscal burdens, including fiscal transfer mechanism to redistribute wealth to weaker areas, contributed to countries needing – and getting – bail-outs.

The solutions so far

Bail-outs: To enable bail-outs of Eurozone states in distress, the solvent nations in the Eurozone have supported struggling nations through guarantees and loans via two short-term facilities:

  • European Financial Stability Facility (EFSF): Created in May 2010 by the EU’s then 27 finance ministers. A limited fund authorised to borrow up to €780 billion backed by guarantees given by the 17 euro-area member states, providing financial assistance conditional on reforms. To date this fund has distributed to Greece, Ireland and Portugal.
  • The European Financial Stabilisation Mechanism (EFSM): Operational since May 2010 and is reliant upon funds raised by the European Commission on the financial markets and guaranteed by the EU budget, thereby involving all 27 member states.

The European Central Bank (ECB) has also stepped up and secured market confidence through OMT, with President Mario Draghi ultimately promising to do  ”whatever it takes to preserve the euro” and announcing a programme to buy an unlimited number of bonds.

A permanent emergency fund: the European Stability Mechanism: The Eurozone countries established the ESM in 2010. Unlike the EFSF, this fund is not based on member states’ guarantees, but comprises in part paid-in capital (€80 billion) and in part callable capital (€620 billion) split between the member states, which gives an effective lending capacity of €500 billion. The ESM Treaty was signed in February 2012 giving the fund the power to provide loans and intervene in the primary and secondary debt markets.[11] The Eurogroup then enabled the ESM to directly recapitalise struggling banks in member states in June 2013 under stringent conditions. The fund can pump cash directly into teetering banks against strict requirements instead of providing support through governments which increases the country’s debt. [12]

Further potential development

A limited fiscal capacity: A limited fund could provide temporary, targeted and flexible financial support to structural adjustment in member states who commit to reforms. The Commission has put forward thoughts for the use of such an instrument – a Competitiveness and Convergence Instrument (CCI). [13] If a fiscal capacity is set up, a key aspect would be whether it would be given the ability to borrow. Building on the limited fund, a more permanent capacity could be set up and be used to absorb country-specific shocks, for instance through an insurance system set up at central level.[14]

European Redemption Fund: This concept was first presented in 2011 by the German Council of Economic Experts and provides a framework for bringing down the euro-area member states’ debt by pooling all ‘bad national debt’ above the limit set out in the Eurozone rules – 60% of GDP – into a joint fund, with member states being obliged to redeem the debt over a specified period of time, for instance 25 years. The fund would issue its own bonds, serviced by the participating member states, and – to get the sufficient credit rating – be backed by a joint guarantee of all euro-area member states. Treaty change would be required and, to limit moral hazard and ensure the redemption of payments, it would have to include strict conditions.

Eurobills: A mechanism to overcome differentiated risk premium put on Eurozone member state debt – commonly issued short-term government debt with a maturity of up to one to two years. They could progressively replace existing short-term debts and create a large integrated short-term securities market in the euro area. Due to their character as financial instruments requiring joint and several guarantees by participating member state, this too would involve Treaty change.

Eurobonds: All Eurozone member states would issue common debt. This would be a permanent fiscal transfer and would certainly also require Treaty changes. This option is less discussed given the opposition from the more fiscally stable countries of the Eurozone such as Germany.

Common tax: Not part of the current discussions, this proposal has support from those favouring a federal EU. It could be a common tax for the Eurozone or the EU as a whole and would generate “own resources” for the EU, creating a European budget separated from national contributions: in other words, creating full fiscal federalism.

Political integration Further integration by giving more powers to EU institutions and the strengthening of democratic accountability and legitimacy.

The problem to be addressed

Further financial, economic and particularly fiscal integration requires political integration. Accountability must take place at the level where decisions are taken and democratic legitimacy needs to be strengthened if further power is transferred to the European level.

The solutions so far

This is the least developed part of the discussion about a changing EU, with few changes adopted to date. The changes that have happened are limited in scope. When the Single Supervisory Mechanism was created, accountability and transparency arrangements were strengthened in negotiations. For instance, the chair and vice-chair of the Supervisory Body will be approved – and potentially dismissed – by the European Parliament, while national parliaments will have a stronger role, through hearings with the supervisory board chair and requesting written replies from the ECB supervisor. [15]

The Commission adopted a recommendation in March 2013 urging European political parties to nominate a candidate for European Commission President in the next European elections.[16] This has been done in previous elections, but not all political partieshave put forward a candidate.

Further potential development

Accountability through the European Parliament: One suggestion is to increase the involvement of the European Parliament in various discussions and in setting the multiannual priorities of the Union, as the EP is the only EU institution directly accountable to the people of Europe. Another suggestion has been that the Parliament adapts its internal organisation to a stronger EMU by setting up a special committee on euro matters to scrutinise the work of the Eurogroup – the special group set up for finance ministers of the Eurozone countries.

In addition other ideas have also been touted, such as having a directly elected president of the EU – whereas today the president is appointed.

The Commission has also tabled a proposal for a revised statute for European political parties which would give a legal status for European political parties and their affiliated foundations, as most of them are today registered as Belgian non profit-making associations.[17]

Move towards a political union: Some argue that there is a need to take further steps towards political union, by gradually giving the EU control over even more areas until the EU level becomes the primary level of power in a fully federal Europe with a European government. The European Parliament’s powers could be strengthened and the Council could form a second chamber. However, while some have always favoured making the EU a federal state, there is very limited support among member states.


Were all the above reforms to be implemented fully and to their ultimate conclusion, the Eurozone would have a single set of authorities for financial services supervision and resolution, issue common debt and have a Eurozone-wide tax base, and have pan-European political entities that would be likely to set the parameters for national budgets and enforce the rules to avoid deviation from agreed economic policies. In effect, the Eurozone would look increasingly like a single country, potentially fragmenting the Single Market and the advantages the UK obtains from it.

5.5 The political will exists to support the Euro but not for full federalism

Fears about a changing Europe are understandable, and legitimate. In the same way that changes in the past have created threats and opportunities for British business, future changes may alter the advantages and disadvantages of being a member of the EU.

However, the extent to which these fears will materialise depends in part on the impact of current changes and likely future developments and in part on the UK’s ability to influence the direction the EU takes in the future, through use of the tools discussed in Chapter 4. The final outcome of European reform is difficult, if not impossible, to predict. What can be done is outline possible scenarios, assessing their likelihood and the potential impact they could have on the factors that underpin the UK’s global role.

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The overall direction of the EU – including the level of integration pursued – is dictated by the details of the current EU Treaties and the priorities and policies of member states.

Were the Eurozone to break up, speculating on the political impact on the UK’s place in the EU would take second place to the consideration that would need to be given to economic consequences on the UK economy following the enormous disruption faced by its closest trading partners in Europe. However, in these circumstances the UK is likely to retain influence in the EU. Only if the EU moved to a fully federal structure would the UK be likely to find its influence significantly set back. In most scenarios short of the creation of a federal state, the UK retains the tools of influence set out in Chapter 4.

The degree of further integration ultimately depends on how far the EU’s key actors are willing to go

European integration is to a large degree controlled by its member states: they sign off each new EU Treaty that sets out what the EU should be doing, what should remain under member state control and how the EU should conduct its business. The member states have always been the most powerful actors in the EU and the crisis has shown that they are still in command. 

Moreover, the member states – 28 in total – are not a homogeneous group; they have diverging views on what the EU should look like, and they all seek to maximise their own advantages by shaping the EU in their vision. The final outcome will therefore depend on the overlap of these visions, with larger countries – such as the UK, France, Germany, Italy and Poland – holding more power than others. What they do have in common is that they all preside over an increasingly Eurosceptic public, with polls showing support for the EU at an all-time low.[18]

The EU’s own institutions also have a say in Europe’s future, but their power remains limited. The European Commission, the European Parliament and the numerous EU agencies influence the day-to-day political outcomes of the EU. However, the overall direction of the EU – including the level of integration pursued –is dictated by the details of the current EU Treaties and the priorities and policies of member states.

Furthermore, integration does not happen in a vacuum; historical events may necessitate a push for integration. The current crisis has instigated a new wave of reform, and future integration is highly dependent on how the crisis develops over the next few years. If pressure remains high, the incentive to reform will remain, but the likelihood of further change will be reduced if the currency union regains market confidence and growth returns in Europe.

For any substantial steps towards further integration, the EU will need Treaty change, which is a substantial obstacle for further integration. Although the EU can take steps through creative ‘outside-the-Treaty’ solutions, including intergovernmental treaties, there are legal limitations making Treaty change necessary if substantial powers are to be given to the EU. This would trigger an extensive process involving a long negotiation and referendums to ratify the agreement in several member states, including in the UK. Therefore a number of member states are hesitant to embark on Treaty change. As President Hollande’s adviser has said: “We will do a treaty change only if we have certainty about a successful ratification process. It would be too embarrassing to fail. The risk is bigger than on the Lisbon Treaty”.[19]

The Eurozone is unlikely to collapse

Although Eurozone governments have taken significant steps towards central supervision and integration, the currency union still struggles with design weakness and market distrust. There are therefore those who argue that, despite plans for further integration, it is not likely that member states will be willing to take the necessary steps forward – with the consequence that the Eurozone will break up.

Those who argue that a break-up is likely often believe that a monetary union comprising countries as diverse as Germany and Cyprus is simply unsustainable without a substantial degree of integration, including burden sharing between member states.[20] If the periphery fails to act on productivity shortfalls, the core would have to tolerate indefinite transfers and the monetisation of debts to prevent competitiveness and balance of payment imbalances from threatening the existence of the euro.

Meanwhile, the periphery, lacking the option of currency devaluation, is enduring the huge pain of ‘internal devaluation’ in order to bring down debts and improve competitiveness. The core has done enough to contain the Eurozone crisis, for now, with programmes including the ECB’s Outright Monetary Transactions (OMT) and the European Stability Mechanism (ESM) as well as the moves towards Banking Union, but relatively little has been done to ease the pain of adjustment in the periphery. Without greater burden sharing – through, say, fiscal transfers or a tolerance of higher inflation in the core – one or a number of the periphery countries may perceive that the pain of remaining in the euro exceeds the risks of exit. The exit of a periphery member would be risky, potentially sparking further exits and even a full break-up of the Eurozone.

Any full break-up of the Eurozone would be hugely disruptive and carry severe macroeconomic consequences. Though the risks are likely to be somewhat smaller if the break-up is managed and planned for, substantial risks would remain, especially while Europe remains economically weak. Irrespective of UK membership of the EU, a full break-up would have substantial costs to the UK since its major trading partners would be thrown into a crisis.

A full break-up would mean that all countries would return to their national currencies. Then a devaluation or revaluation of all new currencies would take place, and all contracts, debt, pensions and wages would be redenominated.[21] There are important legal dimensions to this analysis, including the legal jurisdiction of euro denominated assets and obligations in question. The importance of the size of euro obligations under English and New York law, in the form of Foreign Exchange (FX) swap and forward contracts, as well as interest rate derivatives, should not be underestimated.[22]  The sheer size of these markets illustrates that complications related to the redenomination process around such assets and obligations have the potential to cause very significant disruptions, with dramatic macroeconomic implications.

In addition to the economic consequences, break-up of the Eurozone would have a political impact on the EU as a whole. The euro is a major project for the EU and has had substantial political support. A break-up could reduce the legitimacy and support for the EU and could lead member states to withdraw further powers from the EU level. At the extreme, it could lead to a complete undermining of the EU as a project.

A Eurozone collapse is not a likely scenario. Ultimately, any full or partial break-up of the Eurozone would be a political decision – it cannot be forced by the markets directly (though they can impose costs on countries staying in). The past years have consistently shown that the Eurozone has political support to do ‘what it takes’, as the governor of the European Central Bank put it, at least at crunch points when break-up looks like an imminent danger. An influential German Social Democratic MP remarked in an interview conducted by Policy Network for the CBI: “Eurozone integration is inevitable and Germany will do whatever it takes to keep the euro afloat, even if this is costly for Germany”.[23] Meanwhile, the periphery, to date at least, has shown a willingness to endure deep recession and eye-watering unemployment rather than risk ditching the euro.

However, substantial moves towards a federal superstate – likely to be based on designs intended to support the currency union – could alter the balance of benefits of EU membership.

It is not likely that Europe will move towards a federal superstate

Elements of the debate about achieving a ‘genuine EMU’ involve substantial steps of integration which some have characterised as ‘federal’, and indeed proponents of a federal Europe have argued that much more integration is needed before Europe’s current challenges are solved. 

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The Netherlands’ government is convinced that the time of an ‘ever closer union’ in every possible area is behind us.

The notion of achieving a fully federal European Union has been present from the very start of the European venture. The idea was already present in the Schuman declaration of 1951, and it was championed by several of the EU’s founding fathers, in particular Jean Monnet, who viewed national sovereignty as outdated. In the 1958 Treaty of Rome, the six founding members agreed that they were “determined to lay the foundations of an ever-closer union among the peoples of Europe”, and the commitment to ‘ever-closer union’ still remains part of the current Treaty, although it has been complemented by an increasingly large number of other priorities.

Proponents of a federal Europe argue that pooling sovereignty to the EU level to create a United States of Europe is the only way to accommodate the challenges facing the continent. Creating a federal Europe would mean a substantial pooling of powers to EU level in all areas:

Full financial integration: A fully federal Europe would have created a full banking union, including establishing a common resolution authority with widespread powers and a common scheme for deposit guarantees and bank resolution, sufficiently backed up by a common European fiscal resource.

Full fiscal integration: A federal Europe would mean a move to the very end of the spectrum of fiscal integration with the Eurozone issuing common debt, in the form of Eurobonds. The EU would likely be empowered to tax its population directly, for instance through a common EU VAT, which would create a basis for European own resources. This could substantially boost the EU’s budget, enabling the union to steer economic development and reform across the continent without needing contributions from member states. The EU would also likely to have established other ways to distribute fiscal resources across the Union - this is what is often described as a ‘transfer union’, in which the economically strong member states permanently support weaker member states in the same way that economically strong regions in the UK support less competitive areas.

Full economic integration: Central economic policymaking, such as labour market policy, would be given to the European level. A European Treasury function could take charge of Europe’s economic and fiscal policy, holding powers over member states to push through reforms with substantial sanctioning powers. This could be led by a specially appointed Commissioner in the role of a pan-European finance minister.

Full political union: In a federal scenario, member states would have given the EU competences in a number of areas necessary to a federal union. For instance, in a federal Europe, the EU would likely seek more majority decisions in the common foreign and security policy sphere, one single diplomatic corps, a European defence policy and potentially a European army with a single central command. A federal police could be put in place to deal with federal crimes (such as terrorism, organised crime, human traffic and federal taxes evasion). The EU could, in particular, be entitled to manage asylum policy and the control of external borders. A federal Europe would also mean that the member states would always be represented by the EU in international organisations, including the UN, which in practice would mean France and the UK giving up their seats on the Security Council. The European Council could also be disbanded in favour of a bicameral parliamentary system, a situation that would see all member states losing their ability to shape EU policy in their own interest.

Although not a majority, the federalists are a considerably powerful group, well placed to influence the EU’s development – with both the European federalist movement and a European Federalist Party (EFP), founded in 2005 after the European Union constitution was voted down by France and the Netherlands, in existence. More recently, in 2010 a group of MEPs launched the Spinelli Group, which seeks to ‘inject a federalist momentum’ into political decisions and policies of the EU (see Exhibit 55).

Exhibit 55: The Spinelli Group

The Spinelli Group supports a fully federal EU. It has more than 110 supportive MEPs, 44 active members (EU experts, NGOs and think-tank representatives, politicians, academics) and more than 5,000 signatories to their manifesto from all over Europe. British Liberal Democrat Andrew Duff MEP, former Belgian Prime Minister Guy Verhofstadt and former Italian Prime Minister Mario Monti are all members of its steering group.

The likelihood that Europe will become a federal superstate in the foreseeable future nevertheless remains limited. There are substantial legal obstacles to a fully federal Europe. The Treaty currently sets the limitations of the EU’s powers, and any changes to these powers would have to be approved by all EU member states in a negotiation for a new Treaty. Treaty change, or any further delegation of power to the EU level, would trigger referendums in several EU countries, including in the UK, and other countries that have similar ‘referendum locks’ in place, including Denmark, France, Ireland and Slovakia.  This is not a preferred route for most EU member states. In fact, Professor Anand Menon, an EU politics specialist at King's College London, has said that French President Francois Hollande would be among those most reluctant to hold a new referendum on the EU. [24]

Moreover, political support in key member states for a federal Europe is weak. The majority of member states have not proclaimed support for the federal idea; instead there seems to be a widespread ‘federal fatigue’ among EU member states. In particular, countries such as Germany and the Netherlands, both part of the ‘core Europe’, have been clear that a federal Europe is not a goal for the near future. The Dutch government has recently tested European legislation for subsidiarity and proportionality and come up with recommendations of how to ensure ”Europe where necessary, national where possible”. The introductory remarks to this Dutch review point towards a potential slowing of the traditionally understood trajectory of EU development, allaying UK fears of the march of federal Europe: “The Netherlands’ government is convinced that the time of an ‘ever-closer union’ in every possible area is behind us. Even in the Eurozone, the stress is now put on co-ordination rather than on federal style integration, which now seems a highly remote prospect.” 

It could also be difficult to push through the creation of a federal Europe – both for member states and the European institutions – with an increasingly Eurosceptic public. Figures from Eurobarometer, the EU’s own polling organisation, suggest that public trust in the EU is falling across Europe in both poor and better-off EU nations.[25] The UK is not alone in being sceptical of further EU integration: while 66% of British voters tended not to trust the EU, the same is true for 72% of Spanish, 59% of German, 56% of French and 53% of Italian voters. The countries surveyed account for 350 million of the EU’s 500 million citizens, a worrying number for the EU, and polls have indicate that as much as a quarter or a third of MEPs could be ‘Eurosceptic’ after the next European elections.

It is therefore likely that the degree of integration that member states accept to support the single currency will fall far short of creating a federal state. The degree of integration will dictate the impact on the UK. But the UK will also have a choice about how much it takes part in this process – especially because of the referendum lock.

5.6 The EU is likely to develop pragmatically in a way that will not fundamentally change the balance of advantages and disadvantages for the UK

Although the Eurozone is likely to remain intact and the measures taken to achieve that are likely to fall short of creating a federal state, the EU will take steps in the coming years to solve the challenges of the crisis, meaning further integration in Europe. It is in the UK’s interest that the Eurozone stabilises and returns to growth, but the question remains how compatible any change will be with the EU continuing to support the global trading role to which the UK aspires.  

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The UK has already clearly said it will not take part in full Banking Union co-operation.

The steps likely to be taken – insofar as it is possible to predict – are not likely to fundamentally change the advantages and disadvantages of EU membership or the UK’s ability to influence the outcomes that affect the UK. Most importantly, the UK itself can make a difference as Europe is changing, both by influencing the overall direction of travel and by maximising its influence on the specific policies that impact the UK.

The EU will take further steps towards a Banking Union, but full financial integration seems unlikely

The UK will benefit from the efforts to increase financial stability in the Eurozone without having to take part in the closer co-operation.

Although there were signs of commitment to a full banking union in 2012, that support has declined, largely due to reservations among member states, especially Germany. Tensions were visible at the creation of a single supervisor in 2012, when German pressure reduced the scope of supervision to exempt its smaller savings banks from the ECB’s oversight. The common deposit guarantee scheme, although present in the early discussions, quickly disappeared from the debate. Furthermore, a common European bail-out authority backed by a fund, although seen as a priority, is currently facing objections from those who argue that the transfer of such substantial powers to an unelected authority requires Treaty change.

A number of financially strong member states do not seem willing to pay for other countries’ banks or lost deposits in the event of a failure. They believe that a common fiscal backstop for a banking union would create moral hazard because banks would have little incentive to remain solvent if the EU could bail them out. The ESM has been suggested as a source of funds for bank recapitalisation, through the provision of guarantees, credit lines or direct loans to national schemes. [26] However, as well as requiring a resolution of issues around the provision of unconditional support, this would likely involve a change in the ESM Treaty. [27]

Additionally, some argue that Treaty change would be necessary to give the EU necessary powers for a full banking union. Finally, some seem simply reluctant to lose power over their own banks. National banking markets, which differ widely across member states, could come under threat if national interests diverge from the views of European authorities. Also, if a European authority chose to resolve a bank against the wishes of a member state, the lost deposits would potential voters’ savings.

4

The number of member states required to be outside the Single Supervisory Mechanism for the 'double majority lock' rules to apply.

It therefore seems likely that the EU, instead of creating a full banking union, will rather enhance co-ordination for bank recovery and resolution with the final say to wind down banks remaining at national level. And, instead of a common deposit guarantee scheme or resolution fund, it is more likely that there will be a coordination of national schemes with European authorities mediating in cross-border situations and a potential backstop for the Eurozone schemes in the ESM.

There are, however, those who argue that anything short of a full banking union will fail to secure a stable future for the Eurozone. They argue that the ESM recapitalisation is far from enough and that, without a full banking union, the ‘vicious cycle’ between banks and sovereigns – where their interdependence drags both down into insolvency – will not be broken.

EU Europe Eurozone

Practically though, the balance of power currently lies with the creditor nations, who lack domestic support to take further fiscal responsibility for the Eurozone. Future developments – particularly renewed market stress around the Eurozone’s weaker economies – could, however, alter this balance since an increased risk of a failure of the currency union as a whole would strengthen the motivation for reform in the more solvent member states. As a senior German official said in an interview conducted by Policy Network for the CBI: “What if a French or Italian crisis forces much earlier treaty change than anyone currently envisages? Europe will have to respond to market pressure in weeks not years.”[28]

Regardless of this, the UK has already clearly said it will not take part in full Banking Union co-operation. Irrespective of how far the member states of the Eurozone – and potential countries opting into the Banking Union in the future – are willing to go, the obligations only apply to them. The main risk for the UK – that of being outvoted in the EBA resulting in less influence and potentially suboptimal banking rules – is mitigated by the double majority lock until such time as the UK is one of fewer than four member states outside the single supervisory mechanism. There is significant uncertainty as to when this might occur, given the unclear pathways to joining the Eurozone of many member states (see Exhibit 58).The UK will thus continue to be able to shape the rules affecting its large financial services sector while also avoiding the financial obligations of a single resolution fund but benefitting from increased stability on the continent. The proposals and likely outcomes from financial integration therefore do not fundamentally affect the operation of the Single Market and concomitant advantages of EU membership for the UK.

The EU is likely to commit to limited structural support – conditional on reform – but stop short of permanent fiscal transfers

There are likely to be attempts to raise the levels of economic co-ordination in the EU, both to increase convergence between countries and to boost the overall competitiveness of the continent, but the UK will not have to contribute or be bound by any EU-recommendations unless it chooses to sign up.

Although the Eurozone has shown commitment to support failing countries, permanent fiscal transfers have fallen victim to the same reservations as the fiscal backstops for a banking union. Even bail-outs have started to change shape: the Cypriot bail-out came with a caveat that larger depositors, over €100,000, had to contribute to the rescue package through a ‘bail-in’ with losses of 4.2 billion euros.[29] The former head of the Eurogroup publicly stated that this would be the new approach for future bail-outs and, although he clarified that there were ”no models or templates” for future bail-outs,[30] Cyprus marked a radical departure from the concept of simple transfers from economically stronger states to their weaker neighbours.

The Eurozone therefore seems less likely to take any further substantial steps towards a more permanent fiscal transfer mechanism such as common debt issuance like Eurobills or Eurobonds in the short to medium term. Instead, it seems likely that a limited instrument – such as the proposed Competitiveness and Convergence Instrument (CCI) – could be put in place to provide temporary support for structural reform in member states. Such an instrument is likely to be coupled with strict conditionality. In Germany and other creditor countries, stronger economic governance is supported insofar as it pushes countries to undertake necessary structural reforms of areas such as labour market or pensions. Firm contracts mandating reforms between member states and the Commission are therefore likely to become a condition for CCI funding.

It has been argued that, although economic governance has been strengthened, much more will have to be done to keep budgets of member state governments under control and keep momentum for structural reform going. The economic governance regime continues to be limited by a weak sanctions regime – both in theoretical range and in practical use - for those breaking the Stability and Growth Pact (SGP) or failing to enact reform. In addition, some argue that the lack of fiscal transfers – either to encourage reform or to directly support weaker member states – limits the ability of a number of Eurozone countries to return to growth.

Despite the concerns around the consequ­­ences of a lack of fiscal union in the Eurozone, there is simply not the political will to support fiscal transfers at this time. As long as fiscal burden sharing remains weak, the idea of fiscal union will remain off the table.

In the absence of moves towards creating a permanent fiscal transfer mechanism (that could underpin a more federal EU, either with greater control of UK budgets or with the UK not part of, but marginalised by, a more federal Eurozone bloc), the majority of the changes in this area will not impact the UK. Contracts for structural reform in return for financial assistance, such as contained in the CCI, place obligations only on those member states who sign up to these contracts, either as part of the Eurozone or voluntarily. It is the countries inside the currency bloc that will have to abide by the Eurozone rules and face fines of up to 0.2% of GDP if they do not. Those countries outside the euro will remain free to set their own budget and choose which economic reforms to pursue. The prospects and likely outcomes of the process of economic and fiscal integration will therefore not fundamentally affect the operation of the Single Market.

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Despite the concerns around the consequences of a lack of fiscal union in the Eurozone, there is simply not the political will to support fiscal transfers at this time.

Progress on political union will remain limited

There is backing for increasing the political accountability and legitimacy of the EU- meaning calls for increased forms of political union are likely to follow any steps towards further economic integration. However, there are few firm proposals on the table and any moves towards more federal institutions will be met with resistance by member states. Moreover, there are substantial limitations to the steps the EU can take towards political integration without Treaty change and, given the substantial objections to starting new Treaty negotiations, this is unlikely to happen in the next few years. For the UK, any further transfers of power to the European Union, which would undoubtedly include moves towards political union, would have to be put to the British people under the ‘referendum lock’ laid out in the European Union Act 2011.

5.7 The ‘multi-sphere’ Europe that emerges is not likely to leave the UK sidelined

Taken as a whole, none of the likely measures of further integration undermines the benefits of UK membership of the EU in itself. While there are risks, the Single Market will not inevitably be fragmented in terms of access for UK goods and services, nor will capital or labour flows necessarily be interrupted substantially. The main risk, therefore, is to the continued influence of the UK – that irreplaceable asset which allows the UK to navigate the EU policy process successfully to achieve those outcomes which support its global ambitions.

It has been argued that further integration risks marginalising the UK and other countries outside the Eurozone, as the ‘core’ outnumbers those on the outside and begins to dominate decisions by default. This marginalisation would be worsened if more non-Eurozone member states chose to join the Banking Union or single currency, potentially increasingly stacking the odds against the UK in its attempts to influence the direction of EU policy.

However, in reality, the UK can retain its influence in the most likely scenario of Eurozone integration. The journey to Eurozone membership is occurring at different speeds for different countries and, even when this collection of member states grows, there is little evidence that the Eurozone is likely to caucus as one bloc vote on every issue. The underlying desire to retain the EU as a ‘family of nations’ is likely to see a Union emerge from the crisis that practically safeguards the interests of all members and continue its day-to-day policymaking along the traditional lines of a ‘multi-sphere’ Europe. 

There is a danger that the Eurozone will be able to outvote the UK and other countries outside the currency, but the diverse interests of EU member states means that the UK will still have allies

From November 2014 the Eurozone, following the Lisbon Treaty, will have a qualified majority in the Council with more 65% of the EU population. This formally enables the Eurozone to caucus against those outside the currency bloc in all areas where decisions are made by majority voting, which in practice includes most EU policies (see Exhibit 56).

Exhibit 56: The Eurozone will hold an ‘inbuilt’ majority of votes in the Council as of November 2014

This majority is likely to grow over time, not least because every member state bar the UK and Denmark has committed (as a condition of joining the EU) to adopt the euro as their currency. This leaves these two ‘outsiders’ in an uncomfortable minority position. There are a number of countries set to join in the near future: Latvia is set to join in 2014, while Lithuania, which failed to meet the criteria to join in 2006, has joined the ERM II and is now set to join the Eurozone in 2015.[31]. Even Denmark is considering starting on a pathway to eventually joining the single currency. It is already part of the Exchange Rate Mechanism (ERMII), a mandatory regime for all entering countries (for a minimum of two years) which mimics the conditions of being a Eurozone member, and the current government has publicly stated that its exemption is outdated and that it would like to give Danish voters a say in a referendum within the present election term. Danish entry would potentially leave the UK alone on the outside.

However, although the borders of the currency are likely to broaden over the coming years, many countries are unlikely to join in the short-to-medium term, for both economic and political reasons (see Exhibit 57), leaving the UK with a number of natural allies to balance the powers of the Eurozone as it integrates further.

Exhibit 57: An uncertain future makeup of the Eurozone

All member states except the UK and Denmark are committed to joining the Eurozone as soon as they fulfil the required entry conditions. However, many of the countries outside the currency are unlikely to join in the next few years.

Bulgaria: The aim in 2010 was to join the Eurozone in 2013, but September 2012 saw both Bulgaria’s Prime Minister and Finance Minister signalling publicly that they had halted plans to join, as they saw “no benefits of entering the euro zone, only costs”.[32] The return of Eurozone stabilisation may, of course, bring forward the possibility of entry. Bulgaria has pegged its currency (the Lev) to a currency basket including the euro but is not yet part of the ERM II, and the European Central Bank noted unsatisfactory independence of the national bank in their latest convergence assessment.[33] Given thattwo years of ERM participation is necessary before entry to the Eurozone, the earliest possible entry date for Bulgaria is now 1 January 2016.

Croatia: As a new EU-member from 1 July 2013, Croatia is obliged to join the Eurozone. Although its central bank governor would like to see the kuna replaced by the euro as soon as possible, the country is years away from joining.[34] It has not yet joined the ERM II and continued high government deficits are contributing to a significant build-up of public debt.[35]

The Czech Republic: The lack of a compatible legal framework, low price stability and high public deficits – so high that the European Council has put the country under the ‘excessive deficit procedure’ – means that entry to the Eurozone is likely to be some way off for the Czech Republic.[36]

Hungary: Prime Minister Victor Orbán said in April 2013 that Hungary cannot “seriously consider joining” the Eurozone until its average economic development reaches 90% of that of other Eurozone members.[37] Moreover, Hungary’s legal framework lacks solidity and the country currently falls short of meeting the convergence criteria to join.[38]

Poland: The country does not yet fulfil the economic criteria and, even if this changed, it may be some way off a decision to join the single currency. Although the government’s support for ultimately joining the euro remains, September 2012 saw its foreign minister, Radoslaw Sikorski, admit that Poland may push back plans to join the currency bloc in the immediate future.[39]

Romania: The country is scheduled to join in 2015, but entry by this date is unrealistic. Having been forced to seek financial assistance from the EU and IMF from 2009 to 2011, Romania is currently operating under the EU’s excessive deficit procedure and continues to struggle with price stability. The Commission highlighted in its convergence report in 2012 that Romania’s new bank law did not stand up to the legal criteria for entry. [40] Romania’s President, Traian Basescu, said in March 2013 that joining in 2015 was unfeasible and suggested 2020 would be a more realistic date.[41]

Sweden: An important ally for the UK, Sweden also has an exemption from joining the Eurozone – although this is not as definitive as the British and Danish derogations and does require adherence to the Maastricht rules on convergence. According to the latest progress report, Sweden has not yet made the necessary changes to its central bank legislation and it does not meet the convergence criterion related to participation in the Exchange Rate Mechanism (ERM II) to adopt the single currency. Politically, parties representing two-thirds of the seats in parliament officially still support Sweden joining the euro, but public support is at an all-time low – according to a poll in December 2012, fewer than one in ten Swedes wants their country to join the single currency. [42]

These conclusions depend on a number of assumptions that could potentially change in the future. If the Eurozone stabilises, the incentives to join the currency – or at least the Banking Union– increase, which would in turn reduce the number of potential allies for the UK outside the single currency.

However, irrespective of the size of a potential Eurozone ‘caucus’, influence in the EU and the ability to best realise one’s interests are not only about formal voting power, as Chapter 4 set out. The European Council is driven by consensus and EU legislation is rarely enacted in the face of strong national reservations, especially on the part of big member states. Instead, the EU is about pragmatic co-operation: EU member states focus on finding common ground and acceptable solutions to concrete problems, often in the face of overarching ideological disagreement. This search for compromise is reinforced when one considers the wide-ranging and diverse interests of member states, whether inside or outside the Eurozone, and the desire of countries to keep the EU working for all its members.

Firstly, in the same way that the ‘outsiders’ understand the Eurozone’s need to integrate further to stablise the currency, the Eurozone understands the need for safeguards for non-Eurozone members, and it has shown willingness to provide these (see Exhibit 58). It is not in the Eurozone’s interest to disregard the views of the other outsiders; most members seek a balance of power between the ‘ins’ and ‘outs’. As a senior Swedish official said to the CBI: “On the euro-in/euro-out question, there is a need for minority safeguards”.[43] Indeed, this view is prevalent across Europe, most notably in Germany. One senior German official stated in an interview in Policy network for the CBI: ”We could consider the inclusion of a new clause to protect the UK against discrimination as a Euro-out”.[44]

This rhetoric is backed up to some extent by a number of the safeguards that have already emerged from discussions around further integration. For example, the creation of a Single Supervisory Mechanism threatened to leave the UK in a minority in relation to banking supervision and decisions affecting the Single Market for financial services. However, the UK successfully negotiated safeguards through a ‘double majority’ lock. A recent agreement on the Market in Financial Instruments Directive (MiFID) again signalled that most European member states are supportive of an EU that works for all its members.

Exhibit 58: Safeguards are being secured for Eurozone ‘outsiders’

The UK secured voting safeguards against Eurozone caucusing in the European Banking Authority

The creation of a single supervisor (SSM) for Eurozone banks risked the emergence of a joint Eurozone position on banking matters, which would have an inbuilt majority in the European Banking Authority (EBA) and therefore be able to dictate EU rules to the detriment of non-Eurozone countries. Although caucusing would not necessarily occur in practice – countries seek consensus on EBA decisions – the UK and other ‘outsiders’ were able to secure legal protection through alterations to voting practices in the EBA. Article 44 in the Regulation aligning the EBA Regulation with the new SSM details these safeguards, with a ‘double majority’ rule being put in place to ensure that EBA decisions are approved by a majority which includes a plurality of countries outside the banking union: at least a simple majority of its members from competent authorities of participating Member States and a simple majority of its members from competent authorities of non-participating Member State.[45]

This safeguard only applies as long as there are at least five countries outside the Eurozone. If the ‘outsider’ group is reduced to four or fewer, EBA decisions would require the vote of only one of the ‘outsiders’ to be approved. This is because member states, in line with the broader move away from unanimity, do not wish to effectively give a small minority a ‘veto’ on decisions.

The UK has also secured new legal safeguards to protect the Single Market in secondary laws on financial services to counter potential threats from Eurozone integration

The legislation securing changes to voting modalities also achieved new legal safeguards (contained in Article 1) against currency discrimination in banking and financial services that protect the Single Market in this area: No action, proposal or policy of the ECB shall, directly or indirectly, discriminate against any Member State or group of Member States as a venue for the provision of banking or financial services in any currency.[46]

A similar protection was also introduced during member states’ negotiations on the EU’s cornerstone in the regulation of financial markets – the Markets in Financial Instruments Directive (MiFID). The Council position[47] states that no proposal from any regulator should directly or indirectly, discriminate against a member state (…) as a provision of investment services and activities in any currency. Although this might change following discussions with the Parliament, it shows that the UK can successfully get legal protections in secondary law.

Furthermore, if Eurozone members were to attempt to further their own interests at the expense of the whole EU, there are significant legal safeguards already in place from previous Treaties. It has been argued that the EU Treaties already firmly protect the Single Market against harmful initiatives. There is a question, nevertheless, as to whether these legal safeguards for the Single Market will stand up in court. The test case on Euro clearing (see Exhibit 59) – if it ever comes to court – could show if the EU Treaties provide sufficient support for the Single Market, or if other EU priorities such as the ‘stability of the Eurozone’ are now overtaking the Single Market in priority, thus requiring further legal protections for the UK if it is to continue to enjoy the benefits from EU membership.

Exhibit 59: The current legal protection of the Single Market

The Single Market is enshrined and protected in European law. The EU shall “establish an internal market” in which “the free movement of goods, persons, services and capital is ensured” and restrictions on these freedoms shall be prohibited.[48] However, the EU Treaties also make provision for other EU priorities, such as stability. There is a danger that further integration in one area risks fragmenting the Single Market as a whole – for example, restricting the free provision of financial services across the EU – if primacy is given to other EU priorities above the maintenance of the Single Market.

The current court case between the European Central Bank (ECB) and the UK government on the clearing of Euros is an illustrative case. The ECB has stated that “infrastructures clearing and settling sizeable amounts[49] of euro-denominated securities and derivatives should be located in the euro area”[50]. This could force a number of clearing houses currently located in the UK to relocate to the Eurozone. The UK government has objected to the European Court of Justice (ECJ), arguing that this ECB statement “contravenes European law and fundamental Single Market principles by preventing the clearing of some financial products outside the euro area”.[51] The final outcome of this case will therefore be an important signal on the primacy of the Single Market vis-à-vis other EU priorities such as the Eurozone. 

Finally, even with changed voting weights and increased numbers within the Eurozone, there is no inevitability that those outside the single currency will be outvoted in practice. The Eurozone is not a club of like-minded countries. They do have a common currency, but in most other areas their interests still diverge – in some cases substantially. Germany’s interests are in many cases more similar to Poland and the UK, both currently outside the Eurozone, than to Italy or France. The dividing lines on EU policies like renewable energy, and nuclear in particular, do not overlap with the borders of the Eurozone –nor are interests aligned in areas like trade and services, where the more liberal countries develop their ‘caucus’ against countries that take a more cautious position on market liberalisation. So, while securing safeguards for countries outside the single currency is important, the diverse interests and often divergent aims of Eurozone members mean that the occasions where these safeguards are used in practice are likely to be more limited than many might assume.

An EU that works for all its members

Overall, there is therefore no reason to suppose that the EU that emerges from the economic and currency crisis will not be able to encompass the interests of all its member states. Most importantly, the EU can take steps to safeguard the Single Market, partly because of the continuing clout of those countries outside the single currency to secure safeguards, but also because a significant number of EU countries want Europe to remain a union that works for all its members.

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The Eurozone is not a club of like-minded countries. They do have a common currency, but in most other areas their interests still diverge.

In fact, members of the EU have long been integrating on a number of areas with different dividing lines, creating a Europe of flexible cooperation – a ‘multi-sphere’ rather than ‘two-tier’ Europe (see Exhibit 60). This is not simply a case of the Eurozone diverging in areas of integration from those countries outside the single currency. Nor is this differentiated integration a product simply of a small group of countries, often caricatured as being led by the British, always blocking moves to further integration. Both those who are bound up in the Eurozone project and those outside have been involved in slowing or quickening the pace of integration in various areas.

Member states have been able to create the Schengen Area and a common European patent without having to get agreement from every country, with the lists of countries signing up different for each. For example, while the Italians and Spanish were both founding members of the Eurozone, neither has chosen to adopt the EU’s unitary patent; while Ireland chose the euro and the UK did not, neither takes part in the Schengen Agreement; and while Germany and the Netherlands both share a common currency in the Eurozone, Germany has decided to join ten other member states in introducing a financial transactions tax (FTT) whereas the Netherlands has not.

Exhibit 60: The multi-sphere Europe[52]

interactive icon View Interactive Exhibit 60

Some have argued for using enhanced cooperation in other areas such as services and trade: a form of co-operation introduced in the Treaty of Nice allows countries to move ahead if a large enough minority wishes to do so. Although there are some who argue that flexible integration will fragment the EU, it seems to be a useful way to consolidate the diverging views on European co-operation within the 28 member states.

This process of variable integration is likely to continue. Policy Network research for the CBI indicated that even the French government appears relaxed about an increasingly differentiated process of integration, and it discerns no contradiction between deeper integration in the euro area and the involvement of the UK on issues such as the Single Market, external relations and defence co-operation. As a senior French official put it: “Eurozone integration should not lead to a distancing of the UK.”[53]

This willingness on the part of other EU member states to develop the Union in this ‘multi-sphere’ tradition – including, on occasion, by allowing a subset of member states to come together to co-operate on those areas of shared national interest – can ensure that the UK does not become sidelined and can continue to realise its interests in a European Union working for all its members.

5.8 The most likely scenarios for European integration will not undermine the Single Market or UK influence

The changing EU is not likely to fundamentally alter the balance of pros and cons of EU membership or the UK’s ability to influence. Neither a federal superstate nor a collapse of the Eurozone is a likely outcome; rather the EU is likely to develop pragmatically, integrating just enough to protect the currency. The divergent interests of Eurozone countries mean that they are unlikely to ‘caucus’ on areas beyond those relating to the currency. This does not mean that a changing EU does not have the potential to impact the UK, and the UK and other non-Eurozone states must be alive to the dangers that present themselves as the EU’s institutions and member-state relationships evolve. But if the UK continues to build alliances across Europe to protect the Single Market, as it has done in the past, further integration is compatible with, and indeed can support, the UK’s global future.

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The UK must be alive to the dangers as the EU institutions evolve. But if the UK continues to build alliances across Europe to protect the Single Market, further integration is compatible with, and indeed can support, the UK’s global future.

The spheres of integration in the EU allow the member states some flexibility over where to co-operate with other member states in pursuit of common interests. The direction of travel suggests that this will remain the case for the foreseeable future. This not only protects the UK from areas of unwanted integration but also brings significant opportunities. The EU Unitary Patent has already shown how variable integration can help the UK and benefit important UK industries such as hi-tech and pharmaceuticals. Co-operation with other EU member states on issues from financial regulation to deepening the market for services can bring enormous advantages for the UK, and these can still be realised in the EU that emerges from the economic and currency crisis.

2

The number of countries with a permanent opt-out from the Euro-Denmark and the UK.

However, even though the advantages of UK membership of the EU outweigh the disadvantages and this is not likely to be fundamentally altered by the period of upheaval that the EU is currently undergoing, it may be possible that an alternative relationship between the UK and EU could offer a better balance of advantages and disadvantages than full EU membership. These alternative options for the UK’s relationship with the EU are explored in Chapter 6.


References

[1] All in real terms. Haver Analytics EUDATA database.

[2] Haver Analytics EUDATA database/Eurostat

[3] European Commission, ‘A blueprint for a deep and genuine economic and monetary union - Launching a European Debate’, 2012; European Parliament, ‘Report with recommendations to the Commission on the report of the Presidents of the European Council, the European Commission, the European Central Bank and the Eurogroup "Towards a genuine Economic and Monetary Union"

[4] European Commission, ‘An important step towards a real banking union in Europe: Statement by Commissioner Michel Barnier following the trilogue agreement on the creation of the Single Supervisory Mechanism for the Eurozone’, available at

[5] European Commission, Six-pack? Two-pack? Fiscal compact? A short guide to the new EU fiscal governance, accessed on 16 October 2013

[6] House of Commons Library, ‘The European Financial Stabilisation Mechanism (EFSM)’, 2011

[7] European Central Bank, Financial Integration in Europe, April 2013

[8] European Commission, Proposal for a regulation of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) No 1093/2010 of the European Parliament and of the Council, 2013

[9] European Parliament, Article 136 TFEU, ESM, Fiscal Stability Treaty – Ratification requirements and present situation in Member States October 2012, 3 October 2013

[10] Treaty on the Functioning of the European Union, article 125: the Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State

[11] Treaty Establishing the European Stability Mechanism, 2012

[12] The Eurogroup, ESM direct bank recapitalisation instrument - Main features of the operational framework and way forward, 2013

[13] European Commission, Towards a Deep and Genuine Economic and Monetary Union - The introduction of a Convergence and Competitiveness Instrument, 2013

[14] According to the four presidents report. Herman Van Rompuy, Jos Manuel Barroso, Jean-Claude Juncker & Mario Draghi Towards a genuine economic and monetary union, 2012.

[15] European Parliament, Parliament backs EU banking supervisory system plans, 2013, available at europarl.europa.eu

[16] European Commission, 2014 European Parliament Elections: Commission recommends that political parties nominate candidate for Commission President, 2013, available at http://europa.eu/rapid/press-release_IP-13-215_en.htm

[17] European Commission, Proposal for a regulation of the European Parliament and of the Council on the statute and funding of European political parties and European political foundations, 2013

[18] The Guardian, ‘Crisis for Europe as trust hits record low’, 24th April 2013, available at

[19] Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013

[20] For example, see: Paul De Grauwe, Managing a fragile Eurozone, CESifo Forum, 2011; Céline Allard et al., Toward a Fiscal Union for the Euro Area, IMF Staff discussion paper,  September 2013; and Juncker, J.-C., and G. Tremonti, E-bonds Would End the Crisis, Financial Times, 5 December 2010

[21] Capital Economics, Leaving the euro: A practical guide, 4 June 2013

[22] Jens Norvig and Dr Nick Firoozye, Planning for an orderly break-up of the European Monetary Union, 30 January 2012

[23] Carsten Schneider, member of the German Parliament (Bundestag, SPD) in Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013

[24] BBC Website, ‘EU 'needs new fundamental law' - MEP Verhofstadt’, 2013, available at

[25] The Guardian, ‘Crisis for Europe as trust hits record low’, 24th April 2013, available at

[26] European Council, ESM direct bank recapitalisation instrument: main features of the operational framework and way forward, 20 June 2013

[27] Financial Times, Clash ahead over backstopping weak banks, 13 October 2013.

[28] Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013

[29] Eurogroup, ‘Eurogroup Statement on Cyprus’, 25th March 2013, available at

[30] Financial Times Brussels Blog, ‘The FT/Reuters Dijsselbloem interview transcript’, 26th March 2013, available at

[31] European Commission website, ‘Who can join and when?’, available at

[32] The Economist Eastern Approaches blog, ‘Bulgaria and the Euro: Hard times, hard cash’, 5th September 2012, available at

[33] European Commission, ‘Convergence Report 2012’, 2012

[34] Ainsley Thomson, Wall Street Jounral, Croatia Aims for Speedy Adoption of Euro, 4 June 2013, available at:

[35] European Commission, Assessment of the 2013 economic programme for Croatia, May 2013.

[36] European Commission, ‘Convergence Report 2012’, 2012

[37] politics.hu, ‘Orbán: Hungary will keep forint until its GDP reaches 90% of eurozone average’, 26th April 2013, available at

[38] European Commission, ‘Convergence Report 2012’, 2012

[39] EUobserver.com, ‘Bulgaria shelves euro membership plans’, 4th September, 2012, available at

[40] European Commission, ‘Convergence Report 2012’, 2012

[41] The Telegraph, ‘Romania abandons target date for joining euro’, 18th April 2013, available at

[42] EUbusiness.com, ‘Swedish euro support below 10%: poll’, 2012, available at

[43] Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013          

[44] Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013

[45] European Parliament legislative resolution of 12 September 2013 on the proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) No 1093/2010 establishing a European Supervisory Authority (European Banking Authority) as regards its interaction with Council Regulation (EU) No .../.... conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions (COM(2012)0512 – C7-0289/2012 – 2012/0244(COD)), as adopted in the European Parliamentary Plenary Session in Strasbourg 12.09.2013, to be published in the EU Official Journal.

[46] European Parliament legislative resolution of 12 September 2013 on the proposal for a Council regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions (COM(2012)0511 – C7-0314/2012 – 2012/0242(CNS)), as adopted by the European Parliament in plenary 12.09.2013, to be published in the EU Official Journal.

[47] Financial Times, A good day for Britain in Europe, 18 May 2013

[48] The Treaty on the European Union, available at:

[49] The European Central Bank has suggested a limit at 5% of the aggregated daily net credit exposure of all central counterparties (CCP)’s for one of the main euro-denominated product categories. ECB, Eurosystem oversight policy framework, Jul 2011.

[50] ECB, Standards for the use of Central Counterparties in Eurosystem foreign reserve management operations, November 2011

[51] The Guardian, UK takes ECB to court to save City’s euro trading,  14 September 2011, available at: eur-lex.europa.eu

[52] CBI analysis, based on a Wikipedia graphic of Supranational European Bodies, available at: wikimedia.org

[53] Policy Network, ‘The Single Market and Britain’s future in the EU: where our partners stand’, 2013