The Italian budgetary and financial crisis is getting worse. The conflict between the Italian government and the European Commission on the proposed budget is intensifying. It does not seem likely that the Italian government will yield to the demands of the Commission to adjust the budget. This conflict leads investors to continuing to sell Italian government bonds leading to a surge of the yields on these bonds. It has become the major source of upheaval in the Italian government bond market and risks escalating into a full-fledged crisis of the Eurozone.

Time to think again about the budgetary rules that are being applied by the European Commission.

Since the Eurozone’s debt crisis in 2010, the European Commission has seen a dramatic increase in its power to supervise and control national budgets. This development was motivated by the will of the creditor countries to impose budgetary discipline on the debtor countries, such as Greece, Ireland, Spain and Portugal. As a result, the Stability and Growth Pact was strengthened and the power of the European Commission over the budgetary process of the euro zone member states was tightened.

The new responsibilities of the European Commission create a problem of democratic legitimacy. Not in the sense that the Commission's tighter role in the budgetary procedures of the Member States have been achieved in an undemocratic manner. This increased power of the Commission is the result of decisions in the Council of Ministers and in the European Parliament. These are bodies that have been established in a democratic manner and that have decided to give the European Commission more power over national budgetary procedures after applying the majority rule. Formally there is nothing wrong with the legitimacy of the European Commission.

However, I am talking here about political legitimacy. The European Commission can now force countries to increase taxes and reduce expenditures without, however, having to bear the political costs of these decisions. These costs are borne by national governments. This is a model that does not work.

National governments bear the political costs of expenditures and taxes. The risk therefore arises that they will contest the decisions of non-elected officials who do not bear these costs. This has happened a few times in the past. In 2003-04, when their economies were not doing well, the German and French governments collided with the European Commission about their budgets. The European Commission wanted to force these governments to reduce their budget deficits. Both governments refused to do this and the rules were changed "à la tête du client".

Today the Italian government is doing the same. It is a government that has made a number of election promises and wants to implement them now. That has budgetary implications. The European Commission is now trying to force the Italian government to abandon these election promises without having to bear the political cost of doing so. The new Italian government would pay the political price for shredding its election promises. It will not do so, as the French and German governments did not do in 2003-04.

The model of top-down budgetary control does not work in Europe. It does not work because the whole process of decisions on taxes and expenditures still exists at the national level. It is also at the national level that the democratic principle of "no taxation without representation" is implemented. The European Commission's attempts to bring Italy into line today are therefore also attempts to impose exceptions to this democratic principle. It does not work, and fortunately so.

The only way out of this institutional crisis is to go further into political unification. This implies that large parts of the national budget processes would be transferred to the European Parliament. The principle of no taxation without representation would then be applied at the European level. This would raise the democratic legitimacy of the budgetary process to a higher European level.

We are very far from such a political unification today. This means that, at regular intervals, democratically elected national governments will reject the European Commission's attempts to go counter the will of the electorate.
One would hope that the European Commission understands this quandary and that it takes a flexible position, allowing the Italian government to have its budget deficit of 2.6%. It would be a bow of the Commission to the outcome of a democratic change in Italy. It would also take away a major source of upheaval in the Italian government bond market, and the risk that this entails for the Eurozone as a whole. 

Posted by Paul De Grauwe on 

The Italian budgetary and financial crisis is getting worse. The conflict between the Italian government and the European Commission on the proposed budget is intensifying. It does not seem likely that the Italian government will yield to the demands of the Commission to adjust the budget. This conflict leads investors to continuing to sell Italian government bonds leading to a surge of the yields on these bonds. It has become the major source of upheaval in the Italian government bond market and risks escalating into a full-fledged crisis of the Eurozone.
Time to think again about the budgetary rules that are being applied by the European Commission.
Since the Eurozone’s debt crisis in 2010, the European Commission has seen a dramatic increase in its power to supervise and control national budgets. This development was motivated by the will of the creditor countries to impose budgetary discipline on the debtor countries, such as Greece, Ireland, Spain and Portugal. As a result, the Stability and Growth Pact was strengthened and the power of the European Commission over the budgetary process of the euro zone member states was tightened.

The new responsibilities of the European Commission create a problem of democratic legitimacy. Not in the sense that the Commission's tighter role in the budgetary procedures of the Member States have been achieved in an undemocratic manner. This increased power of the Commission is the result of decisions in the Council of Ministers and in the European Parliament. These are bodies that have been established in a democratic manner and that have decided to give the European Commission more power over national budgetary procedures after applying the majority rule. Formally there is nothing wrong with the legitimacy of the European Commission.

However, I am talking here about political legitimacy. The European Commission can now force countries to increase taxes and reduce expenditures without, however, having to bear the political costs of these decisions. These costs are borne by national governments. This is a model that does not work.

National governments bear the political costs of expenditures and taxes. The risk therefore arises that they will contest the decisions of non-elected officials who do not bear these costs. This has happened a few times in the past. In 2003-04, when their economies were not doing well, the German and French governments collided with the European Commission about their budgets. The European Commission wanted to force these governments to reduce their budget deficits. Both governments refused to do this and the rules were changed "à la tête du client".

Today the Italian government is doing the same. It is a government that has made a number of election promises and wants to implement them now. That has budgetary implications. The European Commission is now trying to force the Italian government to abandon these election promises without having to bear the political cost of doing so. The new Italian government would pay the political price for shredding its election promises. It will not do so, as the French and German governments did not do in 2003-04.

The model of top-down budgetary control does not work in Europe. It does not work because the whole process of decisions on taxes and expenditures still exists at the national level. It is also at the national level that the democratic principle of "no taxation without representation" is implemented. The European Commission's attempts to bring Italy into line today are therefore also attempts to impose exceptions to this democratic principle. It does not work, and fortunately so.

The only way out of this institutional crisis is to go further into political unification. This implies that large parts of the national budget processes would be transferred to the European Parliament. The principle of no taxation without representation would then be applied at the European level. This would raise the democratic legitimacy of the budgetary process to a higher European level.

We are very far from such a political unification today. This means that, at regular intervals, democratically elected national governments will reject the European Commission's attempts to go counter the will of the electorate.
One would hope that the European Commission understands this quandary and that it takes a flexible position, allowing the Italian government to have its budget deficit of 2.6%. It would be a bow of the Commission to the outcome of a democratic change in Italy. It would also take away a major source of upheaval in the Italian government bond market, and the risk that this entails for the Eurozone as a whole. 

(First, Posted by Paul De Grauwe on Ivory Tower)