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Uluslararas Hukuk ve Politika Cilt 7, Say: 27, ss.

87-111, 2011

Stopping Blame Game, Revealingthe Euro Zones Design Faults: Complex Interdependence Withinthe Nation-State Framework
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Mustafa Kutlay
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Abstract The euro zone crisis has become the most serious test-case for European integration. Since the beginning of the euro zone crisis, its leaders have played the blame game against each other. This paper argues that the crisis in the euro zone has arisen not only because of individual member states irresponsible policy choices, but also due to the design faults within the euro zone project. This study scrutinizes complex interdependence within the nation-state framework as the primary cause of the euro zone problem. On the one hand, the single currency regime came into existence under the complex interdependence system mainly driven by financialization and cross-country financial transactions, including skyrocketed government and private debt ratios. On the other hand, the euro zone regime, due to its overwhelming reliance on a nation-state framework, was not armoured against the side-effects of complex interdependence. The paper concludes that unless the European leaders demonstrate the required policy entrepreneurship to take necessary steps and reform the design faults in the euro zone, there does not seem to be any future for the single currency. Keywords: Euro crisis, global financial crisis, complex interdependence within nation-state framework, the future of euro zone, policy entrepreneurship in the EU.

Phdcandidate at Ko University, Department International Relations and Political Science and a member of International Strategic Research Organization (USAK)

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INTRODUCTION
If the euro fails, then Europe fails. Angela Merkel 1
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Jacques Delors once called the single currency the jewel in Europes crown. Abandoning it would be tantamount to declaring the entire European integration project a failure. Barry Eichengreen 2
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The European Union (hereinafter, EU) entered the 21st century with ambitious goals and spectacular achievements in terms of deepening and widening its policy areas and geopolitical space. At the turn of the century, eleven EU members launched the euro as the single currency of the Union. For the first time in history, eleven different nation-states agreed upon a single currency as their national symbol in the monetary realm. The single currency regime was quite important for the international economy, to the extent that the euros potential to dethrone the dollar as the global economic systems major reserve currency became the primary topic of debate for scholars concentrating on the political economy of finance. 3 One of the leading euro-optimists, Robert Mundell, even argued that:
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The EMU countries will eventually comprise a transactions domain that is considerably larger than the dollar area. As an economic giant, Euroland will fully be the equal of the US, and the euro will become an international currency on the same scale as the dollar. From the deeper significance of monetary power relationships, the introduction of the euro will be the most important change in the international monetary system

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The earlier version of this paper was presented at GLODEM Young Scholars Workshop, June 30, 2011, stanbul, Ko University. The author thanks Prof. Ziya ni, Prof. Fikret enses and other participants for their useful comments and suggestions. In the title and subsequent pages, complex interdependence is coined to describe the high level of financial integration among euro zone countries. It does not directly refer to the Complex Interdependence Theory, developed by Robert Keohane and Joseph Nye. David Charter, Euro in danger: Germans Trigger Panic over Future of Single Currency, The Times, May 20, 2010. Barry Eichengreen, Europes Historic Gamble, Project Syndicate, May 15, 2010. For an example, see Benjamin Cohen, Global Currency Rivalry: Can the Euro Ever Challenge the Dollar?, Journal of Common Market Studies, Vol. 41, No. 4, September 2003.

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since the transition, achieved during World War I, from the pound to the dollar as the dominant international currency. 4
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Since money has always been a constitutive/integral part of national sovereignty and national identity, the single currency regime is interpreted as an achievement beyond its economic benefits and enthusiastically embraced by Europhiles as the grand political project towards a common identity. The second development underpinning the EUs increasing role at the international fora was the bold eastern enlargement initiative, which is by far the biggest wave of enlargement over the course of the post-war European integration process. The EUs ability to transform the ten hitherto undemocratic and autarkic Central and Eastern European countries without relying on hard power capabilities was so impressive that some scholars even praised the EU as an alternative hegemonic power bloc based on normative power capabilities and Kantian principles. 5
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The course of events in the EU, however, started to change dramatically in the post-2005 period as the institutional and material challenges posed by the big bang enlargement could not be addressed due to the constitutional debacle, which emerged after the anti-EU constitution referenda results in France and the Netherlands. The unexpected popular backlash in these countries dragged the EU into an ideational and institutional stalemate where Europeans vociferously questioned the identity aspect of the European project. Nevertheless, probably the most serious blow, the euro zone crisis, had yet to come. The euro crisis that erupted in 2008 has endangered the very existence of the jewel in Europes crown, and become the most serious test-case for European integration. This paper investigates the root causes of the euro crisis by concentrating on the very architectural design of the euro zone, rather than merely turning the spotlight on member states policy failures. This study argues that the main problem in the euro zone stems from the widening asymmetry between the increasing financial integration across euro zone economies and the shallow institutional integration amongst member states in terms of monetary union governance. I call this peculiar structural design complex interdependence within the nation-state framework. In this context, the papers first section makes a brief tour de force of the euro zone crisis and aims to show how its management was entrapped into blame game rhetoric by euro zone leaders. The second section turns the spotlight on the euro zone projects

Robert Mundell, What the Euro Means for the Dollar and the International Monetary System, Atlantic Economic Journal, Vol. 26, No. 3, 1998, pp. 227-228. For Normative Power Europe discussions, see Ian Manners, Normative Power Europe: A Contradiction in Terms?, Journal of Common Market Studies, Vol. 40, No. 2, pp. 235258. For Kantian Europe perspective see, Robert Kagan, Of Power and Paradise: America and Europe in the New World Order, (New York: Vintage Books, 2003).

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structural weaknesses and investigates the mechanisms through which complex interdependence within the nation-state framework has paved the way for the monetary unions existential crisis. The final section concludes by underscoring that there does not seem to be any future for the euro zone if its leaders continue the blame game rather than build policy entrepreneurship capabilities and solidarity at the European level to fix the euro zones architectural flaws. A BRIEF STORY OF THE EURO CRISIS: SOLIDARITY AT GUNPOINT In late 2008, one of the worlds leading investment banks, namely Lehman Brothers, triggered the global financial domino by declaring its bankruptcy. The US sub-prime mortgage crisis, after Lehman Brothers collapse, swelled into the global financial crisis in a very short time period. 6 Europe has become the epicentre of the global financial crisis because of its geographical proximity, complex financial linkages, and deep trade relations with the US. First, many European banks went bankrupt due to their overexposure to toxic assets. The member state governments opted for national problem-solving mechanisms at the expense of other member countries to the extent that Ireland, for example, declared a blanket guarantee of bank deposits without consulting other EU members. This exacerbated the anxieties of British decision makers and further pushed the British government to nationalize some of the banks like Northern Rock. In 2009, growth levels in the EU seriously plummeted and aggregate trade volume shrank dramatically. 7 The major turning point for the EU was November 30, 2009, when the recently elected Greek Prime Minister declared the previous Karamanlis governments accounting methods fraudulent, as a result of which Greeces real budget deficit sky-rocketed to 12.7 % of GDP and its public debt to 300 billion euros. After this confession, it became apparent that Greece constitutes the euro zones weakest link due to its triple deficitswollen budget and current-account deficits, plus a soaring public debt. 8
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For a detailed account of the events in this period, see European Commission Economic and Financial Affairs page at <http://ec.europa.eu/economy_finance/focuson/crisis/index_en.htm > For the introduction of an illuminating special issue on the European perspectives of global financial crisis, see Dermod Hodson and Lucia Quaglia, European Perspectives on the Global Financial Crisis: Introduction, Journal of Common Market Studies, Vol. 47, No. 5, 2009, pp. 939953. Greeces Problems: In Search of Credibility, The Economist, February 3rd, 2010.

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Figure 1. Gross public debt to GDP in southern European countries. Source: IMF

The Greek government had undertaken a front-loaded adjustment programme to reduce its public deficit from 15.4% of GDP in 2009 to less than 3% by 2013 and to keep the primary surplus at least 5% of GDP up to 2020. 9 Despite the Greek governments ambitious austerity measures, international rating agencies like Fitch and S&P downgraded Greeces sovereign rating on the ground that Greeces cost-cutting measures were unlikely, on their own, to lead to a sustainable reduction. 10 In fact, the possible Greek default per se was not a matter of life and death for the euro zone since Greece was constituting just 2% of it with its 330 billion dollar economic size. The self-fulfilling prophecy embedded in the modus operandi of financial markets, however, exacerbated the contagion psychology without any regard to the fundamentals. As De Grauwe underlines, periods of euphoria alternate with periods of depression amplifying movements in asset prices that are unrelated to underlying fundamentals. 11
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The crucial turning point for the unfounded market hype was the attitudes of core euro zone member states towards the Greek question. In retrospect, not the Greek authorities credibility problem, but the other euro zone member
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For details see, Marica Frangakis, The Rising Public Debt in the EU: Implications for Policy, Journal of Contemporary European Studies, Vol. 19, No. 1, 2011, p. 14. Kerin Hope, Greece Attacks S&P over Downgrade, Financial Times, December 17, 2009. Paul De Grauwe, Crisis in the Euro Zone and How to Deal with it, CEPS Policy Brief, No. 204, February 2010, p. 1.

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leaders ignorance, especially the Germans, escalated tensions in the markets. The EU member states response to the events surprised many analysts in the sense that rather than acting in a unified manner to develop effective anti-crisis measures, the euro zone leaders started vicious blame-game wars against each other. For quite a long time, Germany declined any support for alleviating Greeces debt burden. German authorities thought that this would mean rewarding Greeks for their irresponsible behaviours that paved the way to moral hazard problems and past habit of fudging the national accounts, as well as sending wrong signals to other peripheral members. A headline of one of Germanys leading tabloids, the Bild, was quite illuminating in reflecting the common mood in Germany at the time: If they [the Greeks] reintroduced the drachma, thats the best possible thing that could happen to our [Germanys] euro. 12 The other parties in the blame game wars were the Greek authorities and other southern European members. While Greek politicians were busy blaming the improper crisis management in the EU and the greedy speculators; other southern Europeans, like Spains Zapatero, were trying to convince the international community that Spain was not like Greece. 13 The tug-of-war among the euro zone countries that was fuelled by short-term oriented nationalist calculations significantly deteriorated the spirit of solidarity in the EU. More importantly, international investors started to question the sustainability of the single currency regime, a perception that put the entire euro zone under fire. In Barry Eichengreens words;
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Its not a pretty picture. The IMF botched its rescue. The ECB hesitates to erect the necessary ring-fence around Greece. Portuguese and Spanish policy makers underestimate the gravity of their position. German leaders are in denial. But although it may be too late for Greece, it is still not too late for Europe. That said a solution will require everyone to wake up. 14
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The response of the euro zone leaders to the wake up call was to prepare a bail-out package in order to stop the entire project falling off a cliff. The result was a jointly designed EU-IMF bail-out package amounting to 110 billion euros designed for Greece in early May, and 750 billion euros for potentially distressed countries in addition to the European Central Banks decision to temporarily purchase government bonds in troubled countries.

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Kate Connolly, Debt Crisis: Germans Rage at Picking up Bill for Pampered Greeks, The Guardian, April 28, 2010. The other reason for German authorities was the German publics reaction to a possible rescue package. According to pools, between 66% and 86% of German population was against bailing-out Greece. Victor Mallet, Lionel Barber and Mark Mulligan, Spain: A legacy in limbo, Financial Times, April 11, 2010. Barry Eichengreen, It is not too Late for Europe, www.voxeu.org, May 7, 2010 (Arrived on June 1, 2011).

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European Financial Stability Facility (EFSF) European Financial Stability Mechanism (EFSM, European Commission) IMF euro rescue plan EU rescue plan for Greece IMF rescue plan for Greece ECB purchases of government bonds (up untilJuly 30, 2010) Sum

All countries 440 60

Germany 147.4 12

France 110.7 9.7

250 80 30 60 920

14.9 22.3 1.8 16.4 214.9

12.3 16.8 1.5 12.3 163.3

Table 1. The rescue packages and the stability limit (billion euros). Source: HansWerner Sinn, Rescuing Europe, CESifo Forum, Vol. 11, August 2010, p. 3.

The rescue package, however, did not successfully tame the fever of the markets because it was too late and too little! 15 There are two main reasons for this perception. First, the rescue package was minuscule in comparison to the southern European countries outstanding risk in the euro zone because the total debt of Spain, Italy, Portugal, and Greece to other euro zone countries was more than three trillion dollars. 16 Second, the European leaders commitment to the rescue package was quite dubious, to the point where the lending mechanisms were not even specified in the plan. The other aspect of the EU leaders credibility problem was the light touch anti-crisis measures, in the sense that none of the structural problems of the euro zone were addressed. On the contrary, the leaders lip service for further financial regulation and the infamous blame game rhetoric continued to dominate public discussion. The member states on the firing line such as Spain, Ireland, Portugal, and Greece were forced to adopt harsh fiscal austerity measures to curb their budget deficit and put their public finance in order (see table 2).
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For detailed analysis see, Hans-Werner Sinn, Rescuing Europe, CESifo Forum, Vol. 11, August 2010. Eurostat figures.

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Setting up a financial stability facility for liquidity and capital support. Banks increased core tier 1 capital ratio to 8 percent following Bank of Portugals recommendatio n.

Increase in core capital to 8 percent and to 10 percent for institutions reliant on wholesale funding and with a limited private shareholding. Individual recapitalization plans requested and assessed by Banco the Espaa

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Stopping Blame Game, Revealing the Euro Zones Design Faults Structural x Freeze/reduction in minimum wages and relaxation of collective dismissal and employment protection regulation to facilitate job reallocation. Reform of collective bargaining system. Liberalization of road transportation system; and reform of the railway sector. Fast-tracking of large investment projects and strengthening the competition authority. x Administrative and creditsupport measures targeted at export-oriented firms. Reforms of the wage bargaining system, promotion of flexibility in working hours. Deregulation of the rental measures Measures to reduce informal activity, fraud, and tax evasion. x Reduction on dismissal costs and criteria, and reform of the collective bargaining system, in particular to allow firms to opt out of collective agreements. Reinforcement of active labour market policies and enhanced links between vocational training, business, and the education system. Improved incentives for the rental market and removal of tax incentives for housing investment.

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Table 2. Austerity measures of the southern European countries (up to May 2011). Source: IMF, Europe: Strengthening the Recovery, Regional Economic Outlook, Washington: IMF Publications Services, May 2011, p. 15.

The regulations and anti-crisis strategies mentioned above, however, deal with the proximate causes of the euro zone crisis and none of the unilateral and multilateral measures address the structural defects of the single currency regime. Therefore, the Greek tragedy, even the much wider southern European problem, do nothing but justify the iceberg metaphor: The dominant approach in European policy circles tends to see what is above the surface, whereas this paper argues that there are vital structural pitfalls throughout the entire euro zone architecture. If the root causes are not tackled swiftly and seriously, there does not seem to be any future to the European monetary unification in the medium-term. In this context, the next part deals with the structural shortages of the euro zone project.

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COMPLEX INTERDEPENDENCE WITHIN THE FRAMEWORK: THE STATE OF THE EURO ZONE

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One of the suitable phrases capturing the structural problems embedded in the euro zone project may be complex interdependence within the nation-state framework. The term has two interrelated aspects; the first is complex independence, mainly stemming from multiple channels of European economic integration, financial globalization as well as its by-product financialization, and the over-debt ratios; the second part is nation-state framework, which mainly refers to the asymmetric balance between monetary and fiscal policy design and the fragmented/inadequate financial surveillance mechanisms. Complex Interdependence The first component of complex interdependence in the case of euro zone is financialization. Krippner defines financialization as a pattern of accumulation in which profits accrue primarily through financial channels rather than through trade and commodity production. 17 Financial in Krippners definition refers to the activities relating to the provision (or transfer) of liquid capital in expectation of future interests, dividends, or capital gains. 18 At the heart of financialization, there is the changing balance and relationship between financial corporations and non-financial firms. In Polanyian terms, the increasing commodification of money 19 triggered a process that broke up the link between financial capital and industrial capital. During the Bretton Woods era, financial markets were regarded as the servant of industrial production and they were given an epiphenomenal role within the context of embedded liberalism. 20 However, owe to the deregulation of the financial markets after the 1980s, finance and production started to act as autonomous aspects of economy. As Watson cogently puts;
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[After the 1970s] financial markets have increasingly embedded a circuit of capital that is fully contained within the financial markets themselves. Finance and production have begun to operate ever more as autonomous aspects of the economy. Financial markets no longer exist solely as a means of providing capital for investment in the productive sectors of the

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Greta R. Krippner, The Financialization of the American Economy, Socio-Economic Review, Vol. 3, 2005, pp. 173-208. Ibid., pp. 174-175. Karl Polanyi, The Great Transformation: The Political and Economic Origins of Our Time, (Boston: Beacon Press, 2001), pp. 71-80. John G. Ruggie, International Regimes, Transactions, and Change: Embedded Liberalism in the Postwar Economic Order, International Organization, Vol. 36, No. 2, 1982, pp. 379-415.

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economy. Financial markets themselves have become a genuine realm for the valorisation of capital. 21
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Similar to the financialization trend in the global political economy, European countries were also influenced by the changing relationship between industry and finance. 22 There are mainly two interrelated aspects of financialization in the European context. The first one is the increasing size and influence of the financial sector in almost all member countries. Between 1997 and 2008, the credit institutions total assets over GDP increased from 107% to 190% in Greece; from 262% to 760% in Ireland; from 156% to 231% in Italy; from 170% to 307% in Spain (see table 3). 23
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1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Greece Ireland Italy Portgual Spain 107 262 156 237 170 123 304 143 286 173 275 142 240 147 281 178 287 156 404 152 274 185 299 155 461 152 287 193 304 142 364 161 263 184 297 124 413 159 252 192 295 124 487 164 240 204 298 142 583 176 242 237 304 147 674 189 255 256 307 167 7115 217 270 281 312 190 760 231 290 309 316

Germany 256

Table 3. Credit institutions, total assets over GDP. Source: Costas Lapavitsas et. al., Eurozone Crisis: Beggar Thyself and Beggar Thy Neighbour, Journal of Balkan and Near Eastern Studies, Vol. 12, No. 4, 2010, p. 352.

Moreover, the leading European banks expanded their assets to such tremendous levels that they have become too-big-to-fail for their home country governments. For example, Dexias total assets in Belgiums economy climbed to 180% and Banco Santanders share in the Spanish GDP increased to 91% (see figure 2). This development went hand-by-hand within a complex web-of-debt

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Mathew Watson, Foundations of International Political Economy, (Hampshire: Palgrave Macmillan, 2005), p. 195. zgr Orhangazi, Financialization and the US Economy, (Massachusetts: Edward Elgar Publishing, 2008), pp. 11-23; Gerard Dumnil, and Dominique Lvy, Costs and Benefits of Neoliberalism: A Class Analysis, in Epstein, G. (ed.), Financialization and the World Economy, (Massachusetts: Edward Elgar Publishing Limited, 2005), pp. 17-46. Costas Lapavitsas et. al., Eurozone Crisis: Beggar Thyself and Beggar Thy Neighbour, Journal of Balkan and Near Eastern Studies, Vol. 12, No. 4, 2010, p. 352.

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networks amongst the member countries, including governments, firms, and households, a point to be elaborated on further in the next section.

Figure 2. Selected banks total assets to home country GDP. Source: JP Morgan.

The other aspect of financialization in the euro zone is related to consumer lending. As traditional banking activities had brought poor profit margins to the banks, they searched for unconventional ways to integrate as many people into the financial system as possible. The immediate effects came into existence with the housing market bubble in the euro zone economies. Over the period in question, housing prices were sky-rocketed in many European economies, including the peripheral ones. From 1996 to 2006, Ireland, the United Kingdom, Spain, France, and Italy all witnessed rises in real and inflation-adjusted housing prices. In Ireland, housing prices rose by 182%; the UK 152%, Spain 115%, France 108%, and Italy 51%. 24 The surge in housing prices, however, only just composed one aspect of a broader consumer pattern, i.e., increasing household debt. The financial liabilities of households in southern European countries dramatically increased during the financialization period. In a decade, household liabilities (over GDP) increased from 12% to more than 53% in Greece; from 41% to 89% in Spain; from 44% to 102% in Portugal (see figure 3).
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Suzanne Kapner, Study Finds Endemic European Housing Bubble, Financial Times, February 14, 2011.

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Figure 3. Financial liabilities of households (% of GDP). Source: Eurostat.

In summary, intensive financialization of European economies composed the first pillar of complex interdependence among European economies. The level of financial interdependence is deeper and more complex in the EU than in other parts of the world economy because the euro zone countries are further bound to each other by geographical proximity and Single Market regulations. This peculiarity paved the way for the second pillar of complex interdependence in euro zone economies, namely the over-debt ratios and cross-country lending, a phenomenon leaving the entire euro zone open to a domino effect. One of the most pressing problems for the euro zone in this period has become the sustainability of debt levels, especially the debt ratios in peripheral countries which pose a serious threat to the balance sheets of core European countries. At the end of 2009, the outstanding government debt of the euro zone periphery totalled nearly 2.9 trillion euros, with Italy holding the 60% of entire debt alone. According to Bryson, almost half of this government debt is held by foreigners, the overwhelming majority of which is held by other euro zone countries. 25 The European banks exposure to southern European economies gives further hints about the intertwined nature of the euro zones financial system. French banks have the most exposure to the euro zone periphery with 550 billion euros, almost 30% of the French GDP. The German banks exposure
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Jay H. Bryson, European Sovereign Debt: Where is the Exposure?, Wells Fargo Economics Group Special Commentary, January 18, 2011.

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is about 420 billion euros, whereas US firms only have a 120 billion euro exposure (see figure 4).

Figure 4. Bank exposures to southern Europe (billion euros). Source: BIS.

The overexposure of euro zone economies leaves the entire system open to a potential domino effect. If debt restructuring among peripheral European governments leads to the insolvency of, say, a French bank, could that not eventually lead to losses for institutions in other countries, say in Germany, that own the debt obligations of that French bank? Given the intertwined nature of the European financial system, it is not unreasonable to expect that losses suffered by one European bank could have a knock-on effect on another European bank located in a different country. 26
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The knock-on effect is the direct result of deep financial integration in the age of neoliberal globalization. The increasing financialization of euro zone economies, the extensive financial transactions across euro zone members, and the over-debt ratios in the peripheral countries in turn mutually contributed to the emergence of an intertwined euro zone system. However, the emergence of a system of complex interdependence, per se, would not have necessarily led to the euro crisis. The euro zones problem stems from the very architecture of the euro zone project because in this period, European policy-makers have tried to manage complex interdependence within the nation-state framework. The
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Jay H. Bryson, European Sovereign Debt: Where is the Exposure?, Wells Fargo Economics Group Special Commentary, January 18, 2011, p. 3.

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next part will look more closely at the asymmetric institutional structure within the euro zone. Within a Nation-State Framework The nation-state framework has implications for the euro zone crisis in two different realms. These are (1) the asymmetry between monetary policy and fiscal policy, and (2) the fragmented financial surveillance and inadequate public regulation. The Limits of Monetary Union without Political Union The euro zone project was based on a nation-state framework from the very emergence of a single currency. Whereas the conduct of monetary policy was transferred to the community level by recognizing the European Central Bank (hereinafter, ECB) as the sole authority to take all related measures so as to conduct monetary policy, fiscal policies (taxation, social security, wage and labour market policies) are maintained almost exclusively by the individual nation-states. For largely socio-political and competition related reasons, in the fiscal realm, the member states insist on sustaining their sovereignty and discretionary decision-making power. The fiscal policies in member states diverged from each other considerably over the last decade thanks to the different institutional settings and diverging policy priorities. From a traditional Optimum Currency Area (hereinafter, OCA) perspective, this institutional and fiscal policy asymmetry creates an obvious impediment to the sustainability of the euro zone because of the lack of political unity. In this context, the persistence of nation-states in implementing fiscal policy paves the way to asymmetric shocks for member countries. Divergent developments in terms of prices and wages among member states, for example, have underpinned these problems. Germany, in this period, pursued a tight wage moderation policy accompanied by ambitious targets to improve competitiveness. Throughout this period, nominal wages in Germany declined considerably vis--vis the rest of the euro zone (see figure 5).

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Figure 5. Nominal unit labour costs (2000=100). Source: European Commission.

Germanys uncoordinated wage moderation policy has major consequences, especially in peripheral euro zone countries, because the southern European countries competitive positions deteriorated remarkably. As De Grauwe mentions, Germanys uncoordinated fiscal policies in terms of wage moderation and labour market reforms have turned into beggar-thy-neighbour policies forcing other countries to institute drastic policies of wage moderation. 27 Most of the peripheral countries, however, could not face the German challenge, and their foreign trade deficit increased year-by-year, as is visible in their chronic current account deficits (see figure 6).
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Paul De Grauwe, Some Thoughts on Monetary and Political Union, in Leila Simona Talani (ed.), The Future of EMU, (New York: Palgrave Macmillan, 2009), pp. 9-28.

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Figure 6. Current account deficit/surplus in selected euro zone countries (% of GDP). Source: IMF.

In order to overcome the institutional asymmetry between monetary and financial policies in the euro zone, member countries introduced the Stability and Growth Pact (hereinafter, SGP) in 1997. The main aim was to provide a benchmark for fiscal discipline for member countries so as to keep their budget deficit and public debt within acceptable limits. The SGP, however, fell short of fulfilling its aims due to three main reasons. First, the euro zone countries did not remain committed to the criteria of the Pact. On the contrary, they continuously bypassed the threshold. For example, during the emergence of the euro zone up to the global financial crisis, Greece overshot the budget deficit target 8 times, i.e., every single year, Germany 4 times, Italy 5 times, Portugal 4 times, and France 3 times (see figure 7).

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Figure 7. Budget performance of euro zone countries (2000-2007). Source: Eurostat.

The second reason for member states to bypass the SGP is the undemocratic nature of the criteria. The excessive deficit procedure designed to force national governments to keep their fiscal house in order is ensured by the Commission, a supranational authority that does not have any political responsibility. The member states, however, feel responsible before the national electorates so as to sustain their perceived political legitimacy. As the conduct of monetary policy has been transferred to the supranational level, member states can only rely on fiscal policies to curb economic problems like unemployment, weak competitiveness, etc. according to their socio-economic structures because countries vary in their savings and investments behaviour and in their next export position, and hence the appropriate budget deficit would vary from country to country. 28 From the varieties of capitalism perspective, the diverging employment, taxation, and wage policies are, in fact, the inescapable result of the institutional structures of these economies. 29 The major pitfall of the SGP was to omit all these deep-rooted institutional differences and to insist on a one-size-fits-all fiscal discipline.
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Philip Arestis and Malcolm Sawyer, The Design Faults of the Economic and Monetary Union, Journal of Contemporary European Studies, Vol. 19, No. 1, 2011, p. 25. For the broader framework of varieties of capitalism discussion see, Peter A. Hall and David Soskice (eds.), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, (Oxford: Oxford University Press, 2001). For another major contribution from European perspective see, Vivien A. Schmidt, The Futures of European Capitalism, (Oxford: Oxford University Press, 2002).

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According to OCA theory, in order to mitigate these asymmetric shocks, there should be fiscal transfer facilities across the member states. Yet this point is deliberately set aside by the core countries to avoid bail-out blackmail in the euro zone. 30 The rigid and undifferentiated one-size-fits-all nature of the SGP also decreases its popularity in the eyes of policy-makers. 31 Even the President of the European Commission at the time, Romano Prodi, harshly criticized the Pact by saying I know very well that the Stability Pact is stupid because all the decisions made under it are so rigid. 32 The third reason the SGP falls short of eliminating fiscal risks is its narrow focus on public balance. In figure 7, Spain and Ireland are not on the list because these two countries have never violated the SGP rules over the period in question. In fact, they are applauded as the success stories and best cases in terms of the SGP criteria. These two countries, however, were hit very hard by the global financial crisis because the private debt of Dublin and Madrid and the housing bubble in these economies were relatively larger in comparison to many other euro zone members. Since the SGP just concentrated on the public side of macroeconomic discipline, it overlooked a very well-known phenomenon that in times of crisis, private debt becomes public debt. 33
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The existing institutional structure of the euro zone creates a paradox that the member states should transfer more of their fiscal policy rights to the supranational level to make the euro zone salient against asymmetric shocks, however, national sovereignty concerns accompanied by the undemocratic and rigid nature of the SGP act as the stumbling blocks for a deeper political union. This neat paradox has become a do or die issue for the sustainability of the single currency regime. As Ubide pinpoints;

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Thomas Mayer, What More Do European Governments Need to do to Save the Eurozone in the Medium Run?, www.voxeu.org, June 17, 2010. The same situation is also the case for the ECB in terms of legitimacy. The first problem with regard to the legitimacy of the ECB is its narrowly defined objectives. The legally defined objective of the ECB makes the Bank to concentrate on a very narrow range of economic issues. For example, fighting against unemployment or any other economic problem is almost entirely excluded from the policy-making agenda under the disguise of price stability. The second problem of the ECB is the independence/accountability asymmetry. Most of the empiric studies show that the ECB is one of the most independent central banks in the world, whereas it has notable accountability problems. See, Richard Baldwin and Charles Wyplosz, The Economics of European Integration, 2nd Edition, (New York: McGraw-Hill Irwin, 2006), pp. 390-391. David Haworth and George Trefgarne, Euro Stability Pact is Stupid, Says Prodi, The Telegraph, October 18, 2002. Carmen Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly, (Princeton: Princeton University Press, 2009).

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European leaders must now make a clear-cut decision; either they move on and complete the Economic and Monetary Union that is needed to underpin the euro, or they accept the risk that the euro zone will fail in its current form. 34
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This paradox brings us to the political economy of monetary unifications. Historical experiences record that no monetary union has ever succeeded without a political union. The Scandinavian Monetary Union and the Latin American Union, for example, were unsuccessful single currency regime efforts because they were not supplemented by a concurrent political union. 35 The peculiar situation in the euro zone is that a centralized monetary authority, the ECB, functions without fiscal capacity. The persistence of national-sovereignty concerns and fiscal decentralization is the primary reason for this peculiar situation. The single currency regime, therefore, seems to come to the limits of the conventional nation-state framework. The construction of a political union, however, is one of the most difficult challenges for the Europhiles, at least in the existing conjuncture because single currency regimes have always been an integral part of state-building and identity-formation efforts. This requires a deep variable at the EU level, i.e., the sense of a common political ideal and selfbelonging to the idea of Europe, which is obviously absent in the EU today. 36
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Fragmented Financial Surveillance Mechanisms The limits of the nation-state framework do have repercussions on the European level financial surveillance mechanisms as well. The complex interdependence in the financial realm and financialization as the by-product of neoliberal globalization has blossomed in Europe under a light touch regulatory regime. The financial regulation system in the euro zone has been characterized by national regulatory institutions which are incapable of conducting supervision operations across national borders. As a matter of fact, the nationally-fragmented nature of the financial governance structure needs to be evaluated as the derivative of the world political economys dominant philosophy in the pre-crisis period. The perfectly competitive market assumption has become currency, even in the corporatist continental European model over the last three decades. Accordingly, the financial markets are regarded as highly competitive places in which information is assumed to be

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Angel Ubide, The European Bicycle Must Accelerate, www.voxeu.org, June 17, 2010 (arrived on June 1, 2011). Kathleen McNamara, Economic and Monetary Union: Innovation and Challenges for the Euro, in H. Wallace, W. Wallace, and M. A. Pollack (eds.), Policy-Making in the European Union, (Oxford: Oxford University Press, 2005), p. 156. Paul De Grauwe, Some Thoughts on Monetary and Political Union, in Leila Simona Talani (ed.), The Future of EMU, (New York: Palgrave Macmillan, 2009), pp. 9-28.

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symmetric/perfect and where arbitrage opportunities are rare. 37 Rational choice theory, efficient market hypothesis, and quantitative research methodology reinforced each other by way of establishing an ideational consensus in the regulatory realm. 38 In this consensus, it was believed that no room was left for financial bubbles and irrational market exuberance. In case of bubbles and short-term disequilibria, state intervention was dismissed because markets were applauded as the most convenient adjustment mechanisms. 39 In this ideational atmosphere, the euro zone regulatory system has never been tackled as a serious problem. On the contrary, the regulatory structure was deliberately kept within the nation-state framework. During the boom periods of the housing bubble and heydays of financial capital flows amongst euro zone member countries, European leaders hailed the existing system as a sign of investors confidence in the euro. When the housing bubble busted, however, it became apparent that the euro zone does not have any system-level regulatory intervention mechanisms. As the European Commission report underlines;
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The crisis has exposed unacceptable risks in the current governance of international and European financial markets, which have proved real and systemic in times of serious turbulence. The unprecedented measures being taken to restore stability in the sector must be matched by robust reform to remedy known weaknesses, identify and prevent the emergence of new vulnerabilities in the future. 40
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One of the hotly debated topics of European Council meetings, therefore, has turned out to be the ways through which euro zone-level financial regulation mechanisms may be established. In this direction, the European Commission put a number of policy initiatives into implementation. First, the European Commission proposed macro-prudential regulations, a field that was completely neglected before, by setting up the European Systemic Risk Council to be operated under the auspices of the ECB. Second, the Commission proposed micro-prudential supervision by setting up European System of Financial Supervision to encourage member states to operate on the basis of harmonized rules. Third, the Commission proposed new rules on hedge funds,

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Sheila C. Dow, Mainstream Methodology, Financial Markets, and Global Political Economy, Contributions to Political Economy, No. 27, 2008, pp. 17. Robert Wade, Beware of What You Wish For: Lessons for International Political Economy from the Transformation of Economics, Review of International Political Economy, Vol. 16, No. 1, 2009, pp. 17; Henry Farrell and Martha Finnemore, Ontology, Methodology, and Causation in the American School of International Political Economy, Review of International Political Economy, Vol. 16, No. 1, 2009, pp. 58-71. Robert Wade, Financial Regime Change, New Left Review, No. 53, 2008, pp. 6. Commission of the European Communities, Communication for the Spring European Council: Driving European Recovery, Volume 1, COM (2009) 114 final, p. 4.

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derivatives, private equity, and new accounting rules. 41 Though these are necessary steps taken in the right direction, in an environment where strong financial interest groups in the EU apply heavy pressure to maintain the status quo, the future of the proposals seems bleak.
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CONCLUSION: QUO VADIS EURO ZONE The euro zone crisis has become the most serious test-case for European integration. From the beginning of the euro zone crisis, leaders have played the blame game against each other. This paper argues, however, that the euro crisis has arisen not only due to the individual member states faults and their macroeconomic policy choices, more than that due to the design faults within the euro zone project. This study scrutinized complex interdependence within the nation-state framework as the primary cause of the euro zone problem. On the one hand, the single currency regime came into existence under the complex interdependence system mainly driven by financialization and crosscountry financial transactions, including sky-rocketed government and private debt ratios. On the other hand, the euro zone regime, due to its overwhelming reliance on the nation-state framework, was not solidified against the sideeffects of complex interdependence. Accordingly, the centralized monetary union was not accompanied by a political union so as to mitigate the asymmetric shocks foreseen by OCA theory. The fragmented and ineffective surveillance mechanisms further exacerbated the side effects of complex interdependence. The word Crisis, which ironically finds its origin in a Greek, means a moment of decision, a crossroads. The euro zone crisis is not the first, and probably not the last crisis of the EU. The history of European integration shows that major political and economic crises motivate European leaders to find innovative solutions and revitalize the integration process, like a phoenix rising from the ashes. It was hardly predictable that the 1970s European Economic Community would overcome Eurosclerosis and leap forward in the 1980s by establishing the Single Market and successfully transforming the entire southern Mediterranean region. 42 The existing crisis in the euro zone is not much different from the 1970s crisis in nature. The key independent variable, however, is the vision of the European leaders and their policy entrepreneurship capabilities. 43 If one approaches the issue from an agentF F F F

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The reforms are based on de Larosire Report named as The High-level Group on Financial Supervision in the EU chaired by Jacques de Larosire. Desmond Dinan, Ever Closer Union: An Introduction to European Integration, (Hampshire: Palgrave Macmillan, 2005), pp. 69-96. For a fascinating account of European Monetary Union and the role of ideas in this process see, Kathleen R. McNamara, The Currency of Ideas: Monetary Politics in the European Union, (Ithaca and London: Cornell University Press, 1998).

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structure perspective, it may be argued that the agents response to the structures challenges determine the ultimate pattern in European integration. 44 In the past crises, political entrepreneurs have successfully addressed serious challenges. The productive cooperation between Helmut Schmidt and Valery Giscard dEstaing or Helmut Kohl and Franois Mitterrand, for example, put the derailed European train back on track. 45 Bureaucratic entrepreneurs like Jacques Delors gathered around epistemic communities also enabled the establishment of the Single Market as well as single currency. 46 The existing leadership in European circles, first and foremost the synergy between Angela Merkel and Nicholas Sarkozy, however, are far from the innovative policy entrepreneurs of previous crises. The tectonic shifts in the global political economy, the depth of the euro zone crisis, and the necessity for an ever closer union makes policy entrepreneurship a vital requirement rather than a choice for Europe in order to secure a future for the euro zone in the coming years. Otherwise, as Eichengreen aptly puts, abandoning [euro] would be tantamount to declaring the entire European integration project a failure.
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REFERENCES
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For a useful study investigating the role of ideas in European integration see, Thomas RisseKappen, Exploring the Nature of the Beast: International Relations Theory and Comparative Policy Analysis Meets the European Integration, Journal of Common Market Studies, Vol. 34, No. 1,1996, pp. 53-80. Kathleen R. McNamara, The Eurocrisis and the Uncertain Future of European Integration, Council on Foreign Relations Working Paper, September 2010. Amy Verdun, The Role of the Delors Committee in the Creation of EMU: An Epistemic Community?, Journal of European Public Policy, Vol. 6, No. 2, 1999, pp. 308-328.

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M. Kutlay Dow, Sheila C., Mainstream Methodology, Financial Markets, and Global Political Economy, Contributions to Political Economy, No. 27, 2008, pp. 13.29. Dumnil, Gerard and Dominique Lvy, Costs and Benefits of Neoliberalism: A Class Analysis, in Epstein, G. (ed.), Financialization and the World Economy, (Massachusetts: Edward Elgar Publishing Limited, 2005), pp. 17-46. Eichengreen, Barry, Europes Historic Gamble, Project Syndicate, May 15, 2010. Eichengreen, Barry, It is not too late for Europe, www.voxeu.org, May 7, 2010 (Accessed on June 1, 2011). Farrell, Henry and Martha Finnemore, Ontology, Methodology, and Causation in the American School of International Political Economy, Review of International Political Economy, Vol. 16, No. 1, 2009, pp. 58-71. Frangakis, Marica, The Rising Public Debt in the EU: Implications for Policy, Journal of Contemporary European Studies, Vol. 19, No. 1, 2011, pp. 7-20. Hall, Peter A. and David Soskice (eds.), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, (Oxford: Oxford University Press, 2001). Haworth, David and George Trefgarne, Euro Stability Pact is Stupid, Says Prodi, The Telegraph, October 18, 2002. Hodson, Dermod and Lucia Quaglia, European Perspectives on the Global Financial Crisis: Introduction, Journal of Common Market Studies, Vol. 47, No. 5, 2009, pp. 939-953. Hope, Kerin, Greece Attacks S&P over Downgrade, Financial Times, December 17, 2009. Kagan, Robert, Of Power and Paradise: America and Europe in the New World Order, (New York: Vintage Books, 2003). Kapner, Suzanne, Study Finds Endemic European Housing Bubble, Financial Times, February 14, 2011. Krippner, Greta R., The Financialization of the American Economy, Socio-Economic Review, Vol. 3, 2005, pp. 173-208. Lapavitsas, Costas et. al., Eurozone Crisis: Beggar Thyself and Beggar Thy Neighbour, Journal of Balkan and Near Eastern Studies, Vol. 12, No. 4, 2010, pp. 321-373. Mallet, Victor, Lionel Barber and Mark Mulligan, Spain: A legacy in Limbo, Financial Times, April 11, 2010. Manners, Ian, Normative Power Europe: A Contradiction in Terms?, Journal of Common Market Studies, Vol. 40, No. 2, pp. 235258. McNamara, Kathleen R., The Eurocrisis and the Uncertain Future of European Integration, Council on Foreign Relations Working Paper, September 2010. McNamara, Kathleen R., The Currency of Ideas: Monetary Politics in the European Union, (Ithaca and London: Cornell University Press, 1998). McNamara, Kathleen, Economic and Monetary Union: Innovation and Challenges for the Euro, in H. Wallace, W. Wallace, and M. A. Pollack (eds.), Policy-Making in the European Union, (Oxford: Oxford University Press, 2005). Mundell, Robert l, What the Euro means for the Dollar and the International Monetary System, Atlantic Economic Journal, Vol. 26, No. 3, 1998, pp. 227-228. Orhangazi, zgr, Financialization and the US Economy, (Massachusetts: Edward Elgar Publishing, 2008). Polanyi, Karl The Great Transformation: The Political and Economic Origins of Our Time, (Boston: Beacon Press, 2001).

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