17 August 2022

Threats and solidarity in the Eurozone: How Italian and German citizens respond to information about Italexit

Previous research suggests a form of ‘democratic constraint’ blocks attempts to reform the euro. While voters in creditor countries oppose debt sharing across the Eurozone, voters in debtor countries are unwilling to push for change by threatening to leave the single currency.

Drawing on a new study, Lucio Baccaro, Björn Bremer and Erik Neimanns claim this argument overlooks the fact citizens in debtor countries are receptive to information about the costs of remaining in the euro, and that citizens in creditor countries are concerned about the costs of a breakup.

The sovereign debt crisis of the early 2010s was never truly resolved, but merely put on hold by the European Central Bank. Mario Draghi’s promise to do “whatever it takes” to save the euro in July 2012 was essential in defusing the danger of a breakup of Europe’s common currency. Later on, the ECB’s asset-purchase programme, which saw the central bank buy government bonds, provided further relief to highly indebted nations.

When Covid-19 struck, causing a significant decline in GDP in several nations and a big increase in public deficits, it fell again on the ECB to resolve the situation. Public debt levels soared, surpassing 150% of GDP in Italy and reaching 120% in Spain, but the Pandemic Emergency Purchase Programme (PEPP) kept bond spreads under control.

Still, the institutional architecture of the euro is conducive to confidence crises because it is meant to expose sovereign bonds to market discipline while prohibiting fiscal transfers, monetary financing, and risk-sharing among member nations. It is commonly acknowledged that adding fiscal transfer or risk-sharing mechanisms would strengthen the euro’s foundation. This is why the introduction of ‘Eurobonds’ was the subject of passionate debate during the Eurozone crisis. However, none of the reform proposals were successful.

Democratic constraint

Academic researchers have argued that what blocks the path towards the institutionalisation of fiscal risk-sharing in the Eurozone is a ‘democratic constraint’ or a ‘constraining dissent’. National public opinion in northern countries is vehemently opposed to providing financial assistance to ‘profligate’ southern countries. Consequently, northern leaders, who are accountable to their constituents, have little room to deviate from the current setup.

In turn, southern politicians confront their own version of the democratic constraint: the ability to threaten a breakup of the common currency would improve their negotiating position. Despite punishing austerity and structural reforms, however, their constituents are hesitant to consider quitting the euro. As the negotiations around the third Greek bailout painfully demonstrated, this weakens their leaders’ ability to negotiate a more equitable distribution of the burden of adjustment.

While these remain popular arguments, we believe that the democratic constraint concept is overly static. It is true that without any genuine motivation or compulsion to reform, northern leaders will do the bare minimum to keep the euro afloat and that this will be insufficient to place the euro on a more stable footing. However, it is also true that preferences for fiscal integration are ‘strategically interdependent’, i.e. dependent on expectations regarding the actions of other actors. In turn, expectations are influenced by the type of information citizens receive about the costs and benefits of different policies.

In other words, whether or not northern citizens agree to fiscal risk-sharing will depend on whether they have information about the costs associated with a refusal to do so. In contrast, southern Europeans’ willingness to leave the euro depends on their evaluation of the costs and benefits, which includes their anticipation of the response of other nations.

LSE

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