After the formation of the grand coalition government in Germany and Macron’s pro-integration push, the discussion on reforming the Eurozone’s architecture has moved to the forefront of EU politics and we can expect this to culminate in the next EU summit on 29 June 2018. According to a metaphor that is widely used, the Eurozone should repair its roof now that there is fair weather in the financial markets and before the next financial storm hits home. The main division appears as always to be between the prudent northern creditor states, led by Germany, which desire strict discipline and responsibility before there can be more risk-sharing across the Eurozone and the highly indebted peripheral states, whose interests France claims to represent, that ask for more integration and common support mechanisms. However, given that the currency union has already morphed into a highly asymmetric and undemocratically rigid structure, what is presented as the only possibility for compromise is in reality a lead into a more restrictive and unequal regime.
The Policy Compromise
The recent policy paper written by 14 French and German prominent economists and published by the Centre for Economic and Policy Research incorporates a number of proposals regarding financial regulation, fiscal policy, sovereign debt restructuring and Eurozone institutional architecture. The proposed policies are purportedly designed to move the Eurozone towards closer union by variously: integrating financial markets and severing the ties of banks to their home countries; imposing common mechanisms for fiscal discipline; providing crisis management and relief mechanisms for Member States in distress; and strengthening the central institutions of the currency union. At the same time, they do not promote federalism in an aggressive manner and they appear to be reversible, allowing individual Member States to maintain an opt-out from most of the institutional reforms, if things do not work out as desired by them. One could say that the paper sketches the contours of a possible compromise between France and Germany (with a discernible bias in favour of the latter) for Eurozone reform without a major overhaul of the Union that would require treaty changes. The main unspoken objective though seems to be the containment of Italy, whose enormous public debt and troubled banking system make the Germans hesitant to commit to further integration and risk-sharing at a European level.
Best of All Worlds
The question of Eurozone reform is framed in the paper in terms of the following dilemma: Should there be more risk sharing and common Eurozone stabilisation mechanisms or should the focus be on tougher enforcement of fiscal rules and market discipline? The authors claim to have found the best of all worlds in their set of proposals, where the policies serving each type of desideratum are intended to reinforce each other and work in tandem with the free market’s invisible hand in order to ensure responsibility, stability and to create an economic environment conducive to growth.
Their central assumption seems to be that the Eurozone’s problematic architecture can be amended and that future crises can be avoided, or at least ameliorated, through the establishment of a more rational, fine-tuned framework that will streamline and support the policies followed by national governments towards the said goals. But of course the framework’s functioning will require the aid of the financial markets which, after the implementation of the proposals, will have become more integrated across the Eurozone and will thus be in a position to play a more effective role in “disciplining” national governments in case they deviate. This, in turn, will presumably settle political problems as well, since politics that are out of line will be out of reach for national governments.
Financial Sector Architecture
On the front of redesigning the financial sector architecture the proposals focus on the integration of financial markets, with particular emphasis on breaking the so-called ‘doom loop’ between national sovereign debt and the respective national banks. Their proposal to limit the amount of sovereign debt of their home states held by banks has already been criticised as being inadequate as a remedy, and possibly dangerous, since it takes away from national governments a key tool that they had for containing acute crises in a direct and immediate way. Furthermore, critics have also argued that the authors of this policy proposal have completely missed the complexity of financial – economic crises, by concentrating too much on the problem of deficits and sovereign debt, which, for most Eurozone countries, was not the most significant factor in bringing about the crisis, and ignoring the crucial contribution of the private sector (e.g. in the housing market bubbles).
Of course further integration of financial markets in the Union is called for by almost all pro-EU commentators, even critics of the current proposal. This is despite the fact that (or maybe exactly because) the homogenised financial markets that will result will presumably favour larger multinational corporations, thus further reinforcing the crucial role they play in shaping the economic and political process inside the European Union. Among other things, this will have as a potential consequence uncontrolled capital transfers out of the weaker member states, thus rendering the latter even more dependent on the stronger member states and the central Eurozone structures. At the same time, the proposals for the enhancement of the powers of institutions such as the European Central Bank (ECB), the Single Supervisory Mechanism (SSM) and the Single Resolution Board (SRB), at both the supervisory and executive level, will definitely result in more centralisation, less democratic control and the further extraction of economic and political power from national governments.
The authors’ insistence on accelerating the clean-up of financial institutions’ balance sheets through the aggressive reduction of Non Performing Loans (NPL’s), which remain a massive problem in the periphery of the Eurozone, presumably means more pressure by the central institutions on national governments to accelerate foreclosures, without taking into account the detrimental social consequences and the injustice of a policy that places the ultimate burden of the financial crisis on the poorest and most indebted members of society.
Finally, the implementation of the authors’ proposal for a European Deposit Insurance Scheme (EDIS) would provide better pan-European guarantees for individual depositors; however, these would not mean much to the large sectors of population, especially in the periphery, that have virtually non-existent savings. Moreover, this scheme would still have to be backed by taxes at the national level and Germany is determined not to commit to it unless all other Eurozone countries meet very strict requirements.
On the front of proposed new fiscal rules and discipline-imposing mechanisms, the authors claim to shift the focus away from the pro-cyclical austerity policies that have been imposed across the Eurozone and especially on the crisis-hit states. They do this by making extensive and detailed proposals that are supposedly more flexible and anti-cyclical. Regarding these proposals the following points can be made:
There is still strong anti-growth bias, since the proposed policies are designed to place limits on government expenditure with the aim of enforcing the implementation of the Fiscal Compact’s target of debt-to-GDP ratio of 60%, a target that is obviously unattainable in the short to medium term for the highly-indebted peripheral states. This would result in permanently reduced public investment and preclude these states’ governments from playing any role in promoting growth in the economy.
The supposedly more flexible rules proposed are in reality going to constitute the operational guidelines of the ‘good’ technocracy favoured by the authors, an Eurozone shared structure that purports to streamline all political decisions towards the desired outcomes, thus extracting the best part of fiscal policy deliberation from political decision making. The crucial role will be played by a so called independent fiscal council at the national level, which will be supervised at the central Eurozone level. In this way, democratic decision making and control of fiscal policies is taken away from the only meaningful Demos that exists, the national one, and placed in the hands of a central technocratic bureaucracy and its national proxies.
Any deviation of national governments from the straight path (i.e. extra spending) will have to be financed by so-called junior bonds – the instrument through which the market will impose discipline. These junior bonds will be liable to re-structuring in case of default and so are expected to have higher yields and thus limit the national governments’ choices.
The proposals also include supposedly more rational and better organized provisions for debt re-structuring, which, however, will have to be tested in real political and market conditions. Italian economists have already directed their criticism against these provisions, since they are likely, as they say, to destabilize the Eurozone by creating a self-fulfilling prophecy of doom.
Countries that request financial assistance will have to implement programs under the supervision of an European Stability Mechanism (ESM) that will have enhanced powers, a variety of new tools at its disposal and nominal accountability (at European Parliament committees). Note that the ESM is an institution where all the power is held by the biggest shareholders (especially Germany) and is outside EU law. Greece, which is still following a program, will remain under the ESM’s sole supervision (with the EC, the ECB and the IMF removed) until its debt-to-GDP ratio reaches 60%, in other words at least for the next couple of generations, if things go well. The asymmetric and unequal relation between creditors and debtors that characterizes the Eurozone is thus further entrenched by the proposals.
The carrot for individual nation-states is the stabilization and shock-absorption funds offered in times of crisis, or even in milder downturns. This amounts to a kind of common insurance policy, where the countries that are more likely to need it have to pay more. The carrot is not very big and is not even necessarily intended to be given to national governments directly, since the policy proposal makes provisions for bypassing them. Moreover, the arrangement seems to be proposed as discretionary, so that countries that are not very likely to need it will be able to opt out, if they see fit.
Another carrot is offered in the form of a Euro-area safe asset, or Sovereign Bond-Backed Securities (ESBS – already examined in depth by an ECB working group), which is a complicated type of structured bond that is designed to mitigate the risk of contagion in the markets due to deteriorating sovereign debt of stressed Eurozone countries. I am not in a position to assess such a technical financial construction; however, others that are qualified have already done so and found it problematic, even dangerous. It is arguable that such a debt-pooling tool appears obscure to the common citizen and would probably be unhelpful as an instrument for financing the Eurozone countries that need it most, as it does not involve any debt mutualisation; on the contrary, it is intended to isolate them by functioning as a firewall that protects private financial institutions, and by extension the Euro itself, from the risk presented by financially troubled member states.
On the front of institutional reforms, the authors make a number of tentative proposals with the aim of distinguishing and clarifying the roles of watchdog and political decision maker at the central Eurozone level, roles that they deem necessary to enact these policies. The fact that they take as their role models far-distanced, opaque and for all intents and purposes democratically unaccountable institutions such as the ECB, the IMF and the ESM, is characteristic of the way they envision the functioning of the currency union. The language that they use is judicial (“prosecutor”, “judge”, “discipline” etc.), making it abundantly clear that they see the central Eurozone institutions as a permanent High Tribunal, whose purpose is to perpetually judge and, if needed, punish the democratically elected national governments.
The fact that this policy insight is considered to be the only viable compromise that can be found for an improved EZ architecture, represents, in my opinion, the best argument for the monetary union’s dissolution. This is because the proposals point towards a bleak future for Eurozone nations, especially the economically weaker ones:
They imply the imposition of rigid hierarchies, where the chasm between creditor and debtor member states is cemented. At the same time, a rule-controlled technocracy, far removed from meaningful democratic control, is further empowered over the national governments, which are left with little if any elbow room as they seem a priori not to be trusted. The few tools they had for investing for growth are taken away, since any initiative towards this direction would have to pass through the so called independent fiscal councils and, ultimately, the central supervisory authorities.
The spectre of automatic sovereign debt restructuring under the supervision of the ESM looms large over financially stressed countries, as they relinquish any crisis control they may have had up to now, not least because they will not be able to rely anymore on their national banks to provide liquidity in difficult times. Furthermore, the integration of financial markets, if successful, will potentially mean more capital flight from weaker members.
Financial markets retain and even expand their power to severely punish deviant countries, although there remains a scope for market supervision and control (albeit in an indirect way), but only at the level of central EZ institutions. From past and present experience it is doubtful whether this can be for the benefit of the weaker actors in the currency union (both between and within member states) rather than the common currency itself, the financial and industrial elites and the stronger, more self-reliant countries, notably Germany.
The latter seems to have a real option of opting out of some of the proposals that involve risk-sharing, or even out of the Eurozone altogether, in case they consider this to be in their national interest. The maintenance of this option on the table will have the effect of keeping the debtor countries under effective ransom; on this basis, no convergence inside the Eurozone can be foreseen in the years to come.
The structure of the currency union, if reformed according to this policy insight, would become even more restrictive, severely limiting the political and economic possibilities of future generations of peripheral nation states, as it would condemn them to remain in perpetuity within a debtor’s prison. This is why such proposals should be rejected out of hand. Unfortunately and despite much recent posturing by Germany it appears that the policies advanced by this paper, or something close to them, may be serious candidates to form the basis of the upcoming discussion on Eurozone reform, not least because they already incorporate most of Germany’s ordoliberal agenda.
Article written by Harris Hatziioannou. Harris lives in Athens, where he works in the private sector. He holds a PhD in Philosophy from the University of London (SOAS) and taught Philosophy at university level. Besides philosophy, Harris’ interests lie in the arts and the economy of the Eurozone. For feedback or question you may contact Harris at firstname.lastname@example.org
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