June 01, 2017
On how to fix the eurozone
VoxEU has produced a very useful eBook, to be published later today, on how to fix the eurozone in light of the election of Emmanuel Macron. It is useful in the sense that we expect a watered-down version of this approach to be followed by Macron and his team. Their fundamental approach is summarised in the introduction by Agnès Bénassy-Quéré and Francesco Giavazzi, the editors of the book. They propose a dual-track approach of fixing the technical problems and engaging in a debate on broader political integration. Specifically, they propose to
“fix the eurozone to make it more resilient; and, simultaneously, start a wider consultation on the future of Europe along a growth/protection agenda – one that hopefully is capable of making Europe ‘popular’ again. It is hoped that the two hands would reinforce each other. To make progress on the future of European integration, European leaders will need political space, and to not be distracted by emergency decisions related to a new crisis. Reciprocally, political momentum for a new, consistent integration strategy will help break the deadlocks that currently prevent technical decisions that need to be made for the Eurozone to become more resilient.”
Our strongest areas of agreement with the authors lie in the diagnosis of the problem, while we differ on the solution offered (see our discussion below). The authors argue, for example, that the ESM may no longer be an effective crisis resolution umbrella, because member states attach stigma to ESM programmes and because the creditor countries are becoming less willing to extend new assistance to countries with doubtful debt sustainability. And the ESM’s funding, while sufficient for Greece, is not going to work for larger countries. Another problem is governance. ESM programmes require unanimous support by member states. One of the suggestions made in the book, by Guido Tabellini, is to involve the European Parliament. The authors also make a series of proposals to increase the ESM’s funding, essentially a callable facility from member states.
The authors also, correctly in our view, identify the diabolic bank-sovereign loop as a major unresolved issue in the eurozone. They are proposing a rule on sovereign debt ceilings for banks, with some transitional agreements on how to mop up the excess supply of sovereign debt that would result from such a rule.
The various authors disagree among themselves on the fiscal union: what function it should have, and how it should be set up. This disagreement is not surprising, given the extraordinary difficulty of constructing a fiscal union among otherwise sovereign member states. It is not hard to run into a large array of technical and legal difficulties. The authors conclude that the biggest risk is for leaders to demonstrate
“that something is done to show that Europe is moving forward, but that this turns out to be a step in the wrong direction. We already have examples of such mistakes, such as retroactive bail-in rules.”
Our fundamental point of disagreement lies in the assertion that the technical fixes presented are easy, relative to a fiscal or political union itself. We see the exact opposite. German political support for eurozone-wide rescue policies and legal manoeuvrability are approaching an absolute limit - which may be cranked up by only a notch during the next crisis. We believe that the proposals made by the authors are going to be much harder to implement than a full political union, complete with treaty change, national referendums, and a ceremonial transfer of sovereignty. The reason lies in the political and legal limitations of the inter-governmental process. The German constitutional court, for example, has argued that the present rescue mechanism complies with German constitutional law, but cannot be extended in fundamental ways and certainly not in the ways the authors suggest. Transferring sovereignty over ESM decisions from national parliament to the EP would currently be unconstitutional under German law. So would the proposal of a quasi opened ended facility. The restrictions were essential to Germany’s acceptance of the ESM in the first place.
We think the dual-track approach will get us nowhere because of these legal limitations alone. The politics will make it even harder. With the expected entry of the AfD and the FDP into the German parliament in the autumn, the political majorities in favour of radical eurozone solutions are not going to get larger.
There is only one strategy that, in our view, would shift Germany’s position on the eurozone in the direction the authors would favour: a threat that a failure to act would constitute a clear and present danger to the future of the euro in general, and to German-owned non-domestic assets in particular. At that point, you don’t want to discuss minor governance changes to the ESM, but try to create a political union, with its own fiscal capacity and both debt-issuing and limited tax-raising powers, and with full central powers over banks. Trying to work within the confines of an inter-governmental system may constitute an interesting intellectual challenge, but is not going to get us anywhere in practice.