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May 16, 2018

... and by the way: we are leaving the eurozone

The Huffington Post Italia had an extraordinary scoop last night when it got ahold of a 39-page draft document setting out a coalition agreement between Lega and Five Star. It is unbelievably extreme - right out of the 1930s. The copy of the contract is dated 14 May at 9.30am. It precedes Monday’s discussions between the party leaders and President Sergio Mattarella, and the parties have already said that it is out of date. It may be, but the document gives a good reflection of the sheer radicalness of two parties. 

The three most important headlines are, from our perspective: an exit clause from the eurozone; a partial cancellation of Italian sovereign debt; and a parallel governance structure that would reduce the role of the prime minister to that of a junior technocrat. There is a lot more in the draft, but we focus on these more extreme ideas which reveal something many Italian liberals have hitherto refused to believe: these two parties want to change Italy beyond recognition. If this coalition came together, it would herald a real challenge to Italy’s liberal democracy, and to the eurozone as a whole.

The parallel governance is probably the single most important, and hitherto unknown, proposal. We translate its name as a Reconciliation Committee, and its role is to adjudicate when there is a conflict between the two parties inside the government. Since such a committee is not foreseen in the Italian constitution, it would only have an informal role. But, as Huffington Post Italia rightly points out, the creation of such a committee would undoubtedly give rise to inter-institutional conflict, and possibly even to a constitutional crisis. The committee would take formal decisions in areas such as international crises, natural disasters, law and order, and public health. It would comes together whenever any of the parties requested it. Its members would be the prime minister, the presidents of Five Star and Lega, the political leaders of the chamber of deputies and the Senate, and any ministers relevant to a particular decision.  

The draft agreement also contains a eurozone exit clause, on page 35. The two parties commit to introducing (our translation)

"specific technical procedures of an economic and legal nature”

to allow the country to leave the euro, or to obtain an opt-out if there is a popular majority. The article points out that this clause questions the principle of the euro's irreversibility. We heard a comment from the two parties yesterday that this clause is no longer in the current draft.

The draft agreement also sets out a request for an EU treaty revision with a radical revision of the stability and growth pact, to allow countries more fiscal leeway to meet their social needs. The two parties also want a significant reduction in Italy’s contributions to the EU budget.

On page 38, almost at the end, there is a reference to the cancellation of the stock of Italian sovereign debt held by the ECB. 

And, finally, the draft agreement favours an opening to Russia, a relationship that should not be characterised by threats but by partnership in economic and trade relations. 

Ansa reports this that the two parties reacted strongly to the warnings from Brussels that the EU expects Italy to continue to focus on deficit and debt reduction. The two leaders complained about unelected eurocrats interfering in national politics. Luigi Di Maio, the leader of Five Star, wrote on Facebook that the admonitions by the EU reflected the European establishment's fear of change. 

We noted a comment in Lavoce by Massimo Baldini and Leonzio Rizzo, who did the maths on the flat tax compromise between the two parties - of a 15% lower band and a 20% higher band. The found that the costs of this tax change would be €50bn. We presume that this number relates to an annual shortfall in fiscal receipts, rather than over the entire budget year. This would equate to about 3% of GDP, which seems a plausible order of magnitude for such an extreme tax cut.

There can be no doubt that Five Star and Lega are following a radical agenda even if this draft agreement were to be rendered a little flatter in subsequent revisions. Whoever leaked this succeeded to give us an insight into the state of mind of the two parties. What worries us even more than the tough language on the eurozone, and the ludicrous request for debt cancellation, is the attempt to undermine the Italian constitution through parallel structures. This is the method by which fascists and communists in the 20th century managed to usurp democracies from within. Coalition committees to adjudicate conflicts about legislation are a normal thing, but a committee with formal executive powers is a completely different animal.

The only line of defence against the constitutional recklessness of the two parties is President Sergio Mattarella, who left no doubt about his intention to uphold the constitution. But history has shown that this formal power matters little in practice when the radical parties have sufficient majorities - as is quite possibly the case here. While the president has the power to call new elections if the talks fail, he could inadvertently trigger an even more radical counter-reaction if the radical parties were to win more votes at the next elections. We would at this stage consider new elections riskier than allowing the two parties to form a government, especially since their majority in the Senate may not be sufficiently large for some of the more radical proposals.

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May 16, 2018

Olaf Scholz scales back Germany’s readiness to reform the eurozone

Olaf Scholz held his budget speech in the Bundestag yesterday, a session that was approvingly presided over by his predecessor Wolfgang Schäuble. Angela Merkel has already scaled down any expectations on eurozone reform. Scholz yesterday went further. 

He is now rowing back on the two issues that Germany seemed to have agreed on. One is chaging the ESM’s legal basis, into EU law. The other is the date of fiscal backstop for the single resolution fund. He does not want the latter happen before 2024, which is of course after the current legislative term expires. This will give the next German government - possibly more conservative than this one - the ability to axe the whole thing altogether. And the changes in the ESM are supposed to happen in different stages. The first is the development of the current ESM into a European Monetary Fund, presumably meaning a higher budget but with the quid-pro-quo of greater powers of intervention in the policies of programme countries. And only after this change occurs will Germany consider the change in the ESM/EMF’s legal basis.

Gone are also the coalition's commitments in favour of an enlarged EU budget. Scholz rejected the European Commission’s recent budget proposals totally, and said that the current budget framework of 1% of GDP was sufficient for the EU to do its job. Given that the UK is leaving, this would imply a fall in the EU’s nominal budget which is what the Commission was trying to avoid. The SPD’s erstwhile generosity in respect of the EU budget is limited only to Germany shouldering part of the UK’s net contributions to the budget, but not to an increase in the size of the budget itself.

What really mattered to Scholz when he presented the budget was the likelihood that Germany is set to meet all the Maastricht criteria for the first time ever in 2019. This is when the debt-to-GDP ratio is forecast to fall to under 60%.

We totally agree with the comment by Gesine Lötzsch, the budget spokeswoman of the Left Party, who wondered yesterday why on earth the SPD wanted the finance ministry job if all they do is to continue the policies of Wolfgang Schäuble. FAZ went even further in its glowing appreciation of Scholz, when it noted that the new finance minister is even tougher on the banking union than Schäuble was.

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May 16, 2018

Et tu Germany?

Emmanuel Macron prepared the field for an open debate about the divergences between France and Germany over Europe with his speech in Aachen. Two comments, one from Zaki Laidi and another by Shahin Vallée and Adam Tooze, now take a closer look at the inconsistency of German thinking with European solidarity. Will this engage the Germans to take risks and go beyond their national interests? We are not so sure. 

Germany aspires to live in a minimalist Europe devoid of any political ambition, only endowed with disciplinary mechanisms as defined by virtuous states. Zaki Laidi writes this ideal is the result of Germany's ordo-liberal thinking. This mindset defines how events are seen and understood. Take the financial crisis: Germany, the Netherlands and the Baltic States, interpreted the crisis as a consequence of budgetary laxity by some member states, or insufficient state control over private sector indebtedness. No macro-economic perspective at all.

Is ordo-liberalism incompatible with macro-economic thinking about the eurozone? Laidi argues in l'Opinion that historically this has been the case. For ordoliberals the national economy is considered the sum of micro-economic decisions. By extension, the European economy simply a sum of national economies where solidarity is to rely on rules that are the same for everyone.

But this prevents a common perspective on the eurozone, and relies on three erroneous assumptions: The first is the German narrative that its economic success and prosperity has nothing to do with other member states. The second is that anticyclical policies will not be possible with the German debt brake in place - as austerity will always take precedence in a cyclical downturn. And the third is the belief that in a market economy the role of the state should be limited to setting rules that guide the choices of economic actors. However the German current-account surplus is not so much the result of excess saving, but of under-investment by German companies according to some recent studies. Compared with France and even Italy, Germany is under-investing in its manufacturing and IT industries. Macron may be the leader who could take France on a road of an ambitious plan for Europe. But for this he also needs a partner in Germany, ready to get out of its inward-looking and moralistic economic thinking. 

Adam Tooze and Shaheen Vallée look at the two principles that guide the German position on European integration, namely that responsibilities and control must be aligned, and that legacy risks must be settled. Though the two principles seem reasonable enough their full impact can be understood if applied it to another policy area, security and defence. Germany has been a free rider on other nations' defence spending. Its most recent budget may be in line with its debt brake, but not with its Nato commitments, nor does it clear any legacy issues. They ask:

"what if the French were to insist, as an absolute precondition for further security cooperation, that Germany not only increase its defence budget immediately, but also make good on its accumulated backlog in defence spending from recent decades?"

Since 1990 France spent cumulatively 30% more on defence than Germany. The costs for France's nuclear deterrence are approximately 4.5% of French GDP over the same total period. The legacy debt is thus substantial. Despite the scale of the challenges that Europe has yet to face, should France hold out until Germany makes good on its legacy defence debt before considering defence investments and mutualisation in Europe? What if, as a quid pro quo, France asked for security policy what Germany does for economic policy? Europe cannot start with a clean slate, it has to take the past as given and move on despite all imperfections and unequal positions. But it has to move if it is not to be torn apart, they conclude.

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