On 5 April 2012 Brendan Halligan, Chairman of the Institute of International and European Affairs, presented a paper a sub-committee of the Irish Parliament in preparation for the Referendum on the changes to the Treaty. The Irish Referendum produced a "yes" vote for Treaty change, but Halligan's paper provides an outstanding summation of what went wrong with the euro project. He reminded the Sub-Committee that the Stability and Growth Pact, negotiated back in 1996 in Dublin during the Irish Presidency of the Ecofin Council, started life with "an unfinished economic leg". With fiscal union a political non-starter, the Pact tried to make do with a kind of "goodwill and best behaviour" clause, with members agreeing to voluntarily restrict their fiscal deficits to no more than 3% of GDP and overall public sector debt to no more than 60%. However, as Halligan notes, this voluntary code was dead in the water from the start:
"... the two largest member states, Germany and France, broke the rule of keeping their budget deficit below 3% of GDP. Two other member states, Italy and Greece, broke the rule of keeping the national debt below 60% of GDP or, at least, reducing the debt level to 60% in progressive steps. Other member states, such as Ireland, ignored the policy advice of the Commission and Council on how to manage their public finances in a sound and sustainable manner, even though they were supposed to take account of it."
Throw in the 2008 crisis and suddenly Europe was in a real mess. The solution to the mess that the EU has come up with - or had by April, when he prepared his paper, was twofold. First, the EU introduced a "fiscal compact", still way short of a fiscal union, but a start at least in reining in extravagant spending since the compact envisages oversight of EU member state budgets. The second element is the European Stability Mechanism (ESM), a new, permanent EU institution able to provide financial assistance to any EU member that is unable to secure funding in the financial markets. Germany had been blocking any agreement for the ESM to be allowed to step in to buy the bonds of troubled EU peripheral states, which is why Italian and Spanish bond yields climbed ever higher through May and June. Now, post the 20th EU heads of state Summit on 28-29 June, Germany has backed down and given its sanction to the ESM to commence bond buying of troubled member states.
As Halligan notes, if the ESM succeeds in doing the job that it was designed to do, namely shoring up state finances in the eyes of the financial markets, then, as he puts it, "The implications for Europe are that, in the immediate-term, the sovereign debt crisis will be resolved and, in the longer term, will be protected from a re-occurrence." The whole point is that if individual EU states are enabled to wind back their debt to the 60% level agreed in the original Stability and Growth Pact, and reaffirmed in the fiscal compact, and if they are protected along the way to achieving this reduction, by the ESM stepping in when the bond markets get twitchy, then we should be able to expect a direct correlation between sound sustainable finances at the national level, and the stability of the currency at the European level. If we get that, then by definition, the European sovereign debt crisis can fade into history.
Of course, this is a huge series of "ifs". As has been pointed out by many commentators, there are severe productivity differentials across the EU. Germany will, for the foreseeable future, be very much more productive than Greece, or Spain, or Italy. This is a structural difference that is quite capable of pulling the whole EU project out of whack, and it is why many argue that good as the "fiscal compact" and the ESM might be, what Europe really needs is a system of transfers, rather than loans, from the richer member nations to the poorer member nations. Loans just generate more debt. Transfers straighten out structural imbalances.
However, there is zero possibility of the Germans tolerating a move to transfers until and unless there is central control over individual member budgets - which means something akin to full fiscal union. As the redoubtable German finance minister, Wolfgang Schäuble commented recently in a scathing dismissal of the idea of euro bonds, "everyone likes spending someone else's money". As we all know, no one is likely to be particularly frugal when they get a shot at that kind of free spending.Europe certainly gives the impression that it is picking up the pace of a move to full fiscal integration, but that could be illusory. There is still an enormous gulf between steps such as a single banking regulator (agreed at the 20th Summit of EU heads), or the "fiscal compact", and full fiscal union in the equivalent of a United States of Europe. So the fundamental flaw in the euro project, monetary union without fiscal union, continues for the time being. How long the markets will continue to tolerate that flaw remains to be seen. Spanish and Italian bond yields over 6.5% were a clear warning shot across the EU's bows. The EU's response has been to put the ESM front and centre. The coming weeks will show if the markets feel the ESM has the firepower to do the job assigned to it.
Further reading on the eurozone:
- Eurosystem Central Banks and the TARGET2 Debt Debate, by John Whittaker
- "If you ever go across the seas to Ireland..." by Anthony Harrington, blog
- Steering Between Deflation and Inflation—A Troubled Road for Developed Economies, by Neil Williams
Tags: Dublin , Ecofin Council , ESM , euro , euro zone , Europe , European Central Bank , European Monetary Union , european sovereign debt crisis , eurozone , Institute of International and European Affairs , Ireland , Irish bailout , Irish debt , Irish economy , Irish Referendum , Republic of Ireland , The Tragedy of the Euro