2011-07 Lorenzo Bini Smaghi, Avoiding the Next Eurozone Crisis
LORENZO BINI SMAGHI is a member of the Executive Board of the European Central Bank.
The Greek debt crisis has shaken the euro just in time for its 10th birthday. This latest challenge should have come as no surprise; it would have been a miracle had the currency been immune to such problems. If anything, the past few years have shown that although the euro is a remarkable construct, it is incomplete: the eurozone is financially unified but not yet politically unified enough. This deficiency underlies the euro’s current problems and makes them more difficult to address.
Monetary unity entails a much greater degree of political unity than many European commentators, politicians, academics, and publics assumed it would. In a monetary union, political decisions taken in one country affect the economies of other countries in very direct and sometimes dramatic ways. This means that many national problems can only be dealt with jointly, across the whole currency area. The Greek economy accounts for only two percent of eurozone GDP, but its current sovereign debt crisis is causing economic instability throughout the whole region. It needs to be resolved through tough political decisions in both Athens and Brussels; it will be up to the Greek government to implement any economic adjustment program, but the financing for that plan is in the European Council’s hands.
The EU’s current institutional framework does not allow for smooth European decision making. Political life in Europe is still essentially domestic. Economic policies are created individually, and largely with national interests in mind. There are very few bodies that hold a eurozone-wide perspective, the European Central Bank being one of them. Unlike other institutions that coordinate policy among eurozone nations, the ECB is tasked with implementing a single monetary policy — one interest rate — for all of them. This forces it to look at the overall macroeconomic and financial picture.
It has proved difficult for countries that have already started recovering from the 2008 economic recession — Germany being the main one — to grasp the global ramifications of the Greek debt problem, the potential for contagion, and the risks to taxpayers. In May 2010, the German parliament had called on Jean-Claude Trichet, the president of the ECB, and Dominique Strauss-Kahn, the head of the International Monetary Fund, to explain the eurozone-wide risks associated with the brewing Greek crisis. Berlin saw no evident danger, but Trichet and Strauss-Kahn reminded that all eurozone countries, including Germany, would eventually feel the effects of a weakened euro.
For its part, Germany, along with the Netherlands and others, has even suggested that private creditors bear part of the burden to finance Greece’s fiscal restructuring. This seems a good idea in theory — why should taxpayers in the rest of the EU bail out irresponsible Greek banks? Yet, in the midst of this crisis, forcing the private sector to take on losses could end up costing taxpayers even more. The reason has to do with the structure of Greek debt. In other emerging economies, debt is spread among many foreign and national lenders, who can each absorb small losses. But most of Greece’s debt is held within the country by a few private banks. They could never shoulder a debt writedown and would collapse. In the end, the EU would have to bail out both the banks and the Greek economy — a much more expensive proposition. In spite of these higher costs, policymakers in several countries believe that the only way they can get domestic support for the Greek bailout is if banks are seen as paying part of the bill.
Nation-level decisionmaking is problematic in another way. Many of the European Council’s decisions during the crisis, particularly those related to bailouts and financial assistance, required unanimity among the representatives of member states. Yet each of those representatives answers to a national government, which, in turn, answers to a parliament. Each of those parliaments has a slightly different set of goals, procedures, and concerns. While Germany demands that Greek banks accept losses, for example, Finland has requested collateral in exchange for providing aid. Such different approaches among members paralyzed the EU’s efforts to address the crisis.
With its current structure, the European Council risks being paralysed as the Polish-Lithuanian Commonwealth, a council that ruled over both Poland and Lithuania in the sixteenth and seventeenth centuries, in which any member could block any decision. The commonwealth ended with economic decline, political turmoil, and eventual partition among the Austrian, Prussian, and Russian empires. So how should the eurozone avoid such a fate? There are three components to strengthening the EU’s capacity to make collective decisions: first, drop the requirements for unanimity for some cases; second, strengthen the rules that constrain national decision making; and third, enforce all of the EU’s rules better.
Strengthening collective decision making would require the EU to modify the rules of the European Financial Stability Facility, so that bailout decisions can be made by a qualified majority (as is the case in the IMF, for example) instead of a unanimity. This may not happen in the short run, but the risk of paralysis and worsening of the crisis might prompt some rethinking on the issue.
The second component — strengthening the rules to constrain national decision making –- is already underway. This year’s EU governance reform package includes proposals are to streamline procedures for economic surveillance and allow for sanctions to kick in automatically whenever a eurozone country breaks the Stability and Growth Pact’s rules. But these plans do not go far enough. In particular, the Stability and Growth Pact, signed by all eurozone members to avoid excessive budget deficits, should be modified to ensure compliance among all countries. In any event, the European Parliament has made progress by taking on the issue. It remains to be seen how successful its efforts will be.
Even if the structure of the EU remained unchanged, individual governments could do more to abide by common fiscal rules. For instance, they could introduce their own debt ceilings consistent with the EU’s stability programs. Such measures would halt excessive debt growth even before EU procedures were initiated. Rather like neighborhood watch programs, national debt ceilings would spread policing responsibilities and involve national parliaments and fiscal institutions in enforcing them.
Debt ceilings, however, contain an inherent “good times” bias — most include no mechanisms to prevent governments from busting through them in times of emergency. One way to police debt ceilings (and to ensure that decisions are in the collective interest) would be to give the EU responsibility for issuing public debt in the eurozone. Member states would no longer have the ability to issue debt to cover expenses over the limit.
Had such measures, known as debt breaks, been in place all along, Greece would neither have been able to expand its debt in 2009 nor hide it. By refusing to issue more debt to Greece, the EU would have forced the country to take corrective measures at a much earlier stage. In that situation, Greece would have had to come up with immediate additional financing on its own — either by sharply cutting expenditures or by raising taxes — or else request the support of the European Stability Mechanism, which finances strict economic adjustment programs. In both scenarios, the damage to the rest of the eurozone would have been more contained than it was this past year.
This is not the same as issuing bonds on behalf of the whole EU in the form of Eurobonds, as some commentators and politicians have proposed. For Eurobonds to work, the eurozone would have to have a federal system of taxation and revenue transfers. Under a debt-brakes system, national treasuries would still be responsible for their own debt, and fiscal instruments would still differ from country to country, but the total amount of debt allowed for each would have to be agreed on at the EU level — and the decision would be binding.
The third component needed for better eurozone policy is stronger enforcement of existing rules. In this respect, the eurozone faces its own version of the old impossible trinity in economics: just as countries cannot have a fixed exchange rate, free capital movement, and an independent monetary policy all at once, the eurozone can’t function if the three enforcing institutions of the Stability and Growth Pact (the Council of Ministers, the European Commission, and the IMF) do not operate properly. The eurozone needs an enforcement mechanism that can both monitor domestic policies and ensure that they are compatible with the union.
The second part of that trinity — the European Commission’s willingness to police — is probably the readiest for being given a stronger role. The EU could give the Economic and Monetary Affairs Commissioner, one of the commission’s 27 members, more power to independently review national budgets, rigorously enforce EU rules, and suggest course corrections for countries with poor fiscal policies. This can be achieved without redrafting the European Commission’s charter. If that still does not work, additional institutional changes may be required — for example, the creation of a European finance minister, as Trichet recently proposed. The minister would have special powers to intervene in national fiscal policies when they get out of order.
The EU’s current institutional framework cannot manage fiscal problems effectively. This does not mean that it is too late to build one that can. Many European citizens want to know why the EU did not monitor Greece’s economy before the crisis — indeed, why the country was even allowed to adopt the euro to begin with if the EU framework could not ensure that its economic practices were sustainable. It is time to turn the monetary union into a stronger political union.
Europe’s union has no modern precedent. It demands original thinking, as much as, if not more than, that of the United States’ Founding Fathers. It also requires similar political courage and leadership.