The debate on improving economic governance in the eurozone is shedding new light on the euro system’s weaknesses, although they were already quite evident when the Maastricht treaty was signed in 1992, and just happened to have been forgotten during the common currency’s first decade.
It has long been clear that a monetary union with a common monetary policy would be unsustainable in the long run, without something of a similar nature in the fiscal domain. This became true in light of the growing heterogeneity in public accounts and in the economic performances of the countries concerned. The well-known conditions of the theory of "optimal currency areas" were far from being met.
Now the euro system looks more like a challenge to economic common sense, consisting as it does of a centralised monetary policy run by the European Central Bank (ECB) but decentralised fiscal and budget policies. The Growth and Stability Pact (GSP) that was meant to guarantee fiscal discipline and coordination hasn’t been taken seriously by important states like France and Germany since the first half of the last decade.
Nevertheless, the euro undoubtedly produced such significant benefits as a boost to intra-European trade, unprecedented stability and lower inflation in many member states. It quickly became the world’s second most important currency and proved itself to be a shield against outside financial turbulence. This caused over-optimism, with acceleration in many fields where more prudence would have been advisable, witness the admission to the euro club of countries like Greece that should have waited longer and the rather quick "widening" of the EU to eastern Europe even though little "deepening" was taking place.
In other words, Europe’s decision-makers came to overlook the basic requirements of a monetary union in a heterogeneous economic area. It needs:
• a sizeable common budget for the provision of public goods,
• fiscal transfers from more prosperous areas to those in economic difficulties,
• some form of communitarisation of public debt (i.e. eurobonds), carried out under stringent rules,
• and, above all, a central bank with all the necessary prerogatives and instruments, including the "parachute" to the whole system deriving from being a "lender of last resort".
These conditions would, of course, lead to fully-fledged political union, but the process can yet be developed in a gradual way, either with a form of banking union, or a fiscal union, or a central bank acting as lender of last resort. This would be in line with the functionalist approach and might be more acceptable in practice. Some say, though, that
this would imply solidarity to a degree difficult to accept, although forgetting the "social market economy" model so clearly stated in the Lisbon treaty and disregarding the fact that solidarity is the other side of the coin of enhanced interdependence that a monetary union brings about.
The final outcome of a monetary union must be a positive sum game for all participants, otherwise it won’t survive for long. After the eurozone’s sovereign debt crisis broke, the measures taken to avoid defaults included the European Financial Stabilisation Mechanism (EFSM), later substituted by the European Stability Mechanism (ESM), together with a more pragmatic and reinforced role for the ECB, acting with the International Monetary Fund (IMF). In March of this year the Fiscal Compact foresees a commitment to budget balance guaranteed by a constitutional law in each state, together with an obligation to reduce public debt to within 60% of GDP in 20 years.
Any assessment of moves toward better economic governance has to acknowledge the contradictory and slow decision-making process at intergovernmental level, where in many instances a misperceived sense of national interest together with upsurges in anti-European public opinion and electoral tactics have led to a stop-and-go process, with the financial markets aggravating instead of improving the situation. The European political class has demonstrated a clear lack of leadership.
The challenge now is twofold: how to cope with the financial crisis and how to create a safer situation in the future through better governance.
Measures to resolve the financial crisis have so far been slow and insufficient, so the problem in many countries has been aggravated. Excessive emphasis on fiscal rigour accompanied by measures to stimulate growth has reinforced recessionary trends placing additional strain on public budgets. The uncertainty created can be seen in the spread on some countries’ government bonds contributing further to the vicious circle.
Any lasting solution to all these problems involves acknowledging at a political level that we Europeans now face a common problem that can only be resolved by greater cohesion and financial solidarity. At a technical and operational level, the ECB must move away from its present ambiguous status to really become Europe’s central bank, with all the necessary power and instruments that include being a lender of last resort. The European banking system must be turned into a banking union with prudential supervision under the ECB’s responsibility. The Fiscal Compact must be quickly implemented, and progress should continue to gradually harmonise fiscal policies.
But fiscal discipline must be accompanied by growth policies as these are of vital importance if we are to turn the vicious circle of fiscal deficits, austerity and rigour, then recession and increased deficits into a virtuous one. Without growth, budget balance and debt reduction will quickly become unsustainable. The "Europe 2020" strategy approved two years ago (including its improvements in economic governance) is a good starting point, offering the basis of the "Growth Compact" that has been asked for by some EU governments.
All this requires two fundamental conditions. First, economic governance must be improved at a political level, with “more Europe“ involving the further strengthening of the roles of the European Parliament and the Commission, and the complete abolish of veto powers in the Council. “More Europe“ obviously implies a strengthening of our common institutions, but the argument that this would cause reductions in national sovereignty appears very weak, since sovereignty in today’s globalised economy is in any case more apparent than real.
In parallel to these changes, there must be a clear acknowledgment by European leaders that if the euro falls not only will the eurozone fall apart but the same will happen to the EU. European public opinion has to be made aware that with our increasing interdependence, the gradual completion of the single market and the stability of exchange rates provided by the euro offer benefits for us all.
But if the euro falls, we will quickly go back to competitive devaluations, intra-EU protection and "beggar-thy-neighbour" policies, the situation that was still evident in the 1970s and 1980s. Europe’s political class needs to find the courage to take the next steps towards a closer union, and understand that the small price nation states will have to pay is negligible compared to the likely consequences of not taking action.
Carlo Secchi is a former MEP and is chairman of the Italian Group of the Trilateral Commission. carlo.secchi@unibocconi.it