THE SUMMIT of EU leaders on Friday was the eighth supposed to produce a definitive solution to the problems of the euro. In the early hours of Friday, dreary-eyed heads of government or state reached agreement on two issues: a new ‘fiscal compact’ with strengthened economic policy coordination to prevent future sovereign insolvency and the development of “stabilisation tools” to deal with current debt problems.
The big question is whether these two solutions will be enough. The initial reaction of financial markets was certainly far from jubilation, but there was no outright disappointment either. Economic commentators were similarly divided.
Naturally, the answer to that question very much depends on what you regard as the cause of the current problems. I use plural on purpose because, in my view, there are several problems that are intentionally or unwittingly conflated by national politicians. The primary problem is that of unsustainable public debt. Another problem is the unavoidable fact that in a currency union, a single monetary policy applies to many different countries with diverse economic conditions. This is the inherent weakness of ‘one-size-fits-all’ policies. A third problem is the widely divergent competitiveness of eurozone members.
To counteract excessive public debt, EU leaders adopted a “fiscal compact”. In reality, however, they have created a discipline club. The compact requires that budgets are balanced and that automatic trigger mechanisms are established. In case of persistent deficits there will be “automatic consequences” from the EU. All these policy constraints are good for countries that appear unable to put their house in order. All too often political expediency makes governments give in too easily to the demands of special interest groups such as trade unions and industry lobbies. More discipline is indeed needed.
But in normal usage the term “fiscal” also covers taxes. The compact does not make any explicit mention of taxation. The European Union has very limited competence on direct taxation and the case law of EU courts has explicitly recognised that member states are free to determine their own systems and rates of taxation. Yet, it should not come as a surprise that as the compact is implemented, high-tax countries start raising objections to the policies of low-tax countries.
The second problem that has plagued the eurozone is the inefficiency of having a single monetary policy applying to countries with very different economic conditions. Since this is not an aspect of fiscal policy, the compact makes no reference to it. Nonetheless, it is one of the inherent weaknesses of monetary integration. The consequence is that any attempt to remedy this weakness necessarily has an impact on fiscal policy, which bears the full burden of the task of offsetting uncorrelated economic shocks across eurozone countries. This strengthens the arguments of those who favour more centralisation and coordination of national policies. Again, it should not be surprising if stronger EU dictums cover most aspects of public expenditure and taxation of eurozone members.
The compact is also silent on the problem of national competitiveness. Perhaps you may think that this is not linked to the current crisis. On the contrary, it is one of the root causes of the crisis. Because some members of the eurozone have not and probably cannot keep up with German levels of productivity, they have to borrow. In the past, divergence in national productivity rates was redressed with periodic currency depreciations. Now this remedy is unavailable. In a true fiscal union, the surplus areas always make transfers to the deficit areas. The compact agreed in Brussels does not foresee such transfers. The German response to this problem is that the others should try to be more like Germany. But it is a logical impossibility for all countries to develop export-led economies. They cannot all at the same time enjoy trade surpluses. Therefore, one of the fundamental dilemmas of the eurozone is not yet resolved.
Lastly, there is the problem that has not yet become apparent. It is the problem of the unintended consequences of centralised control. The compact uses words such as “common rules”, “monitoring”, “coordination”, “assessment”, “endorsement”, “sanctions”. These are all pretty strong words. I wonder how long national electorates will tolerate supervision and direction of their economies by officials and bodies which are unaccountable to them.
In other articles I have written for this newspaper I have argued that in certain cases it is in our collective interest to delegate to supranational institutions responsibility for well-defined policies with strong cross-border effects such as competition or management of common research funds. Prudent and effective macroeconomic management is surely in the collective interest, but what constitutes prudent or effective is rather hard to define in exact terms. We can say with a fair degree of certainty whether a country has achieved budgetary balance but it is not so easy to determine how it can reach it. I don’t know when, but for sure one day there will be policy failure. Then it will be difficult to apportion blame to national or EU officials.
I am afraid that when we eventually reach that state of affairs we will be asking why the eurozone governance structure lacks accountability mechanisms to counterbalance the automatic trigger mechanisms. Their absence will undermine rather than strengthen the political credibility of the fiscal compact.
