MILAN – The debate about improving economic governance within the eurozone is shedding new light on the system’s weaknesses. It was already evident when the Maastricht
Treaty was signed in 1992 that a monetary union without something similar in the fiscal domain would be unsustainable in the long run. Then, for the common currency’s first decade, that fundamental flaw was papered over.
Now the eurozone – with a centralized monetary policy, run by the European Central Bank, alongside 27 national fiscal policies – has come to look like a mockery of economic common sense. Early on, important states like France and Germany stopped taking seriously the European Union’s Stability and Growth Pact (SGP), which was supposed to guarantee fiscal discipline and coordination among the member states.
With the euro’s introduction boosting intra-European trade and lowering inflation in many member states, fiscal obligations were simply ignored. The euro quickly became the world’s second most important currency, and it proved to be a shield against external financial turbulence. Optimism soared and prudence fled – reflected in premature eurozone membership for countries like Greece, as well as in the gap between the pace of EU enlargement and that of institutional integration.
In other words, Europe’s decision-makers ultimately overlooked the basic requirements of a monetary union in a heterogeneous economic area:
• A sizeable common budget for the provision of public goods.
• Fiscal transfers from more prosperous areas to lagging or distressed regions.
• Some form of mutualization of public debt, carried out under stringent rules.
• Above all, a central bank with all of the prerogatives and instruments needed to serve as lender of last resort.
Satisfying these conditions would, of course, lead to fully-fledged political union, but the process could be gradual, starting with a banking union, a fiscal union, or a central bank with lender-of-last-resort status – a functionalist approach that might be more politically viable. Some will oppose greater solidarity nonetheless, disregarding the elementary fact that enhanced interdependence in a monetary union requires it, and ignoring the Lisbon Treaty’s affirmation of Europe’s “social market” model.
A monetary union that does not benefit all of its participants will not survive for long. After the eurozone’s sovereign-debt crisis erupted, defaults were avoided by establishing the European Financial Stabilization Mechanism (since replaced by the European Stability Mechanism), and by crafting a more pragmatic and reinforced role for the ECB (acting with the European Commission and the International Monetary Fund). And a new “fiscal compact” foresees enshrining member states’ commitment to budget balance – and to reducing public debt to within 60% of GDP in 20 years – in their constitutions.
But any assessment of European economic governance must acknowledge the slow, contradictory nature of intergovernmental decision-making, in which a misconceived notion of national interest, together with upsurges in popular anti-EU sentiment and electoral pressure, has led to a stop-and-go process, punctuated by financial-market swoons. Viewed in these terms, the European political class has clearly failed to exercise leadership.
The challenge now is twofold: how to cope with the financial crisis while creating a safer economic future through better governance. Excessive emphasis on fiscal rigor, unaccompanied by measures to stimulate growth, has reinforced recessionary trends, placing additional strain on national budgets and debt/GDP ratios. That drives up affected governments’ borrowing costs further, fueling a downward spiral.
Any lasting solution requires Europeans to acknowledge that they now face a common problem that can be resolved only by greater cohesion and financial solidarity. The ECB must become a genuine central bank for Europe. The European banking system must be turned into a banking union with the ECB responsible for prudential supervision. The fiscal compact must be implemented quickly, and progress on harmonizing fiscal policies should continue.
But fiscal discipline must be accompanied by policies that promote growth, without which balanced budgets and debt reduction cannot be achieved. The Europe 2020 strategy, approved two years ago in part to improve economic governance, is a good starting point, offering the basis for the “growth compact” that some EU governments have sought.
The path to improved European economic governance leads through the EU’s political institutions, with “more Europe” presupposing further strengthening of the European Parliament and the European Commission, and the abolition of veto powers in the European Council. The argument that strengthening Europe’s common institutions would reduce national sovereignty appears very weak, for the simple reason that in today’s globalized economy sovereignty is more apparent than real.
Parallel with these changes, European leaders must publicly acknowledge that if the euro collapses, Europe will quickly revert to competitive devaluations, intra-EU protection, and “beggar-thy-neighbor” policies, all of which were evident in the 1970’s and 1980’s. European public opinion must be made aware that increasing interdependence means that the exchange-rate stability and gradual completion of the single market implied by the euro really do benefit all participants.
Europe’s political class needs to find the courage to take the next steps toward a closer union. The small price that nation-states will have to pay is negligible compared to the likely consequences of inaction.