The Eurozone’s Solidarity Fallacy
In the name of "solidarity," eurozone reformers have continued to introduce new instruments for sharing risk across member states in the event of another crisis. But what the monetary union needs is not joint liability – and the unacceptable degree of moral hazard that would come with it – but rather risk reduction.
FRANKFURT – Since 2010, many measures have been adopted to “crisis-proof” the eurozone. In addition to tighter budgetary rules and the start of a banking union, new efforts are underway to strengthen the European Stability Mechanism (ESM), which is now meant to serve as a backstop for the Single Resolution Fund (SRF). At a recent Eurogroup meeting, eurozone finance ministers agreed on reforms to allow fundamentally “sound” member states to access “contingent” ESM credit lines if they meet certain conditions, and for all sovereign-bond contracts to include collective-action clauses by 2022.
With policymakers still debating whether to create a eurozone budget and deposit insurance scheme, we should consider what the reforms introduced so far might mean for the future. At issue is whether we want a monetary union in which member states are individually responsible for their policies, or one based on solidarity, complete with risk sharing and financial transfers.
In accordance with the European Union’s solidarity principle, the reform has focused on introducing more safety nets and backstops, with a shared budget, joint unemployment and deposit insurance, and so forth. The assumption is that the more risks are shared, the more stable the eurozone will be. But this is a fallacy. In practice, the proliferation of new safeguards has introduced a high degree of moral hazard and created perverse incentives for governments and market participants alike.