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The European crisis and the challenge of efficient economic governance by Juergen B. Donges

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  • 1. /JUERGEN B. DONGES * / The European crisis and the challenge of efficient economic governance1. Introduction; 2. The root cause of the problem: too much economic diver-gence; 2.1. A suboptimal monetary area; 3. Attempted governance in anindirect manner; 3.1. Breach of the fiscal rules; 4. Governance as activismagainst the crisis; 4.1. Constituent principles, violated; 4.2. Financial assis-tance, a never-ending story?; 4.3. Political pressure to impose discipline,insufficient so far; 4.4. Financial markets, with capacity to persuade; 5. Newgovernance design: own responsibility as the key; 5.1. The euro Plus Pact, itis not binding on anyone; 5.2. The Fiscal Stability Pact, a test of nine; 5.3.The Macro-economic Governance Pact, with vague parameters; Conclusion* Professor emeritus of economics at the Faculty of Economic and Social Sciences of theUniversity of Cologne (Germany). From 1969 to 1989 he managed several economicanalysis departments at the Kiel Institute for the World Economy, in which he was theVice-chairman for the previous six years until he took the chair in 1989 in Cologne. Heis currently a Senior Fellow of the Cologne Institute for Economic Policy. He was theChairman of the German Council of Economic Experts (the so-called “Five Wise Men”)and the German Commission on Economic Deregulation. He is an economic advisor inseveral academic institutions and foundations in Germany, Spain and in other coun-tries. He is also a member of the Supervisory Board of several multinational companies.He is the author of several books and articles published in academic journals on inter-national economy and public policies in the field of macro and micro economy. 97
  • 2. The European Crisis and the challenge of efficient economic governance1. IntroductionThe purpose of this article is to focus the current discussion on theneed for economic governance in the European Union (EU) and, inparticular, in the euro area, in the context of the political reality.This is not such an easy task, as it may seem; in practice the rela-tions between national governments, on the one hand, and theseand the European Commission and the European Parliament, onthe other, end up being profoundly redefined, with more Europeanpowers and less national sovereignty. This topic is not new; it has been on the table at the mee-tings of the European Council of the Heads of State andGovernment since the formation of the European Single Market 25years ago (1986 Single European Act). We can interpret agreementsleading to a coordination of economic policies, as the initial steptowards “smooth” European economic governance, specifically to(i) promote employment (1997 European Summit of Luxembourg),(ii) apply structural reforms conducive to flexibility in the productand factor markets (1998 Cardiff Summit), and (iii) institutionalisemacro-economic dialogue among the governments, the EuropeanCentral Bank (ECB) and social partners (1999 Cologne Summit).Apart from the above steps we should add (iv) the agreement of theEuropean Council in 2010 to launch a strategy of structural reformsthat would make the EU at the end of that decade the most dyna-mic economic area in the world.98
  • 3. The Future of the Euro These agreements which were then celebrated as a landmark inthe European integration process have not given the desired results.The reason is very simple: over and above the rhetoric, the govern-ments were not willing to co-operate if the alleged or true nationalinterests indicated otherwise. Such governance installed in theEuropean Council, the Ecofin and in other councils of ministersinvolved, lacked any kind of power of management and supervi-sion of the economic and fiscal policies of the member states. At the current debate the great hope is that in the futurenational interests will come second, giving way to the “MoreEurope”, as the new political logo reads. The aim is to reach gre-ater and efficient intra-European co-ordination of the economicpolicy of the member countries. This aim was raised in 2011-2012 in three basic agreements: (i) the Euro Plus Pact (to strengt-hen the competitiveness and growth capacity of the economies),(ii) The Fiscal Stability Pact (Fiscal Compact to guarantee in allthe countries the sustainability of public finances in the mediumand long term) and (iii) the Macro-economic Governance Pact(Economic Governance Six Pack, to ensure economic and fiscalpolicies compatible with the internal and external balance in theeconomies). Now, the declarations of intent are one thing, put-ting them into practice and applying the appropriate economicpolicies, is quite another. Why should what politicians promisetoday be believable, if in the past (and today, as many of themare still around) did not fulfil their commitments? 99
  • 4. The European Crisis and the challenge of efficient economic governance I will now analyse governance in its past and present dimen-sions. The following section emphasises the significant fact thatthe euro area is not an optimal monetary area. In the third andfourth sections the forms of governance relied on until now areanalysed. The fifth section deals with the new approach forEuropean governance. The last section concludes the analysis in atone of moderate hope.2. The root cause of the problem: too much economicdivergence The crisis of the sovereign debt in Europe has shown a seriousfault in the formation of the single currency: trusting that thegovernments of the member countries would apply quality econo-mic policies in accordance with the common interest of all thepartners, as set forth in the EU Treaty (articles 2 and 121), wasnaive. In Germany, I together with many other economists noticedthis fault then, but political leaders took no notice or it was labe-lled as “academic” and, therefore, irrelevant to take great historicaldecisions. The leaders simply invoked the criterion of the so-calledsupremacy of politics over economics, as they do today when theyrun from one summit to the next to rescue certain countries frombankruptcy and try to stabilise the euro area.100
  • 5. The Future of the Euro2.1. A suboptimal monetary area The architects of the euro area, from the 1989 Delors Report,knew that a monetary union would not be feasible in the long runwithout a fiscal union, not to mention political union. The historyof the different monetary unions in Europe in the 19th Centuryhad left an unequivocal message: all of them failed because ofincompatibilities among the budgetary policies of the membercountries. However, during the negotiations of what would becomethe Maastricht Treaty (of 1992) the prerogative of national budge-tary policy was sealed. The then two main characters of theEuropean project, the German Chancellor Helmut Kohl and theFrench President François Mitterrand, fascinated their counterpartswith their vision of the euro as a pacemaker to accelerate and to gointo greater integration. More than one will remember the famousstatement of the French Finance Minister, Jacques Rueff, ‘Europeshall be made through the currency, or it shall not be made’ (1950),and they took it literally. The French statesman could never haveimagined such a deteriorated environment of public finances as wehave today in many European countries. It was also clear that the five convergence criteria set forth in theMaastricht Treaty, even if they could be fulfilled (something thatnot all countries have done), did not guarantee an optimal mone-tary area (in terms of the theory of Robert Mundell and others). InEurope, it would have been essential for the countries to be quitehomogeneous in terms of economic development and functioning 101
  • 6. The European Crisis and the challenge of efficient economic governanceof the institutions or the prices and salaries in the various countriesshould have been flexible enough (especially downwards in coun-tries with weak growth and great structural unemployment), or forEuropean mobility of labour to be high (from backward regionswith high unemployment rates to dynamic regions with shortageof workers). These conditions for an optimal monetary area did nothappen twenty years ago and do not happen today. The differencebetween Europe and the United States in this is significant. Only a group of countries in the euro area (in central and nort-hern Europe) at least met then and meets now the condition ofhomogeneity. The countries in the southern periphery were not,strictu sensu, ready for their accession in 1999 to the monetaryunion and, therefore, to waive a monetary and exchange ratepolicy as adjustment facilities of internal imbalances (inflation)and external imbalances (current account deficit) and to under-take tax regulations that would restrict government deficit andthe level of government debt. It is not a coincidence that thesecountries have had for the past two years a risk of insolvency (notto have the capacity to re-finance the debt in the capital marketunder affordable conditions), as only sovereign countries have, ifthe State may not resort to the Central Bank to secure financingand must get it by issuing bonds in a foreign currency. Greecemay be the most illustrative example of having done what theGerman Council of Economic Experts has classified as an “origi-nal sin”, in other words, having rushed into accessing the mone-tary union in 2001, forced even through deceit (hiding the truth102
  • 7. The Future of the Euroof their fiscal statistics): the country is now at the mercy of theinternational financial markets (rating agencies), after havingrevealed the serious structural deficiencies in the economy andthe public institutions, which has led to a low growth potentialand low levels of productivity and competitiveness clearly insuf-ficient at this time (globalisation of competition).3. Attempted governance in an indirect manner It was conceptually logical that with the creation of the singlecurrency the powers on monetary policy would be transferredfrom the National Central Banks to the new ECB. However, as thebudgetary policy would carry on being a national responsibility,two principles constituting the euro area were established inorder to guarantee the sustainability of the public finances in themember countries and to ensure that the monetary union wouldwork as a price stability union.• The two principles proclaimed in the Maastrich Treaty are the prohibition to bail out insolvent partners, on the one hand, and the prohibition imposed on the ECB to finance govern- ment deficits (no monetisation), on the other hand. These clauses are contained in the most recent version of the Treaty on the European Union (the Treaty of Lisbon of 2007) in arti- cles 125 and 123, respectively. 103
  • 8. The European Crisis and the challenge of efficient economic governance • The two provisions were supplemented with the Stability and Growth Pact (SGP) approved in 1997 at the European Summit in Amsterdam; in it a ceiling for national budget deficits (3% of GDP) and government debt (60% of GDP) were established under the assumption that the growth rate of the nominal GDP in the euro area would be 5% in the medium term.1 With all this, indirect governance elements were created, in other words, formally maintaining national powers in budgetary policy, but controlling the use of the powers that could destroy the feasibility of the euro area. The monetary union was not designed to pay debts jointly and generate financial transfers from certain States to others, as many today think that that is the case, appealing to solidarity among peoples. There was already solidarity, and there still is, in the good sense of the concept: the more developed countries of the EU must help the least developed for these to advance in real convergence; the various European Structural Funds are for this. But it is not compatible with the concept of solidarity; it rather constitutes a “perversion” (Issing) of it, having to rescue a society that underestimates saving, tends to consume ostentatiously, tolerates waste by the public authorities, does not fulfil tax obli-1 For a profound analysis see A. Brunila, M. Buti and D. Franco (ed.), The Stability andGrowth Pact: The architecture of fiscal policy in EMU. Houndsmills/Basingstoke (UnitedKingdom): Palgrave, 2001 – Círculo de Empresarios (ed.), Pacto de Estabilidad yCrecimiento: alternativas e implicaciones. Libro Marrón 2002. Madrid (December). 104
  • 9. The Future of the Eurogations and claims social benefits beyond the means of thecountry, given its own resources.3.1. Breach of the fiscal rulesThe architecture of indirect governance crumbled when it had topass the first real test, in 2002/03. In those days, Germany(Schröder) and France (Chirac) violated the the fiscal rules of thegame. In Germany, government deficit had reached 3.7% of GDPin 2002 and 3.8% in 2003; in France, it was 3.2% and 4.1% respec-tively. In both cases, most part of the deficit was structural. TheEuropean Commission had activated, according to the SGP, thesupervisory mechanism for ‘excessive government deficit’ againstthese two countries. The German Chancellor explicitly rejected theintervention from Brussels, the same as the French President. Theyboth imposed their criterion at the European Council in November2003, which suspended the process (against the votes of Austria,Spain, Finland and Holland). The then President of the EuropeanCommission, Romano Prodi, had described the SGP in an inter-view (on 18/10/02) as “stupido”, which is highly surprising comingfrom the custodian of the European Treaties. At the European Summit held in March 2005, the SGP wasamended, watering it down a great deal: with new exceptions forbreaking the rules, an assessment of the budgetary situation on acase-by-case basis, considering the special circumstances of eachcountry, relaxing the periods to take the necessary adjustment 105
  • 10. The European Crisis and the challenge of efficient economic governance measures, the differentiation among countries as regards the goal of budgetary consolidation in the medium-term and some com- plex and non-transparent supervisory mechanisms.2 We must remember this in order to understand the reason for the current proposals to depoliticise (“automate”) the decisions on sanctions in case of an infringement of the fiscal regulations. With the erosion of the SGP, the factors that determined the cri- sis of the current sovereign debt, put down roots, a crisis which would have happened anyway, if the 2007-09 global financial and economic crisis had not have appeared. If the governments of the two main countries of the euro area are skipping the Treaty of Europe and the SGP, why wouldn’t the rest do the same if this is what is best for them and open the tap of non-productive public expenditure? Structural government deficits increased conside- rably and with this the volume of the government debt. With this precedent, the supervision of national budgetary policies by the European Commission was reduced to merely a rhetorical exercise that did not scare the rulers much. Economic governance in an indirect manner had failed. The ECB, however, fulfilled its role and its first president, Wim Duisenberg, did not allow political leaders to tie his hands, despite their attempts.2 For this purpose, the European Commission adapted the original regulations No1466/97 and 1467/97 of 7/7/1997; see COM (2005) 154 and COM (2005) 155 of20/4/2005. 106
  • 11. The Future of the Euro4. Governance as activism against the crisis The threat of Greece’s suspension of payments two years agoshowed lack of efficient European economic governance. Instead,a rare and disconcerting political activism appeared. The nume-rous measures taken since May 2010 in Europe seem more like anexercise of muddling through than implementation of a consis-tent and long-term strategy.4.1. Constituent principles, violated It all started in the worst possible manner: the Governments eli-minated in one fell swoop the two principles establishing the euroarea mentioned above. The lifting of the non-rescue clause created the problem ofmoral hazard for Governments with a tendency to excessive publicexpenditure and for reckless banks when it comes to buyinggovernment bonds. The Governments could pass the cost of exces-sive indebtedness to taxpayers from other countries (who had noright to speak or vote when the budgets of the State in questionwere drafted). The banks started a tremendous communicationcampaign to warn of the danger of the euro area (systemic risks) ifindebted countries were not rescued, efficiently concealing to thepublic opinion that their true intention was to protect their share-holders. 107
  • 12. The European Crisis and the challenge of efficient economic governance Under the presidency of Trichet, the ECB was under pressure toundertake a new role: the role of being a “repair shop” for thefaults in the fiscal and growth policies. It acquired in the SecuritiesMarkets Programme, big sums of Treasury bonds from countries introuble which nobody wants. Here lies the difference with otherrelevant central banks (the Federal Reserve, the Bank of England,the Bank of Japan), they also buy government securities in the con-text of their non-conventional monetary policies, but these areassets with considerable profitability. Furthermore, the ECBcurrently grants unlimited liquidity to banks for three years, at asymbolic interest rate (1%) and it accepts low quality securities asguarantee. But it is not in its hand to lead banks to proper grantingof credit to companies or households in the country under affor-dable conditions; the ECB must resign itself to banks choosingmore profitable business in the short-term, as purchasing the debtof the State; therefore, there is not much change in the scenario ofcredit restriction in the private sector in several countries, like inSpain. The European monetary entity is not only “a last resort len-der” anymore, which in situations of financial emergency is justi-fiable, but it has also become “a public debt buyer of last resort”,which is more questionable, because it delays the fiscal adjust-ments of the Governments (and it caused in 2011 the resignationof two German senior members of the monetary authority bodies,first the resignation of Axel Weber, President of the Bundesbankand ex officio member of the ECB Governing Council and, subse-quently, the resignation of Jürgen Stark, member of the Board ofthe ECB and its chief economist). The role that the ECB is playing,108
  • 13. The Future of the Eurofor the moment also under its new president (Draghi), may dama-ge its reputation as an institution independent of political powersand commited to price stability, which is what it has been entrus-ted with in the European Treaty. An additional problem is that the same standards of asset qua-lity, which are used as collateral in the re-financing of commercialbanks by the National Central Bank itself (and, as such, part of theEurosystem), do not govern in the whole of the euro area anymo-re. In several countries in trouble, especially with persistent currentaccount deficits which (already) do not finance in a conventionalmanner import of capital or through financial assistance fromabroad, the respective National Central Banks, with permissionfrom the ECB, accept low quality securities as guarantee of loans,more than what is allowed for emergency liquidity assistance. It isas if they were using the money printing press. This somewhatundermines the monopoly of the ECB to create money. What isquestionable from an economic perspective is hidden behind theenormous increase in the amount of these operations in theEurosystem Target 2 in the past years, which has been vehementlywarned by the Ifo Institute of Munich for the last year.3 TheBundesbank has become a gigantic creditor of hundreds of millionsof euros for the National Central Banks of the other countries, wit-3 See H.-W. Sinn and T. Wollmershäuser, “Target Loans, Current Account Balances andCapital Flows: The ECB’s Rescue Facility”, NBER Working Paper, No 17626 (November).CESifo, “The European Balance of Payments Crisis”, CESifo Forum, Special Issue, January2012. 109
  • 14. The European Crisis and the challenge of efficient economic governance hout protection and right to any kind of compensation if there is any significant bankruptcy of banks and savings banks or if the euro area collapses. The Governments of debtor countries have in reserve a powerful argument to manage to get from others, espe- cially from Germany, concessions in the negotiations over finan- cial assistance. 4.2. Financial assistance, a never-ending story? Political leaders believed, and some of them still do, that the creation of a common rescue fund is the solution to the problems of countries in trouble and it eliminates possible spillover effects. The first rescue mechanism was created with the European Financial Stability Facility (EFSF).4 This fund is provisional (three years, until 2013) and at the beginning had a provision of 440,000 million euros in loans guaranteed by the euro countries; as the Fund wanted to place their issues with the highest ranking ‘AAA’ to get attractive profitability, the real lending capacity would be lower than the allocation, about 250,000 million euros. Ireland (87,500 million euros) and Portugal (78,000 million euros) had to resort to this Fund. Subsequently, in July 2011, the European Council decided to increase the real lending capacity of this rescue fund to 440,000 million euros and, in addition, increase their4 EU Council of Ministers (Ecofin), EFSF Framework Agreement, 9/5/10 and 7/6/10.Web page: http://www.efsf.europa.eu (Legal documents). 110
  • 15. The Future of the Europowers and relax the conditions for granting the loans to countriesin trouble. It even received leverage instruments (with a 4 factor)and the so-called ‘special purpose vehicles’ (off-balance); such ins-truments, applied by private banks, were exactly the ones that trig-gered very harmful effects for the global financial crisis to break in2008. In mid-2012, six months in advance to the original schedule, anew permanent rescue fund will come into force, the ‘EuropeanStabilisation Mechanism’ (ESM).5 This fund will have a provisionin nominal terms of 700,000 million euros (with capital contribu-tions from the member countries amounting to 80,000 millioneuros); the real lending capacity of this new Fund is 500,000million euros. Provisionally, the amount of available resources mayamount to about 800,000 million euros, by transferring the unusedEFSF resources. The IMF, the OECD, the United States and China,among others, recommend a higher firewall (up to 1.5 billioneuros). In parallel with these events, a special treatment has been givento Greece. After the initial financial assistance plan approved inMay 2010 (110,000 million euros, of which 30,000 million euroscame from the IMF), of which politicians said that it would enable5 European Council, Treaty Establishing the European Stability Mechanism (ESM), 25/3/11.Internet: http://www.efsf.europa.eu (Legal documents). – European Council, Treaty sig-ned by the 17 euro area Member States, 2/2/12. Internet:http://www.european.council.europa.eu. 111
  • 16. The European Crisis and the challenge of efficient economic governancethe country to return to the capital market in 2013, in Februarythis year a second package was agreed (130,000 million euros,including a contribution from the IMF, to which a further amountof 24,400 million euros of the first package pending payment willbe added). The latest thing is that private creditors will undertake(about 85.8% voluntarily and the rest will be obliged by law) adeduction of 53.5% and will agree for the rest of their securities anexchange for new Greek long-term treasury bonds and of the EFSFFund at a moderate interest rate (which will reduce the Greekpublic debt in about 107,000 million euros of a total of 350,000million euros). Greece’s main public creditor, the ECB, has escapedthis operation and the asset losses derived from it, by means of atrick, quickly exchanging their former Hellenic bonds, whichwould have undergone a reduction, for new exempt bonds underthe same condition. The official aim is to get the public debt to be reduced from thecurrent 160% of GDP to about 120% of GDP in 2020. The Ecofinbelieves that this level is sustainable, which is quite surprising forthree reasons: firstly, this level was what Greece had in 2008/09,already in the increase and considered unsustainable then;secondly, the tax authorities must improve a great deal in order topromote the capacity to collect taxes and stop tax fraud and capi-tal flight; and thirdly the IMF’s estimates of 2-3% economic growthper year from 2014 must be fulfilled, which implies that the neces-sary structural reforms must be quickly implemented and the eco-nomy must reach considerable gains in international competitive-112
  • 17. The Future of the Euroness by substantial salary and price reductions (according to theestimates, about 50%). All of these points are question marks. Themost probable thing is that the announced aim of debt reductionwill not be attained and that the European governments sooner orlater will again have on the negotiating table Greece’s request forfurther financial assistance.4.3. Political pressure to impose discipline, insufficient so far The European form of governance since the sovereign crisis star-ted in Greece has always been “more of the same”: to want to solvea problem of excessive indebtedness with more debt. The criticalpublic opinion, as in Germany, was calmed down by saying that nocash was going to be paid from national budgets and, therefore,from taxpayers (although there will be in the ESM), but that eachgovernment “only” had to provide guarantees (distributed amongthe countries according to the holdings of the national centralbanks in the share capital of the ECB). As if guarantees could not beenforced at the demand of the creditors, in other words, buyers ofthe securities issued by the EFSF/ESM! The expectations to calmdown the markets, restore confidence and stabilise the euro areawere not met. The markets had noticed that, in the countries badlyaffected by the sovereign debt crisis, progress in fiscal consolidationand structural reforms that raise the potential of growth and com-petitiveness, which there are, were too slow and incomplete. 113
  • 18. The European Crisis and the challenge of efficient economic governance This was caused from outside. The aided governments have notforgotten the political messages launched from the beginning ofthe crisis from Brussels/Paris/Berlin. The messages that are least for-gotten and carry on being repeated with slight variations, are thefollowing: (i) “We will rescue the euro, no matter what it costs”(Barroso); (ii) “We will not allow anyone to fall into insolvency”(Sarkozy); (iii) “If the euro fails, Europe fails” (Merkel). There couldbe no better invitation for irresponsible governments to blackmail.That is how a government in trouble is tempted not to consistentlytake pure and hard measures, therefore reducing the cost of loss ofpolitical support, which any severe fiscal adjustment plan (withunnavoidable cuts in salaries and social benefits and necessary riseof taxes) would imply. In Greece it is already normal for the Troika(the European Commission, the ECB and the IMF), each time thatit visits Athens to verify if Greece’s government has implementedits commitments, to confirm that there is lack of forcefulness in thepolicies applied, especially in relation to the structural reforms. Butas the President of the euro group, Juncker, and the Ecofin finallyhave given the green light for new aid tranches to be given, thegovernment (after Papandreou, Papademos) could, after long nego-tiations, according to the demands of his European partners, andonce at home, do half of it. He could even reject the proposals madeby his partners (Germany, the first) to provide administrative advi-ce in situ, for instance, in order to create an efficient tax agency andto design and manage infrastructure investment projects.114
  • 19. The Future of the Euro If with the aid programmes the idea was to buy time to imple-ment structural reforms in the real economy, as the political leadersrepeatedly emphasised, time was not used productively in all thecountries involved, and Spain was no exception during the lastpart of Zapatero’s government, when the crisis was not officiallydenied anymore: fiscal and economic consolidation policies arri-ved late and lacked consistency and force.4.4. Financial markets, with capacity to persuade One way of overcoming the reluctance of the governments toinexorable political and economic changes in their respectivecountries comes from the market, specifically the spreads of therisk premiums included in the interest rates where the Treasurymay place their issues. As mentioned above, the risk premiums of ten-year bonds, withreference to the German bond, “bund”, reached rocket prices inGreece in 2011 and also considerably in the other peripheral coun-tries with debt problems, including Spain, where the interest ratesreached all-time highs of several hundred basis points. The samehappened with the credit default swaps (CDS) premiums. No mat-ter how much the governments criticised financial agents for this,not to mention also the three main rating agencies (Fitch, Moody’s,Standard & Poor’s), we cannot understimate its deterrent effectwhen it is intended to go into greater debt. The increase in price ofthe debt convinced political leaders in the countries in trouble that 115
  • 20. The European Crisis and the challenge of efficient economic governancethe time of spending happily had gone and that they had to beprepared for a future characterised by austerity. The new govern-ment of Spain (Rajoy) is an example of strict action to modifyunsustainable habits in society and restore the economy. In Italythere was a big change of direction since a government of techno-crats (Monti) started in November last year. Ireland had alreadystarted in March 2011, after early parliamentary elections and theformation of the new government (Kenny). Three months afterthat, the same happened in Portugal (Passos Coelho). Therefore, any decision to artificially reduce the interest rates ofgovernment bonds, as it has already been taken within the contextof rescue packages and as some governments claim, is counterpro-ductive. Eliminating the mechanisms of the market that act, wit-hout political interference, in favour of the quality of public finan-ces, is pointless. Mutualisation of the sovereign debt, no matterhow much it is proclaimed by certain political circles (also Spanish,irrespective of ideologies), as well as academic (including German,Keynesian ideas) and financial (especially the most importantbanks which are anxious to operate in capital markets with greatliquidity, comparable to the U.S. market) circles, is also pointless.There is no reason why we should think that issuing eurobondswould improve the quality of the economic policy in the euro area.On the contrary, a reduction in the price of credit in the countriesin trouble, which the eurobond would entail, would deteriorate theestimates of low cost, which all categories of public sector outlaysand any decision by the public authorities on loan finance, would116
  • 21. The Future of the Eurobe subjected to; furthermore, it would be impossible to put pressu-re on a government from outside to control expenditure and opti-mise tax collection; and, in addition, restructuring processes in thereal economy, which are so important to raise the potential ofgrowth, would be postponed. It is far better for the financial mar-kets to deploy their penalising effects and thus complement therelevant mechanisms planned by the SGP and the coming FiscalStability Pact.5. New governance design: own responsibility as the key It seems that European leaders got it into their heads that the euroarea needs another kind of governance different from what we havehad until now. We will have to carry on thinking in the need for official assiss-tance for certain countries, not only for Greece. As regards Greece,maybe we must think of two options: one, exiting the euro, inprinciple on a provisional basis (until the fundamental problemshave been solved) and continue as a EU member; two, exiting theEconomic and Monetary Union, also for a certain time, but kee-ping the euro as dual currency circulation with their own currency. Politicians now understand better than in the past that, for thefeasibility of the monetary union in the long term, we need robustand resilient foundations to prevent external shocks of offer and 117
  • 22. The European Crisis and the challenge of efficient economic governancedemand, both from outside and from inside (which in some way oranother will happen again). It is not enough to have a determinedcommon monetary policy dealt with by a competent European aut-hority with aims of stability and orderly functioning of inter-bankmarket. This is only one of the required conditions. Two further fun-damental conditions are inexorable for the context of national eco-nomic policies:• On the one hand, there must be some rules on behaviour in bud- getary and economic policy compatible with the efficiency crite- ria in the allocation of production factors and with growth and employment aims. The problem of “moral hazard” must be totally eliminated.• On the other hand, there must be unconditional willingness of the governments to observe these rules and act according to them. There must be a clear division of work and responsibility between the governments and the ECB. Indeed, efficient European governance means the transfer of thenational sovereignty to the European Union in budgetary mattersand in areas essential to the real economy. This would entail a qua-litative leap in the process of integration. The three pillars of the new architecture are:• The Euro Plus Pact (approved at the European Summit of 24-25 March 2011, with immediate effect);• The Fiscal Stability Pact (approved at the European Summit on 1st March 2012, with the exception of the United Kingdom and118
  • 23. The Future of the Euro the Czech Republic, and estimated to come into force, after rati- fication by the national parliaments, on 1st January 2013);• The Macro-economic Governance Pact (approved by the European Parliament in September 2011 and ratified by the European Council, which is in force already). The three Pacts complement one another. Without quality ofpublic finances there will be no appropriate economic growth (“dis-trust effect”), but without economic growth it will be impossible tohave organised public accounts (“tax collection weakness effect”),and with no macro-economic balance growth will be slower (“effectof inefficiency in the allocation of production factors”).5.1. The Euro Plus Pact, it is not binding on anyone This Pact is based on right diagnosis: the potention of growth insouthern countries and the capacity to create employment (to a gre-ater or lesser extent) are low owing to the persistence of negativenational factors: non-qualified labour, insufficient technologicalinnovation in companies, over-regulation of the labour market andof various services, inefficient bureaucracy, deplorable tax fraud andcorruption. For this reason, structural reforms in the economy andthe institutions are so necessary. The governments of the countries of the euro area have under-taken to implement it; other six countries of the EU have also 119
  • 24. The European Crisis and the challenge of efficient economic governance undertaken this commitment (for this reason the term “Plus” has been added to the name of the Pact).6 The scope of action that the Pact contemplates affects the labour market, the educational sys- tem, the environment for research, the tax system and a long etce- tera. All this is praiseworthy. But the main problem of the Pact is that it gives full freedom to the governments to take the measures that they deem appropriate and not to take others that would also be necessary from an objec- tive point of view. There is no sanction in case of lack of strictness. Therefore, this pillar of economic governance of the euro area does not offer security. 5.2. The Fiscal Stability Pact, a test of nine Rightly, the inexorable key is the commitment from the govern- ments to maintain orderly and balanced public finances in the future. This is no dogmatic approach (“neoliberal”, as some call it pejo- ratively), but it is the consequence of an economic analysis, sup- ported by theory and empirical experience. Government deficit must be limited, owing to the “Domar condition”, according to which, for reasons of assignative efficiency, long-term interest rates6 European Council, Conclusions 24/25 March 2011, Annex I: The Euro Plus Pact –Stronger Economic Policy Coordination for Competitiveness, Bruselas, 25/3/11 (EUCO 10/11,CO EUR 6, CONCL 3). 120
  • 25. The Future of the Euromust be higher than the economic growth rate. With no ceiling forgovernment deficit sooner or later we reach a point from which thefinancial expenditure of the State (for servicing the debt) increasessubstantially, which progressively reduces the room for manoeuv-re of the government to seek its economic and social aims. Thelevel of public debt must be limited because of the“Reinhart/Rogoff rule”, derived from econometric studies, whichestablish a critical threshold of 90% of GDP, from which the secu-lar economic growth rate may diminish at least half a percentagepoint per year for three reasons: one, because public debt servicingreduces the margin for productive investment of the State (infras-tructures); two, because payment of interest to foreign creditorsreduces available national income and, therefore, the capacity ofconsumption of households; and three, because the need to re-finance sovereign debt makes financing of private companies incapital markets difficult (“expulsion effect”). The Ltmus test is characterised by strictness under which thegovernments deepen in budgetary consolidation. Despite the factthat in different countries of the euro area some measures invol-ving tax adjustment have been taken already, public finances arenot consolidated at all. According to the European Office ofStatistics (Eurostat), government deficit is excessive (more than3% of GDP) in most of the countries, also in Spain (2011: 8.5% ofGDP). Germany (1%) and four small countries (Estonia, Finland,Luxembourg and Malta) are the few exceptions. Most of thegovernment deficits are structural, in other words, not cyclic but 121
  • 26. The European Crisis and the challenge of efficient economic governance permanent, and, therefore, destructive for the good functioning of the economy. The level of public debt is also too high (higher than 60% of GDP) in almost all the countries, including Germany (2011: 81.2%) and France (85.8%) and now also Spain (68.5%), for the first time since 2011, Spain (68%). Where public debt greatly exceeds all acceptable levels according to the “Reinhart/Rogoff rule” is in the three countries that have been rescued (Greece, Ireland and Portugal) and in Italy. For the latter country, however, there is a differentiating factor in its favour, most of the public debt is internal and, thus, its servicing may be managed directly with its own instruments (by increasing fiscal pressure on its citizens). As mentioned above, the rules on sustainability of public finan- ces as set forth in the Treaty of the European Union and in the SGP have not been efficient to impose budgetary discipline. Its applica- tion has been highly politicised. The mechanisms of penalisation have never been implemented. The new Fiscal Pact has been arran- ged in such a manner that it could put the screws, firstly, on the euro countries on which the agreement is binding.7 The most important advances as regards the SGP, for the moment only on paper, are the following three: • Firstly, the seriousness of government deficit is explicitly ack- nowledged when it is structural. The explicit ceiling established7 European Council, Treaty on Stability, Coordination and Governance in the Economic andMonetary Union, 2/3/12, artículos 3-8. Internet: http//:eur-lex.europa.eu. 122
  • 27. The Future of the Euro is 0.5% of GDP, maintaining the threshold of 3% for total defi- cit. There is thus a large margin for the operation of “automatic stabilisers” in the economic cycle and for discretionary govern- mental measures if there is recession.• Secondly, the aim of limiting the level of public debt at 60% of GDP through a procedure which, if the debt exceeds this per- centage, may activate the supervisory mechanism for “excessive government deficit”, even if the deficit is below 3% of GDP. The country in question shall be forced to reduce it at an average rate of one twentieth per year as a benchmark (“1/20 clause”).• Thirdly, the obligation for each member country to define its medium-term budgetary objective (MTO), quantifying an indi- cator for public expenditure evolution and making sure that the estimated expenditure shall be financed by sustainable income (“golden rule” of budgetary balance). If a country does not orga- nise its budgets in a balanced manner it will be required by the European Commission to submit new budgetary plans. If the new rules are important, a mechanism to enforce them isequally important. The most relevant three new elements are thefollowing:• First, continuous supervision of the policies applied in both summits of the euro area has been devised (two per year, at least, called and chaired by the President of the EU, currently Herman Van Rompuy).• Second, there is a change in the decision process on financial sanctions (of up to 0.2% of GDP) in case of breach and non-ful- 123
  • 28. The European Crisis and the challenge of efficient economic governance filment of the specific recommendations to remedy the situa- tion in the sense that a proposal of the European Commission is considered approved if the Council of the Heads of State and Government of the euro area does not vote against it with a qua- lified majority (until now such a majority was required for the European Council to approve the sanction). Therefore, there will be less room for political maneuvre to prevent the fine (as it was normal in the past after the Schröder/Chirac precedent mentio- ned above). The sanctions are not totally automatic as one would like them to be, but they are moving in that direction. Furthermore, they have a broader scope than before, because the manipulation of fiscal statistics shall also be punished.• Third, the obligation for each member country to transpose the fiscal stability rule into its national legislation is established and, therefore, be explicitly responsible for its fulfilment. The Court of Justice of the EU shall ensure its fulfilment. For the States to decide the medium-term budgetary stability(equivalent to the economic cycle), the most credible formula is toconstitutionally estabish a ceiling for structural government deficit.Germany has already done it (0.35% of GDP for the central govern-ment, from 2016, and cero deficit for the federal states, from 2020).Spain is moving in that direction after the reform of article 135 ofthe Constitution at the end of the previous term of office and therecent approval of the Budgetary Stability Law which will requirefrom 2020 cero structural deficit to the public authorities (whichcould be up to 0.4% of GDP in exceptional circumstances). Other124
  • 29. The Future of the Eurocountries are moving in that direction. The advantage of a consti-tutional rule as regards de margin of debt of the government is that,if a country incurs deficit and constitutional breach, it will need bet-ter arguments for its society than if it only needs to be explainedbefore the Community authorities and take there the relevant war-nings; Brussels is “far” and it is “under suspicion” of meddling innational affairs. The Fiscal Pact will only work if the euro area countries arewilling to do without most of its sovereignty in budgetary matters,which will be transferred to Community institutions. Obviously,this affects the main prerogative of national parliaments, which isto shape the budgets of the State and decide how to finance expen-diture. This will meet great opposition, in all the countries. It is nota trivial matter that the Fiscal Pact must be institutionalisedthrough an inter-governmental agreement, that is to say, a levellower than the Treaty of the EU, which reform would have requi-red the unanimous approval of the twenty-seven, which was notreached. This procedure has opened in the legal field a debate todecide if the procedure chosen is compatible with CommunityLaw, specifically in relation to the mechanisms of sanctions forexcessive government deficit as set forth in article 126 of theTreaty. For European leaders to have lowered the quorum requiredfor parliamentary approval of the inter-governmental agreement isnot a trivil matter either, to 12 of the 17 States that form part of theeuro area. Could it be that some partners are not reliable? It is truethat it has been decided that the countries that do not ratify the 125
  • 30. The European Crisis and the challenge of efficient economic governancePact and transpose to their national legislation the ceiling ofgovernment deficit will be excluded from possible financial bai-lout. However, is this credible, especially if the stability of the euroarea is at risk? This being so, it would be better not to be too hope-ful about this Fiscal Pact.5.3. The Macro-economic Governance Pact, with vagueparameters The same caution is advisable with regards to the solemnlyproclaimed Six Pack (so called because its content has been draf-ted through a Community directive and five regulations).Nodoby doubts that, for the feasibility of the euro area, macro-economic stability is a necessary condition (although not enoughif the requirements for an optimal monetary area are not fulfi-lled). Furthermore, it is true that macro-economic stability goesbeyond budgetary balance, as it has been proven with the recentexperience of different countries (inflationary pressure, propertybubble, excessive private sector debt, competitive weakness ofcompanies, current account imbalance, etc.). However, theEuropean Commission, the European Parliament and theEuropean Council seem to have faith in the capacity of economicpolicy to handle crucial factors in the real economy. This ishighly questionable. An alert mechanism scoreboard was created for the appearanceof internal and external imbalances in the countries, which will be126
  • 31. The Future of the Euromanaged by the European Commission based on ten parameters,as follows: 8• Internal imbalance parameters: evolution of unit labour cost, unemployment rate, private sector indebtedness, credit to the private sector, evolution of property prices and government indebtedness.• External imbalance parameters: surplus and deficit of current account balance, net international investment position, change of export market shares and change of the real effective exchange rates of the euro. For these parameters, critical thresholds have been established,from which the alarm would be triggered, and this would start aprocedure to analyse the causes in order to decide from Europe ifcorrective measures need to be taken or not. For instance, for unitlabour costs the threshold is an increase of 9% in three years, forunemployment rates it is 10% of the workforce as a three-year ave-rage or for current account balance the threshold established is 3year backward moving average of the current account balance as aper cent of GDP, with a threshold of +6% of GDP (surplus) and -4%of GDP (deficit). If there is excessive imbalance, the EuropeanCommission will make the relevant recommendations for thegovernment of the country in question to remedy the imbalance; incase of non-fulfilment, a fine may be imposed (up to 0.1% of GDP).8 European Commission, EU Economic governance “Six Pack“ enters into force,MEMO/11/898, 12/12/2011. 127
  • 32. The European Crisis and the challenge of efficient economic governance The thresholds set are not a consequence of a detailed economicand empirical analysis that may indicate for sure when an imba-lance is excessive for a country and negatively affects the euro areaas a whole. The numerical values rather represent the perception ofpoliticians of the recent events; therefore, they are, unavoidably,arbitrary. But the fundamental question is different: How can agovernment act efficiently? We must remember that the EU proposes an open market eco-nomy with free competition (article 119 of the Treaty of the EU). Alleuro countries have this concept of economic system, some becau-se of the Ludwig Erhard tradition (Germany), and others with reser-vation in favour of the government (France). In a market economy,the government lacks the instruments to control the variables con-templated in this Macro-economic Governance Pact. Therefore, thegovernments should activate a series of interventionist measures,with no guarantee of their efficiency and with a high risk of distor-ting efficiency in the allocation of production factors. In a marketeconomy, responsibilities are distributed in a different way: for levelof employment, social partners (unions and employers); for exportdevelopment, private companies (technology); or for grantingloans, commercial banks (based on the appropriate risk estimate).The current account balance, among other things, represents thesaving trend rooted in society and objective conditions for fixedcapital investment (as explained by the “macro-economic equa-tion” and the “Böhm-Bawerk theorem”). Unions will not acceptgovernment interference in the negotiation of collective agree-128
  • 33. The Future of the Euroments and companies will not stop being creative or innovative inorganisational management and product development for whichelasticity-income of international demand is higher than the unit,and banks will not neglect their classical business, which is to pro-vide credit to companies and households. This economic governance project has no clear future. In thebest-case scenario, the new Summits of the euro area would havematters to discuss. The countries in which the economy works wellcould be taken as a benchmark for the others to rectify their struc-tural deficiencies and improve their productive and competitive-ness levels. In the worst-case scenario, the euro area would be expo-sed to continuous political conflicts, which would not promoteeconomic growth with high employment. It is so easy, and espe-cially politically profitable in countries with domestic problems, tolook for the villain abroad, maybe Germany?Conclusion The sovereign debt crisis has had a healthy effect in convincingpoliticians that by providing liquidity to governments and banksthe stability of the euro area will not be attained in the mediumand long term. The quality of the economic policy must improvein the countries, there must be impeccable follow-up by indepen-dent institutions to weigh up the economic and fiscal situation andit must be guaranteed that national accounts and other relevantstatistics are arranged under utmost scientific accuracy at all times. 129
  • 34. The European Crisis and the challenge of efficient economic governance If in all the euro countries the governments understand thatsound public finances and application of structural reforms is theirresponsibility and if they act seriously according to them, no Statewill have to rescue another State because of over-indebtedness andwaste, and the ECB may stop indirectly financing States and focusmore on its task, ensuring stability in price levels in the euro area.The ESM fund would be reserved to emergency situations caused byexternal factors beyond the government’s control. The Fiscal Pactwould have fulfilled its mission and the Euro Plus Pact would befilled with efficient contents. We would not need to resort to mar-ket interventionism as entailed with the Six Pack. If, on the contrary, there is no determination in the membercountries, any attempt of European economic governance wouldresult more from proactive intentions than harsh reality. The euroarea would have an uncertain future. The alternative of a EuropeanPolitical Union, in which all necessary economic policies could beundertaken from a Community Executive under the control of theEuropean Parliament, with all democratic rights, cannot be seen onthe horizon.130

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