24 April 2019

Jacques Delors Institute: Five reasons why the ESM reform will fail to deliver

Lucas Guttenberg argues that while the planned reform of the European Stability Mechanism (ESM) is necessary to finally bring home the backstop for banking union, it clearly falls short of its initial ambition to also substantially improve the Eurozone’s crisis management framework.

In December 2018, the Euro Summit agreed a term sheet on how to reform the European Stability Mechanism (ESM). In June this year, the summit is due to endorse concrete changes to the ESM treaty. The debate on reforming the ESM was triggered for a rather narrow reason: the necessity to re-open the ESM treaty to include a backstop function for the Single Resolution Fund to finally make headway towards completing banking union.

But once the debate had started, ambition became plentiful in particular in some member states to attach to the backstop a comprehensive reform of the ESM: a new “European Monetary Fund” would finally make Europe independent of US influence in the International Monetary Fund (IMF). By addressing the main remaining gaps, the reform would turn the arrangements quickly built during the crisis into a more stable and sustainable crisis-management architecture.

Before diving into the matter, one point of clarification is necessary: We often have a potential crisis in Italy in mind when we discuss Eurozone crisis management and possible reforms thereof. But looking at the sheer size of the Italian economy and of its outstanding debt, it seems unlikely that the ESM – neither in its current nor after any of the possible reforms – with its large, yet limited, volume would be the weapon of choice in such a crisis. Arguably, in such a situation the ECB would be the only institution with the necessary resources.

So when we talk about ESM reform, Italy is not the scenario we should have in mind. Instead, there are two central scenarios for which the ESM was built and which should be the benchmark for judging any potential reform paths to ESM: First, a small- or medium-sized member state loses market access on its own. Second, one or several of these member states are an innocent bystander affected by contagion coming from another member state.

As argued before, ESM reform is not a silver bullet that can solve all the problems of the Eurozone. Yet the backstop has opened a window of opportunity to substantially improve the Eurozone’s capacity to resolve crises in the future. As I will argue in this policy brief, this opportunity is very likely to be missed – indeed the planned reform might make matters worse in some areas. There are five main reasons for this:

1. As unanimity remains the main decision-making mode, the reform does not change the fact that crisis-management remains highly dependent on the political mood in member state capitals.

2. The reform does not remedy the problem that contagion coming from large member states is hard to contain under the current decision-making procedures.

3. The reform effectively removes precautionary lending from the ESM toolbox.

4. The reform does not clarify how the Eurozone plans to deal with unsustainable public debt in the future.

5. The reform charges ESM staff with new tasks but does not change its internal structure and accountability channels accordingly.

Full policy brief