The general lines of the policies have been clear since May 2010 (and earlier) so the expectation must be that these established lines will be pursued with greater intensity and will be taken to a sufficient, logical conclusion. Remarkably, commentators and markets remain ignorant of the profound changes in economic governance that were launched then, and which are now in operation.
Commentators still prefer to focus on the part of policies labelled "austerity" and overlook the push to restore competitiveness across the whole euro area – but especially urgently in the programme states. A boost to productivity is what will create growth for the long-lasting future – not piling up more public debt. Naturally, restraint on public deficits is at the heart of the policy but the mechanisms include far-reaching structural reform in areas such as the labour market. In practice, the policy content of EU programmes is now tougher than those of the IMF – but completely un-recognised by financial markets or politicians. So the whole euro area is effectively in an IMF-style programme designed to enhance its competitiveness.
Many building blocks of an economic, financial and now political union of the euro area are dropping into place including completing the Single Market, especially in financial services – the delivery mechanism of the currency itself. However, the essential new ingredients creating a genuine euro area political union are the economic governance measures which are giving a collective oversight of the national economies – with powerful sanctions for misbehaviour.
In searching for further building blocks, leaders are dropping taboos. After a decade of breaches of rules - and thus of trust - amongst nations, these plans must set out a delicate sequence of actions that credibly take the euro area to its medium-term goals. Part of that sequence is re-building trust step by step – but in a way that is politically realistic.
Commentators blithely call for mutualisation of public debt and something called a "banking union". What would be the real implications of such policies for Member States? As an example, France has an annual GDP of €2 trillion; so mutualising all euro area public debt would expose France to guarantees that would be more than four times its GDP. Some argue that the bank deposits of euro area residents should be guaranteed and mutualised - amounting to a further €17 trillion on the shoulders of French taxpayers. It is difficult to infer that French electors have just voted for such a dramatic burden. Nevertheless they certainly showed their willingness to take some steps in that direction.
The scene is now set for radical change within the euro area to ensure its survival. A general break-up of the euro would inexorably break up the single market in financial services almost immediately, the goods markets would not be far behind and the European Union itself would become an empty shell. So the euro area must find a set of political balances acceptable to the wide spread of electors – after a proper explanation of the risks of the alternatives. But the end-point of the process will not be a European replica of the United States of America as there is no democratic mandate for such an outcome.
The key test facing the Heads of Government is to create - by late June - a financial bridge from the current situation until the fruits of current policies boost competitiveness and growth becomes fully apparent. The problem is how to rebuild trust amongst the nations – not only between the current generation of political leaders but in a way that they can explain to their voters as being structured to be binding on future leaders.
So the process requires a series of steps that could include these three proposals to restore confidence, and allow time for the drive to restore competitiveness to bear fruit:
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Financial linkages could include a temporary and targeted mutualisation of some public debt, but time/volume limited to maintain discipline. Limited mutualisation of short-term debt through a temporary euro Treasury Bill Fund (the European League for Economic Cooperation proposal) - is designed to maintain powerful pressure on politicians for continuing economic reform. It keeps separate the past debts run up under the sole authority of individual Nation States from future, modest debts which would only be incurred by joint agreement. The volume limitation could well be set at around 15 per cent of GDP, far below the larger commitments implied by many of the eurobond ideas. At five times the size of the US TARP, the Fund would have global clout.
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A banking union limited to the 30-40 banks that are genuinely systemically important to the euro area (E-SIFIs): apply Basel III only to these banks, move their supervision to Europe and empower the ESM (i) to backstop a pre-funded deposit guarantee scheme for them, and (ii) eventually to re-capitalise them if necessary.
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Reform financial regulation to take proper account of the fragile/risky nature of public debt in a world of PSI – default in ordinary terms - given its new leverage to the economic outlook.
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© Graham Bishop
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