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“Europe” is in crisis and the results will eventually be profound for the relationship of nearly 500 million people (and 22% of world GDP) with the rest of the world. The euro may only be 10 years old, but it is the direct result of a political process that began soon after World War II. It is almost exactly 60 years ago that the then French foreign minister Schuman made his famous Declaration “Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity. The coming together of the nations of Europe requires the elimination of the age-old opposition of France and Germany.”
The “concrete achievements” since then include the creation of a single market in 1992 and then the introduction of the euro as the single currency for most EU members in 1999. When financial commentators talk glibly about the possible disintegration of the euro, they may not be thinking deeply about the full implications if such a process were accompanied by a fracturing of this carefully nurtured relationship between France and Germany. There is an alternative outcome to a fracturing: could the crisis instead lead to a deepening of the relationship that would run well beyond France and Germany and include all members of the eurozone?
The crisis has developed well beyond the problems triggered by importing securities backed by sub-prime US mortgages. However, that did precipitate a banking crisis that has required a massive back-stop of public spending, and thus debt, to prevent a slide into a lengthy recession. It is that notching up of debt that has illustrated the unresolved tensions about the conduct of economic policy that is now proving so painful and divisive. At the onset of the first Oil Shock in the 1970’s, public debt/GDP ratios were just over 30%. Forty years later, they will have nearly tripled to 88% in 2011 – according to the European Commission.
Yet EMU was meant to be founded on policies of fiscal caution that were written twenty years ago to prevent exactly this situation happening: a maximum public deficit of 3% of GDP, public debt ratios should be declining to less than 60% and there was a “no bail-out” rule precisely to remove the risk that Germany would have to pay off the debts of other countries – for example Greece was often talked about, even at that stage! Despite the good intentions of the founding fathers, we have just witnessed a frantic weekend of negotiations in mid -May that concluded by announcing:
"The Council and the Member States have decided today on a comprehensive package of measures to preserve financial stability in Europe…we have decided to establish a European stabilisation mechanism. The mechanism is based on … an intergovernmental agreement of euro area Member States. Its activation is subject to strong conditionality…euro area Member States stand ready to complement such resources … guaranteed on a pro rata basis by participating Member States … up to a volume of € 440 billion…..At the same time, the EU will urgently start working on the necessary reforms to complement the existing framework to ensure fiscal sustainability in the euro area..”
Has the pressure of the crisis tipped the 330 million people of the eurozone (and 16% of world GDP) into a tighter union? There is much media discussion about the opposite result – some countries leaving the euro. Under the existing Treaty, there is simply no provision for that, so a country would have to leave the EU as well. That would require a unanimous decision of the 27 members to change the Treaty. In the meantime, anxious depositors would have plenty of time to remove their deposits from banks in any states that might leave. The natural consequence of a collapse of all banks in those states may deter politicians from going down that route. Austerity may be preferable – even if unpleasant.
But a watershed does seem to have been crossed as support was offered to Greece in return for a dramatic tightening of fiscal policy – cutting the budget deficit from 14% of GDP to less than 3% in three years. …hardly a bail-out in the usual sense of a gift! Spain and Portugal were also obliged to offer further fiscal cuts and Italy felt it prudent to do so as well. Schuman’s “de facto solidarity” concept seems to have been fulfilled financially on this occasion but there is a clear price: economic “co-ordination” within the eurozone that will be toughened up substantially to stop this happening again.
The European Commission quickly proposed a "European Semester" for economic – not merely fiscal - policy coordination. Member States would undertake “early coordination at European level as they prepare their national budgets”, thus integrating fiscal policies. But there would be more: “beyond fiscal surveillance, it means a broadening of economic surveillance to the prevention of macroeconomic and competitiveness imbalances … For euro-area Member States it is proposed to upgrade the peer review of macroeconomic imbalances now carried out by the Eurogroup into a structured surveillance framework”.
The heart of the problem lies in the loss of competitiveness of some euro Members who were unwilling to recognise that removing the currency constraint meant they had to conduct a wide array of policies (for example on labour market flexibility) that matched their competitors in the euro area – quite apart from globally. All these policies will now be subject to “structured surveillance” by the eurozone – if the members accept the Commission proposals.
For countries such as Greece and Portugal, this loss of competitiveness showed up as current account deficits above 10% of GDP. These had to be financed by both the public and private sectors taking on huge foreign debts that were bound to become unsustainable eventually. It was the holders of those debts who then cried out for protection in the depth of the crisis. The failure of those lenders could well have triggered a further credit contraction in the rest of the eurozone – and thus another downward twist of the economic spiral.
So the integration of a single financial market emerges as a critical factor: should the EU move towards “more Europe or less” in this field? By co-incidence, former Commissioner Mario Monti published his report on a “new strategy for the single market” in the middle of the crisis. He argued that “The single market for capital and the closely interrelated single market for financial services are critical for the efficient allocation of resources - a key driver of growth and employment - and for the stability of the economy.” He pointed out that the EU is already committed to far-reaching reform as part of the G20 process and said “It would be a serious strategic mistake if the Council… were to favour timid solutions.”
This intervention comes at a critical juncture for the debate on regulatory reform as the proposals derived from the De Larosière Group’s report are now about to be finalised. The Commission proposal would move some regulatory powers to the European level, but the ECOFIN Council – the Member States – cut these back radically. However, the new Lisbon Treaty in now in force and gives co-legislative powers to the European Parliament. Their committee (ECON) has just voted “to beef up the financial supervisory package - well beyond Council proposals”. Both Council and Parliament must agree an identical text for it to become law, so we now add in a constitutional clash as well as an economic and financial crisis.
There is a dimension to this that poses particular problems for the country that hosts the largest financial market in Europe – the United Kingdom. It is not in the eurozone and thus would be outside any of the new arrangements for the co-ordination of the generality of economic policies. After the recent election, the Coalition Agreement specified “The Government believes that Britain should play a leading role in an enlarged European Union, but that no further powers should be transferred to Brussels without a referendum.” Under such a formula, Britain may find it very difficult to accept the likely compromise on shifting some financial regulatory powers to new European level bodies.