Wolfgang Munchau of the Financial Times has the best analysis of the recent policy dispute in Euroland.
Why the stability pact is irrelevant
That was in 1998. Not much has changed. The French and the Germans have once again been discussing whether sanctions should be automatic or not. And central bankers are just as furious. For Jean-Claude Trichet to issue an official note of disagreement – after European Union finance ministers last week drafted a watered-down sanctions package – is extraordinary on several levels. The president of the European Central Bank had demanded a great leap forward. But the French and the Germans are not leaping. They go round in circles. Since the start of the euro, the world has suffered its worst financial crisis ever and the worst recession in 70 years – and the eurozone’s political leaders are still obsessed with the minutiae of the stability pact, which is supposed to police government debt and budget deficit levels.
The real irony is that the pact, in whatever form, is not even relevant to the eurozone’s future. This may be a shocking statement. But look at the evidence. Contrary to popular narrative, fiscal profligacy played only a minor role in the eurozone’s sovereign debt crisis. Successive Greek governments cheated, but on my information, this occurred with at least partial knowledge of the senior European officials involved in the process. They chose not to apply the pact for political reasons. When the full extent of the Greek deficit became public in the autumn of 2009, EU leaders did not want to impose sanctions on a newly elected government. Everybody wanted to give George Papandreou, the Greek prime minister, a last chance. That turned out to be a good decision.
As for Spain and Ireland, they did not breach the rules ever, and would thus never have been subject to sanctions, automatic or otherwise. Even Ireland’s shockingly large projected deficit of 32 per cent of gross domestic product this year will not be a breach. Ireland’s bank bail-out is considered an exceptional circumstance, and not subject to the pact’s sanctions procedure.
Portugal exhibited persistent bouts of fiscal profligacy, but the real problem, again, was the banks. In all three countries, the crisis was caused by private sector imbalances, which far outweigh the relatively small discrepancies between national budgets. Germany may appear a paragon of virtue, but its debt-to-GDP ratio is close to that of France. It is larger than Spain’s and only a little lower than Portugal’s. But Germany’s pre-crisis 8 per cent current account surplus and Spain’s 10 per cent current account deficit were large and real. They have improved, but on the projections I have seen, are deteriorating again.
So if you really want to fix the eurozone’s problem, the pact is not the place to start. Obsession with it does not come out of concern for the eurozone’s future, but from an inter-institutional battle in Brussels.
What about the various proposals on macroeconomic surveillance, including that of the task force chaired by Herman van Rompuy, president of the European Council? He is proposing an early warning system, in addition to the already agreed European Systemic Risk Board. At the very least, one would expect all those new rules and institutions to pass the hindsight test. Had they been there 10 years ago, would they have prevented the Spanish or the Irish housing bubble? I cannot see how. Would José Luis Rodríguez Zapatero, Spain’s prime minister, have really imposed bubble-bursting real-estate taxes, after receiving a high-level delegation from Brussels or Frankfurt? Of course not. There can be only two explanations for Mr van Rompuy’s hubris about his macroeconomic surveillance proposals. Either he is naive, or he has a different agenda.
What about the proposed crisis resolution mechanism? When Angela Merkel, the German chancellor, gave ground last week on automatic sanctions, she gained the concession from Nicolas Sarkozy, the French president, that he would support Germany on crisis resolution.So the €440bn European Financial Stability Facility, set up in May to support eurozone countries with funding difficulties, will not be renewed. In 2013, it will be replaced by a tough crisis resolution mechanism to address the logical inconsistency of a system that rules out exit, default, and bail-out. The Germans continue to support the no bail-out principle; and have accepted that you cannot force a state to exit against its will. This leaves default. Having been very pessimistic on the default-probability of eurozone states, global investors may now be too optimistic again. If Ms Merkel gets her way – and I think she will – this means the eurozone’s future crisis resolution mechanism will be based on default.
The eurozone thus ends up with tough rules, poor implementation, no effective framework to deal with private sector imbalances, and an officially instituted mechanism that encourages default. The crisis was obviously not big enough to bring about genuine policy change. If, or rather when, that next crisis comes, it will probably be too late.
That was in 1998. Not much has changed. The French and the Germans have once again been discussing whether sanctions should be automatic or not. And central bankers are just as furious. For Jean-Claude Trichet to issue an official note of disagreement – after European Union finance ministers last week drafted a watered-down sanctions package – is extraordinary on several levels. The president of the European Central Bank had demanded a great leap forward. But the French and the Germans are not leaping. They go round in circles. Since the start of the euro, the world has suffered its worst financial crisis ever and the worst recession in 70 years – and the eurozone’s political leaders are still obsessed with the minutiae of the stability pact, which is supposed to police government debt and budget deficit levels.
The real irony is that the pact, in whatever form, is not even relevant to the eurozone’s future. This may be a shocking statement. But look at the evidence. Contrary to popular narrative, fiscal profligacy played only a minor role in the eurozone’s sovereign debt crisis. Successive Greek governments cheated, but on my information, this occurred with at least partial knowledge of the senior European officials involved in the process. They chose not to apply the pact for political reasons. When the full extent of the Greek deficit became public in the autumn of 2009, EU leaders did not want to impose sanctions on a newly elected government. Everybody wanted to give George Papandreou, the Greek prime minister, a last chance. That turned out to be a good decision.
As for Spain and Ireland, they did not breach the rules ever, and would thus never have been subject to sanctions, automatic or otherwise. Even Ireland’s shockingly large projected deficit of 32 per cent of gross domestic product this year will not be a breach. Ireland’s bank bail-out is considered an exceptional circumstance, and not subject to the pact’s sanctions procedure.
Portugal exhibited persistent bouts of fiscal profligacy, but the real problem, again, was the banks. In all three countries, the crisis was caused by private sector imbalances, which far outweigh the relatively small discrepancies between national budgets. Germany may appear a paragon of virtue, but its debt-to-GDP ratio is close to that of France. It is larger than Spain’s and only a little lower than Portugal’s. But Germany’s pre-crisis 8 per cent current account surplus and Spain’s 10 per cent current account deficit were large and real. They have improved, but on the projections I have seen, are deteriorating again.
So if you really want to fix the eurozone’s problem, the pact is not the place to start. Obsession with it does not come out of concern for the eurozone’s future, but from an inter-institutional battle in Brussels.
What about the various proposals on macroeconomic surveillance, including that of the task force chaired by Herman van Rompuy, president of the European Council? He is proposing an early warning system, in addition to the already agreed European Systemic Risk Board. At the very least, one would expect all those new rules and institutions to pass the hindsight test. Had they been there 10 years ago, would they have prevented the Spanish or the Irish housing bubble? I cannot see how. Would José Luis Rodríguez Zapatero, Spain’s prime minister, have really imposed bubble-bursting real-estate taxes, after receiving a high-level delegation from Brussels or Frankfurt? Of course not. There can be only two explanations for Mr van Rompuy’s hubris about his macroeconomic surveillance proposals. Either he is naive, or he has a different agenda.
What about the proposed crisis resolution mechanism? When Angela Merkel, the German chancellor, gave ground last week on automatic sanctions, she gained the concession from Nicolas Sarkozy, the French president, that he would support Germany on crisis resolution.So the €440bn European Financial Stability Facility, set up in May to support eurozone countries with funding difficulties, will not be renewed. In 2013, it will be replaced by a tough crisis resolution mechanism to address the logical inconsistency of a system that rules out exit, default, and bail-out. The Germans continue to support the no bail-out principle; and have accepted that you cannot force a state to exit against its will. This leaves default. Having been very pessimistic on the default-probability of eurozone states, global investors may now be too optimistic again. If Ms Merkel gets her way – and I think she will – this means the eurozone’s future crisis resolution mechanism will be based on default.
The eurozone thus ends up with tough rules, poor implementation, no effective framework to deal with private sector imbalances, and an officially instituted mechanism that encourages default. The crisis was obviously not big enough to bring about genuine policy change. If, or rather when, that next crisis comes, it will probably be too late.
