Will the Eurozone Be Able to Align National Interests?

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Yves here. We ran an earlier post by Ashoda Mody, he argued that Eurozone was failing in resolving its recurring crises successfully. That is a coded way of saying that the odds of breakup are rising. Needless to say, that view elicited a lot of commentary from his readers. Mody addresses their reactions and objection below.

By Ashoda Mody, Charles and Marie Robertson Visiting Professor in International Economic Policy at the Woodrow Wilson School, Princeton University. Originally published at Bruegel.

In my opinion published on Friday, I argued that a growing east-west divide, a core-periphery rift, the rise of extremist parties and the adoption of extremist rhetoric and their policy agenda by the mainstream parties are reshaping the concept of Europe. This received some extremely interesting comments which I would like to address.

The comments raise some very important issues both of analysis and for thinking about the scenarios that lie ahead. It is true that there was an alternative to the “falling forward” theory of completing an incomplete monetary union and it was, indeed, the “crowning” vision. That “crowning” view, espoused mainly by the Germans and the Dutch, believed that the monetary union would come after a political union—as the crowning achievement of an economically and politically-integrated Europe.

At the inter-governmental conference at Maastricht in December 1991, Chancellor Helmut Kohl, who had signed on in principle to the introduction of a common currency, went with the presumption that no date would be set for introducing the euro because his advisers had said that the preconditions for a monetary union were not in place. At Maastricht, the matter was apparently discussed by Chancellor Kohl with the French President Francois Mitterrand and Italian Prime Minister Giulio Andreotti. The leaders emerged from that meeting with a target date. The French and the Italians, at least implicitly, therefore favored and adopted the “falling forward” view of European monetary integration. And thus it came to be the guiding vision.

However, at Maastricht or later, no path to achieve the “falling forward” was discussed or even outlined. It was always a presumption that it would happen, possibly when the structure was tested by crises. But even among French technocrats, there was an unease with the falling forward presumption. The Frenchman, Robert Marjolin, one of the great eurocrats of his generation—and the man most responsible for pushing the trade integration agenda after the Treaty of Rome in 1957—warned in his memoirs in 1986 that there was no mechanism that ensured the forward movement of integration. Not surprisingly, German and Dutch authorities, especially the central bankers, were even more skeptical of this view.

The key stumbling block to falling forward has always been achieving an alignment of national interests with European interests. The original goals of integration—to achieve peace and greater trade among the member states—naturally led to an alignment of national and European interests, achieved with some give and take. But with monetary integration, this alignment always required breaking a fundamentally-new barrier. And that is the sharing fiscal sovereignty—or, seen, in politically-crude terms as “paying for the mistakes of other countries.” When the crisis came in 2008, the moment to test the likelihood of such a compromise was presented.

The resistance to sharing fiscal sovereignty has manifested itself in many forms. Overarching proposals such as Eurobonds flashed brilliantly on the horizon for a brief moment only to fade away quickly. Scaled-down versions have been in discussion—including sharing the burden on unemployment insurance. The most promising of these is the banking union. But if the logic of aligning national and European interests is applied to the banking union, we see a compromise that stops short of pooling financial resources. A common supervisory system will help impose greater discipline on banks. But a common deposit insurance system has been ruled out and the proposal for a common resolution fund anticipates that it will be financed over time with levies on banks. If we follow the evolution of the proposed levies, we are led back once again to this relentless logic: there are clear differences across countries on how the burden of the levies will be borne—specifically, what rates will be applied to ensure that the funds being generated do not impose a greater burden on one country to the benefit of another. The financial transactions tax, proposed some two years ago, faded in exactly such an intractable dialogue. Perhaps, the banking union levies will be more successful and perhaps they will prove to be the leading edge that change the dynamics of protecting national interests. Time will tell.

Until then, the shock absorption mechanisms in the system appear to rely entirely on country austerity. By now, I believe, it is widely-agreed that an austerity-only policy is economically and politically untenable. But the framers of the Maastricht Treaty did open up one further possibility. And that was the so-called “no bailout clause.” That provision said that one member state or the Union would not take on the financial obligations of another member state. And, as such, it was presumed that the distressed member state would not impose losses on its private creditors. Critic point out that this was always a chimera: that this disciplining mechanism never had a real chance of working. But it is worth asking why that is the case—why has it not worked?

Most commentators believe that “no bailout” does not work because markets cannot be relied on to create the necessary discipline. Some go further and say that markets are irrational, “investors are mad.” And there is some truth to that. But it is also important to recognize that policy actions contribute to this madness. For years now—and aggravated during the course of the crisis—the policy signals to investors have been mixed. Today, the clear signal to Eurozone creditors and other investors is that barring extraordinary circumstances, investors will be bailed out. This was how the Greek bailout was conducted and actions since then to ease the terms of repayment of official creditors have sent the same signal: if there is a problem, the official sector will be the first line of defense. Given the mixed signals, it should not be a surprise to anyone that investors take advantage of the ambiguity; investors’ presumption that they will be bailed out reinforces the policy obligation to do so.

To be clear, the policy task is not easy. A clear signal of “no bailout” is always hard to send. With the huge debt build-up of past years is especially difficult today. But it is also clear that if losses are not imposed on private creditors, the debt build up will continue and the financial interconnections and fragilities will continue to grow. In making unpleasant decisions today, the alternatives that lie in the future must necessarily be considered. A test case for dealing with such a trade-off between today and the future may well soon need to be faced.

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  1. Ignacio

    This is an interesting post and I would like two comment on both issues: the alignment of interests and the creditor/country bailouts.

    On the first issue, I think that Maastricht marked an inflection point in which “alignment of national interests” was no longer an objective except in the case of defense and to a lesser degree in R&D, environment and agricultural expenses. Agriculture was, in my opinion, a success story but it has been downplayed and the Common Agriculture Policy has been downgraded eversince. Maastricht stablished the view of the EU as a space for free competition and this led to an alignment of national interests with national corporations and finantial institutions. Fiscal and labor harmonization (pushed by french socialists) was forgotten and the new objective was to expand geographically the union as it has occured. Besides, with the expansion, the idea of europe integration at two velocities was abandoned.

    On the second issue, no country bailout, Maastricht is dead. Again, national interests have aligned with national financial interests and this has promoted the bailout of creditors at the expense of taxpayers of the countries in which the debt was originated. The best example was Ireland. How much private debt was nationalized to secure the creditors? If you force private debt nationalization, creditor bailout, at the exclusive expense of taxpayers in the creditor country you are creating an incentive for irresponsible financial practices while at the same time you are discouraging taxpayers and disrupting the whole fiscal system in countries that were net credit recipients. That’s a recipe for disaster and EU breaking (not eurozone breaking, I mean EU breaking).

    The European Constitution was stillborn but its spirit of free-competence space is well alive. If we don’t change that an EU breakup is inevitable.

  2. John

    If one takes a step back from what ‘could be’ by thought leaders one sees the Eurozone as nothing more than a bunch of trading partners, each country selling goods and services to their neighbours with a single currency mostly. Sure, we collaborate on other levels to a degree but in the end we are very nationalistic, with our own languages, culture, history, and….. politics, far away from goes on in Brussels or Strasbourg.

    At the national government levels, things get a bit more complex and favor the status quo of being pro EU austerity policies. National leaders have become ‘pantomime heads of state.’ Meaning, they have given up on being accountable to their citizens and use the excuse: this is what Brussels wants on decision making. Having the current EU structure shields them with excellent cover to make ‘tough choices.’ What ‘tough choices’ means is pushing awful taxes, enacting service cut backs, slashing pensions, etc on their people all the while giving tax breaks to companies, and union busting.

    By the way, our nationalist party here in Belgium, won a large majority of votes in the May elections on the platform of… you guessed it, austerity. As incredible as it sounds party leadership pushed a pro-business, budget slashing agenda. Talking to the average person on the street you come to realize why this is so. The thinking is national governments must balance their budgets like a checkbook. Deficits are not allowed. The conscience favours the pro-EU gods.

    Spain is another example of EU austerity is here to stay. PM Rajoy turned a manageable crises situation for his country to the point of blood letting and then amputation, with egging on from the usual suspects, ECB, EC and Germany, of course. As a result, depression is the order of the day for thousands of Spaniards. What is still hard to believe, even after all these years, Rajoy & parliament are constantly looking for new ways to ratchet up austerity.

    In the end, it is all about protecting creditors, Germany, Holland, et al., at the expense of millions of its citizens through austerity. What many fail to see is the behind the scenes lobby activity. Banksters have been ferocious in keeping things the way they are at the national and EU level, bank bail-outs and all. That is why countries such as Greece are forced to sell off national treasures to kleptocrats on the cheap. There is no alternative (TINA) people are told over and over. I recently witnessed a medical device company want Greek bonds as payment because they knew priority was given to kleptocrats bond holders. Moral hazard.

    Last week, Mr Van Rompuy hinted at a two-track Europe, but like other things he says, don’t count on it. The ruling elite (business and political) love things the way they are just fine. Kleptocrats rule.

    1. tongorad

      “The thinking is national governments must balance their budgets like a checkbook. Deficits are not allowed.”

      The austerity/tough choices regime has got to be one of the biggest propaganda achievements of all time. One can’t overestimate how prevalent this notion is. Trying to understand the psychological appeal of these ideas is essential IMO, for at some weird level, it’s almost as if people really want austerity. Why?

    2. Henry James

      “The thinking is national governments must balance their budgets like a checkbook. Deficits are not allowed.”

      But there is a disconnect here. Even private businesses that adhere to self-imposed standards of financial prudence and probity, and that operate in a world of externally-imposed financial constraints, understand that you need to spend money to make money, and sometimes institute aggressive growth and development strategies. Why aren’t Europeans looking at their futures in the same way? Why are they willing to accept mass unemployment and stagnation? There must be something else going on. Three hypotheses:

      1. Europeans on the whole now believe strong growth and dynamic progress were the low-hanging fruits of a golden age that is gone forever. The future is much more unexciting, bleak & stagnant – but hopefully sustainable. Persistently high unemployment and low growth are bitter facts of life in the new normal. But if we keep most of the social state together with a budgetary tight ship, we can at least keep plugging away, and avoid most of the social ills and dangers that come from a stagnating economy.

      2. Europeans are now much older on average than they used to be, and don’t have as many kids. As a result, they don’t have a lot of energy or imagination on average, at least relatively speaking and in comparison with their forbears, and don’t care all that much about the future beyond the near term, but are happy to adopt a basically conservative policy of “Well, let’s just not do anything risky or drastic; we’ll all be dead before it matters anyway.”

      3. European nationalists resent immigrants and immigration, and don’t want to make their economies all that apppealing to them. Stepping out in front of their European brethren with a national growth and progress strategy would make a country a magnet for more immigration. Along the same lines, and following on point number 2, young people are noisy and bothersome – so why pursue policies that will lead to an influx of more young people from other countries in search of a better life?

      My feeling is that one of the reasons the west is stagnating is that the current generations running the west have chosen stagnation. They willingly accept it; and even like and embrace it.

  3. The Dork of Cork

    Look in many ways this is very simple.
    The nation state destroyed localism
    Think of Paris and its role in the destruction of Languedoc culture and internal / external economy or the rise of Dublin & destruction of the Irish market town following Irish independence.
    It follows that the European market state will eat nation states.
    Of course at this point nothing much will remain.
    When the locals are all gone then the people who remain can become good little Americans where the only ties that bind are materialistic in nature. (this is the true goal of this demonic project)
    But please don’t call it European.

  4. Ignacio

    I completely agree with your analysis about how citizens have internalized that “there is no option but austerity” and this gives ground to unpopular measures. But this does not ensure that austerity has come to stay. Citizens have very different ideas of what expenses should be cut and in many cases those ideas are naive to say the least. For instance, many think that it is the immigrants use of the educational or wealth services what drives deficits. This explains a surge in xenophobic parties. Many blame discretionary spending, and particularly in Spain we have witnessed many excesses that affect the Royal family and many politicians. Those noises help to hide the real austerity drivers. Nevertheless, those cuts and/or tax increases and reduced pensions will increasingly hit regular citizens to the point in which most notice that they are the real targets of austerity and not immigrants or corrupt politicians. When, of if, this point is ever reached is something that nobody can predict. The EU is playing hard with this risk, but somehow the Comission has noticed that pushing too hard was dangerous and recently relaxed somehow their austerity stance. We are to be cooked slowly. Will they succeed?

  5. The Dork of Cork

    Euro countries such as Ireland have been driven into surplus so that the financial centers and local national capitals can consume the surplus.
    All large cities are now foregin in nature.
    The majority of the young worforce in Ireland is of a external character.
    Please rememeber as a workforce they do not contribute to the local physical economy – they work in pointless make work call centers and the like.
    You are smoking some strong politically correct horseshit mate.

  6. The Dork of Cork

    Our lives are currently controlled by a Anglo Dutch monetary oil cartel.
    It injects and extracts energy credits via various little NYFR operations which many people somehow call nation states.
    Spain was a good little boy in 2013.
    From BP annual stat review 2014
    Spain (-5%)
    recorded the largest volumetric decline in
    energy consumption.
    Its local managers will be rewarded
    Oil will seek a yield elsewhere.
    Morrocco is the next Spain etc etc etc.

    Spain became a Industrial country leaving its agrarian past behind.
    Now it has become modernistic the cabal takes away its energy tokens.
    Ironic but predictable outcome me thinks.

    One does not make a pact with the devil and expect to escape with ones soul.
    Spain has now lost its soul
    All that remains is large scale modern Industrial art dotting the landscape.

  7. Worker-Owner

    Consolidation benefits The Few and simplifies their maintenance of order. The evolution to the consolidation of governance towards globalization is an objective of long standing, as simply understood as the conquests of Alexander or The Romans. The Few and their courtiers will call this Human Nature but it is quite obviously the nature of only SOME humans. It is demonstrably incorrect to extrapolate from The Few to The Many who actually show no such inclination. The courtiers, the opinion-management (propaganda) specialists in particular, spend a lot of time and energy trying to sell such an extrapolatory message but it generally falls on deaf ears.

    The current state of heavy consolidation is sitting on a foundation of an enormous surplus that can support all of the overhead of the consolidated governance mechanisms and their associated bureaucracies and militocracies. This is true of the so-called Sovereign Nations and their Multi-National Corporate rivals. Malthus may yet turn out to be right. There are many wise voices expressing such concerns. If things take a turn Malthusian, if Eternal Growth finally proves to have been a fantasy, we will see how this consolidation inevitability meme fairs.

  8. pebird

    When Europe won’t/can’t even issue Eurobonds up to the 3% deficit limit, it’s clear they aren’t serious about even trying to get out the mess they created.

  9. washunate

    Interesting post. That seems to be the big question for a couple decades now. Do people in Europe want to think of themselves as European rather than English or Irish or French or German or whatever? Europe is so homogenous that it’s difficult for Americans to comprehend what that is like. We see the ‘costs of non-Europe’ as obvious. Our Civil War put an end really once and for all to separatist movements.

    One addition I would add: part of the why is that dreaded f word: fraud. That’s really the backstory to what was happening between the intro of the Euro currency and the formal financial crash.

    1. Moneta

      When I worked for a French bank, all I could see were USD signs in their eyes. The Euro buildup happened around the tech boom. They wanted to be part of the party, the Euro seemed to offer the chance to get rich like Americans.

      1. Moneta

        To get into an important meeting in Paris-London, grey hair was de rigueur and a “de” in front of your name helped quite a bit as well as being male of course. Only those from the “colonies” got a derogation, that’s how I got in.

        All this to say that I doubt Europeans see themselves as one big happy family. The French might have had their Revolution but in many instances, you would not believe it.

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