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.