Last Friday, December 9 — the day when 26 of the European Union’s 27 leaders agreed on a “fiscal compact” designed to save the euro and place the bloc on a sounder economic footing — marked exactly 20 years since Germany and France presided over a similar meeting that led to the drafting of the Maastricht Treaty, which became the cornerstone of the single currency.
Among the euro entry conditions agreed in 1991, a country’s public debt would have to be limited to 60 percent of gross domestic product and its deficit to 3 percent of GDP. The first countries to breach the deficit rule were France and Germany in 2003 but they voted to let each other off, thereby undermining the rules that they had been instrumental in drawing up. So, there is more than a hint of irony in the fact that two decades on, France and Germany are again at the forefront of pushing for strict budget discipline, this time as a way of keeping the euro from falling apart.
They have added the proviso that member states must produce balanced budgets and are hoping that EU institutions such as the European Court of Justice will be enlisted to ensure that — this time — the rules are followed and punishment meted out.
For Greece, in a sense this means very little as it is committed to meeting tough fiscal targets for many years to come as part of its EU-IMF bailouts. Athens, for example, had already committed to producing a balanced budget next year. Nevertheless, there is an aspect of the deal that will exert even more fiscal pressure on Greece in the years to come: Countries whose debt is above 60 percent of GDP will have to reduce the extra amount by a twentieth every year. In the best-case scenario, Greece is projected to have a debt of about 120 percent in 2020. This would mean that it would then have to chip away 2-3 percent of that extra 60 percent of debt each year for the next couple of decades to reach the 60 percent ceiling.
In terms of the broader picture, of course events in Brussels are of utmost significance for Greece because the country’s immediate future depends on whether the agreement made in the early hours of Friday morning is enough to prevent the end of the euro. It is in this respect that Greeks and others in the eurozone — as well as those outside the single currency — should be most concerned. When looking beyond the narrow scope of whether the markets will be convinced that the stability lost over the last two years can be regained, the Brussels agreement seems very much like an incomplete thought.
While the crisis has highlighted the fact that monetary union without fiscal union is impossible to pull off, it does not mean that the alignment of debt and deficit figures in the eurozone will guarantee stability and prosperity indefinitely. It would imply that the economies within the eurozone are either all identical or function in unison. Neither is true and neither will come about as a result of what was negotiated in Brussels.
The eurozone economies will remain driven by various different factors — such as exports, tourism, the financial sector and housing market — and therefore exposed to a range of crises and damaging fluctuations. Ireland’s debt rose from 25 percent to 108 percent of GDP over the last four years largely due to the problems in its financial sector. Spain’s debt shot up from 40 percent to 70 percent mostly as a result of the nosedive taken by its real estate market. One of the tools that governments have to counteract these dangerous swings and prevent their countries’ economies being harmed is to engage in expansionary fiscal policy — in other words to dig into public coffers to stimulate the economy or to prevent a collapse. It’s what the US and UK did recently to prevent the financial crisis from bringing down their banks. While this Keynesian approach to economic policy is not popular in Germany, the decision to remove this vital tool from the others’ toolboxes is dicing with danger.
Had the drive for fiscal discipline been balanced with other dynamic policy options, then perhaps the blow of losing the choice of deficit spending would have been softened. The Brussels deal proposes nothing in its place. There has been a vague indication by European Central Bank President Mario Draghi that the ECB could play a more active role if eurozone countries commit to getting their public finances under control. However, it would likely require a serious intervention from the ECB — not just the buying of some Italian or Spanish bonds but the type of investment in eurozone debt that would amount to a quantative easing program (effectively the printing of money) — to really stimulate the euro area, whose economies are expected to register negligible growth for the next two years, according to the latest estimates by the Organization for Economic Cooperation and Development (OECD).
There was no discernible change in the ECB’s mandate agreed in Brussels — for now, it remains a monetary authority focused on interest rates and inflation and not on growth, unemployment and all-round economic stability. Other arrows that could have been fired at the crisis, such as Eurobonds, have remained in the quiver. The pooling of debt is due to be discussed in March but issues such as giving the European Stability Mechanism (ESM) a banking license so it can borrow to rescue indebted countries remained firmly off the agenda. Instead, 500 billion euros was committed to the ESM. Along with the 500 billion available to the current rescue fund, the European Financial Stability Facility (EFSF), and another 200 billion pledged to be channeled through the International Monetary Fund, which could be matched by the emerging economic powers, a backstop of sorts has been created. There are doubts whether it would be enough to hold back the tide of a Spanish or Italian collapse. Italy alone has some 400 billion euros of debt to pay next year.
In any case, what is being created is a mechanism to bail out water when the ship appears to have no engine to power it to a safe harbor. This seems to undermine the attempt to calm the markets. Investors may be encouraged by the eurozone leaders finding some common ground and agreeing on some shared measures going forward, but it is hardly a secret that the markets will only be assuaged if it’s clear that this is a precursor to the ECB intervening more forcefully in the sovereign debt market.
The most gaping absence from last week’s pact was any discussion of fiscal transfers within the eurozone. If strict budget rules are the stick, then the prospect of taxpayers’ money flowing from the richest to the poorest or the strongest to the most troubled would have been the carrot. But Germany and others are unwilling to countenance such an idea and this means that perhaps the most potent weapon the euro area could have in its fight against stability-busting economic cycles remains firmly locked up in a deep underground bunker.
“Rather than creating an inter-regional insurance mechanism involving counter-cyclical transfers, the version on offer would constitutionalize pro-cyclical adjustment in recession-hit countries, with no countervailing measures to boost demand elsewhere in the eurozone,” writes Kevin O’Rourke, a professor of economic history at Oxford University. “Describing this as a ‘fiscal union,’ as some have done, constitutes a near-Orwellian abuse of language.”
The absence of so many devices from the current agreement gives the impression of a eurozone that is trying to stay together by committing as little as possible. It’s like a couple in a long-term relationship who refuse to leave their toothbrushes at each other’s homes for fear that this will indicate some commonality of purpose. Apart from appearing to undermine the very purpose of promoting common rules and moving toward closer economic governance, this reluctance could mean that the eurozone will fail to tackle the one problem that is bigger than debt, deficits or market apprehension: growth.
While the debt-induced crisis has laid bare the structural and institutional weaknesses in the euro, giving Germany and the fiscally conservative ECB an opportunity to address them on their terms, it’s also made it clear that eurozone countries spent the last decade thinking that prosperity and stability was assured by their membership of the single currency. This theory has been debunked and many members of the single currency find themselves with uncompetitive economies and growing numbers of unemployed. Growth is now the only thing that can propel the eurozone away from disintegration and possible disaster.
“The world will start questioning the absence of any EU plan for growth and the inadequate size of liquidity support,” tweeted Sony Kapoor, the managing director of the international think-tank Re-Define, on Sunday.
“There is absolutely no substance [in the agreement] to how short- to medium-term growth is going to be generated and where the resources are going to come from,” he told Bloomberg TV the morning after the Brussels talks. “By locking themselves in a fiscal straitjacket which is even tighter than the one that existed before, the largest economy in the world is behaving in the way that a tiny economy would.
“What worked for Sweden in the 1990s as an open economy at a time when the global economy was growing will definitely not work for the euro area or even the broader European Union. We have a serious, serious problem there.”
Kapoor is just one of many analysts warning that the fiscal rigidity implied in the Brussels pact could end up backfiring by deepening Europe’s recession. Greece is in the frontline of those countries that would be affected by an ongoing failure to address the issue of growth in the eurozone. The crisis has led to flows of private capital to the peripheral eurozone members drying up, production and services are seizing up, current account deficits are growing and the balance of payments problem that has afflicted the weaker members of the single currency is being exacerbated. The scope of Friday’s agreement, which steers clear of anything that might hint at genuine economic or political union, is too narrow to decisively confront any of this.
“This situation is dangerous,” writes Jean Pisani-Ferry, the director of the Bruegel think tank in Brussels. “It was believed that the difference in balance of payments would disappear between euro countries, but they still exist because mobility is weak and banks remain national. To resolve this problem at its root calls for deeper economic integration. This is not the path being adopted.”
Like other countries on the periphery — even with the structural reforms that could free up productive forces — if there is a continuing absence of liquidity and growth stimulus then the only way for Greece to keep chipping away at its debt will be by deploying austerity measures that will eventually choke its economy. Unless this Catch-22 is addressed very soon, what began with one irony — that of the fiscal compact being agreed on the same day as the Maastricht Treaty draft — will end with another: In their effort to prevent the euro collapsing and its members being sucked into an economic depression, Germany and France will ensure that this is exactly what happens.