Many focused their attention, understandably, on the decision by David
Cameron, UK prime minister, to veto a new treaty. But the UK’s behaviour
took attention away from the failure of the eurozone’s leaders to devise a
credible remedy for the ills of the currency union. They propose, instead,
to tighten the screws on fiscal deviants. It may feel good. But it will not
work.
Mr Cameron presented his colleagues with a list of demands designed to protect
both the City and the ability of the UK government to regulate it, largely
unhindered by European regulators.
Mr Cameron could have stated, instead, that he would accept a treaty
applicable only to members and candidate members of the eurozone. He could
have intimated that he would put a treaty that did any more than this to a
UK referendum (which would have been surely lost). Instead, he ended up with
no additional safeguards for the City and a semi-detached status inside the
European Union, of which, he has insisted, he wants the UK to remain a
member. That is not a success. He has achieved nothing positive, but will
undermine the credibility of UK membership of the EU. That brings
substantial costs.
Yet far more important than this piece of British political theatre is what
might now happen inside the eurozone. On this I am pessimistic. Germany and
France have agreed that there is to be no fiscal, financial or political
union. The failure to transcend the defects of the original construction is
predictable, but dire.
The core decision was to strengthen fiscal discipline, so building what Angela
Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French president,
last week calleda “stability and growth union” – or, as I think of it, an
“instability and stagnation union”. Even under an intergovernmental treaty,
this reinforced discipline could probably still occur via EU institutions,
as Olli Rehn, European commissioner for economic and monetary affairs, now
argues.
What are the chief details? First, as the eurozone heads of government stated,
“general government budget deficits shall be balanced or in surplus: this
principle shall be deemed respected if, as a rule, the annual structural
deficit does not exceed 0.5 per cent of nominal gross domestic product”.
Second, “such a rule will also be introduced in member states’ . . . legal
systems . . . The rule will contain an automatic correction mechanism that
shall be triggered in the event of deviation.”
A simple objection to these ideas might be that they are implausibly tough, as
FT Alphaville notes. The Council does state that “steps and sanctions
proposed or recommended by the Commission will be adopted unless a qualified
majority of the euro area member states is opposed”. Even so, I remain
unconvinced that turkeys will vote for Christmas. Yet, suppose they do. This
would mean that, on deeply uncertain estimates of structural deficits, the
Commission - a body of unelected bureaucrats - would impose sanctions on
elected governments, when the latter are under great pressure. What is the
Commission going to do if they still fail to comply? Take them over? The
answer, we now know, is: yes. This is a constitutional monstrosity.
Still more important, as professor Kevin O’Rourke of Oxford university argues
on Project Syndicate, is that it is also an economic monstrosity. Let me
make this point by turning last week’s analysisof the balance of payments
into one of foreign, private and government financial balances in eurozone
members (see charts). To remind readers: these have to add up to zero, by
definition. But how they go about adding up is revealing.
As I notedlast week, fiscal imbalances were modest before the crisis, but the
current account imbalances were huge. Surplus private funds in some
countries (notably Germany and the Netherlands) were intermediated by the
financial system to fund private deficits in others (notably Greece,
Ireland, Portugal and Spain). When crisis hit, these flows ceased. Deficits
of private sectors collapsed (most turning into surpluses), while fiscal
deficits exploded. Now, says Germany, the latter must be slashed.
By definition, the sum of private and current account deficits must also fall
towards zero. The private sectors of erstwhile capital-importing countries
have moved towards surpluses, for a good reason: they are trying to reduce
their debts, not least because their assets are falling in value. Thus the
external deficit needs to fall. That can occur in a good or a bad way. The
good way would be via increased output of exports and import substitutes;
the bad would be via a deeper recession. The good way requires far higher
imports in the core of the eurozone or far greater competitiveness for the
eurozone as a whole. But little chance of either of these exists, under
plausible expectations for demand and activity. That leaves the bad way:
deep recessions, in which the government reduces its deficit by deflating
the private sector yet more.
In brief: it is extremely difficult to eliminate fiscal deficits in the
structural capital-importing countries, without prolonged recessions or huge
improvements in their external competitiveness; but the latter is relative;
so the needed improvements in the external performance of weak eurozone
countries imply a deterioration in that of eurozone capital-exporters, or
radically improved external performance for the eurozone as a whole. The
former means that Germany becomes far less German. The latter implies that
the eurozone becomes a mega-Germany. Who can believe either outcome is
plausible?
This leaves much the most plausible outcome of the orgy of fiscal austerity:
long-term structural recessions in vulnerable countries. To put it bluntly,
the single currency will come to stand for wage falls, debt deflation and
prolonged economic slumps. Can this stand, however big the costs of a
break-up?
The eurozone has no credible plan to fix the flaws of the eurozone, apart from
greater fiscal austerity: there is to be no fiscal, financial or political
union; and there is to be no balanced mechanism for economic adjustment on
both sides of the creditor-debtor divide. The decision is, instead, to try
still harder with a stability and growth pact whose failures have been both
predictable and persistent. Yes, Mr Cameron made a blunder last week. But
that of the eurozone looks far bigger.
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