Abstract
Contrary to public perception, the European Union has dealt well with the Greek debt crisis. European institutions and Member States came together to face the crisis and managed to do so, thanks to coordination and resourcefulness. Now the bigger question looms: how to prevent the recurrence of such a crisis of confidence for as long as possible, and in the event of another crisis, how to manage it. The Task Force on Economic Governance is considering measures that will enforce budgetary discipline of Member States, establish effective crisis mechanisms and increase coordination and supervision of macroeconomic imbalances.
Keywords
Introduction
In September 1929, a New York investment firm placed an advertisement to attract savings. It briefly told the history of the Mississippi Bubble, a famous example of wild speculation from the early eighteenth century, and then said: ‘Today, it is inexcusable to buy a “bubble”—inexcusable because unnecessary. For today every investor has at his disposal facilities for obtaining the facts.’ These facts would substitute the ‘sound principles of investment’ for the ‘hazards of speculation’, so said the ad. The men and women who believed this and rushed to invest their savings were quickly disappointed, just one month later, by the great stock market crash of October 1929.
This advertisement is used as an illustration in a recent book by Carmen Reinhart and Kenneth Rogoff [1], This Time Is Different: Eight Centuries of Financial Folly. The book is widely acclaimed and rightly so. Its title is ironic. The authors’ central claim is that the risk of financial crises has been systematically underestimated throughout history, until the present. Every generation of economists and policymakers believes it has ended the cycle of boom and bust. The reasons and words may vary, from ‘today we have the facts’ (in 1929) to ‘now we have securitised debt’ (in 2007). But the refrain is the same: ‘This time is different’. While every generation believes this, more than one generation has been disappointed in this belief. The book surely makes for sobering reading.
In the light of this long history of financial follies, one can ‘de-dramatise’ the current discussions on the public debt crisis. The discussions started for the European Union in early 2010, when the Greek government faced immediate financing problems. After a few tense months we have re-established confidence. We now have time for reflection and action. I therefore propose to share some reflections on Europe's economic governance by looking back at the way the EU dealt with the crisis and by trying to draw some preliminary lessons for economic policy and for European integration more generally. In this context the work of the Task Force on Economic Governance (which is still ongoing at the moment of writing, summer 2010) will also be touched upon.
Dealing with the crisis
How did the EU deal with the crisis? It is important to focus on the facts, not on perception. In my judgment the EU did reasonably well. We stumbled, but we did not fall.
The EU works under many political constraints. These are often underestimated by outside observers. In any political system there is a difference between coming up with a plan and getting it adopted by a parliament and accepted by the public. In the EU the difficulty is even greater. We are not a single state. In the case of the Eurozone, we are dealing with 16 governments and 16 parliaments (soon 17!) with very different public opinions.
Moreover, at the start of the Greek crisis we did not have the necessary instruments. The Treaties do not provide instruments to deal with a debt crisis. The founders of the Economic and Monetary Union were convinced that the Stability and Growth Pact would suffice to keep budget deficits low. Implementation was deficient, however. Member States sent the wrong signal in 2005 when they softened the Pact. Economic growth and the absence of significant interest rate ‘spreads’ worked as a drug. Notwithstanding the absence of instruments, we were able to develop them. We built a lifeboat at sea.
From the start, the European Council had a twofold guideline: responsibility and solidarity. These were the two guiding principles to which all Heads of State and Government of the Eurozone subscribed. Responsibility on the part of the Greek government. Solidarity from the others in order to protect Greece (and indirectly themselves).
Throughout the process, the EU kept all its commitments towards Greece. Let me recall the sequence of events:
On 11 February 2010, the European Council agreed on the principle that we take action to safeguard the euro's stability and to help Greece.
On 25 March, we agreed on the safety mechanism which would have to be put in place.
It was only on 23 April that the Greek government for the first time effectively and explicitly asked for support.
Within ten days, on 2 May, a deal was reached, and one week later, on 7 May, the support mechanism was effectively triggered.
All along the European Union did what it promised and when it was needed.
In the final stage, between 2 and 7 May 2010, it was no longer just about Greece. We were suddenly talking about the risk of contagion to other countries. This was a very serious threat to the stability of the euro and the financial system. That is why we decided, in a special meeting of the Heads of State and Government of the Eurozone on 7 May, to use ‘the full range of means available’ to protect the euro (Statement by the Heads of State and Government of the euro area, 7 May 2010). These were not empty words. During the following 48 hours, all institutions and Member States assumed their responsibilities:
the Commission rapidly made a proposal;
the finance ministers in the Economic and Financial Affairs Council (ECOFIN) agreed on an impressive safety mechanism for the Eurozone (the ∊750 billion package), before the opening of the Asian markets on Monday morning;
the European Central Bank (ECB) independently changed its policy with regard to sovereign bonds; and
two Member States immediately announced extra cuts to reduce their deficits.
One should consider these actions as one common European effort. Taken as a whole, they clearly show that the EU is able to act, and act decisively. Although this was widely acknowledged, one also heard critical assessments. For instance, it was said that the EU was able to act only when confronted with imminent collapse, or that the EU had only bought time.
Listening to some commentators, one got the impression we were living through the biggest crisis since the Second World War, or even the First. In this period, one observer urged European leaders to use the Churchillian language of ‘blood, toil, tears and sweat’ in order to convey a sense of urgency [3]. However, it was not exactly the outbreak of the Second World War. We were not going through a monetary Armageddon. Verbal inflation cannot bring back confidence. It is a political duty to keep a sense of proportion. We were certainly in a critical moment; one could call it ‘unprecedented’ and ‘historic’. But crises are always unprecedented by definition. Therefore, I am glad that the EU has been able to deal with this one. It took time, the coordination was difficult, but it is the result that counts.
Another line of critique dismissed the safety mechanism for the euro as ‘only buying time’. This disdain is odd. In economic thinking, time is a cost. But not so in politics. In politics, as in human life in general, time is the most precious good.
Politicians try to shape it in order to get things done. Every radical change, such as Greece is now embarking upon, requires time and respite, a temporary protection from the pressure of events in order to better face them afterwards. The EU has now created this breathing space, which did not exist before. The safety mechanism gives the Greeks time to put their house in order. Therefore, the loans are conditional; conditionality is key in this matter. We have given them time, but not an eternity.
Not only the Greeks must use this time. So should the EU as a whole. During the crisis, I suggested, we stumbled but did not fall. In light of the seriousness of the situation that was not a bad response. However, we have now reached the point where stumbling itself could be dangerous. Therefore, we need prudence as much as courage. The next steps will determine the fate of our Economic and Monetary Union.
After the crisis: preliminary lessons for economic policy
What lessons can we draw from the crisis in terms of economic policy? Clearly, the key priorities are fiscal sustainability—preventing public debt from spinning out of control—and being able to deal more effectively with financial trouble. In this respect, our two main missions are to improve both crisis prevention and crisis management.
These are the two subjects of the Task Force on Economic Governance which the European Council has asked me to chair. The Task Force consists of representatives of all 27 Member States (amongst them 25 Ministers of Finance), plus Commissioner Rehn from the Commission, President Trichet from the European Central Bank (ECB), Prime Minister Juncker from the Eurogroup and myself as Chair. Thus all the key actors are around the table.
Right from the start, there was agreement on the four main objectives.
First, we should reach for greater budgetary discipline. All agreed on the need to strengthen the Stability and Growth Pact. The proposals on the table concern both the preventive and the corrective side of the Pact. They include stronger warning procedures and new types of sanctions. Sanctions could already kick in before the 3% threshold for the annual budget deficit is trespassed if, for instance, warnings have been neglected or if the level of debt rises too quickly. To use the traffic light image, until now states were fined only when driving through the red light of the 3% threshold; from now on they could also be in trouble if they go through a yellow light. As of this writing, we are in the process of defining the circumstances under which a yellow light is an infringement of the rules.
In this context, we will modify our approach. In guarding the rules of the Stability Pact, the political focus has so far been almost exclusively on the maximum annual public deficit (the 3% of GDP). Much less attention has been paid to the level of public debt (the 60%). Public debt in the Eurozone is now 85% on average. This needs to be corrected. Even if we refrain from a special procedure for ‘excessive debt’, we could envisage a scenario in which the excessive deficit procedure is triggered earlier for countries where debt is not being reduced quickly enough.
The second objective is to reduce divergences in competitiveness among the Member States. This is vital, especially for the Eurozone. The Stability Pact remains the cornerstone of European economic policy coordination. However, sound budgetary policies are necessary but not sufficient to ensure competitiveness. We should have known this from the start, but it took this crisis to hammer home the point.
Over the years, competitiveness in some Member States has improved thanks to wage moderation and productivity improvement. Others have experienced significant declines in competitiveness and increased balance of payment deficits in their current accounts. If a closer eye had been kept on the figures of these current accounts, the problems of some countries could have been predicted. But this was not a Maastricht criterion.
These imbalances are a particular problem for members of the Eurozone. Their decline in competitiveness was easily dealt with. Countries could no longer devalue but could take advantage of low interest rates. In this respect, membership in the Eurozone acted as a ‘sleeping pill’ for some economies. Nobody wants a rude awakening from market forces. One idea, therefore, is to develop indicators of competitiveness. These should function as an early warning, a wake-up call. Some have proposed going further, with corrective measures for those countries that do not act when the red light flashes.
Turning from crisis prevention to crisis management, let us come to the third and fourth objectives on which our Task Force broadly agrees.
The third objective is to establish an effective crisis mechanism in order to be able to deal with problems such as those we have today in the Eurozone. The general crisis mechanism that was put into place in May—that is, the ∊750 billion safety fund—will function for three years. The question is whether, and if so under which conditions, it should be developed into a permanent fixture of the system.
Our fourth objective is to develop stronger institutions. The EU needs to be able to act more quickly and more efficiently when problems arise. We need stronger supervision to detect macroeconomic imbalances, for example, and better coordination among institutional actors.
A concluding remark on these economic policy lessons. A quick-witted mind might wonder: If you have perfect crisis prevention, why would you need better crisis management? Would it not be smarter to put all the chips on prevention? I do not think so. Again, crises are essentially unpredictable. This is surely the case in the world of credit and financing, where credibility and confidence play key roles. Confidence is about emotions and psychology, just as much as it is about market value and economics. This should imply some modesty. To quote Reinhart and Rogoff once more, ‘Economists do not have a terribly good idea of what kind of events shift confidence and how to concretely assess the confidence vulnerability.’ (2009)
In short, if we are serious about a European economic policy, we should do whatever we can to avoid the type of crises we already know. That is what we did during the credit crisis of 2008–2009, when we avoided all the mistakes that were made in the 1930s because we knew what they were (for instance, this time, unlike then, we stayed away from protectionism by safeguarding the European internal market). But we should also be able to deal with unforeseen circumstances—not if, but when they arrive.
After the crisis: lessons for political integration
Let us consider the third and final issue. What lessons can we draw from the crisis in political terms? What does it mean for the state of European integration? This is a huge subject, so I offer only some brief reflections.
In a way, the old cliché holds: every crisis is an opportunity. It opens the possibility to act, to do things we were unable to do before. Today, one can already feel the pace of events accelerating. But a sense of proportion is in order. I do not belong to those who are almost thanking the markets for obliging the EU to take a step forward in political integration. I would rather not have had this crisis, and I am sure the Greek people and most taxpayers in the EU would agree. However, now that we are at this juncture, as a Union, it would be irresponsible not to draw the right lessons. That is what the work of the Task Force is about.
Beyond specific rules, we are clearly confronted with a tension within the system, the well-known dilemma of being a monetary union but not a full-fledged economic and political union. This tension has been there since the single currency was created. It was known to the diplomats and to the experts; it provided ammunition to critics of the euro. However, the general public was not really made aware of it (at least not by those responsible). The dilemma remained invisible. Few politicians told the proverbial man in the street that sharing a single currency is not just about making peoples’ lives easier when doing business or travelling abroad, but also about being directly affected by economic developments in neighbouring countries. That being in the ‘Eurozone’ means, monetarily speaking, being part of one ‘euro land’. Today, people are discovering what a ‘common destiny’ in monetary matters means. They are discovering that the euro affects their pensions, savings and jobs, their very daily life. It hurts.
This growing public awareness is a major political development, one that is forcing governments to act. What will they do?
We will take those steps towards stronger economic coordination that are currently under discussion in the Task Force. It is necessary and it will be done. Moving forward will be delicate because, beyond the economics, fundamental political issues are at stake. Take the discussion on public deficits: all Member States want the others to play by the rules. They ask for sanctions, but at the same time they are not themselves willing to have Brussels look into their books at a moment's notice. Therefore, I expect the next steps will allow us to better deal with the fundamental dilemma but not to eliminate it. Getting rid of it would require some leap to a federal system, in which the centre would take precedence over the parts; that is not going to happen. Instead, Europe will stay in the realm of squaring the circle between the Union and the Member States—but no doubt at a higher level.
Put differently, the Eurozone will in the near future most probably retain its unique character of a monetary union in which fiscal policy remains in the hands of the Member States. The overall goal, therefore, has to be to make Member States more mindful of their responsibilities towards themselves and the other members of the club. The action—or lack of action—of one affects all.
In this respect, the European Council has an important role to play. Alongside the Commission and the Central Bank, it is responsible for the EU's economic governance. As the body where the Heads of State and Government of the Member States gather to deal with common European issues, it is particularly capable of squaring this circle between the national and the European. It can assume responsibility for European decisions in the face of national parliaments and public opinion, not at a technical level but at a political one.
In some of the first proposals on the table of the Task Force, other attempts to square the circle were apparent. Think of the German idea to integrate the European deficit and debt rules into national legislation: it is a way of making clear that European rules are not just ‘from Brussels'—and therefore easy scapegoats—but are self-imposed by each Member State to the benefit of all. The same is true of the suggestion from Minister Schäuble to hold national finance ministers accountable in their own national parliaments for the examination of the stability programmes of their Eurozone partners. This may have disadvantages, but it would make clear that within the Eurozone the economic and fiscal policies of the partners are not just a matter of foreign affairs and old style financial diplomacy, but that they are, in a way, domestic affairs [2].
Thus, the financial crisis brings Europe unexpectedly forward. It has shown people that the EU affects them, that Europe is ‘our business’. However painful the occasion, it is an encouraging shift.
Footnotes