11 March 2012

Hey Europe, What Is Going On? (Part 7)

In Part 6 of this series we promised to discuss how / for what Europe is using the time that it is buying with all the costly financial measures. Some opinion leaders such as G. Soros have been sceptical about the European Union (EU) and more specifically, about the eurozone from the beginning on, because it has had only one leg. It’s a monetary union, but not a fiscal union, thus it cannot sustain by definition. The Europe’s debt crisis has articulated this point very clearly. A critical mass of the European policy makers seems to have recognised the problem. So, how it’s going with constructing the “second leg” to the eurozone?

On 2 March 2012, the heads of state or government of all EU member states with the exception of the United Kingdom and the Czech Republic signed a Treaty on Stability, Coordination and Governance (TSCG), the so-called Fiscal Compact Treaty. During the signing ceremony, the President of the European Council, Herman Van Rompuy, announced it as “an important step in re-establishing the confidence in our Economic and Monetary Union” (highlights from his speech: stability, coordination, governance). Yet not everyone is happy even within the eurozone, not even in Germany. Instead, some critical voices are saying that the new rules mean an “economic and political suicide” (citing Guntram Wolff, deputy director of the economic think tank Bruegel via EurActiv.com) for at least some of the eurozone countries, such as Spain.

In other words: something is being done, but is it a progress or destruction?

The Treaty

To summarise, the TSCG is about the fiscal discipline and introducing surveillance within the euro area, in particular by establishing a “balanced budget rule” and reducing excessive government debt:
* It requires national budgets to be in balance or in surplus (the annual structural government deficit shall not exceed 0.5% of GDP at market prices, or 1.0% for countries with government debt significantly below 60% of GDP and risks of long-term sustainability of public finances low);
* It prescribes an automatic correction mechanism in the event of deviation, and gives to the EU Court of Justice the right to verify national transposition of the balanced budget rule (the decisions of the EU Court of Justice are binding and can be followed up with a penalty of up to 0.1% of GDP);
* It requires reducing government debt that exceeds 60% of the GDP by a fixed rate each year (1/20 per year as a benchmark);
The treaty also assumes coordination of the member states’ economic policies. The contracting parties have to report on their public debt issuance plans and to make sure that major economic policy reforms are discussed and (if needed) coordinated.

The TSCG will enter into force after it has been ratified by 12 euro area member states. The target date is 1 January 2013.

Main criticism

First, the treaty may easily turn out to be a political disaster:
* There are now “two Europes” or even a multi-speed Europe – those who decide to participate and those who will remain aside;
* The treaty is creating new uncertainty with an intergovernmental agreement outside the EU legal framework;
* Some in the UK are suggesting that the UK should now better leave the EU; the others in Europe are accusing the UK’s coalition government in seeing the EU as a mere free-trade area;
* Most probably, the voters in the deficit countries are not happy about the new austerity measures;
* There are several uncertainties about ratifying the treaty, e.g. Irish referendum and the presidential elections in France.

Secondly, the new “fiscal compact” is told to fail in responding the immediate sovereign debt and credit crisis:
* Some are referring to it as “a dangerous attempt to enforce extreme austerity by all means”;
* The others are asking how can austerity and growth be pursued simultaneously: “Continuous austerity has negative effects on growth, which in turn worsens the problems in countries most affected by the crisis, with public spending cuts contributing to prolonged and deep recessions.”

The following elements have been highlighted as missing from the treaty:
* Granting the European bailout fund a banking licence;
* Introducing Eurobonds;
* A pan-eurozone backstop to the banking sector;
* Imposing of a financial transaction tax;
* A comprehensive financial market regulation, the decoupling of public finances from markets and the decoupling of politics from rating agency assessments;
* A “real plan” for investment and growth.

Some critics say that: “This is still not the economic and fiscal union we need.”
* No shared budget;
* No mechanism to transfer monies between the participating countries.

(Read more about the differing opinions e.g. from EurActiv.com which is the source of the above.)

My Opinion

I’d add one more opinion to the above – my own.

To me it seems that most of the critics do not see the TSCG as part of a bigger plan, the project of One Europe or whatever we call it. Indeed, at least some appear to be expecting that this new fiscal treaty would solve problems which are clearly out of its scope, such as the financial market regulation. I’d say that we are actually talking about a mere preparation for moving towards something like the United States of Europe with the shared/common budget and the long-awaited Eurobonds. This refers to one of the major issues in the whole project: it’s not well enough articulated where the Europe is heading and where the different pieces such as the TSCG fit.

It’s true that the new treaty is lacking a “real plan” for investment and growth. Most probably, it’s still not quite clear yet how to overcome the imbalances within Europe. Sure that if we are talking about austerity and reducing the debt burdens, we are talking about lower growth if any for quite some time. Yet the hope is that this growth will be at least a bit healthier than the debt-fuelled and consumption-driven nominal growth. Furthermore, if the above comment about the “bigger plan” is true, I’d not worry too much about Spain committing an economic suicide. The direction is still towards preparing a “common pot” on the EU level.

Is Europe committing a political suicide, first of all I’m referring to UK remaining aside and to the new uncertainties that result from an intergovernmental agreement? I think that in this sense the current point in time is the moment of truth when the hidden disagreements are coming into the daylight. Not in too distant future, we are going to see who actually is ready to go on with the One Europe project and who is not. When remembering the history, the British Empire and everything, it’s not difficult to see why UK is not excited about it, especially if it’s this much ruled by Germans.      

I’d not expect the financial markets to applause to the above. The progress is far too slow for them. Financial markets tend to be myopic and thus, would most probably be much happier about a quick fix and a nominal imbalanced growth.

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