How the ‘Future of the Euro Area’ Debate has Turned into a ‘Future of the EU’ Debate

by Daniela Schwarzer

Since 2010, the EU has undergone two closely intertwined developments: firstly, the day-to-day management of the sovereign debt crisis with many steps taken ‘overnight’ as a matter of urgency and, secondly, governance reforms which have already changed the functioning of the EMU.

This latter debate has developed considerably during these last three years. In 2010, it started out with a narrow focus on the euro area, driven by the question what would need to be done in order to prevent a comparable crisis in the future.

In 2011, the reform of the euro area became more and more intertwined with crisis management for two reasons. First, crisis management itself changed the euro area to such a degree that some member states claimed more governance reforms in exchange. For instance, with the decision to expand the EFSF, to give it more instruments and to create the permanent European Stability Mechanisms (ESM) the concern of the ‘lenders’ grew that more control over national fiscal and economic policies should counterbalance their readiness to take on larger guarantees and risks for the crisis-stricken member states. Second, the debt and banking crises turned into a fully-fledged crisis of trust. In order to regain trust in the financial markets (at least among long-term oriented investors), the euro area member states have to rework the governance framework upon which the single currency is based.

In 2012, the governance debate developed further in two interesting dimensions. Firstly, the European Union is faced with the question how to cope with its undeniably already strengthened core, the euro area. The pre-in countries such as Poland, Latvia or the Czech Republic of course have a strong interest to be associated as closely as possible to the process of deepening the euro area, and to decision-making once the new structures are in place, even before they enter. They fear a decoupling from a harder core and correctly consider rising entry costs. The opt-out countries and particularly the UK may eventually be driven further away from the EU. A fine line will have to be walked to proceed with the necessary deepening of the euro area without shying away other EU members. Secondly, the future of EMU debate has turned into a ‘future of European democracy’ debate. With the crisis of legitimacy in member states and on the EU level, the decision-making system as such is coming under scrutiny. Proposals range from strengthening the European Parliament to directly electing a European President, from turning the European Commission into a true government to introducing elements of direct democracy. EU Commission President Manuel Barroso advocated a Federation of Nation States . German political leaders have claimed a move towards a political union. The working group on the ‘Future of Europe’ initiated by the German Foreign Minister in its report also lays out steps towards a deeper integrated EU. Meanwhile, the ‘four Presidents’ in the EU/euro area (van Rompuy, Barroso, Draghi, Juncker – yet not EP’s Schulz) are working on their report on deepening the EMU and EU to be submitted to the European Council in December 2012.

The report by the eleven foreign ministers will surely not be a game changer in the future of Europe debate. Yet it is one additional manifestation of a perceived need to get seriously engaged in this process. It gives rise to two interesting observations. The first one concerns the composition of the group: there are nine EMU members plus Poland and Denmark – hence a pre-in and an opt-out country. This way of structuring the debate is promising, if the overall objective is not to divide the EU, while allowing for the euro area to deepen. While it has possibly come at the price of a lower common denominator, hence less decided policy proposals, it is certainly an important signal to associate non-EMU members.

The second observation concerns the scope of issues: Westerwelle and colleagues draw the spectrum of debated issues even larger than is usually done in the ‘future of the euro area debate’ commonly does. While a large part of the final report deals with aspects related to the deepening of the EMU, they also suggest a joint border control, majority voting in CFSP, some of them support the creation of the European army etc.

It has to be observed closely whether this broad approach actually helps or hinders the pressing task to deepen the euro area. It may be helpful if it allows policy makers to better argue their case for deepening the EU it they can add aspects related to Europe’s role in the world and the protection of European interests in a changing global environment. It may be unhelpful if voters feel overwhelmed by sudden European ambition, the urgency and sense of which they do not fully share as policy makers have neglected their leadership task of confronting constituencies with European and global realities. In this case, it may be better to refocus discussions on what has to be done in order to solve the most pressing problems, namely those of the euro area.

Dr.  Daniela Schwarzer is Senior Associate at the Research Division European Integration at the German Institute for International and Security Affairs, Stiftung Wissenschaft und Politik (SWP) in Berlin. From September 2012 till August 2013 she is Fritz Thyssen Fellow at the Weatherhead Centre of the University of Harvard.

Temporary Relief – the Big Tasks are still Ahead

by Daniela Schwarzer

The euro area is going through a moment of relief. After the ECB’s announcement of its new bond-purchasing programme (the OMT) and the German Constitutional court’s green light for the European Stability Mechanism (ESM), the bond and stock markets have recovered. Yet, the crisis probably only pauses – it has by far not been solved yet. The ECB alone cannot ensure the survival of the euro area, which can only be achieved by determined political action. This is why there is so much pressure on the member governments to hammer out a consensus around the question how a fiscal and a banking union can be introduced – steps of deepening which require a strong democratic legitimisation on the EU level.

As long as investors are not convinced of the irrevocability of the European Monetary Union, there will not be a lasting relief from the crisis. Investors still have to assume that a self-fulfilling prophecy materialises and the euro breaks apart – because they try to protect themselves from exactly this scenario. It is this risk of EMU dissolution that is priced-in when Spain, Italy, Portugal and Ireland have to pay high risk premiums when the refinance themselves on the market. Also the real economy suffers from these negative expectations: investment stagnates in some member states. When, as in the case of Greece, there is a risk that investment may lose 50 to 70 % of its value due to a currency depreciation, then no money will flow in. Consequently, the economic situation does not improve or deteriorates further, which then makes an EMU exit more likely. Also, the credit crunch that many companies in southern Europe suffer has to do with scepticism and attempts to avoid risks, in this case on the side of the banks.

The resolution of this crisis of trust requires measures that make the irreversibility of the single currency credible. What the euro area needs is a banking union that is based on three pillars: a powerful supervisory authority, a common deposit guarantee scheme and a bank resolution fund. In the fiscal field, in addition to closer coordination of national policies, the issuance of euro bonds which would make member states less vulnerable to self-fulfilling financial crises like the one we are witnessing since 2010. Also, a serious debate is needed in how far automatic stabilisers would help the eurozone prevent future cyclical imbalances. This is why the emerging debate on a European unemployment scheme and a serious debate on a re-design of the EU budget including EU taxes are so important.

But more mutualisation and risk sharing in the field of banking and public finances, further integration towards more coordinated fiscal and economic policies and possibly the creation of European transfer mechanisms will be politically unsustainable if these steps of integration are not accompanied by democratic decision making on the EU level.

This is where the current debate on political union comes in that is developing in some member states. The big challenge of the European Council meetings up to the end of 2012 will be to create a common understanding that technical solutions to the banking and debt crises and to the governance deficits of the euro area require a far-reaching re-think of the legitimisation of European policy decisions. While the involvement of national parliaments is useful in some regards, the European Parliament is a key actor to bring into the future governance set-up of the euro area.

Dr.  Daniela Schwarzer is Senior Associate at the Research Division European Integration at the German Institute for International and Security Affairs, Stiftung Wissenschaft und Politik (SWP) in Berlin. From September 2012 till August 2013 she is Fritz Thyssen Fellow at the Weatherhead Centre of the University of Harvard.

Approaching Fall

by Ferdi De Ville

Slowly but surely everyone is returning from the summer holidays and getting back to business. For politicians and observers involved in the euro crisis, the long vacation was more tranquil than expected. The open-return flight tickets of politicians did not have to be used preliminary and observers could feel increasingly relaxed at not looking at their smart phones for some time. This welcome time-out was to a large extent thanks to the famous ‘it will be enough’ speech held by Mario Draghi at the end of July in which he declared that the ECB would do everything that is within its mandate to safeguard the euro; including interpreting that mandate broadly.

However, the coming weeks and months promise to be very hectic again. Eurozone leaders will have to be creative once more in developing solutions to unexpected crises and observers will need to learn to understand and use the acronyms and expressions the decision-makers come up with (I recently added OMT and sterilisation to my euro crisis dictionary). Let me use my first blog after the break to set out what is to come and to be expected in the first months of the second half of this year.

September has begun with, again, all the spotlights on the ECB President who outlined the details of its bond buying programme. Judged by the positive reaction by markets and most observers (and the absence of negative reactions by eurozone heads of state or government), it seems that the euro has convincingly taken this first post-summer hurdle. This measure may make what is to come also more manageable. And lots is to come, all steeped in uncertainty.

On 12 September, the Dutch hold general elections on the same day that the German Constitutional Court is to decide if the European Stability Mechanism and the Fiscal Compact violate German basic law. It is widely expected that Karlsruhe will not obstruct the euro crisis resolution, but the details of its argumentation may further limit the manoeuvring room for Merkel. The Dutch elections are unpredictable, the latest polls forecasting that a part of the electorate is returning from the political extremes to the centre. Anyhow, it will be important for the further course of the crisis if the next Dutch government will be more or less flexible towards further support for ailing countries. If, after Finland, the government will further harden its stance, it might become extremely thorny for the eurozone to find the necessary compromises in new emergency situations that will surely pop up in the coming months.

In the beginning of October the troika will submit its new report on Greece on which the extension of its support programme (and thus its survival as a euro member) depends. Much speculation and diverging statements have already been made in anticipation of this report (examples here and here).

In the meantime, it is much expected that Spain will in one way or another have to apply to the rescue mechanism. This has the positive effect of making it eligible for ECB support, but the downside is that it will be subjected to strict conditions that may cause further domestic social unrest. Italy still seems to have a chance to escape this scenario, although reform fatigue and political posturing in the run-up to the elections may quickly change this.

Apart from these ‘big occasions’ that may each become a large incident derailing the euro, much conflict can be expected in filling in the details of some important agreements-in-principle that have been taken before the summer. Most important is fleshing out the banking union. A clash between Germany and the Commission is building up, with the first wanting to limit supranational oversight to multinational, systemically important banks, and the second (referring to problematic cases as Northern Rock, Dexia and Bankia) insisting on including all banks. Later in October, Draghi, Van Rompuy, Barroso and Rehn will present their interim report on how to complete the Economic and Monetary Union.

After the presentation of the ECB’s bond-buying plan, my safest bet would be that we are in for a(nother) fall full of mini- and mega-crises and summits-of-the-not-so-final-chance. Problems in (at least) Greece, Portugal and Cyprus will turn out to be worse than currently known (or acknowledged). Spain will have to eat humble pie and Italy will have show uncharacteristic political determination and stability. The space for compromise between German demands and Greek willingness for more austerity in exchange for money is extremely limited. And finding consensus between Germany and France on abandoning economic sovereignty, between the Commission and Germany on banking union and between northern and southern Europe on solidarity and responsibility in fiscal union will be extremely challenging. Every test contains the possibility of failure. But I think the euro will stand not fall. And that, notwithstanding the continuous reciprocal condemnations and provocations, even Greece will still be part of the eurozone when we start the Christmas holidays.

This brings me to the intriguing question, raised by my colleague Hendrik Vos, of when we will precisely decide that the eurocrisis is over?

To be continued.

Dr. Ferdi De Ville is assistant professor at the Centre for EU Studies, Department of Political Science, Ghent University where he teaches and writes on economic and monetary union and the euro crisis.

Mario Draghi’s Pudding

by Carsten Brzeski

At its meeting on 6 September, the ECB kept interest rates on hold and presented details of its new bond buying programme. Mario Draghi truly presented his “believe me it is enough”. Now the ball is back in the eurozone governments’ court.

The ECB’s macro-economic assessment was clearly not a top priority at this meeting. The ECB’s staff projections have hardly received so little attention as today. In its macro-economic assessment, the ECB acknowledged a further deterioration of the economic situation in the eurozone. In the latest ECB staff projections, GDP growth forecasts for both this and next year were revised downwards. ECB staff now expected GDP growth to come in at -0.4% (from -0.1% in June) and 0.5% (from 1%) for next year. As regards inflation, the projections were revised slightly upwards to 2.5% (from 2.4%) for this year and 1.9% (from 1.6%) for next year. As the economic assessment might still be too positive, a rate cut in the coming months looks still possible.

All eyes were focussed on the ECB’s possible plan for bond purchases. By keeping interest rates unchanged, the pressure to at least deliver on the plan had increased even further. And, indeed, ECB president Draghi delivered the new ECB bazooka: the so-called OMT (outright monetary transactions) programme.

With the start of the OMT, the old Securities Market Programme (SMP) will be officially put to an end. According to the ECB, the new OMT is aimed at”safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”, a clear attempt to present it as a pure monetary policy tool and not as a way to finance governments in need. As expected, the OMT will be conditional on an EFSF/ESM programme. According to the ECB, such a programme does not necessarily have to be a fully-fledged bailout package but could also be a precautionary programme. As the ECB said, “involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme”. In our view, all of this means that the ECB will only activate its OMT programme if a country in question has agreed on a so-called Memorandum of Understanding with the Troika and if EFSF/ESM engages in purchases in the primary market. The OMT will be focused on the short end of the yield curve on, in particular, sovereign bonds with a maturity of between one and three years. The OMT will not only be applied to future bailout candidates but could already be started for Eurozone countries currently under a macroeconomic adjustment programme once they start to regain bond market access (which seems to be a rather stringent condition in our view).

Bond purchases under the OMT programme will be sterilised and the ECB will not take a senior status on its holdings. When and how the ECB plans to intervene, however, was not disclosed. It seems as if there will not be any explicit targets. The ECB only plans to announce its purchases ex post on a weekly and monthly basis. In addition to the OMT programme, the ECB also announced that it will accept government bonds as collaterals independent of their credit ratings (except for Greek bonds).

All in all, the ECB has presented a big new bazooka, which should help buying time. This is probably the furthest the ECB can go to help governments. The focus on the monetary policy transmission and strict conditionality should also calm the Bundesbank temper, even if they would not admit it. However, the emphasis on the transmission mechanism is also a danger as it still contains a logical contradiction. With the OMT, the ECB will only repair the transmission mechanism in countries that ask for EFSF/ESM funding. However, what about the other countries? It remains a bit strange. For the time being, one thing is clear: never underestimate Mario Draghi. He clearly delivered on his “believe me it will be enough” announcement. A man of his word! But as he said himself: “the proof is in the pudding”.

Dr. Carsten Brzeski ( is Senior Economist at ING BELGIUM SA/NV – Economic Research.

Whether ‘S’ Stands for System or for Spain will Decide Future of the Euro

by Ferdi De Ville

Since long, discerning observers have argued that Spain, not Greece (or Ireland or Portugal for that matter), would be the real test for the euro. Now, this moment has arrived. The question is whether decision makers will again argue that the troubles in Spain are a Spanish problem that it has to solve them in exchange for temporary support, or if eurozone leaders will finally recognise that the euro crisis is a collective responsibility that can only be solved through collective adjustments and action.
What is happening in Spain is the inevitable deleveraging-recession-deflationary spiral coming to a head. The origins of the Spanish problems are a massive real estate bubble that inflated during the 2000s and burst after the global financial crisis erupted in 2008. While Spain was a fiscal model before 2008, the implosion of the property market has throttled the state. Its fiscal position has been tackled from all sides. First, an important source of government income in the form of property taxes has diminished. Second, with the mind-blowing rise in unemployment (especially among the recently graduated and former construction workers), income from taxes on labour has dropped and expenses on unemployment benefits soared. Third, the government has to support banks that suffer from a high percentage of failing loans. Fourth, the (federal as well as regional) government is faced with prohibitively high interest yields to refinance outstanding debt and finance deficits.
Under pressure from the financial markets and from new eurozone agreements made in the past two years, the Spanish state has already taken significant austerity measures. However, as in other countries trying this recipe (and as always in history apart from some very specific exceptions), this only makes things worse. The economy sinks deeper because on top of private deleveraging also the government is tightening the belt, and unemployment increases further. This only exacerbates all the fiscal pressures. Unemployed people are unable to repay their loans, affecting the banks. They do not contribute to but have to live from the government budget. The financial markets rightly believe that this cannot endure and, consequently, retreat.
The only way out of this trap is to relax austerity, focus on growth and employment and bring down the financing costs. None of this Spain can do on its own. Its eurozone partners have to agree to give it at least five years time before focussing on fiscal balancing. Northern countries with fiscal space and a low unemployment rate should be prepared to undertake fiscal stimulus and accept temporary higher inflation to allow the periphery to grow their way out of this crisis. And they should at least accept the mutualisation of the part of the debt that is the legacy of the crisis (not necessarily future debt).
The reason why all of these measures that had been proposed since long by an increasing number of observers have not (yet) been taken, is that most of the politicians in the northern countries have not yet recognised that the crisis is a collective responsibility or at least do not dare to say so in public. There are several reasons for this lethal deception. First, there is the ‘Greece effect’. The eurozone crisis started in Greece, where in contrast with other countries that are now in trouble a large responsibility for the crisis is fiscal mismanagement by the government. Because this has –on top of sometimes outrageous overstatement and stereotyping in the case of Greece– wrongly been generalised to other peripheral countries, these have also been treated as if they had justly been punished for their own sins. Second is the opposite believe, especially in Germany, that the AAA countries deserve their rewards and should certainly not be asked to pay for the sinners’ Schulden. They have made painful sacrifices after the introduction of the euro for which they are now compensated and if the southern countries want to further enjoy the benefits of eurozone membership they should be prepared to make the same adjustments. Third is a cultural inclination in stability-oriented countries to refrain from helping troubled countries through fiscal and monetary stimulus because this would encourage moral hazard and lead to inflation and, thus, instability.
The creditor countries thereby fatally overlook their own responsibility for the current crisis. As the crisis has to a large extent been caused by a systemic design error, they are, as ‘fathers’ of this system, just as responsible for its crash as the debtor countries. Similarly, everybody recognises that the current problems are the consequence of reckless (private and public) borrowing. But for every euro of reckless borrowing some reckless lender has been the counterparty. Besides this collective responsibility for the (systemically induced) inappropriate capital flows, deflationary reforms made by Germany (through the Hartz Gesetze) and others are not guiltless either. In a monetary union, individually increasing competitiveness through wage and price restraint is just as collectively harmful as irresponsible fiscal policies.
Only if northern politicians quickly recognise their own countries’ co-responsibility for the crisis, explain it to their populations, and act accordingly, does the euro stand a chance of survival. If, conversely, the narrative will again be that the crisis is a Spanish problem –caused by (the close relationship between) corrupt bankers, politicians and property developers, by its structurally weak labour market and by megalomaniac and irresponsible regional governments– that has to be solved first and foremost by Spain itself, it will very soon be game over for the euro.

Dr. Ferdi De Ville is assistant professor at the Centre for EU Studies, Department of Political Science, Ghent University where he teaches and writes on economic and monetary union and the euro crisis.

Wake me up when September Ends

by Carsten Brzeski

The German Constitutional Court will present its verdict on the European Stabilty Mechanism and the fiscal compact on 12 September. A reversal of the ESM looks unlikely, but more powers and control to the German parliament would limit the often called for flexibility of the ESM already from the start.

At least one European institution does not seem to see a need to rush. The German Constitutional Court announced on 16 July that it will present the final verdict of the expedited proceedings on the ESM Treaty and the fiscal compact only on 12 September. This is later than expected. Normally, the so-called fast-track procedure leads to final decisions after three weeks. It is broadly expected that the verdict on the expedited proceeding could already encompass a decision on the “normal” lawsuits filed against the ESM and the fiscal compact.

The common denominator of the several filed lawsuits is that the ESM would lead to unlimited risks and liabilities for German taxpayers. Moreover, the ESM would undermine the national sovereignty on the national budget. The complainants argue that the ESM would fundamentally change Europe, while the German government has always answered that both the ESM and the fiscal compact were only necessary requirements to ensure the stability of the euro as provided in existing European Treaties.

Basically, there are three possible scenarios: 1) an unconditional yes to the two Treaties; 2) a conditional yes to the two Treaties, asking for more control powers and responsibilities for the German parliament and 3) a refusal of the two Treaties. Obviously, the third option would lead to sheer chaos on financial markets as it would reverse all rescue efforts taken over the last two years. In our view, however, this outcome is highly unlikely and would not be in line with past verdicts. The other two options would finally give the green light for the ESM. Our current take on the most likely outcome is along the lines of an earlier verdict by the Constitutional Court, which had given the German parliament a veto right for all eurozone bailouts. In this scenario, however, the often called for flexibility of the ESM would obviously be reduced or limited already at the start.

An announcement of the German Constitutional Court’s verdict on the ESM in September should still be quick enough not to derail markets, but will not lower uncertainty in the coming weeks. Maybe even more important, the upcoming verdict is another reminder that the destiny of the monetary union is not exclusively in the hands of policy makers. It might be an irony of fate that on the day of the Court’s announcement there will be a second event which could also have an impact on the eurozone crisis management: the Dutch elections.

All of a sudden it looks as if the month September, rather than June or July, will bring new milestones in the eurozone crisis. It might not be their favourite music style, but with two crucial upcoming events that are out of their direct influence, eurozone policymakers might start humming the tune of a successful hit of the American rock band Green Day. “Wake me up when September ends.”

Dr. Carsten Brzeski ( is Senior Economist at ING BELGIUM SA/NV – Economic Research.

Reforming Greece II: Ideas for a Successful Bottom-Up Approach

by Daniela Schwarzer

If a bottom-up approach, which I suggested in my earlier blog, is a promising way to promote reforms in Greece, one should discuss criteria for a successful strategy. A first criterion is to have the strategy formulated within Greece, given the limited success of outside influence (the Troika). A second would be to focus on the capability and commitment of local political, business and corporate entities to innovate. These are the bodies regarded as acting with legitimacy by a population which is traditionally sceptic of the national political elites. Thirdly, progress should be regularly monitored and transparently rewarded. Failure to make progress meanwhile should have negative repercussions.

One approach that meets these criteria would be to set up ‘special modernisation zones’ in Greece. In these modernisation zones, administrative bodies would be re-structured, if needed with external support, to enable the collection of taxes, guaranteeing legal standards and minimising corruption. A reduction in the patronage resulting from the close intertwining of politics and administration would be part of this. Greece’s large political parties have given those belonging to the political camp in power preference with jobs at any one time. This has contributed to the excessive growth of the public sector. The quality of administrative bodies has suffered as a consequence.

Municipalities would apply for the status of such a zone. Applications would be handled by a project board. In the case of a successful application, the municipality would benefit from some temporary tax exemptions with the objective to encourage public investment. Within the framework of the modernisation project, assistance would also be granted in investment planning, in education and infrastructure development. Local authorities would also be given advice when calling upon structural funds and in applying for loans from development banks. Relevant experience in this type of approach exists from twinning and TAIEX programmes, which function in a demand-led manner. Local authorities would have to formulate concrete requirements for staff and expertise, whereupon the supporter network would be scanned for suitable support.

If elected decision-makers apply for the status of a special modernisation zone for their municipality, the problem of ownership, which is only too well-known in externally promoted top-down development processes, would be reduced. Local political leaders would be responsible for the implementation of their own project and required to collaborate constructively with external supporters. They would not be replaced by a technocratic board or made de facto impotent, as is now the case under the troika programme at national level. Furthermore, a ‘Business Angels for Greece Network’ could make entrepreneurial know-how available for start-up businesses and founders of businesses and initiate contacts with investors.

If tax revenue is generated in the special modernisation zones as a result of the measures taken, only a proportion would be paid into the national budget. The rest would be reinvested in the region in growth-promoting projects (infrastructure, education). The requirement to expand the project geographically could be tied to this. Neighbouring local authorities could be linked in with a form of twinning. For instance, communication and transport infrastructure could be expanded in the geographic vicinity. In addition, innovative approaches to financing, such as the construction of town development funds, are to be examined and developed further.

Although the basic principles of modernisation zones are decentralisation and individual initiative, some coordination is needed at the national level. A first step should be the setting up of a project board comprising Greek representatives from politics, business and civil society, as well as some representatives of the EU institutions and other member states. Their task would be to establish the overarching structures for this new policy approach with like-minded Greeks.

The board would moreover be responsible for awarding special zone status and would have to evaluate progress regularly. It would also establish the necessary supporter networks. There is some evidence that a number of Greek protagonists are already becoming more involved in the development of their own country. In the operative phase, a series of round table meetings could define joint standards and information flows. Furthermore, bilateral initiatives at political and non-state level (such as between business associations, town partnerships, in the civil society arena etc.) should be included. German political foundations, which have relaunched activities in Greece since 1 March 2012, could mobilise forces within civil society or support the founding of new organisations, which have committed to social and economic modernisation. Finally, all actors involved should continue to promote public discussion regarding the country’s prospects in the EU and the need for deep-rooted reform.

 Daniela Schwarzer is currently the Head of the Research Division European Integration at the German Institute for International and Security Affairs, Stiftung Wissenschaft und Politik (SWP) in Berlin. She joined the Institute in 2005.

A New Approach in and for Greece I

By Daniela Schwarzer

The election results of June 17th and a possible renegotiation (most probably of the time line) of the conditionality imposed on Greece in exchange for the rescue package may give the country some breathing space. The new growth strategy agreed at the June European summit may also stimulate the Greek economy which is in recession for the fifth consecutive year a little. But even if all this happens and some political stability returns to Athens: the tasks the Greeks are facing are still immense. The question from the outside remains, of course, what can be done to help on top of providing credit.

The first and most important task is to stop all speculation about Greece leaving the Euro immediately and for good. Persistent discussion about a Grexit has slowed the inflow of necessary capital, not only into the bond markets, but also into the real economy. Effects are disastrous. There is a liquidity squeeze: businesses are not being granted credit and often cannot even buy necessary stocks. If investment is taking place at all, this is not to increase production because growth prospects are non-existent. It is mostly for re-configuring production in the face of disappearing sales markets. Thus domestic investment doesn’t increase GDP while foreign companies are reluctant to invest directly. So, a crucial part of the strategy to reinstall trust in Greece consists in stopping the debate on the country’s possible exit.

But what about the EU’s role in supporting the reform process – beyond conditionality (which many see as making things worse rather than better…)? Is there anything to do on top of what the troika and the task force do?  Well, two years of crisis management have made quite clear that the top-down approach to reform is bumping against limitations. Yes, further cuts, liberalisation and far-reaching public sector reforms are pending and need to be implemented. But the task is even larger. Reading and listening to Greeks on the deficiencies of their home country, one priority that emerges is a deep-running administrative and political renovation including an exchange of elites. This is required to put an end to corruption (see the bad records for Greece with Transparency International), clientelism and political cronyism. Such measures are necessary to improve the functioning democracy and to prevent populist parties with an anti-elite, anti-EU discourse gain more and more ground. And it is also a necessary step in the process of ensuring Greece’s return, one day, to a better economic situation. A functioning public administration is needed to improve tax collection capacities. Reasonably swift and reliable responses from the public sector are also necessary to get investment going once the price level has adjusted.

Such far reaching reforms can only be implemented by domestic forces; motivation needs to come from within the break up the structures, in particular when it comes to inducing cultural change both in politics and administration. A possible start is to focus energies on the local levels.

Dr. Daniela Schwarzer is head European integration research division, Stiftung Wissenschaft und Politik (German Institute for International and Security Affairs), Berlin.

The Political Crisis – A Better Europe Starts at Home

By Rainer Emschermann

 As market reforms and budget consolidation are meeting increasing political constraints, it is perhaps not surprising that the call for ‘more Europe’ has become louder. While such eagerness for the European project should be welcomed, it is not genuine but motivated by short-term interests of the political classes. Rising doubts about the determination of some eurozone countries to serve their debt should have sent governments rushing to show their reliability by sticking to rules and shoring up fiscal credibility. But far from it:

After receiving several hundred billion euro in emergency loans and debt relief, the Greek government still asks for more loans which it knows full well it will not pay back entirely. The Spanish government – while also requesting money from the EFSM and the ECB, no strings attached – affords itself a lower VAT rate than Germany, canceled its deficit target and delayed the recapitalisation of its banks for so long that the deadline agreed last October will be missed by those most in need of it. Failing to sustain reform progress, the Italian government had proposed behind closed doors that the ECB break the EU Treaty and finance the Italian budget directly from the printing press; until the European Council told the ESM to do essentially the same. Mr Hollande chooses to simply ignore concerns about both his country´s current account and public deficits being worse than Italy´s. Mr Cameron, representing the massive Southern European interests held by Europe´s biggest financial centre, demands Germany to underwrite eurozone debt but does not accept contributing a penny. Mrs Merkel, advocating austerity across the eurozone, has not proven her metal in a single such reform herself during her seven years in office. Finally, as for the Commission, it may be questionable if markets still consider it a credible guardian of the fiscal compact and the EU´s finances, after this institution was at the forefront of bringing down the no-bailout rule in all but form and is still proposing a large-scale mutualising of eurozone debt. Do you still think it´s a financial crisis? This is a political one.

As long as rules are constantly called into question, potential lenders, both private and public, must be forgiven to hesitate. True, it hurts if interest rates come back to the status quo ante, after a decade of cheap money, which saved e.g. Italy some 5% of GDP annually in debt service. However, to keep interest rates low, you have to show determination to consolidate and to serving your debt. It has worked in Latvia, is beginning to work in Ireland and it has not yet failed in Italy. Mr Monti’s only allies are the financial markets: there is no doubt that with the safety of eurobonds, Mr Berlusconi would be back in power within days.

The crisis resulted from too low interest rates and a collectivised risk through financial market interdependence. Taxpayers bailed out banks and insurances, with a strong national bias[1]. Europe´s recovery must start from here. It must not build on the wishful thinking that Spanish productivity would explode by 20% to re-align it with price levels; given the constantly growing Greek and Spanish external debt of over 90% of GDP, sustaining consumption will only perpetuate this at the expense of debtor credibility. Instead, for a lasting recovery the most basic incentives must be resurrected: Markets and interest rates must be allowed to differentiate between bad risks and good ones, between Greece and Italy. There must be rewards for reforms and consequences for failure, otherwise the latter will be externalised and accumulated in the eurozone. The departure of a country from the eurozone must not be a taboo; in fact, without such taboo, that is less likely to happen. The fiscal compact, seen as a tool of German hegemony, will create much bad blood without having real teeth; the June Council, which again loosened previously agreed conditionality, gave an idea of how things will work in real life. In the end also northern governments will succumb to the short-termism of the electoral cycle. But more integration, if it came at the price of a continuing gap between political responsibility and financial accountability, would be a far cry from the ‘bazooka’ calming financial markets; instead, it would weaken the EU – perhaps fatally.

All of this does not mean that there could not or should not be solidarity. But it must not come on tick. Instead, temporary interest rate subsidies could help, paid by those countries like Germany who are considered financial safe havens and are enjoying a better fiscal situation. This would maintain incentives for consolidation and at the same time help over the short term. Moreover, banks could be forced to re-capitalise from a capital ratio of 9% to, say, 18%. (For comparison: the Turkish banking sector holds an average capital ratio of 15%.) True, this would wipe out at least half of the capital value of current shareholders. But this is only adequate in a situation in which the European taxpayer has had to face so many bail outs.

This re-capitalisation, either with private capital or, above 9% and under tight conditions with the help of the ESM, would have to go hand in hand with the abolition of distortive incentives under the Basel agreement to favour banks holding of public bonds over private lending operations: it is not a bank´s business to provide liquidity to governments; citizens can do that themselves, as sovereign credit risks are transparent. Instead, banks should finance private sector growth. Next, banks must be forced to diversify portfolio risks, so that the interdependence between governments and ‘their’ banking sector – and thus the contagion risk – would be broken, as it should in a European internal market. Finally, the internal operation of the ECB system would have to be assessed in a similar fashion, including country-specific credit breaks or lower maximum mortgage rates, etc.

In short, exiting from the crisis requires a vision of a medium-term goal which needs to redress the economic causes that led into the crisis. Now, one may wonder why all of this is not happening. The most likely explanation is the most worrying: that short-term interests of the political actors prevail over those of (future) taxpayers: for a prime minister of a country in crisis, it is too tempting to blame the need for painful austerity on outsiders and ask for pain killers instead. For the German chancellor the tax financing of German solidarity with southern Europe is politically unattractive as long as she can painlessly bank-roll it. And as long as the prime minister of the EU´s biggest offshore haven presides over the Eurogroup, as long as France´s and Spain´s banks are most exposed to critical risks and can hope to be bailed out by the ESM, as long as the ECB president comes from Goldman Sachs and as long as the head of the IMF has her head on the line for dud loans to Greece, it would be naïve to expect tough action on banks. And too many European institutions are keen to ride a wave that appears to carry them to more influence. The upshot is that political energies are wasted while they are most scarce. It´s like in that recently popular Monty Python football game between Greek and German philosophers: Too many grand ideas, too little action where it really matters.


[1]German taxpayers, having bailed out German banks after the American subprime crisis, are again called upon to contribute to fresh bail-outs across the EU.

Rainer Emschermann is an economist and lives in Brussels.

Nobody Won in the Non-Final

By Ferdi De Ville

The Dutch were most clamorous, even a little arrogant, but eventually played no role and had to slink off. The English played defensive, achieved a minor success but were other than that largely ignored. Super Mario defeated Germany. Spain was the winner in the end.

For a euro-outsider, it must have been difficult and confusing during the past three weeks to distinguish the sports from the political headlines, to know when one was talking about the Euro Summit or the Euro Championship. Many comparisons between the football game and politics in Europe have been made over the period. Maybe the best one, was the following (illustrating the fallacy of composition in the argument that the rest of Europe should copy the German export growth model): in the Germany-Greece game, the Germans secured two-thirds possession of the ball, why couldn’t the Greeks do the same? Other analogies were hypothetical or indefinite. Was Germany kicking out Greece from the tournament in the quarter finals the forerunner of what inevitably will happen within the eurozone? Did the Germans lose two times from the Italians on the same night, first being eliminated by Mario Balotelli, and later defeated during the marathon-negotiations by Mario Monti?

Yes, as the last comparison makes clear, for all the nice metaphors, a crucial difference remains between football and politics. While in football it is clear who wins (if necessary after penalties), this is much less straightforward in politics. In the first hours after the Euro Summit agreement was reached, many, not least in Germany, deemed that Merkel had lost. However, this judgment has changed over the weekend (read for example FT’s Wolfgang Munchau). On Der Spiegel Online on Friday 29th June even two contradictory articles appeared, one entitled ‘How Italy and Spain Defeated Merkel at EU Summit’, the other ‘Merkel’s Tactical Victory: Smart Concessions from a Seasoned Negotiator’.

These conflicting verdicts are understandable. They depend upon one looking at the broad principles or the nitty-gritty details (or lack thereof) decided at the summit. On principles, it is true that some important changes have been decided, that look like giant concessions from the German side because they imply further joint liabilities. In the future, banks in trouble may be recapitalised by the European Stability Mechanism and the same ESM may buy government bonds of solvent and responsible countries that are nonetheless faced with runaway bond rates. However, the banking union will only come into effect after joint European oversight by the ECB has been established. And while countries may now receive ESM assistance without having to undergo humiliating troika screening, they will still have to sign a memorandum that will clarify their obligations in exchange for financial assistance. Thus, the German principle of ‘no joint liability without joint oversight’ has been upheld, while no further money has been allocated. The German negotiators did better in Brussels than their compatriots at the football pitch in Warsaw, pocketing at least a 2-2 draw.

This devil in the details is not only relevant to decide upon who won at last week’s summit, but also to decide on the success of the outcome in solving the euro crisis. For now, it seems that financial markets have welcomed the agreement rather positively. However, they have done so after several summits in the past, only to find the weak spots in the solutions some days later, leading to a further escalation of the crisis. This should certainly not be ruled out this time. It remains to be seen when (and if) the new European banking supervision system will come in place, allowing Spain to transfer the debt associated with recapitalising its banks to the ESM. But, more importantly, it has been noted by Paul De Grauwe that the ESM is much too small to perform its newly granted functions of bank recapitalisation fund and pro-active lender-of-last-resort for sovereigns, and that his may even accelerate the run on Spanish and Italian bonds. Only the ECB can act as a credible lender-of-last-resort and put a cap on bond yields of responsible sovereigns.

Thus, the euro crisis is for the nth time not solved after the umpteenth ‘summit of the last chance’, although especially the decision to cut the lethal link between national governments and national banks is an important step. It will, however, become clear that the ESM will need to be boosted, and that in the end it might only become credible with a banking license that allows it to tap into the unlimited resources of the ECB. This would boil down to Eurobonds in all but name, something that Angela Merkel has ruled out during her lifetime. In the meantime, the ECB might lower its interest rate, and maybe restart its Security Markets Programme, buying Spanish and Italian bonds on the secondary market.

We can expect the ECB to be more accommodating now that the Fiscal Pact is being ratified, and the euro-zone member states have agreed to make progress to implement Van Rompuy’s roadmap to full economic (including fiscal, financial and political) union to complement the monetary pillar. This was requested by ECB president Mario Draghi, who was one of the four drafters of the ‘Masterplan’. His co-ownership of this plan might render him more lenient in providing politicians with (much) time-as-money to establish this full economic and monetary union.

This plan finally looks like a strategy, a long-term vision that is rather the biggest than the smallest common denominator between German (and northern) and French (and southern European) interests and preferences. It is still too much focussed on austerity, and it lacks a real growth and social component. If the eurozone leaders could add these dimensions and agree on this strategy later this year, they might finally begin to resemble the Spanish squad: playing disciplined yet forwardly.

If one thing is certain, it is that last week’s summit was not the final of the euro crisis. And that nobody won, neither Merkel, nor Monti, Rajoy or Hollande. And also not the euro. While the European Championship (and football metaphors) ends here, this blog will thus go on.

Dr. Ferdi De Ville is assistant professor at the Centre for EU Studies, Department of Political Science, Ghent University where he teaches and writes on economic and monetary union and the euro crisis.