Europe’s deepening muddle

By Ashoka Mody

former mission chief for Germany and Ireland at the International Monetary Fund, is currently Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs, Princeton University.

German Finance Minister Wolfgang Schäuble recently declared that the European Union has "moved sovereignty to the European level" - a startling claim, given that European governments seem to be pursuing their national interests more aggressively than at any time since World War II. Was Schäuble's statement supposed to serve as a rallying cry for greater European solidarity? Or was it just a ploy to deflect calls for a larger German contribution to the eurozone's recovery?

Schäuble is at the forefront of Germany's efforts to lead Europe without having to pay its bills. To this end, he has called for EU treaty changes to establish a European "budget commissioner" with authority to spend shared European funds and reject member countries' fiscal strategies when they do not comply with established rules. According to Schäuble, negotiations for such reforms should begin immediately after the European Parliament election in May.

While Schäuble's strategy may sound appealing, it is, at best, the symbolic garb of progress. For starters, the common funds are meager, with no prospect of being increased - not least because of Germany's unrelenting opposition. Likewise, so long as member countries maintain fiscal sovereignty, a new mechanism to facilitate finger-wagging at countries that defy European budget rules will change nothing. Over the last two decades, every effort to discipline the EU's fiscal delinquents has failed, owing to the lack of enforcement authority.

Of course, when a country has run out of options, it will play along to gain access to official bailout funds. But, as Greece's experience has demonstrated, this does not always work out as planned. Indeed, the Greek bailout - jointly funded by the EU and the International Monetary Fund - began disastrously as it delayed a much-needed debt-restructuring and demanded strict austerity. As a result, the influence of extremist political forces has grown, and a public-health tragedy is brewing. Yet Schäuble, in a seemingly interminable quest for more austerity, views Greece as a model for an even more hapless Ukraine.

Europe is in a muddle. With debt restructuring essentially ruled out and without out a sizeable, politically-sanctioned central budget to relieve countries in distress, Europeans have anointed Germany as their presumptive hegemon. Germany relishes that role, but is not able to play the part.

Simply put, Germany is unwilling to spend its taxpayers' euros to bolster Europe. The robust German economy is little more than a memory at this point. Annual GDP grew by more than 3% in 2010 and 2011, because a still-booming Chinese economy was sustaining high demand for German machines and cars; but, as China's GDP growth has slowed, so has Germany's, to an annual rate of less than 1%. This is likely to improve slightly, but Germany's aging population means that its economy faces low potential growth in the long term.

With Germany lacking the economic dynamism to support Europe financially, its leaders have been unwilling to take political risks. The country's two major political parties - the Christian Democrats and the Social Democrats - sidestepped a public dialogue on Europe in the September 2013 election that produced their governing coalition.

More revealing is Schäuble's defense of the European Central Bank's "outright monetary transactions" scheme (which would permit the ECB to purchase unlimited amounts of weaker eurozone countries' government bonds). Even as Germany's Bundesbank fiercely (and rightly) opposed the OMT program for its focus on countries' solvency, rather than liquidity risk - thus creating a backdoor fiscal union - the government was relieved that the German Constitutional Court, assessing the scheme's legality, ultimately passed the buck to the European Court of Justice. After all, establishing a genuine fiscal union would require strong political commitment - and considerable legwork.

The EU is an inspiring political structure that seeks to break the mold of the nineteenth-century nation-state. But progress toward that idealistic vision cannot continue to depend on shopworn symbolism. The euro was the most audacious of those symbols - a construct of dubious economic value, with well-documented fragilities. Its adoption was an act of economic hubris that has imposed costs well beyond Europe's borders.

Today, European leaders are indulging in triumphalism, viewing the current economic reprieve as a validation of failed transnational governance structures. But the depth and persistence of the ongoing crisis have exposed the euro's fundamental fragilities, and should serve as a warning that today's technocratic Band-Aids may not hold in the face of another shock.

Unfortunately, bold action to address these fragilities seems more distant than ever. Relinquishing some control over national budgets to achieve fiscal integration appears politically impossible, and talk of treaty changes - even if it comes from the German finance minister - amounts to little more than empty rhetorical finery.

Adopting the euro was a mistake. But the damage is done, and precipitously abandoning the common currency would only make a bad situation worse. With countries unwilling to cede sovereignty, Europe's only option is to dump the pretense of centralized coordination, leaving countries and banks to deal with - and be disciplined by - their creditors. A step back to this more stable arrangement may offer the only way forward.

Copyright: Project Syndicate


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