Financial markets will make an instant judgment on this week’s summit of European Union leaders, and it had better be favorable.
If the meeting stifles the recent panic and Europe’s bond yields subside, well and good. If the leaders keep vacillating or if the talks break down, the catastrophe that markets have been fearing for months could be upon us.
Those are the stakes in the first instance. Let’s suppose the best plausible case -- the one that markets seem to anticipate. The leaders announce new commitments to fiscal restraint combined with new arrangements for collective fiscal defense. The European Central Bank pronounces itself impressed and moves to backstop distressed public debt. This buys time and staves off disaster.
Yet this would leave vitally important questions about Europe’s future unanswered or even unaddressed. The depth of the crisis and the ineptitude of the EU’s collective leadership -- if one can call it “leadership” -- have conflated three distinct issues. Keep each separately in mind when asking, “Is this deal of any use?”
The first is how to stabilize Europe’s economy. The second is how to avoid a similar breakdown next time. Even more important is a third question, one that Europe’s leaders invariably ignore: how to secure the right of Europe’s citizens to hold their governments to account.
The nuttiest aspect of the current talks has been Germany’s insistence that the second question comes first. Conceivably, I grant you, this could make sense. You might say, for instance, that to lessen any future moral hazard, Italy’s debts should never be underwritten by the EU as a whole. That idea would be wrong, but it would at least be intelligible. And it would answer questions one and two together: no bailouts, now or in the future.
What’s unintelligible is to say, as Germany has up until now, that it might be necessary to underwrite the debts of Italy and other distressed countries -- but not until agreement has been reached on far-reaching EU constitutional reform.
It’s as though critics of the U.S. response to the financial crisis had said, you can have your Troubled Asset Relief Program, a big fiscal stimulus and an enormous unorthodox intervention by the Federal Reserve -- but not until we have written a balanced-budget amendment into the Constitution. Let’s talk about that for a while, spend a year or two getting it drafted and ratified, and then we can deal with the financial meltdown.
Putting logic and necessary haste aside, a further danger in bundling stabilization and long-term reform together is that both get compromised. Stabilization efforts are made to pay lip service to moral-hazard concerns, so they are timid, opaque and indecisive. At the same time, the scale of the emergency is a brute fact that will oblige corners to be cut on long-term fiscal reform. New rules amounting to little in practice are hailed as binding and far-reaching.
Remember the EU’s vaunted Stability and Growth Pact of 1997, which supposedly put limits on public borrowing -- and which Germany, by the way, violated? The same syndrome is evident today. Write a new rule now, worry about enforcing it later. This has been the hallmark of EU governance.
In the current crisis, Europe has tried ineffectually to support distressed sovereign borrowers through the European Financial Stability Facility, and the ECB has bought public debt on a small scale. In other words, the principles of no bailouts and no central-bank financing of governments have already been breached -- but too tentatively to make much difference. It is the worst of both worlds. Markets are led to expect public support (which creates moral hazard) and then the support is too puny to succeed.
Effective curbs on future public borrowing are certainly needed. That could hardly be clearer. But “tough” rules and “automatic” sanctions will be no easier to design and enforce than they have been in the past. Sanctions that might trigger a financial crisis, or that might bite during an emergency rather than long before, are obviously useless: however automatic they might be by design, in those circumstances they will be waived, and the markets will know it. The more this week’s agreement rests on such devices, the less useful it will be.
This is a puzzle that can’t be solved under crisis conditions. But once the danger subsides, I have a suggestion. In the future, it would be better to make an actionable (therefore credible) distinction between public debts that are jointly backed by Europe’s governments and public debts that aren’t. Markets need to believe that defaults on nonguaranteed debt will be allowed to happen. Only then will they discipline reckless borrowers by charging an interest-rate penalty.
To get the EU guarantee, a borrower should have to satisfy a creditworthiness standard and pay an insurance premium to other EU governments that increases according to its debt ratio. An essential further ingredient is to strengthen Europe’s banking system so that it could withstand a threatened default on nonguaranteed debt. This is unlikely to be much discussed by Europe’s leaders this week. Fiscally speaking, it is the most important reform of all.
A structure like this would discourage excessive new borrowing before it’s too late -- and without an EU technocrat or even a qualified majority of EU leaders denying a sovereign European government permission to borrow.
That is important because of the third thing I mentioned earlier: democracy. In principle and even more in practice, the EU has already departed from democratic values to an extraordinary degree. Policy decisions across a wide span of issues, by no means confined to development of the EU’s single market, have migrated to Brussels. Yet lines of democratic accountability still run mainly to national capitals. The EU has a parliament and all the other institutions of genuine democratic rule -- but the structure is hollow. It is a dispensation that no American would recognize as democratic.
Europe’s “democratic deficit” is acknowledged to be a grave problem not just by small-minded British Euroskeptics like myself but also by many of those who want a United States of Europe up there on the world stage alongside the United States of America. If democracy counts for anything, that deficit needs to be closed, either by strengthening the European voter or by diminishing the power of the European center. The deal in the offing at this week’s EU summit threatens to do the opposite.
It’s difficult to exaggerate how much this matters in the long run. The financial crisis has made plain how much Europeans have to change before they see themselves as engaged in a shared political enterprise. Far too much stress has already been placed on an insecure constitutional foundation. One day, something will break.
Whatever else happens this week, Europe’s leaders must avoid adding to the load.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
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