The EU summit: Will the center hold?

Posted By Stephen M. Walt Thursday, December 8, 2011 - 12:40 PM Share

On the eve of the EU Summit, Mark Sheetz offers the following commentary, which differs in some respects from mine. 

In several recent blogs on the euro crisis, Stephen Walt has expressed exasperation with European leaders and pessimism on the fate of the eurozone. His reaction is understandable and consistent with virtually all journalists and economists who study the issue. They are frustrated at the slow pace of European decision-making and the fact that a solution seems obvious. In recent days, demand for action has become nearly hysterical, with analysts, columnists, and editorial writers for the New York Times suggesting that time for a solution is "running short," that "the endgame is fast approaching," that the eurozone is facing a "meltdown," and that a collapse is "perhaps inevitable."

So, what is the solution? Conventional economic wisdom insists that either Germany acquiesce to some sort of bailout or the eurozone is finished. Germany must consent either (a) to the issuance of joint and severally liable Eurobonds or (b) to a policy of monetary easing by the European Central Bank (ECB). The problem is being treated as a technocratic economic matter.  Hence, technocrats have come to power in Greece and Italy. But the matter is essentially political and the crisis turns on central problems of international relations theory, like anarchy, sovereignty, and power.   

Economists believe that the basic problem of the eurozone is economic: that national economic imbalances can no longer be restored through the traditional method of currency devaluation.  But the problems of the eurozone are fundamentally political: (a) it expanded too fast, wider won out over deeper, (b) there is no commitment to common budgetary policies, and (c) there is no mechanism to enforce agreements.

The debate is congealing around two poles, a pessimistic pole predicting the breaking apart of the eurozone versus an optimistic pole of closer integration. The solution includes both. On the one hand, wide economic disparity among members of the eurozone will force weaker members to leave. Greece, as well as those countries that use the euro but cannot afford it (PIGS), will be cast off from the eurozone by a mounting centrifugal force.

On the other hand, the remaining members will converge on tighter economic policy along the German model. As a corollary to more restricted membership, those countries remaining in the eurozone will harmonize their policies regarding deficits and government pensions and achieve some sort of convergence in the major items affecting budget deficits. This will have the effect of bringing Europe closer together, or at least those countries that can achieve convergence. It may also create a more politically coherent Europe, with those remaining in the eurozone leading the European Union economically and politically. Such a situation might even give a common foreign policy the chance to develop and cohere around a small group of stronger European countries.

Some believe that a Greek expulsion from the eurozone will be catastrophic. They assume that a Greek default within the eurozone is manageable, while a Greek exit would make contagion worse. My own feeling is that contagion -- and the accompanying collapse of the European project -- would be the result of Greece staying in the euro, not the result of Greece getting out.  The recent evidence of market contagion to Italy and Spain appears to support this claim. A referendum in Greece would have cleared the air. It would have restored a stark reality that European leaders would not be able to evade. If Greeks had voted "no" on the referendum, Greece would have had little choice but to return to the drachma. That would have been a lesson to others. They would have recognized that they have only two choices: (a) converge fiscal and monetary policies or (b) press the "eject" button. The problem now is that European leaders may still think they can muddle through by patching up a country here and there. That will destroy the clarity exposed by a Greek default.

The divide, as usual, is between France and Germany over monetary policy. The French, along with their southern European allies in Greece, Italy, Spain, and Portugal, favor easy money, while the Germans, along with northern Europeans in the Netherlands, Austria, and Finland, insist on a tight money policy. Any hint of German capitulation to French demands of easier money will be the end of the euro. The first sign of wavering, the first inkling that a compromise is afoot, will signal to the markets that the floodgates for a river of euros are open, that fiscal and monetary discipline are history, that inflation will be rampant, and that the euro will be worthless.

Germans will not pay for the profligacy of their neighbors. Otherwise, where would it stop? Any concession towards easy money will only reinforce the "moral hazard" of further risk-accepting behavior. It is a story as old as Aesop: the ant and the grasshopper. Germany entered into the euro under assurances that all members would conduct their economic affairs responsibly. If this is no longer the case, then Germany will reserve the right to withdraw. A former British chancellor of the exchequer agrees, insisting that Germany would sooner withdraw from the euro than see its integrity compromised. Another (not insignificant) factor is the survival of Angela Merkel as chancellor. Any suggestion of Merkel wavering at the prospect of easy money is tantamount to political suicide. So all the speculation that the ECB or the EFSF will "stabilize" (rescue) the euro is so much folderol.

The power calculus, then, favors Germany. France will be dragged along kicking and screaming, but two points suggest eventual French capitulation. One is that Germany will otherwise threaten to secede from the euro, which would put France in a nasty competitive economic position. And the second is that, without the unity embodied in a common currency, French hopes of ever again exerting influence on the world scene will have evaporated. Europeans understand that they cannot meet global challenges as individual nations because they are no longer great powers. As President Sarkozy conceded, "If Europe does not change quickly enough, global history will be written without Europe."

The original path to the common currency was through a convergence of economic policies. Nations would have budget deficits of no more than 3 percent of GDP, and total debt of no more than 60 percent of GDP. If euro members had stuck to these criteria, they would be in dandy shape now. So a return to that mechanism, with additional penalties for non-compliance, might work. The problem is to create binding agreements.

On the question of enforcement, one possibility mentioned is an automatic increase in taxes to offset a budget deficit beyond acceptable limits. Other devices to ensure compliance with EU oversight of national budgets are available for the same purpose. These sanctions would be imposed by a central authority that can override national budget decisions. The European Court of Justice and the European Commission have been suggested as ultimate arbiters, but such supranational enforcement has its limits in a union of sovereign states.

Sovereign governments may oppose such measures for domestic political reasons. As long as sovereignty remains, national governments may negate previous agreements. Even within national governments, as in the U.S. Congress, existing legislatures may negate the agreements of previous legislatures. Therefore, a more severe penalty is required. 

The ultimate penalty for non-compliance is, of course, expulsion. The eurozone could expel any country that fails -- after a suitable time period -- to adhere to budgetary guidelines set forth in a new agreement. The ultima ratio of economic union is expulsion, just as the ultima ratio of politics is war. It lurks behind every decision as the final alternative.

So the demise of the euro, as a proxy for the EU itself, is not on. Neither is a consolidation on the German federal model. A big push for more Europe is not in the cards now. The loss of that much national sovereignty is unrealistic, given the immature development of a European identity. That is why convergence of fiscal and economic policies is the most likely outcome, not complete structural reform.

But convergence will not save the euro if member states refuse to comply with agreed guidelines. Both France and Germany violated the guidelines in 2003, breaking through the barriers of 3 percent budget deficits and 60 percent debt for more than a year. If the founding members of the eurozone fail to comply or to remedy violations within prescribed time periods, then the euro will well and truly collapse. In a union of sovereign powers, political will is the ultimate arbiter.

Mark S. Sheetz is an Associate in the International Security Program at the John F. Kennedy School of Government of Harvard University. He is currently writing a book on France, Germany, and the Transformation of Europe.  

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DIANA RELKE

7:25 PM ET

December 8, 2011

"This will have the effect of

"This will have the effect of bringing Europe closer together, or at least those countries that can achieve convergence. It may also create a more politically coherent Europe, with those remaining in the eurozone leading the European Union economically and politically. Such a situation might even give a common foreign policy the chance to develop and cohere around a small group of stronger European countries."

This is, of course, precisely what the European countries hoped to avoid. A more homogenous economy means a more homogenous culture. But economists can't be expected to understand that. When your worldview is shaped by the narrow prism of economics, cultural diversity is either an abstraction or a nuisance. And there are no such things as "values." There are only "interests."

 

SCOTTINDALLAS

2:55 PM ET

December 9, 2011

prof forgets his own lessons

"It may also create a more politically coherent Europe, with those remaining in the eurozone leading the European Union economically and politically. Such a situation might even give a common foreign policy the chance to develop and cohere around a small group of stronger European union."

This is a vacuous and tautological point, perhaps you need to re-write. The whole Eurozone can't be said to lead the union? I'd reckon that Germany and France will remain the larger players, principally due to their military and economic size. How this is any different than today is hard to find. Any country not sound enough to be in, and lead the EU won't do much on their own, save the Swiss who aren't in the union, and remain disproportionately influential, though their foreign policy doesn't really matter, just as Ron Paul's foreign policy has zero effect on the US gov't.

You accused the EU of growing too fast, though the PIIGS are not the new-comer outliers, your critique would suggest. Wasn't it the Balkins that were resisting the bailouts initially? They're sound, and they expect Greece to be. Again, in trying to sound eloquent, you diverged from the facts.

You wrote, "Germans will not pay for the profligacy of their neighbors." Yet, that's precisely what they've done in loaning the Greeks this money. In fact, if the Germans were not attached to Greece through the Euro, they'd be buying US treasuries, and the currencies and debt of their trading partners to suppress their own currency. Too few have written that if Germans had their own currency, they couldn't export anything. We fuss plenty about how China suppresses their currency, at some risk and expense to the Chinese themselves. But, too rarely do we look at Germany with the same lens. We must, and we see that Germany is living off the suppressed value of the Euro.

In fact, in a time of currency wars, it's not far fetched to think that some of this foot dragging by the EU isn't self serving. Or, at the very least, it isn't without it's silver lining. That is, it is a way to devalue the Euro, pump some money into the struggling regions of the economy. It's a crude tool, and far from ideal. But even here in the US where we have a better system, we fail to operate it in the optimal fashion. Here, lobbying and influence pervert our policies (as it no doubt does world-wide) and prevent subsidies going to poorer states while the better off states subsidize more homogenous growth policies.

Anyhow, this fight is more akin to Fed Governors battles. Germany would like to moderate economic accelerators, (they'd tighten money or stay neutral) where France would probably prefer some modest incentives, a looser monetary policy. Then, we have the other states more affected by the slowdown, they need aggressive policy. You portray these as genetic dispositions, but they also happen to have different needs, it's not a necessary condition that France would favor looser policies all the time, but for some reason you felt the need to make that assertion.

Again, you assume that Germany is an economic giant, but never point out that Germany is enjoying operating in a currency that is set at a lower value than is appropriate for them. This boosts their trading and exports, which is the principle driver of their economy. So, these calls for Germany to leave the Euro are vastly overstated. You really don't get it, if Germany fled the Euro, France would then be in the cat bird's seat and, while the Euro would fall, France would be the big peg setting the rate with a depreciation for her sickly sisters. Frankly, it would be better for the EU if Germany left, if we considered only the monetary valuation. Apparently you've missed the currency wars which are going strong, there's a reason nation fight these wars, there are very real interests involved.

You claim Germany is in position to determine the fate of the EU, while they have the dominant economy, I dare say France perhaps better represents the demos, and if she were to pull out, I think the EU would collapse. As I stated earlier, if Germany pulled out, it would be a monetary boon to the other members; and, that Germany can't afford to pull out.

I can't discern your conclusion from this equivocally equivocal piece, you seem to be arguing for the status quo. I would say that the status quo is one thing that CAN'T persist. Either the EU strengthens to involve a fiscal union, or it's gonna be a slow messy collapse. As with so many economic dissolutions, it would be better if the whole system would collapse so it can get rebuilt anew, but political and human nature tries to obviate those effects, prolonging the malaise.

 

NICHOLAS WIBBERLEY

8:48 PM ET

December 11, 2011

Scottindallas

The status quo will persist for a while. The final outcome may be up to the people but I don’t think anything much has happened so far. All this recent business was supposed to do was restore market confidence, which it hasn’t yet done. One crude but fairly reliable way to judge market response is the exchange rate between the Euro and the GBP. None of the European press is sanguine.

Trotzdem ist der Verhandlungserfolg teuer erkauft. Denn der Eindruck, dass hier 22 Staaten fest an der Seite Deutschlands stehen, ist falsch. Die meisten Regierungschefs folgen Merkel eher lustlos – nicht aus Überzeugung, sondern weil sie wissen, dass gegen Deutschland keine Lösung der Schuldenkrise möglich ist. Selbst diejenigen, die das deutsche Anliegen – mehr Haushaltsdisziplin – in der Sache unterstützen, zweifeln, ob dies der richtige Zeitpunkt und der richtige Weg ist.

From Die Zeit LINK

True a collapse would be messy, but would it be worse than the war? Ironic is Britain ended up rescuing France and the others yet again.

 

CHRISDORNAN

9:46 PM ET

December 9, 2011

very clever

It was very clever of Stephen Walt to put out this contrasting point of view.

For a while I was genuinely confused about who it was written by (the top line looked like a picture caption).

I kept concluding that nothing is making any sense!

As I said, an interesting contrast.

 

ALIBUTT007

5:37 PM ET

December 23, 2011

good

It was also unclear how the treaty would be enforced and whether some of the countries that signed on might end up dropping out because of resistance to budget cuts back home. Britain has refused to sign the treaty.

"Markets like quick fixes and have no patience with the length of the political processes," said Gianni Toniolo, a professor of economics and history at Duke University.

Italy held its last bond auction of the year on Wednesday and it didn’t go well. Investors demanded even more money to lend to the eurozone’s third-largest economy. Italy paid 6.47 percent interest to borrow (euro) 3 billion ($3.95 billion) for five years, up from 6.30 percent just a month ago.

The higher rates reflected investors’ fears over the inadequacy of last week’s agreement to keep eurozone governments from piling up more debt in the future. Italy has a staggering (euro) 1.9 trillion ($2.5 trillion) in outstanding debt, and its economy is too large for Europe to bail out. Greece, Ireland and Portugal have been bailed out.

European officials are scheduled to meet Thursday to work out the details of the treaty negotiated in Brussels, according to one European official who spoke on condition of anonymity because the talks are confidential.

The new treaty aims to impose tighter rules on how much money eurozone governments can spend. EU leaders agreed to limit deficits to 0.5 percent of economic output in regular economic times and to better enforce penalties against countries whose deficits rise too high.

The treaty will not be signed until March, at the earliest.

Several knotty issues must be resolved, including how budget rules contained in the new treaty will be reconciled with those in the basic treaty of the European Union, which remains unchanged. Another detail to be sorted out is whether countries signing on to the new treaty can legally rely on EU institutions, such as the European Commission and the European Court of Justice, to enforce its rules.

thanks
professional web design

 

STEVE HAROLD

7:22 AM ET

December 25, 2011

As the European crisis

As the European crisis continues to shake the common currency area to its very foundations, investors have been scrambling to reallocate portfolios in order to prepare for any future disasters. Yet, the final emergency that pushes the continent over the edge never seems to come, leaving the EMU teetering on the brink of collapse. Thanks to this never-ending situation that continues to dominate headlines, investors remain uncertain of how to position portfolios with European exposure heading into the new year. Yet, for those looking for a concentrated play on the continent, many might want to focus in on the most scrutinized sector of all, financials.

Financials have been severely beaten down over the course of 2011 as fears over a sovereign default caused many investors to sell off their holdings in a variety of euro zone-based banks. These institutions had, and continue to possess, immense exposure to government bonds from a variety of highly indebted nations suggesting that steep losses could be right around the corner for any bank that has heavy amounts of leverage. Despite this albatross, many banks in the region have seemingly stabilized or even gained in recent weeks, leading some to assume that there could be a turnaround heading into 2011.

Thanks.
Steve
CNA Certification

 

Stephen M. Walt is the Robert and Renée Belfer professor of international relations at Harvard University.

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