European leaders will meet tomorrow and Friday for the EU summit in Brussels, which has been billed as a “make or break” event that will determine not only the fortunes of the eurozone, but of the global economy.
Once again, all the items on the agenda concern the financial and economic crisis that has hit the periphery of the currency union, which is now threatening the core.
The world watches. The crisis is not just a European affair: the economic downturn in Europe is already affecting the US and China. If the euro collapsed, then the European countries would fall into even deeper recession, with potentially global implications. Will the summit be able to achieve concrete reforms to solve the debt crisis, or will it prove to be a frustrating exercise in futility?
What do Europe and the euro need?
At this stage of the crisis, Europe and the euro need three main things.
First, the “growth compact” should be more strongly emphasised. So far, the EU approach to the crisis has mainly focused on fiscal austerity. This is understandable, given that the crisis was initially triggered by excess debt and fiscal instability in the peripheral countries.
However, these countries have already adopted harsh austerity measures. Further austerity would push them even more into recession and result in additional sacrifices that citizens are unprepared (and probably unable) to make.
For a durable solution of the crisis, fiscal austerity must be accompanied by economic growth. But promoting growth might require actions that are the responsibility of national governments, rather than the European Union.
Take the case of Italy. The country needs structural reforms in areas such as public administration, labour market legislation, and the justice system. Only national authorities can initiate these reforms and, if they do not do it, then there are no fiscal austerity measures which can drive Italy out of the tunnel.
Second, Europe needs a step forward towards greater fiscal integration. In the longer term, the currency union must be backed by a fiscal union. In a shorter term perspective, fiscal integration can open up ways for peripheral countries to consolidate their budgetary stances while accessing finance at an affordable cost.
However, from a political perspective, a fiscal union is a challenge even bigger than a monetary union. In a fiscal union, countries give up a large chunk of their sovereignty. Furthermore, a “federal” fiscal policy cannot be decided by a supranational entity with little political accountability, as instead the European Commission currently is.
This raises the issue of political unification, shifting the debate to an entirely new level. Especially now, with many European citizens blaming the euro well beyond its true weaknesses, talks of political unification might find strong opposition.
Third, Europe and the euro need concrete, immediate actions in support of peripheral countries. Greece has a new government willing to maintain the country in the currency union, but also keen to renegotiate the timeline for the implementation of fiscal austerity. Spain has officially requested financial support to inject capital into its shaky banking system. Cyprus has also put forward a request for financial support to its banking system. For Italy, the cost of raising finance remains very high; the recession is hitting hard on households and firms; and the stock market is extremely volatile and weak.
All these are situations that do require quick interventions. It appears that no major decision will be made on Greece at this EU summit, as the representatives of the troika (EU, ECB and IMF) still have to visit the country, re-assess the situation, and report to the EU and the IMF. For Spain – and probably Cyprus as well – there were clear signals last week that the EU was prepared to supply capital. Italy, in addition to the reforms previously mentioned, would badly need a mechanism to refinance its debt at an affordable cost.
What can the summit deliver?
Many observers anticipate that the summit will focus on the report drafted by Mario Draghi (President of the European Central Bank), Herman Van Rompuy (President of the European Council), Jose Manuel Barroso (President of the European Commission), and Jean-Claude Juncker (President of the Eurogroup). This report is believed to articulate a plan to strengthen fiscal integration within the union.
According to this plan, the European Commission would be given strong powers to oversight, monitor, and eventually amend national budget laws. Countries would annually agree on fiscal targets. Deviations from such targets would entail penalties in the form of monetary sanctions or even the obligation to surrender the control of domestic fiscal policy.
These provisions would be the necessary precondition for issuing joint debt instruments. While eurobonds were again rejected by the German Chancellor Angela Merkel just a few days ago, the report might relaunch the idea of eurobills.
These are common debt of maturities of less than one year. They would be issued by a joint debt management office and constitute joint-and-several liabilities of all participating Eurozone countries. In this regard, eurobills would be somewhere in between issuing eurobonds and not issuing any joint debt at all.
A plan like that would not meet all of the needs of Europe and the euro. But it is unlikely that any plan could satisfy all of those needs at this stage.
Indeed, the plan would be a step towards greater fiscal integration. It would provide a mechanism to consolidate fiscal stability while also allowing peripheral countries to access an instrument to raise finance at a reasonable cost. It might even create some policy space to undertake reforms for economic growth, even though the type of reforms that peripheral countries mostly need are more a matter of domestic political will than availability of finance.
The plan would also send a signal. EU leaders have been criticised for being unable to take strong measures to redress the situation. A robust set of provisions that are not exclusively about fiscal austerity measures would provide much needed leadership.
Is the plan likely to be endorsed? Fragments of information filtering from the preliminary meeting of the EU Ministries of Finances seem to suggest that the initial draft of the report will be watered down at the summit.
Still, there is good hope that countries might find a compromise around something similar to the plan described above. Germany should be willing to support a step in the direction of greater fiscal integration. A Sarkozy-led France could have found it difficult to accept provisions that delegate to the European Commission the power to control and modify national budgets.
But President Hollande might be more willing to accept, especially in exchange for eurobills (and maybe eurobonds in the not so distant future) and stronger banking surveillance at the European level. Peripheral countries should also be in favour of a proposal that links fiscal integration to the possibility of issuing joint debt because this would relax some of the pressure on their own debt. Italy, in particular, should back the plan quite strongly.
So, this summit can indeed have an impact on the crisis. If it were to fail, the same might not be true for future meetings.