VoxEU Column EU policies

A no-further-bailouts principle

Solving the EZ crisis will almost certainly involve some financial transfers in exchange for some loss of sovereignty. This column suggests a guiding principle for which policies should be under EZ control. Transfers of authority to supranational bodies must make a no-further-bailout clause credible.

Angela Merkel is right. There can’t be solidarity without control. She is also using the right words – “solidarity” and “control”.

Whatever rescue package is ultimately agreed to prevent the collapse of the euro, it will unavoidably involve some ‘solidarity’ transfers from triple-A countries to zero-A countries. The transfer can be concealed to please public opinion, just like transfers to French agricultural workers under the Common Agricultural Policy have long been presented as generic subsidies to exporters and to environmental protection in rural areas. But whatever it is called, it will be a transfer.

The switch from the EFSF (European Financial Stability Facility) to the ESM (European Stability Mechanism) has nothing to do with the size of the two funds. The ESM will at most mobilise €500 billion, 60 more than the EFSF. But contributions to the ESM (in addition to the initial €80 billion) will be guarantees or callable capital not formally increasing the public debt of the different countries. However, these contingent liabilities are still liabilities that would materialise in case some country cannot pay its debt. Call them contingent transfers, but still it is solidarity or contingent solidarity.

Control is also the right word. Any sizeable transfer requires a change in the allocation of tasks within the Eurozone with a stronger role attributed to supranational authorities.

The transfer of control is ultimately imposed by German voters who continue to award very high approval ratings to Merkel in her conduct of the EZ crisis. Those arguing for unconditional solidarity are asking the German Chancellor to ignore these sentiments.

She could actually try to save the euro without saving her post, agree on solidarity without control, and then not run for re-election in 2013.

  • But even supposing that the checks and balances of the German constitutional system do not prevent her from acting as a kamikaze, would markets consider it as a commitment to a future line of action of Germany?
  • How can markets be reassured that the new government will not undo the decisions of made by Merkel at the end of her mandate?

It is true that she failed to prepare public opinion for the trade-offs involved by the euro rescue strategy, but it is too late now for her to prepare voters to support such a radical change in her strategy.

The type of sovereignty transfers necessary

The real issue is then what types of transfers of sovereignty are required. These must:

  • Reassure the Germans, the Finns and, more broadly, the taxpayers with the triple A; and,
  • Be acceptable to the countries at the epicentre of the EZ crisis.

It is not true that the countries facing a credibility crisis have no bargaining power. They are already getting very close to hitting their outside option.

Austerity without progress in reducing the interest spreads is making the situation unsustainable. This recession in Southern Europe is way more painful than the Great Recession. It is entirely driven by a fall in domestic demand (while in 2008-9 it was driven by falling exports) and is associated with significant falls of disposable income (which did not occur 3 to 4 years ago even in the countries experiencing the largest output losses).

Under these conditions, a euro exit scenario may well become majoritarian if the rescue strategy is perceived as too demanding in terms of loss of sovereignty. Imposing conditions that are too tough could backfire. This is, after all, a historical lesson of another Treaty, the Versailles Treaty, that neither French or German voters would forget.

Browbeat Hollande and Rajoy as well as Merkel

However, I see far too many attempts to exert moral suasion on Angela Merkel, and no effort in trying to persuade Francois Hollande and Mariano Rajoy that they should give up some authority and prepare their public opinions to this event. Leaders at the beginning of their mandate can affect voters’ preferences and even if they do not succeed in this, they can be credible while running against sentiments which are majoritarian in their constituency. They will have enough time to explain why this unpopular choice was necessary, and how it did prevent a far worse outcome.

The sovereignty shifts needed: Making ‘no more bailouts’ credible

Here is a criterion to select the kind of control which must go hand in hand with solidarity: there ought to be the transfer of authority to supranational bodies sufficient to make it possible in the future a default even of a large state without causing the collapse of the Eurozone.

  • A “no further bailouts” clause must be credible under the new allocation of tasks between national and supranational authorities.

This would reduce moral hazard, reassuring taxpayers both in the north (they no longer will have to intervene to save the overspending crickets) and the south (their politicians will be forced to behave as ants, saving for the future).

This is the lesson from American history. A bailout of sovereign states (like the one decided in 1790 by Alexander Hamilton) must involve a regime change preventing a new bailout in the future (like in the 1840 decision of the US Congress not to allow for a new federal bailout).

Which types of delegation of authority are needed?

One of the pillars of the so-called banking union is perfectly aligned to this principle.

  • The ECB should be fully in charge of surveillance over all EZ banks (not only the largest ones).

This means after all that a default by a state in the Eurozone needs not be followed by a collapse of its banks.

Another change in the allocation of tasks consistent with a no further bailouts principle goes deeper.

  • The EZ needs to set and finance a minimum-income scheme at the level of the Eurozone.

This implies that, when a EZ nation goes bankrupt, there is still some transfer preventing absolute poverty, just like in the US the default of the State of New York or of California does not prevent food stamps and welfare checks to be supplied to the most needy people, wherever they are located.

Another delegation of authority consistent with a no further bailouts clause is related to allowing adjustment via migration.

  • The removal of legal barriers to the mobility of people within the Eurozone may require the adoption of a common migration policy vis-à-vis third countries as a single market for labour also implies truly common borders.

If free mobility is actually granted, a EZ nation can default while leaving to its citizens the option to migrate and work elsewhere in the EU.

  • Another transfer of control consistent with a no-further-bailouts principle relates to a common administration and enforcement of the value added tax.

In addition to reducing cross border frauds, this would give to supranational authorities a rather powerful political penalty against governments having a poor record in reducing their debt. They will be visibly forced to tax more their consumers. This political penalty would come together with a fiscal devaluation which would also work towards reducing the gap between the modern-day equivalents of the ant and the grasshopper in Aesop's fable.

There are clearly other forms of delegation of authority or loss of control of national Governments which are consistent with a no-further-bailout principle. As the above examples indicate, they do not require a transfer union. The world has plenty of federations that involve a very modest redistribution across states. Brazil, India and the US, to give just a few examples, all belong to this category.

What matters now is to discuss pragmatically what will be the new allocation of tasks taking us out, together with solidarity, from the EZ crisis. Talking about economic and political union without redefining who should do what is nonsense.

The document of the four presidents (Van Rompuy, Barroso, Juncker and Draghi), presented ahead of the June 29 Summit, was just too vague to be effective. No surprise that it was completely ignored by the final statement issued by the leaders of the Eurozone. Apparently it will become an issue paper for the fall meetings. Let us hope that they are honest in presenting the trade-offs involved in any rescue strategy and that it will not be too late to talk about them.

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