The German-French Proposal: too late – too little – incomplete – wrong direction!


 On Dec 7, 2011 Angela Merkel and Nicolas Sarkozy wrote a joint letter to Council President Herman van Rompuy (who himself had proposed the establishment of Eurobonds) to detail their proposals for the Thursday/Friday Summit:

         They once more propose the establishment of a “new Stability and Growth Union”, mainly consisting of stricter national budget control. The previously threatened automatic sanctions are gone, a qualified majority can also derail the increasingly intense outside interventions in national budget sovereignty.

         Violators of the 3% rule will be forced to conclude a “European Reform Partnership” with the Commission (on behalf of the Eurozone) which include exclusively fiscal (budget savings) and structural measures. Implicitly, France and Germany believe the supply-side dogma that economic growth flows from a balanced budget and “structural” reforms. No recognition, no talk about balance of payment imbalances and their resolutions.

         A future participation of private sector banks (“haircuts”) in restructuring sovereign debt is excluded. Explicitly, Greece is named in this respect as a special case, not to be repeated. All Euro states have committed to service all their sovereign debt completely. Why then do Merkel and Sarkozy propose to include collective action clauses (for the case of sovereign defaults) in future emissions? This is a sensible direction per se, but inconsistent with the no-default option.

         They propose to speed up the establishment of the permanent Stability Mechanism. Some commentators say that they will also propose the ESM to obtain a banking licence – which would enable it to receive (unlimited and cheap) money from the ECB (also sensible).

 

There are a lot of nice words in the preamble, that finally the crisis must be solved and further crises prevented. Still, the proposals are rather disappointing, because they still mirror the German obsession with budget discipline (if slightly reduced). A number of  important issues are not included:

         No mentioning of Eurobonds or joint liability for sovereign debt. Ostensibly Merkel and Sarkozy expect the ECB to be more generous in its financing, once their proposals have been adopted. But in order not to give the (taboo) impression that the ECB needs to be involved in a European solutions, it is not mentioned once.

         Martin Wolf of the FT outlines that the old or new fiscal criteria (3%, 60% rules) would not have caught any of the crisis country, apart from Greece. Thus he concludes, and I concur, that also the diagnosis that the sovereign debt situation is the cause of the crisis, is incorrect. It is rather the balance-of-payments imbalances which lie at the bottom of the crisis. They depict both private and sovereign surplus and debt positions, and not solely the sovereign ones. A number of crisis countries has run budget surpluses or low deficits before the crisis, but all of them had heavy current account deficits which proved to be unsustainable.

         In substance, this means that the necessary adjustments within the Eurozone (towards the rest of the world the Eurozone, as well as the EU are pretty much in balance) need to involve both the private and the sovereign sectors, and both the surplus and the deficit countries. Thus deficit countries need to regain competitiveness and growth via, broadening of their economic base, low wages and low price increases (or deflation) and a strengthening of their growth potential, plus budget discipline; surplus countries need to strengthen their total domestic demand side by relatively higher wages and price increases, thus higher consumption and investment expenditures. If a currency union has balance with the rest of the world, but large imbalances internally, difficult adjustments need to occur both on the surplus and the deficit sides – without endangering the outside balance.

         The letter contains nothing on a European banking supervision, on the need to reduce derivatives trading, on the separation of (casino) investment banking and commercial banking, on the need to prevent too-big-to-fail institutions, and other financial sector measures.

 

In short: This letter, the result of negotiations between the two largest Eurozone economies, will not contain the crisis and will not prevent future crises. Both negotiators compromised on their own (insufficient) proposals, but did not come up with a comprehensive package. It can be predicted that the (toned-down) German stability mania still dominating this proposal will not solve the crisis. It might afford a number of calmer months in the financial markets, but does nothing to get at the roots of the crisis. Everybody knows now that budget discipline is important, but everybody also should know that budget discipline is not everything. Spain and Ireland (plus a few others) could fill evenings relating their respective stories.

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4 Comments

Filed under Crisis Response, European Union, Financial Market Regulation, Fiscal Policy

4 responses to “The German-French Proposal: too late – too little – incomplete – wrong direction!

  1. David Evans

    Well, maybe the example of labor mobility is not the best example but, the point is: How can the Euro survive in the 17 countries of the Euro zone without full economic integration? The plans outlined by Merkel/Sarkosy mandating good fiscal governance are just the beginning and in the classic tradition of the European Union may be complicated, bureaucratic and fraught with obstacles. Europe’s crisis is both political and economic. It may stem from a legacy of overborrowing but, it reflects a lack of political will of the financially solid nations like Germany to united behind their troubled neighbors like Greece and a lack full economic integration within the currency union.

    • kurtbayer

      That is what I have always been saying, i.e. that the present crisis is more a political than economic crisis. This is the reason why in spite of better data (debt ratios) the EU is rated much worse than the US and Japan.
      You don’t need full integrationm, but certainly more than budget surveillance and monetary policy. I always plead for tax policy, for some kind of growth policy to pay the debts off, and others. So far only foreign trade and agriculture are common policies – this is obviously not enough.
      Let us see what Merkozy (and the 15 dwarfs) will come up with tomorrow.

  2. David Evans

    Good analysis and fundamentally correct.

    It is a very good point to note that, “Everybody knows now that budget discipline is important, but everybody also should know that budget discipline is not everything.” Nevertheless, it is perhaps a somewhat limited perspective and it maybe important to outline what are the other factors that must be addressed if the Eurozone is to solve its problems.
    Seen from the perspective of the United States, the Eurozone is not really an economic zone with the requisite procedures or “mind set.” Two issues deserve some attention: labor mobility and willingness to solve European problems with collective action. In the case of the former, Greek unemployed workers find it very difficult to migrate to low unemployment areas like Germany, while “rust belt” workers in the state of Michigan can move easily to the booming oil fields of west Texas. The lack of labor mobility seriously inhibits poorer southern European nations from overcoming their economic problems. Second, the “have” or surplus countries of northern Europe seem loath to assist the southern or deficit countries, while the relatively wealthy state of Massachusetts willingly assists the relatively poorer people of Mississippi. Somehow Germany can invest trillions of Euros in the former East Germany but is relatively unwilling to address the similar demand side problems of southern Europeans?

    The Eurozone needs budget discipline but it also needs to look at a host of other issues if it wants the Euro to survive.

    • kurtbayer

      Yeah, I agree on the second point: solidarity is not there, nationalism on the rise. Also German politicians were ranting against “using hard-earned German money to support lazy Greeks”, even though Greeks retire later than Germans, etc., etc. But the former? Do you know how many Portoguese and Greeks and Italians and Spaniards work in Northern and Central Europe? Austria’s workforce, e.g. is more than 10% foreign-born (however, Turkish and Serb/Bosnian). So migration within Europe is barrier-free, however, of course, you do have language barriers and cultural barriers (which you do not have in the US). Thus, the oft-repeated call for more labor mobility in Europe is not really right. But there, also, recently an anti-immigration sentiment has set in (like in the US where some states, I hear, exclude illegal immigrants from healthcare and school attendance, drivers’ licences, etc.).
      So, let’s hope for the best: I am still optimistic, but less so every day

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