Divisions remain over euro reform

by Katinka Barysch

Europeans agree that the management of the euro must be improved to prevent future crises, or deal with them better if and when they happen. The European Commission is hopeful that it can get all 27 EU countries to agree on a package of reforms it published at the end of September. However, recent conversations in various EU capitals left me with the impression that divisions still run deep on crucial aspects of eurozone reform. Not everyone shares the Germans’ sense of urgency, and there is a risk that complacency sets in before a sustainable new framework has been created.

On September 29th, the European Commission published six draft laws designed to improve the management of the euro. The package foresees earlier and tougher sanctions on countries that break agreed limits on budget deficits and debt levels, new procedures for macro-economic co-ordination to avoid harmful imbalances among EU countries, and a harmonisation of the way EU countries draw up their budgets. The conclusions of Herman Van Rompuy’s taskforce on eurozone governance are expected to go broadly in the same direction. The Commission hopes that the proposed reforms can become law by the summer of 2011 – an ambitious timetable even by the Commission’s own admission.

So far, discussions have mainly taken place among finance ministers, either among 16 of them in the Euro Group or all 27 in Van Rompuy’s taskforce (a slightly enlarged version of Ecofin). Finance ministries tend to welcome strict EU rules, which help them to fend off spending pleas from cabinet colleagues. But the same unity of purpose does not exist among the EU’s heads of state.

In rough terms, the EU countries fall into two camps: a German-led one which puts the emphasis on strict rules and automatic sanctions to enforce discipline; and a French-led group of mainly South European countries that – although aware of the need for fiscal discipline – want more political wiggle-room for economic policy co-ordination that could require an effort also from surplus countries, for example by trying to boost demand.

France’s club Med is weaker than the German stability camp: members such as Greece, Portugal and Spain are in the dock and their voices count for less in the current debate. Italy traditionally punches below its weight in European policy debates; and Rome’s opposition to attaching sanctions not only to excessive deficits but also stubbornly high debt levels is a little too predictable (its own debt being the second highest in the EU).

The German camp looks firmer and stronger. Austria and the Netherlands agree on the need for tough spending limits and sanctions. So do the Nordics, including non-euro countries such as Denmark and Sweden. Most of the Central and East European member-states, having imposed fierce austerity programmes at home, are not afraid of strict rules. “We are Germany’s natural allies in this”, insists one Polish official. “That’s why the Germans are stupid to try and keep the East Europeans out of the euro.”

However, the German-led group is not as cohesive as it appears at first sight. The non-euro countries do not only want stronger rules for the eurozone. They also want to forestall the emergence of a two-tier EU where euro countries closely co-ordinate their economic policies while non-euro ones wait outside the door. The price most non-euro countries are willing to pay for this is to be bound by the tough new rules and even accept financial penalties. However, the EU treaties allow eurozone countries to agree on new measures and sanctions among themselves but not to extend them to non-euro countries. Some in Central Europe now silently hope that the euro reform debate will drag on for so long that they can slip into the euro in the meantime. Poland has added a long-standing demand to the eurozone debate, namely that the costs of pension reform be excluded from budget deficit numbers. Other EU countries could complicate the reform effort with their own idiosyncratic issues. The UK is in the special position that it wants stronger rules for the euro – knowing that another eurozone crisis would harm its exports and finance industry – but under no circumstances does it want to be bound by them.

Although Germany has so far dominated the eurozone reform debate, it still faces an uphill struggle to get all 27 governments to back new rules and penalties. A restive European Parliament will also have a say on some of the proposed changes. The most important condition for creating a consensus on swift eurozone reform is still for France and Germany to reach an agreement. Christine Lagarde, France’s finance minister, and her German counterpart, Wolfgang Schäuble, have put on an admirable show of unity in the euro debates. But it is not always clear in how far they speak on behalf of their bosses at home. Divisions between Germany and France still run deep.

French policy-makers and economists think that the single currency suffers from a design flaw: a lack of economic governance. Closer economic policy co-ordination, including on such things as tax levels and industrial policy, is therefore what the French government is aiming for. Most Germans think that the reason for the current mess is that existing fiscal limits were not applied properly [for the reasons why they should re-think see How to save the euro, by Simon Tilford]. Germans demand stricter rules not only at the EU level but also at the national level. They want other EU countries to emulate Germany’s new constitutional clause, which mandates all future German governments to run balanced budgets from 2016 onwards. Germans do not mind that this clause will give the country’s already mighty constitutional court a direct say in economic management.

Policy-making by judicial decree would be anathema to most French. For them, discretion is the essence of politics, at home and in the eurozone. “Leaders need to be able to lead, especially in a crisis. They should not tie their own hands”, says one of Sarkozy’s economic advisors. The Commission proposals already embody a compromise between Germany and France: the fines proposed by the Commission will bite unless a qualified majority of EU countries votes against them. For many Germans, that still leaves too much room for political cop-outs. For most French, the thought of the Commission deciding something so eminently political as fines is still hard to accept.

Another profound disagreement concerns the idea of bolstering the euro through a permanent crisis resolution mechanism. The Commission omitted this from its September reform package, which is looking only at steps that can be implemented without changing the Lisbon treaty. The Commission, alongside the French, also argues that the EU should first see how its €440 billion safety net (the European Financial Stability Facility) works before it talks about new institutions.

But Berlin is in a hurry. It refuses to contemplate extending the EFSF beyond 2013. And it will accept a permanent rescue fund only if it comes with a bankruptcy procedure for countries that can no longer service their debt. “Without a resolution mechanism, we will have endless bail-outs and no incentives for countries to run a responsible fiscal policy”, warns one German finance ministry official. He speculates whether the EU could use the treaty adjustment that will be necessary for Croatia to join the EU over the next couple of years to set up this new mechanism.

French officials argue that talking about a bankruptcy procedure for countries now would only spook the markets. Generally, the French do not appear to feel the same sense of panic about the fate of the euro that has gripped many Germans. “The euro?” asks one Paris intellectual somewhat tongue in cheek. “France suffers from an identity crisis! It fears about its role in the world, its traditional dominance of Europe, its social model, even its way of life.” While France is concerned about losing its AAA credit rating and being ‘decoupled’ from the German economy, it has been less pro-active in the euro reform debate. Without a sense of urgency, France and Germany are unlikely to make the concerted effort that is still needed to get all EU countries to support a comprehensive reform package. The spectre of an EU lurching from crisis to crisis has not been banished.

Katinka Barysch is deputy director at the Centre for European Reform