About the pseudo-Fiscal Union and the actual Fiscal Control

2011-12-07

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended. Information may be out of date. For further questions contact me.

German Chancellor Merkel has repeatedly stated her determination to change the EU Treaties, to finally create a “fiscal union” in the EU. The willingness to amend the Treaties in order to reach that goal was also expressed in the last joint press conference between Ms. Merkel and French President Sarkozy, on December 5. The issue will play a central role in the upcoming Euro summit starting tomorrow Thursday, December 8 which is expected to end on December 9. Given that a political decision among all European leaders will be finalized in the summit, it would not be wise to reject or accept the proposed Treaty changes a priori. Yet it would be worth shedding light on how Ms. Merkel and Mr. Sarkozy conceive this “fiscal union”.

Ever since the crisis erupted in th eurozone, the rhetoric regarding its causes has always been that profligate spending of certain states was the Achilles Heel (the weak spot) of the single currency, that allowed for the spread of the crisis all across the euro area (“contagion” as they call it) that has been threatening the Euro with destruction. Though it is absolutely true that certain states spent more than they could afford, it is misleading to put the blame for the crisis in the eurozone to these states, as that omits the excessive leverage of Europe’s private banks and the institutional gaps of the euro architecture with one of them being the absence of a genuine fiscal union, while another major flaw was/is the structural trade imbalances between peripheral and core countries (which is what mainly creates all this imbalance and negative dynamics).

This rhetoric identified excessive spending as the main problem, hence the cure exists in ways of reducing and controlling such spending. Understandably the most logical suggestion would be to enforce stricter rules over budget control, by including provisions to control deficits and debt within national constitutions. This is in fact was Ms. Merkel has been calling for and this is how she envisions a future fiscal union – a union where states will be constrained by constitutional law to exceed certain limits. Two questions need to be answered here. The first is how will these “golden rules” lead us out of this crisis? And is a “disciplined union” really a fiscal union?

The answer to the first question could go as follows: States will commit their selves to fiscal discipline, hence markets will restore faith in them and start lending them back again at affordable rates. But if that was the case then the crisis could have been solved with relative ease as they would agree from the beginning to implement such rules, instead of venturing into the creation of dubious mechanisms such as the EFSF, in toxic bailouts, inane austerity etc. all of which have proven to be ineffective in containing the negative dynamics of the crisis. For argument’s sake let us assume that tomorrow Greece or Italy vote for such amendments to their constitutions. Will that cure all the malignancies of their economies? Will the recession be killed off and people start spending again? Will banks find all the capital they are in desperate need of? Will that make their existing debts sustainable? After all why would investors show trust in a constitutional law, when we have the recent real world example of the debt ceiling in the United States that was raised to allow the state for some additional debt to cover whatever expenses it had to? Can’t states just vote on expanding that “debt ceiling” should the circumstances offer no other alternatives? All these and many other questions do not leave any space for optimism, should they be answered.

On the second question: Is a disciplined union really a “fiscal union”? The answer here is a straightforward “No”. What Merkel calls a fiscal union is nothing more that a framework of fiscal control, in the German understanding, over all member-states. I am not examining if this is a sound approach or not, I am only talking about the substance. A fiscal union would imply a series of reforms in the architecture of the euro, such as the creation of a surplus recycling mechanism that would counter-balance the structural trade imbalances across the eurozone; a unified banking sector, since now private banks fall under different laws in each state; a common treasury with jurisdiction over the exact same area the ECB has, with powers to raise revenue and issue bonds on its own accord. In the calls for a “fiscal union” no surplus recycling mechanism exists, no common treasury, no reforms in the banking system; only stricter rules.

European leaders are about to meet tomorrow to discuss ways of amending the EU Treaties so as to pave the road for a “fiscal union”. In truth such “fiscal union” does not exist in the plans since all they are talking about is how to make the budget rules more effective – stricter. Though this could be a very prudent way of avoiding future crises, it does nothing at all to address the current crisis.

These are some first thoughts on the proposed Treaty changes. Again I repeat I am not arguing whether these stricter rules are helpful or not, I am only pointing out that this has nothing to do with a genuine fiscal union. I shall elaborate in full on the matter once the upcoming summit is concluded. As a final comment I would say that European leaders are still hiding behind their finger, as they seem incapable of addressing the systemic crisis, systematically.