Europe: ‘More’ or ‘less’?
The future shape of the EU
An Oxford Analytica Open Conference Call, November 17, 2011
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Call summary
Since the start of the euro-area crisis, leaders of the currency union’s 17 member states have been united in their response: a disorderly default and/or exit of a member state from the euro-area would be tantamount to the end of the euro and spell the failure of the European project. This unity shattered at the end of October, when former Greek Prime Minister George Papandreou announced that he would hold a referendum on the second Greek bailout. German Chancellor Angela Merkel and French President Nicolas Sarkozy responded that Greece could be allowed a disorderly default and that the Greek people must decide in the referendum whether to remain in the euro and the EU. Reports then emerged that Merkel and Sarkozy were meeting with heads of the main EU institutions to explore the creation of a smaller, core euro-area. The French and German governments denied this, claiming that they want more Europe, not less, yet at her party’s conference this week, Merkel unveiled her vision to “complete economic and monetary union and build political union in Europe.”
Appropriate crisis resolution
The German plan is:
- to keep the euro-area intact with its current members;
- to bridge the financial crisis until 2013;
- to provide lasting mechanisms based on the German model of fiscal discipline; and
- to keep responsibility for this discipline within the 17 member states.
However, if this doesn’t work, Germany is also preparing a ‘Plan B’ for a multi-speed Europe, with smaller membership in a tight-knit economic and monetary union. This means that some member states could withdraw voluntarily from the euro-area. Who is in and who is out is a larger question. There is divergence among the larger states: the United Kingdom is calling for ‘less’ Europe and Germany for ‘more’.
Models for change
There are three realistic models for change:
- Enhanced status quo. A euro-area of the same size and the same rules, albeit enforced (as opposed to the first ten years of the euro, when hardly any member states obeyed the Maastricht rules).
- Major treaty reform. This would result in centrally imposed fiscal discipline under new rules.
- Euro exit for some members. This would occur on a voluntary basis.
Where the difficult economies are concerned, under either model, the key questions are whether will they show understanding of what needs to be done -- and whether they are in it for the long haul. The fundamental question is one of tolerance for austerity.
Greece’s challenges
Prime Minister Lucas Papademos will need longer than from now until February 2012 to safeguard the financial viability of his country. Greek citizens are expressing both reform fatigue and reform frustration. However, the new technocratic government may need additional time in order to enact the difficult changes that need to take place.
Popular opposition to top-down changes
The social unrest in Greece is part of wider opposition to government action visible around the world (especially in Europe) -- and a response to the measures that the government is imposing, both because of its effects and because of a popular desire to have a say in the governments actions through a referendum or elections.
The re-emergence of strident populism, with a focus on national priorities and partial isolationism, is possible.
Italy's outlook
Newly appointed Prime Minister Mario Monti faces difficulties in the medium term. There will be a great deal of resentment for measures that have to be implemented, such as the maintenance of a 5% primary surplus. The challenge will be to prevent the channelling of resentment to the EU and persuading the population that Italy itself has imposed these measures. Popular political legitimacy is key.
There is a persistent, though by no means over-riding, sentiment in Italy that leadership should be turned over to Brussels. However, Italy’s best hope is to rely on the markets and not on Europe for direction. Italians must develop a keen understanding of what the markets expect of them in order to navigate the uncertainty and restore confidence in their domestic economy.
EU treaty revision
There are two factors that will affect the timeframe until a treaty change may be required:
- Political pressures. The political calendar may accelerate to match economic failures -- if the economic issues were to extend over the next two years, electorates may begin to question the benefit and their overall position within the euro.
- Financial market pressures. While Italy cannot sustain interest rates at its current level, it is essential to remember that it only pays the market rate on a small proportion of its 1.9 trillion euro debt. The debt-servicing cost within the equation, as opposed to the low growth cost, will take sometime to take effect. If markets lose confidence, they can drive interest rates more quickly, having trickle-down effects on Spain and France, leading to disaster.
Europe's timeframe
The expected timeframe for some sort of drastic change is two years. The proposed treaty revisions by Germany are intended to be implemented in 2012 and take effect in 2013. This reflects the constraints that the German political system is under in order to affect the changes that are now seen as necessary.
It is possible that member states will defy the trend set by the lengthy ratification process of the Lisbon Treaty, as there is a greater sense of urgency to fix this situation. Consequently, Germany’s dedication to saving the euro may lead it to accept the European Central Bank becoming the ‘lender of last resort’, provided that conditions are put in place to limit this and to prevent further crises.
Warning signs
The end of the euro-area in its present form may be signalled by one or more factors:
- Bond market pressures. European countries are forced to pay yields on bonds that are not sustainable.
- Street protests. The narrative is changing towards direct action and demonstrations. This shift makes mass approval easier and more likely; similarly, it is increasingly difficult for governments to portray these protests as the actions of extremists. However, the protest movements are tempered by the lack of coherent alternatives.
- Anti-European election results. Germany’s Christian Democratic Union (CDU) has passed a resolution calling for every euro-area member state to
have the right to withdraw voluntarily from the euro if they fail to meet the principles of the common currency. This has never occurred in a party resolution before; the proliferation of such sentiments could signal the decline of the euro-area.
Greek disorderly default?
The 50% haircut on Greek sovereign debt is being proposed as ‘voluntary’. If they were involuntary, they would trigger a ‘credit event’, leading credit rating agencies to downgrade Greece, forcing it into a disorderly default. This would prohibit the ECB from accepting Greek bonds as collateral, making the Greek government insolvent.
ECB mandate
Because the ECB cannot print more money (quantitative easing), its alternative is to support euro-area governments through purchasing their sovereign bonds on the secondary market. What is to be debated under the potential treaty changes are the degree to which this can occur; EU treaties currently prohibit the ECB from buying bonds directly from euro-area governments.
Franco-German solidarity
Although there may appear to be public tensions between the German and French governments, they are ultimately working towards a coordinated effort for European recovery. The Franco-German alliance is a necessity for either proposed solution, whether it be further European integration or the creation of a multi-tiered system.
How likely is ‘less’ Europe?
For some member states, ‘less’ Europe signals the end of the common market and renationalisation of some policies. As the 27 member states consider reopening the EU treaties, they must ask themselves how a divided Europe will stand in an increasingly globalised world. Some, such as the United Kingdom, believe this is a viable possibility, where increased competitiveness and close ties to the United States might overcome the implied benefits of the EU, as opposed to smaller Central European states, which believe in the importance of belonging to a wider union.
