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A Turning Point for Europe. Benedicta Marzinotto is Lecturer in Political Economy at the
University of Udine... Apr 14, 2017. Project Syndicate
Benedicta Marzinotto is Lecturer in Political Economy at the University of Udine and Fellow at
Large at Bruegel. Economist Benedicta Marzinotto surveys arguments by Daniel Gros, Lucrezia
Reichlin, Joseph Stiglitz, and other Project Syndicate commentators about the state of the EU on
the eve of the French election, and sees hope for the future. APR 14, 2017
The rise of European populism in 2016 gave new urgency to longstanding efforts to unify
European Union and eurozone member states around shared social, political, and economic
goals. Following the French and German elections this year, Europe may have a new opportunity
“perhaps its last” to do just that.
FLORENCE – After the annus horribilis of 2016, when the United Kingdom decided to withdraw
from the European Union and Donald Trump won the US presidency, the first months of 2017 have
given Europeans new cause for hope.
In the Netherlands’ recent general election, the anti-EU populist Geert Wilders fell short of
expectations, and suffered a relative defeat at the ballot box. And in Austria’s presidential election
last December, the pro-European candidate, Alexander Van der Bellen, defeated the far-right
nationalist Norbert Hofer.
Many observers saw these elections as referenda on European integration itself. But the true test of
European solidarity will come next month in the second round of the French presidential election,
in which the far-right National Front’s Marine Le Pen has only a slim chance of beating a more
centrist candidate such as Emmanuel Macron or François Fillon.
Pro-European forces owe their political lifeline, in part, to the tragicomic first 100 days of the
Trump administration, and to the fact that economic growth is returning to the continent. But what
they intend to do with their new lease on life remains to be seen.
Project Syndicate commentators have chronicled Europe’s fitful integration process for years. In
many cases, they have played a leading role in it. So they are well acquainted with the challenges
confronting a supranational body comprising sovereign countries. Some are confident that smart,
targeted reforms can deliver the bloc from its long, post-financial-crisis malaise, whereas others
believe that a more radical overhaul is required. When considered together, what emerges most
clearly is the need to act urgently to shore up the EU and the single currency.
Springtime for Europe?
Herman Van Rompuy, Janis A. Emmanouilidis, and Fabian Zuleeg of the European Policy Center
are optimistic about Europe’s prospects. “The eurozone crisis is far less dangerous now than during
its peak years of 2010-2013,” they argue, because “[g]rowth has picked up across the European
Union, and five million jobs were created between 2014 and 2017.” Assuming that the upcoming
vote in France, together with Germany’s general election in September, deliver pro-euro
candidates, European policymakers “should seize the opportunity later this year to pursue more
ambitious, but pragmatic, reforms.”
Such a “swing back to the center in continental Europe,” writes Gavekal Dragonomics Chief
Economist Anatole Kaletsky, “would strongly suggest that the unexpected victories for populist and
anti-globalization movements in the US and Britain were not primarily a response to
unemployment and disappointing economic performance since the financial crisis.” Noëlle Lenoir,
the President of the European Institute at HEC Paris, echoes this point, and doubts that “the rise of
right-wing populism in Europe truly stemmed from the eurozone’s weaknesses, given that it aligns
so closely with the rise of Trump in the US.” Instead, she concludes that recent populist successes
have been a product of “false claims and scare tactics to compel citizens to retreat inward.”
Now, however, French and German voters have it in their power to prevent what Kaletsky calls a
global “paradigm shift toward protectionism,” which “seemed almost inevitable with Trump’s
election.” Likewise, Daniel Gros of the Center for European Policy Studies suspects that populists
have overestimated European voters’ disdain for economic openness. “The unpopularity of megaregional trade deals in advanced economies does not imply broad-based support for a return to
protectionism,” Gros argues, which is why European policymakers should “ignore the protectionist
noises coming from Trump’s administration, and concentrate on defending the current global
trading system and the liberal international order.”
That will become easier, Kaletsky predicts, “if voters reject populist politics in France and
Germany,” because a “dramatic improvement” in Europe’s economic performance will follow,
building on the gains made since the European Central Bank’s decision in March 2015 to launch a
large-scale bond-buying program. By “creating a mutual support system between strong economies
such as Germany and weaker ones like Italy and Spain,” according to Kaletsky, the ECB “quickly
reversed the fragmentation of the European banking system and eliminated fears of a euro
breakup.” This led to “an upsurge in confidence among both businesses and consumers” that could
soon send “waves of investment flowing into the eurozone.”
More Money, More Problems
Still, even with rays of light visible through the trees, no Project Syndicate commentator thinks that
Europe is out of the woods. Earlier this year, Gros saw “little reason to fear for the euro’s survival in
the near term,” but warned that, “[p]ersistent longer-term yield differentials suggest that market
participants have some doubts about the euro’s long-term survival.” Similarly, French economist
Jean Pisani-Ferry reminds us that, while the ECB has maintained the “eurozone’s stability and
integrity,” it cannot do so indefinitely, “because no central bank can solve political or constitutional
conundrums.”
Those conundrums are baked into the common currency itself, which is why Lucrezia Reichlin of
the London Business School describes the euro as “a major source of disillusionment with
European integration.” As it stands now, writes Barry Eichengreen of the University of California at
Berkeley, “[t]he eurozone is neither appealing enough to attract additional members nor flexible
enough to grant troubled incumbents a temporary holiday.” Accordingly, he expects that inertia
will prop up the euro for now, but considers its long-term sustainability to be an open question.
The euro emerged as a logical consequence of Europe’s post-war economic integration, from the
founding of the European Economic Community in 1957 to facilitate trade among member states,
to the establishment of the European single market in the early 1990s. But Harvard University’s
Martin Feldstein suggests that the EU exceeded its mandate when it introduced the euro in 1999
and shifted monetary policymaking from the national to the supranational level. As the Nobel
laureate economist Joseph Stiglitz notes, “the eurozone’s structure imposed the kind of rigidity
associated with the gold standard,” and “took away its members’ most important mechanism for
adjustment – the exchange rate.”
According to the Harvard economist Dani Rodrik, the creation of the single currency was more or
less in keeping with Europe’s “functionalist” approach to unification, whereby policymakers
assumed that “political integration would follow economic integration.” In the early decades of the
European integration project, Rodrik argues, politics largely kept pace with economics. But the
European project “took a leap into the unknown” when it “adopted an ambitious single-market
agenda that aimed to unify Europe’s economies, whittling away at national policies that hampered
the free movement not just of goods, but also of services, people, and capital.” Rather than allow for
“a common social model to develop alongside economic integration,” EU policymakers pursued
“hyper-globalization on a European scale,” resulting in an “imbalance between the economic and
political legs of the integration process” that hobbles Europe to this day.
To compensate for the absence of a fiscal and political union, in 1997 the EU adopted the Stability
and Growth Pact, which capped member states’ annual fiscal deficits at 3% of GDP and public debt
at 60% of GDP. The SGP, however, was steadily weakened to accommodate violations of its limits
by major EU economies, including France and Germany. Then, as Feldstein recalls, after the 2008
financial crisis, a new “fiscal compact” was instituted, “authorizing the European Commission to
oversee members’ annual budgets and impose fines for violating budget and debt targets.” But this
system, too, has lacked teeth. Gros points out that, because “political considerations” have been
allowed to “affect enforcement rules,” the Commission did not even fine Spain and Portugal in
2016 “for overshooting their fiscal deficit targets by a wide margin.”
A More Perfect Banking Union
According to Gros, “[i]t is now clearer than ever that EU member states prioritize domestic political
imperatives over common rules – and Europe’s common good.” If so, what fate awaits the
incomplete effort to create a European banking union? When the eurozone was established,
policymakers seemed to pay little mind to the banking sector, even as they abolished capital
controls and permitted the free flow of financial services. But most Project Syndicate
commentators, while differing on the details, agree that bank interdependence played a central role
in the euro crisis that began in 2010, and that preventing future crises requires a joint response.
As Christopher Smart of Harvard University’s Kennedy School of Government notes, Europe’s
banks are so “central to the continent’s economy” that “in France and Germany, bank assets
amount to 350-400% of GDP, whereas in the United States, they are equal to just over 100% of
GDP.” But Smart’s research into the eurozone crisis has led him to conclude that European bank
interdependence was more of an asset than a liability during the worst phase of the global financial
collapse. “Because Irish, Portuguese, and Greek banks owed money largely to German, French, and
Dutch banks,” he notes, “the external shocks to the weakest banks and economies were
immediately shared with the strongest.”
Better yet, the financial crisis provoked a “response that improved oversight, strengthened
institutions, and pooled resources” through the creation of an inchoate banking union. For Smart,
it is “remarkable that eurozone regulators can now oversee and, if necessary, intervene on behalf of
the monetary union’s largest banks.” He is confident that if Europe’s leaders can restore “the
banking sector’s credibility, by providing it with more capital and better oversight,” 2017 could turn
out to be “a very good year after all.”
But others take a less rosy view of the current banking-union framework, even as they support the
principle behind it. Reichlin and Shahin Valleé of Soros Fund Management, focusing on the
parlous state of Italy’s fragile banking sector, conclude that there are “troubling problems with the
conceptual foundation of the banking union itself, in particular with its resolution framework.”
They identify some of the same political limitations that are evident in other European rules-based
systems; for example, the Single Resolution Board “lacks the executive authority to implement its
decisions, which are carried out by national authorities.”
In my own recent examination of remaining weaknesses within the eurozone, I welcomed the fact
that “[f]inancial supervision has been placed at the EU level,” and that “government bailouts have
been replaced with creditor bail-ins.” But I warned that “none of this will avert the need for public
bailouts when the next crisis hits,” given “fear that financial contagion will amplify the initial
market reaction.”
There is no disagreement among Project Syndicate commentators about the need for further
banking-sector reforms. While Reichlin and Vallée call for policies “to facilitate a real shift in
banks’ business models in order to restore their profitability,” Sergei Guriev of the European Bank
for Reconstruction and Development suggests that a “deposit-insurance scheme” be created
alongside “a senior tranche of safe sovereign assets, or eurozone-wide risk-free securities.” Smart,
for his part, advises cleaning up banks’ non-performing loans and limiting their sovereign-debt
exposure; putting more money into the EU’s Single Resolution Fund; and furthering capitalmarket integration.
Beyond the Banks
And yet, even if the EU can shore up its banks and establish mechanisms to prevent or mitigate
damage from future financial crises, its flaws are not limited to the financial sector. Although
“fiscal, structural, and political reforms are sorely needed,” argues Nobel laureate economist
Michael Spence, “they will not be sufficient to solve Europe’s growth problem.” Spence points out
that “Europe seems to be trapped in a semi-permanent low-growth equilibrium,” and that “the
eurozone is increasingly turning into a two-speed economic bloc,” owing to a lack of “effective
adjustment mechanisms” designed to maintain more equitable growth among member states.
Unless a “new generation of younger leaders pivot toward deeper integration and inclusive
growth,” Spence believes that Europe’s future could resemble a “slow-motion train wreck.”
Furthermore, even assuming that populists are kept at bay, additional risks loom on the horizon.
For starters, writes New York University’s Nouriel Roubini, “if the UK-EU divorce proceedings
become protracted and acrimonious, growth and markets will suffer.” At the same time, “Europe’s
neighborhood is bad and getting worse,” owing to an increasingly aggressive Russia, “turmoil in the
Middle East,” and the constant specter of terrorism, “which may over time dent business and
consumer confidence.”
In addition to tepid growth, the eurozone also has a serious public-debt problem. As I wrote
previously, highly indebted countries “are limited in their ability to pursue proactive fiscal-stimulus
policies.” For example, “high-debt countries last year still spent an average of around 3-4% of their
GDP on interest payments,” severely “limiting their capacity to deliver economic growth in good
times, and posing a liability in times of crisis.” To address this problem, I believe that the ECB’s
program of quantitative easing should be modified to allow indebted countries – under the
supervision of an independent monitor – to save more on interest payments.
Bureaucratic paralysis – or, worse, complacency – is yet another problem with which Europe must
contend. As Pisani-Ferry notes, “the governance of the eurozone remains excessively cumbersome
and technocratic.” He laments the fact that “most ministers, not to mention legislators, appear to
have become lost in a procedural morass,” even as “they have essentially subcontracted the
eurozone’s stability and integrity to the central bankers.”
That abdication of authority could end badly. A year ago, the University of Munich economist
Hans-Werner Sinn cautioned that the ECB’s policies to “prevent deflation and spur growth” could
be “setting the stage for severe instability.” According to Sinn, the ECB’s extension of cheap credit
to banks on the condition that they lend it out has turned the eurozone’s more troubled economies
into “credit junkies,” and threatens to do the same to countries such as Austria, Germany, and
Luxembourg. With property prices in Germany, the eurozone’s largest economy, now soaring, a
real-estate bubble may form. “If it bursts,” Sinn warns, “the effects could be dire for the euro.”
Short-Term Fixes
Resolving Europe’s structural contradictions and preventing another crisis will not be easy. The
euro is predicated on the assumption that economically similar countries will experience periods of
growth and recession at the same time. In reality, there is profound cyclical and structural
economic diversity among eurozone countries. Moreover, as the Brookings Institution’s Kemal
Derviş notes, the larger EU is, and will remain, a multi-currency union. Thus, any EU-level reform
process must seek to manage Europe’s heterogeneity, rather than try to homogenize the continent’s
socioeconomic and political models.
Likewise, Pisani-Ferry points out that individual eurozone member states disagree not only “about
the nature and root causes of the euro crisis,” but also about “integration” as a shared goal.
Accordingly, he recommends that discussion about Europe’s future “not be framed as necessarily
leading to further integration.” Rather, the primary objective “should be to make the eurozone
work, which may imply giving more powers to the center in some fields, but also less in others.”
Most Project Syndicate commentators would agree with this objective. Even if the current
environment in Europe does not allow for the creation of a deeply integrated political union,
adjustments can still be made to address the eurozone’s design flaws. For example, “to support a
shared fiscal stance and achieve a better mix of monetary and fiscal policy,” Reichlin proposes that
“an independent federal fiscal authority” with “a small budget and some discretionary power” be
established to create “risk-sharing mechanisms.”
Guriev, for his part, would address “the profound asymmetry of eurozone countries’ economic
performance during the crisis” with “a joint unemployment-insurance scheme, whereby cyclical
unemployment benefits would be financed from the EU budget.” Van Rompuy, Emmanouilidis,
and Zuleeg hope that France and Germany will come together later this year to propose reforms
that will give more fiscal flexibility and EU-level support to “eurozone countries that lack the
budgetary space to spur growth on their own.” And Marcel Fratzscher of DIW Berlin urges
Germany to start closing its “huge investment gap,” in order to increase its imports and defang
critics who insist that the euro is too weak and German exports are too high.
Back to Fundamentals
But European leaders will also have to acknowledge that technocratic fixes cannot paper over the
failures of “functionalism” indefinitely. While Europe absolutely “needs a shift in economic policies
to boost growth and wages now,” argues Philippe Legrain of the London School of Economics’
European Institute, “deeper questions about identity, political legitimacy, and trust in institutions
cannot be addressed by tinkering with the Stability and Growth Pact.”
For Stiglitz, who recently published a book about the euro, the only way to overcome the eurozone’s
structural deficiencies is by launching radical reforms that alter the contract between member
states. These include eliminating the single currency’s top-down fiscal rules; creating a solidarity
fund to finance growth; issuing Eurobonds; requiring the ECB to account for employment, growth,
and stability, in addition to inflation, in setting monetary policy; and pursuing an industrial policy
to help “laggards” catch up with other member states.
Yanis Varoufakis, who served as Finance Minister in Greek Prime Minister Alexis Tsipras’s
government, goes even further, proposing a “European New Deal” to solve the EU’s two central
problems: “involuntary unemployment and involuntary intra-EU migration.” He calls on
Europeans to follow a “simple guiding principle: All Europeans should enjoy in their home country
the right to a job paying a living wage, decent housing, high-quality health care and education, and
a clean environment.” To achieve this under existing EU treaties, Varoufakis proposes increased
investment in green energy and sustainable technologies, a living-wage guarantee, an anti-poverty
fund, a “universal basic dividend,” and a right-to-rent rule to prevent immediate evictions.
Unless every European country is “stabilized and made to prosper,” Varoufakis warns, the EU’s
disintegration will be a matter of when, not if. One may disagree with his prescription, or with the
view that the EU should embrace any agenda of comprehensive reform after this year’s critical
elections. But it should be clear to all that a window of opportunity for reinvigorating the European
project has unexpectedly appeared – and that it will not remain open for long.