Yannos Papantoniou: Euro Crisis and the Challenge for Further Integration

The creation of a multinational monetary union raises critical questions concerning the conduct of economic policy. In a national state there are unified authorities for monetary and fiscal policies as well as for the supervision of the financial system.


The national Central Bank emits the national currency and controls its circulation.


The Finance Ministry drafts the budget and formulates fiscal and tax policy. 


The Central Bank, the Finance Ministry and relevant national authorities regulate, supervise and guarantee the functioning of the financial system.


In the Eurozone a unified authority exists only in the monetary field. It is the European Central Bank (ECB). Fiscal policy and the supervision of the financial system belong to the jurisdiction of national states.


The implications of these weaknesses in the system of governance of the Eurozone became apparent during the present crisis. The reflation packages that were adopted in 2008 lacked cohesion. They were uneven and did not correspond to the possibilities of the member countries. Germany, in particular, could provide stronger support for internal demand. It has chosen, instead, by making use of arguments like the future weight of the Social Security problem, to rely on the effectiveness of the reflation packages of other countries (eg. the USA and China) so that her economy recovers through exports.


Besides, the composition of the packages is differentiated among member-countries. In some countries the focus was on tax cuts while in others employment subsidies or additional public investment played a bigger role. So far as sectoral packages are concerned, particularly for the auto industry, they tended to have a protectionist character that limited drastically their contribution to the recovery of the European economy as a whole.


The global crisis revealed cracks in the Eurozone. The absence of a central supervisory authority for the financial system created doubts as to the ability of the weaker member-countries to bail out their banks. Credit risks spread sharply so that overindebted countries such as Greece started to borrow at much higher interest rates in relation to Germany. This tendency, reinforced by negative ratings by international agencies, may lead to credit crises, even to default.


The Greek crisis has highlighted the fact that the euro is a monetary union but not a political union. It does possess a central bank, but not a Treasury. The central bank can provide liquidity in times of crisis, though only a Treasury can address problems of solvency.


These weaknesses were exposed. Greece is a policy failure, as California was in the context of the United States. California’s fiscal crisis, however, did not destabilize the dollar because the federal system contains mechanisms combining assistance with sanctions so as to either prevent or manage default, and thus ensure financial stability.


The absence of such mechanisms within the Eurozone, underlined by the “no bail-out” clause of the Treaty, makes the euro, as well as the sovereign debt of its constituent parts, inviting targets for speculative attacks. Markets take bets on the endurance of the system.


The risk of policy failure in a monetary union is as real as failure in any market system. Ignoring it offers no solution. The alternatives imply either recourse to an external bail-out mechanism, that is, the International Monetary Fund (IMF) undermining thus the integrity of the euro, or thinking the unthinkable – exit from the Eurozone.


In the longer run the Eurozone must invent mechanisms for addressing such failures. Discussion has already started for reinforcing the Eurogroup’s fiscal authority, issuing Eurobonds or setting up a European Monetary Fund.


Stronger coordination of fiscal policies is essential for preventing diverging behaviour on the part of the member-countries of the Eurozone. Reinforcing the authority of the Eurogroup and the ECOFIN Council will improve the effectiveness of fiscal policy, particularly as regards meeting targets as well as redressing imbalances. Germany’s model, consisting in relying on export growth while constraining internal demand, has been heavily criticized recently. Germany’s surplus is mirrored in other countries’ deficits. And, when private demand is weak as is presently the case, external deficits are translated into fiscal deficits leading to credit crises.


Common budget policies and rigorous supervision of their implementation are a sine qua non condition for the efficient functioning of the Eurozone. They will also create a more balanced framework of cooperation with the ECB. Fiscal and monetary policies must function in better harmony in relation to the current situation so that the targets for growth, employment and inflation are more effectively pursued.


The issuance of Eurobonds covering the whole of the Eurozone could help relieve the pressure emanating from credit crises. Such bonds, however, are viewed with suspicion by Germany, which is reluctant to finance overindebted partners. A compensation mechanism imposing a corresponding charge on the weaker economies could help remove Germany’s reservations while serving her long-term interest in sustaining the stability and credibility of the common currency.


A more radical solution to the bail-out problem for failing economies would be the creation of a European Monetary Fund along the lines of the IMF. This fund could extend low-interest loans tied to strict conditionality ensuring the return of the deviant countries to fiscal balance and financial stability.


Unless the Eurozone develops procedures designed to transform it into a fully-fledged economic union, approaching the US model, the future of the euro will be clouded with doubt. Without strong institutions in the fiscal and financial field, the Eurozone will essentially remain a club of countries willing to adhere to certain principles of economic policy, such as price stability and fiscal discipline. Experience, however, suggests that voluntary adherence to principles does not stand the test of time. Deviance is a risk inherent in the life of any system. And if deviance is neither prevented nor controlled, the system faces the risk of dissolution.


It is, therefore, critical for the Eurozone to strengthen its system of governance. The effective conduct of economic policy in the USA contributes to the achievement of substantially higher rates of economic growth compared to the Eurozone. This, quite apart from the risks of break-up or dissolution, should suffice for mobilizing energies in Europe to speed up the integration process.   


The European monetary integration was a partial success. The euro matched the dollar in the global economy having already taken a reserve position among the world’s currencies. This is the first step for the European Union (EU) to undertake a global role. Europe’s influence remains much smaller than America’s, despite their economic equivalence. Effective assumption of global responsibilities requires a strong boost to the integration process. The Lisbon Treaty, which has just entered into force, is a step in the right direction. The creation of the High Representative for Foreign Affairs and Security Policy and President posts, the establishment of a more effective decision- making system and the strengthening of the European Parliament aim at framing and projecting common policies vis-à-vis international issues.


Through its common trade policy, the EU already wields considerable soft power while since 1993, under the Maastricht Treaty, it has been developing a Common Foreign and Security Policy (CFSP) to enable joint action when the interests of the Union as a whole are at stake and to promote and maintain stability around the world.


The EU is also active in economic assistance and peace promotion beyond its borders. The EU helps pay for the UN civil administration in Kosovo, provides ongoing financial support for the Palestinian Authority and is contributing to the reconstruction in Afghanistan. The Union also spends some 9 billion euro annually on development and humanitarian assistance, technical support and peacekeeping, accounting for 60% of the world’s official development aid. More than 160 countries, territories or organizations are covered worldwide.


EU’s neighbourhood includes countries which will one day become members, as well as its other immediate and close neighbours around the Mediterranean, and in South-Eastern and Eastern Europe. The cooperation with these countries aims at dovetailing their policies with those of the EU in trade, environmental and business regulation, energy, communications, education, training and immigration while providing support for infrastructure. By helping reform their economies, create security and consolidate democracy and the rule of law, the EU also helps to make life safer within its own borders.


Global challenges have, however, vastly increased in recent years. In a rapidly changing, ever more interconnected world, Europe is grappling with new issues: globalization, demographic shifts, climate change, the search for sustainable energy as well as facing new security threats. Europe’s engagement in global security, bringing along its substantial resources of soft power in particular, is in much greater demand today than was the case in the context of a bipolar world. The new challenges, unless effectively addressed, constitute a growing threat to the world’s stability and prosperity. The following could be mentioned in this context: 


• Geopolitical Balance: For the first time in five hundred years Europe is neither the source of conflict, nor the centre of power. The Asia-Pacific region is the most dynamic place on earth. However, its combination of rapid growth and strong nationalisms demands of Europeans a long-term understanding of the security implications of change therein.


• Technology. The proliferation of weapons of mass destruction and associated technologies, driven by states and other groups with extreme belief systems, represents a challenge for Europe.


• State Failure. It is prevalent in neighbouring regions and has important social, political and economic consequences for Europeans. The Caucasus, Africa and the Middle East face challenges ranging from pandemic disease, religious radicalism and failing governance. Europe will have no alternative but to manage the consequences of such failure.


• Strategic Partnerships. European security rests on strong partnerships involving Russia and the United States. The role of Russia in European security remains unclear, neither partner nor adversary. The United States, committed as it is the world over, seems unsure as to the role it wishes to play globally and the desired extent of Europe’s involvement. Only by being strong will Europeans convince Russians and Americans alike that partnership with Europe is essential to their own security needs.


• Global Governance. It is steadily gaining in prominence, due to a fast-changing environment, the surge of new economic and political actors and the appearance of new threats and challenges on a global scale. Commercial competition is more ruthless, even as the opportunities multiply. Closely linked financial markets recycle turmoil rapidly. Diseases, old and new, can spread faster than our ability to combat them. Terrorists can use advanced technology in an attempt to impose their primitive world view. Rising energy demand entails less secure and sustainable energy supplies. And climate change, even beyond its environmental consequences, could have serious geopolitical and social repercussions.


It is difficult to evaluate the European integration progress. It seems like the image of a glass: some see it as half-full, while others regard it as half-empty. The progress made since 1957, when the first European Treaties were signed, is beyond any doubt significant. However, if it is measured against present challenges, which are unprecedented in scope and know no frontiers, it is clearly inadequate. Europe must assume its place within the common global effort to face them.  The Euro crisis presents an opportunity for a leap forward in the integration process so as to maintain the momentum achieved by the creation of the common currency. Otherwise, the US dynamic, combined with the emergence of new economic superpowers, such as China and India, and Russia’s return to the forefront, will eventually place Europe on the fringe of the new world order with negative repercussions on prospects of European prosperity as well as on the effectiveness and quality of global governance. Difficult as it may seem today, unification should proceed to higher levels so that Europe attains a stronger position in the international system.

Chicago Booth European Conference 2010 (University of Chicago) Monday, 12 April 2010