The need for banking and fiscal union across the eurozone is now urgent
Europe’s leaders, unlike former US President George H W Bush, have never had trouble with the ‘vision thing’. They have always known what they want their continent to be. But having a vision does not necessarily mean that they know how to implement it. And, when it comes to putting their ideas into practice, the European Union’s leaders have fallen short repeatedly.
Monetary union without banking, fiscal, and political union has been a complete disaster
This tension between Europeans’ goals and their ability to achieve them is playing out again in the wake of the recent EU summit. Europe’s leaders now agree on a vision of what the EU should become: an economic and monetary union complemented by a banking union, a fiscal union, and a political union. The trouble starts as soon as the discussion moves on to how – and especially when – the last three should be established – now, while the iron is hot, or later when tension between countries has cooled?
Under the euro umbrella
Banking union, Europe’s leaders agreed, means creating a single supervisory authority. It means establishing a common deposit-insurance scheme and a mechanism for closing down insolvent financial institutions. It means giving the EU’s rescue facilities the power to inject funds directly into undercapitalised banks.
Likewise, fiscal union means giving the European Commission (or, alternatively, a European Treasury) the authority to veto national budgets, a measure not many finance ministers would relish. It means that some portion of members’ debts will be mutualised: individual governments’ debts would become eurobonds, and thus a joint obligation of all members. The Commission (or Treasury) would then decide how many additional eurobonds to issue and on whose behalf.
Finally, political union means transferring the prerogatives of national legislatures to the European Parliament, which would then decide how to structure Europe’s fiscal, banking, and monetary union. Those responsible for the EU’s day-to-day operations, including the Board of the ECB, would be accountable to the Parliament, which could dismiss them for failing to carry out their mandates. With national pride at a high, this would surely ostricise leaders from their voters.
Bricks without the mortar
Vision aplenty, the problem is that there are two diametrically opposed approaches to implementing it. One strategy assumes that Europe desperately needs the policies of this deeper union now. It cannot wait to inject capital into the banks. It must take immediate steps toward debt mutualisation to stabilise the floundering euro. It needs either the ECB or an expanded European Stability Mechanism to purchase distressed governments’ bonds today.
Over time, according to this view, Europe could build the institutions needed to complement these policies. It could create a single bank supervisor, enhance the European Commission’s powers, or create a European Treasury. Likewise, it could spend time strengthening the European Parliament. But building institutions takes time, which is in dangerously short supply, given the risk of bank runs, sovereign-debt crises, and the collapse of the single currency. That is why the new policies must come first.
The other view is that to proceed with the new policies before the new institutions are in place would be reckless. Mutualising debts before European institutions have a veto over fiscal policies would only encourage more reckless behavior by national governments. Proceeding with capital injections before the single supervisor is in place would only encourage more risk taking, and allowing the ECB to supervise the banks before the European Parliament acquires the power to hold it accountable would only deepen the EU’s democratic deficit and provoke a backlash.
A house of cards
Europe has been here before of course – in the 1990s, when the decision was taken to establish the euro. At that time, there were two schools of thought. One camp argued that it would be reckless to create a monetary union before economic policies had converged and institutional reforms were complete. The other school, by contrast, worried that the existing monetary system was rigid, brittle, and prone to crisis. The comparison is almost identical. The question is whether the European leaders will learn from the mistakes of their own history.
At the time of the euro’s formation, Europe could not wait to complete the institution-building process. It was better to create the euro sooner rather than later, with the relevant reforms and institutions to follow. At the slight risk of overgeneralisation, one can say that the first camp was made up mainly of northern Europeans, while the second was dominated by the south. Then there were the countries which did not need to make a pressure decision, the Brits and the Swiss, who stand on the sidelines now and gloat in their wisdom that the euro was a doomed currency in the first place.
Between the two parties interested in taking the euro on, the 1992 exchange-rate crisis tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro was the factor that decided the argument. The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a complete disaster. But not proceeding would also have been a disaster. The 1992 crisis proved that the existing system was unstable and unfit for purpose. Not moving forward on the euro would have set up Europe for even more disruptive crises. That is why European leaders took the ambitious steps that they did, come what may.
Time is of the essence. Not proceeding now with bank recapitalisation and government bond purchases would similarly lead to disaster. Europe therefore finds itself in a familiar bind. The only way out is to accelerate the institution-building process at a rate of knots. Doing so will not be easy. But disaster does not wait.
(c) Project Syndicate 2012