Monday, 12 December 2011

The path towards a fiscal union

One part of this post was published at the ASI blog, titled "Europe's road to serfdom"


The deal was struck. The EU and the eurozone are on a new path toward a more strict fiscal union. And with the deal, it is very likely a move towards a double speed Europe, or a union within a Union. Britain has isolated itself from the new treaty by a veto from its PM David Cameron. Whether such a move is good or not for the UK, only time will tell. It would be frivolous to make predictions now, as it is very likely that Britain will remain a part of the EU, only now left out of some main decision making and possibly regulatory standards. This isn’t necessarily bad, as Britain mostly suffered under various EU labour and financial market restrictions, but it is a question on how Britain might suffer politically. Loss of power and influence within the EU is certain, and it is left to see how this will impact Britain’s future motivation and public opinion regarding the EU.
The break-up of the Union, at least at the moment, isn’t likely, despite all the negative predictions. Neither will Britain exit, nor will the euro fall. The two-paced union was an unavoidable outcome ever since the euro introduction. The currency itself offered better economic conditions initially to all those who embraced it. It was the reason behind imbalances and it will be the reason for fiscal unity. All those who refuse to enter it, will remain outside like they did before. The UK can still benefit from trade treaties and a more open and flexible labour market (still only a theoretical assumption in most of Europe). It will enjoy less regulations and less fiscal constraint. It will remain to be independent and different than continental Europe, as it was before. I see no big differences in this apparent ‘break-up’ apart from the administrational ones. The euro needed a fiscal union, perhaps not in this form, but it nonetheless needed it. The loss of national sovereignty to the EU is the unfortunate but necessary outcome. It was never going to be the other way around.
The UK mostly did this to protect its money-maker – the City of London. It is encouraging they have finally remembered its importance, and they are finally showing support for once. They also realize that the FTT will present a huge negative impact on the City of London and the UK GDP in times of recovery. Britain finally got fed up with all the unnecessary regulation coming from the EU that was undermining its competitiveness. Introducing the FTT was the final drop, as London would lose its battle over the financial influence against Hong Kong, New York or Singapore. The “big bang” made London into the global financial centre it is today. The FTT would undo all that change and in return offer bigger equality in Europe? No thank you, say the Brits and who could blame them?
I don’t see a decrease of trade levels with the UK either. The EU does a lot of trading with the US, China, Japan and even Switzerland, and the fact that they are out of the single trade zone (well apart from the Swiss) didn’t result in negative outcomes for these countries, quite the opposite – it resulted in more specialization and more gains from trade worldwide.

The treaty agreement itself is much more a plea towards fiscal discipline and austerity. It lacks a long term strategy apart from hope that within a fiscal union there will be less scopes for irresponsible behaviour and everyone will have to act as Germans. If they were treated as Germans by the bond markets before, now they will finally have a chance to act like ones. 
The budgets of eurozone members need to be balanced or in a surplus. This will be introduced in each country’s legal system and possibly be overseen by the European Court of Justice. If any country breaches the 3% deficit ceiling (which was the initial requirement for the euro introduction; if only they had listened before) it will suffer automatic consequences and possible sanctions unless the majority of other nations oppose. I see room for political games once more.
The financial measures in place were designed to increase the firepower of the eurozone institutions to rescue the currency and its most endangered member states. There is a new rescue mechanism, the European Stability Mechanism which is to hold €500bn, and there is an additional €200bn to arrive through the IMF. According to some high numbers being called out before, it isn’t certain whether this will be enough.
The problem with the current plan is that it requires more and more bailouts, which essentially implies more and more debt accumulation. The socialist foundations of Europe are falling apart simply because they refuse to realize (or are unable to realize) that socialism and the welfare state are unsustainable, once you run out of other people’s money, that is. The dependency of peripheral nations is causing the highest burden on the eurozone. Its core members don’t have sympathy towards these countries, they require bailouts to save their own countries’ banks who plied up on peripheral debt due to Basel capital requirements – another example of European regulatory oversight that ended up increasing systemic risk of the financial sector rather than decreasing it. 
As long as the EU officials close their eyes on the only plausible solutions left – defaults that will end further bailouts and dependency (excellently summarized by Dan Mitchell of the Cato Institute), Europe will remain in dire straits. More socialism and more faulty policies that caused the current situation cannot be the answer to its problems. The response must come from a different perspective – just like it did in the 1980s. The question is how much longer will it take for the policymakers to realize they are on the road to serfdom. 

2 comments:

  1. don't you think that by allowing defaults the eurozone (and probably the EU) will necessarily break up?
    It would give rise to panics and mass selloffs of sovereign bonds and possibly all other euro-denominated assets. Not to mention bankruptcies and a lack of liquidity for EU companies..

    the bailouts, no matter how wrong they appear to be, are at least protecting the euro and the eurozone from its demise..I don't think that's socialism, I think that's inevitable regarding the situation we're in

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  2. the anticipated effect of keeping these banks and sovereign nations further dependent on bailouts exceeds the costs of letting them default immediately. The very process of letting them default doesn't have to necessarily imply a euro break-up, and with it the aforementioned panics.

    increasing debt accumulation (to address the bailouts) in order to solve the debt issue isn't a very bright strategy. Imposing automatic fiscal sanctions won't do any good either. The EU policymakers are only postponing the inevitable. And the further we postpone it, the worse it will get, and the harder it will be for us to fix it

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