Are we risking the European project for a few Billion Euros?

For as long as the euro’s architecture remains incomplete, Greeks get to decide whether to pay or not. It’s called sovereignty.

Greece has escalated the European debt crisis, hoping that austerity would be reduced  and debt forgiven as we approach the brink. Indeed the downside risks of a Grexit far  outweigh any imagined benefits: Creditors would lose all loaned taxpayer money, and    reverse the direction of European integration for the first time, precipitating furthercalamities down the road. But for as long as creditors resist deeper integration of theeuro area, with 19 euro members retaining their economic sovereignty, the blackmailing will go on. Not following the rules is the very essence of economic sovereignty. Greececan free-ride while weighing the costs and benefits of following the rules or not. 
The solution to this is not self-defeating austerity, and we hope European leaders willbe too risk-avers to risk Grexident. The answer must be a decisive deepening of the    single currency to render the euro sustainable. 

Leo HOFFMANN-AXTHELM, 10 July 2015

Brussels has entered what feels like an endgame. After the bruising 2014 elections, with a third of votes going to parties opposing European unity, we struggle with four concurrent crises, which join forces to create the perception that Europe is to blame. National politicians happily reinforce this, even while responsible for what happens in Brussels.

One is the migration crisis; with no obvious solutions, the Commission has stepped up its longstanding efforts to replace the country-of-first-entry system with some kind of quota. A second looming crisis is the Brexit, which does pose a fatal threat to the EU and its perception in the world. Then there is Grexit and the fourth crisis underlying it, the still incomplete institutional architecture of the Euro.

Economic and Monetary Union must be deepened decisively. Everyone knows this, but it would push some out of their comfort zone, given the need to give up economic sovereignty, share institutions, finally reduce macroeconomic imbalances such as Germany’s inexcusable trade surpluses (a surplus means the country exports more than it imports, amassing abstract currency rather than enjoying goods and services, let alone investing in Germany’s fast-depleting capital stock).

Only shared institutions can ensure that the economic and fiscal policies across the 19 euro area states are coherent. It is well understood that common rules are not sufficient: when economically or politically convenient, the rules will be bent or broken (France is breaching the fiscal rules, Germany the macroeconomic imbalances procedure, and so on). Retaining economic sovereignty means one is not forced to follow the rules.

And that is the core of the argument: as long as creditors do not agree to pool their economic sovereignty with the debtors, that means everyone retains their economic sovereignty. It really is necessary to spell out this tautology. If Greece retains its economic sovereignty, then Greeks get to decide whether it repays creditors or not. Of course breaking the rules carries sanctions, but after five years of austerity and the promise of more to come, without any hope of ever actually getting rid of the debt, even the threat of Grexit may fail to make Greece obey the rules.

In the medium term, this conflict between national economic and fiscal policy but implied collective responsibility can only be solved by pooling economic sovereignty. In a globalised and interdependent world, this is not actually a loss of sovereignty: European states are increasingly powerless and forced to act together anyways. Only by pooling sovereignty do they stand a chance to collect taxes from multinationals, to mention just one example.

Five Presidents’ Report on Economic and Monetary Union

Deepening Economic and Monetary Union is a top priority of President Juncker. The main angle to achieve this was the Five Presidents’ Report released ahead of the June European Council. Juncker was the pen-holder on the report, which was crucial to ensure a European perspective: ECB-President Draghi has a preference to steer clear of political involvement; while Council President Tusk and Eurogroup-President Dijsselbloem may be biased towards a Member State perspective – one from outside the euro area, the other one concurrently Dutch Finance Minister. The European Parliament’s Schulz was only invited later as a nod to the need for democratic legitimacy in the euro area’s new architecture.

The report is notable for setting a 2025-deadline by which a euro area fiscal capacity should be in place, i.e. a discretionary budget to be administered by the European level. This would be used to smooth out cyclical shocks (if the Commission had budgetary resources available to invest in Greece, national-level austerity would have been less problematic in the first place) and follow other European priorities, such as transnational transport and energy infrastructure which Member States have been delaying for decades. Every currency union in the world has some form of centrally administered fiscal capacity. It also sets out useful measures on completing Banking and Capital Markets Union, as well as macroeconomic convergence (if only to reduce the need for high and unpopular monetary transfers between competitive and uncompetitive regions).

But Jucnker gave too much ground to Member States’ limited appetite for reform, and does not equip more progressive politicians with a blue-print for demands towards deeper integration. It does not foresee euro area unemployment insurance, though such automatic stabilisers would be extremely useful to smooth out macroeconomic imbalances and would associate the EU with something positive for once. Nor does it push a Debt Redemption Fund, which even the German Council of Economic Advisors proposed (Merkel opposed it).

In the European Parliament, the Group leaders of the Socialists (Pitella) and Liberals (Verhofstadt) called for a debt redemption fund and even debt mutualisation on the occasion of the debate with Greek Prime Minister Alexis Tsipras. On the accountability side, a euro area chamber in the European Parliament could be combined with Moscovici’s idea of a Commission Vice-President for the Euro who would also be the full-time Eurogroup-President, as a hybrid “double-hatted” position between the Commission and the Council (thereby also representing Member States), similar to that of the HR/VP, the EU’s Foreign Minister. This EU Finance Minister would be in charge of collecting Financial Transaction Taxes and administering the fiscal capacity.

Leveraging a Greek crisis to deepen Economic and Monetary Union?

Many thought the Greek crisis would create further impetus to finally get our act together and deepen the currency union, make it sustainable. Decisions cannot be put off indefinitely, even in the modus operandi of the EU, once action becomes absolutely inevitable, obstacles can be overcome and even Germany will agree to things such as the bailout fund, banking union, etc. Unfortunately, too many in the European Council simply lack the vision. Not wanting to take any risks, they prefer to administer the status quo – Merkel is the perfect example, withholding her opinion like a wise and silent state woman, only coming down on one side when opponents defeated themselves or public opinion has become apparent.

A consensus-based modus operandi like that of the European Council is not prone to taking any decisions at all, and would muddle through for another five years if it could. In this mind-set, there is no space for grand leaps; every crisis has to be tackled at a time, step-by-step. Suddenly, Greece’s woes are not a catalyst for further reforms, but an impediment.

Yet time is running out. It is astonishing how quickly the demand of ejecting Greece from the euro area has become respectable. Damned if we do “save” Greece and damned if we don’t, contagion and moral hazard have become the two sides of the coin that Europe is flipping on Sunday, 12 July 2015.

Towards a Grexident

All 28 Heads of State or Government will agree or disagree on the proposals the Greeks submitted on Thursday 9 July, currently being checked by the institutions formerly known as Troika. As bridge financing could never be agreed, Sunday should fix the parameters for a 3-year programme worth € 53.5 bn, the EU’s permanent bail-out fund (ESM). This only serves to keep Greece afloat in the short to medium term. Yet the Greeks are wary of agreeing to bailout conditionality without a formal commitment to debt restructuring. Creditors on the other hand prefer to negotiate debt restructuring later, wanting to see clear commitment (and progress) on the structural and fiscal reforms Greece will have to agree to.

The main points of contention will therefore be how concretely debt restructuring is envisaged, and how much austerity and commitment to reform can be extracted.

This is very dangerous, as the downside risks are phenomenal. If European leaders fail to agree a deal on Sunday, they will have another few days to reach a deal. The real deadline is July 20th, when 3.5 bn € worth of bonds held by the ECB come due, which Greece is unable to pay (the IMF default does not affect private creditors and is therefore ignored by credit rating agencies, giving the ECB a justification to continue providing liquidity to Greek banks). Even before that deadline, banks can run dry, at which point the Government may have to issue IOUs or some other form of parallel currency.

This would be a historic breaking point. For the first time since the inception of the European project, integration would be put into reverse. A spiral of blame and counter-blame will further alienate European politicians and peoples. Don’t underestimate how a general atmosphere of defeatism and distrust will be amplified by populists and tabloid journalism. Combine this with Europe’s migration crisis and it is not difficult to see how the debate in the UK will be further poisoned, prompting the British to leave a Union in disarray at the in/out-referendum likely to be held in 2016. The face and prospects of the European project would be changed forever, wiping out any hopes that the EU could become an important player in the governance of this planet in the 21st century.

Delaying or denying debt restructuring is also utterly irrational. If creditors want their money back, they must stop squeezing the Greek budget. Any amount of economists including the IMF will agree that austerity is self-defeating, and the experiment conducted so far shows as much. During the Great Depressions, policy makers could claim ignorance as to the deflationary effects of pro-cyclical policies, today, they cannot.

Creditors’ political capital in the unfolding negotiations should therefore not be directed at haggling over the primary budget surplus. To reduce Greece’s debt-to-GDP ratio, growth is much more effective than any given year’s deficit or surplus. To achieve growth, creditors must insist on the really urgent reforms, such as an independent tax authority, better benefits targeting, cutting the number of civil servants instead of their salaries, etc.

The case for debt restructuring

Given the amount Greece already owes, it also needs debt restructuring to make its debt sustainable, i.e. to enable it to pay back at least part of the debt. This is in the creditors’ interest, and that also appears to be Syriza’s main argument: let’s have a rational conversation on how to achieve an optimal outcome and pay back as much of the money as possible. Commission President Juncker, the European Council President Tusk, IMF Chief Lagarde, France, Italy, the US, have all come down in favour of debt restructuring. Why, then, is this so difficult?

The rational discussion was never in the creditors’ interest. They had quite simply failed to inform their electorates that, in 2010, their taxpayer’s money had knowingly gone into a bottomless pit. Back then, the equation was simpler: Germany and friends had to bail out their banks after they suffer from a Greek default, or bail out Greece directly. Yet the economic crisis was so steep – Greece lost 25% of GDP, comparable to a major war – that any far-fetched hopes of getting the money back evaporated.

Merkel and other creditors had five years at their disposal to gradually and slowly accustom their electorates to the reality that the money had been lost. However, they have still not acknowledged as much. Nominally, the amount is so small that many seem prepared to let Greece default – thereby losing all of it – rather than risk moral hazard. But perhaps the story of the crisis so far is sufficient to keep other countries from emulating such reckless policies and be faced with the Troika…

The bottom line

So we are awaiting a showdown, the cards have been dealt. The downside risk – the reversing of the direction of European integration – far outweighs any possible upside risk, i.e. the repayment of the debts or a deepening of EMU that would make the euro sustainable. So what will happen?

Merkel is seen as the most powerful player, and if nothing else, rationality is one of her strengths. She has for years been far more defensive than her Finance Minister Schäuble, who agrees Greek debt is unsustainable but opposes a restructuring anyways. On Friday, the German Finance Ministry still dismissed the proposals, while French negotiators had gone out of their way to help Greece engineer a package that could not be refused. Given the risks, matters clearly beyond the realm of finance ministries are at stake here.

So events are overtaking us. Via path dependencies and rhetorical entrapment and a flurry of pronouncements – who said what and how often – this confrontational dynamic threatens to make a deal impossible. In these circumstances, leaders should take a step backward and stop obsessing about minute figures such as the exact value of VAT-exemptions allowed under the next program.

Hopefully, it will come to more fundamental assessments. And my best guess remains that at heart, Merkel is risk-averse. She will not let five years’ worth of fire-fighting go down the drain in one big bang. After over ten years in power, she will be preoccupied with her legacy, and following statesmen like Adenauer and Kohl, she will not be remembered as the one wrecking the euro.

Her toughest task will therefore be, as it has been before, to convince her Eastern European counterparts that they share an interest in resolving this crisis, even if the average incomes in a number of these countries is still lower than in Greece. Going into the Euro-Summit on Monday, she already emphasised that without solidarity, there can be no reforms. French President Hollande meanwhile has all but bet what’s left of his credibility on an outcome that keeps Greece in the euro, coining the slogan: “responsibility, solidarity, speed.”

Ultimately, there is a reason why we take interest from our creditors. These payments are a risk-premium guarding against the possibility that the money may not be repaid. We have long understood that this is the case for Greece; we have knowingly bailed out the private creditors, and we are at least partly responsible for the disastrous past five years the Greek people had to endure. We cannot ask Greece to keep taking new loans to roll over the old ones, and expect to impose new conditionality each time, reforming Greece against its own will. The legitimacy of the Greferendum was of course undercut by the ambiguous question and the treacherous way in which the Tsipras Government announced it, with even notable Greekophile Juncker speaking of betrayal. But its results stand; if regaining their sovereignty entails leaving the euro and defaulting, then we cannot truly be surprised at the resounding OXI that 62% of the electorate delivered.

No one knows how a Grexit would play out. Humanitarian aid is being prepared, economic contagion could probably be limited, but political contagion cannot. We are playing with fire, to the detriment of the Greek population.

In the face of uncertainty, we should not risk our great European project for a few billion euros that have been lost anyways.


Photo credits: Heiko Sakurai (2015),

3 thoughts on “Are we risking the European project for a few Billion Euros?

  1. Pingback: Greece’s third memorandum of understanding: the last robbery before the Grexit? |

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