From banks to debt. Why Schäuble’s ideas won’t cure the Eurozone. An essay by the SEP
October 27, 2017
The German hawk and Parmenides: an impossible encounter?
After eight years, Wolfgang Schäuble will no longer be Minister of Finance in the next German government led by Angela Merkel. A pupil of Helmut Kohl and known to be a tough politician and even physically so (he survived an attack in 1990), Schaüble was recently elected President of the Bundestag (the German Parliament). Despite a political activity that has lasted for many decades (he was first elected in 1972), his image in Europe has become increasingly linked to rigour and austerity, especially towards the Mediterranean countries: during the negotiations for the rescue of Greece, his requests in exchange for the granting of loans earned him the nickname of “hawk”.
Parmenides, on the other hand, was a Greek philosopher active around 500 BC in the city of Elea in Magna Graecia. Central in his thought was the reflection on the theme of being as being. Parmenide believed, according to a famous formulation of his poem On Nature, that “being is, but nothing is not”: to him, being meant existing. What Parmenides didn’t know is that he had to deal with Schäuble. 2,500 years after the philosopher, in fact, the powerful former Minister of Finance seems to be the author of what has been called a “non-paper” (Non-paper for paving the way towards a Stability Union), circulated during the last meeting of the Ecofin, the Economic and Financial Affairs Council responsible for the economic policy, taxation and regulation of the European Union’s financial services, made up of the Ministers of Economy and Finance of all Member States. Whatever the genesis of this non-paper, it clearly expresses the position of the current German government on the possible future developments of the Eurozone: it is therefore an essential starting point for Italian political leaders, as they are called upon to decide whether to accept and which elements can be acknowledged among those that the non-paper suggests. Eventually, they’ll be asked to formulate some counter-proposals. Ignoring it, however, would exclude Italy from any negotiations, forcing us in the end to come to terms with decisions taken by others that may be harmful to our own interests.
Continuing the debate between Italian (on the one hand) and French and German (on the other) economists on the future policies of the Union in terms of economy and taxation, the LUISS School of European Political Economy has now come up with an answer to the non-paper, entitled “Il non-documento di Schäuble: elementi per una discussione” (“Schäuble’s non-paper: elements for discussion”) by Angelo Baglioni (Università Cattolica in Milan) and Massimo Bordignon (Università Cattolica in Milan, as well as a member of the European Fiscal Board). The authors, who consider the non-paper to be the “German negotiating platform” for the reform of the common European monetary area, examine the meaning and consequences of its proposals, while not hesitating to denounce the unacceptability of some of them and proposing a number of alternatives.
In the eyes of Baglioni and Bordignon, the non-paper appears to be as “a reoccurrence of already known neins” to a common budget and debt mutualisation, even in its most “softened” forms (such as the introduction of a shared fiscal capacity at European level, and of European safe bonds). But apart from this pars destruens, the non-paper also indicates some new proposals, which the authors critically examine.
The European Monetary Fund
Schäuble’s first proposal contemplates the transformation of the European Stability Mechanism (a fund for Eurozone countries that lose access to financial markets, but conditional on the acceptance of precise reforms by the countries themselves) into a European Monetary Fund with the task of preventing crises and monitoring the application of the Stability and Growth Pact. Baglioni and Bordignon claim to be in favour of this transformation: a European Monetary Fund would be a more flexible instrument than the Stability Mechanism – to which countries access only in desperate conditions – as it would introduce forms of ongoing support that would make it more useful. The one problem that would remain would be defining a governance of said Monetary Fund, which should be able to decide for itself when, if and under what conditions a country were to be supported.
On the other hand, Baglioni and Bordignon are less pleased with the second proposal of the non-paper, which wants to assign the new Fund the extra task of fiscal surveillance: “The reason for rejecting this kind of surveillance doesn’t lie in the fact that it would allow the various countries to cheerfully violate the pacts, or would led them to come up with new reasons for flexibility, no matter our own appetites. It is more because the idea of attributing to a purely technical body a fiscal surveillance tool continues to cultivate the illusion, which is dear to the German ordoliberal approach[…], that there are tax rules which can be applied automatically and with no discretion”. After all, the authors affirm, the Stability Pact has been amended several times precisely because automatic implementation of the rules would have led to economically counterproductive effects. In other words, it is difficult to imagine an agreement that can foresee ex-ante all possible circumstances and situations in such a way as to eradicate completely a discretionary element: “A technical body, almost by definition, cannot be discretionary because it lacks the political legitimacy to be able to play such a role”.
The proposal in the non-paper, however, reveals a practical issue, that is to say that the enforcement of tax rules cannot be dependent on the discretionary power of political convenience, which would undermine the trust between Member States – even though it is all too often thought that only Mediterranean countries give in to temptation: “It is unacceptable that the rules should be bent according to the relative importance of the Member States – as in 2004, for example, when Germany and France, with the support of Italy, managed to avoid the sanctions of the Pact invoked by the Commission”. It is therefore necessary to find an ideal combination of technical judgment and political discretion, bearing in mind that, in the face of a technical opinion expressed publicly, it is difficult for politics to make choices against it without having to pay “the political cost of a decision conflicting with the suggestions of independent technical bodies, both national and European ones”.
Moreover, the Commission’s monitoring on tax rules and recommendations on fiscal and economic aspects for each and every country are “the only real instrument available to the European institutions to introduce a minimum of convergence in the economic policies of Member States”. It is therefore an crucial role, which cannot be sacrificed in the name of the general dissatisfaction of the northern European countries with the Commission, which is accused of being too lax, as well as with the general dissatisfaction of the countries from southern Europe, which, on the other hand, denounce its excessive rigour.
Reducing risks. But how?
The non-paper reinforces a mantra of the German negotiating strategy: reducing risks first, to share them afterwards. There it lies an obvious and not insignificant economic foundation but, the authors stress, this must not become a Berlin alibi to postpone any risk sharing, while imposing increasingly tighter constraints and controls on both public finance and the banking sector. The Italian government needs to have a clear strategy on this subject: “We need to be very clear about which kind of reforms of risk reductions are acceptable and which should be rejected. We must also be realistic in proposing forms of risk-sharing that are politically acceptable”.
As far as the banking sector is concerned, one of the main reasons for alarm – also reported on LUISS Open by Daniel Gros – is the excessive exposure of national banks to the domestic public sector. One solution could be to limit the amount of government securities that a bank can hold in its own country. But the banking sector in Italy has other problems too, related to the delays in managing the stock of impaired loans, with instruments such as the GACS guarantee and the Atlas Fund, which proved to be completely insufficient: in this case too, a clear strategy is needed, which establishes the creation of a national bad bank or initiatives to facilitate market operations.
According to Baglioni and Bordignon, this type of intervention (limiting the holding of government securities and reducing the stock of impaired loans) is the necessary “quid pro quo to the completion of a Banking union. On this front, Germans have so far achieved centralisation of supervision at the ECB and the introduction of the bail-in[…], which would impose a large part of the costs of a banking crisis on local stakeholders (shareholders as well as creditors). The third pillar, in the shape of a Banking union, the European deposit insurance, never materialised. The Commission has in fact given in to the German opposition. The authors argue that this surrender is not acceptable, and they demandi the introduction of a common European insurance fund, albeit on a gradual basis.
A bail-in of government securities?
The latest proposal from the German non-paper is to provide the new Monetary Fund with the possibility of imposing the restructuring of a country’s public debt, with a sort of bail-in applied to government bonds. Baglioni and Bordignon point out, however, that such a clause would have a destabilising effect and could lead to speculative attacks against a country that was merely to consider the possibility of access to assistance from the Fund:“It would automatically cause an increase in the risk premium for countries with high debt, increasing the cost of financing and therefore ensuring a more likely financial crisis. After all, this is a scenario that we have already experienced; a simple joint statement by Angela Merkel and the then French President, Nicholas Sarkozy, on the beach of Deauville in October 2010, on the need to involve the private sector in the losses caused by a country’s default, immediately led to a sharp rise in the risk premium on Greek securities and, by contagion, on all securities in the European periphery, causing the Euro crisis of 2011-12”.
Of course, if the pursuit of a Banking union and European deposit insurance are to be decisively implemented, more caution is needed when it comes to the sharing of public debts, which would not in any way be supported by the German constituency. Tools toward that end would be premature and counterproductive because they would increase the perception by stronger countries that an attempt is being made to pass the cost of debt of weaker countries on to them. This, however, must not exempt Italy from a serious commitment to reduce its own debt, both through the disposing of its assets and through the control of its accounts, taking advantage of the economic recovery and interest rates that are expected to remain low for some time (it should be added that a substantial part of said debt, about 16%, will still remain in the Bank of Italy’s portfolio for a long time). The aim being that of achieving a situation in which the primary surplus finances the part of debt that isn’t covered by the economic growth. This would reassure markets and partners and would place Italy in a more strategically believable position to contribute to “more reasonable and less conflictual” future developments of the Euro zone and the Union itself.