The summer of 2011 is a crucial time for the Eurozone and the European Union. The immediate meltdown of Greece has been avoided by imposing yet more painful austerity measures on the country. But the purchase of a bit more time should not be confused with the resolution of the crisis. The summer of 2011 needs to be used to elaborate a comprehensive new plan for the Eurozone. I have complained before about the damage the current ad-hoc politics and lack of leadership are causing, so what should the cornerstones of a new plan for the Eurozone be? I think four elements are crucial:
1. How to set sovereign debt in Greece and the Eurozone periphery onto a sustainable path?
It is clear that the debt position of Greece is still unsustainable and this will not change unless the overall debt burden is lowered in one way or the other and the interest rates on Greek debt are reduced. There is a lot of discussion about whether or not the private sector can or should be part of the solution. I still maintain that it should (unless there is clear evidence that a knock-on effect would set in which would make the overall situation worse). And above all, Greece needs an investment programme to generate growth. Without growth, there won’t be a reversal in the debt trend and there won’t be support by the Greek people for the undoubtedly difficult reforms that are yet to come.
2. What domestic reforms are needed to set the countries in crisis onto a sustainable path?
There is no doubt that there need to be more serious reforms and domestic adjustments in countries such as Greece. These reforms would involve issues such as the collection of tax revenues, public sector reform and general competitiveness. The social consequences of such reforms need to be softened by EU help. If debt sustainability is addressed effectively we can shift EU help from baling-out investors to helping people cope with economic change. Living within the same currency zone does not mean that every area needs to be equal – this is obviously true even within countries. But there needs to be more economic cohesion in the Eurozone, which also means that countries such as Germany need to do their share, for instance by strengthening domestic demand via wage increases.
3. How should the architecture of Eurozone governance be changed to make it more efficient?
The Stability and Growth Pact has failed to maintain stability because crucial areas were not covered (for instance overall exposure of the financial sector) and fiscal rules were one-size-fits-all so did not allow for policy adjustment. It is worth bearing in mind that there would have been no bank bailouts or public investment programmes if EU governments had stuck to the Pact in the aftermath of the financial crisis. The Pact’s rules should stay as basic targets but there need to be more flexible and effective governance and surveillance mechanisms around it. The questions of how to design a permanent insurance policy (bail-out fund) against financial crises and whether a European treasury and European taxation are needed should also be addressed in this context.
4. We need to go back to banking reform
If it is true that private banks still could not take any loss on the investments they made (whereas of course retaining the profits) then banking reform over the last three years has simply failed. We cannot accept institutionalised moral hazard and the taxpayer needs to be liberated from being liable for the investment risks of banks. There should also be a root and branch review of the role and power of rating agencies as in the wake of the Eurozone crisis they sometimes seemed to have more political might than elected governments. The creation of a public European rating agency seems like a very good idea against this backdrop.
Of course there are many more aspects that could and should be included in a new plan for the Eurozone. But these basic elements – debt sustainability and growth, domestic reform, Eurozone governance and further financial reform – to me seem to be the key areas.
Let’s hope that the summer of 2011 will be remembered in years to come as the time when EU leaders got their act together and set economic policy onto a new path; and not as the time when the last exit was missed before some European countries hit the wall.