Heads of State and Government agreed over the weekend a ‘pact for the Euro’, a successor to the ill-fated Franco-German Competitiveness Pact. At the next European Council meeting in ten days it will be converted into a binding agreement for the euro area countries; non-EMU members can sign up on a voluntary basis.
A bargain has been struck.
The Germans and other ‘northern’ Europeans have agreed to the establishment of a permanent European Stability Mechanism (ESM), a bail-out fund to the tune of half a trillion euro that can lend money to countries in difficulty and directly purchase their bonds. Such support will require a unanimous decision. IMF-style conditionality and interest rates will apply. (The interest rates on such loans can be expected to be lower than those recently given to Greece and Ireland; rates for the former under the existing bail-out arrangement are now to be cut by one percentage point. Ireland wants more, but was not prepared to compromise on its corporation tax rates.). Essentially an IMF-type institution will be established for Europe, whose lending will be senior to that of private-sector bondholders (protecting tax-payers) and which, can impose restructuring agreements and haircuts.
In return all member states have signed up to efforts to achieve greater policy coordination and to constrain somewhat their autonomy in setting policy by way of an annual system of setting common targets, setting national commitments, reporting, and evaluation by the Commission and Council. The measures are to be in the areas: competitiveness, job creation, fiscal consolidation and financial stability. There are no provisions for compulsion or sanctions on member states. The reliance is on peer pressure. Only those actually seeking the support of the EFSF/ESM will actually be forced to make policy changes.
At the most abstract level this is the type of agreement that is necessary: greater European solidarity hand in hand with deeper policy integration.
However, it is far from adequate and problematic for a number of reasons.
At the process level, the Pact immediately prompts the question – although I have not seen anyone else pose it – why we need a (non-binding) Pact for the euro when the European semester and Annual Growth Survey is a very similar process of policy coordination, albeit with, ultimately, the possibility of imposing sanctions. What is explicit in the Pact is the ‘grand bargain’ nature of the deal. This was only implicit in the AGS. I firmly believe in the need for an effective ESM. Non-binding constraints on national policy-making, then, could be seen as a small price to pay for an important advance, indeed essentially ‘for free’ given that they are non-binding. They can be seen as a sop to public opinion in, above all, Germany. Chancellor Merkel needs to be able to show voters that she is insisting on Europe becoming more German in return for what is perceived – wrongly – as German largesse.
In terms of content, the proposals are, on the one hand, a considerable improvement on those in the original Franco-German Pact. This, however, tells us nothing, so economically dreadful and politically inoperable were those ideas. In some areas they are also an improvement on the somewhat less dreadful AGS. Among the notable improvements compared to recent texts I would point to: the repeated mention of the role of the social partners and respect for the rights of national decision-making processes; more careful language on reforms of wage-setting institutions; productivity-enhancing measures are discussed as a way to resolve competitive imbalances rather than just wage adjustment; the labour market reform proposals are based less on a simplistic and reactionary ‘make work pay’ approach, and the language on pension reforms is rather better (mentioning effective, rather than statutory, retirement ages and the need to increase employment rates). There is some encouragement (but still no firm commitment) to a Financial Transactions Tax, recently supported by the European Parliament.
Even so, major problems remain in terms of what the Pact demands governments do. Amongst a long list I would emphasise the fact that any sense of symmetry between surplus and deficit countries in terms of competitive adjustment has gone out of the window: all countries are supposed to become more competitive at the same time. I can understand Heads of State and Government getting puzzled by some complex economic issues, but by a matter of elementary logic?
Far worse, of course, is what is missing. I have set out a blueprint for what I believe would be a genuine and effective ‘grand bargain’ for the euro area and Europe. What is needed, in short, is investment for faster growth, a symmetrical path towards effective competitive rebalancing, and urgent measures to get deficit countries out of the strait-jacket they find themselves in, and to clean up the banks. I won’t go over this ground again here, but clearly the Pact is a million miles from such a blueprint. It fails to set out a concrete and effective roadmap to achieve these vital goals.
How, ultimately, to evaluate the Pact? To the extent that it serves a useful purpose in mollifying public opinion in such a way as to permit the needed establishment of an effective ESM, it may have its uses. Ideally it should then be discarded in favour of an effective blueprint for growth, convergence and consolidation. And a better process for that would be the European semester/AGS. This will almost certainly not happen, though, at least not until things get even worse. The danger is that policymakers will actually believe their own propaganda that the Pact constitutes a resolution of the euro area crisis. It does not.