The recent downgrade to Ireland’s sovereign credit rating by Standard and Poor’s, the second in three months, together with the prospect of a joint devaluation and eurozone entry plan for Latvia, are renewing speculation over the need for an eventual internal eurozone bailout, so as to prevent countries from defaulting on their debt.
The implementation of such a policy would be a giant step towards greater economic coordination within the eurozone. Though Article 103 of the Maastricht Treaty – the famous ‘no bailout’ clause – explicitly rules out the possibility of one member state assuming the debts of another, it is directly contradicted by the less widely noted Article 100, which allows financial assistance to be given to countries experiencing “difficulties caused by natural disasters or exceptional occurrences beyond its control”. There is therefore a legal backdoor to facilitate bailouts should they become unavoidable.
Legal qualms out of the way, the question is how any bailout would be delivered. The first possibility would be for a “one-off” rescue package, supported by a consortium of large member states led by Germany, possibly conjoint with an IMF package which would specify tough conditionality for the recipient country. This option would essentially be little more than a bolstered IMF bailout, with the Fund acting as a fig-leaf to hide the political and financial involvement of one state (Germany) in the macroeconomic management of another (Ireland or Greece). There are advantages to such a ruse (more below).
A second, superficially more satisfying option would be to acknowledge the eurozone bailout for what it is, namely an internal eurozone bailout, and institutionalise it through new or existing EU institutions. The eurozone could have its own internal monetary fund – a form of “EMF” – either acting as an independent institution, or attached to the European Central Bank in Frankfurt. In a similar fashion to the International Monetary Fund, the European fund would concentrate economic decision-making power to its larger, more solvent members over its weaker, less solvent states. A series of EMF interventions would give the EMF board, dominated by Germany and France, the ability to tailor the domestic policies of member states. In anticipation of such a power, German officials have already hinted that they may force Ireland to raise its rates of corporation tax – a longstanding gripe in Berlin.
Finally, a yet third option would be for emergency financial support to be made available for EU member states, but without the imposition of punitive structural adjustment packages by one member state upon another. The only way in which this could become feasible were if there were a single, centralised mechanism for raising funds and delivering spending within the EU. A recent proposal to this effect is for the creation of a eurozone bond market, the money from which could be used to support interventions in weaker eurozone states. Receipt of funds would probably still entail some conditionality, and could still be combined with member-state financed bailout packages. But essentially the proposal will entail an implicit transfer from the creditor states, such as Germany and the Netherlands, who could have issued (and will continue to issue) national bonds at lower rates, and a cheap source of debt for countries such as Ireland or Greece, who cannot.
Which of these avenues is preferable? I am tempted to say: either the first or the third, but most assuredly not the second.
The second option, creation of a European Monetary Fund, would be a further writedown to the bankrupt reputation of the EU. For European politicians cannot have failed to notice that the International Monetary Fund is hugely unpopular, blamed by the countries it supports for ‘forcing’ them to implement the fiscal austerity that previous profligacy has made necessary. I shudder to think that we would now replicate this experience at the European level, with Irish and Greek politicians denouncing European officials for every spending freeze.
The first option, while disappointing for supporters of European integration, at least has the advantage of allowing Irish or Greek politicians to blame the unpopular measures on the hapless International Monetary Fund, while in reality European finance ministries, led from Berlin, will provide both the emergency funds and (more importantly) write the terms of the structural adjustment package. After all, when the average Irish voter thinks of the IMF, they will think of Washington; they will not think of its President as a former European finance minister, and they will not think that the staff who wrote their adjustment package were seconded from the Bundesbank. Then let them think that, while the true power remains in Europe. Invisible power, after all, is power of the best kind.
Yet the most sustainable choice for eurozone in the long run is the third option: to give the Union the ability to create debt, and therefore rescue itself from the vicissitudes of the business cycle – as well as the perceived arbitrariness of the Growth and Stability Pact. That pact binds all states to a minimum 3 per cent deficit regardless of circumstances, and such conditions clearly cannot be fulfilled today by countries such as Ireland. Yet for reasons of political realpolitik, a eurozone bond market is a hugely ambitious undertaking, and it will be critical that the scheme is designed well. In particular, a danger is that if a European financial authority is to disburse the funds – in effect creating a genuine eurozone ‘government’ within the architecture of the European Union – then moral hazard must be avoided by giving power over spending to the most fiscally solvent states, who are implicitly financing the single bond market. Having been given access to a cheaper means of raising credit, the main beneficiaries must not be allowed to transfer their fiscal recklessness to the Union as a whole.
