Ever since the Eurozone debt crisis exploded onto the global financial scene in late 2009, interspersed bouts of political and economic volatility have led many to question the long-term viability of the European Monetary Union (EMU). Indeed, even after the IMF and fellow EU members stepped in to provide financing for debt-laden countries, continuing spasms over the past few months have cast increasing doubt on achieving a defining settlement. The continued tumult over debt restructuring in Greece, coupled with financial contagion into once previously “core” EU members such as Italy, have underscored the scope and depth of the challenge. In some aspects, the EU’s architecture always embedded the seeds of a crisis: Robust economic union coupled with splintered political union would only be sustained until the countries with the weakest economic discipline fell. In light of the crisis, the EU will likely take two steps back in order to move one step forward. Indeed, the EU generally, and member countries in particular, will negotiate the difficult task of attempting to further consolidate political union while simultaneously allowing for greater expressions of sovereignty among key political stakeholders.
About the Author Mr. Steven M. Rogé serves as Portfolio Manager at R. W. Rogé & Company, Inc. and co-Portfolio Manager and President for the Rogé Partners Funds.
Although not necessarily similar in every aspect, countries that received external aid and other economic “periphery” countries have emerged as the main protagonists of the current crisis. All countries that received bailouts initially denied the scope of economic problems and the need for external financial aid, even though all three countries ultimately capitulated to accept assistance from the EU and IMF. The fate of other periphery countries (Spain, Italy) was not much better: Although spared the public humiliation (for now) of having to accept externally imposed terms of austerity, domestic instability and political recriminations littered the landscape as economic growth weakened. While there are some differences, therefore, this group of countries is more tightly bound together through similarities. Most of the countries in this category (perhaps with the exception of Ireland) have lingering structural economic problems and an excusive overhang of leverage that amplified as economic growth slowed and interest payments could not be made after the crisis. These common problems spawned numerous “political narratives” across the region regarding the crisis’s origins and causes: In the case of Ireland, profligate banks, unscrupulous property developers, and complicit government officials “hijacked” the Celtic economic miracle; for Spain, an unsustainable housing bubble and failed government policies led to the sinking of a rising economic star. Although profligate governments are indicted in these political narratives, public anger in the affected countries has also focused on EU countries and bureaucrats- anger at concessions won at the expense of defanged domestic interest groups. Indeed, as the once seemingly latent trade-off between sovereignty and union that defined the original EU reemerged, opposition in the periphery countries mounted.
While one may suspect erosion of EU support was most concentrated in periphery countries, Germany, as a proxy for a “core” country, has arguably faced the greatest policy dilemma. Germany has played the key leadership role in the Eurozone crisis to date for two reasons: 1) Germany is a perennial regional power with significant sunk political and economic capital in the Euro; 2) Germany has emerged as the putative economic power of the region with fiscal resources to fund a bailout. Although Chancellor Angela Merkel ultimately passed a number of bailouts for profligate countries, political support for regional unity came with a price: Her party, the CDU, lost support in traditional regional strongholds; in addition, a preponderance of German citizens has soured on the benefits of the EU. A recent opinion poll showed that 60 percent of respondents opposed any new aid for Greece (after the initial package), and a record number questioning Germany’s continued support for regional integration.
Although facing different challenges, politicians in periphery and core countries face a similar, daunting question: At what price does continued support for EU integration hurt rather than help? Indeed, some analysts feel that the cost-benefit has already tipped in the cases of some countries (e.g. Greece), and a spectacular breakup of the EMU is inevitable. While this possibility cannot be excluded, the EMU will likely survive over the short-term, but experience change in two main areas: 1) A decreased appetite among member states for further integration measures and pushback against existing integration initiatives; 2) Greater fiscal consolidation in EU decision making processes.
One will immediately notice that while these two measures are not completely opposite, there is substantial tension in their implementation. On the one hand, as a function of increased political pressure due to slower economic growth and fiscal redistribution, existing integration initiatives will be reexamined and further integration measures challenged. Indeed, the key weakness of the EMU’s structure entering the crisis was underdeveloped political union that gave states substantial fiscal autonomy without corresponding responsibility. Although numerous regulations were in place to mitigate this problem, such as rules to cap member country’s deficits at 3% of GDP, bureaucrats largely over looked the rules in order to sustain momentum for further integration. That era is likely over: The politically painful bailout of profligate countries has created notable head winds to policy momentum. Existing measures, such as that regarding migration and immigration policies in the EU, have come under question; further expansion efforts for eastern Europe are out of the question.
On the other hand, the EU has established new economic infrastructure that will bind countries together in fiscal union. As a result of the crisis, policymakers have tried to strengthen collective fiscal policy in the EU through creating the European Financial Stability Facility, a mechanism that will become permanent in 2014. The facility is the main conduit through which bailouts are offered; in addition, the facility will also have the ability (but not necessarily the political go ahead) to issue “EU bonds”, a debt instrument that would put all member countries on the hook for debt incurred. Although efforts to increase coordination of fiscal policy are still being developed, it will be a key theme in EU policy moving forward.