The Eurozone is facing a systemic crisis with far-reaching consequences for the future of the Economic and Monetary Union, European integration and Europe in the world. The main purpose of this column is to provide a clearer framework for an organised discussion on the longer term implications of various policy choices that can be made today in response to the Eurozone crisis.
In accordance with well-tested scenario-building methodologies, four main contrasting scenarios were identified as possible:
A »Muddling-through« Scenario: European hierarchy and differentiation
B Break-up Scenario: European fragmentation and disintegration
C Core Europe Scenario: Fiscal union with smaller group
D Completion Scenario: Fiscal union in the EU
The biggest contrast and the key choice is given by Scenario B versus Scenario D, as follows:
Break-up Scenario: European Fragmentation and Disintegration
The Economic and Monetary Union remains incomplete, unable to ensure growth and shaken by instances of sovereign default and exit, with uncontrolled contagion effects. Access to financial resources remains subject to constant uncertainty. Regulation of the financial system to reduce volatility and undue pressure is confronted with substantial resistance and disagreements. The European financial supervisory bodies are weak and there are a number of bottlenecks in inter-bank lending across the Member States, which cannot be reduced by last resort provisions of liquidity from the ECB. As a result, there is a chronic credit crunch, deepening the recession in several Member States.
In the issuance of public debt, differences in borrowing costs across the Member States are too high and, since the resources of the European Stability Mechanism are too low, the risk of sovereign default or of severe and disorderly debt restructuring becomes reality in some countries, with contagion effects on sovereign debt and banks.
A revised Stability and Growth Pact puts pressure on Member States to systematically reduce public debt and structural public deficits, leaving little room for promoting public and private investment. Fiscal consolidation becomes impossible in several Member States because they remained mired in recession over a longer period. Welfare systems are undermined and, in some Member States, partially dismantled, leading to a major increase in poverty. In parallel, the Euro Plus Pact, involving commitments to further convergence of corporate taxation and social contributions/benefits, becomes impossible to implement.
There are neither significant changes in the European instruments for promoting investment nor macroeconomic coordination for growth, nor European industrial policy in connection with European trade policy. The European strategy for growth remains focused on completing the Single Market and structural reforms. In this context, the opportunities provided by the European Single Market and external markets benefit particularly countries with public and private financial resources to invest. As a consequence, the transition towards a greener and smarter economy is blocked and even goes into reverse in several Member States. With these constraints on European aggregate demand, the average unemployment rate and social inequalities increase to unprecedented levels. In the meantime, in the weakened economies, many strategic assets are bought up by non-European countries, reducing Europe’s control over its own production chains.
Some regions are devastated by deep recession with high unemployment triggering stronger emigration flows, including a strong brain drain element, which only worsens the situation. Hostility between European regions will increase, based on stereotypes, leading to a fragmentation of European identity. Protectionist reactions will emerge everywhere pushing for a return to national borders and national currencies and paving the way for the breakdown and fragmentation of the Eurozone. The disintegration of the European Union will become unavoidable. A large global shock will follow, leading to a global recession.
Completion Scenario: Fiscal Union in the EU
The Economic and Monetary Union is completed in the EU, keeping membership open to all Member States that want to join. A two-tier Europe will be avoided, but a two-speed Europe might be necessary, with a new Treaty for all Member States that want to join.
Regulation of the financial system is developed and provides more financial stability and focus on the needs of the real economy. Stronger European supervisory bodies ensure sounder banking activity with more responsible lending and borrowing and normal inter-bank lending across the EU. Hence, unconventional measures by the ECB are less necessary to provide normal access to credit.
A European debt agency ensures joint issuance of public bonds as a last resort, when issuance at national level reaches unreasonable levels. This favours lower and more reasonable borrowing costs in general. If certain countries encounter unusual difficulties, the European Stability Mechanism is equipped to provide financial assistance with a clear but balanced conditionality, deploying more effective and rapid rebalancing and recovery programmes.
A revised Stability and Growth Pact applies pressure on Member States to constantly reduce their public debt and structural public deficits, but leaves some room for promoting smart public and private investment. This smart culture of balanced budgets paves the way for more credible fiscal consolidation. The long-term sustainability of welfare systems is also strengthened. In parallel, the Euro Plus Pact, with its commitments to further convergence of corporate taxation and social contributions/benefits, becomes easier to implement.
Investment, growth and job creation are supported by stronger European instruments, notably Community Programmes, mobilising Community budget resources, EIB loans, guarantees and bonds, private project bonds and other available financing sources, such as pension funds or taxation sources such as a financial transaction tax. These new resources for investment, combined with a European industrial policy, the Single Market and appropriate structural reforms, foster the transition to a greener, smarter and more inclusive economy.
More organised and competitive European production chains are able to better reap the potential of the European Single Market and global markets. Under these framework conditions, differences with regard to investment, growth and employment rates decrease and regions lagging behind can more realistically catch up in terms of competitiveness, social and environmental standards, as well as reduce their external economic and financial deficits. The Eurozone, building on a more consistent Economic and Monetary Union, will coordinate its external position and there will be a single Eurozone representation in the Bretton Woods institutions. The euro will become a reference reserve currency attracting financial resources from all over the world.