European leaders had finally agreed on Europe’s budget for the next seven years. This is a triumph of the nation state that shows at the same time that Europe is not getting anywhere along this logic. The compromise budget that is seen as a success for the hawkish member states is less than a tenth of a per cent lower in terms of the EU GDP than the proposal rejected in November. The difference is below measurement error, but at the same time sacrifices cross border infrastructure projects that may have had some growth stimulating effect, but were not the pet items for any major member state.
For issues and solutions that go beyond the national state logic, it seems now that progress works through the ‘back-door’.
Like it happened last week with the Irish debt deal. The Irish Parliament voted to liquidate the Irish Bank Resolution Corporation and restructured the previous debt financing instrument (promissory notes) into a series of long-term bonds with an average maturity of 35 years. As Wolfgang Münchau has put it in the Financial Times (Münchau, 2013), this is a ‘hidden form of monetary financing’ acknowledged by the ECB. Inflating debt in the long run puts Ireland on a sustainable debt financing trajectory and could also be seen as a model case for the ultimate solution of the Eurozone debt crisis.
What may also work in the longer term is to bring ‘federal Europe’ in through the back door. The plan for a ‘banking union’ (launched by the paper by Herman van Rompuy in June 2012) seems to be a crucial moment in the course of the European integration with more far-reaching consequences than what one would first think. Both the banking union and some form of a ‘federal Europe’ are necessary, as they are pre-determined by the asymmetry between the present construct of the EMU and the level of de facto economic and financial integration that only became apparent during the turbulences of the Eurozone crisis. Federal Europe, but even any form of debt-mutualisation would not work through the front door as the three years history of dealing with the Eurozone crisis, but also the latest budget deal showed.
But it still might work through the back door, just as it did with the latest Irish debt financing deal. This is not a conspiracy, the process and the rationale is explicitly stated in several documents, as e.g. in the paper by Notre Europe on ‘Completing the Euro’ (Enderlein et al, 2012).
Why would the banking union represent a precedence case with long-term implications? The most important rationale of the banking union is to break the deadly loop between banking and sovereign risk (as expressed by the EU Summit in June 2012). This had been overdue. Bank balance sheets make up roughly 350% of Eurozone GDP. According to an IMF working paper (Laeven and Valencia, 2012), the output loss relative to trend and direct fiscal costs of all banking crises between 1970-2011 were 33 per cent (cumulated output loss) and 3.8 per cent (direct fiscal cost) of GDP for advanced economies. For the current Eurozone crisis, a paper by Bruegel based on IMF data shows (Pisany-Ferry, J and Guntram, W, 2012) that by the end of 2011 the cumulated output loss in the euro area amounted to 23 per cent while the direct fiscal cost was estimated to be 3.9 per cent of GDP (in Ireland 41%). Getting a European Banking Supervision and what is even more important a European Banking Resolution Authority to be established, seems now to be unavoidable. Even if the process is in delay and may follow in smaller steps (see Münchau, 2012), it will come.
Such a development has further implications however, first of all in form of a European ‘fiscal capacity’. In order that a European Banking Resolution Authority credibly performs its key functions (recapitalisation, restructuring or liquidation of troubled banks) a ‘fiscal capacity’ at Eurozone level will be needed with resources of up to 4-5% of Eurozone GDP. Initially this might still happen in a more disguised way e.g. through the ESM, but will de facto end up in some sort of a Eurozone budget.
This would clearly reduce sovereign risk, but at the same time also the sovereignty of the sovereign. If banks and sovereigns are so intertwined as we see in the current Eurozone crisis, getting the one under common control will have implications to the other. The loss of national sovereignty happens already, most dramatically in cases when the sovereign is in danger of default (or otherwise under threat), with establishing the banking union this would be true for everybody.
Such a development would involve political and institutional consequences in the sense of the principle: ‘no taxation without representation’. We already have a democratic deficit in Europe and we will get much more of it, if Eurozone crisis management continues without serious institutional changes. Democratic deficit only shows that we have a great deal of cross border interdependence in Europe that requires political decisions at European level at a time when Europe as such does not have an electoral constituency. This will be a compelling challenge after the banking union and Eurozone fiscal capacity had been set in place.
Such a development is by far not optimal and transparent, but seems to be the only way things might work if a breakup of the Eurozone is to be avoided in the longer run. Apart from a few enthusiasts, nobody would sign up for a ‘federal Europe’ now, but step by step as an unintended consequence of a series of necessary decisions, we might end up there. The front door towards a ‘genuine monetary union’ had not been accessible at the time of signing the Maastricht Treaty, debt mutualisation was also not viable and as the latest example shows the monetisation of Irish debt either.
The banking union is indeed necessary, but it has implications that are not thought through or at least will not be clear for all those politicians who might sign for it. This, by the end only shows how European integration works: through path dependency via decisions with unforeseen consequences. The process had been more or less determined at the time of signing the Maastricht Treaty.
On the other hand, it sounds to be a bit frightening that federal Europe might get its way through a crisis in the banking sector and gets accomplished via a ‘financial union’ (banking union). Where will social Europe remain?
Enderlein, H et al (2012): Completing the Euro – A road map towards fiscal union in Europe, report of the “Tommaso Padoa-Schioppa Group”, Notre Europe, Brussels
Laeven, Luc and Fabian Valencia (2012) – “Systemic Banking Database: An Update”, IMF Working Paper WP/12/163, June
Münchau, W (2012): Politics undermines hope of banking union, Financial Times, 16th December
Münchau, W (2013): Ireland shows the way with its debt deal, Financial Times 11th February
Pisany-Ferry, J Wolfram, G (2012): The fiscal implications of a banking union, Bruegel policy brief, 12/02, September, Brussels
van Rompuy, H (2012): Towards a genuine economic and monetary union, report by President of the European Council, June, Brussels