Friday 17 November 2017

All countries will not be equal under fiscal treaty's measures

THE rules are in place, or soon will be, but what is the game? One of the many ways of looking at the fiscal treaty is as the blueprint for a new -- or rather, one might say an older -- way of running countries.

The implication of the treaty is that the real burden of debt in eurozone countries will gradually fall until it is of little or no significance. This is already Germany's plan for itself. Something very similar is now meant to apply across the eurozone.

In Germany's case, this is not just the ideology of sound finances, although that is part of it. The population of Germany is set to fall dramatically over the next 20 years, which will shrink the size of the economy, as well as adding to social costs. Germany plans to reduce its debt burden before its economy inevitably shrinks.

Other EU countries face the same grim conundrum, if not quite so dramatically. But some, especially Italy and Belgium, start with much higher debt burdens than Germany.

Ireland, uniquely, has a growing labour force but, under any conceivable circumstances, will have one of the largest debt burdens in Europe.


One size can hardly fit all. Yet, as Philip Lane of Trinity College pointed out a fiscal conference last week, there is flexibility in the rules to allow for different conditions at different times and places.

As with everything in the crisis, one soundbite is already covering the infinite complexity of the treaty -- "decades of austerity." Behind this lies a belief that, with different policies, things could return to being much as they were. This seems very doubtful.

It is difficult to believe that debt markets will ever be the same as they were in the 30 years before the crash. To take just one, but significant question; will banks be able in future to treat government debt as risk-free and not requiring capital to cover risk?

If not, that alone will reduce lending capacity and raise the cost of money compared with what it has been in most people's lifetimes.

Governments will be awash with debt, as a result of replacing much of the reduced borrowings of the private sector. Levels of 100pc of GDP, which were exceptional to countries like Italy, will be the norm.

The extra growth that we have enjoyed for decades from, at a minimum, public debt rising in line with national output, will no longer be available.

It was not always so. Ireland had virtually no public debt in 1970. Policy was more conservative for longer, with budgets expected to balance, when other countries had accepted the benefits of deficits to smooth the economic cycle.

Governments were unable to leave it at that. The treaty continues the undeniably sound idea that governments should run surpluses in good times, big enough to allow supportive deficits in bad ones. Much of it is an attempt to make it work this time, having failed in the first 10 years of the euro.

As has often been pointed out, Ireland did run surpluses, and much good it did us. The rules do have lots of sensible ideas for monitoring the behaviour of the private sector. They might even work.

The big difference from the 2000s is that, while this is going on, debt burdens will have to fall, either in actual terms or, through inflation in real terms.

The fiscal treaty might best be seen -- not surprisingly -- as a plan to achieve the reduction without inflation. One can have a keen debate about the merits of this approach. Germany and the USA have been on opposite sides of the argument since the oil crises of the 1970s.

An economic historian might say that the end result seems to have been much the same either way, but the eurozone presents a much greater challenge to such a policy than Germany alone (especially when it was just West Germany) ever did.

The single-currency area will have a low debt burden compared with the USA, Japan or the UK, but with very large debt burdens in some of its constituent members.

There is clearly a structural fault (a design flaw, the engineers would call it) when those individual debts can threaten the whole currency, even though the euro's overall position is quite sustainable.

The failure is not so much in the treaty rules but in the nature of the single currency itself.

A common currency is not the same as a common market in goods or services. Even assuming it can be done, getting all the member states' finances into a healthy state may not be enough.

Money is intangible -- a promise to pay, as it said on the old pound notes. It is probably of no significance that it does not say that on euro notes, but the promise is implicit.

Implicit, however, is hardly sufficient to make a paper currency credible. People need to know who is making the promise so that they can judge the risk that it will be kept.

There is no institution that can make that promise. It rests with the member states. Clearly, the worth of their promises varies greatly.

The fiscal treaty seeks to reduce the variations but it cannot eliminate them.

Confidence in the currency will continue to vary from country to country, with risk premia to match. That might be called a common currency, but it hardly seems right to describe it as a single currency. A Greek euro is not the same as a German euro. Ordinary Greeks may have got the practicalities wrong when they hoarded notes whose serial numbers showed they were printed in Germany, but they had correctly identified the problem.

That is why so many observers assume that, once the treaty is in place, the eurozone will move towards creating the conditions for a genuine single currency -- conditions which would have to include at least a partial collective promise to pay, through euro bonds; a eurozone bank-resolution regime with a lender of last resort; and a euro treasury which could adjust the overall fiscal stance of the zone.

That would make the fiscal treaty look like a sideshow. Democracy, as well as efficiency, demands that such a collective promise to pay is accompanied by genuine collective political mechanisms -- de jure political union of some kind.

It is a tall order, but the stakes could not be higher.

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