Thursday 21 February 2019

Jose's good-news speech dodged all vital issues

Barroso missed an opportunity to address the policy failings behind the eurozone crisis

European Commission President Jose Manuel Barroso. Reuters
European Commission President Jose Manuel Barroso. Reuters
EU President Manuel Barroso speaks in the Aula Maxima after receiving his Hon Doctorate from UCC. Photo: Michael MacSweeney/Provision.
Colm McCarthy

Colm McCarthy

In accepting a doctorate from University College Cork on Thursday last, the outgoing European Commission president Jose Manuel Barroso could have taken the opportunity to reflect on his 10 years at the helm of the European Union's key institution.

It has been, on any dispassionate assessment ,a decade of crisis and under-achievement for the EU, by no means all to be laid at the feet of the commission which he heads. He chose instead to make polite remarks about the university whose honour he was accepting, which is perfectly fair and reasonable, but went on to paint a picture of the European Union, and particularly of the common currency project, which reeked of complacency and self-congratulation.

There are four central points to be made about the common currency project which commenced in 1999. The first is that it was a huge undertaking, comparable in potential consequences to the EU's other two great experiments, the successful enlargement of the union and the near-completion of the single market. Persuading countries to abandon their independent currencies and to pool monetary sovereignty in a new set of untried institutional structures required careful design, anticipation of stresses which might arise and advance planning for dealing with them. It is now acknowledged universally, including by some of the project's designers, that it was "riddled with design flaws" in the words of German finance minister Wolfgang Schauble. Barroso's Cork speech contains not a single reference to errors made in designing the common currency, or to any failures in its subsequent crisis management.

The second elephant in the room is the weak response to systemic problems when they arose. When crisis struck in 2008 the response of the common currency's managers was inept. The initial diagnosis, that the source of the crisis lay in budgetary mismanagement in a small number of countries – a diagnosis promulgated enthusiastically by the European Commission – has been shown to have been laughably inadequate. The eurozone suffered a systemic banking crisis (as did several non-Eurozone countries) and took far too long to acknowledge what had happened.

The third central point is that the design flaws which made the common currency vulnerable have yet to be addressed. A common currency area without the necessary architecture of banking union, particularly if accompanied by lax banking supervision, is an unexploded bomb, and the bomb duly went off. There has been some progress on centralised bank supervision but none on a centralised system for dealing with banks that go bust. These remain the potential liability of individual eurozone member states.

Barroso stated in Cork, "We are delivering on the promise that the taxpayer will not be called upon in future to bail out banks that get into difficulty."

This statement is simply untrue. There has been no agreement on a centralised system of bank resolution. The commission has made proposals, it is true, but there has been precisely no political agreement on breaking the doom-loop between banks and treasuries. To be clear, if, for example, the Italian banking system hit the rocks later this year, the over-stretched Italian treasury would have to rely on its own resources to address the issue. On a centralised system of insurance for retail deposits, there has been no progress whatsoever.

Without centralised bank supervision, bank resolution and insurance for retail deposits, the eurozone is just a common currency area, and not a monetary union. You can call it a monetary union if you wish. You can call your cat Lionel Messi, and send it for a trial at Barcelona. Common currency areas are unstable and liable to periodic episodes of financial instability, including the threat of break-up. The task of turning the eurozone common currency area into a proper monetary union is politically challenging, but no useful purpose is served by pretending that it has already been accomplished.

Finally the Barroso speech in Cork made the usual upbeat noises about incipient European recovery, congratulated various heavily indebted countries on whatever progress they have made and generally sought to generate some good feeling about Europe's prospects.

This is dangerous talk, creating the illusion that serious problems have either passed or are in the course of being addressed. It has been demonstrated, in the most painful way imaginable, that the European political leadership designed, during the Nineties, a common currency area that failed its first big test in spectacular fashion. Several eurozone members have had to seek IMF bailouts for the first time in their history, remain massively overburdened with public (and in some cases private) debt and face a decade or more of further consolidation before the sustainability of their public finances is assured. Millions have lost their jobs. The favoured European Commission formula in the initial stages of the crisis was to seek rapid reductions in budget deficits and 'internal devaluation' to restore competitiveness in the financially distressed countries. This policy has not merely yielded deep recessions in those countries, it has prolonged the recession across the eurozone.

This is not the place to go into the policy failings which have exacerbated and prolonged the eurozone crisis. Many of them were not the responsibility of the European Commission but rather of the European Central Bank, and ultimately of political leaders, particularly in France and Germany, who failed to act quickly enough or at all. The Barroso speech in Cork would have been a fine opportunity though, and it is interesting to speculate as to why the commission president chose instead a good-news speech which dodged all of the important issues.

The most likely explanation is that things are looking up (a little) and that financial markets have calmed down. If economic growth returns at decent levels, and stays that way in all of the distressed countries for the best part of a decade, and if the new system of bank supervision keeps them out of trouble, then all might be well. The chances of all of these nice things happening simultaneously are, however, pretty remote. There is likely to be at least one big disappointment somewhere. Italy might fail to resume economic expansion, in which case it is bust. Same goes for Ireland and a few other countries. Greece is probably unable to meet its debt burdens (already reduced through a giant default) even if things go well. And there could be some seriously bust banks lurking out there, with no bank resolution policy in place. So it is a temptation for Jose Manuel Barroso, or for any of the current generation of European political leaders, to accentuate the positive, hope for the best and not to scare people while there is a little bit of optimism around. Temptations like these ought always to be resisted.

The dilemma created by the premature experiment with a common currency, and its subsequent mismanagement, is at root a political rather than a bureaucratic failure. The politicians in the Nineties willed a stable and well-functioning monetary union without designing the institutional structure needed to ensure that outcome. They are now forced to fix the speeding vehicle on the road – it cannot be hauled off to the factory for a refit. But the game that is being played, exemplified in Barroso's Cork speech, is a dangerous one. What precisely is the intention if there is serious trouble in the Italian bond market? What if a bunch of continental European banks get into trouble, or are revealed to have been in trouble all along?

The components of a durable monetary union for Europe are well understood at this stage. Unguaranteed creditors of bust banks must be given to understand, in advance, that they will not be bailed out either by national or by eurozone institutions. Retail depositors must have access to a pre-funded scheme of deposit insurance. Under-capitalised banks must be required to reduce their exorbitant levels of leverage, diluting existing shareholders if necessary. If any of this requires EU treaty changes, so be it.

Barroso ended his Cork address eloquently: "We know from our European history that it is always important to hold on to our dreams and ideals. Nothing worth having is easy to get. And we know from the epigraph WB Yeats chose for his 1914 collection of poems that 'in dreams begins responsibility'."

In Europe's attempts to build a monetary union, the dreams indeed appear to have preceded the responsibility. There is still time to change the sequence.

Sunday Independent

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