Working Toward a True Solution to the Euro Crisis

The crisis in Europe that began in Greece in 2009 has inflicted much pain on the continent. Greece, Ireland, and Portugal have all received international bailouts, and even Spain, the fourth largest economy in the euro area, has requested financial aid.

The tide may now have turned. In May 2012 François Hollande, who was running for president of France on a platform prioritizing economic growth, emerged triumphant. On June 17 Greece’s New Democracy party, which was promising to support austerity policies, won the most votes in a general election. And on the same day, in the general election in France, Hollande’s Socialist Party was victorious. Then, at the June 28–29 euro area summit, it was agreed to directly support banks and to have the European Stability Mechanism directly purchase government bonds.

Will this recent series of events, especially those that occurred in June, alter the outcome of the euro crisis? Are we now on track for a resolution? In what follows below, I attempt to answer these questions.

Still Far from a Solution to the Problems in Greece

Although Greece’s New Democracy became the leading party after the elections on June 17, it did not gain enough seats in parliament to achieve a majority and form a government. By joining with the Panhellenic Socialist Movement (PASOK) and other parties that support the austerity policies that were part of the bailout agreement Greece signed and ratified, New Democracy achieved the needed majority and formed a coalition government. The party’s leader, Antonis Samaras, became prime minister. But Samaras was soon hospitalized because of a detached retina, and Vassilis Rapanos, who was appointed as finance minister in view of his connections to the banking industry as chairman of the National Bank of Greece, suddenly resigned from his post owing to poor health.

These troubles marked the beginning of the new government. Although Greece is set to proceed with its austerity policy, this is only because New Democracy barely managed to form a coalition government. The Greek people voted for it reluctantly and were mainly motivated by a fear of being forced out of the euro. The austerity policy remains highly unpopular. Samaras has pledged to delay the implementation of austerity measures by two years and promises to renegotiate financial terms with the “troika”—the European Union, the European Central Bank, and the International Monetary Fund.

There can be no doubt that this renegotiation will be tough going. This is because the Greek economy is now deteriorating as a result of the austerity measures already implemented, leaving no room to ease the fiscal tightening. If Samaras is unable to negotiate better terms, there is a high probability that the public, tired of the harsh cuts to public spending, will react with extreme demonstrations, throwing the government into confusion. If this happens, Greece will end up right back where it started, continuing to be a flash point of the euro crisis and an enormous problem for Europe.

Insufficient Stimulus for Growth

The next problem is the plan for growth and employment that was revealed following the four-way summit between the leaders of France, Germany, Italy, and Spain on June 22.

During his election campaign, Hollande pledged that his policies would focus on growth. This took the form of balancing government income on the one hand with spending on the other. The income would come from increased taxes on the wealthy. The spending would fund investment to stimulate economic growth and reduced fiscal cuts impacting the middle and working classes.

Although the leaders agreed to €130 billion (later revised down to €120 billion) in new investment in infrastructure and other areas, German Chancellor Angela Merkel was adamant in her opposition to France’s request for further investment. For this reason, the financing actually features little new money. Most of the funding will come from either the European Investment Bank or reallocated EU structural funds. The only new capital amounts to €10 billion, and even that takes the form of new capital for the EIB. The problem for the countries at the brunt of this crisis, such as Spain, is excessive financing of infrastructure and real estate. In this light, it seems overly hopeful to suppose that yet more infrastructure investment will solve the crisis.

The EU Summit: Full of Compromises

The major point of the debate during the June 28–29 EU summit was the issue of creating a mechanism for injecting funds directly into stricken European banks. Banks in Greece, Ireland, Portugal, and Spain have insufficient capital. Although they are receiving support from the European Financial Stability Facility, the EFSF is unable to inject capital directly. Instead, it provides loans to each government, and the governments must then bail out the banks. This setup means that the debt levels of those governments increase with each loan from the EFSF. In the event that a bank’s capital shrinks to the point where it is unable to repay its debts, the debt repayment obligation is transferred to the government that bailed it out. Because that would cause the debt levels of Spain and other troubled countries to rise yet higher, their government bond yields have continued to soar.

The plan is to incorporate the EFSF into the European Stability Mechanism in July. On that occasion, it will become possible to inject capital into banks directly, without impacting the fiscal position of the governments. This will allow Italy, Spain, and other countries to get started on liquidating bad debts without shouldering a heavier debt burden. It will mean, however, that the ESM will bear the risk instead. The ESM is funded by nations whose debt has AAA ratings, such as Germany and Finland. If the ESM is forced to bear losses, Germany and the other funding nations will have to foot the bill. We should not be surprised, accordingly, that Germany was strongly opposed to this aspect of the ESM plan.

But Italy’s prime minister, Mario Monti, drew in Spain’s prime minister, Mariano Rajoy, and they stated that without direct capital injections, they would refuse to approve the €120 billion growth strategy described earlier. Doing this would mean losing the key element of the EU summit and could be seen as a surefire disappointment to the markets. Looking for a way out, Merkel put forward a counterproposal, and it was accepted. In exchange for allowing direct capital injections from the ESM, an EU banking supervisory mechanism is to be constructed.

Behind this compromise were some hard domestic realities for both Germany and Italy. The popular opinion in Germany is that any further support for the southern European nations should not increase the burden on Germany. Merkel needed to secure some tangible result from the summit to placate her critics. In Italy, the government is pressing ahead with unpopular reforms to the labor market and the pension system. Monti knew that, by hook or by crook, he had to come back with a positive result to show his electorate. The outcome of the summit was thus a compromise designed for each country’s specific circumstances. As a result, it is an unstable arrangement that could break down at any moment.

The Failure of the Four Presidents

There are many presidents in the EU. Herman Van Rompuy is president of the European Council, José Manuel Barroso is president of the European Commission, Jean-Claude Juncker is president of the Euro Group, and Mario Draghi is president of the ECB. There is also Jerzy Buzek, who is president of the European Parliament. At the summit, Van Rompuy, Barroso, Juncker, and Draghi all attended and together proposed measures to bring about deeper integration. These integration measures covered financial areas (the establishment of a banking union), fiscal areas (the issuance of euro bonds backed collectively by euro zone countries), and general economic policy. The summit failed to agree on a banking union centralizing bailouts and deposit insurance, but a unified banking supervisory mechanism and direct capital injections via the ESM were accepted. With regard to the integration of economic policy and the issuance of euro bonds, which could generate funds for integrated fiscal policy, the leaders only managed to reach agreement on drawing up a long-term roadmap.

It has become very clear that even after their powers increased following the Lisbon Treaty of 2009, the presidents of the EU can neither coordinate the interests of the member states nor overcome EU crises, despite their united efforts. This shows that the method of increased integration through stronger systems and institutions, which the EU has been employing until now, has not functioned properly. Only by cobbling together compromises have the member states been able to resolve problems. Such is the reality of the current state of European integration.

The Dilemma of Integrated Monetary Policy and Separated Fiscal Policy

The series of actions that have taken place since the start of June have only allowed some breathing space in the euro crisis. It would be difficult to call them a comprehensive solution to the problems. As I have already described, there is a high probability that the Greek problem will flare up again. There is also no guarantee that Spain’s bad debts will be dealt with smoothly following the bursting of its real estate bubble.

The primary reason that there have been no comprehensive solutions is that the structure of the EU is unchanged; monetary policy is integrated but fiscal policy is still separate. To a certain degree, both unified banking supervision and direct capital injections into banks are measures that should have been put into place when monetary policy was integrated across the euro area. However, a banking union that has deposit guarantees and bank bailouts would require large-scale funding. The capital for that would need to come from the public coffers of the member nations. Politically, it is very hard to get voters to agree to their tax payments being used to protect savers and banks in other countries.

Even if such a banking alliance is realized, it will not automatically lead to fiscal integration. True fiscal integration, with something like common euro zone bonds, would involve not only each country financing the debts of other countries; it would also mean that fiscal deficits of other countries would be covered through capital transfers. At the moment, it is almost unimaginable that Germany will cover the enormous fiscal deficits in Greece, Spain, and Italy through capital transfers with no conditions attached.

Common Sense of Identity in Europe Needed

Given the discussion above and the issues that I have been examining, I think the only solution is to await the recognition by the people of Europe that the euro’s problems are their own. In order to fundamentally solve these problems, Europe must encounter a succession of crises, work out a short-term solution for each of them, and gradually gain a better understanding that Europe’s nations are all in the same boat. If it sinks, they will sink together. In the same way that the citizens of individual nations realize that wealthy urban areas should support poorer rural areas, Europe needs an awareness or sense of solidarity among its citizens with regard to wealthy European countries supporting countries whose economies are struggling.

From this perspective, the solution to the euro crisis cannot be found in economic measures or political agreements; it will be found in the consciousness of the European people and the level of their attitudes toward nationalism. Still, I wonder if a sense of unity will be born as a result of crises in Europe. I wonder if political leaders are moving in a direction that will generate this sense of unity. This is the key issue to understand the future of the euro crisis.

(Originally written in Japanese on July 5, 2012. Title background photo by EPA-Jiji.)