BRIEF POLICY

BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE Thomas Klau and François Godement with José Ignacio Torreblanca

Six months after European leaders took decisive action to SUMMARY Europe’s Economic and Monetary Union has avert an imminent financial collapse of European and global been an extraordinary achievement. But the markets, it is clear that they have failed to do enough to stop events of 2010 have made it apparent that the contagion. Having already bailed out Greece, they agreed its political governance was designed for fair weather. Having reluctantly taken the first – on the 60th anniversary of the Schuman Declaration, in steps this year, European leaders must now May 2010 – to create, together with the IMF, a massive make it storm-proof. The move to an agreement €750 billion rescue package to deter speculators or, at worst, to establish a permanent European Stability to assist other eurozone countries in dire budgetary straits. Mechanism (ESM) to replace the EFSF in 2013 represents a fundamental and encouraging But despite this bold move – and decisive but socially and change in the approach of European leaders to politically costly action in many eurozone countries to cut the future of the eurozone. But the new model deficits – the crisis has resumed and deepened. A summer of eurozone governance currently envisaged of uneasy calm was followed in the autumn by a dramatic by the EU, which is based once more on the Maastricht Treaty, will be vulnerable to failure fresh loss of investor confidence in eurozone sovereign debt. for the same reasons as its predecessors. In November, Ireland became the first country to request assistance from the European Financial Stability Fund If Europe wants to remain a serious player and help shape the twenty-first century, it should (EFSF) that EU leaders created in May. instead go beyond Maastricht and finally build a monetary and economic system strong enough A domino effect now threatens to move from the periphery to last. There are at least three other solutions to the core. If Portugal falls, as many expect it to, the fourth- – Eurobonds, a euro-TARP and an expansion of the federal budget. Yet each of them is opposed largest economy in the eurozone, Spain – whose GDP of €1 above all by , the eurozone’s dominant trillion is seven times larger than Ireland’s and represents a power, which feels its robust growth vindicates tenth of the eurozone economy – could be next. Unlike Greece, its own economic model even though its the markets’ first target, Spain did not go into the crisis with political model for a rule- and sanctions-based governance of the eurozone looks to have failed. a large public debt problem and it is threatened above all by Europe now faces a choice between a future the extent of financial sector losses. Even if EFSF funds were of permanent tensions within the EU and a sufficient, as authorities insist, a rescue operation for Spain new grand bargain. Europe needs clearheaded, would mark a dangerous new turning point in the sovereign forward-looking German leadership that would anchor a European Germany in a more German debt crisis. If Spain – a major European country with global Europe. reach – were pushed towards intervention or insolvency, the impact would be disastrous. In the worst-case scenario, it 2 ECFR/26 December 2010 www.ecfr.eu BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE “Even before it began, Europe’s moment as a major world world major a as moment Europe’s began, it before “Even As doubts grew in the spring over the eurozone’s ability to to ability eurozone’s the over spring the in grew doubts As EuropeanAs leaderspublicly quarrelforward,aboutway the 2  1  For 50 years, Europe has been the scene of fierce competition EFSF on 9 May. The main reason is a fundamental change in the beginningof the Since dither.leadersnationalEurope’s Europe at home and abroad would be even more disastrous.moreeven abroadbewould andhome Europeat France’s gradual retreat into silence is as telling as the change Europe’s founding fathers. “Europe will not be made all at at all made be not will “Europe fathers. founding Europe’s The EU has been in crisisbeenhasinEUThebefore. different.thisButistimeit In the past, Europe’s leaders drew on the lessons of two two of lessons the on drew leaders Europe’s past, the In But while the ECB takes the lead in fighting the crisis, crisis, the fighting in lead the takes ECB the while But Wall and GermanreunificationandBerlinWalla creation theof with answered the threat posed by the superior performance of of performance superior the by posed threat the answered German Europe. discipline. In the past, the process of European economic economic European of process the past, the In discipline. surpluscreatestradedamaginghugeimbalances its as even could be followed by Belgium and Italy, both of which are are which of both Italy, and Belgium by followed be could crisis, they have seemed to move only when overwhelming when only move to seemed have they crisis, exports much more expensive, and incur huge losses for its for losseshuge incur expensive,and more muchexports easily could which Germany, including countries, eurozone they home, at cuts budget converging engineering despite out by a massive appreciation of its currency, making its its making currency, its of appreciation massive a by out once, or according to a single plan,” Robert Schuman declared reforms, it sees no reason to spare other countries this this countries other spare to reason no sees it reforms, painfulcompleteditself Having Europe. beyond and within world started singing the a requiemaround forvoices Europe’s influential global storm, ambitions. financial the weather world wars and seized crises as opportunities to deepen deepen to opportunities as crises seized and wars world more heavily indebted than Spain. marketpressure left noalternative, aswhen they created the monetary union. Now, faced with a crisis that has exposed has that crisis a with faced Now, union. monetary the position of Germany at the core of the Europeanthepositionofcoretheproject.Germany the of at the German model of trenchant reform and fiscal restraint. fiscal and reform trenchant of model German the the weaknesses of its eurozone governance, the logical next logical thegovernance, eurozone its ofweaknesses the the single market. In the 1990s, it responded to the fall of the andJapanesetheUS economies decisionwitha complete to integration was driven by compromises between member member between compromises by driven was integration in perspective is profound: from a European Germany to a to Germany European a from profound: is perspective in Now, Germany. and France betweenessentially, and, states battle this won has it feels Germany II, War World since strong growth amid the biggest economic and financial crisis in 1950. “It will be built through concrete achievements which of spiritthe strengthenineconomic unionto be wouldstep see the gains resultinggainspainfuleconomicfromthereformwiped see euro. the of break-up future a about fears strengthen however,it hinges on other member states agreeing to adopt political and economic integration. In the 1980s, Europe Europe 1980s, the In integration. economic and political financial cost of such a collapse would be enormous for all for enormous be would collapse a such of cost financial first create a de facto solidarity.” between diverging economic models. Buoyed by uniquely uniquely by Buoyed models. economic diverging between banks that have loaned to the periphery. The political cost for en.htm. Declaration of 9 May 1950, available at http://europa.eu/abc/symbols/9-may/decl_ Times See, for example, Gideon Rachman, “How Germany could come to kill the euro”, , 22 November 2010. 1 Financial 2 The The EU seems to have created, through the Treaty, an an Treaty, Lisbon the through created, have to seems EU Europe should finally build a monetary and economic system This brief – which is based on a series of interviews with with interviews of series a on based is which – brief This 3 Relations, in May. in Relations, York-basedNewForeignHaass,presidenttheCouncil on of and help shape the 21st century. For this, Europeans need need Europeans this, For century. 21st the shape help and governancecurrently envisaged thebyEU,based oncemore euro crisis in the context of this existential threat to European diplomatic voice. But at precisely the moment that the the that moment the precisely at But voice. diplomatic foreignpolicyhaschallengeEU theeuro, for the creation of thesincedecade theDuring 27. EUentire thecountries but of the crisis and examines a range of possible solutions solutions possible of range a examines and crisis the of onthe Maastricht Treaty, will be vulnerable to failure for the whohave either helped govern the eurozone as politicians or members of the European Council on Foreign Relations Relations Foreign on Council European the of members manages its foreign policy. to the problem. It argues that the new model of eurozone eurozone of model new the that argues It problem. the to to go beyond Maastricht and negotiate a new economicandnewbeyondMaastricht negotiate goanda to to European foreign policy, affecting not just the eurozone 16 it facesitirrelevance theglobalon stageregardless – howitof foreign its coordinate to it enable could that instrument influence and respect. shaped the policy debate as economists – aims to explore the strong enough to last if it wants to remain a serious player serious a remain to wants it if last to enough strong thatrecommends It were.predecessors its as reasons same powerinthe 21st century looks tobeover,” wrote Richard N. power, Germany. eurozone strongest and pliant least the with deal political prestige dwindles as a consequence of the crisis. If the EU EU the If crisis. the of consequence a as dwindles prestige policy more effectively, it faces a new setback as its economic Simply put, the euro crisis has become an existentialthreat an become has crisiseuro the put,Simply foreign policy. It looks at the economic and politicaloriginseconomicandthe atlooks foreignpolicy.It findsitselfunable secureto long-termthe futureeuro,theof been how to match economic power with a commensurate commensurate a with power economic match to how been become reality, Europe would face a debilitating loss of of loss debilitating a face would Europe reality, become  May 2010. Richard N.Haass,“Goodbye toEuropeasahigh-rankingpower”, 3 If a break-up of the eurozone were to to were eurozone the of break-up a If Financial Times,12 The origins of the crisis system of rules. Somewhat naively, it believed in the ‘no bailout’ rule for countries facing the threat of default. But, The sovereign debt crisis that erupted in the eurozone in logically, if you have no bailout, no default and no provision the spring of 2010 was a direct consequence of the rescue for exiting the eurozone, by definition you have a fair-weather operation that EU governments had to conduct to save construction – and this was not even part of the debate or Europe’s financial sector and economy after the collapse of national consciousness, even among intelligent Germans.” Lehman Brothers in September 2008. “The first phase of the maneuver has been successfully accomplished – a collapse has Many of these systemic weaknesses in eurozone governance been averted,” said George Soros in June. “But the underlying resulted from the long and often conflicting search for a causes have not been removed and they have surfaced again way to deliver sufficient budgetary discipline and economic when the financial markets started questioning the credibility convergence while letting national governments and of sovereign debt. That is when the euro took center stage parliaments determine their own policies – leading to the because of a structural weakness in its constitution.”4 Maastricht Treaty in 1991 and the Stability and Growth Pact The unique character of the crisis arises from a number of signed in in 1996. At the time, a number of key policy overlapping failures. The first, shared across the West, is the actors privately expressed doubt that this rule-based model catastrophic failure of legal control and regulatory oversight would last. “Everybody who follows this could predict that of the financial sector. that would happen,” says Jean-Luc Dehaene. “From the start, warned that next to a central bank you need However, the global crisis has also exposed further failures also a form of economic governance. But Germany always that are specific to Europe. The crisis made apparent that the said this would compromise the autonomy of the (European Maastricht-designed political architecture for the eurozone Central) Bank.” – with the deficit-focused Stability and Growth Pact as its pièce de résistance – was inadequate to cope with the real The conflict continued even after the introduction of the euro. challenges that the single currency zone faced. In particular, The years after 1999 saw numerous skirmishes between it failed to prevent both the widening of disparities between eurozone member states, who were keen to preserve their the economies of its members and the huge cross-border bets de facto sovereignty over national budgetary and economic that an increasingly interdependent, ineffectually supervised policy decisions, and the enforcers of the Maastricht-based European banking sector placed on continuing growth and Stability and Growth Pact. The most telling and damaging stability in countries across the eurozone. Ireland and Spain, clash was the successful Franco-German rebellion of 2003 each saddled with massive financial sector debt after a huge and 2004 against a European Commission move to initiate construction boom driven by speculation rather than demand, sanctions procedures against and Berlin for having offer two spectacular illustrations, as they ranked among the failed to take action to bring their respective budget deficits best performers according to the Maastricht rulebook. “We back under the Maastricht limit of three percent of GDP. To have been talking about imbalances at least since 2005 but many smaller member states, it seemed that the rules that nothing was done,” says Jean Pisani-Ferry.5 The lowering of had been enforced against them no longer operated when interest rates in a number of eurozone members as a result two big countries were targeted. of the creation of the single currency facilitated reckless spending and lending. “The creation of the eurozone has failed The subsequent decision in 2005 to introduce a number to enforce fiscal discipline,” says Giuseppe Scognamiglio. of modifications to the rulebook for economic governance “We underestimated the negative windfall effect of the euro,” – a move from ‘Maastricht I’ to ‘Maastricht II’ – was hailed says Pascal Lamy. by some at the time as a victory of common sense over bureaucratic rigidity. Today, it seems like a mistake. “The As has now become apparent, the system built on the French and the Germans killed the Stability Pact in 2004,” foundations of the Maastricht Treaty was also too weak to says Lamy. “This is one of the reasons for the Greek shock.” resist a severe financial market storm. “There was no crisis Either way, the Maastricht model with its Stability and management provision in the treaty,” says Pisani-Ferry. Growth Pact has now failed a second time under even more “There was this strange belief that crisis prevention through dramatic circumstances. With its focus on the public deficit, the stability pact would make crisis management unnecessary Maastricht II has been blind to systemically dangerous and even counterproductive, as it would create the wrong financial sector behaviour resulting from an abrupt lowering incentives.” In the words of Wolfgang Münchau, “Germany, of interest rates as a result of the introduction of the in particular, had reduced monetary union to its fiscal and euro, and it was too weak to avert destabilising economic monetary core, and thought it could achieve a stable and imbalances within the eurozone. It prevented neither gross sustainable budgetary and economic situation through a governmental accounting fraud in a country such as Greece nor problematic levels of national debt even before the rescue of the financial sector. It offered nothing to deal with the financial storm that grew out of these failures. 4 George Soros, “The euro crisis could lead to the destruction of the ” (Humboldt University Lecture, Berlin, 23 June 2010), available at http://ecfr.eu/ content/entry/commentary_the_euro_crisis_could_lead_to_the_destruction_of_ the_europe/ All of these deficiencies have now become key drivers of 5 Unless stated otherwise, quotes are taken from interviews carried out by the authors during market forces as a result of the specific nature of the EU 2010. 3 4 ECFR/26 December 2010 www.ecfr.eu BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE At the same time, the equivocation, angry exchanges and and exchanges angry equivocation, the time, same the At Whereas the US conforms to the recognisable and tested tested and recognisable the to conforms US the Whereas 6  US. However, the markets have now made the eurozone, eurozone, the made now have markets the However, US. a joint European approach to restructuring the financial financial the restructuring to approach European joint a afford. Ireland’s dramatic slide into a public-debt abyss is is abyss public-debt a into slide dramatic Ireland’s afford. that us tells data economic the at look A eurozone. the and a genuinely European plan for dealing with losses in the the in losses with dealing for plan European on genuinely agree a to failure the worse, Even ensemble. cohesive a a steep financial price for being a follow it does nor capital, historical such no accumulated has hand, other the on EU, The whole. the of survival and US the that expect automatically markets The time. any at earth to down crashing come to apt prototype untested an authority of a strong office, divisions between member states crisis have further undermined the eurozone’s standing as as standing eurozone’s the undermined further have crisis the than shape better in is eurozone the accounts, current disastrouslevels,interestbudgetspublicand,rateeffectson enforcecommon decisions andspeakforthe whole with the narrow national focus that eurozone leaders have displayedhaveleaderseurozone that focus nationalnarrow notAmerica, the focus of their anxiety. The reason is simple. and levels debt private and public overall to comes it when recognisable historic model. In the current crisis, it is paying cohesion the ensure to takes it whatever do always will regions, the eurozone remains, in the eyes of many operators, model of an established federal state complete with a large a with complete state federal established an of model h eooit ntl Kltk woe recently. wrote Kaletsky Anatole economist the of benefit the for undertaken bailouts for pay to taxpayers “Irish forcing choice, policy this of consequence direct the take full liability for rescue operations that they could hardly debt sovereign the of outbreak the since again and time the eurozone lacks a politically powerful figurehead able to able figureheadpowerful politically a lacks eurozone the is a post-Westphalian (post-nation-state) experiment, and and experiment, (post-nation-state) post-Westphalian a is sector, other countries could suffer the same fate. Since Since fate. same the suffer could countries other sector, have taken centre stage in the eyes of the markets, with with markets, the of eyes the in stage centre taken have people don’t believe in that.” ultimately, European citizens. Schioppa says the markets attack the eurozone “because it it “because eurozone the attack markets the says Schioppa financialsectormeantthatindividual memberstatesto had bank bondholders in Germany, Britain [and] France,” as as France,” [and] Britain Germany, in bondholders bank budget and flexible fiscal transfers from richer to poorer poorer to richer from transfers fiscal flexible and budget at http://gavekal.com/doc.cfm?src=forum&id=6400. Anatole Kaletsky,“ANew IdeatoSavetheEuro”,GaveKal,2December 2010,available sui generis . Tommaso Padoa- 6 Absent Absent Maastricht III 7  28 October. 28 The ESM can therefore be no more than the first of several of first the than more no be therefore can ESM The The move to an agreement to establish a permanent European The EU’s leaders have implicitly acknowledged this and and this acknowledged implicitly have leaders EU’s The By anchoring it in the treaty, eurozone countries would be would countries eurozone treaty, the in it anchoring By and cohesion of the eurozone. Simply put, the ESM will will ESM the put, Simply eurozone. the of cohesion and eurozone.the of futurethe toleadersEuropean ofapproach a third chance rather than seize the crisis as an opportunityan ascrisis the seize thanrather chance third a the seize we “EitherFischer.Joschka says euro,” the of and agreement to: crisis. But it does not address the economicaddressimbalancesthenot doesand it crisis. But emptively chosen to give the Maastricht-derivedthe giveframework toemptivelychosen the despite However, 2011. of summer the by completed be to governance eurozone of overhaul broad a for called chance to move forward or the euro will break apart.” essential role as co-legislator. Its key elements, as outlined as elements, key Its co-legislator. as role essential represents a fundamental and encouraging change in the the in change encouraging and fundamental a represents eonig alr o Matih I n I, hy ae pre- have they II, and I Maastricht of failure resounding way. “The budgetary surveillance framework currently in in currently framework surveillance budgetary “The way. the lack of plausible European leadership outlined above. above. outlined leadership European plausible of lack the to redesign their economic union in a more fundamental fundamental more a in union economic their redesign to thrashed out in a process in which the , implicitly committing with the full weight of the EU’s highest steps towards restoring faith in the eurozone. “The crisis has in the European Commission’s proposals, indicate a future a indicate proposals, Commission’s European the in an play will Treaty, Lisbon the by strengthened powers its source of law to do whatever it takes to preserve the stability provide for stronger cohesion of the eurozone at times of of times at eurozone the of cohesion stronger for provide place, defined in the Stability and Growth Pact, remains remains Pact, Growth and Stability the in defined place, Stability Mechanism (ESM) to replace the EFSF in 2013 2013 in EFSF the replace to (ESM) Mechanism Stability final report endorsed at the European Council meeting on on meeting Council European the at endorsed report final brutally laid bare the weaknesses of the European model model European the of weaknesses the bare laid brutally broadly valid,” wrote the Van Rompuy Task Force in its its in Force Task Rompuy Van the wrote valid,” broadly uedocs/cms_data/docs/pressdata/en/ec/117236.pdf. European Council”,21 October2001,availableathttp://www.consilium.europa.eu/ “Strengthening EconomicGovernanceinthe EU–ReportoftheTaskForceto • • • • • step up coordination and mutual monitoring of of monitoring mutual and coordination up step target excessive national debt, as well as deficits, withdeficits, as well as debt,nationalexcessivetarget nationalframeworka up set tostatesrequiremember introduce new surveillance and possibly a new sanctions toughen the procedure by making it easier and faster for a so-called European semester a variation of the Stability and Growth Pact sanctions Pact Growth and Stability the of variation a economicandfiscal trends through theintroduction of requirements to makebudgetaryto planning morecompatible withEU procedure procedure to control imbalances in eurozone economies, finance ministers to adopt sanctions based on a scoreboard of economic indicators 7 The precise shape of the reform will now be be now will reform the of shape precise The There are deep disagreements between governments over fact, Maastricht III will make this even more likely: with crucial details of this third Maastricht system of eurozone more options for sanctions built in, as a result of the ongoing governance, such as how to evaluate a country’s imbalances reform, the odds increase that mistakes will occur. Inevitably, or define excessive debt. However these disagreements are as time goes by, these successive errors will weaken the resolved, it already seems clear that ‘Maastricht III’ will system’s legitimacy and facilitate organised rebellion from share essential structural flaws with its two predecessors. unwilling recipients of guidance or punishment. The Franco- In particular, it is not enough to construct a system of German uprising against Maastricht I was criticised by governance that looks efficient and coherent on paper but many as being “un-European”. But both countries at the crumbles when exposed to the reality of politics in the 17 time defended their fiscal stance as appropriate; and, in democracies (including Estonia) that will form the eurozone purely economic and budgetary terms, later developments from January 2011. It is striking that, in the current reform have tended to vindicate the German position. At the time, debate, a number of plain, non-economic yet fundamental the German-inspired straitjacket of rules and punishment practical and political issues have gone almost unmentioned clashed with Berlin’s own forward-thinking and strategic despite having made it structurally quite impossible to economic decisions. When it was applied to Germany as it operate the Maastricht system successfully in the past. had been to others, the Germans, with the French at their side, tore it apart. There are at least three big problems with the Maastricht- derived rulebook that the ongoing reform does not seem The Maastricht framework as it is today, and as it looks set to address. First, the Stability and Growth Pact ignores to emerge from the ongoing reform, takes little or no account the way that in each country the political calendar and, in of these three fundamental realities. It therefore requires a particular, the electoral cycle usually impacts the timing suspension of disbelief to assume that increasing the scope of of economic and budgetary policy decisions as much as sanctions and making them easier to adopt – the aims of the economic considerations. In other words, political timing current reform – will make Maastricht III function where its and political context often trump economic timing. For two predecessors did not. “There is no way one can organise instance, as John Bruton says, “the political reality is that an effective European coordination without major changes in you can only make serious expenditure cuts in economic national practices and, in some cases, structures,” says Hans hard times, because you can only get political consensus to Eichel. Making the Stability and Growth Pact work would, at make cuts in hard times. Making deep cuts in the middle of a minimum, require a significant harmonisation of national the boom may be theoretically the right thing to do, but it’s habits of governance and, in some cases, even national politically impossible.” There are no indications so far that constitutions to make them compatible with the European the third attempt to get the Stability and Growth Pact right coordination and surveillance framework. will acknowledge any of this, let alone create a framework that is able either to bend or to adapt to such a fundamental But, as Padoa-Schioppa points out, this throws up a paradox. reality of politics in a democracy. “Many people say that a federal budgetary system is a dream of an EU that is a much stronger EU than they would like to Second, EU member states’ domestic rules and constitutional see,” he says. “But these same people see it as the EU’s job practices regarding the conduct of their economic and to coordinate national budgetary policies, which is of course budgetary policy differ in fundamental respects. In some much more intrusive. There is no federation I know where member states, it is mostly the finance minister who the federal power coordinates the local powers. We are in the determines budgetary policy; in others, it is the head of paradoxical situation that those who have little ambition to government or the cabinet as a whole. In some member integrate the EU further have big ambitions about the role of states, the parliamentary majority exercises a high degree of the EU as a powerful, intrusive coordinator.” detailed control over the make-up of the budget; in others, the government will simply put the budget to a vote. In the past, the finance ministers assembled in the eurogroup – the eurozone’s main steering committee – have often acted and spoken as if they possess the power to take decisions effectively binding all eurozone governments. But in reality they do not. They can woo, bully, cajole and, as their ultimate weapon, launch unwieldy sanctions procedures. But their collective power is very limited, no matter what the Maastricht rulebook suggests.

Third, it is inevitable that mistakes will be made. Over time, the European Commission, the European Council and the eurogroup, whose job under the Stability and Growth Pact is to guide member states and sanction the wayward, will inevitably give some erroneous guidance and sometimes base harsh sanctions on wrong economic assumptions. In 5 6 ECFR/26 December 2010 www.ecfr.eu BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE –with their likely AAA rating –would facilitate much needed Alternatives Eurobonds Juncker,Italiantheandfinance minister GiulioTremonti in Faced with unabating market unrest and with the decision the with and unrest market unabating with Faced European Council. The most prominent and promising proposal concerns the the concerns proposal promising and prominent most The Eurobond backed by strong European institutions would give Eurobonds are numerous and obvious. The Eurobond market In a spectacular development, it was endorsed – against against – endorsed was it development, spectacular a In Theadvantages switchofa ofmuch existing national debt to PresidentNicolasSarkozy. Merkel’s refusalconsider toeven Notwithstanding Chancellor Merkel’s argument against against argument Merkel’s Chancellor Notwithstanding a new discussion of the initiative followed a pattern often often pattern a followed initiative the of discussion new a German chancellorimmediatelyGermanMerkelAngelarejectedthe aligned fiscal policies. governments have now opened the debate about other means andtaxpayers would footlower refinancing bills. Eurobonds reduced significantly be would countries individual against equivalent market Eurobond massive a of build-up gradual GDP would create a strong incentive for individualincentivestrongformembera create would GDP no eurozoneresistancewhensolidarityfierceafterand only Jean-Claude minister, prime ’s and eurogroup other course seemed sustainable in the face of mounting mounting of face the in sustainable seemed course other of European-wide bonds”, together with a haircut for debt debt for haircut a with together bonds”, European-wide of ceiling, since further debt would have to be paid for with with for paid be to have would debt further since ceiling, repeatedthroughout Germanthe2010,chancellor,as thein the of president the by – opposition German well-known wide basis are the only reasons – along with a safe federal safe a with along – other reasons only the are basis wide and states eurozone for conditions favourable refinancing creating market, Treasury US the rival would opposition the from figures senior two as notable more the all is proposal the of rejection flat Her unrest. market to strengthen the eurozone’s cohesion and commonality. eurozone some taken, EFSF the to successor a establish to the week leading up to the December 2010 meeting of the the of meeting 2010 December the to up leading week the state.membereach and EU the of GDP the percentof 40 to the legal feasibility of a switch to Eurobonds under existingEurobondsunder to switch a feasibilityof legal the to bind their fates in the long term. The scope for speculation summitthein investorsmoreclarity andpredictability andsend one theof system – that US public debt remains as attractive as it does. A investment.Finally, limiting theEurobonds percent40to of strongest possible signals that eurozone countries are willing more and countries stable for guarantees debt holders, plan – followed, though in less categorical fashion, by French states to bring down their debt as closely as possible to thatpossible tocloselyas as debt their downbring statesto higher interest rates. participating EU countries. The depth of the market and its andmarket the ofparticipatingdepth countries.The EU the before day thepublished op-ed an in Steinbrück,called DemocraticSocialFrank-WalterParty, SteinmeierPeer and facehostileof public opinion, agreedeach tostepdeepening FinancialTimes for “thelimitedforintroduction at a moment of doubt and disarray. resiliencegreatundercurrentstheof politics EUeven of essentiallyunchangedtestament a – thestrengthto and of 2010 has left crisis the fundamentals of eurozone eurozone enlargement great the sum, In country’s politics. each internal of patterns shifting the to subject are statedpoliticala and theirgoal.accession But dynamics commitment treaty a remains membership , and WarsawBudapest, , For grown. has turmoil crisis unfolded, has receded in these countries as eurozoneratherthanlater, which prevailed globalthe financialas beforecrisis.thetemptationThe eurojoinsoonertheto economicand position) shiftedhaswherewas back toit Denmark (which is, of course, in a different legal,and Romania politicalPoland, Hungary, Republic, Czech the of position The readiness. its of evaluation generous than to delay ’s entry into the euro through a strict rather ERM membership and the ECB seems currently inclined possible.as has However, hasityetcompleteto twoyears of government soon as eurothe join towanted Bulgaria’s it thatsay continued to crisis, the Throughout in the eurozone. process, so as to avoid potential enlargement new sourcesBaltic the of instability down slowing solidarity, for argue ECB others and eurozone of umbrella the under go to readiness Lithuania’s and Latvia’s of assessment generous a for push some to While crisis. the consequences from draw what about debate a is institutions European other and Commission the Within clear. to assessment is the first hurdle that its the two as countries process, need enlargement Baltic the to key the holds CommissionEuropean The option.realisticearliest the countries, remain keen to Baltic join as two soon as other possible, with the 2014 seen Lithuania, as and Latvia criteria. accession formal the fulfil to it allowing crisis, the of consequence a as down came inflation its when up sped 2011, January in join to due is which Estonia, accessioneurozone.of Thethe furtherexpansion of the not radically transformed the political dynamics affecting Remarkably, the sovereign debt crisis in the eurozone has Eurozone enlargement European law, the Maastricht Treaty has never precluded stabiliser for the eurozone economy and flexible enough to a European debt vehicle, as the occasional past use of EU take over some redistributive functions within the EU. This bonds shows: Eurobonds were issued to help out Italy in 1993 would fit with the general trend of European politics. “The and to ease the transition in Georgia, Kosovo and Moldova EU budget is very small compared with national budgets. before 2004. As recently as November 2008, Hungary was As the EU seems to be required to achieve more and more, assisted with an bond issuance worth of €12 billion. The its budget should be seriously rethought,” says Vaira Vike- German government’s opposition is mainly political in nature, Freiberga. The financing of defence policy, science and prompted by the eurosceptic Constitutional Court and voters’ innovation, overseas aid, or even some social expenditure fear of a small rise in their refinancing costs. But the further such as short-term unemployment assistance, are examples fate of the Eurobond proposal is likely to be driven by the of spending which could be usefully and sensibly transferred need to counter further massive instability in European from national to European level. Given the right policies capital markets as much as by political considerations. At this and budgetary practices, the result would be more economic stage, a commitment to build up a large Eurobond market convergence, more political cohesion, better spending and would undoubtedly be the best available option to make healthier overall economies. Wolfgang Münchau suggests clear to investors that the eurozone will fend off any attempt that moving from one to five percent of GDP – a very modest to undermine its solidarity. Even to Germans, the possible figure compared with typical national or federal budgets small price to pay in the guise of slightly higher refinancing – might be sufficient to achieve the desired economic and costs might seem attractive if the alternative – the risk of the political effect. eurozone collapsing – is worse. But however compelling the economic case may be, the political appetite among EU member states to devolve further A Euro-TARP budgetary power to the EU is currently close to nil. Because of this, Andrew Duff, who as an MEP has personal experience The resistance against Eurobonds has prompted a search for of the fierce resistance of member states, pleads for great other ways to stage a spectacular show of collective European realism and would see a 10-year expansion of the budget to resolve to stem the sovereign debt crisis. Based on the an even more modest 2.5 percent of GDP as an “altogether recognition that the need to bail out the financial sector is the startling growth of the federal budgetary power.” Emma single main cause of the sovereign debt crisis, one interesting Bonino argues that this “federalism lite” would be the most proposal that has emerged is the creation of a European sensible way to move forward. But even this slow expansion version of the Troubled Asset Relief Program (TARP) through of the federal budget would likely come up against massive which the US government bought assets from financial opposition, in particular from France, Germany and the UK. institutions.8 Europeanising the rescue of the banking system The EU’s economic governance has reached an impasse: in this way would undoubtedly take a major burden off the “People say they prefer close coordination and supervision, hardest-hit eurozone members such as Ireland and Spain meaning an intergovernmental path rather than a federal one, and go a long way towards allaying investor concerns about but the truth is that there is no real appetite for that either,” national sovereign debt. It would likely involve a contribution says Emma Bonino. both from bank bondholders and bank shareholders, possibly going as far as a temporary public takeover of troubled financial establishments. But here the ECB’s preference for a blanket bailout, grounded in its understandable fear of a new global credit freeze, clashes with member states’ reluctance to let taxpayers bear the huge cost alone. In particular, the question is whether Germany, which came out against a single European rescue operation for the banking sector as soon as the financial crisis erupted in Europe, would now be more open to consider it.

An expanded budget

This year has demonstrated conclusively that the eurozone needs far more commonality in its budgetary, fiscal and economic framework to survive. In purely economic terms, one compelling option would be a gradual expansion of the EU budget to make it strong enough to act as an automatic

8 Anatole Kaletsky, “A New Idea to Save the Euro”, GaveKal, 2 December 2010, available at http://gavekal.com/doc.cfm?src=forum&id=6400. 7 8 ECFR/26 December 2010 www.ecfr.eu BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE – theproposalsareontable. European leaders must now make it storm-proof. Yet Yet storm-proof. it make now must leaders European an been has Union Monetary and Economic Europe’s Europe now faces a choice between two versions of its future. The second and better choice would entail a new grand grand new a entail would choice better and second The The most subtle defender of Germany’s position, its finance its position, Germany’s of defender subtle most The It can continue to stumble through piecemeal reform, hope reform, piecemeal through stumble to continue can It Conclusion again that their behaviour is herd-like and their collective collective their and herd-like is behaviour their that again a panoply of instruments giving Europe the economic and and economic the Europe giving instruments of panoply a an unwise gamble in both political and economic terms, and capital on betting record, track their given that, accept and rising national resentment across the EU. It is a recipe a is It EU. the across resentment national rising and approach are evident. It entails a risk of permanent tensions, German argument by pointing to the return of interest rate interest of return the to pointing by argument German each promising move towards a better architecture is is architecture better a towards move promising each have 2010 of events the But achievement. extraordinary eurozone member states in the future. But this makes bond makes this But future. the in states member eurozone eurozone lookstohavefailed. discipline and austerity measures. But the limitations of this opposed above all by Germany, the eurozone’s dominant dominant eurozone’s the Germany, by all above opposed of rising superpowers. Eurobonds, Euro-TARP, Eurobudget Berlin politics. European for potential poisonous with one overcome. national policy choices are relentlessly benchmarked by the by benchmarked relentlessly are choices policy national realities, it would instantly acquire the power to write almost to attempt third the that acknowledge to have also would made it apparent that its political governance was designed was governance political its that apparent it made markets against the narrow policy preferences of the most most the of preferences policy narrow the against markets the to twist new a gives Schäuble, Wolfgang minister the of governance sanctions-based and rules- a for model Germany, But it. on dependent more make the Stability and Growth Pact work might very well well very might work Pact Growth and Stability the make is choices policy sound of enforcers permanent as markets judgment often dramatically unsound. Worse, it welcomes welcomes it Worse, unsound. dramatically often judgment the return to a highly fraught European reality where where reality European fraught highly a to return the and time demonstrated have investors same these though the European reality that the euro was supposed to help help to supposed was euro the that reality European the to thepromiseofabetter-organisedfuture. investors the arbiters of economic and fiscal policy – even even – policy fiscal and economic of arbiters the investors feel partners weaker its while model, economic own its spreads within the eurozone as the best way to discipline discipline to way best the as eurozone the within spreads single-handedly an agreement to endow the eurozone with eurozone the endow to agreement an single-handedly suggests, leave it to the financial markets to impose fiscal fiscal impose to markets financial the to it leave suggests, high financing costs for many, dim prospects for growth, growth, for prospects dim many, for costs financing high power. Germany feels that its robust growth vindicates vindicates growth robust its that feels Germany power. powerful country with the best track record – precisely precisely – record track best the with country powerful political cohesion it desperately needs to succeed in aworld to succeed needs itdesperately cohesion political Stability and Growth Pact, refuses to accept that its political for fair weather. Having reluctantly taken the first step, step, first the taken reluctantly Having weather. fair for fail like its predecessors. But if Germany accepted these two for instability, oblivious both to the lessons of the past and past the of lessons the to both oblivious instability, for minister finance Germany’s as and, abate to crisis the for bargain involving Germany. Berlin would first have to to have first would Berlin Germany. involving bargain of the of rector spiritus In exchange for such a German initiative, many among among many initiative, German a such for exchange In anchor a European Germany in a more German Europe. Germany’s eurozone partners, destabilised by their their by destabilised partners, eurozone Germany’s clearheaded, forward-looking German leadership that would w sde daai vleaiiy wud e pn o a to open be would vulnerability, dramatic sudden own profound adaptation of their economic model. Europe needs Among members of the European Robert Cooper ABOUT ECFR Council on Foreign Relations are (United Kingdom) former prime ministers, presidents, Director General for External and The European Council on Foreign Relations (ECFR) is the European commissioners, current Politico-Military Affairs, Council of the and former parliamentarians and EU first pan-European think-tank. 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About the authors Acknowledgements

François Godement is a Senior Policy Fellow at ECFR and The writing of this paper would not have been possible a Professor at Sciences Po, based at the Asia Centre in without the willingness of a group of distinguished members Paris. A historian and analyst of contemporary East Asia, he of the European Council on Foreign Relations to share founded Asia Centre in 2005 after two decades of teaching their insights with the authors. Erik Berglöf, Jan Krzysztof and research about contemporary China, East Asian Bielecki, Svetoslav Bojilov, Emma Bonino, John Bruton, international relations and issues at the French Institute Jean-Luc Dehaene, Andrew Duff, Hans Eichel, Joschka of Oriental Studies (Inalco) and at a Paris based think-tank. Fischer, Mart Laar, Pascal Lamy, Alain Minc, Wolfgang He co-founded the European Committee of CSCAP (Council Münchau, Tommaso Padoa-Schioppa, Jean Pisani-Ferry, for Security Cooperation in the Asia-Pacific). He is also an Giuseppe Scognamiglio, George Soros, Vaira Vike-Freiberga, outside consultant to the Policy Planning staff of the French and Carlos Alonso Zaldívar have each provided fascinating Ministry of Foreign Affairs, and has been a consultant to assessments of the dynamics shaping the current crisis. The OECD and the European Union. authors greatly regret that limitations of space forbade to quote each ECFR member who so generously donated Thomas Klau is a Senior Policy Fellow and the head of time to this project. However, whilst all members of ECFR ECFR’s Paris office. He is a lecturer in European studies at strongly endorse the aim of build a stronger Europe, they the Institut National des Langues et Civilisations Orientales may differ sometimes about the most appropriate path. The (INALCO) in Paris. He is the author, with Jean Quatremer, recommendations the authors have ventured to submit are of Ces hommes qui ont fait l’Euro (1999), a history of the entirely their own, as are all failures of intelligence in this European negotiations leading up to the launch of EMU. A paper. former journalist, he worked as a correspondent in Frankfurt, Brussels and Washington and wrote a political column for We are deeply grateful to Giuseppe Scognamiglio and his Financial Times Deutschland, a paper he helped conceive colleagues at Unicredit, whose committed concern about and launch in 2000. the future of the eurozone acted as a catalyst for this paper. They have offered precious advice and constructive criticism. José Ignacio Torreblanca is a Senior Policy Fellow and Head Without Unicredit’s support and that of its team, this paper of the Madrid Office at the European Council on Foreign would not exist. A very special word of thanks must go to Relations. A professor of political science at UNED University Elena Fenili. We owe a deep debt of gratitude to Zsolt Darvas, in Madrid, a former Fulbright Scholar and Fellow of the , José-Antonio Herce, Marc Klau, Andrés Juan March Institute for Advanced Studies in Madrid, he Ortega, Federico Steinberg and above all Javier Solana for has published extensively on the politics of EU integration, generously sharing their time and precious insights. They including institutional reforms, eastern enlargement and have filled lacunae in our knowledge and enriched our EU foreign policy, as well as on Spanish foreign policy. Since thinking. The paper also benefited greatly from ECFR’s new 2008, he has also been a regular columnist for El Pais. “Germany in Europe” project, which is funded by the Stiftung Mercator.

Warmest thanks also go to the colleagues at ECFR who gave advice and support at difficult moments: Ellen Riotte, Silvia Francescon, Ulrike Guérot, Alba Lamberti, Dimitar Bechev, Daniel Korski, our masterful editor Hans Kundnani, Dick Oosting, Nicholas Walton, and last not least Mark Leonard, who knows how to separate the chaff from the wheat. The final word of thanks must go to Sebastian Kraus and Pirro Vengu, two stellar interns whose quick intelligence never ceased to astound.

11 12 ECFR/26 December 2010 www.ecfr.eu BEYOND MAASTRICHT: A NEW DEAL FOR THE EUROZONE (ECFR/15) Brantner, September 2009 Richard Gowan and Franziska UN: 2009 annual review The EU and human rights at the June 2009 (ECFR/14) Wilson, Nicu Popescu and Andrew the Troubled Neighbourhood European and Russian Power in The Limits of Enlargement-lite: (ECFR/13) Anthony Dworkin, May 2009 Framework for Counterterrorism Towards a New Transatlantic Beyond the “War on Terror”: Godement, April 2009 (ECFR/12) by John Fox and Francois Relations A Power Audit of EU-China (ECFR/11) by Daniel Korski, March 2009 Shaping Europe’s Afghan Surge 2008 (ECFR/10) and Mark Leonard, December by Daniel Korski, Ulrike Guerot relationship Re-wiring the US-EU (ECFR/09) by Pierre Noel, November 2008 deal with Russian Gas Beyond Dependence: How to (ECFR/08) Brantner, September 2008 by Richard Gowan and Franziska Power at the UN Rights? An Audit of European A Global Force for Human (ECFR/07) and Andrew Wilson, August 2008 by Nicu Popescu, Mark Leonard Georgia? Can the EU win the Peace in (ECFR/06) by Nick Witney, July 2008 and Defence Policy Re-energising Europe’s Security (ECFR/05) by Andrew Wilson, February 2008 of the Putin Succession Meeting Medvedev: The Politics (ECFR/04) by Daniel Korski, January 2008 war Afghanistan: Europe’s forgotten (ECFR/03) Paweł Swieboda, December 2007 Europe? Poland’s second return to (ECFR/02) Popescu, November 2007 by Mark Leonard and Nicu Relations A Power Audit of EU-Russia Leonard, October 2007 (ECFR/01) by Ivan Krastev and Mark Herbivorous Powers of Soft Power and the Rise of New World Order: The Balance A lso

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