Bini Smaghi: “The crisis has shown that the euro is an incomplete construct and needs to be completed.”

Via the Irish Economy blog. In a speech at the 8th European Seminar in Poros, on 8th July, Lorenzo Bini Smaghi, Member of the Executive Board of the ECB, did a reasonable job of identifying the problems highlighted by the sovereign debt crisis – although he denies it’s an existential crisis for the EU. But, as a true believer in the “European Project”, his solution may not be to everyone’s taste…

From his 8th July speech

In my view, we should strengthen the capacity of EU institutions to take collective decisions. This would require three components: first, reducing the degree of inter-governmentalism in decision-making and thus diluting the unanimity principle; second, strengthening the rules that constrain national decision-making; and third, establishing a more effective enforcer of those rules.

I have already mentioned the weaknesses of the decision-making process when addressing crises. There are counter-arguments to my view, which have been put forward by distinguished commentators and policy-makers. However, experience – the exchange rate mechanism and the debt crisis are two examples – has shown that under such a mechanism decisions are systematically taken too late and that the burden on taxpayers ultimately increases. All those who attach importance to the interests of taxpayers should reflect on this. Let me be clear. I am not calling for a fiscal union or fiscal transfers to be decided through a majority system. I am just warning that unless decisions concerning the implementation of a financial safety net are taken more efficiently, i.e. through a communitarian approach based on majority decisions, as is the case at global (IMF) level, the risk of implicit transfers will actually increase, which may not be in the interest of most taxpayers. Experience of over 50 years has shown that IMF shareholders, i.e. taxpayers, have never lost money under such a system. Why innovate? There are many other areas where European creativity can be better put at work!

The second component – strengthening the rules – is already under way at EU level via the economic governance reform package. While we still have some misgivings about the current proposals – which in our view do not go far enough – progress is being made. In particular, the SGP should have been further streamlined to avoid drawn-out procedures and reducing the margins for discretion through the greater use of reverse majority voting. The European Parliament has in any event pushed hard in this area, but at the current juncture it remains to be seen how successful its efforts will eventually be.

Much can be done also at national level, without having to change the Treaty or EU secondary law. For instance, the introduction of debt ceilings into national legislation that are consistent with stability programmes approved by the Council would arrest excessive debt growth even before EU procedures were initiated. Rather like “neighbourhood watch” programmes in local communities, this would also spread policing responsibilities and involve national parliaments and fiscal institutions in enforcing the rules.

Debt ceilings, however, contain an inherent “good times” bias – there is nothing to prevent national governments infringing them when difficult decisions about adjustment and consolidation have to be taken. One way to prevent this – and to ensure that decisions are in the collective interest – would be to make public debt issuance a union competence for euro area countries. Member States could transfer to a supra-national agency the right to issue their debt, up to levels agreed by the Council in the context of the yearly approval of the stability programmes. It would no longer be possible to issue debt to cover expenditure over the debt limit set every year.

Had such a system been in place, Greece would neither have been able to hide nor incur the higher deficits and debts in 2009 or in the preceding years. It would have been forced to adopt corrective measures at a much earlier stage. The same would have applied to other countries.

This strong constraint – a genuine “debt brake” – would force a country to make an early decision when its public debt gets too close to the agreed limit. Either it would come up with immediate additional consolidation, or it would have to request the support of the European Stability Mechanism to finance its residual deficit. In this latter case consolidation would happen via an adjustment programme and strong conditionality. In both scenarios, the damaging effects that deferred decisions have on the rest of the euro area – as we have witnessed with every financial assistance package over the last year – would be mitigated.

This is not a proposal for so-called Eurobonds. National treasuries would still be responsible for their own debt, and there would be different debt instruments from one country to another, but the total amount for each country would have to be approved by the Eurogroup, as is currently done for the yearly stability programmes, and it would be binding. There would be no need for explicit or implicit transfers, or tax sharing – ideas often included in Eurobond proposals – as the costs of an excessive fiscal policy would remain with the country concerned.

The third component in strengthening euro area decision-making is to establish a strong enforcer of the rules. In this regard, the euro area faces its own “impossible trinity”: countries do not want to exert peer pressure; the Commission prefers to mediate than to police; and the IMF is only an occasional player in EU affairs. As the euro area has to have a way of both monitoring policies and ensuring their compatibility with monetary union, one of these has to give.

This applies not only to fiscal policies but also to other policies which can cause imbalances within the area.

In my view, the change has to come via the Commission, in particular by clarifying its institutional function and improving its independence. The former could be achieved by enhancing the role of the Economic and Monetary Affairs Commissioner in the correction or, ideally, the prevention of improper budgetary policies, and by giving him or her a strong mandate to rigorously enforce the rules and sanctions.

These proposals for stronger rules and tougher enforcement naturally raise questions of accountability. Democracies take their time because a wrong decision, or even a prudent decision that the public does not fully understand, will incur voter displeasure on election day. But if the recommendations of a stronger enforcer of the rules do not produce good outcomes, who is to hold him or her accountable? This is a very complex question which I cannot fully address here. One solution might be to have the European Parliament more involved.

But ultimately an enforcer of rules cannot be held accountable for outcomes. The responsibility falls on democratically elected governments to agree the right rules ex ante and give the enforcer an appropriate mandate. If outcomes are unsatisfactory, governments must change the rules and mandates, and explain why to the public.