After many months of muddling through – but not getting at the systemic roots of the economic, fiscal and financial crisis – Europe is at the tipping point. If it continues any longer with the status quo of dithering instead of decisiveness, the eurozone will break up and its national economies will weaken. Only by moving forward towards full integration – now – can Europe save itself.
So far, as the former Spanish prime minister Felipe González has put it, Europe’s leaders have been «acting as fireman», putting out one fire after the next but not putting in place a system to prevent the next outbreak. Extend and pretend; pray and delay; kick the can down the street. These are not real and stable solutions but futile Band-Aids. Along with persistent partisan gridlock and the clear slippage of the recovery in the US, Europe’s crisis of governance is dragging down the entire global economy. Stall speed is yielding to contraction and double-dip risk.
It is by now clear that short-term financial stability in Europe can only be purchased with a credible long-term strategy to complete a political and fiscal union. The incoming head of the European Central Bank, Mario Draghi, has rightly argued that Europe urgently needs to «make a quantum step up in economic and political integration». How do we get from here to there?
Clear steps, some outlined this week by the Council for the Future of Europe, include the following.
In the short-term further market contagion needs to be avoided. Rapid implementation of July’s decision to allow the established stabilisation mechanisms to intervene is of critical importance. In addition, the size of these mechanisms must be expanded to avoid a self-fulfilling run on Italian and Spanish debt while their economic policies take time to restore market confidence. Thus, by 2012 – not 2013, as previously planned – these mechanisms should be transformed into a permanent, fully fledged European fund.
Moreover, the eurozone must practically ensure banks are properly capitalised, including through private sector participation. The markets, rightly or wrongly, believe that the capital needs of some banks are larger than the stress tests suggested. Action to restore credibility is necessary.
It is now clear that a monetary union without some form of fiscal federalism and co-ordinated economic policy will not work. Nation-states will need to share certain aspects of sovereignty with a central European entity that would have the capacity to source revenue at the federal level in order to provide European-wide public goods. Furthermore, eurobonds should be created with control mechanisms to avoid large fiscal deficits in any given country.
The stability and growth pact has proven insufficient. Not only Greece, but the central powers of Europe – Germany and France – have ignored its limits in the past. To protect the public from irresponsible policies by any government, and to give comfort to Germany and other core countries that a fiscal union won’t turn out to be a transfer union that puts at risk their own credit rating, the eurozone requires an effective control system. While standards must be strict, the diversity of conditions across the eurozone requires flexibility.
Liquidity support via a fund is sometimes warranted, but situations of clear insolvency should not be addressed with bailouts. Mechanisms for orderly debt resolution must be established for both public and private liabilities if lasting and unmanageable insolvencies arise. Greece, which is clearly insolvent, will soon engage in an orderly restructure of its debt via an exchange offer. The same mechanism can be applied to other nations.
Additionally, in pursuing the necessary fiscal austerity and structural reforms, we must be careful not to undermine any fragile recovery in the short run. We can’t wait years to restore growth, because debt sustainability depends on growth, and because the social and political backlash against austerity may undermine reforms if stagnation persists. Adequate macro-economic policies must be employed to avoid this, including monetary easing by the European Central Bank, a weaker euro to restore competitiveness, and fiscal stimulus in the core countries to compensate for the fiscal drag deriving from austerity in the periphery.
We should also recognise that austerity is necessary but not sufficient to restore growth. To compete in the globalised world, Europe needs to implement an ambitious agenda for growth and employment to boost competitiveness and long-term productivity. Such a growth strategy should include use of existing EU funds to finance infrastructure spending and stimulate job creation in the periphery, as well as programmes to enhance research and development, professional skills and higher education. Without growth, the temptation for economic nationalism will arise.
One of Europe’s key challenges will be a readjustment of the social compact. A social safety net is necessary to allow for labour flexibility when workers need to change jobs and industries over their working lives. But it must face the reality of a fiscal squeeze brought on by the demographic shift to ageing societies.
Finally, beyond these more technical steps, the greatest stumbling block to the assured success of Europe is the lack of legitimacy of its institutions. Only stronger institutions can save Europe, but their strength can be enhanced only through greater popular support. Yet that support is being undermined daily by their present ineffectiveness.
In this sense, the crisis in Europe today is above all political. Further political integration and union can only be built hand in hand, step by step, through a broad and deep engagement of the public. The democratic deficit deriving from the perception that important decisions are taken by unelected Eurocrats in Brussels needs to be filled by political reforms that empower further the European parliament, and by appropriate forms of democratic oversight of legislative and executive decisions.
In short, the greatest task of European leadership today is to re-sell the European idea. They need to remind the public that the absence of war, the freedom of mobility and the rising prosperity they have taken for granted since the end of the cold war has been due to the path toward unity and away from the nationalist demons of the past. To change course now is to put all of that at risk. That is why more European integration, not less, is the only solution.
By Nouriel Roubini and Nicolas Berggruen, professor of economics at New York University’s Stern School of Business and is the co-founder of RGE Monitor and the founder and president of Berggruen Holdings, respectively.