The Eurozone According to Merkel

We had almost given up waiting for them, but then they came in a quasi-clandestine form. German Chancellor Angela Merkel did not announce her ideas for eurozone reform in a formal speech or in a statement before her peers. Rather, she allowed a quickly cobbled-together and telegraphic Franco-German non-paper to leak ahead of the recent meeting of European heads of state and government.

There was no shortage of outcry in other European Union capitals (because of the paper’s undiplomatic bluntness) or in Brussels (because she did not care about EU procedures and the distribution of competences). But the ideas outlined in the paper deserve serious discussion.

The initiative is, first of all, institutional. Whereas earlier, Chancellor Merkel had ruled out the old French idea of eurozone-specific governance for fear of being in a minority among Southern European countries, she has now drawn a lesson from the crisis and is proposing that eurozone countries go ahead and tighten cooperation with any others who are able and willing to join them. This is a significant step.

On the fiscal side, Germany had started by insisting on bolstering sanctions. As is often the case in criminal law, the idea was (and is) more about reassuring public opinion than about preventing wayward behavior. In fact, the EU’s Stability and Growth Pact suffers at least as much from a flawed design as from lack of enforcement (it should never be forgotten that as late as 2007, Ireland and Spain looked like paragons of budgetary virtue). Moreover, for ten years, stewardship from Brussels has failed to bring about reform of national policies, and it is not clear that additional or more automatic sanctions would elicit a greater sense of “ownership” of the rules.

The new paper opens a different path: it suggests revising and harmonizing national accounting, in order to gauge better the vulnerability of eurozone members’ public finances; ensuring that banks’ creditors, rather than governments, pay when crisis strikes; decentralizing fiscal discipline by requiring each country to adopt a constitutional rule on the stability of the debt ratio; and curbing countries’ contingent liabilities by adjusting pension systems to demographic ageing. As long as each government is given enough autonomy in the implementation of these principles to act in accordance with its own institutional framework and traditions, such measures are all on the right track.

But things are less clear when it comes to competitiveness. The paper urges all countries to align real wage growth with productivity gains, get rid of automatic indexation of wages (long gone in France but still alive in Belgium), and commit to a minimum rate of investment in research and development, education, and infrastructure. The praiseworthy intention is to avoid a recurrence of the cost and price divergence within the eurozone during the last ten years. The aim is also – and this is equally commendable – to share the burden of European economic modernization.

However, all of the indicators emphasized in the Franco-German initiative are already being monitored, and, since 2005, many – not least European Central Bank President Jean-Claude Trichet – have loudly, regularly, and ineffectually warned of divergences within the eurozone.

Moreover, the discussions that started several months ago about imbalances within the eurozone have floundered on the issue of the symmetry of adjustment. Those countries whose prices have shot up over the last decade point the finger, correctly, at German competitive disinflation, which has led the ECB to keep interest rates low instead of helping them to halt the price spiral. Germany responds that it cannot be blamed for improving productivity, which is equally true.

The way out of this dialogue of the deaf requires acknowledging that competitiveness is a relative concept, and that all national policies, including those of surplus countries, must be part of the discussion. We have not reached that point yet.

The last set of proposals addresses a problem that has not been stressed enough: divergences within the eurozone reflect insufficient economic integration, for they would not have continued to widen if firms and workers had reacted more swiftly to price differences.

The Merkel document puts forward two ideas here: mutual recognition of qualifications, which would promote labor mobility, and – with no concern for the sanctity of tax sovereignty – harmonization of corporate-tax bases in order to encourage capital mobility. Neither of these initiatives is a game changer as regards the depth of economic integration within the eurozone, but both promise to open a new debate on the structural underpinnings of monetary union.

It remains to be seen what EU member states will make of these proposals. The first reactions have been mostly negative, because of specific concerns such as wage indexation in Belgium or because the EU institutions want to preserve their legal prerogatives. Non-eurozone countries are also concerned that further integration within the core would leave them left out.

Leaving bluntness and a disregard for procedures aside, eurozone members would be wrong to ignore or dilute these ideas. The eurozone needs a Germany that is engaged, not absent, and the paper delivers a message that needs to be heard: (financial) solidarity goes hand in hand with (economic and budgetary) responsibility. The scene is now set for this fundamental conversation.

By Jean Pisani-Ferry, director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis.

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