Erik Jones / Feb 2018
Photo: European Council
The German grand coalition agreement promises to breathe new life into the debate about European macroeconomic governance reform. The German Social Democratic Party (SPD) will hold the ministries for foreign affairs and finance; SPD leader Martin Schulz has made it clear that he is in favor of further integration; and the bullet-point version of the agreement includes a number of eye-catching proposals that seem to cross over a number of previous German red lines. Although emphasis on risk-reduction (and national responsibility) remains prominent, risk-sharing, stabilization, and some kind of common backstop for banking resolution and deposit insurance seems more likely now than ever in the past. Nevertheless, I remain unconvinced. The problem is not whether the SPD rank-and-file will vote in favor of the agreement. That remains to be seen. My doubts arise from the categorical difference between engineering and ethics.
There is clearly an engineering solution to the problems that beset Europe’s economies during the crisis. The most comprehensive effort to tackle the problem comes from the European Commission. Both last spring and late last autumn, the Commission produced a raft of proposals to complete the European banking union, bolster lender-of-last-resort facilities for sovereigns, strengthen and simplify macroeconomic policy coordination, and shore up the plumbing of European capital markets. There were some tweaks that raised eyebrows about the relative importance of institutional roles. The idea that a European Finance Minister would be a Commission Vice President or that a European Monetary Fund would fit into the institutional hierarchy defined by the treaty-based framework were two of the most obvious examples. But only a very ungenerous reader of the Commission’s many proposals could characterize them as wrong-headed or without merit; on the contrary, the Commission did an impressive job synthesizing and distilling a vast literature on lesson from the recent crisis.
The fourteen French and German economists who published a more abbreviated synthesis of proposals were arguably more realistic in political terms. Their paper for the Center for Economic Policy Research strikes a balance between French and German preferences. They place more emphasis on national responsibility (and hence less emphasis on the ‘community method’) than the European Commission proposals do; they also accept the need to work through a more intergovernmental framework. More important, perhaps, the engineering solutions they offer reflect an effort to strike a balance across many different dimensions of difference. The synthetic ‘European Safe Bonds’ proposal is good example insofar as it meets the need for a common risk-free asset while avoiding the mutualization of sovereign debt instruments and relying on market participants rather than governmental or supranational actors to do the heavy lifting. The proposal to split existing sovereign debt into senior and junior tranches is another clever attempt to involve multiple stakeholders in solving complex policy problems — in this case, fiscal discipline. Nicolas Veron’s idea of a graduated charge on bank holdings of their own country’s sovereign debt is a third example of splitting the difference.
What the European Commission and CEPR proposals share with any good engineering solution is a recognition of the need to make compromises. Every key decision implies a trade-off. Every winner implies a loser. The challenge is to make the best of a difficult situation for as many stakeholders as possible — and knowing all the while that doing nothing would be considerably worse.
The problem is that not everyone necessarily views macroeconomic governance reform as an engineering problem. Indeed, some stakeholders view the challenge in ethical rather than engineering terms. And ethical problems are very different from engineering problems. Ethics is not about compromise; it is about right and wrong. Ethical choices promote values and avoid going against them. Of course, ethical people can recognize situations where compromise is necessary. Ethical is not synonymous with unrealistic. They nevertheless believe that compromise should be avoided whenever possible. They also reject the idea that compromises should be ‘institutionalized’ because any institution that makes compromise a norm necessarily sacrifices something of value even when it is not necessary to do so.
Wolfgang Schäuble was a staunch advocate of the ethical view on macroeconomic governance. He argued fervently against debt and moral hazard. Debt creates hostages to fortune that no-one can foresee from the vantage point of the present; moral hazard spreads the consequences of any error in judgment onto those who never agreed to accept risk (or expected to profit from doing so). If Schäuble appeared at times to be uncompromising, it was not because he was unreasonable. He could bow to the pressure of circumstances when necessary; that is why he accepted that Greece should remain within the euro, for example. It is also why he did not rebel against outright monetary transactions or large-scale central bank purchases of sovereign debt. The point is simply that Schäuble saw macroeconomic governance from an ethical perspective and so he could not in good conscience build in compromise as a norm given that such compromise would encourage unethical behavior. Exceptions should be exceptional.
Moreover, Schäuble was not alone. On the contrary, he was surrounded by like-minded policymakers from other countries. The former Dutch finance minister and Eurogroup president Jeroen Dijsselbloem is a good illustration. I don’t want to describe Dijsselbloem as an ally of Schäuble’s, because saying they had an alliance would imply motivations that are not part of the argument. Moreover, the two come from different political traditions. Dijsselbloem is a Social Democrat; Schäuble is a Christian Democrat. They may seem the same thing in this age of grand coalitions, but they are not. Hence, it is enough to say that Dijsselbloem was like-minded insofar as he viewed macroeconomic governance from an ethnical perspective. That ethical perspective explains how he could embrace the bail-in imposed on Cyprus as a model for future banking resolution efforts to follow despite the near disaster that resulted from the banking crisis in that country. From an ethical point of view, the Cypriots should not have taken on the risks they took and the fact that the consequences of their actions could be (largely) contained within the country — no matter how closely that containment ran to failure — should be considered a success.
Dijsselbloem made it clear after the events in Cyprus that the goal should be to avoid any direct recapitalization of a country’s banks with common resources. That is an ethnical commitment and not an engineering one. Moreover, it is a commitment that appears again in the German non-paper on macroeconomic governance reform that most observers believe was drafted and disseminated by Wolfgang Schäuble as a last-ditch effort to shape the debate before he left his position as German finance minister. The Dutch coalition agreement outlines a goal that is much the same. The Dutch coalition agreement and the German non-paper also make it clear that any risk sharing should be preceded by risk reduction – meaning governments and banks should pay down their debts and shed any exposure to risk that they cannot easily absorb themselves. This is a sound engineering principle. You want to build a new edifice on solid foundations.
From an ethical perspective, however, risk reduction is the goal. If governments and banks can achieve that objective, then the next step is to make sure the institutions are in place to discourage them from taking on debt and to avoid moral hazard. Pooled backstops, common deposit insurance, fiscal stabilization mechanisms, and mutualized sovereign debt instruments point in the opposite direction. From an ethical perspective, it may make sense to promise now that such institutions will be provided, but it would be unethical actually to build such institutions because no matter how well engineered they may be, they will encourage policymakers and market participants to do things that are wrong.
Personally, I do not see macroeconomic governance from an ethical perspective. My preference would be for European policymakers to build the best engineering solution they can. But I respect that there are many Europeans who regard the recent crisis as a failure of man and not institutions. They are looking to create an environment where policymakers and market participants make better choices in the future. And so long as those ethical and well-intentioned people are in power in countries like the Netherlands, and elsewhere, I am doubtful that we will see a meaningful compromise on macroeconomic governance reform.
*This opinion piece is a shorter version of an article published by the Spanish think tank Funcas, in the January 2018 issue of the Spanish Economic and Financial Outlook. For the longer version, please go here.