The eurozone is in a deep crisis, which will have serious consequences for the Portuguese and for the European Union. In the beginning of the sovereign debt crisis, Greece, Portugal and Ireland owed thousands of millions of euros and the problem was theirs, i.e., they would have to correct their imbalances through austerity measures. In the current stage of the crisis, Spain, Italy, Belgium and France owe millions of millions of euros, and the debt crisis is now also a problem for the creditor countries – and the final word in the solution of the eurozone crisis is theirs.
Since the beginning of the sovereign debt crisis, several commentators have expressed the hope that surplus countries agree to three measures. First, to change the orientation of the ECB towards a more expansionary monetary policy. Second, to adopt themselves expansionary fiscal policies, which would stimulate imports of goods produced by deficit countries. Finally, countries such as Germany could also take measures to increase wages and thus further stimulate demand. Associated to this view is the idea that a permanent solution to the structural fragility of the euro is the creation of a “European government” that would collect taxes and distribute subsidies and other public expenditures at the European scale. This government would put into work a mechanism of “automatic stabilization” in the eurozone: when Portugal is in recession, as is the case, and Germany is in an expansion, taxes collected in Germany would pay, for instance, unemployment subsidies in Portugal. By definition, this European government would be financed by euro-bonds.
In that scenario, the countries currently in crisis, which implemented economic policies incompatible with the stability of the euro, would determine the economic policy of the wealthier countries and of the ECB. This solution is very unlikely to be accepted by most Germans and Central and Northern European peoples, who would most likely prefer to let the indebted countries default. This would lead to the end of the euro and also of the European Union as we know it; at the very least, the number of member countries would be significantly reduced. A period of economic, social and political chaos would follow, with abrupt falls in standards of living, accompanied by the resurgence of international tensions. This process would have unpredictable consequences, unthinkable in pre-crisis Western Europe. As for Portugal, after the chaos, it would probably return to its pre-European integration status: a poor and peripheral country, politically unstable.
However, eurozone countries may still choose alternative solutions, involving more active ECB policies and/or greater fiscal coordination, which we group into two scenarios.
In the first scenario, during the next few years, the ECB (and the EFSF) intervenes resolutely and in large scale in the sovereign debt market, buying debt issued by European countries with funding problems. At the same time, the countries in trouble successfully implement fiscal consolidation programmes, possibly aided by some form of soft restructuring of their debt. In a few years, investors regain some confidence in those countries and the ECB and the EFSF may stop buying public debt issued by them. At that time, the eurozone will return to the normality of its first years, but with higher spreads for less credible countries.
However, this solution has two problems. The first problem is that it does not guarantee that the behaviour of governments will change so as to avoid a repetition of the crisis – the moral hazard problem remains, and may even worsen in this context. The second problem is that the change in the behaviour of the ECB will hardly be accepted by the German public opinion. Clearly, financial markets do not believe this solution will work, a feeling deepened by the erratic behaviour and the lack of consensus among European leaders. The proposals to revise the stability and growth pact, namely through the establishment of automatic sanctions, are a way of trying to bypass this problem. But, if the stability and growth pact failed, why should one believe that the new proposals will be more effective (even assuming that they are accepted by all countries, which cannot be taken for granted)?
In the second scenario, the European countries reach a political agreement to reduce, if not eliminate, the probability that the eurozone faces a crisis of this kind. The measures include (besides ECB intervention and soft restructuring) a transfer of budgetary powers to a European entity designed by Central and Northern European countries. This entity is committed to presenting balanced budgets for each country under its supervision. National authorities may choose the level and composition of public expenditure, and the type of taxes. The intervention of that European entity in the budgetary process will guarantee that the budgetary targets are met, as it will be able to impose the measures required to correct deviations. For deficit countries, this solution should imply the continuation of austerity, with the goal of reducing the weight of public debt. The refinancing of debt and the financing of temporary deficits might employ euro-bonds, as a way to alleviate austerity.
This solution eliminates the moral hazard risk through a transfer of powers to a more credible entity. However, this would certainly be met with opposition from important sectors within eurozone countries, which would view it as a loss of sovereign powers and a submission to stupid rules (which in any case would be very hard to define).
Last Tuesday’s meeting between Angela Merkel and Nicolas Sarkozy suggests that European leaders are moving from the first to the second scenario. If none of these solutions work, the collapse of the euro, followed by European Union chaos, especially in peripheral countries, will become inevitable.
(with Pedro Bação)