Europe Needs an Alexander Hamilton, Not More Budget Hawks
Without mutual debt in the form of Eurobonds, the continent’s economic crisis will get worse, Euroskepticism will increase, and the EU could fall apart.
Together with many on Europe’s conservative and free market right, I long rejected the idea of a fiscal union in the eurozone. The European Union is not a federal state, and adding a layer of European debt and taxes atop already profligate national budgets would mean more debt-financed spending and moral hazard.
The concern about fiscally prudent nations endlessly subsidizing the less disciplined ones, which I then shared, guided the choices of European leaders in the last financial crisis. Instead of seizing the opportunity for a Hamiltonian grand bargain—a compromise involving the mutualization of public debt in the eurozone—Europeans muddled through thanks to large-scale asset purchases by the European Central Bank and a new credit facility for countries in financial distress, the European Stability Mechanism. The price for governments accessing the financing, such as Greece and Italy, has been a constant micromanaging, from a distance, of their public finances.
But the crisis facing Europe today is qualitatively different, and the response has to be different, too. Compared with the potential for economic destruction from the current deep freeze of the global economy, the prospect of financial mismanagement in some European countries, subsidized by taxpayers in other countries, may be vexing but is trivial.
While no one knows the exact size of the economic contraction coming this year, it is safe to assume that it will be more devastating than any event witnessed since 1945. It is also safe to assume that countries such as Italy, with a pre-coronavirus debt-to-GDP ratio of 135 percent, are effectively bankrupt. And unless the eurozone as a whole can mobilize enough financial firepower to keep them afloat, the bloc’s periphery will end up defaulting on its debt or crashing out, with further catastrophic effects on the global recovery and on Europe’s standing in the world.
Unlike an ordinary recession, the current situation involves bringing practically all economic activity to a sudden halt, with an uncertain prospect of gradual reopening. If nothing is done, businesses and jobs will be destroyed, and reconstituting them once the pandemic is over will be costly and will take a long time.
Hence the need, acknowledged across the political spectrum, for hitherto unseen levels of financial support to the private sector from public budgets. Its purpose, unlike in a recession, is not to stimulate economic activity but rather to keep it alive while it is placed in a policy-induced coma in the form of lockdowns and extreme forms of social distancing. Since, as the experience from the 2008 recovery illustrates, bringing down high rates of unemployment is difficult after economic crises, it is important that governments underwrite a substantial part of salary costs as the pandemic unfolds.
Such measures are expensive. And those European countries that have been hit the hardest by COVID-19—Spain and Italy, for example—are the least able to afford them because of their debt overhang. To be fair, the European Commission has set up a Temporary Support to Mitigate Unemployment Risks in an Emergency scheme, which amounts to up to 100 billion euros ($109 billion) in loans available to governments in order to sustain employment.
Last week, the eurozone’s finance ministers also agreed on a package worth 240 billion euros ($261 billion, around 2 percent of the eurozone’s GDP) available to the bloc’s countries for emergency health care spending, with few or no strings attached. Additional funding would be available through the European Stability Mechanism and new facilities, such as a guarantee fund of the European Investment Bank for small and medium-sized companies.
But is that going to be enough to cushion the economic shock? In the United Kingdom alone, the cost of the job protection scheme introduced by Chancellor of the Exchequer Rishi Sunak to maintain employment was estimated at 78 billion pounds, or $97 billion.
The U.S. coronavirus relief bill mobilizes federal spending worth around $2 trillion, or 10 percent of America’s GDP, with a lot of the money ready to go immediately. While many national governments can complement the EU programs with their own resources, Italy’s and Spain’s room to maneuver is limited.
What’s worse, taking advantage of the current European assistance carries significant risks for countries with large debt burdens, regardless of the favorable terms on which such loans are offered. Yields on Spanish and Italian bonds are now growing, and the spread on Italy’s 10-year bond versus German bunds is up by around 80 basis points relative to its low of around 155 points at the end of March—notwithstanding the European Central Bank’s asset-buying program announced last month.
For Rome and Madrid to take on new loans means gambling on the bank’s willingness to constantly up the ante. Toying with a sovereign debt crisis is risky not just for Spain and Italy but for the entire global economy, especially as portfolios of banks around the globe keep deteriorating.
As a result, a new debt instrument backed by the entire eurozone in order to navigate the crisis is not just a matter of solidarity with Spain and Italy and a powerful political signal. It is first and foremost a matter of economic and financial self-preservation in a crisis that has no precedent in peacetime living memory.
Yet, for Dutch Finance Minister Wopke Hoekstra, what matters is that “for every euro that is spent on the economy, the normal rules apply; for example, if you have a shop that has shut down because of the virus.”
Mindlessly applying what German Foreign Minister Heiko Maas called “torture tools”—the EU’s rules-based scrutiny of national budgets—in a situation that calls for leadership, vision, and generosity is simply penny-wise and pound-foolish. After all, the economic shock of COVID-19 is not a result of Spain’s or Italy’s previous policy mistakes. And if those countries cannot find economic relief within the confines of the common currency, they will look for alternatives.
Italian Prime Minister Giuseppe Conte stated last Friday that Italy did not need help from the “inadequate and inappropriate” European Stability Mechanism, highlighting how politically toxic the troika-prescribed conditionality has become.
Whether or not the decade of fiscal consolidation on the periphery can be blamed for Spain’s and Italy’s lack of preparedness for the pandemic, those countries will not hesitate to make that argument in the most demagogic way possible. Unsurprisingly, a hypothetical referendum on Italy’s EU membership held today would end up in a coin toss, according to a recent poll. It is an illusion to think, especially under the current circumstances, that Brexit has immunized Europeans to the temptations of Euroskepticism.
At a time of an unprecedented global crisis happening against the backdrop of rising powers like Russia and China, whose influence poses a challenge to European democracies, and an arguable decline of U.S. leadership in the world, to insist on doing only what is “fair to the Dutch taxpayer,” as Hoekstra said, is simply petty.
If all European leaders adopted a narrowly transactional view, not much would survive of the European project, from the single market that eroded the economic power of many “national champions” to the treatments currently given to Italian patients by German hospitals with extra capacity.
That does not mean tossing fiscal conservatism out the window. However, it means recognizing, as America’s Founding Fathers did, the magnitude of the challenges facing Europe and the need for the continent’s unity. Here’s to hoping that Europe’s leaders can rise to the occasion.