Policy cooperation in a divergent union

What’s at stake: Although there is a growing consensus that it is too soon to exit from exceptionally expansionary policies, euro-area countries are already exhibiting contrasting approaches to the delicate timing of the transition back to normality. What’s more, recent data show a growing prospect of growth divergence between better performing core-European countries and weaker performing countries at the periphery.

Eurointelligence reports EU Commissioner Joaquin Almunia’s attacks on the lack of policy co-ordination in its forthcoming annual report on the euro area. He says that several countries with excessive current account surpluses have failed to stimulate domestic demand and that their unbalanced economic strategy caused significant problems for the whole of the euro area. These imbalances should have been addressed long before the crises, but those in charge of policy ignored them during the good times. He also criticised the failures of others, notably France, to consolidate their budgets during the good times. The anti-crisis reaction was dominated first and foremost by national concerns.

Wolfgang Münchau says that diverging deficits could fracture the eurozone. The underlying problem is a policy divergence between France, Spain, Italy, Portugal and Greece on one side, and Germany, Finland, Austria, and the Netherlands on the other. The policy divide between France and Germany is the most damaging and the two countries are both guilty of flouting the single most important economic policy rule of the Maastricht treaty. Germany ignored this principle when it unilaterally changed the constitution so that the federal deficit cannot exceed 0.35 per cent of GDP over the economic cycle. By saying that it no longer aims to reduce the French budget deficit to less than 3 per cent of gross domestic product by 2012, France is ignoring it now. The long-term consequences of sustained divergence will be higher interest rates, a race of competitive real devaluations through tax cuts, and an increase in the perception of sovereign default risk within the eurozone.

István P. Székely and Paul van den Noord note that the financial crisis has had asymmetric effects, which poses a long-lasting challenge for intra-EU adjustment. The way countries are affected depends on their initial conditions and associated vulnerabilities. Countries that entered the crisis with a housing bubble and a large net foreign liability position face a need to shift activity from construction to export-oriented activities and to diminish their dependency on external financing. Countries that had been running large current account surpluses and had an associated greater exposure to toxic financial assets need to reduce their export dependency and work off their balance sheet problems. Adjustment is necessary in both cases, but the policy recipes may be quite different.

Sebastian Dullien and Daniela Schwarzer say that EMU needs an external stability pact. The European Monetary Union needs a new stability pact which limits not government budgets, but imbalances in the current accounts of the member states. In such a pact, both deficit and surplus countries would be required to use their fiscal and general economic policies to strive for a rebalancing. If countries are uncooperative, they would be fined. In this way, dangerous trends of external indebtness for single countries can be limited as well as excessive beggar-thy-neighbour policies through revaluation limited. Paul de Grauwe notes that when the pact was conceived, private debt was totally ignored. But since the pact’s creation, private debt exploded, especially in the financial sector, ultimately forcing governments to provide full-scale guarantees, which would later reverberate on the public debt. Eurointelligence notes that this basically means that any effective debt control regime must take private-sector developments into account.

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