New Zealand International Review, May/June 2015, Vol 40, No 3.
There is a bit of a construction shambles around the buildings that house the European Union in Brussels with new buildings, buildings retrofitted for energy efficiency and improvements to the subway and public surrounds. It is not that the activities of the EU are necessarily compromised, but it symbolises that the ‘more perfect union’ it seeks is far from complete.
That is well illustrated in its energy union. The EU energy system is not unified; integrating it is one of the priorities of the recently appointed new president, Jean-Claude Juncker. The problem became more acute last year when it was realised how dependent some of the 28 member states were on imported Russian gas. A third of the EU gas comes from Russia, and half of that through Ukraine.
Given a hard winter and a bullying Putin, a cut in the supplies could have left some very cold and vexed EU citizens, especially in the east. Mercifully, the winter was mild and Russia needed to sell gas for foreign exchange. (Its cut-back of supplies to Ukraine could be justified in commercial terms because they get behind in their payments; yeah right.)
There are other sources of gas from overseas, including Australia, but the shipping terminals are limited and it it is not currently possible to send the gas from west to all of the east because some of the pumps are not reversible. Terminals are being extended and built and the pumps are being given a reverse capability. The risks will not be as high next winter even if it is more severe and Russia is more belligerent, but the situation is a stark reminder that the EU energy system is not integrated, not even physically, let alone commercially; EU energy policy is under construction.
The EU’s problem arises because most of its member states have a national monopolist in charge of gas supply, each jealous of its position and unwilling to coordinate with the one next door. It is not easy to develop a more perfect union because pipes are infrastructural monopolies (common carriers) so the usual solution of increased competition does not work.
The Poles, for instance, are putting in a gas terminal at Swinoujscie which will reduce their dependence upon Russian gas. Swinoujscie is on their Baltic coast about as west as you can get in Poland, butt against the German seaside resort of Ahlbeck. Why not bring the gas in from a North Sea terminal piping it across Germany? Cough! Presumably that would compromise Poland’s national independence or, at least, it would provide challenges to the Polish national gas distributor.
A similar problem of national independence bedevils the European Monetary Union. Before explaining it, a word of caution. Most of us read only English texts written by Americans and Brits who have a political agenda – the euro is a threat to the supremacy of the US dollar and the position of London as a financial centre – and whose monetary history has not been nearly so chaotic as the continent’s.
For the individual or business, not having to keep changing currency whenever one crosses a border is a boon. Interest rates do not need a premium to cover exchange rate volatility between the member states’ currencies and have come down. Having the currency regulated by an independent and prudent European Central Bank (based in Frankfurt) is another benefit
So far, so good. But some issues had not been thought through. Rather than go through the entire list, we focus here on the problem which has led to recent difficulties.
The theory of monetary unions assumes that the significant borrowers are businesses (and individuals) who can go bankrupt, in which case they close down and the shareholders lose all their equity. But sovereign states cannot go out of business and their ‘shareholders’ have quite a different investment in them.
The European Monetary Union established rules which tried to avoid levels of sovereign indebtedness which threatened a debtor crisis. But shortly after the Global Financial Crisis it became evident that some countries were in deep financial trouble with debt they could neither repay nor rollover because lenders no longer trusted them.
Most of the focus has been on Greece but it was not alone, just the most extreme example, so extreme that the usual procedures for sovereign bailout – typically they are applied two or three times a year in the world as a whole – would not work.
Greece got into its difficulties because of generous government spending and a weak tax base (including tax evasion and corruption). Its public accounts were misleading. As a result it borrowed vast sums to cover the fiscal gap but this did not become apparent until 2010 when the statistical base of the government accounts were straightened out.
It is well to remember that European banks chose to lend the sums; voluntarily, many would say ‘recklessly’. As a result, and given the poor performance of the Greek economy (as a consequence of the long recession following the Global Financial Crisis as well as the adjusting to a more sustainable fiscal path), its public debt to annual GDP ratio rose from about 100 percent (which is usually thought to be well above a prudent level) to near 180 percent, a level which involves such high interest outgoings that it will continue to rise even if the Greek government runs a fiscal surplus and the economic performance improves. In the jargon the debt is ‘out of control’. Resolving it is all very complicated.
One complication is the role of Germany. As the largest economy in the EMU it has considerable sway in its decisions, but its role is limited by the German populace being impatient with the spending generosity of the Greek government in contrast to the austerity of (the somewhat richer) German government. A further complication is that there is still deep resentment among the Greeks at the German invasion of Greece during the Second World War.
Greece has improved its fiscal management substantially and now runs a ‘primary surplus’, that is before interest payments. The full deficit, including interest payments, is still large and debt levels will continue to rise unless there is some sort of bailout.
The analysis thus far has been largely in terms of the governments as business entities. But in a democracy, their shareholders have quite a different relationship. While they are happy to benefit personally from government spending, they do not really think of any consequential debt incurred as theirs personally.
Greece has had troubling changes of governments. The latest is that the leftist party of Syriza (an acronym for the Coalition of the Radical Left in Greek) became government after the 25 January 2015 election on the promise of easing back the fiscal austerity. Those who hold Greek bonds were not consulted, nor did they vote. As the subsequent negotiations between them and the Syriza Minister of Finance, Yanis Varoufakis, bear witness there has been little room for manoeuvre other than delaying decisions..
The public lenders are haunted by the fear that to give concessions to Greece may set precedents for other troubled nations. (Spain is mentioned as next in the queue.) But they must also be haunted by the fear of giving neo-fascists throughout Europe a popular cause. (Greece had a military junta from 1967 to 1974.) And they are also haunted by the fear that a Grexit may lead to a collapse of the European Monetary Union, or at least a severe diminution of its size and influence in the long-term.
Perhaps this is too much detail, but it highlights the theme of this article: the EMU is still under construction. Some will argue that its whole conception is impossibly flawed; others that it was being built but was in its incomplete state unprepared for the GFC and its aftershocks.
Avoiding a long economic thesis about how monetary unions work, for these purposes note that a monetary union involves giving up a sovereign exchange rate and thereby abandoning one of the tools of economic management. Grexit can be thought of as the Greeks demanding that tool back unless there is some compensating assistance for its loss. (Having an additional tool in the kit will not simply resolve their problems.) It is instructive that Polish economists have shifted from an enthusiasm for Poland joining the EMU to much greater caution.
This reflects a fundamental challenge faced by the EU which we saw also in its energy system. Many economists would only recommend a monetary union if there was also fiscal (and there fore political) union. Once more the ever more perfect union involves member states giving up chunks of sovereignty.
The Greek debt crisis suggests that fiscal sovereignty is under threat as the EU forces Greece to address its economic policies. This is no different from what usually happens when the IMF leads a consortium to sort out a debt crisis anywhere in the world or, indeed, when a bank has to deal with a private borrower that cannot service its debts.
The EU is likely to be under construction for some time. Could it fall to bits before it is completed, perhaps as the result of it member countries refusing to give up enough sovereignty? Politics is so dependent on the contingent who can tell? Yet I left the study tour optimistic.
My July stay in Brussels coincided with a meeting of the heads of the member states the purpose of which was, among other things, to elect the new EU President. Before doing so they made a pilgrimage to Ypres where the first major battle of the Great War had occurred one hundred years earlier. (Later it would host the Battle of Passchendaele.) They meet solemnly at its Menin Gate, the memorial to the British Commonwealth soldiers who fell there; together and as friends, despite their predecessors being deeply divided a century ago, symbolising their commitment of ‘never again’. It was a war between sovereign states.
This article was made possible by a trip to Europe supported by the European Delegation in Wellington and the German and Polish governments, with travel support by Air New Zealand. As grateful as I am for their assistance, none are responsible for any of the views expressed here.