Should Merkel embrace Macron's vision for Eurozone reform?

No — the chancellor must resist calls for fiscal union.
Hans-Werner Sinn

Financial Times Online, June 27th, 2018.

Angela Merkel has replied to Emmanuel Macron, writes Hans-Werner Sinn. The German and French leaders have found common ground on issues such as asylum policy, external border control, military interventions, terrorism, the digital economy, research, education and Africa. But

they disagree on the roles of redistribution and competition.

In his Sorbonne speech in September, President Macron warned of exposing Europeans to the forces of unbridled competition and advocated a treaty change to establish a fiscal union with international “financial transfers”, a eurozone finance minister and a eurozone budget. Ms Merkel,

on the other hand, recently emphasised the benefit of trade agreements and is reluctant to endorse a fiscal union.

But the German chancellor is under internal attack from the CSU, her coalition partner, over immigration and needs a political success. Under pressure, Ms Merkel has agreed to convert the European Stability Mechanism into a European Monetary Fund under intergovernmental control.

She advocates a European investment fund to help less competitive member states and is even endorsing Mr Macron’s demand for a eurozone budget.

Ms Merkel’s latest concessions have annoyed the CSU. This is because Germany went out of its way to provide financial assistance to member states in trouble and mitigate market-imposed austerity. It was pressed by France to co-finance voluminous fiscal rescue funds in 2010 and 2015, is the largest guarantor of the European Central Bank’s credit default insurance, known as the OMT, and provides by far the largest stock of “target” overdraft credit to other European countries, currently €956bn.

Opposition to Mr Macron’s proposals is not only strong in the CSU, but also in the rest of Europe. There are fears that fresh money for struggling economies will undermine reform incentives and that the French president’s two-speed approach will divide Europe.

Mr Macron’s supporters argue that the eurozone needs an international insurance system to help absorb temporary exogenous shocks. But insurance is impossible when shocks result from bursting domestic bubbles and flawed policies. Moreover, temporary transfers are in danger of becoming permanent such as those that flow to southern Italy, the south of Spain and east Germany. They impede development through what economists call the “Dutch disease”, a reference to the difficulties encountered by the Netherlands in the 1960s and 1970s after a boom driven by natural gas sales.

Fortunately, Ms Merkel does not endorse a common deposit insurance scheme, which would enable the EU’s zombie banks to collect funds from all over Europe and invest them in dubious projects. That proposal rings alarm bells in Germany, whose Landesbanks turned into casinos

when German states protected depositors and lenders. The US had a similarly bad experience with its savings banks in the 1980s. Common deposit insurance mutualised the banks’ risks and enabled them to attract nearly unlimited funds for gambling activities. National and private versions of deposit insurance are better suited to limit moral hazard.

Europe is at a crossroads: either it will keep mutualising risks and liabilities and rely on government intervention or it will settle for the competitive equilibrium of a prosperous market economy.

If it chooses the first course, it risks repeating the mistakes of the US in its early decades. Two waves of debt mutualisation in the 1780s and 1813 caused excessive state borrowing because they artificially reduced interest spreads and blurred repayment responsibilities. The new debt triggered Keynesian booms, which turned into bubbles. Trouble resulted from the attempt to calm the markets by mutualising debt and sharing risks. It was only after this bitter experience that the US reverted to a system of self-liability, banning bailouts of over-indebted states.

Rather than reinventing the wheel, Europe would be well advised to learn from the US experience and return to a policy of hard budget constraints, concentrating its efforts on security, border control, defence and other kinds of public goods.

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