Some Comments on Europe after the Crisis by Charles Goodhart
Charles A. E. Goodhart has recently sketched out a well-grounded and well-argued diagnosis of what the European integration project needs if it is to be sustained and moved forward after the current crisis eventually ends. He puts forward some sensible, if incomplete, suggestions. He provided this reader with a great deal of stimulating intellectual food for thought.
In a paper published by the Institute for New Economic Thinking, Goodhart argues that the European debt crisis has been a political crisis, and I agree. He argues that the political crisis almost certainly will not permanently set back European integration, and I agree. He argues that the crisis has uncovered the failure of the European elite to engage the European general public, and I agree. The European Economic and Monetary Union (EMU) was never going to be win-win for all at all times.
To help Europe to become a more democratic polity, Goodhart proposes the direct election of the president of the European Union. The president would be substantially more independent of national governments including through the power directly to appoint her own commissioners to carry out her mandate. The European Parliament would become more of a counterweight to the president and the commission. The proposals are both sensible and radical, as far as they go. However, what Goodhart leaves unsaid is that this and the other changes he proposes should be embedded in a new European treaty; the appropriate treaty changes would imply changes in the constitutions and legal structures of many of the current members of the European Union (in particular Germany). All this is likely to produce a new Europe divided between the ins and the outs.
Goodhart devotes more space to the reform of the economic structure of Europe: How to build a fiscal counterpart to the monetary union? How to address the issue of banking institutions that are so large that they threaten the fiscal and financial stability of the governments that charter them?
With respect to fiscal reforms, Goodhart advocates, for the second time in 20 years, an approach in which the European Commission, as the central authority, would have a slightly larger budget than at present, and that budget would be tilted away from some of the current functions and toward economic stabilization in the safety-net sense of that concept. This is a sensible, minimalist suggestion.
Goodhart also argues that the European Union should pay more attention in the future than it has in the past to the “external deficits” of the individual members, praising the new Excessive Imbalances Procedure. (He pays less attention to the external surpluses than this reader would like.) In light of recent developments, this is a sensible emphasis. However, Goodhart's argument is predicated on the assumption that the European Union will remain a union of sovereign states that retain most of their economic powers but whose borders define the limits of those powers. If he took as his starting point the US model in which imbalances among the states are irrelevant, Goodhart would end up at a different point. In the process of endorsing a minimalist approach, Goodhart points to a central question for Europe: Should imbalances internal to the euro area matter? Should a housing boom in Spain or a consumption boom in Greece that is financed by private sector lenders in Germany lead to recommendations and possible corrective actions by the members of the European Union and their representatives in Brussels? A housing boom in Nevada or a consumption boom in Illinois does not lead to policy consequences filtered through the decision-making processes in Washington.
As an analytical matter, current account and related financial imbalances within Europe are not all or nothing as Goodhart implies. There is a distinction between Greece and its large government debt that was largely held abroad and Italy where much of the debt is held domestically, but does that distinction make much difference when there is an actual fiscal crisis in Italy? Some Italian debt is owed abroad, but the implicit age distribution of the holders within Italy matters in terms of the political economy of Italy. How that political economy plays out matters to other countries in the European Union as long as there is not a lot more in the way of a common fiscal authority than Goodhart recommends.
In the context of past and prospective EU arrangements for internal economic policy surveillance, Goodhart is correctly critical of the use of fines for countries that have excessive fiscal deficits because they add to the deficits and debt, which is a politically difficult mechanism to enforce. However, his solution—in effect to rely on the markets, credit rating agencies, or some similar mechanism to act via driving up the cost of financing for the member whose performance is falling short—suffers from the same weakness. Higher financing costs add to deficits in the short run, and debt in the longer run.
Missing from the Goodhart prescriptions for European fiscal governance is a more robust taxing authority. Only with that authority in place could the mechanism of a European bond work. If the central authority issued its own debt, for example, to provide stabilization financing to one or more members and, contrary to Goodhart's preferred framework, perhaps to the European Union as a whole, the central authority must have the power at the time to raise taxes either temporarily or permanently on all members so that there is financial assurance that the European obligations can be serviced. In other words, assurance that Europe as a whole can pay. The Goodhart minimalist approach does not go this far, but I suspect that Europe eventually will have to do so.
Finally, turning to the issue of banks and governments, Goodhart correctly describes the problem of nationally chartered institutions that are too big to fail and too big for their governments to rescue, with the consequence that weaknesses in those institutions threaten the fiscal stability of the government and by extension the financial stability of the European Union as a whole. Goodhart does not offer a comprehensive solution to this problem. Capital ratios might be raised but should not be raised too high. An increased burden can be placed on creditors via co-cos (contingent capital obligations) that bail holders of debt instruments into capital in the institution if it gets in trouble. One could have a Europe-wide insurance fund that might be financed out of European Central Bank (ECB) seignorage. (Of course, this would amount to a diversion of revenues that now flow from the ECB to national central banks and on to their governments.) However, uncharacteristically for a person who rarely identifies a problem for which he does not have a solution, Goodhart concludes that there is no really good way to resolve the interaction between bank and public sector debt in Europe.
The reason for Goodhart's lack of imagination, I suspect, is that again he has limited himself to minimalist solutions—to tinkering around the edges of the framework that is already in place. My instinct is that Europe will have to go much bigger and adopt a new Europe-wide banking and financial sector framework. It would consist of institutions with European charters exclusively. The institutions would be regulated, supervised, and subject to deposit insurance, support facilities, and resolution mechanisms that apply evenly across Europe. The relevant government would be expanded from Belgium, Italy, or Germany to Europe as a whole. The challenge would be to control the shadow banking system, including those parts of it that might continue to be owned and controlled by national governments. Preferably, those charters would be outlawed.