Covid-19 may tear apart the European Union. The new crisis arrives after years of populist pressure on the EU from around Europe, with many asking whether the idea of a union was wrong from the start. The virus will ratchet up the tension.
Europeans fought one another for centuries, with increasing cruelty, until 1945. At the end of the Second World War, most of Europe had been destroyed by aerial bombings, and populations had experienced suffering unimaginable to most people today. The project of a European Union was born of the motto: “No more wars among us.”
But there is a big leap from “peace” to a United States of Europe, which would require significant conditions, including minimum agreement about major social issues and a willingness to share resources. Europeans from the EU’s founding countries already share attitudes and moral preferences on topics of fundamental importance for communal living—freedom of thought and of religion; economic freedom; the role of the state vs. the role of the market; gender equality, gay rights, divorce and abortion rights; and attitudes about child-rearing.
But the second condition for a workable union is that its citizens agree to redistribute income across borders, and that, when one country is hit by a shock, the other countries share part of the risk and part of the pain. Moreover, when some common shock arises, the members of the union should agree to take coordinated action and to redistribute the costs. So far, these elements have been lacking, or have been imperfectly handled.
On one side, self-declared virtuous northern European countries refuse to use their savings to help their supposedly lazy southern European counterparts, in a continental version of the fable of the ant and the grasshopper. It’s unfair to withhold aid from “grasshopper” countries now suffering from a pandemic that has nothing to do with their historically irresponsible fiscal behavior. Northern European countries tend to think that the “unethical” behavior of the South—accruing debt, tolerating corruption—is to blame for any problem. Symmetrically, southern European countries tend to downplay their own responsibilities and imperfections, while blaming northern Europeans for their self-centeredness and greed.
Despite its many faults, the EU has managed to create a set of institutions that should be able to keep together countries with inadequate fiscal controls and countries with more rigorous fiscal behavior. The Stability and Growth Pact, for instance, imposes stringent limits on deficits, at least in theory. But applying the pact’s terms right now would be a disaster. Luckily, everyone (except for a few Northern European fiscal hawks) agrees that for now, at least, the pact should be suspended.
In normal times, the European Central Bank would not intervene to stabilize spreads on government bonds, if these discrepancies were due to sloppy fiscal policies. Yet, had the ECB refused to intervene in mid-March, the consequences would have been catastrophic. This is precisely why the press conference that the ECB’s president, Christine Lagarde, held on March 12—when she said that spreads were not her concern—was such a disaster. Her view did not reflect that of the bank’s Governing Council, as became clear a few days later. In exceptional (and, one hopes, short-lived) circumstances, one should have the intelligence to be flexible, and not react to unexpected events according to prescriptions designed for normal times.
During the eurozone crisis, from 2010 to 2012, Europe established the European Stability Mechanism (ESM), which may now prove valuable in the face of the Covid-19 crisis. Unlike the ECB, the ESM can issue bonds—so-called Eurobonds—that are secured (“joint and several”) by all eurozone members. To date, only a small amount of the resources available to the ESM (68 billion euros, out of a total of 500 billion) has been used to help individual grasshopper countries. So far, and for this reason, ESM loans are typically subject to stringent conditions.
Today, the ESM is the right institution to address the impact of Covid-19, not only by financing direct-response costs but also to counterbalance the impact on workers and firms—for example, financing subsidies for those workers who no longer receive a salary. Because Covid is a shared shock, the contribution of the ESM to each country should be proportional to the gravity of that country’s health emergency. The ESM should be ready to build up long-term debt, ideally issuing irredeemable bonds that pay interest and never get reimbursed, as was often the case during times of war. We cannot know with certainty when our economies will recover, so we do not know when or how quickly they will be able to pay off their debts. The ECB could help by buying these bonds as part of its Quantitative Easing liquidity program. Given that these interventions are not about imposing fiscal discipline, the loans offered by the ESM should be subject to minimal conditions related to the virus.
A key problem is that when the ESM was set up, northern European countries insisted on retaining a veto over debt purchases, which they are now using to block these proposals. But the ESM is not the only solution: countries could directly issue bonds jointly guaranteed by the issuing countries, bypassing the veto power of recalcitrant members, who could opt out. Failing this, we would be left with the ECB: there is always a QE program large enough to finance any fiscal need arising from the current emergency.
This is not an ideal solution, as it would shift the burden of what is essentially a fiscal problem on to the central bank, whose business is properly monetary policy. Moreover, the new QE program launched by the ECB on March 12 remains limited by the constraint that ECB holdings of member countries’ bonds can deviate from the bank’s capital key only temporarily, so distressed nations could not rely on the central bank to prop them up indefinitely. Last but not least, notwithstanding the ECB’s independence, such a program would still require a political agreement and the buy-in of the thrifty North.
Covid-19 could offer a chance to bring the European project to a higher level—or to destroy it. After Lagarde’s recent faux pas, prospects looked dim. Since then, they have improved somewhat.
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