When Mario Draghi was asked on Thursday (16 July) whether the recent crisis surrounding Greece had made the monetary union more vulnerable, he gave an astonishingly frank response. Draghi denied that the discussion about Greece made the union more vulnerable; nevertheless, he admitted that:
this union is imperfect. And being imperfect, is fragile, is vulnerable, and doesn’t deliver all the benefits that it could if it were to be completed. So the future now should see decisive steps on further integration.
The question this raises is how best to bring those ‘decisive steps’ about. The Five Presidents Report has some interesting ideas but not all of them point in the right direction. Moreover, the basic assumption behind the effort needs retuning. Europe’s heads of state and government should spend more thinking about sustainability (or resilience) when they try to push ahead with European integration. In doing so, they have to accept that the number of participants in different projects will fluctuate up and down depending upon their willingness and ability. They also have to accept that different projects will vary in intensity and importance over time — both generally and from one Member State to the next. Hence rather than looking to achieve an ever closer union (or unions), the goal should be to make sure that European institutions continue to work effectively across these changes in membership and priority.
Building sustainable integration is a complex challenge for at least two reasons. First, there are some situations where firm commitment to a project is the difference between success and failure. There are not many of these, but they are important. Monetary union as a system of irrevocably fixed exchange rates is at the top of the list. Resilience in this context means making sure that a Member State can remain inside the single currency under any conceivable circumstance. Given the level of commitment required, it may also mean screening potential members closely before allowing them to join. I wouldn’t over emphasize this point, however, because it is easy to conceive of situations where even the most ‘qualified’ Member States could get into trouble. If we can build institutions to handle those cases, they should also be able to manage the rest. That is what we can learn by examining the history of national currency unions.
Second, any decision by one Member State to join or leave a project, or to raise or lower its priority, imposes costs on other Member States. Here you might think of the internal market or the Schengen area, but you could also drill down to any particular aspect of either of these arrangements. These are institutional agreements that work to make it easier to do business by lowering transaction costs. Business tends to flow along the path of least resistance within such an environment. So anytime you change the rules – by increasing or shrinking the membership or by changing how the different members interact – you force businesses to adapt. Resilience means facilitating that adaptation either making it easier for firms to profit from new markets or by softening the impact of the markets (and opportunities) that may have lost.
Unfortunately, politicians and policymakers tend to confuse these two situations. This is easiest when the costs of adjustment are high. Politicians would rather argue that commitment is essential to the project than accept that adaptation is possible even if very painful. The United Kingdom could leave the European Union without destroying the European project, for example. Indeed, responsible European policymakers should be working right now to make that possible – not because it would be good for either Britain or for Europe to see the UK leave the EU but because it would be bad for Britain and for Europe to make the success of European integration hinge on a vote of the British electorate. UK voters should be responsible for their own fate and not that of the Continent. Of course there will be costs no matter what decision they make. The goal should be to ensure those costs are manageable and not catastrophic. In the worst case, a Britain that exits the European Union should be able to re-join.
The other kind of confusion is when policymakers try to recast a necessary commitment in terms of relative adjustment costs. We can see this in the debate about a plan-B for Greece. The idea is that Greece could leave the euro as a single currency without changing the nature of the commitment for other countries. That idea rests on a category error. The euro is not like the internal market or Schengen. It is a different form of commitment insofar as a monetary union is defined as having exchange rates that are ‘irrevocably’ fixed. Of course there is no magical power that holds Greece in the euro. But if Greece were to leave – even ‘temporarily’ – it would change the institution it left behind into something different from a monetary union. Market participants would notice that difference and act upon it. And politicians will have succeeded in transforming a categorical commitment into a question of relative adjustment costs. Hence it would be only reasonable – by the same logic they used to usher Greece out in the first place – to anticipate that other countries could follow. This is not a view restricted to academic economists; European Commissioner Pierre Moscovici made this point explicitly last April. A number of journalists tried to get Draghi to say the same during his 16 July press conference; the fact that he artfully avoided their questions does not hide what we know to be his answer. Here it is worth citing Draghi at length:
I’m not going to comment on politicians’ statements. I only know what our mandate is. And our mandate is to act based on the assumption that Greece is, of course, and will be a member of the euro area.
The responsible course of action in the context of a categorical commitment is to find some way for Greece to remain a member of the euro under any conceivable circumstance. That means European policymakers have to find some way to resolve and recapitalize Greek financial institutions, to separate the fate of Greek banks from Greek government finances, and to allow the Greek government to default. These are not only conceivable scenarios but also necessary conditions for Greece to remain in the euro. By making it possible for these things to come to pass, European policymakers will succeed in making the euro more resilient insofar as it cannot be hostage to the fate of any one country. If allowing Greece to default inside the euro requires some kind of change in the legal framework, the reform will be worth the effort. European integration will become more sustainable as a consequence.
Europe will become weaker and not stronger if Greece exits from the euro. By the same token, Europe will become more fragile and not more resilient if can be held hostage to the outcome of the UK referendum. Europe’s leaders need to focus on fostering sustainable integration if they are to avoid these pitfalls. They will have to look beyond the Five Presidents Report to achieve that objective. A more perfect, less fragile, and less vulnerable union will be their reward.Follow @Erik_Jones_SAIS