Looking Beyond Juncker
LONDON – The European Union appears to be capable of concentrating on only one problem at a time. This summer it is the question of who will succeed José-Manuel Barroso as President of the European Commission. British Prime Minister David Cameron has found himself fighting a rearguard action to try to block the appointment of the arch-federalist Luxembourger Jean-Claude Juncker.
The Commission presidency is no doubt an important job. The Commission retains a monopoly on proposing new legislation, the character of which is heavily influenced by the president. But new legislation is something of a luxury for Europe these days. Rather than contemplating exciting new directives on the desirable characteristics of, say, lawnmowers sold in the EU, Europe’s leaders must complete three urgent and interlinked tasks.
The first is political. In the recent European Parliament election, a quarter of voters in the United Kingdom and France backed parties that are hostile to further integration and committed to restoring a Europe of independent member states. Even in Germany, a euroskeptic party did surprisingly well. The center-left and center-right federalists have responded by making common cause to secure a majority for Juncker.
That is not a stable outcome. Defenders of the European ideal need to engage more directly with its critics and articulate an inspiring vision, rather than sticking their heads in the sand and intoning the words “ever closer union” at every opportunity.
They would find it easier to win over euroskeptics if they could point to more solid and durable economic achievements. Eurozone growth remains sluggish, at 0.7% over the last year, while unemployment, at 11.7%, is unacceptably high. These averages are depressing enough, but some parts of the continent are in far worse shape. Spanish unemployment is above 25%, and the Italian economy has barely grown since the euro’s introduction.
Economic recovery is being held back by financial problems – the third hot topic that EU leaders must address. The single financial market broke down four years ago and has not yet been repaired.
To be sure, the European Central Bank has done what it takes to narrow the borrowing cost differences between European sovereigns. For much of 2012 and 2013, the Spanish and Italian governments were paying 5.5-7% for ten-year money, while the German rate was below 2%. Today, the differential is much lower. Spain and Italy are paying only around 150 basis points more than Germany. ECB President Mario Draghi can take credit for that.
But from businesses’ perspective, things look rather different. For a Spanish or Italian small firm, the interest-rate differential remains as high as it was. An unsecured business loan will cost a Southern European firm two percentage points more than its counterpart on the Rhine, even though the two companies have a similar credit rating. Until 2010, the gap was just a few basis points. It exploded in 2011 and has not narrowed since.
That is a serious competitive disadvantage to add to the penalty of being at a greater distance from the EU’s center of economic gravity. If it persists, it will reinforce the growing division of Europe into “haves” and “have-nots.”
How can such a differential persist in what is supposed to be a single, integrated financial market? The answer, of course, is that the eurozone is no such thing, at least not yet. The crisis of confidence in the EU banking sector that erupted in 2010 has not yet been resolved. European banks are still reluctant to lend to one another, especially across borders. They suspect that some of their counterparts are weak and vulnerable, and have little confidence in the willingness of national bank supervisors to reveal the truth and demand remediation. So German banks with surplus cash would rather deposit it at the ECB than put it to work in Italy or Greece.
The banking union was agreed in order to correct that problem, with the ECB front and center as the single supervisor of all major European banks. But the market is clearly signaling that the banking union has not yet done its job – indeed, that it is by no means complete. There are doubts about the lack of a unified deposit-protection scheme, about the availability of funds to resolve a failing institution, and about whether the ECB’s approach will be rigorous enough to identify the lame ducks, force them to recapitalize, and thus rebuild confidence.
The key test will come this autumn, when the ECB reveals the results of its asset quality review. I expect the supervisors to be rigorous: their institution’s credibility depends on it. But national supervisors and governments retain a significant role. Will they be prepared to be honest and, more important, willing and able to help the walking wounded raise capital?
Recent debt issues by the Italian bank Monte dei Paschi di Siena and others have shown that financing for banks is expensive. Investors need to be offered heavy discounts to persuade them to part with their money. As a result, some banks that suspect that their balance sheets will be revealed to be weaker than they have so far acknowledged are cutting back on lending. The continuing credit constraints are one reason that parts of the European economy remain weak.
So the three problems that Europe will face in the second half of this year are closely connected. The EU will need the strongest leadership team that it can find to steer through treacherous waters and implement crucial financial reforms. Just now, the signs are far from promising. There are few new faces or ideas on the horizon. We must hope to be surprised.
Copyright: Project Syndicate, 2014.
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