Europe’s Fiscal Pact – or how to make a deal with the devil

The euro area is struggling for survival. If you are still in doubt, listen to all those by now far less self-conscious, far less apodictic pronouncements of leading representatives from politics and economy. At the G20 summit in Los Cabos Jose Manuel Barroso even lost countenance!

“The euro is not in danger!” How often did Wolfgang Schäuble, Minister of Finance, how often did the gurus of politics, economics and finance feign unshakable certainty! To no avail. By now, pure fear has spread to the Commission and the European Parliament. With the euro’s collapse not only the idea of European unity will be damaged – the Brussels Babel of Eurocrats will falter as well and with it thousand of its richly endowed sinecures.

A choice between devil and Beelzebub

But there is far more at stake. Rescuing the euro is very expensive, but its collapse is no less so. In both cases, it is again Germany which will be the paymaster of Europe. A return to the Deutschmark will boost the latter’s rate of exchange, which means that large parts of German exports will remain on the shelves. After years of euphoria, we now reap the revenge for a fundamental economic error. While introducing the euro, Germany and France have braved economic reason and experience. Germany’s bill after the euro’s collapse may well amount to 1.5 trillion – nearly half of Germany’s GDP. We have to choose between the devil and Beelzebub.

On the way to political union?

Such things are likely to happen if the cart is put before the horse. The common currency was to come first; would a common state not follow in its wake? This was the idea explicitly endorsed by Helmut Kohl. Unfortunately, history teaches another story: Such an order of things never worked!

Let’s add however, that history is but a teacher, not an irrevocable fate. Theoretically, the project could still work if Europe’s leaders did now what they failed to do in the past. They could still mould its diverse nations into a common political union. “We need, above all, a political union. That means we have to give up parts of our sovereignty to Europe,” Merkel recently announced.

The “fiscal pact” which the four leaders of the Union (Barroso, Van Rompuy, Draghi and Juncker) are now defining is meant to do exactly this: The hitherto sovereign states of Europe shall be united by common political institutions in order to form a federal state. Should this attempt prove successful, the conditions for a common currency would indeed be ready. After all, people agree that a common currency signifies the logical as well as economical completion of a political union.

Alas, the Fiscal pact is nothing more than just another half-baked idea from Brussels

According to the four mentioned European leaders, member States will only be allowed to freely dispose of their revenues. New debt must be approved by a panel of European ministers of finance. It will be handed out to them as euro-denominated bonds.

Even laymen will shake their heads at such a proposal. Its consequences are predictable at first glance. The majority of economically weak states will outvote the minority of the strong. This would, of course, happen in just the same way if not finance ministers, but the European Parliament would have to decide. After all, we can hardly expect southern countries to vote against their own interests. This means, that the north will have to pay, since it guarantees the bonds. There is nothing wrong with such a procedure, if the economic rationale would be on the majority’s side. But that’s just not the case. Should the proposal be implemented, Europe would have destroyed all incentives for weaker countries to strive for balanced budgets. The result would be a huge Mezzogiorno reaching from Greece to Portugal. The economic health of the North would be eroded while the South would not profit in the long term. Europe as a whole would be destroyed.

Why does Brussels not learn from history?

Why don’t we look at successful examples of both political and economic union? Both Switzerland and North America never held themselves accountable for the debts of their constituent members. After the Revolutionary War, then Finance Minister Hamilton (1755 – 1804) decided that the strong federal States of the Union should shoulder the debt burden of their weaker members. But this was to remain a unique and singular act. After that time each state was responsible for its own finance and a balanced budget.

Viewed against this historical background, the proposed fiscal pact turns out to be a half-baked idea produced by Brussels bureaucrats. And it remains so even when we consider its light version: the euro-bill variant. A successful political unification of Europe cannot merely consist of transfers with no foreseeable long-term benefits.

No transfers unless these are accompanied by constitutionally guaranteed rights!

Of course, it can be useful and sometimes necessary for member States to get into debt. But in this case, the donor must be given constitutional guarantees that he has a say or a veto on what is done with his funds. Otherwise there will be no barrier against the current practice of squandering them for political gifts. Whosoever provides money must be able to control its use. Making philanthropic gifts is good and right in times of catastrophe and emergencies, but otherwise harmful, because it does not provide help in order to stimulate self-help – it merely rewards financially irresponsible behavior (moral hazard).

Why should the south borrow from the North?

Co-determination and veto imply control. This raises an important question with regard to European economic behavior in the era of globalization. Supposed, that Spain and Greece will have to suffer a lot more from the crisis, why should they borrow from other European countries? Why not, for example, from China, if the latter gets port facilities and trade offices in exchange, so that it obtains an even better access to European markets? China already takes advantage of the weakness and disintegration of Europe in order to attain its own purposes. This raises a still more important question:

Why should the South buy the products of Northern countries?

This is by no means a purely rhetorical question. In the United States it was to become the focus of attention during the first half of the 19th Century. At that time, the southern states had become more and more independent from the Union as witnessed by their economical interest and behavior. To the once common enemy, England, they sold their cotton and from there they bought industrial products instead of purchasing these from the north. This was equal to a severe economic drain on the north. It signaled the end of economic solidarity within the Union and became the real motive for the bloodiest war of the 19th Century, the American Civil War (1861 – 1865). On the surface this war dealt with the liberation of black people. But economics was the real issue.

Germany’s sales within the EU are by no means assured

What makes us believe that an increasingly indebted and impoverished southern periphery will not embark on a similar path? Why should it continue to buy German industrial products when it may get them in equal quality and much cheaper from the Far East? To be sure, the dominant neo-liberal economic doctrine would enthusiastically applaud such a reversal as it strictly conforms to its textbook. Neo-liberalism is based on the dogma that private buyers must be totally free to do as they like – even if this leads to the ruin of their own country or, in this case, to that of the union.

The United States has not accepted a freedom of choice that destroyed solidarity. It turned to war instead. Violence – the oldest historic instrument to weld smaller units into larger States – has been applied for the same purpose by Napoleon and by Hitler – as we know with hecatombs of uselessly sacrificed lives. Such a policy of violence is out of question in contemporary Europe.

The alternative: a fundamental interest

But if Europe is not following the American way of violence, how can we be sure that the South being abandoned by the North and still more impoverished will not simply boycott German industry, buying instead from Asia so that much of German exports will no longer find a market? We should not believe this to be a merely theoretical threat. It rather results from the logic of neo-liberal economic policies. Recently such a menace was explicitly made by a Frenchman. (1)

I see but one alternative to avoid this scenario. The states of the EU – all its members – must be united by a common fundamental interest. Trade with the North must offer such a substantial advantage to Southern countries that they reject any other solution!

More symbolic competence for Brussels?

A first step in this direction seems to be a tax raised by Brussels in accordance with the economic strength of individual Member States. A federal government set up by the European Parliament will, of course, be held accountable to all citizens of Europe – I am here boldly anticipating future developments – so it will, certainly, use these funds without unduly favoring certain social strata or geographical regions.

Such a tax would, however, remain symbolical even if it involved ten or more percent of all tax revenues. It would remain without effect against the economic (and hence political) collapse of the Union as it does not create a fundamental interest on the part of the poorer Member States to pursue trade with the North. In other words, it does not establish a fundamental interest in the continuance of the Union. Most likely, it would rather lead to further dissatisfaction, because the central bureaucracy would be still more inflated and more and more money would be diverted into dark channels.

I. The trade pact

Again, we should take a look at the unification process of the United States. The countries of Europe will have a fundamental interest in the continued existence of the Union only if all goods produced within the latter enjoy priority over foreign goods produced elsewhere – that is exactly what the American civil war achieved in its own way. If Greek, Italian, Spanish and Portuguese products need only compete against each other but not against products from the rest of the world, they suddenly get much better prices. The revenue of southern countries will rise. There will be money for the promotion of industries, education, etc. Of course, the North will have to pay higher prices, but it too can be sure, that its own products will enjoy priority over foreign ones as well. No less than two thirds of German exports – equivalent to German exports to members of the Union – find a sure market.

The trade pact also leads to a convergence in living standards within the Union. As we all know apart from establishing peace among member States this was the promise on which the Union was based. And it is precisely because this promise now fails that the union may break asunder. The countries of the South now face a process of progressive impoverishment.

Germany’s interests are to be found in Europe, not Asia

A trade pact would be the first and most important step towards a political union, just as happened in the U.S. Its advantages should be obvious to northern countries as well. The “race to the bottom” imposed by Asian low-cost providers now forces northern countries to continually reduce their standard of living. One Agenda 2010 is just not enough. Other agendas will have to follow if Germany wants to remain competitive even when Asians have caught up technologically in more and more branches of industry. We will not be capable of winning this game indefinitely. Germany should be aware of the fact that by its real and permanent interests it is bound to Europe not to Asia.

The Commission’s proposed fiscal pact does not contribute to political union. On the contrary, it creates large imbalances and is, therefore, destructive. It is a pact with the devil. A trade pact that requires all member countries to buy imports primarily in Europe has the opposite effect: It is based on a fundamental common interest and thus creates a solid base for the Union.

The European mercenaries of credit rating agencies

However, such a pact, which would be overseen by a joint European Department of Commerce, is insufficient by itself. As long as money earned within Europe may freely choose those destinations outside of Europe where it gets the biggest return, there is no escape from the dictates of financial markets. Sovereign credit rating agencies, though located outside of Europe, decide on the weal and woe of European States. Merciless, they tear the Union apart if that meets the interests of financial players – even if they just put their bets on such an event.

This manipulation from outside persists even when non-European countries are no longer concerned as they do no longer possess bonds of European sovereign debt. Greek, Spanish and Italian government bonds have already been largely repatriated. (2) They were bought by European banks with cheap money from the ECB. But although foreign countries are no longer involved, the power of rating agencies continues unabated. This paradox is easily explained. The agencies can be sure to exercise a direct influence on Europe’s investors which they, so to speak, lead by the nose. In the neo-liberal economic order investors are transnational and behave as such. They need not feel committed either to their home countries or to the Union. In truth, the EU is not threatened by the verdicts of rating agencies; the Union is threatened by the absence of solidarity on the part of an influential part of its citizens. A minority of wealthy investors within the EU are exclusively committed to their own and not to the common good.

A financial transaction tax will not ward off the danger

Not much would and can be changed by a financial transaction tax hailed by some of its supporters as a kind of silver bullet. However desirable such a tax would be, it but moderately restrains the destabilizing forces of financial markets. And any rate, it can not curb them. It neither closes large yield gaps nor is it meant to prevent large funds from putting their money in long term investments outside Europe. Those who hope that this tax provides a way out of the crisis are mere utopians.

The capital pact II

If we want to save Europe we need capital controls, as they existed for several decades after the war. The wealth of the richest citizens is then no longer free to seek returns abroad but only within the Union where it has been acquired. Thus, in addition to a trade pact, the Union needs a capital pact together with a European Treasury. This again is a fundamental interest shared by a majority as opposed to a minority of European citizens.

Are trade and capital pact unworkable?

If these proposals for a sound and lasting foundation of Europe’s political union, although confirmed by the historical precedent of the US, should be criticized as too remote from current discourse, we should answer such an objection with a much more pungent one: The Commission’s proposed fiscal pact is frankly fantastic as it does not even address let alone solve the main problem, that is existing debt. According to the express opinion of the Commission, each member country is to tackle this problem on its own. How this should be done remains unsaid or else the Commission proposes the usual recipe, that is, austerity, even if it finally kills the economy. (3) The fact is that existing debt can be eliminated only with growth rates similar to those of India, China or Brazil. (4) Or else real interest rates paid for servicing sovereign debt must be negative as is currently true for Germany.

Under given circumstances, there is, of course, no chance for either to happen.

The fiscal pact does not change the fundamental ills

In other words, the fiscal pact is utterly useless, as it does not remove the basic evil of a crushing debt load. Only the trade in combination with the capital pact would establish the conditions for overcoming the debt problem. The two covenants would produce a glut of capital in Europe. All money which up to now was flowing to foreign destinations would be available for investment within the Union. Interest rates would immediately plummet near zero. Every kind of investment in growth projects, including those in the southern periphery, would be cherished as the trade pact ensures higher prices for products of the South! To be sure, such a development is in the elementary interest of Germany as well. Only if the South is prosperous, can it afford the products of the North.

Nevertheless, no solution to a deep going crisis is to be had for free. A number of international agreements would have to be terminated unilaterally and the entire camp of neo-liberalism would shriek with horror. As for my part, I think this is a small sacrifice compared to all the trouble the old continent will have to face if adopting a fiscal pact and similar therapies.

1 See “The devil is sitting at the table”. Interview with the French social scientist Emmanuel Todd in: DER SPIEGEL, 2012/20; p.92

2 See the speech by George Soros in Trento on 2 June 2012 ( ixzz1wvCn2qGn).

3 See Stephan Schulmeister, Fiskalpakt: Die große Selbstbeschädigung Europas (