The return of political economy

The present crisis of the Eurozone is a direct consequence of a half hearted, half considered, half explained and therefore half finished integration.

Based on the European principle of decision-making by the smallest common denominator, the EU is doomed to create incomplete, suboptimal and politically diluted solutions.  By regularly leaving unresolved issues behind itself, the EU will simply progress from crisis to crisis (without any reassurance that it is able to survive the next crisis.)

Political economy is back with a vengeance. Just as the inherent defects of the euro are due to politics, the euro crisis is increasingly turning into a full blown political crisis.

“We all know what we need to do, what we don’t know is how to get reelected, if we do what we need to do.” This simple phrase, attributed to a reputable European leader, has become the motto of the last 3 years. It seems as though viable economic solutions to the current crisis do indeed exist, but that they cannot find their way into practice for political reasons (certainly not in time or in the scale required). But, given the massive political costs of failing to solve the crisis, surely we might as well incur the costs of doing the right thing.

To find a politically workable, economically sustainable solution, four basic, interlinked questions need to be raised, considered and answered by the national communities of the EU:

1. Is there any country that does not have its fair share of guilt in the problems of the euro, or who did not benefit from its imperfect existence before the crisis?

The answer to this is ‘No’. It is clear that core EU countries had a decisive role in the incomplete design and subsequent dilution of the Maastricht criteria. The sins of the profligate are equally obvious on the other side. And the gains of a weaker euro and the single market are obvious for the export driven German economy as well as the (undeservedly) fast improvement in living standards in the south.

2. Is it fair to expect the citizens of Germany and other core EU countries to sign an open cheque (again) for the citizens of the periphery?

To paraphrase the Lineker-principle[1]: the EU is a football pitch where 27 countries play and always the Germans pick up the bill. Only a solution that clearly ring-fences the cost of the past, and excludes the repetition of such mistakes in the future can be even considered. No single free rider country should be able to hold the others to ransom anymore. But the relevant portion of the cost of previous mistakes have to be born by everyone.

3. Is it fair to expect the citizens of Greece to go into a long tunnel without the slightest hope that there is light on the other end?

It is obvious by now that Greece cannot repay its current level of debt even if all the current respectable efforts are maintained for decades. Without hope the process will end in social-economic and political chaos. But it is inevitable that even if Greece could substantially reduce its debt burden, a long–term, painful effort will be needed to restore growth and to return to financial markets.

4. Would anybody be better off if the euro ceased to exist and member states returned to their own currencies?

Clearly not. The dissolution of the Eurozone would cause immediate recession and economic chaos in Europe (and to a large extent elsewhere), with unforeseeable social and political, but well calculable economic consequences, and would probably lead to the end of the current form of European integration. This in turn would accelerate the decline of the European continent and make the process irreversible. However, as originally envisaged, a corrected, strong and sustainable euro could give a significant boost to those efforts trying to save as much as possible of the welfare state-model and to revive the continent’s global economic and political strength in a 21st century multipolar world.

By answering these obvious questions we not only define the political narrative through which the increasingly eurosceptic electorate should be addressed by their respective leaders. But these answers also define the political framework within which economic proposals have a chance to survive the existing political resistance.

Based on these criteria, one possible, but incomplete set of solutions is the following:

First, there is an immediate need to reduce contagion risks and restore overall credibility towards financial markets. Therefore the European banking system need to be recapitalized, based on appropriate (politically non-biased) stress tests. A prudent solution for that is the transformation of EFSF/ESM into an European Monetary Fund, which is able to buy participations in systematically important financial institutions; which can leverage itself (via ECB or markets); and which, similar to the IMF, has relatively strong independence from short term political influence (giving it credibility).

Secondly, efficiency,  sustainability and accountability need to be restored in the governance of the Eurozone. Therefore the already approved new economic governance toolkit (Six pack, Euro plus Pact) should be linked with a pre-agreed orderly, quick and almost automatic exclusion mechanism from the Eurozone as an ultimate sanction for repeated non-delivery by any country. This, combined with constitutional fiscal rules, independent monitoring and stronger and permanent coordination of fiscal and competitiveness policies, should be the ultimate guarantee, that no member state is allowed to put the others at risk.

Thirdly, a socially and economically manageable perspective has to be offered to Greece, in exchange for continuous painful efforts by Greek society and its political elite in the future. Greek debt should be restructured within the Eurozone, to reduce it to approximately half of the current level (to less than 80% of GDP). This should be achieved through a partial, significant haircut to private investors, as well as a conditional suspension/cancellation of a portion of public debt. The conditions of public debt cancellation have to be  strictly linked to the milestones and key steps of a 10 year realistic fiscal consolidation and competitiveness enhancing programme, with the ultimate aim for Greece to return to proper debt service, sustainable growth and market financing (the key targets of this programme should be accepted by a large majority of the Parliament of Greece).

In case of a breach of the key conditions, Greece should be excluded from the Eurozone, based on the above mechanism and the conditionally cancelled (suspended) part of the public debt should also be reactivated. (Such programs should be established for other countries in case of risk of insolvency.)

The acceptance of such solutions in core European countries will require political courage from leaders of otherwise competing political parties in the centre often reaching through usual lines of fire. But even the most Eurosceptic voters of today will not be thankful if they experience the consequences of a Eurozone collapse.

Even if Europe finds the right road forward, it will be a painful travel for a couple of years. And political leaders have the ultimate responsibility to ease the pain, and to avoid causing unnecessary sacrifice to the extent possible.

But, above all, they have to make the sacrifice worthwhile.

Gordon Bajnai is a former prime minister of Hungary and adjunct professor at Columbia University