The lesser evil for the eurozone

Itwas not supposed to happen like this. The formation of a new Germangovernment took so long that it was only after the Italian generalelection on March 4 resulted in a political earthquake that France andGermany started to work on reforming the eurozone. German ChancellorAngela Merkel and French President Emmanuel Macron have now resolved tosort out their differences and deliver a joint reform roadmap by July.But they cannot ignore changes brought by the landslide victory ofItaly’s anti-system parties. Until then, populism had seemed contained.It has now become mainstream.For those who will have to draw theFranco-German blueprint, the message from Italy is that the policyframework that has dominated Europe since the mid-1980s no longercommands broad support. For three decades, the consensus on the need formarket reforms and sound public finances has been strong enough toovercome opposition in small countries (Greece) and outlastprocrastination in large ones (France). In the coming years, however,the eurozone playing field may well become a battleground.The firstcasualty is bound to be the European Stability and Growth Pact, with itsplethora of fiscal rules, monitoring procedures, and eventual sanctionsfor excessive deficits. The 224-page Vade Mecum on implementing fiscaldiscipline in the EU is hopelessly complex, to such a degree that nofinance minister, let alone parliamentarian, fully understands what hisor her country must abide by.For populists, however, indecipherablerules made in Brussels are a simple, straightforward political target.In “Baron Noir” (Black Baron), a popular French TV series, a presidentengulfed in a financial scandal nearly escapes public indignity bymounting a coalition against EU deficit fines. With populism risingalmost everywhere in Europe, reality may soon exceed fiction. For largecountries, the threat of sanctions has always been a paper tiger. Thedifference now is that the EU’s bluff may be called.Absentsanctions, what will ensure that participants in the eurozone behave?This is what Germany is understandably worried about. Whateverreservations one may have about Germany’s fiscal obsession, rules of thegame are required to deal with unsustainable public-debt accumulationin a monetary union. Policy ambiguity cannot be relied on, in a systemdeprived of a strong power centre. If no one knows what will happen if acountry does not behave, the expectation may turn out to be that debtswill be monetised – at a high inflationary cost.At a recentconference in Berlin, economists debated what to do if the euro provesunsustainable. Prominent German scholars expressed the view that, absentcredible sanctions, only the threat of forced exit could disciplinewayward eurozone members. In other words, governments should be facing aclear choice: behave or leave.Technically, this would not be hardto implement. To force out a delinquent country, the ECB could simplyunplug its banking system from euro liquidity. That nearly happened in2015, when Greece was on the brink of exit, and Wolfgang Schauble,Germany’s finance minister at the time, considered pushing Greece out.It took a long, dramatic night of talks for eurozone leaders to agreenot to do it.Pushing a country out would, however, have direconsequences. The irreversibility of the euro may be a myth – nothing isirreversible – but it is a useful myth. If businesses and savers wereto start speculating about the next exit, trust in the common currencywould soon vanish. People would move their savings to protect them fromredenomination risk. A German euro would be worth more than a Frencheuro, which in turn would be worth more than an Italian euro. That’s whyMario Draghi, the ECB’s president, said in 2012 that he would do“whatever it takes” to preserve the euro’s integrity.So, what ifsanctions don’t work and the threat of exit is a cluster bomb that wouldhurt everyone? In a recent paper with French and German colleagues, weadvocate making debt restructuring within the eurozone a crediblepossibility. We do not regard debt restructuring as benign, let alonedesirable, and we do not advocate making it automatic or driven bynumerical triggers.But, in a system without sanctions, fiscalresponsibility can be enforced only if two conditions are met. First,governments and those who finance them must face the consequences ofirresponsibility – that is, ultimately, debt restructuring. Second, theensuing financial disruption must be limited, so that policymakers donot want to avoid restructuring at all costs. This, in turn, requires anumber of reforms that we spell out in our paper.This idea elicitsstrong reservations, not only in Italy, where the policy establishmentis obsessed with the country’s record indebtedness, but also in France,where debt repayment is regarded as the dividing line between advancedand developing countries. The memories of the Deauville summit – anill-conceived regime for addressing excessive public debt hashed out byMerkel and then-French President Nicolas Sarkozy – are still vivid. TheFrench view is that debt restructuring should not be contemplated, evenas a possible outcome.But the French must confront the new reality.While the euro survived the financial disruption of 2010-2012, it is nowconfronted by a potentially more challenging political disruption. Thisthreat must be faced.Absent a shared consensus on the sanctity ofrules, there are not many possibilities. One is a euro without ananchor, something Northern Europe would not want to remain part of forlong. Another is a euro with a wide-open exit door, something that wouldquickly lead to another financial crisis. And still another is a eurowith defined and predictable internal debt-resolution mechanisms. Thelatter option is, admittedly, not without risks, but it is certainlysafer than the exit threat. France, and Europe, should choose the lesserevil. – Project Syndicate* Jean Pisani-Ferry, a professor at theHertie School of Governance (Berlin) and Sciences Po (Paris), holds theTommaso Padoa-Schioppa chair at the European University Institute andis a senior fellow at Bruegel, a Brussels-based think tank.