Is a Workable Eurodeal Actually in the Works?
Italy is pressing forward with a package of austerity reforms, including tax increases on the wealthy, a ban on cash transactions over $1,000 (to reduce tax evasion), and a fairly radical pension reform which will raise retirement ages and change the way that pensions are calculated from a final-years-salary scheme to something more like the US Social Security system, which is based on average contributions over your whole career.
The market seems to like it--Italian bond yields are dropping, most of the large global stock indexes are up, and sighs of relief, though small and uncertain, seem to be emitting from the usual quarters.
There's still a caveat, though: is Italian austerity, by itself, enough to save the euro? Because Germany and France seem to be surprisingly far apart on a deal to rescue the beleaguered currency:
Contrary to what is being reported, Ms Merkel is not proposing a fiscal union. She is proposing an austerity club, a stability pact on steroids. The goal is to enforce life-long austerity, with balanced budget rules enshrined in every national constitution. She also proposes automatic sanctions with a judicially administered regime of compliance. She rejects eurobonds on the grounds that they reduce pressure on fiscal discipline.
Mr Sarkozy's proposal could not be more different. He has said that he is not prepared to cede any sovereignty to the centre. He wants to retain the inter-governmental approach that has so abysmally failed in the past. He opposes any attempts to strengthen the European Commission, or to involve the European Court of Justice in adjudicating on breaches of the rules. While rejecting Ms Merkel's obsession with austerity, he is not interested in a genuine fiscal union either. He is open to a eurozone bond and to the European Central Bank having the role of lender-of-last resort. I would surmise that this is because France would stand to benefit from both.
I'm pretty sure that "Austerity club", as Munchau puts it, is not going to work. Perhaps it would be very nice if the Italians were more like Germans, but such transitions need cultural and institutional infrastructure that cannot be called into existence by sheer will. If you have to ban cash transactions over $1,000 in order to combat tax evasion, you raise two questions:
1) How deep are the cultural roots of tax evasion?
2) Given the answer to #1, how likely is it that the ban will be honored?
People who are saying "We know what will work" are acting as if any agreement now instituted is permanent--as if the problem at hand were a one time decision to pay off bondholders and peripheral nations not to destroy the currency. But this is simply not true. As long as there are sovereigns involved, any agreement made can always fall apart in the future.
Americans should know this. It's the reason that we had to fight a very lengthy civil war in order to end slavery.
As Tyler Cowen put it:
Do not think that Germany has merely to waive a magic wand, or incur a one-time cost, to set things right in the eurozone. Any "set things right" action on Germany's part is, one way or another, a form of doubling down. If it fails it means a bigger eurozone implosion in the future than would happen now, including much higher costs for Germany. The choice is not "German action vs. doom now," it is "German action and some chance of even bigger doom later on vs. doom now." That's a tough call. The Germans understand that one better than do most of the bloggers I've been reading on the topic.
This is not merely a problem for the future. The vulnerability of any deal to years of treaty modifications, referenda, and ultimately a veto-by-exit from any member for whom austerity becomes too onerous, affects the credibility of the deal now. If credibility is weak, bond yields won't fall, and the deal will fail.
Any plan to save the euro leaves one major problem unfixed: low productivity in the periphery, relative to their northern neighbors. Unless companies in the periphery figure out how to get more productive, fast, or workers in the periphery accept deep wage cuts, their output will remain expensive, and uncompetitive, with goods from other countries, and the economy will stagnate.
Most proposals on the table simply leave this problem unfixed. "Austerity Club" actively makes it worse, since tax hikes and spending cut will also depress GDP.
The French idea, as described by Munchau, seems to be to avoid the credibility problems by not relying on promises from the periphery. Germany and the ECB guarantee the debt of other countries, and who (other than the Germans?) cares if Italy can't collect the taxes it needs to? Unfortunately, as a proposal, it is self-refuting; neither the Germans, nor the ECB, are going to debase their credit rating and currency so that Italy and Spain can borrow freely.
Presumably, these are simply negotiating positions. But the time for negotiations is growing short. What's the actual ZOPA? And does any workable, credible plan fall within it?