Political union can save the euro – but only the right sort

Jeremy Warner correctly points to Otmar Issing’s devastating piece in today’s FT, which slams the form of fiscal union towards which the Eurozone is drifting, predicting that it would be likely to lead to the collapse of the EU. Issing says that, although he was an outspoken advocate of the idea that political union should accompany monetary union, it is a mistake to believe that the current crisis can, by forcing a debt union, be a device for political union, bypassing a democratic mandate. He notes the extreme moral hazard created by current arrangements, whereby fiscal incontinence is rewarded and fiscal prudence is punished.

What is intolerable (rightly intolerable) to Germans is the notion that they should fund the spending and borrowing decisions of fiscally irresponsible governments elsewhere in the Eurozone. That cannot stand. No political union built on that premise could be sustained.  As some of us have urged from the start, the real risk of collapse for the euro was never that Greece, Portugal, etc. weren’t bailed out – it was always that they were, and to such an extent that Germany lost faith in the project and withdrew.

No arrangement whereby hard-working Germans, for decades, send their money to be spent by the Berlusconis and Papandreous can work. And the euro cannot survive without transfers over decades. But it does not follow that the euro therefore must collapse. The Germans won’t accept Berlusconis and Papandreous spending their money, but that doesn’t mean they won’t accept anyone doing so. The only body that would be trusted by the Germans to spend money in Italy, and by the Italians to spend money in Italy, is the European Union’s central authorities.

Not only can that work, but it seems to me to be part of what is envisaged (albeit with insufficient detail) by the July 21 agreement. The  agreement empowers the EFSF to spend money directly in member states (bailing out their banks), without going via their governments. It envisages an extension of EU structural funds (monies that are allocated centrally), to address longer-term competitiveness issues within the Eurozone. It envisages much stricter central oversight of member mtate national budgets. In his end-of-summit statement, Sarkozy said that he and Merkel will bring forward proposals for new “economic governance” arrangements for the Eurozone later this year.

A transfer union of debt pooling cannot work. The Germans will not accept it – Issing’s position reflects a wider German sentiment but also a fundamentally correct and inescapable analysis. It does not follow that the euro must therefore fail.  The alternative is a Eurozone confederacy, in which transfers are spent from the centre.