By Rodrigo Sermeno, Transatlantic Economy Analyst
The recent problems in the Eurozone have brought to the fore doubts about whether the European Union (EU) will survive unscathed from the sovereign debt crisis. The uncertainty surrounding the crisis in the Eurozone has divided opinion about the EU’s future into two different camps: those arguing for further integration and those calling for a break up. Those in the further integration camp call for a fiscal union and argue that the best solution to the recurring crisis in Europe is to adopt a union-wide fiscal policy.
A fiscal union would allow the Eurozone to establish a fiscal authority with significant revenue sources of its own, with the discretion to create its own spending priorities, and with the ability to issue its own debt. This fiscal authority would have to set the precedent of fiscal responsibility for Eurozone members, but whether it will impose fiscal discipline on its members more successfully than the Stability and Growth Pact is not clear. The fiscal union would have to include explicit common rules to discourage members from issuing too much debt and to stop overexpansion; without these measures it would just encourage the type of behavior which precipitated this crisis. Additionally, a central drawback of adopting a fiscal union is that it would not come into effect immediately as there are many procedural difficulties, including constitutional and treaty amendments.
That said, the possibility of a fiscal union seems more likely now than ever, especially because the EU is not willing to let debt-stricken Greece have an uncontrolled default and exit the Eurozone easily. However, it would be unwise to disregard the other options available to the EU without careful consideration.
Greece lies at the center stage of the sovereign debt crisis. The possibility of a Greek default rattled stock markets in recent weeks because of the underlying concern whether the healthy economies in the EU will remain willing to support any of the Eurozone’s high debtors in the long-term. A second bailout package for Greece has suffered some setbacks after the country’s debt inspectors interrupted a review mission in Athens due to disagreement over whether Greece was meeting its promised deficit targets. Amid new protests in Athens, the international debt inspectors will return to Greece this week after the government announced a set of new austerity measures.
Those who support a Greek default – amongst them a group of mainstream German economists –argue that the small size of Greece’s banking sector would result in a manageable collapse. These economists argue that even if Greece defaulted, the damage to the banking sector in other EU countries would be less than the costs of a second bailout.
So what options would be available to Greece if it defaulted? According to economist Nouriel Roubini, Greece could leave the Eurozone and adopt its own currency. As it is usual after the collapse of many currency unions, the value of the stronger economy’s currency will appreciate relative to the value of the currency of the weaker economy. In accordance with this, the value of the drachma would plummet and that of the euro would increase. The currency depreciation in Greece would restore competitiveness and eventually lead to growth. Proponents of this idea point to the example of Argentina during its debt and currency crisis in 2001. Argentina established a fixed-peg to the dollar in 1991 that it had to abandon a decade later because of the deterioration in competitiveness and public finances. The initial growth and subsequent decline in Argentina, before it defaulted on its debt and devalued its currency, parallels the recent developments in Greece.
But there is also a critical difference between the crises in Argentina and Greece. The international community and the IMF both favored a financial collapse in Argentina – mainly as a way to punish reckless foreign investors. Greece, by contrast, has the support of the EU and the European Central Bank, which are committed to stop any risk of contagion to other EU members. Whether or not the support is unconditional will depend on the political environment in each of the EU members.
The northern-EU countries have shown some ambivalence about moving toward a fiscal union. The political aspect of a Greek default makes this crisis more troubling because of the impact that it could have elsewhere in the EU and on the citizen’s confidence in the union. The costs of breaking up or staying together are not easy to assess, especially when there are economic, political, and societal implications for all of those involved. In the end, it will come down to the question whether EU members value the long-term benefits of preserving the union as it is, more than the short-term financial costs of keeping Greece in the Eurozone.