The text of Sir John Major’s article on fiscal union, published by The Financial Times on Wednesday 26th October 2011.
SIR JOHN MAJOR:
The crisis in the eurozone was inevitable but has been accelerated, and worsened, by the banking collapse. It will not be solved easily or quickly. When it is, it may lead to a very different European Union.
The root of the present chaos can be traced back to bad politics taking precedence over sensible economics. At Maastricht, which I attended as prime minister, the assumption was that – before the euro was born – the economies of member states would converge: that is, operate at broadly the same levels of efficiency. Safeguards were set: it was agreed national fiscal deficits should not exceed 3 per cent of gross domestic product. Later, a Stability & Growth Pact was enacted to ensure sound fiscal policies. Yet, when the founder members launched the euro in 1999, the wise preconditions were ignored.
After the birth of the euro, some southern states over-indulged on low interest rates and racked up debts. So did their citizens, without hindrance from their governments who basked in the popularity of the boom. When Germany and France over-stepped the criteria on debt without any penalty by the commission, the criteria became toothless. Debt soared. This would have led to a crisis on its own, but it was hastened by the 2008 meltdown.
Hindsight is often graceless. But it is a fact that sterling did not enter the euro because we foresaw flaws in its structure. We believed monetary union without fiscal union was risky; that convergence of the powerful northern economies with southern Europe was unlikely (especially once Germany had absorbed her Eastern lender). I had a political objection as well: that entry into the euro, and the abolition of sterling, would remove key policy options from the British government. That is why, at Maastricht, I opted out of the euro.
It was not easy. The opt-out was only obtained by threatening to veto the treaty. Our European partners were unhappy. Some thought we were acting in bad faith: they had agreed to the British initiative of a single market, and argued that monetary integration was necessary to accompany trade integration. They were upset that we had implicitly endorsed monetary union in the Single European Act of 1986 and, in 1988, had appointed the Governor of the Bank of England to help the Delors Committee examine it. All this was true. But, on the euro, our interests diverged from theirs which caused a policy schism. That may be about to happen again, with far-reaching consequences.
As I write, the eurozone has an immediate dilemma. Policymakers must stabilise the eurozone banks, permit Greece to default and remove market fears of other defaults. Agreement on this is essential, but insufficient. The euro’s flaws will remain. The powerful German economy is still locked within the same currency as weaker economies. She racks up huge trade surpluses within the eurozone while others have comparable deficits. Since Germany has an estimated 30 per cent currency advantage within the euro, this seems likely to continue. It is undesirable and unsettling.
In a sensible world, the southern states would devalue to become competitive – but they cannot. They are locked in a single currency. And because they cannot devalue their currency, they must devalue their living standards and promote reforms to enhance efficiency. This will take years. Meanwhile, wages must fall, unemployment will rise and social unrest will increase. The severity of this medicine may not be bearable in a liberal democracy.
Most obviously, this has an impact on Greece. Of course, it has behaved foolishly. But that does not mitigate the present pain. As salaries are cut, new taxes are imposed and other taxes rise. It is no wonder people are frightened. Some ask: why is Greece in the eurozone at all? The ease of her entry exemplifies the follies of the founders. France insisted: “You cannot say no to the country of Plato.” Maybe not, but every European is now paying the price for admitting an economically unfit nation to compete in the eurozone.
To safeguard the eurozone in the longer term requires a fundamental change of policy. It must become a fiscal union; a union of transfer payments to off-set regional disparities; or it must shrink. The latter option – essentially expelling Greece – has political consequences.
There is no mechanism to do it. What would Greece’s future be? Would she remain democratic in the chaos that might follow? Pushing Greece out is not a risk-free option.
Nor is a transfer union. Germany would hate it and transfer payments would institutionalise inefficiencies. That leaves fiscal union as the most likely destination. But it has huge political consequences. It implies a far greater level of integration, and is an escalator to a federal eurozone. This may be sensible economically, but it is profoundly undemocratic. It would drive voters and decision-makers dangerously far apart. More top-down Europe imposed by a remote elite could provoke a powerful antipathy.
A more integrated eurozone will also provoke non-euro members of the EU by driving them further away from core decision-making. They will react adversely – which is why an early announcement of fiscal union is unlikely. Instead, judicially enforceable controls over deficits, early harmonisation of corporate taxes and a permanent chairman of the eurozone are likely early moves. We are drifting towards full fiscal union: only the timescale is flexible.
This has consequences: non-euro members will not wish to be marginalised and may sniff suspiciously at euro-core proposals, rendering decision-making even more of a hurdle. If the eurozone integrates and co-ordinates policy, non-euro members may co-ordinate too. Confrontation looms. Deeper eurozone integration may encourage non-euro member states to seek to repatriate key policies they can’t influence. The UK will not be alone in this. In the next decade, a federal eurozone will change Europe’s mosaic. Within the eurozone it will become more prescriptive; outside, a looser union could emerge. A pattern of variable alliances is likely. EFTA countries may move closer to non-euro members. One thing is certain – the EU will not remain the same.
In the UK, and elsewhere, many are pressing for their nation to leave the EU. This is an extreme option that would throw up far more problems than it would solve. For the UK it would be a dangerous mistake but, even so, our relationship within the EU will shift. Cool heads and clear minds are needed: our future depends on it.