What populism could mean for euro area

March 29, 2018 08:30
Populists will advocate against the painful structural reforms necessary for a further deepening of, and risk sharing in the European Monetary Union. Photo: Reuters

Europe’s readiness to enter a trade war should be a wake-up call for those relying on the rule of law, international organizations and cooperation – the pillars of the post-war multilateral system. This would be a risk for further European integration.

Populism is undermining these pillars. In Europe, populism is anti-elite, anti-expert, nationalist and EU-critical. Only opposing the euro did not pay off for populists since voters clearly feared the negative consequences for their personal wealth.

Instead, populists will advocate against austerity, tighter monetary policy and the painful structural reforms necessary for a further deepening of, and risk sharing in the European Monetary Union (EMU).

The US president is demonstrating the extreme implications of having a populist in government. Don’t count on:

1. Expert advice (climate change, international trade).

2. International institutions like the WTO, UN etc. – populists might dismantle them, dismissing their legitimacy and regarding them as representing the old elite.

3. International treaties, rules and procedures – populists might declare that previous governments had sold out their peoples’ interests (NAFTA, NATO, Brexit, TPP).

4. International cooperation – populists might bully you if they are powerful enough, or blackmail you if they have less to lose than you do. They will threaten to tear apart a system if they sense that your wealth depends on it.

5. Medium-term policies – populists go for short-term gain (US tax reform and spending plans).

European governments should take note and consider how vulnerable the euro area would be if a populist government openly rejected the EMU’s rules.

If national interests were prioritized over international obligations, Brussels or Frankfurt vs the “will of the people” is a fight that institutions playing by the rules are ill-equipped to win.

It is often argued that the EMU is incomplete as it lacks a common fiscal policy, a banking or capital market union. More importantly, it lacks a common view and therefore the ability to exchange and develop further economic arguments. Instead, its views are segmented along national lines.

A new study published by Bruegel in February proves this point. Analyzing over 50,000 articles on the euro crisis in major national newspapers of the four largest EMU members (Germany, France, Spain and Italy), they found that each country had different reasons for the crisis.

It is difficult to find a common political answer to the EMU’s challenges if public opinions regarding its root causes are so diverse. So what about further deepening of the euro area? The next steps for a closer banking union are prepared – measures that should lead to more formal decisions at the EU summit end-June.

The guiding principle seems to be strengthening the EMU by pooling and sharing risk. As a prerequisite, pre-existing risks like non-performing loans will be reduced. Additionally, rules and restrictions are imposed in order to reduce the incentives for moral hazard. Examples for this principle are abundant.

They rarely work in practice as different societies have different attitudes to their observance. One difficulty for European policymakers and voters is to accept this as a positive and not a normative statement. Hence, many European rules are not time-consistent.

Governments might accept a new set of rules against the distribution of risks through common deposit insurance, unemployment insurance or Eurobonds. But following the rules in times of crisis is a different matter.

As optimistic as we remain about the European project, given its proven ability to solve problems in times of crisis, we wonder what the potential downside is if further risk pooling takes place.

Wouldn’t a government have a strong incentive to default on its bonds or international obligations rather than defaulting on its domestic pension spending otherwise? Wouldn’t it ask for solidarity from its partners in the form of “liquidity assistance”, which is politically difficult to reject? And wouldn’t a populist government first blame unfair international rules rather than its own incompetence?

Hence, it is necessary to have rules and procedures. However, European policymakers should also consider what would happen if a sovereign government chose not to play by them and what safeguards they would have. Following that principle could slow the process of deepening and stabilizing the EMU. But maybe that is exactly what many European voters prefer.

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Chief Economist, Head Economic Research at Bank J Safra Sarasin