Europe and the Irish Election

Enda Kenny, newly elected Irish prime minister

By Patrick Mc Nally

I thought that you might be interested on the impact that Europe is having on the current election here in Ireland. The eurozone crisis has awakened a sleeping giant that of politicisation by fuelling the feeling that there is a democratic deficit in democratic procedures because policymaking has been insulated from public opinion. Discussions are taking place on the EU/IMF bailout and the rate of interest being charged to access these funds. Europe has in many ways become the central issue and not just Europe’s handling of the economic crisis

Many blame Angela Merkel the German Chancellor for fanning the crisis when she warned in November that the insolvent countries might never pay back all their debts. This statement spooked the financial market and increased the rate of interest charged by the market in purchasing Irish bonds. It was also noted that Hungary, Latvia and Romania, countries which are outside the eurozone were borrowing from the EU for balance of payments support at a rate of 2.55 per cent.

Under the arrangements set up after the Greek bailout the EU did not want to make it easy to access the emergency funds so to discourage other countries from having to seek recourse to the Fund a penal rate of 5.83 per cent was charged to Ireland. compared with 5 per cent rate for Greece. A number of economists argue that the Irish rate is an invitation for sovereign default and that debt sustainability and its relation to growth needs to be considered. The question of punishing debt transgressors without tackling the underlining bank crisis risks repeating another deeper banking crisis.

It appears that there is a choice between Ireland defaulting or Europe defaulting. Other choices considered include whether there would be any merits in Ireland leaving the euro and establishing an independent currency. Both Iceland and the UK are cited as examples which could be followed. There are echoes of the old argument about joining a single currency. It was hoped that membership of a hard low-inflation currency would impose discipline and realism on Ireland .Clearly these hopes have been dashed. However apart from the costs involved in leaving the euro, debts would still be denominated in euros and the new currency would depreciate against the euro thus increasing the debt. The old pre-euro policy of devaluation to bring in line real output with the real value of incomes is not seen as an attractive option as it postpones the need for real action to tackle the underlying problems and puts the burden of adjustment on savers and those on fixed incomes. A return to monetary independence for Ireland would mean a return to the old cycle of regular debasement of the currency.

The best hope of getting the Irish economy moving over the next year or two is by exports and a low corporation tax is central to this.  At a time when confidence in Ireland is already shaken a signal that this rate would have to be increased would do further serious damage. However Ireland is a two tier economy, The multinational companies based in Ireland saw export services rise by 11 per cent compared with a year earlier. This year exports overall are expected to grow by 11 per cent. Such figures are underpinned by the 12.5 per cent corporation tax rate. The domestic economy is flat due to the deflationary effect of higher taxes and cuts in domestic programmes. There is a growing recognition that internal costs need to be reduced so that they fall in line with those of Europe. Europe now seems to recognise that Ireland simply cannot survive if it has to pay the high reparations on the loans demanded by Europe and that a sovereign default may occur eventually. These are big issues for Ireland both in terms of what shape the European Union will take and the limits on Irish national sovereignty.

Germany now believes that the euro is Europe and cannot be allowed to fail. Moreover it is the only eurozone country with the financial resources to back up that commitment but political pressure within Germany requires a quid pro quo for the bailout.

The price for German support for expanding and reforming the EU bailout mechanism and its successor will be a competitive pact giving new economic underpinning to the euro by aligning states’ policies with best performers in Germany. Europe must increase its competitiveness by benchmarking which would be based on the member state that shows the best practices. It is intended to remake the European economy in Germany’s own image.

Jacques Delors has argued that the 17 countries using the single currency had much greater rights and responsibilities than the European Union’s remaining 10 members.  Angela Merkel has traditionally opposed the creation of a two-tier union. Germany once a lynchpin of European integration is now reluctant to grant more power to EU institutions.

A Franco-German initiative would see a new intergovernmental body policing fiscal discipline and economic policy harmonisation. This proposal means that the European Commission and the European Parliament will not define its contents. Any targets agreed in the pact will be voluntary and they must be decided unanimously giving every country a veto. Closer economic policy co-ordination will be done by finance ministers in 17 capitals rather than through the EU machinery in Brussels

Germany sees fiscal and economic harmonisation as a continuation of and not a break in its European tradition. This is expressed as a balance between national and European competences. More intergovernmental decision making is regarded as essential to closer co-ordination of financial economic and social policy. The policy marks the genesis of European integration, which Germany sees as evolutionary rather than revolutionary. Angela Merkel is adamant that the pact will amount to a big step forward for EU integration.

Three areas need to be considered: the need to safeguard the euro; the enlargement and scope of the current temporary bailout fund; and fiscal and economic harmonisation of the euro area. The solution is the competitiveness pact which includes a pan-European corporate tax system. Ireland will express concern about the proposed harmonisation of the corporation tax rate.

Other proposed measures in the pact include harmonisation of retirement ages, the abolition of wage indexation to inflation, and common bank crisis-resolution mechanisms. Part and parcel of the pact is the German idea of a ‘debt brake’. This would set constitutional debt limits throughout the euro area. When Enda Kenny and Richard Bruton from Fine Gael visited the European Commission recently they indicated that they would be willing to accept effective fiscal discipline drawing up an amendment that if adopted would enshrine a ‘debt break’ clause in the Constitution.  However some Irish officials see the need for a referendum to adopt a debt clause which would make such a constitutional amendment less likely.

A debt break clause would constitutionally bar budget deficits above a certain threshold. There is a desire to control by law the ability of governments to borrow recklessly again. A new fiscal rule would need to be introduced by statute in the first instance by establishing in European countries legal fiscal councils. Fine Gael if elected indicated it would be willing to establish such a council.

The pact would need to be implemented within 12 months, by a series of mutual intergovernmental agreements – outside the framework of EU law – to underpin a new permanent fund and a deepening of economic policy co-ordination. This would allow speedy implementation of the pact when compared with the lengthy process of change under the EU rules.

Germany may be prepared to back lower interest loans for Ireland and other peripheral eurozone countries if they agree to anchor a new “fiscal framework” in their constitutions, and follow German-style budget rules. An interest rate reduction is seen as essential in the Irish context. These proposals would reshape eurozone economies in Germany’s image with tougher debt and deficit rules, constitutional debt limits and broadly similar labour rules.

Once the new pact is agreed the permanent stability fund (the European Financial Stability Facility, or ESFS), it is believed, will be given new powers to intervene in sovereign debt markets to issue emergency lines without strictures of an IMF style austerity plan and to extend the duration of its loan programme to as long as 30 years. Another option is for the ESFS to make loans for bailout recipients to buy back their sovereign bonds at a discount to their issue price, and to reduce the interest rate on ESFS loans charged for bailout loans.

Some reactions to the proposed pact include the dangers of linking proposals of this nature to the reform of the eurozone bailout fund (EFSF).  Smaller states which see the role of the Commission as balancing the interests of the small and large states will be perturbed by the inter-governmental nature of the pact legislation and the side-lining of the European Commission which is responsible for drawing up EU legislation.

Non-euro countries feel that they are being excluded from this proposed co-ordination and have wondered why. At a recent meeting of the “Weimar Triangle” between Poland, France and Germany, Poland expressed reservations about the proposed pact on the grounds that it would establish a two speed Europe. Poland was assured that the proposal for eurozone-only meetings would be essential but limited in frequency. The counter argument was that the pact is the basis for the best opportunities for reform and is open to new members. Poland also objects to the 17 eurozone members changing the eurozone rules without their input especially as they are treaty-bound to join the euro when conditions are right and they fear they may find themselves facing tough new conditions in relation to the single currency

Many of the proposals in the proposed pact would be acceptable to Ireland. Ireland has already signed up to many elements in the competitiveness pact such as a higher state pension qualification age, and fiscal consolidation. Among the recommendations of a recent Joint Oireachtas committee report was agreement on a new fiscal regime which would incorporate best international practice in the design of fiscal institutions. When combined with regulatory measures at the European level, it was felt that these measures could ease German concerns about fiscal rectitude. Among the Oireachtas recommendations are the establishment of new independent oversight groups including an economic advisory council. This body would have at least 40 per cent of members appointed from abroad, would analyse whether fiscal policy is adhering to the rules, and whether economic policy is sustainable and on track. The report also calls for an independent budget review council composed of economists and financial planners to control fiscal monitoring.

Such recommendations move in the direction of the kind of independent fiscal rules and regulatory framework being proposed in the new pact. If the final result of the pact is a Europe with stable politics, sound government finances and well run companies making things that other nations buy – in effect Ireland shaped in Germany’s image – it might not be such a terrible end.

Yet the proposals for a more competitive euro with better fiscal discipline address the wrong question. This is not a crisis of government but of over-leveraged banks making foolish spending decisions. The consequences of implementing changes will create winners and losers. The apparent anti-European arguments are not really anti-European but arguments for Europe to take a different direction. Democratic politics work out by engaging citizens directly. Putting the eurozone crisis and EU/IMF deal at the centre of the election campaign has helped clarify whether the solutions proposed properly address the real problems and whether the costs are fairly distributed between Ireland and other EU member states.

These are the issues that need to be tackled at the eurozone members-only special meeting on 14 March by which time a new Irish government with a fresh mandate will be in power. The details agreed at this meeting are expected to be ratified at the regular European Union summit to be held on 25 March.

This article was written by Patrick Mc Nally, deputy chair of Federal Union. The opinions expressed are those of the author and not necessarily those of Federal Union (nor of Enda Kenny). 22 February 2011

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