Source: European Voice

The eurozone’s 720 billion euro emergency funding facility, which follows and complements the 110 billion euro rescue package approved for Greece, comes with some seemingly tough conditions attached. Nonetheless, issues of credibility and moral hazard remain, because, despite their repeated commitment to the Lisbon treaty’s ‘no bail-out’ clause, European governments—and the International Monetary Fund (IMF)—eventually provided a safety net for countries at risk of default.

Does this affect the eurozone’s credibility? Probably not. Financial markets never believed the ‘no bail-out’ clause. Nor was confidence boosted by the eurozone’s clumsy attempts to avoid anything that looked remotely like a concession to lax fiscal policies. If, at the beginning of the Greek ‘tragedy’, the eurozone had come out with a credible plan and delivered a message of confidence with one voice, it would have proved more effective—and, in the long run, less costly—to reassure investors, tame volatility, and reduce uncertainty.

The stabilization scheme is good news, as it signals Europe’s ability and willingness to coordinate a policy response and its desire to avert the currency union’s collapse. But European governments may not have done enough to convince the markets. If investors become persuaded that fiscal consolidation is neither economically feasible nor politically manageable, they will further test Europe’s willingness to support the euro. But the scheme is not large enough to deal with contagion spreading in all countries at risk—especially if Italy is involved. It can buy some time to restore fiscal stability and promote growth, but credible action to prevent contagion is now imperative.

IMGXYZ5031IMGZYXThe implicit message of the stabilization scheme is that the onus for restoring confidence now falls on all countries with severe fiscal shortfalls as well as competitiveness problems. But leaving these countries—Portugal, Spain, Italy, and Ireland as well as Greece—to their own policy devices and domestic constraints is a recipe for disaster. The austerity measures these countries are now unveiling are too timid, too narrowly based, and too vulnerable to political pressures to persuade investors. More generally, this crisis has demonstrated how domestic failings can necessitate an emergency intervention by Europe. A European response is also needed when the emergency has passed.

In the case of those countries with the severest fiscal problems, European governments—not just the European Commission and the International Monetary Fund—should be able to discuss, propose, and oblige appropriate action to be taken—and even agree on appropriate sanctions. They should also monitor implementation of the plans.

As well as setting out concrete steps for fiscal consolidation (as current plans do), the plans should set out methods to improve competitiveness and increase productivity, trying to achieve the right balance between fiscal measures and growth-oriented policies, between fiscal coordination and structural reforms. The plans should be credible and there should be no room for complacency. Furthermore, with the public opinion in most vulnerable countries, at best, uncommitted to or, at worst, hostile to any austerity measure, reaching out and building support is critical. Fiscal measures and plans for reforms therefore have to be clearly communicated, while the burden of the adjustment process should be distributed in a transparent and fair way so that people in those countries do not feel unjustly hit.

Beyond these emergency measures, measures are needed to identify potential emergencies. We know that Greece was the tip of the iceberg, rather than an isolated case. Clearly, surveillance at an EU level was not strong enough to prevent countries from building up unsustainable debt positions. As has been proposed, member states should have the right to review other member states’ annual budgets. Such reviews would also act as a means of monitoring compliance with agreed objectives. And surveillance should not be confined to budgetary matters, but should be extended to the main economic indicators, such as GDP growth, productivity growth, and balance of payments.

Greece’s problems have also demonstrated that there was a lack of due diligence when the country was admitted to the currency union. Greater thoroughness—as well as fuller scrutiny of its figures—would have revealed Greece’s structural shortfalls.

Future bids for membership of the eurozone should be reviewed more rigorous. Estonia, whose application the European Commission was approved last week, may provide a test case. The release of timely, reliable and comparable series of macroeconomic indicators—Greece’s statistics were not—should become part of the requirements for members-to-be. The criteria for membership should be changed: the Maastricht criteria assume ‘one size fits all.’ Cyclical as well as structural indicators should be considered.

A currency union requires accurate statistics, a full exchange of information, cooperation on policy and peer pressure. The survival of the single currency union depends on them.

Paola Subacchi is the research director in international economics at Chatham House in London.