Daily Archives: July 11, 2011

The European Union was brought into existence by what Karl Popper called “piecemeal social engineering”. A group of far-sighted statesmen, inspired by the vision of a United States of Europe, recognised that this ideal could be approached only gradually, by setting limited objectives, mobilising the political will needed to achieve them and concluding treaties that required states to surrender only as much sovereignty as they could bear politically. That is how the postwar Coal and Steel Community was transformed into the EU – one step at a time, understanding that each step was incomplete and would require further steps in due course.

The EU’s architects generated the necessary political will by drawing on the memory of the second world war, the threat posed by the Soviet Union and the economic benefits of greater integration. The process fed on its own success and, as the Soviet Union crumbled, it received a powerful boost from the prospect of German reunification.

Germany recognised that it could be reunified only in the context of greater European unification, and it was willing to pay the price. With the Germans helping to reconcile conflicting national interests by putting a little extra on the table, the process of European integration reached its apogee with the Maastricht treaty and the introduction of the euro.

But the euro was an incomplete currency: it had a central bank but no treasury. Its architects were fully aware of this deficiency, but believed that when the need arose, the political will could be summoned to take the next step forward.

That is not what happened, because the euro had other deficiencies of which its architects were unaware. They laboured under the misconception that financial markets can correct their own excesses, so the rules were designed to rein in only public-sector excesses. Even there, they relied too heavily on self-policing by sovereign states.

The excesses, however, were mainly in the private sector, as interest-rate convergence generated economic divergence. Lower interest rates in the weaker countries fuelled housing bubbles, while the strongest country, Germany, had to tighten its belt in order to cope with the burden of reunification. Meanwhile, the financial sector was thoroughly compromised by the spread of unsound financial instruments and poor lending practices.

With Germany reunified, the main impetus behind the integration process was removed. Then, the financial crisis unleashed a process of disintegration. The decisive moment came after Lehman Brothers collapsed, and authorities had to guarantee that no other systemically important financial institution would be allowed to fail. The German chancellor Angela Merkel insisted that there should be no joint EU guarantee; each country would have to take care of its own institutions. That was the root cause of today’s euro crisis.

The financial crisis forced sovereign states to substitute their own credit for the credit that had collapsed, and in Europe each state had to do so on its own, calling into question the creditworthiness of European government bonds. Risk premiums widened, and the eurozone was divided into creditor and debtor countries. Germany changed course 180 degrees from being the main driver of integration to the main opponent of a “transfer union”.

This created a two-speed Europe, with debtor countries sinking under the weight of their liabilities, and surplus countries forging ahead. As the largest creditor, Germany could dictate the terms of assistance, which were punitive and pushed debtor countries towards insolvency. Meanwhile, Germany benefited from the euro crisis, which depressed the exchange rate and boosted its competitiveness further.

As integration has turned into disintegration, the role of the European political establishment was also reversed, from spearheading further unification to defending the status quo. As a result, anyone who considers the status quo undesirable, unacceptable or unsustainable has had to take an anti-European stance. And, as heavily indebted countries are pushed towards insolvency, the number of the disaffected continues to grow, together with support for anti-European parties such as True Finns in Finland.

Yet Europe’s political establishment continues to argue that there is no alternative to the status quo. Financial authorities resort to increasingly desperate measures in order to buy time. But time is working against them: the two-speed Europe is driving member countries further apart. Greece is heading towards disorderly default and/or devaluation, with incalculable consequences.

If this seemingly inexorable process is to be arrested and reversed, both Greece and the eurozone must urgently adopt a plan B. A Greek default may be inevitable, but it need not be disorderly. And, while some contagion will be unavoidable – whatever happens to Greece is likely to spread to Portugal, and Ireland’s financial position, too, could become unsustainable – the rest of the eurozone needs to be ringfenced. That means strengthening the eurozone, which would probably require wider use of Eurobonds and a eurozone-wide deposit-insurance scheme of some kind.

Generating the political will would require a plan B for the EU itself. The European elite needs to revert to the principles that guided the union’s creation, recognising that our understanding of reality is inherently imperfect, and that perceptions are bound to be biased and institutions flawed. An open society does not treat prevailing arrangements as sacrosanct; it allows for alternatives when those arrangements fail.

It should be possible to mobilise a pro-European silent majority behind the idea that when the status quo becomes untenable, we should look for a European solution rather than national ones. “True Europeans” ought to outnumber true Finns and other anti-Europeans in Germany and elsewhere.

The writer is chairman of Soros Fund Management and founder of the Open Society Foundations.

Response by Charles Grant

European leaders must step up their game

George Soros is right that Germany’s new approach to Europe bears some responsibility for the eurozone crisis. Germany’s leaders are finding it hard to consider broader European rather than immediate national interests. The medicine they pushed the European Union to prescribe for Greece, Ireland and Portugal – fiscal austerity and structural reform – was necessary but not sufficient. Germany’s obsession with supply-side economics and its reluctance to take small steps towards a “transfer union” prevented the EU from coming up with plans to promote investment and growth in the struggling countries. So the medicine is failing, and the rest of the eurozone cannot be ring-fenced from Greece’s problems unless the EU does more to boost growth in Portugal, Ireland and elsewhere.

Mr Soros is also right to berate EU leaders for defending the status quo. But there is a reason for their conservatism: they fear being on the wrong side of public opinion, which is an increasingly powerful actor in European politics. The founding fathers did not have to worry about voter sentiment. But now many voters in the surplus countries oppose bail-outs for the southern countries, which they blame on the EU. And in the deficit countries, electors have had enough austerity, which they also blame on the EU.

As Mr Soros writes, a viable plan B will require stronger eurozone governance through schemes such as Eurobonds. But in many parts of the EU, voters have never been more hostile to “more Europe”. Of course, the current generation of European leaders is particularly ill-equipped to explain to voters the need for change.

But Mr Soros does not refer to another fundamental cause of the eurozone’s travails. During the 20 years since the Maastricht treaty was negotiated, the large member-states have become more dominant in the EU, and the European Commission relatively weaker. We are moving towards the Europe des patries, a Europe of nation states, that General Charles de Gaulle wanted. This trend has accelerated during the euro crisis: the French and the Germans have sought to sideline the Commission and create ‘inter-governmental’ rescue mechanisms.

For all its imperfections – the current team of commissioners contains few stars – only the Commission can consider the wider European good, protect the interests of smaller member states and ensure that EU rules (such as on deficits and the single market) are respected. The Commission (like France) doubted that the Germanic medicine the EU has prescribed for debtor countries would work, but lacked the authority to resist Berlin.

Mr Soros’s plan B is not viable unless European leaders raise their game. Those in Germany need to rediscover some of the Helmut Kohl spirit, and remember that leadership carries responsibilities. Encouragingly, some Social Democratic and Green politicians seem to get the point. In surplus countries and debtor countries, leaders need to shape public opinion by explaining the benefits of the euro and why sacrifices are required. And all across the EU, leaders need to treat the Commission with more respect. A sustainable euro needs strong institutions and rules, rather than late-night deals among leaders of big member states.

The writer is director of the Centre for European Reform.

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