Leaders of 19 countries plus the European Union are still gathered at the Mexican resort of Los Cabos with a long list of things to do. Do not expect there to be much consensus in the conclusion — for the following five reasons.

First, it is difficult enough to forge agreement on complicated questions among five negotiators, as meetings of the UN Security Council have demonstrated for decades, but 20 is just too many. The 2008 financial crisis and the global slowdown which followed made plain that institutions dominated by the advanced industrialised democracies no longer reflect the world’s true balance of political and economic power. Attempts to bolster the global economy without support from China, India, Brazil, Russia, Gulf states and others had become impossible. Hence the Group of 20. Yet, it has since become apparent that only when each member feels threatened by the same challenge at the same moment and to more or less the same degree could an organization as unwieldy as this one produce anything more substantive than broad declarations of principle.

Second, the issue is not simply the number of negotiators. It is the wide range of political values and interests represented around the G20 table. It is not the “rise of the rest” that has shifted the terms of debate but the “rise of the different”. In the 1950s and 60s, the world saw the emergence (really the re-emergence) of West Germany and Japan. Though Japan’s surge created genuine anxiety in the US during the 1980s, fears were limited by the recognition that the Japanese, like the Germans and all other G7 members, were believers in free market democracy. There is no such consensus among today’s rising powers. As importantly, G20 members stand at quite different levels of development. Even where they have common political and economic values, poor countries have quite different hopes, fears, needs and plans from rich ones.

A lack of consensus can sometimes be overcome if a commonly recognized leader can set and drive an agenda. Leaders have the muscle, money and influence to persuade other governments to take actions they would not otherwise take. They pay the bills that others cannot afford and provide services no one else will pay for. The third reason why we cannot expect substantive results from the G20 is that, at least for the time being, the US will not provide the consistent leadership it has in the past, because American voters are telling pollsters that they want their elected leaders focused on American, not foreign, problems.

In fact, there is now greater public demand for a sharply reduced US role in the world than at any time since the end of World War II. The United States is the world’s only military and economic superpower and will remain so for years to come, but a 2011 survey of “long-range foreign policy priorities” conducted by the Pew Research Center found that the only priorities winning majority support from US respondents were protection of American jobs, protection of the homeland from terrorist attacks, and reduction of US dependence on imported energy. The percentage of those who favored “reducing the US military commitment overseas” surged from 26 per cent in September 2001 to 46 per cent in May 2011. “Promoting democracy abroad” won support from just 13 percent of respondents, and nearly half said the US “should mind its own business internationally”. With less US leadership, the challenges facing G20 leaders will only be more formidable.

The fourth reason that the G20 will accomplish little in years to come is that America’s most capable and reliable allies will not pick up where America leaves off. Europeans will be preoccupied for years with the bid to restructure European economic and financial governance to restore confidence in the eurozone and in the longer-term credibility of the broader European idea. Japan still has the world’s third largest economy, but it has also had 17 prime ministers in 23 years, complicated domestic reform questions to resolve, and last year’s triple disaster from which it is still recovering.

Finally, rising powers like China, India, Brazil, Russia, Turkey and the Gulf states face far too many complex development problems at home to accept unnecessary responsibilities abroad. In addition, the new players have comparatively little experience in managing the risks that arise from deeper involvement in global politics. Advanced industrial democracies have produced governing institutions, militaries, bureaucracies, companies, investors, lenders, NGOs and leaders with broad experience of international relations. Not so the emerging markets.

If America, Japan, and China will not make a major financial contribution to help refloat the eurozone, why will the European decision-makers that matter—in Berlin, Brussels, the European Central Bank, Madrid, and Athens—care what non-European leaders think they should do? How will developed and developing states agree on how to divvy up the risks and sacrifices that come with substantial reductions of carbon emissions? How can they agree on what do about Syria?

Don’t expect substantive answers to any of these pressing questions from this summit—or from G20 gatherings to come.

Keynesian economists blame the sluggish US growth and lack of job creation on the insufficiency of stimulus measures. If only Congress had agreed with President Obama to greater stimulus, they say, the current US recovery would have been much stronger. This is a dubious proposition. The deeper problem lay in the limitations of fiscal stimulus as a response to the 2008 crisis.

Stimulus spending has been sizeable. According to the International Monetary Fund’s measurement of these things, the fiscal stimulus has been large and persistent. The IMF looks at “general government structural balance as a percent of potential GDP,” which measures the general government budget balance net of automatic stabilisers — spending that kicks in during downturns, such as unemployment benefit.  In 2007, the structural deficit was 2.8 per cent of gross domestic product. This rose to 5.0 per cent of GDP in 2008, mainly because of tax cuts implemented by the Bush administration at the onset of the crisis. With Mr Obama’s stimulus program, the structural deficit rose further to 7.5 per cent of GDP in 2009, and stayed at roughly that level through 2011.

Thus, the structural fiscal expansion was more than 4 per cent of GDP on a sustained basis during 2009-11 compared with 2007. The actual deficit including automatic stabilisers and the Troubled Asset Relief Program (bank bailout) funds was far larger, rising from 2.7 per cent of GDP in 2007 to 13.0 percent of GDP in 2009, 10.5 percent of GDP in 2010, and 9.6 percent of GDP in 2011. Net public debt as a share of GDP soared from 48.2 per cent of GDP in 2007 to 80.3 per cent of GDP in 2011, according to IMF data.

Fiscal stimulus, in short, has been tried, but did not succeed in spurring a robust recovery. Advocates of stimulus bemoan the idea of reversing the fiscal expansion now, in view of the weak economy, and argue that it be prolonged and expanded. The original idea of the stimulus, however, was as a temporary measure that would make a bridge to self-sustaining private-sector-led recovery.

The Keynesian interpretation in late 2008 and early 2009 was that the economic downturn was a cyclical matter. A housing boom had turned temporarily to bust. Consumer spending was temporarily down. Temporary tax cuts would boost consumer spending while a temporary boost in government spending would create temporary jobs in construction and preserve jobs in cash-strapped state and local governments. By 2010 or 2011, a natural recovery would replace the temporary fiscal boost, and allow it to be withdrawn.

Yet the cyclical recovery proved to be anaemic. The national accounts suggest some reasons why. First, the housing bust did not reverse itself. As of the first quarter of 2012, real investments in residential structures remained 55 per cent below the 2005 level. Yet this was not surprising. It was neither possible nor desirable to re-inflate the housing bubble.

Second, the fiscal stimulus was at least partially offset by a rise in household saving. Economic theory and experience teaches that temporary tax cuts and transfers to households, of the kind implemented repeatedly in recent years, are partly or wholly saved. Households pay down their debts rather than making new outlays on consumer goods.

Many state and local governments apparently used the federal transfers to replace rather than augment their own revenues and to replenish their own financial balances, rather than to reverse their plans for layoffs and investment cutbacks. There was no rise in overall government investment (i.e. federal, state, and local) spending as a share of GDP. The stimulus was almost all in the form of tax cuts and transfer payments rather than outlays for investment projects.

Two major implications of the Keynesian interlude are the following. First, and most importantly, there has been no new dynamic growth sector in the US economy to replace the defunct housing boom. Consumer spending did not surge; housing did not return; private investments in industry did not take over; and public investments did not fill the gap. Second, the multipliers on short-term Keynesian stimulus measures proved to be low and variable rather than high and predictable. The continuation of the Keynesian option at this stage is therefore unappealing: a further build-up of public-sector debt with little guarantee of job creation or a reliable exit strategy.

The tragedy is that the Republican opposition to the Obama-led stimulus measures is even wider off the mark. The Republican strategy would make the temporary tax cuts permanent, and even create new tax breaks for top earners, to be paid by swingeing cuts in programs for job training, education, infrastructure, the environment, and support for the poor. The Republicans live in a world in which the rich are the only worthies in the society (the “job creators”), the unemployed and poor should fend for themselves, and public goods do not exist. And they do so despite thirty years of failed trickle-down policies that have created unprecedented inequality, deepening poverty, and no solutions to the loss of jobs.

There is another way, not represented by either US political party. It would be based on the following four premises.

First, the US (and Europe) needs a new source of long-term growth, not a short-term Keynesian bridge to consumer-led growth.

Second, the highest social returns can be achieved by bringing the new technologies – information, communications, transportation, materials, and genomics – to bear on the problems of sustainability and the quality of life. Long-term growth (and quality of life) should be based on an investment-led transition to a low-carbon, low-pollution, and high-amenity built environment, drawing upon the cutting-edge advances of science and engineering.

Third, the transition to sustainability requires a mix of public and private investments. As one example, private investments in low-carbon energy (wind, solar, nuclear) need to be linked to public investments in long-distance transmission grids. Similarly, the transition to smart electric-powered urban mobility will require a mix of private investments and public infrastructure. The public investments should be financed in part through long-term borrowing backed by dedicated future revenue streams (e.g. public-sector tariffs and gradually rising carbon taxes).

Fourth, rather high levels of taxation as a share of national income (as in the highly successful economies of northern Europe) are needed to keep budget deficits low while also ensuring adequate public revenues for universal coverage of high-quality public services and human capital investments that span early childhood through public education, apprenticeships, and job training.

While there are absolutely urgent short-term matters to face — notably putting out the fire of bank runs in the eurozone — the deep solution to the crisis of the high-income countries lies in a long-term vision of sustainable development, one that promotes a mix of complementary public and private investments. To get there, we need to move beyond the stale US political debate pitting short-run Keynesian stimulus on one side versus trickle-down economics on the other.

Related posts:
Larry Summers is playing economic Jeopardy! – Glenn Hubbard
Romney must release a credible budget – Lawrence Summers

After resisting for months, Spain has made an explicit plea for bank aid from its European neighbours. The immediate objective is to recapitalise struggling banks and minimise the risk of disruptive deposit withdrawals. A major challenge is to avoid this emergency funding turning Spain into a long-term ward of the European state, a phenomenon that has already occurred in the three countries to have already received bail-outs – Greece, Ireland and Portugal.

Having botched prior attempts to stabilise its banking system – whether it was the domestic approach based on mergers or the attempt to access a back door to the European Central Bank – Spain now looks set to tap European funds. This would probably be combined with a more detailed commitment to a domestic economic plan emphasising both budgetary adjustment and structural reform.

This use of an external balance sheet would provide the theoretical possibility of rupturing the disruptive feedback loop between weak banks and deteriorating sovereign creditworthiness. But before we all let out a huge sigh of relief, it is important to understand why Spain for so long resisted what seems to be an obvious response to its banking problems.

So far, emergency European funding has been impossible to exit, like a “roach motel”. Rather than act as a catalyst for crowding in private capital needed to restore growth, and financial viability, public money has provided the private sector with the possibility to exit programme countries at a much lower cost; and exit it did. As a result, governments have become highly dependent on official aid to cover their budget needs, meet interest obligations and roll over maturing debt; and domestic companies have been starved of the oxygen that is so critical for investment and job creation.

No wonder, growth and solvency remain so elusive for the programme countries, including in Ireland and Portugal where citizens have been generally supportive of their governments’ policies. The possibility that the counter factual — i.e., no access to external emergency financing — could have yielded a worse outcome is no excuse for repeating the mistake in Spain. Indeed, This is more than just in the country’s self interest. Given its size and crucial role in any revived eurozone (along with France, Germany and Italy), Europe cannot afford Spain to be a long-term ward of the state.

Success requires, first and foremost, a common understanding and vision of what a stable eurozone would look like in three to five years. Increasingly, this speaks to a smaller and less imperfect union, anchored by the big four and including only countries that are both able and willing to deliver on the revamped joint obligations being discussed in official circles — namely, reinforcing monetary union with proper fiscal and growth compacts and enhanced political integration.

This critical contextual step would allow for the immediate implementation of measures to stabilise Europe, including through the establishment of a regional bank deposit scheme. It would provide far greater assurances to the ECB that, this time around, its emergency facilities (including another longer term refinancing operation and an enhanced security purchase program, along with strengthened regional fiscal transfers) have a better prospect of being a bridge to a sustainable European destination — something that continues to elude an institution that has already expanded its balance sheet to 30 percent of aggregate gross domestic product.

Finally, Spain would need to agree to a proper domestic policy mix. This involves not only avoiding the mistake that Greece made in agreeing to a series of unrealistically-designed and technically-flawed programmes but also enabled to make difficult upfront decisions about the best form of burden sharing (something that Ireland was not allowed to do by its European partners).

Given the increasingly delicate situation of the eurozone – from Greece’s bank jog and election uncertainty to the tensions at the very core between France and Germany – governments do not have many more chances to get all this right. And the rest of the world has a vital interest in a better response to what now constitutes a major risk to already tenuous growth and employment prospects.

Related posts:
Eurozone banks must be an international concern – Lorenzo Bini Smaghi
To save the eurozone, save the banks – Jeffrey Sachs

The way in which the Bankia – and other – cases have been managed over the past few weeks confirms that banking supervision in the euro area cannot continue to be implemented in a decentralised way. The incentives of the national authorities to free ride are simply too high and undermine the stability of the entire euro financial system.

The traditional argument put forward in defense of conducting prudential supervision at the national level is that supervisory authorities have to be accountable to taxpayers, who ultimately bear the economic consequences of bank failures. As long as bank rescue operations are financed by taxes collected at the national level, so goes the argument, supervision should remain national.

In a monetary union, however, the decisions taken by a national supervisor impact not only the country’s residents but also the taxpayers and savers of the other countries. Recent events have shown how the uncertainties surrounding the restructuring of Bankia have negatively affected the banking system of the whole euro area and spread to other segments of the financial market, including in countries which had taken action with a view to put their own banking system in order.

The channel of transmission to the other eurozone countries has several dimensions. First, the contagion through the sovereign risk market increases government bond yields, thus also raising the implicit tax burden in other countries. Second, the high cross-border correlation of banking risk depresses the value of bank capital in other parts of the eurozone, fuelling a credit crunch. Third, if domestic funds are not sufficient to ensure adequate bank recapitalisation, as was the case for Greece, Ireland and Portugal, the European facility has to be tapped, which commits other countries’ taxpayers.

Decentralised supervision in the euro area also provides incentives to underestimate risks and to shift the burden of adjustment to the other countries’ taxpayers. The confidential nature of the information collected by supervisors on their respective banks is often used as a reason for not sharing it with the other countries, thus increasing the probability of underestimating the gravity of the situation and the cross-border implications of crises. Decentralised stress-tests have allowed for different amounts of rigour across countries, undermining the credibility of the entire European supervisory structure. The benchmarks and deadlines for recapitalisations have been set primarily with a view to accommodate national preferences rather than to restore stability across the board.

The current system of cooperation among national supervisors under the European Banking Authority is weak and has no sanctioning mechanism to avoid the risks mentioned above. It is paradoxical that while the governments of the eurozone member states have accepted to subject themselves to strict rules and to a sanctioning regime, as foreseen in the fiscal compact, national supervisors can operate with much fewer restrictions. As a result, the incentive to act is linked to market pressure, which experience shows as being the best recipe for doing too little too late.

The current decentralised system of supervision also puts an undue burden on the ECB. The latter relies on the assessment of the national supervisors to judge whether banks are solvent, and can thus be accepted as counterparties for monetary policy operations. This fuels the temptation by national supervisors to understate solvency risks and to address problems through the provision of central bank liquidity rather than capital increases. Only in countries under IMF-EU programme have national supervisors been requested to share all the required information. This may be a reason why resorting to an IMF-EU programme tends to be rejected, until it becomes unavoidable.

In a monetary union the supervisory authorities should give account of their actions – and inaction – not only to the citizens of their own countries but also to the others. In the current EU institutional framework, it’s not clear how such an accountability can be ensured. Financial stability is still largely considered as a national responsibility, which is somewhat paradoxical in a single financial market with a single currency. The role of the European Commission is unclear. In theory, the supervisory and fiscal authorities of the other countries should put pressure on each other to ensure such accountability, but in practice they are reluctant to do so, fearing of having one day to abide by the same requirement.

The cost of such an inefficiency is mainly borne by the taxpayers.

The solution is to centralise bank supervision at the euro area level, especially for systemically relevant institutions. There are two ways to achieve this. The first is that the political authorities of the member states take the initiative and agree to implement a more efficient integrated supervisory system. The second way is that the ECB stops relying only on national supervisors and starts conducting its own assessment on the solvency of major banks, before granting them eligibility to monetary policy operations.

The writer is a visiting scholar at Harvard’s Weatherhead Center for International Affairs and a former member of the ECB’s executive board

Friday’s weak US employment report confirms a disappointing historical pattern: after an encouraging start to the year, job creation has again hit a soft patch. To make things worse, there is a distinct possibility that, absent major policy initiatives on both sides of the Atlantic, the US economy may not accelerate as quickly as many hope – thus increasing America’s vulnerability to the deepening crisis in Europe.

The report again highlights the vulnerability of the employment situation. Net job creation in May amounted to only 69,000, well below consensus expectations of 150,000 and nowhere near the pace needed to address the large shortfall that persists more than three years after the global financial crisis. The unemployment rate inched up to 8.2 per cent, with the employed to adult population ratio at a worrisomely level of only 58.6 per cent.

The disappointing news is not limited to quantities. Composition of employment, duration of unemployment and stagnant earnings remain stubborn challenges.

Long-term joblessness rose to 42.8 per cent of those officially out of work. The average duration of unemployment is still more than twice the historical norm. And those fortunate enough to work are coping with flat earnings growth and declining hours worked.

We have been here before – twice in just the last two years. And on both occasions, the second quarter weakness was reversed later in the year.

Count me among those wishing for a repeat of the rebound, if not a much, much better outcome. Yet this hope comes wrapped in heightened worry. It will be much tougher going this time around given how economic, financial and political factors are converging in a worrisome manner.

Concerned by the never-ending crisis in Europe, a major export market for many companies, CEOs are cautious about hiring; and it does not help that emerging economies, the other source of meaningful external demand, are slowing sharply. Just look at Friday’s fall in China’s manufacturing indicator.

Sluggish job creation and earnings mean that heavily-indebted consumers will remain under pressure. And with the household savings already low, too many families are exhausting their emergency cash.

All this is consistent with the data released earlier in the week suggesting that the private sector is losing vitality – from the unexpected large fall in the ISM purchasing managers’ survey to higher weekly jobless claims and the downward revision in first quarter GDP. Then there is the prospect of a year-end fall in the government’s contribution to economic activity on account of both spending cuts and tax hikes – the so-called “fiscal cliff”.

With the November elections getting closer, it would be foolish to expect politicians to agree to the grand policy bargains needed to reinvigorate the US economy and to encourage companies to get their cash off the sidelines. However, we can hope that they will avoid making a bad situation worse. This requires they pursue two policy initiatives without further delay.

First, Congress needs to get going on measures to reduce the risk of the fiscal cliff. As stressed by Federal Reserve chairman Ben Bernanke and others, the economy is in no position to absorb such a large hit to aggregate demand. Moreover, the blunt nature of the expenditure and tax measures – not the result of coherent fiscal reform but, rather, due to the lack of responsible decision making – would aggravate a budget that is already structurally inefficient and unfair.

Second, the Obama administration needs to work closely with the Fed and congressional committees on contingency measures to counter collateral damage from Europe. Up to now, American officials have been keener on lecturing their European counterparts – with neutral, if not negative consequences – than specify what could be done to navigate the aftermath of potentially messy outcomes on the other side of the Atlantic.

There is only one thing worse than preparing for a crisis that does not happen; and that is not preparing for a crisis that does. It appears that American politicians not only lack plans to deal with adverse European contagion but are also on course to expose the country to additional self-inflicted challenges. Friday’s disheartening data are a timely reminder that these are enormous risks to take with what is already a very fragile employment situation.

Imagine – if you possibly can – that the eurozone crisis is finally resolved. The dust has settled. The euro is still in one piece. How would we have got there?

A lasting solution will require a shift in belief. Belief, in turn, can be measured through bond spreads and, in particular, the level of German yields.

Many investors now expect – and more than a handful of policy makers now fear – that the end is nigh, that the euro is on its last legs. As that belief festers, its self-fulfilling qualities threaten the euro’s survival.

The consequences of that belief are all around us. Slow motion bank runs, widening sovereign spreads and biting recession are symptoms of an underlying fear that the euro will crumble.

The fear is most obviously expressed through capital flight. One oddity of the crisis to date is that, while some countries in the eurozone are suffering enormously, others are doing perfectly well, largely thanks to capital heading northwards. Thus whereas the cost of borrowing is painfully high in Spain, it is ridiculously low in Germany.

Capital flight has created a quasi-currency market within the single currency area. If investors fear euro break-up, they’ll invest today in anticipation of where newly-independent national currencies might head tomorrow. No one has any sure way of working out where a future German euro might trade versus a future Spanish euro, but it’s not hard to believe that the German euro would appreciate dramatically against its southern rivals.

That belief is precisely why we’re witnessing capital flight. Why would investors choose to hold Spanish assets which, in a post-euro world, might lose their value remarkably quickly when they could, instead, opt for German assets which might appreciate thanks to the introduction of a German euro?

Even if the initial probability of a euro break-up is deemed to be low, it might nevertheless be high enough to trigger the capital flight which, day by day, increases the likelihood of eventual euro break-up.

Other than the copious use of effective capital controls, the only way to stop capital flight is to provide a cast-iron political commitment that the euro will survive (no one, after all, believes that the Californian dollar will appreciate against the Illinois dollar). That’s not easy. Imagine, though, that the commitment is provided and that investors believe the politicians are serious. What would then happen?

The flow of capital would reverse. No longer would there be any reason to treat the eurozone as a quasi-currency market. And the narrative which has so bedevilled the eurozone until now would disappear in a puff of smoke.

That narrative is based on the idea of good creditors and bad debtors. The idea is simple. It is also dangerously wrong. Spanish yields are high, apparently, because Spain finds itself in a poor fiscal and banking position whereas German yields are remarkably low because the Germans have delivered the right reforms. It follows, therefore, that other countries in the eurozone should become more Germanic.

It’s a nice idea but also utterly implausible. Not all countries in the eurozone can benefit from 10 year bond yields at below 1.3 per cent. German yields are down at this ludicrously low level because of capital flight, not economic fundamentals.

It follows, then, that a lasting political commitment to the eurozone would encourage capital to head south again. German bond yields would have to rise even as Spanish yields fell. And that conclusion, in turn, provides a clue as to what a lasting political solution might look like.

It’s likely to include some form of common bond issuance alongside a low-level fiscal union and, perhaps, a eurozone-wide deposit insurance scheme for the banking sector. Institutional arrangements would need to be established to stop the process of capital flight unfairly creating winners and losers leading, in turn, to the rise of political extremism.

In other words, there needs to be burden-sharing. The winners have to give something back. Germany cannot insist on austerity for others while benefiting from capital flight. The flow of capital has to be reversed triggering higher German bond yields. If and when that happens, policymakers will finally have convinced themselves and, indeed, everyone else that the euro will survive.

And what if German yields don’t rise? Barring a massive bout of ECB-led quantitative easing, two explanations spring to mind. Either the euro is left teetering on the brink or the recession in southern Europe has begun to drag Germany down too.

Policies designed to save the euro should be judged by the German yield yardstick. Higher German yields should be welcomed everywhere. And that includes Berlin and Frankfurt.

Bank runs are not supposed to happen in a modern advanced economy. Yet, newspapers reported last week that Greek depositors were stepping up their withdrawal of savings held in local banks. Understanding why this is happening – and what we can do about it – is key to assessing the threat to European and global growth, jobs and financial stability.

There are two critical safeguards against the start and disorderly acceleration of bank runs: national deposit insurances schemes and central bank provision of emergency liquidity. They kick in once the banking system’s first line of defence – which consists of strong capital and good assets on the balance sheet – is breached.

Many banks were caught offside by the global financial crisis and the widespread economic and financial deterioration that followed. The result was a sharp erosion – both real and perceived – in capital cushions relative to the quality and size of the assets. Moreover, given the heavy concentration of government bonds on banks’ balance sheets, the situation took a further and significant turn for the worse with the downgrading of sovereign creditworthiness in some European countries, and most prominently in Greece.

Worsening sovereign risk also served to undermine the credibility of the circuit breakers designed to minimise the probability of bank runs. After all, national deposit insurance schemes are as credible as the sovereigns that stand behind them. And with access to emergency central bank liquidity involving the pledging of assets that themselves are now under severe pressures, such funding becomes less straightforward.

These dynamics are dramatically playing out in Greece due to self-reinforcing concerns about another debt default, the imposition of capital controls, and currency denomination that would accompany a possible eurozone exit. In addition to pushing the country further to the edge, they raise legitimate worries about the risk of yet another wave of negative contagion for some other European countries – particularly through the further destabilisation of bank deposits.

Greece’s “bank jog” needs to be immediately stopped if it is not to evolve into a full-fledged bank run with region-wide implications. And to do so, Greece requires even greater support from its already (and understandably) reluctant eurozone partners.

An incredibly disruptive situation could be avoided if Greek depositors were given quick access to a region-wide (as opposed to just national) deposit insurance scheme that is unambiguously supported by the fiscal authorities in the strongest eurozone countries. This would need to be coupled with even larger liquidity support from the European Central Bank, along with direct capital injection into the Greek banks from regional funds (e.g., the European Stability Mechanism, or ESM) and multilateral institutions (namely the International Monetary Fund). Finally, agreement would be needed on how and when to impose burden sharing on banks’ equity holders and bond creditors.

Add these financial requirements to the considerable sums already committed to Greece to cover its primary budget deficit, meet interest payments, roll over maturing debt, and facilitate much needed structural reforms. Each serves to complicate an already tense and stretched relationship between Greece and the troika (ECB, EU and IMF). Together they pose a considerable and urgent challenge – and one that makes it even more difficult to reconcile simultaneously cascading financial demands, economic imperatives, conditionality design, and democratic realities.

Whichever way you look at this troubling situation, last week’s intensification of deposit flight in Greece is much more than just a new wrinkle in what has become a protracted European crisis. If the phenomenon spreads, and it will in the absence of a credible region-wide policy response, control of Greece’s destiny within the eurozone would slip even further away from politicians and policymakers and more directly into the hands of a population that is approaching the June 17 election in a mood of rejection. Already this rejection is not that far from tipping Greece into a classic funding panic and the eurozone into even greater turmoil.

The relationship between Greece and the rest of the eurozone is increasingly reminiscent of the cold war’s balance of terror. We are of course speaking only of financial terror and Greece is not the Soviet Union, but the mechanics are strikingly similar.

Start with the options for Athens. It is important to distinguish between budgetary and external aspects. Greece is forecast to record a slight primary budget deficit in 2012, so should it default, forcing European partners to unplug assistance, it would have to tighten more, but only marginally. However the current account deficit is still expected to be close to 8 per cent of gross domestic product. Without assistance and in the absence of significant private capital inflows, the European Central Bank would have to increase its exposure even further. Should it refuse, as likely, Greece would be forced into an exit and it would have to close its external deficit precipitously. What remains of the economy would fall into chaos. Financial disruption would be massive, resulting in a chain of bankruptcies. Currency depreciation would substantially overshoot, making foreign goods unaffordable, especially as policy institutions have no credibility. Eventually, depreciation would help rebuild competitiveness, but in the meantime the damage would be severe.

A unilateral Greek default would undoubtedly be costly to its partners. Official exposure to Greece through assistance loans, ECB claims on the national central bank and ECB holdings of government bonds amount to more than €250bn. To this sum must be added private sector exposure through bank loans and equity, roughly another €100bn.

Additionally, a Greek exit would signal that there is nothing irrevocable with participation in the euro, turning the European currency into a sort of magnified fixed exchange-rates system; equally importantly, it would force to set rules for converting euro-denominated claims into the new currency, thereby indicating to every business or household what assets and liabilities would become in the case of a euro break-up. No doubt this would trigger massive precautionary moves and undermine the rest of the eurozone.

What this suggests is that a Greek threat to default within the euro is not be credible if the ECB is ready to stop extending liquidity. The next government could wish to renegotiate some aspects of the programme but it will still need it, until it completes the largest part of its adjustment.

The EU official line – no renegotiation of the programme, no exit at any price – is however not credible either. For if the price it puts on exit is infinite, the EU cannot deter Greece from making use of its leverage. To strengthen its hand, it has to be ready to contemplate a forced exit. But it can only do that if equipping itself to limit potential damages. This means beefing-up firewalls and speeding-up preparations for banking union and the issuance of common bonds. Here, it is Berlin that lacks consistency. Signals that it is not ready to pay any price to keep Greece within the euro are only credible if accompanied by willingness to consider bold moves to preserve the common currency.

A lesson from the Cold War is that ultimately, rational behaviour proved to be the best insurance against disaster. Today also, both partners have a common interest in behaving in cool blood. They have to set red lines credibly and unambiguously, as well as to indicate where there is room for discussion. This can only happen after June 17, when a new coalition emerges from the election and forms a government in Athens. In the meantime, we are bound to live dangerously.

If the eurozone is to save itself, it will have to face the real crisis: its banking sector. Far too much time has been spent on fiscal policy when the existential threat to the eurozone is the ongoing collapse of bank lending in the weak economies, as Gavyn Davies recognises. Yes, fiscal policy counts, but the debate commonly framed between “austerity” (more deficit reduction) and “growth” (more deficit spending) is a serious distraction to the survival of the currency union.

The 2008 financial crisis in Europe and the US arose from excessive bank lending during the 2000s caused by deregulation and excess liquidity from the Federal Reserve and the European Central Bank. The excess liquidity found its way to a variety of sub-prime borrowers. There was a housing bubble in the US, UK, Ireland and Spain; a corporate-acquisitions bubble in Iceland; and a public sector spending binge in Greece.

When the easy credit stopped in 2008, the banking sector was over-leveraged and under-capitalised. Bank assets – including mortgage-backed securities, corporate acquisitions, and government bonds – were heavily impaired, so that bank capital plummeted. A financial panic ensued after the Lehman collapse, with banks ceasing to lend to one another or to blue-chip companies. Liquidity dried up. The US and Europe plunged into a very steep downturn.

This was not a typical Keynesian downturn resulting from a fall of aggregate demand, though aggregate demand certainly declined as net worth in housing and equities also fell sharply. The dramatic decline in output in late 2008 and early 2009 resulted mainly from the lack of working capital at enterprises rather than inadequate aggregate demand. Non-financial companies slashed their workforces and sold off inventories in order to replenish liquidity that the banks were no longer providing.

The Fed correctly flooded the economy with liquidity after the Lehman collapse, thereby ending the banking panic by the spring of 2009. The US banks gradually recapitalized through the infusion of public funds (the Troubled Asset Relief Program), the profits on near-zero-interest loans from the Fed, the recovery of asset prices, and the infusion of new equity. The US fiscal stimulus may have played a small role in the start of the US recovery in 2009 but the Fed’s effort to reverse the financial panic was the dominant factor.

The eurozone, by contrast, failed to redress its equally severe banking crisis, especially in the weakest eurozone economies. The Greek banks, with their large holdings of Greek government bonds, suffered a catastrophic loss of capital. When rumors began in December 2009 that Greece might default on its sovereign debt and leave the eurozone, Greece’s banks could no longer float securities or attract deposits or inter-bank lines of credit.

From early 2010 onward, the Greek banks looked to the ECB as their lender of last resort, yet the ECB was constantly ambivalent about its responsibility in this arena. Rumours swirled that Greek would be pushed from the eurozone and that the ECB would reject collateral offered by the Greek banks. Depositors began to flee the Greek banking sector, with bank deposits in Greek monetary institutions peaking in the spring of 2010 and declining thereafter. As deposits fell, and without access to the international capital markets, Greek banks slashed their loan portfolios, leading to a devastating economic contraction that continues to deepen.

The Greek economy is collapsing not mainly from fiscal austerity or the lack of external competitiveness but from the chronic lack of working capital. Greece’s small and medium-sized enterprises can no longer obtain funding. Since 2010, Greece has been trying to stabilize a sophisticated modern economy while its banking sector is shrinking dramatically. It just doesn’t work. The shutdown of Greece’s banking sector brings to mind the dramatic shrinkage of bank lending during 1929-33 in the Great Depression.

Europe’s banking squeeze extends beyond Greece. Overnight deposits have declined since mid-2010 in the banking sectors of several other eurozone countries, including Ireland, Portugal, and Spain. In response, bank lending in those economies has also been cut, causing the current double-dip recession. And the reduction of bank loans could easily intensify if eurozone banks now try to raise their capital-asset ratios by cutting lending rather than by raising fresh capital.

There is still no evidence that European authorities, and notably German politicians, recognize the priority of rescuing the eurozone banks, and especially the banks in Greece and other weak economies. The European Banking Authority is tightening capital adequacy standards without paying enough attention to the ensuing steep credit squeeze. The focus on budget cutting in these circumstances is not only misguided but tragically inapt. Governments cannot close their budget deficits if payroll taxation is plummeting because payrolls themselves are being deeply squeezed.

The bank panic is Greece is now accelerating, and could easily push Greece out of the Eurozone unless decisive actions are taken to prevent a massive run on the Greek banks. If such a run occurs, and drives Greece to leave the euro, Greece’s exit would most likely create an even greater calamity, as Portugal, Spain and perhaps Italy, suffer rapid withdrawals of bank deposits as well. The Eurozone’s unwillingness to keep Greece in the union would create a powerful one-way bet against the survival of the currency union in several other countries as well.

The eurozone has one last chance. Here are the key steps. Re-establish working capital in the weak economies; re-capitalize the banks, using ample public funds as needed; insist that the ECB be a more vigorous lender of last resort for the banking sector. In short, Europe must fight the ongoing banking collapse with the resolve needed to save Europe from a self-inflicted collapse. Credible fiscal policies and increased investments in human capital and infrastructure are surely part of long-term recovery, but the fiscal crisis can be addressed only after Europe’s tottering banking sector has been rescued.

Concern over the US’s long term fiscal situation is pervasive among policymakers and businessmen. Increasingly, commentators worry that without a sweeping “grand bargain” on deficit reduction market players will pounce, driving US borrowing costs to unsustainable levels and demonstrating diminished US leadership in the post-financial crisis world. But the doom and gloom merchants are wrong, or at least misplaced.

Since 2008, the US has by choice and necessity reduced its international role, with the killing of Osama bin Laden a year ago punctuating the end of the 9/11 era. For the first time since the second world war we live in a world without active US leadership, and no one else is willing or able to fill the void. Slow growth and aging populations drag on Europe and Japan. Despite the rise of the rest, emerging states such as China and India resist assuming global roles, and face significant challenges of their own besides. The international order has changed profoundly, and the frequency and effectiveness of multilateral collaboration is declining. I call this world without leadership the G-zero.

But the US is not a loser in this world—far from it. The US remains by far the most capable global actor, and the single most powerful and influential country on the planet. And as both cause and consequence of US resilience, the US remains the unchallenged and unchallengeable financial safe haven.

As a result, the US will almost certainly not face market pressure this year, or for several years to come. But there’s a catch: the very absence of market pressure makes it much harder for US policymakers to reach difficult compromises. This safe-haven curse imperils US efforts to foster robust economic growth and fiscal sustainability.

The safe-haven curse came to the fore last year. In 2011 the political and business communities became convinced that the US needed to get its fiscal house in order or face a financing crisis. Lawmakers in both main US political parties argued that only bold deficit reduction was essential. Republicans pressured the White House to tie a debt-ceiling hike to a deficit deal, and President Obama supported linking the issues. Fear of crisis intensified in the summer, compelling the president and House speaker John Boehner to entertain a controversial deal that would have angered both parties. Ultimately, the talks unraveled and both sides girded for the dire consequences.

But a funny thing happened: there weren’t any. Investors continued outbidding each other to loan money to the US government at historically low yields. Standard & Poor’s downgraded the US—and market players shrugged. When investors looked around the world, they saw Europe mired in a worsening debt crisis, a Middle East unsettled by the Arab Spring, Japan dealing with the aftermath of Fukushima, and China facing an economic slowdown. A little disagreement in Washington seemed positively quaint by comparison, and Treasury bonds as safe as ever.

Today, little has changed, and Washington’s fiscal free pass will not reverse any time soon. The dollar remains the world’s unchallenged reserve currency. US capital markets are still the world’s largest and most liquid. Truly riskless assets don’t exist, but Treasury bills are as close as anyone is going to get.

But cheap financing has a downside: Washington faces no pressure to make tough decisions. Without market urgency or fear of a crisis, lawmakers have little incentive to do anything beyond the absolutely necessary or politically popular. Large-scale deficit reduction and investment in growth—which the US does need, even if not nearly as soon as doomsayers warn—will not be required, and so not politically palatable.

Anyone who believes that US decline is inevitable ignores history. The US’s political and economic systems are resilient, effective, and enjoy wide support. But acknowledging US resilience should not distract from long-term challenges. The US must invest in education and infrastructure, reform entitlements and taxes, and maintain unmatched military and strategic power to protect its interests and those of its allies, especially in rising Asia. All of this will require painful political compromises from Democrats and Republicans. None of it will be cheap, and none of it will be easy. By fueling complacency, the safe-haven curse will make it all the harder.

The US can and should enjoy the benefits of its safe-haven status. In a world without leadership, the US remains capable, resilient, and attractive to others. But for its sake and for the world’s, the US must ensure that short-term victory doesn’t sow the seeds of long-term defeat.

This article was co-authored by David Gordon, head of research at Eurasia Group and former Director of Policy Planning at the US Department of State.

We may not yet have succumbed to a Great Depression but depression, in one form or another, is all around us. And we are witnessing the rise of political extremism, a nationalist backlash against a country’s obligations towards its – typically foreign – creditors. Ghosts from the 1930s have come back to haunt us.

Recovery has either been remarkably muted or, in many parts of Europe, totally non-existent. For some eurozone nations, economic freefall threatens. Politicians and economists squabble over what needs to be done next, as noted by Jeffrey Sachs on the FT A-List (“We must move beyond growth versus austerity”, May 7, 2012).

The emergence of Nikos Michaloliakos and his Golden Dawn party – its emblem a thinly disguised swastika – in Sunday’s Greek elections together with the bumper vote for Marine Le Pen in the first round of the French presidential elections two weeks earlier only serve to highlight the growing disillusionment of voters with mainstream political parties seemingly able to offer neither jam today nor jam tomorrow. For those on the outer fringes of the political spectrum, this is fertile ground – as it proved to be in the 1930s.

The problem can be simply stated. With levels of national income now a lot lower than expected just five years ago, the willingness and ability of debtors to repay their foreign creditors has been seriously reduced. The new slogan for debtors is in danger of becoming “can’t pay, won’t pay”.

To date, the response of creditors has been to demand continued austerity from the debtors: higher taxes, cutbacks in public spending and regular doses of the economic equivalent of cod liver oil, all to be washed down with cheap loans from the International Monetary Fund, the European Central Bank and other generous benefactors. In return, there is a vague promise of a return to growth at some unspecified point in the future.

The creditors insist the debtors have only themselves to blame for the lack of growth. In the years preceding the financial crisis, southern European countries allowed their wages to rise far too quickly, thereby undermining competitiveness.

For creditors, it’s an attractive explanation because it lets them off the hook. Yet it’s an explanation full of holes. If competitiveness in southern Europe was so bad, why did northern European creditors lend to southern European nations with such reckless abandon in the first place? If the problem is only one of competitiveness, why have “well-behaved” northern European nations also ended up back in recession? The Dutch economy is shrinking again as is the UK despite – in the latter’s case – the supposed benefits of regular bouts of quantitative easing and, in the initial stages of the financial crisis, a huge decline in sterling. And if the story is only about competitiveness, why has the allegedly competitive US economy struggled to regain its pre-crisis poise?

Creditors typically absolve themselves from blame until it’s too late. And they demand adjustment from debtors even when the debtors no longer have the political capacity to do so. Yet, as the interwar period demonstrates, problems for debtors inevitably become problems for creditors too.

In 1931, Austria was attempting to deliver the kind of austerity now being witnessed in parts of southern Europe. Under the Gold Standard, the only option to regain competitiveness was to force domestic prices and wages lower. In the process, businesses failed, non-performing loans rose and the banking system began to look incredibly vulnerable. The crisis culminated in the failure of Creditanstalt, a major Viennese bank – the 1931 equivalent of Lehman Brothers. What had up until then been only a Great Recession turned into the Great Depression. A handful of years later, Hitler was welcomed by cheering crowds in Vienna.

For debtor nations, keen to escape from the clutches of their creditors, resurgent nationalism led to waves of default and, in time, to the politics of hate. For creditor nations – the US and France were the key players at the time – it was a rude awakening. Their own economies suffered more than most, a reflection of their adherence to economic orthodoxy – notably their continuing devotion to the Gold Standard – in the wake of an extraordinary economic and financial upheaval.

François Hollande has been elected president of France on a pro-growth platform. This may be no more than wishful thinking unless there is voluntary adjustment from both creditor and debtor nations. To achieve this – and to allow the euro to survive – there needs to be more, not less, Europe. The single currency will need to be buttressed by some kind of federal fiscal policy, including the issuance of common bonds. Lower wages in the periphery will need to be offset by higher wages in the core, prompting German capital to head south and Spanish and Greek workers to head north. And creditors must stop thinking about a world of only saints and sinners. Creditors and debtors are two sides of the same coin. Berlin should take note.

None of this will be easy. Perhaps the success of the far Right will spur mainstream politicians into action. The irony, though, is obvious. A successful resolution of the eurozone crisis needs “more Europe” but growing numbers of voters are beginning to demand less of it. The ghosts have returned.

Amid the eurozone cacophony, the growth rhetoric sounds nicer than the austerity refrain.

But the challenge is to translate rhetoric into facts, especially in countries where market conditions provide no room for deficit spending. Structural reforms are a well-known recipe. While necessary, they take time to produce their effects on growth and employment. So they might not be sufficient to pull the eurozone economy out of stagnation over the next couple of years and to restore market confidence.

The debate needs to take place at a broader level. The foreign exchange market has not worked properly over the past few years and it is increasingly creating obstacles for the European recovery.

The eurozone economy is projected to be in recession this year and to barely stabilise in 2013. The US and Japan have now been growing again for some time, although modestly, and emerging markets are experiencing a soft landing from the crash. This should provide grounds for a depreciation of the euro against other major currencies. The private capital outflows from the eurozone periphery also seem to be pointing in the same direction. A gradual depreciation of the euro would be justified by the loss of competitiveness accumulated by several member countries and the need to reduce the pain associated with the current account adjustment.

Yet such a depreciation is not happening. The reason is that several foreign official institutions, notably the central banks of emerging markets such as China, are continuing to intervene in the foreign exchange market to buy euro-denominated assets at a pace which more than compensates the sales of private market participants.

These interventions are producing two types of distortions. First, they do not allow the external value of the Euro to adjust to underlying fundamentals and thus contribute to a further worsening of economic conditions in the euro area. Second, by investing mainly in low yielding euro assets, the interventions contribute to widen the spreads among eurozone Government bonds and thus fuel financial instability.

These issues can only be addressed directly with the major counterparties, notably China and other Emerging markets, and also other advanced European economies which are pegging to the euro. At times of crises like the one we are currently experiencing, there is a need for stronger cooperation among major economies to avoid beggar-thy-neighbour policies and competitive devaluations.

The eurozone needs to equip itself for such enhanced international cooperation. Unlike  the US and Japan, for example, the competence for the external value of the euro is shared between the European Central Bank and the eurogroup, which comprises eurozone finance ministers. The former is responsible for deciding and implementing foreign exchange interventions, the latter for defining the guidelines of the exchange rate policy of the euro.

Given that the main objective is to convince some of Europe’s partners to change their foreign exchange policies and promote a better functioning of the international financial system, a stronger political stance by European authorities is required. The eurogroup needs to take leadership in in the various international forums where such issues are discussed, bilaterally, trilaterally or in the G7, G20 or the International Monetary Fund. This requires a more efficient functioning of the Eurogroup, in line with the provisions of the Lisbon Treaty.

The problem is that the Eurogroup is currently without leadership, following the resignation of Luxemburg’s Prime and Finance Minister Jean Claude Juncker. Such a vacuum cannot last long. A new President needs be appointed rapidly, with a clear mandate. The selection process should take into account the candidates’ ability to stand up to the other major global powerhouses and defend the interests of the euro area, including by promoting a better functioning of the international financial system.

For the euro to seriously get back on a growth path, it needs to get its interest better represented in the global scene. This requires stronger political institutions, whether comprising finance ministers or Heads of Government, and beginning with the eurogroup. The good news is that it doesn’t require any institutional change. The bad news is that it requires political leadership.

The writer is a visiting scholar at Harvard’s Weatherhead Center for International Studies and a former member of the European Central Bank’s executive board

When finance ministers convene in Washington in a few days’ time to attend the G-20 and the IMF spring meetings, eyes will be on more than the cherry blossoms.

These meetings will in fact take place on the heels of recent developments in the European response to the crisis and amid renewed fears about the health of the peripheral economies. Eurozone countries have signed on to the fiscal compact, accepting further, more stringent obligations in the conduct of their fiscal policy, as well as the jurisdiction of the European Court of Justice for cases of non compliance. They have also agreed to establish a permanent rescue mechanism, the European Stability Mechanism. Like the temporary rescue fund (the European Financial Stability Fund), the ESM is expected to work closely with the IMF through joint lending programmes, to an extent never before seen at the institution, where such close collaboration has been unheard of.

Yet, there is an underlying tension in the relationship between the euro area and the IMF that these recent treaties just widen. Since the introduction of the single currency, the conduct of domestic monetary policy has been fully delegated to the ECB; however, the realm of international monetary relations remains a grey area, with responsibility opaquely attributed to the ECB and the eurozone group of finance ministers. As a result of this significant gap in the institutional design of the single currency, euro area member countries maintain their country-based — as opposed to a euro area-based — representation on the IMF’s executive board, the institution’s main policymaking organ, despite the increasing integration among eurozone countries in all other related policy domains.

This tension may escalate now due to some potentially adverse developments in IMF reform. The 2010 governance reform package, which aims to shift 6 per cent of the voting power to underrepresented economies, is most unlikely to be ratified this year. The US, the largest shareholder with power to veto, may do so no earlier than next year and only after the next Presidential campaign. This could mean a failure to ratify the agreement by the previously determined October deadline, which would put into serious question whether western Europe will indeed give up two seats by the forthcoming board election early this autumn, as had been decided in the context of the overall package to strengthen the voice of emerging members. Euro area countries would, in essence, be able to hide behind the US and postpone a much-needed consolidation of their representation, one that would be more in line with their own regional policies.

But all hope is not lost. Germany, France and Italy may yet provide a burst of leadership by unilaterally establishing their own joint representation by the autumn, through some transitional arrangements; this would signal an endurable commitment to the Euro. Mario Monti, Italian prime minister, has all the credentials to take this initiative forward with his peers in France and Germany. They would set up a “core” multi-country seat around which all euro area members would be included by the following board election in the autumn of 2014. By including countries, as opposed to European institutions, in the seat, the move would be in line with the fund’s legal framework and would reassure national political leaders in Europe.

At the same time, moreover, the move would signal a long-overdue shift towards a proactive strategy vis-à-vis IMF governance reforms whereby Europe could finally break with the current “wait-and-delay” tactic, precisely at a moment when it needs powerful allies within the fund membership in order to erect a credible global firewall. France, Germany and Italy would together help set the right tone for ongoing G-20 and IMF negotiations, where many non-European shareholders are expected to contribute to a sizable increase in the IMF’s financial capacity. This would, as well, jumpstart the forthcoming round of negotiations on the redistribution of the voting rights that will have to be finalised by January 2014, with Europe, this time, no longer in a defensive mode.

Jim O’Neill is chairman of Goldman Sachs Asset Management. This piece was co-authored with Domenico Lombardi, president of The Oxford Institute for Economic Policy and senior fellow at the Brookings Institution.

It is not whether you win but how you play the game. This old sports refrain can be felt after Monday’s announcement on the selection of Jim Yong Kim, the US nominee, as the next president of the World Bank. Yet it will only prove meaningful if Dr Kim now leads all sides to complete the reform of the Bank’s feudal appointment process – a long overdue step that has repeatedly eluded the international community both here and at the International Monetary Fund.

There is no doubt that this contest for the presidency of the World Bank was indeed different and ”better played.” For the first, three qualified and talented individuals were nominated and interviewed by the Bank’s Executive Board. Their expertise and experience were widely discussed in the media. All three took pen to paper to describe their qualifications and their vision for the institution. And two of them – Jose Antonio Ocampo and Ngozi Okonjo-Iweala – even participated in an open question and answer forum.

Stunningly, it took almost 70 years for these basic steps to occur. While they speak to better governance, they only materialized because of the courage and perseverance of a few brave individuals, most importantly Mr Ocampo and Ms Okonjo-Iweala.

Yet all is not good. Once again, overt political considerations trumped the more legitimate dominance of experience and expertise. And, once again, the deliberations of the Executive Board proved excessively mysterious and overly secretive.

Now that the selection is behind them, the major parties are expressing satisfaction, albeit less than complete. American officials are comforted that they retained their nationality-based entitlement to the presidency of the World Bank, just like their European peers did at the IMF last year. Yet even they are aware of the cost to their credibility and that of the Bank. The emerging countries that backed the two non-American candidates have welcomed the more competitive process, though their enthusiasm is restrained by the blatant persistence of nationality as the overriding selection criterion. And World Bank insiders, led by the Executive Directors are rallying behind the new President, noting that the institution is much more important than any particular individual.

It is important to remember that some similar feelings were in play on previous occasions, most recently after last year’s nationality-based appointment of Ms. Lagarde as head of the IMF. Moreover, in one of the previous rounds at the Fund, a senior European official had even acknowledged that the time had come to end the nationality-based entitlements to the leadership of these multilateral institutions.

Yet, every time push came to shove, attempts to crystalize this into proper reform repeatedly failed. And this will happen again if Dr Kim does not immediately spearhead certain changes when he assumes his new responsibilities on July 2.

During his first 100 days in the office, the new president has a golden opportunity to earn the respect of the world by ensuring that the next selection of the World Bank is indeed open, transparent and merit-based. To this end, he should take proposals to the Board that would hard wire much of the ad hoc approach that characterised the partial competitive elements of his selection, and reinforce them by a comprehensive due diligence process.

The IMF would find it very hard not to follow Dr Kim’s lead. Thus both organizations would be able to announce the much-delayed reforms in October at their annual meetings in Japan.

Don’t under-estimate the importance of such a step. With so many people watching around the world, renewed  failure to move forward with reforms at this critical juncture would accelerate the gradual disengagement from the two institutions by a growing number of countries. It would also undermine their standing in the court of public opinion at a time when both need to be viewed as “trusted advisors” and respected promoters of the global public good.

The reform of the appointment process at the IMF and World Bank is not an option. It is an obligation for all those that believe that the credibility and well-functioning of these institutions are central to the wellbeing of the global economy.

In domestic election campaigns European politicians display a kind of cognitive dissonance. They  must be aware that any propositions on European policy will be subject to close reading in the embassies and chancelleries of their partners, yet they tend to talk as if they will only be heard by a domestic audience. The French Presidential campaign, which officially began on Monday, is a case in point. All the major candidates have made commitments on their European policies – to renegotiate this, or abandon that – which may appeal to elements of their target market, but which will not go down well with the Chablis at the first EU summit after their election.

Should one simply classify these declarations as flights of fancy, articulated in the heat of battle, and pay little heed? Perhaps, but one cannot exclude the possibility that at election time politicians, freed from the constraints of office, may be saying what they really think or, indeed, what they think the people really think. And it just may be that they will feel the need at least to attempt to deliver on their promises.

The election takes place at a difficult moment for the European project. Previous certainties about the relentless march of the euro, and progress towards the “ever-closer union” of the Treaty have been thrown into doubt. This ought to benefit Marine Le Pen and the National Front, who want a return to the franc. Whether it would be a ‘franc fort’ or a ‘franc faible’ is not spelled out. But though the travails of the eurozone have given her a good song to sing, there are not yet enough voters prepared to sing along with the chorus.

Most of the other candidates are, ostensibly, “Good Europeans”, though this designation is capable of many interpretations in France. The centrist Francois Bayrou is the most federalist: he argues for a directly elected European President. Bayrou attracts support from many bien pensant French, particularly in the regions, but Europe is not the centrepiece of his campaign which, in any event, is treading water.

More significant, perhaps, is the rhetoric adopted by Jean-Luc Melenchon of the Left Front. He has been the big winner of the campaign so far, threatening to push Le Pen into fourth place in the frst round. If he does, there will be a price to pay by Hollande, who remans the favourite to triumph in the second, for his endorsement. Melenchon is not a deep thinker on European policy, but he has firm views on the European Central Bank, which he would like to see under political control. He sees the ECB’s single-minded pursuit of price stability as one of Europe’s major problems. Hollande is unlikely to be pushed so far, but he himself favours giving  the ECB  a dual mandate like the Federal Reserve, with priority given also to full employment – not self-evidently an absurd proposition. This would be part of the intergovernmental Treaty renegotiation, to which he is firmly committed.

He has attracted much criticism for his hostile stance on the Treaty, which many think he will quietly abandon if elected. I wonder whether they are right to dismiss the renegotiation idea as mere posturing. By the second round of the French election the Treaty will have been signed, but not ratified, and it is by no means clear that the Eurozone will survive intact with only fiscal austerity and a modest increase in support funds.

Hollande has openly questioned the continued viability of the Franco-German motor, now conveniently dubbed Merkozy. He wonders aloud whether it has recently been influenced by France at all. In saying so he reflects a view widely held in the French administration, and not just in the Socialist party. Many in Paris are deeply sceptical about the terms of the Treaty. They fear distancing themselves from the Germans, but they fear the consequences of following their hard economic line even more. The French have always wanted economic governance of the eurozone, and know that may mean going further in collectively guaranteeing member states’ borrowing, and accpeting a more interventionist role for the ECB.

Hollande was snubbed by Merkel when he visited Germany. At one point she planned to campaign for Sarkozy, though that idea was quietly shelved when polls revealed she would be a vote-loser for him. Cameron also gave Hollande the cold shoulder. They would have done better to devote time to undestanding his point of view.

Which leaves the President himself. An intriguing poll among foreign observers in Paris gives Hollande a slight edge, but the foreign press still think Sarkozy will win. So the evolution of his own European policy remains of more than academic interest.  Sarkozy has said France will cut its contribution to the EU Budget, which hints at another rerun of the British rebate debate. More importantly he has called for a Europe which “protects” its citizens. The subtext is clear: part of Europe’s response to the crisis must be to put up the barriers, to immigration and to foreign competition. The French now support measures to exclude foreign firms from public contracts if their home countries do not allow reciprocal access, and he has said that if the Schengen agreement is not revised within a year, France will leave unilaterally,

This latter commitment may not be as tough as it sounds. There is already a process of review under way, which in fact the French have been leading. But the broader aim of a protected European market, linked with a demand that France’s budget contribution should be cut back, is more menacing if the French pursue it with determination, and when they settle on a European policy, they are rarely backward in coming forward.

So whoever wins in May there is trouble ahead in Brussels, Berlin and indeed London. The Commission, with the possible exception of Michel Barnier, will not like the protectionist impulse. The Germans will strongly resist Treaty revision, or any attempt to meddle with the ECB’s mandate. And there is nothing whatsoever in the programmes of any of the serious candidates to please the British. Plus ca change, as we say in England.

A shorter version of this piece appeared in Tuesday’s FT.

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