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There is no Attractive Solution to the Eurozone Debt Crisis: The Time has come to find the Least Worst Option

It has become increasingly difficult to argue that the solution to the Eurozone debt crisis is to provide further bailouts to Greece. This is not because there appears an alternative solution, nor that the risks of contagion to other Eurozone economies in the event of a Greek default have been minimized, nor for any other reason that would indicate the situation in the Eurozone is less intractable than once feared. In fact, the situation in the Eurozone looks ever more intractable amidst political resistance in Athens, government scandals in Italy and opposition to bailouts in Slovakia, to name a few examples. The reason behind the increasing difficulty of arguing for more bailouts as the lesser of a multitude of evils is that there has to be an endpoint to this crisis and the path of ever more bailouts for a country with years of inefficiency to address does not have a clear end.

One of the more useful responses I have seen to this realisation is an attempt by German economists Harald Hau and Bernd Lucke to calculate the cost to Eurozone governments of sovereign defaults by Greece, Portugal, Ireland, Spain and Italy, and compare that to the estimated cost of bailing-out the former until such time as their economic health is restored. It is, of course, difficult to calculate the cost of the latter scenario, but continuing to lend to someone when it is too difficult to envisage at which point they might pay you back is a risky policy regardless the roughness of estimates involved. Calculating the costs of a scenario under which multiple sovereign states, whose bonds are held by financial institutions integral to further sovereign states, default on 25 to 75% of their debt involves rough estimates as well, not to mention the risk involved with that policy option. Thus, the usefulness of the exercise carried out by Hau and Lucke is not in pointing to a clear, painless response to the Eurozone debt crisis, but in carrying out a realistic assessment of the options available.

Unfortunately, European leaders have so far eschewed such action, preferring to make bold statements about their commitment to the euro and the European Union, though without letting on what that means in policy terms. Further to this, to the extent that European leaders could translate a commitment to saving the euro into practical policy, it is unclear whether that could be reconciled with the demands of their domestic taxpayers. Given the lack of progress thus far in reducing the Greek deficit and the apparent desire of the Italian government to avoid difficult economic decisions if there is even the hint of an alternative, any commitment to saving the euro is likely to mean sizable long term fiscal transfers from the core to periphery of the Eurozone. As stated in Spiegel International of 7th October, the north of Italy has been paying the south’s bills for more than 90 years – are the Germans prepared to make such a commitment to peripheral states of the Eurozone?

The answer to that question is ‘probably not’, but of course we don’t know for sure because national politicians have been cagey with their domestic publics about exactly what they are agreeing to at EU level, no less the range of available action. If the French and German people, for example, were given the choice between the national government bailing out banks that hold peripheral sovereign debt and deeper integration of the Eurozone in the form of a European finance minister, Eurobonds and/or a full scale transfer union, then the way forward might become clear. What is not clear is whether those domestic publics would opt for the choice that is less likely to plunge the Eurozone into ever deeper crisis, but then it is not clear whether European leaders will select that option either.

The point of this is not that we are doomed either way so we may as well roll the dice, but that the time for bold pledges has passed and the time for action has well and truly arrived. Attention must be paid to working up credible estimates of the economic costs of various scenarios, along the lines of the aforementioned analysis, and to understanding the political boundaries set by domestic publics. It is no good for Germany to sign up to plans that will be deemed unconstitutional later on, nor for governments in power today to make agreements that their successors will break when they are voted into office as a protest by the people against those very agreements.

There is an economic component to this crisis and there is a political component to this crisis. Excessive concern with one or the other is unlikely to produce a balanced solution, as is ignorance of either one. As I have argued multiple times, the worst thing leaders can do is pretend to their publics that there is a simple choice between bailing out troubled states or not. The choice is between bailing out troubled states and bailing out banks along with the troubled states that are home to those worst hit banks. Once you put it that way, the decision is down to economic calculation and the politics is about soothing tempers of those citizens who were led into the euro under the pretense that fiscal policies could remain separate within the currency union.

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