President Macron, Germany, and the Future of the Euro: Is It Time to Get Real?

In Brussels it is as if 2018 is the new 1989. Everybody seems to be promoting some vision for the future of the eurozone and indeed for the future of the EU.

Around the imposing EU buildings in the well-heeled Schuman district, it may appear that Brexit and President Trump have combined to unite member states in a way that seemed unimaginable at any time during the past decade. However, appearances can be deceptive and the shared consensus that reform is required is exactly where the agreement ends.

A decade of economic and social crises in Europe has resulted in a fractured union. A union not only characterized by a traditional north/south economic divide but also by additional cleavages concerning immigration and the rule of law. Nowhere is the interlinked nature of these cleavages more evident than in the current debates on the future development of both the eurozone and the EU budget.

President Emmanuel Macron’s soaring vision, as outlined in his Sorbonne speech of September 2017, called for the development of Europe as a global economic power built around a more integrated eurozone. Proposing a eurozone finance minister and a eurozone budget to drive investment, President Macron seeks to resurrect classical French thinking on the future of the EU, namely “converge more, spend more.” Although, in this digital age his plan envisages allocating some future new EU taxes (like a harmonized corporate tax rate or common digital turnover tax) to finance this vision. However, the extent of other states’ reservations to both proposed taxes hints at the difficulties of realizing any aspect of these particular goals. Ironically, President Macron, who portrays himself as the great European modernizer, proposes an economic vision of a reformed France often associated with President Nicolas Sarkozy’s policy “Travailler plus pour gagner plus.”

A decade of economic and social crises in Europe has resulted in a fractured union. A union not only characterized by a traditional north/south economic divide but also by additional cleavages.

German Recalcitrance as a Fundamental Question

Yet, for all his endeavor, President Macron’s proposals face two inconvenient realities. First, his proposals—even if fully implemented—would do little to address the underlying causes of Europe’s past decade of financial crises. Namely, severing the close linkages between member states and financial institutions thus ensuring that no bank could drag down a whole country into a financial abyss that happened most clearly with Ireland in 2010. Neither would they help complete Europe’s still incomplete Banking Union nor protect citizens from losing their money in collapsing banks. Within the EU, the blowback on this issue has been sympathetic but firm. The finance ministers from seven EU member states (Denmark, Estonia, Finland, Ireland, Latvia, Lithuania, the Netherlands, and Sweden) publicly called for the EU to focus on key imperatives such as completing the Banking Union and a refocusing on the primary importance of structural reform programs at a national level.

Second, although expected for several months, the absence of a detailed response from Germany to Macron’s vision indicates a distinct chill east of the Rhine for a deeper, more expensive vision of eurozone integration. Although a joint Franco-German proposal is due on the development of the eurozone, expectations are low. This, in reality, reflects the limited ambitions it is likely to contain notwithstanding Chancellor Angela Merkel’s recent comments on developing a European Monetary Fund and establishing a small (very small!) investment fund for the eurozone.

Although reported by the media as a case of Germany refusing to countenance any moves towards fiscal transfers (particularly towards other states perceived as less economically reliable), the issue of German recalcitrance symbolizes the fundamental question now facing the eurozone. Namely, is the euro best protected by the type of deeper political integration proposed by President Macron, or should the focus be on more pragmatic economic measures designed to safeguard the stability of Europe’s financial sector (and by extension European citizens and businesses).

The Return of Fiscal Policy to National Governments

Interestingly, prominent economists from the United States (a large, functioning monetary union with many historic similarities to the development of the eurozone) have argued that there is a specific path forward which can act as a bridge between the French and German positions. The completion of Banking Union—including a European Deposit Insurance Scheme (EDIS) and measures to limit the holdings of government bonds by banks—could be the first steps in developing a truly sustainable eurozone. A eurozone where the “doomed loop” between banks and governments is truly severed. Likewise, the development of a European Monetary Fund would help the eurozone in its path to credibly assume the responsibilities of any potential future crisis.

Italy is a potent reminder of just how fragile the prospects of the eurozone remain. Although often ignored, Italy boasts a strong manufacturing sector, high exports, and low levels of private debt.

However, this view also holds that the EU approach to placing fiscal oversight from Brussels at the core of EMU is fundamentally awed and ultimately unsustainable. Although anathema to true believers in fiscal union, the inconsistencies of having fiscal policy as a national prerogative, but EU level fiscal rules and enforcement is evidenced in the less than optimal operation of the eurozone over the past 15 years. Rather, what is required is the return of fiscal policy to national governments and the introduction of a credible “no bailout” rule (as is the case in the United States—a functioning, and successful, monetary union).

The Banking Union Remains Unfinished in 2018

Unfortunately—no matter what vision of eurozone development you espouse—agreement at EU level will likely be incremental, tortuously achieved, and often incomplete. Banking Union (the EU’s flagship response to the financial crisis) remains unfinished in 2018. While Banking Resolution and Banking Supervision mechanisms have been established, a fully functioning and comprehensive Banking Union remains unfulfilled. Proposals for EDIS remains a point for political discussion only, the necessity of such a policy stuck on the resistance of several northern EU member states. Solidarity, of course, is fine as a political speaking point, but rather less so if it potentially involves significant sums of actual money. Fiscal rules (the eurozone now boasts a “six pack,” a “two pack,” and a “Fiscal Compact”) remain at the center of a Brussels-based enforcement model. A model which in the mind of many “promises, inevitably, not discipline but a dangerous populist backlash.”

Italy is a potent reminder of just how fragile the prospects of the eurozone remain. Although often ignored, Italy boasts a strong manufacturing sector, high exports, and low levels of private debt. However, decades of low growth and high unemployment have resulted in stagnant incomes, rising public dissatisfaction, and the feeling that middle class security is becoming almost impossible to achieve. The second highest public debt in Europe, second only to Greece, limits the potential of any Italian government to raise public spending in an effort to stimulate growth. Domestic reforms of the Italian economy have, even in the most sympathetic reading of the situation, been piecemeal and wholly insufficient.

The Views of Eurozone Reform Are Still Based on National Interests

The reaction of Brussels, and indeed the financial markets, to the formation of the new Italian government highlights a clear understanding of how any economic instability in Rome could reverberate throughout the remainder of the eurozone. Put simply, the “doomed loop” between banks and governments remains, Banking Union remains unfinished, and any banking failure in Italy could in turn collapse the entire eurozone financial system. These possibilities should provide a renewed impetus to the EU to further develop eurozone governance as quickly as possible.

Unfortunately, as the response to President Macron’s proposals shows, member states’ views of eurozone reform are still largely based on national interests. In addition, the formation of an agreed Franco-German position on the euro will likely be a compromise on both sides, as evidenced by Chancellor Merkel’s recent comments. Such proposals will also require support from other member states, many of whom have divergent objectives when it comes to economic governance. One can only hope that this need for consensus does not impede, rather than facilitate, a more sustainable eurozone in the future.

Solidarity, of course, is fine as a political speaking point, but rather less so if it potentially involves significant sums of actual money.

The decision-making process in Brussels is further complicated by ongoing negotiations on the next EU budget. Known as the Multi-Annual Financial Framework (MFF) it will cover the period from 2021-2027. However, as with all financial issues in Brussels, achieving an agreed framework is likely to take another 12 to 18 months to achieve. Although, in light of Britain’s exit from the EU, there is some hope that agreement—even broad in nature—might be achieved by the European elections in May 2019. The European Commission’s key proposals—a bigger budget (meaning larger contributions from net contributors), and a shift from the traditional areas of agriculture and cohesion policy towards external border control, innovation, and the digital economy—represent an attempt to gently nudge the EU budget into the 21st century. It also attempts to draw unity from member states on the issue of strengthening common external borders in light of the divisions resulting from the ongoing migrant crisis.

Inclusivity and Equality between EU Member States

Indeed, the legacy of the financial and migrant crises, added to the current debate on the future MMF, have brought to the fore the issues of inclusivity and equality between the EU member states. It is this fear that some members of the EU will either (a) proceed with further integration in isolation from other members or (b) that older member states will be treated more favorably than newer members that has the potential to seriously impede further reform of the EU’s economic and financial governance. With the exit of Britain from the EU, many non-eurozone members feel that further integration could become solely dependent on the Franco-German axis. An axis that may or may not take full account of the preferences of smaller, more peripheral EU member states.

This issue of equality between member states has been further amplified by the contentious proposal of the European Commission to link the provision of EU funding to the maintenance of the “rule of law.” These rule of law conditions include, but are not limited to, maintaining an independent judicial system and the implementation of effective national mechanisms to combat corruption and fraud. Although most obviously aimed at the current governments in Poland, Hungary, and Romania, such proposals have elicited a high degree of opposition throughout Eastern Europe. Regardless of whether such proposals are warranted, the perception among some EU members is of EU overreach and of a differing approach towards newer EU members being applied from Brussels.

Divisions Go Far beyond the Traditional Franco-German Economic Divide

Overall, President Macron has provided fresh impetus into the issue of eurozone reform, although the recent example of Italy shows that reforming monetary union is an urgent economic necessity rather than an object of grand political vision. In reality, there is a high degree of consensus regarding the overarching policies required to strengthen the euro against future crises. However, while completing the Banking Union has been a standard feature of every conclusion from EU summits over the recent past, the technical and political agreement required to complete this mechanism remains unfulfilled.

In this context, divisions between member states go far beyond the traditional Franco-German or north-south economic divide, but also encompasses a hardening east-west divide. This is a worrying development that has been greatly amplified by the migrant crisis, the ongoing MFF process, and the proposals by the European Commission to link EU funding to the rule of law. These are issues where inclusivity and the equal treatment of EU members are the bones of contention.

What are the likely next steps? Given previous history, it is unlikely the upcoming European summits will bring a “big bang” approach to strengthening the euro. It is likely that advances are limited to specific issues (such as creating the European Monetary Fund) and that this incremental approach continues in the coming years. Such an approach is, of course, dependent on a relatively benign political climate in countries like Italy and Greece in the medium term.

With the exit of Britain from the EU, many non-eurozone members feel that further integration could become solely dependent on the Franco-German axis.

What then of President Macron’s soaring vision? Expect limited concessions from other member states building on the seedlings already planted regarding a very limited investment fund for the eurozone and generalities regarding further deepening in the future. Given the current state of relationships between EU members, it is possible that the issues of inclusivity and equal treatment of member states, both east-west and euro-non euro, emerge as the real points of difficulty in the coming years.