Anatole Kaletsky: Federal Europe

03 November 2010

Back in December 2009 I wrote an article about the Greek Crisis in which I said:

The Dollar has strengthened recently, but I see in this crisis a silver lining that could in the long term vastly enhance the reputation of the Eurozone... Eurozone membership is forcing the Greeks to adopt better economic policy making at knife point. Either democracy will take a more responsible course, or, more likely, certain constraints will have to be put upon democracy... If the EU gets this right it still has a chance to survive the 21st Century...

Over the weekend EU leaders agreed important treaty changes which inspired Anatole Kaletsky, the UK's most impressive economic journalist, to write an article entitled Softly, softly a federal Europe draws nearer. Here I republish a shortened version of his article. I think Kaletsky is still the only UK Journalist who really gets it - notice the comments about "elitist representative democracy" vs "populist democracy". Samuel Brittan has gotten none of this, and is still writing little Englander articles about the futility of authoritarian Germans trying to save the Euro.

While British and US politics have dominated the headlines this year, the truly historic events have occurred in Europe. Britain may have its first coalition government for 70 years and US voters may have shackled their politicians with legislative gridlock, but Europe has done something much more momentous. The EU has taken its most decisive step towards becoming a genuine unitary State, by shifting key policies on taxes and public spending from national to federal level.

That one of the most controversial decisions in modern European history has been taken with almost no public awareness or debate is a tribute to the top-down style of government perfected by the EU’s political elites. This EU version of elitist representative democracy may go down in history as a more successful mechanism for managing the complex compromises demanded in a world of huge geopolitical change than the more populist US and British models.

The €720bn emergency stabilisation package stitched together in May was never more than a temporary solution. It was never going to survive without some kind of commitment to permanent collective guarantees for the debts of eurozone governments. Such guarantees could never work without mechanisms for fiscal transfers across the eurozone. And such transfers would never be agreed by Germany and other creditor nations without much greater central control over national budgets than anyone had previously suggested.

At the EU summit in Brussels last weekend, these mechanisms for control were in principle agreed. Most of the headlines were about peripheral bureaucratic issues such as David Cameron’s defence of Britain’s budget rebate and Ms Merkel’s insistence on revising EU treaties. The real story, however, was that Germany had again backed down. The summit agreed that no country could be forced to leave the euro for failing to pay its debts, but that government defaults within the eurozone remained unacceptable.

The implication, which Germany appears to have accepted, although nobody including the leaders themselves can be precise about what was agreed, was that the EU would create permanent mechanisms for mutual financial support among all eurozone countries, enshrined in future EU treaties. Ms Merkel’s insistence on treaty changes, far from protecting German taxpayers from the financial consequences, reinforces the commitment to future bailouts. By explicitly revising the no-bailout clause, Ms Merkel’s treaty revisions will ensure that EU fiscal federalism will have irreversible legal force.

Why would German politicians agree to rescue failing states with potentially costly bailouts? There are two reasons. First, German industry and finance are critically dependent on the stability and prosperity of the eurozone. Second, political unification has long been regarded as manifest destiny by Germany’s political and business elite.

The Germans, however, are not stupid. They will not agree to become permanent guarantors for the more improvident EU countries without much closer supervision over their tax, spending and borrowing. The condition for fiscal federalism will be a degree of political centralisation that may be hard to imagine at present but is starting to look inevitable.

It is hardly conceivable, for example, that different countries can have widely differing retirement ages, welfare benefits and even healthcare arrangements if the costs of these policies are jointly guaranteed. Indeed, the gradual convergence towards retirement at 67 across Europe is one of the most encouraging consequences of the financial crisis from a strictly economic point of view. Similarly, tax policies will have to be co-ordinated once mutual responsibility for public debts and deficits becomes an acknowledged fact.

European integration has always advanced through crises — and a great leap forward towards fiscal and political federalism has become irreversible after this year’s eurozone crisis. That was, indeed, precisely what the euro’s creators intended.