European leaders went one better this time. Not content with failing to resolve the debt crisis tearing through the eurozone and threatening a global recession, they have now managed to create a new source of instability: the rift between Britain and the rest of the European Union, whose consequences may prove to be momentous indeed.
It was a long time coming. The tension between the eurozone “ins” and the ten non-Eurozone “outs” has been building throughout the debt crisis, which has forced the states belonging to the common currency to take extraordinary—and yet woefully insufficient—measures to keep the euro from spectacularly collapsing. In the Brussels summit that ended yesterday, France and Germany, drivers of the push toward an ever closer union, were unable to persuade British Prime Minister David Cameron to back their plan for greater fiscal integration.
The deal-breaker was a demand by Cameron for special treatment for Britain’s lucrative financial-services industry. Though apparently the French and the Germans were willing to go some way to accommodate the U.K., whose economy is significantly dependent on the City of London, it was not enough. Cameron refused to budge and, as it turned out, he opened the way for the rest of the EU members (with the possible exception of Sweden, Hungary, and the Czech Republic) to agree on an intergovernmental deal outside the framework of the EU which will more closely coordinate fiscal policy. This was something French president Nicolas Sarkozy had long sought, seeing intergovernmentalism as a way to maximize French influence on developments. Germany’s Angela Merkel had resisted this path, preferring to advance with the support of the entire EU membership. But the British Prime Minister, under pressure from unswerving Euroskeptic members of his own Conservative Party, made it impossible for her to escape it. “I don’t think David Cameron was ever with us at the table” is how the German chancellor put it.
Britain’s veto may well be the first step in the country’s exit from the European Union. By its decision to forge ahead without the perenially euro-dyspeptic British, the leaders of the eurozone, whatever one may think of their plans, signaled that they are no longer willing to be held hostage by the eccentricities of each individual member state. The crisis of the last two years has shown that the eurozone cannot survive unless it becomes a much closer union. The significance of the latest summit is that the two pivotal countries in the common currency, Germany and France (in that order), have shown that they are willing to pursue the goal of a deepening union even at the cost of breaking up of the EU.
Given all this, one might be excused for thinking that the British have performed yet another feat of self-harm in their long and tortuous relationship with “the Continent” (as they call Europe). It is a likely outcome that Britain will become increasingly isolated and probably lose business for the city, as the eurozone becomes more fully divorced from it and more financially integrated. But there is a big “if” to all this—it is the correct analysis if the eurozone itself doesn’t break apart. And on this crucial front, Thursday and Friday’s summit offered little cause for reassurance.
The central element of the new “fiscal compact” agreed by the 23 countries on Friday is a fiscal rule, to be adopted by each of the signatories into their legal systems “at constitutional or equivalent level,” that stipulates that national budgets should converge toward balance, i.e. structural deficits should not exceed 0.5 percent of gross domestic product (GDP). Though there is some flexibility to the rule, to allow for cyclical downturns and what the official statement calls “exceptional economic circumstances,” member states are called upon to put automatic mechanisms in place to safeguard against deviations. In particular, if a eurozone country’s deficit exceeds 3 percent of GDP, there will be automatic European sanctions against it (which are, ominously, not spelled out) and the country will have to submit to an austerity program concocted by the European Commission and the European Council in order to return to fiscal virtue.
One problem with this approach is a legal one. Given that the U.K. has blocked a treaty change, which requires unanimity, and that the new rule is the product of an intergovernmental agreement, it is highly questionable whether the council and the commission, which are EU bodies, can carry out their new tasks as the bulldogs of balanced budgets.
The more serious drawback of this approach is that it exhibits all the hallmarks of the flawed German view of the euro crisis. To the austerity-prone Germans, every problem that Europe faces stems from an addiction to spending. But a union between fiscally sound, competitive Northerners and profligate, uncompetitive Southerners cannot work unless both sides are willing to move from their fixed ways. The Franco-German proposals that won the day in Brussels recognize the need for greater fiscal discipline in the South but not the concomitant need for solidarity. The most immediate form such solidarity must take is a commitment to euro bonds. This was once again left out of the official statements.
Still, Mario Draghi, head of the ECB, was pleased with the outcome of the summit, which, let's hope, means the bank will be more active in coming weeks if Italian and Spanish bond rates again threaten to reach unsustainable levels. And the decisions to bring forward the ESM (the permanent and financially more robust rescue mechanism, that will now succeed the EFSF as of next July instead of mid-2013), to drop a requirement that private bondholders take losses in future rescues and to increase IMF funding from European countries by 200 billion euros, are all welcome palliatives.
But make no mistake: This was not the “quantum leap” (the phrase belongs to former ECB chief Jean-Claude Trichet) needed for the eurozone to finally convince the markets of its long-term viability. The doubts persist—until the next “make or break” summit.