Wednesday, 20 October 2010

3 Comments on the SGP3

I would like to contribute three comments regarding the recent Franco-German agreement arrived at recently. This post is a poor contribution to more enlightened commentators’ criticisms of the proposed SGP3.

The first, is a criticism to the article from Charlemagne, which completely fails to mention what I think is probably the most important part of the agreement. The last four paragraphs describe the issues both countries want to see changed that require treaty changes. It fascinates me how the Economist would fail to mention that apparently France has come on board with Germany in terms of cancelling council voting rights. This isn't the most intelligent proposal that's ever come out of a Franco-German agreement, and is offensive to the intellect of anyone reading it and makes a mockery of European solidarity and democracy. It's an insult to the intellect, because anyone who expects every single country in the Euro-zone (much less in the EU) to approve a treaty change denying any given Member state of the EU the right to representation is either disconnected from reality or seriously thinks the rulers of small countries are stupid and their citizens inert.

If we have learned anything since the creation of the Eurozone and the misfit application of the SGP, is that indeed we are not at all equal. Several countries have failed their SGP obligations. Portugal in 2002, Germany and France in 2003, Italy and the Netherlands in 2004 and finally Greece in 2005 all failed to live up to the SGP. The only country that ever came close to being punished was Greece. When the problem hurt France and Germany they decided to change the rules. That's why we are now talking of the SGP3 rather than SGP2. As Caballero, Cababllero and Losada 2006 and Chang 2005 describe, Germany and France are clearly more equal than the rest of the Member states. Call them primus inter pares. As Thornhallson 2006 explains this is understandable. However, it is morally highly objectionable. It should be clear to anyone dedicating even a minute of their time to the ongoing debate about the reform of the SGP, that although France is endorsing a German proposal to withdraw votes from countries not fulfilling their obligations under the SGP, neither France nor Germany will ever let other countries do that to themselves. This is a policy for others and shamefully so.

My second comment is meant to balance out the rant above. In all fairness if I attack I must also congratulate. Si j'accuse, je me doit de féliciter aussi. I think that the creation of a debt retructuring mechanism is the last necessary step in reforming the SGP, after the creation of the EFSF, the EU Financial Supervision Package (here and here) and improvement of budget monitoring powers of the Eurostat. This is important because the mere existence of this course of action should serve as a deterrent against Moral Hazard. The presence of the EFSF means that there is one last alternative to defaulting, but even if this tool is not enough, then it is still possible to settle matters in that fatal manner. It's the sort of tool no one wants to have to use, but that you want to have access to if all other options have been exhausted. So this is a good thing. Secondly I am also quite happy to see that there are plans to create the EFSF as a permanent institution of the EU. I would like to see it under the umbrella of the European Commission, but I guess it'll take some time for this to come to bear.

Another positive development is the apparent dropping of the debt criterion, which was very criticised, and which I won’t particularly miss.

My final comment is that the creation of a permanent EFSF may simply render the SGP redundant, as well as this whole discussion. Elaborating on what I briefly mentioned here, if it is possible for the EFSF to publish a periodic review of the credit worthiness of its guarantors (ie: Eurozone countries) where it calculates the interest rates which it is willing to charge them, this should also serve as a moral hazard averting process, also serving as market signal about the credit worthyness of that sovereign.

Moreover if instead of having virtual "Guarantees" (which are effectively promises of funding in case the member states that the money is effectively channeled to fail to make their interest payments to the EFSF) indefinitely the parties to the EFSF used them only as an initial mechanism, and supplemented it by charging insurance premia to the member states, it could endow the fund with a permanent budget. It occurs to me that the guarantee and the premia could be substitutes, giving the member states to either back up the fund with actual premium payments or to simply guarantee it. The first option should be preferable to the later one. Moreover it could be that each year a member state's total contribution exceeds its agreed guarantee, it receives the surplus or a large percentage of it back. As the guarantee gets replaced by actual funds, it could decrease by the actual funded amount. If all this things were to be implemented the penalties of the SGP would become irrelevant. This is because the dominant signalling mechanism for the Euro-zone countries would be the premium charged by the EFSF. As it would increase, it would put pressure on the relevant countries to limit exposure to default. Because this would be a progressive process, both preventive and punitive stages would be present and accounted for. Its effects would be felt before the much latter ones of the SGP rendering it, for all intents and purposes, obsolete. Sothe recent concerns expressed by ECB officials might be addressed (here and here), to the extent that this might ever become true.

From this overview I am convinced that the EU should focus on those two last steps: (a) A debt restructuring mechanism, and (b) an elaboration of the EFSF along the lines described above. If any of these requires a treaty change (which I think only (a) does), then the biggest threat from the EU would be that that change be linked with that ridiculous proposal of cancelling voting rights when states fail to fulfil their SGP responsibilities. Hopefully Von Rompuy will do as well with this treaty reforming task force as he did with the previous one. If he doesn’t and MSs are chicken enough to accept these terms, then lets hope the EFSF reforms are carried through and that the SGP does indeed take a back seat to the EFSF.

What do you think?

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