From a purely economic point of view, there will be three notorious gatherings. The meeting of the Governing Council of the ECB on the 3rd of March, and the two Council of the EU meetings. An informal one will take place on the 11th March, between the members of the Eurozone, while the formal one will be on the 24th and 25th of March involving all the heads of government of the EU. The first one is supposed to be used to iron out the last details and bargains of the so called Pact for Competitiveness. The second is to be used to finish whatever was not finished by the 11th and to give official notice to the EU member states and institutions of whatever agreement is reached or not. I believe that unless the pact involves some delegation (to the European Commission) of monitoring of compliance and of enforcement of the rules agreed (if indeed anything is agreed) it will not represent a credible commitment. However it might still do the “financial market” trick for Portugal, if the Germans agree to an increase of the EFSF and its permanent version. Regardless of this, to understand the negotiations one must look at the present demands and the relative positions of the players. After this I’ll present a brief summary of what Germany has been up to and what I think countries are willing to compromise on. Then I’ll make some predictions, which will be wrong. Then I’ll make some comments about the Competitiveness PAct and what I believe to be its actually purpose.
Positions of Member States
Germany and France proposed the Pact. Therefore one has to believe that they stand behind it and therefore favour the mutual recognition of professional qualifications, the desindexation of public and minimum wages to inflation, the postponement of the retirement age and the end of flat rates of corporate taxation across the Euro-zone. They are distinguished in that France would probably accept the idea of the EFSF and it’s future progeny, the EMS, purchasing debt in secondary markets, whereas Germany doesn’t. It doesn’t want to create moral hazard by buying peripheral sovereign debt. It doesn’t like the idea of the ECB doing it either. And it doesn’t want the EFSF to do it either. But it doesn’t want any country to restructure or default on their debt because it doesn’t know what damage it’ll do to that country and through it to Germany itself. It’s an unholy pentagram of denial!
The Netherlands and Finland tend to side with Germany on issues of generosity and fiscal rectitude. However, it is dubious that they will be very confortable with wages desindexation, given that it is a fairly common trait of welfare states.Indeed, Belgium is opposed to desindexation of wages to inflation nor does Italy, Austria, Spain or the Luxembourg. Even the Finns are a bit iffy. Ireland dislikes the requirement to eliminate Corporate tax competition in the EU. Portuguese and Greek societies both dislike labour market reforms, such as wage desindexation, retirement age postponement and mutual recognition of professional qualifications. Both of these governments will live with it, if it means lower interest rates or maturity deadlines for their EU held debt (EFSF+Greek programme). Spain has already started implementing some of these reforms, so it probably doesn’t care about the substance as much as the form of these proposals. The same is also pretty much true of Eastern European Eurozone members. Good for them!
Reaching an Agreement: Compromising and Co-opting opponents
Whether an agreement will be reached then seems to depend on whether Mrs Merkel will open her German purse. If she does, she’ll have the support of the opposition, but not of her coalition partner, which will be embarrassing. If she doesn’t, Portugal will most likely need to be bailed out. Some recent reports might be helpful in understanding what will unfold. Greece and Ireland would like to get some renegotiation of their bailouts, which Germany seems likely to agree to. The new Irish government seems similarly inclined.
However, Mrs Merkel does not seem to be too friendly to the idea of actually increasing the size of the EFSF. According to the agreement reached earlier this month, the EFSF will continue to have the same amount of funds it possesses, but the rules will be changed so that all of its resources can be used, rather than only a portion small enough to guarantee it AAA rating at any given time. The result might be that the all the parties will be satisfied, but the EFSF will be left fragilised, which if its rating is lowered might simply lead to a later increase of its actual size. Finally, it is dubious that its powers will be extended to allow it to borrow in secondary markets or to issue Euro-bonds as proposed by Mrs Juncker and Tremonti at the end of last year. Furthermore, recent Portuguese reports advance the idea that Portugal might be offered a less formal, more flexible form of assistance than that given to Greece, in the hope that it’ll satisfy the markets.
On the margins of the discussions between member states, Mr Barroso, Mr Van Rompuy, Mr Trichet and Mr Juncker will lobby for a stronger role of the Commission but rather unsuccessfully so. The only way this might have some weight is if Trichet threatens to increase interest rates, if Barroso threatens to resign or if Juncker threatens to veto any agreement, all of which would be interesting albeit unorthodox and thus unlikely developments. The ECB will eventually raise interest rates, probably calming down German growth, but the truth is this will probably only come to pass after a credible and lasting solution to the problems of the Eurozone is found. Alternatively, raising the interest rates could prove as damaging as it was when the fed did it in the 1930s. then again it could also be quite damaging if the German bubble inflated too much, as a rise in interest rates would pop an superbly inflated bubble, bringing chaos all over the monetary union. The Eurozone is to be handled with care…
Predictions – Positioning, Bargaining edges and the role of Franco-German deals
So, what will happen? – Most likely, Mrs Merkel will get her way through. She holds the purse and she has intelligently coopted all of the direct EU opposition. In the end, a victory for her is a resolution that does not trigger a clash within her coalition. So she’ll hand out some cheap money for Portugal, she’ll caress the loan conditions for Greece and Ireland and make the EFSF look illusionarily bigger. The Belgians won’t let her get the desindexation, which the French will be happy to let through. Everybody’ll agree on a statement to the necessity of mutual recognition of professional standards, but it’ll most likely be inconsequent.
In the end it’s all quite irrelevant. The pact for competitiveness, much as the now forgotten Deauville Agreement, is a smokescreen. It is an edge which Germany brings to the bargaining table so that it can calm down it’s negotiating partners and tone their demands down. It prepares extravagant demands which when they are not met can then be used to say, “well, we offered a reasonable quid-pro-quo. However we are willing to not get it our way, if you accept to drop some of your demands”. In the end both parties come to the table with what they want, but they leave with an agreement corresponding to the what they agree they don’t want. It’s called bargaining and it’s time we accepted that that’s all there is to it, and started calling it what it is: Germany lowering expectations.