Cyprus bailout drama underlines need for global economic co-operation

It is Cyprus this month; where next time? What follows a "Cyprus situation" is largely panic, often based on soundbites from some "experts" apportioning instant blame and implying easy solutions. There are none.

What the Cyprus crisis illustrates though is two things. First is the huge interdependency of the globalised economy. How, many ask, can a country accounting for less than 0.5 per cent of euro zone total economic output put in some jeopardy the entire currency union and by implication destabilise the world economy? The answer is clear: spillover and contagion effects in a currency union and indeed in a globalised economy, in the absence of agreed and enforceable rules of engagement.

Second, while it is evident what is needed to cope with such effects, as in Cyprus, the political process of putting this into practice is tortuous and complicated. Given the nature of the bargaining involved it is inevitable that a long game of poker will be at play, with brinkmanship evident at every turn of the game. That is the nature of all bargaining processes, especially where there are so many players involved.

In this situation we either change the rules of politics, for example by not giving each country a veto over some decisions, or we live with the uncertain political consequences of the process, in the hope that we will get to the right solution. We cannot have both full democratic legitimacy and speedy resolution of international financial crises of this nature.

There is also, though, another dimension to the recurring financial crisis. New waters are being charted and it is in effect a process of learning by doing. It is easy for armchair pundits to be clever with the advantage of hindsight. But the euro zone crisis is a huge learning experience for most policymakers and their electorates, resulting from a slow realisation of just how extensively connected the global economy is, particularly in the financial area.

The vital aspect of this interdependency is that the actions of one country can impact on the well-being of another without the other countries having any say whatsoever with regard to these actions. Ameliorating these so-called spillover effects is at the heart of many international agreements, most particularly at an EU level. Only by acting collectively and signing binding treaties can we regain freedom from the undesirable consequences of the actions of others.

It has been clear for a very long time that individuals can by co-operating enhance, not diminish, their freedom of action. Let us take the example of a stop sign or a traffic light. As individuals we cannot drive as we wish without endangering the lives of others and our own; our lives are too interdependent for this. As such we agree to binding rules to avoid the consequences for you of other people’s actions and likewise yours on them.

In these circumstances we do not cede individual sovereignty, that is our ability to act unfettered by the actions of others. In fact, without this pooling of decision-making you would not be able to risk driving on the roads at all. Sharing in many circumstances then means enhancing, not diminishing, the overall sovereign good.

And so it is with nations, unless we wish to pursue a policy of total self-sufficiency in economic terms. But even here, acting alone, we are not protected from the actions of other countries. We cannot stop the wind blowing harmful particles across the Irish Sea. We cannot counteract the fact that criminals, illegal immigrants and terrorists do not respect national boundaries. We cannot prevent the adverse consequences of the actions of others generating global warming.

Every economic transaction with another person or outside agency involves interdependency. If you borrow from a bank or friend you must meet the conditions of that borrowing, and the creditor takes the risk that you may renege on the loan, thereby creating for both parties interdependency. Make no mistake about it therefore, if Russia provides “aid” to Cyprus a price will have to be paid and binding conditions imposed.

Likewise borrowing from international markets carries a price and conditions. Too often the counterfactual in the euro zone debate is the myth of some self-regulating alternative, free from all external surveillance or control. In reality the freedom of action of nations can be hugely curtailed, unless the conditions that the anonymous international financial market place dictates are respected. These diktats besides are usually only implicit and the withdrawal of reasonably priced funding often immediate and with little warning.

Thus the notion of individual or state sovereignty, unfettered by the actions of external agents, is a mirage. It is simply a question of the degree of self-government that your situation allows: without running the risk of significant two-way negative spillover effects resulting from interdependency.

The logic of the above is that binding international agreements can be the medium through which freedom of action is enhanced, rather than a restraint upon it. Far from being threats to sovereignty, international agreements can often be understood as instruments that strengthen state freedom of action, the EU being perhaps the apotheosis of this.

Given the huge interdependency between countries, the necessity of such international agreements needs to be fully understood. The prize ultimately for all is increased, not diminished, long-term effective freedom of action and wellbeing. If so, the political process of getting to such agreement can become more bearable, no matter how acrimonious the arguments over the detail with regard to operation and fairness. This is something that needs to be borne in mind in any discussion of the ongoing crisis in Cyprus.

John O'Hagan is p rofessor of economics at Trinity College Dubli n