Europe divided as it faces its defining test


BRUSSELS:Confronting forces that brought down Greece and Ireland may be key challenge for the EU

AFTER A year of drama and upheaval, European leaders face a mammoth task in 2011 to gain some control over the sovereign debt emergency. Defending the euro has already stretched them to the limits of their political and fiscal endurance but they remain deeply divided over the scope and scale of their next intervention. Each move they make will have a crucial bearing on the survival of the single currency.

The thread of disruption leads back to lies in Athens over the parlous state of the Greek public accounts. But there is more to it than that. The crisis feeds on critical design flaws in the currency system, wayward public finances throughout Europe, rampant bank mismanagement and panic-prone markets that have yet to regain their composure following the Lehman Brothers explosion in 2008.

With no end in sight to the turmoil, confronting the selfsame forces that brought down Greece and Ireland increasingly looks like the defining test of European integration. Any failure here could trigger a break-up of the euro, with potentially devastating economic and political consequences throughout Europe, and could lead the EU down a path of irreversible decline. While that is something EU leaders are determined to avoid, they remain at odds with each over the best way forward. They promise to do whatever is necessary to avert disaster but cannot agree on what.

At the same time, however, the primacy of German chancellor Angela Merkel in the debate says much about her dominance of European politics. For good or ill, she is perceived to set policy, pace and tone at every turn.

The scene is highly volatile. EU leaders are desperate to reassert the primacy of politics yet they are on the hind foot. In the face of market pressure, for example, efforts to extract bailout costs from private investors were put back for three years. As taxpayers endure massive austerity, they continue to shoulder virtually the entire burden of adjustment.

In question now is whether Portugal can avoid the fate of Ireland and Greece and whether Spain can stay afloat without aid. This, in turn, raises big issues for other heavily indebted countries such as Italy and Belgium. The temporary €750 billion EU-IMF bailout net could bear a Portuguese intervention but a Spanish rescue might split it.

There are questions, too, about whether Europe’s leaders have it in them to trigger support for Madrid. They insist they have, but that there is no need for an intervention in any event. These questions are rooted in the scale of the aid package that might be required – hundreds of billions of euro most likely – and the threat of a domino effect on other weakened countries.

By now, however, there is little enough scope to consider such issues in the abstract. Although 2010 heralded the end of Europe’s infamous no-bailout clause, the political psychodrama set off by that manoeuvre has yet to reach its denouement. That moment seems closer now but there are many acts still to play.

At issue still in the chancelleries and presidential palaces of Europe is whether and how to enlarge the €750 billion net, but this is only one question. The scale of the permanent fund to replace this scheme in 2013 has yet to be quantified. There is strident resistance in Berlin and Paris to the development of “eurobonds”, debt issued with the benefit of a common single-currency guarantee, but the idea keeps surfacing.

For Ireland, the €85 billion EU-IMF bailout marked a humiliating turn. With full employment and boom-time excess still fresh in the memory, the State is now totally reliant on its European and IMF partners and subject to their whims.

However, huge European Central Bank (ECB) loans to burnt-out Irish banks meant Dublin was deep in the danger zone long before the Government’s capitulation. Informed sources point to lingering annoyance in Coalition circles at the manner in which Ireland came under international pressure in those fateful November weeks but the die was by then well cast.

Despite considerable pressure from Paris and Berlin, there was no dilution of Ireland’s 12.5 per cent corporation tax rate in return for rescue aid. But with further debate on eurobonds likely, all signs point to pressure for harmonised taxation policies if such debt is to be issued. On this front and others, Ireland’s negotiating hand is feeble.

With an election imminent, however, it seems likely that Europe’s first interest will be to ensure any incoming government sticks to the terms of the bailout deal. Although Opposition parties are calling for a renegotiation of the package, they may find it is in their interests to blame the outgoing administration for unpopular policies.

Strain and anxiety were everywhere in 2010. Merkel held the line against easy bailouts but her dogged intransigence on core principles led to accusations that she was making matters worse, not least in Ireland. From the summit room came whispered reports of shouting matches between French president Nicolas Sarkozy and ECB chief Jean-Claude Trichet; of threats from Merkel (later denied) that she might pull Germany from the euro; and of ardent Spanish displeasure at moves to burn bondholders. Some emergency meetings continued until the middle of the night; routine meetings ran to the early hours.

There were glaring moments of scarcely concealed tension. Finance ministers emerged tired-eyed from a long meeting in Luxembourg to look in astonishment at television shots of Merkel and Sarkozy declaring in Deauville that they had decided how Europe would respond to the crisis. Thus did European Council president Herman Van Rompuy, chairman of the Luxembourg meeting, find himself squeezed out by Berlin and Paris.

There was farce too. Van Rompuy claimed many months ago that the battle to save the currency was won, remarks that smacked of wishful thinking. Trichet, whose pallor is seen to denote his acute concern about the crisis, is fond of saying, “We never declare victory.” There is good reason for that.

Four things are clear at this point. First, raw politics are at the core of the crisis. This goes between governments, within them and in relations with the people touched by their actions.

For example, Merkel’s reluctance to contemplate bailing out Greece was prompted chiefly by electoral concerns and flowed from deep German aversion to the notion of turning the EU into a fiscal union. Dithering over the Greek deal went on for so long that the €110 billion package, once in place, was swiftly overtaken by the clamour for something bigger for any other distressed country.

Second, the political element seems likely to intensify. As austerity tightens its grip, it seems inevitable that pressure will build for greater private sector contributions to any bailout costs. To be fair to Merkel, she has been to the fore in placing this on the political agenda. While the market response was adverse, EU leaders have pledged to agree by next March how such procedures should be incorporated in the permanent bailout scheme. This is not without resonance in Ireland, for a unilateral move to impose a “haircut” on senior bank bondholders was ruled out when the EU-IMF deal was done.

Third, the response to the crisis is essentially an improvised, experimental one. As such, there is no precedent for such policies, no historical guide and, therefore, no certainty that they will work. This goes both for the bailout schemes themselves and for the drive for austerity in ailing countries. As well as helping to balance the public finances, senior figures in Europe say austerity may also bring down costs in a manner akin to currency devaluation, thereby aiding recovery in the long run. In the short term, however, austerity touches ordinary life in a very severe way.

Fourth, external elements far beyond the control of European leaders cast a shadow over this scene. They include volatility in debt markets, the ever-present danger of uncontrollable, self-fulfilling downward spirals taking hold and the vulnerability of brittle banks and countries to any increase in tension in other financial markets. Another factor is the global economic scene. If the recovery intensified, that would clearly be for the good but the opposite is also true.

The euro crisis has drawn European leaders deeper into each others’ affairs than ever before, but they will have to go further still before they finally reach safe haven. How far? How fast? We may know that soon enough.