Slovakia should refuse an increase in the size of EFSF

Slovakia’s parliament recently voted against the proposed increase to the EFSF. The BBC’s Rob Cameron says “a second vote could be held soon and is likely to succeed”. This policy paper from INESS explains why Slovak politicians should stick to their first answer.

Slovakia should refuse an increase in the size of EFSF (European Financial Stability Facility) and enlargement of the scope of its competences for following reasons:

  • The proposed solution to the sovereign debt crisis, based on redistribution of national debts in the form of EFSF, has proved ineffective throughout the 18 months since its inception. The “disease” continues to spread to other countries. Even the catastrophic scenario has come true – the European Central Bank has even had to come to the aid of Italy with its enormous debt. The crisis is not one of liquidity, but a problem caused by the insolvency of indebted countries and of many creditor financial institutions. Increasing the borrowings of insolvent nations will not address this crisis of insolvency, but will worsen the situation and will endanger the financial health of the other members of the Eurozone and weaken their access to financial markets (see the case of Italy).
  • Political leaders have not been mandated by the voting public to bring about fiscal centralization, which naturally follows such a debt union.
  • The suggested solution introduces the unsubstantiated transfers of wealth from taxpayers in one country to the owners and creditors of financial institutions who lent to the troubled countries.
  • The EFSF and ECB operations are misleadingly described as a rescue of these countries. In reality they constitute a bailout of these countries’ creditors. If this proceeds it will lead to the growth of nationalistic tensions in the EU and so create risks for its long-term stability. In turn this will endanger the existence of the common market and its cornerstones, the free movement of goods, people and capital.
  • Historical experience shows that the main precondition for long-term stability of monetary union is the maintenance of a credible commitment not to bail out any member. The long-term stability of the Eurozone and the euro currency would, contrary to the views expressed by the creators of EFSF, benefit from the bankruptcy of Greece. EU leaders are preventing this at any cost. For this reason, saying No to the increase of EFSF does not mean the end of the monetary union.

GDP is not the appropriate indicator to measure the wealth of Slovak population. Employee compensation and hence ability to pay taxes are substantially lower in Slovakia than in other Eurozone countries (with the exception of Estonia). Hypothetically, if all guarantees as per currently proposed EFSF were called (total amount: EUR 780 bn.; Slovakia’s share: EUR 7.7 bn.), our cost would reach 35% of total general government revenues – the highest share in the Eurozone. EUR 1000 of debt would burden the Slovak taxpayer twice to three times more than the German. To cover potential future costs brought about by membership of the EFSF, we would need to increase taxes twice as much as our neighbour, Austria.

The ‘solution’ to the European sovereign debt crisis via EFSF will therefore prove particularly expensive for Slovakia. Slovakia’s main competitive advantage is its relatively low tax rates compared to other members of EMU. The proposed expansion of EFSF will lower this competitive advantage. It will also hurt Slovakia with respect to the central European region, where few governments will be part of EFSF. The inability to keep Slovak taxes low will lead to lower economic growth, and slower catch up with the higher living standards of the more developed countries.

Slovakia has already passed costly reforms of social welfare system. Slovaks have also paid the bill for an extremely expensive (10% GDP) recapitalization of the Slovak banking sector just ten years ago. The acceptance of costs of bailout of wealthier countries with unreformed social systems and insolvent banking sectors would substantially eliminate the positive effects of these painful reforms. To accept the debts of wealthy and profligate countries will mean that the Slovak taxpayer has tightened his belt in vain.


Foreword to the Slovak edition of The Tragedy of the Euro

The political project of the Euro is in deep trouble. It seems that Friedman’s curse is beginning to materialize. Despite the European Union and International Monetary Fund pledging three quarters of a trillion of our Euros to put out the debt crisis wildfire, interest rates on troubled sovereign debts are even higher than before the announcement of the bailout funds.

Not that this is a surprise to anyone. Another loan to an already over-indebted country is not a real solution to its problems, something private investors know very well. It’s just a very expensive buying of time for those who happened to own the bonds and wonder what to do now. During this bought time, one can pretend that the problem will disappear thanks to sudden and miraculous economic growth. Ireland got bailed out, Portugal got bailed out. For Greece, one bailout was not enough. Now, just a year later, Greece is asking again for the common European credit card in order to support a standard of living they became accustomed to thanks to the Euro and with which it is very hard to part.

Greece is a perfect example of the consequences of the implicit bailout guarantee from other EMU member states. A country on the edge of default with a debt-to-GDP ratio of over 150% – even after “radical” austerity measures – posted a public finance deficit of 10.5% of GDP in 2010. One troubling question keeps reappearing: What will happen to the patchwork safety net if the Italian or Spanish elephant falls into it? Will it hold? Or should Germany and the other countries holding it be better off letting go, so as to avoid being pulled over the cliff of default as well?

Today, we are no longer just uninvolved bystanders, watching with interest as the Euro drama unfolds. Since 2009, the Euro’s problems are our problems, too, and now our chips are on the table. When you see press conferences announcing newer and bigger bailout packages, just divide the figures quoted by one hundred to find out just how much European “solidarity” will cost us.

To mention solidarity while bailing out countries with irresponsible fiscal policy and banks misled by the ECB’s illusory easy money policy leaves a bad taste in Slovaks’ mouths. This kind of “solidarity” is not permitted by the recently ratified Lisbon treaty. Moreover, the Slovak worker can only dream of a Greek-level pension, and Slovakia’s own banking sector had to be restructured just a decade ago at a huge cost (over 10% of GDP). And now, as the second-poorest EMU member, we are expected to send money to pay Portuguese public workers and to save French banks after their unwise investments in Ireland?

There was not much of a discussion about Euro adoption in Slovakia. The eagerness of politicians, experts and the lay public to adopt the Euro as soon as possible is easy to understand. The Euro was supposed to protect us from our own politicians, who clearly showed what they are capable of in the late nineties. And it was flattering, too, to finally be a leader in at least something among our post-communist neighbours. But this desire clouded our perception of the club we were about to join.

Yes, the common currency has its advantages and monetary nationalism is costly and economically indefensible. But many ignore the key question of the currency’s quality: What is the backing of the currency and who controls its production? In fear of another failure by our own political class, we forgot that the Euro is not a gold standard lying outside the reach and control of politicians, but only a bigger and more complicated political project with all the ills that attend this sort of centrally-planned structure. The fact that a politician speaks French or German doesn’t make him a morally pristine agent free of any self-interest.

Thanks to its institutional character, the Euro is a common resource utilized by the EMU countries. Control of money production and all related benefits has been moved from national governments into the platonically guarded supranational space of the Eurosystem. Suddenly, it is possible to cover public finance deficits with newly created Euros, while the costs of this process – in the form of price inflation, various asset bubbles and a deformed production structure – fall not just on the irresponsible country but on all members of the club.

Slovaks have a very intense historical experience with common resources. For them, the Tragedy of the Commons is not just an abstract economic concept, and the saying “He who does not steal, steals from his family” hints at an intimate public understanding of all the problems brought about by ill-defined or undefended property rights. The rules of The Stability and Growth Pact were supposed to police the Euro commons, but the countries involved have simply ignored the rules, making the pact into an impotent manifesto.

With the onset of the financial crisis, the illusion created by newly-created money and cheap loans not backed by savings evaporated. Losses from malinvestments – along with necessary reductions in standards of living or deep cuts in generous social benefits – are painful but inevitable. Changes in the rules of the Euro game (the creation of the European Stabilization Mechanism by the addition of a new article to the Lisbon Treaty) should allow a shifting of the losses from the places where they originated or to taxpayers in other countries. The European Union is changing into a wealth redistribution mechanism between countries before our eyes. The potential default of one member state is automatically – and illogically – associated with the end of the union or even a potential war in Europe by EU representatives. However, hardly anything stirs nationalistic passion more than inequitable transfers of wealth. And an increase of indebtedness among the last relatively healthy countries left in the effort to avert the inevitable defaults doesn’t add to the strength of the Euro.

After 2013, as a part of the permanent European Stabilization Mechanism, Slovakia should guarantee debts of up to almost six billion Euros (one fifth of the current government debt). You won’t find risks like this in the official Slovak SWOT pre-EMU entry analyses. Neither would you find discussion about possible government failures and fiscal free-riding allowed by the institutional setup of the Eurosystem there. We saw the Euro as we wanted to see it, not as it really was. Ireland was presented as a role model for the positive effects of the common European currency, not as a Celtic Tiger on the steroids of irresponsible European monetary policy. The evidence of misuse of the Euro for irresponsible fiscal policy was right in front of us, and in spite of the countless breaches of the Stability and Growth Pact, nobody held the fiscally unsound countries responsible: nobody had to pay.

Even though we have already made the decision and the Euro is already in our pockets, it’s not yet too late in Slovakia to focus on the issues that didn’t resonate enough in the pre-entry, Euro-optimistic discussion. At least we will better understand what is happening to our money these days.