Europe’s Perfect Storm: When Possibility Meets Actuality
“May you live in interesting times.”
What better phrase than the apocryphal Chinese curse above to capture the essence of the weeks, months and years to come? More to the point, just how interesting will those times be? History suggests we should be careful what we wish for. Europe’s debt crisis poses immense risks to the continent’s future, yet because it is technical, these risks are not being as clearly spelled out as they should. One reason for this is risk’s elusive nature.
On August 4, 1914, the day hostilities between France and Germany broke out, the French philosopher Henri Bergson described how, until the actual outbreak of war between France and Germany on that day, the war appeared to him “simultaneously probable and impossible: a complex and contradictory notion which persisted to the end.” Slavoj Žižek explains this tension between possibility and actuality: an event is experienced either as impossible but not real, or real but no longer impossible. “The encounter of the Real as impossible is thus always missed,” writes Žižek. The void between what we know can happen and what we believe will happen – the paradox brilliantly identified by Bergson – is at the heart of European leaders’ current lack of vision and courage. While none of them seem willing to accept that the Eurozone may collapse, the probability of this devastating event rises with each passing day. As policymakers delay the day of reckoning, the economic and social cost of the crisis increases, as does the risk of a chaotic endgame for the euro and a violent and catastrophic end to the European project itself.
To understand how easy it is to underestimate the likelihood of a disaster, it is worth quoting Bergson in full, if only for the sheer powerfulness of his insight:
“In spite of my turmoil, and although a war, even a victorious one, appeared to me as a catastrophe, I experienced what William James spoke about, a feeling of admiration for the facility of the passage from the abstract to the concrete: who would have thought that such a formidable event can emerge in reality with so little fuss? […] I never pretended that one can insert reality into the past and thus work backwards in time. However, one can without any doubt insert there the possible, or, rather, at every moment, the possible inserts itself there. Insofar as unpredictable and new reality creates itself, its image reflects itself behind itself in the indefinite past: this new reality finds itself all the time having been possible; but it is only at the precise moment of its actual emergence that it begins to always have been [possible], and this is why I say that its possibility, which does not precede its reality, will have preceded it once this reality emerges.”
The human tragedies of the 20th century fell precisely in this cognitive gap, as they appeared to be, until the very moment when they broke out, simultaneously probable and impossible. Will Europe’s fate, too, fall into this void – again?
From Athens to Rome: The fuse that will blow up Europe?
The Eurozone crisis has escalated and threatens to undo fifty years of European construction and de facto peace building among European peoples. Yet judging by politicians’ speeches and actions, the scale of the potential damage is several orders of magnitude less than what the threat of the collapse of the Eurozone implies. Political and social failure on this scale was until recently hard to envision.
The dramatic escalation of the crisis was entirely avoidable. Greece had a debt/GDP ratio of 110% in 2008. Three years later, after suffering through the austerity measures imposed on it by the EU and the IMF with the aim of reducing the country’s deficit, its debt/GDP ratio is approaching 170%. That such obviously irrational and self-defeating economic policies were implemented in the first place is regrettable, if not entirely surprising. That they are being perpetuated as the main recipe for crisis exit, notably in systemically important countries like Italy, in spite of their appalling track record, is nothing less than a disaster.
European policymakers had three goals going into the crisis in May 2010: ensuring that Greece’s debt would not be restructured, preventing the crisis from spreading to other European countries, and keeping the Eurozone intact. It has failed comprehensively on the first two counts, and will probably fail on the third.
Why did Europe fail so badly at managing the crisis? Essentially, political elites and technocrats ignored basic economics and refused to face up to the cost of recapitalizing their banks.
How somber does the future look? Two elements are likely to determine Europe’s fate. The first is political elites’ ability to reform Europe’s economic governance – and to do so within a matter of weeks or, at most, months. The second is the extent to which domestic politics can continue to effectively function in the face of the collapse in democratic legitimacy that has been unfolding over the past year.
Wanted: European economic governance
The first sine qua non condition for the survival of the euro is the reform – or rather the ex nihilo creation – of European economic governance. The EU’s budget is incredibly small (a mere 1% of the EU’s GDP), and the present crisis has demonstrated forcefully that the absence of adequate pan-Eurozone fiscal institutions threatens the existence of the euro, and the European project itself.
More specifically, it has been clear for over a year now that Europe’s political leaders have dealt with the sovereign debt crisis in the worst possible way. Extend and pretend the debt burden for insolvent Greece, Eurozone-wide self-defeating austerity with no stimulus in the fiscally sound countries that can afford it, and a central bank with only one third the mandate of a true central bank.
Some of the key reasons behind these policies are simple: ideology and prejudice. Conservative economic ideology that imposes austerity and flies in the face of time-tested macroeconomic theory has caused havoc. The Greek referendum flop in early November betrayed the wrongheadedness of this conservative ideolology. By imposing destructive austerity on troubled economies and forcing their misguided will onto entire populations, EU authorities have ensured that the crisis will spread – as it has.
Standard Keynesian effects such as the government spending multiplier in the aftermath of a balance sheet recession, together with the risk of a debt-deflation spiral, make a powerful case for debt restructuring in Greece, a higher inflation target for the Eurozone, and fiscal stimulus in fiscally sound countries like Germany. Yet European policymakers chose the exact opposite route on each of those policy fronts.
Worse yet, the Germans’ prejudice against inflation (in a recessionary environment that implies a great risk to the very survival of the Eurozone alongside near non-existent inflationary pressures) precludes direly needed amendments to the ECB’s mandate, such as a lender of last resort role and a dual mandate that includes growth and employment in addition to price stability.
For the Eurozone to survive, member countries will inevitably have to integrate decisively more. No amount of financial engineering and gimmicking or political doublespeak – of which the October 26 EU summit on the leveraging of the EFSF was a masterful example – will resolve the crisis. European policymakers’ strategy has failed. If they do not operate a Copernican change in their approach to the crisis, the euro could unravel and the European project could receive a lethal blow in a matter of weeks.
Italy is on the verge of losing market access. Spain will be next, and the fire may reach France within a month. France has already all but lost its AAA rating, with S&P accidentally revealing last week that it is preparing to downgrade the country. The forced sovereign debt restructurings that a creditor run on Italy, Spain and France would force – a very real threat – means that the entire European continent (including the UK), with its highly interconnected financial system, is currently at risk of a full-blown systemic financial crisis of bank runs and wealth destruction – a Lehman on steroids.
The situation is dire. Time is scarce. And the ineptness of those in power is terrifying.
The road not taken. Yet?
To save the euro, and by extension the EU, political leaders must realize that there is only one solution: increased economic and political integration. The alternative is a break-up of the Eurozone, in one form or another, and the catastrophic economic, social and political consequences this would imply – especially if it happens in an unprepared, chaotic way.
It is difficult to envisage a way for the Eurozone to survive that does not include two crucial institutional innovations.
First, there must be a change in the treaty underpinning the ECB to enable it to perform its lender of last resort function when needed. This would allow the ECB to effectively put an end to creditor runs on sovereign debt by allowing it to buy their debt in unlimited quantities for as long as is needed, and possibly to even fix an interest rate target on sovereign bonds – essentially killing off the incentive to speculate over these bonds (although this could create issues of fairness). Adding to the ECB’s mandate maximum employment could allow for higher inflation in the Eurozone as a whole, helping periphery countries to restore growth and achieve internal devaluation relative to core countries by keeping their wages and prices stable.
The EU’s current approach, which consists of imposing on periphery countries austerity measures and internal devaluation through nominal wage deflation is socially and politically unacceptable and will force these countries into economic depression.
Second, the Eurozone must create a federal debt agency backed by Eurobonds with joint and several liability and governed by a European fiscal authority with the legal ability to collect a tax of, for example, 2% (akin to a VAT) across all Eurozone member states.
The lack of joint and several liability is at the heart of the crisis. As Wolfgang Münchau correctly points out, only joint and several liability can produce the kind of credibility that is needed to stem the current creditor runs on sovereign debt. A deep pan-Eurozone debt market characterized by bonds that are jointly and severally guaranteed by all member states of the Eurozone would create attractive bonds that would be bought by a wide pool of international investors. The newly-issued Eurobonds could be used by the ECB in open-market operations and serve to finance long-term productive investments in infrastructure, among other things. This would provide direly needed fiscal support to overindebted countries in the Eurozone periphery, such as Greece, Portugal and Spain, and help them achieve structural transformations.
The need for – real – democracy
The second element that will determine Europe’s fate is politics. The extent to which domestic politics can continue to effectively function and keep extremisms in check will prove to be crucial. This in turn, will depend on how much European citizens feel that their governments are responding to their political demands. Patience has already been exhausted in Greece, in which the Papandreou government had become a vulgar puppet of EU authorities.
In this regard, 2011 has been a somber year for democracy. Arguably, many European countries are only democratic in name. Greece has almost completely lost control over its economic and social policies. So have Ireland, Portugal, Spain, Italy and, to a lesser extent, France. In the aftermath of the biggest recession since the Great Depression, it is hard to think of a better way to deprive citizens of the sense that the institutions that govern them are democratic.
With unelected technocrats, markets and foreign parliaments imposing wrenching austerity measures on weak European countries, what are the citizens of those countries to do? Faced with years of economic depression and plummeting living standards – essentially, a violent ripping up of a population’s hope that the future will be better than the present – many have taken to the streets. And to be sure, many more will. Dani Rodrik reminds us that “As in the 1930’s, the failure of international cooperation has compounded centrist politicians’ inability to respond adequately to their domestic constituents’ economic, social, and cultural demands. The European project and the eurozone have set the terms of debate to such an extent that, with the eurozone in tatters, these elites’ legitimacy will receive an even more serious blow.”
The democratic deficit in European governance, which was already flagrant before the sovereign debt crisis, has morphed into an intergovernmental quasi-dictatorship – a two headed Franco-German monster – that threatens the popular legitimacy of the European Union and the European project.
This massive political failure poses a huge challenge. The key drivers of economic policies in Europe at the moment are the whims of financial markets. As the peoples of Europe progressively come to reject the austerity measures that are being forced upon them – in many cases to protect foreign bondholders, who are part of the top 5% of the wealthiest people on earth – the democratic fabric of Europe will come apart at the seams.
This is an unsustainable and explosive situation. Jürgen Habermas makes the important point that “A dangerous asymmetry has developed because to date the European Union has been sustained and monopolised only by political elites – an asymmetry between the democratic participation of the peoples in what their governments obtain for them on the subjectively remote Brussels stage and the indifference, even apathy, of the citizens of the union regarding the decisions of their parliament in Strasbourg.”
The threat posed by the technocratic and market capture of European policy-making
But what is perhaps most distressing of all is the notion that the crisis threatens some of the psychological pillars of Western society.
Something much more powerful than a sovereign debt, financial, economic and political crisis looms over Europe. Two ideas are at stake. First, liberal democracy and the mixed economy, which are the two pillars of the decent societies that Europe created and sustained in the post-World War II era. Even more importantly, what may be at stake is the very notion that there exists a historical trajectory of progress – a trajectory towards the Western institutional model of a capitalist mode of production underpinned by a liberal democratic political order and broadly open access by citizens to economic and political organizations.
History has never been a linear process, and the current crisis may come to remind us of this fact with a vengeance. Violent upheavals, drastic regime changes, ferocious armed conflict, inhuman forms of social and political extremism, carnage, chaos, unfathomable social disruptions and other destructive excesses defined Europe in the first half of the 20th century. Industrial capitalism has only been with us since the mid-19th century. The 19th century was hardly more stable than the 20th, although less deadly. Between 1789 and 1875, France experienced no fewer than seven different political regimes (monarchy, first republic, empire, monarchic restoration, second republic, second empire and third republic). The Spring of Nations that swept across the European continent in 1848 led to an unprecedented challenge of established authority, only to be stamped out in short order by reactionary factions.
The hard-won political institutions that currently make up our social fabric did not appear out of thin air. They did, however, flounder on more than one occasion. On the eve of World War I, the Belle Epoque gave a false sense of tranquility to the European continent. Few people had the imaginative power to envision the wave of anti-Semitism that would crush the continent over the coming decades. The French philosopher Henri Bergson captured the essence of this paradox, but few others did.
What does this tell us about Europe’s future?
Several important elements separate the current era, notably the existence of extensive trade and financial integration among nations – both the goal and the result of the European project since 1957. But we shouldn’t underestimate the potential for such violent social and political upheavals in the coming decades. In the words of the political scientist John Duffield, “Institutions have had little impact in the past. Why should anyone believe that the world has changed and that institutions will have great influence on future developments in Europe?”
Perhaps the most serious challenge of all is the undermining of the teleological view of history that pervades Western mentalities – the idea that history consists of a movement towards progress – from an initial state to an end-state, and that different societies are positioned at different points along this “development” path, with some of them moving faster than others, but with a general movement towards a putative historical end-state.
The sovereign debt crisis calls into question foundational elements of the economic and political institutions that most people – including political elites – in the West have come to take for granted. However hackneyed, it is important to understand the fragility of the institutions that govern our economic systems and underpin the economic, political and social structure of our everyday lives.
The fragility of our institutions is becoming more and more visible. Francis Fukuyama, in his latest book The Origins of Political Order, identifies three key institutions that characterize modern liberal democracies: “a strong and capable state, the state’s subordination to the rule law and government accountability to all citizens.”
Admittedly, the European Union is an unprecedented institutional laboratory in which member states willfully surrendered part of their sovereignty in exchange for membership in a broader project and the economic, social and political benefits associated with this project. At the same time, what we are witnessing in the current crisis is, arguably, a serious if progressive breakdown in each of the institutions identified by Fukuyama as forming the core of the political order that is at the heart of the functioning of the European Union. This breakdown suggests that the hypothesized trend towards “progress,” even if it exists, is not linear, and severe setbacks can occur – and are currently occurring in Europe.
Indeed, going back to the three components of the modern political order singled out by Fukuyama, several countries, most notably Greece, have lost or may soon lose control over their fiscal policies. Rule of law is being trampled, with the ECB purchasing sovereign bonds ultra vires and “bail-outs” to periphery Eurozone countries being granted even though they are prohibited by the Treaties of the European Union. Accountability has become unworkable and fuzzy, as the politicians who dictate some of the key conditions and policies for a country (such as Greece) and whose decisions affect millions of lives, are elected by a different constituency in a different country (such as Germany). Even more worryingly, perhaps, financial markets have begun to wield enormous indirect political power, as self-fulfilling market panics cause governments throughout Europe to fall and to be replaced by non-elected “technocratic” governments whose explicit mandate is to implement austerity measures and structural reforms, often against the will of the country’s constituents (Lucas Papademos and Mario Monti are the two latest examples).
It is important to remember that in some cases, these “markets” are in fact a handful of traders who liquidate large sovereign debt positions because they decide the country is no longer solvent or fear that other traders will do so. In a sense, governments have become accountable to financial markets. Instead of the market being governed, the market is governing. This situation is not politically, socially or even morally acceptable or sustainable.
Harking back to the origins of both the European project and liberal democracy itself, one cannot help but be struck by the extraordinary amount of contingency that produced each of them, as well as their incredible fragility. Underestimating fragility is dangerous. History is not a steady path, and the fate of an entire continent is at stake. If political leaders move too close to the edge of the cliff, not only will they fall, but they will bring down an entire continent with them – for several generations.
