Double or Quits?

The markets have briefly relented in their pressure on the eurozone, having been impressed by the size of the financial umbrella that was deployed to support countries at risk. However, it is clear to everybody concerned that this package can only buy time. It is essential to use this time to tackle the root of the problem: the fact that so many member states are living beyond their means.

Without further fundamental reforms, no umbrella will be big enough to save the situation. Indeed, the more the umbrella is used, the less effective it will be, as the additional debt created will weigh down the better-off member states, affecting their credit ratings as well.

With this in mind, the European Commission announced a new set of proposals to sharpen the long term effectiveness of the stability mechanism. The proposals included ex ante control by Brussels of national budget plans. But the thrust of the proposal fails to change the fundamental problem which stopped the old stability pact from working:

- if the sanctions are not automatic and immediately painful, then the threat of the pact will only last until the first big member states ignore them (witness the coup de grace given by France and Germany to the old pact);

- if the sanctions are automatic and painful there will be screams from national politicians that they were "forced" to act by "unaccountable bureaucrats in Brussels", and given the massive size of the cuts needed, we may see riots on the streets as a result.

Even if the current set of governments ignore public opinion and press on bravely with the cuts at the EU's behest, how long before radical or reactionary political forces start to become serious forces? And how can this be squared with democratic rule?

As neither route seems very promising, how else can the lid be kept on spending?

Double or Quits

The fact is that if the eurozone members are serious they now only have two options for an orderly emergence from the crisis in the long term. These options are to break with tradition and go "double or quits":

- Either large chunks of spending must be taken from national budgets and made part of the central EU budget: in this case democratic oversight needs to be established at the EU level;

- Or the eurozone should be wound down, and national currencies re-introduced in an orderly manner right now.

The benefits of "Europeanisation" would include:

- ensuring that if "Brussels" is responsible for the money, it is also held accountable politically for the results. It is no longer the distant force ordering an elected national government how to do things ;

- It could also bring substantial financial advantage, by allowing wasteful duplication (spending on the same things in multiple member states) to be slashed. Even if this were done only with the most crisis-hit countries to start with, big savings could be had.

Defence spending

The most obvious candidate for "Europeanisation" of spending is defence. This is not by any means the only solution, but as it represents between 2% and 4% of GDP in most member states, it is a very substantial item.

In political theory, armies are the heart of national sovereignty. In European reality, however, many member states spend many bucks on virtually no bang, and have almost no ability for independent military activity. Member states defence policies sometimes even appear more attuned to the needs of their industrial policy than they are to the needs of facing the challenges of the 21st Century - starving their fighting men and women of the tools they need to fight real battles in the process.

This disastrous state of affairs leads to massive replication of the same basic items, as countries persist in buying separate kit for their own forces, making unit prices higher. If ever there were a budgetary allocation that would benefit from radical change, it is this one.

Surely such wholesale integration into a European army is unthinkable? Certainly it may be for some ministries of defence. But what is the alternative? Let us imagine for a minute that defence spending carries on being a purely national affair. In an environment where funding is being slashed, what is likely to happen to defence spending? Are governments more likely to close a hospital or to buy fewer Eurofighters? Are they more likely to cut payments to old age pensioners, or to cancel a programme for re-equipping their navy?

The answer, in those parts of Europe that are going to have to save the most is going to be pretty easy to guess – and in many countries the announcements of major cuts are already being made. After years of atrophy, EU defence budgets are likely to collapse, and without further integration of forces across the EU or NATO, military capacity will be totally and permanently lost.

At the very least for a core group of countries, using enhanced cooperation to found a single military force could be a very welcome way out of a dead end. And once the principle is established, it is likely to spread like Schengen (with likely the same countries remaining opted out).

Time for a major choice

The EU is near time of fundamental choice. Only a few individuals in the current leadership seem to have grasped this, and most of them are in the EU's institutions, not in member states.

Having looked into the abyss, and then pulled the joker out of the pack with their financial umbrella, many national governments seem to be going back to the notion of "business as usual". This cannot go on. Radical changes are needed – either doubling the bet, or quitting the game in an orderly manner.

It is time to make these choices before the bond market forces them, as if it forces them, the likely outcomes will not be pleasant.

The writer is an independent consultant. He works in four continents, lives in Hamburg and contributes to a number of fora on futures.