EUU, Alm.del - 2012-13 - Bilag 212: Invitation til høring om den finansielle krise og Danmarks placering i fremtidens EU

While not always well understood, the euro-crisis has much more severe implications forthe euro-outs than a little short-term loss ineconomic growth. In fact, because of the crisisof Europe’s common currency, the Europeansingle market itself is under threat. Even if abreak-up of the single currency is averted, theeuro crisis has already subtly altered the singlemarket and greatly changed the prospects forits future. In fact, no matter how the euro crisisplays out, the single market will never be thesame as it was during the carefree years of the2000s. Each of the three likely basic scenariosfor how the euro crisis might develop wouldadversely affect the single market to a differentextent and in different ways.A full break-up of the eurozone has the potentialto shatter the single market beyond recognitionand threaten the Schengen agreement. Amuddling-through scenario in which thecurrent crisis is contained within the singlecurrency’s existing governance structures andwith its existing instruments and only limitedchanges would reduce the depth of the singlemarket. Even a positive scenario in which theeurozone solves the crisis by taking a greatleap forward in terms of economic, fiscal andpolitical integration would likely lead to thewithdrawal of some countries such as the UKand thus shrink the single market.

Business leaders across Europe are anxiously – and rightly– following news of the euro crisis: a break-up of the singlecurrency would lead to huge macroeconomic disruptions,with a large expected drop in economic activity, a strongincrease in unemployment, and potentially widespreadbank failures. The shock waves would definitely not remainlimited to the European Monetary Union (EMU) itself,but would also spread to the rest of the European Union(including countries which still retain their own currency),to the United States and Canada, and to emerging marketsfrom China to India to Brazil. Countries such as Spain orItaly are simply too big to fail. In fact, a full break-up of theeuro might dwarf the failure of Lehman Brothers in 2009.However, regardless of whether or not such a nightmarescenario becomes a reality, the euro crisis has already subtlyaltered the European single market and greatly changedthe prospects for its future. In fact, no matter how the eurocrisis plays out, the single market will never be the sameas it was during the carefree years of the 2000s. In any ofthe plausible outcomes of the euro crisis, the single marketwill emerge in a different, diminished shape – completelyshattered, reduced in depth or reduced in size. While it canbe argued that the set-up of the single market in the 2000sand gaps in oversight and regulatory framework helped fuelthe economic imbalances that now haunt Europe, it is alsoclear that the transformation of the single market will entailserious costs.

To understand this proposition, we need to look at thevarious possible scenarios in more detail. At the moment,there are three likely basic scenarios for how the euro crisismight develop: first, a full break-up of the eurozone; second,a scenario in which the current crisis is contained within thesingle currency’s existing governance structures and withits existing instruments; and third, a scenario in which theeurozone solves the crisis by taking a great leap forward interms of economic, fiscal and political integration.We also need to remember that the single market is far morethan just the legal provisions framing it. The single markethas been shaped just as much by the actions of businessleaders across the EU. It is their decisions to engage incross-border activities, cross-border marketing and cross-border production sharing that have brought the singlemarket to life. In the past two decades, the EU has becomea single market not just on paper but also in the daily livesof citizens and managers. The most visible achievement ofthe single market is the ability to make quick, hassle-freetrips for business or pleasure; within the Schengen areathere are no longer even passport controls. In fact, however,the less visible cross-border production networks that nowspan across western and central Europe are much moreimportant. A significant and growing share of trade in mostEU member states over the past decade has been made upof trade in parts and components – a sign of growing cross-border production networks. These cross-border networkshave been important not only to increase the efficiency andcompetitiveness of the European manufacturing sector, butalso to spread technological progress and hence increaseproductivity in economies of Europe that are catching upwith the most advanced member states.

The odds are that any sensible government faced with theseoptions would choose to leave the eurozone.However, since a reintroduction of the drachma wouldmean a redenomination of deposits in Greek banks intothe new currency and thus a significant loss in the valueof these deposits, a Greek euro exit could send shockwaves through the eurozone. As soon as Italian or Spanishhouseholds learn that a euro in the bank can be quicklyretransformed into a devalued national currency, a largecapital flight towards Germany can be expected to set in.This would further increase liquidity pressure on banks inSpain and Italy. If the ECB is not willing to accept liquiditysupport of several trillion euros (or if the Bundesbank isnot willing to accept a further increase in the TARGET2balances of this magnitude), other governments might befaced with a similar choice as the Greek government andmight ultimately decide to leave the euro as well.The disintegration in the monetary arena would quicklylead to disintegration in other areas: the first obvious resultof a break-up would be the reemergence of strong exchangerate fluctuations. As one of the reasons for introducing anew currency would be to be able to gain competitivenessby devaluation and the countries leaving the eurozonewould almost certainly use their regained national powerover their own central bank to stabilise their bankingsectors and finance their budget deficits with the printingpress, there could be initial devaluations of up to 50 percentor even more. Thus, such a development would thrustEurope back in time to the period of violent monetary andexchange rate instability of the 1970s – that is, before any ofthe arrangements that created at least partial exchange ratestability, such as the European Exchange Rate mechanism,in the 1980s and early 1990s. Moreover, cross-borderfinance would likely come to an almost complete standstilland costs for insuring against exchange rate risks wouldsurge. Add to this the expected wave of bank failures and onewould have to predict a sharp drop in private investment.Such a development would disrupt the single market on twolevels: the business level and the policy level. At the businesslevel, the increased risks and costs of cross-border tradewould lead to a reorientation in both production and salesactivities towards domestic markets. Exchange rate stabilityis crucial, especially for cross-border investment and cross-border production networks, as hedging through financialmarkets usually is not feasible beyond a horizon of twoyears or so. Such a renationalisation of business activitieswould lead to less competitive pressure in all countries andin a number of markets for different goods and services withnegative effects for innovation and productivity.At the policy level, a sudden burst of competitiveness incountries that devalued their currencies and an increase ofunemployment in the other countries would quickly causeaccusations of unfair competition along the lines of theclaims made by the US against China when it had fixed itsexchange rate at a low value in the late 2000s. Calls for new

Euro break-up: a shattered single marketThe worst-case scenario, obviously, would be a break-up ofthe euro. Such a scenario could begin with the withdrawalfrom the single currency of one or more members. Discussionso far has focused on a possible isolated exit by Greece, butit is far from clear whether an exit by one country can becontained or, on the other hand, whether in the process othercountries would also be forced out of the euro. In the courseof these events, it is very likely that the eurozone would endup either completely fragmented or much reduced in size –that is, without Greece, Italy, Spain, Portugal and Ireland.In such a scenario, Greece would at some point fail to serviceits debts – either because it cannot fulfill the conditions of itsbailouts and the troika stops loan disbursement, or becausenew financing needs arise and the troika is unwilling to topup existing credit lines – and would default again. This wouldcut off Greek banks (which hold a large amount of theirassets in Greek government bonds) from refinancing at theEuropean Central Bank (ECB). The Greek government wouldthen be faced with a choice: either reintroduce a nationalcurrency and recapitalise its banks through the printingpress or accept a complete collapse of its banking systemand a much deeper recession than it has so far experienced.

non-tariff-barriers for trade, capital controls or new subsidiesfor ailing industries could be expected to follow soon. Asthe break-up of the eurozone would almost certainly entailbalance-of-payments difficulties for at least some memberstates, a least some of these actions would even be legal underArticle 144 of the Treaty on the Functioning of the EuropeanUnion, which stipulates that EU member states may takeunilateral action to protect their balance of payments even ifthese restrictions damage the single market.Normally, one might hope that, together with the EuropeanCourt of Justice (ECJ), the European Commission couldprotect the single market against these threats. However, inthe break-up scenario, this hope will most likely be in vain.Under current EU law, it is not possible to leave the euro.Thus in order to leave, a country would have to either leavethe EU altogether, violate EU law and hope that no one willtake action, or seek a change to the European Treaties toaccommodate economic realities. But each of these optionswould diminish the power of the Commission and the ECJ:the EU would no longer have jurisdiction over a country thatleft the EU altogether; an open and tolerated violation of EUlaw would undermine the legitimacy of the EU institutions;and a treaty change would create the impression that EUrules were open to alteration whenever opportune.Moreover, the legitimacy and power of the EuropeanCommission stems to a large extent from the acceptanceof its rulings at the national level. If, in a situation of large-scale exchange rate fluctuations, deep recessions, recordunemployment and a general feeling that member states wereunfairly taking advantage of each other, national governmentsmight be inclined to openly revolt against EuropeanCommission proposals and regulations and ECJ rulings. Thiswould not only tie up resources that could otherwise havebeen used to push forward the single market, but might inthe end also force the EU institutions to take a more cautiousapproach in enforcing the single market.The Schengen agreement could also quickly come underpressure if the euro disintegrates. The deep recession followingthe disintegration of EMU would cause new flows of migrantsfrom crisis countries to the rest of the EU. As unemploymentwould rise all over Europe, these migrants would not alwaysbe welcome in the countries to which they moved and mighttrigger a new wave of xenophobia. As we have seen in thepast, this might be used by nationalist forces as an occasionto reinterpret, counteract or even pull out of the Schengenagreement and erect new barriers to the free movement oflabour within the EU.In short, a full-blown break-up of the euro has the potentialto shatter the single market beyond recognition. Fortunately,such a full-blown break-up looks much less likely now than itdid in the early summer 2012 before the ECB committed tointervene in the bond market if necessary to keep the commoncurrency intact. However, one still should be cautious andattribute a non-trivial probability to such a catastrophic chainof events.

Muddling through: a shallower singlemarketThe second-worst outcome of the euro crisis from theperspective of the future of the single market is a muddling-through scenario. In this scenario, there would be nostrong move towards a fiscal union, but rather only partialfixes. Incremental steps towards greater integration andthe existing rescue mechanisms would be able to stabiliseinterest rates on government bonds in the crisis countries atan elevated but not excessively high level. In such a scenario,economic growth would remain subdued in the eurozone overyears and the euro periphery would experience only a veryslow and sluggish recovery from its recession. This scenariocould also include a sub-scenario in which a small countrysuch as Greece leaves the euro but the fallout is containedand the other euro members remain in the monetary union.In such a scenario, brutal exchange rate movements andoutright attempts at beggar-thy-neighbour policies throughnominal devaluations would be prevented. But there wouldstill be dangers for the single market. In particular, the defacto disintegration in the markets for banking and otherfinancial services that we have seen in recent months couldbe expected to continue. Already, banks across the eurozonehave renationalised their business and cut back cross-border lending significantly. Over the medium term, thisdevelopment will lead to a new fragmentation of financingconditions and financing costs along national borders.This would have two effects. First, diminished competitivepressure would lead to less innovation in the quality andprice of financial and payment services for companies andEU citizens. Second, it would drive a permanent wedgebetween financing costs in Germany, the Netherlands andFinland on the one hand and Spain, Italy and Greece onthe other. As the journalist Paul Taylor puts it, “the best-managed Spanish or Italian banks or companies have to payfar more for loans, if they can get them, than their worst-managed German or Dutch peers.”1For example, Spanishglobal firms like Santander whose operations are largelyconducted outside Spain (only 13 percent of Santander’sprofits are earned in Spain) have to face higher borrowingcosts than their European counterparts, thus negativelyaffecting their market position. Such a fragmentation ofmarkets for banking services is not fair because it punishescompanies for their location and not efficient because itcancels the benefits of free markets, which are supposedto reward the best companies and punish poorly managedones. In addition, such a situation could lead to calls forgovernment subsidies in countries with high financingcosts to prevent de-industrialisation and potentially alsofor protectionist measures by their peers in the north as allmember states compete for market shares in a stagnating oreven shrinking market.

Again, the European Commission and the ECJ are usuallysupposed to prevent such policies by member states, but theywould face a number of dilemmas in this scenario. Prohibitingsubsidies that clearly distort the single market is one thing,but prohibiting subsidies that are introduced to correct amarket failure in other markets (in this case the market forbanking and financing services) is another issue and wouldcause conflicts with member states governments.The renationalisation of banking would also have another,more subtle consequence: as financing would becomescarcer and more expensive in some countries, cross-borderproduction sharing or outsourcing might become riskier andmore expensive. Again, business could to a certain extent beexpected to focus more on production in their home markets.As in the break-up scenario, though to a lesser extent, thiswould lower competitive pressure and reduce innovation inthe single market.The muddling-through scenario also poses threats to theSchengen agreement, albeit not as acute as the euro break-up scenario. Weak economic growth in Europe would meanan increase in unemployment and the long recession in thesouth would create new flows of migrants to the northerncountries. Again, the danger is that this will be exploitedby nationalist politicians to push for a rollback of the freemovement of people within the EU.Thus while the muddling-through scenario looks betterthan the full-blown break-up, it still entails significantdamage to the single market. While the single market might(almost) retain its size and geographical coverage, it wouldbe significantly shallower. This is especially tragic because,with politicians unwilling or unable to push strongly for agreat leap forward in integration, this muddling-throughscenario has long looked to be the most likely one.

In economic terms, such a move towards true federalism hasthe potential to end the euro crisis. Financing costs amongcountries would converge again once the risk of spilloverfrom national banking crises to national budgets has beenmitigated. Once it is clear that market sentiment alonecannot push interest rates to unsustainable levels and hencecannot lead to self-fulfilling speculation on a country’sdefault any more, risk premiums on government bondswould fall. Lower interest rate payments would allow for aslower fiscal adjustment path and hence a quicker recoveryfrom the current recession in the periphery. Returningbusiness confidence would add to this trend. With the riskof a euro break-up off the table, cross-border financial flowswould grow again. Overall, economic growth in the eurozonewould be much stronger in the coming years, improving debtsustainability across Europe.However, even this positive scenario entails risks for thesingle market and European integration. In principle, onecould imagine taking many of the integration steps describedabove through enhanced cooperation among the eurozonecountries – and therefore within the framework of a two-speed Europe. In practice, however, it is unlikely that such atwo-speed Europe with a stronger integration of the bankingand financial sector in the core will be viable without at leastsome of the other member states leaving the EU altogether.The drive towards more coherent financial sector supervisionin Europe after the fallout of the US sub-prime crisis 2008/9has already created conflicts between a number of continentalEuropean governments and the British government,which has traditionally had a strong national interest inprotecting its financial industry. The compromises madein the legislative process up to the end of 2011 meant thatnational supervisory authorities kept significant discretionin the regulation and oversight of their national financialinstitutions and the European authorities had limited powerwhen it came to ordering national supervisors what to do.The real banking union that eurozone leaders are nowdiscussing would mean a much stronger centralisation ofoversight – at least within the eurozone itself. However,a bank’s risk can only be fully controlled if either of thecounterparties’ risk is also controlled or if exposure to acounterparty is limited. Thus, over time, there would bepressure by eurozone authorities to impose similar standardsfor non-euro EU banks as they do for eurozone banks. Infact, the recent proposals by the European Commissionon the single supervisory mechanism (SSM) for financialinstitutions implicitly assume that at least some EU memberstates outside the eurozone will join the arrangement andfollow the rules set by the ECB. This has already createdtensions over voting arrangements in the existing EuropeanBanking Authority (EBA): Countries such as the UK whichare unlikely to join the SSM fear that they will be marginalisedand outvoted in the EBA by eurozone countries when itcomes to banking supervision. While a new compromiseis on the table, requiring a double majority (a majority ofSSM-countries and non-SSM-countries) for important EBA

Fiscal union: a smaller single marketThe third scenario is economically the most promising forEurope. In this scenario, the leaders of the euro area actuallytake a great leap forward in terms of fiscal and economicpolicy integration. This would entail a full-fledged bankingunion with a restructuring/recapitalisation mechanismat the European level, centralised banking and financialsupervision and oversight, at least some partial mutualisationof debt, a significant increase in the rescue capacities, forexample by the ECB stepping up to its promises to interveneon a large scale in secondary bonds markets or grantinga banking licence to the ESM, some transfer of revenuesources to the European level and the introduction of someinter-regional transfers to the European level to countermacroeconomic imbalances. To fulfill demands of theGerman constitution and the German constitutional court,such a leap of integration would have to come with strongerdemocratic legitimisation at the European level, eitherthrough a strengthened European Parliament or throughthe introduction of a new chamber made up from deputiesfrom the national parliaments of eurozone countries.

decisions, this is unlikely to solve the smoldering conflict:under the new set-up, three small non-SSM-countries couldin principle block what a large majority wants to do in EBA.Over the medium-term, this does not look to be acceptablefrom the point of view of the SSM-ins. If the SSM countriesreally want some financial sector regulation to be applied,they can – and most likely will – use their legislative majorityto pass secondary EU regulations to their purpose and evenall SSM-outs together will not be able to stop this. As theSSM-ins will not accept that new risks are brought into theirbanking sectors through business connections with bankswhich are regulated under different rules and standards,a compromise would be to limit business of SSM-in bankswith financial institutions in SSM-out countries. This wouldde facto fragment the markets for financial services right inthe middle of the EU’s single market.Both options would seriously alter the cost-benefit calculationof some euro-outs. This would affect Britain and its EUmembership in particular: accepting eurozone regulators’rulings would mean a loss of sovereignty in an importantpolicy area; a fragmentation of the financial market atthe eurozone’s border would be against the financialsector’s business interests and make EU membership lessattractive.Thus even in the best-case scenario the single marketwould suffer. Although it would not be shattered or becomeshallower, the likelihood of a withdrawal of one or severalcountries from the EU would increase and there willalmost certainly be a certain degree of disintegration inthe financial and banking market along currency lines. Inother words, deeper integration in the core would come withdisintegration in the EU’s periphery and shrink the singlemarket. In other words, it might be the least bad – ratherthan best – scenario.Those countries deciding to leave the EU might try tonegotiate a relationship to the EU similar to that of Norwayor Switzerland in order to remain part of the single marketfor goods. Yet this path brings at least two obstacles: first,the EU might not be willing to negotiate with past membersa set-up as generous as those for Switzerland and Norway;second, even though there might be no tariffs for trade withan EU-out such as Switzerland and Norway, there are stillcustoms controls and bureaucracy, elements which mightseriously hamper the countries’ integration in cross-borderproduction networks.

including the probable treatment of legacy problems in thebanking sector (which are still to be resolved by the nationalgovernments) as well as the slow progress on the euro-area’s new “fiscal capacity” leave the institutional outcomeshort of a fully functional fiscal and economic union.At the same time, the centrifugal political forces of the eurocrisis on the single market have become evident with theBritish Prime Minister David Cameron’s speech on Europein January 2013.2Cameron wants a “leaner” union, withmore flexibility for member states to choose or opt-out fromcertain elements of integration. Moreover, Cameron wantsto renegotiate the British relationship within the EU and willoffer the British a referendum to decide whether to stay inthe EU or to leave. Even though Cameron states that in hiseyes the single market is at the centre of the EU and Britainis at the centre of the single markets, his demands actuallythreaten the depth and geographical scope of the singlemarket. More flexibility for single countries in choosingwhich integration steps to apply will inevitably lead to a lesshomogeneous single market. The British referendum on anEU exit carries the potential of a EU with a geographicallyreduced size.

The impact on the EU’s standing in theworldThus, 20 years after its inception, the outlook for the singlemarket is not bright. This may have consequences forEurope’s standing in the world. For years, people all aroundthe world have admired the peaceful integration of Europe.In fact, a host of regional groups of countries from Asiaover Africa to South America have actually tried to copyEuropean integration when drawing up their own regionalinstitutions and rules. Even if the latest step in Europeanintegration, the single currency, is now viewed with morescepticism around the world than it was before the crisisbegan, the single market is still envied. But with cracks inthe single market appearing, it too could lose some of itsshine.This will have important consequences for the EU’sinfluence in global trade negotiations and internationaleconomic policy coordination. First, emerging markets willbe less willing to accept advice from Europe if the generalperception is that the old continent is unable to solve its owneconomic problems sufficiently. This will make it harder forEurope to pursue its interests in international institutionslike the G20 or the International Monetary Fund (IMF).Second, it will be harder for the EU to negotiate preferentialtrade agreements and free trade agreements. If the singlemarket is diminished in any of the three ways describedabove, getting access to it will become less attractive. Othercountries around the world could therefore be less willingto make concessions in return for a trade agreement withthe EU.

It is above all policymakers who can limit this fallout. A leaptowards more integration at the core seems to be the least badoption for the single market, even if it risks being reduced insize and there is some disintegration at the fringe. Of course,safeguarding the single market is not the only objective forpolicymakers. They have to weigh the cost and benefits ofdifferent policy paths. But it is important that they do notdeceive themselves and believe that the single market can beseparated from the current euro issues. The euro has beena catalyst for many elements of the deep de facto economicintegration of Europe that now exists. But conversely, theeuro crisis has also hit the single market.The potential cost of a shattered single market needs to betaken into account when deciding what to give up to save theeuro – not only in terms of monetary costs but also in termsof national sovereignty. But this lesson is also important forthe non-euro EU member states such as the UK: beyond theadverse short-term impact of the recession in the eurozoneon the rest of the EU, there are potential long term costsof the current euro crisis for them. When deciding whetherand how much they will contribute to eurozone bailouts,and how much of a two-speed Europe they are prepared toaccept, they should take these costs into account.Business leaders also have a role to play. They need tobecome more aware of the benefits the single market hasbrought them and of the risk the euro crisis entails for them.They need to clearly define their interests and then lobbyvigorously for a solution to the crisis that will be conducivefor their business activities. At times, they will need to stepup and publicly support potentially unpopular steps towardscloser integration. The single market has been a great projectthat has brought a large number of benefits to Europe, frombetter consumer choices to easier production sharing to avast market for European firms to develop and test theirproducts. Twenty years after the Single European Act thatestablished this single market was signed, it now needs allthe support Europe can collectively muster.

AcknowledgementsThis paper has benefited from ongoing discussions withinthe ECFR and with politicians, bankers and observers.Among the many with which the topic has been discussed,comments by Sony Kapoor, Mark Schieritz and DanielSchwarzer proved especially useful. Inside the ECFR,comments and suggestions by Marco de Andreis, OlafBoehnke, Ulrike Guérot, Mark Leonhard, Thomas Klau, JoséIgnacio Torreblanca and Jan Zielonka provided valuableinsights and helped structure the argument. The ECFR teamin London, in particular Alba Lamberti, Nicholas Waltonand Alexia Gouttebroze, made the internal publicationprocess swift and smooth. Hans Kundnani did a great jobediting the piece and suggesting important additional anglesotherwise underexposed in the original draft.

aBout ecFrTheeuropean council on Foreign relations(ECFR) is thefirst pan-European think-tank. Launched in October 2007, itsobjective is to conduct research and promote informed debateacross Europe on the development of coherent, effective andvalues-based European foreign policy.ECFR has developed a strategy with three distinctive elementsthat define its activities:•pan-european council.ECFR has brought together aadistinguished Council of over one hundred and seventyMembers - politicians, decision makers, thinkers andbusiness people from the EU’s member states and candidatecountries - which meets once a year as a full body. Throughgeographical and thematic task forces, members provideECFR staff with advice and feedback on policy ideas and helpwith ECFR’s activities within their own countries. The Council ischaired by Martti Ahtisaari, Joschka Fischer and Mabel vanOranje.•physical presence in the main eu member states.aECFR, uniquely among European think-tanks, has offices inBerlin, London, Madrid, Paris, Rome, Sofia and Warsaw. Ouroffices are platforms for research, debate, advocacy andcommunications.•distinctive research and policy development process.aECFR has brought together a team of distinguishedresearchers and practitioners from all over Europe to advanceits objectives through innovative projects with a pan-Europeanfocus. ECFR’s activities include primary research, publication ofpolicy reports, private meetings and public debates, ‘friendsof ECFR’ gatherings in EU capitals and outreach to strategicmedia outlets.www.ecfr.eu