Democracy versus the Eurozone

Last October, Greece’s then-prime minister, George Papandreou, proposed a popular referendum on the second rescue package that had just been agreed at the EU’s summit in Brussels. He was quickly told off by German Chancellor Angela Merkel and former French President Nicolas Sarkozy, and Greeks never voted on it.

But, less than a year later, the referendum is de facto taking place anyway. In a union of democracies, it is impossible to force sovereign countries to adhere to rules if their citizens do not accept them anymore.

This has profound implications: all of those grandiose plans to create a political union to support the euro with a common fiscal policy cannot work as long as EU member countries remain both democratic and sovereign. Governments may sign treaties and make solemn commitments to subordinate their fiscal policy to EU rules (or to be more precise, to the wishes of Germany and the European Central Bank). But, in the end, the “people” remain the real sovereign, and they can choose to ignore their governments’ promises and reject any adjustment program from “Brussels.”

In contrast to the United States, the EU cannot send its marshals to enforce its pacts or collect debt. Any country can leave the EU, and thus the eurozone, when the perceived burden of its obligations becomes too onerous. Until now, it had been assumed that the cost of exit would be so high that it would never be considered. That is no longer true, at least for Greece.

But, more broadly, EU commitments have now become relative, which implies that jointly guaranteed Eurobonds cannot be the silver bullet that some hope. As long as member states remain fully sovereign, no one can fully reassure investors that in the event of a eurozone breakup, some states will not simply refuse to pay, or at least refuse to pay for the others. It is not surprising that bonds issued by the European Financial Stability Facility (the eurozone’s rescue fund) are trading at a substantial premium over German debt.

All variants of Eurobonds come with supposedly strong conditionality. Countries that want to use them must follow strict fiscal rules. But who guarantees that these rules will actually be followed? François Hollande’s victory over Sarkozy in France’s presidential election shows that an apparent consensus on the need for austerity can crumble quickly. What recourse do creditor countries have if the debtor countries become the majority and decide to increase spending?

The recently agreed measures to strengthen economic-policy coordination in the eurozone (the so-called “six pack”) imply in principle that the European Commission should be the arbiter in such matters, and that its adjustment programs can formally be overturned only by a two-thirds majority of the member states. But it is unlikely that the Commission will ever be able to impose its view on a large country.

Spain’s experience is instructive in this respect. After the recent elections there, Prime Minister Mariano Rajoy’s new government announced that it did not feel bound by the adjustment program agreed to by the previous administration. Rajoy was roundly rebuked for the form of his announcement, but its substance was proven right: Spain’s adjustment program is now being made more lenient.

The reality is that the larger member states are more equal than the others. Of course, this is not fair, but the EU’s inability to impose its view on democratic countries might actually sometimes be for the best, given that even the Commission is fallible.

The broader message from the Greek and French elections is that the attempt to impose a benevolent creditors’ dictatorship is now being met by a debtors’ revolt. Financial markets have reacted as strongly as they have because investors recognize that the “sovereign” in sovereign debt is an electorate that can simply decide not to pay.

This is already the case in Greece, but the fate of the euro will be decided in the larger, systemically important countries like Italy and Spain. Only determined action by their governments, supported by their citizens, will show that they merit unreserved support from the rest of the eurozone. At this point, nothing less can save the common currency.

Daniel Gros is Director of the Brussels-based Center for European Policy Studies. He has worked for the International Monetary Fund