Monday, 30 April 2012

Governments,Governance and Elections - Implications for the Eurozone

In the previous blog entries I focussed on how good governance is a desirable public good but that it is tremendously difficult to export. Effective demand requires domestic political will and often it is in difficult times of austerity that sacred (policy) cows are sacrificed to the alter of balanced-budgets and sovereign de-ratings. And this equally true in developed mature economies.

Which brings me back to the challenges of governance back in the EU which often preaches developing and would-be EU entrants on the morality of good governance.

We are now in the 5th year since the onset of the financial crisis in 2007. And nowhere near the end of the pain. The news from Spain grows ever-more grim: unemployment is now 1 in 4 and the yields on its debt beginning to inch up. The new government of Rajoy has been in power since November and is in a governance-bind: its domestic political mandate is in effect hostage to the Eurozone agreement for greater austerity to balance books through the Fiscal-Compact .

And pretty much the same picture facing other so-called core Eurozoners: domestic audiences want to see growth: prosperity and jobs in their cities and countries from Finland to Portugual and from Ireland to Slovenia, irrespective of what is agreed for other places.

And this places the current Eurozone framework and, in the absence of a common fiscal policy, the intended 2nd best fiscal co-ordination through mechanisms such as common surveillance and fiscal rules with binding restraints, in a very sticky situation.

In the same way as donors call the shots in the development world since its their money, it is broadly true also for the Eurozone with the creditors doing the same -  be they via the writeoffs of Greek or Irish debt or explicit transfers in the form of EU Structural Funds.

What is different now in 2012 is that domestic EU politics is now taking centre stage and slightly away from the economics/financial debate of what is now the “new norm” of negative or low-growth trajectories for almost all economies aside from Germany and the Scandanavian countries – and even here the dynamics of political economy have changed as Finland has highlighted of late.

How will this play out at the Eurozone level? I expect increased volatility as populist sentiment of pre-electoral phase leads to a more centripetal trend within each of the countries facing elections as simple self-interest comes to the fore. In this sense every Eurozone as well as other non-Eurozone EU countries are in the same boat.

There is already a whiff of this as EU politicians feel the political winds and adjust their antennae accordingly – whispers of a more growth-enhancing focus have quickly matured to Euro-speak and the rather boringly termed Growth Compact that needs to be incorporated as a complement to the Fiscal Compact.

In the end it will still come down to who is the net creditor and Germany will continue to be the ring-master but expect a continuity of EU salami-style economic decision making with gradual weakening of German resolve for pooling sovereign risk and the weakening the Fiscal Compact deficit limits as the new government heads – most likely led by the equally soporific-looking would-be new French president Hollande – gang up. Expect a continuing policy of loose monetary policy under the stewardship of Mr Draghi to soothe bank balance sheets. The EC as the EU’s executive already has off-the-shelf papers ready to be launched if and when we see something like the Growth Compact emerge.

In the meantime, there will be some rocky moments still ahead including the always entertaining Referendums in Ireland – this time on the Fiscal Compact on May 31st coupled with a  possible tail risk that the apple cart of political stability is genuinely toppled through the election of extremists bent on fighting the EU diktat, leading to a possible exit from the Eurozone.

Folk have previously discussed the possibility of Greece exiting the Eurozone, but what probability of say Holland or another core country doing so?  

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