Market pressures on ailing Euro-zone countries persist and the Merkels and Sarkozys struggle to find an answer. The latest hype gaining ground is the idea of Eurobonds. These would be jointly issued bonds by all Euro-zone (or even EU) governments to finance government debt by national (or sub-national) governments.
Ironically, I remember several interesting discussions with my Italian federalist friends who have always lobbied within JEF and UEF to support the introduction of Eurobonds – to allow the EU (budget) to run deficits primarily for EU-wide infrastructure projects. I have always (and continue to) oppose this idea because I think we do not need another layer of debt in the EU while there is sufficient room for mobilising funds to invest in EU-wide infrastructure projects from the ineffective CAP and structural policy – and where necessary also from national coffers. While the financing mechanism for these Eurobonds would be the same, the current discussion is promoting Eurobonds on a very different level.
Eurobonds to solve the debt crisis
Eurobonds as advocated these days are seen as a tool to lower borrowing costs for peripheral Eurozone countries (Greece, Ireland etc.) who struggle with run-away interest rates on newly issued debt. They are practically cut off from the market, hence EU intervention mechanisms like the EFSF are now used to finance their debt. In some ways the EFSF is not so much different from the Eurobonds discussed today except the fact that the EFSF is primarily seen as a crisis intervention – and not a permanent – vehicle. Because (just like with the EFSF) Eurobond debt is guaranteed by countries like Germany or the Nordics borrowing is cheaper for such jointly guaranteed Eurobonds. So, why should we not issue Eurobonds for all EU countries, lowering borrowing costs for those in trouble and thereby help them out? – Because of moral hazard, you silly.
If deficit-prone countries can borrow at cheap rates again, what is their incentive to create sustainable public finances in the first place? Experience tells us that without tougher institutional provisions this is unlikely to happen: When (debt) interest rates decreased dramatically for countries like Italy or Greece after they joined the Euro in the early 2000s, their budgetary profligacy did not stop. Allowing them cheap access to new bonds is unlikely to change the picture. Unless it is done in a more intelligent way this time…
How to make Eurobonds work
The primary challenge is to prevent a repetition of what happened after the Euro introduction, i.e. letting countries accumulate even more debt because the interest on it is so cheap. However, if there were mechanisms to overcome this problem, then Eurobonds would be a helpful tool to potentially help Greece et al. out of the debt spiral they are in. How can this be done? – I believe this can be achieved through a number of (national) institutional provisions, which should be made a pre-requisite for anyone seeking Eurobonds. Such measures should include:
– a zero-deficit (balanced-budget) rule at national and sub-national level that is anchored in the constitution. Realistically, it would be phased in, just like Germany’s ‘Schuldenbremse’;
– a rainy-day fund (Singapore-style?) that takes away from policy-makers at least 50% of budget surpluses and any privatisation proceeds. It may only be tapped under severe economic downturns;
– an independent adviser on national economic development who suggests the growth assumption underlying the national budget (this could e.g. be the EU Commission, OECD etc). Any surplus achieved during the financial year or revenue beyond the initial projection would be locked up;
– a mechanism of regular EU inspections to oversee the reliability of national public finances (maybe via a special cooperation between OLAF-like units and Eurostat);
– a maximum debt level financed through Eurobonds. This could conveniently be at 60% (following the Maastricht criteria) but I think it should be lower at maybe 30%;
– an initial list of state assets that are handed over to the rainy-day fund to be sold or privatised whenever the highest value can be obtained;
– a sustainable answer to government pension (and potentially health) obligations, ideally by at least prohibiting defined-benefits for government employees as well as serious pension ages in the public sector.
This list is long and more than demanding. But given that trust is weak following the mess we are in, these provisions should act as a strong commitment stick for every government that wants to seriously get out of the mess.