The eurozone crisis will likely see the emergence of a new tax- and debt-raising authority in Brussels, according to Andrew Lilico. The economist, who has the ear of the UK government, tells EURACTIV in an exclusive interview Brussels would be trusted by Germans to distribute money in the euro zone, but Silvio Berlusconi is not.
Dr Andrew Lilico is a director and principal of consultancy Europe Economics. He is a member of the UK's Shadow Monetary Policy Committee and has directed major projects on financial regulation for the European Commission, European Parliament, and the UK’s Financial Services Authority, as well as major private sector bodies such as the Corporation of London.
In relation to its deficit reduction policy, his ideas have been described by UK state broadcaster the BBC as providing the “essential theory behind the Coalition's strategy”.
Lilico spoke with EURACTIV’s Jeremy Fleming on 8 August from London.
How realistic are the dangers that there could be a sovereign default in Italy?
Italy will default only if the whole euro collapses, Italy will not default whilst in the eurozone because the founding six members will not allow themselves to be separated.
I think that the speculation is also overdone. I do not think that the euro will collapse and I do not think Italy will default, and the prices are wrong, the problem lies in the failure of policymakers to deliver confidence to the markets.
If the speculation is overdone, are not the speculators to blame, should they not be reined in?
I think it’s a mistake to bash speculators, you are shooting the messenger. The markets are too deep and liquid to be moved by individual groups of hedge funds and so forth. The movements on the markets are being driven by opinion, not by volume shifts.
This week the UK government has underlined its agreement with EU fiscal integration and the creation of a eurobond, the Germans remain unconvinced, why?
I think that the German antipathy is to a particular concept of a fiscal union, which one might think of as a transfer union.
So the Germans are not going to agree to any arrangement whereby Germans send money to Italy for the Italian government to spend as it will, or whereby Germans backstop guarantee Italian government spending. In my view that is just not going to happen. If it was credible that they could do it as a "one-off" then maybe you could just about imagine it, but they are not going to commit to doing that on a long-term basis.
At the same time the euro can only really function if there are much greater transfers. The only way that can work – in my view – is if the Germans are giving money for someone to spend whom they trust, which isn’t Silvio Berlusconi.
The only people whom they trust – assuming that the Italians are not going to volunteer to allow the Germans to spend their money for them – are people in Brussels. So the only way it can work ultimately is to have much greater centralisation of spending decisions.
Fiscal integration could not be controlled from the member states?
So the transfer union concept – or the fiscal union of the sort which I described (of which one version would be collective Eurobonds) I do not think will work.
The way that it will have to work is that the money goes to Brussels and Brussels then spends the money in Italy.
There are in fact two versions of this kind of spending already: one is the existing EU structural funds, and leaders announced an increase in these at the 21 July summit (the exact level of the increase remains unclear), the other thing is EFSF direct funding to banks, again sanctioned at the summit.
But there is no central banking or distribution authority in Brussels, how could that work on a much larger scale?
The EFSF direct funding for banks will be a proto-function for a spending authority in Brussels. A body that had the authority do that spending might – in addition to being able to raise taxes – want to have the ability to raise debt as well.
So if what you mean by eurobond is that a central Brussels authority were entitled to raise its own debts, then I think that that is plausible. But if what you are talking about is an arrangement whereby you pool the debt-raising across the EU, then I think that that is a non-starter.
Where could that reside in Brussels?
You would need a spending authority, now you could imagine that slotting in in some way into the Commission, the current spending functions are spread across several bodies as things stands.
I suspect that the Commission is an important vehicle, but you would probably need day-to-day involvement of the Council of Ministers. That could possibly make for a new DG, with the ability to raise taxes through the Parliament and approved by the Council. There are a number of options taking forward the idea of the current mechanisms for spending structural funds. That would be an extension of what the EU already does. A transfer union concept also would mean that there would be constraint and oversight. Italians would be much less resistant to conditions coming from same type of arrangement as the structural funds [rather than directly from Berlin]. The founding EU six countries have been doing this since the 1950s and a natural continuation of such a system is much less unthinkable than dissolving the euro or transfer unions.
Which ever way it goes, the national parliaments would have to have less fiscal discretion and deficits of more than 1% or 2% of GDP – lower than the 3% Maastricht criteria – will require pre-approval from Brussels. So there would be greater central spending, some central tax and some debt raising, although you could imagine larger contributions from member states also.
Would that have a negative impact on the EU membership of non-eurozone, traditionally eurosceptic countries, would they be sidelined?
Not really, it would deliver the kind of Europe that British Eurosceptics have always wanted and wanted to renegotiate. The single currency has always been a single-state project, it always was, up to the point where there were member states that did not want to become members of the euro. Under this outcome the UK, Denmark and others will remain in a two-tier Europe. If you think things might go in that direction it would take the pressure off the eurosceptics from doing anything very much. It encourages them to be lazy. There would, of course, still be people who would want to leave altogether, but I think they would become fewer. In my view, if nothing changes the destiny of Europe then the internal politics will take the UK out if the EU within the next ten years. Bear in mind that in the UK 86% of people are opposed to the Lisbon Treaty, so this fiscal integration would rescue the UK from euroscepticism.
Are eurobonds likely to appear in the short term?
Not likely. Increasing intra-euro zone competition by greater use of structural funds and much greater governance oversight is the way they ought to, and will, go. As President Sarkozy said in his 21 July statement, European leaders will come out with clearer governance plans in the next two months.
I think that they will start with systems that increase contributions by member states, perhaps with some kind of token tax just to “breach the dyke” on Europe raising taxes directly.
Over time they will extend the role – the balance of direct European taxes to contributions – and, once they have got taxes into position, then they will move on to considering how Europe can issue its own debt.
The other scenario where you get debt issuance near the start is a eurobond-backstopping scenario (as discussed, and rejected, above). The Finns and the Slovakians would not agree to that and the Germans the Dutch and the Austrians are going to find it very difficult to agree to any kind of arrangement that pools their debt with Italy and Spain. It’s one thing to help out Cyprus or Ireland, difficult to bail out Greece, but with Italy and Spain, the amounts are not credible for a debt bail out.
How far can the ECB go in buying sovereign debt in Italy and Spain before itself experiencing problems?
The ECB can only buy a little bit of time. I think the fuss about Spain and Italy is overdone. Spain’s issue is its banking sector, its sovereign debt is not under any particular threat in my view.
The Spanish banking sector and its sovereign debt are not so intertwined as is the Irish case, whereas in Italy the country will peak out at debt of 125% of GDP. But Italy was running 120% of GDP debt 20 years ago, and somewhere between 100-120% is what they have lived with for a long time. They will suck up their debt, and they had a special Maastricht tax to get them into the ERM in the first place.
If push came to shove and they were really down on their luck and they needed to raise a special tax to keep the government going I think that they would do it. I do not see there as being an Italian issue.
There are scenarios out there where things get very bad, but I personally believe that they will suck it [the debt] up, they will make some treaty changes, there will be much deeper political and economic integrations in the eurozone, and they will kick out a couple of members. It is hard to say whom, but certainly the Greeks, I don’t know whether the Portuguese will survive, and it will all work out in the end. Where the ECB will be in trouble will be in respect of the Irish banking sector, and the Greek and Portuguese government bonds, but the ECB will probably make money on the Spanish and Italian bonds it is buying.