Question of political will

Within the euro-area, the focus will be on the 'blueprint' of measures proposed by European Commission President Jose Manuel Barroso on November 28. Some of these measures, like the strengthening of macroeconomic policy coordination, are already in progress and require only minor adjustments to be completed. Others, like the movement toward a comprehensive banking union with common deposit insurance, banking resolution, and supervisory mechanisms, are more controversial and are likely to be achieved only in part. Still others, like the centralisation of treasury facilities in the European Commission and the introduction of short-term euro-bills, are much harder to imagine. The new Dutch government has already expressed its opposition to more centralisation of powers in the EU, an attitude consistent with its recent and challenging coalition negotiations. Other governments facing similar challenges (such as Finland) are likely to follow. The relaxation of pressure is also felt outside the euro-area. This is most obvious in Hungary, where the government no longer feels bound to make concessions for IMF support -- indeed, it is actively campaigning against IMF conditionality. There are also signs that some of the political urgency is draining out of countries like Poland and the Czech Republic, too. This is only natural and outside Hungary it may not be a problem. Nevertheless, the narrative that 'political complacency has set in now that the crisis has abated' is likely to grow particularly if, as expected, the European Council summit this December shows few signs of progress.

Appropriate reforms?

There is growing evidence to suggest that some of the economic prescriptions being applied in the crisis are misguided. The emphasis on fiscal austerity and competitiveness measures is a good illustration. If it turns out that export competitiveness is less important than domestic consumption and government spending is strongly correlated with faster rates of growth, then many of the reforms currently described as essential may turn out to be counter-productive. Moreover, the goals of the reforms may not be ambitious enough to prevent a future crisis. Specifically, it is worth considering whether Europeans can ever strengthen the resilience of their economies by focusing so much attention on rules and enforcement. Indeed, it may be possible that 'resilience' is too modest an objective for European reform. It is useful to recall what made the European macroeconomic framework so fragile in the first place -- the failure to anticipate the future when writing the rules: The architects of the procedures for multilateral surveillance never considered that small countries would need to run ever-larger fiscal surpluses, yet that is what triggered the conflict between the Ecofin Council and the Irish government in 2001.   They never imagined that Germany would fall foul of the prohibition against excessive deficits either, yet that is what led to the suspension of the rules in November 2003.   Nor did they anticipate the turmoil in sovereign debt markets as well as the destructive link between national banking systems and sovereign finances, yet these lie at the core of the problems that Europe faces today. Since current efforts to broaden and strengthen the rules for macroeconomic policy coordination will probably fall prey to some other failure of foresight, it is worth asking whether European politicians have considered sufficiently how they will adapt these rules in the future and in the face of unforeseen events. Here the answer is unclear. Neither Barroso's 'blueprint' taken as a whole nor the component proposals to reform macroeconomic governance, banking supervision and sovereign finances at the European level provide much insight into how the European governance system will adapt to unforeseen circumstances. They will be more resilient in the face of adversity, but they will remain fragile. Antifragile, a new book by Black Swan author Nicholas Nassim Taleb, encourages this line of questioning. His point is that policymakers should design mechanisms to learn from their mistakes and to grow stronger through crisis. This is the essence of what Taleb calls 'anti-fragile'. As Gillian Tett notes in the Financial Times, 'antifragility' goes beyond 'resilience' because it implies a built-in pattern of adaptation. Applied to Europe, anti-fragility means that European political leaders need to focus attention on discretion as well as rules. So far, that focus has been lacking. Despite working at breakneck speed (by their own standards of decision-making), Europe's political leaders have appeared to the outside world to be barely muddling through. Only the ECB has proved 'decisive' in adapting to an unfamiliar situation. In doing so, the ECB has bought time for Europe's political leaders to catch up. However, the next crisis may not be amenable to ECB intervention. Should that happen, Europe's political leaders will likely be too slow to respond. The problem will not be a lack of will, but the lack of appropriate institutions. Unless we believe current leaders can imagine all future possibilities, now is the time to start thinking about how future leaders should learn to adapt to what today's heads of state and government fail to anticipate or get wrong.

I trust you have found this weekly Europe Compass note helpful. The Europe Compass is one element of Oxford Analytica's Europe Practice, which provides analytical insight and advice on the changing political economy of Europe and the implications for corporations, investors and public institutions in all markets and regions. I invite you to contact me or anyone at our Europe Practice with your queries or concerns.

Dr Erik Jones Head of Europe ejones@oxford-analytica.com www.oxan.com Tel: +44 1865 261600