The Birth of Fiscal Unions

Russia’s World War I credit arrangements anticipated some of the political maneuvering about debt and its relation to security that occurred in late-twentieth-century Europe. Post-1945 West Germany was vulnerable for a long time, because it sat on the Cold War’s fault line. As a result, West German governments offered neighboring countries financial help in exchange for security and political solidarity, especially at moments when they were uncertain about the reliability and continuity of US support.

But there were limits. In 1979, when West Germany adopted a fixed exchange-rate regime with a support mechanism for its partners (the European Monetary System), the Bundesbank ensured that it was not committed to unlimited currency interventions and that it might stop when the stability of the Deutsche Mark was endangered.

The logic was repeated on an even larger scale at the beginning of the 1990’s, but this time without any pre-determined limits. The European Union’s commitment to monetary union enabled the eurozone’s Mediterranean countries to improve their debt dynamics and public finances dramatically. Their borrowing costs fell as they locked their currencies into a union with countries – Germany, in particular – with a stronger reputation for stability.

At that point, the problem of how to divide the eventual bill when things became costly was not addressed, and the problem of excessive debt was wished away by the establishment of convergence criteria (which were not fully implemented anyway). But, since 2009, when financial distress in the eurozone’s periphery brought such problems to the fore, Europeans have faced the same question as the WWI Allies. Are security and political interests so overwhelming that they justify assuming large and unlimited liabilities incurred by political systems over which they have no control?

Because Europe is at peace, with no singular, overriding security threat, it is likely that when the extent of the bargain becomes clear, voters and politicians in the rich creditor countries will reject it. But the more uncertain security challenges that Europe faces may just demand the kind of strong fiscal link that the French and Russians were willing to forge before 1914, and that the Germans and French embraced in 1950.

The implications for the present are important: the only palatable way in which the necessary balance between liability and security can be achieved is through a process of political reform that dissolves corrupt oligarchies and weakens incentives for fiscal imprudence. One approach might be to ask citizens in all European countries whether they are prepared to accept some sort of fiscal compact involving a hard limit on debt.

Germans refer to this solution as a Schuldenbremse (debt brake). It presupposes a profound process through which institutions and the assumptions underlying them come to be widely shared. But that takes time, as the history of the US – the world’s most successful union born of emergency – amply demonstrates.

Harold James, Professor of History and International Affairs at Princeton University and Professor of History at the European University Institute, Florence, is the author of Making the European Monetary Union. Jennifer Siegel is a professor of history at Ohio State University.

Copyright: Project Syndicate, 2013.

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