For the European Union, the hour of truth in the financial crisis struck on the morning of September 30 in Dublin. Fifteen days after the collapse of Lehman Brothers, arguably the defining moment of the crisis in the US, the Irish government announced that it would guarantee all deposits at six of Ireland’s big financial institutions.
The move sucked in funds from the UK, threatening to destabilise the British banking system, and prompted similar unilateral announcements of unlimited deposit guarantees elsewhere, above all by Germany on October 5. These measures neatly encapsulated the EU’s inability to forge a collective response to the crisis.
Almost two months later, the EU is getting its act together and has avoided the prospect of direct national control of the European financial system – an outcome that would have inflicted untold damage on the 27-nation bloc’s experiment in gaining strength by sharing sovereignty. Even so, the fall-out from the crisis, in terms of economic reform, trade, financial regulation, the EU’s institutions and the political fate of the continent’s leaders, promises to be immense.
Some enthusiasts of closer integration fear the crisis will deal a heavy blow to the European cause. But policymakers and experts with long experience of the EU and its sometimes audacious, sometimes hapless efforts at unity are less pessimistic.
“It’s fair to say that the EU’s initial response was inadequate, but it is always through crisis that the EU becomes a little less inadequate further down the road,” says Mario Monti, a former EU commissioner. Mr Monti and others draw parallels with the turmoil unleashed in 1992-93 on the EU’s exchange rate mechanism following German reunification. Far from consigning the vision of a single European currency to dust, the upheavals reinforced the determination of leaders to press ahead and led to the euro’s birth in 1999.
For many governments, the latest crisis has seen the euro truly prove its worth. A vulnerable country such as Ireland might have suffered financial meltdown had it not been protected by its eurozone membership. “The security provided by the euro gives Ireland an opportunity to navigate the toughest economic conditions in the history of the state,” says Joe Gill at Bloxham, a Dublin-based stockbroker.
Non-members such as Hungary, which needed €20bn ($25bn, £17bn) in emergency aid, and Iceland, whose currency and biggest banks collapsed, were exposed to the full force of the crisis. Even Denmark, a paragon of Scandinavian economic virtue, had to raise interest rates twice last month to defend the krone. A new Danish bid to join the eurozone seems certain and may be matched by Sweden.
In Warsaw, where the Polish government has hastily drafted a plan to adopt the euro by 2012, entry cannot be taken for granted because the issue is politically divisive. It seems likely nonetheless that the currency union, which is to take in Slovakia on January 1 as its 16th member, will widen even more in the coming years.
This is not to say that everything is rosy in the eurozone. As is shown by the increasing spreads between the yields on government bonds of Greece, Italy and other countries over those of Germany, financial markets do not treat the area as a single entity. Investors are well aware that the EU, unlike the US, is not a federal state and has no central fiscal mechanism to transfer funds from a stable, prosperous country to a country in trouble.
With the yield spreads at their highest in the euro’s nearly 10-year life, investors may pay closer attention during Europe’s unfolding economic recession to what some see as the root cause of such gaps and the most serious weakness of the eurozone’s Mediterranean members – a persistent lack of business competitiveness compared with Germany. Only structural economic reforms can address the problem but it is questionable whether Athens, Lisbon or Rome will have the political strength or willpower to introduce such reforms during what is shaping up to be a long and grim recession.
More likely is the prospect of significant changes in eurozone governance. A taboo was broken on October 12 when President Nicolas Sarkozy of France convened the first ever summit of eurozone heads of government. Strictly speaking, the presence of Gordon Brown, UK prime minister, made this a “eurozone plus one” affair but there was no mistaking the meeting’s importance. “The crisis will lead to closer economic co-ordination everywhere, and that includes the eurozone,” says Angel Gurría, secretary general of the Paris-based Organisation for Economic Co-operation and Development, the developed nations’ club.
For almost 10 years, Germany had shown little enthusiasm for eurozone summits, suspecting a French desire to “politicise” the single currency and compromise the European Central Bank’s independence. In the future, there will seem nothing extraordinary about eurozone leaders getting together.
Mr Sarkozy did, however, overplay his hand by suggesting that he could continue to preside over such meetings next year, when two non-eurozone countries – the Czech Republic, then Sweden – inherit the EU’s rotating presidency from France.
The crucial parts played in the crisis by Mr Sarkozy and Mr Brown contrast with the role of the European Commission. The Brussels-based executive has attracted criticism for supposedly being “behind the curve”. A Commission proposal to increase bank deposit guarantees, for example, emerged only after EU finance ministers had taken the lead and was made public more than a year after the run on Northern Rock, the subsequently nationalised UK mortgage lender.
“They had known this was a problem ever since Northern Rock. I don’t know why it took so long for them to do something,” says Karel Lannoo from the Centre for European Policy Studies think-tank in Brussels, who criticises the “absence” of the Commission. “The Commission was not the motor but the decelerator of European integration.”
In their defence, senior Brussels officials say José Manuel Barroso, Commission president, had his hands tied by governments that wanted at first to handle the crisis primarily at national level. Without naming names, Mr Barroso has observed pointedly that some important member states – the UK springs to mind – were reluctant to support stronger financial market regulation until the crisis hit maximum intensity.
Moreover, Commission initiatives over the past three months cover everything from capital requirements and accountancy rules to credit rating agencies, while more is in the pipeline on derivatives, hedge funds and executive pay. A high-level group chaired by Jacques de Larosière, a former managing director of the International Monetary Fund, is to report to EU leaders next March on methods to improve cross-border financial supervision.
Next Wednesday the Commission will announce an economic recovery programme that will invite member states to launch fiscal stimulus packages. It will also propose accelerated spending of aid for the poorer parts of the EU.
Some politicians remain scathing. Socialists in the European parliament have demanded that Charlie McCreevy, the internal market commissioner with responsibility for financial market regulation, be switched to a different job. In a Financial Times interview, Joschka Fischer, the former German foreign minister, attacked the Commission as “weak right now, with an even weaker president who, as a reward for his weakness, is about to get another five-year term in office”.
Perhaps a more disturbing risk is that the financial crisis, by discrediting free markets in the eyes of many Europeans and unleashing forces of populism and economic nationalism, will ensure that the next Commission, due to be appointed 12 months from now, will have a much less liberal face than the present one. It is easy to imagine Mr Sarkozy and other leaders putting pressure on Mr Barroso, if he is reappointed, to pick commissioners for trade, agriculture, competition and the internal market who will reflect the new political climate.
This, in turn, is likely to make it even harder for free-marketeers to win the argument in matters such as the long-running battle to liberalise the services sector. Plans to adopt binding legislation next year on the fight against climate change may also be affected. Mr Barroso, a passionate supporter both of free trade and of ambitious actions to address global warming, may feel compelled to go along with efforts to introduce disguised protectionist measures such as carbon tariffs, which would be imposed on goods from countries such as China whose greenhouse gas emission policies were deemed below European standards.
The EU’s ability to hold the line on its state aid and competition rules will also be tested, a point made clear last month by Silvio Berlusconi, Italy’s prime minister. “State aid, which until yesterday was considered a sin, is now absolutely essential,” he said delightedly.
European carmakers have already won a sympathetic response from Brussels for their request for €40bn in soft loans to match similar aid for their US competitors. With the precedent of government-directed bail-outs of European banks in mind, other industries may not wait long before putting in their own requests.
Meanwhile, Mr Sarkozy and Mr Berlusconi have made it plain that they see the crisis as a golden opportunity to strengthen the defences of French and Italian companies against hostile foreign takeovers. The French president has even appealed for the creation of European sovereign wealth funds to take stakes in large companies with battered share prices.
Germany’s brusque dismissal of this idea underlines how the crisis has tested the Franco-German relationship, never at its happiest during the year and a half that Mr Sarkozy and Angela Merkel, German chancellor, have been simultaneously in power. French interest in a common EU bank bail-out fund was instantly squashed by Germany, while France was aghast at Germany’s blanket guarantees for bank savings – a step taken only a day after Mr Sarkozy, Ms Merkel, Mr Brown and Mr Berlusconi had agreed in Paris on the need for close co-ordination of national actions in the crisis.
Most unlikely European hero of the moment is Mr Brown, who last December was so allergic to the spirit of continental camaraderie that he chose to sign the EU’s Lisbon treaty on institutional reform on his own, hours after his fellow leaders. In this emergency, he set the pace with his insight that recapitalisation of banks had to be a central component of the bloc’s policy response. He has reaped the reward in climbing opinion poll ratings.
But the punishing recession confronting the UK means Mr Brown has his work cut out to win the next general election, due by 2010. The same is true for Ms Merkel, but her Christian Democrats are helped by the low poll ratings of their Social Democrat coalition partners. Much interest in next year’s German election will focus on the performance of the Left party, which is made up of former east German communists and disaffected SPD leftwingers and hopes to benefit from the financial crisis and recession.
For his part, Mr Sarkozy has displayed energy and imagination in his leadership of the EU at a truly critical moment in its 50-year history, ensuring that Europe will have an influential hand in the coming restructuring of the world’s financial architecture.
Characteristically, however, he has also exploited the crisis to promote French notions of state-guided capitalism at the expense of what he and a multitude of other continental Europeans see as the failed neo-liberalism of the US and UK. To tame these ambitions, Mr Brown may usefully recall what George Curzon, the early 20th-century British statesman, once said of the UK-French relationship: “We go about arm in arm with her, but with one of our hands on her collar.”