October 13, 2011
Open Europe blog team
Richard Sulik has emerged as Brussels’s public enemy number one. As leader of Slovakia’s Freedom and Solidarity party, or SaS, Mr. Sulik has consistently and vocally opposed euro-zone bailouts. SaS parliamentarians’ refusal to back changes to the European Financial Stability Facility led to the collapse of the Slovak coalition government on Tuesday—a powerful illustration of the far-reaching political impact of what some still think is only an economic crisis.
Mr. Sulik’s opposition to paying for what he describes as other people’s mistakes led Germany’s Handelsblatt this week to label his anti-bailout movement a “central European tea party.” Yesterday Slovak lawmakers reached a deal to pass the EFSF expansion in a fresh vote before the end of the week. But at what cost?
There are strong arguments in favor of approving the changes to the EFSF, especially if it will be used to strengthen Europe’s banks. But consider this: In 2010, Slovakia’s GDP per capita was €11,692, while Greece’s was €19,822. Going into this crisis, average earnings in Slovakia stood at €8,700 per year, while in Greece they were around €23,900. Meanwhile, the average Slovak pension was €250 per month, compared to €830 a month in Greece. True, the Greek government has made efforts to adjust the country’s entitlement culture, but you can see why sympathy for Athens is in short supply in Bratislava.
There is another and arguably more compelling reason why Slovaks should question the need to cough up in the name of so-called European “solidarity,” though. Certainly, Slovakia has benefited from euro-zone membership and from EU funds, largely financed by taxpayers in countries such as Germany, Finland, the U.K. and the Netherlands. But Slovakia has also paid a price. Over the last two decades, the country has undergone painful structural reform on the path from communism to a market economy, and later to EU and euro-zone membership. By streamlining its tax code, labor market, social welfare and pension systems, it reduced unemployment, attracted foreign investors and created a base for long-term economic growth.
The immediate effects of reform have not always been easy to swallow. Between 1999 and 2001, the liquidation and restructuring of Slovakia’s publicly and privately owned banks cost the economy between 11% and 15% of GDP, leaving the banking sector almost completely in the hands of foreign owners. But for the most part it worked, and Slovakia’s financial system emerged stronger than it was before.
Having walked this difficult road, Slovakia is now being asked to provide loan guarantees to bail out countries that failed to enact similar reforms. You don’t have to be a paid-up member of the Austrian school of economics to see the potential for moral hazard on a huge scale.
First, banks in several triple-A economies, including Germany, continue to live under the protection of sovereign bailouts and ECB liquidity. They have not been forced to restructure and recapitalize, even though this is an absolutely necessary part of any long-term solution to the crisis. Second, the sovereign bailouts have transferred private-sector risk to the books of taxpayer-backed institutions. In combination with the cheap and plentiful liquidity that the ECB has provided to European banks, this has created perverse incentives, possibly leading banks to chase profits through higher yields on peripheral sovereign debt and thereby increasing their exposure to the crisis. The toxic mix of moral hazard and political failure has left Europe fighting for survival on two fronts, facing both a systemic banking crisis and an increasingly desperate fiscal crisis.
Are sovereign governments learning these lessons? In an ironic twist, the Slovak parliament rejected the EFSF amendments on the very same day that the EU and the International Monetary Fund signaled that Greece would receive the next tranche of its original bailout, even though the country has clearly failed to meet its austerity and deficit targets. Although this is probably necessary to avoid a disorderly Greek default, we desperately need to move away from a situation where assistance trumps reform.
Moving forward, it is encouraging that euro-zone leaders are now considering ways to manage a hard Greek default, while finally looking at ways to recapitalize euro-zone banks. But as EU leaders look for clever ways to leverage the EFSF, possibly quadrupling it in size, without increasing the existing loan guarantees, and as the euro zone reluctantly moves towards more fiscal integration, it must keep one vital lesson in mind: Conditionality is king. Failing to impose costs on those responsible for the crisis, particularly the banks, not only sows the seeds for future economic problems but also fuels political divisions. The euro zone can ill-afford more of either.