Friday, 8 June 2012

Crime and punishment in the Eurozone

By Stephen Spratt

Economists are keen on incentives. Rather than crude prohibitions, the most effective and efficient way to influence behaviour is with economic incentives, where ‘bad’ behaviour is punished and therefore discouraged, while ‘good’ behaviour is rewarded and therefore encouraged.

This came to mind last weekend, which I spent in Ireland, arriving straight after a referendum on the new Eurozone fiscal pact. Given zero growth, high unemployment, brutal public spending cuts, the prospect of all of these continuing for the foreseeable future, and the sense that the EU in general – and Germany in particular – were making things worse not better, I had thought that there was every chance of a resounding victory for the ‘no’ campaign. As it was, 60 per cent voted ‘yes’.

From what I saw, the ‘yes’ campaign used two arguments. The first was fear – bad as things are, they could get a whole lot worse; the prospect that bailout funds might be withheld as some kind of punishment was floated, for example. Second, it was implied that a ‘yes’ vote would enable Ireland to capitalise on its reputation as the EU-IMF’s ‘star pupil’, and renegotiate the terms of its bailout as a reward for its good behaviour.

And there was some reason to believe this might work. In January of this year, a ‘senior German official’ was quoted in the Irish Times as saying that: ‘It should be the case that the good pupils are rewarded for their perseverance, not punished with demands for continued adherence to the programme.’

Putting aside what this says about power imbalances in Europe, and the general offensiveness of the language, it appears the opposite may be true. In the immediate aftermath of the ‘yes’ vote, the Irish Times quoted a spokesman for the German Finance Minister, Wolfgang Schäuble, who said that it would send a ‘negative signal’ for the terms of the Irish deal to be reopened. More precisely, a ‘senior German official’ was quoted as saying that: ‘Ireland is considered a model bailout student so you have to think of the consequences of such a renegotiation which would, in effect, double Ireland’s bailout programme.’

This suggests a complete reversal of the usual approach to incentives: punishment for good behaviour. A Eurozone government – and its citizens – might reasonably conclude that toeing the line is not only immensely painful and unfair, but unlikely to deliver the ‘reward’ of a better deal on external debt. If being ‘good’ means you have to always be the ‘star pupil’ because of the example this sets to the rest of the class, while the ‘difficult pupils’ are cut all the slack, expecting countries to stick to painful austerity packages within the Eurozone may have become even harder than it was already.