Friday, 20 June 2014

The fiscal compact as an obsolescing bargain?

Raymond Vernon coined the term "obsolescing bargain" in the context of interactions between multinational corporations and host countries. When MNCs are deciding where to invest, they have a lot of options and thus a lot of bargaining power. Host countries therefore offer attractive tax and other concessions in order to get investment. However, once investments are made, the threat of expropriation gives more bargaining power to the host country. At this point, there may be an effort to renegotiate the terms of the initial deal, which has "obsolesced" due to shifts in bargaining power.

This sort of problem can potentially affect all sorts of bargains. For instance, a party that has agreed to buy, say, coal may be reluctant to abide by the terms of the deal if the price of coal drops. The coal seller has less bargaining power, and the coal buyer more, than at the time the agreement was concluded. If a contract was signed, the buyer may seek to get out of it via legal loopholes: for instance, declaring force majeure.

This pathway from an obsolescing bargain to a search for legal loopholes now appears to be unfolding in the Eurozone.

Late in 2011, European leaders agreed on a fiscal compact designed to make it much more difficult for countries to run fiscal deficits. Inter alia, it called for constitutional or similar changes limiting budget deficits and instituting automatic correction procedures to address them.

The bargaining situation surrounding this agreement was fundamentally shaped by panic on the bond markets. As I argued the other day (see Weidmann, for one, misses our bond market overlords) the threat of the ECB to sit on the sidelines and let the panic rage gave the ECB's leaders a lot of political influence. In late November 2011, Mario Draghi deployed this influence on behalf of the fiscal compact, hinting transparently that whether the ECB would intervene against the panic would depend on its adoption.  On 9 December, the fiscal compact was agreed; on 14 December, Draghi announced a large injection of liquidity into banks, which they could use to buy sovereign bonds.  His satisfaction at the adoption of the fiscal compact was evident.  (UPDATE: Draghi actually announced the decision on 8 December; my confusion arose from the fact that the details were finalised on 14 December.)

With Eurozone bond prices back to low levels, the bargaining situation has changed. The fiscal compact now appears a very high price for security against a self-fulfilling bond market panic that has faded to a distant prospect.  And it's not surprising that opposition to the terms of the fiscal compact is mobilising. Gabriel's proposal to change the rules on how deficits are counted is an example of the loophole-seeking that is one way the bargain might be revised. (For more on the art of creative fiscal accounting as a way around budget commitments, see Joachim Wehner.)

The most charitable thing that can be said about the pro-austerity case used to justify the fiscal compact is that it's controversial (actually, the evidence against it is overwhelming and mounts all the time). Using a transient situation of market panic to bludgeon elected leaders into accepting constitutional mandates of a policy both controversial and massively consequential displays a contempt for democracy. And if the result is a contempt for constitutional and treaty rules, the architects of those rules have only themselves to blame.

P.S.  There's been a lot of scepticism (here's some from Germans and some from Italians) about whether the fiscal pact will in fact be very binding.  Personally, I hope there are loopholes large enough to drive many, many stimulus-laden trucks through, but I doubt it.  The fact that Renzi is bothering to mobilise formal opposition suggests as much.

No comments:

Post a Comment