Against EFSF? Really?

Estonia's parliament will vote on expanding the powers of EFSF tomorrow together with Germany. As always media and politics have managed to develop a circus out of the discussion preceeding the vote. Polls show that Estonian people are mostly against expanding EFSF (also those supporting our current right-liberal government). Some of the people shout out arguments like "Greece should go bankrupt" or "Why do we have to feed banks". This was followed by a statement from our centre (populist) opposition party that they also don't support joining the EFSF probably hoping to get some votes. Since people are getting very emotional on this subject I will lay out some most important facts about EFSF. (Check these out yourself HERE)

1) First and foremost - EFSF was created with an intention to preserve financial stability in the eurozone by providing temporary financial assistance to governments or banks in difficulty. In other words it is supposed to AVOID crises like we are in now.
2) EFSF finances itself by issuing bonds that are guaranteed by all 17 eurozone countries up to 440 billion euros. Countries participating in EFSF do not pay any additional funds to EFSF, it is backed by guarantees.
3) EFSF is only a temporary measure to handle the current crisis and its permanent follower will be ESM or European Stabilisation Mechanism.

Q: What happens if a country doesn't participate in the EFSF?
A: There's a risk that other countries don't want to particpate as well, who will finance the EFSF then?

Q: Why do we need EFSF at all?
A: To avoid uncontrolled bankruptcies of banks and countries

Q: Why do we need to avoid their bankruptcies if they have overspent?
A: Since if we don't borrowing costs for countries like Italy, Spain, France, Belgium etc will rise significantly leading to other bankruptcies. Banking system as we know it might fall because of the losses that these banks will have (the banks are holding the bonds that are worthless after a bankruptcy of a country). There will be no more euro.

Q: What happens if euro goes?
A: Countries like Germany, Estonia, Finland, Netherlands etc that are financially sound will get currencies that will rise significantly in value causing our exports to fall greatly (it is then more expensive for other countries to buy our products). This will bring massive unemployment and loss in economic welfare. It has been estimated that the effects of such an event would lead to 20-40% fall in GDP in first year. For countries like Spain, Italy and Greece this might even leed to civil war since their currency would devalue so greatly that the people of these countries are unable to pay off their loans. There would be massive unemployment since there is no funding for investments (who would borrow to a bankrupt country in civil war?). GDP of these countries could even fall 50% or more. (Analysis is done by UBS).

The total loss of these events will surpass trillions of euros (if you look at European GDP of about 12 trillion EUR). The countries going through tough austerity measures including budget cuts and reforms will hopefully turn to growth in a couple of years. It is not like regular people of these countries aren't suffering enough already. Hasn't Europe learned anything from its history just 70 years ago? It's not like we are not on the edge of a cliff..

What about Maastricht criteria?

Every country part of the eurozone has to fulfill certain economic conditions (referred to as Maastricht criteria). The country that is not obeying these criteria can be punished by the ECB. The criteria go as follows:

1. Price stability. The inflation rate should be no more than 1.5 percentage points above the rate for the three EU countries with the lowest inflation over the previous year; 
2. Budget deficit. This must generally be below 3% of gross domestic product (GDP);
3. Government debt. The national debt should not exceed 60% of GDP, but a country with a higher level of debt can still adopt the euro provided its debt level are falling steadily;
4. Exchange rate. The national currency's exchange rate should have stayed within certain pre-set margins of fluctuation for two years (no re- or devaluation of currency);
5. Interest rates. The long-term rate should be no more than two percentage points above the rate in the three EU countries with the lowest inflation over the previous year;

Maastricht criteria were the reason why my home country Estonia didn't join the euro in 2007 as planned because of the inflation criteria was not fulfilled even though Estonia is fiscally the toughest and best performing country in Europe (Estonia is part of the eurozone from 2011). That's OK because rules are rules... or are they? Greece, Italy and Belgium (the heart of EU - really?) joined the euro even though their debt was exceeding 100% of GDP. Greece was running the biggest budget deficit with one of the highest inflation rates. Check the following graphs.

So far the criteria have been important for countries willing to adopt euro since it's a precondition for joining (this statement is conditional itself as seen from history). For joining countries it is a good motivational exercise to get their finances in order. Once already in the eurozone motivation quickly disappears.

So how should we deal with that? Shall we fine the countries that are not capable of cut their spending (read: living within their means)? That's like asking for money from a beggar so it probably wouldn't work. There are still couple of things that could be tried.

Make it political! The main reason for not cutting spending or increasing spending for politicians is the support of their voters. Political promises can often lead to overspending so there is motivation for politicians to spend more than possible. So why couldn't it be possible to force the government step down if two out of five criteria are broken for example?

Another idea is to keep away the cookies. Today a lot of countries are receiving structural funds and richer countries are participating in other mechanisms like Framework Programme. Would it make sense to cut funding for countries that aren't fulfilling their duties? Since all of the EU countries aren't in the eurozone it would be impossible, but approach as such would serve its course (as can be seen in Greece today).

I would prefer stabilizing the eurozone with political measures which reduces populism, the mother of all wrongdoings. We should remove the motivation to behave badly, fines and nagging doesn't work here!