Cyprus became the latest euro zone domino to teeter in 2012 just when the worst of the crisis appeared to be over. In March 2013, a compromise rescue plan backed by euro zone finance ministers called for Cyprus to wind down one largely state-owned bank, Popular Bank. The raid on Popular Bank was intended to raise most of the 5.8 billion euros that Cyprus was required to raise as part of the bailout.
Cyprus bank disaster another episode in Europe's crisis of governance
Andrew Sheng examines the idea that democracy itself carries no guarantee of an effective state
Roman Emperor Julius Caesar was famously warned by a seer about the Ides of March, traditionally March 15. On that date this year, banks in Cyprus closed their doors to allow politicians time to decide how to raise €5.8 billion (HK$58 billion) so the country could qualify for a €10 billion bailout from the rest of the euro zone and the International Monetary Fund. The solution suggested, to levy a tax on depositors, sparked the realisation that finally the Europeans had decided to "bail in" investors and depositors, rather than use public funds to "bail out" everyone else.
The crisis caused a stir in global financial markets because it punctured expectations that the worst was over. Instead, it demonstrated another episode of muddling through.
Banks in Cyprus reopened on Thursday, with new capital controls on the amount depositors can take out. Larger depositors with more than €100,000 stand to lose up to 40 per cent of their deposits. A significant portion of deposits belong to Russians, who stand to lose a total of €4 billion to €6 billion. For some investors, this is the price of putting money in higher-risk offshore financial centres. The price to Cyprus of being an offshore financial centre could be a drop in gross domestic product of more than 20 per cent in the next few years.
The Cyprus outcome is not unexpected. If European governments are to be loaded with heavy debt burdens as a result of the crisis, they will be bound to start "taxing" offshore financial centres, where rich Europeans had been avoiding tax for years. If the euro-zone banking union is to have any credibility, they will have to start controlling banking centres that operate largely on tax and regulatory arbitrage. Having banking assets seven to eight times GDP is no longer considered viable.
At the heart of such troubles lies the issue of governance. Financial crises are more governance failures than anything else. Last week, political scientist Francis Fukuyama published an important blog commentary titled "What is Governance?"
His new definition of governance is "a government's ability to make and enforce rules, and to deliver services, regardless of whether that government is democratic or not". Fukuyama has removed any suggestion that democracy is automatically associated with good governance, noting that "an authoritarian regime can be well governed, just as a democracy can be maladministered". He uses four approaches to evaluate governance: how you govern (the processes); the efficiency (how much tax or resources you need); the effectiveness (outcomes rather than objectives) and whether the bureaucracy is independent of politics (the autonomy question).
In dissecting governance, Fukuyama has helped clarify the methodology in thinking about the trade-offs between the ability to have high discretion versus being bogged down by excessive rules, and high capacity to execute versus low capacity. Critics of that approach would argue that strong states with excessive discretion may not be sustainable. On the other hand, weak states with too many rules and no discretion may not be sustainable either.
Fukuyama is right to point out that the bureaucracy's interests may not be identical to those of the people. The bureaucracy is supposed to be the agent of the people, but many serve their own interests, rather than the public.
The simplistic view that the state is deterministic versus the view of free market self-order misses the fundamental point that large bureaucracies also have self-order. Anyone familiar with working in large, complex bureaucracies in China, India or the US, with many layers of government, would recognise that it is not easy to implement policies from the centre. State or provincial governments have a mind of their own.
Indeed, many cities have become more effective instruments of state, and it is not surprising that effective mayors have become national leaders, because they show a capacity to deliver close to the people.
The more interesting question about governance is: why are collective action traps so pervasive? In other words, it is understandable why ineffective and weak bureaucracies or systems are unable to overcome gridlock in their systems, but it is common to see highly effective and capable bureaucracies also caught in gridlock.
These gridlocks are apparent in the resolution of the euro crisis, the stalemate in the Doha World Trade Organisation negotiations and the Durban climate change debates. Next week, the Institute for New Economic Thinking, the Centre for International Governance Innovation, and the Fung Global Institute will be hosting a major conference in Hong Kong on how creative and innovative thinking can open up new avenues for solutions to global governance. As a respected member of the global economic community, Hong Kong should make its voice heard.