The people who talk about the need to make this choice rarely define what they mean by political union or fiscal union. Some who say they favour political union hasten to explain that this does not mean a “transfer union”, but nor is any definition offered for the term transfer union.
The argument for having to make this choice flows from the view that the debts of some eurozone states are so great that they can only emerge from indebtedness if other members offer them money or guarantees.
It is argued that other members will only feel enough solidarity to offer these if both donor and recipient countries are part of a fiscal or political union bound together by ties and mutual controls that are much tighter than those already in place in the European Union’s treaties, in the Stability and Growth Pact, and in the “six pack” of measures agreed last autumn to strengthen the Stability and Growth Pact.
The assumptions that underlie these arguments need to be explored in a rigorous way, and the general public involved in them much more than so far. The issues at stake are too great to be left to specialists, whether in finance, economics or political science.
A political union constructed on the basis of a half-explained assertion that without it we face financial Armageddon is liable to be very fragile. Once the immediate threat has receded, the impulse holding it together would surely dissipate. That is why those who believe that fiscal or political union are what is needed have to get out on the streets and into the media to explain three things:
- Exactly what political union means and does not mean, the powers that would be left to member states and those that would go to the centre.
- The precise degree of resource pooling that is proposed within the fiscal union, and the resources that could be held back to meet member states’ obligations, like pensions and the taxes that would still be set by the states, and those that would be set at EU level and paid into a European treasury.
- How democracy would operate within the new political or fiscal union, and whether voters will have a direct say in naming and/or removing from office key European decision-makers. Or would voters continue only to be allowed to exercise that role indirectly through their national representative on the European Council?
The third point here is important. In a recent address in Dublin, Catherine Day, the European Commission’s Secretary General, said that under proposals already agreed the Commission was taking on “huge new powers” over the national budgetary and economic policies of members states, and that in the exercise of these powers the Commission would have to “acknowledge and deal with political cycles” in these member states. Is it realistic that powers like these, which go to the heart of politics should be dealt with by a Commission whose members have none of them been directly elected to these responsibilities by the voters of Europe?
In short, in a political or fiscal union will the citizens of Europe have a chance to act as European rather than simply as national voters, just as they do when they elect their national MEPs? The present system under which all MEPs are elected solely in national constituencies, has resulted in national quotas for key jobs in the Parliament, even though this is probably contrary to the non-discrimination clauses in the EU Treaties.
These are political choices that must be widely debated, and this article aims to help bring about such a debate. And as a prelude to that debate it also seems useful to offer some analysis as to why we Europeans are in the present economic state, and to discuss whether European integration is itself to blame for the problem.
"My own view is that neither Europe nor the euro is the source of the problem. With or without a single currency, a fiscal crisis in Europe was going to happen around now because of Europe’s ageing population"
If the public believe “Europe” caused the problem, they will not easily be persuaded that “more Europe” is the solution. My own view is that neither Europe nor the euro is the source of the problem. With or without a single currency, a fiscal crisis in Europe was going to happen around now because of Europe’s ageing population. The European Commission has repeatedly produced reports saying that without changes to policies the debt-to-GDP ratios of many European states would reach 500% by 2050, simply because of the increased size of the retired elderly population relative to the working age population. In 2007, the dependency ration in the EU was 25%, in 2050, it will be 50%. So no matter which way one looks at it, the prospect was of a fiscal and economic crisis sooner or later, and of course it now looks to be sooner.
The fiscal crisis facing so many European countries is not a crisis of the euro; it is a crisis of individual sovereign states that happen to be members of the EU and the euro. Neither the Union nor the euro obliged countries to build welfare states or to undertake pension obligations, on the scale they did, or to set pay or subsidy levels where they did.
That said, the eurozone countries combined will have a budget deficit of only 4.5% of GDP and a debt/GDP ratio of 87%, whereas the U.S. government has a deficit of about 10% and debt/GDP ratio of 100%. Like Europe, the U.S. faces the same problem of an ageing society and the extra burden that will place on Medicare, Medicaid and Social Security, problems which President Barack Obama and Congress are failing to tackle.
But the existence of the euro, along with the free movement of capital that preceded it, ushered in an era of cheap credit, and some states availed themselves of this credit rather than undertake the reforms that the long-run fiscal costs of ageing called for.
The banking supervision roles introduced by the Basel Committee and the European Central Bank in Frankfurt (ECB) contributed to the problem by treating government bonds as risk free assets that banks could use to meet their capital requirements. This created an artificial appetite for government bonds, and so added to the problem. An unhealthy inter-dependence between banks’ finances and government finances grew up, and government bonds came to constitute a bigger proportion of bank assets in Europe than they did in the United States.
European banks got too big. The gross debt of eurozone banks comes to 143% of the zone’s GDP, whereas bank debt is only 94% of American GDP. Eurozone banks also owe twice as much in proportion to their assets as do U.S. banks, which have a varied set of fund sources while Europe’s banks depend disproportionately on the fickle wholesale money markets.
The European Banking Authority stress tests for Europe’s 90 biggest banks showed that because of this reliance on short-term funds these banks will have to roll over loans in the coming two years equalling 51% of the euro area’s GDP. In Germany, the two largest banks will have to roll over loans equivalent to 17% of GDP, and the equivalent figure to be rolled over by the two largest banks in the U.S. is only 1.6% of U.S. GDP. Recent EU summits have given this banking aspect of the crisis too little attention and have behaved as if Europe’s only problem was government finances. It’s an unhealthy banking situation that results partly from rules designed to make the banks sounder.
The financial consequences of the ageing of societies can, meanwhile, help our understanding of where interests in the EU diverge, and why EU decision-making is so difficult.
Germany is ageing faster than some other countries, and Germans are therefore more worried than most that the savings they have put aside for retirement, whether in personal savings accounts or pension funds, will be devalued by inflation generated by excessive monetary easing by the ECB.
Critics of Germany say that Germany is asking a lot of some other countries when it demands that they become more competitive, increase their exports and thereby earn the money to pay off their debts. But that is more difficult if their principal market, Germany, is also cutting back and thus reducing the size of their export market. The ageing of Germany’s own population partly explains why Germany is doing this.
The eurozone crisis is in a way doing Europe a favour, because it is forcing European states to move forward more quickly with reforms that are anyway inevitable to deal with the ageing of societies. The United States, which can still borrow easily, is enjoying the false luxury of postponing decisions and worsening its long-term situation.
Even if the EU had no fiscal rule, the markets have now woken from their long slumber and are demanding that those to whom they lend should show how they will balance their books and repay what they owe when it is due. In that sense, the new euro area fiscal treaty is almost superfluous: markets will be imposing discipline on governments that borrow too much, whether or not there is a euro, pact or no pact, and Britain in or Britain out.
"The fiscal crisis is not a crisis of the euro; it is a crisis of individual sovereign states that happen to be members of the EU and the euro. Neither the Union nor the euro obliged countries to build welfare states"
For many eurozone countries, the choice is between the slow, negotiated and slightly less destructive austerity imposed by the “six pack” measures now to be formalised in the inter-governmental treaty agreed by 25 states in Brussels on January 30, or fast and much more destructive austerity imposed by the markets.
The new treaty says: “General government budgets shall be balanced or in surplus.” There will be leeway to run a “structural deficit” up to 0.5% of GDP, as defined in a “country specific” medium term objective for the country in question, to be agreed by the European Commission. Such a rule will have to be introduced in member states' national legal systems on a permanent basis.
It will be interesting to see how this will be interpreted in practice. A structural deficit is something which by its nature is vague, contingent and subject to revision after the event. A structural deficit means the actual deficit re-calculated to take account of the point a national economy is at in the economic cycle. This is difficult for economists to calculate and will be even more of a challenge for the constitutional lawyers to whom the heads of government want to confer some of the responsibility.
And the date from which the 0.5% rule would come into force isn’t yet clear. According to Deutsche Bank, the structural deficit of the euro area as a whole stood in 2011 at 3.2% of GDP.
An aspect of the fiscal compact unveiled at the December 9 European Council also needs to be teased out a bit more. This is the proposal that “standardised and identical Collective Action clauses” will be included in all new euro government bonds. It isn’t clear when this would come into force, but it will place purchasers of these new government bonds in a less favourable position than holders of existing government bonds who are not subject to collective action clauses. This will raise the interest rate.
"The eurozone crisis is in a way doing Europe a favour, because it is forcing European states to move forward more quickly with reforms that are anyway inevitable to deal with the ageing of societies"
Neither the December 9 fiscal compact, nor the treaty of January 30 address the banking problem, which is a pity because as I’ve tried to emphasise the banks’ difficulties are the heart of the problem. Society needs banks, and some banks are well worth saving because they are the repositories of our savings, and the engines of our economies. Financial Times commentator Martin Wolf was right almost a year ago when he wrote that “the German government should tell their people that they are rescuing their own savings under the guise of rescuing peripheral countries.” But we should be careful not to pursue unnecessarily pro-cyclical banking policies that impose higher capital requirements when banks are anyway being forced by the markets to retrench, because that is aggravating the downturn, just as other banking policies aggravated the boom in the past. In the meantime, the ECB must act as a normal central bank and provide liquidity for the markets. It is now doing that through lending the banks considerable amounts of money at very low interest rates.
To return to the question of political union, longer-term German thinking on the reform of the EU treaties was set out towards the end of last year when Chancellor Angela Merkel’s centre-right CDU party adopted a resolution on the subject.
The CDU proposed the direct election by the people of Europe of the President of the European Commission. In my view, this is what we need to create a genuine European demos and sense of shared destiny among EU citizens. Without this, we will be unable to persuade Europeans to make sacrifices for one another, and that is something we must have if economic and monetary union (EMU) is to work. So it is really heartening that a party as important as the CDU has adopted this as policy.
European integration has now gone as far as it can go on the basis of bureaucratic integration. If the European Commission is to have the moral strength to exercise the huge new powers it is being given under the new treaty and under pre-existing agreements, it needs a strong draught of popular democracy. European citizens will, I believe, accept greater mutual solidarity with one another once they feel that citizens of other EU countries are “we” rather than “them”.
If all Europeans are brought together on the same day all over Europe to choose who should be president of the Commission, as the CDU proposes, that will gradually create the “we” feeling among all EU citizens. That is essential if the EU is to have the legitimacy to achieve the demanding goals set out in recent EU legislation and in the inter-governmental treaty. Such a European presidential election would give the EU a real live personality, and create an emotional link between each citizen and his or her President, as happens every four years in the U.S.
This is needed because at present the crisis is driving public opinion in European countries further and further apart, partly because of gross oversimplifications of the nature of our financial problems presented by the media and by some politicians. We need more than the regulation of austerity. We need an outline of a comprehensive solution, with a timetable for its implementation, for each of the 17 eurozone states and at eurozone level too. Each plan must fit into and be contingent upon the other. The 17 national plans and the overall European plan, all synchronised with one another, would give the markets a sufficient sense of direction to stop their destructive, fear-driven flight from the government bonds of one European country after another.
For that to happen, we need unified leadership at EU level and a sense that Europe once again has a centre of gravity. The change must be as much psychological as political. Heads of government must all put themselves in the shoes of the others and think collectively rather than nationally. The crisis we face is as much a crisis of belief as it is a crisis of finance. The finance is actually there, but the belief is not. Part of the reason for the lack of belief is that markets sense there is no shared analysis among European leaders about what is to be done. And until there is a shared analysis of what is wrong, it is difficult to frame the right sort of political or fiscal union.
Some believe that the sole problem was one of foolish and blameworthy borrowers. But increasingly it is recognised that the problem was also one of foolish and blameworthy lenders. Some also believe that if everybody adopted the German model of super competitiveness, reducing wage costs and enhancing savings we could all weather the storm. The difficulty is that the eurozone as a whole is not an export economy, and indeed it exports as little proportionately as does the U.S. For Europe to run an export surplus to pay off its debts, someone else must run an import surplus, and be willing to finance the borrowing to support that. It is not obvious who that will be.
The ECB needs to have the discretion to act as do the British and U.S. central banks and provide liquidity to the market. This will in effect mean printing money, and while in the long run that will build up inflationary pressures, we will have time to prepare for that. If the ECB does not exercise wide discretion now, there may well be no long run for Europe’s economy.
We need to deal with Europe’s banking problem. Many European banks have been allowed to grow too big to fail relative to the size of the tax bases of the individual European countries that guarantee their depositors. We must work towards a situation wherein it will be possible for banks to fail, just like any other businesses, without systemic risks to the economy or losses to depositors. Had we had a Europe-wide retail banking market, a Europe-wide deposit guarantee scheme, and a Europe-wide banking supervision system (as envisioned 20 years ago in the EU’s Maastricht treaty), we could have created a situation in which it would be safe for banks to fail.
The European Commission has produced a Green Paper on a bank resolution mechanism, which would allow banks to go out of business in an orderly way. It’s a proposal that should be pursued. We also need to enforce the new eurozone system to remedy economic imbalances. This should include excesses of private borrowing as well as of government borrowing. It should address excessive surpluses which often destabilise markets as much as do deficits. That’s why the recently-agreed EU excessive imbalance procedure is so important.
And we need a credible proposal for a eurobond. Properly designed, a eurobond could be a much better and timelier means of disciplining government borrowing than fines under the Stability and Growth Pact or the new inter-governmental treaty. All 17 euro area governments could mutually guarantee the repayment of a new collective eurobond, and it would have first call on, say, a fixed share of all VAT receipts. They might also agree that while no euro area country would be obliged to issue eurobonds, it could do so in limited circumstances. These could be that its budget law and five year projections had been approved in advance by the European Commission, and that the eurobond could only be issued over a limited proportion of its total borrowing, as long as their overall debt-to-GDP ratio was no more than about 60%.
This would have a number of advantages. It would guarantee a minimum borrowing capacity to all euro area states. Because of the collective guarantee, the interest rate on the eurobond would be less than that on most national bonds. It would, however, penalise countries that allowed their debt-to-GDP ratios to rise above 60%, because they would be forced to borrow commercially and pay higher rates of interest on the extra borrowing. This would clearly be a strong incentive to reduce their debt level to 60% or below as quickly as possible.
That would be a better discipline than retrospective fines, which are the sole form of discipline we now rely on. This new eurobond would also have real credibility both globally and within the EU because it would be guaranteed by all euro area governments and have a prior call on VAT receipts.
A eurobond could also help create a fixed measure of value that could provide a reliable part of capital base for banks – the role that gold performed in the past, and which the sovereign bonds of wealthy countries did until recently. Banks holding these eurobonds would then have something of real and certain value in their capital base, on the strength of which they could confidently base their lending decisions. In that way, credit would start flowing again, jobs would be created and permanent structural damage to our economies would be avoided. If this happened, rather than being the world’s economic problem Europe could be the provider of a significant part of the world’s economic solution.
The political and fiscal union we would thus create need not be intrusive on the politics of member states. It can be made acceptable to national public opinions so long as some key conditions are met:
- That the top people running the new system will have been directly elected by the people of Europe rather than selected by elites meeting in private. In that way a genuine European demos would be created, without which a political and fiscal union could not long survive.
- That the EU should get a slightly enlarged and wider tax base than its present one.
- That the new political and fiscal union should be accompanied by a genuine effort at public education that explains the interdependence between banks, taxpayers and ordinary people, in a way than banishes present misconceptions and convinces people that saving the banking system and preserving the credit of other EU states is in the public interest of all.