Guido Montani, UEF Vice-President.
In spite of Mrs Merkel and Mr Sarkozy a Fiscal Union is under way
At the burst of the Greek crisis, Mrs Merkel alluded to the possibility of putting Greece outside the euro area. But after the Irish, Spanish and Portuguese crises, the European governments understood that the real alternative was either more Europe or the end of the process of integration. Thus, at the December 2010 Summit, the Heads of State and Government were obliged to declare that: “they stand ready to do whatever is required to ensure the stability of the euro area as a whole. The euro is and will remain a central part of European integration.” Later on, after the Italian and Spanish debt crises, the European Commission announced a proposal for the issuing of Eurobonds. Mrs Merkel and Mr Sarkozy opposed this stance. Mrs Merkel and Mr Sarkozy’s primary aim is to preserve their national power, but since they cannot abandon the euro, they are obliged to accept – step by step – some improvements to the European financial system. What will the final result of this journey be?
Let’s consider the main decisions after the outburst of the financial crisis: a) since January 2011 the European Systemic Risk Board (ESRB), the supervisory structure of European financial institutions and internal market, is operational under the authority of the ECB; b) the European Commission launched a ‘European Semester’ for economic, not merely fiscal, policy co-ordination of national budgets; c) moreover, in order to strengthen the Stability and the Growth Pact the Commission’s recommendations should only be overturned by a Qualified Majority Vote of the Council against the Commission; d) The European Financial Stability Facility (EFSF) was set up as a provisional means – with a capital of € 440 billion – to grant financial assistance to member states of the EMU; in 2013 the EFSF will be substituted by the European Stability Mechanism (ESM) with a total capital of €700 billion and a lending capacity of €500 billion; e) the Commission proposes to finance the EU budget with new own resources such as a financial transaction tax and VAT up to 50% of the budget, in order to reduce national contributions; f) the Commission has issued Project-Bonds to finance European investments; g) the Commission will propose to issue Eurobonds by pooling a share of national debts.
Is there a reasonable plan behind these occasional measures adopted under the pressure of financial markets? To reply to this question we will take into consideration the proposals mentioned – even if they are at present uncertain, such as the Eurobonds – under the following chapters: sovereign debt management; EU budget; relationship between monetary and fiscal policy.
Sovereign Debt management
The financial crisis revealed the inconsistency of the Maastricht decision to build a Monetary Union without a Fiscal Union. If we compare the position of Great Britain – debt/GDP: 80%; deficit/GDP: 10,4% – with the euro area – debt/GDP: 85%; deficit/GDP: 6% – it is difficult to understand why the financial market considers the sovereign debt in Great Britain, with a triple A rating, more secure than other sovereign debts in the euro area. The reason is that in the euro area there is not a European debt but 17 national debts: if international finance attacks the British debt, the Bank of England is ready to defend it; if international finance attacks the bonds of Greece and Italy, the response of the ECB is uncertain. Now there is the EFSF, and in 2013 there will be the ESM, but this fund is “a framework which could provide temporary financial support to euro area countries, with the aim of providing bridge funding for a period of time needed to implement a deep adjustment programme to correct imbalances and regain market access” (ECB, MB, 7/11). The model for this mechanism is the IMF and, like the IMF, it can provide limited and conditional assistance for a short period. In fact, the ESM is already a kind of Eurobond since its capital is made up of shares of national public finance. Moreover the rate of interest on the loans of the ESM will be the sum of the funding cost plus a charge of 200 basis points. Therefore the cost of the loans for the distressed country is a little higher than the best rate quoted on the financial market, but considerably lower than the rate the country should pay for its debt. This fund can easily evolve into a European agency for issuing Eurobonds, by pooling together a share of the national sovereign debts. In the following part of the article we try to explain why the present opposition of Germany and France of this proposal is inconsistent. For the moment, let’s observe that if a share of 40% or even 60% of the national debt is pooled in a “Blue bond”, the “Red bond” – i.e. the national share exceeding the European share – will pay a higher interest rate. There is therefore an incentive for profligate national governments to reduce the excessive debt. Moreover, in order to answer some of the Germans’ legitimate suspicions towards Med countries the decision to create Blue bonds should go with the commitment of excessively indebted countries – Greece and Italy – to reduce their debt to a ceiling of 90% of their GDP in 4 or 5 years. Of course, during the European semester, the Commission should make sure the national debt convergence plan is respected.
The EU has a budget which amounts to 1% of EU GDP (the USA has a federal budget of 19% of GDP). Moreover, 76% of EU budget is financed by revenues, which come from national budgets. The so-called own resources are less than ¼ of the total and the goal of national governments is to reduce the budget at the disposal of the EU to provide European public goods to the European citizens even more. It is a paltry point of view. One should consider that the expenses for social cohesion, regional policies, education, research and development, energy networks, development aid, climate action policies, neighbourhood and external relations, etc. are the real value added provided by the EU to the European citizens. In view of the Multiannual Financial Framework 2014-20 the European Commission has recently put forward the following proposals to overcome these shortcomings: a) to decrease national contributions by introducing new own resources – a tax on financial transactions (FTT) and a modernized VAT – up to 50% of the EU budget revenue in 2020; b) since borrowing from the EU budget is not permitted, the Commission launched the Europe 2020 Project Bond Initiative (PBI). The goal of the PBI is to finance infrastructure investments, which according to a preliminary estimate amount to between €1.5 trillion and €2 trillion from now until 2020. The Project Bonds are issued by the EU and the EIB to mobilise additional sources of private finance. Investments in the European Transport Network, energy sector and broadband network for Internet access are classic public goods because private firms cannot bear the great risks linked to long-term investment.
These proposals of the European Commission are headed in the right direction, but are not enough to solve the budgetary problem of the EU for the following reasons: a) changing the ceiling of the budget (1% of GDP) is considered a taboo, even if it is too low. In fact, if one also takes into account the need for a European Rapid Reaction Force financed by the EU budget and the need to improve some items, such as R&D, its size should be more or less 4% of GDP; this goal does not imply new taxes, but only a transfer of resources from the national budgets to the EU budget; b) national contributions should be abolished and replaced by 100% own resources; new own resources, such as a carbon tax, should be added; c) if the EU budget is financed entirely by European own resources, Article 311 establishing that the Council must adopt its decision on the EU budget by unanimity should be revised. Co-decision between the European Parliament and the Council should become the rule for the future Fiscal Union.
Relationship between the monetary policy and the fiscal policy of the EU
The kernel of the Maastricht Treaty is the clear division of functions between monetary policy and fiscal policy. The euro was created as a “denationalised money” and the independence of the ECB was based on precise constitutional rules: to maintain price stability in the euro area and abstain from fiscal policy interference (no bail-out clause). The problem with the Maastricht Treaty is that fiscal policy was entirely left to national member states under the illusion that the Growth and Stability Pact was a strong enough corset. France and Germany showed that it was not enough and the other member states followed their example. Now, after the crisis of sovereign debts, France and Germany proposed the ESM, i.e. a kind of European Monetary Fund with a limited capacity to help distressed countries. But, when international finance doubts the financial credibility of states like Italy and France, the ESM becomes inappropriate for the simple reason that its maximum capacity of intervention – even if it is increased – is limited. Only a real lender of last resort can successfully come in. The ESM is not a lender of last resort. Only the ECB, which has the power to issue an unlimited quantity of currency, can play the role of a lender of last resort. But if the ECB buys Italian and Spanish bonds, it breaches the Treaty, i.e. the no-bail clause, blurring the line between monetary and fiscal policy. The dilemma of the present architecture of the EMU is well explained by Otmar Issing: “The fact that a member country can be assured that its membership of the euro – even in the case of permanent violations of the rules – will be saved at any price causes a moral hazard and creates an obvious potential for blackmail” (FT, 9/8). The solution to this dilemma should be an orderly default of the distressed country, but the case of Greece shows that, with the Lisbon Treaty, such a decision risks causing the breakdown of the EMU; and if the EMU collapses, nobody can say where the disintegration of Europe will end: many states, such as Spain, Italy, Belgium, France and even Germany could be carried away by the new nationalistic blizzard. The way out is clearly pointed out by Issing himself: “A monetary union cannot survive without a political union … and a political union should be based on a constitution, and imply a European government controlled by a European parliament, elected according to democratic principles.” Is this way accessible today?
The European supranational state
To answer this question the preliminary step is to understand if the hoard of decisions listed above can be put into a coherent institutional framework. A comparison with the USA, the first federal state in history, can help. The USA has a strong federal government and a big federal budget when compared to the budget of its member states. For Europe the situation is the opposite: the bulk of public finance is located at national level. This explains the difficult challenge Europe has to face. The sovereign debts crisis has shown that in Germany and in some other states there is a hard-nosed opposition to the creation of a “transfer union,” i.e. a transfer of financial resources from one country to the other. That is reasonable. Let’s consider the internal and external behaviour of the German government and the German citizens. During the Eighties, the Länder of Saarland and Bremen accumulated unsustainable debts. They asked for a bail out. In 1992 the Constitutional Court declared that the “solidarity obligation contained in the Basic Law” required a bail out by the Federal government. Bremen and Saarland started receiving federal funds in 1994. In the same years, after the unification of Germany, there was a second “solidarity bail out” from Western Germany towards Eastern Germany. Why is it that what is technically and politically viable inside a nation is not possible among European nations? The answer is that Europe is not a nation and, therefore, European solidarity should be established at a lower level of commitment than national solidarity. Each European citizen can understand this point of view: if there is some sort of financial transfer from one state to other states, there should be a political rationale and clear European constitutional rules regulating the transfer: this happens in the case of the expenses financed by means of the EU budget. For this reason the ESM has a limited amount: together with the EU budget, it is the measure of European solidarity. Now, the open issue is the question of Eurobonds. According to the IFO (Institut für Wirtschaftsforschung) the issuing of Eurobonds will oblige Germany to pay a rate of interest (an average of the European rates) higher than the present German rate and in the global markets the “liquidity of the Eurobonds will probably not come close to that of German government bonds.” This German-centric analysis is not correct, both from an economic and a political point of view. Let’s consider the USA once more. Many states of the USA are financially distressed like (and even more than) some EU states. Florida’s governor Jeb Bush (George W.’s brother) considers California, Alabama, Illinois and New York “technically in default” without the aid of the federal government. Even so the Treasury Bonds pay a rate of interest similar to that of the German bonds. Why? Because the United States are a political union and the constitutional architecture of the USA is considered credible by international finance. Eurobonds will create a financial market comparable to the US financial market, thus rendering the EU, with its currency and its financial system, able to compete on an equal footing with the USA and the dollar. Moreover, and here is one of the novelties of the European model, in Europe the monetary policy can be really independent from fiscal policy, if the EU is able to become a political union. In the long run international finance, including sovereign funds, will certainly prefer a currency issued by an independent central bank instead of a currency which is issued by a central bank subordinated to a government struggling with a huge public debt and prone to inflationary policy. At that point the interest rate on Eurobonds will be even lower than that of Treasury Bonds. Eurobonds are not the average of national bonds; they are supranational bonds. The global economy is becoming multipolar. For Europe the choice is to take part, as global player, in the new world, or to leave the stage to China, India, Russia, Brazil, etc.
This model of fiscal union is viable, provided that a democratically legitimate European government managing the European fiscal system is established. This government – of the euro area – should have the power to watch over the observance of the constitutional rules that each member state has ratified, including the observance of a clear dividing line between monetary and fiscal policy. These principles were already established in the Maastricht Treaty: now they should only be rewritten in a clearer and stronger form; for instance, establishing the rules for an orderly default. The EU needs, as Jean-Claude Trichet has proposed, a ministry of finance. Better, the EU needs a Ministry of Economy and Finance. A European democratic government is necessary to overcome the limits of a policy of pure austerity. An austerity policy without a growth policy is a suicide. Europe would have to face not only the problem of lowering the numerator (deficit and debt) but also the difficult problem of increasing the denominator (GDP). Without growth, or in a state of depression, the financial position of many states will soon become unsustainable: in such a case a systemic crisis can wreck the EU. To avoid this danger the European Commission should have the financial means to carry out its “Europe 2020 strategy” with an increased budget.
The cause of the European crisis is not bad finance; the real cause is the inability of the present political leaders to understand the European project of the founding fathers and to adjust it to a changed world. The EU can become a light federation – indeed a supranational federation – very different from the centralized federation of the past, like the USA. The time is ripe for a new European constitutional convention.
Guido Montani, UEF Vice-President.