This essay is excerpted from the book Europa sfida per l’Italia (“Europe: a challenge for Italy”), published by LUISS University Press.

The financial crisis (2008-09) and the sovereign debt crisis (2010-14) are now behind us. The European Union’s economy is finally recovering and labor market conditions are rapidly improving, even with regard to employment rates, which have returned almost everywhere to pre-crisis levels.

There are, however, some important imbalances in the EU economy which need to be corrected: investment rates remain unsatisfactory (see Bastasin’s essay on this very subject); Foreign currency accounts show a large surplus (3% of GDP), reflecting even greater imbalances among member countries (Germany’s surplus exceeded 8% of GDP); The large increases in public and private debt due to the two crises need to be largely reabsorbed and are partly reflected in the high level of bad credit in the banking system (in the EU aggregate, it totals for about EUR 1 trillion). The legacy of a social question heavily exacerbated by the crisis remains, with large strata of low-income working-age population and, among them, a significant drop below the threshold of statistical poverty; Too many young people do not work and do not study, especially in the Southern suburbs. A specific issue, then, concerns Italy, one of the great countries of the Union, which continues to limp behind other member states as far as growth, productivity, employment, state of the public budget and non-performing loans are concerned.

The solution to these problems still encounters a major obstacle in the persistent fragmentation of financial markets within the Euro area. A visible display of such a splintering can be seen in the gap between the interests that debtors from some peripheral countries need to pay to those creditors in the ‘virtuous’ centers to obtain borrowed funds – that’s the infamous spread. The spread among interest rates reflects the different perception regarding the risk factor of debtors; When it presents itself among public debts, this indicates the presence of a country risk element, which inevitably will extend to all other borrowers for that country, systematically penalizing its cost and sometimes even its credit availability (this is especially true for smaller enterprises). An insufficiently recognized effect of the fragmentation of the financial markets is that, in addition to preventing the full spread of the ECB’s expansive monetary policy, it prevents recycling investment in the peripheral countries of the huge financial surpluses that are accumulating in the virtuous center.

The bottom line is that a positive spread indicates the existence of a risk of redenomating the currency – whether perceived or real, it doesn’t matter – that is, the possibility that the debtors of that country at some point will deny their commitments and will seek to satisfy them with a new, devalued national currency. It also indicates an underlying financial fragility that can quickly turn into a banking and financial crisis, up to the loss of access to the international market, in the event that international investors were to see concrete threats to the full repayment of their debts and, therefore, decided to go with a mass smobilisation. Those raising the spectre of Italy’s withdrawal from the Euro must know that such a choice will inevitably be caused by a large banking and financial crisis (I’m referring to the essay by Codogno and Galli); Experience teaches that democratic systems can not survive such an experience, especially when they are already suffering from weak institutions and fragmented political systems. So, much remains to be done to put the Economic and Monetary Union on a more solid basis, but the alternative to abandoning it seems completely irresponsible.

The thesis I would like briefly to point out in this essay is that the way forward in the completion of Monetary Economic Union has been fully identified in the Five Presidents’ Report (hereafter referred simply as the “Report”). This is divided into four chapters: a ‘genuine’ economic union; A financial union; A budget union; and, finally, a political union. It should be clarified, in this regard, that this path does not imply or require the transformation of the Union into a federal state, but only the ‘federalization’ of certain functions, necessary to protect the EU once and for all (the Euro zone) from splitting and potentially destructive financial shocks. It’s not my intention to discuss the aspects of political union and democratic legitimacy, already discussed in other essays.

One must start from an economic union because of more obvious reasons: the existence of wide differences in productivity and costs within the single currency area is the main factor for the instability and, ultimately, the unsustainability of the monetary union. Consequently, a new convergence process is needed to make the economies of participating countries stronger and even more uniform. This requires innovative, flexible economies, able to adapt to technological change and to the challenges of globalization. There are essentially two keys to meeting these challenges: massive investment in human capital on the one hand; The strong relaunch of the internal market on the other.

Human capital is not lacking in Europe, just as there are great universities and research centers; Adequate mobilization of these resources in favor of new technologies and their applications, however, is yet to be achieved, it seems. From this standpoint, even the German economy does not seem sufficiently innovative in the face of the new challenges of digitization; at the same time, peripheral economies show impressive delays and distortions in the quality of university and postgraduate education, in the allocation of research funds, in linking industry and universities, and in youth training.

This, while the big stimulus to resume investments has to come from a new momentum to the internal market: dismantling protections, opening up to new players, accepting the challenge offered by new technologies. The return of statism and protections, denounced by Sabino Cassese in the opening essay of “Europa sfida per l’Italia” (“Europe, a challenge for Italy”), is a deadly threat to our ability of keeping our continent on a path of prosperity and growth. The mobilization of European funds can help speed up investment in the interconnections between large service networks – energy, transport, communications – where huge productive and innovation fields are available. The stimuli of market opening and competition can restart private investment. Whereas, in a closed and protected environment investment does not start, businesses decline, jobs disappear.

Overcoming divergences in productivity and costs is the task of the member countries, but, as I did observe, it is also a key condition for the cohesion and stability of monetary union. This justifies establishing some common policies for the convergence of the economies, as was the case during the European semester and with the economic policy recommendations. Establishing new national competitiveness authorities – already underway – and strengthening of the procedures for correcting macroeconomic imbalances are some instruments identified by the Report to make member states more committed to convergence policies through greater sharing (ownership) of the target. The convergence objective also includes greater focus on those targets that focus on social cohesion, employment, particularly youth employment, and the fight against exclusion and poverty.

The Report states that convergence procedures should be formalized and made more binding by adopting a set of common standards for the functioning of labour market, along with competitiveness, a context for business activity, and public administrations. These standards leave a wide range for differentiating national policies and taking different contexts into account, but can help countries measure in an objective way their progress and those areas where efforts are being devoted. The essential thing to understand here is that without any progress on this front, any advancement in the other pillars of construction is bound to freeze – because here lies the stability and prosperity of monetary union, which must also be an economical one, so as not to break. Whoever invokes solidarity and the loosening of common rules is not believable and ultimately is wasting time, being incapable of adopting credible behaviors for obtaining convergence in their own home.

In this context, it should be pointed out that a debate has opened on the role of the European Stability Mechanism (MES), which can lead this body to have some important tasks in the surveillance of the economic policies in the Euro zone countries – it unclear whether it would be as a complement or as an alternative to the role of the European Commission, which, according to some member states, does not apply the Community discipline strictly enough.

The second pillar is represented by the financial union, which includes banking union and capital markets union. The banking union – already in an advanced state of implementation – includes the Single Supervisory Mechanism (SSM), the mechanism for resolution of failing banks (SRM, assisted by a Single Resolution Fund, SRF), and a continental deposit insurance scheme (EDIS).  The SSM and SRM (with the attached SRF) have already contributed to tackle the problems suffered by the banks after the two financial crises that have hit the EU economy. Instead, the negotiation regarding EDIS is stalled, as well as the one on establishing a last resort common support mechanism for both EDIS and SRF (which is discussed in Buti and Pench in their essay in the aforementioned book).

The reason for this stalling comes down to this: a few months ago, Italy successfully opposed the examination by the Eurogroup – the finance ministers of the Euro area – of a few systems designed to promote the reduction of public portfolios in banks’ balances, a measure necessary to mitigate the relationship between banking risks and sovereign risks, but which would have had a major impact on Italian banks. The ECOFIN Council then decided – and wrote in its final statement – that “the political negotiations [on EDIS] will resume as soon as progress has been made on risk reduction measures”; while noting at the same time the intention of some member states to “resort to an intergovernmental agreement when the EDIS political negotiations resume”. That is to say that from now it will only be possible to proceed unanimously – a clear reaction to the fact that a blocking minority had prevented a qualified majority from acting on risk reduction mechanisms. The European Council accepted Ecofin’s decision verbatim in its December 2016 and March 2017 statements, reiterating that EDIS cannot go ahead without adequate risk mitigation measures.

Such announcements by the ECOFIN Council and the European Council made it clear that in the event of idiosyncratic shocks there will be no solidarity in the sharing of banking risks; In other words, if need be, Italy may find that it is alone in dealing with the impact that markets could have on its banks. This is a central aspect behind keeping a risk averse premium on Italian paper.

On the merger of capital markets, I have already expressed myself: its achievement would open the door to Italy’s use of enormous ‘idle’ capital generated by the current surpluses of Germany (and The Netherlands). But this cannot happen as long as the markets are fragmented by the risk of currency redenomination. It is worth adding that the full achievement of an integrated capital market will require the establishment of a centralized market surveillance authority, as is the case for banks. The current ESMA supervisors (on capital markets) and EIOPA (on pensions and insurance policies) are fundamentally flawed when it comes to governance: the fact that there is no executive committee of officials independent of the national authorities within their councils, as is the case, instead, within the ECB Council. This explains the limited progress made in converging regulatory standards.

The third pillar of Economic and Monetary Union identified in the Report concerns the budget union. Regarding this, the Report unambiguously states: “The cornerstone of EMU [is constituted] by responsible budgetary policies”. Essential elements of this policy are represented by the Stability and Growth Pact guidelines – which were strengthened after the sovereign debt crisis by the Six Pack and the Two Pack – and the so-called Fiscal Compact, which is nothing more transposing the Agreement into national law, with hierarchically over-regulated norms as compared to ordinary legislation. The idea that these norms can now be weakened in substance is a weird one: it suffices to remember that the approval of these standards was a key condition for announcing new ECB instruments (the OMT program) that during the summer of 2012 stabilized the markets and saved the common currency. These instruments would not survive after such a conspicuous abandonment of budget discipline. In fact, in line with the recommendations of the Report itself, the Independent National Public Surveillance Authorities by sector, already set up in Italy, have been joined by a Council of experts, set up on a European-level, supervising over budgeting policies. Once again, there is an attempt to strengthen discipline through new independent technical bodies, for the mistrust that is running over the Commission, which is now perceived as more ‘politicized’, hence less independent. There are still major doubts whether such mechanisms can work in the absence of a serious commitment to cooperate with national political authorities.

What should be modifiable is the excessive complexity of common rules on public budgets. My view is that the principle of the balance for current budgets should be re-established without exception, while at the same time leaving open the possibility of investment capital deficits that will be capable of strengthening convergence and whose performance, certified by the European authorities (the European Investment Bank), turns out to be higher than their financial cost.

The two key ingredients for a budget union are the establishment of a ‘tax capacity’ in the Euro zone and the issuing of a ‘secure’ debt instrument by a European Treasury. Buti and Pench discuss the first aspect into their essay in the aforementioned volume and I do not have to expand on it myself. On the other hand, I can only point out that a financial system in which the Maastricht rule of “no bail out” (Article 125 TFEU) is fully restored, and in which the public debts of the single countries become risky as they are subject to the risk of restructuring, needs a ‘secure’ public debt instrument in order to function, meaning that it’s jointly guaranteed by all member states of the Euro zone and that it’s issued at federal level – essentially, by the MES. A Eurobond, to put it plainly, also allowing the sharing of some of the sovereign risks, albeit in an environment of financial stability and budgetary discipline that ensures that it does not become an instrument that neither allows lax fiscal policies nor institutionalizes stable transfers among member states.