A Budget for the Eurozone. To do What ? And How ?

July 27, 2017
FacebookFacebook MessengerTwitterLinkedInWhatsAppEmail

The proposition of a common Eurozone budget has been circulating for a while among European economists. and it is today back in the policy agenda since the election of Emmanuel Macron as French president.

But so far, the European vision of the new president is rather unclear. It is therefore useful to try to understand what would make the European budget an effective and useful tool.

If no one has ever believed that the Eurozone is an optimal currency area, many economists and policy-makers have long thought that the market flexibility and the nominal objectives (inflation, deficit, etc.) that characterize European institutions would have been sufficient to guarantee the convergence of euro area economies both in times of growth and in times of crisis. This was indeed an illusion, given the evidence available since the early 1990s stating that, even in the United States, transfers from the federal budget have contributed to absorbing more than a third of asymmetric shocks.

In the European Union, rather large transfers are already taking place. Structural funds have the objective of achieving the convergence of per capita incomes; as a result, transfers are made from richer countries/regions to the poorest, regardless of the cyclical position of individual countries. Structural funds therefore cannot work to smooth the cycle and stop the divergences between countries arising from asymmetric shocks.

In 2015 the 5 Presidents Report stated the principles that should be followed in the attempt to absorb asymmetric shocks. The Eurozone budget should (p.15) :

  1. It should not lead to permanent transfers between countries or to transfers in one direction only […]. It should also not be conceived as a way to equalise incomes between Member States.
  2. It should neither undermine the incentives for sound fiscal policy-making at the national level, nor the incentives to address national structural weaknesses. Accordingly, and to prevent moral hazard, it should be tightly linked to compliance with the broad EU governance framework
  3. It should be developed within the framework of the European Union. This would guarantee that it is consistent with the existing EU fiscal framework and with procedures for the coordination of economic policies.[…]
  4. It should not be an instrument for crisis management. The European Stability Mechanism (ESM) already performs that function

Thus, the report puts forward the features of a federal budget: stabilization of asymmetric shocks in normal time, revenue neutral in the medium term (no permanent transfers), and not meant to protect the economy in case of a major crisis. Finally, to take into account the specificity of the European institutional framework, which we could define an “economic federation without political federation”, the Eurozone budget should not hamper the functioning of budgetary rules disciplining member states (regardless of whether these rules are useful and effective). Since the publication of the five presidents report the discussion has further stressed a fifth criterion, rather consensual. In conformity with the principle of “no taxation without representation”

  1. Democratic control over the instance that would manage the budget (the Eurozone “finance minister”)

This principle has been internalized by the Commission in its latest Reflection Paper on European governance (June 2017) where it is explicitly discussed the need to strengthen responsibility in parallel with the building of common fiscal capacity.

Last, but not least, the treasury should be endowed with own resources (Eurobonds? A European corporate tax?) so that stabilization can be carried on not only in the case of asymmetric shocks (positive in some countries and negative in some others), but also in the case of symmetric shocks of different intensity (De Grauwe and Ji, 2016).

European Unemployment benefits as an automatic stabilizer

Various european governments, as well as the Commission (already in 2013), proposed the implementation of a European unemployment benefit scheme, which could contribute to thestabilization of economies hit by asymmetric shocks. Beer et al (2014) discuss the issues that a European unemployment benefit scheme would raise, including the difficult coordination with national welfare policies. They argue that the literature is rather consensual on the fact that, had such a scheme been in place during the crisis, it would have had a significant stabilizing effect on GDP and incomes. Not surprisingly, this impact is also shown to depend on the design of the scheme and on the interaction with national programs

On the other hand, the works cited by Beer et al also reach a consensus on the fact that it would be hard to respect the first criterion, revenue neutraliry. If the scheme had been in place since 1999,  core Eurozone countries would have been net contributors. This is because on one side structural unemployment is much higher in southern countries, and on the other the sensitivity of short-term unemployment to shocks (the so-called Okun coefficient) is different. Focusing on short term unemployment, as most propositions on the table do, can solve the first problem but not the second. To remain revenue neutral the scheme should allow for ex-post compensation (the “clawbacks”), or periodic changes in the parameters of the scheme. Both options would greatly complicate its functioning.

European public goods

Several propositions, e.g.  the one put forward by the Italian government, assign to the Eurozone finance minister the task to provide “European public goods”, i.e. goods whose provision would make sense at the “federal” level. For example transnational public investments, for which one could avoid to go through baroque schemes such as the Juncker Plan, but also the organization at the European level of migration policies, that today rest on the shoulders of a few countries.

Rationalising and organizing public goods provision at the European level is paramount to boost growth and increase productivity, especially in reference to the important economies of scale involved in some sectors, like ecological transition and sustainable growth.

The provision of public goods per se, being linked to structural needs, does not lead to cyclical stabilization and to asymmetric shocks reabsorption. Nevertheless, nothing would prevent the Eurozone finance minister to use it also for stabilization purposes:

  1. In the most direct way, while the assessment of investment needs would have to remain structural and multiannual (an intrinsic characteristic of investment), the minister would have some margin in the short term management of the budget. Nothing would prevent anticipating or delaying expenditures in a given sector/country depending on the cyclical conditions, while making sure that the long-term consistency of the investment plan is maintained.
  2. In a more indirect way, by transferring at the central level a part of the investment expenditure that is now carried on by national governments, the European budget would free resources in the member countries’ finances, which could be uses for social protection and country-specific countercyclical policies.

This of course raises an important point, and in the current situation of institutional paralysis, a potential difficulty. The existence of an aggregate budget would require redefining Governments’ fiscal competencies, and would therefore lead to rethinking the current set of fiscal rules (the Stability Pact and the Fiscal Compact).