Summary:
– The Eurozone faces several major challenges: the incompleteness of the euro, the lack of governance, a broken economic model, and an overall lack of solidarity.
– From the absence of fiscal federalism to the ECB’s overly limited mandate and the failure of Eurozone members to converge, several factors help explain the difficulties encountered.
– Mr. Aglietta and T. Brand propose a set of solutions to try to breathe new life into the Eurozone: fiscal and monetary federalism, political solidarity, and a growth model based on incentives and innovation.
To mark the release of their book, « A New Deal for Europe, » Mr. Aglietta (economist and scientific advisor at CEPII) and T. Brand (economist at the Centre d’Analyse Stratégique) revisited the main topics covered in their book at a CEPII conference on March 21, 2013. The incompleteness of the euro and the need to move towards a model of fiscal and monetary federalism in the eurozone are at the heart of their thinking.
The incompleteness of the euro
According to them, the single currency has suffered from an « original sin » since its creation. The euro is often perceived as a simple medium of exchange rather than a vehicle for bringing together the various member states of the eurozone. According to Mr. Aglietta, the euro is more than that and should be considered a public and social good that facilitates trade, which is not currently the case. This is all the more necessary given that the link between the single currency and fiscal policy is quite close. Since each member country of the Eurozone (EZ) collects taxes, paid in euros by taxpayers, and the public debt of these states is denominated in euros, it turns out that the debts of the countries are « connected » to each other. Mutualizing the debts of eurozone countries is therefore not illogical; on the contrary, it seems perfectly rational. Establishing a common budget would be a real contribution, as the debt would become a kind of collective capital, encouraging greater coordination between countries, according to the authors.
Furthermore, the creation of the euro is the responsibility of the European Central Bank (ECB); therefore, in light of what we have just observed, it appears that monetary and fiscal policies are necessarily closely linked, which would justify greater federalism. The ECB is currently the only real federal « agent » within the eurozone, but according to Mr. Aglietta, it cannot fully play its role. Given that European treaties stipulate that the ECB cannot buy sovereign debt on the primary market, monetization of debt is impossible. However, in the context of fiscal federalism, monetizing government debt (in emergencies or otherwise) appears logical in terms of strategy: the risk of moral hazard is limited because all countries are responsible for their own debt as well as that of their neighbors. Such questions had already been raised by the Werner Report in 1970, when the project to create a single currency was first drafted, but this report was not followed up in view of the crisis and other more pressing issues at the time. However, these questions were not taken up again by the Delors Report at the end of the 1980s.
A lack of European cohesion
For T. Brand, the absence of federalism at the budgetary level is both historical and political. It is historical because the creation of the eurozone was the result of lengthy negotiations, but the model that was chosen was that of Germany, a country known for its extreme aversion to inflation and for its budgetary rigor in view of its own history. It is political because even when, in 1994, Chancellor Kohl’s government proposed strengthening the Franco-German coalition, the French political class was unwilling to take the necessary steps to promote European cohesion rather than purely national cohesion. Since then, the eurozone has been created and the single currency introduced, but no strong and credible European governance has emerged, and even today, many issues continue to divide the various members of the eurozone, which have continued to diverge.
This « denial of interdependence, » as MEP S. Goulard points out, has also led Europe to make the wrong choices or to be too passive when swift action was needed. These decisions have affected the morale of European citizens and fueled a form of discontent (as evidenced by the Italian elections and the difficulties in forming a government), which could lead to a rejection of Europe in some cases, or at least a strong mistrust. According to Mr. Aglietta, we must therefore encourage the emergence of European solidarity. This must be based on Habermas’ concept of « democratic transnationalization. » In other words, a federal constitutional order (where national parliaments would converge), civic solidarity (the development of a European consciousness and debate), and the organization of collective action (again, the idea of fiscal and monetary federalism) must be established.
The « economic mirage model »
In principle, joining the eurozone was supposed to facilitate and promote convergence among European countries. The reasoning was as follows (based on the German model): the fact that all member countries could benefit from low interest rates (ensured by a certain price stability, which we will come back to later) should encourage investment in productive sectors and thus enable an increase in productivity and competitiveness, while ensuring both higher wages and the establishment of a current account surplus. A virtuous circle could then be established and the likelihood of a state having to intervene in the economic process was fairly low, making it difficult for public finances to get out of control.
Unfortunately, however, some countries did not meet the conditions required to benefit from low interest rates, as the macroeconomic environment in these countries was not necessarily healthy. Furthermore, not all investment was directed towards productive sectors and some may have fueled bubbles (mainly in real estate) through an excessive increase in the supply of credit. Once the financial crisis had broken out and spread to the real economy, the illusion of this model was definitively dispelled. Governments were then forced to intervene using expansionary fiscal policy, which had a considerable impact on public finances. Meanwhile, the countries of the eurozone diverged rather than converged overall.
A final criticism of the « European economic model, » if it ever existed, is directed at proponents of the market efficiency hypothesis, an essential element on which the market economy has been based since the 1980s. Since prices are able to incorporate all information, ensuring their stability should ensure a certain degree of macroeconomic stability. From then on, the ECB’s central objective was totarget inflation, ensuring that monetary policy guaranteed price stability and, to a lesser extent, financial and economic stability. It turns out that this assumption of market efficiency is far too strong and that market self-regulation is a myth, yet few alternatives have been proposed to date.
The solutions proposed by Aglietta and Brand
To strengthen the EMU in the future and avoid falling back into a crisis similar to the one we are currently experiencing, Mr. Aglietta and T. Brand provide several elements that could effectively address the current challenges. Four solutions emerge from their thinking: greater political solidarity, fiscal federalism, a new mandate for the ECB, and an economic model guided by incentives and innovation.
Firstly, establishing a common European political strategy based on the principles outlined by Habermas in order to strengthen European solidarity. This should therefore be based on fiscal federalism with the establishment of a common European budget and, undoubtedly, the mutualization of public debt. The adoption of a Redemptions Funds -type system would seem to be an effective solution in Aglietta’s view: the mutualization of debt via a fund would cover the first 60 percent of countries’ GDP, so that each state would be jointly responsible for its own debt and that of its neighbors, and as soon as a country exceeded the 60 percent threshold of its GDP, it would be solely responsible for the surplus debt created. With such a fund, EMU members would be forced to coordinate, which should strengthen governance and the European spirit. These first two points therefore refer to a more democratically and fiscally united zone.
With regard to monetary policy, the ECB’s mandate needs to be broadened and its policy objective should focus less on price stability and more on financing the economy and providing liquidity to the economy and governments, if necessary. Moreover, these two objectives are not necessarily incompatible. The ECB must also continue to develop unconventional policy tools so that it is no longer solely dependent on interest rates to influence monetary policy. Macroprudential and microprudential measures are also two essential elements in defining the ECB’s role for the coming years, and the banking union under the single supervision of the Central Bank appears to be an important first step in this direction. The aim here is therefore to strengthen the role of the ECB, which, while remaining independent, needs to be closer to the Member States and the needs of the real economy, a challenge that would be easier to meet with fiscal federalism.
The final point raised by Mr. Aglietta and T. Brand concerns both the economic model of the eurozone of tomorrow and prices. In their view, a return to competitiveness, which seems to be the eurozone’s main focus alongside public debt sustainability, will only be achieved under certain conditions, and it would be misguided to think that an exogenous shock could lead countries down this path. Upstream, companies must find innovative strategies while expanding their sustainable development activities. The state can play an innovative role in facilitating this task: as in the case of the introduction of a carbon tax, the state must find a way to encourage companies to internalize certain externalities that the markets are unable to integrate. These incentives should lead companies (and especially investors) to change their methods of calculating the risks and future returns of their projects. This type of incentive should ultimately enable the development of a new growth model, promoting a return to competitiveness while relying on a network of innovative and dynamic companies that are better able to attract domestic and foreign investment flows, which are sorely lacking today.
