Introduction: towards a shared vision of the deepening of the EMU

In May 2017, the European Commission presented its Reflection Paper‍[38] to steer the debate about the deepening of the European and Monetary Union (EMU). Additionally, in his speech at the Sorbonne, the French President Macron presented a long list of proposals that, amongst other things, targeted the reform of the EMU.‍[39] In his State of the Union-speech, European Commission President Juncker emphasised that there is now a ´window of opportunity´. Furthermore, in the Netherlands, a report from the Advisory Council on International Affairs takes a similar view.

These, and other, papers and speeches claim first of all that the EMU is not yet complete, which is why the euro remains a major risk, why growth remains sluggish and why unemployment in the South threatens the entire European Union. Secondly, they argue that a debate is necessary to get everyone back on the same page when it comes to deepening the EMU, and thirdly, that there is now both economic and political leeway to act decisively: “It is time to let a pragmatic approach prevail over dogmas, time to build bridges and time to relinquish individual mistrust” (COM (2017) 291, p. 31).

It is clear that the Commission’s Reflection Paper comes at a time when thinking about EMU reform is high on the European agenda and many of the assumptions and recommendations in the Paper are widely shared. This article provides a brief critique of the Reflection Paper, outlines an alternative diagnosis for the European crises, and suggests a number of measures to strengthen the euro that are not mentioned in the Paper.

Diagnosis of disagreements

In the Reflection Paper the Commission makes far-reaching proposals about what is necessary in the long term, including the appointment of a European Minister for Economics and Finance, who will be accountable to the European Parliament (EP); increased resources at the EU level, plus European taxes and tax harmonisation; a European Monetary Fund (EMF); further steps towards a social union; the introduction of Eurobonds; and a fund for the liquidation of failed banks. In addition, the Commission now wants to introduce the principle of joint liability (i.e. risk-sharing).

These proposals represent major shifts away from the existing EMU rules. The euro was set up on the basis of euro criteria that implied that countries must have their own budgets in order, that they must limit their national debt to 60% of GDP, and that they must not expect financial bailouts from other countries.‍[40] Moving away from the no-bailout, the Commission’s proposals represent a movement towards a system of governance that includes an economic and finance minister and in which the EP becomes a more fully-fledged parliament that also has the right to approve and amend budgetary policy.

The question is, however, whether this is necessary. The first thing that needs to be done in order to have a meaningful discussion about the measures to strengthen the EMU is to be clear about the roots of the problems the euro is facing.

In its analysis, the Commission stresses the risks posed by external shocks and advocates the implementation of European shock absorbers. Outside the Commission, many argue that the no-bailout approach must be adhered to, and that ultimately member states have to stand on their own feet. An important factor in this regard is the doubts about the significance of external shocks. An external shock is often a great deal less ‘external’ than the term implies because shocks are often caused by insufficient supervision in member states, by delayed reforms, missed growth opportunities, and accumulation of unsustainable debt. In the case of Italy, Portugal and France, any external ‘shock’ quickly becomes an existential threat simply because these countries have little or no financial leeway of their own to counteract it. If a country respects the Stability and Growth Pact rule of national debt below 60% of GDP it would be able to deal with substantial shocks. This also means that more leniency can be shown temporarily after such a shock or in the face of disappointing economic growth. To make the EU a resilient system, the various components (i.e. the member states) ought to have their own primary cushioning and recovery mechanisms.

As it now stands, weak countries want to reform the EMU whereas strong countries want to reform the member states. It will be hard to arrive at shared perceptions of weaknesses or of ways forward.

Disagreements over short-term solutions

Aside from the lack of a common diagnosis, there is no agreement as to the way to deal with the existing problems. There are at least two main problems in the short term, namely the debt overhang in Southern Europe and the delayed economic reforms, which have led to sluggish economic growth and disappointing unemployment figures. In a move intended to create stability, the Commission is advocating the completion of the banking union through the expansion of both the deposit guarantee scheme and the ‘backstop’ mechanism for failing banks. The Commission further proposes to aggregate debt from weak and strong countries into what are called ‘safe assets’, i.e. packages of debt securities from various countries that together would create a European market for the spreading of debt risk. Economically, this makes them somewhat comparable to the subprime mortgage junk bonds in the United States.

Those who wish to return to the no-bailout system usually have no better short-term response on offer than to argue that growth is necessary to solve the current problems. Debt write-offs are discussable, but this begs the question of whether there would be guarantees to ensure that member states would be, and would remain, reform-minded. The creation of a political union should help to solve the problems in the short term, but it leaves pressing questions unanswered. For instance, how will Italy and Portugal in particular get rid of their excessive debt burdens? Is an effective system of ‘bad banks’ possible or will debt write-offs be necessary? Furthermore, there is probably no backup plan in place should Italy get into trouble after all, for example as the result of an interest rate hike. Would this then be followed by another process of ‘too little too late’ that would leave both Italy and the Eurozone as a whole worse off? Can Italy, given its size, actually become a European IMF ‘programme country’? Is it realistic to offer ‘safe assets’ in exchange for renewed promises of reform?

There is agreement on the need for growth. However, this requires the implementation of a broad range of reforms. The hoped-for structural convergence envisaged since the commencement of the Euro project in 1992 has still not arrived.‍[41] Structural indicators of the quality of the institutions in member states‍[42] indicate that the Netherlands and Germany score very high in terms of the quality of government, the quality of regulation, combatting corruption, and so on. Belgium and France are in the middle, while Southern and Eastern European member states figure lower in the rankings.‍[43] The question remains as to how countries can be induced to reform themselves.

Alternatives for a political union: market forces and managing reforms

The Commission’s proposals are a move towards ‘more Europe’. These measures may be viewed as necessary from a social point of view in order to regain the general public’s trust in those countries with high unemployment or with a view to increasing confidence in banks quickly. However, the Commission’s proposals (e.g. the ‘safe-assets’) can also be viewed as distorting market forces.

An alternative way to strengthen the EMU could be to rekindle market forces and (policy) competition between states. As it stands, already for a long time the EU’s internal market has been more harmonised than the markets in the USA and Canada,‍[44] and current EMU plans threaten to move the EU further down the road of endless harmonisation. Strengthening different kinds of competition may offer an approach towards structural reforms in member states.

Market forces and policy competition

The key question a market-driven approach must answer is how risks can remain with those parties that both assume the risk and hope to reap the benefits. One priority should be to factor in risks relating to government debt. When member states still had their own currencies and central banks, government debt was reasonably secure.‍[45] With a single European Central Bank this is no longer the case. The road ahead to sustainable public debt management is still unclear, given the major risks that banks are running (especially in Italy), the consequences of a risk premium for countries that already have high government debts, and the level of political resistance to risk pricing (particularly in the South). One possible solution is that, over the next 20 years, a certain percentage of government debt held on the books is assigned a risk premium each year. If government debt is given a risk weighting, then banks will immediately have to pay more attention to spreading their investments in government debt over more countries.

The market mechanism could also be deployed to a greater extent when it comes to calls for a banking union and the deposit guarantee scheme. During the banking crisis, the Irish government raised the level of savings deposits that were guaranteed to 100,000 euros and other countries had to follow suit to stop savings deposits moving towards Ireland. This represents a substantial subsidised guarantee of private risks. Market forces and risk awareness can be reintroduced by lowering deposit guarantees.

Also at odds with the mechanism of competition are the proposals for a Europeanisation of social and tax models. Within the EU, and particularly in the discussions about the EMU, little attention has been paid to the benefits of policy competition. The EU has always made great efforts to achieve harmonisation. In the words of Majone: “Unfortunately, […] centralized, top-down harmonization has been practised much more than inter-jurisdictional competition.”‍[46]

Structural convergence

The Commission emphasises the potentially important role the EU budget plays in encouraging structural convergence. The question here is whether member states will set in motion very far-reaching and painful changes in their national institutions merely because they have been given (relatively small) financial incentives to do so. The EU budget is too slim to produce credible incentives and even in some Eastern European countries, where the EU budget represents about 4% of the national economy, financial pressures to reform have had little result (cf. Hungary).

To facilitate reform processes that stand a greater chance of success we may look at past measures that have improved poorly functioning sectors in the internal market. Aviation safety, food safety, and environmental policy are examples of domains where much progress has been made through networks of independent European and national agencies.‍[47] When it comes to the EMU, however, it is difficult to get the debate about independent supervisory bodies off the ground (see the chapter on rule of law in this volume), also because the Commission keeps economic supervision and Eurostat within the own organisation.

The European Commission is due for major reforms

Juncker’s statement in 2016 that France cannot be brought to book about its repeated budget overruns “because it is France”‍[48], and his hope to run a “very political Commission”‍[49] underlines the tendency at EU level to think in terms of a political union rather than in terms of strengthening independent supervisory bodies. Highly developed democracies cannot function without decentralising tasks to independent bodies to ensure check and balances. The proposals put forward by the European Commission in the Reflection Paper include additional competencies for the Commission. The combination of policy tasks, including policy preparation, implementation, supervision and enforcement, is becoming unavoidably incompatible – particularly if the Commission is also trying to be more political. Hence the Commission as an organisation needs to be reformed. The administrative traditions in the Scandinavian countries, based on small central governments and major independent implementation and inspection bodies, could serve as a point of reference to strengthen checks and balances.

This article builds on Schout, A. (2017), ‘De EMU heeft geen weeffouten’, Beleid & Maatschappij, No. 42017.