The case for monetary reform and unemployment insurance
The rejection of continued EU membership by the UK electorate at the June 23 referendum pushed Great Britain into a new type of political and economic crisis. However, the resulting uncertainty also creates a new challenge to the remaining 27 members of the European Union, which is now set to lose the larger of the two member states that have opted out of the single currency.
People in Great Britain, and especially in non-metropolitan England and Wales voted for leaving because they lost confidence in the EU being a win-win game. Similar feelings about the lack of fairness are even more widespread within the Eurozone, and especially in the more peripheral countries which went through a long recession and still struggle with high unemployment and rising poverty.
Following the UK referendum, various officials, including the French and German foreign ministers, called for reforming the EMU and making it more resilient and sustainable, including through the creation of a fiscal capacity for the Eurozone. This paper argues that creating a counter-cyclical fiscal capacity indeed is a crucial and urgent step to halt disintegration, and EMU unemployment insurance can be a pivotal instrument to strengthen economic as well as social cohesion in Europe.
Europe’s multiple crises
When Europe’s crisis is mentioned today, people most likely associate it with the so-called refugee crisis, and the UK referendum result pointing towards Brexit. However, the European Union was already unstable before the 2016 refugee wave arrived and the re-election of David Cameron made it certain that a major Member State would hold a referendum about continued EU membership.
Eurozone crisis made it harder to deal with the other two challenges. It weakened the administrative capacity of Italy and Greece to deal with the crowds of refugees. And it gave a lot of ammunition to UK Euroskeptics who wanted to prove: „the EU is not working“. It just boosted unwelcome migrant flows from the South to the UK and made it harder to reduce the level of immigration. Many Britons, especially those with a left-wing orientation became disaffected when they saw how the community treated its most unfortunate member, Greece, in the Summer of 2015.
Excessive focus on Greece never helped putting a proper analysis of the EMU on the agenda. But it is high time to ask why since 2011 the EU economy decoupled from the US, why countries keeping their national currencies (UK, Sweden, Poland etc.) are more dynamic and stable than those in the euro area, and why the EMU remains so imbalanced and fragile despite investing so much political capital in stabilization and reforms.
No doubt, Greece has been and remains the weakest link in the Eurozone, and there are many internal reasons for that. However, the shortcomings of the whole EMU architecture also require attention, before continuing weak economic performance and future disturbances destabilize the system again, with an increasing likelihood of disintegration.
In June 2015, the Eurozone was diagnosed with serious divergence by the so-called Five Presidents’ Report (5PR). This document was noticed by too few at the time of the storm created by the third Greek bailout. Those who paid attention saw that Jean-Claude Juncker, Donald Tusk, Mario Draghi, Jeroen Dijsselbloem and Martin Schulz actually outlined some very important arguments for revamping the EU’s economic and monetary structures.
Though less visionary than the 2012 Four Presidents’ Report, the 5PR creates a framework for exploring the forest behind the tree. True, the Eurozone has not been in a state of recession for some time, but it has not experienced a proper recovery either after the double dip.
In 2015, three specific actions helped to ensure that the majority of the EU countries would experience positive growth. A more flexible interpretation of fiscal rules was adopted by the Commission, the Juncker plan was launched (creating a new financial instrument called EFSI), and the ECB embarked on quantitative easing (QE) in practice. However, in one year it became clear that, while useful and necessary, these actions do not add up to a full solution either separately or in combination.
Angel Gurria, head of the OECD spoke about a vicious circle driven by falling investment and increasing imbalances, resulting in the erosion of human capital, economic competitiveness and fiscal health. Arguably, this vicious circle cannot be broken without further reforming the Economic and Monetary Union (EMU). As long as core countries are allowed to accumulate ever greater surpluses, while periphery countries can only rely on internal devaluation in bad times, the Eurozone will remain wedded to low growth, deepening asymmetries and vulnerability.
Divergence and the risk of disintegration
Post-war European monetary cooperation disintegrated twice: once in the early 1970s, and then again in the early 1990s. We learned in the recent years that the abolition of national currencies in itself is not sufficient guarantee against another disintegration of the single currency area.
At times of crisis and heightened speculation, a possible break-down, or dissolution of the euro has been mainly discussed in terms of a crash of one or several member states and the resulting need to introduce a new national currency. This is, however not the only way the single currency could die.
Just like the life of humans can end in various ways, a currency union can also be a victim of different diseases. Cancer does not kill the same way as heart attack. Through reforms (notably the Banking Union) and one-off, discretionary measures (by the ECB mainly), the risk of a heart attack has been diminished. However, the risk of cancer is still there, and has probably increased in the meantime.
The divergence that has developed within the euro area between core and periphery is indeed the main threat to the existence of the single currency and to the stability of the EU as a whole. Hence, there is a need for further strengthening of the EMU architecture, and in particular to strengthen its real economic performance and its social dimension.
This ambition should go beyond securing the short-term survival of the single currency, which was the pattern in the 2011-3 period. Without an improvement in real economic and social outcomes, rising nationalist sentiment will continue to turn against either the single currency, or the EU, or both. The democratic governability in Southern Europe is at stake.
Rebalancing the Eurozone is a key question. Various models of rule-based, though limited mechanism of solidarity have already been explored by think tanks, in order to strengthen people’s and markets’ confidence in the euro, and thus create a better institutional foundation for the recovery of investment.
Hostility around bail-out programs and their conditionality have not created a good atmosphere in which more solidarity could be easily promoted, especially if it involves various forms of fiscal transfers. However, there is virtually no serious assessment of the functioning of the euro which would see a chance of long life without a fiscal capacity and risk sharing, ideally in some form of automatic stabilizers that can limit the damage from cyclical downturns. Unemployment insurance (or re-insurance) is a well-developed option for such a function.
Hence, before we get too close to national parliamentary elections in major countries again, and while the third Greek bail-out agreement delivers a certain degree of tranquility, we should use the window of opportunity to discuss a substantial reconstruction of the EMU and make some crucial steps in practice. The work ahead should not only focus on avoiding another heart attack, but on changes needed for truly improving resilience, performance and cohesion.
A broad EMU reform agenda
Beyond occasional bail-outs, there are several broader issues awaiting debate and answers. Should we see the IMF as a permanent participant of EMU stabilization, or we will reach a point soon when the Fund is not needed any longer as a lender or an analyst of debt sustainability? Can the ECB defended from constant legal challenges when it acts in defense of the integrity of the single currency? Can we find the right balance between external support and national responsibility (and bankruptcy if needed) without the risk of contagion and disintegration?
While these and many other questions are raised in connection with EMU deepening, it should not be forgotten that not even the Banking Union has been completed (deposit insurance needs to be delivered to complete the three-pillar system). At the same time, there should be a way to better articulate economic policy in the interest of the euro area as a whole, in order to optimize policy coordination for growth together.
Member states should not be allowed to pursue arbitrary targets (e.g. “black zero”), or accumulate excessive current account surpluses, if those are detrimental to the community as a whole. Establishing a chief economist has been considered for some time, but concrete steps have proven just too difficult, similarly to the external representation of the euro.
The 2012 experience should not be forgotten. Four years ago, the intervention of the ECB turned out to be a game changer. Without it, the Eurozone would probably have quickly disintegrated. However, the ECB only managed to change the game at the level of survival. Today this is not sufficient. What we need is significantly higher rates of growth and a return to real convergence.
A game changer for investment, growth and rebalancing is needed. Ongoing initiatives like creating a Capital Market Union (CMU) or establishing competitiveness councils fall short of this requirement, even if they are often discussed in the context of EMU deepening. Ceterum censeo: fiscal capacity is a necessity, and the case for automatic stabilisers is compelling.
Better governance is necessary (e.g. joint action against excessive imbalances), but it is not obvious that member states would hand over competences to a stronger EMU level governance structure without more risk sharing. This latter would also help strengthening public acceptance of the EMU. Strengthening discipline, solidarity and legitimacy simultaneously would probably pay-off economically as well as politically.
Since 2012, when the reform of the EMU began, the possibility of and need for unemployment insurance within the Eurozone has been frequently discussed. The 5PR, which explains so clearly the problem of divergence, provides another opportunity to have a serious debate on this instrument, potentially opening the avenue of practical changes as well.
Options for automatic stabilisers
Most macroeconomists seem to agree today that the incomplete nature of the EMU makes it unsustainable in its current form, but there can still be a debate about what should be the next step. Automatic stabilisers offer the solution to counter „asymmetric shocks” and resulting imbalances by having a rule-based and conditional mechanism of temporary fiscal transfers.
In discussions on Eurozone fiscal capacity, which are now more frequent than 5-6 years before, experts speak about three possible models of automatic stabilisers. They have different implications in terms of the frequency of transfers, the definition of final beneficiaries, the need for harmonization and governance, as well as the sourcing of the model.
Some economists have explored the possibility of automatic income support for situations of major economic downturns, defined on the basis of the „output gap”. Most likely, such a solution would be in conformity with the current Treaty, but it also has disadvantages. The output gap is a concept too abstract for many people, and when it is calculated, it is often corrected ex post, which risks leading to perverse outcomes. In addition, it entirely lacks a social focus (i.e. it is not certain at all that the beneficiaries of such transfers would be the more vulnerable victims of economic crises).
Reinsurance of national unemployment insurance funds is another possibility. The national capacity of dealing with cyclical unemployment would be supported, but transfers would only be triggered by major crises. Such a scheme would make a stronger and more visible impact at times of crisis, while lacking a role in case of more modest fluctuations. There is a real risk in setting the trigger too high (in terms of rising unemployment above „standard” levels), and thus making the model less effective than potentially possible.
Finally, a partial pooling of unemployment benefit systems would make an economically more advanced solution, by also defining some common minimum standards accross countries (in terms of minimum replacement ratio and duration). The minimum would not be a maximum, because member states could top up payments from the common pool and also extend coverage from their own resources. But the common pool would already have a significant stabilisation effect and it would represent EU solidarity in countries experiencing temporary hardships do to the limitations of their macroeconomic toolbox in the monetary union.
Had such insurance mechanisms existed in the EMU since the times of 1999, the establishment of the single currency, all member states would have been beneficiaries for a shorter or longer period. Countries experiencing a severe recession would have received fiscal transfers amounting to 0,5-1 per cent of their GDP, helping them to a faster recovery and ending up with less poverty and income inequality for which the EU or the euro are blamed today.
Addressing legitimate concerns
From a macroeconomic point of view, stabilisation means dealing with asymmetries and cyclicality. Instability in a monetary union can be linked to uneven growth of productivity but also asymmetric external shocks. These can be addressed to some extent through economic governance, but it is an illusion that perfect stability can be delivered through governance only.
Since perfect ex ante solution (through policy coordination) cannot be developed, it is necessary to have an ex post possibilities, which means we need to have a fiscal capacity for shock absorption (as long as we want to remain in a transparent, orderly and rule based model). This also means introducing elements of a fiscal union, or in other words, transfers.
Some oppose automatic fiscal stabilisers either because they are automatic, while others may be hesitant because they are fiscal (and other types of risk sharing or no risk sharing at all would be preferred). However, those who immediately connect fiscal transfers with moral hazard should not forget that such arrangements are part of national macroeconomic systems at much larger scale. What is more, in 2013 the European Council was about to introduce fiscal transfers called Competitiveness and Convergence Instrument (CCI).
The fact that this 2013 effort failed (due to the failure to connect specific structural reforms with certain amounts of fiscal transfers) should not mean that transfer in general is a non-starter and fiscal capacity would be a wrong idea. It simply means that conditionality cannot be included on a case by case basis, when the transfer has to be made, but it has to play a role at the time of entering the mechanism at the very start.
Another name for entry conditionality is harmonization, but the need for this is often exaggerated in current discussions. Since the suggested safety-net for the euro would only need to be connected with short-term (cyclical) rather than long-term (structural) unemployment, it is a relatively smaller part of labour market organization and statistics that has to be harmonized and not the whole institutional framework.
The degree of harmonisation needed depends on the chosen model, but it would need to be modest in any case, since there is no proposal on the table which would want to cover unemployment in its totality.
Concerns have also been expressed about the future role of social partners, which in various EU countries play a strong role in governing unemployment insurance. Indeed, in any chosen model there would be a need for EU level governance, which could be organized in a tripartite way, giving a real and influential role to the social partners (practically to control the adjustment tools of the mechanism like experience rating and clawbacks).
Just like the case of the Youth Guarantee, the EU level unemployment isurance model would need to draw on the best available practices in Europe, and in those (e.g. Germany and Austria) the social partners play a significant role.
The EMU and the social agenda
All countries in the EU have the ambition to be welfare states in a sense to be able to limit unemployment, poverty and income inequality. This is an ambition born well before the monetary union was created. But the eurozone crisis has severely damaged this capacity in countries of the eurozone periphery, and the problem is linked not simply with the crisis response but the incomplete nature of the EMU.
Alongside economic stabilisation, the key question today is how to strengthen the social dimension of the EMU and counter social divergence. Purely by setting standards without also providing support will not be sufficient. Moving towards an actual fiscal capacity therefore is crucial if we want to see change in reality and not only in principle.
The establishment of a minimalist monetary union in the 1990s produced new types of financial and social risks, and the crisis of the EMU brought the EU to massive divergence and a weakening of the national welfare systems. Such dynamics undermine public confidence in both the EU and its single currency.
Since the very launch of the EU, the social dimension was indispensible for its sustainability and legitimacy. However, the social agenda of the EU was defined in the Delors era, and it has been primarily focusing on employment related legislation. Together with cohesion instruments in the EU budget, social legislation has ensured that the single market does not lead to a polarisation among member states and it makes real convergence possible.
If it is true, that the economics of the EU has to move beyond the Maastricht orthodoxy, it is also true that the pre-Maastricht concept of a Social Europe is insufficient in the 21st century. The financial crisis has produced an unprecedented social crisis in several countries but social policy alone cannot compensate for the malfunctioning of the monetary union. It is the monetary union itself which needs to be repaired and reformed, and this has to be seen as a pre-condition of an effective social agenda, if not the part of that.
National welfare systesms rest on legislative as well as budgetary pillars. Today, however, it is the EMU that controls most of the parameters that frame national welfare systems (and especially the stabilising function of fiscal systems), hence social policy cannot just be a matter of subsidiarity either. The EU social agenda has to connect with a wide spectrum of policies, including economic policy coordination, structural reforms, labour and welfare legislation, and budget resources.
Either model of eurozone unemployment insurance or reinsurance would create a safety net for national welfare systems while also helping to shorten economic recessions and enhance the overall growth potential of the eurozone. Some countries would need to contribute more than others, but in a long enough cycle, all member states would be net beneficiaries at some point. The entire community would benefit from the capacity to support aggregate demand, economic activity, employment and eventually social cohesion in zones of economic downturn.
Brexit calls for a thorough rethinking of the functioning of the EU and potentially opens the door before a paradigm shift on EMU. Together with other emergencies, like immigration and the fight against terrorism, the question of the currency has to be discussed in a new light.
In recent years, expert opinions have converged about how to make the single currency sustainable and how to reconcile its functioning with democratic standards and the European social model. The key question, however, is whether there is still sufficient political capital left among mainstream political forces to promote solutions that can accommodate imbalances and counter divergence between the core and periphery within the Eurozone.
The point with unemployment insurance is that it is a possible element of economic and monetary reform, while it forms part of the social dimension as well. When political capital is limited, the availability of an instrument that could make positive impact on both economic and social sides of the crisis should be appreciated.
In fact this might be the last time when the road forward towards a more perfect EMU is still open. If this chance is missed, and divergence and asymmetries are not dealt with, continuing stagnation will turn even greater shares of the electorate against the euro, and in a few years the only choice will be between orderly or disorderly deconstruction.
*Remark: Prior to being EU Commissioner László Andor was the Chairman of the Scientific Council ot ATTAC Hungary