What Economic Policy For The Euro Area?

Maria João Rodrigues

Social and political tensions in Europe are reaching new heights. Fear of migrants fuels nationalist sentiments and religious animosities are becoming serious. Many people are tempted to break away from what they see as dysfunctional: old political elites, Schengen, the euro, or ‘Brussels’ in general. After fretfully accepting a million asylum-seekers last year, almost all European leaders now seem to be focused squarely on limiting the numbers. There is little confidence left to do more.

Events unfold quickly but, in my view, growing populism and anti-Europeanism are still mainly a consequence of the widespread economic insecurity produced by conservative policies in the first half of this decade.

The long economic crisis, aggravated by the Eurozone’s fragile set-up and abrupt fiscal consolidation, has caused severe social hardship, undermined investment in future growth and deepened inequalities both within and between countries.

More recent challenges such as renewed geopolitical instability, terror attacks/threats and refugee inflows are not the main cause why anti-EU forces are gaining each day. The basic underlying anxiety is socio-economic in origin and relates to the worsening of economic perspectives for the large majority of Europeans over many years.

The centre-left, for its part, is now paying the price for its timidity and weak coordination in the early years of the euro crisis. Our ideas may not have been ‘austerity-lite’, but our actions often were. The Economic and Monetary Union is being repaired in a very incremental way, ‘our’ investment plan carries the name of J.-C. Juncker and has almost no new public money in it, and talks on a scaled-down Financial Transaction Tax are still on-going. Moreover, we have championed the Youth Guarantee, but otherwise we have been too slow in coming up with a serious agenda of progressive reforms.

Can these worrying trends change before it is too late? Can Europe regain popular support, can social democratic parties win back voters, and can a robust economic recovery be achieved at last?

Individual governments cannot change much quickly, especially in the Eurozone. Structural reforms take time, notably the useful ones, while national monetary and fiscal policies are either non-existent or heavily constrained.

Yet a lot could be changed together, collectively, if we actually had a political debate on Eurozone economic policy and really managed our currency union as a single economic entity, which it is.

The Eurozone Is One Macro-economy

Official documents like the Five Presidents’ Report or the 2016 Annual Growth Survey package show increasing recognition of the need to analyse the Eurozone’s overall budgetary and current account positions. Conceptually, we are beginning to get things right.

DG ECFIN experts are rightly reporting on the euro area’s current account surplus of 3.7% of GDP and noting that it is most probably “above what fundamental economic characteristics imply”, reflecting “economic inefficiencies and subdued domestic demand”. They even undertake a certain analysis of the Eurozone’s aggregate fiscal stance, which they find “broadly appropriate” after having considered output gaps, debt sustainability, favourable interest rates and the current account surplus.

However, we should do more than analyse the grand total of national budgetary positions and current accounts at a technical level. Interdependent as the Eurozone is, it should have an economic policy based on a clear top-down view of what its optimal aggregate fiscal stance and current account position should be, and what contribution each Member State should be making to accomplishing both. In other words, the Eurozone needs more common decision-making – or at least serious economic policy coordination, based on a thorough political discussion.

Regrettably, the ECOFIN Council and the Eurogroup do not always debate European Semester priorities in depth. It would be great if their meeting on 14-15 January proved a positive exception. The Commission, for its part, has changed habits and it tabled its draft recommendation on the economic policy of the euro area as early as late November, hoping to encourage a proper EU-level debate.

The European Parliament has taken up the challenge and organised a very interesting plenary debate on the euro area recommendation in December with Commission President Juncker and Eurogroup President Dijsselbloem. In January and February 2016, we will try to conduct a serious debate on the EU’s and Eurozone’s economic policy across the Parliament’s political groups as well as in a two-day joint meeting with national parliamentarians. All this effort should, hopefully, contribute to a serious economic policy debate in preparation for the March European Council.

Domestic Demand Is The Missing Link

In my draft parliamentary report on the economic priorities for 2016, I have highlighted the need for stronger domestic demand in Europe, given high output gaps, the slowdown in global growth and the big excess of savings over investment implied by the Eurozone’s high current account surplus.

Reflation-oriented policies in high-surplus countries, such as stronger wage increases and greater public investment, would benefit all Europe through higher demand and growth, higher inflation, faster deleveraging, as well as reduced pressure on the ECB to extend its money-printing to potentially dangerous levels. At the same time, wage increases in surplus countries would hardly make them less competitive globally, since stronger domestic demand in the Eurozone would also reduce the pressure on the euro’s appreciation, which the high surplus otherwise creates.

A German budget deficit, financing overdue infrastructure repairs and much-needed social investments, would of course benefit Germany first of all. Faster wage increases would be applauded by a large majority of German voters. But also the rest of the Eurozone has a major interest in these developments, otherwise it is forced to maintain painful internal devaluation and stagnate in near-deflation, with a currency that is too strong.

Various German policy-makers often argue that high current account surpluses are needed in their country and others because of an adverse demographic outlook and high expected pension costs in the coming decades. In a household budget-perspective, it is indeed important to save up for the old age.

However, it is equally important for an ageing family to maintain its house and prevent dilapidation. It is also crucial to invest in younger generations and their productive potential – including when it comes to asylum-seekers accorded the right to stay. It is good to diversify savings instead of investing all in foreign banks. And finally, it is important to know that countries do not die like people, the economy is not a household, and excess savings across the board weaken domestic demand.

If the economy grows below potential, today’s excess savings are actually undercutting future output, from which future pensions will need to be paid. It would be therefore wise to have a clear target on what level of financial savings is desirable, and to take action when it is exceeded. Unfortunately, the already high 6% GDP threshold for current account surpluses has not been taken very seriously so far.

Investment And Reforms Go Hand In Hand

Europe’s centre-left forces could of course improve a lot more within the Commission’s proposed policy mix. We have advocated an ambitious investment strategy with real paid-in capital and focus on Europe’s transition to a more sustainable and productive growth model; we have formulated a detailed agenda of progressive structural reforms; we are leading the efforts to complete the Economic and Monetary Union with necessary common instruments; and we are trying to make European economic governance more democratic. We must deliver results on all these initiatives soon.

But in the end, my feeling is that broad Eurozone-wide agreement on a meaningful and growth-friendly economic policy will depend mainly on our ability to persuade our conservative colleagues that measures to strengthen domestic demand at this juncture would really help Europe’s longer-term competitiveness and growth. In particular, we need to explain that high current account surpluses reflect an excess of savings over investment. It must become clear to all that excess savings have now reached a level that is damaging to growth, jobs and ultimately also to the future value of today’s savings.

We should not be afraid to admit that Eurozone governments need to maintain fiscal responsibility in order to re-build trust. This is something where we can agree with Christian Democrat and liberal colleagues despite our grievances about past austerity. Debt/GDP ratios need to decrease; the question is how to get there.

In today’s context, the right economic policy mix for the Eurozone is clearly a social democratic one: stronger domestic demand based on faster wage increases in high-surplus countries and greater investment throughout the Union. Now that ECB interest rates are hitting the bottom, Eurozone countries should use whatever fiscal space they have to boost public and private investment.

While each Eurozone country has got the task of working on longer-term reforms to improve national economic fundamentals, a coordinated boost to domestic demand would be crucial for strengthening recovery and giving Europeans new confidence. Internal cohesion is in short supply in today’s EU, but if we properly talk to each other, we should still be able to re-discover the strength that comes from unity.

This column is sponsored by the S&D Group in the European Parliament