In the latest in our ‘Europe2025’ series, Gustav Horn focuses on macroeconomic institutional reforms for crisis-proofing and a programme of investment to engender vital public goods.
Gustav Horn
After the European Parliament elections, it is time to decide how the European Union will meet the challenges of the near future. If the EU is to survive in the long term, it can only be via deepening European relations.
The priority to which member states and the European Parliament, in particular, should devote their efforts is to make the EU and monetary union crisis-proof. Some steps have been taken but they remain to be completed.
Rapid response
True, the need for a European Monetary Fund is no longer controversial, at least in the overwhelming majority of member states. But they oppose a monetary fund as a European, as against an intergovernmental, institution. Yet the latter would likely make decision-making more complicated, causing damaging delays especially in crisis situations. A rapid response to panic-driven imbalances in the financial markets would hardly be possible. Only a turnaround in the political debate—currently unlikely—can ensure Europe is ready for the next crisis.
Rendering the eurozone resilient to crisis fundamentally entails completing the remit of the European Central Bank, so that it can be the lender of last resort. So far, it has not formally fulfilled this role, even though it did de facto during the peak of the euro crisis in 2011 and 2012. Crises, however, raise the question of its credibility and thus of its effectiveness, which must be clear from the outset and not dependent on uncertain, ad hoc decisions.
All players in the financial markets need to be confident at all times that the ECB can rush to the aid of member states with liquidity, buying up their government bonds. This will nip some financial panic attacks in the bud. Central banks of all major economies have exactly this function.
The European currency area is distinct because of the national independence of its members. Decentralised national fiscal-policy decisions however conflict under certain circumstances with European monetary-policy requirements.
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The concern of many member states is that excessive borrowing by a single government could force the ECB to buy up massively that government’s bonds to keep the financial markets stable for all member states. In other words, the possible negative consequences of such an operation—such as inflation or a general loss of confidence in the currency—would be borne by all eurozone members. This leads to the fear that such a setting is an incentive to risk high public debt more easily and that, in the end, the entire monetary union would be heavily indebted.
This conflict between greater financial safety for the entire monetary union and increased incentives for risky behaviour by individual members remains unresolved. An unavoidable conflict, which has been a source of controversy among economists and politicians since the beginning of monetary union, it can ultimately only be resolved politically.
After all, the states of the monetary union must ultimately bear the political and financial responsibility. If they do not give the ECB a mandate, they risk a crisis of confidence spreading rapidly, with considerable economic and financial consequences for individual states. If they do however give it the mandate, national debts could rise—especially under the influence of nationalist governments—and consequently the burden of high interest rates.
One way out would be to give the ECB a graduated mandate. In the event of a crisis, the bank would have a free hand to buy up to 60 per cent of a country’s government bonds on the secondary market. To go beyond that would require an explicit resolution of the European Parliament. This would mean that the political responsibility for increased intervention would be assumed from a European perspective and the ECB would be relieved of this responsibility. Irrespective of the parliament’s decision, a European Monetary Fund could grant conditional loans at reduced prices to member states in distress, with the help of which they could more easily survive such a crisis.
Investment lagging
Protection against crises is one urgent task and creating greater economic dynamism is another. The European economic area is still suffering in many regions from the after-effects of the financial-market crisis and, above all, the crisis in the eurozone. Investments are particularly weak. In some cases, public investment is lagging far behind demand and its usual dynamics, while in others private investment is also very subdued in view of the economic situation.
At the same time, there is a high need for investment, particularly from a European perspective, in view of the requirements of climate change, energy-system transformation and the digital revolution. All these challenges can be met much more easily on a European level than by purely national efforts.
This can be achieved through an improved division of labour among member states, for instance in energy production. Another avenue is to exploit economies of scale in Europe-wide production. This is particularly important with regard to digital developments.
Against this background, a European investment programme in public goods and within the framework of a European industrial policy should be launched. A sustainable and secure energy supply, achieved through the massive expansion of renewable energies, could be a desired public good. European industrial policy could meanwhile create good supply ocialconditions for the digital economy by investing in a state-of-the-art digital infrastructure across Europe.
These investments could be financed by merging the numerous investment funds, such as the European Fund for Strategic Investments (the Juncker funds), and additional funds could possibly be raised via a European financial-market transactions tax.
With this double step of improved crisis management and a dynamic investment policy, many of the economic challenges facing the EU could be overcome. In the end that should serve to foster acceptance of increased European integration.
Gustav A Horn is professor of economics at the University of Duisburg-Essen, a member of the executive board of the SPD and chair of its Council of Economic Advisers. He is also chair of the Keynes Society.