Why Fiscal Policy In The Eurozone Should Be Fully Renationalised

The global financial crisis has exposed the deep flaws of the euro, and particularly Maastricht’s original sin: to have deprived member states of their fiscal autonomy – by taking away their power to issue money and by imposing strict (and totally arbitrary) limits on government deficits through the Stability and Growth Pact (SGP) – without transferring this spending power to a higher authority, i.e., some form of central government. Or, to put it differently, to have created a monetary union (with, importantly, full capital mobility) without foreseeing the creation of a fiscal and political union capable of addressing structural imbalances and asymmetric negative shocks across the union. This left member states utterly defenceless in the face of economic crises, as the 2008 booms-gone-bust would make amply clear.

Yet, the crisis – which, it is worth remembering, was caused by a build-up of private, not public, debt – didn’t awake European leaders to the need to relax the Maastricht straitjacket, by loosening the budgetary constraints imposed on individual governments (thus allowing them to pursue counter-cyclical stimulus policies) or by moving towards a fully-fledged fiscal union (or at least a modicum of economic coordination between surplus and deficit countries). Instead, Europe’s powers that be – essentially the Berlin-Frankfurt ‘axis of austerity’ – chose to tighten the screws even further, first by imposing on the continent a brutal policy of asymmetric, class-based, demand-crushing austerity and then by ‘locking in’ those supposedly ‘emergency’ measures through the adoption, behind closed doors and beyond public scrutiny, of a complex system of new laws, rules, agreements and even a treaty – the Fiscal Compact – aimed at enforcing permanent austerity on the continent, whatever the cost (and on a much greater scale than that foreseen by the Maastricht Treaty). Importantly, the severe restrictions imposed on the fiscal autonomy of member states since 2010 have not been offset by an increase in the fiscal capacity at the federal level in Europe (on the contrary, the already meagre EU budget has been steadily shrinking since the start of the crisis). The result, predicted by many non-mainstream economists, has been a deeper and more prolonged crisis that of the 1930s (resulting in all-out humanitarian crises in a number of countries).

Thus, it is understandable that many commentators have welcomed the German finance minister Wolfgang Schäuble’s recent call for a ‘fiscal and political union’ backed by a ‘euro budget’. Schäuble is right to advocate institutional changes that might provide the eurozone with its missing political mechanisms, but we have to ask: is fiscal union – and, more specifically, the kind of fiscal union advocated by the German finance minister – what Europe needs at the moment? As argued by Philip Arestis and Malcolm Sawyer, an effective fiscal union would require tax-raising powers at the EMU level in the order of at least 10 per cent of the EMU’s GDP; fiscal transfers from richer to poorer countries; a federal authority with the capacity to engage in deficit spending; the support of the ECB in the operation of fiscal policy; a proportionate transfer of democratic legitimacy, accountability and participation from the national to the supranational level; etc.

Unfortunately, the fiscal union proposed by Schäuble is very different: it revolves around the creation of a European Budget Commissioner with the power to reject national budgets – a supranational fiscal enforcer – but doesn’t foresee the creation of a federal institution with legislative and spending powers. As for the proposed ‘euro budget’, we can expect it to operate according to the well-oiled money-in-exchange-for-reforms logic dear to Dr Schäuble. As Yanis Varoufakis writes: ‘The new high office would be annulling the sovereignty of a European people without having replaced it by a higher-order sovereignty at a federal or supra-national level’. In other words, sovereignty is not being elevated to the European level, it is simply being usurped from the national level, thus accomplishing a lifelong neoliberal dream: the complete separation between the democratic process and economic policies, and the death of active macroeconomic management. This has been described as ‘the politics of depoliticisation’.

It’s not hard to see why such a development would be politically unsustainable, further exacerbating the union’s centrifugal tendencies. Moreover, given the current balance of power in Europe, which sees Germany firmly in the driving seat, the kind of post-democratic, top-down ‘federalism’ proposed by Schäuble would almost certainly subject the EMU to an even tighter deflationary, contractionary and mercantilist straitjacket – and for this reason should be firmly rejected. At the same time, we have to acknowledge that the political conditions are not ripe for a move toward a fully-fledged fiscal and political union, along the lines outlined above. So – barring a break-up scenario – what options does that leave us within the context of the EMU?

The only sensible solution in the short-medium term is to acknowledge that a number of eurozone countries, especially those of the periphery, are in balance sheet recession – a situation in which individuals and companies, following the burst of a debt-financed bubble, collectively focus on saving rather than spending, thus reducing aggregate demand – and in desperate need of a fiscal stimulus, and should thus be allowed to pursue much more expansionary fiscal policies until private sector balance sheets are repaired. This, of course, means scrapping the Fiscal Compact. In order for this to be politically and economically viable, two conditions are necessary: 1) there should be no increase in Germany’s sovereign or private liabilities vis-à-vis periphery countries; 2) periphery countries need to ensure that idle savings in these nations do not flow abroad but are invested in local government bonds.

As argued by Richard Koo, this can be achieved by ‘re-internalising’ fiscal policy in the EMU: i.e., by prohibiting member states from selling government bonds to investors from other countries. As Koo writes, ‘the proposed new rule would allow individual governments to pursue autonomous fiscal policies within its constraint. In effect, governments could run larger deficits as long as they could persuade citizens to hold their debt. This would both instill discipline and provide flexibility to individual governments. A softer version of this plan would involve the introduction of different risk weights for local and foreign bonds.

Moreover, as noted by Philippe Legrain, Germany’s fears of mutualisation could be further assuaged by reinstating the ‘no bailout rule’ (violated by Germany itself in 2010 to save its own banks) and by creating a mechanism for restructuring the debts of insolvent sovereigns. Such a solution would have a number of economic and political benefits: not only would it have an immediate macroeconomic impact (thus leading to increased debt sustainability), it would also engender a more positive attitude toward European institutions (which would no longer be seen simply as enforcers of watertight fiscal rules), thus slowly re-creating the conditions – in the longer run – for moving toward a true solidarity-based and democratic fiscal and political union.

This article appeared in a shorter version in the Autumn 2015 edition of Europe’s World