(These are background/speaking notes for an intervention I had planned to deliver at the International Research Workshop “Full Employment in Europe: With or Without the Euro?” at the University of Grenoble, co-sponsed by the Institute for New Economic Thinking May 15/16, 2014. Unfortunately, a sudden bout of severe flu the night before departure prevented me from travelling, K.B.)
EU economic policy making has two major flaws: one of substance, one of its territorial direction. These flaws have become especially visible during the recent and continuing anti-crisis policies. They are co-responsible for high and growing unemployment, low growth and increasing lack of social cohesion.
The substance flaw is its fiscal consolidation bias: while the Stability and Growth Pact, the Fiscal Compact, the European Semester, the Sixpack and Twopack all are mainly directed towards only one of the important policy elements of a comprehensive policy mix (matrix), the other important objectives of economic policy, full employment, low inflation, growth and balance of payments get much shorter shrift; let alone, environmental safeguarding, social wellbeing objectives, income distribution and other goals.
The territorial flaw is that the institutional setup is such that major policy recommendations and monitoring are directed towards individual member states, while the whole of the Eurozone and EU are not seen as the main focus of policy making. This, of course, is not true of the ECB, but only of the Council side. This flaw prevents an effective demand-side management of the economy.
With the exception of low inflation – the major policy objective pursued by the European Central Bank – and recently, the current balance (see below), only budget consolidation – a balanced “structural” budget, i.e. not containing cyclical influences and one-off effects (e.g. the sale of radio and cellphone licences, saving a bank, etc.) has a clear, statistically defined target, a binding incentive mechanism, containing financial sanctions, and a stringent monitoring mechanism, laid down in the European Semester.
This conceptual/institutional structure, plus a rough back-of-the-element assessment of the time and personnel resources expended towards this objective, justify the judgment that EU and Eurozone economic policy making has a strong bias towards budget consolidation and sovereign debt reduction – at the expense of pursuing other, equally valid policy objectives.
- The “other” objectives
In the “old” days, i.e. up to the 1970s, the international economic policy discussion was full of “magical pentagons, heptagons” and other –gons. They comprised growth, employment, inflation, budget and foreign balance as to-be-pursued objectives, with the knowledge that their respective weights in the objective function would have to be different for different countries, at different times. Miraculously, these were also the times of full employment and high growth. Whether there was causality between this more holistic approach to macro policy-making, I leave to the observer. Later, other objectives, mainly pertaining to preserving the environment and inclusion were added.
In today’s EU and Eurozone, the following conceptual/institutional manifestations of these objectives exist:
- Macroeconomic Dialogue
This is the only institutionalized forum in which the ECFIN Commissioner, the ECB President, the European Labor Federation and the European Business Federation, (containing also a representative of state/owned enterprises) come together 2 times a year, to discuss the macroeconomic fiscal/monetary policy stance. I was present at several of these meetings. My assessment is that they did not result in a mutually agreed policy stance, but rather consisted of separate statements on the positions of the individual organisations participating. Still, even if ineffective, they represent a forum for potential joint decision-making, so far underutilized. It is interesting, if depressing, to note that the official EU website describes the purpose of this dialogue as a “possibility of aligning wage policies with the fiscal/monetary policy mix”, clearly seeing the former as subjugated to the latter, not as a “dialogue among equals”.
- Employment Objectives
While high employment is one of the basic objectives of the European Union (Maastricht Treaty, Art. 2), “full employment and social progress” were added as objectives in the Lisbon Treaty. In reality and policy implementation, however, employment gets lower priority within EU/EZ policy making, especially when compared to budget consolidation. Employment Guidelines as laid down in the 2020 Strategy form the basis in four areas: Increasing labour market participation of women and men, reducing structural unemployment and promoting job quality; Developing a skilled workforce responding to labour market needs and promoting lifelong learning; Improving the quality and performance of education and training systems at all levels and increasing participation in tertiary or equivalent education; Promoting social inclusion and combating poverty.
While there is nothing wrong with the content of these guidelines, which are monitored annually for each member state, the strongest incentive for having the recommendations followed is that they can be published. While they are now part of the “Integrated guidelines for the economic and employment policies of the Member States”, in this way attempting to put them on a more equal footing with fiscal policy, their implementation is a lot weaker than budget consolidation.
The recent alarm about the excessively high rates of youth unemployment in the program countries, but also many other EU/EZ members has led to more debates about active labor market policies, models of “dual” training, like in Germany and Austria and other instruments. It resulted in the allocation of an additional 6 bn Euro (over 7 years) towards combating youth unemployment. Of course, the EU structural funds contain a number of labor-market-effective expenditures, but macroeconomic relations between employment and effective demand, or other such “Keynesian” vestiges are still not in the center of policy-making. Structural reforms and flexibility are still seen as the major instruments.
It should also be mentioned that the recent capital increase of the European Investment Bank also increased the ability of the Bank to promote investment projects with a significant employment content.
Long discussion have centered on the definition of the “proper” inflation target of the ECB. Today “lower than, but close to 2%” is the guidepost used by the Governing Council, while officially it is still “annual growth of the HCP below 2%”.
As a result of the crisis, the ECB has significantly widened its instrument kit, has provided ample liquidity to the banks, has given assurances to do “whatever necessary” and is thinking of variations of quantitative easing, but also of pushing and purchasing structured products in order to overcome the still persistent credit crunch.
One can maintain that especially during the Eurozone crisis, the ECB has proven to be the predominant macroeconomic policy actor, especially in view of the strong divisions and very slow reaction times among EZ finance ministers (especially after 2010 when the Eurozone crisis broke. Immediately after the outbreak of the crisis in 2008/9 they “had all been Keynesians”, developing stimulus programs and helping their banks).
Still, the dialogue and the joint responsibility for macroeconomic policy-making between ECB and Finance Ministers have been, since the formation of the Eurozone, one of ECB predominance. Most of the time, especially when the anti-inflation hardliners had the majority in the Governing Council, this reinforced the “fiscal consolidation” bias of macro policy.
However, more recently, as a result of the inability of the Finance Ministers to act quickly and appropriately during the crisis, ECB predominance must be seen as a plus – notwithstanding the utterances by the ECB President about the “end of the welfare state”. It is to be hoped that it goes the way of F. Fukuyama’s dictum about “the end of history” after the demise of the Soviet Union.
It still needs to be mentioned that the charter of the ECB, in contrast to e.g. the US FED, gives only very little weight to other objectives than fighting inflation. This is one of the original sins from the time of the creation of the Eurozone. It still lingers in many heads of the ECB Governing Council.
There seems to be a near-consensus of EZ policy makers that budget consolidation cum low inflation cum “structural” reforms assure adequate growth.
This view, rooted in neoclassical, some say neo-liberal economics, still form the mainstream of economic thinking in Europe, notwithstanding the fact that this thinking has provoked and extended the deep crisis in Europe.
There is no mentioning that EZ total demand needs to be strengthened, that the still second-largest economic area of the world with 10 trill Euro GDP, more than 15% of global GDP, should or could be the objective of policy-making, instead of a nearly manic focus on “global competitiveness”, i.e. export market shares.
Recently, when looking at the internal trade balance imbalances within the EZ, where e.g. Germany clocks a current balance surplus of 6% of GDP, while the total EZ has a near-balance position vis-à-vis the world, some attention has been directed towards total EZ demand. However, growth is still supposed to come from “more competitiveness”. But: extra-EZ exports still account for only 27% of EZ GDP, 73% of value-added are generated and consumed by internal demand. It might be worth directing economic policy towards this fat tail.
The recent refusal of the ECB head to even discuss the possibility of a deflationary trend in the EZ is also corroboration of the argument that EZ policy rather neglects internal/domestic demand as a policy target. The most recent discussion in the ECB about additional instruments of monetary loosening center also around the effect of a strong Euro on foreign trade, rather than on internal demand.
- Current account imbalances
The “Six Pack” as part of the improved coordination of economic policies, introduced in 2011, identified the Macroeconomic Imbalances Procedure (MIP) as a major policy instrument. The Commission monitors current account imbalances, can introduce in-depths reviews and issue recommendations to member countries. While it is positive that the EU for the first time sees current account imbalances also arising from surpluses, not only deficits, its target values are asymmetric, because it regards deficits beyond 4% of GDP as problematic, but surpluses only if they exceed 6%.
MIP consists of a preventive and a corrective arm, implying that recommendations can be issued, which provide even financial sanctions (0.1% GDP, deposit-fine sequence) in case of non-compliance. So far such recommendations, issued as part of the European Semester, have not been activated.
- Budget Balance
During the negotiations setting up the Eurozone, the Stability and Growth Pact was established, with the well/known threshold values of 3% for the deficit and 60% for the debt ratio. An annual monitoring instrument was installed, and the non-compliance with the recommendations, as a result of the “excessive deficit procedure” threatened with financial sanctions (never activated). During the crisis the definitions, targets and monitoring instruments were strengthened, in order to better coordinate economic policy within the EZ and EU. While earlier notifications of economic and budgetary developments were introduced, more exact definitions of which target values were to be achieved, and when, were issued, the voting procedures changed towards stronger binding force of the recommendations, and the objective of defining budget balance as that of the “structural deficit” stated. Also more flexibility was introduced when macroeconomic shocks occurred. When the crisis proved longer and more protracted, and when some countries were cut off from private bond markets and had to be rescued, timelines were extended and rescue operations started.
Still, today, 6 years after the Lehman case, economic policy making is still primarily focused on achieving balanced budgets, at the expense of other objectives. Thus, the “original sin” of EU macroeconomic policy-making, the stark imbalance of policy objectives, and the lack of a joint EZ economic policy (hindered by the lack of a common EZ fiscal authority with authority of taxes and expenditures of the individual member states and the EZ as a whole) which would enable to align EZ monetary policy with fiscal policy, growth policy and employment policy, still burdens the EZ. The weak growth rates and the socially devastating and still increasing unemployment rates, both for general labor market participants, especially for young ones, are the result of this “sin”.
But, it is not only a lack of institutional consistency. It is even more a result of a misguided economic policy paradigm. Let me refer back to the discussions before the Eurozone was created, which was repeated more strongly 10 years ago when the new member states joined the EU. There were heated discussions about whether the nominal convergence criteria (not contained in the Treaties and enshrined in the Maastricht criteria) were sufficient conditions for joining a successful monetary union (in the absence of an Optimal Currency Area), or whether in addition “real” convergence criteria, the level of development, the employment situation, the institutional capacities of applicants, etc. would not also have to be taken into account. The heavily Central-Bank biased discussion process (not least dominated by the members of the German Bundesbank in the various Committees) eventually ruled out the use of “real” criteria, and led, among others, to today’s lopsided an incomplete macroeconomic policy architecture.
The mismatch in macro policy between monetary and fiscal policies, the primary focus on budget consolidation and structural adjustments – this incomplete economic policy focus, accounts for the slow recovery from the recession, the lack of a growth policy and of effective employment policies in the Eurozone. The increasing “frontrunning” of Eurozone ministers (finance) before ECOFIn meetings also reinforce “fiscal rationalities” before concerns with employment. Institutional and conceptual shortcomings reinforce each other.
3. A Way Forward
A more comprehensive economic policy orientation of the Eurozone requires both a new way of thinking and institutional solutions which avoid some of the past mistakes; a combination of macro and micro objectives, short-term plus long-term orientation and coherent instruments targeting income, employment and environmental objectives. In the short run, emphasis needs to be placed on employment, combating unemployment and given young persons opportunities to join the labor market. But short-run objectives need to be aligned with medium-term orientations. In the medium to long run, maintaining and strengthening Europe’s inclusive well-being-oriented model needs to be safeguarded, strengthening inclusive wellbeing by a production and services economy that banks on socio-environmental strengths, both developing technological and social innovations and based on the ever improving skills base of its population. The planned EU reviews of the Europe 2020 and the Sixpack – unfortunately not coordinated – could be the occasion to change the course of the EU economic policy mix.
In all that follows the question of what would be possible within the statutory confines of the EU Treaty is ignored. There is widespread consensus that the existing treaty has been stretched to its limits, and that further extensions would require a new treaty – for which the mood in the member states does not exist.
– A new governance model which includes a fiscal authority which coordinates fiscal with monetary policies in a continuous dialogue. This would primarily focus on the whole EZ/EU area, in order to determine the optimal fiscal/monetary policy mix, which then would be translated into country-specific guidelines.
– A Balance of Interests discussion forum where potential conflicts between growth/social/environmental objectives tradeoffs can be mitigated
– Socio-economic dialogue, institutionalized at EZ and MS level, with strong participation of civil society, labor unions, business organizations, led by EZ government (role of parliament?)
– Development of a concept of regional (EU/EZ) “competitiveness”, as maintaining and strengthening the beyond-GDP idea of well-being, not in competition with other regions, but as concentrating on intra-EU improvements. This, of course, has an element of competition, outdoing others / but that needs to be relegated to where original competitiveness conceptions come from, i.e. enterprises.
– The “Troika” model of country competitiveness is directed mainly towards improving cost/price competitiveness. In this way it is a static concept, holding the bundle of goods/services produced constant and lowering its costs. It would be more appropriate to develop a dynamic approach, which is directed towards producing a wider and higher-value array of goods/services, both for internal consumption and export
– Such a new concept of EZ development would also include the development of an industrial policy, not to promote individual sectors, but by strengthening the pre-conditions for higher-value production and productivity, by being aware that such measures need to be accompanied by sector-specific instruments; developing value chains and agglomerations (clusters) by appropriate instruments; laying the foundations for well-being by education, R&D efforts and training schemes.
– A Fiscal Union should encompass joint “automatic stabilizers” and proper demand management at the EZ level, as the lack of private demand has not been compensated by governments, and in crisis countries unemployment compensation was heavily cut, thus reducing the countervailing effects of e.g. unemployment insurance.
– Another task of a fiscal union would be a joint tax policy which levels the “tax burden field” between taxes on labor-related income and capital income and prevents the continuous escalation of tax competition for corporate income and capital income taxes downwards.
– Sovereign finance should be taken away from private sector and turned over to ECB: no trade in sovereign bonds, annual evaluation and differentiation of interest rates.
All in all, a more comprehensive economic policy model centering on the well-being of its citizens with the appropriate, more inclusive institutions, and building on Europe’s strengths instead of attempting to emulate “US”, “Asian”, or “Chinese” socio-economic models, is required. This would enable a much more balanced achievement of income, social and environmental objectives, towards a more sustainable economy. A new treaty might be necessary to achieve this.