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Federalists' solution of fiscal union may be what's needed to preserve European project long term

Peter Weber | Getty Images

These existential risks have been a sword of Damocles hanging over what EU politicians call the "European project" ever since its inception on the Capitoline Hill in Rome on March 25, 1957.

But, unlike the British Euro-skeptics, most people don't realize the logic of the "European project" – and its practical implications for state governance - despite the fact that the Treaty of Rome clearly stipulates that its signatories are "determined to lay the foundations of an ever closer union among the peoples of Europe."

Now, more than ever, that "closer union" means decisive steps toward political integration.

That was confirmed as recently as last Tuesday, February 16, 2016. Announcing that they were "concerned about the state of the European project," the foreign ministers of the six founding member countries (France, Germany, Italy, the Netherlands, Belgium and Luxembourg) dined together in Rome to discuss how to strengthen the union of 28 disparate nations.

Whether the revival of this historic format signals a return to the old idea of an EU hard core, or "avant-garde," that would lead the continent's economic and political integration remains to be seen, partly because some governments, such as those of the Visegrad Group (Poland, Hungary, the Czech Republic and Slovakia), strongly oppose that initiative for fear of being relegated to second-class union members.

Sovereignty is gone

In practice, however, that EU hard core already exists; it is most vividly symbolized by the euro area, or, more formally, the European monetary union.

That union, the euro, a fully integrated market for goods and services and an entire institutional infrastructure to make all that function together, are the key milestones of this ambitious European work-in-progress.

In spite of that, the way forward looks daunting to many people. But those who think that way don't know, or have simply forgotten, the history of enormous political difficulties and economic sacrifices the founding members have overcome on the long way from a largely improvised customs union to a single market and a common currency.

It, therefore, seems that what the euro area members have to do now is relatively easy, because most of the required political and economic concessions – i.e., de facto sovereignty transfers - have already been made, and most of the institutions they need are there.

In view of that, the euro area members now have two options to tighten up their economic governance and secure the euro as a global transaction currency, reserve asset and a reliable store of value.


First, there is a radical approach advocated by EU "federalists." That would involve a common fiscal policy managed by the euro area finance ministry – a supranational institution like the European Central Bank (ECB).

That, of course, would involve a complete and formal transfer of sovereignty over important state functions because it would also necessitate harmonization of social and labor market legislations.

And then the euro area would need its own parliament to ensure a system of democratic checks and balances over the budget process and the common economic and social policies.

Muddling through

I can now hear the howls of French "souverainistes" – a large segment of the society that is not limited, as some think, to small political parties, such as Debout la France (Stand up France). Indeed, most French cherish the culture of a strong state, and I don't see them boarding up the huge Ministry of Finance they affectionately call Bercy, an area on the Right Bank that used to be the largest wine and spirits market in the world.

What, then?

Almost certainly, the French will want to have an inter-governmental fiscal management to preserve the appearance of sovereignty. In reality, however, that would just be a stronger version of the current regime of reinforced fiscal surveillance through the EU Commission, the Eurogroup (a forum of euro area finance ministers) and a peer (essentially German) pressure in order to meet specific budget and public debt targets.

Italy will join France in this policy format. The Prime Minister Matteo Renzi is in a quasi-permanent state of guerilla warfare with the EU Commission (which he accuses of being Germany's handmaiden), vowing that "Italy won't be governed from Brussels [i.e., Berlin]."

Such a euro area fiscal system will preclude common debt management, or any kind of "solidarity," beyond the conditional emergency lending through existing or new euro area institutions.

German taskmasters will be watching all this, furious that the two most fiscally vulnerable euro area members (excepting Greece as a special case), with public debt burdens of 160 percent (Italy) and 120 percent (France) of their respective GDPs are playing irresponsible budget games.

But Germany will do nothing to support the euro area growth – and hence the French and Italian fiscal recoveries – by boosting domestic demand instead of pushing exports and living off its euro area neighbors.

And, true to form, Germany will continue to put pressure on France and Italy (which account for nearly 40 percent of the euro area GDP) through the EU Commission and its own public statements, unleashing, as in the past, an ominous chain reaction: unfavorable credit rating reviews, rising costs of French and Italian debt financing, problems for their banking systems, etc.

A growing acrimony and hostility among the three largest euro area members would hardly be conducive to an "ever closer union" dreamed by the founding fathers.

But that's the way it is because France and Italy don't have the German economic fundamentals and are facing different political pressures.

Nobody, for example, can win the French presidential elections in May 2017 on a platform of fiscal austerity with a virtually stagnant growth and a 10.2 percent unemployment rate. Parties running for office will also have to contend with about 35 percent of strongly Europhobic French voters (a combination of extreme right and extreme left electorates).

Italy may have a little more time to maneuver because its next general elections will be in May 2018. Still, Mr. Renzi's run-ins with Brussels and Berlin about his tax cuts are betraying fears that an alliance of virulently Europhobic and anti-German right-of-center parties could unseat his government in case there is no meaningful progress on growth and employment.

Investment thoughts

The euro area is a centerpiece of the "European project," and the euro is its crowning achievement.

The optimal way forward requires a full integration of the euro area fiscal policy. That, however, is very unlikely. The best one can hope for is a reinforced regime of the current inter-governmental fiscal decision making, coordinated and supervised by the EU Commission and subject to peer evaluation. The French and German governments are reported to be presently working on a project along these lines.

Such a system will remain crisis-prone because it will (a) leave each country responsible for its public finances, (b) preclude common debt management and (c) offer only conditional emergency lending through current or possibly new euro area institutions.

The next euro area economic crisis may either lead to the full fiscal integration or to the implosion of the monetary union, depending on the severity of the cyclical downturn and on the prevailing political forces in Germany, France and Italy.

Till then, the ECB will guarantee the financial integrity of the euro area.

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