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European Fiscal Integration: From Borrowing to Spending Union
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    <strong>Artículo publicado en <a href="http://www.lacartadelbolsa.com">La Carta de la Bolsa</a> el Lunes, 17 de Noviembre en la sección: Articulos</strong>
    <h3 class="titulo_articulo">European Fiscal Integration: From Borrowing to Spending Union</h3>
    Redacción
    <p>
	<strong>We examine current ideas aimed at deeper fiscal integration of the eurozone</strong> The financial crisis has exposed the flaws of a monetary union without sufficient fiscal coherence. The immediate crisis has been dealt with, and more robust shock absorbers now exist. However, strengthening the underlying fiscal coherence is still work in progress.<br />
	<strong>Fiscal integration should be understood more broadly</strong><br />
	Many aims of a full fiscal union can be achieved with partial integration measures. We present a systematic framework for the analysis of such partial initiatives.</p>

    <p>
	<strong>‘Spending union’ is currently the most active area of debate</strong><br />
	The measures currentlydiscussed at the EU level, and by the ECB, aim at deeper integration of fiscal spending. This is done both on the side of coordinating the overall fiscal stance, but also by using new allocation keys for EU spending.<br />
	Figure 1: Forms of Political and Fiscal Integration SPENDING Independent Joint BORROWING Independent ‘Rules Union’: Original vision of the EU Treaties with the restriction that all EU Member States should coordinate economic policies (Art. 121 TFEU) and avoid excessive deficits (Art 126). These principles have since been make more explicit through additional legislation (the ‘six pack’ and ‘two pack’, respectively) ‘Spending union’: ‘Cash for Reforms’ proposal by Germany and new Commission proposal, joint unemployment insurance scheme, EU funding for investment spending in fiscally constrained countries Joint ‘Funding Union’: ‘Eurobond’ or ‘Stability bond’ ideas. Common fiscal rules aim at a coordination of spending policies to control free rider effects. Full fiscal union (United States of Europe)<br />
	<br />
	Thinking more broadly about EU fiscal integration<br />
	Background: More fiscal integration is required<br />
	European integration is a gradual process. However, it has become clear in the financial crisis that the extent of integration is not as endogenously determined as the EU Treaties are currently suggesting. Although they specify an ‘ever closer union‘, they also limit conferral of competences to the EU. Financial markets have probed – and found wanting – the degree of fiscal integration accompanying the monetary union. In response, euro member states have erected a scaffold of fiscal rules and measures inside and parallel to the European Treaty framework to stabilise the edifice of the common currency. While these new tools address crisis situations, more will be required to prevent slow economic divergence. As the European Council approaches a summit on 18 December that will discuss proposals for an EUR 300bn investment programme, we take stock of the fiscal integration ideas on offer so far.<br />
	The ability and mandate of the European Central Bank to react to shocks affecting single countries are limited. To this end, the basic idea behind the concept of a fiscal union is to compensate for asymmetric shocks in the economically heterogeneous European Monetary Union. What is important to realise is that while fiscal integration needs to be deepened, there are multiple ways in which this can be done. Full integration of budgets is one extreme approach, but not the only way to move forward. We think it is best to classify fiscal integration schemes by looking at the two sides of sovereign balance sheets. The table on the front page shows the ideas that are, or have been, discussed.<br />
	This table above suggests that a fiscal union can take four forms, the first of which is the status quo1:<br />
	1. A common set of fiscal rules in order to coordinate fiscal policies and to prevent moral hazard and future crises with a fiscal impact in the future.<br />
	2. A common funding scheme<br />
	3. Common spending policies and fiscal transfer mechanisms<br />
	4. Common funding and spending, ie, fully-fledged fiscal union<br />
	None of the latter three schemes has been fully implemented in Europe. Nevertheless the current debate merits a closer look on those measures that were implemented and on the ideas that are currently dealt with in the Brussels universe. We start with an explanation and evaluation of the status quo.<br />
	<br />
	Joint rules: Credibility problems<br />
	The attempt to set up a common rules framework for the Euro area is the oldest approach of creating such a fiscal union. It dates back to the year of 1997 when the heads of state and governments agreed to perpetuate the fiscal entry thresholds into the European Monetary Union (Maastricht criteria) into a permanent framework of fiscal surveillance. The Stability and Growth Pact (SGP), an annex to the EU Treaties, provides the details to the general prescriptions of article 126 TFEU.<br />
	Being the oldest element of a Fiscal Union does not mean that the rules-based approach of fiscal policy coordination was successful. It was supposed to inspire market confidence in government finances but has been broken enthusiastically and is therefore almost meaningless in practice. The credibility of the SGP suffers from the fact that member states refused to surrender sovereignty over major parts of their fiscal policies. At the same time, the sanctions that were supposed to prevent misconduct under the SGP were also never applied in full. These fundamental shortcomings have not been cured with the massive extension of the fiscal and economic surveillance framework that has been introduced in the course of the euro crisis. The SGP was tightened with two amendment procedures (‘Two Pack’), and a similar surveillance framework (the ‘Six Pack’) was set up for macroeconomic imbalances as these could also turn into fiscal risks one day. In 2012, the provisions of a revised SGP were codified in a treaty of international public law, the Fiscal Compact. Germany and other countries from the EMU centre had insisted on that extra framework in exchange for their support for the ESM.<br />
	The reforms looked quite promising at first sight but in the end their effectiveness has been quite narrow due to a lack of political will on a European level to make full use of the rules. For instance, the fiscal adjustment paths that are prescribed to each EMU country were extended at various times. Even then, the willingness for compliance among the member states has remained limited. On 1 October the European Commission published an assessment of the success of economic policy coordination in the EU. According to the survey only 1% of all measures were "fully implemented" and 9% had shown "substantial progress".<br />
	Common Funding: Too hasty – and currently incomplete<br />
	Building the monetary union of the euro area without a complete fiscal union had always been a gamble. The risk was that governments remain dependent on private funding through capital markets and that those markets may withhold funding. For quite some time, therefore, the European institutions and some member states have sought to remove, or at least reduce, the risk of governments losing market access through joint funding instruments.<br />
	As a reaction to market turmoil the fiscal union from a common funding perspective gathered renewed momentum. Greece was granted emergency loans that amounted to an ex-post mutualisation of debt. These loans morphed into the bailout mechanisms EFSF and ESM, the latter of which is permanent following a change in the EU Treaties. These Treaty changes aim to make such aid compatible with the European legal framework which had excluded mutual guarantees among Euro area countries so far (the non-bailout clause in Art 125 TFEU).<br />
	While legal impediments had been addressed to some degree, political impediments were on the rise: The mutual guarantees were controversial, particularly in the economically strong countries of the EMU centre. Resistance<br />
	<br />
	from Finland and the German Bundestag was severe and the scope for fiscal guarantee mechanisms is probably exhausted. As a reaction, the ECB has taken on an ever more important role in stabilising government funding costs via SMP, full MRO allocation, LTROs and the OMT announcement (the OMT is currently before the European Court of Justice). Importantly, to the extent that these measures amount to fiscal union, they are all fiscal union ex-post: Dealing with debts becomes mutualised long after they have been incurred.<br />
	Irrespective of political resistance, EMU turned into an ideas factory on how common funding mechanisms could be designed. Joint debt instruments, generally known as Eurobonds, were proposed by various entities in a plethora of forms. Political resistance from core countries prevented their practical introduction even though the European Commission euphemistically rechristened these instruments ‘Stability Bonds’. The same fate befell voluntary ex-post debt mutualisation schemes (debt redemption funds). Interestingly, while capital markets reaction to joint debt instruments with potentially much deeper liquidity than single-country government bonds was favourable, not even partial mutualisation of peripheral country debt only was seriously debated.<br />
	Aside from debt funding, different thought experiments on common fiscal capacities were also debated. These pooled fiscal resources were to be funded from contributions of member states in relation to their economic output or a fixed share of national taxes (e.g. value-added tax), or even a common European tax like the financial transaction tax. In contrast to most ideas about Eurobonds the allocation of resources from a fiscal capacity or euro area budget – e.g. in case of a severe economic downturn in a member states - would most probably be decided on EU level.<br />
	With nonconventional policy measures being taken by the European Central Bank, the pressure to implement such joint funding schemes became less severe. The ‘Hamilton moment’ often cited in Brussels, where a fiscal crisis could be used to further integration, had passed. For the time being, joint funding is unlikely to materialise. Interestingly, that does not mean that progress on fiscal union is impossible. Instead, the debate has migrated from joint funding to a mix of coordinated and joint spending.<br />
	Joint spending: Gaining ground<br />
	An initial step in that direction was the cash-for-reforms proposal made by Merkel and Hollande in June 2013. That proposal held out the idea that countries could receive fiscal support in return for achieving concrete structural reform goals. However, prospective beneficiaries of this scheme have rejected the idea of having their policies judged by outsiders.<br />
	There are also proposals voiced for a common unemployment insurance which would have the same function as an automatic stabilizer between countries. The idea behind the concept is that in the event of an economic down turn and rising unemployment, the additional transfers to the unemployed would partly com from the common unemployment scheme. This mechanism would soften the fiscal constraints of the country being affected by the recession, i.e. the government would have less pressure to cut spending and have more resources available for investment spending. Former Labour Commissioner Andor proposed a joint basic unemployment support scheme that would amount to the mutualisation of a substantial part of the expenditures for unemployment benefits in European countries. In any case, the idea seems unlikely to be realised as there is no consensus among European countries on the need for such an instrument. In addition, it is difficult to design such a scheme without creating a new transfer mechanism with undesirable<br />
	<br />
	incentives for countries with high structural unemployment. More technical details, such as relying on economic forecasts which often turn out to be incorrect afterwards, should not be underestimated as well.<br />
	However, the idea of joint spending lives on. The ECB recently proposed that governments with fiscal headroom (ie, those that currently conform to the SGP limits) should use it to stimulate demand. Again, that would be a move towards the mutualisation of expenditure, in this case mutualisation of Keynesian pump-priming. As not all governments are indeed of a Keynesian bent, some responses have been cool. However, a joint paper by ECB board member Coeure and his former colleague Asmussen (<a href="http://www.ecb.europa.eu/press/inter/date/2014/html/sp140919.en.html">http://www.ecb.europa.eu/press/inter/date/2014/html/sp140919.en.html</a>) held out the idea that the allocation of EU stimulus funds could be tied to the same 'fiscal headroom' considerations suggested by the ECB. Effectively, the investment spending in countries where the government is already too deeply in deficit would be borne by a joint European investment scheme proposed by Commission President Juncker while less deficious countries would pay for their own. This concept would remove the need for a Keynesian consensus at the level of governments. It would be enough for the European institutions to believe that stimulus spending works and for governments to accept investment. This idea implies a change in how the European Union would think about regional allocation of funds. Spending is now allocated according to where regions are under-developed and even rich countries have received local support on this basis. The Coeure and Asmussen key is different. In essence, it could allow addressing not just divergences in the level of per capita GDP, but also divergences in growth (ie, the first derivative of GDP).<br />
	Will this become the new fiscal union consensus? It is likely that the larger net contributors to the EU budget will balk at the idea of funding stimulus, the merits of which they may not even believe in, in other countries. It is likely that the Commission will have to use some creative arithmetic to achieve the EUR 300bn headline target, including counting investment spending that was already planned in member states and which will not be subject to Commission oversight. How much net new investment funding the Commission can raise, and how it will be raised, is not immediately obvious. Most likely, the European Investment Bank will play a major role. Its lending capacities could be extended by either making full use of its capital leverage which in turn could result in a lower rating than the current triple-A, by increasing the equity of the EIB, or by providing for a more flexible use of EU structural funds that could be turned by the EIB into financial instruments incl. for infrastructure investment.<br />
	Currently, there seems to be another attempt to revive the cash-for-reforms approach within the recent Growth Deal for Europe which provides for an additional disbursement of funds for those EMU countries willing to pursue structural reforms.<br />
	Somewhat concerning is the renewed focus on the provision of 'equity' for investment. This is in essence a return to PFI thinking and like PFI suffers from a simple problem: Infrastructure has long lifetimes, private entities raise debt at higher cost then the public sector, so the ex-ante cost of PFI projects is higher unless the private management can achieve economies in some other ways. This high hurdle rate for making PFI economical is why it has of late been in somewhat of a decline. To combine a controversial fiscal strategy with a controversial execution method is unlikely to increase the chances of progress along the new Commission route.<br />
	All of these initiatives do not follow an economic motivation alone. They can rather be regarded as a political move as spending initiatives are more than<br />
	<br />
	welcome these days in a Europe where politicians have to demonstrate activism given the recent electoral successes of populist forces in national and European elections.<br />
	However, there is also another political side effect. In concentrating on common spending within a Fiscal Union, the public gets the general notion that the overall austerity stance is no longer the main political imperative. Very accommodative monetary policy of the ECB acts as an important enabler of this shift away from fiscal consolidation.<br />
	Outlook: Joint rules the key to credible joint funding and spending<br />
	A sort of European Fiscal Union is already in place today. However, it is far from perfect as the financial crisis has demonstrated. It started with weak common rules even before the Euro was introduced. It was supplemented with inconsistent common funding policies. It is currently experiencing a reorientation towards common spending. It is rather unlikely that the Euro area will become a fully-fledged fiscal union, encompassing both sides of the fiscal balance sheet, soon. While joint funding and spending are only partially developed the current framework of rules has a credibility problem. As the framework for fiscal rules determines the credibility of the underlying policies it does not provide a good outlook for joint funding and spending policies. Successful joint funding without the implicit support of any ECB action will only be possible if euro area countries can credibly signal their willingness to achieve fiscal sustainability in the long run. Joint spending also can only unfold second and third round effects in the private economy if both investors and consumers know that there is something like a long-term plan for credible economic reforms and sound fiscal policies.<br />
	Any attempt for a cash-for-reforms approach under a reform treaty regime will inevitably suffer from the fact that none of the three elements of a fiscal union in Europe has so far been completed. Any extension of common funding mechanisms is politically too controversial. Any common spending will be subject to political distribution battles and the question of democratic legitimacy. Making common spending policies conditional upon compliance with common rules would not solve that problem either as the regime of rules would be politically biased towards those countries dominating in the distribution conflicts.<br />
	To conclude, the current equilibrium seems to be a bad but stable one: While the priorities of politics are clearly on common spending now, credible reforms to the rules framework would be the most urgent step – but the most unpopular. .The European Fiscal Union, in its current, incomplete state, does therefore not seem to be the solution to the Euro crisis. Whether it will be an amplifier will depend on the courage of politics to give credible rules the priority over common funding and spending.</p>

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