The European Project Needs a New Long-Term Vision

February 02, 2018 Europe

The EU is at an important crossroad. For the union to work, people must be willing to share risks and cede more sovereignty.

Back in the 1950s, the European Union's founders had a long-term vision for managing the potentially dangerous period following World War II. Today, we once again need a long-term vision.

The euro area has two main options: The current strategy of improving the Maastricht Treaty, designed to ensure the fiscal discipline required for many states to share a currency; or a more ambitious move toward federalism, which would require greater risk sharing among member states. Neither is compatible with the desire for more sovereignty. This is the heart of the problem.

The euro area has two main options: the current strategy of improving the Maastricht Treaty, or a more ambitious move toward federalism, which would require greater risk sharing among member states.
The Maastricht approach focuses on controlling government debt and deficits. To that end, independent fiscal councils have been introduced in member states. These can be useful in identifying issues such as systematically optimistic growth forecasts, which make projected deficits appear smaller. But to be effective, they must have the power to require prompt corrective action and be staffed by Europeans rather than citizens of the countries concerned. All of this works against the current impulse toward national sovereignty.

The federalist option goes even further. Starting with the U.S. at the end of the eighteenth century, many countries reacted to the difficulties of their member states by increasing the federal capacity to go into debt and by introducing systematic fiscal transfers among their members. This implies a greater level of risk sharing than the euro area countries currently allow. It would entail the issuance of jointly guaranteed bonds, a federal budget and joint insurance plans for deposits and unemployment -- all of which would act as automatic stabilizers, offering support for countries in temporary difficulties.

The practical importance of such risk sharing is debated: In the U.S., for example, financial diversification might be a more important stabilizer. Nonetheless, the sharing of risk -- by reducing the excuses for poor performance -- may have helped the federal government refuse bailouts for states, a policy it has maintained since the 1840s.

The federalist vision requires that countries meet two preliminary conditions. First, every insurance contract must be signed behind the veil of ignorance. You wouldn’t sell me insurance if you suspected that my roof had a good chance of falling in tomorrow -- which is why the countries of northern Europe are wary of entering such agreements with the countries of the south. This asymmetry might be corrected by identifying and isolating the problems inherited from the past and dealing with them adequately. For example, in introducing a European system of deposit insurance, banks' existing troubled assets could be dealt with by transferring them to “bad banks,” which would remain the responsibility of each member state.

A second and much more fundamental condition is a set of common rules to limit moral hazard. Such rules should concern those areas of potential mismanagement that can force a country to ask for help. We have seen, for example, that the supervision of banks should not be carried out at the country level, because the banking sector and the politicians then have too much influence over the process.

Setting rules for common unemployment insurance is more complex. The jobless rate in euro area countries is only partly determined by the economic cycle, which by itself would justify a mechanism of insurance among countries. It also depends on how governments approach such issues as job protection, social security contributions, occupational training, collective negotiations and the protection of professions. Those countries whose choices produce an unemployment rate of 5 percent will not wish to share an insurance system with those whose choices create a 20 percent rate. The same goes for pension and legal systems. Harmonizing policies will require ceding some sovereignty, an idea which even some of those who claim to be federalists still oppose.

Harmonizing policies will require ceding some sovereignty, an idea which even some of those who claim to be federalists still oppose.
Granting extended powers to the European parliament will not make the federalist approach more acceptable. First, there must be an agreement on a foundation of common laws and regulations, as was the case -- in a more modest way -- during the initial phase of the European project. More generally, each member state will fear that the profound contractual incompleteness of a top-down “political Europe” will produce a result even more distant from its aspirations than what we have today. The consequences of federalism should be understood by everyone before we set out on this path.

Federalism is sometimes much more than an insurance policy among regions of a single federation. In other words, transfers between regions can be more structural than conditional. In the U.S., wealthy states such as California and New York systematically and substantially subsidize poor states such as Alabama and Louisiana. Puerto Rico currently receives 30 percent of its gross domestic product from the rest of the U.S. Germany makes large, regular transfers among its Länder, which all receive about the same amount per inhabitant. Italy transfers resources from the north to the south, the U.K. from the south to the north, and Catalonia to the rest of Spain. In Belgium, Flanders transfers funds to Wallonia, whereas financial flows used to move from Wallonia to Flanders.

In the end, everything depends on the willingness of wealthy regions to finance poor regions. We still have an imperfect understanding of what would determine this willingness. Clearly a common language and nationalist feeling help generate the unidirectional transfers in Italy. It can also be argued that the strong separatist movements in regions like Catalonia in Spain and Flanders in Belgium are linked to a sense of cultural and linguistic distance. More generally, the welfare state is usually more developed in homogeneous communities. For better or worse, groups are more receptive to redistribution when the beneficiaries are close to them culturally, linguistically, religiously, and racially.

It's hard to say what path Europe will take. But if we Europeans want to live together, we have to accept the idea of losing a little more of our sovereignty. To achieve this in an era of increased nationalistic fervor, we must rehabilitate the European ideal and remain united around it. This is no easy task.