Markets are also rooting for a European Central Fiscal Capacity

[Note: this is a slightly edited ChatGPT translation of an article for the Italian daily Domani]

An interesting article published a few days ago in  the Financial Times highlights one of the many paradoxes that the European Union is facing. The article is apparently technical and aimed at insiders, but in reality, it highlights a political problem for Europe, a global player that stubbornly does not equip itself with the tools to fully play its role. The authors note that for the first time in its history, mainly because of the Next Generation EU  programme, the European Union is now issuing a debt of significant size, which will reach €900 billion in 2026 (in 2020 it was just €50 billion). This is happening for the first time, as we said, because one of the pillars of the European Union budget is the principle of equilibrium: unlike the Member States, under normal conditions the EU must have a balanced budget. The issuance of debt by the Union, therefore, must always pass “off-balance-sheet”, through financial vehicles set up for specific and exceptional purposes. Until the pandemic, and the creation of Next Generation EU, this had been done for negligible amounts, and there was little debt properly European circulating on the markets.

The debt linked to Next Generation EU  was initially plebiscited by markets, which fought over the first issuances at zero or negative rates; but, notes  the Financial Times, European debt is today less desirable than that of some member countries: the ten-year interest rates of the EU, a debtor with the highest rating (AAA) are higher than those of Germany,  but also to those of France, which has a lower rating (AA). Why are markets more inclined to buy bonds from a relatively riskier debtor like France than those issued by the European Union? The explanation lies in the oft-forgotten fact that liquidity, i.e., the ease with which a security can be traded, also contributes along with risk to determining the attractiveness of financial investment. And a security is liquid, easily exchangeable, if at any given moment there are buyers for those who want to sell, and sellers for those who want to buy. This is precisely the problem with European debt today: of course, today the amount of bonds issued is significant, especially when compared to a few years ago. But what guarantees the markets that debt issuance will continue even after 2026, when the last Next Generation EU bonds will be put on the market? In other words, once this phase is over, will there continue to be a market for European stocks?

In short, investors are skeptical (unfortunately rightly so) and are unable to understand  whether the Next Generation EU  program is an isolated measure, the result of the Covid emergency, or whether it can become a sort of model to finance the colossal investment programs necessary for the ecological and digital transitions in the future. In short, the markets are trying to figure out whether in the more or less near future a European fiscal capacity could materialize: an agency that, acting as a sort of EU finance minister, would be capable of finding resources to finance EU expenditure, including by issuing European debt.

The discussion on reforming the EU fiscal rule is peaking. Just a few days ago, the Eurozone finance ministers reaffirmed their intention to quickly approve a rule that would replace the outdated and no longer credible Stability Pact. As argued here, in order to be approved quickly, the reform will probably, and unfortunately, be a minimalist compromise. It is likely that the new Stability Pact will not be too different from the old one and that it will not allow governments to adequately finance public goods, industrial policies, and public investment.

If this is the case, there is an urgent need to put the creation of a central fiscal capacity back at the centre of the debate on the European institutional set-up. The issue has always been present under the radar but is struggling to impose itself on the agenda of European reforms. It can be argued convincingly (as the former head of Commissioner Gentiloni’s cabinet, Marco Buti, does in an article written with Marcello Messori) that the creation of a central fiscal capacity would make it possible to provide for economic stabilisation and to finance European public goods more effectively and at lower cost than through national policies. It would also make it easier and more stable to finance transnational investment projects, again with an efficiency gain compared to the Next Generation model, which seeks to achieve coherence between national plans (the NRRPs) through conditions on the destination of funds.

 The (modest) difficulties in placing European debt issues add an additional reason for the creation of a central fiscal capacity. Not only would it have obvious macroeconomic and structural benefits, but it would also help stabilise financial markets. Firstly, because, as mentioned above, it would help to provide markets with a stable supply of a safe, liquid and attractive asset, reducing financing costs for the EU. Secondly, because the European financing of part of public policies would make it possible to lighten the burden on the shoulders of member countries, which could more easily keep their debt under control. The segmentation of European financial markets would thus be reduced, and the cost of debt would fall for everyone. Thirdly, the existence of European debt would allow the ECB to sell and buy securities to regulate the liquidity of the system without having to scramble to hold the bonds of different countries in proportion to their economic weight. Finally, because the existence of a European debt would make it possible to consolidate the role of the euro as one of the international reserve currencies, once again ensuring stability and sustainability.

Unfortunately, as we said, the creation of a centralised fiscal capacity is not a priority in today’s EU political agenda. First of all, because it would be necessary to change the Treaties in order to get rid of the principle of equilibrium which, as we said, is now embedded in the European budget. Moreover, the creation of the capacity to spend, tax and borrow centrally, while electoral accountability to the electorate remains at the level of national governments, would require a complex system of checks and balances aimed at ensuring that no further European democratic deficit emerges (which would open up prairies for sovereigntists and Eurosceptics of various backgrounds). It will therefore be difficult to build consensus on such a complex and innovative proposal, among European countries weakened by multiple crises and increasingly looking inwards. In short, it is a complex construction site. But it still needs to be opened as soon as possible.

What is Wrong with the EU?

Eurostat just released the 2012 figures for poverty and social exclusion in the EU. The numbers are terrifying. Let me quote the press release: “In 2012, 124.5 million people, or 24.8% of the population, in the EU were at risk of poverty or social exclusion,  compared with 24.3% in 2011 and 23.7% in 2008. This means that they were in at least one of the following three conditions: at-risk-of-poverty, severely materially deprived or living in households with very low work intensity”
One may be tempted to shrug. After all, 1% in four years, is not that much. Let me put actual people behind the numbers: The number of people at risk of poverty increased of 5.5 millions between 2008 and 2012. Strikingly, always looking at Eurostat data, the number of jobs lost in the EU28 over the same period is almost exactly the same (-5.4 millions).

This is plain unacceptable. And teaches us two lessons

• Our welfare system is not capable anymore to shield workers from the hardship of business cycles. We progressively dismantled welfare, becoming “more like the United States”. But we stubbornly refuse to accept the consequence of this, i.e. that fiscal and monetary policy need (like in the US) to be proactive and flexible, so as to dampen the cycle. Constraints to macroeconomic policy, coupled with a diminished protection from the welfare state, spell disaster, social exclusion, and the destruction of the social fabric.
• The second lesson is that these numbers are there to stay. The economy may recover, but the loss of confidence, of capacity, of social status of those who we pushed into hardship, will stay with us for years to come. We are destroying human capital at amazing speed.

What is enraging is that none of this was inevitable. The crisis could have been shielded by less ideological leadership in European institutions and in some most European capitals. Frontloading of austerity in the periphery was a terrible mistake. Not accompanying it with fiscal expansion in the core was a crime, showing of how little solidarity counts, facing the protestant urge to “punish the sinners”.

The result is that one of the most affluent economic areas of the world barely notices that one quarter of its population lives at risk of poverty. What is wrong with us?

Of the EU Budget and Fiscal Rules

Last Friday the negotiations on the 2014-2020 EU budget were put on hold because of  fundamental disagreements among Member States. Surprise, Surprise… I do not think it is a big deal anyway. There is not doubt that at the next meeting a last-minute- low-key compromise will materialize. A compromise that will most likely save the most controversial items of the EU budget, like agricultural policy, and  cut the very few investment programs that had made it into the budget in the past. But who cares, after all; our leaders will be able to show the usual self complacency, and the rest of us will be left with the all-too familiar sentiment of yet another missed opportunity.

Most commentators blamed David Cameron, but his position was not new, and hardly surprising. The UK has always tried to extract as much as it could from the European process, while giving as little as possible; others did it, are doing it, and will do it. But rarely with the consistency and the single-mindedness of the UK. This was true with EFTA in the 1960s, then again with the infamous UK rebate negotiated by Margaret Thatcher in 1984. If England never played for the common good in the past, how could we expect it to do so at a times of crisis?

No, the real surprise of the failed budget negotiation was not England, but Germany, and the coalition of the fiscal hawks.