The right reform for Europe: a Singular Dream

Following a spree of national elections across Europe it is clear that a reformist majority is emerging across the Continent. In the aftermath of the big financial crisis and in response to the rise of populist isolationism across the Channel or across the Atlantic, one thing is clear: necessary and overdue reform is coming again in Europe. The direction and nature of such reform (whether bold, decentralising, intergovernmental, pro-federal or their opposites) will determine the future of Europe and the long-term viability of its institutions.

A key lesson learned from the financial crisis, which such reform will need to address, is the necessity for effective fiscal policy coordination in order to safeguard the viability of the single currency. Excessively diverging economies cannot coexist well under the straitjacket of the euro.

The abandonment in practice of the infamous “no-bail-out” clause, that was meant to impose the required self-discipline and make the euro viable, has raised the spectre of “moral hazard”. This now forces Europe to adopt alternative credible controls to ensure that habitual profligacy across some Member States is not rendered chronic or endemic across the whole Union. Consequently, the independence of the central bank alone can no longer suffice as guarantor of numismatic stability. Chaotic fiscal divergence resulting from lack of self-discipline or sufficient coordination (the price of independence) is bound, experience shows, to make any monetary policy, when applied simultaneously and indiscriminately on the “prudent” and the “profligate”, feel like a straitjacket for those that suffer it (at least half the time) or look completely schizophrenic to a bystander all the time.

Fiscal coordination, therefore, as a remedy to such “numismatic schizophrenia”, needs to be the focus of reform. Appropriate mechanisms for such coordination can take different shapes and forms:

• One option could be the unlimited sharing of liabilities in the form of a Eurobond (i.e. the opposite of “no-bail-out”). We can call this the “Blind” option, as it involves the assumption of blind liabilities by Member States with minimum or no safeguards designed to protect the “prudent” against advantage takers. It would mean that the “profligate” can partake in European affluence at the expense of the “prudent” without having to home-grow the wealth that makes this possible. It would split Europe in resentful creators of wealth and ungrateful consumers of the same.
• Another option could be the forced coordination via the imposition of common fiscal policies on each Member State by a central directorate in Brussels without any sharing of liabilities and without subsidies from the rich to the poor (i.e. without centralising taxation, or spending but merely centralising decision making on these issues). We can call this the “Authoritarian” option because it involves the stronger and more powerful Member States (led by Germany) dictating policy on everybody else.
• A third option could involve the bold transformation of the EU into a genuine Federal State with full (unlimited) sovereignty and parallel formal dissolution of the sovereignty of the Member States. This would include unlimited centralised taxation powers and a federal government managing all fiscal policy centrally. We can call this the “Full Federal” option.

These are the more obvious options. Each can deliver fiscal coordination and each can be an effective therapy for monetary schizophrenia. But each has obvious and severe disadvantages. The Blind and the Full Federal choices would be decried for opening the floodgates of a dreaded “transfer union”. The Blind choice would not act as a deterrent but rather as a fertiliser for profligacy and would cause resentment by the rich. The Authoritarian choice will in turn cause resentment by the poor. It would make the EU appear abhorrent and would eliminate national sovereignty in essence but not in form.  Brussels would become the synonym of hated dictatorship. Especially as the EU institutions would be no more than proxy power levers in the hands of dominant national governments. Rather than solve institutional imbalances, it would fuel nationalistic antagonisms with unforeseen (although not unforeseeable) consequence. The Full Federal choice is a noble dream ahead of its time. The peoples of Europe are just not ready for it. There is too much euro-scepticism and too many will perceive this as a red flag, a call to arms to fight the “power-grabbing” EU in order to protect the sacred nation-state from such existential threat.

But if these are evidently the wrong choices for Europe, is there no workable alternative, one that would be “just right”? Europe’s “Goldilocks” choice would need to avoid not just the “moral hazard” or the “monetary schizophrenia”, but also the resentment by either rich (or prudent) “givers” or by poor (or profligate) “underlings”. To this end, it is necessary to implement a set of fiscal and investment policies that will bring about in the long term real economic convergence of outcomes, rather than mere fiscal policy coordination. Effective policies should aim to enable the poor to catch up, improve economic output and develop an institutional habit for prudence in economic husbandry, whilst be reassuring to the rich that they will neither be called to assume unlimited liabilities nor relinquish effective control of any funds transferred to this end. We need structures that work well for everybody and that will not just remedy the symptoms but eliminate the causes of instability. A lofty yet not unattainable aspiration.    

Member States need to be convinced to make way for new supra-national institutions that can deliver this convergence of outcomes in a balanced manner. Europe needs a modicum of genuine but limited Federal governance; with defined and limited taxation and spending powers; with, for instance, a constitutional limited power to raise federal taxation up to 10% of European GDP by imposing federal tax rates not exceeding 10% in any category. Member States can continue to manage incremental taxation (in excess of these limits) in the normal way and can remain sovereign in the classic (unlimited) sense. This “Goldilocks” option therefore would involve two distinct layers of governance: a bottom relatively slim layer of federal governance with a joint budget managed democratically by all the peoples of Europe in unison and then a thicker layer of Member State governance on top, with separate local budgets, managed in the traditional way by each Member State, without hindrance or central control from the Federal State, subject only to the principles of the stability pact and provisions regarding the ESM. The ratio (of relative size) between these two layers could be between 1:5 to 1:4 in favour of Member States, over the Federal State: for every Euro managed centrally and jointly by the Federal State would amount a further four to five Euros managed by the Member States.

Convergence would come about in three ways: first, a material portion of the overall European economy (the bottom layer mentioned above) would be managed centrally ensuring uniformity of method and outcomes across the Union; second, the Federal State would dedicate funds with the constitutionally binding strategic aim of actively pursuing such convergence; and third, the Member States would in addition engage in closer coordination amongst themselves with the mediation of (but not commandeering from) the Federal State and there would be mutual oversight of their respective budgets and finances, although without going as far as dictating tax rates or fiscal policy, in respect of which Member States should continue to be free and independent actors.

This Goldilocks option would require the reconstitution of the EU parliament as a normal semi-sovereign parliament, with direct yet limited and constitutionally defined taxation powers and with the prerogative to elect and control a federal government. Such parliament would have only so many powers as are conferred upon it in a limited way by a new treaty.

Given that current EU budget is only about 1% of EU GDP, the new Federal State would be considerably more powerful, under this approach, with the competence to raise (and redistribute) as much as 10% of EU GDP in taxation, ten times the current budget. At the same time the powers of the national Member States would not be eroded radically. They would still be in charge of the lion’s share of the economy, with unlimited taxation powers, on top of the limited federal taxes. In current figures, where overall taxation in Member States is about 45-50% of GDP, this means that if the bottom 10% were to shift to the federal coffers, the Member States would continue to manage about 35% to 40% of GDP, i.e. about four times as much as the Federal State, and in any event a very considerable part of the economy.

Putting even such a modest, yet material, portion of their resources into a joint pot would empower the Member States to enable and equip the EU with the competence to pursue the critical objective of fiscal and broader economic convergence much more effectively. Rather than blindly share all liabilities, rather than allow strong states autocratically to dictate policy centrally to weaker ones on the manner in which the totality of the European resources are managed but without sharing any of these resources, and rather than place the totality of such resources in the hands of a central super state, the prudent approach surely would be to place a modest, yet meaningful portion of these resources under joint democratic control, decided by the people of Europe directly, and not by the national governments, so as to empower democratic process and defuse nationalistic antagonisms. This approach would also allow Europe to moderate the disproportionate power of Germany or other large Member States, something that Germany itself would find very beneficial.

The thicker upper layer managed by Member States, in this Goldilocks scenario (of about 35% - 40% of EU GDP) would ensure there is no material diminution of the nation-state. The nation-state would still be at least 3-4 times more powerful (in fiscal terms) than the Federal State. Crucially, under this “Goldilocks” proposal, the nation-state would be free and fully sovereign to manage its own taxation policies and to set its own tax rates in competition with other Member States, without hindrance from any central bureaucracy, subject only to a sensible coordination within the parameters of the stability pact and the rules of ESM. But any inter-state competition would start on top of the federal rates, which would provide the “common starting ground”. So, if for example federal corporate or personal income tax is 10%, no Member State would be able to go below that and undercut the others, but would need to impose a layer of local tax on top of the federal tax. Whilst this would not entirely eliminate competition in the form of aggressively low taxation policies, it would at least provide a common minimum, “floor”, that would render such practices a little less aggressive, without going as far as imposing complete uniformity through some form of fiscal leveller with centrally dictated tax rates (as in the Authoritarian approach) that would result in diminished inter-state competition that could ultimately damage the European economy and reduce its vitality.

The nation-state is not yet dead or defunct, even if nineteenth-century style nationalism should be superseded by a more modern and less tribal outlook. The Member States have a crucial non-nationalist role to play in managing local economies and participating in European institutional, social and economic progress as vibrant competitive organisations. This role deserves to be safeguarded, even if modestly checked, by any future reform.

But what miracles could the EU deliver if only it had these vital resources, even as little as 10% of EU GDP! It could provide the basic building block, the bottom layer of what is required in a number of fields that could begin to make a difference in achieving social and transnational cohesion (a necessary prerequisite of growth and prosperity) via effective but controlled redistribution, either vertically (across social classes) or horizontally (across regions). The latter (the cross-regional redistribution) would indeed amount to a limited form of “transfer union”, but a very sensible one, without unlimited liabilities, and with full and effective democratic controls on the proper management of any funds so dedicated.

A transformed EU with enhanced taxation powers (of up to 10% of EU GDP) would be empowered to provide things such as: (i) badly needed infrastructure investment in deprived regions, and venture capital across all regions to make the EU the most open, coherent and entrepreneurial place in the world; (ii) a basic pan-European minimum income for all and other limited basic universal benefits making up the first building block to (a minimum federal layer of) a welfare state entitlement, to make the EU the fairest and happiest place in the world and partly eliminate the causes of “benefits tourism”; (iii) world-leading research and development investment to transform the economy to make the EU the most progressive and forward-looking place in the world; (iv) common security, defence, immigration and foreign policies to make the EU the safest and most confident place in the world with maximum control and influence in the near abroad so as to harness refugee and migratory currents, without illusions pertaining to “fortress Europe”.

More importantly, with this Goldilocks option, a meaningful federal budget under joint trans-national parliamentary (rather than inter-governmental) control, would force the establishment of a genuine European polis; it would herald true European democracy and would finally give credence to the notion of EU citizenship and (limited) shared sovereignty - all the key hitherto missing ingredients, whose absence has allowed often unfair, but not altogether unfounded, criticisms about the so-called “democratic deficit” in Europe. Europeans voting in European elections would (as they do today in their home countries) elect a parliament with real (if limited) powers over taxation, which would in turn (in true parliamentary tradition) appoint and control a European Executive. Europeans would be empowered to directly choose their federal leaders, as they choose their local ones, for the things that matter in their daily lives, without intermediaries behind closed doors in the council of ministers, but in open process in the ballot box on EU-wide party politics. A senate could replace the council of ministers as the secondary legislative body representing Member States in the Union. This civic invigoration would be the greatest and most lasting, perhaps the ultimate unifying transformation that our generation can yet deliver to the historic peoples of Europe.

This is our chance, in the coming years to write the next chapter and to attain and bequeath to our children the dream of many past generations - the vision of a truly united European People - in the singular; founded in law, shaped by a colourful diverse but converging history and inspired by our common future: a singular dream for Europe.