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European Commission

[Check Against Delivery]

László Andor

European Commissioner for Employment, Social Affairs and Inclusion

Basic European unemployment insurance as an automatic fiscal stabiliser for an ‘EMU 2.0’

Conference on Economic shock absorbers for the euro zone

Brussels, 20 June 2014

Ladies and Gentlemen,

Also on behalf of the European Commission, welcome to today’s conference on Economic shock absorbers for the euro zone.

I cannot begin but by thanking Bertelsmann Stiftung for our continuous excellent cooperation in exploring possibilities for the creation of automatic fiscal stabilisers at the European level.

The foundation has shown a great deal of intellectual and political leadership on this subject and we have organised together an important event in October 2013 in which many of you participated.

Today we meet again, with a number of new distinguished speakers and with new pieces of technical work at our disposal.

Bertelsmann Stiftung has invested substantial resources and energy in the organisation of these conferences and I would like to put on record my deep gratitude to Aart De Geus, Thomas Fischer and all their colleagues for the effort they have put into this ‘joint venture’.

Compared to October 2013, I expect today’s conference to reach higher in terms of the political discussion. We will have with us two former Prime Ministers, a State Secretary from the incoming Council Presidency, several Members of the European Parliament, a representative of the IMF and other distinguished speakers.

At the same time, we also aim to dig deeper into the possible design of transnational fiscal stabilisers for the EMU. After last October’s event, we identified several questions for further analysis:

  • how to avoid lasting transfers in unemployment-based schemes;

  • how to fine-tune the micro-economic and social impact of such schemes; and

  • how to prevent and mitigate administrative risks potentially arising from the interaction between different levels of government.

The research we have commissioned on this basis will be discussed in the parallel workshops later today.

In addition, the political debate on the need for a shared fiscal capacity at the level of the Economic and Monetary Union has considerably evolved since October and we will be able today to compare the merits of the various options floated so far.

Our conference takes place at a good time: a new European Parliament and Commission are being formed and key priorities for the next five years are being discussed. Moreover, the upcoming Italian Presidency of the Council has decided to make automatic fiscal stabilisers one of the topics for discussion at the informal meeting of Employment and Social Ministers which will take place in Milan in July.

An epistemic community around EMU reform

The main result of the Commission Communication on the social dimension of the EMU and the Bertelsmann conference on automatic stabilisers last October is that an epistemic community has been created in Europe focusing on the reconstruction of the EMU with fiscal capacity as one of the key elements.

We probably agree that macroeconomic instability in Europe has stemmed predominantly from the incomplete design of the Economic and Monetary Union. Troubled countries could not unilaterally devalue, could not call upon a lender of last resort and could not count on any fiscal support from other Member States that would enable them not just to survive but to stimulate economic recovery.

The recognition that the EMU with uniform fiscal rules and monetary arrangements has to be handled as one macroeconomic unit is only slowly developing.

When we advocate fiscal transfers between euro zone countries, we do not do it only out of concern for the employment and social situation. The current functioning of the EMU is suboptimal first of all for economic growth – for all Member States without exception.

That said, employment and social outcomes are probably the decisive factors for the sustainability and legitimacy of the monetary union.

As we have seen in last month's elections to the European Parliament, a growing number of European voters are disillusioned with mainstream parties and with European and national politics in general. This is in my view linked first and foremost to the weakening of the welfare state which we have experienced since the onset of the sovereign debt crisis in 2010.

The fundamentals of a recovery strategy for Europe are now once again being discussed in the context of the EU's institutional transition and the mid-term review of the Europe 2020 Strategy.

If we want to move beyond today's fragile, uncertain and uneven recovery, we need to focus attention on the reform of the EMU, whose current set-up has been the primary factor behind Europe's second recession and behind the declining ability of governments to promote a recovery.

The creation of a fiscal capacity at the level of the EMU is clearly foreseen in the Blueprint for a deep and genuine EMU, which the European Commission put forward in November 2012. The subsequent report of the Presidents of the European Council, the Commission, the ECB and the Eurogroup specifies that such fiscal capacity should help the EMU to be able to absorb economic shocks.

A number of options for automatic fiscal stabilisers at the level of the monetary union have been proposed in the literature. What most of them have in common is their focus on mitigating short-term cyclical downturns occurring in parts of the EMU as opposed to compensating for structural differences among the EMU economies.

Given the constraints which membership in a monetary union implies, it is fundamental to re-create possibilities of macroeconomic adjustment inside the euro zone whereby aggregate demand and economic growth can be maintained.

If short-term shocks and private sector deleveraging cannot be mitigated by autonomous monetary policy, they have to be absorbed by fiscal policy. Structural reforms cannot be the main answer to cyclical developments.

However, given the still elevated levels of public debt in the euro zone, expansionary fiscal policy needs to be based on greater solidarity between Member States, otherwise we risk a re-run of the recent financial crisis.

An automatic stabiliser at the EMU level would help uphold aggregate demand at a time when it is most needed, and it would help prevent short-term crises from unleashing longer-lasting divergence within the monetary union.

Most of us probably agree that developing a mechanism of fiscal transfers between euro zone Member States should be one of the main priorities for the next European Commission. A scheme where EMU Member States would share part of the costs of short-term unemployment insurance would represent the logical next step after the agreement on banking union.

We should try to answer several key questions today:

  • Are automatic fiscal stabilisers at the EMU level still necessary from an economic point of view?

  • Is this a relevant proposition from a political point of view?

  • And do we have well developed options and proposals to be put forward for decision makers?

EMU reform and economic recovery

Ladies and Gentlemen,

Probably there are many in Europe who believe that deepening of the EMU can stop at what has been agreed so far, i.e. the establishment of a permanent European Stability Mechanism able to bail out various smaller countries, strengthened coordination of national economic policies, and the launch of minimalist banking union.

However, even with strong policy coordination and banking union, the EMU is not resilient enough to cope with economic shocks in a way that would be acceptable from the viewpoint of the EU’s Treaty objectives such as balanced economic growth, full employment and social progress.

Finding the right policy mix for a European economic recovery is very much work in progress.

The European Central Bank only recently, and after a long agony, started to address the risk of deflation or very low inflation.

The importance of the German surplus was only recently recognised but there is probably no consensus about how to deal with it.

On-going uncertainty about the sustainability of public and private debt is pushing up risk premia and making any recovery much more difficult.

Moreover, it still has to be seen how the American exit from crisis policies will impact on Europe.

It is still to be seen how quickly (or how slowly) the banking system will restore its capacity to support real investment in the peripheral countries.

There were always those who preferred muddling through to systemic improvement, but in the last two years a shift has taken place, and this allowed the recovery to begin.

EU economy had to recover from a confidence crisis but, contrary to early views, confidence was boosted by the EU level collective efforts, and country level adjustment played a minor role.

Finding right balance between structural reforms and EMU level collective action remains a challenge.

In addition to the economic uncertainty, the social reality also forces us to focus on monetary reform.

The social dimension of the EMU

The mid-term review of the Europe 2020 Strategy is on-going and reflections on the reconstruction of the EMU are part of this process. It is becoming increasingly obvious that the employment and poverty targets of Europe 2020 cannot be reached with our current model of Economic and Monetary Union, which favours macroeconomic adjustment through internal devaluation and deepens socio-economic asymmetries between Member States.

During recent years Europe has experienced unprecedented divergence in terms of economic, employment and social outcomes. This divergence cannot be explained just by structural economic fundamentals such as productivity levels, because it is much larger than what we have observed ever since the EMU was launched.

Part of this divergence has therefore cyclical causes: the implosion of the financial bubble in 2007-10 and the macroeconomic policies implemented in response to this financial crisis.

Instruments that were historically used to limit the social impact of crises were not available any more, while there has been nothing newly introduced to replace them.

For us this also means that the Europe 2020 targets cannot be expected to be achieved, not even with significant delays, when so many governments in Europe lack the ability to conduct economic policies that could generate sufficiently strong economic recovery.

The sovereign debt crisis since 2010 and the fiscal consolidation strategies implemented in response to it have substantially weakened the effectiveness of automatic fiscal stabilisers at the national level, which basically means the ability of a state to immediately act in a countercyclical way as tax revenues drop and social expenditure increases.

Until 2009, national budgets were able to counter the economic downturn reasonably well. Since 2010, many national governments have lost this ability and austerity policies in many cases actually aggravated the economic crisis.

The only mechanism through which troubled countries inside the EMU have been able to restore economic growth was internal devaluation, i.e. cost-cutting in both the private and public sectors by shedding labour and reducing wages. When multiple countries in an overall closed economy pursue internal devaluation at the same time, nobody wins but everybody loses.

So let’s go briefly back to the origins of our incomplete EMU - why and how was this system created?

The ‘Delors paradox’ and the EMU’s fairness

In the early years of European monetary integration, the importance of a fiscal capacity was well understood.

In the 1970s, two high-level reports prepared for the European Commission warned that a common budget as well as stronger political union would be needed for a potential monetary union to work in Europe.

The Marjolin Report of 1975 actually proposed a ‘Community Unemployment Benefit Fund’.

The MacDougall report of 1977 estimated that a monetary union between EEC Member States would need a shared budget to the tune of 5 or 7% of Community GDP in order to function well.

However, in the European Community of the 1970s, agreement on such a large budget was impossible. The European Monetary System launched in 1979 then imploded in September 1992 under the weight of speculative attacks.

The Economic and Monetary Union was enshrined in the Maastricht Treaty of February 1992, without providing for a central budget or strong financial sector regulation. It was simply assumed that individual national governments would always be able to conduct the right fiscal policy for their country and that a laissez faire approach to private finance would always work towards an economic equilibrium.

The EMU 1.0 was designed largely by central bankers. After two decades of monetary instability in Europe, it was assumed in the early 1990s that political stability and better economic performance in Europe required first and foremost monetary stability.

However, while the likelihood of currency crises was practically eliminated by the creation of the single currency, the likelihood of fiscal and social crises has increased, and the overall real economic result is also doubtful.

Political leaders in the early 1990s were far from ignorant about the importance of social cohesion, but they believed that it could be essentially achieved through legislation and social dialogue.

For Jacques Delors and other leading politicians at the time, the social dimension of the Single Market and of the EMU was predominantly about preventing a race to the bottom in employment and working conditions.

However, there is little we could achieve today through further employment and social legislation at the European level, particularly when it comes to dealing with asymmetric cyclical shocks that by definition affect only part of the monetary union.

We can call this ‘the Delors paradox’. On the one hand, we introduce social legislation to improve labour standards and create fair competition in the EU. On the other hand, we settle with a monetary union which in the long run deepens asymmetries in the community and erodes the fiscal base for national welfare states.

Social legislation cannot make up for the absence of a euro zone budget or a genuine lender of last resort. Delors' idea of Social Europe is unfortunately offset by Delors' model of the EMU.

That is not to say that the EMU was intended to be unfair at the time of its design, but it is quite clear today that it has not functioned fairly in practice. We know now that the EMU in its present form contains an inherent bias towards internal devaluation as the prevailing if not the only mechanism of adjustment to economic downturns. Such developments have a particularly negative impact on workers, the unemployed and everyone whose quality of life depends on public services.

New pillars, new stabilising mechanisms are therefore needed in the architecture of the EMU, in order to adapt it a way that it can be trusted to function equally well for each Member State and each social group.

Details of a basic EMU unemployment insurance scheme

Out of the various alternative options for automatic stabilisers, the concept of basic EMU-level unemployment insurance is the one that makes the closest link between stabilising the euro zone and addressing the social problems the monetary crisis has created.

Details of a basic European unemployment insurance have been developed by Sebastian Dullien and published recently by the Bertelsmann Foundation. A number of other experts have contributed to the debate over the recent years, many of whom are in this room.

Unemployment is an indicator whose big advantages are that it very closely follows developments in the economic cycle, it is easily understandable, and it is easily and promptly measurable.

Basic European unemployment insurance would replace the corresponding part of national schemes but could be topped up and extended at the national level.

The levels of the contribution and of the benefit in the European scheme would therefore represent only a relatively low common denominator between the rules of the various national schemes.

The European scheme would therefore involve very little harmonisation, if any at all, when it comes to the generosity or duration of existing national unemployment benefit systems. It would certainly not result in a one-size-fits-all model for national unemployment insurance schemes but it would represent a common core of the fiscal capacity behind them.

The scheme should clearly focus on cyclical unemployment caused by a drop in aggregate demand, as opposed to structural unemployment caused by skills mismatches, less efficient labour market institutions and the like.

For example, the basic European unemployment benefit would be paid only for the first 6 months of unemployment and the amount would represent 40% of the previous reference wage. These exact parameters would of course need to be discussed, depending on the desired macroeconomic stabilisation effect.

The eligibility conditions should not be too strict, so that also workers in short-term or part-time jobs could contribute and qualify for corresponding support. But in any case there would be clear conditionality in terms of the job-search and training effort.

Crucially, this basic European unemployment insurance would help EMU Member States to share part of the financial risk associated with cyclical unemployment.

Citizens would directly benefit from EU solidarity at times of hardship, and Member States would be required to upgrade their employment services and labour market institutions to the best EU standards.

The jobseekers would continue to interact with national authorities (public employment services).

I do not see a need for a direct European payroll tax. However, every month the national authorities would send to the European fund the basic contribution from all their employed workers.

Likewise, every month the European fund would pay to the national authorities an amount corresponding to the sum of all the basic European unemployment benefit payments to be made that month in the country.

In principle, each country would therefore make every month an overall contribution and receive an overall payment from the European scheme. In practice, these two could of course be offset and only the net balance would be paid.

A basic European unemployment insurance scheme would represent a certain safety net at the EMU level for the welfare safety nets of individual Member States. It would provide a limited and predictable short-term stimulus to economies undergoing a downturn in the economic cycle – something that every country is going to experience sooner or later and something that can no longer be expected to be countered by national fiscal capacities on their own.

The overall volume of such a basic European unemployment insurance scheme would be around 1% of GDP, mainly depending on the exact parameters such as duration and level of the benefit or the eligibility conditions. Of course, the net transfers from or into any particular country would be smaller, because drawdowns would be offset by contributions and vice versa.

Focusing fiscal transfers on mitigation of asymmetrically distributed cyclical shocks means that over the long term, all participating Member States are likely to be both contributors and beneficiaries of the scheme.

But even if the balance is not exactly zero after a certain period of time, the effect that economic crises would be less deep and last less long would be good for all countries.

Why is partial pooling of short-term unemployment insurance a good solution?

What are the key advantages of such a scheme compared to other options?

Very importantly, an automatic fiscal stabiliser in the form of basic European unemployment insurance could have a meaningful macroeconomic effect in counteracting a cyclical downturn. It would have a few basic parameters agreed in advance, and its functioning would be entirely predictable and calculable on the basis of these clear rules.

The parameters could be adjusted in response to actual experience, but governments, citizens as well as financial markets would be able to rely on the principle that an EMU country undergoing a cyclical downturn receives a limited fiscal transfer to support the cost of short-term unemployment.

The fact that the scheme would trigger countercyclical transfers automatically and immediately is a major advantage compared to bailout programmes or bank rescues. These are always surrounded by uncertainty which pushes up their cost. The basic European unemployment insurance would be relatively cheap precisely because of its automaticity.

The size, predictability and automaticity also make the basic European unemployment insurance scheme a better alternative compared to discretionary fiscal instruments where a fiscal transfer would be provided in exchange for structural reforms.

The ‘catalogue’ of reforms and corresponding financial support under such discretionary instruments would in my view be very hard to define and the decision-making process would be rather unpredictable.

Moreover, the predictability, limited volume and limited duration of fiscal transfers would make a basic European unemployment insurance scheme a much safer option than various scenarios for mutualisation of euro zone countries’ sovereign debt. This feature is particularly important when Member States consider themselves in the role of a contributor rather than beneficiary.

Finally, I consider a scheme of automatic short-term fiscal transfers between countries to be a better alternative compared to simply granting individual Member States greater budgetary leeway thanks to a more generous interpretation of the EU’s existing fiscal rules.

I have some sympathy for the idea of an ‘investment clause’ and the political scrambling around it. Such a solution would enable to exempt investments in fixed assets and human capital from the calculation of the excessive deficit.

But I believe that simply giving national governments greater fiscal room for manoeuvre is in a way a short-sighted and insufficient step.

The ‘investment clause’ may temporarily support growth in some countries which are relatively close to the core of the euro zone, but it will not help those who have just exited adjustment programmes or are still implementing them.

Moreover, the ‘investment clause’ would not really strengthen the resilience of the EMU against financial crises or other asymmetric shocks. It would not fix the problem of euro zone governments facing the financial markets all on their own and being forced to respond to downturns with pro-cyclical fiscal consolidation.

In other words, tinkering with criteria and with the interpretation of fiscal rules may provide governments with some breathing space for a few years, as long as financial markets stay calm. But it is poor substitute for a genuine, sustainable solution. If we really want to improve the functioning of the EMU, we need to touch the fundamentals: the ECB’s mandate, and especially the absence of a euro zone budget even at a time when national fiscal policies are constrained by a tight fiscal framework.

We should draw the real lessons from the policy experience of the recent years. In recent years, crisis response in the euro zone most often delivered just the minimum necessary to avoid a complete meltdown. European decision makers too often settled with measures where the substance was much more modest than the packaging and the marketing. The most prominent example is the 2012 Compact for Growth and Jobs, whose macroeconomic significance was very small, certainly when compared to the Fiscal Compact to which it pretended to respond.

The approach of giving up on real solutions and over-selling weak ones can only result in disappointment and the electorate will not tolerate this for too long. It may happen that the next months are spent in a heavy political fight over the investment clause, which then turns out to have very limited economic impact in practice. In my view a much better approach would be to focus energy on developing a real fiscal capacity for the EMU, which would have greater economic impact - and a much greater impact in terms of binding the euro zone closer together.

Are cross-country fiscal transfers politically realistic?

You may say that arguing for fiscal transfers between euro zone countries is just a waste of time after the European Parliament elections have sent to Brussels and Strasbourg an increased number of populists and Eurosceptic nationalists.

You may also say that the process of EMU reform has stalled last December and that it is impossible to achieve any breakthrough with the current political constellation in the European Council, or ever.

However, I think that the process of EMU reform will have to resume rather soon, for reasons of both financial and political stability.

Inaction is not something that pro-European political forces could afford after last month’s European elections. Preventing further rise of anti-European sentiments will require going to the root causes of our economic and social troubles. Not much time is left to do this.

The second recession of 2011-13 and the slowness of the recovery have been unique to Europe and have been largely due to the incomplete character of the EMU and the very incremental response to the sovereign debt crisis.

There are basically two possible reactions to the EP election results. One is a panic reaction, which assumes that the populist agenda should be partly absorbed by mainstream parties in order to restore their credibility.

This approach points toward deconstruction of the EU, even if deconstruction is often euphemistically referred to as 'reform'. The blame for the economic and social crisis tends to be put on the welfare state, on immigrants or on allegedly too much bureaucracy.

Such approach ignores or deliberately conceals the fact that Europe’s second recession has much to do with the declining fiscal room for manoeuvre of individual national governments or with the philosophy of ‘expansionary austerity’ which has largely shaped Europe’s response to the sovereign debt crisis of 2010.

The best way to take account of the EP election result is therefore precisely to explore innovative proposals for strengthening the EMU. In particular, we need to develop a mechanism that would enable an effective countercyclical response next time a financial crisis hits.

Such a strategic response would aim at reconstruction of the EU, by sorting out the fundamental problems that have caused frustration in society in recent years. However, a progressive reconstruction of Europe needs to start from the foundations of our Economic and Monetary Union.

The ‘2014 paradox’

Ladies and Gentlemen,

Establishing automatic stabilisers within the EMU is neither a technicality nor a utopia.

What I am speaking about is an effort to find an effective and rules-based response to the key concern expressed by citizens in last month’s European elections.

Voters are turning away from the centre-right and to a lesser extent from the centre-left (both at EU and national levels) mainly due to the declining ability of national governments to deliver what citizens ask from them: counteract the economic crisis, provide good-quality public services and ensure good socio-economic opportunities for everyone.

As I said, the welfare state has been substantially weakened over the past five years. Europe’s monetary union with strict rules for national fiscal policies is often seen as a constraint rather than a solution.

However, the fact is that in order for Member States to gain greater autonomy and ability to strengthen their economies, they will need some more European integration, particularly by completing the monetary union with a fiscal capacity. We can call it the ‘2014 paradox’.

What I am arguing for is not ‘more Europe’ for its own sake, but a mechanism that strengthens the autonomy of each Member State precisely by stabilising the EMU.

Only through an automatic mechanism of short-term support to countries in crisis can the euro zone and its individual Members regain some of the lost ability to shape their own economic and social destiny.

The idea of basic European unemployment insurance represents an example of forward-looking solidarity. Not charity, but support provided because of a will to build a common future together.

It is much better to help each other out in times of crisis than to put the fate of the union and of its individual members at stake whenever a financial crisis occurs. Sharing short-term fiscal risks in a monetary union is what I would consider a proper social contract.

Conclusion

Ladies and Gentlemen,

EMU reform is an important question from economic, social as well as political points of view.

The EU cannot live together for too long with the risk of monetary breakdown which also would bring with itself social and political breakdown.

If our Economic and Monetary Union is meant to be irreversible, it must also be fair and it must be based on solidarity.

We must pay attention to the employment and social outcomes, and try to prevent lasting divergence.

Insisting on the dogma of ‘no fiscal transfers’ in the EMU probably prohibits the functioning of the Europe 2020 strategy, and risks losing the whole meaning of the concept of the European Social Model.

After seven years of financial and economic crises, it is not an exaggeration to speak about the need for a reconstruction in Europe.

This means the reconstruction of the European social model, the reform of our monetary union, and the renewal of the political commitment to the EU.

The importance of the euro zone fiscal capacity and the concept of an automatic fiscal stabiliser should be looked at from this perspective.

Thank you very much for your attention.


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