European-wide unemployment insurance schemes will not solve the problem

On June 10, 2015, the Italian finance minister wrote an Op Ed article for the UK Guardian – Couldn’t Brussels bail out the jobless? – which continued the call from those who sought ‘reform’ of the Economic and Monetary Union in Europe for a European-wide unemployment insurance scheme. This idea continues to resonate within European circles and is held out as a major improvement to the failed Eurozone system. My response is that if this is as far as the political imagination can go in Europe among progressives then there is little hope that the EMU will become a vehicle for sustained prosperity. The creation of a European-wide unemployment insurance scheme is better than the current situation where the responsibility for providing income support to the unemployed outside of the private insurance arrangements is left to their Member States who surrendered their currency sovereignty upon joining the Eurozone. But, it is a weak palliative at best and fails to address the basic problem of mass unemployment, which is inadequate capacity for Member States to run fiscal deficits of a size necessary to bridge the spending gap left by the savings desires of the non-government sector. Until the European debate shifts towards that issue and the policy players and the people who elect them realise that the fiscal design of the Eurozone is flawed at the most elemental level and that the fiscal rules superimposed upon that flawed design only serve to exacerbate the initial failure to construct a sustainable monetary union. Introducing a European-wide unemployment insurance scheme does not take us very far down that road of enlightenment.

The proposal by Italian finance minister, Pier Carlo Padoan was motivated by the his observation that:

… the euro area’s economic performance remains disappointing. The lasting impact of the financial crisis exposes a lack of demand, structural impediments to growth and job creation, and flaws in the architecture of economic and monetary union.

We can agree that there is a lack of demand (overall spending, especially distributed in areas still enduring depression conditions).

The cure is to expand spending and there are only two sectors that can do that: the government sector and the non-government sector.

The latter clearly is unwilling to embark on substantial private capital formation, household consumption expenditure is moderate and net export growth is not substantial enough to stimulate economic growth and any acceptable level, given the remaining mass unemployment.

Public expenditure is essentially also not capable of providing a growth engine because of the ridiculous fiscal restrictions that are imposed upon Member States by the treaties and the regulations within them.

The much-touted Juncker infrastructure plan was not only pitiful in its quantum but a year down the track we know that only a pitiful amount of that pitiful quantum has actually been expended. And even then, the funds were not net additions to the net financial assets of the Member States (that is, a ‘federal’ spending injection funded by the ECB) but were really just redistributed Member State spending. Pitiful is the only word one could use for that ruse.

We can also agree that the disappointing economic performance is a direct result of “flaws” in the design of the Eurozone.

Part of the neo-liberal Groupthink is to push all ills into the so-called “structural impediments” basket. This provides the mandarins with the cover necessary to deny that the problem is the lack of fiscal capacity at the Member State level and to propose so-called ‘reform agendas’, which include all manner of neo-liberal attacks on income support systems, worker entitlements, pensions, and public ownership of assets.

There are no structural impediments to public sector job creation in the Eurozone. Brussels and the ECB could cooperate and announce immediately that they would assist each Member State via coordination and funding in the introduction of a public sector Job Guarantee, which would take the form of an unconditional job offer and a reasonable minimum wage to anyone that wanted to work.

How long do you think the Eurozone unemployment rate would stay at around 11 per cent? How long do you think the Greek unemployment rate would remain around 25 per cent?

They could solve the mass unemployment malaise within days. If it took longer to accomplish the technical requirements to make these jobs operational, it would just mean that the unemployed would now be employed receiving a wage while waiting for a specific work assignment.

These workers would resume spending because they now had some income security again and the multiplier effects would flow on to stimulate private sector employment. Win-win!

Not a structural impediment in sight!

But the Italian finance minister has to run the ‘structural impediment’ line as part of the Groupthink.

Dr Padoan thinks that the crisis has generated a “social emergency”, which has raised “issues of such urgency and complexity that it calls for a more ambitious strategy than any we have previously tried”.

If you go back over the last several years you will find periodically some political or bureaucratic spokesperson within the Eurozone claiming that there is a calamity or emergency that urgently needs to be resolved.

It is now 2016, at least eight years into the crisis, and yet these urgencies seem to come and go without a great deal of progressive action coming out of Brussels or Frankfurt.

When I was young, the tale of the boy who cried wolf was told as a moral teaching. How many times do these political leaders need to ‘cry wolf’ before they lose any credibility at all?

The Italian finance minister claimed that:

The EU’s current policy mix is moving in the right direction.

Among a litany of so-called reforms that the European Commission has introduced to deal with the crisis, he listed the quantitative easing program of the ECB and Juncker’s pitiful investment plan as examples. He was not joking either.

He then claimed that “Eurozone labour markets especially must be made more resilient” and that this could be accomplished “by introducing a common European unemployment insurance scheme”.

He doesn’t exactly tell us what being “more resilient” actually means but we can take it to mean that unemployed workers would be in better position to receive income support which “would smooth demand and cushion the negative fallout of any future crises”.

But such a system would do little to reduce the consequences of the inherent design flaws of the Eurozone. Even in the Italian finance minister’s vision any increase in the degree of “fiscal integration would need to be designed to minimise moral hazard and avoid the need for permanent financial transfers between countries”.

And there you have it – his vision is not to create a redistributive system within the Eurozone such that while performing nations with low unemployment would transfer spending too poorly performing nations with high unemployment through some federal fiscal capacity funded at the federal level.

And just in case you imagined that this proposal was in some way a novel response to the ‘urgency’ of the crisis, you should think again.

In June 1989, the European Council accepted Delors Plan and resolved to begin the first stage on 1 July 1990. This was the precursor to the Maastricht meetings.

Soon after this meeting in Madrid, an Ecofin Committee working party (a sub-committee of the Finance Ministers’ group) considered how the Delors Report could be rendered acceptable to the Member States, bearing in mind that the Delors Committee had deliberately excluded the ‘politicians’ from the process to that point.

The vehement opposition from the British brought home the need to render something that would be politically acceptable.

French politician Élisabeth Guigou was charged with leading this ‘high level’ EMU group. A preliminary agenda setting meeting between European Council members and Ms Guigou was held in Paris on 15 September 1989.

The Minutes show that the Commission should:

… be ready to explain and advocate the need for binding rules in the budgetary field (in October’s meetings for the Group).

On September 27, 1989, the group produced an – issues paper – on the “role of the Community Budget”, in which they sought to separate so-called structural and macroeconomic issues, and determined that the intergovernmental conference that would be held in 1990 should consider whether a federal fiscal capacity in the proposed economic and monetary union was warranted.

They also wanted consideration of the possibility that federal fiscal policy could be used for discretionary changes in spending to help complement Member State policies, in pursuit of commonly agreed macroeconomic objectives.

A series of informal EMU workshops were run by the European Commission in late 1989 to advance the understanding of the options that were available in this regard.

Economists Daniel Gros and Jean Pisani-Ferry (1989) argued at one of these informal EMU workshops that the central issue to be decided related to fiscal policy.

They recognised that the standard view among economists considered that “a monetary union is politically acceptable only if it provides at least some ‘insurance’ scheme in the form of automatic income transfers among participating regions” (Page 14).

That is, they recognised that effective federations provided a federal fiscal capacity to provide relief when states within the federation were in recession.

They concluded that this “raises the issue of the appropriate level and role of the Community budget” and that such transfers could be achieved via a “Community wide unemployment insurance scheme or via some sort of fiscal equalisation mechanism” (Page 14).

[Reference: Gros, D. and Pisani-Ferry, J. (1989) ‘Costs and Benefits of EMU’, EMU Work Program, 11 October].

History tells us that there was no consensus on that point though.

The evolving consensus appeared to agree on very little and what was agreed would prove to be highly damaging to the capacity of the Eurozone to deliver prosperity.

It was widely held that the Bundesbank stipulation the new central bank could never fund government deficits. There was nuanced disagreement over what fiscal rules should be used to bolt down Member State fiscal policy.

There was no mention of the role of fiscal deficits in countering aggregate demand slumps and protecting employment. It was all about rules and constraints so as not to ‘compromise’ spending discipline.

So at that point, the idea of a European-wide unemployment insurance scheme was proposed and rejected as part of the broader rejection of any coherent fiscal capacity at the ‘federal’ level of the new monetary union.

Not much has really changed in the 26 years since then despite the crisis demonstrating that the propositions that were entertained and accepted in 1990 have led to a human disaster across the participating Member States.

The idea has been resurrected in the last several years as European policymakers have demonstrated an incapacity to deal with the crisis.

It is clear that the so-called ‘asymmetric shocks’ (spending contractions not evenly spread across the monetary union) have been particularly damaging to a monetary union comprised of relatively disparate economies.

When a particular state or region succumbs to a major downturn in economic activity, investment declines as sales plummet, unemployment rises, and new capital is hard to attract as it seeks profitable opportunities elsewhere.

The asymmetry of economic performance across a monetary union also highlights one of the major shortcomings of monetary policy: it cannot be spatially targeted.

The main policy tool at the central bank’s command is to set the interest rate, which is a one-size-fits-all tool. The experience of the EMU prior to the crisis illustrates this problem.

Given the fiscal policy settings, the ECB interest rates were too low for economies such as Spain and Ireland, which were undergoing unsustainable, and ultimately, destructive property booms. But some of the other economies, such as Germany and the Netherlands, were experiencing modest growth, which would have been undermined by higher interest rates.

In these instances, only a fiscal policy stimulus can provide the overall spending boost necessary to counteract the fall in private demand. The question then turns to what mix of fiscal policy tools is appropriate.

There are two sources of stimulus that fiscal policy can provide: (a) discretionary changes to the spending and/or taxation settings; and (b) the operation of the in-built automatic stabilisers, which refers to the inherent sensitivity of taxation revenue and spending to changes in economic activity.

Thus when economic activity falls and employment declines, the government automatically receives less taxation revenue and increases spending by way of welfare benefits.

No discretionary changes to the policy settings are needed for this second effect to work. The upshot is that the automatic stabilisers will push the fiscal deficit up and provide a modicum of spending support to the local economy.

In recessions, both sources of stimulus will typically be needed to ensure unemployment doesn’t escalate. Reliance on the automatic stabilisers alone only moderates the contraction, but will usually not provide sufficient stimulus to prevent the recession from occurring.

Automatic spending buffers respond to demand variations without the need for complicated and time-consuming political debate.

The design of the EMU deliberately reduced the potency of these automatic stabilisers.

How?

First, the EU fiscal capacity is miniscule by choice.

Second, the transfer mechanisms (for example, the regional and structural funds) are inflexible and cannot be triggered quickly to respond to cyclical assymetries.

In 2013, the German Young European Federalists proposed that a European level unemployment benefit system be established to “partly replace the national insurance systems”.

The scheme would bolster the so-called “automatic stabilisers” at the European level, which would provide some support to Member States suffering “asymmetric shocks”.

The scheme would be “funded through non-wage labour costs” (for example, a small levy on all payrolls) and provide support for workers for 12 months at half pay.

While the devil would be in the detail, the proponents claim there “would not be much of a change” in payments for the unemployed.

This raises the question as to how the scheme actually would generate a higher level of total income in crisis regions, especially when it is acknowledged that “the national insurance systems are already higher than the ones the European Unemployment Insurance would provide”.

Further, the proposal was essentially political rather than economic given that the support would evaporate after 12 months, thus ensuring that there would not be a “permanent financial redistribution among the member states”.

This is the sort of requirement or constraint that the Italian finance minister also proposes on any such scheme.

However as the current crisis has demonstrated, severe downturns, especially those related to private balance sheet imbalances, take many years to resolve and require long-term fiscal support while the private sector reduces its debt levels.

Successful federations, such as Australia, allow for ongoing redistributions of tax revenue, for example from states with strong growth to those with weaker performance.

But the limits on the transfers proposed by the German scheme and later variations reveal the conservative, neo-liberal nature of the proposal. The aim is to ensure that over the “whole economic cycle, the fiscal net balance would … be almost evened out”.

Why should that be a desirable goal? What the desirable federal fiscal balance should be depends on the circumstances. At times, a balance might be desirable. At other times, a deficit or a surplus might be desirable and these circumstances may or may not coincide with a complete economic cycle.

A group of economists associated with the Jacques Delors Institute also proposed boosting the automatic “cyclical response” capacity in Europe in June 2012.

Their reasoning was symptomatic of the Groupthink among European economists that led to the problem in the first place.

Many of the authors of this report were involved in various studies that gave rise to the design of the EMU.

Now, as the system they lauded had failed, their approach was to patch it up with various ad hoc measures, all of which are ringfenced by the austerity mentality.

They refused to “even consider the option to abandon the euro” and were, instead, guided by the principle: “As much political and economic union as necessary, but as little as possible”.

[Reference: Enderlein, H., Bofinger, P., Boone, L., de Grauwe, P., Piris, J.-C., Pisani-Ferry, J., Rodrigues, M.J., Sapir, A. and Vitorino, A. (2012) ‘Completing the Euro. A Road Map towards Fiscal Union in Europe’, Notre Europe, Jacques Delors Institute, June].

They continued to maintain that the “principle of subsidiarity” – that responsibility should be vested at the appropriate level of government – justifies this minimalist approach to fiscal union.

They advocated what they call a “sui generis form of fiscal federalism”, which is driven by an implicit assumption that the national economies to be involved in this union are not remotely interested in surrendering their fiscal autonomy to the centre.

Of course, the Stability and Growth Pacts and the austerity packages forced onto many of the Eurozone economies during this crisis have already severely compromised the so-called fiscal autonomy of these nations.

It seems that democracy and autonomy can be violated when the Troika is imposing the terms, but in other cases they are upheld as a sacrosanct principle that cannot be compromised.

This sort of hypocrisy has woven its way through the entire debate about economic and monetary integration in Europe and will continue to deliver sub-par outcomes.

These economists proposed a simple rule for the limits of democracy – “sovereignty ends when solvency ends” – which is astounding if you think about it.

The application of this rule inevitably leads to a violation of democracy because the risk of insolvency is intrinsic to the flawed design of the monetary system.

Member States are forced to issue debt in a currency they have no control over and the ECB is formally precluded from giving any guarantees (although of course it has violated that prohibition via programs such as the Security Markets Program.

Default risk and insolvency are always lurking, waiting for the next major economic downturn to arrive. Thus as soon as a nation falls into crisis, its citizens lose the capacity to influence their own destiny and are, instead, at the behest of unelected officials in the European Commission, the ECB and the IMF.

That doesn’t appear to be a road map for a sustainable and prosperous Europe.

The economists’ preferred approach to “cyclical divergences” was to “enhance the real exchange rate channel”, which is code for making internal devaluation more responsive through increased labour mobility and wage cuts in declining regions.

The authors thus invoke the standard neo-liberal approach – workers from recessed regions should move to growing regions and those who stay should work harder for less pay.

To supplement their “structural” emphasis, which they admitted would be “unlikely to solve the inherent difficulties”, they proposed “a cyclical adjustment insurance fund”.

How would it work?

The fund would be managed by Eurozone finance ministers who would build its kitty from contributions from nations experiencing above the Eurozone growth rates and pay out to nations in crisis, to “reduce pressure on public finances”.

The scheme would thus force nations to reduce their domestic spending in times of buoyant economic growth and provide some relief in bad times.

Significantly, the authors stressed the “the system cannot become a hidden instrument for permanent transfers” and nations might only be permitted to “take out what they once paid in”.

Once again the presumption is that the ‘federal’ redistribution would be neutral across the economic cycle and across space, a proposition for which there is no rationale other than fiscal conservatism.

A similar type of transfer system was advocated by Pisani-Ferry et al. (2012), such that in times of recession, nations would enjoy increased “federal” income and be forced to pay it back in better times.

[Reference: Pisani-Ferry, J., Vihriälä, E. and Wolff, G. (2012) ‘Options for a Euro-Area Fiscal Capacity’, Bruegel Policy Contribution, Issue 2013/01, January].

Their “relatively simple rule” would again exploit the “current fiscal framework” and require income support payments to flow whenever there are absolute and large output gaps.

The authority administering the scheme would borrow funds during a recession. It is unclear how the debt would be serviced or relinquished.

The proponents claim that a “natural way to pay the debt incurred in recessions would be to extract payments from countries with output above potential in good times”.

But an examination of the historical record suggests that nations find themselves in that position neither often nor for long. The scheme also depends on how one measures the output gap.

But the estimates of the output gap provided by multilateral organisations such as the OECD and the IMF are biased downwards because their adopted estimates of full employment unemployment are too high (that is, unemployment could be reduced substantially below the levels assumed by the neo-liberals to constitute full capacity).

In this environment, the income support scheme proposed would provide inadequate spending support to nations in recession and would be of limited duration.

The economies would be deemed to be back at full employment, while in reality they were still enduring persistently high unemployment and private spending gaps.

Further, Germany will clearly never allow a Eurobonds system to be introduced nor relax the direct funding constraints on the ECB.

Conclusion

There have been many different permutations of the same sort of proposal to introduce a European-wide unemployment insurance scheme presented in recent years.

They all require the contributions of the Member States.

They are all constrained by the existing fiscal mechanisms at the Eurozone level which cannot support sustained prosperity.

They all avoid facing up to the reality. There is no coherent integrate Europe that is sustainable with a shared currency.

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved.