Madness continues – macro conditionalities on regional transfers in Europe

When 17 countries together have failed to grow for the last 12 months and each successive quarter has seen the growth rate fall increasingly (-0.1 per cent June 2012, -0.7 per cent September 2012, -1.0 per cent December 2012 and -1.1 per cent March-quarter 2013) and the same 17 countries have seen the collective unemployment rate rise (or remain static) for the last 24 months from 9.9 per cent (May 2011) to 12.2 per cent (May 2013) when is it appropriate to conclude that the macroeconomic policy mix is wrong and substantial changes need to be implemented. Answer: Yesterday! Further, why would those same countries decide to implement further policy changes, which will not only make it harder to grow but go against the whole idea of the collective in the first place? Answer: Besotted by destructive neo-liberalism. Welcome to Europe and macroeconomic conditionality on regional funding.

The European Union has a complex set of funding programs which aim to address so-called Objectives. You get some information from – Structural Funds and Cohesion Fund.

In December 2012, the European Parliament’s Committee on Regional Development published a document – Macro-economic Conditionalities in Cohesion Policy – which discussed the EC’s “proposal to introduce wide-scale macro-economic conditionalities in cohesion policy” which will apply in the 2014-2020 period.

The document tells us that:

Such macro-economic conditionalities would make European cohesion policy funding in a Member State dependent on the country’s compliance with the economic governance procedures

First reaction – are these policy makers mad?

The document says (Page 8):

The EU’s Economic Union has so far been unable to prevent major crises in public finances amongst the Member States. Therefore, a key element in strengthening Economic Union could be the introduction of wide-scale macro-economic conditionality.

First, their definition of a fiscal crisis is only meaningful within the arbitrary fiscal rules (Stability and Growth Pact) which they imposed on the EU17 nations. These rules were made up over a in an hour without any reference to any economic reality, to satisfy the political ambitions of Mr Mitterrand. Please read my blog – So who is going to answer for their culpability? – for more discussion on this point.

Second, if we redefined the benchmarks to acknowledge that the budget deficit should rise if there is a major collapse in the non-government spending – and no particular deficit to GDP ratio is good or bad – rather it has to be defined in terms of addressing the output gap (the objective of policy) – then there has been no crisis in public finances in Europe.

Third, we should qualify that by noting that once the ECB stepped in and drove the private bond markets out of the game, there was no crisis anyway. The point is that building on the second observation, the crises we have seen is because member nations with large deficits as a result of the collapse in economic activity have been using a foreign currency and the bond markets know this introduces default risk.

The regional funding proposal thus ties in the redistributive functions existing with the EU to the manic macroeconomic framework that has brought the currency union into crisis.

The document (page 10) claims that:

In terms of economic governance, macro-economic conditionality would have mostly positive effects. It would enlarge the existing sanction ‘toolbox’ and increase the bottom-up drive for sound fiscal and economic policies, as local governments would have much more to lose in the economic governance process. The macro-economic conditionality would offer a more automatic, somewhat innovative sanction that applies to the entire set of economic governance procedures.

Can you believe this stuff? Enlarge the “existing sanction ‘toolbox'” which means further choke the hell out of any growth prospects in nations that require large-scale public spending support to redress a major slowdown in non-government spending.

The point is obvious.

These cohesion and structural funds are targetted at the most disadvantaged regions in Europe, although there are some well-known anomalies where richer regions get funding because they have no employment (why? because they are commuter regions!).

But if these funds are tied into the overall macroeconomic state of their member-nation, which are already bound by harsh sanctions in the form of excessive deficit processes, then it will impose further costs onto poorer regions that have no direct capacity to influence any of the national fiscal outcomes.

That will have mostly negative effects and provide a further axe on growth potential.

EU has been talking about strengthening the economic governance for Europe for some time, without ever agreeing to fully implement a federal solution to their common currency. That means that most of what they are proposing within the economic governance framework will only exacerbate the design flaws already inherent in the monetary union.

The “macro-economic conditionalities” are another reflection of this flawed conception and implementation.

On December 5, 2012, the President of the European Council released – Towards a Genuine Economic and Monetary Union – which was the final version of an Interim Report he had floated in October 2012.

I considered the Interim version in this blog – IMF to get Nobel Peace Prize in 2013.

The final version is not dissimilar and identical in substance.

Van Rompuy (when the hell is he going to retire and give the position to someone who will be constructive) recently gave a – Presentation – on June 28 , 2013, which also included a summary of the proposal.

The proposal is applicable to the Eurozone only.

Essentially, the document recommends that an integrated financial framework being introduced to put banking regulation at the EU level rather than at the member state level. This is sensible, given that the member states do not have central banks, which can provide genuine lender of last resort guarantees to ensure depositors are protected.

Further, given the extensive cross-border capital flows, it makes no sense for a host of regulative frameworks to exist side-by-side.

I remain sceptical about how long it will take to develop an effective supra-national bank regulation framework, given the resistance shown by Germany last year when the Spanish government sought bailout funding to save the Spanish banks.

The more significant initiative is the proposal to create an “Integrated budgetary framework” which aims to produce “sustainable growth and macroeconomic stability”.

As I have noted previously, there are only two ways for the Eurozone to proceed in providing for growth and stability:

1. What I would consider to be the preferred way, given the cultural and economic differences across member states, is for the Eurozone to be broken up in an orderly way and currency sovereignty restored at the member state level. That aligns better with democratic ideals and allows domestic economic policy to be free to produce the best domestic outcomes that are possible given the resource base and structural characteristics of the economy in question.

These currencies would float against each other and the democratically-elected governments would be able to pursue an independent monetary and fiscal policy aimed at advancing national interest. At present, given the state of some of the economies, this aim would require large budget deficits in many such nations.

The nations themselves could then decide whether they wanted to issue debt to the private markets to match these deficits or whether they wanted to pursue more sophisticated and effective accounting arrangements with their own central banks to facilitate the net spending.

All external imbalances would be mediated by exchange rate fluctuations and if they proved to be problematic (for example, by introducing chronic imported inflation) then the sovereign government would have to make some policy choices to discipline the distributional struggle to ensure, for example, that nominal depreciations translated into real depreciations.

The path to that future would be difficult for some nations but certainly no more difficult to what they are already enduring and will go on enduring indefinitely given the flawed structure of the Eurozone.

2. In lieu of the preferred option, and given the seeming (irrational) resistance across the EA17 to abandoning the common currency, the only alternative viable path is for the Eurozone to create a true federation, where the member states become states of the Eurozone along the lines that California or New South Wales are states of the US and Australia, respectively.

The newly-created federal government should then be elected democratically and control the currency-issuing authority (the ECB) so that fiscal policy could be directed at advancing the common purpose across the federation.

Part of that aim (common purpose) would involve extensive fiscal transfers being provided to regions across the federation should the circumstance arise. At present that would require large fiscal injections into areas within Greece, Spain, Ireland, Portugal, Estonia, probably Italy, France and so on.

A well-designed federal constitution would never make federal assistance to a person in say California, conditional on whether the state fiscal authorities in California were adopting the same macroeconomic ideology as the federal sphere.

What we should be looking for at this top-level, mission-statement sort of level was a clear vision that the “Integrated budgetary framework” would allow for fiscally responsible policies to be introduced by the federal government of the Eurozone, such that full employment was a prime objective.

What might be some of the insights that would be required in this context.

First, the so-called federal government would have to recognise that budget deficits are endogenous outcomes, largely outside its discretion as the currency-issuing government, which reflect the state of non-government spending (and saving).

Endogenous just means – determined within the system rather than being imposed from without. In this context, it means that the sovereign government can design its discretionary fiscal policy (spending and tax initiatives) to achieve a certain level of spending in the economy – mixed between public and private – but it doesn’t know what the non-government sector will do until it has done it.

As a result, the budget outcome will reflect both the discretionary government interventions and the spending decisions of the non-government sector, which will be partially affected by the former, but also independent of the former. So the budget outcome is not a sensible aggregate to target within an “Integrated budgetary framework”.

Such a framework should start from the understanding that mass unemployment in a federation always means that overall federal budget deficits are too small relative to non-government spending – that is, public spending is too low relative to the tax collected across the “federal space”, which is, in part, dependent on the overall level of economic activity.

While regional disparities occur across that space, the notion of the regions becomes usurped by the greater understanding that the federal level is where the solutions lie – even if they manifest at the regional level.

Regionally-specific dynamics are not unimportant, but the overwhelming evidence from the research literature points to the conclusion that regional outcomes are strongly dependent on national (currency region) economic activity. The latter is then distributed across regional space via the composition of industry and patterns of migration.

Further, any “Integrated budgetary framework” would acknowledge that the role of any effective federal government within a federation (without or without state governments) is to ensure there is adequate aggregate spending at each regional level relative to the real capacity of that level to produce. This might involve reducing public spending where full employment was already being realised and increasing it in areas where obvious output gaps exist.

The existence of state governments is in fact irrelevant in this regard. Federations tend to have elaborate power-sharing arrangements set out in their constitutions but the broad currency-issuing powers (and commensurate fiscal and monetary policy capacities) have to lie at the federal level for the structure to be economically effective.

The capacity to redistribute aggregate demand as well as increase or reduce it overall is one of the reasons why fiscal policy is the preferred policy tool to manage overall spending in a federal space.

Monetary policy – largely working via interest rate management – is an inferior policy tool in this regard because it is difficult to target regions and specific demographic cohorts via interest rate changes, Further, its impacts are lagged (working indirectly via changes to behaviour) and uncertain (impacts are net effects of creditors and debtors, which are in themselves difficult to estimate).

Citizenship is an important unit for policy makers in a true federation. Everyone is equal under the law (in theory). A citizen living in say Ceuta (Spain, unemployment rate 38.5 per cent in 2012 now worse) or Dytiki Makedonia (Greece, unemployment rate 29.9 in 2012 now worse) is no more or less important from the perspective of enjoying equal access to federal funds than a person in say Salzburg (Austria, unemployment rate 2.5 per cent in 2012) or a citizen living in Tübingen (Germany, unemployment rate 2.7 per cent in 2012) – (Source).

Federations are meant to look after the citizens of the federation irrespective of where they live and what sub-federal governmental jurisdiction the citizens might find themselves in.

At the state jurisdiction level, in a true federation, there would be no question that citizens in one state (for example, Germany) were working to pay for the bailout of another state (say, Spain) in this sophisticated federal structure. Australians consider themselves to be part of a nation, even though there are obvious state and territory loyalties.

There is a “feigned” parochialism across the states and territories in Australia but if there was a particular region in some state/territory that was in deep trouble, the federal government would not first of all determine the rights of those citizens to support based on what the sub-federal governmental jurisdiction was doing.

If a region in Australia is in trouble (for example, when there are massive flood or bushfires, or more pertinent, when a major industry goes broke or leaves) there is no debate about the fact that the Federal government has to spend to restore infrastructure and economic prosperity to make sure citizens in the troubled areas are permanently disadvantaged.

The second option for a European revival is of-course not going to happen. It is clear that the Germans, for example, would be unwilling to become part of a true fiscal federation where Germany becomes a “state” that is subjugated to the welfare needs of the union? It is clear that health care, education, welfare entitlements, public housing etc would not be provided on equal terms to regions across the federation.

The cultural approach necessary to make a federation work is totally absent in Europe at present, which means the common monetary union was always destined to fail.

In lieu of this sort of effective federal design, what we get in place via Mr Rompuy’s proposal for a “Genuine Economic and Monetary Union” is a fake federal framework.

Inasmuch as the centre gains power the manifestations of that power are all anti-growth and anti-citizenship.

On Page 8 of the “Integrated budgetary framework” proposal we read:

Significant improvements to the rules-based framework for fiscal policies in the EMU have been enacted (‘Six-Pack’) or agreed (Treaty on Stability, Coordination and Governance) in the last couple of years, with greater focus on prevention of budgetary imbalances, more importance given to debt developments, better enforcement mechanisms and national ownership of EU rules. The other elements related to strengthening fiscal governance in the euro area (‘Two-Pack’), which are still in the legislative process, should be finalised urgently and be implemented thoroughly. This new governance framework will provide for ex ante coordination of annual budgets of euro area Member States and enhance the surveillance of those experiencing financial difficulties.

So – fiscal rules – tougher rules – tougher surveillance – tougher penalties for breaches of rules – tough, harsh – unworkable.

This is not a model for a functional federation. It will produce prolonged recessions and when growth might finally returned, albeit from a much lower base, the cycle of impoverishment will start again the very next time there is a significant downturn in world demand.

Recurrent and drawn out recessions, interspersed with periods of manic speculative growth in housing markets etc is not a framework that any nation should sign up to.

I considered the proposed “Six-Pack” solution in this blog – The left – entranced by the fiscal austerity mantra sold to them by the conservatives.

When the “Six-Pack” – the so-called “reinforced Stability and Growth Pact (SGP)” – was agreed upon on December 13, 2011, the announcement further de-stabilised the EU economy

The Six-Pack recognised that “23 out of the 27 Member States are in the so-called “excessive deficit procedure” (EDP), a mechanism established in the EU Treaties obliging countries to keep their budget deficits below 3% of GDP and government debt below (or sufficiently declining towards) 60% of GDP”.

These 23 have to undergo formal reviews and “must comply with the recommendations and deadlines decided by the EU Council to correct their excessive deficit”.

Van Rompuy’s Final Report added to the Interim Report by outlining, in more detail, the “Options for the shock absorption function of the euro area fiscal capacity”.

The narrative is stunning. We read that (Page 11):

An EMU fiscal capacity with a limited asymmetric shock absorption function could take the form of an insurance-type system between euro area countries. Contributions from, and disbursements to, national budgets would fluctuate according to each country’s position over the economic cycle.

Which then leads to this conclusion:

… it will be important to ensure that, irrespective of the approach that is followed, establishing this function does not affect the overall level of public expenditure and tax pressure in the euro area.

Which means that they are not envisaging that the federal “fiscal capacity” will be remotely like that needed to maintain effective economic stability in times of asymmetric demand shocks.

First, they only want a “limited asymmetric shock absorption function”, which means that some bureaucrat will apply a rule that says things have become bad enough to warrant some assistance.

Second, but the assistance will come via an insurance payout concept rather than through deficit spending of sufficient magnitude to offset the asymmetric demand shock.

That is a recipe for prolonged recession.

Fiscal discipline is not about meeting some arbitrary rules. Fiscal discipline is ensuring there is enough aggregate demand, distributed across the federal space, that is consistent with full employment. Nothing more and nothing less. If the budget deficit that is required to satisfy this requirement is 10 per cent of GDP or 1 per cent then so be it.

It might be that a budget surplus is required. Then so be it. The actual budget outcome should never be the objective. The budget is a vehicle to a greater economic goal not an end in itself.

Once we get lost in rules that the currency-issuing entity can not really meet with any surety, much less whether these rules are relevant to the current situation that the policy makers confront, then fiscal responsibility is being abandoned in favour of a blind ideology.

That is where the European leadership is at present. Lost in its blind acceptance of an ideology that has already delivered manifest failure and can never be the basis of a policy-making framework that delivers sustained prosperity to its citizens.

The inclusion of the EU regional funding schemes in this manic budgetary framework is further evidence that the political leaders do not want to empower nations (or any federal capacity representing all nations) with the capacities to sustain growth and redistribute it equitably to regions and the citizens that live within the regions.

The reality is that the cohesion and structural adjustment funding schemes provided some semblance of redistributive function in the European economy.

By tying these schemes into the macroeconomic rules applying to the member states, that redistributive function will be largely nullified.


The inclusion of the EU regional funding schemes in this manic budgetary framework is further evidence that the political leaders do not want to empower nations (or any federal capacity representing all nations) with the capacities to sustain growth and redistribute it equitably to regions and the citizens that live within the regions.

The reality is that the cohesion and structural adjustment funding schemes provided some semblance of redistributive function in the European economy.

By tying these schemes into the macroeconomic rules applying to the member states, that redistributive function will be largely nullified.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.

This Post Has 3 Comments

  1. There is a minor typo (omission of a word) in “to make sure citizens in the troubled areas are permanently disadvantaged.” Obviously you mean “are not”.

    I continue to be astonished that such absurd policies are being pursued in the EU (and elsewhere). I have noticed the following in blog discussions and arguments I have had with more orthodox economists online. They have been inculcated into a systematic orthodox dogma which defines their whole intellectual framework. They cannot see outside the framework of this dogma and are particularly intellectually closed on the issue of the extensive empirical evidence which refutes their dogma.

    Given what we now know about neurology, behavioural neurology and neuro-psychology, including the malleability of the human brain right into late adolescence and early adulthood, I suspect the following. The the brains of persons strongly inculcated with a dogma, any dogma, (rather than being properly educated in the philosophy, practices and techniques of empiricism) become literally hard-wired in the brain (with respect to their dogmas) by about the age of 25. The physical neuron pathways are laid down to think and perceive in that way and that way only. In addition, there is of course the emotional component where they are cathected (in a state of strong emotional investment and attachment) to their dogma.

    Quite literally, these people can no longer change and no longer see the world in any way except through the framework or prism of their dogma. So I am saying, Bill, that people over 25 who vehemently and dogmatically oppose the discoveries and insights of MMT are all lost causes. Educactors and activists have to concentrate on the 15 to 25 years cohort to educate a new generation in political economy. (I have somewhat arbitrarily set the lower limit of potential for real socially, economically and philosophically aware thinking to appear at about age 15.)

  2. Before Euro there were various fixes exchange rate arrangements. Given this historical fondness for fixed arrangements, how much financial policy space is left in such systems?

    Making euro work could be as simple as decising annually between european finance ministers, in these ECOFIN meetings, annual permitted deficits and their allotments and then mandating ECB to finance member country deficits.

    It is a sad fact that giving more power to EU undermines democracy. People are not interested in european politics, voter turnouts are lowest of any elections. Language barriers mean we don’t understand each other, lack of common mass media means lack of common agenda, lack of media interest in general means our europan leaders are unaccountable, et cetera. EU is a sad project driven by few power-hungry european federalists. More central government is not always good.

  3. I cannot envision Europe (EU) where the Federal – State political convention could exist?

    I completely agree with Professor Mitchell’s well reasoned conclusion on this matter.

    It also seems that raw ideology has displaced reality in the halls of European power.

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