A Brussels-run unemployment insurance scheme is no fiscal solution

The new European Commission president Jean-Claude Juncker is a federalist. He claims in his new role that his first priority is “to put policies that create growth and jobs at the centre of the policy agenda of the next Commission”. Juncker was also the Prime Minister of Luxembourg and the head of the so-called Eurogroup (2005-2013) which comprised of the Eurozone Finance Ministers, the European Commission’s Vice-President for Economic and Monetary Affairs and the President of the ECB. Juncker and the Eurogroup were vehemently pro-austerity. He also reaffirmed last week at a – Meeting in Brussels of the Alliance of Liberals and Democrats for Europe, that “we need to keep austerity going”. Remember he was Angela Merkel’s choice for the EC Presidency! But there is new talk of federalist type fiscal innovations in Europe under the new Commission. The problem is that they are just neo-liberal smokescreens and will do very little to change the underlying problems that have prolonged the crisis and will ensure there is a repeat down the track.

As an aside, Juncker was famous for his 2011 claim that “When it becomes serious, you have to lie” in reference to his claim that political leaders have to mislead the public to preserve the interests of the European Union. There was a report in the German Magazine, Spiegel Online claiming that he was organising a secret meeting to “discuss a Greek demand to quit the euro zone”.

The Wall Street Journal article on May 9, 2011 – Luxembourg Lies on Secret Meeting – says that Juncker denied the meeting was being held to many media outlets.

Here is a video of Juncker speaking at an – economic governance conference – outlining how he systematically lies in public about economic matters (to avoid speculation) and, one might add, scrutiny of the people.

Anyway, there was a report in the Italian Europa Quotidiano last week (July 11, 2014) – A new fiscal policy for the EU: the European unemployment insurance.

Apparently, Matteo Renzi is keen to advance a “new agenda for growth” and wants to enhace the automatic stabilisers in the European-level (federal) budget.

The article says that “Seven years into the financial crisis, the European economy is still struggling to recover” and “One of the priorities should be the introduction of a pan-European unemployment insurance scheme”.

The article also claims that:

The dichotomy “austerity vs spending” frames much of the political debate in Europe, fuelling discontent and diffidence across the continent. This dichotomy is, however, misleading.

Countries saddened by high public debt – like Italy – have no alternative to keeping balanced budgets, but European integration cannot move further without a critical appraisal of the current system of economic governance. Europe’s lack of adequate fiscal instruments precipitated the economic crisis into a negative spiral for many of the southern European countries. The lack of bold ex ante actions resulted in a deeper recession and heavier social and economic cost ex post. Europe needs new fiscal instruments to prevent cyclical crisis from degenerating into negative spirals.

The setting up of a common minimum employment insurance scheme for the Eurozone countries could act as an economic stabiliser during any future period of downturn.

First, note the construction – those who contrast austerity with spending are misleading the people. There is no competition. Austerity apparently doesn’t preclude spending. All is well. TINA.

Public austerity may be compatible with non-government spending growth under certain circumstances. But in the circumstances that rule in Europe at present, government austerity continues to undermine private confidence and undermines any private spending growth.

The claim by more moderate neo-liberals is that automatic stabilisers constitute spending anyway and militate against any need for discretionary fiscal interventions. So when the economic activity declines, tax revenue drops and welfare payments automatically rise which pushes the fiscal deficit up (usually – under some circumstances it might just reduce the fiscal surplus) and that ‘spending’ boosts the economy.

It is closer to the truth to say that the automatic stabilisers just attenuate how fast and how far economy can fall during a major contraction in private spending. There is no reasonable argument that can be made to say that the automatic stabiliser response will be sufficient to offset a recession or should constitute the government fiscal response to a crisis.

Typically, a major contraction in non-government spending will require a substantial discretionary fiscal stimulus on top of any relief that the automatic stabilisers might bring to avoid large rises in unemployment and lost output and income.

Second, Italy has plenty of alternatives including jettisoning the ridiculous euro and the fiscal rules that just constrain its national prosperity.

The ECB could also give as much spending scope that is needed for any Eurozone nation to stimulate growth if it chose to. Its Securities Market Program (SMP) proved it can control government bond yields and keep them low. It can buy as much public debt as is issued if it wants and then immediately write it off if anyone is concerned about the debt levels being too high. The ECB is the currency issuer in the Eurozone and therefore can always purchase any assets that are for sale in that currency and can never run out of euros.

So the “have no alternative” mantra is just an ideological affirmation of neo-liberalism rather than a factual statement.

Third, it is very true that the “lack of adequate fiscal instruments” at the federal level in Europe is largely the reason the crisis has been so deep and lasted so long. Of-course, with the austerity mindset dominating the leadership, the crisis would have still be bad even with a sensible fiscal capacity at the federal level.

It is one thing to have the capacity to spend freely when it is needed and address asymmetric negative shocks across the regional space of the federation but another to actually use that capacity wisely. Britain is the exemplification of that at present!

Certainly a ‘bold’ response was required. But the creation of a European-level unemployment scheme is not bold at all.

And while it would act as an automatic stabiliser its impact on total spending would be inadequate given the scale of the fiscal response that is currently required.

I analysed various ‘federal’ solutions to the Eurozone in my current book project. I concluded that they are all what might be called ‘austerity’ proposals in that they offer palliative care solutions (‘band aids’) to stop the breach.

In that sense, they fail to address the cause of the breach itself – the lack of a fully functioning fiscal authority and the bias towards pro-cyclical fiscal policy as a result of the SGP rules.

Boosting the automatic stabilisers within the European tax and transfer system

The so-called ‘asymmetric shocks’ (spending contractions not evenly spread across the monetary union) are 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 and unemployment rises, and new capital is hard to attract, seeking 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 are 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 refer 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.

An article by Manuel Müller (July 5, 2013) – EU Unemployment Insurance: Getting the Eurozone back on track – noted that a major advantage of these automatic spending buffers “is that they come into action reliably due to rules established in advance and without the necessity for further political decisions”.

But the design of the EMU deliberately reduces the potency of these automatic stabilisers. As Müller notes, “the EU budget is too small and its transfer mechanisms (such as the structural and regional funds) are too rigid to enable a short term adjustment of different cyclical development”.

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 ‘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 German proposal is 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”.

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 on-going 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 reveal the conservative, neo-liberal nature of the proposal.

Müller said that the aim is to ensure that over “whole economic cycle, the fiscal net balance would … be almost evened out”. Why is that 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 similar proposal came in 2012 from the so-called ‘Tommaso Padoa-Schioppa Group’ – Completing the Euro
A road map towards fiscal union in Europe.

This group also proposed boosting the automatic ‘cyclical response’ capacity in Europe. But their reasoning is 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 in the first place, including several that are associated with the neo-liberal (so-called independent, non-partisan) ‘think tank” Bruegel, which has long advocated austerity and tight fiscal rules.

Now, as the system they lauded has failed, their approach is to patch it up with various ad hoc measures, all of which are ring-fenced by the austerity mentality.

They refused to “even consider the option to abandon the euro” (p.3) and are, instead, guided by the principle: “As much political and economic union as necessary, but as little as possible” (p.3).

They continue to maintain that the “principle of subsidiarity”, justifies this minimalist approach to fiscal union. This principle is a long-standing concept in political theory (as far back to Aristotle), and entered the European dialogue in 1989 as part of a new ‘Eurolanguage’ as the political leaders were intent on pushing through the economic and monetary union.

The Oxford Dictionary defines subsidiarity as “(in politics) the principle that a central authority should have a subsidiary function, performing only those tasks which cannot be performed at a more local level”. The concept was popularised by the Roman Catholic Church in the 1931 encyclical, Quadragesimo Anno, which pronounced that “It is a fundamental principle of social philosophy, fixed and unchangeable, that one should not withdraw from individuals and commit to the community what they can accomplish by their own enterprise and/or industry” (Pope Pius XI, 1931).

The idea is thus generally taken to mean that in a federal structure, issues should be managed at the most decentralised level that is effective. The principle has been referred to as a ‘golden rule’ for allocating functions between various tiers of European governments.

The concept formally became part of European Law when it was included in the wording of the Treaty of the European Union (aka as the Maastricht Treaty) adopted in December 1991. The wording in the Preamble noted that the signatories resolved to create “an ever closer union among the peoples of Europe, in decisions are taken as closely as possible to the citizen in accordance with the principle of subsidiarity”.

The term appears again in Article 5 and Article 12. Article 5 notes that “Under the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.”

This principle was used to justify not creating a federal fiscal capacity. Jacques Delors claimed that it should be used to advance the ‘common good’, which means the debate turns on the meaning of common good.

But there is little doubt if one examines the daily public statements of the European politicians that communitarian perspectives are inherent in their visions. In terms of the common good, we regularly hear concerns expressed about the European unemployment problem and the need for more growth in Europe. While these concepts are not without contest, a broad consensus would suggest that the common good is not being advanced if there are 60 per cent of a nation’s youth unemployed or over 10 per cent of Europe’s willing workers without jobs.

The important point in relation to the allocation of competencies across the levels of government is that there are some functions that have to be performed at the aggregate level in a federal system if the overall system and its components are to function effectively.

The fiscal policy capacity to offset major asymmetric private spending fluctuations is one such function and is intrinsic to the ability of the overall system to achieve common good, however, broadly that is defined.

When the Delors Committee was invoking subsidiarity they were so infested with neo-liberal economic thinking that they failed to understand the imperative for a federal fiscal or treasury competency.

Lower entities in a federal system cannot achieve desirable ends if they are denied access to support from the currency-issuing level of the system and further constrained in the size of deficits they can run.

The ‘Tommaso Padoa-Schioppa Group’ authors claim they advocate 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 SGP and the austerity packages forced onto many of the euro-zone 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 in some circumstances especially when the Troika is imposing the terms, but then in other cases, it is 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.

The ‘Tommaso Padoa-Schioppa Group’ authors 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 SMP).

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.

Their preferred approach to “cyclical divergences” (p.26) is to “enhance the real exchange rate channel” (p.28), 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 worker harder for less pay. The virtue of stable social communities built on family structures and community spirit is ignored. The economy rules and workers are considered meagre pawns in the decisions by management on where to locate industry.

One would think a primary aim for any durable solution to the European crisis is to keep regions viable, especially as the authors recognise that “Linguistic and cultural barriers are certainly important” (p.8). Labour mobility is also unlikely to be of sufficient magnitude to provide any semblance of equalisation in unemployment rates within the euro-zone.

A recent OECD study found that between 2009 and 2011 there was no discernible movement among citizens who were already resident within the euro-zone. The major “labour market adjustment in Europe during the crisis was driven primarily by citizens from outside the euro-zone, such as the recent EU accession countries or non-EU-27/EFTA countries” (see Migration as an adjustment mechanism in the crisis? A comparison of Europe and the United States’, p.23).

While the study found some net in-migration to Germany from Italy, Portugal and Spain between the middle of 2012 to the middle of 2013, Greek migration to Germany declined.

To supplement their ‘structural’ emphasis, which the ‘Tommaso Padoa-Schioppa Group’ authors admit would be “unlikely to solve the inherent difficulties” (p.30), they propose ‘a cyclical adjustment insurance fund’.

This fund would be managed by euro-zone finance ministers and build its kitty from contributions from nations experiencing above the euro-zone growth rates and pay out to nations in crisis, to “reduce pressure on public finances” (p.31). 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 stress the “the system cannot become a hidden instrument for permanent transfers” (p.31) and nations might only be permitted to “take out what they once paid in” (p.32).

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 specific Bruegel reserach paper in 2012 – Options for a Euro-Area Fiscal Capacity’ – proposed a similar type of transfer system such that in times of recession, nations would enjoy increased ‘federal’ income and be forced to pay it back in better times.

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 (p.5).

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” (p.5).

But, an examination of the historical record suggests that nations finding themselves in that position are rare both in incidence and duration. The scheme also depends on how one measures the output gap.

It is clear that 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 will 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 would still be enduring persistently high unemployment and private spending gaps.

The best automatic stabiliser is the Job Guarantee

The best automatic stabiliser is one that provides jobs directly and in proportion to the rise in unemployment that would occur as private spending falls.

In this context, governments would make an unconditional offer of employment at a socially acceptable minimum wage to anyone who cannot find a job, thereby creating a buffer stock of jobs.

The jobs pool would fluctuate automatically according to how strong the rest of the economy was.

The buffer stock of jobs would expand (decline) as private sector employment declined (expanded). To avoid disturbing private sector wage structures and to ensure the JG is consistent with stable inflation, the JG wage rate should be set at the minimum wage level, defined to ensure the worker is never socially excluded.

Since the JG wage would be open to everyone, it would functionally become the national minimum wage. JG workers would enjoy stable incomes, and their increased spending would boost confidence throughout the economy and underpin a private-spending recovery.

The JG would thus become a powerful, additional ‘automatic stabiliser’.

The JG would fulfil an absorption function to minimise the employment and income losses currently associated with the flux of private sector spending.

When private sector employment declines, public sector employment and spending would automatically rise. The nation would remain fully employed, with only the mix between private and public sector employment fluctuating as it responds to the spending decisions of the private sector.

In this respect, the JG would maintain what is referred to as ‘loose’ full employment because the government would be offering jobs to workers who are not currently in demand by the market.

The increased government spending, therefore, would not compete with other resource users. The JG would thus recruit labour ‘off the bottom of the market’ in contradistinction to general government spending, which involves the government competing with other purchasers for resources including labour at market prices.

By not competing with the private market for resources, the JG would avoid the inflationary tendencies of traditional Keynesian pump-priming, which attempts to maintain full capacity utilisation by ‘hiring off the top’, that is, competing for resources at market prices and relying on so-called spending multipliers to generate extra jobs necessary to achieve full employment.

The latter approach fails to provide an integrated full employment-price anchor policy framework.

Further, under a JG, the government knows that the last person who seeks a job on any particular day defines how much government spending is required to ensure there are enough jobs available.

It is also true that because it would be impossible to run a JG matching all the skills to jobs the employment buffer stock comprises ‘loose’ full employment in the sense that there would some skills-based underemployment existing when the pool was large.

In better times, as the JG pool shrank, and was predominantly occupied by workers who would typically be the last employed by any private firm (if ever), the gap between ‘loose’ and ‘true’ full employment would approach zero.

If the business community or anyone else thinks the fiscal deficit associated with the JG at any time is ‘too high’ or that there are ‘too many’ workers in the JG pool then there is a simple remedy available to them.

The JG pool and government spending will fall if private spending rises (for example, invest more in productive capacity). In that sense, the size of the JG would always be determined by the private sector.

Conclusion

There are a plethora of schemes that propose a way out of the euro-zone crisis.

Some are more adventurous than others but most involve gymnastic manipulations of debt classifications, dual currencies, pension plans or unemployment insurance schemes to work around the obvious problem that most refuse to recognise.

Virtually all of the plans seek to work within the SGP straitjacket, appealing to political realities as the justification, without wanting to admit that the political realities are the part of the problem and until they change, little will be done to progress the situation.

If they were really serious about solving the crisis and could escape the neo-liberal Groupthink that stifles lateral thinking they would be advocating a relaxation of the fiscal rules, the expansion of fiscal deficits, the introduction of a broad-based Job Guarantee, and strong currency support for the above by the ECB. That would be the first step!

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.