Subsidiarity – a European Union smokescreen to justify failure

One of the various smokescreens that were erected by the European Commission and the bevy of economists that it either paid or were ideologically aligned to justify the design of the monetary union around the time of the Maastricht process was the concept of subsidiarity. In 1993, the Centre for Economic Policy Research (a European-based research confederation) published its Annual Report – Making Sense of Subsidiarity: How Much Centralization for Europe? – which attempted to justify (ex post) the decisions imported from the 1989 Delors Report into the Maastricht Treaty that eschewed the creation of a federal fiscal capacity. It was one of many reports at the time by pro-Maastricht economists that influenced the political process and pushed the European nations on their inevitable journey to the edge of the ‘plank’ – teetering on the edge of destruction and being saved only because the European Central Bank has violated the spirit of the restrictions that a misapplication of the subsidiarity principle had created. It is interesting to reflect on these earlier reports. We find that the important issues they ignored remain the central issues today and predicate against the monetary union ever being a success.

One of the authors of the 1993 Report, Jean-Pierre Danthine has recently reflected on the work some 25 years after its publication.

In his Op Ed (April 12, 2017) – Subsidiarity: The forgotten concept at the core of Europe’s existential crisis – he argues that “the disenchantment with Europe can arguably be traced to the failed application of the subsidiarity principle that was enshrined in the Maastricht Treaty.”

He recognises that:

Europe’s deep-seated institutional design problem is tied to the inevitable trade-off between efficiency-enhancing centralisation and democracy-enhancing sovereignty.

Let’s go back to the Delors Report 1989, which I argue in my book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – misapplied the concept of subsidiarity.

It is clear from the historical record that the Delors Committee mainly relied on the concept of subsidiarity to justify the absence of a European-level fiscal function in the plan it outlined for monetary union.

The term, subsidiarity, a long-standing concept in political theory (as far back to Aristotle), 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.

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.

To observers, it became immediately obvious that the Maastricht Treaty was somewhat inconsistent in relation to the use of the term subsidiarity.

Ken Endo wrote in his 2001 research paper – Subsidiarity and its Enemies: To What Extent Is Sovereignty Contested in the Mixed Commonwealth of Europe? – that there was “built-in confusion within the Treaty” in the way it constructs the term.

In the Preamble, decentralisation is emphasised (“closely as possible to the citizen”), whereas in Article 5, Brussels “simply might continue its business of integration, by finding a few justifications for such actions”.

At the time, the term ‘subsidiarity’ was thus ambiguous, having both a negative and a positive connotation, depending on the perspective adopted.

The former emphasises the limits of competence of the central body and the right of lower bodies to look after themselves, if they can; while the latter focuses on the rights and necessity of responsible central intervention if the lower entity cannot effectively function.

This imprecision was also recognised in the 1993 CEPR Report, which noted (p.13) that:

… the existing mechanisms for allocating power between the Community and its member states are surprisingly unclear and informal, and they do not appear to rest upon a compelling economic or legal logic. Second, the notion of subsidiarity as expressed in the Treaty will not do much to clarify matters: it too is vague and capable of multiple interpretations, and it should be regarded more as the expression of a broad political principle than a clear guide to the allocation of power.

It also reminded readers that the European Community was rushing headlong into increased integration before Maastricht by introducing the 1986 Single European Act, despite “the lack of coherence in the existing mechanisms of allocation”.

In my 2015 book, I argue that this ‘rush’ and the final Maastricht disaster is best understood in terms of the increasingly dominant influence that neo-liberal economics (Monetarism and its evolved versions) had on the policy makers.

For them, “the lack of coherence in the existing mechanisms of allocation” was not an issue because they had a blind faith in the power of the self-regulating market. All they had to do was set up processes to unfetter the ‘market’ – which is what the Single European Act was motivated to do.

In considering what might be “exclusive competencies” (by jurisdictional level), the 1993 Report noted that (p.21):

It seems fair to conclude that the principle of subsidiarity remains, as it stands, very general and open to many interpretations. The authors of the Maastricht Treaty did not clearly establish the principle as an instrument for the allocation as well as the exercise of competences, and they chose not to give a list of particular areas where Community action was likely to be necessary and efficient. They did not put forward any guidelines for judging the effectiveness and necessity of a particular action. The principle of subsidiarity at the level of the Community therefore remains a general political principle rather than a source of explicit guidance. The political philosophy that it expresses (namely that centralization should be undertaken only when a good case can be made for it) is
unexceptionable. But without further clarification, it is hard to implement in practice.

Yet, as is obvious, they did implement a version of subsidiarity in practice, driven by their Monetarist zeal.

Jacques Delors, who was obviously pushing the Maastricht Treaty with all his might, found no ambiguity. He was after all a ‘Monetarist general’ despite his ‘socialist’ beginnings.

He wrote in 1991 that subsidiarity is about:

… the development of each individual. But, as we all know, steps in this direction presuppose that there are men and women capable of taking on the responsibilities in order to achieve the common good.

[Reference: Delors. J. (1991) ‘The Principle of Subsidiarity: Contribution to the Debate’, in Subsidiarity: The Challenge of Change, Proceedings of the Jacques Delors Colloquium, Maastricht, European Institute of Public Administration, 7-18.]

Further on, he wrote:

Subsidiarity is not simply a limit to intervention by a higher authority vis-à-vis a person or a community in a position to act itself, it is also an obligation for this authority to act vis-à-vis this person or this group to see that it is given the means to achieve its ends.

The emphasis on the common good and its link to subsidiarity was also echoed in the Preamble to the European Parliament’s 1994 – Resolution on the Constitution of the European Union – where it is stated that there is an awareness on:

… behalf of the peoples of Europe … [that there is a] … need for decisions concerning them are taken at a level as close as possible to the citizens themselves, with powers delegated to higher levels only for reasons of the common good.

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.

This also resonates with the statement from Delors that “all relevant economic and monetary unions” share a “sense of national solidarity”.

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.

British economist John Maynard Keynes used the concept of compositional fallacy to expose the flaws in conservative mainstream economics during the Great Depression.

Keynes demonstrated that the mainstream free market economics approach was prone to these fallacies, which are logical errors that arise when something is claimed to be true in general by dint of some specific part of the whole being true.

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 1993 Report (as we are reminded by Jean-Pierre Danthine) concluded that (p.2):

Subsidiarity presupposes that decentralized allocations of power are to be preferred unless there are good reasons for centralization.

I agree with that principle.

But then in relation to determining what functions should be performed at the aggregate level, Chapter 6 of the 1993 Report discussed “Fiscal policy and Macroeconomic Stabilization”.

It concluded that:

Arguments for centralizing EC fiscal policy for macroeconomic stabilization are unconvincing, not because stabilization is unnecessary but because the additional gains of its centralized pursuit are outweighed by the adverse incentives that centralization would entail. Fiscal stabilization at national level remains appropriate, but it is unnecessarily impeded by the Maastricht ceilings on budget deficits, which should therefore be interpreted with flexibility over the business cycle.

There are two points here:

1. They claimed that subsidiarity ruled that Member States should remain responsible for fiscal policy – with the implication that this was a better democratic match – policies could be judged as desirable via elections. They concluded this because they considered a centralised fiscal responsibility would create “adverse incentives”.

2. That the Stability and Growth Pact rules (not yet formalised when the Report was published) would undermine the effectiveness of the decentralised fiscal responsibilities.

The 1993 Report claimed that if there was a federal fiscal capacity, it would amount to “an insurance contract for each member state” (p.118), which would insulate each nation from adverse shocks.

The alternative would be for the Member State “to borrow on international markets the equivalent of its shortfall, and to pay back later when incomes are unexpectedly high.”

They concluded that an insurance option would “elicit perverse national responses” – “moral hazard” (nations would overspend, allow excessive wage settlements etc) such that the “macroeconomic shocks may be self-inflicted wounds” and – “time inconsistency” where long-lasting shocks at the Member State level could encourage the “insurance system collapse”.

When one thinks about these arguments in the context of the situation it is easy to reject them.

First, the borrowing on international markets options is viable if the nation has no credit risk. So, for example, the Australian government never has any trouble borrowing what it likes at acceptable yields (even if the act of borrowing in unnecessary) because it issues its own currency and bond markets know that there is no credit risk.

The Member States of the Eurozone surrendered their currency sovereignty and agreed to use what is effectively a foreign currency. Then the terms at which it enters international debt markets are entirely different and skew the analysis away from this being a viable option to sustain a nation struggling with a deep recession.

Second, the idea that the ‘insurer’ (the federal fiscal capacity) would “collapse” under the weight of funding commitments to Member States dealing with a persistent and deep recession is inapplicable to a currency-issuing entity.

The correct construction would have been to create a true federation where the democratically controlled fiscal capacity would have legislative control of the central bank and hence currency issuance.

Then asymmetric transfers to decentralised regions within the Federation would be unproblematic in a financial sense.

Indeed, the fiscal policy capacity to offset major asymmetric private spending fluctuations is clearly a function that has to be at the level where the currency is issued.

That alignment 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 idea that fiscal policy should be the sole domain of currency users violates the fundamental principles of a federation.

Once the Treaty was signed in March 1992, the European Commission and a phalanx of sympathetic economists set about ‘backfilling’ to justify the arbitrary fiscal rules.

They produced a plethora of research papers and reports, which they claimed provided intellectual and evidential authority to justify the decisions that had been made and to ‘prove’ the Treaty parameters were sound. It was a ridiculous game to observe.

In 1993, another Report came out, this time in European Commission’s own in-house economics journal, European Economy.

The Report – Stable Money-Sound Finances: Community public finance in the perspective of EMU – claimed to be a “Report of an independent group of economists”.

The concept of independence in this case was moot given that the economists they consulted were already caught in the Monetarist web and the European Commission knew that.

A “core issue” the Report dealt with was “whether European union will … need a big central budget, to make EMU successful and sustainable”.

The Report indicated it was following in the footsteps of the 1977 MacDougall Report, which was the product of a similar exercise, whereby the European Commission assembled a group of economists to study how federal systems function in a fiscal context.

The comparison doesn’t stand scrutiny.

The MacDougall Committee assembled for the first time in April 1975 and met on fourteen occasions, finally reporting in April 1977. The 1993 Report was produced after only four meetings of the group of ‘experts’ over a much shorter time frame.

Both panels sought advice from economists in non-European federal systems. In the case of the 1977 committee, it called on the services of Professor Wallace Oates from Princeton University, who had published some seminal works on public finance, and Professor Russell Mathews, a world expert from the Australian National University. Both Oates and Mathews were Keynesian economists.

Oates’ first major piece, published in 1968 – The Theory of Public Finance in a Federal System – was considered the definitive statement on the topic. He argued that (p.44):

… the case for the central government to assume primary responsibility for the stabilization function appears to rest on a firm economic foundation … local government cannot use conventional stabilization tools to much effect and must instead rely mainly on beggar-thy-neighbour policies, policies which from a national standpoint are likely to produce far from the desired results. The central government, on the other hand, is free to adopt monetary policies and fiscal programs involving deficit finance where it is necessary to fulfil the compensatory function. Thus, the Stabilization Branch must do its job primarily at the central-government level

In other words, when a federal system is experiencing an economic downturn, perhaps due to a fall in private consumption or investment spending, which may affect the states within the federation unequally, the federal government must be able to use deficit spending to compensate for the loss of private spending.

Otherwise, output will fall, unemployment will rise and national income will be lost.

Russell Mathews was a long-time supporter of a strong federal stabilisation function. In his final co-authored book, he argued that Australia’s poor economic performance in the late 1970s and into the 1980s was due to the adoption by the Federal government of Monetarist ‘fight inflation first’ policies, their attacks on public expenditure, and their unqualified belief in the virtue of self-regulating free markets.

Contrast that with the non-European economists that the 1993 exercise engaged. First, Canadian economics professor Tom Courchene from the conservative Queens University, a centre of Monetarist thinking in the 1980s and 1990s, promoted the concept of ‘hourglass federalism’.

He claimed, “that very generous levels of federal-provincial welfare support and interprovincial equalization transfers have created in Canada a version of ‘transfer dependency'”. The transfers were also alleged to undermine the “natural economic adjustments”, such that unemployed workers would move to areas where jobs were available in times of recession, a major article of free market doctrine that denies that unemployment can become entrenched.

When mainstream economists talk about ‘natural’ forces they are not considering anything to do with nature or physics. Rather it is code for theoretical free market textbook outcomes that rarely appear in the real world. Courchene also claimed that the design of the EMU with its “more severe fiscal restraints” (p.6) relative to Canada would avoid the damage that federal spending causes in federal systems.

The other economist was Cliff Walsh, from the University of Adelaide in Australia and a well-known advocate of the alleged benefits of dismantling regulation and generating government surpluses.

He argued that the traditional literature on federalism (for example the work of Wallace Oates) was of “limited direct application” to the European situation because of the “unique constitutional and political arrangements in the Community”.

He claimed that, unlike “mature federations” where a “substantial degree of homogeneity in preferences for core public sector services” exists (p.49) and supports a strong central fiscal function (a basic finding from the traditional literature), the situation in Europe is different.

He surmised that “the differences in preferences may be sufficiently large in the Community to suggest that to transfer to the Community level many of the functions naturally allocated to central governments … elsewhere … would impose excessive uniformity costs”.

He concluded that coordinated fiscal rules across decentralised fiscal units “may provide the most effective framework for macroeconomic management”.

While the 1993 Report was used to justify the Maastricht design for the EMU, the 1977 MacDougall Report provided sufficient analysis and evidence for one to reasonably conclude that this design would fail.

The – MacDougall Report – involved (p.11):

… a detailed and quantitative study of public finance in five existing federations (Federal Republic of Germany, U.S.A., Canada, Australia, Switzerland) and three unitary states of (France, Italy and the U.K.) … and in particular the financial relationships between different levels of government and the economic effects of public finance on geographical regions within the countries

In other words, the panel sought to work out how a common currency system might operate where there are decentralised government structures with fiscal capacities and a currency-issuing central bank. What sort of fiscal function should be allocated to the federal ‘government’?

A close reading of the MacDougall Report will leave one wondering why the Eurozone was ever created. The major issues they highlighted were clearly still relevant in the 1990s as the European political elites rammed through their ill thought out plan for a single currency.

They are still relevant today.

The MacDougall Report concluded that (p.11):

It is most unlikely that the Community will be anything like so fully integrated in the field of public finance for many years to come as the existing economic unions we have studied.

The MacDougall panel found that per capita income inequality in the European states (9 at the time) was substantial and that the “redistributive power between member states of the Community’s finances, by comparison, is … very small indeed (1%); partly because the Community budget is relatively so small” (p.12).

This was in comparison with what happened in functioning federations such as Canada, the US and Australia.

Significantly, for our purposes, the MacDougall Report concluded that (p.12):

As well as redistributing income regionally on a continuing basis, public finance in existing economic unions plays a major role in cushioning short-term and cyclical fluctuations. For example, one-half to two-thirds of a short-term loss of primary income in a region due to a fall in its external sales may be automatically offset through lower payments of taxes and insurance contributions to the centre, and higher receipts of unemployment and other benefits.

In other words, an effective federation required a strong fiscal presence at the federal level to smooth out economic fluctuations at the sub-federal level.

In that regard, the MacDougall Report concluded that (p.12):

… there is no such mechanism in operation on any significant scale as between member countries, and that is an important reason why in present circumstances monetary union is impracticable.

The factors that the MacDougall panel of ‘experts’ considered in 1977 would have rendered monetary union “impracticable” were subsequently built-in to the Maastricht Treaty.

The tone of the 1993 Commission Report was very different indeed and reflected the dominance of Monetarist thinking by that time. It concluded, “Community-wide stabilization should be achieved by the single monetary policy and the coordination of national budget policies”.

Under the bold heading “Beware of centralization” (p.4) the Report claims that centralisation undermines the delivery of public services “tailored more to the preferences of the population” and that “democratic control is more effective” at the local level – a play on the subsidiarity concept.

These propositions were advanced by the new ‘public choice theory’, which became one of the neo-liberal ‘attack dogs’ used to undermine the legitimacy of government service provision and deficit spending.

It is ironic to consider these claims to democratic superiority of a decentralised EMU, which were used to justify the design of the EMU in the first place, in the context of the austerity regimes imposed by the Troika in recent times on elected Member State governments.

The 1993 Report came up with the conclusion the Commission was looking for under the bold heading “A small budget will do” (p.6). The panel concluded that:

The central message of the report is that a small ‘EMU budget’ of about 2% of Community GDP is capable of sustaining European economic and monetary union … This is clearly contrary to much of the conventional economic wisdom, reflected in the MacDougall report as well as in the literature on economic and monetary union.

The other 1993 Report mentioned at the outset came to a similar conclusion.

But how did they justify a denial of the evidence base to date? They simply asserted that the “principle of subsidiarity is applied rigorously” (p.6), even though we have already learned that a correct understanding and application of that principle would support the MacDougall ‘wisdom’.

Further, they merely asserted that there would be “No explicit role for the Community budget in Community-wide macroeconomic stabilization” (p.6).

Why not? Simply, because consistent with the Monetarist religious doctrine, only monetary policy mattered and the creation of the European Central Bank would be more than enough to prevent recession.

In addition, they asserted that the coordination of fiscal policies across the Member States would prevent individual governments from undermining the independent monetary policy.

The 1993 Commission Report also concluded that the “shock-absorption mechanism” built into each Member States fiscal policy (automatic fluctuations in taxation and spending as economic activity varied) would be sufficient “to provide a cushion against adverse developments” (p.7).

To give you an idea of how unwilling this panel was to address reality, they concluded (p.7):

For a shock absorption scheme based on changes in unemployment rates, the group estimates that the average annual expenditure might be of the order of 0.2% of EC GDP.

The actual fluctuations in 2008 were many times larger than this and would lead to the conclusion that the economists’ estimates were comical had they not been part of a regime that has deliberately caused millions of workers to lose their jobs.

The 1993 CEPR Report did see through all of this, a point reiterated by Jean-Pierre Danthine’s reflection (cited above).

It clearly understood that even if the application of subsidiarity could justify leaving fiscal policy at the Member State level the act of imposing the fiscal rules that became the Stability and Growth Pact (SGP) rendered “the Maastricht Treaty … internally inconsistent”.

On the one hand, the subsidiarity claim empowered the Member States against Brussels. But, on the other hand, the SGP took that power away – at least in terms of effective use of the fiscal tools left at the Member State level.

The problem that the 1993 CEPR Report failed to really grapple with in rejecting the creation of a federal fiscal capacity is that they offered a very narrow conceptualisation of what that capacity might look like.

The juxtaposition they were considering was:

1. “Embarking on fiscal centralization is likely to unleash Leviathan pressures and weaken accountability” (the Leviathan being the unaccountable and undemocratic Brussels” central); or

2. Fiscal decentralisation but with “Maastricht limits on fiscal policy” to control “the inability of many national governments to resist short-run temptations to bloat budgets and print money”.

However, both the earlier Werner Report (1970) and the MacDougall Report (1977) had emphasised that the creation of the necessary federal fiscal function had to be aligned with the creation of European-level democratic institutions that had charge and responsibility for the fiscal policy setting.

This option was not considered in the 1993 CEPR Report, which helps to explain why they came to the conclusions they did.

The reality is that a functioning federation would never allow a Brussels entity to takes charge of fiscal policy and divorce that policy responsibility from the voters.

If the MacDougall Report model was possible, then all the claims about Member State moral hazard and the rest of the arguments made against centralised fiscal policy would be invalid. The federal fiscal capacity would be accountable to the democratic institutions.

But the failure of the post-Maastricht analysis to embrace that reality reflected the fact that the Member States were never going to agree to the creation of a true federation where the democratic institution (say, the European Parliament) became the centre of economic policy making.

The Franco-German rivalry plus the infestation of Monetarism would never have permitted that reality – a reality that remains today and is the main reason the Eurozone will never deliver sustained prosperity and should be dismantled.

The 1993 CEPR Report also understood that Europe was not culturally ready to federate. We read (p.95):

But centralization may run into another difficulty, namely that people in the UK may be unwilling to contribute to support the poor in Greece, or people in Germany to support people in Portugal. When such problems arise, there will be a limit to the extent to which any form of coordination at EC level can mitigate the erosion, albeit partial, of the welfare state that will be inevitable under decentralization.

Which sums up why the Eurozone is a flawed construct and should be dismantled.

Conclusion

It is interesting to reflect on the offerings that were around at the time the Maastricht process was in full swing.

There was certainly enough discussion available to warn the Member States not to ‘walk the plank’ into the monetary union.

The literature justifying the creation of the union was ideologically skewed and resisted a serious application of the evidence or logic.

They cried subsidiarity but then misused the concept and created a disaster for the working people of Europe.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.