France has received its orders from the masters

The 19 Member States of the Eurozone cover some 4,422,773 km² of territory, much of that is densely populated. The geographic area of Australia covers 7,682,300 km² and is mostly sparsely populated. The reason density matters is because it impacts on the resources that need to be expended to provide infrastructure across the geographic space. In the past month, the French people have elected a new President and a dramatically different National Assembly. In his election campaign, Emmanuel Macron spoke of being part of a major reform process for the dysfunctional Eurozone. To create some federal fiscal capacity including the idea of debt-mutualisation (issuing Euro-level debt) to match spending on public infrastructure etc, which could help to revitalise the stagnation that besets many regions across the currency union. In 2012, François Hollande was also elected on a reform ticket. The same day he was elected he visited Angela Merkel in Germany. The reform process ended before it started. He went away with no uncertainty about what the Germans would tolerate as masters of the union. Well within a short-time of being elected, Emmanuel Macron has also received his instructions from the Germans, this time in the guise of remarks made by Bundesbank boss Jens Weidmann. The orders are clear. Germany will never tolerate the creation of anything like a functioning federal fiscal capacity. End of story. Macron now knows the limits of his volition. What are the limits of being confined to a straitjacket?

Here are two maps. I reduced the scale of the Australian map to fit the width but when expressed in the same scale the left-hand map is more than contained in the right-hand map area. So the Eurozone and then a heap more.

None of this is new and I am sure visitors from Europe to Australia come to realise just how large the land mass of the southern nation actually is.

When I first flew to Europe as a younger man I was quite shocked when, after more than 7 hours of flying (from Melbourne – down in the South East), the captain of the plane announced we were just leaving the North East coast of Australia. That brought things into perspective for me.

The point of this comparison is to reflect on nationhood, and, then, in turn, to think about fiscal spaces.

The ABC news report (July 26, 2017) – SA bank levy opens door for tax power shift from Canberra to the states – tells the story of recent political stoushes between a state government and the federal government in Australia.

The detail is interesting to us but may not be to outsiders.

Basically, there is a complex revenue-sharing arrangement between the states, which under our Constitution have the majority of the spending responsibilities, and the federal government, which has the greater revenue-raising capacity.

Various historical arrangements (for example, the states ceding their income tax powers under the Constitution to the feds during World War 2) have intensified that inequality in spending and revenue capacities.

Remember, the states do not issue the Australian currency and so have to either raise tax revenue or borrow to fund their spending programs.

The Federal government clearly does not have to do either as a funding operation.

Early in this century, the federal and state governments agreed to simplify the tax arrangements and a new Goods and Services Tax (levied at the federal level but distributed fully to the states) was introduced in return for an agreement by the states to abandon a whole range of taxes, which the feds considered were more damaging than others.

Again the detail is not the point here.

The GST and income tax revenue sharing arrangements are complex and the two largest states (NSW and Victoria) traditionally cross subsidise the smaller states such as WA, SA, Tasmania and the two Territories.

The principle that underwrites the cross-subsidies is that:

In effect, … smaller, less well-off states should have the resources to offer the same level of services as richer states based on the principle no Australian should be worse off than any other simply because of where they live.

Rich states are expected to subsidise their neighbours.

A state might be “rich” due to population density (deeper tax base), distribution of industry (often reflecting distribution of resources), and other reasons (favourable geography, proximity to global transport routes etc).

The principle that was formed and agreed at the inception of the Australian federation – the creation of a nation from among the previous separate colonial states (colonies) was as above – that, irrespective of where a person resides, they should have the same level of services available to them.

You can see then why the scale comparison in km² becomes an issue.

It is much easier to provide public infrastructure to a densely-populated region that it is to provide the same infrastructure across a nation such as Australia.

But our nation is built on that principle.

Sure enough, the states fight with the federal government about the revenue-sharing arrangements and other matters. This is typically exacerbated by the fact that the federal government is often of a different political persuasion than the state governments (either completely or partially).

So a lot of the arguments are just political point-scoring and always lapse when the well-being of the nation as a whole is in question.

The ABC report talks about the latest issue that has arisen. One state has decided to take on the big 4 banks and place a levy on them to raise extra revenue to help it fast-track its renewable energy transition. The Federal government had also just announced a bank levy to tax some of the massive profits that the banks make as protected ‘public-private’ institutions.

They are ‘public’ in the sense the government will never let them go broke. They are ‘private’ because all the upside (massive profits) go into the coffers of the shareholders. Privatise gains, socialise losses!

But the decision by one state to reintroduce a franchise-type of tax has challenged the GST revenue-sharing model.

The point of all that though is not to go into the details but to emphasise the principles upon which the ‘member states’ of the Australian federation operate.

These are:

1. The rich states help fund the poor states – always.

2. It doesn’t matter where you live (rich or poor state) the quality and scope of the services should be equal.

3. The federal government stands ready to deal with asymmetric shocks that impact negatively on one or more states. As an example, when a drought or flood arises (as they do often in this country), the Federal government doesn’t blink when it allocates billions of dollars of spending to the affected areas. The unaffected areas know this is the role of the federal government.

These things are embedded deeply in our sense of nationhood.

When the Werner Report was released in its final form on October 13, 1970 and outlined a comprehensive timetable for the creation of a full economic and monetary union by the end of the decade for Europe, several features were prominent.

The conceptualisation of the newly created economic and monetary union as a new ‘nation’ where the member-countries effectively become states of a federation was clearly thought elemental.

That conceptualisation did not emerge around two decades later in the Treaty of Maastricht.

The Report considered short-term economic policy would be “decided in its broad outlines at a Community level” and that the “principal decisions of monetary policy should be centralized” (p.10).

The Report was in keeping with the times where fiscal policy, that is, government spending and taxation decisions, were given a higher priority than monetary policy, which involved interest rate setting.

The Report was clear that national budgets would not be responsible for addressing asymmetric development (p.11).

There was an extremely powerful statement in the Report (pp.12-13), which echoes today:

The centre of decision for economic policy will exercise independently, in accordance with the Community interest, a decisive influence over the general economic policy of the Community. In view of the fact that the role of the Community budget as an economic instrument will be insufficient, the Community’s centre of decision must be in a position to influence the national budgets, especially as regards the level and the direction of the balances and the methods for financing the deficits or utilizing the surpluses.

In summary, the Werner Report concluded that an effective economic and monetary union would require, among other elements (p.12):

• the creation of liquidity throughout the area and monetary and credit policy will be centralized …;
• monetary policy in relation to the outside world will be within the jurisdiction of the Community;
• the policies of the Member States as regards the capital market will be unified;
• the essential features of the whole of the public budgets, and in particular variations in their volume, the size of balances and the methods of financing or utilizing them, will be decided at the Community level …

Of further importance, it was emphasised that while the:

… transfer to the Community level of the powers exercised hitherto by national authorities will go hand-in-hand with the transfer of a corresponding Parliamentary responsibility from the national plane to that of the Community. The centre of decision of economic policy will be politically responsible to a European Parliament (p.13).

The Parliament would be elected on the basis of universal suffrage thereby recognising that economic policy should be democratically determined and those responsible for the policy should be held accountable to the will of the people.

There was no hint that this level of intervention would be the domain of officials centred in Brussels who would do deals with unaccountable bodies such as the IMF that would result in millions of Europeans being made unemployed, which is the norm in Europe in 2017.

The intent of the Werner Report was that:

• There should be a Community-wide central bank, which acts as the lender of last resort and is responsible for regulation and oversight.
• That monetary policy will be centralised.
• That there should be centralised capital market access.
• That the ‘federal’ fiscal operations – size of deficits, debt-issuance etc will dominate national and regional budgets, which will be retained to ensure localised initiatives are effective.

These characteristics are present in a number of functioning federations such as Australia, Canada, and the USA.

They describe closely the way the Australia federation was designed and operates.

This idea that fiscal policy can redress cyclical difficulties across all regions in a federation, legitimised by a sense of ‘federal’ solidarity, is highly significant for an effective monetary union.

Citizens of California or New South Wales refer to themselves as Americans and Australians, respectively.

By contrast, citizens of Germany and Greece refer to themselves as Germans and Greeks, respectively. There is a crucial difference in those self-assignments that no economic or monetary infrastructure can usurp.

The creation of the Eurozone was thus very curious indeed.

The Member States ceded their currency issuing capacities to the European Central Bank and, effectively use a foreign currency. In that regard, the EMU Member States they become equivalent to the states in the US or Australia and thus they do face the risk of insolvency.

Thus the Member States are financially constrained.

Just yesterday, the Australian government announced a huge infrastructure investment in the regional rail system in Victoria. It is putting in $A1.42 billion (a lot) for the regional rail package (Source).

Under the way the revenue-sharing arrangements are designed it could be said that the citizens of the other states are helping to improve remote rail services in Victoria.

Now to the latest in the Eurozone

That discussion is all framing for the recent comments made by the Bundesbank chief Jens Weidmann, which were reported in the German newspaper Welt Am Sonntag (June 25, 2017) – „Gemeinsame Haftung in Europa ist der falsche Weg” (“Joint liability in Europe is the wrong way”).

When François Hollande was elected President of France on May 15, 2012, one of the first things he did (same day) was to travel to Germany to meet with the German Chancellor.

It was almost as if he was turning up for his new job and meeting the boss to get his orders.

On that trip, his plane was hit with lightning and it was reported that “The couple could hardly have started off their working relationship on a worse footing” when the two leaders met (Source).

During the election campaign leading up to his victory, Hollande had been a critic of the German approach and made much of his intention to work for France first and “to steer Europe away from dogged austerity and towards a greater emphasis on growth.”

Hollande returned to Paris empty-handed. The boss had spoken and he returned to do their bidding – as history shows.

Enter – stage centrist-right (which these days means right-wing neo-liberal without the loony libertarian stuff added) – Emmanuel Macron, the new President of France.

Then, his new Party took the majority in the French National Assembly.

A mandate! Reform! Eurobonds! Germany making concessions to Paris (“Deutschland müsse Paris Zugeständnisse machen”)

Well despite what the French people thought they were voting for and despite the obvious confidence of the new politicians, bouyed by their electoral success, nothing gets decided until the Germans assent.

Eurobonds? Joint liability replacing national responsibility? German concessions?

Well, none of that will happen because the bosses of the Eurozone will not allow it.

Bundesbank President Jens Weidmann has left everyone, including Emmanuel Macron, in no uncertain terms what the terms of Macron’s leadership will entail.

There will be little ‘reform’ allowed.

Weidmann’s interview with the Welt Am Sonntag was rather explicit:

Gemeinsame Haftung bei weitgehender nationaler Souveränität wäre der falsche Weg. Das würde die Probleme in Europa eher vergrößern, anstatt sie zu lösen.

“Joint liability with far-reaching national sovereignty would be the wrong way to go. It would increase the problems in Europe rather than resolve them”.

Categorical.

He also rejected any ‘federal’ (joint) funding of public infrastructure:

Ich sehe jedenfalls keinen Grund dafür, warum Italien Brücken in Deutschland mitfinanziert, Portugal deutsche Autobahnabschnitte oder umgekehrt.

“I do not see any reason why Italy should co-finance bridges in Germany or Portugal co-funding sections of the German motorway or vice-versa”

Note, there was no mention of ‘Europe’ here. Just the individual Member States.

But as an Australian and a member of a functioning federation this statement by Weidmann summarises what is wrong with the Eurozone and why it will never deliver sustainable prosperity.

First, citizens in a federation understand fully that if there is a need for a bridge in one state then it might mean that other states will have to forgo the use of the productive resources necessary to construct that bridge

In that sense, the other states are ‘co-financing’ the construction of the bridge where financing is in terms of diverted real resources.

Second, any progressive schooled in Modern Monetary Theory (MMT) would also take exception to the statement by Weidmann. If the federal-level government unit decrees that a bridge is required in one state or another then it does not reduce the financial capacity of that government to fund a motorway in another state.

The idea that taxes fund the spending in a federation is nonsensical. Please read my blog – Taxpayers do not fund anything – for more discussion on this point.

If the Eurozone introduced a true federal fiscal capacity and aligned it with the currency-issuing capacity of the federal-level central bank, then the only constraints that would impinge on the Member States would be the real resources available to the federation.

It might arise that if all available real resources across the federated space are in use that a new project (such as a bridge in Germany) might require real resources to be diverted from other projects or uses, which might include activities in Italy, for example.

But that sort of diverting is common within federations, although in this neo-liberal era where idle resources are the norm (including mass unemployment), the need to take from somewhere to give to another area is reduced.

The problem that Weidmann acknowledges is that Europe will never be a federation. Accordingly, a common currency can never really work across that geographic space.

Germany will never accept the principle that underlies successful federations that all regions should have equal access to the same quality of services.

The Eurozone has seen a massive divergence in scope and quality of public services available to the citizenry since its inception. The divergence has magnified since the crisis.

Tolerating that degree of disparity means that the leadership of the Eurozone are not prepared to embrace an essential characteristics of a common currency and that is why the Eurozone is catastrophically flawed and failing.

Weidmann is both correct and incorrect when he says that the creation of a federal fiscal would not be helpful.

The establishment of a federal fiscal capacity would address the major current constraints on recovery.

First, it would directly redress the stagnant spending conditions across the Eurozone.

Second, it would mesh perfectly with the proposal to create a full banking union. The FFA would be uniquely equipped to ensure that bank deposits were not vulnerable.

Third, the notion of a federal fiscal capacity would have implications for how public debt is issued and who is responsible for it.

While Overt Monetary Financing (OMF) would be the preferable way to consolidate the fiscal policy responsibilities and operations of the federal fiscal capacity with the monetary policy obligations and related liquidity management functions of the ECB, what would happen if there was so-called debt mutualisation (that is, the federal fiscal authority issues its own debt to the private bond markets to match its fiscal deficits).

These federal bonds would carry no default risk because they would be backed by the currency-issuing capacity of the ECB. The Federal Eurobonds would have the same risk-free status as debt issued by the Japanese, US, UK, Australian and other ‘sovereign’ governments.

Debt issued by the Member States, for their own projects, would still carry default risk, but that could be significantly reduced through guarantees provided by the federal government.

Another option could be for the federal authority to use its superior borrowing capacity to raise funds on behalf of the Member States using some sort of federal-state partnership agreement.

All of these arrangements are, however, nuances of the overall fact that the creation of a federal fiscal capacity with its own debt-issuance capacity would solve the so-called sovereign debt crisis in the Eurozone immediately.

The ECB could also easily subsume all the outstanding Member-State debt and write it off as a new beginning. If there were a truly federal spirit operating, none of the ‘better-off’ Member States would begrudge this sort of debt redemption.

However, Weidmann is implicitly correct because the creation of such a federal fiscal capacity is not politically or culturally tenable.

The 1977 MacDougall Study Group clearly understood that (yes, back then!).

An essential requirement for an effective monetary system with multiple tiers of government is that the citizens have to be tolerant of intra-regional transfers of government spending and not insist on proportional participation in that spending.

The other side of this coin is that a particular region might enjoy less of the income they produce so that other regions can enjoy more income than they produce.

To achieve that tolerance there has to be a shared history, which leads to a common culture and identity.

As I noted above, ask the following question: Are the citizens of Berlin or Frankfurt, Germans or Europeans in the first instance?

Language is an aspect of this, but not necessarily intrinsic. In a successful federation such as Australia, people in the states of NSW and Victoria might occasionally complain that the smaller state of Tasmania gets a disproportionate amount of government assistance relative to its ‘tax base’.

However, there is no serious discussion that these federal transfers should stop or that the states with the weaker economies should be forced to endure a lower material standard of living than any other state.

Further, when there is a major dilemma facing one state (perhaps a natural disaster or a significant economic downturn), it is assumed, without question, that the federal government will offer financial assistance to the beleaguered state.

The point is that the citizens within an effective federal system have to share a common sense of purpose and togetherness to ensure that the monetary system works for all states/regions rather than those that have powerful economies.

That capacity and required tolerance is largely non-existent in the Eurozone, which is why talk of a fiscal union will be largely inconsequential.

Weidmann encapsulates that lack of cohesion perfectly – ‘why should Italy help Germany’ type of sentiment.

Conclusion

The point is clear.

Macron can say what he likes. But unless he can get it past the masters (Germany) anything he says will be hot air.

And it is clear from history that Germany will never tolerate the creation of a true federal fiscal capacity.

Which tells me the Eurozone is never going to work in the way the leaders claimed it would at the outset – it will always be prone to stagnation and crisis.

That is enough for today!

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