The German election is finally behind us. In spite of headlines about the rise of the extreme right, Chancellor Angela Merkel is headed for yet another term in power with pro-European partners. This means there is finally a window to discuss eurozone reform in earnest. But what is the goal? It is increasingly popular to argue that the creation of a budget for the eurozone is mere federalist utopia. Bruegel’s Andre Sapir, to name one, argue that Europe should pursue a more pragmatic solution. Their suggestion is to “complete the banking union” and transform the existing European Stability Mechanism (ESM) into a European Monetary Fund (EMF). Past and likely future German Finance Minister Wolfgang Schaüble seems to agree with them.

Such an EMF would exist to provide conditional crisis lending to sovereign nations in trouble, as the ESM does today. It would thus perpetuate our current system of asymmetrical adjustments decreed to bailout recipients who face no parliamentary accountability or scrutiny. It features men in dark suits who arrive with foreign reform dicta. It would also enshrine the deflationary bias of the current framework, in turn deepening the corrosive political dynamics of austerity.

German Chancellor Angela Merkel and French President Emmanuel Macron in Berlin, May 2017.
French President Emmanuel Macron and German Chancellor Angela Merkel in Berlin, May 2017.
Fabrizio Bensch / REUTERS

An improved monetary union with an EMF is certainly more palatable than what exists now. But it is not enough. It is an ahistorical half solution that would fall far short of making the eurozone economically and politically sustainable in the long run. 

Only last year, many worried about the impending collapse of the euro. Today the risk is complacency as a result of centrist, pro-European victories in this year’s elections from France to Germany. Growth and new leadership can deflate populists, but they still linger on the sidelines, too close to power for comfort. Two weeks ago, at the Ambrosetti Forum in Italy, the Netherlands’ Geert Wilders made that very point: the establishment has won 2017 but populists “will be vindicated.”

It is important, therefore, even as macroeconomic recovery in the eurozone takes hold, not to ignore that the only sustainable solution is a complete monetary union with a true federal budget. It would differ from a proposed EMF in four fundamental ways, and they are all crucial to its long-term sustainability.

The only sustainable solution is a complete monetary union with a true federal budget.

First, a single budget should act as a fiscal backstop to the European banking and capital markets unions. The former is far from complete: the supervisory and resolution authorities need to have a greater executive role, as was made clear by the divergent responses to Iberian and Italian mini-crises this past summer. It also requires a fiscal backstop. As suggested by the economists Douglas Diamond and Philip Dybvig, fractional reserve banking systems cannot function without contingent insurance for deposits and, by extension, a fiscal authority to underwrite equity in case of panic. The financial history of the United States is very clear on this point. Only with a degree of fiscal union, in short, is an enduring banking one possible.

Second, individual member states’ stabilization capacity is currently undermined by both divergent fiscal rules and erratic financial markets. Only a supranational budget can provide stabilization in a way that makes credible adjustments in member states while avoiding liquidity traps. A single budget would allow for easier management of the business cycle when individual countries lose market access or, if they so choose, to restructure sovereign debt. 

Although observers such as the New York TimesJosh Barro have questioned or minimized the stabilizing role of the federal budget in the United States, the historical record is unequivocal: the United States could not have dealt with the global financial crisis without a federal budget (think of TARP, bank and auto bailouts, and unemployment insurance extensions). Back in the 1930s, moreover, when the Fed finally assumed the role of lender of last resort, a credible fiscal agent was essential not only to backstopping the crisis but also pursuing recovery. The alternative is Greece’s endless crises. Moreover, it is a myth that stabilization can operate only through “budgetary coordination,” which struggles in good times and fails miserably in bad ones. 

Third, like the single market, the European monetary union facilitates regional concentration of productive capital and human resources with profound distributional consequences. During the crisis, human and financial capital moved from crisis countries to Europe’s core productive hubs. Although the free movement of capital and labor is good in aggregate, within a monetary union, it facilitates the creation of hyper-productive clusters and economic desertification elsewhere.

The headquarters of Monte dei Paschi, an Italian bank, in Siena, June 2017.
Stefano Rellandini / REUTERS

The EU has put policies in place to contain this phenomenon: so-called cohesion funds. But only a real budget can fix the problem inside the eurozone, undertaking new discretionary allocative investments (training and schools in Italy and Portugal, for instance) to ensure that productive capacity is more evenly distributed, which will encourage economic convergence. This fits the experience of other federations, from the United States (where the Sun Belt was the result of federal industrial policy in the 1940s) and Germany (where reunification involved gargantuan transfers to the East). Without such a plan, divergences would only deepen, with profound social consequences. A single budget is the best way to implement that. 

Finally, democratic accountability usually escapes economists, but not so electorates. An EMF would continue to hide financial transfers and political decisions behind an opaque technocratic governance structure akin to that of the ESM today, ruled more like a private company than a representative entity. By contrast, a federal budget would require tax revenues (potentially including a fraction of a unified corporate tax) and ultimately the authority to borrow in the open market, creating a truly European risk-free asset.

Only with a degree of fiscal union is an enduring banking one possible.

It need not be huge. As it happens in Switzerland, a federal budget can be strictly limited by the constituent parts of the federation, cantons for Bern and member states for the eurozone. Yet such a shift in taxing and borrowing power would force a necessary democratic clarification within the Union. In doing so, it would go some way in addressing the mutually reinforcing executive and democratic deficits that have plagued Europe since the Maastricht treaty, when the continent outsourced all adjustment mechanisms to imperfect financial markets.

Now that the German election is behind us, Europe must do better than turning temporary fixes into permanent fixtures of a cracking edifice. Europe’s integration project may be the most ambitious one since the birth of the American republic, yet in history it is just another federation in the works. As we have argued in Foreign Affairs, all the world’s successful federations—Germany, Switzerland, the United States, and even Argentina—have developed a kernel of federal spending with a real lender of last resort, along with an (optional) no-bailout rule for sub-federal entities. A fiscal union for the euro area is therefore not “a solution that has lost contact with problems,” as the Financial Times' Martin Sandbu has argued, but the only historically informed way to save the euro—and the EU.

*The original version of this article incorrectly attributed the quote "federalist utopia" to Martin Sandbu. The piece has been updated to correct the error. 

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  • PIERPAOLO BARBIERI is Executive Director of Greenmantle and a Senior Associate at the Harvard Kennedy School’s Applied History Project.
  •  SHAHIN VALLÉE is a former economic adviser to Emmanuel Macron and EU Council President Herman Van Rompuy and is now a senior economist at a family office.
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