The Pandemic Has Given Us the Opportunity to Transform Europe

In response to COVID-19, EU member states have agreed to policies that once seemed inconceivable. The EU recovery fund falls well short of what’s needed, but there’s now an opening for the European left to demand more radical forms of economic redistribution.

The European Union flag in the European Parliament in Strasbourg, France. (European Union 2013 — European Parliament / Flickr)

Since the beginning of the COVID-19 pandemic, the European Union (EU) and its member states have taken some unprecedented steps to manage the public health crisis and its economic fallout. Although those steps came in response to a global emergency, they have profound long-term implications for economic policy in the EU.

The Left now has a real opportunity to argue for reforms at a pan-European level that will make it easier to advance our agenda. But first we need to make sense of what has been happening over the last eighteen months and place it in the longer historical context of economic policymaking within the EU.

The Fire Last Time

The crisis that followed the 2008 crash opened a debate about economic policy and institutional development in the eurozone and the EU more broadly. A broad consensus emerged among commentators, including those on the Left, that the EU faced a choice between moving forward with further “integration” (i.e., new fiscal powers and policies at the federal level of government) or backward, with some kind of return to national currencies.

“Optimum currency area” theories informed this view. Such theories hold that a monetary union can only hold together if labor and capital are perfectly flexible and mobile, or if a centralized fiscal policy redistributes resources across the union to smooth over any imbalances.

The EU is made up of three broad regional economic groupings: North, South, and East. The “North” centers around Germany and consists of prosperous member states with competitive export industries. The “South” groups together the Mediterranean member states that have lower standards of living, competitively weaker industries, relatively immobile labor, and inflexible capital markets.

Although mainstream economic commentators generally blame the inflexibility of labor markets in the South for its difficulties, the inflexibility of capital is more important. Italy is a case in point: Family businesses that will stay in business much longer than corporate ones after becoming uncompetitive control much of the capital stock in the country. This ties down resources in uncompetitive forms of production for longer periods of time and contributes to a general decline in economic performance.

The third grouping is the “East,” encompassing the newer member states with even lower standards of living but greater flexibility. This has allowed some of them to attract vast amounts of capital from Western Europe over the past three decades, in particular from German industry.

These sectional splits antedated the introduction of the euro. In the late 1980s, Germany accepted the idea that some redistribution had to take place within the EU in order to accommodate the recently admitted Mediterranean member states. While Italy had been a founding member of the European Economic Community in 1957, Greece, Spain, and Portugal only joined the project in the 1980s, thus broadening the coalition of member states keen on redistribution.

The EU’s central budget expanded to include regional and structural funds targeting investment spending to the EU’s poorer regions. However, for various reasons, including the UK’s strong opposition to fiscal federalism, these funds remained relatively modest. The EU budget failed to grow much above 1 percent of EU GDP.

Although these funds made a real difference in some places, on the whole, they proved insufficient to have a major macroeconomic impact. In particular, they failed to prevent the speculative credit bubbles in the South that developed in the first decade of the new century. These bubbles blew up during the financial crisis, exposing the shaky macroeconomic and institutional foundations of the EU’s monetary union.

Disintegrating Europe

Some on the Left argued that disintegration of the EU or the eurozone was the best way forward. A few did so on nationalist grounds, convinced that EU membership itself had proved to be a disaster and arguing for some kind of national-developmental path for the Southern member states. But the majority argued for disintegration out of a sense that progressive reform, in particular redistributive fiscal federalism within the EU, was not a realistic prospect. Member states should therefore free themselves of the fiscal rules imposed by eurozone membership and recoup their monetary policy autonomy.

I argued at the time that the EU would stumble forward toward greater integration, despite the strong opposition in Germany to that prospect, because of the profound historical tendencies that stand behind the entire process of European federalization, which have made disintegration a very costly scenario for all social groups. This was even more so for capitalists in the most powerful member states, who campaigned for some kind of fiscal integration. Their immediate concern was to prevent large-scale defaults by member states on their debts.

The solution to that problem was always going to involve some kind of fiscal liability mutualization, i.e., member states sharing the ultimate burden of paying back the debts of each one of them. The capitalists, in particular the financiers among them, opposed head-on the German government’s early push to introduce debt restructuring as a permanent feature of the EU’s political economy. Angela Merkel ended up blinking.

The practical consequence of this position was that the Left had to fight for the most progressive version of fiscal federalism possible and reject the prospect of disintegration. This amounted to an argument in favor of substantial fiscal transfers from the North to the South (and East), and a solution to the problem of member-state creditworthiness through some kind of liability mutualization scheme.

In the end, the EU only implemented the latter part of this plan. The European Central Bank (ECB) stepped into the breach as a guarantor of last resort for member-state debts. In what some have called “fiscal integration by default,” the ECB started accumulating such debts on its balance sheet.

At first this was only a promise, but after 2015, the ECB went in big. Just before the March 2020 turning point, it had about 20 to 25 percent of the outstanding stock of member-state debts sitting on its books. However, the price for that guarantee was a severe wave of wage and spending cuts combined with regressive labor-market reforms in the “South.”

The debate faded after the defeat of Syriza’s attempt to overturn the troika programs in the summer of 2015. The following year, Brexit replaced economic policy as the main item of debate among left-wing commentators on EU affairs.

The new French president, Emmanuel Macron, made a bold proposal in 2017 to set up a redistributive budget for the eurozone to the tune of “several percentage points of GDP.” That would have meant common borrowing and spending to the tune of several hundred billion euros. However, Macron’s proposal got bogged down in negotiations due to the lack of enthusiasm in Berlin. By the time the COVID-19 pandemic reached Europe, the German government and its Northern allies had watered the scheme down to a puny budget of a few tens of billions.

Conservative Climbdowns

The economic shock caused by the sweeping restrictions that governments implemented in an attempt to manage the public health crisis has revived the debate. Developments since then have vindicated those who argued the EU was going to move forward one way or the other. The EU took a number of steps in response to the pandemic shock, all of which tended to beef up federal economic policies, following the logic of greater integration that had been the subject of so much debate and haggling over the previous ten years.

The first step evinced the greatest degree of continuity with previous initiatives. The ECB stepped up its monetary activism and bought up even greater amounts of public debt. The novelty was that it did so at a time when the overall amount of public debt was skyrocketing.

In the previous decade, especially after 2015, the ECB had bought up public debt just as governments were trimming their deficits. Now, the ECB actively supported fiscal expansion. The German Federal Constitutional Court’s ruling of May 2020, which ordered the German government to complain about the previous round of bond purchases, inadvertently helped to reinforce this policy shift.

The ruling forced not only the German government but also the Bundesbank, Germany’s central bank, to publicly support the ECB’s policy and move away from the ambivalence (if not open hostility in the case of the Bundesbank) they had displayed in the past. The Constitutional Court quickly folded: In May 2021, it summarily rejected a new legal challenge concerning the ECB’s pandemic bond-purchase program. This has firmly entrenched the ECB’s role as guarantor of the creditworthiness of eurozone member states — a role that German negotiators of the Maastricht treaty had explicitly sought to render impossible.

But the really radical innovation was the introduction of the common approach to borrowing and spending that Emmanuel Macron had advocated in the teeth of opposition from Berlin and its Northern allies just a few months previously. In total, the European Commission has received authorization to borrow up to €850 billion in constant 2018 euros. By 2026, when the scheme is due to end, this figure will be higher than a trillion euros in current euros.

The borrowing is backed by the EU budget, not by each member state jointly and severally. This creates a specific federal liability that can only be met by new resources for the EU budget. Since there is no appetite for expanded member-state contributions, governments have agreed that these resources will come from new EU taxes, although the specific taxes will only be decided upon by 2023.

The potential new taxes being discussed at the moment include an energy tax, a carbon border tax, a financial transaction tax, and a tax on large corporations operating across member states. While the volumes of these taxes will not be significant if things remain as they are today, they would still constitute an important step. For the first time in over fifty years, since the creation of the customs union in 1968, we will see the creation of new European taxes. This will reverse the trend of an ever-growing share of the EU budget coming from member-state contributions.

Fiscal Federalism

The new federal borrowing is intended to fund two schemes, both of which had been raised in the debate about a federal redistributive budget over the prior decade. The first is an unemployment reinsurance scheme known as SURE (Support to mitigate Unemployment Risks in an Emergency). A reinsurance scheme is a fund that national unemployment insurance schemes can call upon if the crisis means that their own resources are overrun.

In the EU, governments have used furlough schemes on a massive scale during the pandemic to prevent unemployment from skyrocketing. Workers have remained in their jobs with part of their wages paid by the state. The EU’s reinsurance scheme, which amounts to €100 billion, was intended to support these schemes in the member states. Some see SURE as the first step toward a specifically federal, pan-European unemployment insurance scheme that would run parallel to the national schemes.

Such a scheme would qualify as a federal asymmetric shock absorber because it would automatically redistribute resources from booming member states to those doing less well. The French and Italian state bureaucracies have been proposing this for almost ten years now. Olaf Scholz of the German Social Democratic Party (SPD), who served as his country’s finance minister from 2017, has also pushed the idea. SURE makes it possible to argue that this should become a permanent feature of the EU’s political economy.

However, SURE is less important than the recovery fund set up to boost public investment in the member states. Dubbed Next Generation EU (NGEU), the fund will receive €750 billion in 2018 constant euros to subsidize public investment, primarily in green and digital transition projects. Some 60 percent of it will come in the form of grants, with the rest available in cheap loans.

Crucially, the criteria for allocating resources will privilege member states in the South and East. Italy and Spain will be the two biggest recipients, while Greece and Portugal together will receive more than Germany. In relative terms, Greece stands to receive something close to 12 percent of its GDP, a huge sum by any standard. This manifests the logic of fiscal transfers from wealthier to poorer regions that German conservatives have fought against so bitterly over the past decade.

Angela Merkel’s acceptance of the scheme constituted a clear about-face on her part. This is the second major climbdown for German conservatives on the EU’s macroeconomic regime in the past ten years, the first having come over the ECB’s bond purchasing policies. After grudgingly accepting fiscal integration by default, German conservatives are now having to accept fiscal integration tout court.

We should also note that the EU has suspended the fiscal rules enshrined in the Stability and Growth Pact, which the Left had strongly attacked. The European Commission now wants to have a debate on new rules to replace the old ones.

A Hamilton Moment?

In a May 2020 interview, Olaf Scholz explicitly drew a parallel between what the EU was doing and the financial reforms introduced by Alexander Hamilton during his stint as the first treasury secretary of the postrevolutionary US federal government. This carried symbolic weight because advocates of greater fiscal integration had been urging a “Hamiltonian moment” upon the EU for a long time.

From a serious analytical perspective, any parallel between the eighteenth-century United States and the EU today is deeply flawed. But the symbolism remains important. Governments in the South clearly back the idea of a “Hamiltonian moment,” in the sense that they support a substantial federal redistributive budget. The stumbling block for the last ten years has mostly been Germany and, to a lesser extent, its Northern allies.

In these member states, even the Left is wary of fiscal federalism. Denmark, Finland, and Sweden were leading members of the “Frugals,” the group of member states that fiercely resisted common borrowing and the NGEU scheme, although they all had social democratic prime ministers. For Olaf Scholz to make such a statement while he occupied the number two position in the German government was a clear act of political signaling.

However, his coalition partner Merkel and her Christian Democratic Union (CDU) party eschewed such comparisons. CDU fiscal hawks are adamant that NGEU be a one-off. Yet their former champion Wolfgang Schaüble, Germany’s finance minister during the highpoint of the eurozone crisis, has said that he does not see things that way. Schaüble argues that common borrowing is necessary in a monetary union.

The surprising outcome of September’s election in Germany may thus have a significant impact on the country’s policy. The CDU experienced the worst result in the party’s history with just 24.1 percent of the vote, 1.6 percent less than the SPD, which staged an entirely unexpected recovery during the election campaign after stagnating in the polls over the previous year. The Greens came in third, with the best score in their history (14.8 percent), but one that still fell short of the 20 percent target they had been aiming to reach.

The SPD and the Greens had signaled their wish to govern together before the election. But that will now depend on the willingness of the liberal Free Democratic Party (FDP) to join a coalition government under Scholz. The FDP, which won 11.5 percent of the vote, has the most regressive stance on European economic policy of all the German parties, with the exception of the far-right Alternative for Germany (Alternative für Deutschland, AfD). The Free Democrats should not be allowed to dictate the coalition’s line on major questions, especially since they did not experience any surge in support, while the SPD and the Greens increased their combined vote share by 11 percent.

The Next Step

Whatever happens in Germany, it remains to be seen whether the NGEU proves to be a temporary stopgap or the first step on the way to entrenched fiscal federalism. The word in Europe’s chancelleries and treasuries is that this depends to a large extent on how well Italy and Spain spend their share of the subsidies.

It is therefore no accident that a new coalition government was formed in Italy soon after the NGEU’s creation, with former ECB president Mario Draghi as premier. This was an attempt by Italy’s elites to signal to Brussels, Paris, and Berlin that they will not squander the cash.

My own view is that, in the EU’s history, initiatives such as NGEU have tended to stick. When the Maastricht treaty was signed, many commentators — including a wide cross section of US academic economists — believed that the agreement would fall through, or that Italy would not be admitted into the eurozone.

The ECB’s promise to buy bonds to stabilize the eurozone encouraged a widespread belief that the backlash in Germany would kill the monetary union. The same talk about splits and even a German withdrawal from the monetary union flared up after the German Constitutional Court’s contrarian ruling in May 2020. This time, however, the skeptics are less vocal.

The outcome also depends on what the Left does and argues for. NGEU is just a breach in the previous regime. There are different ways in which fiscal federalism can develop in the EU, some more progressive than others. NGEU itself falls short of what the Left has pushed for, in ways that I will now discuss, and that highlight why the best course of action for the next phase would be to campaign for changes to EU treaties that grant the federal level of government full fiscal powers.

NGEU’s Shortcomings

To begin with, NGEU is not big enough. The amounts initially mooted for a recovery fund were in the region of a trillion and a half euros, about twice the size of NGEU.

The money that’s available in theory won’t all be used, either, as the Northern member states probably won’t draw down the loans that have been earmarked for them. These states can already borrow for themselves at lower rates than are available to the commission.

Finally, the fund will operate until 2026, whereas the original idea was to have it extend to 2023 or 2024 at the latest. Again, this means that the headline amount will prove to be (much) less than meets the eye.

On top of this, the grants component is simply not as large as it should be. Having a loan component at all does not even make sense. Member states in the South may be able to borrow at lower rates from NGEU than on the markets, and at longer maturities, too. But Spain has been paying less than 0.4 percent interest on ten-year bonds, and there has been huge demand for Italy’s debt, so the benefits either country would gain from this are questionable.

Finally, the commitment to new taxes is limited. The annual sums that will have to be levied to pay back the new debt are pretty small in proportion to the EU economy as a whole. The new taxes will thus only play a marginal role in steering that economy.

Such taxes have real potential. Energy taxation could be a substantial spur for savings through innovation. A financial transaction tax, if broadly applied, could yield huge sums for public investment, while also taming the speculative nature of financial markets. A tax on large corporations would be particularly useful in rolling back tax competition and the race to the bottom that it has spawned.

Constitutional Barriers

Why does NGEU fall short? It is not because of uniform opposition from European capitalists to a more ambitious scheme, or even because a substantial proportion of voters across the EU are opposed to fiscal expansion, redistribution, or greater deficits. Rather, it is the constitutional settlement underpinning EU decision-making that is to blame.

There are two main decision-making procedures in the EU. One, of a clearly federal inspiration, is called the “ordinary legislative procedure.” The European Commission proposes legislation, which then has to be adopted in tandem by the European Parliament (by simple majority) and the European Council, the council of ministers representing the member states (by qualified majority). The majority of EU legislation went through under this procedure during the 2014–19 legislature.

The second procedure is of a confederal inspiration. The special legislative procedure involves a proposal by the Commission, followed by unanimous adoption by the member states (with or without the consent of the European Parliament, depending on the legislation). In the case of the Own Resources Decision, which is the revenue side of the EU budget and thus the legislation governing NGEU, not only was unanimity required, but the decision also had to be ratified by each member state’s legislature. This is similar to the way that international treaties are made.

To put it another way, while the EU decides how to govern and regulate its economy by means of a federal democratic procedure, the decision on how to fund itself is largely a matter of interstate diplomacy. Crucially, the unanimity requirement means that the logic of the lowest common denominator applies. This is a crucial advantage for those member states that oppose so-called “positive integration” in fiscal policy — namely, the buildup of federal policies that are backed by actual resources, not just rulemaking.

This is why NGEU falls short. If the ordinary legislative procedure applied to it, it would likely have been twice the size, without a loan component, and covering a time span of two to three years rather than five. A plan sketched in an April 2020 document by the Spanish left-wing coalition government that set the terms of the negotiation followed this outline.

The Spanish proposal had the backing of no fewer than fourteen member states, including France, Italy, and Spain, but also traditional allies of Germany like the Baltic countries and Slovakia. Other Eastern member states such as Poland, Hungary, and the Czech Republic were natural allies because they stand to be net recipients of any fiscal redistribution. In a nutshell, this was an alliance of the South and the East.

Together, these member states have a large majority of the EU’s population and form a majority in the European Council. They also had the European Parliament on their side. On May 15, 2020, in the heat of the negotiation, the Parliament passed a resolution by a huge majority — 505 MEPs out of 705 — calling for a fund that would resemble the Spanish proposal. Almost every single left-wing MEP voted for the resolution.

As the German government quickly allied itself around a compromise proposal with the forces supporting common borrowing and grants, the sole resistance of the so-called “frugal four” (Austria, the Netherlands, Denmark, Sweden) led to a much watered-down fund. The “frugals” risked triggering a political crisis of epic proportions if they decided to veto the proposal. However, the unanimity requirement did not prevent them from doing huge damage nonetheless.

Empowering the European Parliament

Thomas Piketty and his colleagues made a strong case for the progressive nature of fiscal federalism in their 2018 “Manifesto for the Democratization of Europe.” They called for the creation of a new assembly with a majority of delegates from member-state parliaments and a minority from the European Parliament. This new assembly would have the power to raise taxes and allocate the proceeds to member states in proportion to the revenues that each would contribute.

This highlights the principal left-wing argument for fiscal federalism: The centralization of taxation would provide a major tool with which to counter tax competition, which has been a bugbear of the European left since the EU liberalized capital movement within its boundaries in 1990. This has fostered a race to the bottom, a less progressive tax structure, and rising income inequality.

Pan-European tax harmonization would be one way to challenge tax competition. This has been the European left’s main demand in opposition to tax competition over the past three decades. But the unanimity requirement makes that nigh on impossible, as does the democratic principle that each jurisdiction should be free to define its own forms of taxation.

A more plausible option would be to give the federal jurisdiction its own power to raise taxes, with pan-European taxes acting as a floor below which taxation in the whole of the EU could not drop. The additional revenue could then be used to fund public investment, or any other spending priorities that individual member states might have.

While Piketty and his fellow authors support fiscal transfers and redistribution, they believed that opposition to transfers in Germany and the other Northern member states meant that a redistributive federal budget was impossible to achieve and designed their proposal accordingly. It constitutes an attempt to bring about fiscal centralization (European taxes) without transfers, so as to dissociate the fight against tax competition from redistribution. By basically matching contributions and fund allocations, the common European taxes that the new assembly could raise would only allow for greater revenue and spending on the part of each member state, rather than redistribution from one state to another.

The authors do argue for spending on commonly defined priorities — European public goods — but in the absence of transfers, it would become politically elusive to get member states to stick to such priorities. Each state could legitimately claim that the money was “national,” and that the spending should follow “national” priorities, too.

This political consideration is now obsolete. Angela Merkel stated explicitly that the purpose of the recovery fund should be to direct transfers to lagging member states. This principle is therefore no longer a redline for German conservatives. Their Northern allies have also abandoned it, although they are now focusing their energies on limiting the extent of redistribution as much as possible.

The adoption of NGEU means that, from now on, the debate is not about whether fiscal federalism can even happen, but about the conditions under which it can fulfill its progressive potential. The unanimity requirement has proven insufficient to block fiscal initiatives.

Piketty and his collaborators also thought the European Parliament lacked sufficient democratic legitimacy and therefore could not be granted the power to raise taxes, so they proposed the creation of a new assembly made up primarily of national MPs. Again, NGEU shows why that calculation no longer holds.

Although NGEU did not require the consent of the Parliament for its resources, it does require such consent on its spending side — just like the regular EU budget. If the Parliament has the legitimacy to say how the money should be spent, surely it also has the legitimacy to say how it should be raised.

The Parliament is the only directly elected body in the EU. National parliaments in EU member states are elected on the basis of party competition around national issues. That is hardly a legitimate democratic basis when it comes to deciding upon pan-European taxes.

Transforming the EU

Over the last ten years, there has been a growing realization that the EU’s constitutional settlement is deficient, and not just because of the Great Recession. The refugee crisis of 2015, geopolitical events from Ukraine to Afghanistan, and backtracking on the rule of law in Poland and Hungary have led many to question the way that the EU distributes power between the federal center and the member states. The departure of the UK also means that the member state most opposed to any form of centralized EU power is no longer in a position to block change.

Upcoming national elections and the EU’s own “Conference on the Future of Europe” offer opportunities to intervene in this burgeoning debate. The conference is explicitly intended to debate the changes that need to be made to the way the EU operates. In this context, the Left should argue for the EU budget to be governed by the ordinary legislative procedure in both its revenue and spending aspects.

This would mean revising articles 311 and 312 of the Treaty on the Functioning of the European Union (TFEU). That treaty already includes a clause under which a unanimous decision could trigger a shift from the special to the ordinary legislative procedure.

Beyond the legal technicalities, we must express the argument in both economic and democratic terms. The economic argument is that such a change would make it easier to establish fiscal federalism as a permanent feature of the EU’s political economy. Fiscal federalism is necessary to organize redistribution from wealthier to poorer member states, raise the overall level of public investment, and revamp tax systems to reduce income inequality.

Raising public investment is key to fighting climate change, which will also require a substantial level of policy coordination among member states, because the costs of the green transition have to be more or less evenly spread. Federal taxes and spending will make such coordination much easier to achieve.

The democratic argument is that this is what the greater number of the EU’s citizens want to see happen. As we have already seen, a majority of the union’s member states, containing a majority of its population, support a federal budget. Polling conducted in autumn 2020 found that around two-thirds of EU citizens think that NGEU will be an effective response to the economic impact of COVID-19. 56 percent believe that taxation should be decided at least equally at the member state and federal levels.

Moreover, the treaty revisions I am suggesting would also strengthen democratic accountability in the EU. Deciding the EU’s budget through the ordinary legislative procedure would place the European Parliament — the only directly elected European institution — squarely at the center of the economic policy debate. Debate in the Parliament is structured around the left-right cleavage rather than splits between member state groupings. This would be one way to move beyond the sterile standoffs between North and South, East and West.

It is also the best way to show that the debate over economic policy is one between redistributionist socialists who are keen to use taxes to promote social justice, on the one hand, and fiscal conservatives who dislike paying for public health and education, public infrastructure, and welfare benefits, on the other. There is nothing special about political struggle in the EU. The problem is simply that its current constitutional settlement obscures the clear expression of these divisions.