The rebirth of the Eurozone: A living analysis on the alternative routes out of the euro crisis

Inclusive Economy21 Jan 2016Frans Bieckmann, Evert-jan Quak

Is the current recovery policy for the financial and economic crises in the Eurozone a genuine answer for the complexity and diversity of the problems that all member states face? Not really. The responses are too one-sided and mainly export and austerity driven. In particular, the current policy ignores the fact that the euro crisis is a systemic crisis that cannot be overcome with more of the same. This euro crisis living analysis showcases in an innovative and interactive way that there are feasible alternatives that not only could bring back some economic growth to the Eurozone, but could also ensure that the recovery endures and includes all the people of Europe. This requires a dramatic rethink on debt restructuring, rising investment levels without triggering over-indebtedness again, and a systemic change of the financial sector industry. Such a strategy should be combined with a wage-led growth strategy based on more and better jobs to reverse the race to the bottom of the current supply side and export-led competitiveness strategies in the Eurozone. Only then is a healthy future for the single currency possible. 

What is a living analysis?

Navigating out of the euro crisis

This article, one that we call a living analysis on the euro crisis, is a continuation of two previously published analyses. The first article titled ‘Ideals versus Reality – a false start for the Eurozone’ and the second article ‘Debts and Imbalances – the making of the euro crisis’ analysed the problems and causes of the euro crisis by examining the impact the single currency has had on the current crisis. This living analysis is the follow up article aimed exclusively at solutions. The main question of this living analysis: what are feasible and acceptable alternatives for the current recovery policies?

To begin, why is this article called a living analysis? Different from other analyses, this article will be continually updated with up-to-date expert opinions, research articles, data, videos and an overview of relevant academic and policy reports, literature and media coverage. A living analysis is an innovative and easily accessible way of structuring knowledge. Our vision at The Broker is to help improve policies in three different ways: by making policies more evidence-based; by reporting on changing dynamics and; by making recommendations on how to anticipate these changes. We do this by giving an overview of existing knowledge and continuously striving towards an improved and more comprehensive analysis by integrating views of experts. These experts reflect on emerging societal, academic and political trends.

Other living analyses published by The Broker include the Migration Trail, which discusses the dynamics and changes in migration and policy within the European Union, and the Sahel Watch, a focused analysis on the multiple conflicts in the Sahel region of Northern Africa.

To join our analysis or to become a partner in our living analysis on the euro crisis, please contact Evert-Jan Quak at You can click on the table of contents below to go directly to one of the sections of this living analysis.

Rebalancing the debt

With some of the most indebted countries in the world within its borders, one of the most important recovery steps for the Eurozone is to lower the debt burden of its member states to a more sustainable level. ‘The question isn’t knowing whether a debt restructuring is needed […] but which way to do it,’ said recently by ECB executive board member Benoit Coeure. The challenge Coeure is posing is to find a way to restructure Europe’s debt without hurting its economy any further. This includes private investors and creditors governments such as Germany and the Netherlands who may have to endure some losses in accepting that heavy indebted governments cannot pay back all that they owe or they will eventually default.

Factbox: debt-ridden Europe

A country that faces a debt level higher than 95% of the size of its economy (GDP) is, in economic terms, unsustainable. Such countries have to lend more money from the international financial markets to pay back their old debts and interest costs instead of using the money for long-term investments that could increase economic growth level. It is mainly the advanced economies that have the highest government debt to GDP ratio in the world (See map of the IMF below). According to the latest Eurostat data published in the European Economic Forecast Autumn 2015 report, Greece, Portugal, Spain, Italy, Ireland, Cyprus, France and Belgium all have debt levels higher than 95%.  The other EU countries have lower levels, but still many of them have higher levels than the Eurozone’s proposed 60% threshold.
Source: IMF (2012)

Source: IMF (2012)

Up until now, Northern Eurozone nations have been reluctant to consider such a major restructuring, and even against pressure from the IMF that a debt deal must be put on the negotiation table, in the Greek case for example. However, debt relief is not acceptable for Northern European member states as they fear it will incentivize governments to relax the tough public spending cuts (called moral hazard in economics); something that these countries governments see as risky for triggering new financial turmoil. Therefore, the European creditors only accept in principle the idea of reducing interest rates and pushing repayment dates on debt.

Longread ‘Ideals versus reality’

Fifteen years after its introduction, the reality of the Eurozone is very different from the ideals on which the single currency was built.

Read the full research article here

Unfortunately, this policy up until now is not working well. The policy highlights spending cuts (austerity) and regaining economic growth with a strategy of low wages and increasing exports, as The Broker’s research article ‘Debts and Imbalances – the making of the Euro crisis’ detailed. Recent data from AMECO on government debt levels do not show a significant reverse in the debt-burden in most European countries since 2010 when this policy was initiated, especially not in the most indebted countries. Predictions for the upcoming years are also not encouraging. Public debt levels in the Eurozone remain at dangerous levels and are forecast to remain elevated for a long time under the current policies.

Public debt in Eurozone countries


Therefore, many economists like Paul Krugman, Joseph Stiglitz, Giancarlo Corsetti, Paul De Grauwe and others criticize that the current austerity policy without any genuine debt restructuring is indeed failing because it increases unemployment and weakens local demand, and therefore is a burden for already tight government budgets. The result has thus weakened economic growth and left Eurozone countries with high and unsustainable debt levels.

A New Start for the Eurozone: Dealing with Debt – Monitoring the Eurozone 1, Centre for Economic Policy Research.

‘[T]he feedback effects on demand and growth of large unemployment crises: when a large recessionary shock raises unemployment substantially, it is increasingly difficult for workers who have no job to find a match with firms. Unemployment becomes more persistent, lowering the permanent income of households and thus lowering demand. Adverse market conditions also weigh on those workers still with a job. As they become increasingly concerned with the prospect of losing it, they may increase their saving in a precautionary manner, again lowering demand. With policy rates at the zero lower bound, the contraction in demand lowers activity and creates more unemployment, inducing a vicious circle (unemployment, saving, demand, unemployment) that exacerbates the effects of the initial shock. Through this channel, to the extent that a debt overhang discourages investment and growth, low income perspectives reduce demand and employment today, in turn creating a long period of low cyclical growth. Long-term and short-term considerations combine in a perfect storm, condemning a country to a state of a persistently large output gap and inefficient wasting of physical and human capital.’

Other resources:

Open Europe (2012), Can struggling Eurozone countries achieve necessary ‘internal devaluation’ – and at what political cost?
Corporate Watch (2015) False Dilemmas: A Critical Guide to the Euro Zone Crisis
Paul De Grauwe and Yuemei Ji (2013) Panic driven austerity in the Eurozone and its implications
Giancarlo Corsetti (2012) Has austerity gone too far? 


So if current strategies are lacking, what are the alternatives for debt restructuring that go further than lower interest rates and longer pay back periods?

The first option is to let some Eurozone countries go default, although it has been stated by the European Commission and the European Central Bank that European countries that it will in fact not default. Experts like the Greek economist and Parliamentarian Costas Lapavitsas and  German economist Heiner Fassbeck who both wrote the book ‘Against the Troika: Crisis and Austerity in the Eurozone” have pointed out how Southern European countries could default on their debts by leaving the single currency. In their book, the authors suggested that it would be painful, however countries like Greece would be better off without the euro as it would allow them more fiscal and monetary policy tools to restructure their debts and thus stimulate their economies. Yet most businesses, politicians and the majority of the population of heavy indebted countries don’t want such a radical approach. A split would mean higher risks, trading costs and an increase in import prices while savings, pensions and other assets would reduce in value, and travelling abroad would become expensive.

There are other alternatives that would allow countries to restructure their debts without the harsh reality of austerity. According to the Centre for Economic Policy Research (CEPR) and their 2015 publication A new start for the Eurozone: Dealing with debt, these alternatives could only work if they are embedded into a three step scenario. 1 First, a one-off debt restructuring or debt relief policy would be absolutely necessary for the Eurozone. However, the policy would need to be followed by a clear policy framework as to avoid a new stark rise in public debt in the future, including a mechanism to decline the grip of financial speculators on the working of the monetary union.

To begin with the idea of a one-off debt restructuring that would be politically acceptable, economists Charles Wyplosz and Pierre Pâris came up with a solution they call the Political Acceptable Debt Restructuring in the Eurozone (PADRE). Briefly, their strategy entails that the ECB would buy a significant amount of debt from each country in the Eurozone. The specific amount would be dependent on a measurement based on the size of the country’s economy. The ECB will pay for this by borrowing from the financial market. Note that the ECB can cover most of the costs of this loan with the revenues they make from printing money called seigniorage revenues. If PADRE would be implemented in the Eurozone, each member state would benefit from the debt restructuring. Wyplosz and Pâris calculated that Latvia, Greece and Portugal are among the largest beneficiaries.

The PADRE proposal for rebalancing the Eurozone

The way to eliminate politically unacceptable inter-country transfers requires that the ECB acquires and swaps public debts of all Eurozone member countries in proportion to each country’s share of its capital.’ The ECB acquires a share of public debts and swaps them into zero-interest perpetuities, which are bonds or other securities with no fixed maturity date. In practice therefore, the corresponding debts are wiped out. The ECB borrows from the financial markets the amount needed to acquire the debts to buy the public debts. As it pays interest on its obligations to the financial market and receives no interest on the perpetuities, the ECB makes losses.

But in Paris’ and Wyplosz’ publication, they state clearly that the ECB’s money creation capacity (the profit from creating money with a higher market value as their production costs is called seigniorage revenues) is sufficient to make up for the losses. Their idea is to take the total public indebtedness of all Eurozone countries (€9.184 billion in 2013, i.e. 95.5% of Eurozone GDP, with national debts ranging from 10.0% in Estonia to 176.2% in Greece) as a starting point. Then the total debt will be halved, but this is arbitrary and could be different. A reduction of half of the existing debt is €4.592 billion for the whole Eurozone. The ECB capital shares will be used to compute the amount of debt restructured for each Eurozone country by multiplying €4.592 billion by each country’s capital share. The result is that each country will face a debt relief. The amounts as a percentage of national GDPs shows that Latvia, Greece and Portugal are among the large beneficiaries because they have capital shares that are highly relative to their GDPs. Conversely, the ratio of restructured debt to GDP is relatively small for Austria, Finland, Germany and the Netherlands. The post-restructuring gross debt ratios is different for each country, but each country benefits.

Source: Pierre Pâris and Charles Wyplosz (2015), PADRE Politically Acceptable Debt Restructuring in the Eurozone

Even though the CEPR is supportive of the PADRE strategy, the recent revenue calculations of a pure PADRE strategy revealed that it will not be enough to reduce debts to below 95% of GDP for the highly indebted countries. It would not be desirable either to completely rely on seigniorage revenues as ‘the ECB can no longer rely on committed seigniorage revenues to back its interventions […] The ECB cannot use it to smooth out possible losses on its balance sheet, in turn implying that the ECB may in principle run into difficulties in pursuing its monetary strategy if and when it is forced to monetize part of these losses.’ ECPR alternative is to combine the PADRE concept with the establishment of a Stability Fund for the most indebted countries. Revenues from special targeted tax increases, such as increases in VAT or a capital or wealth tax in combination with issuing stability fund bills on the national and Eurozone level, would guarantee current and future income streams over the long-term, which would generate a large sum of money to buy back the debt via the Stability Fund.

Stability fund to buy debts inin heavy indebted Eurozone countries

The idea is to establish a Stability Fund in the most indebted countries by capitalizing small current and future income streams over a long horizon, which will generate in net present value terms a large sum of money to buy back the debt. The researchers are aware that tax increases put a burden on the economy and reduce economic activity and could politically be problematic in many countries. It will break the deadlock of currently high interest rate payments in combination with weak economic growth for a long period. As Stability Funds are not likely to restructure debt to sustainable levels, the Centre for Economic Policy Research opted for a tax redistribution across the whole Eurozone and for private sector involvement. Economically it is perfectly reasonable to ask low-indebted countries like the Netherlands (68%), Germany (74%) and Finland (59%) to contribute to the Stability Funds of high-indebted countries. As already detailed in Part 2, every irresponsible lender has an irresponsible creditor, so there is not one side to blame for the debt-crisis. The idea is to share additional revenue earmarked for debt reduction, for example, revenue raised by a coordinated Eurozone-wide VAT increase for the Stability Funds.

A second requirement is to include the private sector. All the options previously mentioned use public resources to reduce the debt overhang and thus avoid losses for private creditors. However in the end, private creditors may gain from this debt restructuring because asset prices increase if confidence returns after a credible debt reduction.  For this reason, it is desirable, according to the Centre for Economic Policy Research, to implement a scheme that shares some of the cost of the debt reduction with private creditors without threatening financial stability. One option is the debt-equity swap in which holders of government bonds would see a given share of their holdings converted to GDP-indexed bonds, that is, bonds in which the principle payment would be reduced dependent on the level of GDP growth for the country.

Source: CEPR (2015), A New Start for the Eurozone: Dealing with Debt – Monitoring the Eurozone 1

The second step after a one-off debt restructuring is to avoid another debt escalation. The European institutions have to prevent moral hazard by ruling out any similar debt restructuring in the future. The Eurozone has already agreed on a set of rules for fiscal discipline as more resilient banks are reducing the risk of new bailout costs.  For instance, the fiscal compact establishes both maximum deficit and debt reduction rules, and the European Commission now has a larger say in the supervision and coordination of fiscal policies. The CEPR notes however that ‘a contract simply requiring countries to pursue a pre-established path of debt reduction is hardly more credible than the rules that failed to stop the imbalances building up and leading to the current Eurozone crisis.’ In other words, there is a significant danger that the current recovery policy will be systematically disregarded in good times, ‘only to return to the top of the policy agenda when markets switch to their risk-on mode’ and austerity policies are again put into place.

Reform policies

In the aftermath of the euro crisis, there has been some significant policy changes. It is not that nothing has been done so far but the policies are not breaking with the current economical models and frameworks that are in place. It is more of the same. So what has been done? There was the introduction of the Six-pack and Two-pack as well as the Euro Plus Pact, which is reinforcing stricter EU control of member state’s public finances. A number of fiscal backstops have been introduced ad hoc under significant pressures from bond markets. In October 2011, the European Financial Stability Facility (EFSF) was ratified and its successor, the more permanent European Stability Mechanism (ESM), became fully operational in 2013. The new ‘European Semester’ feeds into member states’ national reform programmes (NRPs) and is meant to speed up recovery. By the summer of 2012, the ECB committed itself ‘to do whatever it takes’, in the words of Mario Draghi, by announcing the purchase of Eurozone government bonds in the secondary market in an attempt to stave off new speculative attacks. Coined as Outright Monetary Transactions (OMT), this instrument in effect turned the ECB into a ‘lender of last resort’. Meanwhile, a Banking Union is under construction. These examples show that the macroeconomic policy regime in recent years has undergone some major changes, but they lack opening up the rules of the game; there were no game changers.

An alternative could be a temporary handover of the fiscal reigns to a crisis managing institution if international debts run out of control again. Although it works on the state and municipal level in the United States and Germany, on the federal and national level this would be politically impossible and undesirable to implement within the Eurozone. So what are other ways to improve fiscal discipline without the prospect of austerity during periods of low growth? Especially with the notice that it remains important in a monetary union to have stricter common rules on debt levels due to the higher risk of contamination for other members if one country is facing financial problems.

A better mechanism for the current 3% budget rule, which gives too little political freedom to establish necessary changes and investments in periods of recession, is a more flexible approach with the possibility to relax the 3% threshold on the annual budget deficits during an economic slowdown and combine this with a strict measure on the overall debt levels. The risk of debt distress needs to be calculated and a warning system needs to be implemented with a focus on the long-term. This is also what the IMF proposed in 2014 by amending the exceptional access framework for a more flexible one and its proposal to abolish the systemic exemption. Such changes are fair to establish, particularly after a significant debt restructuring has been put into place and countries are now in a relatively safe position.

Countering imbalances

With a debt restructuring and a renewed policy framework on debt in place, these changes still will not impact the Eurozone’s continuing imbalances. If the Eurozone remains imbalanced, which means inhabiting countries with far too high trade surpluses and countries with high trade deficits, this will lead to a renewed unprecedented flow of money from surplus countries to deficit countries. Such imbalances increase the threat of speculation that could destabilize financial markets in member states. Hence, the Eurozone needs a mechanism of fiscal transfers to counter the threats of imbalances due to the different kinds of economies within the single currency. At the moment, four alternative approaches are dominant in the debate, each of which backed by several institutions.

Treaty on the Functioning of the European Union

It will need some time to be accomplished because Article 125 of the Treaty on the Functioning of the European Union (TFUE) now prevents fiscal transfers among member states. So implementation of any scheme would imply either a change of the Lisbon Treaty or at least a new intergovernmental agreement.

The European Commission, and in particular French president Francois Hollande and his counterparts in Italy and Spain, are in favour of Eurobonds.  They believe that Eurobonds is not only a sensible move towards a closer union but also a quick backdoor method for wealthier countries to subsidize Greece, Portugal, Ireland, Spain and Italy. This means that a euro loan, or bond, could be issued by one country and all countries involved would back the loan. The unfairness in the current Eurozone is that with a single currency, one country pays far higher interest rates (Spain, Italy, and Portugal) than the others. (Germany, Netherlands). This means that by issuing Eurobonds Germany has to pay more for its debts while Spain or Greece will pay less.

Video: Barroso vows to present ‘options’ on euro bonds soon

Not surprisingly, the German government and its central bank, plus their companions in Finland, Austria and the Netherlands, are against the idea of Eurobonds. They don’t want to pay higher interest rates, they fear moral hazard, and they don’t want to change the EU treaties that forbid joint debt liabilities.

Not everyone in Germany is opposing the idea of debt sharing within the common currency however. The council of economic advisors to German chancellor Angela Merkel and the opposition party SPD tried to find a compromise. Their proposal is the redemption fund, a plan to create a common liability for national debts but tied to privatizations, free markets and austerity. The fund allows indebted countries to offset some of their interest costs against lower rates that Germany would pay. Rather than turn all national bonds into Eurobonds over time, the debt redemption fund would be limited to 25 years and would be accompanied by a pledge by member states to put debt limits in their constitutions and commit to economic and fiscal reforms, like flexible labour markets and spending cuts. The idea of the redemption fund is to find resistance, mainly in Southern European countries, that are opposed to further tightening of their economic policy possibilities. Conservative forces in Germany are also against any fiscal help for over indebted member states.

Another alternative for Eurobonds is Eurobills, a short-term one-year debt that is backed by all 17 European members. As first mentioned by economists Christian Hellwig and Thomas Philoppon, EU authorities would have more oversight as to whether issuers are keeping to their commitments of sound budgetary planning with the use of Eurobills. It will therefore lower the moral hazard, an argument used against the use of Eurobonds. The European Commission issued an expert group to study both the debt redemption fund and Eurobills idea. In its final report, the expert group concluded that both a debt redemption fund and Eurobills would have merits in stabilizing government debt markets, supporting monetary policy transmission and promoting financial stability and integration. However, given the very limited experience with the EU’s reformed economic governance, the report of the expert group also stated ‘it may be considered prudent to first collect evidence on the efficiency of that governance before any decisions on schemes of joint issuance are taken.’ With a powerful opposition against Eurobonds, plus the debate of other mechanisms of debt sharing on pause for the short-term, debt-ridden countries are currently facing the high costs of paying back their public debt.

Longread ‘Debts and imbalances’

The economic model of the creditor countries has created a low-wage economy, which is not the solution for a sustainable development path for the Eurozone. Engineering a recovery while keeping the single currency needs a radically different perspective on the economy and policies taken at the supranational and national level.

Read the full research article here

A fourth and slightly different approach to counteract imbalances in the Eurozone was put forward in 2013 by the Italian Presidency of the Council of the European Union. The Italians argued for a European unemployment insurance scheme to mitigate asymmetric and symmetric business cycle shocks. Its distinct advantage is that it is a mechanism for the European economy as a whole. The euro crisis unveiled the lack of fiscal coordination and solidarity among its members. A European unemployment insurance for the monetary union is a balanced way to cushion the impact of an economic downturn. It could help in buffering asymmetric shocks and it would alleviate the burden on the budgets of crisis nations and help them re-establish growth quickly. Simultaneously, such an insurance system would guarantee a minimum of social security for Europeans to rely on in times of a crisis.  ‘We could demonstrate that the EU is indeed about shared values, focussing on solidarity rather than just on saving banks, and improving people’s lives through active and discernible measures,’ was said by Angelica Schwall-Düren, a supporter of this approach and also a former Minister for Federal Affairs, Europe and the Media of the German State of North Rhine-Westphalia.

Overview of ideas related to the European Unemployment Insurance

  • In 1993, Majocchi and Rey delivered a proposal within the MacDougall report advising the implementation of a ‘conjunctural convergence facility’ to once more mitigate asymmetric shocks (Majocchi and Rey, 1993). In contrast to other schemes, this system is not triggered automatically; thus it is dependent on the evaluation of fellow member states to rule out idiosyncratic causes unrelated to external shocks. The fund would provide loans and grants to the struggling state, which in turn could pay benefits or invest, for example, in additional training and thus bring down unemployment rates.
  • In the same year, Italianer and Vanheukelen (1993) developed the idea of a stabilization mechanism based on the national deviations in the annual change of the unemployment rate from the EMU average. Unlike Majocchi and Rey (1993), the stabilization mechanism has an automatic feature, even though the authors propose to cap the receipts to 2% of GDP. They also propose a toned down version in which the transfers are only triggered once a certain threshold is passed in order to only activate the mechanism in the event of significant asymmetric shocks, i.e. not smoothing small waves but rather ‘tsunamis’.
  • Bajo-Rubio and Diaz-Roldan (2003) developed a European unemployment insurance system that functions on a monthly basis as it takes the change over the past 12 months as the reference value to trigger the dispersion of benefits. It is a redistribution scheme in which each country pays (1% of tax revenues). Payments are made to those countries and they then experience a rise in their unemployment rate, however this mechanism is only set in motion if at least one country experiences a drop in its unemployment rate, thus testifying to the source of the negative changes as an asymmetric shock. Each month, the receiving member state uses the transferred funds to support the unemployed. Bajo-Rubio and Diaz-Roldan raised another rule that could be applied to reduce the risk of moral hazard: limit the number of consecutive months in which a country is able to receive funds.
  • Enderlein et al. (2013) did not call directly for a European unemployment insurance fund but rather a cyclical adjustment insurance fund (CAIF), which is once more based on the output gap methodology. They do suggest, however, that the output gap as a main trigger could be complemented with indicators such as inflation rates and short-term (cyclical) unemployment. They have not included the unemployment indicator in their calculations, stating that ‘short-term unemployment is a problematic indicator as long as labour market institutions are in the realm of national legislation.’ Of course, the output gap has its drawbacks as well and the net effect over the period of 1999-2014 would have been far less (less than 0.25% of GDP).
  • Sutherland et al. (2012) proposed the creation of a true EU insurance fund that is built at the EU level and paid in by employers or employees, or alternatively an unemployment benefit system. The EU benefits would set a minimum standard for the member states, which could, in cases of severe crisis, be complemented with supplements and extensions. National channels for raising contributions and distributing the benefits should be utilized to minimize administrative costs. The paper suggests leaving the decision about the means by which to collect the contribution (e.g. tax) up to each individual member state. The authors do not provide a simulation of the impact of such a system concerning net benefits or details on either coverage or replacement rate.
  • Depla (2012) in his paper for the seminar ‘EU level economic stabilisers’ presented an unemployment insurance scheme for the euro area as one part of the toolkit for a wider European reform programme. His unemployment benefits scheme differs from the rest since it is not a replacement or the basis for national schemes, but rather a supplement. The unemployed would only be entitled to the supplement if the European Labour Contract were adhered to and if the sum of national and euro area benefits did not exceed the maximum threshold, thus preventing a transfer from less generous states to countries with highly generous systems. The receipt would be paid from an annual contribution equal to 1% of GDP. Depla’s system not only introduces the European component to the unemployment insurance scheme, as the others do, but it also attaches a social component by limiting the transfers.
  • The most comprehensive and in-depth potential architecture for a European unemployment insurance system was proposed by Dullien (2007, 2012, 2013) with the ultimate aim of absorbing the negative budgetary effects of short-term unemployment caused by the business cycle or asymmetric shocks, though not by structural unemployment. The insurance fund would be financed through a payroll tax and the payments and contributions would be collected by the national agencies in order to use the existing framework and avoid additional bureaucratic costs. The minimal standard of unemployment benefits would be covered at the European level, while each member state would be free to choose the services/benefits that they provide nationally on top of the supranational coverage. He proposed a minimum of 12 weeks with a replacement rate of 50%. In his model, Dullien showed the theoretical impact such a system would have had on crisis-ridden Spain once the housing bubble had burst. The transfer, according to Dullien, could have mitigated almost 25% of the downturn in the immediate aftermath of the collapse. The issue of moral hazard is acknowledged and perceivably alleviated in his system, since the EUI only covers a minimum far below the current replacement rate at the national level, thus maintaining the incentive structure to implement labour market reforms. The EUI is expected to remain balanced in the long run and without clear net receivers and net contributors. One element intended to prevent a one-way financial flow is the exclusion of seasonal unemployment within his scheme. Dullien’s proposal is frequently used as a basis for political demands by parties and other institutions (Brantner and Giegold, 2012).
  • Pisani-Ferry et al. (2013) pursued an European (EMU) unemployment insurance scheme for the same reason as Dullien, i.e. as a fiscal stabilizer. Contrary to Dullien, they proposed an insurance system levied on a corporate income tax fully covering the expenditures. A euro area wide applied corporate tax rate of 12.6% is estimated to be sufficient to cover the average euro area costs for unemployment insurance (1.8% of euro area GDP). Unemployment benefits could be covered in full by this budget, with each member state transferring revenues from the first 12.6% of tax on corporate income. The distributional effect could be significant since revenues collected from the 12.6% tax may not suffice to cover domestic unemployment benefits.  Pisani-Ferry et al. showed that this would have been the case for Ireland in 2010. In another exercise, the authors calculated the magnitude of unemployment benefits in the new common system if receipts are dependent on a set-base value (1.5% of GDP) plus a factor of the deviation of the individual unemployment rate from the euro area average. Consequently, Portugal (with a less generous national unemployment benefits system) would receive more financial resources than needed to cover the benefits, thus creating a fiscal stimulus package, whereas Ireland would experience the opposite. The common unemployment insurance is not covered directly in the paper, but rather moved to the appendix and does not give details of the extent to which benefits are covered at the supranational level.
  • Gros et al. (forthcoming) suggests the creation of a European re-insurance scheme for major deviations from long-term unemployment rates. The basic idea is to transfer funds from the centre to the periphery to finance unemployment benefits when unemployment is measurably higher than normal. The system therefore qualifies as reinsurance for national unemployment benefits funds.
    Source: CEPS The European unemployment insurance is a temporary fiscal stabilizer and financed by taxes that are paid both by employers and employees and collected through national unemployment insurance administrations. This insurance approach relates to all employees and self-employed citizens in the Eurozone that have contributed to national insurance systems for at least 12 months prior to unemployment. If the funding of compensation is paid to unemployed workers at the euro area level, the money is more likely to come from prosperous areas and wealthier citizens. It is thus a redistributive tool that could contribute to stabilization. Or as economists Miroslav Beblavý and Ilaria Maselli wrote in their research report as commissioned by the European Parliament, ‘The purposes of the unemployment insurance are, from a purely economic point of view, to provide a counter-cyclical stabilization mechanism to the economy, and from a social point of view, to alleviate the pain of unemployment by providing income security.’

European Unemployment Insurance explained

The scheme would be financed with taxes paid both by employers and employees and collected through national unemployment insurance administrations. It is different from existing schemes as the European Social Fund and Structural and Cohesion Fund as these two funds do not try to create an income support system for the unemployed, but rather they create complementary activation measures such as training, job search assistance and occupational guidance. Therefore, they are not suitable to stabilize the income fall during a recession period in individual member states that could affect their economies even more as less demand will create more unemployment.

The opposition forces claim there is a risk that transfers among member states that will not be temporary but more permanent. It will make countries like Austria, Germany and the Netherlands net contributors and other countries like Spain, France and Latvia net recipients. Others are against higher taxes on labour, which is not good for demand and competiveness. Several studies have revealed that the scheme would have absorbed 36% of the unemployment shock in 2009. Moreover, it would increase the number of people covered by an unemployment benefit scheme, for instance the self-employed – representing 39% and 27% of total workers in Greece and Italy respectively – who are often excluded from any basic unemployment protection system. Therefore, the scheme would not only have stabilized some of the worst periods of recession, but it would have also given a ‘human face’ to the European recovery approaches to the worst hit countries.

Financing new investments

By rebalancing debts and establishing fiscal transfers within the Eurozone, confidence could increase, be re-established and result in higher economic growth. However, for economic growth, investments are particularly needed and need financing. Even with the current interest rate of the ECB of nearly 0%, a significant increase in investments within the Eurozone economies is rare. The logic behind low interest rates is to stimulate economic activity and investments in households and businesses. Yet with such low interest rates already in place for a prolonged amount of time and without sufficient recovery, the ECB can no longer use the interest instrument effectively. Furthermore, if people and businesses feel that they are overleveraged, the interest rate could be cut to zero but still people won’t want to borrow, invest or consume. In a nutshell, this is another core issue the Eurozone is facing, and don’t forget about the debt and imbalance problems. Therefore, the question is where should the money come from for investments that doesn’t increase debt and inflation to unacceptable levels? In this debate, several options are being discussed.

One obvious option is increasing taxation. Professor Kevin O’Rourke, a Fellow of the British Academy and presenter of the Keynes Lecture in Economics at the British Academy for the Humanities and Social Sciences in London on 7 October 2015, explains this option by referring to the words of economist Paul Samuelson: ‘If you are the kind of person who worries about big governments, you might to live up with large budget deficits to maintain aggregate demand. But if you are the person who is worried about fiscal stability, then maybe you should accept a government that is taxing somewhat higher than you deemed desirable.’

Video: lecture by Professor Kevin O’Rourke

Fortunately, there are other options open for debate then just increasing taxation to avoid too high budget deficits. Adair Turner from the Institute for New Economic Thinking and author of Between Debt and the Devil, Money, Credit and Fixing Global Finance explains that this particular time of low interest rates, low economic growth and high indebted states needs a dramatic approach of governments printing more money. Some historic examples like Zimbabwe or the Weimar Republic have shown that printing money would result in hyperinflation, however Turner has this explanation to offer: ‘Monetary finance is like a medicine, which, taken in small quantities, can be very valuable, and taken in large quantities, is toxic. We have to make a choice as to whether we trust ourselves enough to create a set of rules and institutional relationships that would give us the confidence that we could use money printing and money finance in a responsible fashion in a small amount, or whether we’re so terrified that we’ll misuse it that we lock it away in the medicine cabinet, even if, in certain circumstances, it would be helpful.’

Video: between debt and the devil: money, credit and fixing global finance

There are two ways to create money. One way is to print money and spend it. The other way is the banking system to create credit, money and purchasing power. The problem of the current monetary policy, according to Turner, is that only a small proportion of the money supply of an advanced economy is being printed by the government. Most of the money supply is created by commercial banks through loans. The amount of private credit (for households and for business) as a percentage of GDP was about 50% in the 1950s for advanced economies. The level of private credit gradually increased into the 1990s and has been on the rise for the last 20 years where in 2007 a record was reached of 170% of the GDP. After the economic crisis, private loans collapsed due to distrust in the financial system.

Monetary base

Most of the money that is called the ‘monetary base’ – either the notes and coins which circulate or the holdings which the commercial banks have at the central bank or ECB – use data from the website Tradingeconomics. There is a small percentage of 12% in the Eurozone, around 6% in the Netherlands and Belgium and 17% in Greece. The UK (non-Eurozone member) even has just 3% monetary base.

Over the years, the financial market was increasingly trusted in their money creation. At the same time printing money by governments was increasingly feared. According to Turner, ‘What we’ve got to understand is that both government creation of money and spending power and private creation of money and spending power can be dangerous and both can be useful. Optimal policy is about using both but constraining both, rather than iconizing one and demonizing the other.’

This argument of printing more money has several important supporters including Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, Andrew Jackson and Ben Dyson in Modernising Money, the Financial Times columnist Martin Wolf, and the Positive Money movement.  The new money would: be added into the economy as to finance government spending in place of taxes or borrowing; make direct payments to citizens; redeem outstanding debts, public or private and; make new loans through banks or other intermediaries. There are many significant advantages according to Martin Wolf: ‘It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end “too big to fail” in banking. It would also transfer seignorage – the benefits from creating money – to the public.’ Wolf is opposed to the fact that a significant reduce in the supply of loans in the economy would reduce economic growth and dynamics. He pointed out that only 10% of the private bank loans in the United Kingdom went to the real economy, to entrepreneurs with new business ideas and to investments in productivity growth. Letting banks create money mainly for speculative reasons on property markets is too much of a financial risk and not worth it, as Wolf argues.

See the videos of Positive Money

video course about Banking 101 by Positive Money.

This is important because debt never just goes away. It simply shifts around the economy from the private to the public sector, as professor David Graeber of the London School of Economics explains for The Guardian. This already occurred in the late 1990s when governments started to shift their debt burden into private hands, which resulted in budget surpluses for some countries. Simultaneously, there was a surge in private debts, especially for lower waged workers, which turned into a financial crash. Therefore, allowing governments to print some amount of money instead of letting banks create even more money through loans to finance its fiscal deficit by creating jobs and stimulating investments could therefore be a serious alternative option.

Another option to increase finance for investments in the Eurozone is with Quantitative Easing. The ECB already took the steps forward to circulate more money within the economy with the implementation of a €1.1 trillion scheme that will last until September 2016. ECB President Mario Draghi has also offered to extend this scheme if inflation in the Eurozone does not rise back to the ECB target of 2%. This decision should be seen as a significant change in policy and an indirect attack on austerity policy. It means that the ECB is buying €60 billion of government and private bonds each month from across the Eurozone. In other words, ECB is buying debts of the Eurozone countries to increase money supply and bank reserves of commercial banks so that they can pump this extra created money into the economy through the financial market. In theory, this would keep interest rates low, increase confidence among private banks about their own lending, increase lending and spending, and therefore would boost economic growth and counter deflation.

Quantitative Easing explained

Although the main concern of the ECB is deflation that threatens postponing necessary investments by the private sector that are necessary to kick-start economic development, the programme could give governments some breathing room and avoid the toughest austerity measures, especially in most debt-ridden countries in Europe (e.g. Spain, France, Italy and Greece). However, the compromise with the creditors (e.g. Germany, Netherlands) is that 80% of the bonds bought will sit on national central banks’ balance sheets with just 20% subject to ‘risk-sharing’ through the ECB. This shows how low solidarity within Europe is from the stronger economies to the weaker economies in the Eurozone. With this 20% rule, the stronger economies try to avoid that reforms to cut spending in weaker economies will be postponed. A policy that in theory could ease the most severe austerity in many of Europe’s most struggling economies is now limited.

Jean Pisani-Ferry is a professor at the Hertie School of Governance in Berlin and currently serves as the French government’s Commissioner-General for Policy Planning. He is the former director of Bruegel, the Brussels-based economic think tank. He wrote in his article ‘The ECB and its critics’ for the Project Syndicate website on 31 January 2015 the following:  ‘The argument that QE [Quantitative Easing] will destroy fiscal discipline cannot be rejected out of hand, because both its proponents and its adversaries seem to agree that its days are over. But, though it is true that ECB bond purchases will shelter governments from market pressure, such pressure was already fairly ineffective. It is governments’ job to uphold their end of the bargain and ensure that they do not shirk their responsibilities. This is what the EU’s “fiscal compact” is for.’

However, this current policy of the ECB is exactly the opposite of what the supporters of the printing money option are aiming for. Recovery has been put purely into the hands of banks that are being given more confidence to create money with new loans. It must be said that the impact of Quantitative Easing in the United Kingdom and the United States shows that most of the money was not pumped in the real economy for productive investments, but for speculative policy that increased inequalities and with little impact on job creation. The banks and big corporations used the extra money to improve their own assets (for example to buy their own shares). The money did not help the development of the real economy, or go towards loans to small and medium-sized enterprises (SMEs), or to benefit households in spending more money.

Is Quantitative Easing the answer?

The question remains: is Quantitative Easing the solution to spur economic growth in Europe? The United States and United Kingdom were pumping extra money far earlier into the economy through Quantitative Easing. Although these economies were able to come out of the economic recession earlier than the Eurozone, they also have the advantage of the single currency. In the debate about the effectiveness of Quantitative Easing, the defence is that it is the best way to pump money in an economy, especially when inflation rates are at their lowest in decades. It will benefit employment and build confidence in the financial sector that was not willing to lend capital among them. However, the impact of Quantitative Easing on the real economy is far lower. In the United States and the United Kingdom it is the rich that benefited significantly from the extra money. Bond traders have benefited from making large profits out of the central banks by manipulating the bond market. Corporations that got more money did not use the money to invest, increase productivity and employment, but instead they used the money to buy back their own shares. This is called corporate buybacks in which a company buys back its shares from shareholders.

It hit record levels in 2014 with $555 billion spent in October alone. Share prices rose and it was good for the top 1% of the United States that owns 35% of United States shares for the investment banks to arrange the buybacks. Many company directors had incentive schemes tied to the price of their shares as well. With Unites States corporate borrowing growing at twice the rate of United States corporate sales, it’s unlikely that this situation can be sustained (See also the expert opinion of Eileen Appelbaum at The Broker website). In the United Kingdom, much of the impact of Quantitative Easing has fed into rising asset prices, including property rather than increased investment and therefore spending by companies. The Bank of England’s own assessment notes confirm there is an increase in asset prices and, as in the United States, the ownership of assets is concentrated. The Bank of England estimates that 5% of households in the United Kingdom own 40% of the assets most affected by Quantitative Easing .The prices of central London mansions have soared since 2009 even as real wages continued to decline. So the reality of Quantitative Easing, although it helps the recovery of the economy, is that the same financial sector that had to be rescued some years earlier with billions of dollars and pounds of taxpayers money due to bankers’ risky lending now benefitted again in the midst of financial and economic crisis. The created bailout billions has since encouraged banks to use this extra money through greater risk taking and for higher profit seeking. The first thought of the bankers was not to lend to profitable enterprises but to use the money for speculation that profited the wealthy even more. See more in the blogs of the New Economics Foundation and the Economics Helps website.

The idea of Quantitative Easing is not a bad one though. There is a debate about alternative and strategic forms of Quantitative Easing guarantees that money will go less often into the banking sector and instead flow more directly into the real economy via households, SMEs and government spending. Such policy could blur the line between monetary and fiscal policy but in reality, the distinction has always been blurred. The New Economics Foundation in the United Kingdom has therefore stated: ‘We have already entered the world of monetary policy activism; let’s make it as effective, transparent and accountable as possible.’

A different way to finance necessary investments, especially those in the high-indebted Southern European countries, is to allow the European Investment Bank (EIB) issue bonds for a Pan-European Investment-led Recovery ProgrammeAccording to Guntram Wolff, Director of the Brussels-based economic think tank Bruegel, and backed by economist Joseph Stiglitz and former Greek Finance minister Varoufakis, the EIB and the European Investment Fund (EIF), a smaller offshoot of the EIB, should be given the green light by the European Council to embark upon this investment programme to the tune of 8% of the Eurozone’s GDP. Not only that, this investment programme would allow the EIB to concentrate on large scale infrastructural projects and the EIF to focus on start-ups, SMEs, technologically innovative firms and green energy research. The EIB and EIF have been issuing bonds for decades now and fund investments covering 50% of the projects’ funding costs. This new idea is suggesting that EIB and EIF should now issue bonds to cover the funding of the Pan-Eurozone Investment-led Recovery Programme to the fullest capacity (i.e. waving the convention that 50% of the funds have to come from national sources).

Central bank support for national infrastructure investments

Central bank support for national infrastructure investment has worked before. The Industrial Development Bank of Canada, which supported Canadian SMEs from 1946-1972, was capitalized entirely by the Central Bank with not a single penny of taxpayers’ money required. In New Zealand in 1936, the central bank extended credit for the building of new homes and helped the country out of the Great Depression. Moreover, the majority of the United Kingdom’s major international competitors, including emerging market economies, have public investment banks or equivalent funds supporting infrastructure or SME financing.

Source: New Economics Foundation

Investments are not only important to increase economic growth; they also tackle the imbalances in Europe. First of all, Germany and the Netherlands should not spend their money surpluses abroad. They should instead invest in upgrading their infrastructure and education as to increase productivity and improve their international competiveness versus lowering wages and allowing their capital to be invested abroad. More investments in the North would increase demand in the North in which Southern European countries’ export economies could build. In particular, the northern member countries of the Eurozone face historically low long-term interest rates. The German government, for example, can borrow at less than 1% at a maturity of 10 years. This is a ‘window of opportunities’ according to Paul De Grauwe, professor at the London School of Economics. ‘Money can be borrowed almost for free while in all these countries there are great needs to invest in the energy sector, the public transportation systems, and the environment.’

Financial market regulations

As seen previously, there are feasible options in restructuring current sovereign debts, counter imbalances and increasing investments through alternative mechanisms without the threat of increasing government debt levels or running unacceptable high inflation rates. One particular policy still has to be made; in particular when private banks remain in power to create money out of nothing and thus trigger financial crises. The financial markets need to be regulated to a certain extent and its increasing influence on the economy needs to be limited. Banks are needed, but their power to increase loans must be regulated. This is because banks are not normal industries. To quote Adair Turner again: ‘If finance was like restaurants or hotels or automobiles or clothes, we’d say, well, if it’s grown it must be because as people got richer, they wanted to buy more of these things, and it’s up to consumers. But nobody gets up in the morning and says, I think I’ll have a really good day today: I’ll go and buy some financial services.’ In other words, it is not an end-consumption good and therefore it is reasonable to question whether a nation needs all the finances it has received over the past years.

The European Commission published in 2014 the Structural Banking Reform proposal, which is partially based on the conclusions of the independent Liikanen report. The aim of the proposal is to limit excessive risk-taking in banking due to ‘too big to fall’ implicit insurance incentives, and with that reduce the risk of the public saving the financial sector during the next crisis.  One recommendation is to split the retail banking from investment banking. There is a fierce lobby of the financial sector against this proposal and as they point out: the split is costly; it will reduce the amount of credits in the economy and; harm growth and job creation in the European Union.

More about the debate about banking reforms

See more about the debate about banking reforms here.

The counter lobby’s arguments fit in the idea of softening  banking reforms that urged in the last years in contrast to the rhetoric of policymakers just after the financial crisis. This ‘softening’ can also been illustrated with the European Commission’s recent appeal that suggest that the role of financial markets to create markets is a ‘good thing’. And there is an agreement that legislators should be careful not to damage liquidity by unduly restricting banks’ ability to make markets. This view is increasingly related to the proposed Commission’s Action Plan on Capital Markets Union (CMU). This action plan is exactly the opposite of what an alternative approach should look like if the aim is to reduce the money creation power of the private banks, to stabilize financial markets, to avoid the next crisis, and to stimulate economic growth through other financial instruments as the banks hardly invest in the real economy. A group of European NGOs and think tanks that form Finance Watch therefore opposed the proposal: ‘The CMU revives pre-crisis trends without adequately integrating the lessons from the crisis. It also marks a shift in the political momentum towards short-term growth and competitiveness at all costs, when what is needed is long-term sustainable development of the economy,’ as they stated in a letter to the Commission.

If the CMU would be implemented, no radical systemic change would be stimulated in the financial sector and it will be back to business as usual in the core activities with just some extra checks and balances and some increased resilience within the financial industry. With CMU, the focus is exclusively on how to finance the economy, and the direction is in favour of financial institutions. Although there is faith in the financial sector to finance economic growth again, there is no debate on what they should finance. There is no incentive to shift the direction of capital away from speculation into the real economy and, for example, into decent livelihoods, fair jobs and investments addressing climate change.

Who will benefit from these new proposals? It is likely to be the banks themselves and not the SMEs or businesses that need loans for expansion and productivity growth, as Finance Watch is claiming. For the 90% of SMEs ‘capital market-based financing is largely irrelevant’. There are several studies that show that a financial sector that stays too big for the national economy is more of a burden for economic growth than a blessing. Thus, the debate about alternative banking approaches to invest more in the real productive economy seems to be separated from the debate about who will finance the recovery and where it should be integrated to get the best results out of the investments and loans. What could be proposed to change the direction of capital flows away from speculation and into decent jobs and productivity growth?

Impact of financialization

From: FINNOV Research Programme, Policy Paper

‘Growth relies to a large extent on productivity enhancing innovation, which typically requires investments of patient capital and a distribution of incentives that rewards everyone who contributors to the process – including workers and taxpayers. To be effective, these incentives and rewards need to be roughly commensurate with the money, time and energy that they contribute and put at risk.   The current financial system often promotes impatient capital, which eschews long connections with investment projects. Practices such as corporate stock buybacks to attain short-term boosts in share prices, premature initial public offerings or trade-sales of startups, the use of high leverage to amplify returns at the long-term expense of firms, workers and pension funds, and excessive executive pay at the expense of workers, taxpayers, and long-term shareholders are all symptoms of this problem.’

See also: this Broker blog about the rise of financialization. Or to quote Dean Baker in his blog post for The Broker: ‘For example, there is evidence that a bloated financial sector is a major impediment to growth. While advanced economies need a well working financial sector to allocate capital from savers to those who want to borrow, when the sector gets too large relative to the size of the economy, it is simply a drag on growth (Cecchetti and Kharroubi). From this vantage point, policies designed to reduce the size of the sector, such as a financial transactions tax, will help to boost growth while at the same time hitting some of the highest earners in the economy.’

Some alternative approaches have been mentioned by The Finance Lab, for example. Some examples are community banking, democratize banking decision-making and stimulate patient capital investments. The EU funded FINNOV Research Programme concluded the same suggestions in 2012. Their recommendations are that short-term investment incentives like stock buybacks have to be considered a manipulation of the market and banned, such as in many European countries before the late 1990s. Furthermore, the outcome of the FINNOV research programme highlighted that ring fencing, raising capital requirements, and legally separating executive and financial investor responsibilities may be effective to get the incentives in core banking back to the real productive economy. There have to be new instruments to stop penalizing the higher risk associated with long-term productivity enhancing investments and investments in decent jobs and the green economy. Only then can bank lending to innovative firms of all sizes, and especially the smaller ones, increase significantly. Governments should be more active and stimulate or set thresholds for sustainable long-term investments or investments to SMEs for banks. They could also issue an independent monitoring mechanism to blame and shame the banks that are not improving.

Video: Transforming Finance by The Finance Lab

Finally, the introduction of a financial transaction tax would immediately deliver several positive effects. First of all, it would make high frequency trading unattractive as a business model that serves the real economy in no discernible way and instead encourages speculation and jeopardizes the stability of financial markets. Revenue generated by such a tax would add resources to local, regional and national governments that could be spent on education and infrastructure and for the benefit of individuals and the community.

Avoiding a race to the bottom

With high unemployment levels especially among the youth, and with most job creation in low wage jobs, a genuine European recovery policy should focus on stopping the race to the bottom in the Eurozone and revalue labour. The European unemployment insurance scheme has been mentioned already, and although such schemes would stabilize the European economies during a recession, it will not change fundamentally the functioning of the labour market. This is linked with the export-driven economic model in which a growing amount of wage-work has been purely seen as a cost due to the point of view of being competitive in the international market. It has led to more flexible work and de-standardization of the labour contract, which increases precarious work for lower and middle class European households. The route towards even more flexibility and increasing job insecurity cannot continue. It eventually will become a burden on the economy because workers cannot afford to buy enough to stimulate the overall economy. Cheap credits and gambling on exports sectors for aggregate demand is too risky. So where do we start?

First of all, halting de-standardization of labour contracts, flexibilization and the rolling back of progressive taxation regimes by governments will restore and protect the income position and rights of workers. More structural problems should be addressed as well, as The Broker’s online debate in 2014 revealed. The synthesis report of that debate highlights that the current trend of low wages and faltering job creation in more advanced economies could be halted by increasing productive and greener investments. Achieving this first however requires a change at the core of the financial markets led by investment banks and private equity funds. A shift from capital to labour will reduce the dependence on debts to stimulate growth. Limiting the tax deductibility of interest, for example, would make over-leveraging companies less attractive. Taxing interest, capital gain and dividend income for non-financial companies at higher rates than income generated from their core business will encourage them to refocus on productive investments and long-term sustainability that could improve employment in the end.

If this could be combined with higher real interest rates, this would permit productivity rewards to be passed on to workers in the form of falling prices, driving up real wages, total demand and the rate of job creation. This is also known as good deflation. Secondly, it would help prevent large-scale financial crises by limiting excessive credit binges, as real interest rates rise to offset increasing productivity growth. Finally, slightly higher real interest rates would force companies to focus on productivity growth as a source of profits, as they would not be able to benefit from ultra-cheap financing and relatively lower exchange rates.

Article: Pre-distribution and monetary policy

Read more in The Broker’s expert opinion ‘Pre-distribution and monetary policy: stabilizing employment and growth’ by Thomas Aubrey, founder of Credit Capital Advisory and Senior Adviser at Policy Network. He writes that in an increasingly globalized world that places downward pressure on nominal wages, monetary policy should permit the rewards of productivity growth to be passed on to workers in the form of falling prices. Targeting nominal income growth to equal the growth rate of total factor productivity would allow prices to fall in proportion to productivity growth, and allow the broader workforce to benefit from its productive activity.

Ways of achieving support for research and development activities, education, training and human capital are also important because it could include adequate social protection combined with efficient job activation policies and skills formation. The European Social Fund and the European Globalization Fund provide support to help workers adjust. Nevertheless, not all workers will have the ability to upgrade their skills to meet the requirements of the new knowledge and technology-intensive activities, and thus will remain employed in jobs that are subject to international competition from countries with lower quality standards for employment.

At the same time, policymakers must reject the dogma that governments cannot ‘pick winners’. Either directly or indirectly through institutions such as publicly owned banks and governments, they must ensure that sufficient investment spending is directed to socially useful activities. See for example the book by Mariana Mazzucato The entrepreneurial state. Particularly in the economically weaker regions of Europe, public employment and publicly financed ‘private’ jobs are at the heart of the entire employment system. Economic adjustments based on public spending cuts therefore aggravate regional imbalances.

In line with Mazzucato, there is an increasing and renewed demand by some economists like Justin Lin, Joseph Stiglitz and Ha-Joon Chang to enable sector and industrial policies. Member states of the Eurozone must be able to invest public money in sector development to stimulate future economic growth. Such investments should not just focus on the sectors that have a comparative advantage in the international market, but should also develop economic sectors for economic growth and employment strategies in the long-term. Public investments are essential in generating important breakthroughs for innovations, especially in the first stages of research and public investments development.

Some resources on Industrial Policies

This also justifies a policy in which states use their role to acquire a stake in the commercialization of successful technologies, something economist Dani Rodrik favours. He argues that as member states already play a significant role in funding new technologies, they should use that role to acquire a stake in the commercialization of successful technologies. If they do not lay claim to the spill over effects of their investments, governments should leave the profits entirely to private investors. Rodrik’s is therefore arguing that governments should benefit from new technologies to redistribute the wealth gains among the population through a ‘social innovation dividend’.

Linking economic reforms with a social and democratic Europe

As the numerous examples in this article have shown, many alternative monetary, fiscal and economic policies exist that make Europe not just a more crisis-resistant continent, but also a more social one.  It is a choice between selective investments in the future, to either be financed by cuts in social welfare or to have an inclusive social policy that is embedded in a strong, well-funded welfare state that includes protection for different situations of risk over the life cycle (educational deficits, unemployment, poverty, old age and sickness).

The cutbacks in welfare states since the overall acceptance of the neoliberal or neoclassical economic model in the last two decades, as accelerated by the economic and financial crisis in Europe, have been defended as an economic necessity to give people a greater incentive to find better and more productive work, and therefore promote upward job and social mobility. Yet research has shown that austerity policies in Europe have resulted in a decreasing total income position for lower income groups, including the lower end of the middle class. Cuts in tax credits and employment subsidies, for example, have negatively affected the demand side of the economy and have created the risk of even more economic turmoil.

Given the economic woes in the Eurozone in combination with the ageing predicament, European welfare states are confronted with a formidable social investment challenge. The DG Employment, Social Affairs and Inclusion of the European Commission therefore developed the Social Investment PackageThe package focuses on the importance of social investments rather than the often physical investments in the economy. The package also explicitly distances itself from the traditional stable money, fiscal austerity and structural reform paradigm. ‘The ‘Social Investment Package’ in effect and at long last breaks away from the negative theory of the (welfare) state by underscoring the key importance of activating social services as core providers for dual-earner families and labour markets,’ writes Anton Hemerijck, a professor at Vrije Universiteit Amsterdam and London School of Economics and Political Science.

It is certainly not true that governments in Europe are not taking action. In 2014, Germany finally agreed to establish a minimum wage of €8.50. In the United Kingdom, the minimum wage was increased by 20 pence an hour to £6.70 in March 2015. The Dutch government is considering legislation against ‘bogus constructions’ in labour contracts. There is even a debate about ways to insure workers who have no standard contracts. However, the broader picture is of a shrinking welfare state without an alternative route map to a comprehensive social policy for Europe. Furthermore, workers need more bargaining power and empowerment. ‘Since the 1990s and in particular during the euro crisis it has become clear that the social dialogue increasingly serves the purpose of legitimation; at the same time, the social partners have come to have less of a real say in decision-making. The social dialogue has been markedly diluted due to the lack of support from the European Commission and economic crisis policies at national and European levels,’ as Alexander Schellinger, researcher at the Friedrich Ebert Foundation in Berlin, writes. Schellinger opts for a far more transparent decision-making process within the monetary union, one that is now solely the arena of economic and financial ministers. The inclusion of social partners and ministers of employment and social affairs would increase the dialogue and outward look for alternatives.

Such diversification in decision-making processes on the European level will increase checks and balances and could reduce the democratic deficit within the Eurozone. There are many critics that fear a loss of sovereignty if the democratic deficit on the European level would promote stability and reinforce cohesion within the Eurozone. Whoever wants to keep the euro without its current problems has to step up their efforts towards a fiscal and political union. ‘While the desirability of establishing a monetary union may have been open to question in the 1990’s, dismantling the Eurozone now would trigger profound economic, social, and political upheaval throughout Europe,’ explains Paul De Grauwe. ‘To avoid this outcome, Europe’s leaders must begin designing and implementing strategies aimed at bringing the Eurozone closer to a fiscal union.’ Only with more democracy and transparency, as sociologist and philosopher Jurgen Habermas and many other experts have proclaimed.

Jürgen Habermas’ ideas on Europe

Jürgen Habermas is one of the intellectual figureheads of European integration. A Düsseldorf born philosopher and former assistant of the prominent Frankfurt School theorist Theodor Adorno, Habermas works on the establishment of a pan-European political and cultural identity. His work Structural Transformation of the Public Sphere went on to influence and shape policy debates in Europe. At the start of the millennium, Habermas was one of the leading drivers behind calls for a European constitution.

Recently, the 86-year-old aggressively criticized Merkel’s leadership in Europe in books such as The Lure of Technocracy, while also brought criticism onto himself. In 2013, Habermas clashed in a series of articles with another influential German left-wing intellectual and sociologist Wolfgang Streeck who has identified the kind of European federalism espoused by Habermas as the root of the continent’s crisis.

Habermas told in an interview with The Guardian that he agreed with many of his critics’ main points: ‘Streeck and I also share the view that this technocratic hollowing out of democracy is the result of a neoliberal pattern of market-deregulation policies,’ he said. ‘The balance between politics and the market has got out of sync, at the cost of the welfare state. Where we differ is in terms of the consequences to be drawn from this predicament. I do not see how a return to nation states that have to be run like big corporations in a global market can counter the tendency towards de-democratisation and growing social inequality – something that we also see in Great Britain, by the way.’

Read the whole interview Habermas had with The Guardian. 

This process would also include the way to democratize the economic decision-making on the micro-level for corporations. This is what is called a transfer from the current shareholder economy towards a stakeholder economy where more values than just that of the shareholders can be guaranteed. Professor Robert Reich is a supporter of such a shift in saying, ‘Only some of us are corporate shareholders, and shareholders have won big […] over the last three decades. But we’re all stakeholders in the […] economy, and many stakeholders have done miserably. Maybe a bit more stakeholder capitalism is in order.’  A similar approach is that of the solidarity economy in which economic units are owned and managed by their workers. These include cooperatives, associations of small producers, local and regional economies that are characterized by degrees of cooperation between businesses and communities.

Expert Opinions from The Broker

Robert B. Reich, who is Chancellor’s Professor of Public Policy at the University of California at Berkeley and Senior Fellow at the Blum Center for Developing Economies, argues in favour of a stakeholder economy. ‘The fundamental problem with big businesses nowadays is that their potential to serve the public good has been hijacked by their shareholders. Whereas ten years ago shareholders kept their shares for an average of eight years, this had fallen to four years only four years later and it is now just a couple of months. With devastating consequences for environmental and social values. According to Mayer, the short-termism of shareholders runs against all the principles of wellbeing…What is needed are long-term committed owners, independent boards, more responsibility for conduct and consequences (e.g. distribution within value chains), tougher enforcement, reform of business education, and redefining roles and responsibilities.’

Jose Itzigsohn, professor at the department of Sociology at Brown University, explains the solidarity economy: ‘A solidarity economy is based on economic units owned and managed by their workers. These include cooperatives, associations of small producers, local or regional economies characterized by degrees of cooperation between businesses and communities, local money initiatives, community initiatives for the delivery of services, and the like […] A solidarity economy is based on economic units owned and managed by their workers. These include cooperatives, associations of small producers, local or regional economies characterized by degrees of cooperation between businesses and communities, local money initiatives, community initiatives for the delivery of services, and the like.’

Paul de Beer, Henri Polak Professor of Industrial Relations at the University of Amsterdam, explains how ownership of capital should change: ‘[H]igher tax rates on wealth will probably increase the urge to achieve high returns. For this reason, I would suggest focusing more on distributing wealth instead of taxing it. This could, for example, be achieved by letting employees share in company profits, which would not be paid out in cash but in shares. Thus, workers would gradually acquire an increasing share of the equity of a firm. As employees become shareholders of their own company, the dividing line between employees and shareholders gradually fades. Crucial is that employees do not sell their shares, but accumulate them.’

Wage-led growth

What this series of arguments and research findings has shown is that overall, little has come from the ideals of the single currency. The Eurozone is experiencing an euro crisis with low growth levels, high unemployment, high indebtedness, low investment rates and low productivity growth. The single currency cannot be blamed for all of that because the internal dynamics and political choices in the Eurozone transformed the financial crisis into an euro crisis. The current answer for what is a systemic crisis is not a systemic change, but more of the same by propagating that there is no alternative. As this article showed, there are plenty feasible alternatives.

Many different alternative approaches could rebuild the Eurozone, increase trust and give the European plan a social face. Picking just one alternative is not enough; the Eurozone needs a major shift that integrates the macroeconomic perspectives of debt restructuring, money creation, investments, and fiscal transfers with other perspectives on labour markets, social policy, democracy, and power relations in decisions where capital and profits are invested. What is essential for the Eurozone is to reduce debt and its imbalances. Money that comes free from lower debts should be used for SMEs, innovative businesses and creative start-ups that generate employment and productivity. New ways to create money should be discussed. This means a renewed public sector, systemic changes in the financial sector and a focus on productive industries.

It becomes clear that the recovery and the future of the Eurozone must be built on a wage-led growth strategy. A wage-led growth strategy aims at establishing a full-employment growth model in which sustained wage growth drives demand growth via consumption growth and via the accelerator effects of investment growth as well as productivity growth via labour saving induced technological change. A wage-led growth strategy will result in stable or rising wage shares. How can changes in income distribution be achieved? ‘The starting point for pro-labour distributional policies are minimum wage policies in combination with legislation that strengthens the status of labour unions and collective bargaining institutions,’ as economist Engelbert Stockhammer at the Kingston University writes. He also emphasizes that a wage-led growth strategy includes measures to restrict financial speculation, encourages a more long-term view in corporate governance (such as strengthening the role of stakeholders) and reins in excessive pay in the financial sector; these are complementary with the distribution goals of such a strategy. Such measures are likely to include restrictions on bank bonuses, financial transaction taxes, pro-cyclical credit management, regulation of the shadow banking industry, closure of secrecy jurisdictions (tax havens) as well as the establishment of a sizable not for profit segment within the banking industry. There could also be a strengthening of stakeholders within corporate governance that will also lead to an enhancement of labour’s bargaining power and the wage share.

Wage-led growth explained

Ozlem Onaran, professor of Workforce and Economic Development Policy at the University of Greenwich, wrote for The Broker about wage-led growth. In her view, economic growth should go hand in hand with an improvement in wage share and vice versa. However, current policy has put no end to both the unsustainable debt-led consumption and export-led beggar of neighbour economic models.

‘Debt-led consumption, enabled by financial deregulation and housing bubbles seemed to offer a short-term solution to aggregate demand deficiency caused by falling wage shares in countries like the United States, United Kingdom, Spain, or Ireland until the crisis. The current account deficits and debt in these countries were matched by an export-led model and current account surpluses of countries like Germany or Japan, where exports had to compensate for the decline in domestic demand due to the fall in labour share…However this model also proved to be unsustainable as it could only co-exist with imbalances in the other European countries – an issue, which is now at the epicentre of the euro crisis. A further rise in inequality is the outcome. A truly inclusive solution to the crisis and European imbalances should focus on rising inequality in both functional and personal income distribution…However, mainstream economics continue to guide policy towards further wage moderation along with austerity as one of the major responses to the Great Recession.’

In the report Onaran co-authored for the International Labour Office ‘Is aggregate demand wage-led or profit-led? National and global effects’,  she presented the vicious cycle generated by the decades long race to the bottom. ‘The main caveat of this common wisdom is to treat wages merely as a cost item. However, in reality, wages have a dual role affecting not just costs but also demand.’

A wage-led growth strategy and the amount it could contribute to economic recovery was recently measured by economists Ozlem Onaran and Giorgos Galanis. They indicated that the effects are substantial, particularly if implemented simultaneously at the global level. The wage-led growth strategy is a medium term; one that ensures that over longer periods of time consumption expenditures can grow without rising debt levels. However, fiscal and monetary policy is required to restore full employment alongside such a strategy. If the euro is embedded in such a model, its original optimism and ideals could be reinstalled alongside trust in society for the European project. It has to make sure that Europe does not allow a race to the bottom, but secures a race out of the bottom.


❕ Unfortunately, due to the age of this contribution and several migrations to online content management systems, the footnotes in text may have been lost. The footnotes below are listed in its original order of appearance in text.
  1. Authors of the publication A new start for the Eurozone: Dealing with debt (2015) of the Centre for Economic Policy Research (CEPR) are: Giancarlo Corsetti (Cambridge University and CEPR), Lars P. Feld (Walter Eucken Institut and University of Freiburg), Philip R. Lane (Trinity College Dublin and CEPR), Lucrezia Reichlin (London Business School and CEPR), Hélène Rey (London Business School and CEPR), Dimitri Vayanos (London School of Economics and Political Science and CEPR), Beatrice Weder di Mauro (University of Mainz and CEPR).