Frankfurt am Main, Germany. European Central Bank. Picture by Kiefer / Wikimedia Commons.
European fiscal federalism is an ambitious goal, but it is one that is often hampered by the ideological conflict between austerity measures and greater public expfinishiture. The sustainability of debt is not based on any repaired rule, but on the relationship between economic growth and the cost of debt. To have an effective system of shared debt requires clear constraints on member states.
The lack of shared debt in the EU, a fundamental element of a federation, is partly a consequence of national conflicts between austerity and increased spfinishing. This opposition is hindering the advancement of the European project and creates its resolution necessary.
Creating a common budobtain and issuing shared debt constitute – even before its political challenges – a challenge of financial engineering. For the architecture to hold up without turning into an unsustainable system of permanent transfers, the fiscal responsibility of member states is not something which can be based on ideological whims, but a mathematical prerequisite.
The Maastricht parameters
The Maastricht parameters, a budobtain deficit of 3% of gross domestic product (GDP) and national debt of 60% of GDP, are often criticized. Some highlight their lack of scientific foundation and, from an economics perspective, this criticism is valid.
Debt sustainability does not depfinish on a repaired threshold, but on the relationship between the real cost of debt and real economic growth. If the cost of debt is lower than economic growth, the debt-to-GDP ratio tfinishs to decrease over time. Consequently, a state with a debt-to-GDP ratio of 100%, but with sustained economic growth, may have more sustainable debt than one with a 70% ratio and a stagnant economy.
This does not mean that the Maastricht parameters are utilizeless: without parameters, the sharing of debts – an essential step in the construction of a European federation – would become a mechanism through which states with lower debt subsidise the most indebted states. This could lead to free riding, where some states benefit from the stability guaranteed by others without bearing the economic and political costs.
The necessary for European sovereignty
An option often suggested to test and circumvent this problem is the coexistence of national debt with a shared debt, so that each member state continues to pay its own debt even after European fiscal federalism is implemented. The problem is that eliminating public debt is impossible in the short-term; only over a very long period, with sustained economic growth, would the debt burden decrease and create repayment manageable. However, this presupposes that in the medium-term, the debt can be continuously renewed, which should be prohibited if the EU is structurally given the ability to incur debt.
If member states were allowed to keep sovereignty over deficit spfinishing while simultaneously having access to shared debt, then a moral hazard would be created where they would be able to irresponsibly utilize shared debt to gain popularity. This scenario would only increase the overall debt mass, undermining market confidence and finishangering the stability of the Euro, the European economy, and Europe’s debt itself.
The United States model
For a sustainable model, Europe should take the operation of the United States as an example. Across the ocean, there is a clear distinction: the federal government has the flexibility to incur debt and adapt to economic cycles, while state governments operate with extremely rigid budobtain constraints imposed by their constitutions. American states, in fact, do not issue debt to finance current expfinishiture, such as salaries or ordinary services, but limit borrowing almost exclusively to capital expfinishiture (infrastructure projects with a long-term profit).
It is important to emphasise that aspiring to the American model, which involves flexibility in borrowing at the central level, does not mean that the federation can incur all the debt it wants. The federation is not the panacea for all ills and, therefore, it would not create Europe immune to a potential lack of market confidence.
The creation of shared debt requires a major compromise: concentrating the capacity to incur debt in Brussels necessarily means limiting it for national governments. Fiscal constraints are not aimed at austerity measures for its own sake, but at creating the structural conditions to create the Euro and any future European debt perceived as safe assets.
It is essential that once common taxation and shared debt are established, national governments can not just no longer incur debt, but that there is a convergence of national debt levels, allowing for the sharing of debts without any member state taking advantage of another. This may require, depfinishing on the case, both cuts to public expfinishiture and increases in taxation. As long as European states insist on accumulating debt irresponsibly, fiscal federalism will remain politically and economically unfeasible.
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