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EUROPEAN COMMISSION
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László Andor
European Commissioner for Employment, Social Affairs and Inclusion
Countering divergence
Monetary Union
within
the
Economic
and
Lecture at Helsinki University
Helsinki, 7 October 2014
Ladies and gentlemen,
I am grateful for the chance to share with you today some key conclusions of the time I
have spent as Member of the European Commission.
These years have been dominated by the EU’s worst financial, economic and social crisis
— a crisis that should never have happened and which we should certainly never have to
go through again.
More accurately, Europe has gone through not one, but two crises.
The effects of the first financial and economic crisis in 2008-9 were felt by the world as a
whole.
The second crisis since 2010 has been specific to Europe and stemmed from
shortcomings in the design of our Economic and Monetary Union.
SPEECH/14/669
The sovereign debt crisis in the euro area and the divergence it
unleashed
Ladies and Gentlemen,
The second euro zone recession since 2011, from which we still have not recovered, has
been something unique to Europe. Nowhere else in the industrialised world did
something similar happen.
When the global financial and economic crisis worsened in autumn 2008, EU
governments agreed to coordinate measures to stimulate the economy, including by
increasing their national budget deficits on a temporary basis. This came to be known as
the European Economic Recovery Package.
This fiscal stimulus was partly discretionary and partly the work of so-called automatic
stabilisers within national budgets namely reduced tax revenue and increased social
expenditure at the cost of increased budget deficit. This stimulus helped to generate a
recovery in GDP and to reduce unemployment in 2010.
But while the United States continued to experience a robust and job-rich recovery, the
EU nose-dived into a second recession in 2011.
The reason for this decoupling was that the EMU had been unprepared to handle a
sovereign debt crisis of some smaller Member States.
It had no lender of last resort, no collective framework for resolving bad debt, and no
mechanism for managing aggregate demand in the economy.
Speculation about the solvency of the Greek state was followed by many months of
hesitation. The emergency loan announced on 9 May 2010 was much larger than would
have been the case if Europe had taken collective action more promptly (without waiting
for the regional elections in North Rhine-Westphalia). A few months later Ireland was
effectively forced to bail out its banks and the crisis quickly spread to other countries
too.
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Debts from financial markets were replaced by debts from official sources, which turned
the euro zone into a club of debtors and creditors, set against each other.
We entered a double-dip recession in 2011, accompanied by capital flight from less
stable countries towards more stable ones, causing further financial and economic
polarisation.
The euro zone crisis produced a dramatic rise in unemployment. And although we have
experienced some improvement in the last 12 months, unemployment in Europe remains
still much higher today than at the peak of the first recession in early 2010.
The sovereign debt crisis cast the monetary union — and the EU as a whole —into an
existential crisis.
The EU only started to emerge from this financial maelstrom when the European Central
Bank announced it was ready to launch its outright monetary transaction programme,
and the Presidents of the European Council, the Commission, the European Central Bank
and the Eurogroup came forward with a long-term plan for revamping the Economic and
Monetary Union.
In short, the sovereign debt crisis has shown that without a lender of last resort, a
central budget or a coordination arrangement geared to stabilising aggregate demand,
our Economic and Monetary Union was — at best — designed for fair weather — but not
for the storm of a financial and economic crisis.
In the beginning, the euro did shelter the Member States that use it. It limited
speculative attacks at countries experiencing problems in their financial sector – until
rumours spread that some European leaders were considering forcing certain countries
to exit the Euro. This of course fuelled speculation.
Emergency lending was always agreed at the last minute to keep the euro zone
together, in exchange for heavy fiscal and structural policy conditions which the bailedout countries had to subscribe to. The break-up of the euro zone was luckily avoided.
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However Member States suffering from capital outflows could no longer support their
economies through tailor-made monetary policies and devaluation in their exchange
rate, while at the same time being subject to strict rules on fiscal policy and credit
conditionalities which at least partially turned out to be counter-productive.
The contractionary effects of these strategies have put the EU at a competitive
disadvantage in global terms.
Furthermore, the euro zone crisis has led to social consequences that cannot be
acceptable in the European Union.
While the EU employment rate was over 70% in 2010, it fell to 68.3% in 2013. More
than 25 million people are unemployed across Europe today. This means that we have
moved away, and not towards, our Treaty objective of full employment, and also away
from the 75% employment target of the Europe 2020 Strategy.
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Likewise, we have made negative progress on the social inclusion target of Europe 2020.
The number of people in or at risk of poverty or social exclusion was 118 million in 2010,
but 124 million in 2012.
Crucially, these aggregate figures hide enormous disparities between Member States.
Some countries like Austria or Germany are enjoying economic growth and high
employment. Finland has recently been stagnating in terms of GDP but its
unemployment rate is still below the EU average. However, many other Member States
are struggling with continued economic contraction, with unemployment rates near or
over 20% and with declining household incomes and rising levels of poverty.
Again, I would like to remind you that the problems are concentrated in the euro area,
which is bound together by a single monetary policy without a fiscal capacity.
In the adjusting countries on the euro zone periphery, the second recession has meant
rising long-term unemployment, poverty, social inequalities and emigration of many
young people.
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This slide shows, for example, that outflows of workers from Southern Europe have
considerably increased during the second euro zone recession.
Labour mobility in Europe is still dominated by workers from Central and Eastern Europe,
but their proportion is falling while we see more Italians, Spaniards, Greeks or
Portuguese moving for work.
Unfortunately, these people not always move within Europe but often emigrate to other
continents, which represents a clear human capital loss for Europe as a whole.
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EMU divergence in historical context
Allow me now to put the problem of divergence within the EMU into a longer-term
perspective.
This is a similar graph as I showed you at the beginning, but it goes back all the way to
the early 1990s. For reasons of data availability it is limited to the 12 countries of the
original euro zone, but this is sufficient to clearly illustrate the key point: The current
level of economic and social divergence within the euro area is without precedent in the
entire history of the EMU.
You can see that the gap between unemployment rates in the northern and southern
parts of the euro area was considerable in the 1990s, but they were moving in the same
direction. From the late 1990s until 2008, a convergence towards lower unemployment
rates can be observed, which was then followed by a massive and unprecedented
divergence, particularly strong during the second euro zone recession.
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We could analyse the situation also in terms of GDP developments since the mid-1990s:
there was an almost complete symmetry in the GDP trajectories of the north and south
of the euro zone for over a decade – until the sovereign debt crisis that erupted in 2010.
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How to deal with asymmetry and cyclicality in the EMU?
So why did Europe become so divided in terms of economic and social outcomes?
My answer is that the sovereign debt crisis since 2010 and the policies undertaken in
response to it have substantially weakened the power of the welfare state.
In particular, they have weakened the effectiveness of so-called automatic fiscal
stabilisers at the national level, which basically means the ability of a state to
immediately act in a countercyclical way as tax revenues drop and social expenditure
increases.
Until 2010, national budgets were able to counter the economic downturn by running
deficits. Since 2010, many national governments have lost this ability and austerity
policies in many cases actually aggravated the economic crisis.
This means that instruments that were historically used to limit the social impact of
crises were not available any more, while there has been nothing newly introduced to
replace them.
Over several years, internal devaluation was undertaken in an attempt to stabilise the
troubled economies and to boost their economic competitiveness. However, it has
certainly not borne any good fruit in terms of improving the employment and social
situation.
Moreover, internal devaluation is a recipe that cannot be applied in many countries at
the same time because it undermines overall demand. If many countries cut their wages
and lay off workers, nobody wins in terms of relative competitiveness but everybody
loses. If, in exceptional circumstances, internal devaluation helps a country to return to
growth, it does so at a very high price.
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In essence, this analysis shows us that the EMU in its current form lacks proper tools to
manage two essential features of any economy: asymmetry and cyclicality.
The challenges of asymmetry and cyclicality are relatively easily addressed in a flexible
exchange rate regime, but are much more difficult to tackle in a currency union.
Asymmetric shocks by definition cannot be mitigated by euro-zone wide policies such as
monetary policy.
In the absence of a fiscal capacity that would mitigate asymmetries within the EMU, and
in the absence of a coordinated adjustment by both deficit and surplus countries, the
only available mechanism of adjustment turned out to be internal devaluation.
In addition, the EMU quickly run out of steam in terms of its ability to manage cyclical
developments. There were some policy errors, such as the ECB's interest rate hike in
2011 which undercut the recovery. More recently, the ECB has been hitting some natural
limits to monetary policy, namely the zero lower bound on nominal interest rates.
However, the ECB's potential for countercyclical action has also been constrained by its
narrow mandate, notably by its inability to act as a lender of last resort to governments.
The same factor also decisively constrained the ability of governments to pursue
countercyclical fiscal policy. With both monetary and fiscal policies nearly paralysed, no
wonder that the EMU keeps struggling to emerge from stagnation.
Now, you may object to my analysis, pointing at the need to strengthen the EMU's
potential through structural reforms on the labour markets, product markets and in
public administration. Some people would say that structural reforms can address the
problem of asymmetry if they are more intense in some countries than others, and that
they can also prompt a recovery from a cyclical downturn by making our economies
more competitive. This is probably the greatest and most tragic misunderstanding of our
time.
I want to make clear that I have been a strong supporter of structural reforms. I have
been championing many of them, such as the fight against labour market segmentation,
extension of the active working life or the introduction of the Youth Guarantee.
However, by their nature, structural reforms, only produce results in terms of growth
and employment in the medium term (say 5 years and more). They cannot represent
the solution to short-term cyclical downturns, especially sharp downturns. The response
that is needed against short-term downturns consists mainly of expansionary fiscal and
monetary policies – and their various combinations.
That does not mean that structural reforms should not be pursued immediately. But the
optimum trajectory of GDP and employment can certainly be achieved if structural
reforms are accompanied by fiscal and monetary expansion, not contraction.
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Reconstruction of the EMU
Ladies and Gentlemen,
Let us move on to what has been done and what can still be done to address the design
flaws of the EMU and to better deal with the problems of cyclicality and asymmetry.
The euro-area crisis has led to the establishment of a permanent European Stability
Mechanism that can bail out euro-area member countries.
A banking union has also been agreed and starts being put in place. This means that we
have a framework for better resolving financial crises at the EMU level and for reducing
the risk of further bank bailouts with taxpayer money.
Does this mean that the original shortcomings of the Economic and Monetary Union have
been overcome?
I don’t think so. The main design flaws — the absence of a lender of last resort and of a
common fiscal capacity — are still there.
Moreover, we need to confront the problem of employment and social divergences which
have developed within the EMU.
Employment and social outcomes are probably decisive factors in the sustainability and
legitimacy of the monetary union, which is why the Commission and other players have
been paying increasing attention to them in the context of the debate on the so-called
social dimension of the Economic and Monetary Union.
That term has been somewhat misleading, since the point is not to give the EU or the
euro area competence for social policies. The point is to create conditions enabling to
restore convergence in employment and social outcomes and other economic
fundamentals throughout the currency union, so that we strengthen the whole EMU's
growth potential.
Monitoring key employment and social indicators through a new
scoreboard
Since Member States of a monetary union cannot unilaterally adjust to economic shocks
through the exchange rate and the interest rate, unemployment and social crises are
likely to develop to a greater extent within the currency union rather than outside it.
The “spill-over effect” of employment and social imbalances means that action - or lack
of action - as regards employment and social challenges can affect other Member States.
For example, an unemployment crisis in one country translates into lower demand for
other countries’ products and services. A prolonged period of high unemployment also
implies a loss of human capital that undermines future productivity and therefore the
growth potential of the entire EMU. Moreover, social crises may also fuel political
instability – examples of this are not hard to find in today's Europe.
For the first two decades of the EMU's history, employment and social problems did not
really count as major concerns. The original design of the Economic and Monetary Union
did not take sufficient account of developments in the real economy and structural issues
that are vital for the currency union to function properly.
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However, over the last two years, recognition has grown that the EMU's economic
governance needs to reflect social and employment challenges better, in order to ensure
that they are tackled in an effective and timely way before they blow out of proportion.
That was why one year ago the Commission proposed and the Council endorsed the use
of a scoreboard of key employment and social indicators in the European Semester
process.
The scoreboard is incorporated into the annual Joint Employment Report published each
autumn with the Annual Growth Survey.
It features five headline indicators that focus on employment and social trends which can
severely undermine employment, social cohesion and human capital.
They are:
 the unemployment rate;
 the rate of young people neither in employment, nor in education or training and the
youth unemployment rate;
 the real gross disposable income of households;
 the at-risk-of-poverty rate of the working-age population;
 income inequality as determined by the S80/S20 ratio, which compares the income
of the top fifth of the population and the bottom 20%.
I already mentioned how unemployment in one country matters for the others and how
it can "spill over" through lower aggregate demand, eroded productivity and political
instability. The same goes essentially for all our key employment and social indicators.
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Poverty in working age is a sign of poorly functioning labour markets characterised by
segmentation and polarisation between job-rich and job-poor households. It also points
at shortcomings in the social protection system. Poverty has clearly negative
implications for aggregate demand, productivity as well as political stability.
High and increasing inequality indicates that the economic situation of the majority of
the population is deteriorating and affecting those in the low and middle income
brackets, with income and wealth becoming more highly concentrated in the most
affluent sections of the population.
This adversely affects internal demand and economic performance of the population as a
whole because it reduces opportunities for many.
Monitoring household income developments is important because it reflects the
individual’s capacity to spend and save and to support aggregate demand both within
the country and beyond its borders through trade.
Household income captures developments in labour-market incomes, as well as
reflecting the effectiveness of the tax and benefit systems in offsetting any decline in
market incomes during negative economic shocks.
What the scoreboard indicates today is growing divergence in employment and social
developments across the EU, and in particular within the euro area.
Prior to the crisis, most social and employment performance indicators were converging
across the EU.
But since 2008, the gap has been growing wider.
The divergence is clear from the unemployment rate for young people and the
percentage of young people neither in employment, nor in education or training.
Data for household income and inequality also point to wider divergence within the euro
area than outside.
And the poverty rate has also increased in most southern European Member States of
the euro area.
In many countries, the crisis has intensified the long-term trend towards wage
polarisation and labour market segmentation, which - combined with less redistributive
tax and benefit systems - have fuelled the growth of inequality.
High unemployment, with the largest increases at the lower end of the labour market,
and the impact of fiscal consolidation also explain the significant increase in inequality
observed in the countries most affected by the jobs crisis.
The Commission used the findings of the scoreboard when drafting the 2014 Staff
Working Documents and country-specific recommendations during the 2014 European
Semester process. It has proven to be a useful tool, helping to identify which
employment and social challenges need to be addressed where.
I hope that the scoreboard will serve also our successors as they try to better reflect
employment and social concerns in EU-level economic policy-making.
Ladies and Gentlemen,
What I want to highlight today is the danger of divergence within the monetary union.
Divergence in competitiveness, divergence in output, divergence in employment rates,
unemployment, poverty, household incomes and social inequalities. All these
divergences are dangerous, and they are related.
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This graph shows you perhaps the most striking example of divergence in today's
Europe, namely divergence in unemployment rates. You can see clearly that the
disparities between the core and the periphery of the euro area (solid lines) are much
greater than disparities between groups of non-euro-area countries (dashed lines).
This divergence is clearly at odds with the EU's Treaty objectives of balanced economic
growth, full employment and social progress.
Divergence in a monetary union is particularly dangerous when we lack tools to
overcome it or to compensate for it. In a large macro-economy which is diverse, it is
supposed to be the role of fiscal policy to deal with imbalances.
As you know, the European Union has a very small budget of 1% of GDP. Within that
budget, EU cohesion policy – which is mainly geared towards the development of
economically peripheral regions – amounts to only 0.4% of EU GDP.
Crucially, this is a budget for the Single Market of the EU28, and cohesion policy aims at
promoting long-term convergence (or at least preventing long-term divergence)
between countries and regions forming this Single Market.
By comparison, no budget exists at the level of the euro area, even though the bond of
common currency is much stronger and reduces national autonomy much more than the
Single Market.
Our Economic and Monetary Union certainly does not have a budget to compensate for
disparities in economic performance, a budget that would enable to maintain similar
levels of prosperity based on large-scale redistribution.
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Income equalisation across the EMU would of course not be possible without a strong
political union and without strong democratic legitimation of redistributive decisions
taken at the EMU level.
But what I find highly damaging is that the EMU does not even have a modest insurance
scheme that would enable to provide temporary stimulus to countries experiencing a
downturn in the economic cycle.
For two decades, Member States have been willing to be bound together by a common
currency, with a single exchange rate and interest rate, while not introducing any sort of
fiscal risk-sharing.
Consequently, our Economic and Monetary Union is very vulnerable to economic shocks.
The negative consequences are felt in terms of depressed GDP, high unemployment and
poverty, but also in terms of political instability and rising popular resentment against
Europe.
The importance of automatic fiscal stabilisers
Ladies and gentlemen,
While the scoreboard is clearly a big step forward in improving European governance, it
doesn’t fundamentally alter the original design of the Economic and Monetary Union.
If we want to seriously reinforce the EMU and strengthen its resilience against economic
shocks, we need to address the issues of a lender of last resort and of a shared fiscal
capacity at the EMU level.
Expert debates today focus on the mandate of the European Central Bank to put
economic growth and employment on a par with price stability as is the case in all other
major economies on this planet.
But what is particularly evident is that the original version of the Economic and Monetary
Union could be strengthened by establishing a reliable mechanism for short-term,
countercyclical fiscal transfers across euro area Member States.
I am not advocating such EMU-level fiscal capacity solely out of a concern for the
employment and social situation.
For all Member States without exception, the way the Economic and Monetary Union
functions currently is suboptimal - first and foremost in terms of economic growth.
The Commission’s November 2012 Blueprint for a deep and genuine EMU clearly
envisaged the introduction of a fiscal capacity at the EMU level in the long term.
The subsequent report from the Presidents of the European Council, the Commission,
the European Central Bank and the Eurogroup stated that such fiscal capacity should
help the Economic and Monetary Union to absorb economic shocks.
The expert literature of the past few years has put forward a number of options for
automatic fiscal stabilisers at monetary union level.
Most of them share a focus on mitigating short-term cyclical downturns occurring in
parts of the euro area as opposed to compensating for structural differences.
In other words, the point is to maintain spending at a sufficient level during a downturn
before companies that struggle are turned around or replaced by new ones and before
workers who have lost their jobs can find new employment.
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Focusing fiscal transfers on mitigating asymmetrically distributed cyclical shocks means
that, over the long term, all participating Member States are likely to be both
contributors to and beneficiaries of the scheme.
But even if the balance is not zero after some time, the fact that economic crises would
be less serious and would not last as long would benefit us all.
In my view, the best idea for an automatic fiscal stabiliser at Economic and Monetary
Union level is a scheme which offers greater stabilisation on the basis of developments in
short-term unemployment.
The great advantages of unemployment as an indicator are that it follows developments
in the economic cycle very closely, is easily understandable, and can be measured easily
and quickly.
Such a scheme should clearly focus on cyclical unemployment caused by a fall in
aggregate demand, as opposed to structural unemployment caused by skill mismatches,
less-efficient labour market institutions and the like.
For example, basic European unemployment benefit could be paid for only the first six
months of unemployment and the amount would correspond to 40% of the previous
reference wage.
The precise parameters would, of course, need to be discussed, depending on the
desired macroeconomic stabilisation effect.
The European unemployment insurance scheme would provide fairly basic standard
support for a short spell of unemployment.
Each Member State would be free to levy an additional contribution and pay out
unemployment benefit at a higher rate or for a longer period on top of the European
unemployment insurance paid.
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In any case, there would be clear conditions applying in terms of job-searching and
training attendance.
Crucially, such basic European unemployment insurance would help euro-area Member
States to share some of the financial risk associated with cyclical unemployment.
People would benefit directly in times of hardship, and the Member States would be
required to upgrade their employment services and labour market institutions to the
best EU standards.
The risk of “lasting transfers” under such a scheme could be reduced to a minimum
through two mechanisms, which already exist in federal unemployment insurance
systems elsewhere in the world — namely, experience rating and claw-backs.
Experience rating means that the contributor versus beneficiary profile of each Member
State in the scheme is monitored, and the contribution or draw-down parameters can be
adjusted at the beginning of each period to bring the Member State closer to a projected
balance with the scheme over the medium term.
Claw-backs allow net transfers to be neutralised after the event, which means that the
Member States are allowed to be net beneficiaries for several years before their
contribution and/or draw-down rates are adjusted to compensate for net transfers made.
Conclusion
Ladies and Gentlemen,
My proposal for a countercyclical fiscal capacity at the EMU level is far from technical. In
fact, it is about providing a rule-based response to a deep concern of our fellow
Europeans as shown by the way they voted in the latest European elections.
If the Member States are to gain more autonomy and a greater ability to bolster their
economies against a cyclical downturn, this requires more European integration, in
particular by equipping the monetary union with a scheme for limited sharing of fiscal
risks – essentially a form of insurance.
What I am advocating is not “more Europe” for its own sake, but a mechanism that
strengthens each Member State’s autonomy precisely by stabilising the EMU.
Basic European unemployment insurance is one possible way forward in strengthening
the EMU and preventing harmful divergence from developing further.
But of course it would only represent part of the answer. We need to think about the big
picture of how monetary, fiscal and structural policies interact in today's EMU, and we
need to use all of them to undo the huge socio-economic divergence which has
developed within the EMU over the past years.
If we don’t undo this divergence, at some point the single exchange rate and single
interest rate may simply stop making sense for the highly heterogeneous euro zone, and
Europe may enter the path of economic but also political disintegration.
In order to prevent this from happening, I believe it is in everybody's interest to do what
it takes to strengthen the EMU.
Thank you very much for your attention.
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