Does the eurozone need to become a fiscal union?

9 Oct 2017

In recent years there have been calls for the eurozone to become a fully unified fiscal union. What is this and what would it mean for the eurozone? Is it feasible for 19 countries to be united under one finance minister?


The eurozone is a group of 19 countries all with a common currency: the euro. The euro has three main proposed benefits. The first: to avoid harmful fluctuations in the exchange rate between currencies and reduce variations in competitiveness caused by this varying exchange rate. The second: so that businesses can buy goods and services easily from other eurozone countries without the uncertainty caused by varying exchange rates. The third: so citizens can easily travel between eurozone countries without the hassle of pre-exchanging currency before travel.


The eurozone had humble beginnings as the European Exchange Rate Mechanism (ERM) in 1979. Here member states had to keep the value of their currency within 6% of the value of the Deutsche Mark (DM) by changing the interest rate of the member country (which effects the value of the currency).


One of the many criticisms of the ERM is that the Interest rate for Germany was much higher than other countries and so the DM was valued higher than other European currencies. Weaker economies in the rest of Europe, Britain for example, struggled to keep their currency at DM levels and so had their economies weakened as a result. Britain crashed out the ERM on Black Wednesday in September 1992 after being unable to keep it within the agreed range.


The ERM morphed into the euro in 1999 with eleven member states. The eurozone has its own central bank; the European Central Bank, lead by Mario Draghi which sets the interest rate for the current 19 members. Alongside this is the eurogroup: an assembly of the finance ministers of the member states. Eurogroup meetings discuss political issues regarding the euro, such as the bailout program for Greece.


So, what would a fiscal union look like?


A fiscal union would involve the integration of member states’ budgets under one common budget. Taxation and spending policy would be centralised within one ministry under one finance minister and potentially taxes collected in one part of the eurozone could be spent in a completely different part of the eurozone.


This system has many advantages. For example, Mr Draghi of the ECB often calls on member states to boost their spending in order to pick up some of the slack in the economy and boost growth. By having fiscal policy determined under one roof there would be scope for better and more efficient tackling of economic growth issues.


Furthermore, a combined budget would allow for looser restrictions on credit for nations. Taking less creditworthy nations such as Greece as an example; a unified budget would mean that it would receive adequate liquidity in order to operate properly, it would also be under more fiscally responsible oversight by more affluent Northern European states. This does have the risk of the higher spending countries thinking they will be continuously bailed out by the richer nations in a “too big to fail” state of mind.


A fiscal union would undoubtedly receive opposition from many citizens. The fiscally responsible Germans with a budget surplus of €18.3bn and falling government debt may not be happy to see their tax revenues being spent on generating growth in Italy. Citizens across Europe may not be comfortable with their spending being dictated by foreign citizens.


As well as this, many questions over a democratic deficit would arise. How would a finance minister be appointed? What would the agreed ideology be, socialist or neoliberal? Who would get the largest share of spending? What tax rate would be suitable for economies performing at different levels?


There is potential for many flash points here which could undermine the sustainability of such a fiscal union. As Brexit showed us last year, if citizens feel they have lost sovereignty they are more than willing to express their displeasure. 


Finally, governments tend to be inefficient in their spending of money. Centralised planning would fail to understand the needs of local citizens and their needs. A policy that might work well in France may not be as effective in Slovakia. Just as spending needs differs between a national level and local authority level here in the UK, needs would differ from an EU wide scale to an individual nation level.


It is clear to me on this basis, that fiscal union is something that the eurozone should not aspire to achieve. The potential for continent wide contagion risks are too great and the benefits from such an agreement will fail to reach the pockets of the average European citizen equally. There is a potential for fiscal union to work, but only between economies of similar sizes and speeds, Germany and France for example.


Until the smaller economies of Southern Europe can reach the same size and speed of their northern neighbours, fiscal union should remain just a dream of the European Commission elite. 

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