Benoît Coeuré: Revisiting the European social contract
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the European Conference at Harvard "Europe 2.0 - taking the next step", Cambridge MA,
2 March 2013.
* * *
I wish to thank Jean-Francois Jamet, Johannes Lindner and Jonathan Yiangou for their contributions to this
speech. I remain solely responsible for the opinions contained herein.
Ladies and Gentlemen,
It is a great pleasure to attend the European Conference at Harvard. I will argue in my
remarks that the management of the current crisis is at least as much about social
stabilisation as it is about economic stabilisation. At the heart of the crisis, there is the
challenge of redefining the social contract to safeguard the sustainability of Europe's social
economy model. This model, set out in the Maastricht Treaty, notably aims to promote "social
justice", "solidarity between generations" and "solidarity among Member States".1 In my view,
in order to ensure the sustainability of the social contract and to fulfil its promises both at
national and European level, we need three elements: (i) a broad consensus on the definition
of fairness, the forms of solidarity and the conditions attached to it; (ii) an institutional
architecture ensuring its legitimacy and stability; and (iii) effective policy instruments.
As I will strive to show, a redefinition of the social contract in Europe is essential if we are to
restore the sustainability of public policies as well as trust in the state's ability to positively
influence economic outcomes. In other words, it is a matter of enhancing the sustainability of
national social contracts in a reshaped European framework. Such an evolution will inevitably
change the organisation and role of the state, as well as the institutional architecture of
Economic and Monetary Union. But this does not mean moving away from the concept of the
European social market economy. It means preserving it and consolidating it for the future.
Threats to the European social contract
The Great Recession - as it is often called - did not just have dire consequences for the
economy as a whole. It also resulted in a threat to social cohesion, straining the social
contract in its different dimensions.
The economic crisis has disproportionately affected the more vulnerable social groups.
Lowskilled and young workers were the hardest hit, with a youth unemployment rate of more than
24% in January 2013 in the euro area as a whole (and as high as 55.5% in Spain and 38.7%
in Italy). There are signs of a growing mismatch between worker attributes and job
requirements across a number of euro area countries, consistent with an outward shift in the
aggregate euro area Beveridge curve - i.e. a higher level of unemployment is associated
with a given level of vacancies. Future growth depends on human capital being cultivated
and expanded. That is threatened if too many workers remain unemployed for too long and
lose their employability. The fiscal crisis has also endangered solidarity between generations
by calling into question the ability of governments to raise enough revenues to afford the
services they provide to the older generation. Finally, the crisis is exerting visible strains on
the relationship among the people of Europe, with nationalist temptations that do not help to
achieve a consensus on cooperative solutions or to allow a return to stability and growth.
A rebalancing is inevitable and is now under way, but it is taking its toll. The longer that
rebalancing takes, the higher the social costs. So it is crucial that a sense of urgency is
maintained both at national and at European level.
The national level is still central to the definition of the social contract. Seen from within
Europe, social contracts vary between Member States because of history and political
preferences. Seen from further afield, however, it is apparent that there are common values
in, and common challenges to, these national social contracts. We recognise explicitly those
common values and sought to have them reflected in the Maastricht Treaty. They include
freedom, peace, democracy, tolerance and - vital from a social perspective - solidarity.
Upholding those values faces similar challenges across the continent, in particular the
sustainability of public policies, which are an expression of the social contract.
Europe is also a political union: the social contract exists both within countries and across
countries. The EU can in fact be regarded as perhaps the most ambitious example of the
philosophical theories that underpin the social contract. As Thomas Hobbes remarked in his
Leviathan2, sovereign states are established to regulate social interactions and avoid the
"war of all against all" that would prevail without the rule of law. States, however, compete
with each other and therefore may even resort to arms in the absence of a supranational
body imposing social contract laws. As was recognised by the Nobel Peace Prize, the
European project was the key to ensuring that European states would move from war to
peace. States, in Europe, pursued Kant's dream of constitutionalising international law to
achieve lasting peace3. The doubts I mentioned above, as well as some stirrings of
nationalism and protectionism, show that this dream is today at risk. The social contract
needs revisiting.
The EU and, to an even larger extent, the euro area have gone beyond a combination of
political and economic freedoms with a set of common rules and policies regulating the
internal market. As a result, the EU and the euro area have started evolving from a
microeconomic and legal construct to a fully-fledged economic union. The European social
contract and the national social contracts thus no longer only complement each other:
decisions at European level are having an increasing impact on national economic, social
and political outcomes, while the externalities of national decisions are also getting larger.
In this context, the relationship between the European and national social contracts needs
careful consideration. It can no longer rely on a "permissive consensus" and must rest on an
institutional architecture that is both effective and legitimate. Moreover, as people
increasingly see the impact of policy decisions with European relevance on individual
outcomes, it needs to be emphasised that they - and not only the Member States - are
partners in the European social contract. The contract will therefore need to involve citizens
as much as Member States by making European political institutions more accountable. And
the absence of a European demos cannot justify opposition to this project. Political
fragmentation is the outcome, as much as it is the cause, of an impaired social contract.
The sustainability imperative
John Maynard Keynes famously said: "The long run is a misleading guide to current affairs.
In the long run we are all dead".4 And yet societies live in the long run. Today's choices
influence tomorrow's outcomes, just as yesterday's decisions affect today's situation. This is
even truer in a low-growth, low- interest-rate environment, which increases the discounted
value of tomorrow's costs and benefits. The importance of the long run was widely shown by
the crisis. It was doubt about the accumulation and sustainability of debt which caused
Greece and then Ireland and Portugal to lose access to markets and which associated the
same risk with other Member States. And it is doubt about the stability of the political system
as well as its ability to adopt legitimate, effective and sustainable public policies that worries
citizens in many euro area countries.
This accumulation of debt has taken the form of financial asset bubbles and/or a drift in
public debt, depending on the Member State. Warnings on the long-run sustainability of
public finances were legion long before the crisis erupted. The build-up of untenable
promises is not unique to Europe: the gap between public spending and nominal GDP
growth was even larger in the US and Japan - where the average growth rate in government
spending exceeded the average nominal GDP growth rate by 11⁄2 and 2 percentage points
respectively - than in the euro area, where this difference only amounted to around
one-quarter of a percentage point.
In this sense, the crisis propelled us 20 years into the future: it revealed the unsustainable
character of the unchecked accumulation of excessive liabilities in the private and public
sectors. It forces us to confront challenges today that we thought we had more time to
address. It has made the challenge even more daunting by debasing the pool of wealth that
can be tapped to fund the social model. IMF projections for growth in advanced economies
incorporate marked-down estimates for potential output relative to pre-crisis trends by 10%
or more.5 Such debasing calls for even bolder action to restore sustainability.
In this respect, a central bank can help to mitigate the impact of the crisis, but the steps it
takes cannot be a permanent substitute for resolute action by governments. The central bank
can buy time for political bodies to act, but it cannot buy enough time for them not to act.
In the crisis, the ECB's continued commitment to price stability and the integrity of the euro
has been one of the few elements of certainty in a highly volatile and uncertain environment.
This commitment to monetary stability is not only grounded in its economic merits but is also
a cornerstone of the social contract. It protects poorer households from the dire effects of
inflation on purchasing power. It ensures that no redistribution of wealth takes place that is
unsanctioned by democratic processes, which is exactly what inflation does. And it
buttresses political stability by avoiding the social unrest that unchecked inflation can cause.
Yet buying time is not indefinitely affordable. There is a cost to any delay in reforms. For as
long as entry barriers hinder competition, as long as scarce budgetary resources are not
channelled to support job creation and innovation, and as long as the burden of adjustment is
disproportionately borne by the weakest in the society, these rigidities will not allow any
rebasing of growth on a sustainable footing.
Just as long-term issues caused short-term problems, it is only by working on stabilising our
economies and societies over the long term under an agreed contract that EU members will
return to sustainable growth. Formulating a vision of our common future, rooted in
democratic deliberation, is an urgent priority. It will provide an anchor for, and will enhance
both the efficiency and legitimacy of, actions to confront the crisis. Last December's "Four
Presidents' report" on the future of Economic and Monetary Union provides a blueprint for
such a long-term vision.
Rebalancing the social contract
As political institutions are facing tough choices now because of the unsustainable policies of
the past, the question of the distribution of the adjustment burden has become key. It implies
a redefinition of the social contract both at national level and at European level. What is at
stake is nothing less than the sustainability of the European social market economy.
Within countries
The social contract first needs to be rebalanced within each country along two dimensions:
between generations and within generations.
Excessive liabilities, even if supported by the market, imply a transfer of wealth from future
generations to the current ones - a move that is decided unilaterally by the current
generation. Seen from this perspective, fiscal constraints on governments do not appear as a
loss of sovereignty but rather as the condition for preserving this very sovereignty over time.
Likewise, stronger prudential rules are not a restriction on credit for productive investment,
but a check on excessive risk-taking that would otherwise lead to financial instability.
On the fiscal front, effectively balancing the social contract between generations means
creating room for stabilising policies in future downturns and protecting the coming
generations by forcing the distributional debate to take place in the present. This balancing
act focuses on the quality of public expenditures and implies that deficits are justified only to
the extent that they deliver sufficient returns in terms of future fiscal revenues (through public
investment supporting total factor productivity, for instance, or through the countercyclical
impact of automatic stabilisers).
On the financial front, redefining the social contract between generations means realigning
today's incentives so that tomorrow's fiscal policy is not threatened by financial dominance.
Bailing out banks with taxpayers' money is indeed both unfair and a factor of moral hazard. A
closer link therefore needs to be restored between the responsibility that arises out of
excessive leverage and the costs associated with deleveraging.
The social contract also needs to be rebalanced between the generations alive today. There
is ample room for a debate on the distributional impact of fiscal and economic decisions.
Fairness, a concept which has a particular resonance in this university thanks to John
Rawls6, is a legitimate objective: solidarity can help to ensure that economic progress for the
many is not achieved at the expense of impoverishing the least fortunate households or
depriving them of their right to equal opportunities. A reduction of rents and entry barriers,
which notably disadvantage younger men and women on the labour market, is in that sense
fully consistent with the objective of fairness, while also making the economy more
competitive by setting the right incentives.
National social contracts will continue to differ depending on the distributional choices made
by each constituency. But Europeans now have to recognise that such choices need to be
fully in line with the sustainability imperative.
Across countries
What does the social contract mean at European level? Here again, there are two
dimensions to consider: a horizontal and a vertical dimension.
The horizontal dimension concerns the rights held and responsibilities borne by each
Member State vis-à-vis its partners. The vertical dimension concerns the contract that exists
between individual citizens and the European Union. Both need to be redefined in the light of
the crisis.
The European social contract primarily binds all Member States of the European Union in the
pursuit of the EU's objectives, as laid down in the Treaties. I will focus here on another and
even more demanding contract, the one that binds the euro area countries. Sharing a single
currency creates tight links between markets and a high potential for contagion. This means
that, at the horizontal level between euro area members, there is an obligation to respect
what Isaiah Berlin called the concept of "negative liberty" - to conduct economic policies
individually within limits that do not impinge upon the liberty of the other countries. There is
another obligation to establish institutions and instruments that preserve the stability of the
system taken as a whole. This is an implicit social contract which, before the crisis, was
believed to be largely self-enforcing - if not by countries themselves, then by the discipline of
financial markets. That this assumption was misplaced is now part of history.
So it is now clear that the contract between states has to be enforced more explicitly, by a
stronger "neutral judge". If there are to be open markets and a shared currency between
countries, there also have to be stronger common rules - and a stronger European
Commission to enforce them. The strengthening of the euro area governance framework that
has taken place in recent years is based on this understanding. The rules governing fiscal
sustainability have become tougher, with more powers given to the Commission. For
instance, the new fiscal compact requires all Member States to run a balanced budget over
the cycle, similar to the responsibility of individual states in this country. Under the recently
adopted "two-pack" legislation, the Commission will have to sign off on national budgets
before they are approved by parliaments. This is a more intrusive role than the US federal
government has vis-à-vis the states. Fiscal policies are at the centre of the contract because
trust in the currency requires trust in the sovereign. Prolonged fiscal profligacy results in an
impotent central bank and a debased currency. But the social contract is not only about fiscal
policy. As the founding fathers of the euro very well understood, there is no monetary union
without an economic union.
But to a certain extent, this aspect of the social contract between Member States was always
understood, just not respected. Why should it be different now? The crisis is one explanation.
But it is also the case that the incentives for Member States to abide by and enforce the rules
have fundamentally changed. Before the crisis, the ultimate punishment for unsound national
policies was believed to be default, in line with the principle of "no bail-out" enshrined in the
EU Treaties. But we have seen during the crisis that the mere prospect of euro area
countries failing creates negative and possibly self-fulfilling feedback loops, at great cost to
the euro area. Without a European budget with a stabilising role, there have to be
mechanisms for mutual support in the euro area. And as a condition, there have to be
stronger economic governance and mutual control.
The basic premise of the new social contract between euro area countries, then, is that
countries have to abide by the rules of the community, and when they do, they become
eligible for mutual support. Euro area governments have earmarked €700 billion for countries
that get into difficulty, a sum which can be lent against strong conditionality. And we are now
seeing this concept being further developed before countries get into difficulty via the new
idea of "reform contracts". Countries can decide to undertake difficult structural reforms and
receive financial incentives in return. This benefits both parties to the contract by preserving
the national character of the decision, while protecting the wider euro area by reducing
longterm risks emanating from misguided economic policies.
However, a binding contract between Member States is only needed where national
preferences still play a strong role.7 For instance, it is necessary to work through reform
contracts because countries have different approaches when it comes to labour relations or
unemployment benefits, based on their own histories and cultures. But where national
preferences play a weaker role, it makes sense to shift policies straight to the European
level. Then we do not need to set rules and create incentives, because decisions are out of
the hands of national authorities. This is the vertical dimension of the social contract in
Europe that I mentioned earlier - directly between the European level and the ordinary
citizen.
Examples of this direct relationship include the regulatory roles of the EU: protecting people
from the negative effects of monopolies, regulating against harmful products, and negotiating
suitable trade agreements. The EU also plays a role in redistributing resources from richer to
poorer regions through the cohesion funds, although these amount to only 0.36% of the
Union's GDP.
Where the social contract between the European Union and its citizens needs to be reformed
is in three areas.
First, as I already noted, where there is a role for national preferences, there is still a role for
Europe to monitor national reform processes, facilitate policy learning and mobilise European
instruments (such as the European budget, the European Investment Bank and structural
funds) in support of national policies8.
Second, those policies that belong naturally at European level should be placed there. The
clearest example of this is the banking union. It is obvious that banks within a single currency
area should be governed by the same rules, supervised in a consistent way, and wound up,
if necessary, without pushing individual sovereigns into bankruptcy. It is also the best way to
avoid the cost of financial sector excesses falling on taxpayers. This arrangement would also
include the stabilisation mechanisms, such as the ESM, needed to ensure that the single
currency area can resist extraordinary shocks. In addition, it could include, one day, common
financial instruments, provided that control is exerted by the European level over national
budgets, under the scrutiny of the European Parliament.
This leads me to the third area. The EU needs to find ways to improve its legitimacy. People
in Europe generally feel disconnected from EU decision-making and question whether their
voice is being heard. The "European public space" is notably underdeveloped.
Decisionmaking has become more intergovernmental in the crisis, often bypassing the European
Parliament. And this democratic deficit will only be exacerbated as the European level gains
new powers in the ways I described above. In other words, if we are to strengthen fiscal,
financial and economic union in Europe, we have to strengthen political union as well.
We already have a significant degree of political union in Europe - after all, we have been
building the EU for more than 60 years. We have a European Parliament, which is directly
elected on a proportional basis, like the House of Representatives here. We have a Council
of Ministers, which represents the individual Member States, like the Senate. And
increasingly, we see that national parliaments are becoming more and more involved in EU
decision-making, for instance, by conducting greater scrutiny of Europe's crisis management
or the content of European legislation.
The problem comes from the fact that these bodies are not seen as coherent by citizens.
People do not know who really represents them in Europe. Is it their Prime Minister? Is it
their Member of the European Parliament? Is it their local representative? Instead, they see a
process controlled by elites with no truly democratic credentials. And this is, in fact, far from
the truth: as I just showed, there are many ways in which elected representatives are
involved in European decisions.
The social contract between the EU and its citizens needs to be rebalanced therefore in
various ways: by connecting people more directly with the political process at European
level; by making the European Parliament more relevant to peoples' lives; by giving national
parliaments a more explicit role in holding European decision-makers to account; and by
airing the debates on the future of Europe more widely and transparently in the public
sphere.
Conclusion
Let me conclude by saying that rebalancing the social contract also means rebalancing
growth. For instance, eliminating rents and arbitrary barriers to entry is fair and at the same
time frees up growth potential. Re-anchoring fiscal, financial and economic sustainability
would allow governments to use fiscal policy counter-cyclically, to reduce interest payments
and to reduce risk premia, thereby allowing monetary policy impulses to work better, and
freeing fiscal resources that can be used for the public good. Likewise, balancing
sustainability and solidarity within Member States and at European level can restore
investors' confidence in the capacity of the EU and the euro area to resolve their problems. If
this is achieved, the collective response to the crisis will have protected the sustainability of
national social contracts while reinforcing the effectiveness and legitimacy of the European
contract. It will have demonstrated that Europeans can live up to the motto of the European
Union, and remain "united in diversity".
Thank you for your attention.