Ignazio Visco: European Union - progress or regress?
Dinner speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 50th Anniversary
Conference of the Istituto Affari Internazionali, Rome, 13 November 2015.
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I first wish to thank the Istituto Affari Internazionali for inviting me this evening. And I
congratulate the Institute founded by Altiero Spinelli for its activity, research and contributions
over the last fifty years. Best wishes for a future as rich and productive.
Assessing the recent and prospective evolution of the European Union is an issue far too
vast to be addressed in detail in a short speech. My remarks will therefore focus on what I
see as key elements concerning what was neglected before the crisis, the changes
introduced over the recent difficult years, what further advancement is needed, and, to be
somewhat provocative, some risks of a regress instead.
On the way to the crisis
Today the discussion on reforming the governance of the EU and the euro area centres on
the need to complete the EMU and make it stronger, on how to get to "a deep and genuine
economic and monetary union".1 The need to move towards political union is widely and
hotly debated. But for a long period this issue was underrated and neglected. I recall the
discussions that took place in the late 1990s in OECD Committees, and the analysis put
forward in monographs and surveys. The 1999 OECD report on EMU, for instance, noted
that "long lasting monetary unions among major sovereign nations have never been
observed before, without strong political integration", but then focused on different issues. Its
discussion delved into the costs and benefits of a monetary union, the role of the Stability
and Growth Pact, institutions and processes for macroeconomic policy co-ordination,
exchange rate targets, labour market and wage flexibility, labour mobility, and product market
reforms.2
Interestingly, the same report underscored the potential advantages of a single monetary
policy - not a single fiscal policy - in managing asymmetric shocks. It argued that such
shocks "are more easily absorbed in a monetary union where monetary policy should adopt
the stance most appropriate for the area as a whole than under the previous arrangements,
which were at times shaped by domestic German policy considerations". Also in subsequent
analyses, the words "state" or "political" were more often missing than not. The attention was
instead on such issues as fiscal consolidation, ageing populations, financial fragmentation,
incomplete capital market integration, monetary policy communication, decentralized banking
supervision, under-utilisation of human capital, insufficient structural reforms, all of which
were diligently analysed with foreseeing discussions.
Yet awareness of the need for what today is termed a common "fiscal capacity" had been
present well before the signing of the Maastricht Treaty. A report on fiscal union (the
MacDougall Report) was published already in 1977 on behalf of the European Commission,
and a mention concerning the economic desirability of a transfer of fiscal sovereignty to the
European level is present even in the 1970 Werner Report. Later on, the technical papers
accompanying the 1989 Delors Report and subsequent work by the Commission discussed
the topic in depth.3
The discussion was well alive also in academia. Economists have discussed the costs and
benefits of membership of a monetary union since the seminal contribution on optimal
currency areas by Robert Mundell in 1961.4 Peter Kenen was the first to point out in 1969
that a shared fiscal policy could reduce the costs of being a member of a monetary union. He
argued that the operation of area-wide automatic fiscal stabilizers would allow re-establishing
equilibrium while limiting the necessary reduction (increase) in domestic prices and wages in
countries affected by an adverse (positive) asymmetric demand shock.5
The introduction of the euro was a fundamental step in European history, a political event
that certified the progress made on the road to integration, a profound economic and social
change. It was only a step, however, and not the end of the road. Tommaso
PadoaSchioppa, who contributed so much to the achievement of monetary union, was well aware
of this. On May 3, 1998, when Europe was completing the last steps before the adoption of
the single currency, he wrote in a column for "Corriere della Sera": "The Union has full
competence for microeconomic policy (...), but its capability for macroeconomic policy is,
with the exception of the monetary field, embryonic and unbalanced: it can avoid harm
(excessive deficits) but it cannot do good (a proper fiscal policy). (...) It is thus right not only
to applaud yesterday's step but also to underline its unfinished nature, the risks and the
rashness."6
At the beginning of the euro, Tommaso spoke clearly of the perils and weaknesses of a
"currency without a State". With the global financial crisis and more specifically with the
sovereign debt crisis the importance of the unification process has become crystal clear, but,
in the words of Padoa-Schioppa, "there is more bitterness than satisfaction in witnessing a
prophecy come true. [...] It is clear that we needed more of a European State, not less of a
European currency: without the euro, Europe would now be living a catastrophe. One reason
for the lack of credibility of national politics is that it keeps on giving people the illusion that
national powers are capable of tackling issues (energy, climate, finance, security, migration,
primary goods) which are not national, but continental and global."7
In the absence of political union, the economic governance of the area was based on a
fragile alliance between market forces and rules of conduct. Market forces were to ensure
the economic convergence of the member countries and the definition and implementation of
the necessary structural reforms at national level. Rules of conduct were expected to
guarantee prudent budgetary policies. But economic convergence was slow and difficult; in
some cases the gaps actually widened. In many economies the delays and obstacles to
adjusting to the large-scale global changes weakened competitiveness and the ability to
grow. Mitigated by the improvement in funding conditions after the introduction of the euro,
market pressures alone were not sufficient to drive the necessary reform efforts. Moreover,
the rules for the public finances defined in the European sphere were seldom respected and
sovereign risks were basically not priced by the markets: until the outbreak of the crisis the
spreads between government bond yields within the euro area were close to zero.
Perhaps the convergence process had been displaced, firstly, by the acceleration of the
enlargement of the EU and increased participation in the Eurosystem and, secondly, by a
clear (though according to some, irrelevant) predominance of intergovernmental agreements
over the so-called community method.
The response to the crisis
In this framework, after the global financial crisis and the very severe global recession in
2008-09, the full revelation of the conditions of Greek public finances produced tensions,
which then spread to the economically weaker euro-area countries, characterized by
excessive public or private debt, a foreign trade deficit, poor competitiveness, and low
economic growth. Tensions grew with the bursting of the property bubble and the
consequent disruption of banking in Ireland. With the announcement of the involvement of
private investors in restructuring Greek debt in the summer of 2011, financial markets
suddenly became aware of the implications of the ban on interventions to rescue member
states under the Treaty on European Union. There followed a very serious crisis of
confidence in the ability of the single currency to survive, with negative consequences for the
real economies of individual countries and for the area as a whole.
The list of potential causes of the crisis is rather crowded. Fiscal imbalances, labour market
rigidities and competitiveness deficits, insufficient innovation and productivity growth,
excessive bank lending from core to periphery countries, all these have been good cause of
lags, disturbances and vulnerabilities. But I believe that the sovereign debt crisis should be
interpreted first and foremost as a major lack of trust in the future of the EMU, the euro and
possibly the EU. The severity of the sovereign debt crisis, which at some point threatened
the very existence of the single currency, owes in part to the incompleteness of the EMU
project, which dramatically exposed the reversibility of even the major progress towards
European financial integration made with the introduction of the euro.
The rise in yield spreads between government bonds in the euro area was determined by
two factors, one national and one European, linked respectively to the weaknesses of some
countries' economies and public finances (sustainability risk), and to the incompleteness of
European construction and the attendant fears of a break-up of the monetary union
(redenomination risk). Europe's response to the sovereign debt crisis has consequently been
two-pronged: on the one hand, individual countries have pledged to adopt prudent budgetary
policies and structural reforms to support competiveness; on the other, a far-reaching reform
of EU economic governance has been undertaken.
The definition and implementation of this response was not smooth, let alone optimal. But the
constraints were significant ─ first and foremost, the lack of trust among member states,
partly justified by the episodes which ignited the crisis (fiscal misreporting and failures in
financial supervision). Moreover, there was a lot of ground to be covered in a very short term.
Europe had no tools with which to manage a sovereign crisis and the legal basis for
providing financial support to countries in distress had to be defined. International treaties
needed to be drafted and ratified, also to strengthen peer oversight on national fiscal policies
and structural reforms. Further integration of financial markets was necessary to increase the
resilience of the area to asymmetric shocks: the banking union and the on-going project of
the capital market union are both far reaching reforms, affecting in depth the institutional
fabric of member countries.
The ECB Governing Council, by providing a series of conventional and unconventional
monetary policy measures to fulfil its price stability mandate, ensured accommodative
financial conditions that mitigated the fall in aggregate demand and helped to "buy" the
considerable time needed to implement this strategy, while countering market uncertainties
that could undermine its implementation. The European strategy to respond to the crisis has
brought overall a stabilization of financial conditions and an easing of tensions in sovereign
debt markets, even if we are still in deep and at times unknown waters. But, obviously,
monetary policy cannot guarantee strong and lasting growth on its own, it cannot be a
substitute for the needed reforms, it can only provide favourable conditions to speed the
process up and absorb its short-term costs. A successful effort requires, once again, action
at both the national and the European level.
Lacking a common fiscal capacity, demand in the euro area must draw support from a more
convinced use of the available fiscal space. In particular, this implies a substantial, and
symmetric, respect of the requirements of both the Excessive Deficit Procedure and the
Macroeconomic Imbalance Procedure. In the case of national budgets, the existing flexibility
should be reasonably used within the limits of European fiscal rules. At the same time the
creation of new income, new demand, and new jobs must be supported by measures and
reforms designed, as of now, to raise productivity and enhance growth potential. These
reforms should take into account the structural challenges that characterise our "new world",
including demographic developments, the new wave of technological progress, climate
change. A marked expansion in activities that require expertise and new skills is ahead, but
at the same time it is possible that the scope for employment in the sectors most susceptible
to automation and to the growth of the digital economy will shrink, even considerably.
The way forward
The Five Presidents' Report published in June 20158 sets out a roadmap for completing the
EMU and, specifically, to increase its resilience to local shocks. It calls for contemporaneous
progresses along four dimensions: ensuring that each economy has the structural features to
prosper within the Monetary union (economic union), limiting risks to financial stability and
increasing risk-sharing within the private sector (financial union), ensuring both fiscal
sustainability and fiscal stabilization (fiscal union), and providing democratic foundations for
all the above (political union).
The Report makes proposals to be adopted in two stages and a recent Communication by
the European Commission takes forward key elements of the first stage. On economic
governance, such elements include the introduction of national "Competitiveness Boards"
(mirroring the creation of national Fiscal Councils introduced by the six-pack for fiscal
surveillance) and of an advisory "European Fiscal Board" (providing an independent
evaluation of the implementation of the EU fiscal framework). In addition, steps towards
financial union are also considered (notably through a European Deposit Insurance
Scheme), as well as a more unified representation of the euro area in international
organizations.
For the long term, the Report calls for the creation of a fiscal stabilization function for the
euro-area, complementing national instruments to cushion severe negative shocks.
Participation in this shock-absorption mechanism would be conditional on compliance with
common standards in economic convergence.
Unsurprisingly, the Report is far from being uncontroversial, most notably in the fiscal area.
According to some, the weaknesses are such that the Report risks to be another "missed
opportunity".9 One can doubt the benefits of introducing further layers of "technocratic" control
in an already complex framework, often criticized for lack of democratic accountability. In the
medium term, and at least until the creation of a common fiscal stabilization function, the
shock absorption capacity of euro-area countries remains dangerously limited (especially for
those countries with limited fiscal space). In the longer term, since access to the common
fiscal capacity would be conditional on significant and sustained economic convergence,
there is a risk of introducing a new source of tensions among different Member States within
the euro area.
Regardless of its individual proposals, in my view the key questions to ask about the Report
are two: Are we going in the right direction? And, are these efforts sufficient? I believe that,
however arduous it might prove, it is worth proceeding along the roadmap set out in the
Report. But it might not be sufficient. I believe that more progress on the side of the political
union should not come sequentially, at the very end of the process, but important elements
should be considered right away. In other terms, more action at the economic and financial
level needs to be accompanied by parallel action also at the institutional and intrinsically
political level: for example, on the legal side (from company and bankruptcy laws, to more
basic rights and principles); on solidarity and welfare; on defence and security; on the timing
of elections, and so on. There is also a case for reversing the de facto predominance of the
intergovernmental approach on the so-called community method, even if we must be aware
of the risks of this being dominated by an excessively administrative and bureaucratic
policymaking.
I often joke that, for a sense of shared purposes to be built-up in the euro area and to fully
remove uncertainty in the eyes of interested external partners and observers, perhaps it
would have been better to have a "single army" before adopting a "single currency".... Jokes
apart, and aware that issues such as this have been very much debated over the last sixty
years or so, I believe that those taken in the last few years on monetary policy and banking
supervision are critical steps ahead towards a stronger union. Financial fragmentation along
national lines, which came to represent a hallmark of the euro area crisis, has been reversed
by the European response to the crisis; financial integration is now back to a level
comparable to pre-sovereign debt crisis levels, although some fragmentation still remains.
However, the recent opposition to a common European Deposit Insurance Scheme is
unwelcome news if not outright regress. Some claim that for European integration to proceed
more collective responsibility needs to be necessarily accompanied by a parallel transfer of
sovereignty. One may reply that this transfer of sovereignty has already taken place for
monetary policy and banking supervision, without the corresponding introduction of common
macroeconomic stabilization mechanisms or common deposit insurance.
What is certain, most of the actions needed to strengthen EMU calls for trust. A
confrontational approach would be detrimental. Much can be done at the level of the
European Institutions - Parliament, Council, Commission - to make them better instruments
of a genuine Union, rather than a collection of states. Each country must continue to build on
the progress made so far, before or during the crisis, in macroeconomic and structural
adjustment. All must show some understanding for their peers and play their part in renewing
a shared sense of purpose and trust. We have to realize that Europe's strength lies in the
fact that we are united.