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 see ch. tiebout, 1956, “ a pure theory of local expenditures ”. journal of political economy, 64 : 416 – 424. bis central bankers ’ speeches 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

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. see http : / / eur - lex. europa. eu / lexuriserv / lexuriserv. do? uri = oj : c : 2010 : 083 : 0013 : 0046 : en : pdf, european union, article 3 ( 3 ). bis central bankers ’ speeches treaty on 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