European (Dis)Union: North vs South

The health crisis

The current public health crisis, which has put the world on pause, is a test to human beings and to societies in general. It’s one of the biggest challenges faced by humanity since WWII (as stated by Germany’s chancellor Angela Merkel) and has put in check all structures of society and their response to the unknown. With that being said, the Coronavirus crisis has also been a test to the European Union (particularly, the Eurozone) and its unity.

Since the beginning of the crisis, the unity has been questioned as there wasn’t a prepared common strategy to deal with it.  Indeed, borders started to shut down individually rather than collectively, which didn’t make much sense as it affected the free movement of people, a key pillar in European unity; Italy, which was the first European country severely affected with the virus, appealed to its neighbours for medical equipment and aid, which was promptly denied, further increasing the division and loss of faith in the EU; the question regarding coronabonds re-woke the mutualised debt discussion in the Eurozone and increased pre-existing tensions, with southern countries strongly defending this mutualised debt instrument to respond to the crisis and others (Germany, the Netherlands, Finland and Austria) initially denying it, reopening the old gap between North and South.

Productivity

Indeed, every major crisis becomes a challenge to the EU (more specifically, to the Eurozone) and to its continuity and reinforces core differences between these “two regions”.

One key difference that cannot be ignored is productivity. On average, the “North” is much more productive than the “South”. According to OECD data, in 2018, countries like Germany, Netherlands, or Austria presented a higher GDP per hour than the average GDP per hour in the Eurozone ($59.64/hour); on the other hand, southern Eurozone countries such as Portugal, Spain, Italy or Greece had a lower productivity, below the Eurozone’s benchmark. This productivity division exists for a while and has impacted how countries experience economic growth and thus, their position as economic powers in the EU. Over the years, productivity has been increasing in both regions, with North above and the South always below the benchmark.


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This difference has given space for some remarks throughout the EU’s history, with Southern nations being perceived as lazy by some Northern nations (let us remind some unfortunate comments made by former Dutch Finance Minister and president of the Eurogroup, who stated that crisis-hit countries, which were mainly Southern countries, spent their money on “drinks and women”). As shown in the graph, these comments are somewhat unsubstantiated, as Southern European countries work more hours yearly than Northern countries, reducing productivity, a complex and broad concept, often inherent to cultural characteristics. This serves only to further increase tensions between the two regions and further divide the EU, more noticeably in moments of crisis.


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European Debt Crisis

Another moment of division in the Eurozone dates back to 2008, when the Great Recession led to the European Debt crisis, resulting in the collapse of financial institutions and high government debt. This occurred due a high fiscal divergence between the member states, with Northern countries lending intensively to the South, creating an imbalance of capital flows.

 Indeed, in years prior to the crisis, current accounts of the two “regions” were symmetric, with Germany, Austria or Finland experiencing positive values, while Portugal or Greece had negative accounts. Also, capital accounts presented a similar pattern, with the North experiencing much lower values than the South. Instead of promoting structural change in the economy (greater capital accumulation) to converge with the richer countries, the South channelled capital flows from the North to non-tradable goods, i.e., having no export value and created both consumption and investment bubbles (due to low interest rates). Following the 2008 financial crisis, this led to an unbearable situation that culminated in the financial rescue of many southern countries.


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Who is to blame?

From the North’s point of view, the South was living above its means and was not taking essential structural fiscal measures: while Germany was promoting fiscal discipline (surplus over deficit), the South was excessively expanding domestic demand to raise consumption and investment, unprecedentedly. Southern countries argued that this crisis was a double-edged sword, as creditors were lending at their own risk (low interest rates) and thus, they also had some responsibility for the imbalances in the eurozone.

The lack of common analysis on the crisis encouraged division and the financial rescue packages (based on strict conditionality and fiscal consolidation, dictated by the North) generated political and public criticism in the South, as austerity was deteriorating socio-economic structures and life conditions. The South blamed Germany for imposing its domestic preferences, with major protests against austerity, criticizing what they called the “German-run” Europe.

Nevertheless, while Portugal, Greece or Cyprus were tightening their budgets to repay the debt plus interests, with low investment and unemployment was peeking, Northern countries, like Germany or Austria, benefited from the shift of investment from the south, improving borrowing conditions for their companies (for instance, in 2014, Portugal’s yield of its 10 year bonds were at 5.675%, while Germany’s were 1.944%) and hence, promoting their economic growth, further deepening the division.

Coronabonds

In order to respond to this pandemic crisis, eurozone members discussed possible emergency economic solutions for 10 days, reaching a consensus. The coronabonds, a jointly issued bond, was one of the possible solutions, which intensified the friction between “North” and “South”. The eurobonds were mainly defended by Southern countries because it would be less costly to their governments to pay back the debt, also given the considerable amount of debt that they already have, as they would have easy access to credit at low rates. However, countries in the North, led by the Netherlands (and Germany), declined the idea of a eurobond because it would mean that their own taxpayers would be on the hook for the benefit of other countries, who they claim to have lived beyond their means, raising concerns of moral hazard. This divergency is not new; in 2008, in the financial crisis, the idea of eurobonds also emerged and was not applied. Unlike the previous crisis, where one can argue was caused by financial misbehaviour of some countries (endogenous factors), the current crisis is an exogenous shock that doesn’t discriminate based on cultural and fiscal differences, meaning that there should be a common solution rather than trying to blame countries on something that it’s not their own making.

Even though the EU has reached a short-term agreement worth over €500 billion to respond to the crisis, it hasn’t yet agreed on a common economic recovery, which is still a source of division. The real test will be when the economy slowly starts the path to normality. Meanwhile, populist, right-wing forces and eurosceptics observe, with discontent, how this crisis unfolds.

It’s up to the European Union to stay together.


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Sources: Financial Times, Time, Público, OECD, Pordata, Expresso, npr, NAC, Euronews, The balance


Raquel Novo - Raquel Novo Teresa Thomas - Teresa Thomas

The Federalist Papers: Short overview and considerations about the future of fiscal federalism in the EU

“After full experience of the insufficiency of the existing federal government, you are invited to deliberate upon a New Constitution for the United States of America. The subject speaks its own importance; comprehending in its consequences, nothing less than the existence of the UNION, the safety and welfare of the parts of which it is composed, the fate of an empire, in many
respects, the most interesting in the world.”

— Alexander Hamilton as Publius, Federalist No. 1

Following the American Revolutionary War, and the drafting and ratification of the Articles of Confederation by the 13 states, it soon became obvious that the young confederate government was severely hindered in its functioning by an overall lack of power. Indeed, without an executive or judicial branch, the new government lacked the power and authority to tax, for example. Since it could only request money from states but didn’t have any ability to enforce these requests, both the government and the U.S. army were majorly underfunded.

It was, therefore, to evaluate and, possibly, amend the Articles of Confederation and improve the current situation that delegates from the 13 states gathered in Philadelphia, in 1787, in what was called the Philadelphia (or Constitutional) Convention. Even though a new constitution was drafted and signed in this convention, it was not with this goal in mind that these delegates joined in assembly. However, since many were convinced of the inadequacy of the current system, the convention soon evolved into an effort to redesign and rebuild the whole political structure of the union from a loose confederacy into a more solidly cemented federal union.


However, the drafting of the new constitution and its signing in the convention was only the first step. Next, and most critically, to enter into force, the new Constitution needed to be ratified by 9 of the 13 states. It was to lobby votes in favor of ratification that Alexander Hamilton, one of the convention delegates from the state of New York and the 1st Secretary of Treasury of the United States of the future government, wrote, along with James Madison, one of the most central figures in the drafting of the new Constitution and the Bill of Rights and future president of the U.S., and with John Jay, future 1st Chief Justice of the Supreme Court of the new government, a series of essays whose collection is referred to as The Federalist Papers.

Alexander Hamilton

Alexander Hamilton

The Federalist Papers

The Federalist Papers

James Madison

James Madison

These essays, 85 in total (1), were published as serial installments in newspapers and discussed topics ranging from the benefits of a federal union under the Constitution on matters of war and taxation to the discussion of the principles of separation of powers, how it is upheld by the Constitution and how the system of checks and balances between the three branches of government works under the Constitution, all the while attempting to refute many of the anti-ratification arguments of the time.

Although their effect in promoting the ratification of the Constitution is unverifiable, they certainly are a window into the political and historical framing of the federalists vs anti-federalists debates of the time and can prove useful in understanding some of the debates and arguments employed with regards to federalism in the European Union.


In Federalist No.11, Hamilton talks about the advantages of a common commerce policy, as achievable by federalization with, for example, the ban on inter-state tariffs, echoing many of the free-trade ideas that helped create and develop today’s European Union’s common market.

In Federalist No.30, Hamilton describes the poor situation of the government’s revenues under the Articles of Confederation and argues, namely, that the state of public debt of such a government will be extremely precarious. Indeed, while talking about the future creditors of the government he says:

“to depend upon a government, that must itself depend upon thirteen other governments, for the means of fulfilling its contracts, (…) would require a degree of credulity, not often to be met with in the pecuniary transactions of mankind”

— Alexander Hamilton as Publius, Federalist No. 30

The solution to such a problem, he argued, lied in giving the new Congress the general power to tax and levy tariffs.

However, federal revenues were mainly dependent on tariffs until the beginning of the 20th century, before the creation of the income tax (2). As this new tax was being levied and grew in size, federal fiscal policy also grew in scope, with the creation of the New Deal during the Great Depression, for example.


Both Hamilton’s arguments at the time for a more energetic government, empowered by the power to tax, and the expansion of the scope of federal fiscal policy after the Great Depression timed with the creation of the income tax provide insights into the current discussions on the expansion of centralized fiscal responses by the European Union.

Indeed, for the central institutions of the European Union to be able to provide a more timely and powerful response to a crisis such as the present one, they must also be able to access bigger sources of revenues.

If we want more powerful central institutions in the EU their budgets must also increase.

In 2017, EU budget expenditures were about €137,000 million. These paled in comparison to the U.S federal government’s almost $4,000,000 million in outlays. In Europe, where countries’ governments are already very fiscally active, it is hard to imagine a scenario where an increase of the central EU budget to levels more comparable to those of the U.S. federal government would not come at the cost of shrinking national government’s budgets.

Whether a more centralized response by the EU would, then, be net-beneficial is not something I’m arguing for or against. Indeed, the question that I desire to pose is whether this response, at the expense of member-states’ fiscal power, is politically achievable. Such a question is impossible to definitively answer. On one hand, emergency situations, like the Great Depression in the U.S., seem to be breeding grounds for centralization, on the other, the shifting political landscape in Europe, namely with the rise of Euro-skeptic parties, may foresee a grimmer fate for European federalism.


(1) You can find The Federalist Papers at: https://www.congress.gov/resources/display/content/The+Federalist+Papers or listen to public domain recordings of it by LibriVox at: https://librivox.org/the-federalist-papers-by-alexander-hamilton-john-jay-and-james-madison/

(2)-  Even though Clause 1 of Section 8 of Article 1 of the U.S. Constitution gave Congress the ability to levy taxes it was only with the creation of the 16th Amendment to the U.S. Constitution that Congress was able to levy country-wide income taxes.