Nouriel Roubini and Brunello Rosa: Europe’s Non-Hamiltonian Muddle

ECBThis past week, the European Commission unveiled a plan to help European countries manage the Great Depression-scale shock from COVID-19. Building on a recent Franco-German proposal, the Commission is calling for a €750 billion ($834 billion) recovery fund (€500 billion of which would be distributed as grants, and €250 billion as loans).

The money issued through this so-called “Next Generation EU” plan will flow through European Union programs, in order to achieve the Commission’s goals, including its green and digital economy agenda. The Commission will raise funds in the market by issuing long-term bonds, and their efforts will be backed by a suggested increase in new taxes, such as those on greenhouse-gas emissions, digital services, and other areas of supranational commerce.

Though we are among the few commentators who anticipated that the EU would offer a plan much larger than what most market participants and pundits expected, we also would advise European policymakers to remain realistic about what can be achieved at the moment. Celebrations of the EU’s long-awaited “Hamiltonian moment” of debt mutualisation are premature.

As matters stand, the EU is still an incomplete transfer union in which resources (human, physical, financial) so far move from the periphery to the center – which is to say, to the United Kingdom or Germany. Ironically, one of these poles of attraction, the UK, has decided to leave the EU, ostensibly to end the flow of migrants into its economy. With Brexit, which officially occurred on January 31, the EU has already literally begun to disintegrate.

Optimists believe that, with the UK out, a more cohesive EU can finally emerge. But this prediction seems too rosy. After all, the UK wasn’t so much a hurdle to integration as an excuse for other reluctant member states to avoid closer ties. For example, the UK hasn’t been the one blocking the European Deposit Insurance Scheme, which is needed to complete the eurozone banking union; that honor falls to Germany.

With the rise of populist parties across Europe, it has long been clear that the next major crisis would constitute an existential threat to the EU. The EU now must demonstrate that it is up to the challenge of completing its integration process. Otherwise, it could confront a “Jeffersonian moment” that returns it to some form of confederation with only limited shared sovereignty.

Facing the abyss, France and Germany have devised a plan to mitigate the pandemic’s devastating economic fallout. But while their proposal has its merits, Alexander Hamilton would be unsatisfied – and rightly so. For starters, the envisaged bond issuance would not come with a “joint and several guarantee,” and thus would not constitute genuine debt mutualisation. Financier George Soros’s proposal for EU perpetual bonds, or Consols, would alleviate this problem, but it would not solve it. And, in any case, if the funds do not become available by this summer, it may already be too late for hard-hit countries such as Italy, Greece, and Spain, which will be facing a dreadful tourist season on top of it all.

More to the point, the distrust between the EU’s “frugal four” (Austria, Denmark, the Netherlands, and Sweden) and the allegedly “profligate” southern countries (including Italy, Spain, and Greece) remains so deep that it is frankly difficult to imagine any long-term solution being adopted. A recent ruling by Germany’s own constitutional court sent a powerful signal to European institutions about what to expect on the road ahead. Though the decision eventually will be overruled by the European Court of Justice and ignored by the European Central Bank, the ECB nonetheless faces political limits to its actions.

Germany will either have to offer a partial EU fiscal backstop with its own taxpayers’ money or allow EU institutions to provide a sufficient mutual backstop (starting with the eurozone budget) for the entire monetary union. If the proposed EU recovery fund were capable of revitalising the eurozone budget – particularly its never-agreed stabilisation function – that by itself would represent a significant achievement.

In signing on to a joint plan with France, Germany presumably realised that it could not simply say “nein” to both a monetary and a fiscal backstop (that is, the budding fiscal and transfer union). Both are needed for the euro to survive. But even with backstops in place, critical questions would remain unresolved, not least the sustainability of Italy’s surging public debt. Italy would have to make massive strides to restore growth and competitiveness now that its comparative advantage in tourism has been so severely compromised.

Overall, although any common European approach to the COVID-19 crisis is a step in the right direction (and certainly better than no action), there is little reason to expect the EU to break from its long tradition of merely muddling through. If European leaders can prevent an immediate breakdown of the EU and euro projects, they at least will have averted the enormous economic, social, and political costs that would come from further rapid disintegration. But a net response that reflects the old inertia will leave Europe unequipped for the post-COVID world, where other major continental economies – the United States, China, and India – will make the most important geo-strategic and economic decisions.

About the Authors

Nouriel Roubini, Professor of Economics at New York University’s Stern School of Business and Chairman of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank. His website is NourielRoubini.com.

Brunello Rosa, CEO and Head of Research at Rosa & Roubini Associates, is a visiting professor at Bocconi University.


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