Analytics, Economics, Education and Science, EU – Baltic States, Financial Services, Latvia, Legislation

The Economic and Monetary Union is the major instrument to address EU’s long-term challenges; however, it did not prevent the buildup of economic imbalances. Hence, the Economic and Monetary Union is as yet incomplete both by the standards of economic theory on optimum currency areas and by the standards of those who proposed it in the first place.

In 1989, when Jacques Delors set out his vision of an economic and monetary union, he was very clear: "monetary union without a sufficient degree of convergence of economic policies is unlikely to be durable and could, in fact, be damaging to the European Community."

See: Report on Economic and Monetary Union in the European Communities of 17 April 1989, para 21.

Therefore, the Delors’ report recommended clear fiscal rules for the member states; he said: “in order to reduce adjustment burdens temporarily, it might be necessary in certain circumstances to provide financing flows through official channels", but (…), "on terms and conditions that would prompt the recipient to intensify its adjustment efforts.” Ibid, para 30.

When the Euro was introduced, in order to join the new common currency, the member states had to fulfill a set of key convergence criteria. But the economic and fiscal policy coordination that followed remained weak and no financial backstops within the Euro area were envisaged.

Only in response to the Eurozone crisis were a number of these weaknesses addressed.

EU’s response to crisis

In the response to the crisis, the EU institutions have introduced:

= an upgraded macro-economic governance framework to better coordinate economic policy among the member states, i.e. the European Semester.

= a macroeconomic imbalances procedure to detect and address economic imbalances early on.

= more sophisticated fiscal rules, the six-pack and two-pack regulations and the Fiscal Compact.

= a financial backstop - the European Stability Mechanism to provide temporary fiscal support to the member states in difficulty, against necessary policy conditionality.

= creating a Banking Union to weaken the bank-sovereign loop and ensure financial stability.

= the European Central Bank's monetary policy tools with the famous Mario Draghi's "whatever it takes" expression to calm down financial turmoil in Europe. "Whatever it takes" was referring to outright monetary transactions – ECB's commitment to buy Member States' bonds in the secondary market in unlimited quantity if necessary.

Recently, the European Court of Justice confirmed that outright monetary transactions have been within the mandate of the ECB.

The ECB is also helping the economic recovery with accommodative monetary policy, not least with quantitative easing. But there is still a long way to go to achieve economic convergence.

Economic convergence is not about uniformity; EU’s economic policy must be adjusted to the specifics of each member state, their economic structure and economic cycles. Hence, the economic convergence is about creating in every member state economic structures that are resilient and can adjust to change. They should allow businesses to grow and people to seize opportunities – sometimes against the resistance of special interest groups. Such structures should support people when economic difficulties hit them and help them get on their feet again.

European convergence policy should lead towards a highly competitive Social Market Economy, which on the basis of competition unites free entrepreneurial initiative with social progress.

Such economy should protect diversity while creating unity and stability.

On top of all, such an economy shall be globally competitive.

These challenges are not confined to one member state alone; they are faced by all EU countries and the EU Economic and Monetary Union is the catalyst in addressing them.

Achieving comparative advantages

No doubt, that the EMU process shall be deepen by doing: i.e. reforming the structure of member states’ economies and strengthen economic governance within the existing Treaty with a clear sense of purpose –the economic convergence.

To strengthen economic recovery and to facilitate convergence the Commission concentrates its efforts in three areas: boosting investment, implementing necessary structural reforms and maintaining fiscal responsibility.

Investment in Europe has fallen by 15% since the crisis; and it did not recover as fast as, for example, in the US. The level of investment in Europe is still substantially below its longer-term "sustainable" level of around 20-21% of GDP.

The EU single market is Europe's strongest lever to create new opportunities for economic growth and jobs creation. It is also an essential ingredient for economic convergence within the EMU. To name just one example, completing the Digital Single Market could contribute €250 billion to the European economy over the next five years and create hundreds of thousands of new jobs.

Besides, it is simply unacceptable that people are shut out of jobs because of some professions remain closed. At the same time, the Commission is calling for the tax burden to be shifted from labour to areas that are less detrimental to growth, e.g. areas such as consumption, property or capital. Labour markets and social policy must be reformed so they allow workers to seize opportunities and help them get on their feet again.

Many EU countries shall address the problem of a segmented labour market – with strongly protected jobs for some and very weak protection for others – mainly newcomers to the labour market.

The member states need to develop common benchmarks and standards for functioning product, services and labour markets, competitiveness, business environment, public administration and certain aspects of tax policy. This is a challenging task, with numerous questions for economists and lawyers. If economic reform is the heart of economic convergence, then fiscal responsibility and financial stability are the legs on which it stands. Fiscal responsibility and financial stability are preconditions for economic growth and convergence. “There is no such thing as a sustainable economic growth without sustainable public finances”, argued V. Dombrovskis.

However, the EU and the member states should definitely avoid a repeat of the recent sovereign debt crisis. Though, there are significant differences between EU countries: Estonia has the lowest public debt level in the EU with about 10% of GDP, Greece has reached some 180% and Italy is around 130%, the EU needs to take into account different situations in different states.

Thus, states with excessive deficits need to continue their adjustment, while those with available fiscal space can use it to stimulate investment and the consumption side of the economy.

Financial stability- important element of convergence

Initially, e.g. in the Delors’ report (1989), it was assumed that in an internal market, the banking and financial system would integrate more or less automatically. But the crisis has shown clearly that this is not the case. As long as the banking sector remains under national control it will remain fragmented, with serious risks for the EMU.

Therefore, there was little alternative to building the Banking Union, with its Single Supervisor and Single Resolution Mechanism to wind up failing banks. Banking Union also sets clear bail-in rules in case of the bank failures, instead of bail-out. This ensures that taxpayers are not first in line to pay for banking sector mistakes.

Ideally, the Banking Union also requires that depositors' confidence in banks does not depend on the financial situation of individual member states.

In a monetary union, confidence in the banking system is not just a matter for the member states. It is in the interest of banks and citizens in the Euro area as a whole - to avoid financial crises.

Recent “Five Presidents' Report” puts the European Deposit Insurance Scheme back onto political agenda of the EU. In the coming months, the European Commission will announce proposals for a European Deposit Insurance Scheme, starting with a re-insurance scheme for national deposit guarantee schemes.  

Treaty changes

The Commission vice-president announced that “sooner or later we will need to consider a Treaty change; the Commission goes into this process with an open mind, as we are the facilitator in this process”.

It is true that many EU states, academics, social partners, etc. have shared their ideas over the summer. Thus, finally, the EU-28 will have to shape consensus around common projects that are shared by all states, and – most importantly – to which the European people are willing to subscribe.

Four principles underpin this process, according to the Commission vice-president:

= First, further steps must take into account the nature of the EU as a system based on unity in diversity, so-called "homeland of our homelands" as Vaclav Havel once put it.

The Delors’s report (April 1989) clearly said: "even after attaining EMU, the Community would continue to consist of different nationals with differing economic, social, political and cultural characteristics. The preservation of this would require (…) a balance to be struck between European and national interests."

Any attempts to steer and control the European economy fully through central institutions in Brussels will fail, the Commission vice-president acknowledged. European economic policy-making must continue to be based on clear rules and commitments, and on a system of checks and balances.

The EU institutions will have a strong role to play. But so will national governments and parliaments, as well as the market forces which can give warning signals when policy makers go astray. 

= Second, more risk sharing must go hand-in-hand with stronger rules and more sovereignty sharing. This fundamental principle has underpinned everything the Commission has done since the crisis: e.g. the creation of a European Stability Mechanism as a robust firewall, at the same time strengthening the EU fiscal and macroeconomic framework. 

As Commission President J-C. Juncker said in his 2015 State of the Union speech, Europe may need, over the medium term, to develop the ESM to better deal with shocks that cannot be managed at national level alone. This can be done only if Europe is prepared to take further steps towards joint decision making. A future Euro area treasury could be the place for stronger collective decision making.

= Third, completing EMU must not open up new rifts with those member states that do not share the common currency. Deepening the EMU we must be open and transparent with non-Euro countries. Initiatives concerning the EU internal market should be done within the framework of EU- 28 states.

= Fourth, any further step towards European integration needs clear democratic control and accountability. The closer the Commission is coming to core elements of public policy, the stronger this need becomes.

With these four principles, and powered by the potential of the European economy – still the largest in the world – the EU states can restart the convergence process inspired by the principles of a social market economy, while building a genuinely resilient Economic and Monetary Union.

Reference: European Commission vice-president, V. Dombrovskis’ speech in Humboldt University, Berlin “The Euro and the Future of Europe”, in: 

http://europa.eu/rapid/press-release_SPEECH-15-5687_en.htm?locale=en