Is Europe Headed for a Fiscal Union？

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

Amid the gloom of the pandemics second wave, some European enthusiasts are wondering whether this crisis might finally usher in a “fiscal union” of states — something akin to the U.S.

The roaring success this week of the European Unions first social bond, issued to help fight off the pandemic recession, shows investors are eager to lend money to the EU as a whole, rather than just to constituent countries. At the same time Christine Lagarde, president of the European Central Bank, is encouraging the bloc to consider turning the joint-debt instruments created during the pandemic into permanent tools. This would move the EU a step closer to becoming a federation of states, since the European Commission —which is issuing the bonds — would have a bigger budget to redistribute resources toward countries in need.

Europe, and the euro zone in particular, would gain plenty from a system of cross-border fiscal transfers, provided adequate Brussels checks on national budgets were in place to stop reckless spending. The currency union has a single central bank and monetary policy that cannot easily cater to the needs of an individual country that faces a deep or isolated shock.

But for all the enthusiasm of investors and Lagarde, the obstacles to a fiscal union remain above all political. These wont disappear despite the breakthrough of agreeing joint pandemic funds.

This weeks bond auction to fund an EU scheme that supports labor markets attracted 233 billion euros ($275 billion) in orders — well above the 17 billion-euro issuance. As my colleague Marcus Ashworth explained, this proves the EU can be a serious player in global debt-raising.

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And yet, a lack of appetite from the markets was never the real obstacle to deepening the European project. Investors have flocked to lend money to the European Stability Mechanism — the euro zone‘s rescue fund — since its creation during the last decade’s sovereign debt crisis. The EU social bonds offer a triple-A rating, increasingly scarce in a world of vast sovereign debt. While the EUs 10-year issuance offered a negative yield, it is still less negative — and hence more attractive — than other AAA paper such as German bunds.

Unfortunately the political hurdles to closer union still look sizeable, as some countries with stronger finances fear having to support their endlessly flailing neighbors.

For all its success in terms of orders, this week‘s auction reinforced this concern: The EU’s social bonds yield more than comparable securities from Germany, the Netherlands and Finland, and less than those from Spain, Italy or Greece. At a time when yields are compressed everywhere, these differences are minimal. However, they still show that participating in such “euro bonds” is better for fragile countries (they pay out less than their own bonds) and relatively expensive for those with more robust shoulders.

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The EU did manage to overcome such difficulties in the summer, when it reached a historic agreement over a joint 750-billion euro fund that will disproportionately help countries such as Italy and Spain. Crucially, this tool will offer grants — essentially giving money to the recipients — as well as loans, breaking a euro zone taboo. But negotiations over the fund are ongoing and arduous. The European Parliament is demanding stricter mechanisms to deny money to those countries that break democratic principles such as Hungary and Poland. The Netherlands, long opposed to grants, is also demanding tougher terms on the fund.

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As a result, it‘s unlikely that EU countries will receive any help until mid-2021. For now, individual governments have no trouble funding themselves on the market at very low rates. It’s troubling nonetheless that an instrument set up to deal with an emergency will be delayed because of political wrangling. Old habits die hard in Europe — and excited investors wont change that.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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Ferdinando Giugliano at fgiugliano@bloomberg.net

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James Boxell at jboxell@bloomberg.net