International Economics
09 March 2020

Creating a Decentralised Europe

Charlez Wyplosz, Honorary Professor of International Economics at the Graduate Institute, discusses in this interview a recent research paper he authored on the Eurozone and its governance. Professor Wyplosz focuses the discussion on the characteristics of fiscal federalism and suggests decentralisation as the way forward. 

What was your main motivation to write this paper on the Eurozone?

The situation in the European Union (EU) is a bit schizophrenic. On the one hand, many people from the elites keep calling for more integration while, on the other hand, public opinions are shifting from indifference to hostility regarding integration. Brexit is a spectacular example, but Matteo Salvini successfully convinces a large minority of Italians that the main problem of Italy is the EU. The deepening rift with several Eastern European countries is another worrisome symptom. This growing chasm of views is very dangerous. I have been thinking about it, I can see the political aspects, and I was wondering whether economic principles can shed some light.

As it turns out, they can. We have a large literature on fiscal federalism, which asks the following question: How should tasks be assigned within a federal system? Of course, the EU is not a federal system, but the analyses from this literature provide many relevant answers. Surprisingly, most European economists do not use these results. My understanding is that they put their personal preferences ahead of what they know, or should know. This paper was commissioned by a Brussels-based think tank that asked me to focus on a few issues among those that I had raised in previous articles.

What is its main contribution and how can it impact policy discussions?

The paper applies fiscal federalism to two issues crucial for the Monetary Union: banking integration and fiscal discipline. I try very hard to show that the policy proposals are rooted in general principles, not just in the specificities of the issues. Take fiscal discipline for example. Most people accept that it is indispensable within the Monetary Union, lament the failure of the Stability Pact and go on making proposals that aim at making the pact work. For more than two decades, I have argued that pact cannot work because it violates the principles of fiscal federalism. (Initially, I did not know much about these principles. It took some time for me to realise that it was what I am trying to say.) I therefore propose to ignore the pact and adopt a new arrangement that is decentralised to the national level. I am told that is not realistic from a political point of view. I deeply believe that it is not my task to accept this kind of argument. Politicians have to learn to do better, economists should not accept any implicit political censure.

More generally, I believe that we need to reshape the EU. Some tasks must be brought up to the European level, like the Banking Union which is the other main part of my article. Other tasks currently attributed to the European level should be given back to member states, like fiscal discipline.

What is the subsidiarity principle and why should it be at the heart of the Eurozone?

The subsidiarity principle is part of the fiscal federalism literature. This literature develops criteria for and against centralisation for each public policy task. Often, the result is ambiguous: there are good reasons to centralise and good reasons to decentralise. In those ambiguous cases, the subsidiarity principle says that you keep the tasks at the decentralised level. The principle has been written in the European treaties but those who want more integration systematically ignore it. I think that this bias is a key reason for disenchantment with European integration. Brexit is a case in point.

Why is fiscal (in)discipline a key issue for the Eurozone and why should decentralisation be a desired arrangement?

The Greek crisis has shown that fiscally undisciplined countries eventually hit a wall. It was known and recognised all along and led to the adoption of the Stability Pact, the wrong solution for a key requirement. It is wrong because, in Europe, fiscal policy is a national prerogative to which citizens are deeply attached, rightly or wrongly. Our democracies were born to impose popular oversight over taxation and public spending. The pact eats into that by allowing Europe (the Commission, the Council) to dictate member countries what they should do, year after year. It cannot work because it cannot be enforced. Hence my proposal to decentralise the fiscal discipline imperative back to the national level along with obligations set by the European level but enforced locally.

What is the relevance of the “doom loop”, the two-way dependency between government finances and banking systems, and how can it be broken?

The doom loop is the fact that governments borrow from local banks and, when they become highly indebted, the banks are in deep trouble and have to be rescued by their already highly indebted governments. Scratch my back, I’ll scratch yours: governments too easily borrow and banks are too easily rescued. Greece, Portugal, Italy, France are good examples of this unhealthy arrangement that ends up into a collusion against the taxpayers. It is one reason behind the rise of populism.

There are many ways of breaking the doom loop. Some propose mutualising public debts, so that for example the Italian debt would be guaranteed by, among others, Germany and its taxpayers. No need to explain why Germany is staunchly against this solution. Others want to cap the amounts of national debt that can be held by banks. Obviously, the Italians do not want to hear about that. There are many other arrangements that play with these ideas. Many are seeming complicated so they may look good, until people realise what they try to achieve. My view starts from a basic economic principle: risk diversification. Full banking and financial integration mean that there will not be any more German banks, Italian banks, Dutch banks or national financial markets. This requires centralisation.

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Full citation of the research paper:
Wyplosz, Charles. “Creating a Decentralised Eurozone.” Future of Europe series of research papers, Wilfried Martens Centre for European Studies, Brussels, 2019.

Interview by Guilherme Suedekum, PhD Candidate in International Economics.
Banner picture: excerpt from a picture by EQRoy/