How to renew the European project

Policymakers should consider the roots of the euro zone’s low growth potential, which is not a result of insufficient solidarity, but of individual member states abnegating their national responsibilities.

THE French presidential and legislative elections earlier this year have instilled new hope in the European integration project, by raising the prospect of deeper Franco-German cooperation. And yet some forms of cooperation, not least shared-liability schemes, would be a mistake. As long as member states have sovereignty over fiscal and economic policymaking, France and Germany should focus their efforts on making the euro zone itself more resilient.

French President Emmanuel Macron has started to pursue urgently needed reforms to boost economic growth, and it is crucial that he succeeds in this effort. France is suffering from high structural unemployment and low potential growth, and its public finances are unsustainable in the medium term. Improving this state of affairs will require factor- and product-market reforms, together with deep reductions in public-sector deficits.

From France’s standpoint, there is no better time than now to implement economic reforms. Although the euro zone is showing signs of a solid economic recovery, the European Central Bank is feeling increasing pressure to taper its ultra-expansionary monetary policies. Macron’s government thus has no time to lose, especially given that economic reforms can take time to deliver results, and the next elections are always just around the corner.

In light of this small window of opportunity, the last thing France needs is more joint investment schemes, as some have proposed. Economic growth requires not just capital investments, but also a business environment where innovation is encouraged and rewarded. And at any rate, it wouldn’t make sense for France to rely on other member states for investments. How can France claim to have restored its past grandeur if it is asking for Germany’s help?

Beyond implementing domestic reforms, France can still work with Germany to send a powerful message in support of European integration. But as both countries seek areas where they can cooperate, they must be careful to avoid policies that would threaten the euro zone’s long-term stability.

Unfortunately, some proposals currently being discussed would do precisely that. For example, establishing a shared euro zone-level budget or unemployment-insurance regime would, at this stage, sow the seeds of future conflicts. It is inconceivable that national policymakers, seeing to their countries’ own interests, would prevent these arrangements from mutating into permanent asymmetric transfer schemes.

To avoid distributional conflicts that would only poison the European project, any institutional reform that is proposed in the name of FrancoGerman cooperation should have to pass a strict sustainability test. European policymakers must ensure that there is congruence between the power to make decisions and the liabilities associated with any decisions that are made. It would be naive to think that member states will not offload the costs of their choices onto other member states if given the chance.

And besides, there are many other areas where France and Germany can strengthen cooperation and give new momentum to European integration. To determine where to focus their efforts, French and German leaders should keep three related principles in mind. First, any joint endeavor must respect diversity. The central strength of the European project is that it unites its member states in pursuit of peace and prosperity. But this requires a rich reservoir of ideas, not a single, unified approach.

The second principle is subsidiarity, which holds that decision-making should be decentralized whenever possible. This ensures that local and regional preferences are considered alongside the effects of euro zone-wide harmonization and economies of scale.

The last principle is congruity, to ensure that decision-makers are accountable for the outcomes of their decisions. This means that as long as European electorates insist on retaining sovereignty over fiscal and economic policymaking, shared liability will be a pipe dream.

With these principles in mind, France and Germany could take joint action on a variety of issues, such as climate change, the refugee crisis, and counter-terrorism. Coordinating efforts on these fronts would revitalize the integration process and contribute to Europe’s long-term stability and prosperity.

On economic policy, France and Germany should look for ways to fortify the euro zone and complete the single market. The privilege that government debt enjoys under current banking regulations should be eliminated, and an independent banking regulator, separate from the European Central Bank, should be established within the euro zone. Beyond that, it is time to start phasing in a viable sovereign-insolvency scheme for the bloc.

All of these initiatives could be implemented simultaneously with domestic reforms in France. But there is a risk that they will take a back seat to other proposals, such as shared-liability schemes. To avoid this pitfall, policymakers should consider the roots of the euro zone’s low growth potential, which is not a result of insufficient solidarity, but of individual member states abnegating their national responsibilities. Rather than provide a cure for these problems, shared liability would make them worse.

Proponents believe that more shared liability could pave the way for individual responsibility. But that is an illusion. Once in place, a shared liability scheme would reduce the incentives to deliver on structural reforms. And among German voters, nothing could undermine support for the European project more than yet another set of broken promises.

Christoph M. Schmidt is Chairman of the German Council of Economic Experts and President of the RWI – Leibniz Institute for Economic Research, one of Germany’s leading economic research institutes.

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