11 Jun 2020

Europe’s New Deal Moment


Originally Published: Project Syndicate, 10 June 2020

Many believe that the recent Franco-German proposal for a European recovery fund – to be financed by bonds issued by the European Union – could be the bloc’s “Hamiltonian moment.” The term refers to the 1790 agreement spearheaded by Alexander Hamilton, the United States’ first treasury secretary, whereby the US federal government assumed the debts incurred by the new country’s 13 states during the War of Independence.

On superficial inspection, this analogy seems to warrant the introduction of Eurobonds right now. But a closer look reveals that the equation “Hamilton = Eurobonds now” does not hold, for three reasons.

First, whereas the US states had incurred most of their debts in a common cause, namely the war against Great Britain, that is not true of today’s EU member states. Although some might argue that the bloc’s governments are all fighting against another common enemy, namely COVID-19, this analogy is misleading. The additional debt that most governments will incur to keep national economies afloat during the pandemic will be large, but it will constitute only a fraction of their total debt.

Assume, for example, that the Italian government has to spend the equivalent of 15% of GDP to mitigate the looming pandemic-induced recession. The country’s public-debt ratio would then increase to about 150% of GDP, but the common fight against the coronavirus would have accounted for only one-tenth of the total.

Second, the US states’ wartime debts were not repaid in full by the federal government, because the portion owed to private creditors was substantially restructured – what we would now call “private-sector involvement” – before the federal government assumed them. But a restructuring of EU member states’ existing debt today is out of the question.

Third, the federal government’s assumption of state debts that Hamilton engineered was in a certain sense unavoidable, partly because the main source of government revenues – external tariffs – also had been transferred to the federal level. Likewise, the large-scale introduction of Eurobonds would necessitate the transfer of a substantial share of national government revenues to EU level, along with restrictions on national fiscal policy, as Société Générale Chairman Lorenzo Bini Smaghi has eloquently pointed out. But few EU member states, including those advocating Eurobonds, would be willing to abandon a large part of their fiscal sovereignty.

For these reasons, it is difficult to argue that Europe’s current situation in any way resembles that of the US in the late eighteenth century, and that now is the time to introduce large-scale risk-sharing on Europe’s national public debts.

Some have compared the proposed European recovery fund to the 1948 Marshall Plan, under which the US provided war-ravaged Western Europe with substantial aid to finance reconstruction. But, again, the differences are more important than the similarities. Above all, the problem today is not ruined physical infrastructure, but rather the sudden limitation on the use of existing productive resources.

Arguably the most relevant US historical parallel for Europe today is President Franklin D. Roosevelt’s New Deal of the 1930s. After all, the US had entered the Great Depression with a fragmented banking system organized along state lines, and with the states also responsible for unemployment insurance and poverty relief.

The New Deal changed all that, but much of FDR’s program had to overcome resistance. Although his administration quickly established a banking union by creating the Federal Deposit Insurance Corporation in 1933, introducing fiscal measures and reorganizing unemployment insurance turned out to be much more difficult.

In particular, the US Supreme Court repeatedly stymied the New Deal by ruling that some of its central elements were unconstitutional because they were not federal competences. But after FDR won a landslide re-election in 1936 and threatened to add more supportive justices, the court changed its position – known as “the switch in time that saved nine” – allowing him to implement most of his initiatives.

Then as now, the key issues were unemployment and poverty relief. The New Deal did not simply override state competences in those domains, but instead provided states and municipalities with large federal funding for public works and unemployment compensation.

In a similar vein, the €750 billion ($837 billion) “Next Generation EU” fund, proposed by the EU Commission on the heels of the Franco-German proposal, would channel EU funds through member states and regions. And the bloc’s €100 billion SURE initiative to mitigate unemployment risks in hard-hit member states, which has already been agreed upon, also carries echoes of the New Deal.

The lack of a European unemployment insurance scheme should not be surprising. In the US, unemployment insurance is also still based on state-level schemes that the federal government supplements during recessions. (The $2.2 trillion US economic-rescue package that Congress adopted in March increased federal jobless payments by far more than in previous downturns.)

FDR’s reforms have stood the test of time and are now accepted as an essential part of the US “economic constitution.” The longer-term challenge for the EU will be to implement its COVID-19 crisis measures in such a way that they, too, come to be seen as useful economic stabilization tools when more normal times return.