Common Fiscal Capacity Is Needed to Strengthen Risk Sharing

Forum DOI: 10.1007/s10272-020-0905-1 End of previous Forum article Antonia Díaz* Common Fiscal Capacity Is Needed to Strengthen Risk Sharing The COVID-19 pandemic has shown that the fabric of the European Union project, in its current design, cannot facilitate the needed risk sharing to deepen the Single Market. To boost cross-border banking and capital market integration, we need a common safe asset and therefore common fiscal capacity. © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. * This article draws some ideas from Díaz (2020) and Díaz and Puch (2020). Antonia Díaz, Universidad Carlos III de Madrid, Spain. ZBW – Leibniz Information Centre for Economics The heterogeneous effect of COVID-19 across sectors and regions in the EU Until we have a successful vaccine or an antiviral drug, the COVID-19 shock remains a dramatic example of a negative externality: people may become infected when gathering for social or productive purposes. The very nature of the shock implies that people, depending on their economic activity, have different probabilities of getting infected. In particular, activities that require team production (i.e. an assembly line) or those services that require the joint time of the provider and consumer (a restaurant) are severely disrupted by the coronavirus pandemic and the slow-down measures required to prevent infections. Other activities, however, especially in information and communication sectors, are less affected by the pandemic as workers can move more easily to teleworking. This asymmetric effect of the shock on economic activities becomes an asymmetric impact on countries depending on their sectoral composition. For instance, this shock hits 215 Forum regions specialised in services such as tourism particularly hard. Figure 1 Employment specialisation across European regions, 2016 Figure 1 shows a standard measure of employment specialisation across regions of the European Union. It reveals that regions with greater specialisation in retail trade are more affected by the pandemic. The impact of the shock is not only larger in regions specialised in contactintensive services but, most likely, will have a more persistent effect. There are two reasons for this: first, substitution of labour for capital (robotisation) is much more difficult in non-routine jobs. Second, keeping safe physical distance implies that the very size of plants, shops, restaurants, etc. is a binding capacity constraint during the unlock phase. That is, restarting contact-intensive services in a way that complies with safety conditions requires a significant amount of investment in the sectors that have been hardest hit by COVID-19. Moreover, the shift in consumer expenditures from faceto-face services to online services (or goods) implies that there are sectors that are actually benefitting from this crisis. In particular, the digital sector, dominated by international giants like Netflix, Google and Apple is making substantial profits in, almost literally, captive markets. Risk sharing is needed to deepen economic integration COVID-19 is an example of a shock that hits households, firms and sectors asymmetrically, within and across countries. This is particularly important in the European Union since all measures taken to boost the Single Market lead to exploiting comparative advantages across regions and, thus, sectoral specialisation; especially in the eurozone, as Mongelli et al. (2016) show. This specialisation raises the exposure of any regional economy to some risks and, therefore, increases the variance of its GDP. It could be argued that the COVID-19 shock is an extremely unlikely event, but there are many studies that point out that differences in sectoral composition are in fact an important factor in explaining the size of the business cycle fluctuations in the regions as well as the asymmetries and financial imbalances within the eurozone (see for instance, Imbs, 2004; Corsetti et al., 2008; Atalay, 2017). Kalemli-Ozcan et al. (2003) provide evidence that risk sharing and industrial specialisation are positively correlated using data that combines international and intraregional information. The message is that countries (or regions) that can shield consumption against production risk are better equipped to exploit the gains from specialisation much more and advance further in economic integration. The channels for risk sharing, aside from fiscal transfers, are banking and capital markets integration. 216 Canarica (ES) Guadeloupe (FR) 0 100 0 Martinique (FR) Guyane (FR) 0 25 0 100 20 Réunion (FR) Mayotte (FR) 20 0 Malta Açores (PT) 0 0 10 15 0 50 Madeira (PT) Liechtenstein 0 0 5 20 Administrative boundaries: © EuroGeographics © UN-FAO © Turkstat. Cartography: Eurostat – GISCO 5/2019. Agriculture, forestry and fishing 0 200 400 600 800 km Industry Construction Wholesale and retail trade; transport; accommodation and food services; information and communication Financial and insurance; real estate; professional, scientific and technical; administrative and support service activities Public administration (defence; social security; education; health and social work); arts, entertainment and recreation; others Data not available Note: The share of the total number of persons employed in each NUTS 2 region is computed for the six activities: a similar calculation is made for the whole of the EU28; the most specialised activity is computed by taking the regional shares and subtracting the EU28 shares; the map shows for each region the activity whose employment share exceeded the EU28 average by the largest margin (as measured in percentage point terms). Norway and Switzerland: national data. Germany, Greece, Spain, France, Cyprus, the Netherlands, Poland and Romania: provisional. Slovakia: estimates. Source: Eurostat nama_10a10_3). (online data codes: nama_10r_3empers and Martinez et al. (2019) find that a banking union is efficient in sharing domestic demand shocks, while a capital market union is key to sharing supply shocks. That is, integration should go hand in hand on both fronts. An incomplete risk-sharing architecture within the EMU The question that arises is how countries in the EU, especially those in the Economic and Monetary Union (EMU), share the risks that arise from the industrial specialisation brought by the Single Market. Hoffman et al. (2019a) find for the EMU area that, after the adoption of the euro, bank- Intereconomics 2020 | 4 Forum ing integration grew significantly through wholesale funding and the interbank market, which are highly procyclical (see Admati and Hellwig, 2014), instead of cross-border banking integration. This implies that risk sharing actually plummets during econo (...truncated)