COVID-19 and the Political Economy of Shared Adjustment

Political Economy DOI: 10.1007/s10272-021-0999-0 Ralf Boscheck* COVID-19 and the Political Economy of Shared Adjustment By April 2021, the COVID-19 crisis in Europe had reached a magnitude that, in the eyes of some observers, either deepened lingering divides and threatened the EU’s very existence, or, conversely, forced the Union to address the fundamental flaws of its euro area and provided an opportunity to reboot. From the outset, the EU had to confront fundamental challenges that require coordination; however, decentralised coordination is best as it improves the quality of policy, economic efficiency and civic virtues. While some argue for a debt union to provide the answer to the EU’s call for shared adjustment, a solution should rather be sought in economic reform, accountability and enforcement of constitutional commitments. In 2020, the COVID-19 crisis resulted in the largest global economic contraction since 1946. For 2021-22, most macroeconomic experts predicted the recovery would most likely be K-shaped, with some economies and parts of society recuperating faster and others facing a more lengthy and difficult resurgence. And yet, behind this very general and therefore innocuous statement was a considerable disagreement over adequate policy responses, their short-term consequences and long-term side effects. What is more, some enduring policy tenets appeared to have lost credibility at a time when countries sought direction on how to shoulder the fiscal burden or establish the legitimacy of adjustments to block any further epidemic and economic contagion. By April 2021, the crisis in Europe had reached a magnitude that, in the eyes of some observers, either deepened lingering divides and threatened the EU’s very existence, or, conversely, forced the Union to address the fundamental flaws of its euro area and provided an opportunity to reboot. This article provides a critical perspective © The Author(s) 2021. 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. Ralf Boscheck, Universidad Adolfo Ibáñez, Santiago de Chile, Chile; International Institute for Management Development, Lausanne, Switzerland. 278 on the EU’s ability to manage a shared adjustment to the coronavirus pandemic. EU governance: Fundamentals, post-2008 and COVID-19 In the early 1950s, Robert Schuman and Jean Monnet, the founding fathers of the EU, tried to lay the institutional foundation for economic prosperity in order to stabilise a war-ridden, divided continent. Ever since, the growing diversity of economic capacities and policy preferences at the national and regional levels have presented the single most important challenge to the pursuit of the EU’s core objectives: market creation, policy coordination and cohesion. Europe is but a label. Any “normal” economic state covers nations with widely different GDP growth rates, sectoral compositions, unemployment rates, labour productivity and average manufacturing wages. While disparities among European nations are pronounced, regional differences within them are becoming economically and politically ever more important. Among the Union’s 250 regions, GDP per capita is typically three times higher in the ten wealthiest countries than in the ten at the bottom of the scale. Differences in skills and infrastructures explain patterns of economic activity and rising income polarisation – the coexistence of regional growth magnets and poverty traps. Enlargement has added to this and the complexity of decision making. Past efforts to speed up policymaking and enhance the Union’s management role have largely failed. Early on, France’s threat to withdraw from the Council allowed it to Intereconomics 2021 | 5 Political Economy retain national veto powers on all matters of “vital national interest” until the adoption of the Single European Act in 1986. Thereafter, consultation and cooperation procedures were to centralise policymaking power in the Commission, and qualified majorities were to replace unanimity in taking substantive policy decisions. But many of the resulting policies were simply not executed. On several occasions following the enlargement of the EU, larger member countries demanded a re-weighing of EU Council votes to avoid minorities blocking decisions that often required a qualified majority. But such adjustments typically came at a high political cost and lost operational efficiency. Clearly, political representation within the EU is a major cause for concern; but so are member states’ strategies for setting policy agendas, shaping legislation or obstructing implementation. Under these conditions, and for many, the creation of the European Monetary System (EMS) must be considered a great achievement. But the benefits of the EMS – deeper capital markets, better risk allocation, enhanced contestability and trade creation – are not free. They call for the abolition of national monetary policy as a means of adjustment; the realisation that Europe, as a non-optimal currency area (Mundell, 1961), requires strong fiscal constraints; and the recognition that, with national monetary and fiscal policy adjustment severely limited, a country’s ability to confront economic cycles reflects the flexibility of its labour markets and social policy provisions. Clearly, unsynchronised business cycles, inflexible product and factor markets and little practice of fiscal solidarity make Europe susceptible to asymmetric shocks. Fiscal rules, like those enshrined in the 1997 Stability and Growth Pact (SGP) were to lessen pressures for more expansive monetary policies and the risk of crowding out private sector or, in a common financial market, smaller country borrowers. In addition, fiscal restraints were to limit national discretion or function as a form of self-restraint to curb domestic rent-seeking behaviour. But this idea raises two concerns. First, painful fiscal consolidation may attain the targets in the short term but may be difficult to sustain thereafter. Second, simple rules, such as a budget deficit limit of 3% and a debt ratio of a maximum of 60% of GDP may be considered too rigid to adjust to unexpected conditions. And so, gaming and political concessions were to be expected and became rampant in the precursor and aftermath of the 2008 economic crisis. As early as 2005, the EU, finding it difficult to punish large member countries for violating their fiscal commitments, proposed the acceptance of a breach of the 3% deficit limit given exceptional circumstances. At that point, crit- ZBW – Leibniz Information Centre for Economics ics pointed out that, given the EU impending demographic challenge,1 the debt and deficit limits should be made more restrictive, rather than loosened, to ensure intergenerational justice and prevent current generations living at the (...truncated)