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Federalism or Bust for Europe?

BRUSSELS – August was quieter than feared on the European bond markets. So, while resting on Europe’s beaches and mountains, policymakers could take a step back from the sound and fury of the last few months and think about the future. Is the eurozone sleepwalking into becoming a United States of Europe? Is it exploring uncharted territory? Or are its constituent nation-states drifting apart?

To answer these questions, the best starting point is the US. The model of a federal union that emerged from its history consists of a single currency managed by a federal agency; closely integrated markets for products, labor, and capital; a federal budget that partly, but automatically, offsets economic disturbances affecting individual states; a federal government that assumes responsibility for tackling other major risks, not least those emanating from the banking sector; and states that provide regional public goods but play virtually no role in macroeconomic stabilization.

This model served as a template for the European Union’s architects, notably for the creation of a unified market and a common currency. But, in several respects, Europe has diverged significantly from the American model.

First and foremost, Europe has not established a federal budget. Back in the 1970’s, there was still hope that common spending would eventually amount to 5-10% of EU GDP, but this dream never materialized. The EU’s budget today is no larger than it was 30 years ago: a meager 1% of GDP.

Unlike in the US, where federal public spending grew as a consequence of the creation of new expenditure programs throughout the twentieth century, public spending was already high at the national level when Europe began to integrate. Significant federal spending programs could have emerged only from the transfer of existing national programs to the European level. Not surprisingly, such transfers were strongly resisted.

More recently, the eurozone has begun to create a system of mutual insurance among member states. Since 2010, assistance has been extended to Greece, Ireland, Portugal, and now Cyprus. Spain may soon follow suit, with a particular focus on support for its banking sector. So a specific pattern is emerging: states help each other.

But solidarity is not free. It is conditional on beneficiaries’ having signed on to a fiscal treaty that commits them to budgetary responsibility and makes them liable to quasi-automatic sanctions. Moreover, assistance requires that beneficiaries implement negotiated measures and accept close external monitoring of policy developments. In other words, the price of solidarity is limited sovereignty.

Unlike in America, however, EU member states’ governments – and, increasingly, their parliaments – are calling the shots. Because assistance does not rest on federal resources, but rather on the pooling of national resources, creditor states inevitably demand more power in exchange for providing more support to their neighbors. As a result, currency unification has not brought Europe closer to the US; on the contrary, it has pushed Europe further away.

In the US, the federal government acts as an overall shield against common risks and provides automatic, unconditional support to states in trouble; but, in the end, it does not come to the rescue of a defaulting state, nor does it take over its government. In Europe, by contrast, there is almost no aggregate shield and almost no automatic support for member states in trouble – better-off states simply extend a conditional helping hand to prevent default. So, while US states compete with the center for power, in Europe they increasingly compete with each other.

This inter-state rivalry – at times bordering on acrimony – is what makes the politics of European integration difficult. All federations have experienced periods of tense relations between the federal and state governments. But to accept that your neighbors look over your shoulder and tell you what to do is one degree more dreadful than to accept oversight from the center.

Indeed, a major problem with the current state of affairs is the weakness of EU institutions that are in charge of advancing the common interest and that are accountable to Europeans as a whole. Common European direction cannot emerge from the calculus of national interests by governments and parliaments that are accountable only to national voters.

The big question to which nobody has a clear answer is whether Europe is in the process of inventing a model of its own, or has only taken a detour from the inevitable choice between disaggregation and convergence on the standard federal template. One solution could be to provide national representatives a venue to convene for European-wide debates. Another would be to transfer the insurance role to a federal institution accountable to the European parliament.

Whatever route it takes, Europe in the coming years will have to address the weak representation of the common interest – or else admit that no such common interest can justify remaining on the path of integration.