The Next Steps in EU Economic Integration
The European Union is constantly in motion. Economically and politically, European integration has made immense progress. Despite this, recent events have demonstrated the European Union’s limitations and the need for greater integration. Recent trouble in the European banking sector and new demands on the EU budget for defense spending support for Ukraine, as well as the necessity to respond to U.S. clean energy investments, all demonstrate the need for the European Union to take additional action to strengthen its economic and political union.
The European Union is the deepest and most successful integration experiment in history. It is a single market for trade, services, investment and the movement of workers, with strict competition rules that ensure a level playing field and a complex supranational political structure composed of the European Commission (akin to the executive branch), the EU Council (resembling the U.S. Senate) and the European Parliament (the only place where citizens exercise direct democracy and at the supranational level, equivalent to the U.S. House of Representatives). In addition, the European Union, with almost 450 million consumers, has a market that is larger than that of the United States, which has 335 million. It also has a single currency, the euro, and a single voice on issues such as trade or agricultural policy.
Despite its achievements, the European Union is still a far cry from becoming the United States of Europe, and there are significant shortcomings to the European Union’s current structure. It has an incomplete banking union as there is no common deposit guarantee fund such as the U.S. Federal Deposit Insurance Corporation (FDIC). Even more so, the European Union does not have a capital markets union, so it is overly dependent on banks and does not have a venture capital ecosystem like those in the United States or Israel. Finally, and most importantly, it does not have a full fiscal union with a federal budget equivalent to that of Washington. Each country has its own budget and fiscal policy is loosely coordinated through the rules of the Stability and Growth Pact, which prevents countries from accumulating too much debt and deficit, and is accompanied by a small federal budget equivalent to 1 percent of GDP to finance some common policies, such as agriculture, cohesion or research (compared to the U.S. federal budget equaling more than 20 percent of GDP). During the Covid-19 pandemic, an embryonic fiscal union with a 750-billion-euro centralized budget was created, with the European Union borrowing in international markets for the first time. The so-called NextGenerationEU funds were intended for investments in the countries most impacted by the pandemic and financed by issuing bonds at the European level. But NextGenerationEU is a temporary fund that will end in 2027. There are no plans for eurobonds to become widespread and replace national debt, or for taxes to be shifted from the national to the European level.
The countries' sovereignty cession to Brussels is both incomplete and contested. Comparatively, it is much less than what U.S. states give to the federal government in Washington. What is lacking is a strong European political community, a European demos, that allows the level of economic solidarity and common purpose between one country and another as there is between the different states of the United States. To put it simply, Germany is less willing to be economically as supportive of Greece or Hungary (which are still other countries) as California or New York are willing to be of Mississippi.
Still, as the fathers of European integration such as Jean Monnet or Robert Schuman envisioned, integration in some areas has triggered integration in others. For example, for the single market to function without distortions there had to be a European competition policy. For trade to grow, it was useful to have a common currency that would increase transparency and eliminate exchange rate risk. But in a world of great powers and geopolitical rivalry in which the nationalism and imperialism that the European Union wanted to leave behind are making a comeback, it is increasingly necessary for the European Union to integrate further, especially on financial and fiscal issues.
One element where further integration is urgently needed is a banking union. Unfortunately, the creation of the euro in 1999 was not accompanied by full financial integration. Unlike in the United States, in the European Union, each country remained responsible for the supervision and resolution of its banks, as well as for guaranteeing deposits. The financial crisis of 2008 (and the euro crisis that followed) made it clear that it was necessary to raise banking supervision to the European level, as well as to create a resolution mechanism for insolvent banks with common European resources. This led to the creation of the Single Supervisory Mechanism (under the responsibility of the European Central Bank) and the Single Resolution Mechanism, responsible for resolving banks with the financial support of the European Stability Mechanism, also created during the crisis (a sort of European Monetary Fund to provide financing for European countries that need it). Finally, a single European rulebook was adopted to harmonize European banking regulations. However, the guarantee of deposits remained in national hands. This means that each government guarantees depositors up to 100,000 euros. The problem is that, since some countries have more solid finances than others, a euro deposited in a German bank is “safer” than a euro deposited in a Greek bank, as was evident in the Greek crisis of 2010–2015. The recent financial and banking turmoil caused by the collapse of Silicon Valley Bank in the United States has reminded Europeans that the European Union needs to complete its banking union by creating a federal/European common insurance deposit scheme, and it should do it fast.
Another economic aspect that calls for deeper integration is the budget. Over the last few months it has become clear that U.S. Inflation Reduction Act subsidies require a European response, and that calls for a full fiscal union, with European revenues (taxes and joint debt issuance) and federal spending on strategic programs. A good first start would be the creation of a permanent fiscal capacity to finance European public goods such as energy interconnections, joint defense procurements, or initiatives to accelerate the green transition (it is worth mentioning that the U.S. federal budget grew out of the necessity to finance American public goods as well, from defense to infrastructure). Moreover, deepening economic and fiscal integration would reduce internal economic divergences and increase the European Union’s clout in the global scene.
This permanent central fiscal capacity could be a consolidated but an improved version of the current NextGenerationEU funds. In addition to this discretionary fiscal power, the central fiscal capacity could also include a consolidated version of the temporary Support to mitigate Unemployment Risks in an Emergency mechanism (SURE), working as an automatic stabilizer to help finance short-term unemployment benefits in bad times.
The political economy of banking and fiscal integration has always been complex. Opposition has traditionally come from the relatively richer countries from northern Europe, mainly Germany. That is why the creation of a central fiscal capacity and a European insurance deposit scheme should go hand in hand with new fiscal rules that curb domestic spending (i.e., the reform of the Stability and Growth Pact, which is currently under discussion). To receive funding from the central fiscal capacity, member states would have to agree with the European Commission’s realistic paths towards a balanced fiscal position. The 3 percent of GDP deficit limit and 60 percent of GDP debt limit rules should remain as a reference (changing them would require treaty change), but the concept of sustainability should be seen as the result of a permanent dialogue between member states and EU institutions, the trend being far more important than the pace of debt reduction. Additionally, the debt reduction rule of 1/20th should be suppressed. Otherwise, the European Union could return to the excessive austerity that paved the way to low growth and populism in the aftermath of the global financial crisis.
Ultimately, a central fiscal capacity would facilitate the completion of the banking and capital markets union because it would produce a risk-free asset, and it would support the international role of the euro, which in turn will lower the financing costs of the European Union and give its member states more fiscal space.
Beyond economic integration, it is also reasonable that some countries are reluctant to cede their sovereignty to Brussels on issues such as defense or border control. This is particularly the case for eastern European countries that tend be more nationalistic and perceive Brussels as too progressive. And it was also the case of the United Kingdom, which did not want deeper political integration and always understood the European Union as a transactional project and not as the path toward an “ever closer union,” which is what the founding treaty of the European Union of 1957 advocates. This was a major reason why the United Kingdom decided to leave the European Union in 2016. But the countries that decided to stay in the European Union should understand that the only way forward is toward deeper integration. This will require sacrifices and cessions of sovereignty, but the alternative is that individual European countries, or even the union as a whole, will be of little relevance in a world where multilateralism, which Europeans like so much, is becoming weaker and weaker.
Federico Steinberg is visiting fellow with the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies in Washington, D.C. and a senior analyst at the Royal Elcano Institute.