OUTPUT STABILIZATION PROPERTIES OF A EUROPEAN
UNEMPLOYMENT BENEFIT SCHEME: WHAT IS KNOWN SO FAR
Inês Sofia Alves Oliveira da Rosa
Dissertation
Master in Economics
Supervised by Álvaro Aguiar
Acknowledgments
At the end of this stage, I would like to express my sincere thanks to all those who directly or indirectly contributed to the realization of this dissertation.
Firstly, I would like to thank Professor Álvaro Aguiar, my supervisor, for the endless help, availability and patience, as well as for all the constructive criticism and knowledge shared during this process.
Secondly, I want to thank my parents, my sister and Pedro, my boyfriend, for always supporting me in achieving my goals and pushing me to be the best version of myself.
Finally, I would also like to thank all my colleagues and friends, especially Mafalda de Castro and Rita Reis, for the never-ending patience and support throughout this project.
Abstract
The recent Great Recession rekindled the debate over the need for a transfers’ mechanism that allows for output stabilization inside the euro area, namely a European Unemployment Benefit Scheme. This question was firstly analysed in the contexts of the Theory of the Optimum Currency Areas and the Theory of Fiscal Federalism. Several Institutions and academics have since put forward proposals on this scheme as a mean to further increase the stabilization of the euro area, mainly against asymmetric shocks. This dissertation develops a simple common metric that is applied to five proposals in order to assess what is known, so far, about the stabilization capacity of further euro area fiscal integration (minimal fiscal union) in the form of a fiscal-transfers’ stabilizing mechanism, particularly a European Unemployment Benefit Scheme.
To address this question, two main objectives are set: to determine (i) how far the studies produced/published so far support the implementation a European Unemployment Benefit Scheme; (ii) what essential elements are still lacking in the studies and therefore need further work in terms of quantification. The core task towards these objectives is to gather, explore and compare the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far about the output stabilization capacity of a Euro Area Unemployment Benefit Scheme. After analysing the results of the simulations, it was concluded that all proposed schemes provide average stabilization to the participating countries, even though some non-dominant procyclical effects can be expected. Additionally, the scheme would work in a more than proportional countercyclical way during a period of more severe recession, as simulated during the Great Recession. Its implementation could, therefore, improve the functioning of the monetary union, in terms of benefits as it is in line with the theories and its desirable characteristics.
JEL codes: E24, E61, E62, E63, F15, F45
Keywords: Fiscal Integration, EMU, Stabilization Mechanisms, European Unemployment Benefit Scheme
Resumo
A recente Grande Recessão reacendeu o debate relativamente à necessidade da criação de um sistema de transferências na área euro, com o objetivo de incrementar a estabilização macroeconómica, nomeadamente através de um Sistema de Subsídio de Desemprego Comum Europeu. Esta questão foi primeiramente desenvolvida na Teoria das Zonas Monetárias Ótimas e na Teoria do Federalismo Orçamental. Com o intuito de analisar a capacidade de estabilização macroeconómica de um Sistema de Subsídio de Desemprego Comum Europeu, algumas Instituições e grupos de académicos desenvolveram propostas e simulações. Deste modo, e com o objetivo de analisar e avaliar a capacidade de estabilização macroeconómica deste esquema, foi desenvolvida, nesta dissertação, uma métrica comum, que foi aplicada a cinco propostas de esquemas, com o objetivo de: (i) determinar, até que ponto, os estudos realizados apoiam a implementação deste esquema; (ii) determinar que elementos e fatores estão ausentes nos estudos e necessitam de quantificação. Para atingir estes objetivos será realizada uma análise e comparação da metodologia e resultados das mais importantes simulações empíricas (a nível académico e institucional) relativas à capacidade de estabilização macroeconómica deste esquema.
Após a análise dos resultados, conclui-se que todos os sistemas propostos apresentam uma estabilização média contracíclica para os países participantes, ainda que possam ser esperados alguns efeitos procíclicos. Adicionalmente, foi concluído que o esquema funcionaria de forma contracíclica mais do que proporcional durante períodos de recessão mais severa, tal como foi simulado durante a última grande recessão. A implementação deste esquema poderia, portanto, melhorar o funcionamento da união monetária em termos de benefícios, dado que está alinhada com as teorias e características desejáveis do mesmo.
Códigos JEL: E24, E61, E62, E63, F15, F45
Palavras-chave: União Económica e Monetária, área euro, Sistema de Subsídio de Desemprego Comum Europeu, Política orçamental
Index
1. Introduction ... 1
1.1. Framework ... 1
1.2. Research and objectives ... 3
1.3. Structure ... 4
2. The Context of Academic and Institutional Literature on Fiscal Union in the EMU ... 5
2.1 Fiscal Union in the EMU ... 5
2.2 Stabilization Transfer Mechanism in the Euro Area ... 15
2.3 Interactions with Political Union and Banking Union ... 21
3. How to Assess the Stabilizing Properties of the European Unemployment Benefit Scheme ... 23
3.1 Stabilization and Basic Design of the European Unemployment Benefit Scheme 24 3.2 Simulations and Comparison ... 26
3.3 A Common Metric to Compare Stabilization Properties: Uniformization ... 30
4. Assessing the Stabilizing Performance of the Proposals for a European Unemployment Benefit Scheme ... 35
4.1. General Results ... 35
4.2. Procyclical and Countercyclical effects ... 43
4.3. Stabilization effects during the recent Great Recession ... 45
5. Conclusion ... 49
6. Bibliographic References ... 51
Table Index
Table 1: Simplified stages of the papers that propose a European Unemployment Benefit
Scheme ... 23
Table 2: Design characteristics of the considered proposals on the European Unemployment Benefit Scheme ... 27
Table 3: Contributions and budget neutrality of each proposal ... 29
Table 4: Multiplier effects and stabilization metric of each proposal ... 30
Table 5: Concept of procyclical and countercyclical effects of the common stabilization metric ... 32
Table 6: Interpretation of the stabilization coefficients obtained through the common metric ... 34
Table 7: Stabilization effects under the common metric ... 36
Table 8: Analysis of net contributors and net recipients ... 42
Table 9: Procyclical, neutral and countercyclical effects of the proposals ... 44
Table 10: Stabilization effects of the scheme during the recent Great Recession ... 46
Figure Index
Figure 1: Graphic representation of the schemes' simulations ... 391. Introduction
The purpose of this master’s dissertation is to assess the output stabilization properties to be expected from a European Unemployment Benefit Scheme, a minimal euro area fiscal union. The assessment is based on the analysis and comparison of the methods and results of the most relevant (both academically and institutionally) mechanisms proposed and subject to economic simulations so far.
1.1. Framework
A number of proposals for stabilization mechanisms in the euro area have been put forward, especially in the years after the financial, economic and sovereign debt crisis that hit the euro. These mechanisms constitute greater fiscal integration and aim at completing the monetary union, possibly towards a fiscal union. The mechanism analysed in this dissertation, the European Unemployment Benefit Scheme, has been the proposal with the most attention so far.
To better understand this scheme, it is useful to frame it in the context of a fiscal union.
Fiscal Union
Since the early debates about the common currency, there has been a discussion over what degree of fiscal integration should be instituted in the European and Monetary Union (EMU). The euro area has a unique form of integration. There is full monetary integration, but the fiscal policy is still at the national level, regulated by a set of coordinating rules which target the soundness of national fiscal policies, initially introduced by the Maastricht Treaty and the Stability and Growth Pact (as explained in a broader historical perspective by Bordo, Markiewicz and Jonung, 2013).
More recently, there have been distinctive opinions over the need for a fiscal union on the euro area, as some authors, such as Allard at al., (2013), De Grauwe (2016) and Vetter (2013) believe that the EMU should include a fiscal union with a stabilizing or insurance mechanism in order for the monetary union to function properly, while others are more sceptical (e.g. Bénassy-Quéré, Ragot and Wolff, 2016; Fuest and Peichl, 2012).
diverge. However, one can identify several motives for the existence of deeper fiscal integration or full fiscal union in the presence of a monetary union as developed by the Theory of Optimum Currency Areas and the Theory of Fiscal Federalism, that aim to give some perspective on the centralization of fiscal policy and fiscal risk-sharing (Thirion, 2017, for example).
Additionally, the recent Great Recession brought out some serious concerns that the existing fiscal framework was insufficient to handle the problems that surfaced, such as the failure to create enough room for countercyclical policy during the crisis, contagion and difficulty to access the financial market during the sovereign debt crisis. These failures lead to the resurgence of disintegration forces within the euro area and concerns about the euro as a common currency project (Allard et al., 2013; Dabrowski, 2015).
As part of the answer to the shortcomings exposed by the recent Great Recession, fiscal integration was further intensified by the European authorities, with, to name the most important, the Fiscal Compact, Two-Pack, Six-Pack and the European Stability Mechanism (European Commission, 2012, for example). However, several authors and institutions have pointed out that the current institutional set up is still very far from the main requirements for a fiscal union and its stabilization mechanisms, which led to the rekindling of the debate over the need for a deeper fiscal integration as a way to mitigate the effects of the crisis (Allard et al., 2013 for example). Even though a banking union is in the making and the fiscal rules and coordination have been reinforced, these instruments may not be enough for the smooth functioning of the EMU.
In favour of a move towards a euro area fiscal union, it is argued that a deeper fiscal integration would improve the euro area economic cohesion and competitiveness, reduce asymmetric shocks, allow the Eurozone to have a more capable response to future crisis and boost economic growth within this area (Eurofi, 2014). Despite the weight of all these quite impressive advantages, there are serious limitations to the approval of such integration, the most important one being the current and prospective levels of political and societal integration (Bénassy-Quéré et al., 2016). There are still very strong political objections towards a fiscal union in a very large group of countries, yet, unanimity is required for the approval of deeper fiscal integration (Bargain et al., 2013). Most of the objectors argue that sound national fiscal policy and the creation of the banking union are sufficient to stabilize the euro area.
Macroeconomic Stabilization Mechanism
In the context of broader proposals aimed at stabilizing the monetary union and further increase its cohesion, a fiscal transfers’ mechanism with a stabilization/insurance purpose has been put forward and the discussion around its implementation has been expanded. This mechanism, inside the euro area, can provide cushioning for (asymmetric) shocks, and increase risk-sharing1 inside the monetary union, as argued by Allard et al. (2013), Thirion (2017) and by the European Institutions such as in the reports by the European Commission (2012) and Juncker (2015). From an economic point of view, the institution of such a fiscal-transfers’ stabilizing mechanism could be taken as an emerging (even if minimal) fiscal union. The European Unemployment Benefit Scheme is certainly one of the most studied and promising mechanisms proposed so far, both at the academic and institutional level. Since stabilization is achieved through an automatic stabilizer which are the net transfers from the scheme that react to national unemployment rate, the scheme has the capacity to offset fluctuations in a country’s business cycle, including both expansion periods and recessions, supposedly working in a countercyclical way. Additionally, it can be designed to mainly target large and possibly asymmetric shocks, which could prevent or, at least, cushion part of the shocks such as the recent Great Recession.
1.2. Research and objectives
The main purpose of this dissertation is to assess what is known, so far, about the stabilizing capacity of further euro area fiscal integration (minimal fiscal union) in the form of a fiscal transfers’ stabilizing mechanism, particularly a European Unemployment Benefit Scheme. To address this question, two main objectives are set: to determine (i) how far the studies produced/published support the implementation of a stabilization mechanism, particularly a European Unemployment Benefit Scheme; (ii) what essential elements are still lacking in the studies and therefore need further work in terms of quantification. The core
1 Risk-sharing, according to Thirion and Centre for European Policy Studies (CEPS) (2016) page 7, refers to
“all the policy instruments that imply international pooling and/or transfers of resources among sovereigns and joint guarantees like commonly issue debt”. Inside a monetary union, these instruments can be used for
task towards these objectives is to gather, explore and compare the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far on the subject of the output stabilization capacity of a European Unemployment Benefit Scheme. The analysed schemes have been put forward by Beblavý and Maselli (2014), Dolls, Fuest and Neumann and Peichl (2018), Dullien (2013), Farvaque and Huart (2018) and Fichtner and Haan (2014).
This dissertation provides an academic contribution to a better understanding of the consequences of further fiscal integration in the form of a European Unemployment Benefit Scheme, its stabilization capacity and, thus, to the analysis of the viability of this kind of integration in the euro area. In particular, as there is a lot of ongoing research on this subject, this dissertation provides some useful policy insight by pointing out what still needs to be explored in the simulations/empirical research in order to enhance its policy relevance.
1.3. Structure
This dissertation is organized in the following way: Chapter 2 focuses on the academic and institutional literature of a fiscal union in the EMU, including its integration in the economic policy theory and the recent Great Recession. Afterwards, the three main proposals for further fiscal integration in the euro area are outlined: i) Euro area budget; ii) Eurobonds and iii) Stabilization transfers’ mechanism. Further development of the latter proposal is carried out, with a focus on the European Unemployment Benefit Scheme, its desirable characteristics, funding and main concerns. Finally, interactions with political and banking union are outlined.
Chapter 3 introduces the main proposals for a European Unemployment Benefit Scheme that were selected for our study, such as the design features, financing system and simulation characteristics. Then, the common metric applied to the articles, in order to be able to make a comparison of the various proposals is described.
In Chapter 4, the main stabilization results of our simulation are outlined, including the countercyclical and procyclical effects for each of the proposed schemes, as well as the output stabilization effects during the most recent crisis. The main limitations of the studies are also identified. Finally, in Chapter 5, some concluding remarks and recommendations are made.
2. The Context of Academic and Institutional Literature on Fiscal
Union in the EMU
The study of the economics of a European Unemployment Benefit Scheme requires its contextualization in the framework of a fiscal union, whose background stems from three main analytical directions: (i) the Theory of Optimum Currency Areas, (ii) the Theory of Fiscal Federalism, and (iii) the applied normative analysis of the causes and consequences of the recent Great Recession, namely in the euro area.
It is important to firstly point to the distinction between two types of existing literature: (i) the academic literature, where there is a consistent analysis of the empirical advantages of an emerging fiscal union in the euro area, in the form of a stabilizing/insurance mechanism; and (ii) institutional literature, which mainly consists in articles and reports published by the European Authorities, that mostly have academic background, but have, as a main objective, to describe how a fiscal union could occur at an institutional level. Both these types of literature will be used in this dissertation. Institutional literature in the last years has gained relevance, with the European Authorities supporting further fiscal integration, especially after the most recent crisis.
Chapter 2 proceeds in the following way: section 2.1 reviews contributions to a fiscal union in the EMU, its historical and theoretical background and main elements; section 2.2 reviews the creation of a stabilizing transfer mechanism, its desirable features, financing and main challenges; and section 2.3 very briefly reviews the integration of the banking and political union with the fiscal union in the EMU.
2.1. Fiscal Union in the EMU
Several definitions have been proposed for a fiscal union (Thirion and Centre for European Policy Studies (CEPS), 2016). The expression “fiscal union” has different meanings in the economic policy literature, and the interpretations range from a set of common rules to a full federal integration with a government that has tax and spending authority.
Some authors, notably De Grauwe (see, for example, De Grauwe, 2016), have a strict and very demanding view of a fiscal union in the euro area. De Grauwe proposes the centralization of a significant part of the national budgets into a common budget within the
consolidation of the monetary union, since it would prevent financial markets from being able to force countries into a liquidity crises and default2. A European Social Security System
would allow for the automatic redistribution of income from the countries that are experiencing a positive shock to the countries that are suffering from a negative shock. Most proposals by other authors, however, do not require such a high degree of centralization.
According to Dabrowski (2015), page 7, a fiscal union is defined as a “transfer of part of resources and competences in the area of fiscal policy and fiscal management from the national to supranational level”. This implies centralization of fiscal policy, which requires political union and consequent loss of national sovereignty (Thirion and Centre for European Policy Studies (CEPS), 2016).
Thirion (2017) presents in page 3 a very similar definition, affirming that “fiscal integration can be interpreted as any attempt to further centralize fiscal policies in EMU, either by sharing resources or decision-making power”, adding that “this definition considers a broader set of instruments concerning both risk reduction and shock absorption”.
The key elements for a fiscal union are the following, as summarized by Thirion (2017): fiscal rules and policy coordination, a stabilization mechanism with fiscal transfers, some form of common borrowing such as Eurobonds, and a common budget. Some of these elements are already in place, as argued by Dabrowski (2015) and Thirion and Centre for European Policy Studies (CEPS), (2016). Fiscal rules and mechanisms for crisis intervention have already seen relatively widespread implementation in the eurozone, such as the Crisis Resolution Mechanism. A common set of fiscal rules exists, and was deepened after the most recent great recession, consisting of the Stabilizing and Growth Pact and the supplementary legislation in the EU’s Economic Governance Package (called the “six-pack”). There is a European budget that represents a small fraction of the combined budgets of the member-states. Nevertheless, there is not a common budget within the euro area, even though some proposals have been made, e.g. the Franco-German proposal for a Eurozone budget. Eurobonds are not yet a feasible proposal due to the high level of political integration required. Finally, a stabilization mechanism that allows for the cushioning of shocks is still not developed.
2 This happens due to liquidity constraints, since countries are trying to issue debt in a currency over which
they have no power, and investors don’t finance them. Debt would also be centralized and would be issued in a currency that would be controlled by the authority with that power.
The discussion around a fiscal union in the euro area was initiated years before the most recent crisis, with the first phase of the debate starting in 1970 with the Werner Report and the MacDougall Report in 1977. These reports suggested the introduction of a euro area budget and, as a long-term objective, further centralization (Bénassy-Quéré et al., 2016; Thirion and Centre for European Policy Studies (CEPS), 2016). The second wave started at the end of the 1980s with the Delors Report in 1989, when the Economic and Monetary Union became a real project. At the time, none of these proposals were put into practice. The third wave began after the recent Great Recession with the need to address design flaws in the EMU (see, for example, Beblavý, Gros and Maselli, 2015). It should be reminded that the Maastricht Treaty in 1992 did not include a fiscal union - only further fiscal discipline introduced by the Stability and Growth Pact -, due to intense political resistance from many countries (Bénassy-Quéré et al., 2016).
Focusing on the second key element - a stabilization transfers mechanism, the first academic simulations in federal systems were made by Sala-i-Martin and Sachs (1991) and von Hagen (1992). These studies both took as object of study the United States and taxes as a source of stabilization. However, the results had some discrepancies. According to Sala-i-Martin and Sachs, that use per capita income as a variable, approximately 40% of the shock could be absorbed by taxes; while according to von Hagen, who uses gross state product as a variable, only 10% is absorbed during a shock (Bajo-Rubio and Diaz-Roldán, 2003).
The first simulation using unemployment benefits as a source of stabilization was done by Pisani-Ferry, Italianer and Lescure in 1993. This simulation used the United States, France and Germany, in which, respectively, 17%, 37% and 34-42% of the shock was absorbed (Bajo-Rubio and Días-Roldán, 2003). After the most recent crisis, the discussion rekindled. Several flaws in the construction of the monetary union were aggravated, such as the failure of the no bailout clause, and other instruments were further developed, such as the Six-Pack, Two-Pack, Fiscal Compact, the European Stability Mechanism and Crisis Resolution Mechanisms (Eurofi, 2014; Thirion and Centre for European Policy Studies (CEPS), 2016). Also, several teams of authors started performing simulations for an insurance or stabilization mechanism through an unemployment benefits scheme in the euro area (such as Brandolini, Carta and D'Amuri, 2016 and Dolls et at., 2018) or in the European Union (Beblavý and Maselli, 2014 and Farvaque and Huart, 2018).
At the institutional level, after the crisis, the European institutions released reports proposing more integration and the creation of a stabilization mechanism as a form of
correcting the identified flaws. Three reports published in 2012 centered their attention on this matter: The Van Rompuy Report, the European Commission Report and the Tommaso Padoa-Schioppa group Report (Farvaque and Huart, 2018).
In the economic policy theory context, the subject of fiscal union is not new at all. Kenen (1969), based on the Theory of Optimum Currency Areas, argued that fiscal integration is a necessary condition for proper monetary integration. The Theory of Fiscal Federalism developed by Musgrave (1959) and Oates (1999) studies the distribution of functions to the different levels of the government, including fiscal policy and transfers.
The Theory of Optimum Currency Areas aims to determine the optimality of a monetary union inside a certain geographical domain, and the Theory of Fiscal Federalism aims to determine the optimal distribution of policies and organization of a government within a certain geographical area. This means that while the Theory of Optimum Currency Areas focus on the centralization of policy functions, the Theory of Fiscal Federalism focus on the decentralization of government (Von Hagen, 1993). Given their background relevance for the fiscal union, a brief review of these theories, in turn, is presented next.
Theory I: Optimum Currency Areas
The Theory of Optimum Currency Areas (OCA) was launched by Mundell (1961 and 1973), McKinnon (1963) and Kenen (1969). These authors centred their work on factor mobility and financial integration, openness of a region, and fiscal integration inside a monetary union, respectively. This theory is the most common approach used to “evaluate and study the optimality (and thus the desirability) of monetary unions, in particular that of the euro area” (Bordo et al. (2013), page 453). It balances the benefits for a country of joining a monetary union against its costs of losing the exchange rate as a mechanism to cushion shocks.
According to the Theory of Optimum Currency Areas, there are several benefits for the construction of a monetary union, mainly at the microeconomic level. With the integration in the monetary union, improvements in economic efficiency are expected: (i) the transaction costs due to the exchange of national currency disappear; (ii) the risk coming from the uncertainty of the exchange rate is eliminated (De Grauwe, 2016, for example). The costs of a monetary union are more related to the macroeconomic side of the economy.
The OCA authors argue that, in the case of shocks inside a monetary union, there are three necessary conditions for the member-states to return to equilibrium: wage and price flexibility and mobility of labour between countries. If these adjustment mechanisms fail, the countries will not be able to return to equilibrium. If a monetary union did not exist, there would be another instrument, which would be the exchange rate. Therefore, the loss of monetary independence affects the capacity of countries to deal with shocks (De Grauwe, 2016).
The euro area is still far from being an optimal currency area (Vetter, 2013). Inside the euro area, the prices and wages are very rigid, and the labour mobility is lower than in other monetary unions (Allard et al., 2013). The only relevant policy available is fiscal policy. The establishment of a fiscal union in the currency area was neglected by Mundell and McKinnon in their analysis of optimum currency areas. The issue was introduced by Kenen in 1969. Kenen argues that fiscal integration through a mechanism of fiscal transfers is a basic requirement for the well-functioning of a monetary union since it reduces the costs of losing the exchange rate as a response to shocks. This is especially relevant in the case of wage and price rigidities and limited labour mobility (which is the case of the euro area) due to the mechanism’s stabilization function. Kenen also defends that the domain of fiscal policy and monetary union should be the same, even if the area is not optimal, since fiscal policy can redistribute income in order to correct differences between regions and provide insurance against asymmetric shocks, through interregional transfers. Within a federation with tax and expenditure powers, when a country suffers from a shock, payments to the federal authority are reduced, slowing down the effects of the shock. Additionally, the country receives funds from the federal authority (e.g., unemployment benefits) (Kenen, 1966) (as cited in Kenen, 1969). Therefore, a country can enjoy major advantages by dropping its national currency and exchange rate in order to be able to join a larger fiscal mechanism (Kenen, 1969). The stabilization provided by these mechanisms could be achieved through inter-regional transfers from a country that has had a positive shock to a country with a negative shock, which improves the macroeconomic stability of the monetary union (Fahri and Werning, 2017) or through a common transfers mechanism from a central authority, to which countries make contributions (as in the proposals for a European Unemployment Benefit Scheme).
In his 1973 contribution, Mundell tackled the subject of financial integration inside a monetary union. This model - Mundell II - focuses on financial integration as a way to
provide risk-sharing and consumption smoothing, working as an alternative to interregional fiscal transfers, since they both cushion country-specific shocks. While supporting this idea, Fahri and Werning (2017) also argue that financial integration could not be enough to guarantee the full effects of risk-sharing. Therefore, the intervention of governments through fiscal transfers could be necessary. Berger, Dell’Ariccia and Obstfeld (2018) also argue that, in the past and specially during the most recent recession, the financial markets did not work sufficiently against asymmetric shocks. If the private insurance channel is limited when responding to shocks, then a transfers’ mechanism could be necessary to alleviate the effects of shocks inside the monetary union (Bordo et al., 2013).
In addition to the contributions to the Optimum Currency Areas, Bordo et al., (2013) identify the lack of attention that is paid to political and institutional facts as a severe problem of this theory. This point is very briefly addressed in section 2.3.
Theory II: Fiscal Federalism
The Theory of Fiscal Federalism developed notably by Musgrave (1959) and Oates (1999) aims to determine the most suitable way to attribute responsibilities to different levels of a government. Oates (1999) introduces the Theory of Fiscal Federalism: “The traditional Theory of Fiscal Federalism lays out a general normative framework for the assignment of functions to different levels of government and the appropriate fiscal instrument for carrying out these functions” (Oates, 1999, page 1121). In other words, it aims to give insight on whether a policy tool or area should be centralized to the central government or not. The United States are an example of a federal area that has centralized policy areas, with a significantly large federal budget. In this federal area, approximately 20-35% of the shocks are cushioned by federal transfers mechanisms (Persson, Roland and Tabellini, 1996b; Thirion, 2017).
The Theory of Fiscal Federalism focuses on three main areas: (i) the attribution of stabilization and redistribution functions, taxes and the supply of public goods and services to the different levels of government; (ii) the identification of benefits that result from the decentralization of fiscal policy; (iii) the context in which fiscal policy instruments should be used, mostly concerning transfers and taxes. This theory points out the importance of fiscal policy when it comes to macroeconomic stabilization, mainly through a large central budget and transfers between regions and states that are more affected by asymmetric shocks and
the ones that are not affected or less affected (Spahn, 1994) (as cited in Alves and Afonso, 2008).
The wide variety of federal structures prove that there are no rigid layouts for the ideal distribution of functions to the different levels of the government. However, the theory of Fiscal Federalism aims to provide some form of guideline. Particularly regarding redistribution and stabilization, this theory argues that these should be functions of the central government along with the supply of public good and services. Other areas should be maintained at the national/decentralized level (see, for example, Majocchi, 2008).
The stabilization function should be centralized because it is capable of responding to the several political preferences, can take into consideration the externalities of national/regional fiscal policy and improve the responsibility of the central government (Cavallo, Dallari and Ribba, 2018). The centralization of fiscal policy can efficiently internalize the spill-over effects and externalities that are a consequence of national fiscal policy in highly integrated areas (Majocchi, 2018; Thirion, 2017).
The European Union is still far from a federal area, mainly in three domains: (i) the size of the common budget, which in the European Union is very small and cannot significantly contribute to the stabilization of the area; (ii) in the European Union, the execution of fiscal policy is based on a set of rules, that are not consensual nor transparent nor applicable enough to guarantee fiscal discipline and (iii) insufficient coordination in the policies applied by the different countries in the European Union. While the expansion of the central budget does not appear to be feasible, at least in the short run, the response to asymmetric shocks could be made through a shock-absorption mechanism (Alves and Afonso, 2008). In other words, while a full fiscal union is not feasible in the euro area, maybe the centralized stabilization function can be achieved with a minimal fiscal union, through a common transfers’ mechanism, e.g., the European Unemployment Benefit Scheme.
Fiscal Integration Gaps Exposed by the Crisis
The recent Great Recession brought out very serious concerns over whether the euro area was prepared to deal with the challenges that arose, namely the high levels of deficit and debt and the financial instability. As arguably foreseen by the theories presented above, the existence of a monetary union without the correspondent fiscal union created problems and augmented the effects of the crisis.
As said before, the Eurozone is an area that is characterized by a monetary union without the centralization of fiscal policies. This means that in the case of an asymmetric shock, the only alternative for a country to respond is with national fiscal policy, that is also constrained by fiscal rules. This crisis divided the policy oriented academics into two dominant groups: the first group, such as Bénassy-Quéré et al., (2016) and Fuest and Peichl (2012), that believe that instead of a fiscal union, the solution is to reinforce and intensify fiscal rules and coordination, whether because of political resistance to a fiscal union or because other solutions are available (banking union as a relevant substitute for the fiscal union); and the second group, with institutional and academic supporters, that believe that the only way to prevent or attenuate the effects of a future crisis is by deepening the fiscal integration towards a fiscal union in the euro area through a stabilizing/insurance mechanism and/or common debt.
The financial and subsequent economic crisis was characterized by asymmetric shocks, high deficits and high levels of debt. Some countries, who suffered severe negative shocks, had not built enough buffers during the good times with countercyclical policy. Therefore, they were not able to cushion the effects of the crisis. Other countries, however, had built enough cushioning space to properly respond to the shocks (Allard et al., 2013). Before the crisis, there was already accumulated public debt, macroeconomic imbalances and losses in competitiveness. According to the interpretation of European Commission (2012), these imbalances mostly appeared because some countries did not follow the fiscal rules imposed by the European Union to insure healthy macroeconomic policy.
Due to the high level of financial integration that exists in the euro area, the problem of contagion is serious and has impact in the whole Eurozone. The crisis proved the existence of high levels of interdependence between the countries of the euro area, mainly because of the high financial integration in the monetary union (Eurofi, 2014).
The failures revealed by the recent Great Recession, namely the inability to respond to asymmetric shocks and the problem of contagion showed the importance of inter-regional risk-sharing through mechanisms for countries to pool resources from and share risks (Thirion, 2017).
As mentioned above, according to Mundell (1973) only if perfect and complete markets existed, then private risk sharing through credit and capital markets could provide total insurance against asymmetric shocks without the need for fiscal transfers between countries (Eichengreen, 1991) (as cited in Thirion, 2017). The crisis demonstrated that
country-specific shocks are easily transmitted through the international financial system and this mechanism tends to be not as efficient during times of crisis. It also showed that national fiscal policy cannot fully compensate for output shocks (Furceri and Zdzienicka, 2015).
International risk-sharing can be provided through two main channels: markets and governments. As mentioned above, private capital markets could be insufficient. As an alternative, governments can provide temporary transfers across countries, as a way to provide fiscal risk-sharing. However, fiscal risk-sharing within the euro area practically does not exist, due to the lack of a fiscal authority and centralization and the limited dimension of the budget, that is more targeted towards harmonizing living standards (Allard et al., 2013).
Due to the magnitude and level of contagion of country-specific shocks and the current inability of the euro area to cushion asymmetric shocks, insurance mechanisms at the euro area level could provide a way to stabilize the monetary union.
Three Main Proposals for Further EMU Fiscal Integration
As mentioned in section 2.1., following the perspectives of, for example, Allard et al. (2013), Bordo et al. (2013), Fuest and Peichl (2012) and Vetter (2013), there is a clear convergence on the key elements for the formation of a fiscal union: fiscal rules and policy coordination, stabilization mechanism that allows fiscal transfers, a form of common borrowing (such as Eurobonds) and a common budget. Even though some of these elements - such as rules and mechanisms for crisis intervention - are already implemented and despite some proposals such as the Eurobonds and the Franco-German proposal for a Eurozone budget, the EMU has so far neither common debt instruments, nor fiscal transfer mechanisms nor a common budget. These are yet solely provided at the national level (Vetter, 2013, for example).
At this moment, further integration can follow two different roads: (i) further shared sovereignty, which would include the extension of the already existing elements and the ones in development stages, which are rules and coordination, crisis management mechanisms and banking union or (ii) adding risk-sharing, which would include fiscal insurance (unemployment insurance schemes, rainy-day funds) and common debt (Thirion, 2017). Most authors and institutions that defend the implementation of a fiscal union - such as Allard (2013), De Grauwe (2016), Thirion (e.g., 2017) and others, and institutions such as the European Commission - argue that the most vital step towards a fiscal union and stabilization
of the euro area is the implementation of a instrument with stabilization properties. They consider that further shared sovereignty is not enough for the stabilization of the euro area, as demonstrated by the recent Great Recession. Thus, the next step towards fiscal integration is a mechanism that allows for stabilization inside the monetary union, considering it an emerging/minimal fiscal union. As briefly explained below in Section 2.3., a banking union is not a perfect substitute for a fiscal union, just a complement for the appropriate functioning of the monetary union. In this context, since fiscal rules, coordination and crisis resolution mechanisms are already reinforced and implemented in the euro area, it is important now to understand the benefits that a fiscal stabilization mechanism would have in the monetary union.
There are three main proposals for instruments to deepen fiscal integration towards fiscal union in the euro area which have stabilization properties (Beblavý, Marconi and Maselli, 2017b; Vetter, 2013):
• Common budget for the euro area;
• Common issue of “Eurobonds” by a European Debt Agency;
• Stabilization transfer mechanism, which can be based on output gaps or unemployment rates (developed below in section 2.2).
Eurozone budget. In all major federations, the common budget plays a key role in macroeconomic stabilization (Bénassy-Quéré et al., 2016) because of its importance as a redistributive and stabilizing instrument (De Grauwe, 2006). The European Union has a common budget, nonetheless, it is of very small dimension, even though the MacDougall report defended a federal budget between 5 to 7 percent of total GDP to support the monetary union. 98% of the budget is financed by taxes, duties on imports and Gross National Income. In 2017, 85% of the budget was used towards social and economic cohesion, economic growth and natural resources (Cavallo et al., 2018). Moreover, a euro area budget does not exist.
Consequently, the European budget does not have the ability to react to shocks in the same way a federal budget has. A more centralized budget would allow for risk sharing through the revenues and expenditure guaranteed by transfers. Countries that are hit by a negative shock contribute less and receive benefits from the budget (Allard et al., 2013). The European budget, in order to have an insurance function, would have to be severely increased and fiscal responsibilities would need to be centralized at the European Union
level. In order to increase the budget, federal taxes or the shifting of a more significant amount of national taxes to the federal budget would have to be imposed, which is not politically supported (Bajo-Rubio and Días-Roldán, 2003 and Iara, 2016, for example).
In the report “Toward a Genuine Economic and Monetary Union”, the European institutions defend that the decision making on national budgets should be centralized, and that it should be equipped with a centralized mechanism that could provide funds for countries to implement growth-stimulating measures (Eurofi, 2014).
Eurobonds. A less institutionally developed - although impactful - proposal is the creation of Eurobonds. Eurobonds are “securities commonly issued and backed by all member states” (Thirion and Centre for European Policy Studies (CEPS), 2016, page 15) and its main goals are to guarantee that countries in financial distress have access to the market and to lower the average interest paid (Thirion and Centre for European Policy Studies (CEPS), 2016).
The rationale for Eurobonds is that a country’s debt would be insured by the other countries, allowing them to have economies of scale and reduce costs, which would be an efficient mechanism for risk sharing (Thirion, 2017). However, the creation of Eurobonds carries several challenges, the main being moral hazard. Eurobonds may reduce incentives to maintain healthy fiscal policy, since the higher credibility of fiscally stronger countries compensates in the issuing of the common bonds (Fuest and Peichel, 2012; Thirion and Centre for European Policy Studies (CEPS), 2016). Eurobonds strengthen a fiscal union because they allow for a certain degree of risk-sharing between countries that have a higher risk of default and the ones with less risk, increasing stabilization inside the euro area. Even though this instrument isa complement for the well-being of a fiscal union, it is not proven to be, so far, a feasible proposal for the euro area because of the high political integration it would require.
2.2. Stabilization Transfer Mechanism in the Euro Area
The need for a mechanism that allows transfers was firstly defended by Kenen in 1969, in the context of the Optimum Currency Areas, and then proposed institutionally in the MacDougall Report in 1977 and the Delors Report in 1989. The development of such a mechanism addresses the stabilization of shocks inside the euro area by providing
inter-regional fiscal risk-sharing which allows smoothing of consumption from asymmetric shocks between countries or regions.
As argued above, currently the only available stabilization policy to handle asymmetric shocks inside the euro area is domestic fiscal policy. However, its flexibility is limited because of fiscal rules and coordination that undermine the capacity to handle these shocks in the necessary dimension, which was visible during the recent Great Recession. These constraints call for the implementation of a centralized fiscal policy instrument at the European Union or euro area level that acts as a stabilizing mechanism to react to asymmetric shocks (Bajo-Rubio and Diaz-Roldán, 2003).
One of the most developed solutions for stabilization inside the euro area is a central transfers’ mechanism with stabilizing properties. Two alternative options proposed in the literature are: (i) a rainy-day fund based on output gap; (ii) a mechanism based on unemployment insurance.
The main goal of rainy-day funds linked to output gaps is to allow for transfers between member countries, depending on their relative position on the cycle based on output gaps. If member states are experiencing a relative expansion period, they are net contributors to the fund and if they are experiencing a relative recession, they are net recipients3 (Thirion,
2017).
A proposed alternative is the European Unemployment Benefit Scheme. Unemployment benefits are an important tool for social policy and automatic stabilization, since they cushion the impact of downturns. This automatic mechanism is supposed to work in a countercyclical way since during times of high (low) unemployment, the scheme generates deficits (surpluses) because there is a small (large) number of contributors against a large (small) number of recipients (Thirion, 2017). This mechanism would undoubtedly contribute to the macroeconomic stabilization of member states. In the occurrence of an asymmetric shock, during a period of downturn, contributions from a certain country fall when employment contracts and pay-outs to a country rise due to the increase of unemployment (country is net recipient), cushioning the effects of the shock. During a period of expansion, countries that are in an expansion period increase their contributions
3 For an example, see Enderlein et al., 2012, where countries experiencing an output gap larger (smaller) that
the average euro area output gap contribute to the fund (receive from the fund), even if experiencing negative (positive) output gaps.
(due to the rise of employment) and pay-outs to the country fall due to the decrease in unemployment (country is net contributor), slowing down the economic activity (Andor, Dullien, Jara, Sutherland and Gros, 2014).
The European Unemployment Benefit Scheme can be designed from two different approaches: (i) a reinsurance mechanism of national unemployment schemes, whereby unemployment insurance links transfers to governments to high and rising unemployment-“macroeconomic approach”; or (ii) a centralized mechanism of unemployment insurance that is administered by a centralized entity, i.e., a “genuine” euro area unemployment benefit scheme is introduced with common financing and provisions-“microeconomic approach”.
The “macroeconomic approach” to a European Unemployment Benefit Scheme-an “equivalent scheme”- is a mechanism that reinsures existing national unemployment mechanisms, where transfers between government are linked directly to unemployment rates, not output gaps (in contrast with the rainy-day funds, that are linked to output gaps). The use of the unemployment rate has some advantages over the use of output gaps, such as being directly observable, more accurately forecasted and subjected to lower revisions. This mechanism allows for transfers between the countries which are not affected by an asymmetric shock and the countries that are mostly affected by the shock, guaranteeing risk-sharing and allowing for stabilization inside the euro area. The transfers are made directly to the government that is experiencing the negative shock, not to individuals (Dolls et al., 2018; Thirion, 2017). Usually this mechanism integrates a trigger, which means that a country would only receive a pay-out when the threshold is reached and the mechanism activated (Beblavý and Lenaerts, 2017a).
With the “microeconomic approach”, the proposed mechanism is a “genuine” euro area unemployment insurance scheme, where insurance is provided directly to the individuals in case of unemployment, and temporary transfers are made directly by the central entity. There is no intervention of the national government (Thirion, 2017). The main goal of such a scheme is to stabilize households’ income in case of a negative shock. This scheme functions continually (Beblavý and Lenaerts, 2017a). Examples of these proposals are Dullien (2013) and Dolls et al., (2018).
These two types of schemes require different levels of harmonization. The “genuine” unemployment scheme requires a high level of harmonization, since the benefits are transferred directly from a supranational authority to the citizens, which would demand similar requirements, generosity and duration to all members. The “equivalent” scheme
allows for the national governments to finance the unemployment benefits without changing national policy, since the scheme would transfer to the country the necessary amount to pay for the benefits according to each national system. This would provide incentives for countries to converge to more generous national systems, without the need of formal harmonization (Thirion, 2017).
The unemployment benefits of the scheme to be implemented can be smaller or larger in comparison with each current national system. In the latter case, the European scheme substitutes entirely the national system. If smaller, the European Unemployment scheme complements the national system, replacing only part of it. This would mean that part of the transfers to the unemployed would be made through the European scheme, and the national systems could top them. In this case, the benefit level for the unemployed (the national benefit plus the scheme benefit) would be the same as before the scheme, as well as the contributions, but international risk equalization and economic stabilization would increase (Dullien, 2013; Fichtner and Haan, 2014). This is the case of most of the proposals, such as Dolls et al., (2018) and Farvaque and Huart (2018).
Desirable Main Features of the Stabilizing Transfer Mechanism Some authors and institutions, such as Juncker (2015) and Thirion and Centre for European Policy Studies (CEPS) (2016) identify several basic characteristics for any stabilization/insurance mechanism (Juncker, 2015; Hammond and Von Hagen, 1995, as cited
in Furceri and Zdzienicka, 2015):
• The mechanism should be simple and automatic;
• Transfers and contributions to the fund should be non-regressive;
• Transfers should be temporary between countries and should not lead to permanent transfers. They should be restricted to provide insurance against temporary shocks or, when permanent, should be used only temporarily. The purpose of the mechanism is stabilizing, not redistributing income.
• It should not be an incentive for countries to dismiss healthy fiscal policy or to not implement structural reforms.
• The scheme should be able to cushion a large part of the shock, in order to prevent implementation costs from outweighing the benefits.
This set of desirable features constitutes a useful guide to assess each concrete scheme proposed.
How to Finance the European Unemployment Benefit Scheme The European Unemployment Benefit Scheme requires some form of financing to pull resources from.
There are four main proposals for financing the scheme: a corporate tax, a payroll tax, a contribution paid by member states as a percentage of GDP and debt.
The payroll tax and the corporate tax, as proposed in Dullien (2013) and Pisani-Ferry et al. (2013), are directly related to a “genuine” unemployment benefit scheme, since they create a mechanism that insures at the microeconomic level (Beblabý et al., 2017b). The worker or the employer pay a contribution that has direct correlation to the benefit that is going to be received by the worker in the event of unemployment.
However, some simulations (such as Beblavý and Maselli, 2014) suggest a contribution to the scheme as a percentage of the country’s GDP, which can either be variable or fixed. This contribution method could coincide with the corporate or payroll taxes if all countries were to agree this is the best way to collect resources. In case of no agreement, each member state is free to decide how to collect the funds to contribute the agreed percentage of GDP. The latter generates an “equivalent scheme”.
The most controversial proposal is the common issue of debt. This proposal would imply the issuance of common bonds to finance the scheme, which could provide intertemporal stabilization by allowing for surpluses in good times and deficits in bad times. This alternative might be especially vital in the case of cushioning symmetric shocks (Beblabý et al., (2017b).
The proposals on the European Unemployment Benefit Scheme seek to establish a budgetary rule in order for the scheme to achieve fiscal balance – budget neutrality. Therefore, the institutional and academic articles that have come forward include some form of fiscal rule: it can be a stricter rule, requiring yearly budget neutrality of the scheme; or a less strict rule, requiring budget neutrality in the medium-to-long term, i.e., over the cycle. In the case of medium-to-long term budget neutrality, the matter of debt issuance as a form of financing the scheme during periods of deficit is considered, for example by Dullien’s (2013) proposal with intertemporal stabilization.
Main Challenges: Permanent Transfers and Moral Hazard
In addition to the common moral hazard issues related to unemployment insurance at the individual level (as studied by, for example, Chetty (2005) and Wang and Williamson (1996)), centralized stabilizing mechanisms that allow for transfers within the euro area - including the European Unemployment Benefit Scheme - present two main challenges, that are also withholding political support: permanent transfers (permanent redistribution) and moral hazard. Moral hazard is a central concern, since international risk-sharing achieved through the mechanism decreases incentives for national governments to adopt policies that reduce national risks or that help the economy react to national shocks (Persson and Tabellini, 1996a) or to implement structural reforms in the labour market (Dolls et al., 2018).
Two solutions have been put forward to mitigate moral hazard: a claw-back mechanism based on experience rating4), and the introduction of a trigger. Both options
would also tackle the problem of permanent transfers, by avoiding the case of a country being always a net contributor or always a net recipient. With the trigger, permanent transfers are avoided in two cases: (i) the indicator that triggers transfers is related to the rate of change of an economic indicator, not to its level - in this situation, every recipient-country would eventually become a payer and vice-versa; and (ii) the trigger is high enough so that transfers are only activated during major shocks.
The system of experience rating or claw-back mitigates the risk of moral hazard due to the fact that, if a country constantly pursuits careless policies, it will face increasing contributions to the scheme in the future. The claw-back mechanism or mechanism of experience rating could be used to get close to budget neutrality. It would reduce the risk of permanent transfers because contributions of each country are adjusted in order to be balanced with the scheme over the medium turn, implying that each country would match its payments to its receipts. However, avoiding net transfers and achieving neutral balance of net long-term contributions of each country are not the same. Neutral balance of the net, long contribution is a sufficient but not necessary condition to avoid permanent net transfers.
4 With experience rating, the profile of each member state is monitored (beneficiary or contributor) and
contributions or drawdown parameters are adjusted at the beginning of each period in order for the country to have a balanced budget over the medium term with the mechanism (Andor and Pasimeni, 2016)
In other words, avoidance of net transfers could be guaranteed without achieving neutral country balance (Beblavý et al., 2017b).
Additionally, these risks are reduced if the mechanism covers only short time unemployment and not structural unemployment (Dolls et al., 2018).
2.3. Interactions with Political Union and Banking Union
A fiscal, political and banking union are interconnected features to complete the monetary union and assure the proper functioning of the euro area. The latter two are now developed, along with their connection to fiscal integration. The recent Great Recession revealed strong links between the financial stability of governments and banks. Because banks were allowed to hold unlimited government bonds and national governments were responsible for stabilizing the banking sector, the debt crisis destabilized even further the euro area and this double-sided dependence, which also proved the restructuring of national debt could be very harmful for the banking sector (as in Dolls, Fuest, Heinemann and Peichl, 2016).
As a solution, it was proposed and initiated the process of forming a banking union inside the European Union, which would have as main purposes the increase of financial stability in the euro area and provide a solution for the link between the banks and governments (De Grauwe, 2016).
The banking union in the European Union is based on these key elements: Common Regulatory Framework, Single Supervisory Mechanism and Single Resolution Mechanism, with a Common Resolution Fund, which, at the moment, is financed by the banks inside the program, and a European Deposit Insurance Scheme (see Thirion, 2017, for example). There has been some debate over whether a banking union could be a substitute to a fiscal union – even if incomplete -, since it could mitigate the banking/financial shocks, which are the most destabilizing shocks. However, if there is a risk of asymmetric non-financial shocks in the euro area, a banking union is not enough to stabilize the monetary union (Rey, 2013).
Additionally, Thirion (2017) argues that the proper implementation of the key elements of the banking union could require a higher degree of centralization of resources and authority at the European level, which would necessarily involve an evolution in the direction of a fiscal union. Without this deeper approach, the banking union would be incomplete and would not contribute properly to the stabilization of the monetary union. In
particular, the ability for shock-absorbing of the banking union may depend on the existence of a large common fiscal buffer, which would require a convergence towards a minimal fiscal union.
The most significant limitation of a minimal fiscal union in the euro area is its political conditions and implications. There is no consensus in the euro area when it comes to a fiscal union, with most countries’ representatives being against it. The loss of national powers/sovereignty is the most common reason used to justify this resistance.
The idea that a significant fiscal integration should exist along the monetary union was firstly debated in the Werner Report in 1970 and the MacDougall Report, in 1977, in the context of European Economic Integration. Both these reports emphasized the need of a central budget in the euro area and the possibility of transfers between member states (Thirion and CEPS, 2016). However, this significant fiscal integration was not materialized because of severe political resistance to the loss of national sovereignty and to the sharing of fiscal resources (Bénassy-Quéré et al., 2016).
This did not change much inside the euro area. Up to this date, even though there is support from institutions and academics and some countries are starting to encourage the development of a minimal fiscal union, there is still a very strong political resistance to a euro area fiscal union.
Nevertheless, political union would encompass fiscal union and consequently complete monetary union. The political union would simplify the creation of a transfers’ mechanism, the centralization of part of national budgets and could even decrease the asymmetry of shocks (De Grauwe, 2006). Moreover, it also increases the democratic legitimacy and accountability inside the monetary union (European Commission, 2012).
3. How to Assess the Stabilizing Properties of the European
Unemployment Benefit Scheme
The academic and institutional literature just reviewed in chapter 2 argues in favour of a euro area stabilization mechanism. When there is a centralization of the monetary policy and the lack of the exchange rate, one of the proposals to guarantee the reaction to asymmetric shocks is the existence of a mechanism that allows transfers between members of the monetary union. Also, since there is a strong rigidity of the labour markets and fiscal policy is limited by rules determined by the institutions, it is more urgent to develop such a mechanism. The mechanism under focus in this dissertation is the European Unemployment Benefit Scheme. Typically, the papers or reports that focus on the European Unemployment Benefit Scheme present the proposed design (sometimes with several variants) of the scheme and then proceed with economic simulations of what would have been the results of its implementation in past (but mainly recent) years. These simulated results usually (but not always) include the improvement in macroeconomic stabilization brought about by the proposed European scheme. Our reading of the papers leads to a simplified three-stage structure summarized in the following table:
Table 1: Simplified stages of the papers that propose a European Unemployment Benefit Scheme
3. Stabilization Effects Simulation of the multiplier effects of the benefits and contributions obtained in the previous stage, with a stabilization metric.
Based on the characteristics of national unemployment
schemes and using real macroeconomic data, these articles aim to simulate what would have happened if the
scheme had been implemented.
Benefits and contributions that result from the previous step imply, via multiplier effect, variation
in output that will reduce the output gap. 1. Design A scheme is proposed, that includes: • Duration • Replacement rate • Coverage ratio • Trigger or no trigger • Experience rating • Contributions 2. Implementation Based on the scheme’s design, the contributions and benefits that are implied by the scheme are computed for each country during the chosen period.
In the first step, a European Unemployment Benefit Scheme is proposed. This proposal contains the characteristics of the scheme that would be implemented in the euro area/European Union, which are: duration, replacement rate, coverage ratio, trigger or no trigger, experience rating and contributions. In the second step, the authors compute the benefits and contributions for each country for a certain period in time, according to the characteristics defined in the previous stage. In the third stage, using a stabilization metric, the stabilizing effects are simulated. These metrics are different for each paper and, most of the times, cannot be directly compared. These could be simulated through simpler methods (e.g. Excel) or through a more complex model that uses actual data (e.g. NiGem or Euromod). The key goal of the following steps is to uniformize the stabilization metrics, in stage 3, in order to: (i) be able to compare the results of the several reports; (ii) isolate the effects of the design of the scheme.
Based on this, in the next chapter, there is an analysis and comparison of the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far of the subject of European Unemployment Benefit Scheme. The main objective is to determine how the studies produced/published so far support the implementation of a stabilization mechanism, particularly a European Unemployment Benefit Scheme.
As it is already been seen in previous sections, the macroeconomic stabilization effects of the European Unemployment Benefit Scheme are a key aspect of the scheme's benefits, so even if we do not analyse costs, we know that if the stabilization is modest or in the wrong direction, then it is not worth studying the costs.
The focus of this dissertation on the stabilization properties of the proposals for a European Unemployment Benefit Scheme implies that some other points that were mentioned in chapter 2, above, in the context of macroeconomic stabilization, are not further deepened: there isn’t an analysis of the costs of the scheme, nor its political feasibility. Additionally, there isn’t an exploration of any other stabilizing systems that have been proposed (e.g. rainy-day fund based on output gaps).
3.1
Stabilization and Basic Design of the European Unemployment
Benefit Scheme
to the employees in the countries that adhere to the scheme, in the case they become unemployed. A certain amount of contributions is made to the scheme - through, for example, a share of the employee’s earnings -, instead of to the national system. In the case of unemployment and under certain eligibility criteria, the unemployed in the member state receives payments from the scheme for a certain period of time (duration) and according to their previous earnings (replacement rate).
The scheme contributes for macroeconomic stabilization since, during downturn periods, contributions from a country suffering a negative shock would decrease due to the rise in unemployment, which would cause the decline of payments from the country to the scheme and increase the inflow of funds from the scheme. This would stabilize the purchasing power and GDP. During an expansionary period, an increase in employment would lead to an increase in contributions and, therefore, net payments, since countries would contribute more and receive less funds. This would lead to the deceleration of purchasing power and reduce the overheating of the economy (Andor et al., 2014). The stabilization is achieved through an automatic stabilizer – the net benefits provided by the European Unemployment Benefit Scheme -, that reacts to each member-state unemployment rate.
The average stabilization effects of the scheme are strongly determined by the following design characteristics:
• Replacement rate: unemployment benefit as a percentage of previous wage/earnings; • Coverage ratio: number of unemployed receiving benefits as a percentage of total
number of unemployed;
• Duration: number of months for which the unemployment benefit is paid out; • Contributions;
• Trigger or no trigger: some proposals include an activation mechanism for benefits, that could be the unemployment rate (as in Farvaque and Huart, 2018) or the NAWRU (Beblavý and Maselli, 2014) as the threshold, among others. Countries only receive benefits from the scheme if the threshold is reached;
• Experience rating: the profile of each member state is monitored, and contributions or drawdown parameters are adjusted at the beginning of each period in order for the country to have a balanced budget over the medium term with the mechanism (Andor and Pasimeni, 2016).
