The EU has had a good few weeks, starting with the election of Emmanuel Macron as President of France, backed up by a series of strong economic figures from just about everywhere in Europe, and culminating in the Remainers’ Revenge last Thursday in the UK.

Given the UK’s profound political uncertainty, it is now even possible that Brexit will not happen at all.  Yet the EU is facing a potentially bigger challenge.

Last week, I berated Germany for being partly responsible for the eurozone’s huge current account surplus and urged a relaxation of German fiscal policy. Such a relaxation would indeed contribute something to improving European economic performance and stabilising the euro. But on its own, it will not be enough. 

Leaders such as President Macron who want to ensure the euro’s survival support the construction of a fiscal union, which would ultimately involve the pooling of spending, taxing and borrowing. This is a much bigger deal than mere monetary union. Indeed, it is potentially much bigger than any integration yet attempted.

Forming the monetary union simply meant that member countries used the same currency. Forming a fiscal union means that they will share the same bank account. I fully understand why most German citizens are wary of this.  Interestingly, from a reading of most of the economics literature, you would not think that they had much to be concerned about.

In the imaginary unions discussed there, different parts undergo different shocks from time to time, and therefore alternate with regard to which part of the union helps out which. One of the defects in the design of the single currency was precisely that the system did not have this characteristic. Monetary union without fiscal union meant that there was no natural economic mechanism for the relief of less fortunate members on those occasions when the economic dice rolled against them.

By contrast, within existing fiscal unions such temporary transfers occur all the time.  But often this sharing of alternating ups and downs is not fiscal unions’ most important feature and it is not what German voters should be most worried about.

In most existing fiscal unions, as well as economic fluctuations that affect different parts differently, there tends to be a persistent discrepancy in the level of prosperity of different parts, and sometimes even in their growth rate, with the result that there is a one-way flow of fiscal transfers that persists over decades, and possibly over centuries. 

For instance, the Office for National Statistics announced last month that London effectively subsidises just about all of the rest of the UK, while England subsidises Scotland.  These features of our Union are not here today and gone tomorrow. They are deep-rooted in the nature and structure of the Union.

David Fuller's view

The only chance of the Eurozone surviving is if it forms a fiscal union, as many experienced investors have known for decades.  This goal was never really stated because there had been considerable animosity between several European countries following WWII. 

Moreover, these were not newly formed nations seeking to form a union.  Instead, they had decades or even centuries of independence, with different languages and cultures.

Only Germany can decide whether or not most European states form a fiscal union.  It probably will because it benefits most from the EU and would have a much more expensive currency without it.

Here is a PDF of Roger Bootle’s column.