EPRS | European Parliamentary Research Service Author: Micaela del Monte and Thomas Zandstra European Added Value Unit September 2014 – PE

Abstract The European Parliament has called for a “social dimension” to the Economic and Monetary Union to tackle unemployment and restore growth following the recent economic crisis. Among various alternative options, automatic stabilisers could potentially be means of stabilising the Eurozone, while at the same time addressing social problems associated with the financial crisis. This study explores the prospects for introducing an automatic stabilizer in the form of an Unemployment Insurance Scheme for the euro area, which will provide the monetary union with greater stability in the medium and long term. The experience of the recent crisis appears to have strengthened the case for a common Unemployment Insurance Scheme, and has fed into the debate regarding its establishment to counterbalance asymmetric shocks. Analysis of its potential benefits, had it existed during the recent crisis, shows that such a scheme would have reduced the fall in GDP in the most affected Member States by 71 billion euro in the period between 2009 and 2012.

Asymmetric shocks in a monetary area Whether a monetary union functions properly or not depends inter alia on how well it can absorb asymmetric shocks, i.e. the extent to which it has the appropriate tools to balance such cyclical trends across its different regions. When asymmetric shocks damage an individual country and unemployment rises in a given region, those residents there pay less in tax while at the same time receiving more funds via the social safety net. By contrast, regions experiencing growth pay higher taxes and have lower social expenditure. In theory, the common budget should enable transfer from the booming regions to those in crisis. The rules are established by the government in advance and thus when the crisis happens no further political decisions are generally required. This explains why economists refer to taxes and social expenditure as automatic stabilisers.

The role of automatic stabilizers At the EU level, automatic stabilisers are lacking: the Union budget is too small, and the existing transfer mechanisms (such as the structural or regional funds) are too rigid to react to cyclical economic downturns, and often apply in practice only after the crisis has severely impacted the economy. A recent IMF discussion note argues that, contrary to expectations, the launch of the single currency did not make euro area economies more similar over time or more resilient to shocks. Indeed, the euro area lacks the degree of risk-sharing seen in existing federations. While federations such as the US or Canada manage to smooth about 80 % of regional shocks, the euro area only manages to insulate half of that amount, meaning that if GDP contracts by 1 % in a eurozone country, households’ consumption in that country is depressed by as much as 0.6 %, as opposed to 0.2 % in the US or Canada.

Risk-sharing: insurance against income shocks in EMU remains low

Labour mobility and fiscal policy It is worth noting that, unlike in federal systems such as that of the US, internally mobile labour represents only 3-4 % of the population of the euro area (for a number of reasons, including language and cultural barriers and institutional factors), with the result that labour mobility cannot be expected to significantly alleviate high unemployment in peripheral countries. The consequence is that Member States are left with fiscal policy as the main means of stabilising their economies when hit by country- specific shocks. Indeed, the 2009 crisis has revealed deficiencies in the current design of the monetary union and has magnified the economic and social consequences of rising unemployment. Insufficient income insurance in the event of unemployment increases the social costs of joblessness, but also has reinforced the downturn via its effect on consumption and aggregate demand.

Economic recovery in the US This communication drew inspiration from the US unemployment insurance system which was created a few years after the 1929 stock market crash, to illustrate a vision of a future euro area with its own budget. It has to be said that for some this vision remains an unrealistic option because substantial treaty changes would be needed. In the US, unemployment insurance cover operates at state level. However, since 1935 a federal programme has been in place to support the authorities through the collection of local and federal taxes. In cases of severe recession, Congress can put in place temporary programmes for extending allocations, as was the case in 2002 and This allows the unemployed to continue to receive unemployment allocations even beyond the statutory period, which corresponds on average to 26 weeks. These temporary measures are funded up to a maximum of 50 % from the federal budget. This structure provides the US with a flexible automatic stabilisation instrument when crises strike.

Total unemployment insurance benefits paid by month and type of programme in the US

Flexiblity of the US scheme A less-remarked but interesting aspect of the US system is its capacity to strike a balance vis-à-vis individual states over the cycle: each state can indeed borrow from the federal cash pot in hard times, but these remain as loans and as such need to be returned. This in principle ensures that the objective of stabilising income when most needed is not missed, but at the same time avoids free-riding. If a state is unable to repay the loan, the employers’ contribution is automatically raised. Unlike in most European countries, the US version of unemployment insurance scheme is therefore fully financed by employers. The mechanism is based on the principle that those that fire more also need to contribute more to the fund.

Debt and unemployment The euro area crisis showed that risk premiums on sovereign debt can diverg significantly. Starting from 2010, it became not only difficult but also very expensive for sovereigns on the periphery of Europe to borrow on the market. High interest rates therefore make the financing of public expenditure, which can easily include expenditure on labour market policies in times of high unemployment, very expensive. A government facing tough fiscal constraints may consequently be obliged to cut income support measures at a time when they are needed the most, that is, when unemployment is increasing and vacancies are limited. Moreover, there is a possibility for large shocks to become self-sustaining through pro- cyclical fiscal policy and a negative feedback loop.

The political meaning of the supranational fund The creation of a supranational fund (in whatever form) whereby countries and/or workers and employers contribute during good times could avoid such a trap. In this case, the funding of passive labour market policies would come from a supranational authority and would therefore not be a burden on national budgets, as countries would have to contribute to it only during upswings. In addition to the purely economic aspects, one also needs to consider political and social concerns, and specifically the existence of a form of European solidarity and redistribution within the European Union. Would the scheme also have a political and social added value? The introduction of an unemployment insurance scheme would demonstrate European solidarity in a visible and tangible way for EU citizens on a permanent basis.