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Volume 55 No. 3 May/June 2020 Contents

www.intereconomics.eu Intereconomics Review of European Economic Policy

Editorial

Annette Bongardt et al. Lessons From the Coronavirus Crisis for European Integration ...... 130

Forum

The European Response to the Coronavirus Crisis Introduction ...... 132 Paul De Grauwe The Need for Monetary Financing of Corona Budget Deficits ...... 133 Sébastien Jean How the COVID-19 Pandemic Is Reshaping the Trade Landscape and What to Do About It ...... 135 László Andor SURE – EU Capacity for Stabilising Employment and Incomes in the Pandemic ...... 139 Armanda Cetrulo et al. The Privilege of Working From Home at the Time of Social Distancing ...... 142 Franz Prante et al. Decades of Tight Fiscal Policy Have Left the Health Care System in Italy Ill-Prepared to Fight the COVID-19 Outbreak...... 147 Sebastian Dullien et al. Why Current EU Proposals for Corona-Related Financial Aid Cannot Replace Coronabonds ...... 152 Bodo Herzog Whither Coronabonds? The Past and Future of the EMU in the Coronavirus Pandemic ...... 155 Christian R. Proaño On the Macroeconomic and Social Impact of the Coronavirus Pandemic in Latin America and the Developing World ...... 159 Andreas Backhaus Common Pitfalls in the Interpretation of COVID-19 Data and Statistics ...... 162

Articles

Coronavirus Crisis Philipp Heimberger Potential Output, EU Fiscal Surveillance and the COVID-19 Shock ...... 167 David P. Ellerman, Tej Gonza Coronavirus Crisis: Government Aid That Also Promotes Employee Ownership ...... 175 Climate Policy Claudia Kemfert et al. Great Green Transition and Finance ...... 181 Capital Markets Union Georgios Pavlidis A European Mechanism for the Issuance and Initial Distribution of Debt Securities ....187 Technical Progress Stéphane Ciriani et al. Competition, Technological Change und Productivity Gains: A Sectoral Analysis ...... 192

Letter from America

Barry Eichengreen Coronavirus Pandemic: Europe Is Once Again Forged in a Crisis ...... 199 Abstracted/Indexed in: SCOPUS, EconLit, Google Scholar, EBSCO, CSA, ProQuest, CAB Internation- al, ABS Academic Journal Quality Guide, Academic OneFile, Bibliography of Asian Studies, CAB Ab- stracts, CSA Environmental Sciences, ECONIS, European Sources Online (ESO), Gale, GeoRef, Inter- national Bibliography of Book Reviews (IBR), International Bibliography of Periodical Literature (IBZ), OCLC, Research Papers in Economics (RePEc), SCImago, Summon by ProQuest, World Affairs Online

ZBW – Leibniz Information Centre for Economics 129 Editorial DOI: 10.1007/s10272-020-0883-3

Lessons From the Coronavirus Crisis for European Integration

The COVID-19 pandemic caused an exogenous shock that tests the resilience of European integration. The European Union ﬁ nds itself at a crossroads. National uncoordinated responses threaten core European institutions, yet the crisis is also an opportunity to advance integration and reinforce EU objectives. This calls for addressing public health governance failures, dealing with the economic and institutional fallout, protecting common institutions, building up new ones and using the Green Deal as a crisis exit strategy. The challenge comes at a time when the UK had all but monopolised the EU’s attention and scarce resources with Brexit. This came at a high cost, as the Union was distracted from addressing common problems and neglected governance building.

How did we arrive at the current situation? The world did not heed warnings (e.g. of the Global Preparedness Monitoring Board report of September 2019) to think long term, prepare for a respiratory disease and cooperate on a global level for a coronavirus-type pandemic despite the many admonitions in this millennium alone (SARS, avian ﬂ u, swine ﬂ u, Ebola and Zika). In Europe, the pandemic crisis laid bare governance failures (lack of preparedness, slow responses). The European Centre for Disease Prevention and Control, created post-SARS in 2005 to assess and monitor diseases and coordinate national responses, underestimated the risk to the European population and all but disappeared from the public sphere. Although there are limits to EU public health competences (for supportive action and coordination, for proposing legally binding measures to cross-border threats on health), the Union has a broad margin of discretion on public health matters.

The coronavirus outbreak in Wuhan had been widely televised, showing overstretched hospitals and high fatality rates and the drastic measures taken by China (lockdown, cancellation of the New Year festivities), but was met with complacency in Europe. Initial scattered outbreaks in Europe were said to be controllable and did not spark preventive measures (e.g. control of all ﬂ ights into Europe). The chief preoccupation was to avoid alarming the population rather than to control the spread by informing the public about the perils of not adopting social distancing behaviour. The performance of (much poorer) Asian and African countries, which did signiﬁ cantly better in containing the pandemic, makes governance failures even more striking.

The European Commission attempted to coordinate member states’ responses, aiming to ﬁ nd out about preparedness and promoting joint procurement of medical supplies and equipment. Yet, like member states, it did not grasp the scale of the challenge until Italy requested the activation of the EU’s Civil Protection Mechanism of European solidarity in disasters and not a single member state came forward (instead, prioritising protecting national stocks, as little or nothing had been done to produce or import protective equipment). That said, member states such as Greece that acted earlier than others upon witnessing Italy’s plight, fared better.

Having failed in terms of prevention, member states have since come to converge, in a non- coordinated fashion, by adopting a variety of conﬁ nement and containment strategies in an attempt to control exponentially rising infection numbers that risk outstripping healthcare capacities and reducing them to a level that would allow for following the World Health Or- ganization’s guidance of testing, tracing and isolating. There are limits to what decentralised action can achieve against a virus that respects no borders. Any action at a local, regional or

© The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribu- tion 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics.

Intereconomics 2020 | 3 130 Editorial

national level, even if effective in terms of permitting a tailored approach to limiting contagion, is subject to spillovers. To prevent importing cases, member states cordoned off hotspots and discriminately closed internal Schengen borders. Countries can only open up if others have comparable performance and risk proﬁ les.

The coronavirus crisis illustrated the fragility of European common goods like the single market and the Schengen agreement and even the Economic and Monetary Union (EMU) if national measures are incompatible or insuffi ciently coordinated. Proposed temporary remedies are also problematic. For example, although ‘green corridors’ proposed by the European Commis- sion have tried to safeguard the fl ow of vital goods (at the level of supply chains to limit the risk of disruptions), the free movement of people was suspended (with exceptions for some professions), which has high economic costs. Relaxing state aid rules in the crisis is not compatible with a level playing fi eld if countries with deeper pockets support and give an unfair advantage to their own fi rms (thereby eroding trust in the single market). Electronic contact tracing apps hinge on public acceptance, which requires trust in data protection rules and interoperability.

So what should the EU do? First, the EU should address the economic consequences of the current pandemic crisis through its eurozone framework to complete the economic side of the EMU and avoid negative spillovers to its monetary side. In fact, the immediate response to the economic impact of the crisis is largely being built on and developed within the governance structure of the eurozone through institutions put in place or envisaged at the time of the sovereign debt crisis: European Stability Mechanism, ECB measures, budgetary rules, the still incomplete banking union and the unemployment reinsurance scheme SURE. The proposed recovery fund is a tentative step in the right direction towards common bond issuance, which would also contribute to the EMU’s sustainability. The EU budget should not merely be en- larged but should provide European public goods and objectives ﬁ nanced by own resources.

Second, although it is a signiﬁ cant governance challenge, the EU should defend its interests and its own project rather than wasting time with Brexit and aligning with one side of the internal debate in the UK. Remainers favoured a different, much-diluted Union, essentially a free trade zone with some cooperation in domains where the UK wants to pursue its own objectives at the global level (trade, defence, intelligence, etc.), making use of EU infrastructure, explicitly stated in the 2016 ‘new settlement for the UK within Europe’. Rather than insisting on self-harm- ing extensions, the EU should make sure that the transition period ends by 31 December 2020 and that any future agreement – should there be one – fully respects the integrity of its internal market, its common goods and European values. This is valid for all trade agreements.

Third, the crisis has shown that the EU has got its priorities – smart, social and sustainable development – right. It brought home the importance of digital technologies and may prompt a general re-evaluation of the role of the state (welfare systems and regulation). In fact, the pandemic crisis is an acute crisis within a larger environment and climate crisis context. Health and the environment have public good characteristics, with potentially large longer-term damage costs that tend not to be factored in. Moreover, the degradation of the environment, loss of biodiversity and practices like intensive and factory farming are linked to new diseases. In the novel pandemic, decision-makers adopted science-based policymaking to an extent Annette Bongardt, CICP that unfortunately has not happened in the climate crisis. The crisis context is the right time – University of Évora; and to correct market failures and promote the shift to sustainable production and consumption Universidade Fernando patterns for the benefi t of public health, the environment and sustainable development. The Pessoa, Porto, Portugal. Green Deal already furnishes an adequate exit strategy. Calls for propping up unsustainable industries in the crisis should be resisted in order not to repeat the mistakes committed in the Francisco Torres, Católica aftermath of the fi nancial and sovereign debt crises. Lisbon School of Business and Economics, Portugal. Note: The authors would like to pay tribute to Alberto Alesina whose work inspired so many of us in the fi eld of political economy.

ZBW – Leibniz Information Centre for Economics 131 Forum Introduction DOI: 10.1007/s10272-020-0884-2

The European Response to the Coronavirus Crisis

On 11 March 2020, the World Health Organization declared the novel coronavirus outbreak a global pandemic. Ill-prepared and reluctant to halt economic activities, EU member states were slow to react to slow the spread of the virus. Although necessary, the lockdown measures came with a heavy price. The need for economic and fi nancial assistance for EU member states with limited fi scal space has never been more pressing. The response to the economic damage this crisis has infl icted on the Union must be joint and swift – the future of the EU depends on it.

The Need for Monetary Financing of Corona Budget Deﬁ cits Paul de Grauwe, London School of Economics, UK.

How the COVID-19 Pandemic Is Reshaping the Trade Landscape and What to Do About It Sébastien Jean, Centre d’Études Prospectives et d’Informations Internationales; and National Research Institute for Agriculture, Food and Environment (INRAE), Paris, France.

SURE – EU Capacity for Stabilising Employment and Incomes in the Pandemic László Andor, Foundation for European Progressive Studies, Brussels, Belgium.

The Privilege of Working from Home at the Time of Social Distancing Armanda Cetrulo, Scuola Superiore Sant’Anna, Pisa, Italy. Dario Guaracio, Sapienza University of Rome, Italy. Maria Enrica Virgillito, Scuola Superiore Sant’Anna, Pisa, Italy.

Decades of Tight Fiscal Policy Have Left the Health Care System in Italy Ill Prepared to Fight the COVID-19 Outbreak Franz Prante, Berlin School of Economics and Law (HWR), Germany. Alessandro Bramucci, Berlin School of Economics and Law (HWR), Germany. Achim Truger, German Council of Economic Experts, Wiesbaden; and University of Duisburg-Essen, Germany.

Why Current EU Proposals for Corona-Related Financial Aid Cannot Replace Coronabonds Sebastian Dullien, Macroeconomic Policy Institute (IMK), Düsseldorf, and HTW Berlin – University of Applied Sciences, Germany. Thomas Theobald, University of Bamberg; and Macroeconomic Policy Institute (IMK), Düsseldorf, Germany. Silke Tober, Macroeconomic Policy Institute (IMK), Düsseldorf, Germany. Andrew Watt, Macroeconomic Policy Institute (IMK), Düsseldorf, Germany.

Whither Coronabonds? The Past and Future of the EMU in the Coronavirus Pandemic 2020 Bodo Herzog, ESB Business School, Reutlingen, Germany.

On the Macroeconomic and Social Impact of the Coronavirus Pandemic in Latin America and the Developing World Christian R. Proaño, University of Bamberg, Germany.

Common Pitfalls in the Interpretation of COVID-19 Data and Statistics Andreas Backhaus, Federal Institute for Population Research, Wiesbaden, Germany.

Intereconomics 2020 | 3 132 DOI: 10.1007/s10272-020-0885-1 Forum

Paul De Grauwe The Need for Monetary Financing of Corona Budget Deﬁ cits

The coronavirus pandemic has triggered a combined Crisis demands government interventions that in- negative supply and demand shock of unprecedented crease budget defi cits and public debt intensity. Both are having a signifi cant impact on the production of goods and services, and because everyone’s What would this look like in practice? First, national gov- income ultimately derives from production, household in- ernments must intervene on a massive scale to provide fi - comes are quickly falling. With many economies already nancial support for distressed companies and households in a downward spiral and heading towards recession, the whose earnings are at risk. Most European governments danger is that the downturn will become a self-perpetuat- already seem to be willing to do this. The problem is that ing and ever-deepening rout. large-scale fi scal expansions by eurozone member states could prove tricky, even if the Commission has tabled the The twin supply and demand shocks are likely to trigger activation of the general escape clause of the Stability and many ‘domino effects’. Companies with large fi xed costs Growth Pact (SGP). It is thus critical that the European that suffer a sudden fall in income are facing fi nancial Central Bank (ECB) steps in to prevent the last domino – diffi culties, or even bankruptcy. When that happens, the member state governments – from falling. banks and other entities that have lent money to these companies will also be in trouble. That is why massive Because they have no choice but to support failing com- economic shocks can often lead to banking crises. panies, illiquid banks and struggling households, national governments could be entering dangerous territory. The But the dominoes do not stop falling there. Governments, more their debt increases, the greater the risk that their too, can face fi scal dangers when they step in to mitigate bondholders will panic, as we saw during the 2010-12 sov- the crisis. In the case of the current pandemic, national ereign debt crisis. And the countries experiencing the larg- governments will need to save businesses from bank- est debt increase as a result of the coronavirus crisis – Italy, ruptcy by granting fi nancial support and subsidies, assist Spain, and France – are three of the four largest eurozone workers by funding temporary unemployment schemes economies. and possibly even come to the rescue of large banks. Worse, all of this must be done at a time of declining tax ECB should provide monetary fi nancing of corona- revenues, which means that government defi cits and induced budget defi cits public debt levels will skyrocket. To head off the risk of a bond market panic, the ECB an- We saw how these domino effects work during the 2007- nounced its readiness to buy up distressed governments’ 08 fi nancial crisis. The difference now is that the initial bonds. During the 2012 crisis, the ECB laid the ground- shock did not start in fi nancial markets and then spill over work for such a response with its outright monetary trans- into the real economy. Rather, today’s shocks emerged actions program (OMT). The ECB went a step further in from the real economy and are toppling fi nancial markets. April 2020 by dropping all conditionality attached to the But, as in the past, this crisis demands urgent measures use of OMT. This was the correct decision. Yet it is in- to put more space between the falling dominoes. Think of suffi cient. The ECB must go further, by preparing to buy it as macroeconomic ‘social distancing’. government bonds in primary markets, effectively issuing money to fi nance member states’ budget defi cits during the crisis. © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). The virtue of such a monetary fi nancing is that it spares Open Access funding provided by ZBW – Leibniz Information Centre national governments from having to issue new debt. Be- for Economics. cause all new debt would be monetised, the crisis would not increase government debt-to-GDP ratios. For those countries suffering the worst of the pandemic, the threat of a bondholder panic will be removed from the equation. In Paul De Grauwe, London School of Economics, addition, when the epidemic disappears it will not a leave UK. permanent legacy of unsustainable levels of government debt.

ZBW – Leibniz Information Centre for Economics 133 Forum

The monetary fi nancing of corona-induced budget defi cits certainly politically more independent than, say, the Bank is a form of ‘helicopter money’, i.e. the central bank pro- of England, which can be forced by the UK government to vides cash to fi rms and households using the government provide monetary support. The ECB, in contrast, cannot budget as an intermediary. This is also the appropriate way be forced by any member state government to continue to to organise the distribution of helicopter money. It relies on provide monetary fi nancing to national governments. Thus, the government to decide which households and which it appears that in the eurozone there is a stronger guar- fi rms will receive the cash. The government is the appropri- antee that the central bank will quickly want to return to a ate institution as it is vested with the democratic legitimacy stability-oriented monetary policy. to organise such a distribution of cash. This distribution method is certainly superior to the many proposals that A third objection is that monetary fi nancing is not really that are being made today whereby each citizen would receive different from government debt. When the central bank the same amount of cash (€1,000, for example). Such a buys government bonds, it substitutes these bonds for cash distribution would be very ineffective to counter the monetary liabilities. The latter consist mainly of reserves defl ationary spiral because most of the cash would go to that banks hold at the central bank. These reserves are re- households that have not seen their revenues decline. They munerated with an interest rate by the central bank. Thus would likely hoard the largest part of the cash handout. one type of interest bearing liability issued by the govern- Conversely those who are in greatest need, e.g. the tem- ment is substituted for another type of interest bearing lia- porarily unemployed, and who are now forced to reduce bility issued by the central bank. As a result, in both cases, their consumption would not receive a suffi cient amount of the liabilities of the consolidated public sector will require a cash. A uniform cash handout would be hugely expensive debt service (including interest payments). This may not be in budgetary terms and mostly ineffective in stopping the much of a problem today when the interest rates are close defl ationary dynamics. to zero. But it will become one in the future when the central bank wants to fi ght infl ation by raising the interest rate. Objections to monetary fi nancing What to think of this objection? The problem with it is that it There are many objections one could raise to this proposal pretends that the remuneration of bank reserves is a nec- of monetary fi nancing. As a legal matter, the Treaty on the essary feature of central banking. It is not. Until recently, Functioning of the European Union forbids the ECB from central banks did not pay interest on bank reserves, much engaging in monetary fi nancing of national budget defi cits in the same way as they do not pay interest on banknotes. (i.e. subscribing to newly issued bonds in the primary mar- The remuneration of bank reserves is undesirable and kets). I trust that EU lawyers, with their unbounded inge- should be abolished. When the central bank creates mon- nuity, could surely fi nd a way around this restriction. One ey, it generates ‘seigniorage’, i.e. a profi t that arises from way this could be done is by national governments issu- the fact that the government has granted a monopoly right ing perpetual bonds with a zero interest rate that would be to the central bank to create money (money base). This sei- presented in the primary market and bought by fi nancial gniorage should, therefore, be transferred in its entirety to institutions. The latter would sell them to the ECB after a the Treasury and thus to the taxpayer. There is no good short delay in the secondary markets. There are probably reason why part of this monopoly profi t should be distrib- better ways to circumvent the prohibition of monetary fi - uted to commercial banks. Central banks should return to nancing. The important thing is to realise that in existential the historical practice of not remunerating bank reserves. crisis situations, governments should use all instruments In such a regime, there is a big difference between gov- available to avert catastrophes. A self-imposed rule of no- ernment bonds and money base. The former is an interest monetary fi nancing must then be set aside. Or as Cicero bearing liability of the public sector; the latter is not. put it: Salus populi, suprema lex (the welfare of the people is the supreme law). Time to think outside the box

One might also object on the grounds that monetary fi - Sooner or later, the ECB must accept that monetary fi nanc- nancing would produce infl ation. Yet under the current ing in support of defi cit spending is a necessity not just circumstances, the infl ationary risks are non-existent. If for mitigating the coronavirus crisis, but also for averting a anything, Europe is now facing a defl ationary spiral; mon- downward defl ationary cycle that could pull the eurozone etary fi nancing of budget defi cits is the only way to stop apart. It is time to think outside the box and to set aside dog- this spiral. As soon as the defl ationary dynamic had been mas that may be appropriate in normal times but not when stopped, the ECB will surely halt its monetary fi nancing. In we face an existential crisis. When the existence of a market fact, one can expect that in this respect, the ECB is a more system is at stake, all instruments that are available and that credible institution than most national central banks. It is can be used to avert disasters should be on the table.

Intereconomics 2020 | 3 134 DOI: 10.1007/s10272-020-0890-4 Forum

Sébastien Jean How the COVID-19 Pandemic Is Reshaping the Trade Landscape and What to Do About It

On 8 April 2020, the World Trade Organization (WTO) re- The macroeconomic conditions will also likely suffer lasting leased its forecast for world trade in 2020, announcing that alterations. Based on historical evidence from major pan- it expected a fall in volume of between 13% and 32%. Both demics, Jorda et al. (2020) conclude that signifi cant macro- the magnitude of the fall and the width of the forecasting economic effects persist for about 40 years, resulting in sub- range speak volumes about the violent blow the crisis dealt stantially depressed real rates of return, possibly as a result to international trade and about the uncertainty surrounding of increased risk aversion and precautionary saving. In the ensuing consequences. They refl ect the deeply disruptive present case, this effect might reinforce the underlying trend economic impacts of lockdown measures taken to counter of secular stagnation observed since the global fi nancial cri- the pandemic. Since these measures should be short-lived, sis. The spectacular fall in infl ation expectations witnessed in part of their impact is temporary, and it is reasonable to ex- the US as early as March 2020 points in this direction, while pect that their removal will bring signifi cant economic relief. China’s factory prices fell at the sharpest rate in four years in Yet, I argue that this crisis will create lasting changes in the April 2020 (e.g. Smith, 2020a; Smith 2020b; Chen and Lee, trade landscape and serious threats to the rules-based trad- 2020). Another hint at such possible trends is the fact that ing system, warranting a reconsideration of trade policy pri- upon the end of the strict lockdown, the Chinese economy orities in important respects. witnessed a surge in exports in April but a decline in imports, suggesting that the negative consequences might be more Four reasons why this crisis will bring about lasting long-lasting on demand than on supply. If confi rmed, these change to the trade landscape trends suggest that the economic situation may be marked for some time by lagging demand. In this situation, fi rms’ The fact that the shock is violent does not mean that its con- demand for protection from import competition is gener- sequences will last. Four types of reasons lead to the expec- ally strong. While provisions exist within the WTO system to tation that some of them will be irreversible, though. provide short-term relief in specifi c cases through safeguard measures, the risk that this pressure will result in spiralling Lasting changes in competitive positions and tariffs and retaliatory measures is real. macroeconomic conditions Exacerbated international tensions The looming economic crisis, expected to be of unprecedented scale in peace time at least for decades, will cause The health crisis already spurred confused and non-coop- a large number of bankruptcies and buyouts, in a manner erative responses, marked by more or less direct and formal that is far from homogeneous across countries and sectors. export restrictions, including within the EU (Bown, 2020). Ac- While it is diffi cult to predict the size of the wave, it is likely cording to the WTO (2020), in April 2020, 80 countries had to signifi cantly alter competitive positions. Given the recog- introduced export prohibitions or restrictions as a result of nised importance of hysteresis and irreversibilities in interna- the pandemic; these measures mostly concern health-relat- tional trade (e.g. Baldwin, 1990; Ramanarayanan, 2017), the ed products, but some of them concern food products, even consequences for international trade patterns might be long- though there did not appear to be a supply shortage. Such lasting. measures can be very costly for foreign partners and heavily disruptive for international markets more generally, as pre- © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License vious episodes have shown, in particular in relation to food (https://creativecommons.org/licenses/by/4.0/). crises (e.g. Headey, 2011). Accordingly, they are bound to Open Access funding provided by ZBW – Leibniz Information Centre create strong tensions between partner countries. for Economics. This general context is aggravated by the mounting tensions between the US and China. While the ‘phase one’ deal Sébastien Jean, Centre d’Études Prospectives et signed in January 2020 marked a ceasefi re in the trade war d’Informations Internationales; and National Re- between the two countries, it did not resolve the underlying search Institute for Agriculture, Food and Environ- sources of tensions, far from it (Jean, 2020). Moreover, the ment (INRAE), Paris, France. pandemic will probably call into question China’s enforcement of its import commitments under this agreement.

ZBW – Leibniz Information Centre for Economics 135 Forum

While the woeful absence of US leadership in the pandemic they are likely to trigger policy responses focused on domains response can only add to the strategic rivalry between the deemed critical, to make sure the capacity to act forcefully is two countries, increased tension is also visible in the trade preserved even in conditions of crisis. For a long time, such arena, as witnessed by the US administration’s tightening of concerns have been central to public policies in two areas: the rules restricting exports of sensitive products to China. defence and food. They have translated into a different set of policies, warranting the special status of each of these Increased risk aversion and reconsideration of global value domains in the international trading system and accommo- chains dating wide-ranging state intervention well beyond what is customary in other tradable sectors. But the COVID-19 pan- The coronavirus pandemic is a crisis of epic proportions, in demic has brought two additional domains to the front of health as well as in economic terms. As such, it will probably strategic importance: health and digital infrastructure. Given leave a lasting imprint upon perceptions. Since personal ex- the extraordinary tensions witnessed around procurement of, perience infl uences risk taking behaviours (e.g. Malmendier et among other things, face masks and test reagents, there is al., 2011; Koudjis and Voth, 2014), it is likely that this crisis will probably no need to elaborate on the strategic status gained increase risk aversion among a number of decision makers by the health sector. But it is worth emphasising that digital for a long time. This infl uence might lead to a reconsideration infrastructure also demonstrated its strategic importance, of effi ciency-robustness trade-offs, potentially altering fi rms’ since it has been key to enabling the partial functioning ca- international strategies. This has led to debates and ques- pacities of many economies while maintaining fairly strict tions surrounding vulnerabilities of global value chains (GVCs), lockdown policies. This experiment will probably have lasting and in various cases to calls to relocate production in order to impacts on habits, norms and organisations, accelerating the boost resilience. As Miroudot (2020) emphasises, the capacity increasing relevance of telepresence, a change with power- to maintain production during a crisis is referred to in the man- ful disruptive potential (Baldwin, 2019). As heated controver- agement literature as robustness, while resilience refers to the sies around 5G networks and the leading position of Huawei capacity to return quickly to normal operations after a crisis. illustrates, the critical nature of the infrastructure upon which And on both accounts, the vulnerability of GVCs is question- such new organisations and practices rely was already large- able compared to alternative, less international and less com- ly recognised. It can only be reinforced by the present crisis, plex strategies, either in this crisis or in previous ones. warranting increased state attention on their autonomy in this area. However, the most pressing questions raised by the coronavirus crisis about GVC vulnerabilities may not be related to re- Beyond these concerns of strategic autonomy, states may silience or even robustness, but rather to autonomy and con- also have to adjust their policies to citizens’ heightened ex- trol. Indeed, the pandemic shed crude light on the depend- pectations with regard to the state’s protective role against ence of many advanced countries upon a very limited num- potential threats. To be sure, governments will be eager to ber of suppliers – frequently mainly upon China – to procure make sure that they are better prepared to face any future critical products such as Active Pharmaceutical Ingredients, health crises, but expectations and possible measures may reagents or even personal protective equipment. To assess extend well beyond this specifi c area. An important open the uncertainties created by such a situation, one has to take question is to what extent it will transform perceptions and into account not only the risk of disruption of production in a policies regarding climate change and, more generally, sus- given area (which, after all, is no less at home than abroad), tainable development. After all, even though a direct causa- but also threats like trade confl icts or disruption in the trans- tion cannot be established in the present case, this pandem- portation sector. With rising international tensions, such de- ic can be viewed as a cautionary tale about the dangers for pendence might increasingly be seen as a weakness. Firms mankind of disrupting ecological equilibria. might consider hedging this risk as well, which may lead them to re-assess their strategies, giving more weight to the benefi t Finally, the role of the state in the economy is already being of diversifi ed and easily controllable providers. altered in practice as a result of the support programmes carried out to prevent the pandemics and the ensuing lock- Changes in the role of the state in the economy down measures from wreaking havoc on their productive systems. These programmes are extraordinary in their size From the state point of view, increased awareness of such and in the scope of the measures involved, including guar- situations of dependence raises concerns of strategic au- anteed loans, bailouts, direct or indirect subsidisation, with tonomy – understood in a broad sense – since it jeopard- partial or complete nationalisations likely in several cases. ises its capacity to independently fulfi l missions of vital im- They profoundly alter the practices in most economies and portance. Since such issues were already high on the policy change the background against which disciplines have been agenda before the coronavirus crisis, in particular in the EU, considered and discussed for years, particularly in relation

Intereconomics 2020 | 3 136 Forum

to industrial subsidies and state-owned enterprises (SOEs). Retaining consistency As a matter of fact, several of these measures are probably in breach of commitments made in the WTO Agreement on The consistency of the multilateral trading system is currently Subsidies and Countervailing Measures (SCM). This is fully jeopardised by the failure to maintain two of its overarching understandable given the circumstances, but it modifi es sig- principles: transparency and enforceability. Safeguarding nifi cantly and, in all likelihood, for a long time, the background them is a priority. against which the highly sensitive question of industrial subsidies and SOEs will be discussed in the years to come. Ensuring transparency requires that members live up to their notifi cation obligations. Unfortunately, in many areas, notifi - Objectives and principles for a European trade policy cation obligations have been met with very long delays, when response they have not been purely and simply ignored. This was the case, for instance, when the chair of the WTO Committee on The bottom line is grim for the rules-based trading system: Subsidies and Countervailing Measures told members at a exacerbated tensions will make it all the more diffi cult to meeting in 2016 that compliance with the obligation to no- propose a coordinated response to the need to adapt pub- tify subsidies “remains discouragingly low”.1 Judging by the lic policies to the exceptional circumstances created by the recent WTO information on export-restrictive measures, the COVID-19 crisis and to lasting pressures to protect domes- problem is far from being resolved: on 23 April, only 13 out of tic producers. Worse, these threats materialise in a context 46 members (counting the EU as one) had notifi ed the WTO where the multilateral trading system was already destabi- of the measures they introduced since the outbreak of the lised not only by the ongoing trade war between the US and coronavirus crisis (WTO, 2020, 2). More political emphasis China but also, and more deeply, by its inability to address should be put on the necessity of accurate and timely notifi - the structural challenges raised by the transformation of the cations, as well as substantial deliberation, as preconditions world economy since the Marrakech Agreement was signed for an orderly trading system. in 1994 (Jean, 2019). The pandemic and the ensuing structural changes can only add to the feeling that WTO rules have The binding adjudication of trade dispute settlement, wide- been conceived in a context that differs substantially from ly lauded as one of the main achievements of the WTO, is the one we are living in, increasing the risk of a loss of le- now paralysed by the US veto on the appointment of Appel- gitimacy. The rules-based trading system is threatened with late Body members. While the Multiparty Interim Arbitration irrelevance, and the inability of the WTO to play an active role Agreement is a poor substitute for this institution, it consists in coordinating responses since the outbreak of the crisis of several major players from the trading system, including does not help to assuage these concerns. the EU, China and Brazil. As such, it is a useful temporary solution to retain some enforceability, and hopefully to create Lessons about the costs and dangers of disorderly respons- positive dynamics, making it possible at some point to get es to trade tensions had been learnt the hard way in the in- the Appellate Body back to normal operation. Until then, it terwar period. Preserving coordination and stability in inter- should be maintained and, to the extent possible, reinforced. national trade relationships is thus more essential now than ever and should be the priority of any European trade policy In addition to these cross-cutting principles, strengthening response. It is, however, utterly challenging, both because disciplines on export restrictions is another priority. While Ar- of the frailty of the existing multilateral trading system and ticle XI (§2.a) of the General Agreement on Tariffs and Trade because of the necessity to make trade a lever, not an ob- (GATT) allows “export prohibitions or restrictions temporarily stacle, to legitimise public objectives such as health, security applied to prevent or relieve critical shortages of foodstuffs and sustainable development. A rigid application of existing or other products essential”, their use is especially costly for rules is unlikely to work, given their eroded legitimacy and the trading partners, particularly infl ammatory in times of crisis, fl aws already apparent in their enforcement. A multilateral and rarely serves meaningful purposes. Agreement should agreement to reform the WTO would be the best solution that be sought whereby exporters refrain from resorting to export would allow for an updating of the rules, organising of mutu- restrictions,2 even though the enforceability of such commit- ally profi table grand bargains and coordinating of responses ments is notoriously diffi cult to achieve because they tend to global challenges. Unfortunately, it is clearly out of reach to be used as emergency responses to crisis situations, in in the near future. A more pragmatic approach is needed, a temporality that is incompatible with rules-based dispute building upon political understandings and piecemeal re- settlement, at least in the existing form. form, combining all available levels of political dialogue – at the WTO but also in the G20 and other international forums 1 See https://www.wto.org/english/news_e/news16_e/scm_28oct16_e. – so as to retain the trading system’s consistency, but also to htm. allow it more fl exibility. 2 Evenett and Winters (2020) is an interesting proposal in this respect.

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Allowing fl exibility mote sustainable development are not stymied by exces- sively rigid trade disciplines. Given the intense pressure that the crisis has put on the multilateral trading system, improved fl exibility is also re- Finally, the changes entailed by the pandemic on the role quired. The rules must not only be acceptable to stake- of the state in the economy make it even more necessary holders, they should also be consistent with vital public than before to tackle the question of industrial subsidies policy objectives such as health, security and sustain- and SOEs. This issue was already a central point of conten- able development. This principle is already explicit in WTO tion between big trading powers before the pandemic, with agreements and, for instance, the objective of “allowing China as the main focal point, in a context marked by the for the optimal use of the world’s resources in accordance lack of transparency and by the importance of subsidies in with the objective of sustainable development” is empha- some industrial sectors (Jean and Nicolas, 2019). The sani- sised in the fi rst paragraph of the preamble of the agree- tary crisis and ensuing massive public support plans are ment establishing the WTO. Given the situation described only adding to these concerns. In order to avoid a negative- above, however, it is fundamental to clarify the articulation sum competition game between subsidising programmes, between trade disciplines and other public policy objec- a coordinated approach is urgent. An agreement, let alone tives. new rules, is probably out of reach in the short term. How- ever, enhancing transparency and deliberation might be a As mentioned above, the COVID-19 crisis has shed light on useful fi rst step to at least assess the situation more ac- the specifi city of critical products, and as a result, public curately. Discussions about the respective merits and policies are primarily guided by the need to respond to citi- shortcomings of different types of public support could zens’ demands for protection and security. While defense follow. The public support programmes being carried out and food products are already treated as exceptions for this in response to the coronavirus crisis are not going to van- reason, health-related products and digital infrastructures ish overnight as the present exceptional situation is here to are not. Agreements leaving more space for state interven- stay at least for some time. Seeking agreed rules intended tion for these products should be considered. Irrespective to minimise their distortive impacts is probably the most of opinions about the right policy response to these con- pragmatic approach to preserve some coordination in this cerns, it should be recognised that organising public poli- area. In the longer term, it is the articulation between state cies so as to secure due availability of the corresponding and market that needs to be reconsidered in the multilat- resources is up to each state and that the corresponding eral trading system, but this is a daunting challenge that objectives have precedence on trade rules. This principle cannot be expected to be dealt with quickly. is actually consistent with GATT Article XX (General exceptions), stating inter alia that “nothing in this Agreement Preserving international trade relations shall be construed to prevent the adoption or enforcement by any contracting party of measures: … (b) necessary to The COVID-19 pandemic carries heavy threats, and pre- protect human, animal or plant life or health”. However, the serving stable and coordinated international trade relations conditions of application of these general exceptions are will be essential to avoid catastrophic disorders or con- very strict, making their use diffi cult in practice. The pre- fl icts. The EU has an important role to play in defending the dictability and usability of these provisions could be greatly multilateral consistency, while also promoting fl exibility. At enhanced by coordination on the interpretation of what least in an initial stage, damage control should be the main policies are authorised. An agreement specifi cally focusing focus, but this crisis will also make it necessary to recon- on the limited scope of products concerned could even be sider how trade disciplines should be articulated with other sought to go beyond such interpretation, in particular in the public policy objectives. case of health products.

The same logic should prevail with regards to policies tack- References ling climate change. While responses to this existential Baldwin, R. (1990), Hysteresis in trade, Empirical Economics, 15, 127-142. challenge are second to none in importance, institutional Baldwin, R. (2019), The Globotics Upheaval: Globalisation, Robotics and the asymmetries between subject areas have de facto creat- Future of Work, Oxford University Press. Bellora C., J. C. Bureau, B. Bayramoglu, E. Gozlan and S. Jean (2020), Trade ed what Johnson (2015) calls the structural supremacy of and Biodiversity, Report for the European Parliament, forthcoming. trade law over environmental law (Bellora et al., 2020). This Bown, C. P. (2020), COVID-19: Demand spikes, export restrictions, and is increasingly troublesome, especially as global environ- quality concerns imperil poor country access to medical supplies, in R. Baldwin and S. Evenett (eds.), COVID-19 and Trade Policy: Why mental challenges are looming larger. The rules on general Turning Inward Won’t Work, 31-48, CEPR Press. exceptions and their interpretations should be clariﬁ ed to Chen, Y. and S. Y. Lee (2020, 12 May), China’s factory deﬂ ation deepens make sure that efforts to combat climate change and pro- as pandemic hits demand, Reuters, https://uk.reuters.com/article/

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uk-china-economy-infl ation/chinas-factory-defl ation-deepens-as- Koudijs, P. and H.-J. Voth (2014), Beliefs and Leverage: Personal Expe- pandemic-hits-demand-idUKKBN22O0CO (17 May 2020). rience and Risk Taking in Margin Lending, CEPR Discussion Paper, Evenett S. J. and L. A.Winters (2020), Preparing For A Second Wave Of 9920. Covid-19 A Trade Bargain To Secure Supplies Of Medical Goods, Global Malmendier, U. and S. Nagel (2011), Depression Babies: Do Macroeco- Trade Alert. nomic Experiences Affect Risk Taking?, Quarterly Journal of Econom- Headey, D. (2011), Rethinking the global food crisis: The role of trade ics, 126(1), 373-416. shocks, Food Policy, 36(2), 136-146. Miroudot, S. (2020), Resilience versus robustness in global value chains: Jean, S. (2019), International Trade Disagreements: Beyond Trump, Poli- Some policy implications, in R. Baldwin and S. Evenett (eds.), COV- tique étrangère, 84(1), 57-69. ID-19 and Trade Policy: Why Turning Inward Won’t Work, 117-130, CEPR Jean, S. (2020), The ‘Phase One Deal’: a truce that creates more prob- Press. lems than it solves, CEPII Policy Brief, 29, http://www.cepii.fr/PDF_ Ramanarayanan, A. (2017), Imported inputs, irreversibility, and interna- PUB/pb/2020/pb2020-29.pdf (23 May 2020). tional trade dynamics, Journal of International Economics, 104, 1-18. Jean S. and F. Nicolas (2019), International trade: Rekindling interest in Smith, C. (2020a, 11 March), Staggering’ collapse in infl ation expecta- a multilateral rules-based approach, Think Tank 7 Contribution, IFRI, tions may force Fed’s hand, Financial Times, https://www.ft.com/ https://www.ifri.org/sites/default/fi les/atoms/fi les/t7_2019_discus- content/481645ba-63a7-11ea-b3f3-fe4680ea68b5 (23 May 2020). sion_paper_1_international_trade.pdf (23 May 2020). Smith, C. (2020b, 28 April), Markets point to defl ation risks for US econ- Johnson, T. (2015), Information revelation and structural supremacy: The omy, Financial Times, https://www.ft.com/content/6101eb0c-b63f- World Trade Organization’s incorporation of environmental policy, The 4b80-add4-b8ad20f94040 (23 May 2020). Review of International Organizations, 10(2), 207-229. WTO (2020, 23 April), Export Prohibitions and Restrictions, Information Jorda, T., S. Singh and A. Taylor (2020), Longer-run Economic Conse- note, https://www.wto.org/english/tratop_e/covid19_e/export_prohi- quences of Pandemics, Covid Economics, 1. bitions_report_e.pdf (20 May 2020).

László Andor SURE – EU Capacity for Stabilising Employment and Incomes in the Pandemic

In March 2020, European countries were suddenly over- (SURE). This bold and innovative move must be welcome, whelmed by the COVID-19 pandemic, originating from but the actual profi le of this new instrument requires clarifi - China. The unprecedented nature of this crisis may ex- cation to avoid misunderstandings, false expectations and plain why most national governments, together with lead- eventual disappointment. ers of the EU institutions, responded to this emergency with delays as well as inconsistency. Nevertheless, it From undercurrent to paradigm shift was quickly understood that the challenge was to tame a health care, economic and social crisis simultaneously. The SURE instrument aims to make available fi nan- The search for appropriate tools and strategies began. cial support, in the form of loans granted on favourable terms, to member states that need to mobilise signifi cant Once it was clear that in order to slow down the epidemic, resources to alleviate the socio-economic impact of the much of the economic and social activities had to stop, the pandemic through short-time work (STW) schemes or risk of rapidly rising unemployment became apparent. The similar measures. Total loans could amount to up to €100 EU was expected not only to mobilise existing instruments, billion. The legal basis proposed by the Commission is but also to quickly develop new ones. On 2 April 2020, the Article 122(1) and (2) of the Treaty on the Functioning of European Commission (2020) duly put forward a proposal the European Union (D’Alfonso, 2020). for the creation of a European instrument for temporary Support to mitigate Unemployment Risks in an Emergency If a member state experiences a sudden severe increase in actual and planned public expenditure for the preservation of © The Author(s) 2020. Open Access: This article is distributed under the employment because of its response to the COVID-19 pan- terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). demic, it can request fi nancial assistance under the SURE Open Access funding provided by ZBW – Leibniz Information Centre instrument to cover part of this additional expenditure. Rel- for Economics. evant expenditure concerns the extension or creation of STW schemes or similar measures designed to protect workers from the risk of unemployment and loss of income. László Andor, Foundation for European Progres- sive Studies, Brussels, Belgium. Within the short period of its genesis, SURE was introduced in the context of unemployment reinsurance, but

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there is a very important distinction to be made. Follow- Kurzarbeit has three main preconditions to work: fi rst, ing her nomination as EU Commission President, Ursula a demand side shock after which the same economic von der Leyen announced that during her mandate she structure can bounce back; second, strong partnership1 would introduce an unemployment reinsurance scheme. between employers and trade unions; and third, fi nancial This promise was included in the mission letter of two EU capacity to provide support either from an unemployment Commissioners: Paolo Gentiloni (Economy) and Nicolas fund or elsewhere. Consequently, an EU scheme focusing Schmit (Jobs and Social Rights). However, SURE is not an on Kurzarbeit would be biased for the workers who were unemployment insurance or reinsurance. better off in countries with stronger industrial relations, and it would leave the more precarious workers in the pre- Probably the best characterisation of SURE is that it is a carious benefi t schemes of precarious countries. job insurance scheme (Fernandes and Vandenbroucke, 2020). It is a safety net for jobs, but not for the unem- Limiting EU solidarity to those workers whose jobs can be ployed. The distinction is meaningful. In any existing un- saved would raise questions. The number of unemployed employment insurance scheme, cash (and not a loan) is is bound to rise simply because some companies will die. received by the unemployed individual. This will not be the Furthermore, many people today have temporary con- case with SURE. Nevertheless, to the extent that SURE tracts and in crises most of these are simply not renewed; helps to lower the number of actual unemployed, the na- these people will be added to the number of unemployed tional unemployment benefi t schemes will cope better. without being dismissed either de facto or de jure. Most of them would be unlikely to be considered under STW Kurzarbeit on the EU agenda schemes, similar to the self-employed. It is therefore particularly important that the SURE initiative is open to This is not the fi rst time that the European Commission has programmes designed for the self-employed as well, but highlighted the potential of STW solutions. It was already the even this way it remains an exclusive support tool. case in April 2012, when the Commission put forward the Employment Package to counter the consequences of the The Multiannual Financial Framework perspective: great fi nancial and economic crisis. By popularising STW (or Enhancing the social compartment in German Kurzarbeit) at the time of the euro area crisis, the EU did what it had been doing ever since the launch of the SURE does not only bring a new budgetary tool to the EU Lisbon Strategy: identifying best practices in the member but also a new way of raising and providing resources. states and sharing them through various EU processes. It does not require any upfront cash contributions from member states. To back the lending scheme, member On the other hand, by this clarifi cation the EU was also states would commit irrevocable and callable guarantees moving towards defi ning a European labour model and worth €25 billion to the EU budget, with each guarantee creating consensus around a hierarchy of adjustment calculated on the basis of their respective share of EU possibilities in the labour market for periods of economic gross national income. Such a system should ensure a downturns. If demand drops, adjusting through work- high credit rating, enabling the European Commission to ing time reduction appeared clearly superior to other contract borrowings on the fi nancial markets at favour- options: reduction of wages, reduction of employment able conditions, with the purpose of on-lending them to or reduction of the labour force by lowering the retire- the member state requesting fi nancial assistance. ment age. Though very far from being uniform, Europe indeed showed some great examples of negotiated STW Until now, members states have had the possibility of fi nanc- schemes coupled with training, for instance in Germany ing STW schemes from the European Social Fund (ESF), but and Austria. This internal fl exibility provides a strong ba- with SURE the available volumes will be enhanced by the sis for an economic rebound once demand picks up, cre- newly created borrowing framework. SURE will help sta- ating a competitive advantage especially in comparison bilise employment (and the related work income) for those with the United States. whose jobs can be saved in a recession. On the other hand, the Fund for European Aid for the Most Deprived (FEAD) pro- Very importantly, the 2012 Employment Package promoted vides EU support for those who lack the means for buying internal fl exibility at the time of a recession (as an alterna- daily food for themselves. The missing element, however, tive to external fl exibility). This was seen as the royal road remains the EU capacity to top up national unemployment from an economic as well as social point of view, while not seen as a universal solution or wonder weapon. Make no 1 On the example of Austria, Schnetzer et al. (2020) stress the impor- mistake: the STW arrangement is a much better option than tance of social partners in negotiation, and the resulting effectiveness unemployment, but this option does not exist everywhere. of short-time work arrangements in the COVID-19 crisis.

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insurance funds in the circumstances of a recession. While tion, conditionality at the time of delivery causes delay and the rise of joblessness can be massive, related funding will by defi nition makes the instrument weaker. continue to rely entirely on national resources (Andor, 2020). With a clear conditionality that is strongly linked to cyclical- Another break on the SURE model is the zero percent ity, SURE delivers something that has been missing from the grant component. While borrowing under this scheme, EU architecture: a counter-cyclical fi scal capacity. In other the member state affected will have to cover administra- words, this can be seen as an initial step in the direction that tive costs due to the need to organise the program. So the could eventually turn the MFF from its head to its feet, and actual material help from the EU is about delayed taxation. lead to a proper stabilisation role at the community level. On This may still make sense, but employers will only play ball the other hand, the unemployment reinsurance models that if the benefi ts of organising STW schemes (i.e. keeping have been discussed in the past few years would also have the entire workforce on board without changing contracts) required a coordinated improvement (in coverage, generos- would exceed the administrative and organisational costs ity, attached training services, etc.) in existing unemployment which would need to be shared within the country anyhow. benefi t schemes, which will not be the case here. Some will speak about a missed opportunity as a result. The EMU perspective: Towards macroeconomic stabilisation Getting expectations right

The size of SURE can be compared to that of the ESF, which By creating a new instrument called SURE, the European became an ESF+ in the new Multiannual Financial Framework Commission put forward a bold emergency initiative. Its (MFF) proposal, with over €100 billion for seven years (Andor, size and innovative nature signal not only that the eco- 2018). This, however, is a false comparison, because the ESF nomic and the social crisis response have to go hand in provides grants, while SURE will provide loans. In order to ap- hand, but also that the coronavirus crisis is calling for preciate how bold this initiative is, another comparison should deeper EU integration and inviting new ideas. apply, namely to the two instruments Jean-Claude Juncker proposed for cyclical stabilisation: the European Investment While aware of its limitations, the added value of SURE has to Stabilisation Function2 and a Reform Support Programme,3 be highlighted as European citizens are looking for help at the which between them would have been able to disseminate time of a devastating pandemic. However, it is also important €55 billion. Thus von der Leyen, with just a single instrument, to avoid overselling this tool. We may remember, for example, goes well beyond Juncker, which inadvertently highlights how that when the Youth Guarantee was introduced,5 the Commis- unserious the previous exercise was. sion invested a lot in explaining what it can and what it cannot do. However, the hype and the misinformation caused some Volume is key for any stabilisation, and so is speed. The damage, which is a big risk also now. promotion of SURE highlights this aspect, although in this case funds can be disbursed following a procedure that For SURE to reach its goals, clear rules are needed, as involves the Council, and only if a certain conditionality4 stressed by Balleer et al. (2020). Provided those are fol- is met (short-time work arrangement or similar scheme). lowed, SURE can be seen as a potentially cost-effective Conditionality can be a good thing; it has been rightly intro- automatic stabiliser at the European level, and it may as duced for the ESF itself, which originally and fundamentally well be the starting point for a more ambitious European is not a cyclical but a structural fund. For cyclical stabilisa- unemployment reinsurance system (Vandenbroucke et al., 2020).

In any case, the macroeconomic effect of SURE will not 2 The EISF was supposed to maintain the continuity of investment projects in times of crises. However, this was supposed to happen be robust. The European capacity to limit unemploy- through loans rather than transfers, in a way to compensate for inter- ment will surely be greater than that of the United States, est rates potentially hiking in a turbulent period. where the number of unemployed increased by 20 million 3 The RSP was designed to support structural reforms within the member states in line with recommendations outlined in the context of the in one month, sending the unemployment rate from 4.4% European Semester. Apart from offering a Reform Delivery Tool and in March to 14.6% in April 2020. However, SURE will only technical assistance, it also wanted to introduce a Convergence Fa- play a minor part in the better outcome. cility to provide dedicated support to member states seeking to adopt the euro. 4 Interestingly, Alcidi and Corti (2020) consider SURE unconditional, simply because a Memorandum of Understanding is not supposed to be involved. On the other hand, since a speciﬁ c action has to be taken to access the EU funding, SURE can be classiﬁ ed as a conditional 5 Following the December 2012 Commission proposal and April 2013 stabiliser tool. Council decision.

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Corti, F. and A. Crespy (2020, 17 April), SURE: A quick fi x to be welcomed Perhaps the most important message here is that while in the search for long-term solutions, FEPS Covid Response Papers, structural interventions like SURE can be important, they https://www.feps-europe.eu/resources/publications/723-sure-a- are not substitutes for the appropriate macroeconomic quick-fix-to-be-welcomed-in-the-search-for-long-term-solutions. html (13 May 2020). policies that have to be in place to ensure the fastest pos- D’Alfonso, A. (2020, 16 April), Temporary support to mitigate unemploy- sible recovery. The overall dynamics of unemployment ment risks in an emergency (SURE), European Parliamentary Research will remain functions of the fi scal and monetary mix, while Service Blog, https://epthinktank.eu/2020/04/16/temporary-support-to- mitigate-unemployment-risks-in-an-emergency-sure/ (13 May 2020). structural interventions can have mitigating effects and a European Commission (2020), Proposal for a Council Regulation on the positive infl uence on working conditions. establishment of a European instrument for temporary support to mitigate unemployment risks in an emergency (SURE) following the COVID-19 outbreak, COM/2020/139 fi nal. Fernandes, S. and F. Vandenbroucke (2020), SURE: A Welcome Lynchpin References for a European Unemployment Re-insurance, Jacques Delors Institute Policy Paper, 251, https://institutdelors.eu/en/publications/sure-un- Alcidi, C. and F. Corti (2020, 6 April), Will SURE Shield EU Workers from catalyseur-bienvenu-pour-une-reassurance-chomage-europeenne/ the Corona Crisis?, CEPS In Brief, https://www.ceps.eu/will-sure- (13 May 2020). shield-eu-workers-from-the-corona-crisis/ (13 May 2020). Schnetzer, M., D. Tamesberger and S. Theurl (2020, 7 April), Mitigating Andor, L. (2018), Resources for a Prosperous Europe, WISO DISKURS, mass layoffs in the COVID-19 crisis: Austrian short-time work as inter- 18/2018, https://www.fes-europe.eu/fi leadmin/user_upload/WISO-Dis- national role model, Vox CEPR Policy Portal, https://voxeu.org/article/ kurs__ProsperousEurope-EN__RZ-Web__18-09-27a.pdf (5 May 2020). mitigating-mass-layoffs-covid-19-crisis-austrian-short-time-model Andor L. (2020, 15 April), Europe’s half-empty sandwich, Euractiv, https:// (5 May 2020). www.euractiv.com/section/economy-jobs/opinion/europes-half- Vandenbroucke, F., L. Andor, R. Beetsma, B. Burgoon, G. Fischer, T. empty-sandwich/ (13 May 2020). Kuhn, C. Luigjes and F. Nicoli (2020, 6 April), The European Commis- Balleer, A., B. Gehrke, B. Hochmuth and C. Merkl (2020, 1 May), Guidelines sion’s SURE initiative and euro area unemployment re-insurance, Vox for cost-effective use of SURE: Rule-based short-time work with work- CEPR Policy Portal, https://voxeu.org/article/european-commissioners’ consent and aligned replacement rates, Vox CEPR Policy Portal, htt- s-sure-initiative-and-euro-area-unemployment-re-insurance (13 May ps://voxeu.org/article/guidelines-cost-effective-use-sure (4 May 2020). 2020).

Armanda Cetrulo, Dario Guarascio and Maria Enrica Virgillito* The Privilege of Working From Home at the Time of Social Distancing

The explosion of the COVID-19 pandemic and the ensuing pandemic’s impact on the labour market are now spur- policy of social distancing undertaken by many countries ring (Coibion et al., 2020) scary projections in terms of the have put the organisation of production and of the work number of jobs lost and related income losses. After just process under unprecedented stress.1 Analyses of the the fi rst month, around 11 million European workers have experienced consequences related to the pandemic. An © The Author(s) 2020. Open Access: This article is distributed under the additional four million people are unemployed and an ad- terms of the Creative Commons Attribution 4.0 International License ditional seven million short-term contract workers are at (https://creativecommons.org/licenses/by/4.0/). risk of losing their jobs, as estimated by the European Open Access funding provided by ZBW – Leibniz Information Centre Trade Union Confederation (2020). This combined supply for Economics. and demand crisis recalls some massive policy interven- * The authors acknowledge support from European Union’s Horizon tions that date back to the Great Depression, namely re- 2020 research and innovation programme under grant agreement No. 822781 GROWINPRO – Growth Welfare Innovation Productivity. duced limits of defi cit spending, direct bond purchasing 1 The International Monetary Fund’s April 2020 World Economic Out- by central banks and forms of helicopter money. Even the look projects a drop of 3% for the world economy. During the 2009 Minskian ‘employment of last resort’ proposal has been fi nancial crisis, the drop was 0.1%. resurrected (Saez and Zucman, 2020). The only certainty in a time of massive uncertainty is that this pandemic is Armanda Cetrulo, Scuola Superiore Sant’Anna, and will continue to dramatically affect the labour market Pisa, Italy. and the economy on a global scale.

Dario Guarascio, Sapienza University of Rome, Italy. The direct and indirect impacts of the pandemic are evident in many realms of the economy, from the organisa- Maria Enrica Virgillito, Scuola Superiore tion of production and global value chains, to patent sys- Sant’Anna, Pisa, Italy. tems and appropriability conditions in the pharmaceutical sector, to the provision of health as a public good, to

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the study of unconventional fi scal and monetary policies workers. The remaining nearly 16 million workers perform (Lucchese and Pianta, 2020). Additionally, the implica- tasks that they cannot do remotely. According to our sections for the organisation of the workplace and the work ond fi nding, the occupations that may work from home are process are going to be signifi cant. Social distancing is extremely concentrated among managerial and executive expected to jeopardise business and employment op- categories, academics, technical professionals and cleri- portunities in a labour market that is defi ned by strong in- cal support workers. Sales and service workers, manual equalities and precarious jobs. operators, artisans and elementary occupations have little to no opportunity to work from home. Occupational Doing ‘smart work’ implies access to both material and inequality translates into inequalities in wage distribution. immaterial infrastructure in order to enable the actual im- Indeed, those who can work from home are paid substan- plementation of remote working, e.g. a computer at home, tially more. Finally, looking at the contractual framework access to the Internet and working tasks and activities (whether permanent, autonomous, temporary) we note that can be executed from home (e.g. imputing, elaborat- that temporary workers are mostly concentrated in occu- ing and publishing data and information). However, a large pations that cannot be performed at home. fraction of European workers do not meet these feasibility conditions. Analysis even for the US, which is supposed Data, methodology and results to be more digitalised, indicates a digital divide; in particular, access to a high-speed Internet connection is highly The following results adapt and expand the methodology correlated with income, and in turn the possibility to work proposed by Dingel and Neiman (2020), who analyse the from home increases with income level (Chiou and Tucker, occupations that can be carried out from home in the US 2020). starting from the O*NET dictionary of occupations. The analysis for Italy is based on an integrated database that Italy was the fi rst European country to implement general includes the ICP and the Italian National Institute of Statis- social distancing policies. In the second half of March, a tics (Istat) Labour Force survey, updated in 2016. Decree Law from the Prime Minister formally closed the so-called ‘non-essential’ working activities and once From the ICP dataset we are able to derive information again recommended the application of smart work even regarding generalised work activities and the working for private companies, following a disposition at the end of context of fi ve-digit occupations. The ICP – a survey con- February that strongly encouraged the implementation of ducted by the National Institute for Public Policy Analysis ‘agile’ work for the public administration. The Italian press (INAPP) in collaboration with Istat – represents the only and public opinion have welcomed social distancing as a European source comparable with the American O*Net chance to actually implement smart working on a larger database, the latter being the most comprehensive data- scale given that in 2018 only 3.6% of workers regularly base reporting qualitative and quantitative information on worked from home (Eurostat, 2020). Given the lockdown tasks, skills, work contexts and organisational character- and the requirements of social distancing, working from istics at the fi ve-digit level of observation. The construc- home seems to be a very sensible choice. It would in prin- tion of the dataset entails a complex, multi-layer strategy ciple allow for the provision of information-based services, of data collection and information processing allowing for which in the ‘smart era’ is supposed to be the majority of both detailed occupational descriptions and inter-occupa- the labour force. tional comparability (more in Cetrulo et al., 2019).

But, how many workers are actually in a situation to per- Currently, two waves of the ICP database are available form smart work? And what are the underlying charac- (2007 and 2012) with a spectrum covering 797 occupation- teristics in terms of contractual categories and wage dis- al codes, excluding the armed forces. We rely on the 2012 tributions? This article looks at the Italian occupational wave. The interviews were administered to 16,000 Italian structure, quantifi es the jobs that can be done at home workers to ensure statistical representation with respect and defi nes the composition of the underlying labour force to sectorial, occupational, dimensional and geographi- in terms of occupational, wage and contractual distribu- cal heterogeneities. Both O*NET and ICP questions are tions. To address these issues, we analyse the Italian dic- organised in six main sections, expressions of a content tionary of occupations Indagine Campionaria delle Profes- model that simultaneously provides information from both sioni (ICP), a survey at the fi ve-digit level structured like the a job-oriented and a worker-oriented perspective. The US O*NET dataset and linked with the Italian Labour Force descriptors are: worker characteristics (enduring abilities Survey (ILFS). Our analysis reveals a series of alarming re- and work style of workers), worker requirements (skills and sults. First, only 30% of all of the occupations in the survey education), occupational requirements (organisational and can be performed from home, accounting for 6.7 million work context), experience requirements (training, cross

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functional skills), workforce characteristics (labour market Table 1 information) and occupation-speciﬁ c information (gener- Top ten occupations that can and cannot be alised activities and work context). In so doing, descrip- performed from home, ISCO classiﬁ cation tors are formulated by making it possible to distinguish, for instance, inner individual abilities from competences Cannot be performed at home

acquired on the job. For each question, two rating scales 644 Specialised forestry workers are generally provided: level and importance. 711 Plant and machinery operators for the extraction and initial treatment of minerals To identify the activities that cannot be carried out from 724 Machinery workers in plants for the mass production of home, a series of questions belonging to the generalised wooden items

activities and work context sections of the ICP have been 743 Agricultural machinery drivers selected. 841 Unqualiﬁ ed mining and quarrying personnel

These questions provide insight on the relative importance 842 Unqualiﬁ ed construction personnel and similar professions of: 716 Plant operators for the production of thermal energy and steam, for waste recovery and for the treatment and • performing activities involving (i) use, control and re- distribution of water 2 pairing of machines, equipment, vehicles, (ii) social 645 Fishermen and hunters contact, taking care of or assisting others,3 (iii) email 712 Metal processing and hot working plant operators correspondence; 612 Craftsmen and skilled workers in the construction and maintenance of building structures • performing activities which (i) are carried out outdoors, Can be performed at home (ii) require exposure to diseases and infections, (iii) imply the execution of risky movements or the wearing of 252 Specialists in legal science protective equipment.4 431 Employees in charge of the administrative management of logistics

For each fi ve-digit occupation, these variables are ranked 254 Specialists in linguistic, literary and documentary disciplines according to an importance scale ranging from 0 to 100. Professions classifi ed as ‘not from home’ consisted most- 411 Secretarial and general affairs employees ly of respondents who spend a large fraction of their work- 121 Entrepreneurs and directors of large companies ing time in external environments or use equipment, ma- 122 Directors and general managers of companies chinery or tools or had continuous contact with the public. 211 Specialists in mathematical, computer, chemical, physi- For example, if for a given occupation, most respondents cal and natural sciences report that it is very important to control machinery and 331 Technicians of the organization and administration of use equipment, this occupation cannot be carried out production activities from home. Similarly, if most of the respondents report 432 Economic, accounting and fi nancial management that they perform outdoor tasks for most of their working employees time, this occupation cannot be carried out from home. 251 Management, commercial and banking science specialists Additionally, if sending emails is a very infrequent activity for a given occupation, the occupation cannot be per- Source: ICP-ILFS, 2016. formed from home. The classifi cation is useful in order to identify jobs that can and cannot be executed from home on the basis of the actual performed tasks and work con- cause of the use of working instruments or because of in- texts and starts by excluding all those occupations that tensive social contact).5 require working in a well-defi ned physical space (e.g. be- After identifying the occupational categories at the four- digit level, these are aggregated at the one-digit level 2 For example, “Handling and moving objects”, “Managing machines and processes”, “Manoeuvring vehicles, vehicles and equipment”, “Repairing and maintaining mechanical equipment”. 5 In case of the application of social distancing, an occupation as pri- 3 “Working in direct contact with the public and performing”, “Assisting mary school teacher, which could not be carried out from home ac- and taking care of others”. cording to our classifi cation, will eventually be performed from home. 4 “How often your occupation requires you to work outdoors exposed In fact, there are tasks, largely related to activities as “taking care of to all climatic conditions”, “How often are you exposed to contami- others” or “working with the public” that could potentially be digital- nants”, “How often does your work require exposure to dangerous ised, however, at the cost of entirely reconfi guring the very nature of equipment?”. the profession.

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Figure 1 Figure 2 Percentage of employees in occupations that can Distribution of occupations that can and cannot be and cannot be performed from home performed from home

Elementary occupations 4.2 95.8

Plant and Can work machine operators 0 100 from home 30% Crafts, agriculture and specialised workers 0.5 99.5

Service and sale workers 5 95

Cannot work from home Clerical support workers 71.5 28.5 70% Technical professionals 57 43

Intellectual and 58 42 Source: ICP-ILFS, 2016. scientific workers Legislators, managers and entrepreneurs 61 39

0 102030405060708090100 according to the ISCO classiﬁ cation and are then linked to the Labour Force Survey providing information on the Working from home (%) Not working from home (%) number of employees, wages, contractual types and so- Note: One-digit level, ISCO classiﬁ cation. cio-demographic characteristics of workers (age, gender Source: ICP-ILFS, 2016. and level of education).

Table 1 presents ten occupations which can be performed at home and ten which cannot at the three-digit level. The ably an overestimate since the classifi cation arises from occupations are ranked in terms of the number of variable the identifi cation of jobs that cannot be done from home, co-occurrences, out of thirty selected variables from the but does not ensure that those who can work from home ICP, which defi ne an occupation as unfeasible from home. are actually doing so. Another overestimation bias derives The higher the number of co-occurrences, the higher the from the complementarity between occupations and from ranking of the occupation. the integration of work processes: take the case of travel agencies, whose work, although remotely executable, is Occupations like woodcutters, miners, construction simply not done because of the lack of clients for hotels workers and fi shermen rank among the top professions and restaurants. that cannot be performed at home. On the contrary, occupations involving specialised fi eld knowledge, such By aggregating at the one-digit level according to the as legal or linguistic experts, as well as managerial and ISCO classifi cation, it is possible to analyse the distribu- executive posts are among the top jobs that can be per- tion of the occupations that can or cannot be carried out formed remotely. In terms of organisational hierarchies, from home within each of the eight professional macro occupations that cannot be performed remotely tend to groups. In Figure 2, a highly polarised occupational be located at the lower end of the employment structure. structure emerges with a strong concentration of oppor- Those who self-organise their work activity, give orders or tunities to work from home for the fi rst four occupational are responsible for high-level administrative activities can groups. Agile work is feasible for 60% of those who are at operate remotely. the top of the organisational hierarchy (managers, entrepreneurs and legislators), for scientifi c-academic profes- Figure 1 shows the corresponding number of employees sions and for technical professionals. It increases to 70% for each of the two categories. Only 30% of the work- for administrative tasks. For the lower part of the distribu- force, or 6.7 million workers, have an occupation that can tion, the scenario radically changes. For service occupa- be done from home. For the remaining nearly 16 million tions, such as entertainment operators, service and sales workers, the work tasks and context do not make work- workers, artisans, plant and machine operators as well ing from home feasible. This fi gure is in line with Dingel as elementary professions, the opportunities for remote and Neiman’s (2020) fi nding that 37% of occupations can working reduce drastically with variations ranging from be conducted from home in the US. This share is prob- 5% to 0%.

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Figure 3 Figure 4 Median monthly wage distribution of occupations Contractual framework of occupations that can and that can and cannot be performed from home cannot be performed from home

16,000,000 Not from home Working from home 14,000,000 0.0015 Not working from home 12,000,000

10,000,000 0.0010 9,987,575 8,000,000

6,000,000 Kernel density 0.0005 4,000,000 From home 3,808,863 4,669,688 2,000,000 1,990,370 0.0000 1,638,317 0 427,145 0 1000 2000 3000 4000 5000 Permanent Temporary Autonomous Median monthly wage per occupation, in euro workers workers workers

Source: ICP-ILFS, 2016. Source: ICP-ILFS, 2016.

Inequality in occupations clearly maps into inequality in chetypical cases: a manager and a manual worker. While the corresponding wage structure. In fact, while the distri- the fi rst has the chance to keep giving orders from home, bution of median wages for not-working from home occu- the second can hardly drive a vehicle or use an instru- pations is largely concentrated in the range of €500-1,800 ment remotely. Additionally, while the fi rst is relatively less per month, working from home occupations record me- exposed to infections, contagious diseases and work ac- dian wages largely concentrated in the range of €1,000- cidents, the opposite is true for the second. This means 2,000 per month (see Figure 3), with a fatter right tail. that the coupling of the pandemic and social distancing are confl ating diverse risks: health risks (exposure to so- The nearly 16 million workers who do not have the chance cial contacts is higher for low income occupations), in- to work from home not only earn less money, but they are come risks (exposure to job losses is higher for temporary, also among those most exposed to closer social proxim- low income occupations), and employment risks (feasibility and the possibility of getting infections, the latter be- ity of remote work is lower for low income occupations). ing among the dimensions covered by our classifi cation of working/not working from home (Barbieri et al., 2020). Whereas those who are unable to work remotely are ex- This polarisation in the wage structure is also refl ected in posed signifi cantly more to risks right from the outset, the the contractual structure which sees temporary workers risk exposure of those working from home are hetero- largely concentrated in professions that cannot be carried geneous as well. Take the case of two clerical workers: out from home, affecting almost two million workers, to one is employed by a small enterprise and the other by a which 3.8 million self-employed workers should be added big one (i.e. more than 50 employees). Although perform- to encompass all at-risk jobs, as shown in Figure 4. These ing quite similar job tasks, and therefore both classifi ed are workers who earn less yet face the greatest risk of as occupations which can be done from home, the fi rst unemployment due to their contractual arrangement and worker is going to face more diffi culties and less support have the most diffi culty executing their work remotely. in setting up a work station from home vis-à-vis the second due to the fact that small fi rms are generally less ca- Labour market inequalities during the coronavirus pable of digitalising their administrative activities. pandemic If workers are not equal when facing the consequences of Overall, the spreading of the pandemic exacerbates a se- the pandemic, policies should support forms of internal ries of existing inequalities and increasing vulnerabilities. reorganisation of the workplace and encourage safe con- Although the common perception is that the pandemic is ditions. This means that together with the provisions of ‘the great equaliser’, workers’ tasks, contractual frame- safety equipment (still not guaranteed), a more compre- work and position in the internal organisational hierarchy hensive intervention should seek to reduce working hours strongly affect their ability to work remotely. Take two ar- (at constant wages) and rearrange shifts.

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The reduction of working hours at constant wages would hours should be reduced. Taken together, these initiatives be a much more equitable scheme (with potentially posi- offer a viable solution. tive feedback on the demand side) rather than redundancy payment schemes and supposedly generalised lockdowns. A general organizational fl exibility with reduced References working hours at the same wage would allow for the main- Barbieri, T., G. Basso and S. Scicchitano (2020), Italian Workers at Risk tenance of productive capacity, job and income guaran- During the Covid-19 Epidemic, INAPP working paper, 46. tees. Cetrulo, A., D. Guarascio and M. E. Virgillito (2019), Anatomy of the Italian occupational structure: concentrated power and distributed knowledge, GLO Discussion Paper, 418. All of this, however, requires a massive reorganisational Chiou, L. and C. Tucker (2020), Social Distancing, Internet Access and effort of the production process and clashes with the lack Inequality, NBER Working Paper Series, 26982. Coibion, O., Y. Gorodnichenko and M. Weber (2020), Labor Markets Dur- of organisational capabilities of Italian fi rms, the major- ing the COVID-19 Crisis: A Preliminary View, BFI Working Paper, 2020- ity of which employ less than ten employees. As largely 41. documented (Dosi et al., 2019), Italian fi rms are strongly Dosi, G., D. Guarascio, A. Ricci and M. E. Virgillito (2019), Neodualism in the Italian business fi rms: training, organizational capabilities, and heterogeneous in performance variables and underlying productivity distributions, Small Business Economics. organisational capabilities. Additionally, they tend to dis- European Trade Union Confederation (2020, 6 April): ETUC calls on Eu- play a poor attitude towards workplace collaborative prac- rogroup to help over 10 million workers hit by crisis, Press release, https://www.etuc.org/en/pressrelease/etuc-calls-eurogroup-help- tices and job rotation schemes, which might be very help- over-10-million-workers-hit-crisis (12 May 2020). ful in times of fl exible rostering, and look to be abundantly Eurostat (2020, 6 February), How usual is it to work from home?, Eurostat, equipped by a rigid and hierarchical internal division of https://ec.europa.eu/eurostat/web/products-eurostat-news/-/DDN- 20200206-1. labour (Cetrulo et al., 2019). International Monetary Fund (2020), World Economic Outlook, April 2020: The Great Lockdown, https://www.imf.org/en/Publications/WEO/Is- To mitigate these structural divergences, policies play a sues/2020/04/14/weo-april-2020 (12 May 2020). Lucchese, M. and M. Pianta (2020), The Coming Coronavirus Crisis: What crucial role. First, fi rms should be monitored for the provi- Can We Learn?, Intereconomics, 55(2), 98-104, https://www.intereco- sion of safety devices. Second, a nationwide plan to pro- nomics.eu/contents/year/2020/number/2/article/the-coming-coro- vide equal opportunities for workers who are (technically) navirus-crisis-what-can-we-learn.html (12 May 2020). Saez, E. and G. Zucman (2020, 18 March), Keeping business alive: the capable of performing smart work should be put in place. government will pay, Social Europe, https://www.socialeurope.eu/ Finally, working shifts should be reorganised and working keeping-business-alive-the-government-will-pay.

Franz Prante, Alessandro Bramucci and Achim Truger* Decades of Tight Fiscal Policy Have Left the Health Care System in Italy Ill-Prepared to Fight the COVID-19 Outbreak

The Sars-CoV-2 pandemic and the resulting COVID-19 Italian national health system (Sistema sanitario nazionale, disease is overwhelming some European health systems SSN) has been unable to cope with the care of COVID-19 in an unprecedented manner. The situation remains par- patients. This article takes a closer look at the connec- ticularly serious in Italy. In the most affected regions, the tion between health care and strong budget consolidation in the case of Italy. Although austerity was particularly strong in the aftermath of the economic crisis of 2008 and its consequences in the euro area, Italian ﬁ scal policies Franz Prante, Berlin School of Economics and Law have been characterised by tough consolidation peri- (HWR); and University of Duisburg-Essen, Germany.

Alessandro Bramucci, Berlin School of Economics © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License and Law (HWR), Germany. (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre Achim Truger, University of Duisburg-Essen; and for Economics. German Council of Economic Experts, Wiesbaden, * This contribution is based on preliminary parts of an ongoing research Germany. project on the Italian economy funded by Friedrich-Ebert-Stiftung in Germany.

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Figure 1 Figure 2 Government and compulsory health care Government and compulsory health care expenditure per capita and primary balance in Italy expenditure per capita in selected countries constant prices (2010) and percent of potential GDP constant prices (2010)

euros % euros 2,000 Cyclically adjusted primary balance 8 4,000 (right axis) 1,900 6 3,500 1,800 3,000 1,700 4 1,600 2,500 2 1,500 2,000 1,400 0 1,500 1,300 -2 1,000 1,200 Government/compulsory expenditure on health, per capita, constant prices (left axis) 1,100 -4 500

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 0

Notes: the OECD classiﬁ es government funded and compulsory insur- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 ance funded health care expenditures into the same category. Belgium France Germany Sources: OECD; IMF. Netherlands Portugal Spain Greece Italy Euro area

ods ever since the 1990s. Over the years, the SSN has Notes: Data for Malta and Cyprus are not available and are not included undergone a profound transformation aimed at contain- in the euro area average. Euro membership as of 2020. Breaks present in ing costs and increasing efﬁ ciency. The question now is the data. For 2018, provisional data or OECD estimates. whether the consequences of these measures have left Sources: OECD; authors’ calculations. the SSN unprepared to face the scourge of COVID-19.

Italy’s SSN was founded in 1978. Based on the national constitution (Article 32), the state guarantees the univer- what the government extracted from the national econ- sal right and largely free access to health care services.1 omy in terms of taxes has been larger than what people During the 1990s, a fi rst series of far-reaching reforms received in public services for almost three decades. Fig- was implemented in an attempt to contain costs in the ure 1 also shows that periods with cuts in real health care face of the growing healthcare needs of an ageing popu- expenditure tend to correspond with or follow periods of lation and rapidly improving technologies (Pavolini and strong budget consolidation in the fi rst half of the 1990s Vicarelli, 2013). These reforms were largely in line with the and in the euro crisis after 2010. market-liberal ‘New Public Management’ approach and their primary objective was to limit Italy’s public defi cits The development of Italian health care expenditure is re- and debt (Pavolini and Vicarelli, 2013). Cost containment ported in Figure 2 together with data for selected Euro- was therefore motivated by the macroeconomic context pean countries and the euro area average. Three phases of the time, characterised by Italy’s efforts to meet the can be observed in the evolution of Italian expenditure. In Maastricht criteria and the requirements of the Stability the 1990s, unlike most other industrialised countries, Italy and Growth Pact, which led to an overall tightening of experienced a decline in public and compulsory health public spending. More recently, the global fi nancial crisis care expenditure (measured in constant euros per capita). and the policy response to the euro crisis put a further It was not until the end of the 1990s that a slight upward strain on the Italian economy and signifi cant restrictions trend began when spending increased in parallel to the on health care spending returned to the national agenda other European countries until the late 2000s. From 2010 (De Belvis et al., 2012). Since the early 1990s, the Italian onwards, a new phase of spending containment began, government has registered almost 30 consecutive years lasting until 2015. In this period, public health care spend- of primary budget surpluses (Figure 1). This signals that ing was similarly affected in Portugal and Spain and to a larger extent in Greece, i.e. the countries hardest hit by the euro crisis and the subsequent austerity policies. 1 The European Commission (2019) in its Country Report Italy 2019 By contrast, in this period a rapid increase in public and fi nds the SSN to be generally effi cient and its outcome in terms of health indicators good, albeit with regional disparities in the provision compulsory healthcare spending per capita took place in of health services affecting equity and effi ciency. Germany, France and Belgium.

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Figure 3 Percentage change in government and compulsory health care expenditure per capita in selected countries constant euros (2010)

1990-2000 2000-2010 % % 120 80 100 70 60 80 50 60 40 40 30 20 20 10 0 0

Italy Italy Spain Spain France Greece France Greece Belgium Germany Portugal Portugal Germany Belgium Netherlands Netherlands

2010-2018 1990-2018 %% 30 160 20 140 10 120 100 0 80 -10 60 -20 40 -30 20 -40 0

Italy Italy Spain Spain Greece France Greece France Portugal Belgium Germany Belgium Germany Portugal Netherlands Netherlands Notes: For Belgium, the value for 1990 is missing and was replaced with the value for 1993.

Sources: OECD; authors’ calculations.

Figure 3 shows the percentage change in government research and development and other components) has and compulsory health care per capita for these three suffered a drastic setback. From 2008 to 2018, total pub- different phases and for the entire period between 1990 lic health care expenditure in nominal terms (i.e. including and 2018. From 1990 to 2000, a fi rst phase of expendi- infl ation) increased by only 5.3% in Italy, while in Germa- ture containment took place in Italy, in which public ex- ny it increased by 46.8% (Figure 4a). Moreover, COFOG2 penditure increased by only 8.7%. After a slightly expan- data provides evidence of the extent of cuts in hospital sive second phase from 2000 to 2010, in which spending services.3 Unlike Northern European countries, Italy (to- per capita in Italy increased by 27.1%, the growth of pub- gether with Portugal and even more so Greece) has re- lic health expenditure registered a reduction in the third duced public spending for hospital services. time interval (as was the case in Portugal, Greece and Spain). In this period, characterised by the most recent From 2011 to 2018, cuts in public hospital services have set of budget cuts, per capita spending in Italy decreased contributed substantially to the negative dynamics of the by 8.2% – less strongly than in Greece but more than in percentage growth rate of the total public expenditure for Spain and Portugal. In contrast, the group of Northern health care (Figure 4b). Although austerity policy placed countries registered an increase. Altogether, from 1990 a great burden on the health care system, the share of to 2018, public and compulsory health care expenditure health care expenditures in total government spending per capita in Italy increased by less than 26.8%, which is by far the lowest value among the European countries 2 The Classifi cation of the Functions of Government (COFOG) health reported in Figure 3. aggregate (GF07 and relative groups) classifi es all types of government expenditure for the purpose of health (including expenditure on employees, intermediate consumption, government expenditure on In the last decade, the extent of cuts in the SSN was par- gross capital formation, etc.). The delineation of government expendi- ticularly dramatic. In the wake of the fi nancial and eco- ture in the COFOG classifi cation differs from the System of Health Ac- counts. nomic crisis of 2008, total public healthcare expenditure 3 According to the COFOG classifi cation, day hospitalisation is classi- in Italy (including investments, intermediate consumption, fi ed under hospital services.

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Figure 4a Figure 4b Percentage change of total government spending for Composition of the growth rate of total government health care and for hospital services, 2008-2018 spending for health care in Italy, nominal values

% % 60 8 Health not elsewhere classified 50 R&D health Public health services 40 Hospital services 6 Outpatient services 30 Medical products, appliances and equipment 20 Total 4 10

0 2 -10

-20

-30 0 Spending for hospital services -40 Total government health care spending -50 -2

Italy Greece France 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Portugal Belgium Euro area Germany Netherlands Note: Second level COFOG.

Sources: Eurostat COFOG; authors’ calculations. Sources: Eurostat COFOG; authors’ calculations.

has increased from 10% in 1995 to 14.7% in 2008 and of acute care hospitals in Italy fell below the EU average. remained above 14% after 2008, according to COFOG The trend continued to decline throughout the years of data. This may indicate that health care provision was the euro crisis. important to the government despite general spending constraints. However, this did not prevent Italian expen- The availability of acute care beds was reduced even ditures from falling below the international trend. more drastically than hospital capacity (Figure 6). Al- though a pronounced trend towards reducing acute care In the EU, almost one-third of public health care expendi- beds can be observed in many European countries, few ture is used to cover the running expenses of inpatient European countries have reduced the number of available curative institutions (European Hospital and Healthcare beds as much and to such a low level as Italy. In 1990, It- Federation, 2018). Over the years, hospitals have been aly had seven beds per 1,000 inhabitants, a value close to subject to increasing pressure and have often been seen Germany and above the EU average. In 2017, the number as a major potential source for cuts in public health sys- of acute care beds had dropped to 2.6 per 1,000 inhab- tems (see McKee, 2004; Popic, 2020). Cost containment itants, signifi cantly lower than in Germany with six beds strategies revised the use and provision of inpatient hos- available per 1,000 persons and much closer to the his- pital care in favour of day hospital and outpatient ser- torically low value of Spain. Thus within a rather short time vices, thereby consistently sacrifi cing hospital capacity. period, Italy found itself at the lower end of the spectrum Data from the World Health Organization (WHO) show in Europe. that since the beginning of the 1990s, the number of hospitals has been drastically reduced throughout Europe, There is also a considerable difference in the provision but particularly in Belgium and Italy. Acute care hospitals of intensive care beds, with Italy again at the tail end in are currently a central element in the fi ght against COV- Europe (Rhodes et al., 2012; OECD, 2020). Although in re- ID-19. A higher number of acute care hospitals could have cent years the number of intensive care beds in Italy has also facilitated the isolation of infected patients, reducing remained relatively constant (Figure 7), intensive care ca- the risk of contagion. Figure 5 shows that after starting pacity has not been expanded (in contrast to e.g. Germa- from a level similar to Germany in 1990, Italy has reduced ny) despite warnings of possible bottlenecks in accom- per capita hospital capacity much more than many other modation capacity of intensive care patients (Rhodes et countries within two decades. From 2010 on, the number al., 2012).

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Figure 5 Figure 6 Acute care hospitals per 100,000 inhabitants, eight Acute care beds per 1,000 inhabitants, eight largest largest EMU countries and EU average EMU countries and EU average

4.0 9 France 3.5 8 Belgium 3.0 7 2.5 Germany Germany Italy EU average (post 2004) 6 Italy 2.0 Belgium Greece 5 1.5 France EU average Portugal Spain 4 Greece 1.0 Netherlands Portugal 0.5 Netherlands 3 Spain 0 2

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Note: EU membership as of 2020 with country data available.

Sources: WHO; authors’ calculations. Sources: OECD; authors’ calculations.

Italy, as well as other European countries, would have is a matter of controversy among lung specialists and in- been better prepared for adequate treatment of COVID-19 tensive care physicians (Gattinoni et al., 2010). The current patients in severe and critical condition if the capacity of research gap on COVID-19 may therefore also require a acute and emergency care had not been reduced. Oxy- comprehensive diagnosis of patients by lung specialists, gen-assisted beds are particularly relevant for the inpatient which could lead to better treatment outcomes (see also treatment of COVID-19. For some patients, breathing difﬁ - Begley, 2020). In this context, the substantial reduction in culties worsen in the course of the illness, making intensive the number of pneumological beds during the phase of in- medical care necessary. The public discussion therefore tensiﬁ ed austerity after 2010 in Italy is particularly tragic. focuses primarily on the availability of intensive care ca- According to the data of the Italian Ministry of Health, the pacities and mechanical ventilation equipment. However, number of pneumological beds has decreased from 4,414 the speed at which machine ventilation should be provided in 2010 to 3,573 in 2018 – a reduction of 19%.

The reduction of resources in the public health system and Figure 7 in particular in the operation of public hospitals in Italy has Total number of intensive care beds and been going on for almost 30 years. The Italian population pneumological beds in Italy and Germany is currently paying the price of prolonged tight budget policies in the SSN. The one-sided focus on ﬁ scal constraints and debt reduction has deprived the Italian health sector of 30,000 an important part of its capacity to offer adequate protec- 25,000 tion to the population. The sizeable reduction of resources 20,000 has caused severe difﬁ culty to the SSN in effectively tack- ling the consequences of COVID-19. The outbreak of the 15,000 health crisis has sounded a wake-up call that cannot re- 10,000 main unheard. 5,000

0 2010 2011 2012 2013 2014 2015 2016 2017 2018 References Intensive care beds in Italy Pneumological beds in Italy Begley, S. (2020, 8 April), With ventilators running out, doctors say the Intensive care beds in Germany machines are overused for Covid-19, STAT, https://www.statnews. com/2020/04/08/doctors-say-ventilators-overused-for-covid-19/ (14 Sources: Italian Ministry of Health; Destatis. April 2020).

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De Belvis, A. G., F. Ferrè, M. L. Specchia, L. Valerio, G. Fattore and W. OECD (2020), Beyond Containment: Health systems responses to COVID-19 Ricciardi (2012), The ﬁ nancial crisis in Italy: Implications for the in the OECD, https://read.oecd-ilibrary.org/view/?ref=119_119689- healthcare sector, Health policy, 106, 10-16. ud5comtf84&Title=Beyond%20Containment:Health%20sys- Gattinoni, L., S. Coppola, M. Cressoni, M. Busana and D. Chiumello tems%20responses%20to%20COVID-19%20in%20the%20OECD (2020), Covid-19 Does Not Lead to a “Typical” Acute Respiratory (2 April 2020). Distress Syndrome, American Journal of Respiratory and Critical Care Pavolini E. and G. Vicarelli (2013), Italy: A Strange NHS with Its Paradox- Medicine, advance online publication. es, in: E. Pavolini and A. M. Guillén (eds.), Health Care Systems in Eu- European Commission (2019), Country Report Italy 2019: Including an In- rope under Austerity, Work and Welfare in Europe, Palgrave Macmillan. Depth Review on the prevention and correction of macroeconomic Popic, T. (2020), European health systems and COVID-19: Some early les- imbalances, SWD(2019) 1011 ﬁ nal. sons, EUROPP blog, https://blogs.lse.ac.uk/europpblog/2020/03/20/ European Hospital and Healthcare Federation (2018), Hospital in Europe, european-health-systems-and-covid-19-some-early-lessons/ (29 Health care data 2018. March 2020). McKee, M. (2004), Reducing hospital beds: What are the lessons to be Rhodes, A., P. Ferdinande, H. Flatten, B. Guidet, P. G. Metniz and R. P. learned?, European Observatory on Health Systems and Policies Policy Moreno (2012), The variability of critical care bed numbers in Europe, brief, 6. Intensive Care Medicine, 38, 1647-1653.

Sebastian Dullien, Thomas Theobald, Silke Tober and Andrew Watt Why Current EU Proposals for Corona-Related Financial Aid Cannot Replace Coronabonds

Across Europe, the coronavirus crisis has pushed econo- increase of debt ratios by mere arithmetic: in the case of mies into recessions of a depth not experienced in gen- Italy’s public debt of 135% of GDP in 2019, a drop in nom- erations. The collapse in economic activity in turn is de- inal GDP by 10% in itself increases the debt-to-GDP level livering a triple blow to public debt ratios. First, automatic by 15 percentage points. stabilisers have led to a surge in defi cits as revenues have collapsed and payments for income support skyrock- With public debt-to-GDP levels now set to surpass post- eted. Second, discretionary measures to stabilise the war records and Italy’s ratio approaching levels reached economy against the deep shock are adding hundreds of in Greece on the eve of the country’s debt restructuring billions of unfunded expenditure and targeted tax relief to in early 2012, fears of a return of the sovereign debt crisis public defi cits. Third, collapsing GDP has led to a further have emerged. The combination of weak economic activity, large fi scal defi cits and high debt levels eerily resem- © The Author(s) 2020. Open Access: This article is distributed under the bles the situation in 2010, when investors panicked amid terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). a sudden increase in reported Greek debt levels and triggered the euro crisis. At that time, fi rst Greece and then Open Access funding provided by ZBW – Leibniz Information Centre for Economics. several other euro countries successively experienced a substantial increase in their sovereign risk premiums. This gave rise to a vicious cycle of rising public borrowing costs, plunging economic activity, capital fl ight and further Sebastian Dullien, Macroeconomic Policy Institute soaring risk premiums (Theodoropoulou and Watt, 2012). (IMK), Düsseldorf; and HTW Berlin – University of The role of sovereign yields as benchmarks for private Applied Sciences, Germany. lending rates amplifi ed the economic contraction (Iorgova et al., 2012; Gorton, 2017; Theobald and Tober, 2020). Thomas Theobald, University of Bamberg; and Macroeconomic Policy Institute (IMK), Düsseldorf, Until the summer of 2012, the efforts by euro area govern- Germany. ments, involving several rescue funds amounting to a total of almost €1 billion in lending capacities coupled with Silke Tober, Macroeconomic Policy Institute (IMK), harsh austerity measures, failed to calm fi nancial mar- Düsseldorf, Germany. kets. The rescue measures lacked conviction as they represented a minimalist consensus arising from a drawn- Andrew Watt, Macroeconomic Policy Institute out and costly struggle between national interests rather (IMK), Düsseldorf, Germany. than a convincing European answer. Only when European Central Bank (ECB) president Mario Draghi issued the fa-

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mous promise to do “whatever it takes” to save the euro, ment (Grund et al., 2020) – differ in the amount of detail did the panic subside and the spreads narrow. they provide and in their specifi c features, they all share the idea of common debt issued to fi nance crisis-related A renewed increase in government spreads expenditure. For example, Bofi nger et al. (2020) propose that the euro countries issue joint bonds with a volume of In the current crisis, the European Commission has sus- €1,000 billion to provide support to countries in the corona- pended the fi scal rules and eased restrictions on state aid virus crisis. The borrowed funds are distributed to them by to companies. The ECB has once again, after initial hesi- a formula refl ecting the severity of the health and economic tation, acted resolutely with the announcement of the pur- crisis caused by COVID-19. Servicing and repayment could chase of €750 billion in government bonds – with an option be organised by contributions to a repayment fund based for more – under the Pandemic Emergency Purchase Pro- on GDP or the ECB capital key. Liability for these bonds gramme (PEPP). Yet an open question remains: How long would be joint and several. can the ECB keep spreads from rising? The May 2020 ruling of the German constitutional court questioning the legality Proponents of such proposals argue that, as the new debt of the ECB’s Public Sector Purchase Programme (PSPP) in is supranational, not national in nature, fi nancial markets particular has raised new concerns about possible limits to would not see this increased debt as a direct increase in the central bank’s policies (Brade and Gentzsch, 2020). the liabilities of already fi scally weak member states. As the newly issued debt would cover a signifi cant share of the Moreover, the marked renewed increase in government additional borrowing needed by member states over the spreads despite the ECB’s interventions is putting further acute crisis period, they would not have to tap capital mar- pressure on the European single market, already weakened kets, insulating them from an increase in their spreads. by the uncoordinated closure of borders between EU member states and initial export restrictions of medical supplies Finally, as coronabonds would be at least as safe as German on the part of some member states. With rising spreads, in- sovereign bonds and have a signifi cant volume, they would terest rates increase not only for newly issued government provide a European safe asset to the fi nancial system at a debt, but for the entire national economy through valuation time of increased uncertainty and could be used by the ECB and benchmark effects (Theobald and Tober, 2020). As a for liquidity operations. Such a safe asset would act as a consequence, rising spreads can result in a well-run Italian stability anchor for the fi nancial system. Once market partic- fi rm paying higher interest rates than a poorly managed Ger- ipants have confi dence in its fundamental safety, its coun- man competitor, calling into question the very idea of the sin- ter-cyclical price movements in crisis situations will have a gle market as a mechanism to increase effi ciency and pro- stabilising effect on the economy throughout the euro area. ductivity (Dullien, 2012; Dullien et al. 2020). This problem will Investors’ fl ight to safety lowers fi nancing costs, increasing be exacerbated to the extent to which some countries’ ablil- the fi scal space, while higher prices improve banks’ balance ity to support potentially viable companies is constrained by sheets (Tober, 2013). A large and liquid market of safe sov- fi scal limits whereas other countries are free to do so. ereign bonds in the euro area would furthermore bolster the international role of the euro, thereby benefi ting the econo- Furthermore, as many euro area banks still have a strong mies of all euro countries and increasing the international bias towards domestic sovereign debt, diverging sover- political sway of the EU (Theobald and Tober, 2018). eign yields pose a threat to fi nancial stability. Especially in Italy’s case, not only do higher fi nancing costs weaken the Coronabonds vs. eurobonds scope for public spending, but also the lower price of government bonds stresses bank balance sheets. Increasing Even in Germany, the current proposals have been pro- uncertainty and higher private-sector fi nancing costs may moted by economists who in the past have not been vocal further weaken the economy, leading to a surge in non-per- supporters of joint debt at the European level such as the forming loans in the banking system. eurobonds1 discussed already during the euro crisis.2 Even traditionally sceptical economists have underlined that A common debt instrument the case for coronabonds is very different than that for eurobonds. In their eyes, coronabonds do not carry the risk of These are the reasons why a growing number of economists have called for the introduction of common instru- 1 Here, eurobonds refer to debt elements with joint and several liability ments that provide fi scal support to member states, ena- to fi nance normal expenditure of member states’ governments irre- bling them to weather the crisis without dramatic increases spective of the proposed constructions’ issuance limits or rules. 2 Examples include Michael Hüther from the German Economic Insti- in public debt. While the proposals – such as coronabonds tute (IW) or Gabriel Felbermayr from the Kiel Institute for the World (Bofi nger et al., 2020) or the Pandemic Solidarity Instru- Economy, both co-authors of Bofi nger et al. (2020).

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moral hazard, which has often been spotlighted in the debate Initially leaving the ERF aside for that reason, it is easy to on eurobonds, especially in Germany. After all, coronabonds see why the emergency measures cannot have a support- are proposed as a one-off joint issuance for costs already in- ive effect equivalent to the discussed coronabonds. EIB curred by an external event (the spread of the pandemic). loans, loans from the SURE fund and ESM loans are all credit-based and increase national debt by the amount of Despite the growing support for coronabonds by econo- funds disbursed. Public fi nances will only be relieved to the mists across the political spectrum, the idea has yet to win extent that these loans are cheaper and/or of longer dura- suffi cient political support. While the Netherlands has been tion than those available on the market. Furthermore, in a the most vocal opponent of the idea, supported by Austria situation in which local lenders and national promotional in- and Finland, it is safe to say that, ultimately, the opposition stitutions have to be involved for the full lending capacity of of the German government has been decisive in blocking the EIB programme, to achieve a leverage ratio of 8% seems the introduction of coronabonds. at least optimistic. At the end of the day, the programme might largely merely reclassify existing national funds. The Inadequacy of emergency support measures ESM credit line, which can provide signifi cant interest savings, threatens to stigmatise those member states that use The German fi nance ministry has argued that the support the funds, despite all political assurances, worsening their measures already decided – at least in principle – at the EU capital market conditions. While details of loan conditions level could support the euro area economies suffi ciently for SURE are still sketchy, for as long as the ECB stands well. In this respect, three measures have been highlighted ready to limit yield spreads within narrow margins via PEPP by the German government: and other measures, it is hard to see how the fi scal support can be macroeconomically signifi cant, even for the hardest- • On top of a €40 billion package announced in March, hit countries. the European Investment Bank (EIB) has proposed offering additional guarantees to companies. In the recent With increased national debt levels and a de facto senior- statement from the Eurogroup Finance Ministers, a pan- ity of the credit lines from the EU schemes, there is no rea- European guarantee fund of €25 billion is mentioned that son why investors should be less fi ckle than without these could support an additional €200 billion of EIB lending measures. The risk of a self-fulfi lling fi scal crisis caused by with a focus on SMEs. increasing spreads of highly indebted euro countries thus remains basically unchanged and is limited only by the will- • The European Commission has proposed a scheme to ingness and the ability of the ECB to act. provide fi nancial support for national short-time working (or similar) schemes, called SURE (temporary sup- Returning to the ERF, it is easy to conceive how it could be port to mitigate unemployment risks in an emergency). set up in a way that it serves as an equivalent of the above- The programme is supposed to have a maximum volume discussed coronabonds. In such a scenario, the EU would of €100 billion. It will require member states to provide borrow at least €1,000 billion to fi ll the fund based on nation- guarantees rather than capital upfront. Funds would be al guarantees, support national budgets from this fund, and disbursed as loans. service the debt from higher contributions to the EU budget or by new EU own resources. As at the moment, the Multi- • Lending by the European Stability Mechanism (ESM) will annual Financial Framework of the EU for the years 2021- be available to all euro area member states up to 2% of 2027 is being renegotiated, in principle, the EU budget’s size GDP. This lending will not be subject to detailed condi- could be raised accordingly. tionalities. However, the new credit line (Pandemic Crisis Support) is limited in time – up to when the COVID-19 The joint French-German initiative for a recovery fund of crisis is over, with no clear indication of how that will be €500 billion would be a step in the right direction. Accord- determined – and to “direct and indirect healthcare, cure ing to the plan, the EU would tap capital markets and fund and prevention related costs” (Eurogroup, 2020). spending in the most affected sectors and regions in line with European priorities (Macron and Merkel, 2020). Al- Moreover, there has been an agreement in principle on a EU though the actual volume of transfers between countries recovery fund (ERF), but it has not been spelled out in detail is likely to be relatively small, it is the joint borrowing and and little is known about its likely volume, the allocation of the frontloading that are important as they signal European funds between loans and grants, the refi nancing procedure unity and determination to fi nancial markets and to citizens. or its legal form. All that seems certain is that the recovery Ideally, the design of the Fund could serve as a blueprint for fund will be accompanied by a temporary increase in the EU more active fi scal cooperation in the future, which is essen- budget. tial for the longer-run stability of the monetary union.

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It remains be seen whether the proposal will become reality. Brade, A. and M. Gentzsch (2020, 7 May), PSPP mit „PEPP“, Verfas- In some European countries, there is strong resistance to sungsblog, https://verfassungsblog.de/pspp-mit-pepp/ (17 May 2020). increasing the transfer element in the EU budget, even to the Dullien, S. (2012), Why the euro crisis threatens the EU single market, limited extent proposed by the French-German initiative. In ECFR Policy Brief, 64. particular, it is as yet unclear whether the so-called ‘frugal’ Dullien, S., C. Paetz, A. Watt and S. Watzka (2020), Vorschläge zur Re- form der europäischen Fiskalregeln und Economic Governance, IMK countries will agree to the coronabonds-like construction Report, 158. of the ERF, although the increased stability of the EU would Eurogroup (2020, 8 May), Eurogroup Statement on the Pandemic Crisis also be in their longer-term interest. Support, Press release, https://www.consilium.europa.eu/en/press/ press-releases/2020/05/08/eurogroup-statement-on-the-pandemic- crisis-support/ (19 May 2020). Endowing the EU with stabilising tools Gorton, G. (2017), The history and economics of safe assets, Annual Re- view of Economics, 9, 547-586. Grund, S., L. Guttenberg and C. Odendahl (2020), Sharing the fi scal bur- In conclusion, the coronavirus crisis has made the euro area den of the crisis, Hertie School Policy Paper. vulnerable to a replay of the sovereign debt crisis of the be- Iorgova, S., A. Al-Hassan, K. Chikada, M. Fandl, H. Morsy, J. Pihlman, C. ginning of the past decade. The European Council has so far Schmieder and T. Sun (2012), Safe assets: Financial system corner- stone?, in Global Financial Stability Report: The Quest for Lasting Stabil- failed to come up with a decisive solution that breathes Euro- ity, 81-122, International Monetary Fund. pean solidarity and presents a common front to its fi nancial Macron, E. and A. Merkel (2020, 18 May), European Union – French- markets as well as unity to its citizens. The ECB is being re- German initiative for the European recovery from the coronavirus crisis, France Diplomacy Press Release, https://www.diplomatie. lied upon to do the heavy lifting. This is a hugely risky strat- gouv.fr/en/coming-to-france/coronavirus-advice-for-foreign-na- egy. The European Parliament has called for the setting up of tionals-in-france/coronavirus-statements/article/european-union- a sizable recovery fund. The European Commission and the french-german-initiative-for-the-european-recovery-from-the (26 May 2020). heads of state and government need to seize the opportunity Theobald, T. and S. Tober (2018, 18 May), Why We Need European Safe to tackle the serious threat to the integration project and en- Assets, Social Europe, www.socialeurope.eu/why-we-need-europe- dow the EU with tools to stabilise the economy in the current an-safe-assets (17 May 2020). Theobald, T. and S. Tober (2020), Euro area sovereign yield spreads as and future crises and to address longer-term challenges. determinants of private sector borrowing costs, Economic Modelling, 84(C), 27-37. Theodoropoulou, S. and A. Watt (2012), What did they expect? Lessons for Europe from a retrospective ex-ante evaluation of the fi rst Greek References bail-out programme, ETUI Working Paper, 2012.10. Bofi nger, P., S. Dullien, G. Felbermayr, C. Trebesch, M. Schularick and J. Tober, S. (2013), Risky or Safe? Government Bonds in the Euro Crisis, in Südekum (2020, 21 March), Europa muss jetzt fi nanziell zusammen- G. A. Horn and T. Palley (eds.), Restoring Shared Prosperity – A Policy stehen, Frankfurter Allgemeine Zeitung. Agenda from Leading Keynesian Economists, 113-122.

Bodo Herzog Whither Coronabonds? The Past and Future of the EMU in the Coronavirus Pandemic

The European sovereign debt crisis is almost history, yet the economy worldwide. The global economic downturn is a new next challenge is looming. The novel coronavirus, medically burden for the still weak eurozone. In February and March known as SARS-CoV-2, is sending shockwaves into the real 2020, the European Central Bank (ECB) boldly adopted monetary measures in line with the ‘whatever-it-takes’ paradigm. © The Author(s) 2020. Open Access: This article is distributed under the At the moment, one is reminded of the phrase, “If the euro terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). fails, then Europe fails” by German chancellor Angela Merkel. Open Access funding provided by ZBW – Leibniz Information Centre for Economics. In terms of a unifi ed fi scal stimulus, economists and politicians have found the Holy Grail, too: eurobonds, also known as coronabonds, European Safe Bonds or a fi scal capacity (Blanchard et al., 2017; Brunnermaier, 2017; Bé- nassy-Quéré et al., 2018). Yet, this debate betrays a cer- Bodo Herzog, ESB Business School, Reutlingen, tain naivety as there is a lack of meticulous analysis of the Germany. conditions in the eurozone despite the need for Keynesian defi cit spending in a crisis.

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What is the root cause and what is the symptom? Can Figure 1 eurobonds solve the problem or do they merely treat the Coronavirus stock market crash symptom? % 170 Status quo: Social and economic life in standstill 160 DOW 150 140 The coronavirus pandemic originated in the Chinese city of 130 120 DAX Wuhan at the beginning of December 2019. By mid-Feb- 110 ruary 2020, the epidemiological spread reached Europe. 100 90 EuroStoxx As it has evolved into a global outbreak, the World Health 80 70 S&P500 Organization (WHO) declared the coronavirus (COVID-19) 60 a pandemic on 11 March 2020. The disease has brought 50 social and economic life in China, Europe and much of the .1.2015 world to a standstill. Entire countries are in lockdown or 2 2.7.20152.1.20162.7.2016 2.1.20172.7.2017 2.1.20182.7.2018 2.1.20192.7.2019 2.1.2020 have imposed a quarantine. This is necessary as there are Source: Author’s own illustration based on Data FactSet. currently no medicines or vaccines available. Social distancing and domestic isolation are the only ways to slow the spread of the virus. cies switched to an expansionary path in the eurozone in However, the necessary health protection measures have March 2020. Nevertheless, it is still questionable whether a massive impact on the economy and fi nancial markets. the simultaneous demand and supply shock can be cush- On Monday and Thursday, 9 and 12 March 2020 respec- ioned. In this respect, the call for further fi scal instru- tively, stock markets worldwide plummeted by 10% (Fig- ments, especially in the weakening eurozone, is under- ure 1). The price of oil fell by 30% as the global demand standable. for crude oil collapsed amid the pandemic. However, the debate is dominated by fear and panic. But The developments in the fi nancial markets foreshadow fear is a bad advisor. The widespread paralysis is irration- what will become visible in the real economy soon. Supply al, as is evident during terrorist attacks (e.g. 9/11) or natu- chains from China have been disrupted. Initial estimates ral disasters. The current type of shock can cause panic suggest that China is experiencing the deepest recession because we suddenly expect that many people will die in in decades. So are Europe and the US (German Council a short period or experience an economic bankruptcy. of Economic Experts, 2020; Wollmershäuser, 2020). The coronavirus crisis could take on unprecedented propor- The fi scal challenges of individual member states in the eu- tions in economic history, despite the fact that politicians rozone are negligible against the background of COVID-19, are intervening with fi nancial aid programmes and central which is a life-threatening situation. But the economic banks are increasing liquidity. challenges cannot be ignored either. A strong health care system needs fi nancial resources and therefore a strong Corona crisis management in Europe economy. However, the present panic leads to uncontrol- lable behavioural reactions such as the herd-like behaviour The coronavirus pandemic reveals once again the incom- seen in fi re sales on the stock markets as well as hoarding pleteness of the European Union. National borders were and panic purchases of groceries. This creates a typical closed without any coordination. Additionally, the pan- run-like situation, as people are afraid of going away emp- demic has exposed major country-specifi c differences in ty-handed, similar to bank runs in fi nancial crises.1 the health care systems. Health policy however, just like fi scal and tax policy, is the responsibility of each member The continuous expansion of fi nancial liquidity for the past state. Thus, the country-specifi c spending preferences 20 years is the fallout of several crises, including the ‘new are not refl ecting a lack of European solidarity, but rath- economy’ bubble, the terrorist attacks of 11 September er conscious or neglected decisions in the EU member 2001, the global fi nancial crisis of 2008-2009 and the Eu- states.

1 Interestingly, the consequences of irrational fears or panic are often It is true that the economic shock demands a European deadlier in modern societies. For example, a study by Gaissmaier and and a global response (García Herrero, 2020). The fi rst Gigerenzer (2012) shows that after the terrorist attack of 9/11, many Americans avoided airplanes and switched to cars. As a result, in the priority is rapid action via monetary policy in parallel with year following the attack, there were 1,600 more road deaths than av- fi scal expansion. Indeed, both monetary and fi scal poli- erage.

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Figure 2 differences of eurozone member states, as sovereignty European Central Bank balance sheet and country-speciﬁ c preferences remain national. For in- in billion euro stance, the German Federal Constitutional Court (BVerfG, 1993) has repeatedly emphasised that the core principle of the eurozone is the ‘stability community’ (BVerfG, 3,000 1993). To that extent, eurobonds raise the constitutional 2,500 question of intensiﬁ ed budgetary control with rights of in- 2,000 tervention at the level of member states (Calliess, 2016). 1,500 However, the budgetary law is one of the identity-deter-

1,000 mining tasks of member states as defi ned by the German Basic Law in the Lisbon judgment. Fiscal sovereignty is 500 particularly relevant to democracy, and it is assigned to 0 the environment of the eternity clause of Article 79(3) of 2014 2015 2016 2017 2018 2019 2020 the Basic Law (BVerfG, 2020). Thus, the President of the German Constitutional Court already signalled some time Source: Author’s own illustration based on ECB Statistical Data Ware- house. ago that the idea of eurobonds touches on sensitive areas of the Basic Law (Voßkuhle, 2010). In other words, coronabonds may be diffi cult to implement in the eurozone due ropean sovereign debt crisis. Globally and in the euro- to both national and European legal constraints. zone, central banks have expanded their balance sheets on an unprecedented scale (Figure 2). Although the meas- Thirdly, the historical lessons of failed monetary unions are ures might be right at the moment, their long-term social being ignored due to the acute pandemic in Europe. The and economic effects remain unexplored in research so breakdown of other historical supranational monetary un- far. Anecdotal evidence shows a misallocation of capi- ions, such as the Scandinavian Monetary Union, the Latin tal, overconsumption, a growing income inequality, lower Monetary Union and the Austria-Hungarian Monetary Un- happiness and higher stress levels in Western countries ion, should be a wake-up call to all during times of high (Case and Deaton, 2017; Alvaredo, 2018). uncertainty. Indeed, all historical monetary unions have failed not because of too little but too much solidarity, as Debating coronabonds the principle of liability and control was undermined over time. In the end, a huge collapse occurred as some mem- Coronabonds are an instrument to jointly issue public ber states became more indebted and sought to exter- debt across all member states of the eurozone. Econo- nalise the cost of public debts to the others (Theurl, 1996; mists and politicians, regardless of their ideology, sup- Bordo and Jonung, 1999). In short, moral hazard is not an port this idea if the debate is academically transparent abstract risk, but a reality in a supranational monetary un- and reveals all preconditions. Yet, there is a predominant ion – even within the eurozone (Berthold et al., 2014). cacophony of proponents and opponents who in some cases politely omit or deliberately conceal the required A large body of academic literature documents moral preconditions. hazard risks in the eurozone and recommends precau- tions, whether strict fi scal rules, such as the Maastricht First, the EU or the eurozone is not a state. The Treaty Treaty, or a complete transfer of sovereignty, i.e. a politi- on the Functioning of the European Union (TFEU) clearly cal union (Beetsma and Uhlig, 1999; Beetsma and Boven- states this. There is no European fi scal sovereignty and berg, 1999, 2000, 2003; Herzog, 2018b). With a political hence no right to issue public debt. Moreover, there is union in place, the instrument of joint public borrowing no fi scal budget and no euro fi nance minister with cut- via eurobonds would be fully endorsed. On the contrary, through clauses at member state levels. Fiscal policy as the medium-term damage of an institutional mixture – as well as social, labour and health policies are the respon- history demonstrates – could act as a catalyst for the sibility solely of member states. This explains the coun- break-up of the eurozone. Hence, how realistic is a politi- try-specifi c differences in the tax burden, retirement age cal union? Where is the European roadmap for a political and level, number of hospital beds or the level of general union from France, Italy and Spain? How quickly can it be public services. These differences are refl ecting country- implemented – in one, fi ve, or 50 years? specifi c political preferences. In the absence of a political union and in light of historical Secondly, despite the notion of being ‘united in diver- lessons, the founding fathers of the Maastricht Treaty de- sity’, centralised instruments will not solve the structural signed the eurozone with a rules-based fi scal architecture

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(Herzog and Choi, 2017). Within this framework, there can be Politicians proposing this instrument would fi rst have to show no joint borrowing through eurobonds, as the mixed struc- whether they are willing to hand over sovereignty to Brussels ture touches on the principle of liability and control and gen- in order to establish a political union. It remains highly unlike- erates instability (Herzog, 2012; Herzog and Ferencz, 2019). ly that countries such as Italy, Spain or France would be willing to transfer all sovereignty in fi scal, tax, labour, health and The present rules-based fi scal architecture is built on the social policies to Brussels. But that is indispensable for is- pillars of the no-bailout rule in Article 125 TFEU, the pro- suing joint debt by eurobonds or a eurozone fi scal capacity. hibition of debt fi nancing by the ECB in Article 123 TFEU and the Stability and Growth Pact. The fi scal architecture The eurozone is probably decades away from this epochal was enhanced in the aftermath of the global fi nancial cri- step. Against this background, present crisis management sis. Indeed, the fi scal framework was supplemented by must make use of existing institutional mechanisms. Un- new regulations, including the European Semester and der certain circumstances, additional instruments could the Two- and Six-pack (Herzog, 2018a). These instru- be added, provided that liability and control remain in one ments guarantee liability and control. hand (Calliess, 2015). In any case, the fi scal potential of eurobonds is not more powerful than the hitherto untapped Fourthly, when considering the idea of a European fi s- combination of assistance from the European Stability cal equalisation scheme, it is important to note that such Mechanism (ESM) in conjunction with the ECB’s Outright schemes do not work well even on a small scale, i.e. on Monetary Transactions (OMT) programme. the national level (Konrad, 2014). Furthermore, a fi nancial equalisation scheme cannot be simply transferred to the In regard to crisis prevention, however, the existing fi scal European level (Herzog, 2018b). Even if eurobonds were ap- architecture needs to be made more binding as long as propriate to alleviate the fragility of the eurozone, the legal policymakers do not establish a political union. The aim and political prerequisite must be in place: a political union. is to ensure that all, not only the role models, stick to Eu- ropean fi scal rules. Accordingly, it is conceivable that rule The German Council of Economic Experts (2005) pointed enforcement needs to be strengthened by partial cut- out that the fi scal equalisation system in Germany can- through powers, especially in the event of incompliance not solve the structural heterogeneity across the Länder (Herzog, 2013; Calliess, 2018). In addition, monetary pen- or federal states. Despite fi scal equalisation and a federal alties should be reconsidered by a vote-and-reputation- budget, the differences between the Länder or between function in case of incompliance (Herzog and Hengster- US states are even greater than between the member mann, 2013). It is also possible to supplement the ESM states of the eurozone. On the other hand, all national fi s- with a debt restructuring mechanism (Herzog, 2017). cal equalisation schemes have tough cut-through powers at the state level. For example, there are intervention rights The EU and eurozone is a voluntary union of democratic in ultima ratio, including the appointment of a ‘restructur- states, structured as a ‘stability community’ according to the ing commissioner’ in federal states that do not comply philosophy of the Lisbon Treaty. Thus, each member state with the rules. This commissioner could raise taxes and must support the common rules. Eurobonds destroy the gen- reduce state debts. This would considerably restrict state eral principle of liability and control of the eurozone – even sovereignty. If such a mechanism is even necessary in a as an exceptional instrument in an unprecedented pandemic. single country, such as the US or Germany, it would be The long-term fi scal and economic damage of eurobonds equally urgent in a heterogeneous group of countries. Yet, in a rule-based fi scal architecture – as history corroborates without a political union this mechanism is a profound il- – would be greater than the historical challenge of the coro- lusion. navirus pandemic, unless there is a political union in Europe.

Roadmap to the future References As long as the premises for a closer fi scal integration are not Alvaredo, F., L. Chancel, T. Piketty, E. Saez and G. Zucman (2018), The taken into consideration, the debate about eurobonds will Elephant Curve of Global Inequality and Growth, AEA Papers and Pro- remain marked by European naivety. Solidarity is not a one- ceedings, 108, 103-108. Beetsma, R. and A. Bovenberg (1999), Does monetary unifi cation lead way street (Herzog, 2012). No economist can seriously claim to excessive debt accumulation?, Journal of Public Economics, 74(3), that the eurozone is an optimal currency area, according to 299-325. the theory (Mundell, 1961; Herzog and Hengstermann, 2013). Beetsma, R. and A. Bovenberg (2000), Designing fi scal and monetary institutions for a monetary union, Pubic Choice, 102(3-4), 247-269. Thus, no one can expect eurobonds to solve the structural Beetsma, R. and A. Bovenberg (2003), Strategic debt accumulation in a problems of the eurozone. Imposing eurobonds without the heterogeneous monetary union, European Journal of Political Econo- prerequisites would only destabilise the eurozone. my, 19(1), 1-15.

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Beetsma, R. and H. Uhlig (1999), An analysis of the stability and growth German Federal Constitutional Court – BVerfG (1993), Judgment of the pact, Economic Journal, 109(458), 546-571. Second Senate of 12 October 1993 – 2 BvR 2134 – 2159/92 (BVerfGE Bénassy-Quéré, A., M. K. Brunnermeier, H. Enderlein, E. Farhi, M. 89, 155). Fratzscher, C. Fuest, P.-O. Gourinchas, P. Martin, F. Pisani, H. Rey, N. German Federal Constitutional Court – BVerfG (2020), Judgment of the Véron, B. Weder di Mauro and J. Zettelmeyer (2018), Reconciling risk Second Senate of 5 May 2020 – 2 BvR 859/15 – 2 BvR 980/16 – 2 BvR sharing with market discipline: A constructive approach to euro area 2006/15 – 2 BvR 1651/15, paras. (1-237). reform, CEPR Policy Insight, 91. Herzog, B. (2012), Die Währungsunion ist keine Einbahnstraße, ifo Schnell- Berthold, N., S. Braun and M. Coban (2014), Das Scheitern historischer dienst, 7, 10-13. Währungsräume: Kann sich die Geschichte auch für die Eurozone Herzog, B. (2017), Abwicklungsmechanismus für Mitgliedstaaten des Eu- wiederholen?, Wirtschaftswissenschaftliche Beiträge, 127. roraums, Wirtschaftsdienst, 97(12), 881-888, https://www.wirtschafts- Blanchard, O., C. J. Erceg and J. Lindé (2017), Jump-starting the euro-ar- dienst.eu/inhalt/jahr/2017/heft/12/beitrag/abwicklungsmechanis- ea recovery: Would a rise in core fi scal spending help the periphery?, mus-fuer-mitgliedstaaten-des-euroraums.html (18 April 2020). NBER Macroeconomics Annual Conference, 31(1), 103-182. Herzog, B. (2018a), Reforming the Eurozone: Assessment of the Reform Bordo, M. D. and L. Jonung (1999), The Future of EMU: What Does the His- Package By The European Commission – Treating Symptoms or Root tory of Monetary Unions Tell Us?, NBER Working Paper Series, 7365. Causes?, Journal of Economics & Sociology, 11(3), 59-77. Brunnermaier, M., S. Langfi eld, M. Pagano, R. Reis, S. Van Nieuwerburgh Herzog, B. (2018b), A Monetary Union Without a Fiscal Union, in S. Bu- and D. Vayanos (2017), ESBies: safety in the tranches, Economic Pol- kowski (ed.), Monetary Unions: Background, Advantages and Disadvan- icy, 32(90), 175-219. tages, Vol. I, 99-118, Nova Science Press. Calliess, C. (2015), Nach der Krise ist vor der Krise: Integrationsstand und Herzog, B. and K. Hengstermann (2013), Restoring Credible Economic Reformperspektive der Europeäischen Union, Berliner Online-Beiträge Governance to the Eurozone, Journal of Economic Affairs, 33(1), 2-17. zum Europarecht, 107. Herzog, B. and M. Choi (2017), Policy Rules in the Economic and Mone- Calliess, C. (2016), Thesenpapier zur Refl exionsgruppe Zukunft Europa II: tary Union, Intereconomics, 52(1), 51-56, https://www.intereconomics. Die Zukunft der WWU. eu/contents/year/2017/number/1/article/policy-rules-in-the-econom- Calliess, C. (2018), Zur Zukunft der Europäischen Union – Überlegungen ic-and-monetary-union.html (18 April 2020). im Lichte von Rom-Deklaration und Weißbuch der Kommission, Neue Herzog, B. and M. Ferencz (2019), Disziplinierung ohne politische Diskri- Zeitschrift für Verwaltungsrecht, 1-2. minierung: Warum es Marktkräfte in der Währungsunion bedarf!, ifo Case, A. and A. Deaton (2017), Suicide, age, and wellbeing: an empirical Schnelldienst, 72(1), 20-22. investigation, NBER Working Paper Series, 21279. Konrad, K. (2014), Haushaltsdisziplin in Deutschland unter der Perspek- Gaissmaier, W. and G. Gigerenzer (2012), 9/11, Act II: A Fine-grained tive des Bremen-Syndroms, in D. Gesmann-Nuiss, R. Hartz und M. Analysis of Regional Variations in Traffi c Fatalities in the Aftermath of Dittrich (eds.), Perspektiven der Wirtschaftswissenschaften, Springer the Terrorist Attacks, Psychological Science, 23(12), 1449-1454. Gabler, 109-122. García Herrero, A. (2020), The Pandemic Requires a Coordinated Global Mundell, R. (1961), A Theory of Optimum Currency Areas, American Eco- Economic Response, Intereconomics, 55(2), 66-67, https://www.inter- nomic Review, 51(4), 657-665. economics.eu/contents/year/2020/number/2/article/the-pandemic- Theurl, T. (1996), Währungsunionen ohne politische Integration: die requires-a-coordinated-global-economic-response-6145.html (18 lateinische und die skandinavische Münzunion, in Währungsunion April 2020). und politische Integration: historische Erfahrungen und europäische German Council of Economic Experts (2005), Die Chance nutzen – Refor- Perspektiven, Bankhistorisches Archiv – Beihefte, 30, 15-34. men mutig voranbringen, Jahresgutachten, Sachverständigenrat zur Voßkuhle, A. (2010, 15 March), Waffengeklirre im Hintergrund, Inter- Begutachtung der gesamtwirtschaftlichen Entwicklung. viewed by A. Weinzierl and D. Hipp, Der Spiegel. German Council of Economic Experts (2020), The Economic Outlook in the Wollmershäuser, T. (2020), ifo Konjunkturprognose Frühjahr 2020: Kon- Coronavirus Pandemic, Special Report. junktur bricht ein, ifo Schnelldienst, 1.

Christian R. Proaño On the Macroeconomic and Social Impact of the Coronavirus Pandemic in Latin America and the Developing World

The COVID-19 pandemic will undoubtedly be a deﬁ ning Germany indicate that the current drop in economic activ- event in years to come both in economic, social and politi- ity will be rather comparable to the Great Depression of the cal terms. While the immediate impact of the coronavirus 1930s. pandemic and the related economic slump was assessed to be of a similar magnitude to that of the Great Recession The social costs triggered by the pandemic and the required of 2007-2008 by mid-March 2020, the most recent ﬁ gures social distancing measures including the enforced lock- of key variables such as the initial claims on unemployment downs in many countries will be enormous. A surge in do- insurance in the United States or the foreign new orders in mestic violence since the start of the coronavirus lockdowns

© The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License Christian R. Proaño, University of Bamberg, Ger- (https://creativecommons.org/licenses/by/4.0/). many. Open Access funding provided by ZBW – Leibniz Information Centre for Economics.

ZBW – Leibniz Information Centre for Economics 159 Forum

has already been recorded in many countries (WHO, 2020), Economic growth in Latin America and the Caribbean (LAC) and other side effects concerning the mental health of the region has stalled in recent times: the period from 2014 to population including a sharp increase in suicide rates can be 2019 saw the lowest levels of growth since the 1950s (OECD, expected, as research on past economic recessions indi- 2020, 3). With this near absence of economic dynamism re- cates (Schwandt and von Wachter, 2020). At the same time, lated to the global economic slowdown, the LAC region’s the roll-back of some civil rights under the premise of halting many structural problems such as the high economic and the spread of the virus may lead to increased authoritarian- social inequality and the lack of health and social inclusion ism in countries where democratic institutions are already worsened and became blatantly evident again. These de- weak, such as Hungary, the Philippines and Brazil. velopments were further fueled by the Venezuelan migration and refugee crisis that has led a staggering number of more While the COVID-19 pandemic posits a signifi cant challenge than four million Venezuelans to fl ee their country from 2015 to all societies around the world, it also reveals in the most until 2018 (Bahar and Douglas, 2018), resettling in neigh- dramatic manner the many abysmal differences between bouring South American countries and exerting a signifi cant so-called advanced economies and the developing world. impact on the labour markets and already fragile social safe- While most advanced economies have been able to read- ty nets of the destination countries. ily approve and implement fi scal stimuli of a signifi cant dimension – whether the German initiatives or the $2 trillion Against this background and the current and future chal- US stimulus package – and in France, Germany, Italy, Ja- lenges posited by the COVID-19 pandemic, the region’s pan and the United Kingdom public-sector liquidity support current fi scal situation is quite discouraging. While in 2008 programmes each above 10% of the respective GDPs have LAC countries were in a much better position to deal with been announced (International Monetary Fund, 2020, 2), the the negative macroeconomic impact of the Global Financial fi scal space and the general capability of developing and Crisis due to their solid fi scal positions and relatively low in- low-income countries to confront the current coronavirus debtedness level, the region’s current fi scal situation with an crisis is far more limited. average overall fi scal balance of about -3% of GDP and an average public debt of 62% of GDP in 2019 will most likely Given the extreme pace at which the COVID-19 pandemic restrain the region’s capability to confront the COVID-19 has unfolded around the world, the macroeconomic sta- pandemic. Additionally, the recent signifi cant capital out- bilisation programmes readily implemented in the devel- fl ows from LAC countries and many other emerging and oped world and in particular in the European countries had developing economies will further deteriorate the fi nancing (rightly) a clear national focus. The medium-term recovery conditions for many of these countries, widening the sover- policies must however include an important international eign and corporate spreads between the advanced and the dimension due to the fact that the COVID-19 pandemic is developing world. a global phenomenon. Given its important role not only in economic terms, but also as a beacon of institutional and The restricted and in many cases almost non-existent fi scal political stability in an otherwise much more turbulent world, space is not the only reason why we should expect the de- the European Union should lead the way in ensuring interna- veloping world to be much harder hit by the coronavirus cri- tional support for the developing world. sis. There are many structural differences that render containment and mitigation policies adopted in the developed The situation in Latin America as a predictor for the world only partially viable and enforceable in the LAC region developing world and in the developing world in general. First and foremost, the existing intensive care capacities, direly needed for the Latin America may provide insight into the different chal- patients’ medical treatment against COVID-19, in develop- lenges faced by developing countries and how the EU ing countries are dramatically behind those of advanced could best help those countries. After its announcement in economies. Mexico, for example, has about 25 times less China and the recording of the fi rst COVID-19 cases in Italy intensive care units per 100,000 inhabitants than Germany in early February, the coronavirus pandemic proceeded to (1.2 vs. about 30). Further, the health care systems in the appear in Latin America by the end of February in Brazil and LAC region and the great majority of developing countries has since spread throughout the region quite rapidly, with cover only a fraction of the population (usually those who Brazil, Ecuador and Mexico having the highest numbers of are regularly employed). Further, as highlighted by the World related deaths to date. An analysis of the current situation Health Organization (WHO), “most of the world’s health-care in the Latin American region is important not only in its own systems continue to rely on the most inequitable method for right, but it may serve as well as a predictor of what is to fi nancing health-care services: out-of-pocket payments …. come in the next few months in other parts of the develop- This deprives many families of needed care because they ing world. cannot afford it” (2008, 24). As a result, many potentially in-

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fected people may postpone looking for professional health Urging the European Union to ensure international assistance until it may be too late. In the meantime, they may support for the developing world act as disease vectors, undermining the containment policies put in place. China – and in particular, Alibaba’s Jack Ma – have recently donated millions of masks and testing kits to developing The low health status particularly of the poorest of the pop- countries. Rather than standing behind these initiatives, the ulation may also act as a catalytic factor in the COVID-19 EU should assume a leadership role at various fronts. First pandemic, increasing its impact on the already fragile health and foremost, the intensive care capacities in the develop- systems. The apocalyptic scenes that occurred in the Ec- ing world must be expanded massively. This means that the uadorian city of Guayaquil in April, where the hospitals and EU should not limit the export of vital medical equipment as crematoriums collapsed against the surge in deaths, may the European Commission did in March (Commission Imple- have been the result of a syndemic, i.e. the aggregation of menting Regulation, 2020). Instead, it should promote the ex- multiple epidemics at the same time or consecutively on a pansion of production capacities to cover not only the needs population (BBC, 2020). It is not unlikely that such a syn- of EU countries, but the needs of the rest of the world as well. demic may occur in other parts of the world, as dengue, yel- The Coronavirus Global Response pledging marathon initi- low and Lassa fevers, among others, have been recorded in ated by the EU and its partners on 4 May to collect funds for various parts of the world since the beginning of 2020 (Cent- the development and deployment of diagnostics, treatments ers for Disease Control and Prevention, 2020). and a vaccine is an important initiative in these efforts.

Second, the more widespread urbanisation in developing On the economic side, the short-run stabilisation of aggre- countries, with megacities of a high population density and gate demand is imperative. The World Bank and the Interna- poor sanitation and health services available (Henderson, tional Monetary Fund have recognised the need to expand 2002), may also make social distancing measures less ef- the fi scal space for developing countries, activating credit fective if not factually futile. The dramatic scenes observed lines and asking G20 leaders to allow the poorest countries in the Ecuadorian port city of Guayaquil may thus be repeat- to suspend all repayments of offi cial bilateral loans due to ed in megacities like New Delhi or Lagos. the COVID-19 crisis. Given the historically poor record of the LAC region with regards to effi cient fi scal policy (Espino Third, in contrast to advanced economies such as the ones and González Rozada, 2012; Ardanaz and Izquierdo, 2017), in the euro area or in Scandinavia, where relatively gener- fi nancial support from the EU and multilateral institutions ous unemployment benefi ts are effective mechanisms of should clearly defi ne the permissible use of those funds and aggregate demand stabilisation, unemployment insurance monitor their implementation closely. systems exist only in a few countries in the LAC region. Ad- ditionally, a large fraction of the economically active popula- Obviously, proven macroeconomic stabilisation measures tion in LAC countries works in the informal sector and has such as Germany’s much acclaimed short-term working thus no safety net whatsoever. As many of these people live benefi ts (Kurzarbeit) are not practicable in most LAC econo- near or even below the subsistence level, they are likely to mies and the great majority of developing countries. Alter- circumvent or blatantly ignore the containment policies on native schemes of social distancing based on cheap and a day-to-day basis. As Ricardo Hausmann, Director of Har- recurrent massive testing may be a feasible strategy with the vard’s Growth Lab and former Minister of Finance of Vene- support of the EU. zuela put it: “If people must choose between a 10% chance of dying if they go to work and assured starvation if they stay However, the medium-run recovery of the developing world at home, they are bound to choose work” (2020). Such a be- will be mostly shaped by their capability to compete and haviour, though understandable and even rational from an prevail in the post-COVID-19 world. This will be determined individual economic point of view, will be a great obstacle for by two main factors: access to new and sustainable tech- the effective containment of the epidemic in many countries. nology through long-term foreign direct investment and more favourable trade conditions in international markets. The medium-term consequences of the containment and lockdown measures are not to be forgotten. The low and This is not only in the interest of the developing world; it is quite unevenly distributed internet access in the region may also in the interest of Europe, the US and the rest of the ad- lead to long-lasting and pervasive effects of the school clo- vanced economies. Macroeconomic stability is a major de- sures and the lockdown measures in general and widen the terminant of political stability, and increasing economic and already dramatic economic and social inequality in the re- social inequality leads to more political polarisation (Proaño gion. Lockdowns have much higher economic and social et al., 2019). Time is quickly running out, and not only for costs in poorer societies. Latin America.

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org/commentary/fl attening-covid19-curve-in-developing-countries- References by-ricardo-hausmann-2020-03 (5 May 2020). Henderson, V. (2002), Urbanization in Developing Countries, The World Ardanaz, M. and A. Izquierdo (2017), Current Expenditure Upswings in Bank Research Observer, 17(1), 89-112. Good Times and Capital Expenditure Downswings in Bad Times?: International Monetary Fund (2020), Fiscal Monitor, April 2020. New Evidence from Developing Countries, IDB Working Paper, 838. Izquierdo, A. and M. Ardanaz (2020, 31 March), Fiscal Policy in the Time of Bahar, D. and D. Barrios (2018, 10 December), How many more migrants Coronavirus: Constraints and Policy Options for Latin American and and refugees can we expect out of Venezuela?, Up Front, Brookings. Caribbean Countries, IDB Ideas Matter, https://blogs.iadb.org/ideas- BBC (2020, 28 April), Coronavirus, dengue y sarampión: La peligrosa matter/en/fi scal-policy-in-the-time-of-coronavirus-constraints-and- combinación en América Latina de 3 epidemias cuyos síntomas policy-options-for-latin-american-and-caribbean-countries/ (29 April pueden confundirse, BBC News Mundo, https://www.bbc.com/mun- 2020). do/noticias-america-latina-52383340 (5 May 2020). OECD (2020, 31 March), COVID-19 in Latin America and the Carib- Centers for Disease Control and Prevention (2020), Current Outbreak bean: Regional socio-economic implications and policy priorities, List, https://www.cdc.gov/outbreaks/index.html (5 May 2020). OECD Development matters, https://oecd-development-matters. Commission Implementing Regulation (EU) 2020/402 of 14 March 2020 org/2020/03/31/latin-america-and-the-caribbean-in-the-time-of- making the exportation of certain products subject to the production covid-19-preventing-the-vulnerable-from-falling-behind/ (7 May of an export authorisation (2020), Offi cial Journal of the European Un- 2020). ion, L77I,1-7. Proaño, C. R., J. C. Peña and T. Saalfeld (2019), Inequality, Macroeco- Espino, E. and M. González Rozada (2012), Automatic Stabilization and nomic Performance and Political Polarization: A Panel Analysis of 20 Fiscal Policy: Some Quantitative Implications for Latin America and Advanced Democracies, BERG Working Paper, 149. the Caribbean, IDB Working Paper, 367. Schwandt, H. and T. von Wachter (2020), Socioeconomic Decline and Gourinchas, P.-O. (2020), Flattening the pandemic and recession curves, Death: Midlife Impacts of Graduating in a Recession, NBER Working in R. Baldwin and B. Werder Di Mauro (eds.), Mitigating the COVID Eco- Paper, 26638. nomic Crisis: Act Fast and Do Whatever it Takes, CEPR Press. WHO (2020), COVID-19 and violence against women, What the health Hausmann, R. (2020, 24 March), Flattening the COVID 19 Curve in De- sector/system can do, https://www.who.int/reproductivehealth/pub- veloping Countries, Project Syndicate, https://www.project-syndicate. lications/vaw-covid-19/en/ (29 April 2020).

Andreas Backhaus Common Pitfalls in the Interpretation of COVID-19 Data and Statistics

Policymakers, experts and the general public heavily rely common among these pitfalls given that they have the po- on the data that are being reported in the context of the tential to intentionally or unintentionally mislead the public coronavirus pandemic. Daily data releases on confi rmed debate and thereby the course of future policy actions. COVID-19 cases and deaths provide information on the course of the pandemic. The same data are also essen- The list of pitfalls presented is non-exhaustive. In fact, tial for the estimation of indicators such as the reproduc- as the supply of data has increased since the beginning tion rate and for the evaluation of policy interventions that of the pandemic, new pitfalls have emerged in parallel, seek to slow down the pandemic. while others have decreased in relevance; a tendency that seems likely to continue into the future. Beyond explain- Together with the proliferation of data, however, a num- ing some of the current pitfalls, this paper will serve as a ber of pitfalls have arisen with regard to the interpreta- more general caveat regarding the interpretation of data tion of the data and the conclusions that can be drawn in the context of the SARS-CoV-2 pandemic. from them. The aim of this paper is to highlight the most A primer on case fatality rates, infection fatality rates and mortality rates © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). In the public debate, one can encounter at least three con- Open Access funding provided by ZBW – Leibniz Information Centre cepts that measure the deadliness of SARS-CoV-2: the for Economics. case fatality rate (CFR), the infection fatality rate (IFR) and the mortality rate (MR). Unfortunately, these three concepts are sometimes used interchangeably, which creates confusion as they differ from each other by defi nition. Andreas Backhaus, Federal Institute for Population Research, Wiesbaden, Germany. In its simplest form, the case fatality rate divides the total number of confi rmed deaths by COVID-19 by the to-

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tal number of confi rmed cases of infections with SARS- hence be lower than the IFR (and the CFR). However, the CoV-2, neglecting adjustments for future deaths among computation of the MR is not particularly informative when current cases here. However, the number of confi rmed the pandemic has only been going on for a few months. cases is believed to severely underestimate the true num- For example, the global COVID-19 death count has in- ber of infections. This is due to the asymptomatic process creased more than fi vefold between 1 April and 1 May in of the infection in many individuals and the lack of testing 2020 (Our World in Data, 2020), rendering any MR com- capacities. Hence, the CFR presumably refl ects rather an puted around 1 April essentially meaningless. Thus, the upper bound to the true lethality of SARS-CoV-2, as its MR is more appropriately used as a retrospective measure denominator does not take the undetected infections into of the damage done in terms of lives lost after a pandemic account. has run its course.

The infection fatality rate seeks to represent the lethality Comparability of case fatality rates between more accurately by incorporating the number of undetect- countries ed infections or at least an estimate thereof into its calculation. Consequently, the IFR divides the total number In contrast to the IFR, case fatality rates have been avail- of confi rmed deaths by COVID-19 by the total number of able for many countries relatively early on during the pan- infections with SARS-CoV-2. Due to its larger denomina- demic due to their simplicity. Recall that the computation tor but identical numerator, the IFR is lower than the CFR. of the CFR only requires the total number of confi rmed The IFR represents a crucial parameter in epidemiological deaths by COVID-19 and the total number of confi rmed simulation models, such as that presented by Ferguson et cases of infections with SARS-CoV-2. As a consequence, al. (2020), as it determines the number of expected fatali- CFRs have frequently been compared between countries. ties given the simulated spread of the disease among the For example, the CFR of Italy has at virtually every point population. during the coronavirus pandemic exceeded the CFR of South Korea. A naive interpretation of this persistent dif- The methodological challenge regarding the IFR is, of ference could be that the virus has somehow been dead- course, to fi nd a credible estimate of the undetected cas- lier in Italy than in South Korea for unknown reasons. Such es of infection. An early estimate of the IFR was provided an interpretation overlooks that it must be assured fi rst on the basis of data collected in the course of the SARS- that the CFRs of different countries are comparable. A CoV-2 outbreak on the Diamond Princess cruise ship in comparability between CFRs is given only if the confi rmed February 2020. Mizumoto et al. (2020) estimate that 17.9% cases that enter the calculation of the CFRs are suffi cient- (95% confi dence interval: 15.5-20.2) of the cases were ly similar in terms of characteristics that are associated asymptomatic. Russell et al. (2020), after adjusting for with fatalities. age, estimate that the IFR among the Diamond Princess cases is 1.3% (95% confi dence interval: 0.38-3.6) when Age is among the most important of such characteristics considering all cases, but 6.4% (95% confi dence interval: given the overwhelming evidence that the likelihood of 2.6–13) when considering only cases of patients that are survival is substantially lower for patients at higher ages 70 years and older. The serological studies that are cur- (Docherty et al., 2020; Dowd et al., 2020). Italy and South rently being conducted in several countries and localities Korea are among those countries that have published serve to provide more estimates of the true number of demographic characteristics of their confi rmed cases infections with SARS-CoV-2 that have occurred over the comparatively early and consistently over the course of past few months.1 the pandemic. Figure 1 compares the confi rmed cases by age group in Italy and South Korea. On 19 March 2020, Finally, the (crude) mortality rate (or death rate) of SARS- South Korea exhibited a CFR of 1.1%, while Italy’s CFR CoV-2 is computed by dividing the total number of con- stood at 8.6%. Using data from both countries and from fi rmed deaths by COVID-19 that have occurred in a given the same date, a simple depiction of the distribution of location during a certain period of time by the total popu- the confi rmed cases across ten-year-age groups reveals lation present in the same location during the same time that the CFRs of the two countries are not comparable: period. Therefore, the MR can in principle be computed by the cases in Italy are concentrated in the high-age and dividing a country’s COVID-19 death count by its current hence high-risk groups, as 38% of all confi rmed Italian population. Given that the coronavirus has never infected cases are at least 70 years old. By contrast, the confi rmed a country’s or location’s entire population, the MR will cases in South Korea are distributed more evenly across age groups except for a spike in the young age group (20-

1 For a non-exhaustive overview of the serological studies and the as- 29). Only 10% of the Korean cases are at least 70 years sociated complications, see e.g. Joseph and Branswell (2020). old. Consequently, the conﬁ rmed cases that enter the

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Figure 1 pandemic. This has led to concerns that countries might Share of conﬁ rmed cases of infections with SARS- either be undercounting or overcounting the deaths by CoV-2 by age group in South Korea and Italy COVID-19.

% 30 One way to address these concerns is to look for excess mortality in a given country that is known to have 25 experienced a major outbreak of SARS-CoV-2. Excess 20 mortality can be detected by ﬁ rst collecting data on the 15 total deaths, i.e. the deaths from all causes that are be-

10 ing reported for a given country for 2020, and for previous years. The data from previous years is used to com- 5 pute the average number of deaths that have occurred 0 in a given country, say Italy, during a given time period, 0-9 10-19 20-29 30-39 40-49 50-59 60-69 70-79 80+ say the month of March. This average is then subtracted Confirmed cases South Korea Confirmed cases Italy from the death count in Italy in March 2020. If COVID-19 Note: Total confi rmed cases on 19 March 2020. led to a signifi cant increase in the death count, the dif- Source: Own depiction based on data from Korea Centers for Disease ference between the death count in March 2020 and the Control and Prevention and Istituto Superiore di Sanità. average death count of previous years should be positive and somewhat large; it would hence indicate excess mortality due to COVID-19. This difference can then further be compared to the offi cial COVID-19 death count calculation of the Italian CFR are likely to lead to death from March 2020. If the difference was larger than the much more often than in South Korea, resulting in a high- COVID-19 death count, it would suggest an undercount- er death count and hence a higher CFR for Italy than for ing of COVID-19 deaths, as the reported COVID-19 death South Korea.2 Dudel et al. (2020) show that changes in the count cannot fully account for the observed excess mor- age structure of the confi rmed cases over time explain a tality. signifi cant share of the changes in CFRs. The National Statistical Agency of Italy (Istat, 2020) has A likely cause for these strikingly different age patterns performed these calculations. They fi nd that until 31 of the confi rmed cases are different testing policies and March 2020, deaths in Italy increased by 39% or 25,354 differences in the timing of testing. South Korea start- compared to the average of the fi ve previous years. ed mass testing relatively early on in the pandemic and However, only 13,710 deaths have been recorded as many of the early Korean cases could be linked to the COVID-19-related over the same period, which explains ‘Shincheonji Church of Jesus’ in Daegu. In Italy, mass only 54% of the observed excess mortality. Hence, if an- testing might have started too late to prevent infections ything, deaths from COVID-19 may have been severely from spreading to large parts of the older population at undercounted in Italy despite Italy’s already high report- risk. Bayer and Kuhn (2020) further suggest that particu- ed death toll. larly strong intergenerational ties in Italy could have facilitated the spread from asymptomatic young carriers to the Reporting lags older population. Reporting lags of the data represent another common pit- COVID-19 death counts and excess mortality fall when studying the latest developments of the coronavirus situation. Reporting lags occur, for example, when In general, countries use different systems and classi- decentralised offi ces and institutions do not meet their fi cations for recording deaths by COVID-19. These dif- deadlines for reporting their data to a national agency that ferences may refer, for example, to whether a deceased then processes and publishes the collected data. Rea- patient with a severe comorbidity and a confi rmed sons for such non-compliance can be the high workload SARS-CoV-2 infection is recorded as having died from of local offi ces during an epidemic or local bottlenecks in COVID-19 or from the comorbidity. Further, countries testing capacities. have changed their standards regarding when a death is counted as a death by COVID-19 over the course of the Reporting lags become visible only when updates and revisions to the data are published. Statistics Sweden

2 For an early investigation into the demographics of the case fatality (2020), the Swedish government agency responsible for rates, see Backhaus (2020). producing ofﬁ cial statistics, has been very transparent

Intereconomics 2020 | 3 164 Forum

Figure 2 plies to most data being utilised in the social sciences. Total reported deaths per day in Sweden in March A consequence of using selected samples is that the in- and April 2020 sights obtained by means of statistical analysis cannot be trusted to generalise to the overall population. 450 400 For example, studies that focus on COVID-19 patients 350 admitted to hospitals or even intensive care perform their 300 analyses on a selected sample, as this subsample of indi- 250 viduals infected with SARS-CoV-2 requiring hospitalisa- 200 tion can be justiﬁ ably presumed to differ from the overall 150 population (Williamson et al., 2020). 100 Number of reported deaths 50 The issue of generalisability is even more relevant regard- 0 ing the various serological samples that are being col-

2 April6 April lected and analysed, as they are intended to inform on 1 March5 March9 March 10 April14 April18 April22 April26 April30 April 13 March17 March21 March25 March29 March the true spread of SARS-CoV-2 among the population. 3 April 6 April 14 April 20 April 27 April 4 May Recruitment into these samples often raises concerns about selection: on the one hand, voluntary participation Source: Statistics Sweden (2020), Preliminary statistics on deaths (updated 2020-04-30), Table 8. might attract individuals that suspect they may have experienced an infection with SARS-CoV-2 with mild symptoms. On the other hand, analysing samples that were not regarding the expected reporting lags and the necessary originally collected for the purpose of testing for antibod- revisions to the reported data on daily deaths in Sweden: ies to SARS-CoV-2, such as blood donor samples (Erik- strup et al., 2020), does not resolve all concerns about Statistics on deaths in 2020 refer to data submitted selection but rather shifts them to a different group, in by the Swedish Tax Agency to Statistics Sweden (…) this case blood donors. The over- or underrepresentation These statistics are updated as new data is made avail- of certain risk groups together with the statistical uncer- able, as there is a lag in reporting, in particular for the tainty of the rather small serological samples may result in days closest to publication. Statistics from two weeks severe misjudgements about the true prevalence of anti- ago are not expected to change substantially. bodies in the population.

Statistics Sweden further provides a vivid depiction of Importantly, sample selection bias is not related to sam- the effects of the various data revisions on the total re- ple size. Hence, increasing the sample size by simply col- ported death count per day in Sweden during the months lecting more data will not eliminate the selection problem of March and April (see Figure 2): several days before its if the underlying mechanism that governs the selection respective release date, each data series drops abruptly into the sample is not addressed. and indicates an unreasonably low death count. Every subsequent data release then substantially revises the Endogeneity of policy interventions death count upwards, with additional but less signiﬁ cant revisions in even later releases. For example, the data re- It would certainly be worthwhile to evaluate the effective- lease from 6 April reports a total daily death count of 157 ness of the various lockdown strategies implemented by for 1 April. However, the data release from the following governments across the globe in response to the coro- week revises this initial death count for 1 April upwards by navirus pandemic. For that purpose, it might be tempting almost 100% to 308. The subsequent releases settle the to rank countries according to the stringency of their re- total death count at 324. Hence, it is important to keep in spective lockdown strategies and then to simply compare mind that very recent data are often incomplete and sub- this ranking to a country ranking of the COVID-19 death ject to substantial revisions. They are therefore not ade- toll, which would represent the outcome variable that the quate for immediate use in policy evaluation. lockdowns were supposed to affect.

Sample selection bias However, such a comparison and equally every regression analysis following the same intuition would suffer Most often, the data collected and analysed in the con- from an endogeneity problem. This econometric term is text of the coronavirus pandemic do not represent ran- best understood by asking the question: Why have some dom samples of the underlying population. The same ap- countries with a high COVID-19 death toll, such as Italy

ZBW – Leibniz Information Centre for Economics 165 Forum

and Spain, chosen a stringent lockdown strategy in the fi rst place? A rather undisputed explanation would be References that the situation in these two countries had already been Backhaus, A. (2020, 13 March), Coronavirus: Why it’s so deadly in Italy, more severe and that the spread of the virus had pro- Medium, https://medium.com/@andreasbackhausab/coronavirus- gressed more than in other countries when a lockdown why-its-so-deadly-in-italy-c4200a15a7bf (15 May 2020). Bayer, C. and M. Kuhn (2020), Intergenerational ties and case fatality was fi rst considered. Hence, Spain and Italy had already rates: A cross-country analysis, IZA Discussion Paper Series, 13114. been heading toward a high COVID-19 death toll when the Docherty, A. B., E. M. Harrison, C. A. Green, H. Hardwick, R. Pius, L. Nor- lockdowns were implemented. man, K. A. Holden, J. M. Read, F. Dondelinger, G. Carson, L. Merson, J. Lee, D. Plotkin, L. Sigfrid, S. Halpin, C. Jackson, C. Gamble, P. W. Horby, J. S. Nguyen-Van-Tam, J. Dunning, P. J. Openshaw, J. K. Bail- This implies that the allocation of lockdown strategies lie and M. G. Semple (2020), Features of 16,749 hospitalised UK pa- across countries was not random but driven by early tients with COVID-19 using the ISARIC WHO Clinical Characterisation Protocol, medRxiv, 2020.04.23.20076042. characteristics of the pandemic in the respective coun- Dowd, J. B., L. Andriano, D. M. Brazel, V. Rotondi, P. Block, X. Ding, Y. Liu tries. These early characteristics would simultaneously and M. C. Mills (2020), Demographic science aids in understanding determine the stringency of the lockdown and the future the spread and fatality rates of COVID-19, Proceedings of the National Academy of Sciences, 117(18), 9696-9698. death toll. This would result in an underestimation of the Dudel, C., T. Riffe, E. Acosta, A. van Raalte, C. Strozza and M. Myrskylä lockdown effectiveness, as stringent lockdowns were (2020), Monitoring trends and differences in COVID-19 case-fatality more likely to be implemented where the situation had rates using decomposition methods: Contributions of age structure and age-specifi c fatality, medRxiv, 2020.03.31.20048397. already been critical, with dire prospects for the follow- Erikstrup, C., C. E. Hother, O. B. Vestager Pedersen, K. Mølbak, R. L. ing weeks. Skov, D. K. Holm, S. Sækmose, A. C. Nilsson, P. T. Brooks, J. K. Bold- sen, C. Mikkelsen, M. Gybel-Brask, E. Sørensen, K. M. Dinh, S. Mik- kelsen, B. K. Møller, T. Haunstrup, L. Harritshøj, B. Aagaard Jensen, Hence, in the absence of randomly allocated treatment H. Hjalgrim, S. T. Lillevang and H. Ullum (2020), Estimation of SARS- and control groups or countries, as in the case of the cor- CoV-2 infection fatality rate by real-time antibody screening of blood onavirus pandemic, simple comparisons of policy out- donors, medRxiv, 2020.04.24.20075291. Ferguson, N., D. Laydon, G. Nedjati Gilani, N. Imai, K. Ainslie, M. Bague- comes between groups are potentially highly misleading lin, S. Bhatia, A. Boonyasiri, Z. Cucunuba Perez, G. Cuomo-Dannen- because other variables might have infl uenced both the burg, A. Dighe, I. Dorigatti, H. Fu, K. Gaythorpe, W. Green, A. Hamlet, adoption of the various policies and the outcomes. W. Hinsley, L. Okell, S. Van Elsland, H. Thompson, R. Verity, E. Volz, H. Wang, Y. Wang, P. Walker, C. Walters, P. Winskill, C. Whittaker, C. Donnelly, S. Riley and A. Ghani (2020), Report 9: Impact of non- pharmaceutical interventions (NPIs) to reduce COVID-19 mortality and Conclusion healthcare demand, Imperial College, London. Istat (2020), Impact of the COVID-19 epidemic on the total mortality of the resident population in the fi rst quarter of 2020, https://www.istat.it/it/ From each of the presented pitfalls, a specifi c lesson can fi les//2020/05/Istat-ISS_-eng.pdf (15 May 2020). be derived regarding how to handle data in the coronavi- Joseph, A. and H. Branswell (2020, 24 April), The results of coronavirus ‘serosurveys’ are starting to be released. Here’s how to kick their rus pandemic and what to look out for in the interpreta- tires, STAT, https://www.statnews.com/2020/04/24/the-results-of- tion of COVID-19-related statistics. coronavirus-serosurveys-are-starting-to-be-released-heres-how-to- kick-their-tires/ (15 May 2020). Mizumoto, K., K. Kagaya, A. Zarebski and G. Chowell (2020), Estimating First, when utilising different concepts of rates and the asymptomatic proportion of coronavirus disease 2019 (COVID-19) measurements, for example regarding the lethality, these cases on board the Diamond Princess cruise ship, Yokohama, Japan, concepts must be understood, properly defi ned and 2020, Eurosurveillance, 25(10). Our World in Data (2020), Total confi rmed COVID-19 deaths, https://our- appropriately distinguished. Second, when performing worldindata.org/grapher/total-deaths-covid-19 (15 May 2020). comparisons even of the same measure or rate across Russell, T. W., J. Hellewell, C. I. Jarvis, K. van Zandvoort, S. Abbott, R. countries or contexts, one must assure that the underly- Ratnayake, CMMID COVID-19 working group, S. Flasche, R. M. Eggo, W. J. Edmunds and A. J. Kucharski (2020), Estimating the infection ing data are suffi ciently comparable. Third, if there are and case fatality ratio for coronavirus disease (COVID-19) using age- doubts about the accuracy of the data collected in the adjusted data from the outbreak on the Diamond Princess cruise ship, specifi c coronavirus context, other, independently col- February 2020, Eurosurveillance, 25(12). Statistics Sweden (2020), Preliminary statistics on deaths (updated 2020- lected data can serve as a tool for validation. Fourth, 04-30), https://www.scb.se/en/fi nding-statistics/statistics-by-sub- caution must be applied when interpreting data releases ject-area/population/population-composition/population-statistics/ as fi nal or even real-time information because they are pong/tables-and-graphs/preliminary-statistics-on-deaths/ (10 May 2020). frequently revised. Fifth, any interpretation of data and Williamson, E., A. J. Walker, K. J. Bhaskaran, S. Bacon, C. Bates, C. E. statistics must take into consideration whether selection Morton, H. J. Curtis, A. Mehrkar, D. Evans, P. Inglesby, J. Cockburn, H. bias might have affected the collection of the underlying I. Mcdonald, B. MacKenna, L. Tomlinson, I. J. Douglas, C. T. Rentsch, R. Mathur, A. Wong, R. Grieve, D. Harrison, H. Forbes, A. Schultze, R. sample. Sixth, when comparing policy outcomes be- T. Croker, J. Parry, F. Hester, S. Harper, R. Perera, S. Evans, L. Smeeth tween groups one must be aware of underlying factors and B. Goldacre (2020), OpenSAFELY: factors associated with COV- that may have determined both the policy choices and ID-19-related hospital death in the linked electronic health records of 17 million adult NHS patients, medRxiv, 2020.05.06.20092999. the outcomes.

Intereconomics 2020 | 3 166 DOI: 10.1007/s10272-020-0895-z Coronavirus Crisis

Philipp Heimberger Potential Output, EU Fiscal Surveillance and the COVID-19 Shock

This paper discusses how the technical foundations of the EU’s fi scal rules constrain the fi scal space in EU countries in the context of the COVID-19 pandemic. We review the evidence on how estimates of potential output, which are at the heart of essential control indicators in EU fi scal surveillance, were revised in the ten years running up to the COVID-19 pandemic, and how these revisions affected the fi scal stance of EU countries. We provide fi rst evidence for downward revisions in the European Commission’s potential output estimates against the background of the COVID-19 shock across the EU27 countries, and we assess the potential consequences in terms of fi scal space. According to our results, one additional percentage point in predicted losses of actual output is associated with a loss in potential output of about 0.6 percentage points. Given the importance of model-based estimates in the EU’s fi scal rules, avoiding pro-cyclical fi scal tightening will require that policymakers’ hands are not tied by overly pessimistic views on the development of potential output.

The economic repercussions of the COVID-19 pandemic technical backbone of EU fi scal surveillance (e.g. Costantini, across Europe are severe. The immediate response of na- 2017; Heimberger et al., 2019). The European Commission tional EU governments has been to put forward discretion- uses the PO model for estimating the ‘output gap’, i.e. the ary fi scal measures to mitigate the macroeconomic shock. difference between actual output (GDP) and a model-based Based on a recommendation by the European Commission ‘potential output’. The output gap is interpreted as an indica- (2020a), the European Council activated the general escape tor for the cyclical position of an economy: a negative output clause in the Stability and Growth Pact. While this step tem- gap signals underutilisation of resources, a positive output porarily provides fi scal space for individual governments to gap indicates ‘overheating’. Output gap estimates provide run larger fi scal defi cits, there remains the question about strong guidance for the Commission’s judgments on how the coordination of fi scal policies in Europe once there is a much of the actual fi scal defi cit in a respective EU country is decision to end the suspension of the fi scal rules. ‘structural’ in the sense that it is neither attributable to the effects of business cycle swings on government spending and This paper provides a fi rst analysis on how the technical tax revenues nor to budgetary one-off effects (Mourre et al., foundations of the EU’s fi scal rules contribute to shaping 2014; Buti et al., 2019). the fi scal space of individual EU countries in the aftermath of the COVID19-shock. In this context, the European Com- The Commission’s model-based estimates are used for eval- mission’s potential output (PO) model serves as the core uating and supervising member states’ fi scal performance and underlie the Commission’s recommendations related to medium-term budgetary objectives in the Stability and © The Author(s) 2020. Open Access: This article is distributed under the Growth Pact and in the Fiscal Compact (European Commis- terms of the Creative Commons Attribution 4.0 International License sion, 2019). Previous research on European fi scal policy in (https://creativecommons.org/licenses/by/4.0/). the aftermath of the global fi nancial crisis has shown that this Open Access funding provided by ZBW – Leibniz Information Centre setup implies that model-based estimates of the ‘structural’ for Economics. defi cit feed directly into fi scal policy: when the estimate of the structural defi cit is high(er), the fi scal space in individual member states is (more) constrained, as the countries concerned are obliged to adapt to tighter fi scal constraints (Klär, Philipp Heimberger, Vienna Institute for Interna- 2013; Tereanu et al., 2014; Truger, 2015; Heimberger and tional Economic Studies; and Johannes Kepler Uni- Kapeller, 2017; Fatas, 2019). In what follows, we review the versity Linz, Austria. role of model-based estimates in the EU’s fi scal regulatory framework. Based on a review of how the technical founda-

ZBW – Leibniz Information Centre for Economics 167 Coronavirus Crisis

tions of the existing regulatory framework have affected fi s- Figure 1 cal policy coordination across the EU countries in the ten Structural fi scal balances based on output gap years running up to the COVID-19 pandemic, we provide a estimates fi rst analysis on how revisions in the Commission’s estimates of potential output and ‘structural’ balances in the context of cyclically adjusted balance the COVID-19 shock will contribute to shaping fi scal space SBt = FBt - ׫t OGt - OEt budgetary one-off effects in individual EU member countries once the fi scal rules are structural fiscal fiscal balance balance output gap again activated. budgetary (estimate based on PO-model) elasticity

Model-based estimates in the EU’s ﬁ scal rules Source: Heimberger and Kapeller (2017).

Potential output, defi ned as the level of output in an economy at which all production factors are employed at ‘non-infl a- To empirically illustrate the extent of downward revisions in tionary levels’, is a theoretical concept with no observable potential output, we use the methodology developed in Ball empirical counterpart. The European Commission uses a (2014) and extrapolate the developments in potential output Cobb-Douglas production function to provide estimates for estimates before the fi nancial crisis in 2007 (PO**) to com- potential output (Havik et al., 2014). This PO model is the prepare these pre-crisis trends with potential output estimates ferred operational surveillance tool when it comes to evaluat- in Autumn 2019 (PO*), i.e. the most recent estimates before ing fi scal policies in EU countries. It supplies estimates of po- the start of the COVID-19 pandemic.1 From the y-axis values tential output, which translate into estimates of the structural in Figure 2, it can be seen that losses in potential output in

ﬁ scal balance (SBt ) by using the relative difference between the year 2019 – which are calculated relative to extrapolated actual output and potential output – the so-called output gap pre-crisis trends – vary markedly across European countries,

(OGt), as shown in Figure 1. ranging from 47.6% in Greece and 30.0% in Spain to much smaller losses in countries such as Germany (0.4%). The x- The institutional relevance of these model-based esti- axis values depict losses in actual output. It can be seen that mates is rooted in the EU’s fi scal regulatory framework: the losses in actual output and potential output are almost the Stability and Growth Pact defi nes EU countries’ me- perfectly correlated, suggesting that the countries most af- dium-term budgetary objectives (MTOs) in terms of the fected by the crisis suffered the largest downward revisions structural fi scal balance. In case of a deviation from the in potential output – and vice versa. MTO, a country has to reduce ‘excessive structural defi - cits’ by correcting the structural balance by 0.5% of GDP How do potential output estimates translate into ‘struc- per year (e.g. European Commission, 2019). The expendi- tural’ defi cits? The example of Italy ture rule implies that growth in public expenditures must not exceed growth in potential output. Furthermore, the Via the institutionalisation of structural balances in the EU’s Fiscal Compact refers to estimates of the structural defi cit fi scal regulation framework, downward revisions in potential by stipulating that the structural defi cit must not exceed output increased fi scal consolidation pressures especially in 0.5% of GDP per year – a rule which signatory states had the countries with the largest downward revisions. Negative to codify into national law, preferably as a constitutional output gaps would have been much larger than the Com- safeguard (Treaty on Stability, Coordination and Govern- mission’s offi cial numbers suggested if the underlying views ance, 2012). As a consequence, larger estimates of ‘struc- on potential output had been less pessimistic. As a conse- tural’ defi cits amplify the pressure to implement fi scal con- quence, several EU countries would have reached their me- solidation measures. dium-term budgetary targets much earlier, which would have provided them with additional fi scal space considering the Downward revisions in potential output in the aftermath EU’s fi scal rules. of the global fi nancial crisis

Existing research provides in-depth analysis of revisions in potential output estimates in the aftermath of the global fi - 1 The Commission’s forecast from December 2007 provides time series nancial crisis (Klär, 2013; Ball, 2014; Tereanu et al., 2014; data for potential output for all EU countries through 2009 (we exclude fi ve countries for which the 2007 data could not be compared to the Palumbo, 2015; Truger, 2015; Heimberger and Kapeller, Autumn 2019 data). We take these pre-crisis data, denote them by 2017; Fatas, 2019). All these studies fi nd evidence for sys- PO**, and extend all time-series beyond 2009 by means of log-linear tematic downward revisions in potential output across the extrapolation. Specifi cally, we compute the average annual change in the logarithm of PO** during 2000-2009, and then assume that po- EU’s member countries over the ten years leading up to the tential output has increased at a constant rate from 2010 to 2019 (see COVID-19 pandemic. Ball, 2014, 150).

Intereconomics 2020 | 3 168 Coronavirus Crisis

Figure 2 Downward revisions in potential output in pre-COVID-19 times Correlation of actual and potential output losses, 2019

50 y = 0.97x + 1.29 *UHHFH 7çYDOXH +$&çUREXVW 40 5BVT 6SDLQ 6ORYHQLD /X[HPERXUJ )LQODQG +XQJDU\ %XOJDULD 20 &]HFK5HSXEOLF 5RPDQLD 3RODQG ,UHODQG 3RUWXJDO ,WDO\ 10 $XVWULD 'HQPDUN 1HWKHUODQGV )UDQFH

/RVVLQSRWHQWLDORXWSXWLQ %HOJLXP 6ZHGHQ 0 *HUPDQ\ 01020 40 50 /RVVLQDFWXDORXWSXWLQ

Note: Loss in potential output = (PO**-PO*)/PO**. Loss in actual output = (PO**-Y)/PO**. PO** denotes extrapolated estimate of pre-crisis PO (AMECO, Autumn 2007). See Ball (2014, 150) for details on the extrapolation methodology. PO*stands for PO estimate (AMECO, Autumn 2019). Y denotes real GDP (AMECO, Autumn 2019). *** denotes statistical signiﬁ cance at the 1% level. Six EU27 countries were excluded because their data from the Autumn 2007 forecast could not be compared to the Autumn 2019 data.

Source: AMECO (Autumn 2007, Autumn 2019); own calculations.

To illustrate this point, we use the example of Italy. The rea- Slow growth in the Italian economy over the ten years pre- son for this choice is that the Italian authorities were in open ceding the COVID-19 shock, however, had a strong impact dispute over the Commission’s estimates of potential output on the Commission’s potential output estimates. Figure 3 in pre-COVID-19 times. In June 2019, the European Commis- shows that before the start of the global fi nancial crisis, sion recommended the opening of an excessive defi cit pro- the Commission estimated a steady growth trend in poten- cedure (EDP) because of violations of the EU’s fi scal rules. tial output. However, it then revised Italy’s offi cial potential Although the ultimate political decision was against opening output estimates downwards in several steps as the coun- a new EDP for Italy, the underlying technical debate remains try’s economic crisis deepened. According to the Autumn unresolved. Italian authorities argued that the Commission 2019 estimates, potential output still remains below the level was systematically underestimating the underutilisation of reached before the global fi nancial crisis. economic resources in the Italian economy, i.e. that the offi cial estimate of the negative output gap based on the Com- In what follows, we apply the same approach as in Figure 2 mission’s PO model was too small due to a pro-cyclical esti- to the Italian case, i.e. we extrapolate the pre-crisis devel- mation bias. The Italian argument was that a correction of the opments in Italian potential output. In particular, we use the Commission’s estimates regarding the position of the Italian Commission’s model-based potential output estimates pro- economy in the business cycle would drastically reduce reduced back in 2007 (before the start of the fi nancial and eco- quirements in terms of fi scal consolidation (Gualtieri, 2019). nomic crisis) and extend them by using a constant growth trend for the years 2010-2019.2 By using this simple trend According to the estimates derived from the PO model, Ita- extrapolation, we fi nd a large negative output gap (the differ- ly’s economy was not suffering from underutilisation of eco- ence between actual output and potential output) of -16.9% nomic resources in pre-COVID-19 times. In Autumn 2019, of GDP for the year 2019, which starkly contrasts with the of- the output gap was estimated to stand at -0.2% for the year fi cial Commission estimate of -0.2%. Whereas the European 2019, meaning that the Italian economy operated nearly fully Commission’s offi cial potential output estimate in Autumn in line with its potential output, despite the fact that the Ital- 2019 (i.e. before the start of the COVID-19 pandemic) bends ian unemployment rate still stood at around 10% and infl a- down to meet actual GDP, the trend extrapolation shows a tion was below 1%. Nonetheless, based on this output gap large and growing negative output gap, indicating underutili- assessment, the European Commission’s recommendations sation of economic resources (see Figure 4). saw no fi scal space as the PO model’s conceptual foundations suggested that expansionary fi scal policies would have risked overheating the Italian labour market (Heimberger, 2 The extrapolation is based on the average potential output growth 2019). rates from the 2000-2009 period.

ZBW – Leibniz Information Centre for Economics 169 Coronavirus Crisis

Figure 3 Potential output model revisions for Italy Downward revisions in potential output over time

2007 = 100 Autumn 2007 Spring 2010 Spring 2013 Autumn 2019 100

1995 2000 2005 2007 2010 2015 2020 Year

Source: European Commission forecasts (Autumn 2007; Spring 2010; Spring 2013; Autumn 2019); own calculations.

A simple trend extrapolation, however, is arguably problem- the Italian economy. Over the period 2000-2009, the aver- atic: downward revisions may be justiﬁ ed insofar as the cri- age growth rate of potential output was estimated to be 1.5% sis has triggered hysteresis effects. The concept of hyster- (based on the Commission estimates in Autumn 2007). Even esis postulates that inadequate demand during crisis times when we assume that Italy’s potential output growth rate may have long-run effects on the supply-side potential of an was cut by two-thirds compared to the pre-crisis growth rate economy, e.g. when long-term unemployment leads to skill (making it 0.5% instead of 1.5%), which implies substantial losses among those who lost their jobs during the crisis (e.g. hysteresis effects from 2010 onwards, the negative Italian Ball, 2014; Blanchard et al., 2015). output gap remains substantial (-8.5% of GDP).

To account for this hysteresis argument, we assume that We can demonstrate the relevance of different output gap the crisis indeed reduced the growth in potential output for estimates for Italy by looking at their implications for the ﬁ s-

Figure 4 Alternative potential output estimates for Italy, 1999-2019 At constant 2005 prices

1800

1700 precrisisPOextrapolation hysteresisPO 1600

POAutumn2019 in billion euros 1500 realGDPAutumn2019

1400 precrisisPO

2000 2005 2007 2010 2015 2019 Year

Note: precrisisPO denotes pre-ﬁ nancial-crisis potential output estimate (AMECO, Autumn 2007). POAutumn2019 stands for Commission’s potential output estimates in Autumn 2019. precrisisPOextrapolation stands for extrapolation of the pre-crisis growth trend in potential output (see Ball, 2014, 150). realGDPAutumn2019 denotes real GDP in Autumn 2019. hysteresisPO stands for extrapolation of potential output based on the assumption that the pre- crisis growth in potential output has been cut by two-thirds.

Source: AMECO (Autumn 2007, Autumn 2019); own calculations.

Intereconomics 2020 | 3 170 Coronavirus Crisis

cal space according to the EU’s fi scal rules. Right before Table 1 the coronavirus shock hit, the Commission estimated that Alternative estimates of the output gap for Italy, 2019 the Italian fi scal defi cit would come in at 2.2% of GDP in 2019. Given small offi cial estimates of the output gap, the Potential Output Fiscal ‘Structural’ output gap balance balance ‘structural’ defi cit (2.2%) was estimated to be as large as Commission 1481.1 -0.2 -2.2 -2.2 the headline defi cit. This model-based estimation implied (offi cial) that the Italian government would not meet its medium-term S1: Pre-crisis 1779.7 -16.9 -2.2 6.9 budgetary target, as this target does not allow the ‘struc- trend tural’ defi cit to exceed 0.5% of GDP. As a consequence, the S2: Hysteresis 1615.8 -8.5 -2.2 2.4 Commission continued to demand ‘corrective’ fi scal con- effects solidation measures in the years running up to the coronavirus pandemic. Notes: Potential output in billion euros at constant 2005 prices. Output gap, fi scal balance and structural balance in percent of GDP.

However, Table 1 indicates that Italy would have been run- Source: AMECO (Autumn 2019); own calculations. ning a large ‘structural’ fi scal surplus of 6.9% of GDP in 2019 if we simply extrapolate the pre-fi nancial crisis potential output growth rates (implying an output gap of -16.9% of GDP). Even under the hysteresis scenario, which accounts for the consolidation requirements increase substantially. This argument that post-crisis potential output growth was lower step of introducing ‘fl exibility’ provides additional leeway in than in pre-fi nancial crisis times (but not negative, as sug- the political case-by-case assessment. Paradoxically, how- gested by the Commission’s offi cial Autumn 2019 estimates), ever, it has further increased the relevance of the underly- the ‘structural’ fi scal surplus in 2019 would have been 2.4% ing estimates with the European Commission’s model, and of GDP. thus the importance of technical details. As a consequence, it would have mattered a great deal in the years prior to the Therefore, alternative estimates of the output gap pointing COVID-19 shock if the negative output gap had been esti- to a higher degree of resource underutilisation would have mated to be larger than 4% of GDP in Italy and other coun- reduced the fi scal consolidation pressure on the Italian gov- tries, because the Commission’s own guidelines would ernment in pre-COVID-19 times. The Italian state would have have pointed to the need to stop requirements for further overachieved its medium-term budgetary target, and the fi scal consolidation. Commission’s recommendation for lower government expenditure growth in the face of an offi cially small output gap While we used the example of Italy for illustration purposes, would have been obsolete. downward revisions in potential output closely related to actual output losses also systematically affected the fi scal The European Commission has loosened rigidities related to space in other EU countries (see Figure 2). Especially in the the ‘structural defi cit’ to some extent in 2014 by introducing period 2010-2014, the reliance of European fi scal policymak- so-called ‘fl exibility clauses’ in the Stability and Growth Pact ers on pessimistic views of potential output triggered pro- (European Commission, 2015). This step was at least partly cyclical adjustments in fi scal policy with negative economic a response to the criticism voiced by several EU member growth effects (e.g. Truger, 2015; Heimberger and Kapeller, states over the course of the European debt crisis, where the 2017). Fiscal consolidation caused hysteresis effects (Fatas critics included Italy, Spain, Latvia, Lithuania, Luxembourg, and Summers, 2018), leading to successive rounds of down- Portugal, Slovenia and Slovakia (Ciucci and Zoppe, 2016; ward revisions in potential output that partly validated the Heimberger et al., 2019). original pessimistic potential output forecasts and, in turn, caused further fi scal consolidation requirements (Fatas, The fl exibility guidelines establish a direct link between the 2019). size of the output gap and the required fi scal adjustment effort. In the case of a larger output gap (i.e. when the model First evidence on downward revisions in potential out- estimates suggest that there is a lot of economic slack), lit- put in response to the COVID-19 shock tle or no fi scal adjustment is required. The Commission’s fl exibility guidelines state that in “exceptionally bad times, How will the COVID-19 shock affect the European Commis- interpreted as an output gap below minus 4% of GDP or sion’s potential output estimates, which are at the heart of when real GDP contracts, all Member States, irrespective EU fi scal surveillance? To provide a fi rst analysis concerning of their public debt levels, would be temporarily exempted the impact of the downturn in economic activity on estimates from making any fi scal effort” (European Commission, of potential output in the context of the coronavirus crisis, we 2015, 21). But in the case of a small output gap, the fi scal compare the estimates from the Autumn 2019 forecast and

ZBW – Leibniz Information Centre for Economics 171 Coronavirus Crisis

Figure 5 Revisions in potential output due to the COVID-19 shock, 2021 Correlation of actual and potential output losses: Spring 2020 forecast vs. Autumn 2019 forecast

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Notes: Loss in potential output = (PO**-PO*)/PO**. Loss in actual output = (PO**-Y)/PO**. PO** denotes potential output estimate (AMECO, Autumn 2019). PO* stands for potential output estimate (AMECO, Spring 2020). Y stands for real GDP (AMECO, Spring 2020).

Source: AMECO (Autumn 2019, Spring 2020); own calculations.

the Spring 2020 forecast, which provides the fi rst estimates Downward revisions in potential output translate into higher after the start of the pandemic. ‘structural’ defi cits, which will again become important once the suspension of the EU’s fi scal rules is lifted. To illustrate While Figure 2 looked at data on actual GDP and potential this point, Table 2 compares offi cial and alternative estimates output losses in the year 2019 relative to trends before the for ‘structural’ fi scal balances in all EU27 countries. fi nancial crisis, Figure 5 is based on the Commission’s forecasts for the year 2021. We pose the question: what size are The fi rst column of Table 2 shows the offi cial estimates of the the revisions in actual and potential output when we com- ‘structural’ fi scal balance in the Commission’s Spring 2020 pare the most recent pre-COVID-19 forecast with the Spring forecast for the year 2021. The second column represents al- 2020 forecast. From the y-axis of Figure 5, it can be seen that ternative estimates of the ‘structural’ balance, where we as- estimated potential output losses for 2021 range from 6.4% sume no downward revision in potential output compared to in Malta to -2.5% in Denmark. In fact, Denmark is the only the Autumn 2019 forecast, i.e. potential output remains con- EU27 country that has not experienced a downward revision stant at the most recent pre-COVID-19 estimate. It can be in potential output. seen that the estimated potential output losses (see Figure 5) lead to a more pessimistic view of the size of the ‘structural’ The regression line indicates a statistically signifi cant posi- defi cit across the EU27 countries, with the most pessimistic tive relationship between potential output losses and actual turn in countries with the largest downward revisions in po- output losses. In other words, the Commission systemati- tential output (see, e.g. Malta and Bulgaria). cally reduced its potential output forecast to a larger extent in countries that are also predicted to suffer from a larger drop Once the fi scal rules begin to take effect again, downward in actual output. The correlation is not perfect, but one ad- revisions will make it more diffi cult for several EU27 countries ditional percentage point in predicted losses of actual output to meet their medium-term budgetary objectives. For illustra- is associated with a loss in potential output of about 0.6 per- tion purposes, consider the example of Germany: in 2021, centage points, and the simple bivariate regression explains the downward revision in Germany’s potential output implies more than 30% of the cross-country variation in estimated a ‘structural’ defi cit of 0.5% of GDP. However, the structural potential output losses. This fi rst look at how the COVID-19 balance would be in surplus if we assume no shift to a more shock affects the Commission’s potential output estimates pessimistic view on potential output in comparison to pre- provides evidence that the PO model continues to produce COVID-19 levels. References to the ‘structural’ defi cit – es- estimates that are systematically pro-cyclical in the sense timated based on the Commission’s PO model – are also at that revisions in the PO model estimates are strongly related the heart of Germany’s constitutional ‘debt brake’ (e.g. Hein to changes in economic activity. and Truger, 2014). Once the clauses that exempt the ‘struc-

Intereconomics 2020 | 3 172 Coronavirus Crisis

Table 2 roeconomic downturn and supporting economic recovery. A Alternative estimates of ‘structural’ ﬁ scal balances stronger recovery would imply limited and less persistent ef- for the year 2021 in the EU27 countries fects on potential output, but this outcome is contingent on Spring 2020 estimates vs. estimates without a downward revision in allowing for properly expansionary policies as long as the re- potential output compared to Autumn 2019 covery is incomplete. This paper has documented downward

Country SB ofﬁ cial SB no revision revisions in potential output by the European Commission across the EU27 countries, and these downward revisions Austria -1.14 0.06 tend to be stronger in those countries that are also forecast Belgium -2.91 -2.25 to suffer a larger decline in economic activity relative to the Bulgaria -1.62 0.03 pre-COVID-19 levels. According to our results, one additional Croatia -1.89 0.08 percentage point in predicted losses of actual output is asso- Cyprus -2.11 -0.45 ciated with a loss in potential output of about 0.6 percentage

Czech Republic -2.91 -1.81 points. The problem with downward revisions in potential output is that past research on the links between potential output Denmark 0.64 -0.77 and EU ﬁ scal surveillance shows that pessimistic initial views Estonia -1.90 -1.25 have proven to be self-reinforcing as they reduce ﬁ scal space Germany -0.50 0.20 exactly in those times when it is most needed (e.g. Truger, Finland -1.59 -0.41 2015; Heimberger and Kapeller, 2017; Fatas, 2019). France -2.46 -1.93

Greece 0.81 1.33 Policymakers have to expect that the views produced by the PO model will become more pessimistic in case of a deepen- Hungary -3.08 -1.76 ing of the current economic crisis. Downward revisions in po- Ireland -0.45 1.40 tential output imply relatively smaller output gap estimates, Italy -3.70 -3.44 which (ceteris paribus), directly fi lter into larger ‘structural’ Latvia -3.85 -2.31 defi cits. The EU’s fi scal rules have been temporarily sus- Lithuania -1.58 -0.82 pended in response to the outbreak of the coronavirus pan-

Luxembourg 0.69 1.90 demic, but once this suspension is lifted, model-based as- sessments of excessive ‘structural’ defi cits in the context of Malta -1.34 1.66 the EU’s fi scal rules will force the countries concerned to im- Netherlands -1.57 -0.95 plement fi scal consolidation measures that may hinder eco- Poland -3.10 -1.38 nomic recovery. This may trigger a negative feedback loop, Portugal -1.17 -0.48 where restrictive fi scal policies accelerate the downturn in Romania -9.25 -8.69 economic activity that partly validates the initial pessimistic view, leading to further rounds of downward revisions in po- Slovakia -3.96 -2.45 tential output that systematically restrain the fi scal space for Slovenia -1.20 -0.42 conducting anti-cyclical fi scal policy. Research has shown Spain -5.22 -4.19 that pro-cyclical fi scal tightening has pronounced negative Sweden -0.17 0.65 growth effects (e.g. Blanchard and Leigh, 2013; Jorda and

Note: SB denotes structural balance in % of potential output. Taylor, 2016), which aligns well with the fi nding that aggregate demand was squeezed the most in those European coun- Source: AMECO (Autumn 2019; Spring 2020); own calculations. tries that implemented the harshest fi scal austerity measures during the years of the European debt crisis (De Grauwe and tural’ defi cit limits from being applied are lifted, a more pes- Ji, 2013; Heimberger, 2017; House et al., 2019). simistic view concerning potential output will systematically restrict the fi scal space that is available to German policy- Although the PO model has been revised in several steps makers when it comes to supporting the recovery. over the last years (e.g. Heimberger et al., 2019) and the problem of pro-cyclical estimation biases is well known, the Conclusions analysis presented in this paper suggests that the need for reforming the underlying estimation procedure is as pressing It is a Herculean task to provide a real-time assessment about as never before. It is well known that real-time estimates of how much of the output losses in the context of the COVID-19 potential output are quite uncertain and revision-prone even shock will turn out to be permanent. The extent of hysteresis in normal times. In the context of the COVID-19 pandemic, effects will to a large extent depend on the effectiveness of however, uncertainty is exceptionally high, and future fi scal fi scal policy measures when it comes to mitigating the mac- policy should not be systematically restricted by highly revi-

ZBW – Leibniz Information Centre for Economics 173 Coronavirus Crisis

Coibion, O., Y. Gorodnichenko and M. Ulate (2018), The cyclical sensi- sion-prone model estimates with a pro-cyclical bias. A prag- tivity in estimates of potential output, Brookings Papers on Economic matic solution would therefore be to lock in the potential out- Activity, 2018(2), 343-441. put estimates produced in Autumn 2019 (before the outbreak Costantini, O. (2017), Political economy of the Stability and Growth Pact, European Journal of Economics and Economic Policies: Intervention, of the coronavirus pandemic) until a more reliable approach 14(3), 333-350. to estimating potential output has been developed. Such an De Grauwe, P. and Y. Ji (2013), From Panic-Driven Austerity to Symmetric approach would need to go beyond temporary adjustments Macroeconomic Policies in the Eurozone, Journal of Common Market Studies, 51(S1), 31-41. for individual countries in the existing modelling framework. European Commission (2015), Making the best use of the fl exibility within the existing rules of the Stability and Growth Pact, COM(2015)012 fi nal. An evaluation of the EU’s fi scal rules and debates about European Commission (2019), Vade mecum on the Stability and Growth Pact: 2019 edition, European Economy, Institutional papers, 101. technical reform options was already underway at the begin- European Commission (2020a), Communication from the Commission to ning of the year 2020, as the European Commission initiated the Council on the activation of the general escape clause of the Sta- a process of reviewing economic governance. In an accom- bility and Growth Pact, COM(2020) 123 fi nal. European Commission (2020b), Communication from the Commission: panying document, the European Commission (2020b) ar- Economic governance review, SWD (2020) 2010 fi nal. gues that “the framework relies heavily on variables that are Fatas, A. (2019), Fiscal policy, potential output, and the shifting goal- not directly observable and are frequently revised, such as posts, IMF Economic Review, 67(3), 684-702. Fatas, A. and L. Summers (2018), The permanent effects of fi scal consoli- the output gap and the structural balance, which hampers dation, Journal of International Economics, 112(C), 238-250. the provision of stable policy guidance” (10). Avoiding pro- Fontanari, C., A. Palumbo and C. Salvatori (2019), Potential output in the- cyclical policies in the months and years to come will require ory and practice: A revision and update of Okun’s original method, Institute for New Economic Thinking Working Paper, 93. a reform of the PO model on which the cyclical adjustment of Gualtieri, R. (2019, 23 October), Letter from Italy to the European Com- fi scal control indicators in the EU’s fi scal rules is built. There mission, https://ec.europa.eu/info/sites/info/fi les/economy-fi nance/ are numerous technical papers that work towards achiev- minister_gualtieri_-_letter_to_ec_23_10_2019_1.pdf (3 August 2019). Havik, K., K. Mc Morrow, F. Orlandi, C. Planas, R. Raciborski, W. Roeger, ing better real-time estimates, which are less prone to suf- A. Rossi, A. Thum-Thysen and V. Vandermeulen (2014), The Produc- fer from systematic pro-cyclical revisions (e.g. Coibion et al., tion Function Methodology for Calculating Potential Growth Rates & 2018; Jarocinsky and Lenza, 2018; Fontanari et al., 2019). Output Gaps, European Economy Economic Papers, 535. Heimberger, P. (2017), Did Fiscal Consolidation Cause the Double-Dip Re- cession in the Euro Area?, Review of Keynesian Economics, 5(3), 439-458. Importantly, the European Commission’s PO model would Heimberger, P. and J. Kapeller (2017), The performativity of potential out- need to consider the presence of hysteresis effects. 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Kapeller (2017), The performativity of potential out- into the category of large negative cyclical events, and more put: Pro-cyclicality and path dependency in coordinating European fi scal policies, Review of International Political Economy, 24(5), 909. fl exibility will be required to avoid a vicious circle of feedback Hein, E. and A. Truger (2014), Future fi scal and debt policies: Germany in triggered by the application of the EU’s fi scal rules in the near the context of the European Monetary Union, in P. Arestis, M. Sawyer future, where downward revisions in potential output require (eds.), Fiscal and debt policies for the future, 76-115, Springer. House, C., C. Proebsting and L. Tesar (2019), Austerity in the aftermath additional fi scal consolidation measures, and fi scal consoli- of the great recession, Journal of Monetary Economics, forthcoming. dation undermines the recovery and eventually adversely af- Jarocinski, M. and M. Lenza (2018), An infl ation-predicting measure of fects public debt sustainability. the output gap in the euro area, Journal of Money, Credit and Banking, 50(6), 1189-1224. Jorda, O. and A. Taylor (2016), The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy, Economic Journal, 126(590), 219-255. References Klär, E. (2013), Potential economic variables and actual economic policies in Europe, Intereconomics, 48(1), 33-40, https://www.intereconomics. Ball, L. (2014), Long-term damage from the Great Recession in OECD eu/contents/year/2013/number/1/article/potential-economic-varia- countries, European Journal of Economics and Economic Policies, bles-and-actual-economic-policies-in-europe.html (25 May 2020). 11(2), 149-160. Mourre, G., C. Astarita and S. Princen (2014), Adjusting the budget bal- Blanchard, O. and D. Leigh (2013), Growth forecast errors and fi scal mul- ance for the business cycle: the EU methodology, European Economy tipliers, IMF Working Paper, WP/13/1. Economic Papers, 536. Blanchard, O., E. Cerutti and L. Summers (2015), Infl ation and activity – Palumbo, A. (2015), Studying growth in the modern classical approach: two explorations and their monetary policy implications, IMF Working Theoretical and empirical implications for the analysis of potential Paper, WP/15/230. output, Review of Political Economy, 27(3), 282-307. Buti, M., N. Carnot, A. Hristov, K. Mc Morrow, W. Roeger and V. Van- Tereanu, E., A. Tuladhar and A. Simone (2014), Structural balance target- dermeulen (2019, 23 September), Potential output and EU fi scal sur- ing and output gap uncertainty, IMF Working Paper, 14/107. veillance, VOX CEPR Policy Portal, https://voxeu.org/article/potential- Treaty on Stability, Coordination and Governance in the Economic and output-and-eu-fi scal-surveillance (2 December 2019). 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Intereconomics 2020 | 3 174 DOI: 10.1007/s10272-020-0898-9 Coronavirus Crisis

David P. Ellerman and Tej Gonza Coronavirus Crisis: Government Aid That Also Promotes Employee Ownership

The premise of this paper is that state aid to distressed companies should beneﬁ t not only the current owners but also the employees, who are the ones taking personal risks to continue or restart companies. Government aid during the Great Recession was aimed primarily at restoring the status quo. In the current deeper crisis, aid should be designed to create a fairer, more inclusive and more socially responsible economy by promoting employee ownership as both an incentive and a reward. We show how the Employee Stock Ownership Plan, which has been pioneered in the US for 40 years and can be adapted to the European legal context, can be used as the vehicle for structuring this aid.

The Chinese word for ‘crisis’ combines the characters and services such as healthcare and education. How- for ‘danger’ and ‘opportunity’. While the dangers of the ever, when talking about more standardised economic ongoing coronavirus crisis are increasingly clear, the op- goods, and especially when dealing with the structure portunities have not been sufﬁ ciently explored yet. Our of ownership in the small and medium-sized enterprise paper focuses on how to utilise the ‘opportunity’ while (SME) sector, state ownership is not likely to be desirable. saving the economy from the ‘danger’. An alternative to nationalisation with conventional enter- Around Europe, governments and central banks are prises is establishing broad-based employee ownership currently considering different ﬁ scal and monetary in- (EO) by using government assistance (Mathieu, 2020; Mi- struments to help liquidity-constrained private and tarbeiterbeteiligung, 2020a, 2020b). This paper proposes state-owned enterprises. This includes direct govern- concrete, practical and bi-partisan policy addenda for ment assistance in the form of subsidies, tax breaks, governments to use aid packages to establish (part) EO factoring or buying of receivables and forgiving debts as both for private and state-owned enterprises. well as indirect aid through national or developmental bank loans. The paper suggests that the American Employee Stock Ownership Plan (ESOP) model may be the most relevant Governments should ensure that the aid is inclusive and example for our purpose and explains how government equitable. One option currently being weighed in Europe help can be translated into EO. Subsequently, it outlines is nationalisation. A return to state ownership is sensible the most relevant public policy rationales that support when it comes to strategic infrastructure or public goods the general case for implementing EO on the EU and individual state level. Finally, the key elements of the pro- © The Author(s) 2020. Open Access: This article is distributed under the posal are summarised. terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. Government interventions and the ESOP model

Different forms of government assistance packages may partly be channelled through dedicated legal entities to establish part EO. We propose that EO be struc- David P. Ellerman, Institute for Economic Democ- tured according to the American ESOP model. ESOPs racy, Ljubljana, Slovenia. are probably the most successful existing practice of EO with around 14 million employees included in the plans, Tej Gonza, Institute for Economic Democracy, Lju- roughly 10% of the private workforce in the US, in several bljana, Slovenia. thousand companies of all sizes and sectors (National Center for Employee Ownership [NCEO], 2019).

ZBW – Leibniz Information Centre for Economics 175 Coronavirus Crisis

In a nutshell, ESOP is ownership based on a dedicated Figure 1 trust-like entity associated with a company, which func- Government loan channelled through a Co-Op-ESOP tions as an internal market for shares (and percentages in limited liabilities companies). This trust-like entity main- tains ownership among the current employees of a com- Govt. pany even through generational transitions of workers.

The ESOP model can be recreated in a European legal context. At the Institute for Economic Democracy, we 5. Loan have designed a model for Slovenia, but the same princi- 1. Loan payments ples should apply to other European countries. The idea is 2. Loan funds that the legal entity that would function as an ESOP trust Co-Op- is recognised as a legally constituted cooperative (where 3. New shares ESOP a cooperative law applies). The reason for applying the cooperative legal structure is practical, not ideological. As 4. Future Co-Op-ESOP contributions membership institutions, cooperatives are relatively easy to use to organise employee-members with little to no red tape involved. Historical in Europe, cooperatives have for Source: Authors’ own illustration. ages offered an alternative way of organising production. We call ESOP cooperatives Co-Op-ESOPs.

Structuring government aid to establish employee In the situation where the aid is a liquidity loan rather than ownership in private enterprises an indirect grant (or wealth transfer), the general principle is that part or the whole loan is channelled through To understand how this proposal could be part of the a Co-Op-ESOP, which then transfers the money to the fi nancial intervention legislation, we need to fi rst under- company in return for new issues or treasury shares. This stand its principles. The general principle is when a com- shares the ownership by diluting the existing owners and pany receives a grant from public funds, the help (or part has no cash cost to the company. As the loan is paid off of it) should be shared between the existing owners and with payments put through the Co-Op-ESOP, the workers the employees by making them part owners. get shares equal to their portion of the principal payment into their individual share accounts in the Co-Op-ESOP. The Slovenian government is considering buying receiva- The split between workers is usually according to salary. bles (factoring) from private companies with liquidity dif- The following explains how a loan would be channelled fi culties through a special state trust. Let us think fi rst of through Co-Op-ESOP and repaid to developmental or the underlying idea. A creditor company has a receivable state bank using companies’ retained earnings. from a debtor company which the debtor company probably cannot pay off. The government comes in through In Step 1 (see Figure 1), a government agency makes part this legislation and buys the receivable from the creditor (or all) of a loan package through a Co-Op-ESOP that is company, perhaps at a discount. What does the govern- guaranteed by the Company just like any standard com- ment do with it? If the government ‘swallows’ the receiv- mercial loan. The Company could be either a private com- able, then it is a wealth transfer to the debtor company pany or a state-owned company awaiting future privatisa- whose debt was erased. Hence, debtor companies could tion. In Steps 2 and 3, the Co-Op-ESOP passes the loan be required to agree to the transfer of equal-valued or funds through to the Company in return for newly issued some portion of shares to the Co-Op-ESOP in return for shares or treasury shares of the Company. In accordance the government taking the receivable. Is the creditor com- with the loan agreement, the Company will pay back the pany also getting a gift? It depends on the actual value of loan in instalments over a period of years. But as indicat- the receivable. If it was really worthless, the price for the ed in Step 4, those loan payments will be legally pack- purchase of the receivable was also a wealth transfer and aged as a contribution to the Co-Op-ESOP (which should some transfer to a Co-Op-ESOP might be appropriate be made deductible from taxable income as is the prac- for the creditor company, too. The principles of translat- tice followed in the US). The Co-Op-ESOP then passes ing other forms of direct and indirect grants into EO are the loan payments through to the government in Step 5. the same. The general idea is that the value of state help should be matched by newly issued shares or treasury The relief loans or subsidies may be made well before a shares, which are transferred to Co-Op-ESOP trusts. Co-Op-ESOP can be established, but the same net ef-

Intereconomics 2020 | 3 176 Coronavirus Crisis

Figure 2 Figure 3 Government loan directly to Company with Co-Op- Shares allocated to individual share accounts with ESOP shares timed with loan payments loan payments

Govt. Govt.

1. Loan 5. Loan 7. Shares 5. Loan payments bought payments back after X years 6. Shares Co-Op- Co-Op- allocated to ESOP individual ESOP 4. ESOP share accounts 2. 3. 4. New shares contribution as loan timed with the is paid off. loan payments

Source: Authors’ own illustration. Source: Authors’ own illustration.

fects can still be obtained. Then the loan would be made establishing EO in those are the same. When it comes to directly to the company but each loan payment would be SOEs using government aid to establish EO, this can be accompanied by a tax-incentivised contribution of newly viewed as a partial privatisation in accordance with EU issued shares or treasury shares to the later-established guidelines (where applicable, exempting the companies Co-Op-ESOP (e.g. with a tax-deductible value equal to providing public goods and services that should remain the principal portion of the loan payment), as illustrated under state ownership). in Figure 2. In Slovenia and other economies where there is a high lev- It is only in Step 6 in Figure 3 that shares (equal-valued el of public ownership, many SOEs are in line for privatisa- to the loan principal payment) are allocated to the indi- tion in the upcoming years. Experience shows that impul- vidual employee share accounts in the Co-Op-ESOP as sive privatisations are often characterised by corruption their reward when loan payments are made. If the Com- and underselling. Private investors do not always have the pany continues to make Co-Op-ESOP contributions after long-term health of the enterprise in mind and may simply the loan is paid off, then the Co-Op-ESOP can buy back want to decapitalise the company. the employee shares after say X = 5 years (Step 7) and redistribute them to the share accounts of the current em- Introducing part EO to the privatisation model anchors ployees – to be rolled over again after another X = 5 years. the long-term interest of the company in its employees and the local community. It raises safeguards both One important element of this proposal is that there when enterprises are owned by the government and should be a company evaluation for every private compa- when they are owned by a foreign private investor. It ny that would have to match the value of government aid also motivates employees in the environment of public with the value of shares transferred to Co-Op-ESOP. For employment, infamous for the lack of incentive struc- the purpose of this crisis, a universal method of evalua- tures. Finally, EO in state-owned enterprises serves an- tion could be legally determined with which all companies other function if the government decides to sell the en- should apply, a method that would not be very resource terprises; it is a test for the potential buyer. If the buyer consuming. For example, the net asset value approach objected to minority EO, it would probably be a reliable could be used for evaluation. signal that the buyer is not interested in the long-term health of the company. Government aid for state-owned enterprises and privatisation Doing better than just restoring the status quo

European governments are also putting ﬁ nancial resourc- The EU and the member states interested in an EO ap- es into state-owned enterprises (SOEs). The principles of proach must justify their position on practical as well as

ZBW – Leibniz Information Centre for Economics 177 Coronavirus Crisis

policy grounds. EO has proven to be one of the most effi - Superior economic performance of employee-owned cient organisational models for private enterprises. It also enterprises enjoys high degrees of social and environmental responsibility. This section outlines some of the most relevant Employee-owned companies are more successful not problems addressed by EO. only in times of crisis, but also when business is good. Relative to comparable conventional enterprises, employ- Reward and motivation for employees in times of high risk ee-owned fi rms on average enjoy between 4% and 10% higher productivity (Brill, 2012; Freeman, 2007; Blasi et The fi rst question for the governments providing aid al., 2013; Kruse, 2016), 2.3% greater sales-per-employee should be who would get the most out of it. Frontline growth (NCEO, 2019) and 8.8% faster general growth managers and workers in the fi rms are those taking the (Kramer, 2010; Blasi et al., 2017). personal risks in order to get the economy going again. EO typically increases the wealth (Blasi and Kruse, 2019) Mitigating the problem of extreme economic inequality and wages of employees (Kardas et al., 1998). Moreover, EO improves workers’ quality of life (Bryson, 2016; Erdal, Inequality is a pertinent problem that most governments 2014). around the world are trying to address. The European Commission (2018) reports that the current levels of eco- Greater cooperation and co-responsibility nomic inequality are unjust, unsustainable and ineffi cient – even in one of the most egalitarian economic regions Empirical evidence shows that greater worker autonomy in the world. By democratising the source of income and reduces worker-management confl ict and leads to greater wealth, the capital, EO addresses this issue without im- affi liation for the organisation (Kruse, 2016; Summers and posing redistributive measures. Recent research from the Chillas, 2019). To achieve the full potential in this area, the US shows the average wealth or savings of low- and mid- ownership aspect should be complemented by the change dle-income employees is $17,000 in conventional compa- in workplace culture, with the encouragement stemming nies and $165,000 in employee-owned companies (Blasi from a better fl ow of information, improved management and Kruse, 2019). transparency and greater employee involvement and autonomy (Fakhfakh et al., 2012; Kruse et al., 2010, 2008; Achieving social and environmental responsibility Perotin, 2016; Rosen et al., 2005). The current crisis teaches about the importance of local Higher resilience and lower employee fl uctuation in times ownership. SMEs are generally considered locally re- of economic crisis sponsible, which has to do with a high degree of community interconnectedness between the owners of local Studies comparing employee-owned companies with businesses and community members. There is a natural conventional companies concluded that the former have incentive not to foul one’s own nest. A sustainable form of 20% to 50% higher survival rates on the markets, with the EO anchors the local interest with the ownership interest difference being particularly pronounced in times of crisis and achieves more socially and environmentally respon- (Blair et al., 2000; Blasi et al., 2013; Kruse, 2016). sible business operations (Denton, 1999; Stranahan and Kelly, 2019; Fifty by Fifty, 2018; Gehman et al., 2019). Kruse et al. (2012) found that workers in the ESOP companies are 50% less likely to voluntarily seek employment in Overcoming the decapitalisation problem the next year. During the 2007-08 fi nancial crisis, employee-owned companies in the US had between 20% and The European Commission, the World Bank and the IMF 50% lower lay-off rates, and it is estimated that during the have, in the past decades, pushed for aggressive priva- Great Recession, the US Government saved around $13 tisation policies in the South and the Southwest Balkans billion in unemployment and other programme costs be- that often resulted in value destruction, wealth expropria- cause of EO (NCEO, 2019). tion and deepening the economic gap between the workers and corrupt individuals with political connections. Similar results are found outside the US. In Spain, Mon- Foreign and absentee ownership have their downfalls, dragon companies were very successful in bridging the and governments should reconsider their privatisation 2009 crisis. While the country’s unemployment rate rose policies. to 26%, Mondragon collectively decreased wages by 5% to 10% and allocated few redundant members among co- Overcoming the decapitalisation problem for larger for- operatives (Tremlett, 2013). eign or absentee-owned fi rms can be addressed by es-

Intereconomics 2020 | 3 178 Coronavirus Crisis

tablishing part EO that would guarantee to workers say Europe that, with suitable adjustments, can be imple- and oversight, both de jure and de facto. Again, employee mented in Slovenia or any other European country. interest is the interest for long-term sustainability and success of business enterprise, but also for locally re- ESOPs build more resilient and efﬁ cient enterprises, they sponsible operation. anchor capital in local communities and they provide a model for ownership continuation with SMEs. Moreover, Arranging ownership succession ESOPs provide a socially and environmentally responsible economic model. Finally, for state-owned companies Last but not least of the problems addressed by EO is the awaiting privatisation, EO reduces the state-owned com- so-called ownership succession problem for SMEs (Močnik ponent and serves as a check on buyers not interested in et al., 2019; Duh, 2012; Malinen, 2001; Hnátek, 2013). EO the long-term health of the companies and their surround- through ESOP trusts is a time-tested mechanism for (grad- ing communities. ual) employee buyouts without depending on the employees mortgaging or risking their personal assets. Most of the Instead of resurrecting the established status quo, gov- companies with ESOPs in the US arose out of family suc- ernmental assistance should use this opportunity to in- cession problems in privately held SMEs, therefore ESOP clude ordinary employees, whose combined efforts will is often cited as a desirable succession tool in the business be required to restore economic health in response to the literature (Frisch, 2002; Brill, 2017; Flesher, 1994). ongoing pandemic and in years to come.

Employee ownership: An opportunity in the coronavirus crisis References Blair, M., D. Kruse and J. Blasi (2000), Employee Ownership: An Unstable The frontline people whose efforts will be needed to save Form or a Stabilizing Force?, in M. Blair and T. Kochan (eds.), The new their companies should be supported not simply by their relationship: Human capital in the American corporation, Brookings In- stitution Press. salary but also by the incentive of an ownership reward. Blasi, J. and D. Kruse (2019), Building the Assets of Low and Moderate This article argues that government aid to companies in Income Workers and Their Families: The Role of Employee Ownership, need can be channelled so that an inclusive and sustain- Institute for the Study of Employee Ownership and Profi t Sharing, Rutgers University. able model of EO is established. Blasi, J., R. B. Freeman and D. L. Kruse (2017), Evidence: What the U.S. Research Shows about Worker Ownership, in Oxford University Press There is no shortage of reasons why governments and Handbook of Mutual, Co-Operative and Co-Owned Business, 211-226, Oxford University Press. EU should consider EO as an additional goal in address- Blasi, J., D. Kruse and D. Weltmann (2013), Firm Survival and Perfor- ing the current crisis. It is not diffi cult to justify govern- mance in Privately Held ESOP Companies, in Sharing Ownership, Prof- ment help in establishing EO, since EO is about rewarding its, and Decision-Making in the 21st Century, 109-124, Emerald Group Publishing Limited. employees, who are saving the economy by working in Brill, A. (2012), An Analysis of the Benefi ts S ESOPs Provide the U.S. times of crisis. EO is a structural alternative that resides Economy and Workforce, Matrix Global Advisors White Paper. between absentee ownership and economic hyper-glo- Brill, A. (2017), Employee Stock Ownership Plans as an Exit Strategy for Private Business Owners, Matrix Global Advisors White Paper. balisation on the one hand, and state ownership on the Bryson, A., A. Clark, R. Freeman and C. Green (2016), Share Capitalism other. In this respect, it is a ‘radical-centrist’ idea. and Worker Wellbeing, Labour Economics, 42, 151-158. Denton, D. K. (1999), Employee Involvement, Pollution Control and Pieces to the Puzzle, Environmental Management and Health, 10(2), 105-111. The best model for EO, according to 40 years of experience, Duh, M. (2012), Family Businesses: The Extensiveness of Succession seems to be the American ESOP. By explicit design, ESOPs Problems and Possible Solutions, in T. Burger-Helmchen (ed.), En- include all the employees in a company. They do not require trepreneurship – Gender, Geographies and Social Context, IntechO- pen. employees to sacrifi ce their own savings, and have proven Erdal, D. (2014), Employee Ownership and Health: An Initial Study, in S. to be sustainable over generations of employees and there- Novkovic and T. Webb (eds.), Co-Operatives in a Post-Growth Era: Cre- fore not simply a windfall for one group of workers. Gov- ating Co-Operative Economics, 210-220, Zed Books. European Commission (2018), Wealth Concentration, Knowledge for Pol- ernment grants and loans can be used, at least partially, to icy, 6 November, https://ec.europa.eu/knowledge4policy/foresight/ establish EO if fi nancial resources (or tax breaks and debt topic/diversifying-inequalities/rich-poor-gap_en (10 May 2020). abatements) are channelled through an ESOP-like entity. European Federation for Employee Share Ownership (2020), A Generic ESOP Employee Share Plan for Europe, http://www.efesonline. org/LIBRARY/2020/A%20Generic%20ESOP%20Employee%20 The Institute for Economic Democracy,1 in collaboration Share%20Plan%20for%20Europe.pdf (26 May 2020). with the European Federation for Employee Share Own- Fakhfakh, F., V. Pérotin and M. Gago (2012), Productivity, Capital, and La- bor in Labor-Managed and Conventional Firms: An Investigation on ership (2020), have developed a generic ESOP model for French Data, ILR Review, 65(4), 847-879. Flesher, D. (1994), Using ESOPs to Solve Succession Problems, Journal of Accountancy, 177(5). 1 For more information, see https://ekonomska-demokracija.si.

ZBW – Leibniz Information Centre for Economics 179 Coronavirus Crisis

Fifty by Fifty (2018, 7 November), Next Generation Enterprise Design: Mathieu, M. (2020), Appeal: Employee Share Ownership in Times of Pan- The Employee-Owned Benefi t Corporation, Medium, https://medium. demic, EFES Online, http://www.efesonline.org/corona/EN.htm (10 com/fi fty-by-fi fty/next-generation-enterprise-design-the-employee- May 2020). owned-benefi t-corporation-7b5001f8f1a8 (10 May 2020). Mitarbeiterbeteiligung (2020a), Berlin Appeal: Initiatives to Promote Em- Freeman, S. (2007), Effects of ESOP Adoption and Employee Ownership: ployee Participation, http://mitarbeiterbeteiligung.de/ (10 May 2020). Thirty Years of Research and Experience, Organizational Dynamics Mitarbeiterbeteiligung (2020b), Employee Participation as Emergency Aid Working Papers. for Companies, Initiatives to Promote Employee Participation, http:// Frisch, R. (2002), ESOP Workbook: The Ultimate Instrument in Succession mitarbeiterbeteiligung.de/ (10 May 2020). Planning, 2nd ed., John Wiley & Sons. Močnik, D., M. Duh, K. Crnogaj, M. Rebernik and K. Sirec (2019), Slov- Gehman, J., M. Grimes and K. Cao (2019), Why We Care About Certifi ed enska Podjetnška Demografi ja in Prenos Podjetij: Slovenski Podjetniški B Corporations: From Valuing Growth to Certifying Values Practices, Observatorij 2018. Academy of Management, 5(1), 97-101. National Center for Employee Ownership (2019), A Statistical Profi le of Em- Hnátek, M. (2013), Succession Problems in Family-Owned Businesses: ployee Ownership, https://www.nceo.org/articles/statistical-profi le- An Example from the Czech Republic, Management Review, 3(3). employee-ownership (10 May 2020). Kardas, J. and P. Scharf (1998), Wealth and Income Consequences of Pérotin, V. (2016), What do we really know about workers’ co-operatives?, Employee Ownership, The National Center For Employee Ownership. in A. Webster, L. Shaw and R. Vorberg-Rugh (eds.), Mainstreaming Kramer, B. (2010), Employee Ownership and Participation Effects on Out- Co-Operation: An Alternative for the Twenty-First Century?, 239-260, comes in Firms Majority Employee-Owned through Employee Stock Manchester University Press. Ownership Plans in the US, Economic and Industrial Democracy, 31(4), Rosen, C., J. Case and M. Starbus (2005), Equity: Why Employee Owner- 449-476. ship Is Good for Business, Harvard Business School Press. Kruse, D. (2016), Does Employee Ownership Improve Performance?, IZA Stranahan, S. and M. Kelly (2019), Mission-Led Employee-Owned Firms: World of Labor, 311. The Best of the Best, The Democracy Collaborative, https://democra- Kruse, D., J. Blasi and R. Freeman (2012), Does Linking Worker Pay to cycollaborative.org/learn/publication/mission-led-employee-owned- Firm Performance Help the Best Firms Do Even Better?, NBER Work- fi rms-best-best (10 May 2020). ing Paper Series, 17745. Summers, J. and S. Chillas (2019), Working in Employee-Owned Compa- Kruse, D., R. Freeman and J. Blasi (2008), Do Workers Gain by Sharing? nies: The Role of Economic Democracy Skills, Economic and Industrial Employee Outcomes under Employee Ownership, Profi t Sharing, and Democracy. Broad-Based Stock Options, NBER Working Paper Series, 14322. Tremlett, G. (2013, 7 March), Mondragon: Spain’s Giant Co-Operative Malinen, P. (2001), Like Father Like Son? Small Family Business Succes- Where Times Are Hard but Few Go Bust, The Guardian, https://www. sion Problems in Finland, Enterprise and Innovation Management Stud- theguardian.com/world/2013/mar/07/mondragon-spains-giant-co- ies, 2(3), 195-204. operative.

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Intereconomics 2020 | 3 180 DOI: 10.1007/s10272-020-0896-y Climate Policy

Claudia Kemfert, Dorothea Schäfer and Willi Semmler Great Green Transition and Finance

European governments are struggling to regain economic strength in the coronavirus pandemic as in many countries the number of new infections seems to gradually subside. Growth rates deep in the red call for a reconstruction programme when the crisis is fi nally manageable and economic activity can resume. Amidst this, there are again infl uential groups that claim “this is not the time to insist on strict climate protection goals”. On the contrary, the ongoing COVID-19 crisis has clearly illustrated what climate disasters, often occurring locally, could do to the life of citizens. The reconstruction programme needs to initiate the great green transition. The transformation from a climate-distorting to a climate-protecting economy opens up investment opportunities and points to fi nancing needs comparable with those necessary for the rebuilding of the European economy after World War II. The great green transition is a unique chance to pursue policies for a new and sustainable growth regime.

European governments are striving to meet the ambitious On the other hand, the transformation from a climate-distort- goals of the Paris Climate Agreement of 2015. The German ing into a climate-protecting economy opens up new invest- government wants to limit CO2 emissions so that the global ment opportunities. The resulting fi nancing needs will be in temperature increase does not exceed 1.5 degrees Celsius. a range that is likely to be comparable only with the volumes How German society can achieve this goal is still an open needed for rebuilding the German economy after the World question. However, concrete steps must be decided upon ur- War II, or for the reconstruction of the East German economy gently, and rapid implementation is key. after the reunifi cation. The transformation requires investments in all areas of the economy: low-carbon and climate Within this scenario, the fi nancial sector faces a dilemma. The resilient infrastructure, including energy, transport, drinking climate crisis is a source of fi nancial market instability. Without water, sanitation and telecommunication; human capital in- strict greenhouse gas emission regulation, climate disruption vestments (for planning and implementation, advice, risk man- risks increase that are potentially depreciating the assets of agement, auditing and regulatory capacity); refurbishment banks and other fi nancial institutions. However, with stricter and redesign of public and private buildings (transformation of regulation and higher CO2 emission pricing, there is a risk that the construction industry); agriculture; tourism and many other the legacy investments of fi nancial institutions in the fossil fuel areas (Dullien, 2019a; Krebs, 2020). The investment require- sectors will be devaluated, a risk that increases with stricter ments are so huge that it is justifi ed to call the path to a car- regulation and rising CO2 emission pricing. bon-free and sustainable economy the ‘great green transition’. © The Author(s) 2020. Open Access: This article is distributed under the Eventually, during the transition period, the German corporate terms of the Creative Commons Attribution 4.0 International License sector, which joined the German state and private households (https://creativecommons.org/licenses/by/4.0/). in being a net-saving sector, may again become a net-invest- Open Access funding provided by ZBW – Leibniz Information Centre ing sector (Flassbeck, 2019). for Economics.

Along with the huge opportunities embedded in the fi nancing Claudia Kemfert, German Institute for Economic of the great green transition come huge uncertainties for fi nan- Research (DIW Berlin); and German Advisory Coun- cial institutions, however. To a large extent, the transition path cil on the Environment (SRU), Berlin, Germany. is unknown. Success in transforming the economy will require, and be highly dependent on, innovative fi rms inventing, pro- Dorothea Schäfer, German Institute for Economic ducing and selling climate-protecting technologies and prod- Research (DIW Berlin), Germany; Jönköping Inter- ucts. Accordingly, fi nancial institutions face huge innovation national Business School, Sweden. risks when funding the great green transition. Innovative companies are more fi nancially constrained than those fi rms us- Willi Semmler, New School for Social Research, ing and selling proven technologies and products (Jensen et New York, USA; University of Bielefeld, Germany. al., 2019; Schäfer et al., 2017). The reason for severe funding gaps is the huge uncertainty revolving around the question

ZBW – Leibniz Information Centre for Economics 181 Climate Policy

of long-term sustainability and market success of innovative cycle of certifi cates is at the lower end and the CO2 price is products and technologies. Therefore, banks and institutional very low, as has happened in the past, this would incentiv- investors funding climate tech fi rms face two kinds of depreci- ise fi rms to slow down, if not abolish, their efforts to increase

ation risks. At the one end, if the ﬁ nancial industry conducts a green investments for achieving lower CO2 emissions (Dullien, wait-and-see strategy and sticks to their traditional investment 2020). policy, stranded legacy assets may become a huge source of

future losses should loans and other funding of traditional fos- By contrast, the effect of the CO2 tax is steadier and more sta- sil fuel investments become non-performing. At the other end, ble, thus complementing and supporting green investments. if the ﬁ nancial industry immediately switches to funding only The tax can be implemented quickly, without an extended innovative, yet not ﬁ nancially self-sustainable, climate tech preparation phase. Moreover, as the private sector can limit

ﬁ rms with new technologies, it faces the typical ﬁ rst-mover the tax burden by reducing CO2 emissions, the tax is incen- risk in completely new, innovative and unknown areas of busi- tive compatible and does not suffer from the risk of reversing ness. incentives.

Thus, the crucial question is: how can the necessary invest- Taken alone, CO2 taxes are not effective enough to facilitate ments be initiated, carried out and funded without generating the necessary breakthrough for sustainability policy. In fact, a situation in which devaluation and depreciation endangers the tax must be very high to be effective. The required level

the stability of the ﬁ nancial sector? In 2019, the German cli- is not US$20-30 per tonne of CO2 (or about US$50 as it is mate cabinet proposed a mix of policies – innovation support now planned for Germany in 2025) but rather US$80-100, as for green energy, ﬁ scal policies (tax and subsidies), carbon calculated by Heal and Schlenker (2019). At lower levels, the

pricing and issuance of green bonds. Often, German climate CO2 tax would only very slowly initiate the needed substitu- policy is considered ‘too little and too late’, yet it seems to be tion processes. In addition, ﬁ rms may pass on the tax via price an important ﬁ rst step in the right direction as it focuses on a markups. Instead of adjusting their own production processes

mix of instruments instead of just one. Indeed, a mix of policies towards lower CO2 emissions, companies with enough market is required to achieve the great green transition. Redirecting power could easily increase prices for their customers. innovation policy and innovation fi nance, large scale issuance of green bonds, active fi scal policy, supportive monetary and In tandem with green bond issues at a large scale and used credit policies, fair transitions of employees in old industries in for public green investment, the revenues of a carbon tax can the labour market and better insurance policies are necessary have side benefi ts that are highly welcome, even if they do not to allow a faster transition to a low-carbon economy. initiate changes in behaviour. The revenues could be used to reduce other taxes that are incompatible with sustainability or

Macro instruments for the great green transition to correct unwanted distributional effects of CO2 pricing. As higher fossil fuel prices affect poorer citizens disproportional- Carbon pricing and green bonds ly, tax revenues could serve to compensate them. In addition, the revenues could create an allocative effect if they are paid Sovereign institutions and their chosen policy instruments will out as a citizen dividend, i.e. a per capita refund of revenue.

play a decisive role in mitigating the multiple dilemmas aris- For citizens who themselves cause only limited CO2 emis-

ing around a timely and sufﬁ cient provision of funds for the sions, the balance between the CO2 tax paid and the citizen great green transition. Why is it so important to use a mix of dividend would be positive. Not only does this create a strong

policy instruments at the same time, for example, CO2 pric- incentive to reduce CO2 emissions, it also facilitates a fairer

ing and green investments? The pricing of CO2 emissions is transition to a less carbon intensive economy. now largely undisputed. Disputed, however, is how the pricing should be organised. Some advocates favour focusing only on A sustainability policy needs green bonds the trading of certiﬁ cates and object to the introduction of a

CO2 tax. Public ‘green investments’ ﬁ nanced by ‘green government bonds’, i.e. bonds issued by public agencies on behalf of sov- However, emissions trading poses severe problems: the pric- ereign institutions, are an important complementary tool to

es of the certifi cates on the fi nancial markets are subject to CO2 pricing. The Federal Ministry of Finance in Germany re- extreme fl uctuations, so they are very volatile. Studies with ex- cently pushed forward considerations in this direction. Green isting data suggest that certifi cate prices are many times more bonds are also an essential part of the Green Finance policy volatile than stock prices. The stock markets exhibit anything of the EU Commission (Claringbould et al., 2019). The Action but low volatility. Large fl uctuations in prices mean high plan- Plan aims to develop an EU Green Bond Standard, as well ning uncertainties for investments in the great green transition as benchmarks for low-carbon investment strategies and cli- (Kemfert et al., 2019). Moreover, and paradoxically, if the price mate-related reporting.

Intereconomics 2020 | 3 182 Climate Policy

In designing the policy towards decarbonisation, the relation- Fair intergenerational burden sharing ship between CO2 pricing and green investments, as well as the potential value-added of their simultaneous use, is often Tax increases, especially in suffi cient amounts, are politically ignored. However, some governments have long recognised diffi cult to enforce if the benefi ts to those affected are not the importance and effectiveness of a simultaneous use in directly visible. Scientifi c research discusses whether a suf- their economic policy for sustainability. Further, the benefi ts fi ciently high CO2 tax would cause unequal burdens not just of a joint use of CO2 pricing and green investments are start- within the current generation, but also between present and ing to become common knowledge in scientifi c research. For future generations. Intergenerational fairness implies that it is example, Heine et al. (2019) argue that public green bonds not only the present generation, but also future generations, are more effective when combined with a carbon tax. that benefi t from state spending on education, all kinds of infrastructure, energy supply, digitisation and other invest- Fiscal space should be used for countercyclical green investments with long-term benefi cial effects. For that reason, fu- ments ture benefi ciaries should also participate in the fi nancing of climate-protecting investments. The current fi nancial market Furthermore, it is currently a good time to issue new public conditions, with extremely low, if not negative, interest rates, debt. Countries like Germany – and other Northern EU coun- ensure that the future generations’ repayment burden is low. tries – have enough fi scal space to pursue countercyclical Even very long-term government bonds have negative inter- green investments, even when fi ghting the coronavirus cri- est rates at present. If the growth rate is higher than the inter- sis causes extraordinary large expenses. Other countries, est rate, the debt ratio, i.e. the ratio of public debt to gross especially those with emerging economies, lack such free- domestic product, decreases. With negative interest rates, dom. According to studies by the World Bank and the Inter- future generations will have to repay less than the funds that national Monetary Fund (IMF), the comparison of long-term were originally made available to the state when it took on growth and the interest rates of a country provides a bench- the debt. mark, or an assessment of whether or not there is room for fi scal expansion. If the interest rate is lower than the growth Consequently, scientifi c research must not only focus on the rate, there is suffi cient leeway. In this case, no long-run sov- intergenerational costs, when discussing the issuance of ereign debt problem will arise when issuing green bonds for public debt, but also consider the intergenerational benefi ts. co-funding the great green transition. Since a CO2 tax has only limited effectiveness and does not solve the intergenerational burden sharing problem, green In view of the expected economic downturn and low or nega- bonds are a crucially important instrument of sustainability tive interest rates, Germany could and should increase public policy. investment. The World Bank, the IMF, the European Central Bank (ECB) and the Organisation for Economic Co-operation Use of the revenue from green bonds and Development are also calling for higher public investments from Germany in order to counteract the predicted Of course, money itself is not ‘green’. What makes money global economic downturn and for reducing Germany’s ex- green is its investment in projects that contribute to the great port dependency. Above all, the favourable fi nancing envi- green transition. Thus, if governments issue green public ronment should be used to issue bonds for funding green bonds, they implicitly commit to use the revenues from those investments. bonds for green investments. The question arises as to which green investments the bond revenues should be allocated: The issuance of green government bonds is also a good strategy for Germany in the medium term. From an inter- • Governments could allocate the revenues to development national perspective, Germany has extremely low capital banks, like the European Investment Bank. These fi nan- costs due to low, if not negative, interest rates. Germany cial institutions could then issue government-sponsored could have a comparative cost advantage in the production bonds for which the state guarantees all, or parts of, debt of technologies for the transformation of the energy system. service and repayment. This implies lower risk premiums Low-cost trade credits to other countries, given the low do- for those bonds than for privately issued bonds. As a re- mestic cost of capital, could also help unlock new demand sult, investments into new energy supply become more for climate-friendly export goods. Therefore, in sum, using a feasible. combination of CO2 tax and green public bonds to initiate the urgently needed boost for the great green transition seems • Larger companies mainly fi nance themselves through the to be a reasonable strategy in fi ghting the climate change issuance of shares or bonds, but small and medium-sized and in overcoming the economic weakness from the coro- enterprises (SMEs) in Europe rely strongly on bank loans. navirus pandemic. Loan guarantee programmes are an instrument to reduce

ZBW – Leibniz Information Centre for Economics 183 Climate Policy

interest rates and could be funded by green bond reve- Fratzscher et al. (2017) and McKibbin et al. (2017) elaborate nues. In other words, the revenues would be used to cov- on the importance of monetary policy for climate policy in er the default risk of loans, given the loan is used for green general. Many monetary policy observers argue that infl a- investment purposes. This would ensure that smaller, of- tion targeting is an appropriate goal, even if a climate disas- ten credit-constrained, innovative companies operating in ter has hit the economy. Yet, climate disasters on account of the new manufacturing sectors receive more favourable extreme weather events and the subsequent recovery efforts funding terms (see e.g. Jensen et al., 2019). often cause severe shortages and thus higher infl ation rates. Due to the fact that the problem is on the supply side, cen- • Revenues could go directly into climate-protecting pub- tral banks are required, as it is naturally part of their mandate lic infrastructure. This implies that the state would build, to facilitate credit fl ows and provide credit with low interest own, maintain and manage the infrastructure, e.g. the rates. Against this backdrop, infl ation targeting seems to be grids for renewable energy distribution. of secondary importance when the economy is struggling with negative shocks on the supply side. This ranking holds • Revenues could be used to set up, subsidise and regu- for the current pandemic crisis and equally so for the climate late public-private utility companies generating green en- crisis. ergy, such as a solar energy utility company. For example, Tesla’s planned new factory in Brandenburg could be When climate disasters occur, households and fi rms usually required to use 100% renewable energy instead of gas face severe credit constraints. Moreover, collateral value de-

power plants. With rising CO2 prices and concrete sup- clines due to value losses in housing and real estate. Thus, port programmes, solar process heat is profi table today it is hard to obtain credit, or only at a very large risk premi- at €0.05 per kWh. Another possibility is the combination um. Developing precautionary tools to overcome such con- of photovoltaic and a high temperature heat pump or a hy- straints should be a major task of central banks. brid collector, e.g. for drying, painting, cooling and heat- ing. Alternatively, biomass (boiler), biogas (CHP) or deep Monetary policies could be also supportive with respect to geothermal energy could be used for power and heat pro- developing the market for climate bonds. For example, if duction. central banks accept green bonds as collateral, rating fi rms would rate climate bonds higher. Thus, indirectly via the col- • Direct subsidies for small-scale innovative fi rms introduc- lateral channel, central banks are able to lower capital costs ing new types of green energy. and to ease credit constraints for investments in the great green transition. Central banks could ease credit fl ows af- • Large investments are necessary in education, e.g. set- ter disasters, thereby helping to overcome bottlenecks in ting up educational tracks that provide the appropriate the supply of goods and services, while also facilitating the skills for the transition, such as green engineers, green rebuilding of infrastructure, transport systems and other ser- business managers and green rating specialists. vices of public interest.

• Governments need to invest in precautionary protective While central banks can and should contribute to making the measures against disasters (extreme weather events economy and the fi nancial system more sustainable, they such as heat waves, forest fi res, fl ooding, storms and oth- can only complement, not substitute for decisive political ac- er disasters), with the issuance of green bonds providing tion by governments (Breitenfellner et al., 2019). However, in the means. their role as regulators and supervisors, central banks must assess the extent to which households, fi rms, fi nancial inter- Greening central bank policy mediaries and the stock markets are exposed to the risk of climate change and fi nancial instability arising from devalu- In the current low infl ationary environment, the ECB could ated prior investments in the fossil fuel sectors. become – and such a strategy appears to be emerging under Christine Lagarde – an active player in developing the mar- On the other hand, regulators must be aware of enormous ket for green government bonds. There are various ways to investment opportunities resulting from the planned de- proceed. For example, De Grauwe (2019) recommends that carbonisation of the economy and they must contribute to the ECB should replace old bonds within its quantitative eas- easing the uncertainty around investing in the great green ing programme with new ‘environmental bonds’ that are spe- transition. The regulation of carbon emissions will determine cifi cally issued to fund environmental projects. As the ECB the risk of devaluation. The task of fi nancial regulators is to would only substitute environmental bonds for old bonds, incorporate those risks into banking and fi nancial markets’ there would be no new money created, and infl ation would regulatory frameworks and to ensure fi nancial institutions’ not be affected. compliance and prudential behaviour.

Intereconomics 2020 | 3 184 Climate Policy

In addition, given the threat of ‘stranded’ fossil fuel assets, emission reduction, research and innovation, Europe’s objec- central banks and other supervisory bodies need to de- tives are also about supply security, reducing import depend- velop precautionary instruments and strategies that enable ency and achieving a fully integrated internal energy market. fi nancial institutions to avoid devastating fi re sales of fossil fuel assets and save the fi nancial system a systemic crisis. Model results show that a transition to an energy system that Regulators should also consider a precautionary design of relies 100% on renewables makes economic sense (Schill a public asset management vehicle, a public bad bank so to et al., 2018). These studies confi rm that the switch to a full speak (Schäfer and Zimmermann, 2009), ready to digest de- supply of renewable energies is not only technically feasible valuated fossil fuel assets if a system crisis emerges. In crisis today but can also strengthen the economy by generating in- times, timely reaction is key. novations and technological advantages (see Hainsch et al., 2018; Burandt et al., 2018). With more energy generated by Specifi c areas for action to foster the great green renewable sources, costs will fall, especially for wind power transition and solar photovoltaics. Decreasing storage costs continue to promote competitiveness. Further cost reductions would The public and private sector need to join forces result from a better networking of European regions. Uniform expansion targets for renewable energies and an optimised Innovation research shows that technological innovations design of the EU internal market, as well as the sector cou- are usually a result of a mix of private and public activities pling (i.e. shaping an integrated renewable energy system) of (Lamperti et al., 2019). While the public sector is required electricity, heat and transport would support cost reductions. to set the pace, to a large extent, the private sector must provide the incentives, framework entrepreneurial spirit The framework conditions for investments are important for and funding. The private sources for funding green invest- a full supply of renewables. This requires that expansion is ment are numerous in principle: self-fi nancing, corporate neither capped nor impeded and that fi nancing conditions bond issuing, bank loans, crowdfunding and stock issu- are convenient. In addition, present subsidies for fossil ener- ance. However, public green bonds are most likely, by far, gies must be consistently reduced in all countries and, above the most important and the most effective instrument for all, no new subsidies for nuclear or fossil energies must be initiating and accelerating the great green transition (Heine granted. Due to their often weather-dependent fl uctuations et al., 2019). and fl exibilities in supply, renewable energies must be well interlinked – also by means of intelligent technology. For this Most likely, a substantial part of the risk that renewable en- and for the use of storage facilities (Zerrahn et al., 2018), mar- ergy fi rms, often SMEs, face will come from incumbents un- ket conditions must be improved by removing existing barri- willing to give up their profi t sources. When innovators are ers and by allowing for more fl exibility. trying to establish a new market, incumbent carbon-based oligopolies may erect and defend entry barriers against in- Better climate risk insurance schemes novators in renewable energy supply. This implies that the devaluation risk for fi nancial institutions with a progressive Preventive actions and buffers designed to enhance the lending and investment policy also depends on the rules that resilience against shocks are also important. Low income competition policy and public authorities design and imple- countries, regions and cities have a limited ability to issue cli- ment to keep energy markets open and contestable. mate bonds and enjoy little borrowing power. In addition to tax increases, policymakers and practitioners suggest facili- Promotion of green technologies: Towards 100% renewable tating risk pooling through self-insurance or some collective energy insurance schemes, grants from donors and disaster funds for contingencies. Yet, the issue of debt sustainability, as dis- With the Paris Agreement, participating countries are com- cussed above, also needs to be addressed. mitted to reducing global greenhouse gas emissions by up to 90% by 2050. Beyond the nationally defi ned climate pro- A broader concept of risk pooling could aim at combining tection targets of its individual member states, the EU in- mechanisms of private or public insurance schemes with tends to promote a European energy turnaround (see, e.g. multilateral safety nets and regional catastrophic insurance Hirschhausen et al., 2013). The Clean energy for all Europe- schemes. While donor grants, fi scal and fi nancial policies, ans package (European Commission, 2019) sets the frame- risk pooling as well as insurance funds are a good founda- work, aiming to promote competition for the fastest imple- tion, others suggest that monetary policy should provide mentation and the most innovative technologies. The goal is some insurance by committing to stepping in and providing to achieve nothing less than market leadership in the fi eld of liquidity for disaster-affected regions and countries with low climate-friendly technologies. In addition to energy effi ciency, incomes.

ZBW – Leibniz Information Centre for Economics 185 Climate Policy

Effective transition and international cooperation Claringbould, D., M. Koch and P. Owen (2019), Sustainable fi nance: the Euro- pean Union’s approach to increasing sustainable investments and growth The current pandemic crisis should motivate policymakers to – opportunities and challenges, in C. Kemfert, D. Schäfer, W. Semmler and A. Zaklan (eds.), Green Finance – The Macro Perspective, Vierteljahrshefte build into the recovery plan resilience measures against the zur Wirtschaftsforschung/Quarterly Journal of Economic Research, 88(2), 11- next crisis, the climate crisis.1 The view that designing and im- 27. plementing a policy mix to combat climate change is superior De Grauwe, P. (2019), Green money without infl ation, in C. Kemfert, D. Schäfer, W. Semmler and A. Zaklan (eds.), Green Finance – The Macro Perspective, to focusing on a ‘unicorn’ measure is widely accepted. Moreo- Vierteljahrshefte zur Wirtschaftsforschung/Quarterly Journal of Economic ver, relying only on market forces and hoping that pure cost- Research, 88(2), 51-54. internalisation of environmental externalities will ‘do the trick’ Diekmann, J. (2009), Renewable Energies in Europe: Ambitious Goals now being pursued consistently, DIW Weekly Report, 45. is not enough. To induce an effective transition, as well as to European Commission (2019), Clean energy for all Europeans package, htt- moderate and mitigate the various issues of confl icting inter- ps://ec.europa.eu/energy/topics/energy-strategy/clean-energy-all-euro- ests, the optimal policy should encompass fi scal instruments, peans_en (22 April 2020). Dullien, S. (2019, 18 November), Eine Investitionsagenda für Deutschland, targets and standards, public-private co-funding schemes, Makronom, https://makronom.de/eine-investitionsagenda-fuer- monetary policy, fi nancial regulation, and disclosure practic- deutschland-34164 (22 April 2020). es. Dullien, S. (2020, 7 January), Warum der Glaube in die Überlegenheit des Emissionshandels übertrieben ist, Makronom, https://makronom.de/warum-der-glaube-in-die-ueberlegenheit-des-emissionshandels-uebertrie- Another important issue to consider is how the different ben-ist-34612 (22 April 2020). measures to combat climate change can be scaled up. The Flassbeck, H. (2019), Die Schulden und die ökonomische Logik, in P. Hen- necke, D. Neuberger and D. Schäfer (2019), Schulden – Segen oder best way is to avoid non-cooperative single country actions, to Fluch?, Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Eco- facilitate risk sharing and to encourage international coopera- nomic Research, 88(4), 9-22. tion. For example, the European and North American environ- Fratzscher, M., C. Grosse-Steffen and M. Rieth (2017), Infl ation Targeting as a Shock Absorber, Banque de France Working Papers, 655. mental trading systems could be linked in the future (Erdmann Hainsch, K., T. Burandt, C. Kemfert, K. Löffl er, P.-Y. Oei and C. von Hirschhaus- et al., 2019). Linking offers various benefi ts such as effi cient en (2018), Emission Pathways Towards a Low-Carbon Energy System for carbon pricing for incentivising investment into mitigation op- Europe: A Model-Based Analysis of Decarbonization Scenarios, DIW Dis- cussion Papers, 1745. tions. Therefore, it could be one important long-term option for Heal, G. and W. Schlenker (2019), Coase, Hotelling and Pigou: The Incidence facilitating the great green transition globally. Another option is of a Carbon Tax and CO2 Emissions, NBER Working Papers, 26086. to undertake cooperative actions to accomplish a multilateral Heine, D., W. Semmler, M. Mazzucato, J. P. Braga, M. Flaherty, A. Gevorky- an, E. Hayde and S. Radpour (2019), Financing Low-Carbon Transitions carbon tax. In this way, the contentious issue of a specifi c tax through Carbon Pricing and Green Bonds, World Bank Working Paper, in countries that have no carbon tax in place can be avoided. 8991. Cooperative behaviour concerning large scale climate invest- Hirschhausen, C. von, C. Kemfert, F. Kunz and R. Mendelevitch (2013), Euro- pean Electricity Generation Post-2020: Renewable Energy Not To Be Un- ments is another example. derestimated, DIW Weekly Report, 9, 16-28. Jensen, F., S. Dorothea and A. Stephan (2019), Financial constraints of fi rms Though underinvestment is the dominating risk for the great with environmental innovation, in C. Kemfert, D. Schäfer, W. Semmler and A. Zaklan (eds.), Green Finance – Case Studies, Vierteljahrshefte zur green transition, the risk of over-investment is, of course, also Wirtschaftsforschung/Quarterly Journal of Economic Research, 88(3), 43- present; for example, into innovative fi rms that eventually fail 65. to succeed in the markets for new energies. Yet, the dangers Kemfert, C., D. Schäfer and W. Semmler (2019, 10 September), CO2-Steuer und grüne Investitionen – warum nicht beides?, Makronom, https://makro- of disruptive effects of outdated fossil fuel technology and nom.de/klimapolitik-klimakabinett-co2-steuer-und-gruene-investitionen- stranded assets are looming, with the potential to negatively warum-nicht-beides-32947. affect banking systems and fi nancial markets. The cost of a Krebs, T. (2020, 14 January), Eine gute öffentliche Infrastruktur ist das Fun- dament einer gerechten Gesellschaft, Makronom, https://makronom.de/ wait-and-see strategy rather than starting the great green eine-gute-oeffentliche-infrastruktur-ist-das-fundament-einer-gerechten- transition immediately could be high, making itself visible in gesellschaft-34698. the higher frequency (and severity) of weather extremes, cli- Mazzucato, M. and A. Roventini (2019), The Green Transition: Public Policy, Finance and the Role of the State, in C. Kemfert, D. Schäfer, W. Semmler mate disasters and, subsequently, devaluated (stranded) as- and A. Zaklan (eds.), Green Finance – The Macro Perspective, Vierteljahr- sets. shefte zur Wirtschaftsforschung/Quarterly Journal of Economic Research, 88(2), 73-88. McKibbin, W., A. Morris, A. Panton and P. Wilcoxen (2017), Climate change 1 For more information, see Climate Change Policies and COVID-19 Re- and monetary policy: Dealing with disruption, CAMA working paper series, lief Are Not Mutually Exclusive, SCEPA, 12 May 2020, https://www. 77/2017. economicpolicyresearch.org/insights-blog/climate-change-policies- Schäfer, D., A. Stephan and J. Solórzano Mosquera (2017), Family ownership: and-covid-19-relief-are-not-mutually-exclusive (26 May 2020). does it matter for funding and success of corporate innovations? Small Business Economics, 48(4), 931-951. Schäfer, D. and Klaus Zimmermann (2009), Bad bank(s) and the recapitalisa- References tion of the banking sector, Intereconomics, 44(4), 215-225, https://www. intereconomics.eu/contents/year/2009/number/4/article/bad-banks-and- Burandt, T., K. Löffl er and K. Hainsch (2018), GENeSYS-MOD v2.0 – Enhanc- the-recapitalisation-of-the-banking-sector.html (22 April 2020). ing the Global Energy System Model: Model Improvements, Framework Zerrahn A., W.-P. Schill and C. Kemfert (2018), On the economics of variable Changes, and European Data Set, DIW Data Documentation, 94. renewable energy sources, European Economic Review, 108, 259-279.

Intereconomics 2020 | 3 186 DOI: 10.1007/s10272-020-0894-0 Capital Markets Union

Georgios Pavlidis A European Mechanism for the Issuance and Initial Distribution of Debt Securities

Although the European Union (EU) has implemented initiatives and common rules regarding securities settlements, no similar integration initiatives have been proposed for the issuance and initial distribution of debt securities. The EU does not function as a single market given that issuers of euro debt instruments still have to use multiple and non-harmonised channels and procedures. A harmonised European framework for the issuance and initial distribution of debt securities or the establishment of a new European market infrastructure service is widely considered a way to create a deep and liquid single market for debt instruments. While such a paradigm shift promises signiﬁ cant improvements compared with the existing debt issuance and distribution landscape, a hasty and poorly designed public intervention would risk distorting the market, thereby increasing complexity and bringing more fragmentation.

In May 2019, the Eurosystem launched a public consulta- operations and using the local settlement system for settling tion and invited relevant market participants to provide their transactions (EC, 2003). The location of the fi nancial instru- views on the establishment of a European mechanism for the ments and that of the parties involved in a fi nancial trans- issuance and initial distribution of debt securities in the Eu- action continue to affect issuance, trading, clearing and set- ropean Union (European Central Bank [ECB], 2019b). Estab- tlement procedures. Integrating national fi nancial markets at lishing such a mechanism would have an impact not just on the EU level would require breaking this link. issuers and investors, but also on the central securities depositories (CSDs), custodians, dealers, issuing agents, pay- Thus far, the EU has implemented initiatives and common ing agents and other stakeholders who would have to learn rules regarding securities settlements. For example, the 2014 how to work with the new mechanism. regulation on central securities depositories (CSD Regula- tion; Regulation (EU) 909/2014, 2014) lays out applicable In the aftermath of the recent global fi nancial crisis, the EU rules and requirements for CSDs operating securities settle- has accelerated efforts to establish a single integrated capi- ment systems. Another example is the establishment of the tal market (European Commission [EC], 2015). An important TARGET2-Securities (T2S), a platform for securities settle- component thereof is the market for debt securities, which ments allowing for the safe and simultaneous payment and has almost tripled in the last 20 years in terms of outstand- delivery of securities (ECB, 2019c; ECB, 2018). However, in ing amounts of debt – €17,382 billion in 2019 compared with the context of the issuance and initial distribution of debt se- €6,458 billion in 1999 (ECB, 2020). Nevertheless, since 2001, curities, no similar integration initiatives have been proposed. the EU has identifi ed several problems and restrictions on Therefore, the EU does not function as a single market in this the activities of primary dealers of debt instruments, result- regard and issuers of euro debt instruments still have to re- ing in market-makers often having to set up local securities sort to multiple, non-harmonised channels and procedures.

© The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License Issuance process for debt securities: Weaknesses and (https://creativecommons.org/licenses/by/4.0/). challenges Open Access funding provided by ZBW – Leibniz Information Centre for Economics. Currently, the pre-issuance phase involves the preparation of the debt issuance and price discovery and takes place through syndication, auctioning or private placement, depending on the issuer’s choice (European Post Trade Forum, Georgios Pavlidis, Neapolis University of Pafos, 2017). Dealer banks and agents provide advice to the issuer Cyprus. and underwrite the issuance; these dealers also interact with investors and collect orders following applicable regulatory

ZBW – Leibniz Information Centre for Economics 187 Capital Markets Union

considerations, such as the know-your-customer (KYC) re- Towards a harmonised system for the issuance of debt quirements (Association for Financial Markets in Europe securities [AFME], 2019). Dealer banks may provide the proprietary tools necessary to support these activities, although techni- Harmonisation could be an avenue for creating a deep and cal facilities provided by a third party can be used as well. liquid single market for debt instruments in the EU. Con- At the end of this process, the issuer and the investors contrary to the post-trade phase, where some progress has clude an agreement on the economic terms of the securities been made in regulatory harmonisation (e.g. MiFID II, EMIR, and the trade is fi nalised. CSD Regulation, T2S; Directive 2014/65/EU, 2014; Regula- tion (EU) 648/2012, 2012), no harmonisation initiatives have Meanwhile, in the post-trade phase, debt securities are is- been implemented in the pre-issuance phase. sued in CSDs and are delivered to investors (Wendt et al., 2018). The distribution of debt securities to investors takes A new European secondary law instrument on the issuance place through intermediaries and multiple distribution chan- and initial distribution of debt securities could promote nels (AFME, 2015; SWIFT, 2017). In fact, the distribution of a standardisation and heighten connectivity between plat- new issue is “a very fi rst, short step before secondary market forms, thus improving the access of market participants to operations start” (European Central Securities Depositaries debt securities. Obviously, such a harmonised European Association, 2019). In the lifespan of the debt security, agent framework should be based on the principle of neutrality, banks represent the issuers in terms of the management of which ensures that “the desired market structure is such securities and cash accounts; that is, they collect and dis- that it does not put the location of issuance (i.e. of the issuer tribute interest payments to investors who hold fi nal balanc- CSD and its direct participants) in a privileged position over es with CSDs, local custodians or global custodians. other intermediaries and end users that wish to access the securities” (ECB, 2019a). The main weakness of the existing securities distribution channels, however, is the fact that they remain fragmented Standardisation and harmonisation could cover, among and largely national. Given the variations in national regula- other topics, rounding conventions, aligning defi nitions, tions and procedures for issuing and holding debt securities in particular standardising terminology (Deutsche Börse (Deutsche Bank [DB], 2019), investors may face unnecessary Group, 2005), but also harmonising and standardising of costs and complexity. Whereas issuers, for their part, are processes, including the auction process, order transmis- prevented from effi ciently reaching all investors on an equal sion and the order book. To avoid legal uncertainty and in- basis, especially when small debt issues are involved. Evi- consistencies, standardisation and harmonisation should dently, this should not be the case in a single capital market. cover both ends of the transaction chain, from pre-issuance to post-trade. Furthermore, due to the lack of a pan-European issuance mechanism, issuers are very likely to choose their domestic Establishing a European market infrastructure service market and local CSD. Thus, market participants located at the country of issuance might fi nd themselves in a prefer- The establishment of a new European market infrastructure ential position. Under the current fragmented regime, local service is another method for creating a deep and liquid investors are facing a smaller number of intermediaries and single market for debt instruments. A new central service lower costs of holding assets compared with foreign inves- would allow for a single pre-issuance and an initial distribu- tors (Goldberg, 2002). Such a privileged position in terms of tion process as well as ensure a level playing fi eld for euro issuance location and local participants prevents the entry of debt issuers, investors and other market participants, thus other investors – a situation that is incompatible with a single facilitating the establishment of a genuine single market. The capital market. establishment of a European market infrastructure should not serve as a substitute for harmonisation; rather, the two Finally, the lack of effi ciency by which debt securities are initiatives could be combined in such a way that they com- issued in the EU is aggravated by the insuffi cient interoper- plement each other. ability and the low level of digitalisation among the existing multiple issuance platforms (Callsen, 2018). This ‘structural For the establishment of a European market infrastructure, gap’ renders the issuance and distribution channels in the the involved parties should either adopt or endorse a multi- EU less competitive than those in other jurisdictions, such as lateral arrangement. A practical question is whether this in- the United States and Japan (ECB, 2019a). A pan-European frastructure should be offered by a private or a public entity system could address this gap, signifi cantly improve compe- and what the role of the European Central Bank (ECB) would tition and level the playing fi eld among issuers, investors and be in this context. In our view, the operation of the services other market participants. should be commercially run by the private sector, although

Intereconomics 2020 | 3 188 Capital Markets Union

some form of public-private cooperation could be useful in Advantages of a new European infrastructure service the initial stages of the project, where sponsorship by the public sector would be helpful. Through the proposed EDDI, the market participants will have access to a single, central platform that offers the ad- Two components of a European Distribution of Debt vantages of neutrality and standardisation. Therefore, the Instruments new European infrastructure service would facilitate interactions within markets. Under the 2019 Eurosystem proposal for a European Distri- bution of Debt Instruments (EDDI), a European market infra- From the issuers’ point of view, the EDDI service would en- structure service could have two components on the basis of able them to issue debt instruments that can reach investors a modular, optional and voluntary approach that would allow in the entire EU, without having to choose a specifi c loca- users to choose whether they want to use both components, tion of issuance. Thus, due to its pan-European reach, the one of them or none at all. new service could increase the liquidity of the issued securities and the geographical diversifi cation of the investor base The fi rst component of the proposed new service would be (Committee on the Global Financial System, 2019). Ultimate- a technical toolkit for the pre-issuance phase which would ly, the new service can help promote the effi ciency and at- allow “the communication of an upcoming debt issue, the tractiveness of the issuance of euro debt securities. creation of the order book, the collection of orders from investors and the allocation of the debt instrument issuance From the investors’ point of view, the proposed EDDI service to these orders” (ECB, 2019a). These functionalities can be would offer a single and standardised communication chan- automated and made available to issuers, issuer agents and/ nel for all instruments offered through it; it would facilitate or dealer banks, although there will still be interactions (e.g. interactions and information fl ows between investors and negotiation, consultation, advice) that, by their nature, can- issuers. This would constitute a signifi cant improvement not be part of an automated process. Furthermore, a ‘multi- compared with the multiple, non-standardised channels and currency functionality’ must be developed as it would allow interfaces that are currently available. EDDI to become a ‘one-stop shop’ for borrowers that issue debt both in euro and other currencies. From the custodians’ point of view, the EDDI service would facilitate interactions within the custody chain (Chan et al., The second component would offer functionalities for the 2007; International Securities Services Association, 2017). post-trade phase of debt securities. In particular, it would re- Under the proposed framework, the main criteria for choos- ceive the fi nal allocation from the previous phase and then ing a CSD will be the level of the service and the cost and distribute the newly issued debt instruments via collaborat- not the location of issuance. Custodians will no longer have ing CSDs connected to the system. Notary service could to use a multiplicity of CSDs for European issuances (DB, also be provided, particularly regarding the integrity of the 2019), and for this reason, the EDDI would help them opti- issuance’s global amount. For the life cycle of the securities, mise the custody of debt instrument holdings. the post-trade component would support information fl ows and interest payments and enable secondary market trans- Potential areas of confl ict actions involving different CSDs. Synergies with CSDs could be developed within the framework of the TARGET servic- The 2019 Eurosystem proposal makes clear that EDDI does es, including the T2S auto-collateralisation function (Clear- not aim to compete with existing intermediaries (agents, stream, 2017). dealer banks, custodians, etc.) or force a disintermedia- tion. Intermediaries could resort to EDDI services, opting to The use of the new system should remain optional and not use both, one or none of its modules; they do not need to mandatory, that is, the market participants should be given abandon their own proprietary procedures. Nevertheless, the opportunity to decide whether EDDI’s advantages weigh this would require two things: on the one hand, an EDDI pre- in favour of its use and provide value for money. The two issuance component should be designed to support post- aforementioned modules could be introduced in two sepa- trade outside EDDI; on the other hand, an EDDI post-trade rate stages, beginning with the post-trade platform that al- component should be designed in such a way that it allows ready enjoys support from market participants (International connectivity and linking with private pre-issuance platforms Capital Market Services Association, 2019). In any event, the – whether existing or newly established. functioning of the single fi nancial market requires that access to the new system should not be restricted to certain We argue that EDDI should not distort completion nor dis- categories of issuers (e.g. supranational, sovereign, sub-sov- courage the development of alternative market solutions. ereign issuers) nor to certain CSDs. However, it must be admitted that, even if EDDI is designed

ZBW – Leibniz Information Centre for Economics 189 Capital Markets Union

to be voluntary, the risk that it would gain a dominating po- suance and distribution channels outside EDDI, depending sition remains, especially if it is set up as an ofﬁ cial sector on the issuer’s strategies. In this case, market participants facility, given that market participants will be under pres- should “in principle beneﬁ t from the positive externalities of sure to prefer it over other alternatives. the EDDI harmonisation agenda” (ECB, 2019a).

In any case, EDDI will change the way market participants Inclusion of market participants to ensure support for operate, in particular CSDs. If securities are issued through EDDI EDDI, the CSD’s ranking in the custody chain will no longer be so relevant, i.e. whether the CSD acts as ‘issuer’ or Despite the advantages, however, two more issues need to ‘investor’ for the issuance in question. Therefore, on the be addressed in EDDI’s design. Firstly, the market partici- downside, the CSD will sacrifi ce exclusivity over the prima- pants should be involved in the future governance of EDDI ry deposit as established by the location of issuance. The to ensure that the costs for users will be acceptable and upside, however, is that the CSD will gain access to numer- kept under control. Secondly, EDDI’s design should ad- ous securities issued through EDDI on an equal basis, thus dress market concerns about “access [...] to confi dential creating a level playing fi eld with no location exclusivities. data regarding investors and their relevant trading activity” (International Capital Market Association, 2019). Finally, if the ECB is involved in the operation of the EDDI platform, concerns about potential confl icts of interests Harmonisation initiatives and pan-European projects, such must be addressed as the ECB’s holdings include euro area as the proposed EDDI, are often attractive in theory and bonds as well as sovereign and corporate asset backed give rise to interesting debates at the academic and policy securities. Similarly justifi ed concerns were raised over the levels; however, they are diffi cult to implement in practice International Monetary Fund’s dual role as creditor and host and are met with scepticism by the actual market partici- of a dispute settlement forum in the context of the 2001 pants (International Capital Market Services Association, proposal for a Sovereign Debt Restructuring Mechanism 2019). The establishment of an EDDI promises signifi cant (SDRM), a project that was later abandoned (Krueger, 2002; improvements compared to the existing debt issuance and International Monetary Fund, 2002). In our view, the ECB distribution landscape; nevertheless, a hasty and poorly should not be involved at all in the operation of EDDI or, at designed public intervention would risk distorting the mar- the very least, stringent safeguards should be introduced ket, thereby increasing complexity and leading to more so that the ECB does not gain an information advantage fragmentation (European Central Securities Depositaries over other market participants. Association, 2019). For this reason, the detailed design and actual implementation of the new system must consider EDDI to drive transparency and harmonisation and subsequently address the concerns of market participants. In doing so, the new system may gain support from The issuance of debt in euro would be considerably im- and consensus amongst the largest possible spectrum of proved by the establishment of a pan-European system. As stakeholders who will be called to work with the new sys- the Managing Director of the European Stability Mechanism tem. has correctly pointed out, “a single system to distribute sovereign bonds would offer investors – especially international investors – more transparency and ease access for them” References (Regling, 2018). In the United States, a single system is in Association for Financial Markets in Europe (2015), Post Trade Explained: The place with the New York Fed acting as the fi scal agent of the Role of Post-Trade Services in the Financial Sector. federal government, conducting auctions and performing Association for Financial Markets in Europe (2019), AFME response to the ECB market consultation on a potential mechanism for the issuance and initial auction-related settlements (Federal Reserve Bank of New distribution of debt securities in the European Union (EDDI). York, 2019). Establishing EU rules on the issuance and initial Braeckevelt, F. (2006), Clearing, settlement and depository issues, in Bank distribution of debt securities could eventually lead to a sin- for International Settlements, Asian bond markets: issues and prospects, BIS Papers, 30. gle system for sovereign and sub-sovereign bond auctions, Callsen, G. (2018), Electronifi cation in Primary Bond Markets, Quarterly Re- following the US model. Such an initiative can also foster port, International Capital Market Association, 50(third quarter), 26-27. harmonisation in other fi elds, such as sovereign bond terms Chan, D., F. Fontan, S. Rosati and D. Russo (2007), The Securities Custody Industry, ECB Occasional Paper, 68. and conditions. Clearstream (2017), The Future of Global Debt Issuance, 2025 Outlook. Committee on the Global Financial System (2019), Establishing Viable Capital In our view, the establishment of EDDI would constitute an Markets, Bank for International Settlements, CGFS Papers, 62. Deutsche Bank (2019), Transitioning into the future of securities post-trade, important development towards the Capital Market Union. White Paper. As EDDI would adopt a modular, voluntary and optional ap- Deutsche Börse Group (2005), The European Post-Trade Market: An Introduc- proach, market participants may continue to use existing is- tion, White Paper.

Intereconomics 2020 | 3 190 Capital Markets Union

Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in fi nancial instruments (MiFID II), Offi cial Journal of the European Union, L173, 349-496. European Central Bank (2018), T2S: One year of full operation, T2S Special Series, 7. European Central Bank (2019a), Market consultation on a potential Eurosystem initiative regarding a European mechanism for the issuance and initial distribution of debt securities in the European Union, https://www.ecb.europa. eu/paym/pdf/consultations/market_consultation_on_european_distribu- tion_of_debt_securities.en.pdf (15 March 2020). European Central Bank (2019b), Public consultations, https://www.ecb.europa.eu/paym/cons/html/index.en.html (10 March 2020). Sign up for European Central Bank (2019c), What is TARGET2-Securities (T2S)?, https:// www.ecb.europa.eu/paym/target/t2s/html/index.en.html (15 March 2020). European Central Bank (2020), Statistical Data Warehouse, Debt securities, the bimonthly http://sdw.ecb.int/browse.do?node=9691433 (14 March 2020). European Central Securities Depositaries Association (2019), ECSDA Re- Intereconomics sponse to ECB market consultation related to EDDI. European Commission (2001), Cross-border Clearing and Settlement Arrange- ments in the European Union, First Giovannini Report, https://ec.europa. newsletter eu/info/publications/giovannini-reports_en (14 March 2020). European Commission (2003), EU Clearing and Settlement Arrangements, Second Giovannini Report, https://ec.europa.eu/info/publications/giovannini-reports_en (14 March 2020). European Commission (2015), Action Plan on Building a Capital Markets Un- ion, COM(2015) 468 fi nal, https://ec.europa.eu/transparency/regdoc/ rep/1/2015/EN/1-2015-468-EN-F1-1.PDF (13 March 2020). European Commission (2017), Communication on the mid-term review of the capital markets union action plan, COM(2017) 292 fi nal, https://ec.europa. eu/info/sites/info/fi les/communication-cmu-mid-term-review-june2017_ en.pdf (13 March 2020). European Post Trade Forum (2017), EPTF Report, Annex 3, https://ec.europa. eu/info/sites/info/fi les/170515-eptf-report-annex-3_en.pdf (15 March 2020). Federal Reserve Bank of New York (2019), Treasury Debt Auctions and Buy- backs as Fiscal Agent, https://www.newyorkfed.org/markets/treasury- debt-auctions-and-buybacks-as-fi scal-agent. Goldberg, L., J. Kambhu, J. M. Mahoney, L. Radecki and A. Sarkar (2002), Securities Trading and Settlement in Europe: Issues and Outlook, Federal Reserve Bank of New York, Current Issues in Economics and Finance, 8(4). International Capital Market Association (2019), EDDI – Market consultation on a potential Eurosystem initiative regarding a European mechanism for the is- Stay up to date on suance and initial distribution of debt securities in the European Union. International Capital Market Services Association (2019), Response to Mar- ket consultation on a potential Eurosystem initiative regarding a European ࠮>PKLYHUNPUNKLIH[LZ mechanism for the issuance and initial distribution of debt securities in the European Union. VUJ\YYLU[,\YVWLHU International Monetary Fund (2002), IMF Board Discusses Possible Features of a New Sovereign Debt Restructuring Mechanism, IMF Public Informa- LJVUVTPJHUKWVSP[PJHS tion Notice. International Securities Services Association (2017), Inherent Risks within the PZZ\LZ Global Custody Chain. Krueger, A. (2002), A New Approach to Sovereign Debt Restructuring, Interna- tional Monetary Fund. ࠮;OLSH[LZ[THJYVLJV Regling, K. (2018), The future of the Economic and Monetary Union and the role of the ESM, https://www.esm.europa.eu/speeches-and-presentations/ UVTPJHUHS`ZPZHUK future-economic-and-monetary-union-and-role-esm-speech-klaus- regling (15 March 2020). JVTTLU[HY` Regulation (EU) 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC ࠮;YHUZH[SHU[PJLJVUVTPJ and 2014/65/EU and Regulation (EU) No. 236/2012, Offi cial Journal of the European Union, L257, 1-72. HUHS`ZPZPU[OL3L[[LY Regulation (EU) 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade reposito- MYVT(TLYPJH ries (European market infrastructure regulation – EMIR), Offi cial Journal of the European Union, L201, 1-59. SWIFT (2017), Rewiring securities post-trade: Challenges and opportunities in the new order, White Paper. → Sign up today at Wendt, F., P. Katz and A. Zanza (2018), Organizing Central Securities De- www.intereconomics.eu/newsletter.php positories in Developing Markets: 7 Considerations, IMF Working Paper, WP/18/66.

ZBW – Leibniz Information Centre for Economics 191 Technical Progress DOI: 10.1007/s10272-020-0899-8

Stéphane Ciriani and François Jeanjean* Competition, Technological Change and Productivity Gains: A Sectoral Analysis

The empirical relationship between competition intensity and the rate of productivity growth across 30 sectors of the French economy between 1978 and 2015 displays an inverted U-shape. This implies that there exists an optimal level of competition for each sector, deﬁ ned by the price markup that maximises the growth rate of hourly labour productivity. As there is a signiﬁ cant and strong positive correlation between optimal markups and technical progress rates in each sector, it follows that sectors with high technical progress require higher markups to maximise their labour productivity growth rate. The persistence of non-optimal markups in French sectors is associated with a 0.4% loss in aggregate annual labour productivity growth during the period (1.86%). French long-term productivity growth could have reached 2.25% had markups been at their optimal level. As a result, policies to foster innovation and productivity should aim at enabling the optimal level of markup (or market power), particularly in high-innovation sectors.

Recent research has produced evidence that the rela- in competition intensity harms labour productivity growth. tionship between competition intensity and innovation is These optimal markups are strongly correlated with the nonlinear and depends upon the characteristics of mar- sector rate of technical progress and maximise the growth kets and sectors (Aghion et al., 2013; Schmutzler, 2013). rate of labour productivity in each sector. Sectors with An increase in competition intensity (equivalently, a lower higher rates of technical progress thus have higher opti- markup over marginal cost or over the perfect competi- mal markups. Such sectors necessitate suffi ciently high tion price)1 can lead to diverging effects on innovation. In markups to maximise their labour productivity growth. A line with the prediction that competition above a certain long-term disconnect between actual and optimal sector level can discourage innovation (Aghion et al., 2005; Bouis markups would be detrimental to aggregate labour pro- and Klein, 2008), we fi rst show that in the French economy ductivity growth. Some sectors, such as digital sectors, (30 sectors observed) over the period 1978-2015, markups are more conducive to technical progress than others and and hourly labour productivity growth exhibit an inverted require higher investment and hence a higher markup to U-shaped relationship. We then estimate the sector-spe- maximise their labour productivity growth. cifi c markup thresholds beyond which any further increase Estimation strategy

© The Author(s) 2020. Open Access: This article is distributed under the The estimation strategy to demonstrate that the empiri- terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). cal relationship between competition (markups) and the Open Access funding provided by ZBW – Leibniz Information Centre rate of labour productivity growth is specifi c to each sec- for Economics. tor and can be represented by an inverted U-shaped * The views expressed do not necessarily refl ect those of the institu- curve is as follows: fi rst, actual sector markups are esti- tions with which the authors are affi liated. mated following the methodology of Roeger (1995). Sec- 1 The markup also refl ects market power, as the ability of a fi rm to set ond, a nonparametric identifi cation of the relationship a price above its marginal cost. It represents the difference between prices under imperfect and perfect competition. A higher markup im- between markups and labour productivity growth rates plies lower competition intensity. Conversely, a lower markup implies provides evidence of an inverted U-shape when sectors higher competition intensity. are grouped according to their rate of technical progress. Third, we estimate an econometric model showing that the inverted U relationship between competition and pro- Stéphane Ciriani, Orange, Paris, France. ductivity growth is signifi cant.2 This allows the calcula-

François Jeanjean, Orange, Paris, France. 2 We use a quadratic speciﬁ cation in which the parameters depend on each sector.

Intereconomics 2020 | 3 192 Technical Progress

tion of the markup that maximises the inverted U curve Figure 1 for each sector (the optimal markups). Fourth, a strong Hourly labour productivity growth and markups by positive and signifi cant correlation between the optimal sector markups and the technical progress rates in each sector Annual growth rate is evidenced based on our own computation of the av- % 14 erage level of Hicks-neutral technical progress for each 12 sector.3 This result suggests that a sector with a higher 10 technical progress rate requires a higher optimal markup 8 6 to maximise its own rate of labour productivity growth. 4 Finally, the correlation between technical progress and 2 optimal markups is used to estimate the losses in pro- 0 -2 ductivity growth due to unsuitable markups in each sector -4 during the whole period. -6 -8 -10 Data sample: 30 sectors of the French economy ob- -12 served during 1978-2015 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 Sector markup The OECD database for structural analysis (STAN data- Source: Authors’ own elaboration. base) and the French national accounts system (INSEE) are used to analyse 30 sectors of the French economy seven periods), and each point on the fi gure represents (manufacturing, energy, construction, market services a sector observed during each of the seven specifi c pe- and public administration) over the period 1978-2015.4 riods. The markups are estimated for each of the 30 sectors for seven periods with an average fi ve-year duration, which At fi rst glance, the scatter plot does not provide any ob- provides 210 estimated markups. Seven periods are con- vious or robust result regarding the link between com- sidered: the 1st period (1978-1984), the 2nd period (1985- petition and productivity growth. However, by grouping 1989), the 3rd period (1990-1994), the 4th period (1995- sectors according to their level of technical progress, it 1999), the 5th period (2000-2004), the 6th period (2005- appears that an inverted U-shaped relationship actually 2009) and the 7th period (2010-2015). Each period’s dura- characterises the effect of markups on the rate of hourly tion derives from a trade-off between the accuracy of the labour productivity growth (Figure 2). This graph sug- markup estimations and the number of periods that pro- gests that the relationship between competition intensity vides the largest number of observations. Indeed, longer and labour productivity growth may vary across sectors periods improve the accuracy of markup estimations but subject to their specifi c rate of technical progress. Hence, reduce the number of periods and thus, the number of markups over marginal costs or perfect competition observations. The compound annual growth rate of hour- prices could be related to sector-specifi c characteristics, ly labour productivity is computed for each of the seven meaning that higher markups do not necessarily imply the periods. existence of static monopoly rents.

A nonparametric identifi cation of the markup and Figure 2 provides a scatter plot of four smoothed moving labour productivity growth rate relationship averages. Each curve represents a set of sectors grouped according to their technical progress rate. The smoothed As a fi rst approach, the relationship between competition moving average is computed as follows: a point defi ned and productivity growth can be represented by a scat- by markup xi and annual productivity growth yi , denoted ter plot of the sector markups and the compound annual (xi , yi ), is shifted to point (Xi , Yj ) following: growth rate of hourly labour productivity during the seven periods running from 1978 to 2015 (Figure 1). The scat- i + b i + b X = 1 x and Y = 1 , i Σ j i Σ yj ter plot shows 210 points (30 sectors observed during the 2b + 1j = i - b 2b + 1 j = i - b

with (i, j) {1, ..., n}, where n is the number of observa- 3 The Hicks-neutral technical progress is derived from the markup- adjusted Solow residual following the methodology applied in Roeger tions of a set of sectors and b is the bandwidth of the (1995). This methodology is also applied in Bouis and Klein (2008). smoothing. We use n = 42 for the three sets with the 4 The price deﬂ ator for gross ﬁ xed capital formation for the French highest rate of technical progress (‘High technical pro- economy and the real long-term interest rate, which are used to compute the cost of capital, are retrieved from the AMECO database of gress’, ‘Medium-high technical progress’ and ‘Medium- the European Commission. low technical progress’) and n = 84 for the ‘Low techni-

ZBW – Leibniz Information Centre for Economics 193 Technical Progress

Figure 2 my variable is associated with the squared markup term, Relationship between hourly labour productivity which allows the estimated coefﬁ cient to vary across sec- growth and markup according to the level of tors. The following Equation (1) technical progress 2 (1) Annual hourly productivity growth (smoothed moving average) CAGRprodip = c + αi di markupip + β markupip + intbub + λdp + εip % 6 High technical progress is estimated where i {1, 2, ..., 30} is the index of the sec-

5 tor, p {1, 2, ..., 7} is the index of the period, CAGRprodip is the compound annual growth rate of production at current 4 prices of sector i, markupip is the estimated markup for 3 Medium-high technical progress sector i and intbub is a dummy variable that captures the 2 impact of the Internet bubble, which might have affected the information technology sectors during the fi fth period 1 Medium-low technical progress (2000-2004). During the fi fth period, intbub = 1 (intbub = 0 0 otherwise) for each sector in the information technology -1 category, which includes ‘Computer, electronic and opti- Low technical progress cal products’, ‘Publishing, audio-visual and broadcasting -2 1.0 1.1 1.2 1.3 1.4 1.5 1.6 activities’, and ‘Telecommunications; IT and other infor- Sector markup (smoothed moving average) mation services’. In this equation, the individual (sector) Note: ‘High technical progress’ set groups together sectors with a techni- fi xed effects have been removed to avoid interactions with cal progress rate higher than 2.5%; ‘Medium-high technical progress’ set the dummy indicator. The term d represents the dummy groups sectors with a rate between 2.5% and 1.86%; the ‘Medium-low i technical progress’ set groups sectors with a rate between 1.86% and indicator of sector i, dp is a period fi xed effect, β is the co- 1.5%; and the ‘Low technical progress’ set groups sectors with a rate effi cient of the markup that is common to all sectors, αi is lower than 1.5%. the coeffi cient of the squared markup specifi c to sector i, Source: Authors’ own elaboration. c is a constant and εip is the residual. The optimal markup for sector i is then determined by the following term:

cal progress’ set.5 The smoothing of the moving averages ^ markup_max = - β . reduces the volatility of the observations and reveals the i ^ 2αl trends of the effects of markups on productivity growth. Each smoothed moving average exhibits an inverted U- As a result, the corresponding maximum level of hourly shape with a peak corresponding to a higher markup for productivity growth is defi ned by higher technical progress. Indeed, the peak of the ‘Low 2 technical progress’ set is reached for a markup close to ^ CAGRprod_max = c^ - β . 1.10; the peak of the ‘Medium-low technical progress’ i ^ 4αl set is reached for a markup close to 1.15; the peak of the ‘Medium-high technical progress’ set is reached for a The results of the estimation are presented in Table 1. The markup close to 1.24; and the peak of the ‘High technical fi rst column provides the explanatory variables; the sec- progress’ set is reached for a markup close to 1.34. This ond column provides the estimated coeffi cients of Equa- result suggests that an increase in the rate of technical tion (1) with detailed sector-specifi c squared markups; progress in turn increases the markup level that maxim- the third column provides the associated standard error; ises the hourly productivity growth of the sector. the fourth column provides the optimal markup for each sector, calculated on the basis of the estimated markup Estimation of optimal sector markups coeffi cients; the fi fth column provides the associated standard error; the sixth column provides the annual av- The optimal levels of markup in each of the 30 sectors erage growth rate of maximised labour productivity; and are obtained by estimating an econometric model based the last column provides the associated standard error. on a quadratic function. This specifi cation allows for the The values of the fourth and sixth columns are calculated estimation of the effect of variations in the markups on the with the ‘delta method’. The estimated coeffi cient of the rate of labour productivity growth for each sector. A dum- markup term is signifi cant. The estimated coeffi cients of the squared markup terms are signifi cant for all sectors, with the exception of a single sector for which the coeffi - 5 Six sectors are represented in the three fi rst sets and 12 sectors in the fourth set, as in the fourth set the differences among sectors are not cient is nevertheless close to the 10% signifi cance thresh- suffi cient to distinguish them into two subsets. old. The estimated coeffi cients of the optimal markups are

Intereconomics 2020 | 3 194 Technical Progress

Table 1 Estimations result: Markup and hourly labour productivity growth

Dependent variable: Hourly productivity growth CAGRprod Standard Standard Standard

Explanatory variables coeff. error markupmax error CAPRprodmax error markup 0.2428** (0.0962) markup2 Sector (OECD code) D05T09 Mining and quarrying -0.1051*** (0.0375) 1.1546*** (0.1308) 0.0003 (0.0095) D10T12 Food products, beverages and tobacco -0.1020*** (0.0372) 1.1902*** (0.1474) 0.0046 (0.0046) D13T15 Textiles, wearing apparel, leather and related products -0.0816** (0.0370) 1.4874*** (0.2697) 0.0407** (0.0205) D16T18 Wood and paper products, and printing -0.0836** (0.0371) 1.4521*** (0.2220) 0.0364*** (0.0132) D19 Coke and refi ned petroleum products -0.0994** (0.0477) 1.2211*** (0.3729) 0.0083 (0.0411) D20T21 Chemical and pharmaceutical products -0.0779** (0.0375) 1.5576*** (0.2424) 0.0492*** (0.0143) D22T23 Rubber and plastics products, and other non-metallic mineral -0.0840** (0.0371) 1.4457*** (0.2043) 0.0356*** (0.0103) products D24T25 Basic metals and fabricated metal products, except machinery -0.0910** (0.0370) 1.3336*** (0.1808) 0.0220*** (0.0079) and equipment D26 Computer, electronic and optical products -0.0622 (0.0381) 1.9531*** (0.5329) 0.1032*** (0.0383) D27 Electrical equipment -0.0853** (0.0384) 1.4234*** (0.2205) 0.0329** (0.0160) D28 Machinery and equipment -0.0799** (0.0372) 1.5188*** (0.2477) 0.0445*** (0.0159) D29T30 Transport equipment -0.0807** (0.0376) 1.5048*** (0.2774) 0.0428*** (0.0219) D31T33 Furniture; other manufacturing; repair and installation of machin- -0.0770** (0.0371) 1.5756*** (0.2924) 0.0514** (0.0211) ery and equipment D35 Electricity, gas, steam and air conditioning supply -0.0833** (0.0354) 1.4578*** (0.1096) 0.0371*** (0.0090) D36T39 Water supply; sewerage, waste management and remediation -0.1011*** (0.0381) 1.2006*** (0.1668) 0.0059 (0.0156) activities D41T43 Construction -0.1057*** (0.0371) 1.1487*** (0.1571) -0.0005 (0.0056) D45T47 Wholesale and retail trade, repair of motor vehicles and motorcy- -0.0954** (0.0371) 1.2724*** (0.1483) 0.0146*** (0.0046) cles D49T53 Transportation and storage -0.0837** (0.0375) 1.4506*** (0.2184) 0.0362** (0.0143) D55T56 Accommodation and food service activities -0.1120*** (0.0371) 1.0836*** (0.1394) -0.0083* (0.0048) D58T60 Publishing, audiovisual and broadcasting activities -0.1054*** (0.0377) 1.1515*** (0.1368) 0.0059 (0.0056) D61 Telecommunications -0.0691** (0.0333) 1.7579*** (0.1948) 0.0795*** (0.0112) D62T63 IT and other information services -0.1096*** (0.0377) 1.1081*** (0.1344) 0.0006 (0.0084) D64T66 Financial and insurance activities -0.0929** (0.0373) 1.3061*** (0.1429) 0.0187*** (0.0071) D69T71 Legal and accounting activities; activities of head offi ces; man- -0.1071*** (0.0361) 1.1337*** (0.1839) -0.0023 (0.0070) agement consultancy activities; architecture and engineering activities; technical testing and analysis D72 Scientifi c research and development -0.1018*** (0.0370) 1.1920*** (0.1081) 0.0048 (0.0066) D73T75 Advertising and market research; other professional, scientifi c -0.1010*** (0.0374) 1.2023*** (0.1637) 0.0061 (0.0088) and technical activities; veterinary activities D77T82 Administrative and support service activities -0.1129*** (0.0372) 1.0750*** (0.1193) -0.0094 (0.0072) D84T88 Public administration and defence; compulsory social security; -0.1059*** (0.0374) 1.1460*** (0.1397) -0.0008 (0.0045) education; human health and social work activities D90T93 Arts, entertainment and recreation -0.1059*** (0.0396) 1.1461*** (0.1541) -0.0008 (0.0043) D94T96 Other service activities -0.1062*** (0.0389) 1.1427*** (0.1480) -0.0012 (0.0118) intbub 0.0421* (0.0225) Period fi xed effects yes Sector fi xed effects no Constant -0.1424** (0.0645) R2 0.487 Observations 210

Notes: Signiﬁ cant at 1%(***), 5%(**) and 10%(*). Robust standard errors in parentheses.

Source: Authors’ own calculation.

ZBW – Leibniz Information Centre for Economics 195 Technical Progress

Figure 3 occurs through investment, a higher rate of technical pro- Correlation between optimal markups and total gress strengthens the Schumpeterian effect more than the productivity growth by sector ‘escape competition’ effect. As a result, the trade-off in a sector with a higher rate of technical progress tends to shift Optimal markup 2.0 towards higher markups (Jeanjean, 2020). 1.9 1.8 Labour productivity losses due to unsuitable markups 1.7 1.6 In the previous section, we calculated the optimal markup 1.5 for each sector. This means that when the markup is above 1.4 or below this level, productivity growth is not reaching its 1.3 maximum level. The gap between observed productivity 1.2 growth and maximum productivity growth can be consid- 1.1 ered a productivity loss. To estimate the productivity losses 1.0 -4% -2% 0% 2% 4% 6% 8% for each sector in each period, it is necessary to compute, Rate of technical progress on the one hand, the difference in each period and for each Source: Authors’ own elaboration. sector between the actual markup and the optimal markup:

markupip = markupip - markupmaxi . all highly signiﬁ cant. As a result, the estimates conﬁ rm a nonlinear, inverted U-shaped relationship between com- On the other hand, it is necessary to compute the differ- petition and labour productivity, which captures the actual ence between the hourly labour productivity growth rate rate at which technical progress is adopted in the economy. and the maximum labour productivity growth rate, which is simply the difference between the hourly labour pro- The optimal markup is strongly correlated with the ductivity growth and the rate of productivity growth that is rate of technical progress achieved when markups coincide with their optimal levels in each sector: Figure 3 represents the correlation between the optimal

markup and the average rate of technical progress (denot- CAGRprodip = CAGRprodip - CAGRprodmaxi . ed θg) for each sector.

If markupmaxi is the optimal markup, one can expect that the

The line indicates the linear ﬁ t of the scatter plot. The cor- ﬁ rst difference CAGRprodip is increasing when markupip < 0

relation coeffi cient between the sector-specifi c optimal and decreasing when markupip > 0. Hence, an increase in markup and the rates of technical progress is 0.67, which the variation rate of markups leads to a decrease in the vari- is above the 1% signifi cance threshold (0.416), for the 30 ation rate of labour productivity. Figure 4 presents the varia- observations. The correlation between average markups tions in hourly labour productivity growth as a function of the and the technical progress rate is positive but weakly sig- markup over perfectly competitive prices. nifi cant. In other words, average markups are weakly correlated with technical progress, while the optimal markups The scatter plot points to the impact of the difference be- that we calculated are strongly correlated with technical tween the actual sector markups and the optimal markups progress. Such a strong correlation suggests that sectors on the growth rate of labour productivity. The origin point of experiencing higher rates of technical progress require the graph represents the estimated optimal markup and the higher optimal markups to maximise their productivity corresponding hourly productivity growth for each sector. growth rate. An upward or downward deviation from this optimal markup results in a decrease in the rate of hourly labour productivity Indeed, labour productivity growth refl ects improvements growth. Equation (2) allows for an estimation of the losses in production techniques, which require investment. in productivity growth caused by unsuitable markups. Markups have two contrary effects on investment. On the (2) one hand, they tend to reduce investment, in line with the CAGRprodip = c + |markupip | + β intbub + λ dp + εip ‘escape competition’ effect. On the other hand, they tend to increase investment, in line with the Schumpeterian ef- The Internet bubble may have increased productiv- fect. The markup that maximises investment refl ects an ity growth in the information technology sector during the underlying trade-off between those two effects in each fi fth period (2000-2004) independently of the markup lev- sector. As the productivity impact of technical progress els. This effect can be corrected with the dummy variable

Intereconomics 2020 | 3 196 Technical Progress

Figure 4 Table 2 Optimal markup and maximum hourly labour Check of optimal markup estimations productivity growth Dependent variable: CAGRprod-CAGRprodmax CAGRprod 0.10 Speciﬁ cation (1) (2) (3) 0.08 |markup| - 0.0345*** - 0.0377*** - 0.0373*** 0.06 (0.0108) (0.0090) (0.0091) 0.04 intbub - 0.0306* - 0.0297* 0.02 (0.0171) (0.0177) 0 Period ﬁ xed effects No No Yes

-0.02 Constant 0.0013 0.0014 0.0037 -0.04 (0.0027) (0.002) (0.003) -0.06 R2 0.0555 0.0818 0.1782 -0.08 Observations 210 210 210 -0.10 -0.12 -1.0 -0.5 0 0.5 Notes: ***Signiﬁ cant at 1%, **5% and *10%. Robust standard errors in markup-markupmax parentheses.

Source: Authors’ own elaboration. Source: Authors’ own elaboration.

Average annual productivity losses for each sector intbub, introduced in Equation (1). The term markupip may be either positive or negative depending on the period. The absolute value of the difference between the actual and Differences between actual and optimal levels of markups the optimal level of markup in each sector allows to anal- entail losses in labour productivity growth. It is possible sye the impact of the distance from these sector-specifi c to estimate the average annual labour productivity growth optimal markups on the growth rate of labour productiv- that is lost due to unsuitable markup levels in each sector ity, irrespective of the sign of the difference. The equation between 1978 and 2015. First, it is necessary to compute is estimated for fi rst differences of the dependent variable, the mean of the differences between observed markups i.e. the hourly labour productivity growth rate. and optimal markups. However, as these differences may be positive in some periods and negative in others, it is The results are presented in Table 2, which provides ordi- necessary to compute the fi rst differences in absolute val- nary least squares estimates of Equation (2). Specifi cation ues: (1) does not include the dummy variable that captures the effect of the Internet bubble, whereas specifi cations (2) and mean markup = 7 | markup | / 7 . i Σp=1 ip (3) include it. The coeffi cient of |markup |, as expected, is negative and signifi cant in all specifi cations, which confi rms that hourly labour productivity growth decreases as Second, we calculate the mean of the differences be- soon as markups deviate from their estimated optimal lev- tween observed productivity growth and maximum pro- els. The loss of productivity growth is estimated on aver- ductivity growth: age at 0.373% for a deviation of 0.1 points from the optimal 7 markup. In specifi cations (2) and (3), the Internet bubble mean CAGRprod = CAGRprod / 7 . i Σp=1 ip dummy has a positive and signifi cant coeffi cient. In sum- mary, there exists a markup that maximises the growth rate of hourly labour productivity growth for each sector. Hence, Figure 5 presents the productivity losses due to unsuit- a difference between the actual level of markups and the able markups. This graph shows that hourly labour pro- optimal markups in a given sector induces a divergence be- ductivity growth decreases when the markups deviate tween the observed productivity growth rate and the maxi- from their optimal levels. The correlation between the av- mum productivity growth rate. Figure 3 suggests that the erage distance from the optimal markup and the loss of rate of technical progress determines the potential produc- productivity growth is highly signifi cant. The coeffi cient tivity growth that could be achieved by an optimal markup, of determination is R2 = 0.86. The impact of the produc- and Figure 4 shows that a deviation from this optimal tivity loss on the global economy can be estimated by markup prevents the realisation of full productivity growth. weighting each sector by its share of the global economy.

ZBW – Leibniz Information Centre for Economics 197 Technical Progress

Figure 5 to the digital transformation of the economy, driven by the Productivity losses due to unsuitable markups development of algorithms and data in all industries. Our Annual loss of productivity growth research advocates that the assessment of competition in- % tensity should take into account the technological progress 1 measured in each sector. In digital sectors, specifi cally, 0 the rate of innovation is high, and the trend of productivity -1 growth is essentially driven by investment in technologies (dynamic effi ciency) rather than price competition, which -1 hinders markups above perfectly competitive prices (static -2 effi ciency; Jeanjean, 2015; Houngbonon and Jeanjean, -2 2016). In such sectors, higher prices do not necessarily refl ect higher monopoly rents, and higher markups may re- -3 fl ect the expected return on risky investment in innovation -3 (Ciriani and Lebourges, 2016). -4 0 0.2 0.4 0.6 0.8 Competition policies that aim at lowering prices to mar- Average distance from optimal markup ginal costs (i.e. eliminating market power) could shift com- Source: Authors’ own elaboration. petition intensity beyond its optimal level and thus impede the expected profi t margins necessary to sustain current Empirical results on productivity losses due to and future investments in innovation. In sectors with a unsuitable markups high innovation rate, investments in technologies may be curtailed due to markups below the optimal level. Moreo- The relationship between markups and the rate of labour ver, reduced investment in technologies in these sectors productivity growth across 30 sectors of the French econ- should also have a negative impact on other sectors. omy over the period 1978-2015 has an inverted U-shaped form, which implies that there is an optimal markup for each sector. These markups depend on the sector-specifi c rate References of technical progress: sectors with higher rates of technical Aghion, P., N. Bloom, R. Blundell, R. Griffi th and P. Howitt (2005), Compe- progress require higher markups to maximise their labour tition and innovation: An inverted-U relationship, The Quarterly Journal productivity growth. A markup that differs from its optimal of Economics, 120(2), 701-728. Aghion, P., U. Akcigit and P. Howitt (2014), What do we learn from Schum- level tends to reduce the growth rate of labour productivity. peterian growth theory?, in P. Aghion and S. Durlauf (eds.), Handbook of economic growth, Vol. 2, 515-563, Elsevier. The average annual loss of productivity growth due to un- Arrow, K. J. (1962), Economic Welfare and the Allocation of Resources of Innovative Activity, in National Bureau of Economic Research, The suitable markups in the French economy over the period Rate and Direction of Inventive Activity: Economic and Social Factors, 1978-2015 is estimated at 0.4% (with an average differ- 609-626, Princeton University Press. ence of 0.152 from the optimal markup). As the average Askenazy, P., C. Cahn and D. Irac (2013), Competition, R&D, and the cost of innovation: evidence for France, Oxford Economic Papers, 65(2), annual growth rate of French labour productivity was 293-311. 1.86% over the period, such growth could have reached Bellefl amme, P. and C. Vergari (2011), Incentives to innovate in oligopo- 2.25% had markups been at their optimal levels. lies, The Manchester School, 79(1), 6-28. Bouis, R. and C. Klein (2008), La concurrence favorise-t-elle les gains de productivité? Analyse sectorielle dans les pays de l’OCDE, Economie A direct policy implication is that sectors with strong tech- et statistique, 419(1), 73-99. nical progress should be allowed to adjust their competi- Calligaris, S., C. Criscuolo and L. Marcolin (2018), Markups in the digital era, OECD Science, Technology and Industry Working Papers, 2018/10. tion intensity to their rate of technical progress. Otherwise, Houngbonon, G. V. and F. Jeanjean (2016), What level of competition in- they could be prevented from achieving the full productivity tensity maximises investment in the wireless industry?, Telecommuni- gains derived from the adoption of technologies. In par- cations Policy, 40(8), 774-790. Jeanjean, F. (2015) What causes the megabyte price drop in the mobile ticular, digital sectors, which have high productivity growth industry?, Economia e Politica Industriale, 42(3), 277-296. rates (i.e. high technical progress), require suffi ciently high Jeanjean, F. (2020), Impact of Technical Progress on the Relationship Be- markups (market power) to maximise their labour produc- tween Competition and Investment, Journal of Industry, Competition and Trade. tivity growth. Roeger, W. (1995), Can imperfect competition explain the difference between primal and dual productivity measures?, Estimates for US Public policy to enhance innovation and productivity manufacturing, Journal of Political Economy, 103(2),316-330. Schmutzler, A. (2013), Competition and investment: A unifi ed approach, International Journal of Industrial Organization, 31(5), 477-487. Public debate on competition policy is currently address- Schumpeter, J. (1942), Creative destruction, Capitalism, socialism and de- ing concerns about how competition policies should adapt mocracy, 825, 82-85.

Intereconomics 2020 | 3 198 DOI: 10.1007/s10272-020-0897-x Letter from America

Coronavirus Pandemic: Europe Is Once Again Forged in a Crisis

To an American, the debate around how the European Union should respond to the COVID-19 crisis has a familiar ring. Europe has been debating debt mutualization, transfer union and ﬁ scal federalism for years. The pandemic is just another opportunity for sounding familiar themes.

But the crisis is also a reminder that there is nothing distinctively European about this rhetoric. Closer to home (my home, anyway, where I am spending considerable time at the moment), we see southern state politicians like Florida Senator Rick Scott impugning northern states like New York for their proﬂ igacy. Or, as President Trump put it on Twitter, “Why should the people and taxpayers of America be bailing out poorly run states (like Illinois, as [sic] example) and cities, in all cases Democrat run and managed, when most of the other states are not looking for bailout help?” Northern Europeans have no monopoly on such sentiments. Crises, wherever they occur, have a way of bringing out sectional divisions and reinforcing cultural stereotypes.

Divisions and stereotypes notwithstanding, the need for economic and ﬁ nancial assistance for EU member states with limited ﬁ scal space has never been more pressing. Is there a way forward? At one extreme, one can imagine relying on existing mechanisms. The European Stability Mechanism (ESM), the eurozone’s rescue fund, could loan to the full extent of its capacity. But loans, as opposed to grants, are not what already over-indebted governments need. Moreover, the ESM is set up to loan subject to conditions, and under present circumstances conditionality would be onerous if not downright offensive.

In addition, the European Central Bank (ECB) can do ‘whatever it takes’, to coin a phrase, to support the prices of bonds issued by member states to fi nance their budget defi cits. In the limit, the ECB could resort to yield curve control, pegging interest rates on such bonds in the manner of the Federal Reserve in 1946-51 and the Bank of Japan today. Eventually, however, the ECB would receive pushback from critics objecting that it was straying into the conduct of fi scal policy. In any case, the central bank would only be kicking the can down the road. The fi scal and fi nancial crisis would be back, in other words, as soon as the ECB curtailed its security purchase operations.

At the other end of the spectrum, one can imagine a ‘Great Leap Forward’ involving the signifi - cant pooling of fi scal resources, along with transfers to member states in need. One is reminded of Jean Monnet’s observation that Europe is forged in crises; this is certainly the kind of crisis that justifi es forging. One is also reminded of how planning in the U.S. and British Treasuries for a new international economic and fi nancial order after World War II was already well advanced during the war – indeed, the Bretton Woods Conference occurred while fi ghting was still underway.

Like World War II, the coronavirus crisis is a unique historical moment. The middle of the crisis is not too early to start thinking about the post-crisis European order. European leaders, like John Maynard Keynes and Harry Dexter White in the 1940s, need to signal that they recognize the singularity of the moment and that they have plans for capitalizing upon it. Otherwise, public support for the EU will wither, and there is reason to worry about whether the Union itself will survive.

But a signiﬁ cant pooling of existing revenue sources and a greatly expanded EU budget will require political decisions. Inevitably, there will be lengthy negotiations. There may have to be referenda in some member states – in some cases, repeated referenda perhaps, as in Denmark Barry Eichengreen, Univer- © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribu- sity of California, Berkeley, tion 4.0 International License (https://creativecommons.org/licenses/by/4.0/). USA. Open Access funding provided by ZBW – Leibniz Information Centre for Economics.

ZBW – Leibniz Information Centre for Economics 199 Letter from America

in 1992-93. Anything less would be undemocratic. And abrogating democracy in response to the crisis is not a sustainable way forward. The EU is not Hungary.

There is, however, a middle way. It would start with a modest EU budget targeted at health and testing needs, funded by new rather than existing revenue sources and distributed by an independent ﬁ scal council. A Pandemic Fund is no different, conceptually or politically, from the Structural Funds and the Common Agricultural Policy. A tightly targeted Pandemic Fund could be ramped up without extended politicking or a treaty change. This could be accomplished while at the same time avoiding toxic terms like transfer union and debt mutualization. Assuming that it proves its worth, the Pandemic Fund could eventually become the basis for an expanded EU ﬁ scal capacity.

The case for EU support for member states hit hardest by the pandemic is compelling. Their needs are overwhelming. Moral hazard is not an issue; no one thinks that governments will toler- ate more COVID-19 cases in order to get more funding. If the members of the New Hanseatic League will not help other member states that desperately need hospital beds, ventilators, testing and – one hopes – vaccines, then the EU has no future.

Relying on new taxes rather than existing revenue sources, meanwhile, will avoid complaints that national ﬁ scal prerogatives are being arrogated by Brussels. One new source is the proposed tax on internet companies. The problem is that a digital tax would plausibly raise only $1 billion a year. (Some estimates are slightly higher, but no matter.) $1 billion of tax income could be used to pay the interest on $50 billion of newly issued perpetual bonds, but even this would be inadequate. Ramping up testing to the levels required to fully reopen the European economy may cost twice this much by itself.

But one can also imagine other new revenue sources. The pandemic is a reminder that human- ity’s fate still rests with the natural world. It is just as much a reminder as it is a distraction from the dangers of climate change. When better to start raising petrol taxes than when Europeans are not driving?

Which member states exactly should receive the money? Again, politics threaten to intrude. The solution is for parliaments to ﬁ rst agree on the general criteria governing distribution, and then for the distribution of resources to be delegated to a ﬁ scal council of independent experts. That council would release its decisions and would be subject to audit. This transparency would help to hold it accountable in the court of public opinion. This, of course, is precisely the institutional arrangement that governs the ECB.

Critics will complain about a proliferation of independent technocratic committees. They will observe, as they always do, that ﬁ scal policy is more fundamentally distributive, and therefore political, than monetary policy, the implication being that it cannot be removed from the political sphere.

This objection has two fl aws. First, central bank policy, most especially the unconventional credit and fi nancial policies being implemented by central banks at the moment, is no less fundamentally distributive. Second, this idea is not a proposal for delegating fi scal policy to an independent committee of technocrats. Rather, it is a proposal for delegating the distribution of a specifi c pot of resources – a limited pot initially – and doing so subject to a politically determined mandate.

A political decision can be taken subsequently to close this program down, if and when the pandemic ends, or alternatively to expand it. In the latter case, there will be ﬁ scal and institutional innovations on which to build. Europe will again have been forged in crisis.

Then again, it is easier to recommend a way forward for someone else’s economy than your own.

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