OUTPUT STABILIZATION PROPERTIES OF A EUROPEAN UNEMPLOYMENT BENEFIT SCHEME: WHAT IS KNOWN SO FAR Inês Sofia Alves Oliveira da Rosa
Dissertation Master in Economics
Supervised by Álvaro Aguiar
2019
Acknowledgments
At the end of this stage, I would like to express my sincere thanks to all those who directly or indirectly contributed to the realization of this dissertation. Firstly, I would like to thank Professor Álvaro Aguiar, my supervisor, for the endless help, availability and patience, as well as for all the constructive criticism and knowledge shared during this process. Secondly, I want to thank my parents, my sister and Pedro, my boyfriend, for always supporting me in achieving my goals and pushing me to be the best version of myself. Finally, I would also like to thank all my colleagues and friends, especially Mafalda de Castro and Rita Reis, for the never-ending patience and support throughout this project.
i Abstract
The recent Great Recession rekindled the debate over the need for a transfers’ mechanism that allows for output stabilization inside the euro area, namely a European Unemployment Benefit Scheme. This question was firstly analysed in the contexts of the Theory of the Optimum Currency Areas and the Theory of Fiscal Federalism. Several Institutions and academics have since put forward proposals on this scheme as a mean to further increase the stabilization of the euro area, mainly against asymmetric shocks. This dissertation develops a simple common metric that is applied to five proposals in order to assess what is known, so far, about the stabilization capacity of further euro area fiscal integration (minimal fiscal union) in the form of a fiscal-transfers’ stabilizing mechanism, particularly a European Unemployment Benefit Scheme. To address this question, two main objectives are set: to determine (i) how far the studies produced/published so far support the implementation a European Unemployment Benefit Scheme; (ii) what essential elements are still lacking in the studies and therefore need further work in terms of quantification. The core task towards these objectives is to gather, explore and compare the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far about the output stabilization capacity of a Euro Area Unemployment Benefit Scheme. After analysing the results of the simulations, it was concluded that all proposed schemes provide average stabilization to the participating countries, even though some non-dominant procyclical effects can be expected. Additionally, the scheme would work in a more than proportional countercyclical way during a period of more severe recession, as simulated during the Great Recession. Its implementation could, therefore, improve the functioning of the monetary union, in terms of benefits as it is in line with the theories and its desirable characteristics.
JEL codes: E24, E61, E62, E63, F15, F45
Keywords: Fiscal Integration, EMU, Stabilization Mechanisms, European Unemployment Benefit Scheme
ii Resumo
A recente Grande Recessão reacendeu o debate relativamente à necessidade da criação de um sistema de transferências na área euro, com o objetivo de incrementar a estabilização macroeconómica, nomeadamente através de um Sistema de Subsídio de Desemprego Comum Europeu. Esta questão foi primeiramente desenvolvida na Teoria das Zonas Monetárias Ótimas e na Teoria do Federalismo Orçamental. Com o intuito de analisar a capacidade de estabilização macroeconómica de um Sistema de Subsídio de Desemprego Comum Europeu, algumas Instituições e grupos de académicos desenvolveram propostas e simulações. Deste modo, e com o objetivo de analisar e avaliar a capacidade de estabilização macroeconómica deste esquema, foi desenvolvida, nesta dissertação, uma métrica comum, que foi aplicada a cinco propostas de esquemas, com o objetivo de: (i) determinar, até que ponto, os estudos realizados apoiam a implementação deste esquema; (ii) determinar que elementos e fatores estão ausentes nos estudos e necessitam de quantificação. Para atingir estes objetivos será realizada uma análise e comparação da metodologia e resultados das mais importantes simulações empíricas (a nível académico e institucional) relativas à capacidade de estabilização macroeconómica deste esquema. Após a análise dos resultados, conclui-se que todos os sistemas propostos apresentam uma estabilização média contracíclica para os países participantes, ainda que possam ser esperados alguns efeitos procíclicos. Adicionalmente, foi concluído que o esquema funcionaria de forma contracíclica mais do que proporcional durante períodos de recessão mais severa, tal como foi simulado durante a última grande recessão. A implementação deste esquema poderia, portanto, melhorar o funcionamento da união monetária em termos de benefícios, dado que está alinhada com as teorias e características desejáveis do mesmo.
Códigos JEL: E24, E61, E62, E63, F15, F45
Palavras-chave: União Económica e Monetária, área euro, Sistema de Subsídio de Desemprego Comum Europeu, Política orçamental
iii Index
1. Introduction ...... 1 1.1. Framework ...... 1
1.2. Research and objectives ...... 3
1.3. Structure ...... 4
2. The Context of Academic and Institutional Literature on Fiscal Union in the EMU ... 5 2.1 Fiscal Union in the EMU ...... 5
2.2 Stabilization Transfer Mechanism in the Euro Area ...... 15
2.3 Interactions with Political Union and Banking Union ...... 21
3. How to Assess the Stabilizing Properties of the European Unemployment Benefit Scheme ...... 23 3.1 Stabilization and Basic Design of the European Unemployment Benefit Scheme 24
3.2 Simulations and Comparison ...... 26
3.3 A Common Metric to Compare Stabilization Properties: Uniformization ...... 30
4. Assessing the Stabilizing Performance of the Proposals for a European Unemployment Benefit Scheme ...... 35 4.1. General Results ...... 35
4.2. Procyclical and Countercyclical effects ...... 43
4.3. Stabilization effects during the recent Great Recession ...... 45
5. Conclusion ...... 49
6. Bibliographic References ...... 51
Annex ...... 1
iv Table Index
Table 1: Simplified stages of the papers that propose a European Unemployment Benefit Scheme ...... 23 Table 2: Design characteristics of the considered proposals on the European Unemployment Benefit Scheme ...... 27 Table 3: Contributions and budget neutrality of each proposal ...... 29 Table 4: Multiplier effects and stabilization metric of each proposal ...... 30 Table 5: Concept of procyclical and countercyclical effects of the common stabilization metric ...... 32 Table 6: Interpretation of the stabilization coefficients obtained through the common metric ...... 34 Table 7: Stabilization effects under the common metric ...... 36 Table 8: Analysis of net contributors and net recipients ...... 42 Table 9: Procyclical, neutral and countercyclical effects of the proposals ...... 44 Table 10: Stabilization effects of the scheme during the recent Great Recession ...... 46
Figure Index
Figure 1: Graphic representation of the schemes' simulations ...... 39
v
1. Introduction
The purpose of this master’s dissertation is to assess the output stabilization properties to be expected from a European Unemployment Benefit Scheme, a minimal euro area fiscal union. The assessment is based on the analysis and comparison of the methods and results of the most relevant (both academically and institutionally) mechanisms proposed and subject to economic simulations so far.
1.1. Framework
A number of proposals for stabilization mechanisms in the euro area have been put forward, especially in the years after the financial, economic and sovereign debt crisis that hit the euro. These mechanisms constitute greater fiscal integration and aim at completing the monetary union, possibly towards a fiscal union. The mechanism analysed in this dissertation, the European Unemployment Benefit Scheme, has been the proposal with the most attention so far. To better understand this scheme, it is useful to frame it in the context of a fiscal union.
Fiscal Union
Since the early debates about the common currency, there has been a discussion over what degree of fiscal integration should be instituted in the European and Monetary Union (EMU). The euro area has a unique form of integration. There is full monetary integration, but the fiscal policy is still at the national level, regulated by a set of coordinating rules which target the soundness of national fiscal policies, initially introduced by the Maastricht Treaty and the Stability and Growth Pact (as explained in a broader historical perspective by Bordo, Markiewicz and Jonung, 2013). More recently, there have been distinctive opinions over the need for a fiscal union on the euro area, as some authors, such as Allard at al., (2013), De Grauwe (2016) and Vetter (2013) believe that the EMU should include a fiscal union with a stabilizing or insurance mechanism in order for the monetary union to function properly, while others are more sceptical (e.g. Bénassy-Quéré, Ragot and Wolff, 2016; Fuest and Peichl, 2012). The definition and minimal elements of a fiscal union are not clear-cut, and opinions
1 diverge. However, one can identify several motives for the existence of deeper fiscal integration or full fiscal union in the presence of a monetary union as developed by the Theory of Optimum Currency Areas and the Theory of Fiscal Federalism, that aim to give some perspective on the centralization of fiscal policy and fiscal risk-sharing (Thirion, 2017, for example). Additionally, the recent Great Recession brought out some serious concerns that the existing fiscal framework was insufficient to handle the problems that surfaced, such as the failure to create enough room for countercyclical policy during the crisis, contagion and difficulty to access the financial market during the sovereign debt crisis. These failures lead to the resurgence of disintegration forces within the euro area and concerns about the euro as a common currency project (Allard et al., 2013; Dabrowski, 2015). As part of the answer to the shortcomings exposed by the recent Great Recession, fiscal integration was further intensified by the European authorities, with, to name the most important, the Fiscal Compact, Two-Pack, Six-Pack and the European Stability Mechanism (European Commission, 2012, for example). However, several authors and institutions have pointed out that the current institutional set up is still very far from the main requirements for a fiscal union and its stabilization mechanisms, which led to the rekindling of the debate over the need for a deeper fiscal integration as a way to mitigate the effects of the crisis (Allard et al., 2013 for example). Even though a banking union is in the making and the fiscal rules and coordination have been reinforced, these instruments may not be enough for the smooth functioning of the EMU. In favour of a move towards a euro area fiscal union, it is argued that a deeper fiscal integration would improve the euro area economic cohesion and competitiveness, reduce asymmetric shocks, allow the Eurozone to have a more capable response to future crisis and boost economic growth within this area (Eurofi, 2014). Despite the weight of all these quite impressive advantages, there are serious limitations to the approval of such integration, the most important one being the current and prospective levels of political and societal integration (Bénassy-Quéré et al., 2016). There are still very strong political objections towards a fiscal union in a very large group of countries, yet, unanimity is required for the approval of deeper fiscal integration (Bargain et al., 2013). Most of the objectors argue that sound national fiscal policy and the creation of the banking union are sufficient to stabilize the euro area.
2 Macroeconomic Stabilization Mechanism
In the context of broader proposals aimed at stabilizing the monetary union and further increase its cohesion, a fiscal transfers’ mechanism with a stabilization/insurance purpose has been put forward and the discussion around its implementation has been expanded. This mechanism, inside the euro area, can provide cushioning for (asymmetric) shocks, and increase risk-sharing1 inside the monetary union, as argued by Allard et al. (2013), Thirion (2017) and by the European Institutions such as in the reports by the European Commission (2012) and Juncker (2015). From an economic point of view, the institution of such a fiscal- transfers’ stabilizing mechanism could be taken as an emerging (even if minimal) fiscal union. The European Unemployment Benefit Scheme is certainly one of the most studied and promising mechanisms proposed so far, both at the academic and institutional level. Since stabilization is achieved through an automatic stabilizer which are the net transfers from the scheme that react to national unemployment rate, the scheme has the capacity to offset fluctuations in a country’s business cycle, including both expansion periods and recessions, supposedly working in a countercyclical way. Additionally, it can be designed to mainly target large and possibly asymmetric shocks, which could prevent or, at least, cushion part of the shocks such as the recent Great Recession.
1.2. Research and objectives
The main purpose of this dissertation is to assess what is known, so far, about the stabilizing capacity of further euro area fiscal integration (minimal fiscal union) in the form of a fiscal transfers’ stabilizing mechanism, particularly a European Unemployment Benefit Scheme. To address this question, two main objectives are set: to determine (i) how far the studies produced/published support the implementation of a stabilization mechanism, particularly a European Unemployment Benefit Scheme; (ii) what essential elements are still lacking in the studies and therefore need further work in terms of quantification. The core
1 Risk-sharing, according to Thirion and Centre for European Policy Studies (CEPS) (2016) page 7, refers to “all the policy instruments that imply international pooling and/or transfers of resources among sovereigns and joint guarantees like commonly issue debt”. Inside a monetary union, these instruments can be used for insurance/stabilization purposes.
3 task towards these objectives is to gather, explore and compare the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far on the subject of the output stabilization capacity of a European Unemployment Benefit Scheme. The analysed schemes have been put forward by Beblavy ́ and Maselli (2014), Dolls, Fuest and Neumann and Peichl (2018), Dullien (2013), Farvaque and Huart (2018) and Fichtner and Haan (2014). This dissertation provides an academic contribution to a better understanding of the consequences of further fiscal integration in the form of a European Unemployment Benefit Scheme, its stabilization capacity and, thus, to the analysis of the viability of this kind of integration in the euro area. In particular, as there is a lot of ongoing research on this subject, this dissertation provides some useful policy insight by pointing out what still needs to be explored in the simulations/empirical research in order to enhance its policy relevance.
1.3. Structure
This dissertation is organized in the following way: Chapter 2 focuses on the academic and institutional literature of a fiscal union in the EMU, including its integration in the economic policy theory and the recent Great Recession. Afterwards, the three main proposals for further fiscal integration in the euro area are outlined: i) Euro area budget; ii) Eurobonds and iii) Stabilization transfers’ mechanism. Further development of the latter proposal is carried out, with a focus on the European Unemployment Benefit Scheme, its desirable characteristics, funding and main concerns. Finally, interactions with political and banking union are outlined. Chapter 3 introduces the main proposals for a European Unemployment Benefit Scheme that were selected for our study, such as the design features, financing system and simulation characteristics. Then, the common metric applied to the articles, in order to be able to make a comparison of the various proposals is described. In Chapter 4, the main stabilization results of our simulation are outlined, including the countercyclical and procyclical effects for each of the proposed schemes, as well as the output stabilization effects during the most recent crisis. The main limitations of the studies are also identified. Finally, in Chapter 5, some concluding remarks and recommendations are made. The annex summarizes the articles analysed and compared in this dissertation.
4 2. The Context of Academic and Institutional Literature on Fiscal Union in the EMU
The study of the economics of a European Unemployment Benefit Scheme requires its contextualization in the framework of a fiscal union, whose background stems from three main analytical directions: (i) the Theory of Optimum Currency Areas, (ii) the Theory of Fiscal Federalism, and (iii) the applied normative analysis of the causes and consequences of the recent Great Recession, namely in the euro area. It is important to firstly point to the distinction between two types of existing literature: (i) the academic literature, where there is a consistent analysis of the empirical advantages of an emerging fiscal union in the euro area, in the form of a stabilizing/insurance mechanism; and (ii) institutional literature, which mainly consists in articles and reports published by the European Authorities, that mostly have academic background, but have, as a main objective, to describe how a fiscal union could occur at an institutional level. Both these types of literature will be used in this dissertation. Institutional literature in the last years has gained relevance, with the European Authorities supporting further fiscal integration, especially after the most recent crisis. Chapter 2 proceeds in the following way: section 2.1 reviews contributions to a fiscal union in the EMU, its historical and theoretical background and main elements; section 2.2 reviews the creation of a stabilizing transfer mechanism, its desirable features, financing and main challenges; and section 2.3 very briefly reviews the integration of the banking and political union with the fiscal union in the EMU.
2.1. Fiscal Union in the EMU
Several definitions have been proposed for a fiscal union (Thirion and Centre for European Policy Studies (CEPS), 2016). The expression “fiscal union” has different meanings in the economic policy literature, and the interpretations range from a set of common rules to a full federal integration with a government that has tax and spending authority. Some authors, notably De Grauwe (see, for example, De Grauwe, 2016), have a strict and very demanding view of a fiscal union in the euro area. De Grauwe proposes the centralization of a significant part of the national budgets into a common budget within the Eurozone, which would be managed by European authorities, as necessary for the
5 consolidation of the monetary union, since it would prevent financial markets from being able to force countries into a liquidity crises and default2. A European Social Security System would allow for the automatic redistribution of income from the countries that are experiencing a positive shock to the countries that are suffering from a negative shock. Most proposals by other authors, however, do not require such a high degree of centralization. According to Dabrowski (2015), page 7, a fiscal union is defined as a “transfer of part of resources and competences in the area of fiscal policy and fiscal management from the national to supranational level”. This implies centralization of fiscal policy, which requires political union and consequent loss of national sovereignty (Thirion and Centre for European Policy Studies (CEPS), 2016). Thirion (2017) presents in page 3 a very similar definition, affirming that “fiscal integration can be interpreted as any attempt to further centralize fiscal policies in EMU, either by sharing resources or decision-making power”, adding that “this definition considers a broader set of instruments concerning both risk reduction and shock absorption”. The key elements for a fiscal union are the following, as summarized by Thirion (2017): fiscal rules and policy coordination, a stabilization mechanism with fiscal transfers, some form of common borrowing such as Eurobonds, and a common budget. Some of these elements are already in place, as argued by Dabrowski (2015) and Thirion and Centre for European Policy Studies (CEPS), (2016). Fiscal rules and mechanisms for crisis intervention have already seen relatively widespread implementation in the eurozone, such as the Crisis Resolution Mechanism. A common set of fiscal rules exists, and was deepened after the most recent great recession, consisting of the Stabilizing and Growth Pact and the supplementary legislation in the EU’s Economic Governance Package (called the “six-pack”). There is a European budget that represents a small fraction of the combined budgets of the member- states. Nevertheless, there is not a common budget within the euro area, even though some proposals have been made, e.g. the Franco-German proposal for a Eurozone budget. Eurobonds are not yet a feasible proposal due to the high level of political integration required. Finally, a stabilization mechanism that allows for the cushioning of shocks is still not developed.
2 This happens due to liquidity constraints, since countries are trying to issue debt in a currency over which they have no power, and investors don’t finance them. Debt would also be centralized and would be issued in a currency that would be controlled by the authority with that power.
6 The discussion around a fiscal union in the euro area was initiated years before the most recent crisis, with the first phase of the debate starting in 1970 with the Werner Report and the MacDougall Report in 1977. These reports suggested the introduction of a euro area budget and, as a long-term objective, further centralization (Bénassy-Quéré et al., 2016; Thirion and Centre for European Policy Studies (CEPS), 2016). The second wave started at the end of the 1980s with the Delors Report in 1989, when the Economic and Monetary Union became a real project. At the time, none of these proposals were put into practice. The third wave began after the recent Great Recession with the need to address design flaws in the EMU (see, for example, Beblavy,́ Gros and Maselli, 2015). It should be reminded that the Maastricht Treaty in 1992 did not include a fiscal union - only further fiscal discipline introduced by the Stability and Growth Pact -, due to intense political resistance from many countries (Bénassy-Quéré et al., 2016). Focusing on the second key element - a stabilization transfers mechanism, the first academic simulations in federal systems were made by Sala-i-Martin and Sachs (1991) and von Hagen (1992). These studies both took as object of study the United States and taxes as a source of stabilization. However, the results had some discrepancies. According to Sala-i- Martin and Sachs, that use per capita income as a variable, approximately 40% of the shock could be absorbed by taxes; while according to von Hagen, who uses gross state product as a variable, only 10% is absorbed during a shock (Bajo-Rubio and Diaz-Roldán, 2003). The first simulation using unemployment benefits as a source of stabilization was done by Pisani-Ferry, Italianer and Lescure in 1993. This simulation used the United States, France and Germany, in which, respectively, 17%, 37% and 34-42% of the shock was absorbed (Bajo-Rubio and Días-Roldán, 2003). After the most recent crisis, the discussion rekindled. Several flaws in the construction of the monetary union were aggravated, such as the failure of the no bailout clause, and other instruments were further developed, such as the Six-Pack, Two-Pack, Fiscal Compact, the European Stability Mechanism and Crisis Resolution Mechanisms (Eurofi, 2014; Thirion and Centre for European Policy Studies (CEPS), 2016). Also, several teams of authors started performing simulations for an insurance or stabilization mechanism through an unemployment benefits scheme in the euro area (such as Brandolini, Carta and D'Amuri, 2016 and Dolls et at., 2018) or in the European Union (Beblavy ́ and Maselli, 2014 and Farvaque and Huart, 2018). At the institutional level, after the crisis, the European institutions released reports proposing more integration and the creation of a stabilization mechanism as a form of
7 correcting the identified flaws. Three reports published in 2012 centered their attention on this matter: The Van Rompuy Report, the European Commission Report and the Tommaso Padoa-Schioppa group Report (Farvaque and Huart, 2018). In the economic policy theory context, the subject of fiscal union is not new at all. Kenen (1969), based on the Theory of Optimum Currency Areas, argued that fiscal integration is a necessary condition for proper monetary integration. The Theory of Fiscal Federalism developed by Musgrave (1959) and Oates (1999) studies the distribution of functions to the different levels of the government, including fiscal policy and transfers. The Theory of Optimum Currency Areas aims to determine the optimality of a monetary union inside a certain geographical domain, and the Theory of Fiscal Federalism aims to determine the optimal distribution of policies and organization of a government within a certain geographical area. This means that while the Theory of Optimum Currency Areas focus on the centralization of policy functions, the Theory of Fiscal Federalism focus on the decentralization of government (Von Hagen, 1993). Given their background relevance for the fiscal union, a brief review of these theories, in turn, is presented next.
Theory I: Optimum Currency Areas
The Theory of Optimum Currency Areas (OCA) was launched by Mundell (1961 and 1973), McKinnon (1963) and Kenen (1969). These authors centred their work on factor mobility and financial integration, openness of a region, and fiscal integration inside a monetary union, respectively. This theory is the most common approach used to “evaluate and study the optimality (and thus the desirability) of monetary unions, in particular that of the euro area” (Bordo et al. (2013), page 453). It balances the benefits for a country of joining a monetary union against its costs of losing the exchange rate as a mechanism to cushion shocks. According to the Theory of Optimum Currency Areas, there are several benefits for the construction of a monetary union, mainly at the microeconomic level. With the integration in the monetary union, improvements in economic efficiency are expected: (i) the transaction costs due to the exchange of national currency disappear; (ii) the risk coming from the uncertainty of the exchange rate is eliminated (De Grauwe, 2016, for example). The costs of a monetary union are more related to the macroeconomic side of the economy.
8 The OCA authors argue that, in the case of shocks inside a monetary union, there are three necessary conditions for the member-states to return to equilibrium: wage and price flexibility and mobility of labour between countries. If these adjustment mechanisms fail, the countries will not be able to return to equilibrium. If a monetary union did not exist, there would be another instrument, which would be the exchange rate. Therefore, the loss of monetary independence affects the capacity of countries to deal with shocks (De Grauwe, 2016). The euro area is still far from being an optimal currency area (Vetter, 2013). Inside the euro area, the prices and wages are very rigid, and the labour mobility is lower than in other monetary unions (Allard et al., 2013). The only relevant policy available is fiscal policy. The establishment of a fiscal union in the currency area was neglected by Mundell and McKinnon in their analysis of optimum currency areas. The issue was introduced by Kenen in 1969. Kenen argues that fiscal integration through a mechanism of fiscal transfers is a basic requirement for the well-functioning of a monetary union since it reduces the costs of losing the exchange rate as a response to shocks. This is especially relevant in the case of wage and price rigidities and limited labour mobility (which is the case of the euro area) due to the mechanism’s stabilization function. Kenen also defends that the domain of fiscal policy and monetary union should be the same, even if the area is not optimal, since fiscal policy can redistribute income in order to correct differences between regions and provide insurance against asymmetric shocks, through interregional transfers. Within a federation with tax and expenditure powers, when a country suffers from a shock, payments to the federal authority are reduced, slowing down the effects of the shock. Additionally, the country receives funds from the federal authority (e.g., unemployment benefits) (Kenen, 1966) (as cited in Kenen, 1969). Therefore, a country can enjoy major advantages by dropping its national currency and exchange rate in order to be able to join a larger fiscal mechanism (Kenen, 1969). The stabilization provided by these mechanisms could be achieved through inter-regional transfers from a country that has had a positive shock to a country with a negative shock, which improves the macroeconomic stability of the monetary union (Fahri and Werning, 2017) or through a common transfers mechanism from a central authority, to which countries make contributions (as in the proposals for a European Unemployment Benefit Scheme). In his 1973 contribution, Mundell tackled the subject of financial integration inside a monetary union. This model - Mundell II - focuses on financial integration as a way to
9 provide risk-sharing and consumption smoothing, working as an alternative to interregional fiscal transfers, since they both cushion country-specific shocks. While supporting this idea, Fahri and Werning (2017) also argue that financial integration could not be enough to guarantee the full effects of risk-sharing. Therefore, the intervention of governments through fiscal transfers could be necessary. Berger, Dell’Ariccia and Obstfeld (2018) also argue that, in the past and specially during the most recent recession, the financial markets did not work sufficiently against asymmetric shocks. If the private insurance channel is limited when responding to shocks, then a transfers’ mechanism could be necessary to alleviate the effects of shocks inside the monetary union (Bordo et al., 2013). In addition to the contributions to the Optimum Currency Areas, Bordo et al., (2013) identify the lack of attention that is paid to political and institutional facts as a severe problem of this theory. This point is very briefly addressed in section 2.3.
Theory II: Fiscal Federalism
The Theory of Fiscal Federalism developed notably by Musgrave (1959) and Oates (1999) aims to determine the most suitable way to attribute responsibilities to different levels of a government. Oates (1999) introduces the Theory of Fiscal Federalism: “The traditional Theory of Fiscal Federalism lays out a general normative framework for the assignment of functions to different levels of government and the appropriate fiscal instrument for carrying out these functions” (Oates, 1999, page 1121). In other words, it aims to give insight on whether a policy tool or area should be centralized to the central government or not. The United States are an example of a federal area that has centralized policy areas, with a significantly large federal budget. In this federal area, approximately 20-35% of the shocks are cushioned by federal transfers mechanisms (Persson, Roland and Tabellini, 1996b; Thirion, 2017). The Theory of Fiscal Federalism focuses on three main areas: (i) the attribution of stabilization and redistribution functions, taxes and the supply of public goods and services to the different levels of government; (ii) the identification of benefits that result from the decentralization of fiscal policy; (iii) the context in which fiscal policy instruments should be used, mostly concerning transfers and taxes. This theory points out the importance of fiscal policy when it comes to macroeconomic stabilization, mainly through a large central budget and transfers between regions and states that are more affected by asymmetric shocks and
10 the ones that are not affected or less affected (Spahn, 1994) (as cited in Alves and Afonso, 2008). The wide variety of federal structures prove that there are no rigid layouts for the ideal distribution of functions to the different levels of the government. However, the theory of Fiscal Federalism aims to provide some form of guideline. Particularly regarding redistribution and stabilization, this theory argues that these should be functions of the central government along with the supply of public good and services. Other areas should be maintained at the national/decentralized level (see, for example, Majocchi, 2008). The stabilization function should be centralized because it is capable of responding to the several political preferences, can take into consideration the externalities of national/regional fiscal policy and improve the responsibility of the central government (Cavallo, Dallari and Ribba, 2018). The centralization of fiscal policy can efficiently internalize the spill-over effects and externalities that are a consequence of national fiscal policy in highly integrated areas (Majocchi, 2018; Thirion, 2017). The European Union is still far from a federal area, mainly in three domains: (i) the size of the common budget, which in the European Union is very small and cannot significantly contribute to the stabilization of the area; (ii) in the European Union, the execution of fiscal policy is based on a set of rules, that are not consensual nor transparent nor applicable enough to guarantee fiscal discipline and (iii) insufficient coordination in the policies applied by the different countries in the European Union. While the expansion of the central budget does not appear to be feasible, at least in the short run, the response to asymmetric shocks could be made through a shock-absorption mechanism (Alves and Afonso, 2008). In other words, while a full fiscal union is not feasible in the euro area, maybe the centralized stabilization function can be achieved with a minimal fiscal union, through a common transfers’ mechanism, e.g., the European Unemployment Benefit Scheme.
Fiscal Integration Gaps Exposed by the Crisis
The recent Great Recession brought out very serious concerns over whether the euro area was prepared to deal with the challenges that arose, namely the high levels of deficit and debt and the financial instability. As arguably foreseen by the theories presented above, the existence of a monetary union without the correspondent fiscal union created problems and augmented the effects of the crisis.
11 As said before, the Eurozone is an area that is characterized by a monetary union without the centralization of fiscal policies. This means that in the case of an asymmetric shock, the only alternative for a country to respond is with national fiscal policy, that is also constrained by fiscal rules. This crisis divided the policy oriented academics into two dominant groups: the first group, such as Bénassy-Quéré et al., (2016) and Fuest and Peichl (2012), that believe that instead of a fiscal union, the solution is to reinforce and intensify fiscal rules and coordination, whether because of political resistance to a fiscal union or because other solutions are available (banking union as a relevant substitute for the fiscal union); and the second group, with institutional and academic supporters, that believe that the only way to prevent or attenuate the effects of a future crisis is by deepening the fiscal integration towards a fiscal union in the euro area through a stabilizing/insurance mechanism and/or common debt. The financial and subsequent economic crisis was characterized by asymmetric shocks, high deficits and high levels of debt. Some countries, who suffered severe negative shocks, had not built enough buffers during the good times with countercyclical policy. Therefore, they were not able to cushion the effects of the crisis. Other countries, however, had built enough cushioning space to properly respond to the shocks (Allard et al., 2013). Before the crisis, there was already accumulated public debt, macroeconomic imbalances and losses in competitiveness. According to the interpretation of European Commission (2012), these imbalances mostly appeared because some countries did not follow the fiscal rules imposed by the European Union to insure healthy macroeconomic policy. Due to the high level of financial integration that exists in the euro area, the problem of contagion is serious and has impact in the whole Eurozone. The crisis proved the existence of high levels of interdependence between the countries of the euro area, mainly because of the high financial integration in the monetary union (Eurofi, 2014). The failures revealed by the recent Great Recession, namely the inability to respond to asymmetric shocks and the problem of contagion showed the importance of inter-regional risk-sharing through mechanisms for countries to pool resources from and share risks (Thirion, 2017). As mentioned above, according to Mundell (1973) only if perfect and complete markets existed, then private risk sharing through credit and capital markets could provide total insurance against asymmetric shocks without the need for fiscal transfers between countries (Eichengreen, 1991) (as cited in Thirion, 2017). The crisis demonstrated that
12 country-specific shocks are easily transmitted through the international financial system and this mechanism tends to be not as efficient during times of crisis. It also showed that national fiscal policy cannot fully compensate for output shocks (Furceri and Zdzienicka, 2015). International risk-sharing can be provided through two main channels: markets and governments. As mentioned above, private capital markets could be insufficient. As an alternative, governments can provide temporary transfers across countries, as a way to provide fiscal risk-sharing. However, fiscal risk-sharing within the euro area practically does not exist, due to the lack of a fiscal authority and centralization and the limited dimension of the budget, that is more targeted towards harmonizing living standards (Allard et al., 2013). Due to the magnitude and level of contagion of country-specific shocks and the current inability of the euro area to cushion asymmetric shocks, insurance mechanisms at the euro area level could provide a way to stabilize the monetary union.
Three Main Proposals for Further EMU Fiscal Integration
As mentioned in section 2.1., following the perspectives of, for example, Allard et al. (2013), Bordo et al. (2013), Fuest and Peichl (2012) and Vetter (2013), there is a clear convergence on the key elements for the formation of a fiscal union: fiscal rules and policy coordination, stabilization mechanism that allows fiscal transfers, a form of common borrowing (such as Eurobonds) and a common budget. Even though some of these elements - such as rules and mechanisms for crisis intervention - are already implemented and despite some proposals such as the Eurobonds and the Franco-German proposal for a Eurozone budget, the EMU has so far neither common debt instruments, nor fiscal transfer mechanisms nor a common budget. These are yet solely provided at the national level (Vetter, 2013, for example). At this moment, further integration can follow two different roads: (i) further shared sovereignty, which would include the extension of the already existing elements and the ones in development stages, which are rules and coordination, crisis management mechanisms and banking union or (ii) adding risk-sharing, which would include fiscal insurance (unemployment insurance schemes, rainy-day funds) and common debt (Thirion, 2017). Most authors and institutions that defend the implementation of a fiscal union - such as Allard (2013), De Grauwe (2016), Thirion (e.g., 2017) and others, and institutions such as the European Commission - argue that the most vital step towards a fiscal union and stabilization
13 of the euro area is the implementation of a instrument with stabilization properties. They consider that further shared sovereignty is not enough for the stabilization of the euro area, as demonstrated by the recent Great Recession. Thus, the next step towards fiscal integration is a mechanism that allows for stabilization inside the monetary union, considering it an emerging/minimal fiscal union. As briefly explained below in Section 2.3., a banking union is not a perfect substitute for a fiscal union, just a complement for the appropriate functioning of the monetary union. In this context, since fiscal rules, coordination and crisis resolution mechanisms are already reinforced and implemented in the euro area, it is important now to understand the benefits that a fiscal stabilization mechanism would have in the monetary union. There are three main proposals for instruments to deepen fiscal integration towards fiscal union in the euro area which have stabilization properties (Beblavy,́ Marconi and Maselli, 2017b; Vetter, 2013): • Common budget for the euro area; • Common issue of “Eurobonds” by a European Debt Agency; • Stabilization transfer mechanism, which can be based on output gaps or unemployment rates (developed below in section 2.2).
Eurozone budget. In all major federations, the common budget plays a key role in macroeconomic stabilization (Bénassy-Quéré et al., 2016) because of its importance as a redistributive and stabilizing instrument (De Grauwe, 2006). The European Union has a common budget, nonetheless, it is of very small dimension, even though the MacDougall report defended a federal budget between 5 to 7 percent of total GDP to support the monetary union. 98% of the budget is financed by taxes, duties on imports and Gross National Income. In 2017, 85% of the budget was used towards social and economic cohesion, economic growth and natural resources (Cavallo et al., 2018). Moreover, a euro area budget does not exist. Consequently, the European budget does not have the ability to react to shocks in the same way a federal budget has. A more centralized budget would allow for risk sharing through the revenues and expenditure guaranteed by transfers. Countries that are hit by a negative shock contribute less and receive benefits from the budget (Allard et al., 2013). The European budget, in order to have an insurance function, would have to be severely increased and fiscal responsibilities would need to be centralized at the European Union
14 level. In order to increase the budget, federal taxes or the shifting of a more significant amount of national taxes to the federal budget would have to be imposed, which is not politically supported (Bajo-Rubio and Días-Roldán, 2003 and Iara, 2016, for example). In the report “Toward a Genuine Economic and Monetary Union”, the European institutions defend that the decision making on national budgets should be centralized, and that it should be equipped with a centralized mechanism that could provide funds for countries to implement growth-stimulating measures (Eurofi, 2014).
Eurobonds. A less institutionally developed - although impactful - proposal is the creation of Eurobonds. Eurobonds are “securities commonly issued and backed by all member states” (Thirion and Centre for European Policy Studies (CEPS), 2016, page 15) and its main goals are to guarantee that countries in financial distress have access to the market and to lower the average interest paid (Thirion and Centre for European Policy Studies (CEPS), 2016). The rationale for Eurobonds is that a country’s debt would be insured by the other countries, allowing them to have economies of scale and reduce costs, which would be an efficient mechanism for risk sharing (Thirion, 2017). However, the creation of Eurobonds carries several challenges, the main being moral hazard. Eurobonds may reduce incentives to maintain healthy fiscal policy, since the higher credibility of fiscally stronger countries compensates in the issuing of the common bonds (Fuest and Peichel, 2012; Thirion and Centre for European Policy Studies (CEPS), 2016). Eurobonds strengthen a fiscal union because they allow for a certain degree of risk-sharing between countries that have a higher risk of default and the ones with less risk, increasing stabilization inside the euro area. Even though this instrument is a complement for the well-being of a fiscal union, it is not proven to be, so far, a feasible proposal for the euro area because of the high political integration it would require.
2.2. Stabilization Transfer Mechanism in the Euro Area
The need for a mechanism that allows transfers was firstly defended by Kenen in 1969, in the context of the Optimum Currency Areas, and then proposed institutionally in the MacDougall Report in 1977 and the Delors Report in 1989. The development of such a mechanism addresses the stabilization of shocks inside the euro area by providing inter-
15 regional fiscal risk-sharing which allows smoothing of consumption from asymmetric shocks between countries or regions. As argued above, currently the only available stabilization policy to handle asymmetric shocks inside the euro area is domestic fiscal policy. However, its flexibility is limited because of fiscal rules and coordination that undermine the capacity to handle these shocks in the necessary dimension, which was visible during the recent Great Recession. These constraints call for the implementation of a centralized fiscal policy instrument at the European Union or euro area level that acts as a stabilizing mechanism to react to asymmetric shocks (Bajo-Rubio and Diaz-Roldán, 2003). One of the most developed solutions for stabilization inside the euro area is a central transfers’ mechanism with stabilizing properties. Two alternative options proposed in the literature are: (i) a rainy-day fund based on output gap; (ii) a mechanism based on unemployment insurance. The main goal of rainy-day funds linked to output gaps is to allow for transfers between member countries, depending on their relative position on the cycle based on output gaps. If member states are experiencing a relative expansion period, they are net contributors to the fund and if they are experiencing a relative recession, they are net recipients3 (Thirion, 2017). A proposed alternative is the European Unemployment Benefit Scheme. Unemployment benefits are an important tool for social policy and automatic stabilization, since they cushion the impact of downturns. This automatic mechanism is supposed to work in a countercyclical way since during times of high (low) unemployment, the scheme generates deficits (surpluses) because there is a small (large) number of contributors against a large (small) number of recipients (Thirion, 2017). This mechanism would undoubtedly contribute to the macroeconomic stabilization of member states. In the occurrence of an asymmetric shock, during a period of downturn, contributions from a certain country fall when employment contracts and pay-outs to a country rise due to the increase of unemployment (country is net recipient), cushioning the effects of the shock. During a period of expansion, countries that are in an expansion period increase their contributions
3 For an example, see Enderlein et al., 2012, where countries experiencing an output gap larger (smaller) that the average euro area output gap contribute to the fund (receive from the fund), even if experiencing negative (positive) output gaps.
16 (due to the rise of employment) and pay-outs to the country fall due to the decrease in unemployment (country is net contributor), slowing down the economic activity (Andor, Dullien, Jara, Sutherland and Gros, 2014). The European Unemployment Benefit Scheme can be designed from two different approaches: (i) a reinsurance mechanism of national unemployment schemes, whereby unemployment insurance links transfers to governments to high and rising unemployment- “macroeconomic approach”; or (ii) a centralized mechanism of unemployment insurance that is administered by a centralized entity, i.e., a “genuine” euro area unemployment benefit scheme is introduced with common financing and provisions-“microeconomic approach”. The “macroeconomic approach” to a European Unemployment Benefit Scheme-an “equivalent scheme”- is a mechanism that reinsures existing national unemployment mechanisms, where transfers between government are linked directly to unemployment rates, not output gaps (in contrast with the rainy-day funds, that are linked to output gaps). The use of the unemployment rate has some advantages over the use of output gaps, such as being directly observable, more accurately forecasted and subjected to lower revisions. This mechanism allows for transfers between the countries which are not affected by an asymmetric shock and the countries that are mostly affected by the shock, guaranteeing risk- sharing and allowing for stabilization inside the euro area. The transfers are made directly to the government that is experiencing the negative shock, not to individuals (Dolls et al., 2018; Thirion, 2017). Usually this mechanism integrates a trigger, which means that a country would only receive a pay-out when the threshold is reached and the mechanism activated (Beblavy ́ and Lenaerts, 2017a). With the “microeconomic approach”, the proposed mechanism is a “genuine” euro area unemployment insurance scheme, where insurance is provided directly to the individuals in case of unemployment, and temporary transfers are made directly by the central entity. There is no intervention of the national government (Thirion, 2017). The main goal of such a scheme is to stabilize households’ income in case of a negative shock. This scheme functions continually (Beblavy ́ and Lenaerts, 2017a). Examples of these proposals are Dullien (2013) and Dolls et al., (2018). These two types of schemes require different levels of harmonization. The “genuine” unemployment scheme requires a high level of harmonization, since the benefits are transferred directly from a supranational authority to the citizens, which would demand similar requirements, generosity and duration to all members. The “equivalent” scheme
17 allows for the national governments to finance the unemployment benefits without changing national policy, since the scheme would transfer to the country the necessary amount to pay for the benefits according to each national system. This would provide incentives for countries to converge to more generous national systems, without the need of formal harmonization (Thirion, 2017). The unemployment benefits of the scheme to be implemented can be smaller or larger in comparison with each current national system. In the latter case, the European scheme substitutes entirely the national system. If smaller, the European Unemployment scheme complements the national system, replacing only part of it. This would mean that part of the transfers to the unemployed would be made through the European scheme, and the national systems could top them. In this case, the benefit level for the unemployed (the national benefit plus the scheme benefit) would be the same as before the scheme, as well as the contributions, but international risk equalization and economic stabilization would increase (Dullien, 2013; Fichtner and Haan, 2014). This is the case of most of the proposals, such as Dolls et al., (2018) and Farvaque and Huart (2018).
Desirable Main Features of the Stabilizing Transfer Mechanism
Some authors and institutions, such as Juncker (2015) and Thirion and Centre for European Policy Studies (CEPS) (2016) identify several basic characteristics for any stabilization/insurance mechanism (Juncker, 2015; Hammond and Von Hagen, 1995, as cited in Furceri and Zdzienicka, 2015): • The mechanism should be simple and automatic; • Transfers and contributions to the fund should be non-regressive; • Transfers should be temporary between countries and should not lead to permanent transfers. They should be restricted to provide insurance against temporary shocks or, when permanent, should be used only temporarily. The purpose of the mechanism is stabilizing, not redistributing income. • It should not be an incentive for countries to dismiss healthy fiscal policy or to not implement structural reforms. • The scheme should be able to cushion a large part of the shock, in order to prevent implementation costs from outweighing the benefits.
18
This set of desirable features constitutes a useful guide to assess each concrete scheme proposed.
How to Finance the European Unemployment Benefit Scheme
The European Unemployment Benefit Scheme requires some form of financing to pull resources from. There are four main proposals for financing the scheme: a corporate tax, a payroll tax, a contribution paid by member states as a percentage of GDP and debt. The payroll tax and the corporate tax, as proposed in Dullien (2013) and Pisani-Ferry et al. (2013), are directly related to a “genuine” unemployment benefit scheme, since they create a mechanism that insures at the microeconomic level (Beblaby ́ et al., 2017b). The worker or the employer pay a contribution that has direct correlation to the benefit that is going to be received by the worker in the event of unemployment. However, some simulations (such as Beblavy ́ and Maselli, 2014) suggest a contribution to the scheme as a percentage of the country’s GDP, which can either be variable or fixed. This contribution method could coincide with the corporate or payroll taxes if all countries were to agree this is the best way to collect resources. In case of no agreement, each member state is free to decide how to collect the funds to contribute the agreed percentage of GDP. The latter generates an “equivalent scheme”. The most controversial proposal is the common issue of debt. This proposal would imply the issuance of common bonds to finance the scheme, which could provide intertemporal stabilization by allowing for surpluses in good times and deficits in bad times. This alternative might be especially vital in the case of cushioning symmetric shocks (Beblaby ́ et al., (2017b). The proposals on the European Unemployment Benefit Scheme seek to establish a budgetary rule in order for the scheme to achieve fiscal balance – budget neutrality. Therefore, the institutional and academic articles that have come forward include some form of fiscal rule: it can be a stricter rule, requiring yearly budget neutrality of the scheme; or a less strict rule, requiring budget neutrality in the medium-to-long term, i.e., over the cycle. In the case of medium-to-long term budget neutrality, the matter of debt issuance as a form of financing the scheme during periods of deficit is considered, for example by Dullien’s (2013) proposal with intertemporal stabilization.
19 Main Challenges: Permanent Transfers and Moral Hazard
In addition to the common moral hazard issues related to unemployment insurance at the individual level (as studied by, for example, Chetty (2005) and Wang and Williamson (1996)), centralized stabilizing mechanisms that allow for transfers within the euro area - including the European Unemployment Benefit Scheme - present two main challenges, that are also withholding political support: permanent transfers (permanent redistribution) and moral hazard. Moral hazard is a central concern, since international risk-sharing achieved through the mechanism decreases incentives for national governments to adopt policies that reduce national risks or that help the economy react to national shocks (Persson and Tabellini, 1996a) or to implement structural reforms in the labour market (Dolls et al., 2018). Two solutions have been put forward to mitigate moral hazard: a claw-back mechanism based on experience rating4), and the introduction of a trigger. Both options would also tackle the problem of permanent transfers, by avoiding the case of a country being always a net contributor or always a net recipient. With the trigger, permanent transfers are avoided in two cases: (i) the indicator that triggers transfers is related to the rate of change of an economic indicator, not to its level - in this situation, every recipient-country would eventually become a payer and vice-versa; and (ii) the trigger is high enough so that transfers are only activated during major shocks. The system of experience rating or claw-back mitigates the risk of moral hazard due to the fact that, if a country constantly pursuits careless policies, it will face increasing contributions to the scheme in the future. The claw-back mechanism or mechanism of experience rating could be used to get close to budget neutrality. It would reduce the risk of permanent transfers because contributions of each country are adjusted in order to be balanced with the scheme over the medium turn, implying that each country would match its payments to its receipts. However, avoiding net transfers and achieving neutral balance of net long-term contributions of each country are not the same. Neutral balance of the net, long contribution is a sufficient but not necessary condition to avoid permanent net transfers.
4 With experience rating, the profile of each member state is monitored (beneficiary or contributor) and contributions or drawdown parameters are adjusted at the beginning of each period in order for the country to have a balanced budget over the medium term with the mechanism (Andor and Pasimeni, 2016)
20 In other words, avoidance of net transfers could be guaranteed without achieving neutral country balance (Beblavy ́ et al., 2017b). Additionally, these risks are reduced if the mechanism covers only short time unemployment and not structural unemployment (Dolls et al., 2018).
2.3. Interactions with Political Union and Banking Union
A fiscal, political and banking union are interconnected features to complete the monetary union and assure the proper functioning of the euro area. The latter two are now developed, along with their connection to fiscal integration. The recent Great Recession revealed strong links between the financial stability of governments and banks. Because banks were allowed to hold unlimited government bonds and national governments were responsible for stabilizing the banking sector, the debt crisis destabilized even further the euro area and this double-sided dependence, which also proved the restructuring of national debt could be very harmful for the banking sector (as in Dolls, Fuest, Heinemann and Peichl, 2016). As a solution, it was proposed and initiated the process of forming a banking union inside the European Union, which would have as main purposes the increase of financial stability in the euro area and provide a solution for the link between the banks and governments (De Grauwe, 2016). The banking union in the European Union is based on these key elements: Common Regulatory Framework, Single Supervisory Mechanism and Single Resolution Mechanism, with a Common Resolution Fund, which, at the moment, is financed by the banks inside the program, and a European Deposit Insurance Scheme (see Thirion, 2017, for example). There has been some debate over whether a banking union could be a substitute to a fiscal union – even if incomplete -, since it could mitigate the banking/financial shocks, which are the most destabilizing shocks. However, if there is a risk of asymmetric non-financial shocks in the euro area, a banking union is not enough to stabilize the monetary union (Rey, 2013). Additionally, Thirion (2017) argues that the proper implementation of the key elements of the banking union could require a higher degree of centralization of resources and authority at the European level, which would necessarily involve an evolution in the direction of a fiscal union. Without this deeper approach, the banking union would be incomplete and would not contribute properly to the stabilization of the monetary union. In
21 particular, the ability for shock-absorbing of the banking union may depend on the existence of a large common fiscal buffer, which would require a convergence towards a minimal fiscal union. The most significant limitation of a minimal fiscal union in the euro area is its political conditions and implications. There is no consensus in the euro area when it comes to a fiscal union, with most countries’ representatives being against it. The loss of national powers/sovereignty is the most common reason used to justify this resistance. The idea that a significant fiscal integration should exist along the monetary union was firstly debated in the Werner Report in 1970 and the MacDougall Report, in 1977, in the context of European Economic Integration. Both these reports emphasized the need of a central budget in the euro area and the possibility of transfers between member states (Thirion and CEPS, 2016). However, this significant fiscal integration was not materialized because of severe political resistance to the loss of national sovereignty and to the sharing of fiscal resources (Bénassy-Quéré et al., 2016). This did not change much inside the euro area. Up to this date, even though there is support from institutions and academics and some countries are starting to encourage the development of a minimal fiscal union, there is still a very strong political resistance to a euro area fiscal union. Nevertheless, political union would encompass fiscal union and consequently complete monetary union. The political union would simplify the creation of a transfers’ mechanism, the centralization of part of national budgets and could even decrease the asymmetry of shocks (De Grauwe, 2006). Moreover, it also increases the democratic legitimacy and accountability inside the monetary union (European Commission, 2012).
22 3. How to Assess the Stabilizing Properties of the European Unemployment Benefit Scheme
The academic and institutional literature just reviewed in chapter 2 argues in favour of a euro area stabilization mechanism. When there is a centralization of the monetary policy and the lack of the exchange rate, one of the proposals to guarantee the reaction to asymmetric shocks is the existence of a mechanism that allows transfers between members of the monetary union. Also, since there is a strong rigidity of the labour markets and fiscal policy is limited by rules determined by the institutions, it is more urgent to develop such a mechanism. The mechanism under focus in this dissertation is the European Unemployment Benefit Scheme. Typically, the papers or reports that focus on the European Unemployment Benefit Scheme present the proposed design (sometimes with several variants) of the scheme and then proceed with economic simulations of what would have been the results of its implementation in past (but mainly recent) years. These simulated results usually (but not always) include the improvement in macroeconomic stabilization brought about by the proposed European scheme. Our reading of the papers leads to a simplified three-stage structure summarized in the following table:
Table 1: Simplified stages of the papers that propose a European Unemployment Benefit Scheme
1. Design 2. Implementation A scheme is proposed, Based on the scheme’s design, 3. Stabilization Effects that includes: the contributions and benefits Simulation of the multiplier • Duration that are implied by the scheme effects of the benefits and • Replacement rate are computed for each country contributions obtained in the
• Coverage ratio during the chosen period. previous stage, with a
• Trigger or no trigger stabilization metric. Based on the characteristics • Experience rating of national unemployment Benefits and contributions • Contributions schemes and using real that result from the macroeconomic data, these previous step imply, via articles aim to simulate what multiplier effect, variation would have happened if the in output that will reduce scheme had been the output gap. implemented.
Source: Author’s elaboration
23 In the first step, a European Unemployment Benefit Scheme is proposed. This proposal contains the characteristics of the scheme that would be implemented in the euro area/European Union, which are: duration, replacement rate, coverage ratio, trigger or no trigger, experience rating and contributions. In the second step, the authors compute the benefits and contributions for each country for a certain period in time, according to the characteristics defined in the previous stage. In the third stage, using a stabilization metric, the stabilizing effects are simulated. These metrics are different for each paper and, most of the times, cannot be directly compared. These could be simulated through simpler methods (e.g. Excel) or through a more complex model that uses actual data (e.g. NiGem or Euromod). The key goal of the following steps is to uniformize the stabilization metrics, in stage 3, in order to: (i) be able to compare the results of the several reports; (ii) isolate the effects of the design of the scheme. Based on this, in the next chapter, there is an analysis and comparison of the methods and results of the most relevant (both academically and institutionally) economic simulations produced so far of the subject of European Unemployment Benefit Scheme. The main objective is to determine how the studies produced/published so far support the implementation of a stabilization mechanism, particularly a European Unemployment Benefit Scheme. As it is already been seen in previous sections, the macroeconomic stabilization effects of the European Unemployment Benefit Scheme are a key aspect of the scheme's benefits, so even if we do not analyse costs, we know that if the stabilization is modest or in the wrong direction, then it is not worth studying the costs. The focus of this dissertation on the stabilization properties of the proposals for a European Unemployment Benefit Scheme implies that some other points that were mentioned in chapter 2, above, in the context of macroeconomic stabilization, are not further deepened: there isn’t an analysis of the costs of the scheme, nor its political feasibility. Additionally, there isn’t an exploration of any other stabilizing systems that have been proposed (e.g. rainy-day fund based on output gaps).
3.1 Stabilization and Basic Design of the European Unemployment Benefit Scheme
The basic idea for the European Unemployment Benefit Scheme is to provide insurance
24 to the employees in the countries that adhere to the scheme, in the case they become unemployed. A certain amount of contributions is made to the scheme - through, for example, a share of the employee’s earnings -, instead of to the national system. In the case of unemployment and under certain eligibility criteria, the unemployed in the member state receives payments from the scheme for a certain period of time (duration) and according to their previous earnings (replacement rate). The scheme contributes for macroeconomic stabilization since, during downturn periods, contributions from a country suffering a negative shock would decrease due to the rise in unemployment, which would cause the decline of payments from the country to the scheme and increase the inflow of funds from the scheme. This would stabilize the purchasing power and GDP. During an expansionary period, an increase in employment would lead to an increase in contributions and, therefore, net payments, since countries would contribute more and receive less funds. This would lead to the deceleration of purchasing power and reduce the overheating of the economy (Andor et al., 2014). The stabilization is achieved through an automatic stabilizer – the net benefits provided by the European Unemployment Benefit Scheme -, that reacts to each member-state unemployment rate. The average stabilization effects of the scheme are strongly determined by the following design characteristics: • Replacement rate: unemployment benefit as a percentage of previous wage/earnings; • Coverage ratio: number of unemployed receiving benefits as a percentage of total number of unemployed; • Duration: number of months for which the unemployment benefit is paid out; • Contributions; • Trigger or no trigger: some proposals include an activation mechanism for benefits, that could be the unemployment rate (as in Farvaque and Huart, 2018) or the NAWRU (Beblavy ́ and Maselli, 2014) as the threshold, among others. Countries only receive benefits from the scheme if the threshold is reached; • Experience rating: the profile of each member state is monitored, and contributions or drawdown parameters are adjusted at the beginning of each period in order for the country to have a balanced budget over the medium term with the mechanism (Andor and Pasimeni, 2016).
25 3.2 Simulations and Comparison
In order to measure the size of the stabilization impact in member states, several authors have made simulations to estimate the impact of their proposed schemes, such as Beblavy ́ and Maselli (2014), Brandolini et al., (2016), Dolls et al., (2018), Dullien (2013), Farvaque and Huart (2018), Fichtner and Haan (2014), and Jara, Sutherland and Tumino (2014, 2015 and 2016).
Criteria. Since the objective is to compare simulation results, some important criteria for selecting the papers are defined in advance: v European Union and euro area simulations: the relevancy of this exercise is to determine the stabilization properties of the European Unemployment Benefit Scheme. Accordingly, the simulations were limited to European Union or euro area simulations; v Recent Great Recession and post-crisis simulations (after 2009): One of the main justifications for the implementation of such a scheme arose from the recent Great Recession, therefore it is necessary that the simulations include an analysis of the stabilization effects of the scheme during the crisis; v Macroeconomic stabilization analysis due to the implementation of the European Unemployment Benefit Scheme: since the main objective of this dissertation is to analyse the macroeconomic output stability provided by the scheme, all the simulations that did not offer enough data to apply the designed method or that did not provide a stabilization quantification that was comparable were not included; v Simulation based on actual data: with actual data the results are less dependent on the uncertainty of the model, depending only on design differences. The data is from a common database, while with models the simulations are made with own generated data. Additionally, these schemes are more simplified and allow for a clearer evaluation of the stabilizing effects. Application of these criteria results in the choice of five papers, whose design characteristics concerning the unemployment benefits are summarized in the table below. A more detailed account of each one is presented in the Annex.
26 Table 2: Design characteristics of the considered proposals on the European Unemployment Benefit Scheme
Farvaque Fichtner Beblavy ́ and Dolls et al., and Huart Dullien (2013) and Maselli (2014) (2018) (2018) Haan (2014)
Model A: 70% of 40% average last net monthly 46% Replacement 50% previous 40% average wage in each salary national previous Rate gross earning country Model B: nominal gross wage 30% of compensation last net salary Pick-up rates: 100% short- A) 100% of new short-term term unemployment over past 12 unemployed months + 3% Employed 100% short- Country Coverage 75% short-term with previousa) B) 100% of new short-term term rate in Ratio unemployed employment unemployment over past 12 unemployed fixed year income for a months + 20% of the
1: Design 1: period of up remaining short-term
age to 12 months unemployed St
Model A: Duration 12 Average of 6 12 12 12 (Months) Model B: 6 Activation Yes/No No No No/Yes No Trigger Experience Yes No No No No Rating 12 28 countries 27 countries 18 countries countries European 12 countries euro area, European Sample euro area, euro area, Union, 1999- 1995-2011 Union, 2005- 2000-2013 1999- 2012 2014 2012 EU-SILC Implementation
: EU-SILC and Eurostat and 2 Database AMECO Eurostat and AMECO and EU-LFS AMECO age NiGEM St Source: Author’s elaboration based on the proposals of Beblavy ́ and Maselli (2014), Dolls et al., (2018), Dullien (2013), Farvaque and Huart (2018) and Fichtner and Haan (2014)
27 Note: Fichtner and Haan A and B and Dullien A and B are variants of the same model in terms of: i) Fichtner and Haan: duration and replacement rate; ii) Dullien: coverage ratios.
These studies could originate from two different backgrounds: (i) institutional background, generally for European Institutions; (ii) academic background, developed by and for, for example, think tanks such as CEPS (Centre for European Policy Studies). Of the selected articles, Fichtner and Haan (2014), Farvaque and Huart (2018) and Dolls et al., (2018) have an academic origin and Dullien (2013) – developed for the European Comission and Beblavy ́ and Maselli (2014) – commissioned by the European Parliament - an institutional origin.
Contributions and Budget Neutrality. Each country’s payment to the European Unemployment Benefit Scheme is determined by the mechanism of contribution rate proposed in each paper. Two main characteristics are crucial: i) the span of the period over which budget neutrality is required; ii) the level of the contribution rate. The two characteristics are interrelated because the contribution rates are chosen/calibrated (and sometimes adjusted year by year) in order to deliver each specific budget-neutrality requirement. The following table summarizes these main characteristics (each proposal is further detailed in the Annex).
28 Table 3: Contributions and budget neutrality of each proposal
Experience Budget Neutrality Common Contribution Rate5 Rating 1) 0.5% of nominal compensation Beblavy ́ and Fiscal balance for each plus additional tax Yes Maselli country over the cycle 2) 0.1% of GDP plus additional tax Fiscal balance for the Contribution rate is updated Dolls et al. No scheme every year every year Fiscal balance for the Model A: payroll tax of 1.66% Dullien No scheme over the cycle Model B: payroll tax of 0.65% Baseline model: average rate of Farvaque and Scheme balanced over 2.3% of gross wages No Huart every 3-year period Model with trigger: average rate of 0.7% of gross wages Fichtner and Fiscal balance for the Model A: 1.3% of gross wages No Haan scheme over the cycle Model B: 0.4% of gross wages Source: Author’s elaboration based on the proposals
In Dullien’s proposal, the scheme has to be balanced over the cycle, meaning that it can run yearly surpluses or deficits, as well as issue debt, as long as it is balanced over the business cycle – in practice, by the end of the period underlying the simulation. This allows, as argued by the author, for intertemporal stabilization instead of only interregional stabilization. Fichtner and Haan also use this assumption, implying that the total amount of contributions covers exactly the costs of the scheme during the whole period underlying the simulation. In the Dolls et al. proposal that we consider, the scheme is designed with interregional stabilization only, where budgetary balance is required every year for the scheme, implying yearly adjustments to the contribution rate. In the Farvaque and Huart proposal that we consider, budgetary balance for the scheme is required every three-year period, implying that the common contribution rate may be adjusted every year. Beblavy ́ and Maselli impose country-level budgetary neutrality in the medium-to-long term in their stabilization analysis, including therefore an experience rating mechanism that commands the periodic adjustments
5 All the stabilization simulations under consideration use a common rate, i.e., the same rate for all countries.
29 to each country’s parameters, in order to warrant that each country is balanced vis-à-vis with the scheme over the cycle.
3.3 A Common Metric to Compare Stabilization Properties: Uniformization
The main goal of this stage is to uniformize the stage 3 identified in table 1 of chapter 3, section 3.1., which are the stabilization effects. The analysis of the selected articles shows that even with some homogenization achieved with the selection criteria, the differences in the metrics used by each author to compute the stabilization effects make it very difficult or even impossible to directly compare the results. The different multiplier effects and stabilization metrics are presented in the next table.
Table 4: Multiplier effects and stabilization metric of each proposal
Multiplier effect Stabilization Metrics Authors multiply the net inflow Additional output as a percentage of Beblavy ́ and coming from the scheme fund by the GDP that is gained by countries due to Maselli (2014) fiscal multiplier of the unemployment the implementation of the scheme benefits (1.5) “Percentage of income fluctuations due Variation in gross income with the to transitions in and out of Dolls et al., scheme is measured using Euromod unemployment that is cushioned by (2018) calculator interregional and intertemporal smoothing” Dolls et al., (2018), page 286 Percentage of deterioration in the output Ratio of the change in net transfers as gap over the period which would have Dullien (2013) a % of change in output gap been prevented with the implementation assuming fiscal multiplier of 1 of the scheme Farvaque and GDP growth variability (in %) that is - Variation of GDP with and without Huart (2018) avoided due to the implementation of the the implementation of the scheme scheme Reduction of GDP losses, as a result Fichtner and of the implementation of the scheme, Percentage change in real GDP Haan (2014) estimated through NiGem Source: Author’s elaboration, based on the proposals
30 We construct and apply a common metric to measure the degree of stabilization brought about by each proposed scheme, which overcomes the undesirable heterogeneity in stage 3, while maintaining the desirable heterogeneity in stages 1 and 2. This way, it becomes possible to identify the source of different stabilization effects with the differences in the schemes and not with the differences in measuring stabilization.
Common Metric, First Step. The first step is based on the methodology used in Dullien (2013). The author selects periods during which the simulation of the scheme (stage 2) results in countries switching from a net payment position to a net recipient position. In our common metric, we define (simulated) net transfers, from the scheme to a country and in percentage of GDP, as: net transfers = benefits received by a country – contributions made by a country - If net transfers > 0, country is a net recipient from the scheme. - If net transfers < 0, country is a net payer to the scheme. And, for a particular country i at period t:
∆��� ��������� , = ��� ��������� , − ��� ��������� , (3. 1)
If Δ net transferst > 0, the country (net) receives more from the scheme than in the previous year.
If Δ net transferst < 0, the country (net) receives less from the scheme than in the previous year.
The changes in output gap - output gap that has occurred in the absence of the scheme, i.e., defined as the percentage deviation of actual GDP from natural level GDP – is defined as:
∆������ ��� , = ������ ��� , − ������ ��� , (3. 2)
If ΔYgapt > 0, the country is in expansion (output gap more positive or less negative than in the previous year).
31 If ΔYgapt < 0, the country is in recession (output gap is more negative or less positive than in the previous year).
To conclude, Dullien (2013) relates the net transfers variation and the output gap variation, for each country and each selected period, obtaining the percentage of output gap deterioration that could have been prevented by the European Unemployment Benefit Scheme, assuming a fiscal multiplier of one. The choice of a proper magnitude for the fiscal multiplier of unemployment benefits is extremely challenging, as argued by Beblavy ́ and Maselli (2017). The authors in the selected papers assume values around or above 1. Similar to Dullien (2013) and Farvaque and Huart (2018), we consider a common value of 1 for the fiscal multiplier, as it is a conservative value which assures that the effects of stabilization are due to the scheme and not to the oversize of the multiplier.
∆��� ��������� , ������������� , = ∆������ ��� , (3. 3)
This stabilization percentage can be positive or negative, implying contrasting key properties, as the following table summarizes.
Table 5: Concept of procyclical and countercyclical effects of the common stabilization metric
Country (net) Δ net transfers > 0 receives more and ΔYgap > 0 ∆ during expansions Procyclical Effect >0 ∆ Country (net) (not stabilizing) Δ net transfers < 0 receives less and ΔYgap < 0 during recessions Country net Δ net transfers > 0 receives more and ΔYgap < 0 Countercyclical ∆ during recessions <0 Effect (stabilizing) ∆ Country net Δ net transfers < 0 receives less and ΔYgap > 0 during expansions Source: Author’s elaboration
32 1) This common metric can be applied to the selected articles that compute and present the simulated net transfers (stage 2, table 1, above), regardless of their different stabilization metrics (stage 3, table 1)6
Common Metric, Second Step. Dullien (2013) only applies its method to short periods (between 1 to 4 years) during which a country changes its net position from contributor to recipient. However, we aim at obtaining a value that encompasses the entire period used in each article, including periods of expansion and recession, not only during downturns. In other words, we need a properly weighted average for each country across the chosen period. Hence, the second step of our common metric is based on Dolls et al. (2018). It consists in weighting the stabilizing effects with the relative size of variations in output gap and sum all the weighted stabilizing coefficients for country i across time. The main objective of the weighting is to correct the stabilizing coefficients that are too high during years in which the size of the output gap variations is relatively small and vice-versa. The formula is the following:
|Δ ���� | (∆��� ��������� ) ������������� = ( × ∑ | Δ ���� | Δ ���� (3. 4)
In which: ü The first term of the formula refers to the weighting of the stabilizing effects with the relative size of the output gap variations. The relative size of each shock is obtained by dividing the absolute value of each year’s shock by the sum of the variations in the output gap (in absolute value) throughout the whole period. ü The second term of the formula refers to the stabilization in each period (step 1).
6 Even though Dolls et al. (2018) do not provide net transfers, their results from what we call stage 3 are compatible with our common metric, which makes it possible to compare with the other articles. As the authors consider individuals (not countries), we take (by simplification) their sum of individual income fluctuations as corresponding to the output gap variations - assuming the fiscal multiplier as 1.
33 Stabilization average can be positive or negative with the interpretation provided in the following table:
Table 6: Interpretation of the stabilization coefficients obtained through the common metric
Stabilizationi>0 Procyclical effect dominates The more positive, during period under analysis the less stabilizing is the scheme
Stabilizationi<0 Countercyclical effect dominates The more negative, the during period under analysis more stabilizing is the scheme Source: Author’s elaboration
When negative in sign, stabilization is interpreted as the average percentage of output gap deviations from zero (either positive or negative) that would have been prevented if the scheme was in place (during the simulation period) in country i. If positive in sign, stabilization is interpreted as the average percentage of output gap deviations from zero (either positive or negative) that would have been aggravated by the scheme (during the simulation period) in country i.
34 4. Assessing the Stabilizing Performance of the Proposals for a European Unemployment Benefit Scheme
The common metric presented in chapter 3 is now applied to the papers that have been selected. Taking the simulations of the scheme presented by each proposal (stages 1 and 2, table 1 from Chapter 3, section 3.1.), we apply our common metric to each of the schemes, in order to assess if, in general and in particular, those proposals indeed deliver stabilization, thus computing and comparing countercyclical and procyclical effects. Stabilization will be assessed within the periods of each proposal’s simulations, as well as within a common period corresponding to the recent Great Recession.
4.1. General Results
The application of the above described method/common metric yields the comparable stabilizing coefficients organized in the following table, country-by-country and for a weighted average (with 2015 GDPs). As described in Chapter 3, section 3.4, each value represents the percentage of output gap deviations from zero that could have been prevented by the implementation of the European Unemployment Benefit Scheme. As an example, for the Dolls et al. simulation, between 2000 and 2013, in Austria, 5.8% of output deviations could have been prevented by the implementation of the European Unemployment Benefit Scheme. Therefore, the scheme has a dominant countercyclical effect. In contrast, in the Dolls et al simulation, for Malta, between 2000-2013, the implementation of the European Unemployment Benefit Scheme would have aggravated the output deviations in 4.6%, therefore having a dominant procyclical effect.
35 Table 7: Stabilization effects under the common metric
Beblavy ́ and Dolls et al. Farvaque and Dullien Fichtner and Haan Maselli [18 EA, 2000- Huart [12 EA, 1995-2011] [12 EA, 1999-2012] [28 EU, 2013]7 [27 EU, 2005-2014] 1999-2012] A B Baseline Trigger A B Austria -5.80 -0.85 -1.93 -7.22 -18.55 -2.63 -1 Belgium -3 -5.84 -5.05 -4.65 -52. 40 -2.08 -1.01 Bulgaria -2.31 -13.41 Cyprus -17.70 -9.69 -22.11 Czech -6.90 -14.16 Repub. Denm. -8.26 -21.63 Estonia -6.41 -19.40 -9.47 -12 Finland -2.40 -2.87 -2.37 -4.01 -17.90 -0.95 -0.51 France -7.70 -5.50 -4.67 -10.01 -31.16 0.07 -0.46 Germ. -11 -1.34 -2.08 -5.22 -23.29 -2.53 -1.06 Greece -3.25 -12 -0.65 -1.64 -6.64 1.33 -3.96 -0.96 Hungary -6.91 -16.18 Ireland -7.07 -15.70 -6.84 -6.37 -8.66 -13.05 -4.02 -1.66 Italy -5.50 -2.03 -1.69 -7.59 -17.94 -1.42 -0.51 Latvia -3.85 -21 .6 -6.19 0.69 Lithuan. -5.45 -8.98 -12.68 Luxemb. -7.10 -0.43 -0.43 1.02 -0.19 Malta 4.60 -2.84 -26.99 Netherl. -8.30 -3.71 -3.30 -9.92 -35.67 -2.71 -0.99 Poland -4.65 -23.61 Portugal -13.40 -8.37 -7.59x -7.88 -20.06 -4.90 -2.x16 Romania -0.63 3.24 Slovakia -9.60 -2.82 -13.09 -0.31 -0.14 Slovenia -5.60 -5.17 -12.88 Spain -11,01 -17.80 -1.91 -2.02 -15x.03 -1.54 -6.27 -1.48 Sweden -4.71 -18.73 UK -11.49 -24.78 Average (2015 -9.23 -9.52 -3.01 -2.96 -8.31 -22.20 -2.27 -0.89 GDP) Source: Author’s elaboration
Note: When identified with a ,the value represents the maximum of stabilization for that proposal. When identified with a , , the value represents the minimum of stabilization for that proposal.
7As explained in the correspondent article summary in the Annex, there is a nuance in the Dolls et al. proposal. The authors conduct first a simulation under the scenario of harmonized national systems, which, by itself, would bring about stabilization effects. However, the stabilization coefficients from the national systems harmonization process are not all available in the article. Then, when computing the stabilization coefficient for year t, they compare the common scheme with the national schemes with harmonization, while our calculations for the other papers compare with the national schemes without harmonization.
36 It is useful to highlight some conclusions drawn from the table. As mentioned in Chapter 3, section 3.1., there are several factors that can explain the differences in stabilization coefficients. Through the application of the common metric presented in Chapter 3, section 3.4., the differences that derive from the factors of stage 3 (which is the simulation of the effects of the benefits and contributions with a stabilization metric) were eliminated. Therefore, the remaining differences in stabilization coefficients could be explained by: (i) design of the scheme, such as duration or generosity (coverage ratio and replacement rate) and financing design - contribution rates, experience rating and budget neutrality (stage 1 table 1 in section 3.1.); (ii) characteristics of national systems - national unemployment rate and eligibility criteria (stage 1); (iii) the existence or not of triggers (stage 1); (iv) country-sample (euro area, European Union) and period considered in the simulation (stage 2); (v) differences in the methodology used to obtain the net transfers (stage 2). Although it is not possible to isolate the effects of each of these five factors on stabilization, there are some hints about what to expect from the influence of some factors. Of course, lower generosity or duration of the scheme – impact of stage 1 – could imply lower stabilization. Also, according to Beblavy ́ and Maselli (2014), schemes with triggers are more stabilizing because countries receive similar payments in deeper fluctuations with lower annual contributions to the scheme, since the costs of the scheme are lower (pay-outs to countries are smaller because not a lot of them reach the trigger threshold), as could be the case for Farvaque and Huart (2018) with trigger. Moreover, the requirement for budgetary neutrality could have a negative impact in the stabilization coefficients. According to Dullien (2013) if it is required that a scheme has yearly budget neutrality (revenue that is collected in a year is distributed in the same year), implying a frequent adjustment of the contribution rates, some procyclical effects may occur8. All the proposed schemes have, on average, a negative coefficient, which means countercyclicality, varying between 0.89% (Fichtner and Haan scheme, Model B) and 22.2% (Farvaque and Huart scheme with trigger) of the output gap variation. We recall that countercyclicality is consistent with the theories presented in chapter 2 (Theory of the
8 Dullien (2013) provides the example of the 2009 subprime crisis, where all the member states of the euro area suffered a common negative shock. If the scheme requires fiscal balance every year, benefits and contributions would have increased in all countries, but only the countries in a relative severe recession, such as Spain, would receive large net benefits. Other countries, such as Germany – which are in a relatively better position – would not, because of the small relative increase in unemployment and the need to balance the scheme yearly, which causes some countries to net contribute during recessions. Therefore, the scheme would have procyclical effects for Germany.
37 Optimum Currency Areas and Fiscal Federalism) and with the desirable features of the stabilization mechanism (discussed in section 2.2). Only in six – out of a total of 126 - cases the coefficient is positive, meaning procyclicality: Luxembourg (Farvaque and Huart scheme baseline), Greece, Latvia and Romania (Farvaque and Huart scheme with trigger), France (Fichter and Haan scheme model A) and Malta (Dolls et al., 2018). In the next section there is a more detailed analysis of the procyclical and countercyclical effects. Farvaque and Huart scheme with trigger present the most stabilization out of all the schemes, and notably in comparison to their baseline model. With a trigger, the benefits are similar in larger recessions, but contributions are smaller. However, the Farvaque and Huart scheme with trigger is the proposal that creates procyclical effects in three countries and the largest during normal times, as analysed below in section 4.3. Fichtner and Haan model A presents a more countercyclical stabilization coefficient that model B, due to the higher duration and replacement rate. In general, Fichtner and Haan model B presents the least stabilization of all the schemes, probably because it offers the least generous conditions in terms of duration and replacement rate. In six out of the eight proposed schemes, Portugal and Spain are the most stabilized countries, which could be justified by the higher national unemployment rate or higher amount of short-term unemployed in the country (eligibility criteria). The stabilization coefficients presented in table 7 result from the application of formula 3.4., developed in chapter 3 section 3.3. The graphic illustration that follows plots the numerator (variation of net transfers, y axis) against the denominator (variation of output gap, x axis), for each year in each country. The slope of each simple regression line is directly related to the stabilization and the scheme’s reactivity to the output gap variations. The larger the slope (in absolute value), the bigger the reaction of the scheme to the output variations and the larger (in absolute value) the stabilization coefficients.
38 Figure 1: Graphic representation of the schemes' simulations
39
Source: Author’s elaboration
The highlighted results in table 7 are confirmed: Farvaque and Huart model with trigger has the biggest slope and Fichtner and Haan the smallest slope. In all cases, the line has a negative slope, through the second and fourth quadrants, which means the countercyclical effect is dominant - the more negative the variation output gap is, the more positive the variation in net transfers is and, the more positive the variation in output gap, the more negative the variation in net transfers is. This is in line with the concept analysis summarized in table 5 in chapter 3. In fact, in the proposals with the largest stabilization – Beblavy ́ and Maselli, and Farvaque and Huart – net transfers are more reactive to changes in output gap than in the articles with the smallest stabilization – Fichtner and Haan, and Dullien.
40 Table 8 concludes the presentation of the general results, by focusing on the level of net transfers resulting from each proposal9. Analysis of net transfers to and from the scheme - stage 2 in each of the proposed schemes10 -, permits the identification of the largest net contributors and net recipients, as well as the permanent net contributors and permanent net recipients.11
9 Recall that the change in the level of net transfers is the numerator of the stabilization coefficient in formula 3.4. in chapter 3, section 3.3. 10 With exception of Beblavy ́ and Maselli (2014), since stabilization is only studied during the Great Recession, therefore only including a period of large net transfers from the scheme to 6 countries. 11 Tables for net transfers would be too large for explicit inclusion here. However, these results are available from the author upon justified request to [email protected].
41 Table 8: Analysis of net contributors and net recipients
Three Main Net Permanent Three Main Permanent Net Contributors * Net Net Recipients Contributors Recipients * Dolls et al. Austria, Germany Netherlands, Latvia and Spain Spain [2000-2013] and Netherlands Austria and Luxembourg Dullien Model A France, - Spain, Finland - [2005-2011] Netherlands and and Greece Italy
Model B Belgium, Netherlands Spain, Finland Spain Netherlands and and Greece Luxembourg
Farvaque and Baseline Germany, Netherlands, Spain, Greece Spain, Greece, Finland, Huart Netherlands and Slovenia, and Lithuania Poland and Sweden [2005-2014] Luxembourg Luxembourg and Malta Model with Denmark, Finland - Cyprus, Spain - Trigger and Czech and Portugal Republic
Fichtner and Model A Slovakia, Finland Netherlands, Spain, France Spain, Greece and Haan and Netherlands Austria, and Greece France [1999-2012] Belgium, Slovakia, Finland and Italy Model B Slovakia, Finland, Netherlands, Spain, France Spain, Greece and Netherlands Austria, and Greece France Belgium, Slovakia, Finland and Italy Source: Author’s elaboration based on the selected proposals * Net contributions / receipts are not weighted by the dimension of the countries.
The analysis of the main contributors and main recipients reveal some patterns: (i) The Netherlands are a main contributor in 6 out of the 7 schemes; (ii) Spain is a main
42 recipient in all of the proposed schemes, which could be due to the severe difficulties that the Spanish labour market suffered during the recent Great Recession; (iii) Greece is the second country that appears the most as one of the biggest net recipients. As discussed in chapter 2, section 2.2., the existence of permanent redistributions is one of the main challenges for political feasibility of the European Unemployment Benefit Scheme. Table 8 shows that the proposed designs of the scheme have not yet fully addressed that challenge - only two of the proposals (Dullien and Farvaque, and Huart with trigger) do not result in some permanent net transfers12. Permanent redistribution is more likely to occur in schemes that do not incorporate a claw-back mechanism, such as experience rating (specific contribution rate to each country), or a trigger, such as the case of Farvaque and Huart model with trigger.
4.2. Procyclical and Countercyclical effects
Countercyclicality is a key desirable characteristic of the European Unemployment Benefit Scheme. The general results show that the countercyclical property dominates in most cases, but with exceptions and with different intensities. This section, based on the calculations summarized in table 7, takes a closer look at the stabilization behaviour of the proposals under comparison. Based on each country’s yearly stabilizing effects, procyclical, neutral and countercyclical cases were counted (as well as the percentage of each in total cases) for each proposed scheme, along with the stabilization coefficient of the corresponding periods. Table 9 presents those results 13.
12 It should be noted that in most net-payers the countercyclical property of the schemes remains (see table 7, above) - the exception being Luxembourg in the Farvaque and Huart baseline model. 13 Dolls et al. (2018) is not included in this and the following table, due to the unavailability of the net transfers.
43 Table 9: Procyclical, neutral and countercyclical effects of the proposals
Procyclical and Neutral Countercyclical Stabilization Stabilization Cases (aggravation) Cases effect effect 69 201 Farvaque and Baseline 1.70% -10.01% (25.6%) (74.4%) Huart [27 EU, 107 163 2005-2014] Trigger 11.37% -33.57% (39.6%) (60.4%) 62 106 Fichtner and Model A 1.17% -3.44% (36.9%) (63.1%) Haan [12 EA, 71 97 1999-2012] Model B 0.43% -1.33% (42.3%) (57.7%) 105 95 Model A 1.89% -4.90% Dullien [12 EA, (52.5%) (47.5%) 1995-2011] 77 123 Model B 1.84% -4.80% (38.5%) (61.5%) Bablavy and 7 17 Maselli [28 EU, 2.79 -12.01% (29.2%) (70.8%) 1999-2012] Source: Author’s elaboration
Some examples are helpful in interpreting the table 9. The procyclical and neutral cases represent the total number of events where the effects were procyclical or zero. As an example, in the Farvaque and Huart baseline simulation, during 2005-2014, there were 69 occurrences (25.6% of total occurrences) of procyclical or neutral effects. Similarly, for the countercyclical events: 201 cases (74.4%) with countercyclical effects. The procyclical stabilization effect represents the percentage of output deviations that would have been aggravated with the implementation of the European Unemployment Benefit Scheme in the years where dominant procyclical and neutral effects occurred. For example, again in Farvaque and Huart baseline simulation, in the years in which the 69 cases of procyclical or neutral effects occur, the implementation of the European Unemployment Benefit Scheme would have aggravated the output deviations in 1.7%. As for the countercyclical stabilization effect, in the years in which the 201 cases of countercyclical
44 effects occur, 10.01% of output deviations could have been prevented with the implementation of the European Unemployment Benefit Scheme. In all schemes, except for Dullien (2013) model A, the number of countercyclical cases is clearly larger than the number of procyclical and neutral cases. The exception is justified by the high number of neutral cases (stabilization coefficient is zero) - the number of neutral cases in the Dullien scheme, model A, is 54, much higher than the 20 cases of their model B. Nevertheless, in all schemes, the countercyclical effect is higher than the procyclical and neutral effect during the whole period, which naturally corroborates the general results in Table 7. Particularly concerning the Farvaque and Huart scheme with trigger, it can be concluded, as observed in table 9, that, despite the very high number of procyclical cases – more procyclical cases occur because, even if countries are in a downturn period, they only receive net benefits if they surpass the threshold – the countercyclical stabilization effects are clearly the largest of all schemes.
4.3. Stabilization effects during the recent Great Recession
According to Andor et al. (2014), the matter of marginal stabilization in a recession is the most relevant in measuring the degree of stabilization of the European Unemployment Benefit Scheme, in particular from a political stand of view. In other words, the degree of smoothing out small variations of the cycle may not be as relevant, especially when compared to the ability to cushion large (asymmetric) shocks. Using the same common metric applied so far (developed in chapter 3 section 3.4.), table 10 decomposes the stabilization effects of the proposed schemes into two different business cycle periods, crisis vs normal times; where crisis denotes the period of the great recession 2008-2012 (with small nuances due to information limitations) and normal times denotes the rest of the years in each simulation.
45
Farvaque and Huart Fichtner and Haan Dullien Crisis: 2008-2012 Crisis: 2008-2012 Crisis: 2008-2011 Normal times: 2005-2007; Normal times: 1998-2007 Normal times: 1995-2007 2013-2014 Baseline Trigger A B A B Output Gap Crisis 67.71% 67.71% 54.70% 54.70% 42.89% 42.89% Variations (as Normal % of Total 32.29% 32.29% 45.30% 45.30% 57.11% 57.11% times Period) Stabilization -6.21 -24.24 -1.30 -0,59 -1.91 -2.03 Crisis Coefficient (74.78%) (109.18%) (57,10%) (65.49%) (63.59%) (68.45%) (as % of Total Normal -2.09 2.04 -0.97 -0.31 -1.10 -0.93 Period) times (25.22%) (-9.18%) (42.90%) (34.51%) (36.41%) (31.55%) Table 10: Stabilization effects of the scheme during the recent Great Recession
Source: Author’s elaboration
As an example, for the Farvaque and Huart simulation, baseline model, during the crisis – the sum of output gap variations that occurred during the crisis 2008 - 2012 was 67.71% (32.29% in normal times) of the total sum of output gap variations 2005-2014. The stabilization coefficient during the crisis 2008-2012 is -6.21%, which means that, during that period, 6.21% of output deviations could have been prevented by the implementation of the scheme (2.09% in normal times). This corresponds to 74.78% of the total stabilization in 2005-2014 (25.22% in normal times). In all the proposed schemes the stabilization coefficient is clearly larger in crisis than in normal times (and much larger in the scheme with trigger) and the weight of crisis stabilization in total stabilization is always larger than the corresponding weight of output deviations. It is thus possible to conclude that during the Great Recession, the degree of stabilization that would have been provided by the scheme is itself countercyclical, since the dimension of stabilization provided by the scheme is more than proportional to the dimension of output gap variations (with the multiplier remaining at one, recall). In other words, the proposed European Unemployment Benefit Scheme is not only an automatic stabilizer along the cycle (already concluded from the general results above in section 4.1.), it is more than proportionally countercyclical during a large recession. It is notable that this reinforced countercyclicality during the recent Great Recession shows up in all the proposals
46 under comparison, not just in the one with the trigger, where the non-linearity results automatically. Taking a closer look at the Farvaque and Huart (2018) scheme with trigger, its procyclicality during normal times could be expected, as the authors explain, because the scheme is only activated during times when the unemployment rate is higher than the threshold defined for the trigger (10% change). During the rest of the period, if the unemployment rate is rising and the country is going through a (mild) recession, the scheme is not activated. Additionally, the proposed scheme requires budget neutrality every three years, which can distort its stabilizing effects. The authors indicate solutions for these problems: the procyclical effects could be reduced if the length of the period for budgetary balance was increased and if the trigger was adjusted – the threshold for the scheme to be activated could be lowered. The crisis vs normal times split of the stabilization effects brings out more clearly the influence of the requirement of medium to long-term budget neutrality. Simulations show that the very demanding and more than proportional response of the scheme to the recent Great Recession can generate undesirable procyclical stabilization coefficients later on - in a mild recession during normal times or even in later stages of a large recession -, in order to restore the medium-term budget equilibrium of the scheme. This confirms that, as mentioned above in chapter 4 section 4.1., the financing design can distort the stabilizing properties of the scheme. For example, in the Dullien scheme, model A, in 2010 Spain would experience a procyclical stabilization coefficient of 4.78% due to the large decrease in net flows payed to the country, even though there is a large negative output gap variation. In the Farvaque and Huart scheme with trigger, in 2012, Greece has a procyclical effect of 6.37%. And in normal times, in three out of the six analysed schemes, Spain, France and Greece have procyclical coefficients14. The relative dimension of the output gap deviations is another factor behind the difference of stabilization between countries, calling the attention to the need to further address asymmetric shocks, an important theme in the context of the Optimum Currency Areas Theory briefly explored in chapter 2, section 2.1. For example, Germany or Austria suffered shocks less severe than the euro area average – notably smaller shocks to
14 The results by year and country are not in table 10 because they would be too large for explicit inclusion here. However, these results are available from the author upon justified request to [email protected].
47 unemployment in Germany -, hence their stabilizing effects are smaller during the crisis: Fichtner and Haan’s model A yields, for Germany and Austria, respectively, crisis stabilization coefficients of -0,46% and -0.38%, which compare with -1.3% for all countries or, even more markedly, with Spain’s -5.56% and Greece’s -2.97%. In conclusion, all proposed schemes provide stabilization to the participating members of the euro area/European Union, even though some procyclical effects are detected. The scheme has capacity to work adequately during periods of stronger recession, as simulated during the recent Great Recession, with more than proportional countercyclicality. Three main limitations in the analysis and comparison of the proposals show that further developments are needed, both in the proposals and in their assessment: i) stricter forms of budgetary neutrality could distort the stabilization of the schemes, generating some undesirable procyclical effects, which could be avoided, as proposed by Dullien (2013), through the ability to issue debt or run surpluses; ii) if the European Unemployment Benefit Scheme is meant to react strongly to negative asymmetric shocks, there is a need to enhance the proposals and their analysis, by focusing on asymmetries in order to better represent the effects that such a scheme could have in the euro area; iii) the effects of each element of the identified stages in chapter 3 (stages 1 and 2, design and simulation of implementation), are not possible to isolate in the available versions of the proposals.
48 5. Conclusion
The implementation of a transfers’ mechanism with stabilization properties inside the euro area has been a factor of debate. One of the most studied mechanisms is the European Unemployment Benefit Scheme, with several proposals from the European Institutions and academics. The aim of this dissertation has been to assess and compare the stabilization properties of the main proposals made on this scheme. In order to do so, a common metric was developed and applied to the Dullien (2013) scheme, Farvaque and Huart (2018) scheme, Fichtner and Haan (2014) scheme and the Beblavy ́ and Maselli (2014) scheme, that were later compared to the results by the Dolls et al. (2018) scheme. After analysing the results, we came to the conclusion that all proposed schemes provide average stabilization to the countries that participated, even though some non-dominant procyclical effects can be expected. Additionally, according to the analysis, the scheme would appropriately work in a more than proportional countercyclical way during a period of more severe recession, as simulated during the recent Great Recession. Its implementation could, therefore, improve the functioning of the monetary union, in terms of benefits as it is in line with the theories presented in chapter 2 and its desirable characteristics. Nevertheless, these studies have several limitations, still to be addressed in further refinements of the proposals, both academic and institutional. Firstly, the financing of the scheme – experience rating and budget neutrality - could generate undesirable effects and limit the stabilization capacity of the scheme. Even though these mechanisms could limit some of the concerns, there is a trade-off between the scheme’s capacity to stabilize and moral hazard. Intertemporal stabilization, through the issuance of debt and the ability to maintain surplus could be a way to avoid the problems created by experience rating and budget neutrality. Additionally, since it is the main goal of the mechanism the cushioning of asymmetric shocks, as argued in chapter two, an important next step would be to have a closer focus on this type of shocks, with similar simulations. It is also important to point out some limitations of our study, that could be a useful and interesting starting point for future analysis: the costs of the scheme were not studied. Now that we know that the studied scheme provides stabilization, its comparison with costs - moral hazard, redistribution, political resistance - would be very useful. Additionally, as argued in chapter 2, this scheme is designing to cushion asymmetric shocks, which has also not been integrated in our study.
49 Therefore, as next steps, and in order to further understand the impact that such a mechanism could have on the stabilization of the euro area, further macroeconomic and microeconomic analysis should be conducted, mainly concerning the cushioning of asymmetric shocks, the financing of the scheme and, more ambitiously, the comparison of moral hazard (and other) costs of the scheme with its benefits as an automatic stabilizer.
50 6. Bibliographic References
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51 Bordo, M. D., Jonung, L., & Markiewicz, A. (2013). A Fiscal Union for the Euro: Some Lessons from History. CESifo Economic Studes, 59(3/2013), 449-488. Brandolini, A., Carta, F., & D'Amuri, F. (2016). A Feasible Unemployment-Based Shock Absorber for the Euro Area. Journal of Common Market Studies , 54(5), 1123-1141. Cavallo, A., Dallari, P., & Ribba, A. (2018). The Common Framework for National Fiscal Policies and the Euro Area Fiscal Union. In A. Cavallo, P. Dallari, & A. Ribba, Fiscal Policies in High Debt Euro-Area Countries (pp. 11-49). Springer. Chetty, R. (2005 ). Why do Unemployment Benefits raise Unemployment Durations? Moral Hazard vs Liquidity. NBER Working Paper Series, National Bureau of Economic Research . Dabrowski, M. (2015). Monetary Union and Fiscal and Macroeconomic Governance. European Comission Fellowship Initiative 2014-2015. Brussels: European Commission . De Grauwe, P. (2006). On monetary and political union. CESifo Forum, 07(4), 3-10. De Grauwe, P. (2016). Economics of Monetary Union (Vol. 11). Oxford: Oxford University Press. Delors, J. (1989). Regional implications of economic and monetary integration. European Council, Commitee for the Study of Economic and Monetary Union. Luxembourg : European Council . Dolls, M., Fuest, C., Heinemann, F., & Peichl, A. (2016). Reconciling Insurance with Market Discipline: A Blueprint for a European Fiscal Union. CESifo Economic Studies, 62(2), 210-231. Dolls, M., Fuest, C., Neumann, D., & Peichl, A. (2018). An unemployment insurance scheme for the euro area? A comparison of different alternatives using microdata. Tax Public Finance, 25, 273-309. Dullien, S. (2013). A euro-area wide unemployment insurance as an automatic stabilizer: Who benefits and who pays? , Brussels: European Comission Enderlein, H., Bofinger, P., Boone, L., De Grauwe, P., Piris, J.-C., Pisani-Ferry, J., . . . Vitorino, A. (2012). Completing the Euro: A road map towards fiscal union in Europe. Report of the “Tommaso Padoa-Schioppa Group”. Notre Europe. Eurofi. (2014). Towards a Fiscal Union? Drafted by Eurofi members in The Eurofi Financial Forum 2014. Milan. European Comission. (2012). A blueprint for a deep and genuine economic and monetary union. Launching a European Debate. European Comission, Brussels. Farhi, E., & Werning, I. (2017). Fiscal Unions. American Economic Review, 107(12), 3788-3834.
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53 Mundell, R. A. (1973). A Plan for a European Currency. In H. Johnson, & A. Swoboda, The Economics of Common Currencies (pp. 143-172). London: Allen & Unwin. Musgrave, R. (1959). Theory of public finance: a study in public economy. New York: McGraw-Hill. Oates, E. W. (1999). An Essay on Fiscal Federalism. Journal of Economic Literature, 37(3), 1120- 1149. Padoa-Shioppa, T., Emerson, M., & Scharpf. (1987). Efficiency, stability, and equity: a strategy for the evolution of the economic system of the European community: a report. Oxford University Press. Persson, T., & Tabellini, G. (1996a). Federal Fiscal Constitutions: Risk Sharing and Moral Hazard. Econometrica, 64(3), 623-646. Persson, T., Roland, G., & Tabellini, G. (1996b). The Theory of Fiscal Federalism: What does it mean for Europe? paper presented at Quo Vadis Europe? Kiel. Pisani-Ferry, J., Erkki, V., & Wolff, G. (2013). Options for a euro-area fiscal capacity. Bruegel Policy Contribution(2013/01). Pisani-Ferry, J., Italianer, A., & Lescure, R. (1993). Stabilization properties of budgetary systems: a simulation analysis. European Economy, Reports and Studies, 5, 511-538. Rey, H. (2013). Fiscal Union in the Eurozone? In F. Allen, E. Carletti, & J. Gray, Political, Fiscal and Banking Union in the Eurozone? (pp. 107-116). Philadelphia: FIC Press. Rompuy, V. (2012). Towards a Genuine Economic and Monetary Union. Brussels: European Council. Sala-i-Martin, X., & Sachs, J. (1991). Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States. Cambridge: The National Bureau of Economic Research. Thirion, G. (2017). Economic rationale and design challenges. Centre for European Policy Studies (CEPS). Brussels: Centre for European Policy Studies (CEPS). Thirion, G., & Centre for European Policy Studies (CEPS). (2016). A Fiscal Union for Europe: State of play of the debate and proposals. FIRSTRUN- Fiscal Rules and Strategies under Externalities and Uncertainties. Vetter, S. (2013). Do all roads lead to fiscal union? Options for deeper fiscal integration in the eurozone. Germany: Deutsche Bank AG, DB Research Von Hagen, J. (1992). Fiscal arrangements in a monetary union: evidence from the US. In D. E. Fair, & C. De Boissieu, Fiscal Policy, Taxation and the Financial System in an Increasingly Integrated Europe (pp. 337-359). Dordrecht: Kluwer Academic Publishers.
54 Von Hagen, J. (1993). Policy Issues in the Operation of Currency Unions. In P. R. Masson, & M. P. Taylor, Monetary Union and Fiscal Union: a perspective from Fiscal Federalism (pp. 264-290). Washington DC : Cambridge University Press. Wang, C., & Williamson, S. (1996). Unemployment insurance with moral hazard in a dynamic economy. Carnegie-Rochester Conference Series on Public Policy, 44, 1-41. Werner, P. (1970). Report to the Council and the Commission on the realisation by stages of Economic Aand Monetary Unionin the Community-"Werner Report". Brussels: Council-Commission of the European Communities.
55
Annex
This section aims to provide a summary of the articles analysed and compared in the dissertation, which are: Beblavy ́ and Maselli (2014), Dolls et al., (2018), Dullien (2013), Farvaque and Huart (2018) and Fichtner and Haan (2014). The provided summary contains information on the design characteristics, contributions, stabilization metrics and main results in each of the proposals. The definitions and formulas are from each author.
Dullien (2013)
The purpose of this article is to: (i) analyse some of the issues that occur with the European Unemployment Benefit Scheme and (ii) compute net payments and estimate stabilization properties in the euro area. Dullien proposes the introduction of a European Unemployment Benefits Scheme, that could be topped up by national schemes, with two variants:
Replacement Contribution rate (average Duration rate (payroll Coverage ratio wage in each (months) tax) (%) country) 100% of new short-term unemployment Model A 1.66 over past 12 months + 3% Employed 40% 12 100% of new short-term unemployment Model B 0.65 over past 12 months + 20% of the remaining short-term unemployed
• Due to the shortcomings in the available data that limit severely the accuracy in simulating the number of potential recipients for a European Unemployment Benefit Scheme, the author chooses two different estimates of pick-up rates (in table 1 as coverage ratio); • Budget neutrality of the scheme over the cycle is required. The scheme is allowed to run deficits and surpluses during the simulation period;
1 • Contributions are made as a share of the wage sum until a certain threshold, according to a country’s average income; • The author simulates the effects of the scheme in the following 12 countries of the euro area between 1995 and 2011: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, Netherlands, Austria, Portugal, Finland and Greece.
Assumptions 1) All employees in the euro area are insured; 2) Budget neutrality of the scheme over the cycle is required. The scheme is allowed to run deficits and surpluses during the simulation period; 3) The fiscal multiplier is 1.
Stabilization metric and main results
The author simulates, with the assumptions previously listed, the net payments for each country during the chosen period – stage 3 of table 1 in chapter 3 section 3.1. in the dissertation. Afterwards, the author, based on net payments, computes stabilization properties (stage 4). To do so, as a first step, the author selects, for each country, downturn periods in which net payments for a certain country have turned positive – country goes from net payer to net receiver. The author gives priority to marginal stabilization, which are stabilization properties observed during recessionary periods. For each of the periods, the change in net payments to/from the European Unemployment Benefit Scheme with each of the pick-up rates is computed. Then, Dullien puts this in relation with the change in output gap during the chosen period. The resulting number is the percentage share of the deterioration in the output gap over the period which would have been prevented with the European Unemployment Benefit Scheme. Dullien withdraws some conclusions: (i) no country is a permanent net recipient or net payer, except for the Netherlands in model B, which would have been a permanent net payer; ii) for the large net recipients, large net transfers are due to very large net transfers during the recent Great Recession and not to permanent transfers; (iii) almost every country would have been a net recipient during at least one idiosyncratic period – excluding the recent Great Recession.
2 The main contributors to the scheme, in model A are Germany, France and Italy. In model B the main contributors are Germany, Netherlands and Italy. The main recipients in model A and B are Spain, Finland and Greece. The stabilization coefficient varies considerable between countries and periods – -0.8% in Greece and -55.8% in Austria in model A and -0.2% in Greece and -51.7% in Austria in model B. The lower stabilization coefficients in some cases, such as Germany, could be explained by a detailed analysis of the macroeconomic framework of the time. In Germany, the stabilization coefficient was lower during the recent Great Recession due to the high stability of the labour market.
Farvaque and Huart (2018)
The authors simulate a European Unemployment Benefit Scheme under various scenarios, varying methods of financing (common or country-specific contribution rates) and triggers for pay-outs (all time or inclusion of a threshold). They analyse the impact of the scheme if it was implemented using two measures of stabilization under different fiscal multipliers: (i) variability of national income; (ii) synchronization of national business cycles. In conclusion, the authors support a scheme only with trigger (contemplated in our study). Even though the authors propose 10 variants and 2 stabilization metrics, we will only summarize the ones considered in the dissertation. The goal was to compare similar variants, only changing in the inclusion of a trigger. Therefore, the variant was number 6, where the trigger is defined as “years where short-term unemployment rises more than 10 percentage points” (Farvaque and Huart, 2018, page 6).
3 Replacement Contribution rate (average Duration rate (payroll Coverage ratio Trigger wage in each (months) tax) (%) country) Average of 100% of short- Baseline 2.3% of gross No term unemployed 46% average wage 12 gross wage Average of 100% of short- Trigger 0.7% of gross Yes term unemployed wage
• The proposal demands budget neutrality for the scheme over every 3-year-period. The contribution rate is therefore updated every year in order to guarantee the budgetary balance of the scheme; • The fiscal multiplier is 1; • The net transfers for each country in each year are given by the difference between the benefits received by the country in each year and the contributions payed by the country in each year; • The authors simulate the effects of the scheme in the following 27 countries of the European Union between 2005 and 2014: Belgium, Bulgaria, Czech Republic, Denmark, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, Netherlands, Austria, Poland, Portugal, Romania, Slovenia, Slovakia, Finland, Sweden and United Kingdom.
Benefits are given by:
��,� = �� × � × ��,� × �� × ��,� - RR is the replacement rate
- � , is the average wage of the economy; - � represents a proportion of the average wage. The considered value is 0.8; - CR is the coverage ratio;
- � , is the number of unemployed in the economy.
4 Contributions are given by:
��,� = ��,� × ��,� × ��,�
- � , = 1 − � , , representing total employment;
- � , × � , is the wage bill;
- � , is the contribution rate Stabilization metric
GDP Growth Variability
The first measure is based on the relative variance of the GDP with and without the scheme. To do so, the authors compute the variance of GDP with and without net transfers and compute the rate of variation between both:
��� ∆� , − ��� ∆� , � , = ��� ∆� ,
Where: - � , is the degree of stabilization delivered by the scheme for country i at time t; - � is the country’s GDP.
If � , > 0, ������ �� �������������
In the baseline scenario, Spain is the biggest net recipient and Germany the largest net contributor. Spain, Greece and Sweden would be permanent net recipients and Luxembourg, the Netherlands, Malta and Slovenia would be permanent net contributors. According to the simulation’s results, the scheme and all the proposed variations would stabilize, except for the US Experiment (triggered when unemployment rises 20%). Specifically concerning the variants considered in our study, the baseline model stabilizes in average -3.3% and the model with trigger stabilizes -8.6%. In the baseline model, Greece and Poland are destabilized and in the model with trigger, Ireland, Spain, Cyprus and Latvia are destabilized. In the baseline model, the most stabilized countries are Spain, Portugal and
5 Denmark and in the model with trigger, the most stabilized countries are Malta, Germany and Greece. Spain, which was one of the countries with the most severe shocks in the labour market, could go from being one of the most stabilized countries in the baseline model and a permanent net recipient, to being destabilized due to the very high net contributions made to the scheme in 2008, 2009 and 2012 in the model with trigger. This could be due to the requirement of the scheme to have budget neutrality every three-year or due to the threshold of the trigger that would have not been reached in certain years.
Fichtner and Haan (2014)
The aim of this article is to: (i) estimate the macroeconomic output stabilization impact of a European Unemployment Insurance Scheme in the euro area, through the analysis of its impact on GDP growth and (ii) estimate the influence of the mechanism on the distribution of household’s income through a comparison of the income distribution before and after the scheme is implemented. The authors use Germany as a representation for stronger economies and Spain as a representation for weaker economies. In a similar way to the analysis made to the Farvaque and Huart (2018) proposal, we will only provide detailed account on the stabilization metric that was considered in out dissertation, which is the macroeconomic approach.
The authors suggest two models:
Replacement rate Duration Contribution rate Coverage ratio
(last net salary) (months) (of gross wages) Model Specific to each country, so that the 70% 12 1.3% A share of short-term unemployed in Model the scheme corresponds to the share 30% 6 0.4% B in national systems
• In the Fichtner and Haan scheme, it is assumed that the total contributions made to the mechanism equal the total costs of the European Unemployment Benefit Scheme, for the entire simulation period;
6 • The author simulates the effects of the scheme in the following 12 countries of the euro area between 1999 and 2012: Austria, Belgium, Finland, France, Greece, Germany, Ireland, Italy, Netherlands, Portugal, Slovakia and Spain.
The authors simulate the implementation of the scheme and as a result obtain net transfers for each country between the chosen period- stage 3 in table 1, section 3.1 of chapter 3 of the dissertation. The authors then use these results to obtain the following stabilization measures – stage 4 of the same table.
Measure 1: Macroeconomic stabilization
When comparing to the baseline scenario (scenario without the scheme implemented), transfers from a European Unemployment Benefit Scheme could boost countries with weak economies, leading to a scenario that deviates from the baseline, with positive growth and employment effects. During periods of growth or low unemployment, the European Unemployment Benefit Scheme can slow down the economies, due to increase in contributions. Spain: For model A, the introduction of this mechanism in Spain would contribute to the decrease in the GDP losses between 2008 and 2010, the years when the consequences of the recent Great Recession where most severe. This happens due to a smaller drop in disposable income than in the scenario without the scheme and to the reduction of the weight of unemployment benefits in national schemes. With model B, the effects are only observed later and are less impactful. In the years before the crisis, for both models, growth would be more moderate that with the baseline scenario, since unemployment was decreasing and the increase in contributions would slow down consumption and, therefore, the economy. Germany: With the implementation of the European Unemployment Benefit Scheme in Germany, the economy would experience stronger growth than the one observed in the scenario without the scheme, mainly between 2000 and 2002 and in 2005. Nevertheless, due to the almost permanent net contributions that the country makes to the scheme, over the rest of the period, including the recent Great Recession, the mechanism would have a negative effect on the German economy. This happens because the country has a very stable labour market, that was almost not affected by the most recent great recession, while other member states had severe consequences.
7 Looking at the euro area, it is also possible to notice that this scheme increases the macroeconomic stabilization. With model A, during the most severe years of the recent Great Recession, it is also possible to verify that, especially in 2009, the scheme counteracts the effects. During growth periods, the mechanism dampens the economy. Similar effects are seen with model B, although a lot less noticeable.
Beblavy ́ and Maselli (2014)
The Beblavy ́ and Maselli (2014) report, commissioned by the European Parliament, aims to study two proposals on an European Unemployment Benefit Scheme: (i) an harmonized European Unemployment Benefit Scheme that would include all eligible citizens of the European Union and partially replace the national systems; (ii) a “reinsurance” scheme where the national schemes stay intact and transfers would only occur in the event of a large negative shock. In the latter case, the transfers are not conditional, which means that the national government of each country can use the transfers as it sees fit. Each of these schemes has also two variants: a) no fiscal rule, where countries can permanently have surpluses and deficits with the scheme; b) each country has to have budget neutrality in the medium-to-long term.
No long-term country- Long-term country-level
level budgetary neutrality budgetary neutrality Harmonized European Option 1a Option 1b unemployment benefit Unemployment reinsurance Option 2a Option 2b Source: Table retrieved from Beblavy ́ and Maselli (2014), page 38
• The author simulates the effects of the scheme in the following 28 countries of the euro area between 1999 and 2012: Belgium, Bulgaria, Czech Republic, Denmark, Germany, Estonia, Ireland, Greece, Spain, France, Croatia, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, Netherlands, Austria, Poland, Portugal, Romania, Slovenia, Slovakia, Finland, Sweden, United Kingdom.
8 Scheme 1: Harmonized European Unemployment Benefit
Duration Coverage ratio Replacement ratio Trigger 40% of average monthly 75% of short-term Average of 6 months national nominal No unemployed compensation
Scheme’s Expenditure
����� ����������� = 0,75 × � × 0,4 × ���� × 6 ����ℎ� Where: - U is unemployment; - MNCE is the monthly nominal compensation per employee.
Countries have the ability to define their eligibility rules and replacement rates. If, when implementing these features: - Cost of Unemployment < Gross Expenditure formula, country receives the actual amount; - If Cost of Unemployment > Gross Expenditure formula, country receives amount given by the formula. This would ensure harmonization, since countries would have the incentive to converge their defined features to the formula. This way, if countries want to set up more generous systems they can, but on top of the common scheme.
Scheme’s Revenue
����� ������� = (�� − �) × 0,5���� × 12 ����ℎ�
As previously explained, the article proposes two variants: a) the scheme does not require budget neutrality for each country in the simulation period, therefore countries can be permanently in surplus or deficit with the scheme; b) the scheme require neutral budgetary position for each country in the simulation period. For option 1a) the proposed contribution rate is of 0.5% of nominal compensation.
9 For option 1b), the basis contribution rate is 0.5% of nominal compensation but if a country has a cumulate deficit with the scheme of a minimum of 1%, then the contribution rate doubles to 1%, until the cumulative deficit is under 1%. For alternative 1a) the biggest contributors, in average, are Austria and the Netherlands. The smallest contributors are Luxembourg, Hungary and Lithuania. The biggest recipients are Spain, Poland and Latvia. The smallest recipients are Luxembourg, Malta and the Netherlands. The authors also analyse the average annual balance, country-by- country, with the scheme. During good times (between 1999 and 2008), Spain and Poland had a deficit with the scheme and the Netherlands a surplus. However, after 2009, several countries -Estonia, Greece, Spain, Latvia and Lithuania – had a deficit higher than 0.2% of GDP which, in alternative 1b) would mean an additional rate. In option 1b), the only factor that differs is the contribution side of the countries, not the benefits of the countries. The authors focus their attention of the maximum values. Due to a cumulative deficit during a certain period of time, Spain, Lithuania, Latvia, Poland and Greece would have to double their contributions in order to assure the budget neutrality. This fiscal rule can, nevertheless, have a negative impact on the countercyclical effects of the scheme if, during a period of higher unemployment, the countries are forced to double the contributor to assure the fiscal rule is followed, turning into net payers.
Scheme 2: The Reinsurance Scheme Coverage ratio Replacement ratio Trigger 40% of average monthly national 75% of short-term unemployed Yes nominal compensation
Scheme’s expenditure:
The scheme would be triggered if the difference between unemployment in a certain country in period t is higher than the NAWRU by 2%. Then, the scheme pays to each country:
������� ������ , = 0,4 × ���� × 0,75 �
Revenue of the scheme
10 Contrary to option 1, the scheme would be financed by member states’ contributions, not by contributions made by the employer or the employee. For option 2a), the annual contribution rate would be of 0.1% of GDP until the fund reaches 0,5% of the GDP of the European Union. After that, contributions stop and only restart if the fund falls below that threshold. For option 2b), the annual contribution rate would be of 0.1% of GDP but, if a country has a cumulative deficit with the scheme of a minimum of 1% of GDP, there is an additional contribution rate of 0.2% of GDP every year until the deficit falls below 1% of GDP. The additional contribution is payed even if the regular contribution is not. The reinsurance scheme has fewer costs than the harmonized scheme, since a lot of the countries that would have received benefits in the harmonized scheme would not have received in the “reinsurance” scheme due to their national unemployment rate not reaching the threshold. However, the benefits received during major shocks are of a similar size or higher of the ones received in the harmonized scheme. Therefore, two main effects are observed: i) there is bigger stabilization, since the benefits are similar to the harmonized, but the contribution rate is inferior; ii) the “reinsurance” scheme has a much inferior cost than the harmonized scheme. The countries that receive the most benefits are Spain (4.75% of GDP), followed by Lithuania, Latvia and Poland. A lot of countries never received benefits, including Germany, Portugal, France and Italy. When studying the annual balance, according to the authors, it is possible to observe that this scheme prevents a lot more efficiently the existence of long- term beneficiaries. Only 7 countries have a negative average annual balance: Estonia, Ireland, Greece, Spain, Latvia, Lithuania and Poland. However, it is possible to observe that some countries create a very large surplus with the scheme, being Portugal one of them. This case represents the main problem of a “reinsurance” scheme: if a country is in a recession and with high unemployment rates, if it does not reach the threshold, the country remains a net payer, creating procyclical effects and deteriorating even more the national economy.
Stabilization metric and Results
The results are obtained through an Excel-based simulation. The authors chose national episodes of recession – in this case the authors use the period between 2008 and 2012 to include the recent Great Recession– and, to simulate the
11 stabilization coefficients, multiply the net inflow of each year by the fiscal multiplier (1.5, which is considered a conservative value by the authors), which gives them the additional output as percentage of GDP. The stabilization coefficients are simulated for 6 countries: Estonia, Greece, Ireland, Latvia, Lithuania and Spain. There is not a distinction between option 1 and 2, since the net inflows during the recent Great Recession should be identical, but the authors do use the case of a fiscal rule where each country has to be balanced with the scheme in the medium-to-long term. The country with the biggest stabilization would be Spain, would a total additional output of 6.08% of GDP, that would vary between 1.26% and 1.79% each year. The Baltic countries, which are Estonia, Latvia and Lithuania, would see their additions to output decrease over the years, since the recovery of these economies was faster, with Estonia eventually turning into a net contributor in 2011 and 2012. The stabilizing effects in Greece would only start in 2011. As for Ireland, the stabilization effects would not be hugely considerable, with an additional output of between 0.37% and 0.85% over the years, bringing the total of 2.19% of GDP.
Dolls et al. (2018)
These authors study the introduction of a European Unemployment Benefit Scheme in the euro area, through the analysis of three steps: (i) the harmonization of the national systems; (ii) introduction of a common European Unemployment Benefit Scheme for all countries in the euro area which creates interregional stabilization of shocks; (iii) introduction of an European Unemployment Benefit Scheme that is allowed to run deficits (issuance of debt) and surpluses, which creates intertemporal stabilization. The authors also propose two variants of the scheme: a scheme with a trigger and with experience rating. It is assumed that, if national replacement rate is bigger that the replacement rate of the scheme, the scheme partially replaces national systems. If the other way around, the national system it totally replaced by the common scheme. The author simulates the effects of the scheme in the following 18 countries of the euro area between 2000 and 2013: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Latvia, Malta, Netherlands, Portugal, Slovenia, Slovakia and Spain.
12 Methodology
To analyse the effects of the European Unemployment Benefit Scheme in the euro area, the authors - contrarily to most studies which use macroeconomic aggregate date - use representative household microdata using the European tax-benefit calculator EUROMOD (as in Fichtner and Haan, 2014). As the authors want to reflect income distribution and the labour market conditions for all the countries in the euro area during the considered period, and since there are no data available that crosses both information, the authors build a series of reweighted cross sections that replicate the changes in labour market (data retrieved from the EU-LFS) and average earnings (retrieved from the AMECO database), using as a baseline input data the EU-SILC 2008, which is the database used in Euromod calculations. This data is reweighted to represent the labour market situation in 1999 and then reweighted for every subsequent year in the analysis. The labour market information comes from two sources: i) EU-LFS (Labour Force Survey), from where the authors gather the information about unemployment rates, the size of labour force, percentage of short-term and long-term unemployment and national coverage ratios for 18 socio-demographic sub-groups; ii) from the AMECO database (macroeconomic database), the earnings growth is retrieved, for the information to reflect the changes in tax base of both the common and national schemes. The 18 socio-economic subgroups are determined according to gender, age (<30, 30-50, >50) and education (low, middle and high). The changes in unemployment are reweighted at the sub-group level so that they are reflected both at the sub-group and aggregate level. The authors, for the scenario with national unemployment insurance without a common scheme, build a national unemployment benefit calculator that includes national policy rules and simulates the national benefits in additional to the European Unemployment Benefit Scheme benefits. The authors identify three potential stabilization channels in the implementation of an European Unemployment Benefit Scheme: (i) the first channel consists on the harmonization of the national schemes, through similar generosity and eligibility criteria; (ii) the implementation of a common European Unemployment Benefit Scheme that would allow for interregional smoothing inside the euro area and the one considered in the dissertation. This, according to the authors, is the main contribution of such a scheme; (iii)
13 the implementation of a European Unemployment Benefit Scheme that can run surpluses and issue debt in order to provide intertemporal smoothing. Only the second channel requires the implementation of a common scheme, while the benefits of the first and third channels can be achieved by changes in national schemes alone (i.e. if through harmonization national schemes become more countercyclical and if national schemes can alone issue debt). Therefore, the effects of the second channel represent the added value of the implementation of a European Unemployment Benefit Scheme.
Stabilization metric and results
Effects National Schemes Simulated with national unemployment benefit calculator
Harmonized national schemes
Common European
Unemployment Benefit Scheme without debt issuance- interregional smoothing. Effects Stabilization coefficients are obtained through Euromod and weighted
Common European cross-section data Unemployment Benefit Scheme with debt issuance- intertemporal smoothing
There are four simulations. The stabilizing coefficient for the stabilization effects of each stage is:
∑ Δ��� − ∑ Δ� � = = � + � ∑ Δ�
Where, for a given year:
- � are benefits received by individual i;
- ��� are contributions made by individual i;
14 - � is employment income made by individual i.
The stabilization coefficient, according to the authors, represents “to what extent (un)employment shocks are absorbed by changes in unemployment benefits and social insurance contributions” (Dolls et al., 2018, page 282). The authors use the following measures to simulate the interregional and intertemporal effects of a European Unemployment Benefit Scheme in the euro area.
, , . | ∑ Δ � | (∑ Δ��� − ∑ Δ��� ) � . = ( × ) ∑ | ∑ Δ � | ∑ Δ�
, , | ∑ Δ � | (∑ Δ��� − ∑ Δ��� ) � . = ( × ) ∑ | ∑ Δ � | ∑ Δ�
The authors weighted the stabilizing effects – given by the difference of variations in contributions with the common scheme and the harmonized national schemes – divided by the variation in the employment income – by the relative size of the shocks. The stabilization coefficient gives us the percentage of income fluctuations that is cushioned by the introduction of the European Unemployment Benefit Scheme, due to the transitions in and out of unemployment status. The stabilization effects are made in comparison to the effects that come from the harmonization of the national schemes, not from national schemes without harmonization. The focus of our analysis will be on the interregional stabilization, since it is the one used in our assessment of the stabilization effects, however, it is important to mention that, through the harmonization of the national schemes, a stabilization gain between 7% (in Germany) and 20% (in Cyprus) is observed. The results of the simulations show that the average stabilization varies between 5% (Malta) and -22% (Latvia). The average stabilization in the euro area is -9.9%, which means that the scheme would have made the policy in the euro area more countercyclical. Spain, one of the countries with the highest rate of unemployment, had a stabilization coefficient of -17.8%, only surpassed by Latvia and Greece (-19.4%). Malta is the only country that would have had income fluctuations aggravated as a consequence of the implementation of the scheme. However, the authors find procyclicality in some years for most of the countries.
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