Many observers of the Eurozone debt crisis argue that the Euro can only survive if the common

currency is complemented by a fiscal union. But theres a problem with that: Fiscal union,
mostly understood as a combination of centralized control over public finances with joint
guarantees for government debt, is a fundamentally flawed concept. The political integration
required to achieve it is not in sight. In order for a fiscal union to work, national governments
including parliaments would have to give up the right to set taxes and determine public
expenditure independently and accept a restriction of national sovereignty in other areas of
economic and social policy. The debate about the fiscal compact has shown that most member
countries, in particular France, are not willing to conform. This is an understandable position
considering the absence of democratic control at the EU level with decisions made in Brussels
about key issues like national taxes and expenditures, which directly affect most citizens, simply
lacking legitimacy.
A much more promising approach than fiscal union would be to focus on a Europeanization of
the banking sector. This would require a complete shift of banking regulation and supervision to
the European level and the creation of a European bank resolution mechanism. A key aspect of
this Europeanization would be that banks would no longer be allowed to hold as many domestic
government bonds as they do today. Politically, a Europeanization of the banking sector would
also require countries to give up sovereignty, but in the area of banking regulation and
supervision, which is rather technocratic and more remote from day-to-day concerns of ordinary
citizens. It would be politically much more acceptable to delegate this task to an independent
European body like the European Central Bank than to relinquish the right to set fiscal policy.
One of the key difficulties in overcoming the Euro debt crisis is that the current financial system
is characterized by a close symbiosis between national governments and national banking
systems. The situation in Spain offers a good example. The Spanish banking system is plagued
by huge and unrealized losses from the financing of the real estate bubble. At the same time,
Spanish banks are massively invested in government bonds and the Spanish government puts
pressure on Spanish banks to buy more bonds if funds are available. This undermines the ability
of the banking system to provide credit to sectors which might contribute to an economic
recovery. Financial difficulties of the Spanish government threaten the stability of the Spanish
banking system and vice versa.
A Europeanization of the banking sector would improve the Eurozone situation. Since banks
would be less exposed to their national governments, financial sector stability would be less
endangered if a national government has financial problems. In addition, the finances of national
governments would not be endangered by problems of national banks, because collapsing banks
would be restructured or recapitalized at the European level, rather than threatening to draw their
national governments into bankruptcy. Providing funds at the European level is possible because
control over, and supervision of, the banking system also takes place at the European level. In
the US, for instance, financial problems of the state of California are less dramatic for
Californian banks because their activities and asset holdings are more diversified across the US.
If a bank faces financial difficulties, funds required to restructure or recapitalize the bank would
not have to come from the California government, but rather from a federal institution.

Europe is debilitated by the effects of two years of desperate crisis

management. The prescribed treatment resembles the old practice of
bloodletting on ailing patients. Growing debts are paid with more loans, and
new loans are made dependent on increasingly severe austerity measures. The
results are a greater risk of recession, higher interest rates on refinancing
loans, and the need for runaway financial aid to the southern eurozone
countries. Greece is a dramatic portent of the direction things could take.
Record-breaking unemployment of over 22% in Spain and record interest
rates on Portuguese bonds show that the crisis fever is far from abating.
Portugal, Spain and even Italy have still not managed to extricate themselves
from the downward spiral of recession and debt. It is a vicious circle that
increases the risk of a split in the eurozone something that would have been
unthinkable in 2009.
It has taken two years of futile efforts for governments to finally start talking
about growth and employment as European aims again. This change in
attitude is prompted by shock. The credit-rating downgrades for France, eight
other eurozone countries and the European Financial Stability Facility bailout
fund at the start of the year all show that the capital markets are predicting a
downward spiral. It was particularly insightful to see how Standard & Poor's
justified the downgrades: "We believe that a reform process based on a pillar
of fiscal austerity alone risks becoming self-defeating, as domestic demand
falls in line with consumers' rising concerns about job security and disposable
incomes, eroding national tax revenues."
We need to set a new course now and implement a far more consistent and
precise strategy. First and most importantly: the current situation requires us
to create the right conditions to ensure private capital flows into the real
economies of crisis countries. For this to happen, there needs to be a
guarantee that these crisis countries and their banks can pay their debts
from a robust European Stability Mechanism, which can provide itself with
liquidity from the European Central Bank, and a common debt-reduction pact
as suggested by the German Council of Economic Experts. Growth needs
private investment, and these investments need security!

Secondly, we need to remove any obstacles to investing in Europe and give

hope for an upturn in the economy in order to bring back hesitant private
investors who have lost confidence. Our most important task is therefore to
create a comprehensive European investment programme, which will increase
the competitiveness of crisis countries, expand Europe's industrial
infrastructure particularly its energy networks and promote research and
development. In order to ensure that the momentum of change is not lost in
excessive red tape, the European Investment Bank must play a central role. A
crucial aspect of the project is that it will not be financed by new debts, but by
a European financial transaction tax, which could bring in up to 50bn
if Europe or at least the eurozone is united on the issue. For European
solidarity has two meanings and it is time to show we are committed to both.
Taxing financial markets, promoting research and development, and
mobilising investments: that means learning our lessons from the financial
market crisis and changing our focus. "It's the real economy, stupid!" is a call
now even heard from Anglo-Saxon nations. For a decade "industrial policy"
was one of the most unfashionable terms in politics. But we are now done with
bowing to the demands of the financial industry. Germany's strength the
strength that has made us the anchor of Europe is the result of many years
of hard work to maintain and modernise industrial production. It is also the
fruit of our refusal to follow the trendy yet mistaken teachings of London and
Davos, which accelerated the flywheel of the financial markets by a few
rotations each year. We want less subjugation to a system of mere value
absorption and more respect for the laborious process of value creation this
demand does not come from Occupy Wall Street, but from the management
boards of German industrial companies. We must recognise the larger global
challenge that lies beneath the European financial market and debt crisis.
China will have overtaken the US in terms of gross domestic product by 2020.
Europe's demography is developing towards a smaller working population in
an ageing society. Resources are becoming scarcer. If we want to promote new
growth, we should focus on the quality of the value we are creating. GDP
growth at any cost and quick financial market profits at the price of bad
working conditions and a wasted environment is not a solution, as recent news
like that of Schlecker's bankruptcy has shown us once again.

Europe has the potential to pioneer and supply a sustainable worldwide

economy. Achieving this means addressing the major global challenges:
keeping healthy well into old age, using energy efficiently and from renewable
sources, and ensuring mobility while fossil fuels become scarcer and more
expensive. These problems require real solutions. To find them, we need
excellent researchers, developers, engineers and specialists. The economy of
the future needs an industry of the future. In the global division of labour,
Europe's role must be to conceive, develop and provide new products for a
sustainable economic model built to ensure the prosperity of almost 9 billion
people. That is the current state of the European dream.

Crucially, the Eurozone comprises a number of heterogeneous economies and

is almost certainly not an Optimal Currency Area (OCA). Each country has its
own economic structure, its own institutions, and its own set of fiscal policies.
Individual member states gave up control of important macroeconomic policy
levers such as monetary and exchange rate policy when the Euro was
adopted. These key policy levers were not adequately replaced and this left
individual member states particularly vulnerable to asymmetric shocks and to
divergences in competitiveness. But this does not imply that full fiscal
federalism is a necessary requirement of a successful monetary union. A
commitment to fiscal union is unnecessary. Instead, what is required is a
centralised insurance fund to ameliorate the impact of recession and severe
asymmetric shocks, combined with intergovernmental coordination of policies
to prevent competitiveness and fiscal imbalances from growing too large. An
inter-regional insurance scheme to provide fiscal transfers in a counter
cyclical manner could be funded by a pan Eurozone consumption tax
hypothecated for and paid directly to the centralised insurance fund. The
fund would be mandated to run a surplus over the economic cycle and could
be called upon under strict guidelines to provide direct fiscal support on a
temporary basis to countries suffering recession or a severe asymmetric
shock. The funding should be automatic subject to the conditions and terms
of access agreed annually by Eurozone governments.