A model for a Fiscal Union? What Europe can learn from the German experience

Abstract

The euro has strengthened the economic differences between a more affluent north and a struggling south, which is the core problem of the current crisis in the euro zone. A potential solution to this problem could be to transform the monetary union into a fiscal union. This article sketches two different models for fiscal unions: a federal structure like that of Germany, where federal revenues and expenditures are controlled in significant part by federals laws, which has an extensive bailout system built in; and a confederal system like that of Switzerland, where Cantons are autonomous in their fiscal policies but clear bankruptcy rules are implemented. The article describes the reasons for which the German arrangement, one that strongly relies on income equalisation, have not proven successful in harmonising the financial position of the Länder and municipalities and why bailouts have become rather the rule than the exception. In consequence Germany has introduced a debt brake that does not allow expenditures to be structurally higher than revenues. Although it is too early to evaluate the sustainability of such a mechanism yet, the debt brake seems to be a promising means for preventing an unsustainable built-up of debt under normal economic conditions. This article concludes that as long as debt brakes are not fully implemented and further fiscal harmonisation cannot be expected, the European Union will still have to rely on market-based regulatory instruments and the disciplinary function of interest rates, possibly culminating in a bankruptcy procedure. © 2013 University of Durham and John Wiley & Sons, Ltd.