Macron Marches Into the Breach of EU Overhaul

By Simon Nixon Features Dow Jones Newswires

The symbolism could hardly be clearer: Emmanuel Macron will spend his first full day as president of France in Berlin visiting German Chancellor Angela Merkel.

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The man who campaigned as an ardent pro-European, who greeted the crowds at his victory rally to the strains of the European Union anthem, and who pledged at his inauguration Sunday to "reform and relaunch the EU" is signaling that this work starts immediately.

Yet Mr. Macron may find the challenge of reforming the EU even more daunting than reforming France.

His ambitions for the EU extend from defense to border control, to climate change to tackling so-called social dumping -- the attempt to gain a competitive advantage through looser fiscal, environmental and labor-market policies. But the most eye-catching aspect of his European agenda is his proposal to create a eurozone budget overseen by a eurozone finance minister.

In seeking to deepen eurozone fiscal integration, Mr. Macron isn't short of support. There is a broad agreement across the eurozone that something must be done to restore public confidence in the single currency following a series of shocks that have left much of the continent suffering from high unemployment and stagnating living standards. Berlin and Brussels also recognize that Mr. Macron's election has created a political imperative to show a willingness to engage with the new president's agenda.

But it won't be easy. The European Commission was tasked by EU leaders two years ago to come up with proposals for deepening economic and monetary union, and the commission is due to publish its proposals at the end of this month. Yet these proposals have become the subject of wrangling between national governments with no certainty as to what will emerge, according to Brussels officials with knowledge of the process.

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Two major ideas are under discussion, both broadly in line with ideas floated by Mr. Macron and his allies. The first is to use the eurozone's bailout fund -- European Stability Mechanism -- to create so-called European Safe Bonds, securitized bonds that would be issued by the ESM and backed by a pool of eurozone government bonds. Initially, governments would remain responsible for their own liabilities, but ultimately ESB's could be guaranteed by the ESM -- and therefore jointly guaranteed by Eurozone governments -- transforming them into genuine Eurobonds.

The second proposal is to create a common European-wide unemployment insurance fund, which would allow countries hit by an economic shock to reclaim part of the cost of higher unemployment benefits.

Both ideas are problematic. It isn't clear there will be any market for European safe bonds without an ESM guarantee which governments are in any case unwilling to allow. And with or without an ESM guarantee, there are growing concerns that the creation of a large pool of ESBs could trigger a collapse in demand for the non-pooled bonds of the eurozone's weaker credits, leaving those countries facing higher rather than lower funding costs.

The problem with the unemployment insurance idea is t would require the politically challenging harmonization of the eurozone's highly divergent labor-market rules and welfare systems.

What both proposals show is that it is very hard to find a halfway house between the current eurozone setup, in which there is limited risk-sharing, and a full political union that would allow Brussels far greater oversight of national budgets and labor-market and welfare policies.

This task is made harder by the need to avoid changes to the EU treaties which might trigger referendums in many countries, where public appetite is limited for the transfers of sovereignty needed to underpin deeper fiscal integration, let alone any willingness in Germany and other Northern European countries to pool debts. That could limit the scope of reform to little more than German Finance Minister Wolfgang Schäuble's current proposal to turn the ESM into a European Monetary Fund with increased powers to enforce the eurozone's existing rules.

Would this be so bad? In economic terms, perhaps not. The contrasting fortunes of postcrisis Spain and Ireland with he sluggish recoveries of Italy and Portugal should caution against blaming the eurozone's problems on a lack of fiscal transfers -- as opposed to weak domestic policies.

Evidence from the U.S. suggests the importance of fiscal transfers in stabilizing a currency union can be overstated: Private capital flows help smooth around two-thirds of shocks to regional output, compared with 13% by fiscal transfers, according to the European Central Bank. That suggests the eurozone's priority should be strengthening its banking systems and delivering overhauls that would improve cross-border investment flows.

Nonetheless, Mr. Macron's political imperative remains, and the fate of the eurozone may now hinge on his success. No wonder he is beating a path to Berlin.

(END) Dow Jones Newswires

May 14, 2017 14:29 ET (18:29 GMT)