Fiscal transfers without controls are a bad idea

Yesterday, France’s economy minister, Emmanuel Macron, suggested the Euro Area should have a permanent fiscal transfer mechanism that diverts funds from rich members to poor members. A fiscal transfer scheme between (semi-)sovereign nations without any controls is a really bad idea even for the members of a monetary union.

Germany has a system of fiscal transfers between its 16 Länder, called the Länderfinanzausgleich (LFA). The LFA’s purpose was to speed up equalisation of living standards across Länder by kickstarting rather poor economies with the help of funds from richer parts of Germany. Unfortunately, there is but one example in the sixty-odd year history of the LFA where this actually worked out. Until the mid 1960s Bavaria was a rather agricultural, poor Land, but since then it transformed into one of Germany’s industrial centres and is indeed today’s biggest net contributor to the LFA. Currently only four Länder, Bavaria, Hesse, Baden-Württemberg and Hamburg, pay for the remaining 12, however Hamburg’s share is almost negligible. Not quite what the inventors of the LFA had in mind.

The reason is simple: No checks and balances. Receivers just get the money but there is no control whatsoever that they actually spend it in a productivity-enhancing way. Instead, some Länder have never net contributed to the fund and are still behind the economic power of the three main contributors.

A similar fate will await any Euro Area redistribution scheme. Without means to control the funds, they will just be another cheap source of money that can be wasted on all sorts of useless policies that may or may not increase the reelection chances of an incumbent government. If Mr Macron wants such a scheme he must know that this must come with strings attached. Maybe in form of a beefed up European Infrastructure Fund that builds roads, bridges, railways, broadband connections etc. across Europe with only very little influence from the nations. Or that net contributors decide what project they finance in a receiver country. I doubt that France – or any other country – will accept this loss of sovereignty. But simply transferring money is not only counterproductive as the German example shows, but may also increase national resentments in the contributor countries, the very least we need in Europe.

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I write about economics and politics. I take Ordnungspolitik seriously. While not blogging, I study monetary unions for my doctorate.