Professor Jonathan Rodden, Stanford University, describes how he has applied his on work on numerous federations in the United States and extracted lessons and principles that could be theoretically applied to the European Monetary Union.

1. Representation and Redistribution in
Federations:
Lessons for the EMU
Jonathan Rodden
Stanford University

2. No monetary union without
fiscal union?
This is often presented as an empirical claim.
Many scholars move quickly to the notion that the Euro
cannot survive without “fiscal union,” and reform efforts
focus on bringing it about.
My main goal: Bring relevant facts from existing fiscal
unions, especially the United States, to the debate.
How likely is fiscal union in the EMU, and how would it
work? What are the key challenges?

3. Overview
Political constraints:
What type of reform is possible?
Rules versus discretion?
Fiscal Unions:
Risk-sharing/stabilization
Grants versus fiscal flows
Redistribution
Endogenous fiscal unions
The reform agenda

4. First round of 2016 Austrian Presidential Election

5. Brexit referendum

6. Italian Constitutional Referendum 2016

7. Italian Constitutional Referendum 2016

8. Population density and Democratic vote share, U.S. Counties, 2016

9. A new political cleavage
Perceived winners and losers from:
Skill-biased technological change
Globalization
The European Union
Cosmopolitan, knowledge-economy core versus periphery
Across countries and within countries

10. Why does this matter?
Certain forms of centralization are off the table
Sapir and Wolf (2015), Tabellini (2016): “…the fiscal institute
should have the authority to veto national budgets.”
If something like a “fiscal institute” was possible, how
would it work under these constraints?
Rules versus discretion?
Blackmail?

11. Why fiscal union?
Risk-sharing and stabilization in the absence of monetary
policy
The assumption is that member states experiencing high
levels of volatility cannot self-insure via their own fiscal
policy.
A common argument: The center must have the fiscal
capacity to smooth asymmetric shocks:
Key question: rules versus discretion?
Otherwise, shocks are too likely to turn into debt crises.

12. Lessons from fiscal unions
Risk-sharing and stabilization
Fiscal flows
Grants
A case study of the Great Recession
Redistribution
Income
Representation
Economic geography
Endogenous fiscal unions

13. Stabilization and fiscal
flows
A large literature:
Sali-i-Martin & Sachs (1992), Bayoumi & Masson (1995), Brunila et
al (2003), Von Hagen (1992, 2007), Melitz & Zumer (1998),
Obstfeld & Peri (1998), Sorensen & Yosha (1997), van Wincoop
(1995), Feyrer & Sacerdote (2013), Malkin & Wilson (2013).
In the United States, a $1 decrease in a state’s real per capita
income is associated with a decrease in net fiscal contributions in
the range of $0.25 - $0.40.
An important result that has not been emphasized in the literature
on EMU:
This is driven completely by the tax side. There is no
disproportionate increase in federal receipts in states experiencing
downturns.
Federal expenditures are uncorrelated with state income, but tax
payments are highly correlated.
Implications for EMU?

14. Grants versus fiscal flows
A highly progressive tax system and a system of inter-
personal expenditures seems highly unlikely in the EMU
given political constraints and lack of administrative
capacity.
Most “fiscal union” proposals involve lump-sum grants to
member states.
So let’s take a closer look at grants.

15. Are grants counter-cyclical?
Source: Rodden and Wibbels (2010)
See also Blöchlinger and Egert (2016), Foremny & Solé-Ollé
(2016)

16. What about the great
recession?
Common perception is that federal automatic stabilizers
kicked in and prevented Euro-style fiscal crises from
emerging in troubled states.
In fact, American Recovery and Reinvestment Act was
highly discretionary and highly unusual.

17. How did the stimulus work?
Following the approach of Gros & Belke (2015), let’s focus
on some of the states that were hardest hit by the Great
Recession:
Arizona
Florida
Nevada
What happened to their tax revenues?
Federal grants?
Federal direct expenditures?

18. Real per capita income in the states hardest hit by the Great
Recession

19. Real state-local tax revenue in the states hardest hit by the
Great Recession

20. Real federal grants per capita in the states hardest hit by the
Great Recession

21. Real direct federal expenditures per capita in the states
hardest hit by the Great Recession

22. What happened in the states
that continued to grow during
the Great Recession?
Let’s look at Alaska, North Dakota, and South Dakota

23. Real per capita income in the states that did well during the
Great Recession

24. Real state-local tax revenue in the states that did well during
the Great Recession

25. Real federal grants per capita in the states that did well
during the Great Recession

26. Real direct federal expenditures per capita in states that did
well during the Great Recession

27. Change in real per capita income and real per capita grants
from 2008 to 2009

28. Were temporary increases in
grants sufficient to help hard-
hit states smooth out their
expenditures over the
recession?

29. Real state-local expenditures per capita in the states hardest
hit by the Great Recession

30. How does this compare with
the hard-hit member states in
the EMU?

31. Real revenues and expenditures per capita in Spain and
Ireland

32. How did credit markets react
to U.S. states during the
crisis?

33. Credit Default Swaps for U.S. States

34. Credit Default Swaps for Selected US States and EU Countries

35. To summarize:
Grants typically fall during recessions, but direct
expenditures increase and federal taxes decrease.
The 2009 stimulus was different. Large, discretionary
spike in grants in addition to direct expenditures.
But the grants were not nearly enough to replace falling
state revenues.
Discretionary federal assistance was very poorly targeted.
Expenditure cuts were very large, and undermined a large
part of the stimulus.
Member state fiscal policy in EU is more stabilizing than
that of U.S. states, whose fiscal policy is extremely pro-
cyclical.

36. The U.S. states are not
unusual
Source: Rodden and Wibbels (2010)

37. Redistribution
Why can’t the federal government target states most
effected by recessions?
This raises a set of questions about the political economy
of redistribution.

38. Average income and transfers (1990-2005)
Size of marker reflects
relative per-capita
representation

39. Income, representation, and federal transfers to Brazilian states, 2005-2013
Size of marker
corresponds to
seats per
capita

40. Why are grants often not
progressive?
In a legislative bargaining model, small states are
attractive coalition partners.
Votes can be purchased for lower price
This can easily undermine progressivity if small states are
not also poor

41. Seats per capita and federal transfers in 9 federations

42. Voting weight and EU transfers per capita

43. Representation and
Redistribution
Formulaic equalization does not undermine this effect.
It is often built into formulae that are difficult to renegotiate
Causality?
Maybe over-represented states had more leverage at the
moment of federation formation
But the relationship is still very strong among provinces that
were not parties to the initial bargain
Including new EU member states

44. Endogenous fiscal unions
In a bargaining model of union formation or renegotiation, a
member state’s outside options should shape its voting weight
and future flow of transfers
See, e.g. Morelli
Over-representation and commitment to future transfers are
often meant to assuage fears of exploitation by small and
peripheral units at the stage of federation formation.
Small provinces experiencing the most volatility are often over-
represented and favored in the flow of transfers. The initial
bargain is very sticky.
No precedent for radical reorientation of voting weights in favor
of low-volatility units.

45. Is it true that there are no monetary
unions without fiscal union?
If the relevant definition of fiscal union means progressive
taxation and counter-cyclical expenditures, yes.
Canada and the United States before World War II.
Under what conditions can “fiscal union” be achieved?
Is war a necessary condition?

46. WWI New Deal
WWIII
Koreaa
Federal expenditures as a share of total (federal, state, municipal)
expenditures in the United States, 1900 to present

47. WW
I
New DealWWII Korea
Federal expenditures as a share of total (federal, state, municipal)
expenditures in Canada, 1930 to 1970
WWII Korea

48. European fiscal union?
Many reform proposals call for unrealistic levels of
peacetime fiscal centralization.
Recognizing the moral hazard problem, many proposals
also call for unrealistic (and unprecedented) loss of fiscal
sovereignty for member states.
Unrealistic expectations about delegation to “experts.”
Is there strong evidence to suggest the Euro is doomed
without American-style fiscal union?
Would Florida and Arizona have had a Greek-style crisis if
they were solely responsible for Social Security, Medicare,
and Medicaid?

49. A realist reform agenda
The U.S. experience reveals that banking union is crucial
Gros and Belke (2015)
Enhanced facility for fiscal stabilization by member states?
Reduce debt overhang
Alexander Hamilton as an example
Debt assumption first, fiscal union later
Orderly default process
Loss of sovereignty as part of Bankruptcy
A role for the judiciary?