The ‘sound money, sound finances’ principle for the design of the EA seemed to threaten the traditional redistributive capacity of national welfare states, leading to an increase in disposable income inequality. Thus, fiscal policies have been discussed in the literature as the major causal link between Euro adoption and inequality of disposable income. It was thought that while Euro adoption would lead to lower levels of social spending it could also lead to an increase of disposable income inequality.
Despite the above argumentation, the dynamics that emerged after the introduction of the euro were quite different compared to the ones expected from the above literature. First of all, the institutional constraints that were supposed to keep EA countries fiscally balanced proved ineffective. The corrective arm of the SGP proved to be a soft constraint, unable to perpetuate the harder conditionality of the convergence criteria. Moreover, it was argued that the advent of the euro had the exact opposite effects for a number of countries, namely Spain, Ireland, Greece and Portugal; As these countries entered the Eurozone their interest rates fell dramatically, making the budget constraints even laxer (Fernandez-Villaverde et al. 2013: 149).
We start premise that EA membership was linked with market forces that have been so far elided in the Eurozone-inequality debate. Our point of departure is that interest rate convergence and the elimination of exchange rate risk meant that massive capital inflows softened rather than tightened budget constraints for some of the countries in the EA. This developed mainly via two mechanisms: the reduction of the cost of public debt, and the increased tax revenues coming from the capital inflow-driven economic booms. In this sense, the euro inequality debate rises from a different basis.
We suggest that under soft budget constraints, EA member states could avoid the path of fiscal retrenchment, and also increase social spending even under the “stringent” institutional framework of EA. However, an increase in social spending does not necessarily proffer an equalizing effect. The existing literature suggests that soft budget constraints lead inevitably to postponement of reforms and institutional deterioration (Fernandez-Villaverde et al. 2013).
Under soft budget constraints, especially in countries with chronic problems of bureaucratic inefficiencies and gross inequalities of welfare provisions, increased social spending could adversely exacerbate unequitable distribution of benefits and fiscal sustainability problems. On the other hand, the existence of soft budget constraints could kick-start a modernization process of these unbalanced, fragmented and underdeveloped welfare states, leading to positive distributional consequences.
In our paper we aim to answer these questions: whether governments used these soft budget constraints to increase social spending in the first years of the Euro and whether this social spending was tied to a particular reform narrative, i.e. institutional deterioration/status quo preservation or modernisation.
Modernisation had several definitions, but especially during the Maastricht period, it has been perceived as entailing policies of fiscal discipline and structural reforms. Nevertheless, our paper adopts the original definition of modernisation which was dominant in the 1980s, i.e. democratisation around values like equality and social justice. This has been elided from the policy discussions of the time, due to the narratives of fiscal discipline, but it is very relevant for welfare state reforms and for the inequality debate.
We focus on Greece and Ireland within the scope of transfers: old age pensions. These two countries have different tax and transfer systems, but in both cases after the introduction of the common currency, social spending increased and it was old age pensions of all social transfers which were most pronounced during the euro-years. Moreover, while pensioners were among the most vulnerable and sizable groups in terms of poverty risk spending on pensions is also very path-dependent, with strong traditional stakeholders. Thus, we concentrate on pensions, exactly because pensions’ policy is a very a highly contested and politicized area of transfers.
Our analysis revealed that even in the case of Greece, which is not known for much progress on its welfare state restructuring, and despite the enormous social and political resistance to any serious attempt of pension system recalibration, there were clear elements of modernisation during the euro years. Thus, despite the pervasiveness and persistence of insider privileges within the pension system, the establishment and the increase of minimum social benefits had positive distributional consequences for the elderly also among the lower income classes. In fact it appears that the above reforms were possible because the government could, due to soft budget constraints, maintain almost unharmed the benefits of the groups that were most likely to prevail in a “war of attrition”.
In the case of Ireland under EA and soft budget constraints, the liberal coalition government managed to achieve a more equitable pension system and to reduce poverty among the elderly substantially. Inequality concerns were not really on the conservative coalition’s agenda, however, and the reduction of inequality was rather a side effect of the government’s poverty reduction strategy. Tax relief for private pensions continued to benefit the upper part of the distribution. Yet, the increase in state pensions benefited middle and lower income pensioners and this reduced not only poverty but also inequality. At the same the issue of fiscal sustainability, was not a concern since the Irish welfare system has been always criticized for low provision of benefits. Thus, the pension reform was crucial for reducing inequality among the most vulnerable of this age group. Our study sheds light on the debate about inequality in the EA as how it is imperative to consider market forces.
We find that in both countries, “soft budget constraints” allowed them to lower poverty and inequality among the elderly. They strived to introduce pension fund reforms that would entail benefits for the elderly who were close to the poverty line. Pension spending increased in a progressive way and outsiders (those not covered from the existing schemes) of the system benefited from this increase even in the unlikely case of Greece.
Subsequently, the literature suggesting that the Eurozone entailed only institutional deterioration for certain peripheral countries tends to focus only on an evaluation based on efficiency (fiscal sustainability) and ignores that accession to the EA enabled governments to pursue also reforms with positive social outcomes.
A research seminar on the topic took place on 12 November 2019 at the LSE, organised by the Hellenic Observatory. For more information please visit the event page.