Four scenarios for Europe - scenario 2: ‘Further Integration’

After a painful defeat in the referendum in December 2016, Italian Prime Minister Matteo Renzi has stepped down. New parliamentary elections will be held in the second half of 2017. These will be won by the eurosceptic Five Star movement, but ultimately this party will not succeed in gaining sufficient support for a referendum on membership of the euro. Italy remains a member of the EU and will stay in the euro, but only just.

European leaders will be given a serious fright, all the more because British Prime Minister Theresa May will be carrying on with the Brexit process. Furthermore, eurosceptic parties in other countries will continue to attract voters by pointing to the still struggling economy, the stubbornly high level of unemployment and reports that recent immigrants are having difficulty in integrating into the labour market. The call for decisive action will be intense. Leading politicians in the major Member States will be aware that there could be a lot to lose if the EU disintegrates, and decide to join forces. European leaders will engage in a leap forward with more political and economic integration, in the hope of pulling the continent out of the mire.

The first big step will be dealing with the problem of migration. The plan will entail the systematic and collective protection of the Union’s external borders by significantly expanding the recently formed European Border and Coastguard Service. The European Commission will also make deals on refugees with North African countries, while making agreements with Egypt and Middle Eastern countries on facilities for refugees in their own region. The Member States will moreover initiate a common intelligence and security service to identify radicalism among their own population more quickly and deal with it at an early stage.

While the measures will not solve all the problems associated with migration immediately, this remarkable spurt of decisiveness on the part of Brussels will be convincing: the eurosceptic parties will lose momentum. They also do not succeed in winning the Dutch elections in March 2017. When the French and German voters cast their votes later this year, the front pages of the major newspapers will have been no longer dominated by refugees and asylum seekers for some time. The majority of the voters will vote for the conventional parties. The European Union will have been saved for the time being, but it will not yet be off the critical list.

Having survived the electoral crisis, European politicians will return to the question of how they can get the economy firing again. European budgetary rules will be (temporarily) eased to accommodate Southern European countries battered by spending cuts in order to invest in areas such as infrastructure and sustainability, making use of the low level of interest rates. This will boost economic growth and employment in the short term and strengthen earning power in the longer term. The European and Dutch economies will grow significantly faster than predicted in the base rate of growth associated with the muddling through scenario. The Common Agricultural Policy (CAP) will also be redesigned.

Inflation expectations will also rise as a result of the faster growth rate. The European Central Bank (ECB) will thus be able to taper its quantitative easing policy earlier than planned, after which interest rates in the financial markets will rise gradually and the yield curve will steepen as a result of the improved future prospects. Budgetary stimulation will be applied to compensate for the impact of higher interest rates on the economy. As a successor to the Juncker plan, a common investment fund will be set up to make large investments in infrastructure, clean energy and knowledge development. Each country will contribute to this in proportion to the size of its economy. Countries will also be encouraged to spend a minimum proportion of their national income on R&D.

Higher interest rates and a strengthening economy will raise the returns of the Dutch pension funds, after they have first booked some losses on bonds. The actuarial interest rate will also rise. Both these developments will improve coverage ratios, so that pensions can finally return to being indexed and contributions can be reduced to some extent over time. All this is good news for consumer confidence and household disposable income, which will be reflected in faster growth of consumption.

The EU will now take closer account of macroeconomic imbalances between countries, whereby Germany and the Netherlands will finally accept the need for budgetary stimulus in their economies and Germany’s current account surplus will be reduced. Economic reforms will now be effectively tackled in countries where this is necessary. As an extra boost to growth, the removal of barriers in the services sector will strengthen the European Single Market. The United Kingdom, with which the EU will still be negotiating on its exit, will not participate.

Since unemployment will decline further and the economy will grow, there will be political room for working on upgrading the eurozone to an optimal currency area. This will start with work on a (temporary) programme of common government bonds, or Eurobonds. This will involve what are known as ‘conditional Eurobonds’ that include the right incentives to strengthen the resolve of policymakers to pursue sound financial and economic policies.

Due to sounder government finances and impressive convergence growth figures, the Southern European countries will move increasingly closer to the Northern Member States. The differences in prosperity between countries will narrow and cross-border labour migration will increase. This will increasingly give the eurozone the character of an optimal currency area. To further raise the stability of the eurozone, the Banking Union will be completed, with European supervision of small and medium-sized banks and there will be a European Deposit Guarantee system. The economy of the EU as a whole will pick up and the forecasts will indicate that growth in the eurozone will be faster than in the EU-Member States outside the eurozone. Combined with the improved stability of the currency, Poland, Denmark and Sweden will soon be ready to withdraw euros from their ATMs.

To ensure that the surpluses of countries with a current account surplus are used more effectively to invest in new economic earning potential, the Capital Markets Union will be enhanced with a uniform Euro prospectus and a central European securities market. The improved access for small and medium-sized businesses to venture capital outside the banking system will create a start-up scene in the EU that can rival the US.

Meanwhile, the negotiations with the United Kingdom will come to an end. Relationships will have soured as a result of the process. London will want free access to the Single Market, but will be troubled by internal political divisions. Furthermore, the country will have a weak negotiating position. Banks and manufacturers already will have far-reaching plans to swap Great Britain for Ireland or the continent if Theresa May loses access to the Single Market and the banking passport. At the same time, the UK’s trade with the Union will gradually become less important for the EU as a result of the increased trade between the other EU Member States among themselves (trade diversion). And in the UK itself, a second Scottish independence referendum remains a sword of Damocles hanging over the negotiation process.

Ultimately, the United Kingdom will get the worst end of the deal. The country will have to accept a position similar to that of Switzerland: in exchange for access to the Single Market, the British will continue to pay into the EU to a limited extent and will have to follow European rules without any say as to their substance. This also applies to the rules on free movement of people, although the United Kingdom will remain outside the Schengen zone. The EU will be the clear winner in this process. The deal will further restore confidence in the strength of European cooperation.

This is important, since after the so-called Panama Papers and the Bahama Leaks, the Dominica Documents that still have to be leaked will show that tax evasion is more widespread than previously thought. Strengthened by the resulting public dissatisfaction, it will be decided to gradually introduce a dual taxation system throughout the EU. This will include tax rates on labour, for which Member States will be free to determine the amount and progressiveness, and a uniform tax on capital income, including corporate income tax. The rate for this will be set at 25 per cent. The tax base, including regulations on royalties for instance, will be the same throughout the EU. Impressed by this decisiveness and unity, the United States and Japan will be ready to enter into international agreements regarding corporate tax rates. A global approach to tax evasion will thus come a step closer.

Now that the EU is more clearly speaking with one voice on international issues, negotiations on the free trade agreement TTIP between the EU and the United States will resume. President Trump will welcome doing business with his largest trade partner, which will also emerge as a military ally of stature. Because awareness will have grown in Europe that in addition to speaking with one voice, having a single force would also be desirable: military cooperation within the EU will be intensified after most Member States have expressed their support for a European army. Healthier government finances will allow for investment in achieving the NATO standard for military spending of 2 per cent of GDP.

The eurozone economies, which now will to a great extent correspond to the European Union, will on average outperform the UK economy. The revival of European cooperation will not pass unnoticed in countries surrounding the Union: suffering from boycotts and low oil prices, Russia will also seek conciliation with the EU. Vladimir Putin will thus repeat his desire for a free trade zone ‘from Lisbon to Vladivostok’.

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