The Debate on Economic Governance Intensifies in the EU

The Van Rompuy task force on economic governance has produced its report that will be discussed during the European Council meeting on 28 October. According to Mr. Van Rompuy this will be the biggest reform of the Economic and Monetary Union since the euro was created.

The most important provision is about creating a mechanism for macro-economic surveillance. The mechanism will serve as an early warning system for detecting substantial macroeconomic imbalances, including strong divergences in competitiveness. The mechanism will operate for eurozone member states.

The second reform concerns the corrective arm of the Stability and Growth Pact. The debt criterion will carry much more weight when deciding on the excessive deficit procedure. According to Euractiv the task force has also endorsed plans for an interest-bearing fine on countries with high debts. The task force has also endorsed the European Semester for the coordination of budget planning.

The new proposals may need the revision of the Treaties. Le Figaro reports that France and Germany have agreed on such a revision in 2013 (hat tip: OpenEurope).

In summary, the report of the task force will generally repeat the proposals of the Commission on European economic governance. The big question, however, remains – will these proposals suffice to reverse current macroeconomic imbalances in the eurozone and the EU in general. Economists remain sceptical, and if we do not manage those imbalances, all other political measures will have only incremental value.

Legislative Proposals on EU Economic Governance

The European Commission has now formally proposed amendments to existing legislation and new legislation aimed at improving economic governance.

Here’s the list:

1.A Regulation amending the legislative underpinning of the preventive part of the Stability and Growth Pact (Regulation 1466/97);

2. A Regulation amending the legislative underpinning of the corrective part of the Stability and Growth Pact (Regulation 1467/97);

3. A Regulation on the effective enforcement of budgetary surveillance in the euro area;

4. A new Directive on requirements for the budgetary framework of the Member States;

5. A new Regulation on the prevention and correction of macroeconomic imbalances;

6. A Regulation on enforcement measures to correct excessive macroeconomic imbalances in the euro area.

Commission Proposals on Enhancing Economic Policy Coordination

The Commission has presented its communication on enhancing the coordination of economic policy in the European Union. The main components:

An alert system, including a set of indicators revealing external and internal imbalances combined with qualitative expert analyses. Alert thresholds will be defined and announced for each indicator. In particularly serious cases, the Commission would recommend placing the Member State in an “excessive imbalances position”.

An enforcement mechanism – a Member State in “excessive imbalances position” would be subject to stricter surveillance. The Council would issue policy recommendations; more stringent rules would apply to euro area Member States. By end-September, the Commission will make formal proposals for secondary legislation establishing a framework for dealing with excessive imbalances.

Thematic structural reform surveillance – this surveillance will be carried out in accordance with Article 121 and 148 TFEU and on the basis of the Europe 2020 Integrated Guidelines. . Based on Member States’ National Reform Programmes the Commission will assess the way each country has addressed the bottlenecks it has identified and how it is progressing towards its national Europe 2020 targets.

Reforms of national fiscal frameworks – including fiscal rules and credible enforcement mechanisms; multi-annual budgetary planning.

Enforced Stability and Growth Pact – requirement for Medium-Term budgetary objective (MTO) for Member States with a level of debt or pronounced risks in terms of future debt developments; a clear and simple numerical benchmark for defining a satisfactory pace of debt reduction.

Appropriate sanctions and incentives – an interest-bearing deposit for euro area Member States; ex-ante conditionality linking disbursement of cohesion policy support to structural and institutional reforms; reduction of EU funds payment to Member States or payments for which Member States act as an intermediary (end beneficiaries should not be affected).

The coordination cycle – complementarity of national budgets will be ensured at European level through policy guidance before final decisions on the budget for the following year are taken in Member States. The so-called European Semester will start with an “Annual Growth Survey” prepared by the Commission. By February the European Council provides strategic guidance on policies, which is taken into account by Member States in their Stability and Convergence Programmes (SCPs) and National Reform Programmes (NRPs)which will be submitted in April. The Council issues country-specific policy guidance in early July. In the second part of the year, Member States finalise national budgets. The European Semester will cover all elements of economic surveillance, including policies to ensure fiscal discipline, macroeconomic stability, and to foster growth, in line with the Europe 2020 strategy.

Report on the Public Finances of the EU

The European Commission has published the 2010 Report on Public Finances in EMU. The report reviews how Member States’ fiscal policies have evolved in the wake of the financial and economic crisis. It assesses the prospects for public finances and policy needs ahead.

The report says that both government deficits and debt have deteriorated markedly, reaching levels unprecedented in recent times in the EU. This strong deterioration in the public finances is due to both the automatic effect of economic performance and the support measures introduced by EU governments. According to the Commission these temporary measures have had positive effects on employment and economic activity during the crisis, by supporting private demand and maintaining fundamentally sound activities and jobs that could otherwise have been lost.

The report further notes that reduced fertility and increased life expectancy are set to have a considerable impact on both the growth potential of Member States’ economies and on public budgets. Member States with large deficits and large projected costs from ageing facing the biggest risks, and the most urgency in terms of addressing long-term sustainability issues.

An alarming finding of the report is that the significant consolidation of budgets set out in the Stability and Convergence Programmes are not sufficient to stem or reverse the increases in debt from
the crisis. According to the Commission Member States should seek to shift the tax burden from labour to energy and environmental taxes as part of a “greening” of taxation systems. The report says that expenditure-based consolidations have better track records of success than ones based on tax increases, while gradual consolidations tend to have higher success rates than “cold shower” ones.

The Legal Framework of the European Financial Stability Facility

We now have the initial legal framework of the European Financial Stability Facility. It will be registered as a limited liability company under Luxembourg law (Société Anonyme). The EFSF has been incorporated with Luxembourg as its sole shareholder to expedite its creation, but after the completion of the national approval procedures the shareholding of each Member State in the EFSF will correspond to its respective share in the paid-up capital of the ECB. The obligation of euro-area Member States to issue guarantees for the EFSF debt instruments will enter into force as soon as a critical mass of Member States, representing 90% of shareholding, has completed the relevant national parliamentary procedures.

At the same time EU governments agreed to provide their national budget drafts to each other and to the European Commission before seeking national parliamentary approval. The idea is for each government to present its broad estimates for growth, inflation, revenue and expenditure levels in the spring, roughly six months before national budgets go through parliaments.

Eurointelligence once again underscores the importance of a more comprehensive policy response, citing the Concluding Statement of the IMF Mission on Euro-Area Policies. The main difference is in thoroughly addressing the macroeconomic imbalances, including in the German tax and regulatory systems which have built-in incentives for manufacturing investments, and disincentives for consumption.

The Existential Crisis of the Euro – Where Did We Go Wrong?

The German government is on the forefront of an attempt to restrict the volatility of the euro exchange rate. First, the German financial regulator BaFin placed a unilateral ban on naked short-selling of eurozone sovereign debt instruments, with little effect. Second, Angela Merkel proposed a comprehensive reform of the stability and growth pact, with tougher rules of the game aiming to achieve one thing in particular: that member states bear the responsibility for a solid budget management. Third, Germany is hosting an international conference on financial market regulation in Berlin.

So far, so good. The markets, however, are not impressed. In fact, some analysts say that the euro may fall below parity with the dollar in the first quarter of 2011. The problem is that the decline in the euro may hurt demand for the region’s sovereign bonds in the year when new debt will be soaring.

The President of the eurogroup, Jean-Claude Juncker, says that foreign-exchange intervention isn’t an urgent issue.

One leg of the problem according to Proffessor Michel Aglietta, is that we have a solvency problem with Greece, not a liquidity problem. He says that the austerity program for Greece is a ticking bomb that could cost dearly to the whole European Union. He advocates for immediate restructuring of the Greek debt. He also says that the eurozone will not survive without a system for budgetary transfers among eurozone members. according to him the private sector is not capable to compensate for the draconian austerity measures in Portugal, Spain, Ireland and Italy.

Jan Kregel and Rob Parenteau outline the key aspects of the eurozone predicament using the financial balance approach developed by Wynne Godley. They say that the current attempt at “budgetary discipline” in peripheral eurozone members will lead to fiscal retrenchment, private income deflation, and rising private debt distress. They warn that IMF conditionality is bound to set off the twin contagion vectors of falling trade surpluses and rising bank loan losses in the core nations.

I am not an economist. But these warnings against the current EU approach towards the eurozone crisis come from too many places (for alternative ideas see Peter Bofinger and Stefan Ried, Avinash Persaud, and Paul De Grauwe). This issue is way too serious to be decided upon in a hurry.

The Commission Proposals for Coordination of Economic Governance

The Commission has issued a communication on reform of economic governance in the eurozone, called “Reinforcing economic policy coordination”. EUobserver reports that the proposals have drawn an immediate rebuke from Sweden.

Here’s a list of major proposals:

Improving the functioning of existing mechanisms under the Stability and Growth Pact

• Increase effectiveness of Stability and Convergence Programmes assessments through better ex-ante coordination, including competitiveness developments and underlying structural challenges. This will be done by a scoreboard with details on developments in current accounts, net foreign asset positions, productivity, unit labour costs, employment, and real effective exchange rates, as well as public debt and private sector credit and asset prices.

• National fiscal frameworks to better reflect the priorities of EU budgetary surveillance. This would include formulation of more timely country-specific recommendations, a system of early peer-review of national budgets, a horizontal assessment of the eurozone fiscal stance

Addressing high public debt and safeguarding long-term fiscal sustainability

• Give new prominence to the debt criterion of the Treaty. Conditionality would typically involve an appropriate mix of fiscal consolidation and the strengthening of fiscal governance including tax policies; financial sector stabilisation to the extent that financial sector distress is at the root of the public finances problems; and broader policy interventions to restore macroeconomic stability and external viability.

• Take better account of the interplay between debt and deficit

Better incentives and sanctions to comply with the rules of the Stability and Growth Pact

• Interest-bearing deposits in case of inadequate fiscal policies

• More rigorous and conditional use of EU expenditure to ensure better compliance with the rules of the Stability and Growth Pact

• Recurrent breaches of the Pact to be subjected to more speedy treatment and more rigorous use of the Cohesion Fund Regulation

Excessive Deficit May Prompt Suspension of Regional Aid?

The European Commission considers suspending structural funds for states which are regularly in breach of the EU’s stability and growth pact. An additional criterion being considered is a public debt ratio above 60% of GDP. The Commission also plans to deepen and broaden budgetary surveillance in the future.

I can follow the logic of the Commission in desiring to impose a budget discipline in the EU, but I am particularly worried about Bulgaria. As we already know, there probably will be an excessive deficit procedure against Bulgaria for 2009 and possibly for 2010. True, the gross public debt is relatively small. But even now we face substantial problems in using the structural funds. Any further restriction or suspension of regional aid by the Commission can be devastating for a country that simply is not competitive enough on the EU markets.

Deadlines for the Correction of Budget Deficits

The European Commission has proposed deadlines for the correction of the budget deficits of Greece, Spain, France and Ireland to the Council. EC also proposed a new deadline for the correction of the excessive deficit in the UK.

This is an important step forward in the procedure. Once the deadlines are approved by the Council, the Member States concerned will have six months to take effective action regarding budgetary outcomes in 2009 and to specify the measures that will be necessary to progress towards the correction of the excessive deficit.

We have to observe very carefully this procedure, since it will provide evidence about the practical enforceability of the Stability and Growth Pact.