Dissecting the New Franco-German Proposal for the Eurozone

The German chancellor Merkel and the French president Sarkozy met yesterday and produced this document outlining their new proposal for the reform of the eurozone economic governance. The main points are:

• Regular meetings of the eurozone heads of state and government twice a year;
• President of the eurozone coinciding with the president of the European Council;
• Reinforcing the powers of the eurogroup of finance ministers (whatever that means);
• All Member States of the euro area to incorporate a balanced budget fiscal rule into their national legislation by the summer of 2012;
• All Member States of the euro area should confirm without delay their resolve to swiftly implement the European recommendations for fiscal consolidation and structural reforms;
• Finalizing the negotiation on the Commission’s proposal on “a common consolidated corporate tax base” before the end of 2012;
• Macro-economic conditionality of the Cohesion fund should be extended to the structural funds;
• Joint Franco-German proposal on a Financial Transaction Tax by the end of September 2011.

So how to interpret this proposal? I will divide my analysis in two parts: 1. Efficiency to solve the urgent problems of the eurozone and 2. Long-term institutional considerations.

1. Efficiency to solve the urgent problems of the eurozone

This proposal will not solve the urgent problems of the eurozone. It is far from what is necessary to calm the markets and will not help neither the ECB, nor Italy and Spain. While Merkel and Sarkozy did touch upon the creation of a eurozone bond as a distant possibility, they did not make a positive step in this direction. This happens while many experts claim that only two options remain open – the creation of a eurozone bond or the breakup of the eurozone. I firmly believe that a eurozone breakup will be a huge blow to the whole world economy, and some research supports this view. That is why any further dodging of this issue will only add to the damage to the eurozone economy.

2. Long-term institutional considerations

Looking carefully at the Franco-German proposal, there is nothing really new that is being added to the Pact for the Euro. The common consolidated corporate tax base and the financial transaction tax (Tobin tax) are old ideas, and they are being drafted by the Commission. The “eurozone economic government” is nothing more than a high-level political meeting with unclear powers, but probably within the framework of the Euro Plus Pact. The “president” of the eurozone probably adds some weight to the position of the president of the European Council, but again his/her powers are not clearly defined and would probably only deal with coordination.

What is more troubling is the intrinsic logic of these proposals. They stay within the logic of intergovernmentalism, leaving all the important decisions to an intergovernmental body. This is a recipe for failure. It’s infuriating that after sixty years of supranational regulation we resort to an inefficient mechanism that remains prone to the joint-decision trap. We are curing the problem with more of the same, and this will lead to deepening of the problems. If we want to keep the eurozone intact we must give an independent body – the European Commission or another entity, the power to sanction Member States for their infringement of the budgetary discipline “golden rule”. Any other solution will not work precisely the way the current mechanism for ensuring budgetary stability in the eurozone does not work.

This intergovernmentalist trend must be stopped. Nobody believes that the Member States are able to control each other. If we want the integration process to continue, we need to take into account its inherent logic. Otherwise we will only breed hybrids that will live shortly and leave a mess behind.

The Pact for the Euro: a Summary

The heads of state and government of the еurozone Member States have adopted a new competitiveness pact, called “A Pact for the Euro”. The pact comes as a form of guarantee for Germany in order to increase the funds of the European Stability Mechanism (ESM). You can read more about my concerns about the legality of such a pact here. An early assessment of the Pact for the Euro is available here.

The guiding rules of the Pact for the Euro:

• It will be complementary to the existing instruments of economic governance in the EU;
• It will concentrate on actions where the competence lies with the Member States. In the chosen policy areas common objectives will be agreed upon at the Heads of State or Government level;
• Each year, concrete national commitments will be undertaken by each Head of State or Government;
• The implementation of commitments and progress towards the common policy objectives will be monitored politically by the Heads of State or Government of the Euro area and participating countries on a yearly basis.

The goals of the Pact for the Euro:

• Fostering competitiveness;
• Fostering employment;
• Contributing further to the sustainability of public finances;
• Reinforcing financial stability.

The main policy instruments:

• Monitoring and adjusting unit labour costs (ULC);
• Removing unjustified restrictions on professional services and the retail sector;
• Improving education systems and promote R&D, innovation and infrastructure;
• Removing red tape and improving the regulatory framework (e.g. bankruptcy laws, commercial code);
• Labour market reforms to promote “flexicurity”;
• Tax reforms, such as lowering taxes on labour;
• Aligning the pension system to the national demographic situation;
• Putting in place national legislation for banking resolution;
• Developing a common corporate tax base.

 

 

Looking for the Philosopher’s Stone of Economic Governance Coordination

France and Germany proposed a new way forward for the coordination of economic governance in the European Union. The proposal may be ambitious in scope, but is minimal on detail – the leaked document contains one (1) page only. So how to interpret this?

First of all I am really surprised by the mentoring attitude of Merkel and Sarkozy at the European Council meeting. Wall Street Journal quotes Yves Leterme, the Belgian prime minister:

“There were 18, 19 countries who spoke up to make known their regret on the way it was presented and also on the content. It was truly a surreal summit.”

This misstep will obviously diminish the chance for quick success of the negotiations. Apart from the tactics, however, I am much more interested in the emerging legal obstacles to any compromise. The problem is that too much EU law stands in the way of the proposal in its present form.

The scope of the proposed measures is huge – raising retirement ages across the euro zone, abolishing indexation of wages to inflation, harmonizing corporate and other taxes and instituting a “debt brake” that limits the ability of governments to borrow to fund their spending. Nevertheless, France and Germany seem to believe that this can be done without a proper reform of the Treaties, in some sort of Schengen-like legal framework.

First it’s worth investigating whether the proposals can be introduced as an enhanced cooperation (art. 326 – art. 334 TFEU). Such cooperation must not undermine the internal market or economic, social and territorial cohesion. It must not constitute a barrier to or discrimination in trade between Member States or distort competition between them (art. 326 TFEU). These legal restrictions must be interpreted carefully, and a program to raise the competitiveness of certain Member States may well violate them. An enhanced cooperation also involves a proposal by the Commission and the consent of the European Parliament. It’s approved by the Council with a unanimous vote (art. 329, para. 2 TFEU).

But another way forward may be a Schengen-like legal framework, initially external to EU law. In this case, however, I believe that it must also comply with the criteria set for enhanced cooperation – i.e. it should not undermine the internal market or economic, social and territorial cohesion, and it should not distort competition between Member States. These criteria will be difficult to meet provided that the very purpose of the measures is to improve the competitiveness of the participating Member States. Additionally, it looks like France and Germany do rely on the Commission and the European Systemic Risk Board to perform some functions in this new framework. I can’t imagine how this can be done without someone (for example, the UK), raising the question of the funding of such initiatives by the EU budget. The European Parliament could also have some objections to this.

The most likely (and the slowest) option is Treaty revision. It is also the most legitimate way forward (and maybe the only legal one). True, it would lead to a lot of bargaining and time loss, but it would also bring stability and legal security to this new framework.

Having said this, it’s obvious that some measures must be taken. It’s just that proposing measures without thinking about their legal ramifications is not a good sign for their success. After all, we are talking about unprecedented levels of economic governance coordination. Trying to circumvent Treaty reform may not work simply due to the scale of the proposals.

 

 

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.

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