The EU Fiscal Stability Treaty: Summary and Analysis

 UPDATE: the approved text of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union is available here. 

The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union is expected to be discussed at the European Council meeting on 30 January 2012. I will use the last leaked draft to present a short summary of the treaty, and then analyze its content.

1.       Summary of the Fiscal Stability Treaty

The treaty covers a number of topics as follows:

Scope and Objectives

The contracting parties aim to  strengthen the economic pillar of the Economic and Monetary Union by adopting a set of rules intended to foster budgetary discipline through a fiscal compact, strengthen the coordination of economic policies, and improve the governance of the euro area.

Fiscal Compact

The overall principle is that the government budget must be balanced or in surplus. The annual structural deficit must not exceed 0.5% of GDP. In the event of significant observed deviations from this principle, a correction mechanism will be triggered automatically. The mechanism will include the obligation of the EU Member State to correct the deviations over a defined period of time.

These rules must be transposed in the national law of the participating EU Member States within one year of the entry into force of the fiscal stability treaty through provisions of “binding force and permanent character, preferably constitutional”.

When the ratio of the general government debt to GDP exceeds the 60%, the must  reduce it at an average rate of 1/20 per year as a benchmark.

The participating eurozone Member States commit to support the proposals or recommendations submitted by the European Commission where it considers that a Member State is in breach of the deficit criterion in the framework of an excessive deficit procedure.

If the European Commission concludes in its report that a participating EU Member State has failed to comply with the relevant rules in national law, the matter will be brought to the ECJ by one or more of the participating Member States. T he judgment of the ECJ will be binding on the parties in the procedure, which will have to take the necessary measures to comply with the judgment within a set period. If ECJ finds that the Contracting Party concerned has not complied with its judgment, it may impose on it a lump sum or a penalty payment appropriate in the circumstances that does not exceed 0.1% of GDP. The amounts imposed will be payable to the European Stability Mechanism.

Economic Policy, Coordination and Convergence

The participating Member States agree to take the necessary actions and measures in all the domains which are essential to the good functioning of the euro area in pursuit of the objectives of fostering competitiveness, promoting employment, contributing further to the sustainability of public finances and reinforcing financial stability. This will be done through the adoption of special provisions for the eurozone (art. 136 TFEU) and the enhanced cooperation procedure (art. 20 TEU).

Governance of the Euro Area

The Heads of State or Government of the eurozone Member States will meet informally in Euro Summit meetings, together with the President of the European Commission.

Euro Summit meetings will take place at least twice a year, to discuss the responsibilities of eurozone Member States, other issues concerning the governance of the euro area and the rules that apply to it, including strategic orientations for the conduct of economic policies and for improved competitiveness and increased convergence in the euro area. Non-eurozone Member states that participate in the fiscal stability treaty will be invited to participate at least once a year in the Euro Summit.

General and Final Provisions

The fiscal stability treaty will enter into force on 1 January 2013, provided that twelve participating eurozone Member States have deposited their instrument of ratification, or on the first day of the month following the deposit of the twelfth instrument of ratification, whichever is the earlier.

Within five years of the entry into force of the treaty, participating Member States will take the necessary steps in compliance with the provisions of TEU and TFEU, to incorporate the substance of the treaty into the legal framework of the European Union.

2.       Analysis of the provisions of the Fiscal Stability Treaty

One point must be made at the start: the fiscal stability treaty in its present form is not part of EU law. It is an instrument that is coordinated with and to large extent depending on primary EU law. This is also the main problem of the treaty.

The provisions are intentionally vague in order to avoid any conflict with the enhanced powers of the EU post-Lisbon. The only meaningful instrument is the sui generis infringement procedure in case a participating Member State has failed to apply the automated deficit correction mechanism. However, this procedure is substantially weakened by the fact that Member States, and not the European Commission, must petition the ECJ. This will happen only in extraordinary circumstances and with great unease.

In addition the provisions on economic coordination are totally bland. I fail to understand how these texts may enhance economic policy coordination – they are restating existing opportunities in EU law.

Another concern is whether the fiscal stability treaty will produce the intended effect. In a time when many are openly considering eurozone breakup we need much more substance and detail to stem the crisis. Yes, the UK government did its part in complicating the mitigation efforts, but we really need to respond to market expectations and to political realities today. Too many Europeans are already suffering from the effects of the continuing uncertainty and economic contraction.

What’s Behind the New Eurozone Fiscal Stability Union?

This European Council meeting was quite tumultuous, it appears. But we do have an outcome – a “fiscal stability union”. Below I present a preliminary critical assessment of the proposal, as well as a comment on the toxic role of the United Kingdom in the negotiations.

The “Fiscal Stability Union” in a Nutshell

The statement of eurozone leaders is scant on details. However, what we know is that:

• The golden fiscal stability rule that annual structural deficit should not exceed 0.5% of nominal GDP will be enshrined in eurozone Member States constitutions or equivalent acts;
• There will be an automatic correction mechanism in national legislation that shall be triggered in the event of deviation;
• There will be common standards for the automatic correction mechanism and compliance with those standards will be monitored by the European Commission; the transposition of those standards will be subjected to the jurisdiction of the European Court of Justice;
• Eurozone Member states will have to report their national debt issuance plans;
• When a Member State breaches the 3% budget deficit ceiling there will be automatic consequences unless a qualified majority of Member States decides otherwise;
• Some of those measures will be pursued by more active use of enhanced cooperation.

Urgent Measures

The eurozone leaders have also agreed on a couple of urgent measures:

• The European Stability Mechanism (ESM) treaty will enter into force as soon as Member States representing 90 % of the capital commitments have ratified it, preferably by July 2012;
• Ensuring a combined effective lending capacity of EUR 500 billion by the European Financial Stability Facility (EFSF) and ESM;
• Provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans;
• Unanimity for the ESM will be replaced by a qualified majority of 85 % in case the Commission and the ECB conclude that an urgent decision related to financial assistance is needed.

Legal Analysis of Proposals

Given the objection of the United Kingdom, and possibly Hungary, the revision of EU Treaties seems impossible at the moment. That is why the eurozone leaders speak about an “international agreement” that should be signed by March 2012. This agreement will not be part of EU law (at least initially). I fail to see, though, how can the European Commission participate in the monitoring of fiscal stability in this case. Enhanced cooperation (Art. 20 TEU and art. 329 TFEU) seems more appropriate. The problem there is that only the European Commission can propose an enhanced cooperation to the Council, and the European Parliament must also approve it. This can lead to substantial delays of the procedure. That is why a two-track strategy appears more appropriate. Common standards for fiscal stability should be specified in the “international” agreement. Together with it the eurozone member States should initiate an enhanced cooperation authorization procedure. That is important, because any credible fiscal stability regime will need to transfer monitoring powers to the European Commission. This means that the drafting of rules must start now, in close cooperation with the European Commission and the European Parliament.

The Toxic Role of the United Kingdom

For some time I have been quite skeptical of UK’s role in the European integration process. There are deep divisions within the British political establishment on UK’s place in the EU. However, those internal divisions are spilling over to the EU and creating instability. The truth is that there are too many UK politicians that want the UK out of the EU, and in the European Economic Area.

I fully support the right of UK to define its own place in the integration process. With its decision to object to the new eurozone governance rules, the UK is basically signaling its determination to distance itself further from core EU countries. However, I think that the UK must not be allowed to unilaterally obstruct the further building of the European project. That is why a new political dialogue must be started among EU Member States about the possible modifications of UK’s scope of membership and responsibilities in the EU. This process must reflect the UK’s concerns, as well as the strategic objectives of the Union. What is clear is that we cannot continue to pretend that the UK is on board in support of the integration process.

How to Save the Eurozone in Few Easy Steps

The eurozone is in grave danger, and something must be done, fast. This is the message I get from various corners of the EU commentariat. Economists are particularly pessimistic. But the immediacy of the crisis is something relative – I’ve heard many macabre predictions many times during the last two years.

So I am more interested in the possible impact of the crisis on the future of the European Union. This may sound like an “unknown unknown”, but to my opinion trying to solve the eurozone crisis without taking into account the impact on the EU institutions and the integration project is useless. So let’s see what the options are.

1. Monetization of debt

The excessive debt of peripheral eurozone countries can simply be monetized by the ECB by using the proverbial printing press. The downsides are clear: the threat of moral hazard and inflation. Moral hazard means that once the ECB starts to monetize debts, every eurozone Member State can point to this precedent and demand equal treatment (i.e. more printing of euros to cover unsustainable debt). This leads to the second danger – elevated inflation, although some claim that this is not very likely due to the recession. If monetization happens, it will obviously be accompanied with a form of fiscal union, because there will have to be very strong guarantees against fiscal profligacy. In the short to medium term this approach can save the eurozone, and the European project as a whole. The problems with this approach are twofold: first, it may lead to unsustainable EU fiscal institutions if Germany and other northern Member States push too hard in their desire to guarantee fiscal discipline; second, in the long term this may also mean that peripheral Member States will become even more uncompetitive if again Germany and other northern Member States fail to reform their economies and stimulate internal demand.

In conclusion this approach may lead to long-term mutations that may transform the European Union into an undemocratic and unjust sovereign. On the good side, it saves us from immediate harm.

2. Credit crunch and disintegration of the eurozone

If the ECB does not monetize peripheral eurozone debt, then we may expect consecutive bank runs, asset sell-offs and overall economic misery in the eurozone periphery. This misery will probably be contagious, spilling over to the eurozone core, the US, Japan, China, and all over the world. Sooner, rather than later, the eurozone periphery will reintroduce capital controls and will effectively pull out of the eurozone. The economic and social consequences cannot be reliably foreseen, but will be very damaging to the global economy. Politically, the EU may disappear.

3. The way forward

It is quite obvious that the eurozone core must be convinced to monetize peripheral debt. This solution will be very difficult to achieve, but it serves all interests. However, it must be done carefully in order to protect the European project from excessive German influence that may in the long term transform the EU into some ugly mutant. The peer pressure of G20, and the US in particular, will be instrumental in achieving this difficult victory over petty short-term interests.

 

Of Eurozone Mice and Eurozone Men

This week was tumultuous for the eurozone, in a string of equally tumultuous weeks that preceded it. The Greek Prime Minister proposed a referendum for the new bailout package for Greece, was promptly scolded by his fellow eurozone leaders at the G20 summit, and had to arrange his exodus from the scene. Meanwhile Italy panicked and started redesigning its own austerity programme.

What all this reveals is a new incursion into political entrepreneurship, mainly by the leaders of France and Germany, to somehow solve this crisis. This is also a sign of failure of the European governance mechanism that simply does not withstand the political pressure.

The leaders of the main EU institutions play only supporting roles in this spectacle. The governments of the Member States, aided by the IMF, are once again trying to pull themselves by their own hair.

The crisis of European political leadership notwithstanding, we are experiencing the incapability of the institutional mechanism of the European Union to deliver in this difficult moment. Important decisions are taken outside the multilateral decision-making track. This brings more instability to the system and delegitimizes the decision taken. One of the reasons is the blatant disregard for European Union law.

During the dinner in Cannes Mrs. Merkel and Mr. Sarkozy reportedly asked Mr. Papandreou whether Greece wants to stay in the eurozone or not. The problem of this question is that it has not been discussed with all 26 Member states other than Greece, and to my knowledge it would take all these 26 Member states AND Greece in order to decide on its exit from the eurozone. In other words the political entrepreneurship has neglected the very structure and substance of EU law, hiding behind the veil of urgency. Urgently taken decisions often are bad decisions, though. The European Union is much more than its currency and no economic crisis of any proportion should be used as a tool to destroy what has already been built.

While we, Europeans, remain surprisingly short-sighted, our American allies have already noticed and evaluated the huge importance of our weakness. Perhaps it is time to start thinking strategically and stop shooting in the dark.

 

 

Dear Germany, You Are Deciding the Future of Europe

Dear Germany,

The last two decades were very good for you. You were able to unify your divided territory and your people. You had your fair deal of growth and expansion of trade. You began to “normalize”, as experts say.

Today you have to solve a great problem. It is up to you to decide whether the eurozone project lives or dies. I will not go into the details of the problem and the possible solutions. In any case you know very well what is at stake and what the options really are.

But why should you choose to save the euro? Well, two reasons spring to mind. First, a breakup of the eurozone will be very messy and will likely hurt your banks, pension funds and ultimately – your own citizens. The breakup will negate some of the important benefits of the internal European market and will cause widespread economic troubles around the whole world.

Second, killing the euro will go against your own obligations. When you founded the eurozone you also agreed that any amendment of the rules of the EMU will go through an amendment of the Treaties. That means that countries such as France and Belgium must explicitly agree to the eurozone breakup, and I sincerely doubt that they would. So in case you want to print Deutsche Marks again, you will have to infringe the Treaties in a very blatant way.

If the internal political pressure is really high you might probably risk and do it. But going against the founding principles of the European Union will have a very high price for you. One of the reasons for the unification back in 1990 was that you were securely integrated in the European Community. Yes, you are very different now and yes, you are rightly demanding a stronger voice in the world affairs. But still – there are ambiguous feelings in Europe about a strong and expansionistic German economy, especially if combined with a rapprochement with Russia. You need to think carefully about those considerations.

Whatever you decide to do, I would strongly advise talking sincerely with your own people. Cheap propaganda about the lazy Greeks may sell the newspapers, but we’re not talking about entertainment here. Your choices will define the future of all European citizens, and that means Germans as well. The European Union will never be the same after the breakup of the eurozone, and you will not enjoy the position that you have now.

Please think carefully before making your decision. The world will not end with the euro, but it will be an uglier place.

Best regards,

Vihar Georgiev

 

 

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.

Democracy Is Not the Fundamental Problem of the Eurozone

There has been a lot of discussion recently about the alleged undemocratic character of the austerity programs and bailout agreements for peripheral eurozone Member States. This is not the fundamental problem of the eurozone. Trade imbalances are not resolved, and this will render all rescue efforts futile.

I have followed with great interest the discussion among EU bloggers on the implications of the austerity programs for the level of democracy in peripheral eurozone Member States (see in particular the contributions by Leigh Phillips, Ron Patz, and John Worth). They all raise important questions and are definitely worth reading. What they miss, however, is the true cause of the eurozone crisis and the implications it has for any future efforts to rescue the euro.

The real problem is the trade imbalances of eurozone Member States. One group of Northern countries enjoys significant trade surpluses, while the Southern countries have deteriorating trade deficits. This process of economic divergence has worsened with the introduction of the euro (see the figure below).

Eurozone Current Account Balances as % GDP (source: Political Economy 101)

This has led to all kinds of negative outcomes for Southern economies, including excessive sovereign debt levels. But the current approach to resolving the eurozone crisis has been one-sided. We only try to repair one side of the equation – that is, the excessive spending in peripheral eurozone Member States. We do not take any measures to address the excessive saving in Northern countries like Germany or Netherlands. In addition to this we do not allow Southern countries to devalue their currencies in order to become competitive again.

This approach will not work. The treatment of excessive saving as a “virtue” will only worsen the current divergences. The lack of a devaluation option for Southern countries will bring them literally to the wall.

In this narrative the method for devising unsuccessful measures is of secondary importance.

Voluntary debt rollovers will not do the trick, nor will austerity programs. Bolder and much more balanced action is needed if we really want to repair the damage. If Northern countries continue to overlook their contribution to the crisis, the eurozone will fall under its own weight.

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Technical appendix

Since I am not an economist I thought it would be useful to list some the sources for this post:

Stop Blaming Trade Imbalances On Lazy Greeks, Industrious Germans And Other Stereotypes by Michael Pettis

External versus domestic debt in the euro crisis by Daniel Gros

Rebalancing the Global economy: A Primer for Policymaking – Stijn Claessens, Simon J Evenett, Bernard Hoekman (eds.)

The EMU needs a stability pact for intraregional current account imbalances by Sebastian Dullien and Daniela Schwarzer

 

 

The Old New Idea for a Political Union – Misunderstood?

The Greek financial crisis now threatens the whole eurozone. It appears that without substantial debt restructuring Greece is likely to default, and would have to leave the eurozone. This could lead, however, to substantial collateral damage and unintended effects for the whole European banking and financial system. The other option is a very large fiscal transfer from the eurozone core. This second option will lead donor Member States to demand substantial political guarantees for fiscal discipline in Greece and other possible recipients (i.e. Ireland and Portugal).

It looks like the crisis has brought back the idea for a true European political union on the table. The president of the ECB, Jean-Claude Trichet, himself has called for the establishment of a European financial minister.

Now, the idea is not really new. Back in the 1950s there was such a project, called the European Political Community (EPC) that aimed to politically unite the Member States in the European Economic Community (read more about it in the excellent paper by Berthold Rittberger). The main institutional innovation in the EPC was the central role of the bicameral parliamentary body in adopting the budget and the legislation. The EPC project failed, but some of its ideas were later implemented by including the European Parliament in the legislative and budgetary procedures.

Going back to Mr. Trichet’s ideas, we see something completely different. In his framework, the Council would act on the basis of a proposal by the Commission, in liaison with the ECB, to take some measures directly affecting the economy of the Member State that has not implemented its fiscal stability program. There is no role for the European Parliament whatsoever. Apparently Mr. Trichet believes that the very agreement on a stability program is substantial legitimation for a direct involvement in the economic and fiscal policies of a Member State by the Council.

This is quite doubtful. It’s very difficult to imagine how the same people that violently oppose to austerity measures taken by their democratically elected governments will somehow accept direct interference by an institution of the European Union. It’s equally difficult to imagine that the European Parliament will approve such an institutional framework. I can certainly understand the reasonable motives for proposing such a second stage of austerity enforcement, but I’m afraid that such a procedure will decisively worsen the democratic deficit of the European Union.

If and when the governments of the Member States decide that a more profound Treaty revision is needed for establishing tighter fiscal coordination, they will have to consult their national parliaments and the European Parliament. Such consultations are in fact inevitable, since TEU requires the summoning of a Convention to adopt the draft text of the revision (art. 48, para. 2-5 TEU).

 

 

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.

 

 

Intuitu Personæ: Who Should Lead the ECB?

There’s quite a lot of talk recently about who should replace Jean-Claude Trichet as president of the European Central Bank. Sylvester Eijffinger and Edin Mujagic from Tilburg University say that a firm ECB president, unwilling to yield to political pressure, is needed. Jean Quatremer provides, as usual, a very detailed picture of the behind-the-curtain negotiations surrounding the nomination of the future president of the ECB.

Two things are important here. First, we should avoid at all cost a North-South polarization surrounding this issue. True, the ECB president is elected by qualified majority, but any trust in the eurozone that is still available will be lost if Member States start fighting over this post. Second, whoever is elected should be able to guarantee strong leadership. We certainly do not need an ECB president that divides instead of unifying the eurozone.

At a time of great peril there’s no room for experimenting. I do hope that all Member States, and France and Germany in particular, will not try to over-politicize this nomination. Otherwise consequences may become overwhelming, and history will apportion blame accordingly.