September 29, 2010
Today, the European Commission presented further ideas for the reform of economic governance in the EU and EMU. The package contains six legislative proposals, including a second reform of the Stability and Growth Pact (SGP) and macro-economic coordination (see here). With the media having reported some of the elements during the days before the presentation, coverage in online media today was rather weak with general mainstream media hardly covering the proposals at all. Attention is focused on the rather evident parts of the package such as tougher fines for fiscal sinners, enhanced deficit surveillance and changes in the voting mechanism to actually fine a country.
Much more interesting than this is the proposal on “measures to correct excessive macroeconomic imbalances in the euro area”. If the proposal is passed, for the first time, macroeconomic imbalances will be explicitly included into a formal surveillance process and fines (of 0.1 percent of GDP) might be levied on countries which prove uncooperative in resolving these imbalances. Thus the imperative of macroeconomic coordination set down in Art. 121 which obliges member states to treat economic policies as a matter of common concern can for the first time actually be enforced.
This new element could be crucial for preventing future debt crises in the euro area. The part on budgetary surveillance and coordination basically provides more of the same old approach of the Stability Pact: Governments are not allowed to run excessive deficits and they will be fined if they do not stick to the rules. This has not worked in the past, and the failure is not only due to lacking political commitment to implement the rules. This problem, by the way, is supposed to be tackled with double approach: firstly, making the Commission less dependent on the Ecofin when implementing budgetary surveillance, and secondly, by the new Directive on requirements for budgetary frameworks on Member state level which are supposed to reflect the objectives of the Stability Pact.
In the Greek case the deterioration of public finances was fuelled by excessive government spending and insufficient tax collection, and the new budgetary rules may have helped to prevent the recent developments. But this is not true for Ireland and Spain. Both countries had sound public finances with significant surpluses until the outbreak of the global financial and economic crisis. The crisis brought to light that the prior economic boom was built on a real estate and construction boom coupled with a domestic credit and consumption boom, during which international competitiveness had deteriorated badly. The deep recession and bank rescue packages, not fiscal profligacy brought these countries into dire straits. Even a Stability and Growth Pact with more surveillance and harsher fines would not have been able to prevent these developments.
Looking at macroeconomic imbalances, in contrast, would have spotted the problems. The large current account deficits in Spain and Ireland have shown clearly that the private sector was borrowing excessively and that price competitiveness was deteriorating sharply. This is the reason why we proposed roughly a year ago to introduce an “external stability pact” under which the countries in EMU pledge to keep current account imbalances (both surpluses and deficits) to below 3 percent of GDP and will be fined if they do not fulfill their commitment (see this paper published by the German Institute for International and Security Affairs SWP as well as this post at Eurozone Watch).
With its proposal to introduce an “Excessive Imbalance Procedure”, the Commission has chosen a similar approach. A (yet to be defined) “scoreboard” of indicators is supposed to monitor macroeconomic imbalances. While the commission is not specific about the indicators, it seems very likely from the wording that some kind of current account indicator and some kind of indicator for the price competitiveness will be included. It even suggests sanctions for those countries that repeatedly fail to act on Council recommendations to address excessive imbalances with an annual fine equal to 0.1% of GDP.
What is even more interesting is that the Commission seems to suggest a symmetric approach. The proposal reads as if the Commission suggests deviations in both directions (excessive current account surpluses and deficits) should be addresses by the imbalance procedure and can possibly be fined. From an economic point of view, this approach is sound as current account imbalances always are a problem caused both by policies in the deficit and the surplus country. But this proposal will most probably not be greeted with cheers in surplus countries such as Germany. Interestingly, the Commission’s proposal seems somewhat different from the approach discussed in the Van Rompuy task force on economic governance in which the national finance ministers discuss reform proposals. Also recent Ecofin and Eurogroup documents systematically pointed out the need of the deficit countries to adapt policies. The only notable example was a statement by the Eurogroup of March 15, 2010.
The Commission can prepare itself for hefty discussions. Once we had published our “external stability pact” last year, we learnt how sensitive any proposal that could be interpreted as an “attack” on the German growth model is. Many people in the surplus countries still think that the problem of imbalances in the euro area is one of the deficit countries only. Nevertheless, things move even in Germany: under the impression in particular of the Greek debt crisis, the question whether deficit countries alone can correct imbalances has gained new salience. Moreover, the long-term sustainability of the German growth strategy based mainly on export-led growth is also increasingly questioned. A growing number of politicians link quests for measures to fuel domestic demand to this debate. Be their motives European or not – they help to open up the debate in Germany, which, a year ago, was definitely still conducted in a different mind-set.
But still, agreeing to the Commission’s proposal amounts to Germany admitting that there is something wrong with the current economic growth model driven by ever growing current account surpluses. So any European impulse in the German debate that is to come will be useful. In this context, it will be interesting and crucial to see how the European Parliament positions itself as five of the six proposals are regulations decided in co-decision procedure. The EP is hence, again, a key player in reforming Economic Governance, as it recently was in the shaping of the new European Financial Supervision structures.