The EU’s economic governance: Rewriting the rulebook

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The Greek sovereign debt crisis is forcing Europeans to rethink the coordination of their national economic policies, confronting the euro area with its most severe test since its launch eleven years ago.

Background

Greek sovereign debt crisis

In January 2010, Greece was found sitting on debts that are expected to hit 290 billion euro this year. Its budget deficit stood at 12.7% of gross domestic product, more than four times the EU limit. 

The cost of servicing that debt has risen, hitting the euro currency and prompting speculation over a bailout plan (EURACTIV 04/02/10).

The crisis sparked a wave of panic in financial markets which started spreading to other EU countries with sovereign debt problems, mainly Spain and Portugal.

Faced with an unprecedented speculative attack on the euro, EU countries were compelled to act decisively in order to calm jittery financial markets. In May, they agreed to establish a rescue mechanism worth €750 billion to protect the euro from collapsing under the weight of accumulated debt (EURACTIV 10/05/10).

Root causes left unaddressed

However, the short-term fire-fighting measured soon proved insufficient to tackle the root causes of the problem as markets started questioning the loose coordination of national policies that underpin the eurozone’s economic governance.

Indeed, EU institutions currently only have limited powers on economic policy, an area where unanimity decision-making remains the rule. The EU’s main instruments include reviews and non-binding recommendations by the European Commission, such as the stability and convergence programmes and Broad Economic Policy Guidelines, which are submitted for approval by member states in the EU Council of Minister.

For the eurozone, informal discussions are held prior to the monthly "Ecofin" meeting of EU Economics and Finance Ministers. But these "Eurogroup" meetings remain informal and there is no dedicated political decision-making body to steer the eurozone’s economic policy.

Crucially, sanctions launched against countries that break the public debt and deficit limits – so-called excessive deficit procedures – set out in the Stability and Growth Pact have to be approved by the Ecofin. The result is that none of the legal procedures launched by the European Commission have led to financial penalties once they reach the approval stage.

Van Rompuy 'task force'

EU leaders agreed in June to greater surveillance and coordination of national budgets. However, a deal on sanctions for countries breaking EU rules will only be finalised on 16 September when a high-level task force, led by European Council President Herman Van Rompuy, hands over its final report (EURACTIV 18/06/10).

The Van Rompuy task force will look at a mechanism of early warnings and gradual sanctions aimed at deterring errant governments from letting their public debt or deficits slip.

But the composition of the group – which is made up of finance ministers from the 27 EU member states – has led to questions about its impartiality, with some warning that its proposals will inevitably end up being watered down by governments wary of keeping their national sovereignty on economic policy matters.

Lisbon Treaty offers new possibilities

At their March summit, EU leaders appeared to partially overcome these obstacles, stressing that the EU’s new economic governance should make full use of "the new economic coordination instruments offered by the Lisbon Treaty".

The text explicitly mentions Article 136 of the Lisbon Treaty, which states that the EU Council of Ministers – representing the 27 member states – can adopt measures concerning eurozone countries in order "to strengthen the coordination and surveillance of their budgetary discipline" and "to set out economic policy guidelines for them".

Such measures can be adopted by a qualified majority of the "participating member states," meaning in this case the 16 countries that are currently members of the euro (Article 238.3(a)).

Issues

Stricter budget surveillance: A European 'semester'

Under proposals presented by the European Commission in May, EU countries will review each others' draft annual budgets before they are adopted at national level, with an early peer-review system aimed at preventing a repeat of the Greek sovereign debt crisis.

The system – later backed by EU leaders in June – would apply as of 2011 and would introduce closer economic surveillance to the bloc.

The surveillance would be carried out in the first half of the year during a 'European semester,' before EU governments prepare their national budgets and economic reform programmes. Member states will be required to present their draft budgetary plans in April of each year to give the Commission timeto analyse them and possibly suggest "country-specific policy guidance" in early July.

Member states would then finalise their budgets in the second half of the year (see proposed timeline).

"Coordination of fiscal policy has to be conducted in advance, in order to ensure that national budgets are consistent with the European dimension [and] that they don't put at risk the stability of other member states," said Economic and Monetary Affairs Commissioner Olli Rehn.

"In case of obvious inadequacies in the budget plans for the following year, a revision of [national budget] plans could be recommended," the Commission says.

The system would be applied to all countries, but surveillance would be tighter for those which have adopted the euro. For eurozone countries, such a review mechanism should act as an early-warning system for states found to breach the Stability and Growth Pact, which sets a limit on public debt (60% of GDP) and budget deficits (3% of GDP).

The European Commission claims the system will not violate a country's national sovereignty but will provide an opportunity to check the assumptions on which draft budgets are based, such as economic growth, inflation and interest rates.

Commission President José Manuel Barroso said the system will give national parliaments the chance to better scrutinise their country's budget. "What we are doing is giving parliaments more information and therefore more power," he said.

Debt, not just deficits, in the spotlight

The Stability and Growth Pact limits public deficits to 3% of GDP and national debt to a maximum of 60% of GDP, or close to that value. But while public deficits tend to attract most attention, the debt limit has regularly been overlooked, as the Greek crisis showed.

Member states which surpass the 3% deficit limit in a specific year are subject to official rebukes from the European Commission, which can in theory be followed by financial sanctions. But although the threat of fines influenced markets as well as national governments, they were never actually applied because they required the approval of member states voting in the EU Council of Ministers.

In addition, the procedures only concerned deficits and no such measures were foreseen for countries which break the debt limit, a shortcoming that the Commission now wishes to address. "Excessive debt needs to be addressed more seriously than in the past," stressed Commissioner Rehn.

Under the proposal, countries which do not appear to be on a positive path to rebalance their public finances will now also face sanctions (EURACTIV 18/06/10).

The EU executive is proposing to establish benchmarks to assess debt trends. "Countries with a public debt beyond 60% of GDP could become subject to procedures if decline in debt falls short of this benchmark," Rehn said.

Other factors will also be taken into consideration to assess the soundness of national finances. "It is important that, as we reinforce the role of debt in the excessive deficit procedure, we have to have an intelligent way to do it," said Rehn, adding that the Commission will look into private debt, sustainability of pension systems, government assets and other elements in its overall considerations for specific countries.

In any case, Rehn made clear that "in the end it is public debt which will be taken into account to define sanctions" rather than other factors.

Sanctions: Interest-bearing deposits and EU funding cuts

To give teeth to the surveillance system, the European Commission is proposing a detailed system of sanctions for member states which do not respect the budgetary discipline set out in the Stability and Growth Pact.

First, it proposed reinforcing the preventive arm of the Pact for the euro area by including the possibility of "imposing interest-bearing deposits" in case member states make insufficient progress in consolidating their public finances in good economic times. The deposit would be released once the issue has been addressed after approval from the EU Council of Ministers.

As for incentives, countries which accumulate large surpluses during periods of economic prosperity would be allowed to spend more during downturns without being subjected to an excessive deficit procedure.

On the sanctions side, the Commission had initially threatened to cut EU subsidies for budget offenders, but referred exclusively to regional funding, which primarily benefits the poorer countries of Central and Eastern Europe.

In the updated proposal, cuts are also foreseen for funds targeted at agriculture and fisheries, of which France, Spain, Germany and the UK are among the greatest beneficiaries. In total, this represents more than three quarters of the EU's total budget for the period 2007-2013.

Commenting on the far-reaching implications of such a proposal, Rehn said the suspension of farm subsidies "would concern only transfers from the EU budget to the government concerned. The government would still be obliged to respect its commitment to the farmers. It would not hit the final beneficiaries," Rehn underlined.

Member states will, however, have time to correct their imbalances before the Commission goes ahead with cuts.

Treaty change

However, tougher sanctions cannot be imposed without changing the EU treaties, a tiresome process that requires risky referendums in countries like Ireland. Calls for treaty change have been spearheaded by Germany, which argued in favour of expelling eurozone members as a last resort if they repeatedly broke the Stability and Growth Pact (EURACTIV 18/03/10).

France has taken a more pragmatic stance, arguing that treaty changes would take too long to come into effect and that decisions on sanctions needed to be taken quickly based on the current treaties in order to reassure the markets. Paris's position is that there should be a wider set of sanctions, which would apply automatically and be gradually scaled up.

The two sides eventually put their heads together and Paris and Berlin came out with a joint proposal for economic governance in July (EURACTIV 22/07/10).

"The key issue is to make major progress in developing both the preventive and the corrective arms of the Stability and Growth Pact," explained French Economy Minister Christine Lagarde and her German counterpart Wolfgang Schäuble in a joint contribution to the Van Rompuy task force on economic governance.

In a concession to France, the joint statement argues in favour of "leveraging all options offered under the existing treaties" in order to "move swiftly and operationally" on reforming the governance of the euro zone. Yet, it also meets German demands by supporting "a political accord" that would enable euro-area member states to suspend the voting rights of serial budget offenders in the EU Council of Ministers.

Lagarde and Schäuble said the new sanctions could be put in place using the Lisbon Treaty's "enhanced cooperation" mechanism, whereby nine or more EU member states can choose to move forward in a specific area, leaving other EU countries the option of joining later. "If we need additional rules for the sixteen [eurozone countries], the other countries will not prevent us," Schäuble said.

The statement represents a U-turn for Germany, which has until now insisted that the same set of rules should apply across the 27 EU member states. Indeed, Schäuble again warned against creating a "schism" between eurozone countries and other EU states.

Conscious that such sanctions would require changes to the EU treaties, the joint declaration says "the legal basis for imposing such penalties must be studied in depth".

"This mechanism would have to be included in any revision of the treaty that may in future be agreed to," the statement adds, leaving open the possibility that the changes may be inserted into the accession treaty of a new EU member state, such as Croatia.

Competitiveness 'scoreboard'

The Commission also plans to "deepen and broaden" budgetary surveillance to macro-economic policies, warning that "macro-economic imbalances can have serious consequences over time".

A "competitiveness scoreboard" would review macro-economic indicators such as productivity, unit labour costs, employment, public debt and private sector credit in order to detect asset price booms and excessive credit growth at an early stage.

For all EU member states, these macro-economic imbalances would be addressed under the draft 'Europe 2020' strategy for growth and jobs. For countries which have adopted the euro, the peer review currently carried out by the Eurogroup would be upgraded into more structured surveillance by making use of Article 136 of the EU treaty.

At their June summit, EU leaders gave "orientations" for developing a scoreboard to better monitor competitiveness developments and allow for early detection of unsustainable or dangerous trends.

Focusing not only on budgets but also on competitiveness would make it possible for the EU to have more convergence of economic policies inside the euro zone, argued Herman Van Rompuy, president of the European Council and chairman of the task force on reforming the EU's economic governance.

"We need indicators, we need a monitoring system, we even need a system of warnings and recommendations with possible sanctions if countries don't comply with what is needed for keeping their competitiveness," Van Rompuy told the audience at the 2010 European Business Summit.

EU audit powers on national budget statistics

In March 2010, the European Commission drew up plans to beef up the oversight powers of the bloc's Luxembourg-based statistics body, Eurostat, to ensure that countries report the true size of their deficits.

Under plans approved in June, Eurostat saw its role elevated to an EU statistics agency with enquiry powers to check whether countries are respecting the Stability and Growth Pact (EURACTIV 08/06/10).

Greece was found to have grossly lied about its macro-economic statistics for years, pretending that its budget deficits were lower than they really were and submitting false reports to Eurostat.

In its new role, Eurostat will be able to demand more information about countries' national accounts, including sending frequent missions to countries suspected of submitting false budget reports.

"Previously we could just carry out a technical visit to assess the accounting methodologies and there were limited number of questions we could ask," said a spokesperson for the EU executive. "Though we will not have full audit power, more like semi-audit power, we can send frequent technical missions to assess countries when there are suspicions of deviations," the spokesperson added.

Positions

Presenting the EU executive's proposals on economic governance in May, European Commission President José Manuel Barroso said the recent turmoil on European markets had highlighted the need for closer European cooperation. "It's now clear that we are more interdependent than ever before. Financial difficulties in one euro-area member state have spill-over effects in the others."

"Let's be clear," Barroso said. "You can't have a monetary union without having an economic union. Member states should have the courage to say whether they want an economic union or not. And if they don't, it's better to forget monetary union all together."

Paris and Berlin welcomed the Commission's proposals, with German Chancellor Angela Merkel saying they went in the right direction and that it was not a bad thing that the Commission wanted to have an early look at national budget plans. But she said changes to the EU treaty were still needed to enforce the bloc's budget discipline rules more strictly.

French government spokesman Luc Chatel said Paris backed better fiscal and budgetary co-ordination, but added: "It's parliament that votes on the nation's budgets. It's not the European Commission that votes on the budget of the French nation."

In a joint letter on 6 May, French President Nicolas Sarkozy and German Chancellor Angela Merkel recommended stricter monitoring of eurozone member states' debt and extending surveillance "to structural issues and competitiveness," and not only excessive deficits as is the case today (EURACTIV 07/05/10). 

They also suggest "strengthening the effectiveness of EU recommendations on economic policy".

Moreover, Merkel has expressed support for more radical reforms, like creating a European Monetary Fund or imposing sanctions on eurozone member states that repeatedly break the bloc's economic guidelines, suggesting for example that their voting rights in the EU Council of Ministers could be suspended (EURACTIV 18/03/10). 

However, that would require changing the EU treaties, and France prefers more straightforward reforms, like amending the Stability and Growth Pact.

Speaking at the European Business Summit in June, European Council President Herman Van Rompuy stressed that the task force was trying to define a system of "smart sanctions" against countries in breach of the debt and deficit limits, saying his team was aiming to strengthen the Stability and Growth Pact in a preventive phase.

The task force is not looking for "a nuclear bomb" with one big sanction, Van Rompuy explained, but is instead looking at imposing "more automatic" sanctions in a gradual way, "without too much interference from political bodies".

He explained that the philosophy of the new system was "totally new," as the measures were not based on budgetary surveys but on surveillance at macro-economic level, especially in the field of competitiveness.

"We need indicators, we need a monitoring system, we even need a system of warnings and recommendations with possible sanctions if countries don't comply with what is needed to maintain their competitiveness," Van Rompuy said, mentioning reforms in the labour market, pensions and the product and services market. "It is not only wage restraints. We need more flexibility, we need longer working time for most countries."

That, he added, will make economic convergence possible inside the euro zone and in the EU as a whole.

Olli Rehn, the EU's commissioner for economic and financial affairs, wants "quasi-automatic" sanctions for eurozone countries that violate deficit rules. "If a country violates the Stability and Growth Pact, the sanctions will in future start automatically, unless a majority of EU finance ministers explicitly vote against it." 

Rehn wants to table concrete proposals in the autumn, after the Ecofin has approved stricter sanctions in principle.

Eastern European countries have expressed concern about the practicalities of imposing sanctions on budget offenders. Countries like Poland, which is one of the greatest beneficiaries of EU regional funds, are worried that new sanctions will disproportionately affect their economy. "Why stop cohesion and not agriculture? There should be equal treatment," an Eastern diplomat said.

"Imposing stronger penalties is fraught with difficulties as countries are already in trouble and taking money would only exacerbate these problems," another added (EURACTIV 17/06/10).

At an EU summit in June, the UK won assurances that its sovereignty would be unaffected by changes to the EU's economic rulebook. "This meeting has ensured that UK opt-outs are safeguarded," said UK Prime Minister David Cameron. The bottom line for the UK is that "the euro zone needs to sort out its problems," he added.

Cameron also stressed that the UK would always present its budget to Westminster before Brussels, in response to proposals from the European Commission to have national budgets pre-examined at EU level.

Drawing a line in the sand, French President Nicolas Sarkozy agreed that national sovereignty needs to be respected. The European Commission, he said, should not substitute member states in deciding on growth policies such as research or education.

"I am sorry, it is not Mr Barroso who is in charge of the competitiveness of the different member states of the European Community. It is not the Commission that can take decisions instead of member states on economic policies that each one of us has to take," he said.

German Finance Minister Wolfgang Schäuble said meaningful eurozone reforms would require treaty change. In an interview with French daily Les Echos, he said: "The question is in what way can we make the Stability and Growth Pact more effective within the framework of the existing Treaties. But it is clear that we must also come out with other proposals and accept some Treaty changes, if necessary. There is, among our partners, a bit of scepticism with regard to possible Treaty changes. Many people say it is a long-term process."

"However, if we consider that we cannot limit ourselves to imposing financial sanctions, and that we must also take into account non-financial instruments - such as the temporary withdrawal of voting rights - in order to make member states respect the pact, then Treaty changes are necessary," he continued.

French Economy Minister Christine Lagarde and her German counterpart Wolfgang Schäuble presented their joint contribution to the Van Rompuy task force on economic governance in July (EURACTIV 22/07/10). The two ministers said they were considering launching "enhanced cooperation" on economic governance between the 16 countries that share the euro currency, leaving other EU countries to join if they wished.

The statement represents a U-turn for Germany, which has until now insisted that the same set of rules should apply across the 27 EU member states.

The European Central Bank (ECB) has also supported changes to the EU treaties in order to strengthen the European Commission's hand in punishing countries for falling out of line with the bloc's debt targets. Under the plan, an EU country would have to prove to its neighbours that it does not deserve to be punished for exceeding the EU's debt targets.

In other words, punitive measures, like cutting off deviant countries' access to EU funding, would be thrown to the wind if a country were able to get a majority of member states to agree that the punishment is too harsh. "If there is no Qualified Majority Vote (QMV) against it, then the proposal for sanctions would stand," an EU source explained (EURACTIV 06/07/10).

In the European Parliament, French MEP Alain Lamassoure (European People's Party), chairman of the assembly's budget committee, warned that "the coordination of economic policy in Europe cannot be entrusted only to ministers debating and deciding behind closed doors in Brussels".

"How could elected representatives in a member state agree to have their hands tied by decisions taken previously in Brussels and in secret?" Lamassoure asked. 

To make the procedure more transparent and democratic, Lamassoure recommends involving national parliaments "as of day one" by inviting elected representatives to debate national budgetary orientations on the same day across the EU and in Brussels. Such a procedure would force parliamentarians to work on the same economic assumptions regarding growth, inflation, interest rates and the price of oil, the MEP said.

It would also force everyone to face up to their responsibilities by setting national priorities against EU budget discipline rules, "in broad daylight and in the face of national public opinion via the national media," he said. 

Reacting to the Commission's proposal, the Party of European Socialists (PES) warned about a "shift towards austerity" that would compromise economic recovery. The European Commission "runs the risk of infecting the EU recovery with the virus of punishment," said PES President Poul Nyrup Rasmussen, adding that there is "an over-emphasis on fiscal consolidation in the national member-state programmes".

"Punishment and sanctions just bring division and mutual recrimination," Rasmussen warned. The PES also criticises the Commission proposal for failing to mention the need for new sources of taxation to fuel the EU budget, reiterating its plea for a global financial transactions tax to fight speculation (EURACTIV 14/04/10).

The PES also backs finding other new funding sources for the EU budget, such as the issuing of common Eurobonds or taxing carbon dioxide emissions.

The Alliance of Liberals and Democrats group in the European Parliament (ALDE) questioned member states' determination to offer a collective response to the crisis. "The big question is whether member states will have learnt their lessons," said ALDE group leader Guy Verhofstadt, warning against national tendencies to act in isolation.

ALDE suggested three steps to achieve greater financial stability and coherence in the euro zone and the EU as a whole. "First is the need for a permanent mechanism to entrench financial stability, along the lines of a European Monetary Fund that provides the solidarity but also the discipline where the old Stability and Growth pact was lacking."

"Second is the clear need to provide the Union with a genuine economic pillar that complements the monetary one, as 27 national fiscal policies are not conducive to a stable currency or a sustainable economy. Third, the European Single Market needs to be relaunched and completed along the lines recommended by Mario Monti, taking account of the present context of closer economic interdependence, the challenges of globalisation and the rapidly evolving digital agenda."

In March 2010, the leaders of the three largest political groups in the European Parliament joined forces to call for stronger economic governance in the EU.  In a rare show of cross-party unity, MEPs issued a joint statement urging EU leaders to embrace the need for "incentives and sanctions" in implementing the new economic strategy, dubbed 'Europe 2020'.

Joseph Daul, leader of the European People's Party (EPP), Martin Schulz, leader of the Socialists and Democrats (S&D), and liberal leader Guy Verhofstadt (ALDE) called on EU leaders to abandon the open method of coordination, which uses peer pressure to ensure governments hit their targets, "in favour of stronger instruments".

They say the European Commission should use "all the relevant legal bases in the new Treaty to improve economic coordination and oversee the implementation of national action plans," including the use of incentives and sanctions where appropriate (EURACTIV 12/03/10).

Timeline

  • 1 Jan. 2009: Euro celebrates its tenth anniversary (EURACTIV 05/01/09).
  • Jan. 2010: Greek sovereign debt crisis erupts. The country's deficits are twice bigger than initially reported, leading to a fall in the sovereign debt rating and speculative attacks on the euro.
  • 11 Feb. 2010: Extraordinary European summit. EU leaders seek to prop up Greece with words of support but fail to offer concrete detail of a bailout plan (EURACTIV 11/02/10).
  • 16 Feb. 2010: EU finance ministers meeting. Greece given timetable to solve its debt problem (EURACTIV 17/02/10).
  • 3 March 2010: Greece unveils draconian 4.8 billion euro austerity programme (EURACTIV 04/03/10).
  • 15 March 2010: EU finance ministers agree to provide aid for Greece in principle but offer little detail. Germany refuses bailout, invoking the EU treaties (EURACTIV 16/03/10).
  • 16 March 2010: EU finance ministers support greater European involvement in monitoring national economic policies, agreeing that more "candid" policy recommendations should be made to member states on issues such as employment, education or the fight against poverty (EURACTIV 18/03/10).
  • 17 March 2010: A taboo is broken. German Chancellor Angela Merkel says countries that fail to respect the EU's budget discipline should be allowed to be expelled from the euro zone (EURACTIV 18/03/10).
  • 25 March 2010: Summit of eurozone leaders. Heads of state hammer out Greece rescue mechanism but do not give a precise figure. The mechanism can only be triggered by unanimity, giving Germany a virtual veto power. Markets are unimpressed (EURACTIV 26/03/10).
  • 26 March 2010: European summit agrees closer economic governance in the EU (EURACTIV 29/03/10). To flesh out their ideas, leaders launch task force to reform both the EU and the euro zone's economic governance. The task force, chaired by European Council President Herman Van Rompuy, is made up of the finance ministers from the 27 EU member states.
  • 11 April 2010: Pressed by further turmoil on financial markets, eurozone finance ministers approve 30-billion-euro emergency aid mechanism for Greece (EURACTIV 12/04/10). Market volatility extends to whole euro area.
  • 9 May 2010: EU finance ministers hammer out rescue mechanism worth €750 billion to protect the euro from collapsing under the weight of accumulated debt (EURACTIV 10/05/10). Market volatility gradually eases.
  • 12 May 2010: European Commission unveils communication to reinforce economic governance in the EU. Main proposal consists of a European "semester" of budgetary surveillance and tougher sanctions for countries breaking budget deficit and debt limits (EURACTIV 12/05/10).
  • 17-18 June 2010: European summit in Brussels. EU leaders broadly endorse Commission proposals on economic governance. Britain secures opt-out from any new obligations arising from the scheme (EURACTIV 18/06/10).
  • 30 June 2010: European Commission tables updated proposals for economic governance (EURACTIV 01/07/10).
  • 21 July 2010: France and Germany present joint plans for EU economic governance, saying they backed separate rules for the euro zone, including the "neutralisation" of their EU voting rights (EURACTIV 22/07/10).
  • 6 Sept. 2010: Eurogroup meeting and meeting of Van Rompuy task force on economic governnance.
  • 7 Sept. 2010: Ecofin meeting in Brussels.
  • 16 Sept. 2010: Special EU summit to debate Van Rompuy report and flesh out decisions on economic governance.
  • 29 Sept. 2010: Commission to table proposals for sanctioning budget offenders under revised Stability and Growth Pact.
  • 30 Sept.-1 Oct. 2010: Informal Ecofin meeting and meeting of Van Rompuy task force.
  • 28-29 Oct. 2010: EU Summit due to adopt final plans to overhaul the bloc's economic governance.
  • Jan. 2011: Start of first European semester of budget surveillance.

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