Reforming EMU: political management must be strengthened

Reforming EMU: political management must be strengthened

Concerned at the weakness of euroland’s economic pillar, John Wyles argues the case for a more ambitious economic policy coordination for countries in the euro zone, with stronger roles for the European Commission and Eurogroup ministers.

Riding in the wake of rather tired superlatives, the historic moment came and went with rather less hoopla than it merited and rather more surprise at its smooth passage than was justified. Few of the speeches or written comment dedicated to the arrival of euro notes and coins really did justice to their historic significance, while across euroland politicians and commentators alike were taken aback by the extent of popular enthusiasm for their arrival.

The virtually problem-free distribution of 14 billion notes and 54 billion coins is an enormous achievement on the part of the European Commission, the European Central Bank and national central banks and governments. An awful lot of hard work and intense collaboration at the technical, official and political levels lay behind the smooth delivery of the first euro notes from ATMs shortly after 2002 was chimed in. The euro is the first genuinely European common experience to be shared simultaneously by millions of people. If, as seems likely, it was a truly happy experience, then the euro has been swiftly transformed from a symbol of common citizenship into rather more of a bond.

But Economic and Monetary Union needs more than symbols and bonds to assure a stable future. It would be disastrous if the Union’s political leadership was to regard the introduction of euro notes and coins as a completion of that journey begun more than 30 years ago when Pierre Werner, the Luxembourg prime minister, produced the first blueprint for a single currency. Happily events are unlikely to permit such complacency. Its introduction now fully accomplished, the euro will serve as a penetrating searchlight, throwing into relief serious weaknesses in the political management of euroland’s economy, as well as the Union’s depressing underachievement in raising its growth potential.

Fiscal governance

Unhappily for those who think any discussion of political process in the Union an obsessive exercise in “navel-gazing”, euroland’s shortcomings have everything to do with the inadequacies of the much vaunted but weak intergovernmental process of open coordination. Formally launched in the late 1990s as the preferred alternative to Member States transferring more sovereignty and competences to the Union, open coordination relies on setting targets, benchmarking, monitoring, peer group pressure and political will. Instead of outcomes determined by the tried and tested Community Method, we pass from one year to the next with fingers crossed.

This is essentially the basis upon which fiscal policy has been managed in euroland since January 1 1999. The European Central Bank, a truly federal institution with federal powers, represents the limits of Member States’ political courage and will at the beginning of the 1990s when the Treaty of Maastricht was negotiated. They were not prepared to make an equivalent transfer of sovereignty over fiscal policy to match the sacrifice of putting the ECB in sole charge of monetary policy.

Monetary policy is made through a coherent process by the ECB’s governing council, even if it lacks sufficient transparency. By contrast, euroland’s fiscal policy is not shaped for euroland but is a random amalgamation of the12 fiscal policies of the Member States loosely coordinated by meetings of their finance ministers in the Eurogroup. The euroland interest is asserted only by the legal requirement on each government to avoid a budget deficit larger than 3 per cent of gross domestic product.

Delivering on promises

The process is cloaked in a thin carapace of coordination built on the Broad Economic Policy Guidelines and the Stability Programmes in which each government projects its deficits over three years. These projections are supposed to be more than forecasts but less than firm promises. As a guidance system this is about as useful as a compass in a space rocket. Discussions in the Eurogroup are supposed to add to some more robust political wrapping to the governments’ anaemic pledges, but they certainly do not provide the basis for a discussion between the Eurogroup and the ECB. They do not meet as equals to ponder the future mix of monetary and fiscal policies when the Central Bank knows that the Ministers cannot be relied upon to deliver their promises because they are under no legal obligation to do so.

There are no rules requiring Member States to honour the commitments made in their Stability Programmes. Germany, France and Italy, the three largest euroland economies, are committed to balancing their budgets 2004-2006 but lack credible strategies for cutting their structural deficits. After only three years, the honour of the Eurogroup is already sadly compromised. In early 2000 for example, Ministers agreed that any windfall budget revenues – that is, higher than expected receipts – should be devoted to deficit reduction. Very shortly afterwards, Laurent Fabius, the French finance minister, shamelessly announced that his surplus revenues would fund tax cuts.

At the time, this seemed to escape the scrutiny of many MEPs and commentators. Much more public attention was given to the brouhaha surrounding Ireland’s breach of its Stability Programme commitments in its draft 2001 budget. Many were surprised to discover that the procedures allowed the Commission and the Council to rebuke a Member State for breaking its word. But when the complaint arrived, the Irish government gravely weakened the credibility of the entire process by simply saying that it would not change tack.

Clearly, if the management of EMU lacks credibility, then so does the euro, as revealed daily by its undervalued rate against the US dollar. Lamenting “the absence of real economic powers at the top of the European economic edifice,” a market operator recently contrasted Europe’s arrangement with those of the US where a “seamless cooperation” established Alan Greenspan, chairman of the Federal Reserve, and Treasury Secretary Paul O’Neill as “the parents of a single economic and monetary policy.” He concluded that “if no real executive powers exist at the highest level, the credibility gap is bound to continue undermining the euro in the months and years to come.”

Politics and misplaced optimism

Can coordination of national economic policies be made so effective that it would be the equivalent to an “executive power”? An answer in the affirmative requires a great leap of faith because of the primacy of domestic politics. Governments are failing to deliver on their commitments for a variety of reasons including weakness in the face of powerful domestic constituencies and unjustified optimism that “things will turn out alright” – an optimism which is too frequently tolerated by the Commission. Since all finance ministers are subject to similar domestic constraints, they can hardly be expected to provide a countervailing force asserting the collective European interest against domestic lobbies whose signatures are written all over national budgetary policies.

Yet strengthened coordination is regarded as the “realistic” political objective for 2002 and beyond. The Commission produced a packet of proposals in February 2001 that have so far borne little fruit. It pointed to the need to improve statistical information as the basis for assessing the economic situation and appraising the policy mix. The Commission’s key proposal was for “a set of rules of conduct” that it would table for adoption by the Eurogroup after d iscussion with the ECB. Publicly, the Commission has been extremely vague about what these rules should be and how they should be applied, claiming only that they would “make the area’s economic policy more predictable and hence more credible.”

The Commission is also searching for more effective coordination instruments. Last year’s document signalled that it would be more active in making suggestions for economic policy and also insisted that before adopting an economic policy measure Member States should inform the Commission and other members of euroland. Its other prescriptions mainly centred on meetings – more of the Eurogroup and a new dialogue between the ECB, the Eurogroup and the Commission.

Such proposals put their faith in the emergence of political dynamics and peer group pressures at the European level sufficient to act as a countervailing force to those national interests that tend to divert budgetary policies from their declared objectives. But since governments and ministers depend on national constituencies for their political power, can the European process ever consistently counterbalance domestic imperatives?

Perhaps only if that process is also linked with the winning and losing of political power. Here, the Convention due to start work in March, and the Intergovernmental Conference scheduled for 2004, present real opportunities to create a new governmental structure for Economic and Monetary Union. Institutional change would need to acknowledge the requirement for a measure of central, executive power over national budget making and the corresponding requirement to make that power directly accountable to European citizens. This is the way to deal with the fundamentally undemocratic nature of present arrangements. National budgetary policies influence partner countries’ economies and shared variables such as interest rates without any possibility of being held to account in those countries.

As Romano Prodi, the Commission President has said, it is likely to be an economic crisis that will trigger change in the governance of euroland – rather than a grass roots demand for more democracy. However, the art of good government is to anticipate problems and not be mastered by them. Now is the time for a grand debate on a crisis avoidance strategy for euroland based on institutional reform. Who will step forward and launch it?

John Wyles is a Senior Policy Adviser to The European Policy Centre

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