Smart Consolidation in Europe

Fiscal rules are hotly debated in Europe these days. The rigid approach to consolidation that currently dominates the discourse has cost Europe dearly, writes Ivan Lesay and calls for smart consolidation. He argues that we do not need new rules, but only a better implementation of the existing rules of the Stability and Growth Pact.

The Stability and Growth Pact (SGP) constitutes the basic framework for fiscal policy in the EU. It came into force in the end of the 1990s to keep the public finances of the member states’ in check to pave the way for the introduction of the common European currency. It did not take long for the two most powerful countries of the Union – Germany and France – to break the pact’s rules, intentionally and repeatedly. Due to their voting power in the EU Council they managed to ignore the recommendations for greater budgetary discipline.

However, the situation has changed dramatically since then. Despite the fact that Germany was able to grow and reach the remarkable success it is enjoying today because it repeatedly violated SGP rules, the German government, out of all possible actors, calls for a strict fiscal policy line. The hawkish discourse of German conservatives on budgetary discipline has become so influential that it is now equated with the very rules of the SGP. And that is precisely what’s wrong.

The Stability and Growth Pact is established by several European legislative texts – two treaty articles and several EU regulations. This legal basis contains several clauses that not only make it possible to distinguish between specific types of expenditures, costs and circumstances when assessing how fiscal targets are met, they literally require it. Specific consideration is required primarily for public investments or structural reforms.

SGP is flexible also in praxis and not only in theory. Based on rigorously defined eligibility criteria, member states were allowed to use the so-called investment clause last year. Slovakia was one of the countries who applied. A similar treatment regards systemic pension reforms. When under assessment of excessive deficit, Lithuania was allowed to “deduct” the costs incurred by introducing a mandatory private pension system.

Any voices in Europe calling for smarter public finance consolidation are not calling for changing or bending the rules. The reverse is true: They call for a proper implementation of the rules. The pact has two objectives in its name – stability and growth. It is not rocket science that blind cuts only dampen economic growth in times of crisis. A simple look around Europe confirms this. Despite the fact that most member states are reducing their general government deficits, their debt to GDP ratio is increasing. The International Monetary Fund has been pointing out this fact for several years now.

Public finance consolidation should not be an end in itself. The biggest and fastest consolidation programme is not equivalent to the best. Some investments and reforms might seem expensive today but improve the balance of public budgets in the long run. Smart consolidation should be based on these kinds of considerations. Both, spirit and letter of the SGP, enable such thinking.

The rigid approach to consolidation that currently dominates the discourse has cost Europe dearly. Economic potential has been lost and unemployment rates have increased. Advocates of blunt austerity have successfully defended it as necessary condition to raise market credibility. Yet if the markets are currently at peace, it is largely due to considerable action by the ECB. And the markets will feel even more comfortable when smart investments and reforms are enacted.

Fiscal rules are hotly debated in Europe these days. The debate on a more flexible use of the SGP has been triggered by several events: the change of the government coalition in Germany, the European Parliament elections, the formation of the new European Commission, and Italy’s presidency of the Council of the European Union.

The Italian PM Matteo Renzi is the most outspoken advocate of the new approach, yet support or reluctance for his initiative cannot be divided along the supposed cleavage line on the map of EU, the thrifty North vs. profligate South. Rather than North-South, the relevant division in this area seems to be Right-Left. The French president François Hollande supports a more flexible use of fiscal rules, so does (at least to some extent) Sigmar Gabriel, the new German Vice Chancellor and party leader of the social democrats.

Opponents of smarter implementation of fiscal rules tend to argue that it will be possible to hide basically anything under the labels “structural reform” or “productive public investment”. Of course, the risk cannot be ruled out but it should not be extremely hard to eliminate it. Even as of today, the European Commission recommends which reform or investment is desirable, for example in its country specific recommendations. It is further self-evident that it must be up to an impartial arbiter (like the European Commission) to decide what to consider when assessing how fiscal policy targets are met, and not up to member states themselves.

At the June summit of European leaders it was concluded that in order to enhance growth it is advisable to make best use of the flexibility that is built into the existing rules of the Stability and Growth Pact. One of the biggest and most pertinent challenges ahead of the new European Commission will thus be to change the practice of the implementation of the current European fiscal rules.

Ivan Lesay works as a European Affairs Advisor to the Slovak Minister of Finance. The positions expressed in this article do not represent the official positions of the Slovak Government.

Fotocredit: Sharon Mollerus CC BY 2.0

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