Economic Governance in the European Union - Fiscal ...

Economic Governance in the European Union - Fiscal Policy Discipline Versus Flexibility FABIAN AMTENBRINK and JAKOB DE HAAN*

PLEASE CITE AS: F. Amtenbrink and J. de Haan, ‘Economic Governance in the European Union - Fiscal Policy Discipline Versus Flexibility’, Common Market Law Review 40: 1057-1106, 2003.

1. Introduction Michael Artis recently argued that the Stability and Growth Pact “must rank as one of the most remarkable pieces of policy co-ordination in world history”.1 Yet, such hymn of praise may be overhasty. The accumulation of budget deficits in France, Germany and Portugal has raised doubts about the ability of the current co-ordination rules in place to ensure budget discipline. Following Begg, Hodson and Maher, policy co-ordination can be defined as supranational rules or norms which are agreed by all Member States, which leave primary responsibility for the policy area with national authorities, but set limits on their discretion.2 The EC Treaty mentions various forms of economic policy coordination: the broad economic policy guidelines, multilateral surveillance and the excessive deficit procedure. Broad economic policy guidelines comprise general policy aims for the European Union (EU) as a whole as well as specific recommendations for individual Member States. They are both broad and comprehensive, covering macroeconomic policy, a range of (supply-side) policies, and sustainable development. The Stability and Growth Pact provides the details for multilateral surveillance and the excessive deficit procedure. It consists of two Council Regulations on the strengthening of the surveillance and co-ordination of budgetary positions3 and on speeding up and clarifying the implementation

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Dr. Amtenbrink is Professor of European Union Law at the Erasmus School of Law, Erasmus University Rotterdam. Dr. De Haan is Professor of Political Economy at the Faculty of Economics, University of Groningen. 1 Artis, ”The Stability and Growth Pact: Fiscal Policy in the EMU”, in Breuss, Fink, Griller (eds.), Institutional, Legal and Economic Aspects of the EMU (Springer, 2002), p.115. 2 Begg, Hodson and Maher, “Economic Policy Coordination in the European Union”, National Institute Economic Review, No. 183, (January 2003), p. 66. 3 Council Regulation No. 1466/97, O.J. 1997, L209/1, hereafter referred to as Council Regulation 1466/97.

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Amtenbrink and De Haan: Economic Governance in the European Union

of the excessive deficit procedure4, tied together by a corresponding European Council Resolution.5 Regulation 1466/97 sets out to strengthen multilateral surveillance and gives Member States a goal of a medium term budgetary position of close to balance or in surplus. Regulation 1467/97 clarifies and accelerates the excessive deficit procedure so that within 10 months no-interest bearing deposits and ultimately fines can be imposed in case that no effective actions are taken by the Member State concerned. The multilateral surveillance and excessive deficit procedure employ distinct modes of co-ordination. Whereas the latter can be described as a form of closed co-ordination, the former can be regarded as an application of the so-called open method of co-ordination. The open method relies on self-commitment by the Member States, peer review and benchmarking, placing emphasis on policy learning and consensus building, while the closed method tends to have topdown policy formulation and provides for binding rules and severe sanctions. Also in terms of the distinction between hard and soft law, where hard law lies at one end of a continuum and soft law at the other, the multilateral surveillance and the excessive deficit procedures are different, the latter being harder than the former.6 Following Abbott and Snidal, hard law refers to legally binding obligations that are precise and that delegate authority for interpreting and implementing the law, whereas the realm of soft law begins once legal arrangements are weakened along one or more of the dimensions of obligation, precision, and delegation.7 The fiscal rules currently in place were instituted in a specific historic situation. At the time, there was an urgent need for reversing the trend of rapidly accumulating government debt and to quickly establish credibility for the new currency in its initial phase. Some proponents of changing the current rules argue that now the monetary union has been shown to work, it might be possible to refine the fiscal rules. In their view, a key issue is the need to

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Council Regulation No. 1467/97, O.J. 1997, L 209/6, hereafter referred to as Council Regulation 1467/97. 5 Resolution of the European Council on the Stability and Growth Pact, Amsterdam, 17 June 1997, O.J. 1997, C 236/1. For an overview of the working of the Stability and Growth Pact cf. Amtenbrink, de Haan and Sleijpen, “Stability and Growth Pact: Placebo or Panacea?”, EBL Rev. (1997), 202-210 and 233-238; Hahn, “Der Stabilitätspakt für die Europäische Währungsunion”, JZ (1997), 1133-1141; the same in “The Stability Pact for European Monetary Union: Compliance with Deficit Limit as a Constant Legal Duty”, 35 CML Rev. (1998), 77-100; Maillet, “Le Pact de Stabilité de Croissance: Porteé et Limites du Compromis de Dublin?", Revue du Marché Commun et de L’Union Européenne, no. 404, janvier 1997, 5-12. 6 Along similar lines Hodson and Maher, “Hard, Soft and Open Methods of Policy Co-ordination and the Reform of the Stability and Growth Pact”, Paper prepared for the Conference Building EU Economic Government: Revising the Rules?, organised by NYU in London and UACES, London, 25/26 April, 2003. 7 Abbott and Snidal, “Hard and Soft Law in International Governance” 54(3) International Organization (2000): 421-456; cf. also section 2.

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combine long-run sustainability of fiscal policy with short-run fiscal flexibility as a tool for macroeconomic stabilization. The current EU rules mainly reflect a desire to enhance fiscal discipline. This has led to a criticism that the EU fiscal rules are too rigid and hamper the use of fiscal policy for stabilization purposes in an inappropriate way. Recent proposals by the Commission, that have been largely accepted by the Council in its meeting of 7 March 20038, seek to make the EU fiscal rules more flexible through changes in the interpretation of the Stability and Growth Pact and a greater reliance on discretionary judgments. Others have argued in favour of a more radical adjustment to make the rules in place more flexible, or even to abandon them. Opponents of this view maintain that the credibility of the fiscal policy framework must not be undermined by the impression that the rules are changed in a discretionary way as soon as they begin to bite, especially for the large EU countries. In this view, especially the soft legal rules in place may not be stringent enough to guarantee fiscal discipline and should be changed accordingly. The recent experience with the Stability and Growth Pact is often regarded as evidence in support of this view. This contribution examines fiscal policy co-ordination in the Economic and Monetary Union (EMU) and discusses whether the recently proposed amendments of the Stability and Growth Pact, some of which have since been implemented, will enhance budget discipline. In doing so, it provides a detailed analysis of the legal provisions on multilateral surveillance and the excessive deficit procedure based on the concepts of open and closed method of coordination. Arguably, it is the mixing of these two distinct concepts which stands at the heart of the current controversies. This has to be taken into account when assessing the recent proposals to introduce greater flexibility. Indeed, rather than introducing more flexibility, the analysis of the current system presented hereafter suggests that those elements of economic coordination which prevent the existing rules from being implemented properly should be amended, thereby to some extent depoliticising economic coordination. The contribution begins with a discussion of the fiscal policy rules currently in place, followed by a political-economy analysis of these rules. Thereafter the reform proposals of the Commission, as well as other proposals for institutional reforms, including those foreseen in the Draft Treaty establishing a Constitution for Europe, are examined. It is concluded that the envisaged reform of the pact does little to redress the failure of some Member States to consolidate their public finances in times of economic prosperity.

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ECOFIN, Press release, 6877/03, 15-16. See section 4 for further details.

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2. The open and closed method of economic co-ordination With the introduction of the provisions on EMU into the EC Treaty, a complex system of rules governing the co-ordination of the economic policies of the Member States participating in the euro area and those Member States with a derogation which have yet to join the euro area has been created. This complexity does not only result from the density of the envisaged procedure itself, but also from the method of governance which underlies economic coordination in EMU. The Delors Report, which formed the blue print for the provisions in force today, referred to economic co-ordination in order to limit policy divergence between Member States and the design of an overall economic policy framework, rather than a single European economic policy.9 A Communitywide fiscal policy stance was envisaged to be reached through the coordination of national budgetary policies. At the same time, it emphasized the need for binding rules imposing effective upper limits on budget deficits of individual Member States.10 Interestingly, the Werner Report, which two decades earlier advocated the creation of an EMU by 1980, had envisaged more centralization, emphasizing the need for the harmonization of economic policy instruments and formulation of economic policy at the Community level.11 EMU essentially rests on an asymmetric two-pillar structure, splitting competences between the Community and the Member States.12 The competence for the execution and, to a considerable extent, also for the formulation of economic policy has been left with the Member States. Arguably, at the time of the drafting of the provisions on EMU this not only reflected the diversity between the Member States’ economic structures and economic developments and the different believes of what economic policy can and cannot achieve, but also the political conviction of the Member States at large that fiscal policy should essentially remain a national competence. It is in those policy fields in which a further transfer of competences from the Member States to the Community and the application of the more traditional Community method is rejected that the open method of co-ordination has

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Committee for the Study of Economic and Monetary Union, Report on Economic and Monetary Union in the European Community (Office for Official Publications of the European Communities: 1989), at 21. 10 Committee for the Study of Economic and Monetary Union, supra, at 17. 11 Report to the Council and the Commission on the Realisation by Stages of Economic and Monetary Union in the Community of 8 Oct. 1970, O.J. 1970, C136/1. 12 For Werner, “Le Lien Entre Les Conférences intergouvernementales Sur L’Union Économique Et Monétaire Et Sur L’Union Politique”, in Monar, Ungerer and Wessels, The Maastricht Treaty on European Union (European Interuniversity Press: 1993), 163-172, this is one of the main features differentiating EMU from other areas of Community policy.

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offered a political alternative.13 The open method of co-ordination does not stand for a single mode of governance. Indeed, the open method of coordination can include different features and different approaches in different Community and EU policy areas.14 Rather, it describes a dynamic policy process in which a wide range of elements can be identified, such as the recognition of diversity, the broad participation in policy making, the coordination of multi-level government, use of information, benchmarking, peer review and peer pressure, the lack of any particular rule or single policy objective, as well as structured but unsanctioned guidance by the Commission and the Council.15 Being applied in policy areas with limited or no Community competences, the open method of co-ordination is also characterized by the utilization of so-called soft law or, as Senden and Prechal describe it, “general rules of conduct laid down in instruments which have not been awarded legal force as such, but which nevertheless have certain legal effects and which are directed at and may produce practical effects”.16 Unlike employment policy, with which the open method of co-ordination is often associated17, economic co-ordination in EMU also provides for legally binding rules and the possibility of retribution in case of breach of these rules through the introduction of strict budgetary limits and the threat of severe sanctions. As these elements stand somewhat diametrical to the open method of co-ordination they can be summarised under the term closed method of coordination. 2.1. The open method of co-ordination of Member State’s economic policies A closer analysis of the provisions on economic co-ordination shows that in particular the broad economic policy guidelines and the multilateral surveillance procedure are based on open co-ordination. This does not become evident so much from the aims of economic co-ordination as formulated in the

13 Hodson and Maher, “The Open Method as a new mode of governance: The case of soft economic policy co-ordination”, in Wallace (ed.), The Changing Politics of the European Union, JCMS 2001, 719 – 746, at 740. 14 Radaelli, The Open Method of Co-ordination: A new governance architecture for the European Union (Swedish Institute for European Studies, 2003). 15 Trubek and Mosher, “New Governance, EU Employment Policy, and the European Social Model”, Jean Monnet Working Paper No.6/01, with further references; Commission, White Paper on European Governance, Brussels, 25 July 2001, (COM 2001) 428 final, at 21; Hodson and Maher, op. cit., supra, at 8. 16 Senden and Prechal, “Differentiation in and through Community soft law”, in De Witte, Hanf, Vos (eds.), The many Faces of Differentiation in EU Law, (Intersentia, 2001), 181-199, at 185. 17 Title VIII, Art. 125 – 130 EC (ex Title VIa, Art. 109n – 109s EC); cf. e.g. Kenner, “The EC Employment Title and the ‘Third Way’: Making Soft Law Work?”, International Journal of Comparative Labour Law and Industrial Relations, Vol. 15/1 (1999), 33 – 60.

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EC Treaty, but rather from the instruments applied in achieving these aims. In principle, Art. 98 EC obliges all Member States of the EU, including those with a derogation, to conduct their economic policy with a view to the achievement of the objectives of the Community as defined in Art. 2 EC.18 Sound public finance and the avoidance of excessive government deficits are supposed to form a guiding principle for the activities of the Member States.19 The latter are moreover supposed to consider their economic policies as a matter of common concern and to co-ordinate them with the Council.20 In order to achieve these aims a system of governance has been installed which relies heavily on non-binding guidelines issued to the Member States and the multilateral surveillance of the Member States’ economies without any effective mechanisms to enforce the consolidation of a Member State’s economic policy believed to be heading for an excessive deficit. According to Art. 99(2) paragraph 2 EC, the Council adopts broad guidelines not only for the economic policies of the Member States but also for the Community itself. The fact that the Council decides on the basis of conclusions by the European Council underlines the almost intergovernmental character of this procedure and the dominant role played by the Member States.21 Tellingly, the European Parliament is only informed of the result, i.e. the adopted guidelines.22 The establishment of these guidelines is compulsory.23 Yet, the same cannot be concluded from the EC Treaty for the observance of their contents by the Member States. By stating that the Member States shall conduct their economic policies in the context of the broad economic guidelines, Art. 98 EC seems to suggest that these guidelines are legally binding. However, as will become clear hereafter, these guidelines do not amount to enforce-

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These aims include inter alia the promotion of a harmonious, balanced and sustainable development of economic activities, sustainable and non-inflationary growth and a high degree of convergence of economic performance throughout the Community. 19 Art. 98 and Art. 4 EC, Art. 104(1) EC. 20 Art. 99(1) EC. 21 Louis, "Le Lien Entre Les Conférences Intergouvernementales Sur L’Union Économique Et Monétaire Et Sur L’Union Politique", in Monar, Ungerer and Wessels (eds.), The Maastricht Treaty on European Union (European University Press : 1993), 163 – 172, at 171, describes the role of the European Council as being vague. 22 Art. 99(2) para. 3 EC. In general with regard to the role of the European Parliament cf. Lord, “The European Parliament in the Economic Governance of the European Union”, JCMS 2003, 249 – 267. 23 Cf. e.g. Council Recommendation of 21 June 2002 on the Broad Guidelines of the Economic Policies of the Member States and the Community, Press Release Nr: 10093/02. The recommendations for the years 1993 to 2001 have been published in O.J. 1994 L 7/9; O.J. 1994 L200/38; O.J. 1995 L 191/24; O.J. 1996 L 179/46; O.J. 1997 L 209/12; O.J. 1998 L 200/34; O.J. 1999 L 217/34; (COM /2000/0214final); O.J. 2001 L179/1. The guidelines are both general and country specific economic policy recommendations.

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able obligations, but rather to political commitments by the Member States represented in the Council. The basis for the assessment of the economic situation in each Member State forms information provided by the Member States themselves, as Art. 99(3) paragraph 2 EC in broad terms obliges the Member States to forward to the Commission information concerning important measures in the field of their economic policies and, moreover, “such other information as they deem necessary”. In Council Regulation 1466/97 this obligation to provide information has been formalized and been given a more specific contents. Member States of the euro area have to present so-called stability programmes, which have to be updated annually.24 In accordance with said Regulation these stability programmes have to be based on the plans for future national measures in the field of economic policy and thus on ex ante reporting.25 In addition to the preceding and current year, the data provided has to cover at least the following three years.26 This obligation extents to Member States with a derogation have to forward so-called convergence programmes which roughly have to include the same information.27 Member States have to make these information public.28 Despite the introduction of some common rules on accounts29 and, moreover, on the content and format of the stability and convergence programmes30, this does not prevent Member States in the first place

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Art. 3(1) Council Regulation 1466/97. In contrast, Art. 99(3) paragraph 2 EC refers to information on “important measures taken”. 26 With regard to the required contents cf. Art. 3(2) (a), (3) Council Regulation 1466/97. Art. 7 Council Regulation 1466/97 includes the same requirement for the convergence programmes. Unless stated otherwise, reference to the stability programmes is also to be understood as a reference to the convergence programmes. 27 Art. 122 EC, Art. 7 et seq. Council Regulation 1466/97. In the case of Denmark, according to the Protocol on certain provisions relating to Denmark, all articles and provisions of the EC Treaty and the Statute of the ESCB and ECB referring to a derogation apply. In the case of the UK, the applicable Protocol explicitly lists the applicable provisions, including Art. 116(4) EC, according to which in the second stage of EMU, Member States shall endeavour to avoid excessive government deficits. Both of these Member States forward yearly updated convergence programmes. 28 Art. 3(2) and (3), Art. 4(2) (a) Council Regulation 1466/97. Cf. also Council Regulation (EC) No. 3605/93 of 22 November 1993 on the application of the Protocol on the excessive deficit procedure annexed to the Treaty establishing the European Community, O.J. 1993 L 332/7. 29 Cf. Council Regulation (EC) No. 2223/96 of 25 June 1996 on the European system of national and regional accounts in the Community, O.J. 1996 L 310/1; Council Regulation (EC) No. 1500/2000 of 10 July 2000 implementing Council Regulation (EC) No. 2223/96 with respect to general government expenditure and revenue, O.J. L 172/3; Council Regulation (EC) of the European Parliament and of the Council of 10 June 2002 on quarterly non-financial accounts for general government, O.J. 2002 L 179/1; European System of Accounts (ESA95) on national economic accounting. 30 Cf. ECOFIN Council Endorsement of the Opinion of the Economic and Financial Committee on the content and format of stability and convergence programmes (Code of Conduct) (Press Release, Brussels 10 July 2001), providing among others for a clustered submission and examination of the stability and convergence programmes and the clarification of their contents. 25

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from basing their economic data on inconsistent statistical data or creative bookkeeping.31 This is not to say that the economic assessments offered by the Member States do not undergo an independent review, as the data on government deficit and government debt are verified by Eurostat, the statistical office of the European Communities.32 Indeed, there have been significant upward revisions in the 2001 deficit of Portugal, from 2.2 per cent to 4.1 of Gross Domestic Product (GDP), and also in the deficit of previous years, resulting mainly from changes to comply with ESA9533, and in the 2001 deficit of Italy, revised from 1.4 per cent to 2.2 per cent, due to the application of Eurostat’s recent decision on securisation operations undertaken by general government.34 The limited reliability of economic data forwarded by the Member States in some instances certainly hampers the timely application of the early warning mechanism. Interestingly, neither the EC Treaty nor Council Regulation 1466/97 foresee any mechanism in case that a Member State does not forward or update a stability programme with the prescribed contents or, unintentionally or intentionally presents falls economic data resulting in an inaccurate assessment of the budgetary situation. In principle, the refusal by a Member State to provide a stability programme or otherwise to forward economic data could be interpreted as a clear indication for the existence of budgetary difficulties and, thus, the existence of a danger for the emergence of an excessive deficit. Yet, it is doubtful whether this could justifiably result in the application of the early warning mechanism or, as the case may be, the excessive deficit procedure. It may be argued on the basis of Art. 99 EC and Art. 5 Council Regulation 1466/97 that the Council has to take such decisions based on the assessment of the stability programme or, in the case of the excessive deficit procedure, based on the economic data forwarded by that Member State. It could also be argued that the omission by the Member States constitutes a breach of the reporting requirements under Art. 99 EC and in any event Art. 10

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Issing, “On Macroeconomic Policy Co-ordination in EMU”, JCMS 2002, 345 – 358, at 347, recognises that “[F]rom a practical perspective, co-ordination of different policies creates serious problems with regard to gathering and processing all relevant information in an affective and timely manner.” 32 For a recent example cf. Eurostat, Euro-indicators, news release 116/2002, 30 September 2002. 33 Cf. FN 29. 34 Cf. Eurostat, news release 116/2002, 30 September 2002. Recently, the Commission in two separate communications adopted has called for an upgrade of the euro area economic and budgetary statistics (IP/02/1743). In particular it calls on the ECOFIN Council to adopt a code of best practices on the reporting of budgetary data ahead of the next excessive deficit procedure reporting date of 1 March 2003.

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EC, according to which the Member States are supposed to take all appropriate measures to ensure fulfilment of the obligations arising from the EC Treaty and from action taken by the Community institutions. For this the Member State could, in principle, become subject to a Treaty infringement procedure initiated either by the Commission or by another Member State.35 A Member State choosing not to comply with a judgment of the ECJ confirming the alleged breach of Community law could face penalty payments, subject to the application of a separate procedure and a separate judgment by the ECJ.36. Yet, judicial review arguably amounts to little more than a theoretical course of action. Indeed, other Member States may have few incentives to bring a Member State’s inaction to the attention of the ECJ. The Commission, which may be more inclined to take a tough stand, would be faced with the difficulty of having to proof that the data provided by the Member State was false, rather than based on a different interpretation of the economic variables.37 In any event, if the goal is to avoid the emergence of an excessive deficit, the prospect of the application of a lengthy judicial procedure may not be a very appealing one, as it will almost certainly come to late to be meaningful.38 It is the task of the Council, and thus the Member States, to inspect the stability and convergence programmes and the yearly updates.39 The Member State concerned is not excluded from participating in the voting. The Council has to deliver an opinion on the consistency of the programmes with the broad economic guidelines based on a recommendation by the Commission and after having consulted the Economic and Financial Committee.40 The fact that the Council and thus not the Commission, which is assigned the role as “Guardian of the Treaty” by the EC Treaty, observes the adherence by the Member States to the guidelines underlines the distance of economic co-

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Art. 226 – 227 EC. Art. 228(1) – (2) EC. 37 In the context of Art. 226 EC the burden of proof for an alleged infringement lies with the Commission, cf. case C-210/91, Commission v. Hellenic Republic, [1992] ECR I- 6735. 38 While Art. 226 and Art. 227 EC do not include any time-limits with regard to the pre-litigation procedure, the ECJ has held that the Commission must give the Member State concerned a reasonable period of time to either defend itself or comply with its obligations under Community law. However, a very short time limit may be justified in particular circumstances, such as when there is an urgent need to remedy a breach or where the Member State is fully aware of the Commission’s views long before the procedure has been started, Case 293/85, Commission v. Belgium, [1988] ECR 305. 39 Art. 5(2) Council Regulation 1466/97: Within 2 months of their submission. 40 The Member States, the Commission and the ECB each appoint no more than two members to the Committee. It is supported by the Economic Policy Committee to which the Member States, the Commission and the ECB each appoint four members from among senior officials possessing outstanding competence in the field of economic and structural policy formulation, cf. 2000/604/EC: Council Decision of 29 September 2000 on the composition and the statutes of the Economic Policy Committee (O.J. L 257 of 11 October 2000, p. 28). 36

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ordination from the Community method.41 While the Council in its opinion is supposed to “invite” a Member State to adjust its programme where a strengthening of its objective or contents is thought necessary in order to comply with the broad economic guidelines, it remains at the discretion of the Council to actually issue such a recommendation for adjustments in the first place. In principle, the stability and convergence programmes are more than just a reporting of the status quo. They actually amount to a self-commitment by the Member States to a particular course of action, as the Council, in addition to the examination of the yearly updated stability programmes, also monitors the implementation efforts by the Member States.42 Indeed, it is this feature, which constitutes the main element of the so-called “early warning mechanism” introduced by the Stability and Growth Pact. The Member States’ performances are judged against their submitted programmes.43 Based on this assessment, the Commission can recommend to the Council to address a recommendation to the Member State concerned to take adjustment measures as thought necessary. Council Regulation 1466/97 lays down in some detail what the Council and the Commission have to consider when examining the stability programmes, thus introducing a yardstick for the evaluation of the programmes.44 This is not entirely unproblematic, since Art. 99(5) EC, which forms the legal basis for Council Regulation 1466/97, allows for the adoption by the Council of detailed rules for the multilateral surveillance procedure as laid down in the EC Treaty. It arguably requires an extensive interpretation of Art. 99(3) and (4) EC to subsume the detailed provisions on the strengthening of the surveillance of budgetary positions and the surveillance and co-ordination of economic policies as provided for in the Council Regulation under the somewhat thin Treaty provisions on the multilateral surveillance.45 It may be concluded from Art. 6(1) Council Regulation 1466/97 that the Council must base its own assessment on objective criteria. Yet, neither this provision, nor Art. 99 (4) EC itself supports the view that the Council is under a legal obligation to endorse the Commission’s recommendation or to

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Art. 211 EC. Art. 6(1) Council Regulation 1466/97. 43 As to the scope of this evaluation cf. Art. 6(2) Council Regulation 1466/97. 44 Art. 5(1) Council Regulation 1466/97 refers among other things to the medium-term budget objective, which has to provide for a safety margin to ensure the avoidance of an excessive deficit, the economic assumptions on which the programme is based which have to be based on realistic, and the sufficiency of the planned or actual measures to achieve the targeted adjustment path towards the medium-term budgetary objective. 45 Amtenbrink, de Haan and Sleijpen, op. cit., supra, note 5, at 233. 42

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reject it by a formal vote.46 The commitment by the Member States, be it individually or acting in the Council, is essentially of a political nature as the Resolution of the European Council on the Stability and Growth Pact highlights.47 The Member States pledge to take the corrective budgetary action to meet the medium-term objectives and to take the corrective budgetary action once an early warning is issued in accordance with Art. 99(4) EC. Yet, while the Council commits itself to a “rigorous and timely implementation of all elements of the Stability and Growth Pact in its competence”, the Resolution states somewhat vaguely that the Council “will take the necessary decisions under Art. 103 [now Art. 99] and Art. 104c [now Art. 104] as is practicable”48 This wording fails to provide even any self-commitment by the Council to routinely apply the early warning mechanism once the Commission has made a recommendation to that effect or even to apply the mechanism in case that the Council agrees with the economic assessment underlying a Commission recommendation. Indeed, the Resolution itself recognizes the lack of any obligation of the Council when “inviting” the Council to state in writing the reasons which justify a decision not to act if at any stage of the surveillance procedure it did not act on a Commission recommendation and, in such case, to make public the votes cast by each Member State.49 In any event, the Council Resolution cannot develop legal effect to the extent that Member States could be forced to take the corrective measures necessary as a result of the deteriorating budgetary situation. It is not until a Member State is actually running an excessive deficit that more robust action can be taken. What is more, even where action is taken by the Council in terms of an early warning issued to a Member State, this can hardly be considered a stringent action. As a matter of fact, the Council can do little else to force a Member State to take the necessary adjustment measures in order to meet its self-proclaimed medium-term objective for the budgetary position to be close to balance or in surplus. Relying on the excessive deficit procedure instead seems like closing the stable after the horse has bolted.

46 This course of action could recently be witnessed for Portugal and Germany, cf. section 3, and had been foreseen by Louis, “Chapter I Perspective of the EMU after Maastricht”, in Stuyck (ed.), Financial and Monetary Integration in the European Economic Community (Kluwer Law and Taxation Publishers, 1993), p. 8. 47 Cited supra note 5. 48 Brackets added. 49 Resolution of the European Council on the Stability and Growth Pact, op. cit.,supra, note 5.

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2.2. The closed method of co-ordination Member States’ economic policies Economic governance in EMU can be viewed as a two-stage procedure whereby failure during the first stage, i.e. the multilateral surveillance phase, results in the application of the second stage, which is the excessive deficit procedure. Whereas the multilateral surveillance procedure relies on the voluntary observance by the Member States of the broad economic guidelines, the excessive deficit procedure introduces legal obligations for the Council, a stringent time frame and even the possibility of severe sanctions in the case of a persisting excessive deficit in a Member State. As such, it introduces a closed method of co-ordination into the system of economic coordination in EMU. However, even the excessive deficit procedure is far from unambiguous. Based on the data on government deficit and debt forwarded by the Member States twice a year, the decision on the existence of an excessive deficit is not limited to the mechanical acknowledgement by the Commission that an excessive deficit exists or may occur and, thereafter, the decision by the Council that a Member State has actually breached the excessive deficit limits set by Community law.50 It is an evaluation to be made by the Member States gathered in the Council and thus, essentially a political decision rather than an inevitable automatism which leads to the application of the excessive deficit procedure. This is even more so the case since the EC Treaty and Council Regulation 1467/97 allow for exceptions both for a planned and actual government deficit exceeding the 3 per cent watermark.51 The acceptation of these exceptions entails a considerable degree of judgment on part of the Commission in its recommendation and the Council in its final decision. Indeed, the latter is supposed to take its decision after an “overall assessment’ and “considering any observations which the Member State concerned may wish to make”.52 Council Regulation 1467/97 provides some guidance on the interpretation of these exceptions.53 The Commission has to consider a severe economic downturn to be exceptional, if there is an annual fall of real GDP of at least 2 per cent.54 Yet, it has to do so only “as a rule”, thereby leaving the possibility

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According to Art. 104(5) EC the Commission can also address an opinion to the Council if it comes to the conclusion that an excessive deficit “may occur” (i.e. in the future), whereas according to the wording of Art. 104(6) EC the Council thereafter has to decide whether an excessive deficit actually exists. 51 Cf. Art. 104(2) (a) - (b) EC and Art. 2 Council Regulation 1467/97. 52 Art. 104(6) EC. 53 Council Regulation 1467/97 has been based on Art. 104(14) paragraph 2 EC which allows for the adoption of provisions to replace the Protocol on the excessive deficit procedure annexed to the EC Treaty. Critical on the choice of form Amtenbrink, Sleijpen and de Haan, op. cit., supra note 5, p. 234. 54 Art. 2(2) Council Regulation 1467/97.

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of the recognition of an economic downturn in case of a fall of GDP of less than 2 per cent. Moreover, in its final assessment regarding the existence of an excessive deficit the Council has to take into account any observations made by the Member State concerned showing that the annual fall of real GDP of less than 2 per cent is nevertheless exceptional in the light of further supporting evidence.55 In the European Council Resolution on the Stability and Growth Pact the Member States have declared that in evaluating whether the economic downturn is severe, as a rule, the reference point is whether an annual fall in real GDP of at least 0.75 per cent exists.56 Interestingly, Council Regulation 1467/97 does not include any details on how to define an unusual event outside the control of the Member State except for that it must have had a major impact on the financial position of the general government of the Member State concerned.57 Such exceptional circumstances may be given in the case of natural disasters of a national scale or war.58 While it makes sense from an economic point of view to consider the overall economic situation on a case-by-case basis rather than to mechanically apply a rule based on a pre-fixed reference value, this approach offers a venue to circumvent the basic rule, i.e. no government deficit above 3 per cent. It is for the Member States gathered in the Council to decide whether they consider a government deficit to be exceptional and temporary and resulting from an unusual event outside the control of the Member State or from a severe economic downturn. It is not surprising that the Commission has taken a much more robust approach vis-à-vis these exemptions offered by the Treaty considering that its analysis of the budgetary situation arguably is more impartial than that of the Member States.59 The provisions on the speeding up of the excessive deficit procedure included in Art. 3 - 8 Council Regulation 1467/97 introduce a tight schedule from the decisions on the existence of an excessive deficit to the possible application of sanctions.60 Different to the multilateral surveillance procedure, which does not create legal obligations in this regard, it becomes clear from the wording of Art. 104(6) EC that the Council has to take a decision by a qual-

55

Art. 2(3) Council Regulation 1467/97 lists exemplary the abruptness of the downturn and the accumulated loss of output relative to past trends. 56 Op. cit., supra note 5. 57 Art. 2(1) Council Regulation 1467/97. 58 In the run-up to the U.S.-lead military intervention in Iraq Economic and Financial Affairs Commissioner Solbes was quoted saying that war was an exceptional circumstance which did however not justify moving from the 3 per cent deficit ceiling, cf. Agence Europe No. 8426, at 12. 59 With regard to the incentives and temptations of Member States in the procedure cf. section 3 hereafter. 60 For an overview cf. Amtenbrink, de Haan and Sleijpen, op. cit. supra note 5.

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ified majority vote as to whether or not an excessive deficit exists.61 Tellingly, the Member State concerned is not excluded from this initial decision to open the excessive deficit procedure and thereafter the decision with regard to recommendations.62 In fact, it may be recalled that Art. 104(6) EC - to some extent - institutionalises the influence by the Member States concerned by stating that its observations are considered by the Council. Once the Council has decided that such a deficit exists, it is obliged to issue recommendations to the Member State concerned on how to bring the budgetary situation in line with the Community targets.63 Although these recommendations cannot produce any legal effect as such, their disobedience can have grave consequences. Before that, however, in case the Council decides that no effective action has been taken, Art. 104(8) – (11) EC as well as Council Regulation 1467/97 leave it at the discretion of the Council to make its recommendation public. In practice the desired effect of increasing the pressure on the Member State concerned to act will most times be limited considering that the facts surrounding the application of the excessive deficit procedure to the Member States concerned will already be widely publicised. It is for the Council to request a Member State to take concrete measures for the deficit reduction, albeit that a decision has to be taken within one month of the decision on the lack of effective measures by the Member State. Finally, the actually application of sanctions is also subject to a Council decision, as becomes clear from Art. 104(11) EC.64 Interestingly, neither the EC Treaty nor Council Regulation 1467/97 specifies sanctions in case the debt ratio is too high despite the fact that this constitutes one of the two elements defining an excessive government deficit.65 Although unlike the multilateral surveillance and early warning procedure the Council is actually obliged to take decisions, Art. 104(10) EC excludes the application of Art. 226 EC and Art. 227 EC in the context of the excessive deficit procedure, preventing the Commission or other Member

61

Within three months of the submission of economic data, Art. 3(3) Council Regulation 1467/97. Art. 104(13) EC refers only to decisions taken in accordance with Art. 104(7) – (11) EC not including the initial Council decision in accordance with Art. 104(5) EC on the existence of an excessive deficit and the recommendations issued thereafter in accordance with Art. 104(6) EC. 63 A deadline of up to four months for the Member State to implement correction measures has to be established by the Council in its recommendations, Art. 3(4) Council Regulation 1467/97. 64 At first sight the wording of Art. 6 Council Regulation 1467/97 may be somewhat misleading in this respect, as it suggests an automatic application of sanctions, once a Member State has not taken the measures demanded by the Council. As to the calculation of sanctions in the form of non-interestbearing deposits cf. Amtenbrink, de Haan, and Sleijpen, op. cit., supra note 5. 65 Art. 104(2) (b) EC. Cf. also section 4.1. 62

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States from initiating infringement procedures against a Member State for exceeding the reference value regarding government deficits or debts. This is yet another indication that the Member States represented in the Council are firmly in control not only of the multilateral surveillance, but also the excessive deficit procedure. 3. The political economy of fiscal policy co-ordination in EMU In practice, the track record of economic co-ordination is mixed at best both with regard to the performance by the Member States, as well as the Council in applying the available instruments. This may not only be explained by the combination of closed and open method of economic co-ordination and soft and hard law, but also the limited incentives for Member States provided by the current system to observe the fiscal policy rules and the partial failure of peer review on which much of the success of the system relies. Observing the adherence of the Member States to the objective of a balanced budget or surplus in the medium term stated in their programmes offers a diverse picture. In fact, three groups of countries can be distinguished. The first group includes Member States which already had a balanced budget in 1998/99. Denmark, for instance, had a budget surplus during the entire period 1999-2002. Helped by the favourable economic developments the countries in the first group managed to stick to the objective of a balanced budget or a surplus. Indeed, some commentators argue that budgetary consolidation was more based on a strong economic expansion in the early phase of EMU and a decline in debt servicing due to lower interest rates than on Member States’ willingness to comply with the rules.66 Second, various countries not only targeted for a balanced budget (or a surplus), but also realized it. A good example is Belgium, not a country known for its excellent track record when it comes to sound public finances. Still, it managed to bring back its deficit in a relatively short period. Finally, a third group of countries did not manage to reduce their deficits and moved the years in which they aimed to have a balanced budget in the respective stability programmes forward. A good example is Germany. Early stability programmes foresaw a deficit of only 1 per cent in 2002. However, the stability programme of December 2001 aimed for a deficit of 2 per cent in 2002 and the programme of December 2002 even 3.75 per cent. It is with regard to this last group of countries that the actual application of the existing rules on economic co-ordination by the Council cast doubts on

66

De la Dehesa, ”The ECB and the Stability and Growth Pact”, 4th quarter 2002 briefing to the Economic and Monetary Committee of the European Parliament, at 1.

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the ability of the present system to enforce fiscal discipline. In 2001, Ireland planned to raise public expenditure and to cut taxes. In the broad economic policy guidelines, however, Ireland had been advised to keep fiscal policy tight to avoid exacerbating an already overheating economy. Nevertheless, the Irish government did not change its policies. Begg et al. therefore conclude that the soft co-ordination of the broad economic policy guidelines was unable to discipline the Member State policy.67 In February 2002, on the basis of an examination of the updated stability programmes of Germany and Portugal for the period 2002-2005, the Commission concluded that economic data for both Member States suggested a significant slippage from the budgetary objectives laid down in the previous stability programmes dating from 2001, and recommended the application of the early warning mechanism to Germany and Portugal. However, the Council decided unanimously not to put the Commission’s recommendation for an early warning to the vote and to ‘close the procedure’.68 In fact, in the case of Germany it did so even though in its formal opinion on the updated stability programme the Council itself had come to the conclusion that ‘[…] if growth turns out lower than expected, there is a risk that the general government deficit in 2002 comes even closer to 3 per cent of GDP reference value than in 2001’.69 The Council justified this inaction with the expressed commitments both by Germany and Portugal to avoid the emergence of an excessive deficit, and, in the case of Germany, its continuing efforts to bring the debt level down below the reference value of the EC Treaty. At the time, it could be legitimately hoped for that by making public the budgetary situation in the Member States concerned and by putting pressure on these states to take corrective measures, the intended effect could be reached despite the lack of a formal warning.70 However, the subsequent Council decision for the first time in the short history of EMU to open an excessive deficit procedure, firstly against Portugal and thereafter also against Germany has shattered these hopes.71 Since, the Commission in accordance with Art. 104(3) EC has reported the

67

Op. cit., supra, n. 2. 2407th Council meeting, ECOFIN, Brussels, 12 February 2002 (Doc No. 6108/28); Council Opinion of 12 February 2002 on the updated stability programme for Germany, 2001–2005, J.O. 2002, C 51/1. 69 O.J. 2002 C 51/1; Critical Amtenbrink, “Hear no evil, speak no evil, see no evil!”, Eufocus (2002), Issue 96, 2-4. 70 Critically on the publication of the early-warning Seidel, “Publizitätsverbot für ‘Blauen Brief’ bei einem drohenden Haushaltsdefizit”, EuZW 2002, 161. 71 Council Recommendation to Portugal with a view to bringing an end to the situation of an excessive government deficit - Application of Article 104(7) of the Treaty establishing the European Community of 5 November 2002; Council recommendation of 21 January 2003 with a view to bringing an end to the situation of an excessive government deficit in Germany - Application of Article 104(7) of the Treaty establishing the European Community. Cf. also Amtenbrink, “Excessive deficits: the road to redemption”, Eufocus (2002), Issue 111, 2 - 4. 68

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existence of an excessive deficit in France.72 On 21 January 2003 the ECOFIN adopted a recommendation giving an early warning to France. According to the Commission, the French authorities failed to take corrective measures to address the growing budgetary imbalances. Consequently, the Council decided on 3 June 2003 that France has an excessive deficit. A deadline of 3 October 2003 was established for the French government to take appropriate measures. In line with the Commission proposal, the Council recommended that the French authorities achieve a significantly larger improvement in the cyclicallyadjusted deficit in 2003 than that currently planned and to implement measures ensuring that the cyclically-adjusted deficit is reduced in 2004 by 0.5% of GDP to ensure that the nominal deficit will be below 3% in 2004 at the latest. Interestingly, with Denmark and the Netherlands) two Member States voted against this decision. The Netherlands even had its arguments made public, arguing that France should bring down its structural deficit by at least 0.5% of GDP this year. As yet, it is too early to reach conclusions as to whether sanctions will be applied and whether they will force Member States to change their fiscal policies, i.e. whether the hard law is adhered to. Still, the experience so far suggests that the soft law as applied in the open method of co-ordination of the multilateral surveillance has, to some extent, failed. After all, some of the countries that did not adhere to the commitment to have a balanced budget or a surplus in the medium term currently have an excessive deficit. This can hardly be considered an unexpected development.73 Different elements can be observed in explaining why the Member States in the Council have chosen for such a soft law approach in the first place. According to Abbott and Snidel, soft law measures may be the most appropriate rule type under some circumstances.74 First, soft law reduces negotiating costs. Highly legalized agreements entail significant contracting costs. As soft law reduces the levels of obligation, delegation or precision, the costs of negotiation are similarly reduced, which may make agreement possible. Because the commitments made under hard law are more precise and may involve delegation of interpretation of these rules, it will be harder to reach an agreement. Soft legalization mitigates these costs of reaching an agreement. The negotiating costs argument seems relevant in the case of the Stability and Growth Pact. As is illustrated by its name, at the time of the negotiations the Member States had rather different views on the aims of the Stability and Growth Pact and

72

Commission Press Release of 2 April 2003 (IP/03/471). Cf. Amtenbrink, de Haan and Sleijpen, op. cit. 74 Abbott and Snidel, op. cit., at 434-450. 73

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how to reach them. A rather vague and legally non-binding objective for the medium term helped to reach an agreement. Second, soft law may also reduce sovereignty costs. Accepting a binding legal obligation, especially when it entails delegating authority to a supranational body, is costly to states. States can limit sovereignty costs through arrangements that are non-binding or imprecise or that do not delegate extensive powers. Again this argument seems applicable to the Stability and Growth Pact, as various Member States were unwilling to delegate much authority to the Community level. A scheme that leaves actual policy decisions and implementation at the national level, while at the same time offering the opportunity for peer pressure, is then a natural outcome. Third, in case of considerable uncertainty soft law may be the most appropriate method of legalisation. This observation is also relevant in analysing the existing system of economic coordination. Indeed, one ambiguity in the Stability and Growth Pact has concerned the “close to balance or in surplus” budget objective. The view underlying this objective is that the medium-term budget target should be set such as to provide a safety margin for both cyclical developments and unanticipated budgetary risks. A common interpretation, although not specified as such in the Stability and Growth Pact, has been that this implies a target for the cyclically adjusted budget balance. Tax receipts and government expenditures vary automatically with the output and employment levels. To assess the underlying budgetary situation, one must therefore adjust the actual budget balance for the cyclical conditions. Computations of the cyclically adjusted budget balance require estimates of both the output gap that is the extent to which actual output deviates from its trend, and of the sensitivity of the budget balance to such deviations. The largest problem in computing the cyclically adjusted budget balance is how to estimate the output gap. There exists no universally accepted way of doing this. Instead, different methods give different results and the estimates are often subject to large ex post revisions. Fourth, soft law is a tool of compromise. It can take divergent national circumstances into account through flexible implementation. Soft legalization provides for flexibility in implementation, helping states deal with the domestic political and economic consequences of an agreement. Because even soft legal agreements commit states to characteristic forms of discourse and procedure, soft law also provides a way of achieving compromise over time. Furthermore, it can give states the opportunity to learn about the consequences of what they have agreed to, opening the way for further negotiation. Also this argument seems relevant in the context of the Stability and Growth Pact. The recent Commission proposals for reform were, to quite an extent, based on the experience with the pact.

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It is sometimes argued that soft law is, by definition, not effective. This is, however, too simplistic a view. Whether soft law works depends on the reactions of various participants in the process. Even in areas where there is no explicit obligation to adjust there may be substantial incentives for governments to change policies. Two distinct sets of incentives operate: a “competition” incentive and a “co-operation” (regime-building) incentive.75 The competition incentive derives from both the policy arena and from the market. A country that performs poorly would see its reputation weaken, which may diminish its leverage in the design and implementation of EU policies at large. In addition, markets may punish a poor performer to the extent that poor policies make that country less attractive for investment, whereas good performers would presumably enjoy greater profitability and thus increased investment. The competition incentive will be increasingly relevant in a world of high capital mobility. The co-operation incentive is relevant to the extent that poor performance in any Member State participating in the single currency weakens the performance and attractiveness of the euro area as a whole vis-à-vis the rest of the world. Poor policy in any one member of the club decreases the quality of the club good and may generate a negative externality on the other club members. This will presumably lead to strengthened peer pressure on the poor performer from the other club members. The co-operation incentive depends on the externalities. A number of these so-called spill-over effects have been identified.76 First, there is a potential risk that other governments could in the end feel forced to bail out a bankrupt government of an individual Member State despite the fact that Community law excludes such a move.77 Second, there is a risk for pressures on the European Central Bank (ECB). This may lead to a direct bail-out in the form of the purchasing of the debt of a highly indebted country in the bond market, or an indirect bail-out taking the form of interest rates lower than motivated by price stability considerations.78 Third, lack of fiscal discipline in one member country may affect interest rates and/or the external value of the euro, thereby affecting the other participating Member States. It follows from this analysis that peer pressure will be stronger, the larger the externalities of excessive deficits. However, the risks of the externalities seem small, especially in the short run. For instance, the external value of 75

Padoan, “EMU as an Evolutionary process”, in: Andrews, Henning and Pauly (eds.), Governing the World’s Money (Cornell University Press, 2002), 125-26. 76 Cf. Eijffinger and De Haan, European Monetary and Fiscal Policy (Oxford University Press, 2000). 77 Art. 103(1) sentence 2 EC states that Member States shall not be liable or assume the commitments of another Member State. 78 However, according to Art. 105(1) sentence 1 EC the primary objective of the ECB is to maintain price stability.

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the euro seems currently not to be at risk due to the fact that some countries have an excessive deficit. Also the risk of a bail-out by either the ECB or the other Member States seems rather small as even the countries with an excessive deficit are perfectly capable of borrowing at financial markets. Therefore, governments have little incentives to push hard when another Member State does too little to adhere to the medium-term objective of a balanced budget or a surplus. Thus, the co-operation incentive is weak. Likewise, the competition incentives are weak. So far, financial markets hardly punish a country with an excessive deficit. For instance, when the Council decided that Germany had an excessive deficit, interest rates on German bonds did not rise substantially. The credit ratings of the countries concerned have also not been changed. So neither for a Member State in danger of an excessive deficit nor for the other Member States represented in the Council which is charged with application of the multilateral surveillance and early-warning procedure are the incentives strong enough in the short term to prevent Member States from deviating from strict fiscal rules. One may wonder then why Member States should feel obliged to pursue economic policies which they consider restrictive and potentially harmful for economic outlook and/or inconvenient in the light of the political cycle. Indeed, as Galli argues, there is a “strong temptation for governments to run high deficits since the costs, in terms of higher interests or inflation, are spread over the whole Eurozone”.79 This temptation is likely to increase with the accession of new Member States to the EU which have an even greater demand for public investments. Adding to this, the Member States gathered in the Council have some complementary or concurring interests. In deciding on the application of the early warning procedure and thereafter the excessive deficit procedure they are not impartial to the process as they themselves are subject to the process of economic co-ordination. Thus, it cannot be ruled out that Member States will base their decision not on the merits of the case at hand, but rather on whether the application of the excessive deficit procedure could set a precedent for a course of action to which they themselves may sometime in the future be subjected to.80 This motive may be particularly given in the case of those Member States which themselves have not reached a budgetary situation closed to balance or in surplus and which run the danger of breaching the deficit criterion sometime in the not so distant future. In fact, in principle Member States which themselves run an excessive deficit are not excluded

79

Galli, “The Stability and Growth Pact facing its toughest challenge”, Briefing prepared for the Committee for Economic and Monetary Affairs of the European Parliament, 2003. 80 Geelhoed, “Het Stabiliteitspact, zin en onzin”, SEW 2 (2003), 32 – 49, at 47, refers to a game with a weak referee and players which in the end decide themselves whether and how they play by the rules.

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from decisions in the context of the multilateral surveillance, early warning and excessive deficit procedure.81 The fact that the Council has recently decided to apply the excessive deficit procedure may not so much be proof of the working of the system, but rather reflect the current situation in which a majority of the Member States in the euro area feature a close to balance or surplus budget, making it somewhat easier to take a tough stand. However, in principle a situation can be envisaged in which the required two-third majority would fail to materialize due to a blocking minority by Member States running an excessive deficit.82 The current rules for economic co-ordination imply a whole process of review and several decisions before decisions can be taken in order to maintain or regain budgetary discipline.83 This makes economic co-ordination open to political pressure in the Council. The same ministers, who are responsible for drafting national budgets, also have to decide whether they breach the 3 per cent criterion and the medium term objective. This has to be considered as a severe weakness in economic co-ordination both with regard to the multilateral surveillance and early warning procedure as well as the excessive deficit procedure. 4. Towards more flexibility or more stringency? Several suggestions for a reform of the provisions on economic coordination have been made. Many of these proposals are inspired by the view that the current rules in place do not offer enough flexibility to use fiscal policy in a counter-cyclical way. This view is presently rejected. In fact, if Member States adhere to the medium term objective of the Stability and Growth Pact, the current rules in place offer quite some flexibility. Suppose that the Member States have a balanced budget in the medium term. Then they can let their budget deficit increase up to 3 per cent of GDP. This does not require discretionary policy measures: the working of automatic stabilisers will drive up deficits. In a recession government’s revenues will go down, whereas outlays will go up. How large is the cyclical sensitivity of national budgets? One way to answer this question is to analyse the maximum difference between the actual deficit

81

Art. 104(13) EC only refers to the Member State which is subject of the concrete decision. For an analysis of possible blocking minorities based on the economic data from 1979 – 1996 cf. Sutter, “Zur Glaubwürdigkeit des EWU-Stabilitätspaktes – Einfache Berechnungen und mehrfache Zweifel”, EIoP Vol. 1 (1997) No. 12, which concludes that the present system is gracious towards deficits (…‘defizitfreundlich’…). 83 Mayes, “Independence and Co-ordination – The Eurosystem”, Conference paper for the 5th UACES Research Conference, Budapest 6 – 8 April 2000, at 11. 82

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and the so-called ‘cyclically adjusted deficit’. Estimates of Buti and Sapir suggest that the cyclical component of budget balances rarely surpassed the 3 per cent of GDP level.84 So, if countries stick to the medium term objective of keeping their budget in balance, the Stability and Growth Pact offers substantial room for automatic stabilisers to function. As pointed out by Buti, Eijffinger and Franco85, many of the proposals for reform imply that the Stability and Growth Pact is replaced by some other mechanism to keep national fiscal policies on a sustainable path, be it other rules or a stronger reliance on (financial) market discipline or a combination of these. However, Buti et al. argue that instead of renegotiating the Pact, reinterpreting the current rules in place may be better attainable. In this direction, the Commission has recently presented proposals to improve the interpretation of the Pact in order to ensure a more rigorous adherence to the goal of sound and sustainable public finances. Apart from a more rigorous adherence to the goals set out in the EC Treaty and the Stability and Growth Pact it also becomes necessary to strengthen the institutional framework of economic co-ordination in EMU by addressing some of the shortcomings addressed throughout this contribution. Several proposals have been made in this direction including in the Draft Treaty establishing a Constitution for Europe. 4.1. The Commission proposals In the view of the Commission, due account should be taken of the economic cycle when establishing budgetary objectives at EU level and when carrying out the surveillance of Member States’ budgetary positions. 86 The “close to balance or in surplus” requirement would be defined, taking into account the business cycle situation. Isolating the impact of the economic cycle on budgetary positions, provides a better picture of the true state of public finances in a country, and enables the Commission to carry out a better assessment of compliance with budgetary commitments given in the stability and convergence programmes. The Council agrees with this view. The estimation of cyclically-adjusted balances would be made using the methodology endorsed by the Council on 12 July 2002.87 In this meeting the Council endorsed a report by the Economic Policy Committee to calculate trend income.88

84

Buti and Sapir (eds.), Economic Policy in EMU, Clarendon Press (1998). Buti, Eijffinger and Franco, Revisiting the Stability and Growth Pact: Grand Design or Internal Adjustment?, CEPR discussion paper no. 3692, with further references. 86 Communication from the Commission to Council and European Parliament, Strengthening the coordination of budgetary policies, COM (2002) 668 final, section 5 i). 87 Press release 6877/03. 88 Press release 10668/02. 85

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While it makes sense to take the cyclical situation of a country into account in assessing the budgetary position of that country, it may create all kind of new loopholes for Member States as there is no unique and correct way to adjust the budget for the influence of the business cycle. In fact, the figures on the cyclically adjusted deficit as provided by the Commission often differ substantially from the estimates of the cyclically adjusted deficit figures as published by the Organisation for Economic Co-operation and Development. Furthermore, the published figures are often revised. Only if countries are willing to accept the calculations of the cyclically adjusted deficit of the Commission, so that there is no discussion about them, political debates similar to those which could recently be witnessed when the Council discussed the German and Portuguese public finance situation can be circumvented. The mere fact that the Council has agreed on a certain calculation method for trend income is no guarantee that Member States will accept these calculations. The Commission also proposes to establish clear transitional arrangements for countries with underlying deficits exceeding the ”close to balance or in surplus” requirement.89 The countries concerned would be required to achieve an annual improvement in the underlying budget position of 0.5 per cent of GDP each year until the “close-to-balance or surplus” requirement of the Stability and Growth Pact has been reached. In its meeting on 7 October 2002 the Eurogroup agreed “to commit Member States whose deficits exceed the close to balance or in surplus requirement to a minimum annual reduction of 0.5% of GDP.”90 According to the Commission, this rate of improvement in the underlying budget position should be higher in countries with high deficits or debt. Also, a more ambitious annual improvement in underlying budget positions should be envisaged if growth conditions are favourable. According to the Commission, this proposal recognises that the deadline for reaching the goal of the Stability and Growth Pact cannot be postponed indefinitely. Acceptance of this proposal would be a clear improvement if and to the extent that these would be legally binding. However, this would at least require an amendment of Council Regulation 1466/97.91 The Commission also suggests to introduce a new ”Resolution to reinforce the coordination of budgetary policies”. This Resolution is supposed to represent the solemn political commitment of the Commission, Member States and Council to implement the Stability and Growth Pact in a strict and timely manner in accordance with the proposals set down in the Communication of

89

Commission Communication, op. cit., surpa, section 5 ii). Press release 6877/03, at. 15. Interestingly, the Council has not confirmed this decision, which suggests that the non-euro Member States did not agree with this view. 91 As to the conditions cf. section 4. 2. 90

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the Commission. However, as pointed out before, the fact that the current rules are partly based on a non-binding resolution is an important weakness of the Stability and Growth Pact. Any new non-binding rules, like those referred to in the previous paragraph, are probably as easily put aside as those currently in existence. In the view of the Commission, a pro-cyclical loosening of the budget in good times should be viewed as a violation of budgetary requirements under Community law, and should lead to an appropriate and timely response through the use of the available instruments.92 Member States would have to avoid a pro-cyclical loosening of budget policies in good times as the automatic stabilisers are supposed to provide enough cushion over the economic cycle. To the extent that this proposal implies that a government deficit of below 3 per cent or a government debt of below 60 per cent would as a matter of principle be considered to already constitute the danger or existence of an excessive deficit, this would not only require the amendment of the two Council Regulations forming part of the Stability and Growth Pact, but arguably also the amendment of the Protocol on the excessive deficit procedure and thus, of primary Community law.93 The Council did not go as far as that and considered that “[P]ro-cyclical budget policies in good times have been one of the major flaws in the implementation of the Stability and Growth Pact in the past, in particular in countries that had not reached the close to balance or in surplus position. Automatic stabilisers should operate symmetrically over the cycle and, to this end, Member States shall avoid pro-cyclical policies, especially when growth conditions are favourable. To ensure this, all existing procedures should be used to the fullest.”94 Moreover, budgetary policies should – in the view of the Commission – contribute to growth and employment. The ‘close to balance or in surplus’ requirement should be combined with the right incentives to help ensure the implementation of the so-called Lisbon strategy, aiming at structural reform of the economies of the Member States.95 A small temporary deterioration in the underlying budget position of a Member State could be envisaged, according to the proposals put forward by the Commission, if it derives from the introduction of a large structural reform, such as a tax reform or a long term public investment programme whether in physical infrastructure or in human capital. However, this should only be envisaged if the Member State concerned fulfils strict starting budgetary conditions: substantial progress towards the ‘close to balance or in surplus’ requirement and general government debt below the 60 per cent of GDP reference value. Moreover, the Commission must verify

92

Commission Communication, op. cit., supra., section 5 iii). Cf. Art. 311 EC on the legal status of protocols annexed to the EC Treaty. 94 Press release 6877/03, at 16. 95 Commission Communication, op. cit., supra, section 5iv). 93

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that there is a clear and realistic deadline for returning to a position of “close to balance or in surplus”, and that an adequate safety margin is provided at all times to prevent nominal deficits from breaching the 3 per cent of GDP reference value. To reflect differences in the sustainability of public finances across Member States, a small deviation from the ‘close to balance or in surplus’ requirement of a longer-term nature could be envisaged for Member States where debt levels are well below the 60 per cent of GDP reference value, and when public finances are on a sustainable footing. This will require a careful examination to be made by the Commission of outstanding public debt, contingent liabilities, such as implicit pension obligations, and other costs associated with ageing populations. This proposal, which has been endorsed by the Council, opens up a whole range of new loopholes to deviate from the medium term objective of a balanced budget or a surplus. In fact, this part of the proposal of the Commission reflects the same tensions present in the Stability and Growth Pact that were referred to in the introduction of this paper. Even though it makes sense from an economic perspective to create some more flexibility in order to enable economic reform, practice so far suggests that there is a clear danger that countries will use these escape clauses, thereby undermining the Stability and Growth Pact. The Commission emphasises that the sustainability of public finances should become a core policy objective at the EU level with greater weight being attached to government debt ratios in the budgetary surveillance process. Countries with high debt levels well above the 60 per cent of GDP reference value should be required to set down ambitious long-term debt reduction strategies in their stability and convergence programmes. Failure to achieve a “satisfactory pace” of debt reduction towards the 60 per cent of GDP reference value should result in the activation of the debt criterion of the excessive deficit procedure.96 Against the background of the existing provisions it may come as a surprise to some that the Commission in its proposal to improve the working of the multilateral surveillance and excessive deficit procedure is emphasizing the need for a more prominent role for the monitoring of government debts. Indeed, Art. 104(2) EC defines excessive deficit by referring to the monitoring of the development of the budgetary situation and of the stock of government debt. Based on Art. 104(2) EC and Art. 1 Protocol on the excessive deficit procedure two criteria are applied in this context, namely that the ratio of the planned or actual government deficit to gross domestic product at market price must not exceed 3 per cent, and that the ratio of government debt to gross domestic product at market prices must not exceed 60 per cent, whereby an exception is granted if the ratio is sufficiently diminished and approaching the reference

96

Commission Communication, op. cit., section 5v).

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value at a satisfactory pace. According to Art. 104(3) EC the Commission can initiate the excessive deficit procedure if one or both of these conditions are not met.97 From Art. 104(11) EC it has to be concluded that sanctions can be applied in case of an excessive deficit regardless of whether it is based on a government deficit or a government debt. From all this it can be concluded that the government debt criterion stands on an equal footing with the deficit criterion in assessing whether an excessive deficit exists in a MS. However, Council Regulation 1467/97 does not explicitly take up the government debt criterion. Indeed, Art. 12 of said Regulation only specifies the calculation method for the sanctions applicable in case of an excessive government deficit in accordance with Art. 104(2) (a) EC. A similar specification for government debt is missing. However, Art. 11 Council Regulation 1467/97 states in general terms that whenever the Council decides to apply sanctions to a participating Member State in accordance with Art. 104(11) EC, a non-interest bearing deposit shall be required. It may be concluded from this that sanctions can, and arguably, even have to be applied in case of an excessive government debt. In any event, the quantification of these sanctions is not arranged for by the current rules in place. The lack of any explicit reference to the government debt criterion in Council Regulation 1467/97 indicates the limited importance that has been assigned to this criterion at the time of the drafting of the Regulation. This is confirmed in practice. The Commission in monitoring the Member States has focused on the government deficit criterion, whereas the sustainability of public finances until now was not a core policy objective.98 The Commission’s own explanation is that in the past it has monitored the budget targets set down by the Member States in their stability (convergence) programmes, and taking into account nominal GDP growth, anticipating that the debt ratio would fall.99 The Council, while endorsing the view that the public debt ratio should play an important role in budgetary surveillance, has decided, somewhat vaguely, that “the excessive deficit procedure should contribute to ensuring a satisfactory pace of debt reduction”.100 It remains to be seen whether this implies that sanctions will be applied if the debt ratio exceeds the 60 percent threshold, and if so, how the size of certain sanctions will be determined.

97

Council Regulation No. 3605/93 of 22 November 1993 on the application of the Protocol on the excessive deficit procedure annexed to the EC Treaty (O.J. 1993, L 332/7) defines government debt as the total gross debt at nominal value outstanding at the end of the year of the sector of general government, with the exception of those liabilities the corresponding financial assets of which are held by the sector of the general government. 98 Cf. the remarks made by the Commission in a press release from 27 November 2002 (IP/02/1742) p. 3. 99 Cf. Commission Communication, op. cit., supra note 86, Fn 10. 100 Press release 6877/03, at 16.

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4.2. Strengthening the closed method of economic co-ordination? Considering the current working of economic co-ordination, there is little hope that it can be improved while at the same time leaving the present system of open and closed co-ordination untouched. While some observers at this point may conclude that the logical solution to the problem is to transfer the current system into more traditional forms of Community governance, such proposals would neglect both the political and economic realities. Member States feel little for a transfer of further competencies to the Community level. So , a single fiscal policy for the EU does not seem feasible nor is it – in our view – desirable. Any amendment of the rules on the multilateral surveillance and excessive deficit procedure as laid down in Art. 99 et seq. EC would require an amendment of the EC Treaty itself in accordance with Art. 48 EC and thus the consent of all Member States. To the extent that the excessive deficit procedure is laid down in Council Regulation 1467/97, an amendment of said Regulation would require an unanimous decision by the Council.101 Only the rules on the multilateral surveillance procedure, as far as they are laid down in Council Regulation 1466/97, can be amended by a qualified majority vote in the Council in accordance with Art. 99(5) and Art. 252 EC. Fundamental amendments of the multilateral surveillance and excessive deficit procedure thus in principle require consent of all Member States; something which is not easily achieved. After all, as has been observed before, lack of agreement between the Member States was a driving force for the soft character of the current rules in place. It is thus not surprising that while putting forward a number of institutional amendments highlighted hereafter, the envisaged Treaty establishing a Constitution for Europe is not about to change the current allocation of competencies in the area of economic policy between the Member States and the Community.102 101

Art. 104(14) EC. Cf. Art. III-70 et seq. Draft Treaty establishing a Constitution for Europe, Brussels, 18 July 2003, CONV 850/03, hereafter referred to as Draft Constitution; cf. also Final Report of Working Group VI on Economic Governance, CONV 357/02. Geelhoed, op cit, surpa, FN 41, characterizes the proposals as somewhat disappointing and not entirely thought through. Art. III-88 of the Draft Constitution in its version of 18 July 2003 does provide for the possibility of a closer cooperation between the Member States in the euro area, as they could adopt measures to strengthen the coordination of their budgetary discipline and surveillance of it, and, to set out economic policy guidelines for themselves, while ensuring that these guidelines are compatible with those guidelines adopted for the whole Union and are kept under surveillance. Whether these amendments would actually improve the current system other than to exclude Member States outside the euro area from the decision-making process, is questionable. Already under the current system the Broad Economic Guidelines do not only include general, but also country-specific guidelines which arguably could be extended to possibly even include strategies for groups of Member States. Considering the experience with the application of the current system of multilateral surveillance it is also doubtful whether the right for Member States of the euro area to adopt measures to strengthen this system would actually be exercised. If applied, this new form of closer cooperation within the already existing closer cooperation created by the provisions on EMU could open a gap between Member States with a derogation and the eurogroup. Rather than to subject the former states already prior to the final phase of EMU to the standard of economic coordination and surveillance applied to the Member States in the euro area, two standards of

102

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The consensus among the Member States to remain firmly in charge of economic policy is also likely to decide the faith of the more ambitious proposals to depoliticize the excessive deficit procedure, such as putting the Commission in charge of all decisions relating to the emergence and existence of an excessive deficit either directly or via legal proceedings before the European Court of Justice which would than make the ultimate decisions on deposits and fines.103 The same holds true for the weighing of votes in the Council in the context of the excessive deficit procedure based on the extent of the excessive deficit of each Member State or the complete exclusion of those Member States from the decision-making procedure which have received an early warning or already have an excessive deficit.104 While unsurprisingly no amendments to this effect are envisaged in the Draft Constitution, the latter does foresee excluding the Member State concerned from the voting in the Council in the context of the multilateral surveillance and excessive deficit procedure, thereby removing one of the more flagrant shortcomings of the system in place today.105 Another suggestion which has been picked up in the Draft Constitution is to raise the profile of the Commission by providing it with a right to issue early warnings on excessive deficits directly, that is to say without the need for a separate decision by the Council.106 Such an amendment of the existing procedure could however become a mixed blessing. On the one hand, it may result in a more consistent and effective application of the multilateral surveillance procedure, as Council behaviour such as that relating to Portugal

multilateral surveillance would apply, with the potential of further fragmentation of economic policy in Europe. 103 The latter suggestion has recently been made by the European Economic Advisory Group at the CESifo in its Report on the European Economy 2003. With regard to the application of the Treaty infringement procedure cf. also section 2.1. Eijffinger, op. cit., infra noye 111, at 7, suggests that the Commission should be charged issuing an early warning and also to determine the existence of an excessive deficit. Geelhoed, op. cit. Supra note 80, 48 – 49. 104 The first proposal is advocated by Sutter, op. cit., supra note 82, at 9, with reference to Hasse, “Alternativen zum Stabilitätspakt von Dublin”, Wirtschaftsdienst 77, 15 – 19, which proposes the introduction of a double weighing of votes, whereby the votes assigned to each Member State in accordance with Art. 205(2) EC would be multiplied by a factor based on the average inflation of the two years preceding the year in which the voting takes place. 105 Art. III 71(4) subparagraph 2, Art. III 76(6) subparagraph 2 of the Draft Constitution. 106 Final Report of Working Group VI on Economic Governance, op. cit., supra note 102 , at 5; Wetenschappelijke Raad voor het Regeringsbeleid, op. cit., infra note 110, p. 84. Cf. Art. III 71(4) of the Draft Constitution.

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and Germany would be a thing of the past.107 On the other hand, it cannot be entirely ruled out that although the Council would still be charged with issuing recommendations to the Member State concerned, with the depolitization of the decision to issue an early warning a significant part of the early warning procedure could degenerates into formalism with substantially less political weight attached to it. Already under the present arrangements arguably public interest is somewhat deadening as a result of the repeated application of the early warning procedure. In any event, even under the new regime little could be done at the end of the day to prevent a Member State from running an excessive deficit. Raising the profile of the Commission is also the aim of those observers which argue that the Council should take decisions based on a Commission proposal rather than based on a recommendation as is presently the case.108 The desired effect of this amendment would than have to derive from Art. 250(1) EC, according to which in cases where the Council acts on a proposal from the Commission, a unanimity decision by the Council is required to amend that proposal. Yet, the results of such an amendment of the current system may be limited. Firstly, it can only increase the influence of the Commission with regard to those decisions which include modifiable content and thus amount to more than a simple yes or no vote. While the Draft Constitution does foresee a bigger role for the Commission in the excessive deficit procedure by obliging the Council to take its initial decision on the existence of an excessive deficit on the basis of a Commission proposal109, arguably the influence of the Commission would not increase substantially in practice. Indeed, the Council could simply reject a Commission proposal to establish the existence of an excessive deficit by a qualified majority vote. A different assessment may apply with regard to the subsequent Council decision addressing recommendations to the Member State concerned which, according to the Draft Constitution, would in the future also be based on a Commission proposal. While the Council could still reject a Commission proposal by qualified majority vote, it would require a unanimity vote to decide on recommendations differing from those proposed by the Commission. The Commission could thus have a considerable influence on the contents of the recommendations decided upon by the Council and thus, the adjustment meas-

107

Cf. section 3. Final Report of Working Group VI on Economic Governance, op. cit., supra, at 5; Eijffinger, op. cit., supra, at 8; cf. also Smits, “The position of the European Central Bank in the European constitutional order”, Transcript of the inaugural lecture, Amsterdam, 4 June 2003, section 6 e 109 Art. III 76(5)-(6) of the Draft Constitution. The Commission would continue to issue an opinion on the existence of an excessive deficit beforehand which would however be addressed to the Member State concerned rather than Council. 108

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ures to be taken by the Member State concerned. Yet, this also bears certain risks, as differences in opinions between these two Community institutions could stall the excessive deficit procedure. What is more, in the Draft Constitution the influence of the Commission has not been increased with regard to all decisions. In its current form, the Draft Constitution neither foresees an increased role for the Commission in the drafting of the Broad Economic Guidelines nor in the drafting of the recommendations to a Member State as part of the early-warning procedure. Moreover, the Council decision requesting a Member State with a persisting excessive deficit to take concrete measures and, thereafter, the decision to apply sanctions would continue to be based on a Commission recommendation only.110 5. Conclusion It has become apparent from the analysis of the development of the budgetary situation in the Member States in section III that the popular impression that the Stability and Growth Pact has turned out to be toothless and ineffective should be corrected. In comparison to a period of ten years ago, say, the fiscal situation in most Member States has substantially improved. Still, the recent experience has also shown that the rules in place do not bite enough, especially during the multilateral surveillance phase, to ensure that Member States forego an excessive deficit. While much of the critique at the Stability and Growth Pact refers to the excessive deficit procedure, it is currently submitted that proper multilateral surveillance is, perhaps, even more important. After all, as Gros puts it: “The motto should be rather early warnings than late sanctions”111 The structural deficiencies of the existing provisions on economic coordination in the EU find their roots in two characteristics. Firstly, the rules on economic co-ordination in EMU give the Member States in the Council a vast extent of discretion during each step of the procedures, thereby providing ample opportunities for political tinkering. Secondly, too many elements notably those referring to the medium term objective of a balanced budget or a surplus, are legally non-binding. As a consequence, it is relatively easy for Member States to disregard this objective. It has been argued that the root of the problem is that EU monitoring of the fiscal situation in individual

110

Art. III 71 (2) and (4), 76(7) of the Draft Constitution. In favor of a greater role of the Commission with regard to the broad economic guidelines cf. Wetenschappelijke Raad voor het Regeringsbeleid, Slagvaardigheid in de Europabrede Unie (Sdu Uitgevers, 2003), at 84. 111 Gros, “Should the Stability Pact be reformed?”, Briefing paper for the Monetary Committee of the European Parliament, December 2002, at 4.

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Member States is in the end done by the politicians responsible for these very situations. Peer review in the multilateral surveillance phase is not sufficient as the incentives for Member States to put pressure on another Member State are not strong enough. Member States also do not have sufficient incentives to take measures during the upswing of the business cycle to ensure that there is a sufficient safety margin during the downswing of the business cycle. In the words of Begg et al.: “What seems to bedevil the system is that political decisions on policy are dominated by national interest considerations, rather than the interests of the Euro Area as a whole.”112 Eijffinger is right in pointing out that “… in the end only a higher degree of fiscal integration would remove the inflexibility inherent in the recourse to predefined budgetary rules.”113 Indeed, the structural weakness of economic governance in the EU is the price which the Member States have to pay for retaining the competence over fiscal policy and – linked to this – the application of the open method of co-ordination. The proposals recently put forward by the Commission will not address the described shortcomings. Indeed, some elements of the proposals will only reinforce one of the current weaknesses of the Stability and Growth Pact, i.e. increase the vulnerability of the system to political manoeuvring. This is notably the case with regard to the proposals to take the business cycle and structural reform policies into account in assessing the Member States’ budget situation. Moreover, experience with the application of the multilateral surveillance procedure provides little reason to believe in the existence of a political consensus among the Member States represented in the Council to rigorously apply the existing rules. Neither additional lip services by the Member States in the form of a new Council Resolution, nor the reinterpretation of the existing provisions are likely to bring an end to the current situation. It is difficult to envisage how the existing Stability and Growth Pact could be revised or replaced by a different pact given that the key elements of the multilateral surveillance and excessive deficit procedure are defined by the EC Treaty and thus, primary Community law itself. Any secondary legislation based on these provisions and designed to shape their implementation could not reach beyond was has been determined in primary Community law. Thus, an effective revision would require an amendment of primary Community law in accordance with Art. 48 EU Treaty. Chances are that some Member States would take this as an opportunity to generally call into question the rationale of

112

Begg., Hodson and Maher, op. cit, at. 73. Eijffinger, “How can the Stability and Growth Pact be improved to achieve both stronger discipline and higher flexibility”, European Parliament Briefing Paper, November 2002, at 1.

113

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the existing approach to economic co-ordination in EMU. While addressing some shortcomings, in its current form, the Draft Constitution doe/s not fundamentally reform the existing system of economic coordination. Perhaps the view taken throughout this contribution is too pessimistic. As Begg et al. argue: “The answer lies in the progressive building of a common understanding and commitment. This will inevitably take time, as change will be incremental rather than dramatic. Equally, it would be wrong to expect too much too soon and a lack of hard evidence of change is not necessarily to be deplored in the short term.”114 However, if this process takes too long, it may undermine legitimacy, because co-ordination has to be seen to work to be legitimate.

114

Begg, Hodson, Maher, op. cit., at 75-76.

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