Whither EU Fiscal Rulemaking?
On November 9, 2022, the European Commission published a blueprint for reforming the European Union’s economic-governance framework
Among other things, the document envisions a more integrated approach to EU economic surveillance, strengthened national ownership, simplified rules for governing fiscal risks, and better enforcement of those rules. But the details of the proposal raise doubts about the feasibility of achieving these goals. Specifically, the fiscal component of the proposed framework leaves three fundamental questions unanswered.
The first question is whether the new rules would prevent sovereign insolvency. As of 2021, seven eurozone countries had general government gross debt exceeding 100% of GDP, which means that it is only a matter of time before financial markets become nervous about some countries’ debt sustainability. But the Commission’s proposed method of dealing with excessive debt is even more lenient than the old one under the Stability and Growth Pact (SGP).
The blueprint rejects the previous «1/20th rule» for debt reduction on the grounds that requiring governments to cut their debt each year by 1/20th of the excess above 60% of GDP is too demanding. Instead, the Commission wants member states with «substantial» or «moderate» debt challenges to negotiate a medium-term fiscal plan that will include a downward debt trajectory. The document neither elaborates on the speed of the fiscal adjustment – that will be detailed later in the methodology for debt sustainability analysis (DSA) – nor specifies the criteria for categorizing debt challenges as «substantial», «moderate», or «low».
A second question concerns the blueprint’s promise of greater simplicity. The old rules were criticized for being too complicated, and for relying on fuzzy categories such as potential output or cyclically adjusted fiscal positions. Since these indicators are hard to measure and forecast, producing them has consistently given rise to arbitrary assumptions and methodological doubts.
Here, too, the new framework would take things even further in the wrong direction. Member states are to present a medium-term fiscal program based on a multiannual adjustment path that the Commission will provide after conducting a DSA. These proposals will then be negotiated with the Commission before receiving final approval from the Economic and Financial Affairs Council (ECOFIN).
At first sight, this approach looks attractive, because it departs from the current one-size-fits-all practice. But, given the mandatory nature of fiscal-adjustment programs backed by potential sanctions, a more individualized approach will inevitably lead to much more bargaining between member states and the Commission (and potentially ECOFIN). After all, many different assumptions and variables could factor into negotiations – from the DSA, the fiscal-adjustment path, and its impact on growth, to other factors such as macroeconomic conditions and special fiscal needs (like those relating to the green transition).
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Complicating matters further, the new surveillance framework will operate largely on the basis of forecasts, whereas the old SGP primarily monitored actual variables. Obviously, economic projections can be subject to all manner of errors and faulty assumptions. More to the point, they cannot predict unexpected shocks.
Given the need to shape fiscal policy according to approved medium-term fiscal programs (with potential sanctions for delivery failures), member states will have strong incentives to negotiate for less ambitious adjustment paths, and to suggest rosier macroeconomic forecasts. And while the Commission will try to push for more ambitious paths to avoid the risk of fiscal crises, member states will have the informational advantage in this overly complex process, because they know domestic conditions better than anyone else. And we already know from experience that larger, politically influential member states will tend to receive favorable treatment.
The third question concerns the lack of political appetite to enforce fiscal rules. Between 1997 (two years before the euro’s introduction) and 2021, the general government deficit exceeded 3% of GDP (the maximum level established by the Treaty of the Functioning of the European Union) in eurozone countries in 143 out of 394 observations. Greece and Portugal each breached the deficit ceiling in 18 of those years, while France did so in 17, and Spain in 12.
Similarly, general government gross debt exceeded the 60%-of-GDP limit of 229 times out of 394 observations. Austria, Belgium, Greece, and Italy never recorded a gross debt below the threshold, and France did so only twice (in 2000 and 2001). Portugal’s debt exceeded the limit for 20 years, and Germany’s did so for 19 years. The number of eurozone members with debt above 60% of GDP grew steadily, to 12 out of 19 in 2021.
More importantly, despite the numerous breaches of the Treaty’s deficit and debt limits, the financial sanctions envisioned in the SGP were never adopted. Clearly, eurozone member states have a collective-action problem that any debate about future fiscal discipline will need to address head-on. (In this light, the Commission’s proposal for introducing reputational sanctions also looks problematic, both in terms of potential efficacy and political acceptance.)
Fiscal discipline is essential for euro stability, and for financial and macroeconomic stability in the EU more broadly. Any new framework must minimize the risk of cross-border negative spillovers and contagion, discourage free riding, and address the risk of moral hazard. Unfortunately, the Commission’s new proposals fall far short.
Marek Dabrowski, a non-resident fellow at Bruegel, is a visiting professor at the Central European University in Vienna and a fellow at the Center for Social and Economic Research in Warsaw. He was first deputy minister of finance under Poland’s first post-communist government.