Thematic Briefing #2/2016: The Stability and Growth Pact

BACKGROUND

EuVisions
EuVisions
Nov 4, 2016 · 9 min read

Fiscal policy monitoring and coordination represents a tough matter of contention in European politics. Issues related to the degree of budgetary flexibility that should be accorded to EU Member States, and particularly to euro countries, are by no means new in Brussels. Yet, the Eurozone crisis has significantly contributed to providing these issues with great political salience. European institutions have long tried to constrain the fiscal conduct of EU Member States, among other things in order to prevent the ability of governments to exert excessive inflationary pressures on the European economy. They have done so by setting fiscal standards whose legal basis is provided by the Stability and Growth Pact (SGP). Among the different provisions of the SGP, the most disputed one is the Excessive Deficit Procedure (EDP).

The issue of budgetary discipline and its enforcement finds its very first roots in the 1992 Maastricht Treaty. The treaty limited countries’ budget deficit to 3% of Gross Domestic Product (GDP) and public debt levels to 60%: these limits were part of the criteria aimed at favouring the economic convergence of EU Member States. In 1997 EU Member States agreed to strengthen the monitoring and coordination of national fiscal and economic policies to enforce the deficit and debt limits established by the Maastricht Treaty. Thus, the SGP was signed, with Germany being the moving force behind the arrangement. The pact envisaged heavy sanctions (up to 0.5% of GDP) for countries not abiding by its preventive or corrective rules. Ironically, the first test case on the effectiveness of the SGP was Germany itself, together with France: in 2003, in a time of economic stagnation for the two major Eurozone economies, both of them violated the 3% of GDP budget deficit limit. Notwithstanding EU Commission President Romano Prodi’s initial tough stance on the obligation to stick to the rules, the Eurozone’s finance ministers suspended disciplinary action against the two coutnries, and the Commission eventually did the same. This experience led to a reform of the SGP in 2005 following a the French-German initiative, which made the enforcement of the 3% and 60% rules more flexible across a range of areas and cases (for instance, by eliminating EDP in case of negative growth and setting longer deadlines for the EDP procedures).

This trend towards greater flexibility was dramatically reversed in 2011. After the outset of the Eurozone crisis the European Parliament passed a series of six budget laws — the so-called “six-pack” — intended to make it harder for Eurozone countries to ignore EU warnings, giving more powers to Brussels in policing debt and allowing stricter implementation of the SGP. The “six-pack” was later strengthened by an inter-governmental treaty signed by 25 EU Member States on 2 March 2012 (the United Kingdom and Czech Republic opted-out), known as the Fiscal Compact. Among other things, the treaty required member states to insert a balanced budget rule into their constitutions or ordinary law. Only very recently have some openings been made by the European institutions, most notably with the Commission’s interpretative communication of January 2015 aimed at softening the stance towards countries coping with the refugee crisis. Yet, these developments have not put a brake on the conflict over budgetary discipline at the European level.

POLITICAL FAULT LINES

As a matter of fact, no country so far has been fined for violating the rules of the SGP. However, a great degree of disagreement on the interpretation of these rules has existed since the outset of the Eurozone crisis. The toughest stance has been promoted by Germany. The country’s position can be summarized with the words of German Finance Minister Wolfgang Schäuble, a longstanding sceptic on the relaxation of fiscal criteria: “the Stability and Growth Pact provides sufficient flexibility. It’s doesn’t stand in the way of structural reforms; quite the opposite, it promotes them”. A similar stance has been taken by other northern European countries, such as the Netherlands: Dutch finance minister and Eurogroup chair Jeroen Dijsselbloem has expressed serious concerns on the interpretation of flexibility rules and warned the EU Commission against “not entirely objective” applications of the SGP. These positions have been only partly counterbalanced by another influential German policy-maker, German Vice-Chancellor Sigmar Gabriel, who has always seemed more open to according EU countries more time and flexibility to meet the bloc’s deficit targets, as long as they maintain their commitment to reforms. In a rather median position, German Chancellor Angela Merkel has often tried not to take a conflictual stance on the issue, while being reluctant to make overt concessions and arguing that “the Stability Pact has quite a lot of flexibility that can be used in a clever way. That is the responsibility of the Commission — it’s not one Member State that decides vis-à-vis another”.

Against the generally rigid stance of Northern European countries, another coalition of EU Member States has increasingly advanced requests for greater flexibility. In the past couple of years socialist leaders all around Europe have called for less budgetary constraints. The leadership of this coalition was initially taken by France’s President François Hollande: in 2014 he demanded further leeway in meeting France’s twice-delayed EU budget deficit target of 3% of output in 2015, and called for a special summit of Eurozone leaders to design a growth plan for Europe that would “go further” than the three-year, €300bn investment project promised by Jean-Claude Juncker. However, once France was granted two additional years to correct its budget deficit, Hollande’s priorities shifted to domestic politics. The initiative to soften debt reduction targets then saw a new protagonist in Italian Prime Minister Matteo Renzi. Facing the deterioration of the refugee crisis and with an increasingly Eurosceptic Italian public opinion, Matteo Renzi has recently engaged in a battle against the Commission to relax budgetary discipline, particularly stressing his request to remove refugee crisis costs from the computation of Italy’s deficit, and arguing against the negative effects of budgetary austerity on economic growth. Renzi’s strategy seems to have worked so far, for in the first part of 2016 the Commission granted Rome greater room for manoeuvre in the review of national budget policies.

More troublesome has been the trajectory of the fiscal monitoring of Spain and Portugal, who have been under EDP since 2009 due to recurrent fiscal holes. In the summer of 2016 the Commission threatened them with huge fines, wielding for the first time its disciplinary powers over member states’ budgets. However, after long and acrimonious disputes, the Commission made a drastic turnabout and decided that Spain and Portugal should not be fined for failing to take “effective action” to correct their budget deficits in light of “the challenging economic environment, both countries’ reform efforts and their commitments to comply with the rules of the SGP.”

Greece is yet a different case, for there budgetary flexibility is heavily constrained not so much by the SGP but by the conditions imposed by international creditors. Yet, it is worth noting that, in the face of the problems raised by the refugee crisis, Germany has manifested a certain willingness to grant Greece greater leeway in the country’s overhaul of its pension system. Finally, another (unexpected) addition to the pro-flexibility coalition has been that of Hungarian Prime Minister Viktor Orban, who is no stranger to urging EU officials to ease fiscal pressure on Budapest.

WHAT’S NEXT

The latest concessions of the Commission to Spain and Portugal and the evident difficulty for European institutions to enforce budgetary discipline via sanctions have not put an end to the controversies related to fiscal monitoring. The recent confrontation between the Italian government and the European Commission is illustrative of the persistent frictions around the SGP. The Italian government has been stepping up its anti-Brussels rhetoric after unveiling an expansionary 2017 budget ahead of the country’s constitutional referendum, which will take place on December 4; fiscal expansion has been justified on the basis of the recent earthquakes and the migrant crisis. After receiving a letter from the European Commission demanding “clarifications” from Italy concerning its 2017 budget, Matteo Renzi has threatened to veto the EU’s own budget over a lack of solidarity from the rest of Europe, as the bloc struggles to manage the refugee crisis.

Even though the Commission’s demands for clarification are very unlikely to lead to sanctions, these tensions and threats of inter-governmental impasse show the fragility of the European mechanism of fiscal monitoring, especially since it is not matched by adequate answers to the question of growth and investments. What may ultimately play a decisive role in the matter is the definition of new and viable approaches which combine debt reduction and the stimulation of growth in EU Member States. From this point of view, the launch of Juncker’s Investment Plan, while no panacea, may start providing some answers to overcome what many regard as a trade-off between austerity and growth: Italy would be the first country to benefit from it, and this might effectively contribute to lessening the spread of the anti-Brussels rhetoric across Europe.

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Originally published at EuVisions.

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