Does ‘the Golden Rule’ Translate into ‘Golden’ EU Economic Governance?

Policy Brief Series Issue 7, April 2012

Does ‘the Golden Rule’ Translate into ‘Golden’ EU Economic Governance?

Petr Blizkovsky

1 2

Key Points • On 2 March 2012, 25 EU Members signed the new Treaty on Stability, Coordination and Governance.

• Arguably, this new treaty is a stronger instrument for fiscal discipline than the EU framework.

• The new structure of economic governance has the potential to push EU countries towards needed structural reforms. As such, it is a huge asset. However, the main challenge for EU economic governance remains its implementation.

1

Petr Blizkovsky is Director of Economic and Regional Affairs at the General Secretariat of the Council of the European Union. He is currently EU Fellow at the Lee Kuan Yew School of Public Policy at the National University of Singapore.

2 The opinions expressed in this article are those of the author alone.

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Introduction There has been some good news in EU crisis management: the approach to solving the Greek crisis passed its first test in mid-March 2012 with a nod to the largest ever debt restructuring, aimed at reducing the country’s debt to below 120 per cent of gross domestic product (GDP) in 2020.

Moreover, Italy’s interest rates spreads, a measure of the risk of lending to a debt-laden country, have gone down as a result of the reform effort of the government. In terms of governance responses to the crisis, various policy adjustments have been decided in the EU. 3 They comprise new fiscal rules, improved macro-economic surveillance within the EU and in the Euro Area, and new financial assistance schemes.

However, at both the national and regional levels, real change is dogged by the challenge of implementation.

This policy brief assesses two key points related to the restoration of economic stability and strength in the EU. The first relates to the economic and legal consequences of the new fiscal rules.

The second is linked to the macro-economic imbalances within the EU vis-à-vis growth-related EU policies.

New fiscal rules: business as usual?

On 2 March 2012, the 25 EU Members signed the new Treaty on Stability, Coordination and Governance (TSCG). 4 Its major innovations are the strengthening of EU fiscal rules beyond existing rules, its primary-law nature and the fact that it commits 25 out of the 27 EU Members (all but the United Kingdom and the Czech Republic). The TSCG stipulates new obligations and plans are afoot for it to become part of the EU legal system as soon as possible (agreement by all EU Members is required). In the meantime, the TSCG uses institutions such as the European Commission and the European Court of Justice for its implementation.

Let’s look at the detail of the strengthening of fiscal rules. The EU Treaty defines the budget deficit rule in relation to a nominal deficit of 3 per cent of GDP (Protocol 12 to the EU Treaties). The 3

See Blizkovsky P. (2011) ‘The New Economic Governance of the European Union: What is it and who does what?’, Policy Brief Series, Issue 4, December 2011, Lee Kuan Yew School of Public Policy.

4 Treaty on Stability, Coordination and Governance, text signed on 2 March 2012 by the Heads of State or Government. http://european-council.europa.eu/eurozone-governance/treaty-on-stability.

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secondary EU legislation, following the revision of the Stability and Growth Pact (SGP) in 2005, introduced the notions of a ‘structural deficit’ 5 and ‘the medium term objective’ (MTO), making the SGP more anti-cyclical, stricter in good economic times and lighter in economic downturns. A subsequent modification of the SGP’s implementation rules (together with new rules on macroeconomic surveillance) entered into force in 2011 and is known as the ‘6 pack’. 6 The TSCG, which legally speaking is not an EU instrument, is constructed in line with the logic of the revised SGP of the EU and there is no legal or policy incompatibility between the TSCG and the EU rules. However, the TSCG’s fiscal rule ambition goes beyond the existing EU rules in the following ways:

•

On deficit-rules. It requires participating countries to respect ‘the golden rule’, defined as limiting the annual structural deficit of the general government to below 0.5 per cent of GDP. The rules ‘shall be deemed to be respected if the annual structural balance of the general government is at its country-specific medium-term objective, as defined in the revised Stability and Growth Pact, with a lower limit of a structural deficit of 0.5 per cent of the gross domestic product at market prices’ (Art. 3 [1b], TSCG). In comparison, the EU rules are less strict as the limit for structural deficits are 1 per cent or less of GDP.

•

On exceptions. There are two exceptions to the above rule. One is related to exceptional circumstances such as an ‘unusual event outside the control’ of the country or ‘periods of severe economic downturn’ as defined in the EU rules (Art. 3 [3b], TSCG). Here the country can temporarily deviate from its MTO. The other exception is linked to a country exhibiting a low debt level, which can have a structural deficit up to 1 per cent of GDP. Such a country is defined as one ‘where the ratio of the general government debt to gross domestic product at market prices is significantly below 60 per cent and where risks in terms of long-term sustainability of public finances are low’ (Art. 3 [1d], TSCG).

•

On debt-rule. The TSCG requires its Members to incorporate into their national legal system an obligation to cut annually one twentieth (in other words 5 per cent) of that part of their public

5

‘Annual structural balance of the general government’ refers to the annual cyclically-adjusted balance net of one-off and temporary measures, TSCG, Art. (3).

6 European Union (2011) Official Journal of the European Union, L 306, Vol. 54, 23 November 2011, Luxembourg.

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debt which is exceeding 60 per cent of the GDP (60 per cent/GDP is the SGP threshold). This requirement is identical to EU rules set out in the ‘6 pack’.

•

On implementation. The TSCG ‘golden rule’ of a balanced budget is intended to be incorporated into national legislation ‘through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national budgetary processes’ (Art. 3 [2], TSCG). This incorporation is to happen within one year of the TSCG’s entry into force (expected to be 1 January 2013). Signatories are obliged to put in place national automatic correction mechanisms in case of deviation from the agreed rules. The principle of such mechanism will be proposed by the European Commission.

•

On enforcement. The European Court of Justice on its own initiative or at the request from the European Commission or a TSCG member can judge a lack of incorporation of the golden rule into the national legal system in due time. A possible penalty is foreseen of up to 0.1 per cent of the GDP of the country in question. No specific sanction is foreseen in relation to the debt-rule.

Table 1: Comparison of the fiscal obligations under EU secondary (6 pack) legislation and under the Treaty on Stability, Coordination and Governance EU rules (‘6 pack’)

TSCG Rules

Comment

Criteria for budgetary position Each EU Member State shall have a differentiated Annual structural deficit No difference medium-term objective (MTO) for its budgetary to be in line with the position. The MTO is revised every 3 years or in the MTO (Art. 3 [1b]) event of the implementation of a structural reform with a major impact on the sustainability of public finances (Regulation 1175/11 7 amending Regulation 1466/97, Art. 2 [a]) Annual evaluation of sufficient progress towards the MTO - based on Stability Programme submitted by MS (Regulation 1175/11 amending Regulation 1466/97, Art. 3 [1])

7

Regulation of the European Parliament and of the Council amending Council Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies.

Page |5 Annual structural deficit should remain within the Annual structural deficit Stricter threshold range between 1 % of GDP and balance or surplus not to exceed 0.5% of (Regulation 1175/11 amending Regulation 1466/97, GDP (Art. 3 [b]) Art. 2 [a]) Cases where deviation from above rules is acceptable In the case of an unusual event outside the control of the Member State concerned which has a major impact on the financial position of the general government (Regulation 1175/11 amending Regulation 1466/97, Art. 5)

Exceptional economic Similar definition but circumstances or severe stricter threshold economic downturn in the Euro Area or the EU (Art. 3 [1c])

In periods of severe economic downturn for the Euro Debt level below 60% of Area or the Union as a whole (Regulation 1175/11 GDP (Art. 3 [1d]), but annual structural deficit amending Regulation 1466/97, Art. 5) must not exceed 1% of GDP

Enforcement Commission warning, Council Recommendation in case of deviation from the MTO or the adjustment path to it, recommending deadline for correction (Regulation 1175/11 amending Regulation 1466/97, Art. 6 [2])

Rules embedded in Parallel mechanism, to be national law of the triggered before the EU one above budgetary-law power (Art. 3 [2])

Semi-automatic sanctions (interest-bearing Automatic correction deposit of 0.2% of GDP) in case of non- mechanism in case of deviation from the compliance (Regulation 1173/11 8, Art. 4) MTO or the adjustment path to it (Art. 3 [1e] and 2) Semi-automatic sanctions (non-interest-bearing deposit of 0.2% of GDP) in case of noncompliance (Regulation 1173/11, Art. 5) European Court ruling Semi-automatic sanctions (fine of 0.2 % of GDP) power, penalty shall in case of non-compliance (Regulation 1173/11, not exceed 0.1 % of 8

European Union (2011) Regulation of the European Parliament and of the Council on the effective enforcement of budgetary surveillance in the euro area. Official Journal of the European Union, L 306, Vol. 54, 23 November 2011, Luxembourg.

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GDP (Art. 8)

Note: based on the internal analysis of A. Jaschke, Council Secretariat, unpublished and updated as of March 2012.

Stijn Verhelst argues that the TSCG represents a major change in the Euro Area's fiscal rules.9 He points out that the relevance of the 3 per cent nominal deficit to GDP as defined in the EU Treaty (but in reality also the rules based on the structural deficit threshold) will be less relevant in normal times due to the ‘golden rule’ of the TSCG. Also the likelihood of nominal deficits exceeding the 3 per cent threshold in economic downturns would be less pronounced. On top of this, the same author demonstrates how the nominal growth rate and the debt-to-GDP ratio of a country determine whether the debt-reduction rule or the ‘golden rule’ will be more effective. He concludes that the TSCG’s ‘golden rule’ would prevail in almost all economic circumstances. Therefore, the ‘golden rule’ is supposed to be activated first to prevent fiscal imbalances of the given country. The debt-reduction rule would be more rigorous only for countries with very high debt-to-GDP ratios and very low growth (see Figure 1).

Figure 1: Comparison between the golden rule and the debt-reduction rule

225 200

Debt-to-GDP (in %)

175

Debt-reduction rule more stringent

150 125 100 75

‘Golden Rule’ more stringent

50 25 0 0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

3,5%

4,0%

Nominal Growth (real growth and price increases)

9

Verhelst S. (2012) ‘How EU fiscal norms will become a safety net for the failure of national golden rules’, European Policy Brief, N° 6, January.

Page |7 Source: Stijn Verhelst, European Policy Brief, No. 6, January 2012

The conclusion, in terms of governance, is that the new fiscal rules under the TSCG are based on and compatible with the EU rules but go further both in terms of fiscal objectives and enforcement.

The EU fiscal rules (based on the EU Treaties and on the ‘6 pack’ secondary legislative rules) would merely become a safety net to be triggered in the event that the ‘golden rule’ are not effectively implemented. Thus the change in fiscal rules is fundamental (Table 2).

Table 2: Order of Likelihood of activation of the fiscal instrument (likely order of economic severity of the instrument) Decision on sanction

Participating Member States

European Court of Justice

25 (does not include UK, CZ)

N/A

N/A

25 (does not include UK, CZ)

From the interest-bearing deposit of 0.2% of GDP to a fine of 0.2% of GDP

Council (reverse QMV)**

27, sanctions to 17 (Euro Area) only

Council (QMV)

27, sanctions to 17 (Euro Area) only

Order

Legal basis

Instrument

Parameter

Sanction

1

TSCG

Golden rule

Structural deficit 0.5% of GDP

2*

TSCG

Debt rule

1/20th annual reduction of debt above 60% of GDP

3

EU secondary legislation

6 pack

Adjustment to MTO (preventive part) and excessive structural deficit over 0.5% of GDP

4

EU primary legislation

TFEU***, ‘Nominal’ deficit below 3% Up to a fine of an Art. 126, of GDP appropriate size Protocol 12

below Penalty up to 0.1% of GDP (lack of incorporation of the rule into the national legal system)

* Note that a similar debt rule is also part of the ‘6 pack’ rules ** The Council can stop rather than impose sanctions by qualified majority, making the enforcement almost automatic ***Treaty on functioning of the European Union

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Macro-economic surveillance and growth issues Apart from fiscal discipline, the new economic governance of the EU aims at addressing growthfriendly reforms in the Member States and macro-economic imbalances within the EU and specifically within the Euro Area. The problem here is linked to the fact that the EU Treaty fundamentally leaves the handling of these issues at the national level. However, both sufficient economic growth and elimination of excessive imbalances are preconditions for solving the debt crisis, thereby ensuring the EU economic model and a sustainable functioning of the currency area.

Therefore, four governance instruments have been adopted within the new economic governance to strengthen this dimension: 1. The European Semester as a tool for stronger community involvement in the preparation of national budgets. This combines Broad Economic Policy Guidelines and the review of the Stability or Convergence programmes in a single text for each Member State and is of a policy recommendation nature.

2. Europe 2020 as an EU instrument providing annual guidelines to its Members and the EU as a whole on structural reforms. It is linked to the European Semester and Euro Plus Pact (see point below).

3. The Euro Plus Pact 10 as a political commitment of 23 Member States to increasing competitiveness, fostering employment, reinforcing financial stability, and improving the state of public finances, especially in the pension sector. It also aims – to the extent possible – at tax coordination.

4. A legally binding surveillance framework for the monitoring and correction of excessive imbalances, and an alert mechanism with sanctions (part of the ‘6 pack’ rule). The objective is to prevent potentially harmful imbalances within the EU.

10

Conclusions of the European Council of 24-25 March 2011, http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/120296.pdf .

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The first implementation test came recently for the surveillance of the excessive imbalances as the European Commission issued in February 2012 the first Alert Mechanism Report.11 Economically speaking, the Report is based on five external imbalance indicators (current account balance, international investment position, real effective exchange rate, export market share, nominal unit labour cost) and on five internal imbalance indicators (house prices, private credit flow, private sector debt, general government debt, unemployment rate). The scoreboard identified 12 Member States (apart from the four ‘programme’ countries, Greece, Ireland, Portugal and Romania) where the level of imbalances were deemed to demand more in-depth analysis by the Commission. In the event of a conclusion by the in-depth studies (which are due to be submitted by the European Commission for individual countries in May 2012) that the imbalances pose a serious risk, the next step would be a proposal from the Commission and a recommendation by the Council to the relevant Member States based on the preventive or corrective arms of the procedure. In theory, sanctions could apply where Euro Area members fail to take effective action.

Conclusion The economic crisis has triggered a substantive revision of EU economic governance, with new fiscal rules within the EU more automatic and detached from political judgement. In addition, the new inter-governmental fiscal rules go beyond EU rules, both with the strictness of the parameters and in the legal force.

The commitments of the EU countries to realise the pro-growth structural measures are based on incentives and peer-pressure. This approach has been strengthened and the legally binding surveillance of macro-economic imbalances is a strong new tool in this regard.

The following conclusions can be therefore made: •

Overall, the new EU economic governance toolbox looks promising. The fact that there is external pressure from the supranational level can be seen as a catalyst for reforms which would otherwise be more difficult.

11

European Commission (2012) Alert Mechanism Report. Report from the Commission, Brussels, 14. 2. 2012, COM(2012) 68 Final, 20p.

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•

With greater specificity and clearer legal framework, the new treaty is a stronger instrument for fiscal discipline than the EU framework.

•

However, the perennial issue is of course implementation and carrying out painful measures and restoring confidence will be a real test for the EU.

The Lee Kuan Yew School’s Briefing Room Series is edited by Toby Carroll, Senior Research Fellow at the Centre on Asia and Globalisation, and Claire Leow, Senior Manager for Research Dissemination at the Research Support Unit.

Feedback should be sent to: research.lkyschool@nus.edu.sg