The New Economic Governance of the European Union: What is it and who does what?

Policy Brief Series Issue 4, Dec 2011

The New Economic Governance of the European Union: What is it and who does what?

Petr Blizkovsky 1

Key Points • •

• • •

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The crisis in public finance has triggered a change in the economic governance model of the European Union.

With regards to public finance, the change concerns the full implementation of the fiscal rules of the Stability and Growth Pact with new sanctions that are stronger than before and partly decoupled from political influence.

New legislative rules have been introduced to monitor the macro-economic evolution of the EU and to correct competitiveness slippages in the euro area.

New rescue facilities are aimed at creating a firewall to stabilise the euro area as a whole.

The new economic governance is developing towards a 'variable geometry' and multiple actors.

This means that a smaller number of Member States have committed to coordinating additional measures amongst themselves. Regular meetings of the Euro Summit were introduced. The EU27 remains the owner of the EU project.

Euro Aea members decided recently to institute a new 'reinforced economic union' to which another nine countries of the EU might adhere, the United Kingdom being the exception. This will be legally binding by primary law, meaning that it has power over national law.

1 Petr Blizkovsky is the EU Fellow at the Lee Kuan Yew School of Public Policy, National University of Singapore, and Director for Economic and Regional Affairs at the General Secretariat of the Council of the European Union. His email is blizkovsky@yahoo.com. The opinions expressed in the article are those of the author alone.

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Introduction Understanding the new economic policy instruments in the European Union is becoming a complex exercise. This brief aims to help with this undertaking. The brief does not cover the issue of saving the stressed euro-zone members with short-term actions. Rather, it looks at the long-term governance framework that is now becoming apparent.

The global financial crisis of 2008, followed by the public finance crisis in some EU member states in the ensuing years, has triggered the development of a new form of economic governance in the EU.2 Economic governance for the purpose of this article means a set of rules, procedures and bodies aiming at coordinating the economic policies of the EU. The rationale for economic governance in the EU context is significantly designed to avoid or minimise negative policy slippage by member states to minimise disruptions to the functioning of the monetary union.

The objective of the brief is to analyse the following aspects of EU economic governance:

• New rules, procedures and roles of the bodies involved • The variable geometry of participating member states • Scope for future developments The brief argues that the new EU economic governance is a continuation of the former economic policy design where member states keep their sovereignty in economic policy but goes further in three areas: an emphasis on implementing rules; expanding normative governance to new areas; creating grounds for closer voluntary coordination among member states. The most recent developments on 9 December 2011 go towards introducing stronger budgetary discipline among possibly 26 countries. However, the objective continues to be to focus on implementing these new

2 See Begg, I., Belke, A., Dullien, S., Schwarter, D. and Vilpisauskas, R. (2011), ‘European Economic Governance. Impulses for Crisis Prevention and New Institutions’, Europe in Dialogue 2011 / 12 Bertelsmann Stiftung, available at: http://www.bertelsmann-stiftung.de/cps/rde/xbcr/SID-3B5F55B518068E4F/bst_engl/Europe%20in%20Dialogue%2002%202011%20Economic%20Governance.pdf .

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‘primary law’ rules into the EU treaties as soon as possible, with the agreement of all EU members being necessary.

New rules: what has changed?

The new rule toolbox focuses on three areas: fiscal coordination, competitiveness-related measures and stability facilities.

The key policy architecture on fiscal coordination remains unchanged: fiscal coordination is built on the Stability and Growth Pact (SGP), agreed in the Treaty of Maastricht in 1992. The SGP requires member states to aim for a budgetary position close to balance, or in surplus, over the mediumterm during a period of normal economic growth. In addition, member states are obliged to avoid an excessive deficit exceeding 3 per cent of gross domestic product (GDP). Under the SGP, member states should also have a maximum public debt-to-GDP ratio of 60 per cent (Protocol 12 of the treaties). The problem has been that the deficit rule was not implemented accordingly and the debt criterion has not been enforced.

Subsequent to the Euro Summit of October 2011, the following amendments have been adopted and will take effect from January 2012: 3

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Where governments have a debt level exceeding 60 per cent of GDP, corrective measures are required, including a 5 percentage point reduction a year;

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Where rules are violated, the EU will impose stronger sanctions equivalent to a maximum of 0.5 per cent of the Euro Area member’s GDP (to be withheld as an interest-bearing deposit first, followed by a non-interest-bearing deposit and a fine if violations persist). On top of this, the member state must fulfil macro-economic conditions to qualify for the expenditure from the EU budget (regional funds).

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The imposition of sanctions can now occur ‘semi-automatically’ (at the political level, the Council can stop sanctions with a qualified majority, rather than imposing them as before).

3 The change consists of four new/amended laws: regulation amending regulation 1466/97 on the surveillance of member states' budgetary and economic policies; regulation amending regulation 1467/97 on the EU's excessive deficit procedure; regulation on the enforcement of budgetary surveillance in the euro area; and a directive on requirements for member states' budgetary frameworks. Texts of the regulations are available at www.consilium.europa.eu .

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National frameworks specify the required statistical and forecasting issues in order to implement rules correctly.

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As a political commitment, the euro area members have agreed to introduce debt-breaks in their constitutions or laws. 4

Following their decision on 9 December 2011 5, the heads of state or government of the Euro Area committed to creating a 'reinforced economic union' via an international agreement. The other nine countries (all of them except the UK) are considering joining this agreement. This new agreement should be signed at the latest by March 2012. The key effect of the new agreement would be to incorporate stricter fiscal rules into primary law. These rules would include the obligation for government budgets to be balanced (or in surplus) while structural deficits should not exceed 0.5 per cent of nominal GDP. Such a rule would also be introduced into the national constitutional (or equivalent) law. Under the new procedure monitoring excessive deficits, member states would also be obliged to submit an 'economic partnership programme' to the Commission and EU Council for endorsement. Such a programme would establish the necessary structural reforms to correct the deficit.

On competitiveness-related issues, the new instruments are both of a legislative and political nature. The rationale behind this is to enhance the competitiveness of the economics lagging behind.

The new measures comprise the following:

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Macro-economic imbalance surveillance and correction. 6 This is a completely new measure of a legislative nature. It sets up an alert mechanism based on a scoreboard of indicators, such as the current account, the real effective exchange rate, and private and public debt levels. In the event of imbalances, an excessive imbalance procedure is applied. If the euro area member fails to take effective measures in response to these red flags, a fine of 0.1 per cent of GDP is applicable (decided in the ‘semi-automatic’ manner described above).

4 Statement of the Euro Summit of 26 October 2011.

6 Two Regulations: on the prevention and correction of macroeconomic imbalances and on enforcement measures to correct excessive macroeconomic imbalances in the euro area. Available at www.consilium.europa.eu.

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Europe 2020, including the Integrated Guidelines. Under this scheme, the EU provides guidelines for the reform programmes to member states and monitors their implementation.

This is not a legislative measure but a performance measure based on political peer pressure. In addition to the Integrated Guidelines, there is the 'European semester'. This is a six-month period every year during which the Commission and Council analyse the budgetary and reform plans of each individual Member State. The Council then issues a recommendation to each Member State aimed at eliminating possible planned fiscal policy imbalances and shortcomings in the reform efforts. The aim is to reinforce coordination while major budgetary decisions and reform plans are still under preparation. Then there is the 'national semester', essentially the second part of the year, during which the national authorities adopt their budgets and reform bills after taking into account the recommendations from the EU.

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The Euro Plus Pact 7 is the voluntary political commitment of the euro area members (plus six non-euro area countries) on additional reforms. This non-legislative instrument is under the direct scrutiny of the heads of state or government.

With regards to stabilisation instruments, several facilities have been established to both assist member states under sovereign debt stress and to protect the euro area as a whole. 8 The facilities differ in their respective legal natures (categorised immediately below): •

Created by the European Union: The European Financial Stabilisation Mechanism (EFSM) is financed by a budget of 60 billion euros (currently being used to assist Ireland).

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Created by Member States: This comprises the Balance of Payment (BoP) assistance and the European Financial Stability Facility (EFSF). The BoP is currently being used to assist Greece. The EFSF is being created under private law and should comprise a 440 billion euro effective lending capacity that can be leveraged up to 1 trillion euros. It is being fortified with more funds. This facility will ultimately be replaced by the permanent facility below.

7 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/120296.pdf 8 Verhelst, S. (2011), ‘The Reform of European Economic Governance: towards a Sustainable Monetary Union?’, Egmont - The Royal Institute for International Relations, Brussels, available online: http://www.egmontinstitute.be/paperegm/ep47.pdf .

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Created by an international treaty: The European Stability Mechanism (ESM) is expected to take effect in mid-2012. 9 It will benefit from a maximum lending capacity of 500 billion euros.

Apart from this, in the financial sector, a new European system of financial supervision has been in place since January 2011. It consists of three agencies (for banking, for securities and markets, and for insurance and occupational pensions) plus a European Systemic Risk Board for systemic threat warnings.

Governance: Who does what?

One feature of the new economic governance of the EU is that it is becoming more complex. This is because the sovereignty for conducting economic policies remains primarily at the member state level. That is why any additional commitment requires agreement by all members, and why only some members are willing to participate in the additional voluntary measures. This creates a situation where the core rules are applicable and binding for all 27 member states, while the additional instruments only apply to a small number of them. In essence, there is a ‘flexible geometry’ approach, meaning that various groupings of a smaller number of Member States are committed to more measures. Table 1 presents an overview.

9 Treaty Establishing the European Stability Mechanism, website of the Council of the European Union, http://www.consilium.europa.eu/policies/council-configurations/economic-and-financial-affairs/theeurogroup.aspx?lang=en .

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Table 1: Actors in the economic governance of the European Union Participating Member States 27

17

Body

Role, Instrument

Presidency

European Council Council European Parliament

Policy guidance Legislator/Co-legislator Co-legislator

Fixed term

European Systemic Risk Board

Risk warnings

ECB President

Euro Summit

Policy guidance, decisions

Fixed term

Eurogroup

17

Informal meeting, guidance of the Euro Area

Rotating Fixed term

Fixed term

European Central Bank

Monetary policy

Fixed term

European Financial Stability Facility board meeting

European Financial Stability Facility decisions

Economic and Financial Committee of the EU Chair (EFC)

16

Ad hoc facility

Assistance to Greece

Eurogroup Chair

23 plus

Euro Plus Pact meeting

Euro Plus Pact, open to observers

Euro Summit Chair

17 plus

European Stability Mechanism board

European Stability Mechanism decisions, open to other Members

Eurogroup

Binding rules on budgetary discipline

Not applicable

26*

‘Reinforced economic union’

Chair

or

election

* To be confirmed, under preparation, to be signed before end-March 2012

Scope for Change and Development To date, the European Union represents the most developed and deepest form of macro-regional cooperation in existence. The sharing of sovereignty among member states is without parallel. This arrangement implies heavy negotiations, including the involvement of 27 parliaments. A decision of the Euro Area members on stricter budgetary discipline rules based on primary law creates an important new dimension. A further nine countries are considering joining this initiative. The objective remains to incorporate these bolstered rules into the EU treaty as soon as possible once all 27 member states agree to it.

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The new governance described above corresponds to the maximum number of participants achievable at the moment. The key improvement is the implementation of the old rules of the SGP, which are sound.

Conclusion The current debt crisis is the most serious test the euro area has encountered since its creation, with political repercussions. It also triggered a series of high-level negotiations at the level of Heads of State or Government of the 27 EU Member States, as well as of the 17 euro-area countries. As a result, economic governance was reinforced. The member states continue to uphold sovereignty in economic policy but agreed to strengthen three areas: implementing fiscal rules; expanding normative governance to new areas; and creating grounds for closer voluntary coordination among member states.

The decision to create a closer reinforced economic union will support the economic governance of the euro. The weeks and months ahead will be crucial for implementing the decision taken and ensuring the stability of the euro area as a whole.

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 and Dissemination at the Research Support Unit.

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