Finally a eurozone budget, probably the wrong one

A eurozone budget is an idea whose time, at last, may have come. But what is on the table contains familiar flaws.

The Eurogroup meeting of October 9th reached a detailed agreement on a budgetary instrument for convergence and competitiveness (BICC)—in short, the long-awaited eurozone budget.

The eurozone is in dire need of a budgetary instrument which paves the way to rebalancing growth opportunities in a continent plagued by persistent macroeconomic imbalances, productivity gaps and, consequently, growing inequality. In particular, countries still struggling to achieve full recovery after ten years of sluggish growth, or in the middle of an economic downturn, need to be helped to stay the course of productivity-enhancing reforms and public investment.

But the terms of the agreement create serious cause for concern. The problem lies in the redistributive conflict among Eurozone members which the BICC’s governance structure is likely to spark.

‘National ownership’

The instrument is meant to support ‘structural reforms’ and ‘public investment’ through awarded grants. The size of the grants is predefined, with a 25 per cent national co-financing rate, to set a limit on the budget’s redistributive effect and guarantee ‘national ownership’ of—and therefore true commitment to—the reform and investment projects.

As of the final agreement reached at the Eurogroup meeting, the Euro Summit and Eurogroup will give annual strategic guidelines on key reform and investment priorities, whicht will feed into ‘strengthened Euro Area Recommendations’. Member-state proposals will be assessed by the Eurogroup on the bases of the European Commission’s ‘initial feedback’, with the latter giving final approval.

The final iteration of the BICC’s governance structure is an improvement on the June version, which assigned only a minor role to the commission. In the first draft, the Eurogroup would also assess progress on reform paths and, through this, decide on the disbursement of further grant instalments (the final version does not mention monitoring, which leaves us in doubt as to which mechanism will apply in the end). The strictly intergovernmental structure foreseen in the first version would have been much more at risk of sparking political conflict among eurozone partners.

Implications

Such a design for the eurozone budget has three implications. First, member states are likely to see funds as national contributions with a redistributive effect. Secondly, some states will be long-term net contributors, while others will be long-term net recipients, as allocation will be based on population and (the inverse of) per capita gross domestic product. And, thirdly, intergovernmental entities will play a decisive role in determining how the budget has to be spent at the national level, as the final agreement foresees that member states’ proposals should be ‘linked to the National Reform Programme’ and ‘compatible with the national budgetary process’, with approval depending on ‘the previous year’s Country Specific Recommendations’ (CSR).

At first sight, this all looks correct, as common resources will be used according to common priorities while reducing moral hazard to the extent that funds are set to encourage structural reforms and compliance with budgetary rules. Additionally, if a net contributor wants to reduce the BICC’s redistributive effect, it will be incentivised to promote measures that improve the recipient’s GDP per capita. Therefore, the BICC seems to be in the best position to promote actual convergence.

Nevertheless, this represents, in fact, a risky structure of incentives with potentially perverse effects. First, net contributors are likely to have a much stronger voice than net recipients. Therefore, they will also have a decisive say on the design of the structural reforms to be implemented at national level. Secondly, they will have an incentive to reduce their overall exposure to other members’ systemic risks. Therefore, net contributors will have an interest in privileging structural reforms that are likely to achieve such an effect.

Thirdly, the BICC’s endowment will have to be determined during the Multiannual Financial Framework negotiations. Therefore, net contributors will easily be able to trade off the BICC’s size against their own reform preferences.

Austerity policies

We have already seen what happens in the presence of such a clash of diverging national interests. It is the same constellation as led to the austerity policies supervised by the ‘troika’—of the commission, the European Central Bank and the International Monetary Fund—in countries under financial assistance, in which cost reduction, and in particular downward flexibility of the cost of labour, was key to all implemented structural reforms. This would be a disappointing result, as well as a setback for those governments and experts who have fought for the idea that there is more than one path to competitiveness and fiscal consolidation.                            

Indeed, such an arrangement risks strengthening the eurozone’s bias towards supply-side approaches to structural reforms. Welfare provisions and collective bargaining will still be seen as factors which hold back adjustment in tough times and reduce growth potential in good times, and the role of both internal and eurozone-wide demand in economic recovery will continue to be downplayed.

Thus far, the impact of such a dominant orientation towards economic policies has been tempered by the complex negotiations which accompany the European Semester, the non-binding nature of the European Council’s Broad Economic Policy Guidelines and the loose implementation of CSR.

Democratic control

This could, however, change rapidly if the Euro Summit’s guidelines for structural reforms become a requirement for drawing on the eurozone budget. As desirable as it might be to have effective rules, the proposed framework could considerably pre-empt national democratic control of economic policies, without significantly enhancing growth options.

The legislative procedure to be opened in the coming months will be decisive in determining whether the eurozone budget will be the long-sought instrument of convergence or yet another episode of the European redistributive conflict.

Indeed, the financing mechanisms will determine who the ‘owners’ of the budget will be. These can be either the member states or the European citizens, depending on whether it derives from member states’ contributions or the EU’s own resources. To offset the structure of incentives inherent in the current proposal, the latter must apply.

This might also be the right moment for the European Parliament to claim a greater role as a co-decision-maker in the definition of reform and investment priorities, including the Broad Economic Policy Guidelines. This would strengthen democratic control of the eurozone budget, enable fair debate of economic-policy options and secure the efficacy of the instrument.

Vice versa, an ill-designed eurozone budget risks adding to the political disarray among eurozone members—and might, therefore, be ineffective.