What the European Commission proposes makes sense as far as it goes. But that is not nearly far enough.
Reform of the European Union’s fiscal rules is coming to a crunch. A legislative proposal from the European Commission to change those rules, setting deficit and debt limits for fiscal policy in all member states, is on the table. While it contains sensible elements, improvement is needed on three key points: insufficient room for manoeuvre on public climate investments, lack of parliamentary involvement and inadequate fiscal-policy co-ordination among member states.
After a long wait, the commission presented its proposal at the end of April. It shifts the focus from the annual development of public finances to a longer-term view. In the future, multi-year budget plans (of at least four years) would be agreed between the commission and national governments, based on an analysis of the sustainability of their debt.
The ratio of government debt to gross domestic product would be projected over more than ten years, to derive a reference path for fiscal adjustment such that the ratio declines or stabilises. This is intended to keep budget deficits below 3 per cent of GDP and the debt/GDP ratio to a maximum of 60 per cent in the long term, as per the Stability and Growth Pact, while making short-term budget cuts—economically, socially and ecologically counterproductive—a thing of the past.
The road to a negotiated agreement among EU member states remains rocky and the timetable for a deal before the European Parliament elections just a year away is tight. At the meeting of EU finance ministers on June 16th, contentious issues will be at stake. Germany, for example, is calling for even stricter rules on debt reduction, although the commission is already proposing tougher requirements than originally envisaged in the reform guidelines. Yet if the rules were to require a procylical fiscal-policy stance in the future, as during the eurozone crisis, this would damage debt sustainability.
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The planned shift to individualised debt and budget analyses for member states could provide them with more leeway in shaping their fiscal-policy stances. This could increase each government’s chance of success in ensuring debt sustainability while addressing national economic and social challenges. But the headroom is not sufficient.
Transforming the EU’s energy and transport systems to meet climate targets will require additional public investment of at least €146.5 billion per year, equivalent to 1 per cent of economic output. Much of this cannot however be expected to have positive effects on government debt ratios. The commission’s proposal, and the focus of its technical analytical framework on ensuring declining ratios, would therefore likely result in insufficient public investment at the national level.
Member states could commit to a range of investments and reforms, extending the fiscal-adjustment path, if the commission agreed the investments were consistent with debt sustainability. Details on what would count as ‘good’ or ‘bad’ investments however remain unclear. Quantitative analysis of the medium-term fiscal and growth implications of investments underpinning a longer adjustment period is difficult and would contain the potential for political conflict.
If national governments are to take their climate and energy targets seriously, compliance with the fiscal rules thus reformed would only be possible with additional measures. One suggestion has been an additional EU investment fund, as a permanent successor to the Recovery and Resilience Facility, to finance investments in climate and energy. But this is not currently part of the commission’s fiscal-rules package.
The commission would accrue additional power with the envisaged reform. If, for instance, its technical assessments were to lead to an unfavourable assessment of a member state’s debt sustainability, the latitude for democratic budgetary policy in that country would be greatly narrowed.
If the sustainability analysis revealed a ‘significant debt challenge’, the government could then be subjected to stricter surveillance and face sanctions by default. This would (perversely) increase the cost of government debt, as well as reducing the scope for fiscal-policy decisions at the national level.
The commission’s assessments of debt sustainability for individual member states will always have to be based on forecasts of growth, interest rates, inflation and fiscal policy. Such assumptions, on which bilateral negotiations on multi-year budget plans with member states would rely, should be subject to democratic scrutiny. Yet the commission’s proposal does not provide for co-decision by the European Parliament or the relevant national parliament—and what margin any new government would have to renegotiate the multi-year budget plans remains unclear.
Unfortunately, the commission has learnt too little from past mistakes, as when lack of fiscal-policy co-ordination among member states exacerbated the eurozone crisis. With current expenditure paths derived from the commission’s technical analyses, cuts would be required in a number of (large) euro-area countries to comply with even reformed fiscal rules. The cross-border effects of simultaneous budget cuts could exacerbate the negative impacts of austerity on employment. And with growth slowing, debt/GDP ratios would tend to overshoot the forecasts of the commission.
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Its proposal does not take sufficient account of this collective-action dilemma, falling short when it comes to steering the fiscal stance of the euro area as a whole. Such steering capacity is crucial if the economic and monetary union is to work for all member states.
Consideration of the implications for the euro area as a whole of the budget paths, derived from the debt analyses, for individual member states should therefore be mandatory for the commission. For their part, member states should have to consider the ramifications for the euro area when negotiating their country-specific plans.
The existing EU fiscal rules are not fit for the future and do need reformed. In the coming political negotiations, governments should play a constructive role by not taking ‘tough’ positions which could threaten the stability of the common-currency area once more.
Rather, improvements to the commission’s proposals are needed:
- more scope for public investment on climate and energy, without which realisation of the ambitious climate targets for the coming decades will be a receding horizon;
- obligatory democratic legitimacy in the preparation of multi-year budget plans through greater involvement of parliaments, and
- more co-ordination of fiscal policy among member states.
Philipp Heimberger is an economist at the Vienna Institute for International Economic Studies (wiiw) and the Institute for Comprehensive Analysis of the Economy (Johannes Kepler University Linz).