Year LXIV, 2022, Single Issue, Page 81
REFORM OF THE STABILITY AND GROWTH PACT:
A PROPOSAL LACKING VISION
Introduction.
Reading the European Commission’s Communication setting out orientations for reform of the Stability and Growth Pact (SGP), adopted on 9 November, 2022,[1] the title of Shakespeare’s comedy Much Ado About Nothing immediately springs to mind. Because, back in early 2020, the shortcomings of allowing European economic governance to operate on autopilot, driven solely by strict fiscal rules (moreover now widely recognised as unrealistic by the academic world and much of the political one), were so apparent that the Commission had already decided to organise a public consultation on reform of the pact, subsequently postponed due to the Covid emergency.
As is widely known, the crisis triggered by the pandemic crisis led to suspension of the SGP, which was due to come back into force at the start of 2023. In preparation for this, a public consultation was launched at the end of 2021 to ask citizens and civil society (the protagonists of this consultation were actually universities and think-tanks) how they envisaged a new SGP. The results of the consultation were then made known in a document published by the Commission on 28 March 2022.
Most of those who took part in the consultation had underlined that reform of the pact needed to come about in the context of a general reform of European economic governance, which would see Europe equipped to produce European public goods, and endowed with an adequate budget and an autonomous fiscal capacity. And that only then, with the Europeans endowed with a supranational instrument for growth, would it be possible to envisage restoring the fiscal rules. The planned 60 per cent debt-to-GDP ratio was also deemed unrealistic, and in need of modification (the average debt-to-GDP ratio in the EU currently stands at around 100 per cent).
Furthermore, it was highlighted that putting financial stability before growth was simplistic and, in most cases, useless and wrong, as shown by the financial crisis of 2008-09 and the sovereign debt crisis of 2010-12, when austerity failed to produce expansionary effects. Because, as already remarked in 2005 by Posen and other American colleagues,[2] if austerity in the USA in the early 1990s worked, this is because, in America, it was possible to direct resources away from inefficient public sector allocations and towards efficient markets, and also because the US has a federal constitutional and institutional architecture capable of absorbing macroeconomic shocks through monetary and fiscal reflation measures promptly adopted by the central government. Europe, on the other hand, has none of this, with the result that any adjustment through austerity can only lead to deflation, decreased demand, and depression of growth expectations and consequently of investments: a self-perpetuating spiral that must be stopped through systemic reflation by a supranational government. Which, however, does not yet exist.[3]
In the meantime, a new crisis has hit continental Europe and upset the whole global geopolitical order, causing the re-activation of the pact to be postponed until 2024. For Europe, producing a document that reflects the pre-2020 debate, and thereby ignoring the economic-political consequences of Covid and the Russia-Ukraine war, amounts to turning down an active role in the balance of power that will emerge at international level in the near future.
The most important error of the Commission’s document, therefore, is its failure to set reform of the SGP within the broader debate on the role the EU intends to play in the world in the coming years. Indeed, depending on the direction the EU takes, the proposal looks set to emerge as either useless or even harmful.
I shall herein try to illustrate this thesis by highlighting the few advances that are summarily outlined in the Commission document (first paragraph), before moving on to examine its shortcomings (second paragraph), and finally offering some concluding considerations.
The Merits of the Commission’s Document.
One of the key points when seeking to create a genuine supranational economy (and democracy), in other words to coherently realise the design of a federal Europe finally capable of taking reactive and fully legitimised decisions, is to build a system for monitoring public spending at various levels: local, national, and European. Something along the lines of what happens in India, which has a substantially federal constitution.
In Europe, we have the European Fiscal Board, which was set up in 2016, following the October 2015 announcement of its creation, in order to help the President of the European Commission analyse the European macroeconomic framework and make proposals for improving it. It has a purely advisory and zero-budget role, operating without the support of an ad hoc data analysis structure, instead relying on the data furnished by the Commission.
We also have independent fiscal institutions for monitoring expenditure, largely created during the years following the 2010-12 reforms of European economic governance. A simple but effective way to make the budget formation system in Europe more coherent would be to make these institutions part of a system, transforming them into branches of a multilevel agency responsible for providing monitoring and advice on the distribution of debt loads between the various levels of government.
And yet the Commission document makes no mention of any of this, referring only to the need to “reconsider the mandate and role of the European Fiscal Board”,[4] also in the light of that of the national authorities. Nevertheless, this indication seems to be one that, it can be hoped, might move in the direction mentioned above. And if it did, it would not be a trivial result, even though (in the absence of a more detailed proposal) it could potentially lead to a weakening of the independence and authority of the national bodies (which up until now have worked very well).
Another important merit of the document is that, despite there being no reference to any sort of golden rule allowing strategic investments to be left out of the calculation of member states’ deficits — the public consultation revealed a clear demand for this —, the proposed method of debt sustainability assessment, which the document suggests should be conducted on a multiannual basis, seems, logically enough, to favour productive investments over unproductive expenditure. This kind of development would also be an important result, making it easier to shift national spending away from the current expenditure side, and towards the one that allows individual countries’ economies to move towards the frontier of production possibilities, investing in sectors that increase total factor productivity.
In my view, a final positive element worth underlining is the increasing degree of discretion the Commission would allow itself in the assessment of spending and debt reduction plans, which, according to the proposal, would be negotiated with the individual national governments. The de facto reduction of the rigidity of the existing rules and the increase in the degree of political discretion (albeit passed off as stochastic analysis of macroeconomic data, and therefore as a purely technical change) seem to me to be small but significant steps forward in the direction of giving the European economy a supranational government. Because it will be up to the Commission to set the indicators for assessing the sustainability of debts in the medium term (a period of four years, extendable to seven if necessary).
This new development would, however, have to be carefully explained and justified, in order to avoid any abuses of the tempting opportunity constituted by the supranational transfer of a political power that is, however, entrusted to essentially technical bodies. In view of this consideration, it appears increasingly urgent, to establish an effective supranational democracy, and to address the issue of Treaty reform or that of the Treaty revision procedure with a view to constitutionalisation of the Treaties.
The Limits of the Commission’s Proposal.
We now come to the limits of the proposal published by the Commission as a means of re-opening the debate on reform of the SGP.
The first, macroscopic, one is that the world has profoundly changed, making simple steps to reform the pact no longer adequate. While macroeconomic surveillance of some kind and financial stability are necessary to ensure the resilience of both the single currency and, ultimately, the entire European economy, the priority today is to have the EU assume the attributes of economic sovereignty that will allow it to minimise the negative effects of its dependence on external countries.
If it is true that interdependence is global and affects the whole world, it is also true that Europe, as a processing-based economy, cannot afford not to insulate itself against the negative effects of these interdependencies in crisis situations like the current one. This means that Europe must rebuild strategic alliances requiring colossal investments for growth (in Africa, Latin America, for the reconstruction of Ukraine, to stabilise the Middle Eastern area, etc.); at the same time, the fierce international competition for resources and outlet markets demands equally colossal investments in innovation (of, broadly speaking, technology, products, processes, organisation, markets, and so on).
All this requires huge financial resources. And it does not matter if these have to be obtained through debt. After all, considering that we are currently in a savings glut, i.e., a period characterised by a (growing) excess of global savings looking for stable and profitable investment opportunities, the EU should be making it a priority to create, as an alternative to the US Treasury Bond, which is used to finance current spending, a safe debt instrument that is instead oriented towards investments in innovation.
Furthermore, there is a growing demand for public goods without which the EU risks disintegration: a European energy union, a European security and defence union, a renewed system of communication and transport infrastructures in line with the EU’s future ambitions, and cultural and social infrastructures capable of satisfying the (changing but growing) needs of the citizens. These are needs and demands that must be satisfied to enhance Europe’s supranational cohesion and prevent a loss of support for the ideas of European identity and integration. It must be recognised that the fiscal capacities of the individual countries, which vary greatly in terms of their room for manoeuvre and welfare support needs, cannot be relied upon to this end: a collective effort is required.
Where is all of this in the Commission’s document? Where is the battle (inevitable and in our view bound to be lost) against the fiscal expansion that the USA (to counter monetary restrictions) is pursuing with its Inflation Reduction Act? Where are the financial assistance instruments necessary to foster the emergence of global multilateralism by strengthening regional dynamics in Africa and Latin America? What is the role of public finances with respect to von der Leyen and Breton’s proposal for a “European sovereignty fund”?
I would also advance a further criticism. Failure to rethink the 3 per cent and 60 per cent thresholds is likely to have two harmful consequences. The first is linked to the fact that these parameters are independent of how the targets are achieved, i.e., through spending reductions or tax increases. But we do know that tax multiplier effects are asymmetrical with respect to these two modalities (i.e., their impact, in terms of changes in income, is different); moreover, making one or the other choice can, due to its distributive implications, have potentially distorting effects. Continuing to set targets without indicating how they should preferably be reached may well increase national ownership of the choices made, but it weakens macroeconomic prospects.
The second criticism is that failure to question these parameters risks having a devastating impact in terms of communication and consensus. Because it makes it easy to accuse the European Commission of sticking with unrealistic dogmas. The 3 per cent ceiling could have been reduced (or better still eliminated), with a view to excluding productive and strategic investments from the calculation of the deficit, while the 60 per cent debt-to-GDP ratio ceiling risks becoming not only out of touch, but also highly dangerous. It is good that, according to the proposal, the adjustment path should from now on be multiannual and not automatic in nature, but the fact remains that it implies the need to return within that ceiling. In Italy’s case that means reducing its debt by 90 per cent of its GDP, an objective that can be considered realistic only in the cushioned environment of Brussels. And achievable only through a degree of austerity that would decrease the quality and quantity of public goods and services provided, and risk generating new anti-European narratives, which in our view we could really do without, especially right now when there is a need for stronger European sovereignty.
Concluding Remarks.
What we have seen here is that, compared with the reforms expected by civil society and proposed in the field of academic debate, the Commission’s document offers little clarification and leaves many doubts. In particular, it does not explain how a strengthening of growth — currently stagnant in much of the continent — can be squared with the (undoubted) need to guarantee stability. It seems to echo the debates that preceded the birth of the euro, rather than speaking with authority on the numerous crises that have hit the European continent, and from which we systematically manage to recover later than all the world’s other large economic and political groupings of states.
It can, of course, always be argued that the Commission has simply produced an initial document, just to get a debate started; and that it is now up to the governments, the European Parliament and the Council to take charge of the changes, including the constitutional ones, that are needed to carry forward the above-outlined design — changes that cannot be driven solely by the Commission. And this would be an acceptable argument, were it not for the fact that the Commission has the power of legislative initiative and, when it comes to the need to review a key policy area such as economic governance in a complex, open and interdependent system like that of the EU, we might legitimately have expected it to have come up with some clearer ideas — forward-looking ones, what’s more, rather than ones rooted in the past.
Fabio Masini
[1] European Commission, Communication on orientations for a reform of the EU economic governance framework, COM(2022) 583 final.
[2] Posen A.S., Can Rubinomics Work in the Eurozone? In Id. (Ed.) The Euro at Five: Ready for a Global Role? Special Report n. 18, Washington (DC), Institute for International Economics, 2005, pp. 123-150.
[3] The NGEU recovery package, which looks very much like an asymmetric and supportive reflationary intervention, is unanimously considered an exceptional event that will not be repeated.
[4] European Commission, Communication on orientations for a reform of the EU economic governance framework, op. cit., p. 10.
