What is the EU’s Plan for Enhanced Economic Governance?

As Portugal taps into the bailout fund it is time to take stock of the EU’s Euro Summit of March 11, and the March 24-25 summit, which finalized the EU’s attempts to halt the euro crisis and harmonize member state economies. The results of these summits have been hailed as a “turning point” by European Council President Herman van Rompuy. A post-summit analysis by the European Policy Centre – upon which the following is based – has called the development a “quantum leap” (albeit with caveats) in the EU’s economic governance. On the other hand, the recent innovations aren’t really innovations at all. Rather, they are attempts at strengthening the already existing set-up. Needless to say, that setup did not perform well.  

Before we get to down to the details, it is on the positive side worth noting that Europe’s leaders moved swiftly. After initial anger at the Franco-German “Pact for Competitiveness”, compromises were made and a number of economic governance tools were quickly adopted – albeit with more elements to be implemented at the national level than envisioned by Berlin and Paris. With regards to the viability of eurzone (plus), the sense of urgency in itself has likely proved a confidence building measure. The swath of measures have however been criticized for their overlapping nature and lack of transparency. In that regard, at least, nothing is new in Brussels….  

The main elements of the economic governance package are; The permanent bailout fund (the ESM or European Stability Mechanism), the Euro Plus Pact (a compromise version of the Franco-German “Pact for Competitiveness”), the so-called “Six Pack” (a stronger version of the Stability and Growth Pact), a “European semester” (this calls for monitoring national fiscal policy and is intended to  reinforce fiscal coordination), and a second round of more vigorous bank stress tests, intended to restore confidence in the European banking system.

The ESM, will replace the current bailout fund, the European Financial Stability Mechanism, in 2013 – providing that the ESM is ratified by member states. The ESM’s highest decision making body will consist of a Board of Governors made up of eurozone countries’ finance ministers. They, at least, will be the only members on the board with voting powers. The ESM will be activated only in cases where the eurozone as a whole is deemed threatened, and only on condition of unanimity in the Board of Governors . In addition, all bailouts will be granted under strict conditionality (read austerity measures). 

Considering the unanimity clause, any voting country will be able to block a bailout if it does not consider the eurozone to be threatened, or for that matter, if popular sentiment in a given country prompts it to nix a bailout. The assumption is that no one will be interested in sawing of the branch they are sitting on. Perhaps, but only perhaps. Electorates in Germany, Finland, and the Netherlands have voiced their displeasure with bailouts. A government with its back against the wall could be tempted to appease public sentiment, regardless of the dictates of prudent economics.

The Euro Plus Pact, as mentioned, is related to the Franco-German Pact for Competiveness. The pact aims at increasing competiveness and harmonizing economies through measures such as reviewing national labor market negotiation practices (a sore spot for many countries) limiting public-sector wage increases, improving education and research & development, adjusting pension systems to demographic developments, working toward a common corporate tax level (another sore spot…), and including a debt brake in national fiscal rules.

The Pact does not, as envisioned in the Pact for Competitiveness, allow for methods with which to enforce its provisions. Also, it is up to the member states to interpret the pact and choose which policy mix they intend to implement to achieve the pact’s objectives. In short, the pact is intergovernmental in nature and, rightly or wrongly, leaves the above mentioned areas firmly in the hands of national governments.      

The Six Pack is euro-speak for a set of six legislative proposals originally tabled by the Commission in September 2010. These proposals include measures on how to police debt and imbalances, and how to punish those who do not correct these deficiencies. The Six Pack mainly entails a strengthening of the Stability and Growth Pact (SGP) of 1997. The SGP specifies that the annual deficit not exceed 3 % and that national debt must be lower than 60 % of GDP. In the future, public debt – not only a country’s account deficit – will be included in deficit calculations. In addition, sanctions have been strengthened, and a greater degree of automaticity in applying these sanctions is, in theory at least, part of the enhanced SGP.

 In addition, to the strengthening of the SGP, the Six Pack includes the setting up of a macro-economic surveillance system. This system would entail an annual assessment of economic imbalances and vulnerabilities, and the opportunity for the Council to address policy recommendations to member states placed in an “excessive imbalance position.” If these recommendations are not followed, the agreement allows for the possibility of sanctions – both economic and reputational.

The European semester is intended to monitor national budget decisions while they still are under consideration and prevent inter-EU imbalances before they actually occur.  The novel idea is, that after member states have submitted their budgetary positions to the Commission, the Commission will have the opportunity to make recommendations to the member states, which they should take into consideration when preparing the next year’s budget. Again, the potential problem is that member states are not obliged to abide by Commission recommendations.  

 As some analysts point out, all though European economic governance has had a makeover, it is still built on the same false premises as previously;  that economic convergence can be achieved through the coordination (as opposed to regulation) of widely different economies through a complex set of rules and sanctions. Member states have in the past proven that they are powerful enough to ignore such measures. Germany and France, for example, disregarded the Stability and Growth Pact in 2005. And regardless of the recent innovations, there is no guarantee that this will not happen again. Instead, the eurozone (plus) arrangement will have to rely on the fact that the interdependence the EU’s economies have been proven in the most painful of ways.