Managing the European economy after the introduction of the Euro
Managing the European economy after the introduction of the Euro

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Managing the European economy after the introduction of the Euro

1.4.2 Struggles over the SGP

The real political struggles emerged at the end of 2003 when France and Germany were called to account by the Commission for overtly breaking the 3 per cent deficit rule. The background to this dispute can be seen in the data presented in Table 3. Clearly, although the EU-15 as a whole were keeping to the rule during the early 2000s, France and Germany went into a 3 per cent plus deficit from 2002 onwards.

Table 3 General government deficits (−) or surpluses (+) as percentage of GDP at market prices, 2001–05

EU-15 Germany France Italy UK
2001 −0.9 −2.8 −1.5 −2.6 +0.7
2002 −1.9 −3.5 −3.1 −2.3 −1.5
2003 −2.7 −4.2 −4.2 −2.6 −2.8
2004 −2.6 −3.9 −3.8 −2.8 −2.7
2005 −2.4 −3.4 −3.6 −3.5 −2.4
(adapted from European Union, 2004, Table 75 , p. 626)

It might be noted that the Netherlands and Portugal also recorded deficits of greater than 3 per cent of GDP in the early 2000s, as did Greece (−6.1 per cent in 2005); but it was the fact that the two largest countries ‘at the heart of Europe’ fell into this position that really challenged the SGP. The Council of Ministers met in November 2003 ostensibly to condemn France and Germany on the recommendation of the Commission, but this was rejected. Instead, the decision was made to ‘hold the Excessive Deficit Procedure in abeyance’. This unprecedented decision led to a series of harsh exchanges involving accusations and counter-accusations between the Commission and the Council, but it in effect killed the SGP. The rule now lacks credibility; there is little chance it could be realistically applied to any other country given its suspension in these cases. And what, at the time of writing, is happening to Italy in 2005 seems to confirm this prognosis since its deficit is forecast to rise from −3.5 per cent in 2005 to −4.6 per cent in 2006.

What is the political lesson to be learned from this episode?

If anything, this event has proven that, whatever sovereignty large countries are willing to cede to the Commission in matters of importance like fiscal policy, they will take it back – legally or less legally if necessary for a sufficient number of them. It is probably more constructive to simply recognise this point or realpolitik, declare the growth and stability pact dead, and return fiscal discretion to national governments.

(Alesina and Perotti, 2004, p. 44)

Quite whether this realpolitik reassessment is likely remains to be seen, however. The problem is that although the SGP may be dead, the general question remains: can a single currency and single inflationary objective coexist with such potential variability in fiscal positions? In addition, how is ‘fiscal discipline’ to be organised and guaranteed if there is no effective SGP?. Financial convergence across the Euro-zone is, in large part, predicated upon the ‘confidence’ that inflationary pressures can be coped with. But if ‘fiscal discipline’ fades, and the different EU countries were to expand their economies by indulging in competitive reflations via significantly increasing government expenditures financed by borrowing, this would increase local risk factors at the expense of the carefully crafted common position forged across the Union as a whole. Inflationary pressures could emerge, interest rates rise, and confidence in the Euro be undermined. As a result a ‘one size fits all’ monetary policy would no longer be viable (if, indeed, it ever has been).

Within the SGP rules, where there is a presumption that in the medium term government budgets would balance, only differences in tax rates would allow for differences in government expenditure rates; so the way that fiscal policy is constrained is clear. Higher expenditures on social policy objectives, for instance, could only be financed by increased taxes and/or contributions. What this imparts in the system as a whole, then, is a deflationary bias in economic activity almost regardless of the explicit monetary policy stance adopted by the ECB. But given that the ECB's monetary policy has also been restrictive, always operating in the shadow of the need to fight inflation, a double deflationary bias operates. Autonomous large-scale increases in government expenditure for re-distributive or stabilisation objectives are ruled out. And, given the emergence of a single market in Europe, tax increases could only be levied of non-mobile factors anyway. Capital is very mobile so levying taxes on company profits, for instance, is difficult. Indeed, in their attempt to attract capital and companies to their territories, governments have engaged in corporate tax competition to present their business environments as friendly to company activity, with low corporate tax rates; a ‘race to the bottom’ results. (However, the tax take from corporation tax has actually risen in some instances, but this is because of the recovery in the overall levels of corporate profits, so that even with lower tax rates a higher tax take can ensue.)

For those not committed to the EU's current overall policy stance (supported by the Commission and the Council of Ministers alike it would seem), one that can be termed neo-liberal and pro-market (i.e. generally in favour of liberalisation and de-regulation), this change could open up some intriguing opportunities. A Keynesian-inspired fiscal policy as the key stabilisation and management tool could come to the fore once again as monetary policy and an obsession with inflation targeting retreated. The so-called ‘Brussels-Frankfurt’ consensus that was thought to politically underpin the Maastricht Treaty process would be broken for the good as fiscal discretion and flexibility replaced fiscal rules (Sapir et al., 2003; EuroMemorandum Group, 2005). From the point of view of the Commission's orthodox position, however, fiscal discretion and flexibility means fiscal indiscipline and inflation. If you let countries borrow as much as they like, they will take advantage of this, ratchet up their public debt positions, which will release money into the economy as they borrow, which will in turn lead to inflationary pressures as too much money chases too few goods in a classic monetarist formulation.

In fact, a much looser compromise on policy was forged in March 2005. The SGP was re-negotiated to allow countries to operate ‘close to the reference value’ of 3 per cent deficits rather than to strictly adhere to it. And several new ‘particular circumstances’ were introduced – amongst them expenditure on ‘international aid’, on ‘European policy goals’ (like Research and Development and ‘eEurope’ expenditures), and on ‘European unity’ objectives (for example, convergence and solidarity expenditures) – that were to be given ‘due consideration’ in judging the underlying fiscal position of countries. In effect, this opened up the pact for further political fudging and creative accounting. It was condemned by the ECB and a number of smaller EU countries.

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