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

1.6.3 Fiscal retrenchment?

If we turn to fiscal issues, at the time of entry to the EU in 2004, six of the ten entry countries had government deficits in excess of the SGP/ Maastricht Treaty 3 per cent of GDP rule: the Czech Republic (−5.9 per cent), Cyprus (−4.6 per cent), Hungary (−4.9 per cent), Malta (−5.9 per cent), Poland (−6.0 per cent) and Slovakia (−4.1 per cent). Thus these countries would be required to cut back on their public expenditures or increase taxes so as to move into a more or less balanced budget position as required by the SGP. But, as we have seen, the SGP is somewhat in disarray. So who or what is going to impose ‘fiscal discipline’ on the recalcitrant countries? They could formally be asked to retrench fiscally just at a time when it might be appropriate for them to increase public expenditure on welfare, say, so as to ease the adjustment of their populations to all the competitive and regulatory pressures associated with a transition into the EU.

The two possible saving graces here are the EU's Structural Funds and Cohesion Funds, which are in principle available to offset some of these costs, so as to enhance convergence and integration (Linter, 2001; Hallet, 2004). Just as the countries who traditionally received the bulk of these funds – Ireland, Greece, Spain and Portugal – are seeing a decline in payments relative to GDP since they have converged successfully towards the EU average, there is the emergence of another set of countries and regions to the east that meet the requirements for assistance. Fortuitously, therefore, these funds could be available to be redirected to the newly admitted countries and eligible regions. In addition, the UK's famous ‘rebate’ on payments into the Union is an alternative attractive source of funds (running at over €4.6 bn in 2005), and looks vulnerable in the medium term.

Thus with both monetary and fiscal polices there is a newly emergent set of problems for the EU to grapple with as the Union enlarges; and this could add to the pressures for change just as the traditional mechanisms of rule-based policy come under wider scrutiny. Figure 4 shows how we might judge the relationships between simple rule-based monetary and fiscal policies as the enlargement process proceeds.

Figure 4
Figure 4 Monetary and fiscal rules with enlargement (adapted from Buti et al., 2003)

It shows a hump-shaped relationship. The political preference for simple rules increases with the number of participants, but only up to a point (N* in the figure). Beyond that number, however, the need to take account of a much wider set of country-specific economic circumstances (see earlier in this section and Table 2) makes very simple across-the-board rules sub-optimal. Country diversity requires more flexible rules, even if these are set by a single central authority, and preferences change, hence the downward slope in Figure 4. Quite where the curve inflects is, of course, highly judgemental, but in the EU circumstances it is probably somewhere close to the level of 12–15 countries given the existing and likely future accession members. And this relationship looks even more likely since we have seen that there are already trends towards more flexibility in relationship to the SGP and financial services.

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