Severe crises trigger reforms, and reforms trigger controversy. The ongoing reform of EU economic governance is no different. It comes as an inevitable and necessary consequence of the worst financial and economic dislocations Europe has witnessed in decades. The legitimate and most pertinent question is: Has the Commission found the right answers?
A number of prominent observers who recently posted their views on this site seem to have serious doubts. They either believe the Commission's proposals aim at the right targets but use the wrong tools or aim at the wrong targets.
Here we examine the main points of criticism in turn.
Common analysis but diverging conclusions
In their contribution of 14 October, Francesco Giavazzi and Luigi Spaventa (“The European Commission's proposals: Empty and useless”) focus on the so-called "excessive imbalance procedure", a new mechanism that, if eventually adopted, would broaden EU economic governance with a view to identifying potentially harmful macroeconomic imbalances.
While they remain silent about the other elements of the reform package, they do not leave the slightest trace of doubt about what they think of the proposed excessive imbalance procedure. They call it "an empty and useless exercise". This harsh judgement is motivated by two considerations.
- First, Giavazzi and Spaventa believe that monitoring and correcting macroeconomic imbalances will be a difficult and potentially contentious exercise.
- Second, they maintain that instead of monitoring an indicative scoreboard of macro variables, attention should focus on credit growth, which, if unchecked, is, in their view, the main source of macroeconomic instabilities.
Interestingly, we broadly agree with these two points yet strongly disagree with their conclusions.
To start, if one accepts that fiscal discipline alone is not enough to ensure the stability of the euro – and Giavazzi and Spaventa would seem to do so – one also needs to accept the respective challenges. Arguing that monitoring and correcting macroeconomic imbalances would be difficult cannot really prevent us from addressing the challenge.
True, the institutional and procedural side of the macro surveillance mechanism put forward in the Commission's proposals is new, and we may not be able to fully anticipate all practical difficulties or pitfalls. Nevertheless, it should also be stressed that the Commission is not a complete novice in the field.
When taking stock of the first ten years of the Economic and Monetary Union in 2006/07, the Commission, on top of reviewing the upsides of the project, also – and unmistakeably – pointed to the accumulation of macroeconomic imbalances in the Eurozone arguing even then in favour of a broader economic surveillance process (European Commission 2008). As political economists would have predicted, it took a serious crisis to gather the necessary consensus to broaden economic surveillance.
We also agree with Giavazzi and Spaventa when they say that credit growth should be closely monitored. In fact, we read that part of their contribution as providing support to the plan of a broader macroeconomic surveillance. As indicated in the Commission communication of 30 June 2010, private-sector credit growth would indeed be one of the key indicators of the proposed mechanism (European Commission 2010). The more general idea is to monitor private debt alongside public debt to the extent that the former, if out of hand, carries the risk of becoming a liability for governments.
The big picture
If the tone chosen by Giavazzi and Spaventa is rather defiant we can only ascribe it to the fact that they may have taken a partial view of the ongoing reform process. In our own Vox column of 14 October (Buti and Larch 2010), we made a clear point: the legislative package adopted on 29 September is just one element of a more comprehensive blueprint that seeks to strengthen economic surveillance along various dimensions including, in particular, financial surveillance.
The same reminder goes to Guido Tabellini, who on 5 October seems to have taken a fairly narrow reading of the Commission's reform proposals of 29 September (“Reforming the Stability Pact: Focus on financial supervision”). He suggests that the Commission, rather than trying to mend the Stability and Growth Pact, which he believes has failed, should focus on financial supervision.
There is no mention of the significant work carried out by the European Commission since the end of 2008 to build a new supervisory architecture. And there is no mention either that as a result of this work the Parliament has, earlier this year, given its green light to a new system of financial supervision in Europe addressing many of the shortcomings revealed during the crisis. By way of example, the European Systemic Risk Board (ESRB), one of the key actors in the new supervisory framework, will also serve as interface between a broader macroeconomic surveillance and financial developments.
Maybe in Tabellini's view the new system does not go far enough. Perhaps he is of the opinion that sovereignty in the field of financial supervision should be further centralised, and we may even tend to agree. At the same time, it should be acknowledged that, in view of the extent and the depth of the crisis, the Commission and the Council are working on different fronts.
In actual fact, improving financial supervision has been one of the very first preoccupations at the EU level. This is why the respective legislative works are more advanced than those on fiscal and economic governance. Moreover, and at the risk of repeating ourselves, the reform proposals of 29 September are not meant to provide universal solutions to all possible ills; they are to be considered in conjunction with the overall response to the crisis.
Enforcement, yes please. Sanctions, no thanks
Several observers, including the three mentioned above, question more or less categorically the effectiveness of the proposed system of sanctions; the main argument is that, at the end of the day, member states can always find a majority to block fines. This is a fair point, and we may even agree with Charles Wyplosz, who on 4 October (“Eurozone reform: Not yet fiscal discipline, but a good start”) said that "imposing a fine on a friendly sovereign state with a democratically elected government is an unknown experiment" and that imposing sanctions may give rise to anti-European sentiments.
On the other hand, sanctions or disincentives are part of the institutional history of all EU member states. Admittedly, they are easier to apply at the national level than at the supranational level, but they are not entirely new. In the area of competition policy, the Commission regularly obliges member states to undo certain policies if they are not compatible with EU law. In the area of regional policy, member states are frequently asked to return EU money in case of irregularities. Of course these measures are not popular, but they are necessary.
The strictest reservation concerning new sanctions was advanced by Paul De Grauwe. Going well beyond any justifiable doubt about whether fines will ever be applied in practice, in his Vox column of 4 October (“Why a tougher Stability and Growth Pact is a bad idea”) he raises a fundamental issue of legitimacy. In particular, he contests the proposed system of graduated sanctions on the ground it would conflict with the principle of “no taxation without representation”.
Unfortunately, questioning the democratic legitimacy of EU institutions has become a frequent and, yes, cheap way of criticising things that originate in Brussels. But then, one should keep in mind that, with the Lisbon Treaty, the Commission President is elected by the European Parliament and that the Commission as a whole is responsible to the same Parliament. Moreover, the new Treaty also vests the assembly of directly elected representatives with the right to vote the Commission out of office (see Art 17.8). Clearly, such provisions are not likely to impress hardcore euro sceptics, but they certainly disqualify the claim the Commission lacks democratic legitimacy. Besides, sanctions would not be imposed by the Commission. They would be linked to a decision of the Council in all steps of the surveillance procedure.
Finally, if taken to the letter, De Grauwe's argument would, of course, question many existing rules and institutions, first and foremost the independence of central banks, including that of the ECB.
What is not “empty and useless”
To be fair, there are elements in the Commission's reform package of 29 September that were received somewhat more favourably, at least in principle. These elements include:
(i) the idea of asking member states to upgrade their domestic fiscal frameworks with a view to making them consistent with the obligations under the treaty;
(ii) the plan to use a prudent rate of medium-term economic growth as benchmark for assessing the sustainability of government expenditure plans; and
(iii) the intention under the corrective arm of the Stability and Growth Pact to have an operational definition of when a debt ratio in excess of 60% of GDP is considered to be sufficiently diminishing.
Charles Wyplosz, for instance, explicitly welcomes the idea of strengthening national fiscal frameworks yet thinks the Commission proposal does not go far enough. In fact, the corresponding legislative act lists what we call minimum requirements to domestic fiscal frameworks, not optimal configurations. There are two good reasons for choosing this approach. First, since national fiscal policymaking remains a national prerogative, the legal basis for deliberating budgetary institutions and procedures at the EU level is fairly narrow. Asking for more than minimum requirements would only be possible with a Treaty change, an avenue few are ready to consider (although the latest Franco-German agreement of 18 October would seem to qualify this judgement). Second, budgetary frameworks need to allow for national idiosyncrasies; one-size-fits-all solutions do not exist.
On the proposed benchmark for a sufficiently diminishing debt ratio, in his 7 October Vox column (“Stability and Growth Pact: Counterproductive proposals”), Paolo Manasse sees a major practical difficulty. The application of the benchmark, he warns, would lead to pro-cyclical fiscal policies – something the Commission has always condemned and tried to avert. While Manasse is right about the Commission's concern with pro-cyclical policies, he overlooks an important element of the proposed benchmark: it would not be applied in a mechanical way. The Commission has always been clear about this. If approved, the benchmark would not automatically trigger surveillance procedures. It would simply serve as a first point of reference followed and complemented by an assessment of other relevant factors, including in particular cyclical conditions. The risk of trading off diminishing debt ratios for pro-cyclical policies is, therefore, fairly remote.
Macroeconomic policy analysis in flux
Taking into account the type and size of challenges we are facing in the aftermath of the crisis, it would have been truly surprising if the Commission's proposals for stronger EU governance had been received with unconditional praise.
One important part of the criticism originates in the frustration with past experience. The crisis laid bare weaknesses that cannot simply be shrug off as teething problems, especially since the system underwent a first major reform just five years ago. There is a palpable scepticism about whether, under current institutional arrangements, the system can be mended at all. We tend to condemn the devil we know.
Another important part of the controversy surrounding the Commission's proposals clearly has to do with the fact that the crisis invalidated important building blocks of the prevailing macroeconomic paradigm. The economic profession is rethinking macroeconomic policymaking. For the moment, there are only painfully established facts. Fiscal discipline in combination with low and stable inflation is not enough to guarantee overall macroeconomic stability and economic policy needs new instruments of supervision and new instruments of surveillance. The scope for reform is blatant.
To pretend the legislative package tabled by the Commission on 29 September was the perfect and only answer to the lessons of the crisis would be foolish. However, as we have repeatedly pointed out, the package has to be seen in conjunction with the other reform initiatives undertaken by the Commission and the Council in the recent past. Some of these other initiatives go into the direction vindicated by the some of the critics; possibly not as far as some may wish, but nevertheless.
Symptomatically, the sharpest criticism is levelled against the proposals aimed at occupying virgin surveillance territory, that is, against monitoring and correcting macroeconomic imbalances. For sure, this new arrangement will confront us with difficulties. With the benefit of hindsight we will find out it was not perfect and adjustments will have to be made. But then, only few can afford the luxury of waiting for the hindsight. Policymaking remains an exercise carried out under uncertainty.
Buti, Marco and Martin Larch (2010), “The Commission proposals for stronger EU economic governance: A comprehensive response to the lessons of the Great Recession”, VoxEU.org, 14 October.
De Grauwe, Paul (2010), “Why a tougher Stability and Growth Pact is a bad idea”, VoxEU.org, 4 October.
European Commission (2008), EMU@10. Successes and challenges after 10 years of Economic and Monetary Union, European Economy No. /2008, Brussels.
European Commission (2010), “Enhancing economic policy coordination for stability, growth and jobs – Tools for stronger EU economic governance”, COM(2010) 367/2.
Giavazzi, Francesco and Luigi Spaventa (2010), “The European Commission’s proposals: Empty and useless”, VoxEU.org, 14 October.
Manasse, Paulo (2010), “Stability and Growth Pact: Counterproductive proposals”, VoxEU.org, 7 October.
Tabellini, Guido (2010), “Reforming the Stability Pact: Focus on financial supervision”, VoxEU.org, 5 October.
Wyplosz, Charles (2010), “Eurozone reform: Not yet fiscal discipline, but a good start”, VoxEU.org, 4 October.