Thoughts on the Fiscal Compact

A stricter budgetary discipline, but is it really binding?

, by Florent Banfi

All the versions of this article: [English] [français]

A stricter budgetary discipline, but is it really binding?

The year 2013 starts on new legal basis for the European Union. Following the ratification by Finland the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union has entered into forced on 1 January.

The Treaty introduces the following modifications:

• A “balanced budget rule” with a budget balanced or in surplus when planned and a structural deficit increased by less than 0,5% once implemented.

• A coercive process that can be started not only by the European Commission (who can propose) but also the Member States (who can propose or by a qualified majority reject the European Commission’s proposal).

• A penalty system of 0,1% of GDP decided by the European Court of Justice if the commitments are not respected.

• A European Summit President appointed at the same time as the European Council President. He chairs a biannual meeting where will participate at least the Member States having the euro as currency.

What is the Treaty really all about?

The first articles point out three main objectives:

• The budgetary discipline which is the most detailed and binding part of the Treaty • Coordination of economic policies: one single article presenting generalities • Improved governance through a European Summit President and an additional control by the European Commission

Thus the Treaty appears to favour the budgetary discipline and only mentions the two other goals.

A stricter budgetary discipline, but is it really binding?

The Maastricht Treaty introduced a threshold between the budget obtained at the end of a period and the budget initially planned. The first should not exceed the second by more than 3%. The indicator monitored was named “government deficit”. In the Lisbon Treaty, the principle was kept and deficits are considered either as solely “deficits” or “government deficits”. In both treaties, the deficit at stake is the overall deficit as set in the budget of a Member State.

In the Fiscal compact a new term is introduced: “structural deficit”. How can it be different from the “deficit” or the “government deficit” previously at stake? Should we understand the structural deficit as including all but deficit created by exceptional measures? If this is the case, there seem to be a margin of manoeuvre let to the Member States for bypassing the rule when they wish to overcome the 3%. Instead of arguing on the value of the deficit, the debate will sway to what should be included in the “structural deficit” and what should be put aside. On the other hand, this room for discussion could also be an opportunity to shift to Keynesian economics allowing increasing state-led-investments and by the same token the overall deficit.

The precise definition to take into account is uncertain given it was not found in the Fiscal Compact. The Maastricht Treaty also kept some uncertainty not to be too strict, but the assessment of the criteria were clearly stated. Were accepted deficits in two cases: the deficit was above the threshold but getting closer to its target over the years (i.e. the trend was good) or when on a temporary basis the deficit was higher but still close to the target.

The Fiscal Compact is in that sense less precise than its predecessors and its efficiency will be more liable to its interpretation and implementation. Given that the Maastricht Treaty was not upheld by different Member States, such lack of precision is disappointing.

Is the financial penalty the appropriate measure?

By passing by the European Court of Justice, the process is made legal. Namely, it is hard to conceive that the Member States could be at the origin of a penalty process and validate the penalty to be borne by a national government at the same time. The conformity to the financial commitments will be judged according to European law enforced by this Treaty. The legitimacy which seems to be lacking with the current system (IMF, Troika, European Commission…) will then be enforced thanks to the European Court of Justice. But from an economic viewpoint, can we consider that this penalty, even though capped to 0,1% of GDP, is a positive step forward? If the motivation created by this incentive to implement the budgetary discipline cannot be neglected, paying extra money when attempting to balance the financial accounts is far from logic. Unless the Member states accounted that the ruling of the European Court of Justice will happen sufficiently later to allow for better economic conditions when the penalty will have to be paid, this principle seeks more to warn than to become applicable.

Where are the citizens?

The European Parliament can be heard but cannot oppose a proposal from the European Commission. As far the national Parliaments are concerned: “their prerogatives will fully be respected”. No need to add that this Treaty doesn’t set the means for a strong involvement of the citizens, the same who are directly withstanding the economic measures imposed.

As a conclusion, the Fiscal Compact reinforces the powers of the Member States, the same who didn’t uphold the Maastricht Treaty according to Hoyle. If it was necessary to demonstrate to the financial markets the seriousness of the Member States motivation, it undoubtedly marginalises the European Citizens in name of an efficiency which today is not guaranteed.

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