Wednesday, 29 November 2017

The European Fiscal Board’s first report and the future of the EU’s fiscal framework

Paul Dermine (PhD candidate in EU institutional law, Maastricht University) and Diane Fromage (Assistant Professor of European Law, Faculty of Law, Maastricht University)

EU Fiscal Governance in the post-crisis era: The start of the reflection period and the European Fiscal Board’s first report

Recent events suggest that the Eurozone may soon be entering a new phase of its short but already tumultuous life. As the dust of the sovereign debt crisis starts settling, and the continent slowly returns to growth, winds of change are blowing across the zone, and EMU reform is back on the agenda and hence ardently debated at EU and Member States level. The context is thus ripe to critically reflect on the economic governance system the crisis has brought about, and on the actions carried out by the EU institutions and the Member States within that setting.

This post offers to do just that with regard to fiscal governance. As is well known, the crisis precipitated a substantial upgrade of the rules making up the European fiscal discipline, and an unprecedented strengthening of the surveillance paradigm in the field of budgetary affairs. Since it entered into force, this new normative catalogue introduced mainly by the Six-Pack and the Two-Pack reforms, as well as its main enforcer, i.e. the European Commission, have attracted a great deal of criticism (from the European Central Bank (ECB), the International Monetary Fund and some Member States).

The last blow came recently, from the newly established European Fiscal Board (EFB), which did not wait long before hitting hard. Indeed, the EFB’s creation was first announced in the June 2015 Five Presidents report. The EFB was to ‘coordinate and complement the national fiscal councils that have been set up in the context of the EU Directive on budgetary frameworks. It would provide a public and independent assessment, at European level, of how budgets – and their execution – perform against the economic objectives and recommendations set out in the EU fiscal governance framework. […Furthermore, s]uch a European Fiscal Board should lead to better compliance with the common fiscal rules, a more informed public debate, and stronger coordination of national fiscal policies.’ Its Chair – the Dane Niels Thygesen (a former member of the Delors Committee) – and its four members were designated at the end of 2016 when it hence started to function.

In its first annual report ever, published on 15 November, the EFB presents a mixed picture of the current regulatory framework, and the Commission’s action as its guardian. It focuses on three issues: an evaluation of the implementation of the EU's fiscal framework, a review and assessment of the fiscal stance for the euro area as a whole, and the identification of best practices in the functioning of national fiscal councils. It concludes with some suggestions on the future evolution of the EU’s fiscal framework.

In performing its evaluation, the EFB in fact underlines three characteristics of the current fiscal governance framework that will guide our analysis: its complexity, its persistent asymmetry and the important discretion left to the Commission in the application of the rules in place. It furthermore analyses the possibility of centralized fiscal stabilization within the Euro area.

This report constitutes a welcome opportunity to explore some of the main challenges the EU fiscal governance currently faces, and to suggest potential reform avenues.

Such endeavour is all the more timely as the reincorporation of the Fiscal Compact into EU law and the review of the Six-Pack and Two-Pack reforms will constitute key priorities of the upcoming December EMU package of the Commission. Such political momentum will certainly offer broader opportunities to further enhance and streamline the Stability and Growth Pact (SGP), and the other instruments making up EU fiscal governance.

Background to the EFB’s first report

Before proceeding with an analysis of the EFB’s first report, a few reminders are in order. As is well known, the crisis precipitated a fundamental overhaul of EU fiscal governance. On the one hand, the procedural framework for fiscal surveillance and coordination was substantially strengthened, most notably by increasing the scope and intensity of the oversight exercised by the EU on national public finances. On the other hand, the very substance of the fiscal rules Member States are subject to was tightened and further expanded.

In a nutshell, the fiscal targets are now defined more strictly, requiring stronger yearly adjustment efforts from the Member States. If the deficit remains the central criterion of the EU fiscal discipline regime, the debt criterion has been further operationalized, and an expenditure benchmark was added. The reliance on structural rather than nominal indicators has been further generalized. These developments show the clear intent of the EU to exercise close and continuous scrutiny over all aspects of national budgets, in order to enhance their overall sustainability.

However, conscious of the need to accommodate a range of contingencies, and eager to preserve a certain room for flexibility, the Six-Pack reform has also multiplied the escape clauses entitling Member States to derogate from their budgetary obligations under certain circumstances (i.a. structural reforms implementation, severe economic downturn).

The overpowering complexity of EU fiscal governance

Certainly, a major shortcoming of this new normative body is its overwhelming complexity. In the post-crisis era, EU fiscal discipline consists of a dense web of detailed rules and sub-rules governing public debt, deficit and expenditure. Those rules display a high level of prescription and specificity, and yet, are tempered by an equally complex array of general escape clauses and potential loci for flexibility and derogation. Further increasing the systemic intricacy of the EMU fiscal discipline regime, the rules are spread over different EU regulations and directives, partially replicated in international treaties and national laws (which do not always fully overlap).

Against that background, it is proven that national authorities struggle to understand the exact rules they are to abide to, and the margin of manoeuvre they still enjoy under the current framework. Such lack of clarity also undermines transparency with regard to the rules’ ‘indirect’ addressees, namely the general public and the markets, and may in the long run harm the efficiency of public oversight and market mechanisms as enforcement channels of fiscal discipline in the EMU.

Quite obviously, there is a strong need for simplification. Even the European Commission seems to acknowledge that. Too many rules, too many operational targets do not favor compliance, monitoring, enforcement and overall intelligibility, thereby undermining the legitimacy of the EU’s actions. In that regard, interesting proposals for reform are currently on the table. Correctly positing that the ultimate aim of the EU fiscal regime is the preservation of debt sustainability, IMF officials and, although to a lesser extent, the EFB consider that the system would gain in readability and overall efficiency if it were to revolve around one fiscal anchor (the debt ratio instead of headline deficit) and one operational target (possibly the ‘fiscal effort’ variable). In a similar fashion, a substantial streamlining of the existing escape clauses would also appear necessary.

The structural asymmetry of EU fiscal discipline

Another important issue inherent to the current regime is its structural asymmetry. From the outset, the SGP was designed as a tool to correct excessive deficit and debt levels and tame profligate States. Its rules and procedures are thus exclusively driven by that objective, and the crisis further strengthened this focus. Conversely, the rules do not contemplate that States may be too frugal. Under the SGP, surplus equals balance, and surplus countries are under no parallel duty to bring their fiscal position back to equilibrium. As an asymmetric construct, the SGP is one-sided, and toothless when it comes to dealing with too ‘virtuous’ countries.

This has proven particularly problematic over the last few years, as the Commission was seeking to achieve a positive fiscal stance for the Euro area, and sought to enjoin the few Member States accumulating large budgetary surpluses (such as Germany, Luxembourg or the Netherlands) to engage in mildly expansionary policies by using the available fiscal space and boosting public investment. Under the current regime, such injunctions are at best wishful thinking, and lack any kind of legal support in the texts.

In our view, such asymmetry ought to be corrected, especially at a time when Europe heavily suffers from an investment backlog. Does this mean that an ‘Excessive Surplus Procedure’ should be established? This would probably be a step too far. But if the achievement of budgetary equilibrium is to be the ultimate rationale of the SGP, its provisions should be amended so that when appropriate, fiscal expansion too can be commanded.

How complexity and flexibility empower the European Commission

The current regime’s inherent complexity and flexibility, combined with the conceptual indeterminacy of some of its founding concepts (such as that of the output gap), have also created significant room for administrative discretion, which the Commission has been very eager to exploit. It is indeed impressive to note that at any key stage of the surveillance procedure organized by the SGP (either under its preventive or corrective arm), the Commission enjoys discretion and needs to exercise judgement.

Under a supposedly rules-based system, this appears to be problematic (to some extent at least), and obviously comes at the expense of the predictability, even-handedness and efficiency of the entire regime. The main risk is that certain choices of the Commission may no longer be economically motivated, but founded on political or ad hoc considerations that may run counter to the economic rationale underlying the EMU fiscal framework. In that regard, one may for example mention the very generous decision of the Commission that Italy was eligible to the ‘structural reforms’ escape clause, or its lenient stance in the framework of the Excessive Deficit Procedure against France, which was never stepped up despite the clear insufficiency of the French consolidation efforts ('Because it is France' was the main justification expressly advanced by Juncker).

The surprising decision of the Commission in the summer 2016 not to impose sanctions (even symbolic) on Spain and Portugal for failing to take corrective action in the framework of their EDP, also shows that discretion may come at the expense of enforcement and, ultimately, of compliance. This notwithstanding, it is clear that a system of smart rules cannot do without a dose of flexibility and discretion. In the future, the focus should therefore not be on trying to erase the loci for administrative judgement, but on making sure that such judgement is primarily driven by an economic, non-political rationale.

This might however prove difficult as the Commission (also) needs to ensure that its actions remain legitimate in the eyes of the citizenry in addition to guaranteeing the EU’s fiscal stability and it arguably has to take account of the fact that its decisions to impose fines on non-complying Member States can only be overcome by qualified majority in the Council. Simplifying the normative corpus should nevertheless help in pursuing this objective of economically-based decisions. The Commission should also be more transparent on its methodologies, and consistent in their application. On a different note, the risk of biased, political application of the SGP by the Commission primarily comes from its current hybrid nature: “between an independent executive agency and a political government”, as the EFB rightly puts it (p. 63).

Such risk may be mitigated by a stronger reliance on economic advice independent of short-term political considerations. Where this input should come from remains to be seen. Quite naturally, the EFB has already offered its services. On the face of it, the EFB’s role is significantly different from that of national fiscal councils since it is not bound to take an active role in the implementation of the EU fiscal framework; rather it has to evaluate the Commission’s actions in this regard.

By contrast, even if national councils in most cases do not issue decisions binding on their governments, they have to produce or endorse macroeconomic previsions, they declare the activation of the automatic correction mechanism etc. In its evaluation, the EFB offers to endorse responsibilities closer to that of national councils.

Finally, in an attempt to further reduce discretion, EMU fiscal discipline could gain in consistency, foreseeability and congruence if it were to rely on smarter enforcement mechanisms by means of financial sanctions. Financial sanctions have shown all their limits in the past. In our view, macroeconomic conditionality, i.e. linking access to EU funds to (an almost) compliance with the fiscal rules of the SGP, could be the way to go. It is already used under the current multiannual financial framework, although in a much limited way. The pattern could be generalized under the next framework.

Towards a Fiscal Union?

Next to the issues of complexity, asymmetry and discretion visible in the EU fiscal framework, the question of centralized fiscal stabilization also deserves attention. The Eurocrisis has brought out in the open the founding insufficiencies of the rules-based paradigm, and the necessity to transcend such approach by endowing the supranational level (the EU or the Eurozone) with a fiscal capacity of its own is now clearer than ever.

This shift from negative to positive fiscal integration could take the form of unemployment insurance or investment protection, with the exemption of investments from the golden rule or not. The introduction of a rainy-day fund – also envisaged by the Commission – could also be a possibility. In our view, such a fund could appear to be a valuable option since it would function on the basis of accumulated resources regularly paid by Member States which would have a direct incentive to follow SGP rules. To this type of fund or an unemployment insurance the EFB however favors the protection of investment, which admittedly should be guaranteed too; perhaps it is also the least bold shift towards an unpopular Fiscal/Transfer Union.

Another possibility could be the introduction of an EU budget. Although the EFB acknowledges that this debate falls outside of its remit, it provides its opinion ‘as economists involved in the analysis of public finance more generally’ (p. 67), thereby arguably affirming its standing in the more global EU financial area. The form this budget should take – whether as a dedicated euro area budget (as recently suggested by President Macron) or as a dedicated budget euro area budget line in the EU budget (as envisaged by the European Commission) – is left open; in the absence of a dedicated euro-area parliamentary arena, perhaps the latter option is preferable to avoid further increasing the European democratic gap.

Beyond this, such a move would significantly go beyond the sole fiscal stabilization and adopt a broader stance on fiscal policy. This move, which would in fact represent the return to a perspective adopted at previous stages of the European integration process, would indeed be particularly welcome as it would (eventually) provide remedy to some of the shortcomings of the current fiscal policy design.

What does this report tell us?

This report is, in our view, important for at least two reasons. First, it bears a valuable assessment of the current EU fiscal framework as implemented by the Commission at a time when reflections on the future of the Eurozone architecture are high on the EU agenda. Second, it clears up certain doubts that could have existed when the EFB was first established, in particular as to its capacity to provide a truly independent assessment of the Commission’s actions. Indeed, concerning the latter point, a certain degree of uncertainty existed in light of the close ties between the EFB and the Commission, as well as in light of the absence of the EP’s involvement.

Furthermore, the EFB’s ability to act as an authoritative institution was not a given since it was established as a completely new institution that hence had to first prove its reliability (and independence). The content of the first report analysed here appears to indicate that the EFB is likely to surpass both hurdles successfully, at least as long as it is chaired by the prominent and respected expert Niels Thygesen.

Concerning the future of the EU fiscal framework, it certainly provides a useful and timely assessment. It both highlights the weaknesses in the current fiscal framework and in its enforcement by the Commission and makes a valuable contribution to the debate on its reform; this contribution is all the more valuable as it stems from the EU institution tasked with performing this assessment and not from the ECB or the IMF as had been the case thus far. We will now have to wait until the beginning of December to see if and how these proposals have been picked up by the Commission.

Barnard & Peers: chapter 19
Photo credit: Supertrader 

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