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The EC proposals to reinforce economic governance in Europe

European Commission - MEMO/10/204   20/05/2010

Other available languages: none

MEMO/10/204

Brussels, 20 May 2010

The EC proposals to reinforce economic governance in Europe

On 12 May the Commission proposed to reinforce decisively the economic governance in the European Union. The aim is to strengthen the functioning of the Stability and Growth Pact and extend surveillance to macro-economic imbalances. The Communication proposes to align national budget and policy planning through the establishment of a "European Semester" for economic policy coordination, so that Member States would benefit from early coordination at European level as they prepare their national budgets and national reform programmes. In the medium-to-long term, the Commission intends to make a proposal for a permanent crisis resolution mechanism.

1. Why do we need this package?

The recent crises and the risk for the stability of the euro area have underlined the interdependence among EU economies and exposed the vulnerability of Member States, in particular inside the euro area. Fiscal discipline, competitiveness gaps and private sector imbalances are also a matter for the EU as a whole. This is why there is a need for economic policy coordination across the EU.

The Lisbon Treaty and the Stability and Growth Pact1 establish rules and procedures for such economic policy coordination, which are sound, but have not been sufficiently respected. Peer pressure lacked teeth, good times were not used to reduce public debt sufficiently. Moreover, the build-up of macroeconomic imbalances was not addressed appropriately, even though the Commission had been warning about it for some time. In a number of Member States, this translated into high current account deficits, large external indebtedness and high public debt levels, which are clearly above the 60% reference value set in the Treaty. The financial stability of the Euro area as a whole has been put at risk.

The Commission proposals are needed to establish stronger economic governance in the EU, so as to reinforce compliance with the rules and principles set out in the Treaty and the SGP, especially for the euro area and to establish formal procedures to deal with macroeconomic imbalances that can jeopardize the functioning of EMU.

2. Is this not a problem for the euro area only?

No, the interdependence considers all EU Members States. EU economies are strongly interlinked through the single market. In particular, cross-border trade and financial spill-over, particularly in the banking sector, are large.

3. What is the essence of the Commission's proposals?

The Commission's approach is based on three pillars:

  • reinforcing the Stability and Growth Pact;

  • addressing macro-economic imbalances and divergences in competitiveness;

  • working towards a permanent and robust framework for crisis management.

With a view of achieving a more integrated surveillance of economic policies, it has been suggested under the Europe 2020 initiative to synchronize the assessment of fiscal and structural policies of EU Member States in the so-called European Semester. The present communication proposes to integrate the first two pillars into the European Semester. This should allow Member States to benefit from early coordination at European level when they prepare their national budgets and national reform programs.

There is a difference between the surveillance for the EU as a whole and for the euro area specifically. The integrated surveillance cycle through the European Semester applies to all EU Member States. For the euro area, the Commission proposes to go further by including surveillance of macroeconomic and competitiveness developments, complementing the fiscal surveillance for all EU Member States. The Greek sovereign debt crisis has also showed that a robust framework for crisis management for euro-area Member States is needed.

4. Does this package imply Treaty changes?

No, the Commission's proposals are based on making full use of the surveillance instruments available under the Lisbon Treaty. The Lisbon Treaty provides plenty of room for progress through a better and full use of the existing economic policy instruments, and through revised and new secondary legislation, where needed. In particular, article 136 on economic policy coordination enables us to develop new tools for reinforced economic governance in euro area.

5. Is the Commission using the crisis to impose its views?

No, the Commission, in line with its right of initiative, is proposing to strengthen the economic governance of the EU and the euro area in particular. The Commission will now seek the views of the Member States and the European Parliament, and will bring forward legislative proposals in the coming months.

6. What are the proposals for fiscal discipline?

The issue: Member States haven't done enough in good times to reduce their public debt over the past decade. Furthermore, in some member states' budgets were built on the assumption that the additional revenues received during the boom were to be considered structural improvements in the underlying position rather than temporary additions due to exceptional conditions. When the crisis hit, deficits went up. They are forecasted to exceed 7% on average in the EU in 2010. On unchanged policies, debt ratios are projected to reach 84% in EU (88% for the euro area) in 2011. Large public debt weighs on economic growth and on a government's ability to run counter-cyclical policies when needed. The long-standing fiscal challenges related to ageing emphasises the need for addressing the budgetary challenges head on.

The proposals:

  • Preventive budgetary surveillance must be reinforced, so as to allow early detection and early action. This surveillance takes place mainly through the assessment of Stability and Convergence Programmes. This is the core of the preventive arm of the Stability and Growth Pact.

  • For early detection, the Commission proposes an early peer review at EU level of the broad budgetary guidelines of each Member State, thus informing the Member States' competent authorities of the European perspective and guidance before they adopt their national budget. The approval of the Commission's proposals to reinforce Eurostat's mandate to audit national statistics is a prerequisite to ensure that the assessment is based on accurate data.

  • For early action, the Commission proposes the possibility of imposing interest-bearing deposits on Member States who make insufficient progress to their Medium-Term-Objectives in good economic times, because of inadequate fiscal policies. (Change in secondary legislation needed.)

  • As part of the strengthened preventive action, the Commission also encourages Member States to integrate in their national law the Treaty obligations on budgetary discipline (Protocol Nr12 TFUE), putting in place budgetary procedures that ensure compliance for instance through legally binding instruments.

  • When a Member State goes off track, the corrective part of the Stability and Growth Pact kicks in through the Excessive Deficit Procedure (EDP). The EDP needs strengthening in several ways:

  • Speeding up procedures, in particular for those in repeated breach. (Change in secondary legislation needed.) For instance, the initial steps of the procedure could be skipped for countries in repeated breach.

  • More attention will be given to the debt criterion: Member States with debt ratios above 60% of GDP should become subject to the EDP if the decline of debt in a given period falls short of an appropriate benchmark. This is in line with art 126 TFUE. (Some changes in secondary legislation needed.)

  • Broader and more timely use of the EU budget to ensure compliance with the SGP should be considered.

  • Suspension of the Cohesion Fund is foreseen at a late stage in the EDP, according to art 126 (8) TFUE.

  • Under the new Financial Perspectives, the establishment of fair, timely and effective incentives for compliance should be established. For instance, once the existence of an Excessive Deficit is established (art.126 (6) TFUE), Member States could be asked to redirect funds to improve the quality of their public finances, in particular reducing transfers and public consumption to favour investment.

  • Cohesion policy could play a greater role, for instance by strengthening institutional capacity and efficiency of public administrations. The 5th Cohesion Report will present proposals in that sense.

  • A more rigorous application of the existing suspension clause for Cohesion Fund commitments should be pursued in case of current breaches of the Pact.2

7. Is EU scrutiny of state budgets not against sovereignty?

No, the early peer review would fully respect the prerogatives of national parliaments.

It would only provide information and guidance for the preparation of the national budgets in the following year. This is about informing and ensuring that national budgets are consistent with the European dimension, so that they don't put at risk the stability of the other member states.

Countries which are models of budgetary discipline can be sure to win plaudits from its EU partners, and they can share their experience with others in the peer review, avoiding others to derail and thus contributing to safeguard the financial stability of the EU.

8. And what about competitiveness and other macro-economic imbalances?

The issue: The accumulation of large and persistent imbalances among euro area member states potentially undermines the cohesion of the euro area and hampers the functioning of EMU. During the first decade of the euro, the euro area has seen steady divergence in the current account and competitiveness positions of its Member States. Some euro-area countries have accumulated large current account deficits and experienced large losses in competitiveness. These trends were associated with a misallocation of capital and labour, unsustainable accumulation of debt and housing bubbles. Other Member States accumulated large current account surpluses reflecting persistent weakness in private sector demand.

The proposals:

The Commission proposes a broader economic surveillance framework for the euro area. This surveillance should go beyond the budgetary dimension to address also other macro-economic imbalances such as competitiveness developments and underlying structural challenges. Taking account of the deep economic and financial inter-linkages within the euro area and their impact on the single currency, the Commission, in its Europe 2020 proposal, called for the development of a specific policy framework for the euro area to tackle broader macroeconomic imbalances. The European Council subsequently asked the Commission to present a proposal by June 2010 to strengthen coordination within the euro area

The Communication proposes to upgrade the peer review of macro-economic imbalances now carried out by the Eurogroup into a structured surveillance framework based on art.136 TFEU. On the basis of a scoreboard of external and internal indicators such as current accounts, unit labour costs, public and private sector debt or asset prices, the Commission would asses the risk of emerging macro-economic imbalances, for the euro area as a whole and on a country by country basis. A more in-depth analysis of imbalances would be the basis for country-specific recommendations on action to be taken by a euro area Member States within a stipulated time, taking the form of Council acts with only euro area Member States voting. In case of insufficient action, the Council could decide, on the basis of a Commission proposal, on more precise economic policy recommendations. The Commission could also issue early warnings directly to a euro area member state where necessary.

Depending on the situation of the Member State concerned, the recommendations could address the functioning of labour, product and services markets, in line with the Broad Economic Policy and Employment Guidelines. They could also cover macro-prudential aspects to prevent or curb excessive credit growth or excessive asset price development, in line with the future European Systemic Risk Board analysis.

9. What is the European Semester?

The Commission proposed in its Europe 2020 Strategy to do the assessment of the structural and fiscal policies of Member States in parallel. The European Semester would establish an integrated surveillance cycle, allowing such synchronized assessment to take place in an efficient and effective manner.

The process would be as follows:

  • It would start early in the year with a horizontal review under which the European Council, based on input from the Commission, would discuss the main economic challenges for the EU and the euro area in view of giving strategic guidance.

  • The results of this discussion would be taken into account by Member States when preparing their Stability and Convergence Programs (SCP) and their National Reform Programs (NRP). Member States are encouraged to involve their national parliaments in full respect of national rules and procedures in the process before submission.

  • The SCP and NRP would be issued simultaneously. This means submission of the SCP should take place in the first half of the year instead of towards the end of the year.

  • The Council, based on the Commission's assessment, would subsequently provide assessment and guidance, at a time when budgetary decisions are still in a preparatory phase at national level.

The results of such ex-ante budgetary and economic surveillance at EU level among peers would allow the competent national authorities to be informed of the European perspective and guidance, enabling them to take more informed decisions under their national rules and procedures and in full respect thereof.

10. Why do we need a permanent and robust framework for crisis management?

Because it is "better to be safe than sorry", as recent events have shown.

  • Financial distress can threaten the macro-economic stability of the euro area as a whole and beyond.

  • The best crisis mechanism is fiscal discipline and tackling imbalances before they occur. Ideally, one should avoid the fire from starting.

  • However, if the fire has started, corrective action is needed to avoid that it becomes a forest fire.

  • If, however, corrective action is not enough, additional fire brigades need to be called in. Building on the temporary European stabilisation mechanism decided by ECOFIN on 9 May, the Commission intends in the medium to long term to make a proposal for a permanent crisis resolution mechanism, which will be accompanied by a detailed and demanding programme of policy conditionality.

1 :

http://ec.europa.eu/economy_finance/sgp/index_en.htm

2 :

Council Regulation (EC) No 1084/2006. Article 4 "(a) if the Council has decided in accordance with Article 104(6) of the Treaty that excessive government deficit exists in a beneficiary Member State, and (b) has established in accordance with Article 104(8) of the Treaty that the Member State concerned has not taken effective action in response to a Council recommendation made under Article 104(7) of the Treaty, it may decide to suspend either the totality or part of the commitments from the Fund for the Member State concerned with effect from 1 January of the year following the decision to suspend."


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