It Is Broken. Can It Be Fixed? A Look at the European Union's ...

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It Is Broken. Can It Be Fixed? A Look at the European Union’s
Stability and Growth Pact
It Is Broken. Can It Be Fixed? A Look at the European Union’s
Stability and Growth Pact
Richard F. Emery
Linfield College
Department of Business
900 SE Baker Street
McMinnville, OR 97128
rfemery@linfield.edu
(503) 883-2298

Paper Presented at the 30 th Annual European Studies Conference
At the University of Nebraska at Omaha
October 6-8, 2005
Introduction
In 1992, the European Union (EU), formerly the European Community, adopted the
Treaty on European Union (TEU), more commonly known as the Maastricht Treaty, in honor of
the Dutch city where it was adopted. Perhaps the most significant aspect of the TEU was the
adoption of the three-stage process for completion of the European Monetary Union (EMU). In
actuality, Stage I was already in existence, as it called for the free movement of capital within the
EU and for closer monetary and economic cooperation between the EU member states and their
central banks. Both of these had occurred with the completion of the Single Market at the
beginning of 1992. In addition, Stage I adopted a time-line for the implementation of Stages II
and III to guide the member states toward completion of EMU. Significantly, the TEU spelled
out in Article 121, the requirements necessary for member states to be eligible to enter Stage III.
These requirements became known as the convergence criteria:
• Price stability: an average inflation rate not exceeding by more than 1.5 percent
that of the three best-performing member states.
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• Budgetary discipline: a government financial position that does not include an
excessive deficit, a protocol attached to the treaty provided two reference values:
a budget deficit of less than 3 percent of Gross Domestic Product (GDP) and a
public debt ratio not exceeding 60 percent of GDP.
• Currency stability: observance of normal fluctuation margins of the ERM
(European Rate Mechanism) for at least two years with no devaluations.
• Interest rate convergence: an average nominal long-term interest rate not
exceeding by more than 2 percent that of the three best-performing member
states. (Dinan, 1999, p. 461).
Among other things, Stage II called for the creation of the European Monetary Institute
(EMI), which was to be the forerunner of the European Central Bank (ECB), which would come
into existence at the beginning of Stage III. The EMI came into existence in July 1994, and was
located in Frankfurt, Germany, the seat of the German Bundesbank, a symbol, at least for the
Germans, of sound monetary policy. The EMI was given two major tasks: (a) make the technical
preparations necessary for Stage III of EMU; and (b) help coordinate member states’ monetary
policies. This latter task was difficult to accomplish because the EMI could not make decisions
as the member states remained responsible for their own monetary policies until the
establishment of the ECB at the beginning of Stage III. To be fair, the member states did attempt
to coordinate their monetary policies, but they did so primarily through the auspices of the
European Council’s Council of Economic and Finance Ministers (ECOFIN).
The European Council asked ECOFIN to address two issues it believed central to the
success of EMU: (a) the problems posed by the fact that not all member states would participate
in EMU at the beginning of Stage III (if ever); and (b) how to insure that member states would
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continue the budgetary discipline of the convergence criteria after the beginning of Stage III. Not
surprising this second issue was critically important to Theo Waigel, German Finance Minister
under Chancellor Helmut Kohl. In response to the European Council’s request for a methodology
to continue the budgetary discipline, ECOFIN proposed what eventually became known as the
Stability and Growth Pact (SGP).
The Stability and Growth Pact
The genesis for the SGP is found in Article 104 of the TEU, which states in part:
(1) Member States shall avoid excessive government deficits.
(2) The Commission shall monitor the development of the budgetary situation and of the
stock of government debt in the Member States with a view to identifying gross errors. In
particular it shall examine compliance with budgetary discipline on the basis of the
following two criteria:
(a) whether the ratio of the planned or actual government deficit to gross domestic
product exceeds a reference value, unless: either the ratio has declined
substantially and continuously and reached a level that comes close to the
reference value; or, alternatively, the excess over the reference value is only
exceptional and temporary and the ratio remains close to the reference value
(b) whether the ratio of government debt to gross domestic product exceeds a
reference value, unless the ratio is sufficiently diminishing and approaching the
reference value at a satisfactory pace.
(5) If the Commission considers that an excessive deficit in a Member State exists or may
occur, the Commission shall address an opinion to the Council.
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(9) If a Member State persists in failing to put into practice the recommendations of the
Council, the Council may decide to give notice to the Member State to take…measures
for the deficit reduction which is judged necessary by the Council…
(11) As long as a Member State fails to comply with a decision taken in accordance with
paragraph (9), the Council may decide…to impose fines of an appropriate size.
(http://europa.eu.int.eur-lex/en/treaties/selected/livre223.html#anArt6).
The reference values mentioned in parts 2 (a) and (b) of Article 104 above are the same as the
criteria established under the budgetary discipline portion of the convergence criteria in Article
121 of the TEU, specifically, an annual budget deficit lower than 3 percent of GDP and a public
debt not more than 60 percent of GDP, or at least approaching that value.
It is important to note that at the time this discussion was occurring within ECOFIN,
member states were desperately trying to satisfy the convergence criteria. As part of member
states’ efforts to satisfy the convergence criteria several were cutting budgets in order to get their
deficits below the magic 3 percent.
As budget cuts resulted in less government hiring, fewer and smaller business subsidies,
and lower expenditures on public works, unemployment inevitably increased. As budget
cuts also resulted in less generous social welfare programs, unemployment became less
congenial for many Europeans. These developments reinforced a popular perception that
EMU itself caused unemployment and worsened the plight of the unemployed (Dinan,
1999, p. 470).
There are a couple of interesting political side notes to the proposal that eventually
became the SGP. Originally, the proposal was called the stability pact. However, when the
European Council adopted the proposed agreement at the Dublin summit in December 1996,
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ECOFIN had renamed the pact, the SGP. This was in response to the perception that EMU, or
more specifically, the rush to meet the convergence criteria, was destroying jobs and creating
unemployment.
When ECOFIN was drafting the SGP, German Finance Minister Waigel wanted the fines
to become automatic. However, when the final proposal was adopted, fines were only one of the
possible recourses available for failure to stay within the 3 percent criteria. Further, assessment
of a fine was left to the discretion of the Council rather than automatic. This was agreed to
primarily appease the French, specifically President Jacques Chirac. It is another example of how
often, through the existence of the EU, the French and German governments have bent over
backward to support the other in order to preserve the primacy of the Franco-German
relationship in EU matters.
What is the SGP and what does it do? Formally, the SGP contains three elements:
• A political commitment…to the full and timely implementation of the budget
surveillance process…(which) ensures that effective peer pressure is exerted on a
Member State failing to live up to its commitments.
• Preventive elements which through regular surveillance aim at preventing budget
deficits going above the 3% reference value….It foresees the submission by all
Member States of stability and convergence programs, which are examined by the
Council. The Regulation foresees also the possibility to trigger the early warning
mechanism in the event a slippage in the budgetary position of a Member State is
identified.
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• Dissuasive elements which in the event of the 3% reference value being breached,
require Member States to take immediate corrective action and, if necessary,
allow for the imposition of sanctions.
(http://europa.eu.int/comm/economy_finance/about/activities/sgp/sgp_en.htm)
The SGP does provide a couple of possible exceptions for failing to stay within the 3
percent reference value:
• It results from an unusual event outside the control of the Member State
concerned and has a major impact on the financial position of the general
government;
• It results from a severe economic downturn (if there is an annual fall of real GDP
of at least 2%).
(http://europa.eu.int/comm/economy_finance/about/activities/sgp/edp_en.htm)
The SGP also clarifies the procedure for the imposition of fines. Initially, a member state must
make a non-interest-bearing deposit with the Commission equal to 0.2 percent of GDP plus a
variable amount based on the size of the deficit. Each succeeding year, the Council may require
an additional deposit up to a maximum of 0.5 percent of GDP. The deposit may be converted
into a fine if, in the opinion of the Council, the excessive deficit has not been corrected after two
years.
Deficit and Debt Results
(Insert Table 1 about here)
Table 1 presents the government deficit or surplus as a percentage of GDP for the years
1998 through 2004. It is important to note that only the 12 countries which are members of the
euro-zone are bound by the 3 percent reference value. Other member states would have to satisfy
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all the convergence criteria, including the 3 percent reference value, prior to becoming part of the
euro-zone. The following points summarize some of the more important information from Table
1:
• There has been a miniscule improvement in the deficit to GDP percentage for the
euro-zone 12 for 2004 when compared to 2003, -2.7 percent compared to -2.8
percent. However, there are only three member states that are not in deficit –
Finland, Ireland, and Belgium, compared to five in 2003, as Luxembourg and
Spain went into deficit. This is the first time that Luxembourg has reported a
deficit.
• France and Germany, which account for more than half of EMU output, continue
to have deficits significantly higher than 3 percent as they have for the last three
years. France did show modest improvement when compared to 2003, however,
Germany remained essentially unchanged.
• The situation in Greece continues to worsen. The significant deterioration from
the data reported for 2000 and prior when compared to 2001 and later call into
question the accuracy of the earlier reported information. It is interesting to note
that Greece did not qualify for admission to the euro-zone until 2000, a year after
the other 11 member states qualified. Perhaps Greece fudged its data in order to
qualify.
Although, the United Kingdom is not a member of the euro-zone, it is important to note
that its deficit to GDP percent exceeded the 3 percent reference value for both 2003 and 2004.
This fact is quite interesting because the political rhetoric has long been that the British economy
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is so strong that the British don’t need to and shouldn’t join EMU. Perhaps it is time to end that
myth.
Again, although not part of EMU, all of the recently admitted member states have deficits
when compared to GDP for 2004 with the exception of Estonia which had a surplus of 1.8
percent. Malta -5.2 percent, Poland -4.8 percent, Hungary -4.5 percent, and Cyprus -4.2 percent
had higher deficits than any of the euro-zone countries except for Greece.
(Insert Table 2 about here)
Table 2 presents the government debt as a percentage of GDP for the years 1998 through
2004. As indicated above, the convergence criteria called for government debt of not more than
60 percent of GDP. The following points summarize some of the more important information
from Table 2:
• Three countries – Belgium, Greece, and Italy had debt to GDP ratios considerable
greater than 60 percent when they joined the euro-zone. The reason they were
allowed to join EMU was because of the weasel words – approaching the value.
Certainly, 105 to 120 percent is not really approaching 60 percent, however, what
the table does not indicate, is that these percentages were, at the time, decreasing
quite rapidly, again in order to be able to join EMU. This was particularly
important for Belgium and Italy since they were founding members of the EU and
it was unthinkable to not allow them to join EMU if they so desired. Both
countries’ debt to GDP ratio has continued to decrease since the beginning of
EMU, but obviously does not begin to approach the convergence criteria of 60
percent.
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• As is the case with the deficit to GDP ratio, the debt to GDP ratio for France and
Germany has worsened since 2001. Both countries now exceed the 60 percent
reference value and continue to worsen. In addition, Portugal’s deficit to GDP
ratio continues to worsen from its best year, 2000, and for the second year running
is in excess of 60 percent.
• The same comment concerning Greece’s data, as made above, is applicable here
as well. Notice that its debt to GDP percentage increased from 104.7 percent in
2000 to 114.8 percent the next year, leading to the suspicion that its data for 2000
and earlier years was inaccurate.
• It is perhaps reasonable to conclude that because ECOFIN’s primary focus has
been on what to do about the deficit to GDP ratio, that it has ignored the resulting
debt to GDP ratio. In its 2002 report to the Council and the European Parliament,
the Commission called for renewed attention to the importance of debt.
Only two of the newly admitted member states have a debt to GDP ratio in excess of the
60 percent reference point. Malta’s ratio is 75 percent while Cyprus’ ratio is 71.9 percent. At the
other extreme, Estonia is again the shining light. Its debt to GDP ratio is 4.9 percent, the lowest
of the EU-25.
Critique of the Stability and Growth Pact
The original goal of the Stability and Growth Pact was to safeguard the sustainability of
public finances in EMU. However, according to some experts, this goal has become less clear
over time, moving towards the more ambitious goals of ensuring that all countries follow
sensible, if not optimal, fiscal policies. The Stability and Growth Pact is viewed as too intrusive
and aggressive to achieve the original goal of sustainability of public finances. On the other
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hand, its rules are not strict enough to enforce optimal fiscal policies. Obviously, the Stability
and Growth Pact cannot achieve both goals.
The 3% deficit limit and the 60% debt limit were originally chosen to be consistent with
a stable debt ratio and a trend annual growth rate of nominal GDP of 5%. With 5%
growth, the increase in debt implied by a 3% deficit exactly offsets the reduction in a debt
ratio of 60%. It is now clear, however, that the EMU countries did not and will not grow
uniformly at a rate of 5% annually. Some countries achieved growth rates significantly
above that rate; others, Germany and France in particular, achieved less than that
(Fatas,Von Hagen, Hallett, Strauch, and Sibert, 2003, p. 51).
As a result, slow growing economies, like France and Germany, can experience rising debt ratios
(which they have), even if they stay below the 3 percent deficit limit (which they haven’t). For
countries with high growth rates, especially the newly acceded countries, the 3 percent deficit
limit will prove unduly restrictive. In short, these limits are simply not flexible enough.
Henrik Enderlein suggests that fiscal policy within a monetary union is really a Catch-22
situation.
The conduct of domestic fiscal policies in a monetary union is subject to two largely
opposite requirements. On the one hand, member countries need to be given some
autonomy to undertake stabilizing fiscal measures in the domestic economy. On the
other hand, member countries’ fiscal autonomy needs to be reduced if there is a
credible risk that a country seeks free-riding on overall systemic stability (Enderlein,
2004, p. 1039).
He suggests that by definition the focus of the SGP is on the latter requirement and that based on
the first six years of EMU, this requirement should be given much less emphasis.
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Another concern is that the rules are difficult to enforce. Leaving enforcement to
ECOFIN is akin to having the fox guard the henhouse. This has definitely come to pass, as
evidenced by the fact that France and Germany have yet to be penalized, although they have
been threatened with penalties for exceeding the 3 percent deficit limit. Although this paper has
not gone into detail as to how a member state can be fined for exceeding the 3 percent deficit
limit, suffice it to say that a fine is not automatic, although that very well may be the public
perception. Nevertheless, the fact that France and Germany have not been penalized does suggest
that larger member states can ignore the reference values to no harm. The inference being that
this is a luxury that would not be afforded to smaller member states. Whether this is true or not is
certainly open to speculation. However, it has been cited as at least one of the many factors
which led the Netherlands to reject the Constitutional Treaty this past May.
In fairness, not everyone believes that the fault lies entirely, or even primarily with the
SGP.
There is plenty wrong with the SGP – the arbitrariness of the 3 percent rule, the
consequent pro-cyclical tendencies, and the insufficient room for maneuver it allows to
countries, such as Germany, where the one-size-fits all monetary policy is particularly
restrictive....But the objective of fiscal discipline which the SGP so clumsily and rigidly
pursues is not wrong….The main problem, from which the SGP controversy distracts
attention, is the European Central Bank’s excessive restrictive policy orientation (Martin,
2005, p. 7).
The ECB has long claimed that its only purpose is to pursue price stability, e.g. control inflation.
Nevertheless, Martin argues that in its pursuit of price stability, the ECB reacted too little, too
late when economic growth slowed in the early 2000s. The unfortunate result was that member
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states’ revenue failed to grow at sufficient levels to match the resulting social policy costs
imposed upon them by the economic slow down. The result was that it became exceedingly
difficult, if not impossible, for some member states to satisfy the SGP’s requirements,
specifically, the 3 percent reference value.
In summary, it is probably reasonable to conclude that the SGP has not been as effective
as was believed it would be when first introduced and agreed to nearly a decade ago. Most
experts would probably agree with the following sentiment:
The SGP has achieved two things. First, it shifts the nature of fiscal framework
significantly towards a rule-based concept constraining annual deficits and away from a
framework based on informed judgment. Second, it weakens the position of the European
Commission in the process, to the benefit of ECOFIN….As a result, the process and
decisions taken under it have become more politicized (Fatas, von Hagen, Hallett,
Strauch, and Sibert, 2003, p. 9).
Proposals for Improvement
In an effort to improve the SGP, in late 2002, the Commission put forward a proposal
entitled, Strengthening the Coordination of Budgetary Policies. The proposal started with a
listing of six problems that exist with the EU’s fiscal policy, specifically, the shortcomings of the
SGP. The problems include:
• Decline in political ownership of the SGP by the member states.
• Lack of identification of clear and verifiable budget objectives.
• Fiscal policies have been sufficiently lax so that governments have not been able to stay
below deficit targets during times of slow economic growth.
• Enforcement has been poor.
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• Flexibility is lacking.
• Difficulty in communication and data collection.
As a result the Commission made the following recommendations for reform:
• Add flexibility to the rules. An example would be to allow the use of cyclically adjusted
variables when assessing medium-term budgetary plans. Another example would be to
allow small deviations from the “close-to-balance or in surplus” rules, particularly for
countries that have low debt/GDP ratios.
• Increase political ownership. In other words, all countries must agree that sustainability
of public finances is a core objective.
• Reinforce surveillance. Establish an early warning system, whereby countries would have
sufficient time to change fiscal policy before falling into a situation of excessive deficits.
• Recognize that the level of debt matters. Provide greater incentives for debt reduction,
while penalizing debt increasing behavior.
• Upgrade statistics and improve communication. There should be non-partisan
enforcement whereby the Commission implements the rules, rather than the current
practice where implementation is left to ECOFIN.
Fatas, von Hagen, Hallett, Strauch, and Sibert identified four alternative proposals which put
sustainability of public funds as the main objective, but differ from the strict limits on deficits
and debt. These proposals include:
• The Golden Rule. The Golden Rule argues that it is not the size of the deficit that matters
so much as the composition of the expenditures. Larger deficits can be allowed, but only
if the deficit is the result of public expenditures. This rule is currently followed by both
Germany and the United Kingdom.
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• Debt rules. The argument here is that sustainability relates more to the debt burden than
to the current deficit. An application of this focus is that the deficit criterion should be
loosened for countries with low debt ratios. Governments would tighten their budgets in
good times in order to lower their debt ratios and in bad times could expand their deficit
ratio, while keeping their debt ratio stable, or so the argument goes.
• Country-specific rules. This would allow countries more flexibility in addressing the
deficit and debt situations. Countries would be encouraged to come up with individual
solutions such as Sweden’s proposal for the creation of a stabilization fund to enhance
employment and wage stability in bad times. This would require, for example, a system
of tax smoothing.
• Cushion funds. Essentially, endorse the Swedish proposal, something that Finland has
also done, but do it on a community-wide basis.
As indicated, these proposals all regard sustainability as the main objective of the SGP and see
the current rules as ineffective in meeting the objective.
Fatas, von Hagen, Hallett, Strauch, and Sibert have concluded that the current system is
broken and needs to be fixed. To do so they have proposed the creation of, what they call, a
Sustainability Council for the EMU countries.
The Sustainability Council’s task would be to provide an informed assessment of the
fiscal situation and outlook of each EMU member state, taking into account all relevant
aspects of the situation. This would bring the fiscal policy framework of EMU back to the
spirit of the Maastricht Treaty and the original EDP (excessive deficit procedure).
Importantly, however, by entrusting the analysis and judgment of sustainability to an
independent council, it would solve the basic credibility problem of the SGP, that is that
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the governments through ECOFIN judge the quality of their own policies (Fatas, Von
Hagen, Hallett, Strauch, and Sibert, 2003, p. 67).
They suggest that the Sustainability Council be funded by and report to the European Parliament,
rather than either the Commission or the Council. They acknowledge that the idea for creation of
yet another EU institution may seem unattractive to many. However, they feel that the benefits of
increased transparency and democracy outweigh this concern and warrant consideration of their
proposal.
Enderlein suggests that the problem for EMU is “how to achieve domestically stabilizing
fiscal policies without creating a collective action problem based on free-riding deficit-spending
by member countries’ governments” (Enderlein, 2004, p. 1042). He suggests two possible
solutions: (a) a full-fledged system of fiscal federalism wherein any surplus money from fast
growing member states would be redistributed to low growth countries; and (b) abolishment of
the SGP replacing it with reliance on Article 99 of the TEU’s Broad Economic Policy Guidelines
(BEPGs).
Of these solutions, Enderlein suggests that the first, while having some appeal, is
unrealistic, at least at this juncture. Therefore, he recommends scraping the SGP and relying on
what is referred as the ‘soft’ approach of the BEGPs. He argues that decisions on deficits and
surpluses are fundamentally political in nature and, therefore, the ‘hard’ approach of the SGP
will not work. He distinguishes between the two approaches with the following example: “the
SGP approach: ‘you are not allowed to run deficits above 3 per cent’…the BEPG approach: in
2004 you should reach a budgetary deficit of 1 per cent’” (Enderlein, 2004, p. 1042). Whether
this is merely a matter of semantics or is a significant difference is probably a matter of
interpretation, however, Article 99 does task the Council with the formulation of these BEGPs
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with a subsequent report to the European Parliament. Enderlein’s argument is that it is through
the workings of the Council that member states will be pressured to insure that their fiscal
policies do not allow for significant free-riding deficit-spending making the SGP unnecessary.
Martin’s solution is that the ECB accept responsibility for growth as well as price
stability, as the United States’ Federal Reserve Bank has done.
Fiscal discipline would then have to be reconfigured. While member states would get
more scope for adjustment to their diverse conditions, their fiscal policies would have to
be coordinated so that they add up to overall euro zone fiscal stance that, combined with
a more expansionary monetary stance, gives the euro zone a macroeconomic policy mix
aimed at growth as well as reasonably low inflation. At a minimum, such coordination
would require shifting the focus of the BEPGs to the euro zone policy mix, including
monetary as well as fiscal policy. This would, in turn, require the ECB to negotiate with
the Commission and the Euro Group in Ecofin about the respective policy stances to be
implemented. In other words, the ECB would have to abandon its insistence that even
discussion of monetary policy by such other bodies…is an infringement on its
independence (Martin, 2005, p. 8).
Martin suggests this could be done without treaty revision. All that is required is for the ECB to
change its policy orientation and operating mode. Unfortunately, he doesn’t hold out much hope
that this will occur in the near future.
Begg and Schelkle suggest that there is an effective middle ground based on prevention
and co-ordination.
• There has to be a supranational body in which policy is formulated in a transparent
manner. For this task, a more open Eurogroup is their body of choice.
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• There should be clear parameters for each Member State’s fiscal policy against which its
record can be judged.
• There need to be channels through which national finance ministers can be held to
account when they make (or break) such commitments.
• There should be a political price to pay for Member States that breach agreed policies
without good, economically defensible, reasons.
There are obvious concerns with the effectiveness of Begg and Schelkle’s proposed Eurogroup
holding its finance ministers accountable. Their response is that
Explicit political sanctions at the EU level, such as losing the right to vote on euro
matters in Ecofin, might help to reinforce these commitments, but the main sanction
should be expected from the perception of failure in domestic politics (Begg and
Schelkle, 2005, p. 1055).
In examining the behavior of larger member states compared to that of smaller member
states, Buti and Pench agreed with Fatas, von Hagen, Hallett, Strauch, and Sibert in calling for
greater flexibility. However, they were equally as concerned as to the negative results of greater
flexibility without the ability to enforce the SGP.
For any reform of the Pact to be credible, Member States, especially the larger ones, need
to exhibit greater willingness to subordinate short-term political gains to the long-term
common good of protecting the monetary union from the risk of financial
unsustainability. A powerful signal in this direction would be for the Member States
against which an EDP is being initiated, to agree to abstain from voting at any step of the
procedure concerning any Member State. A self-denying ordinance of this kind,
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especially on the part of the largest Member States, would speak louder than a thousand
Council communiqués on the Pact (Buti and Pench, 2005, p. 1032).
The EU Responds
Nearly two years after issuing its Strengthening the Coordination of Budgetary Policies, the
European Commission, on September 3, 2004, issued its updated proposals to improve the SGP.
The main points of the Commission’s proposals were:
• Current limits on public deficit and public debt would remain unchanged, but more
emphasis would be placed on public debt and the viability of public finances in the
medium and long-term, taking into account retirement financing and growth potential.
• Greater allowance would be made for country-specific circumstances in defining the
medium-term objectives of close to balance or in surplus budgets. The higher the debt
level, the stricter the medium-term budget objective.
• Consideration would be given to economic circumstances and developments in the
implementation of the EDP, used to prelude sanction in the case of a deficit in excess of
the 3 percent of GDP reference value.
• Countries that experience prolonged periods of weak growth could invoke an
exceptional circumstances clause to avoid an EDP, whereas currently this clause applies
only to instances of negative growth, or recession.
• An extended EDP would allow more time between the different stages to tailor the
procedure to each country. Such an approach would avoid the pitfalls of overly strict
adjustments.
• Budgetary surveillance should ensure the achievement of surpluses in good times to
create sufficient room for dealing with economic slowdowns.
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The Commission’s proposals were forwarded to ECOFIN which met in February 2005 in
an effort to reach agreement prior to the March summit of the European Council. Perhaps not
surprisingly, the biggest sticking point evolved between the larger member states which wanted
greater flexibility while the smaller member states wanted the existing budgetary discipline to be
upheld. For example, Hans Eichler, Germany’s finance minister, proposed that member states
breaching the 3 percent reference value be spared disciplinary measures unless they had
committed serious policy errors.
Eichler’s boss, Chancellor Gerhard Schroeder, had called for greater national sovereignty
over economic policy and a diminished role for the Commission. This was summarily rejected
by Karl-Heinz Grasser, Austria’s foreign minister, as well as, interestingly enough, by the
Bundesbank, Germany’s central bank, which indicated that higher interest rates for the euro-zone
were possible if member states abandoned the fiscal discipline required under the SGP.
The final step in the reform process fell to the European Council meeting in Brussels in
March 2005. The Council acknowledged that in effect, the SGP was broken by stating that “the
reform aims at better responding to the shortcomings experienced so far through greater
emphasis to economic developments and an increased focus on safeguarding the sustainability of
public finances” (European Council, 2005, p. 22). The report went on to suggest five areas ripe
for improvement:
• Enhance the economic rationale of the budgetary rules to improve their credibility and
ownership.
• Improve ‘ownership’ by national policy makers.
• Use more effectively periods when economies are growing above trend for budgetary
consolidation in order to avoid pro-cyclical policies.
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• Take better account in Council recommendations of periods when economies are growing
below trend.
• Give sufficient attention in the surveillance of budgetary positions to debt and
sustainability. (European Council, 2005, p. 23).
The document adopted by the Council includes many terms that essentially support the
recommendations of the Commission while indicating that there is no intention to scrap the SGP.
For example, they intend to ‘keep changes to a minimum’ while ‘strengthening national
ownership of the fiscal framework’; promoting ‘cooperation and communication’; ‘improving
peer support and applying peer pressure’; suggesting that ‘national budgetary rules should be
complementary’, while ‘increasing the focus on debt and sustainability’.
A final quote from the document is perhaps a good indication of the Council’s position.
The excessive deficit procedure should remain simple, transparent and equitable.
Nevertheless, the experience of recent years shows possible scope for improvement in its
implementation. The guiding principle for the application of the procedure is the prompt
correction of an excessive deficit. The Council underlines that the purpose of the
excessive deficit procedure is to assist rather than to punish, and therefore to provide
incentives for Member States to pursue budgetary discipline, through enhanced
surveillance, peer support and peer pressure. (European Council, 2005, p. 31).
With nothing more than a cursory view of this document it is obvious that nothing radical
was agreed to that would significantly alter or improve the SGP. Buti and Pench’s reference to a
thousand Council communiqués jumps to mind. Is it any wonder then that the media and general
public responded to this ‘reform’ with a big yawn and complete indifference. Granted, at the
time, the Council was far more concerned with the upcoming referendums in France and the
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Netherlands, which ultimately doomed the Constitution. Again, it is probably not too out-of-line
to suggest that the Council’s relative inaction to reform the SGP contributed to rejection of the
Constitution in the Netherlands. The inaction merely reinforced the perception that the larger
member states can violate commitments with nothing more than a slap on the wrist.
Conclusion
In a paper presented at the EUSA biennial conference in Austin, a week after the Council
met in Brussels, Patrick Crowley asked whether the SGP was ‘bad economies and/or the politics
of least resistance’. His conclusion was that it was both. He concludes with the following:
The SGP currently contains bad economics, but also these contents were arrived at by the
politics of least resistance. If the SGP is to contain good economics, then choosing a pact
on the basis of the politics of least resistance is simply not an option (Crowley, 2005, p.
30).
This seems a good summary statement of the current status of the SGP. No one argues
that the SGP is working well or even as it was originally envisioned. Views for fixing the
problem range the gambit from minor tinkering to scrapping the Pact entirely. Most of the
experts cited in this paper have called for more radical reforms than the Council undertook at the
Brussels summit. This fact does not bode well for the future success of the SGP, at least until the
time that significant economic growth returns to the euro-zone countries.
22

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