Is there a structural or a political fault in the fiscal governance of the EU?
Non-compliance to the Stability and Growth Pact in the early 2000’s. The demise of the excessive deficit procedure
Thesis (M.A.) 2012 44 Pages
3. Literature Review
3.1 Incomplete Fiscal Federation
3.2 The architecture of SGP--- Was the fiscal discipline outlined in Maastricht structurally sound?
3.3 Inter-governmental vs. Supranational: A public-choice approach to non-compliance
4. Empirical Evidence
4.1 Germany and France
4.2 Rest of the Eurozone
4.3 Market Indifference?
The non-compliance to the Stability and Growth Pact in the early 2000’s was a direct challenge to the co-operative virtue of EU fiscal governance, and the fact that its occurrence played little role in affecting the stability for Europe’s most significant achievement yet--- the Single Currency---- was in itself a truly peculiar incident. Betrayed by the deeds of the two locomotives of the European Project, Germany and France, only four years after the adoption of the Euro--- yet the currency strides on and none of the adverse effect that Economists feared had happened. But was that it? The fact that both of these nations could escape sanction by coercing other nations in debt to vote against a punishment for their excessive fiscal deficit announced a deep functional fault in the enforcement of agreed EU treaties on the Commission’s part; and knowing that the stability of the Euro hinged upon an incomplete fiscal federation where fiscal responsibility laid heavily on the shoulders of the member states, there was indeed a commitment crisis exhibiting itself in 2003. This paper aimed to answer two questions: first, what have caused the member states, such as France and most curiously, Germany, the one who had stressed the need for fiscal discipline every step of the way during the negotiation stage to safeguard the Euro, to renegade on a pact that was supposed to guarantee just that? Second, in light of the silence of the international capital market towards the incident, what, if any, had the demise of EDP contributed to the study of fiscal governance and political integration in the EU?
There has been an undeniable fault in the fiscal governance of the European Union: despite the persistent and repeated reports and warnings by the Commission, the Excessive Debt Procedure as outlined in the Maastricht treaty had failed to place sanction upon the fiscal ‘sinners’ as a Qualified Majority Vote in the Council of Minister overturned the Commission’s recommendation on sanctioning, the said sinners, France and Germany, on 25 November 2003, sparking much controversy over the Pact. The violation of the Maastricht deficit criteria in the early 2000’s, shortly after the adoption of the Euro, as they were outlined in the original version of the Stability and Growth Pact, was not the first, nor would be the last, incident where the member states failed or unwilling to adhere to European treaty agreements which they have themselves agreed upon in the European Council: this particular phenomenon of the ‘paradox of non-compliance’, as it was referred to by legal scholar Joseph Weiler, was not at all uncommon in the short and turbulent history of the sixty-odd years of European integration. What was indeed intriguing and made this particular non-compliance case significant lies in the failure of the ‘preventive arm’ of the Pact: the failure of the functioning of the Excessive Deficit Procedure to sanction Germany and France for consistent fiscal profligacy; it was not only an abandonment of commitment to a European initiative but also a direct challenge to the European Union’s capability to govern the distraught member states. Although As empirical market data have shown that the Euro continued to appreciate, the long term interest rates had not raised for the economies in the Eurozone throughout the first few years of the 21st century; it seemed, that, not only were the Euro was largely unaffected by the non-compliance, despite what economists’ fear of the risk which excessive deficit would have lead to the undermining of stability of the Single Currency and affect aversely the borrowing costs in the Eurozone, the principle of fiscal discipline and the fiscal criterion outlined in the SGP were outdated. But that was perhaps not the case; although structural arguments could be an alternate theory for desertion on the larger member states’ part, they have at best provided a weak case for two reasons: first of all, the smaller economies which founded the Eurozone in 1999, with the exception of Portugal and Greece, had much higher level of deficit ratio while the Maastricht criteria was first proposed in 1991 but never was expected to not be included in the EMU due to political concerns ; second, as the budgetary criterion lined out in the Maastricht treaty were meant to be ‘reference values’ and that the ECOFIN has a large discretion in the EDP in deciding whether the member states’ deficit were ‘excessive’, the credibility of the ‘preventive arm’ of the SGP was equally tarnished as the ‘corrective arm’ as they were both hinged upon interpretation of the member states themselves. Although there has been a verdict reached by the ECJ to annul the decision of 2003 in 2004, giving the Commission a procedural victory, there has been no doubt that the fault in the fiscal governance of the EU was clearly a political one: it was generated from the anatomical asymmetry between an unstable status quo within the EU and a monetary union, having little to do with the content of restraint embedded in the treaties themselves.
This dissertation would be sectioned into three segments: the first section would include a brief recount of the political origins of fiscal restraints and governance in the Stability and Growth Pact traced back to the Delors Report until the latest provision of rules which pertained to the Council of Minister’s (the ECOFIN’s) controversial decision on 25th November, 2003; the second section would include a two-ply literature review on structural and political arguments for the violation of the rule-based SGP; the third segment would include a more detailed case study on Germany and France with empirical findings of Eurozone countries’ fiscal performances, in comparison to the general stability performance of the EMU. The dissertation would then ends with a concluding section.
Fiscal governance in the European Union is remarkably idiosyncratic; the powers of monitoring and sanctioning of national fiscal deficit and debts were split between European institutions and the collective action of national governments as the Pact itself was stemmed from a unique dialectical process of the Commission wrestling the strong member states, most notably France and Germany. Fiscal discipline, as a token of the member states’ commitment to the functioning of the Monetary Union, has been introduced since the very beginning of the plan for a single currency in Europe, yet governance by who has been a significant part of debate between amongst member states and the commission as well. While early stages of European integration is largely based on international cooperation, specifically by a Franco-German diarchy since the 1960’s, the European Commission led by Jacques Delors played the crucial rule as a policy entrepreneur at the beginning of a ‘re-launch’ of the European Project; for the first time had a EU treaty been negotiated with a European institution acting independently in European politics and affecting the outcome. The Commission, led by Delors, proposed an independent agency (as if the European Central Bank) to govern fiscal policy, while Germany and France both protested adamantly against the notion while favouring a strict fiscal constraint lined out explicitly instead. Despite the effort of the Delors Commission, it was undeniable that the Commission itself lacked the expertise and power over either one of France and the then Federal Republic of Germany; the Commission had little alternative than to vacillating and reconciling between French and German initiatives, to keep their pressure on each other while sustaining the momentum of the negotiation. The result was the article 104 (c) of the Maastricht treaty, the Excessive Deficit Procedure, which was a complicated, long and lenient Article which gave much discretion to the member states every step of the way. The Pact remained largely unchanged since the signing of Maastricht in 1992 until the 2005 reform, after its preventive arm, the EDP, was overturned in 2003; showing the consistency of the Commission-Member states status quo in fiscal governance up until the reform in 2005.
Europe has been plagued by stagflation and oil crisis in the 70’s in nations such as Britain, France and Germany as they could not come to an agreement to coordinate their monetary policies under the European Monetary system, nor in the removal of intra-Community tariffs. Only in the 80’s when globalization began to pick up momentum and Europe was forced to respond quickly to the renewed challenge from the United States and new competitors from Asia, in particular Japan, the EEC began to reform the struggling EEC. The subsequent Single European Act, as agreed to by Margaret Thatcher, French President François Mitterrand and German Chancellor Helmut Kohl, in 1986, allowed for the first time the Commission, under the lead of Jacques Delors, the political support it needed to put forth of a proposal to reform. But reform did not begin immediately, despite the signing of the Act. In fact, nothing has been done to capture the public’s imagination of a ‘Single Europe’--- not until 1988 when German Chancellor Helmut Kohl transformed ‘a purely bureaucratic initiative into political action’.The European Council meeting in Hannover in 1988 embodied this dawn of a new era of interaction between the Commission and the Franco-German diarchy; beginning with the line ‘the European Council notes with satisfaction that the Council of Economics and Finance Ministers are now engaged upon a serious examination of the Commission’s proposals’, Chancellor Kohl, who was also the President of the European Council at the time, on behalf of the Council thereby confirmed ‘the objective of progressive realisation of Economic and Monetary Union….They (the member states) therefore decided to examine at the European Council meeting in Madrid in June 1989 the means of achieving this Union…..to entrust to a Committee the task of studying and proposing concrete stages leading towards the Union’. Thus came the famous Delors Report published in April 1989, which, in the Commission’s self-portrait of its role in the hatching of the EMU, ‘defined the monetary union objective as a complete liberalisation of capital movements, full integration of financial markets, irreversible convertibility of currencies, irrevocable fixing of exchange rates, and the possible replacement of national currencies with a single currency’.
The Delors Report, 1989 and the Road to Maastricht
‘…in the event of non-compliance by Member States, the Commission, or another appropriately delegated authority….would be responsible for taking effective action to ensure compliance..’
The principle of budgetary restraint, as the Delors Report had emphasized as ‘necessary to develop both binding rules and procedures for‘, was deemed acceptable for all parties included. However, the Commission and the Franco-German diarchy were diverted on the topic of sanctioning mechanism---all for different and conflicting reasons. The Commission, as represented by Alexandre Lamfalussy in a paper attached to the Delors Report, that, ‘the combination of a small community budget, with large, independently determined national budgets leads to the conclusion that, in the absence of fiscal co-ordination, the global fiscal policy of the EMU would be accidental outcome of decision by member states…there would simply be no Community-wide macroeconomic fiscal policy…even within a closed economy, this would be an unappealing prospect…. (therefore) fiscal policy co-ordination would appear to be a vital element of a European EMU and of the process towards it…appropriate arrangements should therefore be put in place which would allow the gradual emergence, and the full operation once the EMU is completed, of a Community-wide fiscal policy’. In other words, the Delors’ Commission was aiming to build itself as if the role of a central government directly engaging in redistributive role in a federative structure; in compliment to the opening quote of this paragraph from the Delors Report, Jacques Delors was determined to expand the function of the Commission. The position of the newly reunified Germany was much different: as the Deutche Marks’ prominence lingers in the European Monetary System despite the huge cost of reunification, Germany was quite satisfied with the current status quo as policymakers in other members tied to the ERM were in the de facto sphere of influence of the strong DM, such as the government of the Benelux countries and Denmark, whose economies and policies were ‘inextricably’ connected with Germany anyway. The German stance was therefore to maintain strong economical and political influence in the yet-to-be-born Eurozone from both the Bundesbank and the Council. This stance has been reflected openly by Senior German officials and central bankers alike; for example, in a news article published in 1988 in the Wall Street Journal, the president of the Bundesbank proclaimed proudly that the DM ‘…has developed into the stability benchmark for the EMS, enabling the system to work. The German economy has contributed to this in so far as the German economic and monetary policy has succeeded keeping the mark the most stable currency in the EMS. It would be fateful not only for the Federal Republic but also for other European countries were the mooring of the EMS to be loosened without knowing what would take its place…. Some of our partners are pointing out that their hands are being tied in the area of economic and monetary policy because they have to accept the mark as dominant in the EMS. To the extent that they have accepted their currencies being pegged to the mark, they see themselves restrained in their pursuit of autonomously set targets for growth, employment and stability’. Fiscal discipline, hinged upon the idea of stability thus has been an ardent German position since the 1970’s and it has never been revoked since, as the Germans also advocated the automatic imposition of large fines by the ESCB (which of course, would have been heavily influenced by the Bundesbank) on Eurozone members who have exceeded the specific levels of budgetary constraints. The most curious stance in the three major players in the negotiation towards Maastricht Treaty was perhaps France’s. With the proposal for a European Central Bank in 1988, the French were not opposed to use the European framework to sustain fiscal stability, but, following its traditional Gaullist, intergovernmentalist style of bargaining at the European level and a emphasis on credit-intensive policies in the hopes to stimulate growth in the Postwar period, the French stood quite resolutely for a strong ECOFIN on the European level that would be responsible for a ‘policy mix’ which included fiscal, structural and economic policies. This mix of preferences was directly reflected on the fiscal component of the Maastricht Treaty.
The Maastricht Treaty
‘The Union should set itself the following objectives…..to promote economic and social progress which is balanced and sustainable, in particular through the creation of an area without internal frontiers, through the strengthening of economic and social cohesion and through the establishment of the economic and monetary union ’
---Article B, the Maastricht Treaty (Treaty of the European Union)
The eventual composition of the fiscal provision in the Maastricht treaty was a compromise that has been challenged but not revoked. The Commission, being the weakest of the three major players in the negotiation, fell far short of their objective as the Commission only retained the initiative to suggest sanction to the Council. Germany, who insisted of the automaticity of sanction by the ESCB and resisted of any European agency (i.e. an independent EU Court) of the control of fiscal policy, eventually only retained the strict fiscal targets which was entailed by their original proposal. Even though the Treaty was challenged and eventually made its way to the Constitutional Court of Germany, (as reproduced below), the mandate rested upon the Treaty of Maastricht was eventually agreed in Germany.
‘The concept of the monetary union as a community of stability is the basis and object of the German Act of Consent. If the Monetary Union were not able to continually develop that stability upon transition to the third stage as provided by the mandate of stability which has been agreed upon, it would move away from the concept which the Maastricht Treaty is based.’
---German Constitutional Judgement of the Maastricht Treaty
The French, while luckless in producing the ‘ gouvernment economique ‘ that they have wanted ever since 1990, had successfully exerted their intergovernmentalist psyche into the EDP whereas the ECOFIN held decisive power over every step of the Procedure after the official adaptation of the Stability and Growth Pact two years prior to the coming of the Euro in 1997. This mix of expectations between the Commission, France and Germany eventually led to the common denominator of all the preferences, Article 104(c), the Excessive Deficit Procedure and the only sanctioning mechanism against fiscal profligacy in the European Union to safeguard the stability of the Euro.
 (CEPS Macroeconomic Policy Group, 2004) p.8.
 (Weiler, 1988):
 (Garrett, The Politics of Maastricht, 1994) p.51.
 (Artis & Butti, 2000)
 (Cavazza, Pelanda, Molho, & Ginet, 1994) pp.61-62
 (Dyson & Featherstone, 1999) p.3
 (Moravcsik, 1999) pp.291-293
 (Griffiths, 2006) pp. 178-179
 (Sandholtz & Zysman, 1992: Recasting the European Bargain, 1989) pp. 95-96
 (Hay & Menon, European Politics, 2007) p.159
 (Cavazza, Pelanda, Molho, & Ginet, 1994) p.60.
 (Kohl, 1988) pp.3-4.
 Ibid. p.7.
 (European Commission, 2010)
 (Delors, 1989) p.23.
 Ibid. p.24.
 Future Chairman of European Monetary Institute, precursor of ECB
 (Lamfalussy, 1989), quoted from (Pisani-Ferry, 2006) pp.825-826.
 (Garrett, The Politics of Maastricht, 1994) pp.54-55.
 (Poehl, 1988)
 (Dyson & Featherstone, 1999) p.6.
 (Garrett, The Politics of Maastricht, 1994) p.55.
 (Baun, 1996) p.5
 (Sandholtz, 1993) p.6
 (Dyson & Featherstone, 1999) p.69
 (Treaty of the European Union, 1992) Article B, p.4
 (Louis, 2007) p.4.
 (Crawford, 1993) p.348, note 16, the author quoting Theo Waigel, the German Minister of Finance while being asked to respond to suggestions that an EU agency or court be established to control the fiscal policies of governments.
 Despite some dispute over whether the Federal Court of Germany (or any other supreme court) determine the de facto limit of European integration, for more, see (Boom, 1995)
 (In Re Maastricht Treaty, 1993) p.29.
 (Dyson & Featherstone, 1999) p.9
 (Pisani-Ferry, 2006) pp.827-828.