Will EU budget rule-breaking become a norm?

Will EU budget rule-breaking become a norm?

This month the European Commission published its assessments of the draft budgetary plans of Eurozone member states for the year 2016. They have already prompted rebukes from EU member states Italy and France; two countries which for years have shown little interest in abiding by European budget agreements.

New rules enacted in the wake of the Greek debt crisis shifted power to the Commission to assess, review and where possible penalize member states.

Rather than leading to a less ad-hoc, less politicized budgetary process, the new rules have merely moved the political debate from member states to the Commission, making it less transparent and accountable to the point where the legitimacy of EU fiscal rules, and the very future of the euro itself, hang in the balance.

Post-crisis changes lead to new problems

Yet things need not have ended up this way. The flurry of new EU fiscal legislation adopted in the post-crisis years – known as the 6 and 2 pack legislation – was enacted precisely to avoid future fiddling with the rules.

The legislation provided for more tools and power for the European Commission. Eurozone countries are now obliged to submit annual draft budgetary plans to the Commission by October 15th. The Commission assesses these plans and can start correction procedures and ultimately, impose sanctions, in case of breaches.

Unlike the old days, where member states had to confirm the Commission’s recommendations –tantamount to asking turkeys to vote for the butcher – the new rules state that a decision by the Commission stands unless overturned by a qualified majority of member states. Any decision taken by the Commission is therefore more likely to stand.

This dynamic has made the opinions, loyalties, and interests of Commission decision makers exponentially more important. The previous Commissioner for Budgetary Discipline, a stern Finn by the name of Olli Rehn, had the backing of powerful northern member states and was known for his dogged – even harsh – insistence on adherence to the rules.

All this changed, however, with the arrival of the new European Commission in 2014. The new Commission president, Mr. Juncker, announced that the new Commission would be ‘more political’. The meaning soon became apparent: tolerated by Mrs. Merkel and actively opposed by Britain, Juncker needed the support of the French socialist government.

This meant accepting France’s finance minister, Pierre Moscovici, as the Union’s new budget czar. This alarmed many EU governments and members of the European Parliament.

One year on, this alarm appears justified:

Extraordinary Times: France and Italy rebuff Commission statements

In January of this year, the Commission published a communication, ostensibly aimed at clarifying the flexibility parameters within the budgetary rules. As such the message notes that there is room for deviation from medium-term deficit goals if a country experiences cost from the implementation of structural reforms, or if additional funding is used for additional investment to boost growth.

The provisions and criteria leave considerable scope for countries to increase ‘investment’ without being caught under the SGP. In March, France, despite having made little effort to respect conditions attached to an earlier extension, received more time to correct its deficit.

These events have clearly had an impact on this fall’s budgetary process: the Commission last week indicated that the French budget, while in line with agreements for 2016, fails to meet the agreed budget deficit in 2017. Moreover, compliance in 2016 is not due to actions on the part of the French government, but mostly due to the improved growth outlook.

The French rebuke was swift, with Prime Minister Valls calling the assessment inappropriate following the Paris attacks. He stated that France was at war and hence, under the ‘unusual event’ exemption in the SGP, the budget rules should not apply to French defense spending. France certainly has no intention of seeking offsetting cuts for increases in security expenditures.

Italy has seized on this, stating it too is dealing with a national emergency: the refugees crisis. Hence, Italian defense and national security spending should also be exempt. Moreover, Italy in its 2016 budget already incorporates additional budgetary flexibility of about 0.4% of GDP under the structural reform and investment clauses of the Commission’s January communication.

In its assessment, the Commission states this will cause a departure from medium-term budgetary objectives, but also indicates the criteria for additional flexibility are met, thus indicating that wiggle-room exists for Italy.

A new EU operating norm on the horizon?

Last year’s events show clear signs of what appears to be a new EU tradition in the making: an autumn budget stand-off between large member states unwilling to comply with budget rules, and a politicized European Commission that looks in every nook and cranny of the rules to find justifications for not enforcing them.

Whether this indeed becomes an annual recurrence in greatly depends on stance the Commission will take this year.

We are at a crucial juncture: for member states like Germany, Finland, the Netherlands and others, where public opinion is already highly skeptical of other countries’ willingness to abide by the rules, the Commission used to be a reliable ally in forcing adherence. Developments in 2014 have further reduced trust and confidence in the future of the EMU.

However, beyond the erosion of trust, an even greater existential threat can materialize from the current wheeling and dealing over budgetary discipline: Italy and France’s debt-to-GDP ratios are the highest of any large EU member state, at 132 and 96% of GDP, respectively. Both countries have posted weak economic recoveries: Italy’s real per-capita GDP is at the same level as in 1996.

Both economies are among the least competitive in the Eurozone; and both are too-big-to-fail: accounting for almost 40% of Eurozone GDP. Moreover, both are also too big-to-save, with a combined debt stock of about €4 trilllion and debt rollover requirements of around €500 billion per year, exceeding the €370 billion available in the ESM bail-out fund.

The Commission would do well to consider this before making its final decisions. A new tradition of politicized budgetary decisions is the last thing the Eurozone needs; the Commission alone has the power to avert it.

Categories: Europe, Finance

About Author

Coen ter Wal

Coen ter Wal is a policy advisor for the economic and financial affairs committee of the European Parliament with experience in consultancy, banking and government in both Europe and the United States. He holds an MSc. in European Political Economy from the London School of Economics along with a BSc in Economics from Tilburg University in the Netherlands.