Talking point
Will reform treaties enhance the prospects of the euro area?

July 5, 2013

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Last week it passed almost unnoticed that the van Rompuy Cabinet presented details on bilateral reform treaties as a new form of economic policy coordination in the euro area. The Fiscal Compact shows, however, that treaty-based reforms require that the underlying agenda is respected beyond the short term by the community of euro-area states.

At the same time as last week’s European Council, an Interim Report on improving economic policy coordination was published by the van Rompuy Cabinet almost unnoticed. The report outlines the route towards bilateral reform treaties that euro-area countries are meant to conclude with European institutions – first and foremost the European Commission. In these treaties, countries are to commit themselves to pursue reforms in those areas that increase the ability of their economies to adjust and thereby also reduce the overall vulnerabilities of the monetary union. This applies particularly to reforms in the markets for labour, goods and services but also in the public sector and the tax and education systems. The supporters of reform treaties see three advantages.

  • Commitment: Bilateral treaties are intended to increase national identification with their reform agenda via a commitment vis-à-vis themselves and third parties.
  • Coherence: Treaties allow tailor-made and binding recommendations in policy areas where peer pressure is ineffective and where the Commission does not have any competences to coordinate and supervise.
  • Control: Using the right indicators, treaties can increase the measurability of reforms and improve the control.

Additional financial incentives are intended to ensure compliance with the reform treaties. These incentives are to be paid out via so-called solidarity mechanisms that could, for instance, disburse subsidised loans in exchange for the implementation of particular reforms. The document explicitly mentions the risk of time inconsistencies and moral hazard. However, it remains vague on how incentive problems are to be averted.

The question can therefore certainly be posed as to whether contractual arrangements that lie outside the scope of the European treaties can indeed effect reforms in the EMU countries. In this context, the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union – the Fiscal Compact – provides an initial indication. It is a treaty signed by 25 EU countries (including all EMU countries) that was concluded in March 2012. While the Fiscal Compact is a multilateral treaty in international public law, the reform treaties are meant to be treaties between individual countries and EU institutions. Nevertheless, despite the legal differences, the Fiscal Compact can be taken as an indication of the real impact of the reform treaties on the EMU countries.

Our table shows that already 14 of the 17 EMU countries have ratified the Fiscal Compact. A special clause in the treaty meant that it already came into force back in January as soon as it had been ratified by a minimum number of 12 EMU countries. The prospects are good that the remaining three countries will ratify soon.

  • The Belgian Parliament already ratified the Fiscal Compact on June 20 (by 111 votes to 23). While the regions and some language communities still have to agree, their approval is a safe bet as there is a broad consensus across the spectrum of Belgian parties – apart from the Greens.
  • Malta expects a ratification of the Fiscal Compact before the summer break.
  • The Netherlands has already ratified the treaty in its first parliamentary chamber. The second chamber will ratify the compact in the course of this year.

However, ratification of the Fiscal Compact is only a part of the story. The compact also provides that fiscal consolidation should be institutionally underpinned by fiscal correction mechanisms that have to be implemented at the national level. These nominal debt brakes are budgetary rules that automatically correct deviations from a country’s fiscal consolidation path. Deviations can result from the inability of some countries to adhere to the annual targets for fiscal adjustment of their structural deficit that is determined by the European Commission.

Our table shows that seven of the 17 EMU countries have not yet implemented their correction mechanisms – they are obliged to do so until the end of this year. It is up to the countries to decide whether they will implement their correction mechanism with constitutional status or as an ordinary law. The only requirement is that the correction mechanism cannot be suspended in the annual budgetary process. Our table shows that the debt brake has constitutional status in only six countries. Belgium, Luxembourg and Portugal have decided to implement laws that require a two-thirds majority in parliament to be changed and that hence have a quasi-constitutional status.

Greece remains a challenge: The country does not yet have any concrete plans on how to implement its national debt brake. This could become problematic with regard to future ESM aid: The Fiscal Compact provides that only those countries that have implemented a correction mechanism by 2014 will benefit from ESM aid in the future. While that provision does not apply to ongoing programmes, it could become relevant for Greece if the country had to change or to extend its current programme unexpectedly.

Our table shows that the euro area countries are making good progress towards implementing the debt brakes. This, however, is only a part of the story: In March, Ecofin and the European Council agreed to ease the fiscal adjustment requirements for EU countries. The financial means that countries need to cofinance projects that receive funding from the EU budget can be deducted from the annual consolidation requirement. The example of the Fiscal Compact shows how easy the “spirit” of treaties can be changed. This is even the case when the Commission – the most independent of all EU institutions – is a signatory. The Commission has on various occasions in the past changed its stance to that held by the majority of euro-area countries in anticipation of certain decisions to be taken by the Council. 

What will be the spirit of the reform treaties? They will most certainly not be shaped by critical self-reflection – that is suggested by the final conclusions of last week’s European Council. The conclusions state that the heads of state and government identify the poor development of the European business cycle as the sole cause of European youth unemployment – but not, however, the lack of structural reforms that could liberalize labour markets and improve young people’s qualifications. A more differentiated look that balances adjustment recessions and structural differences between the Euro area countries would have been desirable.

If self-knowledge is indeed the beginning of wisdom, it will be a rocky road to success for the reform treaties.

 

 

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