Select Committee on European Union Twenty-Sixth Report


APPENDICES

APPENDIX I

Government Response to the Thirteenth Report of the House of Lords Select Committee on the European Union, Session 2002-03

THE STABILITY AND GROWTH PACT

  The House of Lords Select Committee on the European Union published its report "The Stability and Growth Pact" on 11 March 2003. The Government response addresses the Committee's key conclusions (reproduced in the paragraphs in bold below).

THE NEED FOR A STABILITY AND GROWTH PACT

  163[1].  The Committee supports the co-ordination of national fiscal policies across the EU with a view to maintaining sound public finances. Market discipline alone cannot be guaranteed to ensure the sustainability of public finances. A co-ordinating pact or other method of co-ordination between the Member States is necessary to deal with the "free-rider" problem, the risk of default and to help Member States to prepare for the economic effects of ageing populations in the EU; such a method of coordination should also provide stability for the European Central Bank and the market (paragraph 49).

  As the Government stated in Budget 2003, fiscal sustainability is a pre-condition for macroeconomic stability and the Government agrees with the principle of a strong Stability and Growth Pact (SGP) founded on sensible fiscal policy coordination as set out in the EC Treaty.

PROPOSALS TO REFORM THE INTERPRETATION OF THE SGP

  164.  It should be made explicit that the medium-term target of budgets "close to balance or in surplus" is to be measured in terms of the cyclically-adjusted budget balance. The common methodology agreed and adopted by the Commission and Ecofin last year should be used to calculate the underlying budget balances for this target; this means that an extra body of experts is not needed to calculate the cycle (paragraph 80).

  As set out in Budget 2003, the Government has consistently made clear that it supports a prudent interpretation of the SGP, which takes into account, among other elements, the economic cycle. In line with this key aspect of the Government's approach, the 7 March ECOFIN report on strengthening co-ordination of budgetary policies, subsequently endorsed by the Spring European Council on 21 March, recommends that, "Compliance with the close to balance or in surplus requirement of the Stability and Growth Pact should be assessed in cyclically-adjusted terms . . . The estimation of cyclically-adjusted budget balances would be made using the methodology endorsed by the Council on 12 July 2002".

  165.  When monitoring Member States' compliance with the 3 per cent deficit criterion, the Commission should continue to use the actual deficit-to-GDP ratio. However, when deciding how the Pact is to be enforced, the Council should not treat the 3 per cent figure as an absolute limit, never to be breached. The Council's decision whether or not to implement the excessive deficit procedure, once a country has breached the 3 per cent reference value, should take account of the underlying economic situation, including the Member State's position in the economic cycle and possibly its level of debt (paragraphs 81-83).

  The Government has consistently made clear that it supports a prudent interpretation of the SGP, which takes into account the economic cycle, sustainability and the important role of public investment (as specified in Article 104 of the EC Treaty). The Government's principled approach to the SGP governs its stance in EU surveillance procedures. As the Financial Secretary to the Treasury said in her oral evidence to the Committee on 28 January 2003, ". . . it is now the case that the Council and the Commission take into account not just the hard and fast 3 per cent rule, but also take into account the debt positions of different countries and also the cyclical factors; and the use of automatic stabilisers has been specifically mentioned . . . the 3 per cent reference value has been given operational use through a set of guidelines—the Code of Conduct, agreed in 2001—which suggests there is room for flexibility within it."

  166.  The Commission's proposal that Member States should set an adjustment path towards the medium-term target of budgets "close to balance or in surplus" of 0.5 per cent GDP per year should not be treated by the Council as an enforceable rule, any breach of which would activate the excessive deficit procedure (paragraphs 89-91).

  The 7 March ECOFIN report makes clear that it was the Eurogroup, on 7 October 2002, who committed euro area countries not yet close to balance or in surplus to pursuing continuous adjustment of the underlying balance by at least 0.5 per cent of GDP per year. The Government did not participate in this agreement, which therefore does not apply to the UK as a non-participating Member State. The Government believes in the need for a credible framework for EU fiscal policy, which is based around an overall set of economic principles to guide the interpretation of fiscal policies, and which recognises the combination of Member States' country-specific circumstances, thereby allowing the discretion necessary to respond flexibly to shocks. Setting single targets for all Member States does not recognise, for example, individual debt levels, public investment requirements, and targeted tax reforms to promote productivity and work incentives.

  167.  It is important to tackle the fact that the Stability and Growth Pact works asymmetrically across the economic cycle. Furthermore, countries need to be encouraged not to act pro-cyclically in times of boom. The Committee does not, however, consider that the Commission's proposal to apply the sanction of the excessive deficit procedure in good times would be the most effective way of achieving these twin objectives. The Committee shares the concern that the rules of the Pact should not be complicated. The number of situations that lead to the formal sanctions of the excessive deficit procedure being invoked should not be extended, or these measures will lose their force (paragraphs 102-03).

  The Government's principled approach to the SGP governs its stance in EU surveillance procedures. This approach includes taking into account of the economic cycle: allowing the automatic stabilisers to operate fully and symmetrically over the cycle will ensure that fiscal policy supports monetary policy in smoothing economic fluctuations. In line with key aspects of the Government's prudent interpretation of the SGP, the 7 March ECOFIN report explicitly notes that "automatic stabilisers should operate over the cycle and, to this end, Member States shall avoid pro-cyclical policies, especially when growth conditions are favourable".

  168.  Member States with a low level of underlying debt should be allowed "a small deviation" from the target of budgets "close to balance or in surplus". The Government, too, should welcome this move to a more country-specific interpretation of the Pact, as it would allow them to target the UK national priorities of public investment in physical and human capital (paragraph 115).

  The Government welcomes the recommendations in the 7 March ECOFIN report, in line with key aspects of its prudent interpretation, that "particular attention should be paid to country-specific circumstances" in the implementation of the SGP, including to "the long-term sustainability of public finances" and "the evolution and quality of the public finances".

  169.  The Pact should focus more on debt. The stability and convergence programmes of Member States with particularly high debt ratios should contain a clear commitment to an agreed trajectory of reducing debt. In the light of these commitments, the Council opinions on the stability and growth programmes should include guidelines for reducing debt (paragraphs 124-26).

  The Government's principled approach to the SGP includes taking into account the long-term sustainability of the public finances. Low debt levels enhance the sustainability of the public finances and provide a sound basis for investment in public services and reforms to encourage productivity, employment and fairness. In considering the sustainability of the public finances it is also necessary to examine the budgetary impact of an ageing population. The Long-term Public Finance Report, published alongside the 2002 Pre-Budget Report, presents such an assessment. The Government supports the observations in the 7 March ECOFIN report that, "Greater attention must be paid to the longer-term sustainability of public finances. One important way of securing the longer-term sustainability of public finances is the determined pursuit of the comprehensive strategy to meet the challenges of ageing populations agreed by the European Council in Stockholm. The assessment of the sustainability of public finances should be upgraded. In particular, the quality and comparability of long-run budgetary projections should be improved" and that "The pace of decline in public debt plays an important role in budgetary surveillance, especially in highly indebted countries. In conformity with the Treaty provisions, the excessive deficit procedure should contribute to ensuring a satisfactory pace of debt reduction". As the Chancellor said at Treasury Orals on 7 November 2002 (Column 414), "Countries with a high level of debt should be treated differently from countries with a low level".

SURVEILLANCE OVER THE SGP

  170.  To ensure the credibility and proper functioning of the Stability and Growth Pact, situations such as the one last February—when the Council went against the Commission's recommendation and did not send early warnings to Germany and Portugal—must be avoided in the future. The Treaty should be amended to grant the Commission the power to issue early warnings directly to Member States without recourse to the Council. This proposal is in line with the monitoring and surveillance functions of the Commission (paragraphs 143-44).

  As set out in HM Treasury's Memorandum on the SGP, considered as written evidence by the Committee, the Government remains very concerned about the Commission's ideas for institutional change on the SGP, which they are pursuing through the Convention on the Future of Europe, which would increase the role of the Commission in enforcing the disciplines of the Pact, at the expense of Member States.

ENFORCEMENT OF THE SGP

  171.  The Commission's role should not be extended beyond the right to issue an early warning direct to a Member State. The Council should remain the final arbiter of all the enforcement procedures enshrined in the Pact. Only the Council should have the power to enforce sanctions through the excessive deficit procedure and to oblige Member States to take specific actions to remedy excessive deficits (paragraph 145).

  The provisions of Article 104 of the EC Treaty makes clear that whilst the Commission has the right of initiative, it is the Council alone who has the power to adopt decisions and recommendations to a Member States concerned. As set out in HM Treasury's Memorandum on the SGP, considered as written evidence by the Committee, the Government remains very concerned about the Commission's ideas for institutional change on the SGP, which they are pursuing through the Convention on the Future of Europe, which would increase the role of the Commission in enforcing the disciplines of the Pact, at the expense of Member States.

  172.  Peer pressure is the most effective enforcement mechanism currently available in the Stability and Growth Pact. The sanction of fines is a "nuclear deterrent" only to be used as a measure of absolute last resort (paragraphs 158-61).

  The Government is fully committed to and engaged in the framework of co-ordination and surveillance established inter-governmentally by the SGP. The Government's principled approach to the SGP governs its stance in EU surveillance procedures. As the Financial Secretary to the Treasury said in her oral evidence to the Committee on 28 January 2003, "We clearly need a robust framework which has credibility and legitimacy; but within that framework the debate has got to take place based on economic principles in a way which accommodates the individual circumstances of each Member State. The process we have got at the moment of per review, surveillance and stability and convergence programmes being discussed by ECOFIN is quite an effective way of ensuring that that sort of policy coordination takes place. . . I am sure the debate will continue about how it can be made more effective; but even to date peer review pressure has been a very useful way of ensuring coordination takes place".

OVERALL GENERAL CONCLUSION

  173.  Each of the Commission's proposals—to measure the medium-term target of budgets "close to balance or in surplus", to encourage Member States to reduce their underlying deficits to achieve this objective, to encourage countries not to act pro-cyclically in times of boom, to allow Member States with a low level of debt to deviate from the "close to balance or in surplus" target, to encourage highly-indebted countries to reduce their levels of debt—provides Member States with a useful aim and sound objective. However, they should be interpreted as guidelines rather than as rules. Interpreted in an inflexible way that takes no account of the particularities of each individual situation, they would increase the complication of the Pact. This could lead to more transgressions by the Member States and more interventions by the Commission and the Council, which could possibly threaten to undermine the credibility of the very rules that the proposals seek to strengthen. Interpreted in a way that is sensitive to the specific circumstances of each country, the proposals would introduce the necessary extra benchmarks against which the budgetary actions of Member States could be judged and around which peer pressure could be applied in the Council. Such an interpretation should encourage Member States to follow sensible fiscal policies, which could lead to greater stability and growth.

  As set out in Budget 2003, the Government has consistently made clear that it supports a prudent interpretation of the SGP, which takes into account the economic cycle, sustainability and the important role of public investment (as specified in Article 104 of the EC Treaty). A prudent interpretation of the Pact will lock in longer-term fiscal discipline and sustainability, enhancing credibility, while allowing the automatic stabilisers to smooth fluctuations in output, and enabling appropriate increases in investment in public services.

April 2003


1   Numbers refer to paragraph numbers in the Committee's report. Back


 
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