House of Lords - The future of economic governance in the EU

The future of economic governance in the EU - European Union Committee Contents

CHAPTER 3: Fiscal Discipline

64. Since 1997, the Stability and Growth Pact (see Box 1 below) has been the instrument through which the EU seeks to ensure fiscal discipline by Member States. The Commission's package of economic governance includes three Regulations that aim to broaden the SGP's surveillance of fiscal policy (see Box 2 on page 26), and strengthen the sanctions regime (see Box 3 on page 29). In addition, the Commission has proposed that Member States should incorporate certain rules into their domestic fiscal structures to reflect principles agreed at a European level (see Box 4 on page 37).

Fiscal surveillance: the Stability and Growth Pact

65. The SGP requires Member States to comply with two fundamental rules: keeping public accounts close to balance or in surplus and avoiding a current deficit in excess of 3% of GDP, with some latitude in periods of recession. Although a debt criterion of keeping public debt below 60% of GDP has been applied as one of the Maastricht criteria for acceding to the euro, it was not included in the SGP as an explicit target. Sanctions are available under the Pact to enforce the rules (for euro area countries only).

BOX 1

The Stability and Growth Pact

The Stability and Growth Pact (SGP) was established in 1997 as a rule-based framework for the coordination of national fiscal policies in the economic and monetary union (EMU), established to ensure responsible fiscal behaviour among Member States. The rule at the centre of the Pact is that Member States should aim for a budgetary position close to balance or in surplus over the medium term; in normal times, they are also required to ensure that budget deficits do not exceed 3% of GDP. The Pact consists of a preventive and a corrective arm.

The SGP applies to all EU Member States, aside from the provisions for financial sanctions (see below) which apply only to those nations in the euro area. This is because, with the exception of the UK and Denmark which have an opt-out from membership of the euro (see paragraph 2), all Member States are expected to join the euro as soon as they fulfil the convergence criteria. They should therefore be implementing economic policies that will bring them into closer economic convergence with the euro area.

The preventive arm

Under the provisions of the preventive arm, Member States must submit annual stability or convergence programmes, showing how they intend to achieve or maintain sound fiscal positions in the medium term. The Commission undertakes an assessment of these programmes, while the Council expresses an Opinion on them. The preventive arm includes two policy instruments.

The Council, if asked to do so by the Commission, can address an early warning to a Member State to prevent the development of an excessive deficit.
The Commission can directly address policy recommendations to a Member State about the broad implications of its fiscal policies.

The corrective arm

The corrective part of the Pact contains the excessive deficit procedure (EDP). The EDP is triggered if a Member State's deficit goes above a 3% of GDP threshold set out in the Treaty. If the Council decides that the deficit is excessive, it issues recommendations to the Member State concerned to correct the excessive deficit, and gives a time frame for doing so. Non-compliance with the recommendations triggers further steps in the procedures which, for euro area Member States only, would eventually involve the possibility of financial sanctions. These could culminate in fines of up to 0.5% of GDP.

66. Its operation, however, has come under critical scrutiny across Europe. This is partly because of problems in enforcement, and these problems are considered in more detail below. In addition, however, it is clear that the design of the pact was flawed. This can be most clearly seen in the context of countries such as Ireland which before the financial crisis were in apparently sound fiscal situations.

67. The main criticism about the surveillance of the existing SGP has been that it focused almost exclusively on the deficit criterion of the SGP, allowing some Member States to run debt levels well above 60% without being penalised.[92]

THE COMMISSION'S PROPOSALS

68. Against this background, the Commission's proposals aim to reinforce the SGP's surveillance. The suggested changes are explained in detail in the box.

BOX 2

Proposed changes to surveillance under the Stability and Growth Pact

Regulation amending the legislative underpinning of the preventive part of the Stability and Growth Pact (amendment of Council Regulation 1466/97)[93]

This proposal would implement a new principle of 'prudent fiscal policy-making', with the aim of ensuring that extra revenues in positive economic circumstances are not simply spent but are allocated towards debt reduction.

If a Member State is judged not to be running prudent fiscal policies it could lead to the Council making a formal recommendation to change its policies. For euro area Member States, this recommendation could be enforced by a financial sanction (see Box 3 for details).

Regulation amending the legislative underpinning of the corrective part of the Stability and Growth Pact (amendment of Council Regulation 1467/97)[94]

The amendments to this regulation would speed up the stages of the excessive deficit procedure (EDP). In addition to the 3% deficit criterion, the EDP would be triggered if a country's public debt exceeded 60% of GDP. Member States will be benchmarked as to whether they can sufficiently reduce their debt. Those whose debt exceeds 60% of their GDP should take steps to reduce it at a satisfactory pace, defined as a reduction of 1/20th of the difference with the 60% threshold over the last three years.

The proposal also sets out in detail the process by which sanctions would be applied to euro area countries if they failed to follow recommendations issued to them under the EDP.

Both these Regulations will apply to the UK, although the sanctions specified under Regulation 1467/97 are only applicable to euro area Member States.

THE PREVENTIVE ARM OF THE SGP

69. We heard relatively little evidence on the proposed reform of the preventive arm of the SGP, which aims to ensure that Member States run prudent fiscal policies over the medium-term by limiting annual expenditure growth to "medium-term rate of growth of GDP". Dr Marek Dabrowski, Centre for Social and Economic Research, while agreeing that the rules "go in the right direction", noted that determining this growth rate in the current unstable economic environment "appears almost impossible and will become a subject of political bargaining".[95] Professor Louis told us that the revised preventive arm of the SGP was a "substantial complement" to what was possible under the original framework.[96] More importantly, the proposals would allow sanctions to be imposed on Member States at an early stage under the preventive arm, rather than just under the corrective arm; we consider this aspect in more detail later in this chapter.

THE CORRECTIVE ARM OF THE SGP

70. The reform of the corrective arm of the SGP introduces an explicit debt threshold into the pact, thereby ensuring that it would be used as a trigger in the excessive deficit procedure. Our witnesses were generally in favour of this proposal[97] although some also identified potential problems associated with it. Professor Jagjit Chadha, University of Kent felt that there were "significant information hurdles to overcome in assessing the public debt position of any country",[98] and said that an increase in debt might not simply be the result of poor government policies. The Government, while "strongly" supporting the introduction of a debt threshold, also suggested that debt was a complex issue, and that Member States needed to maintain some discretion on how they manage it. The Government had concerns about the Commission's proposals to benchmark how quickly countries are reducing their debt, arguing that the main consideration should be whether a country's debt "is on a downward trajectory", rather than the pace at which it is happening.[99] Dr Dabrowski also raised concerns about setting a numerical target for debt reduction.[100]

71. Mr Leandro acknowledged that these issues were discussed by the Task Force and stated that these factors would be taken into account and an "intelligent assessment" made of whether the country is on the right or wrong path.[101]

72. We welcome the Commission's proposals to introduce an explicit public debt criterion, alongside the deficit criterion, into the excessive deficit procedure under the SGP. We consider it important that the most heavily indebted countries move rapidly to reduce their level of public debt. We do not, therefore, share the Government's concerns about a numerical benchmark for reducing debt under the EDP. We believe that having such a benchmark will be an effective way of exerting pressure on heavily indebted countries to ensure that the higher a country's level of debt the faster it is reduced.

STATISTICS

73. The effective monitoring of Member State's fiscal policies, and the triggering of the excessive deficit procedure, clearly relies on the accurate reporting of deficit and debt statistics. Eurostat, the overseeing EU institution, does not have the power to dictate how national statistics are produced.[102] After repeated problems with Greek government statistics, in particular after Greece revised its government deficit and debt data substantially between the 2 and 21 October 2009 at the start of the euro area financial crisis,[103] the Commission proposed legislation to enhance the powers of Eurostat. This was passed in summer 2010.[104]

74. The IEA made a strong case for reliable, objective and timely economic statistics, concluding that "for the euro to survive, the institutional framework controlling the quality of economic information must be improved". It suggested that the poor quality of some Member States' statistics was well known by Eurostat even before the Greek crisis. However, published concerns about the quality of Greek data "had no discernible impact on the bond ratings until 2009".[105] We have considered this issue in our scrutiny work.[106]

75. The van Rompuy taskforce report contains recommendations to improve the quality of statistics that go beyond the recent legislation. Mr Leandro explained that the taskforce felt that the Commission's proposal to reinforce the powers of Eurostat was insufficient, and that "steps needed to be taken to reinforce the reliability, competence and independence of national statistics systems".[107]

76. Asked about the detail of the Taskforce's proposal, Mr Conrad Smewing, Head of the Fiscal Policy Team at HM Treasury, informed us that discussions in the taskforce had concentrated on higher level reforms to the SGP and professional standards of statisticians.[108] Mr Laurence Copeland of the Institute of Economic Affairs, commented that "governments are just as prone to gaming rules as banks, multinational corporations or, indeed, individuals. If there are rules, we have to make them as game-proof and robust as possible".[109]

77. Accurate and comparable statistics are essential if there is to be effective economic coordination between Member States. The Commission's proposal to enhance the powers of Eurostat, adopted in 2010, was a good start. The van Rompuy taskforce report suggested a need for measures to improve the quality of national statistical data and to strengthen further the Eurostat's powers. We agree, and recommend that the Commission should bring forward legislative proposals to do so to ensure that measures to improve economic governance are not undermined by unreliable statistics.

Sanctions under the SGP

78. The Government have been clear that "sanctions as defined under the Treaty apply only to the euro area".[110] As a result, this proposal will not apply to the UK, and the UK will not have a vote in Council on decisions to apply sanctions. We recognise, however, that the success of these proposals will have direct implications for the health of the euro area as a whole. As we concluded in Chapter 1,[111] the continued health of the euro area is of direct interest to the UK, and we make our recommendations, therefore, to inform the debate currently being held at a European level on this proposal.

BOX 3

Enhancing sanctions under the Stability and Growth Pact

Regulation on the effective enforcement of budgetary surveillance in the euro area[112]

The Regulation would amend the existing sanctions procedure, detailed above, to introduce a new set of graduated financial sanctions for euro area member-states. In particular:

Under the preventive arm of the SGP, an interest-bearing deposit of up to 0.2% of GDP could be imposed for significant deviations from the principle of 'prudent fiscal policy making';
Under the corrective arm, a non-interest bearing deposit of up to 0.2% of GDP would be imposed if a Member State was placed in the EDP. This would be converted into a fine in the event of non-compliance with the recommendation to correct the excessive deficit.

The regulation proposes the use of reverse majority voting when imposing these sanctions. This would mean that the Commission's proposal for a sanction will be considered adopted unless the Council overturns it by qualified majority.[113]

This Regulation will not apply to the UK.

Are sanctions needed?

79. Some witnesses felt that the role sanctions would play in promoting sensible fiscal policies would be overshadowed by the disciplining effects of the markets.[114] Mr Hans Martens, Chief Executive at the European Policy Centre, for example, commented, "it is clear that whatever sanctions come out of this system, they are nothing compared with the sanctions that the market imposes", explaining that when the markets see irresponsible fiscal behaviour, "the interest rate on government debt, and perhaps on private debt, goes up so substantially" that it becomes "the worst sanction" a Government could face.[115] The Minister agreed: "Markets can often exert more effective and speedier discipline than political processes".[116]

80. Yet the markets have not been effective at restraining irresponsible fiscal policies up until now. We described in Chapter 2 the markets' failure to assess correctly the risks posed by different Member States in the euro area.[117] While the markets may have "learnt their lesson", as Mr Cliffe informed us[118], and will not make the same mistake again, it is clear that Member States are not willing to rely upon the markets alone to enforce fiscal discipline. The Treasury stated clearly that Member States themselves must be willing to enforce the SGP: "for the Stability and Growth Pact to be effective and credible, the EU must be clear that it is willing to take action against Member States who do not comply with its terms".[119]

81. After the events of the last year, the markets can no longer assume that all sovereign debt issued by euro area Member States bears the same risk. They will therefore play the key role in restraining fiscal irresponsibility by Member States by charging higher interest rates for countries deemed to have lax fiscal policies. The markets have not, however, always proven effective at enforcing responsible fiscal behaviour and further mechanisms to reinforce compliance must also be available.

82. The rules of the SGP must be enforced by Member States acting together through the Council. Repeated breaches by Member States in the past are proof that compliance is not otherwise guaranteed.

Making sanctions credible

83. While in theory there have always been sanctions available for enforcing the Stability and Growth Pact, Mr de la Chapelle Bizot suggested that "in reality there were no sanctions for breaching the Stability and Growth Pact".[120] The Commission's proposals, therefore, are an attempt to rectify this situation, by making the sanctions plausible. As Mr Zuleeg suggested, the Commission is "trying to give the stability and growth pact teeth".[121]

84. We heard two reasons why the previous sanctions process had been ineffective: the initial sanctions were too severe to use for anything less than the most severe infringements, and the room for political manoeuvre meant that sanctions were never levied when proposed to the Council.

MORE GRADUATED SANCTIONS

85. Mr Leandro explained one reason why the previous sanctions regime for excessive deficits under the SGP had been ineffective: sanctions had started "with a nuclear bomb", which he explained, "could never be used".[122] By starting off with small sanctions, at an earlier stage in the process, it is hoped that the sanctions will be easier to apply, and more politically acceptable. Mr Leandro explained what the van Rompuy taskforce had proposed:

"We would start sanctioning the country in the preventive phase of the Stability and Growth Pact before we even get to the corrective phase, with an interest-bearing deposit if the country seriously deviates from what has been agreed. Then, if it continues misbehaving and falls into the corrective phase of the pact, this interest-bearing deposit will be transformed into a non-interest-bearing deposit. Then, if it continues misbehaving, a fine will be imposed. Then the fine can be increased, as stated in the treaty, so it's a more progressive system and starts earlier".[123]

86. Several witnesses suggested fines were not a credible threat against countries already in fiscal difficulties. As Professor Buiter explained, "the penalties are still not credible, because they are fines ... if a country is fiscally challenged, you are not going to be able to extract money out of it".[124]

87. The Minister felt differently, and drew our attention to provisions that allow sanctions to be reduced or cancelled "on the grounds of exceptional economic circumstances".[125] The ability to impose sanctions earlier in the preventive and corrective arms of the SGP, starting with less punitive interest bearing deposits, gives the Council a more credible sanction to use against countries which may be experiencing financial difficulties.

88. We welcome the introduction of a more graduated system of sanctions against non-compliance with the SGP. The availability of sanctions earlier in the process will help ensure that irresponsible behaviour by Member States is discouraged so that the corrective arm can be avoided.

LESS POLITICAL DISCRETION

89. France and Germany breached the SGP in 2002-2003, leading to a conflict between the Commission (which wanted to initiate sanctions) and the Council (which demurred). Subsequently, France and Germany simply "changed the rules",[126] as Mr Leandro phrased it. Many witnesses saw this as an example of the prime failing of the current sanction regime: too much political discretion in determining when penalties should be imposed. Dr Annunziata summarised the issue: "for the sanctions to be credible, the room for political discretion should be minimised—this is the sad but realistic lesson from the original SGP".[127]

90. Several witnesses argued for sanctions to be made fully automatic, to be triggered when certain criteria are reached. Dr Annunziata, for example, told us that only automatic rules would work: "unless enforceability of rules is ensured, changes to the rules themselves risk being irrelevant". He concluded that suggestions for reverse majority voting are "insufficient".[128] Ms Vicky Ford, Member of the European Parliament, reminded us that "the ECB would like sanctions to be as automatic as possible". She continued, however, that "colleagues around the Parliament would like them to be as automatic as practical, which is slightly different".[129]

91. Mr Leandro described the course taken by the van Rompuy taskforce and the Commission to deal with this issue:

"It was decided to apply reverse majority decision-making, which means that a Commission recommendation for a sanction is automatically approved unless opposed by a qualified majority of Member States". This would ensure that "the decision-making process is also more automatic and provides for less political interference".[130]

92. A number of witnesses suggested that the use of reverse majority voting would make it more likely that sanctions would actually be applied. Mr Zuleeg suggested that "this new majority voting rule ... could work well", adding that it might make it easier for sanctions to actually apply to large Member States "even if they are unwilling to accept them".[131] Professor Buiter was more modest in his praise: "they have gone a very small way towards having more credible sanctions by making a switch to opting in rather than opting out".[132]

93. The Government agreed that reverse majority voting "would make it more difficult for Member States to avoid sanctions".[133] However, they argued that there had to be "the proper institutional balance"[134] between the Commission proposing sanctions, and the Council's ability to overrule their decision if necessary. They gave two reasons for this. First, the Minister argued strongly that "there should be some judgement used to determine whether it is appropriate to levy sanctions",[135] as opposed to a fully automatic process. Secondly, Mr Curwen said: "it is very important for political legitimacy that the governments of the Member States meeting in the Council ultimately take that decision".[136]

94. It was the Minister's view that the van Rompuy taskforce "gets the balance right" between "having an automatic process and having a blocking or reverse majority to overturn a decision to levy sanctions".[137]

95. We believe that fully automatic sanctions are a step too far. The introduction of semi-automatic reverse majority voting, however, is a positive step. By reducing the scope for political interference this new voting system will make it more likely that sanctions will be applied, making them a more effective deterrent to non-compliance.

POLITICAL WILL

96. While the introduction of reverse majority voting will make it harder for Member States to avoid sanctions, the blocking ability of the Council means that political expediency could still affect the way sanctions are applied. The Minister made the point succinctly: "the effectiveness of any sanctions system will be determined by the degree of political will within the Council to apply the system fairly".[138] It remains to be seen whether Member States will continue to maintain their political will to enforce the rules more rigorously once the crisis is past.

97. Several of our witnesses thought it was implausible that sanctions could ever be successfully applied or obeyed. They argued that the sovereignty of Member States would make any attempt to impose sanctions immensely difficult, particularly against larger, more powerful Member States such as France and Germany. Professor Goodhart, for example, told us that "to impose sanction on large sovereign countries, in the present state of the world political system, just can't be done".[139]

98. Mr de la Chapelle Bizot recognised the problem, and argued that the system could work but "only if there is a real endorsement by the different governments of the whole system".[140] Another witness reminded us that much depended on the larger countries being willing to accept the new system: "Germany is by far the most economically and politically powerful country in these questions, so it has to be willing to accept that the rules that are now being drawn up will apply to it".[141]

99. Dr Dermot Hodson, Lecturer in Political Economy at Birkbeck College London, raised another potential consequence of the new system, suggesting that implementing reverse majority voting might lead to a situation "in which Brussels might be blamed" for proposing sanctions, because it is "essentially getting the Commission to take ownership".[142] Mr Martin Larch, from the Directorate General for Economic and Financial Affairs in the European Commission, responded to the concern: "Brussels will take the blame anyway. That may be the case, but it is certainly not the case that the Commission take ownership of the sanctions".[143] Mr Hoban remarked wryly that "it is tempting to blame Brussels for everything", but added that the van Rompuy report asserted the need for the Council to be involved in the sanctions process, which should ensure they took responsibility for the process as well as the Commission.[144]

100. With its ability to block sanctions under the reverse majority voting procedure, final responsibility for the decision to impose sanctions will continue to rest with the Council—as is only appropriate. Only time will tell whether the collective will of Member States is strong enough to ensure that the sanctions process is applied even when the current crisis is over. We endorse the Minister's remark: "the cost of the crisis in the Eurozone is a reminder to us that we must make these processes work much more effectively".[145] We hope that this continues to be true beyond the immediate crisis.

101. We stress the need for the Council to ensure that, despite its ability to block sanctions, they become an effective means to ensure Member States' compliance with the SGP once the current crisis is over. We remain sceptical this will be the case.

Types of sanctions

WITHDRAWAL OF VOTING RIGHTS

102. The van Rompuy taskforce examined the question of whether Member States repeatedly breaking the rules should have their voting rights in Council suspended. Mr Leandro told us that "this was rejected by the taskforce. It was not considered politically feasible",[146] a view which he said the Commission shared.[147] However, the van Rompuy taskforce report did not rule out the possibility, instead noting in a final sentence that it was an "open issue" that the European Council might consider in future.[148]

103. Mr de la Chapelle Bizot was clear that the matter was not closed. "According to the German view, non-financial sanctions could be more dissuasive. It is a question of removing voting rights for outliers. France has decided to support Germany in that view and it is one of the questions that should be raised at a European Council level".[149] Professor Buiter, among others, told us that this would be a useful power for the Council to have: "they should have opted for things like suspending the right to vote on the euro council for wilfully non-compliant Member States".[150]

104. The Minister refused to express a view on the proposal, simply noting that there would be "significant barriers" to implementing such an idea.[151] Mr Curwen from the Treasury went slightly further, suggesting that "I think we would be concerned by any measure which undermined democratic legitimacy in the EU".[152] Other witnesses expressed similar concerns.[153]

105. Professor Louis indicated another difficulty, telling us that there would need to be "a revision of the treaty" to suspend Member States' voting rights for breaking fiscal rules.[154] Mr de la Chapelle Bizot, conceded that a treaty change would be required, but added, "[that] is why some Member States thought about a kind of political agreement, with each Member State recognising the fact that if it is under the excessive deficit procedure, it will decide not to vote in some cases, without any constraint ... [although] it would only be a political commitment without any legal force".[155]

106. We are unconvinced that a political agreement of this nature is practicable. The removal of voting rights would be an extreme measure, presumably only to be used when a country has repeatedly breached the SGP and refused to take corrective action. Under these circumstances, we do not think it would be sensible to rely on such a state keeping to a political agreement that has no validity in law.

107. We do not believe that the withdrawal of voting rights in Council is an appropriate sanction. Not only would it require a significant treaty change, it would raise significant questions about legitimacy and sovereignty if Member States were unable to have any say in decisions taken in Council. Nor do we think that a voluntary 'political agreement' is a plausible solution as an alternative.

INCENTIVES

108. Professor Pisani-Ferry suggested that there should be some form of incentive for better economic governance in Member States—in his words "better institutions could go hand in hand with more flexibility in the implementation of the common rules".[156] Mr de la Chapelle Bizot argued that "we are sure that we have to create incentives", referring to examples such as better access to European Investment Bank financing.[157] Dr Schelkle also expressed her support for the idea.[158]

109. Others however, were less enthusiastic: Mr Martens said dismissively that he could not see the EU giving out incentives like a "Christmas present",[159] while Mr Hoban informed us he was "old fashioned" and thought that "virtue has its own rewards". He questioned: "should people be incentivised simply to obey the rules?".[160] Mr Leandro echoed this viewpoint, arguing that "the real incentive for countries to abide by the rules is the fact that, going forward, the markets will be applying a much more differentiated approach".[161]

110. We believe that the overriding incentive for Member States is that of maintaining a stable and prosperous euro area. We do not feel that other incentives should be necessary.

SANCTIONS OUTSIDE THE EURO AREA

111. At present, sanctions under the SGP can only be imposed on euro area countries.[162] The Commission's proposals do not propose any change to this status quo. The van Rompuy taskforce report, however, proposes extending "enforcement mechanisms" to all Member States "by making a range of EU expenditures conditional upon compliance with the SGP". It suggests that this should be done as soon as possible and "at the latest in the context of the next multiannual financial framework". A footnote in the report excludes the UK because of its opt-out from EMU.[163]

112. This appears to us to be a significant step. The Treaty only envisages the imposition of financial sanctions on Member States whose currency is the euro, reflecting the greater need for a strict observance of fiscal rules in the euro area. This situation has not changed. The problems currently being experienced by euro area Member States are the result of structural failings in the EMU. To suggest widening the scope of a coercive enforcement mechanism to Member States outside the euro area seems unjustified and inconsistent with the principle underlying the Treaty.

113. The Government, considering this issue in the context of structural funds, have stated that they "have a principled objection to proposals for contractually binding 'conditionality' to be applied to funding". They argue that there should be no "punitive link" between entitlement to cohesion funds and the effectiveness of macroeconomic and fiscal policies.[164] We consider the idea of making EU funds conditional upon compliance with the SGP further in our report on the EU financial framework from 2014.[165]

114. We do not support the recommendation in the van Rompuy taskforce report to extend sanctions to Member States outside the euro area (excluding the UK) by making EU expenditure conditional upon compliance with the SGP. Sanctions are imposed on euro area countries on the basis of express Treaty provisions. It is inappropriate to do so through other means for Member States outside the euro area.

Supplementing the SGP: implementing sound fiscal rules at a national level

NATIONAL FISCAL FRAMEWORKS

115. During the inquiry a key question that emerged about fiscal surveillance was whether fiscal discipline had to be imposed by stronger rules and tighter surveillance at an EU level, or should come from reinforcing domestic fiscal structures at a national level. The van Rompuy taskforce report focuses on central oversight, while encouraging the development of domestic fiscal rules and improved institutions.[166] The Commission, meanwhile, have proposed a new Directive on national fiscal frameworks. This Directive would see the objectives of the SGP reflected in national budgetary rules and establish minimum standards for different aspects of the budgetary process (see Box 4 below).

116. Mr Larch explained the rationale behind this Directive: "EU rules are necessary to co-ordinate fiscal policymaking in the EU and in the euro area, but they are not sufficient to make fiscal policy coordination work". He concluded that "there would need to be national fiscal frameworks that are conducive to the kind of fiscal policymaking that is consistent with the provisions of the Treaty".[167]

117. The Commission propose that Member States implement national fiscal rules along the line taken by Germany, which in 2009 introduced a constitutional provision to mandate balanced regional and federal budgets. Ms Barysch explained: "Germany would like to see similar legislation in all Eurozone Member States". She noted that "they also know that not all European countries are as rule-abiding as they are, so they want to have some sort of external oversight for that". Germany envisaged this external oversight coming from the markets which would impose discipline through higher borrowing costs.[168]

BOX 4

Directive on budgetary frameworks of Member States

This proposed Directive sets out minimum requirements to be followed by Member States to strengthen and align their budgetary frameworks with the new European economic governance rules, by:

ensuring consistent accounting systems;
aligning national fiscal rules close to the balance goal, the 3% deficit limit currently set out in the SGP and the proposed addition of a debt threshold of 60% of GDP;
switching to multi-annual budgetary planning; and
ensuring that the system of public finances is covered by the framework (for example, ensuring that public expenditure through regional authorities is accounted for in the same way).

118. We heard evidence that the fiscal discipline in the EMU had a better chance to be respected in a decentralised system. Professor Pisani-Ferry felt that it was difficult to exercise fiscal discipline from Brussels, which could not create a model of fiscal discipline which reflected the differences between Member States' domestic institutional arrangements. He concluded that "you need to decentralise and find definitions of fiscal discipline on which there is ownership at national level", while emphasising that such an approach "was not inconsistent with the overall aim of EU fiscal discipline", but simply a different model.[169] Dr Annunziata took a similar view, and argued that, in the absence of a greater degree of political union, a decentralised system for fiscal discipline was needed where fiscal rules were enshrined in national legislation, so as "to tie the hands of national governments in a way which is recognized as desirable by the elected national legislature".[170]

ACCOUNTING FOR REGIONAL EXPENDITURE

119. This proposal would make countries which delegate substantial levels of expenditure to regional or sub-national bodies ensure that all levels of government operate under the same accounting rules and are subject to the same fiscal rules as the central government. Given that in some countries excessive expenditure by sub-national authorities has had negative effects on public finances at a national level, we welcome this step.

MINIMUM STANDARDS AND BEYOND

120. The Directive would require Member States to place minimum standards on their domestic fiscal frameworks but, as Mr Larch confirmed, the proposed directive "does not require the implementation of these requirements by law. There can be any kind of provision".[171] The van Rompuy taskforce report echoes the Commission's proposals. Mr Leandro explained that "some countries are more sensitive than others about transposing common requirements into national legislation", which was why the report did not specify how the minimum standards should be incorporated.[172]

121. Dr Hodson saw this as a key proposal that might have a real impact:

"If you ask, 'How could we get compliance without exerting peer pressure or sanctions?' it is by making sure that the objectives set at the EU level are compatible with the framework conditions for making fiscal policy. Those Member States that have better defined fiscal rules tend to have a better track record of compliance. I think that was perhaps the most significant part of the Commission's proposals".[173]

122. He expressed regret that the proposal did not require Member States to incorporate the rules in national law, lamenting that it "takes a big step back from what could be a real change to how fiscal policy is made".[174]

123. The Government have not been enthusiastic about the proposal, stating that "the construction and operation of Member States' national fiscal frameworks should be a matter for national governments to decide".[175] The Minister, whilst conceding that it was important to ensure that the right fiscal frameworks were in place in Member States and that a "high-level political agreement" on their outline might be appropriate,[176] emphasised that it was "dangerous to be too specific". He argued that a prescriptive legal framework would make no allowance for differences between Member States, and that "it almost takes away responsibility from Member States ... Real change takes place when Governments take ownership of their fiscal position".[177]

124. Mr Persson also opposed the use of legislation, arguing that it would be "very difficult to tell a national Parliament that from now on, one of our key policies—our budget policy—will be subject to [EU] rules rather than to votes in Parliament".[178]

125. We heard two variants on the proposal. Ms Ford informed us that among some Members of the European Parliament there was a desire for a two-tier system, where euro area nations would have to go further than the proposed Directive and incorporate the fiscal rules suggested in the Directive into national legislation. She explained that "there is quite a lot of concern that they need to have enforceable, clear, transparent budgetary processes across the Eurozone", and suggested that an amendment on these lines might be made by the European Parliament.[179]

126. Dr Annunziata, meanwhile, contended that it was possible to have a set of rules "that are in principle generally accepted and where the thrust of the rule is the same across countries", but where the "details of implementation could vary from country to country".[180] He proposed that limits could be imposed on deficits and public debt, as is currently the case with the SGP, but that each country would have the flexibility to choose what correction mechanism they would use. The details of these mechanisms could vary from country to country "as long as they are set in stone in the legislation giving reasonable assurances that they will guarantee an automatic correction of fiscal policy if certain limits are breached".[181]

127. The Commission's proposal to complement the top-down oversight of fiscal policy through the incorporation of EU-wide rules in domestic budgetary frameworks is a welcome development. We believe it will complement other proposals to enforce responsible fiscal behaviour through promoting a national ownership of EU rules.

128. We welcome the proposal to ensure that, where countries delegate substantial levels of expenditure to sub-national authorities, these bodies are subject to the same fiscal rules as central government.

129. We support the thrust of the draft Directive which states that 'provision' for fiscal rules should be introduced at a national level. We note, however, that the Directive may be more effective if Member States implement these rules through national legislation as far as possible, rather than relying on administrative provisions.

92 EGE 14 (HM Treasury) Back

93 COM (2010) 526 Back

94 COM (2010) 522 Back

95 EGE 10 Back

96 Q 357 Back

97 EGE 9 (Dr Annunziata), EGE 14 (HM Treasury), EGE 18 (Dr Dadush) Back

98 EGE 5 Back

99 EGE 14 Back

100 EGE 10 Back

101 Q 251 Back

102 EGE 8 Back

103 Report on Greek Government Deficit and Debt Statistics, European Commission, COM (2010) 1 final Back