Aka Fiscal Compact

Daniel Gros [1]

 

This Treaty has a long title, but upon closer examination it is long on good intentions and rather short on substance in terms of binding provisions.

The only really substantive binding provision is that the Member States oblige themselves to adopt at the national level rules which limit their structural deficit to 0.5 % of GDP. This should be done ‘preferable at the constitutional level’. The European Court of Justice (of the EU) can be asked to pass a judgment on these national rules, but the maximum fine that could be assessed if a national deficit rule is found not in compliance with the Fiscal Compact is capped at 0.1 % of GDP – hardly a strong deterrent by itself. This is all in terms of binding commitments!

Contrary to a widespread held belief the Fiscal Compact does not give the EU any additional powers over national fiscal policy since it concerns only the broad rules which Member States have to follow in setting up their national ‘debt brakes’, not the implementation of these national rules. This Treaty thus does not give any new powers to the Court of Justice (neither to the Commission) to interfere with the actual conduct of national fiscal policy.

For example, Spain has already a national debt brake which satisfies the rules of the Fiscal Compact. This implies that even if had been in force in early 2012, the Fiscal Compact would have had no implications for the controversy concerning the fiscal overrun of Spain in 2011 (when the deficit turned out to have been over 8 % of GDP, against the about 6 % of GDP programmed), and the announcement of the Spanish government that it did not feel bound by previous commitments to reduce its deficit in 2012 to 5.3 % of GDP. In the end Spain was given some flexibility for 2012, but was forced to stick to its promise to reduce its deficit to 3 % of GDP by 2013, but this was due to the pressure from markets and the sanctions that its EU partners could have imposed under the existing rules of the enhanced Stability Pact.

This example shows that the Fiscal Compact Treaty concerns only the framework for fiscal policy, i.e. the rules setting up national ‘debt brakes’, not their implementation. The Fiscal Compact thus does not give any new powers to the Court of Justice (neither to the Commission) to interfere with the actual conduct of national fiscal policy.

The Fiscal Compact Treaty also contains some sweeping provisions on economic policy coordination, but they are not binding. They repeat essentially often repeated statements of good intentions on structural reforms.

The Treaty also institutes regular meetings of the heads of state of the euro area (at least twice a year). But since these meetings will remain informal there was no need for an international treaty to institute them.

Much has been made of the fact that many non euro member countries have signed the Fiscal Compact. But this does not imply any obligations for them. The signature of the 8 non euro area countries constitutes thus just a political statement which gives them a partial ‘seat at the table’ in the sense that their leaders can participate in most of the euro area summits (but without any real influence on the decision making process).

From a purely legal point of view this Treaty contains an inherent contradiction because it implies that its signatory countries agree binding constraints for their constitutional order via an ordinary international treaty. However, in most countries the (national) constitution is of a higher legal order than international treaties, which implies that even the few binding provisions on the ‘fiscal compact’ constitute essentially a political statement. The only way around this conundrum is to ratify the Fiscal Compact Treaty with a constitutional majority, as will be done in Germany.

The main value of this political statement is of course that it provides political cover for the German government in its efforts to sell the euro rescue operations to a skeptical domestic audience. However, it is doubtful that the ‘fiscal compact’ was really needed for this purpose given that German public opinion remains much more constructive on the euro than widely assumed (see Gros and Roth (2011)) and given that even before the fiscal compact existed all votes in the Bundestag have resulted in very large majorities in favour of all euro area rescue operations, even when they contained large fiscal risks for Germany.

In judging the value of this Treaty one should also keep in mind that of the four large euro area countries three have already national debt brakes at the constitutional level (in Germany already operational, in Spain adopted and in Italy in the course of adoption). In the fourth France, it is already clear that the Treaty will be implemented (if at all given the negative attitude of the opposition) via a so-called ‘loi organique’, and that the French constitution will not be changed. This is implies that at least in France the ‘primacy of policy’ (over legalistic rules) will not change.

Moreover, the prominence of the structural deficit in the Fiscal Compact is dangerous since this concept can never be precisely defined. A structural deficit is computed by adjusting the actual deficit (as determined by Eurostat) by a factor which represents the estimated impact of the business cycle on the deficit. But this estimate cannot be precise because what is structural and what is cyclical is always a subjective judgment and the Commission and Eurostat have often changed their estimates of the structural deficit considerably over time. Just to give one example: Imagine a country with a deficit which is estimated, as of the time of adoption, to be equivalent in structural terms to 0.5 % of GDP – and thus in compliance with the Fiscal Compact. But it is possible that a little later Eurostat changes its estimate of the structural component and finds that the deficit was after all equivalent to more than 0.5 % of GDP. What should be done then? It might be too late in the year to change the budget.

All in all the Fiscal Compact is probably useful despite these limitations. It forces Member States to adopt stronger national fiscal frameworks at home. Some, perhaps most, would have done so anyway under the pressure of the markets, but the new Treaty will probably still make a marginal difference. To what extent the national debt brakes will actually be applied will depend on the strength of national institutions.

The main danger is that the Fiscal Compact has been oversold. It does not constitute a first step towards fiscal union or a European economic governance. It is likely that the ratification process (e.g. the referendum in Ireland) and then the implementation process in some difficult countries (e.g. France) will receive a lot of attention and create a distorted impression of the importance of the Fiscal Compact. However, once the initial excitement is over and the national fiscal rules have been put into place, this Treaty will quietly be forgotten as its only remaining impact will consist of the informal euro area heads of summits which are likely to produce the regular conclusions that ‘Member States commit’ to everything desirable (austerity, structural reforms, etc.). Conclusions which become irrelevant once the heads of state return to their capitals and their domestic political realities.

 

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[1] CEPS, Brussels.