Improving the Stability and Growth Pact

On March 20, the Finance and Economic Ministers of the 25 European Union member states succeeded to find the required consensus to finalise a common position on the reform of the Stability and Growth Pact. This position was subsequently endorsed by the European Council meeting in Brussels, on March 22 and 23.

It is almost certain that a failure to reach an agreement would have captured more prominent headlines in the international media, as there is a tendency to highlight more differences of opinion than to elaborate on points of agreement.

However, the successful finalisation of a compromise solution is definitely a development of significant news value since it was not, by any means, a forgone conclusion. On the contrary, a final agreement had not appeared at all likely, not even in the immediate run-up to the ECOFIN and European Council meetings.

In the end, however, a common way forward has been found, notwithstanding the conflicting viewpoints that had been, at various instances, proclaimed, based no doubt on the particular situation prevailing in the individual member states.

The deliberations of the EU Finance and Economic Ministers have been collated together in the form of a report that has subsequently been reproduced in full, as an appendix to the official text of the Presidency Conclusions that was unanimously adopted by the European Council.

The heading chosen for this report is 'Improving the implementation of the Stability and Growth Pact'. The chosen title is a very indicative one. It reiterates the commitment towards the application of the pact and defines the required reform in terms of measures necessary to facilitate implementation. In the process, the essential principles of the pact have been reaffirmed.

Aim of pact

It is important to keep in mind the underlying context and the overriding concern of the Growth and Stability Pact, namely the need for all adherents to the single currency to follow a common strategy for fiscal responsibility in support of monetary stability.

This implies also the adoption of common parameters and rules to define fiscal responsibility, the principal ones being:

a) an annual budget deficit ceiling of 3% of GDP with the aim of achieving a balanced budget; and

b) an overall cumulative debt ceiling of 60% of annual GDP, to be reached gradually.

The above constraints are, clearly, intended to promote fiscal discipline. It is interesting to note that, in some quarters, the kind of fiscal rigour implied by the pact has been misconstrued as being an obstacle to growth.

This is not the case since budgetary discipline is essential for long-term stability and growth. Without budgetary rigour, there would be a serious risk of short term measures being favoured that could feed inflation but not bring about the kind of structural changes necessary for growth to take place.

This point has been emphasised regularly by Joaquin Almunia, European Commissioner for Economic and Monetary Affairs. He has also often highlighted the fact that it is among those "member states that have strengthened their public finances and which do not have any difficulties with the pact, even in periods of weak growth" such as the present, that one finds "the best examples in terms of growth, cohesion and reforms" such as is the case of Denmark, Finland and Ireland.

Flexibility

The pact is being reformed by providing a greater degree of flexibility in its implementation. However, flexibility must not imply laxity and it is not the intention to allow this to happen as concerns the reform of the pact.

To this end, the institutional prerogatives of the European Commission, within the workings of the pact, have been maintained and have not been replaced by measures subject to a purely inter-governmental system.

This includes the provision for the Commission to invoke 'Excessive Deficit' procedures vis-à-vis those member states that fail to comply with the fiscal discipline criteria defined within the pact.

What has been made more flexible is the mechanism to be applied by the Commission when assessing the compliance or otherwise with the relevant criteria.

This greater flexibility, making possible a more effective appraisal, stems from the fact that a number of parameters have now been brought into the picture and will be taken into due account.

Simplifying somewhat the subject matter for ease of exposition; a number of 'chapter-heads' have been identified to facilitate a transparent rules-based system of appraisal.

These are "general and basic principles allowing member states and EU institutions to better understand the treatment of relevant factors" when assessing budget deficits and fiscal practice.

When a member state is close to the 3% budget deficit threshold and is projecting a temporary excessive deficit, it will be able to specify what factors should be taken into consideration, not only before an Excessive Deficit Procedure is launched but also during successive stages of the procedure.

To a large extent, this 'new' approach has been developed in direct response to what was one of the most common criticisms of the 'old' pact, namely that it was too mechanical and obtuse in nature, being based purely on statistics.

The new approach acknowledges that not all expenditure is identical, even though all expenditure contributes to a potential excessive deficit situation. In particular, it is relevant to distinguish between recurrent expenditure of an administrative nature and expenditure which prepares for the future and which therefore should result in future receipts or savings.

This new approach implies that the fiscal policy of any country will be evaluated not merely on the basis of raw figures but also with reference to the 'quality' of its expenditure. It is hoped that this fresh perspective will help to encourage governments to implement reform in an operational and therefore more concrete fashion.

Structural factors

One specific context in which this approach is expected to be particularly meaningful is in the assessment of the fiscal impact of the necessary structural reforms to update pension systems.

This is a topical subject in Malta but, at least judging from the international press, it appears to be of even more central significance in some of the Central and Eastern European countries, such as Poland and Hungary.

It is expected that expenditure on long-term pension scheme reform would be one of the 'relevant factors' that will need to be taken into account by the Council and the Commission at all stages within the assessment of budget deficits.

Other examples of relevant factors have been mentioned by way of explaining the flexibility inherent within the 'new' approach. For example, these include an increased attention to budgetary efforts made in favour of international solidarity, meaning humanitarian and development aid, especially in response to such unpredictable exigencies as was the urgent need to respond to last December's tsunami disaster.

This consideration would appear to be potentially relevant to all member states. On the other hand, there could be some relevant factors to be taken into account which could be interpreted as having been highlighted in response to the perceived relevance on the part of a particular country.

One such instance is the reference to the cost of the unification of Europe inasmuch as it may represent a budgetary burden and weigh down the growth prospects of a member state, a consideration that has been clearly included in response to the perceived situation of Germany.

However, this ability to respond to particular and even peculiar situations is not intrinsically a bad thing, although it implies a degree of flexibility that will need to be applied judiciously and consistently.

In the past the Growth and Stability Pact had been criticised as being too rigidly focused on the aspect of stability to the detriment of growth. It is hoped that the 'new' approach and consequent reform will indeed improve the implementation of the pact to the extent that it may become a better instrument to foster growth, in the knowledge, however, that no growth will be sustainable unless it is based on sound fiscal and monetary practice.