The economies of the European Union member states need structural reforms.
A country’s economic policy and budgetary discipline is not merely an internal matter if that country is a member of the European Union and the eurozone. Within the framework of a common internal market and currency, one nation’s economic and budgetary decisions can have a significant influence on other countries. This inspired the establishment of EU economic and budgetary policy coordination, which seeks to discover, prevent and correct trends that are harmful to the economic development of member states and the EU as a whole, hinder economic growth and threaten the EU’s economy and the stability of the euro area.
Europe’s economic growth is currently slow due to many countries having too much debt, which leaves no money for the countries to make investments that would benefit the economy. Other problems that the world’s second-largest economy faces include low productivity, too little investment in innovation and development, limited availability of capital (especially for start-ups and small businesses), an ageing population and high unemployment.
The economic policy of the European Commission under Jean-Claude Juncker stands on three complementary pillars of equal importance for stable and sustainable economic development: structural reforms boosting economic growth, responsible fiscal policy and investment promotion. The first two have long been EU priorities, but the addition of the investment pillar arose from the need to use investments to breathe new life into the post-crisis economy.
Since 2010, the EU’s economic policy has been coordinated through the European Semester, an annual process that includes budgetary policy as well as structural reforms and economic policy in general. The main tools of the process are commonly agreed priorities and goals and annual country-specific policy recommendations from the European Commission, approved by the member states’ heads of government. Countries should use these recommendations as a basis for planning their activities and budgets for the following year and report the results via the National Competitiveness Plan. EU countries participating in the Economic and Monetary Union present the Commission with an additional annual stability programme update that provides an overview of the choices made in the state’s budgetary and economic policy.
In the past few years, the European Semester process has been significantly simplified and given a better focus, placing the emphasis only on top priorities. The number and content of policy recommendations varies from state to state and depends largely on the scope of the economic problems the country faces. Consequently, the recommendations made to states with budgetary and macroeconomic issues include detailed policy measures along with deadlines, whereas the pointers given to countries with sound public finances and no major problems are brief and focus mostly on structural reforms. The latter include Estonia, one of the few EU countries that has not been a party to excessive budget deficit or macroeconomic imbalance proceedings. For instance, in May 2016, Estonia received only two policy recommendations from the European Commission, urging Tallinn to improve the quality and availability of public services at the local level with the help of administrative reform, to reduce the gender pay gap and to increase private investment in research and development to boost productivity. At the same time, many countries were given five recommendations with specific measures and deadlines for different policy areas.
EU-wide, this year’s policy recommendations were still dominated by budgetary policy and matters related to reducing government debt. Only three countries out of 28—Estonia, Luxembourg and Sweden—did not receive such a recommendation.
The recommendations highlight each state’s main economic issues; but do the countries act on them? Since the suggestions are qualitative and country-specific, it is quite difficult to compare the states’ progress. On the basis of the annual national reports, the European Commission analyses the countries’ development in areas reflected in the recommendations and assesses the extent of steps taken to implement the suggestions.
In 2015, the European Parliament compiled a summary of the implementation of recommendations given to EU member states and concluded that 6% of all suggestions had been fully implemented and 45% in part, while progress was either minimal or non-existent in 49% per cent of recommendations. Still, these proportions cannot be considered absolute because the economic reforms proposed to the member states tend to be complex and their effects generally take more than a year to become evident. As a result, many recommendations are deemed partially implemented, meaning that a country has assumed the right course and initiated the reforms, which might be expressed in the preparation of necessary laws, creation of implementation mechanisms, etc.
Above all, structural economic reforms are implemented in the country’s own interests to facilitate economic growth, create jobs and reduce budgetary expenditure. Hence, it is necessary to speed up their implementation in the whole of the EU and also tackle the economic reforms that might at first seem complicated.
Aiming for Responsible Budgetary Policy
Joining the eurozone means that a country is obliged to follow a balanced budgetary policy. In 1992, the Maastricht Treaty prescribed that the state budget deficit must not exceed 3% of gross domestic product (GDP) and public debt 60% of GDP. These two limits are also known as the Maastricht criteria. 1997 saw the adoption of the Stability and Growth Pact, designed to avoid the negative effect on the single currency and price stability of irresponsible budgetary policy, and laying the groundwork for coordination of the states’ budgetary and economic policy and the implementation of the aforementioned two criteria. The pact’s goal is to establish a budgetary discipline for member states. According to the pact, member states must strive for a government budget that is almost in balance or in surplus. This goal helps states to react to cyclical changes in the economy more effectively.
Budget coordination was even more strict during the economic crisis: the eurozone states were obliged to present a draft budget to the European Commission for analysis before its adoption to prevent the violation of budgetary rules. Sanctions became harsher and fines were imposed on countries that failed to follow the budgetary criteria. The possibility was also created to stop the payment of structural funds to a country if its finances could not be controlled. This was followed by the European Stability Mechanism, which allows a country in difficulty to receive urgent help.
What happens when a country does not meet the criteria laid down in the Stability and Growth Pact? States that do not adhere to the budgetary rules are subject to the excessive deficit procedure, which provides these countries with detailed injunctions and an action plan to reduce the budget deficit and align the budgetary position with the imposed requirements. In the worst-case scenario, the country would also face sanctions and a fine of up to 0.5% of its GDP. However, fines have not yet been applied to any country. At the peak of the economic crisis in 2010–11, the excessive deficit procedure was launched against a total of 24 EU states. In the light of the Commission’s latest decisions, made in May 2016, only six states are currently undergoing the procedure and are required to make an effort to meet the budgetary requirements: Greece, France, Portugal, Spain, Croatia and the United Kingdom.
The European Economic and Monetary Union (EMU) has been constantly improving over the past few decades and the rules were enhanced considerably during the last economic crisis. Nevertheless, the recent economic crisis taught a clear lesson—the existing budgetary rules and economic coordination system were not sufficient to prevent the crisis and deal with the consequences. While the average debt ratio in the EU before the last economic crisis remained near 60% of GDP, the figure started to rise rapidly in 2009 and today is at 85% , clearly exceeding the 60% limit imposed by the Stability and Growth Pact. At the same time, Greece’s debt level is at 177% and Portugal’s at 132%, while the respective figure for Estonia remains below 10%.
As a result, EMU is like a house that has been under construction for several decades, yet remains unfinished. The walls were strengthened and the holes in the roof fixed during stormy times, but to ensure that the house stands for a long time it is the foundations that need reinforcement. What should be done to make European EMU more effective?
Completion of Economic and Monetary Union
The so-called Five Presidents’ Report, published in June 2015 and authored by European Commission president Jean-Claude Juncker together with the presidents of the European Council (Donald Tusk), the Eurogroup (Jeroen Djisselbloem), the European Central Bank (Mario Draghi) and the European Parliament (Martin Schulz), provided a vision that set the course for European EMU. According to the report, development is needed in four areas:
- the creation of a proper economic union, so that each state’s economic structure also contributes to the prosperity of the whole monetary union;
- the creation of a financial union to ensure the stability of the single currency throughout the European monetary union and increase risk-sharing with the private sector. This requires the finalisation of banking union and boosting the development of the union of capital markets;
- the creation of a fiscal union to ensure the sustainability and stability of finances; and
- the creation of a political union, to serve as the basis for the previously mentioned structures, as this would ensure proper democratic accountability, legitimacy and the strengthening of institutions.2
The discussions about the future of EMU reveal two cross-cutting issues. First, is budgetary discipline achieved with regulated cooperation rather than based on centrally managed budgetary policy? It is a special characteristic of the European Union that it uses a single currency and implements a centrally managed monetary policy, while budgetary and economic policies are entrusted to member states. So far, these policies have been managed via transnational policy coordination and cooperation based on a shared set of rules. This method has often been criticised due to the complexity and occasional ambiguity of the budgetary rules. It has also been argued that the rules are not applied uniformly in every country.
Responsible budgetary policy serves the common interests of EU states, as it helps to manage economic shocks and possible subsequent crises while also supporting the economy’s quick recovery from a crisis. It is therefore important to create a macroeconomic stabilisation mechanism for the entire euro area, which would help states to overcome economic shocks together. A centrally managed budgetary policy, or the so-called eurozone finance ministry, would facilitate better budgetary discipline, more efficient monitoring and transparent budgetary policy to deal with crises more effectively than any one country on its own. This means that the member states would have to relinquish an even greater part of their budget policy sovereignty and delegate certain competences to the shared fiscal union—a logical step for countries using a single currency.
The second issue is how to increase states’ responsibility and sense of ownership when making structural economic reforms that aim to modernise the economy. One of the biggest problems of the current economic management system has been the fact that countries do not assume enough responsibility in implementing necessary reforms because it might be uncomfortable due to objections from stakeholders or politically difficult to execute. As a result, in many countries highly necessary reforms in labour markets, pension systems, healthcare, education, banking and other sectors, which would boost economic growth, create new jobs and increase the state’s competitiveness once implemented, have been waiting their turn for years.
To establish a stronger economic union, the eurozone countries need to move closer to each other more quickly and achieve the same standard of living and economic potential. As Jean-Claude Juncker said when introducing his economic policy programme: “I want to continue with the reform of our Economic and Monetary Union to preserve the stability of our single currency and to enhance the convergence of economic, fiscal and labour market policies between the Member States that share the single currency”. It is important for all member states to practise reasonable economic policy, using the possibilities of the shared internal market to the maximum, increasing investments and reforming outdated policies and structures.
According to the Five Presidents’ Report, the further development of EMU will be implemented in two stages. The first is already in progress and includes activities within the framework of existing EU treaties, for instance the already proposed European Deposit Guarantee Scheme, completion of the banking union and the creation of the union of capital markets. Among other things, the second stage, which involves a plan to create a shared macroeconomic stabilisation mechanism for the euro area and a fiscal union, requires changes in the legal framework and treaties. Both stages should be completed by 2025 at the latest.
All member states are currently discussing these matters and shaping their positions. The European Commission is planning to publish, by spring 2017, a White Paper on the basis of member states’ opinions which will present specific steps to be taken to strengthen EMU, along with a timetable.
Strengthening EMU is not a goal in itself but rather a means for the European Union to manage global economic problems more efficiently, which will eventually increase Europe’s economic competitiveness and the well-being of all Europeans. There are many ways to reinforce a house’s foundations, but one thing is clear—the foundation of the Economic and Monetary Union needs to be strengthened so that the house will stand for a long time and offer refuge from future economic storms.
This article expresses the author’s personal opinions.
This article was published in ICDS Diplomaatia magazine.