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The Evolution of Budgetary Discipline in Economic and Monetary Union (EMU) in light of Current Devel

Photo by Christian Bowen on Unsplash

1. Introduction [1]

The full mechanisms of budgetary discipline in the EU are quite recent developments, the legal basis having been strengthened considerably by the Lisbon Treaty 2009 and subsequent secondary legislation. Mechanisms for achieving compliance have always been one of the cleavages between what is now EU law and public international law, and the slow evolution of EU powers under the Stability and Growth Pact (SGP) have culminated in potentially highly intrusive, though as yet mostly unused, mechanisms of EU involvement in national budgetary decisions. These include important supervision powers for the European Commission in national budgetary decisions, as well as a considerable jurisdiction for the European Court of Justice (ECJ). This blog entry examines the growth of EU competence in supervising Member States' budgets, as the most recent and perhaps most dramatic extension of Economic and Monetary Union (EMU) beyond the Euro currency itself. It examines the initially slow development of the EU's role, followed by the cataclysmic effect of the global financial crisis. In particular, it notes the roles of the European Commission and ECJ. It takes the recent controversy regarding Italy’s proposed budget deficit as a case study of the current powers of the EU and thereby analyses the interaction of the Member States and EU institutions in light of both the evolving legal framework and of theories of EU integration and of compliance with EU law.

2. Long evolution of what is now EMU – EMU I

What is now EMU has undergone quite a long evolution. It began through the linking of Member State currencies in the 1970s through the European Monetary System (EMS) and European Exchange Rate Mechanism (ERM), with a 2.25% target for currency fluctuation. The initial legal basis was in Article 3g European Economic Community (EEC) Treaty (1957) and later Article 3a European Community Treaty (ECT) (1992). Article 3g EEC Treaty referred to the coordination of economic policy and also to balance of payments: “… (g) the application of procedures which shall make it possible to co-ordinate the economic policies of Member States and to remedy disequilibria in their balances of payments.”

While these provisions did not provide an explicit basis for a single currency, they do touch upon the policy substance or background to the subject of a single currency. The ERM and ESM thus began life essentially on an extra-Treaty basis. This phase of EMU had the following features:

- the abolition of exchange controls

- the adoption of criteria of economic convergence in Treaty of Maastricht, in the form of:

i. a maximum current budget deficit of 3% of GDP and maximum overall debt of 60% of GDP,

ii. control of inflation,

iii. a maximum exchange rate fluctuation under the European Exchange Rate Mechanism, and

iv. the coordination of interest rates.

3. EMU - II

Article 3a provided the first direct Treaty basis. It stated:

… 2. Concurrently with the foregoing, and as provided in this Treaty and in accordance with the timetable and the procedures set out therein, these activities shall include the irrevocable fixing of exchange rates leading to the introduction of a single currency, the ECU, and the definition and conduct of a single monetary policy and exchange-rate policy the primary objective of both of which shall be to -maintain price stability and, without prejudice to this objective, to support the general economic policies in the Community, in accordance with the principle of an open market economy with free competition.

3. These activities of the Member States and the Community shall entail compliance with the following guiding principles: stable prices, sound public finances and monetary conditions and a sustainable balance of payments.

This was the basis for a major deepening of the process, which now had these additional features:

- a European Monetary Institute established in 1994 as a forerunner to a European Central Bank (ECB)

- the adoption of a Stability and Growth Pact (SGP) in 1997 to established a broadly common approach to fiscal discipline

- a decision on which Member States were to initially adopt the Euro

- the setting of a 2-year qualifying period for Member States the monetary and fiscal targets

4. EMU III and Subsequent Development

The third stage of EMU was mainly the introduction of the Euro currency itself in 2001 and the coming into effect of the full monetary competence of the European Central Bank. Up until this point, the process was perceived as largely uncontroversial, for the large majority of Member States. In the United Kingdom, the 2001 general election was marked by a major debate about the loss of sovereignty that would result from Euro membership, but in most Member States, the issue seems largely have been seen in technocratic terms and not to have generated intense political debate or division.[2]

The Lisbon Treaty, which came into effect on 1st December 2009, was the next major development in EU competence. Although it might be dubbed ‘EMU IV’, it should be differentiated from the previous stages that were, apart from the SGP, mostly concerned with monetary issues. The changes brought about by the Lisbon Treaty formalised and enhanced the SGP, turning it into a legally biding system of surveillance of national budgetary policy. Article 121 of the Treaty on the Functioning of the European Union (TFEU) sets out a multilateral surveillance system. Amongst its main provisions are Article 121(3) TFEU, which provides for the Commission to report to the council (of Ministers) for the purpose of the latter to monitor individual Member State economic performance:

In order to ensure closer coordination of economic policies and sustained convergence of the economic performances of the Member States, the Council shall, on the basis of reports submitted by the Commission, monitor economic developments in each of the Member States and in the Union as well as the consistency of economic policies with the broad guidelines referred to in paragraph 2, and regularly carry out an overall assessment.

The provision is notable for the broad framing of the language; the term ‘economic’ is used in a general sense not confined to either monetary or fiscal matters. However, fiscal matters are subject to specific provisions, that provide some ‘teeth’ to the process in the area of budgetary discipline. Specifically, Article 126 TFEU provides for the Excessive Deficit Procedure (EDP). Under Article 126(2) TFEU, the Commission has to monitor compliance with budgetary discipline on the basis of two criteria: (a) whether the ratio of the planned or actual government deficit to gross domestic product (GDP) exceeds the reference value of 3%; and (b) whether the ratio of government debt to GDP exceeds the reference value of 60%, unless it is sufficiently diminishing and approaching the reference value at a satisfactory pace. Under Article 126(3) TFEU, if a Member State does not fulfil the requirements under one or both of the above criteria, the Commission has to prepare a report, taking into account whether the government deficit exceeds government investment expenditure and all other relevant factors, including the medium-term economic and budgetary position of the Member State. Subsequent provisions of Article 126 provide for the Commission to report an excess deficit to the Council (of Ministers) and for the Council to direct a Member State to adjust its budgetary position, while fines may be imposed for non-compliance under Regulation 1174/2011.

These basic provisions were enhanced in detail by the adoption of secondary legislation to strengthen the procedure, the so-called ‘two-pack’ and ‘six-pack’. The six-pack[3] did not alter the budgetary or fiscal objectives of the SGP. It established a system of sanctions for its breach. Previously, no sanctions applied, and it was not unusual for the Member States to breach the SGP, the main example being France and Germany, which breached the SGP in 2003. Two further Regulations, the so-called two-pack,[4] were introduced to provide for additional economic surveillance, especially concerning the excessive imbalance procedure, and only applicable to the Eurozone Member States.

This framework involves a staged procedure for bringing Member States back into compliance with the targets originally established in the SGP. In particular, it includes the setting of medium-term budgetary objectives (MTOs) as an intermediate corrective measure.

The above framework preceded the financial crisis, which essentially resulted from excess bad lending by banks, partly through extensive inter-bank lending at European level. This was perceived to necessitate major bailouts by national exchequers, greatly increasing national indebtedness as a result. This crisis, which resulted from what might be termed exceptional conditions, nonetheless prompted another development of EU competences of economic oversight. Three main developments occurred: the adoption of a common system of banking supervision, a quite remarkable restrictions on national budget deficits, and the establishment of a formal means to financially assist Member States in danger of defaulting on debt. The remainder of this blog entry focuses on the issue of national budgetary discipline.

5. The Fiscal Compact

The financial crisis prompted the Member States to further adopt the Fiscal Compact (FC)[5] and the European Stability Mechanism (ESM) Treaty. Adopted subsequently to the six-pack, these strengthened greatly the effect of EU budgetary discipline in national law and provided a legal basis for the granting of financial assistance to Eurozone Member States. Remarkably, the Fiscal Compact or FC also contained a prohibition on national budget deficits, taken in response to greatly increased national debt as a result of national bailouts of over-indebted banking sectors. This is a remarkable and dramatic – indeed almost historically unprecedented – restriction on the fiscal autonomy of the Member States. It is perhaps one of the best examples of the statement attributed to Jean Monnet that “Europe will be forged in crises”.[6] Article 3 FC provides for the prohibition on national budget deficits and for corrective mechanisms should they occur. Article 5 FC provides for partnership programmes in which the European Commission and Member States enter into corrective measures to eliminate a deficit. It is to some extent comparable to the provisions on MTOs under the SGP, but gives the Commission a significantly increased role. A further remarkable feature of the FC is the extent of the jurisdiction it gives to the European Court of Justice (ECJ). Article 8 gives the ECJ jurisdiction over Article 5 and possibly Article 3, meaning that the process of budgetary discipline will be justiciable. Although some provisions of the FC leave open some doubt as to the scope of this, it is highly unusual to give a court jurisdiction over any substantive aspect of budgetary policy.

The FC was adopted on an inter-governmental basis, as the UK under Prime Minister David Cameron and initially the Czech Republic refused to ratify it. As such, it is not technically one of the ‘EU Treaties’ (this term is generally used for the TEU and TFEU as the de facto constitution of the EU), but clearly it is an aspect of EU law.[7] It is comparable to those areas of the EU where flexible cooperation allows some Member State to integrate more than others, although a legally distinct mechanism operating at the intersection of EU law and public international law.

6. The Case of Italy

The Italian example is one of the first cases since the Lisbon Treaty, Fiscal Compact and ESM Treaty came into effect of a Member State breaching or threatening to breach the annual budget deficit rule in a way that has engaged, potentially, the disciplinary or enforcement mechanisms of EU law. A previous example occurred in 2016, when Spain and Portugal were given only symbolic fines[8] for breaching the annual deficit rule. Italy ultimately avoided getting into a formal legal procedure, and the dynamics of the process by which this occurred can provide insight into the current enforcement climate in the EU. It is notable that the European Commission was willing to use its enforcement powers even in a markedly Eurosceptic climate, with Brexit as the dominating political backdrop, but that the Commission has acted only to a limited extent relative to its powers under the Treaties (including here the FC).

In summary, what occurred in 2017-2019[9] is that Italy has been in breach of the maximum deficit rule and of the debt reduction requirements set by the Commission, but – just about – stepped back from the brink in response to what seems a somewhat strained threat of enforcement action from the European Commission. Italy committed an actual breach of the SGP in 2016, 2017 and 2018 by failing to comply with the debt reduction requirement,[10] with its overall debt-to-0GDP ratio being far above the maximum of 60%, ranging somewhat above 130% consistently over this period. The following is a broad outline of the main events regarding the Commission’s threat of enforcement action:

- Italy’s Budget law of 2018 had foreseen a deterioration of 2% of its structural budget debt-GDP imbalance;

- In November 2018, a report by the Commission, exercising the preventive arm of SGP,[11] warned of a serious breach under Italy’s draft budget plan of debt reduction targets;[12]

- On 5th June 2019, the Commission assessed in its report under Article 126(3) TFEU the factors in Italy’s 2018 breach and fiscal forecasts for 2019 and 2020 and signalled that an EDP was necessary;

- On 2nd July 2019, the Italian Prime Minister sent a letter to the Commission outlining a correction improvement in its structural imbalance of > .3% (instead of a deterioration) with a €7.6 billion reduction in borrowing, although the minimal nature of the adjustment is reflected in its justification being lower than expected outlays on new welfare policies that had prompted the initial decision to breach the debt reduction target;[13]

7. Conclusions

The architecture of EU monetary and fiscal economic governance has had a long evolution from the 1970s through the SGP in the 1990s and later the Lisbon Treaty 2009 and the aftermath of the financial crisis in the early-to-mid 2010s. The EU now has acquired substantial powers of oversight of national monetary and fiscal policy. This is especially so for Eurozone countries, but the Fiscal Compact prohibiting budget deficits applies to both Eurozone and other EU Member States that have ratified it. There is limited enforcement experience to date of the full range of EU powers, but the case of Italy can be an instructive example. Italy is compliant with the annual budget deficit rule under the Treaty of Lisbon framework for the SGP, but clearly not in compliance with the debt-GDP ratio. The Commission is attempting to slowly bring Italy into greater compliance by setting debt reduction targets, but Italy is generally not reaching these requirements. Italy has made a somewhat minimal correction to its plan to reject debt reduction targets set for it under the SGP, in response to a threat from the Commission to invoke the EDP against it, succeeded in avoiding enforcement.

Thus, so far, the Commission, exercising its enforcement discretion, has decided not to initiate an EDP, even though the legal, basis for it to do so exists regarding Italy’s breach of both the debt-to-GDP ratio and of its debt reduction targets (though not of Italy’s annual budget deficit). What is especially striking about this recent example is that the Commission has chosen to only partly exercise its enforcement powers, i.e. those under the Lisbon Treaty. In effect, the Fiscal Compact prohibition on deficits is not being enforced or attempted to be implemented by the Commission, which tends to pose the underlying question of whether an absolute prohibition on budget deficits is really either a realistic or desirable policy for the EU to seek to enforce in the first place. Time will tell if this is another example of a period of non-compliance with a major element of the EU legal framework (comparable perhaps to the empty chair crisis[15]) that eventually will see Member States fall into line, or if the Fiscal Compact suffers from a longer-term legitimacy problem.

Indeed, the context of the Italian example illustrates one aspect of the legitimacy questions facing the FC: Italy’s initial decision to reject the budget reduction target was to increase welfare spending, pointing to the conflict between the neo-liberal understanding of economic policy implicit in the framework of European economic governance with its emphasis on strict fiscal discipline, and broader conceptions of public policy including social justice and social welfare. This conflict of public policy goals is confirmed by the quite remarkable non-enforcement to date of the FC restriction on budget deficits. Future conflict over EMU discipline may well result from the clash between narrowly understood fiscal discipline and broader social goals.[16]

Dr Gerard Conway, Brunel University London

[1] This blog is based on a presentation at the UACES Research Network Panel: The Legacy of Austerity on the Enforcement of EU Law and Policy’, UACES 49th annual conference, University of Lisbon, Portugal, 3rd September 2019. I am grateful to the participants for stimulating discussion and questions.

[2] An exception is Sweden, where introduction of the Euro was rejected in a referendum in 2003.

[3] The following instruments were contained in the six-pack: Regulation 1175/2011 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies, OJ L 306, 23.11.2011, p. 12; Regulation 1177/2011 on speeding up and clarifying the implementation of the excessive deficit procedure established under Article 126 TFEU and applies to the Eurozone, OJ L 306, 23.11.2011, p. 33; Regulation 1173/2011 on the effective enforcement of budgetary surveillance in the euro area and applies to the Eurozone, OJ L 306, 23.11.2011, p. 1; Directive 2011/85/EU on requirements for budgetary frameworks of the Member States, OJ L 306, 23.11.2011, p. 41; Regulation 1176/2011 on the prevention and correction of macroeconomic imbalances, OJ L 306, 23.11.2011, p. 25; and Regulation 1174/2011 on enforcement action to correct excessive macroeconomic imbalances in the euro area, OJ L 306, 23.11.2011, p. 8.

[4] Regulation 473/2013/EU on common provisions for monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficits of the Member States in the Eurozone, OJ L 140, 27.05.2013, p. 11; Regulation 472/2013/EU on the strengthening of economic and budgetary surveillance of Member States in the euro area experiencing or threatened with serious difficulties with respect to their financial stability, OJ L 140, 27.05.2013, p. 1.

[5] The full title of which is the Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union.

[6] “Europe will be forged in crises, and will be the sum of the solutions adopted for those crises”: J. Monnet, Mémoires (Paris: Fayard, 1976), p. 14.

[7] See Article 16 FC envisaging its full integration into the EU framework.

[8] Council of the EU, ‘Excessive Deficit Procedure: Council agrees to zero fines and new deadlines for Portugal and Spain’, Press Release 484/16, 9th August 2016.

[10] Under Regulation (EC) 1467/97 on speeding up and clarifying the implementation of the excessive deficit procedure, OJ L 209, 2.8.1997, p. 6; Council Regulation (EU) No. 1177/2011 amending Regulation (EC) No. 1467/97 on speeding up and clarifying the implementation of the excessive deficit procedure, OJ L 306, 23.11.2011, p. 33.

[11] For illuminating analysis of the preventive and corrective arms of the SGP, see J. De Jong & N. Gilbert, ‘The Mixed Success of the Stability and Growth Pact’, VOX, CEPR Policy Portal, 15th January 2019.

[14] European Commission, ‘An EDP for Italy is no longer warranted at this stage’, Press Release IP/19/3569, 3rd July 2019.

[15] i.e. the effective non-implementation of majority voting in the Council (of Ministers) from the 1960s up until the mid-1980s.

[16] See generally, C. Joerges, ‘Social Justice in an Evermore Diverse Union’, ZenTra Working Papers in Transitional Studies No. 62/2015 (2015); C. Joerges, ‘Integration through law and the crisis of law in Europe's emergency’, in M. Dawson, H. Enderlein, C. Joerges (eds.), The End of the Eurocrat’s Dream: Adjusting to European Diversity (Cambridge University Press 2016).

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