The current debate

1. While recognising the need to coordinate fiscal policy within European Monetary Union (EMU) and prevent unsustainable fiscal policies, the ETUC has been consistently critical of the Stability and Growth Pact (SGP), established in 1997 with the aim of ensuring fiscal discipline under the specific conditions of monetary union . ETUC has taken the view - an opinion increasingly accepted in both policymaking and academic circles - that the Pact, whatever its contribution to deficit reduction, lacks a convincing economic rationale and has unnecessarily constrained the economic growth of the- European economy. Consequently it is a barrier to the achievement of the Lisbon Strategy and especially the employment targets. In response to criticism, changes were made at the end of 2002 to the implementation of the Pact , notably to focus more on cyclically adjusted, rather than current budget deficits.

2. As the economic downturn at the start of the new millennium continued, more and more countries exceeded the 3% deficit threshold. In the light of the economic situation, attempts by the Commission to enforce the excessive deficit procedure were rejected by the Council. In December 2003 the political conflicts resulting from the inappropriate fiscal rules of the Pact and the failure to ensure adequate economic growth in line with the potential of the European economy finally resulted in the de facto suspension of the SGP.

3. In response to this crisis (and specifically to a call from the June European Council), in September 2004 the Commission issued a Communication setting out a number of proposals for reforms of the Pact’s implementation. These were discussed at the following EcFin Council meeting, without any concrete policy initiatives being taken. The public debate on these proposals and on the reform of the SGP more generally, is intensifying. The Commission proposals have been heavily criticised by the ECB and by some commentators, claiming that they will remove the needed discipline on national fiscal policy within EMU. It is timely for the ETUC to clearly state its position.

The latest Commission Communication - a step in the right direction

4. The Commission Communication calls for measures to ‘refocus’ the SGP in the following areas:

• Giving more weight to government debt and sustainability in monitoring budgetary positions.

• Greater allowance for ‘country-specific circumstances’ in defining the medium-term objective of close-to balance or in surplus.

• Greater allowance for ‘country-specific circumstances’ implementing the excessive deficit procedure (EDP).

• Clearer focus on budgetary developments in ‘good times’.

• Improved coordination between the SGP, the Broad Economic Policy Guidelines (BEPGs) and national budget processes.

• Better enforcement using direct ‘early warnings’ by the Commission, improving fiscal statistics and increasing peer pressure, improving the link to national budgetary timetables

5. The Commission has not specified these recommendations in great detail. A number of important indications are given, however. ‘Periods of sluggish growth’ are explicitly mentioned as constituting an ‘exceptional circumstance’ justifying temporarily exceeding the 3% limit. ‘Economic conditions and debt levels’ should be used to determine how quickly a deficit over 3% should be corrected, bearing in mind the ‘reasons behind the excessive deficits’. Factors mentioned in evaluating the medium-term requirement for each country include ‘potential economic growth, inflation, liabilities relating to ageing populations, the impact of structural reforms or the need for net investment’. Importantly, the Communication makes repeated reference to the need to prepare for ageing societies. These points are taken up below.

ETUC positions and reform perspectives

6. In an immediate press release the ETUC gave a cautious welcome to the proposals as marking long-overdue recognition that the Pact has become unworkable and is in urgent need of reform. The reforms proposed which remain somewhat vague and need to be developed and concretised, address some of the most important shortcomings of the Pact. By improving the economic rationale behind the coordination of fiscal policy, reforms enacted on the basis of this Communication can indeed, as the Commission argues, improve Member State ‘ownership’ of the Pact and thus improve the coordination of national fiscal policy. Under such circumstances, Commission ‘early warnings’ will carry greater weight. The ETUC rejects the argument, raised notably by the ECB, that such reforms merely dilute the rules and thus pose a danger to responsible fiscal policies in Europe. On the contrary, a more flexible and economically rational application of the principles can only enhance the credibility of the macro-economic framework, producing better outcomes in terms of both growth and stability. Coupled with the ideas for improving the link with domestic policy-making put forward by the Commission - which would also need to be developed - there is a real opportunity for improved and more effective policy coordination.

7. The Commission’s call for a symmetrical fiscal policy that also addresses spending and taxation policies in good times is in accordance with long-standing ETUC demands and is to be welcomed. The ETUC December 2003 resolution called for measures to ensure that the SGP ‘bites’ with effective sanctions when there is an economic upturn.

8. The ETUC also welcomes the greater attention paid to longer-run fiscal sustainability, especially regarding government debt. Government debt levels vary considerably between the EMU member countries (and are, for example, generally much lower among the New Member States, where the need for investment is also even greater). The ETUC cautions, though, that if pension liabilities are incorporated into the analysis of government debt, a much more sophisticated analysis is required than is commonly proposed. Precisely with a view to ageing societies, individuals and pension funds want to hold secure assets like government debt. Yet the application of the SGP will constrain, and ultimately dry up completely, the supply of government debt. More fundamentally, societies as a whole cannot ‘save for retirement’ by cutting debt levels in the present. The best contribution that fiscal policy can make to addressing the demographic challenges facing our societies is to promote investment, economic growth, and employment, directly addressing the problems posed by high dependency ratios. Cutting public spending in these areas - childcare provision is a case in point - is not merely an inappropriate solution; it will seriously exacerbate the demographic problem.

9. As the Commission has now explicitly recognised, any policy recommendations under the SGP must be based on sound economic reasoning and full recognition of broader fiscal and economic circumstances in the country in question. In operationalising the country-specific circumstances, on which the Commission has given some broad indication, a number of points need to be borne in mind. The mention of ‘net investment’ needs to be developed into practical proposals based on the fundamental insight that it is not rational to finance public investment - which generates returns for future generations - out of current taxation. Europe needs to invest more in its human and physical capital: government spending in these areas should be treated differently from consumption-oriented spending. Countries in which debt levels are sustainable should be allowed to follow a ‘golden rule’, effectively excluding investment spending from the deficit. The Pact must be formulated in such a way that coordinated packages of public investment - such as the Growth Initiative recently proposed by the Commission, or the ETUC’s call for a public investment programme in education, research, innovation and social services representing 1% of GDP (December 2003 resolution) - are feasible.

10. Similarly, the mention of ‘inflation’ by the Commission needs to be developed to take account of the fact that those countries in the EDP have tended to also be low-inflation countries where the principal rationale of the SGP - to prevent the externalisation of the costs of expansionary policies in the form of higher inflation, and thus interest rates - simply does not apply. At the same time the higher real interest rate resulting from the lower inflation rate places an additional burden on the growth dynamic in the low-inflation countries. Consequently, a low inflation rate is an important indicator that fiscal policy is not excessively expansionary and that the country in question should not be forced to tighten policy pro-cyclically.

11. Alongside the need for further concretisation of the proposals made by the Commission, the ETUC emphasises that they also leave a number of serious concerns unaddressed. A fully functioning fiscal coordination system in the EMU, as part of an economic governance system that maximises sustainable growth and employment and thus contributes fully to attaining the goals of the European Union will also need consideration of, and reforms in, the following areas in particular:

• There is inadequate recognition of the role of private-sector savings in the assessment of fiscal policy. The Pact focuses solely on public debt and ignores the savings or indebtedness of the private sector. High savings countries, such as Germany, not only can afford a larger budget deficit, they are obliged to run one (or to expand their export surplus) in order to bring overall savings and investment into balance. Overall such countries exert a downward pressure on the common interest rate. Conversely, during the 1990s the USA brought down its fiscal deficits, but at the same time private-sector debt exploded. The problem of sectoral balances - the need for a balance between savings and investment in the private, public and foreign sector in any economy - is a key issue that is ignored not only by the Pact itself, but also by most of the contributions to the debate on its reform.

• The role played by fiscal policy in adjusting national competitiveness within a currency area is a key issue that must be addressed if the EMU is to function smoothly. National fiscal policies, ideally in close cooperation with wage and productivity strategies, need to be given appropriate scope to bring about the necessary adjustments while ruling out beggar-thy-neighbour strategies of real currency depreciation.

• The impact of a fiscal deficit on other countries in a monetary union - its ‘external effects’ - are not just negative, via higher interest rates, as the construction of the SGP implies; there are also positive effects through the boost that fiscal expansion give to the exports of other countries. Similarly, fiscal tightening in one country also has negative demand effects, constraining the scope for economic growth in other countries.

• These points also need to be seen in the context of the overall EMU fiscal deficit (which is currently substantially below 3%).

12. The concerns in Para. 11 will need to be addressed in a medium-term perspective. For now the ETUC calls for a broad public debate, to which all the relevant political actors should contribute, on the recent reform proposals of the Commission. The aim of such a debate must be to further concretise the reform proposals so that they can be implemented as soon as possible. The ETUC firmly believes that they mark a step forward and the European trade union movement stands ready to contribute to the on-going debate. In cooperation with the European Trade Union Institute a more detailed set of proposals will be presented in due course.