Don’t mention the euro

Date: 04/10/03

The euro's deficit rules are apparently unenforceable yet unchangeable

WHEN the prime ministers and presidents of the European Union assemble in Rome on October 4th to start discussing a new constitution for the EU, they will be preparing to do battle on many issues: the relative voting power of countries in the Union; the future of European defence policy and criminal law; the place of religion in a declaration of European values. But one element of the draft that will very probably be nodded through without much ado is Article III-76, on “excessive government deficits”, along with its associated protocol, which lays out a number of fiendish punishments for countries that run budget deficits of more than 3% of GDP.

The excessive-deficit procedure already exists in European law and is being put into the constitution, with minor modifications. This is a very peculiar state of affairs. No less an authority than Romano Prodi, the head of the European Commission, has called the current rules “stupid”. The governments of France, Germany and Britain have all made it clear that they think they should be made more flexible. The whole thing has been falling apart anyway, as France and Germany have repeatedly breached the 3% limit. The drafting of a new constitution would have provided an ideal opportunity to change the rules and make them more realistic. Instead, the entire cumbersome procedure is being set in the stone of constitutional law.

The problem may sound technical but has profound political implications. The excessive-deficit procedure embodies the fundamental political issue facing the EU: how much sovereignty are countries truly prepared to hand over to Brussels? In normal circumstances, when the finances of the 12 countries that have adopted the euro are not heavily in deficit, the handover is not too evident. But when the excessive-deficit procedure kicks in, it becomes (at least in theory) very intrusive indeed. The Union has the power to issue binding recommendations to countries that repeatedly violate the 3% rule. Rather like the International Monetary Fund, it can order countries to raise taxes or cut spending. If countries fail to comply with the IMF, funds are withheld. But the EU can go even further by slapping fines of billions of euros on malefactors. However, while EU countries have agreed to this sanction in theory, they show little sign of being able to live with it in practice. Jean-Pierre Raffarin, the prime minister of France, the country most at risk of being fined, has spoken irritably of not bowing to the wishes of pen-pushers in Brussels.

So why is the Union now intent on incorporating this unworkable piece of legislation into its constitution? The problem is that, while most people can agree that the current procedures are not working, there is no consensus about how to change them. A few dissident voices, including The Economist, have argued that the European single currency does not actually need rules constraining government deficits at all, since the markets can punish governments that borrow irresponsibly.

But this is not an argument that finds much favour within the EU, where most governments still fear that an excessive deficit in one country will inevitably hurt others in the euro area. Instead there is a camp of reformists, which coincides suspiciously with the countries that are finding it hardest to stick to the rules. They argue that the current procedures should be made “more flexible”. Perhaps the definition of the “exceptional circumstances” in which countries can run large deficits could be made more forgiving. Perhaps special rules could be drawn up so that “investment spending” is excluded from the deficit measure. Or perhaps more attention should be paid to overall government debt rather than annual deficits. All interesting ideas, but, alas, there is no consensus in the EU to act upon any of them. Besides, the leaders of several EU countries have repeatedly assured their electorates that the rules on deficits are, in the words of Guy Verhofstadt, Belgium's prime minister, “our bible”, thus making it impossible for them to agree to any changes.

The result is that the excessive-deficit procedure will be incorporated into the constitution and will then gradually fall apart in a rather agonising and public fashion. A further twist in this process was due to take place on October 3rd, just a day before the leaders of EU countries were to gather in Rome. That was when France was meant to tell its European partners how it had responded to recommendations made to it earlier this year to help bring its deficit under control. The short answer is that the government in Paris has blithely ignored these suggestions. The next step is for the European Commission to suggest binding recommendations. If these are then ignored, the first moves towards fining France could take place in January. Keen to avoid so drastic a step, the European authorities seem more inclined to let France break the 3% limit again in 2004 but to demand a few further tokens of budgetary consolidation and to hold the French to their promise to come back below 3% in 2005.

What a sham, what a mess

If the French do indeed return to fiscal discipline in 2005, a full-scale euro-crisis might be avoided. But France's deficit projections have consistently been too optimistic in the past, so there is good reason to expect that they will break the 3% limit for the fourth successive year in 2005. At that point, fines could finally be voted through, with potentially horrible consequences for France's relations with the EU.

More likely, however, the countries that would have to vote for the fines will balk at the consequences - and the fiscal rules governing the euro will finally be exposed as a sham. Unfortunately, by that time, the whole excessive-deficit procedure will probably have been incorporated into Europe's constitution, which could only be amended unanimously by all 25 of the Union's current and future members. So the EU's fiscal rules will be simultaneously unenforceable and unchangeable. Precisely the kind of mess that tends to bring constitutions into disrepute.

Commentary feature. The euro's deficit rules are apparently unenforceable yet unchangeable.

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