EU public finances need new watchdog

By Daniel Gros

Date: 30/09/04

THE new government in Greece has all-of-a-sudden found out that its predecessor was, for some time, misrepresenting the true state of public finances. The size of the data revisions has been extraordinary: the deficit estimate for this year is now 4.6% of gross domestic product (GDP), almost 3% higher than the previously reported 1.7% of GDP.

The cumulative impact of the revisions can be seen in the figures for public debt which, for the end of 2003, went up from around 103% of GDP to close to 110%. With the new figures, Greece now overtakes Italy as the country with the highest debt/GDP ratio.

Much attention has been focused on the inability of the EU's data office Eurostat to detect the problem much earlier.

But this is not justified. Eurostat cannot produce statistics for the entire EU-25. Its numbers can only be as good as the raw data that are provided by member states and national statistical offices.

The speed with which Eurostat numbers - not only for this year, but also for all the years since 2000 - have been changed suggests that even now it has merely taken the new Greek data without analyzing the information in detail.

However, it cannot really be Eurostat's job to play detective with governments.

The institution that is charged with the surveillance of public finances is the European Commission. Unfortunately, this is now the second time in a few years that the Commission has been caught napping. The first occasion was when the deficit for Portugal had to be revised from a little above 1% to more than 4% in 2001-02.

But the misrepresentation by the Greek government is much more serious since it has been systematic and it may even have been instrumental in allowing Greece to clear the hurdle of one of the Maastricht criteria to qualify for eurozone entry, that on the size of the budget deficit.

What should be the consequences of this episode? A first conclusion is clear: monitoring (and forecasting) must be improved. This will require a substantial increase in resources. At present, the Commission does not even have one official per member state to deal full-time just with the monitoring of fiscal policy.

Given such meagre resources, the Commission has to rely on data coming from member state governments, which makes it impossible to formulate an independent point of view.

But, even so, the Commission should have noticed the wide inconsistencies between the path for public debt and the reported deficits. In principle, government debt should go up only through deficits. But the data published with the latest Spring forecast contain a discrepancy between the deficit data and the change in the public debt ratio of several percentage points of GDP.

This alone should have set the alarm bells ringing.

Given the limited resources at the disposal of the Commission it might not have been able to do much more than point out the apparent discrepancies between debt and deficit figures. But this is not enough.

DG ECFIN, the Commission's department of economic and financial affairs, should be allotted more resources to follow closely the public finances in member states (especially those in the eurozone). If this had been the case it would probably have detected the inconsistencies in the figures transmitted by the Greek government.

After all, it was widely known that Greece had bought 45 fighter jets. This should have been reflected in military expenditures. Moreover, even unreported spending has to show up in higher government debt. Anybody following the Greek financial markets and the issuance activity of the Greek government should have noticed the discrepancy with the reported debt numbers (public debt is now estimated to be 7% of GDP higher than before).

In order to be able to perform the task assigned to it by the treaty properly, DG ECFIN needs probably more than 100 extra officials to follow and monitor public finances in member states in real time.

Another useful measure would be the creation of (national) independent budget agencies in member states, similar to the Congressional Budget Office in the US which performs independent analysis and monitoring. Such an agency should have caught the 'oversight' of military expenditure, or the surplus in social security funds. A national independent budget agency could then also report to the European Commission.

Given that governments are increasingly allocating budgetary activities to agencies, standard budgetary analysis should be accompanied by 'below the line' monitoring - looking at debt issuance and credit to the government - that would provide a cross-check to the picture provided by the national accounts and, because of its greater frequency, serve as an early warning device.

The Commission would incorporate the information from these agencies into its decision-making process.

Another consequence must be that the applications of the new member states for membership of the eurozone will have to be scrutinized much more carefully.

Estonia has been running budget surpluses for some time, but others, such as the Czech Republic, seem to have lost all control over fiscal policy.

• Daniel Gros is director of the Centre for European Policy Studies. www.ceps.be

Analysis feature in which the author, who is Director of the Centre for European Policy Studies, suggests that the European Commission should be given more resources to scrutinise public finance in its Member States.