One new Pact for all, and all for one?

By Stewart Fleming

Date: 30/09/04

JOAQUIN Almunia, the monetary affairs commissioner, has argued that reform of the EU's Stability and Growth Pact is necessary to take account of political and economic reality - and he added that changes must be workable.

"We do not want perfect rules which are impossible to enforce we have got to tackle reality," he told a conference on economic policy coordination on Tuesday (28 September).

Almunia believes that last November's decision by EU governments to suspend the implementation of the Pact against France and Germany proves that "peer pressure to support the Pact has turned into peer support against the Commission".

There are also signs, he added, that budget discipline may be breaking down in some new member states.

"Some countries are not implementing their own convergence programme recommendations," he said.

The Commission's report on how to reform the Pact, published on 3 September, argues that the budget deficit cap of 3% of gross domestic product and the 60% debt to national income target should be maintained.

But, it says, these restrictions need to be interpreted more intelligently. The Pact needs to change to take account of the fact that enlargement has made the Union more economically diverse. More emphasis should be put on each country's economic circumstances, especially its debt ratio, in order, for example, to take account of future liabilities such as unfunded pension obligations. In Germany's case, its debt to gross domestic product ratio would soar from 60 to 330% if this were done, says Jöm Quitzau of Deutsche Bank.

Almunia explained that a reformed Pact would strengthen "the link between our rules and economic reality". Actions to correct excessive deficits "should not be taken at any cost". Economic conditions outside a government's control, which were having an adverse impact on a country's budget deficit, needed to be taken into account more, the Spaniard added.

But he conceded that making a distinction between how much of an excessive deficit is due to global economic conditions and how much to lax budget policy is technically difficult. "It's a real issue," he said.

Pessimism prevailed during the conference on both the issue of reforming the Pact and on efforts to try to improve economic policy coordination, and get the "failed" Lisbon economic reform agenda back on track.

Some experts warned, given the technical and political complexities of re-writing the Pact, the chances of meeting next Spring's target date for agreeing reform may be no better than 50/50 unless the proposals are fudged.

This is partly because of the staunch resistance to either more economic policy coordination or to the creation of a more flexible Pact, which is coming from the European Central Bank (ECB).

"The central message I wish to convey here is that there are no convincing arguments in favour of changing the existing blueprint for economic governance [in the EU] by attempts to coordinate ex ante [in advance] macro-economic policies between the main players, monetary policy, fiscal policy and wage policy," Otmar Issing, the ECB's chief economist, told the conference.

Issing reaffirmed the ECB's view that the Pact "is appropriate in its present form but that there is scope for improving its implementation...there is a need to provide enhanced incentives to comply with commitments under the Pact and to increase peer pressures towards enforcing the rules".

Defenders of a stricter adherence to the Pact, like Issing, worry that proposals that introduce greater flexibility into its operation and take more account of country-specific conditions would in practice weaken the rules, which they see as fundamental to the long-term stability of the single currency.

They point, too, to the technical difficulty of drawing up credible country-specific debt rules which, for example, not only take account of such unpredictable factors as the impact of ageing populations on government borrowing but also fulfil the treaty requirement that the rules be applied equitably between countries.

"As you take more account of country specific factors then it becomes almost impossible to observe equal treatment between countries," said Issing.

"How can the Pact be rule-based if there is a rule for each specific situation?" said Lars Heikensten, governor of the Swedish Central Bank.

• Stewart Fleming is a Brussels-based freelance journalist.

At a Conference on EMU and economic governance in Brussels, Joaquín Almunia, European Commissioner for Economic and Monetary Affairs, argued that reform of the EU's Stability and Growth Pact is necessary to take account of political and economic reality adding that changes must be workable, 28 September 2004.

European Commission: Press Release: SPEECH/04/424 http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/04/424&format=HTML&aged=0&language=EN&guiLanguage=en

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