Wednesday, May 29, 2013

The Commission's half-hearted balancing act

Yesterday’s announcements show that austerity will not be stopped in the Eurozone. Only the pace will be slowed down.

It was supposed to be the big showdown. The first occasion for the European Commission to prove that the fiscal and structural framework of the Eurozone has more bite than before. Throughout the crisis, the European Commission has secretly and subsequently received more power to intervene in national fiscal policies and to ensure sound public finances. Two-packs, six-packs, fiscal compacts and European semesters are highly complex and complicated but hard to explain to non-experts. In short, all these new measures and agreements are aimed at denationalizing Eurozone policymaking without moving towards a real political union, giving the Commission an even more important role. Yesterday’s announcements were such a tangled mass consisting of facts, decisions and recommendations that it is hard to distill the essences. Here is a first attempt.

Let’s start with the most important announcement: seven EU countries will be given extra time to bring down their budget deficits. France, Spain, Poland and Slovenia will be given two additional years to bring their fiscal deficits below the 3% GDP threshold, while Belgium, Portugal and the Netherlands received one additional year. According to the Commission, Belgium only narrowly avoided a fine as “no effective action” to correct the deficit had been taken over the past three years. Interestingly, the latest Commission forecasts had presented a structural fiscal adjustment in Belgium by an average of 0.4% of GDP between 2010 and 2012, as ¾% of GDP were required. At the same time, the Commission announced that Italy should be able to leave the so-called excessive deficit procedure this year as the deficit had been brought below 3% of GDP last year.

To be clear and as expected, the European Commission did not propose an end to austerity. To the contrary, the official communication sent a clear message by for example saying that “Europe needs fiscal consolidation – sustainable growth cannot be built on unsustainable debt”. The pace is slowing down, focus is shifting from nominal deficit targets to structural efforts and the nature of fiscal consolidation (expenditures vs revenues) will become more important but austerity will not go away.

Next to the fiscal monitoring, the Commission also announced the so-called country-specific recommendations. The second pillar of the new macro-economic surveillance framework aimed at increasing growth prospects. These recommendations go beyond the headline figures on debt and deficit levels, touching on sensitive areas of national policy such as wage-setting, social and welfare spending.

Technically-speaking, the two pillars are not linked with each other as recommendations on fiscal policies are more binding than the recommendations on structural reforms. However, the Commission yesterday cleverly tried to combine the two. In the case of France, for example, the two additional years to bring the deficit back to 3% of GDP were linked to a “strengthen the long-term sustainability of the pension system by further adjusting all relevant parameters. In particular, the planned reform should be adopted by the end of this year…”. Moreover, France should back the fiscal consolidation by further structural reforms. This sounds like strong language, but it is doubtful that the Commission would really be willing to walk the walk. In fact, last evening, French President Hollande already stated that it was not the Commission’s role to dictate structural reforms.

It seems as if the Eurozone’s path towards a better functioning fiscal and structural framework with a clear distinction between national and Eurozone responsibilities will not be an easy one. For now, the European Commission remains on a tightrope walk, trying to combine economically-justified flexibility with the credibility of the new framework. The risk of this half-hearted strategy is obvious: the slower pace of austerity might be too little to make a difference for the economy but enough not to accelerate structural reforms, while at the same time undermining the credibility of the new fiscal framework

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