EU fiscal policy plans only the first step

ANALYSIS:The days when an Irish finance minister could thumb his nose at Brussels are gone, writes PAT McARDLE

LAST SUNDAY’S extraordinary EU economic and financial affairs council (Ecofin) meeting accepted that setting up a European stabilisation fund was a temporary fix designed to buy time to allow member states to sort out their problems.

It was an incomplete canvas and this was recognised in the conclusions, which stated that the “European Commission will urgently start working on the necessary reforms to complement the existing framework to ensure fiscal sustainability in the euro area”.

This gave the commission its cue and it produced the goods in double-quick time, publishing a communication on Wednesday entitled Reinforcing Economic Policy Co-ordination.

The commission, like the rest of us, has a problem in that it failed to spot the looming crisis. As a result, there is much soul-searching about how to avoid a repetition.

It did attempt to censure our budget policy in 2001 but quickly gave up when faced with a flat rejection from the then finance minister, Charlie McCreevy, and widespread condemnation from virtually everyone else.

A survey by Finance magazine at the time showed a substantial majority of economists in financial institutions supported the government’s economic policy, with strong approval for continued cuts in income taxes. Some were quite vocal, advising the minister not to let the doomsayers get him down.

An MRBI opinion poll showed that more than seven out of 10 voters believed the budget was good for the country. Employers’ group Ibec described the censure as “alarmist”, the Irish Congress of Trade Unions said it appeared to be based on a misunderstanding of the level of development in Ireland, while Mary Harney said other countries would regard it as “bizarre”. Fine Gael’s Avril Doyle described it as heavy-handed, one-sided and a step too far.

They were all wrong, the commission was right and we now know that we should have run much bigger budget surpluses when times were good. At the very least, we should have spent less and switched away from relying on temporary sources of revenue such as stamp duties and VAT on property transactions. The task now is to put in place structures that are sufficiently robust to avoid repeating this type of mistake. It will not be easy. Other member states will guard their fiscal independence just as jealously as the Irish did in 2001.

The commission document is a consultation one; it will reflect on and propose legislative changes in the coming months. These are likely to be controversial. Indeed, its first hurdle may well be the very ministers who commissioned it and who, incidentally, severely curbed commission proposals last weekend that all of the €500 billion stabilisation fund be raised by it.

There is always a tussle between the commission, which wants to expand its role, and the Council of Ministers, which wants to retain as much power as possible.

Nevertheless, the stark realities of the current situation strengthen the commission’s hand. These are set out in the preamble, which notes that:

• the current crisis has no precedent in our generation;
• it has underlined the interdependence of the euro economies;
• public debt was not reduced sufficiently over the past decade;
• vulnerability was aggravated by persistent imbalances;
• the exceptional combination in Greece of lax policy, structural imbalances and statistical misreporting led to an unprecedented debt crisis.

The objective is to prevent a repeat of the Greek situation where one member state jeopardises the entire euro area. To this end, the commission proposes: better ex-ante co-ordination, ie get countries to run broad proposed budgetary parameters past Brussels before they are finalised and go to the national parliaments; penalties for misbehaviour; legally enforced compliance with treaty obligations; much greater emphasis on debt and deficits; and a speedier process for dealing with breaches of the rules. The entire budgetary process would be shifted forward and all this should start in 2011.

This is not tax harmonisation; rather it deals with broad budgetary parameters and will obviously have to respect treaty provisions.

Such measures would be supplemented by deeper and broader economic surveillance including peer reviews. This would encompass all the usual economic indicators, with a particular emphasis on asset price booms.

Guidelines and warnings would be the order of the day, with the recommendations going so far as to address both revenue and expenditure, as the crisis has shown that the composition of government revenue is important.

The commission would issue early warnings directly to a member state. The recommendations could address labour, product and services markets as well credit growth and house prices, with euro-area ministerial votes to encourage compliance.

One certainty is that the commission will get powers to audit national statistics. It proposed this following earlier problems with Greek statistics but was turned down by the ministers.

Finally, the commission asserts that emergency assistance in the form of lending to a member state is not contrary to the Lisbon Treaty.

The first priority is to make the recently announced measures operational; it will then propose a permanent crisis resolution mechanism.

So how would all this affect us if it were operational now? One is tempted to say not a lot, given that Ireland has been singled out as a poster boy for good fiscal behaviour recently. However, that was against a background where others, notably Greece, were badly misbehaving.

It is also worth noting that the commission has twice called on the Government to spell out the measures it intends to take to secure €3 billion in savings in the next budget.

The new regime, even if it is a diluted version of the commission’s proposals, is likely to be more intrusive than the old.

The euro area has two basic problems. First, it must do something to prevent a repeat of the Greek experience. As commission president José Manuel Barroso said, if it does not act, it might as well forget about the euro. Second, it has to deal with the inheritance of the crisis: an average debt level well over 100 per cent of gross domestic product. Getting this back to 60 per cent will be a formidable challenge. The commission’s proposals are merely the first step.

Meanwhile, the Irish deficit, though declining, is likely to be a good deal higher than most, if not all, other euro states. The increased emphasis on debt will probably see us come in for particular attention.

The days when an Irish finance minister could thumb his nose at Brussels with impunity are well and truly gone.