Now that the European Parliament and the Council have finally reached an agreement towards the end of last year on the outlines of the new European budgetary rules, we turn towards Amine Tazi, former chief economist at the Agence France Trésor (AFT) and at the French Banking Federation (FBF) and advisor to Harlem Désir (former French Secretary of State for European Affairs, 2014-2017), to discuss their merits. The reform allows for more room for investment while opening up space for closer dialogue between the Commission and deficit Member States. At the same time, strict rules are being kept in place. Is the reform of the Stability and Growth Pact relevant?
Q1. Could you remind us why a reform of the Stability and Growth Pact (SGP) was necessary when several other reforms had been made previously (2005, 2011-13), before and after the financial crisis, and these general rules were then relaxed during the COVID crisis?
There was already broad consensus among economists for a need for reform. Firstly, the disparities in the public financial situations between Member States and in relation to the established rules had become too significant; this situation often required adjustments to budgetary trajectories and the abandonment of the automatic application of uniform rules. These rules also did not receive strong endorsement from Member States. Furthermore, the obsolescence and complexity of the rules increased with each crisis (2008, 2010-12, 2020) and successive reforms (European Semester and Six Pack (2011), TSCG (2012), Two Pack (2013)), with the multiplication of mechanisms, sanctions modalities and temporary flexibilities offered. Finally, the temporary relaxation of rules in the context of the health crisis was only possible under constraint and because of the urgency of the situation.
In the end, this reform was strongly anticipated and its adoption in early 2024 is very welcome. The review of the SGP by the Commission had already begun in 2019 at the request of many Member States, given the previously mentioned limitations and those present in economists’ debates. The Commission then presented its proposals for reform in 2022, explicitly acknowledging three main criticisms (the pro-cyclical nature of the rules (i.e. budget adjustments that could exacerbate downward economic cycle movements), and the ineffectiveness of sanctions and failure of convergence within the eurozone, even after the eurozone crisis). The Commission then formulated its detailed proposal for the Pact reform in 2023. This served as the basis for a European political agreement for reform at the end of the year.
Q2. The agreed reform is characterised firstly by granting greater freedom to Member States to incur public deficits in order to invest in sectors deemed strategic, such as the green or digital transitions. Will this leeway be sufficient to meet the needs at hand?
The new rules undoubtedly improve the leeway needed for priority investments (environmental, digital, defence) and contribute to greater convergence of economic policies within the EU. Upon closer inspection, two new characteristics can be applauded: i) extending the deadline for reaching the debt (60% of GDP) and deficit (3%) ceilings to four years (or even 7 years) in case of overshoot; ii) the possibility for Member States placed under “excessive deficit procedure” to continue their strategic investments depending on their situation and the structural reforms undertaken. However, the quantitative rule governing structural deficit has not been abandoned, even though the restriction was temporarily lifted to account for the increase in the cost of debt with rising interest rates.
In other words, the new rules are more nuanced, but their complexity remains. There is still a focus on debt control through debt reduction rather than promoting growth driven by investment (as initially proposed by the Commission). And it is uncertain whether the new flexibilities will be sufficient in terms of necessary investments. In terms of climate, for example, the Institute for Climate Economics (I4CE) estimates that at least 813 billion euros per year are needed to achieve the EU’s decarbonisation objective (i.e. reducing net greenhouse gas emissions by 55% by 2030 compared with 1990 levels). However, in 2022, European climate investment deficit was as high as 406 billion euros per year, i.e. 2.6% of the EU’s GDP. In the longer term, the European Commission itself acknowledges that considerable investments (1.5 trillion euros per year between 2030 and 2050) will be necessary in the energy and transport sectors to achieve the net-zero emissions target.
It is therefore perhaps a pity that the Commission’s initial, more balanced, proposal was modified by the “frugal” countries (led by Germany). However, this would not have completely changed the situation. The financing needs are so significant that any reasonable and politically acceptable modification around the SGP could not ensure coverage. Only lasting progress in terms of mutualised debt capacity, based on the model that was agreed during the COVID crisis, could have allowed for better coverage of financial needs. Nevertheless, even if the new rules are deemed imperfect, Europe undoubtedly stands more to gain than to lose with this new reform; it will free up more leeway for priority investments.
Q3. The new SGP rules also involve the establishment of individualised dialogue between the Commission and the deficit Member States, so that they can reduce their deficits over a variable period depending on the reforms undertaken. Do you see this as progress both politically and economically?
Yes, of course. The acceptance and appropriation of rules are necessary for the effectiveness of the European economic and budgetary governance system. Greater involvement of each country is essential to ensure overall coherence and better coordination, with more suitable mechanisms. One of the major weaknesses of the monetary union is the heterogeneity among Member States, which has led to arguments that the single currency was not suitable for the individual situation of many Member States. We also know that an optimal monetary union must be complemented by a budgetary union (a budget specific to the eurozone). Providing the EU with more suitable, nationally acceptable and more effective mechanisms through differentiated recommendations has long been desirable and requested. This is precisely what the new rules offer by proposing a strongly individualised “bottom-up” approach.
I do not think that this undermines budgetary discipline, which, in any event, is still imposed by financial markets. The lessons of the past (the eurozone sovereign debt crisis 2010-2012) will always remind us of this. Budgetary discipline remains essential in a monetary union like the eurozone, due to the negative externalities produced in the event of a debt crisis. However, positive externalities can also be expected from accounting for national specificities to better coordinate growth and investment policies. Transnational investment projects would be the best example of this. And this is undoubtedly the best we can hope for in terms of future investments. Political and economic progress will be judged in light of such achievements…
Q4. Overall, would you say that the SGP, with its quantitative and qualitative components, will allow the EU to implement a better “policy mix” (editor’s note: coordination of budgetary and monetary policies)? Could it be said that with the reform, Europe has confirmed that it has indeed drawn lessons from the great crisis?
The European Commission proposed the most transparent, simple and integrated governance framework that could be voted on. In terms of quality, the new rules provide very welcome changes, even though many trade-offs were necessary. The framework is simplified, more transparent and readable. It adapts to individual situations and improves national appropriation, while ensuring the sustainability of public finances and maintaining economic relevance. This is a formula for optimisation under complicated constraints, with trade-offs between several objectives and options with differentiated contexts. Long-term public debt sustainability was ensured while leaving the necessary leeway for short-term macroeconomic stabilisation, thus achieving greater economic efficiency and more appropriation. It could reasonably be concluded that the European policy-mix will be improved, with the risk of “budgetary dominance” remaining limited.
Some will be disappointed that the role of national budget committees has not evolved much, but I do not share this view. We do not need more institutional complexity. Others argue that the issue of the quality and composition of national public expenditure has not been addressed; national sovereignty over budget policies remains complete when European rules and priorities are respected. I believe that further relinquishing national budgetary sovereignty is fanciful, without being a necessary condition to guarantee the prioritisation of public expenditure favourable to long-term growth. Quantitative rules will probably remain very controversial: if some criticised objectives or digital targets (structural deficit) have not been abandoned, they have at the very least, been made more flexible.
But the main downside of this reform remains the abandonment of the creation of a jointly budgetary capacity financed, among other things, through common debt issuance. The question of issuing common debt remains contentious, particularly in Germany, which remains strongly opposed. Yet, this financial instrument is the only one that can guarantee a real increase in European growth and public investment, capable of bolstering the EU’s “sovereignty” in supporting the twin digital and green transition. In this regard in particular, Europe still has not fully learned its lesson from the health crisis. It is therefore all the more regrettable that this latest reform did not seize this opportunity, after the giant step forward that had been taken in 2020 with the initial debt mutualisation through the Recovery and Resilience Facility (RRF). Most proposals for reforming the European governance framework (IMF, ESM, French Council of Economic Advisers) emphasised this and will continue to do so in the future. Moreover, the major reforms discussed over the last decade (capital markets union, mutualisation of debt capacities or even a budgetary union) are still struggling to materialise. The next European mandate will probably need to address this more effectively.
