The EU needs to work urgently to fix the Growth and Stability Pact,writes John Bruton
I remember the Dublin European summit of December 1996 well. I was in the chair, but early in the day it became clear that we were heading for a deadlock in a dispute that pitted Helmut Kohl of Germany against Jacques Chirac of France.
The dispute was over the proposed Stability Pact. This pact was to enable us to launch the euro on a solid basis, providing that no member-state could borrow and spend euros in a way that would devalue the coins in everyone else's pockets.
Helmut Kohl wanted the penalties imposed on those who exceeded borrowing limits to be automatic. Jacques Chirac wanted escape clauses, political flexibility and an emphasis on employment.
The deadlock was so complete that, after an hour or so, I had to adjourn the meeting to allow private discussions between the protagonists. So the French and Germans went off into a huddle accompanied by the multilingual prime minister and finance minister of Luxembourg, Jean Claude Juncker.
After much animated discussion, the trio returned to the table with the makings of a deal. Countries which were in recession, defined as an annual fall in GDP of 0.75 per cent, would be exempted from the penalties for excessive deficits, and the word "growth" would be added to the title of the pact.
This deal was accepted by all, as was a subsequent regulation of July 7th, 1997, to give it legal effect. This regulation said that, where a country failed to act on a recommendation to reduce an excessive deficit, there would be "an overall maximum period of 10 months from the reporting date of the figures indicating the existence of an excessive deficit until the decision to impose sanctions". It also stated that, where these conditions were breached, the Council of Finance Ministers of the EU, Ecofin, "shall impose sanctions". The word was "shall", not "may".
This is why Charlie McCreevy and his colleagues on Ecofin are now being hauled before the European Court.
The Commission informed Ecofin last November that both France and Germany had failed to fulfil earlier Ecofin budget recommendations, and that excessive deficits of over 3 per cent of GDP persisted. The let-out provided for in the Dublin compromise did not apply because neither country had experienced a decline in GDP of 0.75 per cent.
While Germany's growth rate had been below average, France had been growing faster than its main partners in the previous five years, but still had an excessive deficit. It was also promising that any savings it made by keeping public spending below planned levels would be handed back in tax cuts rather than used to reduce that deficit.
Some might argue that, whatever about these legalities, the Commission should have taken a more pragmatic view. While France and Germany might have been borrowing and spending too much, inflation was still low. This argument might have made sense if the medium-term outlook for the budgets of France and Germany was good.
But in France's case, the budgetary burden arising from its ageing population will start increasing rapidly from 2005 onwards, making it even more difficult to get things back into balance.
In the case of Germany, its rigid wage-setting system continues to keep the cost of employing people in depressed regions well above the value of what their work will produce, and this will keep them on welfare and will keep pushing up the Government's budget deficit.
The problem is that the more France and Germany borrow, the more they will eventually bid up euro interest rates, and those higher interest rates will have to be paid by all of us. Despite this, and their obligation under the 1997 regulation, the Ecofin ministers decided last November to take no action beyond repeating earlier "recommendations". This is why the Commission felt it had no option but to put the matter to the test in the courts.
Judges may uphold the law, but they will not solve political problems. We need to find a way of refurbishing the pact, so that it no longer leads to High Noon confrontations like this.
Before the euro was ever launched France had wanted an "economic government" for the euro zone which could take decisions on EU fiscal management in a politically and socially pragmatic way. This was rejected because it was felt that fiscal decisions should be taken by individual states, not by Europe. Many who criticise the pact now would not really want it replaced by an EU economic government, so we must find a way to make the pact work.
I make four suggestions for a revised pact:
(1) We should link the timing of imposition of penalties in the pact to progress in implementing identified reforms to promote internal economic growth, like pension and labour-market reform.
(2) During an economic downturn we should allow a higher than 3 per cent deficit limit to countries whose debt-GDP ratio is below 60 per cent.
(3) But when the economy is growing exceptionally quickly, we should introduce new penalties for having any deficits at all.
(4) We should involve national parliaments, and by that means opposition parties, in the surveillance process of national budgets. The present excessive deficits arise from overoptimistic growth projections to predict revenue and spending, and unrealistic costings of schemes.
If all parties in national parliaments were involved in the dialogue on the budget with the Commission, checks would be introduced that would bring about much greater realism, and fewer deficits in future.