The most recent draft of the fiscal discipline treaty has outlined strict conditions and tough ramifications for member states that fail to manage their budgets sensibly. Although a good dose of fiscal discipline may be good for Europe, the effectiveness of these policies is not certain.
This treaty is still a draft and it will surely go through several further iterations before it is signed; however, its current content provides an indication of what European leaders want to see from future fiscal rules.
Arguably, the most contentious issue in this draft is the decision to include the requirement for ratification of the treaty by any member state wishing to gain access to the European Stability Mechanism (ESM). Previous drafts stated that eurozone countries only needed to have introduced a commitment to balance their budgets to be eligible for funding from the ESM. This new condition has surprised certain countries and raised concerns for those currently receiving assistance from the eurozone’s temporary bail-out fund, the European Financial Stability Facility, as they will feel pressured to ratify the treaty in order to continue to receive assistance.
Ireland has been one of those showing concern. The government has been under increasing pressure to hold a referendum regarding ratification of the treaty prior this condition being announced; it will find itself under further political and public pressure now that they are effectively being forced into ratification. Ireland’s economic recovery could be put at jeopardy should this condition survive into the final treaty.
Ireland’s economy is almost exclusively dependent on ECB funds and a budget announced in early December removed a further €3.8 billion out of the economy through public service cuts, reductions in capital spending and indirect taxes. As with many EU member states, the outlook for any recovery this year looks grim and official agencies have just down-graded Ireland’s growth projection for 2012 to just 1%.
These types of cuts, which are not unique to Ireland, often come with labour market reforms and short term economic policies that merely keep the wolves from the door. Although they work in the short term, these types of policies have the potential to undo many of the positive labour regulations that the EU has enacted over the years.
The new draft also strengthens both the European Court of Justice (ECJ) and the European Commission. The Commission will be in a position to refer any member state that it considers has failed to set out measures for reducing a deficit above the limit of 3% of gross domestic product (GDP), to the ECJ. It will then be for the ECJ to make a judgement as to whether the member state in question has contravened the conditions set out above. If the member state continues to contravene the conditions then it may face a fine up to 0.1% of its GDP. A question regarding the effectiveness of fining an already struggling member state has to be asked.
The Commission will also be tasked with drafting ‘common principles’ for automatic correction mechanisms member states should adopt if they exceed deficit and debt limits. The detail on these is not yet clear; however, it is this type of guidance and proactive assistance that is more beneficial to member states. The Commission should seek to include more measures such as this rather than default to the traditional and draconian system of fines.