A framework for a stable Europe

By Gerhard Schr÷der

Financial Times

Published: January 17 2005

Reform of the European stability and growth pact is a key issue in European economic and financial affairs. Last autumn, Joaq˙n Almunia, the European commissioner responsible, put forward some constructive ideas; Jacques Chirac of France and Silvio Berlusconi of Italy have also made contributions to the debate. Jean-Claude Juncker of Luxembourg aims to complete the review of the pact during his country's presidency of the European Union. Difficult negotiations await. But no one is better placed than the Luxembourg prime minister, one of the fathers of the pact and a man of tremendous experience, to bring the talks to a successful conclusion.

Reform of the "excessive deficit procedure" will be the cornerstone. Strategies for reform must reflect the fact that it is not just a stability pact, but also a growth pact. Whether a fiscal policy is "right" and promotes stability and growth equally cannot be measured solely by compliance with the deficit reference value of 3 per cent of gross domestic product. This indicator is inadequate to deal with the complex realities of fiscal policy. We must recognise that the goal of consolidating public budgets may well conflict in the short term with the goal of enhancing the potential for economic growth. A reformed pact must take this conflict into account, as well as the need to bring improved growth and employment opportunities into line in the long term with sound public budgets.

Public debate often overlooks the fact that the Maastricht treaty does not automatically define a government deficit of more than 3 per cent of GDP as "excessive", thus triggering the deficit procedure. The Commission must also "take into account all other relevant factors, including the medium-term economic and budgetary position of the member state". If the country has the potential to achieve a deficit ratio of under 3 per cent and to reduce debt in the medium term, there is no requirement for a deficit procedure to be initiated, even if the state's deficit exceeds the reference value.

This is the starting point for the reform concept developed by Hans Eichel, Germany's finance minister, and strongly supported by me - a concept that enhances the growth component of the pact. Under our proposal, the European Commission and council of ministers would use mandatory criteria to review whether an excessive deficit procedure should be instigated against an EU member with a deficit that exceeded the reference value. The most significant criterion would be pursuit of a sound policy for growth and employment, for which the country must be given leeway.

The criteria can be divided into three groups. First, reforms - such as measures under Germany's "Agenda 2010" to safeguard our social security system, to improve the labour market or our tax reforms - can in the short term damp growth or increase deficits. But in the medium term their impact on growth, employment and public budgets is clearly positive. Expenditure on education, innovation, research and development can also have a positive effect. These facts must be considered when assessing the deficit.

Macroeconomic criteria form a second group. Member states must be given sufficient leeway to provide cyclical incentives. At present a deficit of more than 3 per cent is only tolerated during a severe economic downturn. However, in the past few years we have experienced stagnation rather than anything worse. The mechanistic application of the pact has led the EU to recommend further restrictive measures, which have delayed recovery and thus put at risk long-term consolidation. Since the pact is also intended to ensure the stability of the euro, the Commission and council must review the contribution made by the member states to price stability in the eurozone.

Finally, specific burdens borne by member states should be taken into consideration. Also, countries that finance substantial payments promoting solidarity among peoples within and between EU nations must be given leeway to use fiscal policy to improve their potential for growth and employment. Germany's burdens include the still immense costs of unification and high net transfer payments to the EU.

The pact will work better if intervention by European institutions in the budgetary sovereignty of national parliaments is only permitted under very limited conditions. Excessive deficit procedures should not be instigated against EU members if they fulfil most of the above criteria. Instead, a country should itself submit a programme setting out how to bring its deficit ratio below 3 per cent. Only if it is shown that there are serious deficiencies in its programme or if the country, through its own fault, deviates from the consolidation obligations therein should an excessive deficit procedure be initiated.

Member states that fail to meet most of the criteria above and so are subject to deficit procedures must also be given the time they need to gear their economic and fiscal policy to the goals of higher growth and employment and sound public finances. These criteria are qualitative indicators for a country's fiscal policy and should thus also play an important role when determining the period the country is given to reduce its excessive deficit. We must not apply the treaty provisions on imposing mandatory requirements and sanctions too mechanically - it was with considerable forethought that they were formulated as discretionary provisions in the Maastricht treaty.

In addition, more respect should be given to EU members' primary competence over economic and fiscal policy. Only if their competence is respected will countries be willing to align their policies more consistently with the economic goals agreed by the EU as part of the Lisbon strategy to improve competitiveness. The summit of European leaders on March 22 and 23 is our chance to adopt the reform framework that will help bring more growth and employment to Europe and ensure the stability of our single currency.

The writer is chancellor of the Federal Republic of Germany