Economics and politics - comment and analysis
6. April 2016 I Will Denayer I Economic Policy, Economic Theory, Europe

The Six-Pack: EU Mandate For Bad Economic Policy. By John Weeks

The Six-Pack: EU Mandate For Bad Economic Policy

By John Weeks

History provides many examples of authoritarian rule achieved through formally democratic procedures. To these we should add the EU Treaty on Stability, Coordination and Governance (TSCG, also known as the “Six Pack”), adopted by 25 democratically elected EU governments (all but the Czech Republic and the United Kingdom). On an EU website we find the overall purpose of the TSCG boldly highlighted:

”The European Union’s economic governance framework aims to detect, prevent, and correct problematical economic trends such as excessive government deficits or public debt levels, which can stunt growth and put economies at risk.”

The authoritarian implications of this bureaucratically bland sentence are shocking. It asserts the power of the unelected European Commission, as the executive of the European Union, to monitor (“detect”) whether the public budget of an elected member government conforms to EU fiscal rules. If it does not, the Commission claims the power to prevent the implementation of that budget, then to specify the changes (“corrections”) required. All the more worrying is the ideological asymmetry of the “governance framework” – deficits can be excessive, but not surpluses.

The EU website goes on to explain “detection” or “monitoring” as follows,

”Each year, the EU countries that share the euro as their currency submit draft budgetary plans to the European Commission. The Commission assesses the plans to ensure that economic policy among the countries sharing the euro is coordinated and that they all respect the EU’s economic governance rules. The draft budgetary plans are graded as either compliant, partially compliant, or at risk of non-compliance.”

When the EC implements this paragraph literally as in Greece, it reduces the role of national legislatures to endorsing what the Commission judges as “compliant”. TSCG removes national control over budgets. Member governments de facto formulate their budgets for the Commission not their legislatures; after the Commission judges them as satisfactory the national legislature goes through a pro forma approval process.

Adopting the TSCG transfers sovereignty from democratically elected institutions to an unelected bureaucracy. Even if the EU parliament possessed substantial control over the Commission, the TSCG would still be profoundly authoritarian because of the power of the EC bureaucracy over what should be decided democratically.

Treaty-Protected Mismanagement

EU fiscal rules, from the Maastricht Treaty to the TSCG, are not “fit for purpose”, to use a common British phrase. They are anti-democratic, as well as inflexible and impervious to change.   The Treaty specifically commits the adopting government to embed the fiscal rules in law in a manner ensuring their “permanent character, preferably constitutional”. Embodied in treaties, they must change through repeal or adoption of additional treaties. Both involve extremely cumbersome and time-consuming processes.

Were the fiscal rules theoretically and practically sound their anti-democratic and inflexible nature would still discredit them. Far from sound, they are technically flawed, mandating macroeconomic mismanagement. The Treaty mandates specific limits to fiscal policy:

”[The Treaty] requires contracting parties to respect/ensure convergence towards the country-specific medium-term…with a lower limit of a structural deficit (cyclical effects and one-off measures are not taken into account) of 0.5% of GDP; (1.0% of GDP for Member States with a debt ratio significantly below 60% of GDP).”

Before considering the wisdom of the 0.5% deficit target, two major technical mistakes standout, 1) the Treaty uses an unsound measure of the fiscal deficit; and 2) the key concept, “structural deficit”, is theoretical nonsense.

The TSCG adopts the Maastricht deficit specification, total revenue minus total expenditure, the overall deficit. As the IMF explains in its guidelines for fiscal management, the appropriate measure for sound fiscal management is the primary deficit, which excludes interest payments on the public debt (which if reduced would imply partial default).

When the TSCG specifies the 0.5% as a “structural deficit” we go from the arbitrary to the absurd. The Commission as well as the usually competent OECD define “structural deficit” as the deficit that would appear by eliminating cyclical effects; i.e., the deficit when an economy operates at normal capacity.

Making this concept operational requires an analytically sound method of eliminating cyclical effects, then a clear and consistent measure of normal capacity. The EU structural deficit fails on both criteria. In practice the EC bean-counters make no attempt to eliminate cyclical effects. Indeed, the method of calculation of normal capacity ignores the cycle altogether by defining normal capacity as the level of output at which the rate of unemployment implies stable inflation (the “non-accelerating inflation rate of unemployment”, NAIRU). Again, the EC bureaucrats reveal their ideology by taking inflation not output or unemployment as the measure of economic health.

The NAIRU would be sufficiently problematical were attempt made to adapt it to the specific institutional characteristics of each country at specific time periods. For example, if the concept has operational validity, it is extremely unlikely that it would assume the same value before and after the 2008-10 global recession. An inspection of the Eurostat tables for the actual and “structural” deficits shows no evidence of estimations with country specific adjustments.

The decidedly dubious nature of the NAIRU is indicated by its nom de guerre, “the natural rate of unemployment”. This phrase betrays an underlying ideology that 1) unemployment is a natural phenomenon to which all economies automatically adjust; and 2) inflation always results from excess demand. If the first were true the global recession would not have occurred. The second ignores price pressures arising from traded goods and services, petroleum being the most obvious and price-volatile.

The possibility of calculating country and time specific normal capacity would not save the 0.5% rule from the realm of ideological nonsense. First and foremost, it represents static analysis applied to a dynamic process. The formal statement of the 0.5% would be as follows:

Economy A now operates below normal capacity with a fiscal deficit of 2.5% (for example). Other things unchanged, were economy A at normal capacity the deficit would be 1.5% (for example), above the 0.5% requirement. Therefore, the government of country A must now take steps to reduce expenditure or raise taxes, so if the economy were at full capacity the hypothetical deficit would be 0.5%.

The 0.5% rule is a hypothetical outcome based on analytically unsound calculations. This “what if” calculation by statisticians is used by an undemocratic bureaucracy to force elected governments to implement contractionary economic policies. The technically unsound, hypothetical 0.5% target mandates a pro-cyclical macroeconomic policy. To render the rule Kafkaesque, after the EC bureaucracy calculates that a government will not meet the hypothetical target, it then mandates contractionary policies that guarantee that the target cannot be achieved. The problem is imaginary and the solution contradictory.

The wording of the TSCG makes it clear that deviant fiscal behaviour by a member country will not be tolerated:

”Correction mechanisms should ensure automatic action to be undertaken in case of deviation from the [structural deficit target] or the adjustment path towards it, with escape clauses for exceptional circumstances. Compliance with the rule should be monitored by independent institutions.”

The “independent institutions” include the European Commission itself, which adds a distinctly Orwellian character to the already Kafkaesque Treaty.

Painted Into A Recessionary Corner

Economies suffer from growing fiscal deficits in recessions, because falling or slow-growing output results in falling or slow-growing revenue. Such circumstances typically result from a drop in private investment or exports. Economies most effectively overcome recessions by the public sector using its spending powers to compensate for inadequate private demand.

The TSCG legally prohibits the implementation of this effective counter-cyclical fiscal policy. To the contrary, the TSCG forces member governments to apply policies analogous to the practice 200 years ago of bloodletting to restore health to the ill. It is a Treaty designed to enforce perpetual stagnation across the European continent.

The term “Six-Pack” is in a sense a singularly appropriate nickname for the Treaty on Stability, Coordination and Governance. The Six-Pack contains the economic equivalent of a pernicious snake oil, a witch’s brew to turn minor fiscal problems into recessionary downturns. For those dedicated to a prosperous and harmonious European Union, repeal or replacement of the TSCG stands out as an urgent priority.

 

About John Weeks

John Weeks is an economist and Professor Emeritus at SOAS, University of London. John received his PhD in economics from the University of Michigan, Ann Arbor, in 1969. He is author of a new book entitled ‘Economics of the 1%: How mainstream economics serves the rich, obscures reality and distorts policy’ (Anthem).