7 Sep 2010

Proposed Reforms of Europe’s Economic Governance are Flawed

by Stefan Collignon

The recent Greek crisis has highlighted the limits of the current system of governing the economy of the European Union. Union and member state authorities have now come up with a variety of propositions for reforming Europe’s economic governance. Their aim is to raise the efficiency of policy making, i.e. to improve the system’s output. No one, however, talks about the legitimacy of a political system where policy compromises are negotiated between governments, but where the democratic representatives of citizens, namely in the European Parliament, have very little to say.

Most of the proposals currently debated focus on reforming the Stability and Growth Pact and how to reinforce compliance and deepen fiscal policy coordination. After the disaster left by the Karamanlis government, this is understandable. However, there are significant problems with the proposed reforms.

First, they are exclusively intergovernmental and this approach has always been part of the problem and never the solution. National governments have their own agenda and, by definition, they cannot be responsible for the collective interest of all European citizens. Secondly, the proposals seek to strengthen the surveillance of member states by member states. Who has ever found that poachers make good gamekeepers?

Thirdly, to turn poachers into honourable gentlemen, they impose quasi-automatic penalties decided by purely bureaucratic rather than democratic procedures. The ECB even wishes to delegate fiscal policy to an ‘independent European fiscal agency’, as if the democratic principle ‘No taxation without representation’ had no meaning in Europe. But fiscal policy cannot be handed over to an autopilot. It is policy in the noblest sense: making choices that represent public preferences and affect all citizens together. Because only the European Parliament represents all European citizens, it must have the right to discipline and punish (surveiller et punir) member states’ governments.

Fourthly, there is no mechanism that can guarantee the implementation of policies agreed between governments, because member states are supposed to be sovereign. National parliaments are autonomous in their decisions, but they represent the partial interests of their national constituencies. Only the European Parliament has a European constituency. The implementation of policies is therefore conditional on the goodwill of member states. But what happens, if national interests seek the opposite from what is good for all? Intergovernmentalism causes permanent gridlock. See the recent decision by the Slovak Parliament, which refused to pay its country’s contribution to the European Financial Stability Facility, despite benefiting from a stable euro.

The proposed reforms of Europe’s economic governance will not avoid future crises. They are inefficient and undemocratic. They will only increase the gap between citizens and EU institutions. They are a bypass into the abyss. European Democrats – whether Socialists, Liberals or Christian-democrats – must reject such reforms. They need an alternative.

Taking up the idea of tradable deficit permits (Casella, 2001) and linking it to the formulation of the Broad Economic Policy Guidelines (Amato 2002), I have proposed a different approach (for example in Collignon 2004, 2010, and most recently in a forthcoming Briefing Paper to the Economic And Monetary Affairs Committee of the European Parliament that will be posted here). It could open a significant democratic dimension to Europe’s fiscal policy by giving the European Parliament, as the voice of European citizens, the democratic right to control the aggregate budget policies pursued in Europe under the Stability and Growth Pact. This is how it could be done:

•The Economic Policy Guidelines will become a legal act of the European Union that defines the general policy orientations and decides the optimal borrowing requirement for the Euro Area, i.e. the aggregate budget deficit which is considered consistent with the economic environment (business cycle) and the structural requirements of the European economy (public investment, aging etc.). On the basis of a Commission proposal, the Council together with the European Parliament will pass a directive that defines the aggregate amount of borrowing permits, which give public authorities the right to issue new debt, and will allocate these permits to member states.

•The European Parliament will have an active role in the formulation of the desirable aggregate policy stance. Art. 135 of the TFEU requests the Council ‘to set out economic policy guidelines for [member states in the Euro Area], while ensuring that they are compatible with those adopted for the whole of the Union and are kept under surveillance’. A priori, this excludes the Parliament. However, who would object that the Council, with reference to art. 289 and 290, would stipulate that an ordinary legislative procedure regarding the Economic Policy Guidelines will define the desirable aggregate deficit of the Euro Area? Political will is the key to such reform.

•If the aggregate budget position regulates the external effects arising from national budget policies, member states must implement the allocation of public resource in a way that is consistent with the common policy stance. For this purpose, each member state must be allocated a share of the total borrowing authorization. The obvious criterion for this allocation is the relative share in GDP, but one could imagine modifications to this distribution that reflect other criteria, e.g. excesses over the 60% debt ratio.

•Some member states may wish to borrow more than they have been authorized. The coherence of fiscal policy can only be maintained, if the excess borrowing by some countries is compensated by less borrowing in other countries. Hence, there must be the possibility of horizontal transfers of the borrowing permits. Inspired by tradable pollution permits, such transfers could be traded in a specifically set up market. Table 1 gives an indication of the size of such transfers, based on the actual borrowing of the Euro Area in 2009. Total borrowing was €574.7bn, i.e. 6.5% of GDP. Assuming that this was the desirable amount of aggregate borrowing in the crisis situation, Germany’s borrowing share was only half of its GDP weight and Spain’s nearly double. With the tradable permit system, the request of excess borrowing by Ireland, Greece, France and Spain could have been authorized by transferring unused permits from Germany, Italy, the Netherlands, Finland and Austria.

Table 1. Deviations from aggregate borrowing requirements

•The idea of creating borrowing permits through the ordinary legislative procedure also has advantages with respect to the surveillance and implementation of the agreed common fiscal policy. A European law in the form of a directive could oblige financial institutions to lend only to public entities if they can present borrowing permits for the required amount. This ensures that no government can violate the budget position, which was considered optimal by the democratic institutions of the European Union. Thus, contrary to the bureaucratic surveillance proposed by European authorities, the system of borrowing permits would give democratic legitimacy to the process of defining the desirable aggregate budget position for the Euro Area, and decentralize the policy implementation, which would be policed by markets that simply apply the law.


Amato, G. (2002), Verso un DPEF Europeo; NENS No.4 (Nuova Economia Nuova Società), luglio, pp.15-19.

Casella, A. (2001), ‘Trade-able Deficit Permits’ in: Brumila, A., Buti, M and Franco, D. (2001), The Stability and Growth Pact, The Architecture of Fiscal Policy in EMU, London: Palgrave.

Collignon, S. (8 June 2010), Europe’s economic government or how to use the Treaty for more effective economic coordination in the euro area?, http://www.stefancollignon.de/PDF/Collignon_June10.pdf

Collignon, S. (2004), Fiscal Policy and Democracy, paper presented at Monetary Workshop, Österreichische Nationalbank, Vienna, 2004; published as ÖNB Discussion paper No. 4, ‘A Constitutional Treaty for an Enlarged Europe: Institutional and Economic Implications for Economic and Monetary Union’, http://www.stefancollignon.de/PDF/OENBank.pdf

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