The European Union member states (with the exception of the UK and the Czech Republic) agreed yesterday to a new Treaty on "Stability, Coordination and Governance". The text of the agreement can be found in the web site of the European Council. My first reaction after reading the document was that I must have made a mistake and clicked on the wrong (old) document. It is very difficult to see the differences with the current economic policy framework. And, unfortunately, all the flaws of the previous system are still there.
Here is my list of concerns about the agreement.
1. Wrong title. The agreement is mostly about fiscal sustainability not about stability, coordination and governance. The assumption is that anything that produces lower deficits and debt is good for stability. And that if all countries do it together, even better (this is the coordination part). Fiscal sustainability is necessary but putting all the emphasis on it can be counterproductive.
2. Numerical limits at the center of the fiscal policy framework. The agreement relies again on strict numerical limits to enforce fiscal discipline. So far this has not worked and it is difficult to imagine why it would work going forward. The agreement says that countries cannot have deficits that are larger than 0.5% of GDP. The number is defined as "structural" meaning that they allow the budget to be adjusted for the business cycle. This is, obviously, a good idea, but its implementation is full of technical complications that the agreement ignores. Why 0.5% of GDP is the right number for all countries? It makes no sense to impose the same number to all countries except that is makes things easier to remember.. The agreement allows countries to run larger deficits when their debt is low, which makes some sense. But what about other circumstances? There is the room for exceptions, which sounds very reasonable but it goes against the notion that we are producing a simple set of numerical rules (now it is not so easy to remember anymore).
3. Not enough stress on good years. The main failure of fiscal policy in European countries in the last decade has been not to generate large enough surpluses in good years. By focusing so much on the deficit limit of 0.5% we simply ignore that the real issue is on how to generate those surpluses and we put all the emphasis on the bad economic years where getting thins right is so much harder. We have not learned much from the last 10 years.
4. Limited focus on governance. Despite the fact that the word governance appears in the title of the agreement, there is very little change in terms of governance and enforcement. The agreement will be enforced by the governments of the member countries. These are the same actors that can potentially be the sinners. There will be times (as in the years around the 2002/2003 recession) when most countries will violate the agreement (including Germany and France). What happens then? The agreement talks about automatic fines. Fines that are paid to whom? To the potential group of offenders? Do we really believe that if we had had in place an automatic fine imposed on Greece for having violated the deficit limit we would not be in a crisis today?
Providing an economic policy framework to manage the Euro area is not an easy task and I am glad that I was not part of the negotiations that have taken place over the last days. But the agreement shows that we have learned very little from the previous experience. We insist on maintaining a system that does not work and that only provides a distraction to other economic policy issues that, if we try hard enough, we might be able to solve.