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Can the UK learn from the new EU approach to fiscal governance?

Can the UK learn from the new EU approach to fiscal governance?

 


After lengthy negotiations, EU finance ministers agreed on a new approach to member states' fiscal rules and obligations. Iain Begg asks whether there are lessons to be learned in reshaping the EU's approach to the UK.

Something about the eve of Christmas seems to focus the minds of politicians who have been bargaining for months. The trade cooperation agreement between the EU and the UK was agreed on Christmas Eve 2020. On December 20, 2023, EU finance ministers finally agreed on a new economic governance framework, which was finalized 12 days ago.

It took a long time to come. Weeks before the pandemic swept across Europe in early 2020, the European Commission launched an economic governance review, calling it a timely and opportune moment to assess the effectiveness of the current framework for economic and financial oversight.

Such bland words disguised widespread disillusionment with the system in place until the spring of 2020, when the decision was made to suspend EU fiscal rules around the Stability and Growth Pact (SGP). These rules were introduced before the launch of the euro, largely to allay German concerns about the risk that fiscal easing in other member states would undermine currency stability.

One of the main concerns was that the fiscal system tended to be pro-cyclical (making economic cycles more unstable), overly complex, and took too little account of differences in national circumstances. Additionally, despite various reforms enacted in the 2010s, compliance has been spotty and EU level lacks effective powers to limit national governments.

The current agreement seeks to address these shortcomings and should help ensure more sustainable public finances, which is a key objective of the review. The key is the shift to country-specific targets and mandates, described in the Ministerial press release as risk-based differentiated technology trajectories expressed in terms of multi-year net expenditure.

This is quite a long read, but what it actually means is not that complicated. It is about setting parameters for the country's financial situation. For each country, the European Commission will assess compliance with two key criteria – a public deficit below 3% of GDP and public debt below 60% of GDP – and propose a fiscal policy path that ensures a steady adjustment to these. no see. It's about benchmarking or staying within it.

Unlike the current UK approach to fiscal rules, which focuses on ensuring net public debt falls within five years, the new EU framework focuses on public spending trends.

One reason is that the government directly controls spending, but only indirectly controls revenues (and thus the general government deficit). This is because tax revenues increase or decrease depending on fluctuations in the economy itself. This approach could be interpreted as leading to a reduction in the size of the state, but as Wolf Heinrich Reuter estimates, countries are free to choose the size of their government in terms of the ratio of spending to GDP when changing taxes. thus.

Naturally, the disputes leading up to the agreement were about differences in the current financial situations of the member countries on the one hand and ideological clashes on the other. As has been so often the case in the euro's history, France and Germany had opposing views, and according to Politico, when French and German finance ministers met over dinner in Paris on December 19 (was the wine good?) they managed to reach a compromise. It has reached. To resolve their differences.

The resulting compromise involved concessions to various interests. To appease fiscal hardliners (mainly northern member states), two so-called safeguards were adopted to curb fiscal laxity. The price for countries facing the greatest fiscal policy challenges was an extension of the deadline for compliance with the new rules.

The first safeguard requires countries with high public debt (above 90% of GDP) to accept a faster rate of convergence towards the 60% threshold of 1 percentage point per year, while countries in the 60-90% of GDP range A low target of 0.5 percentage points of GDP. Second, highly indebted countries should limit government deficits to 1.5% of GDP (half of the 3% standard).

Indeed, EU regulations have always been of utmost importance to euro area member states, and the UK in particular paid little attention to them before Brexit. Nonetheless, the new EU framework could be beneficial for the UK, where post-2011 fiscal rules have failed to stem the continued deterioration of key fiscal indicators, as explained in a previous article.

Two elements of the new EU approach may be useful. First, specifying an adjustment trajectory will require the government to be clearer about how it will get public finances back on track, rather than relying on achieving targets over the next five years. It may be said that governments are already doing this by creating multi-year spending plans, but putting rules in place to create annual obligations could strengthen commitment and strengthen accountability.

Second, setting targets for total public spending makes it easier for governments to plan and be more transparent to other interests. In the UK system there are periodic spending reviews to set priorities, but there is much less discussion about how total spending should evolve. The spending department says we want it and the Treasury finds reasons to say no.

Any fiscal framework should have provisions for when to suspend rules in response to exceptional circumstances, such as those that have arisen in the EU as a result of the pandemic. This is one area where the EU can learn from the UK. In the revised EU framework, suspensions may be general or country-specific, depending on an assessment by the European Commission and a decision by the Council of Ministers.

However, the suspension period may be extended depending on qualitative judgment. As provided in para. According to Article 3.6 of the Budget Responsibility Charter, the Treasury may temporarily suspend fiscal mandates if there is a negative shock to the economy. But they must explain to Congress why, and present a plan to lift the moratorium in each subsequent budget, a potentially more demanding mandate.

Author: Professor Iain Begg, European Institute, London School of Economics and Political Science. Iain is working on a project on financial frameworks funded in the UK through European Transformation micro-grants.

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