Options for Europe – Part 40

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[NEW MATERIAL TODAY]

The Christophersen Report of August 1990, which expressed the European Commission’s own viewpoint on how economic and fiscal policies might be coordinated, concluded that there “does not need to be a single economic policy in the same way as for monetary policy, and correspondingly there is not the same need for institutional change” (European Commission, 1990: 21). They invoked the principle of ‘subsidiarity’ to justify this view, but, in reality, as we have seen, this principle had been usurped to advance the existing political and ideological preferences of the players involved. In terms of the need for ‘binding rules’ as in the Delors Plan, the Commission was less clear. They noted that one cannot really judge the “sustainability of the fiscal position … in isolation from an overall assessment of the economic situation and development” (European Commission, 1990: 24). In other words, imposing a ‘one-size-fits-all’ set of rules would likely be excessively punitive in certain circumstances. They instead advocated a system of ‘multilateral surveillance’ with the Ecofin at the helm to help coordinate economic policies to ensure they did not pose a “threat to monetary stability” (European Commission, 1990: 24). Within the system the ‘golden rule’ was proposed as the overarching framework for fiscal control.

The ‘back of the envelope’ rules!

As it turned out, it was not the Germans who led the way in defining the binding rules at the IGC. By way of background, the Financial Reform Act of 1969 was a major change to the German ‘Basic Law’ or Constitution (‘Grundgesetz’) and aimed to resolve fiscal imbalance issues (who could spend and on what and who could raise money and for what) between the Federal and State (Länder) levels of government. The “reform created a mandatory, standardised framework for the budget law of central and regional government” (Lübke, 2008: 134) by revising Articles 109 to 115 of the German ‘Basic Law’ or Constitution (‘Grundgesetz’) and introducing the ‘Budgetary Principles Act’ (‘Haushaltsgrundsätzegesetz’) which specify operational issues relating to the management of fiscal policy. While the details do not need to concern us here, the ‘golden rule’ was given authority under Article 115 (Limits of Borrowing), such that “Revenue obtained by borrowing shall not exceed the total expenditures for investments provided for in the budget; exceptions shall be permissible only to avert a disturbance of the overall economic equilibrium”. borrowing was restricted to the total expenditure on public investment unless there was a need “to remedy a serious and sustained disturbance of macroeconomic equilibrium” (Grundgesetz, as amended by Federal Statute of May 12, 1969, Federal Law Gazette I page 357).

But the French had invoked a more strict fiscal regime in 1983, which imposed itself on the IGC in December 1990. François Mitterand imposed fiscal austerity in 1983 when he decided to ignore the already high and rising unemployment rate and prioritise the pursuit of a low inflation strategy. Mitterand told his Prime Minister Pierre Mauroy, at the outset of his third government in March 1983, that he had to “bring down inflation to a rate compatible with our competitors … [and maintain] … the public budget deficit within its current levels” (quote from Le Point, March 28, 1983 translated by Sachs et al., 1986: 296). The ‘current levels’ was 3 per cent. It was left to the then Minister of the Economy, Finance and Budget, Jacques Delors to invoke the radical shift in policy, by abandoning the ‘Programme commun’ (the joint policy focus on inflation and unemployment) and, instead, pursuing the so-called ‘tournant de la rigueur’ (‘turn to austerity’). Their concept of rigour was guided by events that had occured on evening in June 1981.

In 2010, Guy Abeille who was a project manager in the French Ministry of Finance (‘chargé de mission au ministère des Finances’) when François Mitterrand came to power in 1981, told the world how the 3 per cent budget rule entered European political parlance (Abeille, 2010). His tasks including writing a monthly briefing to the Minister on economic developments including the fiscal position. This briefing came through the Director of Budget. He notes that each year he would make handwritten notes (“rien ne serait imprimé” “nothing is printed”) about politically acceptable alterations to the fiscal policies from the previous year. In 1981, the French Ministry of Finance had become concerned with the inflationary consequences of the oil price rise associated with the Yom Kippur War. Up to that point, Abeille said the French government had been running a deficit of around 1 per cent of GDP but any reference to this type of ratio was absent (“Mais en ce temps, nul n’use de cette référence. Ce ratio est absent des esprits; il n’a pas d’existence”).

The rough rule of thumb used by Giscard d’Estaing was that the fiscal deficit would start to garner negative political impacts if it exceeded 30 billion francs and the Ministry of Finance engaged in financial ‘gymnastics’ to deliver an outcome below that (‘fetish’) threshold (“on reconnaît là la limite fétiche”). In 1981, the fiscal deficit rose to around 55 billion francs and forecasts for 1982 revealed the fiscal deficit would be above 100 billion francs, which according to Abeille was “a figure that even the most fearless would not dare to whisper in secret” (“chiffre que les plus intrépides d’entre nous n’auraient même en secret pas osé murmurer”).

One night in June 1981, Abeille was summoned by the deputy director of the Budget Department, Pierre Bilger along with some other ‘economists’, who Abeille notes were considered a “rare species” (“nous sommes considérés dans la faune locale comme appartenant à l’espèce, rare au Budget, des économistes”) because they had mathematical training and could handle numbers and appear knowledgeable (“car passablement mâtinés de mathématiques (nous sommes des ingénieurs de l’économie, en quelque sorte), de la sous-espèce des économistes manieurs de chiffres – sachant faire des additions, nous plaisante-t-on, en référence, évidemment, aux agrégés-sachant-écrire”).

The assembled economists were told that the new President, François Mitterrand (elected May 21, 1981) wanted a simple, practical deficit rule which carried the semblance of authority by being endorsed by economists and would provide an image of fiscal discipline so that he could resist the demands for more funds from his government ministers (“d’une règle, simple, utilitaire, mais marquée du chrême de l’expert, et par là sans appel, vitrifiante, qu’il aura beau jeu de brandir à la face des plus coriaces de ses visiteurs budgétivores”). Abeille noted that the group quickly decided that a deficit to GDP ratio would suffice and be clear and the nuances and shortcomings of such a measure that any reasonable economist would recognise would evade the understanding of the public.

For example, how does one interpret a rising deficit to GDP ratio? It could mean the government is deliberately expanding the gap between spending and revenue at a faster rate than the economy is growing, or it could mean that the economy is contracting and the government is losing tax revenue (and could even be cutting spending). These ambiguities, which we will consider in later chapters, are typically not understood by the public and allow movements in fiscal measures to be misrepresented in the public debate to advance ideological agendas that aim to cut the scope of government activity.

Abeille said that their agenda was politically motivated rather than driven by economic concerns. They quickly did some ‘back of the envelope’ calculations which showed that the projected deficit and GDP estimates gave a deficit to GDP ratio of around 3 per cent. The figure had “no other foundation than the circumstances of the day” but ticked all the boxes (“C’est bien, 3% ; ça n’a pas d’autre fondement que celui des circonstances, mais c’est bien.”). He said that a rule of 1 per cent would have been too restrictive and not able to be sustained given the movements in economic activity would lead it to be violated in the normal course of an economic cycle, and 2 per cent would also be too restrictive.

In another interview, Abeille added that (Le Parisien, 2012b; see also Le Parisien, 2012a):

We imagined the 3% figure in less than an hour, it was a ‘back of an envelope’ calculation, without any theoretical reflection … Mitterrand wanted us to quickly provide him with an easy rule, which sounded economic, with which he could confront the ministers who marched into his office asking for more money … We needed something simple … 3%? It was a good figure, a figure that has stood the test of time, it was reminiscent of the Trinity … Mitterand wanted a standard, we gave it to him. We did not think it would endure beyond 1981 … [the] … Minister of Finance, who was the first to talk about the deficit as a percentage … 100 billion francs was huge … he preferred to speak of 2.6% …

Abeille also said that while he worked as a diligent economist, the 3 per cent “number was no based on economic theory” (Le Parisien, 2012a) and that “it was sometimes necessary to understand the political constraints” (Le Parisien, 2012b).

So France came into the December 1990 IGC with its arbitrary fiscal rule of 3 per cent intending to outdo the German’s ‘golden rule’ in terms of ‘fiscal toughness’. But over the previous decade or so, with this rule in operation for most of it, France’s unemployment rate had risen from around 5.2 per cent to around 8.4 per and would continue to rise into the 1990s as austerity madness gripped Europe. In the years since the IGC, the unemployment rate in France has dipped below the 1990 level only briefly. But with the Monetarist mania focused on inflation control, the matter of unemployment became a distant concern.

The Assizes – Intergovernmental Conference – Rome, December 1990

Intergovernmental Conferences are designed within the European political context to be vehicles for proposing treaty changes. Decisions taken at these conferences have to be reached unanimously by the Member States and, become formal additions to the treaty once they are ratified by the Member States individually,

The Intergovernmental Conference in Rome – or the Assizes (‘assises’ in French) as it became known – was hosted by the Italian parliament as part of Italy’s six-month presidency of the European Council. The meetings were tasked with preparing the changes to the Treaty of Rome that would facilitate, among other things, the achievement of an economic and monetary union. The proposed treaty changes would then be ratified at the meetings in December 1991 to be held in Maastricht.

The deals had been done by the time the Member States converged on Rome in December 1990. Germany had won its demand that if it was to surrender the Deutsche Mark and relegate the Bundesbank to being part of the European System of Central Banks with the newly created European central bank at the helm, then the latter would have to be constituted and act as if it was the Bundesbank – indepedent of the politicians, singularly focused on price stability, and unable to offer any funding assistance to the Member States in economic strife. The resistance to this by the French had faded in the 1980s as its policy makers had been seduced by the now dominant Monetarist views among macroeconomists and monetary theorists. Even the French hope that Ecofin might be bolstered to act as a European fiscal authority was abandoned because the Germans considered this would compromise the focus of the new European central bank on inflation control. Thus, fiscal policy was left as the responsibility of the Member States, albeit with the plan to impose tight ‘binding’ limits on what the national governments could do (Gerbet, 2014). These limits would bias Europe towards stagnation, but that wasn’t fully revealed until the Global Financial Crisis.

In 1990, France’s was running a deficit of 2.5 per cent of GDP and so were comfortable advocating a 3 per cent rule. However, there were rather disparate outcomes in the other EMS nations: Belgium 6.8 per cent of GDP, Denmark 1.3 per cent, Germany 2.9 per cent (which would soon rise sharply as a result of the re-unification outlays), Ireland 2.8 per cent, Italy 11.4 per cent, Netherlands 5.3 per cent and the United Kingdom 1.5 per cent. Luxembourg was an exception and was recording a fiscal surplus in 1990 of 4.3 per cent of GDP.

But unemployment was elevated in all these nations relative to the situation encountered at the beginning of the EMS in 1979. An understanding of the role of the fiscal policy clearly indicated at the time that these deficits were not large enough given the rising unemployment across these nations. But with Monetarism blurring this understanding and, instead promoting a series of myths about fiscal deficits, policy makers were blithe, if not blind, to that reality.

The only question that occupied the gathering in this regard was what could be done for Italy (with concern over Belgium and the Netherlands simmering).

[TO BE CONTINUED]

[WITHIN REACH OF MAASTRICHT NOW]

Additional references

This list will be progressively compiled.

Abeille, G. (2010) ‘A l’origine du déficit à 3% du PIB, une invention 100% … française’, La Tribune, October 1, 2010. http://www.latribune.fr/opinions/tribunes/20101001trib000554871/a-l-origine-du-deficit-a-3-du-pib-une-invention-100-francaise.html

Gerbet, P. (2014) ‘The Intergovernmental Conference (IGC) on Economic and Monetary Union’, Centre Virtuel de la Connaissance sur l’Europe. http://www.cvce.eu/collections/unit-content/-/unit/02bb76df-d066-4c08-a58a-d4686a3e68ff/51f02a97-8ca6-4e94-a616-38b79abf9190

Le Parisien (2012a) ‘L’incroyable histoire de la naissance des 3% de déficit’, September 28, 2012. http://www.leparisien.fr/economie/l-incroyable-histoire-de-la-naissance-des-3-de-deficit-28-09-2012-2184365.php

Le Parisien (2012b) ‘3% de déficit : ‘Le chiffre est né sur un coin de table”, September 28, 2012. http://www.leparisien.fr/espace-premium/actu/le-chiffre-est-ne-sur-un-coin-de-table-28-09-2012-2185515.php

Lübke, A. (2008) ‘Medium-term Financial Planning in the Federal Republic of Germany’, Presupuesto y Gasto Público, 51, 133-144.
That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.

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    One Response to Options for Europe – Part 40

    1. roger erickson says:

      “We imagined the 3% figure in less than an hour,”

      and proud of it! (especially how QUICKLY they did it)
      does that remind you of Alice in Wonderland … or what?

      “Why, sometimes I’ve believed as many as six impossible things before breakfast.”
      ― Lewis Carroll, Alice in Wonderland

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