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Options for Europe – Part 64

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).

Chapter X The Stability and Growth Pact fails within 2 years – so Germany alters the rules


The horse trading that ensued followed the usual European script – a drawn out talk fest with nothing much of substance achieved

The upshot of this saga was that the European Commission decided to alter the SGP rules. On September 3, 2004, the European Commission communicated their intention to the Council and the European Parliament that it would formally work towards “refocusing” the SGP (European Commission, 2004a). Behind the scenes, the horse-trading that had been going on for months following the disastrous impasse between the Commission and the Council followed the usual script – a protracted, agonising process motivated by the deep enmities and suspicions that defined the ‘European Project’. Ultimately, it resulted in a more flexible, but still rigidly, unworkable framework. While the politicians constructed the changes as ‘reforms’ the reality was that they had relaxed their rules. But the ideology remained – there would be insufficient fiscal latitute and the changed rules and procedures that were finally agreed upon were not sufficient to alter the fact that, if followed and/or enforced, they biased the Eurozone to crisis.

By the European summer of 2004, 10 EU states were being processed within the EDP. After the Commission-Council impasse and the resulting European Court of Justice decision in July 2004, Germany promised to take measures to reduce its deficit by 2005 and its EDP was terminated. Some would say that its defiance of the initial process that led to the stand-off had effectively terminated it anyway. But it is worth noting that Germany actually embraced a much more austere policy stance in 2005 as it started to reap the export growth from the ‘overspending’ of its EMU partners.

The case against the Netherlands was also terminated in May 2005, when it recorded a deficit of 2.5 per cent for 2004. The action was stepped up against Greece in February 2005, after Eurostat revised their past public finance data back to 1997 and substantially increased the recorded Greek government deficits for 2003 and 2004. The revised 2004 result of 6.1 per cent of GDP clearly concerned Brussels. This concern was expressed in a report sent to the Council and the European Parliament from the Commission – Towards a European Governance Strategy for Fiscal Statistics (European Commission, 2004b), which “acknowledged deficiencies in the compilation and reporting of fiscal statistics to the Commission” (p. 2).

We do not need to concern ourselves with the specific recommendations of that report. Suffice to say that the results led to an improvement in the quality and coverage of the statistics relating to public finances in Europe. The unfortunate aspect is that the data was still being interpreted through a neo-liberal lens, and as a consequence, incorrect inferences continued to be drawn and destructive policies proposed and implemented. The improved data should have been used as part of an overall strategy to render government fiscal policy more effective in dealing with unforeseen cyclical spending variations so that output and employment growth could have been maintained. Instead it was used as input into the continued sledgehammer approach the European Commission adopted to suppress the fiscal capacity of the Member States, with the catastrophic unemployment rates being the manifestation of this folly.

An “intense round of discussions” (European Commission, 2005a: 12) between Ecofin, the European Commission and ECB representatives followed to seek a reformulation of the SGP. Two major criticisms of the SGP emerged, one for each of the two arms of the Pact. First, the fact that a number of nations were caught up in the EDP indicated that the ‘preventative arm’ was not functioning effectively. Second, with the failure of the ‘preventative arm’ to keep fiscal balances within the specified band, the ‘corrective arm’ that was activated by the EDP, was considered to be too inflexible and prone to pushing governments into ‘pro-cyclical’ policy changes – cutting spending and increasing taxes when the economy was already weak.

The French and German fiasco had highlighted the political need, at least, to address these concerns even though there was no real willingness to retreat from the idea that national governments should be significantly restricted in their fiscal latitude. In the wings, were the central bankers who didn’t want to given an inch. In its 2005 statement on the Ecofin report, the ECB (2005) said that it was “seriously concerned about the proposed changes to the Stability and Growth Pact”. The ECB was also supported by various conservative academic contributions (for example, Buti et al., 2003). Their general argument was that the rules were fine but needed to be enforced more rigorously. But France and Germany were going to have none of that because they were not willing to subject their economies to the dictates of Brussels, unless it was convenient to do so.

There was an ‘extraordinary’ Ecofin meeting on March 20, 2005 in Brussels which signed off on the agreed changes captured in the report to the European Council – Improving the implementation of the Stability and Growth Pact (European Council, 2005). The document formed the basis of the changes that were formalised at the European Council meeting on March 22-23, 2005 in Brussels. The European Commission press release of June 27, 2005 reported on the EU Council decision to adopt the “two modified regulations” to the SGP (European Commission, 2005b). The key aspects of the SGP were left unchanged because otherwise the Treaty would have to be altered. But there were some cosmetic and deeper changes made.

The main changes were as follows (European Commission, 2005b):

  • Medium-term budgetary objectives (MTO) will be differentiated to take into account the diversity of economic and budgetary positions and their sustainability. They will range from a deficit of 1% of GDP to a balance or surplus for euro area and ERM II countries.
  • Euro area and ERM II countries that have not yet reached their MTO will have to pursue an annual improvement of 0.5% of GDP as a benchmark of their cyclically-adjusted balance, net of one-off measures. A higher effort should be pursued in good times.
  • Member States having implemented major structural reforms with a verifiable impact on the long-term sustainability of public finances will be allowed to temporarily deviate from the MTO or the adjustment path towards it.

While retaining the 3 per cent and 60 per cent reference values “without prejudice” they agreed to change the definition of a ‘severe economic downturn’ from an annual fall in real output of at least 2 per cent to something less defined – an “excess over the reference value which results from negative growth … or from accumulated loss of output during a protracted period of very low growth” (European Commission, 2005: 33). Further, the new agreement also emphasised that all “other relevant factors” (p. 34) should be fully considered before an excessive deficit is declared as Stage 1 of the EDP. It also noted what might constitute these factors, a weakness of the original SGP agreement. We learned that if a nation had undertaken so-called “fiscal consolidation efforts in ‘good times'” (p. 34), that is, cutting government programs when growth was strong, it would be viewed more sympathetically in bad times when compared to a government that had not done so. Further, if a nation is implementing the “Lisbon agenda” then any implications for its fiscal balance would be taken into account. We consider that issue separately in the next section. An in-depth discussion from the perspective of the European Commission of the changes made to the SGP is contained in European Commission (2005a).

The upshot is that the was now more ‘wriggle room’ for nations to buy time before an excessive deficit procedure would be invoked. The conditionality was defined in such general terms that the Ecofin could be very lenient or very tough depending on the political bargaining power of the nation concerned. The changes ensured that Germany and France could largely do what they wanted to do, which was the objective of the exercise. On the other hand, the changes were sufficiently defined to provide the Council with the power to impose harsh straitjackets on nations such as Greece, which possessed a low weight in Ecofin’s qualified majority voting system.

The revised SGP and the European Employment Strategy – ideological partners

The SGP was also embedded more formally in the dysfunctional labour market strategy that had infested Europe and elsewhere since the release of the OECD’s Jobs Study in 1994. The history of the European Union tells us that as one highly promoted strategy for ‘sustainable jobs and growth’ fails, a new strategy is announced as the operational action plan.

A crucial part of the ‘Great Moderation’ which we considered earlier, was the abandonment by governments in Europe and elsewhere of any responsibility for full employment. The implications of the ‘Great Moderation’ (and the catch-cry ‘The Business Cycle is Dead’) was that unemployment was no longer considered to be a macroeconomic phenomena. Prior to the resurgence of neo-liberalism, mass unemployment was understood, correctly, to reflect a systemic failure to create enough jobs and that the attainment of full employment required that national governments take responsibility for maintaining sufficient total spending to generate the necessary jobs. The neo-liberal era replaced that understanding with the counter-factual allegation that unemployment was an individual problem. Accordingly, the unemployed were alleged to have ‘chosen’ that state, either because they had failed to invest in appropriate skill development; failed to search for available opportunities with sufficient effort or rigour; and/or had become ‘work shy’ and overly selective in the jobs they would be prepared to accept. The existence of unemployment benefits merely subsidised this sloth.

In this new world, government should only be responsible for the diminished goal of achieving ‘full employability’, which required it to ‘prepare’ individuals for work (for example, by forcing participation in training schemes) and to eliminate disincentives to work. With no strong evidence base to justify their claims, the neo-liberals traced these disincentives to income support frameworks and labour market regulation (for example, unfair dismissal legislation). The overriding priority of macroeconomic policy shifted towards keeping inflation low and suppressing the capacity of governments to use fiscal policy to stabilise total spending. Concerted political campaigns by neo-liberal governments aided and abetted by a capitalist class intent on regaining total control of workplaces, hectored communities into accepting that mass unemployment and rising underemployment was no longer the responsibility of government. The strategy was clear. The politicians and their supporting institutions wanted to break the existing nexus between macroeconomic policy settings and mass unemployment that had defined the Post World War II period up to the 1980s, and to instead, reconstruct the unemployment ‘solution’ in terms of an alleged need for income support cuts, labour market deregulation and heavy demands on the unemployed themselves to satisfy ‘activity tests’ in return for declining real benefit income.

The neo-liberal narrative was formalised in the Jobs Study published in October 1994 by the Paris-based Organisation for Economic Co-operation and Development (OECD). Its main message (OECD, 1994, vii) accurately summarised the state of policy thinking that has dominated since the 1990s:

… it is an inability of OECD economies and societies to adapt rapidly and innovatively to a world of rapid structural change that is the principal cause of high and persistent unemployment … Consequently, the main thrust of the study was directed towards identifying the institutions, rules and regulations, and practices and policies which have weakened the capacity of OECD countries to adapt and to innovate, and to search for appropriate policy responses in all these areas … Action is required in all areas simultaneously for several reasons. First, the roots of structural unemployment have penetrated many if not all areas of the socioeconomic fabric; second, the political difficulties of implementing several of these policies call for a comprehensive strategy … third, there are synergies to exploit if various microeconomic polices are pursued in a co-ordinated way, both with regard to each other and the macroeconomic policy stance.

The OECD Jobs Study (1994: 74) also ratified the growing macroeconomic conservatism by articulating that the major task for macroeconomic policy was to allow governments to “work towards creating a healthy, stable and predictable environment allowing sustained growth of investment, output and employment. This implies a reduction in structural budget deficits and public sector debt over the medium term … [together with] … low inflation.”

Prior to the GFC, the OECD consistently claimed that its policy recommendations had been successful in countries that had implemented them. Unfortunately, the reality was (and is) strikingly at odds with this political hubris. Even with more than a decade of fairly stable economic growth in most nations leading up to the crisis, most countries still languished in high states of labour underutilisation and low to moderate economic growth. Further, underemployment became an increasingly significant source of wasted labour and opportunities for youth remained limited. The neo-liberal period has also been marked by significant increases in income inequality and research now clearly shows that this undermines the potential for growth. The only achievement was that inflation was stabilised, although it was the severity of the 1991 recession that expunged inflationary expectations from the OECD block rather than so-called ‘structural’ reforms. Since that time, labour costs were kept down by harsh industrial relations deregulation and a concerted attack on the labour unions.

The OECD was following the well-trodden path of the IMF in redefining itself to maintain its hegemony in the public debate. The IMF lost its raison d’etre when President Nixon abandoned the gold standard and the Bretton Woods system of fixed exchange rates collapsed. The IMF was created as a core institution within that system but once it collapsed it had no meaningful purpose to fulfill. Joseph Stiglitz (2002: 42) provided a fascinating account of how the IMF sought to dominate thinking about economic policy in both developed and developing countries. Not only did he strongly criticise the ‘one-size-fits-all’ nature of the IMF policy prescriptions, but he also observed that:

The IMF is like so many bureaucracies; it has repeatedly sought to extend what it does, beyond the objectives originally assigned to it. As IMF’s mission creep brought it outside its core area of competency in macroeconomics, into structural issues such as privatisation, labour markets, pension reforms and so forth …

He argued that the combination of the IMF’s fierce promotion of the current dominant neo-liberal ideology in economics, its simplistic yet well-defined policy framework and its good political contacts in the Western world, rendered it a very powerful institution, which often usurped the World Bank’s role in its dealing with poor countries. (Stiglitz was also critical of the World Bank but that is another story).

Jörg Dostal’s (2004) account of how the OECD framed European Union welfare and labour market policies reveals striking similarities to the modus operandi adopted by the IMF. Dostal describes how the OECD deliberately used the 1994 Jobs Study to position itself in the policy debate and was highly successful therein. Dostal (2004: 41) said that “preparation for the economic and monetary union separated macroeconomic policy making from the agenda of employment policy … [in Europe] … Instead, liberal labour market theorists explained unemployment as a structural issue arising from over-regulation of the wage labour relationship and over-generous wage replacement payments …”

The European Commission decided to tailor its own ‘jobs strategy’. At the European Council meeting in Essen on December 9-10, 1994, it formalised the so-called ‘Essen Strategy’, which, effectively cloned the OECD Jobs Study as European Union policy. This strategy became known as the European Employment Strategy (EES) and activated under Article 2 of the Treaty of Amsterdam (European Commission, 1997a), which updated the Treaty of Maastricht. The ‘Title IX Employment’ (Articles 145-150) was formally included in the Treaty of the Functioning of the European Union for the first time and fleshed out the EES. Accordingly, the Member States would “work towards developing a coordinated strategy for employment and particularly for promoting a skilled, trained and adaptable workforce and labour markets responsive to economic change” (European Commission, 1997b).

The similarity of the EES and the Jobs Study is exemplified by the four pillars of the former: employability, entrepreneurship, adaptability and gender equality. This is classic OECD-speak. Bernard Casey (2004) presented a detailed overview of the similarities between the recommendations of both strategies. He said the recommendations of both reflect a ‘structural’ interpretation of unemployment – “symptomatic of an insufficient ability to adapt to change … [implying] … a focus on policies concerned with labour” (p. 5). Mitchell and Muysken (2006) consider the differences between the two approaches that do not need to concern us here.

The relevant connection here is that the EES was a relatively weak framework – a lot of talk and documentation with little real action and intent. Its impact pales into insignificance when considered against the damage that the SGP was doing to employment in the Eurozone (see also Watt, 2004). The EES was subsumed within the ‘Lisbon Strategy’ formulated in 2000, which aimed “to strengthen employment, economic reform and social cohesion as part of a knowledge-based economy.make Europe, by 2010, the most competitive and the most dynamic knowledge-based economy in the world” European Council (2000).

The irony or should we say the exemplification of what went wrong in European policy making circles was revealed in the opening paragraphs of the Lisbon conclusions. We read, on the one hand, that the “Union is experiencing its best macro-economic outlook for a generation … [as a result] … of stability-oriented monetary policy supported by sound fiscal policies”. On the other hand, it is stated that these “strengths should not distract our attention from a number of weaknesses. More than 15 million Europeans are still out of work” and the “employment rate is too low”. An amazing disconnect that only those blinded by the neo-liberal ideology could make!

The Lisbon Strategy was again a clone of the Jobs Study narrative relating to why unemployment arises and emphasised structural policy development eschewing the obvious role that active fiscal policy should play. This disconnect was formalised in the changes made in 2005 to the SGP. The European Council ‘relaunched’ the Lisbon Strategy in March 2005 recognising that it had not achieved its ends and aimed to better ‘interlink’ fiscal policy with the employment strategy on the false premise that restricting the flexibility of governments to run fiscal deficits would “enhance the contribution of fiscal policy to economic growth and support progress towards realising the Lisbon strategy” (European Council, 2005b: 22). As history has shown us – in relief – the strategy failed and the reason it failed is because it was based on false understandings of how the economy operates.

However, this ‘interlinking’ was accommodated in the revised SGP by allowing Member States to use the progress towards ‘structural reforms’ as an offset to its current fiscal position under the “all other relevant factors” clause in the excessive deficit procedure. The idea seemed to be that if a nation was, for example, introducing harsh labour market or welfare system reforms, which increased its fiscal deficit (presumably because total spending fell as incomes were cut and this undermined tax revenue), then it could be excused from the EDP. This is because in the Council’s perverted reasoning, these attacks on prosperity would lead to long-term “fiscal sustainability” (p. 12). There was no clear narrative enlightening us on how this strategy would work for all countries together. There were grand statements about how notions would increase competitiveness and become export behemoths! But for every Euro of exports gained there has to be a euro of import spent and given the extent of intra Eurozone trade is is obvious that Germany’s export strength, for example, is crucially reliant on other Eurozone nations running external deficits. We will return to this discussion in later chapters.


Additional references

This list will be progressively compiled.

Buti, M., Eijffinger, S. and D. Franco, D. (2005) ‘The Stability Pact pains: a forward-looking assessment of the reform debate’, CEPR Working Paper, No. 5216.

Casey, B.H. (2004) ‘The OECD Jobs Strategy and the European Employment Strategy: Two views of the labour market and of the welfare state’, European Journal of Industrial Relations, 10(3), 329-53.

Dostal, J.M. (2004) ‘Campaigning on expertise: How the OECD framed EU welfare and labour market policies – and why success could trigger failure’, Journal of European Public Policy, 11(3), June, 440-460.

European Central Bank (2005) ‘Statement of the Governing Council on the ECOFIN Council’s report on improving the implementation of the Stability and Growth Pact’, March 21, 2005.

European Commission (1997a) ‘Consolidated Version of the Treaty on European Union’, Official Journal of the European Communities, C340/145, November 10, 1997.

European Commission (1997b) ‘Treaty on the Functioning of the European Union (TFEU)’.

European Commission (2004a) ‘Strengthening economic governance and clarifying the implementation of the Stability and Growth Pact’, COM/2004/0581, September 3, 2004.

European Commission (2004b) ‘Towards a European Governance Strategy for Fiscal Statistics’, December 22, 2004. STATISTICS

European Commission (2005a) ‘Public finances in Europe 2005’, European Economy, No. 3, Directorate-General for Economic and Financial Affairs, Brussels.

European Commission (2005b) ‘Stability and Growth Pact reform: Commission welcomes agreement on new Regulations’, Press Release, IP/05/798, Brussels, June 27, 2005.

European Council (2000) ‘Presidency Conclusions, Lisbon European Council’, March 23-24, 2000.

European Council (2005) ‘Improving the implementation of the Stability and Growth Pact’, Brussels, March 21, 2005.

Watt, A. (2004) ‘Reform of the European Employment Strategy after five years: A change of course or merely of presentation?’, European Journal of Industrial Relations, 10(2), 117-137.

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

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