Deutsche Bank: Economic policy coordination in the EU passes stress test

Autor: Bancherul.ro
2008-10-22 11:17

The financial crisis is a stress test also for the European Union. In order to prop up their financial systems numerous EU member states have drawn up national rescue plans for their banks. After a few teething problems, cooperation between the member states, ECB and Commission has been functioning smoothly and appropriately. This is underscored by the conclusions of the regular EU summit that was wrapped up last Thursday. National rescue plans are now backed by a binding catalogue of measures put forward by the Commission.

The French presidency of the EU has performed its role well. However, the level of cooperation achieved is by no means a foot in the door for gouvernance économique. The EU’s concerted action is likely to help restore confidence to the financial markets. Nonetheless, one should not lose sight of the fact that the policy framework of the EU ought to be maintained. The member states should continue to adhere to the budget targets of the stability and growth pact (SGP) in spite of the current state of the economy and the national financial market rescue plans. Moreover, the principles of competition which are vital for the proper functioning of the single market must not be overridden by national rescue plans over the long term.

National rescue plans are inevitably linked with increased government activity. This makes perfect sense as long as the activity has a strategic objective and is of limited duration. Still, the issue of how much additional budget spending on rescue plans is of relevance to the deficit and debt thresholds set out in the stability and growth pact is, on the one hand, steeped in controversy. Therefore, this can only be addressed by looking at a given country’s specific plans. On the other hand, though, the issue naturally also depends on the extent to which components of the rescue plans such as government guarantees or stakes are actually taken up.

Germany has set up an off-budget financial market stabilisation fund. Except for EUR 20 billion of a credit line for loan guarantee defaults these monies do not fall under the Maastricht deficit criterion. Besides, in the wake of the consolidation efforts of the past few years Germany boasts a balanced budget and is a good way off from the 3% threshold which triggers an excessive deficit procedure.

Nevertheless: in Europe, the rescue packages come at an unfavourable juncture for national budgets, since the cyclical cooling of the global economy is already darkening the growth outlook anyway and thus dashing expectations for government revenue flows. The financial crisis now exacerbates the problems with its extraordinary (negative) impact on the single market economy.

Apart from these problems there are also country-specific difficulties. Over the past few years France and Portugal have failed to consolidate their finances to a degree sufficient to shoulder the additional burdens of their rescue plans within the deficit targets of the SGP. In Ireland, the UK and Spain, the burdens are worsened by the problems plaguing the domestic real estate markets. In Ireland and Spain there has been a huge swing from budget surpluses to budget deficits. Both countries are likely to exceed the deficit criterion this year, with Ireland really going over the top.

Necessity is the mother of invention, and politics is a creative field. There is every reason to be concerned that the financial crisis will only be used as a welcome pretext for budget offenders to politically legitimise their non-sustainable fiscal policies ex post – with the corresponding long-term consequences for the taxpayer. The rules-backed self-commitments of the member states remain under fire and the latest demands of some countries for a flexible interpretation of the SGP could systematically undermine the preventive and corrective elements of the pact. Making it even more flexible is not even necessary, for the reform of the SGP in 2005 already amplifies the impact of the automatic fiscal stabilisers during the business cycle.

Once again, this highlights the problems of having decentralised fiscal policy and centralised monetary policy in Europe. The upshot may be that the successful bolstering of confidence in European policy via concerted action in the financial crisis could be undermined again in the medium term. Such a scenario is all the more likely if major fiscal stimulus packages are launched in the wake of the financial crisis. On a medium-term horizon this would boost inflation expectations and dim the growth outlook. The result would be fatal, since it is precisely in times of turmoil that adherence to clearly defined rules provides a foundation for building market players’ confidence in the government as a fiscal player.

Competition considerations are at least as equally important as the fiscal policy aspect. The rapid, unbureaucratic approval of the rescue packages and likewise the Commission’s latest guidelines on the compatibility of the rescue packages with the single market are to be welcomed. The further specification of the EU’s existing guidelines on state aid for rescuing and restructuring firms in difficulty provides that national measures be reviewed at six-month intervals to guarantee their effectiveness and proportionality while minimising the impact of competitive distortions. For now, the measures will generally be permitted for two years. Thus, European competition law already offers appropriate instruments allowing state aid to kick in easily at short notice and long-term competitive distortions to be reduced at the same time. Conflicts between short-term concerted action and simultaneous adherence to single market principles have thus been avoided for now.

But there is no denying that sunset rules are urgently needed. The experience gathered in EU aid policy hitherto shows that industrial policy measures, once in place, are very difficult to rescind. Usually, their political and economic costs are very high. As soon as the dust has settled on the financial crisis it will be time to check whether the national rescue plans contravene the rules of the game under competition law. If this is the case, corrections are in order. Ensuring a level playing field for all market participants must remain the primary target.

The flexibility shown by the politically responsible members of the Eurogroup and the 27 EU member states during the current crisis ought to be a good incentive to collaborate more closely going forward. The level of policy coordination seen in the past few weeks in a system as big and complex as the enlarged EU nurtures hope that in future there can be a common European response to a multitude of international problems and challenges – e.g. in respect of a sensible regulatory framework for the financial markets. This would strengthen the European Union’s role as a partner in setting the rules at the global level.

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