More flexibility for greater stability

Since the announcement by José Manuel Barroso, president-designate of the European Commission, of the composition and portfolios of his team, media attention has focused primarily on the new Commission, which will take office on November 1.

However, that is still six weeks away and, in the meantime, the outgoing Prodi Commission is still at its place of work. This is no caretaker function and the outgoing Commission is still very much involved in key deliberations that could influence significantly the formulation of EU policy in the years to come.

One such example is the position taken by the Commission, announced during a press conference held on September 3, in favour of a more flexible application of the Stability Pact.

The Stability and Growth Pact was adopted in 1997 as an essential condition for European Monetary Union and the introduction of the euro. Its principal concern is to enforce fiscal discipline as a permanent, underlying objective in support of monetary union.

Safeguarding sound government finances was, and is still, seen to be an essential prerequisite to long-term price stability and, consequently, also to sustainable growth.

Indeed, it is well documented that periods of high and unstable budget deficits often precede periods of high money supply growth and consequently high inflation.

So a stable monetary union must also have some safeguards with regard to the acceptable budget imbalances among the member states.

The principal elements of the Stability and Growth Pact can be summarised under three broad headings. A political commitment, by all the parties involved, to the full and timely implementation of the budget surveillance process.

A set of preventive elements which, through regular surveillance, aim to prevent budget deficits going above the 3 per cent reference threshold; and certain dissuasive elements which, in the event of the 3 per cent per cent reference value being breached, allow for the imposition of sanctions until the situation has been rectified.

This last aspect was always bound to be controversial, even more so given that the provisions of the Stability and Growth Pact, although agreed by the parties involved, had still to be tested in practice.

Effectively, the problems experienced by Germany first and by France subsequently to keep their budget deficits under the 3 per cent threshold highlighted the need for further clarification of the pertinent response measures.

In particular, it became quite evident that a more flexible implementation of these provisions was required to better reflect changes in the underlying economic environment, both at the national and international levels, especially in response to periods of exceptionally weak economic growth.

The key areas that should be followed to clarify and improve the practical implementation of the Stability and Growth Pact are outlined within the official communication issued by the Commission.

They are: i) placing more focus on debt sustainability in the surveillance of budgetary provisions (implying enhanced surveillance of both current debt developments as well as of factors that may influence its medium and long-term dynamics);

ii) allowing for more country-specific circumstances in defining the medium term objectives; and

iii) considering the (underlying) economic circumstances in the implementation of the "Excessive Deficit Procedure".

In short, stability objectives must be assessed within the context of and in line with the economic agenda. Europe needs to raise its growth potential as the only way to create more jobs and the principal focus for the achievement of this objective is provided by the Lisbon agenda, which needs to be given new impetus.

The above points were ably elaborated on by outgoing Commissioner Joaquin Almunia. The current formulation of the Stability and Growth Pact already includes a reference to "exceptional circumstances" that would allow a country to be exempt from excessive deficit procedures.

The definition of such circumstances needs to be revisited to cater also for protracted slowdowns, as against the present definition that only considers severe recessions. Furthermore, the relevant adjustment path, for the correction of an excessive deficit, must take into account specific economic factors.

Differences in the underlying economic situation, primarily cyclical conditions, should be given due consideration and could imply the adoption of a country-specific approach.

The crucial principle underlying the Stability and Growth Pact must remain unchanged, namely the requirement that an excessive deficit should be addressed immediately and corrected in the shortest time interval possible.

However, the emphasis must be shifted onto the budgetary adjustment effort needed from a country with an excessive deficit and not rest, primarily, on the eventual outcome of such an effort given that, inevitably, this outcome will be influenced by other factors outside the control of each government.

The usual critics, of anything and everything linked to the European Union, have been quick to proclaim that the latest pronouncement by the Commission is an acknowledgement of the failure of the Stability and Growth Pact and marks its abandonment.

The media has, generally, displayed a much more positive reaction and it has described the communication by the Commission as a call for the reform of the Stability and Growth Pact.

Mr Almunia has commented on this description and he has suggested that "evolution" would be a better choice of word than "reform". I tend to share his view.

We must nor forget the ambitious nature of what is being implemented (a single market and a common currency) nor to underestimate the complexity of the real world.

This is no simple academic exercise but the practical implementation of policy measures for the effective governance of so many countries, with such diverse characteristics.

It would have been most unrealistic to think that a perfect blueprint to regulate fiscal policy across the various countries within the euro zone could have been formulated first time round. Or that whatever blueprint is adopted would not require any refinement over time.

Contrary to the image that Eurosceptics consistently seek to project, of an overbearing Commission dictating policy from Brussels, this latest communication on the Stability and Growth Pact manifestly takes into account the extensive reflections on the subject of the Stability and Growth Pact, that have been expressed in many diverse circles at a European level and within the individual countries.

Being ready to change one's position is neither a sign of weakness nor a reflection of failure. In fact, the opposite is the case.

There is no single element that is more essential for good governance than the readiness to revisit one's deliberations and to make adjustments if and as appropriate.