'Whatever it takes': the Five Presidents' Report on completing Economic and Monetary Union Contents

Chapter 2: Economic and fiscal policy coordination

Introducing the EU’s economic and fiscal policy coordination tools

29.The EU Member States agreed the Stability and Growth Pact (SGP) in 1998, in order to maintain and enforce fiscal discipline in EMU. The SGP was reformed in 2005 when some of the rules were relaxed. However, the 2008 financial crisis and the subsequent sovereign debt problems, especially in the eurozone, revealed severe weaknesses in the EU’s economic governance framework. Since the crisis, a number of legislative measures have been implemented to enhance the surveillance of national budgetary policies and other sources of imbalance. Closer policy surveillance, monitoring and coordination are now in place for euro area Member States following the agreement of the six-pack, two-pack and the Fiscal Compact25. The rules are applied at Member State level and are embedded into the EU’s annual economic policy coordination process, the European Semester. Nevertheless, most of the evidence submitted to this inquiry suggests that the European Semester has done little to encourage euro area Member States to implement fiscal rules more forcefully, while closer economic policy coordination has not reached the level desired.

30.In this chapter we consider the five Presidents’ proposals to enhance the coordination of economic and fiscal policies, largely included in Stage 1 of the plan. These can be seen as attempts to reduce risk through increased discipline. We consider ‘fiscal union’ more broadly in Chapter 3, looking at the relationship between reducing and sharing risks including the issue of fiscal transfers between Member States.

Box 3: The Stability and Growth Pact and complementary policy instruments

Since the onset of the crisis, a succession of developments in EU economic governance have sought to strengthen fiscal discipline while also taking more account of the need for flexibility in fiscal rules.

The original Stability and Growth Pact (SGP) is derived from the Maastricht treaty provisions requiring all EU Member States to avoid excessive deficits, but takes the form of two regulations covering, respectively, its preventative and corrective arms. All Member States are supposed to be subject to the former, but the UK is not bound by the corrective arm and does not, therefore, face the possibility of financial sanctions.

As originally formulated, the SGP had a fiscal rule that countries should have a medium-term goal of public finances “close to balance or in surplus”, but should avoid an annual deficit in excess of 3% of GDP. This was originally expressed purely in nominal terms, but the regulations were revised in 2005 to refer to structurally-adjusted deficits. In circumstances of serious economic downturn (originally a decline in GDP of 2 percentage points), the 3% rule could be waived. This was changed to any decline in GDP.

A country deemed to be in excessive deficit was expected to present a programme for curbing it and, if it failed to do so, could be subject to the corrective arm of the SGP, ultimately facing financial sanctions. Following a recommendation by the Commission, the Council would decide on the action to take through a qualified majority.

The 2011 reform (consisting of revision of the two regulations and constituting two of the components of the six-pack) saw the addition of a debt criterion of 60% of GDP and of ‘reverse majority voting’. It emphasised the medium-term objective (MTO). The new voting system is designed to make it less likely that the Council will over-turn a Commission recommendation by obliging it to reach a majority to oppose the recommendation rather than, as in the past, to support it.26

In addition to the SGP revisions, the six-pack included a directive obliging Member States to introduce a domestic fiscal rule. The resort to a directive allowed the Member State to tailor the rule to its domestic constitutional norms, but the clear intent was to strengthen domestic commitments to fiscal discipline.

Separately, the Fiscal Compact requires signatories to spell out how they will reach their MTO and prescribes pathways.

Further obligations on eurozone countries arise from what became known as the two-pack. In particular, it requires members to submit their draft budgets for year ‘t’ to the Commission for scrutiny by mid-October of year ‘t-1’. The Commission then assesses whether the plans are consistent with sound fiscal policy and the medium-term objectives of the country. The two-pack also requires eurozone countries to have a national Fiscal Council, independent of government.

Faced with objections from countries with weaker public finances, concerned about demands to tighten fiscal policy at an inappropriate time (in what would be a pro-cyclical manner), the Juncker Commission in 2015 issued ‘guidance’ about the circumstances in which a Member State could breach its obligations. Among the items that will be treated flexibly are contributions to the European Fund for Strategic Investment, one of the landmark innovations of the Juncker Commission, which aims to leverage EU and European Investment Bank funds to revive investment in strategic projects.

Although a considerable amount has been achieved in establishing this framework, implementation has not always been perfect.

The EU’s fiscal framework: compliance and implementation

31.Some Member States have struggled to comply with the fiscal rules and to implement economic reforms. Notably, France and Germany breached the SGP rules in 2002/3 but were not subjected to sanctions, while by 2009 most EU countries were in the excessive deficit procedure and the UK remains in excessive deficit. Despite the proliferation of excessive deficits even the first, mild, stage of financial sanctions has never been used.

32.The 2016 Annual Growth Survey (AGS), and Alert Mechanism Report make clear that common fiscal policies should respect the common fiscal rules in order to reduce public debt, and to restore fiscal buffers while avoiding pro-cyclical policies. The AGS also notes that public debt remains very high in many Member States and that this in turn “acts as a drag on growth and makes them more vulnerable to adverse shocks”.27

The EU’s approach to fiscal rules

33.Professor Erik Jones, Professor of European Studies and International Political Economy, Johns Hopkins University, judged that the fiscal framework, as currently applied by euro area Member States, was “completely optional”, and even suggested that Economic and Monetary Union might improve without the framework, subject to financial rules bearing on how markets treated sovereign debt.28 Dr Dermot Hodson, Reader in Political Economy, Birkbeck College, considered the SGP to be an “instance of soft economic policy coordination in which enforcement of rules relies for the most part, on peer pressure and persuasion rather than pecuniary sanctions.”29

34.Megan Greene, Chief Global Economist at Manulife Asset Management, argued that fiscal policy should be set for Member States on a case-by-case basis, and did not agree with the rules-based framework.30 In contrast, Sebastian Barnes, Economic Counsellor to the Chief Economist, OECD, welcomed the existence of fiscal rules, telling us that they “increase the focus on sustainability … since the six-pack, two-pack and Fiscal Compact, Governments are taking them more seriously, partly because they see they have more teeth.” He added, however, that the rules were “essentially a mess; they are very complicated and in parts poorly thought-through, and that raises a question about sustainability of the rules going forward.”31 Martin Sandbu, economics leader writer of the Financial Times, echoed this, while Sylvie Goulard MEP, a member of the European Parliament ECON Committee, thought the complexity of the rules undermined their legitimacy.”32

35.Some witnesses acknowledged that in practice it was difficult for a government to run a budget surplus in good economic times. Sebastian Barnes said:

“There has been an increasing debt trend in basically every developed country. If you want to reverse that, fiscal discipline has to apply in the good times. There is a risk that, because of the flaws in the rules, in good times they will be ignored again and ineffective. That is partly because there are political pressures to ignore them, but also because the economics of the rules are sometimes very hard to defend.”33

Flexibility within the SGP

36.The SGP rules have been designed with in-built flexibility. Megan Greene welcomed the fact that fiscal rules were sometimes “bent”, and drew attention to the budget deficit in Spain, which stood at 5% of GDP in 2014. This explained why the Spanish economy was growing.34 Sylvie Goulard MEP, however, supported balanced budgets with reduced debt.35

37.Further guidance on the best use of flexibility within the existing SGP rules was endorsed by the Council of Ministers on 8 December 2015. Martin Sandbu argued that, within the new guidance, there were “many ways to judge what count as the correct policies towards these medium-term [structural reform] objectives.” The interpretation of the rules could follow the political inclinations of whoever was in power at a given time.36

Pro-cyclicality of EU fiscal rules

38.A pro-cyclical policy is one that accentuates the economic cycle by increasing aggregate demand in periods of above average growth and cutting in periods of downturn. In the Five Presidents’ Report, a reference is made to avoiding pro-cyclical policies in pursuit of ‘responsible fiscal policies’. The Annual Growth Survey in 2015 also emphasised that responsible fiscal policies should “restore necessary fiscal buffers while avoiding pro-cyclical policies.”37 Megan Greene said that “for countries that have no control over their monetary policy or currency, countercyclical fiscal policies are all [they] have got.”38

39.Several witnesses raised the problem of EU fiscal rules being pro-cyclical and highlighted the negative impact of austerity on growth prospects. In our previous report Euro area crisis: an update we concluded that the political ramifications of austerity were as alarming as they were uncertain.39 John Peet criticised pro-cyclical policies as having “too much of a deflationary bias, because the pressure has always been on countries that have large deficits to reduce their deficits and there has been no pressure on surplus countries to offset that.”40 Christian Odendahl, Chief Economist, Centre for European Reform, regretted that strong countercyclical fiscal policies were absent from the Five Presidents’ Report.41

40.Reza Moghadam, Vice-Chairman, Global Capital Markets, Morgan Stanley, criticised the SGP because of the inherent asymmetric burden placed upon debtor countries. He said that while the SGP left a lot of flexibility for Member States to conduct their own fiscal policy, there was no macroeconomic view at the eurozone level to interpret the effects for each individual country. Therefore, more painful adjustments were demanded of debtor countries than were needed. He argued that the adjustment had been “bottom-up”; it had been “driven by individual targets and by adjustment at country level, precisely because … it is being driven by concerns about debt and market access rather than a macroeconomic point of view.”42

41.While we welcome the existence of the rules set out in the Stability and Growth Pact and wider reforms as, at the very least, a framework within which Member States can consider their budgetary policy-making, we note that adherence to the rules is patchy and liable to be influenced by domestic political pressures. While the Pact’s rules allow some flexibility for Member States, which may lessen the degree of pro-cyclicality, we recognise that they are still seen as excessively pro-cyclical.

Strengthening fiscal coordination

42.Clearly more needs to be done. The Five Presidents’ Report argues that fiscal policies are a matter of “vital common interest”43 and that unsustainable fiscal policies in one or a few Member States can affect or spill over to others. The report maintains that responsible national fiscal policies must both ensure that public debt is sustainable and enable fiscal automatic stabilisers to act and cushion against country-specific shocks—it notes that “it is important to ensure also that the sum of national budget balances leads to an appropriate fiscal stance at the level of the euro area as a whole”. The Report states that this is “key to avoiding pro-cyclical fiscal policies at all times.”44

Coordinating an ‘appropriate fiscal stance’

43.The Five Presidents’ Report assumes that an overall fiscal stance at the euro area level is required. At a national level, a fiscal stance is a government’s underlying position in applying fiscal policy—in other words, whether it is running a balanced budget, a budget surplus or a budget deficit. The reasoning behind concern about the fiscal stance is that an appropriate macroeconomic policy stems from the mix of monetary and fiscal measures. In periods of recession, the policy stance should be to stimulate the economy, while in periods of growth the opposite applies. However, there are differing views on whether monetary policy or fiscal policy should be used, although part of the policy challenge is to ensure that they do not conflict with one another.

44.Sebastian Barnes described a euro area fiscal stance as implying that “there should be a decision in the euro area about whether on average it is expansionary or contractionary”; such a stance was unnecessary, though, because in normal times, monetary policy should provide “area-wide macroeconomic management”, while fiscal policy should set medium-term goals around which automatic stabilisers can act.45

45.Janet Henry, Global Chief Economist, HSBC, thought that “the risk of spillover effects is one reason why a coordinated fiscal stance is needed.”46 The eurozone needed to think about the influence that the actions of individual governments could have on the health of the entire euro area economy.47 Martin Sandbu thought that a coordinated stance was not strictly necessary but acknowledged that it would be “economically beneficial because it would allow you to get an optimal, or closer to optimal, fiscal-monetary policy mix.”48

46.In the context of macroeconomic stabilisation, Guntram Wolff thought that the aim should be “very much about coordination of these national fiscal policies and we need to step that up, improve it, and get a more symmetric notion there that considers the areawide fiscal stance.” He considered, though, that the sum of national fiscal policies needed to be right for both the eurozone and individual Member States. 49

47.National fiscal policies have spillover effects on other Member States. In establishing a fiscal stance for the eurozone it is important to take into account the particular conditions of each Member State. Just as there may be between regions within particular countries, there may be a tension, in perception or reality, between what appears to be the right fiscal and monetary stance for the eurozone as a whole and what is right for individual Member States, at least in the short term. The effectiveness of this attempt at coordination will ultimately depend on political will at Member State level.

Advisory European Fiscal Board

48.The Five Presidents’ Report proposed the creation of an advisory European Fiscal Board to enhance the current governance framework. This was followed on 21 October 2015 by a Commission Decision to establish the board and set out its tasks. These are described in Box 4.

Box 4: The role of the advisory European Fiscal Board

The Board’s tasks include providing the Commission with an evaluation of “the implementation of the Union fiscal framework”, and of “the appropriateness of the actual fiscal stance at euro area and national level.” The Commission Decision states that “in this evaluation, the Board may also make suggestions for the future evolution of the Union fiscal framework.” It continues:

“The Board shall advise the Commission on the prospective fiscal stance appropriate for the euro area as a whole based on an economic judgment. It may advise the Commission on the appropriate national fiscal stances that are consistent with its advice on the aggregate fiscal stance of the euro area within the rules of the Stability and Growth Pact. Where it identifies risks jeopardising the proper functioning of the Economic and Monetary Union, the Board shall accompany its advice with a specific consideration of the policy options available under the Stability and Growth Pact.”50

Although formally established by the Commission Decision in October 2015 the Board is not, at the time of writing, operational, and its members have not been appointed.

49.Guntram Wolff told us that the creation of a European Fiscal Board was “a good and necessary step forward”, but he warned that its independence relative to the European Commission was “not totally clearly defined.”51 Professor Issing told us that if the Board was to work, “the precondition is that it is an independent board with independent experts, but, as I almost expected, the Commission has already taken it over.”52 Raoul Ruparel, Co-Director, Open Europe, argued that it was unclear what form the Board would take, for instance whether it would be weighted according to Member States. He thought that it could contribute to the debate but not substantially change what was happening.53

50.Professor Jones believed that the Board would not be effective, because political decisions at the national level meant rules would still not be adhered to: “that kind of political problem will be there whether there is a five-person supervisory board or not. The idea that we will get more abidance because of that board is a political fiction.”54 Fabian Zuleeg agreed it was difficult to achieve coordination without European level decision-making, while “the political decisions linked to fiscal policy are still accountable at the national level.”55

51.The Minister, David Gauke MP, concluded that it was too early to judge whether the Board would foster change. It was “difficult to say how much of a difference the board would make without seeing more detail of precisely how the board would undertake its duties.” The Board would have an advisory role, and would not have “the ability to compel Member States to change their fiscal policies.”56

52.Since the adoption of the two-pack in 2013, euro area Member States have had to establish an independent fiscal institution (or ‘fiscal council’) to assess compliance with fiscal rules. Guntram Wolff recognised that a fiscal board or a fiscal council would never possess the authority to take decisions, but he hoped that they would “push the debate a bit in the direction of a euro area fiscal stance and the better co-ordination of national fiscal policies.” It was crucial that the Board made its recommendations in public in order to have an impact on the debate.57

53.Sebastian Barnes, a member of the Irish Fiscal Council in addition to his role with the OECD, was positive about the impact such bodies could have on the consideration of long-term fiscal policy: “You need real ownership of the public finances to counter the short-termism that can emerge within the political system. In my experience at least, that seems to be a very promising way of getting a culture of thinking about the public finances in the medium term, which is what you need.”58

54.We look forward to seeing how the advisory European Fiscal Board will work once it is operational. As the Board will be merely advisory, it will be for Member States to do the heavy lifting in implementing its recommendations, and we are not convinced that at present there is sufficient desire to do so.

The coordination of economic policies

55.The eurozone has been suffering from inadequate growth since the financial and sovereign debt crisis receded.59 While there are some signs of recovery, economic challenges persist. ‘Economic convergence’ and ‘competitiveness’ are emphasised throughout the ‘Economic Union’ section of the Five Presidents’ Report, which acknowledges that important parts of economic policy should remain national. At the same time it argues that, because of the interconnected nature of eurozone economies, it is in each Member State’s self-interest, as well as the common interest, to be able to “cushion economic shocks well, to modernise economic structures and welfare systems, and make sure that citizens and businesses can adapt to, and benefit from, new demands, trends and challenges.”60

56.The five Presidents accordingly propose the establishment in each euro area Member State of a ‘Competitiveness Authority’, to enhance the economic governance framework in the field of competitiveness. They also suggest measures to strengthen the European Semester through changes to its schedule and the strengthening of the Macroeconomic Imbalances Procedure.

The European Semester: stimulating reforms and managing imbalances

57.Each year, the European Commission undertakes a detailed analysis of EU Member States’ plans of budgetary, macroeconomic and structural reforms, and provides them with country-specific recommendations for the next 12 to 18 months. Various measures to streamline the Semester were announced by the European Commission in a Communication published on 21 October 2015, including: the later publication of Country Reports so as to allow more time for genuine dialogue with Member States and stakeholders; an earlier publication of the Commission’s proposals for country-specific recommendations (CSRs); and reduced and more focused CSRs. The new timetable for the annual European Semester is outlined in Box 5.

Box 5: The European Semester

The European Semester is a schedule of economic surveillance steps that first took place in 2011. Following the rescheduling undertaken in 2015 the Semester works as follows.


  • Euro area Member States submit their draft budgetary plans to the Commission in September. The Commission issues its opinions on them. These are then discussed in the Council.
  • Commission publishes its Annual Growth Survey and Alert Mechanism Report. The AGS sets out the Commission’s economic priorities for the coming year. The Alert Mechanism Report, which analyses the eurozone economy and those of Member States to identify potential imbalances, is the starting point for the Macroeconomic Imbalances Procedure.
  • Commission issues a Recommendation on the economic policy of the euro area. It recommends that euro area Member States undertake certain policies individually and collectively.


  • Euro area Member States adopt their budgets.


  • Commission issues individual Country Reports on the economic policies and situation of each EU Member State.


  • European Council adopts economic priorities based on the AGS.


  • Member States present National Reform Programmes or Stability or Convergence Programmes to the Commission.
  • Council adopts euro area recommendations and agrees conclusions on the AGS and AMR.


  • Commission proposes country-specific recommendations to each Member State. These are endorsed by the European Council in June.

58.In line with the Five Presidents’ Report, the October 2015 Communication also suggests further adjustments to the European Semester. These involve: “better integrating the euro area and national dimensions, a stronger focus on employment and social performance, promoting convergence by benchmarking and pursuing best practices, and the support to reforms from European Structural and Investment Funds and technical assistance.”61

European Semester: driving reforms?

59.Several witnesses doubted the ability of the European Semester to drive reforms in Member States. Thomas Wieser, Chair of both the EU’s Economic and Financial Committee and the Eurogroup Working Group, set the scene:

“On paper, the European Semester is an answer to the collective responsibility that all 28 Member States have under the Treaty for coordinating or closely cooperating on economic policies in general and in the fiscal area very specifically under the Stability and Growth Pact. Much of that is then enshrined in country-specific recommendations. The degree to which Member States follow or take seriously the country-specific recommendations differs enormously. That is already quite optimistic.”62

60.Vice-President Dombrovskis admitted that there was a need to improve the “relatively weak” implementation of country-specific recommendations.63 Gunnar Hökmark MEP, a member of the European Parliament’s ECON Committee, was slightly more positive, suggesting that, while very few Member States were adhering to the rules, the framework still created an environment that stimulated reform.64 Sylvie Goulard MEP said that ultimately the goal of the six-pack and two-pack was to restore trust.65

61.Bruegel referred to their European Semester reform index, which provided a gloomy picture. It showed that “implementation was already weak at the European Semester’s inception, and has deteriorated since, despite the efforts made to improve the European Semester.” They noted that “Even though recommendations related to the Stability and Growth Pact have the strongest legal basis, their implementation rate is also modest. The implementation of recommendations related to the Macroeconomic Imbalance Procedure and other recommendations is even lower.” The European Semester was not effective in enforcing the EU’s fiscal and macroeconomic imbalance rules or fostering economic policy coordination.66

62.Vice-President Dombrovskis told us that under the 2016 European Semester, the European Commission took the approach of “paying more attention to the euro area’s aggregate economic and fiscal performance.” The decision to publish the euro area recommendations at the same time as the Annual Growth Survey would “allow for better discussions on appropriate euro area aggregate economic and fiscal positions, and [allow us] to reflect this thinking in country-specific recommendations for euro-area Member States.”67

Implementing structural reforms

63.In its Communication of 21 October 2015, the European Commission encourages structural reforms in the “competitiveness domain.” Competitiveness is seen as “essential for the resilience and adjustment capacity inside the monetary union and to ensure sustainable growth and convergence looking forward.”68 Vice-President Dombrovskis told us that Member States needed to be able to absorb shocks internally and that “resilient labour markets, flexible product markets and sufficient fiscal buffers would allow automatic stabilisers to play their full role and help to stabilise the economy.” Larger shocks, however, might need to be shared with other Member States within EMU, through measures such as a stabilisation function or the integration of the financial sector.69

64.John Peet highlighted the importance of structural reforms: “if you lose the ability to devalue your currency and you lose your monetary independence then you need structural reforms to make your economy more flexible.”70 Sebastian Barnes thought their impact was uncertain: “Too often, particularly in the European context, it has been the view that structural reforms will somehow miraculously generate growth. They will over the long term, but we need the right demand conditions as well.”71

65.Professor Lorenzo Codogno, Visiting Professor in Practice, European Institute, London School of Economics, criticised the Five Presidents’ Report for failing to focus on how to achieve structural reforms. The emphasis was on monitoring, compliance and using existing tools, particularly with respect to fiscal rules, but this was not sufficient for successful implementation of reforms.72 Veronica Nilsson, Confederal Secretary and Special Advisor to the European Trade Union Confederation (ETUC), argued that it was difficult to take a model from one country and apply it in another. She cited the Danish concept of ‘flexicurity’,73 which was accepted in Denmark but “when it is applied at the European level it becomes different and, in our view, more focused on flexibility than security.”74

66.Reza Moghadam told us that structural reforms were “an important issue for the core of Europe” as well as the periphery.75 He argued, though, that there would be political challenges: “There is a short-term cost, against a long-term benefit”. His point was echoed by David Marsh, who pointed to a backdrop of low demand, high unemployment and significant political and social opposition.76

67.The Four Presidents’ Report had suggested the introduction of a formal contract between individual countries and the rest of Europe, by which major structural reforms would be rewarded by benefits such as risk-sharing or more flexibility. Professor Codogno regretted its absence from the Five Presidents’ Report, arguing that the core countries had “perceived it as a way to push for some form of mutualisation”, while the periphery saw the contract as equivalent to being forced into a programme.77 Dr Waltraud Schelkle, Associate Professor of Political Economy, European Institute, LSE, asked: “Why should Member States provide a public good for the euro area as a whole, such as taking the overall cyclical stance into account when planning their own primary deficit, if all they get in return is avoiding blame and shame and the threat of a fine?”78

The Macroeconomic Imbalances Procedure in focus

68.The Five Presidents’ Report made two suggestions to strengthen the Macroeconomic Imbalances Procedure (MIP). Firstly “it should be used not just to detect imbalances but also to encourage structural reforms through the European Semester.” The Report proposed that the MIP corrective arm should be used “forcefully”, and that it should be “triggered as soon as excessive imbalances are identified and be used to monitor reform implementation.” Secondly, the Report proposed to use the MIP to “better capture imbalances for the euro area as a whole, not just for each individual country” and to “foster adequate reforms in countries accumulating large and sustained current account surpluses if these are driven by, for example, insufficient domestic demand and/or low growth potential.”79 As with the SGP, we note that the sanctions available under the MIP have so far never been used.

69.Professor Codogno argued that “the Macroeconomic Imbalance Procedure is probably not enough to achieve major structural reforms in Europe. We saw that even during the crisis not many governments were able to deliver deep enough structural reforms to solve the structural issues.”80

70.Many witnesses referred to the asymmetry of rules in the current MIP. For instance Professor Paul De Grauwe, John Paulson Chair in European Political Economy, LSE, referring to the current account of the balance of payments, explained that the rules were not “fully symmetrical because … the thresholds for imbalances are asymmetric, in the sense that the threshold for the deficit countries is 4% and for the surplus countries it is 6%”.81 Janet Henry told us that the mantra was “deficits bad, surpluses good … a current account deficit of 4% of GDP is considered to be a problem, but a current account surplus has to go beyond 6% of GDP before it is considered a problem. Germany running on an 8% of GDP surplus has not been heavily criticised, or been the subject of action to address it.”82

71.We welcomed the introduction of the MIP in our 2011 report on The future of economic governance in the EU,83 in which we concluded that those countries in surplus should not be subject to the same procedure as those in deficit, but that they should come under pressure to contribute to the reduction of imbalances in a way that did not affect their global competitiveness.

72.In evidence to this inquiry, a more symmetrical approach to rebalancing was supported by a majority of witnesses, though they were divided on the extent to which a surplus was harmful and how far it could be addressed through the MIP. Many witnesses focused on the current account surpluses in Germany and the Netherlands.

73.David Marsh told us that, although eurozone deficit levels had improved somewhat, current account surpluses were still accumulating in some countries: Germany’s was 8% of GDP, while the Netherlands’ was 12%.84 Martin Sandbu told us that Germany’s current account surplus stood at €186 billion from January to September 2015; it was the largest in the world in absolute terms.85

74.John Peet believed that “German political and economic leaders are proud of their very large current account surplus. They think it is a sign of strength.”86 Professor De Grauwe told us that surpluses were considered to be “a reflection of virtuous policies”.87 This perception made it difficult to impose reforms on Germany:

“We have the institutional infrastructure to deal with it, but politically the European Commission is paralysed. It can only go to deficit countries, to which it can say, ‘You have a deficit and that’s wrong’ … It cannot go to Germany and say that it is wrong to have a surplus, as it would say, ‘What? We are right’ … The solution should be a symmetrical one.”88

75.Martin Sandbu questioned the perception that imbalances were, in themselves, harmful, arguing that it was important to look at how deficits and surpluses were used. He believed that current account asymmetries “can often be a very good thing”, and said that it made “perfect economic sense for an ageing and rich country to export capital to a younger and poorer country, which presumably has greater potential for growth.” The problem was that: “Greece and Portugal [had] not invested [their imported capital] at all, but consumed. In Ireland and Spain, it was invested in houses nobody wanted”.89

76.Martin Sandbu also noted that only €6 billion of Germany’s €186 billion surplus was a surplus with other eurozone countries:

“to all intents and purposes, the current account surplus with the rest of the eurozone has disappeared. Those people who thought that that surplus was a particularly harmful problem for the rest of the currency union should presumably say that the elimination of it has been a very good thing and a boost to growth on the periphery. I do not hear them say that.”90

77.Philippe Legrain, an independent writer and commentator, argued, in contrast, that this reduction in Germany’s surplus with the eurozone meant “that it is exporting its capital elsewhere, draining demand from the eurozone and exporting deflation to the rest of the eurozone.”91 John Peet also believed that the eurozone was suffering from “insufficient demand”, a problem “generated particularly by Germany, which is not doing enough to increase demand”.92 Philippe Legrain was disappointed that the Five Presidents’ Report did nothing to “tackle the issue of a mercantilist German core and the deflationary impact of that.”93

78.Vice-President Dombrovskis told us that large and persistent current account surpluses were seen as macroeconomic imbalances. Germany and the Netherlands were undergoing the formal, legal process of the MIP and they had been advised to stimulate investment and the demand side of their economies, as mentioned in the country-specific recommendations. He added however, that Germany’s macroeconomic imbalance, so far, had not been found to be excessive.94

79.The evidence we have heard suggests that the strengthening of the Macroeconomic Imbalances Procedure, proposed in the Five Presidents’ Report, is unlikely to change the status quo or encourage more symmetrical adjustment between euro area Member States. We agree with those who have suggested that, in order to foster long-term structural reforms at the Member State level, it is necessary for individual Member States to take ownership. There is, however a tension between ensuring Member State ownership (whether in curbing imbalances or in disciplining public finances) and creating an effective enforcement mechanism at the EU level. Given that financial penalties have still not been used under either the SGP or the MIP, despite the introduction of reverse majority voting, in which a majority must be mustered to oppose a Commission proposal, we are sceptical that financial sanctions under the MIP are any more likely to be used in the future. As a result the still large macroeconomic imbalances in the euro area will probably continue to be a source of instability.

National Competitiveness Boards

80.The Five Presidents’ Report proposes the creation of independent and national bodies that would be in charge of “tracking performance and policies in the field of competitiveness.” They would also “help to prevent economic divergence and it would help increase ownership of the necessary reforms at the national level”.95

Box 6: The proposals for National Competiveness Boards

The five Presidents’ suggestion

Competitiveness Authorities should be “independent entities with a mandate to ‘assess whether wages are evolving in line with productivity and compare with developments in other euro area countries and in the main comparable trading partners’”. The Commission would coordinate the recommendations of the Authorities and feed them in to the European Semester process.

The exact form of a Competitiveness Authority should be decided by each Member State, but based on a ‘common template’. In addition, “they should be democratically accountable and operationally independent”.

The aim of the authorities “should not be to harmonise practices and institutions in charge of wage formation across borders”; while “National actors, such as social partners, should continue to play their role according to the established practices in each Member State”, they “should use the opinions of the Authorities as guidance during wage setting negotiations”.

The Commission Recommendation

The Recommendation is aimed at euro area Member States but explicitly encourages other EU Member States to establish Competitiveness Boards.

The Boards should be structurally independent of “any public authority dealing with competitiveness-related issues of the Member State”. Furthermore, they “should be underpinned by national legal provisions ensuring a high degree of functional autonomy and accountability”.

They should be tasked with:

1.Monitoring competitiveness developments in the Member State concerned, taking into account factors that can affect prices and quality content of goods and services relative to global competitors in the short term (including labour costs), as well as longer-term drivers such as productivity and innovation capacity, which are relevant not only for the relative performance of the economy but also for its growth potential and the capacity to attract investment, businesses and human capital;

2.Informing the wage setting processes at national level by providing relevant information;

3.Monitoring policies linked to competitiveness in the Member State concerned, including contributing to ex-post evaluation of policies; and

4.Assessing policy challenges and formulating policy advice in the field of competitiveness. The advice of competitiveness boards should take into account the broader euro area and Union dimension. The boards should, inter alia, provide advice on the implementation of the Country-Specific Recommendations addressed to the concerned Member State by the Council in the context of the European Semester.

Source: Five Presidents’ Report, p 8; Commission Recommendation for a Council Recommendation on the establishment of National Competitiveness Boards within the Euro Area, COM(2015) 601

81.Witnesses were divided on whether the creation of a National Competiveness Board in each Member State would improve competitiveness. Dr Hodson judged the proposal to be a “modest attempt to deal with the perennial problems of adjustment in EMU”. The Boards would have the potential to “increase peer pressure as an instrument of EU economic policy coordination,” though previous EU initiatives in this area had been blunted through lack of national ownership of reforms. Drawing on the Dutch experience, Dr Hodson observed that a Board could sound “the alarm when prices and wages are slow to adjust to country-specific developments. Of course, sounding the alarm is not the same as putting out the fire.”96

82.Raoul Ruparel agreed that the Boards could “provide some useful input”, but argued that they would only produce recommendations and would have no extra power to bring about “substantial change.”97 Professor Issing criticised the intention to create “another bureaucratic level”. He said that Europe had been dealing with this problem since the start of EMU and referred back to the 2000 Lisbon Agenda, where leaders decided to make Europe the “most dynamic region in the world”. He said that the EU had no competencies in respect of structural reforms: this was the responsibility of Member States.98

83.Veronica Nilsson criticised the mandate proposed in the Five Presidents’ Report: “it was very clear that they should influence the wage-setting process and [the ETUC is] very concerned, because we believe that this does not respect the autonomy of the social partners.”99 The Commission’s subsequent Recommendation was not as far-reaching as initially proposed, but she remained concerned that the Boards would interfere with wage-setting.100

84.More broadly, Professor Paul De Grauwe cautioned that:

“by focusing too much on competitiveness in its narrow sense, such as the development of wages, one can easily become trapped in a deflationary spiral where everyone watches national wage developments and then tries to reduce them relative to their neighbour. In no time you are in a deflationary spiral that prevents countries’ economies growing. We have already seen some of that.”101

85.Other witnesses also criticised the narrow focus on competitiveness in the Five Presidents’ Report. Philippe Legrain said that competitiveness was irrelevant in responding to the eurozone’s challenges, and favoured “boosting productivity growth”. Focusing on ‘competitiveness’ meant: “you end up specialising in lower-end production rather than dynamically moving up the value chain and producing better goods for higher wages.”102

86.Professor Jones offered an alternative perspective, pointing out that the countries often cited as losing competitiveness were ones that had in fact experienced “rapid financial disintegration” in which capital moved across borders with net foreign exposures building up as a result: “if you liquidate all those assets at once and pull the money out you end up with countries like Italy, Spain, Portugal and Greece that have no liquidity in their economies. That is what brought them down, not the loss of competitiveness per se.”103

87.André Sapir and Guntram Wolff, of Bruegel, argued that in a monetary union where countries could not devalue their currencies the only options for some countries were internal devaluation and labour market reforms, while other countries had current account surpluses, which contributed to deflationary pressures. National Competitiveness Boards “would need to be coordinated … to ensure symmetric adjustment and prevent a deflationary race to the bottom.”104

88.Several witnesses thought independent Boards would increase transparency, stimulate public discussion and increase national ownership. Many pointed to the success of the Dutch Central Planning Bureau while Thomas Wieser noted that “there are Member States where such issues are not publicly discussed and those are the Member States which, arguably, have the larger productivity problems.”105 Fabian Zuleeg echoed this.106

89.Hans Hack, Senior Managing Director, FTI Consulting, thought the Central Planning Bureau in the Netherlands provided “some sort of anchor to the political system”, and he agreed that political ‘buy-in’ was necessary.107 Though the creation of such boards is optional for non-euro area Member States, Mr Hack suggested that the idea would be “in alignment with the UK’s view on how any economy should be managed.”108 Baroness Bowles of Berkhamsted, former Chair of the European Parliament ECON Committee, also thought that the UK should consider establishing such a Board, depending on its scope.109

90.The Minister supported in principle the creation of Boards within the eurozone. He explained that “competitiveness remains a big challenge for the European Union as a whole and in particular for the eurozone.” He maintained that the proposal was still “high-level policy”, and that Member States were still considering whether they would make an effective contribution: “if there is a view that it can contribute then it is certainly something that we would like to see.”110 The Committee’s scrutiny correspondence with the Minister, reveals that the UK will be considering this Recommendation closely.

91.We note the doubts expressed about the likely effectiveness of National Competitiveness Boards in Member States that do not currently have a similar body in operation.

92.We recognise that the establishment of a Board might bring with it the perception of another layer of bureaucracy being imposed by the EU, unless it is accompanied by a clear objective of how it will improve policy-making and increase national ownership of those policies. There may be a tension between national ownership and the consideration of eurozone-wide benefits, in addition to the inherent tension that exists between the need for Boards to be both independent and accountable. If, on the other hand, National Competitiveness Boards are intended as a first step towards a nationally anchored but eurozone-owned institution, then their independent status could detract from national political accountability.

93.The drive towards improving competitiveness in the eurozone must stress solutions that enhance productivity. We echo the conclusions of our previous report on The future of economic governance in the EU which stated: “It is unreasonable to ask successful Member States to reduce their competitiveness in a global environment. It is, however, in the interests of all Member States in the euro area that the proceeds of those countries in surplus are not deployed in ways which disadvantage their neighbours, and that those countries in deficit are supported in making the structural adjustments necessary to improve productivity and levels of employment.”

The path towards ‘Economic Union’

94.The Five Presidents’ Report states that in the medium term “the convergence process towards more resilient economic structures … should become more [legally] binding.” It maintains that this could be achieved by “agreeing on a set of common high-level standards that would be defined in EU legislation, as sovereignty over policies of common concern would be shared and strong decision-making at euro area level would be established.” The areas identified for common standards are in the fields of “labour markets, competitiveness, business environment and public administrations, as well as certain aspects of tax policy (e.g. corporate tax base).” The Report states that “progress towards these standards would be monitored regularly. Country-Specific Recommendations would continue to be used in this context.”111 Vice-President Dombrovskis told us that one of the main aims of the Five Presidents’ Report was to “restart the process of convergence within economic and monetary union, which had unfortunately stalled since the crisis”, and “to make sure this is convergence towards best practice and best performance.”112

95.Professor Michael Wickens, University of York, said that achieving economic convergence was a “long-term goal.”113 Professor Codogno said that while “a country should try to achieve convergence of its economy, as when there was convergence for the entry into monetary union before 1999”, there was “a serious issue here in terms of general equilibrium … you cannot achieve goals in all different aspects of the economy at the same time, and that will be very challenging. I am puzzled by the approach that has been decided.”114

96.The impetus towards economic convergence is laudable to the extent that it is intended to encourage common and shared aims among euro area countries and to instil discipline in policy-making. This matters as much for non-eurozone countries as for the eurozone. We recognise that any further steps towards economic and fiscal integration will require commensurate democratic and accountability structures to be put in place. The Expert Group’s White Paper in 2017 will be crucial to getting this balance right. Further changes in this direction are likely to require treaty change.

97.We explore the pathways towards greater democratic accountability and legitimacy structures in Chapter 4.

25 These are described in more detail in Boxes 1 and 3.

26 This means that a majority must be mustered to oppose a proposal. The standard practice of QMV requires the support of at least 55% of Member States (currently 16), representing at least 65% of the total EU population to agree to a proposal.

29 Written evidence from Dr Dermot Hodson (EMU0002)

32 Q 32 and Q 97

39 European Union Committee, Euro area crisis: an update (11th Report, Session 2013–14, HL Paper 163)

43 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf, p 14 [accessed 6 April 2016]

44 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf, p 14 [accessed 6 April 2016]

50 Commission Decision (EU) 2015/1937 of 21 October 2015 establishing an independent advisory European Fiscal Board: http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1453282201556&uri=CELEX:32015D1937 [accessed 6 April 2016]

59 Euro area GDP fell by 4.4% in 2009. Since then growth has been slow or negative, peaking at 2.0% in 2010. The aggregate figure masks variations between Member States: over the 2007–11 period euro area growth averaged 0.5% per year; figures for Germany, France, Spain and Italy averaged 1.2%, 0.2%, 0.0% and -0.6% respectively.

60 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf p 7 [accessed 6 April 2016]

61 Communication from the Commission to the European Parliament, the Council and the European Central Bank On steps towards Completing Economic and Monetary Union, COM(2015) 600 [accessed 6 April 2016]

66 Written evidence from Bruegel (EMU0005)

68 Communication from the Commission to the European Parliament, the Council and the European Central Bank On steps towards Completing Economic and Monetary Union, COM(2015) 600 [accessed 6 April 2016]

73 Flexicurity is an integrated strategy for enhancing, at the same time, flexibility and security in the labour market.

75 Q 56 “Periphery” is often used as shorthand to refer to countries such as Cyprus, Greece, Ireland, Portugal and Spain. This is in contrast to “core” countries such as Germany and France.

78 Written evidence from Dr Waltraud Schelkle (EMU0004)

79 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf p 8 [accessed 6 April 2016]

83 European Union Committee, The future of economic governance in the EU (12th Report, Session 2010–12, HL Paper 124)

95 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf [accessed 6 April 2016]

96 Written evidence from Dr Dermot Hodson (EMU0002)

104 Written evidence from Bruegel (EMU0005)

111 European Commission, Completing Europe’s Economic and Monetary Union: https://ec.europa.eu/priorities/sites/beta-political/files/5-presidents-report_en.pdf [accessed 6 April 2016]

113 Written evidence from Professor Michael Wickens (EMU0003)

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