The Limits of Governing Budgetary Policies by Rules

Daniela Schwarzer

The European squabble over budgetary austerity reached a new peak a good week ago when a document drafted by leading representatives of the French Socialist Party, which reportedly had been seen by Elysée officials close to President Hollande, personally attacked German Chancellor Angela Merkel. Less mediatized, but more telling about the nature of the governance problems facing the euro area, are the statements made by Finance Minister Pierre Moscovici this weekend. After having obtained a two-year derogation for France to comply with the 3% deficit threshold of the euro area’s fiscal rules he said: “This is a turning point in the history of European integration since the euro exists. We have witnessed the end of a certain financial orthodoxy and the end of the dogma of austerity.”

Though the French government scaled down this triumphant tone subsequently, these words provoked some strong reactions in Germany. The reason for the Franco-German discord over budgetary policy are, first, competing policy preferences, deeply rooted in normative beliefs over “the right” way out of the current crisis. The German and the French economic mainstream diverge considerably over the question what should come first: The neo-classical paradigm dominant in Germany emphasizes the need for budget consolidation (expenditure cuts instead of tax increases), structural reforms and an adjustment of real price levels in order to then bring back demand, growth and employment thanks to enhanced competitiveness and increased trust among investors. The view dominant in France makes a case for more time to meet the European debt and deficit targets so that austerity does not crush domestic demand which is necessary to prevent a further deterioration of growth and employment and to enable structural reforms.

This divergence of views is not only related to different main-stream economic paradigms. It also reflects the structure of the French and the German economies, which have a tradition of diverging sources of growth. While Germany’s growth is export-driven, economic growth in France depends much more on domestic demand. This is particularly so in the current situation, in which France faces significant problems with competitiveness in European and world markets.

But on top of that, the conflict runs even deeper. Moscovici, and this is not a singular opinion in Paris, questions the rules-based governance set-up which is supposed to control national fiscal policies in the euro area. The German government, together with the European Commission, has meanwhile put a lot of energy in the reform of the rules for domestic fiscal policies since the sovereign debt crisis hit the euro area in 2010. The intention is to limit national discretion (with a certain leeway for cyclical considerations).

Two fundamental assumptions, both of which are highly debatable, underlie the rules-based approach. The first one is that the European fiscal rules can be devised in such a way that they are likely to account for any future economic scenario. In other words: The assumption is that it is efficient and legitimate to regulate fiscal policy decisions by detailed rules and to technocratize surveillance and sanctioning of rule compliance.

The second assumption is that the rules for national fiscal policy-making actually turn into institutions – in other words that they actually impact political actors’ choices and behavior. But for this to work in a democracy (in particular in one of the most sensitive areas for national sovereignty which fiscal policy making is), there needs to be an underlying consensus and shared beliefs for these rules to actually become institutions that shape actors’ behavior.

France is the latest example which shows that these conditions are not yet met in the euro area. It was reasonable by the European Commission and the Eurogroup to grant flexibility to France (and other member states such as Spain, the Netherlands and others). But there is yet no guarantee that policies convergence with the European targets in the near future. Restricting political integration and the governance of fiscal policies merely to the rules-based approach may prove unsustainable.

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