How European Union Fiscal Rules Subverted Democracy and Institutionalized Neoliberalism

Yves here. Anyone who has paid attention to how the various sovereign debt crises have played out in Europe can’t help noticing that a bureaucratic elite is calling the shots and riding roughshod over popular will. But what are the mechanisms which allow these perverse outcomes to come to pass? This post describes the major steps that enabled neoliberalism to become the ruling doctrine.

By John Weeks, a member of the Union for Radical Political Economics (URPE) in London, one of the founders of the UK-based Economists for Rational Economic Policies, and part of the European Research Network on Social and Economic Policy. Receive podcasts of his weekly radio program by Twitter, @johnweeks41. Originally published at Triple Crisis

The EU: Hold Your Nose and Vote “Stay”

Most Americans and many U.S. progressives hold a favorable view the European Union. This positive assessment persists despite the crushing of the Greek challenge to austerity conditionalities set by the European Commission and European Central Bank aided and abetted by the International Monetary Fund.

The primary basis for pro-EU sentiments may be that Americans consider the European Union a bastion of social democracy in contrast to the neoliberal ideology of the Republican and Democratic parties, which Bernie Sanders has so eloquently attacked. However, the institutions of the European Union, especially its executive the European Commission practice a neoliberal ideology and pro-business policies as aggressive as counterparts in the United States.

This is not a recent change, but a long-maturing trend going back at least to when Helmut Kohl of the right-wing Christian Democratic Union replaced the Social Democrat Helmut, Schmidt, as chancellor of Germany. The misplaced belief that Jacques Delors, EC president for ten years, was committed to social democracy perpetuated the illusion of a progressive EU. While no reactionary like Kohl, the French socialist politician supported market oriented “reform” of the European Union’s economic policies.

By the 2000s neoliberals had taken firm control of the European Commission, manifested most obviously in the 1992 Maastricht Treaty. The step-by-step legal codification of EU reactionary economic policies goes far beyond legislation enacted in the United States. As a result, it should surprise no one that in Britain and on the continent support for membership in the European Union splits progressives. In Britain the issues looms large, with a referendum on continued membership scheduled for 23 June.

The progressive case of membership is a hard row to hoe.

Loss of Democracy in the European Union

History provides many examples of authoritarian rule achieved through formally democratic procedures. To these we should add the 2012 EU Treaty on Stability, Coordination and Governance (TSCG), adopted by 25 democratically elected EU governments (the Czech Republic and the United Kingdom took opt-outs). On an EU website we find the overall purpose of the TSCG boldly highlighted:

The European Union’s economic governance framework aims to detect, prevent, and correct problematical economic trends such as excessive government deficits or public debt levels, which can stunt growth and put economies at risk.

This bureaucratically bland sentence asserts the power of the unelected European Commission, as the executive of the European Union, to monitor (“detect”) whether the public budget of an elected member government conforms to EU fiscal rules.  If it does not, the Commission claims the power to prevent the implementation of that budget and to specify the changes (“corrections”) required.

No one can miss the ideological asymmetry of the “governance framework” – deficits can be excessive, but not surpluses. In practice a budget surplus usually goes along with a trade surplus, so that the contractionary effect of the former will be offset the expansionary impact of the latter. Thus, not restricting surpluses carries an implicit mercantilist message.

The EU website goes on to explain “detection” or “monitoring” as follows,
Each year, the EU countries that share the euro as their currency submit draft budgetary plans to the European Commission. The Commission assesses the plans to ensure that economic policy among the countries sharing the euro is coordinated and that they all respect the EU’s economic governance rules. The draft budgetary plans are graded as either compliant, partially compliant, or at risk of non-compliance.

When the EC implements this paragraph literally as it did in Greece, the role national legislatures is to endorse what the Commission judges as “compliant.” The TSCG de facto makes member governments formulate their budgets for the Commission not their legislatures, because there would be little point and considerable embarrassment by submitting to parliament a budget that the EC would reject.  After the Commission judges the budget as satisfactory the national legislature goes through a pro forma approval process.  It will be a small step to require, as in Greece, approval by the EC before revealing the budget to the public.

The TSCG transfers sovereignty from democratic institutions to an unelected bureaucracy. Were it the case that the EU parliament possessed substantial control over the Commission (which it does not), the TSCG would still be profoundly authoritarian because of the power of the EC bureaucracy over what should be decided democratically.

Treaty-Protected Mismanagement

EU fiscal rules, from the Maastricht Treaty to the TSCG are anti-democratic, as well as inflexible to change. The Treaty specifically commits the adopting government to embed the fiscal rules in law in a manner ensuring their “permanent character, preferably constitutional.” Embodied in treaties, they can only change through repeal or adoption of additional treaties. Both involve extremely cumbersome and time consuming processes.

Were the fiscal rules theoretically and practically sound their anti-democratic and inflexible nature would still discredit them. Far from sound, they are technically flawed, mandating macroeconomic mismanagement. The Treaty mandates specific limits to fiscal policy.

[The Treaty] requires contracting parties to respect/ensure convergence towards the country-specific medium-term…with a lower limit of a structural deficit (cyclical effects and one-off measures are not taken into account) of 0.5% of GDP; (1.0% of GDP for Member States with a debt ratio significantly below 60% of GDP).

Before considering the wisdom of the 0.5% deficit target, two major technical mistakes standout, 1) the Treaty uses an unsound measure of the fiscal deficit; and 2) the key concept, “structural deficit,” is theoretical nonsense.

The TSCG adopts the Maastricht deficit specification, total revenue minus total expenditure, which is the overall deficit. As the IMF explains in its guidelines for fiscal management, the appropriate measure for sound fiscal management is the primary deficit, which excludes interest payments on the public debt (which if reduced would imply partial default).

When the TSCG specifies the 0.5% as a “structural deficit” we go from the inappropriate to the absurd. The Commission as well as the usually competent OECD defines “structural deficit” as the deficit that would appear by eliminating cyclical effects; i.e., the deficit when an economy operates at normal capacity.

Making this concept operational requires an analytically sound method of eliminating cyclical effects, then a clear and consistent measure of normal capacity. The EU structural deficit fails on both criteria. In practice the EC bean-counters make no attempt to eliminate cyclical effects. The method of calculation of normal capacity ignores the cycle altogether by defining normal capacity to the level of output at which the rate of unemployment implies stable inflation (the “non-accelerating inflation rate of unemployment,” NAIRU). Again, the EC bureaucrats reveal their ideology by taking inflation not output or unemployment as measure of economic health.

The NAIRU would be sufficiently problematical were attempt made to adapt it to the specific institutional characteristics of each country at specific time periods. For example, if the concept has operational validity, it is extremely unlikely that it would assume the same value before and after the 2008-10 global recession. An inspection of the eurostat tables for the actual and “structural” deficits shows no evidence of estimations with country specific adjustments.

The decidedly dubious nature of the NAIRU is indicated by its nom de guerre, “the natural rate of unemployment.” This phrase betrays an underlying ideology that 1) unemployment is a natural phenomenon to which all economies automatically adjust; and 2) inflation always results from excess demand. If the first were true the global recession would not have occurred. The second ignores price pressures arising from traded goods and services, petroleum being the most obvious and price-volatile.

The possibility of calculating country and time specific normal capacity would not save the 0.5% rule the realm of ideological nonsense. First and foremost, it represents static analysis applied to a dynamic process. The formal statement of the 0.5% would be as follows:

Economy A operates below normal capacity with a fiscal deficit of 2.5% (for example).  Other things unchanged, were economy A at normal capacity the deficit would be 1.5% (for example), above the 0.5% requirement.  Therefore, the government of country A must now take steps to reduce expenditure or raise taxes, so if the economy were at full capacity the hypothetical deficit would be 0.5%.

The 0.5% rule is a hypothetical outcome based on analytically unsound calculations. This “what if” calculation by statisticians is used by an undemocratic bureaucracy to force elected governments to implement contractionary economic policies. The technically unsound, hypothetical 0.5% target mandates a pro-cyclical macroeconomic policy. To render the rule Kafkaesque, after the EC bureaucracy calculates that a government will not meet the hypothetical target, it then mandates contractionary policies that guarantee that the target cannot be achieved. The problem is imaginary and the solution contradictory.

The wording of the TSCG makes it clear that deviant fiscal behavior by a member country will not be tolerated,
Correction mechanisms should ensure automatic action to be undertaken in case of deviation from the [structural deficit target] or the adjustment path towards it, with escape clauses for exceptional circumstances. Compliance with the rule should be monitored by independent institutions.

The “independent institutions” include the European Commission itself, which adds a distinctly Orwellian character to the already Kafkaesque Treaty.

Painted into a Recessionary Corner

Market economies pass through cycles of recession and expansion. They suffer from fiscal deficits in recessions, because falling or slow-growing output results in falling or slow-growing revenue. Such circumstances typically result from a drop in private investment or exports. Economies most effectively overcome recessions by the public sector using its spending powers to compensate for the inadequate private demand.

The TSCG legally prohibits the implementation of this effective countercyclical fiscal policy. It forces member governments to apply policies analogous to the practice 200 years ago of bloodletting to restore health to the ill. It is a Treaty designed to maintain perpetual stagnation across the European continent.

The term “Six-Pack”, the secondary legislation linked to the treaty, is frequently used as synonymous with the TSCG. This is a singularly appropriate nickname for the enabling legislation. The Six-Pack contains the economic equivalent of a pernicious snake oil, a witch’s brew to turn minor fiscal problems into recessionary downturns. For those dedicated to a prosperous and harmonious European Union, repeal or replacement of the TSCG stands out as an urgent priority. Fiscal integration on the basis of the TSCG would be disastrous.

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  1. ke

    What most Americans know about Europe is on a postcard, or the propaganda they were taught in school. The vast majority on this planet is dependent on a MAD money laundering scheme built by Wall Street, copied globally, and automated by WS of the West, silly valley, now strip mining the planet, on auto pilot, with a belief in political discourse, among completely insulated, puppet politicians.

    Back in the day, before joining, Robert R actually said some intelligent things about labor. The crashing actuarial ponzi has been in operation so long it is an assumption. On the one hand money enslaves future generations to the present, and on the other we are all supposed to seek a feudal pension. The casino wins in both directions.

    I have dear friends from H to VI, but sleep walking through life, while natural resources are needlessly strip mined for the sake of maintaining artificial scarcity, is a good way to put it.

    We don’t even need oil, but the economy is leveraged on that contract price, to maintain subservient populations. We are choking on excess oil, storing it all over the ocean, and preventing iran/iraq from putting its product on the market, all to confirm a psychology of dependence, like an ant farm, assuming that individual humans can only wander randomly without the benefit of the collective, serving the sociopathic psychologist writing the scripts.

    Funny, there is a shortage of private demand for more incompetent government.

  2. RabidGandhi

    Another fundamental difference between the US and EU is the difference in central bank mandates, with the Fed having its dual inflation/employment mandate in its bylaws, but under Maastricht the ECB only has a mandate for low inflation.

    That said, the Fed has a dual way for getting around the dual mandate: playing fast and loose with what is defined as unemployment, and just straight out ignoring it (eg, raising interest rates at the first whiff of possibility that there might be a rumour that someone’s uncle’s cousin’s best-friend’s roommate thinks there could eventually be a slight uptick in the CPI). This means, yes there are differences in the founding documents, but is there anywhere in US economic governance that NAIRU is not assumed either?

    1. Benedict@Large

      The dual mandate is a fiction. There’s nothing the Fed can do to lower unemployment (though it can raise it by mistake.) The unemployment rate is set by the fiscal policies of Congress and the Executive. The unemployment rate, should they desire, can even be set to zero. That it is not should be sufficient cause for the guillotines.

      1. RabidGandhi

        I definitely agree w/r/t fiscal policy, but I think the point is that at least in the US there is a nominal (but ignored) primum non nocere written into the Fed’s by-laws. It is supposed to take actions that will “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” What this means is that raising interest rates at the mere rumour of inflation is going against the Fed’s mandate– not that anyone in power cares. Meanwhile in Europe they just dispense with the whole fiction of not having a monetary policy that kills employment.

  3. PlutoniumKun

    I think the process of corporate control of the EU was so slow and gradual plenty of left wingers in Europe still haven’t really grasped what has happened. From the beginning, there was always a tension within Europe between pressure from corporations for more business friendly policies and the generally social democrat lite views of the original founders. I think though to call it ‘neoliberal’ is not quite correct – for me ‘neoliberal’ implies a specific set of policies associated with the Anglosphere – I think in Germany what we’ve seen is the takeover by a more German flavoured right of centre view – it is similar, but is more generally corporatist and mercantilist in nature with a strong dash of Austrian economics.

    I see the results every day when I step outside my apartment in Dublin. Thats to a focus on privatisation and ‘competition’, what was once a fully functioning waste collection service in my city has now become a chaotic privatised service, with competing companies driving down the quality. No more proper wheelie bins collected on the same day, instead there are plastic bin bags everywhere, there to be torn apart by seagulls and foxes, scattering rubbish everywhere. All in the name of ‘competition’, driven by EU Directives. The focus on ‘internal competition’ is gradually eroding sensible regulation in energy, waste and telecommunications. Supposedly in the interest of the consumer, but we all know who really benefits.

    1. Fajensen

      I don’t think all this “competition” really benefits anyone, I believe it’s just there for the principle.

      1. PlutoniumKun

        Well of course the ‘competition’ is a myth. As anyone who has witnessed what has happened in electricity markets can see, it has, if anything, raised prices of electricity for consumers. But various powerful interests have done very well indeed. you can see the same process in water and waste services and pretty much anything that has been directly regulated and privatised. The only areas where I think it can be shown that consumers have benefited from competition are in telecommunications and in air travel. And in the former, I suspect the consolidation of the telecom industry will reverse those gains.

        1. Barry Fay

          The airlines are a terrible example – in fact, there was a great article treating the airlines as a classic example of “crapification”. The seating has become ridiculously cramped (as a way to then “sell” seats that someone can actually sit in!), the service has been basically reduced to the bare minimum, luggage charges are outrageous and ticket prices continue to climb even though one of the major expenses (i.e. fuel!) has become cheaper by 50 per cent. No, the airlines were a bad example.

  4. financial matters

    Nice to read such an excellent analysis. And with very appropriate metaphors.

    “To render the rule Kafkaesque, after the EC bureaucracy calculates that a government will not meet the hypothetical target, it then mandates contractionary policies that guarantee that the target cannot be achieved. The problem is imaginary and the solution contradictory.”

    “The “independent institutions” include the European Commission itself, which adds a distinctly Orwellian character to the already Kafkaesque Treaty.”

  5. rfam

    I would suggest that any country that doesn’t like these rules failed to read the agreement and should exit the EU and start issuing worthless currency. In doing so they can feel free to devalue, run large deficits, borrow all they want and then leave the “neo-liberals” to it. When the banks and hedge funds that over-lend to fund these deficits fail or demand collateral ( you will discuss their predatory nature.

  6. Hansrudolf Suter

    “Thus, not restricting surpluses carries an implicit mercantilist message.” EU guidelines fix trade surplus at 6%, Germany is, I believe, in its seventh year of violation and should be fined. That it doesn’t happen maybe shows that the elite ruling the EU is German.

  7. Schofield

    Given half a chance some human beings who never got much loving as a child will seek to correct the imbalance by “weaponizing” money and using it against the interests of the majority. For those who’ve read the psychoanalyst Alice Miller books they will recognize her argument that resentment builds up in the child and needs expression in the form of subconsciously motivated vengeance as an adult!

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