The Fiscal Compact and National Ownership

Introduction With the adoption of the new Treaty on the EMU's Stability, Cooperation and Governance (TSCG), Europeans have decided to introduce new fiscal rules in an era when most of the countries in the world suspended the use of rules as a response to the outburst of the 2008 economic and financial crisis. The European Union (EU), however, seems to insist on the usefulness of fiscal rules. The European Commission, in fact, has claimed that domestic fiscal rules should become an indispensible part of the new economic governance structure of the Economic and Monetary Union (European Commission 2010). The TSCG serves exactly this purpose by imposing compulsory deficit and debt rules from above on the member states of the euro-zone. The European Union played a pioneering role in the adoption of fiscal rules. Member states of the Economic and Monetary Union abandoned national currencies and delegated monetary policy onto a supranational level. Fiscal policy has remained, however, in the hands of national governments as basically the sole economic stabilisation tool. Since such an asymmetry in the conduct of economic policy can easily reinforce moral hazard in the form of overspending, the founding fathers of the EMU established a solid set of fiscal rules, which were explicitly named in the Maastricht Treaty and were subsequently strengthened by the Stability and Growth Pact later on (i.e., the annual deficit cannot be higher than 3 per cent of the GDP, and the debt ratio should be below 60 per cent or declining towards the target ratio). (3) While all these previous attempts, along with the 2011 reform of the Stability and Growth Pact (the adoption of the so-called six-pack), introduced fiscal rules on a supranational level, the TSCG (to be more precise, its fiscal compact) requires participating countries to adopt rules in their own national legislation, preferably in their constitutions. It is, therefore, high time to analyse the effectiveness of the domestic fiscal rules that were adopted earlier by the member states. In fact, member states became heavily engaged in adopting fiscal rules on the national level right from the very beginning of the so-called Maastricht process, that is, from 1991 onwards. Accordingly, the present study raises the following interrelated questions: To what extent did the EU member states rely on national fiscal rules before the crisis? Were these domestic rules successful enough in eliminating deficit bias? And, based on these results, is it rational to expect the fiscal compact to become an effective disciplining mechanism in the future? While the main argument for the introduction of domestic fiscal rules has always been the buttressing of the accountability and credibility of national fiscal policy-making, the current study shows that a relatively large portion of domestic fiscal rules were adopted only after the start of deceleration of the debt-to-GDP ratios as part of a wider fiscal consolidation programme; that is, national ownership was an integral part of domestic rule-adoption. Accordingly, it might be reasonable to argue that it was not the rule itself which managed to stabilise public finances, but rather the strict political commitment to comprehensive consolidation efforts. Consequently, the fiscal compact can be effective only if national ownership of the new fiscal rules is granted. Following the short introduction that specifies the puzzle and the research questions, section two provides a literature review on the positive political economy of deficit bias and on the effectiveness of fiscal rules. Section three provides a critical assessment on the design of the newly adopted fiscal compact. Section four turns to the empirical analysis of fiscal rules that were adopted by EU states between 1990 and 2004/2007. Section five elaborates on the discussion of the main findings of the empirical study. The last section addresses the question whether the newly adopted Treaty on the EMU's Stability, Cooperation and Governance can be effective enough in the future in light of the previous results on domestic fiscal rules. …