A strong euro area needs reforms

17 February 2017

Europe is working towards better coordination of the fiscal policies of its member states. The European Fiscal Board (EFB) is going to advise the European Commission on fiscal matters to help the Commission achieve this goal. ‘An aggregated European fiscal policy can be useful to achieve a more balanced economic development within the euro area’, says EFB member Roel Beetsma.

University van Amsterdam Professor Roel Beetsma has been a member of the prestigious European Fiscal Board since last October. The EFB consists of five experts from euro and non-euro area countries. This newly installed institution advises the European Commission on the fiscal policies of national member states. Its recommendations are intended to contribute to a better functioning of the monetary union and could reduce the inequalities between countries of the euro area. The EFB is an initiative of the ‘Five Presidents’ of the European Commission, the European Council, the European Central Bank, the European Parliament and the Euro Group. 

Beetsma, who is also vice-dean of the Amsterdam School of Economics (ASE), is in for a rough ride because the functioning of the monetary union is a big concern. The average government debt of the countries of the euro area is near a record high, the inequalities between these countries are huge and public support among voters for further European collaboration is low.

Supporter

Nevertheless, Beetsma is a staunch defender of the European collaboration and the euro. ‘I am in favour of European integration and free movement of services, goods, capital and people’, says Beetsma during an interview about his new appointment. ‘Also, a common currency is to our advantage. Not only does the euro boost international trade, it is also a way to encourage competition between companies in the various member states.’

Still, Beetsma is critical about the developments in Europe. ‘The idea that the euro drives competition only works when countries have similar economic developments enabling them to compete with each other’, says Beetsma. ‘So we need the weaker countries within a monetary union to remain working on national reforms to keep pace with the stronger countries. Unfortunately, the efforts in Greece, Italy and Portugal have not been very successful so far.’

Reforms

According to Beetsma, failing reforms are an important reason behind the current problems. ‘We have gone through a deep crisis that exposed some serious shortcomings of the monetary union. It turned out that the countries that were not willing to reform ran into the largest problems and ended up with the highest deficits.’

Beetsma believes that is was not the introduction of the euro that caused these problems. ‘Politicians from weak countries who claim that their problems are caused by Europe are wrong and just try to hide the lack of reforms in their own country from view. They would be worse off without the euro.’

Tasks of the European Fiscal Board

The recommendations of the EFB will cover four areas. First, the Board monitors if the European Commission properly applies the rules of fiscal policy as laid down in the Stability and Growth Pact.

Secondly, countries that seriously violate these rules will receive the Board’s special attention.

The Board will also advise on possible changes of the Stability and Growth Pact itself. This pact requires that the government debt in a country of the euro area remains below 60% of the gross domestic product and that the financial deficit shows a deficit of no more than 3%.

Finally the Board will investigate the kind of fiscal policy that is desirable at a European level. This will be translated into the fiscal policies of the individual countries. ‘An aggregated fiscal policy can be useful to achieve a more balanced economic development within the euro area’, says Beetsma.

Steering the budget

The latter task will not be easy. An aggregated fiscal policy implies for example that government spending needs to be increased in country A to achieve more economic growth in country B. ‘A problem arises when a country is not able or willing to do what is needed from an aggregated European perspective’, says Beetsma. With government debts well exceeding 100%, countries like Greece, Italy and Portugal have no room for fiscal expansion. ‘With countries that do have room for expansion, on the other hand, one has to take care that their economies do not get overheated.’

Furthermore, in Beetsma’s opinion, countries have grown to regard each other with some distrust, which is due to the repeated failure of imposing real sanctions when countries had not complied with the criteria of the Stability Pact. That is why there is now not a lot of willingness to subsidise each other by expanding government spending. So in November, the Dutch Minister of Finance Jeroen Dijsselbloem rejected the European Commission’s request to the Dutch en German governments for an increase in public spending. Countries like the Netherlands, which operaate within the limits of the criteria of the Stability Pact, are free to formulate their own fiscal policy.

Step by step

Beetsma says that this is why an aggregated European fiscal policy has to be developed step by step. ‘First we have to better know the effects of such a policy. We must have more insight in how an expansion in one country leads to spillover effects in other countries and whether these spillover effects land in the country you are targeting. Former research shows that overall, these spillover effects are limited, but not negligible.’ Once more knowledge about these effects has been accumulated and once the economic climate has improved, Beetsma believes that countries’ willingness to take wider European goals into account when crafting their national fiscal policies will grow.

A time will come, in Beetsma’s view, when the EFB is no longer needed, because ‘in the long run, the installation of a collective European government determining fiscal policy is inevitable.’ Beetsma firmly believes that more political unity and a collective economic policy are needed for Europe to be able to compete with China and the United States. ‘As long as this unity is still some distance away, gradual reforms are our only option.’ 

More information? Email R.M.W.J.Beetsma@uva.nl.

By Bendert Zevenbergen

Published by  Economics and Business