05 July 2013

Deutsche Bank: Will reform treaties enhance the prospects of the euro area?

At the same time as last week’s European Council, an Interim Report on improving economic policy coordination was published by the van Rompuy Cabinet. The report outlines the route towards bilateral reform treaties that euro area countries are meant to conclude with European institutions – first and foremost the Commission. In these treaties, countries are to commit themselves to pursue reforms in those areas that increase the ability of their economies to adjust and thereby also reduce the overall vulnerabilities of the monetary union.

The supporters of reform treaties see three advantages:

• Commitment - bilateral treaties are intended to increase national identification with their reform agenda via a commitment vis-à-vis themselves and third parties.
• Coherence -  treaties allow tailor-made and binding recommendations in policy areas where peer pressure is ineffective and where the Commission does not have any competences to coordinate and supervise.
• Control - treaties can increase the measurability of reforms and improve control.

Additional financial incentives are intended to ensure compliance with the reform treaties.

But are contractual arrangements that lie outside the scope of the European treaties indeed effective to implement reforms in the EMU countries? Despite some legal differences, the Fiscal Compact can provide and initial indication.

14 of the 17 EMU countries have ratified the Fiscal Compact. A special clause in the treaty meant that it already came into force back in January as soon as it had been ratified by a minimum number of 12 EMU countries. The prospects are good that the remaining three countries will ratify soon. The compact also provides that fiscal consolidation should be institutionally underpinned by fiscal correction mechanisms (nominal debt brakes) that have to be implemented at the national level. Seven of the 17 EMU countries have yet to implement theirs, but overall, good progress in being made.

In March, however, ECOFIN and the European Council agreed to ease the fiscal adjustment requirements for EU countries. This shows easy the “spirit” of treaties can be changed, even when the Commission is a signatory.

So what will be the spirit of the reform treaties? The conclusions of the European Council state that the heads of state and government identify the poor development of the European business cycle as the sole cause of European youth unemployment – but not, however, the lack of structural reforms that could liberalise labour markets and improve young people’s qualifications. A more differentiated look that balances adjustment recessions and structural differences between the euro area countries would have been desirable.

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