Currency club members must stick to the rules

ECONOMIC VIEW
The British financial markets yesterday were enjoying the lull before the storm of new information that will hit them later today in the Budget. Separately, another storm, but one relevant to the Government's finances, was swirling in Brussels at the EU finance ministers' meeting, where the official start date for European Monetary Union of the beginning of 1999 was firmly agreed.

This is relevant to the UK because, though we have the opt-out of the single currency, the mechanism used to control the fiscal position of the other EU states will inevitably have an impact on British fiscal policy. Just as the US is in the process of setting the new standard of the balanced budget, so the EU is setting a parallel standard: that countries must not only meet the Maastrich criteria when they join EMU, but that there must be some continuing curb on their borrowing after they have joined.

The EU finance ministers reached no agreement on this thorny issue yesterday, for while it is easy to agree on a date for something to happen, it is much harder to agree the detail on what that something might be. But the German finance minister, Theo Waigel, has staked out the ground in a forcible and effective way. The German plan for a European Stability Council with powers to fine the authorities of EU countries which rose above the 3 per cent of GDP limit on public borrowing, would be the first time that governments anywhere in the developed world were to accept legally-binding extra-territorial curbs on their deficits. There are plenty of precedents for countries having their own constitutional controls on public borrowing, but none for controls externally applied.

There is the de facto control of fiscal deficits imposed by the financial markets, of course, but being "fined" by the markets charging an interest premium is a rather different matter from being fined by part of the EU bureaucracy.

Naturally, the German plan was scorned by our own Chancellor, who argued that taxation and public spending were and would remain a matter solely for national governments. But if the idea that a country would be prepared to hand over the equivalent of 0.25 per cent of GDP to yet another new European body seems a bit over the top, remember the extent of the powers already ceded to Brussels. In any case, the German plan is merely a starter: one idea from the most important country in this particular debate.

The detail of the German plan is therefore less important than the direction of the argument: that quite aside from the hurdles that any country joining EMU has to jump, there should also be some continuing fiscal discipline to control subsequent behaviour. Otherwise a country could be sufficiently prudent to join the currency union, elect a new government which went berserk, and unsettle the entire edifice.

If not a fine, what? It is difficult to see a satisfactory alternative. The option of expulsion or suspension from EMU is not possible: this is a not a club countries can join and then leave.

We know that currency unions can break up, but you cannot construct what is supposedly a permanent union on the basis that anyone failing to meet the club rules will be kicked out.

The main alternative to a fine is some kind of automatic adjustment through the tax or spending mechanisms. For example, there could be some automatic levy imposed on, say, VAT, whereby if a country's deficit rose above the 3 per cent level, taxes would rise automatically to pull it back. But to do this, part of the tax revenues would have to pass directly to Brussels, which would be even more unpopular than the German-inspired fine, particularly since the fine is actually intended as a deposit: once the budget came back under control, the erring country would be reimbursed.

No, the really useful thing that Mr Waigel has done is to draw attention to the point that the Maastrich conditions were badly framed in that, while they set up three credible hurdles for entry, they failed to take into account what might happen after entry. It is rather like making someone pass a competitive examination before taking them on for a job, but then failing to monitor how well the job is performed.

You can make a powerful argument that the continuing discipline ought to be tighter than the entry conditions, certainly as far as public borrowing is concerned. The 3 per cent limit is high, given the enormous unfunded pension liabilities of most EU governments (not Britain) and their adverse demographic profiles. If pension liabilities are not to become an intolerable burden on future generations, most EU governments, far from running deficits, ought to be running surpluses.

Still, this is a start. At least the notion that there should be continuing discipline on public indebtedness is on the table. We should thank the Germans for that. We should thank them, even though we have these opt- outs and the very idea of another European body with power to fine even upsets the Europhiles? Well, yes. The fundamental fiscal position of Britain is already better than that of most other EU states, so this is not our problem. But we do have a direct interest in the success of the European economy. Anything that compels our EU partners to examine the mess they have made of their public finances will encourage them to implement tax and spending reforms, and the sooner that is done the better for the European economy.

Comments