Euro Area Policies: Selected Issues

Euro Area Policies: Selected Issues

Abstract

Euro Area Policies: Selected Issues

Euro Area Structural Reform Governance1

Faster progress on structural reforms is necessary to boost productivity, competitiveness and growth, achieve greater real economic convergence, and improve the resilience of the monetary union. Shifting to outcome-based benchmarking, stronger EU oversight with less discretion in applying existing rules, and better financial incentives for delivering on reform commitments could help accelerate progress on reforms. The governance framework should be simplified, and deeper reforms should be considered in the medium-term, including a greater role for the EU in promoting reforms to further convergence.

A. Why Structural Reform Governance?

1. Insufficient progress on structural reforms. Despite some progress on reforms, labor productivity in the euro area has trailed the United States, especially in crucial sectors such as services and information technology (Figure 1, panel 1). There are also significant productivity gaps within the euro area, especially in the service sectors (Figure 1, panel 2), attributed to lagging product market reforms (Coeuré, 2014). Hence, continued progress on structural reforms is needed to boost growth, productivity, and competitiveness, and further economic convergence (Juncker et. al., 2015; Van Rompuy et. al., 2012; Draghi, 2014). It is estimated that closing 10–20 percent of the gap in product and labor markets relative to best practices in the OECD could help raise euro area GDP by 3½ percent in 2019 compared to the baseline scenario (IMF, 2014a).2

Figure 1.
Figure 1.

Euro Area Productivity

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Note: The category of professional and business services is used for the US. For euro area countries, the sector is “professional, scientific and technology activities.”Source: Bureau of Economic Analysis, Eurostat, IMF staff estimates.

2. Declining impetus for reform. While the positive effects of structural reforms on investor confidence, medium-term growth potential and productivity are generally not questioned, reforms can have short-term economic and political costs. And, in a vicious cycle, the lack of popular support for reforms is, in part, due to the failure to implement comprehensive measures which has led to perceptions of unfairness (Coeuré, 2014). Moreover, there is concern that better financial market conditions could make the need for structural measures seem less urgent.

3. A governance framework to keep reforms on track. There is growing recognition that structural reform governance needs to be improved to ensure that reforms continue to progress in the current economic and political environment. The Four President’s Report (Van Rompuy et. al., 2012) highlighted this need but was only partially implemented. The recent Five President’s report (Juncker et. al, 2015) lays out an ambitious vision for the economic governance of the European Economic and Monetary Union (EMU).

4. Roadmap. This paper builds on existing ideas for improving structural reform governance and outlines concrete proposals for incentivizing the implementation of reforms in the near term and over the longer haul. Section B takes stock of the current EU structural reform governance framework and describes the effectiveness of the various modalities for incentivizing and furthering structural reform objectives—policy coordination, SGP flexibility, fiscal transfers and financial penalties, and legislative options. Section C suggests ways in which these mechanisms might be improved in the near term—within the existing remit of the Treaty—to facilitate implementation. Beyond the near term, more fundamental governance changes would be helpful to ensure reforms in areas currently outside the EU’s jurisdiction and greater convergence within the monetary union (Section D). Section E concludes.

B. The Current Framework: How Effective?

The European Semester “has significantly strengthened the coordination of economic policies.” However, “the addition of numerous ‘packs’, ‘pacts’, ‘procedures’ and manifold reporting requirements have blurred its rationale and effectiveness.” Five President’s Report (Juncker et. al., 2015).

A Complex Framework

5. Limited mandate of the EU institutions under the Treaty (Figure 2).3 The modalities and scope for implementing structural reforms in the EU are enshrined in the Treaty on the Functioning of the European Union (the Treaty). However, Treaty provisions for the governance of structural reforms are less specific than those for fiscal governance, which leaves scope for interpretation of the rules and weaker EU enforcement tools over structural reforms. The Treaty limits the EU’s jurisdiction to areas of “exclusive” competence and “shared” competence with member states. In addition, the EU is empowered to enforce coordination mechanisms by adopting guidelines or arrangements within which member states are mandated to coordinate economic, employment and social policies; and it can guide, coordinate and supplement member state actions in certain areas.

Figure 2.
Figure 2.

EU Governance Framework for Structural Reforms—An Illustration

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Note: Bullet points indicate areas of competence. Thickness of arrows indicates the tools most likely to be used for specific “competencies.” Dashed arrows indicate that Europe 2020 targets play a relatively limited role.Source: IMF staff compilation.

6. A range of processes and implementation tools. The EU governance framework for structural reforms—which, in principle, applies to all EU countries4—consists of:

  • EU secondary legislation, comprising Regulations, Directives and Decisions which set common standards. Regulations are directly enforceable in their entirety, whereas Directives are used to bring national laws in line with a specified objective, leaving national authorities some discretion over the speed and process by which to achieve Directives’ goals.

  • Economic policy coordination under the European Semester. Since 2011, EU countries coordinate fiscal, macroeconomic and structural reform policies through a common annual surveillance cycle—the European Semester—on the basis of national reform and stability or convergence programs. This coordination is based on Articles 121 and 148 of the Treaty (on economic policy coordination and employment policies), and in conformity with the Integrated Guidelines. Coordination was strengthened by the Six-pack and Two-pack legislation, which increased the EU’s capacity to enforce reforms in euro area countries through financial sanctions under certain circumstances (see below).

    • Country-Specific Recommendations (CSRs). Each year, during the European Semester, the EC assesses economic developments, including progress toward Europe 2020 targets,5 and proposes CSRs in a wide range of areas including product markets, R&D and innovation, employment and social policies, public administration and finances, and the financial sector. CSRs for EU countries and the euro area as a whole are discussed and recommended by the Council to member states, adding an element of peer pressure to the EC’s public opinion.

    • Macroeconomic Imbalance Procedure (MIP). The MIP seeks to reduce macroeconomic imbalances. Under its preventive arm, the EC takes macroeconomic imbalances into account when formulating CSRs. Countries found to have severe imbalances can be put under the corrective arm—the Excessive Imbalance Procedure (EIP)—which requires submission of a corrective action plan (CAP) with a clear roadmap and deadlines for implementing structural reforms.6 For euro area countries, failure to deliver a sufficient CAP or comply with commitments can lead to financial sanctions of up to 0.1 percent of GDP per year.

  • Stability and Growth Pact (SGP). The fiscal framework explicitly recognizes the role of structural reforms in achieving a sound budgetary position. Hence, the EU can also incentivize the implementation of structural reforms via its fiscal governance role.

7. Complex framework. While the economic governance framework has been strengthened significantly compared to the pre-crisis period (European Commission, 2014a), the arrangements remain complex, with a range of enforcement tools and overlapping processes (Figure 2). The interaction with the SGP—a separate but overlapping framework that has become increasingly complicated after the Six-pack and Two-pack legislations—adds to the complexity of the overall process. The introduction of coordination and rules-based frameworks via intergovernmental processes (e.g., “Euro Plus Pact,” “Fiscal Compact”) has further added to complexity.

EU Legislation Has Been Effective

8. Regulations and Directives. EU legislation is a potent enforcement mechanism for reforms, but the EU can only legislate in areas where it has “exclusive” and “shared” competencies or provides arrangements for coordination. It cannot adopt legally binding legislation in areas—such as economic policy—where the EU’s powers are restricted to providing guidelines for coordination, unless considered strictly necessary to support the functioning of the Single Market (e.g., labor mobility and pension portability). In case of non-compliance, enforcement works through infringement procedures, with an eventual imposition of fines upon non-compliant member states.

9. Legislated reforms are implemented. Legislation has generally been quite effective in enforcing desired outcomes. More than 99 percent of Internal Market Directives have been transposed into national law (European Commission, 2014b). And upwards of 85 percent of infringement cases are typically settled due to corrective actions taken before they reach the European Court of Justice. Progress toward Europe 2020 goals may also suggest better compliance under the legislative approach (Figure 3): more progress has been made in areas where the targets are legally binding and specified in Directives (energy, climate). In contrast, there has been less progress in areas where targets are not legally binding (employment, poverty), though the crisis has also contributed to these outcomes.

Figure 3.
Figure 3.

Europe 2020 Headline Indicators—Target Values and Progress Since 2008

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Source: European Commission

10. But legislation is no silver bullet. A prominent example of legislation that has been implemented but fallen short of desired outcomes is the Services Directive. Despite full transposition into national law by 2012, the Directive is constrained in promoting cross-border trade in services and labor mobility in part because persisting legal and administrative barriers to the Single Market limit the portability of welfare rights and access to regulated professions.

Policy Coordination: Pluses and Minuses

11. Policy coordination has fostered debate. The European Semester is an improvement over earlier surveillance of structural reforms via the so-called Lisbon process. The peer review embedded in discussions of CSRs has strengthened debate about country-specific and common policy challenges and responses among EU members (European Commission, 2014a and c). There have been notable successes. In line with their CSRs, Italy and Spain took measures to improve SME access to finance in 2014. While some CSR measures that were implemented may have been low-hanging fruit and already part of government plans, it is possible that absent policy coordination reforms could have been weaker (although the counterfactual is hard to establish). More generally, policy coordination has been an important mechanism to encourage action, including in larger countries, which could foster solidarity and evenhandedness.

12. But progress has been slow. It is still early to fully evaluate the relatively new framework, in part because the MIP has not been put to the test and smaller “imbalanced” economies have until recently been outside its scope due to financial programs.7 Moreover, market pressure has also played a role in incentivizing reforms. Nevertheless, the EC’s own assessment is that despite important progress in urgent areas after the crisis, compliance with CSR recommendations has been insufficient in light of the remaining reform challenges (Figures 45). It estimates that, for 2012 and 2013, only around 10 percent of all CSRs have been fully or largely implemented, although there has been “substantial or some progress” on more than half of the CSRs (Deroose and Griesse, 2014).8 Averaging across qualitative evaluations of compliance by the EC indicates that, on the whole, compliance with CSRs also seems to have fallen in 2014 compared to 2013 (Figure 4).

Figure 4.
Figure 4.

Country Compliance with CSR

(Index, Full Compliance = 4)

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Note: The EC assesses progress on CSRs on the scale: none (0), limited (1), some (2), substantial (3), full (4). “Limited” progress indicates that some measures have been announced, but they are insufficient and/or their implementation is at risk;”some” progress denotes that measures have been announced, and are promising, but implementation is uncertain.Source: European Commission (2014c).
Figure 5.
Figure 5.

Progress Toward 2014 CSR Targets

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Notes: CSR recommendations can be counted twice if they belong to two categories; hence, the number of colored squares does not always match the number of recommendations. Red, yellow, green indicate “no or limited,”“some” or “substantial” progress respectively (see note on Figure 4). Fiscal = excessive deficit procedure, budget, tax, pension, healthcare; labor = labor tax wedge, wage-setting, work incentives, activation measures, labor participation, public employment services, vocational training; product = service and retail sector barriers, procurement, land use, competition; financial = banking system operation and supervision, SME credit, distressed assets restructuring, central credit registry; infrastructure = greenhouse gas emissions, energy efficiency, energy networks, competition in transportation sector, housing market; public administration = local governments, public services, administrative reforms to municipal structures, state-owned enterprises, business environment, EU funds, corruption, judicial reforms, and regulatory burdens.Source: IMF Staff classification based on assessment in European Commission 2014c.

13. The EU’s powers: too little, too late. The EU cannot compel compliance as CSRs are not legally binding; it is up to member states to design and implement reforms. The EC and the Council can propose, monitor and assess reforms and outcomes, as well as issue warnings and recommendations when reforms are not consistent with the broad guidelines or risk jeopardizing the monetary union. The EU can also impose sanctions on euro areas countries (see next section) for which the EIP has been triggered, limiting the EU’s capacity to preempt imbalances from arising.

Limited Incentives

14. Weak incentives of members. Member countries may have limited incentives to pressure their peers if the wider and cross-border implications of reforms are not clear. Countries may also refrain from pressuring others in the hope of avoiding pressure themselves.

15. Semi-automatic sanctions are part of the toolkit… The provisions for sanctions vary:

  • EIP. For euro area countries under the EIP, financial sanctions can be applied for an insufficient CAP or non-compliance with actions included in the CAP. If the EC recommends sanctions, the Council considers the decision on the basis of reverse qualified majority voting (RQMV), i.e., sanctions can be applied semi-automatically.

  • SGP flexibility. Failure to implement structural reforms agreed under the SGP can lead to sanctions as well as suspensions of European Structural and Investment (ESI) funds under the excessive deficit procedure (EDP).9

  • ESI funds. In the 2014–2020 programming period, ESI funds are more closely aligned with structural reform priorities and countries are encouraged to program the use of ESI funds to support the implementation of CSRs. Also since 2014, ESI funds can be reprogrammed at the EC’s request and may be suspended for failure to take effective action under the EDP and/or the EIP.10

16. …but excessive discretion in enforcement. The EC has held back in applying the enforcement tools at its disposal (ECB, 2015b, Box 5). Since 2011, the EC has full discretion in recommending that an EIP be launched or when judging insufficient action.11 To date, the EIP has never been opened—and thus no sanctions have been imposed—even though several countries have been diagnosed with excessive imbalances (Spain and Slovenia (2013); Italy, Croatia, and Slovenia (2014); and, Bulgaria, France, Croatia, Italy, and Portugal (2015)). In these cases, the EC stepped up recommendations and monitored policy actions in member states by means of an enhanced process of “specific monitoring” which foresees bi-annual missions and reporting. The EIP was not opened as the EC considered the policies outlined in revised national reform programs and stability or convergence programs to be appropriate for addressing the imbalances. Similarly, under the SGP, there are few precedents of the EC proposing “no effective action.” Thus, the system of semi-automatic sanctions has not resulted in any actual sanctions, although it could be argued that it is the prospect of sanctions that has incentivized countries to take action. Reform fatigue and opposition to additional integration among member states could further undermine the effective use of the EC’s enforcement tools.

C. Proposals for Strengthening Incentives

“…closer coordination of economic policies is essential to ensure the smooth functioning of the Economic and Monetary Union… [there is a need to] develop concrete mechanisms for stronger economic policy coordination, convergence and solidarity.” EU Summit, October 2014

17. Simplicity, accountability, transparency. In the near term, the priority should be to strengthen the implementation of reforms by improving ownership and incentives through greater specificity, transparency, and accountability. This would help reduce excessive discretion in the application of the governance framework, level the playing field across the membership, and provide member states with the necessary support to take politically difficult actions. The following complementary and interrelated proposals—benchmarking in priority areas, making use of the EU’s legislative authority, introducing greater specificity in CSRs, and improving incentive mechanisms—would not require Treaty changes. Figure 6 illustrates the proposals, which are elaborated further in subsequent sections schematically.

Figure 6.
Figure 6.

Four Complementary Proposals for Strengthening the Governance of Structural Reforms: An Illustration

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Source: IMF Staff illustration.

Proposal 1: “Outcome-based” Benchmarks on Area-wide Priorities

“The next step is to restart the convergence process in the euro zone in a sustainable way to lift growth potential…this requires benchmarking against best practice.” J. Dijsselbloem, April 2015

18. “Outcome-based” benchmarks for area-wide priority reforms. EU institutions could specify desirable area-wide priorities for structural reforms with outcome-based area-wide reform targets (“benchmarks”), which are sufficiently concrete, measurable, and directly under the control of policymakers.12 Benchmarking could focus on priority reforms, namely those that further convergence (such as a common energy market, integration of services markets, or digital networks) and those that improve national productivity, competitiveness, the business climate and resilience to shocks (such as harmonizing and reducing the cost of doing business or the time it takes to enforce contracts). Figure 7 and Table 1 provide examples.

Figure 7.
Figure 7.

Structural Reform Indicators: Distance to OECD Best Practice

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Table 1.

Possible Outcome-Based Benchmarks on Area-Wide Priority Reforms

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Barriers to cross-border provision of services were identified by the EC on the basis of “mutual evaluations” done by member states and expert knowledge (see Monteagudo, et. al. (2012); an update of this study is expected in late 2015). Note: The distinction between qualitative and quantitative indicators is primarily based on the underlying data. Thus, indicators relying primarily on surveys are considered qualitative despite their numerical values. Some indicators (e.g., WBDB) are based on both qualitative and quantitative information. Net pension wealth is an OECD indicator measuring the incentive to remain in the workforce for an extended time. Source: Area-wide reform priorities from European Commission (2014b).

19. Ambitious targets. Area-wide goals could be based on regional and global best practices and outcomes (Figure 7). They will need to be given political legitimacy by the Council (and thereby the member states), and the European Parliament (step 1 in Figure 6). Setting and enforcing area-wide benchmarks may be legally easier in areas of “exclusive” and “shared” competence than in the areas where the EU is restricted to coordination. But even in the latter case, there is scope for greater specificity and benchmarking.

20. Advantages: simplicity + transparency + accountability = ownership + implementation. The shift to outcome-based targets would have a number of benefits.

  • Greater ownership. The failure to implement CSRs is sometimes attributed to the top-down nature of the recommendations and the lack of member states’ ownership. Agreement on area-wide benchmarks at the political level (Council and Parliament) could help foster ownership as member states would be involved in setting these benchmarks. Benchmarking may also help generate popular buy-in for reforms by focusing the policy debate on desired outcomes. Member states would work with the EU to define a feasible, but ambitious timeframe for transitioning to the area-wide benchmarks. Finally, they would have some leeway in how they achieve targeted outcomes in that they would be able to develop their own action plans to achieve area-wide goals.

  • Enhanced credibility. Outcome-based benchmarking would help simplify and better prioritize reforms, as well as facilitate monitoring and pre-emptive corrective action where necessary. The focus would be squarely on the ultimate objective, and by making differences in performance clearly visible and comparable across countries, the new approach would reduce the EC’s ability to exercise excessive discretion in utilizing its enforcement tools, increase accountability for action or inaction, and level the playing field across members. It can also help reduce the perception of an overbearing EU as benchmarks would reflect a collective commitment.

21. Challenges: identifying and measuring outcomes. Determining and quantifying the appropriate benchmarks will not always be easy as it may be difficult to find specific quantifiable indicators with all the desired characteristics—measurable with a fair degree of certainty, realistic and enforceable, directly under the control of policymakers, as well as closely and strongly linked to the ultimate structural reform objective. The structural reform indicators already used by the EU, multilateral institutions, policymakers and analysts in their surveillance and research could, however, be a good starting point for determining suitable benchmarks.13 Some of these indicators are produced relatively infrequently at present, and there may be a need for the EU to produce similar (or better) indicators at more frequent intervals. In some cases, benchmarks could be based on indicators that the EU already collects and monitors as well as Eurostat statistics, such as the common methodology for assessing administrative costs posed by regulations (European Commission, 2005). Table 1 provides a non-exhaustive set of potential indicators in EU reform priority areas (European Commission, 2014b).

  • A simple case. France’s 2014 CSR included a recommendation to “simplify companies’ administrative, fiscal and accounting rules and take concrete measures to implement the Government’s ongoing ‘simplification plan’ by December 2014.” An outcome-based approximation of the same recommendation might be, “reduce the time it takes for a company to comply with tax rules to x hours” (similar to the indicator compiled by the World Bank), or “make electronic tax filing mandatory.” While the suggested benchmarks may be narrower in scope than the original formulation, they have the advantage of being focused on a macro-critical outcome, are more transparent and easy to monitor, and, they could conceivably require a broader set of policy actions.

  • A more complex case. Another example could be targets on employment rates such as in the Europe 2020 strategy. While these may seem quite specific and outcome-based, the actual employment rate can be difficult to target effectively as it is subject to confounding factors that influence employment, such as growth, but are not entirely under the control of policymakers. A more easily enforceable target might be one on the labor tax wedge or labor market duality (e.g., “reduce labor tax wedge or labor market duality to x percent in y years”) as this can be directly influenced by policy and has been empirically shown to be one of the factors associated with higher employment rates.

Proposal 2: Legislating Priority Reforms

22. “Upgrade” to EU legislation. For priority reforms, area-wide benchmarks could be implemented via EU legislation, especially to further convergence where the necessary political consensus has already been achieved (Figure 6). If there is political willingness, this would be feasible in areas of “exclusive” and “shared” competence, giving the EU the power to push for faster progress on product market reforms as well as EU-wide initiatives to build a single market for services, capital, energy, transport and the digital sector. Legislation can also be used to benchmark reforms in areas where the EU has powers to coordinate. Directives and Regulations specifying concrete targets generally have a good track record in achieving desired outcomes (Table 2).

Table 2.

Examples of Outcome-Based Directives and Regulations

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23. Advantages of a legislative approach. EU legislation would imply stronger enforcement powers than coordination mechanisms, because legislation, once adopted, must be implemented. Legislation may also be particularly helpful in harmonizing practices and laws to complete the Single Market. And it could strengthen the hand of national governments in pushing through reforms against opposition from local vested interests. It could also promote investor confidence as uniform EU legislation would be easier to navigate than several national laws, and EU laws may be less susceptible to reversals than national legislation. Outcome-based legislation can also foster greater buy-in for reforms by clarifying expectations and providing scope for even-handed application of sanctions for non-compliance across all euro area members.

24. Caveats and complications. A legislative approach may not be appropriate for every reform, but it can take many forms. The choice would depend on the specific policy area, and whether the EU has powers to legislate in that area. For example, a legislative approach to improving insolvency regimes in the euro area could either comprise an EU insolvency law replacing national laws; the specification of a list of best practices that all national insolvency laws should adhere to; or, the specification of outcomes that would need to be delivered within the parameters of national laws. Moreover, legislation would require political consensus, which can take time, and it may be resisted by non-euro area countries to which it would also apply.

25. Smart legislation. The legislative approach can be consistent with the current EC initiative to reduce excessive legislation to cut red tape. In fact, these objectives may reinforce each other by better prioritizing reforms where greater harmonization is needed, and avoiding or removing unnecessary legislation that distracts from important policy goals. Smarter use of legislation would also help clarify the role of EU institutions vis-à-vis member states, allowing it to act selectively but forcefully on matters that have a bearing on the functioning of the EMU.

Proposal 3: Policy Coordination with More Teeth

26. Shift to outcome-based CSRs. Since euro area countries have vastly different starting points, they may need to transition to the area-wide benchmarks at different speeds. Complementing the legislative approach, CSRs could focus on country-specific intermediate benchmarks that measure progress toward the desired area-wide benchmarks (Figure 6), like the national targets to achieve Europe 2020 headline goals. This would simplify CSRs, making them more focused, specific, and transparent in contrast with past CSRs which have, until 2014, on average comprised between 4–8 major recommendations per country, with several sub-recommendations (Table 3).14 Outcome-based CSRs would be easier to monitor and could increase ownership of CSRs through member state endorsement of the area-wide benchmarks.

Table 3.

Alternative Specification of 2014 CSR Recommendations: Some Examples

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Alternatively the common methodology used in the EU to assess the impact of regulations, especially administrative costs, could be used (European Commission, 2005).

The assessment of barriers could be based on Monteagudo, J. et. al., (2012).

Source: European Commission; IMF Staff Proposals.

27. Peer comparison and competition. The EC already rates progress under the CSRs on a five category scale (no/limited/some/substantial progress, or fully implemented). A streamlined MIP dashboard summarizing scores on performance toward benchmarks could provide a picture of the overall track record for reforms, allow better differentiation of country risk and prospects, and could increase the pressure on countries to reform. Such a system may be particularly useful in pressuring the larger countries to reform in order to preserve their relative standing among peers.

28. Even-handed enforcement, timely and credible action. Benchmarking reforms could also reduce the scope for excessive discretion in the application of sanctions by increasing transparency. Semi-automatic sanctions would be allowed to work and their credibility enhanced. Benchmarking can also reduce political complications by providing early warning and scope for pre-emptive action. Reforms take time to implement and bear fruit, and should ideally be implemented in good times when it is possible to cushion redistributive effects. Moreover, sanctions may lack credibility in a downturn. Thus, reforms should be encouraged well before imbalances become excessive and economic circumstances deteriorate. To do so, the EC should take progress toward CSR structural benchmarks into consideration when triggering the EIP.15

Proposal 4: Strengthening Incentives

More support from the EU

29. Funding reforms. Direct financial transfers from the EU could help cover reform costs and support reform. Financial transfers have been successfully used in other countries to foster the implementation of center-led reforms, including Australia, Finland, Germany, Italy, and the United States. For instance, in 2009–2013, the federal government in Australia provided A$6.7 billion (0.1 percent of GDP) to states conditional on commitments to increase skill levels. The U.S. federal government also provides grants to incentivize states, e.g., to ensure adoption of federal education standards and to expand low-income health care coverage via Medicaid, including under the Affordable Care Act.

30. Better prioritization of EU transfers. The scope for direct fiscal transfers from the EU budget is limited as common agricultural policy and structural funds, which are generally not designed to support structural reforms in member countries, absorb more than 70 percent of the EU budget. Nevertheless, ESI funds could be better prioritized and linked more closely to benchmarks to support priority reforms. Should financial sanctions be applied widely, the proceeds could conceivably be recycled as EU financial transfers to support reforms.

31. Allowing use of incentives embedded in the SGP. The EU can incentivize structural reforms via the SGP framework. Under the preventive arm, the implementation of structural reforms with verifiable impact on the long-term sustainability of public finances should be taken into account when assessing progress toward the MTO. Under the corrective arm, progress on structural reform can be taken into account when recommending or extending a deadline for the correction of an excessive deficit. The 2011–13 governance reforms enhanced the links between the fiscal and the structural reform frameworks.16 In 2015, the EC provided guidance on applying the built-in flexibility in the SGP for structural reforms. Countries can now secure SGP flexibility for major planned reforms with long-term positive budgetary impact that are “well specified” and have “credible timelines.” Under the preventive arm, a maximum deviation from the MTO of 0.5 percent of GDP is allowed, provided this deviation can be made up within four years. Under the corrective arm, the deadlines to meet the 3 percent of GDP deficit target can be extended.

  • Full use of SGP flexibility with safeguards. The EC could identify an ex ante list of permissible reforms—based on CSR benchmarks measuring national progress toward area-wide reform goals—that could qualify for SGP flexibility. This would help focus the discussion on implementation rather than on identification of reforms. Where possible, costing estimates could be based on historical experience, and cross-country estimates. For example, a 1 percentage point cut in the tax wedge is, on average, associated with a revenue loss of 0.3 percent of GDP per year (IMF, 2014b, Figure 8.1) and active labor market policies (ALMP) during reforms episodes have cost, on average, about 1 percent of GDP (Figure 8.2). To ensure that flexibility for “permanent” reforms will not compromise the integrity of the SGP framework, countries could pre-commit to binding compensatory fiscal measures in a multi-year framework if agreed structural reforms are not implemented or if the expected returns do not materialize in the specified timeframe. “Safeguard” clauses have been used in Italy’s 2015 budgetary plans.17 Alternatively, flexibility could be provided on a post hoc basis. An outcome-based specification of reforms could reinforce this process.

  • Allow ambitious reforms in countries with good track records. A broader category of reforms should be permitted as the budget may help foster reforms by mitigating their distributive effects, thereby facilitating political consensus. SGP flexibility could be targeted toward appropriate compensation for those affected by reforms to help overcome political obstacles or to incentivize reforms (e.g., a limited window of tax incentives to accelerate the restructuring of balance sheets by banks and corporations). The flexibility provided under the SGP could be increased in countries with a successful track record of reforms, accompanied by appropriate safeguards (see previous bullet). This would allow more ambitious and comprehensive reforms with higher growth dividends and better reflect the fact that gains from structural reforms take time to materialize. For instance, it cost Finland 0.8 percent of GDP in higher spending on ALMPs in 1992 to facilitate the reduction of employment protection. The OECD (2014) estimates that comprehensive reforms in France would take 5–10 years to have a sizeable impact on potential growth and generate noticeable fiscal space.

Figure 8.
Figure 8.

Direct Fiscal Costs of Reforms

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Sources. OECD and IMF staff calculations (Figure 2.7 in IMF, 2014).

32. EU technical support. Several euro area countries face absorptive and administrative hurdles in implementing reforms, including, for example, the inability to attract the best people to provide the necessary expertise and manage the implementation of reforms. In such cases, support from EU institutions can be helpful. It can take the form of voluntary technical assistance; EU-wide knowledge hubs with expertise on how to meet targets; or, direct funding for experts to design and deliver reforms. In Portugal, for example, tax administration improved significantly after the government hired an expert to head the responsible agency. In some countries, EU funding can address absorptive and administrative limits for implementing reforms (e.g., technical assistance as in the Youth Guarantee Scheme).18

Enforcing commitment to reform

33. Making non-compliance more costly. There could be merit in ensuring greater parity with penalties under the SGP framework to simplify the governance framework and take into consideration the fact that structural reforms have direct and indirect effects on the fiscal deficit. Non-compliance could be made somewhat more costly by including provisions for non-interest bearing deposits for failure to comply with the EIP, with repeated offenses also triggering enhanced conditionality-based EU monitoring. By increasing transparency, benchmarking could increase the likelihood of these penalties being used, thereby improving incentives to reform.

34. Leveraging conditional access to ESI funds. With economic governance conditionality for ESI funds becoming operational in 2015, the EC should make appropriate use of the possibility to reprogram and align the use of ESI funds as closely as possible to the implementation of CSR benchmarks to strengthen the financial incentives for reform (e.g., implementation of the Internal Energy Market legislative package has been linked to ESI Funds). Moreover, where possible, an immediate suspension of payments rather than commitments would be more effective.

35. Binding commitments. Extracting commitments from individual countries on achieving reform benchmarks would enhance the legitimacy of sanctions and penalties if they need to be imposed. The commitment should be public, high-level, and sufficiently binding so that there would be a presumption of penalties and sanctions upon failure to meet the agreed outcomes. Requiring that any waivers from sanctions or penalties be fully transparent and a systematic use of a “comply-or-explain” process (Juncker et. al., 2015) would enhance the credibility of the framework.

D. Beyond the Near-term: Moving to a Structural Union

36. The above proposals can help promote the implementation of structural reforms in the near-term, but they bump up against constraints embodied in the Treaty. More fundamental changes to the governance framework could help ensure broader and deeper reforms in euro area countries in areas currently outside the EU’s jurisdiction, but this may entail further Treaty amendments. Deeper reforms in the governance framework should build on the principles embedded in the above proposals—namely, greater clarity and specificity in setting the reform agenda; a clearer division of labor between the EU and member states; a greater say of the EU in a broader set of reforms especially if they are critical for the monetary union; less discretion in assessing compliance with benchmarks, but more flexibility in how benchmarks are achieved; and, finally, larger financial incentives for reform, including under the SGP. Reforms listed in Section A can start sooner as they only require political consensus but not Treaty change.

Under the Current Treaties

Encouraging innovation in member states

37. Ex ante support by national productivity councils (NPC). NPCs could be set up to assist governments ex ante in translating area-wide reform targets into national action plans, possibly with some EC participation. NPCs play a useful role in other federations such as Australia, Belgium, Germany, the Netherlands and New Zealand, although their design and functions vary (Table 4).19 NPCs could be tasked with: designing reforms; monitoring implementation and preliminary outcomes; and proposing amendments to the action plan as necessary to achieve the desired outcome. Governments would be in charge of actual implementation. The dialog between NPCs and governments regarding reform proposals and implementation could improve transparency and help educate the public about the need for and impact of reforms. To the extent member states have leeway to experiment with different approaches to reach the same goals, they would be “laboratories of democracy.”20

Table 4.

National Productivity Councils of Australia and Belgium: A Brief Summary

article image
Sources: http://www.pc.gov.au/; and http://www.eesc.europa.eu/ceslink/?i=ceslink.en.escs-in-member-states-cce-crb

38. Critical design issues. Cross-country examples and national fiscal councils can provide a template for the appropriate governance framework for NPCs. It would be important to ensure strict operational independence from politics, accountability, a strong presence in the public debate, and adequate resources (Debrun and Kinda, 2014).

Transparency and accountability of EU institutions

39. Ex post evaluation by independent “EU structural council.” Greater powers for EU institutions ought to come with greater ex post accountability, in part to address the perceived “democratic deficit” (lack of control over EU decisions). The EC’s discretion increased after the Twopack, the Sixpack and the Treaty on Stability, Coordination and Governance (TSCG) without a corresponding increase in checks and balances. A Chief Economic Analyst (CEA) was appointed in 2012 to review ex ante the EC’s application of the rules; however, these reports are addressed only to the Commissioners and are not public. An independent evaluation process, governed by the Parliament, for the EC’s monitoring and enforcement of the governance framework could be considered, with a presumption of publication of assessments and reviews. The evaluation should be independent of the EC and operationally at arm’s length from the Council and the Parliament.

40. Clarifying and simplifying the governance framework. The framework should be clarified and simplified. This would help explain the context for EU-led reforms including in areas where the EU’s role is currently subject to interpretation (e.g., labor and social policies).

Better Incentives

41. Uniform incentives. The January 2015 EC guidance on SGP flexibility does not specify the magnitude of fiscal space that countries under the corrective arm may obtain in exchange for structural reforms. Extending the 0.5 percent of GDP fiscal space for structural reforms to all countries would simplify and clarify procedures and help focus the discussion on reform implementation. These changes could be considered in the context of reforms to the fiscal framework (such as merging the preventive and corrective arms of the SGP).

42. Bigger and better functioning EU budget. Providing meaningful and strong incentives for structural reforms will require a much bigger and better functioning EU budget, with disbursements closely linked to the full implementation of a set of ex ante agreed measures. Currently, the average annual commitment of ESI financing represents a relatively small share of GDP (Figure 9) for most EU countries except smaller states. In contrast, federal transfers to states in the United States totaled 3.3 percent of GDP in FY 2014 alone.21 A substantially expanded EU budget—funded by a dedicated revenue stream for example—might be able to provide direct fiscal transfers to incentivize and support structural reforms in member countries, in addition to other benefits such as helping to smooth asymmetric shocks.22 The idea of a common euro area fiscal capacity was widely discussed in the context of the Van Rompuy et. al. 2012 report, but did not gain political traction at the time.

Figure 9.
Figure 9.

European Structural and Investment Funds

Average Annual Commitment, 2014–20 (Percent of GDP)

Citation: IMF Staff Country Reports 2015, 205; 10.5089/9781513523088.002.A004

Source: European Commission.

Reforms Requiring Treaty Change

43. Greater EU role. In an increasingly complex global economy, addressing challenges can require reforms that cut across a broad range of areas. There is evidence of sizable interactions between labor and product market reforms linking the effectiveness of deregulation in one market to the level of regulation in the other market (e.g., Berger and Danninger, 2006; Bassanini and Duval, 2006). The mutually reinforcing effects of structural reforms underscore the need for reforms to be considered together. Therefore, it may not be meaningful to limit the EU’s role to a narrowly defined area of “exclusive and shared competence” since its ability to achieve goals in one area can depend crucially on policies in another area outside its purview.

44. Which reforms? The EU should have the ability to enforce reforms that achieve two goals (Draghi, 2014). The first goal would be to allow member states to thrive within the monetary union. This would require reforms that increase growth, competitiveness, and productivity, and reduce vulnerabilities at the national level. The second goal would be to complete the Single Market to improve the resilience of the monetary union and foster further convergence in the absence of common area-wide public sector risk-sharing. This would include reforms that achieve sufficient flexibility in factor markets and greater private sector risk-sharing to enable a faster adjustment to shocks. Some reforms can contribute to achieving both objectives.

E. Summary and Conclusions

45. Reforms should continue. It is important to keep up the momentum for structural reforms to improve flagging productivity, sustain and boost the recovery, and build a stronger monetary union. The 2010–11 reforms strengthened the governance framework and provided the EU more scope and authority to push reforms forward, but implementation challenges are evident even at this early stage.

46. Political commitment for reform. In the near term, the current framework could be made to function better by increasing ownership (by garnering collective political commitment toward ambitious area-wide reforms); strengthening existing incentives (via greater specificity, outcome-based benchmarking, transparency and accountability); and providing stronger and even-handed support for reforms. A simpler framework, dynamic ex ante experimentation with reforms by national productivity councils, and independent ex post evaluation of the implementation of the governance framework would improve transparency and ownership. Deeper reforms are needed in the medium-term, including a broader role for the EU to ensure the resilience of the EMU. These reforms should ideally be combined with amendment of the fiscal framework to increase synergies between the two, while reducing overlaps and complexity. Deep political commitment and political capital is required to bring about these changes to the economic governance framework of the EU to ensure the resilience of the monetary union.

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1

Prepared by Angana Banerji, James John, Sergejs Saksonovs and Tao Wu (EUR); Tidiane Kinda (FAD); and, Bergljot Barkbu and Hanni Schoelermann (EUO).

2

Estimates are derived using the IMF’s EUROMOD multi-economy model. Several recent studies echo these findings, e.g., Anderson et. al. (2014), Barkbu et. al. (2012), ECB (2015a), Hobza and Mourre (2010), Varga and int’Veld (2013).

3

EU institutions refer to the European Commission (EC), the Council of the European Union (Council) and the European Parliament (Parliament).

4

Non-euro area countries cannot be sanctioned under the MIP. The framework also does not apply to countries receiving support under financial assistance programs.

5

Europe 2020 targets: (i) 75 percent employment rate (20–64 years), (ii) 3 percent of EU GDP investment in R&D, (iii) energy sustainability, (iv) lower rate of early school leaving, and, (v) reduction in poverty and social exclusion.

6

The EIP entails recommendations and decisions that are different from the MIP preventive arm, and more frequent monitoring and assessment. It remains to be seen how an EIP would be aligned with the standard EU Semester.

7

The European Commission (2014a) notes that the experience with the framework has been limited and remains untested due to the limited time span since its entry into force. It notes that progress on reforms has been stronger than under the Lisbon process.

8

According to the EC, there has been significant progress in financial sector, insolvency, and pension reforms where there was greatest need after the crisis, but less progress in service sector and some product market reforms. This paper does not evaluate the strength of the reforms envisaged in the CSRs other than to note that there is some overlap between the priority measures proposed by the IMF, EC and the OECD in various policy areas.

9

Under the SGP’s preventive arm, countries could receive a warning and ultimately a financial sanction in form of an interest-bearing deposit (Council decision by RQMV) if the failure to implement structural reforms under SGP flexibility results in a significant deviation from the medium-term objective or the path towards it. In the corrective arm, such a failure could be considered an aggravating factor when assessing effective action, leading to stepped-up procedures with temporary suspension of parts of ESI funds (RQMV decision for the adoption of the first sanction). Persistent non-compliance could to lead to financial sanctions of up to 0.7 percent of GDP for euro area countries.

10

The EC is legally obliged to propose suspension of payments or commitments if the conditions for suspension are met. Payments are only suspended in case of significant non-compliance and if immediate action is sought.

12

The idea of benchmarking is not new. As far back as December 2003, the EU Council of Ministers adopted a shortlist of 14 structural indicators to be used in assessing national reform programs (Ioannou et. al., 2008). Benchmarks were also under consideration during the 2010–11 EU governance reforms. More recent proposals have been made by Padoan and Schäuble (2014), Dijsselbloem (2015) and Juncker et. al. (2015), whereas Draghi (2014) argues for greater specificity in reforms. Outcome-based targets are already used to some extent (e.g., headline targets in Europe 2020, numerical targets in several EU directives).

13

These can be based on: (i) on qualitative information relying on questionnaire responses or opinion surveys; (ii) quantitative information; and, (iii) qualitative indicators based on aggregations of quantitative indicators. The EC already uses similar benchmarks for technical analysis of the impact of reforms and progress toward EU Directives (e.g., Monteagudo et. al, 2012 uses World Bank Doing Business Indicators (WBDB) to assess the potential economic impact of setting up national “points of single contact” for services activities and a “closing the gap” approach with best performing EU countries to assess the actual and potential additional impact of the Services Directive).

14

CSRs have been streamlined in 2015.

15

Extending the EU’s powers to sanction countries under the preventive arm of the MIP, similar to the SGP, could simplify the framework. However, CSRs are not legally binding, and penalties under the preventive arm may violate the principle of “proportionality” as long as the EU’s powers are restricted to coordination.

16

Under the EDP, countries must present an Economic Partnership Program, outlining structural reforms for a durable correction of the deficit, while those receiving EU financial assistance prepare a Macroeconomic Adjustment Program also including structural reforms.

17

Medium-term expenditure frameworks with rolling spending limits could also be considered (e.g., Sweden).

18

The recently announced “Structural Reform Support Service” goes in this direction (European Commission Statement/15/5218).

19

Also advocated by Allard et. al., 2010. More recently, Sapir and Wolff (2015) propose the creation of a network of independent national competitiveness councils (modeled after Belgium) at the level of the euro area to ensure that wage developments are in line with those in trading partner countries and prevent competitiveness problems.

20

Portugal’s 2014 CSR measure for “a functionally independent central evaluation unit at the government level, which assesses and reports every six months on the implementation of these reforms, including consistency with the ex-ante impact assessment, with corrective action if needed” goes in this direction.

21

Grants to state and local governments, excluding direct spending by the federal government in states, or taxes paid by state residents to the federal government. Data are from the Office of Management and Budget and the Congressional Budget Office.

22

Allard et. al. (2010) proposed additional EU revenues through EU-wide taxes, e.g., green levies, to provide transfers to incentivize structural reforms in member countries particularly where potential spillovers are large.

Euro Area Policies: Selected Issues
Author: International Monetary Fund. European Dept.