EUC Report: Economic Governance

Lord Wallace of Saltaire Excerpts

Thursday 16th June 2011 Lords Chamber

[Lord Harrison]

The crisis in the euro area has rarely been out of the news over the past year. Therefore, my committee decided to launch an inquiry into EU economic governance, especially after EU member states banded together to provide financial assistance to Greece in early 2009. Since then the crisis has continued to spread. Indeed, while we were taking evidence Ireland received financial support. Since the report was published, yet another euro area country—Portugal—has asked for and received a loan package. In the wake of these difficulties, the European Union has pushed ahead with proposals to reform its economic governance. The proposals are likely to be agreed at ECOFIN next week, so I thank the Government for providing an opportunity for this timely debate.

The euro area crisis followed the worldwide banking crisis in 2008. The interconnection between sovereign debt and the banking sectors was one of principal elements that contributed to the current crisis. However, it was not the cause of the current problems in the euro area; it was merely the trigger. Our report details two more fundamental reasons for the euro area crisis. First, there is an endemic flaw in the architecture of the monetary union: while monetary policy is centralised, fiscal policy remains fragmented among member states and is inadequately co-ordinated. Secondly, the past decade has seen a build-up of macroeconomic competitiveness imbalances among euro area member states. Within monetary union, states can no longer devalue their currencies to regain temporary competitiveness or adjust their interest rates to take account of variations between different economies.

These problems have been exacerbated by a failure of the markets, and member states themselves, to understand how the monetary union worked. The markets treated the euro area as a single entity, and did not distinguish carefully or sufficiently between the financial health of individual member states. This has meant that for most of the past decade the interest rate on Greece’s sovereign debt has not been much higher than the interest rate on German sovereign debt. It should have been.

Our report focused on a series of six proposals published by the European Commission in autumn 2009, which were designed to address these problems. The proposals would monitor and co-ordinate more closely economic policies among the member states. In parallel with the Commission, the European Council established a task force to consider these issues under the chairmanship of the President of the Council, Herman Van Rompuy. With only minor differences, the task force’s recommendations echoed the proposals put forward by the Commission.

The proposals focus on two distinct aspects of member states’ economies. First, they aim to improve fiscal discipline among member states. The Commission has proposed amending the stability and growth pact to broaden its surveillance of member states’ fiscal policies and, to ensure better compliance, it has suggested strengthening the sanctions regime. In addition, a proposed new directive would incorporate EU-level fiscal rules into domestic fiscal frameworks.

Secondly, the proposals would create new mechanisms to monitor and correct macroeconomic imbalances, such as divergences in current account positions, in competitiveness or in credit and house-price bubbles. In addition to these six proposals, we considered the Council's proposals for a permanent crisis resolution mechanism for euro area member states. The European Council agreed to establish such a mechanism in March this year, although the details of the mechanism are still to be confirmed.

Before I turn to the committee’s view of the Commission's proposals, I should briefly say why the UK should be engaged. After all, we are not a member of the euro area and many of the proposals related to sanctions or fiscal rules will not be binding on the United Kingdom as a result of its opt-out from the monetary union. Our witnesses, however, were unanimous in stating that the health of the euro area directly impacts on the United Kingdom. In 2009, some 60 per cent of the United Kingdom’s trade was with the European Union, the UK financial sector has substantial investment in euro area countries and the Government recognised the UK's substantial interest in Ireland by providing a bilateral loan above and beyond their contribution through the European financial stabilisation mechanism and the IMF.

The Commission's proposals may not all apply to the United Kingdom, but we have a vested interest—a vital interest—in ensuring that they are appropriate and will successfully contribute to the future economic and financial stability of the European Union. In addition to these hard, economic reasons, we believe that the United Kingdom should play an active role for another reason: solidarity. The EU is founded on solidarity and we believe that the United Kingdom should consider and support where possible the interests of other member states. I say to the Minister that it is surprising how often solidarity turns out to be far-sighted self-interest.

I now turn to the Commission's proposals. Taken as a whole, the committee concluded that they are a step in the right direction although they do not go so far as to enact the full fiscal union that some of our witnesses thought was necessary for the future stability of the euro area. Closer economic co-operation is necessary to foster greater economic stability in the European Union, particularly for those countries that have bound themselves together into a single monetary union. The proposals relating to fiscal discipline and co-operation should make it easier for euro area members to arrive at a collective fiscal stance that stands as an equal to a centralised monetary policy. Likewise, the proposals for a new system of macroeconomic surveillance and co-ordination will help to detect and address at an earlier stage excessive imbalances that threaten to destabilise the monetary union.

We also support the establishment of a permanent crisis resolution mechanism. In particular, we concluded that the inclusion of collective action clauses, setting out a formal mechanism for restructuring debt is essential. We felt that these should clearly establish the principle that the private sector should share the burden of any restructuring of sovereign debt. It is only right that, as they share in the rewards, they should share in the risk. The Government's response indicates that private sector involvement will be on a case-by-case basis. I would be interested to hear the Minister say under what circumstances the private sector might be exempted from the restructuring, and a reassurance that this would be the exception not the rule.

While the Government have made it clear that the United Kingdom will not take part in the new permanent crisis mechanism, we believe that there may be times when, as with Ireland, it is clearly in the UK’s interest to participate in financial assistance to member states in difficulties. We welcome, therefore, that the current proposal will allow member states outside the euro area to contribute to rescue packages on an ad hoc basis if they wish to do so.

Our primary concern with these proposals is the likelihood that they will continue to be adhered to rigorously as time goes on. Previous efforts to enforce fiscal discipline among euro area member states have been regrettably ineffective. Under the proposals, the Council will retain responsibility for enforcing responsible fiscal behaviour through sanctions. We concluded that this was indeed appropriate given the sovereign nature of EU member states. Only time will tell, however, whether the collective will of member states is strong enough to ensure that the sanctions procedure is applied when required and when the crisis is over.

In his evidence, Mark Hoban MP stated that:

“The cost of the crisis in the eurozone is a reminder to us that we must make these processes work much more effectively”.

The current crisis must indeed be remembered as a reason why member states should enforce the rules set out in these proposals in good times as well as bad. The ultimate responsibility for this lies with the political authorities of the EU, and the committee, I am sorry to say, remained sceptical that they will have the collective political will to enforce them effectively.

I thank all my fellow members of the committee and Professor Iain Begg—our specialist adviser—Antony Willot and Laura Bonacorsi-Macleod for their sterling work in helping the committee steer its way through a difficult report. I hope that the Minister will come back to this in time because we need constant updates on a very tricky situation that is of huge relevance to the United Kingdom.

[Lord Wallace of Saltaire]

My Lords, we have a rather tight timetable. I remind noble Lords that when the clock says four they are into the fifth minute and should sit down.