Cause and Effect in European Politics and Law

IMF Has Betrayed Its European Allies in the Austerity War

Adelina Marini, June 10, 2013

The IMF has begun admitting mistake after mistake, thus not leaving the European Commission any options to come out dry of the ever more expanding storm around its economic policies. Until recently an ally of the EU in its fight with the debt crisis and the domino of defaults of member states, the Fund, led by the former minister of finance of France, Christine Lagarde, moved entirely into the camp of the oppononets of austerity which until recently it preached tirelessly. The change has begun in the beginning of the year when the Fund's chief economist Olivier Blanchard admitted in a special paper errors in forecasting economic growth after the imposition of measures restricting spending. Then came the unfortunate revelation of a rather technical mistake in the calculations of two influential economists from Harvard - Kenneth Rogoff and Carmen Reinhart - whose work served as a basis of the so called austerity policy of the EU.

The final betrayal was performed last week when the Fund distributed an official confession of violations of its own rules during the negotiations of the first bailout for Greece. This has put the EU and most of all the European Commission and the European Central Bank in a position of self defence. The damages from the "betrayal" are yet to be measured, but of their scale spoke earlier the presentation of the country-specific recommendations which are an important part of the reformed economic governance of the EU - the European semester - which took almost two-year long political efforts. The powdering with ashes on behalf of the IMF in Washington for sure will seriously undermine the authority of the European economic expertise and the efforts of the European officials to implement the so longed close economic-fiscal coordination at EU level.

Since January, when Olivier Blanchard first dropped the bomb, the controversy between austerians and spenders has been growing, but for sure in the past months the proponents of strict fiscal discipline, led by Germany and the northern countries, have been suffering significant defeat yet at a time when they seemed to be winners due to the good results Ireland and Portugal showed, as well as the excellent performance of Latvia and Lithuania. All this put the European Commission in the uneasy position to try and keep what it was left, but in general it had not much room for manoeuvre.

And if with this year's recommendations it had insisted on more belt-tightening, which would have been a logical continuation of the recent policy that led to recovery of confidence of the markets, a return on the credit markets by some of the countries that touched default, and also to a sensible decline of the spreads and the price of the benchmark 10-year bonds, hardly those remarks would have been taken seriously in the ever growing rebellious European capitals, led by France, whose President Francois Hollande most firmly and publicly announced he did not intend to follow the "diktat" of the Commission. That is why, the Commission chose the other approach - to let the belts a bit loose by introducing a short budgetary break for the countries with excessive budget deficits, telling them, while finger-pointing, that they should use the time to implement reforms.

There will hardly be many people to bet a huge sum on believing that the governments will roll up their sleeves and do exactly this. It is more likely to seek a circumvention of this system and a return to the status quo. After all, governments last briefly, while debts are eternal. Moreover, after the Fund's admission it should be expected the attacks against the Commission and the ECB to increase, as well as the pressure over Germany to stop insisting on strict fiscal discipline.

Europe more than ever needs a European consensus

Pressed into the corner, the European Commission made desperate calls not to turn backs on what had been achieved. In his speech when presenting the country-specific recommendations on May 29, Jose Manuel Barroso began with an analysis of the situation stressing that recovery in the short-term is hampered by the high levels of debt - both private and public. Besides, he made a direct rebuke to the member states for not doing enough to return on the path of growth and to take Europe out of the crisis. Mr Barroso explained that the foundation of a healthy economy were investments in education and in ensuring solid and sustainable public finances. He underscored, that growth fueled by public and private debt is not sustainable and recalled that this is precisely the lesson from the crisis. "This is artificial growth, growth based on debt, public or private debt".

In the end of his speech, he said that the entire conversation "austerity vs growth" was futile and counter productive. "Instead of fuelling these debates that are divisive and can only undermine confidence, our capitals should focus on promoting the European consensus which the Commission is putting forward, with more determined and urgent action on growth-enhancing reforms". His deputy, the influential commissioner Olli Rehn, whose powers had been significantly enhanced in the process of reform of the economic governance, also emphasised in his statement that keeping the course of fiscal consolidation and structural reforms remained necessary in Europe because of the high level of public and private debt.

OK, you can let the belt loose, but by one hole only

In a desperate attempt not to lose entirely the attention of the European capitals, the Commission after all proposed a slight belt-loosening which is a two-edged sword. Several member states get one or two-year extensions to correct their budget deficits. Olli Rehn tried to explain that this was quite legitimate and was not the result of external pressure. Moreover, he even quoted the possibilities the European semester gave, saying that the recommendations for structural reforms always go hand in hand with fiscal consolidation, which is why the countries that implement structural reforms will get an extension. Alas, to what extent all the countries that got an austerian holiday will really do structural reforms is a controversial matter, especially given the country-specific recommendations for the troubled countries.

For instance, regarding Italy, Olli Rehn said that it had realised huge structural adjustments in the past two years (the governance of the first technocratic government in the EU with prime minister Mario Monti), but he points out that the new government is making a U-turn in terms of some of the measures. Nevertheless, however, the cabinet of the recently elected Enrico Letta had installed safeguard mechanisms that will ensure that the deficit will remain below 3% of gross domestic product. The specific recommendations for Italy are 6, as we should probably count them with 1 less as for all countries (excluding Romania for which the first recommendation is to stick with the IMF/EU rescue programme), the first recommendation is to continue with fiscal consolidation.

The other recommendations for Italy are not a novelty, as they were mentioned in the in-depth review of the Commission under the macro imbalances procedure. Simply, in the country-specific recommendations, the Commission is a little bit more specific in its demands. Italy is expected to transfer tax burden from labour and capital to consumption, property and environment without involving the budget. It is also recommended to pursue tax evasion, to improve collection and to undertake decisive measures to tackle grey economy and undeclared labour. Once more, Italy is called upon to remove restrictions in the professional services and in general to open its labour and services market. Many of the countries, and it can even be said all the countries, got recommendations to focus on energy interconnector links and energy efficiency. What is specific for Italy is that it is expected to upgrade the capacity of its infrastructure. Another recommendation is to reduce the economic gap between the north and the south.

With France, the recommendations are very similar to those for Italy, which was also visible in the imbalances analysis. France gets an extension of two years to correct its budgetary deficit as the ceiling goes up to 2015. In exchange, however, the Commission expects France to use the time to handle the problems with the declining economic competitiveness, which was a reason for tension with neighbouring Germany. The recommendations to France are also 6 and among them, expectedly, are the already traditional advices to reduce labour costs mostly via reducing social welfare contributions paid by employers.

The minimum wage should be in support of competitiveness and jobs creation. Competition in the services area should also increase, the unjustified restrictions to the access of professional services should also be removed. The recommendations to France are sometimes so specific that they go as far as demanding Francois Hollande's government to abolish regulated tariffs on gas and electricity, to open passenger transport for competition, to start immediate reform of the system for unemployment benefits and to increase the share of old workers on the labour market.

Spain is a pioneer in many aspects in the EU. This is the first country to get an untraditional bailout programme on the basis of which it got money from the EU to recapitalise local banks, but without the conditionality that Greece, Ireland and Portugal were subjected on. Furthermore, Spain is the first that got an extension to reach its mid-term objectives two years ago, which created tension in the EU and led to accusations of applying double standards. Spain this year, too, will get an extension, but contrary to the claims that this is a reward for recent efforts, the recommendations to Madrid show otherwise. First, they are totally nine and are also very detailed as with the other countries.

Spain is required to create before the end of the year an independent fiscal institution (a similar thing was demanded from Bulgaria, too), that will provide analyses, advices and will monitor the implementation of the fiscal policy of national and European fiscal rules. This is quite interesting, because it can be interpreted as not sufficient confidence in the government's ability to achieve the set goals. A specific recommendation for Madrid is also to reduce the volume of government arrears and to avoid further accumulation of payments, as well as to provide regularly data for unpaid bills. A deep pension reform is also recommended that will ensure that the retirement age is in line with life expectancy. The pension recommendation, though, can be found with many of the member states, especially in the periphery and the former communist countries.

Spain is also required to structurally reform the electricity sector by the end of the year, to complete the interconnector links with neighbouring countries for gas and electricity and to stop subsidising unprofitable transport. Another interesting specific recommendation for Spain is to allow independent national assessment of the future infrastructure projects. Furthermore, it is recommended Spain to ensure real competition in the cargo and passenger railway services. Brussels is expecting Madrid to present a comprehensive reform of the local administration and by October 2013 to draw a plan for enhancing the efficiency of the public administration as a whole. Also expected is to increase the efficiency of the judiciary.

Another country under stress, as described in the analysis of the macro economic imbalances in a package with Spain is Slovenia, which has been managing to resist asking a bailout from the eurozone. According to Olli Rehn, Slovenia had decisively addressed the excessive imbalances, it has managed to ensure funding for its financial needs for a certain period of time. In support of its efforts, the Commission has also decided to grant an extension, expecting, however, the country not to waste any time and get on with reforms. And what needs reform is not to at all small. The recommendations for Slovenia are also nine. Reading all the recommendations allows to safely conclude that the more the recommendations are the more problematic the country is.

Slovenia, too, should undertake a reform of its pension system as a major element should be binding compulsory retirement age with life expectancy, which is an euphemism of increasing retirement age. In view of reducing government spending, Ljubljana is advised to limit the social spending for elderly people by moving from institutional care toward home care. The country is expected to conduct a systemic review of the banking system by an independent and by any means external consultant. Other recommendations are related to reducing the length of judicial proceedings at first instance, especially in civil and commercial cases, to remove administrative impediments, restructure the over-indebted or under capitalised, but vital companies, create a legal framework for out-of-court restructuring, quick solving of insolvency cases.

The Eurogroup to take a more leading role in the eurozone

In the country-specific recommendations there is a special set entirely devoted on the eurozone. In it, it is recommended the Eurogroup to take enhanced functions and to follow closely the implementation of the agreed at EU level rules and recommendations. Among the advices are also all those ambitions of the Commission for deepening of the economic and monetary union (EMU), including the establishment of a banking union, which will be the subject of the June European Council.

Fighting the legacy of planning economy

From the Commission's specific recommendations can be drawn a general conclusion about the countries which before the beginning of the 1990s were to the eastern part of the Berlin wall. It can easily be noted that the recommendations are quite similar for all the countries from the former communist block and they are definitely aimed at tackling the legacy of the planning economy which existed under the leadership of the Soviet Union. For instance, countries that are otherwise doing very successfully at EU level, like the Baltic ones, are expected to improve their tax systems, to reform their pension systems with a special focus on early retirement options and the low retirement age. A permanent recommendation for almost all countries in the group is removing regulated prices of electricity and gas, as well as increasing energy efficiency of public buildings and public transport.

Therefore, Latvia, whose application to join the eurozone on January 1st has been approved by the Commission this week, is expected to reduce the tax burden for low wage workers and to shift it on excises, property and environment. Also recommended is a reform in the tertiary education and more specifically the country is asked to link universities' funding with quality. Increasing energy efficiency, especially of residential buildings and the regional heating facilities, reducing the costs for energy and improving the interconnectedness with the energy systems of the EU are also part of the recommendations for Riga. Estonia, the Baltic tiger which is already part of the eurozone, should also improve energy efficiency and the efficiency of the local authorities. It is also expected to improve  the quality of local public services.

Lithuania, which on July 1st takes over the rotating presidency of the EU Council, has to concentrate on fiscal rules, to review its tax system and consider increasing taxes in those areas that will not affect growth, like property and environment. Reform the pension system with a focus on abolishing the options for early retirement and creating clear rules for pension indexation, as well as stimulating the complementary savings schemes, create a more flexible labour market and reform the state-owned enterprises are among the recommendations for the small Baltic state which, too, is expected to apply for the euro area next year.

In the same vein are also the recommendations for the eastern giant - Poland - which was the only one that managed to survive during the crisis maintaining a solid economic growth which, however, is in a period of slow down. An exception to the advices for the former communist states is Warsaw to continue its efforts to increase the participation of women on the labour market investing in affordable childcare and pre-school education. Poland is also expected to gradually abolish the special pension system for miners and to improve water and waste management.

Just like last year's, this year's country specific recommendations make it clear that most member states need structural reforms as in some cases it is about really deep reforms. In the more developed western countries, which have been in the EU for a long time, the focus is on increasing competitiveness and additional opening of the economy in every aspect, while with the newer member states the need to handle the legacy of the past is evident. Against this backdrop, it would really be wrong if, for the sake of the austerity war, the member states, following France's example, decide to turn their backs on the Commission and continue as before. It is true that it is hard to survive in the course of one term. Especially against the backdrop of the long-termness of the efforts, one term of four years is too short a time. Nonetheless, politicians should demonstrate responsibility for the future that goes beyond the next elections, not only protecting their narrow party interests. Something that at this stage seems pretty utopian.