The Fiscal Compact on European Budget Discipline

A Report to the Finnish Parliamentary Committee
17 April 2012

European political leaders and the institutions of the European Union have reacted to the Euro crisis by creating conditional debt packages, in cooperation with the IMF (International Monetary Fund). Such “aid packages” typically prescribe severe austerity measures, similar to the structural adjustment programmes applied to many troubled developing countries, especially since the 1980s. The results have rarely been a success. 2


Throughout 2011, many steps were taken towards increasingly tighter austerity measures and budgetary discipline in the eurozone countries. The package of six legislative initiatives – the so-called six-pack – towards this end came into force in December 2011. With the worsening crisis, efforts have been made to speed up the adoption of the permanent European Stability Mechanism, which is now expected to come into operation within 2012. The idea of a budgetary discipline is also very much part of the Commission proposal for Eurobonds, involving close supervision and control of these countries’ budgets by various EU institutions, and in particular by the European Commission itself. The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the “Fiscal Compact” for short) is the latest, and most far-reaching, proposal for solving the Euro crisis by increasing the level of budgetary discipline within the eurozone.

This Report was presented to the Finnish Parliamentary Finance Committee on 2 March 2012. I briefly examine the Fiscal Compact with a discussion on the causes of the Euro crisis from which the theoretical justification for the fiscal compact has been drawn. This is followed by a consideration of the actual economic impact of the Compact, its legal bases and implications to the rule of law. Finally, I outline some of the effects that the Compact is likely to have on democracy in the European Union.

Causes of the Euro crisis

A Finnish Ministry of Finance memorandum dated 20 December 2011 states that the proposals for the Fiscal Compact arose out of awareness of “the deficiencies in the governance of the [European] economic and financial union that were revealed by the worldwide economic and financial crisis”. It is true that in 2009 the economies of the Eurozone sank into deep economic recession, with the gross domestic product of the zone falling by over four percent. This was the most severe recession in Europe since the Second World War. According to the European Commission, during the 2009 crisis and in its immediate aftermath the EU member states provided a total of 4.6 trillion euros in aid to the financial sector, which accounts for 39 percent of the combined GDP of the entire European Union.3 The recession led to increased spending on Keynesian-style automatic mechanisms and discretionary economic stimulus packages, and at the same time reduced the tax revenues collected by member states. This led to mounting deficits, increased state debt, in some cases dramatically.

Without savings and recovery measures, however, the world’s economy would have careened into a recession every bit as severe as that of the Great Depression of the 1930s. The measures were thus justified, even though in the view of many they were insufficient given the severity of the crisis.4

The ongoing euro crisis is the second phase of this epic recession, of theglobal crisis that began in 2008-2009. Public debt is not the main problem, and in any case, only formspart of the total amount of debt. The main cause of this crisis is privately accumulated debt, the single main source of which is debts in the private financial sector. The main guiding assumption of the Fiscal Compact is that increased fiscal discipline will reassure banks and financial markets that the situation is under control, and that lenders and investors can expect stable conditions in the future. The real problem is not how to restore the faith of market operators, however. Fiscal discipline does nothing at all to tackle the core problem in any way; it is a wrongly administered cure, based on a false diagnosis.

Economic justifications of the Fiscal Compact

The idea of fiscal discipline is based on a commonsensical analogy that is a staple of neoclassical economic theory: the state is like a household, and must adjust its expenses to coincide with its income in any given budgetary period.

By signing the Fiscal Compact, the Eurozone member states pledge to keep their state deficits below 0.5 percent of GDP. Under the terms of the Compact, this upper limit includes the expenses of managing already-existing public debt. In addition, deficit assessments will be based on macro-economic prognoses, which are notoriously prone to high levels of fluctuation and which in some situations have the effect of becoming self-fulfilling prophesies.

In practice, the Compact means that Eurozone countries have taken on the responsibility of maintaining budget surpluses until their existing debts are more or less fully paid off. The measures that states take to control spending have knock-on effects for the whole economy, however. For example, if a state is heavily indebted and develops serious difficulties in servicing its debts on account of recession (and partly on account of interest rates that are set by an outside party), it can attempt to make savings by cutting public expenses and by increasing taxes so as to be better able to pay off its debts.

Such measures lead to an erosionof overall demand within the economic system. When an economy is in recession, tax revenues drop, while on the other hand, other state expenses, such as unemployment payments, increase. Thus the goal of saving in order to pay off debt can easily become self-defeating. What is more, debts can mount regardless of savings, and in some cases, precisely because of state savings.

Spartan economic policies have broader effects also. A single small or medium-sized state can take the level of demand on international markets for granted, but if a sufficiently high number of states attempt to save in order to pay off debts by cutting public expenses, regional and even worldwide demand drops. Similarly, if several states each attempt to improve their own competitiveness simultaneously by preventing salary increases (what is known as the method of internal devaluation), each of them will have correspondingly weaker export markets. As a result, the economic situation of these countries will worsen all the more, and create increased need for public spending.

Additionally, within the framework of legitimate institutions, and particularly in times of recession, overall demand can in fact be stimulated by introducing more money into national economies through central banks. Because of the availability of this option — that is, in those states that have their own central bank — the financing of public spending is not dependent solely on tax or other revenue. The household analogy is therefore deeply misleading, since states have options open to them that no household can ever have.

There is mounting agreement among those who study the world economy that the major problem over the past few decades has been precisely because the neoliberal “global regime of accumulation is unable to establish reasonable levels of demand and productivity to spur growth and development due to system irregularities”.5

From the perspective of economic theory, increased budget discipline is both the wrong response to the problem and is likely to have highly questionable effects on the patient’s health. Depending on the situation, an incorrectly prescribed medicine can be benign — some might even find it invigorating — but if the patient is genuinely ill, or if conditions are otherwise unfavourable, it can make things worse, even fatally so. Greece’s vicious circle of debt and deflation is a good example of this.

A legal perspective on the Fiscal Compact

As a legal document, the Fiscal Compact is peculiar in many ways. To start with, for the time being at least, it is not part of European Union legislation as such but instead stands apart as a separate international agreement. And in stark contrast to standard procedures for the making of contracts and treaties, the Fiscal Compact contains no article to allow for its termination or for signatories to exit from it. The Compact does however contain the demand that it be made a permanent part of the domestic legislation of all the states that are party to it, and that preferably it should be incorporated into their constitutions.

In other words, the Compact was brought into force in a way that circumvents the normal procedures for the implementation of EU legislation, and at the same time creates legally sanctioned room for manoeuvre for the implementation of specific economic and political theories beyond the reach of member states’ own constitutional restraints.

Moreover, the Fiscal Compact in some respects resembles the sort of legislation used in states of exception and states of emergency. The assumption behind the Compact is that member states can decide their own budgets in accordance with standard parliamentarian principles, so long as the maximum deficit limit of 0.5 percent of GDP is not exceeded. But when state deficits come close to or exceed that threshold, a state of exception will enter into effect, and the European Commission is then automatically empowered to take control of the indebted state’s budget.

It is inherent to the concept of legality that the rule of law regulates not only those who act within the legal system, but also the mechanisms by which laws are made, amended, repealed, and replaced. The egalitarian idea that all citizens are equal is also indispensable to the notion of legality: no individual or other agent, and no norm or principle can be above the rule of law. The Fiscal Compact violates this egalitarian principle, albeit in such a way that it enables the notion of legality to be stretched in order to maintain the impression that the Compact does not violate the rule of law.

The Commission’s powers to go over the heads of member states by taking command of their budgetary policies is based on the logic of emergency rule. The Fiscal Compact goes beyond the jurisdiction of the European Union, and also takes precedence over the parliamentary procedures of the member states. The official justification for this is that budgetary deficits are such an exceptionally serious matter that there was a need to depart from normal operating procedures. At the same time, the Fiscal Compact decrees that the Compact itself is untouchable: it includes no provisions for its own amendment or termination. In all these respects, the Fiscal Compact is contrary to the principle of the rule of law.

One possible historical analogy can be found in 1930s Germany. The Brüningen government made use of the powers of exception allowed under the Weimar Constitution to drive through strongly deflationary economic policies, which had the effect of creating mass unemployment. After the National Socialist Party’s electoral wins in 1932 and 1933, legal theoreticians who supported Hitler developed legal means of making his leadership permanent (even though the mandate would be renewed every four years). The methods the lawyers devised were formally legal, but obviously immoral.

Departing from democracy

The idea behind the founding of the European Commission was to establish an institution for promoting the common good in Europe. It was intended to be as independent as possible from the member states and their internal political schisms. It is for this reason that direct democratic representation is absent from the Commission; the Commissioners do not represent their home countries, or any political party. The European Parliament has only an advisory and intermediary role in the selection of Commissioners.

Incrementally but unmistakeably, the European Union has developed legal procedures that have some connections with principles of democratic legitimation. This cannot be said of the European Commission, however, the position of which is similar to that of the Kaiser in Germany in the years prior to 1918. Before the First World War, although there was male suffrage and each vote counted equally, and the Parliament has fairly extensive powers, only the Kaiser and the Chancellor who was subordinate to him had the right to legislate.

The general condition for membership of the European Union is that applicant states uphold democracy and the rule of law; but judged by these criteria, if the EU itself were to seek EU membership it would not be accepted. The undemocratic aspects of the EU are accentuated by the fact that Great Power diplomatic practices are still used in tandem with the European Commission’s own practices for much of what is done within the EU. The draft agreement of the Fiscal Compact is a glaring example of this: it was largely the product of bilateral diplomatic negotiations between France and Germany.

The exceptional provisions allowed for under the terms of the Fiscal Compact are hostile to the basic principles of democracy, as is the fact that the Compact gives rise to legal norms which override EU member states’ own constitutions, and which cannot be changed by democratic means. In a democracy no rule or principle can ever be set in stone, but must always be adapted to the possibilities and constraints at hand. From this perspective, Merkel’s idea of unending budgetary discipline is anti-democratic.

The Fiscal Compact spells the undoing of genuine democracy in Europe, a trend which has already been underway for quite some time. The Compact does not do away with democracy in one fell swoop, of course, but the direction of development is clear.

Heikki Patomäki Professor of World Politics, Department of Political and Economic Studies, University of Helsinki, and Chair, Attac Finland


1 European Budget Discipline is the informal title of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, which was ratified by 25 European Union member states on 2 March 2012. A long memorandum on the Fiscal Compact (EU/2011/1935, Finnish and Swedish only), dated 19 January 2012 that was circulated by the Finnish Parliamentary Finance Committee to the Finnish Parliament carried the following tortuous title, summarizing the contents of the Compact: ”Letter from the Finance Committee to Parliament regarding the proposed regulations of the European parliament and Council proposal pertaining to tighter supervision and assessment of budget proposals and [also regarding] the shared rules for rectification of the excessive budgetary deficits of the Eurozone member States the economies and public finances of which are currently experiencing, or are currently seriously vulnerable to, serious difficulties with their financial stability”.

See Heikki Patomäki (2012) Eurokriisin anatomia. Mitäglobalisaationjälkeen? The Anatomy of the Euro Crisis: What Comes After lobalisation?” (Helsinki:Into), especially Chapter 7.

3 Commission Staff Working Paper. Executive Summary Of The Impact Assessment, Accompanying the document, Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC, s.2, available at docs/ia_2011/sec_2011_1103_en.pdf. 

4 See for example Jack Rasmus (2010) Epic Recession: Prelude to Global Depression, London: Pluto Press.

5 Phillip A. O’Hara (2006) Growth and Development in the Global Political Economy: Social Structures of Accumulation and Modes of Regulation (London: Routledge), p. 208.