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The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico
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The fiscal institution in the Economic and Monetary Union: the contribution of Spain by Ricardo Martínez Rico

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  • 1. /RICARDO MARTÍNEZ RICO * / The fiscal institution in the Economic and Monetary Union: the contribution of Spain1. Introduction; 2. Evolution of the fiscal policies in Europe and Spain;3. Analysis of the relationship between fiscal rigour, macroeconomic sta-bility and growth; 4. Next steps in the Fiscal Institution of the Economicand Monetary Union: the necessary contribution of Spain; 5. Conclusion1. Introduction The current financial crisis in the European Union (EU) hashighlighted the importance of establishing a common framework* Public Sector economist, on leave, and Founding Partner, President and CEO of EquipoEconómico, S.L. He has held office as Deputy Finance Minister Working inside the teamof the Deputy Prime Minister, Rodrigo Rato, and Finance Minister, Cristóbal Montoro.Graduate cum laude in Business Administration at the University of Zaragoza, he stu-dies in the Deutsche Schule of Bilbao and Valencia. He has attended postgraduate cour-ses at the London School of Economics, Kennedy School at Harvard University andWharton Business School. 227
  • 2. The fiscal institution in the Economic and Monetary Union: the contribution of Spainwhich enables the economic agents to act in a macroeconomic sce-nario of stability and confidence in the coming years. In this crisis situation, once again the discussion has sparkedthe debate in Europe of whether the necessary fiscal stability,which will demand the rationalisation of public spending in themember states, will be achieved at the expense of prolonging thecrisis and limiting economic growth possibilities. However, thereshould be no dilemma between sustainability of public accountsand medium term economic growth. The crisis of the Europeansovereign debt is a consequence of overspending and debt whichthe markets are not prepared to fund. In this regard, the onlyrecourse is a fiscal policy designed to mitigate the harsh effects ofthe crisis and boost economic growth within the framework ofmacroeconomic stability, continuous supervision over the sustai-nability of public sector accounts and economic reforms. Spain must cease to be a burden for Europe and once againbecome a driver of growth. Compliance with a route of plausiblecuts in public spending in all Public Administrations is a necessarycondition to do so, though not the only. As previously shown, inthe case of the Spanish economy, stability and reforms make up theformula required to revitalize investment, consumption and jobcreation. Thus, economic reforms and budgetary discipline areequally important.228
  • 3. The Future of the Euro The Spanish case is a clear example of a solid and plausible bud-getary institution, where the principle of subsidiarity enables eachgovernment with sound finances to tackle its internal decisions inaccordance with its economic and social reality (not only becauseof its significance from a regulatory perspective but also because ofthe parallels between the European scenario relative to the coun-tries and the Spanish scenario relative to the AutonomousCommunities). At the same time, those who are forced to ask forhelp must abide by the ensuing conditionality. In Europe, likewise, the need for greater economic and mone-tary integration must take us along the path of clear fiscal rules. Butit must also do so to encouraging income transmission mechanismsbetween countries and regions, availability of financial resourcesand support by way of providing the necessary liquidity to faceemergency situations and the pooling of risks, always in exchangefor strong sets of conditions to prevent moral hazard. Moreover,within the monetary and economic union the imbalances must beaddressed, not only of highly indebted countries, but also thosewith surplus balances. In some way, it must be recovered an incen-tive system to ensure political commitment and compliance withgoals set. Nowadays, the fiscal institution1 is a basic component ofEuropean and Spanish economic policy.1 González Páramo defines it as "the rules which govern the preparation of the budgets, theirdebate and approval in parliament, execution and subsequent control”. "Costs and benefits of fis-cal discipline: the Law of Fiscal Stability in perspective” (Costes y beneficios de la disciplina fis-cal: la Ley de Estabilidad presupuestaria en perspectiva), J.M. González-Páramo, 2001. 229
  • 4. The fiscal institution in the Economic and Monetary Union: the contribution of Spain Throughout this work we shall examine, in first place, how thesustainability of the public finances requires a solid fiscal institu-tion and a firm political commitment by the different Europeangovernments. Only on the basis of the conviction of the benefits ofthis statement can one contribute towards the construction of astronger Europe. Then we shall go on to examine the close relationship betweenfiscal rigour, macroeconomic stability and growth, arriving at theconclusion that the establishment of simple, transparent, automati-cally applied rules with preventive control mechanisms for allPublic Administrations is essential for this ‘positive’ interrelation.All these components are basic for the design of a fiscal policywhich helps to recover the credibility that Europe needs in its pathtowards greater integration to face the sovereign debt crisis. In the last chapter we shall examine the measures taken in Europeand in Spain since the start of the sovereign debt crisis, and we shallreflect on the following steps to be taken in support of the budgetaryinstitution. Then close with the appropriate conclusions.2. Evolution of fiscal policy in Europe and Spain The European political integration project came about in thepost World War years, as an extension of the economic integrationprocess. This was envisaged by one of the founding fathers of the230
  • 5. The Future of the Eurocurrent Union, Jean Monnet. In 1950, he proposed the creation ofa space of peace and prosperity for Europe, via the formation of theEuropean Coal and Steel Community, which became a reality ayear later. His way of conceiving the European construction as aproject made up of very specific steps – beginning with the eco-nomy – is the way to understand many of the milestones thatEurope has achieved in the last sixty years. Examples of this havebeen the creation of the European Economic Communities, thelaunch of the European Monetary System, the creation of the sin-gle European market and the firm commitment that has led to theEconomic and Monetary Union (EMU). During the first decades of the European unification project,Spain was but a mere observer, although fully embraced the inte-gration process along the same lines and endorsed the way of tra-velling the path towards a united Europe. Thus, in the mid-1980s,Spain understood that the current EU offered a chance to take adecisive step in its integration into an international market whichwould bring gains in efficiency, reinforce macroeconomic stabilityand contribute to the increase of wealth and per capita income.That would lead to the development and modernisation of thecountry. And, indeed, this was the case in the first years, where eco-nomic growth rate of Spain was positive over that of the EU, by amaximum of 3pp in 1987 (see Chart 1). However, as of this time,macroeconomic instability driven by an expansive fiscal policy,became a burden for economic growth and job creation, and gene-rated a fast and continuous rise in public debt. The importance of 231
  • 6. The fiscal institution in the Economic and Monetary Union: the contribution of Spainhaving a solid fiscal institution in the economic development ofthe Spanish economy became patently clear. Chart 1 Year-on-year growth in real GDP in Spain and in the European Union Source: Prepared by Equipo Económico with data from the International Monetary Fund After the repeated failures of the European Monetary System star-ted up in 1979, and the progress of the approval of the SingleEuropean Act (1986) in favour of an internal market, the EU mem-ber states took an additional step in Maastricht. EU member statessupport, via the adoption of the Treaty on the European Union(TEU) (1992), the creation of an Economic and Monetary Union,whose third phase would entail the launch of the single currency,the Euro. Title VIII of the Maastricht Treaty set three main axesaround which the design of the EMU should be built around: sin-232
  • 7. The Future of the Eurogle monetary policy, fiscal policies subject to common rules andcoordination mechanisms for the remaining economic policies. Aclear view of establishing nominal convergence mechanisms basedon the fiscal institution was already existent at that stage, foundedon the following common rules: absolute ban on monetary fundingof public deficits, no liability held by the EU or by any other Statein regard to debts acquired by another member state, and the set-ting of limits on deficit (3%) and public debt (60%). As of 1997, theStability and Growth Pact (SGP) introduce stricter rules with a defi-cit target of balance or surplus, supported by an early alert systemand a disciplinary penalty structure designed to correct deviations. For Spain the commitment to meet the convergence criteria esta-blished in the TEU for eligibility for the third phase of the EMUdemanded a radical change to be made in our fiscal policy. Europethen began to act as an anchor in Spanish budgetary policy.However, even when the worst of the recession was over for Spain,governments continued to face enormous difficulties in balancingthe budget in the pursuit of macroeconomic stability. It would not be until the political change of 1996, and with thereference and encouragement arising from the creation of the sin-gle currency, when the necessary fiscal consolidation was finallytackled, that macroeconomic stability was achieved and the basesfor a new economic growth phase were put in place. The startingpoint was poor, in 1995 with a deficit around 7% of the GDP and agrowing public indebtedness which reached 67% in 1996. 233
  • 8. The fiscal institution in the Economic and Monetary Union: the contribution of SpainAlthough the level of indebtedness was lower than the average forthe EU, in the case of Spain the combination of the primary defi-cit, the high cost of financing of the debt and the recession hadrendered unsustainable the growing public debt. As of that timethere was a change in fiscal policy, which took on a markedly coun-ter-cyclical approach. As shown in chart 2, an ambitious fiscal con-solidation programme was implemented which allowed the annualbudgets to close with primary surpluses from 1996 until the end ofthe period and to slow down the growth trend in public debtwhich, after peaking in 1996, dropped by more than 20pp of GDPuntil 2004. Chart 2 Evolution of income and expenditure of Public Administrations and of their budget balances Source: Prepared by Equipo Económico with data from the Ministry of Finance and Public Administrations234
  • 9. The Future of the Euro During the period, the fiscal consolidation drive contributedtowards a strong growth in GDP (average rate of 3.6 between 1996and 2004), which helped reducing debt stock via the positive spre-ad between the economic growth rates and interest rates. The suc-cess in the change of direction in fiscal policy was due to a firmpolitical commitment, a well-designed fiscal consolidation pro-gramme and a substantial reform of the fiscal institution.2 For countries that, like Spain, managed to take part in its foun-dation and for others which joined subsequently – such as the caseof Greece which, with the support of Germany and despite notmeeting at the time the requirements established by the MaastrichtTreaty, became part of the Eurozone two years later – the incorpo-ration to the euro meant the relinquishment of monetary policy infavour of the European Central Bank (ECB). And this total integra-tion in the establishment of monetary policy has fostered greaterprice stability during these years. On the other hand, this relin-quishment made budgetary policy, along with economic liberalisa-tion policies, into the main economic policy instruments in each ofthe Eurozone member countries. We must highlight that, once the objective of forming part ofthe euro was met in full, Spain took an additional step beyond whatwas required in Maastricht. And, in line with the principles agreed2 “The Spanish fiscal institution: from the Stability Pact to the rules of fiscal stability” (Lainstitución presupuestaria española: del Pacto de Estabilidad a las reglas de estabilidadpre¬supuestaria), R. Martínez Rico (2005). 235
  • 10. The fiscal institution in the Economic and Monetary Union: the contribution of Spainin the SGP, it rounded off the fiscal consolidation effort with a deepreform of the fiscal institution. As a result thereof, the approval ofthe fiscal stability laws (the General Law on Fiscal Stability and theOrganic Law additional thereto) brought about a change in thebudgeting process. This mainly consisted of: the definition of a fis-cal stability target (fiscal balance) in the medium term for all PublicAdministrations; for the State, a non-financial expenditure limit,the so-called expenditure ceiling, was applied following parliamen-tary approval during the first half of the year; as a novelty, theContingency Fund was added into the State budget, as a flexibilitycomponent during the life of the budget which removes the needfor making fiscal adjustments, equal to 2% of the non-financialexpenditure ceiling approved by Parliament. The approval of theFiscal Stability Laws was further completed with a new GeneralFiscal Law and a new General Subsidies Law. Specifically, theGeneral Fiscal Law aimed at achieving greater rationalisation of thefiscal process, whereas the General Subsidies Law, on its part, aimedat transferring the governing principles of Fiscal Stability Laws (effi-ciency, transparency and multi-annual framework) to the expendi-ture on subsidies (which would mean 20% of expenditure budget). However, in 2005, the European process of integration andreform came to a halt. The solution provided to the reiterated vio-lations of the 3% limit on public deficit established at Maastricht –and following the pressure exerted by Germany and France in thisregard, backed by the European Commission – was none otherthan the SGP, introducing greater discretionary power and taking a236
  • 11. The Future of the Eurostep back in the capacity of the fiscal institution to contribute togrowth. Along the same lines, with a comfortable fiscal position andwith the same philosophy as that of the reform of the SGP, Spain in2006 approved a reform to render the fiscal and TerritorialAdministration funding processes more flexible, which is the sour-ce of our current fiscal crisis. The relaxation of fiscal stability led toa loss of transparency in its application as a result of the flexiblenew rules. With the outbreak of the international financial crisis as of 2008,the primary surplus of the first years of the period quickly ran out.Discretionary expenditure decisions, the impact of automatic sta-bilisers and the major errors in revenue estimates led to a deficitbalance, which worsened over two years (from 2007 to 2009) by13pp of GDP. This deterioration, which had also taken place in therest of EU members, was more notable in Spain due to its speed andmagnitude (see Chart 3), with few comparable examples within thescope of the OECD (except for the cases of Iceland or Ireland). Thedeficit fiscal position generated a fast increase in public debt, lea-ding to doubts about sustainability thereof, and translating intosignificant rises in the risk premium of the country. At the start of 2010, given the lack of confidence displayed byinternational markets, and in light of the fast deterioration ofpublic finances, the previous Government was forced to implement 237
  • 12. The fiscal institution in the Economic and Monetary Union: the contribution of Spain Chart 3 Budget balance in 2006 and change in budget balance in 2007-2009 Source: Prepared by Equipo Económico with OECD dataa radical change in its fiscal policy and announce a fiscal consoli-dation programme. The sovereign debt crisis, which especially affects several of the“peripheral” member states of the Eurozone (but which has alsoaffect countries such as France and Austria), has highlighted theneed to reinforce the budgetary coordination mechanisms withinthe EMU. In the face of the problems arising from the sovereign238
  • 13. The Future of the Eurodebt crisis and as a result of the fluctuations in the risk premiumsof the Eurozone member states, a double reinforcement movementof the budgetary crisis has taken place from Brussels since the onsetof the crisis. On the one hand, that implemented by the EuropeanCommission, the result of which is, for instance, the legislative pac-kage comprising five regulations and one directive designed to rein-force the preventive part and the disciplinary part of EC mecha-nisms. On the other, that of the member states which, via theEuropean Council, have brought about agreements such as theFiscal Pact, which seeks to guarantee that all countries will committo fiscal stability under the highest level of regulation. The reformenacted last year of the Spanish Constitution must be understoodwithin the framework of this new drive from Europe in support ofthe fiscal institution. The reform, as we shall discuss further in thispaper, guarantees the principle of fiscal stability via the highest ran-king law. Despite efforts invested, and despite the positive effect of theliquidity injections made by the ECB, the current economic scena-rio in Europe continues to be marked by the risk premiums of EUperipheral countries, which continue to be too high. The questionsas to the capacity of such countries to meet their debt commit-ments have burdened economic European Union results over thelast two years. This has led the Commission to forecast a drop inGDP for all of the EU of -0.5% for this year, which sets it back interms of the growth of the world economy. Although it must besaid, that all countries are not behaving in the same way. Germany, 239
  • 14. The fiscal institution in the Economic and Monetary Union: the contribution of Spainfor instance, closed last year with 3% growth, expecting to do sothis year at 0.6%, whereas Italy will experience a drop of around -1.3% of GDP. From a growth perspective, there is an important dif-ference between northern and southern European countries arisingfrom the financial crisis. However, it is worth remembering thestrong interdependence between all member states, includingGermany (second country in the world in terms of export volume,of which 60% are directed to the EU). On its part, the Spanish economy is clearly included in the “slo-wer” group, at an extremely difficult time. In recent months, thereturn to recession, which accumulates after four years of crisis, theadverse effect on employment and on businesses, has led to a 24%unemployment rate. At the same time, there is high external debt,exceeding 160% of the GDP, with a high accumulation of public andprivate debt maturities this year. All these factors have led to a riskpremium of around 340 basis points in the last few months and, morerecently, well above 450 basis points, and to be closely watched by themarkets, that is to say, our creditors. Given this scenario, in 2012, theSpanish economy faces challenges associated with its macroeconomicimbalances yet to be corrected, as well as the potential problems ari-sing from a new challenge from international financial markets. Inthis framework, we expect a drop in GDP during the first quarters,and although its performance will improve towards the end of theyear, it will result in an overall drop in GDP of around -1.5% this year.Meanwhile, the reality experienced by the rest of the world is diffe-rent, with a world economy growth rate of around 3.5% of GDP.240
  • 15. The Future of the Euro Undoubtedly, the unemployment rate is our main negative dif-ferentiating factor compared to all other EU members and the mainconcern for Spanish society. As a result of the economic crisis, nocountry in the OECD has experienced a downturn in the joblessrate as negative as ours. Our rate of unemployment has gone from8.3% of active population in 2007 to almost 24% at the end of2011. The crisis has highlighted the problem with our employmentmodel, as our economy is adjusted by means of redundancies ins-tead of by adding greater flexibility to employment conditions. Despite the gradual correction of the external imbalance (thecurrent account deficit has been reduced from 10% of GDP recor-ded for 2007 to less than 4% in 2011), Spain continues to be signi-ficantly reliant on foreign funding (around 40,000M€ per annum).The need for funds shown by the current account deficit, cannot infact be met by attracting foreign investment to our country.Indeed, the opposite is the case, with recent years witnessing adivestment process, particularly of portfolio assets. The forecastdrop in the GDP combined with the high level of debt, puts thesustainability of our funding at risk. Given such conditions, the cri-sis is requiring a must faster deleveraging process than that initiallyexpected. Since the common denominator of the European sovereign debtcrisis is insufficient GDP growth, only by articulating the reformsin Europe and in Spain in an expedient and firm manner can thecurrent increasing loss of confidence by financial markets be sta- 241
  • 16. The fiscal institution in the Economic and Monetary Union: the contribution of Spainlled. In the case of the Spanish economy, this is a path which wetravelled successfully in the second half of the nineties, whenSpain took part in the foundation of the euro and then went on tolead the fiscal consolidation process in Europe. The new govern-ment seems to have understood this, having begun reforms inthree main areas: sustainability of the public finances and moder-nisation of the public sector, the restructuring and reorganizationof the financial sector and the reform of the labour market. In thecoming years, political commitment to fiscal rigour, macroecono-mic stability and growth must go hand in hand in Spain andEurope, and happen in parallel.3. Analysis of the relationship between fiscal rigour, macroe-conomic stability and growth In the context described in the previous section, fiscal consolida-tion within the EMU is a fundamental tool for recovering macroeco-nomic stability, the confidence of economic players and the path togrowth, leading in turn to job creation. Moreover, the balance in public finances provides the econo-mies participating in the monetary union, which therefore cannotresort to instruments such as currency rates, with greater leeway todeal with external shocks, enabling the implementation of anti-cyclical policies and of automatic stabilisers.242
  • 17. The Future of the Euro At the same time, as has been amply studied in the literature,3fiscal balance fosters a macroeconomic stability scenario which pro-vides a more efficient framework for the development of economicactivity. The reduction in the deficit increases the confidence ofsavers and investors. This translates into a stimulus for investmentand job creation, as well as allowing households and businesses toplan the purchase of durable goods in the long term, thus leading tosustained consumption, which is a key factor of economic growth. One of the most relevant aspects is the stronger credibility of theeconomic policy and the improvement in the funding terms of theeconomies in the international markets, thanks to the reduction ofthe risk premium, which in turn leads to a drop in financial costs,as shown in Chart 4 in the case of Spain as of 1996. The subjectionof European monetary and fiscal policies to certain rules, and theassumption thereof by Spain as a participant in the foundation ofthe Euro, helped to provide additional credibility to the govern-ment’s fiscal consolidation strategy. This strategy was strengthenedby the regulatory reforms introduced by said government as we dis-cussed in the previous section. This positive impact4 on the expec-tations and on the confidence of economic agents explains thesharp drop in long term interest rates, compared to the 10 yearGerman bond. The spread in the Spanish risk premium was actuallyzeroed as of 2003.3 “Fiscal policy and long-run growth”, V. Tanzi and H. Zee, 1997.4 “The Spanish economic model 1996-2004” (El modelo económico español 1996-2004), L.Bernaldo de Quirós and R. Martínez Rico, 2005. 243
  • 18. The fiscal institution in the Economic and Monetary Union: the contribution of Spain However, since 2008, with the arrival of the international finan- cial crisis, the macroeconomic imbalances accumulated by the Spanish economy led to the opposite effect. Furthermore, as a result of the degradation of Spanish public finances between 2003 and 2009, as shown in the aforementioned graph 3, and the doubts in regard to the sustainability of the Spanish public debt, the risk premium increased once again in a significant way as of 2010, now reaching the 450 base point mark. The significance of fiscal consolidation as a tool for the recovery of stability and long term growth has also been proven in practice in many successful fiscal adjustment processes implemented in the last decades in certain European countries, such as Spain (1996- 2004), Ireland (1982-1989) or Sweden and Finland (1993-2000), some of which have been studied in depth in the literature.5 The most successful process was the one implemented in Finland between 1993 and 2000, which managed to reduce pri- mary expenditure by 14pp of GDP. This was mainly based on per- sonnel cost containment, reduction in transfers from the Central Administration to Local Corporations and the pursuit of efficiency in social expenditure, particularly in health services, education and pensions. Moreover, the fiscal institution underwent a reform with the introduction of expenditure ceilings, which proved to be a key5 "Fiscal expansions and adjustments in OECD countries", A. Alesina y R. Perotti, 1995. “AnEmpirical Analysis of Fiscal Adjustments", C. McDermott & R. Wescott, 1996. 244
  • 19. The Future of the Eurotool for cost containment. At the same time, the pension system,the labour market and the financial system underwent a structuralreform. The only expenditure programme that was deliberatelymaintained, thus keeping its 1% share of the GDP, was that ofResearch and Development. The Swedish experience between 1993 and 2000 obtained similarresults in terms of a reduction in primary expenditure (14% GDP),which led to the attainment of fiscal balance in 1997, having closedfinancial year 1993 with a deficit of 12.9%. In contrast with Finland, Chart 4 Evolution of risk premium Source: Financial Times 245
  • 20. The fiscal institution in the Economic and Monetary Union: the contribution of Spainin Sweden the fiscal consolidation took place due to both the cut inexpenditure and the increase in revenue through a tax rise, whilealso implementing simultaneous structural reforms such as the pri-vatisation of public corporations and the liberalisation of the labourmarket. Public spending was reduced by 16pp of GDP over a sevenyear period, mainly through a reduction of the expenses in transfersand benefits (including unemployment benefits) and a reduction inpersonnel and current costs of all public administrations. The intro-duction of three-year expenditure ceilings and annual productivitytargets must be added to such measures. The starting point of all the above was the strict cut in primaryexpenditure, as the basis for the adjustment process, mainly cen-tred on personnel costs, transfers and health services.Undoubtedly, a key factor in all such measures is that they weredone hand in hand with important structural reforms, particularlythose implemented in the labour market, the fiscal system and theprivatisations. Those allowed the adjustment process consolidationand the increase in potential growth, on the basis of a firm politi-cal commitment. Furthermore, it helped proved that fiscal consoli-dation strategies based on spending cuts are more enduring andpromote a better economic performance than those based on reve-nue increase. Experience has likewise proven that fiscal consolidation cannotbe maintained in the medium term without a proper fiscal institu-tion articulation. As shown in the previous section, from the start,246
  • 21. The Future of the Eurothe construction of Europe has been evolving towards a greaterrelinquishment of national policies in favour of European ones. Itis a slow and complicated process in which political divergencesoften prevail over the overall view of what this process means. Thisrelinquishment has meant the need for greater autonomy in theestablishment of rules and objectives, as has been the case, for ins-tance, with monetary policy. Aside from the current supervisionproblems, it is clear that the role of the ECB in regard to price con-trol has been a success. This example should be transferred to thefiscal policy as a source of inspiration to maintain the necessarypolitical commitment and thus achieve effective fiscal coordina-tion in the Eurozone. We live in an open economy, where freedom of movement ofpersons, goods, capital, information and technology are necessaryconditions for improvement of competitiveness and economicdevelopment. A globalised market, with a high level of competi-tion, but also great opportunities, requires a disciplined, foreseea-ble and transparent behaviour by the countries, designed to gene-rate confidence among economic agents. The EMU was born out ofthis perspective although there have been mechanisms, or evenrelevant design components, which have failed. In general, The European construction has been preceded by theestablishment of rules seeking to limit the risks of integration. Theproblem has arisen from the lack of rigour in compliance with suchrules, probably as result of the insufficient clarity of the rules and 247
  • 22. The fiscal institution in the Economic and Monetary Union: the contribution of Spain of political leadership committed to integration. When this hap- pens, it is easier to interpret the situation in one’s own favour, par- ticularly when high political power is held. Therefore, it is impor- tant to have clear and simple rules, in order to reduce the possibili- ties of interpretation and to help control subsequent compliance. At the same time, the establishment of preventing rules to ena- ble the anticipation of sharp increases in public deficit, should be articulated via a greater participation by the EU in the preparation of national budgets, in line with the latest legislative proposals of the European Commission on the matter. Preliminary control is a guarantee of compliance and greater co-responsibility with Brussels, which should in turn lead to better access to European funding. According to economic literature,6 those countries exerting con- siderable effort to achieve fiscal consolidation amid a context of economic uncertainty, should design and announce the establish- ment of a fiscal rule within a reasonable period of time designed to improve credibility. In the case of Spain, this step has been taken by way of the reform of section 135 of the Constitution, a historical event of special political relevance. In our case, constitutional reform has managed to raise to the level of fundamental Law – a relevant issue in our highly decentra- lised State – the commitment of all the Administrations to fiscal6 “Fiscal Rules – anchoring expectations for sustainable public finances”, FMI, 2009. 248
  • 23. The Future of the Eurosustainability. The approval of this reform has meant the recogni-tion of the benefits of fiscal discipline, having assumed the flaws inthe relaxation of the Stability Laws in 2006 as well as the need toprovide a new common legal framework for all of the public sector.Except for force majeure cases (natural disasters or emergencysituations), compliance with the limits on public debt and fiscalbalance set by the EU are guaranteed. Likewise, priority is given toservicing the debt in the budget, a condition which helps build thenecessary confidence in lenders, and is an appropriate antidote forpreventing the loss of confidence in Eurozone countries. The reform also established the need for articulation in a neworganic Law, designed, on the one hand, to regulate the distribu-tion of deficit and debt limits between the variousAdministrations, the exceptional cases of surpluses therein, andthe means and terms for correction of any deviations in one or theother that might take place. On the other hand, it had to establishthe methodology and procedure for calculation of structural defi-cit. It is important that the calculation methodology respects theprocedure used in the EU, to provide discipline and transparencyto the fiscal process and help in the statement of accounts. The cal-culation rule must be clear, and serve to consolidate fiscal discipli-ne, as a permanent long term commitment. Lastly, it must esta-blish the responsibility of the Administrations in the event of fai-lure to achieve fiscal stability targets. In this regard, the credibilityof the reform will depend on the existence of efficient systemswhich encourage the Administrations to meet the fiscal targets. As 249
  • 24. The fiscal institution in the Economic and Monetary Union: the contribution of Spainwe shall mention in the next section, such principles have beenincluded in the Law on Fiscal Stability and Financial Sustainabilityof Public Administrations.4. Next steps in the Fiscal Institution of the Economic andMonetary Union: the necessary contribution of Spain The European debate on sustainability of public finances andthe future of the Euro is set at a time in which, following the con-version of the international crisis into the crisis of the sovereigndebt of several Eurozone countries, we have witnessed myriadEuropean summits, each of which seeming to be the last chance totackle the doubts of the markets in relation to the viability of thedebt, in the first place, of Greece, Portugal and Ireland, and morerecently, of Italy and Spain. It is true that the crisis is far from being resolved. The EU has notalways shown a capacity to react with the speed required by econo-mic relations nowadays – until the tensions reached non peripheraleconomies such as Austria or France, the pace in reaching consen-sus had been much slower than necessary. Moreover, during the cri-sis, it has become obvious that the institutional design of theMonetary Union was incomplete and, above all, as we have men-tioned in this paper, that there has been insufficient political com-mitment to the application of the existing mechanisms of fiscalcoordination. But it is also true that in the last four years, a consi-250
  • 25. The Future of the Euroderable path has been travelled towards European construction,towards an improvement in economic governance, so that in addi-tion to a single monetary policy, Europe is also able to benefit fromgreater integration of fiscal policies. As such, it is worth highlighting the agreements reached, eithervia the community procedure or via inter-governmental agree-ments, in terms of strengthening coordination, supervision andpolicing mechanisms of fiscal and macroeconomic policies. In the first place, the European Semester establishes a new sche-dule whereby, on the basis of the macroeconomic situation of eachmember state and its growth forecast, the budgets and economicpolicies required to meet the commitments undertaken in the EuroPlus Pact and the 2020 Growth Strategy are discussed during thefirst six months of the year in a coordinated fashion and in accor-dance with common rules. In the second place, the adoption of the so-called Six-pack (onedirective and five regulations) constitutes the greatest reform of theSGP and of economic Governance since the Maastricht Treatywhich created the EMU. As of the adoption of the new legislation,the European Commission may establish automatic penalties (ofup 0.2% of GDP) for those countries with excessive deficits whichdo not follow the recommendations for correction. At the sametime, the public debt control mechanism and the required reduc-tion are reinforced in the event of exceeding the 60% GDP level 251
  • 26. The fiscal institution in the Economic and Monetary Union: the contribution of Spain assumed. It also introduces a mechanism designed to prevent excessive imbalances such as unsustainable current account defi- cits, loss of competitiveness and other macroeconomic imbalances. Lastly, the signature of the new Treaty on Stability, Coordination and Growth (by all member states of the EU except for the United Kingdom and the Czech Republic) brings changes at the highest legislative level to fiscal stability regulation. This must be translated in each country in that the structural deficit of the public sector may not exceed 0.5 GDP per annum, subject to auto- matic penalties. These steps will be followed in the months to come by impro- vements seeking to fine-tune the mechanisms of economic con- vergence, via two legislative proposals7 of the European Commission, by establishing a clearer and more demanding sche- dule for fiscal coordination in Europe and implementing fiscal control and monitoring mechanisms in countries facing serious difficulties in regard to their financial stability within the Eurozone. All these measures help towards the consolidation of economic governance, and establish the bases to enable progress to be made7 "Proposal for a regulation of the European Parliament and of the Council on commonprovi¬sions for monitoring and assessing draft budgetary plans and ensuring the correction ofexces¬sive deficit of the Member States in the euro area" and "Proposal for a regulation of theEuropean Parliament and of the Council on the strengthening of economic and budgetary sur- 252
  • 27. The Future of the Eurovia other instruments, in order to provide funding and liquidity tohandle emergency situations, to the extent of including euro-bonds, if necessary, as well as helping the ECB to have greater lee-way when acting in the markets in pursuit of economic stability.Without doubt, greater fiscal coordination broadens the fundingmargin of these countries. But we must be clear that access to fun-ding requires preliminary fiscal control, and not the reverse.Conditionality in all these mechanisms is an essential requirementwhen seeking to limit risk. Any funding requires certain minimumguarantees of repayment of the loan, and this translates intoadjustments and reforms. This is nothing new, but something thathas cropped up on many occasions in IMF interventions.Eurobonds might get to play a key role, but cannot be the onlyitem to support the fiscal union, which will drive the Eurozonetowards optimum monetary union, and for which to date there isno more than a highly experimental road map. Within this working programme so badly needed in Europe, andsupported by conditionality, greater mechanisms for EU incometransmission should be created to help countries facing serious pro-blems – such as that of the sovereign debt crisis – in order to imple-ment the structural reforms required by their economies, with thesupport of Europe in driving growth. This can be done via theencouragement of youth employment and entrepreneur program-veillance of Member States experiencing or threatened with serious difficulties with respect totheir finan¬cial stability in the euro area", European Commission, November 2011 253
  • 28. The fiscal institution in the Economic and Monetary Union: the contribution of Spainmes, the reinforcement of resources available, among other uses,for structural funds or for the activity of the European InvestmentBank. On their part, the Eurozone member states can and must con-tribute to guarantee the future of the single currency, and to thegeneration of the economic growth required to clear any doubts asto the sustainability of sovereign debt, either via their contribu-tions towards the establishment of common rules so that the EMUbecomes an optimum monetary zone, or via the reforms on anational scale which constitute an example for all the others. There is also a high degree of parallelism between the rulesrequired and which must be institutionalized in the MonetaryUnion at a European level, and the process which must be follo-wed in Spain in regard to responsibility, conditionality and subsi-diarity of regional and local Public Administrations. In both cases,the need for a political will capable of applying clear and straight-forward rules, with prevention mechanisms, supported by coordi-nation, monitoring and automatic sanction systems for those whofail to comply with the targets undertaken, has become clearly evi-dent. In this sense, the fact that the new fiscal pact at a Europeanlevel and the recent legislative changes in Spain seem to be goingin the same direction is a positive factor. The case of Spain, where we have a very high degree of decentra-lisation and where the Autonomous Communities and Local254
  • 29. The Future of the EuroCorporations manage approximately 50% of the public expenditure,is a clear example of the need for coordination of fiscal policies toensure that the right signals are sent to markets and investors inregard to the orientation of the fiscal policy. The consolidation effortsmade by some countries and regions are useless if there are otherswhich do not honour their commitments and destabilise the zone,region or country. Europe and, of course, Spain have their own iden-tity, and this applies to act as a unique body in order to establish theaims. The scope of action of each government to achieve fiscal targetsundertaken, via the instruments deemed appropriate, is a differentthing altogether. The principle of subsidiarity must be respected pro-vided that the principle of fiscal balance is observed. Each countrymust have autonomy to define and design its fiscal structure solong as the limits set for deficit, debt and growth in expenditure arerespected. Fiscal competition allows for improvement in revenuecollection efficiency and greater rigour in expenditure control, andthus the greater fiscal coordination in Europe must not be envisagedas a single fiscal policy. However, one of the main instruments at thedisposal of the governments when coordinating fiscal policies is con-ditionality. In any regional funding system there are income transmis-sion mechanisms and penalties aiming to fulfil the set fiscal targets.Therefore, in the event that fiscal stability criteria are not met, be it ata national level within the Eurozone or at a regional level withinSpain, the aid provided, as the case may be via special liquidity facili-ties and even, if necessary, by way of eurobonds or hispanobonds, orby way of larger revenue transmissions at a European level, cannottake place without the acceptance of the conditionality it carries. 255
  • 30. The fiscal institution in the Economic and Monetary Union: the contribution of Spain Spain has understood the need to contribute to the stability inEurope and is leading, for the second time, a solid process ofreforms towards fiscal balance. Following the general elections ofNovember 2011, the new government and a reinforced politicalcapital constitute the main assets to bring about the necessaryreforms. The proof thereof is evident in the fiscal reforms: theRoyal Decree of non-availability, the reform of the Law onStability, the new system for payment to suppliers, the new bill onTransparency or the bill of General State Budgets for 2012 (whichestablishes an adjustment of 27,300 million euros to be made bet-ween cost control and revenue increase). The modification of section 135 of the Spanish Constitutionassumed its inclusion in a subsequent organic Law (the Law ofBudgetary Stability and Financial Sustainability of the PublicAdministrations, recently presented), which specifies changes inthe preparation, execution and control of the Spanish fiscal insti-tution. The recent approval of this bill means a return to the com-mitment to the control of public finances and, more importantly,it adds all of the Public Administrations to its scope of application,which the previous Stability Law failed to do. The three main objectives of this bill are to guarantee the fiscalsustainability of all Public Administrations, to strengthen econo-mic confidence and to reinforce the commits of Spain with theEuropean Union.256
  • 31. The Future of the Euro All Public Administrations must present a balance or a surpluscalculated according to EAS terms and none may incur in structuraldeficit. However, there are two exceptions in the case of structuralreforms with long term fiscal effects (a structural deficit of 0.4% ofthe GDP may be achieved) and in the event of natural disasters, eco-nomic recession and extraordinary economic emergency. In establishing the objectives of stability and public debt, therecommendations of the EU in regard to the Stability Programmemust be taken into account, and all Public Administrations mustapprove an expenditure ceiling in line with the stability target andthe expenditure rule. One of the most important aspects, in accor-dance with European regulations, restricts the growth in expendi-ture by the Public Administrations, as this may not exceed the GDPgrowth rate. Failure to comply with the targets shall require the presenta-tion of an economic and financial plan to allow the correction ofthe deviation for a period of one year. This plan must explain thecauses underlying the deviation and the measures which willbring it back within the limit. In the event of non-compliancewith the plan, the responsible Administration must automaticallyapprove the non-availability of loans to guarantee compliancewith the set target and the meeting of the targets shall be takeninto account when authorising debt issues, granting subsidies andsigning agreements. 257
  • 32. The fiscal institution in the Economic and Monetary Union: the contribution of Spain The Law, on the other hand, strengthens the preventive andmonitoring systems of stability and debt objectives. Therefore, adebt threshold of a preventive nature is established, beyond whichthe only debt operations allowed will be cash transactions. In order to render all Public Administrations jointly responsible,the penalties imposed in Spain in matters of stability shall be assu-med by the responsible administration. In the event of failure toproduce an economic-financial plan, the administration in breachmust put of a deposit of 0.2% of its nominal GDP, which after sixmonths may be converted into a penalty in the event that the vio-lations should continue. After nine months, the Ministry ofFinance and Public Administrations may send a delegation toassess the economic and budgetary situation of the delinquentAdministration. In order to strengthen the principle of transparency, eachPublic Administration must establish the equivalence betweenthe budget and the national accounts. Prior to approval, eachPublic Administration must provide information on its mainbudget guidelines, in order to comply with European regulatoryrequirements. As was set forth in the new draft of section 135 of theConstitution, the Law establishes a temporary period until 2020for gradual compliance, until public debt is 60% of GDP. In orderto ensure compliance with this scenario, public debt must be redu-258
  • 33. The Future of the Euroced whenever the economy experiences positive real growth. Uponreaching a growth rate of 2% or net yearly employment is genera-ted, the debt ratio shall be reduced each year at least by two GDPpoints. On its part, the global structural deficit must be reduced by0.8% of the annual average GDP. Beyond the institutional importance of the reform, it is worthconsidering the political capital that is allowing the deficit problemto be addressed in an integral way and with long term vision. Doubtsas to possible deficit deviations in the current and following finan-cial years should not lead us to lose perspective of the importance ofthe reform. This reform set a trend designed to transform public bud-gets into a reliable institution, with a simple structure, with no roomfor interpretation, equal for all and with an automatic applicationwhich allows it to be protected from temptations from other govern-ments. In this regard, we also view the provisions included in the Billfor the Transparency Law, which, undoubtedly, shall contributetowards generating better knowledge of public finances. The fiscal systems being approved in Spain matched with theEuropean model. There is a strong parallelism between the two,and the construction errors of the European design and of the fis-cal institution in Spain must be corrected by means of a coordina-tion of fiscal policies in which the principles of regulatory equity,subsidiarity, conditionality and sustainability should prevail aboveall others. 259
  • 34. The fiscal institution in the Economic and Monetary Union: the contribution of Spain Without doubt, the future of the euro requires more Europe.The construction of Europe needs rules, adjustments and reforms.Without growth the European model is doomed for failure. Thecurrent crisis is but a result of the structural deficiencies of our eco-nomy, of our excess indebtedness, of our lack of flexibility and ourlack of competitiveness in some aspects. Once again, Spain, on its part, must become a role model of thefiscal institution in Europe, and of the benefits which macroeco-nomic stability brings to the economies, in terms of higher growth,more wealth and greater employment. This is unquestionably thebest way to redistribute income. This is the only way we will mana-ge to get Europe and Spain out of the sovereign debt crisis theyface, ensuring a solid future for the process of European construc-tion, which is the greatest milestone in the search for peace andprosperity in Europe.5. Conclusion Following the same pattern set since the inception of theEuropean integration project after the World War, the EMU cameabout in 1999 as a result of the political aspiration of increasingintegration and as a European response to the globalisation pro-cess. In reality, the integration via the monetary union whichmakes up the Eurozone was not an objective in and of itself, butrather a means to improve competitiveness and efficiency among260
  • 35. The Future of the Euromember countries. The ultimate goal, therefore, was growth, jobcreation and the improvement of social welfare, while at the sametime making inroads in terms of political integration. At that time the countries were aware of the need to set fiscal dis-cipline targets as stability factors for Europe. However, those impor-tant advances in the European construction process became dilutedover the years with the introduction of components carrying greaterflexibility and discretionality in the fiscal institution. The best exam-ple is that the solution provided in 2005 to the violation of the SGPby Germany and France was none other than the reform thereofwhich included greater ambiguity in the search for fiscal stability, forwhich they gained the support of the European Commission. Thediminishing political commitment with the fiscal institution and itsfragility in the face of the vicissitudes of the different governmentsand ideologies became clear at that time. Therefore, with an institu-tional design which was incomplete, and gradually declining overthe years, the EMU was far from representing an optimal monetaryarea, and therefore the imbalances of the Eurozone economies incre-ased, instead of decreasing, placing Europe in a difficult situation inthe face of the global financial crisis. In this context, the current European debt crisis has highlightedthe urgent need for better coordination of the fiscal policies inEurope. At the same time and particularly during the crisis, theexperience since the foundation of the euro has shown the impor-tance of political commitment with the fiscal institution and the 261
  • 36. The fiscal institution in the Economic and Monetary Union: the contribution of Spainneed for preventive rules instead of penalties which are difficult toapply. It is essential to ensure that the accumulation of excessivedeficits does not lead to unsustainable situations which call intoquestion traditional European security and seriously complicatethe capacity for funding growth and job creation. Rules are anecessary condition to ensure compliance with fiscal targets. Butthese rules must be of straightforward and automatic application. Despite the difficulties, the present economic time obligesEurope and Spain to make fast and efficient decisions in order tostraighten out the situation. It is important to take advantage ofcurrent circumstances to tackle ambitious reforms designed tocorrect some of the structural flaws of the Eurozone and of our eco-nomy. It is important to face the current problems from a longterm outlook and to establish the rules of a fiscal institution whichensure the viability of the European project. The future and survival of the euro rests on all member statesbeing able to implement domestic reforms seriously, thus genera-ting a sign of confidence for international investors and whichshall also serve, again in our case, as a calling card for our busines-ses abroad. In Spain, one of the countries which has sustained themost damage from the sharp budgetary deviations of recent years,regional configuration shows evident parallelisms with Europe,both in terms of the need to establish common objectives, and interms of the control systems or the transmission and penaltymechanisms.262
  • 37. The Future of the Euro Spain, as a country which has already proven its ability to takeon this role at the end of the 1990s in the foundation of the Euro,once again has an important role to play. In this regard, it is worthmentioning that, thanks to the latest reforms implemented in sup-port of the fiscal institution, Spain is once again contributing tothe European debate in pursuit of macroeconomic stability in theEurozone and its recovery. The challenge to be addressed, by meansof a change in the economic policy, is to recover confidence andcredibility of our economy, to enable businesses and consumers toconcentrate efforts in business, labour or consumer decisions, andthat macroeconomic issues, such as the risk premium, cease to because for concern. Only in this way may Spain avoid laggingbehind like a second rate club, to which we have already said no afew years back. In order to move forward in building a fiscal union in Europe,which succeeds in turning the EMU into an optimal monetary areaand ensures the good health of the euro and of the European eco-nomy, the necessary mechanisms of income transmission, ensurethe availability of financial resources and required liquidity, to theextent, if necessary, of creating risk pooling instruments, such aseurobonds and, in parallel, the hispanobonds in the case of Spain.These require, however, the establishment of prerequisites, that is,economic adjustments and reforms to be implemented by thecountries facing the most difficulties. The rules are very important,but without reforms it is impossible to grow, and without growth,budgets become unsustainable. A different issue is, provided agre- 263
  • 38. The fiscal institution in the Economic and Monetary Union: the contribution of Spained commitments are met, the respect for the autonomy of eachcountry to decide on its income and expenditure structure.Subsidiarity must govern in Europe for those who are taking thenecessary steps, as is being done in Spain, in order to adapt thebudgets to the economic and social reality of each country. The European construction has taken important steps since thestart of the crisis, but it needs to continue to progress via an incen-tive system to ensure the political commitment with the fiscal ins-titution in the medium and long term. The objectives of peace andprosperity established by the founding fathers of the Europeanconstruction, on a long term horizon, once again depend on ourcapacity to recover the growth and competitiveness of the eco-nomy, and hence employment and the European welfare model.264

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