Saving the Stability Pact from Itself

At their meeting in Scheveningen, the Netherlands, the EU's economic ministers (Ecofin) once again confronted the need to reform the Stability and Growth Pact (SGP). The issues surrounding reform remain controversial and unsettled, but this time, the ministers laid their cards on the table.

The SGP's fundamental problem is that it must strike a balance between two contradictory goals: it must retain bite against excessive debt accumulation, yet it must also give governments more maneuvering room to enact structural reforms and restore Europe's competitiveness. As it stands, the SGP is an obstacle to such reforms. European leaders waste political energy and capital to meet demanding budget targets, while nothing is done to address the really vital challenges: aging populations, high tax burdens, declining competitiveness.

The reason is that structural reforms tend to pay off in the long term, but cost money in the short term. The SGP originally aimed to protect European citizens from myopic governments, but it has ended up forcing even more myopic behavior.

Take pension reform, which aims to reduce the scope of state-run, pay-as-you-go systems and expand private, fully funded schemes. This requires cutting compulsory contributions to the public system, while maintaining benefit levels for current retirees. The result is a temporary increase in budget deficits; the fiscal benefits appear only when private schemes start taking over pension liabilities from the state-run systems. But the SGP's current rules discourage this kind of reform by prohibiting temporary increases in the budget deficit - even if they promise long-term fiscal consolidation.