The Maastricht Failure, vol. 2.0

In the context of the Greek crisis that has been developing over the past few months, one of the key issues has been the strict budgetary requirements that creditors want Athens to comply with. Important to the debate has been the size of Greece's primary budget surplus (i.e. the budget surplus before interest is charged) that would allow it to service its gigantic debt.

It is often overlooked, however, that the eurozone has its own set of fiscal rules that, at least in theory, should be able to keep the macroeconomic performance of its member countries (and those aspiring to join) stable. After a long period of economic convergence that began with the union's creation, the Maastricht Treaty of 1992 introduced the so-called convergence criteria.

The Maastricht Criteria – Theory and Practice

On paper, the fiscal rules sound reasonable – no more than a 3% budget deficit, inflation no higher than 1.5% above the average of the three countries with the lowest inflation in the EU (which is currently 1.7%), no more than 60% government debt as a share of GDP, and maintaining a certain level of long-term interest rates (currently 6.2%).

However, there is a significant gap between well-written policy and its actual implementation. My previous review of compliance with the Maastricht criteria found that of the EU countries, only Bulgaria, Estonia and Lithuania complied with all the requirements with data from 2012. The explanation of many statesmen was that the crisis had forced them to increase their government spending and that is why they had stepped up restrictions in order to save their economies through targeted investment (another question is to what extent government investment produces economic growth and whether increasing government spending is an appropriate policy at all).

By 2014, the situation had not changed fundamentally. The biggest difference was observed in inflation, measured by the consumer price index. However, this is a pan-European trend, caused mainly by the sharp decline in energy prices over the past year. In addition, a few months ago the ECB launched a generous quantitative easing program, which will most likely put an end to the “dangerous deflationary processes” in the near future.

Table 1: Fulfilment of the Maastricht criteria, 2014 (Legend: red – non-fulfilment of criterion; yellow – threshold value )

Data: Eurostat, ECB

In other words, if the eurozone were to be built today, it would include a total of 8 countries – Estonia, [1] the Czech Republic, Denmark, Bulgaria, Romania, Lithuania, Latvia, Sweden and Luxembourg. Even more curious is the fact that of these three countries, only 4 are among the actual members of the eurozone – the remaining countries, which have undertaken to comply with the conditions for participation in the single currency, simply do not do so, which is probably one of the reasons for the euro’s current problems.

Leaving aside the slowdown in inflation, little has changed in the last two years. Countries with significant deficits and debt continue to maintain them despite the end of the crisis, and most of the “champions” of balanced budgets are still located in the East. On the other hand, most Western countries that proclaim themselves to be fiscally conservative and austerity-minded are practically not following through on their own messages.

For this reason, I have no choice but to reiterate my previous conclusions, which are still valid today.

Back in 1998, The Economist explained in detail why most of the countries (then still the future Eurozone) were unable to adhere to the criteria. 17 years ago, the magazine predicted the imminent end of this apparently unattainable regulation. Today, however, the EU continues to argue that the equalization is sensible and, despite evidence of its failure, tries to adhere to it.

With criteria for progress?

The bureaucrats in Brussels need to adopt a completely different line of reasoning. Since historically most countries have never managed to comply with the criteria and this has never led to any particular consequences (even, as in the case of Greece, non-compliance with the criteria has been the reason for generous economic rescue aid), we should ask ourselves whether there is any point in having criteria that are chronically violated (even by the countries that drafted them), and mechanisms and penalties for their enforcement that are systematically not used?

The answer is no.

Research on the issue shows that attempts to fit the significantly different European economies into a single mold tend to lead to negative results. [2]

On the one hand, the failure of the criteria to achieve their original purpose, namely to guarantee the stability of the euro area and the European economic area as a whole, is obvious. What happened to the PIIGS countries [3] since the beginning of the crisis is an example of how “stability mechanisms” are the first victims in times of difficulty.

Another glaring problem is the purely political, not economic, nature of the prescriptions – their specific values are completely random. In practice, there is no real justification for why their observance is considered a magic formula for success and, accordingly, does not bring the countries that adhere to them much more than dubious prestige in the eyes of others.

The very attempt to define economic success through a few budget characteristics is doomed to failure; here the statist belief shines through that if we “just put the numbers together” everything will be fine. In this sense, it doesn’t matter exactly which indicators are selected, given that the chosen approach is totally wrong.

Bulgaria is the most relevant example of how the connection between these few random indicators and real economic development is practically non-existent, and for our efforts we do not receive much more than a pat on the back from Brussels from time to time. The goal of the criteria – achieving balanced and conservative budgeting – is not bad in itself; however, the chosen approach of random regulation and imposition of restrictions is extremely counterproductive.

Thirdly, they are based on a wrong prediction of the future – in the 1990s, the creators of the euro expected that all EU members would embrace the idea of a common currency and strive to become part of the eurozone. However, as it became clear in the following years, a significant number of countries (such as the UK and Denmark, which decided in a referendum not to become part of the eurozone, or Poland and the Czech Republic, which did not make any special efforts to join) preferred to preserve the independence of their national currencies, rather than submit fully to the control of the ECB, which makes compliance with the random rules an unnecessary and pointless burden, given that their ultimate goal is not considered a priority by these countries.

Ultimately, the criteria are nothing more than a failed – and self-serving – attempt to impose common frameworks and constraints on vastly different economies. Even if they set seemingly noble goals, such as a moderate and disciplined budget policy, the top-down approach aimed at uniformity inevitably taints and distorts the results.

[1] With the proviso that it makes it impossible to calculate a long-term interest rate. See here.

[2] For example, Paleta, T, “Maastricht Criteria of… Divergence?”, Review Of Economic Perspectives 2012

[3] Portugal, Ireland, Italy, Greece and Spain

Did you like it? Take a minute to support the EKIP on Patreon!