JOINT COMMITTEE ON EUROPEAN AFFAIRS debate -
Tuesday, 13 Jul 2010

Reinforcing Economic Policy Co-ordination: Discussion

Chairman

I ask everybody to ensure that their mobile phones are switched off completely. If they are left on silent or otherwise they will distort the sound and recording system. Apologies have been received from Deputies Pat Breen, Brendan Howlin and Noel Treacy. We also had an apology from Senator Phil Prendergast who is otherwise engaged but may come along later.

No. 1 is a discussion of the Commission's COM (2010) 250 on reinforcing economic policy co-ordination with representatives from the Department of the Finance and the EU Commission. On behalf of the committee I welcome Ms Mary R. McCarthy, director general, economic and financial affairs, European Commission. We are grateful for her attendance. We also have Mr. Michael McGrath, assistant secretary and Mr. Tony Gallagher, Department of Finance. I thank them all for making time available to come before us.

I must now state the usual privilege notice and please do not take it too seriously but have regard for it. By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they are to give to the committee. If they are directed by the committee to cease giving evidence in relation to a particular matter and they continue to so do, they are entitled thereafter only to qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable. That is not a warning but a statutory provision that we must announce at every meeting.

Ms Mary McCarthy

I thank the committee for the invitation to make a presentation on reinforcing economic policy co-ordination in the European Union. It will cover the communications released on 12 May and 30 June by the Directorate General for Economic and Financial Affairs.

Prior to the financial crisis, the Directorate General had produced some reports on economic conditions in the EU and, in particular, the eurozone. As early as 2006, we had highlighted the growing divergences in the EU in growth inflation, competitiveness and external imbalances in current account surpluses in some countries and current account deficits in others. Since these imbalances had already developed when the financial crisis hit in 2008, not all countries were in a good position to deal with the fall-out from the crisis. If they had been in better positions with fewer imbalances, they would have had more room to manoeuvre.

Once the EU had co-ordinated itself to deal with and contain the financial crisis, it was then faced with other crises in individual member states, mainly the situation in Greece which developed last year and came to a head in February 2010. This brought back to us that all eurozone member states are integrated. When a crisis hits one, it affects others. We realised there was a threat to the stability of the euro area arising from the situation in Greece which could spread to other countries.

Two years ago, we highlighted the need to reinforce economic governance in the eurozone and the EU. We brought forward our proposals in this regard. We found we had sound rules in place, particularly with the Stability and Growth Pact. However, these were not enough and they needed to be reinforced.

The first communication was released on 12 May 2010. In the meantime, a task force established by the European Council to examine governance had its first meeting and produced its first report which was along the same lines as our communication. On 17 June, the European Council examined these reports and endorsed what had been done so far. We were asked to develop further our proposals in more detail. Accordingly, on 30 June, we released a second communication which is more detailed than the first.

In the 12 May communication, we outlined four areas where further reinforcement was needed. We recognised the Stability and Growth Pact had good mechanisms in place but there were various elements of it that needed to be strengthened. We wanted to go more deeply into the provisions around national debt as the pact mainly focuses on budget deficit. With the economic crisis, when there were bad dynamics the debt ratios of countries increased quickly.

Over time since the creation of the euro area, imbalances had increased across member states. Some countries, especially southern European countries, had moved into high budget deficits on their current accounts while others, like Germany, had large surpluses. We needed to see how this could be improved. We also wanted to see how the framework for policy co-ordination could be improved. In that context, we have proposed a European semester which I will outline later.

The final but also important element of the communication concerned the need to have a robust framework for crisis management in euro area countries. When the crisis hit Greece, we found ourselves with few tools to take care of it. In the end it was dealt with it by establishing a temporary mechanism. We examined how this could be made more permanent.

In the 30 June communication we elaborated further on the first three elements while we are still working on the fourth element. The Stability and Growth Pact is a solid set of rules but its major problem is compliance. Member states agree to an annual budget deficit no higher than 3% of GDP and a national debt lower than 60% of GDP. However, they do not always manage to adhere to these reference values. The pact has a preventive arm which deals with problems before they get worse. It also has a corrective arm. There are measures to deal with a country once it has got into an excessive deficit above the 3% reference point.

To reinforce these, we decided to examine the ex ante co-ordination of fiscal policy. Up to now, we see the stability and convergence programmes when all decisions have been made. Instead, we would prefer to talk about the situation up front to provide guidance which would be horizontal across all member states. To achieve this, we have come up with the idea of a European semester.

The Stability and Growth Pact focuses almost exclusively on the deficit criterion, the 3% reference value. There was a reluctance to examine national debt even though the pact's reference value is 60%. It also states all countries which have a debt over 60% of GDP should reduce it. In fact, the focus on debt is rather important because we saw how quickly when deficits get out of control, as they did with the crisis, the debt can start to increase again. We need to focus on the debt. Another element about the debt relates to looking at the future because all countries are faced with aging populations, so we need to have an eye on the sustainability of the fiscal situation in view of expenditures related to aging populations.

One of the other elements we recognised in the existing Stability and Growth Pact was an incentive mechanism, like a carrot and stick mechanism: once member states get into excessive deficits we could impose fines and have measures related to the conditionality of the Cohesion Funds. The point is that this takes place once a member state is in excess of deficit, so it occurs quite late in the process. We should like to try and have the incentive or the essential mechanisms kicking in earlier in order to get member states to react before they are at what may be termed the "nuclear option" phase in the excessive deficit.

For that we are proposing that the EU funds would be conditional on compliance with the Stability and Growth Pact. We are also proposing for eurozone states interest bearing deposits in case of non-compliance. We are imposing tougher treatment for what we call the "sinners", namely, those that recurrently are in non-compliance with the Stability and Growth Pact. That I will explain later on.

I will now turn to one of the other elements of our proposal, macroeconomic imbalance and competitiveness. Because competitiveness had deteriorated in many countries, they were in a bad situation, such as Spain, for example, which was in a bad position to deal with the crisis when it happened. When we are dealing with macroeconomic imbalance and competitiveness, we try to look not only at external imbalances related to competitiveness and current account, but also at internal imbalances. These are cases where countries would have gone through a period of overheating, resulting for example, in the housing bubble as it occurred in Spain. We want to try to nip such imbalances in the bud before they develop into full-blown problems.

One of the things we could do was to introduce another mechanism similar to that used for the Stability and Growth Pact, and this mechanism would have a number of elements. First, we would look at standard economic and financial indicators such as current account balances, competitiveness indicators, credit growth in the private sector to households and corporations and so on. We would look at these variables and get a scoreboard on the basis of that. If a good many variables were over a threshold value, this would indicate that the country in question was developing a harmful economic imbalance. This mechanism consists, first, of a scoreboard and then, like the Stability and Growth Pact, we would have a preventative arm and a corrective arm.

Having done an analysis of the situation in member states, the preventive arm aspect would mean issuing recommendations to them to deal with their imbalances, in the event. Again, as with the Stability and Growth Pact, the corrective arm would work where a member state had got into the position of having a harmful imbalance, when we would see how to deal with that.

Under this aspect of broader surveillance, one element I have just discussed is the imbalances. There is also a second element, namely, the surveillance of structural reforms. The Europe 2020 document that we released earlier this year and which was agreed by the European Council, has objectives and headline targets. The headline targets cover employment, research and development expenditure, social inclusion, education, climate and energy. These are targets that have been set out and we shall follow up on them by having an assessment made of the progress made towards meeting them. The progress will be reported in the individual countries' national reform programmes, and then the Commission will carry out an assessment of the progress that has been made. Here again there is an evaluation and where countries are considered not to have made sufficient progress in terms of these objectives and targets we envisage the possibility of issuing country-specific recommendations and warnings to the particular member states.

As I said, the idea of the European semester is to have a new structure which will help to produce reinforced economic policy co-ordination. The problem with the system we have now is that there is rather loose integration of the various policies. We have one stream going on the fiscal side, another on the structural side, and they are not aligned in time. We want to integrate it all because the room for manoeuvre for pursuing policies to enhance growth, or improve productivity or the adjustment of the economy depends on having a good macro and fiscal framework. We want to put the alignment of the whole operation together, so that we get a better integration of the various policy lines.

The second element we want to take care of here is to allow for ex ante co-ordination at the European level when national budgets and national reform programmes are being prepared. The idea here is that in the past, too often we were being faced with decisions that had already been made, without any discussion having taken place at the European level. We want to change that and have some ex-ante co-ordination across eurozone states and EU member states in order to ensure that the cohesion of the whole euro area is respected.

To give members an idea of what the European semester that will take place will be like, we have produced this chart which shows how the whole system will operate. We hope, if this is agreed at the ECOFIN Council today, that it will operate from the beginning of next year. We hope to have an annual growth survey from the European Commission at the beginning of the year. This growth survey would look at what has been happening, on an horizontal basis, across member states in the past year. It would make an assessment of what has been happening and then have a forward looking part to it providing guidance for the coming years. It would have a macroeconomic scenario and include general suggestions as regards policy guidance for member states.

Once that was completed, there would be a debate at the Council of Ministers, which would provide orientations based on that input. It would then be discussed at the European Parliament and next it would be agreed at the European Council. There would be an annual economic summit, which would take place at the end of February or the beginning of March. Once all of this analysis and presentation has been gone through, all the information would then be on the table for member states to adopt their national reform programmes as well as their stability and convergence programmes.

All the information would have been provided. Already, there would have been a debate at eurozone state and EU member state levels from which the programmes would have come. In this case the national reform programmes and the stability and convergence programmes would be adopted at the same time. Once those have been adopted, we would carry out an assessment based on our spring forecast, which is usually published at the start of May. We would carry out an assessment, and then we would provide policy guidance in June, including Council opinions on the stability and convergence programmes, and including policy implementations and recommendations on the other elements, which are the imbalances and the structural reforms. Then there would be an endorsement of that guidance by the European Council and then we would go into the autumn period where member states would be in their own realm, developing their own budgets and so on. We would then arrive at the end of the year and the cycle would start again.

The final element in the proposal is the crisis management framework. We were faced with a crisis on Greece. We had no instrument to deal with that crisis because the facility for a balance of payments crisis is restricted for non-euro area member states. Given the crisis situation, the Council adopted a temporary stabilisation mechanism on 9 May. The idea is to help with financial assistance member states that are already in difficulty, or are seriously threatened by severe difficulties caused by exceptional circumstances beyond their control. The form of assistance that exists is a loan or a credit line. This is not a community mechanism. This is an agreement among member states. It does not come under the community mechanisms that operate for non-eurozone member states.

The total amount for this mechanism is up to €500 billion, of which €60 billion is in financial support and is subject to strong conditionality. For example, together with the IMF, we adopted strong conditionality on the loan that was provided to Greece. There is a stand-by of up to €440 billion, which is guaranteed by eurozone member states. We are in the process of developing a proposal for a permanent crisis mechanism, and the committee will hear more about this in the course of the rest of the year.

Much of this is being worked on at the moment. I will not be able to give the committee all the details, but we will be producing some drafts for secondary legislation in September that will deal with the various elements of the proposal for enhancing economic policy co-ordination. Thank you.

Chairman

Thank you very much. This is a fairly comprehensive tour. I call on Mr. McGrath to make his submission, and then we will have questions and answers, during which Mr. Gallagher may wish to come in as well.

Mr. Michael McGrath

Thank you, Chairman. I want to convey the apologies of the Secretary General, who is not able to be here. I would also like to introduce Mr. Tony Gallagher, Mr. Shane Enright, Ms Ailish O'Connell and Mr. Ronnie Downes. Ms McCarthy has set out the various points in her presentation, so I will try not to repeat too much some of the issues that are there. However, there is a similarity between our presentations, so I beg the committee's indulgence on that.

Before I turn my attention to the matter before us today, which is the original Commission proposal of reinforcing economic and policy co-ordination, and the subsequent proposal in June that the Commission has also explained, I would like to raise a couple of other brief matters that are relevant. In its mid-2008 assessment of European economic and monetary union after its first ten years of existence, the Commission identified as a challenge the need to improve the euro area's governance and co-ordination of economic policies. The Commission stated that this would involve deepening and broadening economic surveillance arrangements to guide fiscal policy over the cycle and in the long term, to address divergences in growth, inflation and competitiveness. At the time, the financial market difficulties were intensifying and as we know, the economic and financial landscape has considerably deteriorated.

In February of this year, the issue came to a head in Greece, with the result that conditional financial aid had to be provided to it. Developments over the past weeks have highlighted financial markets' concerns about unsustainable debt developments and prospects for growth in the EU, and the euro area member states in particular. The unfolding Greek crisis induced broader financial distress and high and rising public debts raised increasing concerns about some other countries. As financial market tensions persisted and escalated even after agreement on financial assistance and a fiscal and macro-economic adjustment programme for Greece, the Council agreed on 9 May 2010 to set up a European financial stabilisation mechanism. At the same time, Ministers strongly committed to ensuring fiscal sustainability and enhanced economic growth in all member states and agreed that plans for fiscal consolidation and structural reforms would be accelerated, where warranted. A recent Commission communication confirmed that the vast majority of EU countries currently have general government deficits above the 3% of GDP reference value set in the treaty. All of these challenges have demonstrated very clearly the interdependence of the EU's economies, particularly within the euro area. While the EU has been able to co-ordinate remedial actions to counteract the effects of the ongoing financial and economic crises, nevertheless, the need for stronger and earlier economic policy surveillance and co-ordination has become more pressing, together with the need for stronger prevention mechanisms.

It is in this context that the European Commission released its important discussion document COM(2010) 250 on reinforcing economic policy co-ordination within the EU, and in particular the euro area. As mentioned by my Commission colleague, the Commission subsequently published a follow-on communication which develops some of those proposals. The Commission suggests that reform measures are necessary and proposes changes in four specific areas as follows: reinforcing compliance with, and the effectiveness of, the Stability and Growth Pact; greater emphasis to be placed on the correction and avoidance of macro-economic imbalances; an earlier and more integrated coordination of budgetary policy, via the so-called European semester; and a robust framework for crisis management for the euro area member states.

The key emphasis in reinforcing compliance is to look at debt dynamics. The Commission has suggested that this would mean more effort should be put on reaching the 60% debt Maastricht criteria. Member states with debt above the 60% criterion could end up in excessive deficit if they are judged not to be making adequate progress towards it, even if their deficit is within the 3% limit. The Commission has also proposed that penalties for non-compliance could possibly include, in the case of inadequate fiscal policies, interest-bearing deposits that could be redeemed when targets are met, and withholding structural and cohesion funds from poor performers.

In order to correct and avoid macro-economic imbalances, the Commission is proposing that any revised surveillance process would take account of member states' competitiveness position, as it can have spillover effects on the public finances, and the smooth functioning of EMU in general.

In the presentation we heard reference to the Commission's proposal for a national scorecard to be introduced by way of an early warning mechanism to detect these macroeconomic imbalances. This would encompass much more than the standard budgetary analysis but also micro-indicators, including price and cost developments. The intention is that it would pre-empt the build-up of potential harmful macroeconomic imbalances which we have seen in the past.

In terms of the framework referred to, the Commission has proposed the European semester, beginning in 2011, so that stability and convergence programmes are presented at an earlier stage in the year than is currently the case. The intention here is that member states' programmes would be discussed at the Eurogroup before they are fully finalised and implemented, and not afterwards as is currently the case. The Commission has, however, made clear that this would have to respect member states' domestic procedures.

With regard to the crisis resolution mechanism, we already have the European financial stability facility, which is a temporary arrangement, and the proposals in this area are to put something more permanent in its place. These are sensitive issues and it remains to be seen what will emerge. We heard the Commission say there would be more in this regard later in the year.

In terms of the legal basis for proposals, some of the proposals may require effective application of existing rules while others may require legislative changes at EU level. The Commission has stated that none of its proposals will require a treaty change. However, we need to see the detailed proposals so we can be clear on this point. We await the proposals in that regard during September.

As we know, the Commission issued a further communication in this area in terms of clarifying some of the points on stronger EU economic governance. We now have more detail on some of the issues. In terms of broader macroeconomic surveillance, there is a framework for dealing with excessive imbalances. The Commission is proposing that a faster pace of progress towards budgetary balance be achieved for countries with high levels of debt or pronounced risks in terms of debt developments. This will have both a preventive and corrective arm, with annual assessments of the risk of macroeconomic imbalances and the implementation of remedies where such macroeconomic imbalances are thought to be harmful.

In terms of fiscal surveillance, the proposal is to specify the minimum requirements for the design of domestic fiscal frameworks and reporting requirements to allow for verification of compliance. The Commission proposes that certain essential features be present in the domestic fiscal frameworks of all member states while respecting national preferences. It proposes a consistent approach — this is the reference to horizontal measures — in the introduction of national fiscal rules, a switch to multi-annual budgetary planning and a comprehensive system to cover the whole system of general Government finance.

In terms of amendment of the preventive and corrective arm of the Stability and Growth Pact, the focus, as we have heard, is not just on the 3% deficit reference value but also in terms of the debt level. In terms of the enforcement of economic surveillance, there is mention of the temporary imposition of interest-bearing deposit by way of sanctions on euro area member states which are making insufficient progress with consolidation; suspension of cohesion and structural funds or disbursements from the EU budget has also been mentioned. In cases of non-compliance with the rules by a member state, the current or future financial appropriations from the EU funding could be suspended or cancelled. It is not clear if there are legal issues in regard to the EU budget and its components but there will be further clarity as more information becomes available. The initiation of the European semester serves to facilitate member states in taking account of strategic guidance on policies from the European Council in the framing of their national budgets.

With regard to the timeline, the Heads of State and Government mandated President Van Rompuy at the March European Council to set up a task force on the future of governance within the European Union. In its initial months, its focus was primarily on the turbulence on the financial markets, which was of paramount importance. Since that early point, the task force is now focusing more on the issues raised by the Commission's recent communications. The task force is almost entirely composed of Finance Ministers of the 27 member states and generally meets back-to-back with the ECOFIN Council. It met for the first time in May, for the second time in June and for the third time just yesterday.

At its first meeting, the Ministers confirmed their agreement on the four main objectives and also on the direction in which to move forward. At the June European Council of the Heads of State and Government, President Van Rompuy set out some of the issues they had considered. It was agreed that the Stability and Growth Pact would be strengthened, although member states' respective obligations under the treaties would have to be fully respected. It was agreed that the European semester approach should be pursued. There was general agreement that there should also be a greater surveillance of debt levels in the context of the Stability and Growth Pact, but this was broadened out to include references to evolutions of debt and overall sustainability. It was agreed to develop a scoreboard to assess competitiveness and imbalances. It will now be up to the task force and the Commission to put flesh on these orientations, with a fuller discussion to be had at the October European Council when President Van Rompuy will bring forward the task force's final report.

With regard to Ireland's overall position, we welcome the fact the Commission has issued proposals at this time and that President Van Rompuy's task force is advancing its work quickly. In the light of current difficulties, there is consensus that reform of the preventative arm of the pact is needed, as well as putting greater emphasis on debt dynamics and broad structural and competitiveness issues. Governance in economic and monetary union will have to become more integrated than in the past and budgetary scrutiny will be greater. The key question relates to the extent of the changes required. This could also lead to discussions on the need for more fiscal rules or fiscal councils in the member states. In this regard, members will be aware that the Minister for Finance has indicated he is considering these issues and he has asked another committee of the House for its views on this matter.

Some clarity on the European semester has been provided, and we heard more today. The Commission has set out minimum requirements that should be included in member state stability and convergence programmes. Such programmes are to include an updated macroeconomic scenario, concrete indications on plans for the following year, description of envisaged policies, medium-term projections for the main finance variables and an assessment of overall fiscal development in the current and following years with an update of its plans. However, the scope and depth of this process is yet to be decided and discussions are continuing in this regard, as they are in regard to the other aspects of the overall Commission communications issue.

In conclusion, given events in the last couple of years, changes to surveillance and economic policy co-ordination are timely. In that context, we welcome the proposals but we would stress we are still at an early stage in the process. There is much to be discussed and clarified before discussions are finalised and decisions adopted by the European Council. The direction and principles are fairly clear but the important details need to be clarified before final positions are adopted. As members of a European Union and a monetary union, it is in Ireland's interests to see a strengthening of the economic part of the Union. A key issue, yet to be resolved, is the appropriate balance between what needs to be done at a co-ordinated European level and the domestic processes of the member states.

The Chair has allowed me time to set out the issues, recognising that some of them have covered the same ground as my colleague from the Commission. My colleague and I are here to assist the committee in whatever way we can.

Chairman

Thank you. The committee has placed particular emphasis on this issue for the past 18 months at least. In fact, the committee originally raised the whole Lisbon strategy and the 2020 review before it became popular to do so. One point noted by the joint committee, which already has been referred to in the presentation, was that it appears that even though difficulties were identified, the problem continued afterwards for some time. This appears to have been a feature of the Lisbon strategy as well, regarding which there apparently was little by way of annual or six-monthly reviews that would identify deviations from the original objectives. This was perceived by the joint committee to be a failure of the system. Relating the European system to the domestic system and vice versa also was identified as a vital issue by members. This has already been referred to and I am sure will form part of the question and answer session.

Deputy Thomas Byrne

I am grateful to the witnesses for setting out the current position on what is a movable feast that will be subject to change and, hopefully, input from this joint committee. I am glad that a lot of time is being spent on this issue because there was much scaremongering about this particular topic, particularly from Fine Gael. Appropriately, members have heard no mention of corporation tax today.

Chairman

We will not go to that matter now. As the man said to the dentist, we are not going to hurt each other. The Deputy should continue.

Deputy Thomas Byrne

I am glad the joint committee is making efforts to clarify the position.

While I am broadly supportive of this proposal, how would it have suited Ireland in 2008 and 2009, as its public finances rapidly deteriorated and projections on its deficit and borrowing requirements were changing on an almost monthly basis? Second, who came up with the word "semester", as used in the presentation? It must have been a eurocrat in Brussels who never has spoken in plain English because if one looks up the dictionary definition of "semester", it means a six-month period or a term in college. Is it derived from the former definition? I recall hearing about the new proposal for a European semester on the radio and although I consider myself to be reasonably well-educated, I did not have a clue as to what was being proposed. In respect of communicating Europe to its citizens, I consider this word to be incredible and I urge the powers that be in the Commission, as well as the Minister, to try to come up with another term to describe what I accept will be a complicated procedure. I do not know whether it refers to the procedure, its length or the time of year.

However, this will become an issue because this subject is so crucial. There will be much debate on the highly sensitive issues of national budgets and so on, on how Ireland spends its money and with regard to any inference that Europe will dictate to us how we should spend our money. I refer to the scaremongering that arose following the announcement of this proposal and I am glad the witnesses are present to refute it. While I am happy to support broadly this proposal, the term "semester" is highly unfortunate in respect of communicating it to people.

Chairman

It will do no harm to clarify that there was a certain amount of speculation in various journals, both at home and abroad, in the middle of the financial crisis and on the rescue package, as to what was required in a particular situation, some of which was misinformed. In particular, I refer to the suggestion that a major requirement would be a general synchronised or harmonised taxation policy throughout Europe. This of course was entirely untrue but also was promulgated in the international media and by a number of well-placed people at different levels and was not attributable to one particular group.

Senator Paschal Donohoe

I thank the witnesses for their attendance and for making a contribution on a subject that will be of great importance to the future of this country and the European Union. I have a particular interest in this area because I am preparing a report for this joint committee on the subject of the evolution of the Stability and Growth Pact that is on the agenda for discussion later today. I will make four points to the witnesses that arise from the work I have done thus far on the aforementioned report. First, this proposal contains a great deal that Ireland should both welcome and embrace. The tragedy this country will face is that when it emerges from this economic depression, it will have extraordinarily high levels of public debt due to its development of a structural budget deficit. The existence of this structural deficit will make it extremely difficult to deal with the issues pertaining to financing the banks and dealing with chronic unemployment levels. Any development within the European Union or anywhere else that will help to prevent a repetition should be embraced by Ireland. I perceive this to be the direction in which reform of the Stability and Growth Pact may go and if this is the case, Ireland should understand and then embrace it.

That said, the current manner in which these proposals are being considered has a weakness, namely, the extent to which the difficulties under discussion in Europe at present are being framed in budgetary terms. The point repeatedly is made that Ireland has a public debt crisis but it is known that the only successful and sustainable way to manage high levels of public debt is through the generation of high rates of economic growth. If a country succeeds in generating such growth, it is left with more money with which to pay down such debt and its debt to national income ratio falls. At present, the economic growth rate within the European Union is predicted to be approximately 1%, that of China is predicted to be approximately 3% and in the 1980s, the rate was approximately 2.5%. While the thinking associated with the Stability and Growth Pact always refers to macroeconomic imbalances, the issue of competitiveness must be focused on at European Council and review level with the same intensity that is devoted to budgetary performance. Otherwise, we will lock ourselves into a vicious cycle from which it will be very difficult to emerge. I seek the witnesses' response to this point.

In respect of budget flexibility, the report makes the point that if one's public debt levels are higher than 60% of one's national income and one makes insufficiently rapid progress to redress this position, one will be obliged to take further measures. However, I believe the opposite of this proposition also should be considered. Why will an economy with low public debt levels as a percentage of a national income not be allowed to borrow more? Where is the reward for prudent economic management? The point has been reached that at a time when it is desirable for economies to spend more money, they are unable to do so either because they do not have it or are not allowed to. I believe that a feature of this pact that should be considered is that on returning to a period of normality, which we will, it should contain a feature that not only prevents bad things from happening but creates a further incentive for good things to happen. This constitutes a real omission in current thinking.

My final point pertains to what is meant by "debt". At present, there is much focus on examining what are total debt levels and a step forward should be taken to consider what is the structural debt as a percentage of total debt. The real difficulty Ireland faces at present is not that we have a high debt level but that we will have a very high debt level when the economy starts to grow again, that is, our structural debt. I argue that a real weakness in the Stability and Growth Pact in recent years is that while we were patting ourselves on our backs and citing European data on how good were our debt levels, our structural debt levels were growing at a time when our top-line debt performance looked good. This is an omission in the current thinking that should be fixed to facilitate greater awareness on where matters really stand than has been the case in the past.

Senator Terry Leyden

I welcome the contributions made by Ms Mary R. McCarthy, economic adviser to the European Commission, and Mr. Michael McGrath and his staff, who represent the Department of Finance. The presentations have been so comprehensive that they do not require many questions. However, I make the point that Ireland's eventual ratification of the Lisbon treaty has been a marvellous boost to its economy and certainly has enabled it to retain its position within the centre of Europe. In advance of the difficulties experienced throughout the eurozone, this was an excellent decision and this joint committee deserves great credit for its work in this regard. My colleague, Senator Donohoe, who chaired the review on the first Lisbon treaty referendum, deserves particular credit for that work. In light of the present situation, I refer to the crisis management framework that was approved on 9 May and the European stabilisation mechanism of €500 billion, which is an enormous amount of funding. Without this backup, a country the size of Ireland would be experiencing significant difficulties in the light of the considerable effects events in the international economy have had on us.

We should be recognised for investing €25 billion in the National Pensions Reserve Fund which we have cashed in to stimulate the economy and support the banks. That was a prudent decision by the Department of Finance, the former Minister, Mr. Charlie McCreevy, and the then Taoiseach, Deputy Bertie Ahern. During the 2007 general election campaign proposals were made to spend the money on infrastructural projects. The European Union recognises that, while we might have spent too much on public services in terms of pay, benchmarking and social services, our investment in infrastructure has produced good results. We were lagging far behind when it came to the building of roads. However, the Government is not receiving recognition for its investment in infrastructure, from which there will be a return after the crisis passes.

Will Ms McCarthy comment on the security of the eurozone and the euro? The crisis management framework and the European stabilisation mechanism have secured the euro. In these circumstances is it prudent to increase the number of countries in the eurozone? Will extra pressure not be exerted on the stabilisation mechanism? Further entries could be delayed pending the outcome of developments in Greece, Spain and Portugal. Ireland has worked its way out of that group. The Minister for Finance, Deputy Brian Lenihan, the Taoiseach and the Department deserve credit for the measures they took in advance of other countries.

Senator Feargal Quinn

I thank the delegates for their explanation. As Senator Leyden stated, we have been given much information. I come from a business background and I am used to competition, rather than co-ordination. Ms McCarthy used the word "competitiveness", but the European Union is the world's largest economy. If we are to succeed, we must avoid too much co-ordination such that we damage competitiveness. The great benefit of the euro is that it stops nations devaluing their currencies in the way they used to, but some countries have used low interest rates to spoil themselves through provisions for earlier retirement ages, shorter working weeks and so on. There is a clear need for control.

Ms McCarthy referred to incentives but then used the term "carrot and stick". In listening to her I only heard her talk about the stick. Perhaps there is a carrot also. Senator Donohoe discussed the giving of a reward to those who behaved themselves, but I am not sure I understood him. I understand there are limits — a 3% deficit and a debt figure of 60% under the Stability and Growth Pact — but are there carrots also, or do we just receive the blame when we misbehave? Are we referring to the imposition of a tax on those who do not behave? A Stability and Growth Pact that works is necessary, but, if we attempt to co-ordinate to too great an extent, we will reduce our competitiveness in world markets. I am concerned that, whenever the European Union becomes involved in discussions on national budgets, it seeks co-ordination. It is good that the delegates did not discuss harmonisation of the corporation tax rate, but at the back of everyone's mind is the thought that someone is waiting to harmonise or do something else that will lead to co-ordination rather than competition.

Senator John Hanafin

I would like to see the inclusion of a reference to the damage done to European economies by mistrading on financial markets, even though the agenda for reinforcing economic policy co-ordination does not outline specific responsibility in this regard. States can overcome significant fiscal imbalances, but they cannot overcome external financial institutions which prey on their sovereign debt and create difficulties for all member states of the European Union. Will the delegates include this matter in their deliberations to ensure there are strong rules of engagement with financial institutions trading in the European Union?

Chairman

Members have raised a number of new issues, although they are not new to our guests. A good point was made by several members about the use of the carrot and the stick. The concern is that the stick will be such a blunderbuss that it might kill off any possibility of recovery in a particularly sensitive situation. The early identification of a trend would reduce the need for the carrot or the stick, the fundamental point to be made in respect of what has happened in the past five or seven years.

The question of membership of the eurozone which has arisen previously was raised by various members. Some eurozone countries became vulnerable during the crisis by virtue of other countries' ability to devalue their currencies significantly. The committee has discussed the need for members of parliament in each member state to be fully familiar with the circumstances prevailing in other member states. For example, it would be wrong for us to be judgmental in respect of the situation in Greece or Germany unless we were reasonably familiar with the circumstances in these countries. When there is speculation, people usually become judgmental about what should be done without being fully familiar with the prevailing circumstances.

In the past 12 months it has often been stated the European Central Bank, ECB, and the single low interest currency left countries with no option but to follow regardless. It must be borne in mind that this is not true, as individual governments would have been within their rights to introduce credit restrictions to meet their requirements. This option was not taken because governments did not want to be left behind in the rush forward. There are lessons to be learned. There is still the same right. How often during the past 12 months did prominent national and international commentators assert that accepting the ECB's interest rates, set at a certain level, was members states' only option? This assertion was entirely untrue and an attempt to sabotage the euro.

The state of preparedness to which Ms McCarthy referred should offer us a salutary lesson. We should learn from experience and try to ensure we will not get caught out to the same extent again. We should also try to ensure there is monitoring, with minimal use of the carrot and stick approach, to identify issues that will cause economic difficulties long before they arise. It is back to Ms McCarthy for her response.

Ms Mary R. McCarthy

I will try to address all of the questions. I am sure committee members will remind me if I forget any. I can only agree with what the Chairman said. We have been through a very bad period and we are still not out of it. We have to learn lessons, and one of the lessons we have clearly learned is that we made mistakes in the past. We admit it. We followed the Stability and Growth Pact and certain things happened in individual member states of which we were not completely aware. We have learned a lesson from that and we are trying to deal with this. Part of our proposal is to ensure standardisation of statistics and ensure we get the right information from member states. From now on we will put the emphasis on prevention. We do not want to get to the corrective side of things; we do not want any member state to be in that situation because it is much harder to deal with a situation which reaches that ultimate step. The structure we are putting in place is to try to detect emerging problems at an early stage, in the Stability and Growth Pact and the new structured mechanism for harmful imbalances. We use the phrase "harmful imbalances" because we do not want to say the imbalance is on the internal or external side.

This process deals with competitiveness, about which we are truly concerned. It is not that we want every state to be at the euro area average. The point is that member states must make efforts to improve their competitiveness and success in this will depend on their comparative advantage. We will not impose standardisation on member states. It is in the interests of all member states to improve their cost and price competitiveness to be able to deliver on their growth strategy. Every member state has its own growth strategy and various countries use various models. Our point is that the basis for this must be there. This is why we place an emphasis on structural reforms to improve competitiveness and the adjustment of the economy. I do not want committee members to think it is all about the Stability and Growth Pact and macro-economic imbalances. We also work on the micro-economic side, which will help competitiveness.

With regard to the carrot and stick, unfortunately we are considering the stick because in the past a mechanism was in place and while some members adhered to it others did not. We must remedy this situation because we are not speaking about individual member states only; we are speaking about the euro area as a whole, its functioning and success. This is why co-ordination is very important. The financial crisis brought home to us that economies are far more integrated now than they were in the past. Therefore, what one member state does affects other member states. For this reason, we must consider strengthening co-ordination.

I have always thought that the carrot is economic success. Should not the carrot for every member state be that it gets its economy in order and produces the growth due for getting the economy in order? Perhaps we do not emphasise the carrot enough because it is self-evident in the fact that economic success is the reward of putting this in place and making the necessary changes that will generate economic growth, social inclusion and employment. Perhaps we need to do a better job in communicating this.

I apologise if the phrase "European semester" causes a problem. It is a term that tends to be used more on the Continent than in Ireland or the UK. Internally, we call it the annual policy cycle and the semester is what is put in the communication and what everyone else calls it. The idea of the semester is that in the first half of the year discussion takes place on a situation and the problems and in the second half of the year what to do about it would be considered and we would have programmes. I apologise if it is bad communication.

Deputy Thomas Byrne

Public support for what is happening will be found if it is explained to people but not if a term such as "semester" is used, which in the English language relates to academia. Perhaps people might use it to mean a six month period of time if they knew their Latin. It is not a word that I use. Words are important. We have had previous discussion on communicating Europe. On such an important topic the Commission should reconsider use of that term.

Chairman

The point is taken. I thought the Deputy was going to say it was a Meath or Louth term and I am glad he did not. It has special significance for Meath and Louth people at present. We have been accustomed to eurospeak over the years. The terms "phase", "time" or "review period" could be used. One way or the other, the point is made.

Senator Feargal Quinn

One of the eurospeak words I had difficulty with over the past year and now have come to use is "actor". I heard the word being used and I had assumed an actor was someone who went on stage and played a part. However, in European terms an actor is a doer. The Europeans I meet use it all the time. I used to correct it but then discovered I had to give way. There are terms in eurospeak that we must learn.

Chairman

I apologise for the interruption and I ask Ms McCarthy to continue.

Ms Mary R. McCarthy

I am guilty because having lived in Brussels for 20 years when I return to my family they ask me whether I am speaking another language.

A point was made on the high levels of public debt and the structural deficit. Our intention is to focus more on the debt criteria. It is not only examining debt as a percentage of GDP; we will examine the maturity and composition of debt. The idea is to look into the details of the debt and not only the overall figure. This is what is envisaged.

High economic growth is the best way forward. We have suffered a shock to the system and we want to put in place the elements that will return us to a sustainable economic growth path. One must make hard decisions and put the proper adjustments in place to deliver this. It is not a matter of being over it and going back; we have to make the changes. In most cases, these problems did not just happen in 2008; they had been building up over time. In some euro area countries the problems had begun at the beginning of the process in 1999. This is not something that will be addressed overnight. There is no quick fix on this. One must put the proper elements in place to return to a sustainable growth path.

The reward for being a good pupil is that markets will treat one better. It comes naturally. There will be no penalty in terms of long-term interest rates from the markets; all these benefits arise from being a good pupil. It is true we are always thinking of the bad pupils rather than the good ones.

Financial markets and financial regulation are not exactly my area. We are focusing mainly on the fiscal and the structural elements and the new risk board will deal more with the financial side of things. I am sure it will address all those issues that have come up in the course of the financial crisis and will produce changes that will set financial systems on a proper basis.

Have I missed anything?

Senator Terry Leyden

The expansion of the eurozone and battening down the hatches at this stage.

Ms Mary R. McCarthy

As the Senator will be aware, we will expand the eurozone next January when Estonia will join. Estonia is a small country that has proved itself in terms of the adjustment that has taken place there during the crisis. It has fulfilled all the criteria for membership of the euro area and I find no problem with expanding the eurozone to include Estonia.

Chairman

I thank Ms McCarthy. Does Mr. McGrath wish to comment again, or one of his colleagues?

A matter that came up again was the harmonisation of corporation taxes, mentioned by Senator Quinn. That was another issue promulgated in the international media as being in urgent need of address. That, too, is wrong because, as we know, different countries within the European Union are differently placed in terms of geographic access to the main market. If one takes the recent volcanic dust incident, for example, we soon found out that countries that required aircraft for their citizens to travel were suddenly immobilised to a fairly considerable extent. If another example is needed, the United States is a classic one. The same taxation regime does not apply right across the US, the reason being that different states are in a different position to attract industry and ensure their economy vibrates in the way it should.

Another issue mentioned by a number of speakers was the future of manufacturing in Europe which relates to the competitiveness to which the delegates referred. At a family wedding in Spain within the past 12 months, and similarly in Italy, I was shocked to find leather goods marked "Of Italian origin" or "Of Spanish origin". These are countries which were renowned worldwide for their production and manufacturing in that area. It is all very fine to say we in Europe have now gone past that into the information and technology area and we no longer require nor need to rely on such markets. That is not true, of course. Every market must consist of various levels of employment and requirements for employment. If the European Union were to divest itself of manufacturing on the basis that it could no longer compete in that area, that would be a failure of competitiveness which would have serious consequences right across the European Union and could also have serious consequences in terms of security of supply, energy, food and the manufacture of basic household requirements. Although it may seem sound in the first instance to invest in South East Asia and avail of cheap labour, a continuation of that policy would be very dangerous from a European perspective.

Mr. McGrath wants to intervene. I can see he is getting restless.

Mr. Michael McGrath

I thank the Chairman. I am not entirely sure if I actually want to intervene----

Chairman

Maybe one of your colleagues might like to intervene on your behalf.

Mr. Michael McGrath

My colleague from the Commission has addressed most of the specific questions but there may be a couple of points to pick up on. Deputy Byrne asked how this would suit in that the numbers in 2008 were moving considerably, day by day. The experience of the latter part of 2008 and a good part of 2009, not only in Ireland but globally, was one where every time one looked at forecasts they moved. Given that we are in a very turbulent situation, we have seen in the past six to eight months that while the situation is still weak at least there is some element of greater clarity in that a sense of the scale of the problem has come to mind.

Chairman

Is not the problem, again, one of being alerted to the issue long before it becomes obvious? Was it not obvious in 2005 and 2006 — some might include 2004 — that because the danger signs were present in most member states right across the European Union action should have been taken to ensure against the kind of situation that arose?

Mr. Michael McGrath

The experience of the past while has shown clearly that although the Stability and Growth Pact was there to ensure that people did not run deficits, there were weaknesses. That has been the experience and, at this stage, in the order of 21 of the 27 member states are above the reference value of 3% of deficit. There were lessons to be learned from that and there is an issue in terms of the score board. The Commissioner spoke about identifying issues in regard to that point. That will help in identifying weaknesses, both at member state economy level and throughout the Union, and in terms of identifying the linkages between a member state and the problems it might have and the way these are interspersed with other countries. These are important lessons we all must learn and they will be of assistance in the future.

Regarding debt, one of the factors we are seeing is that most member countries now have much higher debt levels than they did before we came into this crisis and they probably will have them for some time because they first have to address the deficit, then the debt situation. That points to the Commission paper which spoke about focusing not only on the deficit but also on the debt. That issue will be of significance.

In the Irish case, our debt ratio this year will be of the order of the mid 80% of GDP. That is on gross level. A member made reference to the National Pensions Reserve Fund, noting that if it was netted off along with other assets held by the NTMA, the ratio would be somewhat lower although still much higher than it was in previous years. That brings us to the issue of growth, which is of the essence. Although the focus of the Commission's papers looked at issues of debt and deficit, how we can correct and address those and learn lessons from them, obviously this is only one element within the wider EU architecture. The EU 2020 strategy is much more focused in terms of looking at how to enhance the growth potential of member countries in the future and addressing debt ratio by enhancing the productive capacity of an economy. That will assist into the future in addressing the weakness.

Looking at the Irish case in terms of the EU 2020 strategy, there are a number of what have been referred to as bottlenecks, which is possibly another jargon term and I apologise for using it. There are various impediments. By addressing these weaknesses we will also address the issue of our future growth potential. One of those is our high structural deficit in terms of correcting our public finances and improving longer term sustainability. Clearly, matters in the financial sector have been identified also, as have improving our competitiveness and prices generally within the economy, and enhancing the productive capacity of labour. These are issues relevant to the EU 2020 strategy. With regard to the carrot and stick, my colleague summed it up neatly by suggesting that clearly the carrot is that the financial markets will penalise people who have significant, unsustainable debt and deficit positions.

Senator Paschal Donohoe

I am sorry for interrupting but I wish to put a question on that point. I understand Mr. McGrath's point completely but is it not also the case that for most of the time leading up to this crisis, bond markets were not doing this? They were buying bonds from Germany at roughly the same price that they were buying them from many countries now in crisis. Understandably, we refer to the way Governments and the Commission misdiagnosed what was happening, but so did the financial markets. They were buying Government debt at the same price from Germany as from Ireland, Spain and Greece. Mr. McGrath is assuming the financial markets will display intelligence in the future but they have failed conspicuously to demonstrate it in the past decade. This is the point Senator Quinn and I are making. Mr. McGrath is correct to say that "good economic performance" is a reward in its own right but we must have in place reinforcement mechanisms for this because the markets do not act in this way nor have they for the past decade. Again, I am sorry for interrupting but I wish to hear Mr. McGrath's comments on the performance of the markets and the fact that they have not displayed much wisdom in the past.

Mr. Michael McGrath

I must urge caution in offering my views in this area because I am not an expert on the financial markets. I appreciate the net point on the spreads issue. For a long period within EU after the introductory phase of the euro the spreads between Germany and other countries were narrow. There is no question about that. There was an issue whereby lending to one was seen to have been lending to all. However, for a long time most members countries were not in excessive deficit for any period. At that point the deficit positions of member countries were seen as rather sustainable with regard to the running of the annual debt. I am not an expert in this area but there is no question there are lessons to be learned for policymakers at national and European level and, clearly, there are lessons to be learned in the wider financial markets as well. Beyond that, I do not believe it is a competency area for me. Essentially, these are the points I sought to make. Perhaps some of my colleagues wish to contribute.

Mr. Tony Gallagher

Senator Donohoe referred to growth and this issue has been covered already. I emphasise the absolute and key importance of implementing structural reforms throughout Europe. The EU has been bedevilled by low growth and unless these reforms are carried out that position will continue. Senator Quinn remarked that there was too much co-ordination involved in the process. At first sight, there is a formidable amount of detail in the framework and proposals put forward. Nevertheless, the intent is to provide the incentives for every member state to gets its underlying finances in order, to ensure that imbalances are sorted out and that the structural basis of the economy is on a sound footing. Combined all in all, these will provide the incentives for each member state to strengthen its economy and, therefore, strengthen its competitiveness in the long term.

Chairman

I thank the witnesses for their presentations. I trust we have all learned economic lessons in recent years and that this generation will have no need to learn other harsh lessons. Past experience in previous recessions has shown the climb-out was not as quick as anticipated, nor is it likely to be as quick as some anticipate on this occasion. The important thing is to ensure the right decisions are made and taken. Often, decisions can be difficult, but difficult decisions are not necessarily always the right decisions. The hope is that the right decisions are being taken and will be taken and that the degree of monitoring and six monthly reviews, whether they are termed semesters, six monthly reviews or called by some other name, will prove successful. Again, I wish the best of luck to the delegation and I extend our thanks for attending today's meeting.

The joint committee went into private session at 3.35 p.m. and adjourned at 4 p.m. until 2 p.m. on Tuesday, 20 July 2010.