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

/RICARDO MARTÍNEZ RICO * /

The fiscal institution in the Economic
and Monetary Union:
the contribution of Spain

1. 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 Economic
and Monetary Union: the necessary contribution of Spain; 5. Conclusion

1. Introduction

The current financial crisis in the European Union (EU) has
highlighted the importance of establishing a common framework

* Public Sector economist, on leave, and Founding Partner, President and CEO of Equipo
Económico, S.L. He has held office as Deputy Finance Minister Working inside the team
of 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 and
Wharton Business School.

227

The fiscal institution in the Economic and Monetary Union:

which 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 sparked
the debate in Europe of whether the necessary fiscal stability,
which will demand the rationalisation of public spending in the
member states, will be achieved at the expense of prolonging the
crisis and limiting economic growth possibilities. However, there
should be no dilemma between sustainability of public accounts
and medium term economic growth. The crisis of the European
sovereign debt is a consequence of overspending and debt which
the markets are not prepared to fund. In this regard, the only
recourse is a fiscal policy designed to mitigate the harsh effects of
the crisis and boost economic growth within the framework of
macroeconomic 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 again
become a driver of growth. Compliance with a route of plausible
cuts in public spending in all Public Administrations is a necessary
condition to do so, though not the only. As previously shown, in
the case of the Spanish economy, stability and reforms make up the
formula required to revitalize investment, consumption and job
creation. Thus, economic reforms and budgetary discipline are
equally important.

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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 each
government with sound finances to tackle its internal decisions in
accordance with its economic and social reality (not only because
of its significance from a regulatory perspective but also because of
the parallels between the European scenario relative to the coun-
tries and the Spanish scenario relative to the Autonomous
Communities). At the same time, those who are forced to ask for
help 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. But
it must also do so to encouraging income transmission mechanisms
between countries and regions, availability of financial resources
and support by way of providing the necessary liquidity to face
emergency situations and the pooling of risks, always in exchange
for strong sets of conditions to prevent moral hazard. Moreover,
within the monetary and economic union the imbalances must be
addressed, not only of highly indebted countries, but also those
with surplus balances. In some way, it must be recovered an incen-
tive system to ensure political commitment and compliance with
goals set. Nowadays, the fiscal institution1 is a basic component of
European and Spanish economic policy.

1 González Páramo defines it as "the rules which govern the preparation of the budgets, their
debate 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


Throughout this work we shall examine, in first place, how the
sustainability of the public finances requires a solid fiscal institu-
tion and a firm political commitment by the different European
governments. Only on the basis of the conviction of the benefits of
this statement can one contribute towards the construction of a
stronger Europe.

Then we shall go on to examine the close relationship between
fiscal rigour, macroeconomic stability and growth, arriving at the
conclusion that the establishment of simple, transparent, automati-
cally applied rules with preventive control mechanisms for all
Public Administrations is essential for this ‘positive’ interrelation.
All these components are basic for the design of a fiscal policy
which helps to recover the credibility that Europe needs in its path
towards greater integration to face the sovereign debt crisis.

In the last chapter we shall examine the measures taken in Europe
and in Spain since the start of the sovereign debt crisis, and we shall
reflect on the following steps to be taken in support of the budgetary
institution. Then close with the appropriate conclusions.

2. Evolution of fiscal policy in Europe and Spain

The European political integration project came about in the
post World War years, as an extension of the economic integration
process. This was envisaged by one of the founding fathers of the

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current Union, Jean Monnet. In 1950, he proposed the creation of
a space of peace and prosperity for Europe, via the formation of the
European Coal and Steel Community, which became a reality a
year later. His way of conceiving the European construction as a
project made up of very specific steps – beginning with the eco-
nomy – is the way to understand many of the milestones that
Europe has achieved in the last sixty years. Examples of this have
been the creation of the European Economic Communities, the
launch of the European Monetary System, the creation of the sin-
gle European market and the firm commitment that has led to the
Economic 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 a
decisive step in its integration into an international market which
would bring gains in efficiency, reinforce macroeconomic stability
and contribute to the increase of wealth and per capita income.
That would lead to the development and modernisation of the
country. 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 a
maximum 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

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having a solid fiscal institution in the economic development of
the 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 Single
European Act (1986) in favour of an internal market, the EU mem-
ber states took an additional step in Maastricht. EU member states
support, 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 axes
around which the design of the EMU should be built around: sin-

232


gle monetary policy, fiscal policies subject to common rules and
coordination mechanisms for the remaining economic policies. A
clear view of establishing nominal convergence mechanisms based
on the fiscal institution was already existent at that stage, founded
on the following common rules: absolute ban on monetary funding
of public deficits, no liability held by the EU or by any other State
in regard to debts acquired by another member state, and the set-
ting of limits on deficit (3%) and public debt (60%). As of 1997, the
Stability and Growth Pact (SGP) introduce stricter rules with a defi-
cit target of balance or surplus, supported by an early alert system
and 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 EMU
demanded a radical change to be made in our fiscal policy. Europe
then 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 balancing
the budget in the pursuit of macroeconomic stability.

It would not be until the political change of 1996, and with the
reference and encouragement arising from the creation of the sin-
gle currency, when the necessary fiscal consolidation was finally
tackled, that macroeconomic stability was achieved and the bases
for a new economic growth phase were put in place. The starting
point was poor, in 1995 with a deficit around 7% of the GDP and a
growing public indebtedness which reached 67% in 1996.

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Although the level of indebtedness was lower than the average for
the EU, in the case of Spain the combination of the primary defi-
cit, the high cost of financing of the debt and the recession had
rendered unsustainable the growing public debt. As of that time
there 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 annual
budgets to close with primary surpluses from 1996 until the end of
the period and to slow down the growth trend in public debt
which, after peaking in 1996, dropped by more than 20pp of GDP
until 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 Administrations

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During the period, the fiscal consolidation drive contributed
towards a strong growth in GDP (average rate of 3.6 between 1996
and 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 firm
political 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 case
of Greece which, with the support of Germany and despite not
meeting at the time the requirements established by the Maastricht
Treaty, became part of the Eurozone two years later – the incorpo-
ration to the euro meant the relinquishment of monetary policy in
favour of the European Central Bank (ECB). And this total integra-
tion in the establishment of monetary policy has fostered greater
price 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 of
the Eurozone member countries.

We must highlight that, once the objective of forming part of
the euro was met in full, Spain took an additional step beyond what
was required in Maastricht. And, in line with the principles agreed

2 “The Spanish fiscal institution: from the Stability Pact to the rules of fiscal stability” (La
institución presupuestaria española: del Pacto de Estabilidad a las reglas de estabilidad
pre¬supuestaria), R. Martínez Rico (2005).

235


in the SGP, it rounded off the fiscal consolidation effort with a deep
reform of the fiscal institution. As a result thereof, the approval of
the fiscal stability laws (the General Law on Fiscal Stability and the
Organic Law additional thereto) brought about a change in the
budgeting process. This mainly consisted of: the definition of a fis-
cal stability target (fiscal balance) in the medium term for all Public
Administrations; 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, the
Contingency Fund was added into the State budget, as a flexibility
component during the life of the budget which removes the need
for making fiscal adjustments, equal to 2% of the non-financial
expenditure ceiling approved by Parliament. The approval of the
Fiscal Stability Laws was further completed with a new General
Fiscal Law and a new General Subsidies Law. Specifically, the
General Fiscal Law aimed at achieving greater rationalisation of the
fiscal process, whereas the General Subsidies Law, on its part, aimed
at 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 and
reform 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 this
regard, backed by the European Commission – was none other
than the SGP, introducing greater discretionary power and taking a

236


step back in the capacity of the fiscal institution to contribute to
growth.

Along the same lines, with a comfortable fiscal position and
with the same philosophy as that of the reform of the SGP, Spain in
2006 approved a reform to render the fiscal and Territorial
Administration funding processes more flexible, which is the sour-
ce of our current fiscal crisis. The relaxation of fiscal stability led to
a loss of transparency in its application as a result of the flexible
new 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 deficit
balance, which worsened over two years (from 2007 to 2009) by
13pp of GDP. This deterioration, which had also taken place in the
rest of EU members, was more notable in Spain due to its speed and
magnitude (see Chart 3), with few comparable examples within the
scope of the OECD (except for the cases of Iceland or Ireland). The
deficit fiscal position generated a fast increase in public debt, lea-
ding to doubts about sustainability thereof, and translating into
significant rises in the risk premium of the country.

At the start of 2010, given the lack of confidence displayed by
international markets, and in light of the fast deterioration of
public finances, the previous Government was forced to implement

237


Chart 3
Budget balance in 2006 and change in budget balance in 2007-2009

Source: Prepared by Equipo Económico with OECD data

a 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 also
affect countries such as France and Austria), has highlighted the
need to reinforce the budgetary coordination mechanisms within
the EMU. In the face of the problems arising from the sovereign

238


debt crisis and as a result of the fluctuations in the risk premiums
of the Eurozone member states, a double reinforcement movement
of the budgetary crisis has taken place from Brussels since the onset
of the crisis. On the one hand, that implemented by the European
Commission, 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 the
European Council, have brought about agreements such as the
Fiscal Pact, which seeks to guarantee that all countries will commit
to fiscal stability under the highest level of regulation. The reform
enacted last year of the Spanish Constitution must be understood
within the framework of this new drive from Europe in support of
the fiscal institution. The reform, as we shall discuss further in this
paper, guarantees the principle of fiscal stability via the highest ran-
king law.

Despite efforts invested, and despite the positive effect of the
liquidity injections made by the ECB, the current economic scena-
rio in Europe continues to be marked by the risk premiums of EU
peripheral countries, which continue to be too high. The questions
as to the capacity of such countries to meet their debt commit-
ments have burdened economic European Union results over the
last two years. This has led the Commission to forecast a drop in
GDP for all of the EU of -0.5% for this year, which sets it back in
terms of the growth of the world economy. Although it must be
said, that all countries are not behaving in the same way. Germany,

239


for instance, closed last year with 3% growth, expecting to do so
this 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 arising
from the financial crisis. However, it is worth remembering the
strong interdependence between all member states, including
Germany (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, the
return to recession, which accumulates after four years of crisis, the
adverse 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 and
private debt maturities this year. All these factors have led to a risk
premium of around 340 basis points in the last few months and, more
recently, well above 450 basis points, and to be closely watched by the
markets, that is to say, our creditors. Given this scenario, in 2012, the
Spanish economy faces challenges associated with its macroeconomic
imbalances yet to be corrected, as well as the potential problems ari-
sing from a new challenge from international financial markets. In
this framework, we expect a drop in GDP during the first quarters,
and although its performance will improve towards the end of the
year, 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


Undoubtedly, the unemployment rate is our main negative dif-
ferentiating factor compared to all other EU members and the main
concern for Spanish society. As a result of the economic crisis, no
country in the OECD has experienced a downturn in the jobless
rate as negative as ours. Our rate of unemployment has gone from
8.3% of active population in 2007 to almost 24% at the end of
2011. The crisis has highlighted the problem with our employment
model, 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 (the
current 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 in
fact be met by attracting foreign investment to our country.
Indeed, the opposite is the case, with recent years witnessing a
divestment process, particularly of portfolio assets. The forecast
drop in the GDP combined with the high level of debt, puts the
sustainability of our funding at risk. Given such conditions, the cri-
sis is requiring a must faster deleveraging process than that initially
expected.

Since the common denominator of the European sovereign debt
crisis is insufficient GDP growth, only by articulating the reforms
in Europe and in Spain in an expedient and firm manner can the
current increasing loss of confidence by financial markets be sta-

241


lled. In the case of the Spanish economy, this is a path which we
travelled successfully in the second half of the nineties, when
Spain took part in the foundation of the euro and then went on to
lead the fiscal consolidation process in Europe. The new govern-
ment seems to have understood this, having begun reforms in
three main areas: sustainability of the public finances and moder-
nisation of the public sector, the restructuring and reorganization
of the financial sector and the reform of the labour market. In the
coming years, political commitment to fiscal rigour, macroecono-
mic stability and growth must go hand in hand in Spain and
Europe, 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 to
growth, leading in turn to job creation.

Moreover, the balance in public finances provides the econo-
mies participating in the monetary union, which therefore cannot
resort to instruments such as currency rates, with greater leeway to
deal with external shocks, enabling the implementation of anti-
cyclical policies and of automatic stabilisers.

242


At the same time, as has been amply studied in the literature,3
fiscal balance fosters a macroeconomic stability scenario which pro-
vides a more efficient framework for the development of economic
activity. The reduction in the deficit increases the confidence of
savers and investors. This translates into a stimulus for investment
and job creation, as well as allowing households and businesses to
plan the purchase of durable goods in the long term, thus leading to
sustained consumption, which is a key factor of economic growth.

One of the most relevant aspects is the stronger credibility of the
economic policy and the improvement in the funding terms of the
economies in the international markets, thanks to the reduction of
the 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 subjection
of European monetary and fiscal policies to certain rules, and the
assumption thereof by Spain as a participant in the foundation of
the Euro, helped to provide additional credibility to the govern-
ment’s fiscal consolidation strategy. This strategy was strengthened
by 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 the
sharp drop in long term interest rates, compared to the 10 year
German bond. The spread in the Spanish risk premium was actually
zeroed 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


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 key

5 "Fiscal expansions and adjustments in OECD countries", A. Alesina y R. Perotti, 1995. “An
Empirical Analysis of Fiscal Adjustments", C. McDermott & R. Wescott, 1996.

244


tool for cost containment. At the same time, the pension system,
the labour market and the financial system underwent a structural
reform. The only expenditure programme that was deliberately
maintained, thus keeping its 1% share of the GDP, was that of
Research and Development.

The Swedish experience between 1993 and 2000 obtained similar
results in terms of a reduction in primary expenditure (14% GDP),
which led to the attainment of fiscal balance in 1997, having closed
financial year 1993 with a deficit of 12.9%. In contrast with Finland,

Chart 4
Evolution of risk premium

Source: Financial Times

245


in Sweden the fiscal consolidation took place due to both the cut in
expenditure and the increase in revenue through a tax rise, while
also implementing simultaneous structural reforms such as the pri-
vatisation of public corporations and the liberalisation of the labour
market. Public spending was reduced by 16pp of GDP over a seven
year period, mainly through a reduction of the expenses in transfers
and benefits (including unemployment benefits) and a reduction in
personnel and current costs of all public administrations. The intro-
duction of three-year expenditure ceilings and annual productivity
targets must be added to such measures.

The starting point of all the above was the strict cut in primary
expenditure, 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 were
done hand in hand with important structural reforms, particularly
those implemented in the labour market, the fiscal system and the
privatisations. Those allowed the adjustment process consolidation
and 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 and
promote a better economic performance than those based on reve-
nue increase.

Experience has likewise proven that fiscal consolidation cannot
be maintained in the medium term without a proper fiscal institu-
tion articulation. As shown in the previous section, from the start,

246


the construction of Europe has been evolving towards a greater
relinquishment of national policies in favour of European ones. It
is a slow and complicated process in which political divergences
often prevail over the overall view of what this process means. This
relinquishment has meant the need for greater autonomy in the
establishment of rules and objectives, as has been the case, for ins-
tance, with monetary policy. Aside from the current supervision
problems, 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 the
fiscal policy as a source of inspiration to maintain the necessary
political commitment and thus achieve effective fiscal coordina-
tion in the Eurozone.

We live in an open economy, where freedom of movement of
persons, goods, capital, information and technology are necessary
conditions for improvement of competitiveness and economic
development. 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 of
this perspective although there have been mechanisms, or even
relevant design components, which have failed.

In general, The European construction has been preceded by the
establishment of rules seeking to limit the risks of integration. The
problem has arisen from the lack of rigour in compliance with such
rules, probably as result of the insufficient clarity of the rules and

247


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 fiscal

6 “Fiscal Rules – anchoring expectations for sustainable public finances”, FMI, 2009.

248


sustainability. The approval of this reform has meant the recogni-
tion of the benefits of fiscal discipline, having assumed the flaws in
the relaxation of the Stability Laws in 2006 as well as the need to
provide a new common legal framework for all of the public sector.
Except for force majeure cases (natural disasters or emergency
situations), compliance with the limits on public debt and fiscal
balance set by the EU are guaranteed. Likewise, priority is given to
servicing the debt in the budget, a condition which helps build the
necessary confidence in lenders, and is an appropriate antidote for
preventing the loss of confidence in Eurozone countries.

The reform also established the need for articulation in a new
organic Law, designed, on the one hand, to regulate the distribu-
tion of deficit and debt limits between the various
Administrations, the exceptional cases of surpluses therein, and
the means and terms for correction of any deviations in one or the
other that might take place. On the other hand, it had to establish
the methodology and procedure for calculation of structural defi-
cit. It is important that the calculation methodology respects the
procedure used in the EU, to provide discipline and transparency
to 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 credibility
of the reform will depend on the existence of efficient systems
which encourage the Administrations to meet the fiscal targets. As

249


we shall mention in the next section, such principles have been
included in the Law on Fiscal Stability and Financial Sustainability
of Public Administrations.

4. Next steps in the Fiscal Institution of the Economic and
Monetary Union: the necessary contribution of Spain

The European debate on sustainability of public finances and
the future of the Euro is set at a time in which, following the con-
version of the international crisis into the crisis of the sovereign
debt of several Eurozone countries, we have witnessed myriad
European summits, each of which seeming to be the last chance to
tackle the doubts of the markets in relation to the viability of the
debt, in the first place, of Greece, Portugal and Ireland, and more
recently, of Italy and Spain.

It is true that the crisis is far from being resolved. The EU has not
always shown a capacity to react with the speed required by econo-
mic relations nowadays – until the tensions reached non peripheral
economies 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 the
Monetary 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 fiscal
coordination. But it is also true that in the last four years, a consi-

250


derable 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 from
greater integration of fiscal policies.

As such, it is worth highlighting the agreements reached, either
via the community procedure or via inter-governmental agree-
ments, in terms of strengthening coordination, supervision and
policing 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 each
member state and its growth forecast, the budgets and economic
policies required to meet the commitments undertaken in the Euro
Plus Pact and the 2020 Growth Strategy are discussed during the
first 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 (one
directive and five regulations) constitutes the greatest reform of the
SGP and of economic Governance since the Maastricht Treaty
which created the EMU. As of the adoption of the new legislation,
the European Commission may establish automatic penalties (of
up 0.2% of GDP) for those countries with excessive deficits which
do not follow the recommendations for correction. At the same
time, the public debt control mechanism and the required reduc-
tion are reinforced in the event of exceeding the 60% GDP level

251


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 made

7 "Proposal for a regulation of the European Parliament and of the Council on common
provi¬sions for monitoring and assessing draft budgetary plans and ensuring the correction of
exces¬sive deficit of the Member States in the euro area" and "Proposal for a regulation of the
European Parliament and of the Council on the strengthening of economic and budgetary sur-

252


via other instruments, in order to provide funding and liquidity to
handle 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 funding
margin 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 requirement
when seeking to limit risk. Any funding requires certain minimum
guarantees of repayment of the loan, and this translates into
adjustments and reforms. This is nothing new, but something that
has cropped up on many occasions in IMF interventions.
Eurobonds might get to play a key role, but cannot be the only
item to support the fiscal union, which will drive the Eurozone
towards optimum monetary union, and for which to date there is
no more than a highly experimental road map.

Within this working programme so badly needed in Europe, and
supported by conditionality, greater mechanisms for EU income
transmission 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 the
support of Europe in driving growth. This can be done via the
encouragement of youth employment and entrepreneur program-

veillance of Member States experiencing or threatened with serious difficulties with respect to
their finan¬cial stability in the euro area", European Commission, November 2011

253


mes, the reinforcement of resources available, among other uses,
for structural funds or for the activity of the European Investment
Bank.

On their part, the Eurozone member states can and must con-
tribute to guarantee the future of the single currency, and to the
generation of the economic growth required to clear any doubts as
to the sustainability of sovereign debt, either via their contribu-
tions towards the establishment of common rules so that the EMU
becomes an optimum monetary zone, or via the reforms on a
national scale which constitute an example for all the others.

There is also a high degree of parallelism between the rules
required and which must be institutionalized in the Monetary
Union 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 who
fail to comply with the targets undertaken, has become clearly evi-
dent. In this sense, the fact that the new fiscal pact at a European
level and the recent legislative changes in Spain seem to be going
in 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 Local

254


Corporations manage approximately 50% of the public expenditure,
is a clear example of the need for coordination of fiscal policies to
ensure that the right signals are sent to markets and investors in
regard to the orientation of the fiscal policy. The consolidation efforts
made by some countries and regions are useless if there are others
which 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 the
aims. The scope of action of each government to achieve fiscal targets
undertaken, via the instruments deemed appropriate, is a different
thing altogether. The principle of subsidiarity must be respected pro-
vided that the principle of fiscal balance is observed. Each country
must have autonomy to define and design its fiscal structure so
long as the limits set for deficit, debt and growth in expenditure are
respected. Fiscal competition allows for improvement in revenue
collection efficiency and greater rigour in expenditure control, and
thus the greater fiscal coordination in Europe must not be envisaged
as a single fiscal policy. However, one of the main instruments at the
disposal 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 at
a national level within the Eurozone or at a regional level within
Spain, the aid provided, as the case may be via special liquidity facili-
ties and even, if necessary, by way of eurobonds or hispanobonds, or
by way of larger revenue transmissions at a European level, cannot
take place without the acceptance of the conditionality it carries.

255


Spain has understood the need to contribute to the stability in
Europe and is leading, for the second time, a solid process of
reforms towards fiscal balance. Following the general elections of
November 2011, the new government and a reinforced political
capital constitute the main assets to bring about the necessary
reforms. The proof thereof is evident in the fiscal reforms: the
Royal Decree of non-availability, the reform of the Law on
Stability, the new system for payment to suppliers, the new bill on
Transparency or the bill of General State Budgets for 2012 (which
establishes 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 Constitution
assumed its inclusion in a subsequent organic Law (the Law of
Budgetary Stability and Financial Sustainability of the Public
Administrations, recently presented), which specifies changes in
the 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 fiscal
sustainability of all Public Administrations, to strengthen econo-
mic confidence and to reinforce the commits of Spain with the
European Union.

256


All Public Administrations must present a balance or a surplus
calculated according to EAS terms and none may incur in structural
deficit. However, there are two exceptions in the case of structural
reforms with long term fiscal effects (a structural deficit of 0.4% of
the 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, the
recommendations of the EU in regard to the Stability Programme
must be taken into account, and all Public Administrations must
approve an expenditure ceiling in line with the stability target and
the 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 GDP
growth rate.

Failure to comply with the targets shall require the presenta-
tion of an economic and financial plan to allow the correction of
the deviation for a period of one year. This plan must explain the
causes underlying the deviation and the measures which will
bring it back within the limit. In the event of non-compliance
with the plan, the responsible Administration must automatically
approve the non-availability of loans to guarantee compliance
with the set target and the meeting of the targets shall be taken
into account when authorising debt issues, granting subsidies and
signing agreements.

257


The Law, on the other hand, strengthens the preventive and
monitoring systems of stability and debt objectives. Therefore, a
debt threshold of a preventive nature is established, beyond which
the 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 to
produce an economic-financial plan, the administration in breach
must put of a deposit of 0.2% of its nominal GDP, which after six
months may be converted into a penalty in the event that the vio-
lations should continue. After nine months, the Ministry of
Finance and Public Administrations may send a delegation to
assess the economic and budgetary situation of the delinquent
Administration.

In order to strengthen the principle of transparency, each
Public Administration must establish the equivalence between
the budget and the national accounts. Prior to approval, each
Public Administration must provide information on its main
budget guidelines, in order to comply with European regulatory
requirements.

As was set forth in the new draft of section 135 of the
Constitution, the Law establishes a temporary period until 2020
for gradual compliance, until public debt is 60% of GDP. In order
to ensure compliance with this scenario, public debt must be redu-

258


ced whenever the economy experiences positive real growth. Upon
reaching a growth rate of 2% or net yearly employment is genera-
ted, the debt ratio shall be reduced each year at least by two GDP
points. On its part, the global structural deficit must be reduced by
0.8% of the annual average GDP.

Beyond the institutional importance of the reform, it is worth
considering the political capital that is allowing the deficit problem
to be addressed in an integral way and with long term vision. Doubts
as to possible deficit deviations in the current and following finan-
cial years should not lead us to lose perspective of the importance of
the reform. This reform set a trend designed to transform public bud-
gets into a reliable institution, with a simple structure, with no room
for interpretation, equal for all and with an automatic application
which allows it to be protected from temptations from other govern-
ments. In this regard, we also view the provisions included in the Bill
for the Transparency Law, which, undoubtedly, shall contribute
towards generating better knowledge of public finances.

The fiscal systems being approved in Spain matched with the
European 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 above
all others.

259


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. The
current crisis is but a result of the structural deficiencies of our eco-
nomy, of our excess indebtedness, of our lack of flexibility and our
lack of competitiveness in some aspects.

Once again, Spain, on its part, must become a role model of the
fiscal 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 the
best way to redistribute income. This is the only way we will mana-
ge to get Europe and Spain out of the sovereign debt crisis they
face, ensuring a solid future for the process of European construc-
tion, which is the greatest milestone in the search for peace and
prosperity in Europe.

5. Conclusion

Following the same pattern set since the inception of the
European integration project after the World War, the EMU came
about in 1999 as a result of the political aspiration of increasing
integration and as a European response to the globalisation pro-
cess. In reality, the integration via the monetary union which
makes up the Eurozone was not an objective in and of itself, but
rather a means to improve competitiveness and efficiency among

260


member countries. The ultimate goal, therefore, was growth, job
creation and the improvement of social welfare, while at the same
time 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 diluted
over the years with the introduction of components carrying greater
flexibility and discretionality in the fiscal institution. The best exam-
ple is that the solution provided in 2005 to the violation of the SGP
by Germany and France was none other than the reform thereof
which included greater ambiguity in the search for fiscal stability, for
which they gained the support of the European Commission. The
diminishing political commitment with the fiscal institution and its
fragility in the face of the vicissitudes of the different governments
and ideologies became clear at that time. Therefore, with an institu-
tional design which was incomplete, and gradually declining over
the years, the EMU was far from representing an optimal monetary
area, and therefore the imbalances of the Eurozone economies incre-
ased, instead of decreasing, placing Europe in a difficult situation in
the face of the global financial crisis.

In this context, the current European debt crisis has highlighted
the urgent need for better coordination of the fiscal policies in
Europe. At the same time and particularly during the crisis, the
experience since the foundation of the euro has shown the impor-
tance of political commitment with the fiscal institution and the

261


need for preventive rules instead of penalties which are difficult to
apply. It is essential to ensure that the accumulation of excessive
deficits does not lead to unsustainable situations which call into
question traditional European security and seriously complicate
the capacity for funding growth and job creation. Rules are a
necessary condition to ensure compliance with fiscal targets. But
these rules must be of straightforward and automatic application.

Despite the difficulties, the present economic time obliges
Europe and Spain to make fast and efficient decisions in order to
straighten out the situation. It is important to take advantage of
current circumstances to tackle ambitious reforms designed to
correct some of the structural flaws of the Eurozone and of our eco-
nomy. It is important to face the current problems from a long
term outlook and to establish the rules of a fiscal institution which
ensure the viability of the European project.

The future and survival of the euro rests on all member states
being able to implement domestic reforms seriously, thus genera-
ting a sign of confidence for international investors and which
shall also serve, again in our case, as a calling card for our busines-
ses abroad. In Spain, one of the countries which has sustained the
most 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 in
terms of the control systems or the transmission and penalty
mechanisms.

262


Spain, as a country which has already proven its ability to take
on 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 worth
mentioning that, thanks to the latest reforms implemented in sup-
port of the fiscal institution, Spain is once again contributing to
the European debate in pursuit of macroeconomic stability in the
Eurozone and its recovery. The challenge to be addressed, by means
of a change in the economic policy, is to recover confidence and
credibility of our economy, to enable businesses and consumers to
concentrate efforts in business, labour or consumer decisions, and
that macroeconomic issues, such as the risk premium, cease to be
cause for concern. Only in this way may Spain avoid lagging
behind like a second rate club, to which we have already said no a
few years back.

In order to move forward in building a fiscal union in Europe,
which succeeds in turning the EMU into an optimal monetary area
and ensures the good health of the euro and of the European eco-
nomy, the necessary mechanisms of income transmission, ensure
the availability of financial resources and required liquidity, to the
extent, if necessary, of creating risk pooling instruments, such as
eurobonds 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 the
countries 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


ed commitments are met, the respect for the autonomy of each
country to decide on its income and expenditure structure.
Subsidiarity must govern in Europe for those who are taking the
necessary steps, as is being done in Spain, in order to adapt the
budgets to the economic and social reality of each country.

The European construction has taken important steps since the
start 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 and
prosperity established by the founding fathers of the European
construction, on a long term horizon, once again depend on our
capacity to recover the growth and competitiveness of the eco-
nomy, and hence employment and the European welfare model.

264

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

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