Lisbon will ask the European Union and the International Monetary Fund to relax Portugal's 2014 budget deficit goal to 4.5 percent of gross domestic product from 4 percent, Portuguese Deputy Prime Minister Paulo Portas said Sept. 11. The same day, Economy Minister Antonio Pires de Lima said that the country would not achieve enduring economic growth if taxation remains at current levels.
Portugal's deficit targets were already relaxed in May, but Lisbon is pushing for further concessions. In early July, political frictions over austerity measures almost caused Portugal's ruling coalition to collapse. Portugal emerged from recession in the second quarter of 2013, but the country still has the third-highest level of unemployment in the eurozone, and the traditionally quiet Portuguese are becoming increasingly restless about the country's fragile economy. In this context, Lisbon will push its lenders for permission to slow down economic reforms.
The strategy carries risks. Though Portugal is expected to finish its bailout program in June 2014, Lisbon is negotiating additional financial assistance from the European Union and the International Monetary Fund. Lisbon fears its borrowing costs could go out of control again without some kind of precautionary credit line. Stratfor expects Lisbon and its lenders to reach an agreement, and that Portugal will have financial help after exiting its bailout. Conditions attached to the aid will be a key topic of negotiation among Lisbon, the European Union and the International Monetary Fund between late 2013 and early 2014.
Meanwhile, France is in a somewhat different situation. French Finance Minister Pierre Moscovici said Sept. 11 that his country's 2013 public deficit would reach 4.1 percent of gross domestic product, higher than the 3.9 percent promised to the European Union. France was one of the many countries that received more time to take its deficit below the 3 percent of gross domestic product demanded by European regulations. But unlike Lisbon, Paris is not under a bailout and does not have to deal with regular inspections by officials from the so-called troika (the European Union, the International Monetary Fund and the European Central Bank). This has prompted the government of French President Francois Hollande to systematically dismiss the EU targets and unilaterally decide its fiscal policy. Hollande is dealing with low approval ratings, and so is pursuing an agenda of slow and timid reforms to prevent social unrest at home.
The European Union has been dealing with enforcement problems since its birth two decades ago. The Maastricht Treaty, which entered force in November 1993, established specific limits of debt and deficit for member countries. Then the Stability and Growth Pact of 1997 gave the European Union power to oversee the fiscal situation of member states and the ability to issue recommendations for policy actions. Most important, it created the excessive deficit procedure, a mechanism for correcting excessive deficits and eventually sanctioning non-complying countries with fines of up to 0.2 percent of gross domestic product.
Despite having these tools at its disposal, the European Union failed to apply sanctions against France and Germany, the largest economies in Europe and the strongest promoters of the Stability and Growth Pact, when they violated the agreement in the early 2000s. Punitive proceedings were started against Portugal in 2002 and Greece in 2005, but fines were never imposed.
Several reforms to enhance enforcement were applied, including the Six Pack in 2010 and the Euro Plus Pact in 2011. These reforms sought to improve EU oversight of member states, to change voting rules to make it more difficult for large states to block sanctions, and to commit member states to make structural reforms. Then in late 2011, the European Union introduced the Fiscal Compact Treaty, which in its original form would have required member states to amend their constitutions to include legal limits on deficits and debt. The treaty was later modified to allow countries to avoid reforming their constitutions, and instead to comply with the treaty by approving binding legislation to cap deficits and debt. The Fiscal Compact Treaty marked a breaking point in the European Union because the United Kingdom and the Czech Republic refused to sign it, highlighting growing political fragmentation in the bloc.
A Fragile Balance
The European crisis is forcing Brussels and member states to strike a difficult balance between credibility and flexibility. On one hand, the constant violation of EU rules has substantially weakened the bloc's credibility. Member states know rules could be bent or ignored if need be, one of the main factors that generated the current crisis in the eurozone. On the other, Brussels understands that some degree of flexibility is called for, particularly in times of crisis. Fiscal consolidation measures are generating unrest, endangering the political survival of traditional ruling elites and jeopardizing the continuation of the European Union.
In this context, enforceability is likely to remain weak and susceptible to political manipulation. Brussels understands that there is only so much it can do when pressuring member states. In the case of countries that are under a bailout, the European Union has more leverage, since it can link the disbursement of bailout tranches to the application of reforms. Even in those cases, however, Brussels is unlikely to deprive a bailout country of financial assistance out of fear this could aggravate the financial crisis. Brussels' leverage is particularly weak in the case of non-eurozone countries, where the threat to remove cohesion funds is the European Union's main negotiation tool. The union is not a federal state, but an agreement by sovereign nations. As a result, the agreement is only viable if and when its signatories decide to respect it.
EU members are likely to push for a more independent fiscal policy in the coming months. The enforceability of EU regulations will remain highly politicized, and Brussels is unlikely to take a hard line against non-compliant nations. In the short term, this will allow national governments room for maneuver to deal with the domestic aspects of the economic crisis. In the long run, it will further weaken the European Union's limited enforcement power, thus reducing its ability to function as a cohesive bloc.
Since the beginning of the crisis, European elites have stressed that crucial institutional reforms, including the creation of a banking union and the construction of a fiscal union, will be necessary to strengthen the European Union and prevent another crisis. As long as enforcement of EU rules remains weak, even these crucial reforms are unlikely to be effective.