Efficient Breach—A Necessary Evil for Fixing the Broken EU SGP

During the recent news coverage of the Greek financial crisis, some pundits have alleged that Greece has ‘broken all the rules,’[1] suggesting that Greece’s economic woes are entirely of its own creation. Few commentators who cite these ‘rules’ ever specify their referent, but for most it is the European Stability and Growth Pact (SGP)—a binding agreement amongst the EU member states focused on stabilizing the European Economic and Monetary Union (EMU)—which contained a variety of national economic restrictions. The rules of SGP were almost immediately violated by the majority of its signatories, largely due to unforeseen economic downturns.[2] In this essay, I adopt an economic perspective of international law[3] to investigate whether or not the assertion that ‘efficient breach’—a breach of legal obligation more efficient than continued compliance given the relative importance of the benefits of adherence vs. the penalties for breach—‘may  become the engine for efficient legal evolution’[4] can be adjudicated veridical in the case of SGP. I will expound a brief history of SGP, showing that it was legally binding. I will then prove that breach of SGP occurred. Moreover, I will argue that this was an instance of efficient breach necessitated by the poor construction and impossible standards of SGP, and a lack of more efficient, feasible alternatives to breach. Finally, I will demonstrate how the persistent and widespread efficient breach of SGP forced subsequent EU action, thereby rendering the economic mandates less strict and thus more achievable.

 

SGP consists of two interconnected European Council regulations. The ‘preventative arm’ was established to strengthen ‘the surveillance of budgetary positions and the surveillance and coordination of economic policies’ in the EU,’[5] while ‘the dissuasive arm’ served to expedite and clarify ‘the implementation of the excessive deficit procedure,’[6] essentially constituting the enforcement mechanisms of the SGP. It is by these regulations that the economic restrictions were established, including the contentious and quickly breached requirement that government deficits of member states be kept ‘within… 3% of GDP,’ and that debt be restricted to a maximum of 60% of GDP.[7] These requirements are collectively referred to as the convergence criteria.

 

The EU is a ‘self-contained regime,’[8] built on the basis of several treaties. It is off of one of the founding treaties of the EU[9] that the SGP builds, rendering the initial economic parameters that govern the EU more stringent and specific, while also establishing enforcement mechanisms for the rules. In short, the SGP is unquestionably binding as the ‘material source’ of its bindingness—the TFEU—derives its authority from its status as a ‘formal source’ given that it is a treaty as defined by Article 38 of the Statute of the International Court of Justice (ICJ).[10] Having established both the details of the SGP’s contents as well as its binding nature, we may proceed to discuss its subsequent breach, which I argue was necessary and efficient.  

 

The extensive records of the European Commission’s Directorate-General for Economic and Financial Affairs (DG ECFIN) provides evidence for the almost immediate, systematic, and widespread breach of the regulations enshrined in the SGP. Each year, a summary of public finances in the EMU is published by the directorate, including specific data on the deficits and debt of all EU states.[11] Gunnar Beck—an EU lawyer, legal theorist, and Barrister-at-Law at University of London—offers a cogent synopsis of the various breaches of SGP over the years, explaining that ‘since the inception of the single currency there have been at least 77 breaches of the SGP by the EU Member States.’ Moreover, Beck states that according to Eurostat’s official government deficit and national debt figures, this may actually be an underestimate.[12] To be precise, out of 17 euro zone Member States, only Finland, Luxembourg, Slovenia, and Slovakia kept their national debt below the 60% threshold from 1999-2011.[13] Among the most egregious violators were France and Germany—the two nations that most passionately argued for SGP.[14] EU state representatives openly confessed these breaches. Christine Lagarde, the former French minister and current IMF head, was alarmingly honest in admitting to having broken the law in order to ‘save the euro.’[15] Arguing for the necessity of these breaches, the national ministers evoke terms directly from the nomenclature of efficient breach; what remains is to examine whether or not this breach truly was efficient. 

 

Posner and Sykes argue that the logic that undergirds efficient breach is that steadfast compliance is not always an efficient choice.[16] Moreover, they adopt a game-theoretic approach, describing how international law enables nations to move from a non-cooperative (Nash) policy equilibrium (which is inherently inefficient), towards a ‘cooperative equilibrium’ that is relatively more efficient, given that nations then ‘behave as if they were internalizing the externalities imposed on other nations.’[17] The EU and the SGP fit squarely into such a paradigm, as the economic literature largely supports the contention that inter-state economic cooperation and convergence fosters positive economic externalities, leading to greater efficiency via cooperation.[18] In principle, the SGP was a commendable endeavor; its strict parameters, however, would prove economically untenable. The convergence parameters were established without adequate foresight, as the possibility of economic crises was not considered. The restrictive rules failed to take into consideration that in the event of a recession, nations would likely engage in a ‘short-term fiscal response… contributing to excessive deficits in most euro area countries,’ undoubtedly leading to ‘a number of challenges for the functioning and credibility of the SGP.’[19] By failing to plan for the worst-case scenario, the SGP was revealed to be admirable politically, but poorly constructed economically.[20]

 

Shortly after SGP’s enactment, the EMU nations were faced with a choice when Europe began experiencing economic troubles. If one nation were to resort to running higher deficits, it would improve its national economic situation, while risking repercussions via SGP’s dissuasive arm. However, the enforcement of the SGP depends on an EC vote; the sanctions are not automatic. Thus, if multiple nations breach simultaneously, a majority vote would be unattainable, as no minister would vote to sanction his own country. The enforcement mechanism is further weakened by the fact that even if the EC did vote to declare a nation in ‘excessive deficit,’ that nation would have four months to act;[21] by the end of that period, ‘as long as action has been taken by the member state concerned, the procedure iterates back to the recommendation stage.’[22] The enforcement mechanisms created by the dissuasive arm by no means reach the threshold of ‘legalized noncompliance,’ as no ‘rules governing deviation from commitments both to facilitate and limit such deviation’ were included in the SGP resolutions.[23] That said, it is clear that the enforcement mechanisms are all but useless in the case of breach by multiple states, as the voting process for sanctions would be stymied.

 

In his critique of SGP, Crowley adopts a social-psychological view of legal compliance, explaining that ‘just because a law is in place as a legal instrument doesn’t necessarily mean that people will abide by it;’ is is the system of incentives and penalties in place that behind the law that ensure compliance and enable the law to become embedded in social behavior.[24] Such an understanding forms the basis of the arguments for efficient breach: if the benefits of adhering and the penalties for breaching are low or nonexistent, then breach is a more efficient choice than compliance. We have already seen that the poor economic construction of SGP’s restrictive parameters forced many nations into breach to stabilize their national economies; however, given the weak and non-automatic enforcement mechanisms that govern the imposition of sanctions under SGP, the penalties were a non-issue. ‘Economic theory suggests that when the benefits of breaching an agreement exceed the costs of complying with an agreement, the system governing the agreement should allow a party to breach the agreement’.[25] This is precisely what happened in the case of SGP. Moreover, the same parties in breach held voting power in the decision to impose sanctions, thereby rendering enforcement of the SGP convergence parameters politically impossible.[26]

 

Beyond the lack of feasible penalties for breach, there were no incentives for states to comply continually with SGP. SGP was implemented as a modification of the Maastricht convergence criteria, which included both a penalty instrument and a system of incentives, while SGP only included penalty instruments.[27] Thus, SGP presented the ideal storm for efficient breach, as by breaching, the nations could assuage their economic woes without fear of repercussions, having forfeited no benefits of compliance. Finally, in order for efficient breach to have been the best option for nations seeking to release themselves from SGP, starting anew must have been less desirable than breach. Starting over was never considered because of its political implausibility. As Romano Prodi—President of the EC in 2002—stated: ‘I know very well that the SGP is stupid, like all rigid decisions. If we want to adjust these, unanimity is needed and it [won’t] work.’[28] The last alternative to efficient breach would be a complete repeal of SGP; however, doing away with it entirely would be impossible, as the result would be a destruction of the premise of EU economic convergence and the mechanisms that govern it. Prodi denied that increased flexibility would eventually result in a complete ‘release of pact shackles,’ going on to argue: “the idea of having divergent economic policies is totally crazy.”’[29] To summarize, the SGP bound its adherents to budgetary rules doomed for failure in a world of divergent economic cycles in which unexpected recessions occur. Its weak enforcement mechanisms and lack of incentives for compliance made breach viable, while the lack of feasible alternatives made efficient breach the most attractive choice for most nations.

 

With this in mind, it is clear that efficient breach served as a tool of legal evolution. Enabled by SGP’s weak voting-based enforcement mechanisms, November 25th, 2003 ‘formally mark[ed] the apex of the SGP crisis when the Council of the European Union decided not to implement the provisions of the SGP recommended by the Commission vis-à-vis France and Germany.’[30] The EC Economic Commission knew that the situation of rampant breach was unsustainable; moreover, they knew that it was damaging the reputation of the EC, bringing into question their ability to enforce binding agreements. In 2004, their commission’s main goal became the formation of ‘specific formal proposals for rejuvenating the SGP,’[31] and in 2005, a revised version of SGP was implemented.

 

If renegotiation was impossible previously, what enabled its reconsideration? The answer lies in the ‘Crisis of SGP,’ a period between 2003-2005 during which Member States breached with increasing frequency and impunity.[32] Furthermore, it is clear that the Pact failed to yield the fiscal performance that it heralded, but this same failure catalyzed the recommendation of new reforms.[33] With enough states willing to renegotiate, the council passed an amendment relaxing the rules of SGP, establishing a new mechanism of ‘medium-term budgetary objectives,’ and in general, rendering the economic parameters less stringent.[34]

 

In conclusion, efficient breach did indeed become the engine for efficient legal evolution in the case of SGP. However, it became so not because of the attractiveness of efficient breach, but rather, because of the initial poor construction of SGP, creating economically unrealistic binding restrictions that presented no benefits for compliance. While I do not defend efficient breach in general, in this case, it was the best of many unappealing options for nations attempting to keep their economies afloat amidst an economic downturn. Efficient breach was a necessary evil in fixing the broken SGP.

 

 

[1] See e.g. H Ellyat, ‘Greece defiant; accused of 'breaking all the rules'.’ CNBC, 16 June 2015,                                  < http://www.cnbc.com/2015/06/16/decision-time-as-greece-slammed-for-breaking-rules.html > [Accessed June 16, 2015]

[2] See e.g. Euro Area Fiscal Policies and the Crisis [April 2010] ECB Occasional Paper Series No. 109 / pg. 56

[3] See e.g. J Dunoff & J Trachtman, ‘Economic Analysis of International Law’ (1999) 24 J. Int’l L. 1

[4] E Posner & A Sykes, ‘Efficient Breach of International Law: Optimal Remedies, “Legalized Noncompliance,” and Related Issues’ (2011) 110, 2 The Michigan Law Review Association 243, 258

[5] Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1997] OJ L 209/1

[6] Council Regulation (EC) No 1467/97 of July 7 1997 on speeding up and clarifying the implementation of the excessive deficit procedure [1997] OJ L 209/6

[7] See Council Regulation, above n7, 3

[8] Fragmentation of International Law: Difficulties Arising from the Diversification and Expansion of International Law, Report of the Study Group of the ILC, A/CN.4/L.702, Fifty-eight session (2006) pg. 11, para 6

[9] See especially: Consolidated Version of the Treaty on the Functioning of the European Union [2012] OJ C 326/47 (TFEU), Art. 121 & 126

[10] H Thirlway, ‘The Sources of International Law’, in M D Evans, International Law (4th edn, 2014) 91, 92.

[11] European Economy, Public finances in EMU 3 [2004] EC DG ECFIN, 3/1, pg. 15

[12] G Beck, ‘The suspension of the rule of law in the euro zone and why Chancerllor Merkel should not place her trust in rules. Part 1, Eutopia Law Blog, 2 July 2012, < http://eutopialaw.com> [accessed 2 August 2015].

[13] See Beck, above n 13

[14] Ibid

[15] Ibid

[16] See Posner, above n 4, 245

[17] See Posner, above n 4, 245

[18] See e.g. Paul De Grauwe, in OUP, Economics of monetary union. (2012) 27

[19] See ECB, above n 2

[20] P Crowley, ‘The Stability and Growth Pact: Bad Economics and/or the Politics of Least Resistance?(2005) University of Pittsburgh Archive of European Integration 1,1

[21] See Council Regulation (EC) No 1467/97, above n 7, Art. 3.4

[22] See Crowley, above n 21, 6

[23] See Posner, above n 4, 253

[24] See Crowley, above n 21, 13

[25] R Morrison, ‘Efficient Breach of International Agreements(1995) 183 Denv. J. Int’l L. & Pol’y 183, 183

[26] Ibid

[27] See Crowley, above n 21, 6

[28] Row over ‘stupid’ EU budget rules, BBC News Business, 17 October, 2002, <http://news.bbc.co.uk/1/hi/business/2336823.stm [accessed 2 August 2015].

[29] Ibid

[30] European Economy, 101 Proposals to reform the Stability and Growth Pact. Why so many? A Survey [2006] EC DG ECFIN, 267/1, pg. 12

[31] See European Economy, above n 12, 7

[32] See European Economy, above n 29, 24

[33] Ibid

[34] Council Regulation (EC) No 1055/2005 of 27 June 2005 amending Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [2005] OJ L 174/1, Art 2a.