What are the pros and cons of an EU – Mercosur free trade agreement?

1. What are the pros and cons of an EU – Mercosur free trade agreement?

2. Housekeeping • No lectures next week • Micheal Collins • Course essays

3. Project questions • Describe the gains from trade. With reference to the stalled WTO Doha Round negotiations, discuss why governments often seem to be prepared to forego these gains. • How is a country’s competitiveness defined and measured? What policies would you propose to address a loss in competitiveness? • Draft what you think should be the Irish government position in the negotiations on the EU budget post-2013. • Critically discuss Ireland’s strategy to meet its challenging greenhouse gas emission targets. • Outline the main features of the global imbalances problem. In what ways do these imbalances pose a threat to global economic stability and what policies would you propose to address them?

4. Deciding the EU budget Session 8 Macroeconomic Concepts and Issues MSc Economic Policy Studies Alan Matthews

5. The context • Negotiations on the next EU medium-term financial framework (MFF) for the period 2014-2020? have started • Build on the budget review exercise conducted in 2007-08 • Considerable dissatisfaction with the outcome of the 2007-13 MFF • What should Ireland be looking for in these negotiations?... • …taking into account that Ireland could be a net contributor in the next MFF period

6. The issues • The absolute size of the future EU budget • The structure of expenditure • Possible changes in budget financing • Budget implementation issues • Addressing the issue of Member State net balances

7. Learning objectives • Examine the structure and operation of the EU budget • Evaluate possible outcomes of the debate on the next EU financial framework and their implications for Ireland • Note: We are not discussing EU influence on national fiscal policy, see McAleese Chapter 15.4

8. Section 1.The Multiannual Financial Framework

9. The MFF • Forms the framework for EU expenditure over a medium term period • Indicates the maximum value and composition of foreseeable EU expenditure • Is not a multi-annual budget • Purpose is • To stabilise the annual budget • To strengthen budgetary discipline • To keep total expenditure increase under control

10. The MFF has been a success story • Discipline and predictability: Ceilings have assured budgetary discipline – allowed multiannual programming. • Reliable compromises: MFF agreements have ensured smooth annual budgetary procedures. • Innovations and flexibility have been possible: Revisions since 2007 have allowed the MFF to cope with almost € 10 bn of unforeseen expenditure; EU Own Resources are serving as collateral to support crisis stabilisation mechanisms. • The Lisbon Treaty enshrines the MFF • EP Fact Sheet on the MFF

11. …but improvements are needed • Lack of flexibility: Reaction to unforeseen circumstances and changing priorities has been very difficult. • Excessive focus on “net balances”: The “juste retour” logic favours pre-allocated expenditure and reduces EU value added. • Domination of grants limits leverage: Instruments of financial engineering linking EU funds with loans and private funds are still very limited. • Amounts dominate over delivery: Negotiations neglect the conditions for effective implementation. • Avoid delays to put new programmes in place – early agreement needed

12. MFF – better system design • Duration of the MFF: 5, 7 (5+2), 10 (5+5) years ? • Flexibility: Between headings, between budget years, via bigger margins, by QMV in Council. • Structure of the MFF: aligned with EU2020, number and classification of headings • EFSM/BOP: Guaranteed lending to Member States – limited by Own Resources ceiling • To be absolutely certain that the Commission will be able to call additional OR from Member States in case of a default on a guaranteed payment, the combined total of payment appropriations the total amount of guaranteed reimbursements due (principal + interest) must not exceed 1.23% of EU GNI in any given budget year.

13. The flexibility dilemma • To date emergency money has been found under MFF ceilings without increasing the overall total. Mainly an accident because CAP ceilings were set too high under Chirac-Schroeder CAP agreement in 2002 • Council can raise about 4 billion using QMV (0.03%), but according to ECJ jurisprudence can only be agreed by unanimity • Contingency margin – but will operate only under principle of overall budget neutrality – one heading must compensate another, but without margins, no degrees of freedom

16. Rationale for government intervention • Allocation – justified by market failures (externalities, public goods, merit goods) • Regulation – setting rules for markets so that they work in the public interest (competition problems, information problems) • Distribution (equity, insurance, special interests) • Stabilisation (use of monetary and fiscal policy to promote economic policy objectives)

17. Fiscal federalismAt what level of government should activity take place? • Decentralisation • Closer matching with local preferences • Provision of services can better match with local requirements (informational problems) • Greater democratic accountability at local level • If we relax assumption that governments maximise citizen welfare, decentralisation promotes greater efficiency in service provision (competition among jurisdictions) • Centralisation • Where preferences are broadly similar • Where spillovers exist • Where there are economies of scale in service provision • Where there is desire to achieve uniformity in provision (equity in health and education) • (on tax side) where resources are mobile

18. The EU budget and fiscal federalism • Principle of subsidiarity • Stabilisation • No direct role • Distribution • Structural funds and cohesion policy • Allocation/regulation • Supervising the single market, competition policy, R&D policy • No compelling case for involvement in health, education, social welfare • Defence and external action • Agricultural policy ?

19. Criteria for EU funding

22. The net balances issue • The focus on net balances is heavily criticised • The fact that a Member State’s net budget balance may bear no relationship to its net benefits from EU membership does not mean that net balances are unimportant. • The obsession with net balances distorts decision-making and leads to sub-optimal EU budget - examples • Criteria for distribution of Pillar 1 and Pillar 2 payments • Roberto explicitly assumed voting behaviour linked to transfer distribution • Can this weakness be addressed? • Addressing distributional outcomes explicitly removes this incentive problem

23. Net budget balances, % GNI, 2007

25. Addressing net imbalances • Four options • Hope that EU budget changes will reduce need for correction mechanisms over time • Finance EU budget solely by EU taxes • Link net balances to levels of Member State prosperity through a generalised correction mechanism (Commission proposal) • Explicitly separate distributional outcomes from allocative decisions on how to spend the EU budget

26. Explicitly keep distributional and allocation budget decisions separate • Idea would be to agree ex ante on the desired level of inter-MS transfers • MS would negotiate the expenditure ceilings on individual MFF headings, knowing that any decisions would not affect their ex ante agreed net balance • Would lead to improved allocative decision-making • Problems include • Agreeing the redistribution coefficient (but one is already implicit in the existing transfers, see next graph) • Payments have very different economic effects • Some are transfers (DPs), some of reimbursements for services and cost incurred…

27. De la Fuente, Domenech and Rant (2008)

28. Section 2.Structure and operation of the EU budget

29. Annual EU budget • Financial statement showing revenue and areas of expenditure in the coming year • Distinction between commitment and payment appropriations • Current payments ceiling is 1.24% GNI • Looming budget problem. Payments have lagged behind payment appropriations in first part of MFF, will have to grow rapidly to catch up.

30. The size of the EU budget

31. EU budget expenditure • Initially dominated by agricultural expenditure • With successive enlargements cohesion expenditure became more important • R&D expenditure has increased due to concerns re EU competitiveness • Note EU budget not allowed to run a deficit

32. Changing policy priorities

34. EU budget revenue • Initial arrangement was financing by fixed national shares • Development of ‘own resources’ to give financial autonomy • Import tariffs and agricultural levies • VAT contribution based on harmonised VAT base • Fourth resource based on GNI • Dominance of latter means that EU has now returned to system of national contributions • Limited by overall ceiling (now 1.24% GNI)

35. Sources of budget revenue

36. Source: DG Budget, Financial Report 2007

37. EU own resources roughly in line with GNI, 2004

38. Section 2.The next financial framework

39. The EU budget review process“Reforming the budget, Changing Europe” • Key objectives • Analyse longer-term challenges and issues facing the EU • See how European budget can be shaped to serve EU policies and to meet the challenges ahead • Seeking a new consensus on EU spending priorities, how the budget is managed and how to fund it • Commission to present report later in 2009

40. Context – the crisis and beyond • Increased global challenges • Climate change, energy, security, migration… • A radically changed economic climate • Economic governance and budgetary consolidation at the heart of the political debate • Climate of budgetary austerity • The EU budget under increased scrutiny • Crisis has reduced GNI (1.05% has become 1.13%) • Letter of five • But also given new roles • EFSM - BOP • Possibly suporting economic governance

41. Principles for the EU budget • Delivering key policy priorities: Implement the Treaty of Lisbon, help deliver EU 2020 strategy. • EU added value: Application of the subsidiarity principle, complementarity between EU and national/regional budgets. • A results-driven budget: Performance budgeting, conditionality, simplified implementation. • Mutual benefits through solidarity: interdependence in the single market distributes benefits widely; solidarity enables geographically concentrated interventions. • A reformed financing of the budget: greater autonomy for EU Own Resources; transparency and fairness to be improved.

42. Budget a tool to achieve EU 2020 objectives • The EU is committed to a fundamental programme of economic reform, the EU2020 strategy, intended to unlock the potential of the EU economy to find new sources of growth and create new jobs: • Smart growth: Research and innovation, infrastructure of the future (transport and energy). • Sustainable growth: Green technology and services; reform of the CAP. • Inclusive growth: Cohesion policy to enable coherent implementation of EU2020 strategy; skills and mobility; cushion major sectoral disruptions. • Citizenship: Assist Member States to assure freedom, security and justice; strengthen European integration. • Global Europe: With globalisation, key issues (energy security, migration, climate change, security) can only be tackled at global level.

43. A budget delivering results • Use of resources through incentives • Possible introduction of conditionalities defining a specific set of targets on which disbursement of EU funds would depend • Other options: performance reserves or modulate co-financing rates to performance • Need to define specific, measurable, achievable, relevant and timed objectives as well as performance indicators. • EU budget to support economic governance: • Macroeconomic stability and structural reforms require each other, • EU budget could provide part of preventative and corrective measures, covering a broader range of expenditure. • Simplify and minimise administrative burden • Implementation procedures and control requirements are too complicated

44. Using the budget to leverage investment • Leverage investment • Projects with long-term potential should involve EU funds used in partnership with the private and banking sectors • Increased use of blending of grants and loans • EU project bonds • Could facilitate major cross-border infrastructure projects • Support from EU budget to project bonds issued by the private • sector or by the EIB to enhance the credit rating • Large scale projects • Require considerable investments over a time period going beyond a financial framework (Galileo, ITER, GMES) • Separate support structure set up by the project promoters, to which EU budget would make a fixed annual contribution

45. Reform of revenue sources • Reform proposals fall into two groups • Simplification of current system of own resources • Replacement of the VAT-based resource by GNI-based payment is widely supported • Introduction of new own resources in the form of one or more EU taxes • Modulated VAT • Tax based on corporate income • New EU Levy on Energy/CO2 (or share of existing energy taxes) • ETS auction revenues with 50% climate earmark (total worth increasing slowly to €20 billion pa in 2020) • Tax on flights • Very limited support for introduction of new EU taxes

46. The composition of the budget • Budget review highlighted widespread support for considerable reorientation of EU spending to meet global challenges • Ireland’s submission to EU Budget consultation • Department of Finance submission supports increased spending on European public goods, only gradual change to CAP spending and greater targeting of Structural Funds on poorer Member States

47. Irish government principles • The overall size of the EU Budget as a percent of EU GNI should be determined at the conclusion of the review process and should reflect the agreed policy priorities of the Union • The Review should lead to a gradual evolution of the EU Budget expenditure rather than radical changes • The need for continued food security and safety would warrant only gradual changes to the Common Agriculture Policy • There should be a greater concentration of Structural and Cohesion Funding on less developed Member States • Productivity enhancing policies should have greater emphasis in the EU Budget, particularly in R&D and technology transfer • Policies and investments that implement EU climate-energy objectives should be supported by the EU Budget • The financing of the EU Budget should continue to be mainly based on GNI and an EU wide tax would not be acceptable to Ireland • Consideration should be given to the gradual phasing out of budget rebates.

48. CAP still largest expenditure item • Original focus on market management to reduce price volatility and increase farm incomes • Pillar 1 (direct payments and market price support) and Pillar 2 (rural development) • Future of direct payments • Distribution of direct payments within countries • Pressure building for fairer allocation between countries

49. Share of cohesion spending growing rapidly • On average, SFs do benefit poorer regions • But should they be more concentrated?

50. Growth and competitiveness policies Source: 2008 EU budget