Maastricht Treaty

The Maastricht Treaty was signed on February 7, 1992 in Maastricht Netherlands. The treaty led to the creation of the euro, and created what is commonly referred to as the pillar structure of the European Union. The treaty established the three pillars of the European Union: European Community, Common Foreign and Security Policy, and the Justice and Home Affairs. The convergence criterion that member states would have to fulfill to show they were eligible to join the single currency area had four basic elements. First, prospective Eurozone members had to keep a tight lid on inflation; specifically no more than 1.5% points higher than the average of the three best performing (lowest inflation) members of the EU. Secondly, there were strict rules on the annual deficits and overall debt; the ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year and the ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. The third criterion states: members have to join the exchange rate mechanism for at least two years, and they were prohibited from devaluing their currency.

Finally, long-term nominal interest rates had to be held down; nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states. The May-Winn Act will be a treaty revision that holds of the formation of the European Monetary Union until the EU is fully integrated, will put systems in place that redesign the way member countries are audited to ensure fiscal discipline, and will revise the convergence criterion for when Europe is truly integrated and ready to form a common currency.

The May-Winn Act revision of the Maastricht Treaty will eliminate premature plans for a common currency (the Euro), until the European Union is fully integrated. This revision is invoked from Balassa’s emphasis on the order of integration process and the preconditions for forming a monetary union. Balassa’s original OCA theory points out a serious threat in integration taking place in the wrong sequence: “According to his logic the common currency is not a tool of integration, but, rather the fruit of the already successfully implemented real integration, which can be platform of further development.” Despite significant convergence of nominal variables, the economies of the potential member countries varied a lot in terms of GDP growth, labor productivity and unemployment rates. The degrees of integration of labor, goods, and financial markets were generally considered to be lower than in the United States, the conventional OCA benchmark case. Taking the OCA conditions seriously would therefore have meant to postpone or even to abandon the EMU project.

Since the Maastricht Treaty prematurely introduced the euro (1999), in hopes that it would grow and eventually become an optimum currency area, Europe has experienced a Myrdal-type circular cumulative effect that condemns the less developed to a downward spiral. The expected convergence of prices and wages has not been achieved; the more advanced gained further competitiveness and the less developed lost competitiveness. This idea is represented in (figure 1 and 2), showing Portugal, Italy, Ireland, Greece, and Spain (PIGGS) further deterioration of balance of trade and income, in comparison with a steeply upward trending Germany. Because Germany has international companies with very strong positions on the world market, it was able to take advantage of the common currency. Figure 1:

Figure 2:

While data shows that the introduction of a common currency; although beneficial for strong economies (Germany), it has been the catalyst and the amplifier of the deteriorating competitiveness of weaker countries (PIIGS). In consequence of the tendency of inflation, characteristic of the weak countries, the euro appreciated for them, while low euro interest rates induced a boom in demand. The boom in the economy pushed up the wages (Balassa-Samuelson effect) and – as a result – the public welfare expenditures as well. The Wall Street Journal Article titled “The European Union Is One Big Fairy Tale” illustrates two competing versions of a famous European fable, ant and the grasshopper. This fable reinforces Balassa’s concept of the dangers of forming a monetary union without completing integration. The classic Keynesian tale of the ant that harvests seed all summer and saves up food for the long winter while the grasshopper spends the summer lounging and singing.

Describe this way; it’s consistent with the 1992 Maastricht Treaty’s intent to force fiscal responsibility. It also fits with German’s stereotypes of their southern neighbors, whose work ethic they frequently criticize. But the truth is that the Maastricht treaty’s benchmark rule: that member countries’ fiscal deficits never exceed 3% of GDP, has been broken repeatedly by every member of the euro zone, including fiscally prudent Germany. And that is because the treaty’s basic premise is mathematically flawed. Germany and other members of Northern Europe that claim a more productive workforce would simply argue that the lessons of the Ant and the Grasshopper have not been learned by Greece and other, more profligate Southern European nations. Ironically enough, a Greek alternative version to this tale places the ant in a different context. In it, a man is so unsatisfied by his own success that by night he steals crops from his neighbors. This angers the king of the gods, who turns him into an ant, although he continues his habit of theft from his neighbors.

No doubt Greeks of today would suggest that northerners who depict themselves as more productive and hardworking than their southern neighbors are really ants who are stealing from them. German and French banks and exporters, having profited from the debt that Greece built up before the 2008 crisis, are now refusing to pay the price for that exploitive relationship, Greece would say. The fable itself highlights the vast difference in European cultures and competitiveness, which is one of the basic reasons why the euro experiment is failing – and shows why the May-Winn act will hold off the formation of a monetary union until further integration is accomplished. The May-Winn Act will delay the forming of the EMU until further integration of the European Union. May-Winn Preconditions must be met before the European Monetary Union is introduced. May-Winn Preconditions include:

1. The European Union must increase openness across countries currently interested in forming the EMU. According to Oxford University Press: “Countries that are very open experience less cost of joining a monetary union compared to relatively closed economies.” The common currency is not only an inadequate tool to eliminate the differences inherent in the real sector, but it makes the task even more difficult by limiting the range of instruments of economic policy. The limitation may mean increased challenges for less developed countries. Although the Bela Balassa’s original OCA theory appears to have been valid, the departure from it, as embodied in the Maastricht treaty, amounted to an unjustified departure in light of the experience PIGGS. Until the EU increase openness it would be very beneficial to not introduce a common currency. Further explanation; in the current EMU Germany is a boom and PIIGS are experiencing a downward economic trend. The European central bank is paralyzed because if it lowers the interest rate to alleviate PIIGS, it will increase inflationary pressures in Germany.

If it raises the interest rate to counter the inflationary pressures in Germany it will intensify the downward spiral in PIIGS. The common central bank cannot stabilize output at the country level; it can only do this at the union level. However if there were no EMU, PIIGS would have the tools to stabilize output at the national level. Thus when PIIGS experience the global economic crisis in 2008 – PIIGS individual central banks can stimulate aggregate demand by reducing the interest rate and allowing their separate currencies to depreciate. 2. The May-Winn Act Auditing revision of the Maastricht Treaty, to ensure that Member States abide by Maastricht Criterion preventing regulatory failure and maintaining fiscal discipline. The May-Winn auditing revision will be modeled after Sarbanes-Oxley Act; a United States federal law that set new or enhanced standards for all U.S. public company boards, management and public accounting firms. The difference is May-Winn will be evaluating countries opposed to individual corporations, will impose harsher punishments against fraud, and will co-exist with the European Court of Auditors and European Commission.

This act will especially focus on the Maastricht criterion of debt and deficit – which has not been satisfied by those who pledged that they would. Breach of Maastricht criterion will now result in the following sanctions: criminal penalties, monetary fines, and in extreme cases expulsion from the union. May-Winn would be a treaty revision that allows for a Member State to be expelled from the EU – something that didn’t exist before. The closest that Community law comes to recognizing a right of expulsion is Article 7(2) and (3) TEU, allowing the council to temporarily suspend some of a Member State’s rights (including voting rights in the council) for a ‘serious and persistent breach by a Member State of the principles mentioned in Article 6(1) of the EU Treaty. Although this might be thought of as a preliminary step to the expulsion of a Member State, but it is not the same as its definitive expulsion – revealing the true unique quality of the May-Winn Act. Greece is an example of a Member State that would have been expelled under May-Winn that is, if Greece had been admitted into the EU in the first place, under this act’s stricter auditing system. Lying to the EU is automatically grounds for expulsion, and Greece used accounting tricks to cover up the true value of their total debt.

Although expulsion of even one member of the European Monetary Union could wreak enormous economic damage, removing Greece from the EU will show other countries, for example Britain, that the EU is a credible OCA, hopefully changing public opinion about becoming a Member State. 3. May-Winn Act criterion further integrates the European Union by promoting increased development and competitiveness in underdeveloped countries such as Portugal, Italy, Ireland, Greece, and Spain. Countries in the European Union will provide monetary support to help get these countries to competing levels of development, for example technology. Underdeveloped countries must develop more similarities including: structural, technological, reliability and efficiency of public and private institution, legal systems, and price/inflation dynamics. EU countries that are underdeveloped will be fully integrated and ready for a common currency when competitive differences are minimized, in relation to more developed countries such as Germany. Kenen [1969] claimed that the increase dynamics of trade due to the common currency successfully eliminates the still remaining structural difference – has proved unsupported. Concluding that the introduction of the common currency, does not affect the micro-level factors of the real sector, such as the development of technology, and does not serve actual convergence.

Once these May-Winn preconditions are met, further integration will be accomplished, and Europe will in fact be ready to form a monetary union. Participating EU members must also conform to the following revisions and additions to the Maastricht Treaty convergence criteria and Stability and Growth Pact. The May-Winn Act calls for a revision of certain stipulations that allow flexibility in the convergence criteria and the Stability and Growth Pact. The Maastricht Treaties convergence criterion was developed with the intention of managing both overspending and excessive indebtedness. But since the debt crisis, it is evident that the implementation of the criteria has not been as effective as intended with controlling the two factors. This is the result of a stipulation to the treaty, Article 104 c(a), which allowed for countries to exceed the excepted levels of debt and GDP as long as “it should be exceptional and temporary and remain close to the reference value”.

This agreement was created as an incentive for countries such as Greece and Italy to cut down on their public expenditures and debt levels. However, for example, in 2003, Greece’s debt of 103% was acknowledged as adequately declining, and was therefore accepted. Yet in 2007 it had increased to 107.8% and continued to climb in years after. With that being said, these economic criteria were not effective fiscal targets for the original twelve Eurozone countries as much as it was for the newer entrants. Looking at the debt and deficit levels of the twelve original members three years prior to the adaptation of the Euro in the figures below, it is evident that at first many did not meet the reference values of the treaty. However, throughout the three years, most countries were able to bring their levels down. With the new stipulation in place, only two Euro-zone countries did not comply with the deficit criterion when using revised numbers. Without the exception, many countries would not have qualified to adopt the Euro.

In order to adjust for certain member states being able to hold debts and deficits so far off from the reference values, circumstances surrounding certain stipulations need to be strengthened or removed. The May-Winn Act will remove any loopholes that allow member states to not adhere to the criteria by shortening and enforcing deadlines for member states to take action, and by restricting the circumstances in which adjustment periods are allowed. It will also assign a numerical benchmark to characterize what is meant by “satisfactory pace”. After the implementation of the reformed Stability and Growth Pact, the real performance in conforming to the Stability and Growth Pact targets declined. At the start of the Eurozone, all of the member states fulfilled inflation convergence criteria. Yet, as seen in figure 3, these values consistently diverged from their original rates.

Also, expenditures exceptionally increased, most notable in countries that did not meet their medium-term objectives. These same countries were prone to not consolidate their public finances in following years to revert their tendency in spending, especially when they experienced unanticipated revenue profits. Because of the flexibility allowed during economic cycles, the relaxed market enforcement of the Stability and Growth Pact rules corroded the efficacy of the goals. Consequently, when an economic recession struck, countries whose numbers were far off from the targets had little room to maneuver and avoid descending into extreme levels of debt and deficit. Figure 3: Average Yearly Inflation in Eurozone Countries, 1999-2007

The May-Winn Act will ordain corrective taxes on member states with excessive debt or deficit as a motivation for member states to consolidate fiscally. Despite experiencing periods of accelerated growth, member states either still experienced deficits or had fiscal policy similar to prior periods. Both the Commission and ECOFIN were unsuccessful in persuading Eurozone members to consolidate their fiscal positions with the Stability and Growth Pact requirements. Countries such as Germany, Ireland, Italy, Belgium, and Greece relaxed during both phases of the cycle. As a result, during phases of downturns, countries conveyed structural fiscal balances that were countercyclical because they had ignored the opportunity to stabilize their position throughout economic booms. Therefore, under the May-Winn Act, it will be mandatory to impose punitive taxes on member states with excessive debt or deficit as a provocation for member states to consolidate fiscally. The May-Winn act will specify that under no circumstances that member states be allowed to submit stock-flow adjustments as a substitute for budget deficits to further deter the use of “creative accounting”.

Reason being that countries began replacing stock-flow adjustments for budget deficits in attempts to disclose issues with deficit levels. Positive stock-flow adjustments signify a greater increase in debt compared to deficit. Although Eurostat investigates the numbers submitted by countries with continuously ample stock-flow adjustments, generally deficit levels are under more scrutiny. This gives member states more temptation to over-report stock-flow adjustments and underreport deficit levels. By eliminating the opportunity to substitute stock-flow adjustments for deficit levels, it will allow for the true representation of deficit levels that can be directly compared to the Stability and Growth Pact criteria.

Overall, the original Maastricht treaty, drafted in early 1992, is not entirely responsible for the current crisis. Yet, the current insufficient criterion, coupled with the lack of discipline by some member states to stick to these guidelines and lack of enforcement by the EU certainly is one to blame. Therefore, ratification to the treaty is essential in regards to the future of both the European Union and the EMU. The May-Winn Act revision of the Maastricht Treaty will make all necessary adjustments to further integration by immediately removing the Euro, in joint with making both crucial and improved additions and revisions to the initial Treaty. The implementation of the May-Winn Act will help aid the European Union in becoming a more integrated, successful, monetary union.

References:

[ 1 ]. http://www.ier.ro/documente/rjea_vol12_no2/rjea_vol12_nr.2_site_art5_.pdf [ 2 ]. “The Theory of Optimum Currency Areas: A Critique” – Oxford University Press [ 3 ]. “The Theory of Optimum Currency Areas: A Critique” – Oxford University Press [ 4 ]. Ngai, Victor. Stability and Growth Pact and Fiscal Discipline in the Eurozone. University of Pennsylvania, 2012. [ 5 ]. Ngai 28

[ 6 ]. Ngai 46