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 ? have started
Build on the budget review exercise conducted in
Considerable dissatisfaction with the outcome of the 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
Negotiations on the next MFF have now started.
These negotiations build on the budget review exercise undertaken by the Commission in 2007/08. This budget review was mandated as part of the agreement between the European Parliament, the Council and the Commission in relation to the financial framework in May The Commission was invited
"to undertake a full, wide ranging review covering all aspects of EU spending, including the CAP, and of resources, including the UK rebate, to report in 2008/9. On the basis of such a review, the European Council can take decisions on all the subjects covered by the review. The review will also be taken into account in the preparatory work on the following Financial Perspective."
Although the commitment to hold the review was seen as a response to a UK demand which failed to achieve as radical a reorientation of EU spending priorities as it wished, there was a widespread feeling of dissatisfaction with the outcome of the current MFF.
In the negotiations leading to the approval of the last two multi-annual EU financial frameworks there was widespread agreement on the need to devote additional resources to areas of common European interest in order to respond to the economic and political challenges posed by a changing international environment. Yet the required money could not be found because net contributors blocked any increase in the overall budget ceiling for fear of seeing their deficits increased, and the main beneficiaries of existing expenditure programmes or financing privileges strongly resisted any attempt to curtail their funding.

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
Five issues, we consider 4.
How big a budget?
Do we want to grow new areas? How much do we want to reshuffle resources among existing areas?
How to mesh the timing of the MFF negotiations with the cycle of EP elections so as to give greater democratic input and oversight of the budgetary process.
Linked with the system of national rebates and correction mechanisms which have grown up.

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 federalism At 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
Public economics
Fiscal federalism
Objectives
Market failures/equity goals
Funding or regulation
Economies of scale
Externalities
Homogeneity of preferences

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
Net balances bear no relationship to the overall benefit of EU membership. For years the Commission resisted publishing estimates

23. Net budget balances, % GNI, 2007
the operation of the EU budget leads to significant transfers among Member States. The recent accession of twelve new Member States with per capita incomes significantly below the EU average means that many more of the older Member States have now become net contributors. No longer just Germany and UK.
Much of the current dissatisfaction with the structure of the EU budget arises from the perceived unfairness particularly among the net contributors where countries with very similar levels of GNI per capita make very different contributions to the EU budget.
For example, Greece, Ireland and Luxembourg are extraordinarily well treated given their income levels. France and Germany have approximately the same income per capita, but the latter's deficit is roughly twice the size of the former's. A similar discrepancy exists between Finland and the Netherlands. On the opposite end of the income scale, Hungary receives much more than Romania despite a higher per capita income, as does Portugal compared to the Czech Republic.
Net transfers unrelated to GNI per head has given rise to complex system of rebates, beginning with UK

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
There are essentially four options to address the problem of unacceptable net balances. The first is to hope that the gradual reform of the EU budget, particularly on the expenditure side, will lead to a more balanced and equitable pattern of net budgetary balances over time such that the pressure for ad hoc corrections will disappear. This is the position of the Irish government in its submission to the budget review consultation.
A second approach is pursued by those who wish to substitute separate EU taxes for the GNI resource. Their argument is that, if the EU were financed by earmarked taxes, this would mean that Member States would no longer be concerned with their net budgetary balances. The taxes would be borne by corporations, consumers, air travellers or polluters, and the net balances would simply reflect the geographical distribution of these taxpayers across the Union. Again, this seems a rather overly-optimistic expectation, especially given that the front-runner for an EU tax is a modulated VAT which would not look hugely different to the current VAT-based resource.
The third approach is to address the issue of net balances by linking Member State net balances explicitly to their levels of relative prosperity. This option of a generalised correction mechanism was supported in the Begg report (2008). For example, the Commission’s proposal for a generalised correction mechanism in its 2004 report
The most radical approach would be to change the structure of the EU budgetary system in such a way that the unavoidable conflict over distributional issues is treated explicitly so that it does not spill over into the rest of the budget discussion. This option can be regarded as taking juste retour thinking to its logical conclusion.
The only approach to address the incentive as well as the fairness issue.

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
the EU budget is large in absolute terms (over €120 billion per year) but small as a percentage of total EU public expenditure (less than 2½%). Although it has increased in real terms over time, it has shrunk as a proportion of EU GNI, while the responsibilities assigned to the Union have increased. The current legal limit for total EU revenue, which has to equal total expenditure, is 1.31% of EU gross national income (GNI) for appropriations for commitments and 1.24% of EU GNI for appropriations for payments. In practice, EU expenditure in the MFF will average less than 1% of EU GNI.

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
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
The most common suggestion for simplification is the replacement of the VAT-based resource by the GNI resource. As a mechanism for funding, the GNI resource has a number of advantages (Begg et al., 2008). It makes it easy to predict how much each Member State will contribute. It is equitable in respecting the ‘ability to pay’ principle by asking Member States to pay equal proportions of their income. Indeed, if there were ever a political decision to vary gross contribution rates to the EU budget by asking Member States to pay in different proportions of their GNIs, it would be a relatively easy matter to do so by adjusting the call-up rates. Its third advantage is that it is an open-ended resource in the sense that Member States are committed to transferring sufficient money to match the EU’s agreed expenditure. This means that the EU does not need to worry about fluctuations in the revenue flows from particular taxes and will not face a financing problem, provided that Member States do not renege on their commitments.
Although the GNI resource is legally considered an ‘own resource’ of the EU, in practice it functions like a national contribution. It encourages Member States to enter the budget process with a determination to keep ‘their’ national contribution to a minimum. It means that the visibility of EU funding from the point of view of citizens is non-existent, meaning that public knowledge of the EU budget is scanty and often ill-informed.
For these reasons, there is minority support for the view that the EU should be granted new tax-raising powers, either to complement or substitute completely for the GNI resource.
There have been various attempts made to suggest suitable candidates for EU taxes. A Commission study (2004) discussed three kinds of tax as possible new own resources in the future: (i) a tax based on energy consumption; (ii) a modulated VAT; (iii) a tax based on corporate income. Other options proposed in the study commissioned by the Commission for the budget review include a tax on flights, assigning the proceeds from the auction of Emissions Trading Permits or some other variant on a carbon tax, or assigning seignorage from the European Central Bank (Begg et al, 2008). However, none of these suggestions has the potential of the first three to be anything more than a niche resource.

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
A number of studies have attempted to set out the desirable size and composition of the EU budget based on these principles (see, for example, Sapir, 2003; Ecorys et al, 2008). These analyses generally conclude that some existing expenditure, particularly under the Competitiveness and Growth heading, the first pillar of the CAP as well as much Rural Development spending, should be shifted from the EU to the Member States. At the same time, there is a case at least in principle for increased EU spending on transport and energy, on security, foreign aid and neighbourhood policies and on environment and climate change, although some of this might replace Member State spending so that overall public spending would not increase.

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: EU budget

51. Global policies
Source: EU budget

52. Trend in Irish net budget balance
Ireland’s net budgetary position has always been positive, although steadily diminishing. At its high point in the early 1990s, transfers contributed 5-6% of Irish GDP. In 1999 the transfer was equivalent to 1.8% of Irish GDP, and by 2008 this had fallen to 0.02% of GDP (Figure 7). A crude extrapolation of the trend suggests that Ireland would make the switch to being a net contributor before 2013.

53. Irish EU receipts and contribution

54. Irish shares in budget expenditure categories, 2007
These shares will change in next MFF

55. Section 3. Next steps

56. Envisaged timeline EP SURE Committee Report May-June 2011
[Special committee on the policy challenges and budgetary resources for a sustainable European Union after 2013]
Commission proposals in June 2011:
A policy document
A new MFF regulation xx
A new Inter-Institutional Agreement
An Own Resources (OR)report
A new OR decision (+ implementing regulation?)
In the second half of 2011, Commission presents the various sectoral legislative proposals for all the post policies and programmes

57. Envisaged timeline
Polish Presidency: detailed examination of Commission proposals
EP to continue preparatory process (SURE – BUDG?)
Danish Presidency : Council negotiations
June 2012: target = unanimous Council agreement
Cypriot Presidency : If necessary, finalise Council negotiations - Negotiations with EP on the MFF regulation and the IIA – EP consent is necessary
target = agreement December 2012
2013: negotiations and adoption of all new legal bases and new own resources decision

58. Inter-institutional collaboration
EP wants to be involved in the entire process
Council: wants to strictly limit it to the Lisbon Treaty
MFF regulation: Art 312 (2) – unanimity + consent
IIA: co-signatories
OR Decision: Art 311 – unanimity (ratification) + consultation
OR Regulation: Art 311 – QMV + consent
OR Regulation: Art 322 (2) – QMV + consultation

59. Article 311 (own resources)
The Union shall provide itself with the means necessary to attain its objectives and carry through its policies.
Without prejudice to other revenue, the budget shall be financed wholly from own resources.
The Council, acting in accordance with a special legislative procedure, shall unanimously and after consulting the European Parliament adopt a decision laying down the provisions relating to the system of own resources of the Union. In this context it may establish new categories of own resources or abolish an existing category. That decision shall not enter into force until it is approved by the Member States in accordance with their respective constitutional requirements.

60. Article 311 (cont)
The Council, acting by means of regulations in accordance with a special legislative procedure, shall lay down implementing measures for the Union’s own resources system in so far as this is provided for in the decision adopted on the basis of the third paragraph. The Council shall act after obtaining the consent of the European Parliament.

61. Article 312 (MFF)
The Council, acting in accordance with a special legislative procedure, shall adopt a regulation laying down the multiannual financial framework. The Council shall act unanimously after obtaining the consent of the European Parliament, which shall be given by a majority of its component members. …
Throughout the procedure leading to the adoption of the financial framework, the European Parliament, the Council and the Commission shall take any measure necessary to facilitate its adoption.

62. Note on codecision and consent procedures
Codecision now called the Ordinary Legislative Procedure
First reading in Parliament (simple majority), first reading in Council (QMV)  can be approved
With Council amendments, second reading in Parliament, either rejection or amendment, if latter, second reading in Council
Conciliation Committee to approve joint text

63. Note on codecision and consent procedures
Parliament considers a draft act forwarded by the Council; it decides whether to approve the draft (it cannot amend it) by an absolute majority of the votes cast. The Treaty does not give Parliament any formal role in the preceding stages of the procedure to consider the Commission proposal, but as a result of interinstitutional arrangements it has become the practice to involve Parliament informally.
See European Parliament webpage for details

64. Looking forward The next MFF will be very difficult to agree
Negotiations taking place in economic conjuncture which is affecting different MS very differently, but most MS are under severe fiscal pressure
First time 27 MS ad particularly the new MS will discuss the budget
First time the Parliament is involved
First time redistribution of CAP monies explicitly on the table

65. Follow up EU Budget http://ec.europa.eu/budget/index_en.htm
EU Budget Review