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Economics of European Integration

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The three fiscal policies in the European Union are: Institutional Arrangements, Excessive Deficit Procedure and the Stability and Growth Pact. For the institutional arrangements these are put in place in order for EU member states to establish sound fiscal policies and has been agreed upon by the member states. These are the institutional arrangements which are under the Articles 121-126 of the Treaty of the Functioning of the European Union: prohibition of monetary financing, prohibition of privileged access to financial institutions, no-bail out clause, fiscal provisions to avoid excessive deficits and the Stability and Growth Pact. These institutional arrangements are put in place, so member states can achieve a balance budget and to strengthen the procedures for excessive deficits (ECB, 2018).

For the EU’s budgetary policies, it is included in the Treaty of the Functioning of the European Union that its member states should avoid excessive government deficits. The base reference for member states are a general government deficit of 3% and a gross debt of 60% in relation to their GDP, however, there is an exemption if a member state’s deficit is temporary and if it remains close to the reference value. The ECOFIN Council is the one who decides if a member state has excessive deficits and they act If there’s a proposal coming from the European Commission. The Council also lays the term to lessen the excessive deficits which sometimes lead to the imposition of sanctions to the concerned member state (ECB, 2018).

The Stability and Growth Pact provides the operational clarification of the EU’s budgetary rules. The Pact contains the procedures for multilateral budgetary surveillance (preventive arm) and the conditions where to apply the excessive deficit procedures (corrective arm). The Pact is considered a vital part of the macroeconomic framework of the European Monetary and Economic Union. It urges the member states to harmonize their budgetary policies and to avoid excessive deficits as a means to achieve macroeconomic stability in the EU. The rationale behind the Pact is to gain sound budgetary policies permanently and for the member states to adhere to the medium-term objectives for their budgetary positions that is ‘close to balance or in surplus’ under the EU’s country-specific considerations (ECB, 2018).

However, according to Larry Elliot (2015) the reason behind why Greece and the other EU countries are experiencing economic difficulties is the lack of fiscal policy within the union. The union also lacks a common mechanism to transfer resources from a member state to another; taxes from the EU’s best performing members cannot be transmuted to higher spending for EU countries that performs poorly. Yes, there is a single currency and interest rate, but it lacks a fiscal union that should be established along with the monetary union. Aside from that, the EU’s obsession in reducing deficit has hindered growth in the Eurozone.

Even though some countries wanted to leave the union (e.g. Italy) they realized that leaving it will plunge their country into a financial crisis even more as unemployment rates will further go up and its banking system will collapse. The membership to the Eurozone is compared to a curse, Italy is put in a bind to follow through with the Eurozone’s absurd fiscal rules and it was not allowed to attain more budget deficits since the EU rules clearly state that in order to bring their country back to competitiveness it must put through with international deflation which entails cost cutting and austerity measures (Elliot, 2018).

French President Emmanuel Macron has given his proposal in order to bring back the faith of the European citizen to the European project after a decade of financial crisis and immigration problems in order to quell the rise of far-right and anti-EU parties in Europe. He proposed that the EU should have its own finance ministry headed by a eurozone finance minister (Chrisafis, 2017). Another alternative in his proposal is to allow the member state to have more freedom to run fiscal policies that will suit their needs (Elliot, 2018)

The European Union needs a fiscal union in order to quell the economic shocks coming from one of its member from spreading throughout the union. Another alternative eyed is that member states should share financial risk in order to mutually insure each other. An example of that is the proposed EMU-wide unemployment insurance system that will stabilize private incomes alongside with a central fiscal capacity that will collect annual contribution from the EU member states linked to local shocks and it also offers benefits without the harmonization of the unemployment insurance system. This facility can smooth business cycles and ensures fiscal discipline and prevent moral hazards (Berger et.al., 2018).

The Eurosclerosis is a term coined by German economist Herbert Giersch which he used to describe the period of economic stagnation in Europe during the 1970’s and 1980’s. In these decades the European Community suffered a snail-paced job growth and further European integration is at a standstill. Giersch identified that the rigid structures in the European Community caused such event, but it is not the only cause. He also blames industries who became reliant on tariffs and government aid which should have been used to improve competitiveness, the rigidness of the labour market prevented it to clear and make incentivized firms in using labour-saving technology, welfare payments to the people made them disincentivize to work, and excessive regulations created barriers to entry for new workers and firms. The era of Eurosclerosis ended when there is a more solid push towards European integration during the 1990’s and 2000’s and when the European Union improved its flexibility in regulations (Investopedia, 2018).

However, Lithuania was not yet a part of the European Community when it experienced Eurosclerosis during the 1970’s and 1980’s. The Baltic state is still a part of the Soviet Union which is facing the similar problem of economic stagnation.

The Soviet Union achieved rapid growth in the 1950’s due to its command economy which in the Soviet authorities coordinated economic activity through directives, social and economic targets and regulations. They also control the Union’s social and economic activity, however, since the Soviet Union does not have an open market that provides price signals and incentives to direct economic activity which led to economic inefficiencies and waste. Due to the Soviet Union’s fixation on industrialization and urbanization; a former backwards economy modernized itself by adopting various Western technologies at the expense of personal consumption. The Soviet authorities knew about the inefficacies of the command economy as they ran out of Western economic models to imitate (Johnston, 2016).

In the 1950’s Nikita Khrushchev attempted to decentralized economic control to allow a second economy to deal with the union’s complex affairs, however, he was to go back to centralized economy since it tore the foundations of the command economy apart. Reforms were resumed in the 1970’s to allow the Soviet economy to have a liberal market system but with the foundations of the centralized economy but the Soviet economy stagnated further. Mikhail Gorbachev’s radical economic reform Perestroika created an atmosphere of openness and encourage individual private incentive. This sense of openness emboldened the Soviet citizens and the took advantage of these freedom to gain information on their ailing economy. The Soviet authorities further relaxed its control to help their ailing economy which further led to its dissolution when the union experienced economic contraction during the late 19080’s to 1990’s (Johnston, 2016).

The Stability and Growth Pact are rules aimed to prevent fiscal policies of EU member states to head towards problematic direction and to correct excessive budget deficits or excessive public debts (ECB, 2018).

The SGP is a binding agreement between the EU member states to coordinate their economic policies and activities cohesively to ensure the stability of the Economic and Monetary Union. The Pact sets two limits to EU member states: a member states government deficit cannot exceed to the reference point of 3% and the national debt cannot exceed 60% of the country’s GDP; penalties are issued for non-compliance. The pact is often criticized for not laying down penalties on the EU’s larger economies such as Germany and France even though they did not comply with the limits while smaller countries such as Greece and Portugal are saddled with heavy penalties (Investopedia, 2018).

Lithuania has also faithfully reducing its government deficit in 2008-2014 in order to attain the Maastricht Criterion of a 3% government deficit.

Source: ECB Convergence Report 2014

Lithuania has presented its Stability Programme in 2017 which is in line with the European Union’s Stability and Growth Pact and it aims to achieve an annual general budget surplus of 0. 3% of the Baltic states’ GDP and it hopes for a balanced economic growth with average 2.5% between 2018 and 2020 through domestic and external demand. In order to achieve this, Lithuania is planning to improve its tax administration, promote activities of state-owned enterprises in a way to increase the states capital return and increase the focus on result-oriented public finance (Anskaitienė, 2017).

In an OECD report, Lithuania’s economy is fairly resistant to external changes since it attained a fast recovery during the 2008 global financial crisis due to high flexibility of Lithuania’s economy. Even though Lithuania strengthened its financial and fiscal framework in order to accommodate the fiscal compact and supervision of the European Union; inequality indicators remain high and share on Lithuania’s informal activities are significant. Lithuania is also affected by the Russian countersanction and it caused Lithuanian export to shrink by 40% but it will not hinder the growth of the Baltic state. The reason behind Lithuania’s volatility was due to it being a small economy that is reliant on exports which accounts for 81% of its GDP (OECD, 2016).

Lithuania’s GDP growth during 1991-2015. Lithuania’s attained a GDP of -1.13% during the Russian Ruble Crisis while in 2009 it attained a -11.8% GDP due to the global financial crisis.

Source: OECD Economic Survey: Lithuania

The informal economy in Lithuania creates an uneven playing field for firms and furthers economic inequality. Even if it is slightly affected by the global financial crisis, Lithuania attained a couple of scrapes from it that still needs healing. The Baltic state also had a housing boom, but it quickly deflated which caused a large number of job loss in the construction sector and those jobs are unlikely to be revived, aside from that this increases the skill mismatch and Lithuania’s structural unemployment by 10-12% (OECD, 2016).

Lithuania’s population is rapidly declining due to low fertility rate, high mortality and significant emigration. This situation puts a risk on Lithuania’s potential output growth and fiscal sustainability. Lithuanian citizens mostly emigrate because of economic reasons with the highest proportion of Lithuanian emigrants moving to the United Kingdom where they can earn five times higher than in Lithuania because inequality and poverty remain high. These emigrants are mostly young, well-educated and female Lithuanians, however, during the global financial crisis the return migration went up and it contributed to the lowest annual net migration in 2014 (OECD,2016).

Emigration in Lithuania remains high as high poverty and inequality persists in the Baltic state. However, Lithuania has seen a surge of return migration in 2008 as a result of the global financial crisis.

Source: OECD Economic Surveys: Lithuania

Lithuania has managed to attain its strong fiscal position by cutting its expenditures as they decrease public wages, temporary cuts in pensions and reduction in selected social benefits. These tight measures are done in order for the Baltic state to ensure financial market confidence and to ensure that it would enter the Eurozone. However, due to its ageing populations Lithuania will have to take care of its ageing population and had to consider the associated fiscal costs it would bring (OECD, 2016).

Conclusion:

Lithuania has been part of the European Union for a decade but due to its strong compliance with the EU requirements in order to be a part of the Eurozone. The country has seen tremendous economic growth and external conditions rarely hinders it brought upon by its strengthened fiscal policy. Lithuania even put its Stability Programme in line with the Stability and Growth Pact in order to be in line more with the EU’s obsession to limit gain deficits and earn surplus.

However, despite of the wonderful picture of growth. Poverty and inequality is still at large in Lithuania which caused some of its citizens to emigrate to countries (e.g. United Kingdom) where they can earn more. A high mortality rate and low fertility also puts Lithuania’s future projected growth at risk.

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