Fiscal Rules, Fiscal Institutions, and Fiscal Performance



266


THE ECONOMIC AND SOCIAL REVIEW

borrowing constraints tend to be associated with municipal governments
incurring larger debts than elsewhere. Von Hagen and Eichengreen (1996)
find that countries where sub-national governments are subject to more
stringent statutory borrowing constraints tend to have higher central
government debt ratios. This is a third substitution effect. Strauch (1998)
shows that constitutional expenditure limits in the US induce a shift from the
(constrained) current budget to the (unconstrained) investment budget, but
they do not constrain total spending effectively.

The key insight then is that the effectiveness of fiscal rules is limited at
best, because politicians are likely to find ways to circumvent them. This
conclusion matters for Europe and its monetary union, because the fiscal
framework of EMU relies heavily on the fiscal rules imposed on the member
governments by the Maastricht Treaty and the Stability and Growth Pact. In
fact, the success of the deficit and debt limits under EMU has been quite
limited so far (Hughes-Hallett, Strauch and von Hagen, 2001). When these
limits were first imposed in 1992, the average debt ratio of the European
Union states stood at 60 per cent of GDP. In 1998, when euro-area member-
ship was decided, it was over 75 per cent. This increase was driven mainly by
the fiscal developments in Germany, France, Spain, Italy, and the UK. It is
probably no coincidence that these are the largest countries among the 12
EMU states. In contrast, the debt ratios of the small states declined
significantly during the post-1992 period, indicating that the fiscal constraints
of EMU were more effective in these states. The experience suggests that the
role of external political pressures, such as admonitions brought by the
European Commission, are not strong enough to coerce internal politics in
large countries. Thus, if they are effective at all, the ex ante controls of EMU
may discipline fiscal policies in the small member states, but not in the larger
ones. Recent experience confirms this conjecture. The German government
was unwilling to accept a warning letter from the Commission, although such
a letter was warranted given its fiscal performance in 2001. Similarly, the
French and the Italian governments announced their intention to ignore
earlier commitments to balancing the budget by 2004 made in their Stability
Programmes. There are also increasing complaints about creative accounting
to circumvent the fiscal rules of EMU.

III POLITICAL COMPETITION AND ACCOUNTABILITY

Procedures for holding policy makers responsible for their actions are a key
element of the incomplete contract between voters and their elected
representatives (Persson
et al. 1997a, b). The election process is the most



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