The procedures leading to the forthcoming accession to the EU did not involve any conditionality on macroeconomic indicators for Candidate countries (CEECs). In several (CEECs) there was a marked deterioration of the fiscal accounts during the run-up to entry in the EU. Apparently, CEECs did not perceive they would be subject to tight fiscal constraints upon entry, although the ceiling of 3% on budget deficit and the Stability and Growth Pact apply to every member of the EU.

Several candidate countries are approaching entry in the European Union with large budget deficits that have a structural nature. During the sharp economic collapse of the early 1990s, lack of access to borrowing induced a significant tightening of fiscal policy. By contrast, deficits have grown and remained high during the subsequent period of growth (Table). Budget deficits have been on average well above 3% of GDP, except for Slovenia and the Baltics. Interestingly, it appears that country size matters for fiscal policy. However, low-deficit countries, especially the Baltics, are also the countries with a currency board, or a fixed exchange rate, regime.

I have tried elsewhere to estimate (Coricelli and Ercolani, 2002) the structural and cyclical components of budget deficits in CEECs. Applying the EU methodology I found that budget deficits in CEECs have a structural nature, although results have to be taken with caution because the estimation of output gaps for CEECs cannot be very reliable, given that CEECs became market economies only at the beginning of the 1990s. Nevertheless, the structural nature of budget deficits can be inferred by simple inspection of the behavior of primary budget deficits and GDP growth in the last six years in Central European candidate countries (excluding the Baltic States). Indeed, Figure 1 shows that the growing primary deficits took place during a period of steady growth.

The lack of a clear position of the European Commission on the framework of fiscal policy that will apply to new member is hard to rationalize. This attitude seems to neglect the key institutional change brought about by the Stability and Growth Pact, that in principle has reduced the scope for flexibility in the interpretation of budgetary positions of member states and has made much more automatic the procedures to be followed for countries with excessive budget deficits.

There are three main areas that make the current EU fiscal rules not appropriate for new acceding countries. The first relates to the 3% budget deficit limit; the second to the absence of a “golden rule” and the third relates to the procedures for assessing fiscal stance and the behavior of national governments.

Incomes per capita in acceding countries are on average 40 percent of those of the average EU country. Convergence to EU levels of GDP per capita is going to be a long term phenomenon. Thus, for a few decades CEECs should display higher rates of growth than those of EU countries. Assuming the Barro well-known rule of thumb on convergence, CEECs should grow at a rate that is 2 percent higher than the average EU. As the average rate of growth of potential output is around 2 percent in the EU, potential output in acceding countries can be expected to grow between 4 and 5 percent per annum. The volatility of GDP growth is also likely to be much higher than that of EU countries. This implies that with neutral fiscal policy stance, fluctuations in cyclical budget balances should display a much larger amplitude, following the higher amplitude of fluctuations in output, if the output elasticity of both revenues and expenditures are similar to those in the EU countries. In Coricelli and Ercolani (2002) it is estimated that the output elasticity of total revenues is around one for most CEECs, while the expenditure elasticity with respect to the output gap is smaller than that found for EU countries. Overall, the elasticity of the budget balance to the output gap is about 0.4 for CEECs, not far from the 0.5 for the average of EU countries. Therefore, higher output volatility is going to be translated in higher budget volatility. Looking at the period 1996-mid 2002, a recent paper by the ECB finds that CEECs posted an average rate of growth of GDP of about 4% against a 2.2% of Euro area countries. Volatility was much higher in CEECs, with a standard deviation of output growth almost three times higher than that of the Euro area (Süppel, 2003). The study concludes that since higher growth and higher volatility of growth reflect a catching up process, they are going to persist in the medium run. Given these structural features, the 3% ceiling on the budget deficit does not represent a sufficient margin to absorb cyclical swings in budget deficits. For current EU members, with an estimated elasticity of the budget to the output gap of around 0.5, the 3% budget deficit limit represents a wide enough margin to absorb regular cyclical fluctuations in the budget. While this is disputable even for current EU members, it is hardly applicable to acceding countries.

Abstracting from the general relevance of the golden rule, we simply discuss its implications for acceding countries. The ratio of public investment to GDP in acceding countries is on average around 4%, as opposed to about 1% in EU countries. Thus, the adoption of some form of golden rule would make a large difference for acceding countries. Empirical evidence on the relationship between public expenditure and growth indicates that public investments tend to increase the rate of growth, raising potential output of the economy. In a EU characterized by disappointing figures on growth and very low estimated growth of potential output, the issue of public investment cannot be underestimated, especially for acceding countries [2].

Rules are important because they can strengthen the credibility of policies. The current crisis of the SGP illustrates however the distinction between the credibility of policies and that of policy-makers. There is indeed an inconsistency in the current framework. Besides the motivations for the specific numbers chosen, there has been several papers by the EC that try to provide economic foundations to the whole apparatus of the deficit/debt ceilings and the SGP. The cornerstones are:

According to the defenders of the SGP, the breach of the 3% ceiling should occur only in exceptional circumstances, in particular during a deep recession. The notion of safety margin is based precisely on the idea that if a country keeps its budget deficit not too far from zero, the 3% limit would be hit when the output gap is around -6%. In the case of Germany, however, during 2001-2002, the period in which fiscal accounts displayed a sharp deterioration, the output gap was positive in 2001 (actual output was above its trend) and only marginally negative (-0.3) in 2002 [4]. In 2003, the worst year for the German budget deficit, the output gap was only -1.6 percent. Similarly, in France in 2002 there was a sharp deterioration of fiscal accounts while the output gap was still positive. Of course, it is well known that there are serious difficulties in measuring output gaps and cyclically adjusted deficits. Nevertheless, these concepts are at the heart of the EC methodology. According to this methodology, the German budget deficit for the period 2001-2003 is defined as almost entirely “structural”.

In this paper we wanted to add the dimension of the enlargement to the already heated debate on EU fiscal rules. From the analysis it emerged that the main drawbacks of current rules from the perspective of acceding countries reveal fundamental shortcomings of the fiscal framework of the EU. Enlargement makes even more visible these shortcomings.