## 1. Financial Sanctions Within The Governance Framework

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### Overview and motivation
- General consensus that structural reforms are needed to boost the euro area’s growth potential; medium-term growth potential has been declining despite cyclical recovery since late 2014.
- Labor productivity in the euro area has trailed the United States, especially in services and information technology.
- Crisis legacies (double-dip recession, protracted weak growth) produced persistently high and long-term unemployment and low private investment, eroding potential output.
- Productivity gaps within the monetary union, especially in service sectors, attributed to lagging product market reforms.
- Estimated impact of partial gap-closure:
  - “Closing 10−20 percent of the distance to best practices in the OECD in product and labor markets could help raise euro area GDP by 3½ percent in 2019 compared to the baseline scenario (IMF, 2014a).”
- Political economy and implementation challenges:
  - Reforms perceived to have short-term economic and political costs; lack of popular support due to partial implementation and perceived unfairness.
  - Improved financial market conditions may reduce perceived urgency for reforms.
- Rationale for EU involvement:
  - EU uniquely positioned to assess member states’ flexibility and resilience to shocks and to help ensure sustained real convergence within EMU.
- Scope of the paper:
  - “Structural reforms” defined broadly across economic areas affected by economic governance framework.
  - Focus is on improving the governance framework; prioritization of specific structural reform policies is left for future work.
  - Paper structure indicated: Section II – stock of structural reform provisions; Section III – effectiveness of existing modalities; Section IV – near-term improvements; Section V – longer-term governance changes.

### A complex governance framework (selected features)
- European Semester (since 2011): annual surveillance cycle based on national reform and stability/convergence programs; produces Country-Specific Recommendations (CSRs).
- Macroeconomic Imbalance Procedure (MIP):
  - Preventive arm: imbalances considered when formulating CSRs.
  - Corrective arm (Excessive Imbalance Procedure, EIP): severe imbalances can lead to EIP requiring submission of a corrective action plan (CAP) with roadmap and deadlines; for euro area countries, non-compliance can lead to financial sanctions up to 0.1 percent of GDP per year.
- Stability and Growth Pact (SGP): fiscal framework that recognizes role of structural reforms in achieving sound budgetary positions; can provide flexibility when reforms have verifiable long-term fiscal impact.
- EU secondary legislation: Regulations, Directives, Decisions:
  - Regulations: directly enforceable in their entirety.
  - Directives: harmonize national laws to specified objectives while leaving discretion on implementation.
- Enhanced cooperation: subset of at least 9 EU countries can adopt common legislation in certain areas.
- Complexity drivers:
  - Overlapping enforcement tools, multiple procedures (“packs”, “pacts”), interaction with Six-pack and Two-pack legislation, and intergovernmental frameworks (Euro Plus Pact, Fiscal Compact).
- Note: MIP does not apply to non-euro area countries and does not apply to countries receiving support under financial assistance programs.

### Effectiveness of the current framework (key assessments)
- Overall assessment: complexity has blunted effectiveness — communication challenges, diluted accountability and ownership, perceptions of EU intrusiveness, and lack of level playing field.
- EU legislation:
  - More than 99 percent of Internal Market Directives have been transposed into national law (European Commission, 2014b).
  - Upwards of 85 percent of infringement cases typically settled due to corrective actions before the ECJ.
  - Progress toward Europe 2020 goals appears stronger in areas with legally binding targets specified in Directives (energy, climate) versus areas without legally binding targets (employment, poverty).
  - Limitations: full transposition (e.g., Services Directive by 2012) did not eliminate legal/administrative barriers to cross-border trade in services and labor mobility.
- EU policy coordination:
  - EC assessment for 2012 and 2013: only around 10 percent of all CSRs were fully or largely implemented; “substantial or some progress” on more than half of CSRs (Deroose and Griesse, 2014).
  - Averaging EC qualitative evaluations indicates compliance with CSRs fell in 2014 relative to 2013.
  - EIP has never been opened despite diagnoses of excessive imbalances in several countries; EC has instead used enhanced “specific monitoring” with bi-annual missions and reporting.
  - Under the SGP, semi-automatic sanctions have not produced actual sanctions to date, though the prospect may have incentivized action.
- Factors impeding traction: political costs of reforms, opposition from vested interests, reform fatigue, lack of national ownership, and cautious EC discretion in triggering enforcement procedures.

### Box 1 — Enforcement provisions and instruments (selected points)
- Semi-automatic sanctions exist but vary across instruments.
- EIP:
  - For euro area countries under the EIP, financial sanctions can be applied for an insufficient CAP or non-compliance with actions included in the CAP.
  - If the EC recommends sanctions, the Council considers the decision on the basis of reverse qualified majority voting (RQMV) — i.e., sanctions can be applied semi-automatically.
- SGP flexibility and EDP:
  - Failure to implement structural reforms agreed under the SGP can lead to sanctions as well as suspensions of European Structural and Investment (ESI) funds under the EDP.
  - Under the SGP’s preventive arm, countries can receive a warning and ultimately a financial sanction in the form of an interest-bearing deposit (Council decision by RQMV) if failure to implement structural reforms under SGP flexibility results in a significant deviation from the medium-term objective or the path towards it.
  - Under the corrective arm, such a failure could be considered an aggravating factor when assessing effective action, leading to stepped-up procedures with a temporary suspension of parts of ESI funds (RQMV decision for the adoption of the first sanction).
  - Persistent non-compliance could lead to financial sanctions of up to 0.7 percent of GDP for euro area countries.
- ESI funds (2014–2020 programming period):
  - ESI funds are more closely aligned with structural reform priorities and countries are encouraged to program ESI funds to support CSRs.
  - Since 2015, ESI funds can be reprogrammed at the EC’s request and may be suspended for failure to take effective action under the EDP and/or the EIP.
  - The EC is legally obliged to propose suspension of payments or commitments if the conditions for suspension are met; payments are only suspended in case of significant non-compliance and if immediate action is sought.

### Three complementary proposals to strengthen governance (overview)
- The three proposals: 1) “outcome-based” structural reform benchmarking; 2) better use of existing EU processes (including legislation and coordination); and 3) improving incentives (including financial incentives).
- Pros:
  - May not necessarily require Treaty changes.
  - Derived from cross-country evidence and EU experience.
  - Aim to simplify operation of current framework without adding bureaucracy; ensure specificity, transparency, consensus, accountability, and traction.
- Cons:
  - Political and operational hurdles exist but are described as not insurmountable.
  - Five Presidents’ Report contains similar proposals, suggesting potential political traction.
- Recommendation:
  - Greater clarity and simplicity in the current EU governance framework is desirable; where simplification does not require Treaty changes, implementation should start.

### Proposal 1 — Outcome-based benchmarks (high-level design and rationale)
- Definition: Benchmarks focus on concrete, measurable reform outcomes directly under policymakers’ control.
- Which reforms to benchmark:
  - Reforms that increase growth, competitiveness and productivity; improve public administration efficiency; reduce national vulnerabilities; complete the Single Market; increase factor market flexibility and private sector risk-sharing.
  - Examples: common energy market, integration of services markets, digital networks, harmonizing/reducing cost of doing business, reducing time to enforce contracts.
- Institutional path:
  - Area-wide benchmarks would need political legitimacy from the Council and the European Parliament.
  - Legally easier in “exclusive” and “shared” competence areas; scope for specificity even where EU role is coordination.
- Advantages:
  - Simpler, more specific reform agenda; increased transparency and accountability.
  - Greater national ownership via involvement in setting benchmarks and collective commitment.
  - Evenhanded enforcement via clearer cross-country comparability, reduced EC discretion, and leveled playing field.
  - Enhanced credibility for semi-automatic sanctions and early warning.
- Challenges:
  - Selecting measurable, realistic, enforceable indicators under policymakers’ control can be difficult.
  - Some reforms are less amenable to measurement and require judgment; prior collective agreement on methodology can mitigate subjectivity.
- Operational examples:
  - France CSR example: from “simplify companies' administrative, fiscal and accounting rules … by December 2014” to an outcome-based target such as “reduce the time it takes for a company to comply with tax rules to x hours” or “make electronic tax filing mandatory.”
  - Employment-related targets: shift from employment rate targets to more enforceable measures like “reduce labor tax wedge or labor market duality to x percent in y years.”
- Use of existing indicators:
  - Structural reform indicators already used by EU and multilateral institutions (e.g., OECD, WBDB, EC scoreboards) could be starting points; some indicators may need more frequent production by the EU.
- Translating benchmarks into national policies:
  - National Productivity Councils (NPCs) could provide ex ante support to translate area-wide targets into national action plans, monitor implementation, and propose amendments.
  - NPCs should be operationally independent, accountable, have strong public presence, and adequate resources; some EC participation could facilitate cross-border policy discussion.

### Illustrative outcome indicators (selected categories from Table 1)
- Productivity and Market Flexibility (National):
  - Labor market flexibility (qualitative): OECD Employment Protection Index; nature of collective bargaining agreements.
  - Labor market flexibility (quantitative): Labor tax wedge; Share of involuntary temporary contracts; Unemployment and inactivity “traps”; Benefit replacement rates; Ratio of minimum to median wages; Collective bargaining agreement coverage.
  - Improving the business environment (qualitative): Global Competitiveness indicators of quality of institutions, infrastructure, technological readiness; Transport network density; WBDB (e.g., number of days to enforce a contract).
  - Product market flexibility (qualitative/quantitative): OECD Product Market and Network Regulation Indicators; Herfindahl-Hirschman Index; Cost of starting a business (WBDB component); EU Justice Scoreboard.
  - Public administration efficiency: Government effectiveness (WB Governance Indicators); Number of days to obtain business licenses; Number of hours to comply with tax rules.
  - Pension reforms (quantitative): Change in net pension wealth; Gross/net replacement rates.
  - Research and innovation (quantitative): Financial support for private R&D.
- Integration (EU) indicators:
  - Single market in goods and services: EC Single Market Scoreboard; Consumer market scoreboard.
  - Energy Union: EC’s energy internal market indicators; Number of interconnections of electricity networks.
  - Digital Single Market: EC’s Digital Agenda scoreboard and the Digital Economy and Society Index.

### Proposal 2 — Making more effective use of EU authority
- Legislative approach:
  - Directives and Regulations specifying concrete targets have a good track record in achieving outcomes.
  - Area-wide benchmarks could be implemented via EU legislation where political consensus exists and competence allows.
- Advantages of legislation:
  - Stronger enforcement powers than coordination mechanisms.
  - Harmonizes practices and laws to complete the Single Market.
  - Strengthens national governments’ hand against local vested interests and promotes investor confidence.
  - Outcome-based legislation can foster buy-in by clarifying expectations and enabling evenhanded sanctions.
- Table 2 illustrative exact targets (selected examples):
  - Late Payment Directive: Harmonize the time for public authorities to pay businesses to 30 days (60 days if exceptional circumstances), and for businesses to pay other businesses to 60 days (unless agreed otherwise).
  - Deposit Guarantee Scheme (DGS) Directives: Increase minimum protection for bank deposits to €100,000. Reach a target level for ex ante funds of DGS of 0.8% of their covered deposits (i.e., about €55 billion) to be reached within 10 years (4 year extension in exceptional circumstances).
  - Renewable Energy Directive: At least a 20 % share of energy from renewable sources in EU gross final consumption of energy in 2020.
  - Clean Power for Transport package: Common technical specifications for recharging and refueling stations.
  - Connected Continent package: Roaming Regulation: Maximum tariffs for calls, texts, and data downloads.
- Limits and trade-offs:
  - Legislation may not be appropriate for every reform; selection depends on policy area and EU competence.
  - Political consensus is required; non-euro area countries may resist measures perceived as extending EMU governance.
- Policy coordination with more teeth:
  - CSRs could focus on country-specific intermediate benchmarks measuring progress toward area-wide benchmarks.
  - EC already rates progress under CSRs on a five-category scale (no/limited/some/substantial progress, or fully implemented); a public summary dashboard could summarize scores toward benchmarks.
- Timing and legal constraints:
  - Reforms should be encouraged in good times; sanctions may lack credibility in downturns.
  - Extending EU powers to sanction countries under the preventive arm of the MIP, or making CSRs legally binding, could simplify the framework but may conflict with the principle of “proportionality” absent Treaty change.
  - In the absence of Treaty change, the EC could take progress toward CSR structural benchmarks into consideration when triggering the EIP.
- Transparency and accountability:
  - Greater powers should be accompanied by greater ex post accountability to address the perceived “democratic deficit.”
  - The Chief Economic Analyst (CEA) reviews EC’s application of rules ex ante but reports are addressed only to Commissioners and are not public.
  - Consider establishing an independent evaluation process governed by the Parliament with a presumption of publication of assessments and reviews.

### Proposal 3 — Strengthening financial incentives
- Budgets and incentives:
  - Member state and EU budgets can mitigate distributive effects of reforms, offset short-term economic costs, and facilitate political consensus.
  - Evidence: reformists more likely to be re-elected when mechanisms soften adverse consequences, including efficient social safety nets.
- Making full use of SGP flexibility:
  - The EC could identify ex ante which reforms—out of CSR benchmarks measuring national progress toward area-wide goals—could qualify for SGP flexibility; an ex ante list would focus discussion on implementation.
  - Costing estimates and historical examples:
    - “A 1 percentage point cut in the tax wedge is, on average, associated with a revenue loss of 0.3 percent of GDP per year (IMF, 2014b, Figure 8.1).”
    - Active labor market policies (ALMP) during reform episodes have cost, on average, about 1 percent of GDP (Figure 8.2).
  - Safeguards: countries could pre-commit to binding compensatory fiscal measures in a multi-year framework if agreed structural reforms are not implemented or expected returns do not materialize (example: Italy's 2015 budgetary plans used such “safeguard” clauses).
- Use of EU funds and transfers:
  - Direct financial transfers from the EU could help cover costs and support reforms, but scope is limited as common agricultural policy and structural funds absorb more than 70 percent of the EU budget.
  - ESI funds could be better prioritized and linked more closely to benchmarks to support priority reforms; proceeds from financial sanctions could conceivably be recycled as EU financial transfers to support reforms.
  - Access to ESI funds could be leveraged by making it conditional on reforms; economic governance conditionality for ESI funds became operational in 2015.
  - Where possible, an immediate suspension of payments rather than commitments would be more effective.
  - A substantially expanded EU budget—funded by a dedicated revenue stream—might provide direct fiscal transfers to incentivize and support structural reforms, especially for smaller states; the idea of a common euro area fiscal capacity was discussed but lacked political traction.
- Technical support and capacity building:
  - Technical support could help euro area countries facing absorptive and administrative hurdles (e.g., inability to attract expertise to manage implementation).
  - Support could include voluntary technical assistance, EU-wide knowledge hubs, or direct funding for experts.
  - Examples: Portugal’s tax administration improvement after revamping top management; technical assistance under the Youth Guarantee Scheme; the “Structural Reform Support Service.”
- Enforcement, transparency, and conditionality:
  - Make non-compliance more costly by including provisions for non-interest bearing deposits for failure to comply with the EIP, with repeated offenses triggering enhanced conditionality-based EU monitoring.
  - Increase transparency and benchmarking to raise likelihood of penalties being used and improve incentives to reform.
  - Extract binding, public, high-level commitments from countries on achieving reform benchmarks; presume penalties upon failure to meet agreed outcomes unless waivers are fully transparent and subject to a “comply-or-explain” process.

### Box 2 — Structural Reforms and the SGP (selected points)
- Structural reform clause:
  - Under the preventive arm of the SGP, the Council and the EC should take into account implementation of structural reforms with verifiable long-term fiscal impact when assessing progress toward the MTO.
  - In January 2015 guidance, countries can secure SGP flexibility for major planned reforms that are “well specified” and have “credible timelines.”
  - Under the preventive arm, a maximum deviation from the MTO of 0.5 percent of GDP is allowed, provided this deviation can be made up within four years.
  - Under the corrective arm, deadlines to meet the 3 percent of GDP deficit target can be extended.
- Fiscal costs and offsets—examples and ranges:
  - Direct fiscal cost ranges for accompanying measures: 0.1−0.25 percent of GDP in France to 1 percent of GDP in Denmark.
  - Finland: 0.8 percent of GDP in higher spending on ALMPs in 1992 to facilitate reduction of employment protection during the same year.
  - Sweden: about 1 percent of GDP of upfront spending to reduce its labor tax wedge during 2007–10.
  - Australia: A$6.7 billion (0.1 percent of GDP) to states conditional on commitments to increase skill levels in 2009–2013.
  - Germany: federal government to provide about €14 billion (0.1 percent of GDP, or 0.35 percent of general government outlays) to the länder and municipalities during 2015–2017 to support infrastructure investment, education and research.
  - United States: federal transfers to states totaled 3.3 percent of GDP in FY 2014 (grants to state and local governments, excluding direct spending by the federal government in states, or taxes paid by state residents to the federal government).
- Options to improve SGP flexibility and incentives (near-term procedural and design options):
  - Extend the 0.5 percent of GDP fiscal space for structural reforms to countries under the corrective arm (i.e., to all countries) to simplify and clarify procedures and focus discussion on reform implementation rather than applicability of flexibility provisions.
  - Provide SGP flexibility on a post hoc basis for reforms by the EC, complemented by outcome-based specifications of reforms.
  - Permit a broader category of reforms under the framework, including targeted compensation for those affected by reforms.
  - Allow countries with good track records additional fiscal space to implement more ambitious reforms, accompanied by safeguards for fiscal framework integrity.
- Use of EU funds and transfers:
  - ESI funds should be better prioritized and linked to benchmarks; proceeds from sanctions could be recycled to support reforms.
  - Economic governance conditionality for ESI funds became operational in 2015 and reprogramming/alignment to CSR benchmarks should be used to strengthen incentives.
- Enforcement and transparency:
  - Make non-compliance more costly (non-interest bearing deposits, enhanced conditionality-based monitoring).
  - Extract binding public commitments on achieving reform benchmarks with a presumption of penalties unless waivers are transparent and subject to “comply-or-explain.”
- Longer-term options:
  - Move toward a structural union with stronger EU engagement in reforms critical for EMU resilience.
  - Deeper governance reforms could require Treaty amendments if they expand EU role beyond “exclusive and shared competence.”
  - Complementary fiscal framework reforms (e.g., merging preventive and corrective arms of the SGP) could increase synergies between structural reform incentives and fiscal rules.

### Key policy recommendations (aggregate)
- Adopt area-wide, outcome-based benchmarks for priority reforms to increase specificity, transparency, and accountability.
- Use EU legislation (Directives/Regulations) where competence and political consensus allow to translate area-wide benchmarks into enforceable requirements.
- Better align SGP flexibility with credible, well-specified reform commitments and consider extending the 0.5 percent of GDP allowance to corrective-arm countries.
- Leverage ESI funds and reprogramming/suspension mechanisms to support and incentivize reforms; consider recycling proceeds from sanctions to fund reforms.
- Establish or strengthen National Productivity Councils to translate area-wide benchmarks into national plans, provide technical support, and monitor implementation.
- Increase transparency and independent ex post evaluation of EU governance and enforcement decisions to bolster legitimacy and democratic accountability.
- Provide targeted fiscal and technical support (ALMPs, compensation, capacity building) to ease political costs and absorption constraints of reforms.

*Source: IMF working paper content unit Box 1 and Box 2 excerpt from _wp15201 — “1. Financial Sanctions Within The Governance Framework.”*

### 1. Financial Sanctions Within The Governance Framework _______________________________ 15

### 1. Financial Sanctions Within The Governance Framework _______________________________ 15

### Overview
- Section title: "1. Financial Sanctions Within The Governance Framework"
- Page reference in source PDF: 15

### Related tables and figures listed in the document
- Tables:
  - Table 1. Possible Outcome-Based Benchmarks on Area-Wide Priority Reforms ____________________ 20
  - Table 2. Examples of Outcome-Based Directives and Regulations _______________________________ 24
  - Table 3. Alternative Specification of 2014 CSR Recommendations: Some Examples ________________ 26
  - Table 4. National Productivity Councils of Australia, Belgium, Germany and New Zealand: A Brief Summary _________________________________________________ 36
- Figures:
  - Figure 1. Euro Area Productivity ___________________________________________________________ 4
  - Figure 2. EU Governance Framework for Structural Reforms—An Illustration ______________________ 8
  - Figure 3. Europe 2020 Headline Indicators—Target Values and Progress Since 2008 ________________ 11
  - Figure 4. Country Compliance with CSRs __________________________________________________ 12
  - Figure 5. Progress Toward 2014 CSR Targets _______________________________________________ 13
  - Figure 6. Three Complementary Proposals for Strengthening the Governance of Structural Reforms: An Illustration _____________________________________________________________________ 16
  - Figure 7. Structural Reform Indicators: Distance to OECD Best Practice __________________________ 18
  - Figure 8. Direct Fiscal Costs of Reforms____________________________________________________ 29
  - Figure 9. Fiscal Costs of Measures Compensating Redistributive Effects of Labor Reforms ___________ 31
  - Figure 10. European Structural and Investment Funds _________________________________________ 33

### Document structure (selected)
- This section appears as the first numbered section in the PDF and precedes:
  - "2. Structural Reforms and the SGP" (page 28)

*Source: _wp15201 - 1. Financial Sanctions Within The Governance Framework _______________________________ 15*

### References _____________________________________________________________________ 38

### _wp15201 - References _____________________________________________________________________ 38

### I. WHY SHOULD THE EU INCENTIVIZE STRUCTURAL REFORMS IN THE EURO AREA?
- General consensus that structural reforms are needed to boost the euro area’s growth potential; medium-term growth potential has been declining despite cyclical recovery since late 2014.
- Labor productivity in the euro area has trailed the United States, especially in services and information technology.
- Crisis legacies—double-dip recession, protracted weak growth—led to persistently high and long-term unemployment and low private investment, eroding potential output.
- Productivity gaps within the monetary union, especially in service sectors, attributed to lagging product market reforms (Coeuré, 2014); sustained divergence could foster imbalances and adverse spillovers (Draghi, 2014).
- Estimated impact of closing part of the gap:
  - Closing 10−20 percent of the distance to best practices in the OECD in product and labor markets could help raise euro area GDP by 3½ percent in 2019 compared to the baseline scenario (IMF, 2014a).  
- Political economy and implementation challenges:
  - Reforms perceived to have short-term economic and political costs; lack of popular support partly due to failure to implement comprehensive measures, diluting benefits and creating perceptions of unfairness (Coeuré, 2014).
  - Widespread view that market pressures are a primary motivator for structural reforms; improved financial market conditions could reduce perceived urgency for reforms.
- Rationale for EU involvement:
  - Gap between need and will for structural reforms; EU best positioned to assess member states’ flexibility and resilience to shocks and to help ensure sustained real convergence.
  - European governance context: 2012 Four Presidents’ Report partially implemented; Five Presidents’ report (Juncker et. al, 2015) renews focus on promoting real convergence.
- Scope of paper:
  - “Structural reforms” defined broadly across economic areas affected by economic governance framework.
  - Focus on improving governance framework; prioritization of specific structural reform policies left for future work.
  - Paper structure: Section II – stock of structural reform provisions; Section III – effectiveness of existing modalities; Section IV – near-term improvements; Section V – longer-term governance changes.

*Acknowledgements excerpt: Thanks to Mahmood Pradhan, Kenneth Kang, Shekhar Aiyar, Helge Berger, Christian Mumssen, and Rishi Goyal (European Department, IMF); and Isabel Grilo, Alessandro Turrini, Emmanuelle Maincent, and Marion Perelle (European Commission). Research and administrative assistance from Jesse Siminitz and Katherine Cincotta.*

### II. A COMPLEX FRAMEWORK
- European Semester strengthened coordination but proliferation of “packs”, “pacts”, “procedures” and reporting has blurred rationale and effectiveness (Five Presidents’ Report).
- EU institutions have a limited mandate to enforce structural reforms; Treaty on the Functioning of the European Union sets areas of “exclusive” and “shared” competence (Articles 3–6), leaving scope for interpretation and fewer enforcement tools over structural reforms.
- Treaty powers include adopting guidelines/arrangements for member state coordination and guiding, coordinating and supplementing member state actions in certain areas.
- Governance tools (apply in principle to all EU countries, with exceptions noted):
  - EU secondary legislation: Regulations, Directives, Decisions.
    - Regulations: directly enforceable in their entirety; imply unification of rules.
    - Directives: aim at harmonization; bring national laws in line with specified objectives while leaving discretion on speed and process.
  - Economic policy coordination: European Semester (since 2011) — common annual surveillance cycle based on national reform and stability/convergence programs; coordination based on Articles 121 and 148 and Integrated Guidelines; strengthened by Six-pack and Two-pack legislation.
    - Country-Specific Recommendations (CSRs): annual EC assessment leading to CSRs across product markets, R&D and innovation, employment and social policies, public administration and finances, and financial sector; Council discusses/recommends CSRs adding peer pressure.
    - Macroeconomic Imbalance Procedure (MIP): seeks to reduce macroeconomic imbalances.
      - Preventive arm: imbalances considered when formulating CSRs.
      - Corrective arm (Excessive Imbalance Procedure, EIP): severe imbalances can lead to EIP requiring submission of a corrective action plan (CAP) with roadmap and deadlines; for euro area countries, non-compliance can lead to financial sanctions up to 0.1 percent of GDP per year.
  - Stability and Growth Pact (SGP): fiscal framework recognizes role of structural reforms in achieving sound budgetary positions; fiscal governance can incentivize structural reform implementation.
  - Enhanced cooperation: subset of EU countries may adopt common legislation (min 9 countries) in policy areas not of exclusive competence; must align with Treaty objectives and other EU law.
- Complexity drivers:
  - Range of enforcement tools and overlapping processes.
  - Interaction with SGP complicated by Six-pack and Two-pack legislation and intergovernmental frameworks (Euro Plus Pact, Fiscal Compact).
- Note on exceptions:
  - Non-euro area countries cannot be sanctioned under the MIP; MIP does not apply to countries receiving support under financial assistance programs.

### III. THE CURRENT FRAMEWORK: HOW EFFECTIVE?
- Overall assessment: Complexity has blunted effectiveness — communication challenges, diluted accountability and ownership, perceptions of EU intrusiveness, and lack of level playing field; some aspects worked better than others.

A. EU Legislation Has Been Effective
- Legislation is a potent enforcement mechanism where EU has “exclusive” or “shared” competencies or provides coordination arrangements; cannot adopt legally binding legislation in areas where powers are limited to coordination unless necessary for Single Market functioning.
- Enforcement via infringement procedures and eventual fines for non-compliant member states.
- Empirical indicators:
  - More than 99 percent of Internal Market Directives have been transposed into national law (European Commission, 2014b).
  - Upwards of 85 percent of infringement cases typically settled due to corrective actions before ECJ.
  - Progress toward Europe 2020 goals appears stronger in areas with legally binding targets specified in Directives (energy, climate) versus areas without legally binding targets (employment, poverty).
- Limitations:
  - Legislation not a silver bullet; Services Directive fully transposed by 2012 but constrained in promoting cross-border trade in services and labor mobility due to persisting legal/administrative barriers limiting portability of welfare rights and access to regulated professions.

B. EU Policy Coordination: Mixed Success
- Newness of framework and limited testing of MIP complicate evaluation; market pressure also confounds attribution.
- European Commission (2014a) notes stronger progress than under Lisbon process; European Semester improved surveillance; peer review in CSRs strengthened debate.
- Notable successes: Italy and Spain implemented measures to improve SME access to finance in 2014 in line with CSRs.
- EC’s assessment of compliance:
  - For 2012 and 2013, only around 10 percent of all CSRs were fully or largely implemented, although there was “substantial or some progress” on more than half of CSRs (Deroose and Griesse, 2014).
  - Averaging EC qualitative evaluations indicates compliance with CSRs seems to have fallen in 2014 compared to 2013.
- Factors impeding traction:
  - Political costs of reforms and opposition from vested interests; reform fatigue; lack of national ownership; lack of appetite for deeper integration.
  - Limited incentives for member states to pressure peers, especially where cross-border implications unclear; countries may avoid peer pressure to avoid reciprocal pressure.
  - EU enforcement powers not sufficiently strong or preemptive: CSRs not legally binding; EU can recommend, monitor, assess, warn, and recommend sanctions but cannot compel compliance except under defined sanctioning processes.
  - EC discretion in opening EIP has been exercised cautiously; EIP has never been opened despite diagnoses of excessive imbalances in several countries (Spain and Slovenia (2013); Italy, Croatia, and Slovenia (2014); Bulgaria, France, Croatia, Italy, and Portugal (2015)).
    - Instead, EC used enhanced “specific monitoring” with bi-annual missions and reporting.
  - Under SGP few precedents of EC proposing “no effective action.” Semi-automatic sanctions have not produced actual sanctions to date, though the prospect may have incentivized action.
- Additional notes:
  - MIP not fully tested as smaller imbalanced economies were outside its scope until recent graduation from financial programs.
  - EC reports significant progress in urgent post-crisis areas (financial sector, insolvency, pension reforms) but less in service sector and some product market reforms.

### IV. THREE PROPOSALS TO STRENGTHEN INCENTIVES
- Overarching aim: improve traction of EU governance framework to better incentivize implementation of structural reforms, while respecting current jurisdictional boundaries (assuming no imminent Treaty change).
- Proposals need to:
  - Improve member state ownership of reforms.
  - Help alleviate political costs of reforms.
  - Reduce excessive discretion in enforcement under current framework.
- Contextual quote: “... closer coordination of economic policies is essential to ensure the smooth functioning of the Economic and Monetary Union ... [there is a need to] develop concrete mechanisms for stronger economic policy coordination, convergence and solidarity.” EU Summit, October 2014
- Design constraints: EU likely more effective champion for reforms serving broader monetary union interests; proposals to foster structural reforms must be implementable without Treaty change and must address challenges identified in previous sections.

*Source: Excerpt from the IMF working paper _wp15201 - References _____________________________________________________________________ 38 (text sections I–IV).*

### Box 1. Financial Sanctions Within the Governance Framework

### Box 1. Financial Sanctions Within the Governance Framework

### Enforcement provisions and instruments
- Semi-automatic sanctions exist in the framework but provisions vary across instruments.
- EIP:
  - For euro area countries under the EIP, financial sanctions can be applied for an insufficient CAP or non-compliance with actions included in the CAP.
  - If the EC recommends sanctions, the Council considers the decision on the basis of reverse qualified majority voting (RQMV), i.e., sanctions can be applied semi-automatically.
- SGP flexibility and EDP:
  - Failure to implement structural reforms agreed under the SGP can lead to sanctions as well as suspensions of European Structural and Investment (ESI) funds under the EDP.
  - Under the SGP’s preventive arm, countries can receive a warning and ultimately a financial sanction in the form of an interest-bearing deposit (Council decision by RQMV) if the failure to implement structural reforms under SGP flexibility results in a significant deviation from the medium-term objective or the path towards it.
  - Under the corrective arm, such a failure could be considered an aggravating factor when assessing effective action, leading to stepped-up procedures with a temporary suspension of parts of ESI funds (RQMV decision for the adoption of the first sanction).
  - Persistent non-compliance could to lead to financial sanctions of up to 0.7 percent of GDP for euro area countries.
- ESI funds (2014–2020 programming period):
  - ESI funds are more closely aligned with structural reform priorities and countries are encouraged to program the use of ESI funds to support the implementation of CSRs.
  - Since 2015, ESI funds can be reprogrammed at the EC’s request and may be suspended for failure to take effective action under the EDP and/or the EIP.
  - The EC is legally obliged to propose suspension of payments or commitments if the conditions for suspension are met. Payments are only suspended in case of significant non-compliance and if immediate action is sought.

### Three complementary proposals to strengthen governance (overview)
- The three proposals: “outcome-based” structural reform benchmarking; better use of existing EU processes; and improving incentives.
- Pros:
  - May not necessarily require Treaty changes.
  - Derived from cross-country evidence of what has worked well so far, including in the EU.
  - Would simplify the operation of the current framework without adding additional layers of bureaucracy.
  - Would ensure greater specificity, transparency, and consensus in setting the reform agenda, improving accountability and traction, reducing excessive discretion, leveling the playing field, and providing member states support for politically difficult actions.
- Cons:
  - May encounter political and operational hurdles, but these are described as not insurmountable.
  - The Five President’s Report (Juncker et al., 2015) contains similar proposals, seen as an important step toward broader political consensus.
- Recommendation:
  - Greater clarity and simplicity in the current EU governance framework is desirable; where simplification does not require Treaty changes, implementation should start.

### Proposal 1: Shifting to “Outcome-based” Benchmarks on Area-wide Priorities
- Rationale and heritage:
  - Benchmarking dates back at least to December 2003 when the EU Council adopted a shortlist of 14 structural indicators.
  - OECD’s Going for Growth reports have relied on cross-country comparisons for a decade.
  - Recent advocacy for greater specificity: Padoan and Schäuble (2014), Dijsselbloem (2015), Juncker et al. (2015), Draghi (2014).
- Definition:
  - “Outcome-based” benchmarks focus on measures of reform outcomes that are concrete, measurable, and directly under policymakers’ control.
- Which reforms to benchmark:
  - Reforms that allow member states to thrive independently within the monetary union: increase growth, competitiveness and productivity, improve efficiency of public administration, reduce national vulnerabilities.
  - Reforms that complete the Single Market to improve resilience and foster convergence: flexibility in factor markets, greater private sector risk-sharing.
  - Examples: common energy market, integration of services markets, digital networks, harmonizing/reducing cost of doing business, reducing time to enforce contracts.
- Institutional path:
  - Area-wide benchmarks would need political legitimacy from the Council and the European Parliament.
  - Legally easier in “exclusive” and “shared” competence areas; scope for specificity even where EU role is coordination.
- Advantages of outcome-based benchmarking:
  - Simpler and more specific reform agenda; increased transparency and accountability.
  - Greater ownership and buy-in: member state involvement in setting benchmarks, collective commitment, leeway on implementation and timelines.
  - Evenhanded effective enforcement: clearer cross-country comparability, reduced EC discretion, increased accountability, leveled playing field.
  - Enhanced credibility: allows semi-automatic sanctions to work, provides early warning and scope for pre-emptive action.
- Challenges:
  - Determining and quantifying appropriate benchmarks may be difficult; indicators must be measurable, realistic, enforceable, under policymakers’ control, and closely linked to objectives.
  - Some areas less amenable to measurement and may involve judgment and subjectivity, but prior collective agreement on methodology can mitigate this.
- Examples illustrating operationalization:
  - Simple case (France CSR 2014): original recommendation to “simplify companies' administrative, fiscal and accounting rules … by December 2014.” Outcome-based approximation: “reduce the time it takes for a company to comply with tax rules to x hours” or “make electronic tax filing mandatory.”
  - Complex case (employment rate targets): employment rates affected by confounding factors; more enforceable targets could be labor tax wedge or labor market duality (e.g., “reduce labor tax wedge or labor market duality to x percent in y years”).
- Use of existing indicators and data:
  - Structural reform indicators already used by EU and multilateral institutions could be a starting point.
  - EC uses similar benchmarks for technical analysis (e.g., Monteagudo et al., 2012 uses WBDB).
  - Some indicators produced infrequently may need more frequent production by the EU.
- Translating benchmarks into national policies:
  - National productivity councils (NPC) could provide ex ante support to translate area-wide targets into national action plans, monitor implementation, and propose amendments.
  - NPCs should ensure operational independence, accountability, strong public presence, and adequate resources.
  - Some EC participation in NPCs could facilitate cross-border policy discussion.

### Illustrative indicators and benchmarks (selected entries from Table 1 and Figure references)
- Productivity and Market Flexibility (National)
  - Labor market flexibility (qualitative): OECD Employment Protection Index; nature of collective bargaining agreements.
  - Labor market flexibility (quantitative): Labor tax wedge; Share of involuntary temporary contracts; Unemployment and inactivity “traps”; Benefit replacement rates; Ratio of minimum to median wages; Collective bargaining agreement coverage.
  - Improving the business environment (qualitative): Global Competitiveness (GC) indicators of quality of institutions, infrastructure, technological readiness; Transport network density; WBDB (e.g., number of days to enforce a contract or complete insolvency proceedings).
  - Product market flexibility (qualitative): OECD Product Market and Network Regulation Indicators; GC indicators of goods market efficiency; Tariff and non-tariff barriers; EU Single Market Scoreboard indicators; Barriers to cross-border flow of services.
  - Product market flexibility (quantitative): Measures of market concentration (e.g., Herfindahl-Hirschman Index); Cost of starting a business (component of WBDB); EU Justice Scoreboard.
  - Public administration efficiency (qualitative): Government effectiveness (WB Governance Indicators); GC indicators of wastefulness of government spending; Use of electronic government.
  - Public administration efficiency (quantitative): Number of days to obtain business licenses; Number of hours to comply with tax rules; WBDB indicators; EU Justice Scoreboard.
  - Pension reforms (quantitative): Change in net pension wealth; Gross/net replacement rates.
  - Modernizing social protection (quantitative): Health expenditure; Net costs of childcare.
  - Research and innovation (quantitative): Financial support for private R&D.
- Integration (EU) indicators
  - Single market in goods and services (qualitative): Consumer market scoreboard (EC consumer evaluations); EC Single Market Scoreboard; Postal services (prices and transit times).
  - Energy Union (quantitative/qualitative): EC’s energy internal market indicators; Number of interconnections of electricity networks.
  - Digital Single Market (qualitative/quantitative): Efficiency of digital market (survey data); EC’s Digital Agenda scoreboard and the Digital Economy and Society Index.
- Figure 7 references cross-country structural reform indicators (Labor Tax Wedge, 2014; Retail Trade Regulation, 2013; Time to Enforce a Contract, 2014; Burden of Tax Compliance, 2014) and suggests benchmarking against regional and global best practices.

### Proposal 2: Making More Effective Use of EU Authority
- Legislative approach:
  - Directives and Regulations specifying concrete targets have a good track record in achieving outcomes.
  - For priority reforms, area-wide benchmarks should be implemented via EU legislation where political consensus exists and competence allows.
  - Legislation can be used in “exclusive” and “shared” competence areas and can also be used where the EU has power to coordinate.
- Advantages of legislation:
  - Stronger enforcement powers than coordination mechanisms because legislation must be implemented.
  - Helpful in harmonizing practices and laws to complete the Single Market.
  - Strengthens national governments’ hand against local vested interests and promotes investor confidence.
  - Outcome-based legislation can foster buy-in by clarifying expectations and enabling evenhanded sanctions.
- Table 2 examples of outcome-based Directives/Regulations (selected entries with exact targets):
  - Late Payment Directive: Harmonize the time for public authorities to pay businesses to 30 days (60 days if exceptional circumstances), and for businesses to pay other businesses to 60 days (unless agreed otherwise).
  - Deposit Guarantee Scheme (DGS) Directives: Increase minimum protection for bank deposits to €100,000. Reach a target level for ex ante funds of DGS of 0.8% of their covered deposits (i.e., about €55 billion) to be reached within 10 years (4 year extension in exceptional circumstances).
  - EU energy package: Renewable Energy Directive: At least a 20 % share of energy from renewable sources in EU gross final consumption of energy in 2020.
  - Clean Power for Transport package: Common technical specifications for recharging and refueling stations.
  - Connected Continent package: Roaming Regulation: Maximum tariffs for calls, texts, and data downloads.
- Limits and trade-offs:
  - Legislation may not be appropriate for every reform; choice depends on policy area and EU competence.
  - Examples: insolvency regimes could be addressed by Regulation, Recommendation, or Directive depending on jurisdictional and political constraints.
  - Legislation requires political consensus and may be resisted by non-euro area countries.
- Policy coordination with more teeth:
  - CSRs could focus on country-specific intermediate benchmarks measuring progress toward area-wide benchmarks.
  - Past CSRs (until 2014) on average comprised between 4–8 major recommendations per country with several sub-recommendations; CSRs were streamlined in 2015.
  - EC already rates progress under CSRs on a five-category scale (no/limited/some/substantial progress, or fully implemented); a public summary dashboard could summarize scores toward benchmarks.
- Timing and legal constraints:
  - Reforms should be encouraged in good times; sanctions may lack credibility in downturns.
  - Extending EU powers to sanction countries under the preventive arm of the MIP, similar to the SGP, and making CSRs legally binding could simplify the framework but may violate the principle of “proportionality” absent Treaty change.
  - In the absence of Treaty change, the EC could take progress toward CSR structural benchmarks into consideration when triggering the EIP.
- Transparency and accountability of EU institutions:
  - Greater powers should be accompanied by greater ex post accountability to address the perceived “democratic deficit.”
  - The Chief Economic Analyst (CEA) reviews EC’s application of rules ex ante but reports are addressed only to Commissioners and are not public.
  - Consideration of an independent evaluation process governed by the Parliament with a presumption of publication of assessments and reviews; evaluation should be independent of the EC and arm’s length from the Council and Parliament.

### Proposal 3: Strengthening Financial Incentives
- Role of budgets and incentives:
  - Member state and EU budgets can mitigate distributive effects of reforms, offset short-term economic costs, and facilitate political consensus.
  - Evidence cited: reformists more likely to be re-elected when mechanisms soften adverse consequences, including efficient social safety nets.
- Making full use of SGP flexibility:
  - The EU should make full use of SGP flexibility while safeguarding the fiscal framework; “outcome-based benchmarking” can support this.
  - EC could identify ex ante which reforms—out of CSR benchmarks measuring national progress toward area-wide goals—could qualify for SGP flexibility. An ex ante list would focus discussion on implementation rather than identification of reforms.
  - Costing estimates could be based on historical experiences and cross-country estimates:
    - Prior research suggests a 1 percentage point cut in the tax wedge is, on average, associated with a revenue loss of 0.3 percent of GDP per year (IMF, 2014b, Figure 8.1).
    - Active labor market policies (ALMP) during reform episodes have cost, on average, about 1 percent of GDP (Figure 8.2).
  - To safeguard the integrity of the SGP, countries could pre-commit to binding compensatory fiscal measures in a multi-year framework if agreed structural reforms are not implemented or expected returns do not materialize. Such "safeguard" clauses have been used in Italy's 2015 budgetary plans.
  - Medium-term expenditure frameworks with rolling horizons are discussed as a complementary fiscal tool.

*Source: IMF Staff. (Content unit: Box 1. Financial Sanctions Within the Governance Framework)*

### Box 2. Structural Reforms and the SGP

### Box 2. Structural Reforms and the SGP

### Structural reform clause and recent guidance
- The structural reform clause under the preventive arm of the SGP requests the Council and the EC to take into account the implementation of structural reforms which have a verifiable impact on the long-term sustainability of public finances when assessing progress toward the medium-term budgetary objective (MTO).
- Under the corrective arm of the SGP, the EC can take into account structural reforms when recommending or extending a deadline for the correction of an excessive deficit.
- The 2011−13 governance reforms enhanced links between the fiscal and structural reform frameworks:
  - Countries under the Excessive Deficit Procedure (EDP) must present an Economic Partnership Program, outlining structural reforms for a durable correction of the deficit.
  - Countries receiving EU financial assistance prepare a Macroeconomic Adjustment Program that also includes structural reforms.
- In January 2015, the EC provided guidance on applying the built-in flexibility in the SGP for structural reforms:
  - Countries can secure SGP flexibility for major planned reforms with long-term positive budgetary impact that are “well specified” and have “credible timelines.”
  - Under the preventive arm, a maximum deviation from the MTO of 0.5 percent of GDP is allowed, provided this deviation can be made up within four years.
  - Under the corrective arm, the deadlines to meet the 3 percent of GDP deficit target can be extended.

### Fiscal costs, offsets, and examples
- The budget can support reforms that do not have a direct and measurable effect on the budget by allowing flexibility to provide compensation or temporary incentives to facilitate implementation.
- Examples and estimated fiscal costs cited in the text:
  - Direct fiscal cost ranges for accompanying measures: 0.1−0.25 percent of GDP in France to 1 percent of GDP in Denmark (Beetsma and Debrun, 2004).
  - Finland: 0.8 percent of GDP in higher spending on ALMPs in 1992 to facilitate reduction of employment protection during the same year.
  - Sweden: about 1 percent of GDP of upfront spending to reduce its labor tax wedge during 2007–10.
  - Australia: the federal government provided A$6.7 billion (0.1 percent of GDP) to states conditional on commitments to increase skill levels in 2009–2013.
  - Germany: federal government to provide about €14 billion (0.1 percent of GDP, or 0.35 percent of general government outlays) to the länder and municipalities during 2015–2017 to support infrastructure investment, education and research.
  - United States: federal transfers to states totaled 3.3 percent of GDP in FY 2014 (grants to state and local governments, excluding direct spending by the federal government in states, or taxes paid by state residents to the federal government).
- Reforms can impose short-term fiscal costs (e.g., more generous unemployment benefits, ALMP spending, tax incentives) even when they generate long-term gains; OECD evidence suggests sizeable lags in realizing growth dividends (e.g., a comprehensive reform package in France would take 5–10 years to have a sizeable impact on potential growth and generate noticeable fiscal space).

### Options to improve SGP flexibility and incentives
- Near-term procedural and design options:
  - Extend the 0.5 percent of GDP fiscal space for structural reforms to countries under the corrective arm (i.e., to all countries) to simplify and clarify procedures and focus discussion on reform implementation rather than applicability of flexibility provisions.
  - Provide SGP flexibility on a post hoc basis for reforms by the EC, complemented by outcome-based specifications of reforms.
  - Permit a broader category of reforms under the framework, including targeted compensation for those affected by reforms (e.g., limited tax incentives to accelerate balance-sheet restructuring by banks and corporations).
  - Allow countries with good track records additional fiscal space to implement more ambitious reforms (more fiscal space and/or a longer time to offset fiscal costs), accompanied by safeguards for fiscal framework integrity.
- Use of EU funds and transfers:
  - Direct financial transfers from the EU could help cover costs and support reform, but scope is limited as common agricultural policy and structural funds absorb more than 70 percent of the EU budget.
  - ESI funds could be better prioritized and linked more closely to benchmarks to support priority reforms; proceeds from widely applied financial sanctions could conceivably be recycled as EU financial transfers to support reforms.
  - Access to ESI funds could be leveraged more effectively by making it conditional on reforms; economic governance conditionality for ESI funds became operational in 2015 and the EC should use reprogramming and alignment to CSR benchmarks to strengthen financial incentives for reform.
  - Where possible, an immediate suspension of payments rather than commitments would be more effective.
  - A substantially expanded EU budget—funded by a dedicated revenue stream, for example—might provide direct fiscal transfers to incentivize and support structural reforms, especially for smaller states; the idea of a common euro area fiscal capacity was discussed but lacked political traction.
- Technical support and capacity building:
  - Technical support from the EU could help euro area countries facing absorptive and administrative hurdles (e.g., inability to attract expertise to manage implementation). Support could include voluntary technical assistance, EU-wide knowledge hubs, or direct funding for experts.
  - Examples: Portugal’s tax administration improvement after revamping top management; technical assistance under the Youth Guarantee Scheme; the recently announced “Structural Reform Support Service.”
- Enforcement, transparency, and conditionality:
  - Make non-compliance more costly by including provisions for non-interest bearing deposits for failure to comply with the EIP, with repeated offenses triggering enhanced conditionality-based EU monitoring.
  - Increase transparency and benchmarking to raise likelihood of penalties being used and improve incentives to reform.
  - Extract binding, public, high-level commitments from countries on achieving reform benchmarks; presume penalties upon failure to meet agreed outcomes unless waivers are fully transparent and subject to a “comply-or-explain” process.

### Longer-term governance and institutional options
- Medium-term objective: move toward a structural union with stronger EU engagement in reforms that are critical for EMU resilience.
- Deeper reforms of the governance framework should build on near-term principles:
  - Greater clarity and specificity in setting the reform agenda.
  - Clearer division of labor between the EU and member states.
  - Greater EU say in a broader set of reforms critical for the monetary union.
  - Less discretion in assessing compliance with benchmarks but more flexibility in how benchmarks are achieved.
  - Larger financial incentives for reform, including under the SGP.
- Such changes may require Treaty amendments if they expand the EU’s role beyond areas of “exclusive and shared competence,” though political consensus could enable progress without a Treaty change in some areas.
- Complementary fiscal framework reforms (e.g., merging preventive and corrective arms of the SGP) could increase synergies between structural reform incentives and fiscal rules while reducing overlap and complexity.
- Near-term improvements to make the current framework function better:
  - Increase ownership via collective political commitment to area-wide reforms (factor market reforms; efficiency of public administration).
  - Strengthen incentives via greater specificity, outcome-based benchmarking, transparency, and accountability.
  - Provide stronger and evenhanded support for reforms, simplify the framework, enable dynamic ex ante experimentation with reforms by NPCs, and require independent ex post evaluation of governance framework implementation.

*Source: _wp15201 - Box 2. Structural Reforms and the SGP_; canonical source URL: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15201.pdf*

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