European Politicians Introduced the “Stability and Growth Pact” (SGP) in 1997 in order to “Manage the Commons”; However, the Regulation of the Commons Failed

These tragic incentives stem from the unique institutional setup in the EMU [European Monetary Union]: one central bank. These incentives were not unknown when the EMU was planned. The Treaty of Maastricht (Treaty on the European Union), in fact, adopted a no-bailout principle (Article 104b) that states that there will be no bailout in case of fiscal crisis of member states. Along with the no bailout clause came the independence of the ECB. This was to ensure that the central bank would not be used for a bailout.

But political interests and the will to go on with the Euro project have proven stronger than the paper on which the no bailout clause has been written. Moreover, the independence of the ECB [European Central Bank] does not guarantee that it will not assist a bailout. In fact and as we have seen, the ECB is supporting all governments continuously by accepting their government bonds in its lending operation. It does not matter that it is forbidden for the ECB to buy bonds from governments directly. With the mechanism of accepting bonds as collateral it can finance governments equally well.

There was another attempt to curb the perverse incentives of incurring in excessive deficits. Politicians introduced “managed commons” regulations to reduce the external effects of the tragedy of the commons. The Stability and Growth Pact (SGP) was adopted in 1997 to limit the tragedy in response to German pressure. The pact permits certain “quotas,” similar to fishing quotas, for the exploitation of the common central bank. The quota sets limits to the exploitation in that deficits are not allowed to exceed three percent of the GDP and total government debt not sixty percent of the GDP. If these limits had been enforced, the incentive would have been to always be at the maximum of the three percent deficit financed indirectly by the ECB. Countries with a three percent deficit would partially externalize their costs on countries with lower deficits.

However, the regulation of the commons failed. The main problem is that the SGP is an agreement of independent states without credible enforcement. Fishing quotas may be enforced by a particular state. But inflation and deficit quotas of independent states are more difficult to enforce. Automatic sanctions, as initially proposed by the German government, were not included in the SGP. Even though countries violated the limits, warnings were issued, but penalties were never enforced. Politically influential countries such as France and Germany, which could have defended the SGP, violated its provisions by having more than three percent deficits from 2003 onward. With a larger number of votes, they and other countries could prevent the imposition of penalties. Consequently, the SGP was a total failure. It could not close the Pandora’s Box of a tragedy of the commons. For 2010, all but one member state are expected to violate the three percent maximum limit on deficits. The general European debt ratio to GDP is eighty-eight percent.

—Philipp Bagus, The Tragedy of the Euro, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2012), 108-110.