FISCAL DISCIPLINE AS A SOCIAL NORM THE EUROPEAN STABILITY PACT N 2007 22 Juillet 2007 Collection OFCE ANR n 2 Jean Paul FITOUSSI Francesco SARACENO Fiscal Discipline as a Social Norm The European Stability Pact Jean Paul Fitoussi Francesco Saraceno July 20 2007 Abstract This paper reviews the arguments for and against the Stability and Growth Pact signed by the countries of the Euro area We find the theoretical debate to be inconclusive as both externality and credibility arguments can be used to yield opposite and equally plausible conclusions We also argue that evidence in favour of a Pact like rule is scant We therefore suggest the view that the Stability Pact is a public social norm and that a country s adherence to that norm is in fact a response to the need to preserve reputation among the other members of the European Union Using this extreme but not implausible hypothesis we build a simple model similar in spirit to Akerlof s 1980 seminal paper on social norms and we show that reputation issues may cause the emergence of a stable but inferior equilibrium We further show that after the enlargement with a number of countries anxious to prove their soundness joining the club the problems posed by the pact social norm are likely to increase JEL Codes D63 D71 E62 E63 Keywords Stability Pact Fiscal Rules Fiscal Policy Social Norms Reputation Enlargement We thank Robert Solow for his thorough reading of a previous draft We also benefited of comments by Philippe Aghion Alberto Alesina Pierfederico Asdrubali Giorgio Basevi James Forder Anton Granik Roberto Perotti and participants to the Third Lectures on Macroeconomic Governance in the EMU Siena May 2006 Observatoire Fran ais des Conjonctures conomiques fitoussi sciences po fr Corresponding author Observatoire Fran ais des Conjonctures conomiques 69 Quai d Orsay 75007 Paris France francesco saraceno sciences po fr 1 Introduction This paper extends to public behaviour the framework introduced by Akerlof s 1980 seminal contribution on social norms Akerlof shows that social norms even when costly to follow for individuals may nevertheless persist if disobedience entails a loss of reputation We argue that public social norms may limit national governments ability to manoeuver when building and managing an economic and monetary union and yet survive because of reputation considerations More specifically the public social norm we consider in this paper is the Stability and Growth Pact SGP signed in 1997 by the countries participating in the European Monetary Union Social norms and their e ect on economic behaviour and outcomes have been investigated at length The essays collected by Hechter and Opp 2001a show the variety of definitions of norms and the disagreement among scholars about their emergence and persistence We do not intend to enter into this debate but rather we highlight some general characteristics of social norms in order to clarify our claim that the Stability Pact is one of them At the core of this literature is the observation that the need for social acceptance contributes to determine individual behaviour Social psychologists have long studied group behaviour and the tendency to conformity In a series of experiments Asch 1951 shows that members of a group even when capable of making the right choice when deciding in isolation tend to conform to group decision regardless of whether the decison is correct or not One of the explanations for group conformity e g Buchanan and Huczynski 1997 may be that groups establish social norms and punish deviation This set of findings serves as a justificatiion for Harsanyi s 1969 postulate that social recognition plays a role along with economic gain in determining the behaviour of economic agents In other words persons want to be rich and famous the and famous part of the expression not being redundant Akerlof 1980 p 753 The postulate helps in giving a general definition Regularity in behaviour is a norm if first members of the society generally conform to it second deviance is disapproved third the fact that most people conform to the norm helps to enforce it Pettit 1990 Such a definition has two important consequences The first is that agents may follow the social norm even when it is against their own economic interest if the gain in reputation or social esteem is su ciently large 1 What matters is a concern for reputation rather than an immediate impact on pri1 Contrary to the game theoretic literature that defines reputation as the coherence between ex ante and ex post behaviour reputation is equivalent to credibility the literature on social norms defines reputation in more general terms as the positive e ect on welfare coming from the acceptance by other members of the community 1 vate or social welfare The second and related consequence is that the norm does not necessarily originate within the sphere of investigation of economics scholars seem to agree on the fact that the emergence of social norms is case specific as on the socio historical conditions that led to it Hechter and Opp 2001b Thus when discussing the norm Stability Pact below we will give some reasons that may explain why that specific norm emerged in the first place The paper by Akerlof 1980 captures well the above mentioned discussion Firms fearing a loss of reputation are willing to pay a wage perceived as fair and higher than the market clearing one thus obtaining suboptimal profits on aggregate this causes involuntary unemployment Freely obeyed social norms may thus result in constraints on individual behaviour as well as in departures from the optimal equilibrium The fear of reputation losses may of course be justified on the ground of economic rationality For example in Akerlof competent workers aware of a firms s bad reputation would refrain from applying for a job in that firm In other words the presence of reputation in the utility function may be seen as the result of a meta maximization problem in which reputation serves as a means towards other ends Becker 1976 Nevertheless Elster 1989 warns against the temptation to think that norms are always disguised expressions or vehicles of self interest so that they can be treated as any other element in the utility maximization process He gives examples of norms that are hard to reconcile with self or common interest that are nevertheless obeyed2 Elster argues forcefully that to accept social norms as a motivational mechanism is not to deny the
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