Paul Taylor, a contributing editor at POLITICO, writes the “Europe At Large” column.
PARIS — Europe’s budget discipline rules, more honored in the breach than in the observance, are outdated, over-complicated and increasingly misguided.
The EU would do better to circumvent the Stability and Growth Pact in order to promote public investment in the green and digital economy, rather than waste energy trying to reform a complex legal framework that has always produced more good intentions than compliance.
Intended to curtail debts and deficits, the pact had to be suspended early in the COVID-19 pandemic, to allow governments to borrow and spend massively to support households and keep businesses on life support during the crisis. An escape clause allowing that emergency spending will remain in force this year and next.
What happens after that is up in the air. The Commission announced this month that the fiscal rules will be back in 2023. Brussels plans to hold consultations on how to reform the system later this year before making proposals to finance ministers.
“Consultations” understates the hardball negotiations that are coming. Influential figures such as Italian Prime Minister Mario Draghi, EU Economic and Monetary Affairs Commissioner Paulo Gentiloni and French Europe Minister Clement Beaune have all called for a comprehensive reworking of the rule book to support investment that raises growth, and to differentiate targets by country rather than imposing one-size-fits-all goals.
‘Paper tiger’
Unfortunately, the chances we’ll see a radical reform that draws lessons from what worked during the pandemic — as well as what didn’t during the eurozone debt crisis — are close to zero. The guardians of fiscal orthodoxy in northern Europe will not countenance it.
Anchored in the 1992 Maastricht Treaty that gave birth to the euro, the rules require governments to keep public debt below 60 percent of Gross Domestic Product and cap their budget deficit at 3 percent of GDP. The reasoning was: since the EU has a macro-economically tiny central budget, and no mechanism for redistributing wealth, each member state of the single currency must maintain sound public finances, to avoid harmful spillovers to its partners.
The 1997 Stability Pact, adopted under German pressure before the launch of the euro, was intended to give teeth to those limits. It provided for graduated sanctions culminating in heavy fines on countries that repeatedly miss the targets. They have never been applied despite serial breaches by southern European countries and have long since lost any credibility.
The whole debate, says economist Nicolas Veron of the Bruegel think-tank and the Peterson Institute for International Economics, is “a political theater of the absurd with no consequence.
“The lesson of the 22 years of the euro’s existence is that sanctions will never be activated and don’t serve as a deterrent even in extreme cases. Hence, all fiscal rules are a paper tiger,” he said.
Many economists argue that the Maastricht criteria were devised for a bygone era of climbing interest rates, inflation and growth. That’s no longer appropriate at a time when borrowing costs have shrunk, the European Central Bank is vacuuming up government bonds, inflation is durably low and growth potential has also declined. The treaty’s limits simply aren’t realistic today, with Italy’s national debt swollen from 130 to 160 percent of GDP during the pandemic, France’s and Spain’s from below 100 to 120 and Greece’s from 185 to 210 percent.
Changing the criteria, however, would require amending the EU treaties with the unanimous agreement of every EU government and parliament — unlikely given that defenders of EU fiscal discipline are loathe to abandon the most important weapon in their arsenal.
Irish Finance Minister Pascal Donohoe, who chairs the Eurogroup of finance ministers, has ruled out calls by experts — including former IMF chief economist Olivier Blanchard — to replace the pact with fiscal standards that set broad objectives tailored to each country, supervised by independent national fiscal boards, rather than enforced by the Commission or EU ministers.
Austrian model
Fortunately, there are changes that could be made without amending EU law, or painfully rewriting a treaty. For that, we can thank the Austrians.
In the 1990s Vienna found a way around the EU debt limits by setting up a state-owned company. Called ASFINAG, it exists to build and maintain Austrian motorways — a massive project with borrowing equivalent to about 5 percent of GDP. At the time, Austria was struggling to meet the criteria to join the euro, making any kind of spending a subject of nervous scrutiny.
But the company’s state-guaranteed borrowing on capital markets was not counted as public debt, because it was serviced by dedicated revenue streams, from truck tolls and an annual user fee for cars. ASFINAG even pays a small annual surplus to the state. Clever.
“It was created to circumvent the pact and allow investment,” recalls Franz Nauschnigg, the economist who helped devise the scheme. “It’s self-financing and gave us a very modern highway network much more cheaply that if you’d done it through public-private partnerships.”
Germany’s Bundesbank, a stickler for fiscal rectitude, challenged this off-balance-sheet borrowing vehicle at the EU Statistics Office. But Eurostat upheld the Austrian model’s exemption from the “general government debt” calculation. Berlin has since adopted a similar system for German motorway construction and maintenance via a company called Autobahn GmbH.
“You could do the same to fund public investment in smart energy grids, solar parks, trans-Mediterranean electricity cables or high-speed broadband,” said Nauschnigg, who has presented his ideas in Brussels, Paris, Berlin and Rome. “It could be done EU-wide, or by creating a system of national ASFINAGs which link together.”
The idea of bracketing more public investment out of budget constraints has gained traction in the campaign for September’s German elections, as politicians debate whether and when to reactivate the constitutional “debt brake” that severely limits government borrowing.
The Greens, running neck-and-neck with the conservative CDU/CSU in opinion polls, have proposed a €500 billion public investment fund for the transition to clean, renewable energy. The center-left Social Democrats, while advocating an early return to the so-called “schwarzer Null” debt limit, also want to exempt certain categories of investment from the calculation.
All these schemes aim to avoid repeating the mistakes of the EU’s response to the euro zone crisis, when synchronized austerity caused public investment to collapse, triggering a double-dip recession, reducing growth potential and aggravating a shortfall in private sector investment.
What’s not to like?
Well, the changes are bound to trigger a fight over what constitutes good and bad debt. Some countries, such as France, have long advocated excluding defense equipment purchases from the debt calculation, for example. Others argue that education spending is the most growth-enhancing investment of all — and should be exempted.
Fiscal hawks, meanwhile, warn that financial markets — the ultimate arbiters of the sustainability of a country’s debt — will not be hoodwinked for long by creative accountancy.
As conservative German MEP Markus Ferber puts it, “Debt is debt. Of course it matters whether I borrow to pay for a nice holiday or to buy a car to get me to work. But I caution against starting a public debate on good and bad debt. We have to look at the reality of debt sustainability.”
The fundamental problem, said Ferber, is that countries like France and Italy did not reduce their debt in good times and will struggle when interest rates rise again. That’s a fair point, and Europe will continue to need sensible rules for balancing current expenditure with revenues. But it must not prevent the EU from bypassing obsolete debt ceilings to promote vital public investment.
