i think the "new europe" members will be getting a raw deal as the "dividers" are taken out...and germany, france, italy strive to pay their burgeoning entitlements
economist.com
Unpicking the fiscal straitjacket
Nov 25th 2003
From The Economist Global Agenda
France and Germany have escaped punishment under the stability pact for their big budget deficits. The pact itself may not escape a long-awaited demise
NEVER has a straitjacket seemed so loose-fitting. The euro area’s “stability and growth pact” was supposed to stop irresponsible member states running excessive budget deficits, defined as 3% of GDP or more. Chief among the restraints was the threat of large fines if member governments breached the 3% limit for three years in a row. For some time now, no one has seriously believed those restraints would hold. In the early hours of Tuesday November 25th, the euro’s fiscal straitjacket finally came apart at the seams.
The pact’s fate was sealed in a meeting of the euro area’s 12 finance ministers. They chewed over the sorry fiscal record of the euro’s two largest members, France and Germany. Both governments ran deficits of more than 3% of GDP last year and will do so again this year. Both expect to breach the limit for the third time in 2004 (see chart). Earlier this year the European Commission, which polices the pact, agreed to give both countries an extra year, until 2005, to bring their deficits back into line. But it also instructed them to revisit their budget plans for 2004 and make extra cuts. France was asked to cut its underlying, cyclically adjusted deficit by a full 1% of GDP, Germany by 0.8%. Both resisted.
Under the pact’s rules, the commission’s prescriptions have no force until formally endorsed in a vote by the euro area’s finance ministers, known as the “eurogroup”. And the votes were simply not there. Instead, the eurogroup agreed on a set of proposals of its own. France will cut its structural deficit by 0.8% of GDP next year, Germany by 0.6%. In 2005, both will bring their deficits below 3%. Nothing will enforce or guarantee this agreement except France and Germany’s word. The commission was dismayed at this outcome, and the euro area’s smaller countries, particularly Austria and the Netherlands, were apoplectic: treaty law was giving way to power politics, they complained.
Now that the pact’s legal procedures have run their course, its architects will have to think again about the economics of the euro and its fiscal rules. The economic flaws of the pact are, by now, painfully obvious and depressingly familiar: its parameters, such as the 3% deficit limit, are arbitrary and its procedures, extracting budget cuts or fines even in a recession, are counter-productive. The 3% limit pays no attention to the nominal growth rate of the economy, nor to a government’s stock of liabilities or assets. Despite its toothlessness, it has already wreaked some damage on European fiscal planning. Italy regularly sells off another piece of government silverware to disguise its budget problems. The Germans are having difficulty passing a much-needed tax cut because of fears that it will add to the country’s fiscal woes.
But if the pact’s problems are all too familiar, life after the pact is less well charted. So far, the financial markets remain quite placid. In fact, they are looking forward to a cyclical recovery that should pull the euro members through their immediate straits. The return of growth will restore most euro-area governments—in France, Germany and elsewhere—to a better fiscal balance. As it does, the hoo-ha over excessive deficits will recede. Indeed, in the immediate future, euro members will probably claim that their fiscal policies are still governed by something they have started calling “the spirit of the pact”.
But will this spirit be enough to sustain faith in the euro in the years ahead? Europe’s central bankers think not. They worry that governments are more likely to run deficits in a monetary union: governments can enjoy the full stimulus of a fiscal expansion, while the unwelcome side-effects (higher inflation or interest rates) are divvied up among all the members. Similar concerns are voiced by smaller members: if the Austrian government borrows too much, its impact on euro-area interest rates is negligible; but if France, Germany or Italy overborrow, borrowing costs rise for everyone. However, not everyone is bothered by this. As economists such as Willem Buiter of the European Bank of Reconstruction and Development point out, in all markets, whether for apples or for capital, a big enough spender will push up the price for everyone else. That is the way markets work.
One option, then, is to leave the policing of government deficits and the pricing of government debt to the markets. Under euro rules, the debt of member governments remains their responsibility and theirs alone. The European Central Bank (ECB) is prohibited from bailing out member governments by printing money to pay off their debts. But would that prohibition, if tested, fare any better than the stability pact’s prohibition on deficits of more than 3%? The ECB is certainly better shielded from political pressures than the stability pact is. But if this week has any lesson, it is that anything Europe’s big governments have stitched together, Europe’s big governments can unpick. |
