BRUSSELS, April 4 (Reuters Breakingviews) - The European Union’s new set of fiscal rules need to answer two simple questions: will they help the bloc’s economy grow? And will countries actually follow them?
The old setup – the Stability and Growth Pact – didn’t score highly on either criteria. The stipulation that member states keep their annual deficits to 3% of GDP and their total public debt to 60% of GDP was set aside routinely and scrapped entirely during the pandemic: in March 2020, the European Commission invoked a “general escape clause” to let countries spend freely during the crisis. The exemption expires at the end of this year.
The fiscal rules are at the crossroads of the EU’s monetary union and budgetary sovereignty. Since national governments control fiscal decisions but the euro’s interest rates and reputation apply across the board, the EU decided it needed guardrails to keep its members in line, even those who have so far kept their own currency.
Even if the official limits for deficits and debts are enshrined in EU treaties, national governments have not hewed to them. The EU has an “excessive deficit” paper trail on every country ever to be a member. Past rounds of budget rules have carried the threat of top-level sanctions but the enforcers could not follow through. In 2003, the EU held back from fining France and Germany for breaching the targets, and, in 2019, threats to fine Italy as much as 3.4 billion euros also went nowhere.
All parties agree the rules must change, but not on what the new regime will look like or who will enforce it. In November, the Commission laid out its vision and it is due to present draft legislation in the coming weeks. Under the plans, countries would present a four-year fiscal adjustment plan and negotiate its trajectory with EU authorities. National governments can ask for more time to achieve their goals if they can justify extra spending via investment and reform commitments.
Fiscal hawks are loath to give Brussels too much power to make deals and express concerns that flexibility over targets might lead to wishy-washy compromises. The International Monetary Fund and countries like Germany want at least some hard targets the Commission can’t fudge. Christian Lindner, Berlin’s finance minister, said he’d push for a policy mix. “I advocate for more binding rules, but in a realistic way,” he said in August. “Almost like Halloween: trick-or-treating.”
Some proposals have suggested adding national traffic cops, such as the independent fiscal councils backed by the IMF. But accountability will not come from more local finger-wagging. Likewise, EU finance ministers suggested smaller fines might be more deployable, but real improvement won’t come just because penalties are easier to swallow.
The EU needs to look at carrots, not sticks. To prosper, countries must invest in education, new technology and better infrastructure. They also need to encourage global manufacturers to consider Europe as an industrial hub, as the U.S. has done with the $369 billion of subsidies and tax credits in its Inflation Reduction Act.
“There isn’t a company in the world that’s not thinking about moving to the U.S. right now,” said Ann Mettler, former head of the Commission’s in-house think tank, on a March panel. “Show me when Brussels has ever put something forward where every company thought I got to be in on this, I got to be in Europe.”
The new budget rules ought to encourage long-term growth. If they emphasise cutting back over moving ahead, they’ll follow the path of past mistakes.
The old regime called for so much austerity as to become practically irrelevant. For example, countries that are over the line on debt are supposed to course-correct quickly, cutting their debt annually by one-20th of the gap between where their total debt actually is and where it is supposed to end up. If followed strictly, a country whose debt was 150% of GDP would need to shrink that ratio by 4.5% per year. The budget cuts and tax increases required to produce those savings would suffocate the economy.
“Frankly it’s not meaningful. If a rule is not meaningful, nobody is following it, it’s not credible, so better reform it,” said Bank of Finland Governor Olli Rehn in late March in Brussels. Rehn’s criticisms are noteworthy because he was the EU Commissioner tasked with defending the rule when it took effect in 2011.
The Commission’s plan to move away from such impractical precision is a step in the right direction. But countries also need positive reasons to shape up.
Better access to global bond markets is one attraction. To entice investors, a country needs sustainable debt management and a credible currency. Good fiscal practices could bring down borrowing costs across the board, especially if combined with other euro-strengthening moves like completing the banking union that began with a move to common financial supervision. It would also help if the EU policy debate shifted towards treating bond markets as routine economic tools instead of regularly stoking fears that, say, Italy or Greece is on the brink of default.
Another priority is helping technology invented in the EU go commercial in the EU, instead of leaving for greener financing pastures. The bloc’s push for capital markets union is more of a slogan than a goalpost – European companies remain dependent on bank loans, and conditions vary widely depending on where a company is located. EU countries need to encourage scale-up financing and allow more cross-border cooperation. Budget rules can encourage spending on infrastructure and regulatory improvements that support these goals.
At least the old system won’t be coming back full force. The European Commission plans to only partially rely on the framework for 2024, skipping some of the more detailed requirements in favour of a medium-term focus it hopes will align with the future guidelines.
EU finance ministers weighed in last month, endorsing the overall goal while also signalling that old debates remain unresolved. For example, they called for the Commission to consider leeway for defence spending as well as productivity investments.
Expect more fights before the finish. The EU still hasn’t made peace with the inherent trade-offs between borrowing and spending, and on promoting growth rather than protecting legacy interests and legalistic grandstanding. New rules need to put the future ahead of philosophy to have a chance to work.
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CONTEXT NEWS
The European Commission is due to release a legislative proposal for new fiscal rules, currently expected in late April or in May, in hopes of getting a deal by year-end. The package will need agreement from member states to take effect.
On March 8, the Commission said they aimed to start using the new rules beginning Jan. 1, 2025. For 2024, they said they would resume fiscal oversight that had been suspended during the pandemic, but “given the specific economic situation characterised by high uncertainty, it would not be appropriate” to enforce the full set of existing measures.
