Bravo, well done; but not yet worthy of an encore.

Article published on March 7, 2003
community published
Article published on March 7, 2003

This article has not been vetted by an editor at Paris HQ

The threats by the Commission to sanction the excessive deficit have been unexceptional. But now something is going to change: the Stability and Growth Pact (SGP) is already in sight.

As expected, which in a certain way was desirable, the Commission gave way to what in Eurocratic terms is called excessive deficit procedure against Germany (as well as Portugal); it is the beginning of a period of strict surveillance of the German public bank balance, whose GDP/deficit ratio is around 3.9%, much higher than the famous threshold of 3% fixed by the SGP.

What can happen in the next ten months? In brief Schröder will be forced to approve several drastic measures (decreasing expenses and improving taxes) in order to recover, partially at least, the public balance, avoiding the heavy sanctions that will be applied if nothing changes. It is difficult to say if these measures are positive for the German economy, since they represent what is called a pro-cyclic policy: since the economy is in recession the government will apply restrictive measures (and it has few choices). It is, just to give you an idea, the opposite of what Bush did after September 11th: when he saw a sectorial crises (transportation, insurance), as well as a lessening of consumer trust, he approved a massive fiscal push, that is to say, more public expenses and less tax.

As the Commission did well in safeguarding the credibility of the pacts agreed between the Members of EU and the institutions, now we should consider whether it is necessary to change these same pacts, and to revise the strategies of economic policy on a Community level in their entirety.

Cui prodest SGP? According to its logic, if there were a recession, lowering taxes because of lower incomes and the helpful increase of unemployment would cause a rebound stabilizing economy. Moreover, the resulting deficit would never be excessive when you start from a balanced budget; the government, in the mean while, would be neutral. It would not spend or cut taxes. When recession hits a particular country (what is technically called asymmetric shock), market forces, according to the same logic, would guarantee a new equilibrium through the flexibility of salaries and workers. If you analyze the actual situation, you can see the SGP game has broken down at its most delicate moment: the stage of European recovery of their financial balances, that is to say, the transition (see the article by Buti of 1998). Recession came when Germany, France, Italy had not yet completed the process of resetting their deficit; it is impossible to believe that they could have faced the slowdown connected to the current economic situation without worsening the public balance. And that is not all: the SGP shows it is inadequate to resolve the shock that hit specific sections and European economic areas. Some practical examples: this summers German floods, the Italian Fiat crises and the Galician ecological and economic disaster. In these cases what does the SGP propose? The Galician fisher should go job-hunting to Greece, the Italian worker should tell his family that he can accept a permanent reduction of his salary, or he must find fresh work abroad. The result is that workers dont want to emigrate en mass while the nation States are rescuing the economy by using emergency measures involving the increase of expenses and the worsening of the deficit: that is what the SGP punishes.

Obviously there is something wrong: in any other State, whether unitary or federal, there would be a compensatory mechanism in order to transfer resources from growing areas to depressed areas, something that the European balance is not able to do. This aid would help to restore these areas, instead of deleting their human resources or decreasing the purchasing power of salaries.

In short, this SGP can be a Stability pact but it has nothing to do with Growth; the misfortune of politicians and Eurocrats who have defended it is that the recession that hit the USA and Europe occurred just at the delicate moment of recovering the public balance.

The situation is worse indeed because the monetary policy is managed by a haughty bureaucrat who, when sharing the analysis of his counterpart from overseas, makes the opposite choice. By maintaining invariable rates in a situation he himself considers worrying, Duisenberg does nothing more than discourage those who (in the Stock Exchange in particular) prefer a growing Europe instead of a Europe stably stuck in the mud, without considering the risks of deflation in Germany (similar to those of the USA, where Greenspan is trying to defend itself), and the fact that the differential of interest rates could lead to a further appreciation of Euro, with a damage to competition of EU export.

Many things have to change: if the government of ECB does not care about growth, the weight of economic recovery rests entirely on the public balances, strictly limited by the SGP. There are two solutions: one is to lighten the SGP, making it flexible towards current trends and to an eventual asymmetric shock. The second, more incisive solution is to give the Community balance a weight, in order to give it the means to stabilise the European economies; the problem is that the management of this balance should be given to institutions with a democratic legitimacy that would manage relevant resources, something that everyone in the EU refuses to do.

For how much longer will the EU act like a dog chasing its own tail?