A Stability Pact for a New European Economic Order

Bernardo de Miguel

6 mins - 27 de Abril de 2023, 07:05

The European Union's Stability Pact was born more than a quarter of a century ago in a post-Cold War world dominated almost without resistance by the West, with incipient globalisation in which China had not yet emerged with full commercial force and in which the technological revolution was just beginning to take its first digital steps. Those old rules of 1997 were the basis for the creation of the euro. And they withstood the gale of the financial crisis with some modifications. But the new world order, accelerated by the pandemic and Russia's invasion of Ukraine, seems incompatible with a Pact that, if applied to the letter, would condemn the eurozone to self-inflicted recession, social catastrophe, and a loss of geo-strategic ground in competition with the US and China. 

The old Pact, despite the German government's regret, is dead, and the reform project approved by the European Commission on Wednesday only maintains on paper the 3% public deficit and 60% debt limits enshrined in the EU Treaty. In practice, it is moving towards a kind of spending rule that is expected to contain and gradually reduce the gigantic red numbers caused by the bank bailouts (2008-2012), the measures to alleviate the impact of Covid-19 (2020) and the fiscal aid to mitigate the escalation of energy prices (2022). 

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Countries with excessive deficits or debt will have to negotiate with Brussels an adjustment path adapted to their economic circumstances, with an annual net expenditure target. The EU will only take action against these countries if this target is not respected or if the recommendations issued are not complied with.

In 2024, when the Commission wants to launch the new Pact, there will be 11 countries with a deficit above 3%; almost half of the EU partners will have a debt level above 60%, and in six of them (France, Italy, Spain, Belgium, Portugal and Greece) the red numbers will still exceed 100%, according to the Commission's own most recent projections. 

If it were up to the German finance minister, the liberal Christian Lindner, disciplinary proceedings would be opened against all these countries in order to impose on them adjustments that already proved suicidal during the euro crisis. 

The Commission has incorporated some parameters into its reform to appease Lindner, such as the requirement of an annual adjustment of 0.5% for countries whose deficits exceed the 3% limit. But France, Spain and Italy (which together account for 44% of the eurozone's GDP) are unlikely to allow a return to Berlin's austerity policies. Even the German government's senior partners, the Socialists and Greens, do not fully share Lindner's irresponsible stance. 

The battle, which will be waged during the Spanish presidency of the EU, is expected to be a tough one, and it will be up to the Spanish government's vice-president, Nadia Calviño, at the head of the EU's Council of Economic and Finance Ministers (Ecofin), to deal with it. The foreseeable clash between Berlin and Paris could even leave the reform up in the air and leave the Commission with the dilemma of recovering the old Pact, suspended in the wake of the pandemic, but without applying its most harmful elements for growth, such as the demand for an accelerated debt cut.

Neither Brussels nor the major euro capitals want to expose themselves to an economic crash that would further widen the widening economic gap between the EU and the US. In 2008, when the financial crisis erupted, the EU's GDP (€12.5 trillion) exceeded that of the US. After the euro crisis, Brexit and the pandemic, the US GDP reached 22.6 trillion euros and the EU closed last year at €15.8 trillion. And in addition to the distance marked by the US, there is now competition from a giant like China and rising countries such as Brazil, South Africa and India that are claiming their place at the table.

The draft reform of the Pact ensures that priority will be given to maintaining public investment, so as not to repeat the catastrophic mistake of the past decade when it was nipped in the bud in several countries (including Spain) by the euro crisis. The text approved by the Commission even points to a preference for spending on four policies considered vital for the EU in the 21st century: the Green Pact, the social rights pillar, digital infrastructure, and security and defence.

But the huge resources required by these four policies do not sit well with a rule that forces most partners to drastically tighten their belts. In decarbonisation alone, it is estimated that the EU may require an annual investment of €450 billion. And the increase in defence spending to reach the 2% target will force countries such as Spain to double this budget item. The complete digitisation of the continent and the protection of networks and infrastructures will leave another juicy bill. And investment in public health and care will also face a dizzying rise, judging by the erosion of the EU's population pyramid.  

In 2021, the Commission's estimates indicated that nine countries would need a brutal adjustment of more than two percentage points of GDP in the structural deficit (i.e. the hardest nut to crack in public accounts) to bring debt down to 60% in 2039. The latest projection postpones the horizon to 2070 and there are already 12 countries that would need a major effort (of between two and six percentage points of GDP) to bring debt below the famous threshold. And it is not just the usual suspects but also Germany, the Netherlands and Austria, which are suffering the cost of an ageing population.

Squaring the budgetary circle will require not only a much more flexible Pact but also an overhaul of state aid rules and the management of European funds to give them a greater supranational dimension. Such a new EU economic order, combining the three legs - budgetary discipline, national subsidies in resource-rich countries, and European subsidies in resource-constrained countries- seems the way forward to stay in this century's global race.

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