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Don’t Count Your Pennies

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Default profile picture roberto foa

Instead of paying up their fines, France and Germany have paid only lip-service to the Growth and Stability Pact. The irony is that while Europe’s financial credibility remains stronger than ever; her political credibility is in tatters.

So, once again France and Germany have been spared the humiliation of punitary sanctions for their budgetary laxness. On November 25th, an all-night meeting of finance ministers in Brussels concluded by agreeing to let Europe’s two largest economies off the hook. Instead of paying up 0.2% of their respective GDPs, France and Germany have had only to pay lip-service to the terms of the Pact.

Yet what is perhaps most fantastic about this story is the amount of hysteria surrounding what, in economic terms, is a complete no-sale. The European Central Bank immediately responded by declaring that the ‘deal’ carried ‘serious dangers’, and more ominously, Dutch Finance Minister Gerrit Zalm talked of ‘a serious constitutional crisis’. Yet talk that the Pact was ‘over’ seemed hysterical to the financial markets, where Europe’s legacy of financial discipline kept the euro rising and rising.

Penny Wise and Pound Foolish

The fact is, the Growth and Stability Pact has basically worked: for all European countries to have kept their deficits even close to around 3% in a time of economic difficulty is historically unprecedented. Italy’s deficit was over 10% for every year of the 80s: in 1990 Greece amassed a whopping 16.1% budget shortfall. In 1983, every country that now participates in the euro had a deficit superior to 3% - 4 countries (Italy, Belgium, Ireland and Portugal) actually had double-digit deficits. Regardless of whether one supports the neo-classical, ‘balanced budget’ dogmatism upon which it is based, we have to accept that today’s Europe is basically fiscally prudent. And it must not be forgotten that both Germany and France (and Portugal, who broke the Pact back in 2001) have struggled hard to keep their deficits within the 3.0% band, even where they have not entirely succeeded. After all, budget deficits cannot be carefully calculated and planned in advance. It was only on November 13th that the German finance ministry recalculated its sums to find an $18 billion gap in their finances; pushing their deficit level from 2.9% to 3.8% of GDP. Even as late as September 25th, German finance minister Eichel was proudly declaring that Germany would meet its deficit requirements - which at the time looked realistic.

Money Makes the World Go Round?

So why has the Ecofin affair aroused so much controversy? The answer has nothing to do with economics and everything to do with the power structure of the EU. For there is no rule that says ‘as soon as a country runs a 3.01% deficit, they must be fined’. Instead, the rules state that when a country breaches the 3% limit, the matter gets referred to the Commission, who then refer it to Ecofin, who finally decide how to act. In other words, the Growth and Stability Pact is, in the words of Ed Balls, Chief Advisor to British Chancellor, “whatever (European finance) ministers agree it says.” So far from representing a breach of protocol, the affair over the Growth and Stability Pact reveals what to many has always been a truism of EU politics: that formally ultimate power rests in Realpolitik between member states and not in collectively applied rules, upheld by the Commission. That raises the suspicion that France and Germany have for the time being escaped sanctions simply because, as the two largest economies in the euro zone, they have greater lobbying power. No wonder ministers like Holland’s Gerrit Zalm are furious. States like Holland find themselves asking - ‘could we have done the same?’ – and conclude, probably rightly, that they could not.

All of which, of course, bodes ill for when Europe opens its gates to 10 new members from the East next year. Just as France and Germany once chided their Southern European neighbours for fiscal irresponsibility, today they incite their Eastern neighbours to show greater budgetary discipline. But they have always been prepared to put their money where their mouth is, and practice what they preach. Even the appearance that that is no longer true is sufficiently a disincentive for Europe’s new members to show financial restraint.

More worryingly, there are signs that even within the euro-zone, countries are prepared to push the already-tight conditions of the Pact to their limits. Italy is on course to break the 3% barrier next year and other countries are not far behind. France and Germany have set a bad example. All of this will not do anything to convince present euro-outsiders that they would be better off joining the single currency – especially in the case of smaller states like Denmark and Sweden.

Time is Money

So how do we save Europe’s credibility? Most commentators – not least of all the European Commission - have suggested that what Europe needs is stricter enforcement. But it is difficult to see that how strict enforcement of the Pact’s arbitrary rules will aid the Union. The irony of the Ecofin decision is that, in the end, it was right. There was no logic in forcing France and Germany to cut their deficits if it would choke off any chance of economic recovery, and most European finance ministers at the Ecofin meeting recognised that. What is wrong is not that the rules of the Pact were ‘interpreted’: but that this ‘interpretation’ has been left to the member states, where realpolitik rules, instead of, say, an independent commission which would assess countries’ deficits on a case-by-case basis - as suggested by the Centre for Economic Policy Research.

The real question is whether member states are prepared to finally sacrifice the illusion of national sovereignty, as enshrined in their Ecofin meetings, and establish a truly non-partial, pan-European budget regulator. Alas: as long as larger states are able to band together to get preferential treatment, the possibility of reform does not look good.

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