MILAN, Nov 21 (Reuters Breakingviews) – The European Union’s troubled fiscal pact, once branded as “stupid” by former European Commission President Romano Prodi, has reached its sell-by date. Countries have blithely ignored it for years. And now the 27-nation bloc wants to overhaul it. The proposed revamp is a step forward. But with the climate challenge set to strain public finances, the discussion needs to rapidly shift to more joint EU funds.
A reform of the Stability and Growth Pact, established in 1997, is long overdue. Born out of the 1992 Maastricht Treaty that paved the way for the euro, the framework aims to cap national deficits at 3% of a country’s GDP and governments’ debt at 60% of GDP. Yet the fiscal rules have been repeatedly trampled upon, including from supposedly thrifty countries such as Germany, without much consequences – an indictment of the feeble enforcement mechanism. Average EU debt has been consistently above the 60% target. At present, it’s at 83% of GDP, and above 100% in six of the 19 euro zone members.
The framework became useless once the Covid-19 pandemic forced nations to spend big to support their faltering economies and is frozen until the end of 2023.
The proposed revamp of the fiscal pact, now under discussion, is an improvement. It would keep the original deficit and debt goals intact, to avoid a laborious treaty change. But it focuses the budget analysis on net expenditure. That’s defined as public spending minus debt interest payments and measures deemed as extraordinary, such as higher unemployment benefits in a recession. Relying on a single indicator promises more transparency and consistency. Yet removing debt interest costs from the calculations might give an unfair advantage to voracious borrowers such as Italy and Greece while at the same time hiding the real size of their fiscal troubles.
The other main feature of the proposed new pact is that states that breach its targets will have at least four years, and up to seven years, to improve their fiscal stance. The rationale is that growth-boosting reforms may require upfront investments that bloat the size of a country’s debt in the short term. The European Commission, the EU’s executive, would agree on targets during bilateral discussions that consider the specific economic characteristics and business cycles of each nation. That’s a welcome departure from the current one-size-fits-all approach. To ensure enforcement, nations failing to deliver on reforms and investment commitments will have their fiscal adjustment period shortened. The Commission would also name and shame non-compliant countries in public scorecards. That may be more effective than threatening fines that never materialised.
Not everyone is happy. German Finance Minister Christian Lindner wants to have clear reduction targets for debts and deficits. Italian Prime Minister Giorgia Meloni would like to exclude expenses like defence. And several member states are nervous about giving the Commission too much clout over budgets, EU officials told Breakingviews. Yet French Finance Minister Bruno Le Maire said on Nov. 9 he was optimistic about reaching a deal with Germany within weeks, ahead of a pan-EU agreement by year end.
BRAVE NEW DEBT WORLD
For all of Brussels’ reforming zeal, Europe’s future debt rules ignore a giant elephant in the room: climate change. Tackling that challenge may require the EU to invest 620 billion euros more per year by 2030, or nearly 4% of the bloc’s annual GDP last year. Pan-EU post-pandemic cash and other joint public funds amounting to around 1% of GDP will help pay for some green investments. But these resources are due to run out after 2026. Meanwhile, the United States is looking to shower its key green industries with tax credits and subsidies for a decade.
One way to address the impending debt dilemma is for the EU to extend a suspension of its state aid regime to allow individual nations to offer incentives for green and strategic industries. But countries with little fiscal room, like Greece, Italy or Spain will struggle to do that effectively. Germany, with debt at just 66% of GDP, has promised nearly 14 billion euros in subsidies to chipmakers Intel(INTC.O) and TSMC(2330.TW). Yet a constitutional court ruling on Nov. 15 may scupper Chancellor Olaf Scholz’s plan for a 60-billion-euro green transition fund.
Another option is to remove green investments from the fiscal rules’ deficit calculations. But differentiating investments from current expenditures may be tricky. And bond investors would in any case spot which national debts are rising too fast. Using proceeds from carbon emission permits and tariffs imposed on carbon-intensive products imported into the EU to pay for green projects is also a good idea. But these may yield just 13 billion euros per year after 2026.
Issuing common EU funds in debt markets, like the 800 billion euros the bloc approved to handle the consequences of Covid-19, seems the most sensible approach to face the mounting joint green challenge. The cash, which won’t directly impact national public finances, could be used to fund projects deemed strategic for the entire bloc, like greater solar and wind power capacity, a comprehensive e-charging network and better ways to recycle critical materials. Germany, the region’s largest economy, and other wealthy countries oppose any form of common EU borrowing for fear they will have to pick up the tab if other nations are less fiscally disciplined.
To solve the conundrum, other EU nations may need to consider a grand fiscal bargain: accepting some numerical deficit and debt reduction targets in exchange for the promise to issue more EU debt after 2026. This would stop short of the fully-fledged fiscal union championed, among others, by former European Central Bank president and Italian Prime Minister Mario Draghi. But it might overcome many countries’ objections to handing control of taxation to a supranational body while boosting the EU’s efforts to fight the global climate threat.
A revised set of fiscal rules is the minimum the EU could do. To address the twin challenge of rising debts and increasing need for green funds, Europe will require a framework that is at the same time more potent and more flexible.
European Union member states are rushing to try and finalise by the end of the year an agreement to overhaul the Stability and Growth Pact, a fiscal framework aimed at keeping member states’ budget spending in check.
The rules of the pact, which were frozen as the Covid-19 pandemic erupted, are suspended until the end of this year.