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The EU’s contentious spending reforms
EU national leaders will have a hard time finding the money to finance the reconstruction of Ukraine (estimated at €380bn) and an even harder time convincing their electorate that their taxes will underwrite this bill. Photo: Shutterstock.com
When the EU’s fiscal rules enshrined in the Stability and Growth Pact were suspended because of COVID, there was broad consensus among economists and politicians that once the medical crisis was over, the public spending rules of the eurozone should be reformed. Now a draft of the new rules that should come into force next year has been made public by the Commission.
As expected, neither the fiscal hawks nor the doves in the 27 member states are happy with the proposed reforms. The softer rules that allow countries with strained public finances to make reforms at their own pace have angered the more fiscally sound politicians in the northern states.
Germany’s Finance Minister Christian Lindner said: “Germany wants clear rules, and numerical references and benchmarks. We still have a lot of work to do.”
Italy’s Economy Minister Giancarlo Giorgetti, while expressing his satisfaction at loosening old fiscal rules, complained that the “golden rule” that excludes spending on infrastructure projects from public expenditure and debt computation is not part of the reforms.
The Commission’s target to obtain the agreement of all 27 member states by the end of the year and before the European Parliament election early next year is probably not achievable. The bickering on the details of the new rules will undoubtedly drag on, with national leaders focusing on how these changes will likely affect their electoral prospects.
The sobering reality is that the EU is facing a combination of elements at the macroeconomic level that make fiscal rectitude, rather than relaxation, a priority for the coming decade and beyond. The days of easy money are over.
Governments wanting to borrow more from investors must get used to paying higher interest rates, as the threat of relatively high inflation is unlikely to convince central bankers to lower interest rates. This will put increasing pressure on debt servicing, especially for countries like Italy and Greece, with already high public debts.
The EU is facing a combination of elements at the macroeconomic level that make fiscal rectitude, rather than relaxation, a priority for the coming decade and beyond
The EU’s ambitious green agenda will also put pressure on public spending. Agora Energiewende, a think-tank, argues that “the EU’s target of cutting emissions by 55 per cent by 2030, relative to 1990, requires additional public spending of more than one per cent of GDP per year over the current decade”. Imposing stricter emissions regulations will help member states achieve this target. Still, it is pretty doubtful whether national leaders would rather dole out subsidies for consumers to buy energy-saving durable goods rather than curb waste in the use of fossil energy.
Elements of a war economy are already creeping into many countries’ budgetary plans. The Economist argues that “European countries will have to spend about 0.5 per cent of GDP more on defence in the coming years to reach NATO’s target of two per cent”.
While the outcome of the Ukraine war remains uncertain, the reconstruction of the country will mostly have to be financed by the US and other Western economies. The World Bank, the EU, the UN and the Ukrainian government estimate that it will cost €380 billion to rebuild Ukraine after the war. National leaders in the EU will have a hard time finding the money to finance this expenditure and an even harder time convincing their electorate that their taxes will underwrite this bill.
But perhaps the most daunting challenge is the slow-burning issue of deteriorating demographics. The Commission projects annual age-related spending, which includes pensions and healthcare, will increase by 1.4 percentage points of GDP between 2019 and 2030. The Economist calculates that “taken together, climate change, defence, Ukraine and ageing could add about 3.3 per cent of GDP in spending per year”.
A common political argument meant to calm the nerves of voters worried about the bleak prospects of future economic well-being is that a growing economy will be enough to ease the financial pressures that the EU faces in the coming decade. The harsh reality is that the party is over. The benign economic climate of the last decade is unlikely to be replicated in the coming one.
Those member states with economic models that promote high added-value economic activities, investment in education that improves the achievement levels of young people, and investment in advanced technology to enhance productivity will prosper.
In an article in the Financial Times , German Finance Minister Christian Lindner sensibly argues: “Common fiscal rules have to ensure a rapid and sufficient reduction of deficits and high debt ratios while allowing for necessary public and private investment. Improving the quality of public finances by prioritising spending remains key.”