Bruno Colmant - Economic Insights

One after another, Europe’s parliaments have discreetly passed legislation approving the European budgetary pact, or to give it its official name, the Treaty on Stability, Coordination and Governance (TSCG). It represents the most important political decision since the Maastricht Treaty in 1992. The pact may even be the most significant politico-economic act of the post-war period. It obliges European countries to reduce excessive public debt by 5% a year until a ratio of debt to GDP of 60% is reached. The 60% figure is not new since it was a qualifying criterion for Euro zone accession in 1999. This rule is now paired with the so-called "golden rule" of a "structural" deficit, i.e. exceptional economic circumstances excluded, not exceeding 0.5% of GDP.

The budgetary pact strips member states of a considerable amount of freedom. European budgetary control to coerce the differently matched member states into aligning budgetary and fiscal policy replaces rather than reinforces them. Without becoming mere executants of the Commission, the member states see their prerogatives reduced. The right to draft a budget and raise taxes is ceded to European institutions dominated by the most powerful countries. These water down or dictate policy decisions. Now a little more federal in nature (like Europe's currency), the European budgetary process resembles a public finance confederation less and less. It should be remembered, though, the budgetary pact is closer to a convergence than a budgetary union as the member states pool nothing.

Cynics may welcome the fact that budgetary pact discipline could make future governments rise above ideological posturing and implement fiscal and social policies which ensure a balanced budget.

There should be no illusions. The budgetary pact means sovereignty is abandoned to technocratic entities with unknown democratic credentials. The fact is that European institutions are organisations which primarily cater to the interests of the dominant countries, particularly Germany, with its austere vision of public finances. The argument can be taken further. We are no doubt witnessing the end of countercyclical Keynesian policies of deficit increases during recessions and economic stabilisers triggering tax cuts and higher social transfers in economic downturns.

Germany never adopted Keynesian theory, suspecting that it drove academia to legitimise government debt and inflation-driven currency depreciation. German scepticism of government intervention in the economy is behind the dissensions currently shaking the ECB. After the monetary integration of East Germany, Germany assigned the European currency a role as a politically unifying force. Henceforth, European economic policy will be more economic than political, with financial market rules dominating.

Moreover, the European Central Bank (ECB), whose founding principle is its political independence, is charged with managing the euro. Let there be no illusions on this point either. While the ECB's main remit is inflation control, we cannot for a second imagine its monetary policy being dissociated from the thrust of German fiscal policy. Fiscal and monetary policies are in fact two sides of the same coin. Budgetary austerity keeps the euro strong and helps to stamp out inflationary surges. The euro has in fact become a derivation of the Deutsche Mark, a deflationist hard currency that imposes weakness on its less strong national components.

Faced with the need to reduce their debt and balance their budgets, weaker countries will have to devalue internally by implementing austerity packages which necessitate fiscal contraction and swingeing pay cuts.

Germany's indisputable competitiveness means other countries are less competitive. An economically evenly-matched Europe would be wishful thinking, unless European growth was driven by exports outside Europe, which is not the case. This is why the Northern countries’ logic of competitive disinflation could lead to (quasi) recessionary deflation in the countries of the South. We could even have a two-speed Europe where an industrial North with savings would exist alongside a South with structural unemployment, like Northern Italy and the Mezzogiorno.

Political differences aside, the budgetary pact will therefore inevitably put the Eurozone members on divergent paths, with capital investment in northern countries and cheap labour in southern countries. Economies are likely to specialise by playing to their strengths. This could increase the fragility of the southern economies as they become increasingly less diversified.

What are we to think of the budgetary pact? Its mere existence is a plus. Yet it may sow the seeds of recession-inducing policies of arbitrary targets for cutting budget deficits and public debt and miserly currency management. The pact also renews the recent Eurozone economic management tactic of austerity to reinforce austerity. In these conditions, the budgetary pact would reinforce the temporary primacy of money over labour. The flip side of a strong currency is unemployment in weak countries and among younger workers. The economic policy framework imposed by the pact could prove to be ill-suited, given the absence of growth and the need for solidarity between member states. It would be difficult in these circumstances to envisage demand-driven measures to stimulate the economy. It is not clear if we are heading towards a European Germany or a German Europe. In the latter case, the golden rule would do the opposite of what alchemists and King Midas sought: gold would turn to lead.