[A-List] EU stability & growth pact: doomed

["Michael Keaney" <michael.keaney@xxxxxx>]

David Owen collaborator/adviser Larry Elliott is not the most obviously
objective person to comment on this topic. And he completely misses the most
obvious parallel of all -- "Sir" Geoffrey Howe's budgets during the first
Thatcher administration. Nevertheless, despite Elliott's harbouring of
wishes that it might somehow continue, even he is forced to admit that the
stability and growth pact is doomed.



A ghoulish remnant

How many jobs will be sacrificed before Europe scraps its absurd stability
and growth pact?

Larry Elliott
Friday November 1, 2002
The Guardian

Try a little thought experiment. Imagine Britain with more than three
million on the dole and an economy deep in the doldrums. The mood is sour:
consumers are reluctant to spend, businesses unwilling to invest. Tax
revenues are falling because fewer people are employed; welfare payments are
going up for the same reason. For those above the age of 20, conjuring up
these images should not be difficult. Britain has been in this situation
all-too-frequently in living memory.

Now imagine that the government's response to this is to raise taxes and cut
public spending, arguing that the priority is to balance the books. What's
your response? A sensible piece of housekeeping that will keep the economy
on an even keel, or monetarist madness that will deepen the recession and
exacerbate the deficit?

It's a bit of a no-brainer, isn't it? Any government that sucks demand out
of the economy when it is already struggling simply makes matters worse.
Life has moved on since the 1920s when it was an article of faith that
budgets had to be balanced come what may. It was central to the Keynesian
revolution that governments should not tighten fiscal policy during
downturns; only hardline Thatcherites thought differently.

Well, not quite. Only hardline Thatcherites and those who believe in
Europe's hilariously misnamed stability and growth pact. In some quarters of
Europe, time has stood still. The stability pact is the Mick Jagger of
economics, long past its sell-by date but still cavorting about the stage as
a ghoulish remnant of the golden age of monetarism. The eurozone may be
heading rapidly towards stagnation, but the pact requires member states to
take steps to balance their budgets. Those with deficits exceeding 3% of GDP
are obliged to bring them back below the ceiling, whatever the state of the
economy, and with the threat of hefty fines if they do not. No flexibility,
no leeway.

And no future. Across Europe, the past few weeks have been alive with
Damascene conversions. The penny has dropped. The cat is out of the bag.
Choose your own metaphor. The stability and growth pact is deflationary,
anachronistic and should be scrapped. It only remains to be seen whether it
is killed off quickly or has a long, painful death. At present, regrettably,
the odds are on the latter, with Europe's unemployed paying the price.

To understand why that is, you have to understand why Europe saddled itself
with this instrument of economic torture. The short answer is that Germany
demanded it as the price of giving up its beloved deutschmark, and without
Germany the euro project would never have got off the ground. What the
Germans wanted the Germans got, and what the Germans wanted was a central
bank that would be a clone of the Bundesbank and draconian rules that would
prevent those countries with a reputation for fiscal incontinence (ie Italy)
from running excessively large budget deficits. Just as rate-capping in the
1980s was an expression of Mrs Thatcher's deep distrust of local government,
so Germany's mistrust of the governments of countries in southern Europe
encouraged the development of rate-capping on a continental scale.

For many of the eurozone's smaller countries sticking to the letter of the
pact was tough going. They had to make painful cuts, but told their
disgruntled electorates that it was a price worth paying for being part of
the single currency. Understandably, they now feel a bit miffed that the big
countries - Germany, France and Italy - are about to break the rules of the
pact and, what's worse, do so with impunity. The European Central Bank,
living up to its image as the Bundesbank redux, is with the small countries
all the way.

The complaints are understandable but, in the the end, misguided. Time has
moved on. Germany is no longer an economic powerhouse; growth is weak and
unemployment high. It is being talked about as the sick man of Europe: even
worse, as Europe's Japan. The International Monetary Fund, not really known
for being a softie when it comes to economic policy, warned yesterday that
Germany risked choking off its modest economic recovery next year if Berlin
took the axe to the budget deficit. Germany accounts for a third of eurozone
GDP, and if it grows slowly there are knock-on effects for France, Italy and
everybody else.

There are two possible ways out of this predicament. The monetarist solution
is to say that Europe's problems have nothing to do with the levels of
interest rates or the rigidity of the stability pact, but are the result of
a lack of structural reform. Higher levels of growth will come as the result
of reducing the power of the unions and making the welfare state less
generous. Embracing Thatcherism, in other words. The alternative is to say
that while Europe may need to reform the supply side of its economy, it also
needs to rethink and remodel its macroeconomic framework to take account of
life as it is in 2002 rather than as it was in 1975. The problem today is
not inflation but deflation.

A few months ago, such sentiments would have been utter heresy. In the past
few weeks they have become acceptable. Romano Prodi, who was an economics
professor before becoming president of the European commission, blew the
gaffe when he said the pact was "stupid". Pascal Lamy, Europe's trade
commissioner, calls the pact "medieval". Such candour is refreshing and long
overdue. Whether it will lead to a change in policy remains to be seen.
European Union finance ministers meet next Thursday to discuss the pact, and
ideally they would agree to root-and-branch reforms. It should not be beyond
the wit and wisdom of European policy makers to establish rules for fiscal
policy that take account of the state of the economy, the level of
government debt and of whether governments are borrowing for investment
rather than current spending.

There are many in Europe who would agree that change is needed. Tony Blair
would certainly like to see it, because the stability pact currently
presents a major impediment to the government calling a euro referendum. It
would be much easier to win over a sceptical British public were Europe to
have an economic policy framework that would allow it to grow faster. The
problem, however, is that the case for reform smack of self-interest when
Europe's big three are flouting the terms of the pact. In an ideal world,
the ECB would recognise the problems and cut interest rates to boost growth,
but it may do the opposite as punishment for fiscal backsliding. In those
circumstances, the scene would be set for an almighty struggle between the
bankers and the politicians, in which - ultimately - there can be only one
winner. Change will come. Europe's monetarist experiment will be abandoned.
The only question is whether it will take a full-blown crisis for the euro
to bring it about.

· Larry Elliott is the Guardian's economics editor