Tack­ling Europe's debt cri­sis

The Pak Banker - - Editorial - Wolf­gang Schu­ble

The In­ter­na­tional Mon­e­tary Fund es­ti­mates that the cri­sisin­duced net cost of fi­nan­cial­sec­tor sup­port pro­vided by G20 coun­tries in 2009 amounted to 1.7 per­cent of GDP ($905 bil­lion), while dis­cre­tionary fis­cal stim­u­lus amounted to 2 per­cent of GDP in 2009 and 2010 both. All the eu­ro­zone coun­tries, ex­cept Lux­em­bourg and Fin­land, re­ported fis­cal deficits in ex­cess of 3 per­cent of GDP in 2009, while Greece, Spain and Ire­land ran deficits of more than 10 per­cent. Within a sin­gle year, eu­ro­zone gov­ern­ments' gen­eral debt in­creased by al­most 10 per­cent­age points (78.7 per­cent of GDP in 2009, com­pared with 69.3 per­cent in 2008).

As for Ger­many, the 2010 fed­eral bud­get fea­tures a record-high deficit of well above 50 bil­lion ($ 66.50 bil­lion). Pub­lic-sec­tor debt will sur­pass 1.7 tril­lion, ap­proach­ing 80 per­cent of GDP. In­ter­est pay­ments, which con­sume more than 10 per­cent of Ger­many's fed­eral bud­get, will grow along with the mount­ing debt bur­den - and even faster if in­ter­est rates rise.

Yet the fi­nan­cial cri­sis and the en­su­ing re­ces­sion go only so far to­ward ex­plain­ing these high lev­els of in­debt­ed­ness. The truth is that many Euro­pean and G20 coun­tries have lived far be­yond their means - in­clud­ing Ger­many, de­spite its rep­u­ta­tion as a paragon of fis­cal rec­ti­tude.

Even in good times, gov­ern­ments have for too long been spend­ing more than they re­ceived. Per­haps worse, some also spent more than they could eas­ily re­pay, given their economies' de­clin­ing long-term growth po­ten­tial be­cause of the ag­ing of their pop­u­la­tions. Such profli­gacy has led to lev­els of debt that will be­come un­sus­tain­able if we do not act.

This is why Ger­many de­cided in 2009 to en­shrine strict fis­cal rules in its con­sti­tu­tion. The Schulden­bremse, or " debt brake", re­quires the fed­eral govern­ment to run a struc­tural deficit of no more than 0.35 per­cent of GDP by 2016, while Ger­many's Ln­der ( fed­eral states) will be banned from run­ning struc­tural deficits at all as of 2020. The cur­rent fed­eral govern­ment will cer­tainly abide by these rules, which im­plies re­duc­ing the struc­tural deficit to about 10 bil­lion by 2016 - a re­duc­tion of about 7 bil­lion a year. Wel­fare ben­e­fits ac­count for more than half of Ger­many's fed­eral spend­ing this year. So there is lit­tle choice but to cut wel­fare spend­ing, at least mod­er­ately. But this sort of fis­cal con­sol­i­da­tion can be achieved only if a ma­jor­ity per­ceives it as be­ing so­cially eq­ui­table. Re­cip­i­ents of so­cial and cor­po­rate wel­fare alike, as well as civil ser­vants, must share the sac­ri­fice.

Thus, Ger­man cor­po­ra­tions will have to con­trib­ute to fis­cal con­sol­i­da­tion through re­duc­tions in sub­si­dies and ad­di­tional taxes on ma­jor en­ergy com­pa­nies, air­lines, and fi­nan­cial in­sti­tu­tions. Sim­i­larly, civil ser­vants must forego promised pay in­creases, and the govern­ment is look­ing for an­nual sav­ings in the fed­eral armed forces of up to 3 bil­lion through struc­tural re­forms. Ger­many's bind­ing fis­cal rules set a pos­i­tive ex­am­ple for other eu­ro­zone coun­tries. But all eu­ro­zone gov­ern­ments need to demon­strate their own com­mit­ment to fis­cal con­sol­i­da­tion in or­der to re­store the con­fi­dence of mar­kets - and of their own cit­i­zens. Re­cent stud­ies show that once a govern­ment's debt bur­den reaches a thresh­old per­ceived to be un­sus­tain­able, more debt will only stunt, not stim­u­late, eco­nomic growth.

Greece's debt cri­sis was a clear warn­ing that Euro­pean pol­i­cy­mak­ers must not al­low pub­lic debt to pile up in­def­i­nitely. The Euro­pean Union was right to re­act de­ci­sively to en­sure the euro's sta­bil­ity by pro­vid­ing short-term as­sis­tance to Greece and es­tab­lish­ing the Euro­pean Fi­nan­cial Sta­bi­liza­tion Mech­a­nism. But, while the Euro­pean Fi­nan­cial Sta­bil­ity Fa­cil­ity is a nec­es­sary step to­ward restor­ing con­fi­dence, the Greek cri­sis has re­vealed struc­tural weak­nesses of the Euro­pean Mon­e­tary Union's (EMU) fis­cal-pol­icy frame­work that can­not, and should not, be fixed by rou­tinely throw­ing other coun­tries' money at the prob­lem.

In­deed, I con­sider the Euro­pean Fi­nan­cial Sta­bil­ity Fa­cil­ity to be a stop­gap mea­sure while we rem­edy the fun­da­men­tal short­com­ings of the Sta­bil­ity and Growth Pact, whose fis­cal rules lack sub­stan­tive and for­mal bite both. This is why we need a more ef­fec­tive cri­sis-pre­ven­tion and cri­sis-res­o­lu­tion frame­work for the eu­ro­zone, one that strength­ens the pact's pre­ven­tive and cor­rec­tive pro­vi­sions. Sanc­tions for eu­ro­zone coun­tries that se­ri­ously in­fringe EMU rules should take ef­fect more quickly and with less po­lit­i­cal dis­cre­tion, and also should be tougher. Ger­many and France have pro­posed stricter rules on bor­row­ing and spend­ing, backed by tough, semiau­to­matic sanc­tions for gov­ern­ments that do not com­ply. Coun­tries that re­peat­edly ig­nore rec­om­men­da­tions for re­duc­ing ex­ces­sive deficits - and those that ma­nip­u­late of­fi­cial statis­tics - should have their EU funds frozen and their vot­ing rights sus­pended.

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