The EU’s fiscal rules need more than technical tweaks

In Freudian psychoanalysis, neurotic behaviour is the manifestation of repressed feelings. In the EU’s obsession with codified rules, it is politics that is being repressed. That is why the newly relaunched debate on the bloc’s fiscal rules is going to be difficult.

The current fiscal framework satisfies no one. Deficit countries find its discipline too constraining to promote economic growth that would improve public finances. Surplus countries see high debt in struggling neighbours and conclude it hasn’t been constraining enough. The rules are too complex to communicate to voters, undermining their democratic acceptability.

The least negative thing anyone has had to say — in particular German finance minister and likely next chancellor, Olaf Scholz — is that the rules did not stop governments from saving their economies from disaster during the Covid lockdowns. It could be a dictionary definition of damning with faint praise.

Significant change is therefore overdue, but few hold out much hope of a consensus on what form it should take. Hence the temptation to tinker at the edges. The problem, however, is that the economic circumstances have changed in at least two consequential ways.

First, the (correct) response to the pandemic caused a jump in public debt-to-gross domestic product ratios. Second, the EU’s priorities require a drastic increase in investment in order to transition to economies that have net zero carbon emissions, are thoroughly digitised, and restore a broad-based opportunity for prosperity.

The current framework does not reflect these changes. Under today’s rules, governments with debt-to-GDP ratios above 60 per cent are supposed to cut the excess by one-twentieth per year. That speed of consolidation is a recipe for a heavy drag on growth, which would very probably defeat its own purpose.

The scale of additional public investment needed is incompatible with the ban on excessive deficits, unless it is funded with deep spending cuts or tax rises elsewhere. Those, too, would harm growth and erode political support for the green and digital transition.

In the absence of reform, therefore, we will not return to a situation where the rules are at least somewhat binding. The most indebted countries will not reduce their debt at the prescribed pace. Governments will borrow to invest so as not to fall behind in the economic transition, deficit limits be damned. The fiscal rules will become a balancing item in the political calculation.

Such observations are largely common ground. As a result a number of good technical proposals have been floated, including from institutions whose concern for sustainable public finances is unimpeachable.

The European Fiscal Board recommends country-specific paths for debt reduction, taking account of some countries’ difficult starting points. Klaus Regling, managing director of the European Stability Mechanism, thinks the 60 per cent ceiling on the ration of public debt to GDP “is no longer relevant” and should be raised. The think-tank Bruegel proposes a “green golden rule” by which public investment spending could be exempted from the fiscal constraints.

These would all be useful reforms. But their adoption does not depend on their usefulness. The deep challenge of the EU’s fiscal rules is that they substitute technical solutions for political ones.

In a multinational bloc with multiple layers of sovereignty, it is tempting to try to eliminate politics altogether. But it is also futile. Like Freud’s repressed emotions, repressed politics does not go away, but causes dysfunction somewhere else — including in the ability of the rules to do their job to everyone’s satisfaction.

The obstacle to good fiscal governance in the EU is not bad rules but poor politics. In particular, the lack of shared political ownership of economic policy in the member states — despite the treaty obligation to “regard their economic policies as a matter of common concern” — makes for mutual distrust. Fiscally weaker countries distrust the motives of stronger ones, who in turn distrust the weaker ones’ ability to manage their economies.

However, the politics of the new post-pandemic recovery funds contain signs of hope. Aside from Hungary and Poland, they have not triggered the old suspicions between weaker and stronger economies. Quite the contrary. It is early days, but if this process is seen as successful, it will prove that Europe’s north and south can trust one another to pursue joint economic goals. That will make more difference to fiscal governance than any technical change.

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