Tuesday

19th Mar 2019

Opinion

Fiscal discipline rules in eurozone are devastating

  • Social unrest has given rise to political polarisation in Italy and France and other southern European countries - which cannot be curbed due to demands for public savings in accordance with the stability and growth pact (Photo: Olivier Ortelpa)

The conflict between Italy and the EU is a symptom of the devastating rules of the eurozone, and the social turmoil in France may well have the same origin.

In suburbs and in the countryside, social unrest has given rise to political polarisation in Italy and France and other southern countries, which cannot be curbed due to the commission's and the council's continuing claim for public savings in accordance with the stability and growth pact.

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The creation of the euro was followed by rules for fiscal discipline to avoid unsustainable public deficits and debts, but there was disagreement on another central issue, namely the need to coordinate economic policies among member states to ensure that no country benefited at the expense of other countries – e.g. to stop beggar-thy-neighbour-policy in the eurozone.

Some emphasised that if monetary policy ensured low inflation and fiscal policy secured healthy public finances, market forces would ensure that no country benefited at the expense of other countries.

Others who also included historical experiences from former monetary unions could not support this market-formed opinion.

Germany's role

When the eurozone was established, there were differences in the countries' competitiveness.

After reunification Germany suffered from poor competitiveness and unemployment was above 10 percent, but without visible influence on wages and employment outlook, in contrast to this market-formed view.

As consequence German employers insisted that the German practice of centralised wage agreements had to be changed so that wage formation took more account of individual companies.

New labour market legislation (Hartz reforms) was implemented, which led to lower wages for already low-paid workers.

Increasing economic inequality followed, as wage competitiveness improved.

The price was political problems. The Social Democratic Party (SPD)'s chairman had to leave and the SPD lost the subsequent election.

The increased German competitiveness increased both exports and employment - but at the expense of employment in other member states where unemployment rose.

This aggravated public sector deficits which led the commission and council – in accordance with the stability and growth pact - to demand public saving with further increased unemployment.

Financial crisis

During the financial crisis unemployment and the public deficit grew further.

The European Commission and Council demanded the rules of fiscal discipline tightened and managed so brutally, that some member states lost their fiscal freedom.

Now 20 years after the establishment of the eurozone it has been clearly demonstrated that market forces - as the neoliberal assumed - cannot create balanced economic development fast enough to avoid prolonged social stress even with structural reforms, because structural reforms both take a long time to implement and often works slowly.

This is again demonstrated in France.

French social turmoil

Several French governments have worked to reform their labour market, and with the present government's recent changes, the French labour market is perhaps more flexible than in Germany.

But an improvement in employment outlook has still to be seen, which also has feed into the present social turmoil.

The crucial economic transmission mechanism between countries in a monetary union is through the balance of payment, as the exchange rate among member states is fixed.

Accordingly, coordination between member states must be rooted in requirements to secure a reasonable balance between exports and imports etc. as reflected in the balance of payments.

That is, economic policy coordination must ensure that production in a country matches the overall demand in the country.

This crucial point of departure for economic coordination is reflected in EU regulation 1176/2011 on the prevention and correction of macroeconomic imbalances in a member state or in the EU-union as a whole.

Surplus and deficit countries

The Netherlands, Denmark and Germany have since 2012 or 2013 overstepped the upper surplus limit, six percent of GDP, on the balance of payment with beggar-thy-neighbour effects for e.g. southern member states reflected in as well high unemployment as public deficit.

But the commission and the council disregard this regulation.

Due to this, and from a professional point of view, the stability and growth pact as well as the fiscal pact must be replaced, as we propose, with a coordination pact which base economic coordination between member states on balance of payment considerations: both excessive surplus and deficits shall be avoided.

Such a pact will induce Germany and other surplus countries to promote domestic activity and reduce a too big export sector benefiting especially deficit countries with too big an unemployment.

This will not only ensure a better policy coordination but also ensure that member states avoid economic disaster.

This is not only a professional opinion but is also demonstrated in practice.

Countries with a reasonable balance of payment situation has never asked for assistance from the IMF.

All four euro-countries (Greece, Ireland, Spain and Portugal) which asked for assistance after the financial crisis experienced huge balance of payment deficits.

And two of those, Spain and Ireland, had a public surplus up to the financial crisis, also brought about by an overheated economy – but no clear warning came from the central indicator, the public balance, in the stability and growth pact.

If a deficit on the balance of payments is avoided, a country can internally finance a deficit on the public balance with surplus on the private balance.

Since 1981 Japan has had a surplus on the balance of payments. An accumulated government debt now surpassing 250 percent of GDP, which is financed without problems, further indicate the central importance of the balance of payment situation.

However, it may be sensible for EU to supplement with a sustainability pact that removes the rigid public deficit and debt limits, and instead requires member states not to process unsustainable public debt that may have negative consequences for other countries if such a situation should erupt.

Jorgen Rosted is former director of the Danish ministry of finance and head of department of the ministry of business affairs. Christen Sorensen is former chairman of the Council of Economic Advisers and a professor of economics.

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