EU: Adjust the rules to the debt?

_ Dr. Ulrich van Suntum, honorary professor, University of Münster, former Secretary-General, German Expert Council for the Assessment of Overall Economic Development (SVR).  30 October 2021.*

Being determines consciousness, it was already said by Karl Marx. Modern economists are now also adapting to this maxim. A current discussion paper by the European Stabilization Mechanism (ESM) openly calls for the Maastricht debt limit to be raised from 60 percent of gross domestic product (GDP) to 100 percent.[1]

In particular, the highly indebted southern countries of the euro area could then breathe a sigh of relief. These have already exceeded this limit by far, most notably Greece with currently 209 percent of GDP. Italy and Portugal are not far behind with 160 percent and 137 percent, respectively, and France, with a national debt of 118 percent of GDP, is miles away from the currently permitted maximum.

A return to the originally planned 60 percent would be unrealistic, argue the ESM economists. For example, Portugal would have to have budget surpluses annually for more than 30 years, but in the past, it has consistently had budget deficits instead. Even in good economic times, the euro countries interpreted the Maastricht target of 3 percent for the annual deficit as a minimum rather than a maximum. As a result, total debt continued to grow.

The financial crisis, the euro rescue and the corona pandemic call for new government billions

Of course, there has never been a lack of excuses for this. First it was the financial crisis, then the euro bailout and finally the corona pandemic that kept asking for new government billions. The idea of saving elsewhere or at least making provisions with budget surpluses in good times never occurred to them. Instead, the original budget rules of the Maastricht Treaty were made more and more “flexible”, that is, they were softened up.[2]

In the end, they were so complicated that they were practically impossible to enforce. The ESM authors’ group also sees it that way. The solution can therefore only lie in a new approach that is as simple as possible, but also politically enforceable.

Their proposal is based on a causality that the economist Evsey Domar discovered in 1944. According to him, the national debt ratio levels off over the long term at a value that corresponds to the ratio of the annual budget deficit and the growth rate of the economy.[3]

For example, the original Maastricht criteria of 3 percent for the deficit and 60 percent for total debt were based on a growth expectation of (nominal) 5 percent per year in the euro area (because 0.3 divided by 0.5 = 0.6). If you subtract an inflation rate of 2 percent from the latter, then the fathers of Maastricht apparently assumed 3 percent real growth in the future.

The adjustment period is also to be made “more flexible”

However, according to the ESM economists, this is no longer achievable from today’s perspective. Real growth of only 1 percent in the euro area is more realistic in the future. But then, according to Adam Riese, an annual budget deficit of 3 percent would result in a national debt ratio of 100 percent in the long term.

Since this corresponds to the value already achieved on average anyway, it would make sense to increase the corresponding target value accordingly. In addition, they propose limiting the rise in government spending for those countries that have already exceeded the new maximum. Up to now, an adjustment period of no more than twenty years was provided for, but this was never observed either. Now this restriction is also to be made more flexible, namely, to be determined individually by the EU Commission for each sinner country. Based on previous experience, it is easy to imagine what this will lead to.

Above all, however, the question arises as to why the 3 percent deficit criterion should be adhered to at all. This is justified in the ESM paper primarily with the necessary scope for stabilizing measures in the event of a recession. But this can only justify a corresponding maximum value, but not a permanent deficit as a regular norm.

There would be an effective way to limit national debt

It would be much closer to orienting oneself on the Swiss debt brake instead.[4] Although it is mentioned in the paper, it is hardly adequately recognized. According to the Swiss model, a balanced state budget is normally provided, so that with positive growth the debt ratio would automatically decrease further and further.

For emergencies such as pandemics or recessions, the Swiss also allow short-term deviations from this rule, but these must be compensated for in better years. Their success has proven them right: their federal debt ratio has been almost constant for ten years and was only an enviable 29 percent even in the 2020 pandemic year.

Even if the individual cantons are not taken into account – anyone looking for a really simple and at the same time highly effective rule to limit national debt really only needs to take a look across the Alps.

Notes

[1]  Francová O. et al. (2021). EU fiscal rules: reform considerations. ESM. URL: https://www.esm.europa.eu/publications/eu-fiscal-rules-reform-considerations

[2] Hinz T. (2021). Corona-Wiederaufbaufonds: Letzte Hoffnung Karlsruhe? Junge Freiheit. URL: https://jungefreiheit.de/debatte/kommentar/2021/corona-wiederaufbaufonds-karlsruhe/

[3] Domar E. (1944). The “Burden of the Debt” and the National Income. The American Economic Review. URL: https://www.jstor.org/stable/1807397

[4] Müller C. et al. (2007). Eine Schuldenbremse für den deutschen Bundeshaushalt. ETH KOF. URL: http://webarchiv.bundestag.de/cgi/show.php?fileToLoad=3749&id=1049

*Translated and republished from the original with kind permission: Van Suntum (2021). Die Regeln den Schulden anpassen? Junge Freiheit.

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