Dodging the difficult stuff

Mar 23rd 2005
From The Economist Global Agenda

At their summit in Brussels, the European Union’s leaders agreed to give euro-area governments more latitude to spend their way out of recessions. They also ripped up a plan to liberalise the EU's internal trade in services. Once again, the Union's leaders have shown that they lack the courage to do what is necessary to boost its sluggish economy

WATCHING the machinations leading up to the summit of European Union leaders held in Brussels on March 22nd-23rd, which focused on Europe’s economy, it was tempting to conclude that there is some poetic justice in the world after all. In 1997, worried that its profligate neighbours would try to free-ride on its credit rating under a unified currency, Germany helped to push through the EU’s stability and growth pact. The pact put tight restrictions on countries’ borrowing—deficits no more than 3% of GDP, total national debt no more than 60%—as a condition of joining the euro.

Now the shoe is on the other foot. Germany has breached the pact’s deficit criterion for three years running, and looks likely to do so again this year. Thanks in part to heavy lobbying by the German government, on Sunday Europe’s finance ministers agreed on revisions to the pact which render it effectively toothless. Hard-and-fast rules have been relaxed: now ministers are simply enjoined to keep deficits “close to the reference value”; and the criteria for determining when a country is in a severe economic downturn (in which case it is allowed to exceed the deficit limits) have been revised from the previous, strict standard—a 2% drop in GDP—to include any negative growth, or a protracted period of very low growth.

The new rules, which have been rubber-stamped by the heads of government, also allow for all manner of “temporary” spending, including pension reform, “fostering international solidarity” (a boon to France, which wants allowances made for its peacekeeping activities) and advancing European policy goals. Germany is even to be given special consideration for the continuing cost of unification, estimated at 4% of annual GDP. Austria’s finance minister, Karl-Heinz Grasser, has called this last concession “a bit of a joke”; at going on 15 years, unification can hardly be considered a temporary emergency.

But defanging the stability pact is not necessarily a bad thing. The one-size-fits-all interest rate of the unified currency has put stress on a number of European economies, including Germany’s. Having given up the power of setting interest rates—and thus the ability to use monetary stimulus to help bring their country out of recession—many argue that governments in the euro area need more, not less, fiscal flexibility.

Nonetheless, news of the stability pact’s apparent demise has been greeted with dismay in many corners. European business leaders are complaining loudly, as is the European Central Bank, which has hinted that interest rates may have to rise to offset any fiscal profligacy. And Gordon Brown, Britain’s finance minister, has indicated that the new agreement’s 1%-of-GDP limit on deficits over the medium term may make it even harder for the Labour government to bring Britain into the euro.

Yet for all the furore, the undermining of the stability pact will not have much impact on Europe’s economy one way or the other. Continental Europe’s dismal unemployment levels and disappointing economic growth will not be turned around by any combination of macroeconomic policies unless considerable microeconomic reform takes place, particularly in its heavily regulated labour markets.

The listless agenda

These sorts of liberalising reforms were also under discussion at the Brussels summit. Unfortunately, the heads of state seem mostly to have been discussing how to avoid them. The meeting failed to revive the so-called Lisbon agenda, a reform programme put forward five years ago with the object of making the EU the most competitive economy in the world by 2010. The Lisbon agenda is more in the nature of a suggestion than a directive; it is left up to individual governments to implement. And, facing opposition from powerful, entrenched interest groups, governments have by and large been reluctant to do so.

The summit produced a lot of talk about Lisbon, but little concrete action. In addition, the heads of state agreed to cut the heart out of a proposed directive to liberalise the EU’s internal trade in services, adding social protections that will effectively protect service workers in the Union's richer nations from competition. This is a concession to France, which, supported by Germany, had been trying to persuade the European Commission to abandon the proposed directive altogether.

A fine bit of local protectionism? Indeed. But the directive’s unpopularity in France was threatening to affect the outcome of its referendum, in May, on the proposed EU constitution. With polls showing the public evenly divided on the constitution, the French government feared that ratification of the services directive could tip the referendum outcome towards a Non. The rejection of the constitution by France—one of the largest EU states, and one of the Union’s founders—would be a huge setback for the commission.

Given these hard political realities, it is not clear how much more the summit could have achieved. It is easier to reach agreement on such things as diluting the stability pact than it is to face the domestic political consequences of making your country more competitive. Unfortunately, it is only the latter sorts of reforms that can push EU growth towards American levels.

Going forward, the focus seems likely to stay on macroeconomics. By the end of June, EU member states need to settle on a budget for the 2007-13 period, and already this is controversial. France wants to renegotiate Britain's rebate, which Margaret Thatcher obtained in 1984. Worth around £2.5 billion last year, this is supposed to compensate for the fact that Britain gets relatively little money under the Common Agricultural Policy, and Tony Blair's government will fight hard to keep it. This will not, however, stop Britain from siding with France and Germany in other coming budget battles, particularly the fight against the commission's proposed spending increases.

Meanwhile, real economic reform will once again move to the back burner. There is hope that the commission might get some help in advancing liberalisation from the Union's new members, who are keener on open markets because, having lower costs, they stand to benefit the most from them in the short run. But without a change of heart by some of the older members, it seems that for the foreseeable future the big economic battles in the EU will be fought on the wrong ground.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.