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23 June 2017

High­ly prob­lem­at­ic

The European Commission’s plans for more state-led stimulus are not going to help the euro zone. By Ludger Schuknecht and Thomas Westphal.

In mid-November 2016, the European Commission issued its opinions on the budget plans of the EU member states. It highlighted its firm political will, and Commissioner Pierre Moscovici announced that the Commission intends to act as finance minister of the euro area. The Commission wants member state budgets to be geared towards the euro area as a whole, with the aim of actively managing the economic cycle.

The Commission left no doubt that it wants fiscal policies to be loosened. It argues that, due to rising global uncertainties, euro area member states should increase their spending by 0.5% of GDP on average in 2017– that’s about €50 billion – even though domestic economies are growing. In particular, it calls on Germany and the Netherlands to boost spending because they purportedly have the fiscal leeway to do so.

The Commission’s claims are highly problematic, both politically and economically. The current fiscal policy stance in euro area economies has nothing to do with austerity, despite the assertions of certain experts. All large euro area countries are pursuing budget policies that range from neutral to expansionary. Low interest rates are providing tremendous relief to national budgets, but very few euro area countries are upholding their pledge to take advantage of these favourable circumstances by cutting debt levels.

The Commission argues that higher spending by countries that have the fiscal capacity to do so will lift the economies of other member states, especially while the ECB is keeping interest rates low. But there is no evidence to back this up. Any spillover effects would be minimal. The German Bundesbank estimates that additional, deficit-financed spending in the amount of 1% of GDP would boost euro area growth by a meagre 0.15%. In other words: Using public money to build bridges and roads in Germany will not pave the way to a better economic future in Portugal.

The Commission is embarking on a path that German policy-makers once referred to in the 1970s as Globalsteuerung– a model of state intervention to steer the economy. Back then, economists and politicians were guided by the belief that they could engineer the performance of national economies and the course of business cycles. In reality, however, this notion of being able to steer the economy gave us escalating levels of government debt that, in the aftermath of the 2009 global economic crisis, led to a debt crisis in the European monetary union. The Commission is stoking expectations about stimulus policy measures that have already proven disappointing at the national level. In addition, its approach distracts attention from structural challenges that often take time to manifest themselves. These challenges cannot be solved with injections of stimulus spending.

Today, the euro area’s economy is growing at an annual pace of 1.7%, well above its “potential” of about 1%. Under these circumstances, our priority must be to boost the potential for growth, not to deliver a short-term, deficit-financed jolt to the economy. To do this, Europe must take steps to improve investment conditions and to provide young people with opportunities for training and employment. This will require doing a better job of harnessing the potential of our internal market. Two years ago, Germany’s Finance Minister Wolfgang Schäuble teamed up with Italy’s Finance Minister Pier Carlo Padoan to propose measures to spur more investment, and last year he called for a refocusing of the EU budget towards forward-looking technologies and necessary national reforms. Little has been done in the meantime.

When it comes to coordinating the budget policies of euro area countries, the Maastricht Treaty assigns a set role to the European Commission. However, this role does not consist – as the Commission is trying to do – of demanding the performance of additional tasks by member states that are working to safeguard sustainable public finances. Instead, the Commission should be making efforts to ensure that all euro countries are pursuing sustainable budget policies.

There is still much be to done in this area. Debt levels in 14of the 19euro area countries exceed the threshold of 60% of GDP – this includes Germany, whose debt-to-GDP ratio stands at just under 70%. Despite a pick-up in economic growth, debt ratios in five euro area states have climbed to record levels, sometimes well over 100%. The gap between Germany and France continues to widen.

The Commission’s proposal would drive debt levels in Europe even higher. One of the key lessons from the crisis years is in danger of being forgotten. Every single country in the monetary union must ensure that its fiscal policy is sustainable. This is an imperative prerequisite for maintaining investor confidence, retaining access to financial markets, and achieving robust growth and employment levels. We must not let ourselves depend on the open-ended continuation of ultra-loose monetary policy.

Germany’s experience shows that a credible consolidation strategy fosters confidence in public budgets and strengthens growth. In 2010, we enshrined debt limits into our constitution, and our general government budget has been close to balance since 2012. The German government has built up the fiscal capacity that will enable us to increase public investment in infrastructure, education and research at an above average level of 5% a year, for years to come. This will help us maintain our position as one of the world’s most competitive economies.

But why shouldn’t we pursue even more stimulus, as called for by the Commission? Both the IMF and the OECD have forecast that Germany’s economy will be running at excess capacity in the foreseeable future. Employment now stands at a record level of over 43.7 million, real wages are rising perceptibly, and there is an acute shortage of skilled labour in several sectors of the economy. For this reason, Germany is certainly not a country that should be urged to increase government spending for the purpose of stimulating the economy.

It is important to avoid making recommendations that would weaken our common fiscal rules and that are incompatible with the mountains of debt facing many euro area countries. Likewise, we should not promote the illusion that state action can steer the economy.

In high-performing market economies, investment activity is driven mainly by private businesses and households. Government policy can contribute to the dynamism of an economy by ensuring a growth-friendly policy framework, liberalised services, improved vocational training, future-proof pension systems and modernised public sectors. In these areas, the Commission’s recommendations are correct, and Germany expresses its full support: Policy-makers have finite powers, and they should use them to find real solutions to problems, in order to achieve the best possible outcomes.

The article appeared first in December 2016 in Süddeutsche Zeitung and Le Monde.

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