Monday 19 February 2018

New debt rules are unlikely to solve Europe's problems

Global crises create strange political bedfellows. Rick Perry, the Texas governor and aspiring US presidential candidate, and German Chancellor Angela Merkel would appear to have little in common, apart from the likelihood that neither will be holding high office two years from now.

But the former cotton farmer from Paint Creek, west Texas, and the ex-physicist from Hamburg are both passionate supporters of the idea of forcing governments -- through the constitutional courts -- to balance their books. In the US it is called a balanced budget amendment, in Germany it is called a debt brake.

Like any economic idea, it has it advocates and its critics. For years both sides have squabbled over the idea and the rest of the world has broadly ignored their esoteric debates.

But now this idea, that governments must be forced by constitutional obligation to always run a budget surplus (or at least be budget neutral) is at the heart of the changes in Europe.

But more than that, the idea of a debt brake is seen as the solution to Europe's two-year-long debt crisis.

For most European countries -- including Germany -- such a change will have huge economic consequences, short term and long.

In the short term, virtually every country in the advanced industrial world would be unable to meet a balanced budget (or debt brake) condition, with only Switzerland, Norway and... well Saudi Arabia able to comply immediately.

In order to comply, the economies of Europe will have to plunge into fresh rounds of austerity (with all the accompanying dampening effects) and not just meet the current EU Stability and Growth Pact criterion, but generate actual budget surpluses. Such surpluses haven't been seen in France for instance in several decades, so this is not going to be easy.

For Merkel getting Europe's laggard economies to change their budgeting culture is a good thing and the debt brake will do that. In that sense she is gaining a precious victory from the current talks under way in Europe.

But many economists fundamentally believe a legal instrument that forces countries to always run a balanced budget will eventually be seen as a catastrophic step. Such debt brakes are already in place in US states and have crippling economic effects, particularly on employment and public services.

Are all European countries to have such debt brakes in all events? What about war, national emergencies, natural disasters, capital spending programmes? Should there be any exceptions?

Never mind the natural recourse countries have had for centuries to deficit spending when their economies need some temporary stimulus. Is this all to end? Apparently so.

But as a legal professor from Harvard University said this week about the European plan -- does anyone really believe it will happen, or happen effectively?

Courts -- even when dealing with constitutional matters -- tend to side with governments, particularly governments citing the national interest at a time of crisis.

The German balanced budget rules even include get-out clauses. For example Germany cannot run a deficit of more than 0.35pc of GDP, but the country's amendment does include reference to "market developments that deviate from normal conditions". This would seem, on the face of it, to provide at least some wriggle room, even for Germany.

While a dose of strong Germanic fiscal discipline would no doubt do this country some good, the proposal for a debt brake or balanced budget amendment is not going to solve all of Europe's ills or Ireland's.

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