Fiscal rules: a return to the past that condemns Europe to irrelevance.

[As usual lately, this is an English AI translation of a piece written in Italian, updated to take into account yesterday’s European Parliament vote]

After three years of near-inaction, and a few months of frantic negotiations, European finance ministers have finally reached an agreement on the reform of the Stability and Growth Pact., that is now being discussed with the European Parliament. At first glance one might think, looking at the ballet of percentages, safeguard clauses, classifications, that this is a technical issue, for insiders. Nothing could be further from the truth. What was at stake, in the discussion that ended with the December last-minute agreement, was the framework within which European countries will have to operate in the coming years to face the challenges that await them. Few things are more relevant today. And that’s why it was a bad agreement. A return to the past that condemns the already battered Europe to irrelevance.

The old Pact now relegated to the attic faced widespread criticism: for its baroque complexity and reliance on numerous, at times arbitrary indicators; for its emphasis on one-size-fits-all yearly limits, fostering short-term discipline that, in effect often turned pro cyclical; for its bias against public investment. Most importantly, the old Pact was consistent with a worldview where the state’s role in the economy had to be limited among other things by imposing restrictive rules on fiscal policies.

That world no longer exists, and this explains the opening, in 2020, of the reform process of the Stability Pact. The 2008 Global Financial Crisis, the calamitous management of the euro crisis, the pandemic and finally inflation, have shown that there can be no stability and growth without stabilisation policies, without adequate levels of public goods such as health and education, without industrial policies and public investment for the ecological and digital transitions. In short, without an active role of the state in the economy.

For this reason, the discussion among academics and policy makers (largely ignored by governments, which woke up at the last minute) centered around the necessity for a philosophical shift. The new rule, it was widely believed, had to change this and put the protection of fiscal space for public policies a the centre of the stage (ensuring, of course sustainability of public finances). A change in philosophy that was to be found in the reform proposal put forward in 2022 by the European Commission. Albeit imperfect, the proposal abandoned the one-size-fits-all annual targets in favor of medium-term plans designed by countries in agreement with the Commission, in a framework that would guarantee debt sustainability and try to achieve an (excessively) moderate protection of public investment.

That framework is still there, but it has been transformed in an empty shell. On paper, multi-annual plans and investment protection still exist. But Germany, reverting to its old obsession with austerity, has imposed a plethora of complex (and as baroque as those of the old Pact) safeguard clauses that will be triggered in the event of excessive debt or deficits (i.e., almost always for almost everyone) and which, overruling the plans agreed with the Commission, go back to imposing one-size-fits-all annual numerical constraints, sometimes even more restrictive than the old rule. Like in the widely criticized old Stability Pact, debt reduction is still the alpha and omega, and it is no coincidence that all frugal countries rejoice that the new rule will be more effective in forcing fiscal discipline than the old one.

The Italian and French governments, the only ones that could have turned the board over, settled for a bare minimum, some short-term flexibility, in order to arrive at their respective elections with some money to spend. A short-sighted and depressing strategy: the elections, and these governments, will pass, but the rule will remain and tie our hands, while China and the United States make colossal investments in the future. It’s all right, as long that those celebrating victory today do not to come and tear their clothes in a few years’ time, when Europe will have become even more irrelevant than it is today.