The Juncker Commission is now up and running, and it is beginning to give an idea of where it wants to go. Unfortunately not far enough. The two defining moments of the first few months are the Juncker plan, and the new guidelines on flexibility in applying the Stability and Growth Pact. Both focus on public investment.
Public investment deficiency is now chronic across the OECD, and particularly in the EU. Less visible and politically sensible than current expenditure, for twenty years it has been the adjustment variable for European governments seeking to meet the Maastricht criteria, and to control their deficit. Since the crisis hit, private investment also collapsed, and it is still kept well below its long term trend by depressed demand and negative expectations.
Let’s start from the most recent Commission measure. The guidelines issued last weeks, that some countries trumpeted as a great victory against austerity, are in fact just a marginal change. The Commission only conceded that the structural effort towards the 60% debt-to-GDP ratio be relaxed for countries growing below potential, while reaffirming that in no circumstance, the 3% deficit limit should be breached, and that any extra investment needs to be compensated by expenditure reduction in the medium term1.
The Juncker plan foresees the creation of an Investment Fund endowed with €21bn from the European budget and from the European Investment Bank. This is meant to lever conspicuous private funds (in a ratio of 15 to 1) to attain €315bn, mobilized in three years. EU countries may chip into the Fund, but this is not compulsory, and the incentives to contribute are unclear: while the contribution to the fund would not be accounted as deficit (the guidelines confirm it), the allocation of investment will not be proportional to countries’ contributions.
Two aspects of the plan raise issues. First, it is hard to see how it will be possible for the newly established fund to raise the announced amount. The expected leverage ratio is very ambitious (some have described the plan as a huge subprime scheme). Second, even assuming that the plan could create a positive dynamics and mobilize private resources to the announced 315 billions, this amounts to just over 2% of GDP for the next three years (approximately 0.7% annually). In comparison, Barack Obama’s American Recovery and Reinvestment Act of 2009 amounted to more than 800 US$ billions. The US mobilized more than twice as much as the Juncker plan, in fresh money, and right at the beginning of the crisis.
To sum up, the plan and the guidelines are welcome in that they put investment back to the centre of the stage. But, as is the norm with Europe, they are too little, far too little, to put the continent back on track, and to reverse the investment trend of the last three decades.
In an ideal world, the crisis and deflation would be dealt with by means of a vast European investment program, financed by the European budget and through Eurobonds. Infrastructures, green growth, the digital economy, are just some of the areas for which the optimal scale of investment is European, and for which a long-term coordinated plan is necessary. That will not happen, however, for the fierce opposition of Germany and other northern countries to any hypothesis of debt mutualisation.
The solution must therefore be found at national level, without losing the need for European-wide coordination, that would guarantee effective and fiscally sustainable investment programs. With Kemal Dervis I recently proposed that the EU adopt a golden rule, similar in spirit to the one implemented in the United Kingdom between 1998 and 2009. The rule requires government current expenditure to be financed from current revenues, while public debt may be used to finance capital accumulation. Investment expenditure, in other words, could be excluded from deficit calculation, without any limit. Such a rule would stabilize the ratio of debt to GDP, and would ensure intergenerational equity (future generations would be called to partially finance the stock of public capital bequeathed to them). Last, but especially in the current situation not least, putting in place such a rule would not require treaty changes, but just an unanimous Council deliberation.
But there’s more in our proposal. The golden rule is not a new idea, and in the past it has been criticized on the ground that it introduces a bias in favor of physical capital; expenditure that – while classified as current – is crucial for future growth (in many countries spending for education would be more growth enhancing than building new highways) would be penalized by the golden rule. This criticism, however, can be turned around and transformed into a strength. At regular intervals, for example every seven years, in connection with the European budget negotiation, the Commission, the Council and the Parliament could find an agreement on the future priorities of the Union, and make a list of areas or expenditure items exempted from deficit calculation for the subsequent years. Joint programs between neighboring countries could be encouraged by providing European Investment Bank co-financing. What Dervis and I propose is in fact returning to industrial policy, through a political and democratic determination of the EU long-term objectives. The entrepreneurial State, through public investment, would once again become the centerpiece of a large-scale European industrial policy, capable of implementing physical as well as intangible investment in selected strategic areas. Waiting for a real federal budget, the bulk of investment would remain responsibility of national governments, in deference to the principle of subsidiarity. But the modified golden rule would coordinate and guide it towards the development and the well-being of the Union as a whole.
Ps an earlier and shorter version of this piece was published in Italian on December 31st in the daily Il Sole 24 Ore.
1. Specifically, the provisions are the following:
Member States in the preventive arm of the Pact can deviate temporarily from their medium-term budget objective or from the agreed fiscal adjustment path towards it, in order to accommodate investment, under the following conditions:
- Their GDP growth is negative or GDP remains well below its potential (resulting in an output gap greater than minus 1.5% of GDP);
- The deviation does not lead to non-respect of the 3% deficit reference value and an appropriate safety margin is preserved;
- Investment levels are effectively increased as a result;
- Eligible investments are national expenditures on projects co-funded by the EU under the Structural and Cohesion policy (including projects co-funded under the Youth Employment Initiative), Trans-European Networks and the Connecting Europe Facility, as well as co-financing of projects also co-financed by the EFSI.
- The deviation is compensated within the timeframe of the Member State’s Stability or Convergence Programme (Member States’ medium-term fiscal plans).
Last Friday the negotiations on the 2014-2020 EU budget were put on hold because of fundamental disagreements among Member States. Surprise, Surprise… I do not think it is a big deal anyway. There is not doubt that at the next meeting a last-minute- low-key compromise will materialize. A compromise that will most likely save the most controversial items of the EU budget, like agricultural policy, and cut the very few investment programs that had made it into the budget in the past. But who cares, after all; our leaders will be able to show the usual self complacency, and the rest of us will be left with the all-too familiar sentiment of yet another missed opportunity.
Most commentators blamed David Cameron, but his position was not new, and hardly surprising. The UK has always tried to extract as much as it could from the European process, while giving as little as possible; others did it, are doing it, and will do it. But rarely with the consistency and the single-mindedness of the UK. This was true with EFTA in the 1960s, then again with the infamous UK rebate negotiated by Margaret Thatcher in 1984. If England never played for the common good in the past, how could we expect it to do so at a times of crisis?
No, the real surprise of the failed budget negotiation was not England, but Germany, and the coalition of the fiscal hawks. Read More
Today the Irish people will vote on the Treaty “on the Stability, Coordination and Governance in the EMU”, also known as the “fiscal compact”. This referendum is of paramount importance for the whole European Union. I recently wrote an editorial on the French daily Le Monde, together with Imola Streho, explaining why we believe it to be poorly designed and economically ill conceived. Here is an English version.
In a moment of chaos, in which it is very difficult to even simply make sense of actual events, it becomes almost impossible to formulate forecasts. I would not be able to bet on grexit (or porxit, spaxit, itaxit, for that matter), in one sense or in another. I just wait and see.
A few things seem to be changing the broad picture, with a mix of encouraging elements, and added uncertainty.
Fact number one: The new French president is acting as a catalyst for those who are unhappy about German-imposed austerity. Yesterday’s informal council meeting, disappointing as usual, shows that Hollande has the strength to at least impose the discussion of his themes to reluctant Germans (for example the eurobonds). But it remains to be seen whether him and his newly found supporters will be able to force implementation of the measures they advocate for.
Not that he needs it, but I feel I must advertise this New York Times editorial by Paul Krugman, on the looming European catastrophe. As usual, it is masterly written. I just want to add one remark: The economic suicide of Europe happens because of ideological blindness. We are trapped in a doctrinal approach to economics and economic policy. There is nothing you can do against fundamentalism.
Should the title of this blog change from Gloomy to Desperate?
Martin Wolf has a very interesting piece on China’s attempt to rebalance its growth model from exports to domestic demand. Wolf remarkably shows how this attempt has been going on for at least a decade, with unequal pace, and several stop-and-go. I’d add that the crisis itself played a contradictory role. China on one side was one of the first countries in 2009 to implement a robust stimulus plan amounting to more than 10% of GDP; on the other, it did not resist (as most countries) more or less hidden protectionist measures and currency manipulation. Wolf concludes that, while successful, the rebalancing from external to domestic demand led to excessive (and not necessarily productive) investment. The new rebalancing challenge of China lies in increasing income and consumption of its population.
What I take from this is that China fully grasps its new role in the world economy. Its leadership understood long ago that the transition from developing/emerging economy to fully developed economy needed to pass among other things through less dependence on exports. A large dynamic economy cannot rely on growth in the rest of the world for its prosperity. Even the debate on reforming the welfare state and on health care had as one of his reasons the necessity to reduce precautionary savings. The rebalancing act is long and unsteady, but definitively under way.
It is also worth noticing that a better balance between domestic and external demand in the large economies is crucial element in reducing the macroeconomic fragility of the world economy through decreasing trade imbalances.
It is striking, in contrast, how Europe remains trapped in a sort of small country syndrome. The “Berlin View” permeating the Fiscal Compact advocates fiscal discipline and domestic demand compression, in order to improve competitiveness and to foster export-led growth. Besides the fact that it is not working, this is equivalent to tying Europe’s fate to the performance of the rest of the world, giving up the ambition of being a major player in the world economic arena. What a difference with the ambition and the forward looking attitude of China…
A picture of Germany somewhat different from the recent past emerges from two articles in the Financial Times of March 30:
- The first shows that, in a framework of decreasing unemployment, Germany’s domestic demand shows signs of vitality. Investment, and more remarkably consumption, increased moderately in 2011 and are forecasted to continue this year. Contrary to what happened in 2009-2011, most of growth for 2012 should come from domestic demand. This goes with (finally!) increasing wages, and some signs of price increases.
- The second article reports discussions on the ratification of the fiscal compact, with some parties in the Bundestag calling for a stop to austerity and for more solidarity towards troubled countries.
This does not mean that the overall stance of Germany will become openly expansionary, as would be sorely needed. But it is at least an indicator that the German domestic context is less monolithic than it used to be. This cannot be bad…