Europe's Tough Budget Taskmaster

Pedro Solbes is drawing fire by insisting that EU members stick to strict limits on their deficits

With his ready smile and affable manner, Pedro Solbes Mira could be anyone's favorite uncle. But that's not how Finance Ministry officials in Paris, Rome, and Berlin see him. To many of them, the 60-year-old European Commissioner for Economic & Monetary Affairs is a bossy Brussels bureaucrat who insists they should curb their budget deficits at precisely the time they'd prefer to boost their flagging economies by spending more. "[Solbes] is cracking the whip when he should be lenient," complains one Italian official. "That's why tension is mounting between him and us."

Tempers are likely to flare at the upcoming meeting of European Union Finance Ministers on Jan. 21. Solbes wants the ministers to censure Germany for running up an "excessive budget deficit." He also wants them to warn France that it is next in line for a scolding. Smaller EU members that have struggled for years to knock their public finances into shape could turn on their spendthrift partners. Whatever happens, the outcome of the meeting will have a major impact on government spending plans, the euro zone economy, and business.

Solbes has been courting controversy for some time. He drew the ire of Germany, France, and Italy on Jan. 8 when he lambasted them for the perilous state of their public finances. He was particularly critical of Germany, whose budget deficit topped 3.75% of gross domestic product in 2002 and is likely to come in at around 3.1% this year. That's still above the 3% ceiling inscribed in the Stability & Growth Pact, which European Union nations subscribed to--ironically at Germany's behest--before the launch of the euro. Germany, along with the rest of the euro zone, has committed to balancing its budget by 2006, a goal that looks increasingly out of reach.

But the Spaniard soldiers on. Although he's a Socialist, Solbes earned a reputation as a tough cost-cutter during his four years as Spain's Finance Minister in the 1990s. Thanks in large part to his efforts, Madrid put its financial house in order: The country's deficit is unlikely to top 0.3% this year. Now, Solbes is pressing other countries to swallow the same bitter medicine. He insists Germany must draw up a plan by May 21 to reduce this year's deficit or eventually face fines that could reach $600 million. He also wants France and Italy, which are expected to run 2003 deficits of 2.9% and 2.2%, respectively, to take urgent remedial action.

But the wayward three are in no mood to listen. German Finance Minister Hans Eichel has already hiked taxes and cut spending once this winter and fears that further deficit-squeezing measures could push the economy into its second recession in two years. A senior French official voices similar concerns. "You have to drive a little more intelligently on a road where there is fog and ice. You could drive into a recession," he says. Indeed, some European policymakers argue that leaders should follow U.S. President George W. Bush's lead and bolster their sputtering economies with tax cuts and more public spending.

Instead of priming the pump, says Solbes, European governments should be spurring growth with structural reforms. The Continent's rigidly regulated labor markets and costly social-security systems are ripe for an overhaul. The fiscal benefits would be twofold: Treasuries would see their tax revenues rise in tandem with corporate profits, while welfare payments would decline.

Mind you, Solbes, a career civil servant, didn't come this far by stubbornly sticking to his guns. It was his idea to give EU countries until 2006--two years longer than the original deadline--to balance their budgets. He also believes that countries that build up surpluses in good years should be able to spend more when times are tough. So it's fine for Luxembourg, for instance, to slip into the red in 2003, when its economy is slowing. But there are limits to how much slack Solbes will cut EU members. "The 3% limit is untouchable," he says.

The question now is whether a majority of European Finance Ministers will back Solbes' assault on Germany when they meet on Jan. 21. They supported him last October when he launched "excessive deficit" proceedings against Portugal, whose deficit topped 3.4% in 2002. In response, Portuguese Finance Minister Manuela Ferreira Leite has slashed spending and expanded the privatization program. But Portugal has far less clout in Brussels than the likes of Germany and France. And since Lisbon was chastised, the global economy has further deteriorated, and pressure for reforming the Stability Pact has been mounting. On Oct. 17, European Commission President Romano Prodi went so far as to call it "stupid."

Despite the might of his opponents, odds are that Solbes will win the day, say insiders. For one thing, Eichel already seems resigned to a public dressing-down and could even himself vote in favor of censuring Germany. For another, most Finance Ministers accept that the euro needs to be underpinned with sound government finances. They also realize that if they allow big countries to flout the rules, it will spell the end of the pact. That could pitch Europe into a new era of economic and financial uncertainty that could hurt far more than Solbes' scoldings.

By David Fairlamb in Frankfurt, with Carol Matlack in Paris

— With assistance by Carol Matlack

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