Commentary: Fiddling While Budgets Bulge

Europe's leaders are using accounting tricks to fix deficits. That won't cut it

Maybe German Finance Minister Hans Eichel was deliberately trying to spark debate when, in early November, he proposed permanently moving the Oct. 3 German Unity Day holiday to a Sunday, to free up an additional workday and generate more tax revenue. Or maybe Eichel was just clueless. Either way, the public outrage was so widespread that even Eichel's fellow Social Democrats stomped on his proposal.

Perhaps it was a bad idea. But does anyone have a better one? Not Eichel's critics, none of whom offered constructive alternatives to his budget consolidation package, a collection of one-off measures and dubious attempts to juice economic growth, such as the holiday deletion. And hardly anyone in politics said a word about the most troubling aspect of his plan, securitization of payments made to the government by former state enterprises Deutsche Post and Deutsche Telekom (DT ) to fund worker pensions. The government figures it can raise $7 billion by issuing bonds backed by that future income. That would bring the deficit marginally closer to 3% of gross domestic product, which is the maximum allowed under Europe's Growth & Stability Pact -- a target Germany hasn't hit since 2001. But financial analysts warn that in the long run these bonds will cost the government more money than simply issuing regular government debt now.

Such one-time budget-cutters are very much in fashion in Europe this year. The Italian Treasury, for example, is engaged in a multiyear program to securitize the government's vast real-estate holdings, effectively trading future rent income for immediate cash. The amounts raised next year could amount to between 0.5% and 1% of gross domestic product, according to Morgan Stanley (MWD ). France is imitating Germany's pension trick to raise around $10 billion and studying Italian-style securitization of government real estate. "Because these are unsustainable one-off accounting tricks that make life easier, they are dangerous," says Eric Chaney, co-head of European economics at Morgan Stanley in London. "The structural deficits remain."

The real problem is spending. But as the proliferation of quick-fix bookkeeping methods demonstrates, European politicians lack the will to get expenditures under control. Their failure, along with the growing U.S. trade and budget deficits, already is unsettling the world economy and contributes to volatility in financial markets. The lack of fiscal discipline "undermines trust in economic policy, and trust is decisive," says Rolf Schneider, head of economic research at Dresdner Bank (AZ ) in Frankfurt.

In years ahead, swelling government debt in Germany, France, and Italy could act as a serious brake on European growth, which is hardly torrid now. Dresdner estimates that, if nothing is done, Germany's public debt will equal nearly 100% of GDP by 2020, vs. 66% this year. That puts Germany on a path to join Italy, which already has a debt ratio of over 100%, in the euro delinquents' club. In that worst-case scenario, European governments would have little budget money leftover after paying interest on the debt and the cost of caring for aging citizens.

Finance ministers can't solve this problem on their own. Municipalities account for nearly half the overall deficit, while opposition parties block spending cuts to please voters. Germany's best shot at reducing the deficit would be to slash subsidies, estimated at more than $200 billion per year, compared with a deficit of $114 billion. But here the opposition Christian Democrats are as much a hindrance as the left-leaning Social Democrats. To protect their constituencies, the conservatives have blocked reductions in giveaways for new home construction, a move that would save the government $9 billion through 2008.

If the warring interests swore an oath of budgetary prudence, it would be possible to make progress. With their slow growth economies and aging populations, France, Germany, and Italy certainly can't afford to push their financial obligations into the future. They should be cutting spending not only to eliminate deficits, but to reduce taxes and bolster consumer spending. "We need a rethinking of the role of the state," says Stefan Bielmeier, a senior economist at Deutsche Bank (DB ). For that matter, even just a little more thinking would be welcome.

By Jack Ewing

With John Rossant in Paris

— With assistance by John Rossant

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