Europe’s Debt Fight May Undermine Push for Growth DealRebecca Christie
Europe’s infighting over debt rules may be the biggest challenge to its ambitions for a new commitment to growth at the Group of 20 summit in Australia.
World leaders have already expressed their frustration with the European Union’s German-mandated obsession with budget deficits. When they sit down in Brisbane this weekend to consider the 28-nation bloc’s call for a “comprehensive” growth strategy that seeks to boost private investment and rein in fiscal excess, the G-20 group will include France and Italy, the euro nations that have most publicly fought the EU view.
Germany and its allies say the debt rules are essential for the EU’s credibility yet the euro area’s six-year slump has already weakened the bloc’s reputation for economic management, regardless of whether the 18 euro members can eventually wrestle their budget deficits under control. As global growth wanes, the rest of the world’s capacity to keep indulging Europe’s budget focus is narrowing too.
“Europe has, from a global perspective, been too tight for years,” said Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics in Washington. Even if the euro area relaxes its stance somewhat, “the global economy is growing slower now, so any undershoot matters more.”
Behind the united facade European leaders will present in Brisbane, France and Italy are straining at the budget limits they’ve been set, spurred on by calls from European Central Bank President Mario Draghi for nations to supplement his “whatever it takes” monetary policy stance.
Specter of Stagnation
Stalling growth in Europe was the top risk identified by the International Monetary Fund when it cut its global economic forecasts last month. Bank of England Governor and Financial Stability Board chief Mark Carney, said “a specter is now haunting Europe -- the specter of economic stagnation.”
U.S. Treasury Secretary Jacob J. Lew warned this week that “the world cannot afford a European lost decade,” in a speech in Seattle. He said Europe’s “status quo policies” don’t support the G-20’s growth agenda and “resolute action by national authorities and other European bodies is needed to reduce the risk that the region could fall into a deeper slump.”
Within the EU, calls for new public spending have taken a back seat to budget rules put in place after the financial crisis. Dutch Finance Minister Jeroen Dijsselbloem, who leads the euro-area finance ministers’ group, said the budget pact requires “a clear sense of responsibility” that its credibility must be preserved.
German Chancellor Angela Merkel said this week that the EU should mobilize private capital, pushing back against critics of Germany’s plan to balance its 2015 budget. Her government has proposed extra investment spending of 10 billion euros ($12.4 billion) starting in 2016 in response to calls on Germany to do more to boost growth. That equates to about 0.1 percent of euro region gross domestic product, offering little encouragement to countries in tighter straits.
For Italy and France, under renewed pressure from the EU to overhaul their spending plans, the focus on budget arithmetic is getting in the way of their broader goals. In its EU budget proposals, Italy argued that its debts look worse than they are because of the way future GDP growth is forecast.
The potential economic damage from underestimating future growth, and as a result restricting fiscal policy too much, is far greater than the possible consequences of easing the budget restrictions, Italy said in its initial budget submission. Indeed, if the current slump is affecting the country’s longer-term growth outlook as much as the EU suggests, that would add to the case against tight fiscal policy now, the Italian government said.
Since then, Italy has sought to update its spending plans to assuage European Commission concerns, while continuing to play up the risks of getting it wrong.
“The Italian economy is going through one of the most severe and lengthy recessions in its history,” Italian Finance Minister Pier Carlo Padoan wrote in a letter to Brussels, pointing out that three years of recession have pushed GDP down more than 9 percent from 2008 levels.
“A fourth year of recession is to be avoided by all means as it would be extremely problematic to pull the country out of such an economic environment,” Padoan wrote. “Furthermore, it would make debt sustainability much harder to be maintained.”
IMF analysis supports this approach, said Carsten Brzeski, chief economist of ING-DiBa AG in Frankfurt. In terms of the EU rules on debt-to-GDP ratios, he said, there’s a case to be made that the GDP boost from more public spending could more than make up for the increase in borrowing and related costs.
In Brisbane, the challenge for EU leaders will be overcoming their global counterparts’ skepticism that the debt rules are the best path to growth. Their internal disagreements will make that argument even tough to win, said Guntram Wolff, director of the Brussels-based Bruegel research group.
“Europe at a global level has lost a lot of influence and a lot of credibility because of our inability to agree and to tackle problems much more forcefully,” he said.