Europe's Deadly Fiscal Paralysis

Yes, Prime Minister, we know you're upset.

Quarrels over European Union budget policy don't amount to much in themselves. Yet they demonstrate a pathology whose importance is hard to exaggerate. If growth in the euro area is not restored, the future of the union itself will be in jeopardy. Instead of grappling with this, however, Europe's leaders are endlessly engaged with trivialities.

Anti-EU sentiment has become so pronounced that Prime Minister David Cameron has promised an "in or out" referendum on U.K. membership if his party wins next year's general election. So last week, when the European Commission told the U.K. to promptly pay an extra 1.7 billion pounds to make a good on a newly assessed shortfall in earlier budget contributions, the timing wasn't ideal. Cameron declared himself "downright angry."

Separately, France and Italy have come under pressure to tighten their fiscal policies to comply with EU rules. Both countries are suffering from stalling economic activity and are struggling to keep earlier promises to get budget deficits below 3 percent of gross domestic product. Their latest plans, first rejected, have been tweaked and resubmitted, and the commission says they now might be all right. A final decision is due by the end of November.

The U.K. case is the simplest: Cameron ought to grit his teeth and pay up. The rules on EU budget contributions are sensible and straightforward. Contributions are tied by formula to income, as they should be, and the extra payment is owed because statistical revisions have altered the assessment of U.K. national income over the past 12 years. It should not have come as a great surprise. That's that.

The case of France and Italy is quite different, as it has to do with their national budgets. Here, the EU rules are anything but sensible. They've demanded fiscal austerity when what's required is fiscal accommodation, if not outright stimulus. And another set of rules make it hard for the European Central Bank to step in, as the U.S. Federal Reserve did (three times), with unconventional monetary stimulus.

QuickTake Europe's QE Quandary

It's good that the commission has shown some flexibility this week, choosing not to reject the French and Italian budgets out of hand. In November, a new set of commissioners takes over, and it's to be hoped that they too will refrain from demanding further tax increases and spending cuts.

The sad thing -- and this is what all three cases have in common -- is the waste of political capital and bureaucratic effort on irrelevancies. Instead of finding ingenious ways to bend or argue over the rules, Europe's leaders need to look at fiscal policy from first principles.

The rules that France and Italy have transgressed (like many other EU governments before them) are no good, and they need to be changed.

There's no great mystery about how to revise them. One of the clearest lessons from the euro area's brutal recession and subsequent nonrecovery is that the members of a single-currency area need to pool risk by merging aspects of their fiscal policies. Two elements are crucial. First, arrangements must be made for jointly guaranteed public borrowing, to increase the capacity of the euro countries to run bigger deficits when the situation demands it. Second, new rules, sensitive to the economic cycle, must be written to prevent those arrangements from leading to too much borrowing when the situation doesn't demand it.

The economic theory is easy, but the politics, evidently, are close to impossible. It's understandable that Europe's leaders recoil from the idea of changing their treaty, because who knows where that process might lead. Harder to forgive is the failure even to recognize the fiscal problem and devise modest reforms that don't require constitutional upheaval.

Squabbling over rules that made no sense to begin with is no substitute for real reform.

--Editors: Clive Crook, Mary Duenwald.

To contact the editor on this story:
David Shipley at davidshipley@bloomberg.net