Why Europe Needs Another Fiscal ‘Booster Shot’ - Barron's

The Eiffel Tower behind a wooden fence during the Covid-19 lockdown in Paris, France.

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The European economy has lost ground compared with the U.S. and China, and the Covid-19 crisis will widen the gap. Europe’s recession was twice deeper than in the U.S. in 2020, but it will recover at slightly more than half the pace of the American economy this year, according to most forecasts.

That is due to a toxic combination of bundled vaccination campaigns, bad political choices when dealing with restrictions and lockdowns, and, in the European Union at least, a cumbersome decision process that prevents swift decisions in a crisis.

The International Monetary Fund, in its European review this week, sees the EU economy growing at 4.5% this year and 3.9% in 2022. That compares to a 6.4% jump this year for the U.S. economy, boosted by the $1.9 trillion Biden stimulus—which will, in part, benefit Europe and add about 0.3% to its 2021 output.

The lack of new fiscal stimulus in Europe, after the significant efforts decided last year by most of the region’s governments, is now weighing on growth. The IMF estimated this week that the European economy needs another 3% of gross domestic product as a “fiscal booster shot,” said Alfred Kammer, head of the IMF’s European department.

The problem is that national governments remain obsessed by the levels of public debt even if they shouldn’t worry for now. And that politics prevent the EU from pushing for a more ambitious package.

Europe can at least show a little progress compared with its reaction to the global financial crisis of 2008. Back then, it reacted to a major shock with fiscal restraint and monetary prudence, until the European Central Bank’s new president Mario Draghi switched gears in 2012 by pledging to do “whatever it takes” to preserve the euro.

Last year, in contrast, the ECB reacted swiftly with a massive asset-buying program, now worth €1.85 trillion, and, after a few months, the EU even managed to launch a €750 billion plan of loans and grants, financed by joint borrowing, to help member countries cope with the consequences of the crisis and invest in the future.

But not one cent of the plan adopted in principle in July and finally greenlighted in December has been spent. It has yet to be ratified by every single of the 27 member states.

Contrast this with the 48 days it took between President Joe Biden’s inauguration in January and the final adoption of his jumbo stimulus plan by Congress.

The EU also decided last year to suspend its cumbersome fiscal rules that theoretically prevent any member countries to post a fiscal deficit topping 3% of GDP and carrying a public debt load above 60% of GDP.

And right they were: because of measures taken to cushion the Covid effect, public debt reached 90% of GDP in the EU at the end of December, and 97% in the eurozone.

The fiscal rules over the years have been criticized as too complex, too rigid, and as a result nearly impossible to enforce in any serious way. But they have also been a straitjacket in times of crisis, used as a tool by some of the austerity-prone governments to prevent any discussion on the pooling of debt or joint fiscal policies.

Some soul searching is now going on, and some economists have put forward many ideas to change the rules and devise more intelligent ways for governments to manage their budgets without putting the monetary union at risk of a major debt crisis, as happened in 2010, starting with Greece.

This is an ideal moment for such reform, as interest payment on public debt has dwindled over the years due to declining interest rates. Annual interest payments on public debt in the eurozone amounted to more than 4% of GDP in 1999, at the onset of the monetary union. It had shrunk to 1.6% of GDP 20 years later, even though the level of public debt had ballooned from 65% to 84% in the meantime.

But any formal proposal for changing fiscal rules will run into the traditional European roadblock, i.e. the temptation to kick any serious problem into the long grass and wait until a crisis becomes existential.

But speed is of the essence in times of crisis, as the EU has illustrated to its detriment in the last year.

So it is likely that a deep recession followed by an underwhelming recovery will make Europeans become poorer compared with Americans. In 2008, the eurozone’s GDP per capita amounted to 78% of the U.S.’ In 2019, after the global financial crisis, it had fallen to 73%. With Europe’s underperformance throughout the Covid crisis, it is likely to shrink further.

The Link Lonk


April 15, 2021 at 07:52PM
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Why Europe Needs Another Fiscal ‘Booster Shot’ - Barron's

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