November 22, 2013
Guest post by Leen Verkade, member of the social-liberal party in The Netherlands, D66.
The issue that the Eurozone rules (Fiscal Compact) should be changed was once again brought up last week by Eurozone chief Dijsselbloem. But the proposed change still is along the same line that has been followed for years, and still does not address some of the underlying problems that caused the problems of the past years.
It would seem that one of the goals of the Stability and Growth Pact (SGP) and its successor, the Fiscal Compact is pretty straightforward: to prevent the turmoil that has recently plagued the Euro. The SGP failed this task and it remains to be seen if the Fiscal Compact would fare much better. Not in the slightest bit because the changes are only marginally different. Although the focus on more enforcement is indeed much needed, that was not the only flaw in the SGP. New amendments should also focus on new ways to measure economic and budgetary performance (now they mainly focus on government debt and budget deficit as percentage of GDP, and to lesser extent on inflation and interest).
Despite the expansion of the rules, crucial aspects that led to the critical situation in some of the member states, are still not covered. If we compare a few of the member states according to the Fiscal Compact criteria it is apparent that it would not have correctly foreseen the problems or predicted the situation those countries are in now.
At the onset of the crisis, the government debt of Belgium was very high compared to that of Portugal and Ireland and even close to that of Greece. Ireland’s debt especially was extremely low, not to mention that it was decreasing. Portugal was also very close to the convergence criteria. Inflation and interest were within the bounds in all countries, and did not diverge much. But we all know what happened, Greece was a disaster, Portugal had severe problems too, Irish debt is skyrocketing, while on the other hand, Belgium got through the crisis fairly smoothly. Much to the contrary of what the criteria would predict.
This failure was of a different nature in each case. For Greece, one of the core problems was that most of its debt was financed by short-term international loans, while that of Belgium was financed almost exclusively by long-term domestic loans. Greece got these loans relatively cheap because of the confidence in the Euro, which somewhat counterbalanced the loss of competitiveness caused by the unnatural level of inflation caused by the Euro. When the crisis hit, however, this advantage was immediately gone and Greece was faced with the need to refinance a large part of its debt against much higher interest rates. This caused a large government deficit, budget cuts which one of the causes of a general economic collapse.
Ireland, on the other hand, had a very low debt at the start of the crisis, and ran a budget surplus, but ended up running budget deficits higher than Greece. The reason behind this is a very different one. The big problem was private sector debt which was not covered by enough assets, leading to a general economic collapse, which in turn caused government debt (the other way around from Greece in some sense).
What also added to the problems in Greece and Ireland is that they have relatively low government budgets as a percentage of GDP. The Belgian government has a tax income of around 45 % (of GDP), against Ireland with 30 % and Greece with 35 %. It would seem that this gives Belgium more flexibility in its budget. Most economic reasoning would be that this would mean the private sector would have more money to invest in the economy, but this did not happen. Nor where Greece and Ireland capable of raising taxes to the level of Belgium to counter its budget deficit.
The reasons for the problems in Portugal were also quite different. Especially the manner in which the government was invested in public private partnerships, made the fiscal position of the government calamitous. Most of these ventures where off-balance sheet ventures and contained non-tradable goods with high mark-ups such as housing and infrastructure. This was also partially caused by the same problem as in Greece, the large inflow of foreign capital because of the Euro, but also with its own peculiarities.
Even with this, admittedly, very basic analysis it can be concluded that the Fiscal Compact fails to take several issues into account that contributed to the perilous situation of the member states and the Euro, and would likely not prevent it in the future. Therefore the Fiscal Compact should also focus on the following things:
- The structure of the debt rather than just the size of it.
- Non-government debt and especially the banking sector.
- Measure government debt and budget deficit against the government budget and not only against GDP.
- Measure the off-balance sheet items and mark-ups of a government.