For a few years now, I have felt as if I live intellectually in the Alps. In the European Council, I used to translate the virtues of discipline into Mediterranean languages, while also interpreting for northern countries the difficulties felt by southern Europe.
A mutual learning process is now essential. The south, as it adapts to the social market economy, must be more determined in pursuing fiscal discipline and structural reforms. Likewise the north, Germany in particular, must appreciate that such efforts by the south are unlikely to generate sustainable improvements unless Europe’s policy framework becomes more growth-friendly.
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When the EU acknowledged in May that Italy, after two years of tight fiscal policy, no longer needed to be under the EU’s “excessive deficit procedure”, it was seen in the country like a release from prison. Although the exit reduces interest rates, and so has a favourable effect on the budget, this interpretation was mistaken. Some in Italy even saw the decision as an EU admission that it had been too tight-fisted to start with. Others jumped straight into discussions on new ways to spend money, as if freed from budgetary constraints intended to safeguard stability and protect future generations.
In fact, achieving stable and sustainable budgetary conditions will require southern countries to make cultural adjustments. In particular, people must accept that budgetary discipline pays. Policy makers will need to persuade people that fiscal discipline is not a forced tribute paid to gods residing in more northern parts of Europe. It is simply appropriate economic behaviour.
Northern Europe must also give something: a deeper understanding of the role of investment in economic activity. The Maastricht treaty did not distinguish sufficiently between public expenditure for consumption and for investment. Consequently, many European countries have achieved budgetary discipline through disproportionate cuts in public investment, which is usually politically less painful – though more damaging – than cutting public current expenditure.
Of course, it is not easy to distinguish among different sorts of public investment – whether productive investments or pseudo-investments (as when a government transfers funds to state-owned companies to cover their current losses). Definitions and measurement need serious work. Yet this alone does not justify assuming that all public sector investment is essentially like consumption, or lacks any economic merit and productive purpose, which is what is done if the pact is taken at face value.
Now that the south is moving closer to the economic and fiscal concepts of central and northern Europe, it is encouraging to see that the European Commission and the European Council – and perhaps even Germany – are more willing to enforce the pact more meaningfully.
But what about structural reforms? Although they have come to be recognised as a top priority, more nations have succeeded in adjusting their budgets than in reform. There are two reasons for this.
The first concerns the game of pitting government against organised interest groups. The task of government is harder when reforms directly affect the interests of well-organised groups, businesses, professionals or public sector employees. Such steps will usually inject competition into a market, wiping out comfortable rents for specific groups. The effects of budgetary measures such as tax rises are, by comparison, more diffuse.
The second reason is that Europe provides less help on the more important task: structural reforms. The focus of European monetary union has been on obtaining budgetary discipline.
Ultimately, this boils down to a simple rule of thumb: if you meet stronger opposition to structural reforms domestically, and receive less of a push from Europe on this than on budgetary consolidation, the likelihood is that you will make less progress on structural reforms.
That is why I welcome the recent reorientation of EU policy – not away from fiscal discipline but towards emphasis on country-specific recommendations on structural reforms, for example to make labour markets more flexible. When I was a member of the European Council, I favoured the idea of contractual arrangements between the commission and individual countries on specific reforms as the way forward. This strengthens the influence of the EU on governments and strengthens the hand of each government in relation to domestic organised groups, all in the interest of achieving structural reforms.
Coupled with mechanisms to facilitate the financing of the reforms in countries that still face high borrowing costs but are pursuing the policies recommended by the EU, these arrangements may help to push Europe towards further reforms to promote growth and employment. The European Council of December 19-20 will, I hope, endorse this.
The writer is former Italian prime minister and chairman of the Berggruen Institute on Governance’s Council for the Future of Europe