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EU Austerity Battle Ramps Up as France Announces New Spending

EU Austerity Battle Ramps Up as France Announces New Spending

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Europe is heading for a bruising battle over austerity as governments set out their positions on how to address huge debt loads and help their economies work past the deep Covid-19 recession.

The European Union suspended fiscal limits in 2020 as countries funneled trillions of euros into emergency health spending and job protection programs. But with a discussion among finance ministers in Slovenia on Friday kicking off a debate on those rules, a day of reckoning is approaching for a decision on when and in what form they should be reinstated.

With some countries still bearing the scars of the austerity that took place after the 2008 financial crisis, there are calls to use the opportunity to dramatically rewrite, or even scrap, the controversial Stability and Growth Pact that limits governments’ room for budget maneuver in the name of fiscal probity. 

EU Austerity Battle Ramps Up as France Announces New Spending

Europe is far from united. On the same day France said its budget would focus on driving economic growth rather than tax hikes, eight EU nations led by Austria wrote a letter in support of cutting debt levels.

“Sound public finances are a central pillar of EU membership,” finance ministers from those countries said in their correspondence. “Fiscal sustainability combined with reforms which support economic growth must continue.”

While most countries agree on the need to cut debt, it’s the pace of that effort, along with the effect on workers and businesses, that’s a big dividing line. In contrast to the eight finance ministers, Italian Prime Minister Mario Draghi has said that the pact is obsolete, and the EU Commission is also pushing for a full revamp.

“We have behind us the pandemic and ahead of us the climate transition,” Paolo Gentiloni, the Italian who serves as EU Economy Commissioner, told reporters on Thursday. “This is why it is so important this discussion.”

To drive the debate, the Commission will start a public consultation in the fall, meaning that no decision is due before the Sept. 26 election in Germany. 

In Europe’s biggest economy, long a bastion of fiscal reticence but not a signatory to the joint letter, politicians vying to succeed Angela Merkel as German chancellor this month are paying lip service to the need for future budget consolidation while also endorsing ambitious spending plans. 

That raises the prospect that the country could be less hawkish than previously, even if Germany is unlikely to match the borrowing appetite that France and Italy will surely have. 

Fiscal Rules

Elements of European Union Stability & Growth Pact before the crisis

  • Deficits should be aimed to stay within limit of 3% of GDP
  • Public debt should be aimed to stay under 60% of GDP
  • EU Commission, finance ministers monitor progress

France’s debt plan will rely on investment to fuel economic growth. Italy is looking a similar path that would see it continue to pump money into the economy.

“We won’t make the error of consolidating public finances too fast and killing off growth,” said France’s finance minister, Bruno Le Maire. “It is perfectly possible to combine a return to growth and a reasonable reconstruction of public finances.” 

As in Germany, domestic politics is also playing a role in France’s budget program. President Emmanuel Macron faces elections in April and is under pressure to wean the economy off emergency aid without disrupting the recovery. 

France’s budget deficit is forecast to be 4.8% of output next year, but Le Maire said it will likely end up being more because of Macron’s investment and jobs plans. 

Many countries are able to tap the EU’s recovery fund for certain spending projects. That will particularly help the weaker south, with almost half of the 800 billion euros ($947 billion) going to Italy, Spain, Portugal and Greece.

Record-low borrowing costs -- France’s 10-year yield is below zero -- also mean governments have space to avoid retrenching.

That argument hasn’t swayed the neighboring U.K., which this week announced tax hikes to fund healthcare spending, putting the country in the vanguard of major developed economies pushing to trim pandemic budget deficits. 

In the EU, the eight fiscal hawks acknowledge that there may be a need for some “simplifications and adaptations’ of budget rules, but only if proposals don’t jeopardize fiscal sustainability.

But some countries, particularly in Southern Europe, desperately want to avoid repeating the sharp spending cuts that choked output for a long period over the past decade.

“We need to make sure that as we move to more normal times, we don’t cut public investment,” Portuguese Finance Minister Joao Leao told reporters. 

©2021 Bloomberg L.P.