The European Union's Growth and Stability Pact is under increasing pressure. A number of EU member states appear unlikely to meet the pact's strict terms, which include budget-deficit limits. The aim of the pact is to make national governments maintain fiscal discipline, but there are increasing worries that it is too rigid and should be relaxed. The outcome of this debate will be vital for the Central and Eastern European candidate countries that are set to join the EU in 2004.
Prague, 18 September 2002 (RFE/RL) -- Just as floodwaters can undermine the foundations of even the strongest building, so, too, can an economic slowdown undermine the best-intentioned financial planning.
That's what has happened with the European Union's Growth and Stability Pact. The pact is a measure designed to ensure that member states in the common-currency euro-zone exercise prudence in their public spending policies. It requires them to work toward balanced budgets and not to exceed a deficit in any one year of 3 percent of gross domestic product, or GDP.
The trouble is that major EU members like Germany, France, and Italy, as well as smaller members like Portugal, are having trouble meeting that target. That's because of lower-than-expected economic growth, but also in some cases because of unwillingness to rein in public-sector spending on grounds of political popularity.
Of course, as with any set of statistics, the figures can be made to look better or worse. France, for instance, is seeking to exclude defense spending from the deficit calculation. Paris has just sharply increased defense spending and does not want the extra 1 billion-euros-a-year ($975 million) cost to push the country toward the deficit limit.
Reports say other countries are seeking similar "escape routes." The European Commission under President Romano Prodi is opposed to such exemptions, however.
The commission can levy fines against those member states that breach the stability-pact limits, and transgressors suffer, in addition, a certain loss of "face" among their partners.
However, there is increasing pressure for the pact to be made more flexible. One such voice is that of Nobel Prize-winning economist Robert Solow, who said last week that the stability pact's terms are themselves restricting economic growth.
German Finance Minister Hans Eichel has also entered the debate, calling for the deficit calculation to be more broadly based, taking into account both built-in or "structural" factors, and also variables of the economic cycle.
Italian Finance Minister Giulio Tremonti has also suggested "interpreting" the way the stability pact is applied, as he put it.
In view of all this, senior London-based financial analyst Marco Annunziata of the Deutsche Bank made a prediction. "If the economic cycle continues in a period of weakness for a year or so, then I think it is very likely that there will be some relaxation in the terms of the stability pact itself," Annunziata said.
Another analyst, Adrian Ottnad of the Bonn Institute for Economics and Society, said any such relaxation would have negative consequences. "Lowering the [requirements of] the stability pact, in such a situation, I believe, would mean to destroy it in the end. And that would cause some trouble for [the value of] the euro," Ottnad said.
With up to 10 candidate countries set to join the EU less than two years from now, the issue of the stability pact is of key importance. The Easterners are meant to start joining the economic and monetary union two years after accession. But many of them, including the Czech Republic, Slovakia, Poland, and Hungary, are running big budget deficits, mostly around 5 percent.
To fit them into the 3 percent rule, let alone to move them toward balanced budgets, will likely require steep austerity policies. So far, only one of the candidates, Hungary, has published its plan for meeting the terms of the stability pact. Some experts question whether it's possible for the Easterners to do it without causing more social pain. "It is clearly the case that for some of these countries -- and the Czech Republic is a case in point -- that it will be difficult for them, at least in the initial stage, to meet the fiscal criteria, the fiscal deficit criteria," Annunziata said. "This is mostly because, in the case of the Czech Republic, of a 'hangover' burden of previous banking reforms. But for the Eastern candidates as a whole, it's because of the fact that they will have to take on an additional burden of structural reform in the next few years following EU accession."
Analyst Ottnad agrees that the Easterners are likely to have difficulties at first, not least because their tax-revenue systems are often still underdeveloped. However, he sticks to his line that the stability-pact conditions must remain firm. "We should not give [the Eastern newcomers] a bad example, and in the long run, as experience shows, we are all better off in controlling our deficits," Ottnad said.
Ottnad went on to say that criticism of the stability pact as being too rigid is wrong. He said much of deficit size is not related to the external economic cycle but is "structural," meaning built in to the system. That means the real cure is reform in the problem areas concerned.
His views parallel those of Tommaso Padoa-Schioppa, an executive board member of the European Central Bank, who said there are no plans to change the stability pact. Padoa-Schioppa said that even in difficult times, the pact prevents countries from pursuing extravagant fiscal policies at the expense of the whole European Community.