How neglecting the Eurozone budget rules helped countries politically and economically

Inclusive Economy18 Dec 2015Evert-jan Quak

To reduce budget deficit under 3% of GDP was one of the main reasons for the recovery package in the Eurozone, which were based on austerity and lowering the production costs to boost exports and economic growth. But history shows that countries need more time during recession to decrease their deficit while increasing economic growth.

Background article

This is a background article for our longread Ideals versus reality – A false start for the Eurozone.Click here to go to the full longread

It was the Germans who proved to be particularly creative at the start of the Eurozone. On one occasion, then Finance Minister Theo Waigel tried to raid the gold reserves of the Bundesbank. Another time, his successor Hans Eichel sold part of the government’s stakes in Deutsche Post and Deutsche Telekom to private investors. Both measures were intended to artificially spruce up Germany’s debt statistics. It was Germany, of all countries, that was the second member state after Portugal to be subjected to an excessive deficit procedure by the European Union. See more on this in Spiegel, Built on a lie: The Fundamental flaw of Europe’s common currency – Part 4: Opposed to Monetary Union, 9 March 2010.

The then Chancellor Gerhard Schröder, who had once denigrated the euro as a ‘sickly premature birth’, promised improvement. In 2003, Schröder called for a ‘change of mentality’ in his own party, the SPD, and in German society as a whole. ‘Much will have to be changed to keep our welfare and social security at least at its current level’, he stressed, as he argued in favour of reforms that would trim entitlements and cut taxes. The Chairman of the SPD, Franz Muntefering, supported the tough medicine administered by Schröder, saying ‘we believe that things must be rearranged and restarted in Germany in this decade’. This resulted in the ‘Agenda 2010’ reform programme, which was in line with the Lisbon Strategy, to make the European Union the ‘most dynamic economic area in the world’.

The implementation and transition period for the reforms in Germany took five years. The policy was in line with what financial markets dictated for a long time, i.e., to keep public spending and taxation low and moderate wage moderation. Cheap household debts were able to maintain purchasing power, which helped the German government to achieve acceptance of the reforms until the economy grew again. That Germany decided to relax the EU budget rules helped Germany to regain economic confidence and growth without unnecessary austerity measures – although it could not help the SPD, which lost the general elections to the conservative CDU of Angela Merkel, who went further with the same policies.

Before 2007, France, Portugal, Italy, Austria and Greece, but not Spain, all had exceeded the 3% budget rule that was set in the Stability and Growth Pact for different reasons. At the same time, most of these countries did not run a reform programme such as that of Germany, which was based on regaining economic growth through labour market reforms. Spending was kept relatively high in times of low economic growth, with the belief that it would turn out for the better in times of high economic growth. Like in Germany, money earned from privatization was used to improve budgets.

The United Kingdom, as a non-Eurozone member that was not limited by the 3% rule, had for a long time a higher budget deficit as it increased its spending on tax credits and education by keeping taxes low, while Denmark, also a non-Eurozone member, had a budget surplus due to high taxes.

Due to the financial crisis and the bailout policy for European banks, the budget deficits rose in nearly all European countries above the 3% threshold. To reduce this deficit again to under 3% was one of the main reasons for the recovery policies in the Eurozone, which were based on lowering the production costs to boost exports and economic growth, while governments reduced their public spending. And, as such, it should be mentioned that countries need more time during recession to decrease their deficit while increasing economic growth.