Rhein on Energy and Climate

For the first time in its 50 year history the majority of EU member states is confronted with the risk of an unsustainable debt burden. Most member states have the “constitutional debt limits” imposed by the Maastricht treaty almost 20 years ago, according to which member states must restrain their annual budget deficits to a maximum of 3 percent and their public debt to less than 60 percent of their GDP.

No member state has been able to balance the budget let alone realise substantial budget surpluses during the 1990s and 2000s, when their economies were expanding at more than 2 percent in certain years.

With the onset of the global financial/economic crisis in 200, policy makers stopped focusing on fiscal discipline, for evident reasons. Saving financial institutions from bankruptcy, preventing social unrest and stimulating demand became the overriding priorities. Exorbitant deficits were the price that everybody, including the most conservative policy makers, accepted.

But having passed through the bottom of the deep recession, though not of unemployment, the time has come to reflect on how to put public finances back to order and prevent them from long-term derailing.

Here are two prescriptions for the appropriate “exit strategies” in the coming 10 years.

  • Starting in 2010-11 budget deficits have to be reined in to no more than the 3 percent authorised under the Treaty. The EU Commission must resume its role as a vigilant watchdog of strict budget discipline. That should become once again a top priority.
  • In parallel, public debt should be lowered to no more than 60 percent of GDP, but that will take longer. Due to the huge deficits in 2009-10 public debt has skyrocketed in all member states, often exceeding 80 percent of GDP. Public debt of that order constitutes a threat to sound budget management. Interest payments absorb unacceptably high amounts of public spending. In Germany with a relatively low debt ratio debt service payments exceed federal budget expenditures for defence, research and education!
  • To reduce the debt/GD ratio, all member states must commit to the objective of balanced budgets by 2020.

If they fail catastrophic scenarios loom at the horizon, due to the rapid deterioration of the age pyramid. In a report published October 14, the Commission has established long-term scenarios for the EU and all 27 member states. In a business as usual hypothesis total public debt of all EU member states would reach the staggering and absolutely unsustainable figure of 480 percent of GDP in 2060!

Finance ministers should be grateful to the Commission for having undertaken this exercise. Scenarios serve as an alarm bell to policy makers, whose job it is either to help them happening or to prevent them from happening.

The medicine that policy makers will have to apply in the coming decade will not be tasty. European countries must learn to get along with very low growth rates, say 1 percent annually in the West and 3-4 percent in the East. Considering stagnant population growth these figures represent a modest per capita growth, not bad for a region that that enjoys the highest prosperity on earth. It is time for European citizens to become aware of the harsh times ahead and stop living beyond their means.

Read also: Containing population growth must become a global priority

Governments will have to focus their expenditures the on the essentials for future welfare: investments in education, research and health, and to refuse any subsidies to particular interest groups.

Budget policy will occupy the centre stage for all European governments in the coming decade. It will require a delicate balancing act combining courage and craftsmanship, and more guidance than ever before from the European Commission.

Brussels 18.10.09 Eberhard Rhein

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