Political leaders across Europe have begun to push back against the campaign of Chancellor Angela Merkel of Germany to put the Continent’s economies into a straitjacket of unrelenting fiscal austerity. It is about time. Two years of insisting that weak economies carry out tax increases and spending cuts have brought nothing but recession and deepening indebtedness.
The German-inspired fiscal compact that 25 heads of government agreed to in December will become binding in January provided at least 12 of the 17 countries using the euro ratify it this year. That process has barely begun. Before it goes any further, euro-zone members need to amend its inflexible, one-size-fits-all deficit ceilings. Failure to do so guarantees a longer, deeper European recession and would likely hurt America’s nascent recovery.
In its present form, the fiscal compact requires all 17 euro-zone countries to bring their deficits down to between 0.5 percent and 1 percent of gross domestic product within a year of ratification or face fines and other penalties. Interim targets have already been set by European Union officials. Meeting those targets would require growth-killing new spending cuts and tax increases in some of Europe’s weakest economies, like Spain, perversely pushing them even deeper into debt.
That is one big reason so many European leaders have now begun to resist the austerity-above-all approach. In Spain, calls for a more lenient 2012 target came from the new center-right government. In France, Germany, Italy and the Netherlands, they come from center-left opposition parties. This shift is less about ideology than about the message European voters across the political spectrum are now sending their leaders: They are fed up with austerity policies that have not worked. And they do not want their governments to renounce all fiscal tools for fighting recessions.
At Madrid’s urging, European finance ministers last week agreed to raise Spain’s deficit target for 2012 to 5.3 percent of domestic product from 4.4 percent. Spain is not the only country that needs relief. Ireland still hopes to meet its 2012 interim target of 8.6 percent but wants help reducing interest costs on the money it borrowed to bail out its banks. Even the Netherlands, long allied with Mrs. Merkel’s austerity demands, now finds itself hard pressed to meet next year’s 3 percent deficit requirement.
Treating each country as a special case would render the fiscal pact meaningless, reigniting the market speculation it was meant to calm. The right answer is a more flexible agreement, allowing all signatories to exceed deficit targets in periods of abnormally slow growth, provided they agree to market reforms and take steps to bring their long-term deficits under control.
Temporary easing of the targets need not lead to permanently larger deficits. If flexibility is linked to structural reforms like more open labor markets, lower pension costs and a more rational tax code, it can bring back the sustained growth needed for long-term balanced budgets. For center-left parties, it is politically easy to call flexible deficit targets. They could enlist broader political support for such flexibility if they also strongly embraced the more difficult labor market, pension and tax reforms.
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