02 May 2012

Charles Wyplosz: The coming revolt against austerity

This column suggests governments shouldn't mix long-term growth and fiscal discipline nor produce another Lisbon strategy. Instead, they should adopt a framework for fiscal policy cooperation, restructure debts, and remember that fiscal discipline is for the long run.

What is to be done? The way out has to be based on five principles.

Principle 1: Don’t mix long-term growth and fiscal discipline

There is zero empirical evidence to support the view that fiscal discipline hurts long-term growth.

• The only evidence, which is not robust, is that very high debt levels stunt growth.
• A reasonable policy conclusion is that fiscal discipline and long-term growth are independent objectives.

The adoption of a Fiscal Compact – however clumsy in its current formulation – represents a major conceptual change. The Stability and Growth Pact failed over and again because it rested on the misleading view that sovereign governments can be forced by the threat of sanctions to alter their fiscal policies. The breakthrough achieved by the new pact is to decentralise back to the national level, where authority lies, the implementation of workable fiscal rules.

The Compact badly needs to be refined – it should require that national rules be effective and implemented. But the Compact is far too important to be jeopardised with a “growth clause” – a loophole that could undermine any gains. We have seen how governments summarily ditched the no-bailout clause, so we cannot allow a loophole to sneak in the new Treaty.

The Compact is about fiscal discipline, period. Growth is another important, but separate issue.

Principle 2: Don’t produce another Lisbon Strategy

Calls for growth are now being morphed into proposals to adopt supply-side policies. Such policies are badly needed everywhere. The defining characteristic of much of the EU is the existence of myriad anti-competition arrangements that cater to special interests and stifle growth. Yet, this cannot be a collective undertaking... Adding a new layer of requirements will create only a few jobs in national and European bureaucracies. More importantly, by pretending that they are doing something useful, once again our leaders will be able to avoid hard decisions.

Principle 3: We need a framework for fiscal policy cooperation

Fiscal policy is a matter of national sovereignty. The only efforts at reducing national sovereignty have focused on discipline and the result, the Stability and Growth Pact, has been a failure. There has been zero effort at coordination.

• The aggregate fiscal policy stance of the eurozone is the invisible hand of national preferences.
• With externalities aplenty and no market mechanism, the outcome has to be suboptimal. Most of the time, it does not matter. This time, it does. It was not by chance that the second G20 Summit called upon nations to adopt expansionary policies in countries that have enough room thanks to solid debt credibility.
• What is true in the world is even truer in the eurozone. Such an assignment of tasks is not even a topic for discussion.
• The Six Pack agreement does not shy from attempts at deep intrusion into national policy issues but it is terribly asymmetric. There is no hint that countries could expand to make up for demand shortfalls elsewhere. Yet, it has always been known that a critical shortcoming of the monetary union is that we do not have a federal budget that can carry out counter-cyclical policies. This has prompted calls for the creation of a fiscal union, but we must admit that such a step is not reachable for a long time, a matter of one generation or two.

The Fiscal Compact allows for national countercyclical policies, but an increasing number of countries have lost market access. One possibility is for countries with continuing market access to quickly use this possibility to adopt expansionary policies. Another possibility is to tap the EFSF-ESM to provide resources to countries in recession to expand, while these funds are currently used to force countries to contract. This does not require any treaty, only common sense.

Principle 4: Restructure debts

Market access is closing down on an ever-increasing number of countries because of expectations that their debts will be restructured. From the start, the notion of debt restructuring has been seen as foreign to Europe and yet it has started to happen, and it will happen again but too little and too late.

• Instead of allowing the noose to tighten until a country suffocates, policymakers should run ahead of the curve and ratify the markets’ judgement.
• Instead of paying juicy interest rates, governments should tax the markets rather than choking their citizens.
• Instead of fearing contagion, we should preventively restructure debts in countries that will never be able to resume growth under their existing (Greece, Portugal, Italy) or predictable (Spain, France, quite possibly Germany) burdens.

This assessment is based on the need to recapitalise banks that hold large amount of soon-toxic public debts.

Principle 5: Fiscal discipline is for the long run

A large number of public debts are above or close to 90-100 per cent of GDP. Unless they are restructured in a way that sharply reduces their values, primary surpluses will be needed to bring debts down to more comfortable levels, clearly below 60 per cent. This will take decades, not years.

• The current emphasis on achieving some nominal deficit targets in 2013 and 2014 may have some legal or symbolic justification.
• From an economic viewpoint, it is simplistic nonsense.

One virtue of the Fiscal Compact is that it shifts the emphasis to cyclically-adjusted budget balances. One weakness is that it reasserts the Stability and Growth Pact’s obsession with annual outcomes and objectives.

Official comments that the model should be the Swiss-German debt-brake arrangement are encouraging. This arrangement allows for quite some short-run flexibility (thanks to a “control account” where overruns can be temporarily parked). All that remains to be done is to ditch the infamous Stability and Growth Pact and insist that the debt-brake arrangement be the model in countries that have not yet adopted solutions that have proved their mettle in achieving fiscal discipline.

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