TCS Daily

This Medieval Rule

By Hans H.J. Labohm - November 29, 2002 12:00 AM

In the face of the current economic malaise Europe's stability pact loses friends. Rising public deficits are tempting Europe's Finance Ministers to loosen its public deficit ceiling (3% of GDP). Romano Prodi, the President of the European Commission, recently stated: 'I know very well that the stability pact is stupid, like all decisions that are rigid.' He was quickly seconded by the EU Trade Commissioner, Pascal Lamy, who described the pact's limit as 'this medieval rule'.

Well ... is it really? Logically speaking, Prodi's statement could be turned around. Then it could be formulated as follows: 'I know very well that abandonment of the stability pact is sagacious, like all decisions that are lax.' In some parts of Europe, this is indeed what people use to believe and/or practice. In other parts, however, it is considered to be a deadly sin.

John Maynard Keynes once observed: 'Practical men, who believe themselves quite exempt from any intellectual influences, are usually the slaves of some defunct economist (...)' It has to be feared that Mr Prodi is no exception to this rule, and that, in this particular case, the defunct economist in question is Mr Keynes himself. This is most unfortunate because Keynesian policies have been given a fair chance to prove what they are worth. And the results have been dismal.

For many decades already, their legacy of public debts is hanging like an albatross around our necks. After the demise of the Keynesian paradigm, at the end of the seventies, governments adopted a new economic policy consensus, including zero budget deficits (preferably surpluses), strict monetary policies, and structural reform (in line with supply-side economics) in order to improve the functioning of markets. This policy consensus has been confirmed and reconfirmed at numerous meetings of international organisations, like those of the G7/8, the IMF and the OECD, as well as those of the European Union. But in many countries, policy actions have been glaringly lagging behind the rhetoric.

The old ingrained Keynesian reflexes are popping up time and again. And there are always plenty of economists who are only too happy to oblige their political masters to present arguments to support such policies. Of course, they argue, one should abide to the rules of the new policy consensus in principle, but - how unfortunate - the specific circumstances of the moment really justify a - temporary, of course - deviation from the rules. Often this is couched in the language of 'automatic stabilisers', which should be allowed to work. Given their size and almost decades-long uninterrupted application, these have, however, long since degenerated into automatic destabilisers.

Some fear that loosening the 3% ceiling may reignite inflation and/or weaken the euro. The pro-loosening lobby is playing these fears down, probably rightly so. However, other, more serious risks, are ignored by them. The most important one being the public debt running out of control. If they cannot control their budgets now, countries will face ever worse problems in the future.

The 3% ceiling and the stability pact have provided the European ministers of finance a fair measure of control over their national budgets. In accordance with the adage, 'if we don't hang together, we will all hang separately', they have achieved this by cooperation, whereas they would have lost the battle by acting in isolation. The ceiling has, so far, been the most effective bulwark against sectional interests ripping public means. This all is put at risk now.

Moreover, tinkering with the 3% deficit ceiling will send a clear signal to the markets that Europe is not serious about putting its own house in order. It seems also to show that that many economic policy makers still nurture the mistaken faith in macroeconomic demand boosting as opposed to structural reform. It would be too far-fetched to allege that loosening the 3% ceiling is tantamount to an active Keynesian approach, but it surely is Keynesianism by default.

At the same time it will reveal the hollowness of the high-spirited rhetoric of the Lisbon Summit (March 2000), where the EU solemnly declared that it aimed at becoming the most competitive and dynamic, knowledge-based economy in the world in ten years time, capable of sustainable economic growth with more and better jobs and greater social cohesion.

George Santayana once said: 'He who forgets history is doomed to repeat its mistakes.' With their statements Mr Prodi and Mr Lamy clearly show that they have learned nothing from recent economic history. If Europe would return to budgetary laxity, it risks to call down the same Eurostasis upon itself as it has experienced in the dismal seventies. Public debts will rise again, and subsequent generations will have to foot the bill. But, contrary to the seventies, there will be ever fewer taxpayers to carry that burden because of the aging of the population. Higher taxes will undermine incentives throughout the economy and suffocate growth. A vicious circle sets in, which will lead to sky-rocketing public debt and ultimately economic implosion. In short, Europe will finally succeed in emulating the 'Japanese model'.

At the recent summit of Johannesburg, Europe showed itself an ardent advocate of the philosophy underlying sustainable development: 'Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.' But of course, Johannesburg was not about such mundane issues as public debt.

Hans H.J. Labohm is senior visiting fellow at the Netherlands Institute of International Relations 'Clingendael'.

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