Is it prudent to do something stupid just because you promised you would? What if the stupid act was something that you committed to as part of a group and others in the group have already kept their commitment?
This is the dilemma the European Union faces as France and Germany bust commitments they made in adopting the euro.
Internal dynamics of the E.U. may seem of little importance to Minnesotans, but the success or failure of that historic experiment will affect us in the long run. In the shorter term, the issue of requiring balanced budgets regardless of the business cycle is important for Minnesota and the United States.
Start with some history. In 1991, the European Union — then 12 nations — agreed to move toward a common currency at the Maastricht conference in the Netherlands. The agreement included a commitment to draw up economic criteria that countries would have to meet before they could participate in the new common currency.
The criteria included standards for exchange rate stability, interest rate stability, low inflation, moderate national debt relative to gross domestic product and annual budget deficits not exceeding 3 percent of GDP. Any country that failed to meet these convergence criteria would be barred from participating in the European Union.
The agreement on prudent economic management was instituted to satisfy the “northern” countries of Germany, the Netherlands, Denmark and Belgium, which feared that the habitually chaotic public finances of the Mediterranean countries — Italy, Spain, Portugal and Greece — would somehow throw a monkey wrench into the new currency system unless curbed beforehand.
The criteria reassured inflation-phobic Germans that Italian fiscal profligacy would not taint the value of the currency that would supplant the deutsch mark.
When the 1998 deadlines for meeting the criteria rolled around, it was Germany whose public finances — sapped by lavish expenditures on reunification — that squeaked by only by resorting to a number of accounting fudges that might have been designed by Enron executives.
More problematically, Germany and France are now conspicuously failing to meet the 3 percent deficit limit for the second and third consecutive years. The pact that all participating countries agreed to stipulates warnings followed by severe fines to be paid into E.U. coffers when the limits are breached. Smaller countries such as Portugal were censured for breaking the limit in the past, and several others, notably the Netherlands, implemented harsh and politically unpopular belt-tightening to meet the criteria.
These smaller nations are now outraged by the blasé manner in which their larger partners have blown through the deficit limit and by the overt threats France is making against countries that call for imposition of the stipulated fines for noncompliance.
France and Germany contend that it does not make sense for nations to cut spending and increase taxes when they are in recession. Most economists, including people like me who are very skeptical of vulgar Keynesianism, agree. Even if you reject the Keynesian idea that governments can and should ward off recessions by manipulating taxing and spending, it does not make sense to step on the fiscal brakes when an economy is in the doldrums.
Some officials in the angry smaller countries tacitly agree, but basically take the position that “a deal is a deal.” They assert that establishing a precedent that small countries have to obey the rules while large ones may ignore them will deal a mortal blow to the tenuous compromises underlying the whole E.U. Small countries won’t agree to further integration measures if big countries are above the law.
From this side of the Atlantic it is hard to say which argument is more important. A budget rule that forces fiscal tightening in recessions is a bad one and should be junked or replaced with one requiring some sort of balanced budget over a longer time span. And different rules for weak and powerful member states will be destructive in the long term.
The crisis could be defused if France and Germany would be apologetic and offer some compensation to those smaller countries that already underwent pain to comply with the limits.
There are lessons for our own country. Rigid rules that require balanced state budgets in recessions have a cost. Like the E.U., Minnesota would be better off if it devised some method of balancing its budget over the entire business cycle rather than in each fiscal year. That is hard to do without building in a bias toward perennial deficit spending. But it is important enough to merit more attention than we are giving it.
There also are lessons for the national Democratic Party. Several party candidates in the 2000, 2002 and 2004 elections either took or are taking the position that we should run budget surpluses every fiscal year, come what may. This is just as stupid as the Republican position that deficits don’t matter as long as taxes on the wealthy are reduced. Knee-jerk championing of the reverse of whatever your opponent supports makes for bad policy and should make for bad politics.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.