Is the Stability and Growth Pact (SGP) of the European Union in reality a “Stagnation and Gloom Pact”?

Does the current, strict Stability and Growth Pact of the EU, with its dogmatic rules for government deficits and government debt and its obvious non-flexibility, lead to a disillusioned and lethargic European population and to years and years of far below average growth, political tensions and consumption staying away? I think it does and so do other economists!

During the last two weeks, I enjoyed a well-deserved holiday in Italy (Veneto region) and Croatia (Dalmacija).

Especially in the latter country, I was confronted once more with the powerful influence of the European Union on this war-struck, formerly Yugoslavian state.

The pristine, brand new highways led to numerous centuries old, but nevertheless dynamic cities and villages. On top of that, the whole country – at least the parts that I saw from it – displayed an impetus of new hope and mounting self-confidence, which I did not expect yet after the devastating ‘civil’ war in the nineties – less than twenty years ago: "we might not be there yet, but we try darn hard to be". 

Of course, one could argue that the direct influence of the EU on this ‘new Croatian self-esteem’ is questionable. Nevertheless, I have little doubt that the imminent membership of the EU worked for this country as a juicy carrot for a hungry and tired horse. And, in my humble opinion, it will continue to do so, when Croatia will take part in the Schengen treaty and – perhaps – the Euro-zone in the near future. 

More than an economic free-trade zone, the European Union is 'a beacon of hope' for countries in need: hope for a better future and more prosperity for people and their children. 

The obvious Croatian success story – from a battlestruck country in dispair in the nineties to a relatively successful and confident nation in the tens – makes it even more pitiful that the EU itself seems under a strong and enduring spell of bookkeepers and hagglers. 

Especially fired up by the eternal German fear for hyperinflation, emerging from the interbellum during the last century, and their worshipping of a balanced budget, these bookkeepers and hagglers feel pressured to fiercely cut the governmental expenditure of the EU member states, in order to reach the utopian situation described in their Holy Grail, aka the SGP: a balanced budget and a state debt of less than 60% of national GDP. 

After the national budgets within the EU will be balanced and government debts will be minimized ‘a new dawn of growth and prosperity will come over the EU. Lean and mean national governments can tap new investments and consequently spur economic growth’, they say. 

This strategy is widely advertized as “Trimming to enable growing” (i.e. ‘Snoeien om te Groeien’) as the Dutch so colourfully call this. Consequently, the whole European economy is economized into oblivion.

Of course – to further dig out this particular anology with agriculture – a gentle and well-executed trim session can strongly increase the yields of fruit trees. 

Spillage, bad investments in unnecessary infrastructure, useless subsidies and other forms of counterproductive government aid, excess bureaucracy and an oversized government apparatus are like overgrown, lifeless branches in a poorly yielding fruit tree: rather disablers than enablers for growth as they suck up the energy, that should be used for growing the desired fruit. It is good when these branches are trimmed from the tree. 

Yet, I can’t help but wondering, if I ever saw a Bonsai tree bearing fruit?! 

In other words: sometimes a tree must be helped to grow higher and stronger: with fertilizer, water and sunshine, instead of the trimming shears alone.

In this time, in which people, companies and (even) many small and large financial institutions all have their own difficulties in trying to make ends meet today and in the future, extremely frugal governments can be the final blow to the national (and even pan-European) economies.

The European governments had to spend so much money upon saving their financial system in recent years, that the ‘excess’ austerity – forced upon them by the SGP – now leads to government measures that really hurt the countries of the European Union.

In The Netherlands for instance, important subjects like the national defence apparatus (“apparently not something from a bleak past anymore”), development aid or the income development of civil servants and educational workers all have been widely neglected by the ‘spending-unhappy’, frugal Dutch government. And so have social housing, education in general, child care, elderly care and health care for the aging population.

The money, saved with these austerity measures, has been used instead to:

• uphold most of the current Mortgage Interest Deductability for many more years to come, even though this is a market-disturbing, “bubblicious” and overly expensive way of subsidizing owner-occupied houses;
  
• to save banks and other financial institutions;
  
• to further stimulate already successful industries and companies through the Dutch “Top Sector Policy”;
  
• to pay export subsidies to companies and institutions, making Dutch exports of agricultural produce and products even cheaper and (perhaps) more market disturbing than they already are at the moment;
  
• to maintain a partially doomed and oversized industry, like the Building and Construction industry, through the deployment of (often unnecessary) infrastructural and commercial projects. 

Too often necessary long term investments have been lagging to short term gains and political clientelism to powerful industries and institutions. As it are not the most necessary, useful or promising sectors and industries in the long run that get the most government money, but the sectors and industries with the best lobby efforts and the best network. I dare to state that this is not a typical Dutch phenomena, but a widespread practice in Europe and (far) beyond. For that matter, this particular phenomena is (of course) not caused by additional austerity as a consequence of the strict demands in the SGP. 

Nevertheless, the negative side-effects from it get reinforced, as too often the money for less "sexy", but yet very necessary long-term, societal investments is simply “gone” or “not available”, due to the impossibility to invest extra money at the expense of the national deficit and debt. And so the SGP is not anymore a Stabilitity and Growth Pact for the European Union, but rather turning into a Stagnation and Gloom Pact.

One look at the current statistics overview of Eurostat proves my point: some statistics are better and others are worse, but virtually no statistics give the impression that the crisis in the European Union is really over and the continent has definitely entered the path to sustainable growth again, in spite of the fact that the crisis enters its seventh year in Europe.

Overview of current Eurostat statistics with a mixture of
slightly positive and quite negative statistics
Picture courtesy of Eurostat
Click to enlarge

The Dutch and European consumers, who should lead the way to this sustainable growth, are still too much shell-shocked from the very high unemployment ratings (11.5% in the Euro-zone), their diminished purchasing power – as a consequence of austerity measures, tax-increases and wage restraint – and general feelings of lethargy and pessimism, in combination with their increasing need to save for a rainy day in the future.

This would be the very moment that a broad package of European government stimulus, aimed at useful, longterm goals could help the European citizens to pass the thresshold from pessimism and lethargy into moderate optimism and confidence about the future.

Such useful goals would be:

• Improved child education for both above and below average children;
• Applied vocational education for less studious, but manually gifted youngsters;
• Fundamental scientific research;
• True corporate innovation and R&D;
• Necessary(!) infrastructure for both road traffic, water and rail transport as well as digital purposes: no bridges to nowhere, but real improvement;
• EU government aid to challenged European (or Euro-zone) countries (i.e. a Marshall plan);
• Improved child care and elderly care; 
• Decreases of (in)direct taxes and costs of labour 

But it doesn’t happen… as the SGP rejects the possibility of sustained higher government debt for a extended period of time.

And so this balance recession, with its ubiquitous austerity among all parties involved – private citizens, companies, financial institutions AND the governments – lingers on, as no party is able to break the devastating spell.

One of the best articles upon this subject and a very original and elucidating view on the current dynamics in the European and world economy came – once again – from Robin Fransman: former chairman of the Holland Financial Center (an intermediary institution for the Dutch banking industry) and one of my favorite Twitter economists (@RF_HFC), with a vision that I often share.

The article called “The slow suicide of Europe” (the article is unfortunately in Dutch, but can be translated by Google Translate)  is an absolute must-read. I will print the main conclusions here, but strongly urge you to read the whole article:

The private sector must and also wants to be in a surplus situation and we cannot avert this very surplus abroad. Who is the only party left? Right, only the government is able to meet the demand for savings of the private citizens. 

The SGP, however, forces the private sector to a zero sum savings’  balance, or forces ‘abroad’ to a negative savings’ balance.

This is an unsustainable situation, which leads to political tensions, currency wars and protectionism, or to depreciations of those same foreign investments. This is also no sustainable solution. 

State debt is not just the result of squandering politicians without backbone; state debt is rather the result of the totally justifiable desire of the private sector to prepare ‘for a rainy day’.  

The SGP should be revised, consequently. First, the structural deficit should be equal to the structural nominal growth, say 1% of productivity growth and 1% inflation. Hence, the debt quote remains equal through the years. The maximum debt quote, now at 60%, should and could go up, when it is used for genuine investments. And we should look at state debt and budget deficit in the broader constellation of private wealth, private debt and the trade balance.

Robin’s articles are not exactly ‘for dummies’ and can be quite hard to understand for non-educated ‘economy fans’.

Nevertheless, I think he nailed the subject here, as he lays a theoretical foundation with respect to the current dynamics on the financial markets and the European economies, which makes the current economic conundrum easier to understand. 

I can only conclude with the hope that the European Union sees that the current SGP is a ‘dead end road’, which should be altered soon in order to preserve our and our children’s wealth for the future. And that a slightly increasing state debt is not bad, when the money is invested wisely and cautiously.