The Stability and Growth Pact was agreed between the then political leaders of the EU Member States at the Summit Meeting held in Dublin in December 1996. The Pact constrained the extent to which any country joining the euro could stimulate its economy and augment public expenditure by limiting its borrowing to not more than 3% of its national income in any year. All the economies concerned were also obliged to reduce their total government debt to no more than 60% of the same figure. If any country's borrowing exceeded 3% it was to be subject to draconian penalties in the form of massive fines to be paid to the EU Commission The exemptions were kept to a minimum to ensure that a highly disciplined financial framework was established, within which all euro-zone countries would have to operate for the foreseeable future. Precluding demand management in this way, however, has locked the euro economies into a permanent state of deflation.
Pressure from Germany was the main reason why the Stability and Growth Pact was agreed. For three decades after World War II the German economy had provided an envied model of low inflation, full employment and high growth. This was achieved with prudent financing, in sharp contrast to the record in other potential members of the Single Currency, such as Italy, which had long established traditions of governmental profligacy. The Germans were thus determined to ensure that the euro-zone fiscal and monetary policies would replicate those which for many years had been implemented by the Bundesbank, the German Central Bank on which, in many important respects, the European Central Bank was to be modelled.
It was apparent, however, from the beginning that the strictures which the Stability and Growth Pact entailed had huge dangers for the future of all participating countries. This was the inevitable result of the heavily restrictive and deflationary bias built into them. All modern economies suffer from fluctuations in growth and unemployment. When there is a downturn, it makes sense to increase public borrowing and expenditure to make up for the lack of spending in the private sector. Similarly, if an economy is over-heating, it is then time to tighten monetary policy, to raise taxes and to make sure that public expenditure is not overextending the resources available. The result, in terms of whether the public finances are overall in surplus or deficit, can involve big swings, typically, as a ratio of national income, of up to 5% or so either way and sometimes even more. The problem about limiting borrowing to only 3% is that this may be much too little to deal with circumstances which have arisen. As a result the fiscal stimulus needed to pull economies suffering downturns out of recession is hobbled. If, at the same time, the European Central Bank is unwilling to use monetary policy - increasing the money supply - as an alternative form of reviving spending, the outcome is all too likely to be a spiral downwards with stagnant growth, rising unemployment and increased public expenditure cuts.
Unfortunately, this is exactly what has happened in practice. Paradoxically, the problems are particularly acute in Germany, which almost everyone now agrees joined the euro at too high an exchange rate. Although Germany still enjoys a healthy export surplus there is still nothing like enough demand to keep the economy at full stretch. The result has been that the growth rate has been dismally low - only 0.2% in 2002 and projected to be little higher in 2003.. At the same time registered unemployment in Germany alone has grown to 4.7m while the actual number of people not registered who would like to work if reasonable jobs were available adds at least another 50% to the total. Since Germany is also most of the rest of the euro-zone's main customer, depressed conditions there then affect all the other countries tied to its economy. This is why the growth rate across the whole of the euro-zone is so poor - only 0.8% in 2002 - and why the total level of registered unemployment is so high - 8.8% in France and 12.0% in Spain, for example, and 8.4% for the euro-zone as a whole, a total of almost 12m people. Again, at least 50% needs to be added to this figure to get a realistic total estimate of the waste of human resources involved in such tragic circumstances. Furthermore, in depressed conditions like these, investment has faltered, eating the seed corn for the future, while the requirement to contain borrowing within the 3% total has led to painful and divisive cuts in public expenditure, all of which in turn worsens the economic outlook and makes public borrowing constraints more irrational
In the light of the catastrophic effects which the Stability and Growth Pact has achieved, is there any reasonable chance that it will be abandoned, or at least significantly watered down? That there is an overwhelming case for doing so is well established. Even Romano Prodi, the President of the Commission referred to the Pact as being "stupid". Unfortunately, however, despite the urgent need for reform, there is every prospect that it will be very difficult to achieve. Perhaps the largest single bulwark against this occurring is the powerful European Central Bank, almost entirely insulated from democratic pressures and obsessed with the requirement it is charged to fulfil of keeping the euro-zone inflation rate down to an unrealistically low 2% or less. Despite Mr Prodi's remarks on the Pact, there is little sign that the Commission is minded to take the necessary action to get changes made. Furthermore, there is great resentment among some of the smaller EU countries, particularly Portugal, which was forced to make such serious cuts in public spending that, for example, its navy ran out of fuel. They cannot see why the Pact rules should now be relaxed to let Germany and France - both having serious difficulties staying within the 3% borrowing limit - off the hook. The outlook for significant change, at least as far as we can see ahead, is therefore poor.
If there are no major reforms to the way that the Stability and Growth Pact operates, however, the outlook for the euro-zone is remarkably gloomy. Many of Western Europe's countries already suffer from severe structural economic problems, particularly to do with their aging and declining populations. The vitality which was so evident in the early decades after World War II has drained away. The changes which need to be made to adapt to the twenty-first century are much more difficult to accomplish against a background of high unemployment, low growth and lack of public spending. Against this background, rules which stop governments taking the actions which decades of experience show are those which need to be undertaken to offset declining economic activity and the onset of recession, make absolutely no sense at all. If the sorts of policies required to provide the necessary stimulus are not taken, however, there is every prospect that the present trends will continue. Growth will stagnate. As night then follows day, unemployment will become even more of a problem, the need for public expenditure to help those who cannot help themselves will rise, and the fiscal balance, far from improving, will get worse and more unmanageable.
As these problems worsen, it is not difficult to predict what the consequences will be. There will be calls for further centralisation. We will be told that the only way of overcoming the inability of the EU to counteract the impact of recessions in some countries is for there to be larger powers of redistribution between them. This will only be achievable by transferring taxing and spending from the nation states to Brussels. The EU is likely to become more inward looking and less willing to help the developing world by offering it trading opportunities. There will be more pressure for tax harmonisation. Instead of getting the EU economies to operate to maximum effectiveness, by creating the right overall monetary and fiscal environment to enable them to grow and develop naturally, there will be greater and greater attempts to manage them by bureaucratic intervention. Far from policies like the Stability and Growth Pact being abandoned, there is a real danger that they will be supplemented by further ill-judged attempts to lay down unworkable rules. This is not what the British people want - nor those in the rest of the EU for that matter.
Faced with these developments within the euro-zone, it is becoming clearer and clearer that we are better off outside the Single Currency. The opinion polls show that increasing numbers of the British public realise that this is the case. The euro has not produced the renaissance in economic performance in the euro-zone which its advocates promised. On the contrary, the performance of the constituent economies has been dismal. The EU is not a natural single currency area but, to the unnatural creation of the euro-zone, rules have been added, exemplified by the Stability and Growth Pact, which are almost totally counterproductive. The result has been the sad mixture of poor economic performance and political alienation which is all too evident across all the countries which are in the Single Currency. We - and the other countries, Sweden and Denmark, which have stayed out of the euro, all of which are doing better than those in the euro-zone - need to make sure that we resist the blandishments of the EU political classes and that we stay out. If the Single Currency countries decide to adopt policies which will ensure that their economies stagnate for the foreseeable future, we are not obliged to follow them. We should have the courage and the clear-sightedness to retain our economic independence and to recover our ability to run our own affairs. It would be far better to do this than to succumb to the EU's misguided policies, designed to make the flawed Single Currency work, but which in practice make the impact of the euro even more damaging than it would be anyway.
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